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State Farm Mutual Automobile Insurance Co. saw its net income drop nearly 60 percent in 2000, attributing the drastic plunge to a larger-than-expected number of losses, auto insurance rate reductions in several states, and expenses involved in starting up new operations.

The Bloomington, Ill., insurer reported net income of $408.1 million in 2000, down $626 million from $1.03 billion in 1999. State Farm's total net worth decreased by $2.1 billion last year, going from $45.8 billion to $43.7 billion.

Dick Luedke, a spokesperson for State Farm, attributed the plunge to a variety of factors. He says that while the United States didn't suffer any major catastrophes in 2000, catastrophe losses were up 15 percent — from $1.43 billion in 1999 to $1.64 billion in 2000 — due to "mid-level catastrophes" that did not receive much publicity, but caused millions of dollars in damage nonetheless. Luedke noted there was a hailstorm in the Midwest in May that caused $208 million in damage, placing it ninth on State Farm's all time list of losses. "We really didn't anticipate the severity of the claims that occurred," he says.

Luedke also says that claim costs were rising, particularly in medical costs and replacement auto parts. After being slapped with a $456 million judgment in the fall of 1999 for breaching its contract with policyholders over the use of non-Original Equipment Manufacturer (OEM) parts, State Farm has suspended the use of those parts, which has driven up claim costs.

The insurer had other significant expenses, including the rollout of the State Farm Bank and the introduction of its mutual funds. The insurer also paid a record $1 billion dividend to policyholders, and also took $672 million in state rate decreases across the country.

On a more positive note, Luedke says that State Farm grew its total number of policies in force by 2.5 percent (from 67.5 million in 1999 to 69.2 million in 2000), and 2.3 percent in auto policies (from 37.1 million in 1999 to 37.9 million in 2000).

Luedke says he does not foresee any changes in underwriting guidelines, nor major expense cutting or job losses at State Farm as a result of the poor earnings. He says that while the insurer offered more state rate decreases than increases in 2000, he expects a reverse trend in 2001. "We feel good about the business we're writing," he says. "We're growing with more agents and more policyholders."

Grim forecast ahead

The problems State Farm faced were similar to those faced by other property/casualty insurers last year, according to John Andre, vice president of the property/casualty division at A.M. Best, an insurance ratings and research company. The auto insurance market remains competitive, which means insurers are trying to keep premiums down. However, claim costs are rising, which means auto insurers are being hard pressed to earn strong profits.

Other than the culprits that Luedke described, Andre says that the company's investment returns suffered a blow, particularly in the fourth quarter, when the stock market took a beating. "Their equities got caught up in a lot of paper losses," Andre says.

Charles Titterton, a director in Standard & Poor's insurance group, says that while State Farm plans to take rate increases in a few states this year, it will not raise rates to the point where it feels that it may drive away customers. "State Farm is very concerned with persistency in policyholder renewal and retention and culling good policyholders," he says. "State Farm has been defending its market share. They're willing to incur operating results that are pretty subpar over a fairly extended period of time to defend that position."

Andre says that State Farm's 2000 results should not be particularly worrisome to the insurer because State Farm still has an extremely strong surplus. As a mutual company, State Farm is not under any stockholder pressure, so Andre says he does not expect any drastic changes to cut costs.

Still, Andre says he does not see trends in the auto industry changing for the better, at least in the near future. "It's not going to get any better," he says. "It may stay the same or get worse."