State Farm’s Surplus Too Large, Suit Contends

A lawsuit claiming that State Farm retains far too much of its policyholders’ premiums in surplus reserves and asking that it be ordered to distribute $6.9 billion to its customers across the country was filed Monday in Los Angeles Superior Court.

Trial attorney William Shernoff, a former president of the California Trial Lawyers Assn. who frequently appears in court against insurers, cited two previous cases--in 1919 and 1977--in which courts had compelled a regular stock company to pay a dividend to stockholders when it was determined that there was an excessive accumulation of surplus.

State Farm is a mutual company, meaning that it is supposedly a nonprofit association of all of its customers, and not a stock company. But Shernoff said: “We think the principle applies with even more force to a mutual company.”

An attorney for State Farm at its Bloomington, Ill., headquarters had not studied the lawsuit and declined to comment, but pointed out that State Farm had recently rebutted suggestions it was holding too large a surplus in California. The company suggested that distributing surplus funds would only mean higher insurance prices later.

All insurance companies hold some funds in surplus against the eventuality of claims. But the Shernoff suit says State Farm holds such funds in far higher proportion to the amount of premiums collected than most other companies.

“The industry standard for sound and prudent management is the maintenance of a surplus of about one-third of annual premium (or) a 3-1 premium-to-surplus ratio,” Shernoff’s suit declared Monday. But, it said, State Farm’s ratio in 1988 was 1.23 to 1, meaning that State Farm holds nearly one dollar in surplus for each dollar it collects in premiums. Nineteen other comparable insurers averaged one dollar in surplus to more than two dollars in premiums, an exact ratio of 2.17 to 1.

“The foregoing statistics,” the suit said, “show that State Farm, unlike any other major property and casualty company, is pursuing a bizarre policy of accumulating more and more surplus by refusing to distribute reasonable dividends and by plowing its extra premium and investment income back into the surplus, thus compounding the problem.”

The $6.9-billion distribution the court is requested to order would bring State Farm into conformity with the currently prevailing industry average of a 2.17-1 ratio.

The suit also asked the court to order State Farm to reimburse customers who did not support the insurer’s contributions to last year’s initiative fight. State Farm contributed more than $5 million to the ballot initiative campaign.

In another legal development on insurance Monday, the Assn. of California Insurance Cos., the industry’s major lobby in the state, announced it would not appeal the recent state Supreme Court decision upholding Proposition 103 to the U.S. Supreme Court.

The lobbying group said the six insurance companies which had joined as individual plaintiffs in the case had informed it they also will not appeal.

Association general manager Edward Levy noted that the high court decision in some ways was favorable to the companies even while upholding most of Proposition 103.

“The Supreme Court essentially rewrote Prop. 103 to provide that insurance companies are entitled to ‘fair and reasonable rates,’ instead of having to show a ‘substantial threat of insolvency’ before rolling back their rates,” Levy said.

The statement said the decision not to appeal did not necessarily mean the insurers would not appeal any rate rollbacks that ultimately might be ordered by state Insurance Commissioner Roxani Gillespie.