State Farm Case Could Have Wider Impact
An ongoing class-action lawsuit against State Farm Insurance Companies–with plaintiffs seeking to force the insurer to give out billions of dollars of what they describe as "excess surplus" to class-action suit members–could have serious implications for other mutual companies, according to industry participants.
Late last month, State Farm, the nations largest auto and home insurer, filed an appeal to reverse a lower-court ruling on its case, Hill, et al. v. State Farm. In this suit, originally filed in a California state court in 1999, plaintiffs claimed the Bloomington, Ill.-based insurer had amassed surplus beyond a "reasonably and prudently" necessary level. They have been trying to force the insurer to hand over up to $47 billion to a class-action members group, made up of some 50 million present and past State Farm policyholders.
At the center of the dispute is whether policyholders have a say in how much surplus their mutual companies can maintain and whether these policyholders can force companies to hand over surplus they define as "excessive."
"This could have wide-ranging implications for mutual insurers in terms of their decisions to declare dividends or retain earnings," said Patrick Watts, assistant vice president at the Alliance of American Insurers. He added that the Downers Grove, Ill.-based Alliance, along with other insurance trade associations, have recently filed a letter brief asking the California Court of Appeal to take up this case.
"We are pleased to have such support. Even the National Association of Insurance Commissioners is supporting us in this case. The NAIC is troubled with the notion that plaintiffs' lawyers and California courts can attempt to regulate an Illinois insurer and remove important business decisions from the corporation," said Phil Supple, a spokesperson for State Farm.
Mr. Supple also pointed out that his company had given out some $3 billion in dividends in the late 1990s. "Obviously, the basic reason for having surplus is to prepare for unpredictable catastrophes and to serve our customers in all facets. We provide dividends when business conditions permit," he said.
And if State Farm is eventually forced to hand over a substantial amount of its surplus, it could have serious consequences for its bottom line.
"It certainly could impact the company's ratings if it's a material amount," said Karen Davies, vice president at New York-based Moody's Investors Service.
"And given the fact that State Farm had a substantial decline in its surplus since the lawsuit was first filed and had its ratings downgraded, I would just add that this ongoing litigation seems a little poorly timed," she said.
At the year-end 1999, State Farm's surplus level was at $45.8 billion, but it fell to $31.8 billion by the end of 2002, mainly because of operating losses and equity declines.
Moody's downgraded State Farm's financial strength rating to "Aa1″ from "Aaa" on July 24, because of the declining surplus levels, Ms. Davies noted.
"I think, in general, State Farm's size and its high-profile in the marketplace makes the company subject to lawsuits like this one," she added.
Commenting on State Farm's appeal to the California appellate court, Mr. Watts explained that it specifically concerns the trial court's ruling on whether contract or corporation law should be used in the case and whether California or Illinois law should take precedence. The trial court, he explained, had rejected State Farm's motion that the "internal affairs doctrine" of the corporation law, rather than contract law, be applied to this case. The lower court has also refused State Farm's request that this matter be resolved in courts in Illinois, where the company is incorporated.
"State Farm takes the position that plaintiffs are unjustifiably seeking a review of what the company board has done in relation to internal governance matters of the corporation. And because the company is domiciled in Illinois, State Farm says those issues should be resolved using Illinois laws andheard in Illinois courts," he said.
Mr. Watts added, "The decision has now been appealed to the California Court of Appeal, the state's intermediate appellate court." And if the appellate court refuses, the case would then go to trial in the superior court in the Los Angeles County, he said.
Lead lawyers representing plaintiffs declined to comment on the lawsuit, but Mr. Watts observed, "They believe that these are just contract issues that should be resolved under California law." Mr. Watts also added that plaintiffs' attorneys apparently believe California is the most favorable state in which to file this type of suit. "Since there are State Farm customers in every state, they could have picked pretty much any state in which to bring this case," he said.
Mr. Watts also added that, in other words, plaintiffs are claiming this is just an issue of reading the policy and interpreting it, "whereas what's really going on in this case is reviewing the activities of State Farm directors and having the courts rule on the company's internal governance."
And while it's hard to predict the eventual outcome of this litigation, another ratings analyst was doubtful that State Farm would ultimately have to give any of its surplus to plaintiffs.
"I will be very surprised if State Farm is going to be made to disgorge any of its surplus," said Charles Titterton, credit analyst at the New York-based Standard & Poor's Ratings Services. "I know of no case where a mutual company has been ordered by anybody to pay out any of its surplus to its policyholders," he commented.
After experiencing some declines, State Farm "continues to have a lot of surplus, a "triple-A" rating's worth," Mr. Titterton observed. "But if State Farm is told to return excess surplus to policyholders, it will still have to pass muster with regulators also. And from a ratings analyst's perspective, this whole concept of 'excess surplus' is a completely foreign concept," he said.
The ongoing
litigation
seems
poorly timed,
Moodys
analyst notes
Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, August 11, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.
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