Mixed Signals.

As competitors raise prices, State Farm's rate cuts could start another price war.

First came the good news. Auto insurance industry analysts cheered Geico Corp.'s recently announced plans to raise its rates in certain states, saying that the move signals that prices in the long-depressed business of personal lines could begin to creep up again. This would lead to better profits as the industry's price war tapers off in favor of profitable underwriting.

"I'm very optimistic about the outlook of the market now that Geico's changed its predatory stance," said Hugh Warns, an equity analyst with Legg Mason. Geico has been among the market's toughest competitors by offering low-cost insurance through its direct-sales program.

Then came the bad news. State Farm Mutual Auto Insurance Co., Bloomington, Ill., has asked for a 12.1% rate decrease for physical-damage coverage in California, and an overall decrease of 5%. "The latest rate action by State Farm must be viewed as a negative for all auto insurers if it reflects a new, more aggressive stance by State Farm," V.J. Dowling Jr. wrote in a research note for Dowling & Partners Securities.

As Low as Possible

A major player such as State Farm, the largest U.S. auto insurer with direct premiums written of $22.4 billion in 1999, can affect the entire auto market as it chases customers, analysts said. "If they really decided to get irrational, they could do some damage," Warns said.

As a mutual insurer, State Farm has more flexibility with rates because it doesn't have to answer to shareholders, said company spokesman Dave Hurst.

"The only person we have to please is the customer or the policyholder," he said. "We want to keep prices as low as possible," while keeping them high enough to pay claims.

Analysts and investors have a reason to watch the yo-yoing of rates in the personal auto insurance business: It is the largest line of property/casualty insurance, representing about 39.6% of sales in 1999, or $118.9 billion of sales. Overall, insurance rates rose by about 1.1% for the 12-month period ending in April, according to Consumer Price Index data. By contrast, auto insurance rates fell by 0.7% for the year ending in April 1999.

Auto insurance rates rose more slowly than auto-repair rates. For the same 12-month period, auto repair and maintenance costs rose 2.9%.

Nudging Rates Back Up

So far, two of State Farm's chief competitors have decided to buck competitive pressures and raise rates. Progressive Corp., ranked fourth, raised rates an average of 7.4% over the last three quarters and won approval for 3% rate hikes during the first quarter. Safeco Corp., ranked 13th, also has planned rate hikes of about 5.1%. Allstate, the No. 2 auto insurer, said it would seek rate increases of about 4% to 5% this year, but it has held out the possibility of decreases by saying it would follow a competitive pricing strategy.

If State Farm keeps the pressure on pricing, Allstate could be forced to maintain low rates. Allstate raised some prices but still "has a bias" toward lowering prices, Warns said. If Allstate is forced to compete one-on-one with State Farm's rates, the battle could "perpetuate pricing competition in this kind of market," Warns said.

Like State Farm, the No. 3ranked Farmers Group has said it plans to continue its effort to gain market share, investment analysts said. Prudential Property & Casualty, which ranks 22nd among auto insurers in 1999 direct premiums written, has lowered rates in at least five states this year, including California and Florida.

The top five insurers controlled 45.9% of the market in 1999.

In the short term, State Farm and Geico might have little effect on rates across the United States. "It's such a big and disparate market in so many different states that nothing happens overnight," said Adam Klauber, an equity analyst with Cochran, Caronia Securities in Chicago. "Over the long term, I see very positive signals. Progressive and Geico have been some of the most aggressive companies out there."

Maintaining Its Share

State Farm likely lowered rates to regain market share it lost in California, Dowling said. Higher claims mixed with such cost-raising issues as State Farm's inability to use aftermarket auto parts shows that "the move was clearly not driven by improving fundamentals," he said.

State Farm's national market share slipped from 20.5% in 1997 to 19.7% in 1998 to 18.9% in 1999, according to A.M. Best Co. data.

State Farm Mutual Auto dropped rates by $965 million during 1999 in 48 states, according to the company's annual report. State Farm's Hurst said the company adjusts rates on a state-by-state basis depending on claims and losses. Though claims experience is the main driver of State Farm's rate-setting process, he added that competition does play a role. "As you know, we're No. 1 in the auto insurance market, and, naturally, we want to retain that position," Hurst said.

Merrill Lynch analyst Jay Cohen said he didn't expect a dramatic turn in personal auto pricing. Geico, while raising rates, said it wouldn't back down on its marketing efforts. It also said it would increase rates only in certain states, and it didn't reveal how high those price hikes would be.

"While the company is taking a tougher stance on rates, it does not appear to be lessening its appetite for growth," Cohen said.

Geico grabbed more market share through 1999 to become the sixth-largest U.S. auto writer with 4.1% of the market. Even while raising rates, Geico said it expected its growth rate of more than 20% to decline modestly.

Underwriting losses have eased some of the pricing competition, Credit Suisse First Boston analyst Charles Gates wrote in a report on the industry. But even with premium increases, underwriting results will continue to fall as existing, under-priced policies expire.

"We believe both the psychology and fundamentals surrounding personal auto insurers are improving," he said.