State Farm: Behind the Veil.

As the No. 1 personal lines insurer continues to lose market share, analysts and observers question its strategy to cut rates.

State Farm Mutual Automobile Insurance Co. had humble beginnings in 1922 as the brainchild of George J. Mecherle, an Illinois farmer turned insurance salesman, who thought he had a better way to sell auto policies to farmers at lower rates. In the 79 years that followed, the company grew from a small operation in the heart of Illinois farm country to the leading auto and homeowners insurer in the United States, with 25 regional offices, more than 79,000 employees and nearly 70 million policies in force.

Warren Buffett--no stranger himself to corporate success sagas--recently called this "one of America's greatest business stories" and urged business schools to study the company, "because it has achieved fabulous success while following a path that in many ways defies the dogma of those institutions."

But lately, some potholes have formed in State Farm Mutual's path. After four strong years, the property/casualty giant reported in 2000 that its net income from all affiliates, including non-insurance affiliates, had plummeted to $408.1 million, down $626 million from 1999. State Farm Mutual's net worth dropped $2.1 billion to $43.7 billion from the year before, after having risen $4 billion in 1999. State Farm Mutual said the main reason for the downturn was a pretax operating loss of $1.9 billion, which included a $3.3 billion underwriting loss. An unrealized loss of $711.5 million reflected operating results of State Farm affiliates as well.

The company tied the underwriting loss in part to increased loss severity, as well as auto rate reductions, which totaled $672 million for the year. In June, State Farm said it plans to stop writing auto insurance in New Jersey because of continuing losses and unique burdens imposed by the state's insurance regulatory system.

Apart from the financials, State Farm had image problems in 2000. The company was appealing an historic court decision that ordered it to pay a $1.05 billion award to its policy-holders for requiring generic parts in auto repairs. That appeal was denied in April 2001, but the company hopes to carry its fight to a higher court. And in June 2000, the television program "Dateline NBC" detailed questionable practices used to deny medical-treatment claims by two medical-review firms that State Farm had employed. The program prompted the National Association of Insurance Commissioners to launch a multistate market-conduct exam of State Farm's auto-injury claims practices. The exam is ongoing.

If State Farm were a publicly traded company and subject to the pressures of edgy investors, its mea culpas might have echoed through the canyons of Wall Street. But as a mutual insurance company, it answers only to its policyholders, who are the owners of the company. Still, some equity analysts who cover State Farm's stock-company Competitors--namely, Allstate, Progressive and Geico--wonder how much longer its managers will pursue their strategy of seeking to buy market share with underwriting losses. Eventually, the analysts warn, even the rating agencies that have applauded State Farm for its super-plush capital base and formidable competitive advantages may start pressing the company to improve its operating performance. Currently, State Farm has the highest ratings from A.M. Best (A++), Standard & Poor's (AAA) and Moody's Investors Service (Aaa).

In recent years, State Farm's strategy has led it to maintain low rates in certain states and reduce rates in others, all with an eye toward winning back market share.

Holding On as No. 1

State Farm, the No. 1 writer of private-passenger auto in the United States, has seen its 21.6% slice of business in 1995 drop to 18.9% in 1999. The other top auto insurers--Allstate and Farmers--also have lost market share over the last three years, while No. 4 Progressive and No. 6 Geico, the latter part of Buffet's Berkshire Hathaway, have doubled the number of policies each has written, according to A.M. Best Co. data. Progressive grew from 2.6% of the market in 1995 to 4.8% in 1999, and Geico moved from 2.5% in 1995 to 4.1% in 1999.

"Competition in the insurance marketplace is fierce, particularly the fight for market share in auto," Vincent J. Trosino, president, vice chairman of the board and chief operating officer, said in the company's 2000 report. "We're not only competing with some of the familiar names like Allstate Farmers and Geico, but also with new ones like Axa Group and Zurich Financial Services--all of which would like to carve away part of the State Farm book of business."

Since 1998, State Farm has instituted $2.7 billion in total auto rate reductions and, since 1997, has given customers $2.6 billion in dividends. The company said that by the end of 2000, State Farm affiliates had gained 1.7 million policies over 1999.

Anthony Diodato, assistant vice president, property/casualty division, A.M. Best Co., said the recent actions State Farm has taken, including rate decreases, underwriting enhancements and dividends, have uniquely positioned the company and adversely affected competitors.

"State Farm has an enviable position of being very overcapitalized and mutual status with no stockholder-earnings pressures," Diodato said. "In addition, State Farm has a superior customer retention resulting from their continued low pricing, well-regarded customer service and policyholder dividends. Competitively, they have lost market share over the past few years. They appear to be using their many advantages to regain lost market share."

Diodato noted that a number of the other market leaders are also nonstock companies and are well-capitalized, but even these organizations don't have the capital cushion--estimated at $16 billion of excess capital relative to A.M. Best's A++ capital requirements--that State Farm has.

"This capital position allows for more flexibility to competitively price business," he said. "The other market leaders stand to lose market share, since they don't have the pricing flexibility."

However, State Farm has more than just capital strength going for it, Diodato said. "They have a vast 50-state reach, strong data-mining capabilities, diverse product offerings, low-cost operation, acknowledged strength in claims service and many other attributes," he said. "These qualities result in excellent customer loyalty and retention. While their market share fell over the past few years, the combination of these recent actions and capital strength will result in their market share increasing in the future."

Although Buffett, chairman and chief executive officer of Berkshire Hathaway Inc., may be an admirer of State Farm's success story, he recently took the company to task for swallowing losses to gain customers. In his 2000 report to stockholders of Berkshire Hathaway, Buffett complained that State Farm's price-cutting was unfair to Geico and other insurers. In just one example, State Farm has lowered rates more than 25% in California over the last six years. Meanwhile, Farmers Insurance Exchange, a unit of Farmers Group, and the second-largest writer of private-passenger auto insurance in California, has filed for a rate increase of an average 6.6%, citing costlier claims.

"State Farm--by far the largest personal auto insurer...has been very slow to raise prices," Buffett said. "Its costs, however, are clearly increasing right along with those of the rest of the industry. Consequently, State Farm had an underwriting loss last year from auto insurance (including rebates to policyholders) of 18% of premiums, compared to 4% at Geico.

"Our loss produced a float cost for us of 6.1%, an unsatisfactory result...But we estimate that State Farm's float cost in 2000 was about 23%. The willingness of the largest player in the industry to tolerate such a cost makes the economics difficult for other participants," Buffett said.

Edward Rust Jr., CEO of State Farm, countered by saying that while Geico tries to make insurance a commodity, State Farm doesn't take that approach. If State Farm won more customers in 2000, Rust reportedly said, he'd like to think the important component was service, something he feels that State Farm does well.

Mary Beth McDade, a spokeswoman for Progressive, said the company does not comment on the strategies of other insurers. But she said that Progressive's promise to its shareholders is "to price our product to obtain a 4% underwriting profit." In markets where that profit proves unobtainable, Progressive will adjust its rates, she said.

Allstate declined to comment on State Farm's activities.

Bloomington, Ill.-based State Farm made headlines last November when it announced a new pricing policy for auto rates that will give discounts to drivers of vehicles which State Farm says are shown to be safest. The new pricing policy, which went into effect Jan. 1, offers a "vehicle-safety discount" that replaces the company's "passive restraint discount" for cars with airbags or automatic safety belts. The new policy applies to 1994 or newer private-passenger vehicles, including SUVs, trucks and larger cars.

State Farm said 36 new vehicle models qualify for both a 20% to 40% personal-injury discount and collision and comprehensive premiums that would be 10% to 40% lower than the standard premiums.

To Alice Schroeder, equity analyst at Morgan Stanley Dean Witter, this was in keeping with several actions that State Farm had taken in previous months, including an unusually large 12.5% rate reduction in physical damages in California, a state that represents 10% of the U.S. auto insurance premiums; a recommitment to its agents in October 2000 that rebuilding market share in its auto business was the company's highest priority; and increasing the portion of agents' cooperative advertising it would pay, meaning the company will now absorb 75 cents, instead of 50 cents, for every dollar that agents spend on marketing.

"We believe that State Farm is in the process of iniplementing a multifaceted strategy to rebuild market share," Schroeder said in a November 2000 research report, adding that the key points of the strategy are "more competitive pricing and more aggressive marketing. "The insurer also is likely to continue funding its growth initiatives through competitive pricing for the time being, she said.

This "newly energized and competitive" State Farm is becoming a more potent force in the market, Schroeder concluded and "will be a limiting factor on other carriers' ability to raise rates in the current inflationary environment."

That's the very concern of investors who think State Farm will continue to use its huge excess capital to limit the amount that prices could rise in the auto insurance business, opined the Wall Street Journal's "Heard on the Street" column on April 25. In Florida, for example, market-leader State Farm notified policyholders last spring of an average 6.4% auto rate hike--the first increase in that state since 1996. However, the increase came in lower than the Florida Department of Insurance's projection of 9.7%, as well as the estimated industry average increase of 9.4%.

But analysts at Lehman Bros. think these concerns are "overblown." In their May update on No. 2 personal lines insurer, Allstate, Lehman analysts start off by asking, "Is State Farm Going to Continue to Be the Bugbear of the Auto Insurance Industry?" Not likely, they respond. According to their calculations, State Farm will struggle in 2001 to achieve what the company considers its top goat--growth in surplus or equity. This is partly due to the weak stock market; just a 1% reduction in the stock market reduces State Farm's surplus by $348 million, Lehman Bros. noted.

"Our argument is the flip side of the one cited in the Wall Street Journal--reduced price competition from the mutual auto insurers," wrote Lehman Bros. The big mutual auto companies like State Farm, USAA and Nationwide do have financial discipline, but the measures these companies use to determine their financial success is different from the stock auto insurers, which care about return on equity, the analysts said. The mutuals "care about book-value growth...and their heavy investment in equities suggests that by their standards 2001 will be a year of poor financial results. These poor financial results, we think, will drive these companies to raise prices."

Underwriting Losses

Underwriting losses have been heavy in the auto insurance business, with industrywide combined ratio for personal lines companies at about 110 in 2000. State Farm Mutual has reported $6.4 billion in underwriting losses and dividends over the past two years in the auto line.

Even the industry leader can lose too much money on underwriting, Lehman analysts said. State Farm and its affiliates reported a combined ratio, including policyholder dividends, of 119.2 in 2000, compared with 110 in 1999. Combined ratio is the percentage of each premium dollar that an insurer spends on claims and expenses.

State Farm has said that it needs to achieve a combined ratio of about 105, on average, which it describes as its break-even point, said Todd Bault, institutional analyst for Sanford C. Bernstein & Co.

Stock companies, on the other hand, need to aim for a combined ratio of 100 to make money. "The rest of the industry--the top companies in the top 10--are not so far from 100," Bault said. "Allstate is already there; Progressive is almost there. Geico had a bad period in 2000, but they've raised rates and they're probably going to be there."

On average, the next big competitors after State Farm "have something like 8% average rate change they need to get back in order to be where they want to be," Bault said. "State Farm's got to get 18% rate to get back to the worst standard where they want to be. It's just out of balance."

This particular number is key to Bault. In his March 23 Bernstein Research report, "Enough Already About State Farm!," he argues that State Farm's "supposed quest for market share vs. profitability compared to other auto insurers has completely failed." He cited State Farm's higher-than-industry-average combined ratio and its loss of market share "while the rest of the top 10 have gained significantly"--33% to 43% in six years.

Even allowing for a lower profitability threshold to fund policyholder dividends, State Farm needs twice the level of price increase to return to sustainable profitability, Bault said. "Current profitability levels are too low to continue pricing for market share," he said.

If State Farm can behave this way--cutting rates to gain market share and not caring about profitability--then the real question is whether the company is succeeding in its strategy. "Yes, they did indeed cut rates because their profitability sank like a stone. But they did not gain market share," Bault said.

A Change in Strategy

Assuming State Farm gets business back, it is expected to incrementally raise its rates, analysts said. But no one knows at what point the company will decide to actively pursue that change in strategy. After all, this is an insurer known for keeping its cards very close to its chest. For one thing, State Farm's top executives declined to be interviewed for this article. For another, some of its own agents can be frustrated in their attempts to obtain information from the company, indicated Robert Lamphier, president of the National Association of State Farm Agents Inc, an organization that the insurer does not recognize.

In August, the company is expected to release the results of its ESS, or Enterprise Structure Study, Lamphier said. "They're keeping this under lock and key," he said, adding that he expects that the announcement will stress the need for restructuring the company and trimming corporate fat. "The one-year sales growth was only 7.2%, and net income dropped 60.5%--that's what ESS is all about," he said.

If State Farm does announce a massive restructuring effort soon, it will be following in the footsteps of nearest-competitor Allstate, now in the midst of a sweeping overhaul that the Northfield, Ill., insurer launched in November 1999. The company said it would reduce annual expenses by some $600 million, leading to cuts of 4,000 nonagent jobs, or roughly 12% of its nonagent work force, by the end of 2000. Allstate said it planned to channel those savings largely into call center and Internet capabilities and phase out company-employed insurance agents, moving them to independent-contractor status.

State Farm, however, has been taking a more leisurely approach in developing its technology capabilities. For some time, consumers contacting State Farm online have been able to receive rate quotes for term life, whole life and auto insurance in 32 states. Beginning last spring, however, State Farm said it would offer auto insurance directly through the Internet in California and renters insurance in Illinois as a pilot program. For the first time, its customers would be able to apply for and bind a contract online.

So far this year, State Farm has been raising rates more often than lowering them. By mid-June, the company had instituted 14 rate increases and four rate reductions. But some analysts argue that these rate hikes aren't big enough. "They're raising rates less than other people, so that would again seem to play towards this goal to gain market share," Bault said. "But again, we have five years where it didn't work. And I don't think it's going to work now."

In its battle for market share, State Farm's expense ratio has deteriorated significantly--signifying the loss of a key advantage, Bault said. "Its expense ratio is now pretty much the same as comparable insurers, around 23% for a direct insurer. It used to have an advantage of probably at least 3 to 5 points of expense. It doesn't have that anymore."

That indicates that State Farm needs to become more efficient. "I have no doubt that State Farm is working on initiatives to do that," Bault said.

To become more lean and mean, he suggests that the giant mutual adopt some of the streamlining measures that stock companies have taken. "They can try to use technology more efficiently, to replace manual processes with electronic processes," he said. "They can do more old-fashioned things like think about restructuring, think about eliminating some people, closing down some agencies--just the basic stuff that you can do."

State Farm also could follow the lead of Allstate and Progressive and develop a multichannel distribution system.

In a mutual, however, there isn't much of an efficiency culture, Bault said. "That's not what it's about," he said. "And if you start to go toward an efficiency culture, even if senior management thinks it's the right thing to do, you will get resistance from people in the company who will say, 'I'm working for a mutual, because I don't want to deal with this aspect of a stock company."

That's a challenge that State Farm will have to confront, Bault emphasized. "It's not insurmountable. It will be tough, but they can do it," he said. "Still, it will be a drag on the progress they could make."

State Farm Continues Clash Over Crash-Parts Lawsuit

State Farm Mutual is asking the Illinois Supreme Court to review its case following a judgment of more than $1 billion against the insurer in October 1999 for using generic replacement parts in auto repairs.

The company has filed a petition for leave to appeal, meaning it is asking Illinois' top court to consider taking on the case. The court's response is expected by the fall, said Michael B. Hyman, of Much, Shelist, Freed, Denenberg, Ament & Rubenstein, a Chicago law firm. Hyman was on the team of plaintiff attorneys who participated in the replacement-parts trial and appeal.

Hyman and colleagues involved in the class-action lawsuit against State Farm say the company's latest request is a long shot. "We don't see any basis for them to hear it," Hyman said. State Farm disagrees. "We think there's very compelling reasons why they should take it," said Steve Vogel, a company spokesman. Hearing the case is at the court's discretion, and it has turned down State Farm before. On Jan. 20, 2000, the insurer asked the Illinois Supreme Court to speed up its appeal by skipping the appellate court and a lengthy appeals process, but the Supreme Court denied the request a month later.

State Farm lost its original case on Oct. 4,1999, when a jury in Williamson County Courthouse, Marion, Ill., reached a decision that effectively said after-market parts--or nonoriginal equipment manufacturer (non-OEM) parts that are not made by auto manufacturers--are incapable of returning a damaged car to its pre-crash condition. The jury found State Farm liable for $456 million in compensatory damages for breach of contract for using after-market parts in auto repairs. The judge in the case assessed $730 million in damages days later, finding that the company engaged in consumer fraud by requiring that parts not made by the original manufacturer be used in repairs.

"Crash parts" are vehicle components typically repaired or replaced as a result of crash damage, rather than as a result of normal vehicle usage.

The company vowed to appeal the decision, insisting it was blameless.

In April, the Illinois Court of Appeal upheld the verdict, but reduced the original $1.18 billion judgment entered by the trial court by $130 million, "to subtract an overlapping award on the two separate counts," according to plaintiffs' attorneys. The total remaining award of $1.05 billion is one of the largest verdicts ever upheld on appeal, the attorneys for the plaintiffs said in a statement. The award averages about $223.40 for each of the 4.7 million members of the class.

At the time, Vogel said the insurer would appeal the decision to the Illinois State Supreme Court. "We are obviously disappointed with this verdict," he said. "We maintain that we have done nothing wrong, that there are some serious issues that need to be addressed; and now we're going to present those issues to the state Supreme Court."

One of those issues, Vogel said, is that the courts thus far have applied a state statute--the Illinois Consumer Fraud Act--"across other states."

In the State Farm document, which is posted on the company's Web site, State Farm said it defended its practices by showing that the non-OEM parts it specified were quality parts, that there were relatively few policyholder complaints and that a State Farm guarantee insures policyholders' satisfaction. State Farm said it also showed that "use of non-OEM parts by a professional repair shop does return a vehicle to its pre-loss condition and that its policyholders were fully informed of the proposed use of non-OEM parts when they were specified."

State Farm argued that there are no safety issues associated with the use of non-OEM parts, because they constitute the outer shell of a vehicle--not the part of a vehicle designed to protect passengers. "This evidence included data from the Insurance Institute for Highway Safety which has crash-tested cars for years, concluding that non-OEM parts don't constitute a safety issue," according to the document. Similar studies by the National Highway Traffic Safety Administration were presented as evidence.

"This verdict leaves standing a number of misconceptions about State Farm," Vogel said. "It also could mean all of us will be subject to an auto-parts monopoly, by eliminating legitimate competing parts manufacturers from the market."

Hyman said State Farm Mutual did not use in-house legal staff, but called instead on three different law firms for each of the trial and appeals phases. He described the company as "an aggressive adversary that has, in the OEM cases, taken a blind eye to their own guilt," which, he maintained, was confirmed by a jury verdict as well as a separate verdict by the trial judge and then affirmed by a three-judge appellate panel. "They were not forthcoming with any sort of remorse to their insureds," Hyman said. "They've taken a very strong position to litigate every tidbit of the case."

Hyman said that during the discovery phase of the trial, State Farm refused to produce certain documents, claiming attorney-client privilege and other reasons. We pushed," and pushed he said. "The judge ordered them to produce, these documents, and when they finally did, they turned out to be the more interesting and revealing documents."

State Farm emphasized that at least 99% of its claims are settled without litigation. Also, the company said that it has actively defended its position in the crash-parts case because the issue of generic parts is very important to its policyholders. Using less expensive, non-OEM parts can keep down the costs of repairs and, ultimately insurance premiums, the insurer said.

"That's why consumer groups, including Ralph Nader's, have staunchly supported us through this process," Vogel said.

State Farm: A Great Place to Work

Gail Audibert started her career in executive recruitment in the mid-1980s, a time when insurance companies seemed like safe, secure places to work. But only a few years later, with downsizing commonplace in American industry at large, many insurance companies were going the same route.

But not State Farm Mutual Automobile Insurance Co. This insurer, Audibert said, "is still very paternalistic. You do a good job, they keep you there. You do a good job, they reward you."

As a partner in Audibert Jones Associates, Farmington, Conn., a firm that handles executive placements in insurance and several other fields, Audibert has dealt with State Farm several times in recent years, when it sought help from her company in finding executives for State Farm's Connecticut operations. She said she also has gathered impressions of the company from conversations with State Farm employees over time.

"Someone there once told me, 'No one in this office ever leaves because he or she isn't happy,'" Audibert said, adding that she understands that turnover is low, with most people leaving mainly because of a spouse's relocation, retirement or other personal reasons. "When State Farm runs an employment ad, they have no problem filling the job," she said.

The array of benefits and perks may help explain that.

In addition to ample group health, disability and dental plans, the company offers a traditional, defined-benefit retirement plan with full company payment of retirement benefits. Employees can retire at age 62 with full retirement benefits, or at age 55, with early retirement benefits. The company also provides employees with financial planning workshops and pre-retirement-planning classes. One-on-one financial counseling is available following the death of an employee or spouse of an employee.

State Farm's employees--parents or not--can take off up to one workday a year to participate in activities that benefit local schools. Also, the company will provide up to $5,000 in financial assistance to employees who adopt a child and as much as four weeks of paid adoption leave for primary caregivers.

The State Farm foundation provides $3.2 million on an annual basis in college scholarships through the Merit Scholarship program. The awards go to legal dependents of State Farm employees, agents and retirees.

Employees have the option of alternative work arrangements, such as staggered hours as a variation of flextime, job-sharing, compressed workweeks, telecommuting and flexible scheduling. The company has a vanpool program offering affordable and convenient transportation to a number of workers. The company stores include automatic teller machines, postal services, personal check-cashing services and credit unions at regional and corporate locations.

Corporate headquarters and regional offices have well-equipped medical facilities, where employees can receive periodic health exams on a voluntary basis, follow a weight-loss program or take an exercise class, attend meetings to stop smoking or receive discounts for joining local health clubs. Private rooms are made available for nursing mothers.

Overall, the mutual insurer provides a stable environment to employees. "You go there, you have a home, a place to stay," Audibert said. "Most insurance companies. don't have that feeling anymore, and a number are even closing offices."

If State Farm tends to treat its corporate employees like family, as Audibert professes, it may have something to do with the fact that the company has always been family-run. Edward B. Rust Jr., current chairman and chief executive officer, is the third generation of Rusts to head the mutual. Since its founding, the group's companies have been run by only two families-the Mecherles, from 1922 to 1954, and the Rusts, from 1954 to the present.

State Farm has 16,300 captive agents who sell only State Farm-sponsored products. It has a total of 79,300 employees in the United States and Canada.

The company's headquarters are in Bloomington, Ill., one of the state's fastest-growing metropolitan areas with 57,707 residents. It's seen an estimated 20.25% increase in population between 1986 and 1995, city, officials said. Bloomington is in the heart of central Illinois, one of the most productive agricultural areas in the nation. With its twin city, the town of Normal, which has another 42,000 residents, Bloomington is the meeting point for three interstates, four major railroad lines and Amtrak, and the Central Illinois Regional Airport. In addition to the State Farm complex, Bloomington has two universities, two hospitals, a convention center and three malls.

Computerworld magazine calls Bloomington "an affordable farm-belt region with a high quality of life." The publication recently ranked State Farm among the 100 best places to work in information technology. "The company offers relatively high salaries and abundant training programs," Computerworld said. This gives State Farm "an obvious staffing edge as the top dog in the region," the magazine said. "But better pay and training are conscious efforts by State Farm to get and keep the best talent."

And for the third consecutive year, Latina Style magazine, which caters to Hispanic women, selected the company for its list of 50 best places for Latinas to work in the United States. In compiling its list, the magazine said it looks for companies with mentorship programs, overall benefits--including medical leave for expectant mothers and flextime--and the number of executive-level Hispanic employees within the company.

The 'Big Dog' Awakens

State Farm Mutual, the market leader in personal lines for the past 40 years, used to be thought of as the industry's sleeping giant. While it was snoozing, its market share was eroding from competitive pricing pressures, the lack of a cohesive new business strategy and the rise of direct-marketers like Progressive and Geico.

Lately, that image has changed, and the insurer is sounding its own wake-up call to competitors in the marketplace.

In an oft-quoted remark, Edward Rust Jr., chairman and chief executive officer of State Farm, declared in 1998 that the "big dog is off the porch," a signal of the group's new competitiveness and zeal to regain lost market share. Toward that end, the company, which reported a net worth of $43.7 billion in 2000, made news by filing for high-profile rate reductions in selected states, including California, and seeking to cut rates for specific classes of vehicles that provide greater protection for passengers.

The "Good Neighbor" company also announced its intention to develop into an increasingly diversified financial-services organization to add and retain customers. Along those lines, the company said in March that it would begin offering, through State Farm VP Management Corp., a family of 10 mutual funds which include three managed-equity funds, three index funds, one balanced fund, two bond funds and one money-market fund.

At the time, Rust said the offering was in response to customers who said they wanted more financial services products from their agents. He also said that providing mutual funds was the next logical step after opening State Farm Bank in 1999. By the end of May, State Farm Bank had more than 75,000 new customers and $700 million in assets, the company said.

More recently, State Farm announced that it would offer wealth-management services beginning later this year through a partnership with Phoenix Home Life Mutual Insurance Co. of Hartford, Conn. In April, State Farm expressed an interest in buying up to 4.9% of the shares of Phoenix Home Life when the company makes its initial public offering. The New York State Department of Insurance already has given Phoenix Home Life's demutualization plan the green light.

In addition, State Farm has made the following moves:

* paid an historic policyholder dividend of $1 billion in June 2000;

* launched initiatives to market to ethnic communities;

* expanded its Internet strategy to better accommodate its agents;

* turned up the volume on its mass-marketing efforts;

* identified and reported claims information that contributed to the ultimate recall of certain Firestone tires;

* increased its commercial product offerings through a partnership with Aon; and

* instituted the sale of health-care products through an alliance with Fortis.

Loyal State Farm Agents Fight for Independence

State Farm Mutual has long said that it believes in the value of the relationship between agent and customer. In State Farm's case, its 16,000-plus agents are captives who write only for the company and its products.

Several thousand of these captive agents also are members of the National Association of State Farm Agents Inc., a group that is not recognized by the insurer.

"That's unfortunate, because we are very dedicated and loyal agents," said Robert Lamphier, association president. "Our mission is to maintain our independent-contractor status."

Lamphier, a former basketball coach at the University of New Mexico, has been a State Farm agent for nearly 18 years, based in Albuquerque. That tenure means he can remember how the company dealt with him and his peers in the years prior to 1996--which has become something of a watershed in the minds of veteran State Farm agents.

That was the year when State Farm introduced a new agent contract that was decidedly different from earlier ones. Agents "basically would be employees of the company," Lamphier said. "It's quite a drastic change. I've talked to a lot of older agents who say if they had to do it over, they wouldn't come on now."

While every contract before this had improved the commission structure, this one cut commissions for the first time, Lamphier said--an assertion that the company says is debatable. State Farm introduced a 33 1/3% reduction in commissions for writing fire and a 20% cut in commissions for writing auto, Lamphier said. Initially, those who signed received a transitional bonus, but the monies for that have been used up, Lamphier said.

State Farm said its newest agency contract aims at rewarding agents who produce quality, long-term business, and it puts a distinct emphasis on life insurance rather than home and auto, the company's traditional strengths. The contract creates a leveling of commissions on life products. Compensation under the new contract could be as much as 20% higher on a present-value basis, company officials maintain.

Lamphier said NASFA was instrumental in convincing the company that agents should be given the choice of keeping their old contracts or going to the new one. The company, however, disagrees with that assessment.

Agents who joined the company after the new contract was introduced do not have a choice of contracts, Lamphier said. However, the new agents have some advantages that seasoned colleagues didn't have. State Farm will spend an average of $250,000 to $300,000 to set up new agents in business. "Everything is paid for--salary and commission, office rent, staff," Lamphier said. "They take care of these agents. We had to struggle."

Under previous contracts, he added, a scratch agent--one who is starting out with no policies--had to spend a two-year period fulfilling company requirements before moving out on his own. The company noted that this also could apply to trainee agents and veteran agents.

In addition to this change in contracts, the insurer altered its long-standing policy on agency succession. Previously, an agent's son, daughter or other relative could apply to carry on the family firm and its book of business, but now, the relative must first work for the company, Lamphier said.

"This isn't technically true," argued Steve Vogel, a company spokesman. "They could apply--we still encourage that sometimes--but they still have to meet our standards.

"The fact is there is no guarantee that they will become agents. We do have an external pool we draw from because the employee base does not provide enough candidates," Vogel said.

NASFA's board had a lot of questions about these changes, particularly with the new contract. When they felt they weren't getting answers, they decided in 1996 to attend State Farm Mutual's annual policyholder meeting-- signing in as the policyholders they truly are--and pose their questions to top executives, including Edward Rust Jr., the chairman and chief executive officer.

"That was one of NASFA's proudest moments," Lamphier said. Company executives agreed to meet with them in a private session following the policyholder meeting.

Vogel emphasized that State Farm executives met with Lamphier's group "as agents and policyholders--not as members of NASFA."

Although the discussion lasted for more than an hour, agents went away feeling they hadn't learned much. "I think we're going to go again to this year's annual meeting," he said, which was scheduled for June 11.

The company said it regularly provides agents with ample opportunities to meet with executives or other representatives and ask questions on anything from contracts to the latest corporate policies.

As for the latest contract, a ream of agents worked with company officials in drafting the document. "And all agents were given the opportunity to provide input into what was a 12-month process" of creating the contract, Vogel said. "When the new contract was introduced, every agency was invited to attend small-group meetings, which thoroughly reviewed the contract." he said. Furthermore, at agency conventions in 1996, 1998 and 2000, agents heard from State Farm's chief agency officer on the direction the company was taking in its distribution strategy. "There also are open forums at these meetings--two-hour sessions with the top leadership--when agents can approach any corporate or regional officer and ask questions," Vogel said. "It's a good opportunity for us to hear what people think,"

The association president said agents are concerned about the company's expansion into Internet sales, which result in low commissions for agents when they eventually are brought into these online transactions.

They also question State Farm Mutual's interest in becoming a one-stop financial portal, with customers able to buy insurance products, open and manage bank accounts, and secure and manage mortgage and car loans online. In 2000, the company made the virtual State Farm Bank available in several states, with plans for a total rollout this year.

"We do insurance best--we're asking why we're in this financial-services aspect," Lamphier said. "I love State Farm; it is really and truly a great company. But a lot of us sometimes can't understand where they're going with us. It seems they want to go around us. But the bottom line is, they still need us."

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