The insurance company’s reasoning for canceling policies for people living in Pacific Palisades in Los Angeles County, California, was due to elevated concerns associated with an increase in the frequency and magnitude of wildfires in the state, according to Newsweek. 

The decision was announced in March, claiming it would cancel 72,000 property policies in California, 30,000 of which were home insurance policies, the Los Angeles Times reported. The cancellations went into effect over the summer. Around 1,600 homes in Pacific Palisades were victims of State Farm’s policy cancellations. 

The insurance company’s decision was deemed a necessary business strategy to prevent “financial failure” allegedly due to California state laws that prevented companies from raising premiums to match the elevated risk, Newsweek reported. Other insurance companies followed State Farm’s decision, which has resulted in a significant homeowner insurance crisis in the state as residents have been limited in their options.

State Farm’s president and chief executive, Denise Hardin, rationalized her corporation’s decision in a letter to California Insurance Commissioner Ricardo Lara, explaining the need to reduce the company’s “overall exposure.” She explained that the company had endured “large underwriting losses.”

“As we discussed, SFG’s capital position has severely deteriorated, and we are increasingly concerned about its financial well-being,” Hardin wrote. “Although there haven’t been significant wildfire losses for several years, windstorm catastrophes in early 2023 and increasing trends in non-catastrophe water losses and liability claims (especially commercial lines and personal umbrella policies), without the additional premium needed to support those cost increases, have generated large underwriting losses.” 

She then elaborated on State Farm’s financial challenges in the state by highlighting other expenses, such as “construction cost inflation,” and emphasizing that the company’s financial strength was much weaker than in 2016.

“SFG has managed its policy growth by limiting writing in high-risk areas for many years, and more recently, by ending all new policy sales,” Hardin added. “However, SFG’s risk exposure grew tremendously in the last few years, with construction cost inflation being a major driver. Taken together, these trends have resulted in a surplus of less than 50 cents for every dollar of risk (as measured by net written premium) we face today, which makes SFG’s financial strength less than a quarter of what it was at year-end 2016.”

She then explained that State Farm was reluctant to take such a drastic measure. Still, she viewed it as necessary for the company’s finances and hoped that doing so would help minimize the impact of such vital decisions by the company.

“We must now take action to reduce our overall exposure to be more commensurate with the capital on hand to cover such exposure, as most insurers in California have already done,” she wrote. “We have been reluctant to take this step, recognizing how difficult it will be for impacted policyholders, in addition to our independent contractor agents who are small business owners and employers in their local California communities. Rebuilding capital, even with higher rates, will take some time. We are striving to minimize the impact of the necessary actions that must be taken.”

She concluded by expressing a need for reform while maintaining that she still wanted a company that was considered empathetic and would be available to aid and assist policyholders in need. However, she prioritized avoiding a “financial failure” for State Farm.

“The swift capital depletion of SFG is an alarm signaling the grave need for rapid and transformational action, including the critical need for rapid review and approval of currently pending and future rate filings,” she wrote. “We take very seriously our responsibility to be there for customers who experience a claim and our actions are with that goal at the fore. A financial failure of SFG will detrimentally impact the entire market, an outcome we are all trying to avoid.”

The wildfires in Southern California are among the costliest and most destructive in the country’s history. As of Wednesday, multiple reports estimated the current cost of damage and subsequent economic losses from the fires between $52 billion and $57 billion.