In August 2023, we wrote about insurer capacity shrinking due to mounting losses from climate change-related disasters. In California, major carriers such as State Farm, Allstate, and Farmers, have stopped writing new property policies or discontinued certain policies to manage risk exposure. If this trend continues, California property owners, especially those in catastrophe (CAT) prone zones, could be without property coverage or need to revert to the California State FAIR plan that offers reduced coverage at a much higher premium.
California’s Department of Insurance (CDI) proposed regulation reforms that could help bring property insurance carriers back to the state. The insurance industry is pushing for the ability to use sound actuarial projections of future losses and the costs of reinsurance premiums in the development of their rates.
We are at the very beginning stages of these changes. While the CDI hopes to have updated regulations sometime in 2024, it may take years to see the impact of the reforms to the insurance market. As an interim step to ensure capacity remains in the state until formal reforms are approved, the CDI approved a 20% increase in December for State Farm. (State Farm originally requested the rate increase to the CDI on February 28, 2023, but it was not approved until December 22, 2023)
It is too soon to say whether or not the regulation reforms will help California property owners secure adequate coverage and provide carriers with the rates they need to operate profitably in the state long-term. But the proposal represents an important step forward.
We hope we continue to see the CDI and insurance carriers work together to develop solutions that support consumers while allowing insurance companies to maintain profitability.
What changes are regulators proposing?
The three biggest changes being proposed include:
Predictive modeling
Carriers would be able to use forward-looking risk models rather than having to rely on historical data to set rates. In exchange, insurance carriers would be required to insure a percentage of homes in higher-risk wildfire-prone areas.
Reinsurance costs
Insurance carriers writing risks in CAT-prone areas face significant reinsurance costs, and currently, these expenses couldn’t be incorporated into the development of a carrier’s rates. Insurance carriers would now have the ability to factor these costs into their rate development.
Required participation in at-risk zones
According to a CDI release, the CDI proposes that carriers “cover all parts of California by writing 75% to 85% of their statewide market share in high wildfire risk communities.” This requirement may be challenging to achieve if passed, given the limited number of homes in at-risk areas. However, this element of the proposal is intended to protect citizens in CAT-zones and could be a jumping-off point for insurers to respond to.
The need for predictive CAT modeling
Many in the insurance industry were excited to see that California might allow carriers to set rates based on predictive modeling. Until now, the state has only allowed insurance companies to use historical data when filing for rate increases, putting California behind other states. In a time of climate change, past data is a poor predictor of future losses. For instance, the California Department of Forestry and Fire Protection, notes that 14 of the states most severe wildfires occurred since 2015. Not being able to use this data in modeling future losses puts the insurance carriers at a disadvantage in establishing appropriate rates.
If the proposed changes pass, carriers can factor in future climate events and other loss indicators to model risk portfolios and project losses. These forward-looking models use sophisticated algorithms. The outputs would be used to file for and set rates.
Each carrier currently uses proprietary property CAT modeling in predicting future losses and rate establishment. The models, and their accuracy, will become increasingly important as climate change-related events continue to escalate.
Why these insurance reforms matter
It’s been a long time since insurers have been rate-adequate across California. Rate adequacy occurs when premiums are high enough to cover operating expenses, claims, and result in a reasonable profit.
Even in low-risk areas untouched by wildfires, water damage-related losses in California have resulted in major payouts. Also, insurance premiums have not kept up with inflation. Construction and replacement costs have skyrocketed, exacerbated by the pandemic. According to a market outlook report prepared by Swiss Re, homeowner property claims costs increased by 36% in the first half of 2023.
Additionally, for years, some carriers were setting low rates and growing market share. Eventually, they were hit with severe, continual losses largely due to wildfires, which affected their risk appetite and capacity.
If the reforms the CDI is proposing help carriers achieve rate adequacy through increased premiums, it will be a significant move for the market. However, capacity and coverage availability has been an ongoing challenge for property owners across the state. The regulations will only be considered successful if/when individuals and businesses can readily access the coverage they need.
What’s next?
We don’t yet know when the regulatory body will vote on these measures, but the CDI plans are to have all of the updated regulation in place by the end of 2024. There may be more iterations of the proposal to come.
In the meantime, we predict the following:
- Industry pressures may push California to go further in the long-term. Other states are already following in Florida’s footsteps, proactively overhauling insurance law to help with inflation and the hard property market.
- We’ll see more carriers utilizing non-admitted options/products in California — also known as excess and surplus (E&S) lines. Carriers can shift non-admitted rates more quickly and easily as needed, based on losses.
- M&A, consolidation, and investment activities may increase capacity in the high-net-worth market.
Moving forward, working together
California contributes nearly 15% to the U.S. GDP. The state is home to 39 million people, some of whom are among the wealthiest in the nation. Large businesses crucial to our infrastructure and economy are headquartered in California. Insurance companies won’t stop writing new policies there indefinitely. However, to move forward, all stakeholders — regulators, consumer protection groups, and carriers — need to collaborate and compromise.
The proposed reforms are a step in the right direction. We remain hopeful that in time all parties can work together to achieve rate adequacy and ensure California residents are properly insured, even in high-risk zones.
We'll be monitoring closely.
