SACRAMENTO, California — California will let insurance companies factor climate change into their pricing, the state’s top regulator announced Thursday, a move aimed at preventing insurers from fleeing the state over fears of massive losses from wildfires and other natural disasters.
Unlike other states, California does not allow insurance companies to consider current or future risks when deciding how much to charge for an insurance policy. Instead, they can only use what’s happened to a property in the past to set the price.
At a time when climate change is making wildfires, floods and storms more common, insurers say this restriction makes it difficult to truly price the risk on properties. It’s one reason why, in the past year, seven of the 12 largest insurance companies operating in California have either suspended or limited new business in the state.
On Thursday, California Insurance Commissioner Ricardo Lara said the state would write new rules to let insurers look to the future when setting rates. But companies will only be allowed to do that if they agree to write more policies for homeowners who live in the most at-risk areas – including communities threatened by wildfires.
“Modernising our insurance market will not be easy, nor will it happen overnight. We are in truly uncharted territory and we have to make tough decisions when the world is changing rapidly,” Lara said at a news conference.
The rule change could mean higher rates for homeowners, who are already seeing dramatic increases. Eight insurance companies doing business in California have requested rate increases of at least 20% or more this year, according to the California Department of Insurance.
Harvey Rosenfield, founder of the advocacy group Consumer Watchdog and author of a 1988 ballot proposition that regulates insurance rates, said Lara’s announcement “will dramatically increase homeowners’ and renters’ insurance bills by hundreds or even thousands of dollars.
But Lara said looking to the future to set rates doesn’t always have to be pessimistic. Insurers can also take into account the billions of dollars the state has spent on better forest management, and the improvements homeowners have made to their homes to make them more resistant to wildfires – all things insurers can’t take into account when setting rates under the current rules.
“Insurers have made a very strong argument that the past is not as good a predictor of the future as it used to be,” said Amy Bach, executive director of United Policyholders, a national insurance consumer organisation. “I think the (insurance) department did what it needed to do to try to restore a viable market. We don’t have a viable market in this state right now in a lot of areas.”
California isn’t the only state that has struggled to keep homeowners insurance companies afloat in the wake of natural disasters. Officials in Florida and Louisiana, which have been hit by hurricanes and floods, have fought to keep companies writing policies. According to a recent report by the First Street Foundation, about a quarter of the nation’s homes are underinsured for climate risk. Florida allows insurers to consider climate risk with restrictions. In states with less regulated insurance markets, insurers are building current and future events into their models.
Wildfires have always been a fact of life in California, where it rains only a few months a year. But as the climate has become hotter and drier, these fires have become much bigger and more intense. According to the California Department of Forestry and Fire Protection, 14 of the top 20 most destructive wildfires in state history have occurred since 2015.
Insurance companies have responded by not renewing coverage for many homeowners who live in wildfire-prone areas. When this happens, homeowners must purchase fire insurance from the California Fair Access to Insurance Requirements (FAIR) Plan. All insurance companies doing business in California must pay into a fund to provide coverage under the FAIR plan.
The number of people enrolled in California’s FAIR plan nearly doubled in the five years leading up to 2021, and that number has almost certainly increased even more in the past two years.
Lara said his plan would require insurance companies to write policies for no less than 85% of their statewide market share in wildfire-prone areas. This means that if a company writes policies for 20 homes, it must write 17 new policies for homeowners in wildfire-prone areas – taking those people off the FAIR Plan.
“This is a historic agreement between the department and the insurance companies,” Lara said.
The American Property Casualty Insurance Association, which represents insurers, called Lara’s actions “the first of many steps needed to address the deterioration” of the market.
“California’s 35-year-old regulatory system is outdated, cumbersome and fails to reflect the increasing catastrophic losses consumers and businesses face due to inflation, climate change, extreme weather and more residents living in wildfire-prone areas,” Denni Ritter, vice president for state government relations, said in a statement.
Jeremy Porter, co-author of the Front Street Foundation’s report on climate risk, said allowing insurers to factor climate change into their pricing could lead to more competition in the state’s insurance market.
“If implemented correctly, this would definitely allow insurers to come back into the market in California,” he said.
Some consumer groups, including Consumer Watchdog, say they are not opposed to insurance companies using a forward-looking model to set their rates. But they want to see what is in that model. It’s not clear that California’s new rules will allow that. State regulators will spend much of next year deciding what the rules will be.
Lara said he’s committed to making those models public.
“The department will be able to review these models to make sure they’re accurate,” he said.
