California is likely to allow insurance companies to factor in the risks of climate change when calculating premiums, marking a major shift in state policy as insurers reduce coverage amid soaring disaster costs.
State Insurance Commissioner Ricardo Lara plans to rewrite insurance regulations to allow wider use of catastrophe models in the nation’s most populous state for the first time in 35 years. The change is designed to entice insurers to extend coverage to homeowners in areas facing growing risks from extreme weather.
It comes as major insurers such as State Farm have stopped writing new policies in California and other states following an intensifying barrage of disasters that, along with expanding real estate development, have fueled economic losses. The move follows a catastrophic summer in which high temperature records were broken around the world.
California law largely prohibits the use of catastrophe models in setting insurance rates under rules imposed by Proposition 103, a state ballot measure passed in 1988 that requires insurers to set premiums based on the previous 20 years of losses.
But in recent years, seven of the 12 largest insurance companies operating in California have either stopped writing new policies or limited them because of extreme weather losses. Several insurers have agreed to expand coverage if the state allows them to use catastrophe models to estimate their economic losses from future disasters. Many of the models use historical catastrophe data and estimates of future losses to create scenarios to predict destruction from hurricanes and other perils.
“The business of writing property insurance has changed forever,” said Stephen Young, senior vice president and general counsel of the Independent Insurance Agents and Brokers of California, during a recent workshop on the changes. “The current regulatory system in California is not up to the task of meeting this challenge.”
Over the past decade, California has experienced nine of the 10 most destructive wildfires in state history. In 2019, the number of insurance cancellations or non-renewals in California jumped to 235,000 from 165,000 a year earlier, state figures show.
California is one of at least five states facing insurance problems, such as companies becoming insolvent or scaling back coverage. Other affected states are Colorado, Florida, Louisiana and Texas, which are highly exposed to wildfire or hurricane losses.
“We’re seeing it across the country,” said Jeremy Porter, director of climate research at the First Street Foundation, a group that analyses data on climate risks. “We’re seeing increased exposure to climate hazards, and we’re seeing it in different regions of the country, different types of hazards.”
The risks vary from wildfires in the West to extreme winds in the Gulf Coast states to heavy rainfall and flooding in the Midwest.
Insurance companies are now factoring in climate-change risks that have largely been ignored in many states’ real estate markets in terms of home values, Porter said.
That includes the cost of some homeowners insurance policies in Florida, which have risen from $1,500 to $9,000 a year, he said. In California, people are losing coverage and relying instead on the state’s insurer of last resort.
About 3 per cent of residents now get their coverage through the FAIR plan, a pool of insurers doing business in California. FAIR sells to residents who cannot get coverage directly from an insurance company. Member companies share profits and losses.
The number of FAIR Plan policies increased by nearly 48 per cent in 2021, the latest year for which figures are available, compared with 2018. The growth has contributed to the plan’s $332 million deficit.
Debate: Open vs. private models
Consumer groups have criticised the move to potentially allow insurers to use catastrophe models, saying the private models shroud the data they use in secrecy. Instead, these groups want the government to develop a public model that can be used to calibrate new insurance rates.
But some consumer advocates said they fear Lara has already made up his mind about allowing the models, despite a series of ongoing public feedback workshops.
Lara’s comments last month about possible changes “felt to me like marching orders being given to department staff, and that those marching orders came directly from a series of closed-door meetings with, in some cases, some legislators and with the insurance industry itself,” Robert Herrell, executive director of the Consumer Federation of California, said last Friday. “We’re just checking a box … because it feels like the die has already been cast here.”
California’s current insurance regulations don’t adequately account for climate change or inflation, Mark Sektnan, vice president of state government relations at the American Property Casualty Insurance Association trade group, said in an interview.
“None of this is picked up in the existing system in California, which is based only on historical losses” on a property over the past 20 years, he said. “It’s like driving your car through the roof by looking in the rear-view mirror and avoiding the windshield.”
Insurers had hoped to get legislation passed this year to implement the changes, but that collapsed before the legislature’s session ended in September.
Lara said in a statement about the workshop that it was “designed to promote a robust insurance market that protects and serves the needs of all Californians”.
“The input we received [last Friday] and throughout this multi-year effort is critical to shaping a sustainable and competitive insurance market that benefits our communities and protects homeowners and businesses from the growing risks posed by climate change.”
Catastrophe models are currently used in most other states, with California being something of an anomaly, said Roger Grenier, senior vice president at Verisk, which develops catastrophe models.
The only place California currently allows the use of models is in the sale of earthquake insurance. Those policies are sold separately from traditional homeowners insurance because the losses can be so high.
But the models are needed as states face more extreme weather, Grenier said.
“When you look at these very rare but high-impact events, catastrophic events, there’s very little historical data with which to develop rates and manage the risk,” he said. “So for many decades, insurers have used catastrophe models that effectively simulate what the loss activity might be.”
Even those who oppose the use of models in general have signalled that they see it as likely to happen in California with traditional homeowners insurance.
“We all acknowledge that the risk of wildfires is changing, and we want to look at new tools to figure out how that affects the likelihood of our homes burning down,” Carmen Balber, executive director of Consumer Watchdog, said in an interview. “We want to make sure those tools are as open and transparent as possible.”
Most companies that sell the models do not release information about how they calculate risk. They consider the models proprietary because they compete with the companies that sell them.
“We invest a lot of our own resources in developing these models,” says Grenier. “We have to protect the intellectual property that we put into them. So that’s really the key issue, that there needs to be an incentive for us to continue to build and improve these models, and protecting [intellectual property] is one way we do that.”
