Governor Gavin Newsom recently issued an executive order with the goal of stabilizing California’s property and casualty (P&C) insurance market, which has been facing significant challenges. This order contains several industry-related provisions that have been long-awaited, though its success in achieving its objectives remains uncertain.
The executive order comprises three primary components, all of which received immediate support from the state’s insurance commissioner. Firstly, it permits insurance companies to consider future climate-related risks when determining their rates, a practice that was previously prohibited. Secondly, it allows reinsurance costs to be factored into rate change calculations, with the potential to pass these costs on to consumers. In exchange for these concessions, insurance carriers will be required to provide coverage to homeowners in wildfire-prone regions at 85% of their statewide coverage. For instance, if a company covers 10% of homeowner policies in California, they must offer 8.5% of the coverage in high-risk areas.
The executive order aims to address the issue of major insurance companies, representing over 60% of the P&C market, either exiting the state or reducing their coverage due to escalating wildfire risks. Companies like State Farm and Allstate had declared their refusal to issue new policies, while Farmers had imposed limits on new homeowners’ policies, severely restricting options for homeowners in high-risk areas. It remains to be seen whether the executive order will influence these companies’ decisions.
Roger Arnemann, General Manager of Guidewire Analytics, an insurance data research and software company, praised the order’s potential impact, especially the ability for insurers to incorporate forward-looking projections for catastrophe risk. He argued that relying solely on historical data was insufficient in a rapidly changing environment of weather and natural disasters.
Despite the current challenges, Arnemann believes California is highly insurable, provided appropriate regulations and risk analytics are in place. Data from Guidewire HazardHub indicates that more than 90% of property damage in California is concentrated in just 10% of the state, where homes are 50 times more likely to suffer wildfire damage. With the right regulatory framework and data analysis, insurers can accurately assess and price risks at both individual property and portfolio levels.
California faces a significant wildfire risk, with an average of 8,273 wildfires annually and an average of 933,000 acres burned each year over the past decade. The state boasts the largest P&C market in the nation, with over $11 billion in homeowners and fire insurance premiums written.
The availability crisis in California’s insurance market is partly attributed to Proposition 103, a 35-year-old regulation aimed at protecting consumers from arbitrary insurance rates and promoting a competitive marketplace. However, a recent white paper by the International Center for Law & Economics criticizes Prop 103 for its inefficiency, inflexibility, and questionable value to the state’s rate-intervenor system. The authors argue that Prop 103’s rate suppression has forced policyholders into surplus-lines markets and the California FAIR Plan, both of which may need to raise rates to meet their obligations.
California’s Insurance Commissioner, Ricardo Lara, acknowledged the current issues in a recent press conference and emphasized the need for regulatory reform to address declining insurance options for homeowners and businesses. However, some skeptics are uncertain about the effectiveness of the new revisions and their reception among consumers. They also note a lack of hazard mitigation measures in the new rules but acknowledge that the situation could have been worse.
Jordan Haedtler, a climate financial policy consultant, prefers the tradeoff of expanded coverage for potentially higher rates over the alternative deal that was reportedly under negotiation. He believes that the Legislature may need to revisit the issue in the future, focusing on regulatory reforms that consider wildfire risk, incentivize climate resilience and hazard mitigation measures for homeowners, and improve transparency in the models proposed by Lara’s plan.
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