Why California’s Reforms in Risk Modeling Represent a Game-Changer

In a groundbreaking initiative to address California’s insurance challenges, the California Department of Insurance (DOI) has unveiled plans to permit insurers to factor reinsurance costs into their rate calculations and assess catastrophe risk using forward-looking projections supplied by risk models. This significant shift, previously prohibited in California, is poised to revolutionize the insurance industry, according to an expert interviewed by Insurance Business.

Roger Arnemann, General Manager & SVP for Guidewire Analytics, explained, “The current requirements that rely solely on historical data are outdated in a time when weather and natural catastrophe events are changing rapidly.” With the governor and commissioner charting a clear path toward reform, there is palpable excitement about how this will develop and potentially reinvigorate the market.

Why Are California’s Reforms So Significant?

California recently introduced a comprehensive package of reforms designed to improve market conditions for consumers who have witnessed a decline in insurance options following a series of insurer withdrawals. Several major insurers, including State Farm, Farmers, Allstate, Nationwide, and AIG, have either ceased writing homeowners’ policies in the state or significantly restricted their business due to sustained losses from wildfires and other catastrophic events.

Arnemann highlighted that the proposal to enable more progressive pricing methods will empower insurers to better assess and price risks. Historically, the inability to incorporate reinsurance costs posed a considerable risk and expense for insurers.

According to Guidewire, conventional insurance risk assessment tools struggle to accurately discern and differentiate risks in wildfire-prone regions. These outdated methods typically evaluate wildfire risks based on limited data elements and consider all properties in broad geographical areas as having equal risk. Some areas or zones may encompass entire cities, zip codes, or other census-defined regions.

Guidewire’s data indicates that over 90% of property damage in California is concentrated in just 10% of the state, with homes in these areas being 50 times more susceptible to wildfire damage, as per the technology firm’s findings.

Harnessing Data and Analytics to Navigate Climate Change-Related Risks

Catastrophe risk is significantly impacted by climate change, influencing the severity and frequency of storms, hurricanes, and wildfires, as Arnemann pointed out. He noted that catastrophes, by their nature, are unpredictable, and the regulatory framework often restricts insurers from considering present, let alone future, conditions.

Modern risk modeling techniques can account for the continuously evolving environmental and urban landscapes, making this dynamic approach essential for insurers, especially given the growing volatility of extreme weather events.

Arnemann emphasized, “Allowing the market to price the risk is the only way to have a market in the first place.” He expressed enthusiasm that the increased capacity to employ modern methods will revitalize the market and address many of the ongoing challenges.

Guidewire provides digital, core, analytics, and machine learning solutions to property and casualty (P&C) insurers, and its HazardHub platform is known for its extensive property risk data, casualty risk data, and hazard risk scoring in the P&C industry.

What Lies Ahead for California’s Insurance Market?

Despite his optimism, Arnemann acknowledged that there is still a considerable journey ahead before California’s insurance market fully recovers. He stressed the importance of the state approving insurers’ rate filings, as the DOI has faced challenges in processing the filings that were due in April, with numerous companies still submitting their rate filings.

Arnemann clarified that while modern risk modeling isn’t a panacea, California’s approach could pave the way for more innovation. “It’s less about having models that are perfectly accurate in representing the changing risk landscape and the increasing frequency and severity of events,” he noted. “It’s more about allowing insurers to leverage the models that do exist.”

He emphasized that models are continuously evolving and that the primary opportunity lies in utilizing higher-resolution models. In conclusion, Arnemann stressed the importance of deploying every available tool to reduce risk and, when risk is unavoidable, ensuring a resilient insurance market that aids people in recovering and rebuilding their lives and livelihoods.