California Proposes Regulatory Changes to Capture Climate Risk

As insurers withdraw or limit their exposure to escalating natural catastrophe risks, California has announced it will write now rules to allow insurers to consider current or future risks in ratemaking. A caveat: the state will require insurers participating in the market to take on customers in the high-risk wildfire areas of the state proportional to their market share.

California is the nation’s largest P&C market with more than $11 billion in homeowners and fire insurance premiums written. Twelve insurers account for 85% of the insurance coverage in the state and seven of these insurers have left the state or limited new policies in the market. Seven of the top 12 insurance companies in California have either paused or restricted new business in the last year – and eight insurers have requested rate increases of 20% or more this year.

“Modernizing our insurance market is not going to be easy or happen overnight. We are in really unchartered territory and we must make difficult choices when the world is changing rapidly,” Lara said at a news conference. “We just don’t have a stable insurance market,” said state Sen. Bill Dodd, a Democrat from Napa, whose Northern California district has been charred by wildfires.

California's proposal would allow insurers to incorporate the cost of reinsurance into their rate calculations. In doing so California would align with the majority of states that allow insurers to consider reinsurance as an expense and thus include some of all of that cost in setting the price of a homeowner’s policy.

The proposal also permits insurers to use forward-looking projections in catastrophe risk modeling, recognizing that historical data and traditional risk assessment tools struggle to accurately identify, localize and differentiate risks associated with the rapidly evolving impacts of climate change, urban expansion and land-use.

The Insurance Information Institute estimates California has more than 1.2 million homes at risk for extreme wildfire, far more than any other state. “The number of acres burned in California has grown steadily in recent years, as more people are moving into fire-prone areas of the state,” the institute said in a statement on the company departures from California. “More homes in harm’s way — combined with rising costs of repairing or replacing houses either damaged or lost to fire — leads to increased insured losses.”

In June, State Farm announced it would stop accepting applications for all business and personal lines of property and casualty insurance (excluding auto), citing inflation, a challenging reinsurance market and rapidly growing catastrophe exposure. “We take seriously our responsibility to manage risk,” State Farm said. “It’s necessary to take these actions now to improve the company’s financial strength.”

Their move follows a decision in November by Allstate, to pause new homeowners, condo and commercial insurance policies in California. “The cost to insure new home customers in California is far higher than the price they would pay for policies due to wildfires, higher costs for repairing homes and higher reinsurance premiums,” Allstate said in a statement.

California is not alone as climate change has made the West warmer and drier over the last three decades and will continue to make weather more extreme and wildfires more frequent and destructive. In Colorado, a study commissioned by state lawmakers found that 76% of carriers decreased their exposures in Colorado in 2022, leaving the five largest insurance companies to dominate the market. In Oregon, a new map released last year rated the wildfire risk of every tax lot in the state — labeling nearly 80,000 structures as high-risk — was abruptly shelved amidst fears of rising rates.

Meanwhile, the Federal Reserve Board of Governors recently released a paper highlighting evidence of decoupling of insurance rates from their underlying risks and identifying restrictive regulation as a driving force behind this pattern.

Image: Ross Stone