After State Farm in late May that , people shopping around for new insurance had one fewer option. When days later that Allstate had quietly made the same decision last year, Californians are now left wondering: How bad is this? And how should the state respond?
The 鈥渃risis鈥� in California鈥檚 insurance market was caused by 鈥渁 laser focus only on affordability,鈥� said Nancy Watkins, a principal at Milliman, an actuarial firm, at a legislative hearing on Wednesday. The companies are operating with 鈥渧ery crude tools鈥� at the expense of availability and reliability, she said.
She said the current regulatory system is too rigid. 鈥淚t鈥檚 like you鈥檝e got your steering wheel locked straight ahead, you鈥檝e got your speed set on cruise control, and now you find yourself on the Pacific Coast Highway,鈥� she said. 鈥淲hat insurance company would agree to that?鈥�
Home insurance premiums in California are a little cheaper than the national average 鈥� and much lower than premiums in other disaster-prone states like Florida and Louisiana. That鈥檚 without accounting for the fact that California has some of the most expensive housing in the country.
California still has about 115 companies offering home insurance, said Michael Soller, a deputy commissioner for the state鈥檚 insurance department. As for whether more companies are likely to follow State Farm and Allstate, 鈥渨e don鈥檛 think that will happen,鈥� he said.
Consumer and insurance industry groups and other experts have ideas for what they鈥檇 like to see California do in the wake of the news 鈥� few of which they agree upon. Here鈥檚 the debate over four of those ideas.
Require State Farm to keep issuing new policies
There鈥檚 disagreement whether this idea, backed by the group Consumer Watchdog, is legal.
The idea hinges on how insurance prices are regulated in California. Under current laws, insurance companies can鈥檛 just charge whatever they want: They have to submit their proposed rates to the insurance department, which they back up by explaining their projected costs, losses, revenue and more. State regulators can approve a company鈥檚 proposed rates, or deny them, if they think, for example, the rates are unjustifiably high, or so low that they could put the company鈥檚 finances at risk.
Harvey Rosenfield, founder of Consumer Watchdog, said if a company suddenly says that it鈥檚 not going to take the same number of customers that it had projected when it got the department鈥檚 approval, then it has changed the assumptions on which the approval was based.
鈥淭hey granted themselves a de facto rate increase by reducing the risk鈥� in a state where that鈥檚 illegal, said Rosenfield. The department could issue a notice to State Farm, he said, and tell the company it needs to keep selling new home insurance policies until it submits new rates and those rates are approved.
The insurance department disputes that it has the power to do this. 鈥淭heir claims are not supported by law,鈥� said Soller, the deputy commissioner. 鈥淭here鈥檚 a reason why it hasn鈥檛 been done by any insurance commissioner before.鈥�
Let insurance companies use forward-looking catastrophe models
The kinds of data and statistical models insurance companies can use to set prices may sound like a nighttime sleep aid, but it鈥檚 a matter of lively discussion in insurance circles.
When a company tries to justify rate changes, it is required to rely on past losses to project future losses. It can鈥檛 use factors like the locations of new homes it is covering 鈥� whether they鈥檙e in downtown San Francisco or rural wine country 鈥� or the increased risk of wildfires due to climate change.
鈥淲e do it in a very old-fashioned way, and it needs to be updated,鈥� said Rex Frazier, president of the Personal Insurance Federation of California, an insurance industry group that counts State Farm as a member. He supports the use of forward-looking models, which are generally provided by other private companies. California already permits insurers to use models for earthquake insurance.
If a company is trying to figure out how much it should charge for earthquake coverage, it would look at proximity to fault lines, Frazier said, but for wildfire insurance, California doesn鈥檛 do that.
鈥淔or wildfire it just says 鈥榃ell, looking backward, what have you paid over the last 20 years for wildfire clients?鈥欌�� he said.
Consumer groups generally oppose letting insurance companies use models, fearing that companies will use them to justify extreme price hikes, and that complex math will make scrutiny a challenge.
鈥淭hey鈥檙e just very sophisticated crystal balls,鈥� said Amy Bach, executive director for United Policyholders, a consumer group. Modeling companies generally see their models as intellectual property, which can pose a challenge for transparency. 鈥淥ur fear is that they overstate risk,鈥� said Bach.
About a week and a half after State Farm鈥檚 announcement, the insurance department said it would host a public workshop on use of models in insurance pricing, ahead of considering regulations. The workshop .
On Wednesday, the Assembly鈥檚 insurance committee held a hearing on models. When asked by a legislator whether the department was moving toward incorporating catastrophe models, a department representative confirmed that it was.
鈥淗istoric losses do not fully account for growing wildfire risks, or risk mitigation measures taken by communities,鈥� said Michael Peterson, a deputy commissioner at the insurance department, during the hearing.
Address the increasing cost of insurance 鈥� for insurance companies
Insurance companies are just like us: They buy insurance! When insurance companies buy it, it鈥檚 called 鈥渞einsurance.鈥�
The cost of reinsurance has , and State Farm cited 鈥渁 challenging reinsurance market鈥� as one of the reasons it decided to stop selling new home insurance policies in California.
When insurance companies explain their costs to the insurance department as part of the process for justifying their prices, they aren鈥檛 allowed to include the cost of reinsurance. The department hasn鈥檛 historically permitted it, Soller said, because it doesn鈥檛 regulate reinsurance.
鈥淲hat are insurers supposed to do when, on the one hand, the Department of Insurance is telling them 鈥榤aintain your solvency鈥� and then, on the other hand, when their costs go up, you can鈥檛 charge for it,鈥� said Frazier.
Insurance industry groups say it would help if they could incorporate the cost of reinsurance into their prices. But consumer groups say that the move would cause premiums to spike.
鈥淐alifornians would see immediate massive rate hikes 鈥� both as soon as that went into effect and ongoing,鈥� said Carmen Balber executive director of Consumer Watchdog. A reinsurance provider regulated by California would address problems she sees with the reinsurance market, Balber said, but that doesn鈥檛 exist currently.
Reduce the risk of disasters
The underlying problem is that disasters happen in California 鈥� at an increasing rate thanks to climate change 鈥� and that homes are at risk. They鈥檙e in the middle of the woods, or surrounded by flammable grasslands, or on the edge of bluffs that are expected to erode. Making homes less likely to burn, flood or collapse would be good for homeowners and would also make California feel less risky to insurers.
There鈥檚 no shortage of ideas for how to reduce risk, and there鈥檚 been action on this front in recent years. The insurance department, for example, has to consider whether homeowners take certain steps to protect their homes 鈥� like installing fire-resistant vents and clearing out vegetation under decks 鈥� in their prices.
California has set aside $2.7 billion for wildfire resilience over the past three years, according to the insurance department. When the department convened a group of environmental advocates, researchers, and public policy and insurance experts to make recommendations on how to reduce the risks of climate change, . Among the recommendations:
- Create statewide hazard maps so that future risks are more clear to the public
- Increase funding to retrofit homes
- And apply fire-resistant building codes in areas with moderate to higher fire risk.
Cutting greenhouse gas emissions would ultimately be the best way to reduce the risk, said Alice Hill, chair of the group convened by the department and a senior fellow for energy and the environment at the Council on Foreign Relations. But the world will get warmer even if we reduce emissions, she said, so focusing on where and how homes are built remains important.
鈥淭hat could mean not building in areas that are just becoming too risky,鈥� Hill said.
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