California allows wildfire cat models, waits for insurance industry reaction

It's still an open question whether insurers will implement catastrophe (cat) risk models in California, now that the state has allowed their use, and whether these models will solve the state's wildfire-related residential home insurance coverage crisis, according to Dr. Julia Borman, director of regulatory and rating agency client services for extreme event solutions at Verisk.

Verisk, the global data analytics and risk assessment firm that serves many top commercial and property and casualty insurers, became the first wildfire catastrophe model provider to ask the California Department of Insurance to review its model. Verisk made the request on January 2, the first day CDI accepted applications for its cat model process under its Sustainable Insurance Strategy. Moody's made the same request the next day.

"A user of the model can choose to incorporate it into their rate making," Borman said, referring to catastrophe models. "It [the new regulation] doesn't say they have to. It says if they choose to, they now can."

California is the last state in the U.S. to allow insurers to use cat models. All other states had already allowed their use. Cat models go further than historical models that California insurers were previously only allowed to use, as Borman explained. "Cat models combine the historical information with the available scientific information to better develop an understanding of the risk potential," she said.

Verisk cat models use several steps:

• Event generation: Catalogs of simulated events show a forecast of frequency, severity, location and other aspects of all plausible catastrophes.
• Local intensity calculations: These show the intensity of the hazard at each site in the simulated events.
• Exposure data: Information on the property, its replacement value and physical characteristics is fed into the model.
• Damage estimation: Calculation of physical damage for each risk exposure in the model.
• Insured loss calculation: This final step applies policy terms and conditions to estimate insured losses.
  

Along with these steps, other types of information can be fed into Verisk's cat model or compared to the results from the model, according to Borman. "Cat models are meant to be an understanding of the risk potential. You can run one location. You can run your portfolio. That's up to the user," she said. "Our models can take into account things like mitigation actions. Insurers can input data like roof types. Then the insurer takes the view of risk and they incorporate it with all of the information that they have."
In related developments, CDI finalized its Net Cost of Reinsurance in Ratemaking Regulation part of its Sustainable Insurance Strategy on December 30, 2024. The new regulation allows insurers to include the cost of reinsurance in their rates, and also requires insurers to increase coverage in high-risk areas. Opponents said earlier in December that the new regulation would lead to less coverage or costlier coverage.

According to a CDI spokesperson, the Sustainable Insurance Strategy requires large insurers that use cat models to cover 85% of wildfire distressed areas, and small or regional insurers must increase their coverage area by 5%. The Net Cost of Reinsurance in Ratemaking Regulation requires insurers using reinsurance to cover 85% of their statewide market share. If they are under this percentage, the insurer must increase coverage by 5% every two years until they reach and maintain 85% coverage.