The flight of insurance from California

Environmental, social, and governance (ESG) policies continue to impact the insurance industry, with states such as California, Florida, Louisiana, and Colorado at the forefront of environmental changes, specifically due to catastrophic events. California has been one of the most affected states when it comes to environmental change, as well as social and state insurance governance. The shifting landscape of the state's insurance industry has received significant attention as companies grapple with adopting policies and risk assessment strategies in response to environmental challenges. Compounding this, major players have decided to leave. The ramifications have created a domino effect across the state and insurance industry.

Why are insurers leaving?

California insurance companies have adjusted their policies and risk assessment strategies due to the escalating risk of wildfires. To mitigate this growing risk, insurance companies have enforced more stringent underwriting guidelines, which include mandatory home hardening criteria and elevated premiums for properties located in high-risk areas. The resulting reduced availability and affordability of insurance coverage has created challenges for homeowners and businesses by causing financial instability and reduced efficacy related to post-fire recovery efforts.

Compared to other states in the US, California has stringent regulations; one example is that Department of Insurance (DOI) approvals take longer. In most cases, rulings do not favor insurance companies. Now, companies like Allstate and State Farm, ranked as the number one and four homeowners' insurers in the state, are pulling out due to high wildfire coverage costs, reinsurance premiums, and high inflation. State Farm cited historic increases in construction costs outpacing inflation, rapidly growing catastrophe exposure, and a difficult reinsurance market as reasons to exit California. Allstate echoed similar reasoning, stating that insuring new homes in California comes with significantly higher expenses than the premiums they receive from policies affected by wildfires, increased costs for home repairs, and elevated reinsurance premiums.

To illustrate these higher expenses, the cost to build a home in California is approximately $1.35 million, which significantly exceeds the national average of $300,000. Reinsurers are growing worried about these costs and the rising cost of disasters, and this is reflected by the price of adjusted property catastrophe rising 33% on average this year, after a 25% increase in 2022. To handle this increasing risk in California, insurers are looking to reinsurers to help bear the risk.

Why are insurers leaving?

Amidst rising claims, insurers have sought to remain competitive through rate increases to maintain profitability and offset higher claim costs. However, rate increases have become a battle due to regulation hurdles. One example is Proposition 103, passed in 1988 by California voters, and under this legislation, insurers are required to obtain approval from the elected insurance commissioner before implementing proposed rate increases. As part of the proposal to the commissioner, insurers would include historical modeling dating back 20 years. However, as cities become more crowded, they naturally expand to the surrounding areas, which means homes are being built in areas that did not exist 20 years ago. In the case of California, this involves building homes in places that are susceptible to wildfires, and unfortunately, there is no historical modeling for these areas.

Before exiting the California market, State Farm attempted to make necessary adjustments to continue providing coverage in the state by proposing to the insurance commission an increase in homeowners insurance premiums of 28.1% and an increase in rental property insurance premiums of 20%. These rate increases could have improved the competitive foothold of State Farm, but they were ultimately struck down. Following the departure of both State Farm and Allstate, both companies were accused of withdrawing from the California property insurance market as a tactic to pressure the commission to approve rate increases. According to Proposition 103, insurers cannot abandon a market solely to increase profits, as such decisions require approval from the state commissioner.

How will this impact insurers in the market?

This exodus of key players from the insurance market impacts not only companies leaving and individuals with homeowners insurance policies, but also anyone from state-funded insurers to private insurers and consumers. Both the states and regulators need to take a cautious and balanced approach to enticing insurers to maintain a presence in California. Action needs to be taken to resolve this growing issue because inaction could lead to other big players in the market heading for the exit. Additional insurer departures could place added stress on the homeowner's insurance market in California, which could lead to a collapse, which is why it is so critical to protect the overall health of the market.

As the health of the insurance market in California continues to be threatened, programs like the California Fair Access to Insurance Requirements (FAIR) plans are on the rise. The FAIR Plan is a non-profit program designed to provide home insurance options to homeowners that reside in high-risk areas. Instead of a single insurer handling the entirety of a given risk, the FAIR plan hedges its risk through taxpayer funding, and various insurance companies. companies. In most cases, these individuals must be qualified for coverage through a traditional insurance provider because they reside in a high-risk area. FAIR Plans are state-operated initiatives that receive financing through taxpayers and private insurance companies. Examples that serve similar purposes include state-run plans like Citizens in Louisiana, and Citizens in Florida. This plan is utilized for basic fire coverage when conventional insurers refuse to provide coverage because the property is in a high-risk zone. Over the past few years, California's FAIR plan saw an influx of applications, reaching over 272,000 homes covered as of 2022. This surge in applications puts a massive burden on the market to fill in the gap left by the insurers who have left, which could lead to a collapse of the private market for homeowners insurance altogether.

This situation is forcing many residents in several areas across California to live without insurance, thus exposing themselves to homeowner risks and losses. The Insurance Information Institute data shows that in California alone, more than 1.2 million homes are exposed to extreme wildfire risk. If the insurance environment does not change, this might lead to a situation where California residents find themselves with no viable options to safeguard their biggest asset—their homes.

Has this happened before?

Unfortunately, insurers leaving a state in the U.S. is not a new phenomenon. States like Florida, Louisiana, and Colorado have witnessed insurers pull business from the state for a variety of reasons:

Florida

• Sixteen homeowners' insurance companies left Florida in July 2022, primarily citing business risk as the reason behind their decision.
• The Florida Office of Insurance Regulation (OIR) is responsible for assessing insurance company ratings. Several companies experienced a downgrade from an A rating to either S or M (Substantial or Moderate), and the primary mortgage providers, Freddie Mac and Fannie Mae, only accept A ratings, which results in customers switching to different insurers to get better rates.
• The uncertainty around availability of reinsurance is forcing insurance companies to rethink taking new risks and renew selected ones. 

Louisiana

• In 2022, more than 80,000 policies were terminated due to the substantial financial losses insurers endured from severe storms such as Laura, Delta, and Zeta, amounting to $10.6 billion.
• In 2021, the devastation caused by Hurricane Ida resulted in an astounding $30 billion in insured losses, pushing multiple insurers into insolvency.

Colorado

• The Marshall Wildfire cost insurers over $2 billion.
• A study commissioned by state lawmakers found that 76% of carriers decreased their exposure in Colorado in 2022, leaving the five largest insurance companies to dominate the market. The average insurance premium has jumped close to 50% in the last three years.

What is next?

The DOI's role will become more crucial as insurance companies exit California and other states. The California DOI is typically reluctant to allow rate increases, but moderate increases where risk is appropriate as expected. Furthermore, Capco anticipates that there will not be sporadic rate hikes despite some insurers requesting significant increases of 20% or even 30% for homeowners. Instead, Capco predicts a greater emphasis on collaboration between insurers and the DOI to ensure ongoing coverage for policyholders as the DOI will take on additional governance and responsibilities when partnering with insurers to protect insured individuals.

Additionally, the rise of individual FAIR plans is almost a guarantee as threats from wildfires, storms, hurricanes, and various other catastrophic events continue to rise.  This is aided by the directive from California's insurance commissioner, Ricardo Lara, to expand its coverage to include commercial, farm, and broader overall protection for policyholders. In addition to those who rely solely on the FAIR plan, an increasing number of insurers in California are preparing to provide supplementary tandem coverage alongside the FAIR plan as a stopgap. Some have already initiated this approach. The combination of risk spreading, and partially outsourced funding is a viable alternative for California insurers and all states with volatile weather patterns. At the time of publication, 30 states with inclement weather patterns have instituted the FAIR Plan. 

Finally, Capco believes more favorable rulings will come out in support of insureds. One significant change is the newly introduced Insurance Code, section 675.1(b)(1). It prevents insurers from cancelling or refusing to renew property insurance policies in wildfire-affected ZIP codes for one year following the declaration of a state of emergency. To speak plainly, this means insurers are obligated to maintain coverage for residents in affected ZIP codes, beginning August 29th, 2023.  

The exodus of insurers from California is an unfolding situation, so it is impossible to predict how it will play out, given it was only last year when Florida, Louisiana, and Colorado saw this happen in their states. The ongoing point of tension is that insurers are trying to run profitable businesses, and government agencies are trying to ensure coverage for all who need it. On top of this, there are legitimate concerns that mass departures could put pressure on the remaining insurers, with heightened policy loads potentially leading to insolvency. As insurer departures continue in California, there is the possibility that one of the solutions instituted around the country will help to put the insurance market right back on track; unfortunately, it is too early to predict.