State Farm, the largest homeowners insurance company in California, recently announced it would stop “accepting new applications including all business and personal lines property and casualty insurance, effective May 27, 2023.” The company said the decision was made “due to historic increases in construction costs outpacing inflation, rapidly growing catastrophe exposure, and a challenging reinsurance market.”
State Farm’s decision echoes a similar declaration made by Allstate in November, which announced in its third quarter 2022 earnings report it would stop writing new policies for homeowners insurance in California.
More frequent and severe weather events have been attributed to climate change, which leads to more risks for damages and higher policy premiums.
According to The Ascent, “In 2021, there were 20 weather events that cost the insurance industry at least $1 billion dollars, above the annual average of 12 severe events since 2000. Fourteen of those events occurred in the U.S.”
Nationwide, there’s a growing trend of many insurance companies’ hiking rates, limiting coverage, or declining new policies altogether.
Florida and Louisiana saw similar reactions from insurance companies following extensive hurricane events.
“Premiums are rising in Colorado amid wildfire threats, and an Oregon effort to map wildfire risk was rejected last year because of fears it would cause premiums to skyrocket,” says ABC News. “Scientists say 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 recent years, California has experienced the largest and most destructive fires in state history.
“Some California homeowners already are going without coverage, and a shortage of new policies could make it more difficult to buy a home.”
In many cases, the only option left for insurance to cover weather damages is a state-run insurance agency, such as Texas Windstorm Insurance Agency, Florida’s Citizens Property Insurance Corp., and the California Fair Access to Insurance Requirements Plan (FAIR).
“In California, the loss of large insurers could create more pressure to loosen consumer-minded policies that have held down rates in the state for years,” ABC News adds. “Voters approved Proposition 103 in 1988, which allows the state insurance commissioner to reject proposed rate increases and order refunds. It has been credited with saving consumers billions of dollars, but the industry says it places constraints on accurate underwriting and pricing risk.
“Last year, Insurance Commissioner Ricardo Lara advanced regulations requiring insurers to give discounts to customers if they followed new standards like building fire-resistance roofs and creating defensible space around their homes.”
Proposition 103 also requires insurance companies in California to receive preapproval before implementing rate hikes.
Before announcing they would stop writing new policies in California, both Allstate and State Farm were seeking major rate hikes in the state.
Consumer Watchdog, a nonpartisan advocacy group, said State Farm’s decision was unlawful, according to ABC News.
“Insurance companies can’t just stop selling insurance to consumers in order to make more money for themselves,” Harvey Rosenfield, the author of Proposition 103 and the founder of the group, said in a statement, according to ABC News. “They have to open their books and get the [state] insurance commissioner’s approval.”
Gabriel Sanchez, a spokesman for the California insurance commissioner’s office, says Rosenfield’s claims aren’t true, according to SiliconValley.com.
“Allstate’s action in November 2022 was reported in industry trade publications at the time, and California law does not require prior approval when a company pauses new policies,” Sanchez noted. “Our department’s rate regulation experts carefully review all insurance company rate filings to protect Californians from unjustifiably high rates.”
A Consumer Watchdog news release included the following recommendations for the California insurance commissioner:
- “Continue the Department’s longstanding protection of Californians against industry proposals to[ ] pass on to consumers the cost of reinsurance, which would cause insurance rates to go up by an estimated 40%, and to replace verifiable data with secret, biased algorithmic models when requesting future insurance rate increases.
- Address redlining and market withdrawal. Set clear and uniform rules for analyzing whether withdrawals are consistent and supported by data. The insurance industry should not decide housing policy in California; that responsibility belongs to state and local officials accountable to the voters.
- Mandate disclosure of each insurance company’s contributions to climate change through direct and indirect emissions, underwriting and investing in fossil fuel projects, and examine whether each company’s underwriting of fossil fuels is consistent with state law and California’s 2045 Net Zero climate goals.
- Require insurance companies to consider the actions taken by homeowners and communities to limit wildfire risk when they decide whether to sell an insurance policy, not just when insurers set premiums as required under the Commissioner’s new rules.
- Initiate a public investigation of whether the insurance industry is evading Proposition 103 when it sells insurance to condo associations.”
Additionally, the Consumer Watchdog news release claims the insurance industry remains profitable in California:
- “California homeowners’ insurance companies were more profitable than the national average over the last 20 years. They earned an average 8.8% return on net worth in California, compared to 6.2% nationally, according to data reported to the National Association of Insurance Commissioners.
- PG&E and Edison, the utilities that caused the biggest fires in California, were forced to reimburse insurance companies $12.1 billion for the damage from the 2017-18 wildfires.”
Broken risk models
In a March 2023 Senate budget committee hearing, Committee Chair Sheldon Whitehouse, D-R.I., “asked how insurers are dealing with ‘weather anomalies’ caused by climate change that make storms and other events harder to predict,” according to Scientific American.
Aon PLC President Eric Andersen agreed it’s an issue: “The models of old that have been used looking backwards are not as valuable to the models that need to be developed for a changing climate.”
The insurance coverage issues currently being experienced in California resemble similar woes Florida experienced after Hurricane Andrew hit Miami in 1992. After the event, many insurance carriers went bankrupt, and several others left the state entirely.
In response, the state created a system for windstorm insurance that’s based on small insurance companies that are backed by the “Citizens Property Insurance Corporation, a state-mandated company that would provide windstorm coverage for homeowners who couldn’t find private insurance,” The New York Times says.
The system worked for a while, but beginning with Hurricane Irma in 2017, Florida has seen a series of hurricanes year after year. This broke the system insurance companies relied on—one bad year followed by a few years when there were no catastrophic weather events.
“Even as homeowners in coastal states face rising costs for wind coverage, they’re being squeezed from yet another direction: Flood insurance,” The New York Times adds.
The National Flood Insurance Program was created by Congress in 1968 to provide affordable flood insurance in flood-prone areas.
“In 2021, FEMA, which runs the program, began setting rates equal to the actual flood risk facing homeowners — an effort to better communicate the true danger facing different properties, and also to stanch the losses for the government,” continues The New York Times.
“Properties located in high-risk areas should plan and expect to pay for that risk,” David Maurstad, head of the flood insurance program, said in a statement.
“The best way for policymakers to help keep insurance affordable is to reduce the risk people face, said Carolyn Kousky, associate vice president for economics and policy at the Environmental Defense Fund,” according to The New York Times. “For example, officials could impose tougher building standards in vulnerable areas.
“Government-mandated programs, like the flood insurance plan, or Citizens in Florida and Louisiana, were meant to be a backstop to the private market. But as climate shocks get worse, she said, ‘we’re now at the point where that’s starting to crack.’”
Preparing the insurance industry for climate change resiliency
The Insurance Regulator State of Climate Risks Survey, conducted by the Deloitte Center for Financial Services, found:
- Most U.S. state insurance regulators expect all types of insurance companies’ climate change risks to increase over the medium to long term, including physical risks, liability risks, and transition risks.
- More than half of the regulators surveyed also indicated climate change is likely to have a high impact or an extremely high impact on coverage availability and underwriting assumptions.
“The regulator survey helped uncover several possible actions that carriers could implement—both within and outside the organization—to boost their climate readiness over the long term,” the Deloitte analysis notes. “The survey results were supplemented by interviews with rating agencies and leading environmental and risk management experts. They identified opportunities for insurers to become more resilient to climate-related risks in five key areas:”
- “Raise the profile of climate risk in the organization.” Deloitte advises companies to “establish a clear governance structure, including the creation or assignment of dedicated roles, at executive as well as staff levels, to evaluate the potential impacts of climate-related risks. They should also embed ongoing climate risk assessment and mitigation efforts across the company, including underwriting, pricing, reserving, investing, and even in new product development.”
- “Improvement assessments of climate risk using advanced analytics.” Deloitte suggests using “historical weather records, insured property data, and assumptions regarding future climate conditions to improve risk selection and pricing. Augmenting climate change models with big data/social media information and predictive analytics also has a huge potential to significantly broaden risk assessment considerations.”
- “Take an enterprise-wide view while managing climate risks.” To provide carriers with a complete understanding of climate risk exposure, Deloitte advises companies to “include climate risk assessment more consistently in their broader enterprise risk management (ERM) framework, which can help in identifying and correlating impacts across different lines of business as well as investments.” This approach should include testing a wide range of climate-related scenarios to discover capital and liquidity weaknesses.
- “Work with policyholders and policymakers to alleviate climate risk exposure.” Deloitte suggests having carriers offer incentives to policyholders, such as premium discounts, “who invest in mitigating climate-related risks and containing related claims through adaptation measures.” Additionally, carriers should educate policyholders and legislators about steps they can take to better protect properties from severe weather events.
- “Work with administrative agencies to develop climate-resilient public policies.” Deloitte analysts advise insurers to work closely with administrative agencies and builder associations to discourage high-risk zone development and to encourage the use of materials and building designs that will withstand regional climate threats. Additionally, building owners and homeowners can be incentivized through government programs to retrofit structures to make them more resilient to natural catastrophes.
“In short, rather than making premiums unaffordable, which can lead to a rise in the number of uninsured, insurers could work proactively with administrative agencies to develop preventive and adaptive public policies supporting a climate-resilient future,” the Deloitte article adds.