Insurance costs rising
In the small Riverside-St Andrews network community tucked into Cupertino foothills, there was consternation among residents when an insurance company designated their neighborhood a wildfire zone. A local resident called Hari wrote in an email to the neighborhood, “Hi Neighbors I got a notice from my current insurance company that my house is in a wildfire zone and I need to carry FAIR Plan fire insurance which costs over $3500.”
The alarming increase in the number and severity of weather and climate disasters in the United States has led insurance companies to raise premiums or withdraw entirely.
Another neighbor wrote back. “Our neighbor Cheng said that AAA canceled his fire insurance due to this concern. We are insured with State Farm, and luckily have no such issue so far.”
State Farm is the largest home insurer in California, covering about 1 in every 5 homes in the state.
“The costs of extreme weather events from climate risk have grown. Insurance has become less available and less affordable. Large insurance companies withdraw from climate-vulnerable regions entirely and sharply raise premium rates and underpay damages from climate disasters,” said Loxdan Haedtlex, a climate financial strategist with the Sunrise Project and Climate Cabinet at an Ethnic Media Services briefing on June 6.
Wildfire risks shape insurance policy
In May, State Farm announced it would pause issuing homeowner insurance policies in the state, citing wildfire risks. “State Farm General Insurance Company made this decision due to historic increases in construction costs outpacing inflation, rapidly growing catastrophe exposure, and a challenging reinsurance market,” they said.
As wildfires continue to grow in frequency and scale across California, and as the state’s homeowner’s insurance crisis continues to worsen, the California Department of Insurance (DOI) has issued a proposed regulation that, for the first time, would allow insurers to rely on catastrophe models in setting insurance rates.
On March 20, State Farm said it would exit the homeowners insurance market in California. The company cited “inflation, catastrophe exposure [and] reinsurance costs” among the reasons. But now it’s telling customers that they can keep their policy if they also sign up for the California FAIR Plan for fire coverage, according to a letter sent out by the company.
California FAIR Plan coverage
The FAIR Plan is a state-created but privately run insurer of last resort which, at its most basic, covers damage from fire, lightning, internal explosions, and smoke.
Private market policies that cover risks to homes other than fire are traditionally known as difference in condition policies.
The Department authorized State Farm to offer a difference in conditions policy to its nonrenewed policyholders who are unable to find traditional coverage from another company. For fire risk, they have to get supplementary insurance that is FAIR Plan.
“ This problem is actively under development and there are major legislative proposals and regulatory proposals being debated in Sacramento,” said Haedtlex.
What drives the cost of insurance?
“You will see a wide variation in the most affordable states in 2021 where homeowners spent less than 1% of their income on homeowners insurance. In contrast, the expenditure share in say Florida in 2021, was more than 4 times higher,” said Vika Kilger, Assistant Vice President of the Insurance Research Council, a nonprofit organization that looks at public policy issues impacting the property casualty insurance industry.
“We looked at the key factors driving the variations that we have seen across the states in affordability,” said Kilger. “We looked at claim data that comes from one of our reports. Natural hazards, most notably wildfires, are an important driver of insurance cost as are weather related events which would be hurricanes, hail, windstorms etc. We look at claim frequency, which means how often claims are filed, catastrophe claims which are identified as a widespread event as opposed to non-catastrophe claims, which are more isolated such as an electrical fire or things that don’t impact a large number of homes. We also look at claims severity, which is the average payment per claim for both catastrophe and non-catastrophe. And then finally we look at a couple of measures that are related to claims settlement. So if you look at Florida, for example, weather, hazard risk, and the expense in litigation index are quite high for Florida,” said Kilger.
Choosing insurance coverage
“Actually, we switched from Farmers to State Farm several years ago simply because Farmers notified us at that time about an outrageous increase in fire insurance premium because we are located in a high-risk area,” said a resident of the Riverside community.
“I searched the internet and found an article explaining the reason State Farm did not do that was because the premium they charge was based on the actual number of claims in the area, rather than the home locations per se (as Farmers did).”
Ensuring that insurance companies stay afloat and functioning
Seven of the state’s 12 largest insurers have paused writing new policies, according to California Insurance Commissioner Ricardo Lara.
“Unlike public and private utilities, insurance companies are not legally obligated to provide coverage to anyone, ” he said at the briefing. “We essentially have been operating with 20th-century regulation for a 21st-century world where climate change is affecting every aspect of our lives.”
“Right now,” said Lara, ” it’s not enough to just shop for insurance. You have to hunt for it.”
“As the insurance commissioner, my job is twofold. I need to make sure that consumers are protected and that insurance companies remain solvent during this crisis.”
His department authorized State Farm to offer a difference in condition policy.
“ I’m doing the largest reform in more than 30 years,” he said “Nobody wants an insurance company to lose solvency and then consumers are the ones that ultimately get hurt.”
Under the proposed regulation, insurers will be permitted to use catastrophe models to simulate the future risks of earthquakes, floods, and wildfires when setting rates, authorizing the use of forward-looking catastrophe models that use algorithms to quantify the risk of future natural disasters. At present unlike other states, California requires insurers to price homeowners insurance based on historical experience. Now the insurers take future risk into account while pricing policies.
His Sustainable Insurance Strategy, says Lara will strengthen the insurance market in California.