California weighs use of catastrophe models in home insurance

By Anne C. Mulkern | 10/05/2023 06:37 AM EDT

The move comes as major insurers such as State Farm have stopped writing new policies in California and other states following an intensifying barrage of disasters that, along with expanding real estate development, has fueled economic losses.

A firefighter searches for human remains in a trailer park destroyed in the Camp Fire on Nov. 16, 2018, in Paradise, Calif.

A firefighter searches for human remains in a trailer park destroyed in the Camp Fire on Nov. 16, 2018, in Paradise, Calif. John Locher/AP Photo

California appears likely to allow insurance companies to consider risks from climate change when calculating premiums, marking a major shift in state policy as underwriters reduce their coverage amid soaring disaster costs.

State Insurance Commissioner Ricardo Lara plans to rewrite insurance regulations to allow wider use of catastrophe models in the nation’s most populous state for the first time in 35 years. The change is meant to entice insurers to expand their coverage to homeowners in areas that face growing perils from extreme weather.

It comes as major insurers such as State Farm have stopped writing new policies in California and other states following an intensifying barrage of disasters that, along with expanding real estate development, has fueled economic losses. The move follows a catastrophe-filled summer in which high temperature records were broken around the world.


California law mostly bars the use of catastrophe models in setting insurance rates under rules imposed by Proposition 103, a state ballot measure passed in 1988 that required insurers to set premiums based on the last 20 years of losses.

But in recent years, seven of the top 12 insurance companies operating in California have either stopped writing new policies or restricted them because of damage from extreme weather. Several insurers have agreed to expand coverage if the state allows them to use catastrophe models to estimate their economic losses from future disasters. Many of the models use historic disaster data and estimates of future losses to generate scenarios for predicting destruction from hurricanes and other perils.

“The business of writing property insurance has changed forever,” Stephen Young, senior vice president and general counsel at Independent Insurance Agents and Brokers of California, said during a recent workshop focused on the changes. “The current regulatory system that California has been using is not up to the task of meeting this challenge.”

In the last decade, California experienced nine of the 10 most destructive wildfires in state history. In 2019, the number of insurer cancellations or nonrenewals in California shot up to 235,000 from 165,000 a year earlier, state figures show.

California is one of at least five states facing insurance problems, such as companies becoming insolvent or scaling back coverage. Other affected states are Colorado, Florida, Louisiana and Texas, which are highly exposed to wildfire or hurricane losses.

“We’re seeing it across the country,” said Jeremy Porter, head of climate research at First Street Foundation, a group that analyzes data related to climate risks. “We’re seeing increased exposure to climate hazards, and we’re seeing it in different regions of the country, different types of hazards.”

The risks vary, from wildfires in the West to extreme winds in Gulf Coast states to heavy rains and flooding in the Midwest.

Insurance companies are now factoring in climate change risks that real estate markets in many states have largely ignored in terms of home values, Porter said.

That includes the cost of some homeowner insurance policies in Florida that have risen from $1,500 to $9,000 annually, he said. In California, people are losing coverage and relying instead on the state-run insurer of last resort.

About 3 percent of residents now get their coverage through the FAIR Plan, a pool of insurers doing business in California. FAIR sells to residents unable to get it directly from an insurance company. Member companies share in profits and losses.

The number of FAIR Plan policies jumped nearly 48 percent in 2021 — the latest year with figures available — compared to 2018. The growth has contributed to the plan’s $332 million deficit.

Debate: Open models vs. private ones

Consumer groups criticize the move to potentially allow insurers to use catastrophe models, saying the private models shroud the data they use in secrecy. Instead, these groups want the state to develop a public model that can be used to calibrate new insurance rates.

But some consumer advocates said they fear Lara already has made up his mind about allowing the models, despite the series of ongoing public feedback workshops.

Lara’s comments last month on potential changes “felt like to me that marching orders have been given to department staff, and that those marching orders came directly from a series of closed-door meetings with in some cases some legislators and with the insurance industry itself,” Robert Herrell, Consumer Federation of California executive director, said last Friday. “We are merely checking a box … because the die feels like it’s already been cast here.”

Current California insurance regulations don’t adequately factor in climate change or inflation, Mark Sektnan, vice president of state government relations at trade group American Property Casualty Insurance Association, said in an interview.

“None of these are picked up in the existing system in California, which is based only on historic losses” on a property over the last 20 years, he said. “That’s like driving your car through the roof by looking through the rearview mirror and avoiding the windshield.”

Insurers had hoped to get legislation passed this year enacting the changes, but that collapsed before the Legislature’s session ended in September.

Lara in a statement on the workshop said it was “aimed at fostering a resilient insurance marketplace that protects and serves the needs of all Californians.”

“The input we received [last Friday], and throughout this multi-year effort, is vital to shaping a sustainable and competitive insurance market that benefits our communities and safeguards homeowners and businesses from the growing risks posed by climate change.”

Catastrophe models currently are used in most other states, with California somewhat of an anomaly, said Roger Grenier, senior vice president at Verisk, which develops catastrophe models.

The one place where California currently allows use of the models is in the sale of insurance for earthquakes. Those policies are sold separately from traditional homeowner insurance, because the damages can be so high.

But the models are needed as states face more extreme weather, Grenier said.

“When you look at these very rare but impactful events, catastrophe events, there’s very little historical data with which to develop rates and manage the risk,” he said. “So insurers for many decades have used catastrophe models, which effectively simulate what the loss activity could be.”

Even those who generally oppose the use of the models signaled they see it as likely to happen in California with traditional homeowners insurance.

“We all acknowledge that the risk of wildfires is changing and we want to look at new tools to figure out how that impacts the likelihood that our homes will burn down,” Carmen Balber, executive director of Consumer Watchdog, said in an interview. “We want to make sure that those tools are as open and transparent as possible.”

Most companies that sell the models do not release information on how they calculate risks. They consider the models proprietary, as they compete with companies selling models.

“We invest a lot of our own resources in developing these models,” Grenier said. “We need to protect the intellectual property that we put into them. So that’s really the the key issue, is that there needs to be an incentive for us to continue to build and improve upon these models and protecting the [intellectual property] is one way that we do that.”