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With news that the California FAIR plan is levying a $1B assessment on insurers in the state – half of which can be passed on to consumers – insurers, regulators, and consumers will increasingly face a difficult question: How to strengthen the growing instability of the state’s home insurance market, particularly in high wildfire risk areas.
While some solutions have been proposed in the wake of the devastating January wildfires, such as allowing the FAIR plan to borrow or issue debt to cover short-term liquidity needs, the majority of these solutions do not address the underlying fundamental issue: Climate related risks are increasingly becoming both more common and more severe.
Without addressing the foundational causes of these large losses, the California home insurance markets – as well as others in Colorado, Washington, and Oregon that are already showing signs of strain – will continue its downward spiral with fewer and fewer coverage options available in the state.
To address the root causes of these increasingly large, more frequent losses, regulators, carriers, and insureds must collectively come to the table in California. Absent unlikely federal action to mitigate climate change causes, all three parties have a vested interest in bringing stability to the California insurance market and ensuring that admitted coverage is available in high-risk areas.
We are seeing several necessary actions to prevent the California homeowners’ market from continuing to deteriorate to the point of potential collapse.
First, to mitigate widespread disaster in high-risk areas, state mandated building codes with incentives for retrofitting existing homes must be put in place.
The state government and department of insurance need to take a heavier hand in ensuring that new construction in wildfire-prone areas has proper mitigation measures mandated. These include ember resistant venting, proper brush clearance, and fire mitigation systems.
While initially this will increase the cost of new construction, the long-term cost as well as ability to more easily obtain financing for homebuyers will outweigh the upfront costs.
Additionally, existing homes need additional incentives in the form of rebates or property tax incentives for retrofitting to mitigate climate risk.Carriers already employ inspection firms to ensure claimed mitigation factors are present. Allying with these firms to consult on retrofitting and ensure mitigation factors are in place prior to a rebate would align regulators, carriers, and insureds interests.
Second, local government needs to step up its involvement in risk mitigation. Outside of the individual home mitigation factors discussed above, local governments must also play a larger role in mitigation of fire risk.
In addition to addressing infrastructure failings such as fire hydrants running dry due to lack of supply or low water pressure, efforts such as controlled burns on high-risk areas, local mandates for brush clearance and maintenance of combustible materials, and proper response procedures to ensure that small fires do not grow, are a must.
This will most certainly pit local governments against individual homeowners, who may not want to alter their property to comply—but the good of the overall community and ability to control a potential wildfire must outweigh individual concerns.
Third, carriers need the ability to utilize real-time risk data and charge rates that are commensurate with risks.As the root causes of wildfires are addressed, carriers must be allowed to more easily use recent risk data and file changes to rates in the admitted market.This will strengthen the insurance market and stabilize to homeowners’ ability to obtain coverage.
Forcing carriers to use lengthy historical data in modeling, while making it difficult to effect rate changes above 7%, will only weaken the market by forcing carriers to choose between charging rates not commensurate with the risk and declining to quote coverage.
By reflecting the true cost of the risk as backed up by real-time data, carriers will be able to backstop the insurance market with more confidence, instead of relying on the FAIR plan as the complete backstop. This will bring much-needed market stability, albeit at higher rates.
Finally, when fires do occur, state regulators need to work with consumers and carriers to more efficiently handle subrogation claims, particularly against utility companies, which can often cause wildfires with inadequate maintenance of power lines.
Again, local governments can also play a larger role here, either through more actively forcing maintenance of power lines or playing a larger role in the subrogation process to ensure their constituents’ interests are being put at the front in the aftermath of a wildfire.
Instituting any of these changes will not be easy, and will require a strong will from state and local authorities to force interested parties to the table. Here we’ve set out a fourfold case for incentivizing individuals to mitigate risk, empowering local governments to place the good of the community over the individual, allowing carriers to charge rates commensurate with risk levels, and streamlining the process to place the costs of a disaster on the primary actor.
If all these actions are taken in concert, we believe that state and local governments can align incentives across the primary players in the insurance sector and bring stability to the market.Solutions that fail to address these root causes will ultimately only be prolonging the issue and will not serve to strengthen the homeowners market in areas with high climate risks.
Brian Nordyke is Managing Director and John Rodgers is COO and Managing Partner in the Financial Services practice of SSA & Company, a global management consulting firm, where he leads insurance engagements. They can be reached respectively at bnordyke@ssaandco.com and jrodgers@ssaandco.com
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