California’s regulatory restrictions to fair, actuarially sound insurance pricing and underwriting, coupled with the need for more mitigation and resilience efforts in the state, are putting financial pressure on insurers and contributing to limited availability of property insurance in high-risk markets, according to the Insurance Information Institute.
California is increasingly marked by natural disasters such as earthquakes, droughts, wildfires, landslides, and recently, floods caused by atmospheric rivers.
Triple-I’s Report “Trends and Insights: California’s Risk Crisis” explores the evolving risk landscape in California, highlighting the challenges posed by Proposition 103, a regulation that has hindered insurers’ ability to operate profitably within the state.
Due to Proposition 103 and its enforcement, insurers are restricted to pricing their coverage based on historical data, prohibiting the use of contemporary data and advanced modeling techniques.
The brief also points out that Proposition 103 has obstructed the adjustment of premium rates by enabling consumer advocacy groups to partake in the rate approval process.
Much has changed in the world since 1988 when Proposition 103 came into effect, and it’s well over time to evolve California’s insurance regulatory system
Sean Kevelighan, CEO of the Triple-I
“While the recently proposed changes by the California Department of Insurance are a move in the right direction, it is becoming increasingly critical to quickly bring market stability into one of the largest state economies,” said Sean Kevelighan.
“Insurance is a key driver to economic stability and growth, but it needs to function in ways that allow insurance to be accurately priced. Insurance prices are the effect rather than the cause of risk.”
This restriction complicates the insurers’ ability to adapt swiftly to market shifts, leading to delays in rate approvals and prices that fail to mirror the current or future risk accurately.
The measure escalates legal and administrative expenses, prompting insurers to consider scaling back or withdrawing their operations in California.
This retreat has driven more Californians towards the California FAIR Plan, the state’s insurer of last resort, which provides limited coverage at elevated premiums.
Underwriting profits can’t keep up with losses Insurers’ underwriting profitability is measured using a “combined ratio” that represents the difference between claims and expenses insurers pay and the premiums they collect.
California Homeowners Insurance Combined Ratio
A ratio below 100 represents an underwriting profit, and one above 100 represents a loss. As the chart at the right shows, insurers have earned healthy underwriting profits on their homeowners business in all but two of the 10 years between 2013 and 2022.
However, the claims and expenses paid in 2017 and 2018 – due largely to wildfire-related losses – were so extreme that the average combined ratio for the period was 108.1.
Underwriting profitability matters because that is where the money comes from to maintain “policyholder surplus” – the funds insurers set aside to ensure that they can pay future claims.
Integral to maintaining policyholder surplus is risk-based pricing, which means aligning underwriting and pricing with the cost of the risk.
Unlike in most other states, insurers in California have not been allowed to price catastrophe risk prospectively.
Instead of letting insurers use the most current data and advanced modeling technologies to inform their pricing, Proposition 103 – in a dynamically evolving risk environment – has required them to price coverage based on historical data alone.
California Insurance Commissioner Ricardo Lara introduced a Sustainable Insurance Strategy in September 2023.
This strategy permits insurers to incorporate forward-looking risk models that emphasize wildfire safety and mitigation efforts and to include reinsurance costs in premium calculations.
As part of this initiative, insurers are required to offer coverage to homeowners in wildfire-vulnerable areas, covering 85% of their statewide coverage footprint.
Public discourse often frames the risk crisis as an “insurance crisis” – conflating cause with effect.
Legislators, spurred by calls from their constituents for lower insurance premiums, often propose measures that would tend to worsen the problem because these proposals generally fail to reflect the importance of accurately valuing risk when pricing coverage.
California’s Proposition 103 and the federal National Flood Insurance Program before its Risk Rating 2.0 reforms are just two examples, according to Triple-I.
Traditional risk-transfer mechanisms are not sufficient to address the looming risk crisis. Insurers are working with communities and commercial partners to encourage investment in disaster mitigation and resilience – efforts that are demonstrating varying degrees of success at improving insurance availability and affordability.
Unfortunately, too often, the public discourse frames the risk crisis as an “insurance crisis” – conflating cause with effect.
Legislators, spurred by calls from their constituents for lower insurance premiums, often propose measures that would tend to worsen the problem because these proposals generally fail to reflect the importance of accurately valuing risk when pricing coverage.
California’s Proposition 103 and the federal flood insurance program prior to its Risk Rating 2.0 reforms are just two examples.
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