Home insurance giants won’t sell new California policies. What it means for all homeowners

State Farm set off alarm bells with its announcement last week that it would no longer sell new home insurance policies in California, but insurers have struggled for years now to pay soaring costs related to catastrophic wildfires because of regulatory controls on premium increases, industry experts told The Sacramento Bee.

As a result, thousands of consumers in wildfire-exposed communities have been dropped when their policies come up for renewal. In 2019, after two years of devastating wildfires, insurers refused to renew 235,597 policies, a jump of 42.7% from 2018. In 2020, 212,727 were not renewed.

“Since the fires of 2017-2018, State Farm has continued to be open for new business in a lot of wildfire-exposed communities — and absorbed a tremendous number of customers who were (not) renewed by other insurers,” said Rex Frazier, president of the Personal Insurance Federation of California. “State Farm’s homeowners’ insurance market share has grown from 17.6% at the end of 2017 to 19.9% at the end of 2021.”

When the California Department of Insurance releases 2022 figures, Frazier said, the company’s market share could very well exceed 21%.

On Thursday, another insurer admitted it had stopped selling policies as well. Allstate, once the state’s fourth-largest insurer for homes, said it stopped selling new policies last year so it could “continue to protect current customers,” a spokeswoman for the firm told the San Francisco Chronicle.

The two joined AIG and Chubb, companies that typically insured luxury homes, in pulling coverage in recent years, according to the Chronicle.

In some regions of the state, California residents are already finding it impossible to get home insurance on the state-licensed commercial market, said UC Davis professor Emily Schlickman, who researches ways to use landscaping and other techniques to help communities and structures withstand wildfire.

“As recent events have depleted decades of profits ... insurance companies have been dropping coverage, raising premiums, and refusing to write new policies,” she said.

And, unlike flood and earthquake insurance, wildfire coverage is bundled into general homeowner’s insurance, Schlickman said, so people living in wildfire-prone areas often cannot get any insurance for their homes, making it difficult to secure a mortgage loan.

A number of factors have driven up costs for California insurers at a much faster rate than their revenue from premiums is growing, Frazier said. The result, he said, is that State Farm and other insurers are retrenching to avoid insolvency.

Why costs are climbing for CA home insurers?

California’s licensed insurers incurred losses of $902.1 million in 2017 and $1.53 billion in 2018, according to state records, far outstripping the $933.2 million and $934.2 million they collected in premiums in each respective year.

These figures are important not simply because the liabilities are so great but because of how those liabilities and the negligible growth in premiums reshaped how key financiers in the insurance business viewed risk in California’s insurance business, Frazier said.

To understand why, you have to know a little something about how insurance companies work. Like banks, they must keep a certain amount of capital on hand, Frazier said, and as they sell more policies, insurers must increase the amount of money they have to support the increased liability. If they can’t increase their capital, they can’t write new policies.

While some publicly traded insurers might be able to issue a stock offering to raise capital, State Farm can’t tap those markets because it’s privately owned by its policyholders. Privately held insurers instead find other insurers with capital to spare and pay them a fee to take on some of the risk.

So, if State Farm insures a group of properties worth $10 million, it could pay one of these re-insurance companies to cover any losses in excess of $5 million on those properties. If State Farm then incurred a $6 million loss, it would pay out $5 million and the re-insurance company would be on the hook for $1 million.

The rewards of these deals outweighed the risks to re-insurers up until climate change turned California’s trees into kindling during a prolonged drought, Frazier said, and skyrocketing inflation began driving up the costs of rebuilding homes.

Schlickman said you can really see the impact of inflation on one Butte County foothills town decimated by the Camp Fire in 2018.

“In Paradise, a conventional wood-framed home is out of reach for many former residents,” she said. “Even modular homes are too expensive, as their cost has doubled since the fire. This is leaving the future of Paradise -- and communities like it — with an uncertain future.”

Home insurers have costs they can’t recoup

Under this inflationary pressure, it’s also more likely that both home insurers and their re-insurance partners will be on the hook for larger payouts, Frazier said.

“Re-insurers treated California wildfire as a secondary risk and did not spend much time analyzing (it),” he explained. “They only treated earthquake as a primary California risk. Now that re-insurers are viewing California wildfire risk as a primary (not secondary) risk, .... re-insurers have increased their prices substantially.”

Insurers, however, cannot afford to pay the soaring re-insurance fees because California does not allow them to factor in re-insurance costs when setting rates for customers, Frazier said. This means home insurers can’t buy as much re-insurance, he said, and as a consequence, they don’t have the capital needed to insure additional properties.

While the number of licensed insurers in the state has remained about the same since 2019, Californians in some regions of the state have experienced a disruptive churn in the carriers willing to serve them, forcing them to scramble to find a new insurer to meet their mortgage obligations.

Even as climate change has resulted in more frequent, more severe wildfires and some wild weather events, Frazier said, the state has held carriers to a formula that bases the premiums they can charge on the average wildfire losses the companies incurred over the last 20 years.

“We don’t think this makes any sense because today’s climate is very different than 20 years ago,” Frazier said. “Why wouldn’t California regulations allow an insurer to use forward-looking climate models to project their future losses, rather than historical experience over the last 20 years?”

Every other state allows carriers not only to factor in the cost of re-insurance but also to use forward-looking loss projection models, Frazier said. Earthquake insurers, he already, already use such modeling in California.

“Under current rules, an insurer gets no credit for writing in new, higher-risk areas because they need to, first, experience big losses in order to get approval to charge the higher rates to support the higher losses they expect in riskier areas. Not a good business decision,” Frazier said.

Think your premiums are high? Talk to Floridians

If state leaders do allow the changes, California consumers could see even larger premium increases than they already have experienced. In about two-thirds of the nation, people spend more on homeowners’ policies than California residents do, said Janet Ruiz, director of strategic communication for the Insurance Information Institute.

On average, Californians pay about $1,300 annually to protect their properties in the event of fire and other casualties, Ruiz said, but in Florida, where hurricane damage is prevalent, homeowners pay about $4,000 for such protection. In other Western states hit by wildfires, she said. annual home insurance premiums average $2,000-plus.

With State Farm’s decision to stop selling new policies, Frazier said, a number of California homeowners will discover they can only get coverage by paying significantly higher premiums to either carriers that are licensed in other states or nations, known as surplus lines insurers, or to California’s insurer of last resort, the California FAIR Plan.

The FAIR Plan, created by California law, is operated by an association of state-licensed insurers. Surplus lines carriers must meet certain capital requirements and can only insure California homeowners who have been rejected by a state-licensed carrier.

A growing number of consumers have gone with these alternative means of coverage in recent years as wildfires lay waste to large swaths of California, in some cases hitting the same communities more than once. Surplus lines carriers wrote 8,247 new policies in 2018 and 11,912 in 2019, up 23.8% and 78.9% respectively when compared with 2017 figures.

The FAIR Plan wrote 75,247 new policies in 2019 and 77,650 the next year, assuring that homeowners can meet mortgage lenders’ requirements for coverage, according to state data. Those figures were more than three times the new business FAIR saw in 2018.

By 2020, many of those consumers still could not find a licensed California insurer to cover them. The state reported that FAIR renewed 163,816 policies that year, up from 117,170 in 2019.

FAIR’s growth makes private home insurers nervous because this last-resort plan has limited capital, Frazier said, and if it runs out of money, the private insurers must pay its unfunded losses. Each company would have to pay a percentage of the liability that is based on their market share. This unknown liability, Frazier said, is another reason why licensed carriers are pulling back on covering risky areas of the state.

In an effort to stem the tide of homeowners being rejected for renewal, California lawmakers passed Senate Bill 824. It stated that, if a state of emergency was declared in a wildfire-ravaged area, a yearlong moratorium restricted insurers from canceling or not renewing policies for homeowners who lived in ZIP codes adjacent to or within the fire’s perimeters. The law was first used in late 2019 and then again in 2020.

The number of non-renewals in moratorium-protected regions jumped by 70% to 97,771 in 2019, compared with a year earlier. But in 2020, the first full year in which the moratorium was used, non-renewals dropped by nearly 20% to 78,366.

What’s the right kind of help for Californians?

Schlickman said she wonders whether this kind of help is really what’s best for Californian consumers.

“Perhaps stopgap insurance measures like the FAIR Plan and moratoriums on non-renewals are delaying the inevitable and are actually putting more lives and properties at risk,” she said. “By insulating people from the real risks of wildfire, are we doing more harm than good? In this case, could market-based insurance actually help us adapt to climate-exacerbated disasters like wildfires?”

There are ways to adapt the FAIR Plan to slow development in wildfire-ravaged areas, she said. State leaders could take steps to limit FAIR coverage to existing homes to slow or freeze risky development. They could offer it only for primary residences to slow down building in the secondary vacation-home market.

In the overall home insurance market, Schlickman said, it might help to be more transparent with homeowners about how their rates were assigned. In effect, the bills then would be a way to educate homeowners on the cost and risks of living in wildfire-prone communities.

Certainly, she said, if state leaders ever to change the formula that determines premiums and allow home insurers to use forward-looking climate models to determine rates, the jump in cost would be a wake-up call.

Insurers already have long been able to assess a wildfire-risk surcharge on homeowner policies, but recently, Lara required insurers to offer discounts to property owners who have taken steps to make their properties safer from wildfire.

Schlickman said this approach is not without risks: Will these discounts promote more development in risky areas, increasing the potential for ignition? Will today’s ideas for increasing resilience work against future wildfires?

“In a way, these incentives serve as a false security blanket for residents as there is no way to make properties ‘fire-proof,’” she said, and “enforcement of these measures is a challenge as some properties are only getting assessed every few decades.”

Lara also has recommended that communities as a whole work together to reduce wildfire risk, using the collaborative framework developed by Firewise USA and Fire Risk Reduction Communities. These are steps that can work, Schlickman said, when there’s collective buy-in and plenty of coordination.

In an upcoming book titled “Designed by Fire,” Schlickman and co-author Brett Milligan bring together 27 global designs and how they tackled the challenge of living in the age of fire.

As residents of Paradise discovered, people can try to create defensible spaces and employ recommended design techniques and still lose everything to wildfire, Schlickman said.