California wildfires and Atlantic hurricanes: Insurers grapple with rising risk

OUTLOOK | August 11, 2023

Authored by RSM US LLP

The insurance sector is under intense pressure as the severity and frequency of wildfires escalate, particularly in the state of California. Major industry players Allstate and State Farm recently decided to stop issuing new policies in California, marking a significant change in the insurance sector's approach to wildfire risk?.

State Farm attributed its decision to various factors, including inflation, a challenging reinsurance market and rapidly increasing exposure to catastrophes. Allstate explained its withdrawal in a press statement: “The cost to insure new home customers in California is far higher than the price they would pay for policies due to wildfires, higher costs for repairing homes and higher reinsurance premiums.”

This situation mirrors a nationwide trend. As climate change intensifies, insurance companies across the country are increasing rates, reducing coverage or withdrawing entirely from regions prone to wildfires and other natural disasters. This trend is not isolated to California, as states like Florida and Louisiana have been struggling with their insurance markets in the aftermath of severe hurricane damage, and Colorado is seeing a surge in insurance premiums due to the wildfire threat??.

A warmer, drier climate in the West over the past three decades, fueled by climate change, has increased the frequency and destruction of wildfires. California, in particular, has experienced some of the largest and most destructive fires in its history??, and 1.2 million homes there are at extreme risk of wildfire damage. The steady increase in the number of acres burned in California each year, combined with rising repair or replacement costs for homes damaged or destroyed by fire, results in increased insurance losses?.

The exit of large insurance providers is expected to have a significant impact on homeowners. Some Californians already choosing to forgo coverage, and the scarcity of new policies could make purchasing a home more difficult. The California Fair Access to Insurance Requirements Plan, which acts as a last-resort insurer, has already seen a surge in enrollments, to 272,846 homes in 2022, a figure that could rise further as traditional insurance options dwindle?.

The withdrawal of large insurers may force a rethinking of policies that have historically protected consumers from rate increases. Proposition 103, passed by California voters in 1988, enables the state insurance commissioner to reject proposed rate hikes and mandate refunds. Although it has saved consumers billions of dollars over the years, the insurance industry argues it restricts accurate risk assessment and pricing??.

The wildfire crisis, aggravated by climate change, poses a daunting challenge to the insurance industry and homeowners alike. The recent exit of significant insurance companies from high-risk states like California is a clear indicator of a changing landscape that could have nationwide repercussions. As we navigate this crisis, the urgency to devise innovative solutions to reduce risk, safeguard homeowners and stabilize the insurance market is heightened.

How can insurers be there for their customers?

1. Invest in preventive measures: Encourage and incentivize homeowners to take measures to reduce wildfire risk. This could include providing discounts for homeowners who create defensible space around their homes, use fire-resistant materials in construction and properly maintain their property. When wildfires do occur, these measures can help to reduce their severity and the damage they cause.
2. Provide risk education and communication: Through informational campaigns, workshops or one-on-one consultations, educate customers about the risks associated with wildfires and how they can protect their properties.
3. Ensure fair practices: Work with government and regulatory bodies to ensure that their practices are fair and do not unnecessarily burden homeowners. For example, in California, the insurance commissioner enacted regulations requiring insurers to give discounts to customers who follow new fire-resistance standards?. This kind of collaboration can ensure that insurance remains accessible and affordable for homeowners, even in high-risk areas.

Insurer preparedness ahead of hurricane season

While the 2023 Atlantic hurricane season is expected to be “near normal,” according to the National Oceanic and Atmospheric Administration (NOAA), the insurance industry should still prepare for the possibility of higher claims activity into late summer, thanks to unusually warm Atlantic waters and an El Nino weather pattern.

Though El Nino winds typically hinder hurricane formation in the Atlantic, warm ocean waters can fuel hurricanes, offsetting the El Nino wind effect. In addition, El Nino can increase the risk of flooding due to increased rainfall in the tropics, as well as high winds and storm surges in coastal regions.

The insurance industry can expect to see higher claims activity in 2023 due to the El Nino climate pattern, which occurs when the surface of the Pacific Ocean is cooler than average. El Nino is expected to continue through the winter, but the Atlantic Ocean has been warmer than years past and warm ocean waters are a key ingredient for hurricane formation. El Nino can lead to increased hurricane activity in the Atlantic Ocean, which can result in more damage to property and infrastructure. Also, El Nino can increase the risk of flooding because of more rainfall in the tropics, which can lead to flooding as well as high winds and storm surges in coastal regions.

An unprecedented start to the 2023 hurricane season was fueled by the high sea surface temperatures, putting insurers at greater risk. Colorado State University recently upgraded its hurricane forecast for this year to above average, according to Bloomberg Intelligence.

NOAA’s metrics for a near-normal season are 13 to 19 named storms, six to eight hurricanes, and three to five major hurricanes (Category 3 or higher).

The number of named storms and hurricanes in the Atlantic Ocean has increased year over year since 2020. The number of major hurricanes has also increased, though not as dramatically.

A driving factor is climate change, which is causing the ocean to warm and thus providing more energy for tropical cyclones to develop and intensify. The increasing storm activity is a serious threat to coastal communities in the Atlantic Ocean. Most major carriers have adjusted their underwriting practices by raising rates, restricting insurance coverage or withdrawing altogether from high-risk regions.

If the East Coast experiences a below-average hurricane season, the states and communities in that region may be at a relatively lower risk for hurricane-related damage and losses. This could result in better loss ratios for insurers, which could lead to lower insurance premiums for customers and fewer claims for insurers operating in those areas. However, even a below-average hurricane season brings a risk of significant damage and losses from a single storm or weather event.

The insurance industry can take some actions to prepare for hurricane season and other potential severe weather events:

• Educate policyholders: Advise policyholders on how to prepare for hurricanes and minimize damage. Information can include tips on securing homes and businesses, creating emergency plans, and obtaining sensors to minimize damage, delivered through a variety of channels that include videos and alerts. Review customers’ policies to ensure optimal coverage based on their specific needs.
• Enhance catastrophe modeling: Invest in predictive analytics and artificial intelligence to gather high-quality weather and historical claims data and improve catastrophe modeling. Price risks more accurately by regularly testing and validating models and adjusting them as needed based on current trends.
• Improve claims handling: Establish dedicated claims teams and use technology such as computer or satellite imagery and remote sensing equipment to obtain real-time data and optimize claims processing, which can help mitigate the financial impact of large-scale hurricanes.

Insurers should also collaborate with other carriers, industry experts, and risk advisors to share data, insights, and best practices, with the goal of improving their emergency response protocol and overall hurricane risk management. Collaboration can enhance the ability of all stakeholders to analyze patterns to understand a hurricane’s impact on the ground and to customers, and to predict the likelihood and severity of catastrophic events more accurately. Insurers should continue to take appropriate measures to prepare for and respond to any potential hurricanes or other natural disasters, regardless of the overall forecast for the season.