As the thick pall of smoke that has loomed over the western US for much of this month begins to clear, it is a good moment to examine how the region’s insurance industry is evolving to meet the perilous threat of wildfire.
In California, where around 15% of the state is currently deemed uninsurable, the California Fair Plan Association has become the only option for many insureds.
It is a complex underwriting landscape for insurers to operate in – a world where traditional actuarial approaches reliant on historical fire maps are being rapidly replaced by new modeling techniques based on house-by-house property data and models that incorporate climate change.
The insurance industry has frequently clashed with regulators over what to do.
Action by the outspoken insurance commissioner Ricardo Lara has suspended all policy non-renewals until December for a million residents living in declared wildfire disaster zones.
The thinking behind the order nearly a year ago was to buy time for fresh capacity to arrive in California, lured by the prospect of rising rates. But despite a trickle of new capacity landing in the homeowners’ market this year, few carriers want more California wildfire risk on their books.
Yet E&S capacity, far from riding to the rescue, has retreated further from the distressed Golden State’s homeowners’ market, influenced by a scarcity of reinsurance capital.
Underwriting, reinsurance, modeling and risk management are all essential pieces of the puzzle that needs to be solved if one of the largest insurance markets in the US can regain functionality.
Underwriting and distribution
A particular chokepoint for agents has become higher-value homes, insured in both the general homeowners’ and the high-net-worth markets.
As Doug May, president of North America at Willis Re, explained: “Most of the modeled loss in the state of California is driven by high-value homes, so that market is really distressed.”
He mentioned Rancho Santa Fe, just north of San Diego, west Los Angeles and Malibu as areas with a particularly big concentration of high-value homes.
“I wouldn’t want to be the owner of a high-value home in, say, Santa Barbara right now, because the value’s going to go down,” he noted.
Agents are having to be inventive, and have taken to pairing the basic fire insurance policy offered by the Fair Plan with a separate contents and liability coverage from a conventional carrier, a type of structure known as a Difference in Conditions (DIC) policy.
DIC policies can supplement a bare-bones-style Fair Plan, meaning that the likes of State Farm, Liberty Mutual and Allstate avoid holding the fire risk, while not losing a more profitable auto insurance customer.
Companies like Farmers that use a captive agent model are sometimes using internal wholesales, passing more challenging properties to the E&S market.
Stan Sanchez, a managing principal at Epic Insurance Brokers & Consultants, called the current market “extremely challenging and frustrating” for customers.
“The California Fair Plan is going to be way over-utilized,” pointed out Sanchez, who noted that the plan can do little for a homeowner whose property is valued at more than $3mn.
Last year, the insurer of last resort, which is owned by all the insurers operating in California based on relative market share, sued the state’s Department of Insurance for trying to force it to extend its policies to areas such as flood and contents, without letting it raise rates.
But the Fair Plan has acceded to demands to raise its limits from $1.5mn per property to $3mn.
Beyond that $3mn limit, the property market has in many areas frozen up, as lenders are reluctant to transact without insurance in place.
Sanchez describes a high-net-worth market where rate rises are highly divergent, with low-risk properties getting away with a 5%-10% rate rise and medium-risk homes being charged a 10%-20% increase. But for homes in high-risk fire zones, rates are up by 100% and as high as 200% in some cases.
“People are paying $35,000 a year to insure a $2mn home in high-risk areas,” said the broker.
Wealthier clients are opting to self-insure, or paying themselves to harden their homes against fires.
New capacity thin on the ground
According to sources, there is little new capacity into the homeowners’ market so far this year. Florida insurer Heritage has begun to offer homeowners’ cover in the Golden State, but there is very little other new paper on the market beyond Cincinnati Financial, which is thought to be treading extremely cautiously.
Others have withdrawn from the market entirely, including Lloyd’s syndicates, or in the case of AIG, tightened underwriting criteria to such a great extent that few properties are getting quoted, or even bound, a broking source noted.
High-net-worth market leader Chubb has scaled back its risk appetite, along with Pure and Nationwide Private Client, although all three carriers are still binding new risks in a challenged market for luxury homes.
There isn’t a rush of new E&S capacity into the California market because, as May explained, “reinsurance capacity for the E&S plays is pretty limited I would say, because nobody knows how to quantify it”.
Retro market retreat
One of the biggest reasons reinsurers are unwilling to back more aggressive or entrepreneurial market entries into California is a lack of retrocession capacity.
“The retro market is very reluctant to cover wildfire,” pointed out a local reinsurance source, who added that reinsurance rates are up 10%-20% on renewal. The supply of retro insurance capacity is reliant on ILS investors backing unrated insurance vehicles, which are often domiciled in Bermuda.
“Some of the capacity that supports those big programs are reinsurers that have retrocessional programs with ILS capacity and a lot of the ILS capacity is very wary of wildfire,” concurred May.
New model army
How to measure wildfire risk has proved a difficult challenge for some of the incumbent modeling agencies. The frequency and ferocity of wildfire events in 2017 and 2018 took the market – and the modeling agencies they rely on – by surprise.
Oregon has been the latest Black Swan-style event. A number of sources expressed surprise at the location of the fires: the lush forests of the Cascadia wildlands.
“This event puts a big question mark on all of the fire models,” said a wholesale broking source.
The Oregon fires are not expected to cause significant reinsurance claims, but will cause nasty losses to many primary carriers operating in the state, where the total homeowners’ premium for 2019 amounted to less than $1bn, according to data from SNL.
“2020 is a record-setting year,” explained Attila Toth, CEO of Zesty.ai, an InsurTech that specializes in modeling fire risk.
Toth argues that, by using more sophisticated modeling techniques, the number of uninsurable homes can be brought down from 15% – around 1.5-1.6 million houses – to a single-digit percentage.
His company serves around half the carriers in California, applying what he describes as “surgical models,” that use data scraped from satellite imagery and a litany of other sources (“it could be satellite, it could be building permits”), to assess the individual fire risk to a specific property.
The advance of data science means the approach can be used to scan the risks of every home in a reinsurance treaty made up of millions of properties.
He said the current status quo of the Fair Plan taking all the worst risks is not sustainable, and both the admitted and E&S market must use new technology to get better at underwriting wildfire risk.
“The Fair Plan, insurers, regulators, reinsurance, the analyst community like us, all have to come together” to bring solutions to the table, argues Toth.
He noted that risk modelers must incorporate a prediction vision of the future that incorporates climate change if wildfire risk can be accurately modeled.
“We are running 10,000-year, 50,000-years simulations and varying the key input factors such as number of drought years, right? This is the biggest driver in terms of how this risk is going to evolve into the future – what is our view in the split of drought years,” said Toth.
Risk mitigation and resilience
Doug Jones, the California Insurance Commissioner from 2011 to January 2019, has evidence that a radical new approach to forest management could bring down insured losses.
He is adamant about the impact ecological forestry management can have on reducing and even eliminating wildfire risk.
Currently a senior director at the non-profit Nature Conservancy, his current mission is how best to manage a woodland in California to reduce the spread of wildfire.
Jones cites the example of insuring water company facilities in a remote area – the chance of a wildfire in that vicinity is the key factor for pricing that risk.
Techniques include controlled burns, an approach practiced by Native American communities for millennia, which helps to eliminate dry shrubbery, while protecting mature trees.
“Eco-forestry can have insurance benefits,” Jones said, pointing to the reduction in wildfire risk for commercial property adjacent to an ecologically managed woodland.
“What the science tells us is that eco-forest management works.”
He explained that using nature as a risk mitigation is already used in coastal areas, where salt marshes protect against hurricanes.
“Better management will significantly reduce the risk of catastrophic wildfires,” Jones added.
Roy Wright, formerly the head of the National Flood Insurance Program and now the president and CEO of IBHS, said the recent history of rising wildfire severity has sharpened the focus on mitigation strategies.
“I do think that the ’17/’18 events brought up all of the dimensions of wildfire in terms of how to understand the risks, how to mitigate the risk, how to price the risk and how to manage risk concentration,” he said.
“All of those were brought to the very front of the game. [In] 2019 [we] returned to historical norms, [where] 2020 is right back to the ‘new normal’ of what we saw in the ‘17 and ‘18.”
“I look at what's happening right now, and I think it's been a clarion call to get everyone to focus.”
“I think the opportunity in front of us is helping insurance and the community understand what they should be doing to reduce that risk. It isn't necessarily going to take this weekend. But it is actions that in the months to come and in the years to come need to be taken.”