Aiming to both quell soaring prices and bring back firms that have left the Golden State, regulators are proposing sweeping reforms that they believe could revive a competitive insurance market.

While experts agree that the status quo may no longer be sustainable, opinions remain divided on the merits of the proposed changes — which some fear could drive up prices further.

“The situation is hurting consumers badly,” Amy Bach, executive director of the consumer advocacy group United Policyholders, told The Hill.

“It doesn’t feel like it’s going to resolve on its own,” Bach added.

California Insurance Commissioner Ricardo Lara last week called for public input on the final phase of his wildfire modeling regulation, which is many months in the making and has sparked significant debate.

Lara’s strategy would update Proposition 103, a 1988 ballot measure that served “to protect consumers from arbitrary insurance rates and practices” and encouraged a competitive and fair marketplace, according to the Insurance Commission. 

Proposition 103 determined that rate changes could only occur with the authorization of the commissioner, while also establishing a public participation process in which so-called “intervenors” could provide technical input and recover associated costs.

Lara’s office said in a press statement that his update aims to close a loophole in Proposition 103: Insurance firms today can request rates at any level to help compensate for an increased risk of losses but are not required to cover all Californians.

The new regulation, in contrast, would require companies to insure properties in distressed regions at a rate equivalent to 85 percent of the firm’s statewide market share. 

In addition, the proposal would incorporate the state’s first use of “catastrophe modeling,” localized simulations of potential risk based on historical analyses and probabilistic calculations that such events will occur in the future.

Whether relying upon such simulations, also known as “cat models,” would end up lowering or raising consumer rates, however, is a matter of contention.

Those in favor of employing these tools argue that other states have long done so and that proactive efforts to adapt California homes to a changing climate could mitigate risk.

“Over the past several years, the state has put billions toward wildfire mitigation efforts and homeowners have made significant investments in home hardening,” Lara said in a statement.

“This is not accounted for by our existing retrospective, past-focused models for ratemaking,” the commissioner continued. “We want consumers to reap the full benefits of these efforts through modern, forward-looking models on how rates are calculated.”

But others are far less certain that the models would account for such improvements — especially because the technology is often proprietary.

Bach cited catastrophe models as a reason for her muted enthusiasm about Lara’s proposal. Yet she expressed willingness “to let the commissioner’s sustainable insurance strategy go into place.”

“If it doesn’t work, then I guess we go back to the drawing board,” Bach said, expressing approval for the mandatory coverage component of the regulation.

Bach stressed that thus far, she has seen no indication that catastrophe models, when applied to wildfire-prone areas, are accounting for active mitigation efforts in price determinations. She also expressed concern that wildfire models are much newer than those for, say, hurricanes.

“We are nervous,” she continued. “The reality is that prices are so high already, and affordability is so low right now.”

Nonetheless, Bach acknowledged that California’s lack of catastrophe models was contributing to the exodus of insurance companies from the state. Beginning in 2022 and 2023, many big firms stopped offering services to new customers, often citing wildfire risk. 

“The writing was on the wall that cat models are going to come to California, just for practical reasons,” she acknowledged.

“We’re glad at least there’s a quid pro quo — that as a condition of insurers getting to use cat models, they also have to pledge to insure more homes in the areas that have been abandoned,” Bach added.

Harvey Rosenfield, founder of Consumer Watchdog and the author of Proposition 103, decried catastrophe models as “completely unjust, untested and unreliable.”

“Models are cloaked in the guise of technological infallibility, but they are drafted, they’re written, they’re controlled by humans,” Rosenfield told The Hill.

He also argued that their use would violate provisions of the voter-approved Proposition 103, because this would deny consumers their legal right to examine the details of these models.

“Nobody has the power to rewrite Proposition 103 to eliminate its protections,” Rosenfield added.

The applicability of catastrophe models to wildfire risk assessments was one focal point in a June 2024 working paper about the adaptation of insurance markets to a changing climate. Although these models have improved the ability of insurers to gauge wildfire risk, the resultant projections remain “inherently uncertain,” according to the paper, published by the National Bureau of Economic Research.

“The modern catastrophe models bring a lot of value to insurance pricing and rate setting,” co-author Judson Boomhower, assistant professor of economics at the University of California San Diego School of Social Sciences, told The Hill.

“They give you a much more nuanced view of risk for a given property or a given area,” added Boomhower, who is also a faculty research fellow at the National Bureau of Economic Research.

That more detailed vantage point, he explained, is more sophisticated than the “backward-looking historical rate-setting methods that insurers have been required to use in California.”

Nonetheless, Boomhower also recognized that catastrophe models “are sort of a black box” due to their proprietary nature and resultant questions of transparency.

“Those are legitimate challenges for regulators to think about, but at a high level, this is the best scientific method for assessing catastrophe risk,” he said.

Boomhower described Florida as “a little bit ahead” of California from this perspective, as the state requires companies to give regulators some insight into how their individual models work.

In the working paper, Boomhower and his colleagues reconstructed pricing formulas used in California by six major insurers — combining data from company-provided premiums with proprietary information from about 100,000 households.

The authors found that following the 2017 and 2018 wildfire seasons, both premiums and the rate of policy cancellations in high-risk areas surged. They also observed increasing reliance on the state’s “quasi-private insurer of last resort” —  called California FAIR —  the basic but expensive property insurance provided when traditional coverage is unavailable.

Among the paper’s key findings was the fact that insurers exhibited “striking variation” in how firms priced wildfire risk, with some only divided the market roughly, at the zip-code-level, and pricing risk at a more granular level — using catastrophe models.

“There’s tons of heterogeneity in wildfire loss risk, even within zip codes or even within neighborhoods,” Boomhower said.

Insurers with less sophisticated models seemed to end up with a slew of higher-risk customers and greater-than-expected costs, which the authors dubbed the “winners’ curse.”

Meanwhile, they found that companies using the more granular models tended to attract lower-risk customers. With that in mind, Boomhower projected that there would be “a lot of competition among insurance companies to find the low-risk homes in these designated high-risk areas.”

“There are parts of the state where wildfire risk has increased really rapidly,” he continued. “Those are places where insurance rates probably do need to go up relative to where they’ve been historically, just to reflect the increasing risk.”

To the extent that Proposition 103 has held rates down, Boomhower acknowledged that the proposed updates could end up raising prices.

“On the other hand, that may be what you need to ensure availability in some of those places,” he said.

While the status quo may not be ideal for anyone, Rosenfield stressed his belief that insurance firms might come back to California without a change in regulation — simply because it will be in their financial interest to do so.

“California is the biggest single insurance market in the planet, and they’re just going to come back in and take advantage of that,” he said.

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The “crisis” in California’s insurance market was caused by “a laser focus only on affordability,” said Nancy Watkins, a principal at Milliman, an actuarial firm, at a legislative hearing on Wednesday.  The companies are operating with “very crude tools” at the expense of availability and reliability, she said.

She said the current regulatory system is too rigid. “It’s like you’ve got your steering wheel locked straight ahead, you’ve got your speed set on cruise control, and now you find yourself on the Pacific Coast Highway,” she said. “What insurance company would agree to that?”

Home insurance premiums in California are a little cheaper than the national average — and much lower than premiums in other disaster-prone states like Florida and Louisiana. That’s without accounting for the fact that California has some of the most expensive housing in the country. 

California still has about 115 companies offering home insurance, said Michael Soller, a deputy commissioner for the state’s insurance department. As for whether more companies are likely to follow State Farm and Allstate, “we don’t think that will happen,” he said

Consumer and insurance industry groups and other experts have ideas for what they’d like to see California do in the wake of the news — few of which they agree upon. Here’s the debate over four of those ideas. 

Require State Farm to keep issuing new policies

There’s disagreement whether this idea, backed by the group Consumer Watchdog, is legal.

The idea hinges on how insurance prices are regulated in California. Under current laws, insurance companies can’t just charge whatever they want: They have to submit their proposed rates to the insurance department, which they back up by explaining their projected costs, losses, revenue and more. State regulators can approve a company’s proposed rates, or deny them, if they think, for example, the rates are unjustifiably high, or so low that they could put the company’s finances at risk.

Harvey Rosenfield, founder of Consumer Watchdog, said if a company suddenly says that it’s not going to take the same number of customers that it had projected when it got the department’s approval, then it has changed the assumptions on which the approval was based. 

“They granted themselves a de facto rate increase by reducing the risk” in a state where that’s illegal, said Rosenfield. The department could issue a notice to State Farm, he said, and tell the company it needs to keep selling new home insurance policies until it submits new rates and those rates are approved. 

The insurance department disputes that it has the power to do this. “Their claims are not supported by law,” said Soller, the deputy commissioner. “There’s a reason why it hasn’t been done by any insurance commissioner before.”

Let insurance companies use forward-looking catastrophe models

The kinds of data and statistical models insurance companies can use to set prices may sound like a nighttime sleep aid, but it’s a matter of lively discussion in insurance circles. 

When a company tries to justify rate changes, it is required to rely on past losses to project future losses. It can’t use factors like the locations of new homes it is covering — whether they’re in downtown San Francisco or rural wine country — or the increased risk of wildfires due to climate change.

“We do it in a very old-fashioned way, and it needs to be updated,” said Rex Frazier, president of the Personal Insurance Federation of California, an insurance industry group that counts State Farm as a member. He supports the use of forward-looking models, which are generally provided by other private companies. California already permits insurers to use models for earthquake insurance. 

If a company is trying to figure out how much it should charge for earthquake coverage, it would look at proximity to fault lines, Frazier said, but for wildfire insurance, California doesn’t do that. 

“For wildfire it just says ‘Well, looking backward, what have you paid over the last 20 years for wildfire clients?’” he said. 

Consumer groups generally oppose letting insurance companies use models, fearing that companies will use them to justify extreme price hikes, and that complex math will make scrutiny a challenge.

“They’re just very sophisticated crystal balls,” said Amy Bach, executive director for United Policyholders, a consumer group. Modeling companies generally see their models as intellectual property, which can pose a challenge for transparency. “Our fear is that they overstate risk,” said Bach. 

About a week and a half after State Farm’s announcement, the insurance department said it would host a public workshop on use of models in insurance pricing, ahead of considering regulations. The workshop will take place on July 13. 

On Wednesday, the Assembly’s insurance committee held a hearing on models. When asked by a legislator whether the department was moving toward incorporating catastrophe models, a department representative confirmed that it was. 

“Historic losses do not fully account for growing wildfire risks, or risk mitigation measures taken by communities,” said Michael Peterson, a deputy commissioner at the insurance department, during the hearing.

Address the increasing cost of insurance — for insurance companies

Insurance companies are just like us: They buy insurance! When insurance companies buy it, it’s called “reinsurance.” 

The cost of reinsurance has risen dramatically, and State Farm cited “a challenging reinsurance market” as one of the reasons it decided to stop selling new home insurance policies in California. 

When insurance companies explain their costs to the insurance department as part of the process for justifying their prices, they aren’t allowed to include the cost of reinsurance. The department hasn’t historically permitted it, Soller said, because it doesn’t regulate reinsurance. 

“What are insurers supposed to do when, on the one hand, the Department of Insurance is telling them ‘maintain your solvency’ and then, on the other hand, when their costs go up, you can’t charge for it,” said Frazier.

Insurance industry groups say it would help if they could incorporate the cost of reinsurance into their prices. But consumer groups say that the move would cause premiums to spike. 

“Californians would see immediate massive rate hikes — both as soon as that went into effect and ongoing,” said Carmen Balber executive director of Consumer Watchdog. A reinsurance provider regulated by California would address problems she sees with the reinsurance market, Balber said, but that doesn’t exist currently.

Reduce the risk of disasters

The underlying problem is that disasters happen in California — at an increasing rate thanks to climate change — and that homes are at risk. They’re in the middle of the woods, or surrounded by flammable grasslands, or on the edge of bluffs that are expected to erode. Making homes less likely to burn, flood or collapse would be good for homeowners and would also make California feel less risky to insurers.

There’s no shortage of ideas for how to reduce risk, and there’s been action on this front in recent years. The insurance department, for example, has required insurance companies to consider whether homeowners take certain steps to protect their homes — like installing fire-resistant vents and clearing out vegetation under decks — in their prices.

California has set aside $2.7 billion for wildfire resilience over the past three years, according to the insurance department. When the department convened a group of environmental advocates, researchers, and public policy and insurance experts to make recommendations on how to reduce the risks of climate change, they came up with a long list. Among the recommendations: 

• Create statewide hazard maps so that future risks are more clear to the public 
• Increase funding to retrofit homes 
• And apply fire-resistant building codes in areas with moderate to higher fire risk.

Cutting greenhouse gas emissions would ultimately be the best way to reduce the risk, said Alice Hill, chair of the group convened by the department and a senior fellow for energy and the environment at the Council on Foreign Relations. But the world will get warmer even if we reduce emissions, she said, so focusing on where and how homes are built remains important.

“That could mean not building in areas that are just becoming too risky,” Hill said.

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