Homeowners Insurance: Repricing Risk

Recent disruptions in the homeowners’ insurance market have origins in costly disasters in California over 50 years ago that provided the impetus to develop the California FAIR Plan.¹ Increasingly familiar to policyholders faced with rate hikes or non-renewal of their existing policies, the FAIR Plan is an insurance option of last resort. It is an option for homeowners in risk-prone areas, homes that no longer comply with current building codes or homeowners that have had multiple claims.

Although homeowners insurance is not required by law, it is required by most mortgage companies. Loss of insurance coverage means a homeowner will likely be in default on their loan, and face foreclosure if they are unable to find alternate coverage. Understanding these ripple effects, California established the FAIR Plan as a solution for these homeowners. Effective for many decades as a resource of last resort for homes in high-risk areas, it was never intended to be a long-term solution, but rather to be a bridge until other insurance solutions became available.

We work with many clients who have had insurance canceled or rates dramatically increased in recent years. In response they’ve had to scramble for other coverage – often including the FAIR plan. Most recently, some companies have declared that they will stop providing coverage in California at all. In this context, it is helpful to understand the limitations of public policy and insurance company exposure that have led to today’s problems.

The insurance market includes two primary types of companies that offer coverage. First is the group of admitted insurance carriers. These companies are licensed to sell insurance in California and are subject to state approval requested rate increases. If an admitted insurance company fails due to insufficient reserves, California will cover the payment of settlements to homeowners. Admitted carriers include household names such as AAA, Allstate, and State Farm.

For those who live in high-risk areas not covered by the admitted carriers, there are other companies that specialize in specialty/surplus coverage, such as Lloyds of London and Chubb Custom Insurance Company. Their offerings tend to be more expensive because they are not subject to the rate increase restrictions that apply to admitted carriers. If they fail, payment of claims is not backed by the state, which creates more risk for policyholders.

For homeowners who cannot find insurance in the voluntary market or are priced out of the specialty market, the California FAIR Plan comes into play. It provides basic fire coverage for properties that are otherwise uninsurable, but homeowners need an additional policy to cover other risks like liability, property damage, or theft until they can get more comprehensive coverage again.

In the late 1980’s, new legislation was passed that limited insurance companies annual rate increases to 7%, and required state approval. It stipulated that insurable risk was to be calculated based on 20 years of historical data for a given region, and could not depend on forward-looking models of losses. Over time, this has been a successful intervention for ratepayers in that rates in California are actually lower than rates in other states with comparable climate risks.² Companies complain, however, that they are unable to raise rates in a timely manner to respond to increased risk.

In response to recent years of high payouts, particularly for wildfire losses, companies have declined to renew policies at a rapid clip and stopped underwriting in high-risk areas. Recently, some admitted carriers are opting to stop underwriting in California altogether. Seven of the top twelve insurance companies in the state, including Allstate, State Farm, and Farmers Insurance have left California or pulled back from offering new policies in the last year.

In turn, that has led to much higher rates of enrollment in the FAIR Plan – as of June 2024, it has over 400,000 policyholders, versus just 140,000 in 2018. The FAIR Plan was intended to provide homeowners with backup coverage paid for in part by admitted insurers, that are required to participate in and contribute to claims payouts for properties covered by the California FAIR Plan. Each company’s liability is based on its percentage of exposure to the overall market in California.

The rapid increase in FAIR Plan exposure in recent years has increased liability for those companies, making participation in the California market less desirable.

California leaders are actively negotiating with insurance companies to tweak policies so that they will continue to protect homeowners but allow them to return to comprehensive policies offered by admitted market carriers.

One significant sticking point is dealing with the use of forward-looking models, including considerations of the rising costs of construction and changing weather patterns. Insurers insist these models are needed to reflect the actual price of the risks they are now insuring. A recent proposal would allow the use of forecasting technology as well as expedite the state’s review process for insurers requesting rate increases. Insurance companies will only be allowed to use these forward-looking catastrophe models if they increase the issuance of policies on properties in wildfire-distressed areas. This would provide a broad range of homes with coverage, thus helping fix a fundamental shortcoming of existing insurance regulation. Insurance companies using catastrophe models also will be required to consider the steps taken by homeowners to mitigate wildfire risk.

New regulations took effect in 2022 that require insurers to give discounts to homeowners who take steps to improve their properties’ wildfire resilience. Some of the improvements this discount applies to include installing a Class-A fire-rated roof, using modern ventilation, and enclosing eaves. Protecting your home from fire damage is a key first step, and insurance coverage provides a needed supplement in the event of disaster.

If you are having trouble finding insurance coverage, the California Department of Insurance has a tool that allows homeowners to find insurers writing coverage in their area along with likely premium rates. We welcome conversations on specific situations to provide context and help clients navigate the process of finding their best path forward.

Resources

¹ The FAIR Plan was put into place following incidents in 1968 – a wave of fires in northern CA and the Watts race riots in southern CA – which left thousands of families uninsured in areas deemed uninsurable.

² Insurance in California is Changing. Here’s How It May Affect You