Over the last five years, every class of natural catastrophe has been more frequent, more powerful, or both. Mother Nature continues to elude our attempts at prediction or control.
Emblematic of this new era is State Farm’s recent announcement that they would not be renewing 72,000 home insurance policies in the state of California, largely as a result of increased wildfire risk. This is a tough but important moment for insurance; true innovation sometimes requires drastic action.
Both State Farm and the State of California have acted in reasonable and predictable ways. California saw the need to ensure that homeowners could access the financial security that insurance provides, and took actions intended to keep insurers in California while keeping insurance affordable. As part of that legislation, home insurance carriers like State Farm were limited by the California Department of Insurance in their ability to adjust catastrophe models for increases in frequency and severity. In other words, while it has been widely misreported that California did not allow any pricing for catastrophe-related fire loss, California did limit the ability of carriers to use climate science to account for changes to future loss not reflected in past claims data.
Regulators also imposed various non-renewal moratoriums, transparency requirements, limitations on excluding wildfire, notification timelines, and appeals processes. These were always in the best interest of the consumer, but led to unmanageable conditions for insurers, or new operational requirements with expenses that could not be factored into rates. Most large historic carriers are grappling with the need for large scale data modernization to reconcile decades of business data; a changing regulatory landscape presents an agility challenge with billions in portfolio risk on the line.
The state’s decisions, while noble in motivation, had an inevitable end. Many regional players had no choice but to comply, as they are dependent on the revenue from the insurance they provide in the largest sub-national economy in the world. But it was only a matter of time before an insurer large enough to walk away from a significant source of premium abandoned a book of business in its entirety. The average homeowners premium in California is $1405 per year; that means the 72,000 homes represent a ballpark of $100M in premium per year. But with over $77B in annual net premium written, State Farm is one of the few carriers large enough to walk away from $100M. Tens of thousands of homeowners will now have to seek insurance from California’s state-operated home insurance program, FAIR.
This outcome, while painful for consumers in the near term, is likely the best thing for the long term insurance market in the state. The reality of the situation is that a larger insurer like State Farm was one of the few with the financial resilience to take such drastic action. And, while State Farm will not re-enter the state immediately, it will likely be back in the future.
In the meantime, State Farm’s exit creates opportunity for innovation. The significant burden on FAIR has created pressure on the State of California and its Department of Insurance to make change. Thus far, this has included adjustments to allow for predictions of future loss. And, as someone close to the market, I can tell you that entrepreneurs and intrapreneurs in countless forms have taken up the charge. FAIR plan policies will not be cheap. Private insurers can absolutely compete with state-provided policies to build profitable portfolios. As incumbents pull back from volatility, we see young businesses like tech-powered MGAs stepping in to meet demand.
The market for insurance capacity and reinsurance support to enter California is, ironically, catching fire. Insurance has always been an entrepreneurial business, and the premium left behind by State Farm and others in the marketplace all but ensures that the forces of innovation and capitalism will create opportunities for more sustainable pricing and portfolio management strategies. In the long term, State Farm’s difficult but necessary choice to exit will be very good for Californians, and forward-thinking insurers should see State Farm’s departure not as a warning, but as an invitation. The vacuum presents an opportunity for a new generation of underwriter, equipped with a new generation of data, models, and technology.
