None of us expected Hilary to show up as a storm, certainly not in California. Who’d have thought that California of all places would get hammered by a tropical storm so bad that a discussion would be needed on the state of property insurance going forward? In reality, however, a lot of experts in the industry have been ringing alarm bells for a good while. While it’s true that their fears didn't stem from anticipating storms to hit the state, their reasons were valid and remain so today.  

What are those reasons and is Storm Hilary going to make things worse? If so, then to what extent? Was there a time when Florida was in the same state? Can we learn from Florida to manage California’s impending crisis better? These questions, and many more, are merited and demand intellectual pondering followed by swift, actionable measures. 

Today, we will discuss what the current state of California’s insurance market is and what lies ahead. 

Storm Hilary is unprecedented, but destructive, nonetheless 

Although the storm is an ongoing event, it has been widely reported that Hilary has already caused several billions in losses in the state of California. Tropical storms usually do leave tremendous amounts of damage in their wake, but the unexpected nature of this calamity has most certainly aggravated the magnitude of the damage. The last time California received a hurricane or tropical storm was 84 years ago in 1939 in the form of El Cordonazo. 

Although Los Angeles' response to Tropical Storm Hilary demonstrated the value of proactive measures and effective communication in mitigating the impact of extreme weather events, loans still require insurance and property owners could find it increasingly tough to find carriers willing to offer coverage at rates from days past. But, why? 

Has it always been like this for California’s insurance industry? Is Hilary simply illuminating a decades old problem that is poised to possibly get worse with time? 

Insurers are leaving California 

Several insurance carriers have been leaving California for one reason or another and the trend shows no signs of slowing down. The state’s insistence on keeping insurance rates low and not factoring in climate change-related risks has also hindered industry’s capacity to respond to unprecedented natural disasters. 

Major insurers like State Farm and Allstate have stopped accepting new applications for property and casualty coverage in the state. This adds to the existing housing challenges faced by Californians, who already contend with high real estate prices, wildfires, and a housing shortage. Add flooding to the mix and you have a cocktail of misery for property buyers, insurance carriers, and lenders.  

Proposition 103, which requires carriers to seek permission from the state government before increasing premiums, and public interest group involvement have further complicated rate hikes. The California FAIR (Fair Access to Insurance Requirements) Plan, designed as a provider of last resort, has witnessed a 70% surge in enrollments since 2019, covering 272,846 homes in 2022. This crisis affects various regions, regardless of their wildfire risk level. 

Even when trying to work in the given market dynamics, insurance carriers have little to no room left to transfer their risk. Normally, insurance companies purchase coverage of their own from reinsurers in order to spread the risk. However, reinsurers have not only raised market-wide prices, but they are also becoming increasingly concerned about facing solvency issues if they foresee an inability to meet their financial obligations in the face of natural disasters. 

This either results in very expensive reinsurance or none at all. Since reinsurance is a core feature of insurance carriers’ business model, the outlook presented by its stakeholders directly affects the attractiveness of a market. 

Why it’s becoming increasingly hard to insure in California 

California’s insurance industry seems ready to share a fate similar to that of Florida. The reasons are similar in some cases and unique in others but each one warrants attention. Let’s explore the four primary drivers of unusually high difficulties that carriers face in California. 

• Legislation 

Proposition 103 is infamous in insurance circles for being an anti-industry law as it requires any insurance rate hikes to get ‘prior approval’ from the California Department of Insurance before they can be implemented. By some estimates, it has saved buyers tens of billions of dollars in lower premiums since getting enacted in 1988. 

For insurers, the law mandates them to not raise prices resulting in them completely stripped of their ability to react to changes in the market such as high risks from floods or wildfires. 

• Inflation 

The only thing good about inflation is that it doesn’t discriminate. In the context of the property market, it causes costs of labor, construction materials, and related services to increase. Insurance payouts, for example for replacement cost insurance, take into account the costs involved in restoring the property to its original condition. Since the cost of doing so increases with inflation, the premiums calculated at the time of writing the policy do not match what they would be if the policy was written today. 

In states where the law does not require ‘prior approval’, insurers have the option of increasing premiums. In California, however, this is not as simple, and carriers are faced with one of two possible choices: make fewer profits while considering a real possibility of losses or pack up their operations and leave.  

• Climate change 

If the possibility of natural disasters increases over time, whether due to climate change or otherwise, the chances of insurance companies having to payout claims increases. Since this directly influences possible losses for carriers, they are again left with one of two possible choices – keep insuring while taking on greater risk or raise prices to reflect this increased risk. 

In California, carriers really only have the latter option available to them despite there being more wildfires with greater intensity with each passing year. These are primarily driven by climate change, and we have tropical storms, such as Hilary, knocking on the door telling us of what’s to come.  

• FED interest rates 

Higher interest rates increase the cost of capital for insurance companies, requiring them to adjust their premiums accordingly. If specific markets, like California, prevent them from doing that or are slowed down in the process by law, they are reluctant to work in such markets. 

Similarly, reinsurers also get exposed to safer investment options such as T-bills and other sovereign bonds as compared to insuring other carriers and charging them premiums. In such scenarios, reinsurers are likely to only insure carriers whose portfolios are less exposed to high-risk markets such as California or Florida. 

What lies ahead 

Studying how Florida withered the proverbial storm when the insurance industry started realizing the horrors of insuring flood, hurricane, and storm prone properties, makes it easier to assume that California’s industry could be looking at the same gloomy future. 

As risks and their probability rise with each passing season, more expensive insurance options will become the norm. This will get exacerbated by insurance companies taking their business to other markets. Fewer carriers would mean less competition which would result in even more expensive coverage options. 

On the other hand, the FED slowing down the pace of rate hikes might not be enough to soothe the industry.  The FED actually putting a pause on rate hikes won’t be enough either. What is needed will be a reduction in rates to clearly signal to the market that inflation has come under control and could be receding. Lower rates will naturally reduce the cost of capital to insurers which could tempt them to revisit expanding their portfolios and might even get carriers in neighboring states like Oregon, Nevada, and Arizona, to consider expanding into California. 

There have been growing calls from insurers about lobbying to pass supportive legislation or create room in existing law that lets them increase premiums in response to the increase in risks. States certainly have responsibilities to all their stakeholders including businesses, and insurance companies will have to be considered key enablers of any initiative that aims to ensure that property owners are never left without adequate coverage options, especially when facing natural disasters. 

What does it mean for property owners and prospective buyers? 

At the end of it all, it is property owners who are left bearing the brunt and nothing that’s been talked about so far points to an overwhelmingly positive outlook for now, as coverage options from big carriers have been steadily decreasing for one reason or another. 

Interestingly, past examples could pave the way for what’s needed to overcome the challenges Californians currently face and could face in greater frequency and intensity going forward. 

The FAIR plan, for example, was set up in response to rapidly increasing wildfires in the state with the objective of providing basic fire insurance that offers protection from internal explosions, as well as smoke, and lightning. The plan also offers windstorm and vandalism coverage. It offers up to a maximum of $20 million in coverage to commercial properties, which was raised in March 2023 from the previous $8.4 million. 

However, the increased coverage limits will take effect once the FAIR Plan submits a new rule filing for approval by the Department of Insurance, with coverage potentially available in the fourth quarter of this year. Building on the framework of the FAIR plan, California could introduce a similar mechanism for an insurer of last resort specifically for flood. 

Additionally, lobbying from interest groups could lead to the relaxation of consumer-friendly policies that have kept rates low in the state for years. However, this may also mean that Californians will have to pay more for home insurance in the future to maintain coverage and support the housing market. 

It’s important to note that while coverage options have been declining, presently, many carriers do exist and are writing policies as usual. Having a database built on real policy documents enables Advocate to learn about who those providers are and enables lenders who work with us to assist their borrowers if they are facing issues in acquiring coverage. 

If you are interested in learning more about what the current state of the insurance market is in Florida and California, join our VP, Kristine Economus at our webinar on September 14th when she will dive deep into the challenges facing the market today in both states and what possible solutions exist going forward.