Global economic losses from natural catastrophes such as floods, hurricanes and wildfires reached $270 billion in 2021, according to an annual report published by reinsurance giant Swiss Re. Though less than half of those losses ($111 billion) were actually insured, the figure equaled the fourth-largest payout since the Swiss Re Institute, the insurer’s research arm, began keeping records in 1970.
Bottom line: The $5 trillion insurance industry is getting rocked by climate disasters with no end in sight.
Though California, with its numerous and massive wildfires, has been an especially disaster-prone state, the situation there promises to spread across the United States. To analyze the situation, Real Assets Adviser editor Mike Consol called on Jim Kane — partner, senior vice president and national practice leader at USI Insurance Services — to provide some insights.
Explain the crisis in the Golden State.
The insurance market in California is in an unprecedented crisis for availability of coverage due to many factors heavily influenced by the prevalence of wildfires. California’s five largest wildfires have occurred since 2015, with “wildfire season” now extending throughout the calendar year. Wildfire increases can be attributed to warming atmosphere, ongoing drought conditions, encroachment of habitation on wildfire zones, land management and the dereliction of government in managing open lands.
The reaction to wildfires from insurance companies has been severe. It is almost impossible for underwriters to secure rates that allow a fair chance of underwriting profit leading fewer companies to offer coverage close to wildfire zones. Realizing clients still have a need for insurance, insurers turn to non-admitted carriers. Non-admitted carriers enable insurers to offer terms to clients as they are not regulated by the state insurance commissioner. The policies come with higher premiums and offer less coverage. This also creates pressure for reinsurers who provide a hedge on the carriers’ risk to also curtail their appetite further increasing premiums and expense.
Why is the situation expected to sweep across other U.S. states?
Atmospheric warming has contributed to other catastrophic losses beyond drought and wildfire. There is a sharp rise in the intensity of weather conditions and associated damage. Tornadoes now occur in unexpected locations. Hurricanes, super storms and microbursts are now more common occurrences.
Coastline states now battle high winds, storm surge and tidal flooding. Land-locked states are experiencing intense weather, creating catastrophic loss from wind and storms. The impact from increased severe weather conditions has expanded the insurance industry’s response from California to several additional states including Colorado (wildfire and hail), Texas (hail, hurricane and flooding), Florida (hurricane and flooding) and beyond.
What are the key factors driving these conditions?
Numerous factors created and exacerbated the unprecedented limits on access to standard insurance protection. Insurers operate on the basic principle that estimating losses is more predictable when the number of participants is larger. Unfortunately, environmental evolution has generated actual losses exceeding underwriting models for nearly a decade. For instance, in 2021 alone, the industry estimates that $1.70 was paid in wildfire claims for every $1 paid in premium. Insurers can’t survive with disparities of this size for a loss as common as wildfire.
Drought has long been an issue in California. However, lack of rain lasting months prior to the main wildfire season creates conditions where residents are surrounded by dry debris waiting for consumption by the next spark. Rising temperatures warms the air and oceans, creating an environment conducive to more dangerous and violent hurricanes and tornadoes. These events include wind, water, hail and other sources of damage to life and property that exceeds the anticipated loss history for insurance carriers.
Technology has also played a part in the hardening insurance market. New modeling techniques are more precise, allowing underwriters to be selective on individual risks and to de-lever on existing coverage with the new data available. The good news is that technology can also help clients. These tools are part of a long-term solution to help educate clients about high-risk conditions and mitigation steps that can be taken to reduce or avoid loss.
How long will these conditions last?
Key factors determining the length of a hard market include rates; underwriting profitability for insurers and reinsurers; and coordinated efforts among clients, the public and private sectors to address the adverse conditions.
The trending use of non-admitted forms is primarily due to the ability of the insurer to charge the necessary rate for coverage designed specifically for an individual risk. It remains to be seen where the premium charge exceeds the appetite and budget for the protection. The current situation is close to this point, if not already there. Recent cases experienced premiums at 10 times the expiring rate with significant reductions in coverage.
Examples of collaboration to address impending catastrophes can be found on both coasts. The city of Miami was recognized for efforts to address the area’s tidal flooding. The plan was developed in anticipation of events worsening in frequency and duration with the theory that an ounce of prevention is worth a pound of cure.
California has a long way to go. The investment of funds in land management and planning is a step toward mitigation of wildfires. An additional step would be the coordination between the federal government and landowners.
There is no panacea for these challenges. However, the problems are not insurmountable with a multi-tiered, collaborative approach.
What other steps can business and clients take to improve their risk management programs?
Clients should adopt a risk management strategy to protect their family and assets. Reducing potential loss or eliminating exposures is the best approach to saving premium and enhancing coverage. A property’s security is the focus of an underwriter assessing the eligibility of the risk.
Understanding potential risk is critical to securing protection and utilizing tools necessary to avoid a catastrophe. Take flooding, for example. More than half the claims made to the National Flood Insurance Program are from clients that do not have a flood policy, typically because their lender did not require it. The risk existed — just not at the level required by law to secure the loan. Educating clients about risks that may be relevant, even if coverage is not mandatory, can make a significant impact in creating a comprehensive risk management plan. There has been progress on flood education, but we still have a long way to go.
In the case of wildfire, better comprehension of the risk from flying embers and smoke damage provides the client a more holistic view of the exposure, the multiple ways wildfire can damage property, and potential mitigation tactics.
What other considerations or consequences will clients face because of the difficulties in the insurance market?
The limitation of eligibility in the current market leaves many clients in unfamiliar territory with few options. Some insurance brokers are now using non-admitted policies, FAIR Plan coverage and manuscript policy forms to provide insurance to customers in high-exposure markets where insurance coverage is more difficult to find. These are not standard pieces of a risk management plan. By definition, these solutions are designed to be customized and unique. They can be riskier for clients. Insurance advisers and clients must conduct heightened due diligence to guard against surprise after a loss.
Both California and Florida, have offered coverage of last resort via the Fair Plan and Citizens Insurance. The Fair Plan is limited (by intent) in the exposures covered and the amount of property insurance offered. Adding additional property over the basic FAIR Plan protection is not a simple added layer of protection. The coordination between the two forms and understanding how claims will be paid is paramount when structuring the program. Florida has similar restrictions with added concerns of solvency to a stressed and overrun state-operated property insurance program. Clients need to make sure they are educated about their plan.