They're never coming back

Large and small property insurers are not the same

Last month, I listened to Victoria Roach, the president of California's public FAIR Plan insurer of last resort, describe the clearinghouse the state has created to send publicly-held policies off to private insurers. She made clear it wasn't working: "We have had very limited success with this [clearinghouse]," Ms. Roach said. Last week, I wrote about the state of Florida's energetic efforts to get policies off its books and into the hands of dodgy private insurers, whether or not a particular homeowner wants a particular policy to be shifted this way.* Florida calls this the Citizens Depopulation Plan.

California and Florida are both feeling the effects of rapid climate change. The two states' approaches are different, but the basic privatization move is the same. Both states are saying "Get this risk off my balance sheet!." They're also both desperately urging private insurers to stick around. And they’re both being ghosted by large insurers.

The problem the two states face is a structural one: increasing climate risk in both places is dampening large, reputable insurers' appetite for home insurance policies. These large insurers have good data and good models. They're looking into the future and they know what's going to happen. To the extent regulators allow them to do it, they are leaving for good, or leaving everywhere other than relatively future-proof, cherry-picked locations.

Smaller, less-informed, more marginal insurers are sticking around to make a quick buck. These are lower-information entities. Their businesses may not be sustainable given their thin capitalization and geographically concentrated risk portfolios.

Eventually, following the next series of disasters, shoddy insurers issuing shoddy policies will be creating public burdens. Those burdens, including those created by the insolvency of the public insurers, will be felt far beyond the borders of Florida or California. Instead, the federal government will inevitably be asked to shore up the situation—meaning that all of us will be on the hook.

What's a state regulator to do? Admitting reality is politically difficult. The first step, though, would be to acknowledge that although sending public policies back to willing private players might make for a short-term political talking point, it will cause even greater political pain and loss in the long run if those private players aren't healthy, and if the public entity is left holding the worst of the worst concentrated risk. This is likely true for property markets around the globe, not just in the US.

Let's take a look at the steps California and Florida regulators are taking to encourage private players to stay around.

California. Private insurers in California are constrained by their regulator from setting rates based on climate models that project future risks (unless they make those models public, which they don't want to do) or sending on to policyholders the costs they pay to shift portions of their risk to reinsurance companies.* Consumer advocates are part of the California rate-setting process if a California insurer wants to raise rates by more than seven percent. Right now, it takes a couple of years for a new proposed rate to be put in place.

These regulatory limits are aimed at smoothing and flattening the shock of insurance rate increases that consumers see. They have had the arguably pernicious effect of muting the "this makes no sense" price signals that private marketplaces are supposed to be good at sending. Some large insurers are exiting or limiting their business in California (Allstate, State Farm, Farmers, USAA).

California's current regulator, Ricardo Lara, is considering a host of reforms designed to lure insurers back to high-risk areas. These changes may include speeding up the rate approval process, allowing insurers to use proprietary forward-looking climate models in assessing risks, and allowing insurers to recover their reinsurance costs, while simultaneously making insurers sell a sufficiently high number of policies in high-risk places (so that their market shares in those riskier places amount to 85% of their market shares in the state overall).***

Listen to what Dave Jones, who was California's insurance commissioner from 2011-2019, told Eli Flesch of Law360 [behind a paywall, sorry] the other day: "In the long term, those efforts of giving insurers more rate [allowing them to charge more], and speeding up the approval process will be overwhelmed by the growing background risk of loss and losses [in California] associated with climate change." In other words, this isn't going to work.

Why? Because the grating, screaming noise of the risk is far louder than the siren song of the California market, particularly in the ears of a well-informed large insurer. California forests are thick with fuel, temperatures are rising, rainfall is diminishing, more people are moving to wildfire areas, property values are going up because housing is scarce, and it's getting more expensive all the time to replace damaged properties. Faced with all of this, a reasonable high-margin insurer will skedaddle. Even if it is allowed to raise its premiums, its business won't be profitable in an environment in which the cost of paying claims is going up so sharply, and it faces the risk of an assessment if the public insurer runs out of money to pay claims.

That's why the FAIR Plan, which keeps gamely saying that it's just a "temporary safety net" put in place to tide consumers over "until coverage offered by a traditional carrier becomes available" is growing so quickly and is so vulnerable to collapse. The traditional carriers are not going to come back.

Why do we know this? Because Florida has already tried these reforms—allowing insurers to raise their rates quickly and pass on their reinsurance costs to consumers—and they haven’t worked.

Florida. Florida has done what the insurers are asking for in California. Florida allows reinsurance costs to be part of the insurers' rate base, allows the use of probabilistic climate models in setting rates, and has limited insurers' liability by cutting down on third-party lawsuits against insurers and not allowing people who sue insurance companies to collect their attorneys' fees if they win. The state has set up a $2 billion taxpayer-funded pot of money for use by insurers struggling to buy reinsurance.

In California, if the FAIR Plan doesn't have enough money to pay claims, insurers who operate in the state are on the hook; in Florida, consumers are on the hook for shortfalls, not insurers.

Nonetheless, despite all this government work to encourage insurers to stay, it's not working out well in Florida. Those marginal insurance companies I wrote about last week are (sort of) filling the gap, but the big better-informed ones are steadily vanishing.

The state is doing whatever it can to keep the house of cards standing. In 2022, Florida's insurance commissioner blasted Demotech, the insurance credit-rating agency I wrote about last week, when it tried to downgrade 17 of the "financial stability ratings" it had issued to not-so-stable insurance companies operating in Florida. Demotech backed off right away, downgrading just one company and withdrawing its ratings for two others.

(Good news for California: Demotech has opened up an unlicensed ("surplus line") coastal home insurance operation in the Golden State.)

Florida *requires* policyholders to leave Citizens' books if a private insurer shows up who is willing to take on the account.* Florida also pays those insurers to absorb accounts previously serviced by Citizens, provides them with regulatory incentives to charge lower rates, and points them toward the relatively good bets that are on its books. Florida's insurance commissioner, Michael Yaworsky, is a real booster: "OIR remains steadfast in our efforts to stabilize Florida's insurance market by implementing legislative reforms and recruiting more insurers to the state."

These two state public plans are not the same. Citizens in Florida is writing insurance for 1.1 million policyholders as of February 2024, representing a significant chunk of the ~3.8 million single-family homes and 7.3 million total housing units in the state as of 2017. In California, the FAIR Plan holds only about 4 percent of all policies. But the FAIR Plan is growing really quickly (27 percent year over year, up to about 375,000 policies today, with most of the growth outside wildfire areas), and like Citizens is really exposed, having issued insurance covering $311 billion in total potential claims so far. It has just $200 million in surplus funds and $700 million in the bank.

But it is increasingly clear that these two state plans have something fundamental in common: They are no longer "insurers of last resort." They're often first in line, providing something labeled insurance that is thin, undercapitalized, and prone to collapse.

Surely we are capable of confronting the fact that these state plans are operating within something less than a real insurance market. In many respects this dessicated structure, as a whole, is a delaying tactic. Eventually, the greater burden caused by this delay will likely fall on the American public in the form of a systemic financial collapse.

So: If good insurance isn't actually available and affordable across a particular geographic area, what's the right public policy response? That’s the question policymakers should be asking. Let’s just not call the answer “insurance.”

* As Citizens says: "Only [Citizens] policies that receive an offer of [private] coverage that is more than 20% greater than Citizens’ estimated renewal premium are eligible to remain with Citizens."

**Reinsurers aren't regulated and can charge whatever they want.

***In other words, part of the price of making a profit selling home insurance in the state of California will be an obligation to provide insurance to riskier California neighborhoods.