In California, the number of acres burned per wildfire and structures damaged per acre have increased since 2013. Relentless years of devastating wildfires are stretching the California homeowners insurance industry to its limits with losses of $37 billion outstripping premiums of $32 billion since 2016.
Faced with the inability to recover all the costs of insuring California wildfires, the California admitted insurance market has been reducing its wildfire exposure. Stricter underwriting eligibility guidelines and higher rates for wildfire-exposed properties have pushed more policyholders into secondary markets, such as the California Fair Access to Insurance Requirements (FAIR) Plan. The FAIR Plan is design to accept properties that are having difficulty in finding insurance in the market and does not decline risks due to wildfire exposure.
To better understand its exposure to wildfire, the FAIR Plan asked Zesty.ai, Inc., a company that provides a wildfire risk score model, to score the FAIR Plan properties relative to wildfire risk. To read more about the FAIR Plan and Zesty.ai’s risk score model, read this paper by Milliman’s Annie Shen, Sheri Scott, and Katherine Dalis. It is the second in a series of articles examining California wildfire risk and tools that could be used to identify, quantify, and mitigate this risk.
In July 2020, Milliman published the research report “Reinsurance as a capital management tool for life insurers.” This report was written by our consultants Eamon Comerford, Paul Fulcher, Rik van Beers and myself.
Capital management is an increasingly important topic for insurers as they look to find ways to manage their risks and the related capital requirements and to optimise their solvency balance sheets. Reinsurance is one of the key capital management tools available to insurers. The paper investigates common reinsurance strategies, along with new developments and innovative strategies that could be implemented by companies.
This blog post is the eighth in a series of posts about this research. Each post provides an overview of a certain section of the Milliman report.
Mortality and catastrophe risk reinsurance
Two common interrelated risks that life insurers can face are mortality risk and catastrophe risk. Mortality risk is the risk of both policyholders dying earlier than expected and more policyholders dying than expected. This risk occurs gradually throughout the duration of the portfolio. If best estimate mortality rates are set too low then, as a result, provisions for mortality covers are insufficient to cover liability payments.
Catastrophe risk is the risk of many policyholders dying or falling sick due to a sudden event, such as a pandemic. The effects of a catastrophe shock are felt more immediately than the effects resulting from a mortality shock. A recent example of this is the COVID-19 pandemic.
Determining mortality risk and catastrophe risk
Setting robust best estimate mortality parameters for an insurer’s portfolio can be subject to a substantial amount of expert judgement, especially in the case of smaller portfolios or where the insurer does not have a lot of experience. Mortality risk can be quite material, as a small variance in the portfolio’s mortality can readily lead to insufficient reserves. This especially holds true if this variance occurs on life covers from individuals with above average sums assured. Estimating catastrophe risk can be challenging. Parameters and models used to determine the catastrophe risk are dependent on the event driving it. In the case of a pandemic, variables such as social distancing, contagiousness, population age structure and lethality are important when calibrating a catastrophe risk model.
To begin to address climate risk effectively, governments, insurers, banks and asset managers, infrastructure experts, and technical assistance and research firms need to be enlisted to work together. Addressing climate change adaptation to reduce risk before disasters hit is the best chance to improve the outcomes of climate risk events.
This is especially true for low-income and small island nations. For many of these nations, resilience efforts are simply out of reach. Insurance may mitigate some of the costs for citizens, but it is of limited benefit in adaptation. The bond markets focus on short durations. And it can be difficult for small countries to obtain even basic infrastructure financing.
Climate adaptation requires significant financing. Basic asset-liability management says that long-term projects should be matched with long-term investments while mitigating long-term risks—like climate change. Linking insurance directly to long-term climate adaptation bonds can help governments more effectively adapt to and manage the effects of climate change.
This article by Milliman’s Michael McCord of the MicroInsurance Centre at Milliman and Abhisheik Dhawan of the UN Capital Development Fund says that coming together to address climate change risks should begin before disaster strikes.
As the 2020 wildfire season again exceeds historical norms, insurers and policymakers must turn their attention from the literal fires to the figurative one: the threat—and increasing likelihood—that this escalating wildfire risk will result in a homeowners insurance crisis in the state of California.
For homeowners, insurance is often the last line of defense against losing everything to wildfire. However, for many, this crucial financial backstop is rapidly becoming harder to obtain as insurers reduce their portfolios due to billions in losses and regulatory restrictions on reflecting the true cost of risk in the premiums charged. This withdrawal is creating an untenable situation for many Californians and efforts to address it are becoming an urgent priority for policy makers.
In this article, Milliman professionals explain in more detail the state of home insurance in California and the regulatory efforts to address the issues thus far.
Reinsurance helps insurers respond financially to large
catastrophes like a wildfire or earthquake. Insurers share a portion of the
premium with reinsurers to rent capital and reduce the burden of a major event
involving multiple policyholders.
In California, regulations allow reinsurance costs for earthquakes
to be included in insurance rates but not for wildfires or other catastrophes.
This penalizes insurance companies that spread the risk of major wildfires, and
results in bottom-line loss and expense outstripping premium over the long
term. This, and other issues, are making it more complicated for homeowners in
the state to find insurance with wildfire protection in the voluntary market.
How can insurance be restructured to solve the wildfire insurance availability issue in California? Milliman consultant Sheri Scott discusses some options in her article “Reshaping insurance to solve California’s wildfire insurance availability issue.”
As a new wildfire season in California is ablaze, answers to
questions about insurers’ pricing, underwriting, and exposure management
functions resulting from the 2017 and 2018 seasons are still taking shape.
According to Milliman estimates, the 2017 wildfire season alone wiped out just
over 10 years of underwriting profits for California homeowners insurers. Moreover,
the combined 2017 and 2018 wildfire seasons wiped out about twice the combined
underwriting profits for the past 26 years, leaving the insurance industry with
an aggregate underwriting loss of over $10 billion for the California homeowners
line of business since 1991.
A historically profitable line of business has recently
become an unprofitable line exposed to a severe peril that is neither easily
measured nor fully understood. As a result, wildfire risk has become a key
focus of Californians, and their property insurers.
Catastrophe simulation models, or “CAT models,” have been
developed for a variety of catastrophic perils, such as hurricanes, floods,
winter storms, earthquakes, and wildfires, to provide insurers with scientific
techniques to quantify and assess their exposure to catastrophic risk. Recognizing
the growing importance of this peril, a number of firms have been working to
apply the latest techniques in catastrophe modeling to wildfires.
In their article “Wildfire catastrophe models could spark the changes California needs,” Milliman’s Eric Xu, Cody Webb, and David D. Evans explain how enhanced quantification and understanding of wildfire risk represents one of the most important challenges for property insurers writing business in the Western United States, and how innovations in the field of catastrophe modeling may assist them with this task.