(Airdate: 2024-04-25) Spectrum 1 News Interview - “Catastrophe Modeling” with ITI host Amrit Singh

Published Date: 04/25/2024

Catastrophe Modeling Comes to California: How AI and Data Are Reshaping the State’s Insurance Landscape

California’s insurance market is undergoing a seismic transformation. As wildfires, floods, and other climate-related disasters grow more destructive, the state’s long-standing approach to regulating insurance — rooted in 1980s-era policies — is being pushed to its limits.

In April 2024, the California Department of Insurance held a workshop on catastrophe modeling, a process that uses artificial intelligence, climate science, and data analytics to project future disaster risks. For the first time, state regulators and insurers discussed formally incorporating these tools into how home insurance rates are calculated.

Insurance industry expert Karl Susman, who testified at the workshop and later joined Spectrum News 1 for a detailed interview, helped clarify what catastrophe modeling really is — and what it means for consumers, regulators, and insurers. His insights reveal both the promise and the controversy behind this major policy shift.

The State’s Breaking Point: Why Change Is Needed

Two more insurance carriers exited California in the week leading up to the Department of Insurance workshop — the latest in a string of withdrawals by major insurers like State Farm, Allstate, and Farmers. The reasons are familiar: rising wildfire losses, regulatory restrictions, and an inability to charge premiums that accurately reflect modern risk.

As Susman explained, “Many of the companies still writing policies in California are raising their prices and premiums.” Those who remain are struggling under a system that, until now, has prevented the use of forward-looking data to model catastrophe exposure.

Unlike nearly every other state in the U.S., California law still forbids insurers from using catastrophe modeling to determine rates. They must base pricing on historical loss data — a method that increasingly fails to capture the reality of climate-driven disasters.

Catastrophe modeling seeks to correct this by allowing insurers to account for current and future conditions, such as worsening droughts, heat waves, and wildfire risks.

What Exactly Is Catastrophe Modeling?

Despite the technical name, catastrophe modeling — or “cat modeling” — is not new. “It’s something that’s been utilized across the world for years,” Susman said. “It’s used in insurance underwriting and rating in literally every state except for California.”

At its core, catastrophe modeling merges science, engineering, statistics, and computer technology to predict the likelihood and potential cost of large-scale disasters.

Susman described it as a way to help both insurers and consumers “work more granularly to find out what their exact risk looks like.” Rather than simply relying on regional averages, cat models evaluate specific factors such as:

• Local vegetation, terrain, and proximity to fire-prone zones
• Building materials, roof type, and maintenance history
• Historical fire activity and weather trends
• Climate projections for temperature, humidity, and wind patterns
• Human mitigation actions — like defensible space and fire-resistant retrofits

“It’s not just looking at the data of what’s happened in the past,” Susman emphasized. “It’s looking at what consumers are doing to their homes today to make them safer from wildfire.”

By integrating this information, the models help insurers estimate both the probability and financial impact of catastrophic events, enabling more precise — and theoretically fairer — pricing.

The Transparency Debate: Is Catastrophe Modeling a “Black Box”?

One of the major criticisms of catastrophe modeling is its perceived lack of transparency. Consumer advocates, including Consumer Watchdog, have warned that allowing insurers to use proprietary algorithms could create a “black box” system, where homeowners are charged based on formulas they cannot understand or challenge.

Susman addressed this concern directly in his Spectrum News interview:

“That’s one of the biggest misconceptions. Every insurance carrier has its own models — its own secret sauce — but the information that comes out of it is completely disclosed to the California Department of Insurance.”

To explain, he used a memorable analogy:

“It would be like if you’re making a hamburger. You have to disclose to everybody that, yes, there are two beef patties, there’s cheese, there’s a bun. But you’re not going to get into the specifics like, what exactly are you seasoning the beef with? Where did you get the lettuce? What temperature do you keep the buns?”

In other words, while insurers will retain proprietary control over their exact algorithms, all model components and outputs must be reviewed by regulators. The Department of Insurance and the Insurance Commissioner will have full access to the data inputs and rate justifications, even if competitors and the public do not.

This compromise seeks to balance consumer protection with commercial confidentiality — allowing oversight without exposing trade secrets.

Learning from Florida: The Right and Wrong Lessons

Critics of catastrophe modeling often point to Florida, where insurance premiums have soared to two or three times higher than the national average, even as multiple insurers have gone bankrupt or left the state.

Consumer Watchdog has argued that California could follow the same path if it embraces catastrophe modeling without proper safeguards.

Susman countered that this comparison is misleading. “They [Consumer Watchdog] were talking about how we should be more like Florida,” he recalled. “And the first thing out of my mouth was, that’s the first time I’ve ever heard Consumer Watchdog say anybody would want to be like Florida.”

He explained that Florida’s problems stem from structural and legal differences, not the modeling itself. For example, Florida’s market is dominated by small, regional insurers and burdened by high litigation rates, reinsurance costs, and hurricane exposure — conditions that don’t directly apply to California.

A more appropriate comparison, he suggested, would be flood insurance, where catastrophe modeling has been used for years.

“With flood insurance, there’s just one program — the National Flood Insurance Program. Rates have gone up in high-risk areas and gone down in lower-risk ones. When you get more exact and precise, you’re inevitably going to have people paying more and others paying less.”

That’s the essence of catastrophe modeling: replacing blanket averages with individualized assessments. The transition may feel painful for some, but it creates a system that more accurately reflects real-world risk.

Ending the Cross-Subsidy Problem

One of the most significant effects of catastrophe modeling will be ending what Susman called the “homogenous pricing” problem — where people in safe, urban areas effectively subsidize those in high-risk, rural zones.

Under the current model, homeowners “living in the hills or canyons” often pay roughly the same as those “living in the middle of the city,” despite vastly different risk profiles.

With catastrophe modeling, pricing becomes more location- and structure-specific. Homes “30, 40, 50 miles away from a fire station up a snake road that a motorcycle can barely make it on” will likely see rate increases, while safer homes could pay less.

This precision-based pricing aims to restore fairness to the system — but also signals a new reality: insurance will cost more in places where it’s riskier to live.

Implementation: What Happens Next?

At the time of the April 2024 workshop, catastrophe modeling was still under regulatory review. The Department of Insurance’s goal is to develop a framework that:

1. Allows modern modeling methods,
2. Ensures transparency and oversight, and
3. Protects consumers from unfair pricing or data misuse.

As of Susman’s testimony, the expectation was that catastrophe modeling would begin phased implementation by late 2024 or early 2025. Insurers will need to submit new rate filings that include their catastrophe models for Department approval — a process that may take several months.

Once approved, these models will influence not only base premium rates but also discounts for wildfire mitigation, creating stronger incentives for homeowners to invest in fire-resistant upgrades.

What Homeowners Can Expect

If catastrophe modeling is fully adopted, here’s what California homeowners are likely to experience:

1. More Accurate Pricing: Rates will better reflect each property’s true risk level, rather than relying on broad geographic averages.
2. Potentially Higher Premiums in High-Risk Areas: Especially for homes in remote, vegetation-dense, or fire-prone regions.
3. Lower Premiums for Safer Homes: Urban or well-mitigated properties may see rate decreases.
4. Increased Transparency with Regulators: The Department of Insurance will continue to audit and approve all model-based rate filings.
5. Greater Incentives for Risk Reduction: Home hardening, defensible space, and community fire mitigation programs could translate directly into savings.

The Bigger Picture: Insurance in the Age of Climate Uncertainty

California’s adoption of catastrophe modeling represents a major step toward climate adaptation in financial systems. Insurance is, at its heart, a mechanism for managing uncertainty — and traditional methods are no longer keeping up with the pace of environmental change.

By leveraging data science and AI, regulators and insurers are trying to build a more sustainable and resilient marketplace — one that acknowledges risk honestly rather than masking it through outdated pricing.

Still, transparency, equity, and consumer protection will remain critical challenges. As Susman pointed out, the key is not whether catastrophe modeling should be used — but how it’s implemented.

Conclusion

California’s move toward catastrophe modeling is both overdue and transformative. It signals a shift from a reactive, backward-looking insurance system to one guided by data, foresight, and adaptation.

For homeowners, the transition may bring growing pains — especially in high-risk zones — but it also promises a future where mitigation pays off, insurers re-enter the market, and the system becomes financially sustainable once again.

In the end, catastrophe modeling isn’t just about algorithms or rates. It’s about redefining how California confronts the risks of living in a changing climate — with fairness, science, and foresight leading the way.