California Insurance Market Reform and Wildfire Risk

Published Date: 09/27/2023

California’s insurance market has reached a critical turning point. In a state shaped by natural beauty and escalating natural disasters—wildfires, earthquakes, and floods—the home insurance system is showing signs of structural failure. As major insurers such as State Farm and Allstate pull back from writing new homeowner policies, state officials are responding with sweeping reforms that could fundamentally reshape how risk is measured, priced, and shared.

Last week, Insurance Commissioner Ricardo Lara announced a comprehensive plan to stabilize California’s “collapsing” insurance market. The proposal, now under public review, represents the most significant regulatory shift in decades. For the first time, insurers would be allowed to factor increasing wildfire risk driven by climate change into rate filings.

Supporters see the move as long-overdue modernization. Critics worry about affordability and access. At its core, this reform effort reflects a deeper challenge: balancing science, consumer protection, and the realities of a warming climate.

Why Insurers Are Leaving California’s Market

California has been stuck in a destabilizing cycle for years. Climate-driven disasters continue to intensify, insurance claims grow larger and more frequent, and regulatory constraints limit how quickly insurers can adjust pricing. Two major factors have pushed insurers toward the exit.

First, Proposition 103—passed by voters in 1988—requires state approval for rate increases and prohibits the use of forward-looking catastrophe models that project future risk. Insurers must rely largely on historical loss data, even as climate conditions change rapidly.

Second, reinsurance costs have surged. Reinsurance is the coverage that insurance companies buy to protect themselves from massive losses. Global catastrophe losses have driven these prices sharply upward, yet California law has historically prevented most of those costs from being reflected in consumer premiums.

The result is a system in which many insurers say they cannot charge enough to cover escalating risks. Faced with that imbalance, major carriers have paused or halted new policy sales, particularly in wildfire-prone regions. Many homeowners have been forced onto the California FAIR Plan, which offers limited and often expensive coverage.

Commissioner Lara’s proposal is designed to reverse that trend by aligning insurance pricing more closely with real-world risk.

Catastrophe Modeling and the Role of Climate Science

At the center of the proposed reforms is the introduction of catastrophe modeling into California’s rate-setting process.

Insurance expert Karl Susman describes catastrophe modeling as the integration of science, engineering, historical data, mathematical analysis, and advanced computer simulation. These models combine information about weather patterns, fire history, vegetation, terrain, construction types, and climate projections to estimate both the likelihood and cost of future disasters.

Instead of relying solely on what happened in the past, catastrophe models project what is likely to happen next. For insurers, this allows premiums to reflect forward-looking risk. For regulators, it provides a data-driven foundation for evaluating rate filings. For consumers, it promises a more transparent and potentially more stable market—though not necessarily a cheaper one.

This marks a fundamental shift in how California approaches risk pricing in a climate-altered future.

Reinsurance Reform and Its Impact on Premiums

Another central component of the proposal addresses reinsurance costs—the often-invisible force behind rising premiums.

As wildfire losses in California and climate disasters worldwide have escalated, reinsurance prices have climbed sharply. Until now, state regulations have largely prevented insurers from passing those costs through to California consumers.

Under the new proposal, insurers would be allowed to include reinsurance costs in rate filings, but only those directly tied to California risk. Global reinsurance losses from events elsewhere, such as hurricanes or international floods, would not be factored into local premiums.

This distinction is critical. It is intended to stabilize the market without forcing Californians to subsidize catastrophe losses in other regions. While this change could lead to incremental premium increases, regulators view it as necessary to keep insurers financially viable within the state.

Mandatory Coverage in High-Risk Areas

One of the most controversial elements of the reform package is a new market participation requirement. Under the proposed rules, insurers would be required to write policies for at least 85% of properties in distressed or high-risk areas if they wish to continue operating in California.

This requirement aims to restore competition in regions that have been effectively abandoned by the private market. Today, limited competition has contributed to rising prices and shrinking consumer choice.

The reform seeks to balance profitability and public responsibility. If insurers want access to California’s lower-risk, high-volume markets, they must also serve the higher-risk communities that currently depend heavily on the FAIR Plan.

While this mandate could expand access to private insurance, it is also likely to put additional upward pressure on premiums in the short term.

Short-Term Rate Pressure and Long-Term Market Stability

In the near term, homeowners should not expect immediate relief. With insurer participation at historic lows, competition has eroded and premiums continue to climb. The state’s proposed reforms are not designed to instantly reduce costs.

Instead, the strategy focuses on long-term stabilization. The expectation is that once catastrophe modeling and reinsurance reforms make California a viable market again, insurers will return. As competition increases, market forces—not regulation alone—could begin to moderate pricing.

This represents a philosophical shift away from strict price controls toward rebuilding the structural incentives that encourage insurers to stay and compete in California.

Public Workshops and Stakeholder Input

To guide the transition, the Department of Insurance has been hosting public workshops to gather feedback from insurers, consumer advocates, and homeowners. These sessions are intended to increase transparency and allow for technical and consumer-focused input as the new rules take shape.

One of the first major virtual workshops, held in late September 2023, focused on catastrophe modeling and reinsurance. Experts emphasized the importance of public education in helping homeowners understand how risk is calculated and how premiums are determined.

The goal of these sessions is to ensure the reforms create a functioning market that remains both financially sustainable and accessible to consumers.

Industry and Government Working Toward a Shared Goal

A notable feature of the current reform effort is the level of collaboration between insurers, regulators, and state leadership. Conversations among the insurance industry, the governor’s office, and the Department of Insurance reflect a shared understanding that a functioning private insurance market is essential for California’s economic stability.

Without that market, the burden increasingly shifts to the FAIR Plan and, ultimately, to taxpayers and homeowners through higher costs and limited protections.

The central objective of the overhaul is to bring insurers back into active participation across the state while preserving essential consumer protections.

Insurance Reform as Part of Climate Adaptation

California’s insurance crisis cannot be separated from the broader reality of climate change. As disasters become more frequent and severe,

traditional methods of spreading and pricing risk are being pushed beyond their limits.

Insurance is fundamentally about managing uncertainty. Yet climate volatility is making that uncertainty more difficult—and more expensive—to manage. By incorporating climate science, advanced modeling, and updated financial rules, the state is taking a significant step toward modernizing how disaster risk is handled.

At the same time, policymakers face the ongoing challenge of ensuring that affordability and access remain central as the system evolves.

Conclusion: A Delicate Balancing Act for the Future

California’s catastrophe insurance overhaul represents one of the most ambitious efforts in the country to align insurance regulation with climate reality. By allowing catastrophe modeling, reforming reinsurance rules, and mandating broader coverage in high-risk areas, the state is attempting to rebuild a market on the brink of collapse.

The path forward will not be painless. Homeowners may face higher premiums in the short term. Insurers will face greater transparency and participation requirements. Regulators must navigate the difficult balance between market sustainability and consumer protection.

The broader question is not whether California can afford to reform its insurance system. It is whether the state can afford not to.