Can California's FAIR Plan handle the heat?

Can California’s FAIR Plan handle the heat? | Insurance Business America

Catastrophe & Flood

Can California’s FAIR Plan handle the heat?

The wildfire program has over $300 billion in exposure

Catastrophe & Flood

By
Nicole Panteloucos

Last week, evacuations were ordered as high temperatures during the Fourth of July weekend ignited a new wave of wildfires across California.

As part of its 2024 Budget, the US Department of the Interior has devoted $1.7 billion to wildfire management. The total economic impact of climate change-fueled wildfires, however, far exceeds this, costing the US between $394 billion to $893 billion annually.

According to Jonathan Naranjo (pictured left), national real estate practice leader, SVP at Newfront Insurance, wildfires are not only an environmental and economic issue but also a significant challenge for the insurance sector.

“Wildfire and high-brush fire exposure has now surpassed earthquake in terms of severity and premium increases. Especially with insurers retracting out of the marketplace completely,” he said.

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FAIR plan grapples with lack of capital

As insurers like Tokio Marine America Insurance Co. and Transpacific Insurance Co. join a string of insurers exiting California’s high-risk home insurance market, the availability of wildfire insurance is diminishing.

The imbalance of supply and demand isn’t just driving up consumer premiums; it’s also straining government programs like the California FAIR Plan (Fair Access to Insurance Requirements).

The program provides property insurance to individuals who are unable to obtain it through the regular insurance market due to high-risk factors, such as living in wildfire-prone areas. “It serves as an insurer of last resort,” added Naranjo, ensuring that property owners can obtain basic insurance coverage despite being in fire risk zones.

As more insurers pull out or restrict business in the state, it’s no surprise that California’s FAIR Plan is experiencing an influx of applications, nearing 1,000 a day. In fact, the number of FAIR Plan policies in California has surged from roughly 127,000 in 2018 to an expected 400,000-plus by this September.

While this government assistance seems promising in theory, the FAIR Plan faces a major problem – it doesn’t have enough money. The program maintains about $300 billion in total exposure (the amount it insures) but only has $200 million in the bank.

Naranjo, likening the Fair Plan to an impending bubble burst, said: “Consider how highly leveraged that model is. The critical question is, what happens when the next major fire occurs? How will it impact the current policyholders of the California FAIR Plan?”

Increased premiums are highly probable.

It’s been predicted that just one major wildfire event could prompt the FAIR Plan to levy a surcharge of nearly $1,000 on insurance policies across the state – and premiums are already high. Between 2019 and 2024, LendingTree reports that home insurance costs have risen nearly 50% in California, with the average cost for residents now at $1,121.

Wildfire coverage is a problem in the North, too

Wildfires aren’t just a concern in the United States; areas in Quebec, Alberta, and British Columbia also face significant wildfire threats. Canadian insurers could face between $700 million and $1.5 billion in insured losses from last summer’s wildfire season.

While these projections are considered relatively manageable, Nathan Tjandrawinata (pictured right), managing director at Beacon, noted that Canadian insurers are still growing more cautious about wildfire risk. He pointed out: “Insurers may choose to withdraw from high-risk areas due to factors like the proximity of trees and forestry to insured properties. In these regions, we don’t anticipate a softening market; insurers are adopting a more cautious approach due to the perceived threat.”

While Canadian insurers haven’t yet reached the level of concern seen among some insurers in California, Tjandrawinata shared that the Canadian market is mirroring current US trends. “In Canadian regions with significant wildfire risks, there’s a trend towards higher premium rates and limited availability of insurance,” making coverage less accessible and more expensive for those who need it most.

Focus on what you can control

As the North American wildfire insurance landscape becomes increasingly unpredictable, Naranjo urges brokers to prioritize elements within their control to uphold client relationships amid market volatility. “The best way to damage a broker-client relationship is to present a renewal proposal with a 100% increase and give the client only one week to decide,” he said. “This doesn’t build confidence or strengthen relationships. So, what I always say is, let’s focus on the things we can control, like getting ahead of renewals early.”

As premiums rise and the demand for wildfire insurance continues to grow in high-risk areas like California, Vancouver, and elsewhere, brokers can implement the following strategies to mitigate client exposures:

Know your risk profile: Understand your client’s property’s construction type (e.g., wood frame vs. steel reinforced concrete), occupancy, and protection class to assess wildfire risk accurately.
Employ valuation tools: Utilize tools like CoreLogic or Marshall and Swift to determine replacement costs based on building construction type, location, and other factors.
Utilize third-party evaluators for accurate assessment: In addition to data tools, utilize third-party evaluators to assess total building costs accurately, especially in urban areas where standard models may underestimate actual reconstruction expenses. Factors like labor and material cost fluctuations can significantly impact these assessments.
Encourage use of fire-resistant materials: Promote building with fire-resistant materials for roofs, siding, and decks to lower the risk of fire damage.