By Eli Flesch, LAW360

https://www.law360.com/insurance-authority/articles/1698279

Farmers Insurance‘s decision to limit homeowners policies sales in California underscored the difficulties of market conditions in the state, while putting pressure on state lawmakers and regulators to adopt longtime industry priorities to reduce risk exposure, experts say.

Far from just a California issue, however, the insurer on Tuesday confirmed it was dropping homeowners policies in Florida, another state beset by natural disasters that are expected to grow worse on account of climate change. Attorneys advising insurers said the Farmers move showed that carriers need more flexibility in setting policy prices, while consumer advocates warned of a lack of competition in the California market.

While Farmers didn’t provide many specific details on how much it would limit its homeowners policies, as California’s second-largest insurer, any limit likely means that the insurer won’t take up the space left by State Farm or Allstate, which have both stopped selling new policies in California altogether. Together, three of California’s top four biggest insurance companies have now all taken steps to limit their exposure.

“It comes down to the fundamental reality that insurers must be able to contain their exposures,” Scott Seaman, the co-chair of Hinshaw & Culbertson LLP’s insurance practice, told Law360. “Without the ability to adequately adjust rates, more insurers may have to pull out. Reinsurers, like insurers, are also concerned with droughts, wildfires, floods, and these various factors impact the costs and availability of reinsurance.”

Last week, the American Property Casualty Insurance Association, the leading insurance industry trade group, called for reforms to Proposition 103 in California, the law that gives regulators power to approve rates. The APCIA also called for policymakers to allow the use of predictive models and reinsurance considerations in ratemaking. This Thursday, state regulators are hosting a workshop on such catastrophe models, which experts say can better predict risk as the climate changes.

Harvey Rosenfield, the president of the advocacy group Consumer Watchdog, who helped craft Proposition 103, described Farmers’ decision to limit homeowners policies as part of an industry “boycott” of California meant to draw policy concessions, but acknowledged that it wasn’t clear to him the extent to which Farmers was pulling back.

“It’s sort of like they want to have it both ways,” he told Law360. “They want to play a role in creating the shortage that the industry is using as a pretext for dismantling consumer protections. At the same time, it doesn’t look to me like they’re really pulling back anywhere near as extensively as the other two companies have done.”

For its part, the California Department of Insurance is pushing back on any suggestion that Farmers’ move will significantly affect consumers. Michael Soller, a department spokesperson, emphasized that Farmers was not departing from California’s market, and was just one of over 100 companies still writing homeowners policies in the state.

Farmers has been writing about 7,000 new policies monthly on average, to the department’s understanding, Soller told Law360 in a statement last week.

There have been recent indications that Farmers has been taking a more cautious approach to the California market. Earlier this year, it canceled over 1,000 policies in San Diego, in what was seen as a hedge against wildfire threats. Following the insurer’s Tuesday notice to Florida officials that it was dropping home, auto andumbrella policies, initial estimates suggested that 90,000 to 100,000 policies there could be canceled.

“California has to get a handle on its cost drivers or approve higher rates if it wants to keep carriers here,” Raymond Tittmann, an attorney with TittmannWeix who advises insurers, told Law360. “Costs of material andlabor are high and rising, regulators are aggressive, the legislature expands the scope of coverage mid-term, nuclear verdicts drive overlarge settlements, and commensurate rates are not approved,” he said.

For his part, Tittmann said he believed that competition in the California market has already declined with the insurer departures, affecting the price of and ability to secure coverage. People who have relationships with carriers are getting declined, he said.

“I think it’s always the case that when the market shrinks, the leverage shifts to the carrier, and therefore the prices are going to go up,” Tittmann said.

While insurance professionals maintain that market conditions and climate change-driven disasters will continue to challenge carriers, analysts have also said that the industry as a whole remains well-capitalized. Insurers this year are holding onto nearly $1 trillion in policyholder surplus — a financial cushion that represents how much money insurers have remaining after subtracting their liabilities from assets.

That surplus offers a more nuanced picture of an industry that has still recorded above-average underwritinglosses in recent years, contributing to “hard market” rate increases. In the first quarter of the year, commercial property premium prices increased by 20.4%, the largest among lines of insurance including general liability, commercial auto, and umbrella, according to a May report from the Council of Insurance Agents and Brokers.

Those underwriting losses have been attributed partly to natural disasters like hurricanes and wildfires, but also to losses from winter storms and out-of-season wind storms. Still, industry observers say big insurers like State Farm, Allstate, and Farmers are unlikely to go insolvent, unlike some smaller carriers in disaster-prone states.

In California, a state highly vulnerable to destructive wildfires given its history of drought, development in high-risk areas, and inadequate forest management, attention will turn this week to the question of allowing new models for pricing fire risks.

While insurance experts and risk professionals have advocated for the use of catastrophe models in underwriting risk, consumer advocates have warned that such a policy could result in higher rates for policyholders, especially those in high-risk areas, and state regulators have concerns over the transparency of private models.

Still, the use of such models in underwriting is permitted in other states, and the California Earthquake Authority, which provides earthquake insurance to over a million policyholders in California, is able to use such models under its founding law.

In a media briefing Tuesday that partly focused on the use of catastrophe models, Richard Gibson, a property and climate expert with the American Academy of Actuaries, said “insurers will have to rethink how they providecoverage to better assess risk and work with regulators so they can offer the coverage needed to consumers.”

Even if regulators do permit such models in policy pricing, as they suggested they would ahead of Thursday’s workshop, it’s far from clear the insurance industry won’t seek further reforms before major players like StateFarm and Allstate return to the market. Farmers’ move, experts say, has only added to the pressure on state regulators.

–Editing by Nick Petruncio.