The Fundamentals of California's Broken Insurance Risk Model

Core Systemic Problems

1. Mismatch Between Risk and Pricing

   • The current regulatory framework under Proposition 103 has historically limited insurers' ability to:

     • Use forward-looking catastrophe models instead of historical data

     • Fully factor in reinsurance costs

     • Price premiums according to actual risk exposure

   • This has created a disconnect between premiums collected and actual risk exposure

2. The FAIR Plan's Structural Vulnerabilities

   • Originally designed as a small, niche provider of last resort

   • Now holds concentrated risk with policies growing 276% between 2018-2024

   • Inadequate capitalization for catastrophic events ($510M in retained earnings vs. $4B in LA fire claims)

   • Lacks sustainable funding mechanisms for extreme events

3. Socialization of Catastrophic Losses

   • The $1B assessment on member insurers and proposed $500M statewide surcharge fundamentally shifts costs to all policyholders

   • Creates equity concerns as low-risk homeowners subsidize high-risk areas

   • Establishes a precedent for recurring "FAIR Plan taxes" across the state

4. Market Dysfunction Feedback Loop

   • Insurers withdraw from high-risk areas due to perceived regulatory constraints

   • More homeowners forced into the FAIR Plan (573,739 policies by March 2025)

   • FAIR Plan exposure becomes more concentrated

   • Catastrophic events trigger assessments on remaining insurers

   • This further incentivizes market withdrawal, continuing the cycle

Comprehensive Solution Framework

Based on the research, a sustainable solution would require:

1. Modernized Risk Assessment and Pricing

• Fully implement CDI's Sustainable Insurance Strategy allowing:

  • Forward-looking catastrophe modeling

  • Inclusion of reinsurance costs in premiums

  • More granular property-level risk assessment

• Develop public catastrophe models for greater transparency and standardization

• Balance actuarial soundness with affordability through targeted subsidies rather than universal rate suppression

2. Restructured Catastrophic Loss Financing

• Implement AB 226 to provide FAIR Plan bond issuance capability

• Create a multi-layered risk-sharing approach:

  • Primary layer: Private insurance with risk-based pricing

  • Secondary layer: State-backed reinsurance program with transparent pricing

  • Catastrophic layer: Federal backstop for extreme events exceeding state capacity

• Pre-fund recovery through dedicated disaster reserves rather than post-event surcharges

• Consider a California Catastrophe Fund similar to Florida's model but with improved governance

3. Mandatory Mitigation with Verified Incentives

• Implement and enforce statewide building codes for fire resistance

• Create meaningful financial incentives for mitigation:

  • Tax credits for home hardening (similar to proposed SAFE HOME Act)

  • Substantial premium discounts with standardized verification

  • Community-level incentives for area-wide mitigation efforts

• Link insurance availability to mitigation compliance in highest-risk zones

4. Strategic Managed Retreat

• Acknowledge that some areas may become fundamentally uninsurable

• Develop clear risk-mapping with public disclosure requirements for real estate transactions

• Create pathways for voluntary relocation from highest-risk areas

• Implement land-use policies limiting new development in extreme fire zones

• Establish transition programs for communities facing repeated catastrophic losses

5. Consumer Protection and Affordability Measures

• Create means-tested premium assistance for low and moderate-income households

• Implement more gradual transition to risk-based pricing

• Develop basic, affordable coverage options for essential protection

• Enhance transparency in premium calculations and non-renewal decisions

• Strengthen consumer advocacy in regulatory processes

Implementation Challenges

The research highlights several significant barriers to reform:

1. Political Challenges

   • Tension between immediate affordability and long-term sustainability

   • Reluctance to acknowledge implications of climate change for land use

   • Resistance to measures that might impact property values

2. Market Trust Deficit

   • Consumer skepticism of insurer profitability claims

   • Insurer skepticism of regulatory commitment to actuarial soundness

   • Declining public confidence in the entire system

3. Resource Constraints

   • Mitigation requires massive investment across millions of properties

   • Limited public funds for subsidizing transition to risk-based pricing

   • Insufficient reinsurance capacity globally for escalating climate risks

4. Timing Mismatch

   • Climate risks are accelerating faster than policy adaptation

   • System reforms take years while market conditions deteriorate rapidly

   • Short-term political pressures favor stopgap measures over sustainable solutions

Conclusion: A New Social Contract for Climate Risk

California's insurance crisis represents a fundamental breakdown in how society allocates and manages climate risk. The traditional insurance model assumes risks are random, measurable, and insurable through risk pooling. Climate change is challenging these assumptions by creating systemic, escalating, and interconnected risks.

What's needed is essentially a new social contract for climate risk that clearly defines:

• Who bears what portion of risk (individual homeowners, insurers, government)

• How costs are allocated (risk-based pricing with targeted subsidies)

• What responsibilities each party has (mitigation, adaptation, retreat)

• The appropriate timeframe for transition to a sustainable system

The statewide surcharges following the LA fires represent an ad hoc attempt to rewrite this social contract without sufficient public deliberation. A more thoughtful, transparent approach is essential to creating a system that is both financially sustainable and socially equitable in an era of accelerating climate risks.