The recent retreat of large homeowners insurance carriers, like Allstate and State Farm, from the California property insurance market signals ongoing regulatory constraints, rising cost inflation and higher catastrophe losses, according to Fitch Ratings.

“We expect these challenges to be neutral for rated insurers, as downside risks for insurers with broader national geographic premium diversification in the property/casualty homeowners’ segment are likely to fall within our rating expectations,” the rating agency added.

On May 26, State Farm announced it would temporarily halt the issuance of new homeowners insurance policies in the state.

According to a consumer alert by the State of California’s Department of Insurance, the factors driving State Farm’s decision include climate change challenges, higher reinsurance costs affecting the insurance industry and global inflation.

The decision reflects State Farm’s poor underwriting experience within the market and will further restrict coverage availability, along with prompting premium rate increases going forward, Fitch Ratings advised.

State Farm has been California’s largest homeowners writer with approximately $2.6 billion direct written premium (DWP) and 20 percent market share, the ratings agency added. “We expect State Farm to remain the market leader in California homeowners insurance, even without writing new business.”

Though wildfire hazard has been viewed as a secondary peril in the property insurance industry, with peak risks focused more on hurricanes and earthquakes; in recent years, wildfire has been a large source of insured losses in California, leading insurers to focus on managing risk aggregations and reducing exposure in areas most prone to catastrophes, Fitch noted.

A rising risk exposure has been the increase in higher value homes built near wilderness areas in the state.

Insurers with exposure to wildfires in California have had challenges in pricing the heightened catastrophe risk into premiums amid higher construction costs, stringent building codes and regulatory hurdles, according to Fitch.

California insurers must receive regulatory approval to raise rates and cannot use catastrophe models to set rates for homeowners insurance policies, including wildfire coverage, it added.

In addition, insurers are required also use historical-loss data when calculating expected future losses.

Additional large diversified carriers have announced reduced appetite for writing California homeowners’ insurance in recent periods, including American International Group (AIG), Chubb. AIG announced its planned exit from the admitted homeowners market in California in 2022.

Last week, Allstate announced that it will follow State Farm’s lead.

According to the California Department of Insurance, 115 insurance companies continue to write residential policies throughout the state.

The residential property market in California is expected to see more growth in the excess and surplus lines market, stated Fitch, offering carriers greater flexibility in setting premium rates and policy terms relative to the more strictly regulated admitted market.

U.S. homeowners insurers face uncertainty related to catastrophe experience and claims severity patterns, which may inhibit a near-term return to an underwriting profit, the ratings agency said. Further material rate increases in most jurisdictions support strong premium growth in 2023, Fitch stated, with segment premiums likely to improve in 2023.