The Reinsurance Association of America (RAA) has weighed in with some recommended fixes to the growing homeowners insurance crisis in California, warning policymakers to be mindful of the risks of inaction.

The RAA white paper, “Dynamics and Challenges in California’s Homeowners Insurance Market,” also warns against actions that would result in rapid growth of the market.

Devastating wildfire losses beginning in 2017 and in ensuing years has forced the insurance industry to re-evalauate how homes and structures can be insured “during an era of droughts and changing environmental conditions that are conducive to wildfire and demographic changes that have increased the number and value of homes and other buildings at risk,” RAA said in a media statement about the white paper.

The challenges are magnified by a legacy regulatory structure that did not contemplate a changing climate that has brought and threatens to bring frequent, catastrophic wildfire risk to residential areas, RAA added.

“Governor Newsom, Commissioner Lara, and the legislative and its leadership deserve praise for their willingness to address the root causes of the current insurance crisis, including their funding of wildfire risk reduction efforts,” said RAA President Frank Nutter. “The next step is ensuring insurance companies receive timely approval to charge an adequate, risk appropriate rate, enabling them to insure catastrophe exposed properties prudently.” (Editor’s Note: Separately, RAA announced that Nutter is retiring at the end of the year.)

California policymakers are currently discussing possible legislation that would bring “Proposition 103 compatible modernization to the rate regulatory structure for new policies” to address the current crisis.

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A proposal under consideration would allow an insurer to include its actual reinsurance costs in its rate filings. Currently, reinsurance costs are only allowed in rate making for earthquake and medical malpractice coverages. This change could easily be made to the California Code by the California Insurance Commissioner, the RAA noted, adding the specific language that could be changed.

Under a related provision, catastrophic models would be authorized as support for estimating expected insurance losses. In exchange, insurers would be required to increase their share of catastrophe-exposed “distressed” markets to at least 85 percent of their statewide market share.

The threshold is a concern, Nutter stated.

“While a commitment to increase writings in catastrophe-exposed areas is understandable, we are concerned that the 85 percent threshold is too high. Insurers need to have adequate rates before they expand their writings. They should not be encouraged to expand rapidly,” he said.

Rapid growth, according to Nutter, could lead to insolvency as has been demonstrated historically.

“The actual costs of reinsurance risk transfer should be permitted to achieve rate adequacy first,” the reinsurance association president stated. ” If a commitment to grow market share in distressed areas is required, it should be achieved in a measured, financially prudent way to ensure insurance promises are kept. Reinsurance is a tool that helps insurers keep their promises.”

As reinsurance cost and catastrophe modeling are accepted in most states’ regulatory processes, the RAA supports their use as a means to evaluate and approve risk appropriate rates. As with the recommendation that reinsurance costs be included in rates, the RAA recommends changes to the California Code to include the ability for reinsurers to use modeling data for all catastrophe exposures, rather than just earthquake and wildfires.

“If rates are not adequate when policies are written, insurers lose money and may ultimately fail,” Nutter said, adding that reinsurance is a risk management tool.

Additional recommendations include changes to the code dealing with the rate of return and profit, removing the +/- 2 percent limitation within the Commissioner’s control, adding an amendment to the code allowing for trade secret protection, and amending code language to reduce prolonged rate filing delays related to watchdog interventions.

Nutter cautioned policymakers about the dangers of inaction.

“Adequate rates lead to competition and consumer choices,” he said. “Forcing insurers to continue to write business at inadequate rates carries significant risks of its own, including short and long-term adverse impacts on insurance availability.”

Climate change will continue to expose California to more catastrophes, Nutter added.

“A prudent approach that recognizes the need for insurers to make a reasonable profit overtime is essential for ensuring that risk bearing capital is available to meet the needs of California and its residents,” said Nutter.