Wildfires, a historically profitable line of business for the property insurance industry, have recently been declared a “top tier peril” by Moody’s rating agency, joining hurricanes and earthquakes.  Only twice between 1960 and 2010 had total U.S. acreage burned totaled more than 9 million. Since 2010, that mark has been surpassed in 2012, 2015, and 2017. In 2018 alone, approximately $24 billion in U.S. losses due to wildfires were reported.  In response to this, insurers are increasing rates, implementing strict underwriting guidelines, and declining to renew policies. This has led to over 340,000 homeowners losing their wildfire insurance policies between 2015 and 2018.  The increase in the frequency and severity of wildfires can be attributed to two key factors: increased housing development in wildfire-prone areas, and climate change. With limited data about this peril and its recent development into a catastrophic-level risk, primary and specialty insurers in conjunction with insurance regulators are looking for ways to properly price wildfire risk and assist the public in combating wildfires.
What is Wildfire Risk?
The recent increase in wildfire activity in the U.S. is no coincidence. Climate change and increased development in wildfire-prone areas have put homeowners at a greater risk of experiencing losses due to wildfires. The impacts of climate change have led to warmer springs and earlier snow melts in the fall and winter. This creates a longer wildfire season, as wildfires occur more frequently and spread faster during periods of drought.  These favorable conditions exist most commonly in the central and western states, with California accounting for approximately 2 million of the estimated 4.5 million U.S. homes at high to extreme wildfire risk.
Housing development into wildland areas has severely exposed Americans to the risk of wildfire. Approximately 43% of new homes built between 1990 and 2010 are in the Wildlife Urban Interface (WUI).  The WUI is the area where wildland vegetation and homes come into contact, and homes are at a greater risk to experience wildfire-related losses.  Development in the WUI poses two major problems: the frequency of wildfires will increase due to human ignition, and those that occur will have a greater impact on homes and will be more difficult to contain.  The three main causes of wildfire ignition are escaped prescribed fire projects, unauthorized human-caused fires, and lightning-caused fires. Human ignition accounts for an estimated 85 percent of wildfires. Development in WUI areas significantly increases wildfire frequency, and the added factor of longer wildfire seasons due to climate change has caused wildfires to quickly become a top-tier risk.
Wildfire Impact on Policyholders
In recent years, wildfires have had a devastating impact on homeowners in Western U.S. states. Homeowner’s policyholders are seeing premium increases that are double or triple the amount that they are accustomed to paying. In many cases, high-risk policyholders face non-renewals, as seen in the figure below. 
The increase in rates and non-renewals impact policyholders beyond their insurance coverage. The idea of having to pay $10,000 annually in insurance premium for wildfire coverage is scaring off potential buyers of homes in the WUI. Homes in the WUI are seeing their home’s values diminish as a result. Four of the 10 high risk counties in California saw sale prices drop from 2018 to 2019, while the other six saw a significant slow in price increase. This problem reflects the situation faced by homeowners in coastal flood prone areas. As risk estimates have begun to more accurately price premiums in these areas, these cost increases have been “negatively capitalized” into home sale prices.  According to the First Street Foundation, this has led to significantly diminished value in coastal areas, “Florida has seen the greatest loss in relative home values at $5.4 billion, followed by New Jersey at $4.5 billion, and New York at $1.3 billion. Ocean City, New Jersey; Miami Beach, Florida; and Charleston, South Carolina saw the greatest losses in relative property value.”  Homeowners in the WUI could potentially see a similar impact as insurers gather more information on the risk.
Mitigation is a key factor in the future of this development. The American Red Cross outlines preventive action that homeowners can take to best protect themselves. This includes creating a defensive space around your home, choosing fire-resistive plants, removing brush and cutting your lawn, and pruning trees.  United Policyholders also aims to protect insureds with its Wildfire Risk Reduction and Asset Protection Program (WRAP). Its goal is to strengthen the relationship with insurance companies and policyholders, so they are willing to work together. This is done by promoting the use of mitigation efforts to better satisfy conditions that are acceptable to the level of risk insurance carriers are willing to bear. 
Problems for the Insurance Industry
The recent increase in wildfire activity has led to three major problems for the insurance industry: large payouts and policy repricing, lack of reliable modeling due to insufficient and irrelevant loss data, and restrictive legislation. Insurance carriers have felt a costly impact from the 2017 and 2018 wildfire season, where claims totaled $24 billion, and paid $1.70 for every $1.00 of written premium.  Data from SNL financial reports some of the worst impacts on loss ratios in 2018, with Allstate at 271%, Farmers 243%, and Travelers 226%. Carriers have been left no choice but to non-renew and significantly increase premium.
A major problem facing insurance carriers and the most important issue going forward for the industry is the outdated methodology of predicting future losses. California regulation mandates the use of historical averages of the past 20 years to determine future rates, a traditional method under normal circumstances. Using this method, rate makers would come to a conclusion that loss years of 2017 and 2018 would occur twice over a 20 year period.  However, we now know this will likely be inaccurate as it does not account for the increase in WUI development and climate change. Because of these inaccuracies, insurance carriers will have to work with insurance regulators to develop new ratemaking guidelines to reflect the current landscape of the wildfire situation.
In addition to large payouts and uncertain methodology for predicting future losses, legislation restricts insurance carriers’ ability to respond to the changing wildfire landscape. State insurance regulators are responsible for ensuring that rates are available and affordable to the public as well as monitoring the solvency of insurance carriers. According to California Proposition 103, rate increases for personal lines exceeding 7% require a court hearing. This essentially limits annual rate increases to 6.9%, which led to non-renewals from carriers.  In December 2019, California state regulators responded to this issue with a temporary ban on non-renewals for 800,000 homes. This one-year moratorium is designed to protect homeowners and to allow for the industry to work on solutions to the affordability issue. 
How can the Insurance Industry Repond?
During the one-year moratorium, the insurance industry must formulate a response to the wildfire insurance affordability dilemma. This will involve developing accurate catastrophe models to improve underwriting techniques and mitigation, communicating and monitoring proper mitigation techniques to policyholders, and working in conjunction with legislators to develop solutions that benefit all parties.
The ability to predict future losses is the key to profitability for any line of insurance coverage. In a time of dynamic change for a risk like wildfires, the ability to do so is crucial. The best new method to predict catastrophic events is catastrophe models. Cat models can be used to simulate events to create projections that cannot be obtained from solely relying on historical data. These complex models have been successfully used to predict the impacts of events such as earthquakes and hurricanes. Wildfire modeling is very complex, and it is in early stages compared to earthquake and hurricane modeling, due to the fact that this risk is developing rapidly. Many factors contribute to these models, such as ignition, fuel source, various climate factors, WUI, fire detection/suppression, and building materials. 
Data analytics and the use of these cat models must be accepted by California insurance legislators in order to obtain the best data for rate filings.  If this is achieved, insurance carriers will have more freedom to act in a manner acceptable to the state insurance commission. Accurate rate pricing will allow insurance carriers to operate with prices consistent with their level of risk. This will lead to fewer non-renewals and restrictions on new business — methods currently used by carriers to manage suffering risk portfolios.
California insurance regulators can benefit from modeling their approach to this issue around measures taken by Florida in response to its need for standardized hurricane models. The Florida Commission on Hurricane Loss Projection Methodology was established to create consistent hurricane modeling standards. Having an agreed-upon projection between insurance companies, regulators, and the public allowed for better communication and coordination to tackle their problems. 
Other than improving ratemaking techniques, cat models provide another key benefit to underwriting methods for insurance carriers and can have a greater impact on the public. Cat models can be used to estimate the value of wildfire mitigation factors.  Determining this value for individual homes or communities can be used to influence policy pricing. Discounts can be offered to insureds or groups of insureds who perform mitigation activities such as clearing brush, installing fire-resistant siding, or implementing evacuation plans.
Florida can also be used as a model for lawmakers to implement changes to mitigation strategies. The state requires insurers to discount homeowners who protect their homes from windstorm damage. These discounts are known as Wind Mitigation Credits. Homeowners are awarded these credits after a certified inspection is done on the home.  The previously mentioned United Policyholders’ WRAP program advocates for a similar system in California where reward programs are available for policyholders who perform wildfire mitigation tasks. WRAP is working with public officials, firefighters, and FireSafe councils, to coordinate these efforts within communities to put together mitigation plans to satisfy a potential reward program for policyholders. 
Insurance carriers have taken steps to improve mitigation efforts for their policyholders. Nationwide and Chubb have both partnered with Wildfire Defense Systems (WDS) to provide mitigation services. These include wildfire monitoring and notification, response services such as sprinkler system installation, and wildfire education and consultation.  Carriers on the E&S side have implemented new programs as well. National Fire & Marine Insurance has recently partnered with the PURE Programs’ High Wildfire Risk Homeowners Insurance Program. PURE Programs, an MGA, offers claims and risk management services along with broader insurance coverage as part of this program. The program is aimed at serving the insurance needs of high-risk homes with over $1 million in rebuilding costs.  Homes with this profile, who have faced non-renewals, are provided with coverage through this program.
There is a great deal of uncertainty remaining for how the insurance industry, regulators, and the public will react and shape the future for protecting against wildfire losses. The insurance industry’s approach to tackling this issue will be a key factor in where people decide to live, and how much risk they are willing to take on and to mitigate against in order to live in the WUI. Regulators must enact legislation to encourage mitigation and to ensure that coverage is attainable and reasonably affordable to homeowners who have suddenly been affected by this risk. This effort should be done in coordination with insurance carriers to ensure that the industry takes on an appropriate level of risk that it can handle. The development of cat modeling will be crucial for all parties involved to gain a better understanding of how losses can strategically be prevented. With limited historical data on losses as large as those experienced in 2017 and 2018, predicting and protecting against future losses will be a challenging process.
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