California Wildfire Implications for the Insurance Industry

The January wildfires in Southern California have brought additional challenges to the insurance industry, with implications for policyholders, insurers, and reinsurers.

In this article for investment bankers, sell-side analysts, and portfolio managers, we summarize how firms approach profitability and risks, the role of state regulators, the potential direction of the California insurance market, and the financial signals to watch.

Increasing Frequency and Severity

Recent years have seen a trend of increasing frequency and severity of catastrophic events. Last year, total losses from such events reached approximately $320 billion worldwide. The California wildfires alone are expected to generate losses of about $30 billion.

Insurance companies are reassessing their risk models and pricing strategies in light of the changing environmental conditions. State insurance commissioners must approve or deny requests for premium increases, so state commissioners play a crucial role in how insurance is priced

In California, there has been tension between insurers seeking rate increases to reflect the changing risk landscape and regulators aiming to keep insurance affordable for consumers. This dynamic can potentially lead to market disruptions if insurers feel unable to operate profitably within the regulatory price constraints. For example, State Farm withdrew from that market last summer when it did not see a balance between the risk it assumed and the premiums it could collect.

If private insurers continue to withdraw from the California market, state-backed insurance programs are likely to emerge—similar to Florida's Citizens Property Insurance Corporation. While this can provide a short-term safety net for Florida homeowners, it’s not a long-term solution. A state-backed insurance program is a strong indication there are underlying market inefficiencies related to pricing.

Market analysis also needs to factor in reinsurance. When primary insurance writers first report their losses after catastrophic events, the amounts do not always account for reinsurance they might have in place that will ultimately cover risk assumed by the primary insurance company.

The cost of reinsuring losses for primary insurers flows directly through to the premiums charged in the reinsurance market. As a result, reinsurance for primary insurance companies increases, and this increased cost will either be passed on to policyholders or reduce the margin of the primary insurance company.

Key Areas for Financial Professionals to Monitor

As investment bankers, sell-side analysts, and portfolio managers analyze the operating environment, there are three core questions they need answered after each catastrophic event:

1. Which companies are impacted?
2. What’s the magnitude of the impact on each company?
3. How might the earnings and capital of companies be affected?

In the near term, earnings calls and press releases among the major insurers are the main sources of information on the financial costs. The FactSet workstation can help assess which companies might be impacted and the magnitude of the impact. It provides historical statutory statements and loss ratios once NAIC reports are filed with updated data.

To learn more, listen to our podcast episode—California Fires: Insurance Market Forecast.

This blog post is for informational purposes only. The information contained in this blog post is not legal, tax, or investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.