AM Best: Addressing California’s wildfire losses and the urgent need for insurance market reform

In AM Best’s Briefing: Reinsurance – January 1 Renewals and What to Expect in 2025, insurance experts, including Carlos Wong-Fupuy, Senior Director at AM Best and Kyle Rhodes, President of North American operations at TransRe, discussed the long-term implications of California’s ongoing wildfire crisis for the insurance market, with a particular focus on the urgent need for systemic reform.

While the immediate destruction caused by the wildfires is severe, the experts emphasised that the broader challenges facing California’s insurance market go far beyond the current crisis.

The state’s insurance system has been under significant pressure for years due to escalating climate risks, regulatory hurdles, and market dysfunction.

Wong-Fupuy highlighted that the California insurance market, in particular, is at a breaking point—a situation that’s been exacerbated by years of poor underwriting results and increasing climate-related catastrophes. He underscored the necessity of long-term reform to create a more sustainable market for the future.

Rhodes highlighted that preemptive underwriting has been a significant issue, with insurers canceling policies in areas once considered safe from wildfires, including his own neighborhood. As insurers reduce their presence, residents are left with fewer coverage options, often with very limited policy limits. He pointed out that the FAIR Plan, California’s last-resort market, offers a maximum personal policy limit of $3 million. While this may seem like a large sum, it is insufficient in high-risk, high-value areas like the Palisades, which was devastated by the recent Los Angeles wildfires.

He added, “The question then becomes, is it insufficient limit for many of those properties, or how many of those properties are really uninsured? It’s hard to tell, and we don’t know at this point.”

Rhodes discussed the broader financial challenges, emphasising the potential shortfall in funds. He explained that if the insured loss amounts to $40 billion, with the FAIR Plan having a 20% market share in the affected areas, it would result in approximately $8 billion in claims for California policyholders to recover.

He highlighted that the FAIR Plan, with only about $2.5 billion in reinsurance and a limited surplus, would struggle to meet this financial gap. Rhodes questioned how long it would take to address this shortfall, considering the plan would need to assess and recover an additional $5.5 billion from insurers.

The experts also discussed how California’s current insurance framework—dependent on the FAIR Plan—is struggling to meet the needs of policyholders after major disasters. Rhodes emphasised the urgency of addressing these gaps, stating: “Who’s inspecting and adjusting these claims for the FAIR Plan. What do they do going forward? That’s a big question.”

He also noted the broader issue of how to fix the broken insurance system in California: “Insurance and reinsurance companies put capital risk in all kinds of hazardous areas all around the world. So, how is the industry, in my opinion, incapable of putting sufficient capital behind California? It is beyond me.”

Wong-Fupuy, speaking on the role of innovation in maintaining market resilience, pointed out the importance of new approaches to risk management. “Innovation is a critical element on the future of the industry,” he said.

“On the reinsurance side, what we have seen is lots of innovation in terms of modelling, risk modelling, capital management, development of new products and financial engineering that we see on the ILS side as well. I guess probably the most obvious area is risk modelling.” He also pointed to the growing significance of secondary perils, which now account for a significant portion of total losses.

Laure Forgeron, CUO of Casualty at Swiss Re, also participated on the panel and weighed in on the impact of technology in addressing systemic risks. “I agree that technology has immense potential. And on the reinsurance side, we’ve seen risk modelling and improvement of risk assessment,” she said, further adding, “But the challenge is really to define the risk relevant data, and here we need people actually in the driver’s seat guiding the technology to areas that bring the highest value.”

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