August 14, 2024
State-level policy changes on catastrophe insurance in California and Louisiana risk inadvertently transforming the US into a testing ground for effective and ineffective approaches to addressing the challenges posed by climate change. It is clear there is a need for a cohesive strategy to protect homeowners.
The policy changes are related to California and Louisiana’s Fair Access to Insurance Requirements (FAIR) plans. FAIR Plans — a collaborative effort involving the insurance industry, state governments, and, to a lesser degree, the federal government — provide property owners unable to secure insurance from the private market an opportunity to purchase hazard insurance from a specialized market known as the residual market. In California, the residual market has primarily concentrated on offering coverage for homeowners in fire-prone areas. In Louisiana, meanwhile, the focus has been on protecting hurricane-prone areas against wind and water damage not covered under flood insurance policies.
One thing both of these “insurers of last resort” have in common is that policies have been increasing in recent years, see FIGURE. As these states experience more disasters – such as Hurricane Ida’s devastating impact on Grand Isle, Louisiana, in 2021– more and more homeowners are being edged out of the private market.
However, the states are taking different routes to reduce the number of FAIR plan policies. In California, the California Department of Insurance (CDI), as part of an agreement with insurance companies, has proposed a new regulation to address concerns related to wildfires and coverage availability in distressed areas ( defined by the percentage of high or very high-risk dwelling units). The regulation would mandate private market insurers write more policies in these vulnerable regions, with large companies covering no less than 85 percent of properties in distressed areas and smaller companies increasing policies in those areas to 5 percent. By doing so, the regulation seeks to enhance coverage accessibility and mitigate wildfire risks. The move is in response to Proposition 103, which was enacted by voters in 1988 and allows insurance companies to choose where they write policies in California. As a result, insurance companies are writing more policies in less risky areas of the state. While the regulation would push insurers to write more policies in distressed areas, it also allows insurers to use "forward-looking catastrophe models" for setting rates. Insurers had previously been barred under Prop 103 from using such models and had set rates based on the last 20 years of losses.
California's move will allow more property owners to switch from FAIR Plan policies to the private market, but it's unclear how rates will be affected by catastrophe modeling. Consumer advocates have criticized third-party models as "black boxes" that use proprietary algorithms to set rates. An earlier draft of CDI's proposed regulation included language that required insurers to submit "all required information and data regarding a model" as part of a complete rate application relying upon the model. While that language was removed, the state has a compliance mechanism that says insurers need to expand coverage to distressed areas to use catastrophe modeling to set rates. For now, it's a step forward.
Louisiana, on the other hand, has taken two steps back. A suite of bills signed into law by Gov. Jeff Landry and supported by the state's new insurance commissioner Tim Temple will deregulate the industry in ways that will hurt homeowners. The first bill, Senate Bill No. 323, changes the state's "bad faith law," which was passed after Hurricane Katrina and protected homeowners from insurers refusing to pay out. Under the original law, policyholders could receive up to 200 percent of a loss if a court ruled an insurer had deliberately avoided negotiating or paying a claim. The new bill reduces that penalty to 50 percent or $5,000, whichever is greater. The bill also allows an additional extension of time for insurers to initiate a loss adjustment after a presidentially or gubernatorially declared emergency or disaster.
House Bill 611 repeals the state's "three-year rule," which prevents insurance companies from increasing deductibles or canceling or declining to renew homeowner policies that have been in effect for over three years. Non-renewal conditions are broad and include nonpayment of premiums, fraud, material risk change, multiple claims, or endangering the insurer's solvency, which is pretty vague. Insurers can also drop up to 5 percent of customers' policies per year for any of these reasons after filing a plan with the commissioner.
Finally, Senate Bill 295 grants insurance companies the authority to adjust rates without obtaining prior approval from the state insurance department, as long as the market is determined to be "non-competitive." Under the law, rate filings are deemed approved unless the commissioner notifies them otherwise within 60 days. The legislation's language lacks clear definitions of competitive and non-competitive markets, making it uncertain when the absence of an approval process will cease.
Combined, these bills deregulate the industry to benefit insurers, and the changes that will come with them can potentially increase reliance on the state's FAIR Plan, not the other way around. In summary, insurers have smaller penalties for refusing to settle and can set their own rates and drop policies simply because of where you live or if you cost them money.
The contrasting approaches taken by California and Louisiana in addressing their FAIR plan challenges underscore the complexity of navigating insurance in an era of increasing climate risk. While not without its shortcomings, California's strategy is to expand coverage in high-risk areas by leveraging catastrophe modeling and incentivizing private insurers. Louisiana, meanwhile, is opting for deregulation that could expose homeowners to increased vulnerabilities while favoring insurance companies.
The effectiveness of these contrasting strategies remains to be seen. It is crucial to keep an eye on how these policy changes affect regular people – not only for the sake of California and Louisiana residents but also those in other states grappling with similar insurance crises exacerbated by climate change. States should not become laboratories with vulnerable homeowners as their test subjects. The need for a cohesive national strategy on catastrophe insurance is becoming increasingly evident as the country navigates uncharted waters, with the well-being of homeowners hanging in the balance.
