California Insurance Reform Creates Opportunity

As wildfires continue to grow in frequency and scale across California, and as the state’s homeowner’s insurance crisis continues to worsen, the California Department of Insurance (DOI) has issued a proposed regulation that, for the first time, would allow insurers to rely on catastrophe models in setting insurance rates. Below, we discuss key takeaways from the proposal for the insurance industry:

1. Catastrophe models allow insurers to account for the effects of climate change.
Unlike other states, California requires insurers to price homeowners insurance based on historical experience, rather than authorizing the use of forward-looking catastrophe models that use algorithms to quantify the risk of future natural disasters. Wildfires and other natural catastrophes have therefore presented a significant challenge to insurers operating in California, which are stuck using artificially low rates as natural disasters increase. As a result, some insurers have reduced their exposure in the state or exited the California market entirely — with seven of the state’s 12 largest insurers having paused writing new policies, according to California Insurance Commissioner Ricardo Lara during a virtual town hall on April 4, 2024. 

Under the proposed regulation, insurers will be permitted to use catastrophe models to simulate the future risks of earthquakes, floods, and wildfires when setting rates, thereby providing insurers with a valuable tool for developing strategies and pricing in high-risk areas. 

2. The proposed regulation attempts to safeguard proprietary information.
Under the proposed regulation, insurers seeking to use catastrophe models will be required to submit their algorithms to the California DOI when seeking to raise rates, and the models will subsequently be reviewed by a DOI-appointed panel. While outside parties or members of the public may petition to participate in the review process, they must sign a nondisclosure agreement and keep the modeling information confidential. 

The proposal would therefore safeguard against public disclosure of proprietary modeling information, though we anticipate consumer/public pushback in favor of more transparency and robust public disclosure. 

3. The reform is part of a broader regulatory initiative — but there may be a catch.
The catastrophe model proposal is the second component of a three-part initiative meant to keep insurers in the state. In February 2024, the DOI announced a proposal that would speed approval of rate increases. The DOI is also expected to unveil another proposal later this year that would allow insurers to take into account the cost of reinsurance when setting rates. 

Interestingly, Commissioner Lara has also stated that insurance carriers will be required to commit to writing at least 85 percent of their in-state homeowner’s policies in wildfire-distressed communities. However, neither proposed regulation has included language to this effect, meaning insurers should continue to monitor regulatory developments to see if any final rules include this threshold. 

4. The reforms present opportunities for insurtechs making use of alternative data.
California’s decision to allow the use of catastrophe models presents an opportunity for companies looking to pioneer innovative uses of nontraditional data to underwrite insurance. For example, an insurance company might incorporate satellite images into its models to assess vegetation dryness surrounding a community or use lightning-strike mapping to assess the risk of wildfire ignitions in a given area. Companies that provide such data, as well as those that use artificial intelligence to create algorithms incorporating it, stand to gain from California’s proposed reforms.

At the same time, companies should remain cognizant of the fact that this regulation is not yet final. The DOI will hold a public workshop on the proposal on April 23, 2024, where interested parties will have an opportunity to comment. Commissioner Lara has said that the DOI intends to finalize the regulation by the end of 2024. 

 

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Goodwin’s Insurtech and Insurance & Reinsurance Transactions team, part of its globally ranked Fintech Practice, advises start-ups, insurers, reinsurers, investors, and others on the legal and regulatory challenges associated with creating, marketing, distributing, and investing in innovative insurance products and companies. Goodwin provides clients with a full-stack insurtech offering, bringing together specialists from across the firm to provide forward-thinking counsel on strategic transactions, regulatory compliance, and litigation matters.

 

This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee a similar outcome.