California Wildfires: Issues, Challenges and Lessons for Insurance and Reinsurance

Estimated economic losses are in the range of USD $130 billion to USD $150 billion^[2]. Industry analysts estimate insured losses to vary between USD $20 billion to USD $45 billion, making this event one of the largest natural disasters reaching systemic levels^[3]. In comparison, insured losses from Hurricanes Harvey and Irma in 2017 are about USD $30 billion each^[11].

This article examines underlying issues, challenges and lessons for the insurance and reinsurance industries from the California’s wildfires and how to address them.

Woes for home and business owners

Limited availability of insurance

With rising catastrophe losses, home and business owners face the challenge of finding insurance cover.

Recently, State Farm and Allstate, two major providers of home insurance, have stopped issuing polices in California, citing inadequate pricing to keep up with increasing losses, rising construction expenses and elevated reinsurance costs in the prevailing hard reinsurance market^[5].

Limited availability of cover has pushed homeowners in California to seek protection from the state insurer, Fair Access to Insurance Requirements (FAIR) Plan, as a last resort. 

Underinsurance and a widening protection gap

In addition to the limited availability of cover, home and business owners also face the issue of underinsurance.

High valued properties may find policy limits insufficient, leaving policyholders underinsured as happened during the wildfire in the Palisades, even though the FAIR Plan sets the personal policy limit at USD $3 million^[4].

With underinsurance, the financial burden for business owners can be severe particularly due to co-insurance clauses in commercial property policies. The financial strain caused by a wide gap between actual losses and insurance cover can force a small business to close.

Pre-emptive underwriting has also been a concern for policyholders, with insurers cancelling policies in areas once considered safe from wildfires. A comparison of economic and insured losses from the California wildfires also shows a wide protection gap prevalent in the market that’s exacerbated by the limited supply of cover and underinsurance.

Impact on pricing and risk modelling

Wildfire risk modelling

Driven by global warming, secondary perils¹ such as floods, wildfire and thunderstorms are increasingly becoming primary drivers of losses. Modelling these perils has become even more challenging with increased frequency and severity attributed to climate change and constant change in exposure with rapid urbanisation and mass population movements. To provide protection for secondary perils, it is paramount that insurers and reinsurers have proper risk assessment capabilities with modelling tools.

Adequacy of pricing

Inadequate pricing to reflect risk exposure to natural perils has been a major concern for insurers in providing cover. In California, insurers have raised their concerns that the regulatory hurdles limited their ability to raise premium rates to reflect risk exposures with increasing losses, construction costs and reinsurance premiums^[5].

Limited supply of reinsurance protection

Onerous reinsurance structural changes

Broadly, the prevailing hard reinsurance market has forced insurers to adopt onerous structural changes to their reinsurance protection.

With increased attachment points, insurers retain more risk exposures than they would have desired, scaling back on covering or excluded risks related to secondary perils as a result.

Scaling back on natural catastrophe reinsurance cover

In 2024, global insured losses from secondary perils such as floods, wildfires and thunderstorms were above the 10-year average, reaching USD $67 billion ^[6].

In fact, in recent years, reinsurers have scaled back natural catastrophe cover particularly for secondary perils after suffering heavy losses. This is evident with the dropping of reinsurance cover for modelled catastrophe risks to 33% in 2023, from 46% in the past^[5].

Impact of California Wildfires on global reinsurance markets

Interestingly, according to industry analysts, the impact from the California wildfires on the global reinsurance market is manageable as reinsured losses are estimated to be within the natural catastrophe budgets of reinsurers for the first quarter of 2025^[2].

However, any adverse loss from this event or the development of natural catastrophe losses in 2025 could put further strain on the availability of capacity for natural catastrophe covers.

Overcoming challenges and lessons to learn

Risk mitigation at ground level

Taking risk mitigation measures at ground level can help to improve the resilience to natural disasters.

For example, homeowners living in wildfire prone areas can create a defensible space around properties by choosing fire resistant plants and building materials and creating empty spaces between shrubs and trees to mitigate the risk of their properties catching fire^[7].

Moreover, back-burning is an effective way to control the spread of wildfire by burning out the fuel between a wildfire and an established control line. The removal of fuel helps to stop the spread and provide suitable conditions to suppress a fire.

Risk mitigation at a policy level

Policies and Standards formulated at local, state and federal levels are important to reduce the risk of losses from natural disasters.

In Australia, the AS 3959:2018 standard specifies the construction requirements for buildings built in bushfire prone areas to improve resistance to bushfires.

A positive aspect after a natural disaster is that it provides societies and governments an opportunity to ‘build back better’, which means rebuilding houses and infrastructure to be more resilient to natural disasters.

It becomes incumbent on authorities not to issue land for new settlements in areas vulnerable to natural disasters. In addition, other risk mitigation efforts can include relocation and re-zoning of affected areas for better risk management following a disaster event.

Improving insurance availability and affordability

Addressing pricing inadequacy issues can improve the availability of insurance cover.

Initiatives at the government level can include de-tariffication measures and rating reviews. For example, the California state regulator has indicated that it would allow reinsurance costs and actuarial-based fire risk loadings in premiums^[5].

With increasing losses from natural disasters particularly related to climate change, insurance affordability has become a key issue for homeowners.

In Australia, home insurance affordability has become a major concern, with 15% or 16.1 million households requiring more than four weeks of gross household income to pay for their premium in 2024^[9].

Client differentiation with risk-based pricing can help homeowners who take risk mitigation measures to enjoy competitive pricing. At a market level, to address affordability concerns of homeowners in disaster prone areas, authorities may consider risk pooling mechanisms.

Improving reinsurance availability

Broadly speaking, the prevailing hard reinsurance market has forced insurers to adopt onerous reinsurance structural changes. However, leveraging positive results of reinsurance coverages, prudent underwriting practices and close relationships with reinsurers, insurers can negotiate for structural changes favourable to them.

Reinsurance brokers can play a pivotal role in recommending appropriate structures backed by solid analysis, sourcing for additional capacity for natural catastrophe covers and negotiating favourable terms and conditions.

Parametric insurance solutions as an alternative

As an alternative or a supplement to traditional reinsurance, insurers and other stakeholders can consider parametric solutions.

Parametric solutions are becoming increasingly popular as they provide flexibility and transparency in cover design, and facilitate quick payouts once triggered. In fact, parametric insurance is gaining momentum in the Asia Pacific (APAC) region with a projected Compound Annual Growth Rate (CAGR) of 10.6% in the period 2022 to 2028^[10].

Role of Public-Private Partnerships (PPP)

Public-Private Partnerships can be a useful mechanism to reduce vulnerabilities to disasters and improve disaster resilience.

Partnerships with technology companies can help to improve risk surveillance and deploy advance wildfire detecting systems for early evacuation to minimise casualties, efficient resource planning and timely responses.

Governments’ engagement with the construction sector is vital in building infrastructure resilient to natural perils. This ensures availability of material and labour for reconstruction efforts and for ‘build back better’ initiatives.

Disaster risk financing efforts with the private sector can be another solution to provide capacity for a speedy recovery after a natural disaster. These efforts could encompass risk pooling or other funding mechanisms.

Enhancing risk modelling capabilities

Proper risk assessment capabilities are paramount for insurers and reinsurers to provide coverage for natural catastrophe perils.

With catastrophe risk modelling, access to high-resolution geospatial tools can improve risk assessment capabilities. For example, wildfire risk modelling can incorporate parameters such as roofing materials, defensible spaces and proximity to fire sources.

With advancements in machine learning and artificial intelligence techniques, modelling tools can process large volumes of data and create a multitude of potential scenarios. These techniques can help to combine decades of climate data with inputs such as temperature, air pressure and wind speeds for modelling and scenario generation.

A wake-up call

The California wildfires have been a wake-up call for societies and governments to act against the increasing threat of natural catastrophe disasters exacerbated by climate change. Availability and affordability of insurance coverage for natural perils has been a major concern for homeowners particularly in areas prone to such disasters.

The insurance and reinsurance industries face challenges with pricing inadequacy, limited modelling capabilities for risk assessment, limited capacity to cover risks from natural perils and regulatory hurdles.

Close collaboration among stakeholders at all levels is paramount to address these issues and improve resilience to natural disasters.

Special Note: The author would like to thank Mudit Gupta (FIAA) for reviewing the article and providing invaluable feedback and Syed Danish Ali for his suggestions.

Footnotes

References

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