July 17, 2023

Did the Economist Magazine Just Call Out the California DOI?

A fascinating, challenging article in the most recent Economist Magazine, dated July 13th 2023 – titled Why people struggle to understand climate risk – may have challenged the thinking of the California Department of Insurance and its Commissioner – Ricardo Lara. The article, which is in part based on Climate Change, Risk Management, and Risk Management Tools – states that “Sticking your head in the sand is plain foolish.” It seems upon several reads that the Magazine is specifically calling out the California DOI for not allowing the most recent modeling tools in property insurance premium pricing.

The short opinion article in the Free Exchange section – reviews of some of the basics of the California Insurance marketplace “State Farm, California’s largest home-insurance provider, retreated from the market altogether, citing the cost of “rapidly growing catastrophe exposure” The article talks briefly about Reinsurance rates but “Few firms mention climate change specifically…” [This blog has discussed the State Farm halt on numerous occassions. Additionally we have discussed the horrible nature of the California insurance landscape.]

The article goes onto merge these two topics quite well: “Insurance is a tool of climate adaptation. Indeed, actuaries have as big a role to play as activists in the fight against climate change. Without insurance, those whose homes burn in a wildfire or are destroyed by a flood will lose everything. The destitute may become refugees. Insurance can also be a spur for corrective action. Higher premiums, which accurately reflect risk, provide an incentive to adapt sooner, whether by discouraging building in risky areas or encouraging people to move away from fire-prone land. If prices are wrong, society will be more hurt by a hotter world than otherwise would be the case.”

The Economist piece then gets into a few of the tools that insurers and reinsurers use: “Natural-disaster reinsurance is typically based on models incorporating the latest science rather than historical statistics, since extreme events are by definition rare. For reinsurers, who ultimately care about their financial exposure, models must be kept up to date with the state of the built environment in vulnerable areas, which helps them calculate potential losses when paired with knowledge of environmental conditions that determine disasters. The former is generally more of a cause of uncertainty than the latter, since the science of climate change is well understood and data improve all the time. Premiums may be on the rise because of better knowledge, rather than continued ignorance.” [So True.]

Then – almost unexpectedly the article seems to pounce on said policy makers: “Policy can also prevent a proper accounting of risk. Californian regulations forbid insurers from using the latest climate models to set prices, since protection would become more costly. Premiums must be based on the average payout over the past 20 years, rather than the latest science. Shying away from ambiguity is understandable.” And then if ends with the final fairly clear note: “Sticking your head in the sand is plain foolish.”

Is the Economists Magazine claiming that Ricardo Lara is sticking his head in the sand? Is the magazine saying that the California DOI is? Clearly they believe that newer climate models SHOULD be allowed in determing premium. Insurers certainly want to. Apparently the California DOI does not want these models used. They prefer or require that past underlying experience be used. The Insurers and the California DOI are in dissagreement.

The Full Economist Article can be found here: Why people struggle to understand climate risk. The views of this article are mostly the views of the Economist Magazine, not Marindependent Insurance Services.