Technology has been embraced in a variety of ways within the homeowners’ insurance market. Many aspects of the claims process have been automated, insurers are utilizing more climate data than ever before to predict the impact of major catastrophe (CAT) events, and improvements to insurers’ systems have gone a long way toward increasing the efficiency and effectiveness of policy administration. With these improvements, why are more insurers leaving areas with high CAT risk like California and Florida if there are solutions available to help assess and price that risk?
The problem is twofold. First, in some states such as California, regulators limit the use of CAT modeling by insurers in the ratemaking process. Instead, insurers are beholden to continue a more archaic approach: prioritize experience for rate assessments.
Second, while the scientific development behind CAT modeling has come a long way, where using it in the insurance product pricing process is permissible, it should not be considered the definitive answer when selecting ultimate CAT loss costs. CAT models are stochastic tools offering a range of outcomes. Insurers must be diligent in understanding data inputs, profitability appetites, and portfolio correlations.
While CAT modeling can be an effective tool, tweaks to the system are needed to curb the steady stream of insurers leaving high CAT-risk markets.
Time for an Upgrade
Earlier this year, the California Department of Insurance hosted a webinar where a variety of stakeholders were invited to offer comments about the role CAT modeling could play in ratemaking and pricing adequacy in the future. This webinar included experts from the industry, as well as various consumer interest groups and other stakeholders.
During this event, it became clear some of California’s fundamental processes are well behind peer states, such as time to review and approve rate filings and allowing insurers to utilize key resources like CAT models to assess CAT risk. When it comes to rapidly evolving and population-dependent risks like wildfires, we as an industry simply do not have enough historic data that is applicable to modern conditions to credibly price products covering such perils. As a result, other tools are needed to make up the difference.
To move CAT modeling forward as an acceptable tool for assessing and pricing risk in volatile markets, we as an industry need to raise awareness from homeowners to regulators as to how CAT models can be utilized by insurers to analyze CAT risk. This California Department of Insurance workshop was a step in the right direction.
Consumers should understand what is going on here: Regulators are restricting the use of viable and broadly adopted technology in the ratemaking process. Expanding the insurers’ toolboxes should lead to a more sustainable market with adequate supply for consumers. This is on us as an industry to spread the word that insurance accessibility and affordability are possible for risk-prone states with some regulatory updates.
Utilizing CAT risk modeling and other climate risk assessment tools more comprehensively to better inform evolving CAT risks will improve insurance accessibility, but there is more that can be done. Technology should supplement creative thinking and alternative product development, such as tailored solutions that allow consumers and insurers to finance risks in a more sophisticated manner based on individual goals and objectives. Such solutions are more resilient to volatility over time.
As an industry, we need to take a step back and look at how and where we build, how we manage climate risk, and how we can lean on technology such as CAT modeling to create a more sustainable industry for consumers. Purely looking backward at experience when prospectively setting rates is ineffective. As a result, insurers will be unable to satisfy all relevant stakeholders including consumers, regulators and shareholders.
By accepting advancements in technology, we can gain a better understanding of climate risk, lead us to innovative solutions, and improve access to affordable insurance in high-risk areas.
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