Viewpoint: California’s Next Steps on Cat Models, Challenges and Issues in Insurance Rate-Making‎

By Elizabeth Tosaris | August 3, 2023

A recently brewing and critical California issue is the conflict between industry’s desire to file catastrophe rating models to inform California property rates and California’s laws allowing a public inspection of rate filings.

A large majority of carriers in the industry believes their present rates are insufficient to support the property risks posed in the state, and that catastrophe models, which are increasingly sophisticated, offer a fair and reasonable way to identify and support adequate rates. At the same time, those responsible for developing these models want to protect their intellectual property from their competitors and others.

Cal. Ins. Code section 1861.07 requires all information provided to the insurance commissioner in connection with a rate change to be available for public inspection. The California Department of Insurance has interpreted the law broadly to require transparency, even when the information that is filed has been marked as confidential, trade secret or proprietary or might otherwise be subject to protection from public disclosure.

This dilemma regarding inspection of catastrophe models is set against the backdrop of increasingly frequent and severe wildfire losses in the state, losses have been cited by more than one insurer as the reason either to depart from the state or at least to halt sales of new policies because they are unable to accept the level of risk given their currently filed and approved rates.

Elizabeth Tosaris

On July 13, the department held a lengthy workshop to explore the legal challenges presented by the use of catastrophe modeling in insurance rate-making, such as how to implement the public inspection requirement of Insurance Code section 1861.07. The workshop was part of the department’s information gathering prior to promulgating regulations. The department received written and oral comments from industry, vendors and members of the public.

This article summarizes some of the oral comments that were made during the hearing:

The department opened the hearing by noting the four questions it wanted the comments to address:

  1. When thinking about incorporating catastrophe models into the rate level calculation for homeowners and commercial insurance, what is the significance of Insurance Code section 1861.07?
  2. To what extent can the methodologies, factors and inner workings of catastrophe models be publicly disclosed in accordance with Section 1861.07 so that the department can evaluate those models?
  3. If the department requires sensitive information in the course of its model review, what are some potential methods of ensuring the department can adequately review catastrophe models in accordance with Section 1861.07?
  4. Other states have incorporated alternative methods of structuring model reviews, such as use of an independent third-party panel. Are there any methods used by other states that would be a viable option in California?

Commentators representing a wide array of interests spoke during the hearing, including insurance brokers, insurers, insurance actuarial firms, academics, public interest groups, members of the public and more.

Unsurprisingly, the consumer protection groups agreed that the Prop 103 laws not only applied to catastrophe models, but they also agreed that the laws required the models to be available to the general public. Comments from consumers and their representatives noted that among the public policy reasons supporting transparency around models are the desire to allow consumers to understand which of the factors are under their control, so that they can take steps to reduce rate for their coverages and also to protect against unwarranted price gouging by the industry.

There was also a sentiment that if the industry was allowed the freedom it wanted to develop and use models, then there must be a corresponding requirement of availability of coverage within the state.

Another set of comments suggested that the rate filing rules of Prop 103 did not apply when the models were developed by third parties, for example parties that were not insurers. Others pointed out that the Prop 103 laws made no mention of catastrophe models, and that the only rules applicable would be the general restrictions against discrimination on illegal factors (such as race) and the general prohibition against inadequate or excessive rates.

Yet another theory advanced during the hearing was that the Insurance Code already allows the use of catastrophe risk rating models in accordance with ASOP guidance, which meant that the actuaries’ ASOP disclosures could be used to meet both the requirements of the law and provide transparency. The commentator advocating for this theory went on to note that the department could consider enabling filing provisions that would allow details about the model beyond what was considered in establishing rates, such as how the modelers developed, reviewed and validated the model, and for the information that the modeler considered intellectual property to be provided to the department confidentially.

Some commentators thought the idea that Californians could insure their way out of climate change was unrealistic, and so wildfire loss should be separated from other fire losses and addressed separately through the sale of separate wildfire loss products. In this vein, one suggestion was to create an agency analogous to the existing California Earthquake Authority, but devoted exclusively to the risk of wildfire, although the details of how this new agency would use models or develop rate were not addressed.

One consumer group suggested that California adopt an industry wide expense factor. Others went farther and suggested the creation of a statewide catastrophe model similar to Florida’s Public Hurricane Loss Model. One suggestion was that the state-wide model should be funded by the state and led by California academic experts and consulting experts as needed. The model itself would be transparent and subject to a public review process overseen by the department. Companies could incorporate the model for rate making and pricing. Others rejected the notion that one model would work for all risks and all insurers.

For those commentators more interested in preserving the possibility of multiple models, there seemed to be some consensus around the idea that portions of the rating model would be public. The commentators in this camp generally suggested that the public would be allowed to see a summary description of the scientific methodology, data sources and academic references used in the model development, the inputs/outputs of the model and sample of validations of the models. Conversely, the public would not be allowed to see any elements that were considered intellectual property, proprietary data sets, software programs, source codes, notational sensitivity analyses and client specific results. In this way, the commentators argued that the twin concerns of public access and protections for investments in a model could both be satisfied.

Some commentators urged that any model that resulted from the hearing would allow for different factors than the department currently allows. These commentators pointed out that one of the problems with existing rules is that they require factors that are based on experience rather than future-looking trends, which fails to account for the increasing risk and frequency of catastrophic wildfire losses.

Others thought that actual events, rather than simulated events should be favored, because there is already a fair amount of credible data. In addition, some of the industry commenters asserted that a major reason that the current rates are inadequate is that rates do not allow for a factor that would address the costs of reinsurance, which is a significant cost to the primary insurance market.

The department has clearly been handed a mandate to find a solution to this difficult problem. And regardless of whether the solution is a legislative one, a rule making one or the development of some new type of model structure, all the commentators shared a sense of urgency.

Consumers and the brokers who represent them stated that the market is already in an availability and affordability crisis that will only deepen if a solution was not found quickly. Therefore, not only will any forthcoming regulations need to navigate the best approach for all the interested parties, the regulations will need to do so as quickly as possible.

Tosaris, a partner in Locke Lord’s San Francisco office, has more than 30 years of insurance regulatory and insurance litigation experience. She has worked with a wide variety of property/casualty insurers on rate related issues, including rate filings, rate hearing and general compliance advice.


Topics California

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