ÜThe smell of soot hangs over America’s east coast. Hundreds of wildfires raging in Canada pollute the air across North America. Mayors advise their citizens to stay at home, close the windows and reactivate the Covid masks. Ironically, in this phase, America’s homeowners are alarmed by new reports: Because two of the largest insurers refuse to take out new home insurance in California. Other insurance giants are cutting back on their businesses. The reason they give is that historical increases in construction costs and the rapid increase in catastrophe risks have made new policies no longer viable. Forest fires in particular have triggered enormous insurance losses.
In fact, across the country, insurers are raising the cost of policies, reducing coverage, or exiting local markets. The obvious explanation is that major fires and floods associated with climate change are unsettling insurers. However, the withdrawal from California shows that the matter is more complicated. Economist Matthew Kahn puts the key question: why don’t homeowners who want to insure their home against risks and insurers, who make money by taking on risks, get together? The increase in catastrophe risks only becomes a problem for an insurer if it cannot react to it with higher premiums at the same time and if the forecasting models notoriously underestimate the risks.
California isn’t recording more wildfires than it used to, according to statistics from the California Department of Forests and Fire Protection. However, because of the long periods of drought, the fires have recently spread much faster and are consuming significantly more fields, trees and buildings. Of the 20 largest wildfires in California, the largest and most insurable eight have occurred in the past six years. 2017, 2018 and 2020 in particular were bad years for California’s insurance industry.
Authorities do not approve premium increases
Insurers complain that the insurance authorities do not approve adequate increases in contributions. Indeed, the California regulator, a political body chaired by the governor, is demanding that the insurance industry use 20-year losses as the benchmark for premium increases. Insurers are prohibited from using forecast models as the basis for premium calculations that take into account climate trends, changes in vegetation and changes in land use, among other things. The number of houses and residential areas on the edges of forests and wooded areas has been increasing rapidly for decades.
The paradoxical result is that the insurance companies must not react to the increasing climate risks. The regulators certainly have good, or at least well marketable, intentions. They wanted to protect the citizens from usury. The consequences of this policy are fatal, however, because they drive out the insurers, says Kahn. “Basically, the governor of California is asking insurers to lose money.”
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