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CDI Releases Draft Regulations on CAT Modeling and Ratemaking for Wildfire Risk

Proposed regulations allow catastrophe models to be incorporated into ratemaking in exchange for increasing availability in distressed areas.

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CDI Releases Draft Regulations on CAT Modeling and Ratemaking for Wildfire Risk

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  • The California Department of Insurance (CDI) has released the next round of draft regulations for its Sustainable Insurance Strategy, which focuses on allowing catastrophe models to be incorporated into ratemaking in exchange for a commitment from insurers to accept more policies in high-risk wildfire areas.

  • Insurers must commit to achieving their quota within a two-year period in order to utilize a forward-looking catastrophe model as part of a complete rate application. The draft outlines two methodologies that would be used to define a quota. Insurers must also maintain documentation that tracks their progress. 

  • As insurers expand their capacity in these fire-prone areas, implementing granular risk assessment tools like Z-FIRE™ becomes even more crucial. Such solutions enable accurate risk differentiation at the individual property level, ensuring fairness and affordability for policyholders.

ZestyAI is committed to leveraging advanced technologies, such as Artificial Intelligence, to predict and mitigate the societal impact of natural disasters. We believe robust governance and compliance are essential for successful AI adoption within the insurance sector. This includes not only understanding but actively shaping regulatory policy through a collaborative approach.

ZestyAI demonstrates this commitment by actively engaging with regulatory bodies. In July and October 2023, we presented solutions at the CDI Wildfire Workshop on how to leverage catastrophe models for improved insurance availability and affordability. Further, in April 2024, CEO Attila Toth provided recommendations for a clear and robust wildfire model review and approval process at the CDI's Catastrophe Modeling and Ratemaking Workshop.

We believe robust governance and compliance are essential for successful AI adoption within the insurance sector. ZestyAI demonstrates this commitment by actively engaging with regulatory bodies.

We are pleased to see the California Department of Insurance release a draft text of proposed regulations on catastrophe modeling and ratemaking aimed at increasing policy availability in high-risk wildfire areas.

Addressing Insurance Availability in Distressed Areas

The California FAIR Plan, acting as a last resort insurer, has seen a significant rise in the number of policies issued in recent years. Since 2019 the total dwelling policies in force have increased by 137% (source: CA FAIR Plan). This trend underscores the difficulties Californians face in securing traditional homeowners insurance.

The proposed regulations address this challenge by introducing market share quotas for insurers in designated distressed areas. These areas, encompassing entire counties or specific sub-regions, have been identified based on their reliance on the FAIR Plan. The draft proposes two alternative commitments for insurers:

  • Increase their market share in distressed areas until it reaches 85% of their total market share in the state. This option is available for homeowners lines only.
  • Increase the total number of policies written in distressed areas by 5%. This option is available for both homeowners and commercial lines.

Insurers must maintain detailed records of their policies in a wildfire risk portfolio, ensuring transparency and accountability in meeting their commitments. This includes regular reporting to the Department of Insurance on the number and location of policies written, as well as any changes in coverage. Comprehensive documentation will enable the Department to monitor compliance effectively and address any discrepancies or issues promptly. Insurers are expected to provide accurate and up-to-date information to facilitate ongoing assessment and oversight.

Insurers must maintain detailed records of their policies in a wildfire risk portfolio, ensuring transparency and accountability in meeting their commitments.

Commitments can be modified if carriers experience significant changes in market share, ensuring that their obligations remain proportionate to their business capacity. Additionally, insurers must attest to their progress in fulfilling their commitments in subsequent rate applications. This attestation involves a formal declaration of compliance, outlining the steps taken and policies written to meet the regulatory requirements. By providing this attestation, insurers affirm their adherence to the commitments and enable the Department to verify ongoing compliance and effectiveness of the regulation.

Balancing Market Expansion with Rate Adequacy: The Role of Catastrophe Models

The proposed regulations offer a potential incentive for insurers. In exchange for meeting market share quotas in distressed areas, carriers can leverage forward-looking catastrophe models to project average annual wildfire losses. This data can then be used to support a justified rate increase application.

ZestyAI believes this integration of catastrophe models into rate applications holds promise. It could enable the expansion of insurance options for homeowners while promoting long-term rate stability. The CDI's announced requirement for higher home acceptability in distressed areas aligns with this approach and represents a positive step.

This could enable the expansion of insurance options for homeowners while promoting long-term rate stability.

Rate adequacy is a core principle of insurance carrier profitability, ensuring premiums charged by insurers are sufficient to cover future losses and expenses. To achieve this, rate applications rely on assumptions reflecting the carrier's anticipated future risk exposure.  If insurers are expected to take on more wildfire risk, it stands to reason that their assumed wildfire losses should reflect this increased average exposure. Catastrophe models can inform carriers about their future risk profile based on the anticipated written exposures, including potential market share expansion in distressed areas.

The Need for Improved Rate Segmentation

Increased risk exposure in fire-prone distressed areas is an inherent consequence of expanding insurance availability. However, implementing risk segmentation strategies, such as those offered by ZestyAI's Z-FIRE solution, can generate significant benefits for both insurers and policyholders.

Risk-based rating and segmentation enable most consumers to benefit from potentially lower premiums based on their individual risk profile. This approach also promotes greater market access for all. Additionally, increased home acceptability in distressed areas allows admitted insurers to reduce the burden on the FAIR Plan, ultimately reducing the overall assessment risk for the admitted market and fostering long-term market stability.

Property-specific features play a critical role in determining wildfire damage susceptibility, even within localized areas. ZestyAI's Z-FIRE Level 2 (L2) score quantifies this risk by predicting the likelihood of a property sustaining damage during a wildfire event. Properties with the lowest L2 score possess a 5% chance of burning, while those with the highest score face an 88% chance of being consumed.

Property-specific features play a critical role in determining wildfire damage susceptibility, even within localized areas.

A review of historical wildfire data, specifically focusing on the 2022 California fire season, reveals that just 37% of properties within designated wildfire perimeters fell within the high-to-very-high L2 risk category. This finding suggests a substantial opportunity for identifying properties with lower risk profiles (63% falling within the low-to-moderate risk categories) even within regions traditionally considered highly susceptible to wildfires.

ZestyAI: Committed to Shaping Regulatory Policy

ZestyAI is dedicated to leveraging artificial intelligence for a more resilient future. We believe in robust governance and compliance to foster successful AI adoption within the insurance industry. We actively participate in shaping regulatory policy, advocating for a collaborative approach that fosters both innovation and regulatory compliance.

ZestyAI will present at the upcoming workshop on June 26th. We look forward to discussing these critical issues with you.

Bryan Rehor is Director, Regulatory Strategy, at ZestyAI

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