California regulations restrict insurers from using sophisticated computer models to consider the rapidly growing wildfire risks from climate change — and that limitation is a factor pushing US insurers out of the state.

State Farm General Insurance Co. announced at the end of May that it had stopped accepting new policy applications for property and casualty insurance in California, citing in part “rapidly growing catastrophe exposure” and the challenge of managing wildfire-related losses. Allstate Corp. quietly did the same thing last year.

Neither company specifically cited California's distinctive limitations on risk modeling, but it’s been a central industry concern for many years. State regulations ask wildfire insurers to set rates for annual catastrophic coverage as a fraction of damages accrued over 20 years — without mention of models that can capture the accelerated rate of land use change and development, weather and wind trends or the state of vegetation.

The de facto prohibition on modern models is one of several practices that impair insurers in the state, said Janet Ruiz, California spokesperson for the Insurance Information Institute, a national nonprofit trade group. (Allstate and State Farm referred questions to the Institute.) It’s a part of an insurance regulatory system passed by popular referendum in the 1980s that established oversight of industry rate-setting and is poorly suited to grapple with wildfire risk worsened by climate change. Not only does no other state keep cat models out of rate-setting, but California allows their use for earthquake insurance, she said.

Historically, the 20-year average may have worked better than it does today. Wildfires were more regular, and the standard arithmetic captured a long-term damages trend, said Claire Souch, vice president of global models and climate risk at Moody’s RMS, a company that builds the models insurers and reinsurers use.

When a rolling 20-year average changes very little, it’s okay that many years saw little or no damage, and some years cost insurers billions. That’s no longer the case. As drought worsened from 2012 to 2016, for example, forests and soil dried out and wildfire risk quietly began to soar — even though the fires themselves had yet to materialize. Insurers were taking on more risk and writing more policies, because the 20-year average allowed them to.

It used to be that for wildfires “you don't need models in the same way that you do for earthquakes,” Souch said. “But from our perspective — and we have been saying for several years now — that isn't correct.”

That was the situation when years of drought and heat exploded into the largest fires the state has ever recorded. The two most destructive conflagrations in the state’s history are the Camp Fire, which in November 2018 killed 85 and scorched 153,336 acres, and the Tubbs Fire, which killed 22 people and burned 36,807 acres a year earlier. The insurance industry lost 20 years of underwriting profit in the last six years, Ruiz said.

Questions as basic as how likely a fire is in a given spot, how fire-resilient a home is, what level a premium is necessary for a degree of risk — which cat (catastrophe) models can help with — are left out of consideration when calculating the price of a policy, according to Nancy Watkins, principal and consulting actuary at the business advisory Milliman Inc.

“All of those things are invisible in that simple, simple model,” she said. “And therefore, the recognition of risk going up or down is not possible, because the model doesn't respond to to any thing other than what happened.”

In other words, the California math is “not a stable number that actually predicts anything,” Watkins said.

Wildfires are complicated. Projecting how much destruction they might cause relies on heat, drought, tree cover, development, building materials, winds, the behavior of smoke and flying embers that can fly out of the main blaze to new areas, all things that cat modelers build into their products.

Science is trying to fill in the gaps. Two new studies came just last month. One is a broad review of what’s driving California’s wildfire problem. The second looks at specific conditions, called downslope wind-driven fires, that cause just 12% of fires but 52% of deaths and 60% of property damage. These events burned an average of 140% more acreage in 2020 than they did in 1992.

Further complicating matters, and called out by both State Farm and Allstate, is the market for reinsurance, which is what insurers buy to guarantee their ability to pay out their own policies. Reinsurers in recent years have responded to wildfire damage, inflation and rising construction costs by raising their prices. California’s system prohibits insurers, who face the same challenges, from passing reinsurance costs to customers, Ruiz said, another ongoing challenge for companies in the state.

A modernized insurance rate formula informed by cat models wouldn’t fix California’s market alone, experts say. Premiums that perfectly capture wildfire risk might be too high for many people to pay. That means a big part of the insurance solution is to reduce the risk itself. There’s much Californians aren’t doing. Fire chiefs in the state regularly implore homeowners to remove dead trees and cut back landscaping from the house. Towns can strengthen building codes. Preventative fires burn off fuel that allow wildfires to spread.

Communities can take on more responsibility themselves by understanding how fires spread and how to stop them. In 2020, 71% of voters in Marin County voted to set up a wildfire prevention authority to step-up local resources, activities and coordination. Start-up companies promise ways to detect and suppress fires before they blow up.

“The goal is really to nip it in the bud, before it becomes big and completely unmanageable,” said Emilie Mazzacurati, a managing director of Caeli Strategy, a climate tech consultancy. “And for me, that’s where the hope is, that we’ll be able to bring down risk for everyone.”

California is not alone in its woe. Florida and Louisiana have parallel struggles as they try to insure homes again increasingly intense hurricanes. The trouble has drawn the federal government’s attention. The White House Council of Economic Advisers in March included in its annual report a discussion of climate pressures on insurance markets, in California and elsewhere. “Even without climate change, natural disasters hover on the edge of insurability,” they wrote.

The US National Oceanic and Atmospheric Administration last year launched a collection of “fire weather tools” that includes a satellite wildfire monitor and models that simulate how smoke travels. The agency is in regular contact with the private sector to identify data gaps, including an February agreement with the American Society of Civil Engineers to ensure NOAA science informs building and other engineering codes. NOAA and the National Science Foundation last month launched a research center that will help insurers and reinsurers build climate data into their work.

“Right now we’re seeing the need for information on current and future climate risk,” said Sarah Kapnick, NOAA chief scientist. “When there’s ambiguity, and a lot of uncertainty, and potential for major losses, we’ll see the markets adjust. And that’s what we’re seeing right now.”

The California Department of Insurance did not respond to requests for comment. It issued a statement May 30, saying in part, “The factors driving State Farm’s decision are beyond our control: climate change challenges, higher reinsurance costs affecting the entire insurance industry, and global inflation.”

Temperatures are rising everywhere and there’s no end to fossil fuel pollution in sight. Without substantial, effective intervention, hard conversations already occurring in parts of the country about whether to abandon regularly flooded areas may visit California as well.

“I think we're gonna have to have that conversation about wildfire risk as well,” Mazzacurati said. “And that's a really difficult conversation because it's really nice to be in the middle of the trees. People have their lives and communities there.”

A looming worst-case scenario like that, on top of the anxiety caused by the state’s biggest home insurer pulling back, could together create a political opportunity to re-evaluate the state’s insurance system, said Michael Wara, director of the climate and energy policy program at Stanford University.

“State Farm’s action affects everybody in California,” he said. “It is not just the people that live in the dangerous places that are impacted. And so that I think that really changes the ballgame.”