State Farm said this month it will stop insuring new homes in California, joining a growing list of insurers that have reduced operations in the Golden State in response to rising wildfire exposure and a challenging reinsurance market.

State Farm, which cited historic increases in construction costs, “rapidly growing” catastrophe risks, and reinsurance market challenges as the reasons behind its decision, is the largest provider of homeowners insurance in the state, protecting an estimated 22% of residents.

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And it is not the only one looking to cut its losses in the wildfire-prone state. Other insurance providers, including AIG and Chubb, have declined to renew policies for thousands of homeowners living in California, citing similar risks of climate catastrophe and a pricing structure that does not allow for them to increase their premiums accordingly.

The number of homeowners in California who have lost coverage has soared in recent years, and nonrenewal of home insurance policies spiked by a whopping 30% in 2021 compared to the previous year, according to the most recent data from the California Department of Insurance.

That's led to an insurance market that's more competitive and costly for homeowners than ever before.

California officials have said that a rise in climate change-fueled disasters is the primary problem. Others, though, say that poor management and regulation are to blame — pointing to California's 1988 insurance law as the primary driver of State Farm's exit.

Regulatory factors in California "have really been the hidden driver" causing insurers to reduce their footprint in the state, Jerry Theodorou, the director of the finance, insurance, and trade program at the R Street Institute, told the Washington Examiner.

While "plenty of other states have seen a rise in natural catastrophes" in recent years, none have seen a drop-off in property insurance the way California has, he said.

California is not the only state hit hard by the effects of weather-induced catastrophe — Florida, for example, incurred roughly $109 billion in damages from Hurricane Ian last fall, making it the third-costliest hurricane in U.S. history — it is the only state that requires insurers take into account 20 years of historical data when setting their premiums.

That means property insurers in California can’t adequately price for risks from wildfires or other climate catastrophes that have ravaged the state in recent years, thanks to a combination of hotter temperatures, drought, and poorly managed forests. And as a result, they are leaving the state at a rate not seen in other parts of the United States.

"The evolution of really what the exposure [to drought and wildfires] has been in California, coupled with all these other economic factors, have really created a lot of financial pressure for companies," Karen Collins, vice president of property and environmental policy at the American Property and Casualty Insurance Association, told the Washington Examiner.

Losses incurred during the 2017 and 2018 wildfire seasons alone were so significant that they wiped out more than 20 years of underwriting profits.

As a result, Collins said, companies are "unable to leverage catastrophic risk management tools like catastrophe models to take into account the impacts of climate change in setting their overall rate level needs. And they are [unable] to reflect the net cost of reinsurance in their pricing — and those costs have surged substantially just in the last few years."

Insurance companies also purchase their own insurance, known as reinsurance, as a sort of shock absorber to help them manage losses past a certain point in the event of disaster.

While reinsurance premiums have spiked in recent years to reflect the uptick in extreme weather, providers in California, unlike other states, are barred under state law from passing those costs along to consumers.

Each year, insurance companies evaluate what percent of their losses was the result of natural disasters — historically, this falls around 6% — and will then set different coverage and deductible options for consumers, as well as determine the reinsurance they plan to buy.

Not being able to reflect those rates in premiums has made it extraordinarily difficult, and expensive, for providers to do business in the Golden State.

Insurance companies can cover climate risk and weather risk, "but they need the flexibility to adjust their pricing and their coverage so that it's something that doesn't bankrupt them," Theodorou said.

Looking ahead

These problems are likely to get worse for homeowners as California endures more widespread and intense wildfires affecting more properties than ever before — and as reinsurance rates continue to spike.

“You have these conditions which are different. And actuaries, the quantitative folks at the insurance companies that determine rates, need to factor in the exposure, not just the experience," Theodorou said.

Global insured losses from catastrophes were anticipated to reach at least $15 billion in the first quarter of 2023 alone, according to insurance broker Aon. Reinsurance providers have upped their rates accordingly.

But without the ability to increase their premiums to reflect risk or the higher costs of their own reinsurance premiums accurately, more providers in California could follow in State Farm's footsteps —leaving new homeowners with fewer options to obtain insurance.

Those without coverage could also be forced to turn to California's FAIR Plan, or an "insurance company of last resort," which consumers can turn to when no private insurers will cover them.

Coverage is limited, high risk, and only covers those who can prove they've been denied coverage by other providers.

It's not a lucrative option, but it could be the only one left for homeowners unless California lifts its current regulations — which APCIA dubbed in a recent white paper as the "hardest market in a generation for property insurance."

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Actuaries must look at both experience and exposure ratings to determine where to set premiums. "The right way to do it is to look at the factors that tell you what is the exposure, what is the potential for loss, what is the likelihood of a loss. Then you're pricing it more accurately and you can stay in business," Theodorou explained.

"But if someone is tying your hands and saying no, you can't charge this amount, the company's hands are tied. And if they see that they're losing money or bleeding red ink, they pull up stakes and then go to places where they can make a buck.”