Morningstar DBRS: ‘More dramatic changes’ may be needed to resolve California insurance crisis

By Michael Loney

April 7 - (The Insurer) - Regulators may need to make more dramatic changes than those undertaken so far to ensure California’s insurance market is sustainable following January’s wildfires, while carriers are expected to file further rate hikes to close the risk-to-pricing gap, Morningstar DBRS said.

In a new report, Morningstar DBRS said the record-breaking wildfire losses have added further concerns to the already challenging California insurance market. California Department of Insurance figures show that roughly $12 billion of claims have already been paid out as of March 5.

Morningstar DBRS said that insurers with a concentration in the California insurance market, such as Mercury General, have been affected more severely than more diversified national players.

“The large wildfire losses are manageable for most national players, but will add to the concerns about their capital allocation and profitability in the California insurance market, which has been particularly challenging for insurers in recent years,” the report said.

It continued: “While the state has taken steps to improve the insurance market conditions, we believe the burdens of strict regulatory environment and high insurance risk remain heavy and may require more dramatic changes to make the insurance market sustainable.”

State Farm General requested an emergency interim premium rate increase of 22% on homeowners insurance, which the state's insurance commissioner provisionally approved on March 14 with conditions on insurance renewal and capital injection. The final rate decision is subject to a public hearing on April 8.

Morningstar DBRS said that rate increases over 7% may require a public hearing or three-way settlement, which could easily take several months to one year if an intervener such as advocacy group Consumer Watchdog objects.

“Appropriate risk-based pricing is critical for insurers to achieve sustainable operations; however, the restrictive regulatory environment in California has materially discouraged appropriate pricing actions, leading to unsustainably low premiums,” the report said.

Morningstar DBRS expects most property insurers to request large rate increases until the risk-to-pricing gap is materially closed, acknowledging that this process will take considerable time given the aforementioned regulatory burdens.

REINSURANCE COVERED SIGNIFICANT LOSSES

In March Morningstar DBRS estimated global reinsurers's LA wildfire losses at around $5 billion, with roughly $3 billion for the European big four reinsurers and $2 billion for the three major Bermuda reinsurers that disclosed their estimates.

The high reinsurance costs since 2023 forced insurers to reconsider their offerings in the high-risk areas of California. Indeed, several large carriers stopped writing new coverage in California.

In December 2024, California reformed its insurance regulations to allow insurers to pass on reinsurance costs to customers for the first time in history, subject to certain limitations.

“Some large insurers have responded favourably by resuming underwriting policies, while others remain cautious, taking a wait-and-see approach. In our opinion, this regulation reform is a step in the right direction, but it may not be sufficient to resolve the insurance crisis in the California market,” the report said.

It added: “Passing high reinsurance costs on to customers could trigger affordability challenges, potentially causing further price interventions from advocacy groups, especially after the recent devastating losses.”

The state's insurer of last resort, Fair Access to Insurance Requirements Plan (FAIR Plan), incurred a disproportionally large loss from the wildfires, estimated at $4 billion.

“With the approved assessment of $1 billion, the FAIR Plan's cash/surplus buffer is projected at $305 million on June 30, 2025 ($1.5 billion at the beginning of 2025), which, in our opinion, is still relatively thin considering that the wildfire season is far from over,” the report said.

The FAIR Plan's significant losses have been exacerbated by its rapid expansion in recent years, with coverage exposure up over 300% since 2021.

“The growing FAIR Plan coverage could be a significant risk for the state and the industry, as a result of the potential for assessments on primary insurers, given that most of the FAIR Plan's customers are exposed to high catastrophe risks. In addition, the higher the assessment risk for private insurers, the less likely they are to expand in California, which then forces more homeowners to join the FAIR Plan,” the report said.