With the historic wildfires in California contained, now comes the reckoning. As far as the (re)insurance implications are concerned, I think it’s reasonable to say there is a fair amount of uncertainty around the ultimate consequences for the industry – both near and long term.
The first is simply whether this type of event is going to be something like a new normal. Of course, it is easy to place too much weight on recent data points and extrapolate noise into infinity.
But recent experience is also in line with expectations of the scientific community and federal agencies who have predicted this kind of Western wildfire as an expected outcome of a warming climate.
This has several implications for (re)insurance. On the one hand, this could lead to real short-term insurability issues in California, particularly for certain type of risk classes like utilities but even more broadly across multiple lines in a state with an aggressively consumer friendly regulator.
On the other, this type of potential capacity crunch as some carriers retrench is the exact type of opportunity that many in the market live for. And even more simply, the recent memory of losses can do wonders for pricing and demand, particularly when underinsurance issues emerge in affluent areas.
A second related point on rising demand relates to reinsurance. This week, Mercury General announced it had blown through its entire reinsurance tower on the Camp Fire alone.
Given that firms are typically required to buy reinsurance to a modelled 1-in-100 level to support a rating, this is…interesting?
If and when more data points emerge of carriers totalling their programmes, it seems likely there will be a necessity for primary carriers to buy more reinsurance limit, particularly if rating agencies become concerned.
Notably, AM Best has already downgraded Aegis Security Insurance Company based on outsized wildfire losses and insufficient reinsurance protection.
This could add more demand to the market just as reinsurers are taking a hard look at their exposures and price adequacy, and even raise questions around the business model of smaller companies with reinsurance dependency.
A third point relates to this. Over the past few years, reinsurers have bent over backwards to allow cedants to apply reinsurance terms in whatever way inures most to their benefit – an understandable soft market phenomenon for those managing clients through the cycle.
But these wildfires add an interesting test of this dynamic. First, there is simply the risk that reinsurers begin to review their exposures and start to worry about California fires as becoming a more systemic risk, and therefore worry more about setting precedents.
Additionally, there is simply the conflicting needs of clients. Primary carriers who have blown through their top layer will try to define the fires as two events to provide access to a second reinsurance limit, assuming a pre-purchased reinstatement.
But those with losses contained in their first reinsurance programme across all fires are incentivised to consider them one event so that only one retention applies.
How reinsurers square that circle, and how the consequences impact cedants, could be the key trigger point that ultimately decides how some of the market dynamics play out.
A final potential wildcard is simply exactly where these losses end up. The more they end up being passed to reinsurers and retro markets, the higher likelihood of messier 1/1 reinsurance renewal across the market. Even uncertainty around these issues and trapped capital may have an incremental impact.
This is not to overhype an event that on its own can easily be absorbed by strong balance sheets, with plenty of excess capacity on the sidelines.
But in a new paradigm where the market is driven more by expectations than by pay-back pricing, it’s not the quantum of recent losses that matters. It is the impact this data point has on your view of the future that predominates.
Some of this is may be in thoughtful tweaks to models based on new information. Some may be simply that old driver of cyclicality: human fear.
Either way, I think it is likely that the multiple potential issues stemming from California will remain a key wildcard for the industry for the foreseeable future.