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Insurance pricing uncertainty persists in wake of California wildfires

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Insurance pricing uncertainty persists in wake of California wildfires

The effects of a tightening in retrocession capacity could be felt first by insurers looking for protection from California wildfire risk after a second consecutive year of deadly and damaging blazes.

A combination of factors have led to warnings that the availability of retro cover — insurance for reinsurers, in effect — could tighten sharply after two straight years of significant catastrophe losses. In California, the retro availability challenge is magnified by the difficulty of modeling wildfire exposure and the potential for highly concentrated losses.

The devastating Camp Fire in Northern California virtually destroyed the town of Paradise, causing losses so steep that they forced one small insurer, Merced Property & Casualty Co., into liquidation.

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Chris Grimes, a director in Fitch Ratings' U.S. insurance group, said primary insurers feel comfortable with continuing to write business as usual if they feel the risks can be ceded to reinsurance markets.

"But whether or not that reinsurance capacity is there to utilize going forward is going to be the real question for those players," Grimes said.

California looks likely to exceed $10 billion in insured wildfire losses for the second year running, with the Camp and Woolsey fires in November already having accounted for more than $9 billion in losses. A number of wildfire-exposed insurance-linked securities have been reported to be at risk of at least some losses, and a $200 million third-party liability placement by PG&E Corp. would almost assuredly be wiped out if the energy utility's infrastructure is found to have started the Camp Fire.

A drop in the supply of retrocessional cover could lead reinsurers to pull back from covering wildfire risks or raise prices to do so, in turn forcing primary insurers to scale back their exposure as well.

"My guess is that we're more likely to see a pricing impact on California business and Western states' business that are wildfire-exposed because of the inability to parameterize the risk, and I think we might see some of the fund capacity not be as aggressive," said Doug May, an executive vice president at Willis Re. "A lot of times when you can't quantify the risk, you'll see the market harden because a lot of people just won't write it."

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Grimes does not think the Golden State is at an "insurance crisis point" yet, but said the gradual build-up and further escalation of losses over a multiyear period may cause insurers to "think a little bit more." Pricing up to now has been "strong enough" to support the earnings insurers have had in California, but companies will now have to evaluate whether their exposures in particular areas, such as the Wildland Urban Interface, is worth it, Grimes said.

"That shifting in their mix of business and the areas that they underwrite, I think is going to be the biggest shift for primary insurers going forward," Grimes said. Making such changes could be tough where a "meaningful amount" insurers' overall exposure is to California homeowners coverage, but Grimes has noticed a few companies, such as Mercury General Corp., increase their reinsurance protection in recent years.

"It would certainly take some fairly large losses over a multiyear period for an entire shift toward who's going to be underwriting that business," he said. "I still think we're going to see national players tomorrow and into the future, but maybe not quite at the levels that they're currently underwriting."

The state's insurer of last resort, the California Fair Plan Association, has seen wildfire risk rising on the properties it insures and has grown the share of premiums it generates from wildfire coverage. It also recorded losses and defense and cost-containment expenses of nearly $49 million in the 2017 accident year, more than double the total in the previous five years combined.