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Sustainability Insights: California’s Evolving Insurance Market Has Mixed Impacts: Spotlight On U.S. Public Finance, Spotlight Off U.S. RMBS


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Sustainability Insights: California’s Evolving Insurance Market Has Mixed Impacts: Spotlight On U.S. Public Finance, Spotlight Off U.S. RMBS

State Farm General Insurance Co. (AA/Stable/--) and Allstate Corp. (AA-/Negative/--), respectively, the largest and fifth largest writers of homeowners' insurance in California based on 2022 direct premiums written, recently announced their decisions to stop accepting new homeowner insurance customers in the state, but will maintain coverage for policy renewals.

Why this matters: 

  • Public information indicates that the insurer decisions in California were based, in part, on concerns about rising wildfire risks. The state's Department of Forestry and Fire Protection reported that nine of the 20 largest wildfires on record (by acreage) occurred in 2020 and 2021, with more than 4 million acres burned. We think natural disasters in California will continue resulting in insured losses and potentially further reduce insurance availability over time.

What we think and why: 

  • USPF issuers: The waning availability of homeowners' insurance could weaken credit quality over time. As demonstrated by California's historical domestic outmigration trends, cost increases could lead to shifts in the social and economic composition of communities in the long term. A slowing revenue environment, absent the state's ability to adapt by cutting expenditures, over the long term could result in budgetary pressures that ultimately lead to credit quality deterioration.
  • RMBS transactions: Given the structural features that help support credit quality and cash flows, we believe this evolution in the U.S. insurance market will likely have minimal impact on ratings even if homeowners have difficulty obtaining insurance.


Insurers' Cost Recovery Typically Results In Higher Premiums

U.S. insurer credit quality is underscored by decisions to limit losses and exit unprofitable business. Extreme weather events have challenged insurers' full recovery of losses, given elevated homeowner repair costs, higher reinsurance premiums, and state regulatory restrictions that limit rate increases for personal insurance lines. In the broader U.S. market, we have observed significant cumulative rate increases of about 33% for high-value homes (greater than $1 million) and about 27% for homes valued at less than $1 million, from 2017 to first-quarter 2023 (see chart 1).

State regulators often limit rate increases for insurers writing personal lines (auto and homeowners' insurance) to maintain coverage access and affordability for consumers. Despite spiking claims for property losses, rate changes for homeowners remained relatively steady at 5%-7%. The inability to raise rates at a pace commensurate with risk could contribute to insurers' withdrawal from the California homeowners' insurance market.

Chart 1


Reinsurance rate hikes contribute to higher costs for private insurers

Insurers purchase reinsurance for additional protection. During the Jan. 1 and July 1, 2023, renewal periods, property catastrophe reinsurers raised rates in the U.S. between 20% and 50%, according to reinsurance broker Guy Carpenter & Co. S&P Global Ratings expects insurers to pass these costs along to policyholders to the extent allowed by regulators, which will likely lead to the additional need for increases in property insurance premiums for commercial and residential customers.

In addition, primary insurers are taking other underwriting actions to limit losses as they grapple with the rising frequency of secondary perils like wildfires, convective storms, and inland flooding. In some cases, insurers are limiting policies-in-force in a particular area to reduce exposure concentrations. According to the Insurance Services Office, a non-profit industry association, the U.S. industry reported nearly $60 billion of insured catastrophe losses in 2022, up from about $56 billion in 2021 (see chart 2).

Our insurance base-case assumption is that natural catastrophe losses will contribute to reduced profitability measured by an insurer's combined ratio. A ratio under 100% indicates profitability and above 100% indicates a loss. For 2022, the combined ratio for the U.S. property-casualty industry was 102.7% and we think for 2023, this ratio could increase as losses stemming from natural catastrophes continue to influence profitability.

Chart 2


California FAIR plan market share grows

Diminishing insurance availability suggests that the state-run insurer of last resort could face pressure from policy growth. The California Fair Access to Insurance Requirements (FAIR) Plan is a state pool providing fire insurance coverage in high-risk areas to residents and businesses that cannot obtain insurance from the traditional marketplace. Between 2018 and 2021, the FAIR Plan's market share of overall residential insurance policies in California increased to 3.0% from 1.6%. This change could reflect the waning availability of private insurance. FAIR Plan policies are typically more expensive because of the high-risk properties insured and provide more limited coverage.

Chart 3


Extreme Weather Could Be A Risk For USPF Issuers

Natural catastrophe insured losses are rising, at least in part stemming from extreme weather events (see chart 2). This is underscored by California's atmospheric river event that started in January 2023 and continued through March (see "California’s Atmospheric River Brings Widespread Damage But Has Limited Credit Impact To Date," published Jan. 26, 2023), and wildfires that occur regularly throughout the year. The atmospheric river event did not lead to any immediate rating actions because, for issuers that experienced the most damage, their reserves and liquidity were sufficient to commence repairs while they submitted eligible expenditures to Federal Emergency Management Agency for reimbursement.

However, other extreme weather events can lead to negative rating actions. For example, public power utilities are exposed to wildfires and legal liabilities associated with California's interpretation of the legal doctrine of inverse condemnation (see "Credit FAQ: How Are California's Wildfire Risks Affecting Utility Credit Quality?" published June 3, 2021). In addition, the western U.S. drought continues to test water utility management teams as they balance conservation, financial operations, and infrastructure requirements to ensure long-term supply. Challenges associated with these types of events, including the possibility of their increasing frequency, can create rebuilding uncertainty and could curtail long-term growth.

Findings on the 2021 heat wave

In December 2022, the Earth System Dynamics journal published research findings that analyzed the extreme heat wave that occurred on the Pacific coast in 2021. The observations and modeling employed by the research team concluded that this event, where temperatures were above 100°F on June 27-29, 2021, could occur every five to 10 years (down from every 1,000 years) under a 2°C warming trajectory. Extreme heat can contribute to the prevalence of drought conditions as precipitation evaporates more quickly and there is less recharge of underground water sources, which together, can lead to higher wildfire risk due to dry vegetation and lower ground moisture, among other impacts. As a result, we think there could be evidence to indicate that extreme heat contributes to the increasing incidences of California's unusual weather patterns and, consequently, insurer losses.

S&P Global Sustainable1's Climate Change Physical Risk dataset shows increased exposure to extreme heat (represented on a 1 to 100 scale) for California's counties over the next 30 years (see map 1). The data provides insight into the potential change in exposure to extreme heat. The scenarios reflect Shared Socioeconomic Pathways (SSPs) from the Intergovernmental Panel on Climate Change (IPCC) and incorporate broad changes in socioeconomic systems. The chart presents findings for the 2020s and 2050s decades through SSP2-4.5--a moderate emissions scenario (SSP2-4.5 implies a 2°C rise in global mean temperature by 2050 compared with the pre-industrial period). Over the 30-year period, underlying exposure data for each county nearly doubles, indicating that there could be more days with extreme heat that exacerbates existing climate conditions faced by entities in the state.

Map 1


Advance planning can help USPF issuers respond to, and recover from, extreme weather events

Consistent with our criteria for analyzing USPF state and local governments and not-for-profit enterprises, we incorporate risk management efforts as an offset to emerging risks, including the physical impacts from extreme weather. We observe that highly experienced management teams across the U.S. typically use a variety of techniques to reduce the potential for operational and financial impacts stemming from these events. One option we've seen issuers employ is purchasing insurance that can help cover damage costs following an event. However, an issuer's broader resiliency initiatives could underpin a multiprong plan to cope with these events and help stabilize credit quality in the face of exposure. The following graphic provides some examples that rated entities have discussed with S&P Global Ratings to help adapt to climate hazards.

California's population trends are already challenged by high cost of living

Our USPF criteria include an economic analysis of the location (for governments) as well as the service area that drives demand for a not-for-profit enterprise (for example, water, sewer, and public power utilities, transportation entities, health care facilities, and primary and secondary education institutions). Two key factors in our analysis are population trends, and diversification of the economy as measured by output. In general, the strength of both can lead to increased revenue for the government or enterprise, which helps cover its operational and debt service costs.

When considering its cost of living as of 2022, California is the third most expensive state after Hawaii and Massachusetts (see map 2). Housing is one component of the cost of living index, and based on a sample of California metropolitan areas, it is a key contributor to California's ranking. We believe reduced competition among the state's private insurers may create higher homeownership costs, which already require more than 100% of the U.S. real median household income to afford the mortgage and other expenses, like property taxes (see table).

Map 2


Metropolitan area typical home value and mortgage affordability as of April 2022 ($)
Metropolitan area Typical home value Monthly mortgage payment Total monthly owner costs Total monthly owner costs less mortgage Annual income needed to afford U.S. average income Amount needed as % of U.S. average income
Los Angeles-Long Beach-Anaheim, CA 953,599 4,930 6,774 1,844 262,217 70,784 270.4
Napa, CA 934,721 4,833 6,640 1,807 257,026 70,784 263.1
Oxnard-Thousand Oaks-Ventura, CA 883,527 4,568 6,276 1,708 242,949 70,784 243.2
Riverside-San Bernardino-Ontario, CA 586,964 3,035 4,170 1,135 161,401 70,784 128.0
Sacramento-Roseville-Folsom, CA 625,193 3,232 4,441 1,209 171,913 70,784 142.9
Salinas, CA 846,971 4,379 6,017 1,638 232,897 70,784 229.0
San Diego-Chula Vista-Carlsbad, CA 945,345 4,887 6,715 1,828 259,947 70,784 267.2
San Francisco-Oakland-Berkeley, CA 1,507,182 7,792 10,706 2,914 414,439 70,784 485.5
San Jose-Sunnyvale-Santa Clara, CA 1,738,119 8,986 12,347 3,361 477,942 70,784 575.2
San Luis Obispo-Paso Robles, CA 887,780 4,590 6,306 1,716 244,119 70,784 244.9
Santa Cruz-Watsonville, CA 1,343,312 6,945 9,542 2,597 369,379 70,784 421.8
Santa Maria-Santa Barbara, CA 973,898 5,035 6,918 1,883 267,799 70,784 278.3
Santa Rosa-Petaluma, CA 834,529 4,315 5,928 1,613 229,476 70,784 224.2
Stockton, CA 575,317 2,974 4,087 1,113 158,199 70,784 123.5
Truckee-Grass Valley, CA 671,333 3,471 4,769 1,298 184,601 70,784 160.8
Ukiah, CA 520,111 2,689 3,695 1,006 143,018 70,784 102.0
Vallejo, CA 628,079 3,247 4,462 1,215 172,707 70,784 144.0
Sources: Harvard Joint Center for Housing Studies, Zillow Home Value Index Data (April 2022), Freddie Mac, Primary Mortgage Market Surveys., U.S. Census.

Given the state's progressive income tax structure, California's high-income earners provide revenue benefits. For example, the state's strong financial results have, in part, stemmed from the high proportion of general fund revenue attributable to capital gains tax and stock options tax from the top taxpayers. However, a high income prerequisite could also prevent many individuals from affording the lifestyle, and California has led select states in absolute, nominal negative net domestic migration in the past 10 years (see chart 4). Although chart 4 excludes international migration, which would likely temper the state's negative trends, we believe that remote and hybrid work arrangements, as well as high home-maintenance costs, including rising insurance premiums, may accelerate the outmigration. Although the migration trends have yet to affect the state's budgetary performance, should a significant share of the top earners choose to move elsewhere, it could pressure revenue collections.

Chart 4


Affordability stresses and physical climate risks could weaken USPF issuers' credit quality over time

As demonstrated by California's historical domestic outmigration trends, rising insurance costs could lead to shifts in the social and economic composition of the state's communities. When combined with other risks the state faces -- like water scarcity and drought -- these shifts could lead to higher costs for homeowners, including property tax increases required to support adaptation and resilient infrastructure investments. Economic activity could decelerate. Although robust economic growth and high incomes have historically bolstered ratings in California, a slowing revenue environment, absent an issuer's ability to adapt by cutting expenditures, in the long term could result in budgetary pressures that ultimately lead to credit quality deterioration. In the short term, however, increasing costs for homeowners' insurance premiums have not led to a marked change in financial performance for the state or the issuers we maintain ratings on in California.

Higher Premiums Will Likely Have A Minimal Rating Impact On U.S. RMBS

Not surprisingly, given California is one of the largest population centers in the U.S., with 11.7% of the nation's total (as of July 2022 according to the U.S. Census Bureau), it is among the top contributors of residential mortgages to RMBS transactions. As previously detailed through our analysis of the Sustainable1 Physical Risk dataset, the state is also subject to frequent extreme weather events such as acute heat and wildfires. An example of a seasoned, representative, and diversified mortgage pool shows California as the top area of exposure, or about 15% of the total pool (see map 3). Major disasters are also noted on the map and include billions of dollars in damages from a cold wave in Texas and Hurricane Ian in Florida.

Map 3

RMBS transactions benefit from various mitigants

General geographic diversification in RMBS transactions reduces the immediate risk from severe weather events, with some portfolios having stronger diversification than others. In our credit analysis, we account for the incremental risks of concentration beyond certain thresholds by increasing the pool's loss projections. S&P Global Ratings also typically expects that all mortgages in the pool carry property insurance at the origination of the loan. In addition, servicers usually advance insurance premiums when the borrower's payment lapses as well as through liquidation to preserve the interests of the trust. The servicer will, however, recoup its advances upon liquidation, but generally at the expense of trust proceeds. Given these aspects, we have not materially changed our view from the analysis performed for our previous article that showed that an increase in insurance premiums under the assessment therein was generally within a rating notch (see "Storm Clouds Or Clear Skies Ahead: How Rising Insurance Premiums From Environmental Physical Risks Could Affect U.S. RMBS And CMBS," published May 3, 2022).

Furthermore, through our surveillance process, we have not yet observed any significant impact to our rated transactions from recent climate events in California. Borrowers affected by extreme weather events often are eligible for mortgage forbearances and deferrals, which can provide temporary relief as they recover. This flexibility ultimately serves to help keep the borrower in the home and the loan performing. For certain transactions, structural features such as the servicer advancing principal and interest and the presence of excess spread can also help minimize the impact from severe weather on transaction cash flows.

In our view, rising insurance premiums are not a key rating driver for RMBS transactions through the combination of the following:

  • Borrower's individual insurance requirement,
  • Servicer blanket insurance backstop,
  • Geographic diversification of loans in securitized pools,
  • Relative size of the premiums versus a borrower's monthly obligation, and
  • Other structural mitigants.

The Insurance Market Will Keep Changing In The State

The waning availability and increased costs associated with homeowners' insurance premiums in California could weaken USPF issuers' credit quality, absent advance planning or management's efforts to manage expenditures in the face of a potentially slowing revenue environment, particularly if the state's outmigration continues or accelerates from housing affordability pressures.

In addition, rating impact on U.S. RMBS securitizations from the declining availability of California residential insurers is unlikely in the near term, but we continue monitoring changes to borrowers' credit profiles and their impact on the performance of rated securitized pools.

Related Research

  • U.S Public Finance 2023 Midyear Outlook, July 18, 2023
  • U.S. Rental Properties' Expense Trends: Insurance Costs Are Rising Significantly, published June 12, 2023
  • Global Credit Outlook 2023: No Easy Way Out, published Dec. 1, 2022
  • Western U.S. Drought: Declining Supply, Rising Challenges, published Aug. 16, 2022
  • Storm Clouds Or Clear Skies Ahead: How Rising Insurance Premiums From Environmental Physical Risks Could Affect U.S. Local Government Credit Ratings, published May 10, 2022
  • Storm Clouds Or Clear Skies Ahead: How Rising Insurance Premiums From Environmental Physical Risks Could Affect U.S. RMBS And CMBS, published May 3, 2022
  • Global Reinsurers Grapple With Climate Change Risks, published Sept. 23, 2021
  • Damage Limitation: Using Enhanced Physical Climate Risk Analytics In The U.S. CMBS Sector, published Feb. 19, 2021

External Research

  • Rapid attribution analysis of the extraordinary heat wave on the Pacific coast of the US and Canada in June 2021, Dec. 8, 2022 (Earth System Dynamics)

This report does not constitute a rating action.

Primary Credit Analysts:Nora G Wittstruck, New York + (212) 438-8589;
Patricia A Kwan, New York + 1 (212) 438 6256;
Kimball Ng, New York +1 212-438-2250;
Secondary Contacts:John Iten, Princeton + 1 (212) 438 1757;
Jane H Ridley, Englewood + 1 (303) 721 4487;
Angha Gupta, Toronto + 1 (647) 480 3545;
Research Contributor:Ronak Chaplot, CRISIL Global Analytical Center, an S&P affiliate, Mumbai
Research Assistant:Matthew T Martin, New York

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