Keeping up with the changing face of wildfires

Before 2017, only two major wildfires had caused significant losses for the re/insurance industry in California—in 1991 and 2007.

Since that year, the US state has suffered a plethora of major events which have caused widespread destruction to life and property and caused billions of dollars of losses to businesses as a whole and the re/insurance market in particular.

Many have pointed the finger of blame towards climate change and the devastating effect of longer periods of warm weather in the region and persistent droughts which have dried the environment and accelerated what could have previously minor incidents into major disasters.

In a discussion with the Re/insurance Lounge, Intelligent Insurer’s online, on-demand platform for interviews and panel discussions with industry leaders, executives from brokers, carriers and modelling firms got together to discuss the issue.

Dealing with severity

The marked changes to the severity of wildfire losses over the past five years or so has prompted a widespread rethink in the industry over how to approach and price these risks, as losses have mounted and the intensity of the events shows no sign of abating.

Rich Attanasio, senior director at AM Best, believes the nature of wildfire risk has fundamentally changed over the past five years.

The biggest issue facing the re/insurance industry is that it is grappling with a loss that is typically absolute, given the widespread destruction that occurs during these events, combined with increasing frequency.

“Unfortunately, in the case of wildfire, what often happens is that its total loss makes it more straightforward in terms of the settlement process, but the dollars you’re looking at for each claim can be fairly elevated,” Attanasio said.

“So the industry is dealing with the frequency and the severity issue at the same time.”

Tom Larsen, senior director at risk modelling specialists CoreLogic, added that one of the biggest problems is that, until recent years the industry didn’t consider wildfires to be a significant enough peril to worry about.

“Some of the barriers have been the perspective that until 2017, wildfire wasn’t a peak peril. It didn’t show up,” he said.

“It was managed primarily using experience-based pricing.”

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Larsen said the issue is that the industry is still viewing the topic through the perspective of past experience, rather than being able to price the risks in somewhere such as California based on current and likely future conditions on the ground.

“To use a car analogy, experience-based pricing is like driving while looking through the rearview mirror—it is good in a stable environment where the road doesn’t curve.”

An additional problem is that under Californian regulations, carriers are unable to use a pure model-based pricing solution, meaning that they are forced by law to use outdated data which significantly diverges from the changed reality of the situation.

“You cannot use a model-based approach alone, the regulator will disallow a pure model-based pricing solution. And if you have a reinsurance cost based on a model solution, which is used in and put into pricing in other admitted markets, it’s still not allowed in the Californian market.

“A number of structural challenges persist today that I believe are slowing us to getting to a better handle on the risk,” he said.

Understanding the dynamics

Nidia Martinez, director of climate risk analytics at Climate Resiliency Hub, Willis Towers Watson, argues that the industry needs to significantly improve its understanding of how the risk is developing and how to price it accurately if it is to provide sufficient coverage to residents and businesses in impacted areas.

In addition to having more data and improved reliability of catastrophe models used to price the risk, the re/insurance industry must improve its understanding of the underlying climate dynamics driving the changes, Martinez said.

“When we talk not only about wildfire, but in general, disparities are increasing in frequency and intensity. We talk about quantitative tools, aggregation management and scenario stress testing, catastrophe models and so on. All of those, and more and more, Earth Observations as well,” she explained.

“There’s also a qualitative side of things. What I want to know is does a client understand or know about the risk? What is the risk mitigation? We call it resilience in the climate lingo—what are some of the things we could do to mitigate this risk.

“Responsibility helps, but that is not going to cut it. We need to talk about hazard and understand the science behind it: what is it we can do, then translate it into dollars. Those are the tools we have at our disposal.”

To view the full Re/insurance Lounge session, click here