If you work for an insurance company that differentiates its California property rates by risk of wildfire, you may be trying to understand what impact Regulation 2644.9 has on your business. Designed to reduce insurance costs for policyholders who take measures to mitigate their wildfire risk, this new regulation presents tremendous challenges for insurers in terms of compliance and the potential erosion of adequate rates for wildfire risk. This paper recaps the changes and offers best practices and strategic insights to help insurers address these challenges and make informed decisions about how to move forward.
Overview of mitigation in rating plans and wildfire risk models
California Code of Regulations Section 2644.9 – Mitigation in Rating Plans and Wildfire Risk Models, effective on October 14, 2022 – is designed to reduce insurance costs for policyholders who take measures to protect their properties from wildfire risk. Regulation 2644.9 applies to any insurer operating in California that differentiates its rates in any way with respect to wildfire risk. Specifically, the new regulation impacts: “An insurer that applies or uses a rate that is developed with, determined by or relies upon, in whole or in part, a rating plan that segments, creates a rate differential, or surcharges the premium based upon a policyholder or applicant's wildfire risk.”1 For example, if a property insurance program offers a brush surcharge or territory relativities that vary based on exposure to wildfire, then the insurance company must comply with this regulation. The regulation applies to both personal property insurance such as homeowners and dwelling fire, as well as commercial property insurance such as business owners’ protection, and other commercial insurance programs that are filed on an admitted basis in California.
Insurers have to submit a California Department of Insurance (CDI) Rate Application complying with Regulation 2644.9 by April 12, 2023. The filing must demonstrate how the insurer has complied with the following requirements.
Requirement 1: Insurers must recognize wildfire risk mitigation measures
Regulation 2644.9 mandates 12 mitigation measures to be reflected in property insurance rates, grouped into the following three categories.
A. Community-level designations. Insurers must offer rate relief to policyholders whose homes or businesses are located in communities designated as a:
- Fire Risk Reduction Community by the Board of Forestry and Fire Protection.
- Firewise USA site in Good Standing.
These designations recognize the reduction in wildfire risk through improved land use planning, the enforcement of building codes, landscaping regulations, forest management projects, steep slope ordinances, and watershed management plans.
B1. Property-level: Immediate surroundings. Insurers must offer rate relief to policyholders who take any of the following five (5) mitigation measures.
- Clear debris and vegetation from under decks.
- Clear debris, vegetation, mulch, stored combustible materials, and any movable combustible objects located within five feet of the building being evaluated.
- Only noncombustible materials, including fences and gates, within five feet of the building.
- No combustible structures, including sheds and other outbuildings, within 30 feet of the building.
- Lot complies with Public Resources Code S. 4291, which requires a defensible space around the building, removal of trees and trimming of branches near chimneys, and no dead vegetation near roofs.
B2. Property-level: Building hardening. Insurers must offer rate relief to policyholders who take any of the following five (5) mitigation measures.
- Class-A fire-rated roof, which provides the highest level of fire protection and resistance.
- Enclosed eaves, which reduce the risk of embers igniting the roof or entering the attic.
- Fire-resistant vents, which resist or prevent the intrusion of flames, embers, and radiant heat.
- Multi-pane windows, which help prevent fire from entering the home.
- At least six inches of noncombustible vertical clearance at the bottom of the exterior surface.
The above classifications must be included in a rate plan that differentiates rates based on wildfire risk. The regulation states that insurers may also consider other wildfire risk mitigation measures. These optional mitigation measures include, but are not limited to, the following.
- Fuel: Type and density of combustible material.
- Slope: Position of structure relative to potential sources of ignition.
- Access: How easy it is for firefighters to access the structure.
- Aspect: Direction of the slope relative to the structure.
- Structural characteristics: Year the building was constructed and whether it has fire-resistant siding material.
- Wind: Degree to which wind speed or direction could affect a wildfire’s progression.
- Other relevant characteristics.
The above optional characteristics are often incorporated into a wildfire risk score or wildfire territory. Some wildfire risk scores are limited to wildfire mitigation measures that the regulation deems optimal, whereas other wildfire models or territory definitions include both optional and mandatory mitigation measures. Any of the mandatory mitigation measures not already addressed in a wildfire risk score, wildfire territory, or elsewhere in the rate plan must be incorporated into the company’s rate plan via this filing.
Requirement 2: Insurers must notify policyholders
Communication to the policyholder is a key aspect of the new regulation. Insurers must provide written notification to policyholders that explains the details of their wildfire risk rating, disclosing the following:
- The potential range of risk classifications and discounts, or rating factors.
- The position of the policyholder’s risk assignment within the range of possibilities.
- A detailed explanation of why the risk was classified that way.
- Mitigation actions the policyholder can take to improve their wildfire risk and how much the policyholder could save on their insurance premium for implementing any or all of them.
Figure 1 shows a sample disclosure an insurer could provide to a policyholder.
Figure 1: Sample disclosure
|A. Community Level
|0.98 to 1.00
|B1. Immediate Surroundings
|i. Vegetation cleared from under decks
|0.98 to 1.00
|Max discount applied
|ii. Combustible material cleared within 5 feet
|0.99 to 1.00
|Max discount applied
|iii. Noncombustible materials within 5 feet
|0.98 to 1.00
|Max discount applied
|iv. Combustible outbuildings > 30 feet
|0.99 to 1.00
|v. Trees trimmed and brush/debris removed
|0.99 to 1.00
|Max discount applied
|B2. Building Hardening
|i. Class-A fire rated roof
|0.98 to 1.00
|ii. Enclosed eaves
|0.98 to 1.00
|iii. Fire-resistant vents
|0.98 to 1.00
|iv. Multi-pane windows or functional shutters
|0.98 to 1.00
|v. Noncombustible vertical clearance > 6 inches
|0.98 to 1.00
|Wildfire Risk Territory
|0.50 to 1.50
The insurer shall disclose the above details to the policyholder no later than fifteen (15) days after receiving the completed application for insurance, and then at least forty-five (45) days prior to renewal, seventy-five (75) days prior to any non-renewal, and within thirty (30) days of the policyholder notifying the insurer that a wildfire risk mitigation measure has been implemented.
Requirement 3: Insurers must establish an appeals process
In addition to providing policyholders with the above disclosures, the insurer must establish an appeals process for the risk classifications. The insurer must provide the policyholder with details about how to initiate the appeals process and how to file a complaint with the CDI if they are not satisfied with the insurer’s response.
Bulletin 2023-22 provides guidance as to how the CDI would like filings submitted to enable CDI staff to efficiently review the submissions. Specific filing guidance in the bulletin includes:
- Submit a Prior Approval Rate Application with the filing type listed as "Rule filing without rate impact” and identify the program name as “Mitigation in Rating Plans Regulation.”
- Do not include any changes to existing rates or rules beyond the scope of Regulation 2644.9.
- The filing must be revenue neutral and include these exhibits:
- Exhibit 19-A: Rating relativity support for any new relativities, discounts, or surcharges that you are introducing.
- Exhibit 19-B: Description of any changes to your wildfire risk scoring models to comply with Regulation 2644.9.
- Exhibit 19-C: Policyholder dislocation. The CDI requires that properties qualifying for the mitigation measures be known with certainty before they can be applied in a dislocation analysis. If you are introducing discounts only, and do not already know which properties qualify for the discounts, then the CDI’s position is that there is no dislocation and the filing is revenue neutral without a base rate offset.
- Complete the Model Checklist if a wildfire risk model is introduced.
- Complete the Mitigation in Rating Plans and Wildfire Risk Models Questionnaire.
If there are changes proposed to the policyholder application for insurance or the declaration page in order to accommodate new rating steps and variables, then these forms also need to be submitted to the CDI for approval. For example, an insurer may decide to make changes to the policyholder application to add questions about whether the property qualifies for wildfire mitigation measures, or to disclose what mitigation measures the policyholder attested to having on the declaration page. Any changes to the application or declaration page need to be included with this filing. The filing must also include the consumer notifications outlined in Requirements 2 and 3 above.
In addition, as noted above, the overall rate change being proposed to comply with the regulation must be revenue neutral, without changes to the rate plan beyond those that are needed to comply with the regulation. To satisfy the requirement that the proposed rate change must be revenue neutral, the CDI has taken the position that a company cannot offset the base rate unless the impact on each individual in-force policy is known with certainty. Said a different way, without knowing which in-force policies qualify for each new mitigation discount, the company is not permitted to offset for the average discount expected to be applied, ensuring that the average rate level remains the same after the new rates go into effect. The result, on average, when applied across the in-force book (unless the company is careful to submit a combination of discounts and surcharges or rating factors that are expected to not impact the average rate level) would be a 0% rate change, and the company possibly eroding its rate level. The CDI’s position is that an adjustment to the base rate, or other adjustments, cannot be made unless these adjustments can be determined with certainty based on knowing whether each individual policy qualifies for the discounts at the time the filing is submitted.
Potential actuarial approaches
Your company could comply with Regulation 2644.9 by doing one of the following:
- Remove all wildfire risk-rating elements from the rate plan and adjust the rates so they no longer differentiate based on wildfire risk.
If you remove the rating steps associated with wildfire risk, you will know which in-force policies are affected by the change, and can then calculate a base rate offset for a revenue neutral rate change. Typical actuarial ratemaking methodology is to determine the average rating factor, discount, or surcharge being removed, and then adjust the base rate so that the total premium across the in-force book of business is the same as it was before the adjustments to remove the wildfire rating steps. This means that, when the in-force policies are rerated using the proposed rates, the total premium remains the same, even though premium for individual policies will change. This is called a base rate offset, which results in a revenue neutral rate change. Some insurers are considering this approach because they have very low exposure to wildfire, which may not warrant the time and cost to implement the consumer notification and appeal processes.
- Introduce a new revenue-neutral table of discounts and surcharges, or rating factors, that addresses each of the 12 mandatory wildfire mitigation measures.
The new rate table will have discounts, or factors below 1.00, for when mitigation measures are met, and surcharges, or factors above 1.00, for when mitigation measures are not met. For example, properties with enclosed eaves receive a 5% discount, or a factor of 0.95, and properties without enclosed eaves receive a 5% surcharge, or a factor of 1.05. This assumes that 50% of the in-force policy premium is expected to be for properties that have enclosed eaves, so that the average discount (or surcharge) is expected to be 0%. That is, the average rating factor for this characteristic is expected to be 1.00 across the entire in-force book of business. Because the distribution of premium is not typically even between properties with and without the mitigation measures, actuaries would typically offset the base rate to result in a revenue neutral rate change. This means that the actuary would calculate the average expected discount, surcharge, or rating factor and adjust the base rate to offset the impact of the average rating factor. For example, if the premium was split so that 25% would be expected to receive a factor of 0.95 for enclosed eaves, and 75% would be expected to receive a factor of 1.05 for not having enclosed eaves, it results in a weighted average rating factor of (0.95 x 25%) + (1.05 x 75%) = 1.025 across the entire book of business. This means that the premium is expected to increase by 2.5% after the new mitigation measure table is introduced if a base rate offset is not applied. To achieve a revenue neutral rate change, actuaries would typically divide the base rate by 1.025, so that after the new discount, surcharges, and rating factors are applied, which average to 1.025, the total premium collected is the same as it was before changes were made to introduce the new wildfire mitigation table of discounts, surcharges, and rating factors.
- Introduce a new table of discounts, or rating factors, that addresses each of the 12 mandatory wildfire mitigation measures.
The new rate table will have only discounts, or factors below 1.00, for when mitigation measures are met, and no discount, or a factor of 1.00, for when mitigation measures are not met. For example, properties with enclosed eaves receive a 5% discount, or a factor of 0.95, and properties without enclosed eaves receive no discount, or a factor of 1.00. If only discounts are introduced, or factors below 1.00, then without a base rate offset, properties with enclosed eaves will get a rate decrease, and those without enclosed eaves will stay at the same rate. From the CDI’s position, this is revenue neutral because it is a new discount and the insurer does not know with certainty which policies will or will not receive it. However, from an actuarial perspective, the average rate will decrease, even though we do not know which policies will receive the discount. For insurers finding it difficult to keep up with the increased wildfire exposure in California and inflationary pressures on the cost to rebuild properties, this method will erode the average rate, and may result in an overall rate level that is inadequate from an actuarial perspective.
Best practices related to the new data
Insurance companies should consider the following when deciding how to comply with Regulation 2644.9.
1. How to get the data to inform the new rates that are being proposed.
Options to determine which properties will qualify for the new wildfire rates include:
- Update the application so the consumer attests to what they have and do not have and consider inspecting the property to confirm the information is correct.
- Use a third-party data provider to collect and provide the data.
- Perform inspections to collect the data.
Insurance companies may reduce the cost of third-party data and/or inspections by choosing to only validate data through third-party data sources, and/or inspections, when the consumer requests one or more of the new discounts. However, the new regulation requires that consumer notifications occur within 15 days of the application and within 30 days of a policyholder notifying the insurer that a wildfire risk mitigation measure has been implemented. To satisfy the notification requirements, the insurer must complete its validation process within these time limits. Many insurers have been moving toward more efficient quoting and binding processes using pre-filled data from a third party on all new business and for certain data elements that change over time for renewal business.
2. How to implement and test the new rates in the quoting process and for renewals.
Insurers will need to determine which policies qualify for the new wildfire mitigation measures and be able to efficiently incorporate the new data into quoting within 15 days of receiving the application and within 30 days of a consumer advising that a new mitigation measure has been implemented. The insurer also needs to be able to efficiently process renewals 45 days prior to the effective date, including the use of updated mitigation data applicable to the renewal term.
3. How to implement and test the policyholder notifications, with revised applications and declarations, including a new appeals process.
The insurer needs to draft the additional consumer notifications, including changes to the application and declaration page, then program those changes and test them. The insurer must also have an appeals process in place. If the insurer is going to non-renew a policy, notification must occur at least 75 days prior to the renewal effective date. Insurers that process renewals 45 days prior to the effective date, which is common for most insurers, and insurers that use a wildfire risk score or other wildfire mitigation eligibility requirements, will need to lengthen their renewal process to 75 days.
Best practices related to the filing support
1. Read Bulletin 2023-2.
Note that the bulletin states that the filing must be submitted as a “Rule filing without rate impact,” not a rate filing.
2. Ensure that the proposed changes will not erode the adequacy of the overall rate level.
Today, California wildfires are a significant exposure for property insurers. Insurers are required to calculate the expected cost of wildfire losses using the insurer’s most recent 20 years of wildfire loss experience relative to its non-catastrophe loss experience.3 This means that current base rates already incorporate the cost of wildfire, but don’t necessarily differentiate the rate for every mandatory mitigation measure listed in the new regulation. Even though the current rate plan may not differentiate the rate based on whether the property has an enclosed eave or not, the average rate already accounts for the fact that some properties have enclosed eaves and some do not. Adding a discount for an enclosed eave, with no surcharge when the eave is not enclosed, will result in properties with enclosed eaves being charged a lower premium and those without enclosed eaves having the same premium as before. This results in less overall premium being collected than prior to the new discounts being implemented. Implementing a discount for enclosed eaves, without a surcharge for eaves that are not enclosed, and without a base rate offset because the insurer does not know with certainty which properties have enclosed eaves, will reduce the overall rate level from what was approved in the prior rate filing. Said another way, if the insurer introduces a new set of discounts or a new wildfire scoring model that only offers discounts, without any offsetting surcharges, it is likely that the overall rate adequacy will erode unless a base rate increase is applied to offset the average discount.
To reduce the loss of premium from introducing new discounts, insurers might evaluate the benefit of using pre-filled data to determine which policies qualify for each new discount in order to offset the base rate with certainty. This will allow policyholders that implement mitigation measures to receive a discounted rate relative to similar properties that did not implement mitigation measures but maintain the same overall average rate level. For the average rate to remain the same, those policies that don’t qualify for the mitigation discounts will receive a premium increase as a result of the base rate offset, and those policies that qualify for the mitigation discounts will receive a premium decrease compared to what they were previously being charged.
It is critical to each insurer’s underwriting results that the options be thoroughly evaluated before submitting a filing in order to ensure that the insurer is not unintentionally reducing its average rate level without an equal reduction in expected loss costs.
3. Complete the CDI support listed in the bulletin.
In addition to preparing Exhibit 19A to support the new proposed rates, Exhibit 19B is required if there are changes to a model, and Exhibit 19C is required if these changes impact individual policyholders in a measurable way. If the insurer does not know which properties will qualify for each of the new mitigation discounts, surcharges, or rating factors, then the CDI’s position is that there is no rate impact and Exhibit 19C is not required. Remember that California is not a me-too state. This means that although an insurer can rely on data found in another California filing as a complement of credibility to its own historical loss experience, it is important that the supplemental data be as specific and appropriate to the insurer as possible—specific relative to California and appropriate relative to the types of risks and mix of business that the insurer is writing and proposing rates for. When insurers refer to rates or loss costs in other California filings as a complement of credibility to its own data, insurers need to support why the rates or loss costs are appropriate for their use. The support may include references to loss cost relativities or other data found in another California filing, appropriate disclosures about how that supplemental data is appropriate, internally developed support such as the last 20 years of experience, or third-party support, such as data from a model vendor or advisory organization. Any actuarial support needs to follow Actuarial Standards of Practice (ASOPs), including but not limited to:
- ASOP 39 – Treatment of Catastrophe Losses In Property/Casualty Insurance Ratemaking.
- ASOP 53 – Estimating Future Costs for Prospective Property/Casualty Risk Transfer and Risk Retention (i.e., Ratemaking), and the ASOPs referenced in ASOP 53.
If a model is introduced, in addition to Exhibit 19B, the Model Checklist is required to be completed describing the model, its intended use, its development, and the validation process. Be sure to use the most recent Model Checklist published on the CDI website, and complete ASOP disclosures, including:
- ASOP 38 – Catastrophe Modeling.
- ASOP 56 – Modeling.
If there are no changes to the model or how the model is used, then a reference to the Model Checklist in the filing in which it was approved should be included. The Mitigation in Rating Plans and Wildfire Risk Models Questionnaire is also required to be completed. Finally, a copy of the proposed rate and rule manual, underwriting eligibility guidelines, application, and declaration page (if the application and declaration page are changing) are required. When these documents are submitted, they need to be submitted in the approved format with tracked changes from approved (i.e., current) to proposed, as well as a clean version of the final proposed view.
Impact of Regulation 2644.9 on P&C insurers
Many property insurers are concerned that the new regulation has the potential to erode rate adequacy for the long term. We have found that insurers are reacting to this issue in one of three ways:
- Some insurers are complying by adding discounts based on assumptions, since they do not have adequate data. They acknowledge that they will reduce their average rate level in the short term and expect to file a rate increase as soon as they determine which policies qualify for each discount. The rate level will decline over the next year as the discounts are implemented on new and renewal business, or as policyholders notify the insurer that mitigation steps have been implemented. Property rate filings are, on average, taking over a year to receive approval from the CDI, so it is likely to take over a year to receive approval for a rate increase to offset the new discounts, and then another year to implement the rate increase on existing policies as they renew. These insurers are acknowledging the expected erosion of revenue, profit, and adequate rate level over the next two years.
- Some insurers are complying by withdrawing their wildfire rates from the rate plan, so they are no longer differentiating premium based on wildfire risk. This means they are going to charge the same rate for every policyholder in the state with respect to wildfire risk. These insurers are likely to restrict their underwriting eligibility requirements to only include properties with low wildfire risk. In those scenarios, it is expected that the current base rates will be adequate to cover the nominal amount of wildfire risk. For those insurers that do not have underwriting eligibility requirements that only accept properties with low wildfire risk, the average rate corresponding to wildfire losses will be very expensive for everyone, even though a very small percentage of the population will be driving the risk.
- Some insurers are not planning to comply with the new regulation at all. Rather, they are withdrawing from California entirely and will no longer write property insurance in the state. This will make it even more difficult for residents to purchase homeowners insurance, which is already a major issue in California today.
Next steps for insurers
Regulation 2644.9 allows policyholders to be charged rates based on the wildfire mitigation measures they implement. This allows policyholders who take appropriate mitigation measures to reduce their wildfire risk and to pay less than their neighbors with similar wildfire risk. In turn it requires insurers to charge more for policyholders that do not implement wildfire mitigation measures unless the insurer chooses not to differentiate its rates on wildfire risk at all. For insurers choosing to not differentiate rate based on wildfire risk, policyholders with little to no wildfire risk will pay more on average than their risk justifies in order to cover the cost of the policies exposed to greater wildfire risk.
Many insurers believe that not being able to offset base rates for new discounts introduced, coupled with the extended period it takes to receive rate increases in California, will erode the already inadequate rate levels for wildfire risk in California and exacerbate the state’s insurability crisis. In addition to the further erosion of their rate adequacy, many insurers will also be saddled with an expensive information technology project to integrate the consumer notifications and appeal process to comply with Regulation 2644.9, further increasing expenses, despite the lower expected premium volume.
An actuarial consulting firm may be able to help you comply with the new regulation and evaluate options in the California P&C market.
2 CDI (February 3, 2023). Bulletin 2023-2: Prior Approval Rate Application Requirements to Comply With Title 10 of the California Code of Regulations, Section 2644.9(d). Retrieved April 6, 2023, from http://www.insurance.ca.gov/0250-insurers/0300-insurers/0200-bulletins/bulletin-notices-commiss-opinion/upload/Bulletin-2023-2.pdf.
3 CDI Rate Template Instructions, Exhibit 9, as detailed at http://www.insurance.ca.gov/0250-insurers/0800-rate-filings/0200-prior-approval-factors/upload/PriorAppRateFilingInstr_Ed01-03-2023.pdf.