A Conversation With Paul Brown
What does assigning a wildfire risk score to a home really mean? How can homeowners understand the implications of these scores and know when to challenge them? After all, if policyholders can show they’ve implemented mitigation techniques, they are entitled to discounts per new legislation from the California Department of Insurance.
In Part 2 of this episode, host Maiclaire Bolton Smith continues the conversation with CoreLogic’s director of Insurance Market Strategy for Hazard and Risk Management about how insurers will need to access big data to effectively translate homeowner wildfire mitigation efforts into insurance discounts.
In This Episode:
1:21 – what exactly is the difference between a risk score and a CAT model?
3:15 – A brief primer on rate filings
3:41 – How do homeowners benefit from wildfire risk scores in their policies?
8:46 – What is the cost of providing transparency to homeowners?
9:43 – How can we be more resilient to natural hazards?
We cannot go on increasing, just increasing the insurance payouts year after year. And so we have to start bringing those down.
Welcome back to Part 2 of our miniseries on wildfire regulations in California. If you missed Part 1, I do recommend going back and catching up on last week’s episode.
To recap, we introduced our guest, Paul Brown, and talked about how California became the first state to require insurers to offer discounts to property owners who implement wildfire safety and mitigation measures.
This week we’re going to find out how risk scores and CAT models help insurers provide policies to homeowners. Here’s Maiclaire and Paul.
Maiclaire Bolton Smith:
Okay. I want to jump into a couple of things that you just said there.
So one thing you mentioned, and I think there’s a couple of important clarifications that I want to make sure our listeners understand, is you did mention CAT models, catastrophe models, and the CDI doesn’t allow the use of CAT models for rate making. And then you started talking about risk scores.
So I want to talk a little bit about how those two things are different. What a CAT model is versus a risk score, I think that’s important. And then I want to talk a little bit more about the risk score as well too. But can you first just talk a little bit about what’s different between a CAT model and a risk score?
Yeah, sure. So historically, CAT models have been used to assess and to manage portfolios of risks. So many, many risks over a whole range of locations at portfolio-level to assess what ultimately is the chance that they will suffer from a large loss. And what the return period will that be, and what the size of that loss. So the severity and the frequency, including factors such as hazards, the individual vulnerabilities of each property. And so it combines all of those into a larger rent set. Typically, that’s how CAT models originated, and how they’ve been used. They do produce, as I mentioned earlier, a great or an annual average loss for each property as well. And now in other territories other than California. And interestingly, for earthquake in California, it is allowed. They are allowed to use CAT models. But for wildfire and other perils, they’re not.
They cannot bring those through and use them within a rate filing. Wildfire risk score, or a risk score more generally, is more centered on what is the hazard that’s associated with a particular location and a property that’s sitting in a location. So, we take the hazard part of what goes into a CAT model, and when we look and give that a score — In our case, from naught to 100 — to give a relativity as to how high a hazard that particular location would be subject to.
And so that is a much, because CAT models can take some time to run, a risk score is an easier way for an underwriter to judge what the hazard is at a particular location.
To clarify what a rate filing is, first we need to define “rate,” which is essentially the price for insurance. A rate filing is an application filed with the government to modify these charges. In the state of California, the law requires the California Department of Insurance, or the CDI, to review those changes and publish them on its website to protect consumers and promote transparency.
So when we think of these scores, these zero to 100 type scores, I know that the California Insurance Commissioner Ricardo Lara has said that they will enforce that companies need to require the wildfire risk score to their policyholders.
So in theory, when somebody gets their home policy, it will say you have a wildfire risk score of 47, or 97, or just depending on what your wildfire risk score is. That’s going to provide a lot of transparency to both insurers who see this but to homeowners in particular.
So I want to talk a little bit about, knowing your wildfire risk score is not just important for getting insurance discounts. I mean, from a homeowner’s perspective, that is important. But why should a homeowner know their risk score and then take steps to harden their home? Can you talk a little bit about why this transparency is really going to benefit homeowners?
Yeah, it’s a good, good point. So yeah, as you mentioned, openness and transparency is one of the key aims for the CDI within this. And as a part of that, I think the dangling of a carrot to consumers, they want to use that openness and transparency to get that risk mitigation up and running. So let’s do that cost-benefit analysis, let’s see how we could get consumers to do it.
As a part of that, the openness and transparency is all a part of building that confidence in the consumer, that the insurer will give some benefit to the policyholders should they undertake some of the mitigation factors and improve the resiliency of their property. So, I think it’s important, it is important from a consumer perspective, for them to understand that this is the premium that I might be paying, which is a part of that openness and transparency, if I were to undertake all of this work.
And the IBHS actually have done some studies around that cost-benefit analysis.
In terms of, how much does a certain mitigation cost, and what is the likely reduction in claims cost? Now, okay, we need to get that claims cost reduction, has to be replicated in terms of a premium reduction, which is some of the difficulty with the data that we have. But certainly on the face of it, there are some studies that show that there are real benefits to the consumer. Certainly just in premium, but there are other benefits as well.
So, the ability for the consumer to see this risk score, and interestingly have the ability to challenge that risk score, which is the other part of the regulation. So the consumer can, if they haven’t already verified with the insurer at the time of underwriting, which I think many insurers will end up doing, they can say to an insurer, “Look you’ve said, I don’t have this mitigation factor. But look, I do actually have that.”
So they can challenge that. They could also challenge some of the hazard aspects, although I think it’s harder for a consumer to really dig in and challenge some of that scientific expertise without some sort of help. And that’s one of the challenges of opening up the wildfire risk score assessment by an insurer is, how can an insurer, and you try to put yourself in the position of not being in the position we are in, of knowing all of this stuff.
But as an insurer to say, well, this is your one in 100-year loss. And what does that really mean to most consumers? We hear one in 100 years, one in 200 years with events being bandied around all over the place. And suddenly we have three or four 100-year events in five years, and it doesn’t make any sense.
Unless you really understand what is going into those numbers. And so that’s one of the challenges that both we and our clients will have, is how do we make that as simple as possible for consumers to understand? So that if they think they can challenge it, then they will do.
So what really goes into those numbers anyway? For that answer, we’re going to look to the United States Geological Survey, or the USGS, which says, “The recurrence interval is based on the probability that the given event will be equaled or exceeded in any given year.” Basically, that means that if someone says that a wildfire is a 100-year event, what they’re really saying is that over the course of 12 months, there is a 1% chance that such a wildfire catastrophe would occur.
If you were unlucky enough to live through a 500-year event, you just experienced a wildfire that had a 0.2% chance of occurring within 12 months. However, just because a 100-year event occurred one day this year doesn’t mean that it can’t happen again tomorrow.
So yeah, there’s a lot of stuff going in there. And that’s going to be difficult. But also, I think it’s also difficult because the granularity, you’re talking about the data quality as well. And we could end up with a lot of risk, a lot of challenges to the risk score.
Which could end up being a fairly high administrative burden. Which, ultimately, the insurer will have to bear as a cost, and ultimately would come back on the policyholder at some point when all costs have to be paid for by the policyholder if you want a stable market.
So ultimately, I think we all, including the regulator, want to make sure that the data that’s going into those do not result in an undue number or frequency of challenges.
The one thing I do want to finish with today is: resilience is such an important topic when we’re talking about natural hazards. I know that California may be the first to do these regulations, but we’re just seeing the start of it, I’m sure, across the country and maybe even around the world as well too.
Can you just talk a little bit about the U.S. Department of the Interior announced $180 million investment in wildfire mitigation and resilience. So, why is this such an important thing when combating natural hazards? Specifically wildfire right now, but why is mitigation so important to resilience in the big picture?
Good question. While we’re not unreasonably, in our industry, focused on the insurance industry, I think there is a bigger and a wider picture here. And that’s one of the reasons why this regulation has come in, is that the events and the losses that have happened go wider than insurance. And so, as far as … Insurance can only cover so much. An insurance policy will cover the financial loss of the building, and the replacement of that, and some additional living expenses.
But it doesn’t cover the hassle. It doesn’t cover the pain, suffering, loss of life, health, loved ones, people dying. And so nobody wants to be living for 12, 24 months in an alternative home while they decide if or they want to rebuild their home in a place that’s just suffered devastating wildfires.
And so as a part of that, we can’t go on. And if we look back at the trend of wildfires, both acres burned and insured losses, they’re quite clearly both in California, and for the U.S. on a much wider survey basis, are continuing to increase. Which is unsustainable.
We cannot go on just increasing the insurance payouts year after year. And so we have to start bringing those down. We have to make sure that fires are not unduly suppressed so that we don’t build up large fuel loads, as we have done over the years, and then decide to build our properties and assets right in the middle or on the edge of those. And that’s where we get the meeting of natural hazards and physical assets.
Yeah. Wow. So interesting. Paul. Thank you so much for joining me today on Core Conversations: A CoreLogic Podcast. It was so great to chat with you.
Thank you very much. It’s been great talking to you, Maiclaire.
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