If the only price insurers are allowed to charge is a price that is almost guaranteed to lose money, there’s no point in issuing the policy in the first ...
In the Morning Jolt yesterday, Jim Geraghty laid out several policy decisions California authorities have made that have exacerbated the damage caused by wildfires. As he wrote, there’s obviously nothing government can do to prevent them entirely, but policy decisions can make them more or less damaging, and California’s decisions have been criticized for years leading up to the past week’s devastation.
Another California policy decision will make recovery efforts from these fires more difficult than they otherwise would be: price controls on insurance.
Insurance price is supposed to be correlated with risk. Higher risk, higher price. Living in an area prone to wildfires is a risk for property insurance. Rather than allowing market prices to take account of that risk, California has heavily regulated the insurance industry for decades.
Proposition 103 is responsible for a lot of California’s insurance regulatory regime. Lars Powell, R. J. Lehmann, and Ian Adams wrote a paper about Prop 103 for the International Center for Law and Economics (ICLE) in 2023. They trace the proposition’s origins to a 1979 California supreme court case that allowed third parties to bring legal action against insurance companies. That decision was a bonanza for trial lawyers, and the proliferation of lawsuits against California insurance companies forced them to raise rates significantly in the 1980s.
The rate hikes were unpopular and voters approved Prop 103 in 1988 by a 51–49 margin. Prop 103 forced an immediate 20 percent rate cut for car and property insurance sold in California, gave the state government power to approve or deny future rate increases, and gave public-interest groups the right to intervene when insurers request rate increases. The regulatory power would be held by the state insurance commissioner, which Prop 103 turned into an elected office.
Perhaps the craziest part of Prop 103 is that it included a provision that makes it extremely hard to amend. Any change to Prop 103 must be approved by a two-thirds majority in both houses of the California Legislature and must “further its purposes,” which is subject to judicial review. “Much has changed in the world, and in California’s insurance industry, since the passage of Prop 103, but the lion’s share of the law remains as it was in 1988,” the ICLE paper says.
One of those things that has improved since 1988 is statistical modeling of wildfire risk. Because that technology basically did not exist in 1988, it is not included in California’s insurance regulatory regime. California’s insurance authorities have in the past few years begun to incorporate some aspects of wildfire catastrophe modeling, but it is still not allowed to be used as justification for rate-hike requests. “This has essentially meant that California—a state that has long prided itself as being on the leading edge when it comes to its response to climate change—is effectively telling insurers to ignore the science,” the paper says.
After decades of strict price controls, the average price of insurance in California is well below the market rate. California’s rate suppression, the difference between the fair actuarial rate and the rate allowed by regulators, is 29 percent for homeowners insurance, the highest of any state. As economist Brian Albrecht put it, California “forces the biggest gap between rates and risk in the nation.”
“Oh, those greedy insurance companies are made of money, they can eat the losses,” some might think. The ICLE paper shows that from 1991 to 2016, California homeowners insurers made total cumulative profits of $10.2 billion. But in 2017 and 2018, they lost a total of $20 billion from wildfires. If an entire industry can lose twice as much money in two years as it made in total the 25 years prior, that’s not going to be sustainable.
Progressive outlet American Prospect published an article in October about alleged insurance-company profiteering off natural disasters. It gave an example of a homeowner near Eaton Canyon in California whose insurance price went up for fire risk and suggested that this was unfair because “Eaton Canyon last had a wildfire three decades ago.” Eaton Canyon has been on fire since January 7. Insurance companies are far from perfect, but they do know some stuff about risk.
Many homeowners insurance companies have left the California market. They have refused to issue new policies and refused to renew existing ones. If the only price they are allowed to charge is a price that is almost guaranteed to lose money, there’s no point in issuing the policy in the first place.
The California government has responded to this government-created problem by creating a government-mandated insurer of last resort, called the Fair Access to Insurance Requirements (FAIR) plan. If homeowners can’t get insurance on the private market, they can get it through the FAIR plan. Unsurprisingly, FAIR coverage is high in wildfire-prone areas.
The San Francisco Chronicle estimates that FAIR could be on the hook for $24 billion worth of property after these wildfires. FAIR is not publicly funded, but if it lacks the money to pay claims — which it almost certainly will after these fires — the state compels private insurance companies to pay for it, which will force higher costs on the rest of their customers and give them yet another reason to get out of the California insurance market.
In an extremely narrow sense, one could frame Prop 103 as a win for insurance customers. They are, in most cases, paying less than they would be without the regulations. But by destroying the signals that prices are supposed to convey, especially the price signals about wildfire risk, it has placed more property in harm’s way than would otherwise be the case. And it has left many homeowners in California with few or no options for insurance outside the FAIR plan, which will likely be financially ruined by the ongoing wildfires. California regulations have turned homeowners insurance, which is supposed to be an aid to people who experience a natural disaster, into a decades-long economic disaster.