An insurance emergency
after officials let crisis fester
Horrific wildfires in Los Angeles have focused attention on California’s ongoing insurance troubles, but because of the state’s inaction its insurance industry is facing an “existential crisis,” as a recent New York Post headline put it. The Wall Street Journal quotes a California insurance agent who notes, “We are in uncharted territory.” It may be uncharted, but officials have long known where this path would lead. They’ve had a detailed map for avoiding this territory, but chose to ignore it.
“Saddled with heavy losses and stifled by a government-controlled system, insurance firms are pulling out of the state or reducing their underwriting,” I wrote for City Journal in 2023 in a piece appropriately called, “California’s Coming Insurance Crisis.” Insurance companies had been waving the warning flags for years, but to no avail.
Even as top insurers stopped writing new property insurance policies or exited the state altogether, the governor and Legislature failed to make the issue a priority.
It’s taken far too long for the Insurance Commissioner Ricardo Lara to implement some modest, albeit sensible reforms. They are useful, as they finally allow insurance companies to use catastrophe models in setting rates rather than relying entirely on past claims. Our officials blame climate change for virtually every problem, yet had refused to let insurance companies price their policies based on information about increasing heat and drought risks likely caused by a warming climate.
The reforms also finally allow insurers to account for rising rates for reinsurance – the insurance policies that insurance companies buy to protect their capital reserves and allow them to write more policies. The department also has worked to speed up the rate-review process, which can take months or even years for insurers to get the OK to adjust rates to reflect market conditions. In exchange, insurers agree to write more policies in fire-prone areas. It may be too little, too late.
The problem is more fundamental. Insurance companies are in the business of writing insurance policies. When those companies are pulling back from or out of a market that suggests an underlying regulatory problem. In California, the problem centers on our prior-approval insurance system (shared by 12 other states). At a time of rising rates, in 1988 voters approved Proposition 103.
It turned the insurance commissioner into an elected position, rolled back property and auto insurance rates by 20%. It created a Byzantine process by which the commissioner must approve rate changes. It’s a system of price controls. Government officials employ a variety of formulas to determine the “reasonable” profits that an insurer can earn. The initiative created a process whereby “intervenors” are paid to essentially oppose rate hikes.
As the Department of Insurance explains, “Proposition 103 authorized a process for the public participation in the administrative process for setting insurance rates. ‘Intervenors’ who participate in rate filings are allowed to recover costs, expenses, and attorney’s fees from insurers, which under law can be passed on to all consumers.” As elected officials, insurance commissioners have a built-in incentive to oppose rate hikes, which aren’t great for political careers.
In one instance, the state’s largest insurer, State Farm, proposed raising rates 6.9% but the commissioner instead ordered the firm to lower rates by 7% and provide $100 million in retroactive rebates to consumers. Years later, the company won its lawsuit, but you can quickly understand why insurers quietly reduce their presence in the state rather than deal with this process – especially after a series of costly wildfires required massive payouts and losses.
“Fires in 2017 and 2018 wiped out a full quarter-century of profits for insurers, leading many carriers to reduce the number of homeowners they covered,” reported The New York Times. “In response, California officials temporarily blocked insurers from dropping homeowners in areas hit by wildfires.”
Lara just announced a similar moratorium, by blocking insurers from dropping homeowners in the affected Los Angeles fires for a year. Whatever relief that may provide individual homeowners, it will only exacerbate the problem. Because of the state’s regulatory system and price controls, insurance companies fear that their rates can’t cover their exposure. Forcing them to offer policies in fire-prone areas will cause them to leave as soon as they can.
Lawmakers have long recognized that the problem involves increasing competition, but not enough to do anything substantive about it.
Recently, Gov. Gavin Newsom announced special legislative efforts to protect California from the incoming Trump administration. Last year, he held an emergency session to deal with supposed oil-company price gouging – a pointless act of performative politics given we all know the cause of our high gas prices (state gas taxes, special fuels formulation and efforts to shutter the fossil-fuels industry).
So Newsom obviously has some tools at his disposal to deal with a true crisis, but has refused to use his political capital to use them. As the Pacific Research Institute’s 2021 book “Saving California” explained, the governor could use his emergency powers to step up forest-clearing efforts and divert funds from the floundering high-speed rail project to projects that will reduce wildfire risk.
It’s a matter of misbegotten priorities. True insurance reform would require another ballot measure, but lawmakers could make improvements within the Prop. 103 straitjacket.
The latest insurance reforms have shown some sign of helping as a couple of insurers announced their willingness to start writing more policies, but throw this unprecedented fire disaster into the mix and all bets are off. To make matters worse, the state-created, industry-funded Fair Access to Insurance Requirements (FAIR) Plan could be on the brink of insolvency as this bare-bones insurer of last resort is dealing with an influx of policy holders and claims.
Insurance isn’t an exciting topic, but it provides the backbone to homeownership and our economy. State officials have long known that a massive disaster could pose an existential crisis. Instead of taking the matter seriously, they’ve continued to focus on their usual progressive policy nostrums allowing true crises to fester. We are indeed heading into dangerous, uncharted territory. Sadly, it seems unlikely that they have the fortitude to lead us out of it.
Steven Greenhut is director of the Pacific Research Institute’s Free Cities Center.
