California’s Insurance Conundrum: How Overregulation Led to Crisis
A California judge recently approved a 17% emergency rate hike for State Farm, marking the state’s first-ever emergency rate increase. This decision comes on the heels of devastating wildfires that ravaged two Los Angeles communities in January 2025. The move might be a step in the right direction for the state’s beleaguered insurance industry.
California has long been known for its stringent regulations and challenging business environment, with the insurance industry being no exception. The state received a D+ grade in the R Street Institute’s 2024 Insurance Regulation Report Card, ranking 44th among states. It particularly struggled in the Underwriting Freedom category, where it placed last.
The roots of this problem date back to 1979 when the California Supreme Court ruled in Royal Globe Insurance Co. v. Superior Court that individuals injured due to negligence could sue not only the at-fault party but also their insurance company. This led to a surge in auto liability claims and, subsequently, higher auto insurance premiums. In response, voters narrowly passed Proposition 103 in 1988, mandating a 20% rate cut and requiring insurance companies to obtain approval for future rate increases.
While intended to control costs, this measure has had unintended consequences. Recent years have seen significant losses due to wildfires and rising residential construction costs. However, the state has prevented insurance rates from rising to reflect actual risks. This has prompted major insurers like State Farm, Allstate, and USAA to limit or stop writing new policies in California. Many residents have had to turn to the California Fair Access to Insurance Requirements (FAIR) Plan, an insurer of last resort that offers less coverage at higher premiums. The FAIR Plan is now facing financial strain.
Bureaucratic inefficiency has also played a role. The average approval time for homeowners insurance filings has ballooned from just over 100 days in 2012 to about a year in 2023. This delay distorts prices and creates perverse incentives in the insurance market.
Interestingly, despite California’s high cost of living, homeowners insurance rates in the state are actually below the national average. This suggests that rates have been artificially suppressed. To address affordability concerns, California should consider removing laws and regulations that restrict housing supply and drive up prices, such as restrictive zoning laws and excessive environmental regulations.
For insurance markets to function properly, insurers need the freedom to set their own prices based on accurate actuarial data. California must eliminate rate approval requirements and consider repealing Proposition 103. Restoring a free and competitive market would give insurers the confidence to write policies again, and price signals would more accurately reflect risk.
While no one enjoys paying higher insurance premiums, many Californians are coming to realize that a functional insurance system, even with higher prices, is preferable to a broken one. As the state navigates this complex issue, finding a balance between regulation and market freedom will be crucial to restoring a healthy insurance market.
