California’s Insurance Woes: A Regulatory Crisis
The recent surge in California’s home insurance crisis is often attributed to climate change, but the real issue lies in the state’s regulatory climate. The insurance market has been transformed into a command economy where insurers are increasingly reluctant to operate due to voter-approved regulations that limit their ability to raise rates.
In 1988, Californians passed Proposition 103, which mandated insurance rate reductions of at least 20% unless it would lead to company insolvency. While the California Supreme Court later allowed for “a fair rate of return,” the political pressure to keep premiums low remains strong. As a result, insurers face extended hearings and government reviews before they can adjust rates to reflect growing wildfire risks.
The consequences are clear: insurers are limiting coverage and leaving the state. Even Insurance Commissioner Ricardo Lara acknowledges that “insurers don’t have to be here, and when we try to overregulate, we’ll see what happened after the Northridge earthquake, when the legislature came in and tried to overregulate, and they no longer write earthquake insurance in California.”
To address this crisis, California needs regulatory reform. The root cause lies in a combination of destructive wildfires and an inefficient regulatory framework. A functioning insurance market requires the ability to hedge against low-probability events by spreading costs across a pool of premium-paying individuals, sorted by risk classes.
California’s interference in the market through rate regulation and prohibition on using forward-looking ‘catastrophe models’ has compounded insurers’ exposure. While the state has recently allowed catastrophe modeling, the prior-approval process still hinders efficient pricing. To fix this, Proposition 103 needs to be repealed, allowing insurance companies to freely adjust prices according to market conditions and risk assessments.
Better land management is also crucial. Cal Fire and other agencies must shift focus from fire suppression to prevention through forest thinning and prescribed burns. A well-functioning insurance market would incentivize home hardening and fire mitigation practices, discouraging construction in high-risk areas without proper precautions.
Moreover, regulatory restrictions on housing development push settlement into higher-risk wildland-urban interface areas. Reforming zoning laws, permitting processes, and urban growth boundaries is essential to alleviate this pressure.
While climate change and risks will continue to evolve, insurance markets can adapt if allowed to do so. For Californians to have viable insurance options for their wildfire problems, they must undo the damaging policy choices that created this crisis.
