Researchers Highlight “Winner’s Curse” in California’s Insurance Crisis
Homeowners across California and the nation are grappling with escalating property insurance costs. In areas susceptible to disasters, such as wildfires, insurance options are becoming limited as insurers either significantly raise premiums or withdraw from high-risk markets. While climate change is a key factor, recent data suggests that rate increases are not always directly tied to the severity of climate-related risks. In California, lawmakers are pushing to reform regulations that weren’t designed for the current climate challenges.
“All of a sudden, regulators are finding themselves on the front lines of climate change, and that creates real challenges in rethinking how we’re regulating these property insurance markets,” said Meredith Fowlie, a professor of agricultural and resource economics at UC Berkeley.
Fowlie is the co-author of new research that delves into the connection between wildfire risk and insurance prices in California. The study, published as a National Bureau of Economic Research working paper, also includes Judson Boomhower of UC San Diego, Jacob Gellman of the University of Alaska Anchorage, and Andrew J. Plantinga of UC Santa Barbara.
The Homeowners Insurance Crisis in California
Fowlie explains that reduced affordability and availability are the primary issues in the California homeowners’ insurance market. This trend isn’t unique to the state; premiums across the U.S. have increased by over 20% in the last year. Major insurers are putting a pause on new policies in certain areas or exiting the market entirely, which leaves homeowners with limited options. Moreover, enrollment in last-resort programs, like California’s FAIR Plan, is rising, indicating that more people are turning to these options.
“To call this a crisis may sound alarmist, but I think it’s appropriate given the important role that homeowner’s insurance plays in our economy,” said Fowlie. “If you’re a homeowner, you need homeowner’s insurance to qualify for a mortgage and hold on to your mortgage — so when prices are rising fast, homeowners have no choice but to pay them.”
She emphasizes the critical role of property insurance in climate change adaptation and the need for a well-functioning homeowners insurance market to help households manage climate risks and recover from disasters. The research highlights the potential destabilizing effects of current price and availability issues for the state and the country.
Factors Behind Price Spikes and Limited Availability
Insurers are facing rising costs nationwide, with claims exceeding premiums. While climate risk is a significant factor, other elements are impacting the insurance market. These include increased construction costs, non-catastrophe losses, and liability claims. California’s regulations on how quickly insurers can raise rates also play a role, according to Fowlie. She suggests that while these regulations are important for ensuring fair and affordable pricing, a balance must be struck to allow insurers to adjust rates to reflect their costs.
The “Winner’s Curse” and Its Impact
The research investigated how insurance premiums relate to wildfire risk, focusing on the data insurers use to price this risk. The study revealed significant variation between insurers in how they price risk. Some use broad levels, such as ZIP codes, whereas others use more granular data. Economists like Fowlie are examining how these information differences impact competition, particularly the “winner’s curse.”
The winner’s curse describes a scenario where a company offering insurance with less-detailed risk information may only attract high-risk clients that other companies are less interested in. To account for this, the company might raise prices, which puts upward pressure on premiums in high-risk areas. A consequence of it is reduced availability: if a company wants to raise prices but is limited by regulations, it might withdraw from high-risk segments. This effect can be compounded by regulatory limits on rate increases without a public hearing.
Potential Regulatory Reforms and Their Impact
Lawmakers are considering regulatory reforms, including streamlining the rate approval process and insurers’ ability to use catastrophe modeling. According to Fowlie, improving access to more granular and sophisticated wildfire risk estimates can improve insurance availability and affordability by helping to signal risk more accurately.
“Overall, the more reliable information we can bring to insurance pricing and underwriting, the better — especially in terms of signaling where the risk is high and where the risk is more manageable,” argued Fowlie.
Fowlie notes that regulatory reforms must balance insurer needs with the need to make insurance available and affordable. A comprehensive approach involves addressing the “soft costs” associated with using catastrophe models, such as licensing fees, staffing expertise, and regulatory compliance.
Advice for Homeowners
Fowlie is optimistic that regulatory reforms will lead to improvements in insurance availability. However, she also acknowledges that as the climate changes, premiums will likely rise to reflect the increasing risks. Addressing these issues will require creative solutions for policymakers to navigate the balance between affordability and availability, especially for lower-income households.
