As Los Angeles recovers from what was, quite possibly, the worst wildfires in the city’s history, many Americans are pointing fingers over who is to blame for the catastrophe and what could have been done to prevent it.
From criticism of the L.A. mayor’s handling of the crisis and lingering questions over cuts to the city’s fire department budget to accusations of failed leadership at the highest level of California state government, few have been spared from rising public anger over the disaster. Much of this anger is justified — especially concerning chronic government mismanagement. However, that relating to property insurance is not.
Some of the fiercest anger has been directed toward insurance companies after the revelation that State Farm had chosen not to renew policies in communities like Pacific Palisades in the months leading up to the wildfires. Celebrities and entertainers have blasted these companies on social media, accusing them of being driven by “pure greed” and caring only for their bottom line. Others have promised never to do business with them again. Even California’s former insurance commissioner has called on insurance companies to step up and do more. While understandable, this anger is misplaced.
Insurance experts have been sounding the alarm that California’s property insurance market is in dire financial straits for years. Specifically, experts have warned that antiquated regulations are preventing insurance carriers from being able to adequately adjust their rates to reflect the risk associated with natural disasters, resulting in many choosing to stop writing new policies, scale back coverage, or exit the state insurance market entirely.
Until last month, a 1988 legislative measure known as Proposition 103 prevented insurers from passing the cost of reinsurance — insurance for insurance companies — onto consumers, with any proposed rate increases greater than 7 percent requiring state regulatory approval. This made California the only state that denied insurers the ability to factor in the cost of reinsurance policies and the power to reject or delay substantial increases outright.
In addition, insurance companies were required to use the prior year’s averages for fire-related damage when calculating the price of premiums for new policies. Since the risk associated with wildfire damage has been increasing, these estimates are often inadequate, meaning insurance companies consistently lose money in those areas with the greatest risk.
Unsurprisingly, many have been forced to reduce coverage in high-risk areas, so they have the reserves necessary to pay out claims when disaster strikes — something mandated by California law. Companies that have made such difficult decisions include some of California’s largest, like Allstate, Farmers and State Farm, each of which previously announced they would either pause or limit issuing new policies in the state.
Illustrating the severity of the situation, State Farm sent a letter to California’s Insurance Commissioner last year explaining that even with the state’s recent approval of a rate hike, the company would be unable to stabilize its financial position without taking action to reduce its overall exposure. State Farm would later discontinue coverage for 72,000 homes and apartments statewide.
Non-renewals like these have forced many Californians to purchase coverage from California’s state-run Fair Access to Insurance Requirements (FAIR) plan, an insurer of last resort offering basic coverage to residents when coverage isn’t otherwise available. Heavily regulated by the state, FAIR is funded by assessments of private insurers. That means that any strains on FAIR are felt by insurers — and ultimately policyholders — if the plan’s reserves are not big enough to pay out claims. With the number of written policies for FAIR surging by 123 percent over the last three years, and its risk exposure growing statewide to $458 billion by 2024 — including $24 billion in Los Angeles — it is not hard to see how the growing price tag of the wildfire damage could push the plan over the edge. That is a huge problem that is not the fault of insurance companies.
Begrudgingly, California has moved to remedy some of the insurance market’s biggest regulatory woes by finalizing plans to allow insurance companies to use catastrophic modeling to calculate wildfire risk and, more important, pass along the cost of reinsurance to customers. However, there is a catch. Insurance companies must commit to “writing at least 85 percent of their statewide market share in wildfire-distressed underserved areas.”
In other words, these reforms do not come freely to insurance companies that must now expand coverage into the areas that pose the most financial risk. While California’s reforms are still a marked improvement over the status quo, they come late in the insurance crisis and still include dangerous price controls.
The wildfires that swept across Los Angeles were horrific, and people have a right to be angry. However, insurance companies are not the problem. Instead, the terrible regulations undermined their financial health for many years and drove many to make tough decisions. If lawmakers are serious about stabilizing the California insurance market and helping those affected by the wildfires, they must remove any remaining regulations that hamper insurers’ ability to operate freely.
