California’s insurance market could go up in smoke after the devastating fires that ravaged Los Angeles. State regulators must step in quickly with targeted and effective reforms to prevent it from collapsing and making homeownership riskier, driving rents higher and halting new construction.
Insurance regulators are at a critical juncture: Rebuild and replace homes on the same high-risk land with no insurers left to help or re-envision how we allow insurers and homeowners in tandem to thrive.
Insurance operates on a simple model — the higher the risk, the higher the premium. For homeowners, the more likely a home is to be destroyed, the higher the price of insurance should be.
Wildfire risk has been rising across California over the last decade, but Proposition 103, approved by voters in 1988, has not allowed insurance prices to rise proportionally — causing insurers to cancel policies or leave the state entirely.
To keep insurers here, we must allow them to set rates fairly, based on risk. Homeowners and builders would rather have an option for insurance, even one with a hefty price tag, than be left with the financial fallout when disaster hits.
Only at the end of last year did Insurance Commissioner Ricardo Lara embrace rules to expand coverage by letting insurers use climate catastrophe modeling and reinsurance costs to more accurately price the risk of their policies.
In the meantime, as homeowners lost their private insurance, hundreds of thousands flocked to California’s state-managed FAIR Plan of last resort or went uninsured entirely. Though it was never intended to be a large-scale insurer, FAIR has taken on hundreds of billions of dollars of risk in the last five years.
According to Victoria Roach, the FAIR Plan’s president, the plan only has $385 million on hand in unreserved funds, a small fraction of the potential incurred losses. But, the Los Angeles fires alone could cost the FAIR Plan $24 billion to compensate property owners for damages.
To cover its losses, the FAIR Plan will charge private insurers a surcharge. Insurers can pass most of those costs along to policyholders. As a result, homeowners across the state, and maybe California taxpayers at large, will be on the hook.
Thus, Proposition 103’s provisions that artificially keep prices low have backfired spectacularly, handcuffing the ability of insurance companies to keep up with growing risks.
Under Lara’s new policies, some homeowners will need to pay substantially more, but most would find that much preferable to the FAIR Plan’s modest coverage — or having no insurance at all.
To be sure, the state will need to help lower-income homeowners afford insurance. Rather than capping insurance rates for lower-income homeowners, which would break the market further, legislators should provide them subsidies to fire-harden their homes and reduce vegetation so their risks — and proportional insurance costs — remain manageable.
Recovering from devastating fires like those in Los Angeles requires making tough choices. Legislators and state regulators must step in to save the home insurance market from the ashes, rebuild communities and increase access to safer locations of the state.
Michael Gunning is chief strategy officer of Lighthouse Public Affairs. Michael Lane is state policy director of SPUR, a public policy think tank in the San Francisco Bay Area. They are co-founders of the California Home Building Alliance, an advocacy organization.