California’s Homeowners’ Insurance Market Is Broken; Here’s How to Repair It

California Insurance Commissioner Ricardo Lara recently stated that “we are in a statewide insurance crisis, affecting millions of Californians.”

In the last few years, major insurance companies like State Farm General have restricted new business in California and have failed to renew thousands of their previous policies. Without the ability to obtain traditional homeowners’ insurance, many California homeowners have obtained coverage through the FAIR Plan, the state’s “insurer of last resort.” This has placed the plan on the brink of financial insolvency and has already necessitated a $1 billion bailout for the plan following the Los Angeles wildfires.

Insurance companies have pulled out of California because the state’s regulatory system renders insurance rates inadequate relative to the risk that insurers are exposed to. Under California’s Proposition 103, insurance rates are subject to a “prior approval system” in which rates must be approved by an elected insurance commissioner prior to their use.

This system restricts which variables are allowed to be incorporated into insurance rates and compounds the inadequacy of insurance rates through regulatory lag and the fact that it takes months for insurance rates to be approved. Some of the practices that California regulations have historically prohibited—such as the utilization of forward-looking catastrophe models and factoring reinsurance costs into rates—are critical in disaster-prone states like California. Proposition 103 also effectively limits rate increases to 6.9% at a time, the maximum permitted increase without a hearing.

The difference between “actuarially sound” rates—which are priced in accordance with risk—and rates that are approved by regulators is called regulatory rate suppression. Research by the International Center for Law & Economics reveals that for both home and auto insurance, California has the worst regulatory rate suppression in the nation. Despite the fact that California is a high-risk, disaster-prone, and expensive state, the average annual cost of homeowners’ insurance is nearly $700 less than the national average.

The impact of California’s dysfunctional regulatory framework has been exacerbated by increasingly devastating wildfires, which magnify the risk that insurance companies are exposed to. The total acreage burned by wildfires in California between 2014 and 2023 was nearly double that of the decade prior. Moreover, while the overall number of wildfires has decreased, the average number of acres burned per wildfire has increased significantly.

When you have a system in which insurers are prevented from setting actuarially sound rates, incorporating all relevant variables into their rate calculations, and are forced to wait months to raise their rates—often only by 6.9 percent—it is no wonder that rates have become disconnected from reality, causing insurers to flee.

California needs to repeal Proposition 103 and should return to the “open competition” model it had before the law was enacted. Doing so would make it feasible for insurers to remain in the state by permitting them to set rates that accurately reflect risk.

A free and robust insurance market also benefits consumers by encouraging competition—if one insurer overcharges a customer relative to their actuarial risk, competitors can undercut them to gain market share.

Due to the fact that Proposition 103 cannot be amended by the Legislature except to “further its purposes,” voters must advocate for the proposition’s repeal through a ballot initiative.

California is in desperate need of insurance reform. On July 1st, academics, experts, and industry leaders will gather in Sacramento for a free public event to discuss the root causes and potential solutions to the state’s growing insurance crisis.

While the event won’t solve the problem overnight, it is only through public awareness of the devastating effects of Proposition 103 that California has any hope of enacting meaningful reform.