Anger misplaced after L.A. fires

As Los Angeles recovers from one of the worst wildfires in the city's history, many Americans are pointing fingers over who is to blame and what could have prevented the fire.

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 state government, few have been spared from rising anger, especially chronic government mismanagement.

Some of the fiercest anger has been directed toward insurance companies after the revelation that State Farm had chosen not to renew policies in Pacific Palisades in the months leading up to the fires. Celebrities and entertainers have blasted these companies for pure greed.

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. Insurance experts have been sounding the alarm that California's property insurance market is in dire financial straits. Specifically, experts have warned that antiquated regulations are preventing insurance carriers from adjusting rates to reflect the risks of natural disasters. Until last month, a 1988 legislative measure, Proposition 103, prevented insurers from passing the cost of reinsurance — insurance for insurance companies — onto consumers, with any proposed rate increases greater than 7% requiring state regulatory approval. This made California the only state that denied insurers the ability to factor in the cost of reinsurance policies.

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 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.

Illustrating the severity of the situation, State Farm wrote 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. 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.

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% 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% 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 market and helping those affected by the wildfires, they must remove any remaining regulations that hamper insurers' ability to operate freely.

Nate Scherer is a policy analyst with the American Consumer Institute.