California is dangerous for insurers, but not due to fires and floods

California's insurance market is in shambles. The storms and floods that battered the state early this year, causing between $500 million and $1.5 billion in insured losses, were just the latest shock to Californians and insurers alike. Major insurance companies are now throwing in the towel––leaving the state because doing business there has been a money loser.

The Golden State is inherently a tough place for insurers to do business because natural disasters are common. California experiences more natural disasters––wildfires, atmospheric river flooding, earthquakes, drought and mudslides––than any other state. Yet this isn't what has spooked insurers. The problems stem from egregious mismanagement and regulatory failure at California's Department of Insurance. While such bureaucratic inefficiencies are commonplace, their effects are wrecking the insurance industry in the state.

For some time now, the insurance industry has been adopting an icier stance towards California. High net worth insurers, which focus on insuring homes valued at over $1 million, are cooling on the state. AIG's Private Client Group announced its decision to stop writing business there in 2021 and in 2022 Chubb, the "world's largest publicly traded property and casualty insurance company", announced it was limiting its California footprint.

Likewise, California auto insurance has also been a losing proposition for insurers. Car accident frequency has increased, but some insurance companies are paying out more in claims and expenses than they are collecting in premiums. Data from the American Property Casualty Insurance Association backs up this claim: Car insurance losses increased by 25 percent from 2020 to 2021, while premiums rose by only 4.5 percent. Auto insurers are challenged by these poor results and may call it quits.

Another indicator of a sickly insurance market is the growth of California's FAIR (Fair Access to Insurance Requirements) Plan. This is a last resort for homeowners who are turned away by private market insurers. And Californians are definitely using it; policies have increased by 240 percent since 2017. Such strong growth in the FAIR Plan is a sure sign that the private market is dysfunctional.

The root of the problem isn't that California is a dangerous place. It's how the state's insurance department approves – or, more commonly, doesn't approve – changes to insurance premiums and rates.

Insurance companies calculate policy rates by analyzing risk. They determine what premiums to charge for losses and expenses in a process known as ratemaking. In some states, California being one, insurers must seek approval from the state insurance department before getting permission to change their prices. In some lines of business, such as workers' compensation, there have been rate decreases in recent years thanks to lower-risk work from home conditions and improved work safety.

In other lines of business, however, the risk has risen, and insurers have sought rate increases. The reasons for higher car insurance rates include higher cost of vehicle repair and replacement and higher accident frequency. Insurers also say that property insurance rates should go up because of more frequent natural disasters.

As the situation has worsened, California Insurance Commissioner Ricardo Lara has been unwilling to grant approval to insurers to increase rates for several years. As a result, insurers who choose to do business in California have been forced to sell insurance at below-market rates, guaranteeing they will lose money. Insurers seeking to charge appropriate risk-adjusted rates are hamstrung by the 1998 passage of Proposition 103, which requires the California Department of Insurance to approve rate changes.

In recent months, perhaps driven by the threat of more insurers leaving the state, the department finally relented and approved some rate increases. In October 2022, after blocking them for two years, California regulators allowed Allstate Northbrook Indemnity Co. to increase auto rates by 6.9 percent, the maximum allowable.

Much of this mess could be avoided if California had a commissioner who cared more about overseeing the state's $300 billion insurance industry rather than politics. Indeed, Lara's failure to take action to prevent insurers from leaving the state, combined with what the Los Angeles Times called "ethical lapses" in its recent endorsement for Lara in his election to remain commissioner, further diminished confidence in his ability to stabilize the fragile California market.

Californians are already suffering enough from a surfeit of extreme weather events. What they need now is a commissioner who understands the importance of a more market-oriented environment – and legislative reforms that give consumers choice and encourages insurers not to pull up stakes.

Jerry Theodorou is the R Street Institute's policy director, Finance, Insurance and Trade. Write to him at jtheodorou@rstreet.org.