Homeowners insurance California is headed for an insurance catastrophe

Californians are in the midst of an environmental crisis as the frequency and intensity of wildfires worsen. This year alone has produced an unseasonable January wildfire in Big Sur and a geographically uncommon fire in Laguna Niguel. Though these are outlier incidents, they are increasingly commonplace, leaving many residents of the Golden State scrambling to find homeowners insurance.

A recent report predicts that wildfire risk in California will continue to grow over the next 30 years from a deadly combination of higher temperatures and lower-than-normal rainfall. This leaves homeowners in moderate-to-low-risk communities concerned with protecting life and property for an issue they likely assumed would never affect them. Couple this with a struggling insurance market, and a crisis may be on the horizon.

Officials in California have enacted numerous laws and regulations to provide coverage options for riskier properties and maintain relative affordability, including the implementation of Proposition 103 in 1988 and the creation of the FAIR Plan in 1968. Proposition 103 requires insurers to seek “prior approval” for rate changes from California’s Department of Insurance (DOI). The FAIR Plan offers residents a temporary, last resort for insurance, often at higher prices and with less robust coverage.

If California would like to see a better-functioning insurance market, it should be careful when implementing additional regulations, which have led to insurers fleeing the state. This year alone has seen the departure of American Insurance Group from California and a significant reduction in insurance offerings from Chubb. These are two of the largest insurers in the nation and both cited burdensome regulation in their decisions.

Compounding the problem, California DOI Commissioner Ricardo Lara proposed additional regulations on insurance companies in February, forcing them to make wildfire risk assessment models and tools public — an intellectual property issue. Specifically, the proposed regulation states that risk modeling will be made public regardless of whether the information and methods are “confidential, proprietary, or trade secret.” This requirement would disincentivize insurers from using their most effective tools, leading to market stagnation and reductions in innovation.

Lara’s proposal also lists many “mandatory factors” insurance companies must consider when assessing a property’s wildfire risk, including the property being part of a “Fire Risk Reduction Community.” Insurers have taken issue with this, noting that the designation is new and should not be a required factor for risk assessment when its track record is unproven.

Some lawmakers are attempting to strangle the already struggling market even further. Assembly Bill 1755 mandates that insurance companies provide policies to all homeowners whose properties undergo certain mitigation efforts regardless of any other factors.

Couple ballooning regulation with increasing wildfire risk, and insurance companies’ incentive to provide policies in California is waning dramatically. Wildfire losses cost providers up to $13 billion in 2020 alone — a number that is likely to grow. If insurance companies feel the regulatory squeeze growing tighter, more may decide to depart the state.

To ensure insurance access for its residents, California should primarily focus on wildfire mitigation, and concentrating on prescribed burns is a good starting point. Commissioner Lara sent notice to insurance companies in April suggesting they increase coverage for prescribed burns, which reduce the likelihood and severity of wildfires by methodically burning dried leaves and brush. Data shows these burns are effective at combating wildfire risk, and the method has been used for centuries.

Educating homeowners on their wildfire vulnerability and methods to promote resiliency is also vital. A number of steps — many of which are taken into account when insurers issue policies — reduce the risk of wildfire damage, such as clearing vegetation and trimming trees.

Effective wildfire mitigation is the most attractive solution for both insurers and consumers. Insurance provides homeowners with financial security, and it is their first line of defense when tragedy strikes. The California DOI must focus on increasing insurers’ appetite to operate in the state. This will increase competition and broaden the risk pool, giving more options at a lower cost.

Caroline Melear is a fellow in finance, insurance and trade at the R Street Institute.