A judicial verdict has recently brought a significant victory to State Farm in the form of an unprecedented emergency rate hike for homeowners insurance in California. Far from being perceived as a negative event, in the larger scheme it could be a favorable development. The Golden State is not known for its business friendliness but rather for its daunting regulations and intense business environment, the insurance sector being no exception.
The 2024 Insurance Regulation Report Card by the R Street Institute painted a grim picture of the state’s standing, ranking it 44th among the states with a distressing D+grade. It bagged the final spot in the Underwriting Freedom category—an indication of the regulatory stranglehold that has gripped the state for almost half a century.
Tracing these issues back to their origins brings us to 1979 when the California Supreme Court ruled in Royal Globe Insurance Co. v. Superior Court, allowing a person injured due to negligence to sue both the party at fault and their insurance provider. This naturally led to an explosion in auto liability claims. The subsequent increase in expensive lawsuits and upsurges in settlements drove auto insurance premiums through the roof.
To seemingly rein in the aggrandized auto insurance costs, Californians narrowly achieved the passage of Proposition 103 in 1988 with a thin majority of 51 percent of the vote. The initiative mandated a 20% rate cut and made it compulsory for future rate expansions to get the insurance commissioner’s endorsement. Unfortunately, California is one of the mere six states abiding by this prior approval prerequisite.
However, perils arise when the government intrudes into markets and insists on manipulating pricing. While the intention might have been to minimize damage, the imposition of price controls exacerbated the situation. The state has witnessed a considerable surge in losses in recent years, severely aggravated by extreme wildfires and a steep spike in residential construction costs.
The restrictive regulations have deterred insurance rates from adequately reflecting these escalating actual risks. Consequently, insuring homes in certain areas has become a daunting, if not impossible task, forcing many to take up the less favorable option of the Fair Access to Insurance Requirements (FAIR) Plan—California’s last-ditch insurer.
The FAIR plan, offering less coverage at inflated premiums, is fast plummeting into financial jeopardy as these provisions are not enough to compensate for a statewide emergency. The state’s stalling game in rate increase decisions has added to the chaos, with prolonged wait times for approval of homeowner’s insurance filings.
The time taken for approvals escalated from marginally above 100 days back in 2012 to nearly an entire year in 2023. Suppressing rates and impelling insurers to shoulder more properties in perilous areas is a strategic failure that, ironically, makes California more susceptible to repeated disasters and extensive losses.
A baffling fact might be that homeowners’ insurance rates in California are still lower than the national average. With the cost living in California being notoriously high, the suppressed home insurance rates are a stark departure from market trends, indicating an unnatural unbalancing of the market dynamics.
If true affordability for homeowners is what the state aims to achieve, it must first revisit and modify the restrictive laws and regulations that artificially inflate housing prices and push residents to settle in risky areas. Undoing such harmful constraints includes comprehensive amendments to zoning and environmental laws, housing mandates, prevailing wage laws, and stringent building codes.
The core essence of any functioning insurance market is the freedom provided to insurance companies to determine their prices and use accurate actuarial data. It should not fall under the whims and control of state regulators or consumer advocacy organizations. Failing to comply with these fundamentals, California has strayed away from the essential principals of a free market.
The ultimate solution to restore balance and alleviate the issues caused by these restrictive regulations entails eliminating the rate approval constraints and overturning Proposition 103. Reinstating a free and competitive market would rebuild the insurers’ confidence in the efficacy of their policies, improving risk models and helping give a more balanced indication of the areas suitable for construction.
While the prospect of higher insurance costs isn’t necessarily appealing especially amidst California’s high cost of living, residents are gradually realizing that a more expensive but functional insurance system is far preferable to one that is fundamentally broken and incapable of providing any insurance at all.