The origins of California’s insurance crisis

A dark cloud has formed over Golden State homeowners. California, once known for its sunny beaches, tech industry, and breathtaking landscapes is facing an exodus of insurance carriers leaving thousands of homeowners scrambling to find new coverage. While the forces leading up to this crisis are somewhat complex, it was both California voters and lawmakers who contributed to the present insurance meltdown.

In 1988 voters approved Proposition 103 known as the Insurance Rate Reduction and Reform Act. It required insurers to obtain state approval for rate increases. It also prohibited companies from factoring in their costs of reinsurance. Consequently, California became one of the first states that prohibited passing on this common expense. This regulatory framework generally functioned until urban sprawl and climate change dramatically increased the number of wildfires in the state.

Reinsurance is a crucial element of the insurance industry. It allows companies to manage their risks by passing on a portion of their liabilities to another insurer thus pooling their risk against catastrophic losses resulting from wildfires, flooding, and earthquakes.

Consequently, insurance companies now find themselves paying higher reinsurance rates thanks to a spike in natural disasters. Many insurers argue that they cannot remain solvent under these regulatory constraints which has led to a wave of non-renewals or outright exits from the state. 

In March 2024 alone, State Farm pulled out of 72,000 California insurance policies. 

The wildfire problem

California’s wildfire seasons have grown longer and more destructive. In 2018 the Camp Fire in Paradise California resulted in insured losses exceeding $12 billion. The insured losses from recent Los Angeles wildfires are estimated to cost $40 billion with another couple of hundred billion in economic losses.

The consequences of a ‘war on prices’

While California’s insurance regulations may have been well-intentioned, they’re a classic example of the law of unintended consequences and policy failure. Homeowners who were struggling to pay skyrocketing homeowner’s insurance premiums now find themselves unable to secure coverage choosing either to ‘go bare’ (risk having no insurance) or getting a policy from the state’s last-resort FAIR Plan. 

In the months leading up to the disastrous LA fires, the California Department of Insurance announced plans to allow insurers to include the cost of reinsurance and the use of catastrophic risk modeling to set rates. It appears lawmakers may have discovered rate hikes are not always the result of greedy corporations trying to line their pockets–they’re an economic necessity. While rates will increase as a result at least homeowners will see an increase in the availability of coverage.

One potential solution

Sadly, it’s older homeowners living on a fixed income who face a Sophie’s Choice of sorts. Take the risk of not insuring the home you’ve paid off or curtail monthly necessities to absorb increasing homeowners insurance premiums. Qualified older homeowners may find relief by tapping into their home’s value with a reverse mortgage to weather these most challenging times.

PS: HECM professionals should be mindful of the impact of increasing premiums and taxes have on the balance of Lifetime Expectancy Set Aside (LESA) accounts that may no longer last as long as projected.