The words “California” and “crisis” seem to belong together as the state jumps from one intractable problem to the next. Northern California’s recent spate of flood storms drew attention to the Golden State’s ailing levees. When an “atmospheric flow” shook the low-lying Sacramento region, a near-endless parade of trucks rushed with debris to shore up an aging system.
It would never occur to the state’s political leaders to invest in infrastructure improvements before near-catastrophic failures strained the levees to the breaking point. They would not even consider investing in the water infrastructure. On the eve of the storms that brought nearly as much rain in three weeks as California had seen in a year, the state was already facing another weather-related crisis: a mega-drought that led to water rationing. Such a problem had long been predicted, but until recently the state did not act urgently to approve new desalination plants or improve infrastructure.
Recent flooding and wildfire season have also cost insurance companies up to $1.5 billion in losses. Insurance markets could weather these blows, but the government-controlled California insurance system won’t allow them. As a result, insurers are pulling out of the state or reducing their insurance business, leaving many homeowners to rely on the naked insurer of last resort: the state-created (albeit insurer-funded) Fair Access to Insurance Requirements Plan. As R Street Institute insurance researcher Jerry Theodorou noted in the Orange County Register, the number of FAIR Plan policies has increased by 240% since 2017.
Auto insurers are also pulling back, notes Mr Theodorou, as losses have risen 25% in a year while premiums have risen just 4.5%. This statistic provides insight into the problem. In 1988, California voters approved a ballot measure, backed by tort attorneys, that turned the insurance commissioner into a rate-setting tsar. “Proposal 103 . . . requires “prior approval” from the California Department of Insurance before insurance companies can introduce property and casualty insurance rates,” the department’s website explains. “The voting action also required every insurer to cut their rates by 20 percent. Prior to Proposition 103, auto, property, and casualty insurance rates were set by insurance companies without the consent of the insurance commissioner.”
Thanks to Republicans’ longstanding weakness in statewide races, Commissioner Ricardo Lara won re-election last year by a 20-point margin, despite controversy over campaign contributions from people associated with companies he regulates. But the real problem isn’t Mr. Lara; it’s the powers that reside in his office. Since the passage of Proposition 103, California has had similar problems with all insurance commissioners, including Republicans. Elected commissioners have every reason to refuse premium increases. Insurers are reluctant to propose changes because doing so would trigger an administrative process that would see “interveners” – consumer groups paid to advocate for the public in the tariff process – charging attorneys’ fees.
In 2016, State Farm General Insurance, which offers fire insurance to 20% of the state’s homeowners, proposed a 6.9% increase in rates. The then insurance commissioner, Democrat Dave Jones, instead ordered the company to cut interest rates by 7% and reimburse consumers $100 million. No wonder insurers avoid this process and instead quietly withdraw from the market.
The Department of Insurance uses a formula to determine rates based in part on a company’s revenue. In State Farm’s case, the department, along with a group called Consumer Watchdog, calculated what the company’s premiums should be based on the total revenue of a group of State Farm-affiliated companies out of state. Although a state appeals court rejected that method in a strongly worded ruling, a San Diego County court nonetheless awarded Consumer Watchdog $2.2 million in attorneys’ fees for its far-fetched opposition in its intervener role.
This regulatory environment explains why California insurers cannot charge rates that reflect their actual risks. It also shows why there is so little competition in the country’s insurance industry. In the long run, competition keeps prices down. Insurance commissioners can certainly keep premiums down by regulation, but the result is a shrinking market. Homeowners then have no choice but to buy inadequate policies from a government-run marketplace.
Proposition 103 isn’t the state’s only insurance problem. In 2018, Gov. Jerry Brown signed legislation prohibiting the cancellation and non-renewal of insurance in wildfire-affected areas for a year after the fires — and Mr. Lara continues to enforce the already overused FAIR plan to offer additional coverage. Such edicts add weight to an overstretched backup insurance fund.
Legislators often speak of the need to help consumers and businesses in California’s many disaster-prone areas secure affordable coverage, yet these same legislators pass ordinances that affect the ability of insurance markets to do so. As a result, insurance could soon join California’s many crises with droughts, fires, floods, infrastructure, traffic congestion, homelessness and crime.
Mr. Greenhut is a Resident Senior Fellow of the R Street Institute. This track is an adaptation of the City Journal special issue, Can California Be Golden Again?.
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