California’s Insurance Overhaul Came Too Late

The massive wildfires in Pacific Palisades and Altadena in Southern California may deal a devastating blow to the state’s fragile home insurance market, which is in the midst of large-scale reforms as part of an effort to lure private insurers back to the state.

In the years running up to yesterday’s, today’s, and likely tomorrow’s fires, several home insurers announced plans to stop writing new policies in California, or even leave the state entirely. The industry and many analysts blamed not just California’s famously hostile mix of dry vegetation, high winds, and scarce rains, but also a rise in construction and reinsurance costs and a regulatory system that made it difficult for insurers to raise rates or think prospectively about risk when setting rates.

In other words, it was simply easier for insurers to not renew policies than it was for them to increase rates to better adjust for risk. Some of these non-renewals occurred in the area now affected by the Eaton Fire in Altadena, though they were most prevalent in the Bay Area and the Sierra Nevada foothills.

In response, California’s insurance commissioner Ricardo Lara rolled out a set of reforms last year that tried to both expand insurance in wildfire prone areas and lure insurers back to the state. The new rules would allow insurers to use models to determine risk (not just historical data, as the law had previously been interpreted to allow) while also mandating that insurance companies operating in the state write policies in fire-prone areas as well as in those that are relatively safe. Lara then issued another rule late last year allowing insurers to use the cost of reinsurance in determining their rates, which insurers in the rest of the country are allowed to do.

Allstate, which announced in November, 2022 that it would stop writing new home insurance policies in California, said last spring that it was considering a return to the state based on the possibility of models being allowed for ratemaking. At the end of last year, partly in response to the reforms, Farmers also said that it would restart writing new policies for some lines of business in California, and that it would increase the number of new homeowners insurance policies it writes every month after instituting limits in 2023. Last week, Verisk submitted a model to project wildfire risk to the state for regulatory agency review for use in rate-setting.

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Consumer advocates have warned that these rules would lead to increases in insurance rates. So has Lara’s predecessor, Dave Jones, who has been skeptical of trying to grow the private insurance market by giving it more flexibility to set rates without addressing the core issues of climate change and fire management policy.

“In the long term, we’re not going to be able to ‘rate increase’ ourselves out of this problem,” he said in an interview with the University of California, pointing to Florida’s insurance problems as an example, despite the flexibility that insurers have in setting rates there. “In the short-and mid-term for California, giving insurers proposed higher rates will get them to start writing new insurance again — although many homes in the wildland urban interface will continue to face challenges. But in the longer term, higher rates alone are likely to be overwhelmed by the higher risks and losses from climate change — just like in Florida.”

Like Florida, California has a backup for the private market, an insurer of last resort. And, like Florida, it’s been trying to make it smaller, to little avail. It may now be so large as to place the rest of the state at financial risk.

California’s FAIR Plan is a fire insurance pool that all property and casualty insurers operating in the state contribute to in proportion to how much business they have in the state; homeowners turn to FAIR when they can’t get insurance otherwise. As the state has experienced massive wildfires and insurers have pulled out, the size of the FAIR Plan has ballooned, with exposure rising to $458 billion in 2024 from $153 billion in 2020, even as it explicitly says that its “goal is attrition” (i.e. getting customers back on normal insurance plans).

“It’s a socialized cost,” Kate Gordon, the chief executive of California Forward, a policy nonprofit, and former advisor to Secretary of Energy Jennifer Granholm, told me. “We see more and more people switching to the FAIR plan. It’s getting massively oversubscribed. It’s going to hit some kind of wall at some point.”

The communities with the most wildfire exposure for the insurer include vacation areas throughout the state such as Lake Arrowhead, Truckee, and Big Bear Lake, and affluent residential communities including Berkeley and the San Francisco suburb Orinda. They also include Pacific Palisades, the fifth most wildfire-exposed market for FAIR in Southern California, with some $5.9 billion of exposure.

While the fires have yet to be substantially contained, let alone extinguished, and the damage has not yet been calculated, the still-raging fires will likely constitute a major hit to the FAIR Plan and California insurers. The number of residential FAIR policies in the Pacific Palisades zip code grew by over 80% between 2023 and 2024, and has quadrupled since 2020. The total financial exposure for residential insurance in Pacific Palisades doubled in the past year, growing to almost $3 billion. In one zipcode affected by the fire in Altadena, residential FAIR plan policies grew by over 40% since 2020, with around $950 million of total exposure.

“As the risk of more climate change-intensified wildfires increases in California, a major wildfire in one geographical area concentrated with FAIR Plan-insured properties could overwhelm the FAIR Plan’s reserves and its capacity to quickly and fully pay consumers’ claims,” Lara wrote in a bulletin in September.

Like other states with insurers of last resort, the FAIR Plan can seek cash from insurers — which could, if the losses are large enough, extract “temporary supplemental fees from their own policyholders,” according to new California insurance regulations. This would mean that Californians who were able to buy private insurance — because they don’t live in a region of the state that insurers have abandoned — could be on the hook for massive wildfire losses. While such an assessment has not occurred since 1994, Victoria Roach, the FAIR Plan’s president, warned in a hearing before the State Assembly last March that a major fire could knock out the plan’s reserves and force it to go to insurers — and their policyholders — to shell out for the difference.