October 08, 2024
An October heat wave in Southern California is a timely and unpleasant reminder that many communities across the state remain vulnerable to drought conditions that fuel wildfires. And with climate change making these fires deadlier and more intense, insurance companies have threatened to leave the state’s home insurance market altogether. Regulators have crafted a plan to deal with this crisis, but more work must be done.
A proposed regulation from the California Department of Insurance (CDI) would require insurance companies to increase coverage in high-risk wildfire areas. This is already affecting premiums: In August, the state approved Allstate’s request to raise homeowners insurance premiums by an average of 34 percent, effective November. CDI is reviewing a similar request by State Farm, the state’s largest insurer.
The deal between the state and insurers aims to increase competition in the private market and entice homeowners away from Fair Access to Insurance (FAIR) Plans, an insurer of last resort with higher premiums. To make the deal more appealing, insurance companies would be able to use third-party climate modeling to assess risk when setting policies. However, for homeowners already insured through the private market, the result is higher premiums and less clarity on how insurers use these models to determine risk.
On average, Californians pay less on homeowners insurance than residents of other states facing climate-exacerbated disasters. Proposition 103, which was passed by voters in 1988, set up a regulatory system requiring the insurance commissioner to approve rate applications by insurers before implementation. Proponents argue that this system and the process that allows residents to challenge rates have kept premiums low. Florida, for example, does not have a similar regulatory system, and residents there are paying nearly five times what Californians pay. Consumer protection organizations have expressed concerns about the recent agreement between the state and insurers. They argue that the deal undermines the protections provided by Proposition 103, which could lead to a significant increase in market rates.
What State Policymakers Can Do
So, how can California promote an extensive private market while ensuring homeowners are not marginalized in the process? There are a few options. Let’s start with incentives that reward good behavior. Just as the “good driver” discount has made car insurance more affordable for everyone across the US, it is time for the “good homeowner” discount. In the case of fire-prone areas, insurers should award mitigation efforts such as clearing vegetation 100 feet from a residence, installing sprinklers in the home or a water storage tank outside the house for firefighters to utilize, and reinforcing homes with fireproof materials, such as metal roofs and stucco or fiber cement walls. Some insurance companies already offer discounts to homeowners who take steps to reduce fire risk, and the state claims new rate-making models will have to consider these efforts.
The challenge comes with implementation. Not everyone can afford to make these sometimes costly home improvements. This is an area where the state can help by offering tax incentives, much like the federal government provides a tax credit for installing solar panels. The state also already has programs that could help cover costs. The CalHome Program, which currently offers grants to local public agencies and nonprofit corporations for housing rehabilitation assistance, could also be extended to help homeowners in risky areas.
You don’t have to look far to find these policies already in place. The federal government-run National Flood Insurance Program (NFIP) offers reduced premiums when homeowners undertake efforts to mitigate risks, such as elevating a home above the base flood elevation. The NFIP also has programs that help cover the costs of elevating a home.
Finally, the organization Consumer Watchdog submitted comments stating that California’s proposed regulation to allow insurers to use third-party models for determining risk “creates a process designed to keep models and their algorithms private, violating Prop 103’s public disclosure requirements.” The comments also highlight two other concerning aspects of the regulation: the absence of a requirement for models to be reliable and the lack of a specified minimum amount of information on the models that insurers should disclose to the public, discouraging expert reviews.
There is no doubt that California is dealing with a challenging situation. The state must balance the need for a robust private insurance market while ensuring homeowners are not financially overwhelmed. While recent regulatory changes are intended to foster competition and expand coverage, they also lead to higher premiums and raise concerns about rate-setting transparency.
The state must take further steps to confront these challenges, such as incentivizing homeowners through tax credits or matching grants to adopt fire-resistant measures. By taking these steps, California can create a fairer and more sustainable insurance landscape for its residents, even in the face of increasing wildfire risks.
