Homeowners’ Insurance Falls Victim to Regulation

Like most people, I don’t like paying high insurance premiums, but I do like being protected against catastrophic losses like those I would face if a wildfire tore through my neighborhood.

In California, especially in rural areas like ours, the risk of wildfire has increased dramatically during the last several years; yet, the state limits what insurance companies can charge. As a result, some companies are refusing to write new homeowner policies here, and other insurers are leaving the state altogether.

This is bad news for California homeowners because the backup plan is the California Fair Plan, which charges about four times as much as commercial policies. The upside is that the Fair Plan will insure almost any structure against fire and extended losses. The downside (in addition to the price tag) is that the only thing it covers is the structure—no liability and no personal property. You’ll need to purchase that elsewhere.

A recent CalMatters article goes into detail on California homeowners’ insurance, but here’s some of what you need to know.

If you currently have homeowners’ insurance, you can expect a rate hike when your policy renews. Before you write a nasty letter telling your insurance company where they can stick their 40 percent increase (or more), be sure you can find coverage elsewhere first.

Both State Farm and Allstate (representing a significant percentage of the overall market) have stopped writing new homeowners’ insurance policies in California and Farmers Insurance put a cap on new policies. We still have about 100 companies willing to write new policies in the state, but not necessarily in our community. When the market leaders leave, it’s worth asking why.

Right now, the state requires insurance companies to price their policies based on an antiquated financial model that uses historical data going back 20 years, rather than creating projections that consider the dramatic changes in the last few years (including the impact of climate change). Past claims are no longer a good predictor of future risk.

Misguided consumer groups are thrilled when they learn that state regulation has kept the cost of homeowners’ insurance in California lower than the national average (unlike states where natural disasters have taken a toll such as Louisiana and Florida).

What consumer groups are forgetting is that the law of supply and demand is immutable. You can break traffic laws. You can break civil laws. You can even break criminal laws. You simply cannot break the law of supply and demand. When rates are kept artificially low, companies cannot afford to stay in business. If we do not allow the free market to set prices that balance risk with return, we will lose access to private insurance.

The state not only uses a broken model to set rates, it also requires all insurance companies doing business in California to share in the losses experienced by the California Fair Plan. If you are a private insurer who represents 20 percent of the California homeowners’ insurance market, you’re on the hook for 20 percent of California Fair Plan losses. No wonder insurance companies are fleeing the state.

In addition, insurance companies buy their own insurance against big payouts (called re-insurance). If they insure $100 million worth of homeowner policies, they buy re-insurance to cover a portion of that amount. The state does not regulate the cost of re-insurance, so re-insurers are charging based on actual risk.

The state requires insurance companies to maintain solvency but does not allow them to increase fees. Right now, insurance premiums aren’t covering the losses. Insurance companies should be allowed to raise their rates.

I know consumer groups worry that without state regulation, insurance companies could gouge homeowners, but that’s not how the free market works unless there’s a monopoly (which there isn’t). If companies set their pricing too high, competitors will undercut them and take the business. Insurance companies know this and will price accordingly.

If you have questions about property management or real estate, please contact me at rselzer@selzerrealty.com or call (707) 462-4000. If you have an idea for a future column, share it with me and if I use it, I’ll send you a $25 gift certificate to Schat’s Bakery.

Dick Selzer is a real estate broker who has been in the business for more than 45 years.

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