As Fire Risks Rise, California Limits Insurers’ Ability to React

Photo courtesy of Ben Heinrich

For California, 2019 was a welcome reprieve from recent record-setting wildfire seasons. According to Cal Fire, approximately 260,000 acres burned across the state. A large area to be sure, this pales in comparison to the approximately 2,000,000 acres burned in 2018 and 1,500,000 acres in 2017.

However, state policy may lead to even worse fire seasons in the future. Despite the governor declaring a wildfire emergency last year, thereby lifting some regulatory obstacles to forest and grassland management, the state’s insurance regulator is frustrating efforts by insurers to have rates reflect real risks.

In California, insurance carriers require government permission to adjust their rates, introducing political considerations into what should be an economic decision. Unsurprisingly, rate increases aren’t popular with voters who have to pay them.

Although rates have increased, in some cases substantially, they remain capped. Consequently, the logical response for insurers is to continue offering coverage to customers with lower risks while cutting off coverage for customers with the highest risks. High-risk customers represent a net loss for insurers since they cannot charge a rate sufficient to cover the risk.

Indeed, this appears to be exactly what’s happening in California. According to the San Francisco Chronicle:

As the cost and risk of California wildfires grow, it’s getting harder for homeowners to get and keep insurance in fire-prone regions including the Sierra foothills, Tahoe and some parts of the Bay Area. Homeowners rejected by mainstream companies are turning in greater numbers to alternative carriers that provide less coverage, higher prices or both.

Rather than liberalizing the insurance market, so that rates can reflect individual risks, the state has forbidden insurers from discontinuing policies in high-risk areas. Writing for the Hoover Institution’s Defining Ideas, Richard Epstein explains that this policy will be to the detriment of both homeowners and insurers in the long term.

If losses pile up next year, insurers may face a choice of bankruptcy or leaving the California market. That would result in far more people losing their coverage. Or insurers may stop offering insurance to new high-risk customers (for fear the government will lock in unprofitable rates for these customers too), and wait for current high-risk customers to either drop coverage or cancel them when the moratorium is lifted.

The environmental consequences of these policies are likely negative. Wildfire risks are increasing for several reasons, including insufficient forest/grassland maintenance and climate change. Another big contributor is the increasing number of people who choose to live in high-risk areas, commonly referred to as the wildland-urban interface.

Policies that shield homeowners from the consequences of this choice can increase risks, by creating an implicit subsidy that spurs more people to move into high-risk areas. This can both increase the number of potential ignition sources and increase the amount of damage should a fire occur. Shifting these costs from homeowners to insurers can also undermine support for policies that could actually reduce risks since voters will have little incentive to support costly initiatives to lower costs for insurers.

Allowing the insurance market to adjust freely to these risks can create better incentives for homeowners and policymakers. Homeowners are more likely to factor fire-risk into their decisions if they know they will bear the costs of these risks. Likewise, they’ll be more likely to support policies that reduce these risks, such as better forest maintenance, if they feel the impact directly in their pocketbook.

Ultimately, policies intended to provide short term benefits to homeowners can, in the long term, increase the harms from increased fire risks by blunting the incentives that a free market would otherwise provide for responsible decisionmaking.

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