Pielke Jr.: ‘California’s Insurance Crisis Guess what? It is not climate change’ – ‘The underlying problem here — policy, not climate’

https://rogerpielkejr.substack.com/p/californias-insurance-crisis

By Roger Pielke Jr.

Excerpt: Dave Jones, California’s insurance commissioner from 2011 to 2018, explained California’s growing insurance crisis in 2023:

Due to the failure to substantially reduce greenhouse-gas emissions in the U.S. and globally, we are marching steadily to an uninsurable future.

Jones sentiment is widely shared — Climate change is causing more and more intense extreme events, which are leading to more frequent and costly disasters, and as a result of growing economic losses, insurance companies are refusing to provide insurance coverage to homeowners. If the U.S. and the world would just reduce emissions, then risks of loss would decrease and the insurance crisis would be averted. Simple.

Also very wrong.

A long-term change in the frequency or intensity of extreme weather events would indeed alter the risk of loss. But insurance is about the management of risk. Without risk, insurance could not exist. As Cuthbert Heath, an early innovator in catastrophe insurance, explained more than a century ago: “Any risk is insurable at the right price.”

Changing risk does not lead to uninsurability. However, changing risk while restricting the ability to price appropriately in response, could lead to uninsurability. It is pricing, not risk, that underlies California’s insurance crisis.

In California, in 1988 a ballot initiative — Proposition 103, championed by Ralph Nader, called “Insurance Rate Reduction and Reform Act”2 — narrowly passed and subsequently transformed how California determined both “fair pricing” and “adequate reserves.” The law has led directly to California’s insurance crisis of 2025 because it prevents insurance companies from charging actuarially sound rates for homeowners insurance.3

Rate suppression refers a situation when the actuarially appropriate insurance rate is larger than the actual rate approved by state regulators, which creates a situation where pricing of insurance does not accurately approximate risk. The figure below, from an analysis by the International Law and Economics Center (ILEC), shows that from 2018-2022 California had the largest rate suppression of any US state, and by a large margin.

The rates that insurance companies are allowed to charge in California are thus not high enough to enable insurance companies to cover the risks that they are taking. That gap is why companies like State Farm have reduced their exposure to the California market.

Insurance rate suppression by state. California is in red. Source: IELC 2023. Note: Data for Florida was unavailable.

Why do California’s regulated insurance rates differ so markedly from those that are deemed to be more actuarially sound?

The answer is not climate change, but public policy — and specifically Proposition 103. Let’s look at three of its provisions that serve to suppress insurance rates.

First, the law requires that insurance companies calculate how they price insurance for fire catastrophes based only on loss experience of the past 20 years (or more):

In those insurance lines and coverages where catastrophes occur, the catastrophic losses of any one accident year in the recorded period are replaced by a loading based on a multi-year, long-term average of catastrophe claims. The number of years over which the average shall be calculated shall be at least 20 years for homeowners multiple peril fire . . .

A backward-looking approach to estimating future risk of loss is deeply problematic for several reasons.

 

For politicians, it is much easier to say that climate change did this to their constituents, not bad public policy.

But disasters happen and, always, someone has to pay. Rather than fix Proposition 103, California policymakers instead utilize a public backstop called the Fair Access to Insurance Requirements (FAIR) Plan. The FAIR plan uses government funds (paid by the public in taxes) and in extreme cases, levies on insurance companies passed on to consumers, to cover gaps in private insurance coverage resulting from insurance rates that do not correspond to risk.

So everyone pays for the policy failure and the actuarial inefficiency persists unaddressed. Socializing disaster losses also short circuits the ability to use insurance pricing to send signals via the market to consumers about the risks of development and homeownership in risky locations. Such price signals can motivate homeowners and developers to employ wildfire mitigation.

A positive path forward would first acknowledge the underlying problem here — policy not climate. California could set a long-term goal, say 20 years, to realign insurance regulation with more sound actuarial pricing. As that releveling occurs, it will continue to be necessary for the public to backstop insurance during the transition.

California’s insurance crisis is the result of democracy — a poorly designed citizen’s initiative approved by voters almost forty years ago. Fixing crisis will require more democracy, meaning sustained public support for getting out of this predicament together and elected officials willing to tell the truth.

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End Excerpt

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