The California Fires Will Test The Severity Of The State’s Insurance Crisis

It’s hard to be an insurance company in California.
The post The California Fires Will Test The Severity Of The State’s Insurance Crisis appeared first on Above the Law.

(Photo by ROBYN BECK/AFP via Getty Images)

I live not too far away from the Eaton fire which, as of Tuesday night, is 35% contained. When the fire started last week due to high winds, the surrounding area (which includes where I live) had its power shut off for up to 48 hours. Not only that, the ash from the fire was visible in the air and turned the streets into ashtrays. The air quality was so bad that many residents voluntarily evacuated to other cities.

Eventually, the multiple fires in Los Angeles County will be contained. But the damage has been done, and the current estimated cost of $250 billion is likely to rise.

Many would expect that insurance would cover the losses. But some insurance companies have either dropped their fire insurance coverage in California or stopped accepting new applications. This means that some homeowners had to turn to the state’s last-resort insurance coverage, which is more expensive and provides less coverage. Others had no insurance, which means they will be out of luck, which is particularly painful for those who owned multimillion-dollar houses.

But the majority who have insurance will file claims with their insurers. Given the size of the damages and recent efforts by insurance companies to stop accepting new clients in California, it may make people wonder how they will handle the large number of claims.

California has been undergoing an insurance crisis for the past few years. Since 2022, several major insurance companies, including State Farm, Allstate, and Farmers, have stopped or limited new fire insurance applications in California, particularly in fire-prone areas. They cite various reasons, including climate change, rising labor and material costs as a result of inflation, and the payouts made due to the 2017 and 2018 wildfires.

Also, California has strict laws which limit how much insurance companies can charge for premiums. Proposition 103 requires insurance companies to obtain approval before implementing a premium rate increase. While this was designed to protect consumers from arbitrary rate increases and has kept premiums low, this has also resulted in stricter underwriting requirements, and the termination of new applications mentioned earlier.

Furthermore, Senate Bill 824 prohibits insurance companies from canceling insurance policies for up to one year after a state of emergency has been declared. Indeed, Insurance Commissioner Ricardo Lara used this to declare a moratorium on cancellations as a result of the recent wildfires.

But in 2023, in an effort to bring insurance companies back, the California Department of Insurance implemented a major regulatory overhaul. This would allow insurance companies to use wildfire catastrophe modeling to set rates and allow them to pass on some of the costs of reinsurance to customers. This generally means substantially higher premiums in exchange for accepting new insurance applications and continuing existing coverage.

It’s hard to be an insurance company in California. Rate increases must be approved by the insurance commissioner. Since the commissioner is directly elected by the voters, a huge, arbitrary rate increase could result in the commissioner being unelectable in the future, or — worse — being recalled. If insurance companies can’t bring in the enough premium revenue to pay out claims and maintain operations, why bother operating?

Some may ask, why doesn’t the state become an insurer? It could expand its current FAIR program to cover more people and make it affordable. Since the state may have less of a profit motive than the private sector, wouldn’t they be trusted to pay claims fairly and quickly?

While that sounds nice, it hasn’t worked out that way. Not only is the state’s FAIR program a “last resort” policy, the insurance commissioner is trying to bring private insurers back to the table. For reasons only the commissioner and legislators know, the state does not want to get too deep in insurance. Maybe it is too much work. Maybe taxpayers and voters in modest and less disaster-prone areas would be angry to see their tax bills go up so that their celebrity and business-titan neighbors in the Pacific Palisades can get their seven- or eight-figure casualty claims paid.

And then there is the matter of addressing the insurance companies’ grievances or, as some of them have done, they will simply stop taking new customers and slowly exit the California market. Premiums will have to increase to account for inflation and to pay laborers fairly, but a system should be set up to increase premiums gradually so customers will not suffer sticker shock.

But there is the matter of climate change, which only Mother Nature can fully control. It is also a controversial topic with its fair share of skeptics. But at least insurance companies acknowledge its existence and its impact on the environment and its customers. That can be a common-ground starting point for discussing how all stakeholders can do their part to improve everyone’s financial bottom line.

The recent California fires have unfortunately displaced a lot of people from all tax brackets. In the near future, we will see how insurance companies treat their customers who were impacted. It is a complicated business but in light of a recent tragedy, doing the right thing can greatly improve the companies’ public images and make customers feel slightly better about paying a higher premium.

Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at [email protected]. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.