State Farm, California’s largest provider of bundle home insurance policies with a 20% market share in 2021, recently announced that it will no longer sell new home insurance policies in the state. This decision has raised concerns about the stability of California’s home insurance market, especially in the midst of recurring wildfires and floods.
The Ongoing Crisis in California’s Insurance Market
State Farm’s withdrawal from California is the latest development in a crisis that has been brewing in the state’s insurance market for years. Following the devastating fires of 2017 and 2018, the number of homeowners who were informed that their policies would not be renewed increased by 42%, affecting nearly 235,000 households. These catastrophic wildfire seasons wiped out decades of industry profits.
Other insurance companies, such as American International Group and Chubb, have also declined to renew policies in the past. In addition, thousands of condo owners were left without insurance as regulated insurers dropped coverage in wildfire-prone areas.
According to Seren Taylor, vice president of the Personal Insurance Federation of California, State Farm’s decision to publicly announce its actions sheds light on an issue that has been occurring quietly for several years. Insurers have been steadily restricting and scaling back their business in California.
It is important to note that State Farm’s current policyholders will not lose coverage. However, prospective home insurance shoppers will have one fewer provider to choose from.
Factors Influencing State Farm’s Decision
State Farm attributes its decision to several factors. Firstly, high construction costs in California make it significantly more expensive to rebuild homes after they are destroyed. Secondly, the state faces a growing natural disaster risk, particularly from wildfires. Lastly, State Farm cited challenges in the reinsurance market, which refers to insurance companies purchasing their own insurance to minimize the financial impact of catastrophic events.
Reinsurance premiums have risen in recent years in disaster-prone states like California, Florida, Louisiana, and Texas. However, California law prohibits insurers from passing along the cost of reinsurance to customers. Industry groups are pushing for changes to allow insurers to shoulder the burden of these rising costs.
How California Regulates Home Insurance
Insurance premiums in California are regulated by the elected Insurance Commissioner, Ricardo Lara. Industry groups argue that the state’s insurance office has not enabled providers to set prices that reflect the actual cost of doing business in fire-prone areas.
Although California currently has relatively inexpensive home insurance compared to other states, the severity of wildfires in recent years has highlighted the need for higher premiums. Michael Wara, director of the climate and energy policy program at the Stanford Woods Institute for the Environment, explained that California realized the potential for significant property damage due to wildfires five years ago.
In the past, the withdrawal of insurers from California has had serious consequences. After the Northridge Earthquake in 1994, many insurers ceased new business in the state, causing the real estate industry to come to a standstill. While the situation is not yet at that extent, a continued decline in insurers could prove costly in the long run, warns Dan Dunmoyer, president of the California Building Industry.
Can California Prevent State Farm’s Retreat?
Various ideas are circulating regarding how California can persuade State Farm to reconsider its decision. Consumer Watchdog argues that Insurance Commissioner Lara has the power to order State Farm to reverse its withdrawal based on Proposition 103, a voter-backed initiative that granted the department the authority to approve or deny premium increases.
However, Michael Wara from Stanford Law believes that this approach is non-constructive and could result in a lengthy legal battle. He anticipates that the entire insurance industry would sue the state, potentially leading to the collapse of the market and disrupting home mortgage transactions. Instead, he suggests exploring alternative solutions.
The Fate of California Homeowners
Another concern affecting California’s insurance industry is the potential demise of the FAIR Plan, a limited insurance option for homeowners when no standard private company is willing to provide coverage. The FAIR Plan is funded by levies on private insurance companies operating in the state.
While the FAIR Plan serves as a safety net, the increased risk of catastrophic wildfires places a disproportionate burden on the plan. In the event of a severe fire season, the plan could become financially insolvent, leaving other insurers responsible for the costs in proportion to their market share.
Given the potential financial liability, State Farm may have opted not to issue new policies anywhere in California rather than limiting coverage to low wildfire risk areas. This scenario is not unique to California, as Texas and Florida have faced similar challenges with their insurers.
FAQs
Q: Will current State Farm policyholders in California be affected by this decision?
A: No, State Farm’s decision only applies to new home insurance policies. Existing policyholders will not lose their coverage.
Q: What factors influenced State Farm to make this decision?
A: State Farm cites high construction costs in California, increasing natural disaster risks, particularly wildfires, and challenges in the reinsurance market as key factors in its decision.
Q: Can the California Insurance Commissioner reverse State Farm’s withdrawal?
A: The power of the Insurance Commissioner to order State Farm to reverse its decision is a subject of debate. While some argue that the authority exists, others believe it would lead to prolonged legal battles and potentially disrupt the insurance market.
Conclusion
State Farm’s decision to stop selling new home insurance policies in California has raised concerns about the stability of the state’s insurance market. Factors such as rising construction costs, growing natural disaster risks, and challenges in the reinsurance market have contributed to this decision. California regulators and industry stakeholders are grappling with potential solutions to ensure the availability of affordable home insurance for residents in the face of increasing wildfires.
