It’s bad enough when home insurance prices rise 10% to 20% per year. But what if they went up 10 to 20 times?
We are two longtime California residents who have worked more than 30 years in and around business and finance. We’ve spent the last year asking two basic questions: What’s wrong with homeowners insurance in California? And is there actually an opportunity to launch a new insurer while so many other carriers flee the market?
The math is not pretty. We’d tell you to cover your eyes, but then you wouldn’t be able to read just how bad it is:
We estimate that 20% to 30% of homes in California have high exposure to wildfire risk, compared to the state’s outdated estimate of 12%. To price those risks, let’s use a simple example. If your home costs $1 million to replace and the expected likelihood of a wildfire loss has gone from a 1-in-400-years event to a 1-in-50-years event, then the premium required just to cover catastrophic wildfire risk increases from $2,500 per year to $20,000 per year. And that excludes all the other risks like theft and water damage.
In a state where the average home price is nearly $900,000 and an average premium hovers around $2,000, this increase is both economically infeasible and politically disastrous.
Over the last two years, eight of the largest 12 California carriershave aggressively reduced their new customers or even exiled existing customers.
No private company will, or should be expected to, offer insurance that is unprofitable.
So, what’s changed from the past, when the homeowners insurance market was more stable? Well, there are simply more dangerous wildfires. The frequency and intensity of these fires has broken existing underwriting models, and insurers are terrified. According to CalFire, more structures in California were destroyed by fire in each of 2017, 2018, and 2020 than in all 10 years prior to 2017 combined. The years 2017 and 2018 were brutal, with wildfire losses consuming approximately twice total premiums collected. It’s hard to say where the figures for 2025 will end, but it will of course be terrible, too.
And despite good intentions, decades of political grandstanding and a short-sighted Californian regulatory approach are also responsible for this mess.
In 1988, voters passed Proposition 103 in an attempt to tame insurance-rate increases. It may have worked for a time. But the deal came with other features that slowly rotted the entire system. There was an elected insurance commissioner, an extremely slow approval process for rate increases, and rigid rules on how insurers set prices.
That was just the start. California also created an Intervenor process—unique to this state—that allows third parties to object to rate increases (and pays them for doing so). Insurers simply could not keep pace with their own costs. So, they gave up.
Another unpleasant surprise lurks in the shadows for insurers—assessments from the Fair Access to Insurance Requirement (FAIR) plan, the state’s insurer of last resort.
When the FAIR plan’s capital is unable to cover losses (as is almost certain to be the case in 2025), the FAIR plan will make an assessment on regulated insurance carriers in California in line with their market share.
For example, the FAIR plan is likely to incur $4 billion of gross losses from the January fires. California regulators have already approved a $1 billion assessment against insurers to keep the FAIR plan solvent. Therefore, State Farm—which has approximately 20% share in California—already has a $200 million bill—for policies that it didn’t underwrite and aren’t on its books. And more assessments could be coming if loss estimates get worse.
In essence, to operate as a regulated carrier in California, a private insurer is exposing itself to unknown and uncapped losses for risks it never knowingly assumed. This is, literally, like being sent a bill for your neighbor’s house when it burns down and yours is still standing.
At this point, State Farm could, in theory, ask to pass most of this on to existing customers—but you can imagine the reaction of policyholders and politicians to that idea. Now do you see why insurers are leaving the state?
With this context, we see only three paths available to the state and its citizens. Only one has a shot of really working.
- Let insurers price insurance to reflect their true cost. The good news is that insurers will show up if they can price freely, but the bad news is that high-risk properties will get massive premium increases commensurate with risk. This will likely bring a substantial fall in home values and property taxes—because the pool of buyers who can afford the true cost of insurance will be small. Many homes would likely end up uninsured. A small plus is that it would align behavior with risk mitigation—building that new house deep in the wilderness may no longer seem like such a good idea.
- Force insurers to insure high-risk homes, and in effect have the premiums of low-risk homes subsidize those in higher-risk areas. A sloppy version of this approach is what seems to be in place today—either through new rules attempting to coerce (or entice?) insurers to write in high-risk areas or through the FAIR plan backstop for which insurers are liable for assessments. But for this to work, pricing in aggregate still needs to be adequate, and the insurers—especially after the LA fires—are unlikely to think that it will be. There’s also another risk: Inherent in this approach are significant cross-subsidies, where high-risk homeowners are charged less than they should be—in order to make the price reasonable—while low-risk homeowners are overcharged in order for the overall portfolio’s pricing to be adequate. So there’s an incentive for low-risk homeowners to opt out of coverage or seek other specialized products—and then the system unravels.
- The state addresses the higher-wildfire-risk homes in some manner and lets the private market deal with the lower-wildfire-risk homes. This would allow 80% of the market to go back to functioning. We think the state would likely need to backstop high-risk homes—probably with some kind of subsidy or tax credit that phases out over time—to avoid an insurance payment or a real estate price shock today. Over time, however, people will pay the actual cost of risk and incentives will correctly align around risk mitigation and building location choices. And the simple act of drawing lines—between high-risk and low-risk—will be a politically explosive issue.
After 12 months wading through the arcana and folly of California insurance, we see no alternative but number three. And because insurance carriers are, appropriately, long-term analysts of risk, they will continue to reduce exposure to California unless real policy change is enacted. And so the hard truth remains: Not only will the future bring more wildfires, it will also bring declining home prices and greater financial risk and stress for all Californians.
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