The Gains from Deregulating the California Residential Real Estate Insurance Market

California should deregulate residential real estate insurance and allow insurers to offer any policy to anyone at any price. The California Fair Plan should be abolished.

As of now, the California Insurance Commissioner (Ricardo Lara) is playing the role of King Solomon as he tries to balance the interest group pressure being applied by incumbent property owners who don’t like rising rates in wildfire risky parts of the state AND the counter-pressure being applied by insurers such as State Farm and property owners in safe areas who are cross-subsidizing those who live in risky areas.

State Farm and other insurers are threatening to leave the state if the Regulator fails to allow for generous rate increases.

Here is a piece from the New York Times today.

In this Substack, I want to return to some themes from my free new book, An Introduction to Natural Disaster Economics focused on the gains from deregulation.

Property Rights

I do not believe that incumbent owners of homes in areas now deemed to face wildfire risk have special property rights. Just because their rates have been low, they do not have the right to future low rates. These long time owners have enjoyed millions of dollars of housing equity gains. They can use a reverse mortgage to tap into those gains to pay their higher insurance premiums.

No Cross-Subsidies

People who made “safer choices” to buy homes in safer parts of the state should not be taxed to subsidize those who make risky choices. Such subsidies create perverse incentives and this moral hazard effect should not be exacerbated!

Avoiding Insurer Retreat

Firms have the right to exit markets where they believe they will lose money. Price ceilings on rates lower expected revenue and thus lower expected profits.

The Resilience Gains from Deregulating the Insurance Industry

If the insurance industry is deregulated, insurers will compete for business. They will actively research the actual risk at the property and community level, and they will start to offer more sophisticated contracts that incentivize property-level and community-level risk resilience investments. These microeconomic forces will reduce aggregate risk and lower the likelihood of future disasters.

The Quantity and Quality of Insurance Under Deregulation

If insurers do not face price ceilings, more insurers will enter the market. The pursuit of profit will cause entry (not retreat)! Now, I do agree that issues arise concerning the quality of the insurers. Nobody wants to pay a premium for insurance during good times, and when a horrible event occurs, for the insurer to go bankrupt or be late in mailing out $ checks. We need more research and discussion concerning how we benchmark insurer “quality”.

Here are some of my pieces that flesh out my points here;

City Journal January 2025 joint with Joe Tracy

My Previous Substack insurance columns.

Here is a direct quote from my June 2024 column; The Insurer as the Adult in the Room.

Point #2 Competition between insurers protects property owners from being overcharged.

Point #3 There is considerable uncertainty about the extent, the timing and the geography of climate change risks but insurance contracts usually just last for one year.

Point #4 Newer structures tend to be more resilient to extreme weather events due to building codes and the fact that new construction is usually of higher quality.

Point #5 Insurers should be free to risk price and to price discriminate based on a structure’s attributes and property’s physical attributes. These can be cheaply verified using drone technology. Home owners could pay for an arm’s length inspection of their home to provide the insurer with up to date detail about the home’s configuration. The Insurer can charge a price for a premium based on all of these data.

Point #6 When state regulators and elected officials insist that insurance prices have a ceiling, they are implicitly redistributing money from people who live in low risk places to those who live in the high risk places. This creates a moral hazard effect and it slows down adaptation. We want economic activity moving away from high risk places.

Point #7 Economic activity has been moving to high risk places in part because safer places such as our Urban Core in progressive,educated cities build very little new housing. These artificial supply constraints push middle class people out to the fringe into hotter places, featuring more pollution from wildfires.

Final Point : If property owners anticipate that they will face higher prices for insurance in risky places, then they will be less likely to move to those areas and they will invest more to offset the risks they face in a specific area (so offsetting flood risk in flood areas, and offsetting fire risk in wildfire areas). Their aggregate demand for resilience solutions will create new market opportunities for entrepreneurs who innovate. The climate doomers and young academics ignore this induced innovation point. Read our 2017 paper and my 2021 Adapting to Climate Change book.

Update: I want to mention that this insurance reform policy debate is another example of an application of the famous Mancur Olson asymmetric interest group theory.

Under the status quo subsidy rules, there are incumbent home owners who live in risky places who know that they greatly gain from their subsidized insurance. They have strong incentives to yell and scream and lobby to keep their cushy $ deal.

In contrast, there are tens of millions of other Californians who are unaware that their tax dollars are being used to subsidize these insiders. The losers from the status quo are spread out and each isn’t losing enough $ here to spend the time to work together to form a lobbying coalition to fight the current policies. For example, renters of properties in low fire risk areas such as in Watts, Los Angeles are paying state taxes and part of this revenue is used to pay for the Fair Plan.

I want to live in an economy where people flip two sides coins. If you invest your $ in a place based asset, you gain if it appreciates in value but you lose if the area’s quality of life declines or if you and your neighbors are unable to use markets and community social capital to protect these places based assets.