Viewpoint: California Needs Regulatory Reform and Quick Rate Review to Halt Personal Lines Meltdown

June 2, 2023 by

The regulation of property/casualty insurance in California has been an epic failure—look no further than the state of the market for personal automobile and homeowners insurance.

California Insurance Commissioner Ricardo Lara’s automobile insurance rate moratorium and refusal to process rate filings from March 2020 to October 2022—31 months—has dramatically reduced options for consumers and made their lives more difficult. He has destabilized the entire personal lines automobile insurance marketplace in California, and foreseeably caused insurance companies to make difficult business decisions that are crushing California consumers.

If the California insurance marketplace is to recover, the California Department of Insurance needs regulatory reform and an expedited and fast-track rate approval process to accelerate the return to some semblance of a competitive insurance marketplace for consumers.

Since 1962, the American Agents Alliance has represented thousands of independent insurance agents in California, and today our members serve hundreds of thousands of California consumers. As insurance agents ourselves, we are well-situated to speak on the current state of the industry and the impact of Lara’s decisions on California consumers.

Never before have we heard from consumers and insurance agents desperate for automobile and homeowners insurance, but unable to obtain it because insurance companies are unwilling or unable to provide it.

The commissioner’s rate moratorium has caused insurers to limit their exposure to this state, in many cases we fear, forever. Most insurance companies now view the California insurance regulatory landscape as overtly political, with a hostile and weaponized ratemaking process that is immune to reason, efficiency and balanced regulation.

To be clear, no one wants higher insurance premiums, however insurers can only continue serving consumers if insurance rates reflect the real costs borne by insurers.

The inflation of automobile claims costs has been well-documented by insurers, as they work to find solutions to the added pressure from increased traffic fatalities, the price of used cars that drive total loss settlements, and the costs and delays of repair part supply chain shortages. The commissioner’s rate moratorium has deprived insurers of pricing for these costs and triggered decisions by them that has created a serious, dire crisis for consumers.

Inflation is driving up the cost of home reconstruction, particularly building materials. Homeowners insurers have had to do what every other type of business has done, increase its prices to cover its rising costs. And with rapid inflation, it is difficult to operate a business when underlying costs are rising significantly.

Complicating matters, it takes six months or more to increase rates through the state approval process, placing insurers further behind the cost curve when they finally do receive a rate increase.

As reinsurance premiums have skyrocketed, home insurers cannot afford to pay more. California is the only state in the country that prohibits insurers’ rates from being based upon their actual reinsurance costs. California’s regulations employ a legal fiction that each insurer uses its own capital to serve policyholders. As reinsurance costs increase, insurers are prohibited from having their rates reflect these higher costs.

Insurers have had to pay more for the same reinsurance coverage, but they cannot afford to pay more because of our rate rules, so they buy less reinsurance, non-renewing their highest risk customers to be able to afford reinsurance with the money they have. California regulations allow earthquake insurers to include reinsurance costs in their rate calculations, but not wildfire insurers—go figure. California regulations should be changed to allow insurers to base their rates on all legitimate expenses, including reinsurance.

Unlike every other state, California regulations prohibit the use of forward-looking climate models to project future losses, and instead require wildfire risk to be priced using an insurer’s average wildfire losses over the last 20 years. This makes no sense, since today’s climate is very different than it was 20 years ago. Under these rules, an insurer gets no credit for writing in new, higher-risk areas because they first need to experience big losses in order to get approval to charge higher rates to support the greater losses anticipated in higher risk areas.

With forward-looking loss projection models, an insurer can tell regulators that they are willing to go into higher risk areas, use the models to demonstrate the anticipated increased losses, and obtain the higher rate necessary to fund the losses in the higher-risk area. Existing regulations punish the very behavior everyone wants, which is for insurers to voluntarily enter high risk areas. If these models are such a problem, why are earthquake insurers currently allowed to develop their loss projections using them?

State Farm’s recent announcement that they have exited the California homeowners marketplace will exacerbate the rock hard homeowners market.

Where are consumers living in high fire risk areas going to go for insurance? The FAIR Plan is currently rate inadequate, and it has limited capital. It is backstopped by private insurers, with zero government assistance. If the FAIR Plan runs out of money, private insurers must fund all of its unfunded losses on a market share basis.

As the financial position of the FAIR Plan deteriorates and the prospect of an assessment increases, every homeowner insurer will begin to consider whether they should reduce their market share to prevent a large assessment. This will create an unpleasant cycle where insurers pull back, the FAIR Plan takes on more risk, creating larger assessment threats, making insurers recede even more.

The personal lines marketplace is in turmoil, with no good end in sight. The CDI should treat this crisis with the seriousness it deserves with needed regulatory reform, and by establishing an expedited and fast-track rate approval process to accelerate the return to a competitive marketplace for agents and consumers.

While a thorough rate approval process is necessary, regulatory reform and urgency should now be priorities. Insurers are continuing to receive months of questions from CDI staff and, for large carriers, questions from “intervenors,” as if time is not of the essence. We would not be in this dire situation if the CDI had processed auto rate filings from March 2020 to October 2022—instead of making blanket assertions that insurers made “excess” profits due to reduced driving during the depths of the COVID pandemic, while not even providing individual insurers that disagreed a method of disproving the assertion.

The CDI cannot continue with a business-as-usual approach, processing rate filings as if everything is fine, because it is not. The logjam of personal automobile rate filings is also delaying much needed homeowners and commercial insurance rate filing review.

State Farm’s recent announcement that it will no longer sell to new customers seems like a clear sign that more bad news is coming for California consumers.

D’Arelli is the executive director of the American Agents Alliance, a national association headquartered in Sacramento, California serving the professional needs of independent property/casualty insurance agents and brokers.

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