California Home Insurance Crisis Provides Another Example of the Pitfalls of Government Intervention

Many Californians find themselves without home insurance coverage as the wildfires continue
The situation was completely avoidable, resulting from government interference with market pricing
No matter the intention, government price controls come with negative consequences

by Brian Balfour, Senior Vice President of Research, John Locke Foundation, January 15, 2025

As the tragic California wildfires continue to rage on, one bit of news has surfaced that will make rebuilding that much more difficult for homeowners: many of them don’t have insurance coverage.

According to reports, “Between 2020 and 2022, insurance companies declined to renew 2.8 million homeowner policies in the state, according to the most recent data from the California Department of Insurance.” That figure includes 531,000 in Los Angeles County, the focal point of the devastating fires.

Some homeowners who saw their insurance cancelled have been able to utilize a state program of expensive reinsurance, but many remain without any coverage at all.

How did this happen? Government meddling in the pricing of insurance.

The past seven years — in particular 2017 and 2018 — have seen record-setting insurance payouts in California due to some of the most destructive wildfire seasons on record, blamed by many on poor forestry management.

Because of such massive payouts and the continued risk of more sizeable payouts in the future, naturally insurance companies have requested significant rate hikes, which they are required to get approved by California’s insurance department.

This process, according to the insurance marketplace experts at PolicyGenius, is made more difficult by California’s Proposition 103. The 1988 law “requires insurance companies to justify rate increase requests for future wildfire losses based on their average annual wildfire losses over the last 20 years.” So, despite the more recent, dramatic spike in wildfire losses, Prop 103 compels insurers to calculate risk based on two decades, which translates into them having to “take on more risk than they are able to compensate for in premiums.”

In short, California has imposed what effectively turns into a price cap on home insurance premiums. Because insurance companies are not allowed to price premiums fully according to their risk exposure, “many insurers have either pulled back from certain areas or have left the state altogether.”

This tragedy serves as yet another reminder of what happens when government decides to intervene in market prices.

Economic laws are not subject to a vote or public opinion, and they can’t be suspended even in natural disasters. In this case, the government of California attempted to ignore the laws of supply and demand, which determine the pricing of goods and services.

What the law of supply states is that the lower the price set for a product, the less supply sellers will be willing to offer. And when government policy restricts prices from rising to reflect market conditions, shortages result.

We are seeing this unfortunately play out in California with the home insurance market. Other prominent examples of price caps causing shortages include rent control policies and ridiculous “anti–price gouging” laws put into effect after natural disasters. In each case, government meddling with freely adjusting market prices creates shortages of scarce resources in demand by consumers.

The other kind of government price control are price floors, in which government policy prevents the price of a good from falling below a certain threshold. Minimum wage laws are the most prominent example.

When prices are not free to adjust downward to reflect market realities, supply surpluses result. For instance, minimum wage laws set above the market-clearing rate for low-skilled labor decrease the demand for low-skilled workers while increasing the amount of workers demanding such positions. The result is more unemployed low-skilled workers, who are not only priced out of the market but also crowded out by increased competition for fewer available opportunities.

In the case of California’s restrictive policies toward home insurance premiums, the notion was likely justified as a means to “protect” consumers from sudden or dramatic premium increases. But such government interference led to predictable shortages, resulting in many of these consumers left with no insurance at all.

The lesson is straightforward: government meddling that prevents freely adjusting market prices causes chaos and harm. All economic goods, because they are scarce and have alternative uses, are allocated by some mechanism. The most efficient and fair mechanism of doing so is allowing freely adjusting market prices based on private ownership of society’s resources. This includes insurance risk.

No amount of wishful thinking or positive intentions can cancel the economic laws that guide market pricing. Continued government meddling in pricing will continue to produce disastrous results.

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CATO: California Insurance Market: Another Victim of the War on Prices | Cato at Liberty Blog

WE: How price controls destroyed California’s housing insurance market - Washington Examiner