Not a Good Neighbor? State Farm Vs. California

The large auto and homeowners insurer State Farm has lately had a rocky relationship with California. In May 2023, the company  – which holds the largest market share in the state – announced it would stop accepting new applications for property and casualty insurance. Then in March 2024, it announced it would not renew approximately 30,000 homeowner, rental, and other property insurance policies. And most recently, the company demanded an expedited  22 percent rate hike for homeowners, a 15 percent increase for renters and condo owners and a 33 percent increase for rental owners. State Insurance Commissioner Ricardo Lara initially denied the proposal, and both sides have met for further discussions. A final decision is not expected for another two weeks.

The feud mostly boils down to housing costs, wildfires, and a state regulation called Proposition 103. The first factor is well-known: California has struggled to build new housing to meet its growing population. The demand for housing and a limited supply have led to skyrocketing costs. Combined with multiple factors that have increased supply chain and construction material costs, building new homes or repairing existing stock is expensive. This mix of issues increases the amount insurers cover and subsequent claims in case something happens, which leads to the next issue.

California is experiencing more and more wildfires. The massive fires that hit Southern California in January are just the latest in an increasing number of fires resulting from over 100 years of forest mismanagement in the US, combined with increasing global temperatures due to climate change. While efforts to mitigate these disasters have recently increased, with the state setting aside billions on wildfire protection and forest resilience, California is playing catch up. When fires destroy residential structures, the housing stock is further limited, exacerbating the state’s housing crisis. Fires also cost billions for insurers. The recent fires in Los Angeles are expected to cost State Farm $7.6 billion,  though reinsurance — insurance for insurance companies — is expected to cover all but $212 million.

The final issue is Proposition 103, passed by voters in 1988. Prop 103 set up a regulatory system requiring the insurance commissioner to approve rate applications by insurers before implementation. Proponents argue that this allows residents to challenge rates and keeps premiums low. However, lower premiums and increasing costs are hitting the state’s insurers hard. California realized it had to act as insurers threatened to leave the state.

In 2024, Lara struck a deal with insurers called the Sustainable Insurance Strategy, which requires insurance companies to increase coverage in high-risk wildfire areas. However, to sweeten the deal for insurers, it grants access to tools in ratemaking that may improve actuarial soundness but are controversial amongst policyholders and advocates. For example, under the new regulations, insurance companies can now use third-party climate modeling to assess risk when setting policies. The latest regulation, announced in December, allows insurers to include reinsurance costs when setting rates. Like anyone with insurance, the companies pay a premium to keep their reinsurance coverage. These tools may help insurers, but they increase costs for policyholders.

And unfortunately, that is the balance the state is attempting to navigate with State Farm. Thanks to Prop 103, homeowner premiums in California are below the national average. Good for consumers, and bad for insurers. However, not everyone in California requires hazard insurance as it is based on risk, and hazard insurance – which is separate but can be bundled with homeowner insurance – is becoming increasingly expensive. With insurers no longer writing policies, more homeowners are turning to the residual markets where the FAIR Plans reside or choosing to go uninsured. By refusing to accept new policies, State Farm is part of the problem here. State Farm also has repeatedly warned of losses from the large claims it is paying out as a bargaining tactic. However, the company’s $5.3 billion net income in 2024, which contrasts with a $6.3 billion net loss in 2023, makes their arguments less convincing.

So what can the state do? California is already working on the housing crisis but must focus more on reducing risk. Unfortunately, with a big question mark on federal funding, options are becoming increasingly limited. The state recently established a grant program to mitigate the risk of wildfires for homeowners. The program funds projects that harden and retrofit existing structures to make them more fire-resistant. It also supports efforts to create defensible space around homes and manage vegetation in fire-prone areas. But the program relies on matching federal grants.

California could look at similar programs in Florida and Alabama that are funded solely by the states and model funding mechanisms on those programs. The state could also help homeowners by offering tax incentives, much like the federal government provides a tax credit for installing solar panels. Existing state programs could help cover costs. The CalHome Program, which currently offers grants to local public agencies and nonprofit corporations for housing rehabilitation assistance, could also be extended to help homeowners in risky areas.

It’s also worth asking what more insurers such as State Farm can do to invest in wildfire mitigation or how they support state-funded programs that reduce community risk. In 2022, the state adopted a rule that requires insurers to provide credits for wildfire-protection measures, which include creating defensible space around a home by removing flammable objects and making fire-resistant improvements to windows, decks, eaves, and roofs. For State Farm policyholders, that discount can amount to up to 10.1 percent off their premium if they complete all 12 approved mitigation steps. However, a common complaint has been that retrofit costs far exceed any discounts.

The situation with State Farm in California highlights the intertwined challenges of housing, climate change, and insurance regulation. As California moves forward, it will be essential to foster collaboration –  not just between insurers and policymakers but also affected communities – to develop strategies that protect residents and the insurance industry’s financial stability. The future of insurance in California depends on finding this delicate balance.