The failure of 'market failure'-driven fire insurance


Should the state and federal government encourage Californians to build houses in high-risk brush-fire zones? The brain says "no," but the policy means "yes."

In the riot-scarred year of 1968, Congress passed the Housing and Urban Development Act, which allowed states to obtain federal reinsurance money if they established property insurance pools of last resort to make homeowner and business policies available to those who lived and worked in areas the insurance companies considered to be too "high risk." The idea, which sounds eminently reasonable, was to make up for the "market failure" of insurers fleeing the smoldering inner cities, thereby allowing working-class residents to obtain affordable property insurance in the ghetto.

These property insurance pools have come to be known as "FAIR" programs, short for "Fair Access to Insurance Requirements, and more than 30 states have created them. FAIR plans generally operate like this: Insurers who do business in a given state are ordered to participate in a one-size-fits-all policy of last resort, usually contributing the same financial support as the company has market share in the state. The rates are generally approved by the state's insurance commissioner, and the policies are backed by the assets of all the insurance companies combined.

Though the motivation for these "residual market programs" were largely driven by reaction to riots and concerns of industry redlining, the federal law's definition of areas prone to "peril" also extended to regions beset by natural disasters, such as the hurricane-battered southeastern coasts, and dependably apocalyptic Southern California.

So when the California Legislature created its own FAIR plan in 1968, it specifically targeted homeowners in high-risk fire areas. As the California Department of Insurance's own Web site puts it, California FAIR was created "after the brush fires and riots of the 1960's made it difficult for some people to purchase fire insurance due to hazards beyond their control."

But are Southern California brush fires truly "beyond the control" of those who choose to build or buy houses in the steep, drought-starved foothills? Specifically, yes; generally, no.

"The frequency and the intensity of the forest fires in the Southern California chaparral are the greatest in the United States, with the possible exception of the wildfires of the New Jersey Pine Barrens," wrote environmental essayist John McPhee, in his marvelous "Los Angeles Against the Mountains" section of The Control of Nature. "It burns as if it were soaked with gasoline… The canyons serve as chimneys, and in minutes whole mountains are aflame, resembling volcanoes, emitting high columns of fire and smoke."

Of course, those canyons—at least the ones not owned by the state or federal government—also serve as glorious, high-end residential real estate, eligible for the state-mandated, below-market FAIR insurance. According to Kiplinger's, the average FAIR policy here costs $350. Part of the reason for the low price is that FAIR plans don't generally cover theft or personal liability. But another is that there is a two-fisted downward pressure on prices—political desire to keep rates affordable, and the massive disincentive for any private insurers to compete against the heavily backed, low-priced plans.

"In theory, rates for FAIR Plan coverage were to be set at break-even level," wrote Ruth Gastel, in the June issue of Insurance Issues Update. "In practice, in most states, there is a subsidy so that rates are lower than they would be in the voluntary market for the same level of risk. FAIR Plans, like many other residual market programs, historically have lost money over the long term, although in a specific year they may be profitable."

California FAIR insures around 160,000 homes, 20,000 of which are in brush-fire areas, according to a Sept. 28 Los Angeles Times article. Of those 20,000, "about 80% of the plan's policyholders live in Southern California," the Times reported, "including pockets of Malibu, Bel-Air, Topanga Canyon, Laurel Canyon, Glendale, Pasadena and Arcadia."

If Malibu residents seem like unlikely beneficiaries of legislation aimed at aiding inner-city minorities, consider that the FAIR plan is just the tip of the Colony's welfare iceberg. Between 1993 and 1996 alone, the famous seaside area was declared a Federal Disaster area five times, triggering more than $60 million in firefighting and cleanup costs, and untold millions more in the form of disaster relief, federally backed below-market Small Business Administration loans, tax breaks, and the day-to-day prevention of further conflagrations (Malibu has five L.A. County Fire stations alone).

So it wasn't all just class warfare that led the controversial L.A. historian Mike Davis to write a chapter in Ecology of Fear entitled "The Case for Letting Malibu Burn"—there's a healthy welfare-reform angle as well.

But then, the whole project of Southern California living is one giant taxpayer-financed battle to stuff more than 20 million people into a water-scarce ecology with massive earthquake fault lines, fantastically steep mountains, and hillsides that desperately yearn to burn. Transferring some of those costs onto those of us happily foolish enough to live here makes sense. Getting the government out of the brush-fire insurance business—and introducing competition to underwrite millionaire Malibu residents—seems like a worthwhile first step.