California's Wonky Insurance and Land Use Regulations Make the State's Wildfires Deadlier and More Destructive

The state has made it exceedingly difficult to build in fire-safe cities, while also making insurance rates in high-risk areas artificially cheap.


California is burning again, with some 26 million people under red flag warnings, and another 250,000 being forced to flee their homes.

The increasing intensity of these fires, which have grown deadlier and more destructive in recent years, has prompted demands from the public for better control and prevention.

So far, the focus has been on reforming the state's utilities, whose equipment continues to spark wildfires. That's left them with massive financial and political liabilities as fire victims demand compensation and politicians demand blood.

Rep. Ro Khanna (D–Calif.), for instance, has called for the state to take control of Pacific Gas & Electric (PG&E), the state's largest utility which was forced into bankruptcy after its equipment was found to have caused last year's deadly Camp Fire in which 85 people died.

"It's time for the state to take ownership of PG&E, and make sure that they are doing what they need to do to keep the power on and keep people safe," he told CNBC on Tuesday.

Last week, the state's top utility regulator also approved the creation of a $21 billion wildfire fund—paid for in equal part by utilities and their customers—that will cover wildfire damages caused by utility company equipment so long as the utility was not negligent.

Another solution gaining support is restricting development in fire-prone areas. The Los Angeles Times on Monday published the results of a June poll finding that some 75 percent of respondents were somewhat supportive of restricting development in susceptible areas.

Lost in the mix, however, is the way that existing development restrictions in fire-safe regions have encouraged home-building in high-risk areas, while perverse insurance regulations have shielded property owners from the true costs of living there.

"Ultimately there are people living in high-risk zones who cannot afford to bear the full risk of the places they've chosen to live," says R.J. Lehmann, an insurance policy expert at R Street Institute. "They didn't have accurate information through market signals."

A lot of these problems, he says, can be traced back to a 1988 state ballot measure, Prop. 103, that created an elected insurance commissioner who must approve rate increases proposed by insurance companies.

"It's unpopular when insurers either raise rates or don't renew policies so [the insurance commissioner] follows those politics even if the market conditions or the environmental conditions would recommend otherwise," Lehmann tells Reason.

In addition, Prop. 103 limits the types of risk and cost increases insurers can use to justify rate increases. That includes the costs of reinsurance (insurance on insurance) as well as future risks like climate change or changing forest conditions.

This means that insurers aren't able to price their insurance policies to accurately reflect the risks homeowners in fire-prone areas are facing. Property owners aren't seeing the full risk of their homes burning down reflected in their insurance policies.

In the absence of being able to charge market rates to consumers, one would expect that insurance companies would decline to cover folks in areas at high risk of fire. There's some evidence that this is happening: The California Department of Insurance (DOI) reports that non-renewal rates have increased following fires in 2017 and 2018.

"If you do want to continue to do business in California, but not in those areas, then the commissioner has a lot undefined authority to make it difficult to not renew policies," says Lehmann.

California law requires insurance companies to provide a policyholder with a reason for not renewing their policy. It also gives consumers the right to have their policy's non-renewal reviewed by the DOI staff.

Last year, the state legislature also passed several bills making it harder to not renew policies for people affected by wildfires. Insurers must renew policies by another year for people in fire-affected areas whose homes were not destroyed. They must renew policies for two years for those whose homes were destroyed by wildfire.

All these things raise the costs of doing business on insurance companies, while protecting customers from price hikes.

Insulating both groups from the costs associated with wildfires is a California legal doctrine that holds utility companies wholly liable for fires caused by their equipment, even when they weren't negligent and followed all state safety regulations.

"The fact that utilities end up eating the costs of wildfires, that has an effect on what the rates are for property insurance because property insurance has been able to discount that," says Lehmann.

By contrast, if insurance companies had to pay out to homeowners in the event of a utility-caused fire (where the utility has not been negligent), they would have to raise their rates to cover this added risk. The knock-on effect would be that building and living in fire-prone areas would become more expensive and less attractive.

There have been several proposals to reform utilities' liabilities for fire damage along these lines.

In June, Gov. Gavin Newsom's office put out a 57-page report on how the state could better respond to wildfires that included a range of proposals, including having the state adopt a fault-based standard for utility liabilities—basically, companies would only be liable for fire damages caused by their equipment when they've been negligent.

That same month, the state's Legislative Analyst's Office (LAO) suggested the same thing in its own report. The change, reads the LAO report, "might encourage insurers to make their coverage or premiums contingent on risk reduction activities undertaken by the homeowner" or even make them less willing to insure homes in high-risk areas.

Absent the ability to find affordable private insurance, some homeowners would likely be forced to move out of high-risk areas.

Higher premiums might also make clear-cutting forests near housing developments to lower the risk of fire and therefore insurance premiums—something often loathed by environmentalists—more politically palatable.

So far, however, the idea of shifting legal liabilities from unpopular utilities to homeowners has attracted little support.

Nevertheless, the incentives created by higher property insurance premiums—and the price signals that would send about building and living in fire-prone areas—would likely mean less destructive, less deadly wildfires.

It would also, of course, mean making housing more expensive in a state that is already suffering from crippling affordability problems.

Lehmann suggests land use reform be coupled with changes to insurance regulations.

Loosening development restrictions in cities would, the thinking goes, lead to more home construction and therefore lower housing costs. That would, in turn, give people who are priced out of fire-prone areas (following insurance reform) safe and affordable places to move to.

"People have to live somewhere," he says. "Where it is low-risk, we have to massively increase the amount of housing you can build."