The Trouble with Homeowners’ Insurance, Explained

In the wake of the most destructive wildfires in U.S. history—the Los Angeles wildfires—“the insurance industry as we know it is in big trouble,” as economics writer Noah Smith recently suggested. Is it trouble the industry can get out of? The details are unclear, but parts of the outline are beginning to form. 

Homeowners insurance is more expensive than ever, and for many it’s becoming unaffordable. There is no average homeowner experience of insurance; insurance is regulated at the state level, and risks vary from state to state. But rates are up everywhere, and California and Florida have become the nation’s emblems for out-of-kilter insurance markets. 

According to the Federal Reserve Bank of Richmond, home insurance premiums grew 21 percent nationally on average from May 2022 to May 2023, versus 12 percent the prior year, from a low of 10 percent in Vermont to a high of 35 percent in Florida. Higher rates are an added cost burden on a housing market that is already facing headwinds from inflation and higher mortgage costs. Some homeowners are forgoing home insurance entirely. 

Inflation, again. 

What’s driving up costs? One big factor, of course, is inflation. “We’ve seen not only 40-year record growth in the [Consumer Price Index], but the cost of, for example, rebuilding materials and labor that’s been increasing about double the rate of inflation,” said Robert Gordon, senior vice president of policy, research and international for the American Property Casualty Insurance Association (APCIA), in an interview with The Dispatch.

Inflation also affects home values. Insurance policies are based on current replacement costs, not on a home’s last sales price. And since the COVID pandemic, according to Goldman Sachs, homes have appreciated by about 20 percent annually—“the strongest home price growth we’ve seen in the country’s history.” 

Also driving up costs are increased development in higher-risk areas and greater frequency and intensity of natural disasters, including more catastrophic events. 

A 2024 report by J.P. Morgan Asset Management also cites more uninsured homeowners (12 percent in 2023, versus just 5 percent in 2015), which makes insurance premiums higher for everyone else. And as private insurers with large losses leave states, more homeowners are forced to turn to expensive state-owned insurers of last resort (such as the California FAIR Plan). 

Finally, better predictive models and improved risk-modelling tools have made risk measurement more accurate and targeted, often resulting in higher rates. 

A tale of two states.

The two flash points for homeowners insurance problems are California and Florida, where very high property values combine with a greater incidence of wildfires and hurricanes to create an elevated risk of loss.

As California faces massive disaster-driven insurance losses from the fires, the state finds itself underinsured. Between the remaining private insurers still operating in the state (many have left) and FAIR, there will not be enough capital to cover losses in the state this year. 

Just halfway into January, estimates for insured losses range from $30 billion to $50 billion, said Gordon. “That’s more than two times the annual homeowners insurance premiums. And we haven’t even hit the wildfire season yet.”

The reason for the shortfall is Proposition 103, legislation approved by the state’s voters in 1988. According to the federal Office of Financial Research, Proposition 103 keeps home insurance rates low with three major levers. Rate increases above 7 percent can be challenged by individuals or groups granted permission to do so by the state, with long resolution times (up to two years). Pricing for catastrophe risk must be based on historical losses—not forward-looking models, despite the growing wildfire risk. And costs of reinsurance (purchased by insurers to help cover claims) may not be included in rates.

A 2023 California Department of Insurance report states that “homeowners insurance companies [had] done far worse in California than nationally.” While direct underwriting profit was 3.6 percent in the U.S. from 2012 to 2021, the state’s homeowners insurance companies posted a 13.1 percent loss. Prop 103 kept rates low—“very low, compared to the exposures,” said Gordon. “That’s why we’ve seen these enormous losses in California.”

The two main levers the insurance industry has to remain solvent, wrote Smith, is to increase premiums and to obtain more reinsurance coverage. Proposition 103 essentially forbids both. 

The result is a “terribly brittle” insurance market, Amias Gerety—a partner at QED Investors and a board member for the insurance company Kin—told Bloomberg. As The Dispatch’s Scott Lincicome reported last week, regulations such as Prop 103 that are intended to keep rates at affordable levels force insurers to price policies “well below their cost.”

Florida homeowners insurance has followed a boom-and-bust cycle, according to Gerety. The most recent bust reached its nadir with Hurricane Ian, in 2022. Many private insurers had left the state, leaving the more expensive state-run option—Citizens Property Insurance Corporation—with more higher-risk policyholders, and getting stuck paying claims of failed insurers. Fewer private insurers meant higher rates from the remaining insurers. 

Rates were further inflated by an only-in-Florida roofing insurance scam that over a 10-year period handed more money to attorneys and adjusters than to policyholders.

State legislators seemed to notice the threat to tax bases of delayed rebuilding and recovery, slower business growth, less in-migration, and more out-migration. Landmark legislation in 2023 introduced tort reforms and better claims processing, and financially shored up the state-run insurer.  

“Since then,” said Gordon, “we’ve seen new capital flowing back into the market. … The rates completely stabilized, a log of new insurers, new reinsurance.” When Florida faced two hurricanes last fall, it was better equipped. Building codes had vastly improved (and are now the strongest in the nation). Insurance premiums are more expensive than ever, but there is more coverage in Florida. 

Nothing to fear but over-regulation?

Regulators have two roles, R.J. Lehmann, editor-in-chief for the International Center for Law & Economics, told Bloomberg: to make sure insurers are solvent, and to protect consumers. Insurers sometimes need to be saved from themselves. For example, insurers have incentive to underprice risks, he observes, in order to attract business from their competition. There’s also a first-mover disadvantage to raising premiums, as it immediately makes that insurer less competitive in the marketplace.

Regulatory rate suppression “might be a sugar high in the short term, but in the long term it devastates the markets and the availability [of insurance] for consumers,” said Gordon. Offering an example of a well-functioning homeowners insurance market, he cites Wisconsin, which has below-average insurance rates and above-average competition.  

However it’s accomplished, neither homeowners, lenders, nor communities can do without affordable insurance. As a report by Fitch Ratings points out, as premiums rise and insurance becomes less available, it has far reaching negative effects on the housing market and overall economy. 

Okay, what now?

There is a consensus that disaster mitigation can significantly reduce risk. For example, a 2023 case study on hurricane risk in Florida by Moody’s indicates that stronger building codes there can lower the cost of home damage by almost a factor of 10.  

Gordon believes new wildfire safety standards are among the most exciting innovations in disaster resiliency in the last few years. The Biden administration’s Federal Wildland Fire Mitigation and Management Commission provided many recommendations on wildfire resiliency, from building with ignition-resistant materials to removing vegetation and other combustible materials from within 5 feet of a structure. “If California gets serious about adopting those recommendations … that will help insurance capital flow back into the marketplace,” Gordon said. 

We may also want to rethink building on fire-dependent chaparral or on hurricane-protecting barrier islands. 

The pieces to the puzzle of shoring up homeowner’s insurance all seem to be there. For each state, the question is whether there’s enough political will to put the pieces together. The trouble, as Smith says, is that the public increasingly sees the insurance industry as “an infinite pot of money.” And given the choice, we will always gladly pay tomorrow for lower insurance premiums today.