PERSPECTIVE ON INSURANCE : Misguided Policies--Then the Earthquake : Price controls only temporarily forestall market forces for homeowners. Now, the double whammy.

“A Great Victory For Consumers!” “Puts People Before Profit!” Such was the tone of much sophisticated opinion upon passage in 1988 of Proposition 103, the “populist” measure imposing price controls on auto, homeowner and other insurance coverage. The initiative provided also for the direct election of the insurance commissioner, thus furthering the perverse politicization of the California insurance market.

A few lonely voices pointed out the obvious: that the insurance affordability crisis was the result of skyrocketing costs abetted in substantial part by misguided public policies, that an industry with thousands of firms must be highly competitive and that price controls enforced by ambitious politicians would reduce the availability and quality of insurance services, with adverse consequences for businesses, consumers, taxpayers and the California economy as a whole.

Oh, how those chickens have come home to roost. In the wake of the Northridge earthquake--with losses vastly greater than predicted even in the “worst-case” assumptions by insurers--the inevitable perversity of the Proposition 103 price controls has emerged, exacerbated by a misguided 1984 state law forcing insurers to offer earthquake coverage to those purchasing homeowner coverage. Under outgoing Insurance Commissioner John Garamendi, most rates for homeowner and earthquake coverage have been frozen since 1989, as Garamendi has attempted to extort rebates from insurers for the “rollback” period under Proposition 103.

This rate freeze--the consumer price index has increased 20% since then--is acute for earthquake coverage, in light of the new information about potential losses revealed by the Northridge disaster. Since insurers must offer earthquake coverage to all purchasers of homeowner policies, and since much earthquake insurance at the frozen 1989 rates is a clear loser for insurers, the required offer of earthquake insurance is equivalent to a tax on the premiums paid for homeowner policies. Thus has the linkage speeded up the availability crisis, but it would have developed in any event over time because of the price controls on homeowner coverage.

And so the inevitable has come to pass. Farmers Insurance has suspended sales of new homeowner policies. State Farm will limit the number of policies to the 1993 level. Twentieth Century will pull out of the homeowner coverage business completely after three years. Safeco has placed a moratorium on sales of earthquake policies and thus of homeowner policies in Southern California. Mercury no longer will offer homeowner policies unless they are purchased with other personal insurance such as auto coverage. Transamerica and Allstate have imposed a moratorium on new homeowner policies.

No one should be surprised at this outcome. As politics is the art of wealth redistribution, insurance rates determined in politicized regulatory processes inevitably will be used to subsidize favored interest groups at the expense of others. This ability to reward allies and punish foes--that is, to exercise political power--will draw the politically ambitious toward the office of insurance commissioner as a steppingstone upward. But ambition for higher office necessarily means a shortened time horizon with respect to the office held currently. Thus, insurance commissioners systematically will find it convenient to ignore the adverse longer-term consequences of their decisions, since it will be their successors who will have to deal with them.

In short, Garamendi’s adverse behavior over these four years, driven by his gubernatorial ambitions, has not been an aberration. The office of insurance commissioner invites demagoguery and rewards efforts to transfer wealth from insurers in order to subsidize favored groups of constituents. A reasonable, farsighted commissioner would do what competitive markets do, that is, allocate rates in accordance with risks, and so would be subjected to attacks by “consumer” advocates and others pursuing their own political interests while masquerading as protectors of the downtrodden.

Always looking for the politically expedient route, Garamendi has ordered that the California Fair Plan (an industry-financed insurer of last resort) offer its residential fire and earthquake coverage statewide. This enables him to avoid the political heat for approving broad rate increases for insurers, but any Fair Plan losses must be covered by insurers in proportion to their statewide business. This provides additional incentives for insurers to leave the state, a non-problem for Garamendi since it is his successor who will have to clean up the ensuing mess.

Apparently forgetting that involuntary servitude is unconstitutional, Garamendi urges a new law preventing insurers from leaving the market. And, in a final effort to avoid the effects of his decisions, Garamendi wants Congress to come up with a national scheme for government insurance against all natural disasters, an idea that would lead inexorably to politicization of insurance markets across the nation.

For the people of California, escape from the Proposition 103 trap will not be easy. Rates must be allocated in accordance with risks, but that outcome is impossible under the political dynamics of the current system. Depending on the outcome of a case now before the state Supreme Court, the Legislature may be able to force future insurance commissioners to make more farsighted decisions. Or perhaps a new ballot initiative may be required. However difficult a process that may be, the insurance sector is too important to be left to the politicians.