California offers valuable lessons for insurance law

California and New Zealand face similar insurance issues but have taken markedly different approaches, says Associate Professor Rohan Havelock.

The Auckland Law School academic’s recent research visit to California saw him meet with officials from the California Department of Insurance (CDI) in Los Angeles and the California Earthquake Authority (CEA) in Sacramento.

Havelock says the conversations gave him fresh insights into the strengths of New Zealand’s arrangements and potential areas for reform.

He points to three key lessons:

1. California takes a more interventionist approach to regulating insurers

For most property and casualty insurance, California requires regulatory approval of premium rates to ensure they’re not excessive, inadequate or unfairly discriminatory.

Insurers must also comply with detailed claims-handling rules. The CDI regulates insurers in California, including premiums, claims handling and consumer complaints, and can require corrective action or pursue enforcement proceedings.

“What struck me was the degree of active oversight,” Havelock says. “The CDI is very proactive. It scrutinises insurers’ conduct; assists in resolving consumer complaints; uses those complaints to identify potential problems across the market; and periodically takes enforcement action.”

New Zealand has recently strengthened its financial conduct regime by creating broad “fair conduct” duties. But, Havelock points out, still allows private insurers to set premiums as they see fit, and doesn’t prescribe how they must administer or respond to claims. He sees scope to consider more targeted oversight, while cautioning against importing California’s model wholesale.

“California and New Zealand have very different insurance markets, regulatory histories and institutions. New Zealand also has a small pool of insurers, so heavier regulation could increase costs or discourage participation. The question is where additional safeguards would be worthwhile without compromising insurance availability and affordability.” 

2. California offers a different way of financing earthquake insurance

Earthquake insurance is voluntary in California. Insurers offering residential property insurance are legally required to also offer earthquake cover. Major losses after the Northridge earthquake in 1994 prompted some to restrict or withdraw from the homeowners market. The CEA (established in 1996) is a publicly managed, privately funded organisation that provides residential earthquake insurance through participating private insurers. It gives insurers an alternative to underwriting earthquake insurance themselves, allowing them to satisfy the mandatory offer requirement.

The CEA began with contributions from participating insurers and now draws on policyholder premiums, investment income, accumulated capital, reinsurance and capital-market protection.

It also has access to contingent financing, including possible insurer assessments and policyholder surcharges. It doesn’t operate with public funding or a government guarantee of its liabilities, says Havelock.

Meanwhile, New Zealand’s Natural Hazards Insurance Scheme is funded principally through homeowner levies, accumulated funds and reinsurance, but ultimately benefits from a statutory Crown funding backstop if the Natural Hazard Fund can’t meet forecast payments.

“This raises an important issue about who ultimately bears the financial risk,” Havelock says.

“The Crown backstop provides valuable security to New Zealand homeowners, but it also creates a potentially substantial taxpayer exposure. This is compounded by the fact that Treasury has calculated that the scheme will be underfunded by approximately 34percent over its first five years.

“California shows that there are other ways of allocating some of that risk.”

3. California offers more direct help to strengthen vulnerable homes

California supports targeted grant programmes for seismic retrofitting, including work to secure older houses to their foundations and to strengthen vulnerable buildings. The CEA also offers premium discounts for qualifying retrofits.

New Zealand’s approach is based on research, guidance and voluntary strengthening at homeowners’ cost. However, there’s no comparable nationwide grant programme for seismic strengthening of private residential homes.

“This may be one of the more readily adaptable ideas,” Havelock says. “California does more than encourage or advise homeowners to strengthen their properties. It helps eligible owners pay for the work.

“Carefully targeted assistance here could reduce damage, future insurance claims, and ultimately, the costs to the Natural Hazard Fund and taxpayers.”