By Sungcheol Jin
The author is the business news editor of the Korea Daily.
In a free market economy, the balance between the invisible hand and the visible hand is crucial. An excess of power in the invisible hand can lead to market failure, while too much interference from the visible hand – the government – may cause government failure.
The invisible hand, a fundamental concept in free market economics, was first introduced by the British economist Adam Smith in his book “The Wealth of Nations.” It describes the efficient production and distribution of goods and services through market-driven price determination. In a competitive market devoid of government intervention, high profits lead to increased production, which in turn boosts supply and reduces prices. This process naturally balances supply and demand through price mechanisms, eliminating the need for artificial government regulation.
Nobel Prize-winning economist Milton Friedman, in his book “Free to Choose,” strongly criticized government intervention in the market. He argued that excessive government interference and regulation could distort the market and lead to government failure, resulting in inefficient production and distribution.
This phenomenon is currently unfolding in the homeowner’s insurance market in California, and the auto insurance market is on a similar path. On November 13, four home and auto insurers announced their withdrawal from the California market, citing government-imposed limits on premium increases as the reason. The government’s artificial control of prices disrupted the balance of supply and demand. Under California law, any proposed increase in home and auto insurance premiums must receive approval from the California Department of Insurance.
For years, insurers have sought double-digit premium increases, pointing to frequent natural disasters, inflation, and rising costs. However, the California state government has typically approved increases of less than 7%. Requests for larger increases undergo a stringent government review process, often leading to rejection. Consequently, insurers are compelled to cap their rate increases around 7%. Yet, insurers’ loss ratios have soared due to escalating costs from mega wildfires and inflation. As a result, many have opted to exit the California market, citing unsustainable losses.
With the withdrawal of these insurers, options in the market have significantly dwindled. For instance, seven of the top 15 home insurance providers by market share have either ceased offering homeowner’s insurance policies or are restricting new enrollments. This contraction in supply has led to soaring premiums, and some consumers are unable to obtain insurance at all, leaving their homes uninsured. For many, their home is their most substantial However, due to inappropriate government intervention in the market, they are left without adequate means to protect their assets from risks.
Insurance industry stakeholders and consumers acknowledge the necessity of government oversight. However, they argue that the current crisis could have been averted if the government had responded more flexibly to changing conditions in the insurance industry, such as climate change or inflation.
In response to the insurers’ departure, the California Department of Insurance recently proposed allowing climate change to be considered as a risk factor when setting homeowner’s insurance premiums, effectively giving insurers the ability to raise premiums beyond 7%. However, this policy change will not take effect until late next year, too late for insurers who cannot afford to sustain losses for another year.
Market economies function best when there is a balance of power between the visible and invisible hands. The California state government needs to listen to both suppliers and consumers, implementing a policy that satisfies both parties soon, to stabilize the home insurance market.