Economists say the 'winner's curse' is another reason for California's high home insurance rates

Many factors driving up the price of homeowner insurance in California are well-documented. There’s the fact that wildfire risks have been creeping into more populated areas of California in recent years because of climate change, as well as a lack of competition due to many insurers leaving the market.

But there’s another less known factor, according to a new working paper by University of California researchers: an economic principle called the “winner’s curse.”

Wait, how can winners be cursed?

If it’s been a while since your last economics course (or if you never took one), the winner’s curse refers to a concept by which firms that “win” certain customers’ business might end up losing money in the long run because they are taking on higher risks.

“Imagine you and I are insurance companies and we're competing; we're operating in the same market,” said Meredith Fowlie, an agriculture and resource economics professor at UC Berkeley. “You are getting granular, high-resolution wildfire risk data and assessments, and I'm not.”

In this case, the insurance company that uses less-detailed data to set its prices assumes it's only “winning” customers whose properties carry high risks. If not, the logic goes, why else would its competitors with more detailed information on the risk of wildfires not snap them up?

“The winner's curse here is the homes I'm winning,” Fowlie said.

How does the winner's curse affect pricing?

Insurers with less detailed data are reasonably led to believe that the homes left on the market are higher-risk properties that other insurers passed up (or set prohibitively high prices for).

In these cases, insurers “don't want to price it the average because [they’re] concerned,” Fowlie said — so they raise their prices due to these real concerns.

And that, the researchers found, contributes to insurers setting higher homeowner insurance premiums and even withdrawing from some large markets with risks that are difficult to model or predict, like wildfires.

Other factors affect pricing, too

Fowlie stressed that she and her fellow researchers only studied the winner’s curse in relation to wildfire risks and not other natural disasters like floods psor earthquakes.

“There's a number of factors putting an upward pressure on prices,” Fowlie said. “We are not suggesting this is the one and only, but we did want to sort of elevate consideration of one of the factors that could be pushing prices up.”

The need for better data

One big way to mitigate the effect of the winner’s curse on pricing, Fowlie said, was improving access to granular data on risk for a particular area or property. That can help insurers come to pricing decisions based on hard information rather than assumptions about risk and pricing based on the market.

While the study focused solely on how access to data on wildfire risk affects pricing, other studies have demonstrated the benefit of property-level and neighborhood-level data when it comes to assessing risks of other natural disasters like flooding.

These factors will be especially important as officials try to get a handle on the insurance affordability crisis as more and more of the state faces risks of wildfire, even leading some insurers to exit the market.

“This was not what we fully expected going into this research: That insurers in the same insurance market are taking very different approaches to pricing wildfire risk,” Fowlie said.