Final answer:
Before 1988, California's insurance market lacked regulatory price controls, allowing the market to dictate premiums. This balancing act, governed by the fundamental law of insurance, required the average payouts not to exceed collected premiums. Regulatory attempts to mandate low rates can cause insurers to exit markets to avoid financial losses.
Step-by-step explanation:
Prior to 1988, insurance companies in California operated in a market where they could set rates based on market demand without regulatory intervention. This condition could have been characterized by a variety of terms; however, 'market stability' might not be the most accurate description. Instead, this environment was better defined by the absence of price controls, which allowed insurance premiums to fluctuate according to the risks presented by insured parties and the decisions of the insurance companies.
The principle behind this approach is that insurance practices must ultimately balance the premiums collected with the payouts made, known as the fundamental law of insurance. Insurance companies continuously evaluate the extent of risk they are willing to take on, adjusting their rates to manage potential losses and ensure profitability.
When government regulators attempt to impose low premium rates, insurance companies may respond by avoiding high-risk or even medium-risk clients to maintain their financial viability. If compelled to charge rates below the actuarially fair level, insurers could either require other customers to make up the difference in premiums or decide to withdraw from the market entirely. Historical examples include situations in New Jersey and Florida, where onerous regulations led to insurance companies exiting those markets rather than sustain untenable financial positions.