The wildfires burning in California are not out. In fact, winds have been picking up today and at least one new fire, dubbed the Auto fire, has started in a dry river bottom overgrown with brush.
The entire state is facing another potential disaster as a result of these fires. Even if they were all somehow put out by tomorrow, the damage is already severe enough that it will likely put a major strain on insurance companies which were already fleeing the state. Current estimates suggest the losses associated with these wildfires could be in the range of $30 billion or more.
Multiple fires raging across the Los Angeles area will cost insurers as much as $30 billion, Wells Fargo and Goldman Sachs estimated in a report released this week.
After accounting for non-insured damages, the total costs will balloon to $40 billion, the report said.
The ongoing fires, according to analysts, “appear to already be the costliest wildfire event in California history.”
As I described here last week, so many California insurers have been cutting back on new policies or simply leaving the state that many homeowners have been forced to sign up with a state created insurer of last resort called the FAIR Plan.
Unlike regular insurance companies, the FAIR Plan can’t refuse to cover homes just because they’re in vulnerable areas. As a result, as the risk of wildfires grows, homes deemed too dangerous by major insurers have been piling up on the FAIR Plan’s books.
Between 2020 and 2024, the number of homes covered by the plan more than doubled, to almost half a million properties with a value that tripled to about half a trillion dollars.
One of the major areas where homeowners found themselves dumped onto the FAIR Plan was Pacific Palisades, site of the worst damage so far. So at this point, you may be wondering how much money the FAIR Plan has on hand to cover these losses.
As of last Friday, the FAIR Plan had just $377 million available to pay claims, according to the office of Senator Alex Padilla, Democrat of California.
So expected losses of $30 billion (at a minimum) and the FAIR plan has about a third of one billion on hand. Obviously that's not going to go very far. But the FAIR Plan has two other options to get money to cover losses. One is called reinsurance and it's basically insurance held by insurance companies in case their losses top their available funds, which is obviously going to happen in this case. How much reinsurance does the FAIR Plan have?
Senator Padilla’s staff said the plan has $5.75 billion in reinsurance available.
That's a lot of money but obviously if the total losses exceed $30 billion, the FAIR Plan's share of that could easily exceed $6 billion. And that brings us to the special feature the FAIR Plan has as an insurer of last resort. When all else fails, they can simply bill the remaining insurers in the state to cover their losses. And that means that even if major insurers aren't wiped out by the losses on their own policies once this is over, they could be getting a massive bill to cover the FAIR Plan losses as well. Neil Alldredge, president of the National Association of Mutual Insurance Companies, says this could be a deal breaker for some of them.
The insurers that have stayed in California were already struggling to make money, Mr. Alldredge said. If they also get a bill from the FAIR Plan, some may reconsider their decision to stick around, he said.
“Will some of them evaluate their risk appetite? Absolutely,” Mr. Alldredge said. “None of this is going to make the California market more attractive.”
Potentially this becomes a downward spiral. If more companies leave, that means more business winds up on the FAIR Plan and fewer remaining insurers are on the hook for the next disaster. So it's not just that it could be very bad financially this time, it's that it could get even worse next time. At what point to insurers decide it's not worth the risk to stick around? That's the question many of them could be asking in a few months.
The only carrot the state has to offer here is big premium increases. In order to keep this from becoming an insurance death spiral, rates will almost certainly go up again. Regular homeowners who get the premium hikes may be thinking about leaving California too.
All of this was entirely predictable and was in fact predicted by the president of the FAIR Plan who warned last March, "We are one event away from a large assessment." She added, "There’s no other way to say it, because we don’t have the money on hand and we have a lot of exposure out there."
The FAIR Plan knew in 2021 that it needed to request a 70% premium increase in order to be prepared for the amount of risk it was taking on but because all requests have to be approved by state regulators they asked for 48.8 percent. What they actually got was 15.7 percent. And that's why the plan with major losses in these fires has so little money on hand.
