LA Fires Threaten California Insurance Market Stability, Housing Costs

Read our story on the harrowing evacuations in Pacific Palisades here.

The Los Angeles County firestorm continues to rage, taking at least five lives, causing injuries and destroying thousands of buildings. Many homes in some of the most affected areas are covered by the California FAIR plan, the state’s insurer of last resort.

The fires could further destabilize an already rickety insurance market.

The timing of the disaster threatens to undermine the fledgling progress state officials have made in attracting insurance companies back to the California market. In the past year, officials have overhauled insurance regulations, working to increase coverage availability to consumers in high-risk areas while responding to long-standing industry requests.

“We’re just going to be in a challenging situation. I think it’s not clear yet how challenging it will be,” said Michael Wara, energy and climate expert at Stanford University.

It’s too early to assess the extent of the destruction, but the fires are likely to be one of the most damaging events in state history. JP Morgan issued a preliminary estimate of $10 billion.

Whatever the final tally, the fires are sure to be a major hit to large insurers like State Farm, Allstate and Farmers, and to the California FAIR Plan.

“The fires have hit one of the highest value areas,” said Ben Collier, professor of risk management and insurance at Temple University.

The FAIR Plan lists Pacific Palisades as one of the areas where it is most financially exposed, responsible for up to $5.9 billion. Last year, Victoria Roach, the FAIR Plan president, said the plan has about $200 million in surplus and $2.5 billion in reinsurance.

The state recently clarified what would happen if the FAIR Plan does not have enough money to pay out claims. Other insurance companies will have to pick up the bill — and will be allowed to pass some of the costs onto customers.

The state protects consumers from any changes to their insurance policy for one year following a disaster.

Insurance Commissioner Ricardo Lara said in a statement that his department is committed to ensuring consumers “receive the services you contracted for with your insurance company,” adding that companies are pledging their commitment to the state.

“We will hold them accountable for the promises they have made,” Lara said.

While it’s too early to tell if the fires will eclipse the available FAIR Plan funds, if they did, “then the next round of claims would be paid by a combination of insurance companies and from other policyholders of private insurance companies,” Collier said.

It can already be hard to get insurance in the state, he said, “and this is likely to make the situation notably worse.”

Within hours of these fires breaking out, internet rumors began to circulate that these fires would bankrupt insurance companies, including the FAIR Plan. That is unlikely to happen, experts said, because insurance carriers have planned for this contingency.

In a statement emailed to KQED, a FAIR Plan spokesperson said they are aware of what they called “misinformation being posted online” but added that it is “too early to provide loss estimates as claims are just beginning to be submitted and processed.”

“The FAIR Plan has payment mechanisms in place, including reinsurance, to ensure all covered claims are paid,” the statement said. “The FAIR Plan remains vigilant in working with its customers in these challenging times.”

State’s insurance regulators have been implementing a massive overhaul of insurance rules designed to ease the crisis in the insurance markets and to allow companies to charge what they think aligns with the risk exposure. In response, some companies are loosening up, offering more coverage to attract customers. The fires could backtrack that progress.

The past year has been accompanied by eye-popping rate increases, particularly in areas with wildfire risk. But Wara said the worst is likely ahead of us.

“The rate increases we’ve had, which have been extreme, especially for the people in the high-risk areas, such as the Sierra or Pacific Palisades, but that is a preview at this point of what is to come,” Wara said.

Customers and insurance companies are likely to feel the pain. Companies often use reinsurance — insurance for insurers — to guarantee they’ll have enough money to pay out claims.

“Insurance companies in a catastrophe are like a bank during a bank run,” Wara said. “And as long as you have enough money in the vault to survive the bank run, you’re OK. But reinsurance means you can keep less money in your own vault because someone else’s vault is available to you.”

However, seeing this destruction could prompt reinsurance companies to pull back further from California, meaning insurance companies either have to raise that capital themselves or further reduce their exposure in the state.

While the state regulates insurance companies, it does not get to exert the same level of control over reinsurers. Nor does the federal government.

Insurance is already pricey in California. Make it much worse, and it could become too expensive for many people to own a home here.

“There are places in Florida where insurance costs $50,000 a year,” Wara said. “If that were to happen in California in the wildland-urban interface, we would be in a very different kind of challenge.”

What has been, until now, an insurance problem could balloon into a homeownership problem, where middle- and working-class people can’t own homes because mortgage, insurance and property taxes simply become too much.

“And [then] you have to sell your house,” Wara said. “And you find that your home value has gone down a lot because the cost of owning your home, including taxes and insurance, is a lot higher than it used to be. And that’s where we might be heading. I hope not.”

But the chances that we are moving in that direction went up as soon as the fires broke out.