Los Angeles is burning. But California’s insurance industry is not about to collapse.
This analysis is in response to breaking news and will be updated. Please contact pr@rstreet.org to speak with the author.
Five fires are raging in the Los Angeles outskirts currently – the Palisades Fire, the Eaton Fire, the Lidia Fire, the Sunset Fire, and the Hurst Fire. They have been stoked by a trifecta of 100 mph wind gusts, elevated heat, and bone-dry grass and shrubs serving as tinder. The severity of the fires has raised questions about the role of climate change in the conflagrations and insurers’ claims-paying capacity. But while we recognize the immensity of the hardship and tragedy to many Angelenos from the fires, we also must recognize that California’s insurance industry is not about to collapse.
Many have ignored or missed recent reforms to California insurance regulation that are poised to make the private market more sustainable, and help stem an exodus of insurers from the Golden State.
Whether the intensity of wildfires is exacerbated by climate change is an open question. An R Street study found that natural catastrophes have increased in severity, but not in frequency. And the main reason catastrophe severity has risen is an increase in the built environment – there is simply more stuff now to be destroyed.
California has long been a personal lines insurance problem state. Insurance companies writing homeowners’, automobile insurance, and workers’ compensation insurance have periodically moved in or out of the state, depending on whether they could make a dollar in California’s overly restrictive insurance regulatory environment. Insurance troubles in the state go back to 1988, when ballot initiative Proposition 103 was passed. This effectively prevented insurance companies from raising their rates in accordance with risk magnitude. It also prohibited insurance companies from using forward-looking catastrophe models, and prevented them from incorporating the cost of reinsurance in their ratemaking (reinsurance is like a shock absorber for insurers–it provides insurance for insurers and allows them to reduce their own risk).
The glimmer of good news for insurance companies is that after 37 years, the California Department of Insurance has finally seen the light. It is relaxing its restrictive position on insurance companies incorporating the impact of reinsurance cost and the use of forward-looking catastrophe models. The state’s insurance commissioner, Ricardo Lara, has agreed to allow insurers to use insights gleaned from forward-looking models, and to take the cost of reinsurance into account when calculating premiums. Further good news for insurers is that the cost of property catastrophe reinsurance, which provides coverage for insurance companies, has gone down on January 1, the date on which annual reinsurance treaties are negotiated.
On December 30, 2024, days before the outbreak of the Palisades fire, data and analytics provider Verisk submitted to Insurance Commissioner Ricardo Lara its application to have insurers employ its wildfire model in their calculation of insurance rates and premiums. This is a major step forward because a forward-looking model takes into account current trends in wildfires, whereas traditional models rely only on past data, assuming the future will resemble the past, which it likely won’t.
Introduction of the new California insurance reforms, called Sustainable Insurance Strategy, is admittedly late, and may not get the attention it deserves in light of the tragic wildfires rightfully garnering the most media attention.
Insurers are financial first responders. By matching their capital to the risks they bear, they are designed and managed to pay policyholder claims on catastrophes such as the current southern California fire cluster, and historically large wildfires such as the Camp Fire. The 2018 Camp Fire resulted in $13.7 billion in insured losses, caused 85 fatalities, and destroyed over 18,000 structures, with an estimated $16.5 billion in damage. As of Wednesday, January 8, the estimated number of homes destroyed in the Palisades fire was 1,100, though a news source indicated the number of homes affected is “uncountable” in light of the dangerous conditions. Pacific Palisades is a wealthy community, with average home values of $3.5 million, suggesting that insured losses would be on the order of $4 billion if 1,100 homes suffered total loss, and assuming cost to rebuild is correlated to property value. This does not, however, take into account the fire continuing to spread, and also does not take into account the impact of reinsurance, which lessens the blow to primary insurers.. One reliable source indicated on January 8 that insured losses would be in the $6 billion to $13 billion range.
The 2023 loss ratio for California homeowners’ insurance was 72.07%, which means that for every dollar of premium insurers earned, they paid out 72 cents in losses. Adding 30 points of expense ratio, meant that the financial result in the state in 2023 was just slightly below break even. This suggests that, barring numerous more such wildfires in 2025, the wildfires could be an earnings event rather than a major dent to insurers’ capital.
The year is young. Let’s hope that in these tragic fires, no more lives will be lost, the reforms will kick in, insurers will have more confidence in their ability to do business in California, and homeowners will be able to get the insurance coverage they need.