California’s Insurance Industry Was Already Struggling, Will the Palisades Fire Break It?

As I described earlier today, California is facing a massive wildfire crisis. At least 30,000 people were under evacuation orders and as many as 1,000 structures in Pacific Palisades, between Malibu and Santa Monica, have been destroyed. 

The fires aren’t even under control yet, but already estimates of the damage suggest it could be $10 billion thanks to the high property values in the Palisades.

Insured losses from the wildfire that broke out Jan. 7 primarily impacting the residential neighborhood of Pacific Palisades in Los Angeles could approach $10 billion, according to a note Wednesday from J.P. Morgan.

The bank emphasized the preliminary nature of the estimate but noted the 2018 Camp fire in Butte County caused inflation-adjusted insured losses of roughly $10 billion and that the current area affected “is an affluent residential area” with a median home price of more than $3 million versus the median home price of $500,000 in Butte County.

All of this is going to fall a California insurance system that was already teetering. State Farm, the largest insurer in the state announced it would not write policies for any new customers back in May 2023. Allstate followed about a week later and then Farmers Insurance announced they were capping the number of new policies they would write. Hartford Financial Services Group and USAA also pulled back.

Then in April of this year, State Farm canceled 72,000 policies including around 1,600 policies in Pacific Palisades. State Farm’s president wrote to California’s Insurance Commissioner to say this was necessary to prevent the company from going out of business.

“As shared with the Department prior to the February 2023 filing, rate increases alone would likely be insufficient to restore SFG’s financial strength,” Hardin wrote. “We must now take action to reduce our overall exposure to be more commensurate with the capital on hand to cover such exposure, as most insurers in California have already done.

“We have been reluctant to take this step, recognizing how difficult it will be for impacted policyholders, in addition to our independent contractor agents who are small business owners and employers in their local California communities.”

All of this meant that hundreds of thousands of people in the state were forced into a state mandated insurer of last resort, the FAIR plan, which insurers homes no one else wants to cover by taking money from all of the companies that work in the state. 

California faces a double-barreled threat: Private insurers could continue to drop policies and decline to write new ones, as they’ve been increasingly doing since a series of severe fires beginning in 2017 with the Tubbs Fire in Northern California. And the FAIR plan, which has been absorbing the shrinking private market, could run out of money to pay its claims.

That wouldn’t mean going bankrupt, as McLean noted. Instead, it would draw from primary insurers to recoup its costs under state law, raising rates across all private policies and sending rates skyrocketing across the state…

In Pacific Palisades alone, the FAIR plan insures nearly $6 billion worth of property, according to September figures — more than all but four communities in California. 

Because the Fair Plan gets money from primary insurers in the state, those insurers are essentially on the hook collectively for the properties they decided they didn’t want to insure individually. In other words, this disaster is going to impact every insurance company in the state. The question now is whether this new disaster is going to be the last straw for some of those insurers. Put another way, what will the state need to offer to get them to stay?

Michael Wara, director of Stanford’s Climate and Energy Policy program and consultant to the state’s Public Utilities Commission on wildfire issues, said the new rules may not be enough to keep insurers around if the insurance payouts get too high.

“We may have crossed a threshold now where we need larger measures in order to essentially create a solvent insurance system,” he said. “And those measures are going to be politically difficult. They may create substantial risk for the balance sheet of the state of California.”

The cost of insurance premiums, which have already spiked dramatically over the last year, are about to go up even more.