One of the most viral moments from the L.A. wildfires was viewing footage of Lynne Levin-Guzman spraying down her parents’ Altadena home with a garden hose while homes around her were burning. She explained that her 90-year-old parents, who had lived in the house for decades, had abruptly had their fire insurance yanked last year, leaving them uninsured.
Levin-Guzman’s story put a face to the insurance crisis behind the wildfire disaster. Due to the surge in wildfires in California in recent years, insurance giants like State Farm, AIG and Allstate stopped writing homeowner policies in the state. That left many homeowners reliant on the state’s insurer of last resort — the Fair Access to Insurance Requirements, or FAIR Plan, which caps coverage at $3 million per residential property.
But the plan is extremely underfunded, with only about $2.5 billion in reinsurance (insurance for insurance companies) and $200 million in surplus cash. In just the devastated Pacific Palisades area alone, the plan has nearly $6 billion in exposure to wildfires.
As a result, explains former California Insurance Commissioner Dave Jones, it’s very likely that the fund will be quickly exhausted, leading to an assessment in which covering the cost of the remaining payouts will be the burden of homeowners across the state via fees that insurers can legally assess in such extreme scenarios.
Jones, who served two terms from 2011 to 2018 and now leads the Climate Risk Initiative at UC Berkeley School of Law, also emphasized in an interview with Capital & Main the urgent need to tackle climate change and for the insurance industry to consider mitigation measures when setting rates for policyholders.
This interview has been edited for brevity and clarity.
Capital & Main: So far, the insured losses from the Southern California wildfires are estimated to exceed $20 billion and the economic losses are predicted to be between $50 billion to $150 billion. Does the scale of the damage threaten the future of insurance in California?
Dave Jones: The good news is that insurance market analysts believe that this will be an earnings event, not a capital event. So thanks to the strength of California’s insurance regulation, the insurers have enough reserves to cover these losses.
They’re not gonna make money this year. But when they went to the insurance department last year and asked for a whole host of regulatory changes, which they were given, they knew and anticipated and were able to model that there was a high likelihood of severe wildfires occurring sometime this calendar year. And now it’s happened.
So they have been given substantial rate increases over the past couple of years and they’ve asked for more. Last year, my successor [current Insurance Commissioner Ricardo Lara] has changed the rules at their request to allow them to use probabilistic models for the catastrophe load of the rate and to incorporate reinsurance costs in the rate and to reduce their exposure to a FAIR plan [a fire insurance pool comprised of all California insurers] shortfall.
And they said that would be sufficient to get them to start writing policies again. As terrible as this event is, I don’t think it should be a complete surprise to the insurance industry, because the risk has just been getting worse and worse in California due to climate change.
We were already expecting that they were going to come in with very high rate increases and were likely to get them. And now they’re gonna be asking for even more because of the losses here, and it probably will be justifiable.
It remains to be seen what their appetite will be for writing in high-risk wildfire areas going forward. Under the regulations, in exchange for being given the ability to include reinsurance costs in their rates and use cap modeling for the catastrophe load of the rate, they agreed to either increase their writing in the high wildfire risk areas by 5% or write enough policies in those areas commensurate with 85% of their market share outside the area.
I would anticipate that they will be good to their word. But this is a big event. It’s killed people, it’s injured people, it’s wiped out a whole community. And it remains to be seen to what extent they’re going to follow through on their commitments to to keep writing in California.
“We’re not doing enough fast enough to transition away from fossil fuels and other greenhouse gas emitters.”
How should insurance companies be considering the impact of climate change?
The bigger picture is that these catastrophic events in California and across the United States are being driven by climate change. And they’re only going to get worse because we’re not moving fast enough to transition from fossil fuels. And regulatory changes like those that were enacted last year in California may help in the short or midterm to get carriers to start writing again. But in the long term, we’re not going to rate-increase our way out of this problem.
We’re still marching steadily towards an uninsurable future in this country and across the globe, because we’re not doing enough fast enough to transition away from fossil fuels and other greenhouse gas emitters. Global temperatures are predicted to continue to rise, and that has an impact on climate, and that’s driving more severe and extreme weather-related events. The risk and losses associated with extreme weather-related events in the long term are going to overwhelm whatever regulatory changes are undertaken to give insurers more rate faster and to reduce their costs.
In the short term or midterm, the regulatory changes last year will help to get insurance written again. But in the long term, they’re not going to solve our problem, and that’s because the problem is driven by greenhouse gas emissions and fossil fuel production.
The insurance industry is also a big financier of fossil fuel production. Is there a role that the government can play in incentivizing the insurance industry to do less investment in that sector?
Dave Jones: When I was insurance commissioner, we recognized that insurers really had no idea what they were investing in with regard to gas-emitting industries and the financial implications of that. As we transition hopefully from fossil fuels, the value of fossil fuel assets is likely to decline. And one of the things you worry about as an insurance regulator is making sure that insurance companies are invested in things that retain value, not decline in value.
And so I required all 3,000 insurance companies that were licensed in California, which represents probably about 50% of the overall U.S. market, to tell me to what extent they had investments in oil, gas, coal, and utilities that derive more than 50% of their electricity from fossil fuels.
And it was a wake-up call. Because no other financial regulator, including bank regulators, had ever asked them that question. And they had to scramble to answer because they didn’t know. But we started collecting this information and making it public and, at that same time in 2016, five major U.S. banks said they were no longer going to loan into coal because the coal Dow Jones stock indexes had dropped 92% and 35 coal companies had gone bankrupt. So I asked the companies voluntarily to divest from coal, and that resulted in about $6 billion in divestment from coal, and a couple of companies also got rid of their oil holdings, too, for good measure.
Are there things that regulators can do? Yes, they can require transparency and they can strongly encourage the financial institutions they regulate to transition. Beyond that, state legislatures could pass laws requiring banks and insurance companies and other financial institutions to adopt plans to transition out of investing in fossil fuels.
“It’s possible that if these fires aren’t brought under control and there are more structures burned … that we’re going to blow through the FAIR Plan’s reserves and reinsurance.”
It seems like this crisis will almost certainly lead to higher premiums and more people in California will be uninsured, especially low-income and middle-income homeowners. [Per the Consumer Federation of America, 15% of the country’s homeowners who earn less than $50,000 a year are uninsured.]
The number of uninsured is growing because the price of insurance is going up because climate change is driving more losses. And it’s not just the perils we’ve known about historically getting worse — hurricanes, tornadoes, floods, wildfires, extreme heat, drought, right? Those things are all getting worse and more frequent. But there are perils which really weren’t a problem that now are a huge problem because of climate change. Severe thunderstorms accounted for 50% of the natural catastrophe losses from insurance last year. And it’s been at that level for two years running.
The perils we’ve suffered from historically are getting worse and more extreme and killing more people and injuring more people and damaging more people and causing bigger insurance payouts and driving insurers to conclude they can’t cover at any cost.
Currently, as you said, the FAIR Plan is likely to be exhausted. That leads to an assessment and then everyone’s rates will go up a little bit, right?
The FAIR Plan has $5.85 billion in exposure in Pacific Palisades alone. They testified last year that they have $200 million in reserves and $2.5 billion in reinsurance, right? Now we’re at 10,000 structures [that have burned so far], not all of them are FAIR Plan insured, maybe just a fraction of them. But in any event, yes, it’s possible that if these fires aren’t brought under control and there are more structures burned and those structures have FAIR Plan insurance — and some number of them do, because the private insurers stopped renewing in Pacific Palisades — that we’re going to blow through the FAIR Plan’s reserves and reinsurance.
What happens then? Well, in the 32 other states that have FAIR plans, the way it works is the insurers are on the hook, not the policyholders. Two states changed that — Florida and Louisiana. In those states, the insurers said, “Look, we don’t want this on our balance sheet. We need to change this law so that if Florida citizens, Louisiana citizens, have a shortfall, they’ll assess all policyholders, not us.” And the legislatures said, “Yes, we’ll do that.”
Well, the insurers here have wanted that for a long time, and they got it this last year. The insurance commissioner issued an order that said that in the event the FAIR Plan exceeds its claims-paying capacity — the claims above whatever money they have — the first billion will be covered by insurers collectively for residential claims and the first billion of the commercial claims will be covered by commercial insurers. But half of that billion the insurers can assess policyholders to recoup. And then after the first billion, the insurers can just directly assess the policyholders to cover any amounts above the first billion that they get assessed by the FAIR Plan.
And that’s a big change, because the law prior to that was the insurers pay, no mention of the policyholders. So if this happens, people are going to get a notice from their insurer if they still have insurance that they’re getting a rate increase.
If they go to the FAIR Plan, they’re gonna get a rate increase there, and it’s gonna be a big one in both cases, and then they’re gonna get another notice that says, “Oh, by the way, the FAIR Plan exceeded its claims-paying capacity, and here’s an additional assessment on you for that.”
That’s gonna be a rude wake-up call.
I can imagine that it will increase inequality in the state because you’re going to have a lot of low-income and middle-income people who just can’t afford insurance any more.
That’s a problem. So what do we do?
- We’ve got to accelerate the transition from fossil fuel.
- Invest more in mitigation.
- Require the insurers to account for that mitigation in their underwriting models.
- We need to shore up the FAIR Plan.
- We’re going to need a federal program of reinsurance for FAIR plans so that the plans can get cheaper reinsurance and pass that savings on to their costs.
- And then we need either a federal or state premium subsidy program for people on the FAIR Plan that’s means-tested. So low-income people, maybe even moderate-income people, get a sliding scale premium subsidy just like we do with the health benefits exchanges for the Affordable Care Act.
