One Event Away
Welcome to the reckoning.
What follows was reported and written by Mary Williams Walsh. It was originally posted at News Items.
Alarm bells for California real estate were ringing long before the wildfires broke out. Almost a year ago, the head of California’s insurer of last resort told state lawmakers that uninsured homeowners were piling into her organization so fast they were going to swamp it.
“We are one event away,” said Victoria Roach, head of the California FAIR Plan, where homeowners go for insurance when no one else will sell it to them. The FAIR Plan may not be a household name, but it’s an important cog in the machinery that has kept California’s property markets humming for half a century.
Now, that one dreaded event is playing out in Los Angeles County, and the machinery is breaking down. The FAIR Plan had a $200 million surplus before the fires. That won’t last long. Ms. Roach said the organization has a good backstop to draw on, $5 billion of reinsurance – but the reinsurance has a $900 million deductible. Per event.
Are the wildfires one event? Half a dozen? Who knows? Either way, the numbers don’t work.
The California FAIR Plan isn’t part of the government. It doesn’t get taxpayer bailouts. It’s a creature of the insurance industry, with the power to assess all property insurers regulated by the California Insurance Department, based on their market share. But how will that work, really, when the property insurers are going to be struggling to pay their own policyholders’ wildfire claims? The big ones have been trying for several years to reduce their exposure to California. Will they really give the FAIR Plan the millions it needs to pay the claims of homeowners they’ve recently dropped?
That’s why the California FAIR Plan has been growing so alarmingly fast – the big insurers have been “non-renewing” hundreds of thousands of California homeowners. That’s insurance lingo for when an insurer tells policyholders it won’t cover them any more when their current policies expire. Many of those homeowners then found no one else would insure them and turned to the insurer of last resort, pushing it to the brink.
If the FAIR Plan were to fail, it could put the lie to the notion that California real estate is good as gold – that lenders will always finance a purchase, knowing the debt will be secured by a house that’s insured, even if it’s standing in a wildfire zone. For half a century home-buyers haven’t had to worry that their deals would fall through before closing, for lack of insurance. “We take all comers,” Ms. Roach testified last year.
California real-estate values have thus held up through riots, earthquakes, municipal bankruptcies, the mortgage meltdown of 2008, even the state’s unsuccessful plea for a federal bailout in 2009. A mid-tier California house sells for more than twice the price of a mid-tier U.S. house. ($773,000 versus $375,000, according to the California Legislative Analyst’s Office.) But now, the wildfires and the fate of the FAIR Plan, and the insurance companies that back it, may finally show that parts of California, however desirable, are uninsurable, and therefore uninhabitable.
The California FAIR Plan was formed in 1968, after deadly riots in south-central Los Angeles made it impossible for small businesses to get insurance there. It soon expanded into home insurance for people living in designated brush-fire zones. After the Northridge earthquake of 1994, it dropped its geographic restrictions and agreed to insure property anywhere in the state.
Its policies are no-frills, and they cost more than regular insurance. Payouts are capped at $3 million for a home and $20 million for a commercial building – bad news for the burned-out residents of Pacific Palisades, where the average house was worth $3.4 million before the fire, according to Zillow. Because of recent non-renewals, Pacific Palisades has one of California’s highest concentrations of FAIR Plan policyholders.
But FAIR Plan policyholders aren’t going to be the only ones getting less than they expected. Researchers at the Federal Reserve Bank of Philadelphia found that nearly 40 percent of earlier California wildfire claims were underpaid by insurers. Insured homeowners expecting to receive the full cost of rebuilding were getting 28 percent less.
“A back-of-the-envelope calculation suggests that households receive about $200,000 to $300,000 less than their entitled amount under California law,” the Fed team reported in 2023.
It appeared many California households were taking their underpayments, using the cash to pay off their mortgages and leaving town, not holding out for more money to rebuild on site. Fighting an insurer isn’t fun, especially when you’re traumatized, living in temporary digs, or waiting in line with hundreds of other families all trying to get money out of the same insurer. And besides, California costs too much, remember? The house they would need $773,000 for in California can be had for $375,000 in another state. People want to get on with life. When they leave their charred ruin behind, someone with deeper pockets is apt to buy it and rebuild, widening California’s wealth-distribution chasm that much more.
That’s what happened in 2018, when a power line in north-central California sparked the Camp Fire, then the most destructive wildfire in state history. It raged from town to town, most notably to Paradise, population 27,000 at the time. There was only one road out of Paradise. It became gridlocked as people tried to flee. Cars became death traps. Eight-eight people were killed and thousands of homes destroyed.
“Paradise is Gone,” said the headline in The New York Times.
But Paradise isn’t gone. Today it has a remarkable new lease on life, thanks in large measure to the California FAIR Plan. For three years in a row, Paradise has been California’s fastest-growing town. Its population is back up to about 11,000. Developers are building houses, and residents of California’s pricey coastal cities have been cashing out and buying them. Despite recent bad experience, the FAIR Plan covers the houses, so lenders are willing to finance the deals. When the Camp Fire roared through, the FAIR Plan insured 9 percent of the houses in Paradise. Now its business in town has tripled. The median home value is said to be $450,000.
Still, there’s trouble in Paradise. Longtime residents whose houses were destroyed by the Camp Fire say they were not made whole by their insurers. One insurer went broke trying to pay claims, leaving its policyholders at the mercy of the California Insurance Guaranty Association, a slow-moving equivalent of the FDIC that never makes anybody whole. After a long wait, the survivors got more money from PG&E, the power company whose equipment started the fire. But it still wasn’t enough to rebuild. They say they can’t compete with the newcomers and are being priced out.
That’s a likely indication of what the coming months will be like in the Los Angeles area. Delays, disappointments, and making do with less.
After the wildfires of 2018, a state senator named Ricardo Lara wrote a bill that put a one-year moratorium on insurance non-renewals in the affected ZIP codes. It passed. Lara, a career politician with no background in insurance, then ran for state insurance commissioner and won. More on his role in a moment.
The year 2018 was a turning point in California. Home insurers were profitable up until 2017, taking in about $7 billion per year in premiums, in the aggregate, and paying out $3 billion to $4 billion of claims. But in 2017, after taking in the usual $7 billion of premiums, they found they had to pay more than $15 billion in claims. Wildfires burned down 10,868 structures in California that year, a record. Then the 2017 record was immediately eclipsed by the wildfires of 2018, which destroyed 24,226 structures.
In those two years, California’s home insurers lost enough money to wipe out all their profits from the previous quarter century.
In most places, big insurance payouts signal that higher premiums are on the way. To oversimplify: Insurers get money to pay claims by collecting premiums. The premiums are supposed to reflect the price of the risks the insurer is taking on. If payouts on claims keep outweighing the premiums taken in, the company will look for the reason, notify its state regulator, and adjust its rates upward. Regulators require insurers to keep a balanced book of business, and insurers can’t do that if they hold premiums flat while claims costs surge ahead.
You knew that already, but it bears repeating here because it helps to explain what’s been going wrong in California. In California, personal insurance rates are harder to raise than elsewhere, thanks to a celebrated 1988 ballot initiative, Proposition 103.
California went to war that year over car insurance. Auto premiums had been rising much faster than inflation, and some insurers were effectively redlining, basing people’s premiums on their ZIP codes. Prop 103 called foremost for sweeping auto-insurance reform, but home insurance was written into it too.
The election campaign was a pitched battle, with personal-injury lawyers and hundreds of insurance companies duking it out with big-name consumer advocates like Ralph Nader. The consumer advocates painted the insurers as greedy predators, abetted by supine regulators. The insurers spent tens of millions of dollars fighting the reform. They knew they’d have to live with it for a long time, because California makes successful ballot initiatives hard to repeal.
The consumers won. Proposition 103 rolled back everybody’s car and homeowners premiums by one year, then cut them another 20 percent. And it sought to keep premiums low, with demanding rules the insurers had to follow if they wanted a rate increase. Prop 103 also made the state insurance commissioner an elected official, with the duty “to ensure that insurance is fair, available, and affordable for all Californians.”
No one stopped to say, “Wait, what about climate change? What if carbon emissions warm the seas and super-charge our wildfires? How can the California insurance commissioner keep insurance fair available and affordable for all Californians then?” It wasn’t an issue in 1988.
Thirty-seven years later, it’s very much an issue for property insurers. They don’t sit and wonder whether climate change is real. They’ve developed sophisticated, forward-looking modeling techniques to project their exposures to climate-driven perios and the likely costs. And reinsurers, which California doesn’t regulate, have been factoring the cost of climate change into their prices. That’s of great interest to the regulated insurers because they use reinsurance to increase their capacity. But in California, Prop 103 bars them from including the cost of reinsurance in their rate proposals.
It’s the same with those sophisticated, forward-looking catastrophe models. The 49 other states let insurers use the models to set their insurance rates. California is the only state that prohibits this. It still requires insurers to base their proposed increases with a 20-year cost look-back. It misses today’s fast-moving trends.
You can see the results in home insurance prices around the country. California has the nation’s most expensive housing and its most destructive wildfires, so you’d expect its home insurance to be the most expensive too. But no. According to bankrate.com, the average annual premium to insure a $300,000 dwelling in California is $1,381 – 37 percent less than the current national average for such a house, $2,181.
Since rates aren’t keeping up with costs in California, the industry has been reducing exposure by non-renewing homeowners. Hundreds of thousands of people have been getting the letters. Often the ones who get them are the ones who need insurance most.
They’re frightened and angry. Once you’ve been dropped, they say, it becomes impossible to get coverage from another insurer unless you pay a lot more. It doesn’t matter if you’ve pruned your trees, replaced your bark mulch with pebbles, or taken other steps to make your house “resilient.” People feel trapped in houses they’ll no longer be able to sell.
Ricardo Lara, the insurance commissioner, had promised to stop the non-renewals, but he spent much of his first term fending off ethics complaints, having repeatedly broken a campaign promise not to take money from the industry. There were calls for his resignation, but in 2022 he won re-election. The non-renewals kept coming, thick and fast.
And not just non-renewals. In 2023, Allstate, State Farm, and several other insurers announced they were going to stop writing new business in California altogether. The FAIR Plan was tottering. Desperate homeowners were making down with policies that covered fire but not wildfire. A shocking number were opting to “go bare” – not insure their houses at all.
That fall, Gov. Gavin Newsom issued an executive order calling on Lara to save the market.
Lara responded with what he called the Sustainable Insurance Strategy, a trade: He would make it easier for insurers to get rate increases; they, in turn, would go back to the regions they’d abandoned and resume writing policies there. It was an incredibly ambitious and complicated deal, but Lara promised it would be up and running by the end of 2024.
It wasn’t a bad idea. But Lara struggled to pull it off. Californians may not be rabid climate-change deniers, but when hundreds of thousands have lost their home insurance, they tend not to see catastrophe modeling in the rate-making process as a top priority. Consumer groups had long since lost faith in Lara for taking money from the industry after promising not to. One group in particular, Consumer Watchdog, took to issuing a steady stream of press releases warning that he was letting insurers use “private black box models” and “secret algorithms” to pick consumers’ pockets.
John Garamendi, California’s first elected insurance commissioner and now a Member of Congress, said he was “very concerned about the way in which the current commissioner has conducted himself in this office” and suggested Lara step down. He and 31 other members of California’s Democratic Congressional Delegation wrote an open letter to Lara, warning that his work “could threaten important consumer protections” of Prop 103. It did not acknowledge that the real culprit was climate change.
In November, with Lara’s year-end deadline looming, a respected policy research group, the Little Hoover Commission, issued an exhaustive study of the home-insurance crisis and how California might best respond to it. The report opened with a glaring rebuke of Lara, saying he was the person the commission most needed to talk with, and he had dodged the group for more than a year. It called his behavior “inexplicable and irresponsible,” and expressed doubt that the Sustainable Insurance Strategy would be in force by year-end, as promised.
On Dec. 30 Lara issued what the last installment of his magnum opus. It still wasn’t in force yet. It had to be vetted by the state’s administrative lawyers. But that didn’t stop Lara from saying he had completed “the largest insurance reform in 30 years for California.”
Said Consumer Watchdog: “This plan could drive up the price of home insurance by 40 percent.”
A good question to ask at that point would have been: What if it really does cost that much? But nobody asked.
One week later, the wildfires were raging out of control in Los Angeles County, providing an answer of sorts: Yes, it really does cost that much. In an age of climate change, there isn’t going to be any home insurance that’s “fair, available, and affordable to all Californians”. Wishful thinking won’t make it so. Welcome to the reckoning.