(Bloomberg) -- With the fires in Los Angeles still burning, the cost of their destruction, beyond the lives lost, remains unknown, but is certain to total in the tens of billions of dollars.
The question of whether funds to rebuild homes will be adequate has become a key concern. That’s because in the years before the fires, a pullback by major insurance companies from the city’s housing market left California’s badly overexposed state-backed insurer, FAIR, as the only financial backstop for many homeowners. Others lack insurance at all.
Here’s what to know about the looming insurance crisis Los Angeles homeowners are facing.
Why was California having an insurance crisis even before the Los Angeles fires?
Insurance is traditionally priced to reflect risk. But in 1988, California voters passed Proposition 103, which limited insurers’ ability to raise property insurance premiums, and broke the price-risk feedback loop.
As climate change worsened fire risk across the state, the suppression of premiums had the unintended consequence of making insuring homes in California increasingly unattractive. In 2018, the Camp Fire, which devastated the town of Paradise in northern California, caused an estimated $12 billion in insured damages. Private insurers said they lost decades of profit and began to question whether the California market was really worth it.
In the two years before the fires now devastating Los Angeles, seven out of the 12 biggest home insurers reduced their coverage in California. More homeowners were forced to turn to California’s FAIR plan, which covers homeowners who cannot obtain private insurance.
Created originally to help families who became uninsurable after the 1965 Watts Riots, a series of violent confrontations between police and residents of mostly Black neighborhoods in Los Angeles, the FAIR plan was meant to be a niche insurer. But starting in 2018, it began to grow significantly. By September of 2024, it had expanded in size by a factor of five and had $458 billion in exposure — the total amount it would owe if it had to pay out on every asset it insured.
FAIR, like other insurers in the state, was not allowed to increase premiums sufficiently to cover its risks; the plan, by its own accounting, lacks adequate reserves for a huge catastrophe.
Will owners in Los Angeles whose homes have burned down get insurance payouts?
The short answer is yes — but probably not enough to fully cover the cost of rebuilding.
Big national private insurers should have enough to cover claims on the homes they still insure. If they don’t, and go bankrupt (which is highly unlikely), policy holders will still be covered by a state guarantee fund. (The fund works similarly to the Federal Deposit Insurance Corporation, which insures bank deposits up to $250,000 in the event of a bank failure.)
The FAIR plan likely does not have enough money on hand to pay out all the claims it will receive, but with the approval of California’s insurance commissioner, the program has the power to raise additional money by putting an assessment — similar to a tax — that will be split by the private insurers (relative to their share in the market) and insured homeowners across the state.
Still, there will be money lost. Not everyone has home insurance; it’s only required of homeowners with a mortgage. Also, many homeowners have policies that cap the damage they can claim. If someone bought a home a decade ago and it has greatly appreciated in value, she may not have a policy large enough to cover the cost to rebuild. The FAIR plan pays out a maximum of $3 million. Many of the homes that have burned, particularly in the Pacific Palisades neighborhood, were worth much more than that.
Moreover, a 2023 paper by the Federal Reserve looking at California found post-fire claims are underpaid by 28% on average. That is, owners are only getting about 72% of what they are legally due — likely because they aren’t willing or able to undertake a long negotiation with their insurer and so settle quickly.
How long will it take for homeowners to get insurance money?
Longer than they’d like. After a policyholder files a claim, the insurance company needs to send out an assessor and the assessor needs to file a report. The insurance company then produces a number it’s willing to pay, and a negotiation begins. Sometimes this negotiation even plays out in court. With more than 12,500 structures damaged already in Los Angeles, this process will be repeated thousands of times. After a major natural disaster, private insurers typically bring assessors in from all around the country. It’s not clear whether the FAIR plan, in particular, has the capacity to handle such an event.
Will homeowners be able to build back the same as before?
There will likely be some big changes. In Florida, hurricanes often lead to accelerated gentrification in desirable neighborhoods. The Los Angeles neighborhood of Pacific Palisades, the site of the largest of the raging wildfires, is already wealthy, but even so, the same pattern is likely to emerge as the many homeowners who won’t get enough of a payout to cover a full rebuild depart the neighborhood. Some may choose to settle their mortgage balance and buy elsewhere for cheaper. Homes that are rebuilt will now have to adhere to California’s fire code, which has become stricter since most of the homes were originally constructed. The code’s requirements will also drive up costs. Constructing homes in neighborhoods required to meet the state’s strictest tier of the fire code can be nearly twice the regular price of construction.
Will the fires raise the cost of everyone’s insurance in the US?
Probably. Insurance costs have been rising all across the US for a few years. There are many culprits, including inflation. But a big reason is that reinsurers — the companies that insure insurers in case of big losses — are raising their rates. Swiss Re, one of the major reinsurers, has already said it will continue to raise rates because prices do not adequately cover rising risks from climate change. A big, expensive fire will reaffirm this decision.
In fact, at the end of 2024, insurers won some big concessions from the state. The insurance commissioner agreed that they can pass re-insurance increases to policy holders and use fire catastrophe prediction models in setting premiums. Both regulatory changes were set to cause rates to go up substantially even before the fires.
What is the long-term impact of these fires on insurance rates?
Higher insurance rates make housing less affordable. Research shows that a growing number of people may be at risk of default on their mortgages if insurance continues to rise. In California, there was already an affordable housing crisis, one that will surely be made more intense in Southern California, with nearly 200,000 displaced by the fires. One way to lower insurance is adhering to those stricter building fire codes, but that also makes construction more expensive.
This situation has led California Senator Adam Schiff and other lawmakers to advocate for the development of a federally-subsidized insurance plan for all catastrophes, similar to the National Flood Insurance Plan (NFIP). There are enough people facing high insurance costs across the country that Congress may find common ground for a bipartisan plan. But one way or another, Americans will pay the price for climate change.
(Corrects estimated percentage by which fire insurance claims are underpaid in California)
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