California’s home insurance crisis is just beginning
With private insurers leaving — and a state-backed program on the hook for billions in payouts — owners may struggle to protect their high-risk homes.
Key points:
- Thousands of homes have been lost in January’s wildfires, which will undoubtedly strain both private and public insurers and exacerbate the ongoing insurance crisis.
- California’s state program — the FAIR Plan — faces so much exposure that it may need to be bailed out.
- If existing insurance markets become too expensive or simply nonviable, other models may emerge, like community or parametric insurance, one expert said.
As Los Angeles-area residents displaced by fires return to their damaged or destroyed homes, they will face decisions and questions about rebuilding. But another fundamental issue — and a major unknown — is the future of home insurance in the region.
According to the official LA County recovery effort, over 15,000 structures have been destroyed so far, and First American puts the number even higher at 17,000 to 24,000 housing units. Officials said another 19,000 homes remain threatened — but that was before a new blaze, the Hughes fire, broke out Jan. 22 near Santa Clarita. That fire has already grown to more than 10,000 acres and is only 14% contained as of Thursday morning.
An already-challenging insurance environment
With fires and other disasters increasing in frequency and severity, insurance providers face more exposure. Prior to this month's wildfires, seven companies had already begun limiting or discontinuing homeowners coverage in California, according to Newsweek. One of the most consequential announcements came last March, when State Farm — the largest insurer in the state — said it would not renew policies for 72,000 California properties. A year earlier, both State Farm and Allstate, another major provider, had stopped issuing new homeowner policies.
As private insurers continue to pull out, who will step in to replace them? And if insurers have determined that certain homes — or entire regions of the U.S. — are uninsurable, does that mean the free market has effectively declared these places to be uninhabitable?
"I think the important thing to remember about insurance is it is a financial risk-transfer mechanism — it doesn't actually reduce risk," Lindsay Brugger, vice president of resilience for the Urban Land Institute, told Real Estate News. "Insurance pricing has multiple factors, and the higher frequency of weather-related claims is absolutely one of them."
Regulations intended to limit insurance costs have been a double-edged sword, she believes. "California has really protected homeowners from rising insurance rates, and understandably so," she explained. "But because of those regulations, the risk that homeowners face has not been able to be priced accurately."
The consequence? Insurers are not keen to issue or renew policies, "because they are not bringing in enough premium to pay out all of the claims that are coming in as weather-related claims increase due to climate change," Brugger said.
The limitations of state-backed programs
With fewer options for affordable private insurance, the state has stepped in to offer its own program — the California FAIR Plan — but it may not remain viable.
The FAIR Plan only covers up to $3 million for an individual property — a substantial amount, but in an area with median home values close to $1 million, according to Zillow, many properties may not be fully covered. And in the wake of the recent wildfires, the fund, which could be on the hook for upward of $5 billion in payouts, now faces so much exposure that it may need to be bailed out, further exacerbating the state's ongoing home insurance crisis.
"Right now, there are 36 state-backed insurance programs in the U.S., and they each offer coverage for natural catastrophes. But of those 36, 21 do not explicitly detail how they would pay any deficit that might occur," Brugger explained. "So that means 21 of those programs wouldn't know what to do if they exhausted all of their reserves. In some cases, they might have to turn around and tax policy holders or put an assessment out, or they might look to the private sector."
What options remain for LA-area homeowners?
Seydina Fall, a senior finance lecturer at Johns Hopkins Carey School of Business, described the private insurance industry as a "market failure" to Real Estate News, but said emerging models may help complement or replace existing private insurers.
One would be a community-focused insurance model where individual communities "start insuring themselves." They would "share the profits when a disaster doesn't happen" but have their own liquidity pool in the case that a disaster does happen, Fall explained. Another is parametric insurance, which evaluates the risk and cost of a trigger event — or parameter — and cuts it into "small slices." Payouts, which are predetermined, are issued when the parameter is triggered instead of being tied to specific property losses.
But a more fundamental question — which may be unpopular with communities and homebuilders — is whether to rebuild at all in places where the "risk is so huge," Fall said.
"If the area becomes not habitable, even if you're wealthy, you're not really going anywhere with that," he explained. "We need to allow nature to regenerate and rejuvenate the environment."