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I am sure that we have all been following the current tragedy going on in Los Angeles with the large fires burning there. One of my friends in the insurance industry told me that he had heard from someone in the reinsurance business that the total insured losses from these fires will be more than Twenty Billion Dollars.
So, I have been thinking about how a catastrophe of this magnitude could be financed. In insurance, everything depends on the pool of risks that are to be covered by the insurance. Let us consider who should be in this pool. How about using all the homes in the LA Basin? This is a pretty big geographic area including all of LA and Orange counties. There are about 1.39 million homes in the basin. Certainly, this is a large enough number of homes for the law of large numbers to work if we had a loss history which would allow an actuary to set rates.
Suppose these homes are currently paying an average annual premium of $2500 each. This would produce a total annual premium of $3,475,000.000. The $2500 premium has been enough in our hypothetical pool to cover all the losses and expenses of running our pool for each of the past 5 years.
I think that you can begin to see the nature of this problem. The $20B loss represents 5.45 times the total annual premium the pool has been collecting each year. And, our pool does not have $20B laying around. So, perhaps we could borrow the money using the future premiums as collateral and increase the premiums enough to pay back the loan. We would have to double the premiums, plus add another $800 per home to cover the interest for the each of the next 5 years. So instead of paying $2500 a year, policies would cost $5800 per year. (Note: this is essentially how catastrophic reinsurance works)
Alternatively, we could perhaps have a special assessment on the pool members and collect the $20B right away. This would mean an assessment of $14,870 for each home in our pool. I am not sure that would be well received.
Perhaps we just need a bigger pool. Maybe we need to have all the homes in CA in our pool rather than just those in the LA Basin….With a larger pool we could spread this loss over a larger number of homes with a lower amount from each home. Hold on, I hear a voice in the back….yes those NorCal folk are already paying for their own large fire losses from past years.
So, how do you feel? Do you want houses in your city to be in a nationwide pool? Do you want to share losses with folks in Florida, or hail prone states like those in the Midwest and Texas? Do you want to help pay for fire losses in California? Or, do you think that this is a California problem? Remember, that some day it might be your state on the wrong side of this issue.
I’m not in the insurance industry. So, I don’t know where the bounds of an insurance pool start and end. I do think they should be set by the insurers not by politicians although regulating insurance is also a good idea and the politicians do that.
My current opinion is that if you live in an area prone to certain hazards, you should pay more and if you live in an area prone to less hazard, you should pay less.
We had a significant increase in our homeowners insurance last summer, primarily due, according to my agent, to excessive claims in other areas. We live in Nebraska and don’t have quite the weather extremes on the coasts. Guess I’ll be looking forward to another steep increase this coming summer.
Florida has a similar issue with the state run insurance pool. They are the insurer of last resort in their state. Many carriers have moved out or stopped quoting. They are a couple of hurricanes away from a liquidity crisis.
Reinsurance will come into play in California and we will all pay a share of that in our homeowners policies. Is it a fair share? I live in Michigan and while we don’t have significant fires (today) or hurricanes, premiums climb.
Topical, this forum post, this is much more than a thought exercise for me, as a California homeowner and taxpayer.
The JP Morgan estimate was $50 billion, with only $20 billion of the losses insured. As much as I wonder about the $20 billion, I’m also thinking of where the other $30 billion will come from.
Among my happiest days this past year for me? The receipt of my 2024 California home insurance premium increase notice. Happy, because my insurance wasn’t outright cancelled. I paid it without a second thought. When that letter comes again this year, how will I feel, if the rate has doubled, or tripled?
I live two houses away from the nearest fire hydrant, so maybe 120 feet. My city is at the confluence of two rivers which flow year round. The nearest river is a 10 minute walk from my house, so it’s a pretty dependable source for water in case of a massive conflagration. It’s not the flashiest city and I don’t enjoy cool coastal weather or ocean views.I have this house because it was affordable (almost) when I bought it 30 years ago, and not so far from work, avoiding a killer commute.
Here’s my take on the California insurance market.
We have something of price controls on insurance, with a statewide Insurance Commissioner (an office created in 1988). Since term limits arrived in the state legislature, a steady stream of elected officials has lookedto extend their careers in other offices statewide (this trickles down to local government, with former officials becoming mayors or city/county council members and supervisors). So the role has been held by a series of career politicians.
It’s a constant struggle for the state to try to keep insurance rates affordable as there is no law that says a company must stay in business in California even if they lose money in the aggregate every few years. Just a few weeks ago, it seems, the commissioner and the industry came up with new rate setting rules that allowed prospective modeling to be included in rate cases. The LA fires will certainly play into this.
We have something of a statewide pool in the high-risk FAIR plan.
https://www.insurance.ca.gov/01-consumers/200-wrr/California-FAIR-Plan.cfm
https://www.cfpnet.com/
This covers only fires, so is no good for other, more typical insurance claims.
A statewide insurance pool is unlikely to be established. I get none of the joys of ocean-facing property or the pleasures of living in the Sierra among the big trees. It’s going to be hard even in single-party California to push through a statewide pool.
I wonder how many insurers will cease doing business in CA? If people cannot get insurance, will lenders continue to make loans?
Our niece lives in LA and has been evacuated 2 times, once from her home, and now from her friends place. She hasn’t learned her homes fate (as of last night), but us expecting bad news.
Quinn is correct in that everyone shares in the cost of insurance; that’s the only way it works. The current fires are only going to make it worse.
If the “free market” were allowed to operate freely, this should take care of itself. When the state imposes caps on premiums, insurers like State Farm do what they must and simply reduce the size of the risk pool.
In the 1990s New York passed a catastrophic health insurance coverage mandate. By December every health insurer in the state save one, had notified the Insurance Commish they would be leaving the state. The governor scrambled to get the legislature to quickly repeal the law so a real disaster was averted.
A lot of the ills we see can be traced back directly to government action.
Because of previous fire losses, State Farm General, the pup company SF uses to write HO policies in CA, is currently financially impaired, meaning that it is allowed to ask for larger increases that the Insurance Commissioner might otherwise approve. With an 18-20% market share, a potential $4B share of the $20B loss might be more than its surplus….The original purpose of regulation was to make sure that insurance companies were solvent and able to pay claims. With an elected regulator, this purpose has devolved into keeping prices low and the electorate happy.
A few months ago the Forest Service stopped controlled burns in California “for the foreseeable future.” While the reason they gave was as a precaution to preserve manpower and resources in case of an emergency, there were rumors of pressure from groups who wanted these areas to remain “natural”. I wonder what impact this had in these areas.
My sister and her husband own a home on a hill in a high-risk area in Napa. They had to evacuate for eight days in the 2017 fires and came close to losing their house. They’ve had their insurance cancelled twice and are now in a high-risk pool to the tune of $14K/year. It’s a big problem, but it’s also a big problem in Florida.
For major nationwide insurance companies we are all in the pool. Major loses can’t be recouped in a relatively small geographic area.
My premiums on Cape Cod have been climbing each year and now we are up to a $35,000 deductible. That’s not because of losses there, but in Florida, Jersey shore and the Carolinas.
We humans have built homes where we shouldn’t have and to make it worse we jammed them together, in some cases, including Jersey, literally a few feet apart.
The reality of climate change is going to be expensive and devastating for millions.
Thanks for the thought-provoking post. I imagine the solution will lie in your first scenario, where premiums rise to $5,800 a year. In this era of climate change (there will be those inclined to deny that, but those folks probably also don’t believe the evidence of active management’s dismal failure), it’s going to be a recurring issue. I suspect we’ll see mass migration out of places with persistent climate (and hence often homeowner’s insurance) problems.
Since you brought up climate change, were you taught in school that there was an Ice Age and that the Earth warmed up gradually and naturally or for some unknown reason? I was taught that.
I feel like “climate change“ always implies climate changes caused by humans the way the term is used nowadays and that the solution to it is for me to keep less of my humble dollars, instead giving them to President Trump or President Biden, or whoever is in government next to fix the problem.
Is that the case? I don’t see this question addressed anywhere, but maybe I haven’t looked at the right locations?
When we lived in a beach house in Oregon, we were subject to the risks of rising ocean levels, increasing storm severity, Cascadia Fault earthquakes (the Big One is coming) and yearly wildfires both in Oregon and just across the border in northern California that sometimes ranged close enough to dump ash on our car.
I kept waiting for our rates to rise exponentially, but it never happened. Our insurer routinely renewed us at a cost lower than what we had paid in our suburban San Francisco house.
I have stopped trying to figure out how the companies set their rates or make their business decisions.
The lure of the coasts both east and west is pretty strong, mass migration is unlikely in my view, that’s is until in some places the land is no longer there.
We’re already seeing migration from California because folks are finding it unaffordable, as Catherine Horiuchi has discussed:
https://humbledollar.com/2024/12/my-humble-abode/
The issue right now may be housing affordability. Rising home insurance rates will only make that worse.
I’m guessing a $16 minimum wage (applicable to servers too) doesn’t help with cost of living. I’m thinking those folks in Malibu aren’t leaving – until the house is in the sea.
Even Cape Cod is disappearing with rising seas.
Being politically involved, I read a good deal. I have never seen one iota of study-based evidence that increasing the minimum wage causes cost-of-living increases in general or higher cost of home ownership in particular. And certainly not homeowners insurance, which is the topic of this article.
Mike,
What usually happens when the minimum wage is increased is that the business is no longer profitable.
So the owner closes the business. And all the workers lose their jobs.