SACRAMENTO, Calif. — The recent wildfires that ravaged numerous neighborhoods in the Los Angeles area pose significant challenges to California’s initiatives to stabilize its insurance market, particularly as many insurers have halted the issuance of homeowners policies due to the heightened risk of wildfires.

The blazes, propelled by strong winds, erupted on Tuesday and quickly spread from coastal regions to inland neighborhoods such as Pasadena and the Hollywood Hills. The destruction of properties in a state notorious for its high real estate costs and precarious insurance landscape may render coverage even more expensive and difficult to procure.

One of the areas that will likely face severe repercussions is Pacific Palisades, an affluent community bordered by the Pacific Ocean and the Santa Monica Mountains. The wildfires that swept through this area are being referred to as the most devastating in the contemporary history of Los Angeles, claiming lives, businesses, a library, cultural landmarks, and homes.

State officials had previously identified Pacific Palisades as among the top five locations in Southern California with the highest wildfire risks. The community has also been notably affected by the lack of available insurance coverage.

Last year, State Farm opted to cease coverage for 72,000 residences and apartments throughout California, resulting in a loss of nearly 70% of its market share specifically in Pacific Palisades, according to reports.

In light of California’s residential insurance crisis and the ongoing wildfires, it’s crucial to understand the implications.

Why is California facing a home insurance crisis?

The state has witnessed several major insurers retreat from providing property coverage as climate change leads to more frequent and severe wildfires, floods, and windstorms. Since 2015, at least 15 of the 20 most destructive wildfires in California’s history have occurred, excluding the current Los Angeles fires.

In 2023, seven of the top 12 largest insurance companies by market share in California either suspended or restricted their issuance of new policies. This has created significant difficulties for homeowners located in high-risk regions in terms of obtaining and affording coverage.

What options do residents have if they can’t secure traditional home insurance?

Homeowners in wildfire-prone areas often have to navigate without insurance or opt for the Fair Access to Insurance Requirements (FAIR) Plan—a state program created as a last resort for individuals unable to find coverage. Many are compelled to purchase this plan to fulfill mortgage obligations, but the coverage it offers is limited to basic property damage with a cap of $3 million. Given the high property values in California, owners who lost homes in the recent fires may find themselves underinsured.

The policies can be notably minimalistic, with some only covering the actual cash value of losses as opposed to full replacement costs, as noted by Amy Bach, executive director of the consumer advocacy group United Policyholders. Despite being designed as a temporary solution, an increasing number of Californians are reliant on it. Since 2020, the number of FAIR residential policies issued in California has surged, surpassing 452,000.

Could claims from the LA wildfires jeopardize the FAIR Plan’s solvency?

The FAIR Plan is primarily funded through the policies sold to its customers; however, if it encounters insolvency issues, insurers may need to contribute to the fund’s stability. A new regulation permits insurers to petition the state for approval to raise rates to recover funds spent on salvaging the FAIR Plan.

Fair Plan spokesperson Hilary McLean stated that it might take several years to assess the total financial impact of the wildfires. While loss estimates are still uncertain, the FAIR Plan is prepared to handle claims stemming from these recent fires.

The FAIR Plan currently holds approximately $700 million in cash reserves and about $2.5 billion in reinsurance as stated in previous legislative hearings. According to real estate data, the average home value in Pacific Palisades is around $3.3 million, suggesting that many higher-value property owners may not consider the FAIR Plan due to its limitations.

While the claims will be substantial, experts indicate this won’t spell disaster for the insurance industry or the FAIR Plan. Newly proposed legislation allows the FAIR Plan to issue “catastrophe bonds” to counter liquidity challenges.

What measures has California taken in response to the insurance crisis?

California officials have recently initiated an extensive overhaul intended to afford insurers greater flexibility in raising premiums in exchange for a renewed willingness to provide policies in high-risk areas. A regulation that became effective this month now allows insurers to factor climate change into their pricing models—something that was previously restricted. This regulation was cited by numerous companies as a prime reason for their withdrawal from California’s insurance market.

Additionally, the state is nearing the approval of a regulation to allow insurers to pass the costs of reinsurance onto consumers, aligning California with other states. Following these new rules, Farmers—California’s second-largest insurer—has begun offering new homeowner policies again. While some experts warn this may lead to easier rate hikes without sufficient oversight, others remain cautiously optimistic.

Assessing the potential impact of the fires on California’s insurance market is challenging at this stage. An expert from the American Property Casualty Insurance Association stated that while it’s too early to predict, an uptick in homeowner premiums may be on the horizon. California’s Insurance Commissioner recently emphasized that the state’s new rules are aimed at helping insurers more accurately evaluate risks associated with climate change and establish feasible rates.

Furthermore, a one-year moratorium has been instituted, preventing insurance companies from canceling coverage for properties affected by the fires. The Commissioner affirmed that insurance providers are committed to California and will be held accountable for those commitments.