The recent and currently active Los Angeles County wildfires have reached unprecedented levels of insured losses. S&P Global Ratings details the fires' likely impact on California's property insurance, housing finance, and state creditworthiness.

California Wildfires Are Challenging For Insurers

California wildfires have had a significant impact on the U.S. property insurance industry over the past three decades, driving up premiums, shaping underwriting practices, and challenging regulatory reform. The most recent California wildfires, which started in early January in Los Angeles County, are expected to result in substantial losses for insurers. Post event, we believe property insurance carriers will raise rates and/or reduce coverage options.

These actions are likely to extend beyond the state of California, leaving homeowners in wildfire-prone areas (such as those in Washington, Oregon, and Colorado) with higher insurance rates and/or reduced coverage options. Chart 1 shows the average annual insurance premiums for each state for $300,000 of dwelling coverage. Interestingly California, Oregon, and Washington are on the lower end of the scale, whereas Nebraska, Florida, and Oklahoma, are at the top, due to risks of severe convective storms. It is expected that the relative position of these fire-prone states will increase sharply in the coming years.

Chart 1

Wildfire-related claims, including those in connection with property damage and business interruptions, have strained insurers' profitability and contributed to a broader trend of increasing risk exposure in catastrophe-prone regions (see "Record Weather-Related Losses Hit U.S. Homeowners Insurers And Pose Challenges In Estimating Catastrophe Risk Charges," published Sept. 3, 2024). Moreover, the rising cost of rebuilding and inflation of claim amounts continue to pressure insurers' earnings stability.

California's FAIR Plan facing strain, but regulatory reform could help to alleviate it

In California specifically, adding to the pressure mentioned above is Proposition 103 (the Reduction and Control of Insurance Rates Act), which requires insurance rates to be approved by the Insurance Commissioner (see Appendix for more information about Proposition 103). Because of the complex and often lengthy rate approval process, property insurers, unable to recoup losses, have either exited or materially reduced policy coverage in

California over the past two years--especially in wildfire prone areas--forcing many homeowners to acquire basic coverage through the state-mandated California FAIR Plan, which is an insurer of last resort. As a result, rapid growth in policies-in-force and exposure in high-risk areas have placed the FAIR Plan's solvency at risk. Supporting FAIR Plan's $458 billion in total exposure is $377 million of liquid funds and $5.78 billion of reinsurance protection. The nearly $7 billion total exposure to the Pacific Palisades and Eaton fires will test the FAIR Plan's ability to meet its claim obligations. Indeed, should there be additional wildfires of comparable severity in the coming months, the FAIR Plan will become even more strained.

The recent regulatory reform as to how rates are set by the California Department of Insurance (CDI) is expected to improve homeowner insurance accessibility and alleviate the strain placed on the FAIR Plan. The changes in the regulation will allow carriers to use wildfire catastrophe (CAT) models as a factor in setting rates. Embedded in the CAT model pricing of insuring wildfire losses is passing reinsurance cost to the insureds to allow for greater insurance availability, albeit at a higher cost. However, there is a stipulation that insurers must increase writing comprehensive policies in wildfire distressed areas "equivalent to no less than 85% of their statewide market share." While details remain unclear, we think the use of nascent wildfire CAT models to capture probable losses--influenced by weather patterns, vegetation types, topography, and human activity--will likely lead to a sharp rise in premiums to account for the complex and as-yet unrealized risk factors. Also, while we expect homeowner insurance accessibility to improve from this reform, we also anticipate delays for the CDI to achieve its full objectives in the near term because of its intricate and lengthy rate approval process, requiring insurers to submit detailed justification for proposed rate increases (see appendix). Unless the CDI changes its process before rate approvals are granted, we believe carriers could be slow to re-enter the admitted market.

The FAIR Plan may provide only partial coverage of rebuilding costs because its maximum coverage per home is $3 million. Moreover, because the FAIR plan has limited funds, it might not be able to fully compensate borrowers on its own. However, there are structural backstops in place to provide supplemental coverage. Should the insurer of last resort fall short of funds, other property insurers in the state may be asked to contribute through a process called an "assessment".

After the first $900 million in claims have been accepted, the FAIR plan can access reinsurance funds. If that amount is insufficient to cover claims, the FAIR Plan would raise written premiums on FAIR Plan policyholders and would be able to assess member insurers. Subsequently, member insurers may request temporary supplemental fees from their own policyholders to recoup all amounts assessed by the FAIR Plan. This was done following the 1994 Northridge Earthquake that impacted the Los Angeles area. The California insurance regulator stated that the first $2 billion beyond what the FAIR Plan can cover will be split evenly between assessments on insurance companies in the state and policyholders. The companies would be assessed in proportion to their respective coverages of the California market over the past two years. For example, if an insurer recently had a 20% market share, it would be responsible for 20% of the assessment. How the policyholders would be assessed is not as clear, because the insurance commissioner has discretion as to how to levy policyholders.

California is just one of 32 states with a state-authorized insurer-of-last resort. During this past hurricane season, after Hurricanes Milton and Helene struck Florida, we published a commentary on the longstanding mechanisms in place to help stabilize the property insurance market given its inherent exposure to natural disasters (see "Florida State Finances And Insurance Mechanisms Help Absorb The Blow Of Another Major Storm," published Oct. 10, 2024). In our view, these statutorily created entities retain significant capacity to levy assessments to augment liquidity if necessary. As with California, we believe the rising frequency of high-cost events in Florida could increase insurance premiums and exert further financial pressure on homeowners over time.

California homeowner insurer profitability indicates insurance in California will become more costly

Chart 2 shows that California homeowner insurance profitability has typically been on par with that of the rest of the country over the past decade, as measured by the direct simple combined ratio (DSCR). The California DSCR levels for 2025 are expected to be at least as extreme as in 2017 and 2018 (higher DSCRs indicate reduced profitability), which will contribute to why insurance in California will become more costly.

Chart 2

The Impact On The California Housing Market May Be Downward Pressure On Home Prices

Most of the structures damaged by the recent California wildfires have been residential housing units. In many ways, the impact of the current catastrophe has exceeded those of previous California wildfires because of the extent to which the fires have burned in densely populated urban/suburban locations. Areas beyond California, such as parts of Florida, have also recently experienced extensive damage and loss from natural disasters. A key difference between storms and wildfires, however, is the uncertainty regarding the duration of the event. While hurricanes tend to be short-lived events (although the recovery can be protracted), fires such as the ones that are affecting Los Angeles County, have continued to spark and expand over a period of weeks. This creates an additional layer of uncertainty regarding the extent of impact on insurance and housing markets. For the residential housing market in California, the resulting impact may translate to downward pressure on home prices. This will be problematic for a state that has already been experiencing muted population growth as many people leave for more tax-friendly affordable places to reside.

An important consideration for assessing the housing impact is whether peril losses on properties secured by mortgages will affect the entities that are exposed to this credit risk. Any ambiguity as to whether the insurance policies in place are sufficient to cover wildfire losses will soon be unveiled. In the case of Florida, separate insurance riders for flood may or may not be present on a given policy, depending typically on whether the property is in a flood zone according to FEMA maps. In the case of California, where the risk concerns wildfires, there is less uncertainty than in Florida, where the risk concerns floods and it may be unclear whether the appropriate coverage is in place. Properties that are financed with mortgages typically have a minimum hazard insurance requirement to protect the lender in cases of peril loss. As a result, a principal loss to the mortgagor upon the occurrence of a peril event would mainly be predicated on the following three events:

• The borrower defaults;
• The property suffers peril damage; and
• Insurance proceeds are insufficient to satisfy the mortgage balance.

Of course, there could be additional trailing effects of the event that manifest into losses, including local economic stress leading to unemployment, ongoing displacement, and decreasing property values, which could arise from a variety of factors (e.g., reluctance to live in fire-prone areas or in neighborhoods for which the community has been fractured). We will focus on the third item and the implications for the residential housing market in the aftermath of the Los Angeles County fires.

Because securitized mortgages typically require that insurance covers the loan amount at a minimum, we will consider the likelihood that the proceeds won't be available to the lender should there be a default coupled with property damage. In our view, this would result if the insurance company failed to pay out, or if the claim payment was applied by the servicer in a non-accretive way. For the first to occur, coverage would either have had to been cancelled or the insurance company would have had insufficient solvency to pay the claim. Hazard insurance coverage involves the mortgage servicer/lender as endorsed payee, and coverage is monitored by servicers. Issues related to lapses should be addressed with servicer blanket policies. For the insolvency issue, insurance companies are regulated by state insurance commissioners, and there should be some form of backstop (e.g., a state guaranty fund) to protect policyholders (as opposed to creditors). In the case of the Los Angeles wildfires (and other perils in other states), a mortgage servicer would therefore be involved in insurance payout administration. For example, Fannie Mae and Freddie Mac servicing guidelines include protocols concerning disbursement of insurance funds, which can vary depending on whether the borrower is current or delinquent on their mortgage.

An important consideration is how many affected homeowners will decide to rebuild. Even if there is a desire on the part of the homeowners, it is unclear as to whether the land will be re-zoned such that it can no longer be developed. However, limiting redevelopment could have serious implications for tax revenue. We expect that the inherent value of land in the Los Angeles County area (due to its natural beauty and agreeable weather) and the associated economic base, coupled with the persistent housing shortage in the country, point to a strong rebuilding effort. Moreover, fresh rebuilds may now entail improved fire resistance as part of the new dwelling construction. In the metropolitan statistical area (MSA) that comprises Los Angeles, the property value index has increased roughly 6% in the past year, even as population growth turned negative. As a result, the ongoing insurance burden will likely influence the price of homes in one way or another. In our publication "The Impact Of Rising Insurance Premiums On U.S. Housing," published April 22, 2024, we contemplated the U.S. homeowners' ability to withstand premium increases under various hypothetical scenarios. In the case of Los Angeles County and other wildfire-prone areas, the assumptions set forth there will soon be put to the test.

California's Credit Strength Is Resilient

We believe that California's extraordinarily strong economy and tax base will be resilient through this disaster. We expect federal funds will cover a significant share of the cleanup and recovery costs, which will alleviate short-term expenditure pressure. While the state will continue to spend, we are not expecting an impact on our rating on California at this time. Our rating currently remains AA-/Stable.

Insured Losses Escalating, But Still Manageable; Insurance Rates Likely To Be Heavily Impacted

Early indications for insured losses from the Los Angeles county wildfire events have climbed to $40 billion from $10 billion since our publication "Insurers Can Absorb Losses Amid Escalating Los Angeles Wildfires," on Jan. 9, 2025. While the final toll on Southern California and the insurance industry will not be available until the wildfires are contained, we believe that the insured losses from the event are manageable and should have no significant impact on capital for our rated (re)insurers. Nevertheless, the impact on homeowners could be substantial in the sense that insurance rates in the region are likely to be heavily impacted. Furthermore, the rising insurance costs and mounting affordability challenges could weigh on the creditworthiness for the state of California over time.

Appendix

What is Proposition 103?

California Proposition 103 is a landmark insurance regulation measure aimed at reducing auto and home insurance premiums and enhancing consumer protections. The proposition was introduced and passed in 1988 in response to soaring insurance rates during the 1980s, which many Californians found burdensome. Its key features include:

• Rates must be approved by the Insurance Commissioner (IC) prior to use.
• Rates cannot be excessive, inadequate, discriminatory, or in violation of the Act.
• A defined process for rate approvals is established, which includes public notice and a hearing process.
• All information submitted as part of a rate application must be available for public inspection.

The rate approval process includes:

• Insurers must file a complete rate application with the California Department of Insurance and the insurer has the burden of proving that the requested rate change is justified.
• The IC makes the rate change request public, and it is deemed approved 60 days after public notice unless either a consumer requests a hearing or the IC decides to hold a hearing.
• Rate change exceeding 7% require a hearing and must be approved or disapproved within 180 days.

The Proposition 103 objectives to curb unfair insurance practices and to provide greater consumer control over the insurance market in California could slow the private insurance market from re-entering the admitted market.

Related Research

• Insurers Can Absorb Losses Amid Escalating Los Angeles Wildfires, Jan. 9, 2025
• Florida State Finances And Insurance Mechanisms Help Absorb The Blow Of Another Major Storm, Oct. 10, 2024
• Record Weather-Related Losses Hit U.S. Homeowners Insurers And Pose Challenges In Estimating Catastrophe Risk Charges, Sept. 3, 2024
• The Impact Of Rising Insurance Premiums On U.S. Housing, April 22, 2024