The California fires will end up setting records in billions in a catastrophe loss. On the East Coast a similar new record cost will continue to be revealed as the trifecta hurricane damages from Debby, Helene, and Milton continue to mount.
Meanwhile, the property and casualty insurance industry and the reinsurers of the world are in reevaluation mode, as they must assess their forward-looking estimates of risk and alter their portfolios and premium-setting policies. And they must contend with politicians who are using rhetoric to seduce voters even as those same politicians admit privately that premiums must change to reflect the best forward-looking estimates of risk from natural disasters. The climate-change critics and detractors in government are forced to contend with rising sea levels and additional damages from fire or wind or water or other climate-related events.
The circumstances of insurers operating in California point to the challenges they face:
For the past 30 years, California regulations have required insurance companies to apply a catastrophe factor to insurance rates based on historical wildfire losses. These outdated rules have contributed to rate spikes and balloon premiums following major wildfire disasters without fully accounting for the growing risk caused by climate change or risk mitigation measures taken by communities or regionally, as a result of local, state, and federal investments.”
Source: Dec. 13, 2024, press release from the California Insurance commissioner about a regulation change: “In a California ‘first,’ Commissioner Lara announces enforcement of regulation to expand insurance coverage across state,” https://www.insurance.ca.gov/0400-news/0100-press-releases/2024/release062-2024.cfm .
Here’s a follow-up press release, issued on December 30, 2024: “Commissioner Lara issues landmark regulation to expand insurance access for Californians amid growing climate risks,” https://www.insurance.ca.gov/0400-news/0100-press-releases/2024/release065-2024.cfm.
The traditional disaster response model is set in motion by a massive loss. The deaths and damages are immediately reported and regretted. Then comes the finger pointing. Lastly, a funding and rebuilding package emerges at various governmental levels from local to state to federal. Then the building and renovation commence and take years. During the recovery phase, innovation spurs new and stronger construction and more resilience to future disasters. In the rebuilding phase, jobs are created. GDP grows. Economics of growth spur the outlook. That stage lies ahead after the casualty counting ends.
Where this all ends up in the structure of the Trump 2.0 administration is unknown. And one must remember that funding for the federal share of mitigation and recovery comes from Washington. We already see the tension in the House of Representatives when it comes to FEMA and disaster relief. The debate over federal funding and conditions attached to the money is likely to intensify, along with the debate over deficit spending.
In all these types of circumstances there are winners and losers. Governance and politics get embroiled in the details and influence the outcomes. That prospect lies immediately ahead.
For now, the investor class must be careful and scrutinize details to determine from where losses are coming and where opportunities lie. And the personal tragedy of deaths and mourning are in the forefront of all our minds and of media coverage.
I will leave it to others to debate if California regulation shanked directionally, too little, too late. We are where we are now.
I am not recommending any security or industry regarding the insurance sector or the broader financial sector. My personal position disclosure is “none.”
Let me extend a personal hat tip to my colleague David Berson, Cumberland’s Chief US Economist, who has deep expertise in insurance finance and analysis of failures and successes in the regulation of financial agents. In his career, David has been chief economist at Fannie Mae and chief economist at Nationwide. David has been enormously helpful in the morning meeting discussions at Cumberland as we have addressed the various financial issues surrounding wildfires in California and hurricanes in Florida and other states. I personally offer many thanks to David for his detailed tutorials about these issues.
I will close with an emailed comment from the CEO of a casualty insurance holding company (his name is purposefully withheld):
The fires in California will be catastrophic for the insurance industry. Losses are currently being estimated between 50 and 150 billion dollars. The impact of climate change and the construction of structures in high-risk areas are the primary contributing factors. The fallout will be dramatically increasing insurance premiums and reduced insurance capacity. Unfortunately, the solution in the short term will be quantifying the cost of climate change so that the cost of the risk is appropriately allocated to increased insurance rates and the limitation of building structures in high-risk areas due to insurance companies refusing to write policies in certain high-risk areas. The long-term solution is the implementation of various initiatives to reduce the causes of climate change and the establishment of appropriate zoning laws to limit development in high-risk areas. These issues discussed above also apply to hurricane risks in the coastal areas of the Southeastern United States.
