Chris Lafakis, Director at Moody's Analytics, discusses how home insurance may change as a result of the devastation in California brought on by the LA fires.
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00:00The devastating fires burning throughout Los Angeles, nowhere near extinguished to start
00:06the week. More than 12,000 structures destroyed, 40,000 acres in ashes. Early estimates suggest
00:13the costliest fire in U.S. history, potentially 10 times the prior record, which was just
00:20over $12 billion.
00:21The California insurance market hangs in the balance and potentially a remaking of the
00:26U.S. map as related to climate disasters on both coasts.
00:30With more on the short and long-term economic consequences, we're joined by Moody's analytics
00:35director, Chris Lefekes, who oversees the company's climate risk initiative.
00:40Chris, thanks for coming on. Needless to say, loss of life and, quite frankly, tens of thousands
00:45of people losing everything they've ever owned is top of mind for Moody's and for all of
00:50us at Cheddar's. At Cheddar's, excuse me.
00:52But let's start with the economic consequences. AccuWeather puts the damage now between $135
00:58and $150 billion, which tripled from late last week. What do you make of that?
01:05Well, I think that it's easy to say that this will be the most costly wildfire in U.S. history.
01:13The prior record, as you said, was $12.5 billion in 2018. In Northern California, there are
01:20going to be all kinds of economic consequences in addition to the human toll that this wildfire
01:27has taken. You have to think about the disruption to economic activity, commerce being disrupted,
01:36people less able and willing to go out and spend their money, less able to work, with
01:43businesses being, of course, shut down temporarily or burned. So there are a vast majority of
01:51economic consequences. And then there are also consequences for the insurance market,
01:57for property values and migration patterns. So a combination of short-term concerns and
02:04long-term concerns and questions as to whether or not the insurance industry is going to
02:11be able to stomach this.
02:13Let's dive in there. The California insurance market, it was in shambles prior to these
02:18fires. State Farm and Allstate stopped issuing new policies. State Farm non-renewed 30,000
02:25California policies. Sixty-nine percent were in the Palisades. What are the implications
02:30of these fires on that California insurance market long-term?
02:35Yes, it's a great question. So the first is we have to mention that single-family house
02:42prices are much more expensive in Los Angeles and Ventura counties than they are throughout
02:47the nation. They're actually more than double the national average. And what that means
02:52is that the rebuilding costs will be quite steep. And that's going to put pressure on
02:59insurers, which, as you mentioned, have already started to withdraw because if the insurer
03:04cannot profitably underwrite a policy, they will pull out. That has happened over the
03:10course of the last four or five years. And what that has led to is the FAIR plan, which
03:18is a plan that is made up of all California insurers that have been admitted to insure
03:24in the state. It is an insurance pool of last resort for potentially citizens who cannot
03:30obtain private insurance. That backstop has grown exponentially over the last five years
03:39or so. The share of policies that have been underwritten by FAIR have increased from 1.7
03:45to 3.0 from 2015 to 2021. They're up 60 percent over the last year alone. Those are policies
03:55that are narrower in coverage and they are more expensive than standard policies. These
04:03are kind of the most expensive forms of insurance. And only when there is a market
04:12failure, if you will, for the economics not to work for private insurers that this plan
04:17will kind of step in. So I would expect that as a result of this, you're going to have
04:22tremendous pressure on the insurance market. The FAIR plan has underwritten lots of policies
04:31which it might not, you know, have the wherewithal to immediately compensate homeowners
04:41for. And so, you know, you might run into a situation where the FAIR plan needs to either
04:48go back to the insurers that participate and get additional funding from them or get
04:55additional funding via an assessment from taxpayers that live in California. So it is
05:02possible that one of those two scenarios could play out. And what that would do is put even
05:08more pressure on insurers that operate within the state of California, cause premiums to
05:15increase even more than they already have and cause a larger number insurers to withdraw
05:19completely from the area.
05:21How close is the private insurance industry in California to collapse?
05:27Well, I think that you'll get, well, I guess the question would be, what do you mean by
05:33collapse? I think that we will have a number of insurers continue to leave the state and
05:40those that stay within California will be circumspect about the coverage limits that
05:48they underwrite for fire and increase the premiums that they charge by a good bit. And
05:56I think that it's important to differentiate between this type of disaster, wildfire versus
06:05your hurricane or flooding, whereas some of those worst case flood events might not be
06:11covered under existing policies. But for most standard policies, you're going to have fire
06:16coverage. And so insurers are on the hook for more than would be the case during a bad
06:24hurricane. So the payouts that are required to be made by insurers in this particular
06:33episode in the Palisades where you have home prices that are double the national average
06:38is going to be immense and it's going to put extraordinary pressure on the private market.
06:44So I would expect absolutely a number of insurers to pull out. And for those insurers that stay
06:50to increase the premiums they charge by a good bit.
06:54But as you know, they can only increase their premiums by somewhere around 7%
06:58according to the state law. Will they have to scrap those laws and allow
07:03insurers, if they're going to stay to raise their premiums, how much they see fit?
07:08I think that certain policymakers will need to consider doing that because if private
07:15insurers are not able to profitably underwrite policies, they will leave the market. And
07:22the insurance market doesn't work with only kind of a fair mandated backstop.
07:28We need private insurers to operate within California. They need to be able to turn a
07:33profit. And that means that they need to assess, they need to have higher premiums than they're
07:40currently allowed to. So it's a question ultimately for lawmakers, but I think that lawmakers will
07:46consider the wherewithal of private insurers to stay within California if they're not allowed to
07:52profitably underwrite policies.