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Listener Alex Duerre from Anchorage, Alaska, asks:
How will the Los Angeles fires affect insurance companies in the United States? Considering Hurricanes Helene and Milton in 2024, at what point do insurance companies fail to pay insurance claims with America’s many natural disasters? Can insurance companies fail?
The catastrophic Los Angeles fires have destroyed at least 12,000 homes, schools and other structures since they began earlier this month. Insured losses can reach up to $20 billion.
Many of the insurance companies we have now were created during “peacetime,” which is when the consequences of climate change were not apparent, said Daniel Aldrich, a professor of political science and public policy at Northeastern University. But over the past century, the number of natural hazards and their magnitude has increased due to climate change, Aldrich said.
Insurance companies now have to deal with an increasingly changing landscape. But it is unlikely that insurance companies will go out of business because the insurance industry is well capitalized and the insurance companies themselves have their own insurance, known as reinsurance.
Don Griffin, a property and casualty expert with the American Association of Property Casualty Insurers, said he thinks insurers will be able to pay all the claims related to the Los Angeles fires.
There are limits to how much people will be able to get, but insurers “exist to give them every penny they’re due,” Griffin said.
To make sure they have enough money to pay claims, the industry runs a surplus, which reached a cumulative total of $1 trillion at the end of June last year, Griffin said.
“Every single insurer in the U.S. is required to have redundancy,” Griffin said. And they must prove they have a sufficient surplus for the state or states in which they do business, Griffin explained.
“It’s basically a savings account that can be used for almost any type of loss that the company has to pay,” Griffin said.
Insurance companies are also subject to a number of checks and balances: State insurance regulators scrutinize their finances, and rating agencies will give them early warnings if they’re not doing well, Griffin said.
And once insurance losses exceed a certain amount, reinsurance kicks in, Griffin said.
The insurance company pays the reinsurer a portion of their premiums, just like a homeowner would for his or her policy, Griffin said.
If insurance companies don’t feel they can adequately cover homeowner claims, they will pull out of a state. But it’s failing in the sense that it’s a market failure, Aldrich said.
In California, the biggest insurers left because they faced disasters caused by climate change and limits on how much they could set premiums, Benjamin Keys, a professor of real estate and finance at the University of Pennsylvania’s Wharton School, said in a recent Marketplace interview.
After the fires in Los Angeles, homeowners in the state can expect premiums to rise.
As part of a series of recent regulatory reforms before the wildfires, insurers will be allowed to include reinsurance fees in the rates they charge homeowners, said Kenneth Klein, a professor at Western California School of Law. The amount insurance companies pay reinsurers is “a very important cost line,” and the amount reinsurers can charge is not regulated, Klein said.
Insurers in the state will also be allowed to raise premiums based on algorithms that model catastrophes, Klein said.
Many states offer Fair Access to Insurance Claims plans, which offer people insurance if they don’t have access to a regular plan. But in California, the FAIR plan had only $377 million available to pay claims and $5.75 billion in reinsurance as of last week.
“FAIR plans were designed to be a Band-Aid in the insurance market, and in recent years, they have expanded beyond their original intended use,” Keys said. “I think the question is going to be whether that system is able to handle a hit as big as this.”
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