What happens when a state insurer of last resort goes belly-up?

A possible next act in this new drama: California

The fires blazing through parts of Los Angeles right now might have been predictable, but they were and are unimaginable. So much anguish and chaos. The idea of fires burning their way through canyons out to the coastline, and people being evacuated all the way down into the flatlands, all of it is unthinkable. I went to high school in Santa Monica, and visited friends and went to parks in Pacific Palisades, right next door. It's eye-widening, horrifying, to see the images of destruction. These fires are continuing to rage.

It's also a moment when the page may begin to turn, when the scene may begin to shift, because this is no anomaly, really. This is no one-off, zig-zag event slipping off an everything-is-normal trajectory. (Of course, some people might have said that about Hurricane Sandy.)

This is a moment when giant financial bets based on keeping the status quo in place in climate-risky areas become visible: In order to keep its property markets ticking, the State of California long ago set up an insurer of last resort, the FAIR Plan. It is likely that the FAIR Plan's solvency will be sorely tested by claims stemming from these fires, and it is unclear what will happen if that insolvency cannot be staunched. As a nation, we may have to finally decide whether to act to shore up, change, or eliminate the structures that made this bet, and bets much like it across the country, possible.

Most of State Farm's policyholders in Pacific Palisades were sent non-renewal notices last year. Many of them likely turned to the California FAIR Plan, the state's insurer of last resort. (Pacific Palisades is a wealthy enclave, so many also probably decided to self-insure, to think of their house as something like a commodity that they could replace with their own money if the worst happened). As of last June, the FAIR Plan, which may not deny fire insurance to anyone, no matter how risky their property, had a surplus of just $385 million available to pay claims. As of last March, the Plan had about $700 million in cash on hand (in addition to the surplus). It had about $5 billion in reinsurance, after a deductible of about $900 million (as long as that deductible is met by a single event).

Its exposure to claims for fire and smoke damage has ballooned to $431 billion from $50 billion in 2018. Between September 2020 and September 2024, the number of FAIR policies grew by 123 percent, to 452,000. Although the FAIR Plan's coverage is both expensive and narrow—covering only property damage due to fire, lightning, smoke, or internal explosions in exchange for much higher premiums than those charged by private insurers—it covers up to $3 million for each residential property and $20 million for commercial ones.

The FAIR Plan will face claims from Pacific Palisades (where its exposure is $5.9 billion and the number of policyholders grew by 85% over the last year) and a number of other areas where ferocious fires are still burning. Estimates are that the six fires will trigger $20 billion in insurance damage claims generally.

It's too early to say what will happen to the FAIR Plan. But it's not too early to say that the financial stability of the FAIR Plan is doubtful. Its exposure is wildly out of proportion to its assets.

Since 2022, it's been offering $3 million in coverage per house—even in California, that's substantial—the phone has been ringing off the hook, and fleets of new policyholders have been arriving, from both risky and not-so-risky wildfire areas, but the Plan's requests for premium increases to match its risks have been taking 18 months to two years to be approved (after substantial slashing) by the California Department of Insurance. The regulator has only recently moved to allow the FAIR Plan to include its reinsurance costs and costs of capital to be included in its rate base. Meanwhile, its exposure continues to skyrocket. Bottom line: It's not currently operating on an actuarily sound basis.

If the FAIR Plan can't pay the claims that are filed with it from its cash on hand (~$350M) plus its surplus (~$700M), and if either (a) it doesn't meet its reinsurance deductible(there's no single fire that adds up to $900M in claims) or (b) claims filed go above the level of reinsurance it has purchased (claims trigger reinsurance but exceed $5 billion), it is in "assessment territory."

You can think of the FAIR Plan as an association of all the insurers permitted to do business in California. If the Plan can't meet its obligations, it can go back to those insurers (everyone who's done business in California within the last two years) and send them each a bill for the shortfall in accordance with their respective market shares in California. If the assessment is for $1 billion or less, the insurers can pass on half the amount to policyholders; if the assessment is for more than $1 billion in a calendar year, the insurers can pass on the whole amount to policyholders (following approval by the Department of Insurance).

The last time an assessment was triggered was after the 1994 Northridge Earthquake. After that, almost all the insurers providing earthquake insurance left the California market. Today, earthquake damage coverage isn't part of a standard home insurance policy in the state.

Such assessments are becoming more likely with each house that burns this week in Los Angeles. Their burden will be felt by insurance companies and policyholders everywhere in the state. More insurance companies may decide it's not worthwhile to do business in California, making the fiscal burden on the FAIR Plan even worse than it already is and the cost of living in California even higher.

The bet on the FAIR Plan is the state's decision to do whatever it takes to keep property markets working, even in risky areas, and to mute the price signal of riskiness that the entire insurance market—a rational domain, focused on profit—is sending.*

That bet may now be being called. No one knows what will happen next. Will the insurers resist making up the shortfall? Will policyholders refuse to pay the supplemental assessments? Will some part of this system (the FAIR Plan? the state?) need a bailout to keep markets moving? If the federal government is asked to step in, will it decide to condition assistance on better risk assessment and real changes in how and where people leave?

California's is not the only "insurer of last resort" in trouble. California's doubled in size over the last five years, but the policy count in the residual markets in Georgia, Louisiana, and Florida went up more than 200% over the same period. In all these places, insurers are losing their appetite for risk, and the states are doing their best to keep property markets rolling. Does this make sense? Who will rescue them, and on what terms?

We are just at the beginning of this story.

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*Back in March of last year, California State Assemblyman Jim Wood (D-Healdsburg, now out of office for family reasons), asked (at 47.29) the president of the FAIR Plan, Victoria Roach, about the Plan's exposure, surplus, cash on hand, and reinsurance, listened to her answers, and said:

"I guess I'm concerned that we're like one bad fire season away from complete insolvency, is what it feels like to me. Unlike the commercial carriers, you can assess the commercial carriers for that, and that's obviously a really unusual model from my perspective, but I'm careful how I characterize this, but it feels like a big gamble in many ways. Quite frankly, if this were on Wall Street, I'm not sure you'd be able to get away with this."

To her credit, the clearly competent and clear-thinking Victoria Roach responded with a light joke.

"I had a member of the voluntary market [an insurance company doing business in CA] tell me, ‘If I could pick a company to reinsure, you would not be the one.’"

She went on:

"I agree with you, because it's not..You're right, it's a gamble. And we are one event away from a large assessment. There's no other way to say it. We don't have the money on hand and we have a lot of exposure out there."