News Currents

Catastrophic wildfires sweep across Southern California

Industry estimates insured losses at more than $1.5 billion and rising

Insured losses are continuing to accumulate from Southern California wildfires that burned in late October, with most insurance industry analysts estimating insured losses will total $1 billion to $1.6 billion. While claims are still flowing in, if those estimates hold true, the wildfires could be the costliest catastrophe insured loss event in 2007 — and potentially the costliest wildfire catastrophe insured loss event in history for the property/casualty insurance industry, according to Fitch Ratings.

Fires take their toll

At the height of the siege, 23 fires burned in seven California counties, destroying more than 2,000 homes and forcing thousands into 28 evacuation shelters, according to the state Office of Emergency Services. A combination of factors —an abundant amount of dry fuel, Santa Ana winds that at times gusted at 100 mph and carried embers up to 1 mile away, and the sheer number of blazes — stretched firefighting resources thin. Officials only had to battle 11 to 12 fires simultaneously in 2003’s Cedar and Old Fires, versus the 23 this October.

According to the National Interagency Coordination Center, five fires remained burning at press time, each more than 60 percent contained. In total, 575,412 acres had burned, and more than 2,700 structures were lost by that time. The Witch Fire in San Diego County incurred some of the largest losses, having burned 197,990 acres. As of Oct. 29, the cost of the Witch Fire alone was estimated at $14.4 million, at 95 percent containment. The Harris Wildland Fire, also in San Diego County, burned 90,440 acres at a cost of $13.3 million.

As firefighters continued to work toward containment goals on the five remaining fires, milder weather conditions seemed favorable, and firefighting officials seemed optimistic that all would be extinguished by Halloween, according to the National Interagency Fire Center.

Loss projections

It is too early to make an accurate projection of the total insured damages from the wildfires because evacuees and claims adjusters were slowly being allowed into charred areas at press time. Nevertheless, preliminary insured loss estimates range between $900 million (the minimum projected by Eqecat Inc.) to $1.6 billion (as estimated by Air Worldwide Corp., The Goldman Sachs Group Inc., Impact Forecasting LLC, a unit of Aon Corp., and Risk Management Solutions). More than 80 percent of the losses stemmed from the Witch Creek Fire that merged with the Guejito and Poomacha Fires, Impact Forecasting indicated.

The Farmers Insurance Group of Companies reported it had received more than 5,500 claims by Oct. 29. Foremost Insurance, one of the Farmers’ companies, had received more than 900 claims resulting from the fires and winds.

State Farm indicated it had received more than 2,000 property claims as of Oct. 26, with nearly 500 of those homes completely destroyed or damaged to the point of being uninhabitable.

Air Worldwide emphasized there is significant uncertainty in the loss estimates, but predicted the number of claims to be significantly larger than the number of destroyed structures. Many of the areas that burned were known to have high-valued homes. The company also predicted the average size of claim for partially damaged homes would be relatively small, according to Glen Daraskevich, vice president of research and modeling.

“If we assume that the average replacement cost for residences, outbuildings and commercial structures is $600,000, $100,000 and $900,000 respectively, then it appears as though insured losses may have crossed over the $1 billion threshold,” noted Thomas Cholnoky, Goldman Sachs analyst.

Fitch indicated the insured losses for this event could easily approach the largest catastrophe loss event thus far this year as reported by ISO’s Property Claims Services unit of $1.2 billion in insured property damage from spring storms in mid-April that affected 18 states and the District of Columbia. Furthermore, the insured losses have the potential to surpass the largest wildfire insured losses for the industry of $1.7 billion ($2.5 billion in 2007 dollars) for the Oakland Hills, Calif., wildfire in 1991, and $2 billion ($2.3 billion in 2007 dollars) for the Southern California wildfires in 2003 that affected an area very similar to the current wildfires.

Each $1 billion of insured loss adds about 20 basis points to the industry’s 2007 loss ratio, based on Fitch’s almost $440 billion 2007 net earned premium forecast. The company also noted that each $1 billion of homeowners insured loss adds about 190 basis points to the industry’s homeowners 2007 loss ratio.

Traditional or E&S?

“The insurance lines of business most affected by this catastrophe are personal lines, particularly homeowners, but also automobile,” Fitch stated. “However, commercial lines will also be affected with claims expected in commercial property and business interruption, that could be significant.”

The company expected the majority of losses to be confined to the primary and excess and surplus lines writers, “with a modest portion of losses ceded to reinsurers under catastrophe treaties, unless the losses increase to significant higher levels and are treated in the aggregate as a single event.”

Initially, Goldman Sachs’ Cholnoky predicted non-traditional E&S lines and Lloyds markets would bear the brunt of the losses because in discussions with California agents, it appeared that most of the traditional writers had avoided writing any exposures in “brush”-defined areas.

“However, based on the widespread nature of the fires, it appears that the losses could be spread more evenly across all of the insurance companies that operate in the state. … Industry losses may have to exceed $3 billion to $5 billion before the reinsurance industry incurs any possible material losses,” Cholnoky said. He cautioned against attempting to identify possible individual company losses using market share, emphasizing that many companies had implemented strict underwriting standards to avoid brush fire exposures.

Daniel Munson, founder and vice president of sales and marketing for RiskMeter/ CDS Business Mapping, predicted losses would be borne by a combination of traditional and E&S carriers, with more being handled by the latter. “After the fires in 2003, standard carriers got much stricter about evaluating brushfire hazards and stricter about enforcing their own rules,” he explained. “Carriers declined a lot more business than they would have before. As standard carriers tightened up their underwriting criteria, someone had to step in — the E&S market.”

Preparation paid off

Despite the significant devastation from the wildfires, Sam Sorich, president of the Association of California Insurance Companies, said the insurance industry is well-prepared financially to respond to such events. Analysts even predicted insurers would be able to handle this plus another insurance event, barring a major catastrophe, such as a massive earthquake along California’s Hayward Fault. Geologists predict a quake along that fault could strike any day, affecting about 2 million people.

“Really since the hurricanes, most insurers have been looking at worst case scenarios and planning for them. Reinsurance strategies have been shifted and companies are most careful about high-risk areas like coastal areas and in California with its earthquakes,” said Craig Weber, senior analyst for Celent. “Barring a cataclysmic problem, I don’t expect to see a huge glut of insolvent insurers around. Insurers have been very busy thinking about the worst case scenario … as they set prices and set underwriting criteria.”

RiskMeter’s Munson said carriers got much better at insurance-to-value calculations following 2003’s fires. “I don’t think we’ll see mass complaints of people not having enough money to cover losses,” he said. “There will be companies that get hurt above their market share because of concentration risk issues. I know one carrier that does a lot of coverage around Lake Arrowhead, so will be hit harder. … Yet I don’t think we’ll see the lawsuit issue (that occurred after Katrina).” Even if there is a Hayward Fault earthquake, Munson predicted the losses would be manageable because the California Earthquake Authority handles most coverages, and traditional insurers are not carrying a lot of earthquake policies on their books.

Indeed, Fitch said, “U.S. property/casualty insurers are positioned to handle insured losses from this event as catastrophe losses have been well below the average this year. PCS estimated $4.7 billion in catastrophe losses through the first nine months of 2007. This is considerably below the $9.3 billion average over the first nine months for the past 15 years. This compares to over $41 billion in losses from Hurricane Katrina alone.”

The company said the level of losses from the October wildfires was expected to be within what the insurance industry had anticipated when pricing catastrophe risk into premiums. Additionally, insurers that write in California and are most affected by wildfires generally are larger, national carriers that have high insurer financial strength ratings. The company said it did not predict a major deterioration in the financial strength of those companies if they incurred losses roughly in proportion to their market shares.

A.M. Best said it would evaluate the potential impact of the wildfires as information becomes available. However, the company anticipated that “the overall ratings impact will be generally limited based on the favorable results of the last several years, subsequent balance sheet enhancement advances regarding insurers risk management awareness and capabilities.”

Similarly, Standard & Poor’s Ratings Services anticipated few insurer rating actions based on the early loss estimates. The company said it was maintaining its current stable outlook on the U.S. personal and commercial insurance sectors, even after incorporating the potential impact of the California wildfires.

“In recent years, (all of the national and larger regional insurance carriers with sizable California market share) have benefited from improving profitability, improved risk management, and strong catastrophe reinsurance programs and capital strength,” S&P Writer Amy Friedman said. “Still, small carriers, and all carriers with business concentrations in Southern California, could be disproportionately affected.”

More WUI wildfires to come

Despite that good news, risk modeling companies said California — and other states prone to wildfires — should expect future wildfire losses to increase.

“Our analysis of housing trends in California have shown that growth in the more fire-prone wildland-urban areas is greater than in traditional urban regions,” said Steven Jakubowski, chief operating officer of Aon Impact Forecasting. “Unfortunately, we are likely to see more catastrophic events in the future as a result of the increased housing growth.

Air Worldwide describes the wildland/urban interface (WUI) as a buffer zone where human development intersects dense woodland vegetation. Fires that ignite in those zones can move readily between structural fuel and vegetation fuel, facilitating rapid spread. According to U.S. Fire Administration statistics, 40 percent of new home development in the western United States is occurring in the WUI. And the rush to build in this area has resulted in an unparalleled accumulation of fuel and development, creating the potential for today’s wildfires to be more destructive than any in history, the company said. (See Insurance Journal West Region’s Oct. 22 issue for information on the WUI’s impact on wildfires.)

“In recent years, there has been significant development in the wildlands that border urban areas, as people seek to live in a more natural environment,” agreed Don Windeler, RMS’ director of model management. “As a result, more properties are at risk from brushfires, which pose a high hazard in these areas.”

Yet while there is more encroachment in wildland areas, Windeler said he’s seeing more risk awareness. Many developers are putting in mitigation measures to ensure that there is some buffer between the wildlands and built structures, and using fire-resistant materials, he said. “With increased exposure, there’s increased mitigation,” he said. “Some (insurance) companies are taking a hard look at policies in urban areas and not renewing policyholders for not taking care of their bargain. On the regulatory side, I believe next year 2008 building codes in California are going to have some measures that for people building in wildland or wildfire-prone areas to have some of the structural features that make a home less likely to catch fire if you have to evacuate and (create) defensible spaces.”

Some say insurers have learned to maintain their underwriting discipline, so the market will get harder and rates will increase in risky areas.

Ultimately, Celent’s Weber said the WUI situation raises the question of whether homeowners and builders bear some responsibility for fireproofing. “My take is that the market will help to address that issue,” he said. “Rates will go up to cover insurer potential losses, and everyone will be looking for ways to mitigate the rate increase. … It’s really the same with hurricanes. Should we be building homes out on sandbars in the middle of unprotected bays? Probably not. But if you choose to live out there, should you pay a lot for your insurance Absolutely.”

Monetary and In-Kind Donations

American Red Cross: 800-733-2767

Salvation Army: 800-725-2769

Good Will Southern California: 888-446-6394

OES Donation Lines: (for business donations) 800-750-2858, TDD 800-735-2929