Before wildfires raged across Southern California in January, several major insurers had already paused or canceled coverage in the state, citing the high risk of fire, state caps on premiums and increased construction costs.
With losses expected to exceed $250 billion from this year’s fires alone, the question isn’t if someone will pay, but who, says professor Kenneth S. Abraham of the University of Virginia School of Law. In a Harvard Law Review blog, “About the California Fires,” Abraham explains whether rising insurance premiums, taxpayer-funded bailouts or homeowners will ultimately cover the costs of the fires.
Abraham, a David and Mary Distinguished Professor of Law, is one of the nation’s leading scholars and teachers in the fields of torts and insurance law. He answers questions regarding the past, present and future of fire insurance in high-risk areas.
Q. In broad strokes, what lessons do you draw from the California fire disaster when it comes to insurance?
A. All the states, but especially states where there are high risks of fire or flood, have to pay more attention to ensuring that everyone who wants insurance against such risks has access to it. It’s going to be expensive, however, because the risks of loss are high. You can’t get around that.
Kenneth S. Abraham is a leading scholar and teacher in the fields of torts and insurance law. (Photo by Jesús Pino)
Q. Where did the idea of fire insurance come from?
A. Fire insurance goes back a long way. It was introduced after the Great Fire of London in 1666. It was sold in the colonies before the Revolution. And it was a risky enterprise. The new insurers had no actuarial data on the probability of fire or on the magnitude of risk posed by different properties.
They knew intuitively that stone and masonry buildings posed less risk than wood buildings, but until there had been a lot of fires, they could not know the precise difference, and, therefore, could not meaningfully calibrate the level of premiums they charged to cover these risks. So, they risked insolvency if they underestimated risk and charged too little for coverage. Eventually they solved this problem by pooling their data on losses to create a statistically more reliable basis for setting premiums, arguably at a cost to competition.
Q. There were stories about insurers canceling policies in at-risk areas in California even before the latest fires. What does an insurance shortage mean for Californians or others facing a lack of insurance options?
A. It means that homeowners will have to search for coverage from other insurers, or that California will have to provide more state-backup coverage.
Q. In your essay, you note some California homeowners have gone “bare,” exacerbating the financial impact of their loss after fire. What does that mean?
A. Homeowners who have paid off their mortgages have sometimes gone “bare” – i.e., uninsured. That’s what happens when premiums rise to a point that they are not affordable to some. Those whose homes have now been destroyed by fire will regret their decision not to renew. But many, if not most, of the nonrenewals could be framed as insurers’ decisions: because of insurers’ desire to reduce their exposure in high-risk areas, because of regulatory limits on premium levels that threaten profitability, or to play “chicken” with regulators in an effort to obtain future approval of premium increases greater than would otherwise be approved.
Q. Can California require insurers to cover homes?
A. Requiring insurers to take all comers would be pretty extreme and probably would never happen. It is true that regulators can require those who sell auto insurance, which is profitable, to continue selling homeowners insurance generally, or even, as California has recently, reach an agreement about how much they will sell, if they want to keep their licenses to sell auto insurance.
