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How wildfire losses can snowball for utilities

If last year’s wildfires are any indication, California utility companies are in for some trouble.

Two massive, deadly fires continue to rage in the state, and authorities are starting to look into whether utilities Pacific Gas and Electric (PG&E) and California Edison could be responsible. Under state law, the companies bear the blame when a failure to properly maintain equipment and power lines, including keeping them free from dead trees, leads to a fire. That’s bad news for their shareholders and for their insurers.

In 2017, which was also a bad year for fires, there were at least $11.7bn in losses, many of which stemmed from large blazes in October in wine country, according to state insurance regulators. Most industry estimates put claims at around $13bn.

Of that, insurance companies are seeking roughly $10bn through subrogation lawsuits against PG&E, which was determined to be at fault for many of the blazes. The lawsuits, consolidated along with liability suits brought by property owners, are set to be tried from September 2019, according to insurance attorneys.

As a result, most of the fire losses for 2017 could be funnelled to the utility and its insurers. The same scenario is likely to play for this year’s losses, which are expected to cost $10bn-$15bn at this stage.

“The net consequence is you may have a fairly dramatic shift if PG&E is ultimately found liable,” said Paul White, a California insurance lawyer, in an interview. “You could see not just property owners, but insurers who have amassed substantial losses seek to shift their exposure to PG&E and theoretically its insurers. The exposure here shifts from a first-party response exposure to a liability exposure for PG&E and its tower of insurance.”

Such an amount could burn through the company’s liability insurance programme.

As this publication previously reported, insurers providing coverage to PG&E for 2017 included Berkshire Hathaway, Aegis Mutual, Allied World, Argo and Apollo. Excess insurers included Swiss Re and Munich Re. The total coverage was roughly $850mn.

Sources have said that the panel has changed less than might have been expected post-loss, but details of the insurers exposed to the 2018 losses have not yet been confirmed.

The liability cover for this year was purchased across the excess casualty insurance and cat reinsurance market, with huge rates online that stretched into the thirties.

PG&E also bought a catastrophe bond providing $200mn of limit that effectively sits excess of the traditional market placement. Sister title Trading Risk has reported that it paid a coupon of only 750 basis points, demonstrating a huge spread of pricing between the ILS and traditional markets as the latter sought payback for 2017 losses.

PG&E’s limit could easily be exhausted if the utility, once again, is hit with a raft of liability and subrogation lawsuits from other insurers. Under a concept called inverse condemnation, utilities in California are liable if equipment within their control harms the property of members of the public. They can additionally be sued for negligence.

Directors’ and officers’ insurance will also likely be implicated by any post-fire aftermath. Already PG&E is facing securities class action suits over the amount of liability it has taken on in connection with the 2017 destruction. More could follow 2018’s fires.

Risk modeller RMS said it expects the Camp Fire, which has been named the most destructive in the state’s history, and the Woolsey Fire to produce total insured losses of $9bn to $13bn. Together, the two blazes have burned a total of 245,000 acres, destroying 12,000 structures and killing 80 people.

The Camp Fire tore through Northern California, leading to the secondary problem of poor air quality in the San Francisco Bay area. The Woolsey Fire to the south burned through Los Angeles suburbs, threatening and consuming multi-million-dollar homes of celebrities in Malibu. Both are still burning and expected to be contained later this month.

The blazes spread quickly because of low moisture, abnormally high temperatures, dry vegetation and intense seasonal winds, according to RMS. The difficult task of keeping the state’s millions of dead trees away from power equipment could also be a factor. Reports from both PG&E and California Edison indicate there may have been incidents that could have sparked the fires.

“The whole state has been under drought for years, and so we have a ton of fuel,” White said.

This year, “my understanding is that the geographical scope of this fire is greater than anything we’ve seen so far,” he added. “Its impact, from a financial perspective is yet to be determined. People are still trying to figure out if their homes are even still standing.”

Bankruptcy has already been hinted at as possible outcome for PG&E. But there is one hope for the financial survival of the utilities. A state law passed in the last legislative session allows the utilities to recoup some of the cost from wildfire liability through bonds, which would be financed in part through extra fees tacked on to customer’s bills. But it is a still untested solution.

It “has a formula that no one has ever seen before, and it’s not actually known what the process is going to look like in terms of analysing the financial stress test which it embodies,” explained Michael Kelly, a lawyer representing plaintiffs who are suing PG&E over the 2017 fires.

However, “I would expect when the legislature next gets into session, there would certainly be a push to extend the bill last year into this year,” he said. “There are so many unanswered questions about how we found ourselves in the same position were in last October. I don’t think anybody is quite certain what the next steps are.”

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