Controlling Wildfire Risk

S&P estimates that insured losses from the California devastation could approach a manageable $2 billion

On Oct. 23, President Bush declared a state of emergency in the seven Southern California counties affected by wildfires. These fires had been more intense than usual because of the arid conditions, low humidity, and gale-force Santa Ana winds that helped to spread the fires and hindered fire-fighting efforts.

Although the fires have been largely contained, more than 2,000 homes and businesses were destroyed and, for a time, in excess of 800,000 people were forced to evacuate a 150-mile area between Malibu and the Mexican border. At their height, some 60,500 homes were threatened by the fires, according to news reports. The fires burned more than 800,000 acres, and losses just on homes in the hard-hit San Diego area were more than $1 billion, according to some estimates.

Despite the magnitude of this tragedy in personal terms, insured losses of around $2 billion are likely to be contained within the personal lines area of the insurance marketplace (i.e., homeowners and auto insurance policies), in Standard & Poor's estimation.

To put those numbers into perspective, the Oakland fires of October 1991 resulted in $2.4 billion in damages in 2005 dollars, according to data from ISO and the Insurance Information Institute. During those fires, 2,800 residences were destroyed. In late October and early November of 2003, fires in Southern California destroyed some 3,640 homes, resulting in $2.2 billion (in 2005 dollars) in insured losses in both San Diego and San Bernardino counties.

Based on early estimates of the damage, the insurance industry is likely to see a relatively modest impact. However, there are a handful of property-casualty insurers with significant exposure to the California homeowners market. According to data from the National Association of Insurance Commissioners (NAIC), State Farm, Zurich Insurance Group, Allstate (ALL; recent price, $52; S&P investment rank 4 STARS, buy), California State Auto Group, and USAA Group were the leading underwriters of homeowners insurance in California in 2006. State Farm, Zurich, and Allstate have a combined market share of 52.2% of the homeowners insurance market. Safeco (SAF; $57; 3 STARS, hold), Mercury General (MCY; $51; not ranked), Allianz (AZ; $22; 4 STARS), and Chubb (CB; $53; 5 STARS, strong buy) are also major California underwriters.

Overall, profitability of homeowners insurance has been on the rise in California over the past 16 years. Loss ratios, which hit 118.77% in 1991 in the aftermath of the Oakland fires, have been trending lower, according to NAIC data. Loss ratios averaged 33.36% in 2006, but could rise again in 2007 as a result of the fires.

Although some publicly traded insurers remain major homeowner insurance underwriters in California, according to Cathy Seifert, head of S&P's financial services equity research group, their exposure will depend heavily on how much business they still write in the afflicted areas. Many insurers are likely to have pulled back somewhat from parts of Southern California following the 2003 wildfires.

Seifert believes the industry should be able to absorb any losses from the current wildfires fairly easily. During the first half of 2007, there were only $3.6 billion of direct property losses stemming from catastrophic events, according to data from ISO's Property Claims Services unit. That compared with $6.5 billion in the first half of 2006. Overall industry profitability also was solid during 2006 and the first half of 2007, and surplus capital levels rose. The industry reported a net underwriting gain of $31 billion for 2006 and a gain of $14.4 billion for the first half of 2007. The industry's total surplus stood at $512.8 billion at the end of June 2007, a 5.5% increase from the end of 2006.

Although this unfortunate event is clearly disruptive to the California economy and to many affected individuals, S&P believes the financial impact from this catastrophe will not pose a material adverse impact to the insurers with exposure to the California homeowners market.

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