LA wildfires likely will increase homeowner costs

Home loans and insurance are among the expenses predicted to rise

LA wildfires likely will increase homeowner costs

Home loans and insurance are among the expenses predicted to rise
House_California_fire

Homeowners in fire-devasted neighborhoods around Los Angeles could face higher costs for insurance and mortgages.

Driven by high winds, multiple fires burning out of control since Jan. 7 have killed at least 24 people and destroyed around 12,000 structures in Southern California, according to the latest reports.

The disaster, which is predicted to be among the costliest in U.S. history, is expected to worsen California’s insurance crisis and potentially make mortgages more expensive and harder to obtain in some areas of the state, experts say.

Insurers, like State Farm, have already left areas of California. This was partly due to regulations that cap premium increases but also came after several large fires.

“A lot of the big players have already left, not all the way, but they’ve been heading for the exits,” said Benjamin Keys, a professor of real estate and finance at the University of Pennsylvania’s Wharton School. “And it’s a function of growing disaster risk, wildfires, big wildfires in 2017, 2018, big wildfires in 2020, 2021, and now this, which may eclipse any of those previous disasters.”

Insurers scaled back as costs rose for “reinsurance,” the insurance that insurance companies buy to cover catastrophic losses from natural disasters.

Keys predicted the LA fires likely will compel the state to give insurance companies more flexibility in setting rates.

“We’re going to see a loosening of regulations, which is going to bring insurers back into the state eventually, but at a higher price point,” Keys told Scotsman Guide. “So, we’re going to see households paying a higher premium that more accurately reflects the risk.” 

Numerous homeowners also could be kicked off private plans and forced into the state’s insurance program of last resort, known as the Fair Access to Insurance Requirements (FAIR) plan, which typically costs significantly more than private insurance.

Whereas FAIR plans in the neighboring West Coast states of Oregon and Washington cover a small percentage of high-risk policyholders, California’s program grew exponentially in recent years as insurance companies pulled back their business.

California’s FAIR plan “is actually now slightly larger than Florida’s,” Keys said. The program has grown to $458 billion in exposure as of September from about $50 billion in 2018. It has about $6 billion in exposure in Pacific Palisades, which has seen heavy damage from the fires.

Home insurance in California remains inexpensive compared to parts of Florida and other high-risk areas because of its hard caps on premium increases.

“Recently, the state insurance office changed some of these rules to allow insurers to price using catastrophe models,” Keys said. “There was a sense that was going to bring insurers back into the state in 2025 and that the market was going to normalize, and these wildfires throw those plans into disarray.” 

The fires also could make mortgages more expensive in affected areas, which is partially due to how loans in the pricey LA market are often securitized.

“This is quite a different market from the markets in other parts of the U.S. because of the very high house prices in [the Los Angeles area],” said Amine Ouazad, a professor of applied economics at HEC Montréal.

Ouazad said homes in the LA-affected neighborhoods have a higher concentration of large non-conforming loans, which can’t be securitized by Fannie Mae and Freddie Mac.

In the aftermath of big fires, private-label securities tend to require “more skin in the game and higher interest rates,” Ouazad said.

“The estimates that we have differ depending on the types of events,” Ouazad said. “We have anything from small increases in interest rates to pretty large increases.”

He also said the downpayment requirement can rise between 3% to 6%, which for a $1 million loan would increase the required downpayment by $30,000 to $60,000.

While at Rutgers University, Ouazad co-authored a study on the impact of natural disasters on the primary mortgage market and mortgage-backed securities.

Ouazad said that homes and land in neighborhoods damaged by wildfires tend to lose value, leading to higher losses for lenders and investors in mortgage-backed securities if those properties default.

The default losses tend to be greater after natural disasters than in normal default situations caused by a job loss or divorce, Ouazad said. The character of a neighborhood also can change dramatically with fewer stores and homes built in the aftermath.

Author

  • Victor Whitman

    Victor Whitman is a contributing writer for Scotsman Guide and a former editor of the publication’s commercial magazine. 

More Headlines