By Telis Demos

Projections for insured losses from the Los Angeles wildfires are reaching $30 billion and beyond. That is in a territory where insurers' insurance, also known as reinsurance, may be expected to start to pick up a sizable portion of the tab.

At least, that is how it is supposed to work. But like so much in the insurance business these days, the situation is in flux.

Over the past couple of years, reinsurers have often had the upper hand on their primary insurance counterparts, which write policies for consumers and businesses. Reinsurers have at times been able to push through higher rates, or provide less coverage for the same money.

That helped stabilize reinsurers after years of rising catastrophe losses and low profitability. But the shift has been cited as a reason why some primary insurers have left parts of tricky markets, like the one for California homeowners. And it helps explain why some insurers' shares have underperformed in recent years, despite often being able to raise premiums on many consumers.

Yet one aspect of these tragic wildfires may be working to the benefit of some primary insurers: being designated as two catastrophes. This means insurers may be able to dip into their reinsurance coverage twice, in some cases potentially limiting the losses they will have to retain.

Verisk PCS, a provider of catastrophe loss information that is often used as an industry benchmark, has designated two separate events, the Palisades fire and the Eaton fire. The California Department of Forestry and Fire Protection, known as Cal Fire, is also tracking them as two incidents.

Verisk's Extreme Event Solutions group this week estimated that the insured loss of the two fires could be between $28 billion and $35 billion, broken down into $20 billion to $25 billion for the Palisades fire, and $8 billion to $10 billion for the Eaton fire.

Opting to seek reinsurance for two catastrophes, rather than one, could make a big difference to some primary insurers' loss exposure.

For example, Mercury General Corp., a publicly traded insurance group primarily offering personal automobile and homeowners' policies, in a statement this week took note of PCS's designation. As of 2023, Mercury had a roughly 6% share of California homeowners direct written premiums, according to S&P Global Market Intelligence data tracked by analysts and rating agencies.

Mercury said in the statement that it hasn't yet determined if it will consider the wildfires as two events. But depending on how sizable the insured losses get, there could be a significant potential economic impact in that choice.

If it was treated as two events, Mercury said it could use its reinsurance limit of up to $1.29 billion for the first event, then, after paying to reinstate its coverage, a limit of $1.238 billion for the second event. That would make Mercury responsible for a $150 million retention for each event, plus the cost of an up-to $101 million reinstatement premium, according to the company.

Depending on the ultimate insured loss levels, going the two-event route could result in a smaller loss for the company than from a single larger event, according to Neuberger Berman global insurance analyst Chai Gohil.

Mercury didn't provide additional comment on its expected share of industry losses or anticipated exposure. It said in an earlier statement that based on available information at that time, it expected its losses to exceed its reinsurance retention level of $150 million.

If similar math were to play out across many carriers, it could make a big difference in how much of the industry's losses are ultimately borne by primary insurers. Often insurance stocks that drop sharply as a catastrophe hits later rally back as loss estimates narrow and things like reinsurance coverage become clearer.

Right now, the market appears to be pricing in a single event, based on how many primary insurance stocks have traded, says Neuberger's Gohil. "But if this is two events, it may shift more of the losses to reinsurers," he said.

How disasters are designated has been contentious in the past, including after the Sept. 11 attacks. The developer that controlled the World Trade Center at the time fought with insurers for years over whether it could receive coverage for two occurrences rather than one after planes hit each Twin Tower.

For some insurers, it also could still be advantageous to elect to treat the wildfires as a single event. That could be the case for an insurer that has sold off risk via the catastrophe bond market, which often provides coverage for tail risks such as major disasters. So-called cat bonds can be used by primary insurers and reinsurers. These instruments can earn a relatively high yield for investors, but risk losses of principal when designated events or loss levels occur.

For cat bonds and other insurance-linked securities, the single-versus-multiple question can be "highly consequential," according to Florian Steiger, chief executive of Icosa Investments, which focuses on alternative fixed-income investments. "If events are lumped together, it naturally increases the likelihood of reaching that trigger, which can substantially affect both issuers and investors."

There are both short-term and long-term questions at stake, too. Insurers might benefit from more coverage for these wildfires. But they might also end up costing themselves in a later catastrophe by using up their coverage capacity, or by risking paying higher rates next year.

Evercore ISI analyst David Motemaden said that he anticipated reinsurance's share of industry losses from the wildfires could be around 15% to 20%, or toward the high end of the range expected with Hurricane Milton. But, he added, he didn't think this would "change the trajectory of pricing." Evercore ISI analysts this week wrote that they are anticipating an overall pricing drop of 10% to 20% in the midyear reinsurance renewals.

This dynamic is the usual push-and-pull between insurers, reinsures and cat-bond holders. But it is made even more complicated by evolving risks from nonhurricane risks such as wildfires or winter storms, and the impact of inflation on how much disaster recoveries cost.

And in California in particular, new state rules designed to bolster the market can allow premiums in the future to take insurers' reinsurance costs into account. So how the coverage ultimately shakes out may be a critical question for everyone who bears the risks of the next fire.

Write to Telis Demos at Telis.Demos@wsj.com

(END) Dow Jones Newswires

January 23, 2025 05:30 ET (10:30 GMT)

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