# The Economic Toll of The Los Angeles Wildfires

An episode of [Patrick Boyle On Finance](https://invisiblenetwork.ai/podcast/1547740313), 19 Jan 2025, 20 min.

Audio: https://traffic.megaphone.fm/APO5868514479.mp3

The Los Angeles wildfires have destroyed more than 12,000 structures and at least 24 people have died with more unaccounted for as multiple wildfires, fueled by severe drought conditions and strong winds, continue to burn. Wells Fargo and Goldman Sachs estimate that the destruction will cost insurers as much as $30 billion dollars and after accounting for non-insured damages, the total costs will balloon to $40 billion. The ongoing fires, already appear to be the costliest wildfire event in California history. Patrick's Books: Statistics For The Trading Floor: https://amzn.to/3eerLA0 Derivatives For The Trading Floor: https://amzn.to/3cjsyPF Corporate Finance: https://amzn.to/3fn3rvC Ways To Support The Channel Patreon: https://www.patreon.com/PatrickBoyleOnFinance Buy Me a Coffee: https://www.buymeacoffee.com/patrickboyle Visit our website: https://www.onfinance.org Follow Patrick on Twitter Here: https://bsky.app/profile/pboyle.bsky.social Business Inquiries ➡️ sponsors@onfinance.org

## Transcript

[0:00] On January 2nd, the National Interagency Fire Center warned
[0:04] that there was significant fire potential across Southern
[0:08] California due to warm weather, persistently dry conditions, and
[0:12] Santa Ana winds in what is usually the regions wet season.
[0:17] Santa Ana winds, which are sometimes called the devil
[0:20] winds, are linked to some of the worst wildfires in California
[0:24] history. They blow from the Great Basin
[0:27] and the upper Mojave Desert towards the coast, which is the
[0:31] opposite direction of the normal winds, which carry moist air
[0:35] from the Pacific into the region.
[0:38] These dry desert winds dry out plants and vegetation, making
[0:43] them more flammable, and the highwind speeds can feed small
[0:46] fires, turning them into a rapidly spreading blaze.
[0:50] Most of the damage has been done by the two largest fires, the
[0:54] Palisades Fire and the Eaton Fire, which are likely the
[0:58] second and 4th most destructive fires in California's history.
[1:03] They've killed at least 27 people, forced over 200,000 to
[1:07] evacuate and destroyed or damaged more than 12,000
[1:11] structures. More than 80,000 people are
[1:14] still under evacuation orders and many don't know what, if
[1:18] anything, is left of their homes or possessions.
[1:22] It's difficult to visualise the scale of the disaster.
[1:25] The area burned is equivalent to three times the size of
[1:29] Manhattan. Block after block of houses have
[1:32] been burned to the ground, leaving the city, which had been
[1:36] struggling with multiple social and economic problems, looking
[1:40] like a war zone. California has a long history of
[1:44] wildfires. The earliest one on record was
[1:47] the Santiago Canyon Fire of 1889, which burned around
[1:52] 300,000 acres and was the largest wildfire in the state's
[1:56] history in terms of acreage burned until it was surpassed in
[2:00] 20, 2018. Sometimes something as simple as
[2:04] a lightning strike can start these fires.
[2:06] Other times people are to blame. Wildfires have been started by
[2:11] downed power lines, by the careless actions of residents.
[2:15] One of the biggest fires in recent history started when a
[2:18] truck blew out its tire and its wheels scraping along the
[2:22] roadway showered out sparks, which started 3 separate fires.
[2:27] People have increasingly moved to living in more wooded areas
[2:32] in California over the years too, which means that their
[2:35] actions are more likely to cause fires as they live in the woods.
[2:40] And more properties are at risk, too, when fires occur.
[2:44] Daniel Swain of UCLA explains that a phenomenon known as
[2:49] hydroclimate whiplash, where 2 very wet years were followed by
[2:53] a very dry one, helped to turn the Los Angeles wildfire into a
[2:58] raging inferno. During the wet years, plant life
[3:01] flourished, and then a lack of rain since May dried out the
[3:06] plans, meaning that any spark could start a fire.
[3:10] According to a New York Times article from a few years ago,
[3:13] 100 years of successfully fighting small fires in
[3:17] California means that when fires start today, they're burning
[3:21] through places that have a lot more plans to burn than would
[3:25] have been the case if there'd been more small fires in the
[3:28] past. The Forest Service is, of
[3:31] course, aware of this and have been trying to fix the problem
[3:34] with controlled burns and vegetation thinning for quite
[3:38] some time. But environmental reviews, which
[3:41] are required from both the state and federal governments, can
[3:45] delay this work for years. According to the Property and
[3:49] Environment Research Centre, reviews for mechanical thinning
[3:53] can take over five years and reviews of prescribed burns can
[3:57] take over seven years, which makes good forest management
[4:01] much more difficult. While many are blaming these
[4:04] specific policies for the current fires, it's not clear
[4:08] that these rules contributed to the severity of the fires that
[4:12] are burning today, as according to Luca Carmigiani, a researcher
[4:17] at San Diego State University, the hillsides currently burning
[4:22] are not areas where controlled burns would typically be done as
[4:26] prescribed. Burns in areas like that are
[4:29] very hard to keep under control. The Santa Monica Mountains,
[4:33] where the Palisades Fire is still burning, has been the site
[4:37] of over half a million acres of mechanical thinning over the
[4:40] last year due to the high winds. Even the Pacific Coast Highway
[4:45] wasn't enough of a firebreak to prevent a beachside Malibu homes
[4:50] from burning down. There are a number of estimates
[4:53] for how much the Los Angeles wildfires will cost, and experts
[4:57] are predicting that they will be the most expensive wildfires in
[5:01] U.S. history. You can't really compare these
[5:04] fires to others, as wildfires usually burn in much more remote
[5:09] locations. Last March, for example, a much
[5:12] larger wildfire in the Texas Panhandle burned more than
[5:16] 1,000,000 acres, but fewer than 150 houses were burned.
[5:21] Due to its rural location, the LA wildfires are better compared
[5:25] to events like Hurricane Katrina in 2005, which left 400,000
[5:30] people homeless and caused 100 and $61 billion in damage, or
[5:35] Hurricane Harvey which flooded Houston in 2017, causing $125
[5:41] billion in damage. Hurricane Helene last year
[5:46] caused nearly $80 billion in damage from Florida through to
[5:50] North Carolina. AccuWeather has estimated that
[5:55] the fires may cost as much as $275 billion in damage, and
[6:00] estimates from Wells Fargo and Goldman Sachs say that the
[6:04] insurance industry may lose as much as $40 billion.
[6:09] At present, around 12,000 buildings are damaged or
[6:13] destroyed in Los Angeles, which is fewer than the 18,000 burned
[6:17] by the Camp Fire in Northern California in 2018.
[6:22] The LA homes are, however, much more expensive than the ones
[6:25] burnt down in 2018, as the average home in Pacific
[6:29] Palisades is worth $3.4 million and the average home in Altadena
[6:35] is worth $1.3 million. It's worth noting that a big
[6:40] part of the home value is the value of the land it's built on,
[6:44] and so a $3,000,000 home might really be $1,000,000 structure
[6:49] on a $2,000,000 plot of land, so reconstruction cost might be
[6:53] significantly below overall home value.
[6:57] The problem in Los Angeles, though, is the scale of the
[7:01] disaster. If one or two houses burnt down,
[7:04] you might be able to rebuild them for $150.00 a square foot.
[7:09] But when 12,000 homes need to be rebuilt all at once, there are
[7:13] not enough workers or building supplies available and prices
[7:17] could more than double, meaning that many people who had
[7:21] insurance may find that they were still underinsured.
[7:25] Insurance won't necessarily cover the full cost of
[7:28] rebuilding for very high end homes either, as in recent years
[7:33] many insurance companies withdrew from riding policies in
[7:37] many of the affected areas and the state backed insurer of last
[7:41] resort caps coverage at $3,000,000 per residential
[7:45] property. I'll explain in just a moment
[7:48] how state price control regulations led to the non
[7:52] renewal of thousands of home insurance policies in
[7:55] California. Apart from the cost of
[7:58] buildings, government funding will be needed to repair and
[8:02] reconstruct damaged infrastructure.
[8:04] Things like roads, power lines, water infrastructure, schools,
[8:08] and police stations will all need to be rebuilt or repaired.
[8:13] The fires will affect employment and productivity in the state
[8:17] too. The people who have been
[8:19] evacuated are unlikely to be able to work while they get
[8:22] their lives back in order, and many service jobs in the
[8:26] affected area are likely to temporarily disappear too.
[8:30] The fires haven't hit many major centres of employment like
[8:34] factories or office buildings, But Goldman Sachs estimates that
[8:38] the fires will knock between 15 and 25,000 positions off the
[8:43] Labour Department's employment report for January, which is
[8:47] less than occurred during Hurricane Helene last year,
[8:50] after which people quickly return to work.
[8:54] California is already a very expensive place to live, and
[8:58] loss of housing will only make that situation worse in the
[9:02] short term as people who lost their homes look to rent a place
[9:06] to live while they rebuild. The high demand for rental
[9:10] properties will push prices up. A lot of the houses that were
[9:15] destroyed in the fire were built during California's post war
[9:19] building boom in the 1950s. Due to planning rules, it's been
[9:23] very difficult to modify these homes over time or build any new
[9:28] ones. The city might take this
[9:30] opportunity to ease its housing shortage by zoning for denser
[9:35] mixed-use neighbourhoods. Otherwise, people will likely
[9:38] just build bigger and more luxurious homes where their old
[9:41] home used to be, as that's what generally happened after other
[9:45] fires. While the cause of the fires is
[9:48] still unclear, a number of lawsuits have already been filed
[9:52] against Southern California Edison, blaming them for the
[9:57] Eaton Fire, the second largest ongoing blaze.
[10:01] Shares in California utilities have all sold off year to date
[10:05] as investors worry about the risk of massive lawsuits, as
[10:09] California's law of inverse condemnation liability could
[10:14] make them liable for damages if the blaze started from their
[10:18] equipment, regardless of whether the utility behaved negligently.
[10:23] This rule was used against PG&E, forcing the company into
[10:27] bankruptcy after it was found liable for billions of dollars
[10:31] in damages after the 2018 campfire, which killed 85
[10:36] people. Warren Buffett warned in his
[10:39] 2024 letter to investors that California utilities may be
[10:44] uninvestable because of the risk of this type of lawsuit.
[10:48] Even if Edison International is found liable for the Eaton fire,
[10:53] it still is unlikely to go bankrupt like PG&E did because
[10:57] of its participation in California's $21 billion
[11:01] Wildfire Fund that was established in 2019, offering
[11:06] the potential for faster compensation for victims of
[11:09] utility caused fires but gave protection to participating
[11:14] power companies should they be hit with massive claims.
[11:18] The Wildfire fund essentially acts as a form of reinsurance,
[11:23] but it only covers claims against the three utilities that
[11:27] agreed to contribute to it and only pays out if the utility is
[11:31] found liable for causing the fire.
[11:34] This fund won't compensate victims of the Pacific Palisades
[11:38] fire, as Pacific Palisades is served by the Los Angeles
[11:43] Department of Water and Power, which is municipally owned and
[11:46] opted not to participate in the fund.
[11:49] No cause for the Palisades fire has been announced yet, but
[11:54] investigators are allegedly focusing on human cost factors
[11:58] rather than power utility equipment.
[12:01] California law requires insurance companies to hold
[12:05] adequate reserves to pay out claims even in extreme
[12:08] situations like these fires. For that reason, this event is
[12:13] not expected to push any insurance companies into
[12:16] bankruptcy. California has had a homeowners
[12:20] insurance crisis, which has been building for years.
[12:24] It started with a 1988 ballot initiative called Proposition
[12:28] One O 3, where voters decided to limit how much insurance
[12:33] companies could raise their rates.
[12:35] Under the rules, regulators had to approve premium increases and
[12:40] began requiring insurance companies to show that proposed
[12:44] increases were based on historic losses.
[12:48] They weren't allowed to use forward-looking risk
[12:51] assessments. The rules also limited insurers
[12:54] ability to pass on the cost of the reinsurance they buy.
[12:59] Reinsurance is like an insurance policy that insurance companies
[13:03] themselves buy to protect against huge events like these
[13:07] wildfires, which could otherwise wipe them out.
[13:11] Capping prices below the level where insurance companies can
[13:14] make a profit might have sounded like a good way of keeping
[13:18] prices low, but it just caused the big insurance companies to
[13:22] pull out of selling insurance in California and others to stop
[13:26] selling insurance in the highest risk areas where potential
[13:30] losses were greater than what they could charge in premiums.
[13:34] This all came to a head in 2023 when the state's two largest
[13:38] home insurers, State Farm and Farmers, said that they'd stop
[13:43] issuing new policies in California and cancel thousands
[13:47] of policies in Pacific Palisades, one of the areas
[13:51] destroyed in the fires. An estimated 10% of Californian
[13:56] residences have no home insurance at all.
[13:59] But if you buy a home with a mortgage, your bank will usually
[14:03] require you to insure it. So most people need to insure
[14:07] their home whether they want to or not.
[14:10] The FAIR Plan is a fire insurance program backed by the
[14:14] state of California for property owners who can't get private
[14:18] market insurance coverage. It caps coverage at $3,000,000.
[14:23] So some of the very expensive homes that have burnt down will
[14:27] be underinsured. These last resort plans are more
[14:31] expensive and provide less coverage than the typical
[14:35] commercial plan would, but they're needed in places where
[14:38] private insurance companies don't want to sell insurance.
[14:42] Demand for the California Fare Plan has skyrocketed 164% since
[14:48] 2019 because of California's broken insurance market.
[14:53] If the FAIR Plan doesn't have the money to pay out all claims,
[14:57] it then collects money from all of the insurance companies that
[15:01] operate in California. This means that those who were
[15:05] able to get insurance in lower risk areas have to pay higher
[15:09] premiums to reflect the lack of insurance caused by price
[15:13] controls in high risk areas, which isn't really fair, but
[15:17] these types of distortions occur when you move away from free
[15:21] market pricing. Gavin Newsom did recognize the
[15:25] problems that the rules were creating, but one of the
[15:29] problems is that Prop 103 was almost impossible to change as
[15:34] amendments required 2/3 approval in the legislature and then
[15:39] voter approval in a referendum in 2023.
[15:43] Newsom took unilateral action and issued an executive order to
[15:47] stabilize the state's insurance market, and they recently
[15:51] finalized rules that gave insurance companies permission
[15:55] to pass along the costs of reinsurance to customers and to
[15:59] use forward-looking models that take into account the risk of
[16:03] wildfires in deciding on insurance rates.
[16:06] But even then, the state would only allow those changes if
[16:10] insurance companies also agreed to meet a certain quota of
[16:15] policies in disaster prone areas.
[16:18] So once again, a market distortion where low risk
[16:22] homeowners are forced to subsidize high risk homeowners.
[16:26] Market prices send signals telling consumers about the true
[16:30] costs of building and living in wildfire prone areas, and
[16:35] government enforced rules prevent those signals from being
[16:38] sent. California's failed attempt at
[16:42] price controls left homeowners unable to adequately insure
[16:46] themselves in the face of growing wildfire risk.
[16:50] Florida similarly has a home insurance crisis, with insurance
[16:55] companies fleeing that state, going out of business or
[16:58] choosing not to renew policies in high risk areas.
[17:02] Citing legal costs, fraud, and climate change, a 2017 Florida
[17:08] Supreme Court decision allowed courts to award a plaintiff's
[17:12] attorney 2 1/2 times their hourly billing rate.
[17:16] When courts rule in favour of policy holders, this result is
[17:20] in an explosion of insurance lawsuits in Florida.
[17:24] And today, roughly 79% of home insurance lawsuits in the United
[17:29] States now occur in Florida, despite the fact that only 9% of
[17:34] home insurance claims happened there.
[17:37] It's easier for insurance companies to just do business
[17:40] elsewhere and so they leave. On January the 8th, the
[17:45] President declared the LA wildfires to be a major disaster
[17:49] and approved federal aid to help pay short term costs such as
[17:53] debris cleanup and emergency protection.
[17:56] Victims of the California fires are eligible for a small payment
[18:00] for necessities like food and fuel, but this won't be the only
[18:05] federal aid provided. So far, long term aid has not
[18:09] been announced, but FEMA has been critical for California's
[18:13] recovery in the past, having given the state $4 billion
[18:17] following eight blazes between 2017 and 2021.
[18:22] It's worth noting that California pays more in federal
[18:25] taxes than it receives back in federal benefits, but this
[18:29] hasn't stopped some people complaining about federal
[18:32] payouts. In the coming years, insurance
[18:35] prices can be expected to rise in California and in other
[18:39] places susceptible to large scale disasters like this.
[18:43] Insurance companies typically buy reinsurance policies so that
[18:47] they'll be able to survive should a disaster like this
[18:51] occur. The cost of reinsurance goes up
[18:53] around the world as risk rises, losses increase, and the costs
[18:58] of reconstruction goes up. Reinsurance companies will have
[19:02] to make huge payouts for the LA wildfires, and this will likely
[19:07] push up reinsurance premiums both in California and in the
[19:11] rest of the world. So to a certain extent, everyone
[19:15] who buys insurance will be paying for this disaster.
[19:19] Thanks for tuning into this week's podcast, with particular
[19:22] thanks to my supporters on Patreon who make it all happen.
[19:26] If you'd like to support the channel, there's a link in the
[19:29] show notes. Have a great day and talk to you
[19:31] next week. Bye.

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