Wildfire risk

The wildfire seasons of 2017 and 2018 featured the deadliest and most destructive fires in California’s history. The state’s Department of Insurance data showed that the 2018 wildfires resulted in $12 billion in insured losses as of April 2019, a figure that has climbed over the past few months as homeowners and businesses continue to assess damages from the Camp, Woosley and Hill fires.

Primary insurers bore the brunt of a large portion of California’s wildfire losses, although the heightened activity and increasing costs associated with these events is leading to a number of them not renewing policies for customers or ceding more to the reinsurance market.

Utility and energy companies face significant potential losses from wildfire: for example, Pacific Gas and Electric Company (PG&E) had to file for bankruptcy as a result of the financial challenges it faced from the 2017 and 2018 fires.

Wildfire, along with asbestos and cyber, was identified by Marsh’s 2019 Excellence in Risk Management Report as one of the emerging risks that captives are increasingly being used to insure.

Most energy and utility companies in the US are assumed to be using a captive or cell company in some form.
“There are a lot of utility companies in the US, and most of the urban or rural utility companies have captive insurance companies,” says Alex Sarfo, senior financial analyst, property/casualty at AM Best. “It’s very common for them to have this facility.”

Specialty insurers and captives play a significant role in providing coverage for utility companies. Specialty insurers often operate at mutuals, with membership available to utility and energy companies. Many of the electric utility companies also have wholly-owned captive insurance subsidiaries to provide the primary layer of insurance coverage, while using the specialty and commercial markets for higher layer protection, according to Sarfo.

“Given the wildfire exposure in California from 2017 and 2018 alone, it is becoming increasingly difficult for utilities with wildfire risk in California to find sufficient direct insurance,” says Eric Scheiner, partner at Kennedys Law.

Why a captive?
An energy or utility company may use a captive due to its ability to tailor coverages, or to provide more control in the claims process, but perhaps one of the main reasons is cost savings.

“It’s not just utility companies, but other types of corporations, such as retail, manufacturing, pharmaceutical or even banks. They see the utility and ability of a captive—it saves them billions,” says Fred Eslami, senior financial analyst at AM Best.

A number of energy companies have traditionally used Associated Electric & Gas Insurance Services Limited (AEGIS), a Bermuda-based mutual insurance company that provides liability and property coverage to its members.

There is also a mutual insurance company, Energy Insurance Mutual (EIM), that is often used by the energy industry. Sometimes both mutual companies will be on the same insurance tower, according to Scheiner.

Energy Insurance Services (EIS), a South Carolina-sponsored captive insurance company and subsidiary of EIM, offers cell captive solutions to its members. Any EIM members can form a protected cell, subject to the approval of EIS. The cell covers a range of coverages including traditional property/casualty retention programmes, wildfire protections and employee benefits.

The benefit to the member companies is that it allows them to tailor specific coverages for their operating entities, efficiently share risk between operations, and take more control over risk exposures.

The risks a utility will take on in a captive are typically property, business interruption, general liability, and sometimes D&O, according to Sarfo.

“Some of the risks are not necessarily retained by the captives, but they are passed through to the commercial markets or to specialty companies in the insurance marketplace,” says Sarfo.

“If they are taking on risk from property damage, for instance, they may take the first layer of self-insured retention—a retention of maybe $1 or $2 million. The next layer might go to specialty reinsurance companies in the commercial market.”

EIM conducted a survey in June 2019 of its members that asked what their most important risk management consideration will be in the next five years. Nine percent answered wildfire—although cyber liability still ranked number one (26 percent).

Wildfire liability
The large scale of losses that emanate from wildfires creates much contention over who is to blame, and who therefore should foot the bill.

Officials blamed Pacific Gas and Electric Company (PG&E’s) equipment for starting almost every major fire in California in 2017. Allegedly, around 40 of the 315 wildfires in its service areas in 2017 and 2018 were caused by its equipment.

On June 18, law firm Baron & Budd announced a $1 billion settlement with PG&E on behalf of 14 public entities for taxpayer losses caused by the 2015 Butte Fire, 2017 North Bay Fires, and 2018 Camp Fire. The settlement does not affect the claims of any residents, individuals, or businesses affected by the fires, however.

PG&E’s general liability insurance relating to wildfires for 2018 was estimated at $1.4 billion. In order to broaden its market reach and increase capacity for risks such as wildfire, it also established a captive insurance company.

EIM was used to insure PG&E for wildfire liability, although the retention was small, according to Saarfo. “They retained $20 million of the $200 million limit; the rest went to the commercial market,” he says.

EIS offers an array of third party liability coverage to EIM members, which includes wildfire liability for property damage.

Scheiner suggests that a captive would in theory give the utility company more control in the claims process, and with risk management generally, along with direct access to alternative markets, including reinsurers. He says utility companies face a wide variety of allegations of liability from wildfires.

“Electric utility companies can start wildfires in many ways, including electrical transformer malfunctions, hot materials dropped from transmission lines to the ground below, animals short-circuiting power lines, high winds (especially in California) causing lines to touch and spark, trees falling on lines and grounding them, uncontrolled vegetation coming in contact with wires, and lightning strikes,” Scheiner says.

Kennedy’s 2018 report, Wildfire Liability from a US Perspective, identified the plaintiffs making liability claims as homeowners, evacuees, farmers, businesses, automobile owners, governmental entities, and disaster relief organisations. The utility and energy companies that potentially face wildfire claims include power/electric, oil and gas companies, due to their having facilities, equipment and power lines in grassy or wooded areas that could serve as ignition sources, the report said.

“Theories of liability against utility companies can include negligence, trespass, nuisance, intentional or negligent infliction of emotional distress, wrongful death, unlawful or unfair business practices, business interruption, violations of state statutes, codes, or ordinances, as well as inverse condemnation in certain jurisdictions,” says Scheiner.

“Inverse condemnation can be difficult to defend against in California if the source of the fire is attributable directly to a utility company that has the power of eminent domain.”