PG&E uses cat bond as California wrestles with fire liability
Pacific Gas and Electric Co, the Californian utility firm, is using a catastrophe bond to adapt to what it calls the "new normal" of increased wildfire risk. After its equipment was blamed for many of the state’s fires over the past year, PG&E is at the heart of a debate over who should shoulder the costs of rising natural catastrophe damage.
Four of the top 10 most destructive wildfires in California in terms of structures destroyed have occurred since October 2017, according to insurance rating agency AM Best.
Most recently, the Carr wildfire, which started in July and is still burning, reportedly started by a flat tyre, has caused an estimated $1.5bn in insured losses so far, according to the agency. US media have reported eight deaths so far.
It is in this context that PG&E has issued a $200m catastrophe bond to protect it against damage caused by wildfires in California. Catastrophe bonds, or insurance-linked securities (ILS), move extreme insurance risks into the hands of bondholders, who get paid a high coupon for taking the risk.
The bond protects the utility for three years against property damage caused by wildfires for which it is liable, rather than damages to its own property, according to the ILS website Artemis.
"The new normal presented by the increased wildfire risk in the state means we have to be more creative about the insurance solutions that make sense for our customers and help mitigate that risk," a spokesperson at the firm told GlobalCapital.
PG&E is finalising $350m worth of insurance coverage, a 140% increase compared with the policy it had in place before the wildfires last October.
This coverage includes the cat bond, thought to be the first ever to protect solely against wildfire risks.
PG&E is currently liable for the costs of wildfires in the state caused by its equipment, even if it did not act negligently. Investigators have named the firm’s equipment as the ignition source of 16 fires in northern California since October, according to Bloomberg.
In its business update on July 27, PG&E announced it accrued charges of $2.5bn over the first half of the year related to estimated third party claims in connection with 14 of the northern California wildfires.
The firm’s share price has fallen by 36% since last October, from $68.13 to $43.90.
Last month California governor Jerry Brown proposed legislation that would force courts to take into account whether utility firms had acted reasonably when ruling on their liability for fire damage, but this would not affect 2017's liabilities.
Is this the future?
Higher population density and climate change are ramping up losses caused by wildfires in California.
California’s population has grown by more than 2m in under a decade, with more people moving to areas prone to wildfires, according to AM Best. The areas hit by last year’s fires had not been thought of as high risk.
“As housing development continues in more rural areas and wildlands, the threat for insureds and insurers will continue to grow,” said the rating agency.
On top of this, higher temperatures and lower rainfall are playing a role.
The last time California had an annual average temperature below the historical norm was in 1998, according to AM Best. Over the 19 years since then, 12 have suffered below average precipitation, too.
“While it is too early to call it a trend with two consecutive devastating fire seasons, many observers are concerned that the combination of a growing population, increased construction as new homes and businesses are built in previously remote areas, and rising long term temperature trends statewide may represent a new normal in California,” said the rating agency.
AM Best said insurers would have to rethink underwriting strategies and risk management to reflect the changing environment. It added that they were highly likely to adjust pricing.