(Bloomberg) -- Listen to the Big Take podcast on iHeart, Apple Podcasts, Spotify and the Bloomberg Terminal. 

As climate risks grow, some private home insurance providers  are retreating from US regions most vulnerable to catastrophe. And homeowners who can’t get coverage through the private market are increasingly turning to insurance “plans of last resort,” created by states.

The amount of liability taken on by these types of insurance plans is staggering, and growing: by some estimates, they’re holding more than $1 trillion of risk.

On today’s Big Take podcast, climate reporter Leslie Kaufman and California reporter Nadia Lopez share an investigation into how skyrocketing enrollment in state-created plans could create the conditions for a financial crisis. 

Listen to the Big Take podcast every weekday and subscribe to our daily newsletter

Here is a lightly edited transcript of the conversation:

Sarah Holder: In January, an insurance company called The Hartford announced that it would no longer issue any new homeowners insurance policies in California. Three other insurance companies — USAA, Allstate, and State Farm — have stopped writing or severely limited new homeowners policies across the state. 

According to Bloomberg reporter Nadia Lopez, the breaking point for a lot of these insurance companies was the Camp Fire back in 2018. 

Bloomberg TV Anchor: And the video we’re looking at is unbelievable. I mean really staggering, the voracity of the fire we’re seeing. 

Nadia Lopez: It burnt down 18,000 buildings, caused $16.5 billion in damage, killed 85 people, left a lot more missing. It made it the most expensive, catastrophic, and lethal fire in the state's history.

Sarah Holder: And insurance companies were on the hook for a lot of that damage. 

Leslie Kaufman: It was really a big financial blow and made everyone say, “Oh my goodness, our model might not be working.”

Sarah Holder: This is Leslie Kaufman, a climate reporter for Bloomberg. Leslie and our colleague Nadia say that as private companies have pulled back, the state has stepped in… to help people get the coverage they need through residual insurance plans, sometimes called FAIR plans.

Nadia Lopez: It's a bare bones option that's usually far more expensive than a traditional policy, but it covers what a private insurer won't, like a wildfire.

Sarah Holder: It’s supposed to be a plan of last resort. But the number of people in these types of plans is growing. 

Leslie Kaufman: These were never meant to be big plans. These were meant to be teeny plans that served a tiny part of the marketplace.

The problem is, climate change is really changing that dynamic. It's made them much more common, much more mainstream, which means the risks are much greater.

Sarah Holder: And with more people relying on this kind of insurance — questions are starting to emerge about whether these plans are prepared financially to handle a major catastrophe.

Leslie Kaufman:  The number of policies have absolutely grown by staggering amounts. The current liability in California is $290 billion. That's about six times what it was, uh, only five years ago. 

Sarah Holder:  Today on the Big Take: why insurance has become so hard to get for some homeowners, and how skyrocketing enrollment in state created plans could create the conditions for a sweeping financial crisis. I’m Sarah Holder and this is the Big Take from Bloomberg News. 

Sarah Holder:  The Camp Fire that tore through Paradise, California in 2018 was said to have been the costliest natural catastrophe of the year, with an estimated $12.5 billion in insured losses.

Now, typically, when insurance companies have to pay out a bunch of money like this, they respond by raising rates.

But this time in California, my colleagues Leslie Kaufman and Nadia Lopez say the insurance companies couldn’t just do that. 

Leslie Kaufman:  The campfire wiped out double the profits of 25 years. So not just 25 years of profits — twice that amount. So they went to California and said, we have all this risk and you have people in risky places. We want to raise rates now. And California said, “No can do.” California has a proposition on the books that limits the amount of money you can raise. 

Nadia Lopez: California right now has some of the most consumer friendly of regulations that keep rates low. And when an insurance company does want to raise their rates, they're subjected to approval from the Department of Insurance. 

Sarah Holder:  Nadia says that while the regulations have saved consumers $150 billion dollars on premiums over the last 25 years, the insurance industry argues that the caps have hurt them. They say they’ve made it harder to adapt to the growing risk of catastrophes brought on by climate change. 

Nadia Lopez:  They can only use historical data to set rates. They can't use forward looking climate data currently, which is something they'd been advocating for a long time. So ultimately, they argue that the state's current rules don't allow them to increase premiums enough to reflect the risk that they keep taking on.

Sarah Holder: And so a bunch of private companies have just decided to stop writing new policies entirely for Californians in certain high-risk wildfire zones.

Nadia Lopez: There's currently about 11 million people who live in California's wildfire risk zones. These are areas that include LA County, San Diego, uh, the vineyards of Napa and Sonoma, the Sierra Nevada foothills. It's unclear exactly the total number of homes, but there are significant populations across the state.

Sarah Holder: All of this has made the state-created insurance plan increasingly popular. 

Leslie Kaufman: So people are pouring into these plans as private insurers pull out. They have nowhere else to go.

Sarah Holder: So now this plan of last resort is bearing the risk that private insurers refused to cover. Which has raised a question: is there enough money to cover all these new policies if another Camp Fire were to happen? 

The plan doesn't make its finances public… but a state report estimates it’s holding roughly $100 million in reserves as of 2021.

Nadia Lopez: That's less than 1% of the insured losses from the campfire.

Sarah Holder: And this problem is bigger than just California. Because state-created insurance plans exist in lots of other states – in total, 36 states have these kinds of residual plans that offer natural disaster coverage. And they all need to reckon with the same existential challenge: 

Nadia Lopez: As states have assumed more and more risk, they're dodging a fundamental question. How can they cover claims in the wake of a huge and major catastrophe?

Leslie Kaufman: Right. Well so, this is the really tricky part. They do get premiums, but they are not forced, like a private insurer, to do the kind of stress testing to make sure that they have enough reserves and reinsurance to pay their all their claims. I think how they're going to pay, should there really be a decimating event, a really big catastrophic event, is too unclear in too many of the cases.

Sarah Holder: After the break – what homeowners and state policymakers are doing to prepare for the worst.

Sarah Holder: Welcome back to the Big Take from Bloomberg News. I’m Sarah Holder. Before the break we were talking about state-created insurance plans and the question of whether they will be able to cover a bunch of claims in the event of a major catastrophe. We asked Nadia to walk us through a scenario: Say there’s a huge wildfire in an area of California where a lot of FAIR plan policyholders live. How would the plan pay their claims?

Nadia Lopez: The Fair Plan has a certain number of reserves. And if they don't have enough money to cover all of the claims from that event in that area, then, legally, they would place an assessment on all of its members, and all of its members are those private insurers. 

Sarah Holder: Yes — private insurers are the members of the state-created plan. And some of these members are the very same companies that have said they no longer want to write new homeowners policies in the state. 

Nadia Lopez: So those private insurers would still be on the hook for paying out those claims in areas that they'd said they didn't want to cover anymore.

And this is what's creating a lot of uncertainty and a lot of concern for the private insurance market. That's why they're pulling out, right? If they have to participate, uh, in the FAIR plan, proportional to their market share, they're going to reduce their market share in that state.

That's what makes sense to them, so that the risk they take on through the FAIR plan becomes lower. But then it's like a, it's like a horrendous cycle. It's only creating more problems.

Sarah Holder: Wait, this is crazy!

Nadia Lopez: Yes. It is. This is why we wrote this story because it is — it is a very…

Sarah Holder: A vicious cycle.

Nadia Lopez: Vicious cycle. Yes. The more that private insurers retreat. The bigger the FAIR plan grows, so that presents more risk to the private insurers that are attempting to reduce their risk by retreating. But then more people are left without options.

So this is all happening at a really fast rate. And inevitably there will be another wildfire or natural disaster. And the consequences of that — the financial consequences of that — will be really detrimental for both Californians and the private insurance market.

And so if a catastrophic event triggers this massive assessment, it could force a lot of private insurers into bankruptcy. What would happen otherwise? Would the state step in and say, no, in order for them to recoup some of those losses, we'll allow them to put a surcharge on all their policyholders? But it's unclear. That's what  we don't have the answer to yet. But, inevitably, there will be a wildfire at some point, because climate change is not slowing down. So, how is the state going to account for this possibility?

Sarah Holder: Yeah, I mean, how is the state going to account for this possibility? 

Nadia Lopez: Right now, as the private insurers are retreating, Ricardo Lara, the California Insurance Commissioner, has put forth a plan that he's calling the largest insurance reform in the state since Proposition 103 was passed back in the ‘80s, which set those friendly consumer regulations, right? So, his plan would drastically change the way the rules currently work.

It would allow insurers to raise rates. more quickly and to allow for increases based on future climate risk data and reinsurance costs. And these are big changes that the private insurers have been saying they really wanted for a long time and that he says will now contribute to stabilizing the market and bringing them back to do business in California. The concern is that this change could lead to rate hikes of as much as 50%. That's what some sources have told me. And that could create a real burden on Californians who live in areas that are already, really difficult for them to, um, be living in due to cost of living expenses and other things.

Sarah Holder: As for the state's FAIR plan, the California Department of Insurance said in a statement that it performs a triennial examination to “evaluate the financial condition, assess corporate governance, identify current and prospective risks, and evaluate system controls and procedures used to mitigate those risks.”

Of course, California’s is not the only state-mandated plan facing this risk – of the 36 states with these residual insurance plans, 21 declined to explain how, exactly, they’d pay deficits that exceed their assets. That’s according to new research from Milliman, an insurance consulting group.  

Leslie and Nadia say that when insurers talk about how to address the concern presented by climate change, there’s one thing that comes up again and again. It’s known as hardening. 

Leslie Kaufman: And this is becoming a theme with insurance companies: how they can become your partner in hardening. And what does that look like? That means that if you're in a flood zone, you need to go up on stilts or make sure that your sump pump, uh, is powered so that it wouldn't go out during a flood.

If you're in a fire zone, you have to have a five foot protection around your house with nothing combustible. And that includes plants and shrubs. So their, their answer is if we're going to do all of this and make it affordable and you're going to continue to live in California forests and Florida coastal areas, we have to come up with a plan B to make this a little bit better.

Sarah Holder:  But strategies like hardening only go so far as the risks of major storms and fires increase. Which raises a question: is moving away from these disaster prone areas something people should be considering?Nadia Lopez: I think that a lot of people are not left with many options.  Tons of people, most people live in parts of the state that aren't necessarily exposed to wildfires in the San Francisco Bay Area or other parts of the coast, but increasingly more people are being exposed to wildfire risk all over. These are their communities. Some people chose to live in these places because they can't afford the high cost of living in a city like San Francisco or L.A., and some people have deep communal ties to these areas. It's a really tricky problem, because even though there are some places of California that some people say we shouldn't be building in anymore, you can't really tell people that they should leave the communities that they loved and have lived in for generations.

©2024 Bloomberg L.P.