Alternative capital can offer wildfire coverage, but pricing remains a challenge, according to Morningstar DBRS.

Wildfires have become an increasingly common risk in California’s property insurance market, and alternative capital may offer coverage solutions, including through multi-peril reinsurance instruments. However, pricing remains a significant challenge, according to Morningstar DBRS analysts.

In a recent report, Morningstar DBRS highlighted the ongoing wildfires in the Los Angeles area, which have caused unprecedented property damage. Insured losses could surpass $30 billion, posing a negative yet manageable impact on insurers’ credit profiles. Broking firm BMS estimates that insurance and reinsurance market losses from California wildfires in the LA region may exceed $25 billion, while KBW analysts suggest the losses could climb as high as $40 billion, impacting the broader market.

Despite the significant losses, Morningstar DBRS notes that California's leading property insurers are likely to manage the impact due to their diversified risk exposures and access to global reinsurance capacity. However, the wildfires exacerbate an ongoing crisis in California's property insurance market. Major insurers have already ceased issuing new policies in the state as regulators grapple with affordability and insurability challenges.

Reinsurance costs are also expected to rise, further straining primary insurers' ability to offer coverage. Analysts emphasized that reinsurance capacity is critical for direct carriers to underwrite and price wildfire risks effectively. However, the rising costs of reinsurance, combined with reinsurers' reluctance to take on California wildfire risks, complicate the market. Past events, such as the 2018 Camp and Woolsey fires, demonstrated how significant losses can concentrate in a single season. As a result, many direct insurers now retain more wildfire risk due to uneconomical reinsurance rates, leveraging nationwide diversification for capacity.

Given California's vast insurance market, analysts stress the need for both insurers and reinsurers to restore sustainable pricing and ensure the availability of home insurance. While reinsurance remains key for providing broad coverage, it does not address the challenge of insuring homes near wildlands.

As wildfires become more frequent, additional capacity may emerge to cover the risk, potentially through alternative reinsurance capital solutions. Still, pricing will likely remain a barrier. The Insurance-Linked Securities (ILS) market has retreated from wildfire risks in recent years due to concerns over frequency, climate impacts, and inadequate pricing. However, if capital deployment terms and costs align with the risks and offer sustainable returns, the market could attract more capacity to address this growing peril.