TODAY’S STUDY: How To Address The California Wildfires
DRAFT Report from California Governor Gavin Newsom’s Blue Ribbon Commission on Catastrophic Wildfire Cost and Recovery
Last September, in the midst of the worst wildfire season in California’s history, the legislature passed and then-Governor Brown signed SB 901. Among other things, the bill created a Commission on Catastrophic Wildfire Cost and Recovery to provide recommendations to the governor and legislature on how to manage the long-term costs and liabilities associated with utility-caused wildfires.
This Executive Summary provides an overview of the work of the commission to date, which is divided into three attached sections, each written by a two-member workgroup. The Executive Summary will be put up for consideration and adoption at the June 7, 2019 meeting of the Commission. While the workgroup reports themselves will not be considered for adoption by the full commission, the Executive Summary does not stand alone, as much of the supporting detail and considerations is included in the workgroup reports…
Finding 1. California faces an unprecedented multi-dimensional emergency caused by catastrophic wildfires.
Finding 2. California has a decentralized system of regulating and governing the wildfire prevention and mitigation of its 56 public and private electrical utilities that creates inconsistent rules for addressing wildfire risk, redundancy of effort and squandering of scarce resources.
Finding 3. The current application of inverse condemnation, holding utilities strictly liable for any wildfire caused by utility equipment regardless of standard of care or negligence, imperils the viability of the state’s utilities, customers’ access to affordable energy and clean water, and the state’s climate and clean energy goals; it also, does not equitably socialize the costs of utility-caused wildfires.
Finding 4. The increasing costs of capital and the risk of bankruptcy associated with the application of strict liability inverse condemnation doctrine to water companies, publiclyowned utilities, and investor-owned utilities is harmful to wildfire victims, ratepayers, and the utilities themselves.
Finding 5. The current process for determining cost recovery contributes to the uncertainty that utilities face, ultimately increasing costs to ratepayers while resulting in insufficient investment in wildfire mitigation.
Finding 6. The financial mechanisms for paying wildfire liabilities associated with utilitycaused fires are strained and not sustainable for victims, ratepayers and utility shareholders.
Finding 7. Wildfire risk is created by multiple parties who should all be incentivized to reduce risk and share in paying for wildfire damages.
Finding 8. The time required for, and the uncertainty of, investor-owned utility wildfire cost recovery from ratepayers reduces investor confidence in utilities, and limits utility access to capital after a major fire.
Finding 9. Californians’ electric costs are increasing due to wildfire mitigation investments and other capital and regulatory requirements.
Finding 10. The liabilities associated with wildfire are challenging to model and not well understood.
Finding 11. Admitted lines home insurance is becoming more difficult and more expensive to obtain in high wildfire risk areas in California.
Finding 12. As more homeowners in the WUI are unable to find home insurance from admitted carriers, more are having to purchase fire insurance from the surplus lines market or from the FAIR Plan.
Finding 13. The home insurance market in California is not in crisis yet, although we are marching steadily toward a future where home insurance will be increasingly unavailable and/or unaffordable for many in the wildland urban interface in California. More destructive fires in the future of the sort we saw in 2017 and 2018 will only accelerate this trend.
Finding 14. California does not currently require a new government created insurance program beyond than the FAIR Plan to support home insurance availability in the WUI.
As is clear from the findings above, the current wildfire situation in California requires a balancing act. It is critical that not only utilities, but also homeowners, renters, federal, state and local government, and others, act to reduce the risks of wildfires in the WUI. We must not incentivize risky behavior, including the risks many Californians take by continuing to move into the most fire-prone areas of the WUI; by remaining un- or underinsured; or by neglecting to maintain proper home hardening and fire safety standards. But we also cannot put the entire cost of wildfires onto ratepayers’ backs. Cost recovery from utility-related fires must be spread across those with the responsibility to help reduce these wildfires in a way that is fair, does not incentivize risk, and does not overly burden utilities to the extent that they could be driven out of business.
This is not an easy task. Where the commission landed, after hours of testimony and expert consultation, is as follows:
First, the prudent manager standard for electric utilities must be modified to bring clarity to the cost-recovery process.
Second, the commission recommends that the current strict liability application of inverse condemnation for utilities be replaced with a fault-based standard.
If the inverse condemnation/strict liability standard is reformed, the commission recommends the creation of a modest Wildfire Victims Fund to more quickly and equitably socialize wildfire costs. Such a fund would be structured to avoid subsidizing risk: it would only be available to utilities found to be prudent, and would only pay out settlements to claimants at the levels they would have received in the absence of the fund’s creation.
In the absence of inverse condemnation/strict liability reform, the commission recommends the Wildfire Victims Fund be much larger, though we recognize some real challenges, risks, and downsides to this outcome – not least of which is that creation of a large fund might go against the overarching need to ensure that the state is not ultimately subsidizing risky behavior from homeowners, renters, federal and local officials, and utilities. The commission has attempted to address some of these concerns through the fund details but many questions and concerns remain.
Absent either reform of strict liability or the establishment of a large wildfire fund, immediately revising the prudent manager standard and establishing a liquidity fund would resolve some of the issues currently facing the state’s electric utilities.
Finally, the commission recommends a series of reforms related to the homeowner’s insurance markets, to maintain availability and affordability of insurance in the wildland urban interface, while also ensuring that policy prices remain fundamentally tied to risk.
Although the summary recommendations below were written up separately by the commission workgroups, the commission urges that any changes to inverse condemnation, the prudent manager standard, cost recovery, or creation of a Wildfire Victims Fund be considered in a coordinated fashion. Interactions between the three frameworks are so direct and so strong that modification of one or more without close coordination is likely to lead to failure of policy effectiveness or other severe unintended consequences.
The commission recommends the following as the clearest way to more equitably socialize costs, relieve the extreme burden of ratepayers, and meet the principles enumerated by the Governor’s Energy Strike Force.
Recommendation 1. Replace the current strict liability application of inverse condemnation for electric and water utilities with a fault-based negligence standard
The current liability regime stems from the constitutional doctrine of inverse condemnation. In applying this doctrine, courts have assigned liability to utilities even in the absence of a finding of negligence.
Converting this strict liability regime to a fault-based standard reduces the burden to ratepayers by removing significant wildfire liability, decreasing the cost of capital, and reducing the risk of bankruptcy, while maintaining a robust incentive for utilities to mitigate wildfire risk.
Recommendation 2. Revise and clarify the prudent manager standard for utilities
The current inverse condemnation rules include a prudent manager standard to determine cost recovery. Refining the prudent manager standard is a necessary additional step to provide clarity to utilities and their lenders. When utility equipment contributes to a wildfire, the CPUC must determine that the utility prudently managed its system before IOUs can recover liability costs from their electric customers. The commission received testimony that that the current standard for determining prudency is unclear and protracted. This process has led to significant uncertainty in the capital markets regarding the costs that utilities face, which in turn leads to increased costs for utility customers.
Regardless of whether the strict liability application of inverse condemnation remains the rule, the commission recommends modifications to the approach of determining prudence, in order to bring certainty to the process while still holding utilities responsible for negligence.
The objectives of this reform would be to 1) ensure that ratepayers pay for just and reasonable investments (such as investments in prevention and safety), but do not pay for avoidable, negligent behavior and 2) ensure cost recovery reflects the host of factors—including risky homeowner or renter behavior—that contribute to the extent of wildfire damage, and does not hold utilities solely liable in cases where other factors contribute to the magnitude of the damages.
Below are three options for reforming the prudent manager standard.
In the absence of a Wildfire Victims Fund or other mechanism to further socialize costs:
Cost Recovery Option 1: Burden shifting. In order to increase the certainty that prudently incurred costs will be allowed in rates, CPUC process could be modified to allow for a presumption of prudence for a utility wildfire expense given a prima facie showing but still allow for a challenger to attempt to prove, by a preponderance of the evidence, that an expense was imprudently incurred.
Cost Recovery Option 2: Further refinement of those SB901 factors the CPUC should consider when assessing disallowances, to give a higher weighting to those factors that acknowledge the unique, exogenous circumstances possibly present in a catastrophic wildfire.
If a Wildfire Victims Fund is simultaneously created and utility shareholders make a substantial up-front contribution to the Fund:
Cost Recovery Option 3: Maximize utility shareholder liability up to the point it harms ratepayers or impacts service. One option might be to have a predetermined maximum liability that shareholders may be subject to under the current (or an alternative) framework for prudency. This option should only be considered if only if shareholders make substantial upfront contributions to a fund.
Recommendation 3. Establish an Electric Utility Wildfire Board which consolidates governance of all utility catastrophic wildfire prevention and mitigation into a single entity separate from the California Public Utilities Commission.
The IOUs, POUs, and cooperatives are governed by separate wildfire prevention and mitigation rules. Moreover, there is no consolidated data gathering, best practices development, or other centralized efforts to maximize the state’s fire prevention and mitigation efforts. This results in inconsistent policies, duplication of efforts, and lack of efficient coordination. The commission recommends that a single, purpose-built state entity be created to have governing authority over all utility wildfire prevention and mitigation activities. The entity would set and enforce safety standards and implement, administer and adjudicate fault-based standards for both IOUs and POUs. The workgroup envisions a robust entity with (a) data collection and other information technology efforts; (b) liability and conduct standards development activities; and (c) liability standards enforcement activities.
Taken together, these actions would significantly reduce the risk to ratepayers from overwhelming wildfire liability. But taking these actions would not entirely eliminate that risk. Utilities would continue to face liquidity challenges if they are perceived to face the risk of significant wildfire liabilities under the revised prudent manager standard.
For this reason, the commission recommends that an additional modest funding mechanism be considered to create a buffer against the shock of liability from catastrophic fires. Such a mechanism is further described below. In the event that the inverse condemnation/strict liability standard were revised, such a fund would need to cover significantly less liability, and would therefore require a smaller capitalization than if the current inverse doctrine were to stay in place.
Funding Mechanism: Wildfire Victims Fund
Catastrophe funds, such as a Wildfire Victims Fund, can be useful tools when rapid changes in perception of risk from a particular peril (wildfire, hurricane, earthquake) lead to disruptions in insurance markets or to a risk that traditional insurers are either unable or unwilling to manage through the normal underwriting process. The degree to which the State’s utilities continue to face such a perception will determine whether a fund is needed, and if so, how large it should be.
In the absence of reform to the current application of strict liability to the state’s utilities, the commission recommends that the legislature establish a large and broadly sourced Wildfire Victims Fund to more quickly and equitably socialize wildfire costs. Ultimately, how such a reserve fund is structured, and how effective it is, depends on what other reforms the legislature adopts. To be most effective, a fund should be coupled to greater investment in wildfire mitigation, and to reforms to the liability regime, cost recovery process, and property insurance markets.
At the same time, while this discussion focuses on a fund that would be designed to pay claims from wildfire victims, the commission believes that a smaller fund, designed to provide liquidity to utilities after large wildfires, could provide some but not all of the benefits of the larger claims-paying fund.
Recommendation 4. Absent changes to the strict liability application of inverse condemnation, the legislature should consider establishing a large and broadly sourced Wildfire Victims Fund, to more quickly and equitably socialize wildfire costs, and maintain the heath of the state’s utilities.
This fund should be designed based upon the following objectives:
1. Pool risks broadly, and be sourced beyond electric ratepayers.
2. Include contributions from utility shareholders and ratepayers that reflect differential risk
3. Limit risk pooling when the utility engages in negligent behavior.
4. Treat wildfire victims fairly
5. Improve utility solvency and liquidity so that utilities may continue to offer reliable, affordable service to Californians and make progress towards California’s clean energy goals
6. Maintain incentives for all parties to pursue wildfire mitigation efforts.
Recommendation 5. The Wildfire Victims Fund, which should be created as soon as possible— ideally to cover potential 2019 fires, but if not the 2020 fire season and beyond--should be taxexempt, and limited to “catastrophic” electric utility caused wildfires.
The fund would ideally have the following attributes:
Participation and Capitalization: Participation in the Fund should be voluntary, with participants benefitting from changes to the cost-recovery standard. Participating utilities must maintain a specified level of commercial wildfire liability or general liability, with a specified minimum deductible.
The Fund should be highly capitalized to survive anticipated third-party damages6and with relatively equal contributions from ratepayers, shareholders, property owners (through a surcharge on property insurance) and the State of California (through forfeited tax revenue from the tax-exempt status of the Fund, and through statewide investments in mitigation).
Claims Payment: The Fund should pay claims in excess of the mandated, combined commercial insurance and deductible, up to a cap. Specifically, the Fund should pay a maximum amount per fire incident, and a maximum amount per utility in a given year. Any excess liability incurred by a utility would remain with that utility and be subject to CPUC prudency review and follow through cost allocation.
It is critical that the fund not have the perverse outcome of actually incentivizing risky behavior on the part of utilities or claimants. To that end, claimants to the Wildfire Victims Fund should not be entitled to larger settlements than they would have received in the absence of its creation. The fund should pay insured, underinsured, and uninsured losses from utility caused wildfires at values approximating their settlement value through predetermined discounts. Similarly, if a utility is found to be imprudent, or partially imprudent with respect to a wildfire, the fund should pay claims only up to a specified amount, directly tied to the level of up-front shareholder contributions to a fund.
In addition to claims payment, money contributed to or earned by a Wildfire Victims Fund should be used for a variety of purposes to further its goals, including purchase of reinsurance or other risk transfer, developing a better understanding of and recommendations for risk based approaches to wildfire mitigation, and public education on the risk of wildfire and the actions that can be taken to avoid or reduce vulnerability.
Sunset Clause: Finally, the fund should not be permanent. Instead, it should be designed to last so long as necessary but no longer (estimated 10 years), with a planned mechanism to wind down Fund operations and return unused capital to all contributors in an equitable fashion.
Challenges in Creating a Wildfire Victims Fund
Establishing a Wildfire Victims Fund of sufficient size and with adequate contributions, that does not perversely incentivize risky behavior on the part of homeowners, renters, federal, state and local officials, and utilities, is a daunting task. Creating a large, deep-pocketed fund could have the unintended outcome of encouraging claimants to inflate their claims, for instance. Or, the presence of the fund as a backstop could encourage homeowners, renters, and local governments to pay less attention to important fire-prevention efforts. Balancing the objective of creating a large enough fund to be meaningful, the importance of better socializing costs, and the imperative to actually reduce the overall risk of catastrophic wildfire presents important challenges.
Key among these is that the likely largest potential contributor to the fund, PG&E, is currently undergoing Chapter 11 reorganization, and its financial liabilities for fires in 2017 and 2018 have not been resolved. This reorganization, which will not be finished this legislative session, may have implications for the utility’s available liquidity to contribute immediately to a fund. This is particularly concerning given the likely higher contribution expected from PG&E due to its territory size and recent wildfire history.
In addition, shareholders of all the state’s IOUs may object to sizeable initial contributions to the fund, even though they will benefit from the risk pooling a fund creates as well as from associated cost recovery reform.
Maintaining payouts at current settlement values both for subrogation claims from insurers, and for payments to underinsured homeowners, also present both legal and implementation challenges. Moreover, once established, a fund would require some mechanism to ensure submitted claims for under- and un-insured homeowners are reasonable, given there is no intermediary such as the courts, or an insurance company, reviewing claims’ veracity. Not maintaining payouts at current settlement values, and the potential for claims inflation, both will dramatically increase the cost of the fund and so compromises its likely usefulness.
Finally, there are important affordability challenges to consider in thinking through the potential of a large Wildfire Victims Fund. The state has an overall goal of maintaining affordable electric utility rates, which could be increased as a result of utility contributions to such a fund. On the other hand, such a fund might be the least-worst option for utility customers in that it would render a future of escalating and unpredictable electricity bills somewhat less costly and much more predictable.
Creating and maintaining a very large Wildfire Victims Fund, combined with significant cost recovery reform, is not an easy path. Further work is needed to identify the costs, consequences, and feasibility of parts of the proposal as presented here.
Insurance is becoming more difficult and more expensive to obtain in high wildfire risk areas in California, and while we are not yet in a crisis, it will be increasingly unavailable and/or unaffordable for many in the wildland urban interface in California. More destructive fires in the future of the sort we saw in 2017 and 2018 will only accelerate this trend. The state should take measures to help bring stability to the market, while ensuring that the market accurately reflects the underlying risk.
The commission recommends the following:
Recommendation 6. California should preserve its risk-based approach to pricing insurance. The commission strongly recommends that California maintain incentives created through riskbased pricing of insurance for all stakeholders to avoid and mitigate risk. Furthermore, the state should not act to suppress prices in high-wildfire risk areas by increased cross-subsidy from lowrisk areas.
Recommendation 7. Improve the California FAIR Plan, California’s last-resort basic home insurance, by increasing the claims cap. In addition, the commission believes that a targeted premium subsidy for existing homeowners in the WUI who are very low income and for whom the FAIR Plan is the only option for insurance is potentially justified.
Recommendation 8. Improve the California Insurance Guarantee Association by increasing the claims cap.
Recommendation 9. Require Fire Risk Underwriting Models used by insurers to be filed and approved by CDI. In addition, require insurers to file annually with CDI for review and approval the insurers’ replacement cost estimating models/tools and the inputs they are using as well as a comparison of recent loss experience to estimates based on these tools.
Recommendation 10. Set home fire risk reduction and community risk reduction standards with input from insurers and require insurers to write insurance where home owner and community both meet standards OR require insurers to implement a tiered mitigation credit based on the level of home hardening.
Recommendation 11. Require insurers to calculate and provide a replacement housing estimate in writing to insureds annually and before entering into insurance contract.
Recommendation 12. Require CDI to undertake a data call on the insurers’ subrogation claims, as well as on the insurers reinsurance cost and availability.
Recommendation 13. Require homeowners insurers to offer a one-year notice of non-renewal, in addition to the existing 45-day notice, when there is no change in the risk presented at the insured property within the homeowners’ control, or if the insured has been with the same insurer for five years or more.
Recommendation 14. Mandate that all homeowners’ insurers offer a “Difference in Conditions” policy or a Comprehensive Personal Liability/Residential Workers’ Compensation coverage.
Recommendation 15. Require that there be a valid quote for insurance coverage before any real estate offer is accepted.
Reduction of Wildfire Risk in California
As noted at the outset, the commission recognizes that addressing the impact of wildfires on California’s utilities requires both reducing fire risk on the front end, and fairly paying out for claims based on fire damages when they occur. While most of this report focuses on cost liability and cost recovery, we cannot lose sight of the critical need to mitigate the risk that these fires will become catastrophic. These final recommendations focus on this important point.
Recommendation 16. Establish a Wildfire Vulnerability Risk and Reduction Coordinator within the Governor’s Office of Planning and Research. The Risk Reduction Coordinator would be charged with conducting research and providing regular recommendations to the legislature, governor, CPUC, Insurance Commissioner, and local governments on optimal levels of risk mitigation spending within the state by various parties.
Recommendation 17. Provide significant state investments in prevention and mitigation efforts, whether funded by a state tax and a specific fund in the state budget for direct mitigation or small grants for home hardening.
Recommendation 18. Take action to significantly increase consistency of private property maintenance laws by developing best practices or minimum standards for fire risk, and minimum allowed penalties for non-compliance.
Recommendation 19. The workgroup recommends that the state require that any municipality or government body that approves new development, including new construction on vacant land, is able to provide firefighting service to that property within a certain maximum time.
Recommendation 20. Development fee for new construction in the WUI. New development that will put more lives and property at risk, ought to pay a development impact fee to the State of California to help find risk reduction efforts that will benefit the new development.
In this report, the commission has attempted to address the current catastrophic wildfire liability situation in a way that recognizes the severity of the problem and its many different contributors; addresses the critical need to provide cost recovery for those with serious damages while not bankrupting utilities in the process; and highlights the importance of actively reducing wildfire risk while simultaneously structuring a system to pay for damages from these fires.
Bearing all these factors in mind, the commission recommends that the legislature immediately revise the CPUC’s prudent manager standard and cost recovery process along the lines discussed above.
The commission further recommends a change to the current inverse condemnation/strict liability standard, with the addition of a modest Wildfire Victims Fund to pay out claims quickly and equitably.
In the absence of inverse/strict liability reform—or in the event this is not a possible near-term alternative—the commission recommends that the state create a larger Wildfire Victims Fund to cover reasonable costs incurred in catastrophic wildfires. However, the commission fully recognizes the challenges of capitalizing and standing up such a fund, and understands that in the short term a smaller bridge fund may be necessary, on the road to eventual inverse condemnation/strict liability reform.