As California utilities falter, legislators, governor back ‘tower of finance’ solution to wildfire costs

Wildfires scorched California in 2017 and 2018 and left two of its three dominant investor-owned utilities (IOUs) in dire financial straits.

Meteorologists say this is the “new normal.”

If California does not control the costs of these events, it could drain ratepayers, utility shareholders and taxpayers, and make the state’s climate and renewables goals unachievable.

But a solution is in the works that could help manage the costs.

Dubbed a “tower of finance,” the model calls for finance strategies such as funding, commercial insurance and asset-backed bonds to be brought into use one method at a time to meet losses from costly climate catastrophes like wildfires. The idea is backed by the Governor’s Strike Force report on wildfire mitigation solutions and is now making its way through the legislature.

Assembly Bill (AB) 235, introduced January 18 by Assembly Member Chad Mayes, R, would create the California Wildfire Catastrophe Fund Authority to build such a tower of finance. The bill would require utilities to contribute to a fund that finances wildfire victim claims. The Authority’s board could also issue and sell recovery bonds secured by the fund and its annual contributions.

Wildfire costs have driven Pacific Gas and Electric (PG&E) into bankruptcy and are threatening Southern California Edison (SCE). Between the growing attention to AB 235 and the Strike Force endorsement, the “tower of finance” solution has begun to emerge as a possible way for California to move ahead safely and cost-effectively.

Stakeholders’ take

California’s utilities endorse variations of the tower of finance approach.

“For damage above commercial insurance, there is a critical need for an alternative risk financing vehicle, such as a catastrophic wildfire insurance fund sanctioned by the state,” SCE VP for Risk Management David Heller told the Governor’s Blue Ribbon Commission on Wildfires March 13.

In addition to commercial insurance and the fund, utilities should “be able to securitize their liabilities through a dedicated rate component” to “avoid a future liquidity crisis that could lead to bankruptcy,” San Diego Gas & Electric (SDG&E) VP of Regulatory Affairs Dan Skopec told the commission.

Public utilities don’t have shareholders, leaving customers to face all costs from catastrophic wildfires, Sacramento Municipal Utility District (SMUD) Senior Attorney Joy Mastache told the committee in calling for an AB 235-like fund. SMUD’s insurance rates have quadrupled in recent years and new billion-dollar wildfires could cause another spike, she testified.

Both the bill and the ‘tower of finance’ model have the cautious support of private insurers, victims’ groups and environmental advocates.

A fund could avoid imposing costs on utility customers through reinsurance funded by “a dedicated surcharge on property insurance policies,” ratepayer advocacy group The Utility Reform Network (TURN) Executive Director Mark Toney told the committee.

California’s fund is comparable to the Florida Hurricane Catastrophe Fund “which has been in operation and covering billions in losses since the mid-1990s,” he added. It would offset wildfire damage claims quickly, but if a utility is later determined to have been negligent or imprudent, shareholders would be required to reimburse the fund.

The most important stakeholder approval may be that of the Governor’s Strike Force because it has the potential to enlist Governor Newsom’s political leverage in service to legislative action.

The Strike Force report warned the only way to prevent putting utilities “near insolvency was to change the way wildfire liability is handled.” Changing California’s complicated liability laws may not be legislatively or legally feasible, which could make handling liability through a tower approach even more important.

Alternative solutions

The report named seven principles that all cost solutions should address:

  1. Keeping power safe and affordable
  2. Holding utilities accountable for safety violations
  3. Fairness to wildfire victims
  4. Equitable cost allocation to stakeholders
  5. Reduce overall wildfire costs
  6. Maintain state clean energy goals
  7. Recognize existing cost to taxpayers

Three cost allocation concepts meet these principles, the report said.

One is “a catastrophic wildfire fund” that would “spread the cost of catastrophic wildfires more broadly.” Such a fund would be built with pooled utility capital and other financial tools.

The report also proposes a “liquidity-only” fund that would provide capital for utilities to pay wildfire damage claims quickly. This is important but does nothing about the tens of billions of dollars in wildfire costs that threaten utilities’ financial stability.

A third solution is the legislative effort to correct the California courts’ uniquely strict liability standards.

Called inverse condemnation, it “holds utilities strictly liable for all property damage associated with wildfires if their infrastructure is found to be a cause of ignition — whether the utility was negligent or not,” University of Pennsylvania Wharton Risk Management Center Executive Director Carolyn Kousky wrote in a recent opinion piece. The state could deal more effectively with the costs of climate change-induced wildfires if lawmakers modify inverse condemnation, she wrote.

Previous legislative efforts to address inverse condemnation have failed and many told Utility Dive it was off the table in the current session. Revisions of it “have been debated and soundly defeated,” Up from the Ashes Executive Director Patrick McCallum said. “It won’t pass the legislature, so it is a distraction from getting a wildfire fund in place.”

The Strike Force call for altering strict liability may have given revision of inverse condemnation new life. But it remains to be seen if the Governor has the political leverage to overcome the legislative and legal challenges this California Supreme Court-validated provision faces without overburdening his larger efforts.

And “it would still need to be coupled with a sound financing tower,” Kousky said.

Other floated solutions include technology and de-energization.

Technology got mixed reviews from leading tech providers and users in March at the California Public Utilities Commission (CPUC) Wildfire Technology Innovation Summit.

There were “many exciting technologies, but nothing actionable yet,” California Energy Commission Energy Systems Research Office Supervisor David Erne told Utility Dive. His panel of technology providers agreed “utilities will need better integration of data” and “consolidation technology to translate it into actionable information.”

Two of California’s top utility meteorologists, SCE Fire Weather Meteorologist Tom Rolinski and SDG&E Principal Meteorologist Steve Vanderburg, agreed new situational awareness technologies are exciting, but it is not clear how to get people to respond when forecasting capabilities show them wildfire dangers are imminent.

De-energization has also been put forth as a solution. When utilities see high heat, low humidity and strong winds in areas with dry vegetation, de-energizing can eliminate the threat of ignition from a downed power line, Vanderburg said.

But the practice weighs heavily on utility decision-makers after 2018’s Camp Fire, which killed 86 people and destroyed 18,661 structures, including most of the town of Paradise. In October 2018, PG&E, facing an imminent wildfire threat, shut off power lines in high risk areas. Customers protested the blackout, especially when no fire occurred.

The next month, facing another wildfire threat, PG&E did not de-energize. The Camp Fire followed.

There is no way to prove de-energizing avoided the October fire or that not de-energizing caused the Camp Fire, but what is clear is that customer response is as important as utility predictive capabilities.

Tower strategies vary

The tower

Eight of California’s 20 most destructive wildfires were in 2017 and 2018, according to Wharton’s “Financing Third Party Wildfire Damages: Options for California’s Electric Utilities.” In the 1980s, the state’s annual wildfire costs averaged $61 million (in 2018 dollars). They have averaged $450 million per year since 2010.

“When utilities act negligently, they should bear costs proportional to their negligence,” the Wharton paper acknowledged. But, in the absence of inverse condemnation reform, utilities will “need financing mechanisms that enable them to cover this growing liability.”

Such mechanisms “are not mutually exclusive, and several should be layered together,” the paper added. They would “require an annual contribution and/or initial capitalization,” and, to equitably distribute costs, “ratepayers would shoulder cost-effective pre-wildfire financing and shareholders would pay post-loss costs in proportion to utility imprudence.”

In such a “tower of financing,” different layers would each take on a portion of the risk, Wharton’s Kousky told Utility Dive.

The bottom layer of the tower would be “a dedicated rate component for some level of funded self-insurance,” the paper said. Commercial insurance and catastrophe bonds are likely to play only a small role because of rising premium costs and a diminishing provider group. That will necessitate “some type of risk pool or industry captive.”

An industry captive would be an insurance company that only insures utilities, Kousky said. “They still own the risk, but the captive can access reinsurance directly” and unused premiums “either go back to the utilities or stay in the reserve account.” An alternative is a pool of industry capital, which is suggested by the Strike Force.

“The practical future is fitting all the layers together in the most cost-effective way possible,” Kousky said. Money for it will come from ratepayers, shareholders or taxpayers. The best layering will protect all three sources of funding as much as possible, but still capture the applicable benefits obtained by the California Earthquake Authority (CEA).

Funds like the CEA, established by statute, “exist for the benefit of their policyholders,” CEA General Counsel Tom Welsh told Utility Dive. They tend to not have a high volume of premium payments and claim payments, which allows them to accrue enough “claim-paying capacity” to cover a catastrophic event.

CEA’s tower of financing first pays out “cash in the bank,” then through reinsurance. When the reinsurers’ pre-set limits are reached, CEA can access “several forms of debt” to cover “extremely catastrophic events,” Welsh said. “That would be repaid from CEA’s future revenue, including from surcharges that California’s insured would be required to pay.”

His description of a wildfire fund tower was similar to Kousky’s and to the one outlined by the Strike Force. Any fund’s viability “will ultimately depend on how large the capitalization is,” Welsh added. And that will likely “depend on the politics that lead to the fund.”

“Utilities will need to restructure, but we need them to achieve our goals,” Natural Resources Defense Council Director for Western Transmission Carl Zichella said. “We want them to aggressively improve and harden their systems, and that can’t happen if they are always on the brink of bankruptcy. A fund that is well-capitalized and replenished as needed can keep them from being up against the wall after the catastrophic wildfires that are going to keep coming.”