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The Los Angeles area wildfire event that began on January 7, 2025, could go down as one of the most destructive disasters in U.S. history. NBC News says that more than 12,300 structures have been destroyed. Additionally, at least 27 people have lost their lives.
According to AccuWeather, total damages and economic loss could total $250 to $275 billion. In comparison, Hurricane Helene’s losses are estimated at $225 to $250 billion, and the Maui wildfires causes losses of around $13 billion to $16 billion. The National Weather Service says Hurricane Katrina caused approximately $108 billion in damage in 2005.
The LA wildfires will cost insurers billions. Forensic accounting can help ensure that business interruption insurance claims are managed fairly and accurately.
CoreLogic estimates that the residential and commercial insurance losses for the Eaton and Palisades fires could range between $35 billion and $45 billion, including losses to the FAIR Plan, making this the most expensive fire event in the state’s history. For comparison, the insured losses from the Camp Fire in 2018 at $10 billion, or approximately $13 billion when adjusted for inflation, according the Gallagher Re data below, published by Artemis.
Some carriers will be impacted more than others, in part because some were already limiting their exposures in the California market. For instance, CBS News reports that State Farm dropped approximately 1,600 homeowners insurance policies in Pacific Palisades over the summer. Allstate and Farmers Insurance had also taken steps to reduce exposures in the state.
Most insurers are expected to end up at or slightly above their respective per-occurrence reinsurance retentions, but this data is still developing according to Reinsurance News.
Prior to this event, many property owners had to secure insurance through the California FAIR Plan, the state’s insurer of last resort. According to estimates by Evercore ISI reported by The Wall Street Journal, the FAIR Plan could have up to $6 billion in losses, but it only has an estimated $200 million in cash and $2.5 billion in reinsurance according to its own disclosures. Regulated insurers are required to cover the difference through assessments, but Bulletin 2024-8 (issued in September 2024), part of an overall reform of the FAIR plan, lets insurers pass the costs on to policyholders. Under these new rules, insurers can seek approval tom impose temporary fees on their customers to recover up to 50% of their first $1 billion of an assessment and 100% of any costs over that.
The chart below illustrates how much the FAIR Plan’s exposure has increased in recent years.
Higher premiums for homeowners are likely, as the California Department of Insurance is allowing insurers to incorporate computer-based cat models to assess wildfire risks when determining property insurance rates, and after the Mosquito fire the state has enacted moratoriums preventing insurers from canceling or non-renewing residential insurance policies in certain areas for up to a year.
Business Interruption Claims
While much of the initial coverage has been on property damage, business interruption losses are also significant. Many businesses had to shut down due to evacuations, with some facing extended closures for repairs.
Business interruption insurance provides financial relief for lost income and additional expenses during closures caused by covered losses. Some policies may also include extra expense coverage, which can help with additional costs that are incurred as a direct result, as well as contingent business interruption coverage, which covers losses stemming from disruption to a supplier or business partner.
For businesses impacted by the recent wildfires, business interruption coverage will be critical. However, challenges may arise in the following areas:
- Covered perils: Coverage is typically tied to commercial property insurance and covers the same perils. Perils that are excluded from standard commercial property insurance, including floods, will not be covered. Disputes are less likely over coverage compared to COVID-19 related claims, which lacked a direct property damage trigger. At the same time, landslides are not covered under standard property insurance, and this could pose a problem for some businesses as landslides are a common risk after wildfires due to soil erosion.
- Coverage periods: Rebuilding could present delays due to shortages of qualified contractors, inspectors, equipment or available building materials. While many policies limit coverage to one-year, longer recovery periods may require lengthy and careful negotiations.
- Cause of evacuation: Many business interruption policies include civil authority coverage, which provides coverage for government-mandated evacuations. However, some businesses may have closed due to fears of wildfire and loss of business, even though an evacuation order had not been issued for the area.
- Income calculations: The business interruption benefit for lost revenue is based on financial records, but determining exactly how much income was lost can be complex. For example, a business that makes most of its revenue in the summer would not lose as much for a closure in January as it would for a closure in July, so simply looking at the average monthly revenue might not result in an accurate loss estimate. It can also be difficult to estimate lost revenue from business activities with irregular revenue, such as businesses with seasonal peaks or irregular earnings (e.g. the NFL decided to move the Los Angeles Rams’ playoff game to Arizona, and concerts have been canceled).
The Role of Forensic Accounting
In the aftermath of the wildfires, or any natural disaster, a balance must exist between helping businesses recover and ensuring the insurance companies remain healthy so they can continue to provide coverage. This means that claims need to be paid fairly and accurately, with policyholders receiving precisely what they are owed under the terms of the policy. Forensic accounting is critical in helping achieve these objectives.
Mistakes in business interruption claim submissions are common. It’s an overwhelming time for business owners. They are dealing with the potential failure of their businesses, and in addition to navigating their own livelihoods, they are concerned about the wellbeing of employees and loved ones.
Business owners need to file their insurance claims quickly, but they may not have access to the accounting support needed to do so accurately, as there may be a shortage of professional services available – particularly now, as businesses and their accountants are already busy wrapping up the 2024 year-end and tax filings.
As a result of these conditions, there can be a significant difference between the claimed amount and the amount actually due according to the policy terms. This variation arises from many common mistakes and oversights, such as:
- Assuming perfect business: Using unrealistic assumptions such as 100% occupancy rates for hotels (when historical occupancy rates should be used instead).
- Misclassifying revenue: Incorrectly including non-revenue items like tips in revenue projections for a restaurant, or a incorrectly including sales taxes for a store.
- Duplicating expense items: Counting the same business expense in multiple categories, causing double counting.
- Neglecting saved expenses: Failing to exclude costs paused during closures, for example when businesses are closed.
- Ignoring post-loss revenue increases: Some businesses are likely to see a surge in business as soon as they re-open because customers have been waiting, which should be factored into claims.
In addition to mistakes in accounting assumptions, some business interruption claims may unfortunately include intentional fraud. Insurers need to pay a close look at all claims, as they potentially can include includes instances of:
- Exaggerating or Padding the Loss: Claimants inflate the impact of the business interruption by overestimating the extent or duration of losses, for example hotels inflating the number of catering or group reservations lost during the closure, beyond historical averages.
- Overstating Pre-Loss Income: This involves reporting higher-than-actual revenue levels prior to the loss event, creating a false baseline for compensation calculations. This could be an event venue claiming pre-loss revenue based on all weekends being fully booked, ignoring cancellations or no-shows that were common in past data.
- Understating Income During the Loss Period: Businesses may omit or downplay revenue earned during the interruption period, such as online sales, alternate business operations, or partial recoveries.
- Understating Expenses: Some claimants minimize reported operating costs, like the cost of goods sold, to create an artificially high profit margin, thereby inflating the loss amount.
- Fabricating Supporting Documentation: Fraudulent claims may involve falsified financial records, sales receipts, or inventory reports to misrepresent losses or pre-loss performance.
- Misclassifying Costs or Losses: Shifting non-covered costs into covered categories (e.g., maintenance or capital improvements) to boost recoverable amounts.
Conclusion
The devastating Los Angeles wildfires have caused significant loss of life and widespread damage, underscoring the complexities of managing business interruption insurance claims. Amid such challenges, forensic accounting plays a critical role in ensuring that claims are handled fairly, accurately, and in accordance with policy terms.
At Alan Gray, we specialize in providing forensic accounting services to insurance companies, attorneys, third-party administrators, and businesses. Our expertise helps resolve disputes, uncover errors or intentional misstatements, and ensure that businesses receive the compensation they are entitled to under their coverage.
In times of significant disruption such as these, accurate claims management is crucial not only for policyholders but also for maintaining the trust and sustainability of the insurance industry.
Contact Alan Gray to learn how our forensic accounting expertise can support your claims management and help navigate the complexities of disaster recovery.
Contact us to learn how our forensic accounting expertise can support your claims management needs.
