Recent wildfires leading to financial liabilities for Pacific Gas and Electric Co., Hawaii Electric, and PacifiCorp in Oregon illustrate the rising credit risks that could result from the combination of regulations and the physical impacts of a changing climate.

Why it matters:  Although wildfires are primarily sparked by lightning and human activities, prolonged periods of extreme heat and pervasive drought conditions can exacerbate their frequency and severity, resulting in higher risks to public safety, and financial and economic losses for states, local governments, and power utilities that could strain financial performance and liquidity.

What we think and why:  The growing frequency and severity of climate-related physical risks can weigh on the credit quality of some entities more than others. S&P Global Ratings believes based on the historical incidences of wildfires, management teams may need to undertake a multi-pronged strategy to build resilience to this hazard (as well as other physical risks), to help preserve stable credit fundamentals in the face of an acute event.

Global Insured Losses Are Rising, At Least In Part, From Physical Risks

From 1992 to 2022, the growth trend of annual insured losses from natural disasters averaged 5%-7% per year, with more severe climatic events accounting for the majority of insured losses, according to Swiss Re. In 2022, global natural disasters resulted in $132 billion in insured losses, making it the fifth-costliest year on record (chart 1). Since 2020, global weather-related insured losses have exceeded $100 billion annually, highlighting a generally rising trend.

Chart 1

Insurers' relatively high credit quality is underscored by decisions to limit losses and exit unprofitable business in response to extreme weather-related events (chart 2). These losses have strained insurers' ability to achieve their profitability targets, given the increasing frequency of such events, elevated construction costs, the higher cost of reinsurance, and state regulatory restrictions that can limit rate increases for personal insurance lines. Property insurance and reinsurance serve an important role in building economic and financial resilience for loss-affected policyholders after a loss event. However, we believe physical risk aggregations raise the potential for volatility in earnings and capital of insurers and reinsurers, which is a negative consideration in our assessment of their creditworthiness.

Chart 2

Governments Can Help Coordinate Wildfire Management Initiatives

Although the benefits of risk management and resilience can be difficult to quantify, S&P Global Ratings believes that government coordination to fund adaptation and build resilience to climate hazards could curtail the cost of economic losses. Between 2013 and 2022, global economic losses from combined climate hazards, using data from Aon PLC, averaged more than $320 billion annually (chart 3). Wildfires contributed about $14 billion on average annually to the global total but hit a high of almost $32 billion in 2017. Furthermore, in 2023, one of the most devastating fires in U.S. history occurred in Maui, Hawaii, as the compounding hazards of drought conditions and high temperatures exacerbated the event, leading to nearly 100 deaths and almost $5.5 billion in property damage costs, while Canada had its most destructive wildfire season on record; 45.7 million acres (18.5 million hectares) burned and losses are still being tallied.

Chart 3

Funding wildfire management could require creative solutions

Implementing wildfire management and resilience initiatives is resource intensive and could affect local and regional government budget decisions. As more frequent and severe wildfires drive up public spending, and as the wildland-urban interface (WUI) continues to expand, policymakers at all levels of government might face decisions about prioritizing funding for prevention, adaptation, preparedness, management, responsiveness, and recovery from wildfires.

Federal or central government disaster assistance provides important financial support for communities to recover from fires and other disasters and has historically helped offset both the immediate and long-term budget impact of disasters on state, provincial, and local governments. Absent adaptation and additional resilience measures, wildfires and other climate hazards could become more damaging, and could financially pressure public-sector disaster recovery arrangements (such as the U.S. Federal Emergency Management Agency [FEMA] and Canada's Disaster Financial Assistance Arrangements [DFAA]) and insurers of last resort to deal with increasing losses and costs of recovery while promoting risk mitigation and resilience. As a result, local and regional governments globally could bear a greater share of risk, including the potential for less financial support following an acute event.

In Canada, 73% of the C$7.9 billion in post-disaster assistance provided by the DFAA was paid out in the past 10 years. A federal proposal to overhaul the payment arrangements predates the record 2023 wildfire season, the costs of which remain undetermined. The proposed reforms, which received preliminary funding in Canada's 2023-2024 budget, would enhance tools, supports, and incentives for risk mitigation and preparedness at the provincial and municipal level.

Better coordination among governments and stronger risk reduction measures could help improve public safety and potentially reduce the public and private cost of wildfires, much of which is currently borne by central governments and insurers (chart 4). Still, by implementing prudent risk reduction and resiliency measures and investing in infrastructure improvements, governments could lower their vulnerability to future wildfires and natural disasters.

Chart 4

Future state: Data analytics could enhance risk management

In our view, the growing availability and use of data could help governments enhance risk management and regulatory practices to protect communities' public safety and minimize financial losses from wildfires. In particular, predictive analytics and sophisticated forecasting technologies could help governments map and model fire hazards within the WUI. Dynamic models can assess the potential for changes in rainfall and wind patterns, vegetation density, land use and development, extreme heat, and drought, all of which could intensify wildfires, affect how they spread into the WUI, and leave communities more vulnerable to frequent and severe wildfires over time.

S&P Global Ratings believes data sharing and new tools to measure short- and long-term exposure could reduce uncertainty to support state and local government decision-making and prepare for future events. Oregon developed its Wildfire Risk Explorer and mapping tools for local governments and homeowners to inform updates to Community Wildfire Protection Plans and Natural Hazard Mitigation Plans. Furthermore, Canada's first National Risk Profile, published in May 2023, identified gaps in wildland fire resilience and priorities for disaster prevention and mitigation, including the need to adopt better tools, assessments, and technologies to improve prediction and early warning.

State-specific codes or programs could help prepare for wildfires

Urbanization of the WUI further increases wildfire risk for U.S. governments. The U.S. Fire Administration defines the WUI as the zone of transition between undeveloped wildland or vegetation and the area where building structures and other human development meet. Encroachment into the WUI will likely result in a greater number of homes and populations residing near fire-prone areas and increase the likelihood of human-related ignitions. To help manage development in the WUI, four states adopted specific codes while eight others have guidelines or programs to reduce fire risk (chart 5). Among U.S. states, California implemented the broadest legislative reforms to mandate wildfire resilience investments by property owners. The U.S. federal government's National Climate Resilience Framework, introduced in September 2023, could help reinforce state-specific programs and codes to improve resilience of existing infrastructure to both acute and chronic hazards.

Chart 5

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Strong financial management and balance sheets could help stabilize credit fundamentals

The confluence of climate change and WUI expansion could exacerbate the trend of increasing wildfire activity. The corresponding impact of wildfire events on credit fundamentals could be influenced by how local, state/provincial, and national governments adjust their fiscal and risk management strategies to support long-term planning and preparation to adapt and build resilience. In the aftermath of natural disasters, property owners might be unable or unwilling to pay property taxes, which could result in higher payment delinquencies or home foreclosures. In general, experienced management teams typically establish financial reserves to cover costs for natural disasters, among other risks, sufficient to absorb multi-year property tax delinquencies. Furthermore, we think a multi-pronged approach to wildfire exposure management could help offset fire-related rating pressures (table 1 and chart 7).

Table 1

Chart 7

Power Utilities Are Particularly Vulnerable To Wildfires

All power utilities are exposed to wind-driven events, which is a key contributor to utility-caused wildfires. High winds can spark and spread a wildfire if trees and limbs come into contact with power lines or cause electrical lines to fall onto combustible material (dry brush and trees).

Chart 8

Investment in wildfire mitigation plans can help reduce infrastructure damage

Adaptation and resilience to wildfire risks could reduce damages and financial liabilities for power utilities and generally include system and grid hardening, technology, proactive surveillance, and vegetation management. In addition, because modern economies are heavily dependent on electricity, system hardening also allows for the faster restoration of operations, reducing the potential economic loss following an event. Although system hardening is often expensive and can take years to fully implement, its long-term benefits typically outweigh the short-term costs. Examples of system hardening are burying power lines, installing cover conductors (the insulation of bare electrical wires with durable, long-lived materials that reduce the probability of an electrical fault or spark), and replacing wood poles with steel and concrete ones.

Coupled with resiliency and system hardening, some utilities use of public safety power shutoffs (PSPS). A PSPS is a program that proactively de-energizes power lines in response to forecast weather conditions to reduce the risk of a utility's power line sparking a fire. Most utilities exposed to significant wildfire risks typically adopt protocols and policies to de-energize power lines in advance of threatening conditions. But some might not pre-emptively shut off power because they believe doing so introduces other public safety or health risks, particularly for electric utilities located in large urban areas. However, the ultimate decision to initiate a PSPS event involves senior operating personnel at the utilities.

Following the catastrophic Camp Fire in 2018, California mandated all investor-owned (IOU) and publicly owned (POU) utilities in the state to implement comprehensive wildfire mitigation plans. The system investments in hardening assets and technology to build resilience to physical risks, among other things, have helped reduce the number of structures destroyed by fires in the state (chart 9). By comparison, since 2020, structures destroyed by wildfires in Colorado, Hawaii, Idaho, Oregon, Texas, and Washington increased by more than 100% from the 2016-2019 period while Arizona, Montana, and Utah have each seen increases of at least 20% in the same timeframe (chart 10).

Chart 9

Chart 10

In combination with other wildfire risk management strategies, maintaining or increasing property and liability insurance coverage can reduce a utility's financial exposure to physical risks. However, given the evolving issues in the insurance market mentioned previously, some utilities are contemplating use of self-insurance. Under the self-insurance model, a utility forms a captive insurer or initiates a fund through a customer charge that it uses to pay losses from physical events. This model may be an effective substitute if private liability insurance premiums are unaffordable, or coverage is unavailable in the commercial marketplace.

Negligence laws in western U.S. states can create litigation risks for power utilities

The negligence laws for all western U.S. states require that the plaintiff demonstrates the defendant is at fault for acting in a deficient manner or breaching the duty of care. While there are differences between states' standards of negligence, we consider litigation a material credit risk that affects the power utilities sector. Arizona, California, New Mexico, and Washington operate under a pure comparative negligence standard that can find a defendant liable even if a plaintiff was 99% at fault. However, in such a scenario, the defendant's liability is limited to just 1%. Colorado, Hawaii, Idaho, Montana, Nevada, Oregon, Texas, and Utah operate under the modified comparative negligence standard, which limits the defendant's risk. In these states, the defendant can be found liable for damages only if they caused at least 50% of the damages. Because the modified comparative standard of negligence is less onerous on the defendant, we assess utilities that operate in these states as having somewhat lower credit risk (chart 11).

Chart 11

In California, IOUs and POUs are held to a higher level of accountability through the state's interpretation of inverse condemnation doctrine--whereby a California utility can be financially responsible if its facilities were a contributing cause of a wildfire, regardless of negligence. Although we don't view this interpretation positively for the sector, California remains the only western U.S. state that supports this interpretation for utilities.

Wildfire Management Is Multi-Jurisdictional And Multi-Pronged

An entity's approach to planning for and adapting to wildfire risks typically includes multiple levels of governments working together to fund mitigation. The combination of extreme heat, drought, and expansion of the WUI will likely lead to an increasing frequency of wildfires and continue to test management teams to evolve and implement additional risk management efforts to help preserve credit quality as acute events intensify over time.

Related Research

• A Storm Is Brewing: Extreme Weather Events Pressure North American Utilities' Credit Quality, Nov. 9, 2023
• The Evolving Impact Of Environmental And Social Factors On Credit Ratings, Oct. 25, 2023
• A Closer Look At The Three Major California Investor-Owned Electric Utilities Amid The 2023 Wildfire Season, Oct. 24, 2023
• Hawaii Wildfires: Strong Reserves Position Governments And Related Credits Well In Short Term Despite Pressures And Uncertainty, Aug. 23, 2023
• Sustainability Insights: California’s Evolving Insurance Market Has Mixed Impacts: Spotlight On U.S. Public Finance, Spotlight Off U.S. RMBS, Aug. 2, 2023
• Keeping The Lights On: U.S. Utilities’ Exposure To Physical Climate Risks, Sept. 16, 2021