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To onlookers, the flames and winds that bullied, threatened and devoured so much of the Southern California landscape in late October had an Armageddon-like quality. And certainly for home owners in those normally sunny, seductive and often expensive valleys of sage and night-blooming jasmine, the destruction of their redwood homes, gardens and, in a very few cases, loved ones must have seemed like the beginning of the end of the world.

But for the county governments and other public entities that use the California State Association of Counties' Excess Insurance Authority to help manage their exposure and insurance coverage, those searing flames so far have resembled nothing more than a glittering firebug.

The other two counties--Orange and Los Angeles, both with far greater population densities--don't participate in the pool. They prefer to use a more traditional combination of self-insurance and excess capacity.

The majority of the CSAC-insured public-entity damage in the October fires, by far, fell on San Diego County, a county of more than 3 million people packed into 4,281 square miles, yielding a population density of about 710 people per square mile.

Susan Eldridge, a senior risk and insurance analyst with San Diego County, says the property loss from this year's fires could be close to double the $4.5 million in losses the county suffered in the wildfires that burned almost 1,500 homes in San Diego in 2003.

She also says the 2003 fires damaged numerous public park structures, but that this year's loss will have a greater impact in a smaller area. "I would say less locations, but moneywise it's going to be more," says Eldridge.

San Diego County's chief loss was from the massive Witch Canyon fire. The flames charred 200,000 acres of land and damaged buildings belonging to the San Pasqual Academy, a 238-acre, county-run education center for 135 foster children located in Escondido, just north of the city of San Diego. Eldridge says there was damage or destruction of 24 structures that serve as the academy's classrooms or student and staff housing. In addition, the fire destroyed more than 1,000 homes.

But even as Eldridge spoke by telephone to Risk & Insurance® shortly after the fire in late October, adjusters were on site tallying the damage to the academy. Eldridge, however, declines to hazard a guess as to the financial loss.

Elsewhere in Southern California, in San Bernardino Country, with 1.99 million people scattered over more than 20,164 square miles, according to state Department of Finance figures, the Rim of the World Unified School District took a hit from the Running Springs and Grass Valley fires.

Part of a sprawling complex of 10 schools spread out over 110 square miles, the high school, perched atop a mountain with stunning views of the Inland Empire Valley, suffered smoke and wind-driven ash damage to three buildings, says Karla Rhay, the chief administrative officer for Southern California Schools Risk Management, a group of 31 Southern California school districts covered by CSAC-EIA.

The Running Springs and Grass Valley fires also destroyed more than 370 homes in San Bernardino Country and about 14,000 acres of land.

By contrast, Riverside County to the south, with 1.95 million residents on 7,243 square miles; Santa Barbara County bordering the Pacific, with about 420,000 residents living on 2,745 square miles; and Ventura County to the west, with about 817,000 people on 1,864 square miles, all had next to nothing in public property loss.

Because San Diego shares its risk with counties and public entities throughout the state, even as its property losses look as if they will burn through the $8 million limit of CSAC-EIA's shared self-insured layer of property coverage, it and the other members are likely to feel few ill effects, at least as far as premiums are concerned, according to county risk management experts.

"I don't think this is going to turn the market at all," says Mike Fleming, the Sacramento-based general manager of the authority, the property insurance pool which has been in existence since 1984. A soft catastrophic insurance market in 2007 played a role. More important, however, is the risk management structure through which these large Southern California counties are protected.

That's because the towers, layers and tranches of the EIA's insurance program represent one of the most effective and far-reaching risk management pools in the world, according to its members. Above that self-insured layer of $8 million is a primary layer followed by excess layers that combined take limits all the way up to $600 million, according to Fleming.

The EIA uses Lexington Insurance Co. as its primary-layer property underwriter, and the self-insured layer of the pool can absorb losses at $3 million per occurrence and $8 million in the aggregate, according to Fleming.

As of early November, the estimated losses just from San Diego County of about $9 million were likely to breach through both the per-occurrence limit and the aggregate limit. "If we weren't there already, this is probably going to get us there," says Fleming.

Eldridge, who pays about $1.6 million in premiums to insure $1.5 billion in insured property values, says her county saw a "slight bump" in its premiums after the 2003 fires and that she expects a similar slight bump this time.

Rates in the commercial property market are also driven by global catastrophe losses, which make no distinction as to whether property is covered by a pool or a private carrier. As a result, the world market will have to absorb the breach of the primary layer of the San Diego losses.

With a soft global property-catastrophe market, carriers flush with cash and modelers estimating the Southern California fire damage at about $1 billion, or less than 3 percent of the insured losses sustained in the wake of Hurricane Katrina in 2005, the global markets have plenty of capacity to absorb shock.

According to Fitch Ratings, catastrophic losses have been well below average so far in 2007. The ISO's Property Claims Service estimates that there were $4.7 billion in catastrophic losses through the first nine months of 2007, far below the $7.8 billion in catastrophic losses for the first nine months of 2006, and about half of the $9.3 billion average over each of the last 15 years. This compares to $41 billion in losses from Hurricane Katrina alone in 2005.

That's why Southern California risk professionals prefer talking about a "bump," as opposed to a "spike" in rates.

HOW IT ALL BEGAN

To understand the historical basis for Fleming's confidence, one needs to look at how counties were looking at insurance and risk management back in the 1970s. That was when representatives of various California county governments, tired of the sometimes merciless yet always reoccurring business cycles of insurance markets, first hit on the idea of forming pools to spread their risk.

California's legislature, which in this case showed a propensity for action, soon wrote and passed enabling legislation. The CSAC-EIA, as it is known today, was on its way.

Over the years, as the authority has grown, taken on new members and become more sophisticated, it has added insurance beyond its original property/casualty programs. The hard market of the mid-1980s, for example, resulted in the formation of a new liability pool.

"As we have evolved, it has become recognized as an extremely efficient way to self-insure and to buy insurance," says Fleming. "It's a great testimony for good government and efficient government."

Jim Sessions, a board member of the CSAC-EIA who left a steady career as a risk manager and insurance broker in the private market to join Riverside County as a risk manager in 2000, says that, when he first saw the rates that EIA member Riverside was paying for property insurance, he thought somebody was miscalculating.

"I came here and looked at the rate and thought, 'It's got to be written wrong,' " says Sessions.

Sessions says his experience in the private market taught him that property premium rates can be roughly calculated at 10 cents per hundred dollars of insured value. Riverside was at a very small fraction of that.

"Because to me, a highly protected risk is 2.5 cents per hundred, and we were at 1.1 cents per hundred, and we are not a highly protected risk," Sessions says.

To get those rates, member counties, cities and authorities in California are sorted, shuffled and categorized into seven towers, in which they are mixed and matched with municipalities that counterbalance their risks and exposures to give pool members the most coverage possible for the lowest rate possible.

Counties that have a higher likelihood of wildfire damage are lumped in with counties whose chances of a wildfire are much smaller. Large arid counties like San Diego, Riverside and San Bernardino, which have high property exposure to wildfires, are lumped in with smaller counties, whose exposure is far less.

A Riverside County, for example, which has more than $1 billion in insured property spread out over its 7,243 square miles, can be in a tower with tiny Alpine, a county nestled in the cool embrace of the Sierras beyond the reach of scorching flames.

Alpine, the least populous country in California, has 1,241 inhabitants spread over just 727 square miles, according to 2006 state Department of Finance numbers.

"To have a pooling arrangement that can meet the needs of an Alpine County and have that go all the way to a Riverside or a San Bernardino, that's a huge stretch," says Riverside's Sessions.

The towers have helped convince major insurance players to come into each tower, says Sessions, and that has raised the capacity by a factor of six or seven, instead of each country looking for capacity in the marketplace on their own.

"An underwriter can sit back and say, 'Well, they can have a regional earthquake, or they can have a regional conflagration, and I'm not in it for both counties. I only get one of them.' And that makes good underwriting sense," he says.

The magnitude of the number of counties involved means the law of large numbers works in the counties' favor.

But there are limits to what the flexibility of the EIA can tolerate.

Take Los Angeles County, home to the city of Los Angeles and massive populations in communities like Santa Monica that hug the precious Southern California coastline. L.A. County's population of around 10.24 million on 4,079 square miles, according to state figures, is almost one-third of the entire state's population of 36.45 million.

If L.A. County, which is not a member of CSAC's EIA, were to jump into the pool, the sheer weight and displacement of its exposures would wash smaller members right out of it. "The problem is we're the 800-pound gorilla. We would drive the pool results because we're so big," says Rocky Armfield, that county's risk manager.

But just because Los Angeles County isn't a member of the pool doesn't mean Armfield doesn't recognize its value. "I have been a risk manager in municipalities that are members of pools, and they are very beneficial. They are a good way to go," says Armfield.

JUST ONE BROKER

If pricing the tranches and towers of CSAC's EIA approaches advanced mathematics in its complexity--indeed, even requires it--there's at least one aspect in which the arrangement is starkly simple. The EIA is served by only one broker, Alliant Insurance Services.

Laurie Milhiser, the risk manager in Riverside's neighboring county of San Bernardino to the north, says Alliant establishes a point person for each county and that person is the main point of contact for claims, whether for a wildfire, workers' comp or any other claim category.

She says the arrangement gives Alliant enough flexibility to terminate a county policy in midstream, renegotiate it and write a new one. Milhiser says she thinks the EIA's towers are well put together and serve members well. But she says risk managers within the system are dependent on Alliant to keep them updated on the many twists and turns of arrangements within the pools.

For example, Milhiser, who has been a risk manager in San Bernardino County for the past two years, was recently deposed in a flood liability case in which there was confusion about which policy she was testifying about, because the policy had been reworked preceding her tenure.

She says Fleming's office referred her to Alliant when she had concerns about which policy she was making sworn statements about. "The only people who really seems to know exactly what the insurance programs were is the broker," Milhiser says. "It gets confusing, and it means that we are putting a great deal of trust in that agency."

Milhiser says she has concerns about pools in general, particularly the concept of shared limits, which she said might lead some entities to be underinsured in some cases. However, she says that is not the case with CSAC's pools.

Ralph Hurst, the Alliant vice chairman who manages property risk for CSAC, was in the field in late October and could not be reached for comment.

DAN REYNOLDS is senior editor of Risk & Insurance®.

December 1, 2007

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