Hedge funds speculating on wildfire insurance claims in California were just dealt a legal blow, after the state adopted new legislation designed to stifle such bets.
Under the law, approved last month by California Governor Gavin Newsom, alternative investment managers buying so-called subrogation claims from insurers would see those transactions voided unless the utilities targeted were given the option to settle on the same terms.
The bill will make it “a lot more difficult” for hedge funds to execute trades on favorable terms, Willis Hon, a partner at Los Angeles-based law firm Nossaman LLP, said in an interview.
“It’s a lot of work finding these funds and developing the deal, drafting the agreement, and doing your due diligence,” he said. “If the electric utility can just step in and exercise the right of first refusal, it makes the whole proposition a lot more risky and uncertain.”
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Subrogation claims have been targeted by hedge funds, private equity firms and other alternative investment managers as a lucrative way to take risk off insurers’ hands. Insurers bringing initial claims against utilities are often keen to offload the risk of potentially long and costly legal battles to third parties. Hedge funds, which generally buy such claims at a discount, take on the risk of pursuing claims, and pocket the gains if they prevail in court.
The model has raised concerns among Californians worried that devastating wildfires are being used as an arena for profiteering at the expense of the California Wildfire Fund, which was created in 2019 to help reimburse fire-related claims. The California Earthquake Authority, which is the administrator of the fund, describes subrogation bets as “opportunistic, profit-driven investment speculation,” and has pledged to take on “hedge funds and other speculators” engaged in such transactions.
The new law has “major implications” for alternative investment managers targeting subrogation, Hon said last month in a written comment co-authored by fellow Nossaman partner, Bradford Kuhn.
Aside from giving utilities the right to settle, the new law also makes it harder for hedge funds to price subrogation deals by attaching a non-disclosure clause, Hon said. The upshot is the market for subrogated claims will probably “shrink,” he said.
In California, such claims have targeted utilities, including Edison International’s Southern California Edison and Pacific Gas & Electric Corp., after they were suspected of being liable for wildfire-related losses.
The market for trading subrogation claims is far from transparent, and hedge funds aren’t required to publish the value of transactions. Notable cases to date include Baupost Group LLC, which in 2020 generated an estimated $1 billion of profits from claims it bought against PG&E, Bloomberg has previously reported.
Hedge funds generally “will not bid on a claim unless they think they can turn it around for a larger profit,” said Mark Toney, executive director of The Utility Reform Network, a ratepayer advocacy group. “We support strategies that keep the hedge fund profiteering structurally out of the system.”