Hedge Funds Face California Rebuke Over Role in Wildfire Claims

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Hedge Funds Face California Rebuke Over Role in Wildfire Claims

(Bloomberg) — Hedge funds are facing pushback in California as their bets tied to insurance claims stemming from the Los Angeles wildfires are attacked as unethical.

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The transactions in focus are tied to so-called subrogation claims, which hedge funds, private equity firms and other alternative investment managers have been buying from insurers over the past few months. Subrogation kicks in if a third party such as a utility is suspected of being responsible for losses covered by insurers.

Hedge funds buying these claims from insurers are now under attack from the California Earthquake Authority, which is the administrator of the California Wildfire Fund. It has described such transactions as “opportunistic, profit-driven investment speculation,” and says it’s planning to take on “hedge funds and other speculators” that it claims “are actively seeking to profit from California’s devastating wildfire catastrophes.”

In practice, that means the authority will try to block the payout of what it says could end up being “billions of dollars” to the investors that bought the claims, according to materials prepared ahead of a meeting that took place last month with the California Catastrophe Response Council, which oversees the fund. To that end, it plans to engage California’s state legislature, according to a transcript of comments made during the meeting and seen by Bloomberg.

A spokesperson for the authority declined to comment.

Bradley Max, a director at Cherokee Acquisition, a New York-based investment bank that trades and invests in subrogation claims, says the development has “put a chill on bidding,” which is already visible in pricing.

Subrogation rights tied to the Eaton Fire that ripped through Southern California in January were trading as high as 50 cents on the dollar at one point, but have now dropped “at least a few points lower,” Max said.

Still, even though the political development has led to lower prices on the subrogation claims, it hasn’t held back transactions, he said.

Cherokee said in April it had brokered deals linked to the Los Angeles fires for “larger, more sophisticated distressed debt hedge funds.” And by April 15, investment bank Oppenheimer & Co. Inc. had executed 10 transactions tied to the Eaton and Palisades fires totaling over $1 billion worth of recovery rights, Ronald Ryder, co-head of special assets at Oppenheimer, told the California Earthquake Authority. That includes over $125 million in claims traded in just one day, Ryder wrote.

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A spokesperson for Oppenheimer declined to comment. Cherokee didn’t name the hedge funds for which it brokered deals.

In an email to the California Earthquake Authority, Ryder said that as catastrophic weather events become “more prevalent,” insurers are increasingly resorting to “recovery subrogation in the secondary market to fortify the balance sheet.”

There’s a growing consensus that insurers can’t cover the rising costs of weather-related catastrophes alone, especially as climate change fuels more extreme events. For that reason, the industry is looking for ways to shift part of its financial risk over to capital markets, with alternative asset managers often the only investor class willing to step in.

Efforts to prevent investors from profiting from the subrogation claims they’ve bought represent “a politically motivated attempt to not pay legitimate obligations,” Max at Cherokee said. They’re “trying to beat up deep-pocketed hedge funds, despite the ethical and legal implications,” he said.

Recovery of subrogation claims is costly and can take years to play out, which is why insurers have started selling them in exchange for an upfront cash payment. The hedge funds buying them are betting that the recovery sum at the end of the process will exceed the amount they paid the insurer to buy the claim.

The market for investing in subrogation claims is characterized by over-the-counter deals with little to no transparency. Subrogation deals had a seminal moment more than half a decade ago, when faulty power lines and equipment failures at California utility PG&E Corp. were blamed for wildfires in the state. Back then, hedge fund Baupost Group LLC purchased claims against PG&E worth $6.8 billion. Bloomberg has previously reported that Baupost may have generated an estimated $1 billion of profits.

The California Wildfire Fund, which is administered by the state’s Earthquake Authority and overseen by the California Catastrophe Response Council, was set up in 2019 to help reimburse claims arising from wildfires caused by utility companies. If hedge funds prevail in their subrogation claims, some of the money could end up coming from the California Wildfire Fund.

The fund, which sits on about $13 billion in liquid assets, is partly capitalized by three utilities — San Diego Gas & Electric Co., Edison International’s Southern California Edison and PG&E. While the cause of the January fires remains under investigation, it’s already clear that the Eaton Fire started inside the service territory of Edison and therefore leaves the fund potentially exposed, the authority said.

With current estimates for insured losses as high as $45 billion, the January Southern California wildfires are expected to be the costliest in US history, according to the California Earthquake Authority.

The Earthquake Authority and Catastrophe Response Council are now reviewing claims and administration procedures as they take the matter to the state legislature.

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