Los Angeles utility lawsuits underscore climate liability risk

Bloomberg News

The ongoing legal challenges the Los Angeles Department of Water and Power faces after a devastating 2025 wildfire are setting a "precedential" course for California, highlighting the state's escalating exposure to climate-related liabilities and the urgent need for a regulatory overhaul.

The legal exposure, which includes a state court ruling that LADWP can be held liable for not keeping a city reservoir filled, crystallizes the need for state intervention, said Matt Fabian, president and partner at Municipal Market Analytics, who fielded client calls from investors after a Los Angeles County Superior Court's Feb. 19 ruling.

"It was time to affirm this is something that will fall to the state, if not to pay, to facilitate payment through the utility or county," he said.

Superior Court Judge Samantha Jessner said in her ruling that a California law allows property and business owners to pursue claims that LADWP failed to supply enough water to fight the blaze that consumed the Pacific Palisades area. 

LADWP has been criticized because the Santa Ynez Reservoir in the Pacific Palisades hills had been taken offline for repairs to its cover. Critics say the reservoir could have provided water to help extinguish the fire or prevent the blaze from growing to the devastating level it did.

The blaze was driven by hurricane-force winds over parched terrain that had not seen significant rain for months.

Daniel Levin, co-managing partner for Munger Tolles & Olson, who represents LADWP and the city, filed a demurrer arguing the utility could not be liable for failing to provide water for firefighting and lack of maintenance on the reservoir. 

The judge in her ruling concluded "the city and LADWP's demurrer is overruled."

Jessner also said the utility could be sued for causing secondary fires that extended the blaze's timeline. Jonathan Rinderknecht, 29, was indicted on three felony counts in October alleging that he was responsible for starting the wildfire, which was initially thought to have been quickly extinguished, but re-ignited a week later. 

Fabian emphasized that he was not saying LADWP doesn't have the resources to finance a solution to its litigation on its own, but said the increasing frequency of natural disasters means state governments need to craft solutions.

"It's too large for local governments to deal with, so it needs to emanate up to the state," Fabian said. "What is happening in California portends what can happen elsewhere, where you have credit issues driven by COVID-19 or climate change that the state needs to remediate."

A central issue is the intersection of climate change and liability.

Utilities are "magnets for climate-related costs," and the increasing difficulty LADWP could face in securing casualty insurance is a prime example, Fabian said. Insurers are focusing on future risks and the burden climate change will place on infrastructure, making it difficult for utilities, which often prioritize keeping near-term rates low, to meet the insurers' criteria, he said.

Changes at the state level that Fabian said could help are state legislation that removes or transfers utility exposure to certain liabilities, or finding other ways to help manage future liability. The second is insurance market reform and creating more state programs to retool the insurance market, potentially providing subsidies or transferring insurance-related risks, so they aren't entirely borne by the utility.

California created a bond-funded Wildfire Fund, where investor-owned power companies like Edison International can seek reimbursement for legal claims from the state. The investor-owned utility faces legal exposure from the Eaton fire, which destroyed much of the community of Altadena at the same time the Palisades fire laid waste to parts of west Los Angeles.

The Wildfire Fund was expanded to $39 billion in September when Gov. Gavin Newsom signed Senate Bill 254, but it doesn't apply to municipal utilities like LADWP. Originally set at $21 billion, the fund was created in the aftermath of the 2018 Camp Fire, which bankrupted Pacific Gas & Electric.

California Insurance Commissioner Ricardo Lara has been working on insurance policy reforms at the property insurance level with mixed results.

His primary focus has been to try to retain insurance companies that have been exiting California, saying climate-change related liabilities like fires and flooding were making it too costly to operate in the state.

The Los Angeles County fires brought more attention to the issue, because some homeowners had let their insurance lapse as prices soared or been dropped by insurers ahead of the fires.

The issue has resulted in a competitive race to replace Lara, who is prevented by term limits from seeking another term in November.

The crowded field includes a healthy mix of Democrats, Republicans and one candidate from another party. Among the Democrats running are Patrick Wolff, a financial analyst; state Sen. Benjamin Allen, who represents Pacific Palisades and other parts of Los Angeles County; Steven Bradford, a former state senator and assemblymember; and Jane Kim, an attorney and former member of the San Francisco Board of Supervisors.

The Republicans include Stacy Korsgaden, who owns an insurance and financial services agency, and Robert Howell, president of Exatron, a cybersecurity equipment manufacturer in Silicon Valley.

Eduardo "Lalo" Vargas, a Los Angeles Unified School District teacher, is running via the Peace and Freedom Party. 

The current legal and financial climate is also affecting the municipal bond market. While LADWP has benefited from a general tightening of spreads in the municipal bond market, the utility's bonds carry a "cost penalty" for managers who must field calls from clients about the "headline credit" risk, Fabian said. This added friction makes managers less likely to buy LADWP bonds, despite strong institutional demand, he said.

LADWP credit spreads have narrowed since the wildfires, but remain wider than pre-wildfire levels, Fabian said.

Ultimately, utilities only have one device to cover costs: raising rates, Fabian said.

If the state does not find a solution to secure satisfaction in private lawsuits and reform the insurance market, the costs associated with liabilities like inverse condemnation, which is particularly potent for utilities under California law, will eventually be borne by the local economy through drastically increased rate structures, he said.

The state has been criticized for being slow to advance policy solutions, especially when compared to states like Florida, which is seen as a leader in modernizing its private insurance market by transferring risk from insurance companies to the state, Fabian said. The consensus is that any solution now must be scalable and repeatable to prevent California from "lurching year to year" in the face of predictable climate events, he said.

Overall, the county's bonds have fared better than expected after the fires.

No municipal bonds have experienced defaults as a result of the January 2025 Los Angeles wildfires, and assessed value declines have been modest, Nuveen said in an credit research report on Feb. 19. Though the full impact of the disaster continues to unfold, Nuveen said.

Some municipalities may experience minor assessed value reductions from property reassessments, but the impact remains limited, Nuveen said.

Santa Monica-Malibu Unified School District Facilities Improvement District No. 2 "for example, saw just a 0.4% year-over-year assessed value decline in fiscal year 2026," Nuveen said. "As rebuilding advances and insurance claims process slowly, impacted tax bases should gradually recover."

Assessed values determine the tax levy pledged to general obligation unlimited tax bonds issued by cities and schools. 

The report notes that Los Angeles and LADWP face multiple lawsuits, one of which is seeking $10 billion in damages. "If either the city or LADWP were found liable, a large settlement against either entity could negatively impact the city and its utility enterprises," Nuveen said. "Significant additional borrowing for capital or legal settlements could pressure LADWP's credit."

LADWP has reported estimated physical damage of $93 million for the water system and $23 million for the power infrastructure, which Nuveen said is a small portion of overall operating expenditures. Most of the costs are expected to be Federal Emergency Management System-reimbursed and affected areas represent just 1.1% of water system customer accounts and 0.7% of power system customer accounts.

Moody's Ratings, KBRA and Fitch Ratings currently assign LADWP power revenue bonds the same rating they did before the Palisades Fire: Aa2 by Moody's, with a negative outlook assigned in January 2025 after the wildfire, AA by KBRA, and AA-minus by Fitch. The latter two assign stable outlooks. S&P Global Ratings rates the power revenue bonds A with a negative outlook, after a two-notch downgrade in the aftermath of the wildfire.

The water bond ratings, which had historically been rated a notch higher by the rating agencies, were lowered by all but Moody's in the fire's aftermath.

Fitch and KBRA both lowered the water revenue bond ratings a notch to AA-minus for Fitch and AA for KBRA after the fires. KBRA lifted its outlook to stable in May. Fitch revised the outlook to stable from negative in October. S&P lowered the rating two notches to AA-minus and assigns a negative outlook. Moody's maintained an Aa2 rating, but revised the outlook to negative, where it remains.