California's 'Regulatory Failure' Blamed for Wildfire Insurance Disaster

A few years after settling down with her husband in California's East Bay, Nancy Wallace narrowly escaped death when the devastating Oakland Hills firestorm of 1991 burned down her home and claimed the lives of 25 people.

"It was a shock, we really had no experience of this kind of loss, and certainly not wildfire at that level," Wallace, a professor of finance and real estate at UC Berkeley's Haas School of Business, told Newsweek.

At the time, the fire was considered the most destructive in the Golden State's history, having burned down an estimated 2,843 single-family dwellings and hundreds of apartments. More than three decades later, the devastation caused by the Oakland Hills firestorm pales compared to that brought about by the Los Angeles fires in January, with at least 12,000 homes, businesses and other structures estimated to have been destroyed.

For Wallace, devastating wildfires no longer come as a shock. "Once it happened [the Oakland Hills fire], we learned that actually the area where we lived had burned at least twice in the 10 years before that," she said. But while she has learned to expect wildfires, she thinks that the insurance crisis laid bare by the Los Angeles fires was created by a "regulatory failure" in California, rather than climate change alone.

The Insurance Crisis Weighing on California Homeowners

Devastating wildfires have become more frequent in California over the past decade, fueled by warmer temperatures and drier conditions caused by climate change.

In the face of the growing risk of paying out enormous claims, and unable to raise their premiums beyond what Golden State regulators find reasonable, several insurers have cut coverage across California, announcing non-renewals for thousands of policyholders in fire-prone areas. In Southern California, State Farms canceled thousands of policies just months before the fires ravaged entire neighborhoods in those same areas.

As insurers started fleeing, Golden State homeowners found themselves with limited options for coverage; California's FAIR Plan, which acts as an insurer of last resort providing fire coverage for those who can't find it on the traditional market, has ballooned in size, acquiring thousands of new policies.

But the coverage offered by the FAIR Plan is often more limited than the one found in the traditional market; many who lost their homes in the Los Angeles fires and were covered by the FAIR Plan won't receive enough money to rebuild their homes.

California regulators recently passed legislation forcing insurers to offer coverage in wildfire-prone areas, requiring that they write policies in those areas "equivalent to no less than 85 percent of their statewide market share." But the coverage won't increase immediately; companies are required to increase their coverage by 5 percent every two years.

California's Regulatory Failure

For Wallace, Proposition 103—legislation narrowly approved by California voters in 1988 that protects residents from insurance company abuses, requiring insurers to get the approval of the California Department of Insurance (CDI) for rate hikes—played a significant part in creating the current crisis.

Under Proposition 103, California regulators prevented insurance companies from using forward-looking estimates of risk when setting their rates.

"They allowed pricing based only on the 20-year backward-looking average experience of individual firms. So rate-setting, if you needed a rate increase, had to be based on a backward-looking average," Wallace explained. "And obviously looking back over 20 years and over your own portfolio, firm by firm, meant that you were not picking up on what is happening, the meteorological data showing that the maximum temperature is rising quite rapidly and increasing the risk."

Wallace says that having kept homeowners' insurance prices artificially low in California's fire country might have led to more people moving to those areas, exacerbating problems like narrow roads and dense development—which made the Los Angeles fires in January so destructive.

Research by Redfin found that more people moved into fire-prone areas of America in 2023 than out, with Riverside County seeing the largest net inflow of new residents, for a total of 7,807. An estimated 78.5 percent of homes in the county face a high fire risk.

As wildfires became more frequent and more severe in the past few years, California regulators realized that the backward-looking model was no longer assessing the risk faced by homeowners and property insurers correctly. In September 2023, "they began to acknowledge that their rules about pricing had to be changed," Wallace said.

"The [California's insurance] commissioner, under an executive order by the governor, was required to rethink their pricing in the face of the mounting evidence that was not consistent with anything modern science had to say," Wallace said. "So starting in 2023, there was a recognition that change had to happen, and that change was implemented on December 31, 2024."

At the end of last year, insurers were allowed to implement very significant premium hikes, "some of them between 28 percent and 32 percent, depending on the firm," Wallace said. The rate hikes will become evident to policyholders in spring, when the majority of policies are renewed.

"They also allowed the use of reinsurance rates as part of the rate structure, which it wasn't allowed as part of Proposition 103," Wallace added. Reinsurance is, essentially, insurance for insurers, and what many companies need after catastrophic events like wildfires. Experts previously told Newsweek that they expect reinsurance rates to soar in Southern California following the Los Angeles fires last month.

But Proposition 103, which does not allow actuarial models for pricing, has not been overturned, Wallace said. The biggest concern for Wallace and her colleagues is that many firms are not using the new models. "There's a lot of questions about the models themselves and the information that the firms will use to price the risk," she said.

How to Solve California's Insurance Crisis

Forecasting the potential losses caused by a wildfire, which is considered a very rare event, is a problem for insurers, Wallace said. "We just need all hands on deck, understanding how to properly model these phenomena, working between economists, meteorologists, ecologists—we need to have a broad-based strategy to develop these models. And that simply hasn't happened."

For Wallace, more should be done to make homes in California fire-resilient. "The housing stock in California is about on average 45 years old. Many homes have been built with less than perfect aerated rooms, that are less than fully fire-proof. Many homes have single-pane glass that does not radiate heat," she said. "These things cost money, they're very expensive. Everyone would be much happier if we provided resources—think of home improvement loans, or cap property taxes loans, whereby people can harden their homes. These risks cannot be borne just by insurance companies."

The Golden State government has to think of various ways of incentivizing people to harden their homes, Wallace said. "We are going to have fires, fires have always been part of California; but we need to protect people's properties from total losses," she added.

"I do think there is a doable solution, but it means being inventive in terms of having the banks understand that offering home improvement loans and hardening homes are good for them because it makes the houses safer. And after all, housing is the collateral on mortgages."

In Los Angeles County and especially in Altadena, where many homeowners who lost their homes are likely to be able to afford only a fraction of the cost of rebuilding their properties, the California government will have to find "some kind of policies to provide subsidies," Wallace said.

California regulators might have inadvertently played a role in creating the perfect insurance storm—but now they hold the key to resolving it, she said.