The horrific wildfires that devastated the Los Angeles area—and necessitated a $1 billion bailout of the FAIR Plan, California’s insurer of last resort—have many people asking why so few homeowners harden their homes against wildfires.

Home hardening is how homeowners reduce their wildfire risk by retrofitting their homes with fire-resistant materials and removing excess vegetation. A report by Guidewire analyzed data from over 90,000 California homes and found that home hardening consistently reduced wildfire risk, in terms of likelihood and damage severity.

The wildland-urban interface is where human development and nature collide, leading to greater wildfire risk. From 1985 to 2013, around 80% of the buildings destroyed by wildfires in California were located in this interface. The areas ravaged by the Los Angeles County wildfires—Altadena, Malibu and Pacific Palisades—are all part of this zone. Yet despite the risks involved with living in these areas, it appears that few homes there were fire-resistant. Meanwhile, fire-resistant architecture and defensible open space appear to have saved some of the homes that were not destroyed.

Why aren’t more homeowners taking steps to reduce their wildfire risk? The answer involves California’s broken property insurance market.

In 2022, California Insurance Commissioner Ricardo Lara mandated that insurers provide discounts to policyholders who implement specific wildfire mitigation efforts on their properties, including fire-resistant vents and Class-A fire-rated roofs. Discounts vary by insurer and are itemized in companies’ rate filings. State Farm policyholders, for example, who adopt all 12 mitigation steps and get certified by a nonprofit can receive premium discounts of about 10%.

According to a recent Politico report, however, experts conclude that the discounts are “too small to encourage wildfire mitigation.” The State Farm discount for fire-resistant windows for example, which can cost more than $700 per window, amounts to 0.1% or a $14 discount on a $13,800 annual insurance premium. Few policyholders will be moved by such small discounts to adopt expensive upgrades.

So why don’t insurers just offer larger discounts to improve outcomes? California’s broken insurance market disincentivizes insurers from doing so—because insurance rates are not actuarially sound.

To understand why that is, you need to understand the concept of “regulatory rate suppression”—which is the difference between market rates that allow insurers to cover expected costs and rates that are approved by regulators.

Research from the International Center for Law & Economics found that California is the worst in the nation for both home and auto insurance rate suppression. Even though California is an expensive and disaster-prone state, the average cost of homeowners insurance, $1,250 per year, is well below the national average of $1,915. While this sounds like a boon to consumers, in practice, insurance companies operating in California are overexposed to risk. They respond by charging homeowners who undertake fire-risk mitigation efforts more than they should to make up the difference. So-called “premium revenue” from armored homes is precious to insurers in California.

The discrepancy between what risky homes should pay compared to what they do pay is the result of Proposition 103 and the state’s regulatory system, which requires insurance companies to receive approval from the California insurance commissioner before changing rates on property and casualty insurance policies. Under this system, companies are limited by price controls and by the variables they are allowed to factor into insurance rates, such as previous prohibitions on using catastrophe models and pricing reinsurance costs into rates. The system is notoriously inefficient, taking months on average to reach a decision for rate filings and even longer if applications are moved to a rate hearing.

Even the FAIR Plan, California’s “insurer of last resort,” which had its reserves decimated by the Los Angeles area fires, has fallen victim to the state’s regulatory hurdles. According to Victoria Roach, president of the FAIR Plan, in 2021 the plan had a “rate need” of 70% but instead applied for a 48.8% rate increase; only a 15.7% increase was approved.