Los Angeles is experiencing one of the most destructive wildfire disasters in its history. Fires that erupted on 7 January have swept through communities including Pacific Palisades and Altadena, killing at least sixteen people by this weekend, destroying thousands of structures and forcing more than 100,000 residents to evacuate. The Palisades and Eaton fires alone have burned tens of thousands of acres, while strong Santa Ana winds, exceptionally dry vegetation and months with very little rainfall created conditions in which fires spread through densely populated neighbourhoods with extraordinary speed. The immediate priority is obviously containing the fires and protecting residents. But the economic significance extends far beyond Los Angeles. California is confronting a problem that more countries will eventually face as climate risks intensify: what happens to a market economy when assets remain physically valuable but the probability of their destruction becomes too high for private insurance to cover at politically acceptable prices?
Insurance is essentially a mechanism for pooling uncertain losses. A homeowner pays a relatively small known premium so an insurer assumes the risk of a much larger uncertain loss. This works when insurers can estimate probabilities reasonably well and when losses are sufficiently diversified. One house burns down while thousands do not, allowing premiums from the larger pool to finance the claim. Climate change complicates this model because risks become increasingly correlated. A wildfire does not destroy one randomly selected house. It can destroy an entire neighbourhood simultaneously. A hurricane damages thousands of properties at once. A flood affects everyone along the same river basin. The more correlated the losses become, the more capital insurers need to survive them.
This is why California’s insurance crisis began well before this week’s fires. Major insurers have reduced new coverage or withdrawn from parts of the state’s homeowners market, arguing that regulated premiums do not adequately reflect rising wildfire risk, rebuilding costs and reinsurance expenses. Homeowners unable to obtain ordinary coverage increasingly rely on California’s FAIR Plan, an insurer of last resort whose exposure has expanded dramatically. The system therefore faces a fundamental conflict between actuarial pricing and political affordability. If insurers charge premiums fully reflecting expected wildfire losses, insurance may become unaffordable for many households. If regulators hold premiums below expected risk, insurers eventually reduce supply because writing policies becomes unprofitable.
Neither side can solve the problem by pretending the other constraint does not exist. Insurance companies cannot sustainably sell a product whose expected payouts exceed premiums and investment returns. Governments cannot simply accept a market equilibrium in which millions of households cannot insure homes, because mortgages generally require insurance and housing is the principal asset held by many middle-class families. Climate risk therefore becomes a financial-stability issue.
Consider a simplified house worth $1 million. If the annual probability of catastrophic destruction were 0.1%, the expected annual loss from that risk would be roughly $1,000 before administrative costs and other hazards. If climate and local conditions raise the probability to 1%, the expected loss becomes $10,000. At 2%, it becomes $20,000. Nothing about the physical house changed. The economics changed because the probability distribution around it changed.
This is the crucial point: climate change can reduce asset values without physically destroying the asset. If insurance premiums rise substantially, future buyers are willing to pay less for the house because ownership carries higher annual costs. If insurance becomes unavailable entirely, mortgage financing becomes harder, reducing the pool of potential buyers further. Climate risk therefore becomes capitalised into property prices before the fire arrives.
This creates what could become a climate repricing problem across global property markets. Coastal homes exposed to sea-level rise, houses in floodplains and communities near wildfire zones may currently be valued partly according to historical risk that no longer describes future conditions. As insurers and lenders update their models, those assets can lose value gradually or suddenly.
The political difficulty is obvious.
Homeowners reasonably say: I bought this property under one set of assumptions. Why should my family’s largest asset collapse because insurers suddenly change their models?
Insurers respond: continuing to price according to yesterday’s climate does not make tomorrow’s losses disappear.
Governments then face pressure to socialise part of the risk.
California’s FAIR Plan already does this indirectly because private insurers participate in supporting the system if claims overwhelm its reserves. Federal disaster assistance creates another layer of public risk sharing. After catastrophes, governments provide emergency funds and reconstruction assistance because allowing entire communities to absorb losses individually would be socially and politically unacceptable.
The result is a moral-hazard problem. If households expect government eventually to absorb catastrophic losses, the market signal discouraging construction in high-risk areas becomes weaker. Developers continue building. Buyers continue purchasing. Local governments continue collecting property taxes. When disaster arrives, costs become national or statewide.
This does not mean disaster assistance should disappear. Refusing assistance after families lose everything would impose enormous human costs and would be politically unrealistic. The better question is how public policy can provide protection without continually subsidising additional exposure.
That requires separating existing risk from new risk.
Governments may reasonably help households already living in vulnerable areas adapt or relocate. They should be much more cautious about encouraging new construction where models show severe and increasing hazard.
Land-use policy therefore becomes climate policy.
Building codes become climate policy.
Electricity-grid maintenance becomes climate policy.
Vegetation management becomes climate policy.
Insurance regulation becomes climate policy.
The climate debate often focuses overwhelmingly on reducing emissions, but even extremely successful global mitigation cannot eliminate the warming and risk already embedded in the system. Governments therefore need adaptation policy alongside mitigation.
Los Angeles demonstrates how expensive delayed adaptation can become.
Homes can be constructed with more fire-resistant materials.
Vegetation can be managed around communities.
Electrical infrastructure can be hardened.
Emergency water systems can be improved.
Evacuation routes can be designed around realistic population density.
None eliminates wildfire.
Each changes the expected loss.
The economics of adaptation therefore resembles preventive healthcare. Spending before disaster appears expensive because the benefit is an event that does not occur. After disaster, the same expenditure appears obviously worthwhile.
This is the prevention paradox.
A government spends $5 billion strengthening infrastructure and nothing dramatic happens.
Voters see $5 billion spent.
A government does not spend it and later suffers $50 billion of destruction.
Everyone asks why preparation was inadequate.
Political incentives systematically favour visible recovery over invisible prevention.
Climate change makes that bias increasingly expensive.
The Los Angeles fires also demonstrate that climate risk cannot be reduced to climate change alone. Southern California has always experienced wildfire. Santa Ana winds existed before industrial warming. Housing expansion into fire-prone landscapes increases exposure independently of climate. Vegetation management and infrastructure matter. Ignition sources matter.
Climate change acts partly as a risk multiplier rather than a single cause.
Warmer conditions and altered precipitation can increase the probability that vegetation becomes dry enough to burn intensely. But whether that hazard becomes a billion-dollar disaster depends on how many people and assets are placed in its path.
This distinction between hazard and exposure is essential.
A fire in an uninhabited forest is an ecological event.
The same fire moving through thousands of expensive homes becomes an economic catastrophe.
Disaster risk therefore can increase even if the underlying natural hazard remains constant, simply because more valuable assets are exposed.
Los Angeles contains some of the world’s most expensive real estate, meaning insured losses could become enormous. Early estimates vary widely because the fires remain active and final damage is unknown. Any precise total this weekend should therefore be treated cautiously. What is already clear is that reconstruction costs will extend far beyond rebuilding individual houses.
Roads.
Schools.
Power lines.
Water systems.
Businesses.
Lost wages.
Temporary accommodation.
Health effects from smoke.
Local tax revenues.
Disasters produce second-round economic effects not captured by insured property losses.
This is why the headline insurance bill understates social cost.
A restaurant that survives physically can still fail because its customers evacuated.
A worker can lose income because their employer burned down.
A school closure forces parents to reduce working hours.
Smoke can increase hospital admissions.
Economic networks transmit physical destruction outward.
This is similar to what we saw with electricity failures in South Africa: infrastructure is valuable partly because other economic activity depends on it.
Housing reconstruction will create another distributional problem. Wealthier homeowners may possess savings, legal support and alternative accommodation allowing them to navigate insurance claims and rebuilding delays. Lower-income households and renters have fewer buffers.
Climate disasters therefore can increase inequality even when the physical hazard affects rich and poor neighbourhoods.
This is resilience inequality.
Two households can experience the same $100,000 loss.
For one, it represents an inconvenience.
For another, financial ruin.
Policy therefore should not evaluate vulnerability solely according to probability of exposure.
It should consider capacity to recover.
This is particularly relevant to Altadena, which contains a more economically and racially diverse population than some of the extremely wealthy coastal areas affected by the Palisades fire. Rebuilding can generate another risk: households unable to finance reconstruction sell damaged property, while wealthier investors purchase land. A disaster can therefore accelerate displacement and alter the social composition of communities.
Climate adaptation is consequently connected to housing affordability.
If rebuilding rules require expensive fire-resistant standards, future risk falls but construction costs rise.
If standards remain weak to preserve affordability, the rebuilt community remains vulnerable.
Again, policy confronts a trade-off rather than a perfect solution.
The economically sensible response is often to subsidise risk reduction rather than risk itself.
Instead of permanently subsidising below-market insurance premiums for highly vulnerable homes, governments can subsidise fire-resistant roofs, defensible space, community infrastructure and relocation where risk becomes extreme.
This changes incentives.
Public money reduces expected future losses rather than simply paying repeatedly after those losses occur.
Insurance pricing can reinforce this by offering lower premiums when households make verifiable improvements.
The challenge is measurement.
How much does one intervention reduce fire probability?
How should neighbourhood-level mitigation affect individual premiums?
What happens when one homeowner clears vegetation but their neighbour does not?
Wildfire creates local externalities because one property’s condition can affect another’s risk.
That means purely individual adaptation is insufficient.
Community-level planning is required.
The same applies internationally to climate policy.
Individual choices matter.
System design matters more.
Los Angeles therefore should not be interpreted simply as a warning that everyone needs better personal emergency preparation. It is evidence that urban planning, insurance markets, infrastructure and climate policy increasingly need to be designed together.
The insurance industry may actually become one of the most politically important climate institutions because it translates abstract climate models into prices households can see.
A scientific report saying wildfire risk increased 20% feels distant.
An insurance premium increasing from $3,000 to $8,000 does not.
Markets therefore can communicate climate risk faster than political systems.
But market signals can be socially brutal.
That is where government enters.
The objective should not be suppressing the signal entirely.
It should be helping households respond to it.
This distinction will become increasingly important far beyond California.
Florida faces rapidly rising hurricane-insurance costs.
European regions face flood risk.
South Asian cities face heat and extreme rainfall.
Coastal communities worldwide face sea-level rise.
The specific hazard changes.
The economic problem remains similar:
who owns an asset whose historical risk profile no longer describes its future?
There is no painless answer.
The homeowner did not create climate change individually.
The insurer cannot absorb unlimited losses.
The taxpayer cannot rationally guarantee every increasingly risky property forever.
The lender cannot ignore collateral risk.
Eventually some combination of higher premiums, adaptation, public subsidy and lower property values absorbs the cost.
Climate economics is therefore increasingly becoming distributional economics.
The physical damage is only the beginning.
The political conflict concerns who carries it.
Los Angeles is wealthy enough to rebuild.
That itself makes the case globally important.
If one of the richest metropolitan regions in the world struggles to make insurance markets function under increasing climate risk, much poorer cities will face even harder constraints.
Mumbai, Jakarta, Manila, Lagos and other large cities contain enormous populations exposed to flooding, heat or coastal risk while governments and households possess far less fiscal capacity per person.
Adaptation finance therefore cannot remain a secondary part of climate negotiations.
COP29’s argument over hundreds of billions in climate finance last November was partly about exactly this future.
The cost arrives whether governments finance prevention or reconstruction.
The only choice is when, how and by whom it is paid.
The fires burning across Los Angeles this week make that choice visible.
Climate change is often discussed as a problem measured in degrees Celsius by 2050.
For households, it will increasingly be measured in insurance premiums, mortgage availability, electricity bills, taxes and property values.
That is when climate politics becomes much harder.
People can disagree abstractly about climate models.
They cannot easily ignore a letter saying their home is no longer insurable.
The next phase of climate policy will therefore not be fought only over emissions targets.
It will be fought over balance sheets.
And the central question will increasingly be the one California is confronting now:
when yesterday’s safe asset becomes tomorrow’s climate risk, who absorbs the difference?
