Building in Harm’s Way: How Institutional Distortions Shape Wildfire Risk in San Diego
Ospital: "Housing Supply, Property Insurance, and Exposure to Wildfire Risk" CRC Discussion Paper No. 571
In the past two decades, nearly half of all new residential construction in the United States occurred in areas exposed to natural hazards. In his recent research, Augusto Ospital (LMU Munich, Project B10) examines why development continues to occur in harm’s way, focusing on wildfire risk exposure in the San Diego metropolitan area. He argues that two interacting institutional distortions shape this geography: regulated property insurance pricing and stringent land-use constraints.
The first distortion involves a regulated insurance schedule in California that has compressed premiums relative to actual wildfire risk. Ospital’s empirical estimates reveal that wildfire risk is significantly underpriced; premiums are 10.5% below actuarially fair levels and 24.1% below a standard benchmark that includes an 18% risk load. This creates systemic cross-subsidization, in which policyholders in low-risk areas pay premiums that exceed their expected losses to cover the shortfall in high-risk zones.
The second distortion is the prevalence of building restrictions in safer, high-amenity central neighborhoods. These areas are frequently close to their regulatory “build-out” capacity, whereas the fire-prone urban periphery retains ample spare capacity for new development. Consequently, the steepness of housing supply (captured by markup elasticities) is much higher in safer areas, ranging from 1.2 to 1.5, than in the riskiest zones, where elasticities fall below 0.2.
Using a quantitative spatial equilibrium model estimated with granular spatial data, the study estimates the total present-value welfare cost of wildfire risk in San Diego at $17.5 billion. The incidence of this cost is notably unequal: while renters bear a burden of $15.5 billion and owners of land at risk bear a burden of $8.3 billion, owners of safe land experience a $6.3 billion offsetting gain through equilibrium scarcity effects.
Counterfactual simulations suggest that reforming these distortions yields significant distributional shifts. Implementing risk-based insurance pricing (setting premiums to reflect expected losses plus a risk load) would reduce the population in the riskiest areas but increase the welfare cost borne by renters by $359 million due to higher average rents in the city. Conversely, targeted up-zoning within half a mile of major transit stops reduces the welfare cost borne by renters by $475 million by shifting development toward the safer urban core.
Crucially, the research demonstrates that targeted housing supply reform can attenuate the burden that risk-based insurance pricing places on renters. This is especially relevant as moving toward more risk-based pricing is a central component of California’s recently implemented Sustainable Insurance Strategy. Ultimately, these results highlight that the spatial distribution of climate risk is a product of interacting urban institutions that direct development toward the hazardous urban fringe.
Link: Housing Supply, Property Insurance, and Exposure to Wildfire Risk
