Photo by Karsten Gohm on Unsplash

It’s time to turn our attention to property and casualty insurance in our overview of insurance and its regulation in California. This will be a fertile area for many future in-depth posts! This post lays the groundwork by reviewing some basic concepts.

The many different types of insurance are generally categorized into two1 major groupings: (1) life and health; (2) property and casualty (often abbreviated “P&C”). Although life and health insurance are conceptually related in both addressing personal risks, they have very different economic and regulatory characteristics. By contrast, property insurance and casualty insurance are fundamentally united.

Property insurance provides financial protection against damage to or loss of real property. Casualty (or liability) insurance provides financial protection for legal liability arising from unintentional wrongful acts that harm someone’s person or property. These coverages often need to be combined to offer complete protection in the relevant domain.

We can see how tightly linked property insurance and casualty insurance are by reflecting on what an auto insurance policy or a homeowners insurance policy covers.

• Your auto insurance policy insures you against damage to your vehicle, and against injury or damage you cause with your vehicle (for which you may be liable)

• Your homeowners insurance policy insures against damage to your home, and against injury that someone suffers at your home (for which you may be liable)

It would make no sense to buy, for example, an auto insurance policy that only covered damage to your vehicle but did not cover you for damage you could cause others. Similar considerations hold across most lines of P&C, which is why property insurance and casualty (liability) insurance are so tightly bound together.

P&C insurance is roughly evenly split between “personal lines,” which covers individuals, and “commercial lines,” which cover businesses. P&C direct written premiums in the United States were $1.06 trillion in 2024, and P&C direct written premiums in California in 2024 were roughly 10% of this at $106 billion2. The pie chart below shows the breakout of major types of P&C Insurance in the United States.

Personal lines are dominated by private auto and homeowners insurance. (Farmowners insurance is a tiny sliver of the “Homeowners & Farmowners” slice in the pie chart.) Commercial lines, on the other hand, cover a wide range of risks. Thus in practice, consumers think of P&C primarily as auto and home insurance, while business owners and managers think of P&C as a myriad of different lines.

P&C Insurance Regulation in California

California’s regulatory system for P&C was established by the passage of Proposition 103 in 1988.

The regulation of P&C insurance varies significantly from state to state. One key dimension of this variation is the way insurance rates and products are reviewed and approved. The systems used by states regarding pricing generally fall into the following categories3, ordered from most to least strict.

• Prior Approval: Rates must be filed with the state, which the department of insurance must approve before they can be used.

• Modified Prior Approval: Rate revisions based only on experience are subject to the “file and use” system, but revisions based on more fundamental factors are subject to prior approval.

• Flex Rating: Rate revisions within a given band are subject to the “file and use” system, but rate revisions outside that band require prior approval.

• File and Use: Rates must be filed with the state and then can be used immediately or after a short waiting period; the department of insurance retains authority to disapprove the rate later.

• Use and File: Insurers can change rates before filing, but must then file the new rate within some time period; the department of insurance may then later disapprove and require refunds or adjustments.

• No File/Open Competition: Insurers can change rates and do not need to formally file, but must keep records available upon request for review and potential remedial action.

Prior to 1988, California operated under a form of open competition established by the McBride-Grunsky Insurance Regulatory Act (“McBride Act”) of 1947. Rate manuals had to be filed, but prices were controlled primarily through competition rather than regulatory review and approval.

During the 1980s, California suffered a sustained period of rapidly rising auto insurance rates. The root cause appears to have been a 1979 decision by the California Supreme Court: Royal Globe Insurance Company vs. Superior Court, which allowed third parties to sue the insurer of a tortfeasor4, even if the third party was not party to the insurance contract in question. Insurance-related litigation dramatically increased, with the number of auto-liability claim filings in Superior Court increasing 82% between 1980 and 1987, and the severity of claims rising fourfold. Auto insurance premiums rose 70% between 1984 and 19875.

According to an analysis published in 1999, insurance companies operating in California during this time were not making abnormal profits and the rising insurance rates appear to have been largely in line with rising costs6. Nevertheless, people were understandably furious. There were five competing ballot measures in 1988 and almost a hundred million dollars spent, all with different ideas for how to reform insurance regulation. In the end, only Proposition 103 passed by the thin margin of 51.2% in favor vs. 48.8% against.

Ironically, less than three months before Proposition 103 passed, the Royal Globe case was overruled in 1988 by Moradi-Shalal vs. Fireman’s Fund Insurance Companies, which reversed the 1979 expansion of liability. Nevertheless, Proposition 103 became the law of the land and it completely revolutionized the way P&C insurance has been regulated in California ever since.

The organization that led the campaign for Proposition 103 is Consumer Watchdog, who maintains the text of the proposition here with annotations for which provisions have been upheld, struck down, or amended since. Some of the key surviving provisions include the following:

• The Insurance Commissioner became an elected role. (Prior to 1988, California had appointed the Insurance Commissioner, as most states still do.)

• California replaced its Open Competition system with a Prior Approval rate review system, with the Insurance Commissioner having the ultimate authority to deny or approve any rate.

• California created a consumer intervenor system that is unique to California

  • A public hearing may be requested for any rate increase

  • A public hearing is mandatory for any rate increase for personal lines of 7% or more, and for any rate increase for commercial lines of 15% or more.

  • A member of the public that meets certain criteria can participate in the hearing as an intervenor; an intervenor that makes a “substantial contribution” to the rate review can recover costs, expenses and attorney’s fees from insurers. (The insurers may then pass those costs on to consumers.)

  • The California Department of Insurance (CDI) maintains a record of total compensation awarded to intervenors from 2013-20267.

• A specific rate-setting formula for auto insurance was established, requiring that rates be based in descending order by the following criteria: (1) the insured’s driving record; (2) the number of miles driven by the insured; (3) the number of years of driving experience; (4) other factors as allowed by the Insurance Commissioner.

• A “good driver discount” of at least 20% must be offered to auto insurance customers who meet certain criteria.

• Any P&C insurance rate should only be approved by the Insurance Commissioner if such rate is neither “excessive,” “inadequate” nor “unfairly discriminatory”.

• The business of insurance was deemed subject to California’s state-specific antitrust, unfair business practices, and civil-rights law. (The McBride Act had previously exempted insurance from these laws.)

• The California Legislature shall only pass laws that “further the purpose” of Proposition 103.

Just as significant as the actual text of Proposition 103 are both the body of implementing regulation written to implement it, and the way in which the regulations have been executed.

For example, insurance companies until recently were prohibited from using forward-looking models to predict the risk of wildfire in justifying any rates filed with the CDI for approval. This prohibition was a key reason many insurance companies decided after the wildfires of 2017-2018 that they could not profitably write homeowners insurance in California.

But the text of Proposition 103 says nothing about wildfires!

Instead, what happened is the CDI wrote a long, complicated set of regulations to implement Proposition 103. Included in those regulations are the rules for how to calculate an allowable rate of return for any given rate filing. Those rules required wildfire risk to be calculated using historical data rather than forward-looking models. The regulations were finally changed last year to allow wildfire risk to be estimated prospectively rather than retrospectively. Partly as a result of this change, more insurance companies are starting to submit rate filings to offer home insurance.

If the regulations were changed last year, why is it taking so long for insurance companies to return? Well, that brings us to an example of our second point about how the impact of Proposition 103 goes far beyond the actual text: it’s not just the regulations that are written to implement it, it’s how those regulations are carried out.

Having an onerous prior approval regime obviously creates the potential for substantial delay. Proposition 103 includes language intended to ensure that most rate filings would be approved within a reasonable timeframe. Nevertheless, over the years California has become extremely slow in approving rates8. Most states generally approve P&C rates within three months. Florida, Hawaii and New Jersey generally take between 100-200 days. California is one of only two states in America where the median time to approve rates is over 300 days. (That means half of the fillings take longer than 300 days to approve!)

There is much, much more to say about Proposition 103 and its consequences. The main thing to take away from this brief review is that Proposition 103 completely changed the regulation of P&C insurance in California. It replaced a relatively simple (perhaps overly so) system with one that is much more complicated and intricate.

Photo by Dominik Lange on Unsplash

In the last post, we reviewed the dysfunctional state of how long-term care (LTC) is provided in the United States. To recapitulate the key points:

• LTC is a critical and expensive need for many people in their last years of life

• Due to demographic aging, the need for LTC will grow across all rich countries, including the US

• There is an important role for the government to play in providing LTC

• The logical way for the government to provide LTC in the US would be through Medicare

• Instead, the predominant way the government provides LTC in the US is through Medicaid

• Medicaid requires many recipients to spend down their savings to be reimbursed for LTC care

• The US has repeatedly tried and failed to fix this situation over the last four decades

• The problem will likely not be solved at the state level — California tried recently by dramatically expanding Medi-Cal, but then retreated due to budget constraints

As we turn our attention to the regulation of the private LTC insurance market, the above context helps explain both why the private LTC insurance market became dysfunctional, and why state regulators have been slow to address the problems with private LTC insurance — and unfortunately, particularly slow in California.

Private insurers started offering LTC insurance in the United States in the 1970s. California adopted regulation to allow the sale of LTC insurance in California in 1990 (as codified in INS 10235.16). Sales grew rapidly throughout the subsequent decade before dropping sharply in the early 2000s, as shown in the chart below1.

A key milestone occurred in 1996 when President Clinton signed into law the Health Insurance Portability and Accountability Act (HIPAA). Recall from the last post that one element of the failed Clinton healthcare plan had been an attempt to include a national LTC program. In the wake of that failure, HIPAA facilitated access to the private LTC insurance market by providing favorable federal income tax treatment to holders of qualified LTC Insurance policies. Critically, a key component of what made an LTC insurance policy “qualified” was it could not have a cash surrender value. A “surrender value” means if you stop paying premiums — i.e. you allow the policy to “lapse” — you receive a cash value back in return. The lack of a surrender value for qualified LTC insurance policies means that customers lose all benefits and receive no cash back if they lapse2.

The lack of LTC insurance surrender value is a critical component to elaborate upon.

Typically, an insurance policy provides protection for each year premiums are paid. A term life insurance policy, for example, protects against the peril of early death in each year it is in force. Similarly, a home insurance policy protects against various perils to a house (fire, wind, etc.) in each year it is in force. If you allow the policy to lapse at some point, you still received the benefit of insurance protection for each year you paid premiums (even if in fact nothing bad happened).

A cash value life insurance policy is somewhat different: it has a term life insurance component, but it also has a savings component. A large part of the premiums paid into a cash value life insurance policy are invested on your behalf. Some kind of surrender value is therefore necessary to reflect the value accrued from those investments. The details are complex, and (as explained in a prior post) the surrender value may not fully make the customer whole for lapsing, but still there is generally some meaningful surrender value.

LTC insurance is different from both of these cases. It does not have a savings component like a cash value life insurance policy. But it also does not really provide protection for each year you pay into it, because the risk of needing LTC in the early years is so small. It is an unusual insurance product where you pay many years in advance of the need for protection. This enormous gap between when premiums are paid and when protection is needed creates substantial risk for mispricing, which was magnified in the early years when LTC insurance was new and insurers lacked underwriting experience.

To protect consumers, LTC insurance was designed to be “guaranteed renewal,” which means the premiums are generally designed to remain the same each year, and the policy cannot be canceled. To further protect consumers, all premium levels, both for new and for renewing customers, must be approved by the Department of Insurance and must be actuarially justified.

In hindsight, we can see that it was not smart for states to allow the market to develop the way they did. Both insurers and regulators were bound to get the pricing wrong given high complexity and lack of experience data. If the product was too expensive, consumers would be angry at having paid too much; if the product was too cheap, insurance companies would need to increase rates, imposing an unfair hardship on consumers.

The product was too cheap, big time. Insurers (and regulators) made plenty of mistakes: overestimating how many customers would lapse, underestimating how long customers would live and how great their need would be in old age, and overestimating how high interest rates would be3. Insurance companies lost billions of dollars on LTC insurance.

By the early 2010s, it was clear LTC insurance premiums would have to go up, and state regulators have faced a brutal dilemma ever since. If rates go up too far and too fast, there is a clear hardship and injustice imposed on customers. If rates are kept below an actuarially appropriate level, the market cannot function, severely reducing availability, competition, and innovation; in the worst case scenario insurers could fail, imposing even more harm on consumers.

Over the past fifteen years, states have worked together through the National Association of Insurance Commissioners (NAIC) to address this problem. The NAIC has developed and updated a Long-Term Care Insurance Multistate Rate Review Framework to streamline and harmonize LTC insurance rate review. Principles have been developed to balance the need to stabilize insurance companies with the need to protect consumers and make insurance companies bear appropriate responsibility for their pricing mistakes.

Approving rate increases under such circumstances is deeply unpleasant. And the temptation is always strong to delay doing unpleasant things. The data show that California has delayed more than most other states. California takes longer than most other states to approve LTC rate increases, and it is stingier than most other states in the rates it approves4.

The scatter plot shows, for each of the 50 states (plus DC and Puerto Rico), the average number of months to approve an insurance rate filing for LTC, and the ratio of the average requested rate approved. California is in the lower right quadrant showing very long approval time and very low ratio of approved to requested rates. In addition, the lower two boxes provide some additional information:

• The lower left hand corner box shows summary data across all states:

  • The average # months to approve is 8.1, with standard deviation of 5.3 months

  • The average amount of rate approved is 66%, with standard deviation of 21%

• The lower right-hand box highlights the data for CA and NY:

  • The average # months to approve is 17, which is nearly 2 standard deviations above the mean

  • The average amount of rate approved is 44-47%, which is 1 standard deviation below the mean

Interestingly, California looks almost identical to New York State in this data, which is notable because in 2023 Adrienne Harris, who was then the chief insurance regulator for New York state, wrote (or at least authorized) a remarkable report called: Long Term Care Insurance: Looking Back and Thinking Ahead. It is forthright, unsparing, and insightful. After providing a clear-eyed analysis of the problem, it provides a summary paragraph worth quoting in full5:

With the benefit of hindsight and acknowledging the factors that make pricing LTC insurance so difficult, the Insurance Department’s (and later DFS’s) approach may have been too conservative, and premium rate increases in many cases could have been granted sooner and in larger amounts in order to better stabilize the market as a whole and to flatten out eventual rate increases for consumers. As vital as it is to protect consumers from burdensome rate increases whenever possible, the Insurance Department and DFS probably could have confronted sooner the insurers’ initial mispricing through earlier (and larger) rate increases to better safeguard the sustainability of the LTC insurance market as a whole. In this troubled insurance market, it is fair to ask whether earlier rate increases, though no doubt painful to consumers, might have led to less consumer burden in the long run by reducing the need for later, even larger, rate increases; by keeping more insurers in the LTC insurance market6, thereby increasing competition and consumer choice; and by shoring up LTC insurers that could otherwise suffer from financial distress that could threaten consumer benefits.

The report concludes with several steps the department had (as of mid-2023) taken in order to protect LTC insurance company solvency and ensure premiums reflect economic reality so that LTC insurers can remain in the market, while also taking steps to mitigate the impact of rate increases on older and more vulnerable consumers7. Time will tell how well New York’s reforms work.

I have not found any comparable self-reflection by the California Department of Insurance.

What I have found is a recent report by R.J. Lehmann and Ian Adams from the International Center for Law & Economics, From Friction to Function: Reforming California’s Long-Term Care Insurance System. The authors draw on different data to show the same pattern of slow rate approvals with inadequate rate increases. They find no evidence that California’s lengthy delays are protecting consumers, whereas the resulting damage8 to the LTC insurance market has been harmful to consumers. Among their recommendations for reform are establishing timeline accountability and escalation (to speed up decisions), consolidating review authority for hybrid products (to foster product innovation), and adopting certain best practices from the NAIC and other multi-state joint projects.

There are limits to what the private LTC insurance market can do for consumers. Ultimately, the federal government desperately needs to find a better way to provide a baseline level of LTC, which hopefully one day means moving LTC out of Medicaid and into Medicare9.

Nevertheless, the private LTC insurance market has a role to play. With the benefit of four decades of painful experience, products and pricing have improved. Many state regulators have spent over fifteen years figuring out the best ways to make the painful compromises needed to move forward. It is time for California to do the same.

Photo by Annabel Podevyn on Unsplash

In order to appreciate the issues with how private long-term care (LTC) insurers are regulated, we first must have a broader context of LTC in America. This post provides that broader context; the next post will drill into the problems of regulating LTC insurance in California.

Across the world, the need for LTC services is growing with demographic aging. Although the population of the United States (shown below as a solid black line) is generally younger than other countries, the general trend is the same and the overall level is broadly similar to other rich countries. (Source: Long-Term Care Around the World, edited by Jonathan Gruber and Kathleen McGarry.)

LTC services are expensive and needed near end of life, when people are vulnerable and must rely on savings rather than earnings. The amount of LTC services one will need varies widely and is impossible to predict before old age. This creates a role for the government to aggregate and mediate savings across the population, and so the government plays a large part in funding LTC services in all rich-world countries.

How does the US fare at funding the LTC needs of our population? The answer is we are somewhat stingy in how much care we provide, and utterly dysfunctional in how we provide it.

Comparing LTC spending between countries is complex. Funding can be public or private. Care can be provided institutionally (e.g. in a nursing home), professionally at home (e.g. by home health aids), or informally at home (e.g. by a spouse or an adult child). Informal home care is not free: the cost is foregone wages (i.e. the person could be working elsewhere). And a truly apples-to-apples comparison between countries requires adjusting both for the size of the economy and the age of the population.

The chart below shows the output of this analysis by healthcare economists Jonathan Gruber and Kathleen McGarry (again from Long-Term Care Around the World).

The bars show the age-adjusted share of GDP spent on LTC services for each country, with the US #5 from the right. At 2.1% the US is relatively stingy, and as the world’s richest major economy, we could certainly afford to spend a larger share of our GDP. But the age-adjusted total amount we spend on LTC is not crazy low.

No, what is crazy is how that spending is provided. Most countries provide LTC services as a normal part of healthcare. But in America, many people are literally driven into financial distress before they can access government-funded LTC care. That is because Medicaid, the program designed to provide medical care to the poor, is how the government pays for LTC services, and Medicaid requires people to spend down nearly all their assets before it will provide LTC services1.

Medicaid pays for over 60% of all LTC services in the United States. More than 4 in 5 middle-class people 65 or older who need LTC for five years or more will eventually enroll in Medicaid. And nobody is happy with how Medicaid delivers LTC services. We have bolted LTC services for ordinary people in old age onto a program designed to help the indigent. It’s madness.

Contrary to what many people believe, Medicare does not pay for LTC services, even though this would clearly be the more logical way for the government to provide it2. Why is this the case?

When Medicare was originally developed in 1965, it was designed for discrete, medical episodes such as might require hospitalization. Medicaid, meanwhile, supplemented existing public assistance programs that were already paying nursing homes and similar providers for people who had exhausted their income. It was easier to expand Medicaid to meet the growing LTC need than to create a new benefit within Medicare.

The need to restructure how LTC services are provided has been recognized for decades, but our politics have repeatedly fallen short. I prompted ChatGPT to provide the following table to summarize how the federal government has repeatedly tried and failed to fix the way it provides LTC services3.

Because the federal government attempts at reform have repeatedly failed, state governments have started trying to fill the gap.

The most ambitious attempt is Washington state, which after many years of development and planning has just begun (as of July 1) to operate the nation’s first state-operated dedicated program for LTC insurance.

The Washington state program took over a decade to stand up and had to solve several daunting problems along the way to initial implementation:

• What about people who already have LTC coverage? A workable mechanism had to be developed to take account of people with private coverage who would be incensed at paying taxes to cover a risk they had paid to cover for themselves.

• Who qualifies as a caregiver? SEIU, the powerful union that represents professional caregivers, advocated for higher wages on behalf of their members. AARP, the powerful interest group representing older people, advocated for lower costs on behalf of their beneficiaries.

• How to handle people who move? Restricting benefits to Washington residents would make the program cheaper and easier to administer without the need to ensure Washington’s program is followed in all other states and territories, but it also was a political nonstarter. The program is therefore designed to be portable.

It is also critical to note that the Washington state program is relatively modest, providing only $36,500 of lifetime benefits in 2026 dollars. The modest size was necessary to make it affordable at tax levels Washington residents would accept. (And perhaps also to reduce the risk of fraud from residents of outside states trying to move to Washington to earn generous benefits without having paid into the program.) Since the average person turning 65 today will need $138,000 in LTC benefits — with some people needing far more — it’s clear the Washington program is only filling a small portion of the need.

California also took some steps in recent years to expand coverage for LTC services, but we then largely retraced those steps when realizing we had taken a leap too far and were at risk of breaking our budget.

In 2019, a Long Term Care Insurance Task Force was established in the California Department of Insurance (CDI) to explore developing a statewide LTC insurance program. The Task Force published a Feasibility Report in 2022 and an Actuarial Report in 2023. To date, no legislation based on these reports has been enacted, and the Task Force was disbanded in 2024.

Instead, California aggressively expanded Medi-Cal (California’s version of Medicaid) to eliminate the asset test altogether for LTC services, before quickly reinstating the asset test. A brief timeline of events:

• Before 2022 (and going back decades), Medi-Cal required applicants for LTC services to have assets under $2,000 for an individual or $3,000 for a couple, excluding certain exempt assets like a primary residence or a vehicle

• With the passage of AB 133 in 2021, a two-phase process began to lift this asset test

  • Phase 1 (July 1, 2022) increased the asset limit from $2,000 to $130,000

  • Phase 2 (January 1, 2024) removed the asset limit entirely

• In the budget passed in 2025, the asset limit returned (starting January 1, 2026) at $130,000 for individuals, with each additional household member adding $65,000.

• In the budget that has just been passed in 2026, the individual asset limit was dropped from $130,000 to $21,000, with the limit for couples dropped from $195,000 to $31,000.

And so California’s brief, radical experiment with providing LTC services to everyone via Medi-Cal has largely been walked back for now.

What about private LTC care insurance? If reforming how the government provides LTC is so challenging, can private life insurance companies meet the need?

The next post will cover the travails of private LTC insurance and the associated regulatory challenges.

One of the most important and difficult financial problems many people face is saving adequately for retirement and old age. Many people do not have access to either a pension or a sufficiently generous (or any) employer sponsored 401(k) retirement account. While individual retirement accounts (IRAs) are available to all, they have fairly low yearly contribution limits, and people often find it hard to consistently put money aside and invest it appropriately on their own.

Cash value life insurance and annuities offer a solution. They offer a myriad of investment options that are managed for you, they have potential tax benefits, and they can accept unlimited contribution amounts. As a bonus, these are often bundled with a term life insurance product to protect dependents such as a spouse or children from the loss of income that would result from an untimely death.

However, these products are very complex, and the purchase decision is often emotional. Most people have a hard time figuring out which life insurance or annuity products (if any) would be best for them. As a result, the purchase generally requires a consultative sales process by agents.

Commissions paid to life insurance agents typically have a high commission for the sale (sometimes 100% of the first-year premium) and low commissions for renewals1. The rationale is that the sale is the hard part, whereas once the policy is sold it is designed to last for decades. Life insurance companies want to pay agents only for the true value-add.

So we have a complex product, an emotional purchase decision, and a commission structure where the agent is paid to close the sale regardless of what happens afterwards. That combination creates a clear risk that consumers may get sold products that are not in their best interest.

This is not a new concern. Uncovered, Katherine Hempstead’s magnificent history of insurance in America, describes the ambivalence people had towards life insurance companies all the way back in the 1800’s. On the one hand, life insurance was becoming increasingly necessary as a way to establish savings and manage the risk of early death. But consumers also had a number of frustrations with life insurance, including bad behavior by sales agents, which was abetted by the front-loaded commission system2.

There is a long history over the last century and a half of regulating sales practices of life insurance. Products have evolved and circumstances have changed. It is not enough just to note that the risk to consumers exists; this is well known. The question is whether consumers are being harmed and outcomes can be improved.

I am concerned that there is evidence consumers are being harmed. The key issue is what the Life Insurance Consumer Advocacy Center (LICAC) calls, “the lapse problem.”

When a customer lapses, they stop making payments and allow the policy to expire. With term life insurance this is perfectly normal. Term life is pure insurance purchased on a periodic basis, and if the customer decides they no longer need the insurance, they may simply allow it to terminate.

Allowing cash value life insurance to lapse is different. There is often a loss of value, either because there are “surrender charges,” (not all the cash value can be recouped) or because there are tax consequences. Some lapsing for cash value life insurance is to be expected, of course. But if customers lapse to a large degree, it suggests that too many of them may have been sold a product that did not meet their needs.

Analysis by Daniel Gottlieb (professor at USC Marshall School of Business) and Kent Smetters (professor at UPenn Wharton) suggests that customer lapse rates are indeed very high. Their paper, Lapse-Based Insurance, was initially published in 2016; a later version was published in 2021. They report data from multiple sources indicating evidence of very high lapse rates. For example:

• For life insurance policyholders that are expected to last until death:

  • 25% of policyholders lapse within three years

  • 40% of policyholders lapse within ten years

• For universal life policies (which generally have a substantial cash value that needs to last until death to be realized)

  • 88% of universal life policies do not terminate with a death benefit claim

  • 76% of universal life policies sold to seniors at age 65 never pay a claim

What is even more concerning is Gottlieb’s and Smetters’ claim that life insurance companies actually make more money from customers who lapse than from those who do not! Here is what they say:

As we show, life insurance companies make positive earnings on clients who lapse and negative earnings on those who keep their policies. However, insurers do not seem to make extraordinary profits. Rather, policyholders who lapse cross-subsidize those who do not. Making a profit from policies that lapse is a taboo topic in the life insurance industry. As one of their main trade groups recently put it, “[t]he life insurance business vigorously seeks to minimize the lapsing of policies” (ACLI 2017: 64). Still, as we show herein, insurers seem to compete on this margin. This result is the opposite of the conventional (“rational”) view that insurers use front loads to reduce lapses. [Emphasis added]

A “front load” requires larger upfront funding of investment value. In theory, if life insurance companies make money from customers who persist – i.e. if life insurers want to minimize lapsing of cash value life insurance policies – then they should compete to find the optimal way to structure the front load to select for customers who are most likely to persist indefinitely.

The Gottlieb and Smetters analysis says it’s the other way around: life insurers compete to find customers who will persist long enough to be profitable, but not for too long – because customers who persist indefinitely end up being a net loss for the life insurer. If this is true, it suggests the life insurance industry has settled into a perverse equilibrium. The problem is not that they are making abnormal profits; the problem is they are profiting from designing their product and sales to attract customers who are less likely to get the benefit they need from their life insurance.

I must stress that I do not know whether Gottlieb and Smetters are correct. What I do believe is we should take their work seriously and investigate further. The California Department of Insurance (CDI) has the data, the resources, and the authority to study the situation in California and issue an authoritative analysis. They should do so.

I know that, “we need to do a study” is not exactly a call to arms, and sometimes can be used as a way to delay until people become distracted. But in this case, we really do need to do more analysis – and anyway, this is not an issue people are focused on3. No urgency will be lost by taking the time to do this analysis, and if the analysis is done well then much could be gained.

Meanwhile, is there anything that should be done to enhance consumer protection?

LICAC advocates that life insurance agents who sell cash value life insurance should be held to a fiduciary duty. Specifically, this means the agent would need to sell only policies that are suitable to and in the best interests of the consumer. New York implemented a suitability and best interest requirement regulation for all life insurance and annuities in 2018. The industry immediately sued to block its implementation. In 2021 the regulation was struck down, but that decision was reversed in 2022 and the regulation now stands.

The CDI tried to get something similar passed in the California state legislature4 in 2024, but the legislation that made it out of committee was watered down. This led to a bizarre situation where the coalition of consumer advocacy groups that had previously supported the bill ended up arguing that it should be defeated. They lost, and the bill (SB 263 in 2024) that passed lacked the key “suitability and best interest” requirement for life insurance.

Here again, I think we need to do a study.

Just because the industry opposes a law designed to protect consumers does not mean the law would actually provide the desired protection. Customers may not benefit and could even be harmed if it deters consumers from getting insurance they should have. Fortunately, New York state is doing the experiment for us. CDI should analyze the New York experience to determine what lessons we can take.

Life insurance can be extremely valuable in the proper circumstances. For roughly two hundred years, the challenge has been figuring out how to make sure the right products are sold to the right customers. Smart regulation grounded in solid analysis could help us meet that challenge.

In the discussion about insurance regulation, the focus generally is on how insurance companies treat their customers, and whether the marketplace works to the benefit of consumers. Key topics include affordability, availability, marketing tactics, coverage terms, and claims behavior. It is natural for the general public to focus on these things: they are all very important, and they are how most people interact with insurance companies.

But there is another component of insurance regulation that is just as important: the balance sheet.

Insurance companies are paid cash to make promises. The cash they are paid is invested and posted on the asset side of the balance sheet; the promises they make are recorded and posted on the liability side of the balance sheet. A key job of the regulator is to monitor the assets and the liabilities, i.e. the investments and the promises, to make sure both are posted accurately and risk is appropriately managed throughout.

An insurance company can get in trouble on either side of the balance sheet, but the risk for life insurers tends to be more with the assets than the liabilities1. Life insurance promises stretch over decades, which is a long time to play with your customers’ money. The temptation is always there to take more risk to chase higher returns. Regulators must stop life insurers from taking too much risk and jeopardizing their customers — and, in the worst case scenario, jeopardizing the broader economy.

There is increasing concern that regulators have not been up to the task.

After the Great Financial Crisis of 2008-2009, life insurers faced historically low returns from safe government bonds, increasing the pressure to take more risk. Over time, private equity firms exploited what they saw as an opportunity: buy life insurance companies at a low price (since profits were lower due to lower investment returns), find clever ways to evade regulatory restrictions, and then increase risk to chase higher profits2.

A case in point is described in a detailed Bloomberg.com story published last November. The life insurance company PHL Variable Insurance Company was acquired by a private equity company in 2016. It was then allowed to take too much risk, only to enter court-supervised receivership in 2024. Analysts believe many more such failures could follow if regulators are unable to improve their oversight.

How do life insurance companies, especially those owned by private equity firms, evade the regulations that are supposed to keep their risk under control? Let’s step through three different tricks life insurers use.

The first trick is to invest in fancy financial products that comply with the letter of the regulatory rules but violate the spirit. An example is what’s called a “collateralized loan obligation” (CLO). Without going too much into the weeds, CLOs allow insurance companies to take on more leverage (and hence more risk) while getting around the regulations that were designed to restrain this behavior.

The National Association of Insurance Commissioners (NAIC) flagged this issue in a 2022 memo, which was part of a four-year process that finally resulted in new regulations to address CLO investments. However, not only were the new rules not as strict as they could have been, but also the insurance companies have moved on to new fancy financial products that allow them to do the same thing — take more risk, while evading the regulations designed to constrain risk-taking.

The second trick is to use private credit ratings to get more favorable regulatory risk treatment. A “credit rating” is a risk assessment by a rating agency that determines how risky a particular debt investment is. Regulators use credit ratings to determine how much risk insurance companies are taking in their investments. But insurance companies are allowed to obtain a private rating, which is disclosed only to the issuer of the debt and to select investors, rather than disseminated publicly. While regulators can see these ratings, the general public cannot. And it turns out that keeping these credit ratings private make them less useful.

According to a recent academic study, the use of private ratings has risen 10-fold since 2018, and these private ratings are “predominantly in opaque securities and concentrated among large and [private equity] owned insurers.” The same analysis shows that privately rated investments are more risky, and that insurance companies appear to be strategically using private ratings to circumvent regulations and take more risk.

The third trick is the most complicated, and also the most significant. Insurance companies use what is called a “related party transaction” to actively mislead regulators. Let’s step through how this works.

Many times, a life insurance company will reduce its risk by buying what is called “reinsurance,” which is when an insurance company enters into a contract with another insurance company to take some of its risk. This is absolutely normal and healthy; it allows insurance companies to spread risk more evenly, lower their costs, and increase their capacity to serve customers.

So far, so good.

But what some life insurers – especially those owned by private equity firms – have been doing over the last fifteen years, is buying fake reinsurance from themselves. Wait, what? Yes: the insurers are engaging in paper transactions that look like they are reducing risk, but actually just shuffles the boxes around so they can take more risk than would otherwise be allowed.

How do they do this?

A life insurer would purchase reinsurance from an affiliated company domiciled outside the United States someplace where disclosure requirements are less stringent. In principle, it can be fine to purchase reinsurance from an affiliated company, so long as regulators are able to scrutinize the contracts to be sure the transaction is truly economic and not done for the purpose of evading regulatory constraints.

The problem is, when it comes to analyzing a complicated reinsurance contract, unless you know everything you can’t be sure of anything. If you can’t read and analyze every part of the contract, then some other part may void or change any other part. By purchasing reinsurance from an affiliated company, the life insurer is able to control both sides of the deal; and by doing the deal with an affiliate domiciled outside the US, the life insurer is able to hide the details of what is really going on.

Let’s go back to PHL Variable Insurance Company. Remember that PHL was acquired by a private equity firm in 2016, and then ended up going into receivership in 2024. Take a look at the way PHL used reinsurance starting in 2017, the year after it was acquired by a private equity firm.

Notice that giant jump in reinsurance purchased from “affiliates” in 2019? That’s PHL taking on a huge amount more risk and hiding the ball from regulators. And then several years later, it went bust.

So what happens when a life insurance company goes into receivership?

California, like all states, has a guarantee fund. The maximum amount the guarantee fund will pay for each insured life is $250,000 for any one insured life no matter how many policies and contracts there were with the same company, even if the policies provided different types of coverages. That’s the same amount as the FDIC insurance for your bank account, even though your life insurance may be the bulk of your retirement fund.

When a bank goes under, the FDIC insurance generally makes everyone whole. That’s not the case for the guarantee fund for life insurance companies. Many life insurance customers have the majority of their retirement savings in their life insurance, and when a life insurance company goes into receivership, those people can suffer meaningful losses3.

There are also potential systemic risks that could cause even greater harm. In the worst case scenario, if one or more major life insurance companies were to go into receivership, the loss of confidence could cause a domino effect that would cause wider losses and potentially even damage the economy.

Regulators have been behind the curve for too long. They need to get ahead of this growing risk before it’s too late.

These are hard problems, and there are no easy answers. When I ran for Insurance Commissioner, I had a section on my website where I wrote about the issue of related party transactions and pledged to attack it with better state-level disclosures and national leadership within the NAIC. That is not a comprehensive plan, but at least it was a start by committing to take the problem seriously.

California is a gigantic insurance market. The next Insurance Commissioner has the potential to play a leadership role in building the coalition within the NAIC and/or with the broader public needed to bring about meaningful reform.

This is a pretty photo that looks like something a life insurance company might use in its marketing.

Photo by Aziz Acharki on Unsplash.

When I was running for California Insurance Commissioner, hardly anyone ever asked me about life insurance. Of course, home insurance was far and away the number one topic — as it should be, since California’s home insurance market is in crisis due to years of mistakes in regulation. Sometimes people would ask about other property & casualty (P&C) insurance lines. Occasionally people would ask about health insurance.

Hardly anyone ever brought up life insurance: not voters, not journalists, not political clubs, not donors. This is a shame. Life insurance is just as big a business as P&C insurance in California (as measured by gross written premiums). While California’s regulation of life insurance is not as involved as for P&C, there is still substantial regulatory oversight. And life insurance faces some very important regulatory issues.

This post will provide a basic primer on life insurance, and then the next few posts will dive into some of the most critical regulatory issues.

The chart below organizes the main products offered by life insurance companies by the risk each product addresses and the potential loss incurred if the risk happens.

The unifying theme here is the risks all have to do with the economic consequences of adverse events to one’s life or wellbeing. The first three products insure against death or longevity. The second three products insure against some life harm or impairment. Let’s step through them in order.

Term Life Insurance

This is a straightforward insurance product. It is easy for the insurer to underwrite and reasonably easy for the customer to understand. The insurance covers a finite period of time (the “term”) and insures against the peril of death. Many times this is offered by an employer to an employee as a benefit. If it is purchased separately, the prototypical customer is a younger or middle-aged adult with a spouse or children. The product protects against the loss of income or other support that would result from death during the term by paying a cash benefit in the event of death.

Cash Value Life Insurance

This refers to a whole range of products that combines a term life product (the “death benefit”) with some form of savings product (the “cash value”). The premiums that go toward the cash value benefit are invested on behalf of the customer. How and when the customer (or the customer’s heirs) receive the cash value varies widely across different products. These products are complex. They may be hard to understand; they may contain hidden fees; their value may depend partly on tax issues that require expert advice.

From a regulatory perspective, there are (at least) two big high-level issues.

1. Insurance companies that offer cash value life insurance products have financially complex balance sheets, necessitating sophisticated financial regulation.

2. Cash value life insurance products are complex products that are aggressively sold, which means sales practices require appropriate regulation.

Annuities

Like the cash value component of a life insurance product, an annuity is essentially an investment and savings product. The defining feature of an annuity is that after the customer pays into it for some amount of time, the annuity then turns around and pays a perpetual income stream to the customer. As such, it is an investment product that insures against outliving one’s savings. (Another way of looking at an annuity is an investment that facilitates more confident consumption, since you can put aside a fixed amount of money each year to ensure you do not outlive your savings.)

The two key regulatory issues for annuities are the same as for cash value life insurance products. They are complex products that are aggressively sold, and the companies that offer them have financially complex balance sheets.

Supplemental Benefits

This is the simplest of the “adjacent life” product types. The insured is paid a supplemental amount to help pay for some medical event that is not fully covered by medical insurance. Typically this is sold to companies, who bundle it with their health insurance and offer it to employees as a benefit. This is relatively easy for the insurance company to underwrite and relatively easy for the customer to understand.

Disability Insurance

Disability insurance insures against loss of income from some form of disability that does not happen as a result of a workplace injury1. Basic disability insurance is already universally provided by Social Security, however there can be restrictive requirements to qualify and/or the benefits may not be sufficient.

In California, most employers must participate in the State Disability Insurance Program unless a voluntary (private) plan has been approved by the Employment Development Division. Most supplemental disability insurance (i.e. in excess of Social Security) is provided by the state program. The regulation of private disability insurance is therefore a relatively minor issue in the overall picture in California.

Long-Term Care Insurance

As we age, the risk increases exponentially that we may need some combination of medical and assisted living care outside of an acute care unit of a hospital. This care can be very expensive. Medicare provides very limited coverage, and while Medi-Cal (California’s version of Medicaid) provides more coverage, it is only when a person’s assets and income are substantially depleted, and the care may not be adequate. Long-term care (LTC) insurance is purchased to provide higher quality coverage if needed, without requiring substantial depletion of assets and income.

LTC insurance has substantial regulatory issues that arise from the complexity of the product, the cost of the care, and the fact that the insurance contract is generally entered into decades before the insured event (i.e. needing long-term care) occurs.

Some of the key regulatory issues include:

• Suitability Standards: Potential customers must meet criteria for being suitable candidates to purchase long-term care insurance. These criteria must be developed and monitored for compliance.

• Policy Terms: LTC insurance has a range of complicated provisions such as outlines of coverage, inflation protection, nonforfeiture provisions, replacement notices, and disclosures. The definition of all of these and their communication to customers must be developed and monitored.

• Benefit Triggers: Determining when someone qualifies for long-term care (i.e. when the insurance policy begins to pay out) can be complicated and contentious, which necessitates regulatory oversight.

• Allowable Pricing: Both initial rates and subsequent rate increases require prior approval before being implemented.

The allowable pricing is especially contentious. LTC insurance has been an economic disaster for insurance companies. Per the linked article: “For decades, the [insurance] industry severely underestimated how many policyholders would use their coverage, how long they would live, and how much their care would cost.” This means insurance companies are now routinely applying for big rate increases that meet the criteria for approval under the California insurance Code. These increases, however, can be devastating for existing customers.

Imagine a customer who bought an LTC policy at age 50 and is now 60 years old. The customer anticipates needing to pay another 10-30 years of premiums before there is a substantial risk of needing long-term care. Now the insurance company wants to jack up the premiums by a huge amount. The insurance company argues this increase is needed to make the product economically viable. The customer argues this increase is a bait and switch that is deeply unfair and economically burdensome. Both are right. What should the regulator do?

Hey, I never said insurance regulation was easy.

The next three posts will dive deeper into some specific life insurance regulatory issues, with the third post devoted to LTC insurance.

Healthcare has become a very large part of the U.S. economy. Are we getting our money’s worth?

Health insurance is unique in how inextricably linked it is to how we get healthcare. We don’t use home insurance to buy homes, or auto insurance to buy cars, but we do use health insurance to get healthcare – and sometimes it is used to ration or restrict the healthcare we can get.

Health insurance regulation is also different in practice than other lines of insurance. Other lines of insurance are regulated primarily at the state level, and ultimately by each state’s insurance commissioner. Health insurance regulation, by contrast, is much more dictated by federal law. Additionally, the California Insurance Commissioner is much less involved in regulating health insurance than insurance commissioners in other states.

This post will provide some context for why health insurance and its regulation are so different from other kinds of insurance. The next post will describe how state regulation of health insurance operates in California, with an emphasis on why the Insurance Commissioner has so little oversight and what the implications are.

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As detailed in Uncovered, The Story of Insurance in America by Katherine Hempstead, health insurance is a relatively new form of insurance. Fire insurance in America predates the Declaration of Independence. Life insurance was already big business in America before the Civil War. By contrast, health insurance in America originated as “a small and seemingly unimportant” part of disability insurance in the late nineteenth century.

How times have changed! Private health insurance is now the largest insurance category in America (as measured by direct written premiums), and this does not even include government health insurance. Meanwhile, total U.S. national health expenditures have risen to 18% of total GDP, from merely 5% in 1960 (the earliest data I could find). Healthcare, and health insurance alongside, are now massive.

The rise of modern medicine at the turn of the twentieth century created a whole new kind of healthcare that could effectively treat illness. This also created a whole new problem: healthcare that patients often could not afford – which meant doctors and hospitals often could not get paid. The sharp rise in healthcare costs collided with the Great Depression, which gave birth in the 1930s in the United States to the first generation of modern health insurance and health financing products.

Healthcare is a uniquely challenging market. When you need it, your life may be on the line and you will pay almost anything for it. Knowledge is very specialized, so you have to rely on what doctors tell you — and the moment when you most need it may be precisely when you are least able to comparison shop. At the same time, you may have private knowledge about when you are likely to become sick plus you are likely to ask for as much as you can get when you need it, so normal insurance is subject to especially severe “moral hazard” problems. And finally, a person may find their life in danger through no fault of their own, with the cure costing far more than they can afford, and which a profit-making insurance company would have an economic incentive to deny.

Every single rich, developed country around the world has its own idiosyncratic history about how it has grappled to provide access to modern healthcare. Every single developed country has found it has needed the government to play a major role. And while there is no end of dispute about the economically optimal design for delivering healthcare, economists generally agree the special nature of healthcare requires much more government involvement than almost any other market.

Different systems have evolved around the world for structuring the government’s role in delivering healthcare. The economist and popular writer Paul Krugman provides a useful framework for organizing how developed countries deliver healthcare, determined by the intersection of two major decisions.

1. Is the insurance that pays for healthcare provided by a government insurance program that is funded by taxes? Or is it provided by private insurers that are funded by charging premiums (with significant government intervention)?

2. Is the healthcare provided by hospitals and clinics run by the government? Or is it provided by privately run hospitals and clinics (with significant government regulation)?

Krugman complements the framework with a matrix to categorize various countries around the world into three basic systems. (The asterisk denotes a country with a hybrid system.)

The empty box means there are no countries where private insurers fund public providers, which makes intuitive sense. But counterintuitively, the United States actually uses all three systems at the same time! And even specific elements of our system have a complex, hybrid structure. (Medicaid, for example, is a highly complicated mix of federal and state funding and oversight.)

From what I can tell in my review of the literature, there is no clear answer as to which system is best. Each system can do the basic job of keeping costs under control, providing universal access, and delivering good quality. But uniquely in the United States, we don’t have one system — we have a muddled mishmash of three systems.

As is widely known, America’s healthcare delivery system is highly unsatisfactory. We spend too much on healthcare, too many people lack adequate coverage, and we get less good health outcomes in aggregate than other developed countries.

Major healthcare reform has been a recurring national focus. President Nixon tried to do it in 1971, then President Clinton tried again in 1993, and then President Obama finally passed the Affordable Care Act in 2010. But the Affordable Care Act only went so far, has faced major resistance, and now seems to be coming under increasing strain as prices rise, care is rationed, access remains challenged, and health outcomes remain unsatisfactory.

Healthcare has been a major issue in our national politics for many decades, and it seems likely to continue to be so for the foreseeable future.

What does this mean for health insurance regulation in California?

The big issues around health insurance are about our healthcare system. This is a key difference between health insurance and other forms of insurance. The big issues around home insurance are not about housing; the big issues around auto insurance are not about driving. But what people really care about is the cost, accessibility, and outcomes they are getting from the whole healthcare system – to which health insurance is inextricably and maddeningly linked.

The big issues with our healthcare system are structural at the national level. This is not to minimize the importance of actions that can be taken at the state level. For example, California has aggressively expanded Medi-Cal (i.e. Medicaid in California) to cover 14.5 million Californians, over 35% of the state’s population. That is a big effort to expand access to healthcare. But this effort to expand access comes with a big price tag and has to navigate all the inefficiencies of our messed up healthcare system. California cannot fix the root causes of our broken healthcare system; that can only be done at the national level.

The big issues with our healthcare system can’t be solved on our own. In the gubernatorial primary, many candidates advocated for a California-run “Medicare for all,” i.e. a state-run single-payer healthcare system. The idea is that if America won’t fix our national healthcare system, California will fix it here in our state. But saying something doesn’t make it so. Democrats who control the state government have repeatedly found the costs and risks of trying to create a state-run single-payer system to be overwhelming.

My prudence on this last point should not be confused with a lack of passion.

When I was 22 years old, I was diagnosed with a leaky heart valve. My doctor assured me I would be fine. But it meant I would eventually need heart surgery – and just like that, I was uninsurable unless I was employed. I’m fortunate: I had good insurance when the time for surgery came, and everything went well. But you shouldn’t have to be fortunate in America to have available, adequate, and affordable healthcare.

I strongly believe every American has a right to healthcare that is available, adequate and affordable. I also strongly believe political candidates have a responsibility to talk honestly about what is and isn’t feasible. And so when I ran for California Insurance Commissioner, I tried to focus on policies relating to California’s insurance regulation that could make a real difference, yet were actually realistic.

The next post will explain how health insurance is regulated in California, the role the Insurance Commissioner plays, and what I believe is a big and realistic opportunity to improve how California regulates health insurance.

Photo by Josh Felise on Unsplash (Eventually I will move away from images of wolves — but not yet)

The last post explained why the Insurance Commissioner race is the most important statewide election in California this fall. After Labor Day, as people start tuning into the elections, I will analyze the backgrounds, plans, and qualifications of each of the two Insurance Commissioner candidates.

One thing I learned on the campaign trail is many voters haven’t had the opportunity to learn the ins and outs of how insurance works. This series of posts will provide a basic primer so people can better understand the key issues

I will not advocate for specific policies, but if you are curious, here is my policy platform from when I was a candidate for Insurance Commissioner in the primary earlier this year.

This first post will cover key general concepts. Future posts will get into the details for each of the major types of insurance: (1) health, (2) life, (3) property & casualty.

Let’s dive in!

What is Insurance?

Insurance involves two key ideas:

1. Transferring risk from an individual to a group so losses are more evenly and predictably distributed

2. Defining, quantifying, and allocating the costs and benefits of this risk transfer

The details are complicated and vary widely across different kinds of insurance and types of risk. But the core idea is simple: insurance transfers risk from an individual to a group.

What are the Benefits of Insurance?

At a high level insurance provides five critically important benefits.

1. An individual substitutes a smaller, predictable cost for a larger, uncertain cost

2. Society benefits from increased predictability resulting from the use of insurance

3. Society benefits from the information generated by pricing risk

4. Insurance can align incentives to reduce risk

5. Insurance can be a way to redistribute income or wealth

Let’s briefly explain each of these benefits.

Substitute Small, Certain Cost for Large, Uncertain Cost: This is the benefit each of us directly gets from our insurance. Where it matters most is when the cost would be disastrous. For example, if your house burns down you could be financially ruined without insurance.

Society Benefiting from Increased Predictability: Even if the total economic loss remains the same (i.e. risk is not reduced), the increased predictability of how losses are distributed can be highly beneficial beyond the direct coverage. For example, a bank can more easily offer a mortgage if your house is insured, as the loan will not default if the house is destroyed.

Society Benefiting from Risk Pricing Signals: The activity of underwriting insurance generates valuable information. For example, in order for insurance companies to offer home insurance, they must analyze the effects of climate change, which is then reflected in pricing. These price signals can then be used by others to make decisions about the impact of climate change.

Aligning Incentives to Reduce Risk: The activity of designing, marketing and providing insurance can align incentives between the insurer and the insured to reduce risk. For example, an insurance company may identify actions that reduce fire risk for a house, and offer a discount to a customer who takes these actions. The insurer gains a customer, the customer gets a discount, and risk is reduced.

Insurance as Income or Wealth Transfer: In some cases insurance is a mechanism for economic redistribution. For example, health insurance in all developed countries is subsidized to some degree for people with preexisting conditions. Subsidizing health insurance for those whose preexisting conditions would otherwise make it unaffordable is a form of economic redistribution.

How is Insurance Provided?

In general, insurance can be provided in one of three ways: (1) a closed group self-insures; (2) a private group sells insurance; (3) the government provides insurance.

Self-Insurance: In some cases, a group or an association that is financially stable, will endure indefinitely, and has a specific insurance need may provide insurance directly to its members.

Private Insurance: Most of the time, insurance is provided by an insurance company. There are two main types of insurance companies. A “stock insurer” is a corporation owned by shareholders (either public or private); a “mutual insurer” is a corporation owned by policyholders. It is often hard to tell the difference between these. For example, Allstate and State Farm are both giant insurance companies that advertise widely. Allstate is a stock insurer and State Farm is a mutual insurer.

Government Insurance: The economist and columnist Paul Krugman has famously written that the federal government is “an insurance company with an army,” because most of the federal budget is spent on Social Security, Medicare, and Medicaid. Social Security insures against poverty in old age (as well as disability and premature death of a spouse or parent). Medicare and Medicaid are forms of health insurance. The federal government also provides some other forms of insurance, e.g. flood insurance and terrorism insurance.

What are the Advantages and Disadvantages of Government Versus Private Insurers?

Recall the five benefits insurance provides:

1. Substituting a small, predictable cost for a large, unpredictable risk

2. Increased predictability from insurance usage

3. Information generated by pricing risk

4. Alignment of incentives to reduce risk

5. Mechanism for income/wealth redistribution

The third and fourth benefits each arise from competition among private insurers. If the government enters an insurance market, it may crowd out other private insurers and eliminate the competition that generates better risk pricing and more innovative ways to reduce risk. Furthermore, if government pricing is inefficient, it may result in economic redistribution that is unintentional or counterproductive.

Even in those cases where we want to use insurance as an intentional mechanism for economic redistribution, this can be done in other ways, e.g. by taxes and subsidies.

However, there are some cases where the government is better suited to provide insurance.

What Risks Can the Private Market not Insure?

Risks that can be insured by the private market generally meet the following criteria:

• There is a large number of homogenous, independent exposures at risk

• The loss produced by the risk is economically measurable

• The loss is well defined and clearly verifiable

• The loss is probabilistic and calculable

• The loss is not something the insured is likely to intentionally make happen

• The loss is not catastrophic

Fire insurance for the home fits these criteria very well, which is why around the world fire insurance is generally provided by private insurers.

Terrorism, on the other hand, does not fit these criteria. It is very hard to predict it probabilistically, and there is the potential for catastrophic loss (e.g. a nuclear, biological or chemical attack). This is why around the world terrorism insurance is generally provided by governments.

Technology can change which risks can be insured by the private market. For years, flood insurance was not considered an insurable risk by the private market. The U.S. government has provided flood insurance via the National Flood Insurance Program (NFIP) since 1968. However, the NFIP has been problematic because pricing has been inefficient and incentives have been misaligned to reduce risk. At the same time, technology advances have made private flood insurance more feasible. There have been recent attempts to reform the NFIP and encourage private insurers to enter the market.

Finally, there are some risks for which it is more efficient to have a single government provider. Social Security insures against poverty in old age by providing a universal basic annuity. For people with greater savings and more varied needs, it makes sense for private life insurers to compete to provide more complex annuity products. By contrast, it is more efficient for the government to administer the universal basic annuity provided by Social Security, and it also allows low income beneficiaries to be directly subsidized.

Why and How Should We Regulate Private Insurers?

We will revisit this question continually as we analyze each specific category of insurance in future posts.

Much of the regulation of insurance in the U.S. happens at the state level. (This is less the case for health insurance; it is more the case for life and property & casualty.) This is mainly an accident of history, as we will describe in future posts.

There are several important reasons to regulate insurance.

Solvency: Insurance is a business where a company is paid premiums today for the promise to pay out claims in the future. This creates the risk that an insurance company may lack the ability or willingness to pay its claims faithfully when the time comes. Good regulation ensures this does not happen.

Information asymmetry: Insurance is complex. Customers may lack the information to make informed decisions about what they are buying, what they need, or how much they can trust the insurer. Good regulation corrects for this, e.g. by standardizing product/coverage terms, mandating disclosures, and generating information the market fails to provide.

Sales practices: Given the complex and emotional nature of insurance, insurance sales need stricter oversight than many other markets. This is why insurance agents are licensed and sales practices are highly regulated.

Fraud: Insurance creates the risk of fraud on both sides. Claimants may make fake claims to get money from insurance companies; insurance companies may withhold money from claimants that they are legitimately owed. Regulation is necessary both to police fraud directly and to assist legal actions to prevent or punish such behavior.

Market functioning: Regulation can help insurance markets function more effectively. We want to make sure insurance companies never have market power to charge unfair prices. (There is a debate whether this is best done through competition or price controls; we will revisit this debate in later posts.) Skillful regulation can also align incentives to reduce risk, promote innovation, prevent abusive activities, and generally improve customer experience without unduly raising costs.

Equity and fairness: Regulation can prohibit activities that are harmful or unjust. Unfair discrimination must be prevented. Privacy must be protected. We may wish to disallow the use of certain information for underwriting or marketing, e.g. credit scores.

Transparency: Finally, there is an affirmative value to providing transparency and insight. Regulators have privileged access to information that can both directly inform the public and also help other organizations inform the public.

The next post will start our deep dive into insurance categories with health insurance.

AI image generated by Claude. No wolves were harmed in the production of this image.

Welcome to my Substack newsletter, Wolff’s Den. My goal is to provide you with thoughtful, enjoyable and downright indispensable insights about politics and policy that builds on what I learned over the last year running for California Insurance Commissioner.

As I write this in mid-July, I hope you are enjoying a restful summer. I know that most people barely give a thought to the fall elections until Labor Day. But if you can spare some time in between beach reads, I ask you to give some thought to what is by far the most important statewide California election this fall: Insurance Commissioner.

Why the Insurance Commissioner Race Stands Out

It is useful to sort all the statewide elections into four groups, loosely in descending order of importance.

• Group One: Governor

• Group Two: Attorney General, Insurance Commissioner

• Group Three: Controller, Secretary of State, Superintendent of Public Instruction, Treasurer

• Group Four: Board of Equalization (four equal-population districts, each with its own election to select a representative)

Now that we are through the primary, each election will have only two candidates on the ballot.

The most important election by far, of course, is the Governor. As a practical matter, however, no Republican has a realistic chance to win statewide election. Barring something truly unexpected, Xavier Becerra, the Democrat, should easily beat Steve Hilton, the Republican.

The second most important tier of statewide offices is Attorney General and Insurance Commissioner. The Attorney General election is uninteresting this year, because Rob Bonta is both the incumbent and a Democrat, and he is facing a Republican, Michael Gates. It would take an Eric Swalwell-level implosion for Bonta to lose this race.

But the Insurance Commissioner race is highly competitive! Two strong Democrats are squaring off against each other: State Senator Ben Allen and former San Francisco Supervisor Jane Kim. I have endorsed Ben Allen, and in future posts I expect to have much more to say about the two candidates. But for now, the most important thing to note is this race will be a tough fight and it deserves your full attention.

The third most important tier of statewide offices is Controller, Secretary of State, Superintendent of Public Instruction, and Treasurer. I don’t want to overly downplay the significance of each of these offices. A truly capable, energetic person can do some real good in any of these four offices, while a truly incompetent or unethical person could do some real damage. But none of these “tier three” offices has the level of responsibility of the “tier two” offices, and in each of the four races there is a Democrat facing a Republican in a state where it is currently almost impossible for a Republican to beat a Democrat statewide.

Finally, the “tier four” level of statewide offices is Board of Equalization. There are four equal-population districts for Board of Equalization, and each district has an election this fall to choose their representative. (Fun fact: the Controller has the fifth seat on the Board of Equalization and represents the entire state.) The Board of Equalization is decidedly less important than other statewide offices. The San Francisco Chronicle even called for its elimination this spring! But the district elections are more interesting than most of the statewide elections because the districts are only equally apportioned by population, not by party — plus two of the four districts feature a Democrat vs. Democrat contest.

(A brief side note: the District Two election for Board of Equalization features Democrat John Pimentel versus Democrat Sally Lieber. District two covers all of the California coast north of the LA area. Since I am friends with John Pimentel, I ask you to visit his campaign website and check him out.)

As you can see, the Insurance Commissioner election is uniquely competitive and significant among all of California’s fall statewide races.

Why the Insurance Commissioner Role Matters

Now let’s dive into why the Insurance Commissioner role matters so much.

The Insurance Commissioner oversees the California Department of Insurance (CDI), composed of 1,400 professionals. The CDI regulates most forms of insurance in California, including home, auto, life, workers’ compensation, long-term care, and various lines of property and casualty insurance that affect businesses and individuals. (Most health insurance is regulated by a different department called the California Department of Managed Healthcare, although the CDI does regulate a small amount of health insurance also.)

A lot of the law that governs how all these lines of insurance operate in California is regulatory as opposed to statutory, which is a fancy way of saying that the CDI makes a lot of the important decisions about how all these lines of insurance operate. The CDI also routinely consults with the state legislature on the laws they write, which means the CDI helps develop much of the insurance law they don’t directly write.

The CDI doesn’t just write regulations: they also interpret regulations (subject to the oversight of the state judicial system) and they enforce regulations. When it comes to state insurance regulation, the CDI has a legislative, judicial, and executive function.

And sitting on top of the CDI is the elected Insurance Commissioner, who is the ultimate decision maker. While of course the Insurance Commissioner must follow the law and decisions can be challenged by lawsuit where there is appropriate jurisdiction, the Insurance Commissioner has the last word at the CDI.

Furthermore, the Insurance Commissioner answers only to the electorate – not to the governor or the legislature. Staff informs and advises, internal counsel reviews and opines, but ultimately it is the Insurance Commissioner who decides.

In short: if the public wants insurance to function well, the public had better choose the right person to be Insurance Commissioner!

And there are very good reasons the public should want insurance to function well.

To start with, the amount we pay for insurance is a decent chunk of California’s total economic activity. In 2024, total property & casualty insurance premiums were $107 billion, and total life and annuity insurance industry premiums were $108 billion. Together, these amount to roughly 5% of California’s $4 trillion 2024 GDP, and for many consumers it can be a larger share of their out of pocket annual expenditures.

When it comes to life and annuity, the Insurance Commissioner indirectly affects the cost of premiums by fostering a healthy, competitive market and by ensuring customers are empowered in their purchase decisions and protected from deception or abuse.

When it comes to property & casualty, the Insurance Commissioner does all of the above and more. Ever since voters enacted Proposition 103 in 1988, the Insurance Commissioner directly reviews and approves property & casualty premiums. Reasonable people can (and do!) debate how this awesome power should be used, but only the Insurance Commissioner ultimately decides how to use this power.

How much we pay for insurance gets a lot of attention, since the price we pay affects each and every one of us. But the point of buying insurance is not to pay the bills – it’s to have protection when you need it. In your time of need, you want your insurance to treat you right. Insurance must be well regulated to maximize your chances of being paid fairly, promptly, and adequately. And who has ultimate responsibility for that regulation? The Insurance Commissioner.

Furthermore, insurance is wrapped up in many other major issues that affect all of us, such as privacy, fraud, economic efficiency and equity. (Fraud is committed on both sides, by the way – both by insurance companies and by claimants, which ultimately leads to higher premiums and less fair claims payouts.) Skillful regulation can protect our privacy, reduce fraud, and promote efficiency and equity. Once again, it is the Insurance Commissioner who is responsible for making sure regulation achieves these results.

Finally, insurance is systemically important for the rest of the economy. The price signals sent by insurance allows us to identify, quantify, and ultimately mitigate risk of all kinds throughout the economy – so long as those price signals are accurate. And a well functioning insurance market is necessary for much of the rest of the economy to function. You can’t drive a car, operate a business, or get a mortgage without insurance.

California has been suffering for years from a major crisis in the availability of home insurance, which has had serious adverse effects throughout the state. The one person who has by far the most responsibility both for causing and curing this crisis is the Insurance Commissioner.

So to sum it up: this role matters a lot!

I will have a lot to say in the future about the two candidates for Insurance Commissioner, the key issues, and much more. For now, just make a mental note to pay close attention to this upcoming race as you relax and enjoy the summer break.