Black Box Technology Could Improve ‘Sub-Standard’ Approaches

Insurance industry expectations regarding “other-than-standard” underwriting classifications seem to be evolving continuously.

But to whom must these labels be acceptable? In particular, what are the real expectations of our customers and agents?

From both an actuarial and underwriting perspective, the question has become, “how wide must the bell curve be around the 100% mortality (i.e., “standard” risk) point on a basic mortality distribution graph?” (See chart.)

Or, for those in marketing (where anything that impedes a sale is anathema), the facetious question is, “how accepting should we be of an underwriters decision to label an otherwise extraordinarily healthy applicant as sub-standard or even standard?”

Of course, widening the “band-width” of “standard” is analogous to squeezing a balloon, i.e., we can only rearrange a fixed amount of air. Improving the price of one classification, by segregating it from a previously larger, inclusive classification, increases the price for the residual classification.

Some insurers have avoided this trend, preferring to offer the best “standard” rates by deliberately not diluting the classification. This only proves that, when it comes to underwriting and differentiation, there are no egalitarian means.

The cost of one group is always supported by another.

The problem confronting insurance companies today is the reality that underwriting decisions have become a primary basis for competition, much like product innovation and price.

And, this competition is not focused on relative underwriting prowess because underwriting is still knowledge-based. That knowledge must be widely and uniformly held, if for no other reason than the involvement of the same reinsurance companies.

Instead, underwriting competition now is around the non-compensated risk a company is willing to endure, and the profit margin it is willing to shave, in order to get the business.

But, rather than succumb to these unfavorable pressures, why not focus on better understanding the motivations behind them? Then, we can develop favorable protocols to deal with them.

If the real motivation is price, there have always been remedial actions that can be taken. These, of course, have ranged from changing product types to excluding contractually problematic underwriting risks.

Most companies have some means to “buy-down” the base premium by mixing in appropriate amounts of term insurance rider or other lower priced, and usually non-commissionable, coverage.

But, some companies enable an even more sophisticated alternative–by actuarially converting sub-standard table ratings to “temporary” flat extras, and then recalculating the resulting lower target premiums.

These temporary flat extras are not really positioned or illustrated as additional premiums paid by the client (although the required premiums will still be higher than “standard” levels). Rather, they function as additional internal mortality charges subtracted from the policys cash value along with the cost-of-insurance charges and other policy expenses.

This is “black-box” technology at its finest. The actuary iteratively manipulates combinations of target premiums and temporary flat extras to arrive at similar profitability levels and also competitive spreadsheet targets, such as ending cash values or projected policy durations.

Once the internal parameters are known, the policy illustration system is then “fooled” to mirror the desired results, using the functionality and limitations of the illustration system and the constraints of the approved policy filing. Its all perfectly compliant, but complicated to execute.

And, if the motivation is the label itself, this same “black-box” approach can often produce a base rate of “standard” or even “preferred” for a still “sub-standard” risk. Or, if the motivation is driven by the agent-client relationship in an effort to enhance the perceived value of representation, this, too, can be accomplished.

Most importantly, this type of creativity can preserve a companys underwriting integrity and pricing profitability. Its a wonderful example of how flexibility and customization can become the basis of differentiation, with all parties emerging victorious.

Bruce W. Gordon, CLU, is senior vice president and chief marketing officer at Kansas City Life, Kansas City, Mo. His e-mail is bgordon@kclife.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, November 12, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


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