The life insurance industry’s beloved ordinary life business is now a century and a half old. It has been having some pains as it copes with the effects of economic swings and war, but it isn’t going away. In fact, the business shows plenty of vitality such as its recent shift to writing simpler products, very large face amounts, preferred issues and older ages.

Of tremendous interest right now is the preferred risk classification. This is a system of identifying life insurance risk by differences in medical and socio-economic circumstances of each individual applicant.

This system is not new, but in today’s market, is far more developed than a decade ago to the point that it has become a mainstream practice at many insurers.

The trend hasn’t come out of the blue. It reflects the culture of individualism that is seen everywhere in the United States (and that is accompanied by the demise of the employment covenant). It is almost as if every individual today could have his or her own life insurance rate, based on the individual’s own circumstances.

Classification by preferred risk is the newest in a long line of historic risk class innovations. Chart 1 details such innovations since 1868; all did much good for the ordinary life business by stimulating increased sales.

It is worth noting that every time a risk class innovation comes along, the actuarial profession hurriedly searches for solid data to back up the innovation. That even happened in the case of the very first innovation, way back in 1868 when “The American Experience Table” was created from data of the Mutual Life Insurance Company of New York. This was solid data, usable as late as 1941.

I was privileged to have served on various data search initiatives for the 4 latest innovations mentioned in Chart 1. The nonsmoker/smoker innovation of the 1980s was a particularly striking development. This is because the differences in mortality between nonsmokers and smokers turned out to be far larger than anyone had imagined. That discovery spurred product changes like offers of nonsmoker discounts, starting at 10% and, later on, at much higher percentages.

All during 2006, various industry groups, including my own firm, studied the latest innovation: preferred/standard pricing. Again, the differences in mortality are more than had been imagined. Chart 2 provides some salient examples.

All people in Chart 2 are age 50, and yet “1000q” varies from .66 (for female class I preferred) to 7.37 (for standard male smokers). (Note: 1000q is the number of deaths per 1000 in one year.) Preferred risk classification calls for prices which are in accord with this tremendous variation.

When the search team looked for data, product design characteristics also emerged. For nonsmokers, some companies use 2 preferred classes; others use only one. For smokers, some companies use 1 preferred class; others companies use none. Of course, some companies are using no preferred classes at all, but many are considering adoption.

Whenever preferred classes are used, the balance of the business (the nonpreferred part) is usually called “standard.” Suitable mortality tables are needed to fit the classification pattern selected.

Back in the early days (say, pre-1960), classification was based on age. This made things easy. When the nonsmoker/smoker innovation came along, though, things became more difficult, due to differences in degree and type of smoking and in time lapsed since quitting. But suitable underwriting rules emerged. For defining classification, they worked just fine.

It’s the same with preferred/standard pricing. Underwriting rules are most important.

There are some relatively new rules, relating to blood-profiles and to socio-economic status. Again, the rules work fine for defining classification. They can, for instance, easily distinguish between super-preferred class I and preferred class II. (Incidentally, the class I business is very super-preferred indeed, and the underwriting rules are very strict, relating to the socio-economic upper class.)

The last comment brings to mind the vigorous market that is developing for large-amount policies for middle-aged people–sometimes colloquially called “brokerage term.” The new research in preferred/standard pricing will provide this market with solid data. This should enable insurers to price their products for this market with greater confidence than before.

As noted above, the ordinary life business has been experiencing some pains in recent years. But it shows vigorous signs, too. It’s in the process of product re-design brought about by changeover to the 2001 Commissioners Standard Ordinary Tables.

This compulsory changeover presents the industry with the perfect opportunity to introduce preferred/standard pricing on a proper basis.