Substandard ratings, particularly with older applicants, are naturally commonplace, but calling them impaired risks can be misleading.
Obviously, the purpose of underwriting is to assess applicants comparatively, applying appropriate ratings so the resulting financial risk to the insurer is relatively equal.
The term "substandard" once implied an underwriting assessment different than "standard." But with the arrival of "preferred," "super-preferred," and other better-than- standard ratings, "substandard" has really become obsolete. Now, "impaired risk" seems the most widely used, and perhaps politically correct, term; but it, too, implies an assessment thats less healthy than standard.
If we assume any risk, properly evaluated and priced, is comparatively financially neutral to the insurer, then "impaired risk" may be a better description of the likely negative financial ramifications of an incorrect underwriting or pricing decision.
In the hotly contested, older-age and affluent market, this may have particular relevance and cause for concern. The sheer size of many such cases can distort the law of averages relative to the insurers overall block of business. Thus, any "impairment" to an otherwise proper risk assessment and offered price could be disastrous.
However, how does a company really determine or understand when, or even if, a risk is impaired? After all, underwriting is certainly not an exact science.
We set underwriting guidelines with the expectation that overall profitability targets for a block of business will be achieved if the guidelines are followed. But, applying the guidelines is more interpretative and judgmental than definitive or precise. Mistakes are expected and inevitable, and they can work for or against the company.
Consequently, the degree to which the risk might be impaired may not be obvious if the underwriting guidelines have been applied as designed. But, if the guidelines are deliberately overruled, we can infer the risk is probably impaired.
Consider the effect of the increasingly prevalent automatic table reduction programs. If the underwriting guidelines in place before enactment of these programs were correctly correlated to some aggregate expected profitability, then by definition, table reduction programs by themselves will result in decreased profitability.
So, how do companies justify the programs? Does focus on the top line take precedence over the bottom line? Is it the belief that competitors underwriting guidelines are unnecessarily conservative, and therefore, a deterioration in profitability simply wont materialize?
Is it driven by the ever-increasing shifts in risk to the reinsurers, whose different assumptions regarding expected mortality may tolerate these programs? Perhaps reinsurers, given the larger size of their policy blocks, can absorb any damage more easily?
Or, is it simply a view that any profitability will still offset internal expenses, and therefore can be justified in the aggregate?
Whatever the rationale, the risk will become impaired to some degree relative to original pricing assumptions. Unless we believe those assumptions are wrong, such moves can be dangerous.
Life insurance remains an unusual business, in that we must often manage more on the basis of assumptions than facts. The results we report today, in some respects, are the product of decisions made by our predecessors regarding risk selection.
The legacy we owe both our customers and our management successors is a policy of sound decision-making that favors the future. The risk selection and pricing decisions we make today will constitute the cornerstone of that future, and avoiding any known impairment to that risk should be paramount.
Bruce W. Gordon, CLU, is vice president-distribution, individual insurance, at Sun Life Insurance Company of Canada, Wellesley Hills, Mass. He may be e-mailed at firstname.lastname@example.org .
Reproduced from National Underwriter Life & Health/Financial Services Edition, November 6, 2000. Copyright 2000 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.