Its a commonly held belief that the pricing of life insurance is as much art as science. Given the fiercely competitive nature of the life insurance market today, however, such art has been raised to Rembrandt-like levels.
The question is, why? Certainly, some pricing differences between companies are attributable primarily to different views of sufficient returns for a given product. Even so, most carriers target 2% to 5% after-tax profit margins and/or a 10% to 14% return on investment on most of their new life policy pricing.
If carriers have similar profit targets, what, then, can explain differences in price competitiveness they often display? To outside observers, this can be one of lifes greatest mysteries!
I suggest the answer lies in the varying approaches to pricing that insurers can use. Here are some examples:
Expense allocations. Choosing whether expenses should be allocated on a per policy, percent of premium, or per $1,000 of insurance basis may seem to be a trivial decision. However, judicious choices here can alter a carriers competitive position. These "brush strokes" are most evident when comparing particular pricing cells–the price for a specific combination of gender, risk class, and issue age.
Carriers that feel comfortable in their ability to predict future business mix by age, risk class, etc., may effectively force certain pricing cells to pick up a greater expense burden than other key competitive cells.
Capital allocations. Such allocations between pricing cells can be shifted in the same way as expenses, provided that overall capital requirements (rating agency, National Association of Insurance Commissioners, or internal) can be met.
As an example, smokers and older-age insureds may be priced with a heavier mortality (C-2) risk capital component than nonsmokers and younger ages, helping to improve nonsmoker and younger-age pricing.
Further, when you view capital requirements at the company level, not product level, you may find additional reductions in capital are possible in product pricing.
Modal premiums in pricing. Recognizing these premiums can improve profit results, particularly if expenses associated with the increased processing costs have already been "baked" into the companys expense assumptions.
Future profits associated with the premium tail. In term life insurance pricing, recognizing these future profits beyond the level premium period can be a source of distinction between carrier pricing.
Many companies today choose to ignore any profits or losses after the level current premium period. One of the outgrowths of Regulation Triple-X is that the steeply rising yearly renewable term premiums normally charged after the level premium period may be less helpful in mitigating reserves than in pre-X days. Therefore, less severe YRT premium jumps may lead to better business retention at that point and increased future tail profits.
