The odds of perfectly matching risks to life-insurance premiums are zero -- but much improved.
Progress in insurance underwriting stands in sharp contrast to Wall Street's failure to adequately assess risk in financial markets, a shortcoming brought into sharp relief by the subprime mortgage meltdown and the resulting damage to some of the nation's largest banks.
"Watching the current subprime problems unfold and spread, creating such economic problems, I could not help but to think that Wall Street has much to learn from actuaries," said Heekyung Youn, a mathematician who teaches actuarial science at the University of St. Thomas.
"I get the feeling that, even though the current crisis is a new situation that we are facing, if the whole enterprise had been assessed more carefully, as actuaries do when they develop a new insurance product, we may have been able to avoid or reduce the level of current difficulties," Youn said.
Insurance actuaries, judging risks before underwriters price policies, have increased their sharing of information and refined computer models to measure the interplay between risks. For example: what to charge a smoker who also scuba dives and makes his living in a chemical plant.
In contrast, the combination of risks in credit markets -- easy credit, lax standards for qualifying for mortgages, and the bundling of mortgages into securities -- made the quality of loans hard to assess and turned into a toxic brew for Wall Street.
Death by coconut
Actuaries know the odds of being killed by a falling coconut -- one in 250 million -- but can be clueless about the risks associated with thousands of home loans bundled together with virtually no information about individual borrowers.
Actuaries, who build elaborate mathematical tools used to predict and spread risk, can claim to have reduced unexpected exposure for insurance underwriters and to cut the costs of insurance coverage for some who previously couldn't afford it.
"Over the past 20 years, the speed and accuracy of underwriting medical conditions in insurance applicants has increased dramatically," said Neil McKay, chief actuary at Golden Valley-based Allianz Life Insurance Co. of North America.
Improved gathering and sharing of information about people with all manner of medical histories has sharpened the ability of actuaries to assess insurance risks, he said.
McKay cited the hypothetical case of a 70-year-old man undergoing surgery for prostate cancer. In years past, such a patient would be uninsurable for two years after the surgery. Now, if modern blood tests show the cancer is gone, the same man would pay no more for life insurance, McKay said.
"Our current understanding of the natural history of prostate cancer based upon extensive sophisticated studies is that older males with low-grade prostate cancer are much more likely to die with the disease than from it, thus enabling some men to obtain much better rates than would have been possible in the past," he said.
Sophisticated modeling of the interaction of illnesses and the odds that they will lead to death has made underwriting more of a science than an art.
McKay said it has enabled "underwriting shops to account for the many variables such as age, duration of disease, severity of disease, and type of treatment to be taken into consideration in generating a specific mortality risk for every applicant."
The same goes for insuring people with risky occupations -- or avocations.
The odds of dying in an airplane crash? One in 432,484.
Kevin Pledge, chair of the Society of Actuary's technology section, said risk analysis is full of serendipity. "You're answering questions you didn't know to ask," he said.
Consider a 55-year-old general aviation pilot. Years ago, Allianz would have charged $2.50 per thousand extra to insure the hobby pilot who flew solo 300 hours a year, McKay said. That amounts to an extra $1,250 a year in premiums on a $500,000 universal life policy.
Thanks to better information sharing and more powerful predictive computer models, the general aviation pilot today pays no more for life insurance than someone who's never been in a cockpit, McKay said.
Until a few years ago, Thrivent Financial for Lutherans offered lower life insurance rates for nonsmokers than for smokers. Either insurance applicants smoked or they didn't. But that distinction has grown more refined in the face of better information on other health factors, such as body build, blood pressure and cholesterol levels.
Today, Thrivent has three life insurance rates for non-tobacco users, a broad category that excludes smokers and chewers of tobacco, and two for tobacco users.
"We can charge rates that are even more closely related to the health status of the insured," said Neil Fackler, Thrivent director of life pricing.
Of course, all mathematical models still have their limitations.
"We're not going to be able to predict perfectly how long someone's going to live," Fackler said.
The odds of that happening may be lower than being hit by lightning in any given year: 1 in 700,000.
Mike Meyers • 612-673-1746