Life-altering experience: the new mortality table for life products gives insurers the opportunity to develop more competitive products. (Mortality: Life/Health).

1941...1958...1980...2001. Once every 20 years or so, a new mortality table is developed for individual life-insurance products. The National Association of Insurance Commissioners approved the latest table, the 2001 Commisioners Standard Ordinary Table, in December.

After it is adopted by individual states, it will be the minimum valuation and nonforfeiture standard for new life insurance products.

Like its predecessors, the new mortality table reflects improvements in insured mortality. Continuing the trend from the 1980 CSO, the 2001 CSO is a family of tables. It includes sex-distinct and gender-blended tables, as well as smoker and nonsmoker versions. The three most significant structural changes in the new table are that it is a 25-year select and ultimate table; the final maturity age is 120, not 100; and there is no extended term table. Unlike the current table, which was developed during a time of great change in the design of life insurance products, the new one will not mark a major watershed in life insurance product development. There are no new products waiting in the wings, and mortality improvements already have been reflected in pricing.

Nevertheless, the new table will affect life insurance products, and different types of products will be affected differently. In examining the significance of the impact of the 2001 CSO, it is important to distinguish the effect of the table on product features and pricing from its effect on product structure. Although product features and pricing may not change significantly under the new table, product structure will change. Product structure changes are not uniform, however, and vary by age, sex and underwriting class.

The reductions are greater for men than women, and greater for nonsmokers than smokers. The following changes are expected:

* term insurance rates will be reduced;

* level term products will be available for longer periods at higher issue ages;

* statutory reserves and cash values for traditional life-insurance products will be decreased an average of 20%;

* minimum nonforfeiture values for traditional products will decrease;

* guaranteed cash surrender value for accumulation-type products will increase;

* premiums for paid-up additions will decrease;

* universal-life maximum expense loads and surrender charges will be reduced, as will be the guaranteed cost of insurance rates;

* net single premiums, guideline premiums and seven-pay premiums will be reduced, requiring more insurance per dollar of premium or cash value to meet the limitations on life insurance in the Internal Revenue Code; and

* tax reserves under section 807 of the IRS Code will also be reduced, offsetting a part of the pricing benefit of reduced statutory reserves.

Getting Started

The arrival of a new CSO table poses a significant strategic business challenge for all life insurance companies. The underlying mortality table is a fundamental part of the structure of all life insurance policies and all products must be brought into compliance by the Jan. 1, 2009, mandatory adoption date. The earliest products may appear in the market in 2004.

The conversion process will most directly affect a life insurer's product development. Life insurance portfolios are more extensive and complex than they were at the time of the last conversion 20 years ago. Competition is intense, and product development resources are scarce. These elements will add to the challenge.

Significant resources are needed for the conversion. A conversion strategy is key, as products can be converted on a plan-by-plan and state-by-state basis during the period from adoption of the table to the mandatory adoption date. Federal tax requirements will also affect this decision. The 2001 CSO becomes the "prevailing table" under the federal tax code and the basis for "reasonable mortality" under code section 7702 once it has been adopted by 26 states.

In developing a conversion strategy; companies will need to decide which products to convert to the new table. Once this is determined, the products will have to be repriced and the impact of the new table on product performance, profitability and competitiveness has to be examined. Companies will have to understand the effect of the changes and how those changes may differ under the various versions of the table. Insurers must provide for the following changes:

* reserves, cash values, dividends and nonforfeiture values will have to be recalculated;

* dividend strategies may need to be revised;

* new tax reserves and tax limits will need to be incorporated;

* policy forms must be updated and filed with the states; and

* administration and illustration systems must be updated and tested.

It is critical that companies not only address product-related issues, but also examine their product development process to eliminate inefficiency and maximize productivity. It is important for companies to remember that the implementation effort required for conversion is independent of the magnitude of the change. In other words, it takes as much effort to implement a 1% change in premium as it does to implement a 20% change. Because it is mandated by state and federal tax requirements, companies must adopt the table. The only choices relate to timing and portfolio structure.

Readiness Assessment

Regardless of the actual product changes, the conversion must be carefully planned and managed. A key first step is a readiness assessment; that is, a brief evaluation of a company's product portfolio and its product development process in anticipation of the new table. Both areas are critical to a successful conversion effort.

In planning for the conversion, life insurers will want to analyze the effects of the new table on existing products in their product portfolio. A product assessment is designed to determine the impact of the 2001 CSO on financial results, competitive positioning and product structure. Begin by determining the scope of the review, such as which products will be analyzed and whether the company is going to replace its entire portfolio or phase out some older products.

In a product assessment, baseline financials and competitive results for existing designs are established and financial and competitive results for comparable 2001 CSO products are analyzed. Two alternative measures which may be used are as follows:

* consistent profitability under both tables, and

* consistent competitiveness under both tables.

From the assessment, companies can measure the impact that the new table has on their existing products and can begin to develop appropriate changes to product structure to migrate the products to a 2001 CSO-compliant basis, while maintaining the relative competitive standing and profitability of their product portfolio.

The analysis prepared in the product assessment forms the basis for a portfolio conversion plan, a plan to convert or replace 1980 CSO products that prioritizes and outlines the conversion. It is a road map of product development activities that spans the period from the earliest permissible date of adoption to the final mandatory adoption date. The portfolio conversion plan maps the changes and how the corporate product strategy goals will be achieved.

The portfolio conversion plan is based, in part, on the premise that the existing product portfolio will be converted to the new table with changes based on optimizing current product designs. While the goal of the product readiness assessment is to analyze the effects of converting an existing portfolio of products, the magnitude of the product development effort presents an opportunity to focus on the broader issues of what changes will make the products more competitive. That may lead to product design and distribution changes that go far beyond the portfolio conversion. For example, one possible strategy may be to consider strategic alliances for products or product outsourcing. Outcomes of the product strategy review may include a plan to rationalize the product portfolio and implement a new product strategy.

Quality Improvement Opportunity

The product changes that will result are only part of the story The portfolio re-engineering should be a powerful motivation for companies to examine, improve and execute a new, much higher standard of quality within product development.

Process and quality improvement techniques give insurers a proven way to streamline the product development process so that products can be developed more quickly and efficiently, gaining competitive advantage in the marketplace. New product development can cost anywhere from several hundred thousand dollars to several million dollars of internal and external resources.

Another important objective is to create a workplace where improvement is continuous and the collective brainpower tends not only to today's execution but also to building the processes that give competitive advantage for tomorrow. If the product development process is reliably and consistently improved, it can become a competitive weapon. Given that the conversion will not result in fundamentally new products, advantage will fall to those who can deliver 2001 CSO-compliant plans with the best speed to market and the best value added to policyholders, producers and corporate shareholders.

The process assessment considers the design of a company's life-insurance product development process, the organization and leadership of its product development, project management expertise, the ongoing ability to improve and govern the product development process and the cultural aids and barriers to undertaking this change. Following such an assessment, companies should develop plans to accomplish the following:

* improve the product development process;

* provide the necessary leadership forums and formats to govern the transition and the resultant accelerated new product development process;

* implement process management that ensures that the new process will sustain the gains made, and continually improve; and

* provide project management to each product program and to the product development improvement project as a whole.

The benefits of establishing this clearly defined product development process will extend well beyond the conversion.

The implementation of the table poses a significant business challenge for all life insurance companies. The 2001 CSO provides companies with opportunities to determine their readiness, plan for their product conversion and revitalize and improve their product development process for this and future projects. Successful planning and preparation will result in good execution. The resulting improvements from both a product and a process assessment will have long-term benefits for a company's ability to gain and sustain a competitive advantage in the marketplace.

Christian DesRochers, is senior vice president, Aon Consulting, Insurance consulting Services.