Why are preferred risk policies with reduced premiums issued by insurance companies?

Preferred risk policies with reduced premiums are issued to individuals who demonstrate better than average mortality or morbidity experience. This means that these individuals are assessed as being healthier or at a lower risk of illness or death compared to the general population, leading to a lower likelihood of the insurer having to pay out benefits.

The pricing of life insurance is heavily influenced by the insurer's estimation of risk. Those classified as preferred risks are likely to live longer due to favorable health metrics, lifestyle choices, and medical histories. As a result, insurance companies reward these individuals with lower premiums, reflecting the decreased risk that they represent to the insurer. This is an important concept in underwriting, as it allows insurers to segment their clientele based on risk factors, ensuring that those at a lower risk are charged appropriately.

The other options do not correctly relate to why preferred risk policies are issued with reduced premiums. For instance, having a higher face amount may indicate a higher level of coverage but does not necessarily mean the insured presents less risk. Similarly, a better ability to pay premiums does not translate into a lower risk profile, and worse than average mortality or morbidity experience clearly indicates a higher risk, which would typically result in higher premiums rather than lower.