What it means
When someone buys life insurance, the insurer screens them, so newly insured people tend to be healthier than the general population of the same age. For the first few years after the policy starts, their death rates are lower than average, a phase known as the select period.
After the select period ends, usually somewhere between two and fifteen years depending on the table, the benefit of that screening fades. From then on, the death rates depend mainly on a person's current age and no longer on how long ago they were underwritten, and those long-run rates are the ultimate part of the table.
Actuaries often publish a combined "select and ultimate" table, which has several columns for the early years and then a single ultimate column. Someone aged 40 who was underwritten one year ago has a different rate than someone aged 40 who was underwritten ten years ago, but after the select period the two share the same rate.
For a finance reader, the table matters because mortality rates drive the price of life insurance, annuities and pension promises. If a company assumes people will die sooner than they really do, it may overcharge for life cover and undercharge for annuities, and the reverse is also true.
The choice of table is a judgement. Tables are built from past data, and population health, medical progress and the mix of insured people all change, so companies review their assumptions regularly and add a margin of prudence.
Ultimate rates also feed into reserves, which are funds set aside to pay future claims. A small change in an assumed death rate, applied to thousands of policies, can move the required reserve by a large amount.
In practice
Real-world examples.
Example
A life insurer is setting premiums for a 20-year term product sold to people in their 40s. Its actuaries use select rates for the first five years and ultimate rates thereafter. The lower early rates reduce the premium in the early years, but the later rates determine the long-term cost.
Example
A pension fund trustee asks an actuary why the fund's liabilities rose by $12,000,000 after the mortality assumptions were updated. The actuary explains that the new ultimate table shows people living longer, so the fund expects to pay pensions for more years.
Example
A company buying a block of annuity contracts from another insurer checks which mortality table the seller used. The buyer prefers a more recent ultimate table, because outdated assumptions could understate how long the annuities will be paid and overstate the price it should pay.
Formula
Calculation
Expected claims cost = number of policyholders x ultimate mortality rate x benefit per policy
Net cost per policy = expected claims cost / number of policyholders
An insurer has 10,000 policyholders, all aged 60 and past the select period. Assume the ultimate table gives a mortality rate of 0.008 (0.8%) at that age, and each policy pays a $100,000 death benefit.
Expected deaths = 10,000 x 0.008 = 80.
Expected claims cost = 80 x 100,000 = $8,000,000.
Net cost per policy = 8,000,000 / 10,000 = $800 per year.
That $800 is the pure cost of claims before the insurer adds expenses, profit and a safety margin. The rate of 0.8% is an assumed figure used for illustration and is not taken from any real table.Case study
Seen in the real world.
Cedarpoint Life is a fictional insurer, and this story is illustrative. It sold a block of 5,000 whole-life policies, each with a $50,000 benefit, to people who were all aged 50 at the time of purchase.
For the first three years, the company's actual claims ran well below expectations, because the policyholders had been medically screened. The finance team was tempted to cut its reserve, but the actuary reminded them that the lower rates belong to the select period. In year four, the ultimate rate of 0.4% would apply, giving expected deaths of 5,000 x 0.004 = 20 and claims of 20 x 50,000 = $1,000,000.
Because the team used the ultimate rates for later years, the reserve stayed adequate, and claims in year four came in close to the $1,000,000 estimate. The illustrative lesson is that early favourable experience should not be extended into the future.
Watch out
Common mistakes.
- Using select rates for the whole life of a policy. They only apply in the early years after underwriting, and rates rise once the ultimate phase begins.
- Assuming one table suits every product. Annuity buyers tend to live longer than the general population, so annuity and life cover tables differ.
- Treating the table as fixed. Mortality improves or worsens over time, so tables need regular updating.
Questions
People also ask.
What does ultimate mean in this context?
It means the long-run rates that apply after the select period, when the effect of underwriting has worn off.
Who builds mortality tables?
Actuaries and industry bodies create them from large sets of insurer and population data.
Why does mortality matter to non-insurers?
Pension schemes, structured settlements and some lending products depend on life expectancy, so the same tables influence their pricing and reserves.
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