What it means
Life insurers promise to pay a sum when a policyholder dies, possibly decades from now. To make sure the money will be there, they hold reserves, which are funds set aside today to meet future claims.
The size of the reserve depends on how likely death is at each age, and the mortality table supplies that information. A table shows, for each age, the probability of dying within the next year, often written as a rate per 1,000 people.
Death rates are low at young ages and rise steeply later in life. Tables may be split by sex and by smoker status, since those groups have different experience.
The word valuation signals the purpose, since the table is used to value the insurer's liabilities, and regulators usually require it to be cautious, with death rates somewhat higher than the insurer expects in practice. This builds in a safety margin so reserves are likely to be enough.
In the United States, tables of this kind are developed by industry bodies and adopted by state insurance regulators. Companies also use their own experience tables for pricing, which are different from valuation tables.
A pricing table reflects what the insurer expects to happen and the competitive market, while the valuation table reflects the minimum standard set by regulation. Differences between the two help explain why reserves and premiums are not calculated in the same way.
Pension schemes use similar tables to estimate how long members will live and how much to set aside. The mortality assumption is one of the most important inputs, because people living longer raises the cost of lifetime payments.
Even a small change in the assumed life expectancy can shift a pension liability by millions of dollars. For non-specialists, the key point is that reserves are only as sound as the assumptions behind them.
When a regulator updates the prescribed table, insurers may need to adjust reserves, and that can affect profits and capital. Tables are updated from time to time as life expectancy and data improve.
In practice
Real-world examples.
Example
A life insurer calculates its year-end reserve for 50,000 term policies. The actuarial team applies the prescribed valuation table to each age group and adds the results to find the total.
Example
A regulator updates the prescribed table to reflect longer life expectancy. Insurers selling annuities, which pay income for life, find that they must increase reserves because their customers are expected to live longer. The actuary also reports the effect to the regulator and explains how the extra capital will be raised.
Example
A pension fund consultant tests how a one-year increase in assumed life expectancy affects a scheme's liabilities. The scheme's deficit rises by several million dollars, and the trustees discuss higher contributions.
Formula
Calculation
Expected death claims = number of policies x mortality rate x benefit; reserve for one year = expected claims / (1 + interest rate)
Suppose an insurer has 10,000 policyholders aged 50, each with a $100,000 policy, and the table gives a mortality rate of 0.005 (5 deaths per 1,000). Expected claims are 10,000 x 0.005 x 100,000 = $5,000,000. If the insurer assumes it earns 4% on its investments over the year, the amount needed today is 5,000,000 / 1.04 = $4,807,692. The mortality rate here is invented for illustration and is not from a real table.Case study
Seen in the real world.
Northbridge Life is an illustrative, fictional insurer with 20,000 term policies of $250,000 each, held by customers aged 45. Its actuary uses the prescribed table, which gives a death rate of 0.003 at that age.
The expected claims for the year are 20,000 x 0.003 x 250,000 = $15,000,000. Discounted at 4%, the amount needed today is 15,000,000 / 1.04 = $14,423,077.
In this illustrative story the regulator later adopts a table with a slightly higher rate of 0.0033. The expected claims rise to $16,500,000, which discounts to $15,865,385, and the finance director must find about $1,442,308 of additional reserves. The company decides to raise some of the money by retaining profit instead of paying a dividend that year.
Watch out
Common mistakes.
- Assuming the valuation table predicts actual deaths, when it is deliberately cautious and may overstate them.
- Confusing it with the pricing table, when insurers set premiums using their own experience and the market.
- Forgetting that mortality alone does not set the reserve, because the interest rate assumption also matters.
Questions
People also ask.
Who decides which table an insurer must use?
Insurance regulators prescribe it, and in the United States state regulators adopt tables developed by industry bodies.
Why are valuation tables cautious?
To give a margin of safety so that reserves are likely to be enough to pay claims.
Does the table apply to annuities too?
Annuities use mortality tables as well, but the caution runs the other way because the risk is that people live longer.
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