It's hard sometimes to escape the impression that life insurance is a macabre and cold-blooded business. In reality, the insurer's need to remain profitable is tied to the needs of its customers. When you buy life insurance, you're counting on your insurer to come through for your loved ones if worst comes to worst. If an insurer doesn't calculate its risks accurately, it might be unable to meet its financial obligations. The mortality table is the primary tool used to calculate risks.
The idea behind life insurance is deceptively simple. If you have a large enough group, you can predict how many of its members will die in any given year. You won't know who, specifically, though some are at higher risk than others. Insurance companies calculate premiums by placing an applicant in the appropriate group, such as male non-smokers, then applying pertinent factors such as age and family health history. If your health is poor you're more likely to die in a given year, and they'll charge you a correspondingly higher premium to reflect their increased risk of a payout.
NAIC Mortality Table
The life insurance industry gets a high level of regulatory scrutiny since any negligence could expose consumers to risk. Oversight is especially crucial when it comes to the companies' cash reserves. They're required to maintain enough liquidity to pay out their clients' claims, even in a bad investment year, but that takes money away from the company's bottom line. So, rather than letting each insurer weigh self-interest against responsibility, the National Association of Insurance Commissioners publishes an official mortality table for all companies. The size of an insurer's investment pool must be calculated from the standard NAIC mortality data.
How They Work
The mortality tables show how many more years people will live, on the average, at any given age. For example, if you're a 25-year old female as of 2012, you can expect to live another 56.4 years on the average. The same table shows you can expect your 80-year old grandfather to be a raucous presence at eight more years of family get-togethers. Further data show the effect of various other risk factors, such as accidents and illness. For example, your likelihood of dying in a car accident is roughly 20 times higher than the likelihood of dying in an air crash.
The standard mortality tables must be used to calculate financial reserves, but companies are free to mine all available data in search of a competitive advantage. For example, some companies look for specific niches of good-risk clients within a bad-risk group. Those insurers offer coverage at normal or near-normal rates to survivors of some forms of cancer and other acute illnesses. Other companies go in the opposite direction. They refine a set of criteria that identifies unusually desirable low-risk clients, and target them with policies offering low premiums and a rich set of options.
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