Mortality cross subsidy

Mortality cross subsidy

Actuaries calculate annuity rates assuming people will live until their normal life expectancy, but some policyholders will die before they are expected to and some will live longer than expected.

Insurance companies make a profit from those dying early and a loss from those living longer, but they use savings from the early deaths to subsidise the income paid to those who live longer than expected. This is called mortality cross subsidy.

Mortality cross subsidy is unique to annuities and clearly favours those in good health who may live longer than expected at the expense of those who die early.

To overcome this problem insurance companies offer enhanced annuities. Enhanced annuities pay a higher income for those who have a medical condition that may reduce their normal life expectancy (see section on enhanced annuities).