Net Amount at Risk: What it is, How it Works

What Is Net Amount at Risk?

The net amount at risk is the monetary difference between the amount of money paid out for a life insurance policy and the accrued cash value paid for it by the insured individual. The net amount at risk number is critical to insurance companies as it represents how much of the policy has been paid for before it has to be distributed, which impacts the profitability of the company and how it manages its reserve balances.

Understanding Net Amount at Risk

When an individual buys an insurance policy, they pay for it through insurance premiums on a monthly, quarterly, or annual basis. These payments grow over time and represent the accrued cash value an insured individual has paid into their policy.

The death benefit—the amount paid out on a policy holder's death—is a set amount. This is the amount of life insurance a person chooses to buy. For example, a person might buy a $1 million life insurance policy, which will pay $1 million upon that person's death. If the policyholder passes away early into the life insurance policy, the amount paid into it will be small compared to the amount paid into it if the policyholder passed away at a much later point in life. The difference between the amount paid out and the amount accrued is the net amount at risk.

For example, if a policy's death benefit is $200,000, and its accrued cash value is $75,000, then the net amount at risk equals $125,000.

The accrued cash value in a permanent policy is designed to grow, and this growth reduces the net amount at risk in a policy, which keeps the mortality cost at reasonable levels.

As an example of this concept in action, consider a whole life insurance policy issued for a face value of $100,000. At the time of issue, the entire $100,000 is at risk, but as the cash value accumulates, it functions as a reserve account, which reduces the net amount at risk for the insurance company.

Therefore, if the cash value of the insurance policy rises to $60,000 by year 30, the net amount at risk is then $40,000. As the age of the insured increases, the net amount at risk decreases. Whenever a policy is in effect before the insured reaches the fully paid-up age, there will always be a net amount at risk.

Though life insurance is intended to apply to a policyholder's life, if a person lives past the age of 100, then the life insurance policy expires. The policyholder is paid their death benefit, which is taxed, and they are no longer covered. The age requirement of 100 was updated to 120 in 2001 for new life insurance policies.

Net Amount at Risk and Statutory Reserves

If an insured individual dies before their policy has been fully paid up, the insurance company is liable to pay this obligation. Therefore actuarial analyses must be accurate to be able to balance a company's reserves and its potential future obligations.

In the United States, insurance companies are required to keep statutory reserves. Statutory reserves are assets that an insurance company must have on its balance sheet that ensures that it can pay out claims on its future obligations. Statutory reserves are calculated using the Commissioner's Reserve Valuation Method (CRVM).

If an insurance company has a loss equal to its net amount at risk, this loss is compensated by the premiums of those who haven't died as yet and from income from invested premiums. The sum at risk is the difference between the death benefit paid and the reserves of an insurance company.