Annuity Mortality and Expense (M&E) Ratio Calculator

What exactly is an annuity mortality and expense ratio?

The Mortality and Expense (M&E) ratio is a recurring fee charged by insurance companies on certain annuity contracts, predominantly variable annuities. This fee compensates the insurer for the guaranteed elements of the contract and the operational risks they assume.

• Mortality: Covers the insurance risk, guaranteeing that if the annuitant dies, the beneficiary receives a minimum death benefit (usually the original investment amount), regardless of market performance.
• Expense: Protects the insurer against the risk that the administrative costs required to manage the contract over its lifetime will exceed their initial projections.

The fee is calculated as an annualized percentage of the annuity's account value and is deducted directly from the investment, ensuring the insurer can honor its lifetime payout guarantees.

What specific costs and risks does the M&E fee cover?

The M&E fee specifically covers two primary categories of risk and operational costs for the insurance company:

1. Mortality Risks:
   • Guaranteeing a basic death benefit to beneficiaries, even if the account value drops below the initial investment due to market loss.
   • Guaranteeing lifetime income payments, protecting against the risk that the annuitant outlives their life expectancy.
2. Expense Risks:
   • Administrative and operational costs of issuing, updating, and maintaining the contract.
   • Distribution costs, including marketing, issuing prospectuses, and compensating brokers or financial advisors via commissions.

If the actual costs of these guarantees or administrative duties exceed the collected M&E fees, the insurance company must absorb the financial loss.

What is the average annual M&E ratio for a variable annuity?

The average annual M&E ratio for a standard variable annuity typically ranges between 1.15% and 1.25% of the account's total value.

While the standard industry average sits around 1.25%, the exact percentage depends heavily on the issuing company, the specific share class of the annuity, and the base guarantees included in the contract.

How is the M&E ratio calculated and deducted from the account balance?

The M&E ratio is expressed as an annual percentage but is calculated and deducted on a daily basis. It is not billed as a lump sum or out-of-pocket expense; rather, it is continuously subtracted from the annuity’s underlying investment sub-accounts.

Here is how the calculation works:

1. The insurance company divides the annual M&E percentage (e.g., 1.25%) by 365 to determine the daily deduction rate.
2. At the end of each trading day, this daily rate is multiplied by the current net asset value (NAV) of your account.
3. The resulting fee is instantly deducted, lowering the daily unit value of your investments.

Because it is tied to the account balance, the actual dollar amount of the fee fluctuates. As your account value grows, the total dollar amount deducted also increases.

Does the M&E fee apply to all types of annuities or just specific ones?

The M&E fee does not apply to all types of annuities. It is primarily and almost exclusively associated with Variable Annuities.

• Variable Annuities: Carry an M&E fee because the policyholder's funds are invested in the market. The insurer must explicitly charge to cover the risk of market-driven losses affecting death benefits.
• Fixed Annuities: Do not have explicit M&E fees. The insurance company absorbs risks and costs by offering a slightly lower guaranteed interest rate than they expect to earn on their own corporate investments.
• Fixed Indexed Annuities (FIAs): Generally do not charge M&E fees. Like fixed annuities, administrative and mortality costs are baked into the product's design, such as interest rate caps or participation rates.

Can the insurance company increase the M&E ratio after the contract is signed?

Generally, no. Once an annuity contract is signed and issued, the core M&E ratio is locked in and contractually guaranteed for the life of the policy.

Insurance companies set the M&E ratio based on actuarial projections at the time of issuance. The "expense risk" portion of the fee specifically protects the consumer against future cost increases. If the insurer's administrative costs rise significantly a decade later, they cannot pass those operational shortfalls onto existing policyholders by raising the M&E fee.

However, it is important to differentiate the base M&E fee from underlying fund expenses or fees for optional riders, which occasionally have prospectus provisions allowing for adjustments within strict limits.

How significantly does the M&E ratio impact the long-term growth of the investment?

The M&E ratio creates a continuous drag on performance, which significantly impacts compounding growth over long time horizons. Because the fee is deducted regardless of whether the market goes up or down, it continuously reduces net returns.

Consider a $100,000 investment growing at a gross rate of 7% annually over 20 years:

In this example, the 1.25% M&E ratio reduces the final portfolio value by over $83,000. Investors must weigh the value of the annuity's death benefits and tax deferral against this substantial long-term reduction in overall wealth.

Is the M&E fee separate from underlying fund management fees and optional riders?

Yes, the M&E fee is entirely separate from underlying fund management fees and optional riders. It is just one piece of the total fee structure in a variable annuity.

A typical variable annuity has three distinct layers of fees:

1. M&E Ratio: Covers basic insurance guarantees and administrative risks.
2. Sub-account (Fund) Expenses: Managed by third parties, these mutual fund-like accounts charge standard expense ratios (typically 0.25% to 1.00%) for portfolio management.
3. Optional Rider Fees: If you add enhancements like guaranteed lifetime withdrawal benefits (GLWB) or an upgraded death benefit, the insurer charges an additional fee (often 0.50% to 1.50%).

When combined, the total annual costs for a variable annuity can easily exceed 2.5% to 3.0% of the account value.

Are there specific annuity share classes that offer lower M&E ratios?

Yes, the M&E ratio varies significantly based on the specific share class of the variable annuity, which dictates how the selling broker is compensated and how long the surrender period lasts.

• B-Shares: The most common class. Features a standard M&E (around 1.25%) and a typical 5- to 7-year surrender charge schedule.
• L-Shares: Offer a shorter surrender period (usually 3-4 years) but compensate for this flexibility by charging a higher M&E ratio (often 1.50% to 1.70%).
• C-Shares: Have no surrender charges, providing total liquidity, but typically carry the highest M&E ratios.
• I-Shares (Advisory): Sold by fiduciary advisors who do not earn commissions. These feature the lowest M&E ratios (often 0.15% to 0.40%), making them highly cost-effective.

Can the M&E fee be negotiated or eliminated by the insurance provider?

For the average retail investor, standard M&E fees cannot be negotiated. Annuities are heavily regulated, and their fee structures are filed with state insurance departments, meaning insurers must charge the exact rates outlined in their prospectuses uniformly to all buyers.

However, you can effectively reduce or eliminate traditional, high M&E fees through your purchasing strategy:

• Buy Direct: Purchasing directly from low-cost providers strips out the traditional commission costs, drastically lowering the M&E fee.
• Fee-Based Annuities: Working with a Registered Investment Advisor (RIA) grants access to "I-share" annuities. Because the advisor charges a separate management fee, the insurance company eliminates the commission-funding portion of the M&E ratio, lowering it to a nominal amount.

Sources

• SEC: Variable Annuities: What You Should Know
• FINRA: Annuities Overview
• Investopedia: Mortality and Expense Risk Charge (M&E)

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