What Is the Mortality and Expense Fee and How Does It Work?

Insurance companies charge various fees to cover costs and risks, one of which is the mortality and expense (M&E) fee. This fee is common in variable annuities and certain life insurance policies, affecting the overall cost of these financial products. Understanding how it works is essential for evaluating the true cost of an investment or insurance contract.

Since M&E fees impact long-term returns, knowing what they cover and how they are applied helps consumers make informed decisions.

Composition of the Fee

The M&E fee consists of multiple components that compensate the insurer for different costs and risks. While bundled under a single percentage, these charges cover distinct financial obligations.

Mortality Charges

A key component is the mortality charge, which accounts for the risk insurers take when guaranteeing certain benefits. In variable annuities, this charge ensures beneficiaries receive a minimum payout even if the account value declines. Insurers calculate these charges using actuarial projections based on life expectancy and historical mortality rates.

Mortality charges also fund death benefits that exceed the contract’s accumulated value. If an annuity holder dies while their investments are underperforming, the insurer covers the shortfall. These costs are spread across all contract holders, meaning those who live longer effectively subsidize those who pass away early. For contracts with higher mortality risk exposure, these charges can significantly impact long-term returns.

Distribution Expenses

Another portion of the M&E fee covers distribution costs, including compensation for financial professionals. Instead of charging an upfront sales fee, insurers recover these costs through ongoing deductions from the policy’s value.

Beyond commissions, distribution expenses include marketing, advertising, and training programs for sales representatives. Insurers also allocate funds to regulatory compliance measures required for selling annuities and life insurance policies. These costs continue throughout the policy’s duration, even if the policyholder no longer interacts with their financial advisor.

Administrative Costs

The final component covers administrative expenses such as record-keeping, transaction processing, customer service, and regulatory compliance. Insurers must maintain systems for tracking policyholder information, processing withdrawals, and generating account statements.

Administrative costs also include legal and regulatory requirements imposed by agencies such as the Securities and Exchange Commission (SEC) for variable annuities and state insurance departments for life insurance policies. Insurers allocate resources for auditing, reporting, and oversight. By incorporating these costs into the M&E fee, insurers sustain the infrastructure needed to support policyholders.

Contracts That Commonly Include It

The M&E fee is most associated with variable annuities, which require insurers to manage investment risk and contractual guarantees. Unlike fixed annuities, which provide stable returns, variable annuities allow policyholders to invest in sub-accounts tied to market performance. This introduces uncertainty for insurers, making the M&E fee necessary to offset financial exposure. Since variable annuities are designed for long-term retirement planning, these fees accumulate over time, increasing the overall cost of the contract.

Certain life insurance policies, particularly variable life insurance, also include M&E fees. These policies combine a death benefit with an investment component, allowing policyholders to allocate funds across different investment options. Because the cash value fluctuates with market performance, insurers charge M&E fees to account for the added complexity and risk. Unlike whole life insurance, where premiums and benefits are predetermined, variable life insurance requires active management, contributing to ongoing costs.

Group annuity contracts, often used in employer-sponsored retirement plans, may also include M&E fees, though they tend to be lower than those in individual contracts. Employers offering annuity-based retirement solutions rely on insurers for investment options and administrative support. While plan participants may not always see these fees explicitly listed, they are embedded within the annuity product’s expense structure.

Calculating and Deducting the Fee

The M&E fee is typically expressed as an annual percentage of the annuity’s or life insurance policy’s account value but is deducted periodically—often daily or monthly. This ongoing deduction reduces the contract’s value over time, meaning the actual cost fluctuates based on the fee rate and account balance.

For example, if an annuity has a 1.25% M&E fee and an account value of $100,000, the total annual charge would be $1,250. Since the fee is applied in smaller increments throughout the year, the deduction adjusts as the account balance changes due to investment performance and withdrawals.

Because the fee is a percentage rather than a fixed dollar amount, its impact grows as the contract value increases. If the same annuity’s value rises to $150,000, the 1.25% fee results in an annual charge of $1,875. Over time, this compounding effect can significantly erode returns.

Insurers deduct the M&E fee directly from the contract’s cash value, ensuring automatic withdrawals. While this simplifies the process, it also means investors may not always notice the gradual reduction in their account balance. Unlike surrender fees, which are explicitly listed in transaction statements, M&E fees are often embedded within the daily valuation of the contract. Some insurers provide detailed breakdowns in annual statements or online account summaries, but disclosure levels vary.

Tax Considerations

The taxation of annuities and life insurance policies with M&E fees depends on whether they are held in qualified or non-qualified accounts. For non-qualified annuities, earnings grow tax-deferred, meaning policyholders do not owe taxes on investment gains until they make withdrawals. The IRS applies the last-in, first-out (LIFO) method, taxing withdrawals as ordinary income rather than capital gains, which can result in a higher tax burden.

For individuals who surrender an annuity or take withdrawals before age 59½, an additional 10% early withdrawal penalty may apply under IRC Section 72(q), unless an exception is met. This penalty is levied on the taxable portion of the distribution, further reducing the net amount received.

Life insurance policies with M&E fees follow different tax rules. The death benefit paid to beneficiaries is generally income tax-free under IRC Section 101(a). However, if the policyholder accesses the cash value through loans or withdrawals, the tax treatment depends on whether the policy is classified as a Modified Endowment Contract (MEC) under IRC Section 7702A.

Disclosures in Policy Documents

Insurance companies must disclose M&E fees in policy documents, but transparency varies. These fees are typically outlined in the prospectus for variable annuities and life insurance policies, detailing costs, risks, and contractual terms. While the prospectus includes a breakdown of annual expenses, including M&E fees, understanding the long-term financial impact requires careful review.

Beyond the prospectus, insurers may include fee disclosures in annual statements and online account summaries. Some companies provide itemized breakdowns showing how much has been deducted for M&E fees over a given period, while others embed these costs within broader expense categories. Policyholders who want a clearer picture of their total costs should review these documents closely and ask their financial advisor or insurer for clarification. Since these fees affect investment returns, understanding their application helps individuals decide whether to keep, modify, or surrender a policy.