The net amount at risk is the monetary difference between the death benefit paid by a permanent life insurance policy and the accrued cash value. For example, if a policy's death benefit is $200,000, and its accrued cash value is $75,000, then the amount at risk equals $125,000. The amount at risk determines the cost of protection provided by the policy.

Breaking Down Net Amount at Risk

In general, the 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 even though the actual cost per $1,000 of death benefit is growing every year. 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 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 its 30th year in force, the net amount at risk is then $40,000.

As the age of the insured increases, mortality cost per thousand dollars of the net amount of risk increases. As long as cash value continues to increase in a whole life policy, and those gains are greater than mortality costs and other expenses, a policy should continue to grow and remain in force.

Net Amount at Risk vs. Legal Reserve

If a life insurance policyholder dies before age 100, the insurance company loses the net amount at risk for that person's policy. This loss is compensated by the premiums of those who haven't died yet and from income from invested premiums. Since the sum of the net amount at risk and the legal reserve equals the face value of the policy, the net amount at risk and the legal reserve are inversely proportional. As the legal reserve increases, the net amount at risk decreases. The main purpose of the legal reserve is to provide lifetime protection, but because more money is collected in premiums in the early years of a policy than is needed to cover the mortality charge, level-premium policies develop a cash value, which the policyholder can borrow against, or can surrender the policy for its cash value if the policyholder no longer wishes to continue the life insurance policy. However, the cash value is initially less than the legal reserve because of deductions of sales expenses and other acquisition costs.