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ACTL3002 Life Insurance and Superannuation Models

Model Solutions to Tutorial 2


See Dickson et al. Solutions Manual for assigned problems.

1. (a)

35
7| a
(12)

(b) 120
a35:15
(c) 2

(2)
50
1/4| a

= 2v 1/4

1/4 p50

(2)

a
50+(1/4)

(12)
(d) 12 I (12) a 65
(e)

20:10
15| a

2. First, note that the probability of survival for t years under the new mortality table can be expressed
as
t
t
0
0
0
0
t px = px px+1 px+t1 = (1 + r) px px+1 px+t1 = (1 + r) t px .
Thus, the APV of a (discrete) whole life annuity-due can be evaluated as
a
x =

v t t p0x =

t=0

v t (1 + r) t px =

t=0

v 0t t px = a
0x

t=0

which is the APV of a (discrete) whole life annuity-due evaluated using the old mortality table but at
the rate of interest j where j satisfies
1+r
1
=
.
1+j
1+i
Solving for this new rate of interest, we get
j=

ir
1+r

provided i > r. [This requirement of i > r is to ensure we are not discounting at a negative interest
rate.] If r > 0, we would expect survival probabilities in the new table to be higher which will make
annuity payments to be more likely and therefore will increase the annuity value. For the annuity value
to be higher, then the discount rate must be smaller. Vice versa holds.
3. Note that, under Gompertz law, we have that the probability of survival for t years can be written as
 Z t



Z t
x
s
p
=
exp

ds
=
exp
bc
c
ds
t x
x+s
0

exp bc



x
t
c 1 / log c = ebc (c 1)/ log c .
t

Now, consider the substandard case. The probability of survival for t years in the substandard mortality
table can be written as
 Z t



Z t
0
0
= exp
x+s ds = exp (1 + k)
x+s ds
t px
0

= e

bcx (1+k)(ct 1)/ log c

=e

bcx+r (ct 1)/ log c

where r satisfies
cx+r = cx (1 + k)
1

=t px+r

or equivalently
r = log(1 + k)/ log c.
Thus, it becomes straightforward to see that
a
0x =

vtt p0x =

t=0

x+r .
v t t px+r = a

t=0

Note that the APV of life annuities decreases with age, i.e. the older one gets, the cheaper the cost
of life annuities is (generally). This is because survival becomes less likely as we age. Thus, in this
case where we have substandard mortality rates, survival is therefore less likely for substandard than
for the standard, in which case, we would therefore expect a cheaper cost of life annuities. To make
the cost less expensive, one could therefore rate up the age, as in this situation where Gompertz law is
assumed. [Indeed, you can extend this rating up of age principle in the case of Makeham law. Try it!]
4. By actuarial equivalence, we are required to solve for K from the equation
100000 = K
a10 + K

40
10| a

so that
K=

a
10

We know that
a
10 =
and that
a
50 =

= K
a10 + K v 10

10 p40

a
50

100000
.
50
+ v 10 10 p40 a

1 v 10
= 8.435332
d

1 0.32907
1 A50
=
= 17.44418.
d
0.04/1.04

Now, from the relationship


1
A40:10
= A40 v 10

10 p40

A50

we get
v 10

10 p40

1
A40 A40:10

A50

0.23056 0.01151
= 0.665664.
0.32907

Hence, finally we get


K=

100000
100000
=
= 4, 988.21.
8.435332 + 0.665664 (17.44418)
20.04729

5. We are interested in the probability that the present value random variable of the annuity exceeds the
expectation. Now we know that
1 eT (x)
a
T (x) =
.

Rt

Now under the constant force assumption, t px = e 0 x+s ds = e0.06t . Also, we know that the APV
of the life annuity is
Z
Z
a
x =
v t t px dt =
e0.06t .e0.04t dt
t=0
t=0
Z
=
e0.1t dt = 10 [0 1] = 10
t=0

So, the probability of interest is








log (1 10)
log 0.6
1 eT (x)
> 10 = P T (x) >
= P T (x) >
P

0.04

Given the constant force of mortality, we can easily obtain the distribution of the exact future lifetime.
We know that t px = P (T (x) > t), so that





log 0.6
log 0.6
P T (x) >
= exp 0.06
= 0.46476.
0.04
0.04
Thus, the required probability is equal to 0.4648. If the net single premium is a
x for the life annuity,
then it has the interpretation of the probability that the premium is insufficient to pay the benefits.

- End of Tutorial 2 model solutions -