Module 8 Premiums 1 Module: Premiums Section 8.1 - Introduction In Module 6, we discussed how to find the actuarial present value of an insurance benefit. In Module 7, we developed the tools to find the actuarial present value of the annuity of premium payments for an insurance benefit, In this module we will use both the value of the benefit and the value of the annuity to find out what premium should be charged for the insurance. The text Actuarial Mathematics presents three methods for finding an insurance premium. Until the final section of this module, we will focus all our attention on the equivalence principle method, which we will introduce in the next section. This is the most important method for Exam M. In the final section of the module we will discuss the percentile premium method, since it is included in the exam readings. The third method presented in Actuarial Mathematics, the exponential premium method, is not included on the Exam M syllabus. As in previous sections, we will introduce basic concepts and principles for the fully continuous whole life insurance and follow that with a large number of variations for term, deferral and the discrete case. The Equivalence Principle The equivalence principle method requires that the expected joss for an insurance be 0, It is important to remember that an individual insurance policy can lose or make money for the insurer. Suppose that you sell an insurance where the premium is $19.17 per year for a $1000 benefit at death. If the insured dies in year 1, you will pay out far more in benefits than you ever got in premiums ~ in other words, you have a loss. If the insured lives for 60 years you will have received far more in premiums and interest earnings than the benefit you pay - and you make a profit. The idea is to find what premium gives you an average loss of 0. This premium is referred to as a benefit premium or a net premium. In practice, the insurer will calculate beneft premiums and add on additional ‘amounts for expense and profit, but we will cover that in a later module. EACTEX 2006 Exam M/ Exam 3 asset, Stewart, & Steeby2 Module 8 ~ Premiums We have already seen some simple premium calculations where the Payments are not made in annuity form. If you wanted to buy an insurance with a single payment at the time the policy begins, your benefit premium would be the actuarial present value of the insurance, and it would be called the single benefit premium. We have already seen exam problems which asked for the single benefit premium instead of simply asking for the actuarial present value. ‘SACTEX 2006 Exam M / Exam 3 Hassett, Stewart, & SteebyModule 8 ~ Premiums 3 Section 8.2 Fully Continuous Benefit and Premium Fully continuous means that both the insurance benefit and the premium payment are continuous. We begin with this basic benefit structure where the benefit is paid at the moment of death and the premium payments are also made continuously. Continuous Whole Life with a Continuous Life Annuity Premium Suppose a continuous whole life insurance with benefit 1 for (x) has a premium P which is paid with a continuous annuity. Then the loss function for this insurance is (8.1) A(t) Pa) From Module 6, v* Is the present value of the benefit of 1 paid at death. From Module 7, P(3a) is the present value of the annuity of premium that was received. In words, the loss function at time t is Loss at time t = [PV of benefit paid at t] - [PV of premiums paid in [0,t)] If the present value of the benefit is larger than the present value of the premiums paid for it, you are losing money. Suppose for example that F Keo) -| 05 and /= 0,06, Then, at time t ~ 0.05(8a) 1.0 For small values of t the value ((t) will be positive, indicating a loss. For large values of f the value of /(t) will be negative, indicating a negative loss, ie., again. For t=1: m=(4 1 3} —0.05(35) 1-v =|4_|-0.05 Fr 06 [iecoe5 8948 What this says is that for ¢=1, you have a loss of 0.8948. You only received one year of premium (0.05 paid continuously), but paid out $1 at @ACTEX 2006 Hassett, Stewart, & Steeby4 Module 8 ~ Premiums For t=25, [(25)= -0.4252. This negative value indicates a profit because the present value of premiums is greater than the present value of the benefit paid. This is common sense. If you sell life insurance, you make more money if death occurs later rather than sooner. The graph of I(t) is shown below. . Loss function it) The time of death, which determines whether there is a gain or loss, is 2 random variable T. This means the insurer’s gain or loss can be written as a random variable. 2 The insurer's loss random L variable depends on the time of death. As a random variable, L has an expected value E(L). If we are going to break even on the average, we need E(L)=0. Thus we are looking for the premium value P which makes E(L)=0. That is the eq lence principle. (8.3) Equivalence principle Find the premium value which makes E(L) = 0. | If we calculate E(L), we see that (8.4) F(L) = EW") ~ PE (3p) ACTEX 2008 ” Exam Mi / Exam 5 , Stewart, & SteebyModule 8 - Premiums Recall From Module 6: E(v") is the actuarial present value of the benefit of 1 paid at death. From Module 7 PE (ap) is the actuarial present value of the annuity of premium In words, this means: E(L) = APV of benefits ~ APV of premiums Of course there is a special notation for that premium. For a fully continuous whole life insurance it is denoted by P(Ax). The bar over the P indicates that we are making continuous payments, and the Ax in parentheses is the expected value of the insurance that is being purchased. The notation indicates what type of insurance is being purchased and the method used to pay for it. The formula you will use for Pak) under the equivalence principle is (8.5) You can derive it by setting the expected value of (8.5) equal to 0: 0=E(L) = Ev’) E[P (Ar) ar} = &v") P(A.) El) Ae-P(A)ae => P(Ar) = z Example (8.6) Let the remaining lifetime at birth random variable X be uniform fon [0,100] and 5=0.05. In Module 6, we showed that ‘Aso = 0.2771. In Module 7, we showed that ay = 14.458. Then As _ 0.2771 Bo 14.458 Note that Ue premium on $1 in insurance benefit is quite small. The premium on a benefit of 1,000 would be 01917 Ban P (Asc) 20007 (Aso) = 19.17 ACTEX 2006 Exam M / Exam 3 Hassett, Stewar:, & Steeby6 Module 8 ~ Premiums Remember that this is an expected value calculation! The premium will enable you to break even with a large number of policies on the average. If you have only one policy at this premium, it will lose or gain money depending on when death occurs. Important Note! Exercise 1: Let the remaining lifetime at birth random variable X be uniform on [0,110] and 6 = 0.06 ) Find 1000P | Answer: 14.53 Recall that for exponential random variables Ae = It follows that (8.7) Some Useful Identities —xam M may require variance calculations using the formulas (8.8) Exam M/ Exam 3Module 8 - Premiums 7 ‘These useful identities are derived as follow: Recall that Thus we find the important result fu) pa, a wy-f S| ("A -4,") J This can be further simplified, since we can use the identity 6a, + A. =1 to show that @ACTEX 2008 ~~ Exam M/ Exam 3 Hassett, Stewart, & Steeby8 Module 8 - Premiums Example (8.9) Let the remaining lifetime at birth random variable be exponential with w= 0.04. Let 5=0.06. Find P(A.) and v(t). Solution: By (8.7), P(A) = w= 0.04. For the variance we need 3 0.04 0.04 + 0.06 __0.04 - 1 0.04 + 0.06 0.40 =0.25 10.0 Applying (8.8), the answer is vy Ax As = 0.25 — 0.16 - (6a) (0.60) ‘You must know the terminology as well as the basic computational rules. For example, we mentioned earlier that when the equivalence principle is used the premium obtained is called the benefit premium. Keys to Success The next example is an exam problem which is a direct application of the equivalence method rules we have just presented. However the problem does not say “use the equivalence method” - instead, it asks for the benefit premium. If a problem says “find the benefit premium”, use the Equivalence Principle. @ACTEX 2006 Exam M/ Exam 3 Hassett, Stewart, & Steebyvodule 8 ~ Premiums Example (8.10) ¢ Fall 2001 #34 SOA/CAS For a fully continuous whole life insurance of 1: 0.04 c.08 ‘tne loss-at-issue random variable based on the benefit mium. wu é L pre Calculate Var(L). Solution: We will use (8.8): vil) = We find the components of (8.8) like we did in the last example. =—2 2 0.04+0.08 3 2 0.04 0.04+0.16 wie This problem illustrates the importance of the basic formulas for insurance and annuities we learned in Modules 6 and 7. If you know the basics, the premium problems follow. Other Fully Continuous Benefit Premiums There are a number of possible ways to design benefit premium mbinations. You might want to buy whole life but pay for it over the next n years. You might want to buy term for the next ten years and pay for it during that period. There is a wide range of possible combinations of benefit alans and payment plans. However, the reasoning we used for whole life will give premium results in the same way every time. If L is the 285 random variable, Z is the benefit random variable and Y is the payment nnuity random variable, we can find the premium P in the same series of ps that was used for the whole life case. = ACTEX 2006 Exam M/ Exam 3 Fassett, Stewart, & Steeby10 Module 8 ~ Premiums Exam Toolkit Finding the premium, P 1) Write L = Z-Py 2) Set E(L)equal to zero: 0=E(L) E(Z) - PE(Y) = E(Insurance) — (Premium)E(Annuity) E(Z) _ E(insurance) EY) E(Annuity) 3) Solve to get P We will now go through a list of five more insurance combinations. In each case we will go through the same series of steps: 1, We will go directly to the quotient described in step 3, above and tell you what the premium is. . Then, we will describe the special actuarial notation for the benefit premium and how that notation is developed. 3. Finally, we will give an example based on values already calculated in Modules 6 and 7. We will begin by restating the results from Modules 6 and 7. We will use these results in our premium examples. Remember that you can't do the Premium calculation if you don’t know how to do the preliminary benefit and annuity calculations. This is a good time to review those basics. Results from Modules 6 and 7. We repeatedly looked at problems where the remaining lifetime at birth random variable X was uniform on [0,100) and 5 = 0.05. We found that Aso = 0.2771 Rios = 0.1124 , = 05199 Asoia = 0.6323 Bs = 14.458 Byg3q = 7.354 To illustrate one more possibility we calculated 3,, good review for you to check this calculation.) 4.273. (It would be a Now we are ready to introduce more premium benefit structures. In the following sections, we will simply refer to the above example calculations as our uniform example. @ACTEX 2006 Exam M / Exam'3 Hassett, Stewart, & SteebyModule 8 ~ Premiums ut aryear Term Insurance For this insurance, the insurance benefit is n-year term and the payments are made as a continuous n-year temporary annuity. Insurance benefit is n-year term insurance payable at the moment of death, time 0 1 2 premiym — yj F—_F paid e Eontinuousty starateot B por yeor for avimum of. years (erat is, contindous temporary Senay The premium notation is Plata). The bar over the P indicates continuous Premium payments. The payments are made over the same term as the benefit indicated by the actuarial present value expression in parentheses. The premium calculation is (8.11) Tit our unifurin exampie 0.1124 => = 0.01528 7.354 ~ 9-0 @ACTEX 2006 - Exam M / Exam 3 Hossett, Stewart, & Steeby12 Module 8 ~ Premiums myear Endowment Insurance For this insurance, the benefit is an n-year endowment insurance and the payments are made as a continuous n-year temporary annuity Insurance benefit is n-year endowment insurance, payable at the moment of death or at t=n, wrichever comes frst; A> time ° 1 2 at 9 premium = \—y— vy WY nd oe gee per year (erat i, 2 sonuiy) The premium notation is P(Axa). The bar over the P indicates continuous premium payments. The payments are made over the same term as the benefit which is indicated by the APV expression in parentheses. The premium calculation is (8.12) In our uniform example P (Asia) = Av = = 0.08598 @ACTEX 2006 Exam M/ Exam 3 Hassett, Stewart, & Steedyscdule 8 ~ Premiums 13 t-aayment Whole Life this insurance the benefit is whole life and the payments are made as a guntinuous A-year temporary annuity. In other words, payments are made years in exchange for whole life coverage. Insurance benefit is whole life insurance, — Os 0 1 2 et time b + premium ees — ped Prema ? a ? P er year fore (ee, 2 sana) Tne premium notation is »P(Ax|. The bar over the P indicates continuous premium payments. The leading subscript indicates that payments are made as an h-year temporary annuity. The premium calculation is (8.13) [ In our uniform example 10P [Azo} 0.03768 Exam M/ Exam 314 Module 8 ~ Premiums payment year Endowment Insurance For this insurance, the benefit is an n-year endowment insurance and the Payments are made as a continuous h-year temporary annuity. Insurance benefit is o-year endowment insurence, payable at the moment of death or at t=n, whichever comes frst; A, prmiim WKF LH “ F B pee year moeimum at Gehaes Sn The premium notation is »P(Axa). The bar over the P indicates continuous. premium payments. The leading subscript indicates that payments are made as an h-year temporary annuity. The premium calculation is (8.14) In our uniform example GACTEX 2008 “Exam M/ Exam 3 Hassett, Stewart, & SteebyModule 8 ~ Premiums 15 aryear pure endowment For this insurance, the benefit is an n-year pure endowment and the payments are made as a continuous n-year temporary annuity. Insurance Beets n-yer pure endowment payable at = pony fave att = 0; A tme 9 mt ? um ay Lo . — F 7 ® since P per year ae Sum ot wet sree ‘The premium notation is Bla a): The bar over the P indicates continuous premium payments. There is no leading subscript and the temporary annuity of premium payments has the same term as the pure endowment. The premium calculation is (8.15) ale In our uniform example Exercise 2: Let the remaining lifetime at birth random variable X be uniform on [0,110] and 6 = 0.06. Find P(Azs), :0P (Azs} and P(Asoza) . Answer: ____ 0.01452, 0.02737, 0.08091 ACTEX 2006 Exam M/ Exam 3 Hassett, Stewart, & Steeby16 Module 8 ~ Premiums More General Applications of the Equivalence Principle In the preceding sections we have looked at a simple scheme that works When the benefit and the payment annuity are level with amounts of 1. There are exam questions in which either the benefit or the annuity (or both!) are variable, as we will see in the example on the next page, taken from the Spring 2000 exam. This is tougher than the calculations in the preceding sections, but was on an exam and we need to deal with it. ‘ACTEX 2006 ‘Exam M/ Exam 3 Hassett, Stewart, & SteebyModule 8 - Premiums 7 Example (8.16) + Spring 2001 #32 _SOA/CAS For a fully continuous whole life insurance on (x): 1. The level premium is determined by the equivalence principle. Death benefits are given by b, = (1 + /)' where iis the interest rate. 2. 3. Lis the loss random variable at time of issue. 4. Tis the future lifetime random variable for (x). We will derive an expression for the loss random variable L with the new benefit b: If the benefit is variable, then the present value of the benefit for death at time tis bv’ (instead of v"), Then the loss random variable becomes Note that we were given b; Thus we have the simplification, V! -B(gs) =1-B(3a L= by" -P( Ban). (This isa standard prosiem tick.) Now we will find F, the premium determined by the equivalence principle. ‘Remember that this s a variable benefit; this means none of our previous notations apply since the previous ‘notations are used where the benefit is level at 1. Applying the equivalence principle we have = E(L) =1- Pe (a) Now we can simplify L. Remember that 3; the expression for P, we have L The basic identity a, ="—* tells us that the denominator of the expression for £ is 1~A, and that the first part of the numerator is 63, -1=-A,. thus vi-A L An 1-A, This final expression was one of the multiple choices. @ACTEX 2006 Exam M/ Exam 3 Hassett, Stewart, & Steeby18 Module 8 - Premiums Section 8.2 - Fully Discrete Benefit Premium As we cid in Modules 6 and 7, we proceed to the fully discrete case in which premiums are paid at the beginning of the year and benefits are paid at the end of the year of death. Once again, the discrete case follows patterns similar to the continuous and we will move through it more rapidly. Fully Discrete Whole Life Benefit Premiums The premium for this insurance is denoted by P,. The absence of the bar over P indicates discrete, not continuous payments. The absence of a continuous A.in parentheses indicates that the benefit is discrete and paid at year end: for discrete benefits only subscripts are used. Recall that for discrete insurances and annuities we look at the random variable K(x), the curtate lifetime random variable. For a specific value k of K(x), the loss function for this insurance is (8.17) Tk) = —P (ea) If K =2, the timeline for the individual loss would look like this: Insurance benefit is payable at the end of the year of death, Ay benent 1 Payment occurs premums py he oO LS Death occurs 12,3) For K = 2, the specific value of (k) would be 1(2) = v? - P, (a3) Since K(x) is a random variable, the insurer's loss is actually a random variable £ such that (8.18) @ACTEX 2006 Exam M / Exam 3 Hassett, Stewart, & SteebyModule 8 Premiums 19 Applying the equivalence principle we see that 0= E(t) EU") — PE (Sq) =A Pedy (8.19) (8.20) Example (8.21) We return to the Illustrative life table segment used in Module 7. Find Pesand V(L), where L is the loss function for (65). k y 1000q, ay 10004, _1000(7A,, 0 65 7,533,964 21.32 9.8969 439.80 236.03 1 66 7,373,338 23.29 9.6362 454.56 249.20 2 67 7,201,635 25.44 9.3726 469.47, -262.83 3 68 7,018,432 27.79 9.1066 484.53 276.92 4 69 6,823,367 30.37 8.8387 499.70 291.46 5 70 6,616,155 3318 8.5693 514.95 306.42 Acs _ 0.4398 Pes = SE = 0.0444 OSs 9.8969 4 V(L) = A = Ass (d-des) __ 0.23603 ~ 0.4398? "06 | sr ial 8969)| = 0.1358 ‘GACTEX 2008 xem M/ Exam 3 Hassett, Stewart, & Steeby20 Module 8 ~ Premiums Use the Illustrative life table to find Pj, and V(L), where L is the loss function for (67). Answer: 501; _v{u)=0.15074 Other Discrete Benefit Premiums There are formulas analogous to (8.11) - (8.15) for the discrete versions of benefit premiums. These are listed below. You can remember them and understand the notation by comparison to the continuous case. Fully Discrete Benefit Premiums (8.22) —nevear term insurance (8.23) —_n-year endowment insurance (8.24) h-payment whole life (8.25) —_h-payment n-year endowment insurance »P.ay (8.26) n-year pure endowment Pa Example (8.27) In Module 6, we used the Illustrative Life Table to find Ais = 0.06082. In Module 7, we found that 55 = 2.7737, Ass _ 0.06082 S.08082 _ 0.0219 3 27737 Exercise 4: Use the Illustrative life table to find .Pis. Answer: 0.1586 @ACTEX 2006 “Exam M / Exam 3 Hassett, Stewart, & SteebyModule 8 ~ Premiums 2a Geometric Series Problems We discussed the geometric distribution in Modules 2 and 3. When the probability function of K(x) is geometric, we can find A, using a geometric series and then find d,and Py. This computational trick Is a good candidate for an Exam M question. It is used in the Actuarial Mathematics readings (see example 6.3.1 in Important Note! | Actuarial Mathematics). The following example illustrates it Example (8.28) Let P(K(x) =k) = kPx Gear = 01x = 0.02(0,98)", k =0,1,..., and i =.05, Then = 1 1 2d A #9 gy = 0.02. + 0,02(0.98) +z + 0.02(0.987 5 + ye Tog * COS) T ogr +0-02(0-98)' Togs o2| 1 | 1.05], _ (0.98), 1.05} You may have recognized the general pattern here. It is probably not worth memorizing, but one could prove in general that if P(K(x) = k) = pq* then lei 4=sS, P= se pei isi Exercise 5: Work through Example 6.3.1 on page 181 of Actuarial Mathematics. It is also a problem with a geometric distribution for K(x), although it is stated less directly @ACTEX 2008 Exam M/ Exam 3 Hassett, Stewart, & Steeby22 Module 8 ~ Premiums Section 8.4 - Semicontinuous Benefit Premiums A realistic assumption for insurance is that the benefit is paid at the moment of death but payments are made at the beginning of each payment period. That would give a continuous benefit with a discrete annuity payment. The term semicontinous is used to describe this situation. If K = 2, the timeline for the individual loss would look like this. Insurance benefit is payable at the moment ofthe year of death, Ay benef 1e—__ Payment occurs at ‘moment of death premiums — ome 6 ry ae Whole life with continuous benefit and beginning-of-year discrete life annuity premiums is denoted by P(Ax}. The lack of a bar on the P indicates discrete Premium payments and the A. in parentheses indicates payment at time of death. The calculation (as you would expect) is (8.29) ums of interest are listed below. The table below is presented for completeness, not for memorization. If you know the fully Continuous case you can logically build all the Important Note? | other tables by imitation. ‘Semicontinuous Benefit Pret (8.30) n-year term insurance (8.31) —_n-year endowment insurance, (8.32) h-payment whole life | (8.33) —_h-payment n-year endowment insurance L ACTEX 2006 Hassett, Stewart, & Steeby Exam M/ Exam 3Module 8 ~ Premiums 23 If you are given a discrete life table calculation of P, you can adjust it to a i more realistic semicontinous basis by using the fact that Ax ~ L.A, under the UDD assumption. This yields (8.34) Similarly, we can obtain (8.35) The endowment insurance is trickier. The important relation here is (assuming UDD) Asa The pure endowment component is not adjusted for continuity Because it involves a single discrete payment. The relation for the premium is (8.36) P(A sii Example (8.37) In Example (8.21), we used the illustrative life table to show that Pis = 0.0444, If we assume UDD, it follows that 5. 0.06 P Tarp pay (0:0444) = 0.04: (Ae) in(a.ogy (°-0444) 8? This is important. The premium needs to be larger than the discrete value that was calculated from the life table because the benefit is paid sooner. ‘ACTEX 2006 Exam M / Exam 3 Hassett, Stewart, & Steeby24 Module 8 - Premiums Exercise 6: Assuming UDD, use the Illustrative Life Table to find P(As7) Answer: 0.05158 @ACTEX 2008 Exam M/ Exam 3 Hassett, Stewart, & SteebyModule 8 - Premiums 25 Section 8.5 - m-thly Benefit Premiums The last step in our huge collection of formula sets deals with m-thly premiums. This makes sense if you think about how people buy insurance. My own insurance payments were deducted from my paychecks every two weeks, and most of my friends had the same situation. Probably, the most widely applicd combination of benefits and premiums for life insurance is a benefit paid at moment of death (or as nearly as possible) and m-thly premium payments (usually per paycheck). With this in mind, it is worth reviewing why we have introduced so many premium benefit combination: + We had to study the continuous case because of the continuous nature of the benefit. + We had to study the annual case because the life tables are annual, and life tables contain the basic information about mortality. + In the last section we had to study how to adjust the life table results to calculate continuous benefit values. Now we need to take the final step of learning to adjust the life table results to better model the m-thly case of premium payment. To see ail this in practice, we will return to the Illustrative Life table. Using the basic annual data, we calculated a fully discrete whole life premium. benefit for age 65. Ass _ 0.4398 fs = 0.04444 Be” 9.8969 Pos = Both the numerator and the denominator of this benefit premium are not cumpicicly ‘eiisiit, We Know citet the benefit is typically really cioser to continuous. For the Illustrative Life Table /=0.06 and 6 =In(1.06) = 0.05827. The present value of the benefit is more realistically calculated as (0.4398) = 0.45286 ( 0.06 0.05827 The more realistic present value of the benefit is higher than the life table value because the benefit is paid sooner than year end. We know thet the premium is more likely to be m-thly. Suppose that m= 12 for a monthly paycheck deduction, We will need i‘? = 0.05841 and d") — 0.05813, since they are used to find the m-thly annuity value. We calculated i"! and d'" in Modules 6 and 7. This would be an excellent time to review those calculations. ‘@ACTEX 2006 Exam M/ Exam 3 Hassett, Stewart, & Steeby26 Module 8 ~ Premiums Recall that m 1A ‘ 1 where Al") 7 For our situation, ye = (2:26 45177 | soseaz|(0-4398) = saz) __ 1- A _ 1-0.45177 ag = 15045177 _ 9.43110 qt 0.05813 ° Note that this monthly annuity is lower in value that the annual life table value of dys = 9.8969. We can use these two adjusted values to get a more realistic premium. Using an obvious extension of the notation, we call this more realistic premiuin P(A.) The absence of @ har on the P and the superscript of 12 Indicate discrete monthly premium payments, and the Ass indicates that we are providing a continuous whole life benefit to (65). The calculation is Acs _ 0.45286 pi? (Ags) = 2 = SO (A a 9.4311 0.04802. The premium has increased as we moved from the annual payment to the more realistic monthly payment. Don’t get confused here. When you calculate the m-thly premium, you are calculating the annual premium paid mthly. Caution! This means that the insured will never see this annual premium directly. The insured will pay one-twelfth of it each month. The original numerator of Pzswas too low and the denominator was too high. ‘The decimal numbers here do not indicate the practical significance of the difference. On a policy for $1,000,000 the premium P,swould be lower than the more realistic premium P\ (Aes) by $3,690 per year. In the following pages, we will present another huge array of formulas. This seems forbidding, but it is built on a simple foundation: + The premium under the equivalence method is always the present value of the benefit divided by the present value of the annuity stream ‘@ACTEX 2006 Exam M / Exam 3 Hassett, Stewart, & SteebyModule 8 ~ Premiums 27 + You know how to get the present values required either from the life table (in the annual case) or by integration (if a survival model is given). + You can adjust the life table numbers using the simple steps involving 6, *” and d'”outlined above. ‘The next exercise gives you a chance to review the process. Exercise 7: Use the Illustrative Life Table to find P% (Aer) Answer: 0.05427 There is one more notation that will be included in our final set of tables because it appears in Actuarial Mathematics. We have already implicitly introduced the notation. (8.38) Ay an x Actuarial Mathematics also introduces a notation for the premium when the benefit is paid at year end but the payments are made m-thly: (8.39) | An Pal Pin = Note that this notation uses subscripts instead of parentheses with a benefit Present value symbol. The following tables complete the array of Premium benefits studied in this module. Do not memorize them. Read through them to be sure that you know the basic facts about benefits and annuities and how to put them together to get the premiums. Keys to Success Logical development beats memorization here @ACTEX 2006 Exon M/ Exam 3 Hassett, Stewart, & Steeby28 Module 8 ~ Prem ums m-thly Premiums ith Benefit Payable at Moment of Death (8.40) —_n-year term insurance po (As) (8.41) _n-year endowment insurance POA, (8.42) __h-year payment whole life (8.43) _ h-year payment n-year endowment insurance (3.99) rryear erin insurance (8.45) __n-year endowment insurance (8.46) _h-year payment whole life (8.47) _ h- year payment n-year endowment insurance ,P'7) = Sea Note that in every one of these m-thly cases, you are calculating the total amount of annual premium that will be divided by m to get the actual m-thly payment. Important Note! (8.46) and (8.47) involve payments over A years, but they are not h-payment. There are fhm payments in the h years. @ACTEX 2006 Exam M/ Exam 3 Hassett, Stewart, & Steeby$~ Premicms 29 Section 8.6 Applying the Equivalence Principle to Variable Benefits “arial exams have problems in which the preceding formulas cannot ly applied since the benefits have some additional features. One ture is the return of premium feature: you get your premiums back point, and that makes the insurance seem as if it were a bargain 2e of feature is a popular sales tool for agents). The next two pages :xam problems that apply the equivalence principle to return of 7 Exam M / Exam 3 ~ Stewart, & Steeby30 Module 8 ~ Premiums Example (8.48) + Fall 2001_ #12 SOA/CAS A fund is established by collecting an amount P from each of 100 independent lives age 70. The fund will pay the following benefits: + 10 payable at the end of the year of death, for those who die before the age of 72, or +P, payable at age 72, to those who survive. You are given: . Mortality follows the Illustrative Life Table. 0.08 Calculate P using the equivalence principle. Solution: A single premium of P is paid initially. To apply the equivalence principle we will solve for P using the equation P = APV of future benefits To find the APV, we first review the benefits to be paid, 10 10 Time ase 70 a Re oe Probability of payment gin oan prop ‘Note that Pro Br = 2Pro, the probability that an insured will survive two years and collect survival benefit P. The g-values needed are given directly in the Illustrative Life Table and we obtain the necessary p-values from them. Gro = 0.03318 — pr = 0.96682 qn = 0.03626 — py = 0.96374 ‘The actuarial present value of future benefits is 10[vgro +¥? Progr] + PY? DroPn ~ 19 |2:03318 o2seen(.cvezs {0-26een(0 96374) 1.08 1.087 1.087 0.60778 + 0.79884P Applying the equivalence principle we have .60778 + 0.79884P — 02 @ACTEX 2006 Exam M / Exam 3 Hassett, Stewart, & SteebyModule 8 - Premiums 31 Example (8.49) ¢ Fall 2001 #40 soa/cas For a special fully discrete 10-payment whole life insurance on (30) with level annual benefit premium 77 : ') The death benefit is equal to 1000 plus the refund, without interest, of the benefit premiums paid. ii) Aw = 0.102 iii) 19 Aso = 0.088 iv) UA) gq = 0.078 VY) Ssg3q = 7.747 Calculate 7. Sout To apply the equivalence principle, we set APV of premiums = APV of benefits APV of premiums — TrSsqiq = 7.74777 APY of benefits Without knowing exactly what lies ahead, itis still clear that this is where you will use the rest of the information given. We first make a table to review the situation, Death Benefit 1000 1000 «1000 ++ ~— 1000 1000 Return of Premium ” anon tor t00r 3 10 1 Ase 300k 320033 ao ate Tite Geath benefits show that the insurance is whole life for 1000. Its APV is 1000As9 = 102 The return of premium shown in the timeline is an increasing annuity for 10 years. This is where we get to use (iv). The APV of the increasing annuity in those first ten lines is (IA) y:q = 0.07877 Finally, the return of premium in the timeline shows that starting in ten years there is a lifetime benefit at death of 1077. This is a ten year deferred whole life benefit of 1077. Its APV is 1077 1g Aso = .8877 Adding the benefit components we find thet the APV of future benefits is 102 + .887 — .078r7 = 102 + 95817 Applying the equivalence principle gives the equation 7.747 = 102 +.9587 — m7 =15.024 SACTEX 2006 - ~ Exam M / Exam 3 Hassett, Stewart, & Steeby32 Module 8 ~ Premiums Section 8.7 The Loss Function and Percentile Premiums We #2ve already discussed the loss random variable L. Recall that for fully cont “uous and fully discrete whole life, the loss functions are given by Continuous: L=v' -P(a) Discrete: Lav" —P, (azq). In th2 example on the next page, we will look at a life table loss function for 2 30 year old in some detail ace < 2006 Exam M/ Exam 3 Hasses:, Stewart, & Steeby= Premiums Example (8.50) ing the Illustrative Life table for (30) a) Find Pay b). Graph the loss function, /, for (30) as a function of k, the curtate etime. Find the probability that an insured 30 year old with this premium will have 2 loss. 2 Py = Ae a 010288 o.o06463 Gn 15,8562 ‘The loss function as a function of k is 1(k) =v" ~ 0.006463 (8a) For example, an individual with a curtate remaining life of 38 years has 1(38) = (&y — 0.008463(aa) .00064 Simitarty, 1009) -(| ~ 0.006463() = ~0.005859 We used a spreadsheet to calculate values of /(k) and create the following graph. ‘Loss Funetion for (30) ©) This graph illustrates a point that we made earlier. Note that the loss function eventually becomes negative. Our previous calculations of / for = 38 and # = 39 show that | first becomes negative for k — 39. 30 year id people with this benefit premium will produce @ foss if they live 38 more Jeate oF ess, and 2 gain if they live 39 additional years or more. Thus the Srobabilty of 2 loss is simply the probability that the curtate remaining fetime is less than or equal to 38 Plioss) = P(K < 38) =1~P(K > 38) ta _ 6.823.367 9 r615 he 9,501,381 Exam M/ Exam 334 Module 8 ~ Premiums In the previous example, we found the premium using the equivalence method, and then calculated the probability of a loss for an individual insured risk. With the percentile premium method we specify what we want the probability of a loss to be, and then find the smallest premium that would give that desired probability of loss. We illustrate this in the next exemple. Example (8.51) Using the Illustrative Life table for (30), find the smallest premium 7 such that the probability of a loss is at most 10%. Use the table interest rate of 6%. If (k)>0 and Ik +1) <0, the probability of @ loss at age 30 is P(K(30)Sk), 25 we saw in the last example. We need to find the point in the table where that probability crosses over from less than 10% to greater. In other words, we need to find the largest remaining lifetime such that P(K(30)< k) < 0.10. We saw in the last example that P(K k)=1~ c2Po0 Thus we look for the largest value of k that has koi P30 = estes > 0.90, that is: Irayees > 0.9039 = 0.90(9, 501,381) = 8,551, 242.9 The value 8,551,242.9 falls in between Isgand sy which correspond to k=26 and k=27. We will check the relevant probabilities for these values of k to make our point, but such a check should not be needed Once you know this material well. fxs _ ,_ 8,563,435 P(K < 26) =1~ 26pm = 1-H = 1 - 32082 (k $26) P: ho 9,501,381 ly _ 8,479,908 P(K £27) =1~ arp = 1-22 = 1 - 8479908 (ks27) P: lo» 9,501,381 0987 1075 It is now clear that k=25 is the largest remaining lifetime that gives @ loss probability less than 10%. ‘The next step is to find the premium 77. We do this by setting the loss function equal to 0 for k = 26. When we do this the only losses will be Incurred by those with Ks25. v L=v ~1(aq)=0- 7 0.0148, Note that this premium is more than double the equivalence principle premium of the last example. To get a smaller probability of individual Joss, we have to lower the age at which the loss changes to positive from negative. You need a higher premium to lower that age point. “@ACTEX 2008 Exam M/ Exam 3 Hassett, Stewart, & SteebyModule 8 - Premiums 35 Exam Toolkit Here is a recap of the steps a life table percentile premium problem. If you are using a life table to look for the smallest premium 1 which has a probability of loss p for age x, 1) Calculate (1 — p)l, 2) Find the remaining lifetime k such that Vee > (L= p) le > Levees 3) Set the loss function for k, L 3) =0 to get mr. Exercise 8: Using the Illustrative Life table for (60), find the smallest premium such that the probability of a loss is less than 20%. - Anewer: 0.0630 The continuous case can be much simpler, especially if we use a simple survival model like the exponential. (We did the life table approach first because it is closer to real application). The next example shows a simple exponential. Example (8.52) Let the remaining lifetime at birth random variable be exponential with w= 0,04, Let = 0.05. For age (30), find the smallest premium 77 such that the probability of a loss is less than 50%, Solutio Note that due to the memoryless property of the exponential random variable the ege (30) is irrelevant. The remaining lifetime T at any age is exponential with 4 = 0.04. We first find the age t such that P(T (1~ Pl > Fenct 3) Set the loss function for k, | = v*" — rr(dzq) = 0 to get 7 m, 7, Does Not fy the Equivalence Principle | Whole Life when the Pre Continuous Case: Lav" =n (an) E(L) = Ax - 77x Ad) ‘@ACTEX 2006 - Exam M / Exam 3 Hassett, Stewart, & SteebyModule S - Premiums 45 Section 8.11 - Module 8 Practice Problems Problem Set A 1. Let the remaining lifetime at birth random variable be uniform on [0, 95] and &=0.05. Find 5,000P (Av). 2 Using the Illustrative Life Table with / = 0.06, find Poza. 3. Given A, = 35, Ann =0.42, £, = 0.55, and /=0.05. Find »P,. 4. Using the Illustrative Life Table with 7 — 0.06, find V(L) where L is the loss at issue random variable for a whole life discrete insurance issued to (55). 5. Assuming deaths are uniformly distributed over each year and using the Ilustrative Life Table with 7 = 0.06, find P(Acs) . 6. The remaining lifetime at birth random variable is exponential with y = 0.04. If 5 = 0.06, find P(Azoza)- @ACTEX 2008 Exam M/ Exam 3 Hassett, Stewart, & Steeby46 Module 8 ~ Premiums Problem Set B 1. For @ special 2-payment whole life insurance on (70) i) Premiums are 7 at the beginning of year 1 and g at the beginning of year 2. ii) The death benefit of 1,000 is paid at the end of the year of death. i) Mortality follows the Illustrative Life Table iv) 7=0.06 Calculate 17 using the equivalence principle. 2. For a special 3-payment whole life insurance on (50): 1) Premiums are 77 at ne beginning of years 1, 2, and 3. ii) Death benefit is paid at the end of the year of death iii) If death occurs in the first 3 years, the death benefit is 1,000 plus refund of premiums without interest. Otherwise, the death benefit is 1,000. iv) qo = 0.01, gs: vy) i= 0.02, gs2 = 0.03, As) = 0.35 0.95 and s:.qx0 = 0.025, k—0,4,-+,39. Find Pao. For a special 3-year fully-discrete term insurance on (40) you are given: i) Benefits are 1,000k paid at the end of year k, K=1, 2, or 3, if death occurs in year k. ii) Premiums are level and determined by the equivalence principle iii) The remaining lifetime of (40) is uniform on [0, 50}. iv) /=0.05 Compute the premium 7. @ACTEX 2006 Exam M/ Exam 3 Hassett, Stewart, & SteebyModule 8 ~ Premiums 47 5. For a special fully-discrete 2-year endowment insurance on (x) of 2,000, the premiums determined by the equivalence principle are 1,387 at the beginning of year 1 and 500 at the beginning of year 2. Also d = 0.05. Calculate the level annual premiums using the equivalence principle. 6. L is the loss at issue of a fully continuous whole life insurance of 1,009 on (x). The remaining lifetime random variable for (x) is linear on [0, 50}. If 6 =0.06, calculate V(L). Premiums are calculated using the equivalence principle. SACTEX 3008 Exam M/ Exam 3 Hassett, Stewart, & Steeby48 Module 8 = Prem == Section 8.12 Module 8 Practice Problem Solutions Problem Set A 1. The remaining lifetime for (30) is linear over [0, 65]. 1 ripe to et0s (0 = & and v' =e Axial = Aro ~0Es0 Aco From the tables we have Asy = 0.10248 Aug = 0.16132 w0E 9 = 0.54733 Atoza = 0.10248 — 0.54733(0.16132) = 0.01418 Aso = Asoia+ 0&3 = 0.01418 + 0.54733 5615 0.0566 0 9= {06 Exam M/E “ACTEX 2006 Hassett, Stewart, & SteebyModule 8 - Premiums 49 3. Pe = ay Ala = A, ~9Ex Ann = 0.35 — 0.55(0.42) = 0.119 Aca = Ais + ,E_ = 0.119 + 0.55 = 0.669 1 Ara _ 10.669 = 6.951 4. v(l= (4) ada)? From the Table we get Ase = 0.30514 = 0.13067 and és; = 12.2758 0.06 = 228 = 0.0566 9-706 ~° 1 = 9:13067 - (0.30514) + = 0.078 {(0.0566)(12.2758)| 0.06 { ~ In(1.06) = 0.017 Tea) @ACTEX 2006 Exam M / Exam 3 Hassett, Szewart, & Steeby50 Module 8 - Premiums 6. For a person aged 20, the remaining lifetime is still exponential with w= 0.04. = [Pet (0.04 2° at = sopan V2? = e854) @- P0820) _ 9.1353 = Aims Ew = 0.4812 A, 1- 0.4812 = 8.6467 0.06 SAE? = u.us5/ 8.6467 ‘ACTEX 2006 — - ~ “Exam M / Exam 3 Hassett, Stewart, & SteebyModule 8 ~ Premiums 51 Problem Set 8 1 APV of benefits = 1,000Ay = 514.95 7 APV of premiums = 17 + Zv? pro 2 =n[.+(5}f 1 Ja --0.03318)] 2) (7.06 =7(1.456) By the equivalence principle: 514.95 = - 353.67 7" Tas ~ 353 tov of Premiums = 7(1 + pss +V%pes pss) 49:99 , 0.99/0,98 | 105" Trosy | 17(2.8229) : APV of benefits = 1, 000As» + 17 qo + 277 V* ps» Gs: + 317V2Piso Psi sz _ 350-4 1(0:02 2(0.99)(0.02) | 3(0.99) 98)(0 03) [2-05 (1.05)° (1.05) mt = 350 +77(0.1209} By the equivalence principle: 77(2,8229) = 350 + 77 (0.1209) = 129.53 ‘@ACTEX 2006 - Exam M / Exam 3 Hassett, Stewart, & Steeby52 Module 8 ~ Premiums 3. Ass = Sov" aso = $2(0.95)"" (0.025 = 0.025(0.95 + 0.95? +--. +0.95% = 0.025(0.95)(1 + 0.95 + +0.95%) jt = 0.025(0.95) | = 0.414 1-Axo ) = Ae, d=1-v=0. a: d v 05 a, = 259414 _ 11.720 0.05 o. — Ax _ 0.414 A are ay «11.720 4 Because the remaining 1 1950 = 0.02. Al: a 19 0.02 Also v = 75 ~Ealzos)-| = 77(2.8041) APV of benefits = 1,000V gay + 2,000V?:Ge9 + 3,000V?29s0 fo.02 , 2(0.02) _ 3(0.02) 105” (1.05)' (1.05)" = 107.159 By the equivalence principle: m(2.8041) = 107.159 = 7 = 38.215. APV of premiums = nl 1,000) ‘EACTEX 2006 Hassett, Stewart, & Steeby mM / Exam 3Module 8 - Premiums 53 5. We first need to compute p.. vel-d=0.95 APV of premiums = 1,387 + 500(0.95) p. , 387 + 475p. APV of benefits = 2,000(1— py)v + 2,000p; (1 — px-1)v? + 2,000 py pyr V? = 2,000(1~ p,)v +2,000v7p, 1,900 ~ 1,900 p, = 1,805p, By the equivalence principle 1,387 + 475p. =1,900-95p, + p,=0.90 For level premium 77, APV of premiums = 77 + 77(0.90)(0.95) = 7r(1.855) 2,000(1 ~ 0.90)(0.95) + 2,000(0.95}* (0.90) = 1,814.5 m(1.855)=1,814.5 => 1 =978.17 APV of benefit: 6. v= 00H 0.1663 - (0.3167)'| | = 141,369 |(0.06)(a1.388)/° | @ACTEX 2006 Exam M/ Exam 3 Hassett, Stewart, & Steeby4 Module 8 - Premiums Section 8.13 - Module 8 Exam Problems 1. Spring 2000 #31 SOA/CAS Company ABC issued a fully discrete three-year term insurance of 1000 on Pat whose stated age at issue was 30. You are given: @ (i) 7 = 0.04 (ili) Premiums are determined using the equivalence principle. During year 3, Company ABC discovers that Pat was really age 31 when the insurance was issued. Using the equivalence principle, Company ABC adjusts the death benefit to the level death benefit it should have been at issue, given the premium charged. Calculate the adjusted death benefit. (A). 646 (8) 664 (712 (D) 750 () 963 @ACTEX 2006 Exam M / Exam 3 Hassett, Stewart, & SteebyModule 8 ~ Premiums 55 2. Fall 2001 #24 SOA/CAS For a special 2-payment whole life insurance on (80): (i) Premiums of 7 are paid at the beginning of years 1 and 3. (ii) The death benefit is paid at the end of the year of death (ill) There is a partial refund of premium feature: If (80) dies in either year 1 or year 3, the death benefit is 1000+ 7 Otherwise, the death benefit is 1000. (iv) Mortality follows the Illustrative Life Table. (vy) .7= 0.06 Calculate 1, using the equivalence principle, (A) 369 (8) 381 (©) 397 (D) 409 (2) 425 3. Fall 2001 #39 SOA/CAS For a special 3-year deferred whole life annuity-due on (x): (@) i= 0.04 (ii) The first annual payment is 1000. Payments in the following years increase by 4% per year. (iv) There is no death benefit during the three year deferral period. (v) _ Level benefit premiums are payable at the beginning of each of (vi) @, =11.05 is the curtate expectation of life for (x). “ kK 1 2 [3] Px 099 [098 | 097 | Calculate the annual benefit premium, (A) 2625 (8) 2825 (c) 3025 (D) 3225 (€) 3425 @ACTEX 2006 - Exam M/ Exam 3 Hassett, Stewart, & Steeby56 Module 8 - Prem 4. Fall 2001 #40 SOA/CAS. For a special fully discrete 10-payment whole life insurance on (30) with annual benefit premium 7 : @ ) (ii) (w) ™) Calculate 7 (a) @) (c) (D) 1) The death benefit is equal to 1000 plus the refund, wit ~-= interest, of the benefit premiums paid Aw = 0.102 aA = 0.088 (A),,z5 = 0.078 se Syqiq = 7.747 14.9 15.9 15.1 15.2 15.3 5. Fall 2002 #12 SOA/CAS Fora fully discrete whole life insurance of 1000 on (40), you are given: i) (i) (iii) (iv) o At the end i= 0.06 Mortality follows the Illustrative Life Table. dugg = 7.70 duoim = 7-57 1000A ;, 5 = 60.00 of the tenth year, the insured elects an option to retain :7= coverage of 1000 for life, but pay premiums for the next ten years only. Calculate the revised annual benefit premium for the next 10 years. (A) (8) (c) (0) (e) EACTEX 2006 a. 15 17 19 21 Exam M/ i Hassett, Stewart, & SteebyModule 8 ~ Premiums 57 6. Fall 2002 #26 SOA/CAS For a fully discrete whole life insurance of 1000 on (60), you are given: (@ 7 = 0.06 (ii) Mortality follows the Illustrative Life Table, except that there are extra mortality risks at age 60 such that deo = 0.015. Calculate the annual benefit premium for this insurance. (A) 31.5 (8) 32.0 (©) 32.4 (0) 33.4 (E) 33.2 7. Fall 2003 #8 CAS Given: i) i= 6% iii) 1000Ay = 168 iv) 1000As) = 264 Calculate 1000 iP (Aso), the benefit premium for a 10-payment fully discrete life insurance of 1,000 on (40). (A) 21.53 (8) 21.88 (©) 22,19 (0) 22.51 (2) 22.83 ‘@ACTEX 2006 ~ exam M / Exam 3 Hassett, Scewart, & Steeby58 Module 8 ~ Premiums 8. Fall 2000 #16 SOA/CAS For a fully discrete whole life insurance of 10,000 on (30): () 7 denotes the annual premium and L(m) denotes the loss-at- issue random variable for this insurance. (ii) Mortality follows the Illustrative Life Table. (ili) i=0.06 Calculate the lowest premium, 77’, such that the probability is less than 0.5 that the loss L(77’) is positive. (A) 34.6 (8) 36.6 () 36.8 (0) 39.0 (E) 39.4 9. Fall 2003 #14 SOA For a fully discrete whole life insurance of 1000 on (40), the contract premium is the level annual benefit premium based on the mortality assumption at issue. At time 10, the actuary decides to increase the mortality rates for ages 50 and higher. You are given: (i) d= 0.05 (ii)__Mortality assumptions: At issue deo = 0.02, k =0,1,2,...,49 0.04, k =0,1,2, (iii) sol Is the prospective loss random variable at time 10 using the Contract premium. Calculate E[10L|K(40) > 10] using the revised mortality assumption. Revised prospectively at 724 (A) Less than 225 (8) At least 225, but less than 250 (C) At least 250, but less than 275 (D) At least 275, but less than 300 (E) Atleast 300 SACTEX 2008 Exam M/ Exam 3 Hassett, Stewart, & SteebyModule 8 ~ Premiums 59 10, Fall 2003 #31 SOA For a block of fully discrete whole life insurances of 1 on independent lives age x, you are given: @) 7 = 0.06 (i) A, = 0.24905 (iii) 7A, = 6.09476 (iv) 7 = 0.025 , where 77 is the contract premium for each policy. (v) _ Losses are based on the contract premium. Using the normal approximation, calculate the minimum number of policies the insurer must issue so that the probability of a positive total loss on the policies issued is less than or equal to 0.05. (A) 25 (8) 27 (Cc) 29 (D2) 314 (E) 33 11. Fall 2004 #5 CAS For a special decreasing 15-year term life insurance on a person age 30, you are given: + Mortality follows DeMoivre with w = 100. + The benefit payment is 2,000 for the first 10 years and 1,000 for the last 5 years. + The death benefit is payable at the end of the year of death. + v=0.95 Calculated the level annual premium for this insurance. (A) 14.90 (8) 18.60 (c) 19.58 (D) 25.96 (€) 27.33 @ACTEX 2006 - Exam M/ Exam 3 Hassett, Stewart, & Steeby60 Module 8 - Pre 12. Spring 2000 #35 SOA/CAS The distribution of Jack’s future lifetime is a two-point mixture: (i) With probability 0.60, Jack’s future lifetime follows ~*~ Illustrative Life Table, with deaths uniformly distributed each year of age. (ii) With probability 0.40, Jack's future lifetime follows a cor force of mortality 4 = 0.02. A fully continuous whole life insurance of 1000 is issued on Jack at age 62. Calculate the benefit premium for this insurance at / = 0.06. (A) 31 (8) 32 (©) 33 (0) 34 (2) 35 13, Fall 2001 #34 SOA/CAS For a fully Continuous whole life insurance of 1: 0) 0.04 Gi) 0.08 (iii) L is the loss-at-issue random variable based on the bene" premium. Calculate Var (L). 1 wo * w 2 5 2 © + 1 o 4 e) 2 & 2 ‘@ACTEX 2006 ~ - Exam Hassett, Stewart, & SteebyModule 8 ~ Pres ciums 61 14, Spring 2001 #2 SOA/CAS On January 1, 2002, Pat, age 40, purchases a 5-payment, 10-year term insurance of 100,000: (i) Death benefits are payable at the moment of death. (ii) Contract premiums of 4000 are payable annually at the beginning of each year for 5 years. (ii) 7 = 0.05 (iv) Lis the loss random variable at time of issue. Calculate the value of L if Pat dies on June 30, 2004. (A) 77,100 (8) 80,700 (C) 82,700 (0) 85,900 (&) 88,000 15. Fall 2003 #8 SOA For a special () (i) ii) ww) Calculate 7. (a) 1) (©) (0) (E) @ACTEX 2008 fully discrete whole life insurance of 1000 on (40): The level benefit premium for each of the first 20 years is 17. The benefit premium payable thereafter at age x is 1000vq,, x = 60,61,62,... Mortality follows the Illustrative Life Table. 1= 0.06 4,79 Exam M/ Exam 3 Hassett, Stewars, & Steeby62 Module 8 ~ Premiums 16. Fall 2003 #37 SoA dg actuaries use the same mortality table to price a fully discrete 2-year endowment insurance of 1000 on (x) () Kevin calculates non-ievel benefit premiums of 608 for the first year and 350 for the second year. Gi) Kira calculates level annual benefit premiums of (iii) d= 0,05 Calculate i. (A) 482 (B) 489 (C) 497 (D) 508 (&) 517 17. Fall 2000 #35 soa/cas For a special 30-year deferred annual whole life annuity-due of 1 on (35): )) If death occurs during the deferral Period, the single benefit premium 'S refunded without interest at the end of the year of death, Gi) &s = 9,90 Gill) Assy = 0.21 wv) = 0.07 Calculate the single benefit premium for this Special deferred annuity, @ 13 (@) 14 (4s () 16 (©) 417 BACTEX 2008 ° Exam 4 / kam 3 Hassett, Stewart, & SteebyModule 8 - Premiums 63 Section 8.14 - Module 8 Exam Problem Solutions 1 The original premium will remain in force after the adjustment. We calculate it first. APV of benefits = 1000 (vain + ¥?pae gas +¥*Pae Pas Js) = 1000{2:04 , 299(0.02) | 0.99(0.98)(0.03)) - 1.04 1.047 Toa? = 53.80 APV of premiums = P(1+Vpso +V*p20 Ps) 2.8489P The premium, P = 18.884, remains, but the benefit will be changed to a new adjusted amount B. APV of benefits = B(vqs: + V2ps gaz +°Pn Psa Gos) (f 04 * = 0.080228 APV of premiums 18.884(1+ vps: +V7px psa) o.aee[s + = 18.884(2.82119) = 53.2754 Using the equivalence principle: APY of benefits = APV of premiums 8(0.08022) = 53.2754 ~ B= 664.11 Answer B @ACTEX 2006 Exam M/ Exam 3 Hassett, Stewart, & Steeby64 Module 8 ~ Premiums 2. We start with a timeline Death Benefit for lite 1000 1000-1000, 1000 Return of Premium t 5 Pre z z Remaining Lifetime 0 1 2 3 4 From the tables we will use: ge: = 0.08764, ge: = 0.09561, and Aen = 66575 ‘We will use the equivalence principle. APV of premiums = 77(1+v?pe0 ps:) 0.9197(0.91236) eee 1.067 = 1.74680 APV of benefits = 1000As0 +7 (vqso + ¥° Pw Pu Ge2) 0.9197 (0.91236) (0.09561) 1.06" = 665.75 +7 (0.07156) Using the equivalence principle: APV of benefits = APV of premiums 1.746877 ~ 665.75 + 77(0.07156) = 397.41 7 985.75 © 1.6752 Answer C ACTEX 2006 Exam M/ Exam 3 Hassett, Stewart, & SteebyModule 8 ~ Premiums 65 3. We will use the equivalence principle. Let 7 be the unknown premium. APV of premiums = 77(1+ vp, + V2Px) = la 2:99 , 0-98) ~ 1.04" 1.047 = 2.858077 Benefits start at the beginning of year 4, and increase at a rate of 4%. The fact that the interest rate is also 4% will give us a nice cancellation. _ 3Pe fe Pe 2 {_sPx APV of benefits 1000 #2-;] + 1000(2.04);*2s-] + 1000(1.04) iz oa 1000 = Toge sr + she + Px t-) = 100085. The last sum looks forbidding, but the trick is to remember that we are given @, =11.05 and we know that Thus 3De + 4D + sDe +.) = Cx — De — 2Pe =11.05- 0.99 - 0.98 = 9.08 apy cfpenerte - 1000, 5 _ 1000. V of benefits Loa? °F) Pet stewed) = TRS. Using the equivaience principle: APV of benefits = APV of premiums 8072.09 = 2.858077 8072.09 Faso = 2824.38 Answer B ©ACTEX 2006 Exam M/ Exam 3 Hassett, Stewart, & Steeby66 Module 8 ~ Premiums 4. We will use the equivalence principle. Let 7 be the unknown premium. APV of premiums = 77a;9sq= 7.74717 The APV of benefits has more components: APV of whole life benefit = 1000Ax 10 and 1077 Return of premium benefit pays k7r for death in year k = after that. APV of return of premium benefit is 77(IA),.:¢+ 107 (:0A2) Thus the total APV of benefits is 1000Ay) + 77(JA)jo:q + 107(:4As0) = 102 + 77[0.078 + (10)(0.088)] Using the equivalence principle: APV of benefits = APV of premiums 102 + 77(0.078 + 0.88) = 7.7477 102 = 302 15.024 ™= 6799-35 Answer B @ACTEX 2006 - Exam M/ Exam 3 Hassett, Stewart, & SteebyModule 8 - Premiums 67 5. From the Illustrative Life table we will need Aap = 0.16132, 40 = 14.8166 , and 20s = 0.53667. The original insurance was whole life. For a benefit of 1, the premium was Aso Sa 0.16132 Pao = 4.8166 = 0.01089 Under the new elected option for a benefit of 1, the insured would have paid Pa = 0.01089 for the first ten years and would begin to pay the adjusted Premium of 7 thereafter. Under this new option for a benefit of 1 APV of premiums = Prodsaia + (10E%0) (77Scaz9) = 0.01089(7.70) + 0.53667(7.57) 7 Under the new elected option for a benefit of 1, APV of benefits = Ay = 0.16132 Using the equivalence principle for the entire lifetime of the policy: APV of benefits = APV of premiums 0.16132 = 0.01089(7.70) + 0.53667(7.57)77 For a benefit of 1000, 10007 = 19.07 Answer D GACTEX 2006 Exam M / Exam 3 Hassett, Stewart, & Steeby68 Modu 2 8 - Premiums 6. The only change in risk is at age 60. From age 61 on, experience still follows the Illustrative Life Table. Thus the life table entries ds: = 10.9041 and Aq = 0.38279 are valid for the insured. To get the premium for (60) we will vse recursion equations to work backwards to find ao and As. By=1+ vein =1+{ Fela 0.015)(10.9041) = 11.133 0.36986 =Vq60 + =(4. + ) Aso = Vso + pada =| 420.015 0.985(0.38279 Using the equivalence principle: ‘APV of benefits = APV of premiums 1000 Ag = 369.86 = 11.1337 369.86 11.133 = 33.22 Answer E 7. We are asked to find 1000;9Py» ~ 2200#s = for the numerator but must find the denominator from the given information. The idea is to use the given values of Awand Ato find dwand as). Then we can use the recursion relation We are given the value needed Ban - s9Ean dca. First note that d Then Now we use the recursion. Gioia = G40 ~ 10Es9 dso = 14.699 - 0.540(13.004) = 7.7677 It follows that 10004. __168 1000 s0Pio = = 21.88 7.677 Answer B ‘GACTEX 2006 Exam M/ Exam 3 Hassett, Stewart, & Steebywocule 8 ~ Premiums 69 8. (This is a percentile premium method problem.) Recall the steps in the problem of finding the percentile premium for a penefit of 1. a) Calculate (1p) b) Find the remaining lifetime k such that Iy.« > (1—p)le > Irsuet 0 to get 7 c) Set the loss function for k, | =v" — 1 (aia In this case 1— p = 0.50 and x = 30. The table shows Iso = 9,501,381. a) (1-p)l, = 0.50(9,501, 381) = 4,750, 690.5 b) By inspection, /7 > 4,750,690.5 > Is. Thus k = 47. [gg] ~-0610 and dag = 16.589 using the financial calculator. Thus for a benefit of 1, 0.0610 Té.saq = 200368 For the benefit of 10,000, 77’ = 10,0007 = 36.8 Answer C 2006 Exam M / Exam 3 +, Stewart, & Steeby70 9. Module 8 ~ Premiums We have two things to do here. 1) 2) 1) The original premium continues to be used after age 50, and we need to find it. 2) We need to find the expected loss from age 50 on using 1) and the new mortality Find the original premium. First note that d = 0.05 gives / = 0.05263 The origirial assumption was that 2% of all insureds die each year starting at (40). Thus the remaining lifetime, T, for (40) was assumed to be DeMoivre with w- 40 =50 and nqzo = 0.02 for k=0,...,49. Thus Au =0.02v +0.02v? +....+.0,02V = 0.02a53 = 0.02(17.538) = 0.35076 1= Aw _ 1-0.35076 d 0.05 = 12.985 1000Aco Be0 Find the expected loss starting at age 50. The revised assumption is that 4% of all insureds die each year starting at (50). Thus the remaining lifetime, T, for (50) is now assumed to be DeMoivre with w-50=25 and «qso=0.04 for K=0,..,24. Thus 27.013 Aso = 0.04V +0,04v? +.... + 0.04v75 0.0425 = 0.04(13.72959) = 0.54918, 0.54918 0.05 =9.0163 E[so£ | K (40) = 10] = 1000As» ~ 1000Pin &so 549.18 - 27.013(9.0163) = 305.62 Answer E ‘@ACTEX 2006 “Exam M / Exam 3 Hassett, Stewart, & SteebyModule 8 ~ Premiums 7 10. This is @ normal approximation problem involving the loss L. First we need to find the mean and variance of L for an individual policy. Then we will use the normal approximation. Individual Mean First we find. 3, -icA 0.24905 ee" (ees 1.06 Per policy: E(L)= A, ~7d,= 0.24905 — 0.025(13.267) = -0.08262. This is a profit. Note that E(L) is not 0. This means we cannot use the equivalence principle version of the variance formula. Instead, we must use v= fs + 2 | (7A. A?) = 1.4417? (0.09476 — 0.24905*) = 0.06083 a Normal approximation The number of policies NV is unknown. If we denote the aggregate loss for NV policies by L,, the mean and variance of L, are E(Ls) = -0.08262N and V(L.) = 0.06083N The standard deviation of L. is then go = V0.06082N = 0.26083/N We need to find WV so that the probability of a positive valuc of L, is less than or equal to 0.05. We will solve P(Ls > 0) = 0.05 for N using the - transformation. 0 (08262N) Plla >0)=P|Z> = 0.26083 0.05 The 95" percentile of the standard normal Z is 1.645. Thus we need =1645 — N=26.97 ((0.08262N) (0.26083V) Rounding NV up to get an integral value, we have WV = 27 Answer B ZACTEX 2006 Exam M/ Exam 3 Hassett, Stewart, & Steeby72 Module 8 ~ Premiums 14, We use the equivalence principle. The benefit is not level, but cea be handled by a standard technique. The sum Aba + Ait is the expected value of a benefit which is 2 in years 1-10 and 1 in years 11-15. Thus APV of benefits = 1000[ Ali + Ajoia] Note that v = 0.95 implies that / = 0.05263 and d = 0.05 To find Ai,zy and Aljzs we use the fact that the remaining lifetime of (70) is DeMoivre with w= 70. Thus 2 1 lie dist 1 ative tv + bvs=F ag = 4 (10.1975 Baia 9g" F994 Wo GQ = 79 9879 ) 0.14568 (7.624) = 0.10891 Aina APV of benefits = 1000[ Aisig + Algo] = 254.59 The unknown premium, 17, is level for 15 years. Thus APV of premiums = 7ra9:a We need dyea-= ifn We can make use of the fact that Anis We have the first piece, and the second is given by Alo + 1sEx0- (0.95)"* = 0.36401 70-15) ssE = :5P0V¥ = Pao V! [ 70 } Thus Asia = 0.14568 + 0.36401 = 0.50969, and 1 Asszy _ 1- 0.50969 d 0.05 806 oo Using the equivalence principle 254.59 = 9.8067 7 = 254.59 9.806 25.96 Answer D SACTEX 2006 Exam Mj Exan 3 Hassett, Stewart, & Steeby73 voesle 8 ~ Premiums adicated, this is a mixture problem. In Jack's case, we will let Z ~~ ‘represent his actual unit benefit random variable, LT his unit benefit random variable under the Illustrative life table survival model, and Chis unit benefit random variable under the constant force survival model. | that if Z is a 60%-40% mixture of two distributions LT and C, then = 0.6E(LT) + 0.4E(C). Mesn_benefit_under constant force, We denote the expected value of a continuous benefit of 1 by E(C) = Ae . Then w= 0.02, 5 =In(1.06) and M: 0.02 = 0:02 ___ 0.255: O02 +in(d0ey 75° Mean benefit under the Illustrative life table, We denote the expected value of a continuous benefit of 1 by E(LT) = Au « grit 0.06 Ba = Lag, = 2:22 (0.3967) = 0.4085 B= Aaa Ta gy (013967) = 0.408: Mean benefit under the mixture We denote the expected value of @ continuous benefit of 1 for the actual mixture by As. Then = 6A + .AA% — 0.6(0.4085) + 0.4(0.2555) = 0.3473 To get the APV of premiums we will need a2 for the mixture, _l-Ag _ 1-0.3473 a= = = 11.20 3a =F" = “nosy 7117048 0.3473, ~hen th Pes = 03473 _ 9.03100. For the benefit hen the unit premium is Be = Tepors ~ 0.03200.. For the benef of 2000 1000 Pe. = 31. Answer A @ACTEK 2008 - Sam M/ Exam 3 Fassett, Stewart, & Steeby74 Module 8 ~ Premiums 13. This problem uses the terminology “L is the loss-at-issue random variable based on the benefit premium.” This means that the premium was found using the equivalence principal and we can use the variance formula V(t) = 44 (6a.) For a constant force model with w= 0.04 and 5 = 0.08, we have — woot a wil Ax = —— => id “Ax = =S we 3 W425 5 Then For the constant force model 3 2 “ U4d 3 Then Answer B 14. This insurance is semi-continuous. Benefits are paid at death, but premiums are paid only at the start of the year if Pat is still alive. Pat's death occurs in two and a half years at time ¢ = 2.5. The present value of the benefit paid is 100,000 Tog 7 88.517. Pat paid premiums at times 0, 1 and 2. The PV of premiums paid is 4,000/1 +41] _ 11,438 1.05 * 1.057 The present value loss for Pat is L = 88,517 ~ 11,438 = 77,079 Answer A @ACTEX 2008 Bam M/ Ban} Hassett, Stewart, & SteebyModule 8 - Premiums 75 15. We will need the following table values. qo = 14.8166 cq = 11.1454 Aug = 0.16132 Aeg = 0.36913 20 Esp = 0.27414 APV of benefits = 1000Aco = 161.32 The APV of premiums is more complex. If 7 is the unknown level premium for the first 20 years, the APV of premiums is Tr 9x5 + 20x 5 1000VG0-« (+ Pe0)V* is = M935 + 20E 01 000Aco 1 (daa = 20Esa8e0) + 20201000 Aco 77 (14.8166 — 0.27414(11,1454)) + 1000(0.27414) (0.36913) 11.7612m + 101.19 4 0 Applying the equivalence principle 11.7612r + 101.19 = 161.32 W511 Answer B ‘@ACTEX 2006 Exam M / Exam 3 Hassett, Stewart, & Steeby76 Module 8 - Premiums 16. The crucial missing values in this problem are the probabilities p, and q.from the life table. However both actuaries used the same life table to find their premiums. We will look at the APV of their premiums to find the missing probabilities. In this analysis we will also use the fact that v =1-d = 0.95 Kevin came up with @ premium of 608 at time 0 and a premium of 350 at time 1. The APV of Kevin's premiums is 608 + 350vp, = 608 + 332.5p, kira came up with an unknown level premium of 7. (This is what we are looking for.) The APV of Kira’s premiums is m7(1-+ Pav) = 7(1-+.95p.) To solve this problem, we need to assume that each actuary used the equivalence principle. (This is not stated.) The present value of benefits also uses the unknown p,and qx. nefits = 1000(vqx + vp} = 1000{0.95(1 ~ px) + (0.95)" px] = 950- 47.50p, Actuarial equivalence for Kevin will give us pe. 608 + 332.5p,= 950-47.5p, —- P, Now we can use actuarial equivalence for Kira and the fact that p, = 0.9 to find 7. 1 (1+0.95p,) = 950 - 47.5p, m(1 + 0.95(0.90)] = 950 - 47.5(0.9) 489.08 Answer B 17. Let P be the single benefit premium, i.e., the APV of the annuity. P= PAs. + anchs = PAL oy + cE des Since A.,35 Ay.gq +00 Ess, if follows that soEss = 0.21—0.07 = 0.14 P = P(0.07) +(0.14)(9.90) _ (0.14)(9.90) ~~ 1=0.07 =1.49 Pp Answer C ‘@ACTEX 2006 Exam M/ Exam 3 Hassett, Stewart, & Steeby