Life Contigency

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Life Contigency

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LIFE CONTINGENCIES 1

1

1 SURVIVAL DISTRIBUTIONS AND LIFE

TABLES

1.1 Some Special Random Variables and the Survival

Function

Definition 1.1. Let (x) denote a person aged x and X be a random vari-

able representing the age-at-death of (0). We will call X as the age-at-

death (of a newborn) random variable.

Since X is a random variable, we can talk about its cdf as well as the

complement of its cdf. The cdf of X,

FX (x) = P r[X ≤ x]

gives the probability that (0) will die before attaining age x. Furthermore,

the complement of the cdf of X, which we will denote by s(x), i.e.,

gives the probability that a newborn will survive to age x. Because of this,

we will call s(x) as the survival function.

random variable X.

1. Find the probability that (0) dies between ages x1 and x2 .

2. Find the conditional probability that (0) will die between ages x1 and

x2 given survival to x1 .

Definition 1.2. Let T (x) (or simply T ) denote a random variable repre-

senting the future lifetime of (x). We will call T , the time-until-failure

(of a person aged x) random variable.

The cdf of T , which is G(t) = P r[T ≤ t] gives the probability that (x)

will die before attaining age x + t. This probability statement is given a

special symbol, t qx . The complement of G(t) gives the probability that (x)

will survive to age x + t. The notation we will use to denote this probability

statement is t px . Obviously, t px + t qx = 1.

We note that if x = 0, then T (0) = X and x p0 = s(x), x ≥ 0.

Example 1.2. Express the following probability statements in terms of

the survival function of T and/or its complement.

1. The probability that (x) will survive t years and die within the fol-

lowing u years.

2. The probability that (x) will survive to age x + t then die before

attaining age x + t + 1.

2

Definition 1.3. Let K(x) (or simply K) be a discrete random variable

representing the completed future years lived by x, i.e., K(x) = [T (x)]. We

will call K as the curtate future lifetime of (x). The pmf of K is

where k = 0, 1, 2, . . .

Recall the survival function, s(x), we mentioned earlier. The survival

function is a continuous function in x, defined on the interval 0 ≤ x ≤ ω,

where ω is called the limiting age. Moreover, s(x) is a decreasing function

with s(0) = 1 and s(ω) = 0. We can express t px and t qx in terms of s(x)

as what the following shows: We first note that x+t p0 = (x p0 )(t px ). Then,

x+t p0 s(x + t)

t px = = ,

x p0 s(x)

and

s(x + t) s(x) − s(x + t)

t qx = 1 − t px = 1 − = .

s(x) s(x)

x

Example 1.3. Let s(x) = 1 − 105 , where 0 ≤ x ≤ 105. Find the following

probabilities.

1. The probability that (0) will survive to age 15.

2. The probability that (0) will die between ages 15 and 42.

3. The probability that a life aged 15 will survive to age 42.

4. The probability that a life aged 15 will die before attaining age 42.

Suppose FX (x) and fX (x) are respectively, the cdf and pdf of the random

variable X. Recall that,

0 FX (x + ∆x) − FX (x)

FX (x) = lim = fX (x).

∆x→0 ∆x

Then,

FX (x + ∆x) − FX (x)

P r[x < X ≤ x + ∆x|X > x] =

1 − FX (x)

FX (x + ∆x) − FX (x) ∆x

=

∆x 1 − FX (x)

∆x

≈ fX (x)

1 − FX (x)

fX (x)

= ∆x

1 − FX (x)

fX (x)

The expression 1−F X (x)

gives the conditional pdf of X at exact age x

given survival to x. This conditional pdf is called the force of mortality and

3

is denoted by µ(x). The force of mortality is also called the failure rate or

the hazard rate.

Consider the following,

d d d

s(x) = [1 − FX (x)] = − FX (x) = −fX (x).

dx dx dx

Thus,

fX (x) s0 (x)

µ(x) = =− .

1 − FX (x) s(x)

Moreover, since s(x) is a decreasing function, then s0 (x) < 0, thus the force

of mortality is a nonnegative function.

We now find an expression for the pdf of X in terms of the force of

mortality. We know that

s0 (y) d

µ(y) = − = − log s(y),

s(y) dy

or equivalently,

−µ(y)dy = d log s(y).

Integrating from x to x + n,

Z x+n Z x+n

s(x + n)

− µ(y)dy = − d log s(y) = log s(x+n)−log s(x) = log = log n px .

x x s(x)

R x+n

n px = e− x

µ(y)dy

.

If we let s = y − x, we have

Rn

n px = e− 0

µx (s)ds

.

Rx

s(x) = x p0 = e− 0

µx (s)ds

.

It follows that,

d d d h Rx i d Rx

f (x) = FX (x) = [1 − s(x)] = 1 − e− 0 µx (s)ds = − e− 0 µx (s)ds

dx dx Z x dx dx

− 0x µx (s)ds

R d

= e µx (s)ds = x p0 µ(x).

dx 0

4

d d d s(x + t)

gT (t) = GT (t) = t qx = 1−

dt dt dt s(x)

0

1 0 s(x + t) s (x + t)

= − s (x + t) = − = t px µx (t).

s(x) s(x) s(x + t)

Thus, the pdf of T is

gT (t) = t px µx (t).

Clearly, t px µx (t) denotes the probability that (x) dies between ages x+t

and x + t + dt and Z ∞

t px µx (t)dt = 1.

0

Let l0 be the number of newborns in a cohort (a closed group). We call this

group of newborns, a random survivorship group. Each newborns’s age-at-

death has a distribution specified by the survival function s(x). Let each

life in the group be indexed by j = 1, 2, . . . , l0 and let L(x) be a discrete

random variable representing the number of survivors to age x out of the

l0 lives in the cohort. Thus,

l0

X

L(x) = Ij ,

j=1

1 if j survives to age x

Ij =

0 otherwise.

We know that, Ij has a Bernoulli distribution and that E[Ij ] = s(x). It

follows that

Xl0 Xl0

E[L(x)] = E[Ij ] = s(x) = l0 s(x).

j=1 j=1

survivors to age x among the l0 newborns. It follows then, that

lx

s(x) = .

l0

We note that if the Ij ’s are independent, then L(x) has a binomial distri-

bution with parameters n = l0 and p = s(x).

Let n Dx be a discrete random variable representing the number of deaths

between ages x and x + n among the l0 lives in the cohort. We can see

that n Dx has a binomial distribution with parameters n = l0 and p =

s(x) − s(x + n). Thus,

5

We will use the notation n dx for E[n Dx ], thus n dx denotes the expected

number of deaths between ages x and x + n among the l0 newborns.

Now, since s(x) = llx0 ,

d d

s(x) lx

µ(x) = − dx = − dx ,

s(x) lx

or equivalently,

d

lx = −lx µ(x).

dx

The expression lx µ(x) is the expected density of deaths in the age interval

(x, x + dx). Furthermore,

µ(x)lx dx = −dlx .

Z x+n Z x+n

µ(y)ly dy = (−dly ) = −ly ]x+n

x = lx − lx+n .

x x

dx columns of the corresponding mortality table for age 0 to 2 using the

radix 100000.

We have introduced the random variables T and K. We now talk about

their expected values.

We will denote the expected value of T by eox , called the complete-

expectation-of-life. Thus,

Z ∞ Z ∞ Z ∞

o ∞

ex = E[T (x)] = tt px µx (t)dt = t(−dt (t px )) = t(−t px )]0 + t px dt.

0 0 0

R∞

However, if we assumed that E[T (x)] exists then lim t(−t px ) and 0 t px dt

R∞ t→∞

both exists, i.e., lim t(−t px ) < ∞ and 0 t px dt < ∞. Furthermore,

t→∞

lim t(−t px ) = 0.

t→∞

Therefore,

Z ∞

eox = E[T (x)] = t px dt.

0

Z ∞ Z ∞

E[T (x)2 ] = t2 t px µx (t)dt = 2 tt px dt.

0 0

Thus,

6

Z ∞

V ar[T (x)] = E[T (x)2 ] − (E[T (x)])2 = 2 tt px dt − (eox )2 .

0

We note that we assumed above that E[T (x)] and E[T (x)2 ] exist. More-

over, we can also find the median and the mode of the distribution of T (x).

If we denote the median of T (x) by m(x), then the median of T (x) is the

solution of the equation

1 s(x + m(x)) 1

P r[T (x) > m(x)] = or = .

2 x 2

The mode of the distribution of T (x) is the value t where the pdf of T , i.e.,

the function gT (t) = t px µx (t) attains its maximum value.

The expected value of K(x) is denoted by ex , and is called the curtate-

expectation-of-life. Thus,

∞

X ∞

X ∞

X

ex = E[K(x)] = k k px qx+k = k∆(−k px ) = k(−k px )]∞

0 + k+1 px .

k=0 k=0 k=0

Using the same argument as above, then if E[K(x)] exists then lim k(−k px ) =

k→∞

0. Thus,

∞

X

ex = E[K(x)] = k px .

k=1

Also,

∞

X ∞

X ∞

X

E[K(x)2 ] = k 2 k px qx+k = ∆(−k px ) = k 2 (−k px )]∞

0 + (∆k 2 )(k+1 px )

k=0 k=0 k=0

k→∞

∞

X ∞

X

2

E[K(x) ] = (2k + 1)k+1 px = (2k − 1)k px .

k=0 k=1

Therefore,

∞

X

V ar[K(x)] = E[K(x)2 ] − (E[K(x)])2 = (2k − 1)k px − (ex )2 .

k=1

Another life table function is Lx , which denotes the total expected num-

ber of years lived between ages x and x + 1 by the survivors of the l0

lives.Thus,

Z 1

Lx = lx+1 + tlx+t µx (t)dt,

0

where lx+1 represents the years lived between ages x and x + 1 of those

R1

who survive to age x + 1, and 0 tlx+t µx (t)dt represents the years lived by

those who died between ages x and x + 1.

7

Our expression for Lx may be simplified in the following way:

Z 1 Z 1 Z 1

Lx = lx+1 + tlx+t µx (t)dt = lx+1 − tdt lx+t = lx+1 −tlx+t ]10 + lx+t dt,

0 0 0

or equivalently, Z 1

Lx = lx+t dt.

0

In this form, we can say that Lx is the mean value of lx over the age interval

(x, x + 1). An approximation for Lx is given by

1 1

Lx ≈ (lx+1 + lx ) = lx − dx .

2 2

Another life table function is the central death rate over the age interval

(x, x + 1), denoted by mx and defined as

R1

0

lx+t µx (t)dt −lx+t ]10 lx − lx+1 dx

mx = R1 = = = .

l dt Lx L x Lx

0 x+t

If we extend the age interval from (x, x + 1) to (x, x + n), then the

definitions of Lx and mx can be extended appropriately as follows:

Z n Z n

L

n x = nlx+n + tl µ

x+t x (t)dt = lx+t dt,

0 0

and Rn

l µ (t)dt

0 R x+t x lx − lx+n n dx

n mx = n = = .

l dt

0 x+t

L x Lx

Another life table function is Tx which denotes the total number of years

lived beyond age x by the l0 lives. Thus,

Z ∞ Z ∞ Z ∞

Tx = tlx+t µx (t)dt = − tdt lx+t = lx+t dt.

0 0 0

t→∞

future lifetimes of the lx survivors of the l0 lives at age x is

R∞ Z ∞

Tx lx+t dt o

= 0 = t px dt = ex .

lx lx 0

The life table exhibits some function like lx and dx , as well as some prob-

abilities like px and qx . However the age x in these functions are always

integral values. If we want to find the values of these functions when the

age is say x + s, where x is an integer and s is between 0 and 1, we need to

make cetain assumptions regarding fractional ages. These assumptions are

called the uniform death distribution (UDD), the constant force of mortality

and the Balducci. These are also called linear, exponential and hyperbolic

assumptions respectively.

8

Definition 1.4. Suppose x is an integer and t is a real number such that

0 ≤ t ≤ 1. The the survival function using the given functional age as-

sumptions are as follows:

1. Uniform death distribution: s(x + t) = (1 − t)s(x) + ts(x + 1);

2. Constant force of mortality: s(x + t) = s(x)eµt , where µ = − log px ;

1 1−t t

3. Balducci: s(x+t) = s(x) + s(x+1

UDD Constant Force Balducci

of Mortality

px

t qx tqx 1 − e−µt 1−(1−t)qx

tq

t px 1 − tqx e−µt x

1−(1−t)qx

yqx −µy yqx

y px+t 1−tqx 1−e 1−(1−y−t)qx

qx qx

µx (t) 1−tqx µ 1−(1−t)qx

px qx

t px µx (t) qx e−µt µ [1−(1−t)qx ]2

Example 1.5. Given s(40) = 0.7746 and s(41) = 0.7681. Find µ40 ( 14 ),

using the three fractional age assumptions.

Example 1.6. Using the UDD assumption, show that t qx = tqx , 0 ≤ t ≤ 1.

Example 1.7. Using the constant force of mortality assumption, show that

µx (t) = µ.

We now discuss some laws that try to explain the mortality of lives at

different ages.

in x. Thus, lx = k(ω − x), where ω is the limiting age. But since

lx = l0 s(x), then under De Moivre’s law

x

s(x) = 1 − .

ω

The corresponding force of mortality is:

1

µ(x) = .

ω−x

rate proportional to itself. He also claimed that death is caused by

aging.

1

If we let µ(x) to represent man’s susceptibity to death, then µ(x)

represents man’s resistance to death. Thus,

1 1

D( ) = −h( ),

µ(x) µ(x)

9

where h is the constant of proportionality. This implies that

x

s(x) = e−m(c −1)

,

B

where m = log c .

which was not incorporated by Gompertz. Makeham defines the force

of mortality as

µ(x) = A + Bcx ,

where A captures the accidental hazard B and c are defined in the

same way they defined in Gompertz. The corresponding survival

function is x

s(x) = e−[Ax+m(c −1)] .

Exercise 1.1. The following problems were lifted from the textbook “Ac-

tuarial Mathematics” (2nd edition) by Bowers, Gerber, Hickman, Jones and

Nesbitt. These problems are exercises from Chapter 3 found on pp. 84-91.

1. (Ex. 3.1) Complete the following table:

π

tan x, 0 ≤ x ≤ 2

e−x , x > 0

1

1− 1+x , x ≥0

x

2. (Ex. 3.5) If s(x) = 1 − 100 , 0 ≤ x ≤ 100, calculate

(b) FX (x); (d) P r[10 < X < 40]

x

p

3. (Ex. 3.7) If s(x) = 1− 100 , 0 ≤ x ≤ 100, evaluate

10

(a) 17 p19 ; (d) µ(36);

(b) 15 q36 ;

(c) 15|13 q36 ; (e) E[T (36)]

∞

X

4. (Ex. 3.8) Confirm that k| q0 = −∆s(k) and that k| q0 = 1.

k=0

are independent with survival defined in Table 3.3.1, exhibit the pmf

of L(65) and the mean and variance of L(65).

x

7. (Ex. 3.11) If s(x) = 1 − 12 , 0 ≤ x ≤ 12, l0 = 9, and the survival

times are independent, then (3 D0 , 3 D3 , 3 D6 , 3 D9 ) is known to have a

multinomial distribution. Calculate

(a) the expected value of a each random varibale;

(b) the variance of each random variable;

(c) the coefficient of correlation between each pair of random vari-

ables.

8. (Ex. 3.15) Consider a random survivorship group consisting of two

subgroups: (1) the survivors of 1,600 persons joining at birth; (2)

the survivors of 540 persons joining at age 10. An excerpt from the

appropriate mortality table for both both subgroups follows:

x lx

0 40

10 39

70 26

(1) and (2), respectively, estimate the number c, such that P r(Y1 +

Y2 > c) = 0.05. Assume the lives are independent and ignore half-unit

corrections.

9. (Ex 3.18) If the random variable T has pdf given by

calculate

(a) E[T ];

(b) V ar[T ];

(c) the median of T ;

(d) the mode of the distribution of T

11

10. (Ex. 3.19) If

µx (t) = t, t ≥ 0,

calculate

(a) t px µx (t);

(b) eox

HINT: If Z ∼ N (0, 1), then

1 2

fZ (z) = √ e−z /2 .

2π

∂

(a) ∂x t px = − tpx [µ(x) − µx (t)];

d o o

(b) dx ex = ex µ(x) − 1;

(c) ∆ex = qx ex+1 − px

12. (Ex. 3.38) Using the lx column of Table 3.3.1, compute 1/2 p65 , for

each of the fractional age assumptions.

x α

s(x) = 1 − , 0 ≤ x < ω, α > 0.

ω

Calculate

Acx

µ(x) = ,

1 + Bcx

for x > 0.

(b) Show that the mode of X, the age-at-death random variable is

log(log c) − log A

x0 = .

log c

3 10

15. (Ex. 3.44) If µ(x) = 100−x − 250−x for 40 < x < 100, calculate

(a) 40 p50 ;

12

2 Life Insurances

2.1 Introduction

Insurance systems were established to reduce the adverse financial impact

of some type of random events, usually loss of life or an object of some

or of great value. In this chapter we will discuss some basic types of life

insurances. There will also be two different types of classification. One is

based on whether the benefit is paid at the moment of death of the insured

or at the end of the year of death of the insured. The other classification

is one whether the benefit size is fixed or if it varies depending on the time

of death of the insured.

Under these classification we will consider the following basic types of

insurance:

1. WHOLE LIFE insurance pays the benefit upon the death of the in-

sured any time in the future.

2. n-YEAR TERM insurance pays the benefit upon the death of the

insured if death occurs within n years after issue.

3. n-YEAR PURE ENDOWMENT pays the benefit at the end of n

years only if the insured survives to that time.

of the insured if death occurs within the n-year term or the end of n

years if the insured survives to that time.

5. m-YEAR DEFERRED WHOLE LIFE insurance pays the benefit

upon the death of the insured only if the insured dies at least m

years after issue.

6. m-YEAR DEFERRED, n-YEAR TEMPORARY insurance pays the

benefit upon the death of the insured only if death occurs at least m

years and at most m + n years after issue.

To denote the (net) present value of the insurance, that is, the (net)

present value of the benefit, we will use the random variable Z. Z is

dependent on several things. These are the size of the benefit, interest rate

and more importantly, the time of death of the insured, because this date

will tell us when the benefit is to be paid by the insurer to the beneficiaries

of the insured. Thus, for each type of insurance we will define the random

variable Z and then we will derive an expression for its expected value. The

expected value of Z, E[Z] is called the net single premium (NSP) of the

insurance.

The time of payment of benefit of the insurance is dependent on the length

of time between issue at age x and the death of (x). Thus, our insurance

model will be dependent on the random variable T = T (x). If we use bT to

13

denote the benefit function, and vT to denote our discount function, then

the random variable Z is defined as Z = bT vT .

T

v if T ≥ 0

vT =

0 otherwise.

and

bT = 1, T ≥ 0.

Thus,

vT

if T ≥ 0

Z=

0 otherwise.

Therefore, Z ∞

Āx = E[Z] = v t t px µx (t)dt.

0

Z ∞ Z ∞ Z ∞

2 2t −2δt

E[Z ] = v t px µx (t)dt = e t px µx (t)dt = e(−2δ)t t px µx (t)dt.

0 0 0

j-th moment of the distribution of Z can be found by

Z ∞ Z ∞

E[Z j ] = (v t )j t px µx (t)dt = e(−jδ)t t px µx (t)dt.

0 0

Thus,

E[Z j ] at δt is equal to E[Z] at jδt .

This is called the rule of moments which holds generally for insur-

ances paying only a unit amount, and when the force of interest is

deterministic. We will use the notation 2 Āx for E[Z 2 ]. i.e., the actu-

arial present value for a whole insurance for a unit amount calculated

at 2δ.

vT

if T ≤ n

vT =

0 otherwise.

and

bT = 1, T ≥ 0.

Thus,

vT

if T ≤ n

Z=

0 otherwise.

14

Therefore, Z n

Ā1x:n| = E[Z] = v t t px µx (t)dt.

0

vn

if T ≥ n

vT =

0 otherwise.

and

1 if T ≥ n

bT =

0 otherwise.

Thus,

vn

if T ≥ n

Z=

0 otherwise.

Therefore,

Z ∞ Z ∞

1

Ax:n| = E[Z] = v n t px µx (t)dt = v n t px µx (t)dt = v n [1−G(n)] = v n (1−n qx ) = v n n px .

n n

We can derive the E[Z] in another way. Since the size of the pay-

ment and the payment date are predetermined, the only element of

uncertainty is whether or not a claim will occur. Let

1 if (x) survives to age x + n

Y =

0 otherwise.

Then, Z = v n Y . Thus,

1

Āx:n| = E[Z] = E[v n Y ] = v n E[Y ] = v n n px .

Also,

1 1 2

− (Āx:n| ) .

vT

if T ≤ n

vT =

vn if T > n.

and

bT = 1, T ≥ 0.

15

Thus,

vT

if T ≤ n

Z=

vn if T > n.

Therefore,

Z n Z ∞

t

Āx:n| = E[Z] = v t px µx (t)dt + v n t px µx (t)dt = Ā1x:n| + Āx:n|

1

.

0 n

the NSP’s of the n-pure endowment and n-year term insurance.

To get the variance we need to define the following random variables:

vT vT

if T ≤ n 0 if T ≤ n if T ≤ n

Z1 = ; Z2 = ; Z3 =

0 if T > n. vn if T > n. vn if T > n.

and that E[Z1 Z2 ] = 0, for all t, then

= V ar[Z1 ] + V ar[Z2 ] − 2E[Z1 ]E[Z2 ]

= [ 2Ā1x:n| − (Ā1x:n| )2 ] + [ 2Āx:n|

1 1 2

− (Āx:n| ) ] − 2Ā1x:n| Āx:n|

1

2 1

= Āx:n| + 2Āx:n|

1

− [(Ā1x:n| )2 + 2Ā1x:n| Āx:n|

1 1 2

+ (Āx:n| ) ]

2 1

= Āx:n| + 2Āx:n|

1

− [Ā1x:n| + Āx:n|

1 2

]

2 1

= Āx:n| + 2Āx:n|

1

− (Āx:n| )2

vT = v T if T ≥ 0,

and

0 if T ≤ m

bT =

1 if T > m.

Thus,

0 if T ≤ m

Z=

vT if T > m.

Therefore,

Z ∞

m| Āx = E[Z] = v t t px µx (t)dt.

m

16

Example 2.1. The pdf of T (x) is given by

1

80 if 0 ≤ T ≤ 80

gT (t) =

0 elsewhere.

At the force of interest δ, calculate for Z

1. the NSP;

2. V ar[Z];

3. the 90th percentile, ξZ0.9 .

Example 2.2. Consider a 5 year deferred whole life insurance payable at

the moment of death of (x). The individual is subject to a constant force of

mortality µ = 0.04. For the distribution of the present value of the benefit

payment at δ = 0.10, calculate

1. the expectation;

2. the variance;

3. the median ξZ0.5 .

Example 2.3. Assume that each of 100 independent lives are

i.) aged x;

ii.) subject to the constant force of mortality µ = 0.04;

iii.) insured for the death benefit amount of 10 units, payable at the mo-

ment of death.

The benefit payments are to be withdrawn from an investment fund earning

δ = 0.06. Calculate the minimum amount at t = 0 so that the probability

is approximately 0.95 that sufficient funds will be on hand to withdraw the

benefit payment at the death of each individual.

The payments of the benefit are due at the end of the year of death. The

year is considered not be calendar years but instead is from birthday to

birthday of the insured. The benefit and discount functions are dependent

on the random variable K. Thus, we will denote the benefit function by

bK+1 and the discount function by vK+1 . Then, the random variable Z is

defined as Z = bK+1 vK+1 . We cosider some basic insurances payable at

the end of the year of death:

1. whole life insurance

vK+1 = v K+1 if K = 0, 1, 2, . . .

and

bK+1 = 1 if K = 0, 1, 2, . . .

17

Thus,

Z = v K+1 if K = 0, 1, 2, . . . .

Therefore,

∞

X

Ax = E[Z] = v k+1 k px qx+k

k=0

and

∞

X

2 2

V ar[Z] = Ax − (Ax ) , where Ax = 2

e−2δ(k+1) k px qx+k .

k=0

1 if K = 0, 1, 2, . . . , n − 1

bK+1 =

0 if K = n, n + 1, n + 2, . . . .

and

v K+1

if K = 0, 1, 2, . . . , n − 1

vK+1 =

0 if K = n, n + 1, n + 2, . . . .

Thus,

v K+1

if K = 0, 1, 2, . . . , n − 1

Z=

0 if K = n, n + 1, n + 2, . . . .

and

n−1

X

A1x:n | = E[Z] = v k+1 k px qx+k .

k=0

bK+1 = 1 if K = 0, 1, 2, . . .

and

v K+1

if K = 0, 1, 2, . . . , n − 1

vK+1 =

vn if K = n, n + 1, n + 2, . . . .

Thus,

v K+1

if K = 0, 1, 2, . . . , n − 1

Z=

vn if K = n, n + 1, n + 2, . . . .

Therefore,

18

n−1

X ∞

X n−1

X

Ax:n| = v k+1 k px qx+k + v k+1 k px qx+k = v k+1 k px qx+k +v n n px = A1x:n| +Ax:n|

1

,

k=0 k=n k=0

since

∞

X ∞

X n−1

X

v k+1 k px qx+k = v n ( k px qx+k − k px qx+k ) = v n (1−n qx ) = v n n px .

k=n k=0 k=0

0 if K = 0, 1, 2, . . . , m − 1

bK+1 =

1 if K = m, m + 1, m + 2, . . . .

and

0 if K = 0, 1, 2, . . . , m − 1

vK+1 =

v k+1 if K = m, m + 1, m + 2, . . . .

Thus,

0 if K = 0, 1, 2, . . . , m − 1

Z=

v k+1 if K = m, m + 1, m + 2, . . . .

Therefore,

∞

X

m| Ax = E[Z] = v k+1 k px qx+k .

k=m

Consider a whole life insurance with a unit benefit. We know that {Z ≤

log z

z} = φ, whenever z < 0. If 0 < z < 1, then {Z ≤ z} = {T ≥ log v } and if

z ≥ 1, {Z ≤ z} = Ω. Thus, the cdf of Z can be expressed in terms of the

cdf of T in the following manner:

0 if z ≤ 0

log z

FZ (z) = 1 − FT ( log v ) if 0 < z < 1

1 z ≥ 1.

1 log z

( δz )fT ( log v) if 0 < z < 1

fZ (z) =

0 elsewhere.

Example 2.4. Given the pdf of T as:

1

80 if 0 < t < 80

fT (t) =

0 elsewhere.

Find the pdf and cdf of Z.

19

We now consider an m year deferred insurances payable at the moment

of death and at the end of the year of death. We note that for an m year

deferred whole life insurance, although T is continuous, Z is mixed with

pmf at 0 because {Z = 0} corresponds to {T ≤ m}. Thus,

Then, for 0 < z < v m ,

FZ (z) = P r[Z ≤ z]

= P r[Z = 0] + P r[0 < Z ≤ z]

= P r[T ≤ m] + P r[0 < v T ≤ z]

log z

= P r[T ≤ m] + P r[T ≥ ]

log v

log z

= FT (m) + 1 − FT ( )

log m

FT (m) if z = 0

log z

FZ (z) = FT (m) + 1 − FT ( log v ) 0 < z < vm .

1 z ≥ vm

at the moment of death. If the constant force of mortality is used with

µ = 0.04 and suppose δ = 0.10, then find the pdf of Z.

We consider an insurance with a varying benefit and payable at the moment

of death.

1 at the moment of death during the first year; 2 at the moment of

death during the second year; 3 at the moment of death during the

third year and so on.

Then, when T ≥ 0,

bT = [T + 1], vT = v T .

So,

Z = [T + 1]v T ,

where T ≥ 0. Therefore,

Z ∞

(I Ā)x = E[Z] = [t + 1]v t t px µx (t)dt.

0

20

1

2. An mth ly increasing whole life insurance providing a payment of m

th 2

at the moment of death during the first m of the year; m at the mo-

ment of death during the second mth of a year, and so on, increasing

1

by m at mth ly intervals thoughout the term of the insurance. Then,

when T > 0,

[T m + 1]

bT = , vT = v T .

m

So, for T ≥ 0,

v T [T m + 1]

Z= .

m

Therefore,

Z ∞ t

v [tm + 1]

(I (m) Ā)x = E[Z] = t px µx (t)dt.

0 m

life insurance. Thus,

Z ∞

(I¯Ā)x = lim (I (m) Ā)x = tv t t px µx (t)dt.

m→∞ 0

bT = T, vT = v T ,

whenever T ≥ 0. Thus,

Z = T vT ,

whever T ≥ 0.

moment of death during the first year, n − 1 at the moment of death

during the second year, and so on until the coverage is terminated at

the end of the nth year. Thus,

n − [T ] if T < n

bT = ,

0 if T ≥ n

vT = v T , T > 0.

Thus,

V T (n − [T ])

if T < n

Z= .

0 of T ≥ n

Therefore,

Z n

(DĀ)1x:n| = E[Z] = v t (n − [t])t px µx (t)dt.

0

end of the year of death.

21

1. An increasing whole life insurance paying K + 1 units at the end of

K + 1 years provided the insured dies after K complete years. Then,

for K = 0, 1, 2, . . .

Thus, whenever K = 0, 1, 2, . . .

Z = (K + 1)v K+1 ,

and

∞

X

(IA)x = E[Z] = (k + 1)v k+1 k px qx+k .

k=0

end of the first year if death occurs during the first year; a payment

of 2 at the end of the second year if death occurs during the second

year, and so on, a payment of n at the end of the nth year if death

occurs during the nth year and then the policy terminates at the end

of the nth year. Thus,

K +1 if K = 0, 1, 2, . . . , n − 1

bK+1 = ,

0 of K = n, n + 1, n + 2, . . .

and

vK+1 = v K+1 , K = 0, 1, 2, . . . .

Thus,

(K + 1)v K+1

if K = 0, 1, 2, . . . , n − 1

Z= .

0 of K = n, n + 1, n + 1, . . .

Therefore,

n−1

X

(IA)1x:n| = E[Z] = (k + 1)v k+1 k px qx+k .

k=0

end of the first year if death occurs during the first year; a payment of

n − 1 at the end of the second year if death occurs during the second

year, and so on until a payment of 1 at the end of the nth year if

death occurs during the nth year, then the policy terminates at the

end of the nth year. Thus

n−K if K = 0, 1, 2, . . . , n − 1

bK+1 = ,

0 of K = n, n + 1, n + 2, . . .

and

vK+1 = v K+1 , K = 0, 1, 2, . . . .

22

Thus,

(n − K)v K+1

if K = 0, 1, 2, . . . , n − 1

Z= .

0 of K = n, n + 1, n + 1, . . .

Therefore,

n−1

X

(DA)1x:n| = E[Z] = (n − k)v k+1 k px qx+k .

k=0

moment of death and at the end of the year of

death

Consider an n-year term insurance, then

Z n

Ā1x:n| = v t t px µx (t)dt

0

n−1

X Z k+1

= v t t px µx (t)dt

k=0 k

n−1

XZ 1

= v k+s k+s px µx+k (s)ds since t = k + s

k=0 0

n−1

X Z 1

= v k+1 k px v s−1 s px+k µx+k (s)ds

k=0 0

n−1

X Z 1

= v k+1 k px qx+k v s−1 ds since under UDD s px+k µx+k (s) = qx+k

k=0 0

n−1

X Z 1 Z 1

k+1 s−1

= v k px qx+k s̄1| since v dt = (1 + i) v s ds = (1 + i)ā1| = s̄1|

k=0 0 0

1

(1 + i)t 1

Z

i i

= A since s̄1| = (1 + i)t dt = |0 =

δ x:n| 0 log(1 + i)t δ

Moreover,

i i

Āx = lim Ā1x:n| = lim A = Ax .

n→∞ n→∞ δ x:n| δ

Alternatively, we recall that T = K + S, where S represents the frac-

tional part of the year lived in the year of death. We know that under

UDD, K and S are independent then K + 1 and 1 − S are also indepen-

dent. Moreover, S is uniformly distributed in (0, 1). This implies that 1−S

is also uniformly distributed in (0, 1). Thus,

i

Āx = E[v T ] = E[v K+1 (1 + i)1−S ] = E[v K+1 ]E[(1 + i)1−s ] = Ax .

δ

23

This is true because 1 − S is uniformly distributed in (0, 1), then

Z 1

i

E[(1 + i)1−S ] = (1 + i)1−s ds = .

0 δ

Consider an n-year term increasing insurance payable at the moment of

death. The present value random variable is

[T + 1]v T

if T < n

Z= .

0 of T ≥ n

But, [T + 1] = K + 1 and since T = K + S, then

if T < n

Z= .

0 of T ≥ n

Let W be the present value random variable for the annually increasing

n-year term insurance payable at the end of the year of death, so

(K + 1)v K+1

if K = 0, 1, 2, . . . , n − 1

W = .

0 of K = n, n + 1, n + 1, . . .

Then,

Z = W v S−1 = W (1 + i)1−S .

Since W is a function of K + 1 and K + 1 and 1 − S are independent under

UDD, we have

i

E[Z] = E[W (1 + i)1−S ] = E[W ]E[(1 + i)1−S ] = (IA)1x:n| .

δ

Example 2.6. Calculate the NSP and variance for a 10000, 30-year en-

dowment insurance providing the death benefit at the moment of death for

a male aged 35 at issue policy. Use the illustrative life table, the UDD

assumptions and i = 0.06.

Example 2.7. Calculate for a life aged 50, the APV for an annually de-

creasing 5-year term insurance paying 5000 at the moment of death in the

first year, 4000 in the second year and so on. Use the illustrative life table,

the UDD assumption and i = 0.06.

3 LIFE ANNUITIES

In the theory of interest we discussed annuities. We said that an annuity

is a sequence of periodic payments. To determine the present value as well

as the accumulated value of an annuity only three things were considered,

the size of the periodic payments, the term of the annuity and the interest

rate used. Moreover the term of the annuity is fixed or pre-defined. In this

chapter we will consider another type of annuity - the life annuity. Since

this is an annuity, it will be a sequence of periodic payments. However, the

term of payment is also contingent on the survival of the annuitant. This

means that the payments are made for as long as the annuitant is alive and

24

the payments terminates upon the death of the annuitant. Since the time of

death of an individual is not pre-determined, the term of the life annuity is

uncertain. Thus, to determine the present value of the annuity, we consider

the interest rate as well as the time until death of the annuitant.

There are two methods in finding the present value of a life annuity.

These are the aggregate payment technique and the current payment tech-

nique. The steps in finding the present value using these techniques are:

1. Aggregate payment technique

(a) Record interest only present value of all payments to be made

by the annuity if death occurs at time t;

(b) Multiply the present value, found in (a.) by the probability or

the pdf of death at time t;

(c) Add/Integrate over all times of death t.

2. Current payment technique

(b) Determine the APV of the payment due at time t;

(c) Add/Integrate these APV’s for all payments.

The types of life annuities that we will discussed are the following:

1. Whole life annuity - provides a payment of 1 per year for as long the

annuitant (x) is alive and the payment terminates upon the death of

the annuitant.

as long as the annuitant (x) is alive within the given n-year term.

The payment terminates upon the death of the annuitant if death

occurs within the n-year term or at the end of n-years if the annuitant

survives to that time.

to commence m years after the start of the annuity’s term and will

continue for as long as the annuitant is alive.

4. m-year deferred, n-year temporary life annuity - provides a payment

of 1 per year, m years after the start of the term of the annuity.

The payments continue for as long as the annuitant is alive within

n-year paying period. The payments terminates upon the death of

the annuitant, if death occurs with the first m+n years after the start

of the annuity’s term or at the end of m + n years, if the annuitant

survives to that time.

25

As it was with Theory of Interest, there is another classification of life

annuities depending on the time when the annuity payment is made. We

have the continuous life annuity wherein the annual payments is payable

continuously within the year. We also have the life annuity-due wherein

the annual payments are made at the beginning of each year; and the life

annuity-immediate, wherein the annual payments are made at the end of

each year.

In the aggregate payment technique, we will denote by Y , the random

variable representing the present value of all payments considering interest

alone. Thus, Y is a function of T , when the annuity payments are made

continuous and is a function of K when the annuity payments are made

either at the beginning or at the end of each year.

Consider a continuous whole life annuity. This provides an annual payment

of 1 payable continuous during the year. Under the aggregate payment

technique, we have

Y = ā T | T > 0.

Then, the expected value of Y , which is denoted by āx is

Z ∞

āx = E[Y ] = ā t| t px µx (t)dt. (1)

0

Under the current payment technique, the actuarial present value of the

payment of 1 made at time t is v t t px , thus āx is

Z ∞

āx = v t t px dt. (2)

0

We can show that (1) and (2) are equivalent by integrating by parts 1.

To do this, we let

1 − vt

u = āt| = and dv = t px µx (t)dt,

δ

then

1

du = − v t log vdt = v t dt and v = −t px .

δ

Thus, Z ∞ Z ∞

∞ t

āx = āt| (−t px )|0 + v t px dt = v t t px dt.

0 0

We now find the cdf of Y , when Y = āT | .

log(1 − δy)

= P r[v T ≥ 1 − δy] = P r[T ≤ − ]

δ

log(1 − δy) 1

= FT [− ] for 0<y<

δ δ

26

Then, the pdf of Y is

d d log(1 − δy)

fY (y) = FY (y) = FT [− ]

dy dy δ

1 log(1 − δy) 1

= fT [− ] for 0<y< .

1 − δy δ δ

We can see that the cdf and pdf of Y are dependent on the cdf and the

pdf of T . To show the relationship of Āx and āx , we have

Z ∞

Āx = v t t px µx (t)dt.

0

have du = −δv t dt and v = −t px . Thus,

Z ∞

Āx = −v t t px |∞

0 − δ v t t px dt = 1 − δāx .

0

1 − vT 1−Z

Y = āT | = = ,

δ δ

where Z = v T , for T > 0. Then,

1 − E[Z] 1 − Āx

āx = E[Y ] = = .

δ δ

Furthermore,

1−Z 1 1

V ar[Y ] = V ar[āx ] = V ar[ ] = 2 V ar[v T ] = 2 [ 2Āx − (Āx )2 ].

δ δ δ

Consider now an n-year temporary life annuity. Then under the aggre-

gate payment technique, the random variable Y is defined as

(

āT | if T < n

Y = .

ān| of T ≥ n

Thus,

Z n Z ∞

āx:n| = E[Y ] = āt| t px µx (t) + ān| t px µx (t)

0 n

Z n

= āt| t px µx (t) + ān| t px ,

0

since Z ∞

t px µx (t)dt = t qx |∞

n = 1 − n qx = n px .

n

27

Under the current payment technique, we have

Z n

āx:n| = v t t px dt.

0

To show the relationship between Āx:n| and āx:n| , we have

(

āT | if T < n

Y = .

ān| of T ≥ n

is equivalent to

vT

1−Z if T < n

Y = where Z= .

δ vn if T ≥ n

Thus,

1−Z 1 − Āx:n|

āx:n| = E[Y ] = E[ ]= .

δ δ

Also,

1−Z 1 1

V ar[Y ] = V ar[ ] = 2 V ar[Z] = 2 [ 2Āx:n| − (Āx:n| )2 ].

δ δ δ

We note that the actuarial accumulated value value at the end of the

term of an n-year temporary life annuity of 1 per year payable continuously

while (x) survives is denoted by s̄x:n| . Thus,

Z n t Z n Z n

1 v t px t Ex 1

s̄x:n| = āx:n| = dt = dt = dt.

n Ex 0 n Ex 0 n Ex 0 n−t Ex+t

We now consider the m-year deferred whole life annuity. Under the

aggregate payment technique, we have

0 if T < n

Y =

v n āT −n| if T ≥ n

or equivalently,

0 if T < n

Y =

āT | − ān| if T ≥ n

Thus,

Z ∞

n| āx = E[Y ] = (āt| − ān| )t px µx (t)dt

n

Z ∞

= v n āt−n| t px µx (t)dt

n

Z ∞

n

= v ās| n+s px µx+n (s)ds let t − n = s

0

Z ∞

= v n n px ās| s px+n µx+n (s)ds

0

= n Ex āx+n

28

Under the current payment technique,

Z ∞

n| āx = v t t px dt.

n

Moreover,

Z ∞ Z ∞

v t t px dt = v n+s n+s px ds let t=n+s

n 0

Z ∞

n

= v n px v s s px+n ds

0

= n Ex āx+n .

Also,

Z ∞ Z ∞ Z n

t t

n| āx = v t px dt = v t px dt − v t t px dt

n 0 0

1 − Āx 1 − Āx:n|

= āx − āx:n| = −

δ δ

Āx:n| − Āx

=

δ

∂

1. ∂x āx ;

∂

2. ∂n n| āx

and δt = δ. Evaluate

1. āx = E[āT | ];

2. V ar[āT | ];

3.3.1 Life Annuity Due

Consider a whole life annuity due of 1 per year. Under the aggregate

payment technique, we have

Y = äK+1| for K = 0, 1, 2, . . . .

Thus,

∞

X

äx = E[Y ] = E[ äK+1| ] = äK+1| k px qx+k .

0

29

1−v K+1

Also, since äK+1| = d , we have

1 − v K+1 1 − Ax

äx = E[ äK+1| ] = E[ ]= .

d d

Moreover,

1 − v K+1 1 1

V ar[Y ] = V ar[äK+1| ] = V ar[ ] = 2 V ar[v K=1 ] = 2 [ 2Ax −(Ax )2 ].

d d d

Under the current payment technique,

∞

X ∞

X

äx = v k k px = k Ex .

k=0 k=0

For the n-year temporary life annuity due of 1 per year, we have under

the aggregate payment technique

äK+1| if K = 0, 1, 2, . . . n − 1

Y =

än| if K = n, n + 1, . . .

Thus,

n−1

X ∞

X

äx:n| = E[Y ] = äk+1| k px qx+k + äk+1| k px qx+k

k=0 k=n

n−1

X

= äk+1| k px qx+k + än| n px ,

k=0

n−1

X

äx:n| = v k k px .

k=0

v K+1

1−Z if K = 0, 1, 2, . . . n − 1

Y = where Y = .

d vn if K = n, n + 1, . . .

Then,

1−Z 1 − Ax:n|

äx:n| = E[Y ] = E[ ]= ,

d d

and

1−Z 1 1

V ar[Y ] = V ar[ ] = 2 V ar[Z] = 2 [ 2Ax:n| − (Ax:n| )2 ].

d d d

We now consider an n-year deferred whole life annuity-due of 1. Under

the aggregate payment technique,

0 if K = 0, 1, 2, . . . n − 1

Y =

v n äK−n| if K = n, n + 1, . . . .

30

Thus,

∞

X

n| äx = E[Y ] = v n äk−n| k px qx+k .

k=n

∞

X

n| äx = v k k px .

k=n

∞

X ∞

X n

X

n| äx = v k k px qx+k = v k k px qx+k − v k k px qx+k = äx − äx:n| .

k=n k=0 k=0

Furthermore,

1 − Ax 1 − Ax:n| Ax:n| − Ax

n| äx = äx − äx:n| = − = .

d d d

Finally,

∞

X ∞

X

n| äx = v k k px qx+k = v n n px v k k px+n = n Ex äx+n .

k=n k=0

For a whole life annuity immediate of 1 per year, the actuarial present value

is

X∞

ax = v k k px .

k=1

ax = äx + 1.

Under the aggregate payment technique,

Y = aK| where K = 1, 2, 3, . . . .

It follows that

1 − vK 1 − (1 + i)v K+1 1 − (1 + i)Ax

ax = E[Y ] = E[aK| ] = E[ ] = E[ ]= .

i i i

For the n-year temporary life annuity immediate of 1 per year, the apv

is

n

X

ax:n| = v k k px = äx:n| − 1 + n Ex .

k=1

For an n-year deferred whole life annuity immediate of 1 per year, the

apv is

X∞

a

n| x = v k k px .

k=n+1

31

It is very easy to show that

values of life annuity due and life annuity immediate and the net single

premiums of the corresponding life insurance. We have,

Therefore,

Ax = väx − ax .

Analogously, it can be shown that

1

Ax:n| = väx:n| − ax:n| .

Also,

1

Ax:n| = Ax:n| + n Ex = väx:n| − ax:n| + n Ex = väx:n| − ax:n−1|

1

Consider a whole life annuity of 1 per year payable in installments of m at

the beginning of each mth of a year while (x) survives. Let J be a random

variable representing the number of complete mth ’s of a year lived in the

year of death. Thus,

J = [ (T − K)m ].

1

We note that there are m payments of m for each complete year lived and

1

J + 1 payments of m in the year of death. Thus, under the aggregate

payment technique,

mK+J J+1

X 1 j/m (m) 1 − v K+ m

Y = v = ä J+1 = .

j=0

m K+ m | d(m)

Then,

J+1

1 − v K+ m 1 − A(m)

ä(m)

x = E[Y ] = E[ (m)

]= .

d d(m)

Under current payment technique, we have

∞

1 X h

ä(m)

x = vm h px .

m m

h=0

(m)

We show a relationship between äx and äx . We know that

x and 1 = däx + Ax .

d(m) ä(m)

x + A(m)

x = däx + Ax ,

32

or equivalently,

d 1

ä(m)

x = äx − (A(m)

x − Ax ).

d(m) d(m)

(m) i (m) (m)

Applying UDD, Ax = A

i(m) x

=s Ax and since d(m) ä = d, then,

1| 1|

s − 1 ä d a¨x − (s − 1)(1 − däx )

(m) 1| 1| 1|

ä(m)

x = ä äx − Ax =

1| d(m) d(m)

(m) (m) (m)

1−s + ds äx d s −1

1| 1| (m) 1|

= = s äx − = α(m)äx − β(m)

d(m) d(m) 1| d(m)

(m)

s −1

d (m) id 1| i−i(m)

where α(m) = d(m)

s = i(m) d(m)

and β(m) = d(m) = i(m) d(m)

.

1|

(m)

A simpler relationship is äx = äx − m−12m .

Example 3.3. On the basis of the illustrative life table with interest at

i = 0.06, calculate the APV of a whole life annuity due of 1000 per month

for a retiree aged 65.

Exercise 3.1. The following problems were lifted from the textbook “Ac-

tuarial Mathematics” (2nd edition) by Bowers, Gerber, Hickman, Jones

and Nesbitt. These problems are exercises from Chapter 4 found on pp.

126-132.

µ

Āx = .

µ+δ

1

2. (Ex. 4.2) Let µ(x) = 1+x , ∀x > 0.

Z ∞

1+x

Āx = 1 − δ e−δt dt.

0 1 + x+t

d

(b) Use (a) to show that dx Āx < 0, ∀x > 0.

dĀx

= −v(I¯Ā)x .

di

and that δ = 0.05.

33

(a) Calculate Ā140:25| ;

(b) Determine the APV for a 25-year term insurance with benefit

amount for death at time t, bt = e0.05t , for (40) at policy issue.

5. (Ex. 4.9)

(b) Show that if T has a gamma distribution, with parameters α

and β, then

−α

δ

Āx = 1 + .

β

6. (Ex. 4.10) Given bt = t, µx (t) = µ and δt = δ, derive expressions

for

7. (Ex. 4.11) The r. v. Z, is the PV r.v. for the whole life insurance

of unit amount payable at the moment of death and issued to (x). If

δ = 0.05 and µx (t) = 0.01,

(b) graph the pdf of Z;

(c) calculate Āx and V ar[Z].

8. (Ex. 4.14) If lx = 100 − x, 0 ≤ x ≤ 100 and i = 0.05, evaluate

1

(a) Ax:20| ; (b) A1x:20|

(a) Describe the benefit of the insurance with APV given by the

symbol (IA)x:m| .

(b) Express the APV of (a) in terms of the symbols in Tables 4.2.1

and 4.3.1.

11. (Ex. 4.20) Show that under the constant force of mortality assump-

tion between integral ages

∞

X i + qx+k

Āx = v k+1 k px µx (k) ,

δ + µx (k)

k=0

34

12. (Ex. 4.21)

(a) Show that Z ∞

Āx = v t t px µx (t)dt

0

can be rewritten as

Z ∞

1

Āx = x

v y y p0 µy dy, x ≥ 0.

x p0 v x

d

Āx = Āx (µx + δ) − µx , x ≥ 0.

dx

(c) Use the same technique to show

d 1

Ā = Ā1x:n| (µx + δ) + Āx:n|

1

µx+n − µx x ≥ 0.

dx x:n|

13. (Ex. 4.28) Assume that T (x) has a pdf given by

2 2

fT (t) = √ e−t /200 , t>0

10 2π

and δ = 0.05. Show that

(a) Āx = 2e0.125 [1 − Φ(0.5)] = 0.6992;

(b) 2 Āx = 2e0.5 [1 − Φ(1)] = 0.5232;

(c) V ar[Z] = 0.0343, where Z = v T ;

(d) ξZ0.5 = 0.7076

4 BENEFIT PREMIUMS

4.1 Introduction

In practice life insurance is purchased by a life annuity of contract(gross)

premiums. These contract premiums provide not only for the benefit to

paid but also for the expenses in initiating and maintaining the insurance

and margins for profits for the insurance company. In contrast, benefit

premiums provide only for the benefit. In this chapter we will discuss

benefit premiums. The benefit premiums we will consider are those which

satisfy the equivalence principle. This principle satisfies,

E[L] = 0,

where L is called the insurer’s loss defined as the random variable of the

present value of the benefits to be paid by the insurer less the present value

of the benefit premiums to be paid by the insured. In other words,

35

5 Fully Continuous Premiums

In general the random variable L is defined as

L = Z − P̄ Y,

where Z is the present value of the benefit as defined in Chapter 2, Y is the

present value of the life annuity as defined in Chapter 3 and P̄ is the annual

premium payable continuously. If the equivalence principle is applied then,

E[L] = E[Z − P̄ Y ] = E[Z] − P̄ E[Y ] = 0.

Thus,

E[Z]

.

P̄ =

E[Y ]

Consider a fully continuous level annual benefit premium for a unit

amount whole life insurance payable at the moment of death of (x), then,

L = v T − P̄ āT | where T > 0.

E[v T ] Āx

P̄ (Āx ) = P̄ = = .

E[āT | ] āx

E[L2 ].

1 − vT

V ar[L] = V ar[v T − P̄ āT | ] = V ar[v T − P̄ ]

δ

P̄ P̄ P̄

= V ar[v T (1 + ) − ] = (1 + )2 V ar[v T ]

δ δ δ

P̄ 2 2

= (1 + ) [ Āx − (Āx ) ]

δ

Āx

Since P̄ = āx , then

(1 + ) = (1 + ) =( ) =( ) .

δ δāx δāx δāx

Therefore,

2

Āx − (Āx )

V ar[L] = .

(δāx )2

We now find an expression for the cdf of L in terms of the cdf of T .

1 − vT

FL (u) = P r[L ≤ u] = P r[v t − P̄ ( ) ≤ u]

δ

δu + P̄ 1 δu + P̄

= P r[v T ≤ ] = P r[T ≥ − log( )]

δ + P̄ δ δ + P̄

1 δu + P̄ P̄

= 1 − FT (− log( )) where u > −

δ δ + P̄ δ

36

Then, the pdf of L is

d 1 δu + P̄ 1

fL (u) = FL (u) = {fT (− log( ))}( ),

du δ δ + P̄ δu + P̄

Plan bT v T P̄ Y , where Y is P̄

Whole Life 1v T āT | , T ≥ 0 P̄ (Āx ) = Āx

āx

Ā1x:n|

n-year 1v T āT | , T ≤ n P̄ (Ā1x:n| ) = āx:n|

term 0 ān| , T > n

Āx:n|

n-year 1v T āT | , T ≤ n P̄ (Āx:n| ) = āx:n|

endowment 1v n ān| , T > n

T Āx

h-payment 1v āT | , T ≤ h h P̄ (Āx ) = āx:h|

whole life 1v T āh| , T > h

h-payment 1v T āT | , T ≤ h

Āx:n|

n-year 1v T āh| , h < T ≤ n h P̄ (Āx:n| ) = āx:h|

endowment 1v n āh| , T > n

the force of interest δ, find an expression for P̄ (Āx ).

Example 5.2. Show that the variance of the loss L, associated with an

n-year endowment insurance can be expressed as:

2

Āx:n| − (Āx:n| )2

V ar(L) = .

(δāx:n| )2

1−δāx 1−δ Āx

1. P̄ (Āx ) = āx = Āx

;

1−δāx:n| 1−δ Āx:n|

2. P̄ (Āx:n| ) = āx:n| = Āx:n|

To find the benefit discrete premium P , we follow the same procedure as

in finding P̄ . Consider level annual premiums payable at the beginning of

each year for a unit whole life insurance payable at the end of the year of

death. Then, for K = 0, 1, 2, . . ..

37

Then,

L = Z − P Y = v K+1 − P äK+1| .

This implies that using the equivalence principle

Ax

Px = P = .

äx

It can be shown easily that

2

Ax − (Ax )2

V ar[L] = .

(däx )2

0.04

Example 6.1. Suppose k| qx = c(0.96)k+1 , where k = 0, 1, 2 . . ., c = 0.96

and i = 0.06, find Px .

Example 6.2. Consider a 10,000 fully discrete whole life insurance. Let π

denote an annual premium for this policy and L(π) denote the loss-at-issue

random variable for one such policy on the basis of the Illustrative Life

Table, 6% interest and issue age 35.

1. Determine the premium πa , such that the loss of L(πa ) has mean 0.

Calculate the variance of L(πa ).

2. Approximate the smallest nonnegative premium πb , such that the

probability is less than 0.5 that the loss L(πb ) is positive. Find the

variance of L(πb ).

3. Determine the premium πc , such that the probability of a positive

total loss on 100 such independent policies is 0.05 by the normal

approximation.

Most of the time, the premium paid for an insurance policy is made several

times in a year, instead of once a year. The premium paid m times per

year, with no adjustment in the death benefit is called the true fractional

(m)

premiums. The notations Px and P (m) (Āx ) represents the true level

annual benefit premium, payable in mthly installments, for a a unit whole

life insurance payable at the end of the year of death and at the moment

of death respectively.

Summary of Benefit Payments

(m)

Whole Life Px = A(m) x

P (m) (Āx ) = Ā(m)

x

äx äx

1(m) Ā1x:n| Ā1x:n|

n-year term P = (m) P (m) (Ā1x:n| ) = (m)

x:n| ä ä

x:n| x:n|

(m) Ax:n| Āx:n|

n-year endowment P = (m) P (m) (Āx:n| ) = (m)

x:n| ä ä

x:n| x:n|

(m) Āx (m) Āx

h-payment, whole life h Px = (m) hP (Āx ) = (m)

ä ä

x:h| x:h|

(m) Ax:n| (m) Āx:n|

h-payment, n-year endowment hP = (m) hP (Āx:n| ) = (m)

x:n| ä ä

x:h| x:h|

38

We note that the actual amount of each fractional premium is P (m) /m.

The payment term h is in years. Furthermore, we express the fractional

premium as a multiple of the corresponding annual premium. Thus, for

(m)

instance we express h P as

x:n|

(m)

äx:h|

hP = h Px:n| .

x:n| (m)

ä

x:h|

Example 6.3. Calculate the level annual benefit premium payable in semi-

annual installments for a 10,000, 20-year endowment insurance with pro-

ceeds paid at the end of the policy year of death (discrete) issued to (50),

on the basis of the Illustrative Life Table with i = 0.06.

Exercise 6.1. The following problems were lifted from the textbook “Ac-

tuarial Mathematics” (2nd edition) by Bowers, Gerber, Hickman, Jones

and Nesbitt. These problems are exercises from Chapter 5 found on pp.

158-166.

1. (Ex. 5.1) Using UDD in each year of age and the Illustrative Life

Table with i = 0.06, calculate

(a) ā20 , ā50 , ā80 ;

(b) V ar[āT | ], for x = 20, 50, 80.

2. (Ex. 5.2) Using the values obtained in Exercise 5.1, calculate the

standard deviation and the coefficient of variation σµ , of the following

present value random variables.

(a) Individual annuities issued at ages 20, 50, 80 with life incomes

of 1000 per year payable continuously;

(b) A group of 100 annuities, each issued at age 50, with life incomes

of 1000 per year payable continuously.

3. (Ex. 5.6) Assume µx (t) = µ and δt = δ, t ≥ 0. Given the following

definition for Y , display its distribution function.

(

(a) Y = āT | , T ≥ 0 0 0≤T <n

(c) Y =

āT | − ān| T ≥ n

( (

āT | 0 ≤ T < n ān| 0 ≤ T < n

(b) Y = (d) Y =

ān| T ≥ n āT | T ≥ n

V ar[v K+1 ]

V ar[aK| ] = V ar[äK+1| ] = .

d2

5. (Ex. 5.12) Prove the following identities.

39

Ax:n| −Ax

(a) ax:n| = 1 Ex äx+1:n| (b) n| ax = − n Ex

d

Ax:n| = väx:n| − ax:n−1| .

a(m)

x =s ax + [(1 + i)ax − (1 + )Ax ],

1| i(m) m

and that under UDD, this becomes

(m)

1 − ä

(m) 1|

a(m)

x =s ax + (1 + i) Ax .

1| i(m)

8. (Ex. 5.19) Show that the annuity-immediate analogue of (5.4.7) is

(m)

1 − (1 + i(m) /m)Ax (m) (m) (m)

a(m)

x = =a − ä Ax ,

i(m) ∞| ∞|

(m)

1 − ä

1|

a(m)

x = α(m)ax + .

i(m)

9. (Ex. 5.22)

(m)

(a) Develop a formula for s̈ in terms of s̈25:40| .

25:40|

(b) On the basis of the Illustrative Life Table, with i = 0.06, calcu-

late the values of

(12) (12)

i. ä ; ii. s̈

25:40| 25:40|

¯

δ(Iā) + T v T = āT | ,

T|

¯ x + (I¯Ā)x = āx ,

δ(Iā)

¯ x is the APV of a life annuity to (x) under which payments

where (Iā)

are being made continuously at the rate of t per annum at time t.

11. (Ex. 5.47) Show that

d

äx = −v(Ia)x ,

di

where

∞

X

(Ia)x = tv t t px .

t=1

40

7 BENEFIT PREMIUMS

7.1 Introduction

In practice life insurance is purchased by a life annuity of contract(gross)

premiums. These contract premiums provide not only for the benefit to

paid but also for the expenses in initiating and maintaining the insurance

and margins for profits for the insurance company. In contrast, benefit

premiums provide only for the benefit. In this chapter we will discuss

benefit premiums. The benefit premiums we will consider are those which

satisfy the equivalence principle. This principle satisfies,

E[L] = 0,

where L is called the insurer’s loss defined as the random variable of the

present value of the benefits to be paid by the insurer less the present value

of the benefit premiums to be paid by the insured. In other words,

In general the random variable L is defined as

L = Z − P̄ Y,

present value of the life annuity as defined in Chapter 3 and P̄ is the annual

premium payable continuously. If the equivalence principle is applied then,

Thus,

E[Z]

P̄ = .

E[Y ]

Consider a fully continuous level annual benefit premium for a unit

amount whole life insurance payable at the moment of death of (x), then,

E[v T ] Āx

P̄ (Āx ) = P̄ = = .

E[āT | ] āx

E[L2 ].

41

1 − vT

V ar[L] = V ar[v T − P̄ āT | ] = V ar[v T − P̄ ]

δ

P̄ P̄ P̄

= V ar[v T (1 + ) − ] = (1 + )2 V ar[v T ]

δ δ δ

P̄ 2 2

= (1 + ) [ Āx − (Āx ) ]

δ

Āx

Since P̄ = āx , then

(1 + ) = (1 + ) =( ) =( ) .

δ δāx δāx δāx

Therefore,

2

Āx − (Āx )

V ar[L] = .

(δāx )2

We now find an expression for the cdf of L in terms of the cdf of T .

1 − vT

FL (u) = P r[L ≤ u] = P r[v t − P̄ ( ) ≤ u]

δ

δu + P̄ 1 δu + P̄

= P r[v T ≤ ] = P r[T ≥ − log( )]

δ + P̄ δ δ + P̄

1 δu + P̄ P̄

= 1 − FT (− log( )) where u > −

δ δ + P̄ δ

Then, the pdf of L is

d 1 δu + P̄ 1

fL (u) = FL (u) = {fT (− log( ))}( ),

du δ δ + P̄ δu + P̄

where u > − P̄δ .

Summary of Benefit Payments

Loss Components Premium

Plan bT v T P̄ Y , where Y is P̄

Whole Life 1v T āT | , T ≥ 0 P̄ (Āx ) = Āx

āx

Ā1x:n|

n-year 1v T āT | , T ≤ n P̄ (Ā1x:n| ) = āx:n|

term 0 ān| , T > n

Āx:n|

n-year 1v T āT | , T ≤ n P̄ (Āx:n| ) = āx:n|

endowment 1v n ān| , T > n

T Āx

h-payment 1v āT | , T ≤ h h P̄ (Āx ) = āx:h|

whole life 1v T āh| , T > h

h-payment 1v T āT | , T ≤ h

Āx:n|

n-year 1v T āh| , h < T ≤ n h P̄ (Āx:n| ) = āx:h|

endowment 1v n āh| , T > n

42

Example 7.1. Under the constant force of mortality µ)x(t) = µ. Given

the force of interest δ, find an expression for P̄ (Āx ).

SOLUTION:

Z ∞ Z ∞ Z ∞

µ

Āx = v t t px µx (t)dt = e−δt e−µt µdt = µ e−(µ+δ) dt = .

0 0 0 µ+δ

Z ∞ Z ∞ Z ∞

1

āx = v t t px dt = e−δt e−µt dt = e−(µ+δ) dt = .

0 0 0 µ+δ

Therefore,

µ

Āx µ+δ

P̄ (Āx ) = = 1 = µ.

āx µ+δ

Example 7.2. Show that the variance of the loss L, associated with an

n-year endowment insurance can be expressed as:

2

Āx:n| − (Āx:n| )2

V ar(L) = .

(δāx:n| )2

SOLUTION:

Define Z3 = Z1 + Z2 , where

T

v if T ≤ n 0 if T ≤ n

Z1 = and Z2 = .

0 if T > n vn if T > n

1 − Z3 P̄ P̄

L = Z3 − P̄ Y = Z3 − P̄ ( ) = Z3 1 + − .

δ δ δ

Therefore,

2

P̄ P̄ P̄

V ar[L] = V ar Z3 1 + − = 1+ V ar[Z3 ]

δ δ δ

2

P̄

2 Āx:n| − (Āx:n| )2

= 1+ [2 Āx:n| − (Āx:n| )2 ] =

δ (δāx:n| )2

1−δāx 1−δ Āx

1. P̄ (Āx ) = āx = Āx

;

1−δāx:n| 1−δ Āx:n|

2. P̄ (Āx:n| ) = āx:n| = Āx:n|

43

7.3 Fully Discrete Premiums

To find the benefit discrete premium P , we follow the same procedure as

in finding P̄ . Consider level annual premiums payable at the beginning of

each year for a unit whole life insurance payable at the end of the year of

death. Then, for K = 0, 1, 2, . . ..

Z = v K+1 and Y = äK+1| .

Then,

L = Z − P Y = v K+1 − P äK+1| .

This implies that using the equivalence principle

Ax

Px = P = .

äx

It can be shown easily that

2

Ax − (Ax )2

V ar[L] = .

(däx )2

0.04

Example 7.3. Suppose k| qx = c(0.96)k+1 , where k = 0, 1, 2 . . ., c = 0.96

and i = 0.06, find Px .

SOLUTION: P∞ a

We know that the sum of an infinite geometric series is k=0 ark = 1−r

and d = 1 − (1 + i)−1 .

∞ ∞ ∞ k+1

X

k+1

X

−(k+1) k+1

X 0.96

Ax = v k| qx =c (1 − 06) (0.96) =c

1.06

k=0 k=0 k=0

0.96

0.04 1.06

= = 0.4

0.96 1 − 0.96

1.06

1 − Ax 1 − 0.4

äx = = = 10.60.

d 1 − (1.06)−1

Therefore,

Ax 0.4

= Px = = 0.0377.

äx 10.6

To find V ar[L], we first determine 2 Ax .

∞ ∞ ∞ k+1

X X X 0.96

2

Ax = v 2(k+1) k| qx = c (1 − 06)−2(k+1) (0.96)k+1 = c

(1.06)2

k=0 k=0 k=0

0.96

!

0.04 (1.06)2

= 0.96 = 0.2445.

0.96 1 − (1.06) 2

Therefore,

2

Ax − (Ax )2 0.2445 − (0.4)2

V ar[L] = 2

= = 0.2347.

(däx ) [(0.0566)(10.60)]2

44

7.4 True m-thly Payment Premiums

Most of the time, the premium paid for an insurance policy is made several

times in a year, instead of once a year. The premium paid m times per

year, with no adjustment in the death benefit is called the true fractional

(m)

premiums. The notations Px and P (m) (Āx ) represents the true level

annual benefit premium, payable in mthly installments, for a a unit whole

life insurance payable at the end of the year of death and at the moment

of death respectively.

(m)

Whole Life Px = A(m) x

P (m) (Āx ) = Ā(m)

x

äx äx

1(m) Ā1x:n| Ā1x:n|

(m)

n-year term P = (m) P (Ā1x:n| ) = (m)

x:n| ä ä

x:n| x:n|

(m) Ax:n| Āx:n|

n-year endowment P = (m) P (m) (Āx:n| ) = (m)

x:n| ä ä

x:n| x:n|

(m) Āx (m) Āx

h-payment, whole life h Px = (m) hP (Āx ) = (m)

ä ä

x:h| x:h|

(m) Ax:n| (m) Āx:n|

h-payment, n-year endowment hP = (m) hP (Āx:n| ) = (m)

x:n| ä ä

x:h| x:h|

We note that the actual amount of each fractional premium is P (m) /m.

The payment term h is in years. Furthermore, we express the fractional

premium as a multiple of the corresponding annual premium. Thus, for

(m)

instance we express h P as

x:n|

(m)

äx:h|

hP = h Px:n| .

x:n| (m)

ä

x:h|

Example 7.4. Calculate the level annual benefit premium payable in semi-

annual installments for a 10,000, 20-year endowment insurance with pro-

ceeds paid at the end of the policy year of death (discrete) issued to (50),

on the basis of the Illustrative Life Table with i = 0.06.

SOLUTION: From the Illustrative Life Table, we get

19

X

ä50:20| = v k k p50 = 11.291832.

k=0

we have

id i − i(2)

α(2) = = 1.0002122 and β(2) = = 0.25739081.

i(2) d(2) i(2) d(2)

Then,

(2)

ä = α(2)ä50:20| − β(2)[1 − 20 E50 ] = 11.096159.

50:20|

45

Therefore,

(2)

A50:20| 0.036083889

10000P = 10000 (2)

= 10000 = 325.19.

50:20|

ä 11.096159

50:20|

Exercise 7.1. The following problems were lifted from the textbook “Ac-

tuarial Mathematics” (2nd edition) by Bowers, Gerber, Hickman, Jones

and Nesbitt. These problems are exercises from Chapter 6 found on pp.

197-202.

1. (Ex. 6.4) A fully continuous whole life insurance with unit benefit

has a level premium. The r.v T (x), has an exponential distribution

with E[T (x)] = 50 and the force of interest is δ = 0.06. If the principle

of equivalence is used, find the benefit premium rate.

2. (Ex. 6.6) Derive an expression for

2

Āx − (Āx )2

,

(δāx )2

3. (Ex. 6.7) If δ = 0, show that

1

P̄ (Āx ) = .

eox

dāx d

1+ P̄ (Āx ) − Āx = µ(x).

dx dx

2

Ax −(Ax )2

(däx )2 , if

k| qx = (1 − r)rk , k = 0, 1, 2, . . . .

µ.

(a) Exhibit the pdf of L;

µ−P̄

(b) Show that E[L] = µ+δ ;

(c) Use (b.) to confirm that E[L] = 0 when P̄ = P̄ (Āx ).

7. (Ex. 6.36) Use the assumptions in Exercise 6.35, with µ = 0.03 and

δ = 0.06.

(a) Evaluate P r[L ≤ 0] when P̄ = P̄ (Āx );

(b) Determine P̄ so that P r[L > 0] = 0.5.

46

8 Benefit Reserves

We note the following:

• At the issuance of an insurance or an annuity, the APV of the pay-

ment(s) to be made by the insurer is exactly equal to the APV of

the net premiums to be made by the insured. This is due to the

equivalence principle.

• As time goes on, the APV of the premiums paid by the insured gener-

ally decreases and for the insurer, if it is an annuity the APV generally

decreases and if it is an insurance the APV generally increases.

• This implies that at time t 6= 0, the value of the difference between

these two values is not zero.

• Thus, it is important that we have a measure of this difference because

the insurer needs to have enough funds when payments for benefits

are required to be given sometime at time t 6= 0.

• The difference of the value of the benefit at time over the value of

the benefit premiums at time t 6= 0. This is what we use to define

reserves.

To determine the prospective loss RV, we consider

• Let U be the time until death RV of (x + t), with pdf fU (u) =

u px+t µx+t (u), where u ≥ 0.

tL = v u − P̄ āu|

Consider a unit whole life insurance payable at the moment of death

issued to (x) issued on a fully continuous basis with annual premiums of

P̄ (Āx ). The prospective loss is

tL = v u − P̄ (Āx )āu| ,

then the benefit reserve is E[tL]. Let E[t L] = t (V̄ Āx ). Then,

47

1. P̄ (Ā35 );

2. t (V̄ Ā35 );

We consider reserves related to benefit annual premiums payable at the

beginning of each year and insurance benefit payable at the end of the year

of death.

• Let J denote the discrete RV representing the curt ate future lifetime

of (x + k) with pmf

kL = v J+1 − P äJ+1| .

kL = v J+1 − Px äJ+1| .

k Vx = E[k L]

= E[v J+1 ] − Px E[äJ+1| ]

= Ax+k − Px äx+k

0.04

Example 8.2. If k qx = c(0.96)k+1 , k = 0, 1, 2, . . . where c = 0.96 and

i = 0.06, calculate

1. Px ;

2. k Vx

48

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