Chapter 3: Survival Distributions and Life Tables

Distribution function of X: Force of mortality µ(x):

FX (x) = Pr(X ≤ x) fX (x)

µ(x) =
1 − FX (x)
Survival function s(x): s0 (x)
= −
s(x)
s(x) = 1 − FX (x)
Relations between survival functions and
Probability of death between age x and force of mortality:
age y:  x 
Z
Pr(x < X ≤ z) = FX (z) − FX (x) s(x) = exp − µ(y)dy 
= s(x) − s(z) 0
x+n
 
Probability of death between age x and
Z
age y given survival to age x: n px = exp − µ(y)dy 
x
FX (z) − FX (x)
Pr(x < X ≤ z|X > x) = Derivatives:
1 − FX (x)
s(x) − s(z) d
= t qx = t px · µ(x + t) = fT (x) (t)
s(x) dt
d
Notations: t px = − t px · µ(x + t)
dt
d
t qx = Pr[T (x) ≤ t] Tx = −lx
dt
= prob. (x) dies within t years d
Lx = −dx
= distribution function of T (x) dt
t px = Pr[T (x) > t] d
e̊x = µ(x)e̊x − 1
= prob. (x) attains age x + t dt
= 1 − t qx Mean and variance of T and K:

E[T (x)] ≡ complete expectation of life

t|u qx = Pr[t < T (x) ≤ t + u] Z∞
= t+u qx − t qx ≡ e̊x = t px dt
= t px − t+u px 0

= t px · u qx+t E[K(x)] ≡ curtate expectation of life

X∞
Relations with survival functions: ≡ ex = k px
k=1
s(x + t)
t px = Z∞
s(x)
V ar[T (x)] = 2 t · t px dt − e̊2x
s(x + t)
t qx = 1− 0
s(x) ∞
X
Curtate future lifetime (K(x) ≡ greatest V ar[K(x)] = (2k − 1) k px − e2x
k=1
integer in T (x)):

Pr[K(x) = k] = Pr[k ≤ T (x) < k + 1] Total lifetime after age x: Tx

= k px − k+1 px
Z∞
= k px · qx+k Tx = lx+t dt
= k| qx 0

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Total lifetime between age x and x + 1: Lx Central death rate: mx

Lx = Tx − Tx+1 lx − lx+1
mx =
Z1 Z1 Lx
= lx+t dt = lx · t px dt lx − lx+n
n mx =
n Lx
0 0

Total lifetime from age x to x + n: Fraction of year lived between age x and
n Lx
age x + 1 by dx : a(x)
n−1
X
n Lx = Tx − Tx+n = Lx+k R1
k=0 t · t px · µ(x + t) dt
0 Lx − lx+1
Zn a(x) = =
R1 lx − lx+1
= lx+t dt t px · µ(x + t) dt
0
0

Average lifetime after x: e̊x Recursion formulas:

Tx E[K] = ex = px (1 + ex+1 )
e̊x =
lx E[T ] = e̊x = px (1 + e̊x+1 ) + qx a(x)
Average lifetime from x to x + 1: e̊x: 1 ex = ex: n + n px ex+n
e̊x = e̊x: n + n px e̊x+n
Lx
e̊x: 1 =
lx
E[K ∧ (m + n)] = ex: m+n
Median future lifetime of (x): m(x) = ex: m + m px ex+m: n

s(x + m(x)) 1 E[T ∧ (m + n)] = e̊x: m+n

P r[T (x) > m(x)] = = = e̊x: m +
s(x) 2 m px e̊x+m: n

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 Chapter 4: Life Insurance

Whole life insurance: Āx Discrete whole life: Ax

Z∞
∞
E[Z] = Āx = v t · t px µx (t)dt X
E[Z] = Ax = v k+1 · k px · qx+k
0 k=0
V ar[Z] = Āx − (Āx )2
2 ∞
X
= v k+1 · k| qx
k=0

n-year term insurance: Āx: n 1 V ar[Z] = Ax − (Ax )2

2

Zn
E[Z] = Āx: n = 1
v t · t px µx (t)dt
Discrete n-year term: A1x: n
0
V ar[Z] = Ā1x: n − (Ā1x: n )2
2

n−1
X
E[Z] = A1x: n = v k+1 · k px · qx+k
k=0
m-year deferred whole life: m| Āx
V ar[Z] = Ax: n − (A1x: n )2
2 1

Z∞
E[Z] = m| Āx = v t · t px µx (t)dt
m
1 Discrete n-year endowment: Ax: n
m| Āx = Āx − Āx: m

n−1
X
n-year pure endowment: Āx: n 1 E[Z] = Ax: n = v k+1 · k px · qx+k + v n · n px
k=0
1
E[Z] = Āx: n = v · n px ≡ n Ex n V ar[Z] = Āx: n − (Āx: n )2
2

V ar[Z] = 2
Āx:1n − (Āx:1n )2 = v 2n · n px · n qx Āx: n = Ā1x: n + Āx:1n

n-year endowment insurance: Āx: n

Recursion and other relations:
Zn
E[Z] = Āx: n = v t t px µx (t)dt + v n n px Āx = Ā1x: n + n| Āx
0 2 2 1 2
Āx = Āx: n + n| Āx
V ar[Z] = Āx: n − (Āx: n )2
2

n| Āx = n Ex · Āx+n
Āx: n = Ā1x: n + Āx:1n 1
Āx = Āx: n + n Ex · Āx+n
Ax = vqx + vpx Ax+1
m-yr deferred n-yr term: Ax = v 2 qx + v 2 px 2Ax
2
m|n Āx
A1x: n 1
= vqx + vpx Ax+1: n−1
1
m|n Āx = m Ex · Āx+m: n m|n Ax = vpx · (m−1)|n Ax+1
1 1
= Āx: m+n − Āx: m Ax: 1 = v
= m| Āx − m+n| Āx Ax: 2 = vqx + v 2 px

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Varying benefit insurances: Interest theory reminder

Z∞ 1 − vn
an =
(I Ā)x = bt + 1cv t · t px µx (t)dt i
1 − vn i
0 ā n = = an
δ δ
Zn 1 1 1
(I Ā)1x: n = bt + 1cv t · t px µx (t)dt ā ∞ = , a ∞ = , ä ∞ =
δ i d
0 ä n − nv n
Z∞ (Ia) n =
i
t n − ā n
(IA)x = t · v · t px µx (t)dt
(Da) n =
0 δ
Zn 1
(Ia) ∞ =
1
(IA)x: n = t · v t · t px µx (t)dt δ2
(n + 1)a n = (Ia) n + (Da) n
0
i
Zn s̄ 1 =
δ
1
(DĀ)x: n = (n − btc)v t · t px µx (t)dt
d = iv
0 1 1+i
Zn (Ia) ∞ = = 2
id i
(DA)1x: n = (n − t)v t · t px µx (t)dt
0
Doubling the constant force of interest δ
(IA)x = Ax + vpx (IA)x+1
= vqx + vpx [(IA)x+1 + Ax+1 ] 1 + i → (1 + i)2
(DA)1x: n 1
= nvqx + vpx (DA)x+1: v → v2
n−1
i → 2i + i2
(IA)1x: n + (DA)1x: n = nĀ1x: n
d → 2d − d2
(I Ā)1x: n + (DĀ)1x: n = (n + 1)Ā1x: n
i 2i + i2
(IA)1x: n + (DA)1x: n = (n + 1)A1x: n →
δ 2δ

Limit of interest rate i = 0:

Accumulated cost of insurance:
i=0
1
Ax −→ 1
Āx: n i=0
n k̄x = A1x: n −→ n qx
n Ex
i=0
n| Ax −→ n px
i=0
Share of the survivor: Ax: n −→ 1
i=0
1 (1 + i)n m|n Ax −→ m|n qx
accumulation factor = = i=0
n Ex n px (IA)x −→ 1 + ex
i=0
(IA)x −→ e̊x

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 Chapter 5: Life Annuities

Whole life annuity: āx Recursion relations

Z∞
āx = āx: 1 + vpx āx+1
āx = E[ā T ] = ā t · t px µ(x + t)dt
āx = āx: n + n| āx
0
Z∞ Z∞ äx = 1 + vpx äx+1
= t
v · t px dt = t Ex dt
2
äx = 1 + v 2 px 2äx+1
0 0 äx: n = 1 + vpx äx+1: n−1
2
Āx − (Āx )2 (m) (m)
V ar[ā T ] = äx: n = ä(m)
x − n Ex · äx+n
δ2
ax = vpx + vpx ax+1
ax: n = vpx + vpx ax+1: n−1
n-year temporary annuity: āx: n
(Iä)x = 1 + vpx [(Iä)x+1 + äx+1 ]
Zn Zn
= äx + vpx (Iä)x+1
āx: n = v t · t px dt = t Ex dt
0 0 Whole life annuity due: äx
2
Āx: n − (Āx: n )2
V ar[Y ] = ∞
δ2 X
äx = E[ä K+1 ] = v k · k px
k=0
n-year deferred annuity: n| āx Ax − (Ax
2
)2
V ar[ä K+1 ] =
Z∞ Z∞ d2
n| āx = v t · t px dt = t Ex dt
n n n-yr temporary annuity due: äx: n
n
= v · n px āx+n = n Ex · āx+n
n| āx
2 2n n−1
V ar[Y ] = v · n px (āx+n − 2āx+n ) − (n| āx )2
X
δ äx: n = E[Y ] = v k · k px
k=0
2
Ax: n − (Ax: n )2
V ar[Y ] =
d2
n-yr certain and life annuity: āx: n

āx: n = āx + ā n − āx: n n-yr deferred annuity due: n| äx

= ā n + n| āx = ā n + n Ex · āx+n
∞
X
n| äx = E[Y ] = v k · k px
Most important identity k=n
= äx − äx: n
1 = δāx + Āx = · äx+n
n Ex
1 − Āx
āx =
δ
Āx: n = 1 − δāx: n n-yr certain and life due: äx: n
2
Āx: n = 1 − (2δ) 2āx: n
1 − Ax äx: n = äx + ä n − äx: n
äx =
d X ∞
1 − Ax: n = ä n + v k · k px
äx: n =
d k=n
1 = däx: n + Ax: n = ä n +n| äx

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Whole life immediate: ax Accumulation function:
X∞
ax = E[ä K ] = v k · k px Zn
k=1 āx: n 1
s̄x: n = =
1 − (1 + i)Ax n Ex n−t Ex+t
ax = 0
i

m-thly annuities Limit of interest rate i = 0:

(m)
1 − Ax
ä(m)
x = i=0
d(m) ax −→ ex
(m) (m)
2
Ax − (Ax )2 i=0
äx −→ 1 + ex
V ar[Y ] =
(d(m) )2 i=0
āx −→ e̊x
1
a(m)
x = ä(m)
x − ax: n
i=0
−→ ex: n
m
1 i=0
(m)
ax: n
(m)
= äx: n − (1 − n Ex ) äx: n −→ 1 + ex: n−1
m i=0
āx: n −→ e̊x: n

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 Chapter 6: Benefit Premiums

Loss function: h-payment insurance premiums:

Loss = PV of Benefits − PV of Premiums
Fully continuous equivalence premiums Āx
(whole life and endowment only): h P̄ (Āx ) =
āx: h
Āx: n
Āx h P̄ (Āx: n ) =
P̄ (Āx ) = āx: h
āx
Ax
δ Āx h Px =
P̄ (Āx ) = äx: h
1 − Āx
1 Ax: n
P̄ (Āx ) = −δ h Px: n =
āx äx: h
 2
P̄ Pure endowment annual premium Px: n1 :
Āx − (Āx )2
2 
V ar[L] = 1+
δ it is the reciprocal of the actuarial accumulated
2
Āx − (Āx )2 value s̈x: n because the share of the survivor who
V ar[L] = has deposited Px: n1 at the beginning of each year
(δāx )2
for n years is the contractual $1 pure endow-
2
Āx − (Āx )2
V ar[L] = ment, i.e.
(1 − Āx )2
Fully discrete equivalence premiums Px: n1 s̈x: n = 1 (1)
(whole life and endowment only):
P minus P over P problems:
The difference in magnitude of level benefit pre-
Ax miums is solely attributable to the investment
P (Ax ) = = Px
äx feature of the contract. Hence, comparisons of
dAx the policy values of survivors at age x + n may
P (Ax ) =
1 − Ax be done by analyzing future benefits:
1
P (Ax ) = −d 1
− Px:
n Px
1
n
äx ( n Px − Px: n )s̈x: n = Ax+n =
Px: n1
P 22
 
Ax − (Ax )2

V ar[L] = 1+ Px: n − n Px
d (Px: n − n Px )s̈x: n = 1 − Ax+n =
Px: n1
2
Ax − (Ax )2
V ar[L] = Px: n − Px: 1
n
(däx )2 1
(Px: n − Px: n )s̈x: n = 1=
Px: n1
2
Ax − (Ax )2
V ar[L] =
(1 − Ax )2 Miscellaneous identities:
Semicontinuous equivalence premiums: P̄ (Āx: n )
Āx: n =
P̄ (Āx: n ) + δ
Āx Px: n
P (Āx ) = Ax: n =
äx Px: n + d
m-thly equivalence premiums: 1
āx: n =
P̄ (Āx: n ) + δ
(m) A#
P# = 1
(m)
ä# äx: n =
Px: n + d

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 Chapter 7: Benefit Reserves

Benefit reserve t V : Variance of the loss function

The expected value of the prospective loss at  2
time t. P̄
Āx+t − (Āx+t )2
2 
V ar[ t L] = 1+
δ
Continuous reserve formulas: 2
Āx+t − (Āx+t )2
V ar[ t L] = assuming EP
(1 − Āx )2
Prospective: t V̄ (Āx ) = Āx+t − P̄ (Āx )āx+t  2 h
Ā1x: n P̄ i
Retrospective: V̄ (Ā ) = P̄ (Ā )s̄ − V ar[ t L] = 1+ 2
Āx+t: n−t − (Āx+t: n−t )2
t x x x: t δ
t Ex
Premium diff.:

t V̄ (Āx ) = P̄ (Āx+t ) − P̄ (Āx ) āx+t
 2
Āx+t: n−t − (Āx+t: n−t )2
V ar[ t L] = assuming EP

P̄ (Āx )
 (1 − Āx: n )2
Paid-up Ins.: t V̄ (Āx ) = 1 − Āx+t
P̄ (Āx+t )
āx+t Cost of insurance: funding of the accumu-
Annuity res.: t V̄ (Āx ) = 1 −
āx lated costs of the death claims incurred between
Āx+t − Āx age x and x + t by the living at t, e.g.
Death ben.: t V̄ (Āx ) =
1 − Āx
dx (1 + i)3 + dx+1 (1 + i)2 + dx+2 (1 + i) + dx+
P̄ (Āx+t ) − P̄ (Āx ) 4 kx =
Premium res.: t V̄ (Āx ) = lx+4
P̄ (Āx+t ) + δ
A1x: 4
=
Discrete reserve formulas: 4 Ex
dx qx
k Vx = Ax+k − Pk äx+k 1 kx = =
h i lx+1 px
k Vx: n = Px+k: n−k − Px: n äx+k: n−k
" # Accumulated differences of premiums:
Px: n
k Vx: n = 1− Ax+k: n−k
Px+k: n−k 1
( n Px − Px: n
− n Vx:1 n )
n )s̈x: n = n Vx
t Vx: n = Px: n s̈x: n − t kx = Ax+n − 0 = Ax+n
äx+k ( n Px − Px )s̈x: n = n
− n Vx
k Vx = 1− n Vx
äx
= Px äx+n
Px+k − Px
k Vx = (Px: n − Px )s̈x: n = n Vx: n − n Vx
Px+k + d
Ax+k − Ax = 1 − n Vx
k Vx = m m
1 − Ax ( m Px: n − m Px )s̈x: m = m Vx: n − m Vx
= Ax+m: n−m − Ax+m
h-payment reserves:
h
t V̄ = Āx+t: n−t − h P̄ (Āx: n )āx+t: h−t
Relation between various terminal re-
h
k Vx: n = Ax+k: n−k − h Px: n äx+k: h−k serves (whole life/endowment only):
h
kV (Āx: n ) = Āx+k: n−k −h P (Āx: n )äx+k: h−k
m+n+p Vx = 1−
h 1(m) (m) (m)
k Vx: n = Ax+k: n−k − h Px: n äx+k: h−k (1 − m Vx )(1 − n Vx+m )(1 − p Vx+m+n )

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 Chapter 8: Benefit Reserves

Notations:
bj : death benefit payable at the end of year of death for the j-th policy year
πj−1 : benefit premium paid at the beginning of the j-th policy year
bt : death benefit payable at the moment of death
πt : annual rate of benefit premiums payable continuously at t
Benefit reserve:
∞
X ∞
X
j+1
hV = bh+j+1 v j px+h qx+h+j − πh+j v j j px+h
j=0 j=0
Z∞ ∞
X
t V̄ = bt+u v u u px+t µx (t + u)du − πt+u v u u px+t du
0 0

Recursion relations:

hV + πh = v qx+h · bh+1 + v px+h · h+1 V

(h V + πh )(1 + i) = qx+h · bh+1 + px+h · h+1 V
(h V + πh )(1 + i) = h+1 V + qx+h (bh+1 − h+1 V )

Terminology:
“policy year h+1” ≡ the policy year from time t = h to time t = h + 1
“h V + πh ” ≡ initial benefit reserve for policy year h + 1
“h V ” ≡ terminal benefit reserve for policy year h
“h+1 V ” ≡ terminal benefit reserve for policy year h + 1

Net amount at Risk for policy year h + 1

Net Amount Risk ≡ bh+1 − h+1 V

When the death benefit is defined as a function of the reserve:

For each premium P , the cost of providing the ensuing year’s death benefit , based on the net amount at
risk at age x + h, is : vqx+h (bh+1 − h+1 V ). The leftover, P − vqx+h (bh+1 − h+1 V ) is the source of reserve
creation. Accumulated to age x + n, we have:
n−1
X
nV = [P − vqx+h (bh+1 − h+1 V )] (1 + i)n−h
h=0
n−1
X
= P s̈ n − vqx+h (bh+1 − h+1 V )(1 + i)n−h
h=0

• If the death benefit is equal to the benefit reserve for the first n policy years

nV = P s̈ n

• If the death benefit is equal to $1 plus the benefit reserve for the first n policy years
n−1
X
nV = P s̈ n − vqx+h (1 + i)n−h
h=0

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 • If the death benefit is equal to $1 plus the benefit reserve for the first n policy years and qx+h ≡ q
constant

nV = P s̈ n − vqs̈ n = (P − vq)s̈ n

Reserves at fractional durations:

( h V + πh )(1 + i)s = s px+h · h+s V + s qx+h v 1−s

UDD ⇒ ( h V + πh )(1 + i)s = (1 − s · qx+h ) h+s V + s · qx+h v 1−s
= h+s V + s · qx+h (v 1−s − h+s V )
1−s 1−s
h+s V = v · 1−s qx+h+s · bh+1 + v · 1−s px+h+s · h+1 V
UDD ⇒ h+s V = (1 − s)( h V + πh ) + s(h+1 V )
i.e. h+s V = (1 − s)( h V ) + (s)(h+1 V ) + (1 − s)(πh )
| {z }
unearned premium
Next year losses:

Λh ≡ losses incurred from time h to h + 1

E[Λh ] = 0
V ar[Λh ] = v 2 (bh+1 − h+1 V )2 px+h qx+h

The Hattendorf theorem

V ar[ h L] = V ar[Λh ] + v 2 px+h V ar[ h+1 L]

= v 2 (bh+1 − h+1 V )2 px+h · qx+h + v 2 px+h V ar[ h+1 L]
V ar[ h L] = v 2 (bh+1 − h+1 V )2 px+h · qx+h
+v 4 (bh+2 − h+2 V )2 px+h · px+h+1 · qx+h+1
+v 6 (bh+3 − h+3 V )2 px+h · px+h+1 · px+h+2 · qx+h+2 + · · ·

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 Chapter 9: Multiple Life Functions

Joint survival function: Last survivor status T (xy):

sT (x)T (y) (s, t) = P r[T (x) > s&T (y) > t] T (xy) + T (xy) = T (x) + T (y)
t pxy = sT (x)T (y) (t, t) T (xy) · T (xy) = T (x) · T (y)
= P r[T (x) > t and T (y) > t] fT (xy) + fT (xy) = fT (x) + fT (y)
FT (xy) + FT (xy) = FT (x) + FT (y)
t pxy + t pxy = t px + t py
Joint life status:
Āxy + Āxy = Āx + Āy
FT (t) = P r[min(T (x), T (y)) ≤ t]
āxy + āxy = āx + āy
= t qxy e̊xy + e̊xy = e̊x + e̊y
= 1 − t pxy
exy + exy = ex + ey
n| qxy = n| qx + n| qy − n| qxy
Independant lives

t pxy = t px · t py Complete expectation of the last-survivor

+ t qy − t qx · t qy status:
t qxy = t qx
Z∞
e̊xy = t pxy dt
Complete expectation of the joint-life sta- 0
tus: X∞

Z∞ exy = k pxy
1
e̊xy = t pxy dt
0 Variances:
Z∞
PDF joint-life status: V ar[T (u)] = 2 t · t pu dt − (e̊u )2
fT (xy) (t) = t pxy · µxy (t) 0
Z∞
fT (xy) (t) fT (xy) (t)
µxy (t) = = V ar[T (xy)] = 2 t · t pxy dt − (e̊xy )2
1 − FT (xy) (t) t pxy
0
Z∞
Independant lives
V ar[T (xy)] = 2 t · t pxy dt − (e̊xy )2
µxy (t) = µ(x + t) + µ(y + t) 0
fT (xy) (t) = t px · t py [µ(x + t) + µ(y + t)]
Notes:
For joint-life status, work with p’s:
Curtate joint-life functions: n pxy = n px · n py
k pxy = k px · k py [IL] For last-survivor status, work with q’s:
k qxy = k qx + k qy − k qx · k qy [IL] = n qx · n qy
n qxy
P r[K = k] = k pxy − k+1 pxy
= k pxy · qx+k:y+k “Exactly one” status:
= k pxy · qx+k:y+k = k| qxy [1]
n pxy = n pxy − n pxy
qx+t:y+t = qx+k + qy+k − qx+k · qy+k [IL]
∞ = n px + n py − 2 n p x · n p y
X
exy = E[K(xy)] = k pxy = n qx + n qy − 2 n qx · n qy
1 [1]
āxy = āx + āy − 2āxy

Exam M - Life Contingencies - LGD

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Common shock model: Insurances:
sT (x) (t) = sT ∗ (x) (t) · sz (t)
Āx = 1 − δāx
= sT ∗ (x) (t) · e−λt Āxy = 1 − δāxy
sT (y) (t) = sT ∗ (y) (t) · sz (t) Āxy = 1 − δāxy
= sT ∗ (y) (t) · e−λt
sT (x)T (y) (t) = sT ∗ (x) (t) · · ·T ∗ (y) (t) · sz (t)
Premiums:
= sT ∗ (x) (t) · sT ∗ (y) (t) · e−λt
µxy (t) = µ(x + t) + µ(y + t) + λ 1
Px = −d
äx
1
Insurance functions: Pxy = −d
äxy
∞
Au =
X
v k+1 · k pu · qu+k 1
Pxy = −d
k=0 äxy
X∞
= v k+1 P r[K = k]
Annuity functions:
k=0
∞
X Z∞
Axy = v k+1 · k pxy · qx+k:y+k
āu = v t · t pu dt
k=0
X∞ 0
k+1
Axy = v ( k px · qx+k + k py · qy+k Āu − (Āu )2
2
var[Y ] =
k=0 δ2
− k pxy · qx+k:y+k )

Reversionary annuities:
Variance of insurance functions: A reversioanry annuity is payable during the ex-
V ar[Z] = 2
Au − (Au )2 istence of one status u only if another status v
has failed. E.g. an annuity of 1 per year payable
V ar[Z] = 2
Axy − (Axy )2
continuously to (y) after the death of (x).
Cov[v T (xy) , v T (xy) ] = (Āx − Āxy )(Āy − Āxy )
āx|y = āy − āxy

Covariance of T (xy) and T (xy):

Cov [T (xy), T (xy)] = Cov [T (x), T (y)] + {E [T (x)] − E [T (xy)]} · {(E [T (y)] − E [T (xy)]}
= Cov [T (x), T (y)] + (e̊x − e̊xy ) (e̊y − e̊xy )
= (e̊x − e̊xy ) (e̊y − e̊xy ) [IL]

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 Chapter 10 & 11: Multiple Decrement Models

Notations: Probability density functions:

(j)
Joint PDF: fT,J (t, j) = t p(τ ) (j)
x · µx (t)
t qx = probability of decrement in the next
t years due to cause j (j)
Marginal PDF of J: fJ (j) = ∞ qx
Z∞
(τ )
t qx = probability of decrement in the next = fT,J (t, j)dt
t years due to all causes 0
Xm
= (j)
t qx Marginal PDF of T : fT (t) = t p(τ ) (τ )
x · µx (t)
j=1 Xm
= fT,J (t, j)
µ(j)
x = the force of decrement due only j=1
to decrement j (j)
µx (t)
Conditional PDF: fJ|T (j|t) = (τ )
µx (t)
µ(τ
x
)
= the force of decrement due to all
causes simultaneously
m
X Survivorship group:
= µ(j)
x (τ )
j=1
Group of la people at some age a at time t = 0.
Each member of the group has a joint pdf for
(τ ) time until decrement and cause of decrement.
t px = probability of surviving t years
despite all decrements
= 1 − t qx(τ ) (j)
n dx = la(τ ) · (τ )
x−a pa · n qx(j)
Rt (τ ) x−a+n
− µx (s)ds Z
= e 0
= la(τ ) (τ )
t pa · µ(j)
a (t)dt
x−a
m
X
(τ ) (j)
n dx = n dx
j=1
Derivative: m
X
la(τ ) = la(j)
j=1
d  (τ )  d  (τ ) 
t px =− t qx = − t p(τ ) (τ )
x µx (j)
dx
dt dt qx(j) = (τ )
lx

Integral forms of t qx :
Associated single decrement:

0 (j)
Zt t qx = probability of decrement from cause j only
(j) (τ ) (j)
t qx = s px · µx (s)ds Zt
 
0 (j)
0 t px = exp − µ(j) x (s)ds

Zt 0
(τ ) (τ )
t qx = s px · µ(τ )
x (s)ds = 1 − t qx(j)
0

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Basic relationships: Actuarial present values
 
 Zt h i  m
∞ 
(τ )
µ(1) (m)
Z
t px = exp − x (s) + · · · + µx (s) ds
X (j) t
  Ā =  Bx+t v · t p(τ ) (j)
x µx (t)dt

0 j=1
m 0
0 (i)
Y
(τ )
t px = t px
i=1 Instead of summing the benefits for each pos-
0 (j) (j) sible cause of death, it is often easier to write
t qx ≥ t qx
0 (j) (τ )
the benefit as one benefit given regardless of the
t px ≥ t px cause of death and add/subtract other benefits
according to the cause of death.
UDD for multiple decrements:
(j) Premiums:
t qx = t · qx(j)
(τ ) ∞
t qx = t · qx(τ ) (τ ) (τ )
Bk+1 v k+1 · k px · qx+k
(τ )
P

qx(j) = (τ )
t px · µ(j)
x (t) Px(τ ) = k=0
∞
(τ )
v k · k px
P
(j) (j)
qx qx
µ(j)
x (t) = (τ )
= (τ )
k=0
t px 1 − t · qx ∞
(j) (τ ) (j)
Bk+1 v k+1
P
· k px · qx+k
 qx(j) k=0
Px(j) =
0 (j)

(τ ) qxt
t px = t px ∞
(τ )
v k · k px
P
k=0
Decrements uniformly distributed in the
associated single decrement table:
0 (j) 0
t qx = t · qx(j)
 
0 (1) 1 0 (2)
qx(1) = qx 1− q
2 x
 
0 (2) 1 0 (1)
qx(2) = qx 1− q
2 x
 
0 1 0 (2) 1 0 (3) 1 0 (2) 0 (3)
qx(1) = qx(1) 1 − q − qx + qx · qx
2 x 2 3

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 Chapter 15: Models Including Expenses

Notations:

G ≡ expense loaded ( or gross) premium

b ≡ face amount of the policy
G/b ≡ per unit gross premium

Expense policy fee:

The portion of G that is independent of b.

Asset shares notations:

G ≡ level annual contract premium

k AS ≡ asset share assigned to the policy at time t = k
ck ≡ fraction of premium paid for expenses at k (i.e. cG is the expenxe premium)
ek ≡ expenses paid per policy at time t = k
(d)
qx+k ≡ probability of decrement by death
(w)
qx+k ≡ probability of decrement by withdrawal
k CV ≡ cash amount due to the policy holder as a withdrawal benefit
bk ≡ death benefit due at time t = k

Recursion formula:
(d) (w) (τ )
[ k AS + G(1 − ck ) − ek ] (1 + i) = qx+k · bk+1 + qx+k · k+1 CV + px+k · k+1 AS
(d) (w)
= k+1 AS + qx+k (bk+1 − k+1 AS) + qx+k ( k+1 CV − k+1 AS)

Direct formula:
n−1 (d) (w)
X G(1 − ch ) − eh − vqx+h bh+1 − vqx+h h+1 CV
n AS = (τ )
h=0 n−h Ex+h

Exam M - Life Contingencies - LGD

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 Constant Force of Mortality
µ
• Chapter 3 (IA)x = Āx āx =
(µ + δ)2
µ(1 + i)
µ(x) = µ > 0, ∀x (I Ā)x = Āx äx =
−µx (µ + δ)(q + i)
s(x) = e
q(1 + i)
lx = l0 e−µx (IA)x = Ax äx =
(q + i)2
= e−nµ = (px )n
n px 1
1 (Ia)x = (āx )2 =
e̊x = = E[T ] = E[X] (µ + δ)2
µ
1+i 2
 
e̊x: n = e̊x (1 − n px ) (Iä)x = (äx )2 =
q+i
1
V ar[T ] = V ar[x] = 2 • Chapter 6
µ
mx = µ 1
Px = vqx = Px: n
ln2
Median[T ] = = Median[X] P̄ (Āx ) = µ = P̄ (Ā1x: n )
µ
px For fully discrete whole life, w/ EP,
ex = = E[K]
qx
px V ar[Loss] = p · 2Ax
V ar[K] =
(qx )2
For fully continuous whole life, w/EP,
• Chapter 4 V ar[Loss] = 2Āx

µ • Chapter 7
Āx =
µ+δ (Āx ) = 0, t ≥ 0
t V̄
2 µ
Āx = k Vx = 0, k = 0, 1, 2, . . .
µ + 2δ
Ā1x: n = Āx (1 − n Ex ) For fully discrete whole life, assuming EP,
−n(µ+δ)
n Ex = e V ar[ k Loss] = p · 2Ax , k = 0, 1, 2, . . .
µ
(IA)x =
(µ + δ)2 For fully continuous whole life, assuming EP,
q
Ax =
q+i V ar[ t Loss] = 2Āx , t ≥ 0
2 q
Ax = • Chapter 9
q + 2i + i2
1 For two constant forces, i.e. µM acting on (x)
Ax: n = Ax (1 − n Ex )
and µF acting on (y), we have:

• Chapter 5 µM + µF
Āxy =
µM + µF + δ
1 1
āx = āxy =
µ+δ µ + µF + δ
M

2 1 1
āx = e̊xy =
µ + 2δ µ + µF
M

1+i
äx = qxy
q+i Axy =
qxy + i
2 (1 + i)2
äx = 1+i
q + 2i + i2 äxy =
qxy + i
āx: n = āx (1 − n Ex ) pxy
äx: n = äx (1 − n Ex ) exy =
qxy

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 De Moivre’s Law

• Chapter 3 ā 2(ω−x)
2
Āx =
x 2(ω − x)
s(x) = 1 − a ω−x
ω
ω−x Ax =
lx = l0 ∝ (ω − x) ω−x
ω an
1 A1x: n =
qx = µ(x) = ω−x
ω−x (Ia) ω−x
m (IA)x =
n|m qx = ω−x
ω−x
ω−x−n (Ia) ω−x
n px = (IA)x =
ω−x ω−x
t px µ(x + t) = qx = µ(x) = fT (x), 0 ≤ t < ω − x (Ia) n
(IA)1x: n =
1 ω−x
Lx = (lx + lx+1 ) (Ia) n
2 (IA)1x: n =
ω−x ω−x
e̊x = = E[T ] = Median[T ]
2
ω−x 1
ex = − = E[K]
2 2 • Chapter 5
(ω − x) 2 1−Ax
V ar[T ] = No useful formulas: use äx = d and the
12 chapter 4 formulas.
(ω − x)2 − 1
V ar[K] =
12 • Chapter 9
qx 2dx
mx = 1 =
1 − 2 qx lx + lx+1
1 ω−x
a(x) = E[S] = e̊xx = (≡ MDML with µ = 2/(ω − x))
2 3
n 2(ω − x)
e̊x: n = n n px + n q x e̊xx =
2 3
n e̊xy = y−x px e̊yy + y−x qx e̊y
e̊x: n = ex: n + n qx
2
• Chapter 4
For two lives with different ω’s, simply translate
ā ω−x
Āx = one of the age by the difference in ω’s. E.g.
ω−x
ā n
Ā1x: n = Age 30, ω = 100 ⇔ Age 15, ω = 85
ω−x

Modified De Moivre’s Law

• Chapter 3 (ω − x)2 c
V ar[T ] =
 x c (c + 1)2 (c + 2)
s(x) = 1−
 ω c • Chapter 9
ω−x
lx = l0 ∝ (ω − x)c ω−x
ω e̊xx =
c 2c + 1
µ(x) = 2c
ω−x ≡ e̊x with µ =
ω−x−n c ω−x
 
n px =
ω−x
ω−x
e̊x = = E[T ]
c+1
Exam M - Life Contingencies - LGD
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 Uniform Distribution of Deaths (UDD)

• Chapter 3 • Chapter 6

= t · qx , 0 ≤ t ≤ 1 i
t qx P (Āx ) = Px
qx δ
µ(x + t) = , 0≤t≤1 i 1
1 − tqx P (Ā1x: n ) = P
lx+t = lx − t · dx , 0 ≤ t ≤ 1 δ x: n
sqx i 1
s qx+t = , 0≤s+t≤1 P (Āx: n ) = P + Px: n1
1 − tqx δ x: n
1 Px
V ar[T ] = V ar[K] + Px(m) =
12 α(m) − β(m)(Px + d)
1 qx (m) Px: n
mx = µ(x + ) = Px: n =
2 1 − 12 qx α(m) − β(m)(Px: 1
n + d)
1 (m) n Px
Lx = lx − dx n Px =
2 α(m) − β(m)(Px: 1
n + d)
1 i 1(m)
a(x) = hP
(m)
(Ā1x: n ) = hP
2 δ x: n
1
e̊x: 1 = px + q x • Chapter 7
2
t px µ(x + t) = qx , 0 ≤ t ≤ 1 h (m) h (m)
k Vx: n = k Vx: n + β(m) h Px: n · k Vx:1 h
• Chapter 4 h (m) h
(Āx: n ) + β(m) h P (m) (Āx: n ) k Vx:1 h
kV (Āx: n ) = kV
i h i h 1
Āx = Ax k V( Āx: n ) = · V + hk Vx: h1
δ δ k x: h
i
Ax(m) = (m)
Ax • Chapter 10
i UDDMDT
i 1
Ā1x: n = A
δ x: n t qx
(j)
= t · qx(j)
i
(I Ā)1x: n = (IA)1x: n qx(j) = µ(j)
x (0)
δ
i 1 i qx(τ ) = µ(τ )
x (0)
Āx: n = Ax: n + Ax:1n = A1x: n + n Ex  qx(j)
δ δ 0 (j)

(τ ) qx(τ )
i t px = t px
n| Āx = Ax
δ n| (j)
qx
2 2i + i2 2 µ(j)
x =
Āx = Ax 1 − t · qx
(τ )
2δ
(τ )
• Chapter 5 qx
µ(τ
x
)
= (τ )
1 − t · qx
m−1
ä(m)
x ' äx −
2m UDDASDT
ä(m) = α(m)äx − β(m) 0 (j) 0
x
t qx = t · qx(j)
(m)
äx: n = α(m)äx: n − β(m)(1 − n Ex ) 0 (1)

1 0 (2)

qx(1) = qx 1− q
with:
id
α(m) = (m) (m) ∼ 1 2 x
i d
 
0 1 0 (1)
i − i(m) m−1 qx(2) = qx(2) 1 − q
and β(m) = (m) (m) ∼ 2 x
i d 2m 0 (1)

1 0 (2) 1 0 (3) 1 0 (2) 0 (3)

(m) (m)
= äx − n Ex äx+n
(m) qx(1) = qx 1− q − qx + qx · qx
äx: n 2 x 2 3

Exam M - Life Contingencies - LGD

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 Chapter 1: The Poisson Process

Poisson process with rate λ: Sum of Poisson processes:

(λt)k If N1 , · · · , Nk are independent Poisson processes
P r[N (s + t) − N (s) = k] = e−λt with rates λ1 , · · · , λk then, N = N1 + · · · + Nk
k!
E[N (t)] = λt is a Poisson process with rate λ = λ1 + · · · + λk .
V ar[N (t)] = λt
Special events in a Poisson process:
Interarrival time distribution: Let N be a Poisson process with rate λ.
The waiting time between events. Let Tn de- Some events i are special with a probability
note the time since occurence of the event n − 1. P r[event is special] = πi and Ñi counts the spe-
Then the Tn are independent random variables cial events of kind i. Then, Ñi is a Poisson
following an exponential distribution with mean process with rate λ̃i = πi λ and the Ñi are inde-
1/λ. pendent of one another.
If the probability πi (t) changes with time, then
P r[Ti ≤ t] = 1 − e−λt
fT (t) = λe−λt Zt
1 E[Ñi (t)] = λ π(s)ds
E[T ] =
λ
0
1
V ar[T ] =
λ2 Non-homogeneous Poisson process:

Waiting time distribution: λ(t) ≡ intensity function

Let Sn be the time
Pn of the n-occurence of the m(t) ≡ mean value function
event, i.e. Sn = i=1 Ti .
Zt
Sn has a gamma distribution with parameters n
and θ = 1/λ = λ(y)dy
0
1
Sn ≡ GammaRV[α = n, θ = ] [m(t)]k
λ P r[N (t) = k] = e−m(t)
∞
X (λt)j k!
P r[Sn ≤ t] = e−λt
j! Compound Poisson process:
j=n
(λt)n−1 N (t)
fSn (t) = λe−λt X
(n − i)! X(t) = Yi N (t) PoissonRV w/ rate λ
n i=1
E[Sn ] =
λ E[X(t)] = λt · E[Y ]
n
V ar[Sn ] = V ar[X(t)] = λt · E[Y 2 ]
λ2

Two competing Poisson processes:

Probability that n events in the Poisson process (N1 ,λ1 ) occur before m events in the Poisson process
(N2 ,λ2 ):
n+m−1
X n+m−1  λ1 k  λ2 n+m−1−k
P r[Sn1 < Sm2
] = k
λ1 + λ2 λ 1 + λ2
k=n
 n
λ1
P r[Sn1 < S12 ] =
λ1 + λ2
λ1
P r[S11 < S12 ] =
λ1 + λ 2

Exam M - Loss Models - LGD

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 Chapter 2&3: Random Variables

k-th raw moment: Left censored and shifted variable:

0
µk = E[X k ] 
0 X<d
L
Y = (X − d)+ =
k-th central moment: X −d X ≥d

µk = E[(X − µ)k ] Moments of the left censored and shifted

variable:
Variance:
V ar[x] = σ 2 = E[X 2 ] − E[X]2 Z∞
0 E[(X − d)k+ ] = (x − d)k f (x)dx
= µ2 = µ2 − µ2
d
Standard deviation: X
p = (x − d)k p(x)
σ = V ar[X] x>d
k
Coefficient of variation: = e (d)[1 − F (d)]

σ/µ Limited loss:

Skewness: 
X X<u
Y = (X ∧ u) =
E[(X − µ)3 ] µ3 u X≥u
γ1 = 3
= 3
σ σ
Kurtosis: Limited expected value:
E[(X − µ)4 ] µ4 Z0 Zu
γ1 = = 4
σ4 σ E[X ∧ u] = − F (x)dx + S(x)dx
Left truncated and shifted variable (aka −∞ 0
excess loss variable): Zu
Y P = X − d|X > d = [1 − F (x)]dx if X is always positive
0
Mean excess loss function:
eX (d) ≡ e(d) = E[Y P ] Moments of the limited loss variable:

= E[X − d|X > d] Zu

R∞ k
S(x)dx E[(X ∧ u) ] = xk f (x)dx + uk [1 − F (u)]
= d
1 − F (d) −∞
E[X] − E[X ∧ d] X
= = xk p(x) + uk [1 − F (u)]
1 − F (d) x≤u
Higher moments of the excess loss vari-
able: Moment generating functions mX (t):
ekx (d) = E[(X − d)k |X > d]
mX (t) = E[etX ]
R∞
(x − d)k f (x)dx
= d Sum of random variables Sk = X1 +· · ·+Xk :
1 − F (d)
(x − d)k p(x) k
P
Y
x>d mSk (t) = mXj (t)
=
1 − F (d) j=1

Exam M - Loss Models - LGD

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 Chapter 4: Classifying and Creating distributions
P
k-point mixture ( ai = 1): • If X is a Normal distribution η(θ, V ) and θ
follows a Normal distribution θ ∼ η(µ, A),
FY (y) = a1 FX1 (y) + · · · + ak FXk (y)
then the resulting distribution is a Normal
fY (y) = a1 fX1 (y) + · · · + ak fXk (y) distribution η(µ, A + V )
E[Y ] = a1 E[X1 ] + · · · + ak E[Xk ]
E[Y 2 ] = a1 E[X12 ] + · · · + ak E[Xk2 ]
P
Splicing (aj > 0, aj = 1):

Tail weight:  a1 f1 (x)
 c0 < x < c1
f (x) = .. ..
. .
existence of moments ⇒ light tail 
ak fk (x) ck−1 < x < ck

hazard rate increases ⇒ light tail
Discrete probability function (pf ):
Multiplication by a constant θ, y > 0:
y 1 y pk = P r[N = k]
Y = θX ⇒ FY (y) = FX ( ) and fY (y) = fX ( )
θ θ θ

Raising to a power: Probability generating function (pgf ):

τ > 0 : FY (y) = FX (y τ )

PN (z) = E[z N ] = p0 + p1 z + p2 z 2 + · · ·

fY (y) = τ y τ −1 fX (y τ )


1
Y = Xτ ⇒ P 0 (1) = E[N ]
 τ < 0 : FY (y) = 1 − FX (y τ )
P 00 (1) = E[N (N − 1)]

fY (y) = −τ y τ −1 fX (y τ )


τ > 0: transformed distribution

Poisson distribution:
τ = −1: inverse distribution
τ < 0: inverse transformed λk
pk = e−λ
k!
Exponentiation:
P (z) = eλ(z−1)
FY (y) = FX (ln(y)) E[N ] = λ
Y = eX ⇒
fY (y) = y1 fX (ln(y))
V ar[N ] = λ
Mixing:
The random variable X depends upon a para-
Negative Binomial distribution:
meter θ, itself a random variable Θ. For a given
Number of failures before success r with proba-
value Θ = θ, the individual pdf is fX|Θ (x|θ).
bility of success p = 1/(1 + β)
Z
fX (x) = fX|Θ (x|θ)fΘ (θ)dθ   k  r
k+r−1 β 1
pk =
• If X is a Poisson distribution with parame- k 1+β 1+β
ter λ, and λ follows a Gamma distribution P (z) = [1 − β(z − 1)]−r
with parameters (α, θ), then the resulting E[N ] = rβ
distribution is a Negative Binomial distri-
V ar[N ] = rβ(1 + β)
bution with parameters (r = α, β = θ)
• If X is an Exponential distribution with • If N1 and N2 are independent Negative
mean 1/Λ and Λ is a Gamma distribution Binomial distributions with parameters
with parameters (α, θ), then the resulting (r1 , β) and (r2 , β), then N1 + N2 is a Neg-
distribution is a 2-parameter Pareto distri- ative Binomial distribution with parame-
bution with parameters (α0 = α, θ0 = 1θ ) ters (r = r1 + r2 , β)

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 • If N is a Negative Binomial distribution Compound frequency and (a, b, 0) class:
with parameters (r, β) and some events j Let S be a compound distribution of primary
are special with probability πj , then Ñj , and secondary distributions N and M with pn =
the count of special events j, is a Nega- P r[N = n] and fn = P r[M = n]. If N is a mem-
tive Binomial distribution with parame- ber of the (a, b, 0) class
ters (r̃j = r, β̃j = πj β)
k  
1 X j·b
gk = a+ fj gk−j
1 − af0 k
j=1
Geometric distribution:
Special case of the negative binomial distribu- g0 = Pprim (f0 )
tion with r = 1 k
λX
gk = j · fj gk−j
βk k
pk = j=1
(1 + β)k+1
1 Mixed Poisson models:
P (z) = [1 − β(z − 1)]−1 =
1 − β(z − 1) If P (z) id the pgf of a Poisson distribution with
E[N ] = β rate λ drawn from a discrete random variable Λ,
V ar[N ] = β(1 + β) then

P (z|λ) = eλ(z−1)
Binomial distribution: P (z) = pΛ (λ1 )eλ1 (z−1) + · · · + pΛ (λn )eλn (z−1)
Counting number of successes in m trials given
a probability of sucess “q”
Exposure modifications on frequency:
n policies in force. Nj claims produced by the
 
m
pk = q k (1 − q)m−k j-th policy. N = N1 + · · · + Nn . If the Nj are in-
k
P (z) = [1 + q(z − 1)]m dependent and identcally distributed, then the
probability generating function for N is
E[N ] = mq
V ar[N ] = mq(1 − q) PN (z) = [PN1 (z)]n

If the company exposure grows to n∗ , let N ∗

The (a, b, 0) class: represent the new total number of claims,
pk b ∗ n∗
=a+ PN ∗ (z) = [PN1 (z)]n = [PN (z)] n
pk−1 k
Conditional expectations:
a > 0 ⇒ negative binomial or geometric Z
E[X|Λ = λ] = xfX|Λ (x|λ)dx
distribution
a = 0 ⇒ Poisson distribution E[X] = E [E[X|Λ]]
a < 0 ⇒ Binomial distribution V ar[X] = E [V ar[X|Λ]] + V ar[E[X|Λ]]

The variance of the random variable X is the

Compound frequency models: sum of two parts: the mean of the conditional
variance plus the variance of the conditional
P (z) = Pprim (Psec (z)) mean.

Exposure modifications on frequency for common distributions:

N Parameters for N Parameters for N ∗
∗
Poisson λ → λ∗ = nn λ
∗
Negative Binomial r, β → r∗ = nn r, β ∗ = β

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 Chapter 5: Frequency and Severity with Coverage Modifications

Notations: Effect of deductible for various distribu-

tions:
X ≡ amount of loss
Y L ≡ amount paid per loss X : exp[mean θ] ⇒ Y P : exp[mean θ]
YP ≡ amount paid per payment X : uniform[0, ω] ⇒ Y P : uniform[0, ω − d]
X : 2Pareto[α, θ] ⇒ Y P : 2Pareto[α0 = α, θ0 = θ + α]
Per loss variable:
Loss elimination ratio:
fY L (0) = FX (d)
E[X ∧ d]
fY L (y) = fx (y + d) LERX (d) =
E[X]
FY L (y) = FX (y + d)
relations:
Per payment variable:
c(X ∧ d) = (cX) ∧ (cd)
fx (y + d) c(X − d)+ = (cX − cd)+
fY P (y) =
1 − FX (d)
A = (A ∧ b) + (A − b)+
FX (y + d) − FX (d)
FY L (y) =
1 − FX (d) Inflation on expected cost per loss:
  
Relations per loss / per payment variable: L d
E[Y ] = (1 + r) E(X) − E X ∧
1+r
YP
= Y L |Y L > 0
E[Y L ] Inflation on expected cost per payment:
E[Y P ] =
P r[Y L > 0] h 
d
i
(1 + r) E(X) − E X ∧ 1+r
E[(Y L )k ] E[Y P ] =
E[(Y P )k ] =
 
d
P r[Y L > 0] 1 − FX 1+r

Simple (or ordinary) deductible d: u-coverage limit:

X = X YL = X ∧u
L
Y = (X − d)+ YP = X ∧ u|X > 0
P L
Y = X − d|X > d E[Y ] = E[X ∧ u]
L Zu
E[Y ] = E[(X − d)+ ]
= E[X] − E[X ∧ d] = [1 − Fx (x)]dx
P 0
E[Y ] = E[X − d|X > d]
E[X] − E[X ∧ d] u-coverage limit with inflation:
=
1 − FX (d)  
u
E[X ∧ u] → (1 + r)E X ∧
Franchise deductible d: 1+r

X = X u-coverage limit and d ordinary de-

Y L
= 0 if X < d, X if X > d ductible:
P
Y = X|X > d, Y L = (X ∧ u) − (X ∧ d)
P P
Yfranchise = Yordinary +d YP = (X ∧ u) − (X ∧ d)|X > 0
L
E[Y ] = E[X] − E[X ∧ d] + d[1 − FX (d)] = (X ∧ u) − d|X > d
P L
E[Y ] = E[X|X > d] E[Y ] = E[X ∧ u] − E[X ∧ d]
E[X] − E[X ∧ d] E[X ∧ u] − E[X ∧ d]
= +d E[Y P ] =
1 − FX (d) 1 − FX (d)

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 u-coverage limit and d ordinary deductible Probability of payment for a loss with de-
with inflation: ductible d:
    
L u d
E[Y ] = (1 + r) E X ∧ −E X ∧ v = 1 − FX (d)
1+r 1+r
h i h i
u
E X ∧ 1+r d
− E X ∧ 1+r Unmodified frequency:
P The number of claims N (frequency) does not
E[Y ] = (1 + r)  
d
1 − FX 1+r change, only the probabilities associated with
the severity are modified to include the possi-
Coinsurance factor α: bility of zero payment.
First calculate Ỹ L and Ỹ P with deductible and
limits. Then apply α Bernoulli random variable:

0 @ 1−p
Y L = αỸ L N =
1 @ p
YP = αỸ P
E[N ] = p
V ar[N ] = (1 − p)p

Deductible, limit, inflation and coinsurance:

d
d∗ =
1+r
u
u∗ =
1+r
E[Y L ] = α(1 + r) {E[X ∧ u∗ ] − E[X ∧ d∗ ]}
E[X ∧ u∗ ] − E[X ∧ d∗ ]
E[Y P ] = α(1 + r)
1 − FX (d∗ )
2
E[Y L ] = α2 (1 + r)2 E (X ∧ u∗ )2 − E (X ∧ d∗ )2 − 2d∗ E[X ∧ u∗ ] + 2d∗ E[X ∧ d∗ ]
    

Modified frequency:
N ∗ (the modified frequency) has a compound distribution: The primary distribution is N , and the secondary
distribution is the Bernoulli random variable I. The probability generating function is

PN ∗ (z) = PN [1 + v(z − 1)]

The frequency distribution is modified to include only non-zero claim amounts. Each claim amount prob-
ability is modified by dividing it by th eprobability of a non-zero claim. For common distributions, the
frequency distribution changes as follows (the number of positive payments is nothing else than a special
event with probability π = v)
N Parameters for N Parameters for N ∗
Poisson λ → λ∗ = vλ
Binomial m, q → m∗ = m, q ∗ = vq
Negative Binomial r, β → r∗ = r, β ∗ = vβ

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 Chapter 6: Aggregate Loss Models
The aggregate loss compound random n-fold convolution of the cdf of X:
variable: k
∗(n) ∗(n−1)
X
N
X FX (k) = FX (k − j)fX (j)
S = Xj j=0
j=1

∗(0) 0 , k<0
E[S] = E[N ] · E[X] FX (k) =
1 , k≥0
V ar[S] = E[N ] · V ar[X] + V ar[N ] · E[X]2
Pdf of the compound distribution:
S ' η(E[S], V ar[S]) if E[N ] is large
∞
Probability generating function: ∗(n)
X
fS (k) = pn · fX (k)
n=0
PS (z) = PN [PX (z)]
Cdf of the compound distribution:
Notations:
∞
∗(n)
X
fk = P r[X = k] FS (k) = p n · FX (k)
pk = P r[N = k] n=0

gk = P r[S = k] Mean of the compound distribution:

Compound probabilities: ∞
X ∞
X
E[S] = k · fS (k) = [1 − FS (k)]
g0 = PN (f0 ) if P r[X = 0] = f0 6= 0 k=0 k=0
gk = p0 · P r[sum of X’s = k]
Net stop-loss premium:
+ p1 · P r[sum of one X = k]
+ p2 · P r[sum of two X’s = k] Z∞
+ ··· E [(S − d)+ ] = (x − d)fS (x)dx
d
If N is in the (a, b, 0) class, then X∞
E [(S − d)+ ] = (x − d)fS (x)
g0 = PN (f0 ) d+1
k  
1 X j·b d−1
gk = a+ fj · gk−j
X
1 − af0 k E [(S − d)+ ] = E[S] − d − (x − d)fS (x)
j=1 x=0
∞
n-fold convolution of the pdf of X: X
E [(S − d)+ ] = [1 − FS (d)]
∗(n) d
fX (k) = P r[sum of n X’s = k]
d−1
k X
∗(n)
fX (k) =
X ∗(n−1)
fX (k − j)fX (j) = E[S] − [1 − FS (d)]
x=0
j=0
∗(1) Linear interpolation a < d < b:
fX (k) = fX (k) = fk

∗(0) 1 , k=0 b−d d−a
fX (k) = E [(S − d)+ ] = E [(S − a)+ ]+ E [(S − b)+ ]
0 , otherwise b−a b−a
Recursion relations for stop-loss insurance:
E [(S − d − 1)+ ] = E [(S − d)+ ] − [1 − FS (d)]
E [(S − sj )] = E [(S − sj+1 )] + (sj+1 − sj )P r[S ≥ sj+1 ]
where the sj ’s are the possible values of S, S : s0 = 0 < s1 < s2 < · · · and
P r[S ≥ sj+1 ] = 1 − P r[S = s0 or S = s1 or · · · or S = sj ]

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 Last Chapter: Multi-State Transition Models

Notations:

Q(i,j)
n = P r[Mn+1 = j|Mn = i]
(i,j)
k Qn = P r[Mn+k = j|Mn = i]
Pn(i) = Q(i,i)
n
(i)
k Pn = P r[Mn+1 = · · · = Mn+k = i|Mn = i]

Theorem:

k Qn = Qn · Qn+1 · · · Qn+k−1
k Qn = Qk for a homogeneous Markov chain

Inequality:
(i) (i) (i)
k Pn = Pn(i) · Pn+1 · · · Pn+k−1 ≤ k Q(i,i)
n

Cash flows while in states:

(i)
lC = cash flow at time l if subject in state i at time l
k vn = present value of 1 paid k years after time t = n
(i)
AP Vs@n (C ) = actuarial present value at time t = n of all future payments to be
made while in state i, given that the subject is in state s at t = n
∞ h
X i h i
AP Vs@n (C (i) ) = Q(s,i)
k n · n+k C (i)
· k vn
k=0

Cash flows upon transitions:

(i,j)
l+1 C = cash flow at time l + 1 if subject in state i at time l and state j at time l + 1
(s,i) (i,j)
l Qn · Qn+l = probability of being in state i at time l and in state j at time l + 1
(i,j)
AP Vs@n (C ) = actuarial present value at time t = n of a cash flow to be paid upon
transition from state i to state j
∞ h i h i
(i,j)
X
AP Vs@n (C (i,j) ) = Q(s,i)
k n · Qn+k · n+k+1 C (i,j)
· k+1 vn
k=0

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