INSTITUTE AND FACULTY OF ACTUARIES

EXAMINERS’ REPORT
September 2010 examinations

Subject CT6 — Statistical Methods

Core Technical

Introduction

The attached subject report has been written by the Principal Examiner with the aim of
helping candidates. The questions and comments are based around Core Reading as the
interpretation of the syllabus to which the examiners are working. They have however given
credit for any alternative approach or interpretation which they consider to be reasonable.

T J Birse
Chairman of the Board of Examiners

December 2010

© Institute and Faculty of Actuaries

 Subject CT6 (Statistical Methods Core Technical) — September 2010 — Examiners’ Report

2
1 We know that, approximately, θ − θˆ ≈ N (0, τ ) where τ2 can be approximated by
n
0.15.

⎡ ⎤
⎢ θ − θˆ
Then P −1.96 ≤ ≤ 1.96 ⎥ = 0.95
⎢ 0.15 ⎥
⎢⎣ n ⎥⎦

0.15
And we require 1.96 × ≤ 0.01
n

1.962 × 0.15
That is n ≥ = 5762.4 i.e. n must be at least 5763
0.012

This question was generally poorly answered.

2 The adjustment coefficient satisfies the equation:

λ + λμ(1 + θ) R = λM X ( R)

1/ μ 1
Where X is exponentially distributed with mean μ so that M X (t ) = =
1/ μ − t 1 − μt

1
So we have 1 + μ(1 + θ) R =
1 − μR

and so 1 − μR + Rμ(1 + θ)(1 − μR ) = 1

−μR + μR + μθR − μ 2 R 2 (1 + θ) = 0

Dividing through by μR gives

μR (1 + θ) = θ

θ
So R = .
μ(1 + θ)

This question was well answered by most candidates.

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 Subject CT6 (Statistical Methods Core Technical) — September 2010 — Examiners’ Report

3 (i) Let the parameters be c and γ as per the tables.

Then we have:

γ γ
1 − e−c×20 = 0.1 so e−c×20 = 0.9 and so c × 20γ = − log 0.9 (A)

And similarly c × 95γ = − log 0.1 (B)

γ
⎛ 20 ⎞ log 0.9
(A) divided by (B) gives ⎜ ⎟ = = 0.0457575
⎝ 95 ⎠ log 0.1

log 0.0457575
So γ = = 1.9795337
⎛ 20 ⎞
log ⎜ ⎟
⎝ 95 ⎠

log 0.9
And substituting into (A) we have c = − = 0.000280056
201.9795337

(ii) The 99.5th percentile loss is given by

1.9795337
1 − e−0.00280056 x = 0.995

So that −0.000280056 x1.9795337 = log 0.005

⎛ log 0.005 ⎞
log ⎜ ⎟
log x = ⎝ −0.000280056 ⎠ = 4.97486366
1.9795337

So x = e 4.97486366 = 144.73

Most candidates scored well on this question.

4 Let the prior distribution of μ have a Gamma distribution with parameters α and λ
as per the tables.

α α
Then = 50 and 2 = 152
λ λ

50
Then dividing the first by the second λ = = 0.22222
152

And so α = 50 × 0.22222 = 11.111111

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 Subject CT6 (Statistical Methods Core Technical) — September 2010 — Examiners’ Report

The posterior distribution of μ is then given by

f (μ x) ∝ f ( x μ) f (μ)

∝ e−10μ ×μ630 ×μ10.11111e−0.22222μ

∝ μ640.11111e−10.22222μ

Which is the pdf of a Gamma distribution with parameters α ' = 641.11111 and
λ '= 10.22222

Now under all or nothing loss, the Bayesian estimate is given by the mode of the
posterior distribution. So we must find the maximum of

f ( x) = x640.11111e−10.2222 x (we may ignore constants here)

Differentiating:

(
f '( x) = e−10.22222 x −10.2222 x640.11111 + 640.1111x639.11111 )
= x639.1111e−10.22222 x (−10.2222 x + 640.11111)

And setting this equal to zero we get

640.111111
x= = 62.62
10.22222

Alternatively, credit was given for differentiating the log of the posterior (which is simpler).
This question was well answered by most candidates.

127.9 + 88.9 + 149.7

5 (i) The overall mean is given by X = = 122.1 67
3

1 3 ⎛1 7 ⎞ 335.1 + 65.1 + 33.9

( )
E s 2 (θ ) = ∑ ⎜ ∑ ( X ij − X i ) 2 ⎟ =
⎜
3 i =1 ⎝ 6 j =1 ⎟ 3
= 144.7
⎠

Var (m(θ )) =
1 3
∑ (X i − X )2 − 1 E (S 2 (θ ))
2 i =1 7
(127.9 − 122.1) + (88.9 − 122.1) 2 + (149.7 − 122.1) 2 144.7
2
= −
2 7
= 928.14

7
So the credibility factor is Z = = 0.978213
7 + 144.7
928.14

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 Subject CT6 (Statistical Methods Core Technical) — September 2010 — Examiners’ Report

And the credibility premia for the risks are:

For risk 1 : 0.978213 × 127.9 + (1 − 0.978213) × 122.167 = 127.8

For risk 2 : 0.978213 × 88.9 + (1 − 0.978213) × 122.167 = 89.6
For risk 3 : 0.978213 × 149.7 + (1 − 0.978213) × 122.167 = 149.1

(ii) The data show that the variation within risks is relatively low (the Si 2 are low,
especially for the 2nd and 3rd risks) but there seems to be quite a high variation
between the average claims on the risks.

With the Si 2 being low, this variation cannot be explained just by variability
in the claims, and must be due to variability in the underlying parameter.

This means that we can put relatively little weight on the information provided
by the data set as a whole, and must put more on the data from the individual
risks, leading to a relatively high credibility factor.

Most candidates scored well on part (i). Only the better candidates were able to give a clear
explanation in part (ii).

6 (i) We must write f(x) in the form:

⎡ xθ − b(θ) ⎤
f ( x) = exp ⎢ + c( x, φ) ⎥
⎣ a (φ) ⎦

For some parameters θ, φ and functions a,b and c.

xα
αα α−1
−
μ
f ( x) = x e
μ α Γ (α )

⎡⎛ x ⎞ ⎤
= exp ⎢⎜ − − log μ ⎟ α + (α − 1) log x + α log α − log Γ(α) ⎥
⎣⎝ μ ⎠ ⎦

Which is of the required form with:

1
θ=−
μ

φ=α

1
a (φ) =
φ

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 Subject CT6 (Statistical Methods Core Technical) — September 2010 — Examiners’ Report

b(θ) = − log( −θ) = log μ

c ( x, φ) = (φ − 1) log x + φ log φ − log Γ (φ)

(ii) The mean and variance for members of the exponential family are given by
b '(θ) and a (φ)b ''(θ) .

1
In this case b '(θ) = − =μ
θ

b ''(θ) = θ−2 = μ 2 so the variance is μ 2 / α as required.

Generally well answered, though many candidates did not score full marks on part (i)
because they failed to specify all the parameters involved.

7 (i) First note that the probability of a claim exceeding 100 is e −100λ .

The likelihood function for the given data is:

L = C × λ85e−85×42×λ × (e−100×λ )39

Where C is some constant. Taking logarithms gives

l = log L = C '+ 85 log λ − 85 × 42 × λ − 100 × 39 × λ

Differentiating with respect to λ gives

∂l 85
= − 85 × 42 − 100 × 39
∂λ λ

Setting this expression equal to zero we get:

85
λˆ = = 0.011379
85 × 42 + 100 × 39

∂ 2l 85
And this gives a maximum since 2
=− <0
∂λ λ2

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 Subject CT6 (Statistical Methods Core Technical) — September 2010 — Examiners’ Report

(ii) We must first calculate the mean amount paid by the insurer per claim. This is

100 100
100
∫ xλe −λx dx + 100 P( X > 100) = ⎡ − xe−λx ⎤ + ∫e
−λx
dx + 100e−100λ
⎣ ⎦0
0 0
100
−100λ ⎡ 1 ⎤
= −100e + ⎢ − e −λx ⎥ + 100e −100λ
⎣ λ ⎦0

=
1
λ
(
1 − e −100λ )
So we must show the given value of λ results in the actual average paid by the
85 × 42 + 39 × 100
insurer. This is = 60.24
85 + 39

Substituting for λ in the expression derived above, we get

1
0.011164
(
1 − e −100×0.0111654 =
0.6725435
0.011164
)
= 60.24 as required.

Stronger candidates scored well on this question, whereas the weaker candidates struggled
with the calculations required in part (ii).

8 (i) The adjustment coefficient satisfies the equation

λ + λ(1 + θ) E ( X1 ) R = λM X1 ( R)

M
That is 1 + (1 + θ) E ( X1 ) R = ∑ e Rj p j
j =1

Applying the inequality given in the question we have

M
1 + (1 + θ) E ( X1 ) R ≤ ∑ p j (
j RM j
e +1− )
j =1 M M

M M
e RM 1 e RM E ( X1 ) E ( X1 )
So 1 + (1 + θ) E ( X1 ) R ≤
M
∑ jp j + 1 −
M
∑ jp j =
M
+1−
M
j =1 j =1

E ( X1 ) RM
So (1 + θ) E ( X1 ) R ≤ (e − 1)
M

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 Subject CT6 (Statistical Methods Core Technical) — September 2010 — Examiners’ Report

and so

1 ⎛ R 2 M 2 R3M 3 ⎞ ⎛ RM R 2 M 2 ⎞
(1 + θ) R ≤ ⎜⎜1 + RM + + + " − 1⎟ = R ⎜1 + + + "⎟
M 2! 3! ⎟ ⎜ 2! 3! ⎟
⎝ ⎠ ⎝ ⎠
⎛ 2
R M 2 ⎞
(1 + θ) R < R ⎜1 + RM + + "⎟ = R × e RM
⎜ 2! ⎟
⎝ ⎠

Taking logs, we have

log(1 + θ) < RM

log(1 + θ)
And so R > as required.
M

To get the other inequality, we go back to

M
1 + (1 + θ) E ( X1 ) R = ∑ e Rj p j
j =1

M
R2 j 2 R2
And so 1 + (1 + θ) E ( X1 ) R > ∑ p j (1 + Rj + ) = 1 + RE ( X1 ) + E ( X i2 )
j =1 2 2

R 2 m2
So we have (1 + θ)m1R > m1R +
2

Rm2
i.e. θm1 >
2

2θm1
i.e. R < as required.
m2

(ii) (a) In this case we have:

M=3

And E ( X1 ) = 2.5 and E ( X12 ) = (4 + 9) / 2 = 6.5

So the inequality in the question gives:

1 2 × 0.3 × 2.5
log1.3 < R <
3 6.5

That is 0.08745 < R < 0.23077

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 Subject CT6 (Statistical Methods Core Technical) — September 2010 — Examiners’ Report

(b) By Lundberg;s inequality ψ(U ) ≤ e− RU ≤ e−0.08745U .

This question was not well answered, with relatively few candidates scoring more than 5
marks.

9 (i) The development ratio for development year 2 to development year 3 is given
by 1862.3/1820 = 1.023242

Therefore W = 1762 × 1.023242 = 1803.0

Because there is no claims development beyond development year 3

X = 1803.0 also.

The development factor from development year 1 to ultimate is given by

2122.5/1805 = 1.1759003

So the ratio from development year 1 to development year 2 is given by

1.1759003/1.023242 = 1.149190785

But under the definition of the chain ladder approach, this is calculated as:

1762 + 1820 3582

1.149190785 = =
Y + 1485 Y + 1485

3582
So Y = − 1485 = 1632.0
1.149190785

(ii) We require the development ratio from year 0 to year 1; this is given by:

1485 + 1632 + 1805 4922

= = 1.385308
1001 + 1250 + 1302 3553

The development factor to ultimate is therefore

1.385308 × 1.149190785× 1.023242 = 1.628984285

⎛ 1 ⎞
And so Z = 2278.8 − 2500 × 0.9 × ⎜1 − ⎟ = 1410.0
⎝ 1.628984285 ⎠

(iii) The outstanding claims reserve is

1862.3 + 2122.5 + 2278.8 − 1820 − 1805 − 1410 = 1228.6

This slightly unusual question was nevertheless generally well answered, showing that
candidates understood the principles underlying the calculations. Many candidates scored
full marks here.

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 Subject CT6 (Statistical Methods Core Technical) — September 2010 — Examiners’ Report

10 (i) We require:

• The risk of flood damage is a constant p for each building.

• There can only be one claim per policy per year.
• The risk of flood damage is independent from building to building.

(ii) Let the individual claim amounts net of re-insurance be X. Then

E (αX ) = αE ( X ) = 400α

And Var (αX ) = α 2Var ( X ) = (50α)2

So if Y represents the aggregate annual claims net of re-insurance, then we

have:

E (Y ) = 10, 000 × 0.03 × 400α = 120, 000α

and

Var (Y ) = 10, 000 × 0.03 × (50α)2 + 10, 000 × 0.03 × 0.97 × (400α) 2 = 47,310, 000α 2
= (6,878.23α)2

We require α to be chosen so that

P (Y > 120, 000) = 0.01

120, 000 − 120, 000α

i.e. P( N (0,1) > ) = 0.01
6,878.23α

120, 000 − 120, 000α

= 2.3263
6,878.23α

120,000
i.e. α = = 0.8823476; α = 88.2% to 3sf
120,000 + 2.3263 × 6,878.23

(iii) The mean claim amount for the re-insurer is (1 − 0.882 ) × 400 = 47.20

The annual premiums for reinsurance are 10,000 × 0.03 × 47.20 × 1.15 = 16,284

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 Subject CT6 (Statistical Methods Core Technical) — September 2010 — Examiners’ Report

(iv) We must show that using a retention of 358.50 to calculate the premium for
the individual excess of loss arrangement gives the same result as the
proportional reinsurance arrangement in part (ii).

We first calculate the mean claim amount paid by re-insurer. This is equal to

∫ ( x − 358.50) f ( x)dx
358.50

⎡ 358.50 − 400 ⎤ ⎡ 358.50 − 400 ⎤ ⎛ ⎛ 358.50 − 400 ⎞ ⎞

= 400 ⎢1 − Φ ( ) ⎥ − 50 ⎢0 − ϕ( ) ⎥ − 358.50 × ⎜1 − Φ ⎜ ⎟⎟
⎣ 50 ⎦ ⎣ 50 ⎦ ⎝ ⎝ 50 ⎠⎠

This gives

400 [1 − Φ(−0.83) ] + 50ϕ(−0.83) − 358.50 × (1 − Φ (−0.83))

0.832
1 −
= 400 × 0.79673 + 50 × e 2 − 358.50 × 0.79673
2π
= 47.20

Then the aggregate premium charged will be 10, 000 × 0.03 × 47.20 × 1.15 =
16,284 which is the same as under the first arrangement as required.

Carrying forward more than 3 significant figures from the result in (ii) gives a slightly
different value in (iii). To full accuracy, the solution in (iii) becomes 16,236 resulting in a
minor discrepancy between the answers in (iii) and (iv). This appears not to have concerned
candidates who were generally happy to observe that the results in (iii) and (iv) were
approximately equal. The examiners gave credit for either approach.

This question was a good differentiator – the better prepared candidates were able to score
well whilst weaker candidates struggled.

11 (i) Let B be the backward shift operator. Then the time series has the form:

(1 − 2αB + α 2 B 2 )Yt = et

(1 − αB) 2 Yt = et

And the roots of the characteristic equation will have modulus greater than 1
ands so the series will be stationary provided that α < 1 .

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 Subject CT6 (Statistical Methods Core Technical) — September 2010 — Examiners’ Report

(ii) Firstly, note that Cov(Yt , et ) = Cov(et , et ) = σ2

So, taking the covariance of the defining equation with Yt we get:

γ 0 = 2αγ1 − α 2 γ 2 + σ 2 (A)

Taking the covariance with Yt −1 we get

γ1 = 2αγ 0 − α 2 γ1
i.e. (1 + α 2 ) γ1 = 2αγ 0 (B)

Finally, taking the covariance with Yt −2 gives:

γ 2 = 2αγ1 − α 2 γ 0 (C)

In general, for k ≥ 2 we have γ k = 2αγ k −1 − α 2 γ k −2

Substituting the expression for γ 2 in (C) into (A) gives:

γ 0 = 2αγ1 − α 2 (2αγ1 − α 2 γ 0 ) + σ2

So that

(1 − α 4 ) γ 0 = 2α(1 − α 2 ) γ1 + σ2

And now substituting the expression for γ1 in (B) we get

2αγ 0
(1 − α 4 ) γ 0 = 2α(1 − α 2 ) × 2
+ σ2
(1 + α )

⎛ 4 4α (1 − α ) ⎞
2 2
2
⎜⎜ 1 − α − 2 ⎟⎟ γ 0 = σ
⎝ 1+ α ⎠

(1 + α 2 − α 4 − α 6 − 4α 2 + 4α 4 ) γ 0 = (1 + α 2 )σ2

(1 + α 2 ) (1 + α 2 )
So γ 0 = 2 4 6
σ2 = 2 3
σ2
(1 − 3α + 3α − α ) (1 − α )

2αγ 0 ⎛ 2α(1 + α 2 ) ⎞ 2 2α
And so γ1 = = ⎜ ⎟ σ = σ2
1+ α 2 ⎜ 2 3 2 ⎟ 2 3
⎝ (1 − α ) (1 + α ) ⎠ (1 − α )

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 Subject CT6 (Statistical Methods Core Technical) — September 2010 — Examiners’ Report

And more generally γ k = 2αγ k −1 − α 2 γ k −2 (D)

(iii) Suppose γ k −1 = Aα k −1 + (k − 1) Bα k −1 and γ k −2 = Aα k −2 + (k − 2) Bα k −2 and

substitute into (D).

γ k = 2αAα k −1 + 2α(k − 1) Bα k −1 − α 2 Aα k −2 − (k − 2)α 2 Bα k −2

= A(2α k − α k ) + B(2α k (k − 1) − (k − 2)α k ) = Aα k + Bkα k

Which is of the correct form, so the general form of the expression holds.

Setting k = 0 we get γ 0 = A

(1 + α 2 )
So A = 2 3
σ2
(1 − α )

Setting k = 1 we get γ1 = ( A + B)α

γ1 ⎛ 2α ⎞ 2 (1 + α 2 ) 2 ⎛ 1 − α 2 ⎞ 2 σ2
So B = − A = ⎜⎜ ⎟ σ − (1 − α 2 )3 σ = ⎜⎜ (1 − α 2 )3 ⎟⎟ σ = (1 − α 2 ) 2
2 3⎟
α ⎝ α (1 − α ) ⎠ ⎝ ⎠

[Alternatively, solve using the formula on page 4 of the Tables:

We have g k = 2αg k −1 + α 2 g k − 2 = 0

Using the Tables formula, the roots are λ1 = λ2 = α so we have a solution

of the form g k = ( A + Bk )λk = ( A + Bk )α k

Set k = 0 and k = 1 to get the same equations as before.]

Another good differentiator, with strong candidates scoring well, and weaker candidates
struggling with parts (ii) and (iii) in particular.

END OF EXAMINERS’ REPORT

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