2.1.

5 A new case Christine

At age 50, Christine subscribes a 10-years deferred annuity with an annual premium of 10'000 payable
15 times. The product is payable annually per beginning of the year from age 65 until death with 10
guaranteed terms (paid in all cases, even if she dies before age 65). The annual premium includes a
loading to finance acquisition costs of 1.55% of the present value of premiums, as well as a loading to
cover annual administrative costs of 1.2% of the annuity during deferment time, and 2.4% of the annuity
during benefit payment duration. Technical bases for the pricing are SF 1998/03 with a technical interest
rate of 1.5%.

1) What is the amount of the insured annuity?

2) What are the (pure) mathematical provisions at the beginning of the insurance years where Christine
reaches age 60, 70 and 80?

3) For those three same years, what are the (pure) risk and savings premiums?

4) Explain the sign of risk and savings premiums.

Tips: SF98/03 with 𝑖𝑖 = 1.5%

ä80 = 8.97387

ä81 = 8.43377

𝑞𝑞80 = 0.040349
2.2 Technical provisions
2.2.1 Provision for administrative costs
In each premium, a cost loading G is perceived, as we expressed it in (21/1). However, the cost
process is not always parallel to the premium cashing process, in particular for policies with single
premium payment. Hence, it is necessary to set up a mathematical provision to insure a correct
financing of the cost process. In a voluntarily simplified way, we can express this provision as
follows:

t (VG ) = γ ⋅ ä x+t:n−t − G ⋅ ä x +t:k −t (23/1)

This equation expresses the prospective view of the provision that is equal to the difference between
present value of future effective costs (γ per annum) and present value of future cost loadings G.
When premium payment is over, only the first term on the right side of the equation remains. In
specific cases, this formula must be adapted. If, for instance, we pick up example 2 from 2.1.1:

ä x:n
The cost loading is equal to G = β ⋅ P"+γ 1 + γ 2
ä x:k

From the equivalence principle for administrative costs, we get:

t (VG ) = (β ⋅ P"+γ 1 ) ⋅ ä x+t:k −t + γ 2 ⋅ ä x +t:n −t − G ⋅ ä x +t:k −t

  ä x:n 
   t<k
γ 2 ⋅  ä x +t:n −t − ⋅ä
t (VG ) = 
from which it follows that ä x:k x +t:k −t 
  
γ ⋅ä t≥k
 2 x +t:n −t

Example 2 (continued): for this endowment policy with loading factors β = 2% and γ = 1.5‰,
G = 241.5 and, at age 40, 5(VG) = 115.6. The provision is maximum at age
60 (end of premium payment) where it reaches 713.9.

Is there a recursion formula for the administrative cost provision according to (23/1)? Starting from
(13/6), we have ä x:n − 1=1 E x ⋅ ä x +1:n −1

from which we draw two equations for durations k and n:

 γ ⋅ ä x +t:n −t − γ =1 E x +t ⋅ γ ⋅ ä x +t +1:n −t −1
G ⋅ ä x +t:k −t − G =1 E x +t ⋅ G ⋅ ä x +t +1:k −t −1

Subtracting the second one from the first one and taking (23/1) into account, we get:

t (VG ) + G − γ =1 E x+t ⋅t +1 (VG ) (23/2)

The interpretation of this equation is as follows: first, we add the cost loading G that we receive as
part of the premium to the initial provision; then we pay the effective cost γ at the beginning of the
year; then we invest the remaining amount at interest rate i and we shall have enough provision to
finance the costs relating to policies of surviving insured people.

From (23/2), we can decompose the loading G into following parts:

G = γ − v ⋅ q x +t ⋅t +1 (VG ) + v⋅t +1 (VG )− t (VG ) (23/3)

GRx +t = −v ⋅ q x +t ⋅t +1 (VG )
where we define:  (23/4)
GE x +t = v⋅t +1 (VG )− t (VG )

We can interpret equation (23/3) as follows: the loading G (null after premium payment ends):

 allows for payment of the costs of the year γ,

 includes a negative risk premium GRx+t reflecting the profit the insurer is making if the
insured person dies prematurely, as the provision is released,
 also includes a savings premium GEx+t which is used to set the provision to the required
level to continue the insurance process.

Example 2 (continued): endowment policy, 5(VG) = 115.6 and 6(VG) = 139.8, hence GR40 = -0.2,
GE40 = 22.2 and β⋅P” + γ⋅FA = 219.4, which satisfies the condition that
the sum of those three elements is equal to the loading G.

We can transform the second relation of (23/4) into a recursion formula similar to (21/7):

t +1 (VG ) = (1 + i ) ⋅ ( t (VG ) + GE x +t ) (23/5)

2.2.2 Deferred acquisition costs
The acquisition cost loading can be expressed as a function of various quantities, such as the face
amount, the premium, the sum or premiums, the present value of premiums, etc. Let us note

K : quantity taken as reference for the calculation of the acquisition cost loading.

α ⋅K
The loading in each premium is F= (23/6)
ä x:k

α ⋅ K t =0

Not yet amortised costs: t (VF ) =  F ⋅ ä x + t:k −t t<k (23/7)
0 t≥k


Example 2 (continued): for this endowment policy with loading factor α = 1.2%, F = 58.4 and at
age 40, 5(VF) = 994. The provision decreases continuously from its initial
value 1’200 at policy inception.

We shall establish a recursion formula, taking (13/6) as a starting point and multiplying by F:
F ⋅ ä x +t:k −t = F + 1 E x +t ⋅ F ⋅ ä x +t +1:k −t −1 ⇔ F − F ⋅ ä x +t:k −t =−1 E x +t ⋅ F ⋅ ä x +t +1:k −t −1 ⇔

t (VF ) − F =1 E x+t ⋅t +1 (VF ) (23/8)

The interpretation is straightforward: after using the loading F to amortise a part of the deferred
acquisition costs at the beginning of the year, taking interest and death cases into account, we obtain
the deferred acquisition costs at the end of the year for survivors. There is also a split between risk
/ savings premiums:

F = v ⋅ q x +t ⋅t +1 (VF )+ t (VF ) − v⋅t +1 (VF ) ⇔

F = FR x +t + FE x +t (23/9)

 FRx +t = v ⋅ q x +t ⋅t +1 (VF )
with two components:  (23/10)
 FE x +t = t (VF ) − v⋅t +1 (VF )
Example 2 (continued): for this endowment policy, 5(VF) = 994 and 6(VF) = 951: FR40 = 1.4,
FE40 = 57, which satisfies the condition that the sum of those two elements
is equal to the loading F.

Equations (23/9) and (23/10) are meaningful only during premium payment (t < k). After that, all
values are equal to zero. Beforehand there is a positive risk premium FRx+t because in case the
insured dies, the insurer must amortise the remaining deferred acquisition costs at once instead of
over the remaining duration of premium payment. The savings premium FEx+t is always positive. It
is equal to the yearly amortisation as we can also see if we write the second equation of (23/10) as:

t +1 (VF ) = (1 + i ) ⋅ ( t (VF ) − FE x+t ) (23/11)

2.2.3 Summary