MA516-833 Contingencies I

Section 12
Contingent Assurances and Reversionary Annuities
Handout

Objectives for this section:

 To evaluate expected values and variances for the present value of contingent assurances
(payable if the lives die in a specified order)

 To evaluate expected values for the present value of reversionary annuities (payable to one
life after the death of another life)

Reading for this section:

AEC tuition notes for CT5, Chapter 9, pages 9 to 57.

Contingent Assurances

A contingent assurance is an assurance on two or more lives under which the sum assured is
payable only if the deaths occur in a specified order.

Example 1

represents the expected present value of an assurance of 1 payable immediately on the death
of (x) if (x) dies before (y).

Exercise 1

(a) What do you think is the meaning of A xy1 ?

(b) Can you express A 1xy  A xy1 in terms of a function you have already seen?

(c) If the two lives are both aged x and have identical mortality, can you express A1xx in
terms of a function you have already seen?

Solution 1

(a) A xy1 is the expected present value of an assurance of 1 payable immediately on

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Integral expression for Contingent Assurances

Consider A1
xy

The random variable representing the present value of this assurance is

vTx if

0 if Tx  Ty

We could evaluate this expected value by appropriate integration of the density functions of the
random variables of Tx and Ty.

However, throughout this section we will instead use the projected cash flow approach.

General Approach for Expected Values of Contingent Assurances

The projected cash flow approach to writing down an integral expression for the expected present
value of the benefit under a contingent assurance is:

 Consider a time t at which the specified life dies so that the benefit becomes payable
 Discount the payment by vt
 Multiply by the probability that the life has survived up to time t, then died in that instant.
 Multiply by the probability for the other life.
 Integrate over all times t when the benefit may be payable.

 
 A   v t px  x t . t p y dt   vt t pxy  x t dt
1
xy
t
[1]
0 0

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Exercise 2

(a) What do you think is the meaning of Axy2 ?

(b) Write down an integral expression for this function.

(c) Can you express it in terms of functions you have already seen?

Solution 2

(a) Axy2 represents the value of an assurance of 1 payable immediately on

Variance of Present Values of Contingent Assurances

If we write down the integral for the expected value using the project cash flow approach, as in [1]
above, this doesn’t directly enable us to say anything about the variance.

However, let us call the random variable representing the present value of this assurance Z . In
Example 1, where the benefit is payable immediately on the death of (x) if (x) dies before (y),

Z= vTx if Tx  Ty
Z = 0 otherwise.

Then A1 =E [ z]
xy

and A*1  E[ Z 2 ] where A*1 is evaluated as for A1 but at the special rate of interest
xy xy xy

Thus the variance of the present value of this contingent assurance is

Var [ z] = E[ Z 2 ]  ( E[ Z ]) 2 =

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Contingent Term Assurance

n A1 or A1 represents the expected present value of an assurance of 1 payable immediately on

xy xy : n|

the death of (x) if (x) dies before (y) and within n years.

n
A1   vt t px  x t t p y dt
xy : n|
0
n
  vt t pxy  x t dt
0
 
  vt t pxy  x t dt   vt t pxy  x t dt
0 n

 A xy1   v r  n r  n pxy  x  r  n dr
0

 A xy1 v n n pxy Ax 1n: y  n

It wouldn’t really make sense to have a contingent endowment assurance. So there is no standard
actuarial symbol for an assurance which is paid on survival to time n or earlier in the event of death
in the specified order.

Contingent Assurances Payable at the end of the Year; Evaluating the Integral expression

In previous Sections, we would start by calculating a value for the expected present value of
assurances payable at the end of the year of death.

We then used the result as a basis to approximate the expected present value of assurances payable
immediately on death.

For example, assuming deaths occur in the middle of the year on average,

A  A
xy xy

Contingent assurances can be payable at the end of the year of death:

Example 2

A1 represents the expected present value of an assurance of 1 payable at the end of the year of
xy

death of (x) if (x) dies before (y).


A1   v t 1 t pxy qx 1 t: y t
xy
0

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But to evaluate this, we still need to deal with the fact that q 1 is an integral
x t: y  t

So the usual way to proceed is to start with the expression for the assurance payable immediately on
death, and get an approximation from this, assuming as before that deaths occur in the middle of the
year on average.

ie, get a value for A1 , then since A1  (1  i )½ A1

xy xy xy

our approximation is


We evaluate the integral A 1xy   vt t pxy  x t dt by a numerical method, such as the repeated
0

Simpson’s rule.

Premiums for Contingent Assurances

The policyholder won’t want to continue paying premiums on a policy where there is no longer any
chance of a benefit. Therefore, premiums should cease on the death which causes the benefit to be
paid, or on the death which means that no benefit will be paid.

Exercise 3

Stan buys a policy which pays ₤100,000 immediately if he dies before Oliver. Premiums are
payable annually in advance. When should premiums cease?

[2]

Exercise 4

Consider an assurance with expected present value Axy2 . Premiums are payable annually in
advance. Write down a formula similar to [2].

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Reversionary Annuities

Definition of a Reversionary Annuity

A reversionary annuity is an annuity which commences on the failure of a given status and
continues thereafter while another given status remains in force.

= the expected present value of an annuity of 1 pa payable continuously, commencing

on the death of (x) and continuing throughout the further lifetime (if any) of (y).

Expected Present Value of a Reversionary Annuity

Use the projected cash flow approach, ie we look at the probability that a payment is made at
time t and integrate over all possible times of payment.

A payment of amount dt will be made in any period t to t+dt if (y) is alive and (x) is dead.

a x| y 

If payments cease at the end of n years, the expected present value of the reversionary annuity is
a y:n  axy:n

Exercise 5

Find an expression containing only single and joint life functions for the expected present value
of an annuity of 1 pa. payable continuously during the lifetime of Elizabeth, the first payment to
be made n years after the death of Fitzwilliam.

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Variances for the present value of reversionary annuities

There is no simple expression for the variance of a reversionary annuity. We will not consider this
further in this module.

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Section 12 Practice Exercises

1
Write down the actuarial symbol and an integral for the expected present value of a benefit of 1
payable immediately on the death of (x) if (x) dies after (y) and within n years. Simplify the
integral into the value of assurances payable on the first death.

2
A unit assurance benefit is payable immediately on the death of a man aged 50 provided he dies
after his 55th birthday and his death occurs after, but within 10 years of, the death of another life
now aged 45. Derive an expression in terms of assurance functions payable on first death for
valuing this benefit assuming that both lives are subject to the same mortality table.

3
A joint-life policy offers the following benefits:

 an assurance benefit of £60,000 payable at the end of year of first death provided this
occurs within 15 years
 an annual annuity-due with the first payment made fifteen years after the start of the policy
with the payment being £15,000 per annum if both lives are still alive but only £10,000 per
annum if one life is still alive.

Premiums are paid annually in advance for at most 15 years or until the first death if earlier.

Calculate the premium for a 53 year old male and a 50 year old female assuming
PMA92C20/PFA92C20 mortality as appropriate and 4% per annum interest.

4. [If you have the ActEd notes you will see that this is ActEd question 9.22. Use the approach in
these notes to write down the integral expression, rather than the method in the ActEd solution.
Your answer will differ from the ActEd answer by a few pounds. This is due to rounding – both
methods are correct, but, in my opinion, the ActEd method requires more thinking. What is your
opinion?]

Jack and Vera are both aged 60. If Jack dies before age 65, Vera will receive ₤10,000 pa until her
75th birthday or earlier death, paid annually in arrears from the end of the year of Jack’s death. Find
the expected present value of the benefits using PMA92C20 mortality/PFA92C20 mortality as
appropriate and 4% pa interest.

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