Used

Exam 3
Fall 2006 Answer Key
(12 December 2006)

Question Answer
1 C
2 D
3 E
4 B
5 E
6 E
7 E
8 B
9 B
10 C
11 C
12 E
13 D
14 B
15 B
16 E
17 E
18 C
19 A
20 A
21 E
22 D
23 B
24 B
25 D
26 C
27 A
28 C
29 D
30 D
31 A
32 B
33 B
34 C
35 C
36 E
37 E
38 B
39 D
40 D
NOVEMBER 2006 CAS 3

NOVEMBER 2006 CAS COURSE 3 SOLUTIONS

1. The median of the exponential distribution with mean ) is - , where J] Ð-Ñ œ "  /-Î) œ Þ& ,
so - œ ) 68# .
The pdf and cdf of the exponential distribution are 0 ÐCÑ œ ") /CÎ) and J ÐCÑ œ "  /CÎ) .
The pdf of ]$ based on sample size 5 is
0]$ ÐCÑ œ #x&x#x Ò"  /CÎ) Ó# Ò/CÎ) Ó# † ") /CÎ) œ $! ") Ò/$CÎ)  #/%CÎ)  /&CÎ) Ó .

IÒ]$ Ó œ '! C † 0]$ ÐCÑ .C œ '! C † $! ") Ò/$CÎ)  #/%CÎ)  /&CÎ) Ó .C .

The bias of ]$ as an estimator of the median of ] is IÒ]$ Ó  ) 68# .
∞ ∞

We use the integration rule '! >8 /+> .> œ 8x

∞
8" to get
+
IÒ]$ Ó œ $! ") Ò Ð$Î")Ñ#  Ð%Î#)Ñ#  Ð&Î")Ñ# Ó œ Þ()$) Þ Bias is ÐÞ()$  68 #Ñ) œ Þ!*) . Answer: C

2. The pdf is 0 ÐBÑ œ Ð)  "ÑB) and 68 0 ÐBÑ œ 68Ð)  "Ñ  ) 68B

and ..) 68 0 ÐBÑ œ )"
"
 68 B . Setting the derivative of the loglikelihood function to 0, we get
.
.) 68 P œ D ..) 68 0 ÐB3 Ñ œ )"
&
 D68 B œ p ) œ D&
68 B  " œ "Þ)( . Answer: D

3. "Claim sizes are 10 or greater" indicates that ) œ "!. The mean of the single parameter Pareto with
) œ "! is   αα) "!α "!!
" œ α" Þ The sample mean is ' . According to the method of moments, we set
"!α
α" œ "!!
' and solve for α. The resulting value is α œ #Þ& . Answer: E

4. According to the Neyman-Pearson Lemma with significance level .05 for this hypothesis test with
single sample value 8, a point 8 will be in the critical region if T ÐR œ 8l) œ )! Ñ  Þ!& .
Only the points 8 œ ! or 8 œ " satisfy this requirement. Answer: A

5. Based on the total data set, the probabilities of 0 , 1 and 2 claims are .97 , .02 , and .01.
The expected numbers for each territory and claim amount are
Number
of Claims Territory 1 Territory 2 Territory 3 Territory 4 Total
0 97 194 388 291 970
1 2 4 8 6 20
2 1 2 4 3 10
ÐS I Ñ#
The Chi-Square statistic is U œ D 3 I 3 , over all cells, where I3 is the expected number of
3
observations for a cell and S3 is the observed number. There are 12 cells, and summing column-by-
column, we get
Ð*(*(Ñ# Ð##Ñ# Ð""Ñ# Ð"))"*%Ñ# Ð%'Ñ# Ð$$Ñ#
Uœ *(  #  "  "*%  â  '  $ œ ""Þ*" .
The number of degrees of freedom is 6. There are 12 categories (cells), and we lose a degree of freedom
for each cell in the bottom row, because the 8 œ # values are known once the 8 œ ! and 8 œ " values are
known for each Territory (for instance, with 100 observations for Territory 1, with 97 at 8 œ ! and 2 at
8 œ ", there must be " at 8 œ #).

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NOVEMBER 2006 CAS 3

We also lose a degree of freedom for Territory 4 at 8 œ ! and 8 œ ", since once we know the number of
8 œ ! observations for Territories 1,2, and 3 out of 970 observations of 8 œ !, the rest must be for
Territory 4. The 5% significance critical value for the Chi-Square distribution with 6 degrees of freedom
is 12.59. l""Þ*"  "#Þ&*l œ Þ') . Answer: E

6. A Type II error occurs when the null hypothesis is false, but it is not rejected.
Since L" is based on an interval that is the last part of the interval for L! , rejection will take place of the
sample value is close to 10. In order to have a 5% level of significance, the rejection region will be
B  *Þ&. This is true, because if L! is true, there is on a 5% chance that B  *Þ&. The null hypothesis will
not be rejected if B Ÿ *Þ&. If L" is true, the probability of not rejecting L! is
T ÒB Ÿ *Þ&l\ is uniform on Ò&ß "!Ó Ó œ Þ* . This is the probability of Type II error. Answer: E
The CAS answer key lists the answer as A.

7. The test statistic is > œ È $Þ&$ œ #Þ*# .

Þ'"&'Î#"
> has a >-distribution with 20 degrees of freedom. The :-value of > is the probability T ÐlX l  #Þ*#Ñ
where X has a >-distribution with 20 degrees of freedom. The answer is listed as C, but the >-table that I
have for CAS Exam 3 does not have that value in the table.

 3 C Ñ
s œ DÐB3 BÑÐC
8. "  # s œ
œ "*Þ& , α C "s
B œ %&  Ð"*Þ&ÑÐ$Ñ œ  "$Þ& .
DÐB3 BÑ
For B œ "Þ# ($1,200), the predicted premium is  "$Þ&  Ð"*Þ&ÑÐ"Þ#Ñ œ *Þ* . Answer: B

9. With 8 œ "!, the pdf of ]# is

0]# ÐCÑ œ "x"!x)x Ò"  /CÎ) Ó" Ò/CÎ) Ó) † ") /CÎ) œ #!!
*! *CÎ#!!
Ò/  /"!CÎ#!! Ó œ Þ%&Ò/Þ!%&C  /Þ!&C Ó .
T Ò]#  &!Ó œ '&! Þ%&Ò/Þ!%&C  /Þ!&C Ó .C œ Þ%&Ò / Þ!%&  / Þ!& Ó œ Þ$"& .
∞ Þ!%&Ð&!Ñ Þ!&Ð&!Ñ
Answer: B

10. "l# ;Ò'!Ó œ :Ò'!Ó † # ;Ò'!Ó" œ :Ò'!Ó † Ð"  # :Ò'!Ó" Ñ œ :Ò'!Ó † Ð"  :Ò'!Ó" † :Ò'!Ó# Ñ
œ :Ò'!Ó † Ð"  :Ò'!Ó" † :'# Ñ œ ÐÞ*)ÑÒ"  ÐÞ*(ÑÐÞ*'ÑÓ œ Þ!'(%# . Answer: C

11. The average number of complete years lived between ages 60 and 65 is /'!À&l .
j'" j'# j'$ j'% j'&
/'!À&l œ :'!  # :'!  $ :'!  % :'!  & :'! œ j'! œ %Þ(( . Answer: C

12. #! :&&À'!œ "  #! ;&&À'! œ "  Ð#! ;&& ÑÐ#! ;'! Ñ .

Þ#&
&&l#! ;! œ && :! † #! ;&& p Þ#& œ =Ð&&Ñ † #! ;&& p Þ#& œ Ð!Þ*Ñ † #! ;&& p † #! ;&& œ Þ* Þ
Þ$
'!l#! ;! œ '! :! † #! ;'! p Þ$ œ =Ð'!Ñ † #! ;'! p Þ$ œ Ð!Þ)&Ñ † #! ;'! p † #! ;'! œ Þ)& Þ
Then, #! :&&À'! œ "  Ð Þ#& Þ$
Þ* ÑÐ Þ)& Ñ œ Þ*!# . Answer: E

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NOVEMBER 2006 CAS 3

>;
13. Under UDD, we have > ;B= œ "=B; for ! Ÿ =  > Ÿ " and > :B .ÐB  >Ñ œ ;B for !  >  ".
B
1. Þ#& :'# Þ& ;'#Þ#& œ Þ#& :'# † Ð"  Þ& :'#Þ#& Ñ œ Þ#& :'#  Þ(& :'# œ Þ(& ;'#  Þ#& ;'# œ ÐÞ(&  Þ#&Ñ;'#
œ Þ& ;'# œ Þ& ÐÞ!"'$)Ñ œ Þ!!)"* . False.
Þ#& ; Þ#& ; Þ#& ;
2. Þ#& ;'#Þ& œ "Þ& ;'# ß Þ#& ;'#Þ(& œ "Þ(&'#;  "Þ& ;'# (compare denominators). True.
'# '# '#
3. Constant density within each year of age under UDD. True. Answer: D

14. "!l"! ;$!À%! œ "! :$!À%!  #! :$!À%! œ "! :$! † "! :%!  #! :$! † #! :%! œ #! :$!  #! :$! † #! :%!
""!$!#!
œ ""!$!  Ð ""!$!#! ""!%!#!
""!$! ÑÐ ""!%! Ñ œ Þ#"%#)'

"!l"! ;$!À%! œ #! ;$!À%!  "! ;$!À%! œ #! ;$! † #! ;%!  #! ;$! † #! ;%!

#! #! "! "!
œ Ð ""!$! ÑÐ ""!%! Ñ  Ð ""!$! ÑÐ ""!%! Ñ œ Þ!&$&(" Þ

Þ#"%#)'  Þ!&$&(" œ Þ"'" . Answer: B

15. Expected lifetime of system X is /° !À! œ '! > :!À! .> œ '! Ð> :! Ñ# .> œ '! ÐÞ!"># Ñ# .> œ # years.
"! "! "!

/° ! œ '! > :! .> œ '! Þ!"># .> œ $Þ$$ , so that the expected lifetime of system Y is #Ð$Þ$$Ñ  # œ %Þ'' .
Expected lifetime of system Y is /° !À! œ /° !  /° !  /° !À! .
"! "!

The difference in expected lifetimes of systems X and Y is 1.66 . Answer: B

Ð7 Ñ Ð7 Ñ Ð7 Ñ Ð7 Ñ Ð7 Ñ Ð7 Ñ
16. % ;'& œ "  % :'& œ "  :'& † :'' † :'( † :') œ "  ÐÞ*$ÑÐÞ*"ÑÐÞ)*ÑÐÞ)(Ñ œ Þ$%%(
Ð7 Ñ Ð7 Ñ Ð"Ñ Ð#Ñ
(for instance :'& œ "  ;'& œ "  ;'&  ;'& œ "  Þ!#  Þ!& œ Þ*$).
Ð"Ñ Ð7 Ñ Ð"Ñ
$l ;'& œ $ :'& † ;') œ ÐÞ*$ÑÐÞ*"ÑÐÞ)*ÑÐÞ!&Ñ œ Þ!$('' .
The difference is Þ$%%(  Þ!$('' œ Þ$" . Answer: E

17. 8 :B œ /B:Ò  '! .B> .>Ó œ /B:Ò  '! Þ"&> .>Ó œ /Þ!(&8 .
Ð7 Ñ 8 Ð7 Ñ 8 #

APV of accidental death benefit is #'! > :B † .B> .> œ #'! /Þ!(&> † #! >
#! Ð7 Ñ Ð"Ñ #! #
.>
Using the substitution, = œ Þ!(&># , .= œ Þ"&> .> , and the integral become
' /= .= , so the APV is # ‚ $" Ð  /Þ!(&> ¹
>œ#!
"
Ñ œ $# Ð"  /$! Ñ .
#

#!ÐÞ"&Ñ >œ!

'!#! > :BÐ7 Ñ † .Ð#Ñ ' #! Þ!(&># † > .> . We see that this integral is twice as large as
The APV of the benefit for death due to other causes is
B> .> œ ! /
'!#! /Þ!(&># † > .> , so '!#! /Þ!(&># † > .> œ # Ð"  /$! Ñ .
"!
#! "! $
The total APV is #$ Ð"  /$! Ñ . Answer: E

7 " ÐBÎ)Ñ 7
18. The Weibull density is 0" ÐBÑ œ 7 B )/7 œ "&!!" BÎ"&!!
/ (actually, exponential with mean
α #
#Ð"#ß!!!Ñ
1500). The Pareto density is 0# ÐBÑ œ ÐBα))Ñα" œ ÐB"#ß!!!Ñ$

The pdf of the spliced distribution is 0 ÐBÑ œ š " "

- 0 ÐBÑ B Ÿ %!!!
Þ
In order to be a valid pdf, we must have '! 0 ÐBÑ .B œ " .
-# 0# ÐBÑ B  %!!!
∞

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NOVEMBER 2006 CAS 3

This implies that '! -" 0" ÐBÑ .B  '%!!! -# 0# ÐBÑ .B œ " . This equation becomes
%!!! ∞

"#ß!!!
-" J" Ð%!!!Ñ  -# Ò"  J# Ð%!!!ÑÓ œ -" Ò"  /%!!!Î"&!! Ó  -# Ð %ß!!!"#ß!!! Ñ# œ " , which is
Þ!'*%)$-"  Þ&'#&-# œ " .

Therefore, '! -" 0" ÐBÑ .B œ Þ' , from which we get Þ!'*%)$-" œ Þ', and -" œ Þ""&)!& .
We are also told that the probability that losses are less than $4000 is 0.6.
%!!!

Then Þ&'#&-# œ Þ%, so that -# œ Þ(""" .

We wish to find T Ð\  "&ß !!!Ñ œ T Ð\ Ÿ %!!!Ñ  T Ð%!!!  \  #&ß !!!Ñ

T Ð%!!!  \  #&ß !!!Ñ œ -# '%!!! 0# ÐBÑ .B œ Þ("""ÒJ# Ð#&ß !!!Ñ  J#Ð%!!!ÑÓ

œ Þ'  T Ð%!!!  \  #&ß !!!Ñ Þ
#&ß!!!

"#ß!!! "#ß!!!
œ Þ("""ÒÐ %ß!!!"#ß!!! Ñ#  Ð #&ß!!!"#ß!!! Ñ# Ó œ Þ$#&# .
Finally, T Ð\  #&ß !!!Ñ œ Þ'  Þ$#&# œ Þ*#&# . Answer: C

T ÐR œ !Ñ œ '! T ÐR œ !l" Ñ 0 Ð" Ñ . " œ '! Ð""" Ñ< † #" . " œ '! Ð""" Ñ% † #" . "
19. R is a continuous mixture distribution. T ÐR   "Ñ œ "  T ÐR œ !Ñ .
# # #

(0 Ð" Ñ is the pdf of the uniform distribution on Ð!ß #Ñ, which is "# ).
'!# " % † " . " œ " '!# " % . " œ " † " † Ò"  "$ Ó œ Þ"'!& .
Ð"" Ñ # # Ð"" Ñ # $ $
Then, T ÐR   "Ñ œ "  Þ"'!& œ Þ)$*& . Answer: A

20. The benefit payment \ is a mixture of standard benefit payment \" with weight .75 and accident
benefit payment \# with weight .25.
T Ð\  "&ß !!!Ñ œ Þ(&T Ð\"  "&ß !!!Ñ  Þ#&T Ð\#  "&ß !!!Ñ .
\" has a lognormal distribution, so
68 "&ß!!!  (
T Ð\"  "&ß !!!Ñ œ "  FÐ # Ñ œ "  FÐ"Þ$Ñ œ "  Þ*!$# œ Þ!*') .
\# œ #\" , so
68 (ß&!!!  (
T Ð\#  "&ß !!!Ñ œ T Ð#\"  "&ß !!!Ñ œ T Ð\"  (ß &!!Ñ œ "  FÐ # Ñ œ "  FÐÞ*'Ñ
œ "  Þ)$" œ Þ"'* (linear interpolation in the normal table to get FÐÞ*'Ñ) .
Then T Ð\  "&ß !!!Ñ œ Þ(&ÐÞ!*')Ñ  Þ#&ÐÞ"'*Ñ œ Þ""& . Answer: A

Ð"ß#Ñ
21. U"! is the probability that for ÐBÑ and ÐCÑ, alive at age 64 and 85, ÐBÑ will survive the year, but ÐCÑ
will die within the year. This probability that (64) survives the year is :'% for ÐBÑ, which is
=B Ð'&Ñ
=B Ð'%Ñ œ Þ*)'!"$ . The probability that (85) dies during the year is ;)& for ÐCÑ, which is
= Ð)'Ñ
"  =C Ð)&Ñ œ Þ!'''( (ÐCÑ's mortality follows DeMoivre's Law with = œ "!!)Þ
C
Ð"ß#Ñ B C
Then, U"! œ :'% † ;)& œ ÐÞ*)'!"$ÑÐÞ!'''(Ñ œ Þ!'' . Answer: E

Ð\ß^Ñ
22. $ U! is the Ð"ß $Ñ entry in the matrix U! ‚ U" ‚ U# .
This will be row 1 of U! ‚ U" "multiplied by" column 3 of U# .
Row 1 of U! ‚ U" is Þ!) Þ(% Þ") .
Ð\ß^Ñ
Then, $ U! œ ÐÞ!)ÑÐÞ%Ñ  ÐÞ(%ÑÐ!Ñ  ÐÞ")ÑÐ"Ñ œ Þ#"# . Answer: D

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NOVEMBER 2006 CAS 3

<Ð<"ÑÐ<#Ñ" $ <Ð<"ÑÐ<#ÑÐ<$Ñ" % <Ð<"ÑÐ<#ÑÐ<$Ð<%Ñ" &

23. We want T ÐR œ $ß %ß &Ñ œ $x Ð"" Ñ<$  %x Ð"" Ñ<%
 &x Ð"" Ñ<& .
IÒR Ó œ <" œ $ , Z +<ÒR Ó œ <" Ð"  "Ñ œ "# p " œ $ß < œ " .
"8 8
We see that since < œ ", the distribution is geometric with probability function :8 œ Ð"" Ñ8" œ %$8" Þ
$ % &
The probability is $%%  $%&  $%'  œ Þ#%' . Answer: B

24. Answer: B

25. For the integer random variable R with probability function T ÐR œ 8Ñ œ :8 , the probability
generating function is TR Ð>Ñ œ :!  :" >:# >#  â .
T w Ð"Ñ œ IÒR Ó and T ww Ð"Ñ œ IÒR ÐR  "ÑÓ œ IÒR # Ó  IÒR Ó .
We are given T w Ð"Ñ œ # œ IÒR Ó and T ww Ð"Ñ œ IÒR # Ó  IÒR Ó œ IÒR #Ó  # œ ' , so that IÒR #Ó œ ) .
Then, Z +<ÒR Ó œ IÒR # Ó  ÐIÒR ÓÑ# œ )  ## œ % . Answer: D

26. 1. The time intervals must be disjoint for independence. False.

2. There can be non-homogeneous Poisson processes. False.
3. True. Answer: C

27. Since calls are accepted continuously, we assume that the operator starts a call as soon as the
previous one is completed. From the lack of memory property of the exponential distribution, it is
irrelevant how long the current call has taken, the remaining time until the call is completed is exponential
with a mean of 3 minutes. T ÐX Ÿ #Ñ œ JX Ð#Ñ œ "  /#Î$ œ Þ%)( . Answer: A

'"& -Ð>Ñ .> œ '"$ Ð#  '>Ñ .>  '$% #! .>  '%& Ð$'  %>Ñ .> œ '' .
28. The number of cars arriving between 10 a.m. and 2 p.m. has a Poisson distribution with mean
Answer: C

29. Aggregate loss W has a compound distribution W with IÒR Ó œ Ð"!!!ÑÐÞ$Ñ œ $!! ß
&!!
Z +<ÒR Ó œ Ð"!!!ÑÐÞ$ÑÐÞ(Ñ œ #"! for frequency, and IÒ\Ó œ $" œ #&! ,
#Ð&!!# Ñ
IÒ\ # Ó œ Ð$"ÑÐ$#Ñ œ #&!ß !!! and Z +<Ò\Ó œ #&!ß !!!  Ð#&!Ñ# œ ")(ß &!! for severity.

ÈZ +<Ò\Ó œ )$#* .
Z +<Ò\Ó œ IÒR Ó † Z +<Ò\Ó  Z +<ÒR Ó † ÐIÒ\ÓÑ# œ '*ß $(&ß !!! and
Answer: D

30. Inflation will have increased cost by a factor of Ð"Þ!'Ñ% œ "Þ#'#%(( by year >  %.
The Pareto distribution is a scale distribution with scale parameter ) , so the loss random variable ] in
year >  % is Pareto with α œ % and ) œ "Þ#'#%((Ð$!!!Ñ œ $()( . The expected cost per loss in year
>  % for Policy R is just the expected loss IÒ] Ó œ $()(
%" œ "#'# . Policy S has a deductible of 500 and a
maximum covered loss of 3000, so the amount paid under Policy S is Ð] • $!!!Ñ  Ð] • &!!Ñ . The
expected cost per loss under Policy S is
IÒ] • $!!!Ó  I] • &!!Ó œ $()( $()(
%" Ò"  Ð $!!!$()( Ñ
%"
Ó  $()( $()(
%" Ò"  Ð &!!$()( Ñ
%"
Ó œ '&" .
The difference in cost per loss between Policy R and Policy S is "#'#  '&" œ '"". Answer: D

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NOVEMBER 2006 CAS 3

31. The probability that a payment is above the deductible of 500 is

#!!!
"  J Ð&!!Ñ œ Ð &!!#!!! Ñ# œ Þ'% . The negative binomial distribution satisfies the "infinite divisibility"
property, which implies that the number of losses that are above the deductible, say Q , is also negative
binomial with the same <, and with "new " " œ "old " " ‚ .64 œ #Þ&' .
Then Z +<ÒQ Ó œ Ð$ÑÐ#Þ&'ÑÐ$Þ&'Ñ œ #(Þ$% . Answer: A

32. The Poisson distribution also satisfies the infinite divisibility property. The number of losses greater
than 100,000, say Q , has a Poisson distribution with
"new -" œ "old -" ‚ T Ð\  "!!ß !!!Ñ œ ÐÞ$ÑÐÞ%Ñ œ Þ"# .
Probability of at least one loss greater than 100,000 in a year is
T ÐQ   "Ñ œ "  T ÐQ œ !Ñ œ "  /Þ"# œ Þ""$ . Answer: B

 
33. Z +<Ò^Ó œ #&l EB  Ð&l EB Ñ# .
 &  &$ .
&l EB œ @ & :B † EB& œ / † /&. † $ . œ Þ#%#'".
 .
We have used the relationship EC œ $ . for constant force of mortality.
  .
Similarly, #&l EB œ Ð@& Ñ# & :B † EB& œ /"!$ † /&. † #$ . œ Þ""#$$ .
Z +<Ò^Ó œ Þ#%#'"  ÐÞ""#$$Ñ# œ Þ!&$%( . Answer: B

34. E " œ E"  @# # :*! † E "

*!À#!l *!À#l *#À")l
E" is calculate using 10% interest rate, so
*!À#l
; : †;
E" œ @;*!  @# "l ;*! œ "Þ"
*! *! *"
 Ð"Þ"Ñ # œ Þ$!*!
*!À#l
E" is found using 6% interest, so we can use insurance values from the Illustrative Table and the
*#À")l
j
following identity E*# œ E "  @") ") :*# E""! p Þ)"%#( œ E "
 Ð"Þ!'Ñ""!") j † ÐÞ*#&"&Ñ
*#À")l *#À")l *#

p E" œ Þ)"#%( (since the Illustrative Table last age is 110, the 18-year term insurance at age 92 is
*#À")l
almost exactly equal to the whole life insurance at age 92).
j
Then E " œ Þ$!*!  Ð"Þ"Ñ*## j † ÐÞ)"%#(Ñ œ Þ(%$ . Answer: C
*!À#!l *!

U
35. If the purchase price is U, the extended warranty pays # if failure is in the 4th or 5th year. The APV
U 
of this benefit is # † @$ $ :! E " . @$ œ /$$ œ /Þ"# , $ :! œ :! † :" † :# œ ÐÞ**#ÑÐÞ*)&ÑÐÞ*(%Ñ ,
$À#l
 
and E " . Under UDD, E " œ $3 † E " œ $3 † Ò/$ ;$  /#$ :$ ;% Ó œ Þ!*)!"% .
$À#l $À#l $À#l
3 œ /$  " œ /Þ!%  ". The APV of the extended warranty is
U Þ"#
# †/ ÐÞ**#ÑÐÞ*)&ÑÐÞ*(%ÑÐÞ!*)!"%Ñ œ Þ!%"%U . Answer: C

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NOVEMBER 2006 CAS 3

ÞÞ ÞÞ
36. #!!!T Ò+&!À"!l  "Þ# † "! I&! † +'!À"&l Ó œ "!ß !!!ß !!!E " .
&!À#&l
We find the annuity and insurance values from
E&! œ E "  #& I&! E(& œ E "  #! I&! † & I(! E(& , and
&!À#&l &!À#&l
ÞÞ ÞÞ ÞÞ ÞÞ ÞÞ ÞÞ
+&! œ +&!À"!l  "! I&! +'! , and +'! œ +6!À"&l  "! I'! & I(! +(& .
From the Illustrative Table, we get E " œ Þ#%*!&  ÐÞ#$!%(ÑÐÞ'!*%'ÑÐÞ&*"%*Ñ œ Þ"'&*( ,
&!À#&l
ÞÞ
+&!À"!l œ "$Þ#'')  ÐÞ&"!)"ÑÐ""Þ"%&%Ñ œ (Þ&($' , and
ÞÞ
+6!À"&l œ ""Þ"%&%  ÐÞ%&"#!ÑÐÞ'!*%'ÑÐ(Þ#"(Ñ œ *Þ"'!) .
Þ"'&*(
Then, T œ &!!! † (Þ&($'"Þ#ÐÞ&"!)"ÑÐ*Þ"'!)Ñ œ '#Þ* . Answer: E

ÞÞ
+
37. For the fully discrete whole life insurance, the reserve is # ZB œ "  ÞÞ+B# .
B
..
+B œ "  @:B  @# # :B  @$ $ :B (the summation ends because > :B œ ! for > œ %ß &ß ÞÞÞ).
:B œ "  Þ" œ Þ* (note that !l ;B œ ;B ), # :B œ "  # ;B œ "  Ð;B  "l ;B Ñ œ "  ÐÞ"  Þ#Ñ œ Þ( ß
$ :B œ "  $ ;B œ "  Ð;B  "l ;B  #l ;B Ñ œ "  ÐÞ"  Þ#  Þ$Ñ œ Þ% .
.. Þ( Þ%
Then, +B œ "  Ð"Þ!&Ñ #  Ð"Þ!&Ñ$ œ #Þ)$(' .

.. : Þ%ÎÞ(
+B# œ "  @:B# œ "  @ † $ :B œ "  "Þ!& œ "Þ&%%# .
# B

# ZB œ "  "Þ&%%#
#Þ)$(' œ Þ%&& . Answer: E

38. The first year premium is $500, since Robin is initially classified as Standard.
The expected second year premium is
%&! UÐWßT Ñ  &!! UÐWßWÑ  &(& UÐWßR Ñ œ %&!ÐÞ$Ñ  &!!ÐÞ&Ñ  &(&ÐÞ#Ñ œ &!!,
so the APV of the second year premium is &!!@ œ %('Þ# .
The expected third year premium is
%&! # UÐWßT Ñ  &!! # UÐWßWÑ  &(& # UÐWßR Ñ .
We get these probabilities by "multiplying" the second row of U by each column of U:
ÐWßT Ñ
#U œ ÐÞ$ÑÐÞ'Ñ  ÐÞ&ÑÐÞ$Ñ  ÐÞ#ÑÐ!Ñ œ Þ$$ ß
ÐWßWÑ
# U œ ÐÞ$ÑÐÞ$Ñ  ÐÞ&ÑÐÞ&Ñ  ÐÞ#ÑÐÞ%Ñ œ Þ%# ß
ÐWßR Ñ
#U œ ÐÞ$ÑÐÞ"Ñ  ÐÞ&ÑÐÞ#Ñ  ÐÞ#ÑÐÞ'Ñ œ Þ#& .
The expected third year premium is %&!ÐÞ$$Ñ  &!!ÐÞ%#Ñ  &(&ÐÞ#&Ñ œ &!#Þ$ ,
&!#Þ$
and the APV of the third year premium is Ð"Þ!&Ñ # œ %&&.' Þ

The APV of the first three years of premiums is &!!  %('Þ#  %&&Þ' œ "%$"Þ) .
Answer: B

39. With premium of T , the company's surplus at the end of the first year, before losses are paid, is
Ð"Þ"&ÑÐ$  T Ñ . Since loss of 25 has probability 10%, if Ð"Þ"&ÑÐ$  T Ñ  #& then ruin will occur with
probability at least .1. If Ð"Þ"&ÑÐ$  T Ñ  "! then ruin will occur with probability Þ"  Þ& œ Þ'.
Therefore, if "! Ÿ Ð"Þ"&ÑÐ$  T Ñ  #& , the probability of ruin is no more than 10%. The minimum T
satisfying this constraint is 5.7 . The premium must be the next highest integer value, 6. Answer: D

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NOVEMBER 2006 CAS 3

40. It is often easier to calculate the probability of survival as the complement of the probability of ruin.
We identify the possible losses in the first two years that lead to ruin.
Surplus at time 0 after premium is 16, so ruin occurs in the first year with probability .1 (loss of 25).
If ruin does not occur in the first year, then the loss was either 0 or 10. If the first year loss is 0, then after
premium at the start of the second year, the surplus is 25, and ruin cannot occur in the second year (since
the loss is at most 25). If the first year loss is 10, then after premium at the start of the second year, the
surplus is 16, and ruin will occur in the second year if the loss is 25 (probability .1).\
The loss combinations leading to ruin, and their probabilities are
Ruin in 1st year: .1 , Ruin in 2nd year: ÐÞ%ÑÐÞ"Ñ œ Þ!% .
Total probability of ruin within 2 years is .14, and the probability of surviving 2 years is .86 .
Answer: D

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