Actuarial Maths Lecture 9

Infinite Ruins problem

Consider an insurance company with initial reserves u and a
large portfolio so that premiums are arriving continuously at
the rate £c per year (or other time unit).

Suppose that the claims occur randomly according to the

Poisson model at a rate of λ per year.

Let Xi denote a typical claim (when made).

If 𝜆𝐸(𝑋𝑖 ) ≥ 𝑐 then the company will certainly be ruined.

If 𝜆𝐸 (𝑋𝑖 ) < 𝑐 then there is a chance (≠ 1 or 0) of ruin.

Books often use “𝜓(𝑢)” – probability of ruin, we use the

opposite 𝑅(𝑢) = 1 − 𝜓(𝑢).

Let 𝑅(𝑢) denotes the probability of survival (= Non-ruin)

starting with funds u.

To survive, the company must be able to survive after the first

claim and whatever that claim size might be.

Let f(x) denote the pdf of claim sizes.

We consider 𝑅(𝑢) made up of terms conditional on the time of

the first claim (time till first claim is exponential) and the

amount of claim

𝑅(𝑢) = 𝐸𝑡 (𝐸𝑥 (Survival |𝑥 )|𝑡)

∞ 𝑢+𝑐𝑡
= ∫ {∫ 𝑅(𝑢 + 𝑐𝑡 − 𝑥 )𝑓(𝑥 )𝑑𝑥 } 𝜆𝑒 −𝜆𝑡 𝑑𝑡
0 0

↑
Poisson Law = Exponential time

Make the substitution

𝜔−𝑢 1
𝜔 = 𝑢 + 𝑐𝑡 → 𝑡 = 𝑎𝑛𝑑 𝑑𝑡 = 𝑑𝜔
𝑐 𝑐
 ∞
𝜆 −𝜆(𝜔−𝑢)
𝑅(𝑢) = ∫ 𝑒 𝑐 𝑝(𝜔)𝑑𝜔
𝜔=𝑢 𝑐

where
𝜔
𝑝(𝜔) = ∫ 𝑅(𝜔 − 𝑥)𝑓(𝑥 )𝑑𝑥 ← 𝑐𝑜𝑛𝑣𝑜𝑙𝑢𝑡𝑖𝑜𝑛
𝑥=0

Now differentiate (under ∫ sign)

∞
𝜆 2 −𝜆(𝜔−𝑢) 𝜆
( )
𝑅′ 𝑢 = ∫ ( ) 𝑒 𝑐 ( )
𝑝 𝜔 𝑑𝜔 − 𝑝(𝑢)
𝜔=𝑢 𝑐 𝑐
That is
𝜆 𝜆 𝑢
𝑅′(𝑢) = 𝑅(𝑢) − ∫ 𝑅 (𝑢 − 𝑥 )𝑓(𝑥)𝑑𝑥
𝑐 𝑐 0

an integro-differential equation for 𝑅 (𝑢).

To solve this equation, we take Laplace transforms using

properties (A.5) on the left and (A.13) for the convolution on
the right which gives
𝜆
𝑠 𝑟(𝑠) − 𝑅(0) = {𝑟(𝑠) − 𝑟(𝑠)𝜙(𝑠)}
𝑐

where 𝑟(𝑠) is the LT of 𝑅(𝑢) and

𝑓 (𝑠) is the LT of 𝑓 (𝑢).
Hence, we have
𝑅(0)
𝑟(𝑠) =
𝜆 𝜆
𝑠 − 𝑐 + 𝑐 𝜙(𝑠)

Therefore to find the probability of survival, 𝑅(𝑢), given that

the claim size distribution is f

- transform it to 𝜙,

- substitute in above to get 𝑟(𝑠)

- transform back for 𝑅(𝑢).

Note: The above formula involves the unknown 𝑅(0) – this

can be obtained by the condition that 𝑅(𝑢) → 1 as 𝑢 → ∞.

Example 1:
An insurance company has an average of 20 claims per year
and claim sizes have a mean of £350 and the revenue from
policy premiums is £10,000 per year.

Find the ruin probability if the company starts with the initial
reserve of £u and the claim size distribution is exponential.
Solution:
λ =20 per annum - claim rate

c=10,000 - annual income rate

𝑥
1 −
𝑓(𝑥 ) = 𝑒 350 −Claim size distribution
350

Using property (B.5) of LT

1 1 1
𝜙(𝑠) = . =
350 (𝑠 + 1 ) 350𝑠 + 1
350

𝑅(0)
𝑟(𝑠) =
20 20 1
𝑠 − 10,000 + 10,000 .
350𝑠 + 1

10 𝑅(0) (350𝑠 + 1)
=
𝑠(3500𝑠 + 3)

10 𝑅(0) 1 2450
= ( − )
3 𝑠 (3500𝑠 + 3)

10 𝑅(0) 1 2450
= ( − )
3 𝑠 3500 (𝑠 + 3 )
3500

Now invert LT using properties B.1 and B.5 to obtain

 10 𝑅(0) 2450 − 3 𝑢
𝑅(𝑢) = (1 − 𝑒 3500 )
3 3500

10 𝑅(0) 7 − 3 𝑢
𝑅(𝑢) = (1 − 𝑒 3500 )
3 10

𝑅(0) is determined by 𝑅(𝑢) → 1 as 𝑢 → ∞, so

10 𝑅(0) 3
( )
=1 →𝑅 0 =
3 10

Hence

7 − 3 𝑢
𝑅(𝑢) = (1 − 𝑒 3500 )
10

For example if the company starts with u=£20,000 the

probability of survival is
7 −17.14
𝑅(20,000) = (1 − 𝑒 ) = 0.99999997
10

Question:

What initial value of fund would give a 1 in million chance of

ruin?
Solution: Ruin probability = 1 − 𝑅 (𝑢) = 10−6

−6
7 −( 3 )𝑢 7 − ( 3 )𝑢
10 = 1 − (1 − 𝑒 3500 ) = 𝑒 3500
10 10

3
⟹ 13.46 = 𝑢
3500

⟹ 𝑢 = £15,702

If the claim size pdf f(x) is a Gamma distribution then 𝜙(𝑠) is

rational (B.7), so then is 𝑟(𝑠) and so the above method can be
applied (rather long and messy unless f(x) is simply
exponential).

Lower Bound/Approximation for R(u).

Suppose the claim size X has Mgf 𝑀𝑋 (𝑡).

∞
𝑡𝑋 )
𝑀𝑋 (𝑡) = 𝐸 (𝑒 = ∫ 𝑒 𝑡𝑋 𝑓(𝑥 )𝑑𝑥
0

So, 𝑀𝑋 (𝑡) = 𝜙(−𝑡).

Consider the equation

𝜆[𝑀𝑋 (𝑡) − 1] = 𝑐𝑡

One solution is 𝑡 = 0, there is another positive solution 𝑟0 ,

i.e 𝑟0 is the solution of

𝜆[𝑀𝑋 (𝑟0 ) − 1] = 𝑐𝑟0

Definition of 𝑟0 : 𝑟0 is the smallest positive root.

Theorem:

𝑅(𝑢) ≥ (1 − 𝑒 −𝑢 𝑟0 )

For proof: See Reference B-G-H-J, Chapter 13.

In fact, often we will find that 𝑅(𝑢) ≅ (1 − 𝑒−𝑢 𝑟0 )

and 𝑟0 is called the ADJUSTMENT COEFFICIENT.

Example 2: Previous example (ctd)

1 − 𝑥
𝑓(𝑥 ) = 𝑒 350
350

The Mgf is

1
𝑀𝑋 (𝑡) = (= 𝜙(−𝑡))
1 − 350𝑡

The equation to solve is

𝜆[𝑀𝑋 (𝑟0 ) − 1] = 𝑐𝑟0

i.e.

1
20 (1−350𝑟 − 1) = 10,000𝑟

350𝑟
= 500𝑟
1 − 350𝑟

⟹ 7 = 10 − 3500𝑟

3
⟹ 𝑟0 =
3500

Theorem says
3𝑢
−
𝑅(𝑢) ≥ (1 − 𝑒 3500 )  Lower bound

In fact

7 − 3𝑢
𝑅(𝑢) = (1 − 𝑒 3500 )
10

Example 3:

With λ=20, c=10,000 as before. Suppose claim sizes have pdf

𝑓(𝑥 ) = 2𝑘(𝑒 −𝑘𝑥 − 𝑒 −2𝑘𝑥 )

1
where 𝑘 = .
250
The Mgf of this distribution is

2𝑘 2𝑘 2𝑘 2
𝑀(𝑡) = − =
𝑘 − 𝑡 2𝑘 − 𝑡 (𝑘 − 𝑡)(2𝑘 − 𝑡)

The adjustment coefficient is the smallest positive root of

2𝑘 2
20[(𝑘−𝑡)(2𝑘−𝑡) − 1] = 10,000t

2𝑘 2 − (2𝑘 2 − 3𝑘𝑡 + 𝑡 2 )
[ ] = 500𝑡
(2𝑘 2 − 3𝑘𝑡 + 𝑡 2 )

3𝑘𝑡 − 𝑡 2 = 500𝑡 (2𝑘 2 − 3𝑘𝑡 + 𝑡 2 )

3𝑘 − 𝑡 = 500 (2𝑘 2 − 3𝑘𝑡 + 𝑡 2 )

500𝑡 2 + 𝑡(1 − 1500𝑘) + 1000𝑘 2 − 3𝑘 = 0

1
Put 𝑘 = 250 (given), then equation becomes

2
1
500𝑡 − 5𝑡 + =0
250

5 ± √17
⟹𝑡=
1000

The smallest root (smallest positive) is

5 − √17
𝑟0 = = 0.000877
1000
Theorem says

𝑅(𝑢) ≥ (1 − 𝑒 −𝑢𝑟0 )  Lower bound

Eg:

u=£20,000 ⟹ 𝑅 (20,000) ≥ (1 − 𝑒 −17.53 ) =0.99999976

Note: Mean of distribution is

3 3 ∗ 250
𝐸 (Claim) = = = 375
2𝑘 2

close to earlier version

Note that the second method requires only the single value 𝑟0 -

which could be easily found numerically; the first exact method

requires a function (as inverse of LT) to be found.