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# BWRR3023: Actuarial Science

Topic 3: Annuities & Life Annuities

Mdm Rodziah Ahmad College of Business Univerisiti Utara Malaysia Semester II 2010/2011

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Contents

3.1 Introduction 3.2 Types of Annuities with compound interest 3.3 Relationship between Annuities Due/ Immediate 3.4 Perpetuity 3.5 Deferred Annuities 3.6 Life Annuities 3.7 Discrete Life Annuities 3.8 Continuous Life Annuities 3.9 Life Annuities with monthly payments

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3.1 Introduction

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An annuity is a series of payments made at equal intervals Ex: a car loan is repaid with equal instalment A retiree purchases an annuity from insurance company upon his retirement A life insurance policy is purchased with monthly premiums. For discussion purpose, we assume the annuities with fixed amount, no default risk

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2 Annuities-due : Payments due at the beginning of period 0 1 2 ««. n-1 n y 3..2.1 Annuities immediate payment at the end of interval 0 1 2 ««. n-1 n RZI 4 .2.3.2 Types of Annuities with compound interest y 3..

v 1 v ! i n 2 3 n RZI 5 .2.1-1 Annuities Immediate (PV) Consider an annuity with payments of 1 unit each made at the end of every year until n-years.2.3.. y PV of the annuity y an | ! v v v .13..

2.13.1-2 Annuities Immediate (FV) y The accumulated value of annuity at time n (future value of a ) n| sn ! a n * (1 i ) n i (1 i ) n 1 ! i RZI 6 .2.3.

2.13.2.P) If the annuity is a regular payment of P.1-3 Annuities Immediate (Regular payment. y PV !Pa | n y y FV ! Psn | RZI 7 .3.P) payment.

09 ¹ ! $388.47 RZI 8 .2.97 ¹ ª º FV 100 s5 ! a5 1.09 ¸ PV 100 a5 ! 100 © © 0.1-4 Annuities Immediate (Example I) Calculate the present value of an annuity immediate of amount $100 paid annually for 5 years at the rate of interest of 9%. Also calculate its future value at time 5 y Solutions: 5 y ¨ 1 1.3.2.13.095 ! $598.

He will pay back the loan through monthly installments over 5 years. What is the monthly installment he needs to pay? RZI 9 .1-4 Annuities Immediate (Example II) y A man borrows a loan of $20.2.13.2.000 to purchase a car at annual nominal rate of interest of 6%.3. with the first installment to be made one month after the release of the loan.

1-4 Annuities Immediate (Example II) y $20.2.05 Solutions: The rate of interest per payment period is (6/12)% = 0. Let P be the monthly installment.000 ! P a6 0 0.000 ! P 0.7256 RZI 10 .2.005) 60 ! P 51.66 P! 51.5%. As there are 5x12 = 60 payments: 1 (1.3.7256 $20.005 $20.13.000 ! $386.

An education fund requires the investors to deposit equal installments annually at the end of each year.000 to pay for his son·s education overseas in 10 years· time.5% is paid.3.2.1-4 Annuities Immediate (Example III) y A man wants to save $100.13.2. how much does the man need to save each year in order to meet his target? RZI 11 . If interest of 7.

3.000 $100.000 P! ! ! $7.075)10 1 ! ! 14.2.59 s1 0 14. future value: s1 0 y (1.13. P is $100.075 Then the required amount of installment.068.2.1471 RZI 12 .1-4 Annuities Immediate (Example III) y Solutions: We first calculate.1471 0.

23.. v n 1 a 1 vn 1 vn ! ! d 1 v RZI 13 .2-1 Annuities Due (PV) y Consider an annuities with payments of 1 unit each made at the beginning of every years until n-years: an n ! 1 v .3.2..2.

2.3.23.2.2-2 Annuities Due (FV) | ! an | * (1 i ) n s n (1 i ) 1 ! d n RZI 14 .

2.2-3 Annuities-Due (Example) y A company wants to provide a retirement plan for an employee who is aged 55 now.000 every year for 15 years upon her retirement at the age of 65. The plan will provide her with an annuityimmediate of $7.2.2. The company is funding this plan with an annuitydue of 10 years. If the rate of interest is 5%. what is the amount of installment the company should pay? RZI 15 .Annuities3.3.

P which is (1. This is equal to: y $7.657.61 0.2-3 Annuities-Due (Example) Solution: y We first calculate the PV of the retirement annuity.05) 15 ! $7.61 ! $5.2068 RZI 16 .05 P 0| s1 This amount should be equal to the FV of the company installments.05)10 1 P 0| ! P v s1 ! P v13.000a1 5 y 1 (1.501.3.61 1 (1.657.000 v ! $72.53 13.2068! $72.657.Annuities3.2.2.05)1 P ! $72.2.

3 Relationship between Annuities Due and Immediate an | ! (1 i )an | and | ! (1 i ) sn | s n RZI 17 .3.

v p 0 yn v As 1 vn an| ! i 1 ag| ! i 1 g a | ! d y RZI 18 . n 1@ n p g .4 Perpetuity Perpetuity is an annuity with no termination date.3.

y n-period annuity-immediate: y An annuity with n payments for which the first payment is to be made at time m+1.3. The PV of this annuity is ¨ 1 vn ¸ v an | ! v © ¹ © i ¹ ! a m n| a m | º ª m m a m n| ! a m | v m a n | RZI 19 .5 Deferred Annuities Of one for which the first payment is made sometime in the future.

3. y RZI 20 .6 Life Annuities A life annuity is a series of payments made at equal intervals during the future lifetime of a given individual y It is contingent upon the survival of the recipient (annuitant) y PV of the annuities that involve the contingent payment is Actuarial Present Value.

1 Discrete n-year Temporary nlife annuity a) Discrete n-year temporary life annuity-immediate with a payment of 1 unit n a x:n| ! § v k k p x k !1 b) Discrete n-year temporary life annuity-due a x:n| ! § v k k p x k !0 n 1 21 .7.3.

7.3.1 Discrete n-year Temporary nlife annuity y Relationship between (a) and (b) a x:n| ! 1 a x:n 1| 22 .

855 957.1 Discrete n-year Temporary nlife annuity Example: Find APV of 3 years temporary life annuities immediate issued to a person aged 45 from this life table.3.7. With interest rate =5% x 45 46 47 48 lx 964.187 962.421 23 .106 959.

71105 1 24 .3. ! 0.85778 ! 2. 2 959855 3 957421 ) (1.05) ( ) ! (1. 964187 .05) ( 964187 . . 964187 .05) ( ) (1.90295 0.1 Discrete n-year Temporary nlife annuity Solutions: 3 a45:3| ! §vk k p45 k !1 ! v1 p45 v2 2 p45 v3 3 p45 l46 2 l47 3 l48 ! v v v l45 l45 l45 962106 .7. .95032 0.

g a x ! § v k *k p x b) Discrete whole life annuity-due that makes payments at the beginning of every year as long as the annuitant survives.7.2 Discrete Whole Life Annuities a) Discrete whole life annuityimmediate that makes payments at the end of every year as long as the annuitant survives. g k !1 x ! § v k *k p x a k !0 25 .3.

2 Discrete Whole Life Annuities y Relationship between a x and a x 1 a x ! 1 v * p x * a x 1 26 .7.3.

3 Discrete Deferred Life Annuities y Discrete n-year deferred whole life annuity-due n| a x ! § v *k p x k k !n g y Discrete n-year deferred whole life annuity-immediate g n| ax ! §v * p k k k ! n 1 x 27 .3.7.

7.3.3 Discrete Deferred Life Annuities y Discrete n-year certain and whole life annuity-due g a x:n | ! an | § v k *k p x !an | n| a x k !n y Discrete n-year certain and whole life annuity-immediate a x:n | ! an | v k *k p x !an | n| a x § k ! n 1 28 g .

3 Discrete Deferred Life Annuities y Actuarial accumulated value of an n-year temporary annuity-due paying 1 every year while life (x) survives is denoted by: ¨ x:n | ! ! §© s E x k !0 © n ª n 1 a x:n | 1 nk Exk n ¸ ¹ ¹ º Whereby n E x ! v *n p x 29 .3.7.

8 Continuous Life Annuities y Continuous Whole life annuity payments are made continuously. t. a x ! ´ v *t p x dt 0 y Continuous n-year temporary life annuity t g Payments at most up to time n (if the annuitant survives until time n) a x:n | ! ´ v *t p x dt t 0 30 n . with a momentary payment of dt made at every time.3.

3.8 Continuous Life Annuities y Relationship between a x and a x 1 a x ! a x:1| vp x * a x 1 31 .

32 . Find the APV of this product available to a 6-y-o.77 to survive to age 6.6. A 5-y-o can get either one-year temporary life annuity with PV of 0. The annual force of interest =0.2.Example: y A continuous whole and temporary life annuities pays 1*dt in benefits at each time. A 5y-o has a probability of 0.67 or a whole life annuity with PV of 5. t.

6 and a5:1| ! 0.82015 a6 ! 0.Solutions: y We use ax ! ax:1| vpx * ax 1 a5 ! 5.2 a x 1 ? ! and p5 ! 0.2 e * 0.6 0.77 a x a x:1| A vp x (5.67) ! 7.77 33 .67 v!e 0.

3.9 Life Annuities with monthly payments y If we have series of payment with P. times the P with the relevant annuities 34 .