Ruin Probability in a Threshold Insurance Risk Model

Isaac K. M. Kwan and Hailiang Yang

1
Abstract. This paper considers the ruin probability under
a threshold insurance risk model. We assume that the claim
size of an insurance business depends on the claim time. The
integro-differential equations satised by the ruin probability
are derived. A Lundberg type upper bound for the ruin proba-
bility is obtained. In some special cases, closed form solutions
for the ruin probability are obtained. Some numerical exam-
ples are included.
Keywords: Threshold insurance risk model, Ruin probabil-
ity, Lundberg inequality, exponential claim distribution, ODE
with advanced argument.
1 Introduction
The Cram er-Lundberg model was introduced in the early
20th century. The main results on ruin probability include the
Lundberg inequality and Cram er-Lundberg approximation. It
is very difcult or even impossible to obtain the closed form
solution for the ruin probability except for some special cases
such as mixed-exponential or phase-type claim size distribu-
tions. (See, Rolski et al., 1999)
As the assumption of the Cram er-Lundberg model is con-
sidered too restrictive to be applicable, a lot of work has
been done on developing more general and realistic models
based on it. Popular models are the Sparre-Andersen Model,
the Markov modulated risk model and the diffusion-perturbed
risk model.
In the Cram er-Lundberg model, the inter-arrival times of
claims independently and identically follow an exponential
distribution. This assumption has been criticized for its lack
of applicability in real situations. In the real world, the depen-
dent structure is a very common phenomenon. Recently, de-
pendent structure in claim sizes sequence has been considered
in the insurance risk model by many authors. Discrete time au-
toregressive model and its extension-linear model are the sim-
plest cases (Bowers, et al., 1986; Gerber, 1982). The common
shock component can describe wide scale loss due to natural
disasters. Cossette and Marceau (2000) studied the discrete-
time common shock risk models with different classes of busi-
ness. For more references and detailed discussions on the de-
pendent insurance risk models, we refer the readers to the pa-
pers by Dhaene and Denuit (1999), Dhaene and Goovaerts
(1996) and Dhaene et al. (2002a, 2002b) and the references
therein.
1
Department of Statistics and Actuarial Science, The University of Hong
Kong, Pokfulam Road, Hong Kong, e-mails: h0008303@hkusua.hku.hk
(Kwan), hlyang@hkusua.hku.hk (Yang)
In a recent interesting paper by Albrecher and Boxma
(2004), the model with dependence between claim size and
inter-arrival time was rst introduced. In their model, the
change of the inter-arrival time distribution depends on the
previous claimsize through a threshold structure. The ultimate
ruin probability can be written as the inversion of Laplace
transform of a known function form. However, its closed form
cannot always be found. Albrecher and Boxma (2005) studied
the Gerber-Shiu function in the model with dependence be-
tween claim size and inter-arrival time.
In this paper, a new dependent model which reverses the
dependent structure of the model by Albrecher and Boxma
(2004) is introduced. From the accounting point of view, if
losses are inspected and aggregately reported at an arbitrary
time, then the longer the time that comes between the in-
spections, the larger the aggregate losses should be. The new
model can be applied to this situation. The model can also be
related to the Markov-modulated risk model, but the regime-
switching process is caused by an endogenous factor rather
than some exogenous factors. The model can be reformulated
as a random walk process with independent increments sub-
ject to a regime-switching process with 2 states. The Markov
modulated risk model, rst introduced by Asmussen (1989,
2000), assumes the parameters of the classical model follow
a Markov process. In that model, premium rate and claim dis-
tribution vary according to some exogenous changes of eco-
nomic states. Yang and Yin (2004) obtained a coupled sys-
tem of integro-differential equations for the ruin probability
for this model. Ng and Yang (2005, 2006) considered the joint
density of surplus prior to and after ruin under this model.
Their work has contributed to solving the ruin problem of
an insurance company subject to exogenous economic cycle
switching.
2 The Insurance Risk Model
In our model, the distribution of claim size depends on the
length of inter-arrival time. Let X
k
be the size of the k-th
claim, T
k
be the inter-arrival time between the (k-1)-th claim
and the k-th claim. If T
k
is less than a threshold level a, then
X
k
follows a distribution F
1
. Otherwise, it follows another
distribution F
2
. We assume inter-arrival time independently
and identically follows an exponential distribution.
Let U
t
(u) be the surplus process at time t given the initial
surplus u, the dynamic of U
t
(u) is given by:
U
t
(u) = u +ct S
t
,
where S
t
=

N(t)
k=1
X
k
and c is a constant and denotes the
premium rate.
c BELGIAN ACTUARIAL BULLETIN, Vol. 7, No. 1, 2007
We assume the following net prot condition is satised:
ct = (1 +)E[S
t
], > 0.
Note that, by Walds Identity, we have
ct = (1 +)t(P(T < a)
1
+P(T a)
2
),
therefore
c = (1 +)((1 e
a
)
1
+e
a

2
).
Let T = inf
t0
{t : U
t
(u) < 0} be the time of ruin, then
(u) = P{T = |U(0) = u} is the ultimate survival proba-
bility, and (u) = 1 (u) is the ultimate ruin probability.
3 Integro-differential Equation and the Integral
Equation
The following theorem gives the integro-differential equation
satised by the survival probability.
Theorem 3.1. The ultimate survival probability (x) satises
the following integro-differential equation:
c
d(u)
du
(u)
= e
a
_
u+ca
0
[f
1
(x) f
2
(x)](u +ca x)dx

_
u
0
f
1
(x)(u x)dx. (1)
Proof. By conditioning on the claim time, we have
(u) =
_
a
0
e
t
_
u+ct
0
f
1
(x)(u +ct x)dxdt
+
_

a
e
t
_
u+ct
0
f
2
(x)(u +ct x)dxdt.
Let s = u +ct
c(u) =
_
u+ca
u
e
(
su
c
)
_
s
0
f
1
(x)(s x)dxds
+
_

u+ca
e
(
su
c
)
_
s
0
f
2
(x)(s x)dxds.
(2)
Differentiating both sides with respect to u:
c
d(u)
du
=e
a
_
u+ca
0
f
1
(x)(u +ca x)dx

_
u
0
f
1
(x)(u x)dx
+

c
_
u+ca
u
e
(
su
c
)
_
s
0
f
1
(x)(s x)dxds
e
a
_
u+ca
0
f
2
(x)(u +ca x)dx
+

c
_

u+ca
e
(
su
c
)
_
s
0
f
2
(x)(s x)dxds.
Substituting (2) into the equation above, we have:
c
d(u)
du
= e
a
_
u+ca
0
[f
1
(x) f
2
(x)](u +ca x)dx

_
u
0
f
1
(x)(u x)dx +(u).
From this we have (1), and the proof of Theorem 3.1 is com-
pleted.
From theorem 3.1, we can obtain the following result.
Theorem 3.2. The ultimate ruin probability (u) satises the
following integral equation:
c(u) =
__

u
F
1
(x)dx +
_
u
0
(u x)F
1
(x)dx
_
+e
a
__

u+ca
[F
2
(x) F
1
(x)]dx (3)
+
_
u+ca
0
(u +ca x)[F
2
(x) F
1
(x)]dx
_
.
Proof. Integrating both sides of the equation (1) from 0 to u,
we have
c[(u) (0)]
_
u
0
(y)dy
= e
a
_
u
0
_
y+ca
0
[f
1
(x) f
2
(x)](y +ca x)dxdy

_
u
0
_
y
0
f
1
(x)(y x)dxdy
= e
a
__
u+ca
0
_
u+ca
ca
[f
1
(y x) f
2
(y x)](x)dydx

_
u+ca
ca
_
x
ca
[f
1
(x) f
2
(x)](y x)dydx
_

_
u
0
_
u
x
f
1
(x)(y x)dydx
= e
a
_
u+ca
0
(x)
_
[F
1
(u +ca x) F
1
(ca x)]
[F
2
(u +ca x) F
2
(ca x)]
_
dx

_
u
0
_
uy
0
f
1
(x)(y)dxdy.
Therefore,
c[(u) (0)]
=
_
u
0
(x)F
1
(u x)dx
+e
a
_
u+ca
0
(u +ca x)[F
1
(x) F
2
(x)]dx
e
a
_
ca
0
(ca x)[F
1
(x) F
2
(x)]dx. (4)
42
Let u ,
c[1 (0)] =
1
+e
a
(
2

1
)
e
a
_
ca
0
(ca x)[F
1
(x) F
2
(x)]dx
(0) = 1

1
c

e
a
c
(
2

1
)
e
a
c
_
ca
0
(ca x)[F
1
(x) F
2
(x)]dx.
Substituting this equation into (4) the result is obtained by
substituting (u) = 1 (u).
In general, an explicit solution for ultimate ruin probability
cannot be obtained. However, it can be estimated in several
ways. In the following, we will provide an upper bound and
introduce a simulation method. Since the adjustment coef-
cient plays an important role here, lets turn to the adjustment
coefcient rst.
4 Adjustment Coefcient and Lundberg Inequality
By similar argument as in the case of the classical model, we
have the following result.
Theorem 4.1. Assume that both M
1
(r) =
_

0
e
rx
f
1
(x)dx
and M
2
(r) =
_

0
e
rx
f
2
(x)dx exist, and that there exists
r
1

, r
2

{} such that M
i
(r) < if r < r
i

and
lim
rr
i

M
i
(r) = for i = 1, 2. Then, there exists an
unique positive number R > 0 such that E[e
R(XcT)
] = 1.
R is called the adjustment coefcient.
Similar to the classical model, Lundbergs inequality can be
obtained with the adjustment coefcient as follows:
Theorem 4.2. (Lundbergs Inequality)
(u) e
Ru
(5)
where u > 0 is the initial surplus, and R is the adjustment
coefcient dened in Theorem 4.1.
Proof. Let S be a random walk with an identical and indepen-
dent increment Y = X cT. Then the classical technique of
changing measure can be applied to our model too. By a simi-
lar argument (see Asmussen, 2000), and dening a new prob-
ability measure by P
L
(A) = E[e
RS
n
; A], A F
n
, we have
(u) = E
L
[e
RS
(u)
], where (u) is the ruin time. The result
follows immediately by noting that (u) = E
L
[e
RS
(u)
] =
e
Ru
E
L
[e
R(u)
] e
Ru
(here (u) is the rst overshoot
amount).
In addition, from the above proof, we can see, similar to the
classical case, that we can use (u) = E
L
[e
RS
(u)
] to de-
velop a simulation algorithm to simulate the ruin probability.
5 Exponential Claim Size Distribution
Suppose the distributions F
1
and F
2
are exponential, i.e.
F
1
(x) = 1e

1
x
and F
2
(x) = 1e

2
x
. Then we show, in
this section, that the ruin probability satises a second order
linear differential equation with advanced argument.
Theorem 5.1. (u) satises the following third order differ-
ential equation with advanced argument:
c
d
3
(u)
du
3
+ (c
1
+c
2
)
d
2
(u)
du
2
+
2
(c
1
)
d(u)
du
e
a
(
1

2
)
d(u +ca)
du
= 0. (6)
Proof. From equation (1), we have
c
(1)
(u) (u)
= e
a
_
u+ca
0
[
1
e

1
x

2
e

2
x
](u +ca x)dx

_
u
0

1
e

1
x
(u x)dx.
Differentiating both sides with respect to u once and substi-
tuting (1) into the equation, we have
c
d
2
(u)
du
2

d(u)
du
= e
a
(
1

2
)(u +ca)

1
(u)
1
_
c
d(u)
du
(u)
_
+e
a
(
2

1
)
_
u+ca
0

2
e

2
(u+cax)
(x)dx.
Rearranging the terms,
c
d
2
(u)
du
2
+ (c
1
)
d(u)
du
e
a
(
1

2
)(u +ca)
= e
a
(
2

1
)
_
u+ca
0

2
e

2
(u+cax)
(x)dx.
Let
h(u) = e
a
(
2

1
)
_
u+ca
0

2
e

2
(u+cax)
(x)dx
Then,
dh(u)
du
= e
a
(
2

1
)
2
_
(u +ca)
_
u+ca
0

2
e

2
(u+cax)
(x)dx
_
,
dh(u)
du
= e
a
(
2

1
)
2
(u +ca)
2
h(u)
and
dh(u)
du
+
2
h(u) = e
a
(
2

1
)
2
(u +ca).
Substituting
h(u) = c
d
2
(u)
du
2
+ (c
1
)
d(u)
du
e
a
(
1

2
)(u +ca)
43
into the above equations and rearranging the term, we have
c
d
3
(u)
du
3
+ (c
1
+c
2
)
d
2
(u)
du
2
+
2
(c
1
)
d(u)
du
e
a
(
1

2
)
d(u +ca)
du
= 0.
The result follows immediately by substituting (u) = 1
(u) into the above equation.
Corollary 5.1. The ultimate ruin probability (u) satises the
following second order differential equation with advanced ar-
gument:
c
d
2
(u)
du
2
+ (c
1
+c
2
)
d(u)
du
+
2
(c
1
)(u)
e
a
(
1

2
)(u +ca) = 0. (7)
Proof. Since () = 0,

() = 0 and

() = 0, the
result follows immediately by integrating (6) from u to .
Theorem 5.2. The solution to the differential equation (7) is:
(u) =
n

i=1
p
i
(u)e
R
i
u
where R
i
C are the roots of the following characteristic
equation:
cR
2
+ (c
1
+c
2
)R +
2
(c
1
)
e
a
(
1

2
)e
Rca
= 0 (8)
and p
i
(u) is a l 1-th order polynomial in u only if the mul-
tiplicity of the root R
i
is l. In addition, n is nite if the region
of the possible roots is conned within any vertical strip in the
complex plane.
Proof. By Taylors Theorem,
(u +ca) =

k=0
(ca)
k

(k)
(u)
k!
Substituting this into (7):
c
d
2
(u)
du
2
+ (c
1
+c
2
)
d(u)
du
+
2
(c
1
)(u)
e
a
(
1

2
)

k=0
(ca)
k

(k)
(u)
k!
= 0.
Then, it becomes an ordinary differential equation. The corre-
sponding characteristic equation is:
cR
2
+ (c
1
+c
2
)R +
2
(c
1
)
e
a
(
1

2
)

k=0
(ca)
k
R
k
k!
= 0
or, equivalently,
cR
2
+ (c
1
+c
2
)R +
2
(c
1
)
e
a
(
1

2
)e
Rca
= 0.
Since
h(R) = cR
2
+ (c
1
+c
2
)R +
2
(c
1
)
e
a
(
1

2
)e
Rca
is an entire function, there can be only a nite number of zeros
of h(R) in any compact set. This implies there are only a nite
number of solutions in any vertical strip in the complex plane.
Moreover, the linearity of the equation (7) implies any nite
sum of the functions u
k
e
R
i
u
, k = 0, 1, 2, . . . , l 1 where R
i
is a root of multiplicity l of (8), is a solution of (7) (see Hale
and Verduyn Lunel, 1993).
The main problem to nd the solution of a second order
differential equation with advanced argument is that the non-
linearity of the characteristic equation makes it very difcult,
if not impossible, to nd all its roots explicitly. But, for the
current case, the characteristic equation (8) can be solved as
shown in the following subsection.
5.1 Explicit Solution
In this section, we try to obtain the analytical formula of (u)
from the second order differential equation with advanced ar-
gument (7).
First of all, it is important to see that, since as u ,
(u) 0, we do not need to care about the root R
i
of the
characteristic equation (8) with non-negative real part.
Next, we will show that the negative real roots of (8) always
exist.
Lemma 5.1. The characteristic equation (8) always has 2 neg-
ative real roots.
Proof. Let
g(x) = cx
2
+ (c
1
+c
2
)x +
2
(c
1
)
h(x) = e
a
(
1

2
)e
cax
So, solving (8) is equivalent to nding the interception points
of g(x) and h(x). We tackle the problem by looking at differ-
ent cases.
Case 1:
1
>
2
. For this case, we have
1
<
2
. There-
fore, by the net-prot condition, c >
1
c
1
> 0.
This implies g(x) = (cx + c
1
)(x +
2
) has 2 negative
real roots
1
and
2
. As h(x) > 0, x R, h(x) > g(x) for
x [
1
,
2
]. Moreover, by the net-prot condition,
g(0) h(0) =
2
(c
1
) e
a
(
1

2
)
=
1

2
(c ((1 e
a
)
1
+e
a

2
)) > 0.
Note that g(x) > h(x) as x , g(x) h(x) is strictly
decreasing on x (,
1
], and g(x) h(x) is strictly in-
creasing on x (
2
, 0]. We have shown that g(x) h(x) < 0
for x [
1
,
2
]. Therefore it is clear that the characteristic
equation has 2 negative real roots.
Case 2:
1
<
2
. Now, h(x) < 0, x R. If g(x) at its
minimum is less than h(x), then there must be 2 negative
real roots of g(x) = h(x). This can be seen from the fol-
lowing reasoning: by the net-prot condition, g(0) > h(0); as
44
x , g(x) > h(x); and g(x) h(x) is strictly decreas-
ing when x < and g(x) h(x) is strictly increasing when
x > , where is the only point at which g

(x) = h

(x), i.e.
g(x) h(x) attains its minimum at . The minimum point of
g(x) is
c
1
c
2
2c
and its minimum value is:
g
_
c
1
c
2
2c
_
=
( +c
2
c
1
)
2
4c
.
The value of h(x) at
c
1
c
2
2c
is:
h
_
c
1
c
2
2c
_
= (
1

2
)e

a
c
(+c
1
+c
2
)
.
Let r(a) =
(+c
2
c
1
)
2
4c
(
1

2
)e

a
c
(+c
1
+c
2
)
, then
r(0) =
( +c
2
c
1
)
2
4c
(
1

2
)
=
( +c
1
c
2
)
2
4c
0,
and,
r

(a) =
(
1

2
)( +c
1
+c
2
)
c
e

a
c
(+c
1
+c
2
)
< 0,
for all a R
+
. As a , r(a)
(+c
2
c
1
)
2
4c
< 0.
These imply r(a) < 0, a R
+
. Therefore, it is shown that
g(x) at its minimum is always less than h(x). By noting that
g(x) h(x) < 0 at its minimum point , there must be 2
negative real roots of g(x) = h(x).
Now, we will show that the multiple roots of (8), if they
exist, must be real.
Lemma 5.2. There is no multiple root of (8) unless the follow-
ing condition is satised:
_

_
2A+
_
(B
2
4AC)k
2
+ 4A
2
Dk
2
e
2ABk+

(B
2
4AC)k
2
+4A
2
2A
= 0, for
1
>
2
2A
_
(B
2
4AC)k
2
+ 4A
2
Dk
2
e
2ABk

(B
2
4AC)k
2
+4A
2
2A
= 0, for
2
>
1
(9)
with A = c, B = c
1
+ c
2
, C =
2
(c
1
), D =
e
a
(
1

2
) and k = ca. In addition, if the condition
above is satised, the real double roots are the one and only
one multiple root.
Proof. Let f(x) = Ax
2
+Bx+CDe
kx
and g(x) = Ax
2
+
Bx + C where A, B, C, k are dened before. Since g(x) can
be factorized into g(x) = (cx+c
1
)(x+
2
), all of its roots
are real. This implies B
2
4AC 0. If r is a multiple root, it
must satisfy the following system of simultaneous equations:
_
f(r) = 0
f

(r) = 0

_
Ar
2
+Br +C De
kr
= 0
2Ar +B Dke
kr
= 0
Therefore,
Akr
2
+ (Bk 2A)r + (Ck B) = 0. (10)
The determinant of the quadratic equation (10) is:
(Bk2A)
2
4(Ak)(CkB) = (B
2
4AC)k
2
+4A
2
> 0.
Therefore, r must be real. The solution of (10) is:
r =
2ABk
_
(B
2
4AC)k
2
+ 4A
2
2Ak
.
From the proof of Lemma 5.1, if
1
>
2
, then the roots of
the characteristic equation are outside the set
_
B

B
2
4AC
2A
,
B +

B
2
4AC
2A
_
.
Therefore,
2ABk +
_
(B
2
4AC)k
2
+ 4A
2
2Ak
is the only possible double root. Substituting this into 2Ar +
B Dke
kr
= 0, we have
2A
_
2ABk +
_
(B
2
4AC)k
2
+ 4A
2
2Ak
_
+B
Dke
k

2ABk+

(B
2
4AC)k
2
+4A
2
2Ak

= 0,
or
2A+
_
(B
2
4AC)k
2
+ 4A
2
Dk
2
e
k

2ABk+

(B
2
4AC)k
2
+4A
2
2Ak

= 0.
This is the double root condition for
1
>
2
. The proof for

2
>
1
is similar.
It is not possible to have a root of multiplicity more than
2 because the quadratic equation (10) does not have double
roots. Besides real roots, the characteristic equation may have
some complex roots. Now, we want to restrict the possible
range of complex roots.
Lemma 5.3. If R
i
is a complex root of the characteristic equa-
tion, then R
i
is an element of the following set:
Case 1:
1
>
2
If roots of g(p) +h(p) = 0 exist,
_
r = p +qi :p (
1
,
1
) (
2
,
2
),
q =

B +

B
2
4C
2
_
.
Otherwise,
_
r = p +qi : p (
1
,
2
), q =

B +

B
2
4C
2
_
.
45
Case 2:
2
>
1
_
r = p +qi :p (
1
,
1
) (
2
, min(
2
, 0)),
q =

B +

B
2
4C
2
_
where,
B = (p +
2
)
2
+ (p + (
1

c
))
2
,
C = (p +
2
)
2
(p + (
1

c
))
2
(

c
)
2
e
2a
(
1

2
)
2
e
2cap
,

1
and
2
are the 2 negative real roots of the equation g(x)
h(x) = 0,
1
and
2
are the 2 negative real roots of the equa-
tion g(x) +h(x) = 0, where
g(x) = (x +
2
)(x + (
1

c
))
h(x) = (

c
)e
a
(
1

2
)e
cax
.
Proof. Suppose R = p + qi C : p R, q R\{0} is
a complex root of (8). Since the characteristic equation is a
real analytic function, a complex root must exist in the form
of conjugate pairs. Let R be a complex root and R be its con-
jugate. Substituting R and R into (8), we have the following
system of simultaneous equations:
_

_
cR
2
+ (c
1
+c
2
)R +
2
(c
1
)
= e
a
(
1

2
)e
Rca
cR
2
+ (c
1
+c
2
)R +
2
(c
1
)
= e
a
(
1

2
)e
Rca
.
(11)
Factorizing the left hand sides, we have
_
(cR +c
1
)(R +
2
) = e
a
(
1

2
)e
Rca
(cR +c
1
)(R +
2
) = e
a
(
1

2
)e
Rca
.
Multiplying the rst equation in (11) by the second one, we
obtain
_
|R|
2
+
2
(R +R) +
2
2
_

_
c
2
|R|
2
+c(c
1
)(R +R) + (c
1
)
2
_
=
2
e
2a
(
1
2)
2
e
ca(R+R)
.
Substituting R = p +qi, we have
_
p
2
+q
2
+ 2
2
p +
2
2
_

_
c
2
(p
2
+q
2
) + 2c(c
1
)p + (c
1
)
2
_
=
2
e
2a
(
1

2
)
2
e
2cap
Therefore,
q
4
+Bq
2
+C = 0 (12)
where
B = (p +
2
)
2
+ (p + (
1

c
))
2
,
C = (p +
2
)
2
(p + (
1

c
))
2
(

c
)
2
e
2a
(
1

2
)
2
e
2cap
.
So (12) is a quadratic equation in q
2
. From the basic knowl-
edge about quadratic equations, since B > 0, it is impossible
for both roots to be greater than zero. So, we must have C < 0.
This implies:
(p +
2
)
2
(p +(
1

c
))
2
(

c
)
2
e
2a
(
1

2
)
2
e
2cap
< 0.
Hence,
_
(p +
2
)(p + (
1

c
)) + (

c
)e
a
(
1

2
)e
cap
> 0
(p +
2
)(p + (
1

c
)) (

c
)e
a
(
1

2
)e
cap
< 0
(13)
or
_
(p +
2
)(p + (
1

c
)) + (

c
)e
a
(
1

2
)e
cap
< 0
(p +
2
)(p + (
1

c
)) (

c
)e
a
(
1

2
)e
cap
> 0.
(14)
Now we investigate the problem by considering 2 cases:
Case 1:
1
>
2
.
Let
g(p) = (p +
2
)(p + (
1

c
)),
h(p) = (

c
)e
a
(
1

2
)e
cap
and
1
and
2
be the 2 negative real roots of g(p) = h(p)
such that
1
<
2
. From the proof of Lemma 5.1, it is seen
that g(p) > h(p) > 0, p (,
1
) (
2
, 0). There-
fore, (14) is rejected. So, (13) is the only possible solution,
i.e. p (
1
,
2
). As g(p) is strictly decreasing from posi-
tive to negative up to the minimum and then strictly increas-
ing to positive again when p moves from
1
to
2
and h(p)
is always positive, there are at most 2 roots of the equation
g(p) + h(p) = 0 or g(p) > h(p), p 0. Let
1
and

2
be these 2 roots, if they exist, such that
1

2
. Then
the possible range of a complex root is R = p + qi, where
p (
1
,
1
) (
2
,
2
) if roots of g(p) + h(p) = 0 exist,
p (
1
,
2
), otherwise, and
q =

B +

B
2
4C
2
with B and C dened as before.
The proof of case 2:
1
<
2
is similar.
The nal step to prove that (8) only have 2 distinct negative
real roots, no root of the characteristic equation is complex, is
by using the Rouch es Theorem.
Theorem 5.3. With the conditions imposed on the ultimate
ruin probability: C([0, ), [0, 1]) and

(u) < 0, u
0, the solution of the second order differential equation with
advanced argument (7) does not have any oscillatory terms,
46
i.e. no root of the characteristic equation is complex. More-
over, the 2 distinct negative real roots are simple roots, i.e. the
double root condition (9) does not exist.
Proof. As g(x) is a quadratic function and h(x) is an expo-
nential function, we can always nd a closed contour in the
left-half plane such that |g(x)| > |h(x)|. (For the denition
of g(x) and h(x), please refer to the proof of Lemma 5.1)
As g(x) has only 2 roots in the left-half plane, by Rouch es
Theorem, g(x) h(x) also has only 2 roots in the left-half
plane. And, Lemma 5.1 shows that there are always 2 distinct
negative real roots. This completes the proof (Rudin, 1987).
Therefore, the solution of (7) is:
(u) =

Ae
R
1
u
+

Be
R
2
u
, (15)
where

A and

B are some real constants, R
1
and R
2
are the 2
negative real roots of the characteristic equation (8).
In order to determine the constants

A and

B, substituting
(15) into (1) and (3), then putting u = 0, we obtain a system
of simultaneous equations as in (16).
By solving these 2 equations with 2 unknowns, we obtain
the constants

A and

B.
Remarks: 1. Similar to the classical compound Poisson
model, when the claim size is exponentially distributed, the
ruin probability has an explicit expression.
2. By substituting (15) into equation (6) and using (16), it
is easy to see that (15) is a solution of the original equation.
3. If the claim sizes have an Erlang or hyperexponential
distribution, it should be still possible to obtain an explicit ex-
pression for the ruin probability, but the mathematics becomes
very complex in this case. This is an interesting topic, we will
investigate this in our future research.
5.2 Numerical Illustration
In this numerical illustration, the following values are as-
signed: = 1,
1
= 1,
2
= 0.1, c = 10, and a = 0.1,
1.0, 5.0. Therefore, the net prot condition is satised. In the
following numerical illustration, both values obtained by the
simulation method as described in Asmussen (2000) and the
analytical formula described in Section 5.1 are shown. Their
values are compared and the following error measures are
shown in the table: Error = Simulation Value - Analytical An-
swer; ABS(Error) = Absolute Error; Relative Error = Absolute
Error/Simulation Value; 10000 simulations were used for all
cases.
From tables 1-3, it is seen that the absolute error is of or-
der 10
4
and the relative error is less than 1% for most cases.
When the ruin probability is very small, some simulated nu-
merical values have little bigger relative errors (about 3%).
This is because the ruin probability is too small and it may
need huge number of simulations to obtain accurate results in
these cases. In view of this, it can be concluded that the simu-
lation and the analytical formula give consistent results.
Acknowledgments. We would like to thank the referee for his
careful reading of the paper and helpful suggestions and com-
ments. This research was supported by the Research Grants
Council of the Hong Kong Special Administrative Region,
China (Project No. HKU 7050/05P)
References
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47
_

_
_
cR
1
+e
a
e
R
1
ca
_

1(1e
(R
1
+
1
)ca
)
R
1
+
1


2(1e
(R
1
+
2
)ca
)
R
1
+
2
__

A
+
_
cR
2
+e
a
e
R
2
ca
_

1(1e
(R
2
+
1
)ca
)
R
2
+
1


2(1e
(R
2
+
2
)ca
)
R
2
+
2
__

B = +e
a
_
e

2
ca
e

1
ca
_
_
c e
a
e
R
1
ca
_
1e
(R
1
+
2
)ca
R
1
+
2

1e
(R
1
+
1
)ca
R
1
+
1
__

A
+
_
c e
a
e
R
2
ca
_
1e
(R
2
+
2
)ca
R
2
+
2

1e
(R
2
+
1
)ca
R
2
+
1
__

B =
1
+e
a
_
e

2
ca

2

e

1
ca

1
_
(16)
u Simulation Analytical Error ABS(Error) Relative Error
0.00 0.9115596118 0.9116696406 (0.0001100288) 0.0001100288 0.0121%
0.50 0.9048371313 0.9054406162 (0.0006034849) 0.0006034849 0.0667%
1.00 0.8985198057 0.8999696713 (0.0014498656) 0.0014498656 0.1614%
1.50 0.8959430657 0.8949803872 0.0009626785 0.0009626785 0.1074%
2.00 0.8921900284 0.8902997967 0.0018902317 0.0018902317 0.2119%
2.50 0.8848555856 0.8858196541 (0.0009640685) 0.0009640685 0.1090%
3.00 0.8813273961 0.8814722047 (0.0001448086) 0.0001448086 0.0164%
3.50 0.8773258376 0.8772150256 0.0001108120 0.0001108120 0.0126%
4.00 0.8722445930 0.8730215425 (0.0007769495) 0.0007769495 0.0891%
4.50 0.8685343156 0.8688750959 (0.0003407803) 0.0003407803 0.0392%
5.00 0.8645557028 0.8647652296 (0.0002095268) 0.0002095268 0.0242%
5.50 0.8623378291 0.8606853686 0.0016524605 0.0016524605 0.1916%
6.00 0.8564633668 0.8566313659 (0.0001679991) 0.0001679991 0.0196%
6.50 0.8534838914 0.8526005937 0.0008832977 0.0008832977 0.1035%
7.00 0.8482639014 0.8485913750 (0.0003274736) 0.0003274736 0.0386%
7.50 0.8451824181 0.8446026277 0.0005797904 0.0005797904 0.0686%
8.00 0.8405123096 0.8406336418 (0.0001213322) 0.0001213322 0.0144%
8.50 0.8363292482 0.8366839407 (0.0003546925) 0.0003546925 0.0424%
9.00 0.8328753270 0.8327531934 0.0001221336 0.0001221336 0.0147%
9.50 0.8275063948 0.8288411609 (0.0013347661) 0.0013347661 0.1613%
10.00 0.8253310033 0.8249476610 0.0003833423 0.0003833423 0.0464%
100.00 0.3537946754 0.3534812424 0.0003134330 0.0003134330 0.0886%
1000.00 0.0000736495 0.0000737511 (0.0000001015) 0.0000001015 0.1379%
Table 1: Threshold Model: (u) with a = 0.1
48
u Simulation Analytical Error ABS(Error) Relative Error
0.00 0.2625050912 0.2601480944 0.0023569968 0.0023569968 0.8979%
0.50 0.2246567269 0.2237709041 0.0008858228 0.0008858228 0.3943%
1.00 0.1977463165 0.1982445034 (0.0004981869) 0.0004981869 0.2519%
1.50 0.1803669841 0.1797307357 0.0006362484 0.0006362484 0.3528%
2.00 0.1664142034 0.1657785099 0.0006356935 0.0006356935 0.3820%
2.50 0.1563116991 0.1548213168 0.0014903823 0.0014903823 0.9535%
3.00 0.1467117461 0.1458568266 0.0008549195 0.0008549195 0.5827%
3.50 0.1376949726 0.1382425851 (0.0005476125) 0.0005476125 0.3977%
4.00 0.1305287148 0.1315657393 (0.0010370245) 0.0010370245 0.7945%
4.50 0.1254713687 0.1255599647 (0.0000885960) 0.0000885960 0.0706%
5.00 0.1196010346 0.1200524915 (0.0004514569) 0.0004514569 0.3775%
5.50 0.1153665576 0.1149303218 0.0004362358 0.0004362358 0.3781%
6.00 0.1097673734 0.1101186841 (0.0003513107) 0.0003513107 0.3201%
6.50 0.1049012689 0.1055672905 (0.0006660216) 0.0006660216 0.6349%
7.00 0.1008715708 0.1012415696 (0.0003699988) 0.0003699988 0.3668%
7.50 0.0971278418 0.0971170724 0.0000107695 0.0000107695 0.0111%
8.00 0.0926352101 0.0931759009 (0.0005406908) 0.0005406908 0.5837%
8.50 0.0899396220 0.0894044274 0.0005351946 0.0005351946 0.5951%
9.00 0.0859221546 0.0857918359 0.0001303187 0.0001303187 0.1517%
9.50 0.0825878080 0.0823291892 0.0002586188 0.0002586188 0.3131%
10.00 0.0791310366 0.0790088300 0.0001222066 0.0001222066 0.1544%
100.00 0.0000484060 0.0000483619 0.0000000441 0.0000000441 0.0911%
1000.00 3.59479E-37 3.57541E-37 1.93769E-39 1.93769E-39 0.5390%
Table 2: Threshold model with exponential claims: (u) with a = 1.0
u Simulation Analytical Error ABS(Error) Relative Error
0.00 0.0998797604 0.1000459789 (0.0001662185) 0.0001662185 0.1664%
0.50 0.0634174570 0.0638083541 0.(0003908971) 0.0003908971) 0.6164%
1.00 0.0407301485 0.0407014333 0.0000287152 0.0000287152 0.0705%
1.50 0.0259903835 0.0259670576 0.0000233259 0.0000233259 0.0897%
2.00 0.0164675026 0.0165712891 (0.0001037865) 0.0001037865 0.6303%
2.50 0.0107655853 0.0105796016 0.0001859837 0.0001859837 1.7276%
3.00 0.0068542675 0.0067584853 0.0000957822 0.0000957822 1.3974%
3.50 0.0043268066 0.0043214179 0.0000053887 0.0000053887 0.1245%
4.00 0.0027779508 0.0027668890 0.0000110618 0.0000110618 0.3982%
4.50 0.0017843073 0.0017751202 0.0000091871 0.0000091871 0.5149%
5.00 0.0011643828 0.0011422101 0.0000221727 0.0000221727 1.9042%
5.50 0.0007338959 0.0007381444 (0.0000042485) 0.0000042485 0.5789%
6.00 0.0004807254 0.0004800209 0.0000007045 0.0000007045 0.1465%
6.50 0.0003150775 0.0003149777 0.0000000998 0.0000000998 0.0317%
7.00 0.0002129975 0.0002093073 0.0000036902 0.0000036902 1.7325%
7.50 0.0001370107 0.0001415159 (0.0000045052) 0.0000045052 3.2882%
8.00 0.0000958759 0.0000978973 (0.0000020214) 0.0000020214 2.1983%
8.50 0.0000681606 0.0000697112 (0.0000015506) 0.0000015506 2.2750%
9.00 0.0000506812 0.0000513834 (0.0000007022) 0.0000007022 1.3854%
9.50 0.0000393105 0.0000393590 (0.0000000485) 0.0000000485 0.1233%
10.00 0.0000325404 0.0000313702 0.0000011702 0.0000011702 3.5961%
100.00 2.28643E-09 2.34957E-09 (6.31416E-11) 6.31416E-11 2.7616%
1000.00 1.93411E-48 1.93411E-48 (1.17416E-50) 1.17416E-50 0.6108%
Table 3: Threshold model with exponential claims: (u) with a = 5.0
49