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Life Contingencies

LIFE CONTINGENCIES

Single Life Model

Basic Random Variables


X – denotes the age-at-death random variable

(x) – denotes a life aged x


(ie someone who’s already survived to age x)

ω – denotes terminal age (unless otherwise stated, we assume ω = ∞ )


(no one survive past age ω )

T = T(x) – denotes the continuous future lifetime of (x) random variable


T=X–x|X>x
Note that X = T(0)

K = K(x) – denotes the curtate future lifetime of (x) random variable


This is a discretization of the T random variable.

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Life Contingencies

The Age-at-Death Random Variable: X


Supp ( X ) = (0, ω )

(cumulative distribution function – cdf)


FX ( x ) = Pr( X ≤ x ) = x q0 (Recall that F ′ = f , the probability density
function (pdf))

(survival function – sf)


s X ( x ) = Pr( X > x ) = x p0 = 1− x q0 (Note that s ′ = − f )

(force of mortality – fom) aka hazard rate or failure rate


= − [ln( s X ( x )]
f X ( x) d
μ ( x) =
s X ( x) dx

Comments and Concepts

1. The force of mortality is the rate of mortality at a particular point in time.


The expression μ ( x )dx represents the probability that a newborn that has
survived to age x dies in the next instant “dx”.
x
2. x p0 = exp( − ∫ μ ( s )ds )
0

x x
3. x q0 = Pr( X ≤ x ) = ∫ f X ( s )ds = ∫ s p0 μ ( s )ds
0 0

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Life Contingencies

The (continuous) Future Lifetime Random Variable: T = T(x)


Supp (T ) = (0, ω − x )

f X ( x + t)
(pdf): f T (t ) =
Pr( X > t )

Pr( x < X ≤ x + t ) Pr( X > x + t )


(cdf): FT (t ) = Pr(T ≤ t )= t q x = = 1−
Pr( X > x ) Pr( X > x )

Pr( X > x + t ) p0
(sf): sT (t ) = Pr(T > t )= t p x = = x +t
= 1− t q x
Pr( X > x ) x p0

Comments and Concepts

1. f T (t )= t p x ⋅ μ ( x + t )

t
2. t q x = ∫0 s p x ⋅ μ ( x + s )ds

t x +t ∞
3. t p x = exp( − ∫ μ ( x + s )ds ) = exp( − ∫ μ ( s )ds ) Also, t p x = ∫ s p x ⋅ μ ( x + s )ds
0 x t

4. 1 q x = q x and 1 p x = p x

5. (survival factorization) n +t p x = n p x ⋅t p x + n

6. (deferred mortality)
t +u
t |u qx = Pr(t < T ( x ) ≤ t + u ) = ∫ s p x ⋅ μ ( x + s )ds = t p x − t + u p x = t + u qx − t qx = t p x ⋅u qx + t
t

d
− [t px ]
7.
d
[ t p x ] = − f T (t ) =− t p x ⋅ μ ( x + t ) and so μ ( x + t ) = dt
dt t px

8.
d
[ t p x ]= t p x [μ ( x ) − μ ( x + t )] (Use 2nd equality in 3. above and the FTC)
dx

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Life Contingencies

9. (complete expectation of life for (x), aka mean residual lifetime)


0 ∞ ∞
ex = E[T ( x )] = ∫ t⋅t p x ⋅ μ ( x + t )dt = ∫ t p x dt (The last equality is used often.)
0 0

∞ ∞
10. E[(T ( x )) 2 ] = ∫0 t 2 ⋅t p x ⋅ μ ( x + t )dt = ∫02t⋅t p x dt (Helps us get variance of T.)

11. (n-year temporary complete expectation of life for (x); this is the
expected number of years lived by (x) between ages x and x+n)
0 n n
e x :n | = E[T ( x ) ∧ n ] = ∫ t⋅t p x ⋅ μ ( x + t )dt + n⋅n p x = ∫ t p x dt
0 0

12. (Recursion Formulas)


0 0 0 0 1 0
e x = e x:n| + n p x ⋅ e x + n and when n = 1 we get e x = ∫ t p x dt + p x ⋅ e x +1
0
0 0 0
e x:n| = e x:m| + m p x ⋅ e x + m:n −m|

13. The kth percentile of T(x), denoted ck, is found by solving


ck p x = 1 − .01k
The median future lifetime of (x) is c50.

14. The mode of T is the point(s) at which the pdf f T (t ) is maximized.

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Life Contingencies

The Curtate Future Lifetime Random Variable: K = K(x)


Supp ( K ) = (0,1,2, L , ω − x − 1)

The probability distribution table for K is

K Pr
0 Pr(0 ≤ T < 1) = Pr(0 < T ≤ 1) = q x ( = 0| q x )
1 Pr(1 ≤ T < 2) = Pr(1 < T ≤ 2) = 1| q x
2 Pr(2 ≤ T < 3) = Pr(2 < T ≤ 3) = 2| q x
M M

Note: n| q x = n p x − n +1 p x = n +1 q x − n q x = n p x ⋅ q x + n

k
(cdf): FK ( k ) = Pr( K ≤ k ) = ∑ n| q x (Notice that Pr( K ≤ k ) = Pr(T ≤ k + 1)= k +1 q x )
n =0

Comments and Concepts

1. (curtate expectation of life for (x))


∞ ∞
e x = E [ K ( x )] = ∑ k ⋅k | q x = ∑ k p x
k =0 k =1

(The last equality is used often. Notice the index starts at k = 1.)
∞ ∞
2. E[( K ( x )) 2 ] = ∑ k 2 ⋅k | q x = ∑ (2k − 1)⋅k p x (Helps us get variance of K.)
k =0 k =1

3. (n-year temporary curtate expectation of life for (x); this is the expected
complete number of years lived by (x) between ages x and x+n)
n
e x:n| = ∑ k p x
k =1

4. (Recursion Formulas)
e x = e x:n| + n p x ⋅ e x + n and when n = 1 we get e x = p x ⋅ (1 + e x +1 )
e x:n| = e x:m| + m p x ⋅ e x + m:n −m|

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Life Contingencies

Life Table Notation

l0 = (arbitrary) number of newborns


lx
l x = l0 ⋅ x p0 = (expected) number of survivors at age x (Note: x p0 = )
l0
n d x = l x − l x +n = number of deaths between ages x and x+n
(1dx = dx )
Note: n d x = d x + d x +1 + L + d x +n −1

Formulas and concepts involving life table notation

l x+n d l −l d x +n l x +n − l x +n+m
1. n px = and n q x = n x = x x +n = 1− n p x and n|m qx = m
=
lx lx lx lx lx


d
[l x ]
, and so [l x ] = −l x ⋅ μ (x )
dx d
2. μ ( x ) =
lx dx

n n
3. n d x = ∫ l x +t ⋅ μ ( x + t )dt (follows since n q x = ∫ t p x ⋅ μ ( x + t )dt )
0 0

4. n Lx = the total number of years lived in the next n years by the l x people
alive at age x
n x+n
n L x = ∫ l x +t dt = ∫ l y dy = n ⋅ l x + n + n d x ⋅ E[T ( x) | T ( x) < n]
0 x
n n

Note that E[T ( x) | T ( x) < n] =


∫0
t ⋅t p x ⋅ μ ( x + t )dt
=
∫0
t ⋅ l x + t ⋅ μ ( x + t )dt
n qx n dx

d
5. [ n Lx ] = l x + n − l x =− n d x
dx

6. Tx = ∞ Lx the total number of years lived in the future by the l x people alive
at age x

d
7. n Lx = Tx − Tx + n and [Tx ] = −l x
dx

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Life Contingencies

Life Table Notation (continued)


0 Tx 0 L
8. e x = and e x:n| = n x
lx lx

2Y x ∞
9. E[(T ( x )) 2 ] = where Y x = ∫0Tx +t dt
lx

dx
10. n m x = n
is the n-year central mortality weight
n Lx

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Life Contingencies

Extending Discrete to Continuous (Fractional Age Assumptions)


(x is an integer and all formulas are valid for 0 ≤ t ≤ 1 )

UDD (Uniform Distribution of Deaths: t d x = t ⋅ d x )

t q x = t ⋅ q x , and so t p x = 1 − t ⋅ q x , and f T (t ) = q x (a constant wrt t)

qx qx
Then l x +t = l x − t ⋅ d x and μ ( x + t ) = and m x =
1 − t ⋅ qx 1 − 0.5q x

Defining V(x) to be the random variable representing the fraction of the year
lived in the year in which (x) dies, we can relate the random variables T and
K; namely, T(x) = K(x) + V(x), and K and V are independent.

Under UDD, we have V(x) ~ U(0,1).


0 0 1
Then e x = e x + 0.5 . Also e x:n| = e x:n| + 0.5( n q x ) and Var (T ( x )) = Var( K ( x )) +
12

t ⋅ qx qx
For 0 ≤ s + t ≤ 1 , t q x + s = and t p x + s ⋅ μ ( x + s + t ) =
1 − s ⋅ qx 1 − s ⋅ qx

Constant Force (Exponential Interpolation: μ ( x + t ) = μ )

For 0 ≤ s + t ≤ 1 , t p x + s = e − μ⋅t = ( p x ) t

mx = μ

Balducci (Hyperbolic Interpolation)

1 1 ⎛ 1 1⎞
= + t ⎜⎜ − ⎟⎟
l x +t lx ⎝ l x +1 l x ⎠

qx t ⋅ qx
μ( x + t) = and for 0 ≤ s + t ≤ 1 , t qx + s = = t ⋅ μ( x + s + t)
1 − (1 − t ) ⋅ q x 1 − (1 − s − t ) ⋅ qx

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Life Contingencies

Select and Ultimate Mortality

Select mortality rates are used for a period (usually 3 years or less) and are
different than the ultimate (general population) rates.

[x] denotes an x-year old for which select rates are used starting at age x

[x] + k denotes an (x + k)-year old for which select rates are used starting at
age x

[x + k] denotes an (x + k)-year old for which select rates are used starting at
age x + k

(x + k) denotes an (x + k)-year old for which ultimate rates are used starting
at age x + k

Comments:
1. [x] + k = (x + k) if k exceeds the select period

2. The force of mortality for [x] is denoted μ x (t ) .

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Life Contingencies

Multiple-Life Models

For the moment, we consider only two independent lives (x) and (y). The
models can easily be extended to more than two lives.

Joint-Life Status: T ( xy ) = Min{T ( x ), T ( y )}


(Joint-life status fails on the earlier of the deaths of (x) and (y))

t p xy = Pr(T ( xy ) > t ) = Pr(T ( x ) > t ) ⋅ Pr(T ( y ) > t ) = t p x ⋅t p y

t q xy = 1− t p xy

0 ∞
e xy = ∫ t p xy dt
0


e xy = ∑ k p xy
k =1

t |u q xy = t p xy − t +u p xy

μ xy (t ) = μ x (t ) + μ y (t )

Last-Survivor Status: T ( xy ) = Max{T ( x ), T ( y )}


(Last-survivor status fails on the latest of the deaths of (x) and (y))

For independent lives (x) and (y):

t qxy = Pr(T ( xy ) ≤ t ) = Pr(T ( x ) ≤ t ) ⋅ Pr(T ( y ) ≤ t ) = t qx ⋅t q y

t p xy = 1− t q xy

t |u q xy = t +u q xy − t q xy

p x ⋅ μ x (t )+ t p y ⋅ μ y (t )− t p xy ⋅ μ xy (t )
μ xy (t ) =
t

t p xy

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Life Contingencies

Contingent Probabilities

Notation:
n q x1 y = Pr((x) dies first and within the next n years)

∞ q x1 y = Pr((x) dies first)

n q x y2 = Pr((y) dies second and within the next n years)

1
The notation x y indicates that the joint-life status (xy) fails due to the failure
of the (x) status, ie the death of (x).

Contingent Probability Formulas:


n
n q x1 y = ∫ t p xy ⋅ μ x (t )dt
0
n
n q x y2 = ∫ t q x ⋅ t p y ⋅ μ y (t )dt
0

Contingent Probability Relationships:

1. n q x = n q x1 y + n q x2 y

2. n q y = n q x y1 + n q x y2

3. n q xy = n q x1 y + n q x 1y

4. n q xy = n q x2 y + n q x 2y

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Life Contingencies

Common Shock Model


(In recent exams, this has been the only model tested in which the lifetimes of
(x) and (y) are dependent.)

Notation: Z = the common shock random variable.


1
Always Z ~ EX ( mean = ) . ( λ = the fom of the shock)
λ

T*(x) = future lifetime of (x) random variable in the absence


of the common shock ( Pr(T * ( x ) > t )= t p *x )

T*(y) = future lifetime of (y) random variable in the absence


of the common shock ( Pr(T * ( y ) > t )= t p *y )

Z, T*(x), and T*(y) are all assumed mutually independent

Define T ( x ) = Min{T * ( x ), Z } and define T ( y ) = Min{T * ( y ), Z } .


(T(x) and T(y) are not independent, and T ( xy ) = Min{T * ( x ), T * ( y ), Z } )

Formulas: t p x = Pr(T ( x ) > t ) = t p*x ⋅ Pr( Z > t ) = t p*x ⋅ e − λt


t p y = Pr(T ( y ) > t ) = t p*y ⋅ Pr( Z > t ) = t p*y ⋅ e − λt
t p xy = Pr(T ( xy ) > t ) = t p*x ⋅t p *y ⋅ Pr( Z > t ) = t p*x ⋅t p *y ⋅ e − λt

Often Tested Special Case of Common Shock Model


(x) and (y) have constant forces, μ x and μ y , respectively

1 1
Given: T * ( x ) ~ EX (mean = ) and T * ( y ) ~ EX ( mean = )
μx μy

− μ y ⋅t
Formulas: t p*x = e − μ x ⋅t and t p*y = e
− ( μ y + λ ) ⋅t
t p x = e − ( μ x + λ )⋅t and t py = e
− ( μ x + μ y + λ ) ⋅t
t p xy = e

Special Probability:
Pr((x) and (y) die within n years by the common shock)
=∫
0
n
t
n
p xy ⋅ λdt = ∫ λ ⋅ e
0
− ( μ x + μ y + λ ) ⋅t
dt =
λ
μx + μ y + λ
⋅ 1− e
−(μ
( x + μ y + λ )⋅n
)
Paris’s Exam MLC Seminar Page 12 of 52
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Life Contingencies

Insurance Present Value Random Variables


Single Life

Insurance Payable At The End Of The Year Of Death


(unless otherwise stated, benefit amount is 1 and age at issue is x)
(PVRV = Present Value Random Variable)
(SBP = Single Benefit Premium)
(APV = Actuarial Present Value)

1. whole life insurance

The probability distribution table for the PVRV, Z x , is

Zx Probability
v Pr(K = 0) = q x
v2 Pr(K = 1) = 1| q x
v3 Pr(K = 2) = 2| q x
M M

PVRV = Z x = v K +1

SBP = APV = E[ Z x ] = E[v K +1 ] = Ax = vqx + v 2 1| qx + L

E[ Z x2 ]= 2Ax = v 2 q x + v 4 1| qx + L . Therefore, Var ( Z x ) = Var ( v K +1 ) = 2Ax − ( Ax ) 2

Comments and Concepts: (Applies to all insurances in this section.)

(i) 2 A means to perform the same calculation as with A , except use


double the force of interest. We will generally have for insurance that if
Z is the PVRV, then E[Z] = A and E[ Z 2 ]= 2A . This will not be the
situation for annuities.

(ii) We can calculate probabilities involving the random variable Z by


rewriting the event in terms of the random variable K.

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Life Contingencies

2. n-year term insurance (benefit is paid if death occurs within next n years)

The probability distribution table for the PVRV, Z x:n | , is 1

1
Z x:n | Probability
v Pr(K = 0) = q x
2
v Pr(K = 1) = 1| q x
v3 Pr(K = 2) = 2| q x
M M
vn Pr(K = n − 1 ) = n −1| qx
0 Pr(K ≥ n ) = n p x

⎧v K +1 L K < n
PVRV = Z x:n | = ⎨ 1

⎩0 L K ≥ n

SBP = APV = E[ Z x:n | ] = Ax:n | = vqx + v 2 1| qx + L + v n n −1| qx


1 1

E[( Z x1 :n | ) 2 ] = 2 Ax1 :n | = v 2 qx + v 4 1| qx + L + v 2 n n −1| qx .

Therefore, Var ( Z x:n | ) = 2 Ax:n | − ( Ax:n | ) 2


1 1 1

Comments and Concepts:


1
The symbol x : n | is based on the contingent probability notation from
page 11 of these notes. Here, the “life” y is n | , an n-year certain period.
Observe that n-year term insurance pays a death benefit when the status
1
x : n | fails. That is, the death benefit is paid on the death of (x) as long as
this death occurs before the death of the n-year certain period (within n
years).

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Life Contingencies

3. n-year pure endowment (benefit is paid if participant survives n years)

1
The probability distribution table for the PVRV, Z x:n | , is

Z x:n |
1
Probability
0 Pr( K < n ) = n q x
v n
Pr( K ≥ n ) = n p x

1 ⎧0 L K < n
PVRV = Z x:n | = ⎨
⎩v L K ≥ n
n

SBP = APV = E[ Z x:n | ] = Ax:n | = v n n p x (Another notation: n E x = A x:n| = v n n p x )


1 1 1

E[( Z x :n | ) 2 ] = 2 Ax :n | = v 2 n n p x . Therefore, Var ( Z x:n | ) = 2 Ax :n | − ( Ax:n | ) 2


1 1 1 1 1

Comments and Concepts:


1
The symbol x : n | is based on the contingent probability notation from
page 11 of these notes. Observe that an n-year pure endowment pays
1
when the status x : n | fails. That is, the benefit is paid on the death of the
n-year certain period, n | , as long as this death occurs before the death of
(x). This is equivalent to saying the benefit is paid after n years, as long
as (x) survives that long.

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Life Contingencies

4. n-year endowment insurance (benefit is paid at end of year of death if


participant dies before age x + n, and benefit is paid at age x + n if
participant survives to age x + n)

The probability distribution table for the PVRV, Z x:n | , is

Z x :n | Probability
v Pr(K = 0) = q x
v2 Pr(K = 1) = 1| q x
v3 Pr(K = 2) = 2| q x
M M
vn Pr(K = n − 1 ) = n −1| qx
vn Pr(K ≥ n ) = n p x

⎧v K +1 L K < n
PVRV = Z x:n | = ⎪⎨
1
= Z x:n | + Z x:n |
1

⎪⎩v n L K ≥ n

SBP = APV = E[ Z x:n | ] = Ax:n | = Ax:n | + Ax:n | 1 1

E[( Z x :n | ) 2 ]= 2Ax :n | = 2 Ax :n | + 2 Ax :n | . Therefore, Var ( Z x :n | ) = 2 A x:n | − ( Ax :n | ) 2


1 1

Comments and Concepts:


(i) Observe that n-year endowment insurance pays when the joint life
status x : n | fails. The benefit is guaranteed to be paid and will be paid at
the earlier of the death of (x) and the death of n | .
(ii) On a random variable level, ( Z x:n | ) 2 = ( Z x:n | ) 2 + ( Z x:n | ) 2 since Z x:n | ⋅ Z x:n | = 0 .
1 1 1 1

So the expectation calculations above should be clear.

(iii) WARNING: Var ( Z x:n | ) ≠ Var ( Z x:n | ) + Var ( Z x:n | ) It is easy to show that if
1 1

X and Y are random variables such that their product is 0, then


Cov ( X , Y ) = − μ X ⋅ μ Y . Therefore the correct variance formula is

Var ( Z x :n | ) = Var ( Z x1 :n | ) + Var ( Z x :n | ) − 2 Ax1 :n | Ax :n |


1 1

(iv) With n = 1, we get A x:1| = v ⋅ q x + v ⋅ p x = v ( q x + p x ) = v

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Life Contingencies

5. n-year deferred whole life insurance (benefit is paid at end of year of


death if participant dies after age x + n, no benefit is paid if participant
dies prior to age x + n)

The probability distribution table for the PVRV, n | Z x , is

n| Zx Probability
0 Pr( K < n ) = n q x
v n +1 Pr(K = n) = n| q x
v n+2 Pr(K = n + 1) = n +1| q x
M M

⎧0L K < n
PVRV = n | Z x = ⎨ = Z x − Z x :n |
1

K +1
⎩v LK ≥ n

SBP = APV = E[ n | Z x ]= n | Ax = Ax − Ax:n | 1

E[( n | Z x ) 2 ]= n2|Ax = 2Ax − 2 Ax1 :n | . Therefore, Var ( n | Z x ) = n2|Ax −( n | Ax ) 2

Comments and Concepts:

(i) We also have the following APV formula: n| Ax = v n n p x Ax + n

(ii) Remembering the meaning of 2 A , we also get n2| Ax = v 2 n ⋅ n p x ⋅ 2 Ax + n

(iii) The ideas above can be extended to an n-year deferred, j-year term
insurance, or an n-year deferred, j-year pure endowment, or a … If you
are tested on one of these other insurance types, just use the basic
principals learned by studying the above insurances.

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Life Contingencies

6. whole life increasing insurance beginning at 1

The probability distribution table for the PVRV, ( IZ ) x , is

( IZ ) x Probability
v Pr(K = 0) = q x
2v 2 Pr(K = 1) = 1| q x
3v 3 Pr(K = 2) = 2| q x
M M

PVRV = ( IZ ) x = ( K + 1) ⋅ v K +1

SBP = APV = E[( IZ ) x ] = ( IA) x = Ax +1| Ax + 2| Ax + L

7. n-year term increasing insurance beginning at 1

The probability distribution table for the PVRV, ( IZ ) x:n | , is 1

( IZ ) x1 :n | Probability
v Pr(K = 0) = q x
2v 2 Pr(K = 1) = 1| q x
3v 3 Pr(K = 2) = 2| q x
M M
nv n Pr(K = n − 1 ) = n −1| qx
0 Pr(K ≥ n ) = n p x

⎧( K + 1) ⋅ v K +1 L K < n
PVRV = ( IZ ) x:n | = ⎨ 1

⎩0 L K ≥ n

SBP = APV =
E[( IZ ) x1 :n | ] = ( IA) x1 :n | = v ⋅ qx + 2v 2 ⋅ p x ⋅ qx +1 + 3v 3 ⋅2 p x ⋅ qx +1 + L + nv n ⋅n −1 p x ⋅ qn + n −1

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Life Contingencies

8. n-year decreasing insurance to 1

The probability distribution table for the PVRV, ( DZ ) x:n | , is 1

( DZ ) x1 :n | Probability
nv Pr(K = 0) = q x
(n − 1)v 2
Pr(K = 1) = 1| q x
(n − 2)v 3 Pr(K = 2) = 2| q x
M M
vn Pr(K = n − 1 ) = n −1| qx
0 Pr(K ≥ n ) = n p x

⎧(n − K ) ⋅ v K +1 L K < n
PVRV = ( DZ ) x:n | = ⎨1

⎩0 L K ≥ n

SBP = APV = E[( DZ ) x:n | ] = ( DA) x:n | = Ax:n | + Ax:n −1| + Ax:n − 2| + L + Ax:1|
1 1
1 1 1 1

Remark: ( DA) x:n| + ( IA) x:n| = ( n + 1) A x:n|


1 1
1

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Life Contingencies

Insurance Payable At The Moment Of Death

1. whole life insurance

PVRV = Z x = v T = e −δ ⋅T

SBP = APV = E[ Z x ] = Ax = ∫0 e −δ ⋅t ⋅t p x ⋅ μ x (t )dt


E[ Z x ]= Ax = ∫ e − 2δ ⋅t ⋅t p x ⋅ μ x (t )dt
2 2

2
Therefore, Var ( Z x )= Ax − ( Ax ) 2 .

Important Comment on Notation: We are using a bar over Z to denote a


different random variable than the random variable Z. Sometimes a bar
over a random variable indicates the mean of a random sample from the
same distribution as the random variable. That’s not the case here.
What we mean by using the bar notation is that the insurance is paid at
the time of death, and thus the PVRV is a function of the complete future
lifetime random variable, T.

2. n-year term insurance

⎧v T LT < n
PVRV = Z x:n | = ⎨ 1

⎩0LT ≥ n

n n
SBP = APV = E[ Z x:n | ] = Ax:n | = ∫0 v t ⋅ f T (t )dt = ∫0 e −δ ⋅t ⋅t p x ⋅ μ x (t )dt
1 1

n
E[( Z x :n | ) 2 ]= Ax :n | = ∫ e − 2δ ⋅t ⋅t p x ⋅ μ x (t )dt
1 2 1

2
Therefore, Var ( Z x:n | ) = Ax:n | − ( Ax:n | ) 2 .
1 1 1

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Life Contingencies

3. n-year endowment insurance

⎧v T LT < n
PVRV = Z x:n | = ⎨ = Z x1 :n | + Z x :n |
1

⎩v LT ≥ n
n

SBP = APV = E[ Z x:n | ] = Ax:n | = Ax:n | + Ax:n | 1 1

2 2
E[( Z x :n | ) 2 ]= Ax :n | = Ax :n | + 2 Ax :n |
1 1

2
Therefore, Var ( Z x:n | ) = Ax:n | − ( Ax:n | ) 2 .

Comments and Concepts: (Comments (ii) – (iv) are analogues to the same
numbered comments in the n-year endowment insurance payable at the end
of the year of death case – “the discrete case”.)

(i) Notice that the pure endowment random variable is always discrete,
1
and so we do not have a Z x:n | random variable. Subsequently, there are no
1 2 1
actuarial symbols Ax:n | or Ax:n | .

(ii) On a random variable level, ( Z x:n | ) 2 = ( Z x:n | ) 2 + ( Z x:n | ) 2 since Z x:n | ⋅ Z x:n | = 0 .
1 1 1 1

So the expectation calculations above should be clear.

(iii) WARNING: Var ( Z x:n | ) ≠ Var ( Z x:n | ) + Var ( Z x:n | ) It is easy to show that if
1 1

X and Y are random variables such that their product is 0, then


Cov( X , Y ) = − μ X ⋅ μ Y . Therefore the correct variance formula is

Var ( Z x:n | ) = Var ( Z x :n | ) + Var ( Z x :n | ) − 2 Ax :n | Ax :n |


1 1 1 1

(iv) We do not get the nice formula in the n = 1 case that we got in the
discrete case.

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Life Contingencies

4. n-year deferred whole life insurance

⎧0LT < n
PVRV = n | Z x = ⎨ = Z x − Z x:n |
1

⎩v LT ≥ n
T

SBP = APV = E[n| Z x ]= n| Ax = Ax − Ax:n| 1

2 2 2
E[( n | Z x ) 2 ]= n | Ax = Ax − Ax1 :n |

2
Therefore, Var ( n | Z x )= n | Ax −( n | Ax ) 2 .

Comments and Concepts: (These comments are analogues to the same


numbered comments in the n-year deferred whole life insurance payable
at the end of the year of death case – “the discrete case”.)

(i) We also have the following APV formula: n| A x = v n n p x A x +n

2 2
(ii) Remembering the meaning of 2 A , we also get n| A x = v 2 n ⋅n p x ⋅ A x +n

(iii) The ideas above can be extended to an n-year deferred, j-year term
insurance, or an n-year deferred, j-year pure endowment, or a … If you
are tested on one of these other insurance types, just use the basic
principals learned by studying the above insurances.

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Life Contingencies

Often Tested 1-Year Recursion Relationships

Ax = A x:1| + vp x Ax +1 = vq x + vp x Ax +1
1

A x:n| = A x:1| + vp x A x +1:n −1| = vq x + vp x A x +1:n −1|


1 1 1 1

A x:n| = A x:1| + vp x A x +1:n −1| = vq x + vp x A x +1:n −1|


1

The next three are the continuous analogues to the previous three.

A x = A x:1| + vp x A x +1
1

A x:n| = A x:1| + vp x A x +1:n −1|


1 1 1

A x:n| = A x1 :1| + vp x A x +1:n −1|

Non-unit Insurance (benefit payable at time T is bT)

PVRV = Z = bT v T (whole life)

⎧bT v T L T < n
Z =⎨ (n-year term)
⎩0 L T ≥ n
M
M
2
Z = bT2 v 2T (whole life)

2 ⎧bT2 v 2T L T < n
Z =⎨ (n-year term)
⎩0 L T ≥ n
M
M
Notice that E[Z2] will not equal 2A unless the benefit is 1.

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Life Contingencies

Annuity Present Value Random Variables


Single Life

Life Annuities (Due) Payable At The Beginning Of The Year


(all the following annuities have an annual payment of 1)

1. whole life annuity due

The probability distribution table for the PVRV, Y&&x , is

Y&&x Probability
a&&1| Pr(K = 0) = q x
a&&2| Pr(K = 1) = 1| q x
M M

K +1
1− v 1 − Zx
PVRV = Y&&x = a&&K +1| = =
d d

SBP = APV = E[Y&&x ] = a&&x = a&&1| ⋅ qx + a&&2| ⋅1| qx + L = 1 + vp x + v 2 ⋅2 px + L

Comments and Concepts:

1 − Z x ⎤ 1 − Ax
(i) a&&x = E[Y&&x ] = E ⎡⎢ ⎥= (equivalently, Ax = 1 − d ⋅ a&&x )
⎣ d ⎦ d

⋅ Var ( Z x ) = 2 ⋅ (2 Ax − ( Ax ) 2 )
1 1
(ii) Var (Y&&x ) = 2
d d

(iii) We can calculate probabilities involving the random variable Y by


rewriting the event in terms of the random variable K.

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Life Contingencies

2. n-year temporary life annuity due (pays 1 until the earlier of the death of
the annuitant or an n-year certain period)

The probability distribution table for the PVRV, Y&&x:n | , is

Y&&x :n | Probability
a&&1| Pr(K = 0) = q x
a&&2| Pr(K = 1) = 1| q x
a&&3| Pr(K = 2) = 2| q x
M M
a&&n| Pr(K = n − 1 ) = n −1| qx
a&&n| Pr(K ≥ n ) = n p x

⎧1 − v K +1
⎧a&&K +1| L K < n ⎪⎪ d L K < n 1 − Z x :n |
PVRV = Y&&x:n | = ⎪⎨ =⎨ =
⎪⎩a&&n| L K ≥ n ⎪1 − v L K ≥ n
n
d
⎩⎪ d

SBP = APV =
E[Y&&x :n | ] = a&&x :n | = a&&1| ⋅ qx + L + a&&n | ⋅n −1| qx + a&&n | ⋅n p x = 1 + vp x + v 2 ⋅2 p x + L + v n −1 ⋅n −1 p x

Comments and Concepts:

⎡1 − Z x :n | ⎤ 1 − Ax :n |
(i) a&&x:n | = E[Y&&x:n | ] = E ⎢ ⎥= (equivalently, Ax:n| = 1 − d ⋅ a&&x:n| )
⎣ d ⎦ d

(ii) Var (Y&&x:n | ) =


d
1
2
1
(
⋅ Var ( Z x:n | ) = 2 ⋅ 2 Ax :n | − ( Ax:n | ) 2
d
)
(iii) We denote the actuarial accumulated value (AAV) of an n-year
temporary annuity due by &s&x:n| and define it by the relationship
a&&x:n| a&&x:n| a&&x:n|
a&&x:n| = &s&x:n| ⋅ v n ⋅n p x . That is, &s&x:n| = = = .
v n ⋅n p x n Ex 1
A x:n|
(See page 44 for a more complete discussion on AAV’s.)

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Life Contingencies

3. n-year deferred life annuity due

The probability distribution table for the PVRV, n |Y&&x , is

n| x Y&& Probability
0 Pr(K < n) = n q x
n| a&&1| Pr(K = n) = n| q x
n| a&&2| Pr(K = n+1) = n +1| qx
M M

⎧⎪0L K < n
PVRV = n |Y&&x = n| a&&K +1−n| = ⎨ = Y&&x − Y&&x:n |
⎪⎩a&&K +1| − a&&n| L K ≥ n

SBP = APV = E[ n |Y&&x ]= n | a&&x = a&&x − a&&x:n | = v n ⋅n p x + v n +1⋅n +1 p x + L

Comments and Concepts:

(i) n| a&&x = v n ⋅n p x ⋅ a&&x + n

(ii) a&&x = a&&x:n| + n| a&&x = a&&x:n| + v n ⋅n p x ⋅ a&&x +n

⋅ v ⋅n p x ⋅ (a&&x + n − 2 a&&x + n )+ n2|a&&x (unlikely to see this on the exam)


2 2n
(iii) E[( n |Y&&x ) 2 ] =
d

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Life Contingencies

4. n-year certain and life annuity due (pays 1 until the later of the death of
the annuitant or an n-year certain period)

The probability distribution table for the PVRV, Y&&x:n | , is

Y&&x :n | Probability
a&&n| Pr(K < n) = n q x
a&&n +1| Pr(K = n) = n| q x
a&&n +2| Pr(K = n+1) = n +1| q x
M M

⎧a&& L K < n
PVRV = Y&&x:n | = a&&n | + n |Y&&x = ⎪⎨
n|

⎪⎩a&&K +1| L K ≥ n

SBP = APV = E[Y&&x:n | ] = a&&x:n | = a&&n | + n |a&&x

Comments and Concepts:

Observe that an n-year certain and life annuity due pays until the failure of
the last-survivor status x : n | (here, the “life” y is n | , an n-year certain
period). That is, the annuity pays until the later of the death of (x) and the
death of n | , or equivalently, it pays as long as (x) is alive, with a minimum
of n years.

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Life Contingencies

Life Annuities (Immediate) Payable At The End Of The Year


(all the following annuities have an annual payment of 1)

Comments and Concepts:

When dealing with annuities immediate, use the above formulas for
annuities due and relationships between annuities immediate and annuities
due.

Examples:

1. If Yx is the PVRV for a whole life annuity immediate, then Yx = Y&&x − 1 .


Then SBP = APV = a x = E[Yx ] = E[Y&&x − 1] = a&&x − 1 = v ⋅ p x + v 2 ⋅2 p x + L and
Var (Yx ) = Var (Y&&x ) .

Important Special Formula:


If i = 0, then a x = e x = E[ K ( x )]

2. If Y x:n | is the PVRV for an n-year temporary life annuity immediate,


then Y x:n | = Y&&x:n +1| − 1 . Then SBP = APV =

a x :n | = E[Y x :n | ] = E[Y&&x :n +1| − 1] = a&&x :n +1| − 1 = v ⋅ p x + v 2 ⋅2 p x + Lv n ⋅n p x and

Var (Y x:n | ) = Var (Y&&x:n +1| )

Important Special Formulas:


(i) If i = 0, then a x:n| = ex:n|
(ii) a x:n| = a&&x:n| − 1 + v n ⋅n p x = a&&x:n| − 1+ n E x

3. If n |Yx is the PVRV for an n-year deferred life annuity immediate, then
&& Then SBP = APV = E[ Y ]= a = a&& and
n |Yx = n +1|Yx . n| x n | x n +1| x

Var ( n |Yx ) = Var ( n +1|Y&&x )

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Life Contingencies

Continuous Life Annuities


(all the following annuities have an annual payment rate of 1)

1. whole life continuous annuity

1 − vT 1− Z x
PVRV = Y x = a T | = =
δ δ

∞ ∞
SBP = APV = E[Y x ] = a x = ∫0 a t | ⋅t p x ⋅ μ x (t )dt = ∫0 v t ⋅t p x dt

Comments and Concepts:

⎡1 − Z x ⎤ 1 − A x
(i) a x = E[Y x ] = E ⎢ ⎥= δ (equivalently, A x = 1 − δ ⋅ a x )
⎣ δ ⎦

(ii) Var (Y x ) =
δ
1
2
⋅ Var ( Z x ) =
δ
1
2
(
2
⋅ Ax − ( Ax )2 )
0
(iii) If i = 0, then a x = e x .

Important Comment on Notation: Just as with the case of insurance


payable at the moment of death, we are using a bar over Y to denote a
different random variable than the random variable Y. What we mean by
using the bar notation is that the annuity is paid continuously, and thus the
PVRV is a function of the complete future lifetime random variable, T.

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Life Contingencies

2. n-year temporary life continuous annuity

⎧a T | LT < n 1 − Z x :n |
PVRV = Y x:n | = ⎪⎨ =
⎪⎩a n | LT ≥ n δ

n n
SBP = APV = E[Y x:n | ] = a x:n | = ∫0 a t | ⋅t p x ⋅ μ x (t )dt + a n | ⋅n p x = ∫0 v t ⋅t p x dt

Comments and Concepts:

⎡1 − Z x :n | ⎤ 1 − A x :n |
(i) a x:n | = E[Y x:n | ] = E ⎢ ⎥= δ (equivalently, A x:n| = 1 − δ ⋅ a x:n| )
⎣ δ ⎦

(ii) Var (Y x:n | ) =


δ
1
2
⋅ Var ( Z x :n | ) =
1
δ 2
(2
⋅ Ax:n | − ( Ax :n | ) 2 )
0
(iii) If i = 0, then a x:n| = e x:n| .

(iv) We denote the actuarial accumulated value (AAV) of an n-year


temporary continuous annuity by s x:n| and define it by the relationship
a x:n| a x:n| a x:n|
a x:n| = s x:n| ⋅ v n ⋅n p x . Then s x:n| = = = .
v ⋅n p x n E x
n
1
A x:n|
(See page 44 for a more complete discussion on AAV’s.)

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Life Contingencies

3. n-year deferred whole life continuous annuity

⎧0LT < n ⎧0LT < n Z x:n | − Z x


PVRV = n |Y x = ⎨ =⎨ n = Y x − Y x :n | =
⎩a T | − a n | LT ≥ n ⎩v ⋅ a T − n | LT ≥ n δ

∞ ∞
SBP = APV = E[ n |Y x ]= n | a x = a x − a x:n | = ∫n v n ⋅ a t − n | ⋅t p x ⋅ μ x (t )dt = ∫n v t ⋅t p x dt

Comments and Concepts:

(i) n| a x = v n ⋅n p x ⋅ a x + n

(ii) a x = a x:n| + n| a x = a x:n| + v n ⋅n p x ⋅ a x +n

(iii) E[( n |Y x ) 2 ] =
δ
2
( 2
⋅ v 2 n ⋅n p x ⋅ a x + n − a x + n ) (unlikely to see this on the exam)

4. n-year certain and life continuous annuity

⎧a n | LT < n
PVRV = Y x:n | = a n | + n |Y x = ⎪⎨
⎪⎩a T | LT ≥ n

SBP = APV = E[Y x:n | ] = a x:n | = a n | + n | a x

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Life Contingencies

Life Annuities Due Payable mthly

These annuities also have an annual payment of 1. Thus the symbol C ⋅ a&&x( m )
C
represents the APV of a life annuity to (x) that pays at the beginning of
m
each of m periods per year for the life of (x). The total annual payment each
year is C.

Under the UDD assumption we have:

a&&x( m ) = α ( m ) ⋅ a&&x − β ( m ) and a&&x( :mn|) = α ( m ) ⋅ a&&x:n| − β ( m ) ⋅ (1− n E x )

where the values of α (m) and β (m) will be given in the tables

Often Tested 1-Year Recursion Relationships

a&&x = 1 + v ⋅ p x ⋅ a&&x +1
a&&x:n | = 1 + v ⋅ p x ⋅ a&&x +1:n −1|
a x = a x:1| + v ⋅ p x ⋅ a x +1
a x:n | = a x:1| + v ⋅ p x ⋅ a x +1:n −1|
a x = v ⋅ p x + v ⋅ p x ⋅ a x +1 = v ⋅ p x ⋅ (1 + a x +1 )

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Life Contingencies

Insurance and Annuity Present Value Random Variables


Multiple Life

Contingent Insurance Payable at the Moment of Death

Type 1: Pays 1 on the death of (x) if (x) dies first



SBP = APV = A x y = ∫0 v t ⋅ t p xy ⋅ μ x (t )dt
1

Type 2: Pays 1 on the death of (x) if (x) dies second



SBP = APV = A x y = ∫0 v t ⋅ t q y ⋅ t p x ⋅ μ x (t )dt
2

Interchange the roles of (x) and (y) to get similar formulas for insurance
payable on the death of (y).

Contingent insurance payable at the end of the year of death


(Use summations instead of integrals)

Contingent Insurance Relationships

1. A x = A x1 y + A x2 y

2. A y = A x y1 + A x y2

3. A xy = A x1 y + A x 1y

4. A xy = A x2 y + A x y2

There are similar relationships in the discrete case, i.e. no bars.

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Life Contingencies

Continuous Insurance and Annuities for Joint-Life Status


(Replace x in all single life formulas by xy)

1. A xy = E[v T ( xy ) ] = ∫0 v t ⋅t p xy ⋅ μ xy (t )dt


A xy = E[v 2T ( xy ) ] = ∫ v 2 t ⋅t p xy ⋅ μ xy (t )dt
2
2. 0
2
So Var ( Z xy ) = Axy − ( Axy ) 2 = variance of PVRV for insurance that pays 1 at
the moment of the first death of (x) or (y)

∞ 1 − A xy
3. a xy = ∫0 v t ⋅t p xy dt =
δ

n 1 − A xy:n|
4. a xy:n| = ∫0 v t ⋅t p xy dt =
δ
This is the APV of an n-year temporary life annuity that pays continuously
at a rate of 1 per year for the joint lifetimes of (x) and (y). This annuity
pays until failure of the xy : n | status, which fails at the first of the death
of (x), the death of (y), and the death of n | . That is, the annuity pays until
the first of the death of (x) or the death of (y), up to a maximum of n years.
n
5. A xy:n| = ∫0 v t ⋅t p xy ⋅ μ xy (t )dt
1

6. Var (Y xy ) =
1
δ 2
(A 2
xy )
− ( Axy ) 2 = variance of PVRV for a continuous annuity

that pays 1 per year for as long as the joint-life status (xy) survives, i.e. as
long as both (x) and (y) are alive.
M
You get the idea.

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Life Contingencies

Discrete Insurance and Annuities for Joint-Life Status


(Replace x in all single life formulas by xy)


1. Axy = E[v K ( xy )+1 ] = ∑ v k +1 ⋅k | q xy
k =0


2. 2
Axy = E[v 2 ( K ( xy ) +1) ] = ∑ v 2 ( k +1) ⋅k | q xy
k =0

So Var ( Z xy ) = Axy − ( Axy ) 2 = variance of PVRV for insurance that pays 1 at the
2

end of the year of the first of the death of (x) or the death of (y)

n −1
3. Axy:n| = A xy:n| + v n ⋅n p xy = ∑ v k +1 ⋅k | q xy + v n ⋅n p xy
1

k =0

∞ 1 − Axy
4. a&&xy = ∑ v k ⋅k p xy =
k =0 d

n −1 1 − Axy:n|
5. a&&xy:n| = ∑ v k ⋅k p xy =
k =0 d

6. Var (Y&&xy :n | ) =
1
d2
(A
2
xy : n |
)
− ( Axy :n | ) 2 = variance of PVRV for an n-year temporary

life annuity due that pays 1 at the beginning of each year that the joint-life
status xy : n | survives, i.e. as long as both (x) and (y) are alive, up to a
maximum of n years.
M
You get the idea.

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Life Contingencies

Insurance and Annuities for Last-Survivor Status


Method 1: Replace x in all single life formulas by xy , or this is the same as
replacing the subscript xy in the joint-life status formulas above by xy .

Method 2: (This can make many computations much easier.) Make use of the
following relationships.

Often Used Relationships Between Joint-Life and Last-Survivor Statuses


Note: T ( xy ) + T ( xy ) = T ( x ) + T ( y ) and T ( xy ) ⋅ T ( xy ) = T ( x ) ⋅ T ( y )

1. t p xy + t p xy = t p x + t p y

2. t q xy + t q xy = t q x + t q y

0 0 0 0
3. e xy + e xy = e x + e y

4. e xy + e xy = e x + e y

5. Axy + Axy = Ax + Ay

6. a xy + a xy = a x + a y

7. Axy:n| + Axy:n| = Ax:n| + Ay:n|

8. A xy:n| + A xy:n| = A x:n| + A y:n|


1 1 1 1

9. a xy:n| + a xy:n| = a x:n| + a y:n|

10. n| a xy + n| a xy = n| a x + n| a y

11. Cov(T ( xy ), T ( xy )) = Cov(T ( x ), T ( y )) + ⎛⎜ e x − e xy ⎞⎟ ⋅ ⎛⎜ e y − e xy ⎞⎟


0 0 0 0

⎝ ⎠ ⎝ ⎠

There are formulas in the continuous case too ( a ’s and A ’s), and there are
other formulas, e.g. n-year deferred insurance, pure endowments, ….

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Life Contingencies

Loss Random Variables and Reserves

We focus on the single life case with issue age x. The ideas can be extended
to the multiple life case, as will be seen in some of the examples that we’ll do.

Loss-at-issue Random Variable

Suppose insurance is purchased with annual premiums of Q. Then the


random variable representing the loss-at-issue will be of the form L = Z − Q ⋅ Y .

Examples:

1a. Fully Continuous Whole Life Insurance of 1 with premiums of Q for life
1− Z x
⎛ Q⎞ Q
L = Z x − Q ⋅Y x = Z x − Q ⋅ = ⎜1 + ⎟ ⋅ Z x −
δ ⎝ δ⎠ δ
⎛ Q⎞ Q
E [ L] = A x − Q ⋅ a x = ⎜1 + ⎟ ⋅ A x −
⎝ δ⎠ δ

( ) ( )
2 2
⎛ Q⎞ ⎛ Q⎞ 2
Var ( L) = ⎜1 + ⎟ ⋅ Var Z x = ⎜1 + ⎟ ⋅ Ax − ( Ax ) 2
⎝ δ⎠ ⎝ δ⎠

1b. Fully Discrete Whole Life Insurance of 1 with premiums of Q for life
1 − Zx ⎛ Q ⎞ Q
L = Z x − Q ⋅ Yx = Z x − Q ⋅ = ⎜1 + ⎟ ⋅ Z x −
d ⎝ d⎠ d
⎛ Q⎞ Q
E[ L] = Ax − Q ⋅ a&&x = ⎜1 + ⎟ ⋅ Ax −
⎝ d⎠ d
2 2

Var ( L) = ⎜1 + ⎟ ⋅ Var (Z x ) = ⎜1 + ⎟ ⋅ (2 Ax − ( Ax ) 2 )
⎛ Q⎞ ⎛ Q⎞
⎝ d⎠ ⎝ d⎠

2a. Fully Continuous n-year Endowment Insurance of 1 with premiums of Q


1 − Z x:n | ⎛ Q⎞ Q
L = Z x :n | − Q ⋅ Y x :n | = Z x :n | − Q ⋅ = ⎜1 + ⎟ ⋅ Z x :n | −
δ ⎝ δ⎠ δ
⎛ Q⎞ Q
E[ L] = A x:n| − Q ⋅ a x:n| = ⎜1 + ⎟ ⋅ A x:n| −
⎝ δ⎠ δ

( ) ( )
2 2
⎛ Q⎞ ⎛ Q⎞ 2
Var ( L) = ⎜1 + ⎟ ⋅ Var Z x :n | = ⎜1 + ⎟ ⋅ Ax:n | − ( Ax :n | ) 2
⎝ δ⎠ ⎝ δ⎠

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Life Contingencies

2b. Fully Discrete n-year Endowment Insurance of 1 with premiums of Q


1 − Z x :n |
⎛ Q⎞ Q
L = Z x:n | − Q ⋅ Y&&x :n | = Z x :n | − Q ⋅ = ⎜1 + ⎟ ⋅ Z x : n | −
d ⎝ d⎠ d
⎛ Q⎞ Q
E[ L] = Ax:n| − Q ⋅ a&&x:n| = ⎜1 + ⎟ ⋅ Ax:n| −
⎝ d⎠ d

( ) ( )
2 2
⎛ Q⎞ ⎛ Q⎞
Var ( L) = ⎜1 + ⎟ ⋅ Var Z x:n | = ⎜1 + ⎟ ⋅ 2 Ax :n | − ( Ax:n | ) 2
⎝ d⎠ ⎝ d⎠

You get the idea. There are many combinations of the type of insurance
purchased and the method of paying premiums. We use one more example
to illustrate the concept of the loss-at-issue random variable.

3. Insurance – n-year term with benefit of 1 payable at the moment of death


Premiums - paid at the beginning of each year for h ( ≤ n) years

(This is called h-payment, n-year term insurance. During the first h


years, premiums are paid while living and the benefit is paid upon death.
During the next n – h years, the insurance is already paid in full and so no
premiums are paid, but the benefit is still paid upon death. After n years,
the policy has expired and no benefit will be paid upon death.)

L = Z x :n | − Q ⋅ Y&&x :h |
E [ L] = A x:n| − Q ⋅ a&&x:h|
1

(If you’re asked about variance of this one, skip it. ☺)

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Life Contingencies

Calculating Premiums

Method 1: Percentiles
The premium Q is found by solving a probability equation such as
Pr( L > 0) = 0.05 (probability of a positive loss is 5%). This equation can
be solved by writing the event first in terms of the random variable Z and
then in terms of the random variable T (or K). Then use the distribution
of T (or K) to solve the probability equation. We will illustrate this with
examples.

Method 2: Equivalence Principle


The premium when found using the equivalence principle is called the
benefit premium.

The premium Q is found by solving the equation E[ L] = 0 . This is the


same equation as the one obtained by setting the APV at issue of benefits
equal to the APV at issue of premiums.

Examples and Notation:

1. For fully discrete insurance of 1, benefit premiums are

Ax
Px = = whole life insurance with premiums paid for life
a&&x

A x1 :n|
P x1 :n| = = n-year term insurance with at most n premiums
a&&x:n|

Ax:n|
h Px:n| = = h-payment n-year endowment insurance
a&&x:h|
M
You get the idea.

Important Fact: Px:n| = P x:n| + P x:n|


1 1

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Life Contingencies

2. For fully continuous insurance of 1, benefit premiums are

Ax
P( A x ) = = whole life insurance with premiums paid for life
ax

Ax
P ( n| A x ) =
n|
k = k-payment n-year deferred whole life insurance
a x:k |
M
You get the idea.

3. For semi-continuous insurance of 1, benefit premiums are

Ax
P( A x ) = = whole life insurance with premiums paid for life
a&&x

A x1 :n|
h P ( A x:n| ) = = h-payment n-year term insurance
1

a&&x:h|
M
You get the idea. Notice the notation suggests, as is correct, that
the benefit is paid at the moment of death, and the premiums are
paid at the beginning of each year.

4. mthly benefit premiums

Ax
Px(12 ) = = fully discrete whole life insurance with premiums
a&&x(12 )
Px(12 )
of paid at the beginning of each month for life
12

A x:n|
P ( 4 ) ( A x:n| ) = = semi-continuous n-year endowment insurance
a&&x( 4:n)|
P ( 4 ) ( A x:n| )
with premiums of paid at the beginning
4
of each quarter until death of the insurance expires
M
You get the idea.

Paris’s Exam MLC Seminar Page 40 of 52


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Life Contingencies

Special Relationships When Using Benefit Premiums


Fully Continuous or Fully Discrete Whole Life or Endowment Insurance

For fully continuous or fully discrete whole life insurance or endowment


insurance, the variance of the loss-at-issue random variable had a factor of
⎛ Q⎞ ⎛ Q⎞
⎜1 + ⎟ (continuous case) or ⎜1 + ⎟ (discrete case).
⎝ δ⎠ ⎝ d⎠

If Q is the benefit premium, then we have

Ax
1. Fully Continuous Whole Life - Q = P( A x ) =
ax

⎛ Q⎞ Ax δ ⋅ a x + Ax 1 1
⎜1 + ⎟ = 1 + = = =
⎝ δ⎠ δ ⋅ax δ ⋅ax δ ⋅ a x 1 − Ax

A x:n|
2. Fully Continuous n-year Endowment Insurance - Q = P( A x:n| ) =
a x:n|

⎛ Q⎞ A x:n| δ ⋅ a x:n| + A x:n| 1 1


⎜1 + ⎟ = 1 + = = =
⎝ δ⎠ δ ⋅ a x:n| δ ⋅ a x:n| δ ⋅ a x:n| 1 − A x:n|

Ax
3. Fully Discrete Whole Life - Q = Px =
a&&x

⎛ Q⎞ Ax d ⋅ a&&x + Ax 1 1
⎜1 + ⎟ = 1 + = = =
⎝ d⎠ d ⋅ a&&x d ⋅ a&&x d ⋅ a&&x 1 − Ax

Ax:n|
4. Fully Discrete n-year Endowment Insurance - Q = Px:n| =
a&&x:n|

⎛ Q⎞ Ax:n| d ⋅ a&&x:n| + Ax:n| 1 1


⎜1 + ⎟ = 1 + = = =
⎝ d⎠ d ⋅ a&&x:n| d ⋅ a&&x:n| d ⋅ a&&x:n| 1 − Ax:n|

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Life Contingencies

Prospective Loss At Time t Random Variable

Notation: t L denotes the prospective loss at time t random variable

t L = PVFBRVx +t − PVFPRV x +t , where

PVFBRVx+t = PVRV of Future Benefits from age x + t, and


PVFPRVx+t = PVRV of Future Premiums from age x + t

Note: 0 L = L = loss-at-issue random variable.

Terminal (End of Year) Reserves

Notation: tV denotes the tth year terminal (EOY) reserves

V = E[ t L | T ( x) ≥ t ]
t ( tV = E[ t L | K ( x) ≥ t ] in the discrete case)

Prospective Calculation of Reserves:

V = APVFBx +t − APVFPx +t , where


t

APVFBx+t = APV of Future Benefits from age x + t, and


APVFPx+t = APV of Future Premiums from age x + t

Benefit reserves means the premiums are the benefit premiums. Benefit
reserves can be calculated either prospectively or retrospectively.

Retrospective Calculation of Benefit Reserves: [See Page 44 for a


discussion of Actuarial Accumulated Value (AAV) of contingent payments.]

V = AAVPPx +t − AAVPB x +t , where


t

AAVPPx+t = AAV of Past Premiums up to age x + t, and


AAVPBx+t = AAV of Past Benefits up to age x + t

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Life Contingencies

Examples of Prospective Terminal Benefit Reserves and Notation:


(Insurance Benefit = 1)

1. Fully Discrete Whole Life Insurance

V x = Ax +t − Px a&&x + t
t

2. Fully Discrete n-year Pure Endowment

V x:n| = A x +t:n −t| − P x:n| a&&x +t:n −t| (Important Fact: V x:n| = 1 )
1 1 1 1
t n

3. Fully Discrete n-year Endowment Insurance

V x:n| = Ax +t:n −t| − Px:n| a&&x + t:n −t| = t V x1 :n| + t V x:n| (Important Fact: nV x:n| = 1 )
1

4. Fully Discrete h-payment Whole Life Insurance

⎧⎪ Ax +t − h Px a&&x +t:h −t| Lt < h


h
t Vx = ⎨
⎪⎩ Ax +t Lt ≥ h

5. Fully Continuous n-year Term Insurance

V ( A x:n| ) = A x +t:n −t| − P( A x:n| ) ⋅ a x +t:n −t|


1 1 1
t

6. Fully Continuous n-year Deferred Life Annuity

⎧⎪ n −t| a x +t − P( n| a x ) ⋅ a x + t:n −t| L t < n


t V ( n| a x ) = ⎨
⎪⎩ a x + t Lt ≥ n

7. Semi-continuous Whole Life Insurance

V ( A x ) = A x +t − P ( A x ) ⋅ a&&x +t
t

M
You get the idea.

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Life Contingencies

Special Benefit Reserve Formulas


Whole Life and Endowment Insurance

a&&x +t P − P x:t|
1

1. tV x = 1 − = ( Px + t − Px ) ⋅ a&&x +t = x
a&&x 1
P x:t|

a&&x + t :n − t |
2. tVx:n| = 1 − = ( Px + t :n − t | − Px:n| ) ⋅ a&&x + t :n − t |
a&&x:n|

P( A x ) − P( A x:t| )
1
a
3. t V ( A x ) = 1 − x +t = [ P( A x +t ) − P( A x )] ⋅ a x +t = 1
ax P( A x:t| )

a x + t :n − t |
4. t V ( A x:n| ) = 1 − = [ P ( A x + t :n − t | ) − P ( A x:n| )] ⋅ a x + t :n − t |
a x:n |

Terminal vs Initial Reserves and Retrospective Actuarial Calculations

Calculate terminal reserves for the tth year by calculating reserves at the end
of the tth year. In a prospective calculation, the benefit for the tth year will
not be included, but the premium for the (t+1)st year is included.

Calculate initial reserves for the tth year by calculating reserves at the
beginning of the tth year. In a prospective calculation, the premium for the tth
year will not be included.

The initial reserves for the (t+1)st year will exceed the terminal reserves for
the tth year by the amount of premium paid at time t.

The retrospective calculation of reserves relies on being able to calculate the


Actuarial Accumulated Value (AAV) of contingent payments. For a
contingent payment at time k, the AAV at time n is calculated by actuarially
accumulating the APV at time 0 of the contingent payment to time n. The
APV at time 0 of a contingent payment is the interest discounted value of the
expected payment. If a payment C is made at time k contingent on event E,
then the APV at time 0 of the payment is C ⋅ Pr( E ) ⋅ v k . The AAV at time n of
C ⋅ Pr( E ) ⋅ v k C ⋅ Pr( E ) ⋅ (1 + i )
n −k
1
this payment is AAVn = APV0 ⋅ = = .
n Ex v n n px n px

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Life Contingencies

Special Variance Formulas for


(Conditional) Loss At Time t Random Variable
Fully Continuous or Fully Discrete Whole Life or Endowment Insurance

For fully continuous or fully discrete whole life insurance or endowment


insurance, the variance of the (conditional) loss at time t random variable is
(See P. 33 of these notes.)

1. Fully Continuous Whole Life Insurance

(A ) (A )
2
⎛ P( A x ) ⎞
2
⎛ 1 ⎞
Var ( t L | T ( x) ≥ t ) = ⎜⎜1 + ⎟ ⋅
2 2
− ( A x +t ) = ⎜2
⎟ ⋅ − ( A x +t ) 2
δ ⎟⎠
x +t x +t
⎝ ⎝1 − Ax ⎠

2. Fully Continuous n-year Endowment Insurance (t < n)

(A )
2
⎛ P ( A x :n | ) ⎞
Var ( t L | T ( x ) ≥ t ) = ⎜⎜ 1 + ⎟ ⋅
2
⎟ x + t :n − t | − ( A x + t :n − t | ) 2
⎝ δ ⎠

(A )
2
⎛ 1 ⎞ 2
= ⎜⎜ ⎟⎟ ⋅ x + t :n − t | − ( A x + t :n − t | ) 2
⎝ 1 − A x :n | ⎠

3. Fully Discrete Whole Life Insurance


2
⎛ 1 ⎞ 2
2
⎛ P ⎞
(
Var ( t L | K ( x) ≥ t ) = ⎜1 + x ⎟ ⋅ 2 Ax + t − ( Ax +t ) 2 = ⎜⎜ ) (
⎟⎟ ⋅ Ax +t − ( Ax +t ) 2 )
⎝ d ⎠ ⎝ 1 − Ax ⎠

4. Fully Discrete n-year Endowment Insurance (t < n)


2
⎛ 1 ⎞
2

Var ( t L | K ( x) ≥ t ) = ⎜1 +

Px:n|
d

⎟ ⋅

(A
2
x + t ::n − t |
− ( Ax + t::n −t | ) = ⎜
2
)
⎜1 − A ⎟
⎟ ⋅ (A
2
x + t ::n − t |
− ( Ax + t::n −t | ) 2 )
⎝ ⎠ ⎝ x:n| ⎠

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Life Contingencies

Recursive Relationship for Insurance Terminal Reserves


(often tested)

tV = bt +1 ⋅ v ⋅ q x +t − Qt + t +1V ⋅ v ⋅ p x +t , where

Qt = premium at time t, and


bt+1 = death benefit at time t+1

Recursive Relationship for Variance of


(Conditional) Loss At Time t Discrete Random Variable

Var ( t L | K ( x) ≥ t ) = (v(bt +1 − t +1V )) ⋅ p x + t ⋅ q x +t + v 2 ⋅ p x +t ⋅ Var ( t +1 L | K ( x) ≥ t + 1)


2

where bt+1 = death benefit at time t+1

Approximating Benefit Reserves at Fractional Durations


(0 < s < 1)

t+s V = (1 − s )( t V + Qt ) + s ( t +1V ) = (1 − s )( t V ) + s ( t +1V ) + (1 − s )(Qt )

where Qt = premium at time t

Note: (1 − s)(Qt ) is called the unearned premium

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Life Contingencies

Expense Augmented Models

Unless otherwise stated, assume expenses are paid BOY


Exception: Settlement expenses are paid at the time benefit is paid

Replace “benefits” by “benefits plus expenses” and replace “premiums” by


“expense loaded premiums” in the random variable expressions discussed
above. All formulas use the same concept as in the non-expense model.
The following illustrates this.

Recursion Relation for Expense Augmented Terminal Reserves

Vea = (bt +1 + se) ⋅ v ⋅ q x + t + E t − Qt + t +1Vea ⋅ v ⋅ p x + t , where


t

V = expense augmented terminal reserves at time t


t ea

se = settlement expenses
Et = BOY expenses paid at time t
Qt = expense loaded premium at time t (usually more in 1st year)

Comments on Expense Loaded Premiums

1. Generally, part of the expense loaded premium will depend on the face
amount of the policy. The amount of the expense loaded premium that
does not depend on the face amount of the policy is called the policy fee.

2. Letting Qt denote the expense loaded premium at time t, and letting Pt


denote the benefit premium at time t, then et = Qt – Pt is called the
expense loading at time t.

3. The expense loaded premium pays expenses, but not any profit. The
contract premium is charged in order to expect a profit.

Separating Benefits and Expenses in an Expense Augmented Model

V = tVben + tVexp , where


t ea

V
t ben = reserves as before in the non-expense model (using the premiums Qt)
V
t exp = expense reserves
= APVF(expenses)x+t – APVF(expense loadings)x+t

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Life Contingencies

Multiple Decrement Models


Two random variables:
T(x) – future lifetime of (x) random variable
J – mode of decrement random variable

Notation:
t q x( j ) = Pr((x) departs within t years by decrement j)

t p x( j ) has no meaning

t q x(τ ) = Pr((x) departs within t years) = ∑ j


t q x( j )

t p x(τ ) = Pr((x) survives all decrements for t years) = 1− t q x(τ )

μ x( j ) (t ) = force of mortality due to decrement j

μ x(τ ) (t ) = total force of mortality = ∑μ


j
( j)
x (t)

Multiple Decrement Service Table Notation

l x(τ ) = the total number that have survived all decrements to age x

l x( j ) = the total number at age x that will eventually depart by cause j

n d x(τ ) = the total number departing in next n years

∞ d x(τ ) = l x(τ )

n d x( j ) = the total number departing in next n years by cause j

∞ d x( j ) = l x( j )

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Life Contingencies

Multiple Decrement Model Facts:

1. f T ,J (t , j )= t p x(τ ) ⋅ μ x( j ) (t )

2. f T (t )= t p x(τ ) ⋅ μ x(τ ) (t )

3. f J ( j ) = ∫0 t p x(τ ) ⋅ μ x( j ) (t )dt = ∞ q x( j )

t d x(τ )
4. t q x(τ ) = ∫0 s p x(τ ) ⋅ μ x(τ ) ( s )ds = t
l x(τ )

t d x( j )
5. t q x( j ) = ∫0 s p x(τ ) ⋅ μ x( j ) ( s )ds = t
l x(τ )

⎧ t p x(τ ) − t +u p x(τ )
⎪ d (τ )
6. t |u q x(τ ) = ⎨ t +u q x(τ ) − t q x(τ ) = u (τx)+t
⎪ p (τ ) ⋅ q (τ ) lx
⎩ t x u x +t

(τ ) d x( +j )t
7. t |u q =t p ⋅ q
( j)
x x u
( j)
x +t = (τ ) u
lx

0 (τ ) ∞
8. E[T ] = e x = ∫0 t p x(τ ) dt = expected time until decrement

9. Pr( K ( x ) = k ) = Pr( k ≤ T ( x ) < k + 1)= k | q x(τ )

μ x( j ) (t )
10. Pr( J = j | T = t ) = f J |T ( j | t ) =
μ x(τ ) (t )

q x( j )
11. Pr( J = j | T ≤ t ) = t
(τ )
t qx

f T , J (t , j )
12. f T |J (t | j ) =
f J ( j)

∞ f T , J (t , j )
13. E[T | J = j ] = ∫0 t ⋅ dt = expected time until departure, given the cause
f J ( j)
is by decrement j

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Life Contingencies

Associated Single Decrement Tables (Absolute Rates of Decrement)


(Associated single decrement events are independent)

Probability Formulas:
d
t
− [ t p ′x( j ) ]
p ′x( j ) = exp(− ∫ μ x( j ) ( s )ds) ⇒ μ x( j ) (t ) = dt
t
0
t px
′( j )

t
t q ′x( j ) = 1− t p ′x( j ) = ∫ s p ′x( j ) ⋅ μ x( j ) ( s )ds
0

t p x(τ ) = ∏ t p ′x( j )
j

Calculating Total Probabilities:

If given associated single decrement probabilities (primes) then calculate


total probabilities by

t p x(τ ) = ∏ t p ′x( j ) and t q x(τ ) = 1− t p x(τ )


j

If given multiple decrement probabilities (no primes) then calculate total


probabilities by

t q x(τ ) = ∑ t q x( j ) and t p x(τ ) = 1− t q x(τ )


j

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Life Contingencies

Relating Multiple Decrement Probabilities (no primes) to


Associated Single Decrement Probabilities (primes)

Two Cases:

Case 1: MUDD
( t qx( j ) = t ⋅ qx( j ) ; UDD assumption in the multiple decrement model)
q x( j )
(τ )
Important Formula: s p′
x
( j)
=( s p )
x
q x( t )

Case 2: SUDD
( t q′x( j ) = t ⋅ q′x( j ) ; UDD assumption in the associated single decrement model)

Important Formulas: q x(1) = q′x(1) ⋅ ⎛⎜1 − q′x( 2 ) ⎞⎟ (2 decrement case)


1
⎝ 2 ⎠

⎛ 1 1 ⎞
q x(1) = q′x(1) ⋅ ⎜1 − ( q′x( 2 ) + q′x( 3) ) + q′x( 2 ) ⋅ q′x( 3) ⎟ (3 decrement case)
⎝ 2 3 ⎠

Interchange the roles of the superscripts to get probabilities of departing


by causes other than cause 1. For example, interchanging the roles of 1
and 2 in the 3 decrement case gives us the probability

⎛ 1 1 ⎞
q x( 2 ) = q′x( 2 ) ⋅ ⎜1 − ( q′x(1) + q′x( 3) ) + q′x(1) ⋅ q′x( 3) ⎟
⎝ 2 3 ⎠

It is unlikely that you will see more than 3 decrements.

Timing of Decrements
If some decrements happen at a fixed point in time, then calculate 1-year
mortality probabilities in the associated single decrement table by using the
d x( j )
formula q ′x( j ) = ( j)
, where NAR x( j ) is the number at risk for decrement j, at
NAR x
d x( j )
age x. Note that q ( j)
x = always.
lx

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Life Contingencies

Asset Shares
This concept is based on a double decrement model, death and withdrawal. The
death benefit at time h is denoted by h DB . If withdrawal occurs at time h, then
a cash value, denoted h CV , is paid at that time. We let h AS denote the asset
share at time h. Assume 0 AS = 0 . There are two main formulas.

Recursion Formula:

h AS + G (1 − ch ) − E h =( h +1 DB + h +1 se) ⋅ v ⋅ q x( d+h) + ( h +1 CV + h +1 se) ⋅ v ⋅ q x( w+ h) + v ⋅ p x(τ+)h ⋅h +1 AS

where G = contract premium


ch = percentage of contract premium expense at time h
Eh = other non-settlement expenses at time h
h+1se = settlement expenses at time h+1
q x(d+ h) = probability that (x+h) dies by age x+h+1
q x( w+ h) = probability that (x+h) withdraws by age x+h+1

Time 0 Actuarial Present Value Formula:

APV0 ( n AS ) = v n ⋅n p x(τ ) ⋅n AS
= APV0(Premiums paid from time 0 through n-1, backing
out non-settlement expenses)
– APV0(Benefits + settlement expenses from time 1 through n)

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