Financial Actuary Life Tables - Practicing in R

Department of Financial Engineering

Universidad Autónoma de Bucaramanga
Deadline: 11/05/2020

Practice 1: Life Annuities

To survive or not to survive

Cynthia is 20 years old and joins the actuarial department of an insurance company for
a summer internship. As a first challenge Cynthia’s supervisor asks her to compare the (ex-
pected) present values of a pure endowment on the one hand versus a guaranteed payment
on the other hand.

In this chapter you will always work with the 1999 period life table for females in Belgium
of which the one-year survival probabilities px have been preloaded as px. For this exercise
you will consider a single payment of 10,000 EUR and a constant interest rate i = 2%.
1 # PV of guaranteed payment of 10 ,000 in 5 years
2 PV <- _ _ _ * ( _ _ _ ) ^ _ _ _
3 PV
4
5 # 5 year survival probabilities of (20)
6 kpx <- _ _ _ ( px [( _ _ _ ) :( _ _ _ ) ])
7
8 # EPV of pure endowment of 10 ,000 in 5 years for (20)
9 ___
Listing 1: R example
Short- and long-term

Let’s discover what happens to the present value of the guaranteed payment and the pure
endowment of 10,000 EUR when you change the time horizon from 5 to 10 or 30 years. The
interest rate is still constant at 2% and the survival probabilities px have been preloaded.
1 # PV of guaranteed payments of 10 ,000 in 5 , 10 and 30 years
2 PV <- _ _ _ * ( _ _ _ ) ^ - c ( _ _ _ )
3 PV
4

5 # Survival probabilities of (20)

6 kpx <- _ _ _ ( px [( _ _ _ ) : _ _ _ ])
7
8 # EPV of pure endowments of 10 ,000 in 5 , 10 and 30 years for (20)
9 ___ * ___[c(___)]
Listing 2: R example
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Practice 2: The whole, temporary and deferred life annuity

Ages, interest rates and the whole life annuity

To gain some intuition, Cynthia plotted the expected present values ax of a whole life
annuity due (with constant benefits of 1 EUR) for varying ages x from 0 to 100 and for five
different interest rates i. Do it.
A function to price a life annuity

Cynthia’s internship supervisor does not have much experience with R. He asks her to
write an R function that calculates the EPV of a (whole) life annuity due on (x) for a given
constant interest rate i and life table.

Benefits 1 1 1 1 1 1 ...

Time 0 1 2 3 4 5 ...

Discount Factors 1 v(1) v(2) v(3) v(4) v(5) ...

Survival Probabilities 1 1 px 2 px 3 px 4 px 5 px ...

äx For constant benefit of 1 EUR and constant discount factor v.

Since the benefit is constant at 1 EUR, there is no need to take it explicitly into account
in the calculations.
1 # Function to compute the EPV of a whole life annuity due for a given age ,
interest rate i and life table
2 life _ annuity _ due <- function ( age , i , life _ table ) {
3 px <- _ _ _
4 kpx <- c ( _ _ _ , _ _ _ ( px [( _ _ _ ) : length ( px ) ]) )
5 discount _ factors <- ( _ _ _ ) ^ - (0:( _ _ _ ) )
6 sum ( discount _ factors * kpx )
7 }
8

9 # EPV of a whole life annuity due for (20) at interest rate 2% using life _
table
10 life _ annuity _ due ( _ _ _ , _ _ _ , _ _ _ )
11
12 # EPV of a whole life annuity due for (20) at interest rate 5% and for
(65) at interest rate 2% using life _ table
13 life _ annuity _ due ( _ _ _ , _ _ _ , _ _ _ )
14 life _ annuity _ due ( _ _ _ , _ _ _ , _ _ _ )
Listing 3: R example
Immediate vs due

As a follow-up assignment Cynthia’s supervisor asks her to figure out how to adjust the
script for an immediate life annuity in which the payments start after one year.
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Benefits 1 1 1 1 1 1 ...

Time 0 1 2 3 4 5 ...

Discount Factors 1 v(1) v(2) v(3) v(4) v(5) ...

Survival Probabilities 1 1 px 2 px 3 px 4 px 5 px ...

ax For constant benefit of 1 EUR and constant discount factor v.

The Belgian 1999 female life table is preloaded as life table and the solution code from
the previous exercise is given as a starting point. Type life annuity due to the console if
you want to recall the function definition.
1 # EPV of a whole life annuity due for (20) at interest rate 2% using life _
table
2 life _ annuity _ due (20 , 0.02 , life _ table )
3
4 # Function to compute the EPV of a whole life immediate annuity for a
given age , interest rate i and life table
5 life _ immediate _ annuity <- function ( age , i , life _ table ) {
6 px <- _ _ _
7 kpx <- _ _ _ ( px [( age + 1) : length ( px ) ])
8 discount _ factors <- ( _ _ _ ) ^ - ( _ _ _ )
9 sum ( _ _ _ )
10 }
11

12 # EPV of a whole life immediate annuity for (20) at interest rate 2% using
life _ table
13 life _ immediate _ annuity ( _ _ _ , _ _ _ , _ _ _ )
Listing 4: R example
Temporary vs lifelong

Finally, can you assist Cynthia in writing a function for a temporary life annuity due in
which the payments are restricted in time? The first payment takes place at time 0 and the
last at time n − 1.
Benefits 1 1 1 ... 1 0 0
...
Time 0 1 2 n-1 1 n+1
...
Discount Factors 1 v(1) v(2) v(n − 1)

1 px 2 px
... n−1 px
Survival Probabilities 1

äx:n For constant benefit of 1 EUR and constant discount factor v.

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Both life table and the R function life annuity due are still available in your workspace.
1 # EPV of a whole life annuity due for (20) at interest rate 2% using life _
table
2 life _ annuity _ due (20 , 0.02 , life _ table )
3
4 # Function to compute the EPV of a temporary life annuity due for a given
age , period of n years , interest rate i and life table
5 temporary _ life _ annuity _ due <- function ( age , n , i , life _ table ) {
6 px <- 1 - life _ table $ qx
7 kpx <- c (1 , cumprod ( px [( _ _ _ ) :( _ _ _ ) ]) )
8 discount _ factors <- (1 + i ) ^ - (0:( _ _ _ ) )
9 ___
10 }
11
12 # EPV of a temporary life annuity due for (20) over 10 years at interest
rate 2% using life _ table
13 temporary _ life _ annuity _ due ( _ _ _ , _ _ _ , _ _ _ , _ _ _ )
Listing 5: R example
Practice 3: Guaranteed payments
Pension calculations ignoring mortality

Cynthia’s supervisor wants to stimulate her awareness of the time value of money and the
use of survival probabilities in retirement calculations. He asks Cynthia to run some pension
calculations - with and without taking mortality into account - for her own situation, that
is a female living in Belgium, aged 20.
Cynthia comes up with a scenario in which her future employer pays her a pension from
age 65 on until age 100. Her first yearly pension payment in this scenario equals 20,000 EUR
and builds up each year with 2% (to offset inflation). Assume that the interest rate for the
next 45 years is 3% and 4% thereafter.
What is the present value when mortality is not taken into account? Hence, you can
assume that all 36 payments from age 65 until 100 are guaranteed.
1 # Pension benefits
2 benefits <- _ _ _ * _ _ _ ^ ( _ _ _ )
3
4 # Discount factors ( to age 65)
5 discount _ factors <- _ _ _ ^ - ( _ _ _ )
6
7 # PV of pension at age 65
8 PV _ 65 <- _ _ _ ( _ _ _ * _ _ _ )
9 PV _ 65
10
11 # PV of pension at age 20
12 PV _ 20 <- _ _ _ * _ _ _ ^ - _ _ _
13 PV _ 20
Listing 6: R example
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Pension calculations accounting for mortality

Curtate vs complete life expectancy

How does the present value change if you take mortality into account? The pension
payments are then no longer guaranteed but depend on the survival of the recipient. The
one-year survival probabilities px have been preloaded as well as the variables benefits,
discount factors, PV 65 and PV 20 created in the previous exercise.
1 # Survival probabilities of (65) up to age 100
2 kpx <- c (1 , _ _ _ ( px [( _ _ _ ) :( _ _ _ ) ]) )
3
4 # EPV of pension at age 65
5 EPV _ 65 <- _ _ _ ( _ _ _ * _ _ _ * _ _ _ )
6 cbind ( PV _ 65 , EPV _ 65)
7

8 # EPV of pension at age 20

9 EPV _ 20 <- EPV _ 65 * (1.03 ^ - 45 * _ _ _ ( px [( _ _ _ ) :( _ _ _ ) ]) )
10 cbind ( PV _ 20 , EPV _ 20)
Listing 7: R example
Practise 4: On premium payments and retirement plans
A retirement plan for Miss Cathleen

As a final assignment during her summer internship Cynthia is asked to do some calcula-
tions for Miss Cathleen. Miss Cathleen is a teacher, aged 40, who is planning for retirement.
She wants to buy an annuity that provides her 18,000 EUR annually for life, beginning at
age 65. Nothing is paid in case of death before 65. The figure below depicts the retirement
plan for Miss Cathleen.
Age 40 41 ... 64 65 66 ...
...
Time 0 1 24 25 26 ...
... ...
Benefits 0 0 0 18*103 18*103
... ...
Discount Factors 1 1.03−1 1.03−24 1.03−25 1.03−26

1 p40
... 24 p40 25 p40 26 p40 ...
Survival Probabilities 1

The one-year survival probabilities px are again preloaded.

1 # Survival probabilities of (40)
2 kpx <- c ( _ _ _ , _ _ _ ( px [( _ _ _ ) : _ _ _ ]) )
3
4 # Discount factors ( to age 40)
5 discount _ factors <- (1 + _ _ _ ) ^ -(0:( _ _ _ ) )
6

7 # Pension benefits
8 benefits <- c ( rep ( _ _ _ , _ _ _ ) , rep ( _ _ _ , length ( kpx ) - 25) )
9
10 # The single premium
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11 single _ premium <- _ _ _

12 single _ premium
Listing 8: R example
From single to annual premium

Miss Cathleen wants to finance her deferred life annuity with annual premiums payable
for 25 years beginning at age 40. But since she plans to reduce her teaching hours from age
55 on, the premium should reduce by one-half after 15 years, as shown in the graph below.
What will be the initial premium to be paid by Miss Cathleen?

In this exercise, you will use two common R functions. with() allows you to evaluate an
R expression in a local environment constructed from a data frame. This avoids the need of
repeatedly typing life table$ to extract columns. For instance, the log mortality rates of
18-year-olds over the years can be extracted using:
Age 40 ... 54 55 ... 64 65 ...
... ... 25 ...
Time 0 14 15 24
... ... ...
Premiums P P 0.5P 0.5P 0

The variables kpx, discount factors and single premium computed in the previous
exercise are preloaded.
1 # Premium pattern rho
2 rho <- c ( rep (1 , _ _ _ ) , rep (0.5 , _ _ _ ) , rep (0 , _ _ _ ) )
3
4 # The initial premium
5 initial _ premium <- _ _ _ / _ _ _ ( _ _ _ * _ _ _ * _ _ _ )
6 initial _ premium
7
8 # The annual premiums
9 ___ * ___
10
11 # Sum of the annual premiums ( no actuarial discounting )
12 ___(___ * ___)
Listing 9: R example
A good deal? Outliving your life expectancy

The previous premium calculations for Miss Cathleen’s retirement plan are based on the
1999 Belgian period life table for women. This means that the premiums take into account
how long on average a 40-year-old woman has yet to live. Recall that curtate life expectancy
of (40) is computed as the sum of k p40 for k = 1, 2, 3, . . .
When will this product turn out to be a favorable deal? How much money will Miss
Cathleen receive if she would die at age 75? Or at age 95?
The variables kpx, discount factors, benefits and single premium defined earlier
are preloaded. Start by inspecting the value of single premium once more in the console.
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1 # Curtate life expectancy of (40)

2 ___(___)
3
4 # Present value of annuity benefits when (40) lives until age 75
5 subset1 <- _ _ _
6 ___(___ * ___)
7
8 # Present value of annuity benefits when (40) lives until age 95
9 subset2 <- _ _ _
10 ___(___ * ___)
Listing 10: R example