Winter term 2020/21 Sheet 6

Dr. Stefan Schelling

Dr. Manuel Rach

Exercises in Life-, Health- and Pension-Mathematics

Exercise 6.1 (Safety margin)

An insurance company offers an immediate, temporary annuity-due with up-front premium
P and the following characteristics:
Annuity payments R = 12 000 A
C (annually)
Age of the beneficiaries x = 65
Year of birth τ = 1943
Duration m = 25

Assume that the insurance company has sold a total of n = 10 000 of these policies.
(a) The company wants to determine a premium that also takes account of the risk of the
policies. That is why, the premium P is chosen such that it is sufficient to cover losses
at a 95% quantile, i.e.
!
P(n · P ≥ R · Z) = 0.95 ,
where R · Z is the (random) payoff of the contract portfolio. Determine the premium
P , assuming that the different contracts are independent and identically distributed
(i.i.d.) and that the pool size n is sufficiently large to apply the central limit theorem.

(b) Why is (in practice) the assumption of independent contracts not necessarily fulfilled?
Why is this a problem?
Hint: The 0.95-quantile of the standard normal distribution is z0,95 = 1.6449 .

Exercise 6.2 (State-space models)

Let us consider the following life insurance contracts:

(a) an immediate life annuity-due with annual payments R .

(b) a term life insurance with a sum insured S .

Assume that we have a Markovian life insurance model with states ’alive’ ( l ) and ’dead’
( d ), i.e. state space S := {l, d} , and transitions

l → l, l → d, d → d.

Describe all possible benefits Lt (z0 , . . . , zt ) , ∀z0 , . . . , zt ∈ S and ∀t ∈ N0 .

Exercise 6.3 (Chapman-Kolmogorov equation)
Use the Chapman-Kolmogorov equation to show that for all 0 ≤ s ≤ t :

(i) t px = s px · t−s px+s ,

(ii) t qx = s qx + s px · t−s qx+s .

Exercise 6.4
Consider a Markovian model with state space S . For a current state P zt ∈ S and t ∈ N0 ,
we have a transition probability pt,t+1 (zt , j) , i.e. pt,t+1 (zt , j) ≥ 0 and pt,t+1 (zt , j) = 1 .
j∈S

To also define transitions within a year, we assume that for τ ∈ [0, 1] , the transition proba-
bility pt,t+τ (zt , j) is linear in τ .
Show that for all zt , j ∈ S , τ ∈ [0, 1] :

(a) pt,t+τ (zt , j) ≥ 0

P
(b) j∈S pt,t+τ (zt , j) = 1
Solution 6.1

(a) The portfolio Z consists of n contracts Zi with the following payoff:

 X

 v j if Ki < m ,
Xn 
 j≤Ki
Z = Zi mit Zi = m−1
X
v j if Ki ≥ m ,

i=1 


j=0

where Ki denotes the residual lifetime of the policyholder of contract i .

We now assume that the contracts Zi are independent and identically distributed. We
can determine their mean µ and variance σ (see also Exercise 4.4):
(τ )
µ = E(Zi ) = äx:n ,
1 (τ ) (τ )
σ 2 = Var(Zi ) = 2
· ( Ãx:n − (Ax:n )2 ) ,
(1 − v)

(τ ) (τ )
with ĩ = 2i + i2 and Ãx:n = (ĩ) Ax:n .

We can use DAV 2004R(M) with technical interest rate i = 0, 9% to determine µ

and σ 2 . From t = 2008, x = 65 , we can determine the age-shift h(τ ) = +4 for time
τ = 1943 . Then,
(1943) (1965)
µ = ä65:25 = ä69:25 = 19.32 ,

ĩ = 2i + i2 = 1.8081% ,
(1943) (1965)
Ã65:25 = Ã69:25 = 0.687015 ,
(1943) (1965)
A65:25 = A69:25 = 0.827676 ,
1
⇒ σ2 = · ( Ãx:n − (Ax:n )2 ) = 24.73 .
(1 − v)2

For the portfolio of n contracts, we can use that the contracts are i.i.d. distributed.
Then,
E(R · Z) = R · n · µ
Var(R · Z) = R2 · n · σ 2

The premium P now has to satisfy

!
P(n · P ≥ R · Z) = 0.95 .

If n is large enough, Z is approximately normally distributed (central limit theorem).

We then find that:
   
R·Z −R·n·µ n·P −R·n·µ n·P −R·n·µ
P √ ≤ √ ≈ N0,1 √ = 0.95
R·σ n R·σ n R·σ n
 n·P −R·n·µ
⇒ √ = z0.95
R·σ n
R·σ
⇔ P = R · µ + z0.95 · √ = 231 833.8 + 981.6 = 232 815.4 .
n

(b) If there are systematic changes that simultaneously affect each of the n contracts, for
example:

• A general increase in life expectancy (e.g. better medication).

• A general in- / decrease in the interest rate level.

Then, the underlying assumptions to compute the risk margin turn out to be wrong
and the reserves might not be sufficient.

Solution 6.2

(a) In case of a life annuity-due, we have

Lt (l) = R , ∀t ∈ N0
Lt (d) = 0 , ∀t ∈ N0
Lt+1 (l, d) = 0 , ∀t ∈ N0

(b) In case of a term life insurance, we have

Lt (l) = 0 , ∀t ∈ N0
Lt (d) = 0 , ∀t ∈ N0

S , t = 0, ..., n − 1
Lt+1 (l, d) =
0 ,t ≥ n

Solution 6.3
Chapman-Kolmogorov for s = 0 and 0 ≤ u ≤ t : Π(0, t) = Π(0, u)Π(u, t) , hence, in the
case of life insurance, we have:

     
t px t qx u px u qx p t−u qx+u
= · t−u x+u
0 1 0 1 0 1
 
u px · t−u px+u u qx + u px · t−u qx+u
=
0 1

Hence, t px = u px · t−u px+u and t qx = u qx + u px · t−u qx+u .

Solution 6.4

(a) Since τ ≥ 0 , we get

pt,t+τ (zt , j) = (1 − τ ) pt,t (zt , j) +τ pt,t+1 (zt , j) ≥ 0.

| {z } | {z }
≥0 ≥0

(b) We have
X X
pt,t+τ (zt , j) = (1 − τ )pt,t (zt , j) + τ pt,t+1 (zt , j)
j∈S j∈S
X X
= (1 − τ ) pt,t (zt , j) + τ pt,t+1 (zt , j)
j∈S j∈S

= (1 − τ ) + τ = 1.