Lecture Notes (Chapter 5) ASC2014 Life Contingencies I

ASC2014 Life Contingencies I BSc (Hons) in Actuarial Studies
CHAPTER 5
LIFE INSURANCE PREMIUMS
5.1) Premium Calculation
An insurance policy is a financial agreement between the insurance company and the
policyholder. The insurance company agrees to pay some benefits or a sum insured on
the death of the policyholder within the term of the insurance. The policyholder on the
other hand, agrees to pay premiums to the insurance company to secure these benefits.
The premiums will also need to reimburse the insurance company for the expenses
associated with the insurance policy.
An insurance policy is funded by contract premiums (a series of payment usually

contingent on survival of the policyholder) to cover the benefits, expenses associated with
maintaining the policy contract, profit margins and contingency margin (deviation due to
adverse experience).
Contract premiums can be classified as net premiums (benefit premiums) or gross

premiums (expense-loaded premiums). If the calculation of premium does not explicitly
allowed for the insurance company’s expenses then the premium paid is referred to as the
net premium. Otherwise, if the calculation of premium does explicitly allowed for the
insurance company’s expenses then the premium is called a gross premium.
The premium may be paid in a single payment by the policyholder. In this case, the
premium is called a single premium. However, a regular series of payments, possibly
annually, semi-annually, quarterly, or monthly are more common. Monthly payment may
be the most common mode of payment due to the fact that employed people receive their
salaries monthly and it is convenient to have payments made within the same frequency as
income is received. A monthly deduction on the monthly salary may also be arranged.
One important feature for any life insurance policy is that premiums are payable in
advance, with the first premium payable when the policy is purchased. Regular premiums
for a policy on a single life cease upon death of the policyholder. The premium paying term
is decided based on what type of insurance is purchased. In a whole life insurance for
example, premiums are payable as long as the policyholder is alive and only cease upon
death where the benefits are payable.
Premiums are payable to not just secure life insurance benefits but to also secure annuity
benefits as well. Deferred annuities may be purchased by regular premiums payable
throughout the deferred period or by way of a single premium at the start of the deferred
period. For example, a person aged 45 might secure a retirement income by paying regular
premiums over a 20-year period to secure annuity payments from age 65.
School of Mathematical Sciences (SMS) page 139 August 2020 Semester

The cash flows for a traditional life insurance policy consist of the insurance or annuity
benefit outgo (and associated expenses) and the premium income. The income and outgo
cash flows depend on the future lifetime of the policyholder unless the policy is purchased
by a single premium.
5.2) Future Loss Random Variable
As mentioned in the previous paragraphs above, we can model the future outgo less future
income with the random variable that represents the present value of the future loss. When
expenses are excluded, the premiums are the net premiums and the random variable is
referred to as the future loss at issue, denoted by 0 Ln . When expenses are included, the
premiums are the gross premiums and the random variable is referred to as the gross future
g
loss, denoted by 0 L .
Let PVFB 0 denote the present value random variable of (at time of issue of the insurance
policy) future benefits to be paid by the insurance company or insurer.
Let PVFP 0 denote the present value random variable of (at time of issue of the insurance
policy) future premiums to be paid by the policyholder or insured.
Denote by PVFE 0 the present value random variable associated with future expenses
incurred by the insurer.
Therefore, we have
0 Ln = PVFB 0 − PVFP0
0 Lg = PVFB 0 − PVFP0 + PVFE 0
In other words ,
0 Ln = PV of benefit outgo – PV of net premium income
0 Lg = PV of benefit outgo – PV of net premium income + PV of expenses

5.3) Principles of Premium Calculation
Equivalence Principle (or Actuarial Equivalence Principle)
The Equivalence Principle requires that the expected loss of an insurance policy to the
insurer be equal to zero. If L is the loss random variable for the insurer, then, under the
equivalence principle, E[ L] = E[PVFB] − E[PVFP] = 0 .
In many cases, the premium will be a level amount Q per year for the payment period, and
we can write the future loss random variable in the form
L = Z − QY
where Z and Y represent the PVRVs for the benefit and net premium annuity respectively.
Therefore,
E[ L] = E[ Z ] − Q E[ Y ] = APV of benefits – APV of net premium annuity
Hence, specifically in the case of insurance contract, the Equivalence Principle would be
E[PVFB] = E[PVFP] ; or
APV of benefits = APV of net premium annuity
For policies with discrete premiums, it is assumed that premiums are payable at the
beginning of each year or months unless specified otherwise.
An insurance policy usually involves a contract in which a life annuity of premiums will
be paid to provide for the policy’s benefits. If the death benefit is payable at the moment
of death and the premiums are payable continuously until death, the policy is referred to as
fully continuous. In the case of a fully discrete policy, death benefit is payable at the end
of the year of death and premiums are payable as a discrete life annuity due.

5.4) Fully Continuous Insurances
Consider a fully continuous level premium for a whole life insurance of 1 payable at the
moment of death of (x). The future loss random variable is given by
L = v T − Q aT |
If the premium Q is determined by the Equivalence Principle,
E [ L ] = E [ v T ] − Q E [ aT | ] = 0
E [v T ] Ax
Q = P ( Ax ) = =
E [ aT | ] a x
1 −  ax 1  Ax
We can show that P ( Ax ) = = − =
ax ax 1 − Ax
Example 1 (Fully Continuous Insurances)(Equivalence Principle Premium)(Formula)
(a) Let L denote the future loss random variable of a fully continuous n-year term
insurance of 1 payable at the moment of death of (x), with premiums payable for n
1
A x :n |
years. Then Q = P ( A x:n| ) =
1
a x :n |
(b) Let L denote the future loss random variable of a fully continuous n-year
endowment insurance of 1 payable at the moment of death of (x), with premiums
A x :n |
payable for n years. Then Q = P ( A x:n| ) =
a x :n |
(c) Let L denote the future loss random variable of a fully continuous n-year deferred
whole life insurance, with premiums payable during the n-year deferred period.
n | Ax
Then Q = P ( n| Ax ) =
a x :n |
(d) Let L denote the future loss random variable of a fully continuous n-year deferred
whole life annuity, with premiums payable during the n-year deferred period.
n| a x
Then Q = P ( n| a x ) =
a x :n |

Example 2 (Fully Continuous Insurances)(Equivalence Principle)(Constant Force)
Let L denote the future loss random variable of a fully continuous whole life insurance
policy of 1 issued to (x). Assume a constant force of mortality  and a constant force of
interest  . Calculate the premium as determined by the Equivalence Principle.
Solution
 1
Under constant force of mortality, Ax = and a x = .
 +  +
Hence P( A x ) = Q =
Example 3a (Fully Continuous Insurances)(Equivalence Principle)(Constant Force)
You are given
•  = 0.02
•  = 0.04
• Premiums are determined by the Equivalence Principle
Calculate the premium for a fully continuous 20-year endowment insurance of 1 on a life
age x.
Solution
1 − e − (  + ) n
Under constant force of mortality (why?), a x:n| = and
 +

A x:20 = (1 − e − (  + ) n ) + e − (  + ) n
 +
Therefore
1 − e − ( 0.02+ 0.04 )( 20)
a x:20| = = 11.64676
0.02 + 0.04
0.02
A x:20 = (1 − e − (0.02 + 0.04) 20 ) + e − (0.02 + 0.04) 20 =
0.02 + 0.04
P( Ax:20 ) = Q =

Example 3b (Fully Continuous Insurances)(Equivalence Principle)(Constant Force)
You are given
•  = 0.01
•  = 0.05
Calculate the premium for a special fully continuous whole life insurance that pays a
benefit of 1000 plus a refund of all premiums without interest at the moment of death.
Solution Let P denote the premium.
E [ PVFB ] = 1000 Ax + P( I A ) x
E [ PVFP ] = P a x
By the Equivalence Principle, 1000 Ax + P( I A ) x = Pa x
1000 Ax
P=
ax − (I A)x
 1 
Under constant force, Ax = , ax = , and ( I A ) x = .
 +  + ( +  )2
Therefore P =
Example 4 (Fully Continuous Insurances)(Equivalence Principle)(Uniform)
You are given
• Mortality is uniformly distributed with  = 120

•  = 0.05
Calculate the premium for a fully continuous whole life insurance of 1 on a life age 40.
Solution
a − x |
Under uniform distribution of mortality, Ax = .
−x
a80
A40 = =
80
 Ax  A40
Using P ( Ax ) = , we get P ( A40 ) = = 0.016262
1 − Ax 1 − A40

5.5) Fully Discrete Insurances
Consider a fully discrete level premium for a whole life insurance of 1 payable at the end
of year of death of (x). The future loss random variable is given by
L = v K +1 − Q aK +1|
If the premium Q is determined by the Equivalence Principle,
E [ L ] = E [ v K +1 ] − Q E [ aK +1| ] = 0
E [v K +1 ] Ax
Q = P ( Ax ) = Px = =
E [ aK +1| ] ax
1 − dax 1 dAx
We can show that Px = = −d =
ax ax 1 − Ax
Example 5 (Fully Discrete Insurances)(Equivalence Principle)(Formula)
(a) Let L denote the future loss random variable of a fully discrete n-year term
insurance of 1 payable at the end of the year of death of (x), with premiums payable
A1
for n years. Then Q = P ( A1 ) = P1 = x:n|
x:n| x:n | ax:n|
(b) Let L denote the future loss random variable of a discrete n-year endowment
insurance of 1 payable at the end of year of death of (x), with premiums payable for
A
n years. Then Q = P ( Ax:n| ) = Px:n| = x:n|
ax:n|
(c) Let L denote the future loss random variable of a fully discrete k-payment whole
life policy of 1 payable at the end of year of death of (x), with premiums payable
A
for k years. Then Q = k P ( Ax ) = k Px = x
ax:k |
(d) Let L denote the future loss random variable of a fully discrete n-year deferred
whole life annuity, with premiums payable during the n-year deferred period. Then
ax
Q = P ( n| ax ) = n|
ax:n|

Example 6 (Fully Discrete Insurances)(Equivalence Principle)(Level Premium)
You are given
• A40 = 0.168 , A50 = 0.264

• 10 E 40 = 0.540
• i = 0.06
Calculate 10 P40 .
Ax
[Hint: k Px = ]
a x:k
Solution

Example 7 (Fully Discrete Insurances)(Equivalence Principle)(Special Insurance)
For a special fully discrete 30-payment whole life insurance on a life age 45 with benefit
of 1000 upon death, you are given
• Death benefit is payable at the end of year of death

• The premium for this insurance is equal to 1000 P45 for the first 15 years followed
by a premium of  for the remaining 15 years
• Mortality follows the Standard Ultimate Life Table
• i = 0.05
Calculate  .
Solution (Answer: 12.0467)
E [ PVFB ] = 1000 A45

E [ PVFP ] = 1000P45 a45:15 +  15 E45 a60:15
By the Equivalence Principle, 1000 A45 = 1000 P45 a45:15 +  15 E45 a60:15
1000 A45 − 1000 P45 a45:15

=
15 E45 a60:15
1000 P45 a45 − 1000 P45 a45:15
=
15 E45 a60:15
=
Ax
[Hint: Px = x = ax :n | + n E x ax + n and
, a m+n E x = m E x . n E x+m ]
ax

For a special fully discrete 20-year term insurance on a life age 30, you are given

• Death benefit is 1000 during the first ten years and 2000 during the next ten years
• The premium for this insurance is  for each of the first ten years and 2 for each
of the next ten years
• a30:10| = 8.7201 , a30:20| = 15.0364 , a40:10| = 8.6602
• 1000 A 1 = 16.66 , 1000 A 1 = 32 .61
30:10| 40:10|
Calculate  .
E [ PVFB ] = 1000 A 1 + 2000 10 E30 A 1

30:10 40:10
E [ PVFP ] = 2 a30:20 −  a30:10

By the Equivalence Principle, 1000 A 1 + 2000 10 E30 A 1 = 2 a30:20 −  a30:10
30:10 40:10
1000 A 1 + 2000 10 E30 A 1

= 30:10 40:10
2 a30:20 − a30:10
=

For a special 10-year deferred life annuity due on a life age 20, you are given
• The annuity pays 1000 per year

• If the annuitant dies within the 10 years, the premiums are refunded without interest
• The premium paid is  , payable at the beginning of each year for 10 years
Calculate  .
Solution
E [ PVFB ] =  ( IA ) 1 + 100010| a20

20:10|
E [ PVFP ] =  a20:10|
By the Equivalence Principle,  ( IA ) 1 + 1000 10| a20 =  a20:10|
20:10|
100010| a20
 =
a20:10| − ( IA ) 1
20:10|
For a special fully discrete whole life insurance on a life age 30, you are given

• Death benefit is equal to 1000 plus the refund of premium paid without interest
• The premium paid is  , payable at the beginning of each year for 10 years
Calculate  .
Solution
E [ PVFB ] = 1000 A30 +  ( IA ) 1 + 10 10|A30

30:10|
E [ PVFP ] =  a30:10|
By the Equivalence Principle, 1000 A30 +  ( IA ) 1 + 10 10|A30 =  a30:10|
30:10|
1000 A30
 =
a30:10| − ( IA ) 1 − 1010| A30
30:10|

Example 11 (Fully Discrete Insurances)(Equivalence Principle)(Short Term)
A special fully discrete 3-year endowment insurance issued to a life age x, you are given
• Death benefits are 1000, 2000, 3000 for the three years
• The insurance pays 1500 if the insured survives 3 years
• Premiums are payable at the beginning of the first two years only
• The premium for the first year is  and 0.5 for the second year
• q x = 0.10 , q x +1 = 0.15 and q x + 2 = 0.25
• d = 0.05
Calculate  .
Solution
E [ PVFB ] = 1000 vqx + 2000 v 2 1| q x + 3000 v 3 2| q x + 1500 v 3 3 p x
E [ PVFP ] =  + 0 .5 vp x
By the Equivalence Principle,
1000 vqx + 2000 v 2 1| q x + 3000 v 3 2| q x + 1500 v 3 3 p x =  + 0.5 vpx
1000 vqx + 2000 v 2 1| q x + 3000 v 3 2| q x + 1500 v 3 3 p x

 = = 1098 .75
1 + 0.5 vpx

A special fully discrete 3-year term insurance issued to a life age x, you are given
• Death benefits are 1000, 2000, 3000 for the three years
• Premiums of  per year are payable at the beginning of the year
• q x = 0.05 , q x +1 = 0.10 and q x + 2 = 0.15
• i = 0.07
Calculate  .
Solution
E [ PVFB ] = 1000 vqx + 2000 v 2 1| q x + 3000 v 3 2| q x
E [ PVFP ] =  +  vpx +  v 2 p x
2
1000 vqx + 2000 v 2 1| q x + 3000 v 3 2| q x =  +  vpx +  v 2 2 p x
1000 vqx + 2000 v 2 1| q x + 3000 v 3 2| q x

= = 199 .9335
1 + vpx + v 2 2 p x

A special fully discrete 3-year term insurance issued to a life age x, you are given
• The death benefit is 1000

• Premiums of  per year are payable at the beginning of the year
• If the insured survives 3 years, the premiums are refunded without interest
• q x = 0.02 , 1| q x = 0.03 and 2| q x = 0.05
• i = 0.08
Calculate  .
Solution
E [ PVFB ] = 1000 vqx + 1000 v 2 1| q x + 1000 v 3 2| q x + 3v 3 3 p x
E [ PVFP ] =  +  vpx +  v 2 p x
2
1000 vqx + 1000 v 2 1| qx + 1000 v 3 2| qx + 3v 3 3 p x =  +  vpx +  v 2 2 p x
1000 vqx + 1000 v 2 1| q x + 1000 v 3 2| q x

 = = 145 .07
1 + vpx + v 2 2 p x − 3v 3 3 p x

5.6) Premium with m-thly Payments
If premiums are payable m times a year, rather than annually, we use the generic symbol
P (m) to denote what we should call the true fractional premium. Note that P (m) is the annual
(m)
rate of premium, so that the amount of premium paid in each of the m1 -th of the year is Pm
. For example, for a whole life insurance policy of 1 with death benefit payable at the end
of year of death and with premium payable at the beginning of each of the m-thly period,
the annual rate of premium is denoted as P ( m ) ( Ax ) or Px(m ) . For this same insurance with
death benefit payable at the moment of death, the annual rate of premium will be denoted
as P ( m ) ( A x ) .
Example 14 (Premium with m-thly Payments)(Various Types)
Various types of insurance policies with their annual premiums are listed below
Ax Ax
(a) whole life insurance P ( m ) ( Ax ) = , Px
(m)
=
ax( m ) ax( m )
1
A x:n A1
(b) n-year term insurance P ( m ) ( A x1 :n ) = ( m ) , P1( m ) = (xm:n)
ax:n x :n a x :n
A x:n A
(c) n-year endowment insurance P ( m ) ( Ax:n| ) = (m)
, P (m)
= x :n
(m)
a x:n x : n a x :n
Ax A
(d) k-payment whole life insurance k P ( m ) ( Ax ) = (m)
, k Px( m ) = ( mx )
a x:k a x:k
The m-thly annuities can be estimated either by assuming UDD between integral ages or
by using Woolhouse’s formula
Recall that under UDD,

ax( m ) =  ( m ) ax −  ( m )
a x( :mn ) =  (m)a x:n −  (m)(1 − n E x )
The Woolhouse Approximation Formula are
m −1 m2 −1
ax( m )  ax − − ( x +  )
2m 12 m 2
m −1 m2 − 1
a x( :mn )  a x:n − (1− n E x ) −  x +  − n E x (  x + n +  )
2m 12 m 2

Example 15 (Premium with m-thly Payments)(UDD)( a x( :mn ) =  (m)a x:n −  (m)(1 − n E x ) )
For a 20-year endowment insurance of 1 on a life age 60, you are given

• Deaths are uniformly distributed over each year of age
• Death benefits are paid at the moment of death
• Annual premiums of  are payable at the beginning of each month
• i = 0.05
Calculate  and the monthly premium.
Solution
Ax:n|
We calculate  using P ( m ) ( Ax:n| ) =
ax( m:n|)
A60:20| = A 1 + 20 E60
60: 20|
= i
 A1 + 20 E60 under UDD
60: 20|
=
= 0.597477014
Next, we have
(12)
a60:20 =  (12) a60:20 −  (12)(1 − 20 E60 )
A60:20|
Therefore,  = P (12) ( A60:20| ) = (12)
= and the monthly premium is .
a60:20|

Example 16 (Premium with m-thly Payments)(UDD)( a x( :mn ) =  (m)a x:n −  (m)(1 − n E x ) )
For a 3-year endowment insurance of 1 on a life age 70, you are given
• Death benefits are paid at the end of year of death

• Deaths are uniformly distributed over each year of age
• Premiums are payable at the beginning of each quarter but for the first two years
only
• q70 = 0.023 , 1| q70 = 0.027 and 2| q70 = 0.033
• i = 0.06
•  (4) = 1.00027 ,  (4) = 0.38424
Calculate  and the quarterly premium.
Solution
Ax:n
We use k Px(:nm ) =
ax( :mn )
A70:3 = vq70 + v 2 1| q70 + v 3 2| q70 + v 3 3 p70

=
(4)
a70:2|
=  ( 4 ) a70:2| −  ( 4 )(1− 2 E70 )
=  (4)[1 + vp70 ] −  (4)(1 − v 2 2 p70 )
=
A70:3
2
(4)
P70:3 = (4)
= 0.4527288 and the quarterly premium is 0.1131822
a70:3

5.7) Gross Premiums
Recall that 0 Lg denote the gross future loss random variable and
A gross premium is a premium actually charged by the insurance company taking into
account expenses and profits. An insurance company must charge a premium high enough
to cover benefits as well as expenses. Examples of expenses are categorized as follows
The per-premium expenses varies as a percent of premium, for example commissions and
premium taxes. The per-policy expenses are fixed amount per policy, regardless of policy
size, and that includes premium collection expenses and policy issue expenses. The per-
face amount expenses vary by size of policy, usually expressed per 1000 of face amount,
for example underwriting. Sometimes the per-face amount expenses are combined with the
per-policy expenses. The settlement expenses are incurred in settling claims, it depends
on the size of the claim or they can be fixed.
Expenses other than the settlement expenses may vary between the first year of a policy
and the other years (renewal years). First year commissions are usually higher than the
renewal commissions. Many other expenses such as underwriting and policy issue occur
only in the first year.
Under Equivalence Principle, we have E[ 0 Lg ] = 0 . Then we obtain the following:
E[PVFB] + E[PVFE] = E[PVFP] ; or
APV of benefits + APV of expenses = APV of gross premium annuity

Example 17 (Gross Premium)
For a fully discrete 10-pay whole life insurance of 10,000 on a life age 45, you are given
• A45 = 0 .25 and a45:10| = 7

• d = 0.05
• Expenses are paid at the beginning of the year
• Expenses on the policy are as follows
_____________________________________
Year % of Premium Per policy

_____________________________________
1 50 200
2+ 10 20
_____________________________________
Calculate the gross premium using the Equivalence Principle.
Solution
Let G be the gross premium.
E [ PVFB ] = 10 ,000 A45
E [ PVFP ] = G a45:10|
E [ PVFE ] = [G ( 0.1a45:10| + 0.4 )] + [ 20 a45 + 180 ]
By the Equivalence Principle, E[0 Lg ] = 0
Ga45:10| = 10 ,000 A45 + [G ( 0.1a45:10| + 0.4 )] + [ 20 a45 + 180 ]
G = 505 .08

For a fully discrete 30-year term insurance of 1,000 on a life age 25, you are given

• i = 0.05
_____________________________________

_____________________________________
1 55 10
2+ 10 5
_____________________________________
Calculate the gross premium using the Equivalence Principle.
E [ PVFB ]
E [ PVFP ]
E [ PVFE ]

For a fully discrete whole life insurance of 1,000 on a life age x, you are given
• Premiums are paid at the beginning of each year

• The gross annual premium calculated using the Equivalence Principle is 14
• Ax = 0.207
• d = 0.04
_____________________________________

_____________________________________
1 50 10
2+ 10 k
_____________________________________
Determine k.
E [ PVFB ]
E [ PVFP ]
E [ PVFE ]

Example 20 (Gross Premium)(Express in terms of life insurances and life annuities)
For a 10-payment 20-year endowment insurance of 1,000 on a life age 40, you are given

• Death benefits are payable at the moment of death
• Expenses are paid at the beginning of each policy year
____________________________________________

Taxes Commissions
____________________________________________
1 4 25 10
2+ 4 5 5
____________________________________________
Express the gross premium in terms of life insurances and life annuities.
Solution
E [ PVFB ]
E [ PVFP ]
E [ PVFE ]
1000 A40:20| + 5a40:20| + 5

G=
0.91a40:10| − 0.2

5.8) Future Loss and Variance of Future Loss
Recall that the present value of future benefits less the present value of future premiums is
called the future loss at issue or net future loss at issue. We have
0 Ln = PVFB 0 − PVFP0
The gross future loss at issue is
Example 21 (Net future loss at issue)( 0 L )

For a 10-year deferred fully continuous whole life insurance of 1000, you are given
•  = 0.04
•  = 0.02
• Premiums are payable for life
Calculate the net future loss at issue if the policyholder dies at the end of 20 years.
Solution
 1
First we calculate n| Ax =  e − (  + ) n and a x =
 +  +
Next, we determine the premium using the Equivalence Principle
1000 n| Ax
Q= =
ax
1 − v 20 1 − e −20
a20 = = =
 
If the policyholder dies at the end of 20 years,
0 Ln = PVFB0 − PVFP0
= 1000v 20 − Qa20
= 308 .46

Example 22 (Net future loss at issue)( 0 L )

For a special continuous whole life insurance of 1000, you are given
•  = 0.05
• The policyholder pays a premium of 20 at the beginning of each year
Calculate the net future loss at issue if the policyholder dies at the end of 25.8 years.
Solution
The premium has already been calculated, so we do not need a mortality assumption to
calculate the future loss. If the policyholder dies at the end of 25.8 years,
0 Ln = PVFB0 − PVFP0
= 1000v 25.8 − 20a26
= −23.05
Example 23 (Gross future loss at issue)( 0 Lg )
For a fully discrete whole life insurance of 1000 on a life age 45, you are given

• Death benefits are payable at the end of year of death
• v = 0.96
_____________________________________

_____________________________________
1 50 100
2+ 5 4
_____________________________________
Calculate the gross future loss at issue if the policyholder dies at time 30.2.
Solution
PVFB 0 = 1000 v 31
PVFP 0 = 22a31
PVFE 0 = [22(0.05a31 + 0.45)] + [4 a31 + 96]
0 Lg = PVFB 0 − PVFP0 + PVFE 0 = 84 .692

Example 24 (Gross future loss at issue)( 0 Lg )
For a fully discrete whole life insurance of 1000 on a life age 50, you are given

• Death benefits are payable at the end of year of death
• a50 = 13 , A50 = 0.35
_____________________________________

_____________________________________
1 45 55.00
2+ 5 5.75
_____________________________________
Calculate the gross future loss at issue.
Solution
PVFB 0 =
PVFP 0 =
PVFE 0 =
0 Lg = PVFB 0 − PVFP0 + PVFE 0 = −4

Calculating the variance of 0 Ln and 0 Lg are about the same for continuous and discrete
insurances. Sometimes we will just use 0 L to denote the net future loss and gross future
loss random variable.
Example 25 (Variance of Net Future Loss)( Var [ 0 L ] )
Let 0 L denote the future loss random variable for a fully continuous whole life insurance
on a life age x and let Q denote the premium charged. Then
Q Q
L = v T − QaT = (1 + )v T − and
 
0
Var[ 0 L ] = Var[vT − QaT ]

Q Q
= Var [(1 + )v T − ]
 
Q
= (1 + ) 2 Var [ v T ]

Q
= (1 + ) 2 ( 2Ax − ( Ax ) 2 )

2
 1  2
=  ( Ax − ( Ax ) )
2
(Tutorial 5)
 1 − Ax 
Q Q
For a face amount of b instead of 1, we have 0 L = bv T − QaT = (b + )v T − and
 
Q
Var [ 0 L ] = ( b + ) 2 ( 2Ax − ( Ax ) 2 )

For a fully continuous n-year endowment insurance on a life age x, we have
Q 2
Var [ 0 L ] = (b + ) 2 ( A x:n − ( A x:n ) 2 )


Example 26 (Variance of Net Future Loss)( Var [ 0 L ] )
Let 0 L denote the future loss random variable for a fully discrete whole life insurance on
a life age x and let Q denote the premium charged. Then
Q K +1 Q
0 L = v K +1 − Qa K +1 = (1 + )v − and
d d
Var[ 0 L] = Var[v K +1 − QaK +1 ]

Q K +1 Q
= Var [(1 + )v − ]
d d
Q 2
= (1 + ) Var[ v K +1 ]
d
Q
= (1 + ) 2 ( 2Ax − ( Ax ) 2 )
d
Q K +1 Q
For a face amount of b instead of 1, we have 0 L = bv K +1 − Qa K +1 = (b + )v − and
d d
Q 2 2
Var [ 0 L ] = ( b + ) ( Ax − ( Ax ) 2 )
d
For a fully discrete n-year endowment insurance on a life age x, we have
Q 2 2
Var [ 0 L ] = (b + ) ( Ax:n − ( Ax:n ) 2 )
d

Example 27 (Variance of Net Future Loss)( Var [ 0 L ] )(Constant Force)
Consider a fully continuous whole life insurance. You are given
• The force of mortality is 

• The force of interest is 
• 0 L is the future loss random variable
Calculate Var [ 0 L ] .
Solution
Q
We have Var [ 0 L ] = (1 + ) 2 ( 2 Ax − ( Ax ) 2 )

A − ( Ax ) 2
2
 Ax
= x since Q =
(1 − Ax ) 2 1 − Ax

− ( + ) 2 
=
 + 2
=
(1 − 
 + ) 2
 + 2
Example 28 (Variance of Net Future Loss)( Var [ 0 L ] )(Constant Force)
Consider a fully continuous 20-year endowment insurance. You are given
•  = 0.02
•  = 0.05
• Premiums are set such that the expected future loss equal to − 0.1
• 0 L is the future loss random variable
Calculate Var [ 0 L ] .
Solution

Gross future loss for whole life and endowment insurances with level expenses can be
calculated by formula. Let G be the gross premium, f the first year expense, e the renewal
expense, E the settlement expense, and b the face amount. The gross future loss for a fully
discrete whole life insurance is
0 Lg = (b + E )v K +1 − GaK +1 + [eaK +1 + f − e]
Var[ 0 Lg ] = Var[(b + E )v K +1 − GaK +1 + [eaK +1 + f − e]]

1 − v K +1
= Var[(b + E )v K +1 − (G − e)( ) + f − e]
d
G − e K +1 G − e
= Var[(b + E + )v − + f − e]
d d
G−e 2
= (b + E + ) Var[v K +1 ]
d
G−e 2 2
= (b + E + ) ( Ax − ( Ax ) 2 )
d
For a fully discrete n-year endowment insurance on a life age x, we have
G−e 2 2
Var[ 0 Lg ] = (b + E + ) ( Ax:n − ( Ax:n ) 2 )
d
Similar formula exists for fully continuous insurances with continuous premiums.
G−e 2
Var[ 0 Lg ] = (b + E + )2 ( Ax − ( Ax )2 )

G −e 2
Var[ 0 Lg ] = (b + E + ) 2 ( A x:n − ( A x:n ) 2 )


Example 29 (Variance of Gross Future Loss)( Var [ 0 Lg ] )
For a fully continuous whole life insurance of 1 on a life age x, you are given
• Var [ v T ] = 0 .1
• a x = 12
• Expenses are paid 0.0010 per year, payable continuously
• Gross premium is net premium plus 0.0033
• g
0 L is the gross future loss random variable
•  = 0.05
Calculate Var [ 0 Lg ] .
Solution
G−e
Var [ 0 Lg ] = ( b + E + ) 2 Var [ v T ]

G−e
= (1 + ) 2 Var [ v T ]

0.033333 + 0.0033 − 0.0010 2
= (1 + ) ( 0.1)
0.05
= 0.29332
1
(because G = P ( Ax ) + 0.0033 = −  + 0.0033 )
ax

Example 30 (Variance of Gross Future Loss)( Var [ 0 Lg ] )
For a fully continuous whole life insurance of 1000 on a life age x, you are given
• Ax = 0.22 , 2 Ax = 0.10
• a x = 19 .5
• Expenses are at a continuous rate of 6% premium plus 1 in all years, plus an
additional 50% of annual premum plus 10 incurred at the beginning of the first year.
• Gross premiums are determined by the Equivalence Principle
• g
0 L is the gross future loss random variable
Calculate Var [ 0 Lg ] .
Solution (Answer: 87,395)

Lecture Notes (Chapter 5) ASC2014 Life Contingencies I

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Lecture Notes (Chapter 5) ASC2014 Life Contingencies I

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ASC2014 Life Contingencies I BSc (Hons) in Actuarial Studies

5.1) Premium Calculation

An insurance policy is funded by contract premiums (a series of payment usually

Contract premiums can be classified as net premiums (benefit premiums) or gross

School of Mathematical Sciences (SMS) page 139 August 2020 Semester

5.2) Future Loss Random Variable

0 Lg = PVFB 0 − PVFP0 + PVFE 0

0 Ln = PV of benefit outgo – PV of net premium income

0 Lg = PV of benefit outgo – PV of net premium income + PV of expenses

School of Mathematical Sciences (SMS) page 140 August 2020 Semester

5.3) Principles of Premium Calculation

Equivalence Principle (or Actuarial Equivalence Principle)

E[ L] = E[ Z ] − Q E[ Y ] = APV of benefits – APV of net premium annuity

APV of benefits = APV of net premium annuity

School of Mathematical Sciences (SMS) page 141 August 2020 Semester

5.4) Fully Continuous Insurances

If the premium Q is determined by the Equivalence Principle,

Example 1 (Fully Continuous Insurances)(Equivalence Principle Premium)(Formula)

School of Mathematical Sciences (SMS) page 142 August 2020 Semester

Example 2 (Fully Continuous Insurances)(Equivalence Principle)(Constant Force)

Example 3a (Fully Continuous Insurances)(Equivalence Principle)(Constant Force)

You are given

School of Mathematical Sciences (SMS) page 143 August 2020 Semester

Example 3b (Fully Continuous Insurances)(Equivalence Principle)(Constant Force)

You are given

Solution Let P denote the premium.

Example 4 (Fully Continuous Insurances)(Equivalence Principle)(Uniform)

You are given

• Mortality is uniformly distributed with  = 120

School of Mathematical Sciences (SMS) page 144 August 2020 Semester

5.5) Fully Discrete Insurances

If the premium Q is determined by the Equivalence Principle,

Example 5 (Fully Discrete Insurances)(Equivalence Principle)(Formula)

School of Mathematical Sciences (SMS) page 145 August 2020 Semester

Example 6 (Fully Discrete Insurances)(Equivalence Principle)(Level Premium)

You are given

• A40 = 0.168 , A50 = 0.264

School of Mathematical Sciences (SMS) page 146 August 2020 Semester

Example 7 (Fully Discrete Insurances)(Equivalence Principle)(Special Insurance)

• Death benefit is payable at the end of year of death

Solution (Answer: 12.0467)

E [ PVFB ] = 1000 A45

1000 A45 − 1000 P45 a45:15

School of Mathematical Sciences (SMS) page 147 August 2020 Semester

Example 8 (Fully Discrete Insurances)(Equivalence Principle)(Special Insurance)

• Death benefit is payable at the end of year of death

Solution (Answer: 3.007960)

E [ PVFB ] = 1000 A 1 + 2000 10 E30 A 1

E [ PVFP ] = 2 a30:20 −  a30:10

1000 A 1 + 2000 10 E30 A 1

School of Mathematical Sciences (SMS) page 148 August 2020 Semester

Example 9 (Fully Discrete Insurances)(Equivalence Principle)(Special Insurance)

• The annuity pays 1000 per year

E [ PVFB ] =  ( IA ) 1 + 100010| a20

Example 10 (Fully Discrete Insurances)(Equivalence Principle)(Special Insurance)

• Death benefit is payable at the end of year of death

E [ PVFB ] = 1000 A30 +  ( IA ) 1 + 10 10|A30

School of Mathematical Sciences (SMS) page 149 August 2020 Semester

Example 11 (Fully Discrete Insurances)(Equivalence Principle)(Short Term)

E [ PVFB ] = 1000 vqx + 2000 v 2 1| q x + 3000 v 3 2| q x + 1500 v 3 3 p x

By the Equivalence Principle,

1000 vqx + 2000 v 2 1| q x + 3000 v 3 2| q x + 1500 v 3 3 p x =  + 0.5 vpx

1000 vqx + 2000 v 2 1| q x + 3000 v 3 2| q x + 1500 v 3 3 p x