Introduction To Actuarial Mathematics

SOA Course 3
Study program Fall 2004 exams

Thank you for downloading the free copy of Part 1 of the BPP Course 3 Study Program
for the Fall 2004 exams. We are confident that you will find it helpful.
Contents
This file includes the following :
BPP Course 3 Study Guide
Unit 1 Actuarial models
Unit 2 The life table
Unit 3 Insurance functions
Unit 4 Annuities
Question & Answer Bank Part 1 Questions
Question & Answer Bank Part 1 Solutions
The full BPP Course 3 Study Program includes:
Course Notes on all syllabus topics (no other textbooks are required)
An expanded Question & Answer Bank for each part that includes 50 questions with solutions
Assignments following each part with 25 exam-style questions with full solutions
Past exam pack includes full solutions to all SOA/CAS exams since May 2000
Email Tutor Support, designed to help you if you get stuck.
You can order the full BPP Course 3 Study Program online at www.bpp.com
This page is intentionally left blank.
Course 3 Study Guide Fall 2004
BPP Professional Education: 2004 exams Page 1
Course 3
Study Guide for the Fall 2004 exam
Overview
This Study Guide contains everything you need to know before starting to use the BPP
Course 3 study program, including:
the structure of the course notes and practice questions
advice on how to study efficiently and prepare for the exam
a study plan for the session leading to the Fall 2004 exam
details of how to email a question to our tutors if you get stuck
a listing of additional study support available from BPP
the full Syllabus
the Tables for the Course 3 exam (produced by the profession)
binder labels.
How long will this Study Guide take to read?
It should take about 1 hour to read this Study Guide carefully. It will be time well spent,
because youll be able to work through the course notes more efficiently if you understand
how the BPP study program is structured.
Study Guide Fall 2004 Course 3
Page 2 BPP Professional Education: 2004 exams
Contents
Section Page
1 Introduction 3
2 How to use the BPP study program 4
2.1 Structure of the course 4
2.2 Structure of each unit 6
2.3 Binder labels 7
3 Tutor support and optional products and services 9
3.1 Tutor support 9
3.2 Practice exams 10
3.3 Flashcards 10
3.4 Seminars 10

4 Study skills 11
4.1 Overall study plan 11
4.2 Study sessions 11
4.3 Order of study 12
4.4 Active study 13
5 Possible study plans 14
6 Syllabus 16
Appendix
Tables for the Course 3 examination
1 Introduction
Were confident that this BPP Course 3* study program will have a very positive impact on
the way you study for the actuarial exams. We believe that students should spend their
time focusing on learning and preparing for the exam, not juggling their time between
textbooks, study manuals to re-explain those textbooks and additional textbooks with
solutions. BPPs courses contain everything you need to know. Just start at page 1 and
enjoy a simpler approach to study.
Weve designed the courses to cover the learning objectives in an order thats right for you.
Our notes include worked examples, self-test questions and review summaries to aid your
understanding. We also include a large number of brand new exam-style questions, which
are arranged clearly so that you can easily find the right questions to practice. And, as an
added feature, the BPP Past Exam Pack, with solutions to all of the Course 3 exams
released by the SOA since May 2000 have been added to the study program. Our
experienced tutors have worked hard on a course structure so you can focus on learning.
For BPP, providing a study program means providing a commitment to support students all
the way through to the exam. Our full-time tutors will answer any questions you may have
by email so that you always have the support you need. And we also offer seminars,
which are co-ordinated with your study material to give you the very best chance of
success in the exam.
Passing the actuarial exams is difficult enough. We understand that youre competing
against some very bright people and that its always hard to find time for studying between
working and socializing. The amount of material covered in Course 3 is daunting and the
last thing you need to worry about is how to approach the study. BPPs study programs
provide the very best support to help you maximize your chances of success in the exam
and to make good progress towards qualification.
As you have more contact with BPP, youll find us to be a very friendly and proactive
company. We are committed to providing high quality study support. We respond quickly
to students requests and will do all we can to meet your specific needs, eg offering a
seminar near you. We look forward to helping you.
Good luck with your studying.
David Carr
CEO, BPP Professional Education
* Note to CAS students: This study program is designed to help students prepare for the SOA
Course 3 exam. Please check the BPP website for details of our CAS Exam 3 study program.
2 How to use the BPP study program
2.1 Structure of the course
Course notes
The course notes are divided into 5 parts to help you structure your progress through the
session leading to the Course 3 exam.
The following table shows how the parts and the units relate to each other and provides an
estimate of the time you should plan for the first run-through of each unit:
Part Unit Title
Time
(hours)
1 Actuarial models 1.5
2 The life table 6
3 Insurance functions 4
1
4 Annuities 4
5 Premiums 2.5
6 Reserves 3
7 Joint life functions 8
2
8 Multiple decrement models 4
9 Introduction to loss distributions 1
10 Frequency distributions 3
11 Continuous distributions 4
12 Compound distributions 4
3
13 Reinsurance 3
14 Markov chains 4
15 The Poisson process 4
4
16 Brownian motion 4
17 Ruin theory 5
5
18 Simulation 3
Each unit of the course notes includes a unit summary the summaries can serve as a
useful review aid.
Throughout the course notes you will find short self-assessment questions, which are
designed to test your understanding of the material and to ensure that you study actively.
They are not intended to be representative of exam questions. Solutions are given at the
end of each chapter.
Question & Answer Bank
The Question & Answer Bank is also divided into five parts. Each part of the Question &
Answer Bank includes 50 new exam-style questions to test your understanding of the
associated part of the notes.
The Review Question & Answer Bank contains 75 new exam-style questions to test your
understanding of the whole course.
Assignments
There are five assignments to help you assess your level of understanding of the
associated part of the notes. Each assignment includes 25 new exam-style questions and
should take around 2 hours to complete.
Order of study
For each part of the course, we recommend that you:
read the course notes carefully
review the course notes
attempt several questions from the Question & Answer Bank
attempt the assignment under exam conditions.

For more detail on how to structure your studying, see Section 4 on Study Skills.
Added Feature Past exam packs
Our past exam packs contain all of the questions from the SOA released Course 3 exam
papers from May 2000 to present and BPPs full solutions, including comments to help you
with your exam technique, references to the course notes, and alternative approaches.
2.2 Structure of each unit
As you work through the course notes, youll see a variety of symbols in the margin. The
symbols have been designed to help you find your way through the course notes quickly
and efficiently.
The symbols and their meanings are as follows:
An important point, often a definition or a new concept.
An example question with a fully worked solution.
A self-assessment question to test your understanding of the course. Full
solutions are given at the end of the unit.
A multiple-choice question, which may be appropriate for the exam. Full
solutions are given at the end of the unit.
Youll also find the following symbols at the start of each unit:
An overview of the unit with advice on the main points to bear in mind.
A guide to the time required to study each unit on your first run-through.
The relevant learning objectives are also listed at the start of each unit.
2.3 Binder labels
Cut out the labels printed below and place them in the pockets on the spines of your BPP
binders.
Course 3
Actuarial Models
Fall 2004
Volume 1
Course 3
Actuarial Models
Fall 2004
Volume 2
This page has been left blank so that
you can cut out and use the binder labels.
3 Tutor support and optional BPP products and services
3.1 Tutor supportincluded with every BPP study program
Our tutors are here to help you pass. If you get stuck, you can email technical questions
about the course material to our team of Course 3 tutors. Well answer your questions
thoroughly and quickly so that you can get on with your studying with no worries.
If you have a question about the course material
From time to time you may come across something in the study material that is unclear to
you. The best way to solve such problems is often through discussion with friends and
colleagues they will probably have had similar experiences while studying. Whats more,
youll usually remember the answer more clearly if you worked it out for yourself, with or
without help from your friends.
If you are still stuck, then you can email your questions to our team of Course 3 tutors.
You should send an email to:
course3support@bpptraining.com
Please help us to help you by stating your name and your question clearly. Also, tell us
your fax number if you have one our answers might include an actuarial formula that is
easier to fax than to type in an email!
We also put answers to frequently asked questions about the course material on our
website at www.bpp.com. This information is updated regularly and is consolidated into
the rewriting of the course material each session.
If you have any non-technical questions about BPPs study programs
If you have any non-technical questions or if you have any ideas, suggestions or feedback
on BPPs study programs, you should send an email to:
info@bpptraining.com
Please dont hesitate to contact us we look forward to helping you. And, dont forget to
periodically check our website at www.bpp.com for other useful study tips that will appear
from time to time.
3.2 Practice exams
BPP has two Course 3 practice exams available to give you a realistic test of your exam
preparation. Each practice exam contains brand new exam-style questions and is supplied
with full solutions.
Each practice exam costs $25.
3.3 Flashcards
For Fall 2004, BPP is offering user-friendly flashcards to supplement the study program.
Great for those on the go, theyll help you remember the most important formulas,
concepts, alternative solution methods and exam shortcuts.
3.4 Seminars
BPP offers a range of public seminars in major cities to help you prepare effectively for the
exams. Our seminars have a maximum group size of 18 which means that every student
will be able to ask questions and get personal help from the instructor.
Our seminars are designed to be interactive. They are challenging but enjoyablea
positive learning experience clearly focused on helping each student pass the exam.
We pride ourselves on the quality of our teaching. In feedback from past seminars, 96% of
students rated our instructors in the top two categories Very Good (83%) or Good (13%).
The most up-to-date information on upcoming BPP seminars with dates, locations and
seminar registration deadlines can be found on the BPP website at www.bpp.com.
4 Study skills
4.1 Overall study plan
Develop a realistic study plan, build in time for relaxation and allow some time for
contingencies. Be aware of busy times at work, when you may not be able to take as
much study leave as you would like. Once you have set your plan, be determined to stick
to it. (You dont have to be too prescriptive at this stage about what precisely you do on
each study day. The main thing is to be clear that you will cover all the important activities
in an appropriate manner.)
Manage your study to allow plenty of time for the concepts you meet in this course to
become ingrained in your mind. Most successful students will complete the course no
later than the end of March, leaving at least a month for review. By finishing the course as
quickly as possible, you will have a much clearer view of the big picture. It will also allow
you to structure your review so that you can concentrate on the important and difficult
areas of the course. How often do you think Im just getting the hang of this, I wish the
exam was two weeks later?
Two possible study plans are included in Section 5 of this Study Guide.
4.2 Study sessions
Only do activities that will increase your chance of passing. Dont include activities for the
sake of it and dont spend too much time reviewing material that you already understand.
You will only improve your chances of passing the exam by getting on top of the material
that you currently find difficult.
Each study session should have a specific purpose and be based on a specific task,
eg Finish reading Unit 4 and attempt Questions 21 through 25 from the Part 1 Question
and Answer Bank not a specific amount of time, eg Three hours studying the material in
Unit 3.
Study somewhere quiet and free from distractions (eg a library or a desk at home
dedicated to study). Find out when you operate at your peak, and try to study at those
times of the day. This might be between 8 am and 10 am or could be in the evening. Take
short breaks during your study to remain focused its definitely time for a short break if
you find that your brain is tired and that your concentration has started to drift from the
information in front of you.
4.3 Order of study
You should work through each of the units in turn. To get the maximum benefit from each
unit you should proceed in the following order:
1. Read the learning objectives. These are set out in the box at the beginning of each
unit.
2. Take a few minutes to look at the unit summary at the end of each unit. This will give
you a useful overview of the material that you are about to study and help you to
appreciate the context of the ideas that you meet.
3. Study the BPP course notes in detail, annotating the pages and possibly making your
own notes. Try the short self-assessment questions as you come to them. Our
suggested solutions are at the end of each unit.
4. Read the unit summary again carefully. If there are any ideas that you cant
remember covering in the notes, read the relevant section of the notes again to
refresh your memory.
You may like to attempt some questions from the Question & Answer Bank when you have
completed a part of the course. Its a good idea to annotate the questions with details of
when you attempted each one and whether you got it right or wrong. This makes it easier to
ensure that you try all of the questions as part of your review without repeating any that you
got right first time.
Once youve read the relevant part of the notes and tried a selection of questions from the
Question & Answer Bank, you should attempt the corresponding assignment. Try to
complete the assignment under exam conditions monitor the time you have taken and dont
refer to your notes. Although this seems difficult, it will really help you to prepare for the
exam. Youll learn much more from getting something wrong than from getting it right simply
by referring to the course notes.
Its a fact that people are more likely to remember something if they review it periodically. So,
do look over the units you have studied so far from time to time. It is useful to re-read the
unit summaries or to try the self-assessment questions again a few days after reading the
unit itself.
To be really prepared for the exam, you should not only know and understand the course
notes but also be aware of what the examiners will expect. Your review program should
include plenty of question practice so that you are aware of the typical format, content and
length of exam questions. You should attempt as many questions as you can from the
Question & Answer Bank (including the review part) and the past exam pack.
4.4 Active study
Here are some techniques that will help you to study actively.
1. Dont believe everything you read! Good students tend to question everything that
they read. They will ask why, when, how? when confronted with a new concept,
and they will apply their own judgement. The self-assessment questions will help
you to achieve this.
2. As you read the course notes, think of possible questions that the examiners could
ask. This will help you to understand the examiners point of view and should mean
that there are fewer nasty surprises in the exam room.
3. Annotate your notes with your own ideas and questions. This will make your study
more active and will help when you come to review the material. Do not simply copy
out the notes without thinking about the issues.
4. Attempt the questions in the notes as you work through the course. Write down
your answer before you check against the solution.
5. Attempt other questions on a similar basis, ie write down your answer before looking
at the solution provided. Attempting the assignments under exam conditions forces
you to think and act in a way that is similar to how you will behave in the exam.
6. Attend a BPP Course 3 review seminar. These focus on developing the skills
needed to pass the exam. The registration deadlines for the Fall 2004 exam
seminars are shown on the BPP website at www.bpp.com.
7. Sit a practice exam a few weeks before the real exam to identify your weaknesses
and work to improve them. Use the past exam pack and supplement that with one
or both of the practice exams written by BPP.
5 Possible study plans
Here are possible study plans for students starting in May 2004 and July 2004.
For students starting to study in May 2004
Week
#
Week
beginning
Activity
1 May 17
2 May 24
Read & review Part 1 of the course notes
3 May 31 Attempt questions from Q&A Bank Part 1 and complete Assignment 1
4 June 7
5 June 14
6 June 21 Attempt questions from Q&A Bank Part 2 and complete Assignment 2
7 June 28 Review Parts 1 & 2
8 July 5
9 July 12
10 July 19
Attempt questions from Q&A Bank Part 3 and complete Assignment 3
11 July 26
12 August 2*
13 August 9 Attempt questions from Q&A Bank Part 4 and complete Assignment 4
14 August 16 Review Parts 3 & 4
15 August 23
16 August 30
17 September 6 Attempt questions from Q&A Bank Part 5 and complete Assignment 5
18 September 13 Enjoy a well-deserved week off
19 September 20
20 September 27
21 October 4
22 October 11
23 October 18
24 October 25
Six-week review period:
Attempt all questions from Review Q&A Bank and all remaining
question from Q&A Bank Parts 1 5
Attempt past exams or a BPP practice exam under exam conditions
Attend a BPP review seminar
Identify your weaknesses and work to improve them
25 November 1 Course 3 exam (November 2)
* Note: Check the BPP website for seminar registration deadlines.
For students starting to study in July 2004
Week
#
Week
beginning
Activity
1 July 5
2 July 12
3 July 19
4 July 26
5 August 2*
6 August 9
7 August 16
8 August 23
9 August 30
10 September 6
11 September 13 One spare week to allow for vacations & contingencies
12 September 20
13 September 27
14 October 4
15 October 11
16 October 18
17 October 25
Six-week review period:
Attempt all questions from Review Q&A Bank and all remaining
question from Q&A Bank Parts 1 5
Attempt past exams or a BPP practice exam under exam conditions
Attend a BPP review seminar
Identify your weaknesses and work to improve them
18 November 1 Course 3 exam (November 2)
* Note: Check the BPP website for seminar registration deadlines.
Course 3 contains a large amount of material, including many new concepts that will take
time to understand. If you start to study in mid-July, you will be under enormous
pressure to complete the reading quickly and leave an adequate amount of time for
review. Youll need to work hard and work efficiently to complete each part thoroughly in
two weeks.
6 Syllabus
The Syllabus is an important part of your study. You should review this Syllabus now and
when you have completed the course notes to make sure that you understand what you
are required to know for the exam. The relevant learning objectives are listed at the start
of each unit.
Understanding Actuarial Models
The candidate is expected to understand the models and techniques listed below and to
be able to apply them to solve problems set in a business context. The effects of
regulations, laws, accounting practices and competition on the results produced by these
models are not considered in this course. The candidate is expected to be able to:
1. Explain what a mathematical model is and, in particular, what an actuarial model
can be.
2. Discuss the value of building models for such purposes as: forecasting, estimating
the impact of making changes to the modeled situation, estimating the impact of
external changes on the modeled situation.
3. Identify the models and methods available, and understand the difference between
the models and the methods.
4. Explain the difference between a stochastic and a deterministic model and identify
the advantages/disadvantages of each.
5. Understand that all models presented (eg survival models, stochastic processes,
aggregate loss models) are closely related.
6. Formulate a model for the present value, with respect to an assumed interest rate
structure, of a set of future contingent cash flows. The model may be stochastic or
deterministic.
7. Determine the characteristics of the components and the effects of changes to the
components of the model in 6. Components include:
a deterministic interest rate structure;
a scheme for the amounts of the cash flows;
a probability distribution of the times of the cash flows; and
the probability distribution of the present value of the set of cash flows.
8. Apply a principle to a present value model to associate a cost or pattern of costs
(possibly contingent) with a set of future contingent cash flows.
Principles include: equivalence, exponential, standard deviation, variance,

and percentile.
Models include: present value models based on 9 12 below.
Applications include: insurance, health care, credit risk, environmental risk,

consumer behavior (eg subscriptions), and warranties.
9.** Characterize discrete and continuous univariate probability distributions for failure
time random variables in terms of the life table functions,
x
l ,
x
q ,
x
p ,
n x
q ,
n x
p ,
and
| m n x
q , the cumulative distribution function, the survival function, the probability
density function and the hazard function (force of mortality), as appropriate.
Establish relations between the different functions.
Develop expressions, including recursion relations, in terms of the functions

for probabilities and moments associated with functions of failure time
random variables, and calculate such quantities using simple failure time
distributions.
Express the impact of explanatory variables on a failure time distribution in

terms of proportional hazards and accelerated failure time models.
10. Given the joint distribution of two failure times:
Calculate probabilities and moments associated with functions of these

random variables.
Characterize the distribution of the smaller failure time (the joint life status)
and the larger failure time (the last survivor status) in terms of functions
analogous to those in 9, as appropriate.
Develop expressions, including recursion relations, for probabilities and

moments of functions of the joint life status and the last survivor status, and
express these in terms of the univariate functions in 9 in the case in which
the two failure times are independent.
Characterize the joint distribution of two failure times, the joint life status and
the last survivor status using the common shock model.
11. Characterize the joint distribution (pdf and cdf) of the time until failure and the
cause of failure in the competing risk (multiple decrement) model, in terms of the
functions
( )
x
l
t
,
( )
t x
q
t
,
( )
t x
p
t
,
( )
t x
d
t
,
( )
( )
t x
t
t
m .
Establish relations between the functions.
Given the joint distribution of the time of failure and the cause of failure,
calculate probabilities and moments associated with functions of these
random variables.
Apply assumptions about the pattern of failures between integral ages to

obtain the associated (discrete) single decrement models from a discrete
multiple decrement model as well as the discrete multiple decrement model
that results from two or more discrete single decrement models.
12.** Generalize the models of 9, 10, and 11 to multiple state models characterized in
terms of transition probability functions or transition intensity functions (forces of
transition).
13. Define a counting distribution (frequency distribution).
Characterize the following distributions in terms of their parameters and

moments: Poisson, mixed Poisson, negative binomial and binomial
distributions.
Identify the applications for which these distributions are used and the
reasons why they are used.
Given the parameters of a distribution, apply the distribution to an

application.
14. Define a loss distribution.
Characterize the following families of distributions in terms of their

parameters and moments: transformed beta, transformed gamma, inverse
transformed gamma, lognormal and inverse Gaussian.
Apply the following techniques for creating new families of distributions:

multiplication by a constant, raising to a power, exponentiation, and mixing.
Identify the applications in which these distributions are used and the
reasons why they are used.
Given the parameters of a distribution, apply the distribution to an

application.
15. Define a compound distribution.
16.** Calculate probabilities associated with a compound distribution when the
compounding distribution is a member of the families in 13, and the compounded
distribution is discrete or a discretization of a continuous distribution.
17. Adjust the calculation of 16 for the impact of policy modifications such as
deductibles, policy limits and coinsurance.
18. Define a stochastic process and distinguish between discrete-time and continuous-
time processes.
19. Characterize a discrete-time Markov chain in terms of the transition probability
matrix.
Use the Chapman-Kolmogorov equations to obtain probabilities associated

with a discrete-time Markov chain.
Classify the states of a discrete-time Markov chain.
Calculate the limiting probabilities of a discrete-time Markov chain.

20. Define a counting process.
21. Characterize a Poisson process in terms of
the distribution of the waiting times between events,
the distribution of the process increments,
the behavior of the process over an infinitesimal time interval.

22. Define a nonhomogeneous Poisson process.
Calculate probabilities associated with numbers of events and time periods

of interest.
23. Define a compound Poisson process.
Calculate moments associated with the value of the process at a given time.
Characterize the value of the process at a given time as a compound

Poisson random variable.
24. Define a Brownian motion process.
Determine the distribution of the value of the process at any time.
Determine the distribution of a hitting time.
Calculate the probability that one hitting time will be smaller than another.
Define a Brownian motion process with drift and a geometric Brownian

motion process.
25. For a discrete-time surplus process:
Calculate the probability of ruin within a finite time by a recursion relation.
Analyze the probability of ultimate ruin via the adjustment coefficient and
establish bounds.
26. For a continuous-time Poisson surplus process:
Derive an expression for the probability of ruin assuming that the claim
amounts are combinations of exponential random variables.
Calculate the probability that the surplus falls below its initial level,
determine the deficit at the time this first occurs, and characterize the
maximal aggregate loss as a compound geometric random variable.
Approximate the probability of ruin using the compound geometric

recursion.
Analyze the probability of ruin: analytically (eg adjustment coefficient);

numerically; and by establishing bounds.
Determine the characteristics of the distribution of the amount of surplus

(deficit) at: first time below the initial level; and the lowest level (maximal
aggregate loss).
27.** Analyze the impact of reinsurance on the probability of ruin and the expected
maximum aggregate loss of a surplus process.
28. Generate discrete random variables using basic simulation methods.
29. Generate continuous random variables using basic simulation methods.
30. Construct an algorithm to appropriately simulate outcomes under a stochastic
model.
Applications of Actuarial Models
The candidate is expected to be able to apply the models above to business applications.
The candidate should be able to determine an appropriate model for a given business
problem and be able to determine quantities that are important in making business decisions,
given the values of the model parameters. Relevant business applications include, but are
not limited to:
Premium (rate) for life insurance and annuity contracts,
Premium (rate) for accident and health insurance contracts,
Premium (rate) for casualty (liability) insurance contracts,
Premium (rate) for property insurance contracts,
Rates for coverages under group benefit plans,
Loss reserves for insurance contracts,
Benefit reserves for insurance contracts,
Resident fees for Continuing Care Retirement Communities (CCRCs),**
Cost of a warranty for manufactured goods,
Value of a financial instrument such as: a loan, a stock, an option, etc.,
Risk classification.
Solvency (ruin).
** Based upon the official SOA notice of 12/21/00, the learning objective/application stated here is not
consistent with the references listed in the SOA/CAS syllabus. The BPP Study Program is based on the most
current SOA readings.
All study material produced by
BPP Professional Education is copyright
and is sold for the exclusive use of the purchaser.
You may not hire out, lend, give out, sell,
store or transmit electronically or photocopy
any part of the study material.
You must take care of your study material to ensure
that it is not used or copied by anybody else.
Legal action will be taken if these terms are infringed.
In addition, we may seek to take disciplinary action
through the profession or through your employer.
Actuarial models Course 3
Fall 2004 exams BPP Professional Education
Course 3
Fall 2004 exams
Part 1
Course Notes
Instructions
Read the Course Notes actively. Do not blindly accept what you read. You should think
about the ideas covered and decide for yourself whether you agree.
Attempt the self-assessment questions as you work through the Course Notes
and write down your answer before you check against the solution.
When you have finished the Course Notes in this part of the course, attempt some of the
questions in the Question & Answer Bank.
Course 3 Professional models
BPP Professional Education Fall 2004 exams
Course 3, Unit 1 Actuarial models
Unit 1
Actuarial models
Unit overview
This chapter introduces you to some of the actuarial models that are covered in Course 3.
It also reminds you of some of the models that you should already have come across in
Courses 1 and 2.
This chapter is an introduction to the whole of Course 3 and will give you a good overview
of the techniques you will be studying during the rest of the course.
Advice on study
This chapter is not as long as many of the other chapters in the course. It covers a wide
range of ideas but is not very mathematical. You will have no formulae to learn, so you
should be able to read through the ideas relatively quickly.
How long will this unit take to study?
We suggest that you might need about 1 hours to study the ideas outlined in this
chapter.
Actuarial models Course 3, Unit 1
Learning objectives
1 Explain what a mathematical model is, and, in particular, what an actuarial model
can be.
2 Discuss the value of building models for such purposes as: forecasting, estimating
the impact of making changes to the modeled situation, estimating the impact of
external changes on the modeled situation.
4 Explain the difference between a stochastic and a deterministic model and identify
the advantages/disadvantages of each.
1 Introduction
A model is a theoretical representation of a practical situation.
Actuaries spend a considerable amount of time trying to predict what is likely to happen in
the future. In order to do so, they look at what has happened in the past, and try to
quantify it. This process usually involves building a model of some kind.
The type of model used will depend very much on the practical situation being observed.
It may also depend on the answer to some (or all) of the following questions.
How accurate do I want my model to be?
Is simplicity more important than accuracy?
Who is going to interpret the results of the model?
Are there any follow-up studies that need to be done based on the model I am
using?
In order to develop our ideas, let us look at a simple example that you should already be
familiar with.
Example 1.1
An actuary wishes to model the number of motor claims that are expected in the coming
years from a closed portfolio of policies. He has decided to use the Poisson distribution to
model the number of claims. Outline how he might go about setting up the model.
Solution
We have deliberately chosen a relatively simple situation here. The stages he might go
through are as follows:
Collect some past data. The actuary will need to know how many claims have
been received in the past.
Decide on whether to stratify the data, or to look at the portfolio as a whole. Are
the claim numbers likely to be affected by factors such as type of car, address of
driver and so on?
If these factors are important, we must decide which to use and which to ignore.
There are likely to be a number of factors whose importance is marginal.
Subdivide the data into the different groups that are believed to be likely to have
different claim rates.
Within each group, estimate the claim rate from the past data. This would involve
calculating a Poisson parameter for each group of data.
Decide whether there are factors that are likely to change our experience in the
future, and allow for these where possible.
Predict what our claims experience is likely to be in future, allowing for any external
factors.
In due course, review the claims that come in subsequently, and update the model
in the light of this updated experience.
Notice that there are really three basic processes:
(i) Analyze the data that has been received in the past
(ii) Use the past data to predict what might be about to happen in the future.
(iii) Subsequently, update the experience to try to improve the accuracy of future
predictions.
While not all actuarial models work in precisely this way, many do, and this procedure,
which can be used in a wide variety of situations, is one example.
Question 1.1
How might the actuary test that the Poisson distribution was an appropriate model in the
example above?
2 Models you have seen before
2.1 The deterministic cash flow model
You have already used cashflows to model situations as part of your study of previous
courses. For example, you have used cashflow models to determine the rate of return on
an investment.
Example 1.2
In return for an initial investment of $1,000, a company promises to pay an investor the
sum of $200 at the end of a year, and to return the initial investment of $1,000 at the end
of the second year. What is the return on this investment?
Solution
A simple equation of value will provide the answer here:
1000 200 1000
2
= + v v + = 5 5 0
2
v v
Solving this equation of value, we find that:
1 1 4 5 5
0.90499
10
v
- - -
= =
So the rate of return on the investment is:
1
1 10.5%
0.90499
- =
2.2 Stochastic cashflow models
You may also have seen an example of a stochastic cashflow model. Here the amount
and/or timing of the cashflows may be uncertain, and statistical analysis may be needed.
Here is a very simple example.
Example 1.3
It is believed that the interest rate on a certain type of bond will be either 4% or 6% for the
next three years, but the actual value is unknown. Either possibility is believed to be
equally likely. Assuming that the actual interest rate is constant throughout the time
period, find the expected accumulated value at time 3 of an initial investment of $1 at time
0.
Solution
The accumulated amount of the investment will be either 104
3
. or 106
3
. . Since each of
these is equally likely, the expected accumulated value will be:
3 3
1.04 1.06 1.15794 + =
So the expected accumulated value is $1.16.
Question 1.2
What is the variance of the accumulated amount at the end of three years, assuming the
same interest rate model as in the example above?
Of course, the distribution of the future interest rate is likely to be more complex than that
given here. For example we might want to use a continuous distribution taking values on
the range (4%, 8%) to get a more realistic model. It is also unlikely that the interest rate
would be fixed for the whole term of the investment.
Question 1.3
Suppose that the rate of return in each year had been equally likely to be 4% or 6%, with
returns in individual years being independent. What would the expected accumulation
have been at the end of three years in this case?
Models of future interest rate patterns can be much more complex than this. In the real
world there are likely to be interactions between interest rates, inflation, money supply and
other economic variables. A more realistic interest rate model might have time related
variables for each of these parameters (ie a series of random variables ( ) X t denoting
interest rates at time t , a series of random variables ( ) I t denoting inflation at time t , and
so on). We might then expect ( ) X t to be dependent on inflation at earlier time periods, ie
( ) X t will be dependent on ( 1) I t - , ( 2) I t - , as well as other random variables. You will
see more of time series models of this type in Course 4.
These two simple examples should remind you that you are already aware of a number of
different possible methods for building a model.
We now outline briefly some of the models that you are likely to come across while
studying Course 3.
3 Models used in Course 3
3.1 Survival models
Much of Course 3 is devoted to analysing cashflows contingent on human life. For
example, we may agree to pay to a policyholder a fixed sum of $1,200 each month for the
rest of his life, in exchange for a single premium now of $200,000. This type of policy is
called a life annuity.
How do we know the correct single premium to charge? We will need to ask the following
questions (amongst others):
How likely is the policyholder to live for a long time? The lower the mortality of the
policyholder, the higher the premium we will need to charge.
How much interest can we earn on the single premium? If we can earn higher
returns on the money before we have to pay most of it back as income to the
policyholder, then we can charge correspondingly less for the policy in the first
place.
What running costs are we likely to experience over the life of the policy? We will
need to charge an additional amount in the premium to cover our expenses.
What are the other likely costs of the company, eg the tax position?
How many policies of this type do we expect to sell? If we have some fixed
expenses (for example the costs of paying rental for our office premises), then the
larger the number of policies we sell, the smaller amount we need to charge this
policy for its share of the fixed expenses.
What other types of policies do we sell, and how profitable are they? Do we have
any particular profit target to be made on policies of this type?
What premium rates are being charged by other companies in the market place?
Can we match these rates? If not, are we realistically going to be able to sell many
policies of this type?
We will not consider all of these problems in Course 3. However they are examples of the
types of problems likely to face actuaries whose job it is to set premiums for life annuity
policies.
However, the first of these problems (the policyholders likely future mortality) is central to
the ideas in Course 3. The first nine units of the course explain how we can calculate
simple premiums for policies like this, and also for policies that pay out benefits on death.
For example, we will consider a term insurance policy that pays out a fixed sum if the
policyholder dies within a certain term. This means that we need to make assumptions in
our model about the likely future mortality of policyholders.
In order to do this, we need to make assumptions about the likely length of time for which
a person or group of people may live. Such a model is called a survival model.
For example, we might decide to use a random variable to represent the length of the
future lifetime of a male life currently aged 40 exact.
Question 1.4
What range of values would this random variable take?
In fact random variables for the future lifetime form the basis of much of the theory in the
first part of Course 3.
We use two random variables for future lifetime. We will use the random variable ( ) T x to
stand for the complete future lifetime of some individual. The complete future lifetime is
the actual length of time from now until death. The random variable in Question 1.4 above
is an example of a complete future lifetime.
The other type of random variable we use for future lifetimes is the curtate future lifetime.
This is a counting random variable that gives us the number of complete years from now
until death. So if a person aged 40 exact now dies at age 62, say, then the value of the
curtate future lifetime random variable is 22.
We use the function ( ) K x for the curtate future lifetime. In any particular case, K will
take the values 0, 1, 2, and so on, up to the maximum value that it is believed possible
that K can take.
If we know the distribution of the future lifetime random variable, we can use it to find the
probability that the future lifetime of an individual exceeds any number x . This is called
the survival function of the individual.
We can also calculate the expected value of the future lifetime and the variance of the
future lifetime. We will come back to this in Units 2 through 8 of this course.
Question 1.5
The future lifetime of a certain type of electrical component is believed to have an
exponential distribution with a mean of 200 hours. What proportion of components of this
type will we expect to last longer than 500 hours? If I have a box of ten of these
components, what is the probability that exactly three of them last longer than 500 hours?
3.2 The life table
Consider a large number of people all born at the same moment. If we know their survival
function, then we can calculate the expected number of survivors, out of the initial group,
who are alive at any point in the future. A table of the expected number of survivors at
each integer age in the future is called a life table.
For example, we could consider a sample of 10,000 policyholders who all take out a
certain type of policy on a fixed date. We could then calculate, given information about
their future lifetimes, how many we would expect to be alive one year later, two years
later, three years later, and so on.
Life tables are used extensively to calculate functions associated with survival. For
example we could use a life table to find:
the probability that a policyholder aged 50 dies in the next year
the expected future length of life for a policyholder aged 60
the number of policyholders in the group who would be expected to survive to age
100.
A life table is a model of the likely future mortality of a group of individuals. As such, we
can use it to predict what may happen in the future to some other group of people, eg
those who are applying to us for some particular type of insurance policy.
There is an example life table in the Tables for Course 3, which you should have a copy of
already. (If not, you can obtain a copy by downloading it from the internet at
www.soa.org/eande/c3_tables.pdf) If you look at the first two columns of the Illustrative
Life Table in the Course 3 Tables, you will find that the table follows the mortality
experience of a theoretical group of 10,000,000 lives, from birth (at age 0 x = ) through to
the final age given (110, at which point there are only 11 out of the 10,000,000 lives left
alive). We can use the life table to predict the likely future mortality experience of any
group of lives. However, we wouldnt necessarily expect our group to behave in exactly
the same way, and there may be reasons why the group under consideration would have
different mortality characteristics. So care needs to be taken when considering whether a
mortality table is appropriate in any set of circumstances.
There are a number of other functions given in the Illustrative Life Table. You should be
familiar with all of these by the time you have finished the Part 1 of Course 3.
Question 1.6
A mortality study is observing the future lifetimes of a group of 10,000 people all currently
aged exactly 30. If the mortality of this group follows that of the Illustrative Life Table, how
many of these lives do you expect to survive to age 60?
3.3 Annuities and Insurances
In order to decide how much to charge in premiums for a policy, we need to calculate the
value of the benefits paid out. The premiums will depend also on mortality and interest
rate assumptions.
For example, consider a term insurance policy. We may want to charge a monthly
premium in exchange for a promise to pay out $100,000 if the policyholder dies in the next
20 years. Before we can charge a premium, we need to value the benefits, taking account
of the fact that we may pay out $100,000, or we may pay out nothing. The premium to be
charged needs to take into account the likelihood that the benefit is paid.
Policies that pay out in this way are called insurance policies. Examples of insurance
policies include:
Whole life policies. These pay out on the death of the policyholder, whenever this
takes place.
Term insurance policies. These pay out only if the policyholder dies within a
certain period or term. If the policyholder survives to the end of the period, no
benefit is paid.
Endowment policies. These will pay out on death within the term of the policy or
on survival at the end of the term. They are really a combination of a term
insurance and a savings policy.
Pure endowments. These pay out only on survival to the end of the term. If the
policyholder dies sooner, no benefit payment is made. These are fairly
uncommon.
We shall see later on how to value the benefits arising under each of these types of policy.
Once the benefits have been valued, we can then decide on an appropriate premium to
charge.
We will also be able to place a value on a stream of annuity payments. You have already
come across the idea of an annuity certain in Course 2. We now look at how to value
annuity payments that are dependent on survival (eg the policy mentioned at the start of
Section 3.1).
There are various different types of annuities that are dependent on survival:
The amounts may be paid at different intervals (annually, monthly, weekly), and
may be paid in advance or in arrears.
Amounts might increase over time. For example the monthly payment might start
at $1,000 per month and increase in line with inflation, or at a fixed rate of 2% a
year.
Amounts may be guaranteed for a fixed period. For example, an annuity might be
paid to a policyholder for life, but with a five year guarantee. This means that, if
the policyholder were to die in the first five years, payments would continue to be
made up until the end of five years (probably to the husband or wife of the original
policyholder).
A joint life annuity might be paid provided that the two lives who purchased it
initially were still alive. Alternatively it might be paid until the second death of the
two.
A reversionary annuity does not start to be paid until a death has occurred. For
example, a policyholder might purchase an annuity that pays $1,000 each month
to his wife after his death, assuming that she is still alive.
We will see how to calculate the value of payments made under most of these types of
arrangement during our study of actuarial functions.
3.4 Premiums and reserves
We have outlined very briefly how we might calculate a premium for one of the policies
given above. But what does an insurer do with the premiums? Can an insurance
company go out and spend the premiums it receives without worrying about the future?
The answer is no. It must retain the premiums (or most of them), since it expects to pay
out benefits in the future. In the meantime, it has a responsibility to invest the sum of
money that is associated with the particular group of policies. This sum is called a
reserve.
Companies must monitor the level of reserves that they need to hold. They have to be
able to calculate the sum needed at any time in the future so that, under a certain set of
assumptions, there will be enough money available to pay out benefits. When all policies
have finished running, there might be some left over, in which case an additional profit
may emerge from this group of policies.
In Unit 6 we will describe how reserves are calculated for different types of policy. We will
also see how the size of a reserve is likely to vary over the term of a policy.
3.5 Joint life functions
Although we express the life table as the experience of a group of lives, we use it initially
to find probabilities associated with a single life. We can extend the idea to estimate
probabilities associated with joint lives. For example, we could ask:
What is the probability that two lives currently aged 60 both survive to age 80?
Given two lives, one now aged 40 and one aged 50, what is the expected time of
the second death?
Given three lives all aged 40, what is the present value of a payment of $10,000
made on the date of the second of the three deaths?
We see that, in this last example, we are combining the ideas of life expectancy and
cashflows, ie we need a model that incorporates present values of future cashflows, as
well as survival probabilities. We will come across these ideas throughout the course.
We will also need the concept of independence. If we wish to use the individual survival
probabilities to find the probability that two lives both survive, we will need to assume that
the mortality of both lives is independent. Alternatively, if mortality is not independent, we
need to know exactly how the mortality of one life affects that of the other. This is usually
very difficult to quantify, and we will often make the assumption of independent mortality
rates, even though this is perhaps not very realistic.
Question 1.7
Why might you expect mortality rates not to be independent between two married
partners?
Even so, the assumption of independence of mortality rates is often made in practice.
Question 1.8
If the probability that A survives to age 60 is 0.8, and the probability that B survives to age
60 is 0.9, what is the probability that (assuming independence):
(i) they both survive to age 60?
(ii) the both die before age 60?
3.6 Loss distributions
You have already met the idea of a continuous random variable. Later in the course we
will look at examples of a number of these distributions, and see how they are used to
model the likely claims arising from different kinds of insurance portfolios. You will need to
be able to calculate means and variances of different distributions, as well as to use
various techniques to derive further types of probability distributions. For example, if a
random variable X has normal distribution, then we need to be able to find the
distribution of the random variable e
X
.
Question 1.9
You have already come across the idea of a moment generating function. Explain what a
moment generating function is, and how it can be used.
We will also meet the idea of a compound distribution. A compound random variable is a
random variable that can be expressed as the sum of a random number of random
variables. For example, if N has a Poisson distribution with a mean of 50, and X has
lognormal distribution with parameters = 6 and
2
2 = , then we say that the random
variable:
S X X X
N
= + + +
1 2
"
has a compound Poisson distribution. We shall see how to analyze compound
distributions later in the course.
Compound distributions can provide a more realistic model of the likely future claims
experience. When we look at the claims likely to arise under a group of policies, we do
not know either the number of claims we are likely to receive, or the amounts of the
individual claims. Using a compound distribution, we model the uncertainty in the claim
numbers using, in the example above, a Poisson distribution, and the uncertainty in the
claim amounts by using a lognormal distribution.
We can also model the likely experience from a portfolio of policies by looking at each
policy, rather than by looking at each claim. In this case, if we had a portfolio of 10,000
motor policies, then we could model the total aggregate claim amount by using the
random variable:
1 2 10,000
S X X X = + + + "
where
i
X is the amount paid during the course of the year on the i th policy. Of course,
we would hope and expect that a large proportion of these
i
X s would be equal to zero (if
no claim was made on a particular policy during the year).
Question 1.10
What other distributions might be suitable for modeling the claim number distribution N ?
3.7 Stochastic processes
A large part of the final section of the course looks at the idea of a stochastic process.
The random variables in the section above model the amount of claims received in a fixed
unit of time (typically one year). A stochastic process might look at the likely future claim
amount over a variable time period.
For example, consider the Poisson model mentioned earlier in this unit for the number of
claims received in a year from a particular policy or group of policies. If we look at a fixed
time period of one year, we might decide that for a certain group, the total number of
claims received might have a (50) Poisson distribution. However, if we want to look at
claims received over different time periods, the number of claims received will be different.
For example, over a two year period the number of claims would be (100) Poisson , over a
five year period it would be (250) Poisson , and over a three month period it would be
(12.5) Poisson .
A stochastic process assigns a random variable to each interval along a time line. For
every interval of time, we can write down a distribution that represents the number of
claims likely to arise in that time interval. So, in the example just given, we say that claims
have a (50 ) Poisson t distribution, where t is the length of the time interval (in years).
We will look in Course 3 at various different types of stochastic processes, including the
ideas of a compound Poisson process, a Markov chain, and a Brownian motion process.
All of these can be used to generalize the idea of the aggregate claim amount (or number
of claims) to a variable time period. A very brief summary of each type of process is
included here.
3.8 Compound Poisson Processes
We saw earlier how we might model the aggregate claims from a portfolio by using a
compound Poisson distribution.
Question 1.11
What is the defining equation for a compound Poisson random variable?
As you might have guessed, a compound Poisson process is a generalization of this
situation over time. So if we have a time period of length t , ( ) S t represents the
aggregate claims incurred over the whole t year period. ( ) N t , the total number of claims
incurred over the period, will have a Poisson distribution with parameter t l , where l is
the rate at which claims arrive in a unit of time.
3.9 Markov Chains
A student is analyzing weather patterns. He classifies each days weather as sunny,
cloudy or rainy. These three classifications can be modeled as the three states of a
Markov model.
The student may well believe that the type of weather on any particular day is a function of
what it was on the previous day. For example, he may believe that if the weather is cloudy
today, the probability that it is cloudy tomorrow is 0.6. But if it is sunny today, the
probability that it is cloudy tomorrow is only 0.4.
If probabilities are assigned to each possible transition from one state to another, then we
can use Markov chain analysis to answer various questions, eg:
If it is sunny today, what is the probability that it will be sunny in three days time?
What proportion of the time is the weather sunny?
How long on average will it be until the next rainy day?

This type of analysis can be applied to any situation where something or someone is
moving between different states. For example, you might have a situation where your
motor insurance premium is reduced in the following year if you make no claims this year.
The policy might have various possible states (no discount, 25% discount, 50% discount),
and policyholders would move between the states from year to year, depending on
whether they make claims in any year or not. This is another example of a Markov chain.
3.10 Brownian Motion
Brownian motion is an example of a statistical process that can take an infinite number of
states, ie the state space is continuous.
In the Markov chain analysis above, we decided that there were only three possible types
of weather that we wished to model. However, consider trying to model the price of a
share on the NYSE. The number of prices possible is very large, and while in practice the
price may have to be a multiple of cents, because the number of possibilities is so great, it
may be more realistic to model the progress of a share price using the assumption that it
can take any value between, say zero and $100. The share price may then be modelled
using Brownian motion. We have:
the price takes any value in a continuous range of values
the monitoring of the price may also take place continuously, so that we are not
just looking at the price once per day, but every hour, or every minute, and so on.
This means that if we draw a graph of the share price, it will take the form of a continuous
curve over time. The unit on Brownian motion explains how we could model share prices
in this way.
3.11 Simulation
The final part of Course 3 looks at methods of simulating values from random variables.
In order to assess whether our models are realistic or not, we have to look and see what
sort of values are generated by them. These may be values from some particular
distribution, for example, or from a stochastic process. We need to be able to generate
sequences of numbers that represent claim amounts, or claim numbers arising in a given
period, and so on.
There are various methods that can be used to generate variables of this kind. You may
have a very simple random number generator on your calculator. This might, for example,
generate numbers that are uniformly distributed in the range from zero to one. We shall
see later on in the course how we can use this random number generator to generate
values from other types of distributions, for example a normal distribution or a Poisson
distribution. We will also see how to generate values for a Markov chain, and a Brownian
motion process.
Question 1.12
Does the random number generator on your calculator generate numbers from a
continuous random variable?
4 Conclusion
This chapter gives you a very brief synopsis of the key ideas that you will come across
during your study of Course 3. You may wish to refer back to it as you reach the various
parts of the course that are mentioned here. At this stage, we can only give you a very
basic understanding of the key elements of the course. As you go through the course,
watch out for links between the various different parts of the course, and try to see how
the ideas are connected. You should also try to look out for links between what you learn
here and what you can remember from your study of previous actuarial subjects. Again
there are connections which can help to deepen your understanding of the new material.
You will find further advice on how to study the course, and the order in which to attempt
things, in the Study Guide. If you have not already done so, please read the Study Guide
before you proceed further with your reading of the chapters in Course 3. You will
hopefully find that it should give you some help in deciding how to tackle the substantial
task of covering all the relevant material for the Course 3 exam.
You know this already, but the amount of material you need to learn for Course 3 is
enormous. Get started as soon as you can, study for as long as you can, and as often as
you can. You will find that the exam is upon you before you are ready for it, unless you
are ruthlessly efficient in organizing your time between now and the exam.
Good luck.
Unit 1 Summary
A model is an attempt to formalize mathematically the experiences that we may see going
on around us.
Actuarial models may have some or all of the following components:
a cashflow component
a survival function component
a life table component
a model for the size or number of future claim amounts
a time related element.

When devising a model, an actuary might want to go through the following stages:
decide on the purpose of the model
collect an appropriate amount of relevant past data
set up the model equations, using parameter values estimated from past data,
adjusted if necessary for changes in likely future experience
test the model to see if it produces realistic results
watch the future experience as it materializes, and compare the actual future
experience with the output from the model
update the parameter values in the model (and the structure of the model itself if
necessary) in the light of new past experience.
A survival model is a model of the future lifetime of a group of people. We will model both
the complete future lifetime (the exact time until the moment of death) and the curtate
future lifetime (the time until death rounded to the next lower whole number of years).
We will be interested both in the probability density function of the future lifetime, and in
the distribution function.
A life table is a theoretical model of the likely future survival pattern of a group of
individuals.
We can use a life table to calculate probabilities of survival or of death within a particular
period.
By combining survival models with cashflow models, we can calculate expected present
values of benefits arising under insurance policies, for example the benefits paid under
pure endowments, whole life policies, term insurance policies and endowment insurance
policies.
By summing the values of individual payments, we can calculate the expected present
values of streams of payments (annuities).
These annuity payments may be made at various time intervals, may be paid in advance
or in arrears, may be contingent on the survival of one or more lives, or may be
reversionary.
By looking at the expected present values of benefits, it is possible to calculate a premium
to be charged for a policy.
Once a policy is in force, an insurer needs to monitor the experience of policyholders. If
too many (or too few) policyholders die, there may be financial implications for the
company.
The process of calculating a reserve for a group of policies is part of this monitoring
process.
The amount to be paid out on a policy is often modeled using a continuous random
variable. There are a variety of probability distributions that are useful for modeling the
shape of a claim amount distribution.
An insurer will be interested in the mean and variance of the claim amount. It will also be
interested in the probability that individual claim amounts exceed certain large values (for
example, the probability that an individual claim amount exceeds $1,000,000).
The number of claims arising from a group of policies is also important. A frequency
distribution will be used to model this.
We can combine both of these ideas using compound distributions. A compound
distribution is the sum of a random number of random variables.
An insurer can also purchase reinsurance in order to reduce the mean amount that needs
to be paid out on a group of policies. Reinsurance will also (probably) reduce the variance
of the claim outgo.
We can model the likely claims experience over time by using different types of stochastic
processes.
A compound Poisson process is an extension in time of a compound Poisson distribution.
We can use a compound Poisson process to model the aggregate claim payment over a
period of time.
Markov Chains may be used to analyze situations where a variable moves between a
small fixed number of classes. Markov chains may be used to analyze how much time on
average will be spent in each class.
Brownian motion is an example of a stochastic process with a continuous range of state
spaces. It can be used to model share prices and other variables that can be deemed to
vary continuously.
We need to be able to generate outcomes from our models, so that we can see whether
they give us a realistic picture of what is actually happening in the real world. We do this
using simulation techniques.
Simulation enables us to generate random samples from particular types of probability
distributions.
We can also develop methods that simulate stochastic processes, for example Markov
chain and Brownian motion data.
This page has been left blank so that you can keep the
summary pages together to help you with your review.
Unit 1 Solutions
Solution 1.1
He might compare the numbers of claims received subsequently with those that were
predicted by the Poisson model. Some form of goodness of fit test, for example using the
chi-square distribution, might be appropriate.
Note that, in real life, the Poisson distribution might well be too simple a model to fit the
actual data well. For example, it is possible that individuals do make claims that have a
Poisson distribution, but that the underlying Poisson parameter is different for different
classes of individuals. In particular, we might find that policyholders in the age range 20-
25 made claims that had a Poisson distribution with a mean of 0.3 claims per year,
whereas policyholders in the 25-30 age group made claims that had a Poisson distribution
with a mean of 0.1 per year, and so on. In this case the overall claim number distribution
would be a mixture of different types of Poisson distributions. We cover mixture
distributions later in Course 3.
Solution 1.2
The variance of the amount will be:
6 6 2
1.04 1.06 1.15794 0.0010945 + - =
Solution 1.3
We now have independent interest rates from year to year. So the probability that the
interest rate is 4% in each of the three years is now 1/8. The probability that the rate is
6% every year is also 1/8. We also have the possibility of two years at 4% and one year
at 6% (probability 3/8), and one year at 4% and two years at 6% (probability 3/8).
So the expected accumulated amount is now:
3 2 2 3
1 3 3 1
1.04 1.04 1.06 1.04 1.06 1.06 1.157625
8 8 8 8
+ + + =
So the expected accumulated growth is now 15.76%.
Solution 1.4
The future lifetime of this individual could take any value within a particular range. So we
might model the future lifetime using a continuous random variable defined on the interval
from zero to 70 years, say. If we choose an upper limit of 70, we are assuming that it is
not possible to live to an age greater than 110, given that the life is currently aged 40.
Solution 1.5
The density function of the future lifetime is:
/ 200
1
( ) , 0
200
t
f t e t
-
=
So the probability that a component lasts for more than 500 hours is:
/ 200 / 200 2.5
500
500
1
0.08208
200
t t
e dt e e
- - -
= - = =
The number of components lasting more than 500 hours in a box of 10 has a binomial
distribution (assuming that the lifetimes of individual components are independent). So
the probability that exactly 3 of the 10 last for more than 500 hours is:
3 7
10
0.08208 (1 0.08208) 0.03644
3

- =

You should already have met both the exponential distribution and the binomial distribution
in your study for previous exams.
Solution 1.6
In the illustrative life table, out of the 9,501,381 lives alive at age 30, 8,188,074 survive to
age 60. So if this group of lives follows the same pattern, we would expect to have a
number of survivors equal to:
8,188,074
10,000 8,618
9,501,381
=
So we would expect 8,618 of the lives to be still alive at age 60.
We shall develop these ideas further in Units 2 and 3 of the course.
Solution 1.7
For a number of reasons. Both partners might be exposed to the risk of accidents which
kill them both, for example being killed in the same car accident. Also, any health related
mortality factors are likely to affect them both if they have similar diets, lifestyles and so
on. Finally, bereavement is itself a very traumatic situation. If one partner dies, this may
affect the health and consequently the survival chances of the remaining partner.
Solution 1.8
If mortality rates are independent, the probability that they both survive to age 60 is
0.8 0.9 0.72 = . The probability that neither of them survives (ie they both die) is
0.2 0.1 0.02 = .
Solution 1.9
The moment generating function of a random variable X is defined to be the expectation
of
tX
e :
( ) ( )
tX
X
M t E e =
We can expand this expression as a series to find the moments of the random variable
( ( ) E X ,
2
( ) E X ,
3
( ) E X and so on).
We will see more of this later on in the course.
Solution 1.10
Almost any frequency distribution. For example, the binomial distribution, the negative
binomial distribution, the geometric distribution. You will see many more of these
distributions later on, if you have not met them already.
Solution 1.11
1 2 N
S X X X = + + + " , where N has a Poisson distribution. X can have any type of
distribution.
Solution 1.12
In theory yes, but in practice no. The generator on my calculator gives me a number
rounded to three decimal places, ie I get a value from the frequency distribution defined on
the numbers 0.000, 0.001, 0.002, 0.003, , 0.999, with the probability that each number
is generated is 0.001.
Course 3, Unit 2 The life table
Unit 2
The life table
Unit overview
This unit looks at survival and death probabilities for integer and fractional ages. It
develops the ideas of the future lifetime random variable and expected future lifetimes.
Some mortality laws are then considered, and we derive expressions for survival
probabilities based on these laws. The unit finishes with an introduction to select and
ultimate mortality.
Advice on study
You should ensure that you are completely happy with the work and notation covered in
this unit before proceeding to later units.
We recommend that you should allow 6 hours to study this unit of the course.
The life table Course 3, Unit 2
Learning objectives
9 Characterize discrete and continuous univariate probability distributions for failure
time random variables in terms of the life table functions, , , , ,
x x x n x n x
l q p q p and
| m n x
q , the cumulative distribution function, the survival function, the probability
density function and the hazard function (force of mortality), as appropriate
Establish relations between the different functions.
Develop expressions, including recursion relations, in terms of the functions
for probabilities and moments associated with functions of failure time
random variables, and calculate such quantities using simple failure time
distributions.
1 Introduction
In order to plan finances in an insurance or pensions company you will need to be able to
answer questions such as: How much will the pension payments for our customers be in
the coming year? or When will we have to pay out for John Does life insurance policy?.
We are not able to obtain exact answers to such questions, since time of death for most
people is unknown, but having a model for human mortality will enable us to find a good
approximation.
Actuaries have studied human mortality for many years and have built up life tables for
typical populations showing how many people out of a particular cohort are expected to
survive to each age.
In this unit we will cover the notation associated with mortality and develop the groundwork
needed for the subsequent units.
This unit introduces much new notation and many definitions. You may need to read it
several times in order to be confident in the use of the symbols defined.
2 Future lifetimes
Definition
The age-at-death of a newborn baby is X.
The distribution function of X is ( )
X
F x .
The survival function ( ) s x is defined to be > Pr( ) X x .
In words, the survival function is the probability of a newborn baby surviving to age x.
Question 2.1
What is the connection between ( ) s x and ( )
X
F x ?
Definition
The future lifetime of a life aged x is ( ) T x , where = ( ) T x X x , given that > X x .
t x
q is the probability that a life aged x dies in the next t years.
t x
p is the probability that a life aged x survives for the next t years.
By convention, if we are talking about a time period of 1 year then the probability notation is
x
q or
x
p .
Question 2.2
Define in words what the symbols
x
q and
x
p mean.
We can now link our definitions as follows:
t x
p is the probability that a life aged x survives for the next t years. This is the same as
the probability that a new born baby survives to age + x t given that it survives to age x,
ie:
= > = > + > Pr( ( ) ) Pr( | )
t x
p T x t X x t X x
But by the definition of conditional probabilities this can be written as:
+
+ > + +
= = =
>
0
0
1 ( ) Pr( ) ( )
Pr( ) ( ) 1 ( )
x t X
x X
p F x t X x t s x t
X x p s x F x
Similarly:
< +
= = + > =
>
+ +
= =
Pr( )
Pr( ( ) ) Pr( | )
Pr( )
( ) ( ) ( ) ( )
( ) 1 ( )
t x
X X
X
x X x t
q T x t X x t X x
X x
F x t F x s x s x t
s x F x
Question 2.3
Define in words what the following notation means:
(i)
25 30
q
(ii)
15 27
p
(iii) < Pr( 60) X
(iv) < < Pr(32 79) X
(v) (15)
X
F
(vi) (60) T
(vii) (24) s
Question 2.4
Find two alternative expressions for
+ s t x
p by splitting up the probability in two different
ways.
3 Curtate future lifetime and curtate expectation of life
3.1 Curtate future lifetime
Definition
The curtate future lifetime is the complete number of years the life lives after age x. It is
denoted by ( ) K x .
Question 2.5
Is ( ) K x a discrete or continuous random variable?
We can express = Pr( ( ) ) K x k in terms of the notation that we have already used:
+ +
= = < + = < +
= =
1
Pr( ( ) ) Pr( ( ) 1) Pr( ( ) 1)
k x k x k x x k
K x k k T x k k T x k
p p p q
The second equality relies on the assumption that ( ) T x is a continuous random variable
(which is reasonable).
Notice that the last expression,
+ k x x k
p q , is a useful way of thinking of = Pr( ( ) ) K x k . The
probability is equivalent to the probability that a life aged x survives to age + x k and then
dies in the following year.
3.2 Curtate expectation of life
Definition
The curtate expectation of life is defined to be ( ) ( ) E K x and it is denoted as
x
e .
We can find a simple expression for
x
e by using the definition of expectation:
( )

+
= =
+ +
= = = =
= + +

"
0 0
1 1 2 2
( ) Pr( ( ) )
1 2
x k x x k
k k
x x x x
e E K x k K x k k p q
p q p q
We can write this sum as:
+
+ +
+ + +
+ +
+ + +
+ "
1 1
2 2 2 2
3 3 3 3 3 3
x x
x x x x
x x x x x x
p q
p q p q
p q p q p q
If we then sum the columns we get:

+
= =
=

1
x j x x j
k j k
e p q
Now
+
=
j x x j
j k
p q represents the probability of dying at any age beyond + x k , which is
k x
p .
Finally, therefore, our expression becomes:
=
=

1
x k x
k
e p
Curtate expectation of life
The curtate expectation of life,
x
e , is given by:
=
=

1
x k x
k
e p
Question 2.6
Show algebraically that
+
=
1
1
x
x
x
e
e
p
.
We can also derive an expression for the variance of the curtate expectation of life. Consider
( )
2
( ) E K x :
( )

+
=
=

2 2
0
( )
k x x k
k
E K x k p q
Using a similar argument to the one used in the expectation, summing in columns we get:
( )

+ + +
= = =

+
= =
=
= + + +
=
=

"
2
1 2 3
1
1
( ) 3 5
(2 1)
(2 1)
j x x j j x x j j x x j
j j j
j x x j
k j k
k x
k
E K x p q p q p q
k p q
k p
Question 2.7
Show that
( )

+ + +
= = =
= + + +

"
2
1 2 3
( ) 3 5
j x x j j x x j j x x j
j j j
E K x p q p q p q .
The variance of ( ) K x therefore is given by:
2
1
(2 1)
k x x
k
k p e
Variance of curtate future lifetime
The variance of the curtate future lifetime is given by:
( )

=
=
2
1
var ( ) (2 1)
k x x
k
K x k p e
4 Force of mortality
The force of mortality, ( ) x , is an instantaneous measure of mortality at age x. It is defined
to be:
| |
= < < + >
|
\ .
0
1
( ) lim Pr( | )
h
x x X x h X x
h
ie ( ) x h is the probability that an individual who survives to age x then dies in the next h
years, where h is a short period of time. The force of mortality is also known as the failure
rate or the hazard rate.
Returning to the notation we used for the survival function:
+
=
0
1 ( ) ( )
( ) lim
( ) h
s x s x h
x
h s x
But,
+
=
0
( ) ( )
lim ( )
h
s x h s x
s x
h
, assuming that ( ) s x is differentiable. So the force of
mortality becomes:

=
( )
( )
( )
s x
x
s x
We are now going to derive a series of results connecting the distribution function of X,
survival probabilities and the force of mortality. You should be comfortable with the stages of
the derivations, but we have also summarized the findings at the end so that you are aware
of the key results.

=
( )
( )
( )
s x
x
s x
can be rewritten as = ( ) ln ( )
d
x s x
dx
.
If we integrate both sides of this expression between + x t and x, we get:
| |
+
+ +
= =
( )
( ) ln ( ) ln
( )
x t
x t
x
x
s x t
y dy s x
s x
which, by rearrangement, gives us:
+

+
=
`

)
( )
exp ( )
( )
x t
x
s x t
y dy
s x
But
+
=
( )
( )
t x
s x t
p
s x
, so we have the result that
+

=
`

)
exp ( )
x t
t x
x
p y dy .
In particular:

=
`

)
0
0
exp ( )
t
t
p y dy
which gives us:

=
`

)
0
( ) exp ( )
t
s t y dy or

=
`

)
0
( ) exp ( )
x
s x y dy
Differentiating this last expression with respect to x, we get:

= =
`

)
0
0
( ) exp ( ) ( ) ( )
x
x
s x y dy x p x
Since = ( ) 1 ( ) s x F x , = ( ) ( ) s x f x , so:
=
0
( ) ( )
x
f x p x
So we have found an expression for the probability density function of the future lifetime
random variable for a new-born baby.
We can also find the probability density function of the future lifetime of a life aged x. Let us
define
( )
( )
T x
F t to be the cumulative distribution function of the future lifetime of a life aged
x, then since = =
( )
( ) Pr( ( ) )
T x t x
F t T x t q :
+ +
= = = =
`
)
( ) ( )
( ) ( )
( ) ( ) 1
( ) ( )
T x T x t x
d d d s x t s x t
f t F t q
dt dt dt s x s x
We can multiply the numerator and denominator of this fraction by + ( ) s x t , in order to get a
form we can simplify:
( + + +
= = = +
(
+

( )
( ) ( ) ( )
( ) ( )
( ) ( ) ( )
T x t x
s x t s x t s x t
f t p x t
s x s x s x t
From this we have:
= = + (1 ) ( )
t x t x t x
d d
p q p x t
dt dt
ie = + ( )
t x t x
d
p p x t
dt
Finally we can integrate both sides of the expression = + ( )
t x t x
d
q p x t
dt
between the limits
0 and t to obtain:
= +
0
( )
t
t x s x
q p x s ds
We now give a summary of the important formulas:
Summary of important formulas
+

=
`

)
exp ( )
x t
t x
x
p y dy

=
`

)
0
( ) exp ( )
x
s x y dy
=
0
( ) ( )
x
f x p x
= +
( )
( ) ( )
T x t x
f t p x t
= + ( )
t x t x
d
p p x t
dt
= +
0
( )
t
t x s x
q p x s ds
Question 2.8
If = ( ) 0.002 x for all ages from 20 to 60, calculate the probability that a life aged exactly
28
(i) dies before he is 38
(ii) survives to his 60
th
birthday.
Question 2.9
Find an expression for ( ) s x for a population where = + ( ) 0.0001 0.05 x x .
5 Deferred mortality
Deferred mortality
The probability that an individual aged x survives to age + x n , but then dies before age
+ + x n m is written as
| n m x
q .
The period of n years, written before the line, is called the deferred period. We want the
probability of death in an m year period but starting in n years time.
From the definition it can be seen that:
+ + +
= = =
| n m x n x m x n m n x n x n x m n x
q p q q q p p
Question 2.10
What does
| n x
q represent? What other expressions are there for
| n x
q ?
6 Interpretation of life tables
Very often as actuaries we have to calculate probabilities such as
t x
p and
t x
q for a
particular individual. Rather than having to construct each value from first principles, life
tables have been created to help us. These contain tabulated values of several variables
against age. The problem with using the data from a mortality table is that the characteristics
of the group of lives represented in the table may not truly match those of the individual you
are working with.
The lowest age in the table can vary depending on the purpose of the table; for example a
table for retirements is very unlikely to start at age 0! There is one example of a life table, the
Illustrative Life Table, which we will refer to from now on as the Tables. At the moment you
need to use the first three columns you will meet the other notation in later units. Before
we can look at an example of a life table we need some more definitions.
Consider a life table that starts at age 0 for a closed group of individuals:
Definition
0
l is the number of newborns being considered (the radix of the table)
x
l is the number of survivors at age x
x
d is the number of deaths between ages x and +1 x
n x
d is the number of deaths between ages x and + x n
You may want to look at the figures in your Illustrative Life Table as you consider these
definitions.
We can now connect these new definitions to each other and to the other notation in this
unit.
It should be clear that:
+
=
1 x x x
d l l
+
=
n x x x n
d l l
Further:
=
x
x
x
d
q
l
+
= = =
1
1
x x x x
x
x x x
d l d l
p
l l l
+
= =
n x x x n
n x
x x
d l l
q
l l
The last equation then gives rise to:
+ +
= = = 1 1
x x n x n
n x n x
x x
l l l
p q
l l
Question 2.11
Use the Illustrative Life Table to calculate the probability that a life:
(i) aged 35 survives to 65
(ii) aged 27 dies before 47
(iii) aged 47 dies when they are 50
(iv) aged 49 lives to at least 100
(v) aged 40 dies between 75 and 80
Here the ages are exact, for example aged 35 means exact age 35.
Question 2.12
Sketch graphs of
x
l ,
x
d and
x
q for ages 0 to 100.
These definitions and interpretation of the life table are known as the deterministic
survivorship interpretation. An alternative interpretation is the random survivorship
interpretation. This is where we consider
0
l newborns each with probability of surviving to
age x of ( ) s x . The values in the life table now become expected numbers, for example
x
l
is the expected number of survivors at age x.
The mathematical properties of the functions
x
q ,
x
l and
x
d are the same under both
interpretations but the random survivorship interpretation takes into account the inherent
randomness of the number of survivors.
The maximum age of people in the cohort is , which is called the limiting age. Typically,
will be between 100 and 120 for a human population.
We can now link the life table functions to the probability functions and force of mortality.
Since
+
=
x n
n x
x
l
p
l
, it follows that:
=
0
0
x
x
l
p
l
But =
0
( )
x
p s x , so:
=
0
( )
x
l l s x
Consider the expression
1
x
x
dl
l dx
. We can use the previous result as follows:
= = =
0 0
0 0
[ ( )] 1 1 ( ) 1 ( )
( ) ( ) ( )
x
x
d l s x l dl ds x ds x
l dx l s x dx l s x dx s x dx
But, from Section 4, we know that =
1 ( )
( )
( )
ds x
x
s x dx
, so:
=
1
( )
x
x
dl
x
l dx
If we integrate both sides of this expression between the limits of x and , we get:
( )
x y
x
l l y dy
If we now write down the corresponding result for
+ x n
l and take the difference, we get:
+
+
=

( )
x n
x x n y
x
l l l y dy
7 Complete expectation of life
In Section 3 we considered the curtate expectation of life. We now extend that idea to look
at the complete future lifetime and the complete expectation of life.
As a reminder, the future lifetime of a life is ( ) T x , ie the length of life beyond age x. Also
remember that ( ) T x is a continuous random variable.
Definition
The complete expectation of life is defined to be ( ) ( ) E T x and it is denoted as
x
e .
We can find a simple expression for
x
e by using the definition of expectation:
( )

| |
= = = + =
|
\ .

( )
0 0 0
( ) ( ) ( )
x T x t x t x
d
e E T x t f t dt t p x t dt t p dt
dt
Using integration by parts, =

dv du
u dx uv v dx
dx dx
, where = u t , we get:

= + = (

0
0 0
x t x t x t x
e t p p dt p dt
Note that this is analogous to the discrete result where we summed
t x
p instead of
integrating it.
Question 2.13
Is it true that

= +
0 40
40 e e ?
We can also derive an expression for the variance of the complete expectation of life.
Consider
( )
2
( ) E T x :
( )

| |
= = + =
|
\ .

2 2 2 2
( )
0 0 0
( ) ( ) ( )
T x t x t x
d
E T x t f t dt t p x t dt t p dt
dt
since
= 0
x
p .
Using integration by parts with =
2
u t , we get:
( )

(
= + =

2 2
0
0 0
( ) 2 2
t x t x t x
E T x t p t p dt t p dt
This means that the variance is given by:
( )

(
=

2
0
var ( ) 2
t x x
T x t p dt e
Question 2.14
What is the standard deviation of future lifetime if = ( ) 0.02 x for all ages?
8 Recursive formulas for expectations of life
In this section we are going to develop recursive formulas for the curtate and complete
expectation of life.
Consider the curtate expectation of life,
=
=

1
x k x
k
e p . This sum can be expanded and
simplified:
+ + +
+
=
+
= + + +
= + + + + (

(
= + (
(

= +
"
"
2 3
1 1 2 1 3 1
1
1
1
x x x x
x x x x x
x x k x
k
x x x
e p p p
p p p p p
p p p
p p e
Recursive formula
The recursive formula for the curtate expectation of life is:
+
= +
1 x x x x
e p p e
This formula is used backwards ie you input a value of, say,
100
e and get
99
e . The starting
point is the limiting age of the table, since
= 0 e .
Question 2.15
Using the Illustrative Life Table, calculate
107
e recursively.
Consider also the complete expectation of life,
=

0
x t x
e p dt . This integral can be
manipulated as follows:

+
= = +
= +

1
0 0 1
1
1 1
0 1
x t x t x t x
t x x t x
e p dt p dt p dt
p dt p p dt
Changing the variable on the second integral, so that = 1 s t , we get:

+ +
= + = +

1 1
1 1
0 0 0
x t x x s x t x x x
e p dt p p ds p dt p e
Recursive formula
The recursive formula for the complete expectation of life is:

+
= +
1
1
0
x t x x x
e p dt p e
Question 2.16
For a certain population, = exp( 0.02 )
t x
p t and
=
20
50 e . Using the recursive formula
given, calculate
23
e .
9 Median future lifetime
Definition
The median future lifetime, ( ) m x , can be found by solving:
( ) > = Pr ( ) ( ) 0.5 T x m x
Since ( )
+
> =
( )
Pr ( )
( )
s x t
T x t
s x
, we can also find the median future lifetime by solving:
+
=
( ( ))
0.5
( )
s x m x
s x
Question 2.17
How would you find the quartiles of the future lifetime? How would you find the mode of
future lifetime?
Question 2.18
In a very poor country, the survival function is given by = ( ) exp( 0.03 ) s x x . What is the
median and interquartile range of future lifetime of a life aged x?
10 Central death rate
Definition
The central death rate (over the interval from x to +1 x ) is:
+
+
+
=

1
0
1
0
( )
x t
x
x t
l x t dt
m
l dt
The central death rate
x
m is a measure of the rate of mortality over the year from exact age
x to exact age +1 x . The formula can be interpreted as a weighted average of the force of
mortality over the next year of age.
We are going to introduce some more definitions in order to derive another expression for
the central death rate.
Definition
n x
L is the total expected time spent alive between ages x and + x n by survivors to age x
of the original group:
+ +
= + +
0
( )
n
n x x t x n
L t l x t dt nl
Question 2.19
Explain the structure of the above equation.
Question 2.20
Use integration by parts to show that
+
=
0
n
n x x t
L l dt .
Question 2.21
Show that =
0
n
n x
t x
x
L
p dt
l
.
We now introduce another way of considering the last integral.
Definition
=
:
0
n
t x
x n
p dt e is the n-year temporary complete life expectancy of a life aged x.
This is the expected number of years lived by a life aged x in the next n years.
Finally we return to the central death rate.
Question 2.22
Show that
+
=
1 x x
x
x
l l
m
L
.
We can expand the idea of total time spent alive:
Definition
x
T is the total number of years lived beyond age x by survivors to age x in the original
group.
+
= +
0
( )
x x t
T t l x t dt
You should be able to see that
= lim
x n x
n
T L .
Question 2.23
Show that
=
x
x
x
T
e
l
?
The definition of
x
m can be extended to time periods longer than one year:
Definition
The average death rate (over the interval from x to + x n ) is:
+
+
+
+
= =
0
0
( )
n
x t
x x n
n x
n
n x
x t
l x t dt
l l
m
L
l dt
Finally let us consider another life table function:
Definition
( ) a x is the average number of years lived between x and +1 x by those in the group who
die between those ages:
( )

+
+
+ +
= = = <
+ +

1 1
0 0
1 1
0 0
( ) ( )
( ) ( ) | ( ) 1
( ) ( )
x t t x
x t t x
t l x t dt t p x t dt
a x E T x T x
l x t dt p x t dt
Question 2.24
For a particular population = ( ) 1
500
x
s x . Find (40) , (50) ,
10 40
q and
10 40
m .
Comment on the values you obtain.
11 Fractional ages
So far we have assumed that the ages we are working with are integer ages, but we may
wish to work with fractional ages to calculate such quantities as
3.5 46.5
p .
Consider the expression given above. We can split it up as follows:
=
3.5 46.5 0.5 46.5 3 47
p p p
We can arrive at an approximation for the first factor if we make certain assumptions about
the mortality with the year from age 46 to age 47. The second factor can be calculated
directly from the life table. In other words, we can always reduce an expression involving
fractional ages to one of the form
t x
p where 0 1 t .
There are three different assumptions that we have to consider about the mortality during a
year. Under each assumption we can arrive at approximations for the life table functions.
11.1 Uniform distribution of deaths
We are assuming here that the probability density function of future lifetime, + ( )
t x
p x t , is
a constant for an integer value of x and 0 1 t .
With this assumption the general relation ( )
0
t
t x s x
q p x s ds = +
results in the following:

( )
0 0
t t
t x s x
q p x s ds c ds ct = + = =

If we substitute = 1 t into the above we see that
x
c q = and hence
t x x
q t q = . Since
t x
q is
the distribution function, by differentiating the relation
t x x
q t q = we see that the density
function is given by ( )
t x x
p x t q + = .
In summary, we have the following relations as a result of the assumption of a uniform
distribution of deaths:
( )
and 1
( )
1 1
t x x t x x
t x x
x x x
t x t x x
q t q p t q
p x t q
q q q
x t
p q tq
= =
+ =
+ = = =

Now consider the expression
+ s t x t
q where 0 1 t s < . We know that
+
=
s x t x s t x t
p p p , so:
+ +
= = 1 1
s x
s t x t s t x t
t x
p
q p
p
Now we can use the approximation that we have already found:
+

= = =

1 1 ( )
1 1
1 1 1
s x x x
s t x t
t x x x
q sq s t q
q
q tq tq
Note that
+ +
( )
s t x t x t
q s t q if 0 t since + x t is not an integer.
To summarize the results for uniform distribution of deaths:
Results for uniform distribution of deaths
x is an integer and 0 1 t
= + ( )
x t x
q p x t
= 1
t x x
p tq
=
t x x
q tq
+ =
( )
1
x
x
q
x t
tq
+

=
( )
1
x
s t x t
x
s t q
q
tq
11.2 Constant force of mortality
We are assuming here that + = ( ) x t , a constant for an integer value of x and 0 1 t .
We know that exp ( )
x t
t x
x
p y dy
+
| |
|
=
|
\ .
, so under our new assumption:

| |

+
+
= = =
exp ( ) exp exp( )

x t
x t
t x
x
x
p y dy y t
Substituting = 1 t into this expression, we get = exp( )
x
p , so we can deduce further
results:
= 1 exp( )
x
q = ( )
t
t x x
p p = 1 ( )
t
t x x
q p = ln
x
p
Now consider
+ s t x t
p where 0 1 t s :
| |

+
+
+
(
(
= = =
(

exp exp ( ) ( )
x s
s t
s t x t x
x t
p dy s t p
Giving:
+
= 1 ( )
s t
s t x t x
q p
Finally:
+ = = = ( ) ( ) ln ( ) exp( )
t t
t x x x x
p x t p p p t
To summarize the results for constant force of mortality:
Results for constant force of mortality
= 1 exp( )
x
q
+ = = ( ) ln ( ) exp( )
t
t x x x
p x t p p t
= ( )
t
t x x
p p = 1 ( )
t
t x x
q p
+ = ( ) x t

+
= 1 ( )
s t
s t x t x
q p
11.3 Hyperbolic form for
x
t
p
We are assuming here that = +
1
1
t x x
t
t
p p
for an integer value of x and 0 1 t .
We can manipulate the expression for the assumption as follows:

= = = =
+ + + +
1 1
(1 ) (1 ) 1
x x x x
t x
x x x x x x x
p q q p
p
t p t p t p q tq p tq
Therefore:
+ +
= =
+
1 1
1 1 (1 )
x x x x
t x
x x x
q tq q tq
q
q tq t q
Further, we can find an expression for the force of mortality:
( )
+ =
= +
=
+
+
=
+
= = =
+ +
2
2
2
1
( )
1
(1 )(1 )
(1 ) 1
(1 )
1 (1 )
1
(1 )
1 1 (1 )
t x
t x
x x x x
t x
x x
t x
x x
x x x x
x
x x
x x x
x x x x x
d
x t p
p dt
q q tq q
p
q q
p
q tq
q tq q q
q
q tq
q q q
q tq t q p tq
Finally an expression for
+ s t x t
q where 0 1 t s can be derived as follows:
+
+
= =
+
+
=
+
+ +
=
+
=

1 1
1 1
1 1
1
1
1
1 1
1
( )
1 (1 )
s x x x x
s t x t
t x x x x
x x
x x
x x x x
x x
x
x
p q q tq
q
p q sq q
q tq
q sq
q sq q tq
q sq
s t q
s q
To summarize the results for the hyperbolic form for
t x
p :
Results for hyperbolic form
=
1 (1 )
x
t x
x
tq
q
t q
0 1 t
=
+
1
1
x
t x
x x
q
p
q tq
0 1 t
+ =

( )
1 (1 )
x
x
q
x t
t q
0 1 t
+

=

( )
1 (1 )
x
s t x t
x
s t q
q
s q
0 1 t s
Example 2.1
Calculate an approximate value for
4 73.5
p using the Tables under the assumption that we
have:
(i) a uniform distribution of deaths between integer ages
(ii) a hyperbolic form for
t x
p between integer ages
Solution
(i) We have to split up the probability into factors that we can evaluate using the
expressions we have derived:
=
4 73.5 0.5 73.5 3 74 0.5 77
p p p p
This can be simplified as follows:
0.5 73.5 3 74 0.5 77 0.5 73.5 3 74 0.5 77
73
3 74 77
73
(1 ) (1 )
(1 0.5)
1 (1 0.5 )
1 0.5
p p p q p q
q
p q
q
=
| |
=
|
\ .
Using the Tables:
= = =
74
73
73
5,664,051
1 1 0.0432983
5,920,394
l
q
l
= = =
77
3 74
74
4,828,182
0.8524256
5,664,051
l
p
l
= = =
78
77
77
4,530,360
1 1 0.061684
4,828,182
l
q
l
Therefore =
4 73.5
0.8079 p .
(ii) We can use part of the above solution:
=
=
| | | |
=
| |

\ . \ .
4 73.5 0.5 73.5 3 74 0.5 77
0.5 73.5 3 74 0.5 77
73 77
3 74
73 77
(1 ) (1 )
(1 0.5) 0.5
1 1
1 (1 1) 1 (1 0.5)
p p p p
q p q
q q
p
q q
Using the probabilities calculated above =
4 73.5
0.8074 p .
Question 2.25
The approximate value of
0.5 61.5
q assuming a uniform distribution of deaths between
integer ages and the mortality of the Tables is:
A 0.00693
B 0.00745
C 0.00756
D 0.00812
E 0.01362
Question 2.26
10 50.5
p assuming a constant force of mortality between integer
ages and the mortality of the Tables is:
A 0.91112
B 0.91114
C 0.91116
D 0.91118
E 0.91120
Question 2.27
10 50.5
p assuming a hyperbolic form for
t x
p between integer
ages and the mortality of the Tables is:
A 0.91112
B 0.91114
C 0.91116
D 0.91118
E 0.91120
12 Mortality laws
It can be useful to have the force of mortality expressed as a simple mathematical function
since we can then calculate life table functions without using a life table. There is still debate
about whether human mortality follows such simple formulas but we are going to consider
some of the laws here and look at how the laws can be applied.
De Moivres law
De Moivres mortality law states that

=
1
( ) ( ) x x , where < 0 x .
Gompertzs law
Gompertzs mortality law states that = ( )
x
x Bc , where > > 0, 1, 0 B c x .
Makehams law
Makehams mortality law states that = + ( )
x
x A Bc , where > 0 B , > , 1, 0 A B c x .
Weibulls law
Weibulls mortality law states that = ( )
n
x kx , where > > 0, 0, 0 k n x .
The rationale behind Gompertz and Makehams laws is that it was observed that when ( ) x
was plotted on a logarithmic scale against age, the graph appears to follow a straight line for
much of the age range.
Question 2.28
Derive expressions for ( ) s x and
t x
p for each of the mortality laws stated above.
Question 2.29
Over a period of time it has been found that, for a very large population whose mortality
conforms to Gompertzs law, =
10 15
0.957076 p and =
10 20
0.896579 p . Find
17 18
p for
this population.
13 Select mortality
Some life tables are select mortality tables. Functions in such a table depend upon age and
duration since an event. Depending on the select period, at some point in the future mortality
will be assumed to return to that of the general population. This is referred to as the ultimate
part of the table.
Let us think about particular events to help clarify this issue.
The first event is taking out a life insurance policy. In order to be accepted for the policy, the
person will have to go through some sort of medical screening process, either by filling out a
form or visiting a doctor for an examination. The mortality of this person straight after
passing the medical screening will be lower than the mortality of the general population since
they have been declared fit. Over a length of time, say 3 years, the persons mortality will
come back into line with that of the general population. The select period in this case is 3
years and beyond that time the person will experience ultimate mortality.
Another event could be giving up smoking. The mortality of the person straight after giving
up will be higher than that of the general population. After 10 years, the harmful effects of
smoking will have reduced to such an extent that the persons mortality again returns to that
of the general population. The select period here is 10 years.
Notation for select mortality
Select mortality is indicated using square parentheses, for example:
[20]
l ,
+ [35] 2
q , etc
If the table had a select period of 3 years, then the column headings for the number of
people alive would be:
[ ] x
l ,
+ [ ] 1 x
l ,
+ [ ] 2 x
l , and
+3 x
l ,
For example a table for life insurance with a three-year select period could be:
[ ] x
[ ] x
l
+ [ ] 1 x
l
+ [ ] 2 x
l
+3 x
l + 3 x
22 35,628.36 35,619.24 35,607.78 35,596.15 25
23 35,615.35 35,604.89 35,590.01 35,581.18 26
24 35,602.78 35,589.99 35,575.03 35,562.59 27
Notice that for durations beyond the select period, the square parenthesis notation is
dropped, for example with a three-year select period,
+ +
= =
[24] 3 27 [24] 7 31
, l l l l . The table is
followed horizontally for a life until the end of the select period, when it is then followed
vertically.
Example 2.2
Calculate
+ [23] 2
q using the figures in the table above and explain what
+ [23] 2
q means.
Solution
+
+
= = =
26
[23] 2
[23] 2
35,581.18
1 1 0.000248
35,590.01
l
q
l
+ [23] 2
q means the probability that a life currently aged 25, who was selected at age 23,
dies in the next year.
Question 2.30
The value of
2 [22]
p using the above select mortality table is:
A 0.99815
B 0.99928
C 0.99934
D 0.99942
E 0.99981
Unit 2 Summary
Future lifetimes
The age-at-death of a newborn baby is X.
The survival function ( ) s x is defined to be > Pr( ) X x .
The future lifetime of a life aged x is ( ) T x , where = > ( ) | T x X x X x .
t x
q is the probability that a life aged x dies in the next t years.
t x
p is the probability that a life aged x survives for the next t years.
Curtate future lifetime and curtate expectation of life
The curtate future lifetime is the complete number of years the life lives after age x. It is
denoted by ( ) K x .
The curtate expectation of life is defined to be ( ) ( ) E K x and it is denoted as
x
e , where:
=
=

1
x k x
k
e p
The variance of curtate future lifetime is given by:
( )

=
=
2
1
var ( ) (2 1)
k x x
k
K x k p e
Force of mortality
The force of mortality at age x is ( ) x .
+

=
`

)
exp ( )
x t
t x
x
p y dy

=
`

)
0
( ) exp ( )
x
s x y dy
=
0
( ) ( )
x
f x p x = +
( )
( ) ( )
T x t x
f t p x t
= + ( )
t x t x
d
p p x t
dt
= +
0
( )
t
t x s x
q p x s ds
Deferred mortality
+
=
| n m x n x m x n
q p q
Life tables
0
l is the number of newborns being considered (the radix).
x
l is the number of survivors at age x.
x
d is the number of deaths between ages x and +1 x .
n x
d is the number of deaths between ages x and + x n .
Complete expectation of life
The complete future lifetime is the length of life life beyond age x. It is denoted by ( ) T x .
The complete expectation of life is defined to be ( ) ( ) E T x and it is denoted as
x
e , where:
=

0
x t x
e p dt
The variance of complete future lifetime is given by:
( )

(
=

2
0
var ( ) 2
t x x
T x t p dt e
Recursive formulas for expectations of life
The recursive formula for the curtate expectation of life is:
+
= +
1 x x x x
e p p e
The recursive formula for the complete expectation of life is:

+
= +
1
1
0
x t x x x
e p dt p e
Median future lifetime
The median future lifetime of a life aged x, ( ) m x , can be found by solving:
( ) > = Pr ( ) ( ) 0.5 T x m x
Central death rate
The central death rate (over the interval from x to +1 x ) is:
+
+
+
=

1
0
1
0
( )
x t
x
x t
l x t dt
m
l dt
n x
L is the total expected time spent alive between ages x and + x n by survivors to age x
of the original group:
+ + +
= + + =

0 0
( )
n n
n x x t x n x t
L t l x t dt nl l dt
The n-year temporary complete life expectancy of a life aged x is
=
:
0
n
t x
x n
p dt e .
x
T is the total number of years lived beyond age x by survivors to age x in the original
group.
+
= +
0
( )
x x t
T t l x t dt
The central death rate (over the interval from x to + x n ) is:
+
+
+
+
= =
0
0
( )
n
x t
x x n
n x
n
n x
x t
l x t dt
l l
m
L
l dt
( ) a x is the average number of years lived between x and +1 x by those in the group who
die between those ages:
( )

+
+
+ +
= = = <
+ +

1 1
0 0
1 1
0 0
( ) ( )
( ) ( ) | ( ) 1
( ) ( )
x t t x
x t t x
t l x t dt t p x t dt
a x E T x T x
l x t dt p x t dt
( )
= + 1
x x x
e p q a x
Fractional ages
Assuming a uniform distribution of deaths between integer ages:
= + ( )
x t x
q p x t = 1
t x x
p tq =
t x x
q tq
+ =
( )
1
x
x
q
x t
tq
+

=
( )
1
x
s t x t
x
s t q
q
tq
Assuming a constant force of mortality between integer ages:
= 1 exp( )
x
q = ( )
t
t x x
p p = 1 ( )
t
t x x
q p

+ =
=
( ) ln ( )
exp( )
t
t x x x
p x t p p
t
+ = ( ) x t

+
= 1 ( )
s t
s t x t x
q p
Assuming a hyperbolic form for
t x
p between integer ages:
=
1 (1 )
x
t x
x
tq
q
t q

=
+
1
1
x
t x
x x
q
p
q tq
+ =

( )
1 (1 )
x
x
q
x t
t q
+

=

( )
1 (1 )
x
s t x t
x
s t q
q
s q
= ( )
x
s x

+
=
( )
t x
x t
p
x
Mortality laws
De Moivres mortality law states that

=
1
( ) ( ) x x , where < 0 x .
Under this law:
( )
( )
= =
t x
x t
x
s x p
x
Gompertzs mortality law states that = ( )
x
x Bc , where > > 0, 1, 0 B c x .
Under this law:
( )
= ( ) exp ( 1)
x
s x m c
( )
= exp ( 1)
x t
t x
p mc c where =
ln
B
m
c
Makehams mortality law states that = + ( )
x
x A Bc , where > 0 B , A B , > 1, 0 c x .
Under this law:
( )
= ( ) exp ( 1)
x
s x Ax m c
( )
= exp ( 1)
x t
t x
p At mc c where =
ln
B
m
c
Weibulls mortality law states that = ( )
n
x kx , where > > 0, 0, 0 k n x .
Under this law:
( )
+
=
1
( ) exp
n
s x ux
( )
+ +
(
= +

1 1
exp ( )
n n
t x
p u x t x where =
+1
k
u
n
Some life tables are select mortality tables. Functions in such a table depend upon age
and duration since an event. Select mortality is indicated using square parentheses, for
example
[20]
l ,
+ [35] 2
q .
summary pages together to help you with your review.
Unit 2 Solutions
Solution 2.1
We know that = ( ) Pr( )
X
F x X x , so:
= ( ) 1 ( )
X
F x s x
Solution 2.2
x
q is the probability that a life aged x dies in the next year.
x
p is the probability that a life aged x survives to age +1 x .
Solution 2.3
(i) The probability that a life aged 30 dies before his 55
th
birthday.
(ii) The probability that a life aged 27 survives to his 42
nd
birthday.
(iii) The probability that a newborn baby dies before he is 60.
(iv) The probability that a newborn baby dies between age 32 and age 79.
(v) = (15) Pr( 15)
X
F X which is the probability that a newborn baby dies before he is
15.
(vi) The future lifetime of a life aged 60.
(vii) = (24) Pr( 24) s X , which is the probability that a newborn baby survives to at least
age 24.
Solution 2.4
This can be split up in two ways. Survival to age + + x s t is equivalent to survival to + x t
followed by survival for another s years, or it is equivalent to survival to + x s followed by
survival for another t years. In symbols:
+ + +
= =
s t x t x s x t s x t x s
p p p p p
Solution 2.5
( ) K x is a discrete random variable.
Solution 2.6
If we substitute = 1 s into the expression in Solution 2.4, we obtain:
+ +
=
1 1 x t x t x
p p p
Or rearranging this:
+
+
=
1
1
t x
t x
x
p
p
p
Since = + + +"
1 2 3 x x x x
e p p p , it follows that:
+ + + +
= + + +"
1 1 1 2 1 3 1 x x x x
e p p p
Using the previous expression:
+ + + +
= + + +
= + + +
+ + +
=
=
"
"
"
1 1 1 2 1 3 1
3 2 4
2 3 4
x x x x
x x x
x x x
x x x
x
x x
x
e p p p
p p p
p p p
p p p
p
e p
p
From this it is clear that:
+
=
1
1
x
x
x
e
e
p
Solution 2.7
This can be shown by expanding the expression for
( )
2
( ) E K x :
( )

+
=
+ + + +
+ + + +
+ + +
+ +
+
=
= + + + +
= + + + +
+ + + +
+ + +
+ +
"
"
"
"
"
2 2
0
1 1 2 2 3 3 4 4
1 1 2 2 3 3 4 4
2 2 3 3 4 4
3 3 4 4
4 4
( )
4 9 16
3 3 3
5 5
7
k x x k
k
x x x x x x x x
x x x x x x x x
x x x x x x
x x x x
x x
E K x k p q
p q p q p q p q
p q p q p q p q
p q p q p q
p q p q
p q
Solution 2.8
(i) We can calculate this as follows:
| |
=
=
=
=
=
10 28 10 28
38
28
38
28
1
1 exp 0.002
1 exp 0.002
1 exp( 0.02)
0.0198
q p
dy
y
(ii) Similarly:
| |
=
=
=
=
60
32 28
28
60
28
exp 0.002
exp 0.002
exp( 0.064)
0.9380
p dy
y
Solution 2.9
Using the definition of ( ) s x :
( )
=
= +
(
=
(

=
0
0
1.5
0
1.5
( ) exp ( )
exp (0.0001 0.05 )
2
exp 0.0001 0.05
3
exp 0.0001 0.033
x
x
x
s x y dy
y dy
y y
x x
Solution 2.10
| n x
q is the probability that an individual survives to age + x n but dies before he is
+ +1 x n .
It can be simplified as follows:
+ + +
= = =
| 1 1 n x n x x n n x n x n x n x
q p q q q p p
Solution 2.11
(i) =
65
35
0.799728
l
l
(ii) =
47
27
1 0.047489
l
l
(iii)
| |
=
|
\ .
50 51
47 50
1 0.005831
l l
l l
(iv) =
100
49
0.004450
l
l
(v)
| |
=
|
\ .
75 80
40 75
1 0.159099
l l
l l
Solution 2.12
For
x
l we are assuming that we have started with 100,000 lives. Notice that the number
of people alive decreases slowly at first but then decreases very quickly after the age of
about 60. This graph is valid for a developed country, but for a third world country the
steep decline would take place at a much earlier age.
0
10000
20000
30000
40000
50000
60000
70000
80000
90000
100000
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100
Age x
l
x
The number of deaths will be (relatively) high at first due to deaths during birth and early
infant months. The number then decreases during childhood and there is another rise at
the late teenage years. This increase is due to deaths by drugs, suicide and vehicle
accidents. The number then falls again, starting to rise at about age 30, and continues to
rise with age until the seventies. The number of deaths will reach its peak among the
elderly (perhaps between ages 75 and 85) and then drop to zero as age increases
because the number of lives still alive is much reduced. Again this graph is only valid for a
developed country.
0
500
1000
1500
2000
2500
3000
3500
4000
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100
Age x
d
x
The graph for
x
q has many of the same features as the graph for the number of deaths,
such as the teenage accident hump and high infant mortality; as age increases, the
probability of death in the coming year increases steadily. We have used a logarithmic
scale for the
x
q axis so that the main features are visible.
-4.0
-3.5
-3.0
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100
Age x
l
o
g

q
x
Solution 2.13
This relationship is not true. It would only be true if the probability of dying before the age
of 40 is 0.
Solution 2.14
We know that:
+

=
`

)
exp ( )
x t
t x
x
p y dy
Which here is:
| |
+
= = exp 0.02 exp( 0.02 )
x t
t x
x
p y t
We need to find the complete expectation of life:

(
= = =
(
0
0
exp( 0.02 )
50
0.02
x t x
t
e p dt
Then we can use the formula for variance using integration by parts with = 2 u t :
( )

(
=

(
= +
(

(
=
(

(
=
(

=
2
0
2
0
0
2
0
2
var ( ) 2 exp( 0.02 )
exp( 0.02 ) 2
2 exp( 0.02 ) 50
0.02 0.02
exp( 0.02 )
100 50
0.02
1
100 50
0.02
2500
x
T x t t dt e
t
t t dt
t
Thus the standard deviation is 50.
Solution 2.15
The limiting age of the table is 110 since there are no survivors after this age, therefore
=
110
0 e .
We can calculate that =
109
11
36
p , =
108
36
108
p and =
107
108
292
p , so:
= + =
109 110
11 11
0.3056
36 36
e e
= + =
108 109
36 36
0.4352
108 108
e e
= + =
107 108
108 108
0.5308
292 292
e e
Solution 2.16
Since = exp( 0.02 )
t x
p t , = = exp( 0.02) 0.98012
x
p .
Using the recursive formula:

+
+
= +
(
= +
(
= +
= +
1
1
0
1
1
0
1
1
exp( 0.02 ) 0.980199
exp( 0.02 )
0.980199
0.02
1 exp( 0.02)
0.980199
0.02 0.02
0.990066 0.980199
x x
x
x
x
e t dt e
t
e
e
e
We can start with
=
20
50 e to give:
=
21
50 e
=
22
50 e
=
23
50 e
Solution 2.17
To find the lower and upper quartiles you would solve the following equations:
+
=
( ( ))
0.75
( )
s x l x
s x
+
=
( ( ))
0.25
( )
s x u x
s x
where ( ) l x and ( ) u x are the lower and upper quartiles respectively.
To find the mode, set the derivative of
( )
( )
T x
f t with respect to t equal to 0, and solve the
resulting equation.
Solution 2.18
If = ( ) exp( 0.03 ) s x x , then the equation for the median is:
+ +
= =
( ( )) exp( 0.03[ ( )])

0.5
( ) exp( 0.03 )
s x m x x m x
s x x
This can be solved as follows:
+
= =
= =
exp( 0.03[ ( )])

exp( 0.03 ( )) 0.5
exp( 0.03 )
ln0.5
( ) 23.1
0.03
x m x
m x
x
m x
ie the median future lifetime is 23.1 years.
Similarly, the lower quartile and upper quartile are:
= =
ln0.75
( ) 9.59
0.03
l x = =
ln0.25
( ) 46.2
0.03
u x
so the interquartile range is 36.6 years.
Solution 2.19
We need to work out the total expected time spent alive between x and + x n , so we must
consider two groups of lives separately, namely those that survive to + x n and those that
dont.
Those that survive to + x n have a time spent alive of n and there are expected to be
+ x n
l
of them. Altogether they contribute
+ x n
nl to the total expected time spent alive.
The length of time spent alive by those who die before + x n is expected to be
( )
0
( )
n
T x
t f t dt .
There were
x
l people alive at age x, so the total contribution from this group is:

+
= + = +

( )
0 0 0
( ) ( ) ( )
n n n
x T x x t x x t
l t f t dt l t p x t dt t l x t dt
Summing gives the required result.
Solution 2.20
We know that = + ( )
t x t x
d
p p x t
dt
, therefore
+ +
= + ( )
x t x t
d
l l x t
dt
.
If we perform integration by parts using = u t , we get:
+ + + +
= + + = (

0
0 0
n n
n
n x x t x t x n x t
L t l l dt nl l dt
Solution 2.21
+
+
= = =

0
0 0
n
x t
n n
x t n x
t x
x x x
l dt
l L
dt p dt
l l l
Solution 2.22

+
+
+
+ +
= = = =

1 1
0 0 1
1
0
( ) ( )
x t x t x
x x x x
x
x x x
x t
l x t dt l p x t dt
l q l l
m
L L L
l dt
Solution 2.23
+

+
= = +
0
0
( )
( )
x t
x
t x
x x
t l x t dt
T
t p x t dt
l l
Using integration by parts with = u t , we get:

= + = (

0
0 0
x
t x t x t x
x
T
t p p dt p dt
l
But
0
t x x
p dt e , so
=
x
x
x
T
e
l
.
Solution 2.24
We can find the values of as follows:

= =
( ) 1 500
( )
( ) 1 500
s x
x
s x x
Giving:
= =
= =
1 500
(40) 0.00217
1 40 500
1 500
(50) 0.00222
1 50 500
Now for
n x
q :
+
= =
( )
1 1
( )
n x n x
s x n
q p
s x
Giving:
= = =
10 40
(50) 1 50 500
1 1 0.02174
(40) 1 40 500
s
q
s
Finally for
n x
m we divide the expression for
n x
m by
x
l giving:
( )

= = =
+ (
+ | |
(
|

( \ .

2
0 0
0
1 1 1
1 500
1 500
1
1 500
1 500 2 500
n x n x n x
n x
n n n
t x
p p p
m
x t
x t
p dt dt
x
x
Putting in the values in the question:
( )

= = =
(
+ | |
(
|
( \ .

10 40
10 40
10
2 2
2
0
1 0.92 0.02174
0.002198
250 0.92 0.90
1 500 40
1
1 40 500 2 500
p
m
t
Solution 2.25
Answer C.
Using the assumption of uniform distribution of deaths, we have:
61
0.5 61.5
61
(1 0.5)
1 0.5
q
q
q
where = = =
62
61
61
7,954,179
1 1 0.0150115
8,075, 403
l
q
l
.
This gives =
0.5 61.5
0.00756 q .
Solution 2.26
Answer C.
We simplify the probability as follows (whatever our assumption):
=
10 50.5 0.5 50.5 9 51 0.5 60
p p p p
Under the assumption of constant force of mortality this simplifies to:
=
| | | |
=
| |
\ . \ .
=
0.5 0.5
10 50.5 50 9 51 60
0.5 0.5
51 61
9 51
50 60
( ) ( )
0.91116
p p p p
l l
p
l l
Solution 2.27
Answer B.
The probability simplifies in the same way as Question 2.26, ie
=
10 50.5 0.5 50.5 9 51 0.5 60
p p p p
Under the assumption of a hyperbolic form for
t x
p , this simplifies to:
( )
=
| |
=
|
\ .
=
10 50.5 0.5 50.5 9 51 0.5 60
60 60
50
51 60
(1 ) (1 )
0.5
1 0.5 1
1 0.5
0.91114
p q p q
l q
q
l q
Solution 2.28
De Moivres law:
| |

= = = =
` `

) )

1
0
0 0
( ) exp ( ) exp ( ) exp ln( )
x x
x x
s x y dy y dy y

+ + +
= = =
( ) ( ) ( )
( )
t x
s x t x t x t x
p
s x x
Gompertzs law:

=
`

)

( | |
| |
= = = + = | (
`
|
|
\ . (

\ .
)
0
0 0
( ) exp ( )
exp exp exp exp ( 1)
ln ln ln ln
x
x
x
y x
y x
s x y dy
Bc Bc B B
Bc dy c
c c c c
This is often written as
( )
exp ( 1)
x
m c where =
ln
B
m
c
.
( ) ( )
( ) ( )
+
+
+
= =
= + + =
( )
exp ( 1) exp ( 1)
( )
exp exp ( 1)
x t x
t x
x t x x t
s x t
p m c m c
s x
mc m mc m mc c
Makehams law:
( ) ( )

=
`

)

(

= = (
`
(

)
= + =
0
0 0
( ) exp ( )
exp exp
ln
exp exp ( 1)
x
x
x
y
y
x x
s x y dy
Bc
A Bc dy Ay
c
Ax mc m Ax m c
where =
ln
B
m
c
.
( ) ( )
( )
( )
+
+
+
= = +
= + + + +
=
( )
exp ( ) ( 1) exp ( 1)
( )
exp ( )
exp ( 1)
x t x
t x
x t x
x t
s x t
p A x t m c Ax m c
s x
A x t mc m Ax mc m
At mc c
Weibulls law:
+ +

=
`

)

( | |

= = = | (
`
|
+ +
(

\ .
)
0
1 1
0 0
( ) exp ( )
exp exp exp
1 1
x
x
x
n n
n
s x y dy
ky kx
ky dy
n n
This is sometimes written as
( )
+
1
exp
n
ux where =
+1
k
u
n
.
( ) ( )
( ) ( )
+ +
+ + + +
+
= = +
(
= + + = +

1 1
1 1 1 1
( )
exp ( ) exp
( )
exp ( ) exp ( )
n n
t x
n n n n
s x t
p u x t ux
s x
u x t ux u x t x
Solution 2.29
We first need to find the parameters for Gompertzs law. From the previous question:
( )
= exp ( 1)
x t
t x
p mc c
So we have simultaneous equations:
( )
= =
15 10
10 15
exp ( 1) 0.957076 p mc c
( )
= =
20 10
10 20
exp ( 1) 0.896579 p mc c
Taking logs and dividing the two equations:

= =

15 10
20 10 5
ln0.957076 ( 1) 1
ln0.896579
( 1)
mc c
mc c c
From this we get that = 1.2 c . By substituting this value back into the equation we can get
that = 0.00054848 m , ie = 0.0001 B .
We require
17 18
p , which is:
| |
= =
|
\ .
18 17
17 18
0.0001
exp 1.2 (1.2 1) 0.733911
ln1.2
p
Solution 2.30
Answer D.
+
= = =
[22] 2
2 [22]
[22]
35,607.78
0.99942
35,628.36
l
p
l
Course 3, Unit 3 Insurance functions
Unit 3
Insurance functions
Unit overview
In this unit we look at the various life insurance benefits. These are benefits paid on or
after the death of the policyholder. In some cases benefits are paid immediately on death.
In other cases benefits are paid at the end of year of death or at some other convenient
point in the year. The benefit can also be paid on survival to a certain date.
First we describe each benefit in practical terms and then we introduce the new notation
that is required for this unit. Next we derive the actuarial present value of each benefit by
considering random variables.
The unit concludes with sections looking at benefits that change over time, recursive
relationships to find term insurance benefits and the relationships between benefits
payable at different times.
Advice on study
This is another unit that introduces new notation. Spend plenty of time familiarizing
yourself with the different insurance benefits and how they are calculated.
Insurance functions Course 3, Unit 3
Learning objectives
6 Formulate a model for the present value, with respect to an assumed interest rate
deterministic.
8 Apply a principle to a present value model to associate a cost or pattern of costs
(possibly contingent) with a set of future contingent cashflows.
Principles include: equivalence, exponential, standard deviation, variance
and percentile.
Models include: present value models based on learning objectives
9-12.
consumer behavior (eg subscriptions) and warranties.
1 Introduction
In this unit we are going to look at life insurance payments, ie payments made on the
death of the policyholder. Policyholders pay premiums in order to receive a benefit
payment on death. Here we have two unknowns; the length of time before death (which
will affect the number of premiums that will be received) and the rate of interest that is
earned on the premiums that are invested.
2 Types of benefit
There are several types of death benefit. You need to be familiar with each one, noting if
and when payments are made. In this section we describe how claims occur under each
type of policy. The next section covers the notation used for each policy.
2.1 Whole life insurance
A whole life insurance policy provides a payment on the death of the policyholder at any
point in the future. The payment can be made immediately on death (although in practice
there will be a short delay while the insurance company processes the claim and posts the
check!) at the end of the year of death or at other times.
2.2 Pure endowment
A pure endowment policy provides a payment if the policyholder survives to a certain date.
No payment is made otherwise.
2.3 Term insurance
A term insurance policy provides a payment on the death of the policyholder as long as he
dies within a specified time period. If the policyholder dies after this time period has
elapsed, no payment is made. The payment can be made immediately on death or at the
end of the year of death or at other times.
2.4 Endowment insurance
An endowment insurance policy provides a payment on the death of the policyholder if he
dies within a specified time period or if he survives to the end of that period. It is a
combination of a pure endowment and a term insurance. The death payment can be
made immediately on death or at the end of the year of death.
2.5 Deferred insurance
A deferred insurance policy provides a payment on the death of the policyholder as long
as the death occurs after a specified time period (which is called the deferred period).
3 Notation
International Actuarial Notation is a system of communication used by actuaries globally in
order to ensure that actuaries in different countries can understand each others workings.
You have already met the notation for annuities in Course 2, namely
n
a ,
n
a ,
n
a etc, as
well as in Unit 2 eg
t x
p ,
t x
q .
Question 3.1
What does the bar on a mean?
Question 3.2
What does the symbol
| m
n
a mean?
In order to understand the symbols associated with life insurance, it is necessary for us to
introduce some further notation. Consider the subscript that follows the a symbol in the
annuity functions above. It describes a status that at any stage is either active or inactive.
When the status is active, payments are made. In this context n means that the condition
is active for n years, ie payments are made for n years.
n is usually used for a definite number of years, whereas x is used for a life. When we
talk about x being active it means that the person is alive.
We will now detail some alternative subscripts that we will be using in connection with
insurance:
Subscript Meaning
uv Payment is made whilst both u and v are active
uv
Payment is made whilst at least one of u and v is active
| u v
Payment is made whilst u is inactive but v is active
1
: u v
Payment is made only if u becomes inactive first
1
: u v
Payment is made only if v becomes inactive first
The symbol for the actuarial present value of death benefits paid at the end of year of
death is A. If benefits are paid immediately on death the symbol is A . We will now look at
this new notation in the context of the policies covered in Section 2. The notation assumes
that payment is made immediately on death and in each case refers to the actuarial
present value of the benefits concerned.
The symbol used for whole life insurance is
x
A . The subscript x means that the payment
is made on the death of the policyholder at any point in the future.
3.2 Pure endowment
The symbol for a pure endowment with a term of n years is
1
: x n
A . The 1 above the n
means that the payment is made on the expiry of n years but only if the policyholder is still
alive at that point. In other words, the status n has to be the first condition to become
inactive in order for the payment to be made.
3.3 Term insurance
The symbol for a term insurance (with a term of n years) is
1
: x n
A . The 1 above the x
means that the policyholder must come to an end (ie die!) before the n years have been
completed in order for payment to be made.
The symbol for endowment assurance (with a term of n years) is
: x n
A . The subscript
: x n means that payment is made on death if death occurs in the first n years or on
survival to n years. The payment is made on the first of the two statuses to terminate.
The symbol for deferred whole life insurance (with a deferred period of m years) is
| m x
A .
Note that this refers to a policyholder who is currently aged x, so he will have to survive at
least m years (ie until age + x m) in order to receive the payment on his eventual death.
Deferred term insurance and endowments also exist.
4 Evaluating benefits
We will study each type of benefit in detail and express the present value of the benefit as
a random variable. We can then develop expressions for the mean and variance of these
random variables. In each section we consider benefits that are paid at the end of the
year of death and benefits that are paid immediately. We will assume throughout that the
policyholder is aged x when he takes out his policy and will use the notation (x) to
represent a life aged x.
Benefit paid at the end of the year of death
Deterministic model
Consider a whole life insurance with a benefit of 1 paid at the end of the year of death.
The benefit will be paid at the end of the first year if the policyholder dies in the first year.
The benefit will be paid at the end of the second year if the policyholder survives the first
year and then dies in the second year, and so on. If we know survival and death
probabilities, then an expression for the actuarial present value of the benefit is:
+
+ +
=
= + + + =

2 3 1
1 2 2 |
0
k
x x x x x x k x
k
A v q v p q v p q v q
Stochastic model
We will now write ( ) K x , the curtate future lifetime of (x) as K for convenience. The
random variable for the present value of this benefit is then given by:
+
=
1 K
Z v
The actuarial present value is the expected value of this random variable:
+ +
=
= = = =
1 1
0
( ) ( ) Pr( )
K k
x
k
A E Z E v v K k
The stochastic and deterministic formulas are the same since, from Unit 2,
= =
|
Pr( )
k x
K k q .
The variance is given by:
| |
( )
( )
( )
( )
( )
+ +
=
= =
=
2
2
2 2
1 2 2 1
2
2
var[ ] ( ) ( )
( ) ( )
K K
x x
x x
Z E Z E Z
E v A E v A
A A
The first term in this expression is in the same form as the present value of a whole life
insurance, but this time v has been replaced by
2
v . Effectively this means that the first
term is the present value of a whole life insurance calculated at a different rate of interest,
namely +
2
(1 ) 1 i .
Question 3.3
Explain why the new interest rate is +
2
(1 ) 1 i .
Question 3.4
What is the equivalent new force of interest?
Benefit paid immediately on death
Deterministic model
Consider a whole life insurance policy with a benefit of 1 payable immediately on death.
Consider the short time interval + ( , ) t t dt . The probability that (x) survives to age + x t
and then dies during the interval + ( , ) t t dt is:
+ t x dt x t
p q
So the actuarial present value of the benefit would be:
+
+
t dt
t x dt x t
v p q
But
+
+ ( )
dt x t
q x t dt for small time intervals, so the probability is approximately:
+ ( )
t x
p x t dt
The actuarial present value is approximately:
+ ( )
t
t x
v p x t dt
Considering all possible times of death gives:
= +
0
( )
t
x t x
A v p x t dt
Stochastic model
The random variable Z, which represents the present value of the above benefit, is
( ) T x
v
where ( ) T x ( 0) is the future lifetime of the policyholder. We will drop the ( ) x notation
for convenience.
The actuarial present value of this benefit is ( ) E Z :
= = =
0
( ) ( ) ( )
T t
x T
A E Z E v v f t dt
Question 3.5
Do the stochastic and deterministic models give the same value for the actuarial present
value of this benefit?
Now consider the variance:
| |
( ) ( )
( ) ( )
| |
(
=
|
(

\ .
(
=
(

2
2
2
2
var
( )
T T
T T
Z E v E v
E v E v
The actuarial notation for
2
( )
T
E v is
2
x
A . Therefore:
| | ( )
=
2
2
var
x x
Z A A
4.2 Pure endowment
Deterministic model
For a pure endowment policy on (x) with a benefit of 1 and a term of n years, the benefit is
paid if the policyholder survives to at least age + x n . The actuarial present value of this
benefit is:
= + =
1
:
0
n n
n x n x n x
x n
A q v p v p
Stochastic model
The random variable representing the present value of this benefit is:
=

>
0
n
T n
Z
v T n
or equivalently:
<
0
n
K n
Z
v K n
The actuarial present value of the benefit is ( ) E Z :
= = +
1
:
[ ] 0 Pr( )
n
x n
A E Z v K n
The versions obtained using the stochastic and deterministic approaches are equivalent
since, from Unit 2, = Pr( )
n x
K n p .
Notice that
1
: x n
A is meaningless since the benefit is only ever paid at time n.
( )
| |
( ) ( )
( ) ( )
=
=
=
2
2
2 2
1
:
2
2 1
:
var[ ] ( )
n
n x
x n
n
n x
x n
Z E Z E Z
v p A
v p A
The first term is the actuarial present value of a pure endowment calculated at a rate of
interest +
2
(1 ) 1 i , so the variance is:
( )
=
2
2 1 1
: :
var[ ]
x n x n
Z A A
Question 3.6
Suppose that Z is the present value of a 10-year pure endowment policy issued to a
person aged 52. The sum insured is $100,000. Find the expected value and the standard
deviation of Z, assuming that interest is 4% a year effective and that mortality follows the
Tables.
4.3 Term life insurance
Deterministic model
Consider a term life insurance with a benefit of 1 and a term of n years. Suppose that the
benefit is payable at the end of the year of death.
year and then dies in the second year and so on up to the nth year. If we know survival
and death probabilities, then an expression for the actuarial present value of the benefit is:
+
+ + +
=
= + + + + =

1
1 2 3 1
1 2 2 1 1 |
:
0
n
n k
x x x x x n x x n k x
x n
k
A vq v p q v p q v p q v q
Stochastic model
For this policy the random variable which represents the present value of the benefit is:
+
<
1
0
K
K n
v
Z
K n
The actuarial present value is the expected value of this random variable:

+ +
= =
= = = + = =

1 1
1 1 1
:
0 0
( ) Pr( ) 0 Pr( ) Pr( )
n n
k k
x n
k k
A E Z v K k K n v K k
The stochastic and deterministic formulas are the same since, from Unit 2,
= =
|
Pr( )
k x
K k q .
The variance is given by:
( )
| |
( ) ( )
( )
+
=
+
=
=
=
=
1
2
2
1
|
0
1
2 1
2 1
|
:
0
2
2 1 1
: :
var[ ] ( )
n
k
k x
k
n
k
k x
x n
k
x n x n
Z v q E Z
v q A
A A
Benefit paid immediately
Deterministic model
Consider a term life insurance with a term of n years and a benefit of 1 payable
immediately on death. Using a similar method as for the whole life insurance:
= +
1
:
0
( )
n
t
t x
x n
A v p x t dt
This is the same integral as for the whole life insurance, but this one has an upper limit of
n since no benefit is paid if death occurs after n years.
Stochastic model
The random variable Z, which represents the present value of the above benefit is:

=

>
0
T
T n v
Z
T n
= = + = +

1
:
0 0
( ) ( ) 0 ( ) ( )
n n
t t
T T t x
x n
n
A E Z v f t dt f t dt v p x t dt
( )
| |
( ) ( )
= + = +

2 2
2
2 1
:
0 0
var[ ] ( ) ( ) ( )
n n
t
t
t x t x
x n
Z v p x t dt E Z v p x t dt A
The first term is the actuarial present value of a term life insurance with v replaced by
2
v .
Therefore:
( )
=
2
2 1 1
: :
var[ ]
x n x n
Z A A
Note that there is an alternative way of setting up the random variable that you may see in
other books or the exams.
Define
t
b to be the benefit function,
t
v to be the discount function and Z to be the random
variable that represents the present value of the benefit. Hence:
=
t t
Z b v
For the term life insurance we have been considering:

=

>
1
0
t
t n
b
t n
=
t
t
v v , where 0 t

=

>
0
T
T n
v
Z
T n
Deterministic model
Consider an endowment insurance policy with a benefit of 1 and a term of n years where
the benefit is payable at the end of the year of death.
year and then dies in the second year, and so on up to the nth year. The benefit will also
be paid if the policyholder survives for n years. If we know survival and death probabilities,
then an expression for the actuarial present value of the benefit is:
+
=
= +

1
1
|
:
0
n
n k
n x k x
x n
k
A v p v q
Stochastic model
Again consider the situation where the benefit is paid at the end of year of death.
Question 3.7
What is Z, the random variable representing the present value of this benefit? What are
( ) E Z and var[ ] Z ?
Benefit paid immediately
Deterministic model
Consider an endowment insurance policy with a term of n years and a benefit of 1 where
the benefit is payable immediately on death. Endowment insurance is the combination of a
term life insurance and a pure endowment, ie:
= +
1 1
:
: :
x n
x n x n
A A A
An expression for the actuarial present value of the endowment insurance is then:
= + +
:
0
( )
n
t n
t x n x
x n
A v p x t dt v p
Stochastic model
=

>
T
n
v T n
Z
T n
v
= + >
0
( ) ( ) Pr( )
n
t n
T
E Z v f t dt v T n
( ) ( )
| |
( ) ( ) ( )
= + >
= + >
2 2
2
0
2
2 2
:
0
var[ ] ( ) Pr( ) ( )
( ) Pr( )
n
t n
T
n
t n
T
x n
Z v f t dt v T n E Z
v f t dt v T n A
The first two terms are the present value of an endowment insurance policy with v
replaced by
2
v . Therefore:
( )
=
2
2
: :
var[ ]
x n x n
Z A A
Benefit paid immediately on death
Deterministic model
Consider a deferred whole life insurance with a benefit of 1 payable immediately on death
with a deferred period of m years. The actuarial present value is similar to the whole life
insurance covered earlier. However, the earliest time any benefit can be paid is m, so the
required expression is:
= +
|
( )
t
m x t x
m
A v p x t dt
Stochastic model
=

>
0
T
T m
Z
T m v
|
( ) ( )
t
m x T
m
E Z A v f t dt
= =

( )
| |
( ) ( )
=
=
2
2
2
2
|
var[ ] ( ) ( )
( )
t
T
m
t
T m x
m
Z v f t dt E Z
v f t dt A
The first term is the present value of a deferred insurance policy with v replaced by
2
v .
Therefore:
( )
=
2
2
| |
var[ ]
m x m x
Z A A
Question 3.8
Suppose that Z is the random variable representing a deferred insurance with a benefit of
1 payable at the end of year of death and a deferred term of m years. Write down an
expression for Z in terms of future lifetime random variables. What is ( ) E Z ? What is
var[ ] Z ?
Question 3.9
For the same deferred insurance as defined in Question 3.8, find an expression for the
actuarial present value using a deterministic approach.
We can also have deferred term life insurance and deferred endowment insurance.
5 Valuing insurance where benefits change over time
5.1 Increasing insurances
Consider a whole life insurance where a benefit of t is paid immediately on death at time t.
Using T to denote the complete future lifetime, the random variable representing the
present value is:
=
T
Z Tv where 0 T
The actuarial present value of this benefit is written as ( )
x
I A .
This is a continuously increasing benefit and is referred to as a continuously increasing
whole life insurance.
Question 3.10
Write down integral expressions for ( ) E Z and var[ ] Z .
In the discussion above, the increases took place continuously. Alternatively the increases
could take place at the beginning of each year. This time a benefit of + (

1 t is paid
immediately on death at time t. Recall that (

x represents the integer part of x. This
policy pays 1 immediately on death in the first year, 2 immediately on death in the second
year etc. The random variable representing the present value is:
= + (

1
T
Z T v where 0 T
The notation for the actuarial present value of this policy is ( )
x
IA .
Question 3.11
Write down an integral expression for ( ) E Z .
In fact the increases could take place more frequently than once a year. If increases of
amount
1
m
take place m times per year at the start of each period, with a first benefit of
1
m
, then the random variable representing the present value of the benefit is:
+ (

=
1
T
Tm
Z v
m
where 0 T
The actuarial notation for the actuarial present value of this benefit is
( )
( )
m
x
I A .
Question 3.12
What happens when m in the above expression?
Question 3.13
What do you think
1
:
( )
x n
IA represents? Write down an expression for Z in terms of T.
Question 3.14
What do you think
:
( )
x n
IA represents? Write down an expression for Z in terms of T.
If you are confident working with double integrals, you can also show that
=

|
0
( )
x s x
I A A ds .
Question 3.15
Explain what the actuarial symbols ( )
x
IA ,
1
:
( )
x n
IA and
:
( )
x n
IA mean. In each case, write
down an expression for Z in terms of T. what is an expression for ( ) E Z ?
5.2 Decreasing insurance
A policy that pays n immediately on death in the first year, 1 n immediately on death in
the second year etc with no benefit after n years is called an annually decreasing n-year
term life insurance. The random variable representing the present value of this benefit is:

(

=

>
( )
0
T
T n
v n T
Z
T n
The notation for the actuarial present value of this benefit is
1
:
( )
x n
DA .
Question 3.16
Write down an integral expression for ( ) E Z .
Question 3.17
Suppose that Z represents a continuously decreasing n-year term life insurance. Write
down an expression for Z in terms of T.
Question 3.18
What is +
1 1
: :
( ) ( )
x n x n
DA IA equal to?
Question 3.19
Explain what the actuarial symbol
1
:
( )
x n
DA means. Write down an expression for Z in
terms of K. What is an expression for [ ] E Z ?
6 Recursive relationships
Recursive relationships were derived for life expectancies in Unit 2. We can also derive
recursive relationships for the value of term insurance benefits.
Recall that:

+ +
+
= =
= =

1 1
1 1 1
|
:
0 0
n n
k k
k x k x x k
x n
k k
A v q v p q
This can be re-expressed:
+
+
=
+
+ + +
=
+
= +
= +
= +
1
1 1
:
1
2
1
1 1
0
1
1: 1
n
k
x k x x k
x n
k
n
i
x x i x x i
i
x x
x n
A vq v p q
vq vp v p q
vq vp A
where = 0,1, , 1 x .
To use this formula we define
+
=
1
:0
0
x n
A .
Question 3.20
Calculate the value of
1
50:5
A recursively using an interest rate of 8% per annum and
assuming mortality follows the Tables.
Similarly:
+
= +
: 1: 1
x x
x n x n
A vq vp A where =
:0
0
x
A
+
= +
1 x x x x
A vq vp A where = 0,1, , 1 x ,
= 0 A
Question 3.21
Find a recursive formula for ( )
x
IA where = 0,1, , 1 x .
7 Relationship between benefits payable at different times
In this section we consider a whole life insurance and make an assumption of a uniform
distribution of deaths to arrive at an approximate relationship between
x
A and
x
A .
Consider a whole life insurance as the sum of deferred term life insurances:
+ +
= + + + +
= + + +
1 1 1 1
0| 1| 2| 3|
:1 :1 :1 :1
1 1 2 1
2
:1 1:1 2:1
x
x x x x
x x
x x x
A A A A A
A vp A v p A
Now we know from Unit 2 that, under a uniform distribution of deaths between integer
ages:
+ +
+
= + + =

1 1
1
:1
0 0
( )
t t
t x k x k
x k
A v p x k t dt v q dt
Further:
= =
1
1
0
1
t
v
v dt a
This means that we can simplify
+
1
:1 x k
A :
+ +
+

= =
1
1
:1
0
1
t
x k x k
x k
v
A q v dt q
Which in turn means that we can simplify
x
A :
( )
( )
( )
+ +
+ +
+ +
+ + +
= + + +
= + + +
=
2
1 2 2
2
1 2 2
2 3
1 2 2
1
x x x x x x
x x x x x
x x x x x
x
v
A q vp q v p q
iv
q vp q v p q
i
vq v p q v p q
i
A
Question 3.22
Show that
1 1
: : x n x n
i
A A .
Similarly it can be shown that the following relationships hold:
1 1
: :
( ) ( )
x n x n
i
IA IA

(
| |

( |
\ .

1 1
( ) ( )
x x x
i
I A IA A
d
7.1 Insurances payable mthly
Suppose we have a whole life insurance for a life aged exactly x where the benefit of 1 is
payable at the end of the quarter when death occurs. The actuarial present value of this
benefit is written as
(4)
x
A .
In general we have
( ) m
x
A for a whole life insurance for a life aged exactly x where the
benefit of 1 is payable at the end of the mthly period during which death occurs.
Clearly we should be able to approximate
( ) m
x
A in terms of
x
A . It can be shown that:
=
( )
( )
m
x x
m
i
A A
i
Question 3.23
A person aged exactly 45 takes out a whole life insurance policy with a benefit of $60,000
payable at the end of the month of death. Assuming interest rates of 6% a year effective
and mortality as given in the Tables find an approximate value for the actuarial present
value of this benefit.
Unit 3 Summary
Whole life insurance
A whole life insurance policy provides a payment on the death of the policyholder at any
point in the future.
If the benefit is payable at the end of year of death, we have:
+
=
=

1
|
k
x k x
k o
A v q or
+
=
= =
1
0
Pr( )
k
x
k
A v K k
| | ( )
=
2
2
var
x x
Z A A
If the benefit is payable immediately on death, we have:
= +
0
( )
t
x t x
A v p x t dt or
0
( )
t
x T
A v f t dt
| | ( )
=
2
2
var
x x
Z A A
Pure endowment
A pure endowment policy provides a payment if the policyholder survives to a certain date.
No payment is made otherwise.
=
1
:
n
n x
x n
A v p
( )
=
2
2 1 1
: :
var[ ]
x n x n
Z A A
Notice that
1
: x n
A is meaningless since the benefit is only ever paid at time n. The
alternative notation
n x
E is sometimes used for
1
: x n
A . (See the Illustrative Life Table used
in conjunction with the Course 3 exam.)
Term insurance
A term life insurance policy provides a payment on the death of the policyholder as long as
he dies within a specified time period. If the policyholder dies after that time has elapsed,
no payment is made.
+
=
=

1
1 1
|
:
0
n
k
k x
x n
k
A v q or
+
=
= =
1
1 1
:
0
Pr( )
n
k
x n
k
A v K k
| |
( )
=
2
2 1 1
: :
var
x n x n
Z A A
= +
1
:
0
( )
n
t
t x
x n
A v p x t dt or =
1
:
0
( )
n
t
T
x n
A v f t dt
| |
( )
=
2
2 1 1
: :
var
x n x n
Z A A
Endowment insurance
An endowment insurance policy provides a payment on the death of the policyholder if he
dies within a specified time period or if he survives to the end of that period. It is a
combination of a pure endowment and a term life insurance.
+
=
= +

1
1
|
:
0
n
n k
n x k x
x n
k
A v p v q or
+
=
= > + =
1
1
:
0
Pr( ) Pr( )
n
n k
x n
k
A v K n v K k
| |
( )
=
2
2
: :
var
x n x n
Z A A
= + +
:
0
( )
n
n t
n x t x
x n
A v p v p x t dt or = > +
:
0
Pr( ) ( )
n
n t
T
x n
A v T n v f t dt
| |
( )
=
2
2
: :
var
x n x n
Z A A
Deferred insurance
A deferred insurance policy provides a payment on the death of the policyholder as long
as the death occurs after the deferred period.
If the benefit is payable at the end of year of death, for a deferred whole life insurance we
have:
+
=
= =
1
|
Pr( )
k
m x
k m
A v K k
| | ( )
=
2
2
| |
var
m x m x
Z A A
If the benefit is payable immediately on death, for a deferred whole life insurance we have:
=

|
( )
t
m x T
m
A v f t dt
| | ( )
=
2
2
| |
var
m x m x
Z A A
We can also have deferred term life insurance and deferred endowment insurance.
Valuing insurances where benefits change over time
A continuously increasing whole life insurance is where a benefit of t is paid immediately
on death at time t. We have:
= +
0
( ) ( )
t
x t x
I A tv p x t dt
An annually increasing whole life insurance is where a benefit of + (

1 t is paid
immediately on death at time t. We have:
= + + (

0
( ) 1 ( )
t
x t x
I A t v p x t dt
An annually decreasing n-year term life insurance is where a benefit of (

( ) n t is paid
immediately on death at time t. We have:
= + (

1
:
0
( ) ( ) ( )
n
t
t x
x n
DA v n t p x t dt
Other formulas are constructed in a similar way.
Notice also that: + = +
1 1 1
: : :
( ) ( ) ( 1)
x n x n x n
DA IA n A
Recursive relationships
+
= +
1 1
: 1: 1
x x
x n x n
A vq vp A where =
1
:0
0
x
A
+
= +
: 1: 1
x x
x n x n
A vq vp A where =
:0
0
x
A
+
= +
1 x x x x
A vq vp A where = 0,1, , 1 x ,
= 0 A
+ +
= + +
1 1
( ) ( )
x x x x x x
IA vq vp A vp IA
Relationships between benefits payable at different times
Approximate relationships hold between the present values of insurance benefits payable
immediately on death and at the end of year of death:
x x
i
A A
1 1
: : x n x n
i
A A
1 1
: :
( ) ( )
x n x n
i
IA IA

(
| |

( |
\ .

1 1
( ) ( )
x x x
i
I A IA A
d
Insurances payable mthly
=
( )
( )
m
x x
m
i
A A
i
Unit 3 Solutions
Solution 3.1
It means that the payments are made continuously.
Solution 3.2
This is the present value of an annuity of 1 payable at the end of each year starting in m
years time and continuing for a further n years.
Solution 3.3
If we say that the new interest rate is I, associated with V, then:
= = = +
2
2
1 1
1 1 (1 ) 1 I i
V
v
as required.
Solution 3.4
If we are using a force of interest, , then

=
T T
v e . Thus:
( ) ( ) ( )

= =
2 2
2
T
T T
v e e
The equivalent new force of interest is therefore 2 .
Solution 3.5
Yes, the stochastic and deterministic models give the same result for the actuarial present
value. Recall from Unit 2 that:
= + ( ) ( )
T t x
f t p x t
Solution 3.6
For a 10-year pure endowment policy on a life aged 52:
=

>
10
0
10
100,000 10
T
Z
v T
= >
10
[ ] Pr( 10) E Z v T and
( )
= >
10
2 2 2
var[ ] 100,000 Pr( 10) ( ) Z v T E Z
If mortality follows the Tables we can use the fact that > =
10 52
Pr( 10) T p to evaluate
these. We get:
= =
10 62
52
[ ] 100,000 1.04 $60,781.56
l
E Z
l
( )
= =
2
2 20 62
52
var[ ] 100,000 1.04 60,781.56 411,786,125
l
Z
l
Therefore the standard deviation is $20,292.51.
Solution 3.7
The random variable representing the present value of an endowment insurance with
benefit paid at the end of year of death is:
+
<
1 K
n
v K n
Z
K n v
The expectation and variance are as follows:
+
=
= = +
1
1
0
( ) Pr( ) Pr( )
n
k n
k
E Z v K k v K n
| |
+
=
= = +
1
2
1 2 2
0
var[ ] ( ) Pr( ) ( ) Pr( ) ( )
n
k n
k
Z v K k v K n E Z
The variance can be written as
( )
2
2
: : x n x n
A A .
Solution 3.8
The random variable representing the present value of a deferred insurance paid at the
end of year of death is:
+
<
1
0
K
K m
Z
v K m
The expectation is as follows:
+
=
= =
1
( ) Pr( )
k
k m
E Z v K k
The variance of the random variable is:
| | | |

+ +
= =
= = = =

2 2
1 2 2 1
var[ ] ( ) Pr( ) ( ) ( ) Pr( ) ( )
k k
k m k m
Z v K k E Z v K k E Z
The first term is just the actuarial present value of a deferred insurance evaluated at the
new rate of interest +
2
(1 ) 1 i , so we can write
( )
=
2
2
| |
var[ ]
m x m x
Z A A .
Solution 3.9
The benefit will be paid after +1 m years if death occurs during year m to +1 m and after
+ 2 m years if death occurs during year +1 m to + 2 m and so on. The actuarial present
value is then:
1 2 3
| 1 1 2 2
m m m
m x m x x m m x x m m x x m
A v p q v p q v p q
+ + +
+ + + + + + +
= + + +
Solution 3.10
If =
T
Z Tv , then:
=

0
( ) ( )
t
T
E Z tv f t dt
( )
| |
2
2
0
var[ ] ( ) ( )
t
T
Z tv f t dt E Z
Solution 3.11
If = + (

1
T
Z T v , then:
= + (

0
[ ] 1 ( )
t
T
E Z t v f t dt
Solution 3.12
When m ,
+ (

1 Tm
T
m
, therefore the actuarial present value of the benefit becomes
( )
x
I A .
Rather than thinking about this mathematically, you can arrive at this conclusion from
general reasoning. m is the number of times per year that the increases take place. As
this value becomes very large, it is equivalent to the increases taking place continuously,
ie a continuously increasing whole life insurance.
Solution 3.13
1
:
( )
x n
IA is the notation for the actuarial present value an increasing term life insurance
where the increases take place at the beginning of each year and the benefit is paid
immediately on death. Therefore on death in year 1 the benefit would be 1, on death in
year 2 the benefit would be 2, and so on.
The random variable that represents the present value of this benefit is:

+ (

=

>
1
0
T
T n
T v
Z
T n
Solution 3.14
:
( )
x n
IA is the notation for the actuarial present value of an increasing endowment
insurance where the increases take place at the beginning of each year and the benefit is
paid immediately on death. Therefore on death in year 1 the benefit would be 1, on death
in year 2 the benefit would be 2 and so on. If the policyholder survives to age + x n , then
he receives a benefit of n.
The random variable that represents the present value of this benefit is:
+ (

=

>
1
T
n
T v T n
Z
nv
T n
Solution 3.15
( )
x
IA represents the actuarial present value of an increasing whole life insurance where
the increases take place at the beginning of each year and the benefit is paid at the end of
the year of death.
The random variable representing the present value of the benefit is
+
= +
1
( 1)
K
Z K v where
= 0,1, K .
The expected value of Z is:
+
=
= + =
1
0
[ ] ( 1) Pr( )
k
k
E Z k v K k
1
:
( )
x n
IA represents the actuarial present value of an increasing term life insurance where
the increases take place at the beginning of each year and the benefit is paid at the end of
the year of death provided death occurs within n years.
The random variable representing the present value is:
+
<
+
=

1
( 1)
0
K
K n
K v
Z
K n
+
=
= + =
1
1
0
[ ] ( 1) Pr( )
n
k
k
E Z k v K k
:
( )
x n
IA represents the actuarial present value of an increasing endowment insurance
where the increases take place at the beginning of each year and the benefit is paid at the
end of year of death if death occurs within n years or on survival for n years.
The random variable representing this present value is:
+
+ <
1
( 1)
K
n
K v K n
Z
nv K n
+
=
= + = +
1
1
0
( ) ( 1) Pr( ) Pr( )
n
k n
k
E Z k v K k nv K n
Solution 3.16
If Z is given by:

(

=

>
( )
0
T
T n
v n T
Z
T n
Then ( ) E Z is given by:
= (

0
[ ] ( ) ( )
n
t
T
E Z v n t f t dt
Solution 3.17
The random variable representing the present value of a continuously decreasing n-year
term life insurance is:

=

>
( )
0
T
T n
v n T
Z
T n
Solution 3.18
If we calculate the sum of an increasing and a decreasing term insurance we get a level
term insurance:
+ = +
1 1 1
: : :
( ) ( ) ( 1)
x n x n x n
DA IA n A
Notice that the amount of the benefit in the level insurance is +1 n and not n since the
benefit in, for example, year 1 is n from the decreasing insurance and 1 from the
increasing insurance.
Solution 3.19
1
:
( )
x n
DA represents the actuarial present value of a decreasing term insurance where the
decreases take place at the beginning of each year and the benefit is paid at the end of
the year of death provided death occurs within n years. There is a benefit of n if death
occurs in the first year.
The random variable representing the present value is:
+
<

=

1
( )
0
K
K n
n K v
Z
K n
+
=
= =
1
1
0
[ ] ( ) Pr( )
n
k
k
E Z n k v K k
Solution 3.20
Using the recursive formula, we have:
= +
1 1
50 50
50:5 51:4
A vq vp A
= +
1 1
51 51
51:4 52:3
A vq vp A
= +
1 1
52 52
52:3 53:2
A vq vp A
= +
1 1
53 53
53:2 54:1
A vq vp A
| |
= + = =
|
\ .
1 1
54 54
54:1 55:0
1 8,640,861
1 0.007626
1.08 8,712,621
A vq vp A
Working back through the recursive formulas:
| |
= + =
|
\ .
1
53:2
1 8,712,621 1 8,712,621
1 0.007626 0.01402
1.08 8,779,128 1.08 8,779,128
A
| |
= + =
|
\ .
1
52:3
1 8,779,128 1 8,779,128
1 0.01402 0.01935
1.08 8,840,770 1.08 8,840,770
A
| |
= + =
|
\ .
1
51:4
1 8,840,770 1 8,840,770
1 0.01935 0.02375
1.08 8,897,913 1.08 8,897,913
A
| |
= + =
|
\ .
1
50:5
1 8,897,913 1 8,897,913
1 0.02375 0.02734
1.08 8,950,901 1.08 8,950,901
A
Solution 3.21
( )
x
IA can be written as follows:
+ +
= + + +
2 3
1 2 2
( ) 2 3
x x x x x x
IA vq v p q v p q
This can be split up:
+ +
+ +
= + + +
+ + +
2 3
1 2 2
2 3
1 2 2
( )
2
x x x x x x
x x x x
IA vq v p q v p q
v p q v p q
Common factors can then be taken:
+ + +
+ + +
(
= + + +

(
+ + +

2
1 1 2
2
1 1 2
( )
2
x x x x x x
x x x x
IA vq vp vq v p q
vp vq v p q
This can be written as:
+ +
= + +
1 1
( ) ( )
x x x x x x
IA vq vp A vp IA
So the recursive formula is
+ +
= + +
1 1
( ) ( )
x x x x x x
IA vq vp A vp IA .
Solution 3.22
Using a similar argument to the one used in the notes, we can proceed as follows.
Consider a term life insurance as the sum of deferred term life insurances:
+ + +
= + + + +
= + + + +
1 1 1 1 1
0| 1| 2| 1|
: :1 :1 :1 :1
1 1 2 1 1 1
2 1 1:1 :1 1:1 2:1
n
x n x x x x
n
x x n x x n x x x
A A A A A
A vp A v p A v p A
Now we know that under a uniform distribution of deaths between integer ages:
+ +
+
= + + =

1 1
1
:1
0 0
( )
t t
t x k x k
x k
A v p x k t dt v q dt
Further:
= =
1
1
0
1
t
v
v dt a
This means that we can simplify
+
1
:1 x k
A :
+ +
+

= =
1
1
:1
0
1
t
x k x k
x k
v
A q v dt q
Which in turn means that we can simplify
x
A :
( )
( )
+ + +
+ + +
+ + + +
= + + + +
=
1 2 1
1 2 2 1 1
:
2 3
1 2 2 1 1
1
:
1
n
x x x x x n x x n
x n
n
x x x x x n x x n
x n
v
A q vp q v p q v p q
i
vq v p q v p q v p q
i
A
Solution 3.23
We require
(12)
45
60,000A . This can be calculated as follows:
( ) ( )
=

(12)
45 45
45
112 112
0.06 0.06
60,000 60,000 60 1,000
12 1.06 1 12 1.06 1
A A A
Using the values from the Tables, =
45
1,000 201.20 A , which makes the actuarial present
value $12,400.49.
Course 3, Unit 4 Annuities
Unit 4
Annuities
Unit overview
In this unit we will study life annuities. We consider whole of life annuities, temporary
annuities, deferred annuities and guaranteed annuities. Deterministic and stochastic
models are developed for each type of annuity. We also consider the situations where the
annuity payments are made annually in advance, annually in arrears, m times a year (in
advance and in arrears), and continuously throughout the year.
Advice on study
In this unit we assume knowledge of annuities-certain and lifetime random variables. You
may wish to revise these topics before continuing.
Annuities Course 3, Unit 4
Learning objectives
6 Formulate a model for the present value, with respect to an assumed interest rate
deterministic.
8 Apply a principle to a present value model to associate a cost or pattern of costs
(possibly contingent) with a set of future contingent cashflows.
Principles include: equivalence, exponential, standard deviation, variance

and percentile.
Models include: present value models based on learning objectives 9
12.

consumer behavior (eg subscriptions) and warrants.
1 Introduction
In the previous unit we studied life insurance contracts. Under the terms of such contracts,
benefits are payable upon the death of the policyholder. In this unit we consider policies
that provide (regular) benefit payments as long as the policyholder is alive. Such policies
are known as annuities or life annuities.
You should already be familiar with the concept of annuities-certain. Recall that an
annuity-certain provides a series of payments made at regular time intervals or a payment
stream payable continuously over some period of time. These payments do not depend
on the survival of the policyholder.
A life annuity is similar but, when calculating the present value of the series of payments,
we must make an allowance for the probability of each payment being made, ie the
probability that the policyholder is still alive.
A pension plan is an example of an annuity. Once a person retires they receive a series of
regular payments until they die. (They may also receive other benefits, depending on the
exact terms of the plan.)
2 Types of annuities
There are several types of annuities that you could be asked about in the Course 3
examination. This section covers the details of the policies. The next section introduces
the notation that is used for annuities.
2.1 Life annuities
A life annuity is a series of payments made at regular time intervals, or a payment stream
payable continuously, throughout the lifetime of the policyholder.
2.2 Temporary and whole life annuities
An annuity is said to be temporary if the payments are limited to a given number of years.
Otherwise, it is said to be a whole life annuity.
2.3 Annuities-due
If a payment is made at the beginning of each time interval, then the payments are said to
be made in advance. An annuity payable in advance is often referred to as an annuity-
due.
2.4 Immediate annuities
If a payment is made at the end of each time interval, then the payments are said to be
made in arrears. An annuity payable in arrears is often referred to as an immediate
annuity.
2.5 Deferred annuities
A deferred life annuity is one that starts to be paid after a given period of time (the
deferment period) has elapsed.
2.6 Guaranteed annuities
If the annuity payments are certain to be paid for the first n years and are contingent on
life thereafter, then the annuity is said to be guaranteed for n years.
2.7 Annuities payable m times a year
If annuity payments are made m times every year, then the annuity is said to be payable
mthly. For example, an annuity that provides payments at the end of every 3 months is
said to be payable quarterly in arrears.
2.8 Premiums for annuities and insurance policies
Life annuities are usually purchased by a single premium, ie a single lump sum payment.
To determine the amount of the premium, we have to be able to calculate the expected
present value, or the actuarial present value (APV), of the annuity.
On the other hand, most life insurance products are purchased by a series of regular
(usually monthly) premiums, rather than by a single lump sum. In the next unit we will see
how to calculate such premiums.
3 Notation
In this section we introduce the notation that is used to represent annuity functions. You
may wish to reread Section 3 of Unit 3 to remind yourself of the conventions used in
International Actuarial Notation.
3.1 Whole life annuities
The symbol used for a whole life annuity payable annually in arrears is
x
a . The subscript
x denotes the age of the policyholder when he purchases his annuity.
If the payments are made annually in advance, then we put a double dot above the a . So
the symbol used for a whole life annuity-due is
x
a
.
If the annuity is payable continuously, we put a bar above the a . So the symbol used for a
continuously payable whole life annuity is
x
a .
3.2 Temporary annuities
The symbol used for a temporary immediate annuity, payable for a maximum of n years is
: x n
a .
3.3 Deferred annuities
The symbol for a deferred whole life immediate annuity is
| m x
a . The subscript of | m in
front of the a tells us that the annuity is deferred for a period of m years. (Since this
annuity is payable in arrears, the first payment will be made when the policyholder reaches
age 1 x m + + . If he dies before that age, no benefit will be payable.)
3.4 Guaranteed annuities
The symbol for an annuity that is guaranteed for n years is
: x n
a .
3.5 Annuities payable m times a year
The symbol for a whole life annuity that is payable m times a year is
( ) m
x
a .
3.6 Actuarial present values
More precisely, each of the symbols we have described above represents the actuarial
present value of a given type of annuity.
In the sections that follow, we will develop a deterministic model and a stochastic model
for each type of annuity, and show how the actuarial present values are calculated.
Unless otherwise stated, we will assume a constant rate of interest throughout.
4 Whole of life annuities with annual payments
In this section we will consider whole of life annuities that are payable annually at the rate
of one unit each year. We begin with the case when the payments are made annually in
arrears.
4.1 Payments made annually in arrears
Suppose that a policyholder, who is currently age x , is due to receive payments of one
unit at the end of each year for the remainder of his life. Since we dont know how long the
policyholder will live, we dont know how many annuity payments will be made. This
means that the present value of the annuity cannot be known with certainty at the outset
(ie when the policy is purchased).
In the deterministic model described below, we assume that the probability of the
policyholder surviving to each future age is known. These values are then used to
calculate the actuarial present value of the annuity.
Deterministic model
Since the annuity payments are made annually in arrears, the first payment is made in one
years time. The present value of this first payment is v . However, this payment will only
be made if the policyholder survives to age x + 1. Since the probability of survival is p
x
,
the actuarial present value of the first payment is:
v p
x
Now consider the second payment, which is due in two years time. The present value of
this payment is v
2
and the probability that it is made is just the probability that the
policyholder survives to age x + 2, ie
2
p
x
. The actuarial present value of the second
payment is therefore:
v p
x
2
2
Continuing in this way, we can find a formula for the actuarial present value of the entire
payment stream. The symbol that is used to denote this actuarial present value is a
x
. So
we have:
a vp v p v p v p
x x x x
k
k x
k
= + + + =
=
2
2
3
3
1
"
Stochastic model
We now consider an alternative way of modeling the present value of the annuity. The
stochastic model expresses the present value of the life annuity in terms of a lifetime
random variable. The random variable needed here is the curtate future lifetime, ( ) K x . In
the discussion that follows, the age x has been dropped in order to simplify the notation.
Since payments are made at the end of each year, as long as the policyholder is still alive,
the last payment will be made (with certainty) in K years time. (Recall that, if K k = , then
the policyholder is still alive at age x k + but dies before age x k + + 1. So the last
payment would be made at age x k + , ie in k years time.) The payments are illustrated
on the timeline below.
The present value of this series of payments is therefore:
v v v a
K
K
+ + + =
2
"
which is clearly a function of the random variable K .
Actuarial present value
The actuarial present value of the annuity is then given by:
K k k
k k
E a a K k a K k
0 1
( ) Pr( ) Pr( )

= =
= = = =

since a
0
0 = .
It is not immediately obvious that the deterministic and stochastic models give the same
actuarial present value. We now explain why a K k v p
k
k
k
k x
k
Pr( ) = =
=

0 1
.
age
x x + 1 x + 2 x K + x K + + 1
1 1 1
By substituting a v
k
j
j
k
=
=
1
into the expression for the actuarial present value, we obtain:
k
j
K
k j
E a v K k
1 1
( ) Pr( )
= =
= =

Next we have to change the order of summation. Note that, since j k in the first double
summation above, we must ensure that k j in the rearranged expression. We therefore
have to sum over values of k from j to . This gives:
E a v K k
K
j
k j j
( ) Pr( ) = =
=

1
Finally, pulling the v
j
term out from the inner sum, we see that:

= = = =
= = = = =

j j j
j x x
K
j k j j j
E a v K k v K j v p a
1 1 1
( ) Pr( ) Pr( )
Variance
Using the stochastic approach it is quite simple to derive an expression for the variance of
the present value of the annuity.
Recall from your knowledge of annuities-certain that:
a
v
i
K
K
=
1
Hence:
( )
2 2
1 1 1
var( ) var var 1 var( )
K
K K
K
v
a v v
i
i i

-
= = - =

However, var( ) a
K
is more commonly expressed in terms of life insurance functions.
In the last unit we saw that:
the present value of a whole of life insurance with unit sum assured payable at the
end of the year of death is v
K+1
E v A
K
x
( )
+
=
1

( )
( )
2
2
1 2( 1) 1 2
var( ) ( )
K K K
x x
v E v E v A A
+ + +

= - = -

Remember that the superscript in front of the first A indicates that the insurance function
should be evaluated at twice the standard force of interest, or equivalently, at rate of
interest ( ) 1 1
2
+ i .
It now follows that:
2 2 1
1
2 2 2 2
( ) 1 1
var( ) var var( )
K
K x x
K
A A v
a v
v
i i v d
+
+

-
= = =

(Recall that
2
var( ) var( ) cX c X = for any constant c and random variable X .)
4.2 Payments made annually in advance
Now suppose that payments of one unit are made at the beginning of every year
throughout the life of a policyholder that is now aged x . The actuarial present value of
this annuity-due is denoted by
a
x
. The only difference between the annuity-due and the
immediate annuity described in the previous section is the payment of one unit that is
made at age x . Since the present value of this first payment is 1, and it is made with
certainty, the actuarial present value of the annuity-due satisfies the equation:
a a
x x
= + 1
Deterministic model
Assuming that the survival probabilities are known, the actuarial present value of the
annuity-due may be calculated using the equation:
a vp v p v p v p
x x x x
k
k
k x
= + + + + =
=
1
2
2
3
3
0
"
Question 4.1
Show that the actuarial present value of the annuity-due satisfies the recursive formula:
1
1
x x x
a v p a
+
= +

Example 4.1
30
a
given that a
29
17.200
= ,
29
0.999 p = and 0.05 i = .
Solution
From the recursive formula we have:
29 29 30
1 a v p a = +

So:
29
30
29
1 1.05 16.200
17.027
0.999
a
a
v p
-
= = =
Stochastic model
Again we want to express the present value of the annuity in terms of a future lifetime
random variable.
With an annuity-due, the policyholder receives a payment of one unit at the start of every
year for the whole of his life. The payments made under this annuity are illustrated on the
timeline below.
age
x x + 1 x + 2 x K + x K + + 1
1 1 1 1
As we can see from the picture, there are K + 1 payments altogether. The present value
of the annuity-due can therefore be expressed as:
1
2
1
+ + + + =
+
v v v a
K
K
"

The actuarial present value is given by:
E a a K k
K k
k
(
)

Pr( )
+ +
=
= =
1 1
0
It can be shown (using the same argument that was used in the case of an immediate
annuity) that the deterministic and stochastic models give the same result, ie that:
Pr( ) a K k v p
k
k
k
k x
k
+
=
= =

1
0 0
Variance
Writing the annuity-certain as:
a
v
d
K
K
+
+
=

1
1
1
we find that:
var(
) var( )
( )
a
d
v
A A
d
K
K x x
+
+
= =

1 2
1
2 2
2
1
Notice that var(
) var( ) a a
K K +
=
1
. This result is to be expected since the only difference
between these annuities is the payment that is made (with certainty) at age x under the
annuity-due.
Tables
Values of
a
x
are given in the Tables for ages 0 to 110. Values of a
x
are not listed since
they are easily calculated from the values of
a
x
. All the functions in the Tables are
calculated using an interest rate of 6% a year.
Question 4.2
A life aged exactly 40 purchases a whole life annuity under which payments of $5,000 are
made annually in arrears. The expectation and standard deviation of the present value of
this annuity, calculated assuming interest and mortality as given in the Tables are,
respectively:
A $69,083 and $188
B $69,083 and $13,281
C $69,083 and $35,282
D $74,083 and $13,281
E $74,083 and $35,282
4.3 Extra risk
We have seen above that the actuarial present value of an annuity can be expressed as a
sum of terms of the form v p
k
k x
. Sometimes, however, we need to find the present value
of an annuity payable to a life that experiences non-standard mortality. In other words, we
have to make an adjustment to the survival probabilities before we can work out the
actuarial present value of the annuity. A person whose survival probabilities are lower
than the standard values for his age (according to some life table) is said to be an impaired
life.
One way to adjust the standard mortality to allow for impairment is to apply an age rating.
To do this we treat the life under consideration, assumed to be age x , as if he were
actually aged x s + . (Note that the value of s could be either positive or negative,
depending on our beliefs about the lifes mortality.)
Alternatively, we could make an addition (or subtraction) to the standard force of mortality.
Recall that:
exp ( )
x k
k x
x
p y dy m
+

= -

where ( ) y m denotes the (standard) force of mortality at age y .

Now define:
* ( ) ( ) x x m m m = + for all ages x
If we use the symbol
k x
p
*
to denote the probability of survival from age x to age x k +
calculated using force of mortality * ( ) x m , then:
*
exp ( ( ) ) exp ( )
x k x k
k k
k x k x
x x
p y dt e y dt e p
m m
m m m
+ +
- -

= - + = - =

Also, if denotes the standard force of interest, we have:
v e =

From the discussion above, we know that the actuarial present value of an annuity is a
sum of terms of the form
k
k x
v p .
We can now write:
v p e p v p
k
k x
k
k x
k
k x
* ( )
( *) = =
+
where v * is defined by the equation:
v e ve *
( )
= =
+
So, when we are calculating the actuarial present value of an annuity, we can treat a
constant addition of to the standard force of mortality as a constant addition of to the
standard force of interest.
Example 4.2
A life aged 65 purchases a whole life annuity-due with an annual payment of 8,000.
Calculate the actuarial present value of this annuity assuming an interest rate of 5% and a
constant addition of 0.0094787 to the standard force of mortality used in the Tables.
Solution
The actuarial present value of the annuity is
*
a
65
, evaluated using an interest rate of 5%
and non-standard mortality. However:
@

@
*
a a
65 65
5% 6% =
since:
v ve e i *
.
. * .
.
= = = =

1
105
0 9433963 0 06
0 0094787
So the actuarial present value of the annuity is:
8 000 6% 8 000 9 8969 79175 2
65
,

@ , . , . a = =
Note that this method of switching the addition from the force of mortality to the interest
rate does not work for insurance functions since they cannot be expressed solely in terms
of v p
k
k x
. However, insurance functions can be dealt with using a premium conversion
formula.
4.4 Premium conversion formula for whole life policies
We have already remarked that:
a
v
d
K
K
+
+
=

1
1
1
and E v A
K
x
( )
+
=
1
If we take the expected value of each side of the first equation above, we obtain:
a
A
d
x
x
=
1
This can be rearranged to give the premium conversion formula for whole life policies:
Premium conversion formula for whole life policies
A da
x x
= 1

Example 4.3
Verify this formula for the values of
a
40
and A
40
given in the Tables.
Solution
From the Tables we have:
. a
40
14 8166 = A
40
016132 = .
0.06
0.0566038
1 1.06
i
d
i
= = =
+
So:
40 40
1 1 (0.0566038 14.8166) 0.161324 da A - = - = =
Question 4.3
The value of A
50
, calculated assuming an interest rate of 5% a year and a constant
addition of 0.0094787 to the standard force of mortality used in the Tables, is:
A 0.24905
B 0.36825
C 0.63175
D 0.75095
E none of the above
5 Temporary annuities with annual payments
Now suppose that, instead of being payable for the whole of a policyholders life, payments
made under an annuity are limited to a maximum of n years.
5.1 Temporary annuities payable annually in arrears
Consider a policyholder that purchases an annuity at age x and receives annuity
payments annually in arrears. Even if the policyholder survives past the age of x n + , he
would receive the final payment at age x n + .
Once again, we can model the present value of the annuity in two ways. The notation
used to denote the actuarial present value of this annuity is a
x n :
.
Deterministic model
If the survival probabilities are known, then the actuarial present value of the n -year life
annuity is given by:
a v p v p v p v p
x n
x x
n
n x
k
k
n
k x
:
= + + + =
=
2
2
1
"
Example 4.4
Calculate the actuarial present value of a 3-year annuity, payable to a life now aged 60 on
survival to the end of each year, given that:
(i) the annual payment is $10,000
(ii) p p p
60 61 62
0 99 = = = .
(iii) the interest rate is 5% a year.
Solution
The actuarial present value is:
( )
2 3
60 2 60 3 60
60:3
2 3
2 3
10,000 10,000
0.99 0.99 0.99
10,000
1.05
1.05 1.05
26,700.17
a vp v p v p = + +

= + +

=
Question 4.4
Now suppose that the annuity payments in Example 4.4 are made annually in advance.
The actuarial present value of the annuity is then:
A $26,969.87
B $28,035.18
C $28,062.48
D $28,318.37
E $36,700.17
Stochastic model
Since there is now a maximum of n payments and each payment is contingent on
survival, the total number of annuity payments that will be made is min{ , } K n . The present
value of the annuity is therefore:
v v v a
K n
K n
+ + + =
2
"
min{ , }
min{ , }
The actuarial present value of the annuity may therefore be expressed as:
E a a K k
K n k n
k
( ) Pr( )
min{ , } min{ , }
= =
=
0
Again, it is not immediately obvious that the deterministic and stochastic models lead to
the same result. We will now show that this is indeed the case.
First observe that:
E a a K k
a K k a K k
a K k a K n
K n k n
k
k
k
n
n
k n
k
k
n
n
( ) Pr( )
Pr( ) Pr( )
Pr( ) Pr( )
min{ , } min{ , }
= =
= = + =
= = + +
=
= = +
0
0 1
0
1
Now replace a
k
by v
j
j
k
=
1
in the first term and change the order of summation. We then
have:
a K k v K k
v K k
k
k
n
j
j
k
k
n
j
k j
n
j
n
Pr( ) Pr( )
Pr( )
= = =
= =
= = =
= =

0 1 0
1
Pulling the v
j
term outside the inner summation gives:
a K k v K k
v j K n
k
k
n
j
k j
n
j
n
j
j
n
Pr( ) Pr( )
Pr( )
= = =
=
= = =
=

0 1
1
If we write Pr( ) Pr( ) Pr( ) j K n K j K n = + 1 , we then see that:
a K k v K j v K n
v K j a K n
k
k
n
j
j
n
j
j
n
j
j
n
n
Pr( ) Pr( ) Pr( )
Pr( ) Pr( )
= = +
= +
= = =
=

0 1 1
1
1
1
Finally, substituting this last expression into the formula for the actuarial present value, we
obtain:
E a v K j a K n a K n
v p
a
K n
j
j
n
n n
j
j x
j
n
x n
( ) Pr( ) Pr( ) Pr( )
min{ , }
:
= + + +
=
=
=
=
1
1
1 1
So the deterministic and stochastic models do give the same result.
Variance
As in previous cases, we can use our knowledge of annuities-certain to express the
present value of the temporary annuity as:
a
v
i
K n
K n
min{ , }
min{ , }
=
1
Then:
min{ , }
min{ , }
min{ , } 2
1 1
var( ) var var( )
K n
K n
K n
v
a v
i
i

-
= =

From the last unit, we know that:
:
( )
x n
A E Z =
where:
1
if
if
K
n
v K n
Z
v K n
+
<
Another way of expressing this result is as follows:

min{ 1, }
:
( )
K n
x n
A E v
+
=
So the variance of the temporary annuity is:
var( ) var( )
( )
min{ , }
min{ , }
: :
a
i v
v
A A
d
K n
K n
x n x n
= =

+ +
+ + 1
2 2
1 1
2
1 1
2
2
Again, the superscript of 2 in front of the first insurance symbol indicates that it should be
calculated using twice the standard force of interest.
5.2 Temporary annuities payable annually in advance
The notation used to denote the actuarial present value of an n -year life annuity payable
to a life currently aged x is
:
a
x n
. As the maximum number of payments made under this
annuity is n , the latest possible payment date is at age x n + 1.
Deterministic model
If the survival probabilities are known, then the actuarial present value of the annuity is:
:
a vp v p v p v p
x n
x x
n
n x
k
k x
k
n
= + + + + =
1
2
2
1
1
0
1
"
Stochastic model
Since payments continue throughout the policyholders life, up to and including age
x n + 1, the present value of the annuity may be expressed as:
1
2 1
1
+ + + + =
+
v v v a
K n
K n
"
min{ , }
min{ , }

From the discussion above it follows that:
E a a K k
K n k n
k
(
)

Pr( )
min{ , } min{ , } + +
=
= =
1 1
0
This can be shown to be equivalent to
:
a
x n
.
Variance
The variance of the present value is:
var(
)
( )
min{ , }
: :
a
A A
d
K n
x n x n
+
=

1
2 2
2
Question 4.5
Show that var(
)
( )
min{ , }
: :
a
A A
d
K n
x n x n
+
=

1
2 2
2
.
Tables
Values of
:
a
x n
and a
x n :
are not given in the Tables. However, we can easily work them
out from the values of
a
x
since:
n
x n x x n
x n
a a v p a
:
+
=

and
n n
x n x x n x n x x n
x n
a a v p a a v p a
:
( 1) ( 1)

+ +
= - = - - -
Question 4.6
Show that
n
x n x x n
x n
a a v p a
:
+
=

.
The notation
n x
E is sometimes used instead of v p
n
n x
. Values of
x
E
5
1000 ,
x
E
10
1000
and
x
E
20
1000 are given in the Tables for ages 0 to 110.
Example 4.5
:
a
40 25
assuming mortality and interest as used in the Tables.
Solution
Using the formula given above, we have:

. ( . )
, ,
, ,
.
.
:
a a v p a
40 25
40
25
25 40 65
25
14 8166 106
7 533 964
9 313166
9 8969
129512
=
=
=

5.3 Premium conversion formula
There is also a premium conversion formula for temporary annuities and endowment
insurances.
Premium conversion formula for temporary annuities
A da
x n x n : :
= 1
Question 4.7
Show that A da
x n x n : :
= 1 .
6 Deferred life annuities
Payments made under an annuity do not necessarily have to begin in the first year of the
policy. In some cases, annuity payments are deferred for a number of years.
6.1 Deferred whole life annuities payable annually in arrears
Consider a life aged x , who is due to receive an annuity payable annually in arrears. If
this annuity is deferred for a period of m years, then the first payment will be made when
the policyholder reaches age x m + + 1 and annual payments will be made throughout life
thereafter. Note that, if the policyholder dies before age x m + + 1, no payments will be
made.
As usual, we would like to develop a formula for the present value of this annuity, which
we will denote by the symbol
m x
a
|
.
Deterministic model
Since the payments start at age x m + + 1 and are contingent on survival, the actuarial
present value is given by:
m x
m
m x
m
m x
m
m x
a v p v p v p
|
= + + +
+
+
+
+
+
+
1
1
2
2
3
3
"
This can be rewritten as:
( )
2 3
| 2 3
m
m x m x x m x m x m
m
m x x m
m x x m
a v p v p v p v p
v p a
E a
+ + +
+
+
= + + +
=
=
"
This last expression may also be deduced by general reasoning:
The probability that the policyholder is still alive at the end of the m-year deferment
period is
m x
p .
Given that he does survive to age x m + , the actuarial present value at age x m +
of the whole of life annuity is a
x m +
.
However, we want the actuarial present value at age x , so we have to discount the
value at age x m + by multiplying by a factor of v
m
. Since v p E
m
m x m x
= , we
have the required result.
Another way we can express
| m x
a is as follows:
|
1
1 1
:
k
m x k x
k m
m
k k
k x k x
k k
x
x m
a v p
v p v p
a a
= +
= =
=
= -
= -

Stochastic model
If we now think in terms of future lifetime random variables, we know that the last payment
will be made at age x K + . The payment series is illustrated on the timeline below.
In the discussion above, we saw that a deferred annuity can be viewed as the difference
between a whole life annuity and a temporary annuity. Hence, the present value of a
whole life annuity, deferred for m years, is given by:
a a
K K m
min{ , }
E a a E a E a
K K m K K m
( ) ( ) ( )
min{ , } min{ , }
=
We have already seen that:
E a v p
K
k
k
k x
( ) =
=
1
and E a v p
K m
k
k
m
k x
( )
min{ , }
=
=
1
age
x x m + 1 x m + + 2 x m + + x K + x K + + 1
1 1 1
So:
E a a v p v p v p a
K K m
k
k
k x
k
k
m
k x
k
k m
k x m x
( )
min{ , }
|
= = =
=
= = +

1 1 1
Once again we have shown that the deterministic and stochastic models give us the same
result.
Variance
Recall that for any two random variables X and Y , the variance of X Y - is given by:
var( ) var( ) var( ) 2cov( , ) X Y X Y X Y - = + -
where cov( , ) X Y denotes the covariance of X and Y . Covariance is defined by the
equation:
cov( , ) ( ) ( ) ( ) X Y E XY E X E Y = -
Recall also that, given random variables X and Y , and a constant k :
cov( , ) 0 k X =
and
cov( , ) cov( , ) kX Y k X Y =
We will use these results in the derivation of the variance of the deferred annuity.
First note that the variance is given by:
var( ) var( ) var( ) cov( , )
min{ , } min{ , } min{ , }
a a a a a a
K K m K K m K K m
= + 2
We have already seen that:
var( )
( )
a
A A
d
K
x x
=

2 2
2
and:
var( )
( )
min{ , }
: :
a
A A
d
K m
x m x m
=

+ +
2
1 1
2
2
In addition:
min{ , }
min{ , }
min{ , }
2
1 min{ 1, 1}
2
1 1
cov( , ) cov ,
1
cov( , )
1
cov( , )
K K m
K K m
K K m
K K m
v v
a a
i i
v v
i
v v
d
+ + +

- -
=

=
=
and:
cov( , ) ( ) ( ) ( )
( )
min{ , } min{ , } min{ , }
min{ , }
:
v v E v v E v E v
E v A A
K K m K K m K K m
K K m
x
x m
+ + + + + + + + +
+ + + +
+
=
=
1 1 1 1 1 1 1 1 1
1 1 1
1
Now we can write:
2( 1)
1 min{ 1, 1}
2
if
if
K
K K m
K m
v K m
v
v K m
W Z
+
+ + + +
+ +
=

>
= +
where:
2( 1)
if
0 if
K
v K m
W
K m
+

=

>
and
2
0 if
if
K m
K m
Z
v K m
+ +

=

>
From Unit 3, we know that:

2 1
|
: 1
( )
x m
E W A
+
= and
1
1|
( )
m
m x
E Z v A
+
+
=
Hence:
1 min{ 1, 1} 2 1 1
1|
|
: 1
( )
K K m m
m x
x m
E v A v A
+ + + + +
+
+
= +
and:
{
2 2 2 2
2 min{ , } : 1 : 1
2 1 1
1|
| : 1 : 1
1
var( ) ( ) ( )
2
x x
K K m x m x m
m
m x x
x m x m
a a A A A A
d
A v A A A
+ +
+
+
+ +
= +
| |
+
` |
\ .
)
6.2 Deferred whole life annuities payable annually in advance
Now consider the case of a deferred annuity-due. If the deferment period is m years, then
the first annuity payment will be made at age x m + , provided that the policyholder is still
alive.
Deterministic model
The actuarial present value of this deferred annuity is:
m x
m
m x
m
m x
m
m x
m
m x x m
x
x m
a v p v p v p
v p a
a a
|
:

= + + +
=
=
+
+
+
+
+
1
1
2
2
"
Stochastic model
The present value of this deferred annuity may be expressed in terms of the curtate future
lifetime as:

min{ , }
a a
K K m + +
1 1
As in the case of a deferred annuity payable annually in arrears, we can show that the
deterministic and stochastic models give the same result, ie:
E a a a a
K K m
x
x m
(

)

min{ , } : + +
=
1 1
Variance
The variance of this deferred annuity-due is given by:
{
2 2 2 2
min{ , } : : 2
2 1
|
| :
:
1
var( ) ( ) ( )
2
x x
K K m x m x m
m x x
x m
x m
a a A A A A
d
A A A A
- = - + -

- + -

The proof of this result is similar to that for a deferred annuity payable annually in arrears.
Example 4.6
Calculate the values of
20 40 |
a and
25 35 |
a using the Tables.

Solution
We have:
20| 40 20 40 60
0.27414 11.1454 3.0554 a E a = = =

and
25 25 60
25| 35 25 35 60 60
35
8,188,074
(1.06) 11.1454 2.2571
9, 420, 657
l
a E a v a
l
-
= = = =

Note that, since
25 35
E is not given in the Tables, we had to work it out from first
principles.
Question 4.8
A life aged exactly 25 has purchased a deferred, whole life annuity-due, under which
annual payments of one unit will be made. You are given that:
(i) the deferment period is 30 years
(ii) A
25 30
0 25
:
. =
(iii) A
25 30
1
0 05
:
. =
(iv) a
55
10 85 = . .
The actuarial present value of this annuity is:
A 2.07
B 2.17
C 2.27
D 2.37
E 2.47
6.3 Deferred temporary annuities with annual payments
Now consider an n -year temporary annuity that is deferred for a period of m years. If the
payments are made annually in advance, then the actuarial present value of this annuity is
denoted by
m
x n
a
|
:
. If they are made annually in arrears, then the notation used is

m
x n
a
|
:
.
The actuarial present value can be evaluated using the formula:
m
x n
m x
x m n
a E a
|
: :

=
+
or
m m x
x n x m n
a E a
|
: : +
=
To see why these formulas are correct, consider a life aged x who purchases an n -year
annuity-due with a deferment period of m years.
The first annuity payment will be made at age x m + if the policyholder lives to that
age. Otherwise no benefit will be paid. The probability of survival is
m x
p .
Starting at age
x m +
, and continuing for
n
years, an annual annuity payment of
one unit is made. These payments are again contingent on survival. The actuarial
present value of this annuity at age
x m +
is
:
a
x m n +
.
Discounting back to age x and incorporating the probability of survival, we see that
the actuarial present value at age x of this annuity is
m
m x
x m n
v p a
: +
.
Question 4.9
Which of the following statements are correct?
I
m
x n x m x m n
a a a
|
: : :
+ =
+
II
m
x n
m
x n
m
a a v
|
:
|
:
= +
III
m x m x x m
a E a
|

=
+ + + 1 1
A none of them
B I and II only
C I and III only
D II and III only
E I, II and III
7 Guaranteed annuities
Now suppose that a policyholder, currently aged x , buys a life annuity under which
payments are guaranteed for the first m years of the policy. (Payments after the age of
x m + are contingent on survival.) This annuity can be considered to be the sum of an m-
year annuity-certain and a deferred life annuity.
7.1 Guaranteed annuities payable annually in arrears
The actuarial present value of an immediate annuity payable at the rate of one unit a year
to a life currently aged x , and guaranteed for a period of m years, is denoted by a
x m :
.
Deterministic model
If the survival probabilities are known, then the deterministic model can be used to
calculate the actuarial present value of the guaranteed annuity.
The actuarial present value may be expressed in many ways:
m m m
m x m x
x m
m
m x x m
m
m x x m
m
m x
m
a v v v v p v p
a v p a
a E a
a a
2 1 2
1 2
:
|
+ +
+ +
+
+
= + + + + + +
= +
= +
= +
" "
Stochastic model
Alternatively, the present value can be expressed in terms of the curtate future lifetime:
a a a
m K K m
+
min{ , }
Using the results obtained above, we see that the actuarial present value then satisfies the
equation:
E a a a a E a E a
a a a
a a
m K K m m K K m
m
x
x m
m
m x
( ) ( ) ( )
min{ , } min{ , }
:
|
+ = +
= +
= +
Variance
Since a
m
is a constant, the variance of the present value satisfies the equation:
var( ) var( )
min{ , } min{ , }
a a a a a
m K K m K K m
+ =
So the variance of a guaranteed annuity is the same as the variance of a deferred annuity,
provided that the guarantee period and deferment period are the same.
7.2 Guaranteed annuities payable annually in advance
Similar logic can be applied when the payments are made annually in advance.
Question 4.10
Write down formulas for the present value and actuarial present value of an annuity-due
under which the payments are guaranteed for the first m years.
Question 4.11
A life aged 40 purchases an annuity-due. Annual payments of $12,000 are guaranteed for
the first 10 years of the policy and are payable for life thereafter. Assuming mortality and
interest are as given in the Tables, the actuarial present value of this annuity is:
A $179,059
B $183,741
C $189,040
D $266,358
E $288,382
8 Annuities payable m times a year
In this section we study annuities that are payable m times every year. We consider an
annuity paid at the start (or end) of each 1/ m th of a year. Each annuity payment is now
of amount 1/ m , so that we end up with a total payment of one unit each year. In this
case we would say that we have an annuity of one unit a year, payable mthly in advance
(or arrears). For example, if we receive payments of $1,000 at the end of every month, we
would say that an annuity of $12,000 a year is payable monthly in arrears.
We shall now develop the models assuming that the payments are made in arrears.
8.1 Whole of life annuities payable m times a year
Suppose that we have a policyholder, who is currently aged x , and is due to receive
payments of 1/ m payable mthly in arrears throughout his life.
Deterministic model
The actuarial present value of this annuity is denoted by a
x
m ( )
. In terms of survival
probabilities it is given by:
a
m
v p
m
v p
m
v p
x
m m
m x
m
m x
k m
k m x
k
( ) /
/
/
/
/
/
= + + =
=
1 1 1
1
1
2
2
1
"
Stochastic model
In order to develop a stochastic model we need more information than just an individuals
curtate future lifetime. In fact, what we need is a random variable to denote the age at the
start period of length 1/ m during which death occurred.
We now define the random variable J by the equation:
( ) J T K m = -

ie J is the integer part of ( ) T K m , where T denotes the complete future lifetime and K
denotes the curtate future lifetime. By this definition, J is the number of complete mths of
a year lived in the year of death.
The following example should help you to understand what is going on here.
Example 4.7
Suppose that a policyholder receives a monthly immediate annuity. If this policyholder has
a complete future lifetime of 5.8 years, calculate the value of J and interpret the result.
Solution
We have m = 12 and T = 5 8 . . Hence:
0.8 12 9.6 9 J = = =

This is saying that the policyholder survives for 9 whole months in his year of death, but
dies before the end of the 10
th
month. Altogether, he would receive 69 annuity payments.
We can now express the present value of an immediate annuity with mthly payments in
terms of the random variables K and J . The formula is:
1 1 1
1 2
m
v
m
v
m
v a
m m K J m
K J m
m / / /
/
( )
+ + + =
+
+
"
1
( ) ( )
/ /
0 0
( ) Pr[( ) ( )]
m
m m
K J m k j m
k j
E a a K k J j
-
+ +
= =
= = =

Now define:
H Km J = +
Note that H represents the number of complete periods of length m 1/ years for which the
policyholder survives.
Then:
m m m m
h m h m K J m H m
h h
E a E a a H h a H h
( ) ( ) ( ) ( )
/ / / /
0 1
( ) ( ) Pr( ) Pr( )

+
= =
= = = = =

since
m
a
( )
0
0 = .
If we replace
m
h m
a
( )
/
by
h
i m
i
v
m
/
1
1
=
, we then obtain:
h
m i m
K J m
h i
E a v H h
m
( ) /
/
1 1
1
( ) Pr( )
+
= =
= =

Next, we change the order of summation, noting that i h . This gives:
m i m
K J m
i h i
E a v H h
m
( ) /
/
1
1
( ) Pr( )

+
= =
= =

Pulling the
1
m
v
i m /
term outside of the inner summation, we obtain:
m i m
K J m
i h i
i m
i
i m
i
i m
i
i m
i m x
i
E a v H h
m
v H i
m
v Km J i
m
v K J m i m
m
v p
m
( ) /
/
1
/
1
/
1
/
1
/
/
1
1
( ) Pr( )
1
Pr( )
1
Pr( )
1
Pr( / / )
1

+
= =
=
= =
=
= +
= +
=

Again, this is the result that we obtained using the deterministic model.
Variance
The variance is obtained in the usual way:
/
( ) ( 1) /
( ) ( ) 1/ 2
/
1 1
var( ) var var( )
( )
K J m
m K J m
m m m
K J m
v
a v
i i v
+
+ +
+

-
= =

It is easily checked that:
( ) 1/ ( ) m m m
i v d =
Also, since v
K J m + + ( ) / 1
is the present value of a whole life insurance with unit sum
assured payable at the end of the period of length 1/ m in which death occurs, we have:

( )
2
( ) ( ) 2
( )
( ) 2
/
var( )
( )
m m
x x
m
m
K J m
A A
a
d
+
-
=
We can obtain similar results for annuities-due payable m times a year. If the annuity
payments are made at the start of each period, then the symbol used to denote the
actuarial present value is
( )
a
x
m
.
Question 4.12
Write down an expression in terms of survival probabilities for the actuarial present value
of a life annuity of one unit a year, payable mthly in advance, to a life currently aged x .
Tables
Values of a
x
m ( )
and
( )
a
x
m
are not given in the Tables. However, they may be calculated
using the formulas below.
Evaluating mthly life annuities
Assuming that deaths occurs uniformly over each year of age, the actuarial present value
of a whole of life annuity, payable mthly in advance, satisfies the equation:
( )
( ) ( )
m
x x
a m a m a b = -

Here:
( )
( ) ( )
m
id
i d
m m
= and ( )
( )
( ) ( )
m
i i
i d
m
m m
=

Also, since the only difference between
( )
a
x
m
and a
x
m ( )
is that
( )
a
x
m
has an extra payment
of amount 1/ m at age x , values of a
x
m ( )
can be calculated using the identity:
a a
m
x
m
x
m ( ) ( )
=
1
Note that the values of
( ) m
i ,
( ) m
d , ( ) m a and ( ) m b are given in the Tables for
1, 2, 4,12 m = and .
In order to prove the above result, we first note that there is a premium conversion formula
that holds for mthly annuities.
Premium conversion formula for mthly annuities
( ) ( ) ( )
1
m m m
x x
A d a = -

Question 4.13
Show that
( ) ( ) ( )
1
m m m
x x
A d a = -

.
Subtracting
( ) ( ) ( )
1
m m m
x x
A d a = -

from the equation:
x x
A da 1 =

we obtain:
m m m
x x x x
A A d a da
( ) ( ) ( )
=

This can be rearranged as:
d a da A A
m
x
m
x x x
m ( ) ( ) ( )

= +
Dividing through by d
m ( )
then gives:
( )

( ) ( )
( ) ( )
1
m m
x x x x
m m
d
a a A A
d d
= - -
Now, if we assume that deaths are uniformly distributed across each year of age, we have:
A
i
i
A
x
m
m
x
( )
( )
=
Substituting this in the above, we obtain:

( )
( )
( ) ( ) ( ) ( ) ( ) ( )
1
m
m
x x x x x x
m m m m m m
d i d i i
a a A A a A
d d i d i d
-
= - - = -

Finally, replacing A
x
by 1 da
x
gives:

( )
( )
( ) ( ) ( )
( ) ( )
( ) ( ) ( ) ( ) ( )
( )
( ) ( ) ( ) ( )
(1 )
( )
( ) ( )
m
m
x x x
m m m
m m
x
m m m m m
m
x
m m m m
x
d i i
a a da
d i d
d d i i i i
a
d i d i d
id i i
a
i d i d
m a m a b
-
= - -

- -
= + -

-
= -
= -
Example 4.8
Use the Tables to calculate the value of
( )
a
40
12
. Assume that deaths are uniformly
distributed between integer ages.
Solution
From the Tables, we have:
( ) . 12 100028 = and ( ) . 12 0 46812 =
Hence:
( )
( ) ( . . ) . .
( )
a a
40
12
40
12 12 100028 14 8166 0 46812 14 353 = = =
Question 4.14
Verify the values of ( ) 12 and ( ) 12 given in the Tables.
Question 4.15
A policyholder now aged exactly 60 has purchased a whole of life annuity under which she
receives payments of $5,000 at the end of every three months, provided she is still alive at
that time. The actuarial present value of this annuity, calculated using the values given in
the Tables, is:
A $195,283
B $210,283
C $215,283
D $220,283
E $235,283
8.2 Temporary annuities payable m times a year
The formula:
( )
( ) ( )
m
x x
a m a m a b = -

only works for whole life annuities. To value a temporary annuity that is payable m times
a year, we must first express the temporary annuity in terms of whole life annuities. This
can be done as follows:
( ) ( ) ( )
:
m m m
x n x x n
x n
a a E a
+
= -

Then each of the whole life terms can be evaluated using the , formula.
Question 4.16
A life office sells a 10-year temporary annuity to a life now aged 65. The policy pays out
$2,000 at the start of every month. The actuarial present value of the annuity, calculated
using the values given in the Tables is:
A $13,463
B $64,337
C $91,928
D $135,886
E $161,559
9 Continuous life annuities
Suppose now that, instead of payments being made at the beginning or end of each year,
a policyholder receives a continuous stream of payments until he dies. In practice the
payments may be made weekly rather than continuously. A continuous payment stream is
a theoretical concept that is often used to model a series of payments that are made many
times a year.
9.1 Whole of life annuities
Deterministic model
As we are now working in continuous time, we can no longer just work out the actuarial
present value of each payment and add them all together. The continuous analog of
summation is integration, and thats what we must do here.
Consider the short time interval ( , ) t t dt + . If the rate of payment is one unit per annum,
then over a time interval of length dt , the total amount paid will be dt . If dt is small then
the value at time 0 (ie when the policyholder is aged x ) of this payment stream is
approximately:
v dt
t
Also the probability that the policyholder is alive to receive this payment is approximately:
t x
p
So the actuarial present value of the payment stream payable from time t to time t dt + is
approximately:
v p dt
t
t x
Considering all possible values of t and letting dt 0 , we find that the actuarial present
value of the annuity is:
0
t
x t x
a v p dt
Stochastic model
Since we are now working in continuous time, we must write the present value of the
annuity in terms of ( ) T x , the complete future lifetime random variable. For notational
convenience we will drop the x here.
Also, as the annuity is payable continuously at the rate of one unit a year throughout the
lifetime of the policyholder, the present value of the annuity is a
T
.
The actuarial present value may be expressed as:
0
( ) ( )
T
T t
E a a f t dt
where f t
T
( ) is the PDF of T .
Question 4.17
Show that
0
( )
t
t x
T
E a v p dt
.
Variance
Since:
a
v
T
T
=
1
it follows that:
2
1 1
var( ) var var( )
T
T
T
v
a v
d
d

-
= =

In the previous unit we saw that:
var( ) ( ) v A A
T
x x
=
2 2
So we now have:
2 2
2
( )
var( )
x x
T
A A
a
d
-
=
Tables
Values of a
x
are not given in the Tables. However, values of ( ) and ( ) are listed,
so we can obtain values of a
x
by letting m in the formula:
( )
( ) ( )
m
x x
a m a m a b = -

Hence:
( ) ( )
x x
a a a b = -
This formula makes the implicit assumption that deaths are uniformly distributed between
integer ages.
The following approximation is also sometimes used:
a a
x x

1
2
This follows since ( ) 1 a and
1
( )
2
b .
Example 4.9
Calculate the value of a
55
assuming interest and mortality as given in the Tables.
Solution
From the formula above we have:
a a
55 55
100028 12 2758 0 50985 117694 = = = ( )
( ) ( . . ) . .
9.2 Temporary annuities
Deterministic model
We can apply similar logic to that used in previous sections to calculate the actuarial
present values of temporary, guaranteed and deferred annuities that are payable
continuously.
In particular, we can express the actuarial present value of a continuously payable
temporary annuity in terms of whole life annuities as follows:
a a E a
x n
x n x x n
:
=
+
The integral representation of a
x n :
is therefore:
:
0 0
0 0
0
0
t n t
t x n x t x n
x n
t n t
t x n t x
t t
t x t x
n
n
t
t x
a v p dt v p v p dt
v p dt v p dt
v p dt v p dt
v p dt

+

+
+

= -
= -
= -
=

Similarly, we can write:

|
t
m x t x
m
a v p dt
and
|
: 0
n
t t
n x t x
n
x n n
a a a v dt v p dt
= + = +

Question 4.18
The value of a
30 25 :
, calculated using the interest and mortality assumed in the Tables is:
A 12.8568
B 13.2250
C 14.4541
D 16.0986
E 17.8446
As in the annual payments case, the actuarial present value of a whole of life annuity may
be calculated using a recursive formula. The formula is:
a a vp a
x
x
x x
= +
+
:1
1
We prove this as follows:
1
0 1
1
:1
0
1
:1
t t
x t x t x
s
x s x
x
x x
x
a v p dt v p dt
a v p v p ds
a v p a
+
+
= +
= +
= +

Example 4.10
Calculate the value of a
30
given that a
31
15.206 = , 0.05 i = and x ( ) 0.01 = for
x 30 31 < .
Solution
From the recursive formula we have:
a a v p a
30 30 31
30:1
= +
Now:
p e
0.01
30
0.99005
= =
Also:
t
t
t t
t
a v p dt
e e dt
e
e
1
30
30:1
0
1
0.01
0
1
( 0.01)
0
(ln1.05 0.01)
1
0.01
1
1
ln1.05 0.01
0.97117

+
+
=
=
(
=

+
(
=

+
=
So:
a
30
1
0.97117 0.99005 15.206
1.05
15.309
| |
= +
|
\ .
=
Stochastic model
The present value of a continuously payable, n -year temporary annuity is:
a
a T n
a T n
T n
T
n
min{ , }
=

>
R
S
|
T
|
if
if
E a a f t dt
T n t n
T
( ) ( )
min{ , } min{ , }
=

z
0
It is not obvious that this is the same as the result given for the deterministic model. We
prove this result below.
First observe that:
min{ , }
0
0
( ) ( ) ( )
( ) Pr( )
n
T T
T n t n
n
n
T
t n
E a a f t dt a f t dt
a f t dt a T n
= +
= + >

Since a v ds
t
s
t
=
z
0
, we may write the first term as:
0 0 0
( ) ( )
n n t
s
T T
t
a f t dt v f t ds dt =

Changing the order of integration (and noting that s t ) gives:
0 0
( ) ( )
n n n
s
T T
t
s
a f t dt v f t dt ds =

We can now pull the v
s
term outside the inner integral to obtain:
0 0
0
( ) ( )
Pr( )
n n n
s
T T
t
s
n
s
a f t dt v f t dt ds
v s T n ds
=
=

Now, writing:
Pr( ) Pr( ) Pr( ) Pr( ) Pr( ) s T n T s T n T s T n = > = > >
gives:
0 0 0
0 0
0
( ) Pr( ) Pr( )
n n n
s s
T
t
n n
s s
s x n x
n
s
s x n x
n
a f t dt v T s ds v T n ds
v p ds p v ds
v p ds p a
= > - >
= -
= -


Substituting this back into the original expression for the actuarial present value, we have:
E a v p ds p a p a
v p ds
T n
s
s x
n
n x
n
n x
n
s
s x
n
( )
min{ , }
= +
=
z
z
0
0
which was the integral expression obtained using the deterministic model.
Variance
Since:
a
v
T n
T n
min{ , }
min{ , }
=
1
it follows that:
var( ) var( )
min{ , }
min{ , }
: :
a v
A A
T n
T n
x n x n
= =

F
H
I
K 1
2
2
2
2

9.3 Premium conversion formulas for continuously payable annuities
Premium conversion formulas also exist for whole life and temporary annuities that are
payable continuously. The formulas are given below.
Premium conversion formulas for continuous annuities
A a
x x
= 1
A a
x n x n : :
= 1
The proofs of these results are similar to those for annuities-due.
Question 4.19
You are given that i = 0 05 . , a
30 10
7 8
:
. = ,
10 30
0 99 p = . . The value of A
30 10
1
:
is:
A 0.00552
B 0.01166
C 0.01466
D 0.02080
E 0.61944
10 Accumulations
In the final section of this unit we consider accumulated fund values.
Suppose that:
N policyholders, all aged exactly x , contribute one unit to a fund at the start of
each year for the next n years
each contribution is contingent on survival
At the end of the n -year period, the fund is divided equally amongst the surviving
policyholders.
We want to know:
the accumulated value of the fund at the end of the

n
-year period
the share of the fund per surviving policyholder.

First of all, we can say that the actuarial present value of the contributions from each
individual policyholder is
:
a
x n
. Since we start with N policyholders, the actuarial present
value of the fund is Na
x n
:
.
If the rate of interest is i each year, then the accumulated value of the fund at the end of
n years will be Na i
x n
n
( )
:
1+ .
At the outset, the number of surviving policyholders is unknown
it is a random variable.
However, if N is large, we can approximate the actual number of survivors by the
expected number, ie N p
n x
. Then the expected share per surviving policyholder is
approximately:
Na i
N p
a
v p
a
E
x n
n
n x
x n
n
n x
x n
n x
( )

: : :
1+
= =
The notation
:
s
x n
is sometimes used instead of
:
a
E
x n
n x
.
Question 4.20
A number of lives, all aged exactly 45 at the outset, contribute to a fund at the rate of 100 a
year payable continuously for the first 5 years and 150 a year payable continuously for the
following 5 years. At the end of 10 years the fund is divided equally amongst the
survivors. Assuming interest and mortality as given in the Tables, the amount received by
each survivor is:
A 1,703
B 1,707
C 1,709
D 1,803
E 1,813
End of Part 1
Congratulations! You have completed the Course Notes in Part 1 of this study program.
Time to practice questions
We recommend that you now work through a selection of questions from Part 1 of the
Question & Answer Bank and then attempt the Part 1 Assignment. This will test your
understanding of the material you have covered so far.
We also recommend that you attempt some genuine past exam questions in order to gain
an understanding of the style, format and difficulty of Course 3 exam questions. After
completing Part 1 of this study program, you should be able to attempt the following exam
questions from the Past Exam Pack:
Past exam paper Questions
May 2000 1, 5, 8, 12, 13, 21, 29, 36, 39
November 2000 3, 4, 10, 20, 25, 26, 28, 31, 36
May 2001 1, 13, 14, 17, 24, 27, 33, 34, 39
November 2001 1, 2, 3, 8, 17, 26, 37
November 2002 1, 3, 4, 31, 32, 35, 39
Planning the rest of your study
You should make steady progress through the remaining units of this study program to
leave adequate time for review and to practice questions. Our Study Guide includes
illustrative study schedules to help you plan your time between now and the exam.
In order to help you remember the material covered in Part 1, we recommend that you
review it regularly. You may find it useful to re-read the concise summaries or attempt the
self-assessment questions. Our Course 3 flashcards are also an excellent review of the
material. Visit our website at www.bpp.com for full details.
summary pages together to help with your review.
Unit 4 Summary
Whole of life annuities
Payable annually in arrears Payable annually in advance
PV a
K
= PV a
K
=
+
1
k
x k x
k
APV a v p
1
=
= =

k
x k x
k
APV a v p
0
=
= =

var( )
( )
PV
A A
d
x x
=

2 2
2
var( )
( )
PV
A A
d
x x
=

2 2
2
Values of
a
x
are given in the Tables. Values of a
x
can be calculated using the formula:
a a
x x
=
1
Recursive formula
1
1
x x x
a v p a
+
= +

Extra risk
Let * ( ) ( ) y y m m m = + for all 0 y > . In addition, let
*
x
a
denote the actuarial present value of

a whole life annuity-due payable to a life aged x , who is subject to force of mortality * m .
Then:
*
@ @ *
x x
a i a i =

where * 1 i e
d m +
= - .
In other words, a constant addition to the standard force of mortality can be treated as a
constant addition to the standard force of interest.
Temporary annuities
PV a
K n
=
min{ , }
PV a
K n
=
+
min{ , } 1
n
k
k x
x n
k
APV a v p
:
1 =
= =

n
k
k x
x n
k
APV a v p
1
:
0
=
= =

var( )
( )
: :
PV
A A
d
x n x n
=

+ +
2
1 1
2
2
var( )
( )
: :
PV
A A
d
x n x n
=

2 2
2
Values of
:
a
x n
are not given in the Tables, but can be calculated using the formula:

:
a a E a
x n
x n x x n
=
+
Similarly:
a a E a
x n
x n x x n
:
=
+
Deferred whole of life annuities (m-year deferment period)
Payable annually in arrears
PV a a
K K m
=
min{ , }
m x m x x m x
x m
APV a E a a a
|
:
+
= = = -
{
2 2 2 2
: 1 : 1 2
2 1
1|
| : 1
: 1
1
var( ) ( ) ( )
2
x x
x m x m
m x x
x m
x m
PV A A A A
d
A A A A
+ +
+
+
+
= - + -

- + -


Payable annually in advance
PV a a
K K m
=
+ +

min{ , } 1 1
m x m x x m x
x m
APV a E a a a
|
:

+
= = = -
{
2 2 2 2
: : 2
2 1
|
| :
:
1
var( ) ( ) ( )
2
x x
x m x m
m x x
x m
x m
PV A A A A
d
A A A A
= - + -

- + -

Deferred temporary annuities (m-year deferment period, n-year term)

m
x n
m x
x m n
APV a
E a
|
:
: +
=
=
m
x n
m x
x m n
APV a
E a
|
:
:
+
=
=
Guaranteed annuities (whole life, m-year guarantee)
PV a a a
m K K m
= +
min{ , }
PV a a a
m K K m
= +
+ +

min{ , } 1 1
m x
m
x m
APV a a a
|
:
= = +
m x
m
x m
APV a a a
|
:
= = +

The variances are the same as those for deferred annuities with a deferment period of m
years.
Whole life annuities payable m times a year
Define J to be the whole number of periods of length 1/ m survived in the year of death,
ie ( ) J T K m = -

.
Payable m-thly in arrears Payable m-thly in advance
PV a
K J m
m
=
+ /
( )
PV a
K J m
m
=
+ +
( ) /
( )
1
m k m
x k m x
k
APV a v p
m
( ) /
/
1
1
=
= =

m k m
x k m x
k
m
x
APV a v p
m
a
m
( ) /
/
0
( )
1
1
=
= =
= +
var( )
( )
( )
( ) ( )
( )
PV
A A
d
x
m
x
m
m
=

2 2
2
var( )
( )
( )
( ) ( )
( )
PV
A A
d
x
m
x
m
m
=

2 2
2
Values of
( )
a
x
m
are not given in the Tables, but can be calculated using the formula:
( )
( )
( )
a m a m
x
m
x
=
where:
( )
( ) ( )
m
id
i d
m m
= and ( )
( )
( ) ( )
m
i i
i d
m
m m
=

This formula assumes that deaths occur uniformly between integer ages. Values of ( ) m
and ( ) m are listed in the Tables for m = 1 2 4 12 , , , and .
Temporary annuities payable m times a year
( ) ( ) ( )
:
m m m
x n x x n
x n
a a E a
+
= -
( ) ( ) ( )
:
m m m
x n x x n
x n
a a E a
+
= -

Whole life annuities payable continuously
PV a
T
=
t
x t x
APV a v p dt
0
= =
var( )
( )
PV
A A
x x
=

2 2
2
Values of a
x
a a
x x
= ( )
( )
Temporary annuities payable continuously (n-year term)
PV a
T n
=
min{ , }
n
t
t x
x n
APV a v p dt
:
0
= =
var( )
( )
: :
PV
A A
x n x n
=

2 2
2
Values of a
x n :
a a E a
x n
x n x x n
:
=
+
Recursive formulas

a v p a
x x x
= +
+
1
1
1
:1
x x x
x
a a v p a
+
= +
Premium conversion formulas
A d a
x x
= 1

A d a
x n x n : :
= 1
A d a
x
m m
x
m ( ) ( ) ( )
= 1 A d a
x n
m m
x n
m
:
( ) ( )
:
( )
= 1
A a
x x
= 1 A a
x n x n : :
= 1
Note that the formula A d a
x n
m m
x n
m
:
( ) ( )
:
( )
= 1 is not used in this unit. It is listed here for the

sake of completeness.
Accumulations
Suppose that a number of lives, all aged exactly x , contribute one unit to a fund at the
start of every year for a period of n years and the contributions are contingent on survival.
If the fund is divided equally amongst the survivors at the end of the n -year period, then
the share per survivor is approximately
:
a
E
x n
n x
.
Unit 4 Solutions
Solution 4.1
From the deterministic model, we have:
a v p v p v p
v p v p v p
v p a
x x x x
x x x
x x
= + + + +
= + + + +
= +
+ +
+
1
1 1
1
2
2
3
3
1
2
2 1
1
"
"
e j
Solution 4.2
Answer B.
The actuarial present value of the annuity is:
5 000 5 000 14 8166 1 69 083
40
, , ( . ) , a = =
The variance is:
5 000
25 000 1000 25 1000
25 000 48 63 25 16132
0 05660
176 388 483 3
2
2
40 40
2
2
2
40 40
2
2
2
2
,
( ) ( , , ) ( , )
( , . ) ( . )
.
, , .
A A
d
A A
d
F
H
G
I
K
J
=

=

=
So the standard deviation is 176 388 483 3 13 28113 , , . , . =
Solution 4.3
Answer B.
In order to calculate the value of A
50
we have to use the premium conversion formula:
A da
50 50
1 =

From Example 4.2, we know that:
@

@
*
a a
50 50
5% 6% =
where * denotes non-standard mortality. Hence:
A da
50 50
1 1
0 05
105
13 2668 0 36825
* *
.
.
. . = =
F
H
G
I
K
J
=
Note that d is calculated using the standard rate of interest, ie 5% a year.
Solution 4.4
Answer D.
10 000 10 000 1
10 000 1
0 99
105
0 99
105
28 318 37
60 3
60
2
2 60
2
2
,

,
,
.
.
.
.
, .
:
a v p v p = + +
= + +
F
H
G
I
K
J
=
e j
Solution 4.5
From our knowledge of annuities-certain we have:
min{ , }
min{ , }
a
v
d
K n
K n
+
+
=

1
1
1
So:
var(
) var
var( )
( )
( )
min{ , }
min{ , }
min{ , }
min{ , } min{ , }
: :
a
v
d
d
v
d
E v E v
A A
d
K n
K n
K n
K n K n
x n x n
+
+
+
+ +
=

F
H
G
I
K
J
=
=
R
S
T
U
V
W
=

1
1
2
1
2
2 1 1
2
2 2
2
1
1
1
e j e j
Solution 4.6
We have:

:
a v p a v p v p v p
v p v p
v p v p
v p
a
x
n
n x x n
k
k x
k
n
n x
k
k x n
k
k
k x
k
n k
n k x
k
k
k x
k
j
j x
j n
k
k x
k
n
x n
=
=
=
=
=
+
=
+
=
+
+
=
0 0
0 0
0
0
1
Solution 4.7
From Section 5.2, we know that:
)
: min{ , }
a E a
x n K n
=
+1
So:
min{ 1, } min{ 1, }
:
:
1
1 1 ( )
K n K n
x n
x n
A
v E v
a E
d d d
+ + -

- -
= = =

Rearranging gives:
A da
x n x n : :
= 1
Solution 4.8
Answer D.
30 25 30 25 55
25 30
25 30
1
55
1 0 20 1185 2 37
|
:
:
|

( ) ( ) . . . a E a A A a = = + = =
Solution 4.9
Answer C.
Statement I
a a v p v p v p
v p v p v p
v p v p v p
a
x m n x m
x x
m n
m n x
x x
m
m x
m
m x
m
m x
m n
m n x
m
x n
: :
|
:
( )
+
+
+
+
+
+
+
+
+
= + + +
+ + +
= + + +
=
2
2
2
2
1
1
2
2
"
"
"
Rearranging this gives:
m
x n x m x m n
a a a
|
: : :
+ =
+
So I is correct.
Statement II
m
x n
m
m x
m
m x
m n
m n x
a v p v p v p
|
:
= + + +
+
+
+
+
1
1
1
1
"
But:
m
x n
m m
m x
m
m x
m n
m n x
m
a v v p v p v p v
|
:
+ = + + + +
+
+
+
+
+
+
1
1
2
2
"
So II is incorrect.
Statement III
m x x m
m
m x x m x m
m
m x
m
m x
m
m x
m x
E a v p v p v p
v p v p v p
a
+ + +
+
+ + + + +
+
+
+
+
+
+
= + + +
= + + +
=
1 1
1
1 1
2
2 1
1
1
2
2
3
3
1
( )
|
"
"
So III is correct.
Solution 4.10
The present value is:
PV a a a
m K K m
= +
+ +

min{ , } 1 1

:
|
a a a a E a
x m
m
m x
m
m x x m
= + = +
+
Solution 4.11
Answer A.

10 40 50
10
12,000 a E a

+

The factors are:
( . )
. / .
. a
v
d
10
10 10
1 1 106
0 06 106
7 80169 =

=

=
10 40
0 53667 E = . 4
. a
50
13 2668 =
So the actuarial present value is:
12000 7 80169 0 53667 13 2668 179 059 03 , . ( . . ) , . + =
ie $179,059 to the nearest dollar.
(Note that you get 179,060 if you use
10
10 40
v p instead of
10 40
E . This is due to
rounding.)
Solution 4.12
( ) 1/ 2 /
1/ 2 /
/
/
0
( )
1 1 1
1
1
m m m
x m x m x
k m
k m x
k
m
x
a v p v p
m m m
v p
m
a
m
=
= + + +
=
= +
"
Solution 4.13
We can write:
( 1) /
( ) ( ) ( 1) /
( ) ( ) ( )
1 1 1
1 ( ) 1
K J m
m m K J m
x x
m m m
v
a E E v A
d d d
+ +
+ +

-

= = - = -

and rearranging this gives:
( ) ( ) ( )
1
m m m
x x
A d a = -

Solution 4.14
The formulas for ( ) 12 and ( ) 12 give:
(12) (12)
0.06 (0.06/ 1.06)
(12) 1.00028
0.058410607 0.058127667
id
i d
a

= = =
(12)
(12) (12)
0.06 0.058410607
(12) 0.46812
0.058410607 0.058127667
i i
i d
b
- -
= = =
NB These calculations are very sensitive to rounding. You have to use lots of decimal
places in the intermediate steps to produce accurate answers for (12) a and (12) b . In the
examination, you should use the values of a and b given in the Tables.
Solution 4.15
Answer B.
Since the policyholder receives $5,000 at the end of every three months, the total payment
received in a year is 4 5,000 $20,000 = . The actuarial present value is given by:
( )
(4) (4)
60 60
60
1
20,000 20,000
4
1
20,000 (4) (4)
4
20,000 (1.00027 11.1454) 0.38424 0.25
210,283.39
a a
a a b

= -

= - -

= - -
=
Solution 4.16
Answer E.

(12) (12) (12)
10 65
75 65
65:10
24,000 24,000 a a E a

= -

The factors are:
( )
( ) ( . . ) . .
( )
a a
65
12
65
12 12 100028 9 8969 0 46812 9 4316 = = =
( )
( ) ( . . ) . .
( )
a a
75
12
75
12 12 100028 7 2170 0 46812 67509 = = =
10 65
0 39994 E = .
So the actuarial present value is:
24 000 9 4316 0 39994 67509 161559 47 , . ( . . ) , . =
ie $161,559 to the nearest dollar.
Solution 4.17
By definition:
0
( ) ( )
T
T t
E a a f t dt
Writing a v ds
t
s
t
=
z
0
, we obtain:
0 0
( ) ( )
t
s
T
T
E a v f t ds dt
=

Changing the order of integration (noting that s t ) gives:
0
( ) ( )
s
T
T
s
E a v f t dt ds

=

We can now pull the v
s
term outside the first integral and simplify. We obtain:
0 0 0
( ) ( ) Pr( )
s s s
T s x
T
s
E a v f t dt ds v T s ds v p ds

= = > =

as required.
Solution 4.18
Answer A.
We can write:
a a E a
30 25
30 25 30 55
:
=
The individual factors are:
a a
30 30
100028 15 8561 0 50985 15 3507 = = = ( )
( ) . . . .
a a
55 55
100028 122758 0 50985 117694 = = = ( )
( ) . . . .
25 30
25 55
30
25
106
8 640 861
9 501381
0 211896 E v
l
l
= = =
( . )
, ,
, ,
.
So:
a
30 25
15 3507 0 211896 117694 128568
:
. ( . . ) . = =
Solution 4.19
Answer B.
First note that:
1 1
10 30
30:10 30:10
30:10 30:10
A A A A E = - = -
By premium conversion:
A a
30 10 30 10
1 1 105 7 8 0 619437
: :
(ln . . ) . = = =
Also:
10 30
10
10 30
10
105 0 99 0 607774 E v p = = =
( . ) . .
So:
A
30 10
1
0 619437 0 607774 0 011663
:
. . . = =
Solution 4.20
Answer A.
The actuarial present value of the fund per original member is:
100 50
45 10
5 45
50 5
a E a
: :
+
We can calculate a
45 10 :
as follows:
a a E a
a E a
45 10
45 10 45 55
45 10 45 55
100028 141121 0 50985 0 52652 100028 12 2758 0 50985
7 4094
:
( )
( ) ( )
( )
. . . . . . .
.
=
=
=
=

Similarly:
a
50 5
4 2706
:
. =
So the actuarial present value per original member is:
( . ) ( . . ) . 100 7 4094 50 072988 4 2706 89679 + =
The share of the fund per surviving policyholder is then:
10 45
896.79 896.79
1,703.24
0.52652 E
= =
Actuarial models Course 3
Fall 2004 exams BPP Professional Education
Course 3
Fall 2004 exams
Part 1
Question & Answer Bank
Instructions
This Question & Answer Bank contains 50 exam-style questions.
We recommend that you attempt a selection of these questions after completing
Part 1 of the Course Notes and the remaining questions as part of your review.
Its a good idea to annotate the questions with details of when you attempted each one
and whether you got it right or wrong. This makes it easier to ensure that you complete all
of questions and identify the areas of the course that you are finding most difficult.
Course 3 Professional models
BPP Professional Education Fall 2004 exams
Course 3 Question and Answer Bank Part 1 Questions
Part 1 Questions
Question 1
The annual rate of interest earned on a certain investment is equally likely to be 5%, 6%
or 7% in each year. Tony invests $1,000 at the start of each of the next three years.
Assuming that returns in individual years are independent, Tonys expected return at the
end of three years is:
A $3,183.60
B $3,183.67
C $3,374.62
D $3,374.89
E $3,395.11
Question 2
Suzy invests $1,000 into the investment described in Question 1. If she makes no
additions or withdrawals, the standard deviation of her return at the end of three years is:
A $15.89
B $45.59
C $53.00
D $65.72
E $166.54
Question 3
Which of the following expressions are equivalent to
| n k x t
q
+
?
I
[ ]
Pr ( ) n T x t k < +
II
x t n k x t n
x t
l l
l
+ + + + +
+
-
III
n x t n k x t
p p
+ + +
-
A I only
B II only
C III only
D I and II only
E II and III only
Question and Answer Bank Part 1 Questions Course 3
Question 4
In a certain population:

- < <
= - <
30
1 0.01 for 0 50
1.75 0.025 for 50 70
0 for 70
t
t t
p t t
t
The curtate expectation of life of (30) is:
A 27 years
B 35 years
C 40 years
D 42 years
E 50 years
Question 5
Given mortality as in Question 4, the standard deviation of the curtate future lifetime is:
A 20.7 years
B 26.1 years
C 35.0 years
D 43.9 years
E 46.8 years
Question 6
Given mortality as in Question 4, calculate
20 70
p .
A 0.333
B 0.350
C 0.417
D 0.583
E 0.650
Question 7
Given mortality as in Question 4, calculate
10 30
m .
A 0.0100
B 0.0101
C 0.0105
D 0.0111
E 0.0115
Question 8
Calculate
0.75 55.5
p using the information given in the Tables and assuming a uniform
distribution of deaths between integer ages.
A 0.99307
B 0.99309
C 0.99317
D 0.99327
E 0.99329
Question 9
Repeat Question 8 assuming a constant force of mortality between integer ages.
A 0.99307
B 0.99309
C 0.99317
D 0.99327
E 0.99329
Question 10
You are given the following information:

42
35.0 e =

40
0.995 p =

41
0.993 p =
The value of
40
e is:
A 36.6
B 36.7
C 36.8
D 36.9
E 37.0
Question 11
If
0.01
( ) 0.001
x
x x e m = , then the value of (50) s is:
A 0.0162
B 0.0824
C 0.1727
D 0.8273
E 0.9704
Question 12
In a certain population, the survival function is given by:

-

=

2
1 for 0 100
( )
100
0 otherwise
x
x
s x
The value of
[ ]
(25) E T is:
A 24.5 years
B 25.0 years
C 25.5 years
D 37.5 years
E 50.0 years
Question 13
In a certain population:
(60.75) 0.0105 m =
(61.75) 0.0318 m =
deaths are uniformly distributed between integer ages.

The probability that a person aged 60.25 will die within 18 months is:
A 0.0306
B 0.0309
C 0.0312
D 0.0314
E 0.0317
Question 14
You are given that:

0.05
( )
x
x A e m = +
,
0 x

(40) 0.85 s =
The value of A is:
A

4.20
B

3.19
C 0.00
D 3.19
E 4.20
Question 15
You are given that
70
0.953 p = . Assuming a hyperbolic form for
t x
p , the value of
0.75 70
p is:
A 0.948
B 0.956
C 0.964
D 0.976
E 0.988
Question 16
Given mortality as in Question 15, the value of
0.25 70.75
q is:
A 0.0118
B 0.0119
C 0.0120
D 0.0121
E 0.0122
Question 17
You are given the following extract from a select-and-ultimate mortality table with a 2-year
select period:
x
[ ] x
l
[ ] 1 x
l
+ 2 x
l
+
2 x +
50 80,625 79,954 78,839 52
51 79,137 78,402 77,252 53
52 77,575 76,770 75,578 54
The probability that a life aged exactly 52, who became select one year ago, survives to
age 53 is:
A 0.9792
B 0.9799
C 0.9844
D 0.9853
E 0.9896
Question 18
Use the life table in Question 17 to calculate the value of
0.5 [51] 0.8
q
+
. Assume that the
force of mortality is constant between integer ages.
A 0.00462
B 0.00464
C 0.00520
D 0.00625
E 0.00628
Question 19
Calculate the median future lifetime of (25), given that the lifetime distribution is
exponential with a mean of 70.
A 22.5
B 24.3
C 35.0
D 45.0
E 48.5
Question 20
You are given that:
(90) 0.32 m =
the force of mortality is constant between integer ages.

Calculate the average number of years lived between the ages of 90 and 91 for lives that
die between those two ages.
A 0.23
B 0.32
C 0.47
D 0.50
E 0.73
Question 21
Assuming that mortality conforms to de Moivres law and that (80) 0.15 m = , calculate the
value of
20 60
p .
A 0.1125
B 0.1534
C 0.2308
D 0.2500
E 0.4724
Question 22
Consider the following three statements about
: x n
A :
I
: 1: 1
x
x n x n
A vq A
+ -
= +
II
|
:
x n x n x
x n
A A A E = - +
III
2
1
1
:
0
n
k n
k x x k n x
x n
k
A v p q v p
-
+
+ -
=
= +
Which of these statements are correct?

A I only
B II only
C III only
D I and II only
E II and III only
Question 23
Assuming mortality and interest as given in the Tables, the value of
1
10|
35:20
A is:
A 0.0481
B 0.0495
C 0.0509
D 0.0886
E 0.0991
Question 24
A life aged 50 purchases a whole life insurance. A benefit of $75,000 is payable at the
end of the year of death if death occurs before age 60. A benefit of $50,000 is payable at
the end of the year of death if death occurs after age 60. Assuming mortality and interest
as given in the Tables, the actuarial present value of the benefit is:
A $9,451
B $10,237
C $13,526
D $13,965
E $17,166
Question 25
Assuming mortality and interest as given in the Tables, the standard deviation of the
present value of a 10-year term life insurance on (50) that pays $75,000 at the end of the
year of death is:
A $1,639
B $3,037
C $4,510
D $15,093
E $15,876
Question 26
present value of a deferred whole life insurance on (50) with a deferment period of 10
years, which pays $50,000 at the end of the year of death is:
A $1,181
B $5,181
C $6,134
D $10,143
E $11,733
Question 27
present value of the benefit described in Question 24 is:
A $8,146
B $13,412
C $14,920
D $16,291
E $18,734
Question 28
If mortality is the same as that given in the Tables and 0.05 i = for the next 6 years and
0.06 i = thereafter, then
1
32:10
A is equal to:
A 0.01037
B 0.01601
C 0.57784
D 0.57948
E 0.87836
Question 29
Consider the following three statements concerning ( )
x
IA :
I ( ) ( )
x x
i
IA IA
d
II
0
( ) ( )
t
x t x
IA t v p x t dt m
= +
III
1
1
0
( ) ( ) ( )
t
x t x x x
IA t v p x t dt vp IA m
+
= + +

Which of these statements are correct?
A I only
B II only
C III only
D I and II only
E II and III only
Question 30
A life aged 30 takes out a 30-year term life assurance under which a benefit of $10,000 is
payable two months after the date of death. Assuming mortality and interest as given in
the Tables, the expected present value of this benefit is:
A 480
B 482
C 483
D 485
E 490
Question 31
The value of
45:20
A , calculated using mortality and interest as given in the Tables and
assuming a uniform distribution of deaths between integer ages, is:
A 0.3223
B 0.3448
C 0.3474
D 0.3550
E 0.4029
Question 32
(4)
5|
35
A assuming interest and mortality as given in the Tables and a
uniform distribution of deaths between integer ages.
A 0.11658
B 0.11917
C 0.12077
D 0.12094
E 0.12182
Question 33
A life aged 60 has purchased an annuity that provides payments at the start of each year
for the next 5 years. The amount of the first payment is $10,000. Each subsequent
payment is $2,000 higher than the last. Assuming that mortality follows that in the Tables
and 0.05 i = , the expected present value of the annuity is:
A $56,852
B $57,820
C $59,694
D $60,711
E $75,129
Question 34
The standard deviation of the present value of the annuity described in Question 33 is:
A $624
B $8,129
C $8,729
D $27,817
E $29,486
Question 35
You are given that:

40
13.300 a =
0.04 i =

40
0.995 p =
The value of
41
a
is then:
A 12.725
B 12.856
C 13.300
D 13.681
E 13.901
Question 36
A whole life annuity is payable annually in advance to (60) at the rate of 10 a year.
Assuming that mortality and interest conform to that given in the Tables, the variance of
the present value of this annuity is:
A 72.7
B 128.4
C 1,143.1
D 1,242.1
E 1,284.4
Question 37
A life aged 50 wishes to purchase a policy with the following terms:
a death benefit of 25,000 is payable immediately if death occurs before age 60
on survival to age 60, an annuity of 5,000 is payable annually in advance
the annuity payments are guaranteed for the first five years
payments are contingent on survival thereafter

Assuming that interest and mortality conform to that given in the Tables, the expected
present value of the benefit is:
A 30,296
B 30,341
C 31,707
D 35,195
E 38,239
Question 38
You are given the following information:

30
16.250 a =

40
15.125 a =

10 30
0.987 p =
0.04 i =
The value of
1
30:10
A is:
A 0.0088
B 0.0130
C 0.0866
D 0.0961
E 0.1461
Question 39
One hundred lives, all aged exactly 50, pay $200 into a fund at the beginning of each
month for the next 15 years. The fund earns interest at the effective annual rate of 6%.
At the end of 15 years the fund is divided equally amongst the survivors. Assuming
mortality as in the Tables, the share per survivor is:
A $54,040
B $59,214
C $64,850
D $70,351
E $86,276
Question 40
A life aged 68 purchases a temporary life annuity under which payments of $10,000 are
made at the start of each of the next three years. Calculate the expected present value of
this annuity assuming an effective annual rate of interest of 6% and a constant deduction
of 0.00947843 from the standard force of mortality used in the Tables.
A $27,303
B $27,332
C $27,493
D $27,562
E $27,810
Question 41
A life aged 47 receives an annuity payable continuously at the rate of M a year. The
annuity is guaranteed for the next 13 years and continues for life thereafter. The expected
present value of the annuity is 100,000, assuming mortality and interest as given in the
Tables. The value of M (correct to the nearest $1) is:
A 7,090
B 7,096
C 7,122
D 7,348
E 7,374
Question 42
A life aged 60 has just purchased a whole of life annuity-due. You are given the following
information:

60
0.98 p =

2 60
0.93 p =
0.04 i =

61
11.60 a =
If
61
p increases by 0.02, then the expected present value of the annuity changes by:
A 0.19
B 0.20
C 0.21
D 0.22
E 0.23
Question 43
You are given that
55
0.01
t
q t = for 1 10 t . Calculate
60:5
a using an effective annual
rate of interest of 5%.
A 4.1972
B 4.2038
C 4.2054
D 4.4032
E 4.4549
Question 44
A life aged 70 purchases a whole life annuity, which is payable twice yearly in arrears. If
the total annual payment is 10,000 and mortality and interest follow those given in the
Tables, then the actuarial present value of the annuity is:
A 78,137
B 83,137
C 83,285
D 88,137
E 88,285
Question 45
Mark is aged 45. He buys a policy that provides:
a benefit of $40,000 at the end of the year of death, if death occurs before age 65
a benefit of $15,000 payable on survival to age 65
a life annuity of $10,000 a year, payable annually in arrears from age 65 onwards.
Assuming that mortality and interest conform to those given in the Tables, the probability
that Mark will receive benefits with a present value of less than $40,000 is:
A 0.0563
B 0.2341
C 0.2573
D 0.7097
E 0.7427
Question 46
You are given that:

28:30
14.197 a =

30 28
0.885 p =
0.05 i =
The value of
1
28:30
A is:
A 0.0423
B 0.1026
C 0.1192
D 0.2048
E 0.3240
Question 47
You are given the following extract from a select-and-ultimate mortality table with a 2-year
select period:
x
[ ] x
l
[ ] 1 x
l
+ 2 x
l
+
2 x +
50 80,625 79,954 78,839 52
51 79,137 78,402 77,252 53
52 77,575 76,770 75,578 54
Given that 0.05 i = , the value of
[51]:3
A is:
A 0.82499
B 0.86158
C 0.86529
D 0.86541
E 0.88586
Question 48
Assuming that 0.05 i = and that mortality follows the life table in Question 47, calculate
the value of
52:3
a
.
A 2.6692
B 2.7764
C 2.8027
D 2.8262
E 2.8314
Question 49
A life aged 50 purchases a 10-year endowment assurance with a sum assured of
$20,000. The benefit is paid on survival to age 60 or at the end of the year of earlier
death. You are given the following information:
0.04 i =
standard mortality is that given in the Tables
standard mortality applies between ages 50 and 53
between ages 53 and 60, there is a constant addition of 0.019048194 to the

standard force of mortality.
Calculate the expected present value of the endowment assurance.
A $12,091
B $13,165
C $13,815
D $13,919
E $15,911
Question 50
Five hundred lives, all aged exactly 45, pay $1,000 into a fund at the beginning of each
year for the next 10 years. The fund earns interest at the effective annual rate of 6%. At
the end of 10 years the fund is divided up. Each surviving member receives an amount
S . In addition,
1
2
S is paid in respect of each member who died. Mortality is expected to
conform to that given in the Tables. Calculate the expected share per survivor.
A $14,100
B $14,382
C $14,527
D $14,954
E $15,407
Course 3 Question and Answer Bank Part 1 Solutions
Part 1 Solutions
Solution 1
C Tonys return R is given by:
[ ]
1 2 3 2 3 3
1,000 (1 )(1 )(1 ) (1 )(1 ) (1 ) R i i i i i i = + + + + + + + +
where
k
i denotes the rate of interest earned in year k . The expected return is therefore:
( ) ( )
1 2 3 2 3 3
( ) 1,000 (1 )(1 )(1 ) (1 )(1 ) (1 ) E R E i i i E i i E i = + + + + + + + +

Since the
k
i are independent and identically distributed:
3 2
( ) 1,000 (1 ) (1 ) (1 ) E R j j j

= + + + + +

where ( )
k
j E i = .
Also, since the annual interest rate is equally likely to be 5%, 6% or 7%, it follows that
0.06 j = .
So Tonys expected return is given by:
3 2
( ) 1,000 (1.06) (1.06) (1.06) $3,374.62 E R

= + + =

Solution 2
A Suzys return S is given by:
1 2 3
1,000(1 )(1 )(1 ) S i i i = + + +
We can calculate the variance of Suzys return using the formula:
[ ]
2
2
var( ) ( ) ( ) S E S E S = -
Since the
k
i are independent, we have:
2 2 2 2 2
1 2 3
2 2 2 2
1 2 3
( ) 1,000 (1 ) (1 ) (1 )
1,000 (1 ) (1 ) (1 )
E S E i i i
E i E i E i

= + + +

= + + +

Question and Answer Bank Part 1 Solutions Course 3
Also, since the
k
i are identically distributed:
( ) [ ]
2 2
2
2 2
1 var(1 ) (1 )
var( ) (1 )
(1 )
k k k
k
E i i E i
i j
j s

+ = + + +

= + +
= + +
where
2
var( )
k
i s = .
We can calculate
2
s as follows:
( )
( )
2 2 2
2
2 2 2
0.05 0.06 0.07
0.06 0.000066667
3
k
k
E i E i s
+ +
= - = - =

So:
( )
( )
( )
( )
3
6
2 2 2
3
6
2 2
var( ) 1,000 (1 ) 1
1,000 0.000066667 (1.06) 1.06
252.510
S j j s

= + + - +

= + -

=
Hence the standard deviation of Suzys return is 252.510 $15.89 = .
Solution 3
C The symbol
| n k x t
q
+
denotes the probability that ( x t + ) survives for n years and then
dies some time during the subsequent k years, that is the probability that ( x t + ) dies
between the ages of x t n + + and x t n k + + + .
The expression in I is the probability that ( x t + ) dies between the ages of x t n + + and
x t k + + . So this is not equal to
| n k x t
q
+
.
The expression in II is negative since
x t n k x t n
l l
+ + + + +
< . So this is not equal to
| n k x t
q
+
.
The expression in III is the probability that ( x t + ) survives to age x t n + + , but not to age
x t n k + + + . This is equal to
| n k x t
q
+
.
Solution 4
D The curtate expectation of life of (30) is:
69 49 69
30 30
1 1 50
(1 0.01 ) (1.75 0.025 )
k
k k k
e p k k
= = =
= = - + -

Using the well-known identity
1
1
( 1)
2
n
k
k n n
=
= +
, this becomes:
30
1 1 1
49 0.01 49 50 35 0.025 69 70 49 50
2 2 2
49 12.25 35 29.75
42
e

= - + - -

= - + -
=
Solution 5
A The variance is given by:
( )
69
2
30
30
1
49 69
2
1 50
49 69
2 2 2
1 50
var (30) (2 1)
(2 1)(1 0.01 ) (2 1)(1.75 0.025 ) 42
(2.01 0.02 1) (3.525 0.05 1.75) 42
k
k
k k
k k
K k p e
k k k k
k k k k
=
= =
= =
= - -
= - - + - - -
= - - + - - -

Using the formulas
1
1
( 1)
2
n
k
k n n
=
= +
and
2
1
1
( 1)(2 1)
6
n
k
k n n n
=
= + +
, we find that:
49
2
1
1 1
(2.01 0.02 1) 2.01 49 50 0.02 49 50 99 49 1,604.75
2 6
k
k k
=

- - = - - =


Similarly:
69
2
50
1 1
(3.525 0.05 1.75) 3.525 69 70 49 50
2 2
1 1
0.05 69 70 139 49 50 99
6 6
(20 1.75)
4,194.75 3,573.5 35
586.25
k
k k
=

- - = -

- -

-
= - -
=
So:
( )
2
var (30) 1, 604.75 586.25 42 427 K = + - =
So the standard deviation of the curtate future lifetime is 427 20.7 = years.
Solution 6
C
60 30
20 70
40 30
1.75 0.025 60
0.417
1 0.01 40
p
p
p
-
= = =
-
Solution 7
C From the definition of
t x
m , we have:
30 40 30 40
10 30
10
10 30
30
0
t
l l l l
m
L
l dt
+
- -
= =
Dividing the numerator and denominator by

30
l gives:
10 30
10 30
10
30
0
t
q
m
p dt
=

Since
30
1 0.01
t
p t = - for 0 100 t < < , it follows that:
10 30
0.01 10 0.1 q = =
( )
10 10 10
2 2
30
0 0 0
(1 0.01 ) 0.005 10 0.005 10 9.5
t
p dt t dt t t

= - = - = - =

Hence:
10 30
0.1
0.0105
9.5
m = =
Solution 8
A Since the uniform distribution of deaths assumption applies between integer ages, we
have to write the survival probability
0.75 55.5
p as
0.5 55.5 0.25 56
p p and calculate each of
these terms separately. We have:
( )
0.25 56 0.25 56
56
1
1 0.25 by UDD assumption
1 0.25 0.00975
0.997563
p q
q
= -
= -
= -
=
Also:
55
0.5 55.5
0.5 55
1 0.00896
0.995500
1 0.5 0.00896
p
p
p
-
= = =
-
Multiplying these together gives:
0.75 55.5
0.997563 0.995500 0.99307 p = =
Solution 9
A Again we have to write
0.75 55.5 0.5 55.5 0.25 56
p p p =
Then:
( )
1 1
4 4
0.25 56 56
(0.99025) 0.997554 p p = = =
( )
1 1
2 2
0.5 55.5 55
(0.99104) 0.995510 p p = = =
So:
0.75 55.5
0.997554 0.995510 0.99307 p = =
Solution 10
A From the definition of the curtate expectation of life, we have:
40 40
1
40 2 40 40
3
40 2 40 2 40 2 42
3
40 2 40 2 40 42
1
40 2 40 2 40 42
0.995 (0.995 0.993) (0.995 0.993 35.0)
36.6
k
k
k
k
k
k
k
k
e p
p p p
p p p p
p p p p
p p p e
-
=
=
=
= + +
= + +
= + +
= + +
= + +
=

Solution 11
C By definition:
50
50 0
0
(50) exp ( ) s p x dx m

= = -

If
0.01
( ) 0.001
x
x x e m = , then integrating by parts, we obtain:
50 50
0.01
0 0
50
50
0.01 0.01
0
0
50
0.5 0.01
0
0.5 0.5
( ) 0.001
0.001 0.001
0.01 0.01
0.1
(0.1 50 ) 0
0.01
5 10 10
1.75639
x
x x
x
x dx x e dx
x e e dx
e e
e e
m =

= -

= - -

= - -

=

Hence:
1.75639
(50) 0.1727 s e
-
= =
Solution 12
B The complete expectation of life at age 25 is given by:
[ ]
25 25
0
(25)
t
E T e p dt
= =
From the survival function:

2
1 for 0 100
( )
100
0 otherwise
x
x
s x

- < <

=

we obtain:
2
25
(25 ) 1 for 0 75
75
(25)
0 otherwise
t
t
s t t
p
s

+ - < <

= =


Hence:
[ ]
2
75
0
1
2
0
1
3
0
(25) 1
75
75 (substituting 1 )
75
75
3
25
t
E T dt
t
u du u
u

= -

= = -

=

=
Solution 13
B We want to calculate
1.5 60.25
q . This can be expressed as:
( )
1.5 60.25 1.5 60.25 0.75 60.25 0.75 61
1 1 q p p p = - = -
By the UDD assumption:
0.75 61 61
1 0.75 p q = -
and:
1
61 61 61
0
(61 ) (61 )
t t
q p t dt p t m m = + = +
for all t , 0 1 t < <

In particular:
61 0.75 61 61
(61.75) (1 0.75 ) (61.75) q p q m m = = -
Rearranging gives:
61
(61.75) 0.0318
0.03106
1 0.75 (61.75) 1 (0.75 0.0318)
q
m
m
= = =
+ +
So:
0.75 61
1 (0.75 0.03106) 0.97671 p = - =
We can then calculate the value of
0.75 60.25
p using the UDD assumption as follows:
60 60 60
0.75 60.25
0.25 60 0.25 60 60
1 1
1 1 0.25
p q q
p
p q q
- -
= = =
- -
Using the same method as for
61
q , we obtain:
60
(60.75) 0.0105
0.01042
1 0.75 (60.75) 1 (0.75 0.0105)
q
m
m
= = =
+ +
So:
0.75 60.25
1 0.01042
0.99217
1 (0.25 0.01042)
p
-
= =
-
Finally, we have:
( )
1.5 60.25
1 0.99217 0.97671 0.0309 q = - =
Solution 14
B From the definition of ( ) s x , we have:
( )
{ }
40
0
40
0.05
0
40
0.05
0
2
(40) exp ( )
exp
exp 20
exp 40 20 20
x
x
s x dx
A e dx
Ax e
A e
m

= -

= - +

= - +

= - - +
Now (40) 0.85 s = implies that:

2
40 20 20 ln0.85 A e - - + =
Rearranging gives:
2
ln0.85 20 20
3.19
40
e
A
- +
= - = -
Solution 15
C If
t x
p has a hyperbolic form, then:
1
1 (1 )
x x
t x
x x x
q p
p
t q p tq
-
= =
- - +
for integer values of x and 0 1 t .
So:
70
0.75 70
70 70
0.953
0.964
0.75 0.953 (0.75 0.047)
p
p
p q
= = =
+ +
Solution 16
A If
t x
p has a hyperbolic form, then:
( ) ( )
1 (1 )
x x
s t x t
x x x
s t q s t q
q
s q p sq
- +
- -
= =
- - +
for integer values of x and 0 1 t .
So:
70
0.25 70.75
70 70
0.25 0.25 0.047
0.0118
1
q
q
p q

= = =
+
Solution 17
D The required survival probability is:
53
[51] 1
[51] 1
77,252
0.9853
78, 402
l
p
l
+
+
= = =
Solution 18
E The probability
0.5 [51] 0.8
q
+
can be expressed as:
0.5 [51] 0.8 0.5 [51] 0.8 0.2 [51] 0.8 0.3 [51] 1
1 1 q p p p
+ + + +
= - = -
Now:
{ }
( )
0.2
0.2 [51] 0.8
0
0.2
[51]
0.2
exp ([51] 0.8 )
exp 0.2 ([51]) using the constant force of mortality assumption
= p
78, 402
79,137
0.998136
p t dt m
m
+

= - + +

= -

=

=
Similarly:
( )
0.3
0.3
0.3 [51] 1 [51] 1
77,252
0.995577
78, 402
p p
+ +

= = =

Hence:
0.5 [51] 0.8
1 0.998136 0.995577 0.00628 q
+
= - =
Solution 19
E The median future lifetime is the value of (25) m that satisfies the equation:
Pr( (25) (25)) 0.5 T m > =
Now:
(25 (25)) / 70
25 / 70
(25) / 70
(25 (25))
Pr( (25) (25))
(25)
m
m
s m
T m
s
e
e
e
- +
-
-
+
> =
=
=
So the median future lifetime is:
(25) 70ln0.5 48.5 m = - =
Solution 20
C The average number of years lived between the ages of 90 and 91 by lives that die
between those ages is:
1
90
0
1
90
0
(90 )
(90)
(90 )
t
t
t p t dt
a
p t dt
m
m
+
=
+
Since (90) 0.32 m = and the force of mortality is constant between 90 and 91:
1
0.32
0
1
0.32
0
0.32
(90)
0.32
t
t
t e dt
a
e dt
Integrating by parts gives:

1 1
0.32 0.32
0 0
1
0.32
0
1
0.32 0.32
0
0.32
0.32 0.32
0.32
(90)
1
0.32
1
1
1
0.32
1
0.47
t t
t
t
t e e dt
a
e
e e
e
e e
e
- -
-
- -
-
- -
-

- +

=

-

- -

=
-

- - -

=
-
=

Solution 21
D According to de Moivres law:
1
( ) x
x
m
w
=
-
for 0 x w <
So:
{ }
0
0
exp ( )
1
exp
exp ln( ) ln( )
t
t x
t
p x s ds
ds
x s
x t x
x t
x
m
w
w w
w
w

= - +

= -

- -

= - - - -
- -
=
-
Since (80) 0.15 m = , it follows that:

1
80 86.6667
0.15
w = + =
Hence:
20 60
86.6667 60 20
0.2500
86.6667 60
p
- -
= =
-
Solution 22
E
: x n
A can be expressed as:
1
1
:
0
1
1
1
2
2
1 1
0
2
1
1 1
0
1: 1
(setting 1)
n
k n
k x x k n x
x n
k
n
k n
x k x x k n x
k
n
j n
x j x x j n x
j
n
j n
x x j x x j n x
j
x x
x n
A v p q v p
vq v p q v p
vq v p q v p j k
vq vp v p q v p
vq v p A
-
+
+
=
-
+
+
=
-
+
+ + +
=
-
+
+ + +
=
+ -
= +
= + +
= + + = -
= + +
= +
Statement I is incorrect since the factor of

x
vp has been omitted.
Now consider the RHS of statement II. This can be expanded as follows:
1 1
|
0
1
1
0
:
k k n
x n x n x k x x k k x x k n x
k k n
n
k n
k x x k n x
k
x n
A A E v p q v p q v p
v p q v p
A

+ +
+ +
= =
-
+
+
=
- + = - +
= +
=

So statement II is correct.
Finally, we can also write:
1
1
:
0
2
1
1 1
0
2
1
1
0
n
k n
k x x k n x
x n
k
n
k n n
k x x k n x x n n x
k
n
k n
k x x k n x
k
A v p q v p
v p q v p q v p
v p q v p
-
+
+
=
-
+
+ - + -
=
-
+
+ -
=
= +
= + +
= +
So statement III is also correct.

Solution 23
B The value of
1
10|
35:20
A can be calculated as follows:
( )
( )
1 1
10| 10 35
35:20 45:20
1
10 35
45:20
10 35 45 20 45 65
0.06
0.54318 0.20120 0.25634 0.43980
ln1.06
0.0495
A E A
i
E A
i
E A E A
d
d
=

= -
= -
=
Solution 24
D The actuarial present value of the benefit is:
( ) ( )
1
10| 50 50 10 50 60
50:10
75,000 50,000 75,000 25,000
75 249.05 25 510.81 0.36913
13,964.87
A A A E A + = -
= -
=
Solution 25
D The present value of the benefit can be expressed as:
1
75,000 if 9
0 if 10
K
v K
Y
K
+
We can calculate var( ) Y as follows:

( )
( )
( )
2
1 1 2 2
50:10 50:10
2
2 2 20 2
50 10 50 60 50 10 50 60
2 10
2
2
var( ) 75,000
75,000
75 1,000 94.76 [(1.06) 0.51081 177.41]
75 249.05 [0.51081 369.13]
248,381, 441.1 20,585,302.3
227,796,13
Y A A
A v p A A E A
-

= -

= - - -

= -

- -

= -
= 8.8
So the standard deviation of the present value of the benefit is 227,796,138.8 15,093 = .
Solution 26
C The present value of the benefit can be expressed as:
1
0 if 9
50,000 if 10
K
K
Z
v K
+

The variance of Z is given by:

( )
( )
( )
2
2 2
50 10| 50
10|
2
2 10 2
10 50 60 10 50 60
2
2 10 2
var( ) 50,000
50,000
50 (1.06) 510.81 177.41 50 0.51081 369.13
37,625, 499.9
Z A A
v E A E A
-

= -

= -

= -

=
So the standard deviation of Z is 37,625, 499.9 6,134 = .
Solution 27
B The variance of the present value is given by:
var( ) var( ) var( ) 2cov( , ) Y Z Y Z Y Z + = + +
From Solution 25 and Solution 26, we know that var( ) 227,769,138.8 Y = and
var( ) 37,625, 499.9 Z = .
The covariance term is:
1
10| 50
50:10
cov( , ) ( ) ( ) ( )
0 75,000 50,000
Y Z E YZ E Y E Z
A A
= -
= -
Since:
( )
( )
1
50 10 50 60
50:10
75,000 75,000
75 249.05 0.51081 369.13
4,537.1
A A E A = -
= -
=
and:
10| 50 10 50 60
50,000 50,000
50 0.51081 369.13
9, 427.8
A E A =
=
=
we have:
cov( , ) 42,774,738.4 Y Z = -
Hence:
var( ) 227,796,138.8 37,625, 499.9 (2 42,774,738.4)
179,872,161.9
Y Z + = + -
=
So the standard deviation of Y Z + is 179,872,161.9 13, 412 =
Solution 28
C The symbol
1
32:10
A denotes the expected present value of a benefit of 1 payable to (32)
on survival to age 42. So:
1 6 4 6 4
10 32
32:10
9,259,571
(1.05) (1.06) (1.05) (1.06) 0.57784
9, 471,591
A p
- - - -
= = =
Solution 29
A ( )
x
IA can be expressed in integral form as follows:
0
( ) 1 ( )
t
x t x
IA t v p x t dt m
= + +


This can be manipulated as follows:
1
0
1
0
0
1
0
0
1
0
0
1
0
( ) ( 1) ( )
( 1) ( ) letting
( 1) by UDD
( 1)
1
( 1)
1
( 1)
( )
k
t
x t x
k
k
k s
k x s x k
k
k s
k x x k
k
k
k x x k
k
k
k x x k
k
k
k x x k
k
IA k v p x t dt
k v p v p x k s ds s t k
k v p q v ds
k v p q a
v
k v p q
v
k v p q
v
i
IA
m
m
d
d
d
+
=
+
=
+
=
+
=
+
=
+
+
=
= + +
= + + + = -
+
= +
-
= +
-
= +
=
x
So statement I is correct.
Statement II is incorrect since in II the benefit amount increases continuously through
time.
Also:
1
0 1
1
1
1
0 0
1
1
0 0
1
1
0 0
( ) ( ) 1 ( )
( ) 2 ( 1) letting 1
( ) 2 ( 1 )
( ) ( 1 )
t t
x t x t x
t r
t x r x
t r
t x x r x
t t
t x x t x
IA v p x t dt t v p x t dt
v p x t dt r v p x r dr r t
v p x t dt v p r v p x r dr
v p x t dt v p v p x t dt
v p
m m
m m
m m
m m
+
+
+
= + + + +

= + + + + + = -

= + + + + +

= + + + +
+

( )
1
0
1
1 1
0
1 ( 1 )
( ) ( )
r
x r x
t
t x x x x
r v p x r dr
v p x t dt v p A IA
m
m
+
+ +
+ + +

= + + +
So statement III is incorrect since the

1 x x
v p A
+
term is missing.
Solution 30
A If the benefit were payable immediately on death, then the expected present value would
be
1
30:30
10,000 A . However, as there is a two-month delay in the payment, the expected
present value is:
( )
1 2 / 12 2 / 12 30
30 30 30 60
30:30
2 / 12
30
10,000 10,000
0.06
10,000 (1.06) 0.10248
ln1.06
8,188,074
(1.06) 0.36913
9,501,381
480.25
i
v A v A v p A
d
-
-
-
Solution 31
C Since only the death benefit can be accelerated and we are assuming a uniform
distribution of deaths between integer ages:
( )
( )
1 1
45:20
45:20 45:20
45 20 45 65 20 45
0.06
0.20120 0.25634 0.43980 0.25634
ln1.06
0.3474
i
A A A
i
A E A E
d
d
= +
= - +
= - +
=
Solution 32
E We can express
(4)
5|
35
A as follows:
(4) (4)
5| 5 35 5 35 40
35 40
(4)
0.73873 1.02223 0.16132 0.12182
i
A E A E A
i
= = = =
Solution 33
D Working in $1,000s, the expected present value of the annuity is:
2 3 4
60 2 60 3 60 4 60
2 3
4
10 12 14 16 18
12 8,075, 403 14 7,954,179 16 7,823,879
10
1.05 8,188,074 8,188,074 8,188,074
1.05 1.05
18 7,683,979
8,188,074
1.05
10 11.2713 12.3357 13.2066 13
v p v p v p v p + + + +

= + + +

+

= + + + + .8970
60.7106
$60,711
=
=
Solution 34
C To calculate the variance of the PV, we require the PV of the benefit and Pr( ) K k = for
each 0,1, 2,3 k = and Pr( 4) K . These are shown in the table below:
k Pr( ) K k = PV benefit ( )
2
PV benefit
0 60
0.01376 q = 10
100
1 60 61
0.01480 p q = 10 12 21.4286 v + =
459.1837
2 2 60 62
0.01591 p q =
2
10 12 14 34.1270 v v + + = 1,164.6510
3 3 60 63
0.01709 p q =
2 3
10 12 14 16 47.9484 v v v + + + = 2,299.0477
4 4 60
0.93844 p =
2 3 4
10 12 14 16 18 62.7570 v v v v + + + + = 3,938.4448
Now:
2
( ) (100 0.01376) (459.1837 0.01480) (1,164.6510 0.01591)
(2,299.0477 0.01709) (3,938.4448 0.93844)
3,761.965
E PV = + +
+ +
=
So:
2
var( ) 3,761.965 60.7106 76.1896 PV = - =
Hence, the standard deviation of the present value is 76.1896 8.729 $8,729 = = .
Solution 35
E From the recursive formula, we have:
40 40 41
1 a v p a = +

Rearranging this gives:
40 40
41
40 40
1 13.300 1.04
13.901
0.995
a a
a
v p v p

= = = =
Solution 36
E If the rate of payment were 1 a year, then the variance would be:
( )
2
2
2
60 60
2 2
0.17741 (0.36913)
12.844
(0.06/ 1.06)
A A
d

= =
Since the rate of payment is 10 units a year, the variance is
( )
2
2
60 60
2
100 1284.4
A A
d
=
Solution 37
B The EPV of the death benefit is:
( )
( )
1
50 10 50 60
50:10
25,000 25,000
0.06
25,000 0.24905 (0.51081 0.36913)
ln1.06
1,557.3
i
A A E A

=

=
The EPV of the guaranteed part of the annuity is:
5
10 50
5
1 (1.06)
5,000 5,000 0.51081
(0.06/ 1.06)
11, 404.1
E a

=
=
The EPV of the life annuity is:

10 50 5 60 65
5,000 5,000 0.51081 0.68756 9.8969
17,379.6
E E a =
=
So the EPV of the total benefit is:

1,557.3 11, 404.1 17,379.6 30,341 + + =
Solution 38
D We can write:
1
10 30
30:10
30:10
A A E =
( )
30:10 30:10
30 10 30 40
10
1
1
0.04 0.987
1 16.250 15.125
1.04
1.04
0.76289
A da
d a E a
=
=

=

=

So:
1
10 30:10
0.987
0.76289 0.0961
1.04
A = =
Solution 39
C The EPV of the contributions per original member is
(12)
50:15
2, 400a
. So the share per

survivor is
(12)
50:15
15 50
2, 400a
E
.
We can calculate
15 50
E as follows:
15 50 10 50 5 60
0.51081 0.68756 0.35121 E E E = = =
The annuity factor can be expressed as:
(12) (12) (12)
15 50
50 65
50:15
a a E a =

Now:
(12)
50
50
(12) (12) 1.00028 13.2668 0.46812 12.8024 a a = = =

and:
(12)
65
65
(12) (12) 1.00028 9.8969 0.46812 9.4316 a a = = =

So:
( )
(12)
50:15
12.8024 0.35121 9.4316 9.4899 a = =
It follows that the share per survivor is:

2, 400 9.4899
64,850
0.35121
=
Solution 40
E The force of mortality at age x for this life is given by:
0.00947843
x x

=
So the probability of surviving from age x to age x n + is:
0.00947843
0
exp
n
n
n x x t n x
p dt p e

+

= =


It follows that:
0.00947843
( )
n n n n
n x n x n x
v p v p e v p

= =
where:
0.00947843
1
0.952380653 0.05
1
v v e i
i

= = = =
+
So:
68:3 68:3
2
68 2 68
2
@6% @5%
1
1 6,823,367 1 6,616,155
1
1.05 7,018, 432 7,018, 432
1.05
2.78095
a a
v p v p
=
= + +

= + +

=

The EPV of the annuity is therefore:
68:3
10,000 27,810 a
Solution 41
D The equation of value is:
( )
+ =
13 47 60
13
100,000 M a E a
The factors in this expression are:
13 13
13
1 1 1.06
9.1157
ln1.06
v
a

= = =
13 13
13 47 13 47
8,188,074
1.06 0.42241
9,088,049
E v p

= = =
60 60
( ) ( ) (1.00028 11.1454) 0.50985 10.6387 a a = = =
So:
( ) 9.1157 4.4939 100,000 7,348 M M + = =
Solution 42
C Before the survival probability is increased, we have:
60 60 61
1
1 1 0.98 11.60 11.931
1.04
a v p a

= + = + =

and:
2 60
61
60
0.93
0.94898
0.98
p
p
p
= = =
Increasing the value of
61
p by 0.02 and using * to denote the adjusted functions, gives:
61
0.96898 p
*
=
and:
61 61 62
62
0.96898
1 1
1.04
a v p a a
* *
= + = +

However:
61 61 62 62 62
0.94898
1 1 11.60 11.617
1.04
a v p a a a = + = + = =

So:
61
0.96898
1 11.617 11.823
1.04
a
*
= + =
and:
60 60 61
0.98
1 1 11.823 12.141
1.04
a v p a
* *
= + = + =

Hence the expected present value of the annuity is increased by 12.141 11.931 0.21 - =
Solution 43
A We can calculate the EPV of the annuity using life table functions:
2 3 4 5
60 2 60 3 60 4 60 5 60
60:5
a v p v p v p v p v p = + + + +
To calculate the survival probabilities, we can construct a life table using the rule
55
0.01
t
q t = for 1 10 t . Since we are given information relating to age 55, we will take
this to be the first age in the table.
According to the rule, the probability of dying between the ages of 55 and 56 is 0.01. So if
we use a radix of 100, we will have 99 survivors at age 56.
If we then let 2 t = , we find that the probability of dying between the ages of 55 and 57 is
0.02. So out of the 100 starters at age 55, we have 98 survivors at age 57.
Continuing in this way, we obtain the following life table:
x
x
l
x
d
55 100 1
56 99 1
57 98 1
# # #
x 155 x 1
# # #
65 90
From the table, we see that
61
60
60
94
95
l
p
l
= = ,
62
2 60
60
93
95
l
p
l
= = , and so on.
Hence:
60:5
2 3 4 5
94 93 92 91 90
1.05 95
1.05 95 1.05 95 1.05 95 1.05 95
4.1972
a = + + + +

=
Solution 44
A The actuarial present value of the annuity is:
(2) (2)
1
70 70 2
1
70
2
1
2
10,000 10,000
10,000 (2) (2)
10,000 1.00021 8.5693 0.25739
78,137
a a
a a b

= -

= - -

= - -

=
Solution 45
E if Mark dies before age 60, then a benefit of $40,000 will be paid at the end of the year of
his death. The present value of this benefit would be less than $40,000.
If Mark dies between the ages of 65 and 66, then he will receive a benefit of $15,000 at
age 65. The present value of this benefit would be less than $40,000.
If Mark dies between the ages of 65 n + and 65 1 n + + , then he will receive a benefit of
$15,000 at age 65, followed by annuity payments of $10,000 at ages 66, 67, , 65 n + .
So the present value of the benefit received would be:
20 20
15,000 10,000
n
v v a +
To calculate the probability that this PV is less than $40,000, we need to find the smallest
value of n such that:
20 20
15,000 10,000 40,000
n
v v a +
Rearranging this inequality gives:
20
40,000(1.06) 15,000
11.32854
10,000
n
a
-
=
Since
1
n
n
v
a
i
-
= , it follows that:
1 (11.32854 0.06) 0.32029
n
v - =
Taking logs, we obtain:
ln1.06 ln0.32029 n -
So:
19.54 n
Hence the present value of the benefit will exceed $40,000 if and only if Mark survives to
age 85. The probability that the present value of the benefit is less than $40,000 is
therefore:
85
40 45
45
2,358,246
1 1 0.7427
9,164,051
l
q
l
= - = - =
Solution 46
C The present value of the term insurance can be written as:
1 1
28:30 28:30 28:30
A A A = -
28:30
28:30
0.05
1 1 14.197 0.32395
1.05
A da = - = - =
In addition:
1 30 30
30 28
28:30
(1.05) 0.885 0.20477 A v p
-
= = =
So:
1
28:30
0.32395 0.20477 0.11918 A = - =
Solution 47
C The present value of this endowment insurance is:
2 3
[51] [51] [51] 1 2 [51]
[51]:3
[51] [51] 1 [51] 1 53
53
2 3
[51] [51] [51]
2 3
1 1 1
1.05
1.05 1.05
1 79,137 78, 402 1 78, 402 77,252 1 77, 252
1.05 79,137 79,137 79,137
1.05 1.05
A v q v p q v p
l l l l
l
l l l
+
+ +
= + +
- -
= + +

- -
= + +

0.86529

=
Solution 48
C The present value of the annuity is:
2
52 2 52
52:3
2
1
1 77,252 1 75,578
1
1.05 78,839 78,839
1.05
2.8027
a v p v p = + +

= + +

=
Solution 49
D The expected present value of the endowment insurance is:
( )
*
= +
1 3
3 50
50:10
50:3 53:7
20,000 20,000 A A v p A
where * denotes non-standard mortality.
We can calculate the first term as follows:
1 2 3
50 50 51 2 50 52
50:3
2 3
1 1 1
0.00591985 0.00638405 0.00688681
1.04
1.04 1.04
0.01772
A vq v p q v p q = + +

= + +

=
(To reduce rounding error, the probabilities in the above equation have been calculated
using the tabulated values of
x
l .)
By premium conversion, we can write:
53:7 53:7
1 A da
* *
= -

In the annuity term, a constant addition to the force of mortality can be treated as a
constant addition to the force of interest. We can therefore value
53:7
a
*
using standard
mortality and force of interest * d , where:
* 0.019048194 ln1.04 0.019048194 0.058268907 d d = + = + =
It then follows that:
*
* 1 0.06 i e
d
= - =
So:
53:7 53:7
7
53 7 53 60
7
@4% @6%
1 8,188,074
12.6896 11.1454
8,779,128
1.06
5.7763
a a
a v p a
*
=
= -
= -
=

It follows that:
53:7
0.04
1 5.7763 0.77783
1.04
A
*
= - =
Substituting these values into the equation for the endowment insurance gives:
50:10
3
1 8,779,128
20,000 20,000 0.01772 0.77783
8,950,901
1.04
13,919
A

= +

=
Solution 50
A The total fund at the end of 10 years is:
( )
[ ]
[ ]
10 10
45 10 45 55
45:10
10
500 1,000 1.06 500,000 1.06
500,000 1.06 14.1121 (0.52652 12.2758)
6,848,779.84
a a E a = -
= -
=

The expected number of survivors will be:
10 45
8,640,861
500 500 471.45
9,164,051
p = =
The expected share per survivor can then be calculated from the equation:
1
2
471.45 (500 471.45) 6,848,779.84 S S + - =
This simplifies to give $14,100 S = .

Introduction To Actuarial Mathematics

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Introduction To Actuarial Mathematics

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SOA Course 3

Study program Fall 2004 exams

the structure of the course notes and practice questions

advice on how to study efficiently and prepare for the exam

details of how to email a question to our tutors if you get stuck

a listing of additional study support available from BPP

the full Syllabus

the Tables for the Course 3 exam (produced by the profession)

read the course notes carefully

review the course notes

attempt several questions from the Question & Answer Bank

attempt the assignment under exam conditions.

a deterministic interest rate structure;

a scheme for the amounts of the cash flows;

a probability distribution of the times of the cash flows; and

Principles include: equivalence, exponential, standard deviation, variance,

Models include: present value models based on 9 12 below.

Applications include: insurance, health care, credit risk, environmental risk,

Establish relations between the different functions.

Develop expressions, including recursion relations, in terms of the functions

Express the impact of explanatory variables on a failure time distribution in

Calculate probabilities and moments associated with functions of these

Develop expressions, including recursion relations, for probabilities and

Establish relations between the functions.

Apply assumptions about the pattern of failures between integral ages to

Characterize the following distributions in terms of their parameters and

Given the parameters of a distribution, apply the distribution to an

Characterize the following families of distributions in terms of their

Apply the following techniques for creating new families of distributions:

Given the parameters of a distribution, apply the distribution to an

Use the Chapman-Kolmogorov equations to obtain probabilities associated

Classify the states of a discrete-time Markov chain.

Calculate the limiting probabilities of a discrete-time Markov chain.

the distribution of the waiting times between events,

the distribution of the process increments,

the behavior of the process over an infinitesimal time interval.

Calculate probabilities associated with numbers of events and time periods

Characterize the value of the process at a given time as a compound

Determine the distribution of the value of the process at any time.

Determine the distribution of a hitting time.

Define a Brownian motion process with drift and a geometric Brownian

Calculate the probability of ruin within a finite time by a recursion relation.

Approximate the probability of ruin using the compound geometric

Analyze the probability of ruin: analytically (eg adjustment coefficient);

Determine the characteristics of the distribution of the amount of surplus

Premium (rate) for life insurance and annuity contracts,

Premium (rate) for accident and health insurance contracts,

Premium (rate) for casualty (liability) insurance contracts,

Premium (rate) for property insurance contracts,

Rates for coverages under group benefit plans,

Loss reserves for insurance contracts,

Benefit reserves for insurance contracts,

Resident fees for Continuing Care Retirement Communities (CCRCs),**

Cost of a warranty for manufactured goods,

Value of a financial instrument such as: a loan, a stock, an option, etc.,

How accurate do I want my model to be?

Is simplicity more important than accuracy?

Who is going to interpret the results of the model?

the probability that a policyholder aged 50 dies in the next year

the expected future length of life for a policyholder aged 60

What proportion of the time is the weather sunny?

How long on average will it be until the next rainy day?

the price takes any value in a continuous range of values