Actuarial mathematics 2

Life insurance contracts

Edward Furman

Department of Mathematics and Statistics

York University

January 30, 2012

Edward Furman Actuarial mathematics MATH 3280 1 / 45

Definition 0.1 (Life insurance.)
Life insurance is a contract that is designed to reduce the
financial impact of an untimely death.

The payment is a single one.

The payment can be made either upon death or thereafter.

Question
Given a life status (u), what is its expected future lifetime? If the
insurance amount is one dollar: 1.) what is the r.v. representing
the payment upon death of (u)? 2.) what is the r.v. representing
the payment at the end of the year of death of (u)?

Recall that, e.g., T (u) : Ru [0, ].

Edward Furman Actuarial mathematics MATH 3280 2 / 45

Solution
The expected lifetime of (u) is E[T (u)].
The payment upon death is v T (u) .
The payment at the end of the year of death is v K (u)+1 .

Recall that the price is the expected loss, for identity utility =
fairness principle (or equivalence principle).

Net premium for an insurance contract.

The net premium for an immediately payable insurance is
E[v T (u) ] for a life status (u). Also, the net premium for an
insurance payable at the end of the year of death is E[v K (u)+1 ].
I.e.,
Z Z
T (u) t
E[v ]= v t pu (u + t)dt = v t d t pu := Au .
Ru Ru

Edward Furman Actuarial mathematics MATH 3280 3 / 45

Also
X X
E[v K (u)+1 ] = v k +1 k pu qu+k = v k +1 k pu := Au .
k Ru k Ru

Example 0.1 (Whole life insurance.)

Let (u) = (x). Then Ru = [0, ), and
Z
Ax := E[v T (u) ] = v t t px (x + t)dt,
0

as well as

X
Ax := E[v K (u)+1 ] = v k +1 k px qx+k .
k =0

Edward Furman Actuarial mathematics MATH 3280 4 / 45

Edward Furman Actuarial mathematics MATH 3280 5 / 45
Example 0.2 (n-year term insurance.)
1
Let (u) = (x : n ). Thus Ru = [0, n) {}, and
Z n
T (u)
A 1 := E[v ]= v t t px (x + t)dt + 0,
x:n 0

as well as
n1
X
K (u)+1
A1 := E[v ]= v k +1 k px qx+k .
x:n
k =0

Proposition 0.1
We have that, for A 1 = 0 (why?), and for all x,
x:0

A1 = vqx + vpx A 1 .
x:n x+1:n1

Edward Furman Actuarial mathematics MATH 3280 6 / 45

Proof.

n1
X n1
X
A1 = v k +1 k px qx+k = vqx + v k +1 k px qx+k
x:n
k =0 k =1
n1
X
= vqx + vpx v k k 1 px+1 qx+k
k =1
n2
X
= vqx + vpx v k +1 k px+1 qx+k +1
k =0
= vqx + vpx A 1 ,
x+1:n1

as required.

Edward Furman Actuarial mathematics MATH 3280 7 / 45

Corollary 0.1
We have that
Ax = vqx + vpx Ax+1 .

Proposition 0.2
Under the UDD assumption for each year of age, we have that

UDD i
Au = Au .

Proof.
We have that
UDD
t pu (u + t) = qu , 0 t 1, u = 0, 1, . . . .

Then
Z 1 Z
t
Au = = v t pu (u + t)dt + v t t pu (u + t)dt
0 1
Edward Furman Actuarial mathematics MATH 3280 8 / 45
Proof (cont.)

Z 1 Z
t
Au = v t pu (u + t)dt + v t+1 t+1 pu (u + 1 + t)dt
0 0
Z 1 Z
t
= v t pu (u + t)dt + v t+1 pu t pu+1 (u + 1 + t)dt
0 0
Z 1 Z
t
= v t pu (u + t)dt + vpu v t t pu+1 (u + 1 + t)dt
0 0
Z 1 Z 1
UDD
= t
v qu dt + vpu Au+1 = qu et dt + vpu Au+1
0 0
1 e 1v
= qu + vpu Au+1 = qu + vpu Au+1 .

Edward Furman Actuarial mathematics MATH 3280 9 / 45

Proof (cont.)
Thus we have that:
UDD i
Au = vqu + vpu Au+1 .

The domain for the latter relationship is: u = 0, 1, . . . and
A = 0. Further,
 
UDD i i
Au = vqu + vpu vqu+1 + vpu+1 Au+2

i i
= vqu + v 2 pu qu+1 + v 2 pu pu+1 Au+2

i  
= v 0 pu qu+0 + v 2 pu qu+1 + v 3 pu pu+1 qu+2 + + 0


i X k +1 i
= v k pu qu+k = Au ,

k =0

which completes the proof.

Edward Furman Actuarial mathematics MATH 3280 10 / 45
Example 0.3 (Pure endowment insurance.)
1
Let (u) = (x : n ). Then it only makes sense to speak of the
discrete case. The r.v. representing the future payment is
1
v K (x:n ) , Thus

X
A 1 := v n k px qx+k = v n P[T (x) n] = v n n px
x:n
k =n

Example 0.4 (General endowment insurance.)

Let (u) = (x : n ). Then by definition of T (x : n ) we have that
Z n
Ax:n := v t t px (x + t)dt + v n n px = A 1 + A 1 .
0 x:n x:n

Note that
1 1
v T (x:n ) = v T (x :n ) + v T (x:n ) .

Edward Furman Actuarial mathematics MATH 3280 11 / 45

Example 0.5 (Example 0.4 (cont.))
Do we have that
1 1
T (x : n ) = T (x : n ) + T (x : n )?

Also,
1 1
Ax:n := E[v K (x :n )+1 + v K (x:n ) ], i.e.,
n1
X
Ax:n = v k +1 k px qx+k + v n n px = A 1 +A 1 .
x:n x:n
k =0

Note:
Of course, we have that,

lim A 1 = Ax .
n x:n

Edward Furman Actuarial mathematics MATH 3280 12 / 45

Proposition 0.3
The variance of the r.v. representing the future payment due to
death of (u) is
Var[v T (u) ] = 2 Au (Au )2 ,
where 2 Au is an insurance payable using = 2.

Proof.
We have that
Z Z
T (u) 2 2t
e
t
E[(v ) ]= e t pu (u + t)dt = t pu (u + t)dt,
Ru Ru

that is an insurance payable with a new force of interest. This

completes the proof.

Edward Furman Actuarial mathematics MATH 3280 13 / 45

Corollary 0.2
The variance of the r.v. representing the present value of due to
the pure endowment insurance is
1
Var[v T (x:n ) ] = v 2n n px (n qx ).

Proof.
Note that for the pure endowment insurance we have that the
second moment is
1
E[v 2T (x:n ) ] = v 2n n px .

Thus the variance is

v 2n n px (v n n px )2 ,

as required.

Edward Furman Actuarial mathematics MATH 3280 14 / 45

Proposition 0.4
The variance of the general endowment insurance is

Var[v T (x:n ]
 2
= 2A 1 A 1 + v 2n n px n qx 2A 1 v n n px .
x:n x:n x:n

Proof.
Note that

Var[v T (x:n ]
1 1
= Var[v T (x :n + v T (x:n ]
1 1 1 1
= Var[v T (x :n ] + Var[v T (x:n ] + 2Cov[v T (x :n , v T (x:n ) ]
1 1 1 1
= Var[v T (x :n ] + Var[v T (x:n ] 2E[v T (x :n ]]E[v T (x:n ],

which completes the proof.

Edward Furman Actuarial mathematics MATH 3280 15 / 45
Insurances mentioned above can be used as building blocks to
create other forms of insurances.

Example 0.6 (Deferred insurance.)

An m year deferred n years term insurance provides for a
benefit following the death of the insured only if the insured dies
at least m years following policy issue and before the end of the
policy. Thus we have that
m+n1
X
m|n Ax := A 1 A1 = v k +1 k pu qu+k .
u:m+n u:m
k =m

The continuous counterpart is then:

Z m+n
m|n Au := A 1 A1 = v t t pu (u + t)dt.
u:m+n u:m m

Edward Furman Actuarial mathematics MATH 3280 16 / 45

Example 0.7 (Deferred whole life insurance.)
Take n in the previous example, and get

X
m| Au = Au A 1 = v k +1 k pu qu+k ,
u:m
k =m

with the continuous counterpart given then by:

Z
m| Au = Au A 1 = v t t pu (u + t)dt.
u:m m

Edward Furman Actuarial mathematics MATH 3280 17 / 45

Note, that we have been interested in calculating expectations
of transformed future life time r.v.s. These r.v.s can be more
general.

Example 0.8 (Annually increasing whole life insurance.)

Consider the r.v. (K (u) + 1)v K (u)+1 . The present value is

X
(IA)u := E[K (u) + 1)v K (u)+1 ] = (k + 1)v k +1 k pu qu+k .
k =0

Example 0.9 (Continuously increasing whole life insurance.)

Consider the r.v. T (u)v T (u) , then
Z
T (u)
(IA)u := E[T (u)v ]= tv t t pu (u + t)dt.
0

Edward Furman Actuarial mathematics MATH 3280 18 / 45

Example 0.10 (Annually increasing continuous whole life
insurance.)
Let the r.v. of interest be T (u) + 1V T (u) . Then
Z
T (u)
(IA)u := E[T (u) + 1V ]= t + 1 v t t pu (u + t)dt.
0

Example 0.11 (m-thly per year increasing continuous whole life

insurance.)
Let the r.v. of interest be T (u)m+1
m v T (u) . Then:
  Z
(m) T (u)m + 1 T (u) tm + 1 t
(I A)u := E v = v t pu (u+t).
m 0 m

Remark.
Of course, for m , the just mentioned insurance reduces to
the continuously increasing one.
Edward Furman Actuarial mathematics MATH 3280 19 / 45
Proposition 0.5
We have that Z
(IA)u = s| Au ds.
0

Proof.

Z Z t 
(IA)u = ds v t t pu (u + t)dt
Z0 Z 0

= v t t pu (u + t)dtds
0 s
Z
= s| Au ds,
0

as required.

Edward Furman Actuarial mathematics MATH 3280 20 / 45

 Figure: Auxiliary plot.

Note:
For the totally discrete counterpart, i.e., for (IA)u , we should
again have (why?)

X
(IA)u = j| Au = Au + 1| Au + 2| Au + ...
j=0

Edward Furman Actuarial mathematics MATH 3280 21 / 45

Benefits must not be increasing.

Example 0.12 (Annually decreasing n-year term insurance.)

1
Let the r.v. of interest be (n K (u))v K (u:n +1 . Then

1
n1
X
K (u:n +1
(DA) 1 := E[(n K (u))v ]= (n k)v k +1 k pu qu+k .
u:n
k =0

Proposition 0.6
We have that
n1
X
(DA) 1 = A1 .
u:n u:nj
j=0

Edward Furman Actuarial mathematics MATH 3280 22 / 45

Proof.
Note that
X1
nk
nk = (1).
j=0

Then
n1
X
(DA) 1 = (n k)v k +1 k pu qu+k
u:n
k =0
X1
n1 nk
X
= (1)v k +1 k pu qu+k
k =0 j=0
n1 nj1
X X n1
X
= (1)v k +1 k pu qu+k = A1 ,
u:nj
j=0 k =0 j=0

as needed.

Edward Furman Actuarial mathematics MATH 3280 23 / 45

Figure: Annually decreasing 8-year term insurance.

Edward Furman Actuarial mathematics MATH 3280 24 / 45

Proposition 0.7
Let the actuarial present value r.v. be generally given by
Z = b(K (u) + 1)v T (u) . And assume the UDD approximation for
each integer u. Then

UDD i
E[b(K (u) + 1)v T (u) ] = E[b(K (u) + 1)v K (u)+1 ]

for any life status (u).

Proof (cont.)
Recall that T = K + J with J U(0, 1) because of the UDD.
We have also proven that under the UDD K and J are
independent. Namely

P[K = k, J j] = k pu qu+k j = P[K = k]P[J j].

Edward Furman Actuarial mathematics MATH 3280 25 / 45

Proof (cont.)
Also

E[b(K (u) + 1)v T (u) ]

= E[b(K (u) + 1)v K (u)+1+J(u)1 ]
= E[b(K (u) + 1)v K (u)+1 v J(u)1 ]
UDD
= E[b(K (u) + 1)v K (u)+1 ]E[v J(u)1 ]
= E[b(K (u) + 1)v K (u)+1 ]E[(1 + i)1J(u) ],

where
1 1
d (1 + i)1s
Z Z
1J(u) 1s
E[(1 + i) ]= (1 + i) ds = ,
0 0 ln(1 + i)

which is
E[(1 + i)1J(u) ] = i/.

Edward Furman Actuarial mathematics MATH 3280 26 / 45

Corollary 0.3
Thus, we easily have that

UDD i
Ax = Ax ,

with b(K + 1) 1. And also

UDD i
(IA)x = (IA)x ,

with b(K + 1) = K + 1.

Question:
What about (IA)x ?

Edward Furman Actuarial mathematics MATH 3280 27 / 45

Proposition 0.8
Under the UDD, we have that
   
UDD i 1+i 1
(IA)x = (IA)x Ax .
i

Proof.
The r.v. corresponding to the price above is

Z = Tv T = (K + J)v K +J = (K + 1)v K +J + (J 1)v K +J

= (K + 1)v K +J (1 J)v K +1 v J1
= (K + 1)v K +1 (1 + i)1J (1 J)v K +1 (1 + i)1J .

Also, note that 1 J U(0, 1). Indeed

P[1 J j] = P[J 1 j] = j.

Recall that J and K are independent because of the UDD

assumption and take expectations
Edward Furman Actuarial mathematics MATH 3280 28 / 45
Proof (cont.)

E[Z ]
UDD
= E[(K + 1)v K +1 (1 + i)1J ] E[v K +1 ]E[(1 J)(1 + i)1J ]
i
= (IA)x Ax E[(1 J)(1 + i)1J ]

i
= (IA)x Ax E[(J)(1 + i)J ]

Z 1
i d (1 + i)j
= (IA)x Ax j
0 ln(1 + i)
Z 1 !
i Ax
= (IA)x jd (1 + i)j
ln(1 + i) 0
Z 1 !
i Ax j 1 j
= (IA)x j(1 + i) |0 (1 + i) dj
ln(1 + i) 0
 
i Ax i
= (IA)x (1 + i) .
ln(1 + i) ln(1 + i)
Edward Furman Actuarial mathematics MATH 3280 29 / 45
An insurance can be payable m-thly.

Example 0.13 (m-thly payable whole life insurance.)

The price of an m-thly payable whole life insurance is

(m)
X
Ax := (v 1/m )k +1 k px 1 qx+ k .
m m m
k =0

Note that this is not the expectation of the transformed K (x),

but rather an expectation of a transformation of
K (m) (x) = K (x)m + J(x), where this time J(x) counts the
number of total m-thly periods (x) was alive. Thus
(m)
Ax := E[(v 1/m )Km+J+1 ] = E[(v)K +(J+1)/m ]
m1
X X
= v k +(j+1)/m P[K = k, J = j].
k =0 j=0

Edward Furman Actuarial mathematics MATH 3280 30 / 45

Proposition 0.9
We have that under the UDD for integer ages,

(m) UDD i
Ax = Ax ,
i (m)

where i (m) = m((1 + i)1/m 1).

Proof.
We have that
m1
(m)
X X
K +(J+1)/m
E[v ] = v k +(j+1)/m k px j/m|1/m qx+k = Ax .
k =0 j=0

In addition, under the UDD

j/m|1/m qx+k = (j+1)/m qx+k (j)/m qx+k

UDD j +1 j 1
= qx+k qx+k = qx+k .
m m m
Edward Furman Actuarial mathematics MATH 3280 31 / 45
Proof (cont.)
Thus
m1
(m) UDD
X X 1
Ax = v k +1 v (j+1)/m1 k px qx+k
m
k =0 j=0
m1
X
k +1
X 1
= v k px qx+k (1 + i)1(j+1)/m
m
k =0 j=0
m1
X
k +1
X 1
= v k px qx+k (1 + i) (v (1/m) )j+1
m
k =0 j=0

X 1 1/m 1 v (m1+1)/m
= v k +1 k px qx+k (1 + i) v
m 1 v 1/m
k =0

X 1 1v
= v k +1 k px qx+k (1 + i) 1/m
.
mv (1 v 1/m )
k =0

Moreover
Edward Furman Actuarial mathematics MATH 3280 32 / 45
Proof.

(m) UDD
X 1 1v
Ax = v k +1 k px qx+k (1 + i)
m (1 + i)1/m 1
k =0

X (1 v)(1 + i)
= v k +1 k px qx+k
i (m)
k =0

X i i
= v k +1 k px qx+k = Ax ,
i (m) i (m)
k =0

which completes the proof.

Edward Furman Actuarial mathematics MATH 3280 33 / 45

Figure: Insurances payed at the end of the year of death.

Edward Furman Actuarial mathematics MATH 3280 34 / 45

Figure: Immediately payed insurances.

Edward Furman Actuarial mathematics MATH 3280 35 / 45

Proposition 0.10
We have that
Ax:y + Ax:y = Ax + Ay ,
as well as
Ax:y + Ax:y = Ax + Ay .

Proof.
Because of the definition of say T (x : y) and T (x : y), we have
that
v T (x:y ) + v T (x:y ) = v T (x) + v T (y ) .
Taking expectations throughout then completes the proof.

Example 0.14
An insurance that pays one dollar upon the death of the first of
(x) and (y) is
Z
T (x:y )
Ax:y := E[v ]= v t t px:y ((x : y) + t)dt.
0
Edward Furman Actuarial mathematics MATH 3280 36 / 45
Example 0.15
An insurance that pays one dollar upon the death of the last
one of (x) and (y) is
Z
Ax:y := E[v T (x:y ) ] = v t t px:y ((x : y) + t)dt.
0

Example 0.16
An insurance that pays one dollar upon the death of (x) if
1
he/she dies first is A 1 . Of course it is an expectation of v T (x :y ) .
x:y
The latter is v T (x) if T (x) < T (y) and v = 0 if T (x) T (y).
Thus
1
Z Z
A 1 := E[v T (x :y ) ] = vt fT (x),T (y ) (t, s)dsdt
x:y 0 t

Edward Furman Actuarial mathematics MATH 3280 37 / 45

Ex. (cont.)
The latter expression is rewritten as
1
Z Z
A 1 := E[v T (x :y ] = vt fT (x),T (y ) (t, s)dsdt
x :y 0 t
Z Z
= vt fT (y )|T (x) (s| t)ds fT (x) (t)dt
0
Z Zt
ind
= vt fT (y ) (s)ds fT (x) (t)dt
0 t
Z
= v t F T (y ) (t) fT (x) (t)dt
Z0
= v t t py t px (x + t)dt,
0

i.e., if (x) dies at any time t when (y) is alive, then v t dollars are
payed. Check at home that if = 0, then A 1 = q 1 .
x :y x:y

Edward Furman Actuarial mathematics MATH 3280 38 / 45

Example 0.17
An insurance payable upon death of (y) if it precedes the death
of (x) is
2
Z Z t
T (x:y ) t
A 2 := E[v ]= v fT (x),T (y ) (s, t)dsdt.
x:y 0 0

Proposition 0.11
Under independence of the future lifetimes of (x) and (y), we
have that
ind
A 2 = Ay A 1 .
x:y x:y

Proof.
By definition
Z Z t
t
A 2 = v fT (x)| T (y ) (s| t)ds fT (y ) (t)dt.
x:y 0 0

Edward Furman Actuarial mathematics MATH 3280 39 / 45

Proof.
By independence and in actuarial notation
Z
A 2= v t t qx t py (y + t)dt
x:y 0
Z
= v t (1 t px ) t py (y + t)dt,
0

as required.

Remark.
The result holds for dependent future lifetimes too. Prove at
home by looking at the corresponding r.v.s.

Proposition 0.12
Under independence of the future lifetimes of (x) and (y), we
have that Z
ind 
A 2 = s Ay s px (x + s)ds.

x:y 0
Edward Furman Actuarial mathematics MATH 3280 40 / 45
Proof.
From the previous proposition, changing the order of integration
and by substitution u = t s,
Z
A 2= v t t qx t py (y + t)dt
x:y 0
Z Z t
ind
= vt s px (x + s)ds t py (y + t)dt
0
Z Z 0
= v t s px (x + s) t py (y + t)dtds
0 s
Z Z
= v u+s s px (x + s) u+s py (y + u + s)duds
Z0 0 Z
s
= v s py s px (x + s) v u u py +s (y + u + s)duds
Z0 0

= v s s py s px (x + s)Ay +s ds.
0

Also, we can write the deferred insurance as

Edward Furman Actuarial mathematics MATH 3280 41 / 45
Proof. cont.


Ay = Ay A 1
s
y :s
Z
= v u+s u+s py (y + u + s)du
0
Z
= v s s py v u u py +s (y + u + s)du
0
= v s s py Ay +s .

This completes the proof.

Remark.
We will often use the notation s Ex := v s s px . This is refereed to
as the stochastic discount factor.

Edward Furman Actuarial mathematics MATH 3280 42 / 45

Example 0.18
Assume m sources of decrement and a whole life insurance
contract due to each one. Also, let b(x + t)(j) , j = 1, . . . , m be
the payment due to the decrement j. Then the overall price is
m Z
X
A= b(x + t)(j) v t t px (j) (x + t)dt.
j=1 0

Example 0.19
Let b(x + t)(1) = t and b(x + t)(2) = 0 for all t > 0. Assume
UDD for each year of death. Then
Z Z
X k +1
(1)
A= tv t
t px (x + t)dt = tv t t px (1) (x + t)dt
0 k =0 k
Z 1
X
= (k + s)v k +s k +s px (1) (x + k + s)ds
k =0 0

Edward Furman Actuarial mathematics MATH 3280 43 / 45

Example 0.20 (Example. cont.)
Then by the UDD
UDD
t px (x + t) = qx ,
and

X Z 1
A= v k k px
(k + s)v s s px+k (1) (x + k + s)ds
k =0 0
Z 1
UDD (1)
X
k +1
= v k px qx+k (k + s)v s1 ds
k =0 0
Z 1
(1)
X
k +1
= v k px qx+k (k + s)(1 + i)1s ds
k =0 0
 
X
k +1 (1) i 1 1
= v k px qx+k k+ .
i
k =0

Edward Furman Actuarial mathematics MATH 3280 44 / 45

Remark
Note that if b(x + k + s)(j) is more cumbersome than (k + s)
than using, e.g., the midpoint rule
Z 1
b(x + k + s)(j) (1 + i)1s ds b(x + k + 1/2)(j) (1 + i)11/2 .
0

Edward Furman Actuarial mathematics MATH 3280 45 / 45