1

DHW 2.2, 2.4 – The Future Lifetime Random Variable

Quick review of continuous random variables:

If X is a continuous random variable, then we have three important functions:

 Cumulative Distribution Function (CDF):

 Survival Function:

 Density Function:

Note: CDF-capital F only! Survival-could notate using either S or s.

Relationship between CDF and density:

The future lifetime random variable:

Notation: (x) – a life aged x (i.e. still alive at age x)

e.g. A life age 30 is denoted ______.

Tx = Future lifetime of (x) = Time-to-failure for (x).

T0 = Lifetime of a newborn/new item.

Two notations for survival function & CDF:

Survival function: _______ = _______ = Pr[Tx > t]

CDF: _______ = _______ = Pr[Tx ≤ t]

Relationships between Tx and T0:

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1
Example 1: Suppose that S0(x) = 10 √100 − 𝑥 , 0 ≤ x ≤ 100 = ω.
Note: The symbol omega (ω) is often used for the maximum possible lifetime
under certain models. “Terminal age”

a. Find Pr[19 ≤ T0 ≤ 51].

b. Pr[T19 ≤ 32].

c. Find a formula for S19(t) for t ∈ [0, 81].

d. Compute 32 𝑝19 and 32 𝑞19 .

Some more notation: 𝑢|𝑡 𝑞𝑥 = Pr[(x) waits u years to die, and then dies within the next t years]
“Deferred mortality probability”

Relationships between 𝑢|𝑡 𝑞𝑥 , 𝑡 𝑝𝑥 , 𝑡 𝑞𝑥 , etc. (Draw a timeline; two relationships):

Example 1, continued
e. Label each probability in (a) and (b) using the p and q notations.
 3

Abbreviation: For periods of one year, we abbreviate as follows:

1 𝑝𝑥 = ______ ; 1 𝑞𝑥 = ______ ; 𝑡|1 𝑞𝑥 = ______

Recall: Definition of conditional probability; conditional probability on a tree diagram.

Illustration: Consider ages 60, 61, 65. Draw and label a tree diagram showing various states
(e.g. “still alive at 61/survived” and “failed by 61”). Use both labeling schemes
(i.e. the p-q notation and the sx(t) notation)

Question: What conclusions do we draw about various relationships between the survival,
failure, deferred failure probabilities?

Formulas: 𝑡 𝑝𝑥 ⋅ 𝑢 𝑝𝑥+𝑡 = ________

𝑡 𝑝𝑥 ⋅ 𝑢 𝑞𝑥+𝑡 = ________

Example 2: Suppose that q60 = .1, p61 = .8, 3p62 = .7.

a. Find 2 𝑝60 .

b. Find 2|3 𝑞60 .

c. Find 5 𝑝60 .

Homework for DHW 2.2/2.4:

 Read DHW chapters 1 & 2. You may also want to skim over MQR sections 5.1 & 5.3.
 Do DHW pages 36-37 #2.3, 2.6, 2.7 – my worked-out solutions will be on Moodle—
some answers appear at the end of Chapter 2.
 4

DHW 2.3/2.5 - Force of mortality and expectation of life

Recall: Sx(t) = 𝑡 𝑝𝑥 = Pr[Tx > t]

Fx(t) = 𝑡 𝑞𝑥 = 1 – 𝑡 𝑝𝑥

𝑑
fx(t) = 𝑑𝑥 𝐹𝑥 (𝑡)

Warmup Example: Suppose that 𝑡 𝑝𝑥 = e –.1t.

a. Find Pr[(x) dies within 10 years].

b. Find 2|3 𝑞𝑥 .

Let’s examine Pr[ Tx < t + dt | Tx > t] for a fixed (very small) dt > 0.

Note: μx+t ⋅ dt ≈ Pr[ Tx < t + dt | Tx > t] for small dt.

Definition: The force of mortality (or hazard rate) μx+t (λx+t in MQR) is defined by

lim 1
μx+t = dt→0 dt
Pr[ Tx < t + dt | Tx > t] ← notation emphasizes future lifetime,
although x + t = age
…or equivalently by…

lim 1
μx = dt→0 Pr[ T0 < x + dt | T0 > x] . ← notation emphasizes age at failure
dt

…or equivalently…

Definition: μx = and μx+t = .

___________ _____________

I find it useful to remember that the overall subscript should be the age, which should make some intuitive sense.
 5

1
Example 1: Suppose that 𝑡 𝑝𝑥 = 80 (80 − 𝑡), 𝑡 ∈ [0, 80].
Find a formula for μx+t . (CW: Give name for model)

Example 2: Suppose that 𝑡 𝑝𝑥 = e –.1t for all t > 0.

Find a formula for μx+t . (CW: Name the model)

Formula: A very commonly used formula for the density of Tx comes from
rearranging the definition of μx + t :

What if we’re given only a formula for μx+t . How do we find the survival function and density?
 6

Summary: How to get stuff from other stuff (survival, cdf, pdf, and force of mortality).

 Given sx(t) = 𝑡 𝑝𝑥 or Fx(t) = 𝑡 𝑞𝑥 ,…

 Given fx(t) , …

 Given μx + t , …

18000−110𝑡−𝑡 2
Example 3: Suppose that 𝑡 𝑝0 = for 0 ≤ t ≤ 90.
18000

Find the force of mortality at age 50.

Example 4: Suppose that the force of mortality is given by 𝜇30+𝑡 = 𝑡 2 .

a. Find 2 𝑝30 .

b. Find a formula for 𝑡 𝑝30 .

 7

Example 5: Discuss the setup of these problems from the SOA 300 (will complete as HW):

a. 10.7 b. 11.0 c. 11.2 d. 11.6 e. 11.8

CW: Discuss TI-30XS Table Feature!
 8

Complete Expectation of Life:

Definition: We define the complete expectation of life by _______________.

1
Example 6: Suppose that Tx has density 𝑓𝑥 (𝑡) = 8 (64 − 𝑡)1/2 , 𝑡 ∈ [0, 64].

Compute the complete expectation of lifetime for (x).

Alternate Formula: E[Tx] = ________________.

Why would this work at all?? Look at ∫ Sx(t)dt, and use integration by parts,
u = Sx(t), dv = dt.
 9

Recall: (a) To get Sx(t) = 𝑡 𝑝𝑥 from 𝜇𝑥+𝑡 …

(b) If 𝜇𝑥+𝑡 is a constant μ, we get…

Example 7: Suppose the force of mortality for (30) is given by

. 03, 𝑡 ∈ [0, 2]
𝜇30+𝑡 = { .
. 05, 𝑡 ∈ [2, ∞)

Use the “Alternate Formula” to compute the complete expectation of life for (30).

CW: The cleanest way to do the t > 2 part of the integral is to factor 𝑡 𝑝𝑥 = 2 𝑝𝑥 ⋅ 𝑡−2 𝑝𝑥+2 .
 10

Example 8: Use standard probability facts to answer the following questions:

a. Suppose future lifetime for (x) is uniform on [0, a]. (So the ω for the model
would be x + a, I think.)

Find the complete expectation of life and the variance of Tx.

b. Suppose future lifetime for (x) is uniformly distributed and that

the complete expectation of future lifetime is 30. Find the variance of Tx.

c. Find the complete expectation of future lifetime for a life subject to a constant
force of mortality equal to μ.

Example: Discuss:
 11

Homework: DHW ∮2.3, 2.5, 2.6 – Force of mortality & expectation of life

 DHW Chapter 2 exercises #2.1a, c, d, f (part g actually requires a spreadsheet—let’s skip it!)

 From the “SOA 300”: #32

Given that S0(t) = 1 – {et / 100} for all t ∈ (1, 4.5),

calculate 𝜇4 .

 Also complete #13, 22, 98 from the “SOA 300” (included in previous pages of these notes)

 Optional: MQR(5e) problems 5.11, 5.12, 5.13, 5.15 are good problems, too. They’re
perhaps a little less straightforward:
 12

DHW 2.6 / MQR 6.3 – Curtate expectation of life, etc.:

Definition: Let Kx denote the number of full years that x will live.
Kx is called the curtate future lifetime random variable.

So Kx = max {z ∈ ℤ | z ≤ Tx}.

Illustration: If (x) lives exactly 35.6 more years, then Tx = ____ and Kx = _____.

The curtate expectation of life for (x) is notated/defined by

_________________ .

Recall: We used integration by parts to get an alternate formula for complete exp. of life:

Formula: We have a similar formula for the curtate expectation of life:

See reading on next page!

 13

Source: Morris DeGroot, Probability and Statistics 2e, Addison-Wesley.

 14

Temporary expectation of life:

Warmup illustration:
 Suppose you are required, for the next five years, to pay a 25-year-old person $1 for every
day that he/she is still alive during the 5-year period. If you had many such contracts, you
might be interested in the average number of years—only out of the next 5—that a 25-year
old tends to live.

 Imagine a very crude lifetime model for some type of animal, in which 50% of the
population will live for exactly 2 years, 40% for exactly 3 years, and 10% for exactly 7 years.
Then the 5-year temporary expectation of life would be…

 Notice that the answer wouldn’t change if you just pretend that all the animals die at the end
of the 5th year.

Definition: The n-year temporary expectation of life for (x) is the average is notated/defined
by

________ = E[ min{Tx , n} ]
Useful formula: Adaptation of the “alternate” expectation formula to the temporary case.

This is the same formula, if we modify the original survival function so that everyone is
guaranteed to die instantly if they reach year #n. This is how we might model the lifetime of a
gallon of milk, for example.

Example: Suppose the force of mortality for (30) is given by

. 03, 𝑡 ∈ [0, 2]
𝜇30+𝑡 = { .
. 05, 𝑡 ∈ [2, ∞)

Compute the 5-year temporary expectation of life for (30).

 15

Discrete/curtate version:

𝑡
Example: Suppose that 𝑡 𝑝𝑥 = 1 − 10 for t ∈ [0, 10]. Compute

a. …the complete expectation of life for (x).

b. …the 3-year curtate expectation of life for (x).

 16

DHW 3.1-3.3, MQR 6.1-6.6 – The Life Table and Fractional Age Assumptions

Example 1:

x ℓx dx
30 1000 4
31 996 3
32 993 5
33 988 5
34 9
35 974
36 973 6

a. Radix = ________ ← somewhat arbitrarily chosen (not required to be an integer)

meaning of the statements ℓ31 = 996, ℓ32 = 993

meaning of the statements d30 = 4, d31 = 3

b. Compute ℓ37.

c. Compute 𝑝32 and 3 𝑝32

d. Compute 𝑞32 and 3 𝑞32 . (The 2nd question can be answered using either dx’s or ℓx’s.)

e. Compute the probability that a life currently aged 32 dies between ages 35 and 36.
Also give the actuarial notation.

Think about: Let x be any particular age represented on a life table.

How to find px , qx , 𝑛 𝑝𝑥 , 𝑛 𝑞𝑥 (for n an integer):

 17

It’s easiest to do things intuitively, but to be complete, here are the definitions:

Actual definitions: Let ℓinitial = an arbitrary positive number ← radix

Let ℓx+1 = px ℓx for each integer x > (initial age).

⇒ ℓx is defined by ℓx = E[# lives at age x]

Let dx = qx ℓx = E[# deaths during the year following age x]

I often find it useful to think of probabilities as (# still alive)/(# originally alive) or

(# deaths occurring)/(# originally alive).

Example 2: Here is an excerpt from a life table:

x ℓx
40 1000
⋮ ⋮
70 920
⋮ ⋮
80 850

Find an expression for 30|10 𝑞40 .

Example 3: Suppose that ℓx = ω – x for some fixed ω > 0.

What can we say about 𝑡 𝑝𝑥 ?

What about probabilities involving fractions of a year?

Typically, actuaries make one (only one at a time) of the following simplifying assumptions:

1. Uniform distribution of deaths (UDD) between integer ages.

2. Constant force of mortality between integer ages.

Definition: To assume UDD means to assume that, for every integer age x,

𝑠 𝑞𝑥 = s ⋅ 𝑞𝑥 for every s ∈ [0, 1].

 18

Illustration 4: Suppose that q80 = .02 . Under the UDD assumption…

What should be the value of .1 𝑞80 , .3|.1 𝑞80 , .5|.1 𝑞80 , and .9|.1 𝑞80 ?
Maybe also illustrate on a life table that has, e.g., ℓ80 = 1000.

Fact: Let x be an integer age. Under the UDD assumption, we have

(Definition) 𝑠 𝑞𝑥 = s ⋅ 𝑞𝑥 for every s ∈ [0, 1].

(Consequence #1) 𝑠|𝑡 𝑞𝑥 = t ⋅ 𝑞𝑥 whenever t + s ≤ ____ and s, t ∈ [0, 1].

(Consequence #2) Linear interpolation between ℓx and ℓx + 1 may be used.

Example 5: Consider the following life table, and assume UDD:

x ℓx dx
70 100 1
71 99 2
72 97 5
73 92 5

a. As a preliminary step (our actual goal is to answer (b) and (c) below),
compute ℓ71.5 , ℓ71.9 , and ℓ72.1 .

b. Compute .4 𝑝71.5 and .4 𝑞71.5 .

c. Compute .6 𝑝71.5 and .6 𝑞71.5. Notice that we no longer need to consider

ℓ71, now that we have computed ℓ71.5 and ℓ72.1 .
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Recall: Tx , Kx , ex , x

Temporary notation:
Let x be an integer age. Write Tx = Kx + Rx , so Rx ∈ [0, 1].
(Think of Rx as the “remainder” random variable.)

Useful fact: The UDD assumption is equivalent to the assumption that Rx is ___________.

Theorem: Relating complete and curtate expectation of life under UDD.

Assume UDD. Then _________________.

Warning: I wouldn’t try to adapt this theorem to temporary periods, e.g. x:n

Proof of theorem:

Example 6: Discuss SOA #120 (adapted).

The probability of leaving employment during a particular year is denoted qx.

You are given the following probabilities and the UDD assumption,

Compute the temporary 1.5-year complete expected employed lifetime of

an employee who is entering the second year; that is, compute .

Main idea: Want to integrate a survival function. Can we write down the relevant survival
function? Note—this example is not about the theorem above.
 20

HW – Life table and UDD

 Read DHW Sections 3.1-3.3, 3.6-3.7, especially the less mathematical sections. Also
MQR Sections 6.1-6.3 is material worth reading. If the equations get too tedious, you
can skim those sections.

 Do MQR (paperback book) Exercises 6-1bc , 6.2 , and 6.10 (hint: Example 3 in notes).

 Complete problem SOA #120 as stated above in the lecture example.

 “UDD and μx + s”
Under UDD, we can fairly quickly get a force of mortality at any point during the year.
Suppose ℓ60 = 500 and ℓ61 = 490, and assume UDD. Compute μ60.4 by using the
following steps:

1. Recall that UDD means sqx = s ⋅ qx for s ∈ [0, 1]. We are using x = 60 in this
problem. Let F60(s), f60(s), and S60(s) denote the cdf, density, and survival function
for T60. Find formulas for these three functions for s ∈ [0, 1]. (One of these is given,
and one of these should be a constant function on [0,1].)
2. Now compute the values of F60(.4), f60(.4). and S60(.4). (There are two ways to
handle the cdf and survival quantities: you could use formulas you found in (1), or
you could use linear interpolation to get the value of ℓ60.4. The only way to get the
density, though, is through the formula in step 1.)
3. Now compute μ60.4. (Think of this as μx+s with x = 60, s = .4.)
4. Let’s generalize this procedure. Repeat the steps 1-3 as follows:
a. Let x be any integer. Express qx in terms of ℓx and ℓx+1. Also compute fx(s)
for s ∈ [0,1].
 21

b. Let s ∈ [0, 1]. Express the survival function spx in terms of ℓx and ℓx+s.
c. Write down the definition of μx+s and then re-express in terms of ℓx , ℓx+1,
and ℓx+s. (Observe that, under UDD, you could go even further and re-express
ℓx+s in terms of ℓx and ℓx+s.)

 Next time, I’ll probably assign all of DHW Exercise 3.2. You can do parts a, c, e now if
you like.

Plan for next time, review UDD; emphasize connection between life table, UDD, density, force
of mortality, and then do constant force between ages; then lots of problems to try in groups.
 22

Assumptions between integer ages, continued.

Recall: Facts about the UDD assumption:

1. Under UDD, 𝑠 𝑞𝑥 = ____________ for s ∈ [0, 1] and x ∈ ℤ.

2. Under UDD, we may use linear interpolation to compute ℓx if x is between

integer ages.

e.g. Assume UDD. Then ℓ35.8 = _________________.

Recall also: To get 𝑡 𝑝𝑥 from μx + t. (Mention also special case μx + t ≡ μ, constant.)

We could make a different choice of assumptions for inter-age probabilities:

Constant force between integer ages:

Definition:

Main facts: Let x ∈ ℤ be an integer age.

1. Under the constant force (btwn integer ages) assumption, we have

𝑠 𝑝𝑥 =

2. Under constant force, we have “exponential interpolation” between integer ages

(cf. MQR).
 23

Example: Consider a life table with

ℓ60 = 80,000
ℓ61 = 79,000
ℓ62 = 77,000.
Assume that the force of mortality is constant during each year of age.

a. Find .6 𝑝60.8 and .6 𝑞60.8 .

b. Find the value of μ60.5 . (That is, find the value of μ that applies during
ages (60, 61).)

HW: DHW Exercise 3.2 (can download from Moodle if needed)

Quiz next time covering survival probabilities, μx+t, etc., life tables, UDD.

Good optional study problems for MLC exam: MQR #6.22, 6.24:
 24

Problems to try in groups:

1. Given μx = x5, find a simplified expression for tpx. (You might find it helpful
to convert the formula μx = x5 to the form μx + t = ⋯, so that you can fix the x in your
notation.)

2. Suppose that ℓx + t = 50 – t for all t < 50.

a. Find formulas for 𝑡 𝑝𝑥 and for the density fTx(x) for Tx.
Also identify the name of this distribution for Tx.

b. Find a formula for μx+t.

3. Here’s a chunk of a life table…

x ℓx

40 1000
⋮ ⋮
50 950
51 940
52 925
53 900

a. Compute 10|2 𝑞40 .

b. Compute .2 𝑝50.8 under the UDD assumption.

c. Compute .4 𝑝51 under the assumption of constant force of mortality during each
year of age.

d. Suppose deaths follow UDD between ages 50 and 51 but follow constant force of
mortality between ages 51 and 52. Compute .6 𝑝50.8. (You’ve done most of the
work in (b) and (c).)

e. Recall the formula sqx = s ⋅ qx (for s ∈ [0, 1]) under the UDD assumption.
Consider age x = 50.
Find the formulas (under UDD) for sp50 and for the density f50(s) for T50
for s ∈ [0, 1]. Finally, find the value of μ50.5.

f. Suppose that deaths follow the “constant force between ages” assumption. Find
the μ that applies during ages [50, 51]. (Hint: Write down a formula that relates
p50 and μ.)

Continued on next page.

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4. Write an equation that relates the indicated quanitites.

a. 𝑝30 , 𝑝31 , 2 𝑝30

b. 𝑝30 , 𝑝31 , 2 𝑞30
c. 𝑝30 , 𝑝31 , 1| 𝑞30

c. 10 𝑝30 , 10 𝑝40 , and 20 𝑝30

d. 10 𝑝30 , 5 𝑝40 , and 10|5 𝑞30

e. 10 𝑝30 , 15 𝑝30 , and 10|5 𝑞30

f. ℓ30, ℓ40, ℓ45 and 10|5 𝑞30 .

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DHW 3.7-3.9; MQR 6.7 – Select/Select and Ultimate Life Tables

Main idea: If (x) has just been approved for a new life insurance contract, there may have been
a medical exam. So we know something about (x), at least in the short term:
(x) was healthy enough to be accepted for a new life insurance policy.

This should affect (in the short term) our survival model for (x).

We say that (x) was selected at age x, or that (x) is a select life.

The period of higher survival probabilities is called the select period.

The period that follows (during which the positive “effects” of selection have
worn off) is called the ultimate period

Notation:

𝑡 𝑝[𝑥]= Pr[A life currently aged x, selected at age x, survives for ≥ t additional years]
𝑞
𝑡 [𝑥] = 1 − 𝑡 𝑝[𝑥]

𝑡 𝑝[𝑥]+𝑠 = Pr[A selected at age x but now aged x + s survives for ≥ t additional years]
𝑡 𝑞[𝑥]+𝑠 = 1 − 𝑡 𝑝[𝑥]+𝑠

Layout of a select and ultimate table (MQR(5e) Table 6.5):

Note: In our next lesson, we will construct

a life table in Excel—bring a laptop or
plan to share with a classmate.
 27

Example based on DHW(1e) Table 3.7

Below is a life table with a two-year select period.

a. Find 4 𝑝[51] . ← Pr[a life aged 51, selected at age 51, survives > 4 yrs]

b. Find 3 𝑝[50]+1 . ← Pr[a life aged 50+1, selected at age 50, survives > 4 yrs]

c. Find 2| 𝑞[51] ← Pr[a life aged 51, selected at age 51, lives 2 yrs then dies
during following year]
 28

DHW Example 3.8

You are given this excerpt from the standard mortality for Australian men:

ℓ60 = 89,777
ℓ61 = 89,015
ℓ70 = 77,946

If (x) has a particular surgery, his survival probability during the following year is
cut to .5; that is, 𝑝[𝑥] = .5 .

If he survives that year, he is fully cured and returns to regular mortality. So

𝑝[𝑥]+𝑡 = 𝑝𝑥+𝑡 whenever t ≥ 1.

a. Find the probability that a man aged 60 who is just about to have surgery will be
alive at age 70.

b. Find the probability that a man aged 60 who had surgery at age 59 will be alive
at age 70.

HW: MQR(5e) problem 6.36 (below) and DHW Exercise 3.3.

The reading in DHW (sections 3.7-3.9) will give you a good idea of the practical aspects
of this theory. As usual, the math notation in DHW gets a little overwhelming and
overdone—don’t work too hard at keeping track of every detail the first time you read
through! 

MQR Problem 6.36:

Next time we’ll discuss MQR problem 6.34 and recursions on life tables.
We’ll also discuss the Makeham and Gompertz models and use Excel—plan to bring laptops to
share.
 29

DHW – Finishing off Chapters 2 and 3:

 Gompertz and Makeham Survival Models
 Construction of a select and ultimate life table

Let A ∈ ℝ, B ∈ (0, 1) and c > 0 be constants.

Definition: The survival model given by μx = Bcx is said to follow Gompertz’ law. (1825)

The survival model given by μx = A + Bcx is said to follow Makeham’s law.

Preliminary calculus fact:

𝑎
∫𝑎 𝑐 𝑠 𝑑𝑠 =
1
0

Notation: Two common notational conventions (both are used in DHW):

 In DHW, log(⋯) means ______.

 In DHW, exp(⋯) means ______.

1. Let’s compute a formula for 𝑡 𝑝𝑥 under Makeham’s law.

To start with: For a fixed x, we have μx+s = ____________.

2. In particular, for a fixed starting age y, we get py = ____________.

 30

3. Suppose that a select and ultimate model has a 2-year select period,
follows Makeham’s law for the ultimate period, and satisfies

μ[x] + s = .92 – s μx + s , s ∈ [0, 2].

Thus, the effects of selection gradually wear off until the select force of mortality
matches standard mortality at time s = 2.

For t ∈ [0, 2], we get

μ[x] + s =

𝑡 𝑝[𝑥] =

, t ∈ [0, 2]

4. In particular, when t = 1 and when t = 2, we have

 31

DHW Example 3.13 “Standard Select Survival Model” / “Standard Ultimate Survival Model”

We will construct DHW Table 3.7—The ultimate model is the Makeham model with

A = .00022 , B = 2.7 × 10–6, c = 1.124.

Outline: It will be convenient at times to relabel y = x + 2 . We’ll construct the ultimate

part of the table first (so dealing with only y’s at first).

i. Starting with y = 20, complete the y (i.e. x + 2) and x columns in the spreadsheet
through age 82. Then choose ℓ20 = 100,000 in the ℓy column.

ii. We use (2) from the first part of these notes to fill in the 𝑝𝑦 columns, first
for y = 20. Right away compute ℓ21 (in the y column) and check the value
against the correct one from the textbook (next page of these notes). Using
“ctrl-click” to select nonadjacent columns, extend your formulas down the page.

iii. In terms of ℓ’s, we have

(a) 2 𝑝[𝑥] = and (b) 𝑝[𝑥] = .
________ __________

Use (4) from these notes to get 2 𝑝[20] . Then we can figure out ℓ[20] from (a).
Once we have ℓ[20], we can use (4) and (b) to find 𝑝[𝑥] and finally ℓ[20]+1.

***Careful: Use the x column (not the y = x + 2 column) for the ages involved
in computations for the select portion of the table. (It took me a
while to fix this problem when I worked this example.)

Excel tips:
 Pay attention to which age—the select age x or the ultimate age y = x + 2—is
needed for the formula you’re entering.
 Get each formula to work for the first age in the table before you extend your
formulas into a column. In practice, you can usually check your work against
an existing model, as we are doing in class.
 You may need to widen some columns in order for Excel to give you the same
rounding that we see in the textbook’s table.
 DHW uses exp{…} but Excel uses exp(…). DHW uses log(…) for Excel’s
LN(…) .
 32

Note: The full version of the “Standard Select and Ultimate Table” is on p.66 of DHW 1 st ed. and in Table D1, page
583 in DHW 2nd ed.

Homework: Do the problems listed below:

SOA #66:
 33

Homework, continued:
A problem based on SOA #286: Don’t worry, it’s not as long as it looks.

Consider the Gompertz survival model with B = 5 × 10–6 , c = 1.2 .

1. Compute a formula for 𝑡 𝑝50 .

2. Use your multiview to evaluate the formula in (1) when t = 1 and when t = 2.
Do it the efficient way:
 Put “1 [Store →] X” in your calculator and hit [Enter].
 Enter the formula from (1), using the X button every time you see a t in
the formula. Hit [enter] to get the value of 1 𝑝50 (i.e. 𝑝50 ).
 Put “2 [Store →] X” in your calculator and hit [Enter].
 Do not retype the formula for 𝑡 𝑝50 . Rather, use your arrow keys to
highlight the formula the first time you typed it. Hit [Enter] to have your
Multiview retype it for you! Then hit [Enter] to evaluate the formula with
your new choice of X (i.e. X = t = 2.)

3. You’ve done most of the work now. Use step 2 to find q50 and 1| 𝑞50 , the probabilities
of failure during the first and second years, respectively, that follow age 50.

4. Read the following remark:

The expected present value of a $10 two-year term insurance contract (with benefit
payable at end of year of death) at annual effective rate 6% is notated by

and computed by

10 v ⋅ q50 + 10 v2 ⋅ 1| 𝑞50 , where v = 1.06–1.

Think of it in this way: We discount $10 at 6% for one year a payment occurs at the end of the
first year that follows age 50 (which happens with probability q50), and we discount $10 for two
years if a payment occurs at the end of the following year (which happens with probability
1| 𝑞50 ).

We’ll carefully develop this line of thinking, from scratch, assuming no prior background in
interest theory, very soon.
 34

DHW 4.1, 4.4.2 / MQR(5e) 1.1, 7.1:

Present Value of Insurance and Endowments, Discrete Case

Quick summary of interest notation.

Illustration 1: To increase a quantity X by 4%:

To increase X by 4% and then increase the result by 4%:

Let i denote the effective interest rate per period. (Today we’re going to use periods of one
year, but that isn’t built into the symbol i.)

Illustration 2: A bank savings account pays 6% annual interest (effective).

You deposit $100 today and another $100 in two years. And that’s it.
Find an expression for the balance five years from today.

Illustration 3: You know that you will have a bill of $500 due six months from today,
and another $500 bill due two years from today.

You fund those obligations by depositing X into an account paying 6% annual

effective interest. Write an equation of value.

Notation: i, v, d, δ

Convention: The quantities i and v are quoted annually unless otherwise stated. This
convention is followed on Exam MLC.
 35

The present value of insurance random variable, fully discrete case:

Context:
 Consider a whole life insurance policy on (x) that pays $1 at the end of the year of
death.
 Let Kx = curtate future lifetime = beginning of year of death.
 Let Z or 𝐴𝐾𝑥∗ represent the present value random variable for this $1 payment.

(Draw timeline.)

Assuming constant force of interest, then in terms of v we get

Z = ________

 The expected present value (EPV) or actuarial present value (APV) of a whole life
insurance of $1 is notated Ax ; so with Z defined as above, Ax = E[Z].

 Other terms for APV of an insurance benefit: net benefit, single benefit premium (the
term “single” is not optional),

 Note that the symbols involving capital letter A are for amount $1 only!

Example 1: (adapted from MQR5)

A payment of 10 will be made at the end of the year of death for (x).
Survival for (x) is modeled as follows:

k Pr[Kx = k] = 𝑘| 𝑞𝑥
0 .2
1 .3
2 .2
3 .15
4 .15

Note that 5 𝑞𝑥 = 1 in this example.

Compute the expected present value (APV) of the $10 payment at 1% interest (i = .01).
Also give the actuarial notation.
 36

Example 2: Consider a special fully discrete* insurance policy on (60) that pays 300 if death
occurs during the first two years, 400 if death occurs during the following year.

You are given:

𝑝60 = 𝑝61 = .99

𝑝62 = .95

i = .03

Compute the expected present value of the death benefit.

*SOA’s term “fully discrete” means that all payments occur at the end of the year of death.

Terminology: In DHW, the (undiscounted) amount of the death benefit is called the sum insured.
DHW often uses S for this amount, though this is by no means a standard convention.

Random variable analysis.

Recall: If X is a discrete r.v. and g is a function, then E[g(X)] = _______________.

Illustration 3: Compare v2 with an equivalent expression involving δ.

Illustration 4: By considering Z = 𝑃𝑉($1 at end of year of death)

to be a function of curtate lifetime Kx, we may compute formulas

Z = ______

Ax = E[Z] =
2
Ax = E[Z2] =

Var[Z] = ____________ ← Important relationship.

 37

Modifications of the present value (of $1) random variable:

In each case, we’ll write down the notation and formulas for the PV random variables in terms of
v, Kx and Kx* = Kx + 1. All payments for failures of (x) occur at end of year of death.

 n-year term insurance: Payment occurs if and only if (x) fails within an n-year period.

 n-year deferred insurance: Payment occurs if and only if failure occurs after n years.

 n-year endowment: Payment occurs if and only if (x) is alive at the end of an n year
period (⇔ the n-year period fails/ends before (x) does).

𝑛 𝐸𝑥 =

 n-year endowment insurance: Payment occurs if (x) fails within n years. Otherwise, (x)
has survived for n years and receives $1 at that time (the endowment benefit)

 The pre-superscript 2 denotes squaring v or doubling δ as before. We get…

… but not for endowment-insurance!

(Var[sum of r.v.’s that are not indep.])
Notational convention:
 The joint status x : y fails (by definition) if either (x) or (y) has failed.
 Thinking of y as an n-year period, we write ____ instead of y.
 The status 1𝑥:𝑛⌉ fails if and only if x fails before 𝑛⌉, i.e. within n years.
1
 The status 𝑥:𝑛⌉
fails if and only if the n-year period fails (expires) before (x) does.

Also note: Decorating the Z’s is a somewhat nonstandard practice. This is an innovation in the MQR book
that isn’t widely used elsewhere. (The decorations on the A’s are standard, however.)

Moreover, the A’s always represent EPVs of $1 payments. The symbol Z in many cases is used
to represent EPVs of other dollar amounts—the symbol Z is usually explicitly defined every time
it’s used.
 38

Illustration 5: Draw diagrams that relate (a) endowment, endowment insurance, term insurance
(b) whole life insurance, term insurance, deferred insurance.

Example 6: Consider a fully discrete 3-year term insurance of 100 on (60).

Let Z be the present value random variable for this insurance.
Compute Var[Z] in terms of A’s and 2A’s. Use i = .06 .

Example 7: Consider a fully discrete 3-year endowment-insurance of 100 on (60).

Assume 𝑝60 = .9, 𝑝61 = .8, 𝑝62 = .7, d = .05 .

Let X be the present value random variable for this endowment insurance.
Find expressions for the single benefit premium (APV) and for Var[X].
 39

Homework: Over the next week or so, read DHW chapter 4 (optionally read MQR Ch. 7:
copies are in JH 271 bookcase down low). Some of it might not make much sense yet, but that’s
ok. Also do the following problems:

Tip: You’ll need to condition on whether you’ve got a smoker or nonsmoker in some way.
 40

Answers:

#4: 1730 #34: .19 #109: 36,829

 41

DHW Chapter 4 / MQR Chapter 7, continued – Discounting life contingent payments

Context for today: Fully discrete case.

Recall Notations for…

P.V. Rand. Var. EPV

whole life insurance on (x):

n-year term insurance on (x):

n-year deferred insurance on (x):

n-year endowment* on (x):

n-year endowment-insurance on (x):

*CW: Write down both notations & EPV formula

Example 1: (MQR5e Exercise 7.11)

Example 2: Apply the result of Example 1 to show how Ax is related to Ax+n and to the n-year
term insurance.

Example 3: Special case: Recursion on a life table. (MQR5e Exercise 7.6)

 42

Example 4: Outline a strategy to solve the following HW problem:

Example 5: Outline a strategy to solve

 43

Example 6: Here is a section of the Exam MLC “Illustrative Life Table”:

Note: All values on this table are computed using i = .06 .

Compute the net single premium (i.e. EPV or APV) of a 5-year term insurance
of 9000 on (70).

Notation: Suppose that, for n = 1, 2, 3, …, a whole life policy on x pays $n at time n if

death occurs during the year preceding time n. (So if failure occurs during the 3rd
full year, i.e. during t ∈ [2, 3), i.e. Kx = 2, then $3 is paid at time 3).

The expected present value for this increasing insurance is denoted IAx.

Example 7: (MQR5e Example 7.10)

Main point: What happens if mortality is changed for just the first year?

Suppose that (IA)80 = 4, based on q80 = .1 and v = .925 .

(80) decides to take up skydiving, and this modifies the survival model in year
one only, with the new q80 = .2 and the other qx values unchanged.

Our goal is to compute the revised value for (IA)80.

a. Assuming (80) survives to age 81, the EPV at age 81 of benefits beyond age 81
does not depend on the new q80. Let B81 denote this EPV. Find B81.

b. Compute the revised value of (IA)80.

 44

Some loose ends:

Relationship to life table and expectation of life

Recall: Computing curtate expectation of life from tpx ’s.

Illustration: What happens if we “split off” the first n terms of the sum that computes ex?

Particular case: If n = 1, we get a one-year recursion:

Example 8: Suppose that 𝑒70 = 15 based on 𝑞70 = .01 .

a. This immediately implies a value for 𝑒71 .

b. If (70) has surgery or takes up skydiving, we may revise 𝑞70 , say 𝑞70 = .02.
Compute the revised value for 𝑒70 .
 45

Another loose end:

Var(Zx) = 2Ax – Ax2

…but not for endowment insurance!

i. Recall the “useful” definition of Cov[X, Y] and the relationship to Var[X+Y]:

ii. What happens when we multiply the p.v. random variables for an n-year endowment
and an n-year term insurance?

iii. What is the implication for

iv. Finally, recall that

and compute Var[𝑍𝑥:𝑛⌉ ].

 46

Homework:
MQR5e /6e (same, I think): Problems 7.7, 7.13, 7.14, and SOA#231 below.
Optional: MQR5e #7.5, a cute little factoring problem.

MQR:

SOA:

Plan: You can use the one-year recursion for A80 to determine q80, and hence q[80].
Then you’ll get the answer by using the one-year recursion for A[80].
 47

DHW Chapter 4, lecture 3: EPV of benefits, continuous case

Notation: Tx δ μx+t

Recall: Density and survival function for Tx in terms of μx+t:

Special case: If μ is constant, get…

More notation:
For today, let Zx = 𝑍̅𝑥 denote the present value of $1, payable at the instant of death.

We have

Expected values:

Recall the general formula for E[g(X)], where X is any continuous r.v.:

E[g(X)] = ________________

Whole life insurance (fully continuous, $1 benefit):

𝐴̅𝑥 = 𝐸[𝑍̅𝑥 ] = ______________________

Term insurance (fully continuous, $1 benefit):

Endowment insurance (fully continuous death benefit + endowment, each $1):

Question: Why no bar on the endowment?

 48

Discounting benefits for interest and survivorship

Look what happens when we split apart the integral for 𝐴̅𝑥 at time n:
(For t > n, factor tpx into two pieces.)

Conclusion:

Example 1: Find the EPV and variance of a policy that pays 100 at the moment of death.

Assume a constant force of interest δ = .06 and constant force of mortality μ= .02.

Example 2: Consider a policy on (x) that pays 100 at moment of death, if death occurs within
10 years. The death benefit increases to 200 if death occurs later.

Assume a constant force of interest δ = .06 and constant force of mortality μ= .02.

Find the EPV of the death benefit. Quick way: layering & discounting.

Example 3: Find the APV/EPV/Single Benefit Premium for a benefit that pays 100 at the
moment of death, if and only if the death occurs after a 10-year deferral period.
 49

. 01, 𝑡 < 10
Example 4: Suppose that 𝜇50+𝑡 = { .
. 02, 𝑡 ≥ 10
Find the expected present value of an insurance benefit of $1000 on (50), payable
at the moment of death, at δ = .04 .

The values for 𝐴̅𝑥 do not typically appear on a life table. Why? If we’re willing to assume
UDD, we get…

But eδ and i are related:

We get a convenient formula:

𝑖
𝐴̅𝑥 =
⏟ 𝐴𝑥
𝑈𝐷𝐷
𝛿

If we drop the UDD assumption, we still get an approximation: change the = to ≈.

 50

Example 5: Use the SOA “Illustrative Life Table” to find the single benefit premium
(at i = .06) for a 5-year continuous endowment insurance of 3000 on (70).
Just sketch out the solution.

Example 6 Discuss solution to the following HW problem:

 51

Homework:

141. Complete #141 as outlined in previous page of notes.

5 5 2
Answers:#215: .6614 ; #141: 3.75 ; #3: − (7) ≈.04535
9
 52

DHW Chapter 4 Wrapup: Some practice & review with EPV’s of benefits.
Some of these problems will require this excerpt from the SOA Illustrative Life Table (i = .06 on
this table). Sketch out solutions only, we’re going for understanding/problem solving here, not
crazy decimal numbers. Note to CJW: Solutions found in “notes dhw ch 4 in class practice solns”

1. A special fully discrete one-year deferred two-year term insurance on (66) pays
$2000 at the end of the year of death if death occurs between ages 67 and 69.

Mortality follows the Illustrative Life Table and i = .025.

Find the EPV and the variance of the present value of this insurance.

*If the life table had dx’s handy, this could be really quick.

2. Compute the single benefit premium for a two-year endowment insurance of 500 on (70),
with i = .025 and mortality following the Illustrative Life Table.

3. A special fully discrete whole life insurance on (67) pays 10,000 if death occurs during
the first five years and 15,000 if death occurs thereafter. (Fully discrete—benefits paid at
end of year of death.) Find the APV if mortality follows the Illustrative Life Table and
i = .06.

4. A special fully discrete whole life insurance on (67) pays 10,000 if death occurs during
the first five years and 5,000 if death occurs thereafter.
Find the APV if mortality follows the Illustrative Life Table and i = .06.
 53

5. A special life policy on (50) pays $10,000 at the end of the first year if death occurs
within that year. The expected present value at age 51 of future benefits, given survival
to age 51, is $12,000. The net single premium of this policy is 11,705.36 at i = .025 .
Find q50.

6. Using the Illustrative Life Table for mortality and i = .06, find an expression for the
variance of a whole life policy of 5000 on (71).

7. A special fully continuous whole life insurance on (x) pays 10,000 if death occurs
during the first five years and 15,000 if death occurs thereafter. (Fully discrete—benefits
paid at end of year of death.) Find the APV if μ is a constant μ = .01 and δ = .06.

8. A special fully continuous whole life insurance on (x) pays 10,000 if death occurs
during the first five years and 5,000 if death occurs thereafter. (Fully discrete—benefits
paid at end of year of death.) Find the APV if μ is a constant μ = .01 and δ = .06.

9. Let Z70 = present value r.v. for discrete whole life insurance of 1, where mortality follows
Illustrative Life Table and i = .06. (So Z70 = vKx + 1 where Kx is curtate future lifetime.)

Find Pr[Z70 > .4]. Plan: Try to restate as Pr[K70 < b1] and reinterpret as 𝑏2 𝑞70 .
 54

DHW Ch. 5 / MQR Ch 7 – Annuities, Part 1

Note: Our next set of notes
Timeline: involves using Excel—plan to
bring/share laptops.

Definition: Let

𝑌̈𝑥 = 𝑎̈ ̅̅̅̅̅̅̅̅
𝐾𝑥 +1⌉ = Present value r.v. for annuity due paying $1 at beginning
of each year to (x), while (x) is alive.

𝑎̈ 𝑥 = 𝐸[𝑌̈𝑥 ]. Note: If (x) dies before time n, then the number

of payments is (Kx + 1) because of the time-0
payment.

Formula for 𝑎̈ 𝑥 :

By considering 𝑌̈𝑥 to be a sum of present value r.v.’s that take the value vt with
probability tpx , we may use linearity of the E[…] operator to write…

Recall: If s = b + bw + bw2 + bw3 + … + bwn – 1 (so n = # terms in sum) then…

By considering 𝑌̈𝑥 to be a geometric series with final term equal to 𝑣 𝐾𝑥

(so that # terms appearing in sum is Kx + 1) , we get…

𝑌̈𝑥 =
 55

Variations:

 n-year term annuity due: annual payments of $1 at the beginning of each of the first n
years (only)

= 𝑎̈ min(𝐾𝑥 +1 ,𝑛) =

Note: If (x) dies before time n, then the number of payments is (Kx + 1) because
of the time-0 payment.

1−𝐴𝑥:𝑛⌉
̅̅̅
𝑎̈ 𝑥:𝑛⌉ = E[ ]= 𝑑

 n-year deferred annuity due: annual payments of $1 at the beginning of each year that
begin at the beginning of the nth year (so at time n)

EPV, valued at age x / time 0, is notated 𝑛| 𝑎̈ 𝑥 .

 Relationship between 𝑛| 𝑎̈ 𝑥 and 𝑎̈ 𝑥+𝑛 :

 Relationship between temporary, deferred, and whole life annuities:

 56

Example 1:

Consider ℓ60 = 1000, ℓ61 = 998, ℓ62 = 995, ℓ63 = 990, i = .06.

A 4-year annuity pays 500 to (60) at the beginning of each year that (60) remains alive.
Write down notation and an expression to compute the expected present value of this
annuity.

Example 2: Use…

… to find the EPV of…

a. …a 5-year temporary annuity-due making annual payments of 500 to (70), while

alive. Assume i = .06 as in this table.

b. …a 5-year deferred whole life annuity that makes annual payments of 500 to (70),
commencing at the 75th birthday, while alive. (That is, what does it cost, at
time 0 / age 70, to provide annuity payments that would begin at age 75?)
 57

Other variation: Annuities immediate – payments at the end of each year.

Notation: Same as other notations, but delete the “due dots”.

To get 𝑎𝑥:𝑛⌉ from 𝑎̈ 𝑥:𝑛⌉ :

 Remove the PV of the time-0 $1 payment from 𝑎̈ 𝑥:𝑛⌉ .

 Add the EPV of a time-n payment of $1, if (x) is still alive. (There’s a term from the
previous chapter for this particular $1 payment!)
 Formula:

Example 3:

Consider p60 = .1, p61 = .998, p62 = .995, p63 = .990, i = .06.

A 4-year annuity pays 500 to (60) at the end of each year that (60) remains alive.
Write down notation and an expression to compute the expected present value of this
annuity.

Homework:

 Begin plowing through the reading in DHW Ch. 5. You may also want to read through
MQR Ch. 8—on the shelf in JH 271. Note that MQR begins with the annuity immediate
case, which doesn’t make a lot of practical sense as annuities due are much more
common in insurance contexts.

 Do DHW (2nd ed.) Exercise 5.8ab (answers on p. 142).

 58

DHW Chapter 5, MQR Chapter 8, part 2

Variance of annuities

1−𝑣 𝐾𝑥 +1 1−𝑣 𝐾𝑥 +1
Recall: 𝑌̈ = 𝑎̈ ̅̅̅̅̅̅̅̅ 2 Kx
𝐾𝑥 +1⌉ = 1 + v + v + ⋯ + v = 1−𝑣 = 𝑑

Formulas: 𝑎̈ 𝑥 = 𝐸[𝑌̈] =

Var[𝑌̈] =

Learn the derivation of this variance formula! It’s quite handy to know.

Example 1: Consider the SOA Illustrative Life Table at i = .06:

Consider the present value of a whole-life annuity due that pays 10,000 to (70) at
the beginning of each year. Compute the variance of the present value of this
annuity.
 59

Example 2: Consider a special three-year annuity immediate that pays 100k to (x) at time k if
(x) is alive at age x + k for k = 1, 2, 3.

Given px+k = .99 – .02k, k = 0, 1, 2, 3 and i = .03, show how to find the variance
of the present value of this annuity.

Annuities Payable Continuously

Recall that 𝑎̈ 𝑥 = ∑∞
𝑡=0 𝑡 𝑝𝑥 𝑣𝑡.

Consider an annuity payable continuously at a rate of 1 per year.

1 1
(Think: Every 𝑛th of a year, you get $ 𝑛. Take the limit of this arrangement as n → ∞.)

The PV of a continuously paid annuity certain at rate $1 per year is

𝑛
𝑎̅𝑛⌉ = ∫𝑡=0 𝑒 –𝛿𝑡 𝑑𝑡 =

Replacing n with the future lifetime (time-to-failure) r.v. Tx, we get the p.v. random variable…

𝑌̅ = 𝑎̅̅̅̅
𝑇𝑥 ⌉ =

Formula: Let 𝑌̅ = 𝑎̅̅̅̅

𝑇𝑥 ⌉ denote the present value random variable for this continuously
payable annuity. (As usual, there isn’t a universally agreed-upon notation for the
p.v. random variable, but the EPV notation is standard.)

The expected present value of this annuity is denoted / computed via

∞
𝑎̅𝑥 =E[𝑌̅] = ∫𝑡=0 𝑒 −𝛿𝑡 ⋅ 𝑡 𝑝𝑥 𝑑𝑡 .

and the variance can be computed by using the relationship between 𝑎̅𝑇𝑥 ⌉ and
the corresponding “fully continuous” insurance PV r.v. (the r.v. whose expected
value is 𝐴̅𝑥 ):

Var[𝑌̅] =
 60

Modifications: The p.v. formula is easily modified to get a term annuity (stop the ∫ at the end of
the period) or to get a deferred annuity (multiply by nEx to discount/adjust conditioning).

Example 3: Suppose δ = .03 and μ = .02 . Compute the expected present value of…

a. a 10-year term annuity on (x) paying at a continuous rate of 500 per year.

b. a 10-year deferred whole life annuity paid sold to (x), paying at a continuous rate
of 5000 per year.

c. Show how to find the 2nd moment of the p.v. random variable for an annuity
paying at a continuous rate of 1 per year (δ and μ as above).
(Use the facts relating Var[annuity pv] to the moments for pv(insurance).
∞
It is not valid to try to integrate ∫(0,∞) (eδ t)2tpx; the formula ∫𝑡=0 𝑒 −𝛿𝑡 ⋅ 𝑡 𝑝𝑥 𝑑𝑡 arose
as a limit of the expected value of a sum of PVs. The square of that sum of PVs is
not the same as sum of the PV2’s.)
 61

Homework:

I think the best way to do #114 is to think about how to find the variance of a discrete
random variable (here, the present value random variable) if you know its probability mass
function.

(Note/reminder: SOA uses the term “special” to indicate that something unusual
is going on, in this case the non-level payment amounts.)

Answers: #114: 114.2 #67: 7.217

 62

Constructing a life table, continued: Ax and 𝒂̈ 𝒙 on a life table.

Main formulas in play:

 If ω is a terminal age, then Aω – 1 = ________. ← We’ll set ω = 130, so this is a

statement about A129.

 One-year recursion for Ay:

 Relationship between Ay and 𝑎̈ 𝑦 :

 How to get d and v from i. Perhaps create a cell in your Excel file to keep track of
these:

 Relationships between 𝑎̈ [𝑥] , 𝑎̈ [𝑥]+1 , 𝑎̈ 𝑥+2 under a two-year select period:

𝑎̈ [𝑥]+1 = ($1 at time 0) + 𝑝[𝑥]+1 𝑣 𝑎̈ 𝑥+2 ; 𝑎̈ [𝑥] = $1 + 𝑝[𝑥] 𝑣 𝑎̈ [𝑥]+1

Download my skeleton from Moodle.

Tips: Select the entire row below the x, L_[x], etc. headings and then use View → Freeze
Panes to keep the headings visible as you scroll down.

F4 – tap this key after entering a cell number to add the $’s, locking in the cell as a
constant location. (Not sure on a Mac.)

1. We’ll use ω = 130 and i = .05. Get A129 and then use backwards recursion to get the
other Ax’s. Of course, you’ll need to get the d and v in the header of the spreadsheet first.

This is the only step at which you’ll need to “start at the bottom” of the spreadsheet.

Check your work at this stage. Careful to use the y and py columns (the ultimate ages
and survival probabilities, not the select ages / probabilities).

2. Use the relationship between Ax and 𝑎̈ 𝑥 to get the 𝑎̈ 𝑦 = 𝑎̈ 𝑥+2 column.

3. Add a 𝑝[𝑥]+1 column. (Use the fact that 2 𝑝[𝑥] = 𝑝[𝑥] 𝑝[𝑥]+1 .)

4. Use the relationships between 𝑎̈ [𝑥] , 𝑎̈ [𝑥]+1 , 𝑎̈ 𝑥+2 to get and finally 𝑎̈ [𝑥] 𝑎̈ [𝑥]+1.

These models are found in Appendix D of DHW 2e and on pages 66, 83, and 144 of DHW 1e. If
you have 1e, you may want to jot down the page numbers inside the front cover for easy access
63
 64

DHW Ch. 5, continued – Annuities wrap-up – assorted examples – brief intro to premiums

Today’s objective: Cover an assortment of examples related to annuities.

1. Based on DHW 6.9.2: Constant addition to μx.

Suppose that (x) has a particularly dangerous job.
′
Let μx+t denote the standard force of mortality and let 𝜇𝑥+𝑡 = 𝜇𝑥+𝑡 + .01 denote
the force of mortality for the “impaired life”. (DHW: .01 is called ϕ.)

a. Suppose that δ = .04. This implies (i, v, d) can be found…

b. Look at an expression for 𝑎̈ ′𝑥:3⌉ . Reinterpret as a computation of 𝑎̈ 𝑥:3⌉ with

a different δ. We like this because we could possibly find the latter quantity from a life
table.

c. Now look at an expression A′𝑥 ∶ 3⌉. (Careful with which interest rate is which!)

d. Look at 3E′ x.

e. Now look at a 3-year term insurance.

Remark (DHW2e p. 168): Generally, when using the constant addition to the force of mortality,
it is simplest to calculate the annuity function first, using a simple adjustment of δ, then use
relationship between the endowment insurance A′𝑥 ∶ 3⌉ and 𝑎̈ ′𝑥:3⌉ to get a link to to the EPVs for
death benefits.
 65

Guaranteed annuities. SOA #130

 66

Not an annuity problem but gives an opportunity to note an integration shortcut:

̅̅̅𝒙
Good time to introduce: 𝒊𝒂
 67

Benefit Premiums:

Illustration: For a fully discrete n-year term insurance of 500 on (x), the (annual, net) benefit
premium is the amount π for which

𝜋𝑎̈ 𝑥:𝑛⌉ = 500 A 1 .

𝑥 ∶ 𝑛⌉

Example: You are given ℓ60 = 1000, ℓ61 = 990, ℓ62 = 970, v = .98 .
Find the level benefit premium for a special fully discrete 3-year endowment
insurance on (60) that pays
 500 at the end of the year of death for failures during the first two
years and
 800 at the end of year 3 if (60) survives beyond age 62.
 68

Homework: Complete the problems outlined in class today. Also do

Notes: Y is a discrete random variable and cannot take all that many possible values! Don’t use
anything “fancy” to do this problem, other than to list the handful of various cases that can occur.

Compute the premium amount.

(Illustrative Life Table: Use ℓ30 = 9,501,381 ℓ31 = 9,486,854 ℓ32 = 9,471,591, ℓ33 = 9,455,522
or use 1000𝑞30 = 1.53, 1000𝑞31 = 1.61, 1000𝑞32 = 1.70 .)
 69

Tip: This question would be easier if it dealt with the implied values for the 𝑎̅𝑥 ’s. Do that first,
and then compare the new 𝐴̅𝑥 to the old one. Be careful, as the δ actually changes in this
problem.

From MQR: Suppose Tx has an exponential distribution with μ = .06 and δ = .04.
Consider the present value random variable 𝑌̅𝑥 = 𝑎̅𝑇𝑥 ⌉ . Find Pr[𝑌̅𝑥 > 𝐸[𝑌̅𝑥 ]].

This one is like SOA #166. The solution is in MQR 5e Example 8.12 (on Moodle).

From MQR5e: Read all of section 8.7 (scanned to Moodle). These are excellent examples.

Answers:

#130: K = 538.38
#56: 4
#166: .79
#196: 12.46*
#147: 1.28
#63: .8
MQR: e-12.77075(.06) ≈ .46475

*#196: Shortcut:
Everyone receives the first payment of 10, so you could replace Var[Y] with Var[Y–10].
This eliminates the first payment of 10 without any impact on the variance.
70
71
72
73
 74

------------------------------------------------------------------------------------------------------------
 75

Practice Example – mthly stuff – tougher question (at least I think) from the SPR 2012 MLC

You’ll need the tables on the reverse side!

Avoid this major trap: SOA would never ask you to work with the 12 terms necessary to
compute the EPV of the annuity formed by the premium stream. You should make use of the
UDD assumption to replace the EPV of the quarterly annuity with the EPV of an annual annuity.

Avoiding a second trap: Don’t forget that the (m)thly 𝑎̈ (𝑚) EPV notation for quarterly
payments is for payments of 1/m per period, but the notation for the annual-payment annuity is
for 1 per period.

Other optional practice on mthly topics

May13 #22 Woolhouse, compute reserve
Nov13 #7 – Incl. UDD monthly annuity formula
#284
 76

Solution.
 77

DHW Chapter 6, MQR Chapter 9 – Premiums

SOA premium notations:

P = level annual premium to fund a death benefit of $1

or (perhaps) an endowment-insurance of $1

(From SOA MLC Notation/Terminology Document Nov. 3, 2015)

π = level annual premium to fund any other death benefit

Note:
 MQR (5e) usually follows the SOA conventions, but several inconsistencies with
the P vs. π convention:
o Eq’n 9.2 on p. 190 – change P to π (death ben = X, not 1)
 DHW does not appear to follow this convention. They use P and π
interchangeably.

Def’n: The net loss-at-issue random variable

0L = PV of future losses = PV(policy benefits – premium stream)

Other variations:

MQR: Lx – subscript indicates age.

DHW: L0 – subscript indicates t = 0 – beginning of policy.

DHW superscripts: 𝐿𝑛0 ← unfortunate, because DHW also uses “n” for length
of a term insurance
𝑔
𝐿0 = gross (expense-augmented) loss at issue
= PV(policy benefits + expenses – premium stream)

Note: Intuitively, a big + loss should mean that the premiums did not fund the benefits/expenses.
This helps me to remember to subtract the premiums from what the insurer will pay out.
 78

Illustration 1: DHW(2e) Example 6.2

← Note: no premium would be paid at time 20 / age 80.

Definition: Let’s use the generic notation 0L for the loss-at-issue r.v. (either case – net or
gross)

We say that premiums are determined using the equivalence principle if

E[0L] = 0 ;

that is, if

EPV[premium stream] = EPV[benefits pd + expenses (if considering expenses)].

Example 2:
 79

Example 3: Write down equations (in terms of 𝑎̈ ’s and A’s) to compute P for…

a. … an n-year term insurance of 1.

b. …and n-year endowment insurance of 1.

Illustration 4: Consider the geometric series expansion for the PV random variable
for an n-year annuity due:

𝑎̈ ̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅̅
min(𝐾𝑥 +1, 𝑛)⌉ =

Taking expectations, we notice that we get a notationally-pleasing formula

relating 𝑎̈ 𝑥:𝑛⌉
̅̅̅ and the one-year endowment insurance:

Example 5: DHW Example 6.4d

a. Find an expression for the mean of 0L.

b. Find an expression for P (what I usually would call π) using the equivalence principle.
Show also how to find P if only given 𝑎̈ 𝑥:𝑛⌉
̅̅̅ .
 80

Incorporating expenses

Useful technique: “Split off” any recurring portions of a one-time initial expense.

Example 6: MQR (5e) Example 9.8

Consider a fully discrete whole life policy on (x).

Expenses at time of first premium: 75% of the premium plus $10

Expenses at time of other premium pmts: 10% of premium plus $2
Settlement expense of $20 at time of death benefit payment.

Given 𝑎̈ 𝑥 = 16.5133 , Ax = .06528, compute the expense-augmented premium

per $1000 of death benefit.

Note: I really don’t like MQR’s solution. It’s not at all efficient. Don’t do annuity-immediate
solutions, splitting off t = 0 from other expenses.

Example 7: DHW (2e) Example 6.6, modified*.

Consider a fully discrete* 25-year endowment insurance on [30].

 Initial expenses are $2000 plus 50% of the first premium.

 Renewal expenses are 2.5% of each subsequent premium.
 Sum insured (DHW’s term for amount of death /endowment benefit) of
$100,000.

Calculate the gross premium G using i = .05 , 𝑎̈ [30]:25⌉ ̅̅̅̅̅ = 14.73113 ,

and the relationship between 𝑎̈ [30]:25⌉
̅̅̅̅̅ and 𝐴[30]:25 .

(Note: Get 𝐴[30]:25 = .2985176 .)

*DHW’s version has a discrete premium stream but a moment-of-death benefit but an annual
discrete premium stream. So you have to find the EPV of the benefits using another method, e.g.
life tables.
 81

Funding a benefit that returns premiums paid, without interest:

Example: MQR (5e) Example 9.9

A discrete whole life insurance is issued to (x).

The failure benefit is 1000 plus the return of net annual premiums without
interest.

Calculate the net annual premium, given

Ax = .42898, (IA)x = 6.16761, i = .05 .

Variance of the loss-at-issue r.v.

Consider a whole-life policy on (x) with death benefit (DHW: Sum insured) of B.

Recall the relationship between the p.v. random variables for annuities-due and death benefits
(amt = 1) on (x):

Theorem: Var[0L] = ___________________________

Learn this proof:

Remark: A similar theorem holds for the fully continuous setting. Replace d by δ and add
“bars” as appropriate. The proof is the same.
 82

HW: ∙ Read DHW Chapter 6 (try to get the gist of what’s going on, don’t keep too much track
of looking things up on the various tables.)
∙ Read MQR section 9.7 in detail (Moodle).
∙ Do MQR (5e) Exercises 9.10 (9.10: use death benefit $1), 9.12, 9.26, and SOA #172:

Calculate the amount of each annual benefit premium.

Answer: 3363.
 83

DHW (2e) 6.8/MQR (5e) 9.3

The Premium Percentile Principle
Example 1:
Technique for computing variance of a linear combination of Z = “AKx”= 𝑣 𝐾𝑥 +1 and 𝑎̈ ̅̅̅̅̅̅̅̅
1+𝐾𝑥 ⌉ :

A special life annuity product pays income of C at the beginning of every year and a death
benefit of B at the end of the year of death. Find an expression (in terms of Ax , 2Ax , and d ) for
the variance of the present value of the payments made to the insured under this product.

Two ways to set premiums (there are others):

 Equivalence principle
 Portfolio premium percentile principle

Key math facts in play:

 E[∑ Xi] =

 Var[∑ Xi] = …if…

 CLT: If {Xi | i = 1, … , n} are pairwise independent and n is large, then

W = ∑ Xi ≈ normal.
 84

Example 2: MQR Example 9.5

Consider a portfolio of n whole life insurance contracts with $1 death benefit and annual
premium P = .025 (which has not necessarily been determined by the equivalence principle.)
Using the normal approximation, determine the minimum number of contracts to be issued to
independent lives all age x so that the probability of a positive loss on the collection of contracts
does not exceed .05.

Use Ax = .24905 , 2Ax = .09476 , i = .06 .

a. As a preliminary step, define the single-policy PV of loss r.v. in terms of the

corresponding insurance and annuity r.v.’s.

b. Find E[Li] and Var[Li], where Li is the loss on policy #i.

c. Compute the expected value and variance for the sum W of the losses.

d. Determine n as indicated in the problem.

 85

For the next example:

(12)
 Note that 𝑎̈ [30] denotes EPV of a monthly annuity paid at a rate of $1 per year.
(12)
 Therefore, 12𝑎̈ [30] = EPV of annuity paid at rate $12/year ⇔ $1 / month.
(12)
 So π × 12𝑎̈ [30] = EPV of annuity paid at rate (π × 12) / year ⇔ π / month.

Example 3: (DHW 2e Example 6.12b)

An insurer issues whole life policies to select lives aged 30. The sum insured
of $100,000 is paid at the end of the month of death, and level monthly premiums
are payable throughout the term of the policy.

 The interest rate is 5% per year.

 Initial expenses: 15% of the total (i.e. without interest) of the first year’s
premiums
 Renewal expenses: 4% of every premium, including those of the first year.
(12) (12)
 You determine that 12𝑎̈ [30] = 227.065 and 100,000 𝐴[30] = 7,866.18 and
(12) (12) 2
that 2𝐴[30] − (𝐴[30] ) =.0053515 .
 The portfolio has 10,000 identical, independent policies

Determine the premium π such that the probability of a positive loss for the
portfolio is 5%.

(DHW: “…the probability that the future loss on the portfolio is negative is 95%.”)

a. As a preliminary step: Write a mixture of English/math to define the PV of future

loss random variable for policy # i : Li.

b. Find expressions for E[Li] and Var[Li].

c. Let W = ∑ Li be the p.v. of loss on the portfolio. Find E[W], Var[W], and
Determine π.
 86

This line of reasoning can be used to answer other questions about aggregated quantities:

Example 4:

ans: 1.43 million

 87

HW DHW 6.8: Read DHW 6.7 (esp. “simple illustration” paragraphs at beginning) and
part d of Example 6.10. Read DHW 6.8. Then do…

Answers:
#24: 27
#72: 281
#209: 1296.39
 88

DHW 7, MQR 10 – Reserves part 1

Exerpts from the SOA November 2013 Notation Document (applies to 2014 MLC)
 89

Other differences:
DHW MQR SOA
Net Premium to fund insurance of $1:

Gross (Expemse-augmented) Premium:

Death benefit/sum insured:

 90

DEFINITIONS FOLLOWING MQR5E CH.10 & 11; OTHERWISE FOLLOWING DHW PRESENTATION :

Definition 10.2 & 11.20: The time-t reserve tV is defined to be the conditional expected
value (with money valued at time t) of future losses, given that contract is still in force at time t.

That is, with all money valued at time t,

tV = E[tL | (x) is alive at time t ] = E[ tL | Kx ≥ t ]

= E[Value at time t of future benefits and (if considered) expenses] – E[Premiums]

We include all time-t cash flows in these time-t expected values.

 Net premium reserve: MQR: tV DHW: tVn

 Net premium reserve: always computed under the equivalence principle, ignoring
expenses. May have to (re-)compute a net premium if a different premium is given.
 Expense-augmented/gross premium reserve: MQR: tVG, DHW: tVg
 The tL’s (Lt’s) can be decorated with superscripts in a similar manner.
 DHW terminology: “policy value” – suggestive of a savings account.

If the equivalence principle is used to set premiums, and if the reserving assumptions
(mortality/interest rate) are the same assumptions as those used in setting the premium, then we
have 0V = _____________
 91

Reserves as liabilities
It can be useful to think of a reserve as if it is a savings account that helps the insurer to fund
what will occur later.

DHW Notation: note to CJW: Comment on SOA/MQR notational differences

All subscripts refer to time of cash flows, valued in the time-value-of-money sense at the
time of the subscript.

Main idea:
The sum of tV and the time-t premium, less time t expenses, will carry forward at interest for one
year and fund whatever needs to happen at time t + 1.

 If [x] + t dies during the year (t, t + 1)—occurs with probability q[x]+t —then the value tL
at time t of the loss is…

 If [x] + t dies during the year (t, t + 1)—occurs with probability p[x]+t —then the value tL
at time t of the loss is…

Taking expectaions (E[tL | not dead] = tV by definition):

𝑡𝑉 = 𝐸[𝐿t ] = 𝑞[𝑥]+𝑡 𝑣(𝑆𝑡+1 + 𝐸𝑡+1 ) + 𝑝[𝑥]+𝑡 𝑣 𝐸[𝐿

⏟ 𝑡+1 ] + 𝑒𝑡 − 𝑃𝑡
𝑡+1 𝑉

Rearranging and annotating:

In English:
 92

Finally, an example of a reserve computation.

Example 1: MQR (5e) Example 9.8, 11.5

Consider a fully discrete whole life policy on (x).

Expenses at time of first premium: 75% of the premium plus $10

Expenses at time of each subsequent premium: 10% of premium plus $2
Settlement expense of $20 at time of death benefit payment.

a. Recast the expense structure in terms of expenses that occur at the beginning of every
year (including at t = 0) plus additional expenses that occur only at t = 0.

b. Given 𝑎̈ 𝑥 = 16.5133 , Ax = .06528, we compute the expense-augmented premium

for a $1000 death benefit as follows:

c. Find an expression for the t-th gross premium reserve, using the same mortality and
interest basis as that of the premium computation.
 93

Example2: DHW (2e) 7.2

Important note: The net premium reserve computation implicitly uses the
net premium as determined by the equivalence principle,
even if another premium is actually charged by the insurer.
Solution (b):

HW: Read DHW Sections 7.1, 7.3.1 (through & incl. solution to 7.1(b), esp. last two eq’ns
concerning 10V and 11V). Read p.181 “Speaking generally” paragraph & p.182 “The insurer
will…” paragraph. Read 7.3.2, 7.3.3 (Assume that you have read Ax’s and 𝑎̈ 𝑥 ’s, etc. from a life
table.) (After break: 7.3.4, 7.3.5, 7.6-7.9. Skip 7.4-7.5 until MA 398.)
 94

Reserves – Part 2 – (Prospective) Reserves and Retrospective Benefit Reserves

Recall: tV = expected present value (at time t) of future losses (losses stemming from future time
periods)
(i.e. benefits + expenses (for gross prem. reserves) – premiums),
given that the policy remains in force at time t

Example 1:

Consider a special fully discrete 4-year term insurance policy of 10,000 on (60).

Net (benefit) premiums are due at the beginning of each year.

All of the premiums are equal, except for the first premium, which is half of the others.

Use ℓ60 = 1000, ℓ61 = 998, ℓ62 = 994, ℓ63 = 985, ℓ64 = 974

Our goal is to determine the time t = 2 net reserve 2V.

a. As a first step, we figure out the amounts of the equivalence principle net
premiums.

Note that these must be computed from the “t = 0” perspective; premiums

are contractually set at the very beginning of the contract, not at the point in
time that reserving decisions are made.

b. Compute 2V using the same interest and mortality assumptions (or “basis”) as in
(a).
 95

Example 2:

Consider a 10-year endowment insurance contract on (60) with death and maturity
benefits of 10,000.

a. Show how to determine the premium from a life table that gives the values of
Ax , 𝑎̈ 𝑥 , and 10Ex.

b. Find 8V in terms of the premium and the values on the life table.

By taking the view that a large homogeneous pool of insureds contributes their individual
premiums to a big fund that pays out benefits, we might take the “expected savings account
value” view and consider tV to be the expected per-remaining-policyholder share of the account
value. (The actual experienced per policy amount “saved up” is called the asset share. If we
restrict our attention to net premiums and net reserves only, and if we compute expected amounts
“saved up”, that expected amount it is called the retrospective benefit reserve. Cf. DHW Section
7.7.)

Retrospective benefit reserve:

tV
retro
= E[time-t value of premiums] – E[time-t value of previous benefits],
conditional upon policy being in force ((x) still alive!) at time t.

To get the time-t expected value of the money with the correct probability conditioning,
we divide the corresponding time-0 quantities by tEx.

Example 3: Show how to compute the retrospective net benefit reserve at time 8 for the policy
in Example 2 above.
 96

Remarks (See especially DHW Section 7.7—note that DHW uses “policy value” when
SOA uses “reserve”)

1. Theorem:
If
 The premiums are determined using the equivalence principle, and
 the same basis (e.g. interest, mortality, etc.) is used to compute the
equivalence principle premium, tVprospective and tVretro,
then
prospective
tV = tVretro.

2. From SOA’s 2014 MLC Study Note:

Thus, the Theorem (#1 above) holds for net premiums on the MLC exam
but not necessarily for gross premiums.

3. From DHW 2e Example 7.15: The retrospective [net premium reserve] offers an
efficient calculation method at the start of a contract, when premium changes will
occur later. The prospective approach is more effective at later points in time,
when changes are in the past.
 97

DHW2e Examples 7.15-7.16

A fully discrete whole life policy on (40).

Death benefit for first five years = $5000.
Death benefit for subsequent years = $100,000.
Premiums are paid for a maximum of 20 years.
The premiums increase by 50% after the initial five-year period (i.e. beginning with the t = 5
premium.)

a. Let π = premium during the first 5 years. So 1.5π = later premiums.

Show how to compute π using standard quantities from a life table.

b. Assuming the assumptions in Theorem (Remark #1) hold, show how to compute 4V using
the retrospective method.

c. Show how to compute 20V using the prospective method.

 98

HW: Read DHW 2e Example 7.15 closely and skim Example 7.16. If you have the 1st edition,
I’ll post it on Moodle (remind me!) Also do the following problems:

Answer: –204.12

Answer: 50.51
 99

SOA #274, 275: For a special fully discrete whole life insurance on (x), you are given:

Calculate qx+2 and also calculate the net premium reserve at the end of year 4 (i.e. 4V).
Answers: .09125, 101.05
SOA Written #10

Answers: a. 31,111 ; b. 32,499 ; c. .401 ; d. 17,617

 100

Reserves Part 3 – Modified & Full Preliminary Term Reserves (DHW 7.9)

Some definitions:

 For today, let πg and πn be the gross and net premiums for a policy that has a level
premium structure. Let tVg and tVn denote the reserves.

 The difference πg – πn is called the expense loading or expense premium; notation πe.
(So this is the additional amount that must be added to πn in order to cover expenses.)

 The difference tVg – tVn is called the expense reserve; notation tVe (DHW: expense
policy value).

 Note that tVe = EPVtime t[expenses for future contract periods less expense premiums]
given in-force policy.

 DHW 2e notes that, if expenses were incurred as a level sum at each premium date, then
πe would equal those expenses (result: tVe = 0). However, if expenses are weighted to
the start of the contract (normally the case), then πe will be greater than the renewal
expense.
 101

DHW 2e Example 7.17: Consider a whole life policy on [50], sum insured = $100,000, funded
by level premiums payable throughout the term of the contract.

 The DHW life table is used to get Ax’s and 𝑎̈ 𝑥 ’s.

 Initial expenses: 50% of gross premium + $250
 Renewal expenses for subsequent premiums: 3% of gross premium + $25

a. Restate the expense structure in the usual way.

b. Compute πg , πn ,and πe. (Using life table, will get 1435.89, 1321.31, 114.58).
c. Compare πe to the dollar amount of the t = 0 expenses and to the dollar amount of
expenses for the subsequent premiums.

d. Compute 10Vg , 10Vn , 10Ve (Using life table, get 13,645.98 ; 14,416.12; –770.14).
Note that 10Vn is the greatest of these values (future gross premiums do more than
covering future losses and expenses), so 10Ve is negative.

Definition: The negative expense reserve is referred to as the deferred acquisition cost
(DAC).
 102

Remark from DHW 2e, Section 7.8:

Negative policy values arise when a contract is poorly designed, so that the value of benefits in early
years exceeds the value of premiums, followed by a period when the order is reversed. If the policyholder
lapses, then the policyholder will have benefitted from the higher benefits in the early years without
waiting around to pay for the benefit in the later years. In fact, the policyholder may be able to achieve
the same benefit at a cheaper price by lapsing and buying a new policy—“lapse and re-entry.”

SOA Study Note for Spring 2014 MLC:

Main idea of modified reserves:

 Insurer computes a gross premium and contractually agrees that the policyholder will pay
this amount. Let’s say it’s a level premium πG. There is also an actual net premium πN
that forms a portion of the gross premium.
 The insurer pretends (for the purpose of reserving only—this does not change what the
customer actually pays) that a different (nonlevel) net premium structure is in place.
 The actual πN and the “pretend” nonlevel net premium structure should both have an
expected present value that funds the expected benefits. That is, they are actuarially
equivalent net premiums.
 The “pretend” nonlevel net premium is used to set the actual reserves tVmod (or tVFPT).

Full Preliminary Term Reserves

In FTP reserving, The “pretend nonlevel net premium” described above is calculated in the
following particular way:
 We pretend that two policies are sold instead of one policy.
 The first policy is sold to [x] at time t = 0. It is a one-year term policy and has its own
premium. (This is a pretend premium—[x] doesn’t need to know about this.)
 If [x] lives for a year, then a whole life policy is sold to ([x]+ 1). This second policy is
funded by a level net premium determined at time t = 1 and based only on benefits paid
for time periods occurring beyond t = 1.
 [x] actually pays the gross premium (no pretending) set in the contract, but the insurer
sets all tV’s equal to EPVtime t[future net losses under nonlevel “pretend premium”
structure].
 Notation: tVFPT.
Example DHW 2e 7.18: Consider the same policy from Example 7.17 (sold to [50] $100,000
death benefit.)
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a. Compute the “pretend” FPT premiums, which we will denote by 1 𝜋[50] and 𝜋[50]+1 .
(DHW notation 1P[50] and P[50]+1)

(Compare to πG ≈ 1436, πN ≈ 1321, time t = 0 expenses 964, other years’ expenses 68)

Remark: We have 1 𝜋[50] + 1 𝐸[50] 𝜋[50]+1 𝑎̈ [50]+1 = 𝜋 𝑁 𝑎̈ [50] (where πN is the level net
premium)

b. Compute the FPT reserve at times 0, 1, 2, 10. Compare to the corresponding net and
gross premium reserves. (Comparison is scanned on next page.)
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Comparison:

↑↑
Typos: The [50]+1 ’s for the A’s and a’s (but not P’s) at time 2 should all be 52 ’s.

At time 10:

Note: FPT reserving is only one type of modification to the net reserve; there are many other
variations.

Remark (DHW 2e p. 230): The FPT method implicitly assumes that the whole first year
premium is spent on the cost of insurance (for that year) and the acquisition expenses. In this
case, that assumption overstates the acquisition expenses slightly.

HW: Reading: DHW 2e section 7.9 (if you have 1e, use downloadable supplement section
2.3).

SOA problems to do are listed at the end of this handout.

Also read and think about the SOA written question (#17) and its solution on the next page of
this packet. You may need to fill in some of the algebra details on your own in the solution
sketch.
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Solution:
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Do these problems:

Tip: You know d and annuity values, so you also know Ax’s.
You know v and q80, so you also know about 𝑎̈ 81 and hence A81.

Answer: 350 (might need to round to nearest 10)

Answer: –27. Does it make sense to you that this should be negative?
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DHW (2e) Section 7.3.4 Analysis of surplus (profit and loss by source)

DHW (2e) Examples 7.3/7.8

[60] puchases a fully discrete (cash flows at beginnings/ends of years) 20-year endowment
insurance:

 Death benefit = maturity benefit = $100,000

 The contract is funded by a premium of $5200, payable for at most 10 years.

Assumptions for reserve computations (“reserve basis”/DHW: “policy value bases”):

 Expenses: 10% of first premium, 5% of subsequent premiums, plus $200 on payment of

the death or maturity benefit.

The following values have been computed from a life table, using 5% for the premium basis.:

a. Compute 0V and 5V. Note that 0V ≠ 0. This is not uncommon, as the assumptions (e.g.
the life table used, interest rate assumed, etc.) used for reserving is often based on more
conservative assumptions than the corresponding assumptions used for setting premiums.
(“Reserve basis” versus “premium basis” assumptions.) Get 2023; 29067.11

b. In a similar manner, we could compute 6V = 35324.45 .

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c. π = 5200, DB = 100,000, 5V = 29067.11, 6V = 35324.45

Assume throughout that the actual reserving has been done (for better or worse) according to the
computations of 5V and 6V that were performed at time t = 0.

(DHW p. 199: “If the insurer’s assets were worth less (resp. more) than this, then losses (resp. profits) have been
made in previous years. These do not concern us—we are concerned only with what happens in the 6 th year [5,6].”)

Comparison of experience to reserve basis assumptions:

Experience Assumptions
Expenses 6% of (t = 5) premium 5% of each premium
+ $250 for for pmt of death + $200 for pmt of death
benefit (t = 6) benefit
Interest earned for t ∈ [5, 6] 6.5% of all assets 5% of all assets
Mortality 1 death out of ℓ65 = 100 lives 100 q65 = .5914587 (life table)

(i.) Assets at time 5, immediately after receiving premiums/paying

premium-related expenses:

(ii.) Assets associated with the end of the time period t ∈ [5, 6]; i.e. after paying
the death benefit and setting aside reserves for the remaining 99 policies:
Note: There is a 100th reserve 6V, but that reserve no longer needs to be saved—it
can be released and used to help fund the benefit for the death that occurred.

Thus, it looks like the insurer has made a profit in the sixth year of 18,848.
(Note: DHW’s gives 18,919, which is actually correct. The rounded off data does not add up
properly at this step.)
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Comparison of experience to reserve basis assumptions:

Experience Assumptions
Expenses 6% of (t = 5) premium 5% of each premium
+ $250 for for pmt of death + $200 for pmt of death
benefit (t = 6) benefit
Interest earned for t ∈ [5, 6] 6.5% of all assets 5% of all assets
Mortality 1 death out of ℓ65 = 100 lives 100 q65 = .5914587 (life table)
5V = 29067.11, 6V = 35324.45, π = 5200, death ben. = 100,000
Idea: Start with reserving assumptions. Then change one thing at a time (and leave it changed) according to
experience, assessing impact of each change.
Assets(xexper, yexper, zexper) – Assets(xassumption, yassumption, zassumption)
= [Assets (xexper, yassumption, zassumption) – Assets (xassumption, yassumption, zassumption) ]
+ [Assets (xexper, yexper, zassumption) – Assets (xexper, yassumption, zassumption) ]
+ [Assets (xexper, yexper, zexper) – Assets (xexper, yexper, zassumption) ]
*Think about adjusting one light switch at a time—how does each successive adjustment contribute to the total
change in the lighting of the room?
(iii.) We add one “difference” at a time* to break down the $18919 profit:
∘ Profit from interest: Assume experience matches assumptions, except for interest. Compare
experienced amount of interest to interest assumptions.

∘ Profit/loss from expenses: Assume experienced interest but expected mortality. Compare
experienced expense amount to expense assumptions.

∘ Profit/loss from mortality: Assume experienced interest and expenses. Compare the
experienced costs resulting from death to costs expected based on mortality assumptions.

Conclusions—how to report our findings “in English”:

 Profit of 51,011 attributable to interest.
 Loss from expenses, allowing for actual interest rate but allowing for the expected mortality, was
5568. (Or profit from expenses, allowing… was –5568.)
 Loss from mortality, allowing for actual interest and expenses, was 26524 (profit –26524).
Observe that 51,011 + –5688 + – 26524 = 18919, a profit.
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(iv) We could choose to do the analysis of profit by source in a different order:

Comparison of experience to reserve basis assumptions:

Experience Assumptions
Expenses 6% of (t = 5) premium 5% of each premium
+ $250 for for pmt of death + $200 for pmt of death
benefit (t = 6) benefit
Interest earned for t ∈ [5, 6] 6.5% of all assets 5% of all assets
Mortality 1 death out of ℓ65 = 100 lives 100 q65 = .5914587 (life table)

5V = 29067.11, 6V = 35324.45, π = 5200, death ben. = 100,000

∘ Loss from expenses allowing for assumed interest rate and expected mortality:

∘ Profit from interest, allowing for actual expenses but expected mortality:

∘ Profit from mortality, allowing for actual expenses:

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Homework:

1. Repeat the analysis of profit by source in the previous page (iv) by considering
profit from mortality, then interest, then from expenses.

2. SOA problems 304-305. Some notes:

 These two examples deal with an annuity income product.
 Note that the payments to the policyholders and the expenses occur at the end of the
year—this is a little different than what we’re used to with insurance products.

Answer: #304: –9900

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In #305, you’ll need to compute 10V. Reserves are calculated from assumptions (you don’t have
experience yet when you’re doing reserving.) Use the recursion

[t-1V + (time (t – 1) premium) – (time (t – 1) expenses)] × (1 + iassumption)

=
px+t – 1 ⋅ (insurer costs if alive, including setting up tV) + qx + t – 1 ⋅ (costs if died)

In #305, the time (t – 1) = 9 premium received and expenses paid out, associated with year
[9, 10], are both 0: There is no premium and the expenses for this period are t = 10 expenses.

The “costs if alive” in the above recursion includes both the anticipated $50 expense per policy
and the $1000 payout per life.

Answer: #305: 10V = 10,721.88; gain from mortality = 26563.76