MID-YEAR EXAMINATIONS 2009

Unit: Date: Time Allowed:

ACST151 Introduction to Actuarial Studies Thursday June 18, 2009 at 9:20 am 3 Hours plus 10 minutes Reading Time

Total Number of Questions: 8 Instructions: Answer ALL questions. The total number of marks is 100. The total value of each question is shown in parenthesis at the beginning of the question. The value of each sub-section of a question is shown after each sub-section. Use four (4) answer books (marked A, B, C and D) as follows: In answer book marked write your answer(s) to Question(s) A 1 and 2 B 3 and 4 C 5 and 6 D 7 and 8

Materials permitted: No dictionaries permitted. Non-programmable calculators (no text retrieval capacity) permitted.

PLEASE ANSWER QUESTION 1 and QUESTION 2 in BOOKLET A. Question 1 [12 marks] (a) Insurance customers are required to display utmost good faith. What does this mean? What are the consequences if a customer does not display utmost good faith? [2 marks] (b) Long term life insurance contracts often include non-forfeiture provisions. Explain how non-forfeiture provisions work. [2 marks] (c) In the context of life insurance, what does twisting mean? [2 marks] (d) In general insurance, what are IBNR claims? [2 marks] (e) In general insurance, what is the Unearned Premium Reserve? [2 marks] (f) Is the following statement True or False ? If False, write the correct definition. The Incurred Claims for a Year is equal to Claims Paid in the year, plus Claims Outstanding at the Start of the Year, less Claims Outstanding at the End of the Year. [2 marks] Question 2 [12 marks] (a) Joe is in a dangerous job and has a probability of death of 5% per month. If deaths occur at mid-month on average, what is the Joes life expectancy (in months)? [4 marks] (b) Joe is currently uninsured. At the end of each month, a life insurance salesman will come and visit Joe and try to persuade him to buy a policy. If Joe is uninsured at the start of the month: there is a 5% chance he will die during the month while uninsured there is a 10% chance he will buy insurance at the end of the month there is no probability that both events will occur in the same month The premiums on the policy are due at the end of every month, to pay for the next months insurance cover.. Joe is rather careless and sometimes he forgets to pay the premium. The insurance company instantly cancels the policy if he does not pay. If Joe is insured at the start of the month: there is a 5% chance he will die during the month while insured there is a 20% chance his insurance will be cancelled at the end of the month there is no probability that both events will occur in the same month What is the probability that Joe will die while uninsured? [8 marks]

PLEASE ANSWER QUESTION 3 AND QUESTION 4 in BOOKLET B. Question 3 [14 marks] Kevin is an actuarial assistant who works in a small general insurance company. He has been asked to provide advice about the calculation of the risk premium and the probability of ruin for the insurer. In order to do this he has collected past data and analysed it, built a model for the claim frequency and claim size, and run simulations of future experience. Based on past data, Kevin thinks that the number of claims for one policy follows a Poisson distribution with expected value 3. And he thinks that the following table represents the claim size distribution for each claim. Claim Size $100 $150 $320 $400 Probability 0.4 0.3 0.2 0.1

(a) What is the risk premium for one policy? [3 marks] (b) What is the probability that a policy will have exactly two claims, with total cost $250? [3 marks] (c) What is the probability that total claims on any policy will exceed $280 in any year? [5 marks] (d) Suppose that the company buys reinsurance with a retention limit of $200 on each claim, so that the reinsurer pays the excess for any claim above $200. What would be the expected value of the annual claim cost payable by the reinsurer? [3 marks]

Question 4 [10 marks] The information provided in the previous question relates to this question also. Kevin has decided to use a spreadsheet to simulate the claims for one policy for five years. A copy of the spreadsheet is shown on the next page. (a) First he sets up a lookup table for the number of claims, which is a Poisson (3) random variable. What is the EXCEL command in cell A10 ? [2 marks] (b) Then he uses random number to generate the number of claims for one policy for one year. What is the EXCEL command in cell C20? [2 marks] (c) Then for each claim, he generates a random number to determine the claim size for that claim. What is the EXCEL command in cell C22? [3 marks] (d) Then he calculates the total claim costs for the policy for one year. What is the EXCEL command in cell C33? [1 mark] (e) Finally he checks to see how many years (out of 5 years) had total claims exceeding $500. What is the EXCEL command in cell G35? [2 marks]

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

A B C D Simulation of Claims Experience for One Policy

17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

Table for Number of Claims Cumulati ve Number Distributi on of Claims 0.00000 0 0.04979 1 0.19915 2 0.42319 3 0.64723 4 0.81526 5 0.91608 6 0.96649 7 0.98810 8 0.99620 9 0.99890 10 The possibility of more than 10 claims can be ignored (too small). Year 1 Number of Claims in year Claim No 1 2 3 4 5 6 7 8 9 10 Total 4 150 100 100 150 0 0 0 0 0 0 500 Year 2 4 100 150 150 150 0 0 0 0 0 0 550

Table for Size of Claim Cumulati ve Number Distributi of on Claims 0.00000 100 0.40000 150 0.70000 320 0.90000 400 1.00000

Year 3 2 320 150 0 0 0 0 0 0 0 0 470

Year 4 4 100 400 100 320 0 0 0 0 0 0 920 2

Year 5 1 100 0 0 0 0 0 0 0 0 0 100

Number of Years Claims Exceed $500

PLEASE ANSWER QUESTION 5 and QUESTION 6 in BOOKLET C. Question 5 [19 marks] For the following question, use the life table given in the table below, where l(x) represents the number of men alive at exact age x.

Age x
50 51 52 53 54 55 56 57 58 59

l(x)
96,891 96,638 96,362 96,058 95,724 95,357 94,950 94,500 94,000 93,445

Age x
60 61 62 63 64 65 66 67 68 69 70

l(x)
92,826 92,137 91,366 90,507 89,550 88,482 87,295 85,975 84,511 82,888 81,096

(a) Alex is a male aged 60. He has two brothers, twins who are aged 55. What is the probability Alex will survive to age 70, and at least one of his brothers will be alive to attend his birthday party? You may assume independence of mortality risks. [4 marks] (b) A life insurance company is selling endowment assurances with a 4-year term, to male customers aged 60. Interest is assumed to be 5% per annum. The sum insured is $10,000. i. What would be the single premium for this policy? [5 marks] ii. What would be the annual premium (payable at the start of each year of the 4-year policy)? [5 marks] iii. Two years have gone by, (time t = 2) and the premium for the third year has just been paid. The economy has deteriorated and the actuary now believes that future interest rates will be just 2% instead of 5%. What is the prospective reserve for each policy that is still in force ? [5 marks]

Question 6 [8 marks] Actuaries build models for various purposes such as setting premiums and calculating reserves. The process for building a model involves: Setting out the objectives Developing an understanding of the process which is being modelled Choosing a model Collecting data Fitting the model (estimating parameters) Checking the goodness of fit of the model After using the model to solve a problem, the actuary should carefully consider possible sources of error, i.e. factors which might affect the reliability of the answers. Describe the main sources of error which should be considered.

PLEASE ANSWER QUESTION 7 and QUESTION 8 in BOOKLET D. Question 7 [13 marks] (a) A charity provides support for children in a poor country. Each donor is asked to contribute money to cover educational expenses for one child from age 5 to age 16. The first contribution of $100 is payable on the childs fifth birthday; then there are more contributions on each birthday up to and including the sixteenth birthday. The amount increases in line with inflation, at 5% per annum compound. Mary wants to put a lump sum in a bank account now (i.e. on the childs fourth birthday) which will be sufficient to pay all future educational expenses. The bank account earns interest at 6% per annum. Assuming that all children survive and remain in the school program, what is the present value of future payments? [6 marks] (b) Unfortunately many children drop out of school before age 16. Suppose that each year, 4% of children drop out of the program. That is, there are 100 children in the program at age 5 there are 96 children in the program at age 6 there are 92.16 children in the program at age 7 and so on. Once a child drops out of the program, then he/she is not entitled to any more annual payments. Allowing for the expected drop-outs, what is the present value of expected future payments for one child who is currently age 4 exactly? [7 marks] Question 8 [12 marks] Ferranzia is a small developing country which does not have any insurance legislation. In the last few years, problems have arisen because some insurance companies have become insolvent. Some companies were deliberate frauds, simply collecting premiums and then stealing the money. Others were just very badly managed in different ways. The Prime Minister has asked your advice. What legislation would you recommend, to help create a more stable insurance industry in Ferranzia? List your recommendations.

END OF EXAMINATION