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ARCH-MLC

ARCH-MLC Fall 2009 SOA MLC by Yufeng Guo, ASA This electronic book is intended for individual

Fall 2009 SOA MLC

by Yufeng Guo, ASA

This electronic book is intended for individual buyer use for the sole purpose of preparing for Exam MLC. This book can NOT be resold to others. No part of this publication may be reproduced for resale or multiple copy distribution without the express written permission of the author.

Copyright Notice and Disclaimers

This manual is ©2009 by Yufeng Guo. All Rights Reserved.

This manual (and any portion thereof) may not be reproduced in any form without express written permission from the author.

The author of this manual makes no warrant that this manual is free from errors. I will post an errata on my website (www.archactuarial.com). Please let me know of any errors you may find at yufeng_guo@msn.com. Under no theory of law will the author be liable for any amount greater than the purchase price of this manual.

Arch MLC: Spring 2009

Yufeng Guo

December 17, 2008

Chapter 0

Feature of Arch MLC Manual

Cover everything in the SOA MLC syllabus.

Thorough explanation of the core concepts with worked out problems

Reference to Actuarial Mathematics and Models for Quantifying Risk . You can use either textbook as a companion to go with Arch MLC.

Low Cost: $99. For $99, you bring a quality study manual home.

No shipping charge. Good saving for international exam candidates.

Convenience. After you buy Arch MLC PDF, you can print a hard copy. You can also install the PDF in your computer.

PDF has detailed bookmarks for quick reference.

PDF has a clickable table of contents for quick reference.

Contents

0 INTRODUCTION

9

The origin of Arch Manual

9

Praises of the Arch Manual originally written by Nathan and Robin

10

About Yufeng Guo

10

How to use this manual

11

1 ACTUARIAL MATHEMATICS: CHAPTER 3 SURVIVAL DISTRIBU- TIONS AND LIFE TABLES

13

3.2.1 The Survival Function

15

3.2.2 Time-until-Death for a Person Age x

16

3.2.3 Curtate-Future-Lifetime

19

3.2.4 Force of Mortality

20

3.3-3.5 Life Tables

21

3.5.2

Recursion Formulas

27

3.6 Assumptions for Fractional Ages

28

3.7 Some Analytical Laws of Mortality

33

Modified DeMoivre’s Law

35

3.8

Select and Ultimate Tables

35

Conclusion

38

CHAPTER 3 Formula Summary

39

Past SOA/CAS Exam Questions:

43

Problems from Pre-2000 SOA-CAS exams

56

Solutions to Chapter 3

58

2 ACTUARIAL MATHEMATICS CHAPTER 4 – LIFE INSURANCE

61

4.2

Insurances Payable at the Moment of Death

62

TYPES OF INSURANCE

63

 

4.2.1 Level Benefit Insurance

63

4.2.2 Endowment Insurance

66

4.2.3 Deferred Insurance

68

4.2.4 Varying Benefit Insurance

70

4.3 Insurances Payable at the End of the Year of Death

73

4.4 Relationships between Insurances Payable at the Moment of death and the

End of the Year of Death

79

CHAPTER 4 Formula Summary

81

Past SOA/CAS Exam Questions:

83

3

Chapter 0

Problems from Pre-2000 SOA-CAS exams

93

Solutions

95

3 ACTUARIAL MATHEMATICS: CHAPTER 5 LIFE ANNUITIES

97

5.2

Continuous Life Annuities

97

The most important equation so far(!)

100

5.3 Discrete Life Annuities

106

5.4 Life Annuities with m -thly Payments

112

CHAPTER 5 Formula Summary

116

Continuous Annuities:

116

 

Discrete annuities:

117

Past SOA/CAS Exam Questions:

118

Problems from Pre-2000 SOA-CAS exams

131

Solutions to Pre-2000 Problems: Chapter 5

133

4 ACTUARIAL MATHEMATICS: CHAPTER 6 BENEFIT PREMIUMS 135

6.2 Fully Continuous Premiums

136

6.3 Fully Discrete Premiums

142

6.4 True m -thly Payment Premiums

147

CHAPTER 6 Formula Summary

151

Past SOA/CAS Exam Questions:

152

Problems from Pre-2000 SOA-CAS exams

168

Solutions to Pre-2000 Exam Questions: Chapter 6

170

5 ACTUARIAL MATHEMATICS: CHAPTER 7 BENEFIT RESERVES 173

7.2 Fully Continuous Benefit Reserves

174

7.3 Other Methods for Calculating the Benefit Reserve

177

1) Prospective Formula

177

2) Retrospective Formula

177

3) Premium Dierence Formula

180

4) Paid-Up Insurance Formula

180

5) Other Reserve Formulas

181

7.4 Fully Discrete Reserves

183

7.5 Benefit Reserves on a Semi-Continuous Basis

186

7.6 Benefit Reserves Based on True m-thly Benefit Premiums

187

CHAPTER 7 Formula Summary

188

Continuous Reserve Formulas:

188

Discrete Reserves:

188

Past SOA/CAS Exam Questions:

190

Problems from Pre-2000 SOA-CAS exams

194

Solutions to Pre-2000 Questions: Chapter 7

196

6 ACTUARIAL MATHEMATICS: CHAPTER 8 ANALYSIS OF BENEFIT

RESERVES

197

8.2 Benefit Reserves for General Insurances

197

8.3 Recursion Relations for Fully Discrete Benefit Reserves

202

8.4 Benefit Reserves at Fractional Durations

205

Chapter 0

8.5

The Hattendorf Theorem

208

CHAPTER 8 Formula Summary

212

Chapter 8 More Formulas

213

Past SOA/CAS Exam Questions:

214

Problems from Pre-2000 SOA-CAS exams

234

Solutions to Pre-2000 Problems: Chapter 8

237

7 ACTUARIAL MATHEMATICS: CHAPTER 9 MULTIPLE LIFE FUNC-

TIONS

241

9.2

Joint Distributions of Future Lifetimes

241

9.3

Joint Life Status

243

The following is important!

243

9.4

Last Survivor Status

248

9.5

More Probabilities and Expectations

250

9.6

Dependent Lifetime Models

253

9.6.1

Common Shock –(Non-Theoretical Version)

253

9.7

Insurance and Annuity Benefits

256

9.7.1 Survival Statuses

256

9.7.2 Special Two-Life Annuities

262

9.7.3 Reversionary Annuities

263

9.9

Simple Contingent Functions

265

CHAPTER 9 Formula Summary

268

Past SOA/CAS Exam Questions:

270

Problems from Pre-2000 SOA-CAS exams

283

Solutions to Pre-2000 Exam Questions: Chapter 9

285

8 ACTUARIAL MATHEMATICS: CHAPTER 10 MULTIPLE DECREMENT

MODELS

287

10.2 Two Random Variables

287

Probability density functions:

289

10.3 Random Survivorship Group

292

10.4 Deterministic Survivorship Group

292

10.5 Associated Single Decrement Tables

296

 

10.5.1

Basic Relationships

297

10.5.4

Uniform Distribution Assumption for Multiple Decrements

298

10.6 Construction of a Multiple Decrement Table

300

CASE I : Two decrements that are uniformly distributed in the asso- ciated single decrement table

300

CASE II : Three decrements that are uniformly distributed in the as- sociated single decrement table

300

CASE III : Multiple decrements – some are uniformly distributed in the associated single decrement table and some are

300

CHAPTER 10 Formula Summary

305

Past SOA/CAS Exam Questions:

307

Problems from Pre-2000 SOA-CAS Exams

317

Solutions to Pre-2000 Problems: Chapter 10

320

Chapter 0

9 ACTUARIAL MATHEMATICS: CHAPTER 11 APPLICATIONS OF MUL-

TIPLE DECREMENT THEORY

323

11.2 Actuarial Present Values and Their Numerical Estimation

323

11.3 Benefit Premiums and Reserves

324

CHAPTER 11 Formula Summary

327

ARCH Sample Exam Problem

327

Solution:

327

Past SOA/CAS Exam Questions:

329

10 ACTUARIAL MATHEMATICS: CHAPTER 15 INSURANCE MODELS

INCLUDING EXPENSES

335

15.2

Expense Augmented Models

335

15.4

More Expenses

338

15.6.1 Asset Shares

341

CHAPTER 15 Formula Summary

343

Asset Shares

343

Past SOA/CAS Exam Questions:

343

SOLUTIONS to Past SOA-CAS Exam Problems:

347

11 DANIEL CHAPTER 1 - MULTI-STATE TRANSITION MODELS FOR

ACTUARIAL APPLICATIONS

351

1.1 Introduction

351

1.2 Non-homogeneous Markov Chains

354

CHAPTER 2 – CASH FLOWS AND THEIR ACTUARIAL PRESENT VALUES 359

Section 2.1 Introduction

359

Cash Flows while in states

359

Cash Flows upon transitions

364

Actuarial Present Values

364

ARCH Warm-up Questions:

369

Solutions

372

Past SOA/CAS Exam Questions:

375

12 DANIEL STUDY NOTE ON POISSON PROCESS

385

5.3 The Poisson Process

385

5.3.1 Counting Processes

385

5.3.2 Definition of the Poisson Process

386

5.3.3 Interarrival and Waiting Time Distributions

387

5.3.4 Further Properties of Poisson Processes

389

5.3.5 Conditional Distribution of the Arrival Times

392

5.4 Generalizations of the Poisson Process

393

5.4.1 Nonhomogeneous Poisson Process

393

5.4.2 Compound Poisson Process

395

5.4.3 Conditional or Mixed Poisson Processes: Gamma-Poisson Model 398

CHAPTER 5 Formula Summary

401

ARCH Warm-up Problems:

402

Solutions:

403

Past SOA/CAS Exam Questions:

404

Chapter -1

13 ARCH Practice Exam

417

Answer Key for Practice Exam

430

14 SOLUTION TO MAY 2007 MLC

449

Chapter -1

Chapter 0

INTRODUCTION

The origin of Arch Manual

The Arch Manual was originally written by two gifted actuaries, Nathan Hardiman and Robin Cunningham.

In the late 90’s, Nathan Hardiman and Robin Cunningham worked full-time at the former Je erson Pilot Financial. Nathan and Robin, like other exam candidates, faced the daunt- ing challenge of plowing through di cult textbooks and mastering the fundamentals of life contingency theories and probability models to pass the Course 3 exam, the most di cult of the four preliminary actuarial exams and the exam with the highest failure rate.

The di culty of Course 3 was mainly due to its enormous scope. Candidates were required to read encyclopedia-like textbooks such as Actuarial Mathematics and Probability Models, gain sophisticated understanding of complex concepts such as multiple decrements, Markov Chain, Brownian motion, and be ready to tackle tricky word problems on the exam.

Since Nathan and Robin both already had families and full-time jobs when they began study- ing for exams, they created their own study framework and philosophy for quickly passing Course 3. After passing the exam in one sitting using their unique study methods, Nathan and Robin decided to jointly write a new study guide that would enable candidates to build a core body of knowledge for Course 3 quickly. They wanted their manual to use straight talk and down-to-earth examples to explain di cult fundamental concepts intuitively and simply.

Nathan and Robin published the first edition of their study manual for Course 3 in 2001. They named their study manual the Arch-3. Since its publication, Arch has been a popular study manual for Course 3 and Exam M.

Arch’s power lies in its simplicity. While textbooks talk fancy, Arch talks simple. While textbooks rigorously prove theorems, Arch explains the intuition. While textbooks demand attention to everything, Arch separates the critical from the trivial.

While Arch sells well, Nathan and Robin climbed corporate ladder higher and higher. With

9

Chapter 0

each day passing, they have less and less time to keep up with the SOA’s syllabus changes. Finally, in fall, 2006, Nathan and Robin decided to withdraw from the Arch manual business and passed on the copyright and ownership of Arch M manual to Yufeng Guo, who is the author of Deeper Understanding manuals for Exam P, FM, and M.

Nathan and Robin’s contribution to actuarial education was not just the Arch manual but more importantly the Arch’s e ective teaching style. Before Arch was published, many thought that learning di cult things such as Course 3 ought to be slow and painful. Arch’s straight talk and down-to-earth examples showed the actuarial community that learning di cult actuarial theories can indeed by fast-paced and enjoyable.

Praises of the Arch Manual originally written by Nathan and Robin

-I am a huge fan of ARCH. It is by far the best study manual and I am recom- mending it to all of my friends. I actually bought [several other manuals]. Now I think I wasted a whole set of money on the others since they always end up confusing me and I always have to come back to ARCH for clarification.

-I start a seminar on Friday, and I never would have been able to finish and understand the material without your study guide.

-I want to personally thank both of you for the fantastic and brilliant work that you did on ARCH. Seeing as it’s not my first time tackling this exam, I’ve had the chance to use [several other manuals]; however this is by far superior to all of those products. I have and will continue to recommend it to others in my company.

-I would first like to say that I am very happy with your manual so far. I feel that I am progressing through the syllabus much faster than I would have without it, and the depth of understanding that I am on my own giving up due to my not using the texts themselves is more than compensated for by the excellent coverage of the important topics in your manual.

About Yufeng Guo

Yufeng Guo was born in central China. After receiving his Bachelor’s degree in physics at Zhengzhou University, he attended Beijing Law School and received his Masters of law. He was an attorney and law school lecturer in China before immigrating to the United States. He received his Masters of accounting at Indiana University. He has pursued a life actuarial career and passed exams 1, 2, 3, 4, 5, 6, and 7 in rapid succession after discovering a successful study strategy. Mr. Guo’s exam records are as follows:

Chapter 0

Fall 2002

Passed Course 1

Spring 2003

Passed Course 2,3

Fall 2003

Passed Course 4

Spring 2004

Passed Course 6

Fall 2004

Passed Course 5

Spring 2005

Passed Course 7

Study guides by Mr. Guo:

Deeper Understanding, Faster Calc: P

Deeper Understanding, Faster Calc: FM

Deeper Understanding, Faster Calc: MLC

Deeper Understanding, Faster Calc: MFE

Deeper Understanding, Faster Calc: C

Guo’s Solution to Derivatives Markets: Exam FM

Guo’s Solution to Derivatives Markets: Exam MFE

In addition, Mr. Guo teaches online classes for Exam P, FM, MFE, and MLC. For details see http://www.guo.coursehost.com and http://www.myactuaryexam.com. If you have questions, you can email Mr. Guo at yufeng guo@msn.com.

FAQ

I notice you have two study guides for MLC: Arch MLC and Deeper Understanding MLC. What’s the dierence? Which one should I buy?

Dierence: Arch MLC focuses on thoroughly explaining the core concepts. Deeper Under- standing MLC focuses on teaching conceptual insights and calculation shortcuts.

Which one to buy: If money is not an issue, consider buying both. If you want to buy only one guide, choose the one that better fits your need. For example, if you already have a study guide and want to learn calculation shortcuts, buy Deeper Understanding: MLC. If your goal, on the other hand, is to master basic concepts, buy Arch MLC.

How to use this manual

The ARCH manual is designed and written in such a way as to help you learn the material as e ciently as possible. The material for the course is broken down into dierent chapters from the textbooks. The chapters are presented using down-to-earth explanations. In addition, I point out the critical concepts and formulas most likely to be tested.

Each chapter of this manual contains plenty of examples with solutions. You are likely to benefit a great deal if every time you get to an example, you cover up the solution and

Chapter 0

attempt to work it. You will get many of them wrong, especially the first time you see them. But the problem-solving experience will be extremely valuable!

On the exam, you will not be asked to explain anything. You will be asked to calculate numerical answers. Therefore, much of our explanation of the material is done by way of numerical examples and practice questions. Examples range from very simple ones (to make sure you know the basic concepts), to thought provoking ones (to help you think about what you’ve learned and really understand it), to exam questions from prior exams (to get you ready for exam day).

I also suggest problems from the texts for you to work. Many of the problems in the

text are not transferable to the exam. Some, however, provide useful insight and prac- tice. Solutions to these suggested problems are available on the Download Samples page at

www.archactuarial.com.

A formula summary for each chapter is included. These summaries are intended to serve as

a reference as you familiarize yourself with the syllabus material.

Finally, there’s a full length practice exam of new questions. This practice exam is designed

to

be used in conjunction with the prior Course 3 and Exam M problems in the SOA website

at

www.soa.org. Make sure you work all of these exams!

All materials contained herein are copyrighted by Yufeng Guo. This PDF study manual is for individual use for the sole purpose of taking Exam MLC. Reselling this manual is prohibited. Redistribution of this manual in any form is prohibited.

Please check www.archactuarial.com for errata and answers to suggested text exercises.

Chapter 1

ACTUARIAL MATHEMATICS:

CHAPTER 3 SURVIVAL DISTRIBUTIONS AND LIFE TABLES

Option A reference: Actuarial Mathematics Chapter 3

Option B reference: Models for Quantifying Risk Chapter 5,6

This text forms the heart and soul of the exam syllabus. The basic principles of life insurance (and annuities) are explained throughout the book. You need to have a solid understanding of this material in order to pass the exam. However, you do not need to understand the majority of the underlying theory in this text. The key points that a student must learn from this text are:

KEYPOINTS:

1. Notation – much of this notation is new. While it can be confusing at first, there is some logic to it. It will help you to remember and understand the many symbols if you regularly translate the notation into words as you read.

2. Basic ideas – for example, chapter four introduces a variety of types of insurance. You will want to make sure you have an understanding of these dierent products and their benefit designs. Another key point is that there are many parallels. Again in Chapter 4, the first part of the chapter considers products which pay a benefit immediately upon death. The second part of the chapter considers the same products except that the benefit is paid at the end of the year in which death occurs. It is helpful to realize that you are really learning only one set of products, with a couple of benefit options, rather than two sets of products. These parallels run throughout the text (e.g., continuous vs curtate functions).

13

Chapter 1

3. Learn key formulas – there is no substitute for being able to recall the formula for, say, a net level premium reserve for term insurance. If you can do this for most of the formulas, you will be ready to answer questions quickly. This manual has tools to help you learn these formulas, so don’t feel overwhelmed!

To the text!!!

Chapter 1

Chapter 3 is all about notation, definitions, and a few basic ideas that are essential to life contingencies. If you can make yourself comfortable with the symbols and methods of Chapter 3, the rest of Actuarial Mathematics will be easier to absorb.

3.2.1 The Survival Function

Option A reference: Actuarial Mathematics Chapter 3.2.1

Option B reference: Models for Quantifying Risk Chapter 5.1

Consider a newborn (i.e. a person whose attained age = 0).

Definitions X = newborn’s age at death You can also think of X as “the future lifetime of a newborn”.

Define F (x) = Pr (X x), where x 0. Read as “the probability that death will occur prior to (or at) age x”. In statistics, F (x) is the cumulative distribution function for the future lifetime of a newborn. If y>x , it is always true that F (y ) > F (x). This makes sense. For a newborn, F (98), the probability of dying before age 98, is greater than F (94), the probability of dying before age 94.

Define s(x)=1 F (X )=1 Pr(X x). The function s(x) is a survival function. Read it as “the probability that death does not occur by age x” or “the probability of attaining (surviving to) age x”.

Pr(x<X z ) =

probability that a newborn dies between ages x and z

= F (z ) F (x)

= [1 s(z )] [1 s(x)]

= s(x) s(z )

F(x) s(x) the pdf y=f(x) O x z
F(x)
s(x)
the pdf
y=f(x)
O x
z

The figure shows the probability distribution function f (x) for death at age x. For any value of x, F (x) is equal to the area under the curve y = f (x) and to the left of x. Similarly s(x) is equal to the area under the curve and to the right of x.

By the way, you may have noticed that in our discussion, we dropped the subscript X in

F X (x)

you can ignore it. I don’t know if the authors realize it but they are being a little

Chapter 1

inconsistent in their treatment of F and s! If two di erent random variables, say X and Y , referred to the future lifetimes of two dierent newborns, then you would need to keep the F and s straight for each kid. That’s all the subscript is indicating.

3.2.2 Time-until-Death for a Person Age x

Option A reference: Actuarial Mathematics Chapter 3.2.2

Option B reference: Models for Quantifying Risk Chapter 5.3

Newborns are great, but if our pension and insurance companies are going to make money we need to be able to deal with people who are older than 0. So

Consider a person with attained age = x. The simple F (x) and s(x) functions no longer work, since we are now dealing with a person who has already survived to age x. We are facing a conditional probability situation.

Pr(x<X z |X>x)

= probability that person living at age x will die between ages x and z

= the probability that an x-year-old will die before turning z

[F (z ) F (x)]

=

[1 F (x)] = [s(x) s(z )]

[s(x)]

Why is this a conditional probability? Because it is the probability that a newborn will die before age z given that the newborn survives to age x.

EXAMPLE:

1. Write two expressions (one with F only and one with s only) for the prob- ability that a newborn dies between 17 and 40, assuming the newborn dies between 10 and 40.

2. Interpret the following expression in English (or the language of your choice!).

SOLUTION:

1.

S (20) S (35)

1 S (80)

F (40) F (17) F (40) F (10)

or

s(17) s(40) s(10) s(40)

Chapter 1

2. “The probability of death between ages 20 and 35, given that the newborn

}

will not attain age 80.”

Now, let the symbol “(x)” represent a person age x and let T (x) be the future lifetime of a person age x. (So T (25) is the future lifetime of (25), a twenty-five-year-old.) Two basic probability functions exist regarding T (x):

t q x

t p x

=

probability that person age x will die within t years

=

Pr[T (x) t ] where t 0

=

probability that person age x will survive at least t years

=

Pr[T (x) > t] where t 0

q p t x t x Age x x+t
q
p
t
x
t
x
Age
x
x+t

In the figure, t q x is the probability that ( x)’s death will occur in the age-interval (x, x + t ), and t p x is the probability that ( x)’s death will occur in the age interval (x + t, ! ). ( ! represents the oldest possible age to which a person may survive.)

Useful notes:

t p 0 is just s(t ).

If t = 1, the convention is to drop the symbol 1, leaving us with either p x or q x .

Remember, these are the two basic functions. The formulas that follow are simply take-o s on t p x or t q x which you will learn with practice.

The symbol

t| u q x

represents the probability that (x) (that is, a person age x) survives at least t more years, but dies before reaching age x + t + u . This is equal to each of the following expressions, each of which you want to be able to put into words:

Pr[t<T (x) t + u ]

t+ u q x t q x

t p x t+ u p x

(As with q x and p x , if u = 1, we drop it, leaving t| q x , the probability that (x) will survive t years but not t + 1 years.)

Chapter 1

Useful formulas:

t| u q x

t p x = x + t p 0 x p 0

= s(x + t )

s(x)

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

s(x + t ) s(x + t + u )

=

=

s(x)

s(x + t ) s(x + t ) s(x + t + u )

s(x)

s(x + t )

= t p x u q x + t

This last equation makes sense. It says “The probability of ( x) dying between t and t + u years from now ( t| u q x ) is equal to the probability that ( x) will first survive t years ( t p x ) and then die within u years ( u q x + t ).” If you don’t remember anything else from the above, remember the following!

CONCEPT REVIEW:

t p x = s(x + t ) s(x)

1. Write the symbol for the probability that (52) lives to at least age 77.

2. Write the symbol for the probability that a person age 74 dies before age 91.

3. Write the symbol for probability that (33) dies before age 34.

4. Write the symbol for probability that a person age 43 lives to age 50, but doesn’t survive to age 67.

5. Write 5 | 6 q x in terms of F and then in terms of p .

SOLUTIONS:

1. 25 p 52

2. 17 q 74

3. q 33

4. 7 | 17 q 43

5.

5 | 6 q x = s(x + 5) s(x + 11) = F (x + 11) F (x + 5)

s(x)

1 F (x)

= 5 p x (1 6 p x +5 ) or = 5 p x 11 p x .

}

To help memorize symbols, practice translating symbols into words and express words in symbols. You can also make flash cards and quiz yourself.

Chapter 1

3.2.3 Curtate-Future-Lifetime

Option A reference: Actuarial Mathematics Chapter 3.2.3

Option B reference: Models for Quantifying Risk Chapter 5.3.6

Suppose a person born on Jan 1, 1900 died on Sept 30, 1990. How old was he at death? The true age was about 90.75 years old. The curtate age was 90. To find the curtate age, first find the true age. Next, throw away all the decimals and keep the integer. If there’s no decimal, then the curtate age is equal to the continuous (true) age. For example, if T (x) = 90, then K (x) = 90. (This book and others use ‘Curtate’ and ‘Discrete’ interchangeably.)

Previously, we defined T (x) to be the future lifetime of (x). This is a continuous function. Now we define

K (x) =

curtate future lifetime of (x)

= greatest integer in T (x)

= number of future years completed by (x) prior to death

= number of future birthdays (x) will have the opportunity to celebrate

A couple of formulas apply:

Pr(K (x) = k ) =

Pr(k T (x) < k + 1)

= Pr(k<T (x) k + 1)

= k p x

k +1 p x

= k p x q x + k

= k | q x

(Remember, the 1 in front of q has been dropped.)

EXAMPLE:

If s(x) = 100 x for every x, what is the probability that K = 19 for (18)?

100

SOLUTION:

Pr(K (18) = 19) = 19 | q 18 = s(37) s(18) s(38)

= 63 62

82

1

= 82 .

}

Chapter 1

3.2.4 Force of Mortality

Option A reference: Actuarial Mathematics Chapter 3.2.4

Option B reference: Models for Quantifying Risk Chapter 5.1.4

The force of mortality can be thought of as the probability of death at a particular instant given survival up to that time. This is an instantaneous measure, rather than an interval measure. There is good bit of theory in this section, but the most important items are the following formulas and the table of relationships.

µ(x) =

f (x) 1 F

(x) = s 0 (x) s(x)

(3.2 .13)

It is very important to know the relationships and requirements given in Table 3.2.1. These will probably be tested on the exam. Below is a summary of the useful information in this table. Each row shows 4 ways to express the function in the left column.

 

F (x)

s(x)

f (x)

 

µ(x)

 
 

x

 

F (x)

F (x)

1 s(x)

x

R f (u ) du

0

1 e R

0

x

 

µ ( t) dt

s(x)

1 F (x)

s(x)

1

R

x

f (u ) du

e R

0

µ ( t) dt

 

x

f (x)

F 0 (x)

s 0 (x)

f (x)

µ(x) e R

0

µ ( t) dt

µ(x)

F

s 0 ( x )

 

f

( x )

 

µ(x)

0 ( x x ) )

1 F (

s

( x )

s

( x )

EXAMPLE: Constant Force of Mortality

If the force of mortality is a constant µ for every age x, show that

1. s(x) = e µx 2. t p x = e µt

SOLUTION:

1.

2.

x

s(x) = e R

0

µ

dt = e µx .

t p x = s(x + t ) s(x)

= e µt .

}

Chapter 1

3.3-3.5 Life Tables

Option A reference: Actuarial Mathematics Chapter 3.3-3.5

Option B reference: Models for Quantifying Risk Chapter 6

Life Table is widely used actuarial practice. Even today, Life Tables are often loaded into systems for calculating reserves, premium rates, and the surrender cash value of an insurance policy. Learning Life Tables will not only help you pass Exam MLC, it also helps you when you become an actuary.

Definitions:

l 0 =

l i

!

number of people in cohort at age 0, also called the “radix”

=

number of people in cohort at age i (those remaining from the original l 0 )

=

limiting age at which probability of survival = 0 (s(x) = 0 for all x ! )

n d x = number alive at age x who die by age x + n

Relationships:

l

q

x

x

= l 0 s(x)

=

l

x

l x +1

l

x l x l x + n

n q x =

l

l x + n

x

n

n

p x =

d x = l x l x+ n

l x

Illustrative Life Table: Basic Functions

Age

l x

d x

1,000 q x

0

100,000.0

2,042.2

20.4

1

97,957.8

131.6

1.4

2

97,826.3

119.7

1.2

3

97,706.6

109.8

1.1

.

.

.

.

.

.

40

93,131.6

259.0

2.8

41

92,872.6

276.9

3.0

42

92,595.7

296.5

3.2

43

92,299.2

317.8

3.4

Chapter 1

EXAMPLE: Life Table Mortality

Above is an excerpt from the Illustrative Life Table in the book. The following questions are all based on this excerpt.

1. Find s(42).

2. Find 40 d 2 .

3. Find 38 q 3 .

4. Find 2 | q 40 .

SOLUTION:

1. s(42) = 92,595.7 = 0.925957.

100,000

2. 40 d 2 = l 2 l 42 = 5230.6

3. 38 q 3 = 1 38 p 3 = 1 l 41

l

3

= 1 97,706.6 92,872.6 = 0.04947 .

4. 2 | q 40 = 2 p 40 · q 42 = 92,595.7 (0.0032) = 0 .003182 .

93,131.6

}

Concepts which follow from the Life Table:

Based on Equation (3.2.13) on an earlier page, we can determine that the probability density function f (t ) for T (x) is given by f (t ) = t p x µ(x + t ). This says that the probability that (x) will die at age x + t , symbolized by f (t ), is equal to the probability that ( x) will survive t years and then be hit at that instant by the force of mortality. Among other things, this tells us that

Z

0

1

1

t p x µ(x + t )dt = Z 0 f (t )dt = 1.

The complete-expectation-of-life is the expected value of T (x) (or E [T (x)] for fans of Statistics) and is denoted e x . If you remember how to find the expected value of a continuous random variable, you can figure out that

1

e x = E [T (x)] = Z 0 t p x dt

Var[T (x)] = 2 Z 0 t · t p x dt x

e

1

2

(3.5.4)

The book shows how to figure both of these formulas out with integration by parts in Sec- tion 3 .5 .1. I suggest that you memorize these two expressions.

The median future lifetime of ( x) is denoted m(x) and simply represents the number m such that m p x = m q x . In other words, it is the number of years that (x) is equally likely to survive or not survive. It can be found by solving any of the following:

Pr[T (x) > m(x)] = 1

2

Chapter 1

or

or

s[x + m (x)]

s(x)

m p x = 1

2 .

= 1

2

The curtate-expectation-of-life is E [K (x)] and is denoted e x (no circle). To remember the dierence between e x and e x , remember “life is a continuous circle.” So a circle means continuous. e x = E [T (x)] and e x = E [K (x)].

Here are the formulas, note the Continuous/Curtate parallel:

e x = E [K (x)] =

1

X k p x

1

Var[K (x)] =

1

X (2k 1) · k p x e

1

2

x

EXAMPLE: Constant Force of Mortality

Find e 0 and e 50 if the force of mortality is a constant µ.

SOLUTION:

e 0 = Z 1

0

t p 0 dt = Z 1 e µt dt = 1

0

µ

e µt 1

0

e 50 = Z

0

1 t p 50 dt = Z

0

1

e µt dt = 1

µ

e µt

1

0

= 1

µ

= 1

µ

If the force of mortality is constant, your future expected lifetime is the same

}

whether you are 0 (a newborn) or 50.

EXAMPLE: DeMoivre’s Law for Mortality

(We’ll learn DeMoivre later in this chapter.)

If

s(x) = (

50 x

0

50

0 <x< 50 Otherwise

for all x between 0 and 50, find e 0 and e 45 .

SOLUTION:

e 0 =

50

X

1

t p 0 =

50

X

1

50 t

50

= 50 1

50

50

X

1

t

Chapter 1

e 45 =

= 50 1

50

(50)(51)

2

= 24.5

5

X

1

t p 45 =

5

X

1

s(45 + t )

s(45)

=

5

X

1

= 4+3+2+1+0

5

= 2.

5 t

5

}

More Life Functions:

The expression L x denotes the total expected number of years, full or fractional, lived between ages x and x + 1 by survivors of the initial group of l 0 lives. Those who survive to x + 1 will live one year between x and x + 1, contributing one full year to L x . Those who die during the year will contribute a fraction of a year to L x .

L x = Z

0

1

l x + t dt

The expression m x is the central death rate over the interval x to x + 1. Make sure not to confuse m x with m(x), the median future lifetime!

m x = (l x l x +1 )

L

x

L x and m x can be extended to time periods longer than a year:

n L x = Z

0

n

l x + t dt

n m x =

l x l x + n

n L x

The remaining of Section 3.5.1 has obscure symbols T x and (x). They rarely show up in the exam. Don’t spend too much time on them.

Let T x be the total number of years lived beyond age x by the survivorship group with l 0 initial members (i.e. the l x people still alive at age x). Be careful with notation. This is not T (x), the future lifetime of ( x).

1

T x = Z 0 l x+ t dt

(3.5 .16)

Note from the definitions that you can think of T x as 1 L x .

The final symbol is (x). It’s the expected death time given x dies next year.

Chapter 1

(x) = E [T |T < 1] = R

1

R

0

f

0

tf

( t) dt

( t) dt

1

= R

0

t t p x µ ( x + t) dt t p x µ ( x + t) dt

1

R

0

1

= R

0

R

0

t· l x+ t

l

x

1

µ

( x + t) dt

1

l

x+ t

x

l

µ

( x + t) dt

= R

0

t· l x+ t µ ( x + t) dt l x+ t µ ( x + t) dt

1

R

0

1

If UDD, then f (t ) = q x = c is a constant. Then (x) = R

1

R

0

0

t· cdt

cdt

1

= R

0

R

0

1

tdt

1

dt

1

= R tdt =

0

1

2 .

EXAMPLE: Constant Force of Mortality If l 0 = 1000 and the force of mortality is a constant µ = 0.1, find

(A)

(B)

(C)

L 5

m 5

T 5

Chapter 1

SOLUTION:

(A)

Since

L 5 = Z l 5+ t dt = Z 0 t p 5 l 5 dt.

0

1

1

l 5 = l 0 e µ · 5 = 1000e 0 . 5 = 606.5 ,

we have

1

L 5 = 606.5 Z e 0 . 1 t dt = 606.5 h 10e 0 . 1 t i

0

1

0

= 606.5 h 10(1 e 0 . 1 ) i = 577.16.

(B)

m 5 = l 5 l 6 = 606.5 548 .8

L

5

577

.16

= 0.10

This approximates the rate at which people were dying between the 5th and 6th years.

(C)

T 5 = Z

0

1

1000e 0 . 1(5+ t) dt = 606.5 Z

0

1

e 0 . 1 t dt = 6065

So if we add up all of the time lived by each of the people alive at t = 5, we

expect to get a total of 6065 years, or 10 years per person.

}

Relationship:

T x

l x

=

e

x

This relationship makes sense. It says that the average number of years lived, e x , by the members of l x is equal to the total number of years lived by this group divided by l x .

We can determine the average number of years lived between x and x + n by the l x survivors at age x as:

n

L x

l

x

n L x

l x

n

= Z 0 t p x dt

= n-year temporary complete life expectancy of (x)

e = x : n
e
= x : n

(p.71)

Chapter 1

3.5.2 Recursion Formulas

Option A reference: Actuarial Mathematics Chapter 3.5.2

Option B reference: Models for Quantifying Risk Chapter 6

These are basically ways to avoid working integrals. They are based on the Trapezoid Rule for integration – maybe you remember the trapezoid rule from calculus. Backward:

u (x) = c(x) + d (x) u (x + 1)

Forward:

u (x + 1) = u (x) c(x)

d

(x)

Note that the Forward Method is simply an algebraic recombination of the Backward Method. Note also that this Forward formula is dierent from the book – work out the formulas yourself to convince yourself of their equivalence. Then, learn whichever form you find more straightforward.

The text shows how to use these formulas to compute e x and e x starting with e ! and e ! and working backward. For e x , using the recursion once will produce e ! 1 , the second iteration will produce e ! 2 , etc. until you get all the way back to e 0 , when you will have produced a list of e x for every x between 0 and ! .

The formulas are: for e x ,

u (x) = e x

c(x) = p x

d (x) = p x

Starting Value = e ! = u (! )=0

So to start, set x +1= ! and the recursion will produce u (x) = u (! 1).

For

e x ,

u (x) =

e x

1

c(x) = Z 0 s p x ds

d (x) = p x

Starting Value = e ! = u (! )=0

Chapter 1

3.6 Assumptions for Fractional Ages

Option A reference: Actuarial Mathematics Chapter 3.6

Option B reference: Models for Quantifying Risk Chapter 6.5

(OK, you can start paying attention again