Morsmos, Vol. 5, No. 2, 2001, pp.

37{50

Monte Carlo approa h to insuran e ruin

problems using onjugate pro esses 
Luis F. Hoyos-Reyes
1

Abstra t
In this paper is dis ussed a simulation method developed by S.
Asmussen alled onjugate pro esses whi h is based on a version
of Wald's fundamental identity. With this method it is possible
to simulate within nite time risk reserve pro esses with innite
time horizons. This allows us to onstru t Monte Carlo estimators
for the ruin probability, whi h is one of the main problems in
insuran e risk theory. Some examples of the Poisson/Exponential
and Poisson/Uniform ases are presented.

2000 Mathemati s Subje t Classi ation: 60K30, 65C05.

Keywords and phrases: Conjugate pro esses, Monte Carlo estimators,
risk reserve pro ess, ruin probability, Wald's fundamental identity.

1 Introdu tion
One of the main problems in insuran e risk theory is to estimate the
ruin probability [1-8,11℄. It an be roughly des ribed as follows.
The risk reserve pro ess over (0; t℄ is the dieren e between a pre-
mium deterministi pro ess u + t and the a umulated laims Zt (a
ompound Poisson pro ess), for some given initial apital u  0 . The
premium in ome rate is xed by the insuran e ompany and is in-
dependent of t. The idea is to study the behavior of the risk reserve
pro ess that models the a umulated apital over nite or innite time
 Resear h partially supported by a CONACyT s holarship. This paper is part of

the author's M. S . Thesis presented at the Divisi

on de Cien ias B
asi as e Ingenier
a,

UAM-Iztapalapa.
1
Professor at Departamento de Sistemas, UAM-Az apotzal o.

37
38 Luis F. Hoyos-Reyes

horizons, in parti ular the probability that exists a moment  when the
risk pro ess is negative. This is alled the ruin probability.
The main purpose of this paper is to introdu e Monte Carlo esti-
mators (MCEs) for the ruin probability in innite time horizon using
onjugate pro esses. This approa h allows us to simulate within nite
time a risk reserve pro ess with innite time horizon. Here, we onstru t
a MCE for the ruin probability using the empiri al distribution of the
ruin events after a suÆ iently large number of simulations. Some ex-
amples of the Poisson/Exponential (P/E) and Poisson/Uniform (P/U)
ases are presented.
This paper is organized as follows. We begin in x2 by introdu ing
basi terminology and notation. In x3 we show a formulation for the
onjugate pro ess and onstru t the MCEs. In x4 we ompute exam-
ples of the P/E and P/U ases. Finally, x5 presents some on luding
remarks.
2 Preliminaries
Assumption 2.1
(a) The laims arrive a ording to a Poisson pro ess fNtgt0 with
intensity  and inter laim times fTt gt1 .
(b) The laim sizes X1; X2 ; : : : are i.i.d nonnegative random variables
with a nite mean .
( ) Xi and fNt gt0 are independent.
Denition 2.2 The a umulated laim pro ess is Zt := Nn=0 Xn for
P t

t  0, with X0 := 0.
We next re all the lassi al risk reserve pro ess [2,7,8℄.
Denition 2.3 Let u be the initial apital and > 0 be the premium
in ome rate.
We dene the risk reserve pro ess
Yt := Zt t; t 2 (0; 1);
and the time to ruin
 := inf ft > 0 : Yt > ug :
 Insuran e ruin problems 39

Denition 2.4 A family (F )2 of distributions on R is alled a on-

jugate family if the F are mutually equivalent with densities of the
form
dF
(1) dF0
(x) = exp f( 0 )x h0 ()g

and if for some xed 0 2  the parameter set  ontains all  2 R for
whi h (1) denes a probability density for some h (). 0

Then, by denition, P := P is the probability law of the pro ess Yt .

0
In addition, 0 < 0 is the solution of
0 X ( 0 ) = =;
 
where X ( ) := E eX is the moment generating fun tion of X . This
denition of 0 allows us to hoose the sign of E Yt as we prove below
(Proposition 2.7).  
Also note that  ( ) = E eX = X ( ).
0 0
Equation (1) implies that h () is given in terms of the umulant
0
generating fun tion of F by 0

h0 () := log E0 e( 0 )X :

The a umulated laim pro ess Zt is a ompound Poisson pro ess, so

its moment generating fun tion [2℄ is

(2) Zt ( ) = et(X () 1) :

Proposition 2.5 Let ; 0 2  with  6= 0 . Then

  0 ( +   0 )
  ( ) = :
  0 (  0 )

Proof: Using (1)

40 Luis F. Hoyos-Reyes

Z 1 x
  ( ) = e dF (x)
1
Z 1 x e( 0 )x
= e dF (x)
1 E0 e( 0 )X 0
= ((+   )0) :
0

0 0

Proposition 2.6 logEeYt

t = (X ( ) 1)  .
Proof: By denition of Yt , we an see that

EeYt = Zt ( )=e t :
Hen e, from (2) we have
EeYt = et(X () 1)  t :
Applying the log fun tion to both sides of the latter equation and di-
viding by t, ompletes the proof. 
Now from Proposition 2.5
E eZt = E e(+  )Zt =E e(  )Zt :
0
0
0
0

Using (2)
E eZt = et (  )( () 1) ;
0 0

whi h implies that under P , Zt is also a ompound Poisson pro ess with
arrival rate  =  ( 0) and laims distribution F . Therefore,
0
repla ing E with E in Proposition 2.6 we obtain

(3) log Et e =  ( ( ) 1)

Yt
 = 0 ( 0 )(0 ( ) 1)  :

Proposition 2.7 If 00X exists in an interval I that ontains 0, then

 := E Yt > 0 when  > 0
and

 < 0 when  > 0:

 Insuran e ruin problems 41

Proof: Let  ( ) := log Et eYt , so that from (3)

 ( ) =  ( ( ) 1)  :
In parti ular, if  = 0,
0 ( ) =  ( ( ) 1)  ;
0 0

and taking  = 0 we have

0 (0 ) = 0 ( 0 ) :
0 0

On the other hand, re alling that  ( ) = X ( ), we get

0

0X ( 0 ) = = = 0 ( 0 ); 0

whi h yields
0 ( 0 ) = 0:
0

Also, for all  2 I

00 ( ) = 00X ( ) = E (X 2 eX ) > 0;
0 0

so that 0 is a lo al minimum, and  (
) is onvex on I .

0
Now let  2 . Then Proposition 2.5 implies
 ( ) =  ( +  0 )  ( 0 );
0 0

and, therefore,

(4) 0 (0) = 00 (  0 );

and, moreover,
0 ( ) = 0X ( +  0 ):
On the other hand,
0 ( ) = (E Yt eYt )=E eYt ;
and so
0 (0) = E Yt =  :
42 Luis F. Hoyos-Reyes

Using (4)
 = 0 (
0
 0 );
and
0 = 00 ( 0 ) = 0:
The last two equalities and the onvexity of  (
) yield the desired
0
on lusion. 
3 Monte Carlo estimators
Our main purpose in this se tion is to estimate the ruin probability
onsidering an innite time horizon for the risk reserve pro ess. We
rst introdu e some denitions.
Denition 3.1 Let u and  be as in Denition 2.3. The ruin probabil-
ity in nite time is
(u; T ) := P ( < T );
and the ruin probability in innite time is
(u) := P ( < 1):

The premium in ome rate is usually taken as

= (1 + )EZt =t:
As Zt is a ompound Poisson pro ess, is independent of t. The number
 is alled the safety loading, and is related to the apital expe ted
growth as follows.
Proposition 3.2 If  > 0, then P ( < 1) = 1.
Proof: Under the law P , Zt is a ompound Poisson pro ess with
Nt s Poisson( ) and laim sizes Xi s F . Therefore

E (Zt ) =  tE X:
 Insuran e ruin problems 43

Applying the strong law of large numbers to the a umulated laim

pro ess yields

(5) lim 1 (Zt  tE X ) = 0 a.s.

t!1 t

Now, from Proposition 2.7 we have E (Zt t) > 0 and, therefore,  < 0,
and using (5)

lim 1t (Zt
t!1
 tE X  tE X ) =  E X > 0 a.s.
This implies
(Zt  t(1 + )E X ) ! +1 a.s.;
whi h ompletes the proof. 
Consider a onjugate family (F )2 governing a random walk fSt gt0
in dis rete or ontinuous time. Dene FT := (St ; t  T ), with the usual
extension to stopping times.
Next, we present the version of the Wald's fundamental identity used
by Asmussen [1,2℄. The proof an be seen in [3℄.
Theorem 3.3 Let  be a stopping time for fSt gt0 and G 2 F , G 
f < 1g. Then for ea h 0;  2 

(6) P0 G = E [exp f(0  )S   (0 )g ; G℄ :

From Denition 2.3 and (6)

dP0
(7) dP
= exp f(0 )Y  ( 0 )g ;

and integrating (7) over f < 1g we an express the ruin probability

in innite time as

(u) = E [(exp f(0 )Y  ( 0 )g)
I f < 1g℄ :

44 Luis F. Hoyos-Reyes

Proposition 3.4 Let  > 0. If we ompute n simulations of the on-

jugate pro ess

R := exp f(0 )Y  ( 0 )g ;

then with probability 1

1X
n
Ri ! (u) as n ! 1;

n i=1

where Ri is the nal value of the realization of the onjugate pro ess
after simulation i (i = 1; 2; : : : ).

Proof: By Proposition 3.2 the ruin o urs almost surely, and so ea h

of the n simulations of R an be performed in a nite number of steps.
Moreover, as
= (u);
E R
by the strong law of large numbers it follows that, with probability 1,
1X n
Ri ! (u) as n ! 1: 

n i=1

We all n1 Pni=1 Ri a Monte Carlo estimator (MCE) for (u).

Observe that integrating (7) over f < T g we an write the ruin
probability in a nite time T as

(u; T ) = E [(exp f(0 )Y  ( 0)g)
I f < T g℄ :

Then, in this ase, the orresponding onjugate pro ess is
RT:= exp f(0 )Y  ( 0)g
I f < T g ;
and so we ould onstru t an analogous MCE for (u; T ).
Remark 3.5 (a) Observe that if  = 0, then RT = I f < T g. Thus
to simulate RT is equivalent to simulate the original pro ess Yt ,
0

whi h, in insuran e terminology is alled a rude simulation [7,8℄.

0
 Insuran e ruin problems 45

(b) We an simplify RT taking  as the Lundberg value 1 := +

0 , where > 0 is the unique solution of Lundberg's equation
 ( ) = 0. In this ase, RT is alled the Lundberg pro ess.
0
Using Proposition 2.7 one an see that  (0 1) = 0, whi h
1
1
implies that
= exp( Y )
I f < T g :
RT1
Therefore, taking
> 0,  = (1 +
)
1 and using Theorem 3.3
we obtain the following expression:

(8) RT1 (1+
) = exp f ( + 1
)Y +  (1
)g
I f < T g :

1

( ) In (b), the orresponding varian e 2 = Var RT is

21 (1+
) = E1 [exp f 2( + 1)Y +  (1
)g
I f < T g℄ 2(u; T );
1

and for the innite horizon ase is

21 (1+
) = E exp f 2( + 1)Y +  (1
)g 2(u):

1 1

(d) The overshot B (u) of the risk pro ess, dened as B (u) := Y u is
useful to al ulate 2 . It is known [1,2℄ that when the laims are
exponentially distributed and the arrival pro ess is Poisson (P/E
1

ase), B (u) is exponentially distributed:

(9) P (B (u) > b) = exp( b=E X ):

4 P/E and P/U examples

4.1 Example P/E

The Poisson/Exponential ase has been extensively resear hed [1-5℄ be-
ause it is easy to al ulate the ruin probability for the innite time
46 Luis F. Hoyos-Reyes

horizon. It is a well known fa t [5℄ that if the safety loading  is posi-

tive, then

(u) = 1 +1  exp (1u+ ) :

 
(10)
Let us onsider the P/E ase with  := EX = 1,  = 0:8,  = 0:1
and T = 1. The right-hand side of (10) depends on the initial apital
u. Let (u) = 0:05. Then the initial apital is u = 31:904, and the
premium in ome rate is = (1 + ) (remember that we deal with a
ompound Poisson Pro ess Zt ).
We solve the Lundberg equation for using Proposition 2.6:
 ( ) = (X ( ) 1) = 0:
0

Then = 0 is the trivial solution, and the other solution is

= ( )= = 0:0909:
Now we al ulate the varian es:

20 = E I 2f < 1g

0 E20 I f < 1g = (u) 2(u) = 0:0475

21= Var R = Var e T = Var e (u+B(u)) = e 2 Var e B(u) :

1 1 1 1 1

From (1), E X = (1 ) 1 , whi h together with (9) implies that

1
B (u) s exp(1 ). Thus

E1 e 2 B(u) = (1 )=(1 + ) and E 1 e B (u) =1 :

Hen e,
= e 2 u 11 + (1 )2 = 2:08  10 5 < 2 :
 
21 0

Note that the dieren e between the varian es is signi ant, whi h is
an statisti al advantage [9℄ to onstru t onden e intervals for (u).
To show some numeri al results, let  = 1,  = 0:8,  = 0:1, = 0:88.
>From Proposition 2.6, we an see that Nt is a Poisson pro ess with
arrival rate , and X is exponentially distributed with parameter = .
 Insuran e ruin problems 47

Moreover, = 0:0909, 0 = 0:0488 and 1 = 0:0421.

One an ompare the theoreti al results versus the Monte Carlo
estimators (MCEs) in Table 1, where

Table 1: Innite Time Horizon P/E

u n (u) ^ (u) MCE SMCE "R
31.9 100 0.05 0.0498 4:5  10 4 5:00  10 4 4:0  10 3
31.9 1000 0.05 0.0499 1:4  10 4 1:41  10 4 2:0  10 3
16.7 1000 0.20 0.1997 5:7  10 4 5:90  10 4 1:5  10 3

MCE := 2=n
1=2 is the standard error of the MCE, SMCE is the

orresponding estimator, and the relative error is
"R :=j 1 ^ (u)= (u) j :
Noti e the good tness between the standard error MCE and its esti-
mator SMCE . Obviously, we have better aproximations to (u) taking
larger samples be ause the MCEs are onsistent.
4.2 Example P/U

Let us assume that the laims size distribution is uniform over (0; 1).
First of all, we need to nd the distibution F , and then we have to
show an expression for the onjugate pro ess RT (1
) . From (1)
1

e(  )x 1
F (x) =  
1 ; 0 < x < 1:
0

e 0

Re all that under P , Zt is also a ompound Poisson pro ess with pa-
rameter
 
 = e +
1 =( + 1
):
1

From Proposition 2.6 and (8) we obtain that in the nite horizon ase,
and letting 0 := + 1
,
! !
e +1 1
(11) RT1 (1+
) = exp 0 Y + 
0
1 0
I f < T g;
whereas in the innite time horizon
48 Luis F. Hoyos-Reyes

! !
e +1 1
(12) R1 (1+
) = exp 0 Y + 
0
1 0 :

Let = 0:05. Then from Lundberg's equation

e 1

1 = 0;
we get = 0:508439. Moreover, simple omputations show that 0 =
0:025078 and 1 = + 0 = 0:024922.
Unfortunately, there are no theoreti al results for the P/U ase, so
we annot ompare the real and the estimated values like we did under
the P/E assumptions. However, it is possible to estimate the varian e
of the onjugate pro ess and to ompute the estimator SMCE of the
standard error; see Table 2.

Table 2: Innite Time Horizon P/U

^ (u) ^2 SMCE
1.00 0.199 1:5  10 2 1:2  10 2
0.10 0.223 6:2  10 4 2:5  10 3
0.05 0.220 9:9  10 5 9:9  10 4
0.00 0.220 4:2  10 6 2:0  10 4
The omputations were made with n = 100, and u = 30.
Observe that the best estimation o urs when
= 0, whi h is on-
sistent with the asymptoti optimality proved by Asmussen [2℄.
5 Con luding remarks
In the previous se tions we have introdu ed MCEs for the ruin probabil-
ity using onjugate pro esses. In parti ular, we have shown formulations
for the onjugate pro ess under the P/U assumptions for both nite (11)
and innite (12) time horizons.
The P/U ase has not been dis ussed enough in the literature, and
so it is suitable for the simulation approa h.
Finally it is important to mention two main advantages of the MCEs
using onjugate pro esses: (i) the relative simpli ity of the formulation,
 Insuran e ruin problems 49

and (ii) the minimum omputational resour es needed ompared with

the diusion approa h [1,2℄, and the martingale approa h [6℄.
A knowledgement
The author is grateful to Dr. Onesimo Hernandez-Lerma for his
valuable omments and useful suggestions.
Luis F. Hoyos-Reyes

Departamento de Sistemas ,

UAM - Az apotzal o,

Av. San Pablo No. 180,

02200 M
exi o D.F., MEXICO,

hrlf orreo.az .uam.mx.

Referen es
[1℄ Asmussen, S., Approximations for the probability of ruin within
nite time, S andinavian A tuarial J. 20 (1984), 31-57.
[2℄ Asmussen, S., Conjugate pro esses and the simulation of ruin
problems, Sto hasti Pro esses and their Appli ations 20 (1985),
213-229.
[3℄ Asmussen, S., Applied Probability and Queues, Wiley, Chi hester,
U.K., 1987.
[4℄ Asmussen, S. and Rolski, T., Computational methods in risk the-
ory: A matrix-algorithmi approa h, Insuran e: Mathemati s and
E onomi s 10 (1991), 259-274.
[5℄ Beard, R.E., Pentikainen, T. and Pessonen, E., Risk Theory,
Chapman and Hall, New York, 1984.
[6℄ Dassios, A. and Embre hts, P., Martingales and insuran e risk,
Commun. Statist.-Sto hasti Models 5 (1989), 181-217.
[7℄ Embre hts, P., Sto hasti Modelling in insuran e, CLAPEM-IV
Pro eedings, Mexi o City 1990.
[8℄ Embre hts, P. and Wouters, P., Simulating risk solven y, Insur-
an e:Mathemati s and E onomi s 9 (1990), 141-148.
[9℄ Ross, S.M., Sto hasti Pro esses, Wiley, New York, 1983.
[10℄ Ross, S.M., A Course in Simulation, Ma millan, New York, 1990.
50 Luis F. Hoyos-Reyes

[11℄ Tijms, H.C., Sto hasti Models, An Algorithmi Approa h, Wiley,

Chi hester, U.K., 1998.