ACTSC 612: Life Insurance Mathematics 1

Assignment 3

<Due on November 27th, 2017>

Student Number: 20723532

Student Name: Shone Mousseiri

Group Partners: Maria, Eugene

Department of Statistics and Actuarial Science,

University of Waterloo
Question 1)

(a)

14 = 0

14 = 1
( = ) =
14 = 2

14 = 3

Define the net loss at issue random variable as:

0 = 1 +1
+1|

By the equivalence principle:

Set [0 ] = 0:
[ +1 ] =
+1|

=


1 +1
= +1 | =
=0
1 1 1 1 1
= + 2 + 3 + 4 =
4 4 4 4
1 = 2.36245027
= 4|0.06

4
1 1 (1.06)4
=
4 0.06
= 0.8662764

0.8662764
=
2.3645027
= 0.36668556
(b) Solving (0 > 0) = 0.25:
1 +1
(0 > 0) = +1 > 0


= +1 1 + >


= +1 >
+

= ( + 1) log > log
+

log
=
< + 1
; log() = log(1 + i) < 0
log

We also know:
( = 0) = ( < 1) = 0.25
So set:

log
1= + 1
log

2 log = log
+

2 =
+
2 = (1 2 )
2
=
1 2
For = 0.06:
1 0.06
1.062 1.06
max = 0.457959
1 1 2
1.06
(c) Assuming = 0.3667:

1 = [1 ] = +1 +1

+1 = +1 |+1
=0

1 1 1
= + 2 + 3
3 3 3
1 1 (1.06)3
=
3 0.06
= 0.891004

+1 = 1 + 2| + 3|
3
= 1.925596
= 0.706116

So 1 = [1 ] = 0.891004 0.706116 = 0.184888.

As expected because it is lower than the amount under the equivalence principle.
Question 2)

(a) Assume equivalence principle.

1[42] = 0.998735 0|[42] = 0.0012651

2[42] = 0.996697 1|[42] = 0.00203821

3[42] = 0.994307 2|[42] = 0.00238963

Set [0 ] = 0:
1000001:| :| = 0
1 :|
1000001:| = 0

31
:| = 1:| + :1|
1:| = +1 |
=0 :31| = 3
= 0|[42] + 2 1|[42] + 3 2|[42]
= 3 3
= 0.00522525
= 0.883935
1 :|
= 2.8818335

100000 0.00522525
=
2.8818335
= 181.3168596

(b)

100,000 ; 0|[42]+1
2
1 = 100,000 (1 + ) ; 1|[42]+1


(1 + ) ; 2[42]+1
 1[42]+1 = 0.9979592 0|[42]+1 = 0.00204080

2[42]+1 = 0.99556655 1|[42] = 0.00239265

[1 ] = (100,000 ) 0|[42]+1 + [100,0002 (1 + )] 1|[42]+1 (1 + ) 2[42]+1

100,000 100,000 1
= 181.3169 0|[42]+1 + 181.3169 1 + |
1.04 (1.04) 2 1.04 1 [42]+1
1
181.3169 1 +
1.04 2 [42]+1
= 95972.52925(0.00204080) + 92099.96123(0.00239265) 355.6600731(0.99556655)
= 62.1404

(1 ) = (1 ) = 1 2 61.14042

1 2 = (100,000 )2 0|[42]+1 + [100,0002 (1 + )]2 1|[42]+1

(1 + )2 2[42]+1

= 95972.529252 (0.00204080) + 92099.961232 (0.00239265)

+ 355.66007312 (0.99556655)
= 3.9218604859 107
Hence,
(1 ) = 6262.177474

(c)

Again, by assuming the equivalence principle, we have

0 = [42 ] = min[42] +1,3 181.316859642:3|

= [42]:| 181.316859642:3|

= 142:| + 3 42 181.316859642:3|

We know that
31
1:| = =0 +1 | = 0.00522525 and 3 42 = 0.883935

0 = (0.00522525 + 0.883935) 181.3168596(2.8818335)

 = 587.661, which is much lower, but it makes sense since a payout is certain in the case

of endowment.

(d)

1 ; 0|[42]+1
[42]+1 = 2
(1 + ) ; 1 0|[42]+1

Where 0|[42]+1 = 0.00204080

[42]+1 = ( ) 0|[42]+1 + [2 (1 + )]1 0|[42]+1

587.661
= 181.3169 0.00204080
1.04
587.661 1
+ 181.3169 1 + 0.99795920
(1.04) 2 1.04

= 188.065708

2
[42]+1 = [42]+1 = [42]+1 [42]+1 2

Where [42]+1
2
= ( )2 0|[42]+1 + [2 (1 + )]2 1 0|[42]+1

= (383.741757)2 0.00204080 + (187.665555)2 0.99795920 = 35447.010491044

Hence,

[42]+1 = 8.84873

(e)

When comparing against the results found in part b), we noticed that the mean in part d) is

higher than that of part b), and the standard deviation is significantly lower. This means that,

in the term insurance case, the distribution of the future loss random variable [42]+1 has a
 much greater spread albeit a lower mean. The result makes sense since, in the case of

endowment, a payout is certain. It is only the timing of the payout that is random. However,

in the case of term insurance, neither the payout nor the timing is certain.

Question 3)

Need to first determine the annual premiums (p) by the equivalence principle

(i.e. (25 ) = 0)

We have =

By the slicing approach, we can write

1000025 500030| 25 = 25

1000025 500030 p25 30 55 = 25

From the ILT @ i=0.06, we know that

p = 55 = 95650.15
30 25
86408.6
; 25 = 81.6496
1000
; 55 = 305.1431
1000
; 25 = 16.22419
25

Hence,

576.5193902037
= = 35.53455613
16.22419

Using this, we can calculate the time 15 policy value 15

15 = (15 ) = @ = 15 @ = 15
= 1000040 500015| 40 (40 )

= 1000040 500015 p40 15 55 35.53455613(40 )

From the ILT @ i=0.06, we then have

161.3242 86408.6 305.1431

15 = 10000 5000 (1.06)15 35.53455613(14.81661)
1000 93131.64 1000
 = 496.0698185

Question 4)

First find the premium of a person aged 20 by the equivalence principle

0 = 20 (20 )

20
=
(20 )

Then,

20 (1 20 )
1020 = 30 30 = (1 30 ) 30
(20 ) 20
(1 30 )20 (1 20 )30 20 30
= = = 1 30
20 20 20

Hence,

40
2020 =1 = 0.095 40 = 0.905
20 20

50
3020 =1 = 0.18 50 = 0.82
20 20

Similarly, for a person aged 30, the premium required by the equivalence principle is

30
=
(30 )

And

30 (1 30 )
2030 = 50 50 = (1 50 ) 50
(30 ) 30
(1 50 )30 (1 30 )50 30 50
= = = 1 50 = 0.16
30 30 30
50
= 0.84
30
 Express 1020 in terms of the information given, we have

30 1 0.82
1020 = 1 = 1 50 50 = 1 = 0.02381
20 30 20 0.84

Question 5)

First, we need to determine the premium collected from a person with a select age of 60 by the

equivalence principle. Define the present value of future loss variable as follows

; 0.1

2 (1 + )
0 = ; 0.108
3
3| ; 0.792

Set 0 = 1.06
1 1
0.1 + 1.06 1 1
2 1 + 1.06 0.108 + 1.063
3| 0.792

127355
= = 0.33494906
380222

Notice that at time 2, the present value future loss variable is non-random since it is an

endowment. That is, 2 = with a probability of 1.

Hence, 2 = 2 = 1.06
1
0.33494906 = 0.6084472

Question 6)

*Spreadsheet attached

a) Gross Premium = 1277.352768

Net Premium = 1131.328763
Expense = Gross Premium Net Premium = 146.024005

b)
2 30 = 1354.028524
c)
2 30 = 836.3639086

d) Yes, the difference of 517.6646154 is due to the fact that we have non-level expense

payments. In calculating the net premium, we smoothed out the expenses by using a level

expense payment that has the same expected present value. However, since a significant

initial expense payment (40% gross premium +$125) is made at the beginning, the

remaining expense amount due in the future is less than the case when net premiums are

used.

e) @t=0.05, 2 30 = 2417.11859

This is almost three times greater than the result obtained in part c). However, this is not

surprising. Recall that the gross premium policy value is just the EPV of future benefits

plus the EPV of future expenses subtracting off the EPV of future gross premiums

receivable.

As the location parameter A of the Makeham model increases to 0.0055, the entire hazard

rate (i.e. force of mortality) curve is being shifted upwards, implying that the policyholder

is more likely to die at every point in his/her lifetime. This implies that a payout more

likely at every moment in this policyholders lifetime. Therefore, the present value of

future benefits payable becomes more expensive.

When the interest rate decreases from 6% to 5%, the gross premium annuity is being

discounted less. Hence, a smaller amount of gross premium is required for the same present

value.

Therefore, a greater reserve is needed in this case.

Question 7)

(a)

Notice that the one-off premium paid at time 0, by the equivalence principle, is just the term

insurance present value. = 1

40:10|

And hence

0 =0

1 = 1
41:9|

= 1
40+:10|

The recursive relation learnt in class is as follows (where is the premium @ t):

( + )(1 + ) = + + + ( +1)

Hence,

1 (1 + )
40:10|
( 1) =

And

( )(1 + ) +
( +1) = 1
+

Alternatively, we can also express it more generally by the use of indicator functions
 + ( = 0) 1 (1 + ) = + + + ( +1)
40:10|

Hence,

+ ( = 0) 1 (1 + ) +
40:10|
+1 =
+

1 ; = 0
Where ( = 0) =
0;

(b)

We need to first find an expression for the effective h-year rate

(1 + ) = 1 +

1
= (1 + ) 1

For = 0, , 2, ,10 , using the same formula, we write

( + ( = 0) ) 1 + = + + + ( +)

1
( + ( = 0) ) (1 + ) = + + + ( +)

Thus,
 1
( + ( = 0) ) (1 + ) +
( +) =
+