Anualidades Contingetes

Actuarial mathematics 2
Life insurance contracts

Edward Furman
Department of Mathematics and Statistics
York University
January 31, 2011
Edward Furman Actuarial mathematics MATH 3280 1/ 45
Denition 0.1 (Life insurance.)
Life insurance is a contract that is designed to reduce the
nancial impact of an untimely death.
The payment is a single one.
The payment can be made either upon death or thereafter.
Question
Given a life status (u), what is its expected future lifetime? If the
insurance amount is one dollar: 1.) what is the r.v. representing
the payment upon death of (u)? 2.) what is the r.v. representing
the payment at the end of the year of death of (u)?
Recall that, e.g., T(u) : R
u
[0, ].
Solution
The expected lifetime of (u) is E[T(u)].
The payment upon death is v
T(u)
.
The payment at the end of the year of death is v
K(u)+1
.
Recall that the price is the expected loss, for identity utility =
fairness principle (or equivalence principle).
Net premium for an insurance contract.
The net premium for an immediately payable insurance is
E[v
T(u)
] for a life status (u). Also, the net premium for an
insurance payable at the end of the year of death is E[v
K(u)+1
].
I.e.,
E[v
T(u)
] =
R
u
v
t
t
p
u
(u + t )dt =
R
u
v
t
d
t
p
u
:= A
u
.
Also
E[v
K(u)+1
] =
kR
u
v
k+1
k
p
u
q
u+k
=
kR
u
v
k+1
k
p
u
:= A
u
.
Example 0.1 (Whole life insurance.)
Let (u) = (x). Then R
u
= [0, ), and
A
x
:= E[v
T(u)
] =

0
v
t
t
p
x
(x + t )dt ,
as well as
A
x
:= E[v
K(u)+1
] =
k=0
v
k+1
k
p
x
q
x+k
.
Example 0.2 (n-year term insurance.)
Let (u) = (
1
x : n). Thus R
u
= [0, n) {}, and
A
1
x:n
:= E[v
T(u)
] =
n
0
v
t
t
p
x
(x + t )dt + 0,
as well as
A
1
x:n
:= E[v
K(u)+1
] =
n1
k=0
v
k+1
k
p
x
q
x+k
.
Proposition 0.1
We have that, for A
1
x:0
= 0 (why?), and for all x,
A
1
x:n
= vq
x
+ vp
x
A
1
x+1:n1
.
Proof.
A
1
x:n
=
n1
k=0
v
k+1
k
p
x
q
x+k
= vq
x
+
n1
k=1
v
k+1
k
p
x
q
x+k
= vq
x
+ vp
x
n1
k=1
v
k
k1
p
x+1
q
x+k
= vq
x
+ vp
x
n2
k=0
v
k+1
k
p
x+1
q
x+k+1
= vq
x
+ vp
x
A
1
x+1:n1
,
as required.
Corollary 0.1
We have that
A
x
= vq
x
+vp
x
A
x+1
.
Proposition 0.2
Under the UDD assumption for each year of age, we have that
A
u
UDD
=
i
A
u
.
Proof.
We have that
t
p
u
(u + t )
UDD
= q
u
, 0 t 1, u = 0, 1, . . . .
Then
A
u
= =
1
0
v
t
t
p
u
(u + t )dt +

1
v
t
t
p
u
(u +t )dt
Proof (cont.)
A
u
=
1
0
v
t
t
p
u
(u + t )dt +

0
v
t+1
t+1
p
u
(u + 1 + t )dt
=
1
0
v
t
t
p
u
(u + t )dt +

0
v
t+1
p
u
t
p
u+1
(u + 1 + t )dt
=
1
0
v
t
t
p
u
(u + t )dt + vp
u

0
v
t
t
p
u+1
(u + 1 + t )dt
UDD
=
1
0
v
t
q
u
dt + vp
u
A
u+1
= q
u
1
0
e
t
dt + vp
u
A
u+1
=
1 e
q
u
+ vp
u
A
u+1
=
1 v
q
u
+ vp
u
A
u+1
.
Proof (cont.)
Thus we have that:
A
u
UDD
=
i
vq
u
+ vp
u
A
u+1
.
The domain for the latter relationship is: u = 0, 1, . . . and
A
= 0. Further,
A
u
UDD
=
i
vq
u
+ vp
u
vq
u+1
+ vp
u+1
A
u+2
=
i
vq
u
+
i
v
2
p
u
q
u+1
+ v
2
p
u
p
u+1
A
u+2
=
i
v
0
p
u
q
u+0
+ v
2
p
u
q
u+1
+ v
3
p
u
p
u+1
q
u+2
+ + 0
=
i
k=0
v
k+1
k
p
u
q
u+k
=
i
A
u
,
which completes the proof.
Example 0.3 (Pure endowment insurance.)
Let (u) = (x :
1
n). Then it only makes sense to speak of the
discrete case. The r.v. representing the future payment is
v
K(x:
1
n )
, Thus
A
x:
1
n
:= v
n
k=n
k
p
x
q
x+k
= v
n
P[T(x) n] = v
n
n
p
x
Example 0.4 (General endowment insurance.)
Let (u) = (x : n). Then by denition of T(x : n) we have that
A
x:n
:=
n
0
v
t
t
p
x
(x + t )dt + v
n
n
p
x
= A
1
x:n
+ A
x:
1
n
.
Note that
v
T(x:n)
= v
T(
1
x:n)
+v
T(x:
1
n )
.
Example 0.5 (Example 0.4 (cont.))
Do we have that
T(x : n) = T(
1
x : n) + T(x :
1
n)?
Also,
A
x:n
:= E[v
K(
1
x:n)+1
+ v
K(x:
1
n )
], i .e.,
A
x:n
=
n1
k=0
v
k+1
k
p
x
q
x+k
+ v
n
n
p
x
= A
1
x:n
+ A
x:
1
n
.
Note:
Of course, we have that,
lim
n
A
1
x:n
= A
x
.
Proposition 0.3
The variance of the r.v. representing the future payment due to
death of (u) is
Var[v
T(u)
] =
2
A
u
(A
u
)
2
,
where
2
A
u
is an insurance payable using
= 2.
Proof.
We have that
E[(v
T(u)
)
2
] =
R
u
e
2t
t
p
u
(u + t )dt =
R
u
e
t
t
p
u
(u + t )dt ,
that is an insurance payable with a new force of interest. This
completes the proof.
Corollary 0.2
The variance of the r.v. representing the present value of due to
the pure endowment insurance is
Var[v
T(x:
1
n )
] = v
2n
n
p
x
(
n
q
x
).
Proof.
Note that for the pure endowment insurance we have that the
second moment is
E[v
2T(x:
1
n )
] = v
2n
n
p
x
.
Thus the variance is
v
2n
n
p
x
(v
n
n
p
x
)
2
,
as required.
Proposition 0.4
The variance of the general endowment insurance is
Var[v
T(x:n
]
=
2
A
1
x:n

A
1
x:n
2
+ v
2n
n
p
xn
q
x
2A
1
x:n
v
n
n
p
x
.
Proof.
Note that
Var[v
T(x:n
]
= Var[v
T(
1
x:n
+ v
T(x:
1
n
]
= Var[v
T(
1
x:n
] +Var[v
T(x:
1
n
] +2Cov[v
T(
1
x:n
, v
T(x:
1
n )
]
= Var[v
T(
1
x:n
] +Var[v
T(x:
1
n
] 2E[v
T(
1
x:n
]]E[v
T(x:
1
n
],
Insurances mentioned above can be used as building blocks to
create other forms of insurances.
Example 0.6 (Deferred insurance.)
An m year deferred n years term insurance provides for a
benet following the death of the insured only if the insured dies
at least m years following policy issue and before the end of the
policy. Thus we have that
m|n
A
x
:= A
1
u:m+n
A
1
u:m
=
m+n1
k=m
v
k+1
k
p
u
q
u+k
.
The continuous counterpart is then:
m|n
A
u
:= A
1
u:m+n
A
1
u:m
=
m+n
m
v
t
t
p
u
(u + t )dt .
Example 0.7 (Deferred whole life insurance.)
Take n in the previous example, and get
m|
A
u
= A
u
A
1
u:m
=
k=m
v
k+1
k
p
u
q
u+k
,
with the continuous counterpart given then by:
m|
A
u
= A
u
A
1
u:m
=

m
v
t
t
p
u
(u + t )dt .
Note, that we have been interested in calculating expectations
of transformed future life time r.v.s. These r.v.s can be more
general.
Example 0.8 (Annually increasing whole life insurance.)
Consider the r.v. (K(u) + 1)v
K(u)+1
. The present value is
(IA)
u
:= E[K(u) + 1)v
K(u)+1
] =
k=0
(k + 1)v
k+1
k
p
u
q
u+k
.
Example 0.9 (Continuously increasing whole life insurance.)
Consider the r.v. T(u)v
T(u)
, then
(IA)
u
:= E[T(u)v
T(u)
] =

0
tv
t
t
p
u
(u + t )dt .
Example 0.10 (Annually increasing continuous whole life
insurance.)
Let the r.v. of interest be T(u) + 1V
T(u)
. Then
(IA)
u
:= E[T(u) + 1V
T(u)
] =

0
t + 1 v
t
t
p
u
(u + t )dt .
Example 0.11 (m-thly per year increasing continuous whole life
insurance.)
Let the r.v. of interest be
T(u)m+1
m
v
T(u)
. Then:
(I
(m)
A)
u
:= E
T(u)m + 1
m
v
T(u)

0
tm + 1
m
v
t
t
p
u
(u+t ).
Remark.
Of course, for m , the just mentioned insurance reduces to
the continuously increasing one.
Proposition 0.5
We have that
(IA)
u
=

0
s|
A
u
ds.
Proof.
(IA)
u
=
t
0
ds
v
t
t
p
u
(u + t )dt
=

s
v
t
t
p
u
(u + t )dtds
=

0
s|
A
u
ds,
as required.
Figure: Auxiliary plot.
Note:
For the totally discrete counterpart, i.e., for (IA)
u
, we should
again have (why?)
(IA)
u
=
j =0
j |
A
u
= A
u
+
1|
A
u
+
2|
A
u
+ ...
Benets must not be increasing.
Example 0.12 (Annually decreasing n-year term insurance.)
Let the r.v. of interest be (n K(u))v
K(
1
u:n+1
. Then
(DA)
1
u:n
:= E[(n K(u))v
K(
1
u:n+1
] =
n1
k=0
(n k)v
k+1
k
p
u
q
u+k
.
Proposition 0.6
We have that
(DA)
1
u:n
=
n1
j =0
A
1
u:nj
.
Proof.
Note that
n k =
nk1
j =0
(1).
Then
(DA)
1
u:n
=
n1
k=0
(n k)v
k+1
k
p
u
q
u+k
=
n1
k=0
nk1
j =0
(1)v
k+1
k
p
u
q
u+k
=
n1
j =0
nj 1
k=0
(1)v
k+1
k
p
u
q
u+k
=
n1
j =0
A
1
u:nj
,
as needed.
Figure: Annually decreasing 8-year term insurance.
Proposition 0.7
Let the actuarial present value r.v. be generally given by
Z = b(K(u) + 1)v
T(u)
. And assume the UDD approximation for
each integer u. Then
E[b(K(u) + 1)v
T(u)
]
UDD
=
i
E[b(K(u) + 1)v
K(u)+1
]
for any life status (u).
Proof (cont.)
Recall that T = K + J with J U(0, 1) because of the UDD.
We have also proven that under the UDD K and J are
independent. Namely
P[K = k, J j ] =
k
p
u
q
u+k
j = P[K = k]P[J j ].
Proof (cont.)
Also
E[b(K(u) + 1)v
T(u)
]
= E[b(K(u) + 1)v
K(u)+1+J(u)1
]
= E[b(K(u) + 1)v
K(u)+1
v
J(u)1
]
UDD
= E[b(K(u) + 1)v
K(u)+1
]E[v
J(u)1
]
= E[b(K(u) + 1)v
K(u)+1
]E[(1 + i )
1J(u)
],
where
E[(1 + i )
1J(u)
] =
1
0
(1 + i )
1s
ds =
1
0
d(1 + i )
1s
ln(1 + i )
,
which is
E[(1 + i )
1J(u)
] = i /.
Corollary 0.3
Thus, we easily have that
A
x
UDD
=
i
A
x
,
with b(K + 1) 1. And also
(IA)
x
UDD
=
i
(IA)
x
,
with b(K + 1) = K + 1.
Question:
What about (IA)
x
?
Proposition 0.8
Under the UDD, we have that
(IA)
x
UDD
=
i
(IA)
x

1 + i
i

1
A
x
.
Proof.
The r.v. corresponding to the price above is
Z = Tv
T
= (K + J)v
K+J
= (K + 1)v
K+J
+ (J 1)v
K+J
= (K + 1)v
K+J
(1 J)v
K+1
v
J1
= (K + 1)v
K+1
(1 + i )
1J
(1 J)v
K+1
(1 + i )
1J
.
Also, note that 1 J U(0, 1). Indeed
P[1 J j ] = P[J 1 j ] = j .
Recall that J and K are independent because of the UDD
assumption and take expectations
Proof (cont.)
E[Z]
UDD
= E[(K + 1)v
K+1
(1 + i )
1J
] E[v
K+1
]E[(1 J)(1 + i )
1J
]
=
i
(IA)
x
A
x
E[(1 J)(1 + i )
1J
]
=
i
(IA)
x
A
x
E[(J)(1 + i )
J
]
=
i
(IA)
x
A
x
1
0
j
d(1 + i )
j
ln(1 + i )
=
i
(IA)
x

A
x
ln(1 + i )
1
0
jd(1 + i )
j
=
i
(IA)
x

A
x
ln(1 + i )
j (1 + i )
j
|
1
0
1
0
(1 + i )
j
dj
=
i
(IA)
x

A
x
ln(1 + i )
(1 + i )
i
ln(1 + i )
.
An insurance can be payable m-thly.
Example 0.13 (m-thly payable whole life insurance.)
The price of an m-thly payable whole life insurance is
A
(m)
x
:=
k=0
(v
1/m
)
k+1
k
m
p
x
1
m
q
x+
k
m
.
Note that this is not the expectation of the transformed K(x),
but rather an expectation of a transformation of
K
(m)
(x) = K(x)m + J(x), where this time J(x) counts the
number of total m-thly periods (x) was alive. Thus
A
(m)
x
:= E[(v
1/m
)
Km+J+1
] = E[(v)
K+(J+1)/m
]
=
k=0
m
j =0
v
k+(j +1)/m
P[K = k, J = j ].
Proposition 0.9
We have that under the UDD for integer ages,
A
(m)
x
UDD
=
i
i
(m)
A
x
,
where i
(m)
= m((1 + i )
1/m
1).
Proof.
We have that
E[v
K+(J+1)/m
] =
k=0
m1
j =0
v
k+(j +1)/m
k
p
x

j /m|1/m
q
x+k
= A
(m)
x
.
In addition, under the UDD
j /m|1/m
q
x+k
=
(j +1)/m
q
x+k

(j )/m
q
x+k
UDD
=
j + 1
m
q
x+k

j
m
q
x+k
=
1
m
q
x+k
.
Proof (cont.)
Thus
A
(m)
x
UDD
=
k=0
v
k+1
m1
j =0
v
(j +1)/m1
k
p
x

1
m
q
x+k
=
k=0
v
k+1
k
p
x
q
x+k
m1
j =0
(1 + i )
1(j +1)/m
1
m
=
k=0
v
k+1
k
p
x
q
x+k
(1 + i )
m1
j =0
(v
(1/m)
)
j +1
1
m
=
k=0
v
k+1
k
p
x
q
x+k
(1 + i )
1
m
v
1/m
1 v
(m1+1)/m
1 v
1/m
=
k=0
v
k+1
k
p
x
q
x+k
(1 + i )
1
m
1 v
v
1/m
(1 v
1/m
)
.
Moreover
Proof.
A
(m)
x
UDD
=
k=0
v
k+1
k
p
x
q
x+k
(1 + i )
1
m
1 v
(1 + i )
1/m
1
=
k=0
v
k+1
k
p
x
q
x+k
(1 v)(1 + i )
i
(m)
=
k=0
v
k+1
k
p
x
q
x+k
i
i
(m)
=
i
i
(m)
A
x
,
Proposition 0.10
We have that
A
x:y
+ A
x:y
= A
x
+ A
y
,
as well as
A
x:y
+ A
x:y
= A
x
+ A
y
.
Proof.
Because of the denition of say T(x : y) and T(x : y), we have
that
v
T(x:y)
+ v
T(x:y)
= v
T(x)
+ v
T(y)
.
Taking expectations throughout then completes the proof.
Example 0.14
An insurance that pays one dollar upon the death of the rst of
(x) and (y) is
A
x:y
:= E[v
T(x:y)
] =

0
v
t
t
p
x:y
((x : y) + t )dt .
Example 0.15
An insurance that pays one dollar upon the death of the last
one of (x) and (y) is
A
x:y
:= E[v
T(x:y)
] =

0
v
t
t
p
x:y
((x : y) + t )dt .
Example 0.16
An insurance that pays one dollar upon the death of (x) if
he/she dies rst is A
1
x:y
. Of course it is an expectation of v
T(
1
x:y)
.
The latter is v
T(x)
if T(x) < T(y) and v
= 0 if T(x) T(y).
Thus
A
1
x:y
:= E[v
T(
1
x:y)
] =

0
v
t

t
f
T(x),T(y)
(t , s)dsdt
Ex. (cont.)
The latter expression is rewritten as
A
1
x:y
:= E[v
T(
1
x:y
] =

0
v
t

t
f
T(x),T(y)
(t , s)dsdt
=

0
v
t

t
f
T(y)|T(x)
(s| t )ds f
T(x)
(t )dt
ind
=

0
v
t

t
f
T(y)
(s)ds f
T(x)
(t )dt
=

0
v
t
F
T(y)
(t ) f
T(x)
(t )dt
=

0
v
t
t
p
y

t
p
x
(x + t )dt ,
i.e., if (x) dies at any time t when (y) is alive, then v
t
dollars are
payed. Check at home that if = 0, then A
1
x:y
=

q
1
x:y
.
Example 0.17
An insurance payable upon death of (y) if it precedes the death
of (x) is
A
x:
2
y
:= E[v
T(x:
2
y)
] =

0
v
t
t
0
f
T(x),T(y)
(s, t )dsdt .
Proposition 0.11
Under independence of the future lifetimes of (x) and (y), we
have that
A
x:
2
y
ind
= A
y
A
x:
1
y
.
Proof.
By denition
A
x:
2
y
=

0
v
t
t
0
f
T(x)| T(y)
(s| t )ds f
T(y)
(t )dt .
Proof.
By independence and in actuarial notation
A
x:
2
y
=

0
v
t
t
q
x

t
p
y
(y + t )dt
=

0
v
t
(1
t
p
x
)
t
p
y
(y +t )dt ,
as required.
Remark.
The result holds for dependent future lifetimes too. Prove at
home by looking at the corresponding r.v.s.
Proposition 0.12
Under independence of the future lifetimes of (x) and (y), we
have that
A
x:
2
y
ind
=

0
s
A
y

s
p
x
(x + s)ds.
Proof.
From the previous proposition, changing the order of integration
and by substitution u = t s,
A
x:
2
y
=

0
v
t
t
q
x

t
p
y
(y + t )dt
ind
=

0
v
t
t
0
s
p
x
(x + s)ds
t
p
y
(y + t )dt
=

s
v
t
s
p
x
(x + s)
t
p
y
(y + t )dtds
=

0
v
u+s
s
p
x
(x + s)
u+s
p
y
(y +u + s)duds
=

0
v
s
s
p
y s
p
x
(x + s)

0
v
u
u
p
y+s
(y + u + s)duds
=

0
v
s
s
p
y s
p
x
(x + s)A
y+s
ds.
Also, we can write the deferred insurance as
Proof. cont.
s
A
y
= A
y
A
1
y:s
=

0
v
u+s
u+s
p
y
(y + u + s)du
= v
s
s
p
y

0
v
u
u
p
y+s
(y + u + s)du
= v
s
s
p
y
A
y+s
.
This completes the proof.
Remark.
We will often use the notation
s
E
x
:= v
s
s
p
x
. This is refereed to
as the stochastic discount factor.
Example 0.18
Assume m sources of decrement and a whole life insurance
contract due to each one. Also, let b(x + t )
(j )
, j = 1, . . . , m be
the payment due to the decrement j . Then the overall price is
A =
m
j =1

0
b(x +t )
(j )
v
t
t
p
(j )
(x + t )dt .
Example 0.19
Let b(x + t )
(1)
= t and b(x + t )
(2)
= 0 for all t > 0. Assume
UDD for each year of death. Then
A =

0
tv
t
t
p
(1)
(x + t )dt =
k=0
k+1
k
tv
t
t
p
(1)
(x + t )dt
=
k=0
1
0
(k + s)v
k+s
k+s
p
(1)
(x + k + s)ds
Example 0.20 (Example. cont.)
Then by the UDD
t
p
x
(x + t )
UDD
= q
x
,
and
A =
k=0
v
k
k
p
1
0
(k + s)v
s
s
p
x+k
(1)
(x + k + s)ds
UDD
=
k=0
v
k+1
k
p
x
q
(1)
x+k
1
0
(k + s)v
s1
ds
=
k=0
v
k+1
k
p
x
q
(1)
x+k
1
0
(k + s)(1 + i )
1s
ds
=
k=0
v
k+1
k
p
x
q
(1)
x+k
i
k +
1

1
i
.

Remark
Note that if b(x + k + s)
(j )
is more cumbersome than (k + s)
than using, e.g., the midpoint rule
1
0
b(x + k + s)
(j )
(1 + i )
1s
ds b(x + k + 1/2)
(j )
(1 + i )
11/2
.
Figure: Insurances payed at the end of the year of death.
Figure: Immediately payed insurances.

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Actuarial mathematics 2

Life insurance contracts

Edward Furman Actuarial mathematics MATH 3280 42/ 45

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