ASC2014 Life Contingencies I BSc (Hons) in Actuarial Studies

CHAPTER 4
LIFE ANNUITIES

An annuity is a series of payments that could vary according to the timing of the payment
(end of the year (annuity immediate) or beginning of the year (annuity-due)), and may have
a fixed maturity (annuity certain), payments can be made more frequently than once a year
(annuity payable m-thly) or continuously. In some cases the payments may vary from year
to year (varying benefits). For this chapter we expect students to be familiar with most of
the concept of annuity, its terminology, notation and theory.

In this chapter, we consider annuity models under which the making of each scheduled
payment is contingent upon some random event. Life annuity theory is analoguous to
annuity theory but incorporate survival as a condition for payment.

Life annuities (or contingent annuities) are closely related to the life insurance models in
the previous chapter. To recap, in the insurance models in Chapter 3, a single payment is
made at the time of failure (death) of the entity of interest. In annuity models, a sequence
of payments is made during the continued survival of the entity of interest up until failure
occurs.

A life annuity is a series of payments to (or from) an individual as long as the individual is
alive. The payments are normally made at regular interval and the most common situation
is that the payments of the same amount. The valuation of annuities is important as
annuities appear in the calculation of premiums and reserve. A retirement plan can be
regarded as a system of purchasing deferred life annuities by some form of temporary
annuity of contributions during active service.

In this chapter, we will continue to assume a constant effective annual rate of interest i or
the equivalent constant force of interest  . To refresh, we review some annuity theory.

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We summarize below some formulas relating to annuities

(Compound Interest)
m
1  i (m)  1
v= 1 +  = 1 + i
1
vm =
1+ i 1+ i m
(m)
 m 
m
 d (m) 
1 −  = 1 − d
1
v = 1− d v m = 1− d (m)
m
 m 

d i
i= d= d = iv  = ln(1 + i )
1− d 1+ i

i (m) d (m) d (m)

d (m) = i (m) =
1
= vm
1+ im 1− dm
(m) (m) (m)
i

 = i (  ) = lim i ( m ) = lim d ( m )
m→ m→

(Annuity immediate)

1 − vn
n mn
1 − vn
an = v =  v = i(m)
k
k
a (m)
n
= 1
m
m

k =1 i k =1

(Annuity due)

n −1
1 − vn mn −1
1 − vn
an =  v =  v = d (m)
k
k
a (m)
n
= 1
m
m

k =0 d k =0

(Continuous annuity)

n 1 − vn
an =  v t dt =
0 

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4.1) Continuous Annuities

4.1.1) Continuous Whole Life Annuity

A continuous whole life annuity pays a benefit of 1 per year continuously as long as the
annuitant survives. Let Y denote the present value random variable of this continuous whole
life annuity. Recall that T x is the future lifetime of (x). Then

Y = aT

The actuarial present value of the continuous whole life annuity is the expected value of Y.
Therefore,
 
ax = E[Y ] = E[ aT ] =  at t p x  x +t dt =  v t t p x dt (See Example 1)
0 0

4.1.2) Continuous Temporary Life Annuity

A continuous n-year temporary life annuity pays a benefit of 1 per year continuously for n
years at the most, as long as the annuitant survives. Let Y denote the present value random
variable of this temporary n-year continuous life annuity. Recall that T x or T is the future
lifetime of (x). Then
a T n
Y = T
 an T n

The actuarial present value of the temporary n-year continuous life annuity is the expected
value of Y. Therefore,

n  n n
a x:n = E [Y ] =  at t p x  x +t dt +  an t p x  x +t dt =  at t px  x +t dt + an n p x =  v t t p x dt
0 n 0 0

4.1.3) Continuous n-year Deferred Whole Life Annuity

A continous n-year deferred whole life annuity pays a benefit of 1 per year continuously
while the annuitant (x) survives from (x+n) onwards. The first payment is made at age x+n
and will continue until the death of (x). Let Y denote the present value random variable of
this n-year continuous deferred whole life annuity. Recall that T x or T is the future lifetime
of (x). Then
0 T n
Y =
 n| aT − n = aT − an T n

The actuarial present value of the temporary n-year continuous life annuity is the expected
value of Y. Therefore,
 
n| a x = E [Y ] =  ( at − an ) t p x  x +t dt =  v t t p x dt
n n

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Example 1 (Continuous Annuities)(Useful formula)

Show that


(a) ax = 
0
v t t p x dt
n
(b) a x:n =  v t t p x dt
0

(c) n| ax =  v t t p x dt
n

Solution

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Example 2 (Continuous Annuities)(Some relationship)

Prove that
1 − Ax
(a) a x =

1 − A x:n
(b) a x:n =


Solution

Example 3 (Continuous Annuities)(Some relationship)(Constant Force)

Show that under constant force of mortality

1
(a) a x =
 +
1 − e − (  + ) n
(b) a x:n =
 +
e − (  + ) n
(c) n| a x =
 +

Solution

(a) (b)

ax =  v t t p x dt
0

= e − t e −  t dt
0

= e − (  + ) t
0

1
=
 +

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Example 4 (Continuous Annuities)(Some useful formula)

Prove that

(a) ax = ax:n + n| ax
(b) ax = ax:n + n Ex ax + n
(c) ax:m + n = ax:m + m Ex ax + m:n

Solution

 n 
(a) ax =  v t t px dt =  v t t p x dt +  v t t p x dt = a x:n + n| a x
0 0 n

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Example 5 (Continuous Annuities)(+Chapter 3)

You are given

• A x = 0.28 , A x:10 = 0.05 , A x +10 = 0.46

1

• a x = 12

Calculate ax:10 .

Solution (Answer: 7.5)

Recall that A x = A x:n + n E x A x + n . Therefore A x = A x:10 + 10 E x A x +10

1 1

10 Ex =

A x:10 =
1 − Ax 1 − Ax
Since a x = , we get  = =
 ax
1 − A x:n 1 − A x:10
From a x:n = , we get a x:10 = =
 

Example 6 (Continuous Annuities)(+Chapter 3)

You are given

• Mortality is uniformly distributed with  = 100

•  = 0.05

Calculate a35:20 .

Solution
an
Under uniform distribution, A x:n =
1
, so
−x
a20 1 − e − (0.05)(20) 4
A35:20 = = = (1 − e −1 )
1

100 − 35 (0.05)65 13
 n  − ( 0.05)( 20 )  20  9 −1
Now, Ax :n1 | = e −n 1 −  , so A35:201 | = e 1 − = e
 −x  100 − 35  13
A x:n =

1 − A x:n 1 − A35:20
Using a x:n = , we obtained a35:20 = = 11.0163
 

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Example 7 (Continuous Annuities)(Varying Force)

A continuous whole life annuity on a life age x makes payments at a rate of 100 per year.
You are given
 0.03 t  10
• x+t = 
0.06 t  10
•  t = 0.04

Calculate the actuarial present value of this annuity.

Solution (Answer: 1215.75)

We will use ax = ax:n + n Ex ax + n from Example 4. (why?)

1 − e − (  + ) n e − (  + ) n
Under constant force (why?) , a x:n = and n E x a x + n =
 +  +

1 − e − (  + )10
a x:10 = =
 +

1
E x a x +10 = e − (  + )10 =
 +
10

The actuarial present value of this annuity is

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4.2) Discrete Annuities (Due)

4.2.1) Whole Life Annuity Due

A whole life annuity due pays a benefit of 1 at the beginning of the year as long as the
annuitant survives. Let Y denote the present value random variable of this whole life
annuity due. Recall that K x or K is the curtate future lifetime of (x). Then
Y = a K +1
The actuarial present value of the whole life annuity due is the expected value of Y.
Therefore,
  
a x = E [Y ] = E [ a K +1 ] =  a k +1 P ( K x = k ) =  ak +1 k | q x =  v k k p x
k =0 k =0 k =0

4.2.2) Temporary Life Annuity Due

A temporary n-year life annuity due pays a benefit of 1 per year at the beginning of the
year for n years at the most, as long as the annuitant survives. Let Y denote the present
value random variable of this temporary n-year life annuity due. Recall that K x or K is the
curtate future lifetime of (x). Then
a K n
Y =  K +1
 an K n
The actuarial present value of the temporary n-year life annuity due is the expected value
of Y. Therefore,
n −1  n −1 
a x:n = E [Y ] =  a k +1 P ( K x = k ) +  a n P ( K x = k ) =  a k +1 | k | q x +  a n k | q x
k =0 k =n k =0 k =n
n −1 n −1
=  a k +1 k | q x + a n n p x =  v k k p x
k =0 k =0

4.2.3) n-year Deferred Whole Life Annuity Due

An n-year deferred whole life annuity due pays a benefit of 1 per year at the beginning of
the year while the annuitant (x) survives from (x+n) onwards. The first payment is made at
age x+n and will continue until the death of (x). Let Y denote the present value random
variable of this n-year deferred whole life annuity due. Recall that K x or K is the curtate
future lifetime of (x). Then
 0 Kn
Y =
 n| a K +1−n = a K +1 − an K  n

The actuarial present value of the n-year deferred whole life annuity due is the expected
value of Y. Therefore,
  

n | a x = E [Y ] =  n | a k +1− n P ( K x = k ) =  ( ak +1 − an ) k | q x =  v k k p x
k =n k =n k =n

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Example 8 (Discrete Annuities)(Due)(Useful formula)

Show that

(a) ax =  v k k p x
k =0
n −1
(b) a x:n =  v k k p x
k =0

(c) n| ax = v k
k px
k =n

Solution
k
(a) Since ak +1 = 1 + v + v 2 + ... + v k =  v t , we have
t =0
  k

a k +1 k |
qx =   v t k | qx
k =0 k =0 t =0

=  (1 + v + v 2 + ... + v k ) k | q x
k =0

= q x + (1 + v ) 1| q x + (1 + v + v 2 ) 2| q x + (1 + v + v 2 + v 3 ) 3| q x + ...
= ( q x +1| q x + 2| q x + ...) + v (1| q x + 2| q x + ...) + v 2 ( 2| q x + ...) + ...
   
=  v t  k | q x =  v t  ( k p x − k +1 p x )
t =0 k =t t =0 k =t
 
= v t t p x =  v k k p x
t =0 k =0
k
(b) Since ak +1 = 1 + v + v 2 + ... + v k =  v t , we have
t =0
n −1 n −1 k n −1

a k +1 k |
q x =   v t k | q x =  (1 + v + v 2 + ... + v k ) k | q x
k =0 k =0 t =0 k =0

= q x + (1 + v ) 1| q x + (1 + v + v 2 ) 2| q x + ... + (1 + v + v 2 + ... + v n −1 ) n −1| q x

= ( q x +1| q x + 2| q x + ...+ n −1| q x ) + v(1| q x + 2| q x + ...+ n −1| q x ) + ... + v n −1 ( n −1| q x )

n −1 n −1 n −1 n −1 n −1
=  v t  k | q x =  v t  ( k p x − k +1 p x ) =  v t ( t p x − n p x )
t =0 k =t t =0 k =t t =0
n −1 n −1 n −1
=  v t t p x − (  v t ) n p x =  v k k p x − an| n p x
t =0 t =0 k =0
n −1 n −1
Hence a x:n =  ak +1 k | q x + a n| n p x =  v k k p x
k =0 k =0

(c) Exercise

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Example 9 (Discrete Annuities)(Due)(Some relationship)

Prove that
1 − Ax
(a) ax =
d
1 − Ax:n
(b) a x:n =
d

Solution

Example 10 (Discrete Annuities)(Due)(Some useful formula)

Prove that

(a) ax = ax:n + n| ax
(b) ax = ax:n + n Ex ax + n
(c) ax:m + n = ax:m + m Ex ax + m:n

Solution

(a)

ax =  v k k px
k =0
n −1 
=  v k k px +  v k k px
k =0 k =n

= a x :n + n | a x

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Example 11 (Discrete Annuities)(Temporary Life Annuity Due)

You are given

• q x = 0 .01 , q x +1 = 0 .02 , and q x + 2 = 0.04

• i = 0.05

Calculate a x:3 .

Solution
n −1
We will use a x:n =  v k k p x
k =0
2
a x:3 =  v k k p x = 1 + vp x + v 2 2 p x = 1 + vp x + v 2 p x p x +1
k =0

= 1 + 1.105 (1 − 0.01) + ( 1.105 ) 2 (1 − 0.01)(1 − 0.02)

= 2.8229

Example 12 (Discrete Annuities)(Temporary Life Annuity Due)

You are given

• Mortality follows the Standard Ultimate Life Table

• i = 0.05

Calculate a35:30 .

Solution (Answer: 15.9944)

We will use a x = a x:n + n E x a x +n

Using m+n E x = m E x . n E x + m , we get 30 E 35 =10 E 35 . 20 E 45

a35:30 = a35 − 30 E35a65

=

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Example 13 (Discrete Annuities)(Temporary Life Annuity Due)

You are given

• 0| qx = 0.33 , 1| qx = 0.24 , 2| qx = 0.16 , and 3| qx = 0.11

• a1 = 1.00 , a2 = 1.93 , a3 = 2.80 , and a4 = 3.62

Calculate a x:4 .

Solution (Answer: 2.2186)

n −1
We will use a x:n =  ak +1 k | q x + an n p x
k =0
3
a x:4 =  a k +1 k | q x + a 4 4 p x
k =0

= a1 0| qx + a2 1| qx + a3 2| qx + a4 3| qx + a4 4 p x

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4.3) Discrete Annuities (Immediate)

4.3.1) Whole Life Annuity Immediate

A whole life annuity immediate pays a benefit of 1 at the end of the year as long as the
annuitant survives. Let Y denote the present value random variable of this whole life
annuity immediate. Recall that K x or K is the curtate future lifetime of (x). Then
Y = aK
The actuarial present value of the whole life annuity immediate is the expected value of Y.
Therefore,
  
a x = E [Y ] = E [ a K ] =  a k P ( K x = k ) =  ak k | qx =  v k k p x
k =1 k =1 k =1

4.3.2) Temporary Life Annuity Immediate

A temporary n-year life annuity immediate pays a benefit of 1 per year at the end of the
year for n years at the most, as long as the annuitant survives. Let Y denote the present
value random variable of this temporary n-year life annuity immediate. Recall that K x or
K is the curtate future lifetime of (x). Then
a K n
Y = K
 an K n
The actuarial present value of the temporary n-year life annuity immediate is the expected
value of Y. Therefore,
n −1  n −1 
a x:n = E [Y ] =  ak P ( K x = k ) +  an P ( K x = k ) =  ak k | qx +  an k | qx
k =1 k =n k =1 k =n
n −1 n
=  ak k | q x + an n p x =  v k k p x
k =1 k =1

4.3.3) n-year Deferred Whole Life Annuity Immediate

An n-year deferred whole life annuity immediate pays a benefit of 1 per year at the end of
the year while the annuitant (x) survives from (x+n) onwards. The first payment is made at
age x+n+1 and will continue until the death of (x). Let Y denote the present value random
variable of this n-year deferred whole life annuity immediate. Recall that K x or K is the
curtate future lifetime of (x). Then

 0 Kn
Y =
 n| a K − n = a K − an K n

The actuarial present value of the n-year deferred whole life annuity immediate is the
expected value of Y. Therefore,
  

n | a x = E [Y ] =  n | a k − n P ( K x = k ) =  ( ak − an ) k | qx = v k
k px
k =n k =n k = n +1

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Example 14 (Discrete Annuities)(Immediate)(Useful formula)

Show that

(a) a x =  v k k p x
k =1
n
(b) a x:n =  v k k p x
k =1

(c) n| ax = v k
k px
k = n +1

Solution
k
(a) Since ak = v + v 2 + ... + v k =  v t , we have
t =1
  k

a k k|
qx =   v t k | qx
k =1 k =1 t =1

=  ( v + v 2 + ... + v k ) k | q x
k =1

= v 1| q x + ( v + v 2 ) 2| q x + ( v + v 2 + v 3 ) 3| q x + ...
= v (1| q x + 2| q x + ...) + v 2 ( 2| q x + 3| q x + ...) + v 3 ( 3| q x + ...) + ...
   
=  v t  k | q x =  v t  ( k p x − k +1 p x )
t =1 k =t t =1 k =t
 
= v t t p x =  v k k p x
t =1 k =1
k
(b) Since ak = v + v 2 + ... + v k =  v t , we have
t =1
n −1 n −1 k n −1

a k k|
q x =   v t k | q x =  ( v + v 2 + ... + v k ) k | q x
k =1 k =1 t =1 k =1

= v 1| q x + ( v + v ) 2| q x + ( v + v 2 + v 3 ) 3| q x + ... + ( v + v 2 + ... + v n −1 ) n −1| q x

2

= v (1| q x + 2| q x + ...+ n −1| q x ) + v 2 ( 2| q x + 3| q x + ...+ n −1| q x ) + ... + v n −1 ( n −1| q x )

n −1 n −1 n −1 n −1 n −1
=  v t  k | q x =  v t  ( k p x − k +1 p x ) =  v t ( t p x − n p x )
t =1 k =t t =1 k =t t =1
n n −1
=  v t t p x − v n n p x − ( v t ) n p x
t =1 t =1
n
=  v k k p x − a n| n p x
k =1
n −1 n
Hence a x:n = a k k|
qx + an n p x =  v k k p x
k =1 k =1

(c) Exercise

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Example 15 (Discrete Annuities)(Immediate)(Some relationship)

Prove that
1 − (1 + i ) Ax
(a) a x =
i
1 − (1 + i ) Ax:n + i n E x
(b) a x:n =
i

Solution

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Example 16 (Discrete Annuities)(Immediate)(Some Useful Formula)

Prove that

(a) ax = ax:n + n| ax
(b) ax = ax:n + n Ex ax + n
(c) ax:m + n = ax:m + m Ex ax + m:n

Solution

 n 
(a) a x =  v k
k px =  v k
k px + v k
k p x = a x :n + n | a x
k =1 k =1 k = n +1

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Example 17 (Discrete Annuities)(Due & Immediate)(Some relationship)

Prove that

(a) ax = a x + 1
(b) a x:n = a x:n −1 + 1
(c) n| ax = n| a x + n E x
(d) a x:n = a x:n + 1 − n E x

Solution

(a)

ax =  v k k px
k =0

= v 0 0 px +  v k k px
k =1

= 1 + ax

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Example 18 (Discrete Annuities)(Temporary Life Annuity Immediate)

You are given

• Mortality follows the Standard Ultimate Life Table

• i = 0.05

Calculate a65:20 .

Solution (Answer: 11.13581)

a65:20 = a65 − 20 E65 a85 from Example 16(a)

= ( a65 − 1) − 20 E65 ( a85 − 1) from Example 17(a)
=

Example 19 (Discrete Annuities)(Temporary Life Annuity Immediate)(+Chapter 3)

You are given

• Ax = 0 .22 , Ax + 25 = 0 .46
• Ax :251 | = 0.20
• i = 0.06

Calculate a x:25 .

Solution (Answer: 11.072)

From Example 17, ax:n = ax:n − 1 + n Ex

1 − Ax:n
From Example 9, a x:n =
d

From Chapter 3 Example 16, Ax:n = A1 + Ax :n| 1

x:n

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4.4) Variance

Example 20a (Variance)(Continuous Whole Life Annuity)

Let Y denote the present value random variable of a continuous whole life annuity. Prove
2
Ax − ( Ax ) 2
that Var [Y ] = = 2 [ a x − 2 a x ] − ( a x ) 2 .
2

Solution

Var[Y ] = Var[aT ]
= Var [ 1−v ]
T

= 1
2
Var [ v T ]
= 1
2
[ 2Ax − ( Ax ) 2 ]
= 1
2
[1 − ( 2 ) 2 a x − (1 −  a x ) 2 ]
= [1 − ( 2 ) 2 a x − (1 − 2 a x +  2 a x )]
1 2
2

= 2 [a x − 2 a x ] − ( a x ) 2

Example 20b (Variance)(Continuous Temporary Life Annuity)

Let Y denote the present value random variable of a continuous temporary life annuity.
2
Ax:n − ( Ax:n ) 2
Prove that Var[Y ] = = 2 [ a x:n − 2 a x:n ] − ( a x:n ) 2 .
2

Solution

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Example 20c (Variance)(Discrete Whole Life Annuity Due)

Let Y denote the present value random variable of a whole life annuity due. Prove that
( 2Ax − ( Ax ) 2 ) 2
Var [Y ] = = d [ ax − 2 ax ] + 2 ax − ( ax ) 2
d2

Solution

Var [Y ] = Var[aK +1 ]
K +1
= Var [ 1− vd ]
= 1
d2
Var[v K +1 ]
= 1 2
d2 x( A − ( Ax ) 2 )
= 1
d2
[(1− 2d 2 ax ) − (1 − dax ) 2 ]
= 1
d2
[(1 − ( 2d − d 2 ) 2 ax ) − (1 − dax ) 2 ]
= d2 [ax − 2 ax ] + 2 ax − (ax )2

Note that 2 is 2  but 2d is not 2 d !

From v = 1 − d , v 2 = (1 − d ) 2 = 1 − 2d + d 2 = 1 − (2 d − d 2 )
Therefore, v 2 = 1 − 2d

− 2
v = e − , v = ( e ) = e −2
2

Therefore, v 2 = e −2

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Example 21 (Variance)(Continuous Whole Life Annuity)(Constant Force)

You are given

• Force of mortality  x +t = 
• Force of interest  t = 
• 2
ax = 4, ax = 5
• Y is the present value random variable for a continuous whole life annuity of 1 on
a life age x

Calculate Var [Y ] .

Solution

Under constant force of mortality, a x = 1

 + , 2a x = 1
 + 2 .
Solve to obtain  = 0.15 and  = 0.05 .

Var [Y ] = 2 [a x − 2 a x ] − ( a x ) 2 = 15

Example 22a (Variance)(Continuous Whole Life Annuity)

You are given

• Y is the present value random variable for a continuous whole life annuity of 1 on
a life age x
• E [Y ] = 15 , E [Y 2 ] = 240
• Force of interest  t = 0 .05

Calculate 2 Ax .

Solution

Since Var [Y ] = 2 [a x − 2 a x ] − ( a x )2 , we have

E [Y ] = a x = 15 and E[Y 2 ] = 2 [a x − 2 a x ] = 240

Therefore 2 a x = 9 and 2 Ax = 1 − 2 2a x = 1 − 2(0.05)( 9) = 0.1

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Example 22b (Variance)(Discrete Whole Life Annuity Due)

You are given

• Y is the present value random variable for a whole life annuity due of 1 on a life
age x
• E [Y ] = 15 , E [Y 2 ] = 288
• d = 0.05

Calculate 2 Ax .

Solution (Answer: 0.22)

Example 23 (Variance)(Continuous Temporary Life Annuity)

You are given

• Y is the present value random variable for a continuous n-year temporary life
annuity of 1 on a life age x
• a x:n = 4.9, 2 a x:n = 3.6
•  = 0.095

Calculate Var [Y ] .

Solution (Answer: 3.3584)

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Example 24a (Variance)(Discrete Annuity from First Principles)

You are given

• Y is the present value random variable for a 3-year temporary life annuity due on
a life age 60 that pays 1 in the first year, 2 in the second year, and 3 in the third
year
• q60 = 0.011 , q61 = 0 .014 , q62 = 0 .018 , and q63 = 0.025
• i = 0.05

Calculate Var [Y ] .

Solution
n −1 n −1
We will use E [Y *] =  ak +1 k | q x + an n p x and E [Y 2 *] =  ak +1 2 k | q x + a n 2 n p x
k =0 k =0
2
E [Y *] =  a k +1 k | q x + a3 3 p x
k =0

= a1 . 0| q60 + a2 1| q60 + a3 2| q60 + a3 3 p60 You can start from here based on timeline

= 1.0| q60 + (1 + 2v ) 1| q60 + (1 + 2v + 3v 2 ) 2| q60 + (1 + 2v + 3v 2 ) 3 p60

= 1.q60 + (1 + 2v ) ( p60q61 ) + (1 + 2v + 3v 2 ) 2 p60
= 1.q60 + (1 + 2v ) ( p60 q61 ) + (1 + 2v + 3v 2 ) p60 p61
= 1.q60 + (1 + 2v ) ((1 − q60 ) q61 ) + (1 + 2v + 3v 2 )(1 − q60 )(1 − q61 )
= 1.( 0.011 ) + (1 + 2 v ) (1 − 0.011 )( 0.014 ) + (1 + 2 v + 3v 2 )(1 − 0.011 )(1 − 0.014 )
= 1.( 0.011 ) + (1 + 2 v ) ( 0.013846 ) + (1 + 2 v + 3v 2 )( 0.975154 )
= 1.(0.011) + (2.90476 ) (0.013846 ) + (5.62585)( 0.975154 )
= 5.53729

n −1
E [Y 2 *] =  a k +1 2 k | q x + a n 2 n p x
k =0

= a1 2 . 0| q60 + a2 2 1| q60 + a3 2 2| q60 + a3 2 3 p60

= 12.0| q60 + (1 + 2v ) 2 1|q60 + (1 + 2v + 3v 2 ) 2 2|q60 + (1 + 2v + 3v 2 ) 2 3 p60 Then get this line

= 12.( 0.011 ) + (1 + 2 v ) 2 ( 0.013846 ) + (1 + 2 v + 3v 2 ) 2 ( 0.975154 )

= 12.( 0.011 ) + ( 2.90476 ) 2 ( 0.013846 ) + (5.62585 ) 2 ( 0.975154 )
= 30 .99164

Var [Y ] = 0.33006

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Example 24b (Variance)(Discrete Annuity from First Principles)

You are given

• Y is the present value random variable for a special life annuity on a life age 70
that pays 10 at the end of every tenth year, starting from today if the insured is
alive at that point
• 10 p 70 = 0 . 8 , 20 p 70 = 0 . 5 , and 30 p 70 = 0

• i = 0.04

Calculate Var [Y ] .

Solution

E [Y ] = 0.0|10 q70 + (10v10 ) 10|10 q70 + (10v10 + 10v 20 ) q + (10v10 + 10v 20 ) 30 p70
20|10 70

= 0.10 q70 + (10v10 ) (10 p70 − 20 p70 ) + (10v10 + 10v 20 )( p − 30 p70 ) + (10v10 + 10v 20 ) 30 p70
20 70

= ( 0) ( 0.2 ) + (10 v 10 ) ( 0.3) + (10 v 10 + 10 v 20 )( 0.5) + (10 v 10 + 10 v 20 )( 0)

= 7.68645

E [Y 2 ] = 02.0|10 q70 + (10v10 ) 2 q + (10v10 + 10v 20 ) 2 20|10 q70 + (10v10 + 10v 20 ) 2

10|10 70 p
30 70

= ( 0) ( 0.2 ) + (10 v ) ( 0.3) + (10 v + 10 v ) ( 0.5) + (10 v + 10 v ) ( 0)

2 10 2 10 20 2 10 20 2

= 77 .75727

Var [Y ] = 18.67579

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4.5) Varying Annuities & Recursive Formulas

In the previous sections we have considered life annuities with level payments. Some of
the annuities that arise in actuarial practice are not level. In this section, we calculate the
actuarial present value of non-level life annuities in which the amount of annuity payment
either increases or decreases arithmetically. The symbols for actuarial present value of
increasing and decreasing annuities are parallel to the corresponding symbols for
increasing and decreasing insurances.

4.5.1) Increasing Annuities

The actuarial present value of a continuous whole life annuity with a continuously
increasing rate of payment, paying t per year is denoted by


( I a ) x =  t v t t p x dt
0

For temporary increasing life annuity, we have

n
( Ia ) x:n =  t v t t p x dt
0

For discrete annuities, we have, respectively, the whole life annuity due and immediate,
 
( Ia) x =  ( k + 1) v k k p x and ( Ia ) x =  k v k k p x
k =0 k =1

4.5.2) Decreasing Annuities

The actuarial present value of a continuously decreasing continuous life annuity that pays
at a rate of n − t at time t until time n is denoted by

n
( Da ) x:n =  ( n − t ) v t t p x dt
0

For discrete annuities, we have, respectively, the decreasing n-year temporary life annuity
due and immediate,
n −1 n
(Da ) x:n =  ( n − k ) v k k p x and (Da ) x:n =  ( n + 1 − k ) v k k p x
k =0 k =1

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4.5.3) Recursive Formula

We can relate annuities at age x to those at age x + 1 .

Example 25 (Some useful recursive formulas)

Prove that

(a) a x = v px a x +1 + a x:1
(b) ax = v p x ax +1 + 1
(c) a x = vp x a x +1 + vp x
(d) a x:n = v p x a x +1:n −1 + a x:1
(e) a x:n = v p x a x +1:n −1 + 1
(f) a x:n = vp x a x +1:n −1 + vp x
(g) n| a x = v p x n −1| a x +1
(h) n| ax = v p x n −1| ax +1
(i) n| a x = v px n −1| a x +1

Solution

(b) (e)
 n −1
ax =  v k k px a x :n =  v k k p x
k =0 k =0
 n −1

=v 0
0 px +  v k
k px let k = u + 1 = v 0 0 px +  v k k px let k = u + 1
k =1 k =1
 n−2

= 1 +  v u +1 u +1 p x = 1 +  v u +1 u +1 p x
u =0 u =0
 n−2

= 1 +  v u v 1 p x u p x +1 = 1 +  v u v 1 p x u p x +1
u =0 u =0
 n−2

= 1 + vp x  v u u p x +1 = 1 + vp x  v u u p x +1
u =0 u =0

= 1 + vp x a x +1 = 1 + vp x a x +1:n −1

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Example 26 (Varying Annuities)

A person aged 20 purchased a special 5-year temporary annuity due with payments of
1,3,5,7, and 9. You are given

• a20:4 = 3.41 , a20:4 = 3.04

• (Ia )20:4 = 8.05 , (Ia )20:4 = 7.17

Calculate the actuarial present value of the annuity.

Solution

The annuity payments of 1,3,5,7,9 can be arranged in the following manner

1
2,4,6,8
1, 1, 1, 1

The actuarial present value of the annuity is

1 + 2(Ia ) 20:4 + a20:4 = 1 + 2(7.17) + 3.04 = 18.38

Example 27 (Varying Annuities)

A person aged x purchased a special annuity immediate with payments of 10,8,6, and 4 in
the first 4 years, followed by payments of 2 per year thereafter. You are given

• ax = 18 .60 , a x:5 = 4.33

• (Ia ) x:5 = 12

Calculate the actuarial present value of the annuity.

Solution

The annuity payments of 10,8,6,4,2,2,2,…,2 can be arranged in the following manner

10, 10, 10, 10, 10

− 2,−4,−6,−8,−10
2, 2, 2, 2, 2, 2...2

The actuarial present value of the annuity is

10a x:5 − 2(Ia ) x:5 + 2a x = 10(4.33) − 2(12) + 2(18.60 − 1) = 54.5

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Example 28 (Recursive Formula)(Whole Life Annuities)

You are given

• a19 = 25 .04 , a20 = 24 .85

• i = 0.03

Calculate p19 .

Solution (Answer: 0.9964)

From Example 25(b), ax = v p x ax +1 + 1

a19 = v p19 a20 + 1

Example 29 (Recursive Formula)(Whole Life Annuities)

Consider the following incomplete life table

x qx lx dx
50 508
51 0.00600
52 91,365

You are given

• a51 = 11 .888
• i = 0.03
Calculate a 50 . (Hint: a x = vp x a x +1 + vp x )

Solution (Answer: 12.444)

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4.6) Life Annuities Payable m-thly

Annual annuities are quite rare. We would more commonly see annuities payable monthly.
However, the annual annuity is still important when we do not have full information about
mortality between integer ages, because we are working with integer age life table.

When payments are made m-thly, the standard actuarial convention and notation considers
a unit annual payment, but paid m times a year so that each actual payment is of size m1 . In
practice, life annuities are normally payable more frequently than once a year, such as
monthly (m = 12) , quarterly (m = 4) , or semi-annually (m = 2) . Payments can cease
somewhere within a year and not just at the year-end point.

The following actuarial notation for life annuities payable m-thly should be intuitively
clear.

(Whole Life Annuities)

 
a x(m ) = vm v
t t
1
m t px ax( m ) = 1
m
m
t px
m m
t =1 t =0

(Temporary Life Annuities)

mn mn −1
a x( :mn ) = vm v
t t
1
m t px a x( :mn ) = 1
m
m
t px
m m
t =1 t =0

(Deferred Whole Life Annuities)

 
=  v
t t
(m)
n| a x
1
m
vm t px ( m ) =
n| a x
1
m
m
t px
m m
t = mn +1 t = mn

An analogous set of identities to those developed in the annual payment case exist in the
m-thly payment case as well, such as

n| a x( m ) = v n n p x a x(m+ n) n| ax( m ) = v n n px ax(m+ n)

a x(m ) = a x( :mn ) + n| a x( m ) ax( m ) = a x( :mn ) + n | ax( m )

Annuities with m-thly payments are common in practice, yet mortality tables provide
mortality rates only at integer ages. A method is needed to develop the actuarial present
value of an m-thly annuity from the actuarial present value of an annual annuity. We resort
to approximation approach. We will consider the Uniform Distribution of Deaths
Approximation and the Woolhouse Approximation Formula.

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4.6.1) Uniform Distribution of Deaths Approximation

Let’s explore the whole life annuity case. Recall that A x = 1 −  a x and Ax = 1 − dax . It can
be shown that Ax(m ) = 1 − d ( m ) ax( m ) .

We define
id i − i(m)
 (m) = (m) (m)
and  (m) = .
i d i ( m )d ( m )

Example 30 (Annuities Payable m-thly)(Uniform Distribution of Deaths Approximation)

(a) Show that under the Uniform Distribution of Deaths Approximation,

ax( m ) =  ( m ) ax −  ( m )

id i −
(b) Deduce that a x = ax −
 2
2

Solution
1 − Ax( m )
(a) a
(m)
x =
d (m)
1 − i ( mi ) Ax
= under UDD
d (m)
i ( m ) − iA
= ( m ) ( m )x
i d

i ( m ) − i (1 − da x )
=
i(m)d (m)
id i − i(m)
= ( m ) ( m ) ax − ( m ) ( m )
i d i d

=  ( m ) ax −  ( m )

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Example 31 (Annuities Payable m-thly)(Uniform Distribution of Deaths Approximation)

Show that under the Uniform Distribution of Deaths Approximation

(a) ax( :mn ) =  (m)ax:n −  (m)(1 − n E x )

(b) n| ax( m ) =  ( m) n| ax −  ( m) n E x

Solution:

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Example 32 (Annuities Payable m-thly)(Uniform Distribution of Deaths Approximation)

You are given

• Deaths are uniformly distributed over each year of age

• i = 0.05
• ax( 2 ) = 15

Calculate ax and Ax( 2 ) .

Solution

We will use ax( m ) =  ( m ) ax −  ( m )

Example 33 (Annuities Payable m-thly)(Uniform Distribution of Deaths Approximation)

You are given

• Deaths are uniformly distributed over each year of age

• A1 = 0.01419
x:n

• n E x = 0.54733
• i = 0.10
•  ( 4) = 1.00019
•  (4) = 0.38272

Calculate a x( :4)n .

Solution (Answer: 4.65095)

We will use a x( :mn ) =  (m)a x:n −  (m)(1 − n E x )

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4.6.2) Woolhouse Approximation Formula

Consider a continuous function g (t ) for which a number of successive derivatives exist.

The Woolhouse formula states that


 m −1 m2 −1 
 g ( ) = m  g (t ) − 2m .g (t ) 0 − 12m 2 .g (t ) 0 + ...
t  
m
t =1  t =1 

Let g (t ) = v t t p x . Then it can shown that g (t ) = −v t t p x (  x +t +  ) . Furthermore,


 t m −1 m2 −1 
 mt x  t x 2m
t
v m
p = m v p − ( − 1) − 2
(  x +  ) + ...
t =1  t =1 12 m 

Consequently,

 
m −1 m2 −1
 v m t px =  vt t px +
t
1
m
− (  x +  ) + ...
t =1
m
t =1 2m 12 m 2

And therefore,
m −1 m2 −1
a x(m ) = a x + − (  x +  ) + ...
2m 12 m 2

In practice, the Woolhouse formula is seldom applied using more than three terms.

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Example 34 (Woolhouse Approximation Formula)

Derive the Woolhouse three-term Approximation Formula,

m − 1 m2 − 1
(a) a x( m )  a x − − ( x +  )
2m 12 m 2
m −1 m2 − 1
(b) a x( :mn|)  a x:n| − (1 − n E x ) −   x +  − n Ex ( x+n +  )
2m 12 m 2
 m − 1 m2 − 1 
(c) n| ax( m )  n| ax − n E x  + 2
( x+n +  )
 2m 12m 

Solution

m − 1 m2 − 1
(a) a x( m )  a x + − ( x +  )
2m 12 m 2
m − 1 m2 − 1
ax( m ) − 1
m  ( a x − 1) + − (x +  )
2m 12 m 2

m − 1 m2 − 1
(c) a = ax −
(m)
x − ( x +  )
2m 12 m 2
m − 1 m2 − 1
ax+ n = ax+ n −
(m)
− (  x+n +  )
2m 12 m 2
m −1 m2 −1
n E x a x+n = n E x a x+n − n E x [
(m)
 + (  x + n +  )]
2m 12 m 2
 m − 1 m2 − 1 

a
n| x
(m)
= 
a −
n| x n x 
E + 2
(  x + n +  )
 2m 12m 

(b) a x( :mn|) = a x( m ) − n | ax( m )

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Example 35 (Woolhouse Approximation Formula)

From Woolhouse three-term Approximation Formula, write down the Woolhouse two-
term Approximation Formula for

(a) a x( m )
(b) ax( m:n)|
(c) n| ax( m )

Solution

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Example 36 (Annuities Payable m-thly)(Woolhouse Approximation Formula)

(m)
An actuary attempts to estimate a80 using Woolhouse three-term Approximation
Formula and found the following results

• ( 2)
a80 = 8.29340
• ( 4)
a80 = 8.16715

(12 )
Calculate a80 .

Solution
m −1 m2 −1
We will use ax( m )  ax − − ( x +  )
2m 12 m 2
We have
1 3
( 2)
a80 = a80 − − ( 80 +  ) and
4 48
3 15
( 4)
a80 = a80 − − ( 80 +  )
8 192

Solve to obtain 80 +  = 0.08

Now,

11 143
(12 )
a80 = a80 − − ( 80 +  )
24 1728

 (2) 1 3  11 143
=  a80 + + ( 80 +  )  − − ( 80 +  )
 4 48  24 1728
= 8.08345

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Example 37 (Annuities Payable m-thly)(Woolhouse Approximation Formula)

You are given

• Ax :n | = 0.693
• n E x = 0 .566
•  x = 0.008 ,  x + n = 0.025
•  = 0.04

Estimate a x( :4)n using Woolhouse’s two-term and three-term Approximation Formula.

Solution
m −1 m2 − 1
We will use a  a x:n −
(m)
(1− n E x ) −  x +  − n E x (  x + n +  )
x :n
2m 12 m 2
1 − Ax:n 1 − Ax:n 1 − Ax:n
We first obtain a x:n = = = = 7.829523 .
d 1− v 1 − e −

(Using Woolhouse’s two-term Approximation Formula)

3
a x( :4)n = a x:n − (1− n E x ) = 7.6668
8

(Using Woolhouse’s three-term Approximation Formula)

3
a x( :4)n = a x:n − (1− n E x ) −
15
 x +  − n E x (  x + n +  ) = 7.6659
8 192

School of Mathematical Sciences (SMS) page 137 August 2020 Semester

ASC2014 Life Contingencies I BSc (Hons) in Actuarial Studies

Comparison of annuities by payment frequency

Complete the table below by using Standard Ultimate Life Table with interest of 5% per
year and appropriate equations under UDD assumptions.

x ax ax(4) ax ax(4) ax
20 18.9664 19.3375 19.4621 19.5875 19.9664

40 17.4578 17.8286 17.9532 18.0786 18.4578

60 13.9041 14.2742 14.3988 14.5242 14.9041

[Hints: a x( m ) = 1
m
+ ax( m ) and ax = a x + 1 ]

What are the reasons for this ordering?

The payments under the annuity due are paid earlier. According to the time value of money,
the value of an annuity with earlier payments will be higher than an annuity with later
payments (for interest rates greater than zero).

We will illustrate this by using timeline as below. Suppose the life dies after seven months
and assume payment of 1 is made per year.

months

0 3 6 9 12

How many payments have collected for a x , ax(4) , a x , ax(4) and a x ?

School of Mathematical Sciences (SMS) page 138 August 2020 Semester