M3630Weeks6to7 f2019 1

Insurance Benefits
Lecture: Weeks 6-7
Lecture: Weeks 6-7 (Math 3630) Insurance Benefits Fall 2019 - Valdez 1 / 37
An introduction
An introduction
Central theme: to quantify the value today of a (random) amount to
be paid at a random time in the future.
main application is in life insurance contracts, but could be applied in
other contexts, e.g. warranty contracts.
Generally computed in two steps:
1 take the present value (PV) random variable, bT vT ; and
2 calculate the expected value E[bT vT ] for the average value - this value
is referred to as the Actuarial Present Value (APV).
In general, we want to understand the entire distribution of the PV
random variable bT vT :
it could be highly skewed, in which case, there is danger to use
expectation.
other ways of summarizing the distribution such as variances and
percentiles/quantiles may be useful.
An introduction
A simple illustration
Consider the simple illustration of valuing a three-year term insurance
policy issued to age 35 where if he dies within the first year, a $1,000
benefit is payable at the end of his year of death.
If he dies within the second year, a $2,000 benefit is payable at the end of
his year of death. If he dies within the third year, a $5,000 benefit is
payable at the end of his year of death.
Assume a constant interest rate (annual effective) of 5% and the following
extract from a mortality table:
x qx
35 0.005
36 0.006
37 0.007
38 0.008
Calculate the APV of the benefits.

An introduction chapter summary
Chapter summary
Life insurance
benefits payable contingent upon death; payment made to a designated
beneficiary
actuarial present values (APV)
actuarial symbols and notation
Insurances payable at the moment of death
continuous
level benefits, varying benefits (e.g. increasing, decreasing)
Insurances payable at the end of year of death
discrete
level benefits, varying benefits (e.g. increasing, decreasing)
Chapter 4, DHW
The present value random variable
The present value random variable
Denote by Z, the present value random variable.

This gives the value, at policy issue, of the benefit payment. Issue age
is usually denoted by x.
In the case where the benefit is payable at the moment of death, Z
clearly depends on the time-until-death T . For simplicity, we drop the
subscript x for age-at-issue.
It is Z = bT vT where:
bT is called the benefit payment function
vT is the discount function
In the case where we have a constant (fixed) interest rate, then

vT = v T = (1 + i)−T = e−δT .
Policy types term life
Fixed term life insurance

An n-year term life insurance provides payment if the insured dies
within n years from issue.
For a unit of benefit payment, we have
(
1, T ≤ n
bT = and vT = v T .
0, T > n
The present value random variable is therefore
(
vT , T ≤ n
Z= = v T I(T ≤ n)
0, T >n
where I(·) is called indicator function. E[Z] is called the APV of the
insurance.
Actuarial notation:
Z n Z n
t
1
Ā x: n = E[Z] = v fx (t)dt = v t tpx µx+t dt.
0 0
Policy types term life
Rule of moments
The j-th moment of the distribution of Z can be expressed as:
Z n Z n
e−(jδ)t tpx µx+t dt.
j tj
E Z = v tpx µx+t dt =
0 0
This is actually equal to the APV but evaluated at the force of

interest jδ.
In general, we have the following rule of moment:
E Z j @ δt = E[Z]@ jδt .

For example, the variance can be expressed as

2
Var[Z] = 2Āx:
1 1
n − Āx: n .
Traditional life insurance
Traditional insurances - continuous
Benefit PV r.v. APV Variance

Type bT Z E[Z] Var[Z]
Term 2
I(T ≤ n) v T · I(T ≤ n) Ā 1x: n 2Ā1
x: n − Ā1x: n
life
Whole 2
1 vT Āx 2Ā
x − Āx
life
Pure 2
I(T > n) v n · I(T > n) Ax: n1 or n Ex 2A 1
x: n − Ax: 1n
endowment
2
Endowment 1 v min(T,n) Āx: n 2Ā
x: n − Āx: n
2
Deferred I(T > n) v T · I(T > n) n|Āx
2
n|Āx − n|Āx
Traditional life insurance pure endowment
Pure endowment insurance

For an n-year pure endowment insurance, we can also express the PV
random variable as:
Z = v n I(Tx > n),
where I(E) is 1 if the event E is true, and 0 otherwise.
The term I(I(Tx > n)) is a binary random variable with mean
E[I(Tx > n)] = npx and Var[I(Tx > n)] = npx (1 − npx ).
APV for pure endowment:
Ax: 1n = n Ex = v n npx .
Variance (show also using rule of moments):

2
Var[Z] = v 2n npx · nqx = 2Ax: n1 − Ax: 1n .
Traditional life insurance endowment
Endowment insurance
An n-year endowment insurance is the sum of an n-year term and and
n-year pure endowment:
Z = Z1 + Z2 = v min(T,n) = v T · I(T ≤ n) + v n I(Tx > n),
where Z1 = v T · I(T ≤ n) is the term component and

Z2 = v n I(Tx > n) is the pure endowment component.
Therefore, it is clear that:
Āx: n = Ā 1x: n + n Ex = v n npx .
One can also use the variance of sums of random variables to get:
Var[Z] = Var[Z1 ] + Var[Z2 ] + 2Cov[Z1 , Z2 ]
where one can show that Cov[Z1 , Z2 ] = E[Z1 ]E[Z2 ] since Z1 · Z2 = 0.

Traditional life insurance deferred
Deferred insurance
An n-year deferred insurance can be viewed as a discounted (with

life) whole life insurance:
n|Āx = n Ex · Āx+n
The pure endowment insurance is used as a discounting with life

contingent payments.
Special cases constant force
Constant force of mortality - all throughout life
Assume mortality is based on a constant force, say µ, and interest is also

based on a constant force of interest, say δ.
Find expressions for the APV for the following types of insurances:
whole life insurance;
n-year term life insurance;
n-year endowment insurance; and
n-year deferred life insurance.
Check out the (corresponding) variances for each of these types of
insurance.
[Details in class]
Special cases constant force
APVs under constant force of mortality

Assume constant force of mortality µ and constant force of interest δ.
Type APV
µ
Ā 1x: n = 1 − e−(µ+δ)n

Term
µ+δ
µ
Whole Āx =
µ+δ
Pure Ax: 1n = n Ex = e−(µ+δ)n
µ
1 − e−(µ+δ)n + e−(µ+δ)n

Endowment Āx: n =
µ+δ
µ −(µ+δ)n
Deferred n|Āx =
µ+δ
e
Special cases De Moivre’s law
De Moivre’s law
Find expressions for the APV for the same types of insurances in the case
where you have:
De Moivre’s law.
Special cases whole life - illustration
Illustrative example 1
For a whole life insurance of $1,000 on (x) with benefits payable at the
moment of death, you are given:
(
0.04, 0 < t ≤ 10
δt =
0.05, t > 10
and (
0.006, 0 < t ≤ 10
µx+t =
0.007, t > 10
Calculate the actuarial present value for this insurance.
Special cases whole life
Equivalent probability calculations

We can also compute probabilities of Z as follows. Consider the present
value random variable Z for a whole life issued to age x. For 0 < α < 1,
the following is straightforward:
Pr[Z ≤ α] = Pr[e−δTx ≤ α = Pr[−δTx ≤ log(α)]

= Pr[Tx > −(1/δ) log(α)] = upx ,
where
u = (1/δ) log(1/α) = log(1/α)1/δ .
Consider the case where α = 0.75 and δ = 0.05. Then

u = log(1/0.75)1/0.05 = 5.753641.
Thus, the probability Pr[Z ≤ 0.75] is equivalent to the probability
that (x) will survive for another 5.753641 years.
Varying benefits
Insurances with varying benefits
Type bT Z APV
Increasing
bT + 1cv T

bT + 1c I Ā x
whole life
Whole life
v T bT m + 1c /m I (m) Ā

bT m + 1c /m
increasing m-thly x
Constant increasing
T vT I¯Ā

T x
whole life
( (
Decreasing n − bT c, T ≤n (n − bT c) v T , T ≤ n 1
DĀ
n-year term 0, T >n 0, T >n
x: n
* These items will be discussed in class.
Varying benefits varying benefits - illustration
For a whole life insurance on (50) with death benefits payable at the
moment of death, you are given:
Mortality follows De Moivre’s law with ω = 110.
bt = 10000(1.10)t , for t ≥ 0
δ = 5%
Z denotes the present value random variable for this insurance.
Calculate E[Z] and Var[Z].
Can you find an explicit expression for the distribution function of Z, i.e.
Pr[Z ≤ z]?
Discrete insurances term insurance
Insurances payable at EOY of death

For insurances payable at the end of the year (EOY) of death, the PV
r.v. Z clearly depends on the curtate future lifetime Kx .
It is Z = bK+1 vK+1 .
To illustrate, consider an n-year term insurance which pays benefit at
the end of year of death:
(
1, K = 0, 1, . . . , n − 1
bK+1 = , vK+1 = v K+1 ,
0, otherwise
and therefore
(
v K+1 , K = 0, 1, . . . , n − 1
Z= .
0, otherwise
Discrete insurances term insurance
- continued
APV of n-year term:

n−1
X n−1
X
A1x: n = E[Z] = v k+1 k|qx = v k+1 kpx · qx+k
k=0 k=0
Rule of moments also apply in discrete situations. For example,

2
Var[Z] = 2Ax:
1 1
n − Ax: n ,
where
n−1X
2
A1x: n = E Z 2 = e−2δ(k+1) kpx · qx+k .
k=0
Traditional life insurance
Traditional insurances - discrete
Benefit PV r.v. APV Variance

Type bT Z E[Z] Var[Z]
Term 2
I(K < n) v K+1 · I(K < n) A 1x: n 2A1
x: n − A1x: n
life
Whole
1 v K+1 Ax 2A
x − (Ax )2
life
2
Endowment 1 v min(K+1,n) Ax: n 2A
x: n − Ax: n
2
Deferred I(K ≥ n) v K+1 · I(K ≥ n) n|Ax
2
n|Ax − n|Ax
Traditional life insurance recursive relationships
Recursive relationships
The following will be derived/discussed in class:

whole life insurance: Ax = vqx + vpx Ax+1
term insurance: A1x: n = vqx + vpx Ax +

1
1: n−1
endowment insurance: Ax: n = vqx + vpx Ax+1: n−1
Traditional life insurance interest rate sensitivity
1.0
Makeham parameters:
A = 0.00022, B = 2.7 × 10−6 , c = 1.124
0.8
0.6
Ax
0.4
0.2
i = 1%
i = 5%
i = 10%
i = 15%
0.0
i = 20%
20 40 60 80 100
x
Figure: Actuarial Present Value of a discrete whole life insurance for various
interest rate assumptions
Traditional life insurance mortality rate sensitivity
1.0
1.0
Makeham parameters: Makeham parameters:
A = 0.00022, B = 2.7 × 10−6 , c varying A = 0.00022, B = 2.7 × 10−6 , c varying
0.8
0.8
c = 1.124 c = 1.124
0.6
0.6
c = 1.130 c = 1.130
c = 1.136 c = 1.136
Ax
qx
c = 1.142 c = 1.142
c = 1.148 c = 1.148
0.4
0.4
0.2
0.2
0.0
0.0
20 40 60 80 100 20 40 60 80 100
x x
Figure: Actuarial Present Value of a discrete whole life insurance for various
mortality rate assumptions with interest rate fixed at 5%
Traditional life insurance illustrative example
For a whole life insurance of 1 on (41) with death benefit payable at the
end of the year of death, let Z be the present value random variable for
this insurance.
You are given:
i = 0.05;
p40 = 0.9972;
A41 − A40 = 0.00822; and

2A − 2A40 = 0.00433.
41
Calculate Var[Z].
Traditional life insurance other forms
Other forms of insurance
Varying benefit insurances

Very similar to the continuous cases
You are expected to read and understand these other forms of
insurances.
It is also useful to understand the various (possible) recursion
relations resulting from these various forms.
Traditional life insurance illustration of varying benefit amounts
Illustration of varying benefits
For a special life insurance issued to (45), you are given:

Death benefits are payable at the end of the year of death.
The benefit amount is $100,000 in the in the first 10 years of death,
decreasing to $50,000 after that until reaching age 65.
An endowment benefit of $100,000 is paid if the insured reaches age
65.
There are no benefits to be paid past the age of 65.
Mortality follows the Standard Ultimate Life Table at i = 0.05.
Calculate the actuarial present value (APV) for this insurance.
Traditional life insurance illustrative example
For a whole life insurance issued to age 40, you are given:
Death benefits are payable at the moment of death.
The benefit amount is $1,000 in the first year of death, increasing by
$500 each year thereafter for the next 3 years, and then becomes level
at $5,000 thereafter.
Mortality follows the Standard Ultimate Life Table at i = 0.05.
Deaths are uniformly distributed over each year of age.
Calculate the APV for this insurance.
Insurance payable m-thly
Insurances payable m-thly

Consider the case where we have just one-year term and the benefit is
payable at the end of the m-th of the year of death.
We thus have
m−1
(m)
X
A1 = v (r+1)/m · r/mpx · 1/mqx+r/m .
x: 1 r=0
We can show that under the UDD assumption, this leads us to:
(m) i
A1 = A1 .
x: 1 i(m) x: 1
In general, we can generalize this to:
(m) i
A1 = A1x: n .
x: n i(m)
Insurance payable m-thly
Other types of insurances with m-thly payments
For other types, we can also similarly derive the following (with the
UDD assumption):
(m) i
whole life insurance: Ax = Ax
i(m)
(m) i
deferred life insurance: n|Ax = A
i(m) n| x
(m) i
endowment insurance: Ax: n = A1 + Ax: 1n
i(m) x: n
Relationships
Relationships - continuous and discrete
For some forms of insurances, we can get explicit relationships under

the UDD assumption:
i
whole life insurance: Āx = Ax
δ
i 1
term insurance: Ā1x: n = A
δ x: n
i
(IA)1x: n
1
increasing term insurance: I Ā x: n =
δ
Relationships illustrative example
For a three-year term insurance of 1000 on [50], you are given:

Death benefits are payable at the end of the quarter of death.
Mortality follows a select and ultimate life table with a two-year select
period:
[x] `[x] `[x]+1 `x+2 x+2
50 9706 9687 9661 52
51 9680 9660 9630 53
52 9653 9629 9596 54

i = 5%
Calculate the APV for this insurance.
Illustrative examples
Each of 100 independent lives purchases a single premium 5-year deferred

whole life insurance of 10 payable at the moment of death.
You are given:
µ = 0.004
δ = 0.006
F is the aggregate amount the insurer receives from the 100 lives.
The 95th percentile of the standard Normal distribution is 1.645.

Using a Normal approximation, calculate F such that the probability the
insurer has sufficient funds to pay all claims is 0.95.
Suppose interest rate i = 6% and mortality is based on the following life

table:
x 90 91 92 93 94 95 96 97 98 99 100
`x 800 740 680 620 560 500 440 380 320 100 0
Calculate the following:

(a) A94
1
(b) A90: 5
(4)
(c) 3|A92 , assuming UDD between integral ages
(d) A95: 3
A five-year term insurance policy is issued to (45) with benefit amount of

$10,000 payable at the end of the year of death.
Mortality is based on the following select and ultimate life table:
x `[x] `[x]+1 `[x]+2 `x+3 x+3

45 5282 5105 4856 4600 48
46 4753 4524 4322 4109 49
47 4242 4111 3948 3750 50
48 3816 3628 3480 3233 51
Calculate the APV for this insurance if i = 5%.
Note: This is a modified question from SOA Spring 2016 exam.

A life insurance policy is issued to (35) with present value random variable:

T35
10v , 0 < T35 ≤ 25

Z = 40v T35 , 25 < T35 ≤ 45

0, T > 45

You are also given:

Mortality follows the Standard Ultimate Life Table.
i = 0.05
Calculate the expected value and the standard deviation of Z.
Other terminologies
Other terminologies and notations used

Expression Other terms/symbols used
Expected Present Value (EPV)

Actuarial Present Value (APV) Net Single Premium (NSP)
single benefit premium
basis assumptions
interest per year effective

interest rate (i)
discount rate
sum insured (S)

benefit amount (b)
death benefit
Expected value of Z E(Z)
Variance of Z Var(Z) V [Z]

M3630Weeks6to7 f2019 1

Uploaded by

Copyright:

Available Formats

M3630Weeks6to7 f2019 1

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

M3630Weeks6to7 f2019 1

Uploaded by

Copyright:

Available Formats

Insurance Benefits

Lecture: Weeks 6-7

Calculate the APV of the benefits.

The present value random variable

Denote by Z, the present value random variable.

In the case where we have a constant (fixed) interest rate, then

Fixed term life insurance

This is actually equal to the APV but evaluated at the force of

For example, the variance can be expressed as

Traditional insurances - continuous

Benefit PV r.v. APV Variance

Pure endowment insurance

Variance (show also using rule of moments):

Z = Z1 + Z2 = v min(T,n) = v T · I(T ≤ n) + v n I(Tx > n),

where Z1 = v T · I(T ≤ n) is the term component and

Āx: n = Ā 1x: n + n Ex = v n npx .

Var[Z] = Var[Z1 ] + Var[Z2 ] + 2Cov[Z1 , Z2 ]

where one can show that Cov[Z1 , Z2 ] = E[Z1 ]E[Z2 ] since Z1 · Z2 = 0.

An n-year deferred insurance can be viewed as a discounted (with

The pure endowment insurance is used as a discounting with life

Constant force of mortality - all throughout life

Assume mortality is based on a constant force, say µ, and interest is also

APVs under constant force of mortality

Pure Ax: 1n = n Ex = e−(µ+δ)n

Equivalent probability calculations

Pr[Z ≤ α] = Pr[e−δTx ≤ α = Pr[−δTx ≤ log(α)]

Consider the case where α = 0.75 and δ = 0.05. Then

Insurances with varying benefits

* These items will be discussed in class.

Insurances payable at EOY of death

APV of n-year term:

Rule of moments also apply in discrete situations. For example,

Traditional insurances - discrete

Benefit PV r.v. APV Variance

The following will be derived/discussed in class:

term insurance: A1x: n = vqx + vpx Ax +

endowment insurance: Ax: n = vqx + vpx Ax+1: n−1

A41 − A40 = 0.00822; and

Other forms of insurance

Varying benefit insurances

Illustration of varying benefits

For a special life insurance issued to (45), you are given:

Calculate the actuarial present value (APV) for this insurance.

Calculate the APV for this insurance.

Insurances payable m-thly

In general, we can generalize this to:

Other types of insurances with m-thly payments

Relationships - continuous and discrete

For some forms of insurances, we can get explicit relationships under

For a three-year term insurance of 1000 on [50], you are given:

Deaths are uniformly distributed over each year of age.

Calculate the APV for this insurance.

Each of 100 independent lives purchases a single premium 5-year deferred

The 95th percentile of the standard Normal distribution is 1.645.

Suppose interest rate i = 6% and mortality is based on the following life

Calculate the following:

A five-year term insurance policy is issued to (45) with benefit amount of

x `[x] `[x]+1 `[x]+2 `x+3 x+3

Calculate the APV for this insurance if i = 5%.