Answers to Exercises Chapter 6

1. HN(16.3)
Loss Deductible Coinsurance without stop-loss Coinsurance with stop-loss Amount paid by insurance
1500 200 0.20*1300=260 260 1500-460=1040
6000 200 0.20*5800=1160 1160 6000-1360=4640

2. Annuities and health insurance

(a) Suppose his annual income is x. See the excel spreadsheet for calculation. x should satisfy
x × p60 x × p61 x × p100
+ 2
+ ... + = 5, 000, 000
1+r (1 + r) (1 + r)41

p60 , p61 , ... are probabilities of surviving age 60, 61, etc. These probabilities are calculated in
the spreadsheet. We can solve for x = 382, 672.5.
(b) If Mr.Wong chooses to save on his own, let his annual income y. y satisfies
y y y
+ + ... + = 5, 000, 000
1 + r (1 + r)2 (1 + r)26

Solve for y = 347, 821.6.

(c) When Mr. Wong is 61, the actuarial value of his annuity is

5, 000, 000 × (1 + 5%) − 382, 672.5 × p60 + 5, 000, 000 × (1 + 5%) × d60 /p60 = 4, 901, 124

When Mr.Wong is 62, the actuarial value of his annuity is

4, 901, 124 × (1 + 5%) − 382, 672.5 × p61 + 4, 901, 124 × (1 + 5%) × d61 /p61 = 4, 800, 051

...
When Mr.Wong is 65, the actuarial value of his annuity is 4,482,894. See the spreadsheet for
calculation. If he decides to withdraw from the annuity, he will get less than the actuarial
value, because premium loadings are front-ended.
(d) The average death probability for 65-year-old in the population is 0.01009.

0.01009 = 0.1 × 0.05 + P r(death|not sick) × 0.95

Therefore, the remaining people’s death probability is P r(death|not sick) = 0.00536. This
number is lower than the number shown in the mortality table.
(e) Buyers with worse health conditions withdraw from the annuity and the remaining people’s
death probability are lower than indicated by the mortality table. Therefore, the annuity
payment will be higher than what is calculated based on the mortality table.

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 (f) Actuarial price for the health insurance is 800, 000 × 0.05 = 40, 000. If he can lock in the
premium level for 5 years, the premium level will be higher, as the probability of getting sick
increases with age.
(g) The health insurance alleviates the adverse selection in annuities as it reduces the incentives
of the people with poor health to withdraw from the annuity.

3. (a)

4. (b)

5. Life Insurance
The following table present the cash flow schedule of a life insurance (including critical illness)
policy. Use the information in the table to answer the following questions. Assume all premiums
are paid at the beginning of each year, and all payments (death benefit and surrender value) are
paid at the end of each year. If you cannot see the number clearly, you may refer to the separate
PDF file. Assume Mr. Chan is at the end of the 45th year of his life. Premiums are paid at the
beginning of the year (the first premium paid right after he turns 46). Benefits are realized at the
end of each year.

(a) Basics.

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 i. How many years should Mr. Chan wait to surrender the policy (assuming survival and
no critical illness) if he wants to recover the total premium he paid (ignoring discount
rate)? Here we assume the cash value of non-guaranteed terminal bonus is realized.
Answer: He needs to wait for at least 20 years to surrender the policy when he is 65.
(Note: If the student uses any interpolation method to solve for the number of years,
they should get full mark.)
ii. Assume a discount rate of 5%. If Mr. Chan wants to surrender the policy (assuming
survival and no critical illness) only if the present value of cash value (assuming the cash
value of non-guaranteed terminal bonus is realized) is no smaller than the present value
of total premium paid. Does he need to wait for longer or shorter than your answer in
question (i)? Explain. (Note: You don’t need to solve for the exact number of years)
Answer: He needs to wait for longer because the cash value is discounted by more than
the total premium paid. When the discount rate is positive, the PV of cash value will be
smaller than the PV of premium payment.
(b) Cash value.
i. Assume the premium paid by the policyholder can earn an 5% interest rate from the
insurers’ investment and assume the insured survives without getting major diseases.
Add a column that calculate the future value of the total premium payment at the end
of each policy year. [Hint: You may use the NPV function and FV function in Excel. See
here for the use of NPV. ]
Answer: After period T , the future value is calculated as follows.
• If T < 20, the future value is

4879 × (1 + 5%)T + 4879 × (1 + 5%)T −1 + ... + 4879 × (1 + 5%)

• If T ≥ 20, the future value is

4879 × (1 + 5%)T + 4879 × (1 + 5%)T −1 + ... + 4879 × (1 + 5%)T −19

For numbers, see the spreadsheet.

ii. Use the information in the Life Table attached and add one column that calculates the
theoretical cash value at the end of each year (assuming zero premium loading) and zero
dividend realization.
Notice that to answer this question, we need to make several assumptions: (1) We use
the death probability to proxy for the probability of death plus getting major disease; (2)
the guarateed part earns an investment return of 3%. Here we assume that the mortality
cost is deducted at the end of the year, so the principal that earns interest includes
the previous year’s cash value plus the new premium contribution (not subtracting the
mortality cost).
Answer: See the spreadsheet.
iii. Assume Mr. Chan survives until 75 years old (after 30 years) and does not get a major
disease. Calculate the IRR Mr. Chan earned when he surrenders the policy at 75 years
old (in the end of the year).
Answer: The IRR is 3.38%.
(c) The Free 10-year Crisis Cover.
i. The policy provided a promotional offer to Mr. Chan that there is a free 10-year crisis
cover for the first 10 years when the policy is in force. Calculate the present value
of expected claim benefits (assuming zero terminal bonus) with and without the free
10-year crisis cover. Assume that the probability of claiming benefits equals the death

3
 probability listed in the mortality table and the policyholder does not terminate the
policy until death. Calculate the percentage increase of claim benefits provided by the
free 10-year crisis cover. Use a discount rate of 3% in your calculation.
Answer: The PV of expected death benefits increases by 2.4%.
(d) Policy surrender and policy loans.
Suppose Mr Chan has paid premium on time for 15 years. He retired at 60 and his income
experienced a large drop. He cannot fulfill the next 5 years of premium payment requirement.
He has two options. Option 1: surrender the policy at 60. Option 2: pay 5 more years of
premium using policy loans.
i. What is the surrender value of Option 1 (assuming the projected non-guaranteed terminal
bonus is realized)?
Answer: The surrender value is 45221 USD with dividend.
ii. Suppose the policy loan requires an interest rate of 5%. What is the cash value that
he can receive after he uses policy loan to pay for 5 additional years of premium and
surrender at age 65 (assuming survival and no major diseases and dividends are realized
as shown in Column B)?
Answer: 113664 - FV(premium loan) = 85356.47 USD.

6. Annuity In this exercise, we analyze the HKMC Annuity Plan (simplified). The following table lists
information of this plan. For more details, check this website. In this exercise, we assume the buyer
is male. The first column lists the age of the insured at the purchase. The second column lists the
guaranteed monthly annuity payment. The third and fourth columns list the number of guaranteed
period of annuity payments, which we will analyze further in subquestions. For simplicity, we
assume that payments are made annually. For example, if a 65-year-old buyer buys the annuity, he
gets an annual payment of 5800×12 at the end of every year if he survives. For simplicity, you don’t
need to calculate the payment and death probability in each month of the year. The payment ends
when the insured is 100 years old. Use the Life Table attached to answer the following questions.

4
(a) Suppose the policy does not have any death benefit, which means if the insured dies the
policy stops making payments (i.e., ignore Column 3 and 4). Assume the policyholder does
not surrender the policy before death.
i. Calculate the internal rate of return (IRR) of this policy for buyers of 65 (the buyer is
right before his 65th birthday). Assume the first payment starts one year later. That is,
the buyer can receive 5800 × 12 at the end of every year. Note: the IRR is such that the
PV of premium equals the PV of expected benefits. (8’)
Answer: We proceed with the following steps. The expected payment in each year is
5800 × 12 × pT , where pT is the probability of surviving into year T (T ≥ 65), see Column
D in the spreadsheet. Then use the IRR function to calculate the internal rate of return
as 2.927%.
ii. Suppose there is another financial instrument (e.g., a bond) that can achieve the same
level of IRR as you calculate in part (i). What is the benefit of the annuity plan, compared
with the alternative instrument?
Answer: If one uses the alternative instrument, if he lives longer than he expected, he

5
 will run out of wealth.
(b) Death benefit and IRR.
The death benefit we consider is simpler than the death benefit from the actual plan (if you
read the document through the link). Assume that if the insured dies within the guaranteed
period, the beneficiary can receive the same amount of income for several months (the number
of months with guaranteed income is specified in the last column for different ages).
i. Recalculate your answer to question a(i). For simplicity, the guaranteed 182 months can
be approximated by 180 months (15 years).
Answer: See spreadsheet. The IRR is 3.801%.
ii. Calculate the IRR for a buyer of 80 years old. For simplicity, the guaranteed 129 months
can be approxiated by 132 months (11 years).
Answer: See spreadsheet. The IRR is 3.413%.
iii. Compare the two IRRs. Do older buyers get a higher or lower IRR than younger buyers?
What are possible reasons?
Answer: Younger buyers get a higher IRR. One possible reason is that the liabilities to
younger buyers are longer dated so that the insurers can invest the premium into some
long-term assets. Typically longer-term asset provide a higher return.
(c) Policy surrender.
In this subquestion, we examine the surrender of the policy. Suppose a buyer purchases the
policy right after his 65th birthday and receives the specified payments until right before his
75th birthday. Then he unfortunately is diagnosed with cancer and needs to pay a large
amount of medical expenses (0.7 million HKD).
i. Suppose the annual interest credited to the account is 5%, and assume the premium
loading is 0. Assume there exists a death benefit: the income payment will continue for
at least 182 months (you may use 180 months, or 15 years as an approximation) if the
annuitant dies before 80. Calculate the theoretical surrender value of the policy when the
buyer surrenders the policy if there is no premium loading. Does the theoretical surrender
value increase or decrease with age? Why? (10’)
Answer:
• Before 66th birthday: 1, 000, 000 × (1 + 5%) − 5800 × 12 = 980, 400.
• Before 67th birthday: 980, 400 × (1 + 5%) − 5800 × 12 = 959, 820.
• ...
• The actuarially fair surrender value before the 75th birthday is 753473.306. For
calculation, see the spreadsheet.
The acturially fair surrender value decreases with age because people get more income
before surrender when the surrender age is older. Therefore, their surrender values are
smaller. Moreover, because there is guaranteed death benefit, so there is no subsidy from
those who die to those who are alive.
ii. Explain why such policy surrender brings adverse selection problem to the annuity policy.
Answer: Those that have health shocks may surrender the policy. The remaining buyers
in the pool tend to have lower death probability, so that the insurance company will need
to pay more.
iii. If you are a financial consultant to an elderly who is going to enter into the annuity policy,
can you provide a reason to convince the buyer to simultaneously buy a health insurance?
Answer: Buying a health insurance can prevent early liquidation of the annuity, which
is subject to front-end premium loading.

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人口生命表 Life Tables

表 12 2019 年香港男性人口生命表
Table 12 Hong Kong life table for males, 2019
確切年齡 確切年齡 確切年齡
x 歲和 x+1 歲之間的 確切年齡 x 歲的 x 歲和 x+1 歲之間的 x 歲和 x+1 歲之間的 確切年齡 x 歲以上 確切年齡 x 歲的
年齡 死亡概率 尚存人數 死亡人數 生存人年 總生存人年 平均預期壽命
Age Probability Number of Number of deaths Number of Total person-years Expectation
of dying survivors between exact person-years lived lived after of life
between exact at exact age x age x and age x+1 between exact exact age x at exact age x
age x and age x+1 age x and age x+1
x q(x) l(x) d(x) L(x) T(x) e(x)

0 0.00162250 1 000 000 1 623 998 702 82 212 463 82.21

1 0.00019344 998 377 193 998 281 81 213 761 81.35
2 0.00015686 998 184 157 998 106 80 215 480 80.36
3 0.00012524 998 027 125 997 965 79 217 374 79.37
4 0.00009857 997 902 98 997 853 78 219 409 78.38
5 0.00007701 997 804 77 997 766 77 221 556 77.39
6 0.00006084 997 727 61 997 697 76 223 790 76.40
7 0.00005002 997 666 50 997 641 75 226 093 75.40
8 0.00004524 997 616 45 997 594 74 228 452 74.41
9 0.00004718 997 571 47 997 548 73 230 858 73.41
10 0.00005633 997 524 56 997 496 72 233 310 72.41
11 0.00007291 997 468 73 997 432 71 235 814 71.42
12 0.00009653 997 395 96 997 347 70 238 382 70.42
13 0.00012564 997 299 125 997 237 69 241 035 69.43
14 0.00015800 997 174 158 997 095 68 243 798 68.44
15 0.00018870 997 016 188 996 922 67 246 703 67.45
16 0.00021443 996 828 214 996 721 66 249 781 66.46
17 0.00023349 996 614 233 996 498 65 253 060 65.47
18 0.00024539 996 381 245 996 259 64 256 562 64.49
19 0.00025127 996 136 250 996 011 63 260 303 63.51
20 0.00025481 995 886 254 995 759 62 264 292 62.52
21 0.00026013 995 632 259 995 503 61 268 533 61.54
22 0.00027172 995 373 270 995 238 60 273 030 60.55
23 0.00029114 995 103 290 994 958 59 277 792 59.57
24 0.00031860 994 813 317 994 655 58 282 834 58.59
25 0.00035281 994 496 351 994 321 57 288 179 57.61
26 0.00039116 994 145 389 993 951 56 293 858 56.63
27 0.00042968 993 756 427 993 543 55 299 907 55.65
28 0.00046707 993 329 464 993 097 54 306 364 54.67
29 0.00050262 992 865 499 992 616 53 313 267 53.70
30 0.00053344 992 366 529 992 102 52 320 651 52.72
31 0.00055947 991 837 555 991 560 51 328 549 51.75
32 0.00058352 991 282 578 990 993 50 336 989 50.78
33 0.00060809 990 704 602 990 403 49 345 996 49.81
34 0.00063664 990 102 630 989 787 48 355 593 48.84
35 0.00067580 989 472 669 989 138 47 365 806 47.87
36 0.00073018 988 803 722 988 442 46 376 668 46.90
37 0.00080236 988 081 793 987 685 45 388 226 45.94
38 0.00089355 987 288 882 986 847 44 400 541 44.97
39 0.00100287 986 406 989 985 912 43 413 694 44.01
40 0.00112482 985 417 1 108 984 863 42 427 782 43.06
41 0.00125401 984 309 1 234 983 692 41 442 919 42.10
42 0.00138511 983 075 1 362 982 394 40 459 227 41.16
43 0.00151730 981 713 1 490 980 968 39 476 833 40.21
44 0.00165192 980 223 1 619 979 414 38 495 865 39.27
45 0.00179352 978 604 1 755 977 727 37 516 451 38.34
46 0.00194738 976 849 1 902 975 898 36 538 724 37.40
47 0.00211958 974 947 2 066 973 914 35 562 826 36.48
48 0.00231228 972 881 2 250 971 756 34 588 912 35.55
49 0.00252595 970 631 2 452 969 405 33 617 156 34.63

香港人口生命表 2014–2069 30 Hong Kong Life Tables 2014–2069

人口生命表 Life Tables

表 12 （續） 2019 年香港男性人口生命表

Table 12 (Cont’d) Hong Kong life table for males, 2019
確切年齡 確切年齡 確切年齡
x 歲和 x+1 歲之間的 確切年齡 x 歲的 x 歲和 x+1 歲之間的 x 歲和 x+1 歲之間的 確切年齡 x 歲以上 確切年齡 x 歲的
年齡 死亡概率 尚存人數 死亡人數 生存人年 總生存人年 平均預期壽命
Age Probability Number of Number of deaths Number of Total person-years Expectation
of dying survivors between exact person-years lived lived after of life
between exact at exact age x age x and age x+1 between exact exact age x at exact age x
age x and age x+1 age x and age x+1
x q(x) l(x) d(x) L(x) T(x) e(x)

50 0.00274999 968 179 2 662 966 848 32 647 751 33.72

51 0.00297844 965 517 2 876 964 079 31 680 903 32.81
52 0.00320998 962 641 3 090 961 096 30 716 824 31.91
53 0.00345019 959 551 3 311 957 896 29 755 728 31.01
54 0.00370895 956 240 3 547 954 467 28 797 832 30.12
55 0.00400300 952 693 3 814 950 786 27 843 365 29.23
56 0.00434727 948 879 4 125 946 817 26 892 579 28.34
57 0.00475490 944 754 4 492 942 508 25 945 762 27.46
58 0.00523369 940 262 4 921 937 802 25 003 254 26.59
59 0.00578616 935 341 5 412 932 635 24 065 452 25.73
60 0.00639625 929 929 5 948 926 955 23 132 817 24.88
61 0.00705099 923 981 6 515 920 724 22 205 862 24.03
62 0.00774045 917 466 7 102 913 915 21 285 138 23.20
63 0.00847057 910 364 7 711 906 509 20 371 223 22.38
64 0.00925418 902 653 8 353 898 477 19 464 714 21.56
65 0.01009394 894 300 9 027 889 787 18 566 237 20.76
66 0.01100561 885 273 9 743 880 402 17 676 450 19.97
67 0.01201798 875 530 10 522 870 269 16 796 048 19.18
68 0.01315812 865 008 11 382 859 317 15 925 779 18.41
69 0.01445331 853 626 12 338 847 457 15 066 462 17.65
70 0.01590698 841 288 13 382 834 597 14 219 005 16.90
71 0.01752795 827 906 14 511 820 651 13 384 408 16.17
72 0.01933036 813 395 15 723 805 534 12 563 757 15.45
73 0.02134681 797 672 17 028 789 158 11 758 223 14.74
74 0.02361215 780 644 18 433 771 428 10 969 065 14.05
75 0.02615837 762 211 19 938 752 242 10 197 637 13.38
76 0.02901072 742 273 21 534 731 506 9 445 395 12.72
77 0.03218674 720 739 23 198 709 140 8 713 889 12.09
78 0.03570063 697 541 24 903 685 090 8 004 749 11.48
79 0.03955787 672 638 26 608 659 334 7 319 659 10.88
80 0.04376247 646 030 28 272 631 894 6 660 325 10.31
81 0.04831253 617 758 29 845 602 836 6 028 431 9.76
82 0.05320361 587 913 31 279 572 274 5 425 595 9.23
83 0.05843045 556 634 32 524 540 372 4 853 321 8.72
84 0.06398744 524 110 33 536 507 342 4 312 949 8.23
85 0.07005385 490 574 34 367 473 391 3 805 607 7.76
86 0.07667262 456 207 34 979 438 718 3 332 216 7.30
87 0.08388956 421 228 35 337 403 560 2 893 498 6.87
88 0.09175339 385 891 35 407 368 188 2 489 938 6.45
89 0.10031580 350 484 35 159 332 905 2 121 750 6.05
90 0.10963133 315 325 34 570 298 040 1 788 845 5.67
91 0.11975740 280 755 33 622 263 944 1 490 805 5.31
92 0.13075406 247 133 32 314 230 976 1 226 861 4.96
93 0.14268386 214 819 30 651 199 494 995 885 4.64
94 0.15561151 184 168 28 659 169 839 796 391 4.32
95 0.16960348 155 509 26 375 142 322 626 552 4.03
96 0.18472755 129 134 23 855 117 207 484 230 3.75
97 0.20105214 105 279 21 167 94 696 367 023 3.49
98 0.21864560 84 112 18 391 74 917 272 327 3.24
99 0.23757528 65 721 15 614 57 914 197 410 3.00
（註釋 Note）
100+ 1.00000000 50 107 50 107 139 496 139 496 2.78

註釋： 這數字是指 100 歲的平均預期壽命。 Note : This figure refers to the expectation of life at age 100.

香港人口生命表 2014–2069 31 Hong Kong Life Tables 2014–2069