Dr Sanjeewa Perera

Department of Mathematics
University of Colombo





FM 2002 ACTUARIAL
MATHEMATICS I
1
CHAPTER 2
FM 2002 ACTUARIAL
MATHEMATICS I
2
Introduction
"What is the value today of a random sum of
money which will be paid at a random time in the
future?
A=Random amount, T=Random Time


Present Value=Av
T
Expected Present Value = E[Av
T
]
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MATHEMATICS I
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A
T
Meaning of E[Av
T
]
Average present value of the actual payment.
Averages are reasonable in the insurance context
since, from the company's point of view.
The average cost (and income) per policy is therefore
a reasonable starting point from which to determine
the premium.
The expected present value is usually referred to as
the Actuarial present value in the insurance context.
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MATHEMATICS I
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Insurance Contracts
Consist of two parts:
Benefit payments,
Premium payments
A life insurance policy paying benefit b
t
if death
occurs at time t has actuarial present value E[b
T
v
T
].
The actuarial present value is also called the
Net single premium.
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MATHEMATICS I
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Life Insurance
The net single premium is the average value
of the benefit payments, in today's money.
The net single premium is the amount of the
single premium payment which would be
required on the policy issue date by an
insurer with no expenses (and no profit
requirement). The actuarial present value of
the premium payments must be at least equal
to the actuarial present value of the benefit
payments, or the company would go
bankrupt.
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MATHEMATICS I
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What we want to do now?
Next two methods are developed for
computing the net single premium for
commonly issued life insurances and
develops methods for computing the
actuarial present value of the premium
payments. These two sets of methods are
then combined to enable the computation of
insurance premiums.
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MATHEMATICS I
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Important Facts
In the case of life insurance, the amount that is paid
at the time of death is usually fixed by the policy and
is non-random.
The net single premium for an insurance which pays
1 at the time of death is then E[v
T
].


In insurance notation: bar: an insurance paid at the
time of death, subscripts: status whose death causes
the insurance to be paid.
FM 2002 ACTUARIAL
MATHEMATICS I
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1
exp( )
1
v
i
o = =
+
n-Year Pure Endowment Insurance
This pays the full benefit amount at the end of the n
th

year if the insured survives at least n years.

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MATHEMATICS I
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1, if ( )
, if ( )
,
0, if ( )
0, if ( )
n
t
T x n
v T x n
b Z
T x n
T x n
>
>
= =

<
<

Show that

Since if the benefit is paid, the benefit payment
occurs at time n,


FM 2002 ACTUARIAL
MATHEMATICS I
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n
n x n x
E v p =
Use the life table to find the net single premium for a 5
year pure endowment policy for (30) assuming an
interest rate of 6%.


FM 2002 ACTUARIAL
MATHEMATICS I
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5
5 30 5 30
The net single premium for the pure endowment polic
0.7409
y i
.
s
1 E v p = = =
n-Year Term Insurance
This type insurance provides for a benefit payment
only if the insured dies within n years of policy
inception.

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MATHEMATICS I
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Rule of Moments
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MATHEMATICS I
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Whole Life Insurance
The full benefit is paid no matter when the insured
dies in the future.
The whole life benefit can be obtained by taking
the limit as n (approaches to infinity) in the n-year
term insurance setting.


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MATHEMATICS I
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Suppose that T(x) has an exponential distribution with
mean 50. If the force of interest is 5%, find the net single
premium for a whole life policy for (x), if the benefit of $
1000 is payable at the moment of death.
T(x) is exponentially distributed with 1/50.
Net single premium = E[1000 v
T
]
Net single premium = E[1000 exp(- T(x))]


FM 2002 ACTUARIAL
MATHEMATICS I
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0
1
[1000exp( ( ))] 1000exp( 0.05 ) exp
50 50
=285.71
t
E T x t dt o

| |
=
|
\ .
}
For a whole life insurance of 1000 on (x) with benefits
payable at the moment of death, you are given:



Calculate the single benefit premium for this insurance.
FM 2002 ACTUARIAL
MATHEMATICS I
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n-Year Endowment Insurance
Provides for the payment of the full benefit at the
time of death of the insured if this occurs before time
n and for the payment of the full benefit at time n
otherwise.




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MATHEMATICS I
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:
[ ]
T n
x n
A E v
.
=
Show that
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MATHEMATICS I
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Another idea
Let Z
1
, Z
2
and Z
3
be the PV of term, pure endowment
and endowment insurances.




Clearly Z
3
=Z
1
+ Z
2
. E[Z
3
]= E[Z
1
]+E[Z
2
].


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MATHEMATICS I
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Deferred Insurance
For an n-year deferred whole insurance, a benefit is
payable if the insured dies at least n years following
issue:






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MATHEMATICS I
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m-Year Deferred n-Year Term Insurance
Provides the same benefits as n year term insurance
between times m and m + n provided the insured
lives m years.




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MATHEMATICS I
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| ( , ]
[ 1 ( ( ))]
T
mn x m m n
A E v T x
+
=
|
m n
t
mn x t x x t
m
A v p dt
+
+
=
}
Constant mortality
FM 2002 ACTUARIAL
MATHEMATICS I
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Assume mortality is based on a constant force and
interest is also based on a constant force of interest .
Find expressions for the APV for the following types of
insurances:
Whole life insurance
n-year term life insurance
n-year endowment life insurance
m-year deferred life insurance
Find the expression for the above insurance if we
assume De Moivres law.

Non Fixed Constant Benefits Insurances
All of the insurances discussed thus far have a fixed
constant benefit. Increasing whole life insurance
provides a benefit which increase linearly in time.
Similarly, increasing and decreasing n-year term
insurance provides for linearly increasing
(decreasing) benefit over the term of the insurance.
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MATHEMATICS I
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Insurances Payable the End of the Year of Death
Direct computation of the net single premium for
an insurance payable at the time of death is
impossible using only the life table.
These net single premiums can be easily related to
the net single premium for an insurance that is
payable at the end of the year of death.
For these insurance Z depends on Curtate life time
K.

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MATHEMATICS I
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Consider n-year term insurance
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MATHEMATICS I
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Whole life
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MATHEMATICS I
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n- year endowment insurance
The APV of a (discrete) endowment life insurance is the sum of
the APV of a (discrete) term and a pure endowment:



The policy pays a death benefit of $1 at the end of the year of
death, if death is prior to the end of n years, and a benefit of $1 if
the insured survives at least n years.
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MATHEMATICS I
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Summary

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MATHEMATICS I
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Computation using Life Table
Consider whole life insurance policy

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MATHEMATICS I
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1
1
0
1
0
[ ]
= ( ( ) )
=
K
x
k
k
k
x k
k
x
A E v
v P K x k
d
v
l
+

+
=

+
+
=
=
=

Show that

How would you compute this using the life table?







FM 2002 ACTUARIAL
MATHEMATICS I
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1 1
: : x x
n n
A A =
1 [ , )
:
[ , ) 1
:
[ 1 ( ( ))]
= [ 1 ( ( ))]
n
n
x
n
n
n
x
n
A E v T x
E v K x A

=
=
1 1
: :
=
x x
n n
n n
x n
n x
x
A A
l
v p v
l
+
=
=
With UDD
FM 2002 ACTUARIAL
MATHEMATICS I
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Use the life table to find the net single premium for
a 5 year endowment policy for (30), with death
benefit paid at the moment of death, assuming an
interest rate of 6%.

The net single premium for a pure endowment
policy is
For the endowment policy, the net single premium
for a 5 year term policy must be added to this
amount. From the relation given earlier,
FM 2002 ACTUARIAL
MATHEMATICS I
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The relationship between insurances payable at
the time of death and insurances payable at the
end of the year of death is used to complete the
calculation. This gives


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MATHEMATICS I
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