Valuation of (Life) Annuities
Entails finding values of different types of life
annuities
Concepts similar to insurance and fixed annuities
Coursepack
Chapter 11
Exclude Section 11-6 (on Guaranteed annuities)
Practice questions from past papers but
exclude questions on guaranteed annuities.
Life Annuities
Life annuity is a string of payments dependent on
the continuation life of an annuitant
Regular intervals (normally)
Generally uniform amount
Important also for life premium calculation and
policy value (reserves)
Review of Annuities Certain
ä| = 1+v + v2 + …… + vn-1 =
a| = v + v2 + …… + vn =
ä| = a| - vn + 1
Annual Life Annuities
Payable annually
Conditional on survival of annuitant to the payment
date
Throughout life/ whole life annuity
If maximum term called ‘term’ or ‘temporary’
In practice, annual annuities quite rare, generally
monthly
Primarily interested in expected present value of
cashflows
Transformation of symbols
a| ax
ä| ä x
a| ax:|
ä| äx:|
Whole life annuity due
Payable annually at the beginning of year for life
lx x äx = lx + v x lx+1 + v2 x lx+2 + ……..
äx= 1+v px+ v2 2px +…………
äx= Kpx
Whole life immediate annuity
Payable annually at the end of year for life
lx x ax = v x lx+1 + v2 x lx+2 + ……..
ax= v px+ v2 2px +…………
ax= Kpx
Term life annuity due
Payable annually at beginning of year for a
maximum of pre-determined term (say “n” years)
äx:| = 1 + vPx + v2 2Px + …… vn-1 Px
subject to survival
n-1
Term life annuity immediate
Payable annually at end of year for a maximum of
pre-determined term (say “n” years) subject to
äx:| = vPx + v2 2Px + …… vn Px
survival
n
Important Relationship between life
annuities
1. | = v p + v2 2px +………… vn npx
= 1+v px+ v2 2px +………… vn-1 px
x
=äx + vn npx – 1
n-1
2. äx = 1+ax
3. äx = 1+vpx äx+1
4. ax = vPx äx+1
Important Relationship between life
annuities
5. äx: | = 1+ ax: |
6. ax: |= vPx+vPx ax+1: |
7. ax= ax: |+ vn nPx ax+n
(splitting into 2 periods of “n” years and
beyond)
Note : All relationships can be derived by
logic.
Important relationship
between annuity and insurance
Recall: 1= d ä| + vn
A loan of 1 at time= 0 equals “d” payments at the
beginning of year for n years and return of capital at
the end of n years
Let us bring mortality into consideration
A person loans out 1 for n years in exchange of “d”
interest at beginning of year for as long as he is
surviving for n years and return on capital of 1 in
case of death during n years (at end of year of death)
or survival till n years
Important relationship
between annuity and insurance
1= d | + or
|
Similarly, äx = (1- )/d
= (1- )/d
Important to understand the concept behind
relationship
Example 1
You are given:
x lx
50 1000
51 950
52 900
53 870
i=10% find ä50|
Answer: 3.26
Example 2
If | = 0.9 and i= 5%, find a40|
Answer : 1.1
Deferred Life Annuity
Similar concept as deferred life insurance
“m”-year deferred annuity is an arrangement
Used for retirement planning (purchase
whereas payment starts after a gap of “m” years
deferred pensions at say age 60 during
periodic savings in active life time)
Tax savings for this purpose in every
country
Voluntary Pension Scheme in Pakistan
Deferred Life Annuity
denotes life annuity where payment starts at time t
=m
denotes life annuity where payment starts at time t
= m+1
Deferred Life Annuity
= vm mpx (similar to insurance)
annuity starting at beginning of age “x+m”
= vm mpx
discounted to age “x”
vm mpx
| |
= vm mpx
=
| |
OR m/ax:| = ax:| - ax:|
Deferred Life Annuity
Example
| = v5 5p30 |
OR = | - |
Example 3
You are given | = 8, 10 E50 = 0.6 and = 9.
Find
Example 4
You are given :
A30: |= .7, | = .1 & i=5%
Calculate ä30: |
