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The principles of insurance and life table

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194 views71 pages

Insurance

The principles of insurance and life table

Uploaded by

Mariam Hashim
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF or read online on Scribd
Amelie) History of One of the first attempts to manage risk dates back to insurance ‘the 17th or 18th century. Japanese rice farmers made agreements with buyers to deliver them a specific amount of rice on a certain date for an already specified price. Starting in the 1980s, some large US banks established departments specialized in financial risk management, which indicates the growing importance of risk management. In the 1990s some scandals happened at several institutions and large losses were incurred. Basic Concepts ~<=— a Insurance is an important part of our economy. Without the protection insurance affords us, we would have to spend more time and money protecting ourselves from the risks of loss and less time in enjoying life and pursuing goals. Insurance is a very old concept. Basically, it means many people paying a little money to create a bigger pool of money so that anyone who is unfortunate ‘enough to suffer a loss is reimbursed financially for that loss. The person purchasing insurance, known as the insured, agrees to make payments of prescribed amounts to the company. These payments are typically known as, premiums. neti ee Ree eu For example, it reimburses for losses from specified perils, such as fire, Peau Rg ee PN me Ae ee oe OR ROD aes a Ra ECR uur Rusa The insured receives a ......., called the .. which details the conditions and circumstances under which the insurer will compensate the insured, or their designated beneficiary or assignee Insurance policy ~ contract 2- define the following: insurance, insured, premiums, perils and reimb There is no single definition of risk. Economists, behavioral scientists, risk ieorists, statisticians, and actuaries each have their own concept of risk. However, risk historically has been defined in terms of uncertainty. Based on this concept, risk is defined as uncertainty concerning the occurrence of a loss . For example, 1- the risk of being killed in an auto accident is present because uncertainty is present. 2- The risk of lung cancer for smokers is present because uncertainty is present, 3+ The risk of flunking a college course is present because uncertainty is present. The risk of the individual assets and of the portfolios that we talked about so far, is the type of diversifiable risk, which can be reduced by diversification of assets within portfolios. This type is usually firm-specific risk. It is also called unsystematic risk, for it is related to internal Conditions and circumstances and varies from firm to firm. It is due to a random set of specifications unique to a specific firm, such as lawsuits in which the firm is involved, the ‘marketing program it conducts, a workers’ strike that it faces, or the type and quality of contracts it wins or loses. All these events and circumstances can be mitigated with a certain degree of the firm's diversification of assets. The other type of risk is the undiversifiable or systematic risk, which is general and market related. It is due to circumstances and conditions that all firms are affected by simultaneously and with no discrimination 5< Insurable risk must meet certain criteria: Losses to be insured must be definable Losses must be accidental Losses must be large enough to cause a hardship to the insured vv ¥ There must be a homogeneous group of risks large enough to make losses v predictable (Law of large numbers) > Losses must not be catastrophic to many members of the group at the same time > The insurance company must be able to determine a reasonable cost for the insurance The insurance company must be able to calculate the chance. An insurance risk class is a group of individuals or companies that have similar characteristics, which are used to determine the risk associated with underwriting a new policy and the premium that should be charged for coverage. Determining the insurance risk class is a primary component of an insurance company’s underwriting process. +An insurance risk class is a way for insurers to underwrite policies based on one's belonging to a particular risk group. *People in each risk group will generally share similar characteristics that help insurers better estimate the chances that the policyholder will file a claim. Gale... | *Riskier risk groups will pay higher premiums. for example, people who are sick, older, or have a poor driving record. *Risk (1) Any chance of loss; (2) Uncertainty; (3) The insured or the property or object to which the insurance policy relates. *Risk Control techniques or programs used to reduce or eliminate the chance of loss and to reduce the total amount of loss should an event occur. Risk and Return Basic Concepts The Return on an investment asset is defined by the change in value, in addition to any cash distribution, all expressed as a percentage of the asset original value. Areturn of premium (ROP) life insurance rider is an optional add-on to a term life policy that, if you outlive the policy term, pays you all or some of the money you spent on policy payments. A return of premium life insurance policy may be worth it if you can afford to pay a higher premium. However, if you don’t outlive your term, it will have been much more expensive than a traditional term plan, while essentially offering the same death benefit. It’s important to understand that you aren’t receiving any additional money, but the money that you have previously paid into the policy. There is also a chance you won’t be able to see this benefit come to fruition. Return-of-premium life insurance is a term life policy designed to give you money back after the term life ends. Example I: let’s say you buy a 20-year return of premium term life insurance plan. If you pass within the 20-year term, your family will receive the death benefit and the premium payments will be kept by the insurer. However, if you outlive the 20-year term, you will be able to get a refund of your premium payments. a Example 2: if you're a healthy 40-year-old looking to buy a 20-year, $500,000 policy, ou can expect to pay nearly five times as much for a return of premium policy fompared with a standard term life insurance policy without ROP benefits. Sample premium costs for ROP life insurance for a 40-year-old non-smoker in excellent health is about $1,600 for a man and $1,450 for a woman. Of course, these amounts vary by provider and with other known factors in place. By comparison, a 40-year-old male with excellent health buying a $500,000 term life insurance policy will pay about $228 annually for a 10-year term and $300 annually for a 20-year term. If you smoke and are in poor health, those premium costs can jump to about $750 for a 10-year policy and over $1,000 annually for a 20-year policy. Finally, in the economics and finance literature, authors often make a distinction between risk and uncertainty. The term “risk” is often used in situations where the probability of possible outcomes can be estimated with some accuracy, while “uncertainty” is used in situations where such probabilities cannot be estimated. A risk can be defined as a random number, X, whose actual outcome (or realization) is unknown. Yet, a set of possible outcomes has to be specified, and probabilities over this set have to be assigned. The following table illustrates the relation between payoffs and states of the world. Payoffs of two coupon bonds State Of The World alternative st sz 50 150 120-100 td 100 100 a 03 7 100-100 05 ta 0s Payoffs of three coupon bonds State Of The World alternative st 2 50 150 eS 150 200 - 200 270 ier . 07 os os i investment choice considered as “losses xt 50 60 cy 00 60 % 52 61 xa 50 60 The possible yields (per 100 monetary units) provided by four investments are represented . Risks of this type are usually called speculative risks 4 oa pblas. reer perry Good Pa Asset '$50000 '$30000 Asset 100000 $-40000 Asset 30000 $10000 Pe 04 06 decision is one that has maximum payoff than another decision under each state of nature. Or decision is one that has a minimum losses than another decision under each state of nature. preeerrs oe Asset X '$800000 Asset Y 1300000 Asset Z Events And Random Amounts Objective risk: (also called degree of risk) is defined as the relative variation of actual loss from expected loss . Chance of loss is closely related to the concept of risk. Chance of loss is defined as the probability that an event will occur . Like risk, “probability” has both objective and subjective aspects. % Objective probability refers to the long-run relative frequency of an event based on the assumptions of an infinite number of observations and of no change in the underlying conditions. For example, the probability of getting a head from the toss of a perfectly balanced coin is 1/2 because there are two sides, and only one is a head. an FO Likewise, the probability of rolling a 6 with a single die is 1/6, since there are six sides and only one side has six dots Definition: sample space $ for a probability experiment is the set of all possible outcomes of the experiment. Note that the set E is a subset of the sample space , S since every element of E is an element of S. Subjective probability: is the individual's personal estimate of the chance of Joss. Subjective probability need not coincide with objective probability. For example, people who buy a lottery ticket on their birthday may believe it is their lucky day and overestimate the small chance of WiNMiD gee. Q Risk managers can employ number of techniques to assist in predicting loss levels, including the following: m= Probability analysis m Regression analysis m Forecasting Q Probability analysis: to determine expected losses, insurance actuaries apply probability and statistical analysis to given loss situations. situations. Q The probability ( P) of such an event is equal to the number of events likely to occur ( X) divided by the number of exposure units (N). Thus, if a vehicle fleet has 500 vehicles and on average 100 vehicles suffer physical damage each year, = — 1- The probability that a fleet vehicle will be damaged in any given year is: P(physical damage) 100/500= .20 or 20% he risk manager must also be concerned with the characteristics of the event being analyzed. Some events are independent events the occurrence does not affect the occurrence of another event. Example: The probability of a fire at the City 1 is 5 % and that the probability of a fire at the City 2 is 4 %. Obviously, the occurrence of one of these events does not influence the occurrence of the other event. If events are independent, the probability that they will occur together is the product of the individual probabilities. Thus, the probability that both production facilities will be damaged by fire is= P(fire at City 1) * P(fire at City 2) = P(fire at both City's) =.04 *.05 =.002 or 2%. Events are mutually exclusive if the occurrence of one event precludes the occurrence of the second event. mutually exclusive case: P(A or B)=P(A)+P(B) For example, if'a building is destroyed by fire, it cannot also be destroyed by flood. If the probability that a building will be destroyed by fire is 2 % and the probability that the building will be destroyed by flood is 1 %, then the probability the building will be destroyed by either fire or flood is= P(fire destroys) P(flood destroys) P(fire or flood destroys) .02 + .01= .03 or 3% If the independent events are not mutually exclusive, then more than one event could occur. Care must be taken not to “double-count” when determining the probability that at least one event will occur. not mutually exclusive = P(A) + P(B) - P(A and B). For example, if the probability of minor fire damage is 4 % and the probability of minor flood damage is 3 %, then the probability of at least one of these events occurring is= P(fire) + P(flood) - P(fire and flood) = P(at least one event)= .04 + .03 — (.04 *.03) =.0688 or 6.88%. ers eae: (Cone Peer a 2 Pert) Cary Coat j ear sade Be e wor a ey a, 2 felge7 el (-15 a) ieegs Se ma “pay De , pat, Fae agi ts fase) Parle What is the probability of getting a diamond or a queen from a well-shuffled deck of 52 cards? 4/13 A box contains 50 tickets numbered 1 to 50. If a ticket is drawn at random, what is the probability that the number drawn is a multiple of 3 or 5? . Why tossing a coin, the event of getting head and tail are mutually exclusive? Because the probability of getting head and tail simultaneously is 0 Why in a six-sided die, the events “2” and “5” are mutually exclusive? Because cannot get both the events 2 and 5 at the same time when we threw one die. . Why in a deck of 52 cards, drawing a red card and drawing a Trefl are mutually exclusive events? Becau SO Rue de eee UM oe err eae ee ae Cm em eee ee Ue eee eee sc) eae BRO ee et (2) prediction of future losses with some accuracy based on the law of large numbers, The primary purpose of pooling, or the s as measured by the standard Ce Cu ema Re eet Ren en Expected Rate of Return: The expected rate of return is the sum of products of individual returns(x;) and their probabilities. Were expected H =x pil Di Example Ocis ae X, 09 AS 0405 X. 10 30 03 Xs 0.11 o2o 0275 Problems yf ae oe Pina Cor Se See a ~ Find the expected value for the following probability distribution: 1 3 ESE 0.20 0.20 010 045 0.25 POO, 0.80 Measuring The Risk Measuring The Risk: “The first simple and straightforward way to measure the risk of an asset is the range of returns or the dispersion, which isthe difference between the highest and t ‘The second messure of ik can be the probablity tibutlon of returns. The standard deviation {c} would bean appropriate tool to measure che dlaperion around the expected ret thet the |. Wigher te standard deviation the wider the dispersion and the greater the risk Standard deviation [25 ralvatanca ore two bes mathematical concepts that have on tnportantplce in vious ports of the financial sector, While standard deviation measures the square root of the variar ‘each point from the mean. The third measure is called the coe considers the relative dispersion of data around the value expected. ‘the variance is the average of nt of variation (Coefv) which If we také asset X, which has three probable returns, 9%, 10%, ane 11%, if we compare it to asset Y , which also has three probabl returns, 5%, 10%, and 15% as shown in the following table: 1 09 05 2 10 10 3 a a5 Range -11-.09=.02 -15-05=.10 + The range reflects the variability, which stands for the risk. We can conclude that the greater the range of returns of an asset, the more the variability and the higher the risk. aa Assume that two business owners each own an identical storage building valued at $50,000. Assume there is a 10 percent chance in any year that each building will be destroyed by a peril, and that a loss to either building is an independent event. The expected annual loss for each owner is $5000 as shown below: Expected loss = .90 * $0 + .10 * $50,000 = $5000 = ae od A common measure of risk is the standard deviation, which is the square root of ihe variance. The standard deviation (SD) for the expected value of the loss is 5,000, as shown below: v = ¥ (xi — 1)?pi/ Epi SD: $5000)? +0.10($50,000 — $5000)*) = $15000 Suppose instead of bearing the risk of loss individually the two owners decide to pool (combine) their loss exposures, and each agrees to pay an equal share of any loss that might occur. Under nario, there are four possible outcomes Possible Outcomes Probability as shown in the following table:~ Possible Outcomes Probability table First building destroyed, second building no loss First building no loss, second building destroyed Both buildings are destroyed 10°10 =.01 v Expected loss =.81*$0 + .09*$25,000+.90*$25,000 +.01 * $50,000= $5,000 The reduced probability of the extreme values is reflected in a lower standard deviation (SD) as shown below: sD a [ae = $5000)? + .09($25,000 — $5000) ? + .09($25,000 ~ $5000) ? + .01($50,000 ~ $5000)? = $10,607 Thus, as additional individuals are added to the pooling arrangement, the standard deviation continues to decline =come down while the expected value of the loss remains unchanged . Standard Deviation (a): | o= VE, (x;— wp The standard deviation for the returns on asset Y is larger than the deviation of the returns on asset X, which makes asset Y riskier than as V0.000054 = 0.0073, a, = V0.001 0.0353 Then 9, # 2 1 09 098 25 2 10 098 50 3 ot 098 25 This additional measure is called the coefficient of variation which considers the relative dispersion of data around the value expected. Coef x @ =—= 0.074, Coef y = 0.353. u The high coefficient of variation for asset Y (.353) confirms that it is riskier than asset . Generally, the higher the coefficient of variation, the greater the risk associated with the asset. Which of the two assets shown in the following table is riskier? Use both the standard de 49% 1.63 higher / possible accident Causes a loss, whose amount depends on the severity of the accident itself. We assume that the outcomes of the random loss X, Y are: 0, 100, 200, 300, 400, 500 with the following probabilities 0.99, 0.002, 0.004, 0.002, 0.001, 0.001 The outcome X = 0 denotes that the accident does not occur. The expected = E[X] = 2.5 The range [X] =.989 The variance= Var[X] = 763.76 SD=0[X] = SD=\V= 27.64 s Coef[X]=11.056 Coef{X]= Calculate and compere? ae a a ra io ea = a 1- Determine the expected fund's returns? 2- Determine the Rai nds returns 3- Determine th ach fund's returns? De nt of variation value of each fund’s returns? 6- interpret your answers’ Caleulate the Mean, Variance, Standard deviations, Covariance, Correlation Coefficient for each of two pairs of assets, X and Y and Z and iW. ox = VE; (x; — 1x)? pi oy = VE; (x; — Hy}? pi Cov(x,y)= 3; (x; = 109)" (Yi — HY) Pi Corr = Cov(x, TIS/5=155—87/5=.174 —Y/S=.20.69/5=.138 Variance 046 067 0339 0129) 5D 214 259 1841 “1136 Cov. 0554 020353, Corr 99.9% + 973% Strong positively Strong negatively Formula for Correlation Coefficient DS ci - ®) yi-9D : 9 Sei) ora) o,.5, > Pe rd Deviat P. oy > %.¥ —> Population Mean Do (xi - ®) Gi - 5D Vc - «) Swi - v9? Ss,,.S,> s > A correlation coefficient this close to +100 would be considered an indication of perfectly positively correlated assets which exhibit similar dynamics, which makes them move up and down in tandem. This type of matching pattern would not benefit from diversification in risk reduction. A correlation coefficient of -97.3% shows the case opposite to that of the X and Y combination. It indicates that assets Z and W are almost perfectly negatively correlated, which means that the return changes of these assets go up and down opposite to each other. This is the ideal opportunity for these assets to cancel each other out. If ‘one is down, the other is up to compensate—that is the beauty of diversification. The combination of such assets in a portfolio gives the opportunity to have an optimal impact of diversifying the risk away. ample A random sample of eight drivers insured with a company and having similar auto insurance policies was selected. The following table lists their driving experiences (in years) and monthly auto insurance premiums. — me tetae et Em 0 SSS Su negative relationship between these two variables? aly 2 Find the least squares regression line by choosing appropriate dependent and independent variables based ‘on your answer in part a. Interpret the meaning of the values of the regression equation. The following table gives information on ages and cholesterol levels for a random ample of 10 men. Does the Age depend on the Cholesterol level or does the Cholesterol level pend on the Age? Do you expect a positive or a negative relationship between iese two variables? 2- Find the least squares regression line by choosing appropriate dependent and independent variables based on your answer in part 1? 3- Interpret the meaning of the values of the regression equation? ne q 58 69 43 39 63 52 a7 31 74. 36 Regression analysis is another method for forecasting losses. Regression analysis haracterizes the relationship between two or more variables and then uses this aracterization to predict values of a variable. $520 $840 $1200 $1500 $1630 $2300 $2900 $3400 $4000 Relationship Between Payroll and Number of Workers Compensation Claims rove that: egression results: Y =—6.1413 + .1074 X, R2=.9519 edicted number of claims next year if the payroll is $4.8 million 509.38 es aH ey Correlation coefficient= Cov(x,y)/ oxoy "= Veer - cox] [zy yr) For the following table:- I- Calculate the correlation coefficient 2- Regression Equation (elae Acute) a Mel amare ay Beta systematic undiversifiable market risk. (B) is a mathematical tool to measure A Beta coefficient can measure the volatility of an individual stock compared to the systemat the entire market. In statistical terms, b represents the slope of the line through a regression of data points, In fi each of these data points represents an individual stock's returns against those of the market as a whole, Beta is calculated by dividing security's returns and the market's returns by the product of the of the the of the market's returns period over a specified ‘sense, an index of the extent to which a security return moves in response to changes in the overall market. The beta value can be positive or negative A negative value says that the asset return pattern moves in the opposite direction from the market. Mathematically, beta is obtained by dividing the covariance between the individual security return (ki) and the market return (km) by the variance of market return. Cov(Re, Rm) Drees 1- Beta Value Equal to 1.0 Ifa stock has a beta of 1.0, it indicates that its price activity is strongly correlated with the market. A stock with a beta of 1.0 has systematic risk. 2- Beta Value Less Than One A beta value that is less than 1.0 means that the security is theoretically less volatile than the market. 3- Beta Value Greater Than One A beta that is greater than 1.0 indicates that the security's price is theoretically more volatile than the market. 4- Negative Beta Value Some stocks have negative betas. A beta of -1.0 means that the stock is inversely correlated to the market benchmark ona 1:1 Formula: Beta Coefficient (B) = Covariance(Re,Am) Variance(Am) Where, Re = return on individual stock &m = return on the overall market Covariance = changes in stock’s returns in relation to changes in market returns Variance = how far the markets data point spread out from their average value Despite their complexities, insurance contracts generally can be divided into the following pa I- Declarations: Declarations are statements that provide information about the particular property or activity to be insured. The declarations section usually can be found on the first page of the policy or on a policy insert. 2- Definitions: Insurance contracts typically contain a page or section of definitions. The purpose of the various definitions is to define clearly the meaning of key words or phrases so that coverage under the policy can be determined more easily. 3- Insuring agreement: The insuring agreement is the heart of an insurance contract. The insuring agreement summarizes the major promises of the insurer. The insurer agrees to do certain things, such as paying losses from covered perils, providing certain service: 4- Exclusions: Exclusions are another basic part of any insurance contract. There are three major types of exclusions (1) excluded perils, (2) excluded losses, and (3) excluded property. Exclusions are necessary because the peril may be considered uninsurable by commercial insurers. 5- Conditions: Conditions are another important part of an insurance contract, Conditions are provisions in the policy that qualify or place limitations on the insurer’s promise to perform. In effect, the conditions section imposes certain duties on the insured. 6- Miscellaneous provisions: Insurance contracts also contain a number of miscellaneous provisions. Tem: different time periods, the risk manager must employ TRU Mela e la Pee aC Ce ee ecg CR eC ae the time value of money must be considered. eC ae eee ea] Phe Mew CMM iene ea ete faerie tm aati mated aera) CRC cre) Ce eC mM Pee Ree RT Co mame) cash flows in different time periods, it is Toe Roem the earning of interest. Thus, if you multiply the starting amount (the present value, or PV) by | plus} the interest rate (/ ), it will give you the amount one year from today (the future value, or FV ): ‘The future value of a present amount: PV *(1 +i)" = FV, where “ n” is the number of time periods. Dividing both sides of our compounding equation by (1 +7)" yields the following expression This operation—bringing a future value back to present value—is called| discounting Alife table includes the elements represented in the r example, the following probabilities can be c; 100000 98000 97920 97800 97650 97450 97220 ly gen age 42 and 45 85000 84600 This Table gives an extract from a life table. Calculate (a) lo. E (b) 10P30 10.00.00 (©) 43s. ooo (d) [Link] aren (e) the probability that a life currently aged 9830.55 lexactly 30 dies between ages 35) and 36. 9789.29 9734.12 9673.56 9607.07 9534.08, t4o = bo — d39 = 9 @ cf 4 9453.97 Too = 10000 0.94540. dys 58.17 Ths ~ 9789.29 0.00564, as ag = 13s S = 0.02107. Io dy 34.78 38.10 41.76 45.81 50.26 55.17 60.56 66.49 72.99 80.11 Life Annuities Life annuities are different from the annuities certain that we discussed earlier. In a major distinction, life annuities are more related to life insurance for being contingent. A contingent contract involves a sequence of payments that are dependent on an occurrence of a certain event that cannot be foretold, In this case, it is either death or living up to a certain age. This element of uncertainty requires the use of probability distribution, which in this context is in the form of a mortality table. Like life insurance, life annuities are dealt with by insurance companies and the person to whom the annuity would be payable, is called an nnuitant, as opposed to the “ d”. Life insurance proceeds are payable to survivors upon the death of the insured. The typical stated premium of life annuities and life insurance is usually a gross premium, which includes the loading costs in addition to the net premium. Loading costs include a company’s operating expenses and profit margin. The net premium is the pure cost of the ultimate benefits to the annuitant or the insured, usually broken down into installments unless it is paid in a single payment on the day of purchase. In this case it is called a net single premium, while a yearly installment is called a net annual premium. Our calculations here focus on the net premium but without the loading component, since the loading would vary from one company to another. This is. why we assume that the present value of the net premium would equal the present value of all future benefits. 3 Get for age 30 is. 001316. It is calculated as dy bso 127 qo = 96,477 001316 live one more year at by 96,350 pom = = 998684 This would give us another formula for qx and pr Pe = las The last formula would be a proof of the previous ge formula: a= Since fe41 = le — de. then he present value of $1,00 for each person alive at age x. Collectively for each age group it would be calculated by multiplying the present value for $1.00 (v*) or 1/(1 +r)" by the number of living people in age group x : the present value for $1.00 of a payment to the beneficiaries of people who die at age x. It is calculated by multiplying the number of people who will die at age x, (dy) by the present value of $1.00 for the time x+l. ‘Ng: the present value of annuity of payments for all persons living at each age group from x to the end of the table, age 100. So it can be viewed as the summation of D's above. yD i Dy + Dugi + Deyo + +++ + Desi00 A ‘Mg + the summation of all Cy. It represents the present value of a $1.00 payment for all people who eventually die but are still alive at age x. It is like Ny, an accumulation of the values back from age x to age 0. M= D0 Ce TyPES OF LIFE ANNUITIES = The life annuities discussed here are called , referring to their distinct characteristic: that they are for a single living person and they cease Re Cm ay hole Lif nO Routt a Whole Life Annuities = Whole Life Annuities AU Ordinary Whole Life Annuity This type of annuity, also called an immediate whole life annuity is distinguished by the receipt of its payments at the end of each year of the annuitant’s life. We can look at these payments as a series of individual pure endowments, and for this reason, let’s consider @ as the present value of $1.00 a year for each person in the age group x. The collective endowments LE, +2E, +3E, +--+ 100E ‘ad of $1.00, then Ds Duss + Desa + Days toe + Des too Dy Nicole is 45 years old. She is thinking of buying a whole life annuity that would pay her $2,000 at the end of each year for the rest of her life. What would the premium be for this We immediately knew that this is an ordinary whole life annuity since the payments are to be made at the end of each year. so = 200 (8) 154.084.29 (aaa) = 29,697.75 W Whole Life Annuity Due This is the same as a whole life annui except that the first payment is made at the time of purchase and continues to be made after that on the same time of each year for the rest of the annuitant’s life. Since we designated our formulas based on a $1.00 payment, and we stated s annuity has the first payment made one year earlier, we can conclude that the whole innuity due (di) is different from the ordinary whole life annuity (a): J which made the numerator Ny, Ns iy = Ds ‘and for payment P instead of $1.00, we obtain the formula for the whole life annuity due: + Drsi00 Dy + Drs + De Dy ay = w Deferred Whole Life Annuity This is an annuity whose first payment is deferred to a period (n) that is beyond one year after the purchase date. Since the purchase occurs at age x, the deferment period would be x + n for the annuity due, which starts on the day of purchase. It could also be x+1+ n for the ordinary annuity, which starts one year after the purchase date, at x+1 The present value of the deferred ordinary whole life annuity would be 74x which can be obtained by lay = (n+ LEg) + (n+ 2E,) + (n+ 3Ey) oo + + LOE) lay = Destin + Desain + Drssan t+" Desiooen = Dy +140 nay = ae and for payment P: wity due (nai) by In the same manner, we can obtain the deferred whole life illic = Ex + (+ 1Ey) + (0 + 2Ey) +2 + (n+ 100E,) lig = Dein t Desian + Dasain to + Destooen — Dy Nese Mie = and for payment P it would be A person aged 33 wants to purchase an ordinary if annuity that would pay ‘him $3, i 323,068.92 33 = 3.000 ( ze ) = 27,553.43 Temporary Life Annuity Due In an ip temporary life annuity, the pay- ments are made at the end of each year, but if the payments are made at the fj beginning of each year, the annuity would be considered a temporary annuity due (d,1), and it would be calculated as the difference between a whole life annuity due (@,), and a deferred annuity due (n|éx): Find the net present value of the annuity in Example 17 if the annuitant requests that the payments be made at the beginning of the year. This request makes the annuity a temporary annuity due: N; G5 = P(e 342,274.28 — 187.6. 4c = P( = 3,600 ( 19,205.35 Nas — Ni . diggs) = 3,600 (@*) = 28,986.75 Forborne Temporary Life Annuity Due Sometimes the annuitant of the tem- porary life annuity due chooses not to cash the payments, allowing them to accumulate for a certain period of time (1) and become a pure endowment. In this case, when the annuitant forbears to draw the annuity, it would be called a forborne temporary life annuity (11 F,), which is calculated as and for payment P it would be nky =p (oN) Drin J At the start of the year, David tums 50 and is to receive $3,000 as his temporary life f annuity payment, which continues until he is 60 years old. David decides to leave the money with the insurance company to accumulate for 10 years. How much will he get when he tums 60? Ny = Nesn RFemip Cones , r( Des ) Nw — Noo 10Fs0 = 3,000 a) Doo 118,106.84 223) = 00 { t18tos84—35:32928 po (oars = 42,016.82 M Deferred Temporary Life Annuity Deferred Temporary Life Annuity This the last type of temporary life annuity, along ith the ordinary and due types. Payments of this annuity will not start until a period of time (k) has elapsed from the day of annuity purchase; k is more than one year. The deferred temporary life annuity is most likely to be an annuity due, and its present value (k|éi,;z1) Would be calculated as where k is the deferment period, x is the annuitant age, and n is the annuity § time. For a payment P, the net single premium or the present value of the deferred temporary life annuity would be 6 years paying an annual payment of $2,500 to a 15-year-old boy. This annuity comes with a stipulation that the annuitant will not start to receive ind the net single premium for a temporary life annuity that runs for 12 pp (Nett Nesken ia = p (Se Batee = 19,928.70 In practice, insurance companies agree to collect their net single premium not only in annual installments but also quarterly, monthly, or other terms. This increases the cost to the policyholder, but people can often afford a small premium despite the expense attached to such a convenience. The additional cost to the premium can be figured out as an added certain percentage (j).So if we denote the less than annual premium by p(m) and the annual premium by P. P(i-+ 7) m \ pm) — eos 7” \Let's suppose that Dan, who we met earlier, cannot afford o pay his annual premium of $3,092.45 and asks the X company to let him pay whatever they deem appropriate | every other month, that is, in six payments a year. Given that the company charges 61% extra, determine how much | his bimonthly premium would be. P = $3,092.45; j = 64% = .065 _ Pati) pom m (o _ 3,092.45(1 + .065) po = = 548.91

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