Faculty of Actuaries Institute of Actuaries

EXAMINATION
September 2006

Subject CT5 — Contingencies

Core Technical

EXAMINERS’ REPORT
Introduction

The attached subject report has been written by the Principal Examiner with the aim of
helping candidates. The questions and comments are based around Core Reading as the
interpretation of the syllabus to which the examiners are working. They have however given
credit for any alternative approach or interpretation which they consider to be reasonable.

M A Stocker
Chairman of the Board of Examiners

November 2006

Comments

No comments are given

© Faculty of Actuaries
© Institute of Actuaries
 Subject CT5 (Contingencies Core Technical) — September 2006 — Examiners’ Report

1 If funds chose at random which annuities to insure and which to self-insure, we would
expect approximately the same mortality experience in both groups. The self-insured
experience is heavier, meaning their lives are somehow below standard on average.

The most likely explanation is that the pension funds make informed decisions based
on the health or reason for retirement of the pensioners. Those retiring early due to
ill-health or those known to have poor health are retained for payment directly by the
fund. That should be cheaper than paying a premium to the insurer based on normal
mortality for these lives. The remainder of the lives, known to be on reasonable health
are insured.

This is adverse selection.

Sensible comments regarding other forms of selection are also acceptable.

20 20
−δt
2 (i) EPV = 200, 000 ∫ e HH
t p40 σ 40+t dt = 200, 000 ∫ e−δt t p40
HH
σ40+t dt
0 0
t
20 − ∫ (μ 40 + r +σ40 + r ) dr
= 200, 000 ∫ e −δt e 0 σ40+t dt
0

where:

HH
t p40 is the probability that the healthy life aged 40is healthy at age 40+t

HH
tp40 is the probability that the healthy life aged 40 is healthy at all points up
to age 40+t (These 2 probabilities are the same for this model)

δ = ln(1.08) = 0.076961

(ii)
t
20 − ∫ (μ 40 + r +σ40 + r ) dr
From EPV = 200, 000 ∫ e −δt e 0 σ40+t dt
0
t
20 − ∫ {(0.01) +(0.02)}dr
EPV = 200, 000 ∫ e −(0.076961)t e 0 (0.02)dt
0

20 20
− (0.076961)t − (0.03)t
= 200, 000 ∫ e e (0.02)dt = 200, 000 ∫ e− (0.106961)t (0.02)dt
0 0
(200, 000)(0.02) ⎡ −(0.106961)t ⎤ 20
=− e = 37,396.79[1 − 0.11775] = 32,993.32
0.106961 ⎣ ⎦0

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 Subject CT5 (Contingencies Core Technical) — September 2006 — Examiners’ Report

1
3 A1 = ∫ e−δ.075t t p70μ70+t dt in the general case.
70:1
0

Here, assuming μ is constant for 0 < t < 1, we get

μ = -ln(p70) = -ln(1 - .03930) = 0.040093

t p70 = exp(-μt) = exp(-.040093t)
δ.075 = ln(1.075) = 0.07232

1
A1 = ∫ e −0.07232t e−0.040093t (0.040093)dt
70:1
0
−(0.040093) ⎡e −(0.07232+0.040093)t ⎤
1
=
(0.07232 + 0.040093) ⎣ ⎦0
= (−0.35610)(0.89368 − 1) = 0.0379

4 EPV of benefits:

(12)
20, 000a65|60 = 20, 000(a60
(12)
− a65:60
(12)
) = 20, 000(a60 − a65:60 ) = 20, 000(15.652 − 11.682)
= 79, 400

EPV premiums:

(The premium term will be the joint lifetime of the two lives because if his death is
first the annuity commences or if her death is first, there will never be any annuity.)

Let P be the monthly premium

(12)
12 Pa65:60 = 12 P(a65:60 − 11
24
) = 12 P(12.682 − 0.458) = 146.688 P

Equation of value allowing for expenses:

1.015(79,400) = (1 - 0.05)(146.688P) ⇒ 80,591 = 139.3536P ⇒ P

= 578.32 per month

5 (i) This is the present value of a joint life annuity of amount 1 per annum payable
continuously until the first death of 2 lives (x) and (y).

∞ ∞
(ii) E[ g (T )] = ∫ t pxy μ x +t: y +t at dt or E[ g (T )] = ∫ t pxy e −δt dt
0 0

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 Subject CT5 (Contingencies Core Technical) — September 2006 — Examiners’ Report

2
A xy − ( A xy ) 2 2
(iii) Var[ g (T )] = where A xy indicates that the function is to be
δ 2

evaluated at force of interest 2δ.

6 (i) EPV past service benefits:

20 ( z M 55
ia
+ z M 55
ra
) 20 (34, 048 + 128, 026)
40, 000 = 40, 000 = 119, 737
80 s54 D55 80 (9.745)(1,389)

EPV future service benefits:

z ia z ra
40, 000 ( R55 + R55 ) 40, 000 (163, 063 + 963,869)
= = 41, 628
80 s54 D55 80 (9.745)(1,389)

EPV total pension benefits = 119,737 + 41,628 = £161,365

s
N 55 88, 615
(ii) (k )(40, 000) = 41, 628 ⇒ ( k )(40, 000) = 41, 628 ⇒ k = .159
s54 D55 (9.745)(1,389)

i.e. 15.9% salary per annum

∑ s Exc,t s mx,t ∑ Exc,t s mx,t

7 ACF = x x

∑ s
Exc,t ∑ Exc,t
x x

Here

s
E xc,t s
E xc,t s m x ,t E xc,t leading to s
m x ,t E xc,t s m x ,t

Age-group Population Deaths Population

0–19 2,900,000 580 800,000 0.0002 160

20–44 3,500,000 2,450 1,000,000 0.0007 700
45–69 2,900,000 20,300 900,000 0.007 6,300
70 and over 700,000 49,000 300,000
0.07 21,000
Total 10,000,000 72,330 3,000,000 28,160

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 Subject CT5 (Contingencies Core Technical) — September 2006 — Examiners’ Report

72,330 28,160
ACF = = (0.007233 0.0093867) = 0.77056
10, 000, 000 3, 000, 000

Indirectly standardised mortality rate = (ACF)*(Province crude rate)

⎛ 25,344 ⎞
= (0.77056) ⎜ ⎟ = (0.77056)(0.008448) = 0.00651
⎝ 3, 000, 000 ⎠

8 (i)

tV = n −t px +t e−δ( n−t )
∂ ∂ ∂ ∂
tV = ( n−t px +t e−δ( n−t ) ) = {e−δ( n−t ) ( n−t px+t )} + { n−t px +t (e−δ( n−t ) )}
∂t ∂t ∂t ∂t

1 ∂ ∂ ∂ ⎛l ⎞ ∂
( n−t px +t ) = ln( n−t px +t ) = ln ⎜ x + n ⎟ = {ln(l x+ n ) − ln(l x +t )} = μ x+t
n −t p x +t ∂t ∂t ∂t ⎝ l x +t ⎠ ∂t
∂
⇒ ( n−t px +t ) = (μ x +t )( n−t px+t )
∂t

∂ −δ( n−t )
(e ) = δe−δ( n−t )
∂t

∂ −δ ( n −t )
⇒ t V = {e (μ x +t )( n−t px +t )} + { n−t px+t δe−δ( n−t ) } = n−t px +t e−δ( n−t ) (μ x+t + δ)
∂t
∂
⇒ t V = (μ x +t + δ) t V
∂t

(ii) The change in reserve at time t consists of the interest earned and the release
of reserves from the deaths.

(The release may be more easily seen if the last line of (i) is rewritten as:
∂
t V = δ t V − μ x+t (0 − t V ) where the pure endowment has zero death
∂t
benefit.)

(iii) nV = 1.

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 Subject CT5 (Contingencies Core Technical) — September 2006 — Examiners’ Report

9 (i) Survival table

x qx px t-1px

60 0.008022 0.99198 1
61 0.009009 0.99099 0.991978
62 0.010112 0.98989 0.983041

Unit fund

Value of Allocation Bid/offer Interest Management Value of

units at charge units at
start of end of year
year
Year 1 0.00 4,250.00 212.50 242.25 32.10 4,247.65
Year 2 4,247.65 5,200.00 260.00 551.26 73.04 9,665.87
Year 3 9,665.87 5,200.00 260.00 876.35 116.12 15,366.10

Non-unit fund

Unallocated Bid/offer Expenses Interest Management Extra End of year

premium charge death cashflows
benefit

Year 1 750.00 212.50 600.00 14.50 32.10 126.37 282.73

Year 2 -200.00 260.00 100.00 -1.60 73.04 93.10 -61.66
Year 3 -200.00 260.00 100.00 -1.60 116.12 46.86 27.66

Non-unit Probability Profit Discount Expected

fund cash in force at signature factor present
flow (profit start of value of
vector) year profit
Year 1 282.73 1 282.73 0.909091 257.03
Year 2 -61.66 0.991978 -61.16 0.826446 -50.55
Year 3 27.66 0.983041 27.19 0.751315 20.43

Total NPV 226.91

Expected NPV = 226.91

(ii) The NPV would decrease. Holding reserves would delay the emergence of
some of the Year 1 cash flow, and as the non-unit fund earns 4%, well below
the risk discount rate, the NPV would reduce.

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 Subject CT5 (Contingencies Core Technical) — September 2006 — Examiners’ Report

10 (i) The 2 deaths were 70 and 69 respectively at 1/1/2005. The reserves for these
policies at 31/12/2005 were

⎛ a ⎞ ⎛ 9.998 ⎞
26V = 12, 000 ⎜1 − 71 ⎟ = 12, 000 ⎜1 − ⎟ = 5, 626.10 and
⎝ a45 ⎠ ⎝ 18.823 ⎠

⎛ a ⎞ ⎛ 10.375 ⎞
24V = 10, 000 ⎜1 − 70 ⎟ = 10, 000 ⎜ 1 − ⎟ = 4, 410.92
⎝ a46 ⎠ ⎝ 18.563 ⎠

Total death strain at risk, sorted by age at 1/1/2005:

Age 69: 500,000 - (175,000 + 4,410.92) = 320,589.08

Age 70: 400,000 - (150,000 + 5,626.10) = 244,373.90

Expected death strain:

(q69)(320,589.08) + (q70)(244,373.90)
= (0.022226)(320,589.08) + (0.024783)(244,373.90)
= 7,125.41 + 6,056.32
= 13,181.73

Actual death strain:

(12,000-5,626.10)+(10,000-4,410.92) = 6,373.90+5,589.08 = 11,962.98

Mortality profit = EDS – ADS = 13,181.73-11,962.98 = 1,218.75 profit

(ii) (a) Expected claims:

(q69)(500,000)+(q70)(400,000)
= (0.022226)(500,000) + (0.024783)(400,000)
= 11,113 + 9,913.2 = 21,026.20

Actual claims:

12,000 + 10,000 = 22,000

(b) Actual claims were higher than expected claims but the company still
made a mortality profit. This can only have occurred because the
deaths were disproportionately concentrated on lower DSAR lives
(policies more mature on average). (This can be seen by comparing the
ratio of reserves to sum assured for the death claim policies with the
corresponding ratio for the full portfolio.)

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 Subject CT5 (Contingencies Core Technical) — September 2006 — Examiners’ Report

5, 000v 2 aT if T63 ≥ 2 (or 5, 000(aT − a2 )

11 (i) g(T) = 63 − 2 63

0 if T63 < 2

(ii)

E[ g (T )] = (100)(5, 000)v 2 2 p63a65 = (500, 000)(0.92456)(0.992617)(14.871 − 0.5)

= (500, 000)(13.1887) = 6,594,350

(iii) Var[ g (T )] = E[ g (T ) 2 ] − E[ g (T )]2

For £1 of annuity:

∞
E[ g (T ) ] = ∫ t p63μ63+t [v 2 at −2 ]2 dt
2

Let t = r + 2 ⇒

∞
E[ g (T ) ] = ∫ r + 2 p63μ63+ r + 2 [v 2 ar ]2 dr
2

0
∞ 2
⎡1 − v r ⎤
= ∫ r p652 p63μ65+ r v ⎢ 4
⎥ dr
⎢
⎣ δ ⎥⎦
0
4 ∞
2 p63v
∫ r p65μ65+r [1 − 2v
r
= + v 2 r ]dr
δ
2
0
4
2 p63v 2
= [1 − 2 A65 + A65 ]
δ
2

where

⎛ 0.04 ⎞
A65 = (1.04)0.5 (1 − da65 ) = 1.019804{1 − ⎜ ⎟ (14.871)} = 0.436515
⎝ 1.04 ⎠

2
and A65 = (1.04)( 2 A65 ) = (1.04)(0.20847) = 0.21681

(0.992617)(0.85480)
∴ E[ g (T ) 2 ] = [1 − (2)(0.436515) + (0.21681)] = 189.622
(0.039221) 2

Var[ g (T )] = 189.622 − (13.1887)2 = 15.680

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 Subject CT5 (Contingencies Core Technical) — September 2006 — Examiners’ Report

For annuity of 5,000 we need to increase by 5,0002 and for 100 (independent)
lives we need to multiply by 100.

Total variance = (15.680)(5,0002)(100) = 39,200,000,000 = (197,999)2

12 EPV benefits:

110, 000 A 1 − 10, 000( IA) 1

(functions @ 6% p.a.)
[50]:10 [50]:10

= 110, 000{ A[50] − v10 10 p[50] A60 } − 10, 000{( IA)[50] − v10 10 p[50] (10 A60 + ( IA)60 )}
= 110, 000 A[50] − 10, 000( IA)[50] + v10 10 p[50]{10, 000(( IA)60 − A60 )}
= (110, 000)(0.20463) − (10, 000)(4.84789) + (0.55839)(0.95684){10, 000(5.46572 − 0.32692)}
= 22,509.30 − 48, 478.90 + 27, 456.09 = 1, 486.49

EPV gross premiums

Let P be annual premium

6%
Pa[50]:10 = 7.698 P

EPV expenses

4%
200 + 0.25 P + 0.02 Pa[50]:9
6%
+ 50a[50]:9
4%
+ 200 A 1
[50]:10
4%
= 150 + 0.23P + 0.02 Pa[50]:10
6%
+ 50a[50]:10
4%
+ 200( A[50] − v10 p A )
(4%) 10 [50] 60
= 150 + 0.23P + 0.02 P(7.698) + (50)(8.318) + 200(0.32868 − (0.67556)(0.95684)(0.45640))
= 150 + 415.90 + 6.73 + P(.23 + 0.15396) = 572.63 + 0.38396 P

Equation of value:

7.698P = 1,486.49 + 572.63 + 0.38396P ⇒ 7.31404P = 2,059.12 so P = 281.53 p.a.

(ii) If K59 ≥ 1 GFLRV = 50(1.01923)9 − 0.98(281.53) else (i.e. K59 = 0)

GFLRV = 10, 000v + 200(1.01923)9 v

.06 .04
+50(1.01923)9 − 0.98(281.53)
or
GFLRV = 10, 000v + 200(1.01923)10 v
.06 .06
+50(1.01923) − 0.98(281.53)
9

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 Subject CT5 (Contingencies Core Technical) — September 2006 — Examiners’ Report

(iii)
9V = 10, 000q59v.06 + 200(1.01923)9 q59v.04
+50(1.01923)9 − 0.98(281.53)
= (10, 000)(0.007140)(0.94340) + (237.40)((0.007140)(0.96154) + 59.35 − 275.90
= 67.36 + 1.63 + 59.35 − 275.90 = −147.56

(iv) The reserve is negative. The expected future income exceeds expected future
outgo, because past outgo exceeded past income, meaning the office needs a
net inflow in the last year to recoup previous losses. However, it is at risk of
the policy lapsing, and never getting this net inflow.

END OF EXAMINERS’ REPORT

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