MLC Preparation Notes

Exam MLC Preparation Notes
Yeng M. Chang
2013
All Rights Reserved
2
Contents
Preface 7
1 Continuous Survival Models 9

1.1 CDFs, Survival Functions, x+t . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
1.2 Parametric Survival Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
1.2.1 Uniform Distribution (de Moivres Law) . . . . . . . . . . . . . . . . . . . . . 15
1.2.2 Exponential Distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
1.2.3 Gompertz Distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
1.2.4 Makeham Distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
1.3 kth Moments (Exam P/1 Review) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
1.4 International Actuarial Notation: Tx . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
1.5 More Formulas to Know . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
1.6 SOA Released Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
1.7 Formula Summary Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
2 Discrete Survival Models 25

2.1 Commonly Used Symbols . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
2.2 Kx , Kx , Rx . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
2.3 Probabilities and Expectation of Kx . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
2.4 Term Expectation of Life . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
2.5 Temporary Curtate Expectation of Life . . . . . . . . . . . . . . . . . . . . . . . . . . 30
3 Life Tables 35
3.1 Calculating Probabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
3.2 Fractional Age Assumptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
3.2.1 Uniform Distribution of Deaths (UDD) Assumption . . . . . . . . . . . . . . 38
3.2.2 Constant Force of Mortality (CF) Assumption . . . . . . . . . . . . . . . . . . 40
3.3 Select and Ultimate Life Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
3
4 CONTENTS
4 Valuation of Insurances 45
4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
4.2 Types of Insurances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
4.3 Variances and Moments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
4.3.1 Discrete Whole Life Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
4.3.2 Continuous Whole Life Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . 49
4.3.3 Term Insurances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
4.3.4 Deferred Insurances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
4.3.5 Pure Endowment Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
4.3.6 Endowment Insurances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
4.4 Mortality Assumptions on the Entire Domain of Tx . . . . . . . . . . . . . . . . . . . 52
4.4.1 Continuous Insurances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
4.4.1.1 Fundamental Equations . . . . . . . . . . . . . . . . . . . . . . . . . . 52
4.4.1.2 Whole Life Insurance (Ax ) . . . . . . . . . . . . . . . . . . . . . . . . 53
4.4.1.3 Term Insurance (A1xn ) . . . . . . . . . . . . . . . . . . . . . . . . . . 53
4.4.1.4 Deferred Whole Life Insurance (n Ax ) . . . . . . . . . . . . . . . . . 54
4.4.1.5 Deferred Term Insurance (u A1xn ) . . . . . . . . . . . . . . . . . . . . 54
4.4.1.6 Endowment Insurance (Axn ) . . . . . . . . . . . . . . . . . . . . . . 54
4.4.1.7 Calculation of Higher Moments . . . . . . . . . . . . . . . . . . . . . 55
4.4.2 Discrete Insurances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
4.4.2.1 Fundamental Equations . . . . . . . . . . . . . . . . . . . . . . . . . . 55
4.4.2.2 Whole Life Insurance (Ax ) . . . . . . . . . . . . . . . . . . . . . . . . 57
4.4.2.3 Term Insurance (A1xn ) . . . . . . . . . . . . . . . . . . . . . . . . . . 57
4.4.2.4 Deferred Whole Life Insurance (n Ax ) . . . . . . . . . . . . . . . . . 58
4.4.2.5 Deferred Term Insurance (u A1xn ) . . . . . . . . . . . . . . . . . . . . 58
4.4.2.6 Endowment Insurance (Axn ) . . . . . . . . . . . . . . . . . . . . . . 58
4.4.2.7 Calculation of Higher Moments . . . . . . . . . . . . . . . . . . . . . 58
4.5 UDD Assumption: Continuous-Discrete Relationships . . . . . . . . . . . . . . . . . . 59
4.6 mthly Insurances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
4.7 UDD Assumption: Discrete-mthly Relationships . . . . . . . . . . . . . . . . . . . . . 65
4.8 Insurances with Variable Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
4.8.1 General Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
4.8.2 Arithmetically Changing Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . 66
4.9 Recursive Relationships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68
4.10 Actuarial Accumulated Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
4.13 Appendix: Fully-Variable Insurances . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
5 Valuation of Annuities 77
5.1 Review from FM/2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77
5.1.1 Discrete Annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77
5.1.2 Continuous Annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
5.1.3 mthly annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
5.2 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
5.3 Whole-Life Annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81
5.4 Whole Life Annuity-Insurance Relationships and Moments . . . . . . . . . . . . . . . 82
5.5 Non-Insurance Annuity APV Formulas . . . . . . . . . . . . . . . . . . . . . . . . . . . 83
5.6 kth Moments of Annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85
6 CONTENTS
Preface
This set of notes is meant to prepare you to take exam MLC by the Society of Actuaries. Numbers
surrounded by [ ] indicate a specific source cited in the bibliography, presented at the end of this
set of notes.
I base this set of notes on Models for Quantifying Risk by Cunningham, et al., (4th edition)
which I will abbreviate as MQR throughout this text (see [1]); Actuarial Mathematics for Life
Contingent Risks by Dickson, et al., which I will abbreviate as AMLCR (see [3]); their respective
supplementary notes (see [2], [4]); concepts which are in the SOA sample questions and released
exams for exam MLC; and my experiences from taking Math 450 and Math 460 at the University
of Wisconsin - Eau Claire with Prof. Herschel Day.
I will rely immensely on exam P and FM material as I go through this text. Information in footnotes
and appendices consist of technical information that is needed to add coherence to the discussion,
but is unnecessary for the the purpose of studying for the exam.
This set of notes would not exist without the help and support of many people. First of all, I thank
the professors whose courses I took as an undergraduate at the University of Wisconsin - Eau Claire.
Specifically, I would like to thank Dr. Carolyn Otto, Dr. Chris Ahrendt, and Dr. Dandrielle Lewis
for teaching me how to write mathematics and for pushing me to learn the LATEX typesetting
language. I would also like to thank Dr. Vicki Whitledge, my advisor and Probability professor
during my undergraduate years, as this text would not exist had I not taken her Probability course.
Also, I would like to thank Prof. Herschel Day for teaching me the course MLC material in Math
450 and Math 460.
I would also like to thank Jim Daniel, Abraham Weishaus, and Steve Paris for correcting errors,
helping out with proofs, and/or giving suggestions as I was creating these notes. In addition, I
would like to thank the various people who gave me feedback on my notes through the online
Actuarial Outpost.
Last, but definitely not least, I would like to thank my girlfriend Katie Miller for her support as I
took on this ambitious project during my undergraduate years.
I wish you the best of luck as you prepare for this exam! If you find any typos, mistakes, or have
any suggestions for this set of notes, please contact me at (e-mail address omitted).
Yeng Chang
July 18, 2013
7
8 CONTENTS
Chapter 1
Continuous Survival Models

References: AMLCR, Chapters 2.2 - 2.5, 2.6.2, 2.7; MQR, Chapters 5.1 - 5.3.5.
1.1 CDFs, Survival Functions, x+t

In this chapter, assume that all random variables are continuous. Recall, from exam P/1, the
cumulative distribution function (CDF) of a random variable X:
FX (x) = P (X x) (1.1)
where P is the probability, hence P (X x) is read as the probability that X is less than or
equal to the value x. You may also see Pr(X x) instead of the above. Suppose that X is a
nonnegative continuous random variable, i.e., X 0. The CDF of X must satisfy the following
properties:
1. FX is continuous and non-decreasing for all x.
2. FX (0) = 0
3. limx FX (x) = 1.
Define the survival function to be the complement of the CDF, denoted SX . For all x, we write
SX (x) = 1 FX (x). Then the survival function has the following properties:
1. SX is continuous and non-increasing for all x.
2. SX (0) = 1 FX (0) = 1
3. limx SX (x) = limx [1 FX (x)] = 0.
The reason why the complement of the CDF is known as the survival function will be clear very
shortly. For exam MLC, the main focus is on random variables and the properties and descriptive
quantities of random variables. Hence, much of the basis for what is in MLC can be derived by
using principles from probabilty.
Consider the time-to-failure random variable of someone age x, denoted Tx . This random variable
should be viewed as the amount of years that someone age x will fail (or die) - hence, its domain is
in the interval (0, ). This particular random variable will have CDF FTx (t) and survival function
STx (t). To make our lives easier, we will remove the T in the subscript throughout the course;
hence, the CDF and survival functions of Tx will be Fx (t) and Sx (t) respectively.
9
10 CHAPTER 1. CONTINUOUS SURVIVAL MODELS
Notice that Fx (t) = P (Tx t). This can be interpreted as the probability that someone currently
age x will die within t years. The survival function, Sx (t) = P (Tx > t). This is the probability that
someone age x will die at some point after t years, or in other words, survive at least t years. Hence
this is the reason why the complement of the CDF is known as the survival function.
Let us now consider the intution behind the properties of the survival function using the random
variable Tx :
1. Sx (0) = 1: the probability of someone age x surviving to time 0 is 1.
2. Sx (t) is continuous and non-increasing for all t: the probability of someone age x surviving
t years decreases as t increases.
3. limt Sx (t) = 0: the probability of someone age x surviving years is 0. Eventually, all
lives age x must die.
Of course, as you should remember from probability, the probability density function (PDF) of a
continuous random variable X, denoted fX , is the derivative of the CDF of X. Similarly, for the
random variable Tx ,
d
[FTx (t)] = fTx (t) = fx (t) (1.2)
dt
which is the PDF of the time-to-failure of someone age x. Again, we drop the T in the subscript
for the PDF. We can also write the PDF in terms of the survival function:
d d
[Sx (t)] = [1 Fx (t)] = fx (t)
dt dt
d
[Sx (t)] = fx (t). (1.3)
dt
Hence, the negative derivative of the survival function of Tx is the PDF of Tx . This relationship
holds for any continuous random variable in general.
We can also integrate the PDF to get the CDF of the survival function:
t t
d
du [Fx (u)] du = fx (u) du
0 0
t
Fx (t) Fx (0) = fx (u) du

0
t
Fx (t) = fx (u) du (1.4)

0
We can find a similar relationship with the survival function:
t
1 Fx (t) = 1 fx (u) du
0
t
Sx (t) = 1 fx (u) du.

0
1.1. CDFS, SURVIVAL FUNCTIONS, x+t 11

Because Tx takes on values in the interval (0, ), fx (u) du = 1. Hence, for any value t such that
0
0 < t < ,
t
fx (u) du + fx (u) du = 1
0 t
t
fx (u) du = 1 fx (u) du = Sx (t)

t 0
Hence, we can write

Sx (t) = fx (u) du.1 (1.5)

t
For the rest of this course, we will use the notation (x) to refer to a person or thing whose age
is x. For exam MLC, one particular value of interest for x is the case when x = 0. Our goal is to
analyze how we can relate our general formulas mentioned so far in this chapter to those of when
x = 0.
Consider T0 , the time-to-failure random variable of someone age 0, or that of a newborn. Given
T0 > x, T0 is defined in the equation T0 = x + Tx . To understand the intuition behind this formula,
suppose that (0) is known to fail at age d. Then of course, T0 = d. After one year, (0) is now (1).
Thus, T1 = d 1 = T0 1. After another year, (1) is now (2) and T2 = (T0 1) 1 = T0 2. Repeat
this recursion for any positive integral (or integer) n and you get the relationship Tn = T0 n,
given T0 > n. It may be more intuitive to understand this relationship when written in the form
Tx = T0 xT0 > x.
Let x 0 be constant and t 0 be variable. We assume that
Fx (t) = P (Tx t) = P (T0 x + tT0 > x). (1.6)
This assumption is definitely reasonable. In words, what (1.6) states is that the probability of (x)
surviving t years is the probability that a newborn, (0), dies within x + t years, given survival to
x years. By use of conditional probability (from exam P/1),
P (T0 x + t T0 > x) P (x < T0 x + t)

Fx (t) = P (Tx t) = P (T0 x + tT0 > x) = = . (1.7)
P (T0 > x) P (T0 > x)
Using CDFs, we can write
P (x < T0 x + t) F0 (x + t) F0 (x)
Fx (t) = P (Tx t) = = . (1.8)
P (T0 > x) 1 F0 (x)
1
In addition, we assume that Sx (t) is differentiable for all t > 0. This guarantees the existence of the force of
mortality, which we will mention later in this chapter.
Using survival functions, we can write
F0 (x + t) F0 (x)
Fx (t) = P (Tx t) =
1 F0 (x)
[1 S0 (x + t)] [1 S0 (x)]
=
S0 (x)
S0 (x) S0 (x + t)
=
S0 (x)
S0 (x + t)
=1 . (1.9)
S0 (x)
Taking the complement of this, we have
S0 (x + t)
Sx (t) = 1 [1 ]
S0 (x)
S0 (x + t)
= . (1.10)
S0 (x)
Equation (1.10) has a very intuitive interpretation: the probability that (x) survives t years is the
probability that (0) survives x + t years, given (0) survives x years. This is essentially the use of
conditional probability in survival functions.
We now focus on a quantity called the force of mortality for someone currently age x, denoted
x .2 We define
S0 (x + dx)
1
P (T0 x + dxT0 > x) S0 (x)
x = lim+ = lim+
dx0 dx dx0 dx
S0 (x) S0 (x + dx)
S0 (x)
= lim+
dx0 dx
1 S0 (x) S0 (x + dx)
= lim+ [ ]
dx0 S0 (x) dx
1 S0 (x) S0 (x + dx)
= lim+ [ ]
S0 (x) dx0 dx
1 S0 (x + dx) S0 (x)
= lim+ [ ]
S0 (x) dx0 dx
1 S0 (x + dx) S0 (x)
= lim+ [ ]
S0 (x) dx0 (x + dx) x
1 d
= [S0 (x)]. (1.11)
S0 (x) dx
2
This is an unfortunate source of notational ambiguity with X , which in exam P/1, is often used to signify the
expected value of the random variable X. For the rest of this course, assume x is used to represent the force of
mortality for someone currently age x.
1.1. CDFS, SURVIVAL FUNCTIONS, x+t 13
We can also write
1 d
x = [S0 (x)]
S0 (x) dx
d
[S0 (x)]
= dx
S0 (x)
f0 (x)
= (1.12)
S0 (x)

using equation (1.3). Notice that f0 (x) = F0 (x). x can be interpreted as the instantaneous rate
of failure at age x, given survival to age x. Similarly, we can define a force of mortaility for (x) t
years after, denoted x+t . Let x 0 be fixed and t 0 be variable. x+t is defined as:
1 d
x+t = [S0 (x + t)]
S0 (x + t) d(x + t)
1 d
= [S0 (x + t)]
S0 (x + t) dt
1 d
= [S0 (x)Sx (t)] by equation (1.10)
S0 (x + t) dt
S0 (x) d
= [Sx (t)]
S0 (x + t) dt
1 d
= [Sx (t)] by equation (1.10) (1.13)
Sx (t) dt
fx (t)
= by equation (1.3) (1.14)
Sx (t)
Some references may also use x (t) to emphasize that the force of mortality depends on t. On
exam MLC, both of these notations will be used.3
Furthermore, notice that we can also write
d
[Sx (t)] d
x+t = dt = [ln Sx (t)]. (1.15)
Sx (t) dt
Thus,
t t
d
x+s ds = ds [ln Sx (s)] ds
0 0
= [ln Sx (t) ln Sx (0)]
= [ln Sx (t)] since Sx (0) = 1 ln Sx (0) = 0.
3
See Notation and Terminology used on Exam MLC, found in http://www.soa.org/Files/Edu/edu-2013-spring-
mlc-notation.pdf for the spring 2013 sitting. For the most current document, check the most current syllabus.
Solving for Sx (t), we get

t
[ln Sx (t)] = x+s ds

0
t
ln Sx (t) = x+s ds
0
t

Sx (t) = exp x+s ds . (1.16)

0
where exp(x) = ex . Be sure to practice these concepts using the SOA sample question list in section
1.6 after reading the rest of this chapter.
1.2. PARAMETRIC SURVIVAL MODELS 15
1.2 Parametric Survival Models

While we did work with quite a few probability concepts in section 1.1, we did not apply them to
any specific probability distributions. This section outlines possible distributions we could use for
the random variable Tx .
1.2.1 Uniform Distribution (de Moivres Law)

Recall from exam P/1 that a random variable following the uniform distribution has domain in
a closed interval [a, b]. In the case of survival models, suppose that T0 (0, ].4 In other words,
suppose that is the limiting age, or the highest age at which a person can live. For (x), if Tx
follows a uniform distribution, then fx (t) is constant in the interval (0, x] and
1
fx (t) = (1.17)
x
t
Fx (t) = (1.18)
x
xt
Sx (t) = (1.19)
x
1
x+t = (1.20)
xt
x
E[Tx ] = (1.21)
2
( x)2
V [Tx ] = (1.22)
12
where E[Tx ] and V [Tx ] are the expected value and variance of Tx respectively,5 and t < x. In
exam MLC, the uniform distribution can referred to as de Moivres Law.
1.2.2 Exponential Distribution

Recall from exam P/1 that a random variable following the exponential distribution has domain
in the interval (0, ). If Tx follows an exponential distribution, then
fx (t) = et (1.23)
Fx (t) = 1 et (1.24)
Sx (t) = et (1.25)
1
E[Tx ] = (1.26)

1
V [Tx ] = 2 . (1.27)

There is a valid reason why is used as the parameter for the exponential distribution. Notice that
et
x+t = t = . Thus, the force of mortality is constant for the exponential distribution. Hence,
e
the exponential distribution is sometimes referred to as the constant force distribution.
4
The symbol is used to mean in or is a member of.
5
The expected value and variance of Tx will be further discussed in the next section.
1.2.3 Gompertz Distribution

This distribution is defined by its force of mortality:
x+t = Bcx+t (1.28)
where B (0, 1) and c > 1. The survival function is given by
Bcx (ct 1)
Sx (t) = exp [ ]. (1.29)
ln c
The proof is left to the reader. You can use equation (1.14) to derive the PDF.
1.2.4 Makeham Distribution

This distribution is also defined by its force of mortality - it adds an additional constant A to the
force of mortality of the Gompertz distribution:
x+t = A + Bcx+t (1.30)
where B > 0, c > 1, and A > B. The survival function is given by

Bcx
Sx (t) = exp [ (1 ct ) At] . (1.31)
ln c
The proof is left to the reader. You can use equation (1.14) to derive the PDF.
1.3 kth Moments (Exam P/1 Review)

Recall that the kth moment of a continuous random variable X, for k 0, is given by

E[X ] = xk fX (x) dx.

k
(1.32)

In particular, the mean of X is the first moment, i.e., the case when k = 1. The variance (or the
second central moment) of X, denoted V [X] or Var[X], is defined by
V [X] = E[(X E[X])2 ] = E[X 2 2XE[X] + E[X]2 ]

= E[X 2 ] 2E[X]E[X] + (E[X])2
= E[X 2 ] (E[X])2 . (1.33)
1.3. kTH MOMENTS (EXAM P/1 REVIEW) 17
Assume that X takes on nonnegative values. If the mean of X exists and is finite, an alternate
formula for the mean of X, where X (a, ) is

E[X] = a + Sx (x) dx.6 (1.37)

a
Now consider Tx . The kth moment of Tx is given by

E[(Tx ) ] = tk fx (t) dt.

k
(1.38)
0
6
Here is how this formula is proven: suppose X is a nonnegative random variable taking values in (a, b). Then,
by definition,
b
E[X] = xfX (x) dx.
a
Using integration by parts with u = x and dv = fX (x)dx, we have du = dx and v = FX (x) + C, where C is an
arbitrary constant. Since it does not matter what value C takes, we set C = 1. Then
b
E[X] = xfX (x) dx
a
b
= b[FX (b) 1] a[FX (a) 1] [FX (x) 1] dx.
a
Using the fact that FX (b) = 1 and FX (a) = 0, we have
b
E[X] = a(1) [FX (x) 1] dx
a
b
= a + [1 FX (x)] dx. (1.35)
a
In particular, if X (0, b), then

b b
E[X] = [1 FX (x)] dx = SX (x) dx. (1.36)
0 0
Equations (1.35) and (1.36) also apply for the case in which b , provided that E[X] exists and is finite. Even
more generally, we can show that for integral k > 0, if X (a, b), where a 0,
b
E[X ] = xk fX (x) dx
k
a
b
= b [FX (b) 1] a [FX (a) 1] [FX (x) 1]kxk1 dx
k k
a
b
= ak + k xk1 [1 Fx (x)] dx (1.37)
a
provided that the moments exist and are finite.

In particular, since Tx (0, ), we can write, by equation (1.36),

E[Tx ] = Sx (t) dt (1.39)

0
provided that E[Tx ] exists and is finite. Equation (1.39) will be very important throughout this
course.
Although not mentioned in any of the sources for exam MLC, by equation (1.37), it can be shown
that
E[(Tx )k ] = k tk1 Sx (t) dt (1.40)

0
provided that these moments exist and are finite. Equation (1.40) can be very useful in calculating
the variance and the moments of Tx .
1.4 International Actuarial Notation: Tx

In 1844, David Jones, a British actuary, wrote a book titled The Value of Annuities and Revisionary
Payments, from which a new system called International Actuarial Notation was created.7
Exam MLC uses International Actuarial Notation in its questions, so it will be necessary to be
able to read and interpret this system of notation. This section will briefly introduce this system
of notation; we will learn more on this system of notation as we go throughout the course.
For the material mentioned so far in this text, we can write for (x):
t px : the probability that (x) survives t years. Notice that this is equivalent to Sx (t).
t px
Age x x+t
Recall that t px = Sx (t) = P (Tx > t). The arrow in the timeline above indicates where failure
or death of (x) would occur in the computation of the probability t px .
t qx : the probability that (x) dies or fails within t years. Notice that this is equivalent to
Fx (t).
t qx
Age x x+t
Recall that t qx = Fx (t) = P (Tx t). The arrow in the timeline above indicates where failure
or death of (x) would occur in the computation of the probability t qx .
7
For further details, see the article The International Actuarial Notation by Frank P. Di Paolo in the newsletter
The Actuary, March 1976 - Vol. 10, No. 3. See also International Actuarial Notation by F.S. Perryman from
Proceedings of the Casualty Actuarial Society, Vol. XXXVI, pp. 123-131, for an actuarial symbol reference.
1.4. INTERNATIONAL ACTUARIAL NOTATION: Tx 19
ut qx : the probability that (x) survives u years and dies or fails within the t years following
the u years of survival. In other words, this is the probability that (x) survives u years and
dies or fails within u + t years. This is known as a deferred mortaility probability, i.e., it
is the probability that death occurs in some interval following a deferred period. We define
ut qx = P (u < Tx u + t) = Sx (u) Sx (u + t) = Fx (u + t) Fx (u). Consider the timeline below.
ut qx
Age x x+u x+u+t
The arrow in the timeline above indicates where failure or death would occur for (x) in
computing the probability ut qx . Now consider the following timeline:
Sx (u + t)
Sx (u)
Age x x+u x+u+t
The arrows in the timeline indicate where failure or death would occur in the computations of
the probabilities Sx (u + t) = P (Tx > u + t) and Sx (u) = P (Tx > u). Think of Sx (u) Sx (u + t)
as subtracting intervals of failure, indicated by the arrows. If you subtract the interval of
failure described by Sx (u) from the interval of failure described by Sx (u + t), you get the
interval of failure for ut qx . By removing the dashed lines in the timeline below, you get the
timeline of the interval of failure for ut qx . Hence, ut qx = Sx (u) Sx (u + t).
Sx (u + t)
Sx (u)
Age x x+u x+u+t
As a notational convention, if t = 1, t px , t qx , and ut qx are written as px , qx , and u qx respectively.

Using these new notations, we can write:
t px = 1 t qx (1.41)
ut qx = u px u+t px (1.42)
d
[t px ] d
x+t = dt = [ln t px ] by equations (1.13), (1.15) (1.43)
t px dt
fx (t) = t px x+t by equation (1.14) (1.44)
t

t px = exp x+s ds by equation (1.16) (1.45)

0
t
t qx = t px x+t dt by equations (1.4), (1.44) (1.46)

0

t px = t px x+t dt by equations (1.5), (1.44) (1.47)

t
x+t p0
t px = by equation (1.10). (1.48)
x p0
It is a strongly suggested exercise for the reader to verify these relationships using their survival
function definitions. These relationships will be important throughout the course.
Another notational convention that is used is to write

ex = E[Tx ].
ex is known as the complete expectation of life.8 By the discussion in section 1.3, assuming
that E[Tx ] exists and is finite,

ex = tfx (t) dt
0

= tt px x+t dt by equation (1.44) (1.49)

0

= Sx (t) dt by equation (1.39)

0

= t px dt. (1.50)
0
Intuitively, equation (1.50) makes sense. If you sum up all of the infinitesimally small intervals
that (x) can survive, you should get the expected lifetime of (x). Using equation (1.40), the kth
moment of Tx is given by, assuming each moment exists and is finite,

E[(Tx ) ] = k tk1 t px dt.

k
(1.51)
0
8
The adjective complete is used to make the distinction between the complete and curtate expectations of life.
Discussion on the curtate expectation of life will be in the next chapter.
1.5. MORE FORMULAS TO KNOW 21
Needless to say, the amount of new notation is massive in this section. In section 1.7, we provide
a formula summary sheet.
1.5 More Formulas to Know

Using equation (1.10), we have for u, t > 0,
S0 (x + t + u)
Sx (t + u) =
S0 (x)
S0 (x + t) S0 (x + t + u)
=[ ][ ]
S0 (x) S0 (x + t)
= Sx (t)Sx+t (u) by equation (1.10). (1.52)
Using the actuarial notation in section 1.4, equation (1.52) can be written as:
t+u px = t px u px+t . (1.53)

Intuitively, equation (1.53) makes sense. The probability that (x) survives t + u years is the proba-
bility that x survives t years and, given Tx > t, the probability that (x + t) survives u years. (1.53)
can be looked at as an application of the general multiplication rule for two events. Recall from
probability that this rule states that for two events E and F , P (E)P (F E) = P (E F ). If we let
E be the event of (x) surviving to x + t and F be the event of surviving to x + t + u, given (x)
survives to x + t, then we have
P ((x) survives to x + t) P ((x) survives to x + t + u(x) survives to x + t)
= P ((x) survives to x + t (x) survives to x + t + u)
= P ((x) survives to x + t + u)
Equation (1.53) will prove useful in future chapters.
However, in general, failure probabilities do not follow the general multplication rule. That is, for
u, t > 0,
t+u qx t qx u qx+t .
When trying to find probabilities of failure given probabilities over disjoint periods, it is usually
best to use equation (1.41) to switch to survival probabilities, and then use equation (1.53) as
necessary.
Using equations (1.42) and (1.53), we can write:
ut qx = u px u+t px
= u px u px t px+u
= u px (1 t px+u )
= u px t qx+u . (1.54)
Intuitively, (1.54) makes sense. The probability that (x) fails within the age interval (x+u, x+u+t]9
is the probability that (x) survives to age x + u and fails within the following t years.
9
See the discussion on page 17. For Tx , it does not matter whether we use (), [], (], or [), since Tx is continuous.
However, for the discrete time-to-failure random variable, the meaning of these intervals does differ. A discussion
on the discrete time-to-failure random variable is in the next chapter.
1.6 SOA Released Questions

Be sure to download the SOA 309 sample questions.10 I will refer to these as the SOA 309. In
addition, be sure to have a copy of the tables provided with exam MLC.11 I will refer to the
Illustrative Life Table in the tables provided for MLC as the ILT.
At the time of this writing, the May 2012, November 2012, and May 2013 MLC exams have been
released by the SOA.
Relevant Questions: SOA 309: #13, 22, 32, 59, 98, 116, 155, 171, 188, 200.
A distribution present in some of the SOAs sample questions is known as the Modified de
Moivres Law, where for a constant > 0,
xt
Sx (t) = ( ) (1.55)
x

x+t = (1.56)
xt
x
E[Tx ] = . (1.57)
+1
10
At the time of this writing, they can be found at http://www.soa.org/Files/Edu/edu-2013-spring-mlc-que.pdf.
11
At the time of this writing, the ILT can be found at http://www.soa.org/Files/Edu/edu-2013-mlc-tables.pdf.
1.7. FORMULA SUMMARY SHEET 23
1.7 Formula Summary Sheet

Tx = T0 xT0 > x
Uniform Distribution (de Moivres Law):

1
fx (t) =
x
t
Fx (t) =
x
xt
Sx (t) =
x
1
x+t =
xt
x
E[Tx ] =
2
( x)2
V [Tx ] =
12
Exponential Distribution (constant force of mortality ):
fx (t) = et
Fx (t) = 1 et
Sx (t) = et
1
E[Tx ] =

1
V [Tx ] = 2 .

Gompertz Distribution:
x+t = Bcx+t
Bcx (ct 1)
Sx (t) = exp [ ]
ln c
where B (0, 1) and c > 1.
Makeham Distribution:
x+t = A + Bcx+t
Bcx
Sx (t) = exp [ (1 ct ) At]
ln c
where B > 0, c > 1, and A > B.
Relationships among formulas:
t px = Sx (t) = 1 t qx
t+u px = t px u px+t
t qx = Fx (t) = 1 t px
ut qx = u px u+t px
= u px t qx+u
d
[ t px ] d
x+t = dt = [ln t px ]
t px dt
fx (t) = t px x+t
t

t px = exp x+s ds

0
t
t qx = t px x+t dt
0

t px = t px x+t dt
t
x+t p0
t px =
x p0

ex = E[Tx ] = tt px x+t dt
0

= t px dt
0

E[(Tx ) ] = k tk1 t px dt
k
0
Chapter 2
Discrete Survival Models

References: AMLCR, Chapter 2.6, Supplementary Notes1 ; MQR, Chapters 5.3.6., 6.3.3., 6.3.4.
Before we discuss discrete survival models, we discuss symbols that will be used throughout the
rest of this text.2
2.1 Commonly Used Symbols

In order to abbreviate statements throughout this text, we define the following sets:
1. The set of integers is denoted Z, which is the set {, 3, 2, 1, 0, 1, 2, 3, }. Z is the set of

all positive and negative whole numbers. We say that x is an integer by writing x Z.
2. The set of natural numbers is denoted N, which is the set {1, 2, 3, }.3 N is the set of all
whole numbers greater than or equal to 1. We say that x is an natural number by writing
x N.
3. The set of rational numbers is denoted Q, which is the set of numbers that can be written
a
in the form , where a, b Z and b 0. In other words, the rational numbers is the set of
b
all ratios of integers with a nonzero denominator. We say that x is an rational number by
writing x Q.
4. The set of irrational numbers is denoted R Q,4 which is the set of all numbers that are
not rational numbers. We say that x is an irrational number by writing x R Q.
5. The set of real numbers, denoted R, is the set R = Q (R Q). We say that x is an real
number by writing x R.
1
These are provided in the current syllabus. For the spring 2013 sitting, see http://www.soa.org/files/edu/edu-
2012-spring-mlc-studynotes.pdf.
2
Readers familiar with undergraduate real analysis may skip section 2.1 without loss of continuity. For the
reader familiar with undergraduate linear algebra or abstract algebra, it is suggested that he or she goes through
the definitions of the floor and ceiling functions.
3
Some textbooks use 0 as the lowest number of N, rather than 1.
4
The symbol is used to denote difference among sets. For example, if X, Y are sets, X Y is the set consisting
of elements that are in X but not Y . Some texts may also use to denote difference among sets.
25
26 CHAPTER 2. DISCRETE SURVIVAL MODELS
Let x R and R Z be defined by x = max{k Zk x}.5 is known as the floor function,

and x is known as the floor of x. One can think of the floor of a number as the rounded down
value of the number to the nearest integer, or the integer part of the number.
Examples.
1. 5.4 = 5
2. 6.97 = 6
3. 7 = 7.
Let x R and R Z be defined by x = min{k Zk x}. is known as the ceiling function,

and x is known as the ceiling of x. One can think of the floor function as the rounded up value
of the number to the nearest integer.
Examples.
1. 5.4 = 6
2. 6.97 = 7
3. 7 = 7.
2.2 Kx, Kx, Rx

We define three new random variables in this section. First,
Kx = Tx . (2.1)
Kx 6 is known as the curtate time-to-failure random variable. It is the integer part of the
time-to-failure random variable Tx defined in chapter 1.7 We define another random variable as
the fractional part of Tx , denoted Rx , such that
Tx = Kx + Rx . (2.2)
Rx is a continuous random variable where Rx [0, 1). We define another random variable
Kx = Kx + 1.8 (2.3)
Kx is known as the time interval of failure random variable. For example, suppose that (85)

fails at age 87.5. Below is a timeline outlining the relationships between K85 , K85 , and T85 .
5
max{k Zk x} is the largest integer k such that k is less than or equal to x.
6
K(x) may also be used on exam MLC.
7
Notice that Kx is a discrete random variable.
8
Notice that Kx is a discrete random variable.
2.3. PROBABILITIES AND EXPECTATION OF Kx 27
R85 = 0.5
Age 85 86 87 87.5 88
T85 = 2.5
K85 = 0 K85 = 1 K85 = 2

K85 =1 K85 =2 K85 =3
The reason why Kx is known as the time interval of failure of (x) is because it is the (annual)
interval at which (x) fails. Using the example in the timeline above, there are three age intervals:
85 to 86, 86 to 87, and 87 to 88. Since (85) fails at 87.5, (85) fails in the third age interval, i.e.,

87 to 88, and thus, K85 = 3. Also, if 1 T85 < 2, i.e., if failure were to occur between ages 86 and

87, then K85 = 2, which is the second age interval. Similarly, if 0 T85 < 1, i.e., if failure were to

occur between ages 85 and 86, then K85 = 1, which is the first age interval.
Since (85) fails at 87.5, note that K85 = 2.5 = 2.9 The fractional part of 87.5 is 0.5 = R85 . Of
course, if T85 = 2.5, K85 + R85 = 2 + 0.5 = 2.5 by the definition provided in equation (2.2).
2.3 Probabilities and Expectation of Kx

The concepts in this section can easily be extended to Kx by using the relationship given by
equation (2.3).
Let k N {0}.10 Notice that Kx = k if and only if (x) fails at age x + k or between ages x + k and
x + k + 1.11
Thus, to compute probabilities on Kx , we note that
P (Kx = k) = P (k Tx < k + 1)
= k qx by the definition on p. 1712 (2.4)
= k px qx+k by equation (1.54). (2.5)
Here is another piece of International Actuarial Notation: we denote
ex = E[Kx ]. (2.6)
ex is known as the curtate expectation of life.13
9
This is the rounded down value of 2.5 to the nearest integer.
10
N {0} is the set of natural numbers in addition to the number 0.
11
Not including age x + k + 1, since the floor of k + 1 is k + 1 and not k.
12
Since Tx is a continuous random variable, P (k Tx < k + 1) = P (k < Tx k + 1), which is what is stated in the
definition on p. 17.
13
Note the differences between the curtate and complete expectations of life.
Provided that E[Kx ] exists and is finite, by definition,

ex = k P (Kx = k)
k=0

= k k qx by equation (2.4) (2.7)
k=0

= k(k px k+1 px ) by equation (1.42)
k=0
= 0 + (px 2 px ) + 2(2 px 3 px ) + 3(3 px 4 px ) +
= px + 2 px + 3 p x +

= k px . (2.8)
k=1
Equation (2.8) follows the same line of intuition as equation (1.50) does. The only difference
between these two equations is that (2.8) applies to the discrete case, whereas (1.50) applies to
the continuous case.
Let r N. Provided each moment of Kx exists and is finite, the rth moment of Kx is given by

E[(Kx )r ] = k r (k px k+1 px )
k=0
= 0 + (px 2 px ) + 2r (2 px 3 px ) + 3r (3 px 4 px ) +
= px (1r 0r ) + 2 px (2r 1r ) + 3 px (3r 2r ) +

= k px [k r (k 1)r ] . (2.9)
k=1
Formula (2.9) is not as easy to use as formula (1.51), so we present the formula for the second
moment. By (2.9), provided that the second moment exists and is finite,

E[(Kx )2 ] = k px [k 2 (k 1)2 ]
k=1

= k px [k 2 (k 2 2k + 1)]
k=1

= k px [2k 1]
k=1

= 2 k k px k px
k=1 k=1)

= 2 k k px e x . (2.10)
k=1
2.4. TERM EXPECTATION OF LIFE 29
2.4 Term Expectation of Life

Tx , Tx n

Consider the random variable min(Tx , n) = , where n R is such that n > 0. We

n, Tx >n
call this random variable W1 .14 The expected value of this random variable is given by, using the
double expectation formula from exam P/1,15
E[W1 ] = E[Tx Tx n]P (Tx n) + E[nTx > n]P (Tx > n).
Given Tx n, the PDF of Tx is given by:
P (Tx = t Tx n) P (Tx = t) t px x+t

fTx Tx n (t) = P (Tx = tTx n) = = = .
P (Tx n) P (Tx n) n qx
Thus,
n
t px x+t
E[W1 ] = t ( ) dt n qx + n n px
n qx
0
n
= tt px x+t dt + n n px
0
n
d
= t ( [t px ]) dt + n n px by equation (1.43)
dt
0
n
d
= t( [t px ]) dt + n n px . (2.11)
dt
0
d
Using integration by parts with u = t and dv = [t px ] dt,
dt
n

E[W1 ] = n n px 0 t px dt + n n px
0

n
= n n px + t px dt + n n px
0
n
= t px dt. (2.12)
0
The standard symbol for equation (2.12) is exn , which is known as the term expectation of
16
life. The term expectation of life is the expected future lifetime for (x) over the next n years
only.
14
Note that there is no symbol or standard letter given to this variable in the texts for exam MLC. We are calling
this W1 for convenience.
15
The double expectation formula for two random variables X and Y is E[X] = EY [EX [XY ]].
16
It is also known as the partial expectation of life.
2.5 Temporary Curtate Expectation of Life

Let n N. There is an analogous concept in the discrete case of what is in section 2.4. Consider the

Kx , K x n

random variable min(Kx , n) = We call this random variable W2 for convenience.

n, K x > n.
As W2 is a function of Kx , we write
n
E[W2 ] = k (k px k+1 px ) + n (k px k+1 px ) by equations (2.4) and (1.42).
k=0 k=n+1
Notice that

(k px k+1 px ) = n+1 px n+2 px + n+2 px n+3 px + n+3 px +
k=n+1
= n+1 px .
Thus,

n (k px k+1 px ) = n n+1 px . (2.13)
k=n+1
Now,
n
k (k px k+1 px ) = 0 + (px 2 px ) + 2(2 px 3 px ) + 3(3 px 4 px ) + + n(n px n+1 px )
k=0
= px + 2 px + 3 px + + n px n n+1 px
n
= k px n n+1 px . (2.14)
k=1
Therefore,
n
E[W2 ] = k px n n+1 px + n n+1 px
k=1
n
= k px . (2.15)
k=1
The standard symbol for equation (2.15) is exn , which is known as the temporary curtate
expectation of life. The temporary curtate expectation of life is the expected number of whole
years that (x) lives over the age interval (x, x + n].
2.6. SOA RELEASED QUESTIONS 31

Relevant Questions: SOA 309: #21, 28, 65, 120, 161, 171, 189, 207; November 2012: #3; April
2013: #20.
There are a few concepts that are covered in the sample questions that are not covered in AMLCR
or MQR.17 For questions in which x+t is a piecewise function, the following will be useful. Consider
exn . Suppose we wanted to write this in terms of
for (x), exm , where m < n.
n
Noting that
exn = t px dt, we have
0
n m n

exn = t px dt = t px dt + t px dt
0 0 m
n
=
exm + t px dt.
m
Set u = t m.18 Then du = dt and
n nm

exm + t px dt =
exm + m+u px du
m mm
nm
=
exm + m+u px du
0
nm
=
exm + m px u px+m du
0
nm
exm + m px
= u px+m du
0
=
exm + m px
ex+mnm . (2.16)
(2.16) should be memorized. It comes up in quite a few of the sample questions as an extremely
convenient shortcut. We can also derive a similar formula for the discrete case. Consider for (x),
exn . Then for integral m < n,
n
exn = k px
k=1
m n
= k px + k px
k=1 k=m+1
n
= exm + k px
k=m+1
17
I thank Jim Daniel for suggesting that I add this section.
18
Credit goes to Steve Paris for giving me this step.
Set u = k m. Then
n nm
exm + k px = exm + m+u px
k=m+1 u+m=m+1
nm
= exm + m+u px
u=1
nm
= exm + m px u px+m
u=1
nm
= exm + m px u px+m
u=1
= exm + m px ex+mnm . (2.17)
Notice that (2.17) and (2.16) are almost identical, with the exception of the on top of the e
symbol for (2.16).
(2.16) and (2.17) should be considered first priority for this exam, as they do come up in the sample
questions.
The following equation has not come up in the released questions, but may be useful. Consider
now, for (x),
ex . For n < , we have
n

ex = t px dt = t px dt + t px dt
0 0 n

=
exn + t px dt
n
w
=
exn + lim t px dt.
w
n
Set u = t n. Then du = dt and

w wn

exn + lim t px dt =
exn + lim u+n px du
w w
n nn
wn
exn + lim
= n px u px+n du
w
0
wn
exn + n px lim
= u px+n du
w
0

=
exn + n px u px+n du
0
=
exn + n px
ex+n . (2.18)
2.6. SOA RELEASED QUESTIONS 33
Similarly, in the discrete case,

n
ex = k px = k px + k px
k=1 k=1 k=n+1
w
= exn + lim k px .
w
k=n+1
Set u = k n. Then
w wn
exn + lim k px = exn + lim n+u px
w w
k=n+1 n+u=n+1
wn
= exn + lim n px u px+n
w
u=1
= exn + n px ex+n . (2.19)
Again, notice how (2.18) and (2.19) are nearly identical. The case in which n = 1 of (2.19) does
come up in the sample questions: note that this states that
ex = ex1 + px ex+1 = px + px ex+1 = px (1 + ex+1 ) . (2.20)

Kx = Tx
Tx = Kx + Rx
Kx = Kx + 1
P (Kx = k) = P (k Tx < k + 1)
= k qx
= k px qx+k
E[Kx ] = ex

= k P (Kx = k)
k=0

= k px
k=1

E[(Kx )r ] = k px [k r (k 1)r ]
k=1
n

exn = E[min(Tx , n)] = t px dt
0
=
exm + m px
ex+mnm , for m < n
n
exn = E[min(Kx , n)] = k px
k=1
= exm + m px ex+mnm , for m < n

ex =
exn + n px
ex+n
ex = exn + n px ex+n
= px (1 + ex+1 )
Chapter 3
Life Tables
References: AMLCR, Chapters 3.2 - 3.3, 3.6 - 3.91 ; MQR, Chapters 5.4, 6.1 - 6.4, 6.6.1 - 6.6.2,
6.7.
3.1 Calculating Probabilities

What is a life table? Let x N {0}. Below is an example of a life table.
x lx
50 500
51 490
52 470
53 430
54 370
55 290
As usual, x represents the age of a person or thing. lx represents the expected number of lives
of a population who are alive of age x.2 A life table is a table which has (at the very least)
the following information:
1. n ages x0 , x1 , , xn1 where each xi N {0} i N3 with a starting age
x(0) = min{x0 , x1 , , xn1 }4 and limiting age = max{x0 , x1 , , xn1 }, so that x(0) xi
xi ;
2. n values lx0 , lx1 , , lxn1 corresponding to each respective age xi .
The number of lives with the starting age, i.e., lx(0) , is known as the radix. Of course, for these
definitions to make sense, we assume that each xi 0 and lxi 0 xi .5 For the life table illustrated
above, x(0) = 50 is the starting age, l50 = 500 is the radix, and = 55 is the limiting age.
1
The supplementary notes to AMLCR provide background information for the sections from AMLCR that we
have omitted in this chapter (3.4 through 3.5). We will not focus too much on these sections, as they only provide
background information, and nothing really with assistance in solving exam MLC problems, judging by the released
exams. We will use the background from these chapters to give a context to the concepts in this chapter, but we
will not dedicate a whole section to them, as AMLCR does.
2
MQR uses `x instead of lx . MQRs notation will not be used on exam MLC.
3
is read as for all or for each.
4
Note that AMLCR uses x0 for the starting age. We use x(0) to indicate that it is an order statistic, i.e., the
smallest value.
5
A more rigorous approach to the life table can be found in [3, pp. 41-42].
35
36 CHAPTER 3. LIFE TABLES
Lets try calculating probabilities with this table.

Examples. Assume that the following questions are based on a population whose life table is
given above.
1. What is the probability that someone age 50 survives to age 51?

Solution. There are currently 500 lives age 50. If this particular person survives to age 51,
then he or she must be one of the 490 people who survived to age 51. This probability is
l51 490
p50 = = = 0.98.
l50 500
2. What is the probability that someone age 50 dies before reaching age 51?
Solution. We want to find q50 . Notice that q50 = 1 p50 = 1 0.98 = 0.02. When working
with life tables, the relationships we have developed still apply. Alternatively, there are
currently 500 lives age 50. 490 of these people survive to age 51, which implies that 10 have
10
died before reaching age 51. Thus, q50 = = 0.02.
500
3. What is the probability that someone age 53 survives to age 55?
Solution. We want to find 2 p53 , i.e., the probability that someone age 53 survives two
years. There are 430 people who are age 53. 290 of them survive to age 55, so therefore,
290
2 p53 = 0.674. Alternatively, by equation (1.53), we know that 2 p53 = p53 p54 . The
430
l54 370
probability of someone age 53 surviving one year is = . The probability of someone
l53 430
l55 290 370 290 290
age 54 surviving one year is = . Thus, 2 p53 = p53 p54 = ( )( )= 0.674.6
l54 370 430 370 430
4. What is the probability that someone age 50 survives to age 52 but dies before reaching age
53?
Solution. This probability is given by 2 q50 = 2 p50 q52 by equation (1.54). Now notice that
l52 470 40
2 p50 = = = 0.94 and q52 = 0.085. Using the exact values for these two quantities,
l50 500 470
we multiply them to get 0.08.
Make sure you try the examples above on your own until you are comfortable calculating proba-
bilities with life tables.
We define for 0 t x(0) ,
lx(0) +t = lx(0) t px(0) . (3.1)
This makes sense, as it says that the expected number of lives who are alive with age x(0) + t is
the number who are alive at x(0) multiplied by the probability that they survive t years.
6
In this case, using (1.53) was not necessary, but depending on the information you are given in a question, you
may have to use (1.53). It will be especially useful when estimating probabilities on life tables for non-integral ages
of failure.
3.1. CALCULATING PROBABILITIES 37
Thus, if x is such that x(0) x x + t ,
lx+t = lx(0) +x+tx(0) = lx(0) x+tx(0) px(0) by (3.1)

= lx(0) xx(0) px(0) t px(0) +xx(0) by (1.53)
= lx(0) xx(0) px(0) t px
= lx(0) +xx(0) t px by (3.1)
= lx t px . (3.2)
Therefore,
lx+t
t px = . (3.3)
lx
We used this equation in the examples in this section without mathematically formalizing it. See
examples 1 and 3.
By equation (1.41), we have that
lx+t lx lx+t
t qx =1 = . (3.4)
lx lx
Consider the numerator lx lx+t . What is this actually describing? If we look at the example life
table in this section, for example, l50 l52 = 30. What does this quantity describe? It is the number
of deaths that have occured in the age interval (50, 52). The number of deaths over this period is
described by the symbol 2 d50 , i.e., from the ages of 50 to 52. In general, the number of deaths in
the interval (x, x + t) is t dx = lx lx+t .7
Thus,
t dx
t qx = . (3.5)
lx
We used this equation in example 2 without mathematically formalizing it. We could also present
a formula for ut qx , but as you see from example 4, it is best just to use equation (1.54) with (3.3)
and (3.4).
7
AMLCR does not mention this notation, nor is it in International Actuarial Notation by Perryman. However,
both of these sources do mention dx , the number of deaths that occur in the age interval (x, x + 1). The Notation
and Terminology used on Exam MLC document for spring 2013 does not provide any comment on whether or not
this notation will be used.
As an exercise, complete the following life table. The values that have been filled in are the ones
stated in the example, in addition to d55 . Round final answers to three decimal places at most.
x lx px qx dx
50 500 0.98 0.02
51 490
52 470
53 430
54 370
55 290 100
The solution is given below. Due to rounding, p51 + q51 does not equal 1.
x lx px qx dx
50 500 0.98 0.02 10
51 490 0.96 0.041 20
52 470 0.915 0.085 40
53 430 0.86 0.14 60
54 370 0.784 0.216 80
55 290 0.655 0.345 100
Here are some observations to notice about life tables that we can get from this particular life
table:
1. lx is non-increasing as the age, x, increases. We do not introduce additional lives into lx at

any age. This would cause our px and qx values to fall outside the interval (0, 1).
2. As lx is non-increasing as x increases, px is non-increasing as x increases.
3. As px is non-increasing as x increases, qx and dx are non-decreasing as x increases.
3.2 Fractional Age Assumptions

If you look at any of the life tables in section 3.1, you would notice they all are based on integral
ages. But what if we want to calculate probabilties for non-integral ages? For example, what is the
probability that (52) survives to age 53.25? If we are just given a life table like the ones in section
3.1, we would have to make assumptions about the behavior between integral ages.8
3.2.1 Uniform Distribution of Deaths (UDD) Assumption

Suppose that s (0, 1) is fixed. If, for some x N {0}, we are given lx and lx+1 , where x = x + s,
and wanted to find lx+s , the simplest way to estimate lx+s would be to use linear interpolation.
8
[1, pp. 102-103] covers the hyperbolic/Balducci assumption; however, this has since been dropped from the
MLC syllabus and will not be covered in this text.
3.2. FRACTIONAL AGE ASSUMPTIONS 39
Let x be the independent variable and lx be the dependent variable. From Calculus, the slope, m,
of the secant line connecting the points (x, lx ) and (x + 1, lx+1 ) is
lx+1 lx
m= = lx+1 lx .9 (3.6)
(x + 1) x
We assume this slope m is constant throughout the interval (x, x + 1). This would imply that
lx+s = (lx+1 lx )(x + s) + b for some b R.10 Of course, lx+0 = lx , so that lx = (lx+1 lx )x + b. Thus,
we can write
lx+s = (lx+1 lx )(x + s) + b

= (lx+1 lx )x + b + (lx+1 lx )s
= lx + slx+1 slx
= (1 s)lx + slx+1 . (3.7)
Now here is where things get very interesting: define x and s as stated earlier in this section. Then
lx lx+s
s qx =
lx
lx (1 s)lx slx+1
= by equation (3.7)
lx
slx slx+1
=
lx
lx lx+1
= s( )
lx
= sqx by equation (3.4). (3.8)
Equation (3.8) is known as the uniform distribution of deaths (UDD) assumption.11 The
reason why this is known as the uniform distribution of deaths assumption is the following: recall
that Tx = Kx + Rx by equation (2.2). It can be shown that (3.8) is equivalent to stating that, for
x N {0}, Rx follows a uniform distribution in (0, 1), and Kx and Rx are independent.12
Of course, you can use previously developed relationships among formulas to gather many new
ways to rewrite formulas under the UDD assumption, but we will focus on only two of these in
particular.
Notice that, for variable s (0, 1), by equation (3.8),
d
[s qx ] = qx . (3.9)
ds
But also remember that by definition, s qx = P (Tx s) = Fx (s). Thus,

d d
[s qx ] = qx = [Fx (s)] = fx (s)
ds ds
9
Of course, m 0, as lx is non-increasing as x increases.
10
This is simply the familiar linear equation y = mx + b in a different form.
11
AMLCR calls this the UDD1 assumption. See [3, p. 44].
12
AMLCR calls this statement the UDD2 assumption. For the purpose of studying for exam MLC, proving
this statement is not particularly useful. A proof of this statement can be found in [3, pp. 45-46].
and by equation (1.44),

qx = fx (s) = s px x+s . (3.10)
Under UDD, it can also be shown that
1
ex = ex + .
(3.11)
2
(3.11) follows from the fact that Tx = Kx + Rx , where Rx follows a uniform distribution in (0, 1).
1
This implies that E[Tx ] = E[Kx ] + E[Rx ], and since the mean of Rx is , equation (3.11) follows.
2
3.2.2 Constant Force of Mortality (CF) Assumption

Not only can we linearly interpolate between integral years, but we can also exponentially inter-
polate. Suppose for x N {0} and s (0, 1) that lx+s is an exponential function in the form
lx+1
lx+s = abs . We know that lx+0 = lx = a and lx+1 = ab, so that lx+1 = blx b = and
lx
lx+1 s
lx+s = abs = lx ( ) = (lx )1s (lx+1 )s . (3.12)
lx
By equation (3.3),
lx+1 = lx px .
Hence, (3.12) states that
lx+s = (lx )1s (lx px )s = lx (px )s . (3.13)
This implies that
lx+s
(px )s = = s px , (3.14)
lx
by equation (3.3). Lastly, by equation (1.43),
d d d
x+s = [ln s px ] = [ln((px )s )] = [s ln px ] = ln px . (3.15)
ds ds ds
Notice that x+s does not depend on s, hence, it is constant in the age interval (x, x + 1), so we
write x = x+s . This is why the exponential assumption of lx+s is called constant force (CF)
assumption. This leads to px = exp (x ), or (px )s = s px = exp (sx ). Equivalently, by equation
(1.25), we can say that Tx follows an exponential distribution in the age interval (x, x + 1).
3.3. SELECT AND ULTIMATE LIFE TABLES 41
3.3 Select and Ultimate Life Tables

Consider a person (x) purchasing life insurance. This particular person would have to go through
a process called underwriting, in which he or she would have to answer questions to a company
in order to determine his or her eligibility for the desired insurance policy. If the person is eligible
for this insurance policy and enters the group of people insured by the company, we say that he
or she is selected, or select at age x. We assume that the duration that (x) is selected, or the
select period, is finite. We assume that during the select period, (x) follows a different mortality
table from others whose mortality is solely dictated by their age.
After the select period, the initial effect of selection is worn off and then (x) is said to follow
ultimate mortality, during which (x) would revert to mortality solely dictated by his or her age.
We write [x] to denote a life selected at age x, and include the usual actuarial notation with [x].
For example, p[20] represents the probability that someone selected at age 20 survives one year,
p[20]+1 is the probability that someone who was selected at age 20 and lived to 21 survives one
year, and p[21] is the probability that someone who was selected at age 21 survives one year.
The life table equations from section 3.1 apply; however, it is necessary to pay attention to the
select period. When ultimate mortality is reached, the [] around the age are dropped.
Example. For a select and ultimate table with a three-year select period, write equations in terms
of lx the following: (i) 2 p[20] , (ii) 2 p[19]+1 , and (iii) 2 p[18]+2 .
Solution.
(i) If [20] is selected, then the select period ends when he or she reaches age 23. So, since 2 p[20] is
the probability that [20] survives two years to age 22, mortality remains in the select period when
computing this probability. Hence, 2 p[20] = p[20] p[20]+1 by equation (1.53), and p[20] p[20]+1 =
l[20]+1 l[20]+2 l[20]+2
( )( )= .
l[20] l[20]+1 l[20]
(ii) If [19] is selected, then 2 p[19]+1 implies that [19] lives to age 20. The select period is three
years, which implies that this person currently age 20 reaches ultimate mortality at age 19 + 3 =
22 years. We wish to find the probability that this person survives two years, to age 22. Hence,
l[19]+2 l22 l22
2 p[19]+1 = p[19]+1 p[19]+2 = ( )( )= . Notice that l22 is in this equation instead of
l[19]+1 l[19]+2 l[19]+1
l[19]+3 due to the select period ending after three years, and ultimate mortality starting.
(iii) If [18] is selected, 2 p[18]+2 implies that [18] lives to age 20. The select period is three years,
which implies that this person currently age 20 reaches ultimate mortality at age 18 + 3 = 21.
We wish to find the probability that this person survives two years, to age 22. Hence, 2 p[18]+2 =
l21 l22 l22
p[18]+2 p21 = ( )( ) = .
l[18]+2 l21 l[18]+2
As you probably notice from the above examples, equation (1.53) is important in these calculations.
Do not try memorizing more equations for select and ultimate tables; they are just extensions of
the life table model presented in section 3.1 with a select period.

Relevant Questions: SOA 309: #66, 106, 131, 136, 168, 219, 267, 276; April 2012: #1, 2, 13;
November 2012: #2; April 2013: #19.
There is one equation that may prove useful that is not covered in AMLCR or MQR. Assume
UDD between integral ages. Suppose we want to find s qx+t , where s, t (0, 1) such that s + t 1
and x N {0}. Now
lx+t+s
s qx+t =1
lx+t
lx+t lx+t+s
=
lx+t
(1 t)lx + tlx+1 [(1 (t + s))lx + (t + s)lx+1 ]
= by equation (3.7)
lx+t
lx tlx + tlx+1 lx + (t + s)lx (t + s)lx+1
=
lx+t
s(lx lx+1 )
=
lx+t
sdx
=
lx+t
sdx
( )
lx
=
lx+t
( )
lx
sqx
= by equations (3.3), (3.5)
t px
sqx
=
1 t qx
sqx
= by equation (3.8). (3.16)
1 tqx

lx+t
t px =
lx
lx lx+t t dx
t qx = =
lx lx
Let s, t (0, 1) such that s + t 1.
Uniform Distribution of Deaths (UDD)
lx+s = (1 s)lx + slx+1

s qx = sqx
qx = s px x+s
1
ex = ex +
2
sqx
s qx+t =
1 tqx
Constant Force of Mortality (CF)
lx+s = (lx )1s (lx+1 )s

s sx+s
s px = (px ) = e
Chapter 4
Valuation of Insurances
References: AMLCR, Chapter 4; MQR, Chapters 7.1 - 7.5, 10.1.
This is the chapter where AMLCR and MQR start presenting very different perspectives on the
same material. We will do our best to include both perspectives in the discussion in this text.
4.1 Introduction
In this section, we focus on the valuation of insurances. An insurance makes a single payment
due to the occurrence of a defined random event. The main focus of this course is on life insurance,
which makes a single payment due to death of a person. However, the concepts presented here can
easily be extended to insurances for machinery, cars, homes, etc.
From exam FM/2, one possible way to value an insurance is to take the present value of the cash
flow that the company will pay upon the persons death. But there is one problem: how do we
know when the person will die?
If (x) possesses a $5,000 insurance which pays right at the moment of his or her death, which, say,
were to occur 25 years from now, then from FM/2, we know that the present value of the insurance
would be 5000v 25 .1 But the problem is, if we do not currently know when the death of (x) would
occur, all we would know is that if (x) were to die Tx years from now, the present value of the
insurance would be 5000v Tx . Notice that Tx , the time-to-failure random variable, is brought into
the present value of the insurance.
So, given the present value of the insurance 5000v Tx , it seems that it would be logical to value
this insurance by taking the expected present value (EPV) of this insurance, i.e., E[5000v Tx ].
Another name for the EPV is the actuarial present value (APV).2 Of course, in order to value
this insurance, we would need to make assumptions about the distribution of Tx . This discussion
forms the basis for pricing continuous insurances.
1 1
Where v = , i being the effective annual interest rate.
2
1 +i
AMLCR also calls the APV/EPV the Actuarial Value, and MQR also calls the APV/EPV the Net Single
Premium (NSP), but none of these terms will be in exam MLC.
45
46 CHAPTER 4. VALUATION OF INSURANCES
Now another thing to consider is the following: realistically, insurances do not pay right at the
moment of death of a person. If we consider the discrete-time-to-failure random variables Kx and
Kx , we could find an expression for the present value of an insurance which uses one of these two
random variables. Suppose (x) were to die Tx = 24.5 years from now. When would it be most
logical for the insurance of $5,000 to pay?
What about the beginning of the year of death? Paying at Tx = 24 = Kx years from now does
not make any sense, as there would be no reason for the insurance company to pay, as death has
not occurred yet. Thus, it would be most logical for the company to pay the insurance benefit
at the end of the year of death, i.e., Kx + 1 = 24 + 1 = 25 = Kx years from now. So the expression
for the present value of such an insurance would be 5000v Kx = 5000v Kx +1 , and the APV/EPV of

such an insurance would be E[5000v Kx ] = E[5000v Kx +1 ], and of course, we would need to make

assumptions about the distributions of Kx and Kx in order to price this insurance. This discussion
forms the basis for pricing discrete insurances.
Where AMLCR and MQR differ is in their choices of random variables to price the discrete
insurances: AMLCR uses Kx , whereas MQR uses Kx . Another way in which these two texts differ
is their notation of the present value random variable for the different types of insurances presented
in this chapter. AMLCR and the SOAs released questions use Z to represent the present value
(PV) random variable for an insurance, regardless of the insurance type. MQR decorates Z using
symbols which are similar to those from exam FM/2, depending on the insurance type. All three
sources, however, have the same symbols for the APV/EPV for each type of insurance.
We will go into further detail on the symbols that are used as we go throughout this chapter.
Most of the time, we will be using the MQR notation for the present value random variable for the
different types of insurances. Although this system of notation is not used by the SOA or AMLCR,
this system of notation makes it easier to relate each type of insurance with its respective APV
symbol.
4.2 Types of Insurances

From reading the introduction, the main idea you should have gotten is that we use the random
variable Tx to price continuous insurances, which pay at the moment of death, and either Kx +1
or Kx to price discrete insurances, which pay at the end of the year of death. AMLCR and the
SOA use Z to denote the present value (PV) random variable for an insurance, regardless of the
insurance type; however, we will follow the MQR convention and decorate the Z as needed. A
chart of the insurance types, along with their various symbols from MQR, are below. Similar to
exam FM/2, bars on top of letters indicate continuous insurances; lack thereof indicate discrete
insurances. Note that all of the insurance types are unit benefits, i.e., they pay a benefit of 1.
Thus, for an insurance which pays a benefit of b, multiply the PV random variables by b. To convert
the discrete insurances to the Kx form, use the formula Kx = Kx + 1.
4.2. TYPES OF INSURANCES
Table of Discrete Insurance Types (P (Kx = k) = k1 qx )
PV Random Name of Payment Description Definition Expected Value
Variable Insurance

Ax = v k P (Kx = k)

Zx Whole Life Pays 1 at the end of Zx = v Kx
k=1
Insurance the year of death

v Kx , Kx n

n
1
Zxn Term Insurance Pays 1 at the end of 1
Zxn = A1xn = v k P (Kx = k)
the year of death if 0,

Kx > n k=1
death occurs within n

years

0,
Kx n
n Zx Deferred Whole Pays 1 at the end of Z
n x = Kx n Ax = v k P (Kx = k)
v , K x > n

k=n+1
Life Insurance the year of death if
death occurs after n
years

0,
Kx u or Kx > u + n u+n
1
u Z xn Deferred Term Pays 1 at the end of 1
u Z xn = K
1
u Axn = v k P (Kx = k)
v , u < Kx u + n

x k=u+1
Insurance the year of death
after the u-year
deferral period if
death occurs within
the following n years

0, Kx n

Z xn1 Pure Pays 1 at n years if Z xn1 = n
Axn1 = n Ex = v n n px
v , K x > n

Endowment insured survives past
n years
1
Zxn Endowment Pays 1 at n years or Zxn = Zxn + Z xn1 Axn = A1xn + n Ex
Insurance the end of the year of
death if death occurs
within n years,
whichever comes first
47
48
Table of Continuous Insurance Types(fx (t) = t px x+t )
Variable Insurance

Zx Whole Life Pays 1 at the moment Zx = v Tx Ax = v t fx (t) dt
0
Insurance of death

v Tx , Tx n
n
Zxn
1
Term Insurance Pays 1 at the moment 1
Zxn = A1xn = v t fx (t) dt
0, Tx > n

0
of death if death
occurs within n years

0,
Tx n = v t fx (t) dt
n Zx Deferred Whole Pays 1 at the moment n Zx = T n Ax
v , T x > n
x
n
Life Insurance of death if death
occurs after n years
u+n
1 1 0,
Tx u or Tx > u + n 1
u Z xn Deferred Term Pays 1 at the moment Z
u xn = T u Axn = v t fx (t) dt
v , u < Tx u + n
x
u
Insurance of death after the
u-year deferral period
CHAPTER 4. VALUATION OF INSURANCES

if death occurs within
the following n years
Zxn Endowment Pays 1 at n years or Zxn = Zxn

1
+ Z xn1 Axn = A1xn + n Ex
Insurance the moment of death
if death occurs within
n years, whichever
comes first
4.3. VARIANCES AND MOMENTS 49
We now go into detail on moments of the present value random variables of insurances.
4.3 Variances and Moments

We present here a very useful theorem.
Theorem. Following the AMLCR/SOA convention, let Z be the PV random variable of an insur-
ance in either the Table of Discrete or Continuous Insurance Types. The kth moment of the PV
random variable of any insurance with annual (level) benefit b > 0, force of interest = ln(1 + i),
and expected value E[Z] = A() is given by E[(bZ)k ] = bk A(k), given that each moment exists
and is finite.
The proof is left to the reader.
Exercise. Prove the theorem above for the discrete and continuous endowment insurances.
4.3.1 Discrete Whole Life Insurance

Using the theorem in this section, consider the second moment of a discrete whole life insur-

ance, E[(Zx )2 ]. Then since A() = v k P (Kx = k) = ek P (Kx = k), E[(Zx )2 ] = A(2) =
k=1 k=1
e2k P (Kx = k), which is denoted by

k=1

2
Ax = e2k P (Kx = k). (4.1)
k=1
The superscripted 2 in 2 Ax signifies that it is Ax calculated at force of interest 2, rather than

. 2 Ax does not refer to the second moment of Zx ; it is only a coincidence that it is the second
moment. Rather, it refers to Ax calculated with double the force of interest.
We can deduce from above the variance of Zx :
V [Zx ] = 2 Ax (Ax )2 . (4.2)
If a discrete whole life insurance pays a (level) benefit of b, we have:
V [bZx ] = b2 [2 Ax (Ax )2 ]. (4.3)
4.3.2 Continuous Whole Life Insurance

The material in this section is very similar to the discussion in 4.3.1. For the random variable Zx ,

as A() = v t fx (t) dt = et fx (t) dt, the second moment is given by A(2), which is denoted by
0 0

2
Ax = e2t fx (t) dt. (4.4)
0
2A
Like with x , x
2A does not refer to the second moment of Zx ; it is only a coincidence that it is
the second moment. Rather, the superscripted 2 in 2 Ax signifies that it is Ax calculated at force
of interest 2, rather than .
The continuous analogues of (4.2) and (4.3) are:

V [Zx ] = 2 Ax (Ax )2 (4.5)
V [bZx ] = b2 [2 Ax (Ax )2 ]. (4.6)
4.3.3 Term Insurances

Using the theorem in this section, we can show that for the term insurance present value random
1
variable Zxn ,
n
2
A1xn = e2k P (Kx = k) (4.7)
k=1
1 2 1
V [Zxn ]= Axn (A1xn )2 (4.8)
1
V [bZxn ] = b2 [2 A1xn (A1xn )2 ]. (4.9)
Similarly, for the continuous analog Zxn

1
,
n
2
A1xn = e2t fx (t) dt (4.10)
0
V [Zxn
1
]= 2 1
Axn (A1xn )2 (4.11)
V [bZ 1 ] = xn b2 [2 A1xn (A1xn )2 ]. (4.12)
4.3.4 Deferred Insurances

For n Zx , we have

2k
2
n Ax = e P (Kx = k) (4.13)
k=n+1
2 2
V [n Zx ] = n Ax (n Ax ) (4.14)
V [b n Zx ] = b2 [2 n Ax (n Ax )2 ]. (4.15)
For n Zx , we have

2 2k
n Ax = e fx (t) dt (4.16)
n
V [n Zx ] = 2 2
n Ax (n Ax ) (4.17)
V [b n Zx ] = b2 [2 n Ax (n Ax )2 ]. (4.18)
1
For u Z xn , we have
u+n
2 1
u Axn = e2k P (Kx = k) (4.19)
k=u+1
1 2 1 1 2
V [u Z xn ]= u Axn (u Axn ) (4.20)
1
V [b u Z xn ] = b2 [2 u Axn
1 1
(u Axn )2 ]. (4.21)
4.3. VARIANCES AND MOMENTS 51
For u Z xn
1
, we have
u+n
2 1 2t
u Axn = e fx (t) dt (4.22)
u
V [u Z xn
1
] = 2 u Axn
1 1
(u Axn )2 (4.23)
V [b u Z xn
1
] = b2 [2 u Axn
1
(u Axn
1
)2 ]. (4.24)
4.3.5 Pure Endowment Insurance

Note that the pure endowment is solely a discrete insurance, and not continuous. For Z xn1 , we
have3
Axn1 = e2n n px
2
(4.25)
V [Z xn1 ] = 2 Axn1 (Axn1 )2 = 2 Axn1 (n Ex )2 (4.26)
V [bZ xn1 ] = b2 [2 Axn1 (Axn1 )2 ] = b2 [2 Axn1 (n Ex )2 ]. (4.27)
4.3.6 Endowment Insurances

1
Consider Zxn = Zxn 1
+ Z xn1 . To find the variance of Zxn , notice that since Zxn and Z xn1 have the
same probability mass function, we have
1
V [Zxn ] = V [Zxn ] + V [Z xn1 ] + 2 Cov(Zxn
1
, Z xn1 ).4 (4.28)
Consider the random variable Zxn 1

Z xn1 . For Kx n, this random variable has a value of 0. For
Kx > n, this random variable has a value of 0. So the value of this random variable is 0 for all Kx .
1
Hence, E[Zxn Z xn1 ] = 0. Therefore,
1
Cov(Zxn , Z xn1 ) = E[Zxn
1
Z xn1 ] E[Zxn
1
]E[Z xn1 ]
1
= 0 E[Zxn ]E[Z xn1 ]
= A1xn n Ex . (4.29)
For the continuous analogue, it can be shown similarly that
V [Zxn ] = V [Zxn
1
] + V [Z xn1 ] + 2 (A1xn n Ex ). (4.30)
3
Note that there is no notation for n Ex calculated with force of interest 2.
4
This is an application of the following formula for two random variables X and Y : V [X + Y ] = V [X] + V [Y ] +
2 Cov(X, Y ), where Cov(X, Y ) = E[XY ] E[X]E[Y ].
4.4 Mortality Assumptions on the Entire Domain of Tx

4.4.1 Continuous Insurances
Review section 1.2 before proceeding. Be sure to be able to interpret the information in section
1.2 using the actuarial notation that we have since developed (i.e., t px , t qx , etc.).
4.4.1.1 Fundamental Equations

Everything in this section is built from two equations that we will present here.
Let 0 a < b be real numbers. Then if Tx follows an exponential distribution (or the constant force
distribution), we have fx (t) = et and v t = et . The present value for an insurance which pays a
unit benefit continuously from time a to time b is given by
b b
t t t
v fx (t) dt = e e dt
a a
b
= et et dt
a
b
= e(+)t dt
a
1
= [ ] [e(+)b e(+)a ]
+
[e(+)a e(+)b ]
= . (4.31)
+
1
If Tx follows a uniform distribution (or de Moivres law), we have fx (t) = and assuming
x
0 a < b x, similarly,
b b
t t 1
v fx (t) dt = e ( x ) dt
a a
b
1
= et dt
x
a
1 1
= ( ) (eb ea )
x
ea eb
= . (4.32)
( x)
4.4. MORTALITY ASSUMPTIONS ON THE ENTIRE DOMAIN OF Tx 53
4.4.1.2 Whole Life Insurance (Ax )

In the case of the constant force distribution, the whole life insurance pays in the time interval
(0, ). Hence, by (4.31), we have
[e(+)(0) e(+)b ] [1 e(+)b ]

lim { } = lim { }
b + b +
(1 0)
=
+

= . (4.33)
+
One thing is important to notice here: under the constant force distribution, the APV of the whole
life insurance does not depend on the age x. Hence, Ax = Ay for all ages x 0 and y 0 under the
constant force distribution.
In the case of the uniform distribution, the whole life insurance pays in the time interval (0, x].
Hence, by (4.32), we have
e(0) e(x) 1 e(x)

=
( x) ( x)
1 v x
=
( x)
a
x 5
= . (4.34)
x
4.4.1.3 Term Insurance (A1xn )

For the constant force distribution, set a = 0 and b = n in equation (4.31). Note that since n Ex =
v n n px = en en = e(+)n under the constant force distribution, we have
[e(+)(0) e(+)(n) ] [1 e(+)n ]

=
+ +
= Ax [1 e(+)n ] by equation (4.33)
= Ax (1 n Ex ). (4.35)
For the uniform distribution, set a = 0 and b = n x in equation (4.32). This leads to
e(0) en 1 en
=
( x) ( x)
a
n
= . (4.36)
x
5 1 vn
This uses the fact that, from exam FM/2, a
n = .

4.4.1.4 Deferred Whole Life Insurance (n Ax )

You could, if you want to, set a = 0 and b in equation (4.31) and set a = 0 and b = x
in equation (4.32), but I suggest not doing this. In fact, I think it is easiest to use the following
relationship: it can be easily shown through properties of integrals that
Ax = A1xn + n Ax . (4.37)
To prove this, use the definitions from the Table of Continuous Insurance Types. For equation
(4.32), inputting the values above for a and b does not lead to a useful simplification of n Ax ; in
fact, when simplified, it leads to (4.37). However, for the constant force distribution, simplifying
leads to
= Ax A1
n Ax xn

= Ax Ax (1 n Ex ) by equation (4.35)
= Ax n Ex . (4.38)
4.4.1.5 Deferred Term Insurance (u A1xn )

In equations (4.31) and (4.32), set a = u and b = u + n. Then we have, for equation (4.31):
[e(+)u e(+)(u+n) ] e(+)u [1 e(+)n ]

=
+ +
= Ax e(+)u [1 e(+)n ] by equation (4.33)
= Ax (1 n Ex )e(+)u since e(+)n = n Ex
= e(+)u A1xn by equation (4.35). (4.39)
We could also write A1xn u Ex for equation (4.39). For equation (4.32), assuming u + n x, we
have:
eu e(u+n) eu (1 en )
=
( x) ( x)
1 en
= eu [ ]
( x)
= eu A1xn by equation (4.36). (4.40)
4.4.1.6 Endowment Insurance (Axn )

Use the definition Axn = A1xn + n Ex and the formulas previously developed in this section to find
the formulas for Axn .
4.4.1.7 Calculation of Higher Moments

The theorem presented in section 4.3 is extremely useful for the formulas given in this section.
Assume that each moment of the present value random variables of insurances exist and are finite.
In calculating the kth moment (where k > 0) of the present value random variable of any insurance
paying a unit benefit, simply change the value of the force of interest of the expected value to
k. For example, the kth moment of the present value random variable of a whole life insurance

paying a unit benefit, assuming Tx follows an exponential distribution, is . For a whole life
+ k
insurance paying a level benefit of b > 0, assuming Tx follows an exponential distribution, the kth

moment would be given by bk ( ).
+ k
4.4.2 Discrete Insurances

4.4.2.1 Fundamental Equations
Before we go on to valuing the discrete insurances under the uniform and exponential distribution
assumptions for Tx , let us find what the probability mass function (PMF) of Kx is.
By equation (2.3), we have P (Kx = k) = P (Kx + 1 = k) = P (Kx = k 1) = k1 qx by equation (2.4).
By equation (2.5), this is equal to k1 px qx+k1 . Under the uniform distribution, we have:
x (k 1) (x + k 1) 1
k1 px qx+k1 = [1 ]
x (x + k 1)
x k + 1 (x + k 1) + (x + k 1) + 1
= [ ]
x xk+1
1
= . (4.41)
x
So, interestingly enough, the PMF of Kx is the same form as the PDF of Tx under the uniform
distribution. However, for the exponential (constant force) distribution, the PMF of Kx and the
PDF of Tx are not of the same form. Under the exponential distribution, we have:
k1 px qx+k1 = e(k1) (1 e ) 6
= ek e (1 e )
= ek (e 1). (4.42)
Now we proceed to valuing the insurances. Suppose that an insurance pays a unit benefit to (x) if
(x) dies in the age interval (x + a 1, x + b) at the end of years x + a through x + b. The value of
this insurance is given by
b
v k k1 px qx+k1 . (4.43)
k=a
6
Do not forget that qx = 1 qx .
Under the exponential distribution, we have:7

b b
v k k1 px qx+k1 = v k ek (e 1)
k=a k=a
b
= (e 1) ek ek since v k = ek
k=a
b
= (e 1) ek(+)
k=a
(+)a

= (e 1) [e + e(+)(a+1) + + e(+)b ]
= (e 1)e(+)a [1 + e(+) + e(+)(2) + + e(+)(ba) ]
1 e(+)(ba+1)
= (e 1)e(+)a [ ]. (4.44)
1 e(+)
Under the uniform distribution, we have:

b b
1
v k k1 px qx+k1 = v k ( )
k=a k=a x
1
= (v a + v a+1 + + v b )
x
va
= (1 + v + + v ba )
x
va 1 v ba+1
= ( )
x 1v

v a 1 v ba+1
=
x i

1+i
v a (1 + i) 1 v ba+1
= ( )
x i
v a1 1 v ba+1
= ( )
x i
v a1
=( )a . (4.45)
x ba+1
7
The derivations on this page use the following facts:
1 xn+1
1. 1 + x + x2 + + xn = for x 1. We implicitly assume that i > 0, so that 0 < v < 1.
1x
i
2. 1 v = d = , from exam FM/2.
1+i
1 vn
3. an = , from exam FM/2.
i
4.4.2.2 Whole Life Insurance (Ax )

Under the constant force distribution, set a = 1 and b in equation (4.44). Then we have
(e 1)e(+) (+)b (e 1)e(+)

lim [1 e ] =
1 e(+) b 1 e(+)
e 1
= +
e [1 e(+) ]
e 1
= +
e 1
e 1 e
= ( + ) ( )
e 1 e
1 e
=
e e
qx

1 e
=
e 1 + 1 e

i, since 1 + i = e qx
qx
= . (4.46)
qx + i
Under the uniform distribution, set a = 1 and b = x in equation (4.45). Then

ax
(4.47)
x
follows directly for the value of Ax .
4.4.2.3 Term Insurance (A1xn )

Under the exponential distribution, set a = 1 and b = n in equation (4.44). Then we have
(e 1)e(+)
[1 e(+)n ] = Ax [1 e(+)n ]
1 e(+)
= Ax (1 n Ex ). (4.48)
Under the uniform distribution, set a = 1 and b = n x in equation (4.45). Then we have
an
. (4.49)
x
4.4.2.4 Deferred Whole Life Insurance (n Ax )

Similar to what I suggested in section 4.4.1.4, I would suggest using the relationship
Ax = A1xn + n Ax (4.50)
to compute n Ax . This can be proven easily using the definitions from the Table of Discrete In-
surance Types. Similarly, for discrete insurances, it can be shown that under the exponential
distribution,
n Ax = Ax n Ex . (4.51)
4.4.2.5 Deferred Term Insurance (u A1xn )

Set a = u + 1 and b = u + n in equation (4.44). Then we have
1 e(+)(u+n(u+1)+1) (+)(u+1) 1 e
(+)n
(e 1)e(+)(u+1) [ ] = (e
1)e [ ]
1 e(+) 1 e(+)
(e 1)e(+)
= [1 e(+)n ] e(+)u
1 e(+)
= e(+)n A1xn . (4.52)
Similar to section 4.4.1.5, we could also write A1xn u Ex . For equation (4.45), set a = u + 1 and
b = u + n x. Then we have
v u+11 vu
( ) au+n(u+1)+1 = ( ) an
x x
= v u A1xn . (4.53)
4.4.2.6 Endowment Insurance (Axn )

Similar to 4.4.1.6, use the definition Axn = A1xn + n Ex and the formulas previously developed in
this section to find the formulas for Axn .
4.4.2.7 Calculation of Higher Moments

For any formula involving , the force of interest, use the theorem in section 4.3 using the method
described in section 4.4.1.7. However, notice that the uniform distribution formulas for discrete
insurances tend to not use ; rather, they rely on v and the effective annual rate of interest i.
Consider the following: suppose that an effective rate of interest i has relationship with in the
equation 1 + i = e . If is multiplied by k > 0, where k Z, suppose there is an effective annual
interest rate i such that 1 + i = ek . This implies that 1 + i = (e )k = (1 + i)k , so that i = (1 + i)k 1.
So, in calculating the kth moment of an insurance whose expected value has known interest rate
i, change each i to (1 + i)k 1.
4.5. UDD ASSUMPTION: CONTINUOUS-DISCRETE RELATIONSHIPS 59
4.5 UDD Assumption: Continuous-Discrete Relationships

Review section 3.2.1 before proceeding. For this section, we assume x N {0}.
Assume the UDD assumption for non-integral ages. Then for s (0, 1), we have qx = s px x+s by
equation (3.10).
Then for the continuous whole life insurance EPV Ax , we have:

Ax = et t px x+t dt
0
k+1

= et t px x+t dt.
k=0
k
Notice that t R and k N {0}. This is similar to saying that Tx has domain in the real numbers,
and Kx has domain in the nonnegative integers.8 So the fractional part, which we typically call Rx
but will label s in our integration, is defined by t = k + s. Using this substitution with s = t k as
the new variable of integration, we have ds = dt and
k+1 k+1k

t
e t px x+t dt = e(k+s) k+s px x+k+s ds
k=0 k=0
k kk
1

= e(k+s) k+s px x+k+s ds
k=0 0
1

= e(k+s) k px s px+k x+k+s ds
k=0 0
1

= e(k+s) k px qx+k ds by the UDD assumption
k=0 0
1

= e(k+s) k qx ds.
k=0 0
8
Note that we are not using Kx here, as Kx does not take value 0, which is in the summation.
Define k = k + 1.9 Then we have k = k 1 and

1 1

(k+s)
ds = e(k
1+s)
e k qx k 1 qx ds
k=0 0 k 1=0 0
1

k
= e k 1 qx e(s1) ds (4.54)
k =1 0
1
= Ax [e ( ) (e 1)]

e 1
= Ax ( )

i
= Ax ( ) . (4.55)

Modifying (4.54) - you can show that the integration leads to the following equation - we can find
a relationship using A1xn :
1
n
k i
e k 1 qx e(s1) ds = A1xn ( ) . (4.56)
k =1
0
Modifying (4.54), we can find a relationship using n Ax :

1

k i
e k 1 qx e(s1) ds = n Ax ( ) . (4.57)
k =n+1
0
We can also extend our results to u A1xn and get a similar result. The main idea to get from
this section is for any insurance which has a level present value random variable for one straight
i
(and possibly infinite) period, under UDD, the Continuous EPV = Discrete EPV rule applies.

Examples of insurances which do not follow this rule:
1. Endowment insurance: it does not have a level present value random variable. If failure occurs
before n years, the present value random variable takes value v Tx . If failure occurs after n
years, the present random variable takes value v n . If the present value random variable were
to take value v Tx after n years, the rule would apply (but it does not - actually, this would
i
be a whole life insurance). However, you can use the rule Axn = A1xn + n Ex = A1xn + n Ex if

given the UDD assumption.

v k , Kx n

2. Define a discrete insurance with present value random variable Z = 0, n < Kx n + 2

k
v , Kx > n + 2.

Though this insurance has a level present value random variable (equal to v k when it does
pay the benefit), the period at which it pays the benefit is broken up by the period when it
pays nothing, when n < Kx n + 2.
9
This is to be consistent with the Kx notation that we have used in this text.
4.5. UDD ASSUMPTION: CONTINUOUS-DISCRETE RELATIONSHIPS 61
i
3. Note that Axn1 Axn1 , since there is no such thing as Axn1 .

We can also extend our results to kth moments of present value random variables of insurances,
assuming the moments exist and are finite. In order to not mix up the variables, we will refer to
kth moments as pth moments in this section. Recall that by the theorem presented in section 4.3,
we can find the pth moment of an insurance by multiplying the force of interest by p.
In the case of the whole life insurance, modifying (4.54) and using the theorem presented in section
4.3,
1

pk ep
qx ep(s1) ds = epk ) (ep 1)

e k 1 k 1 qx (
k =1 k =1 p
0

ep 1
= epk

k 1 qx ( ). (4.58)
k =1 p
When p = 2, we have

e2 1 e2 1
e2k

k 1 qx ( ) = 2 Ax ( ). (4.59)
k =1 2 2
(1 + i)2 1
In terms of i in the numerator, (4.59) would be 2 Ax [ ]. Similarly, for any insurance
2
which has a level present value random variable for one straight random variable for one straight
(1 + i)2 1
(and possibly infinite) period, under UDD, the 2 Continuous EPV = 2 Discrete EPV * [ ]
2
rule applies.
4.6 mthly Insurances

Let m > 1 be such that m Z. An mthly insurance is an insurance which pays a benefit at the
1
end of the th of a year in which death occurs.
m
We define the random variable
(m) 1
Kx = mTx . (4.60)
m
(m) 1
Kx is the time-to-failure random variable for (x), rounded down to the nearest th of a year.
m
It can be thought of as the mthly analogue of Kx .
We also define10
(m)
Jx = mKx + 1. (4.61)
1
Jx is the th time interval of failure random variable for (x). It is the mthly analogue of Kx .
m
Consider the example from section 2.2, where (85) dies at age 87.5.
R85 = 0.5
Age 85 85.5 86 86.5 87 87.5 88

T85 = 2.5
(2) (2) (2) (2) (2) (2)
K85 = 0 K85 = 0.5 K85 = 1 K85 = 1.5 K85 = 2 K85 = 2.5
J85 = 1 J85 = 2 J85 = 3 J85 = 4 J85 = 5 J85 = 6
(2) 1
Notice that K85 deals with periods rounded to the nearest of a year, or the nearest semiannual
2
(2) 1
period. As T85 = 2.5, we have K85 = 2.5 2 = 2.5 and J85 = (2)(2.5) + 1 = 6.
2
To be consistent, we will use Jx in the notation of the EPV/APV of insurances.
(m) (m)
To make our lives a little easier, let us find the probability mass function for Kx . If Kx = k,
then
(m) k k 1
P (Kx = k) = P ( Tx < + )
m m m
= k 1 qx . (4.62)
m
Then it immediately follows that
(m) j1
P (Jx = j) = P (Kx = )=
j1 1 qx . (4.63)
m m m
10 (m)
This random variable comes from MQR. You would think that MQR would use Kx instead of Jx to denote
this symbol, but it does not.
4.6. mTHLY INSURANCES 63
m
i(m) i(m)
In order to maintain consistent notation, recall that for m > 0, (1 + ) = 1 + i, and is the
m m
i(m) 1
effective mthly rate. We define the mthly discount factor v ( )= .11 When m = 1,
m i(m)
1+
m
1
we will use the usual v = notation.
1+i
i(m)
For m 1, we will often use k = , or v(k). The reason why we are using this notation is because
m
MQR uses v to denote the mthly discount factor, which is improper notation, as it only applies to
the effective annual interest rate.
The theorem presented in 4.3 also applies to mthly insurances. Similar to what has been presented,
(m) (m)
we have the notations 2 Ax , 2 A(m)1xn , and 2 Axn to represent the EPV/APV of their respective
insurances calculated under the force of interest 2.
11 i(m)
None of the texts for MLC use the v ( ) notation. We use it to remove ambiguity from v, which MQR uses
m
for the mthly discount factor, although v is reserved for the annual interest rate.
64
Table of mthly Insurance Types (P (Jx = j) = j1 1
qx )
m m
Variable Insurance

(m) (m) (m)
Zx Whole Life Pays 1 at the end of Zx = [v(k)]Jx Ax = [v(k)]j P (Jx = j)
j=1
Insurance the m1 th period of
death

[v(k)]Jx , Jx n
mn
Z (m)1xn Term Insurance Pays 1 at the end of Z (m)1xn = A(m)1xn = [v(k)]j P (Jx = j)
0, Jx > n
j=1
the m1 th period of
death if death occurs
within n years
(m) (m) (m)
Zxn Endowment Pays 1 at n years or Zxn = Z (m)1xn + Z xn1 Axn = A(m)1xn + n Ex
Insurance at the end of the m1 th
period of death if
death occurs within n
years, whichever
comes first
CHAPTER 4. VALUATION OF INSURANCES

4.7. UDD ASSUMPTION: DISCRETE-mTHLY RELATIONSHIPS 65
4.7 UDD Assumption: Discrete-mthly Relationships

It can be shown that, given an mthly insurance which has a level present random variable for
one straight (and possibly) infinite period (the same condition as section 4.5), that mthly EPV =
i
Discrete EPV * (m) . We do not present the proof here, as it is rather cumbersome.12
i
(m) i i
In the cases that have been presented in this text, Ax = (m) Ax and A(m)1xn = (m) A1xn .
i i
4.8 Insurances with Variable Benefits

4.8.1 General Cases
Let Z be the present value random variable of an insurance. If the insurance pays benefit bt at
time t at the moment of the death of (x) (i.e., the insurance is continuous) if death occurs in the
age interval (x + a, x + b), then its APV/EPV is given by
b
t
bt v fx (t) dt. (4.64)
a
If the insurance pays bk at the end of the year of the death of (x) (i.e., the insurance is discrete)
if death occurs in the age interval (x + a 1, x + b), where b N, then its APV/EPV is given by
b
bk v k k1 px qx+k1 . (4.65)
k=a
1
If the insurance pays bj at the end of the th of a year of the death of (x) (i.e., the insurance is
m
a1 b
mthly) if death occurs in the age interval (x + , x + ), then its APV/EPV is given by
m m
b
bj [v(k)]j j1
m
px 1 qx+ j1 .
m m
(4.66)
j=a
12
For a partial proof of this relationship, see [1, pp. 138-139].
4.8.2 Arithmetically Changing Benefits

For exam MLC, there are various symbols for insurances which pay arithmetically changing benefits
every period.
Before we present these symbols and their meanings, we build the framework for these symbols.
You may recognize some of these conventions from exam FM/2.
Each symbol has two parts: the insurance part and the I or D.
The easiest part to grasp is the insurance part. All symbols for the insurances are covered in the
expected value columns in each of the Tables in pp. 45-46, and p. 62 of this text.
I, as you may recall from exam FM/2, refers to an increase of some amount each period. We can
I, I (m) .13 Each one of these symbols describe the time frequency at which
manipulate I like so: I,
the insurance benefit is increasing. If I is used, the insurance is increasing continuously. If I is
used, the insurance is increasing annually by one unit each year. If I (m) is used, the insurance is
1 1
increasing at the end of each th of a year by one unit each th of a year.
m m
Examples.
1. (IA)x is the APV of a discrete whole life insurance for (x) (implied by the Ax ). If (x) dies
in year 1, the benefit will pay 1 at the end of the first year; if (x) dies in year 2, the benefit
will pay 2 at the end of the second year; and so on (the annual increase is implied by the I).
In general, this particular insurance pays k at time k, where k is an natural number. Thus,
the APV is given by

(IA)x = kv k k1 px qx+k1 dt. (4.67)
k=1
x is the APV of a continuous whole life insurance for (x) (implied by the Ax ). This
2. (I A)
insurance pays at the moment of death of (x). Since we have I in here, the insurance benefit
increases annually. So if (x) dies in the first year, the benefit will pay 1 at the moment of
death; if (x) dies in the second year, the benefit will pay 2 at the end of the second year at
the moment of death, and so on. Observe that we can describe the benefit amount at time
t for (x) as 1, if (x) dies in the first year; 2, if (x) dies in the second year, and so on. In
general, the insurance pays t at every integer time t, so the APV is given by
1 2 3
x = 1v fx (t) dt + 2v fx (t) dt + 3v t fx (t) dt + .
(I A) t t
(4.68)
0 1 2
The benefit amount is given by the graph below.
13
Note that I (m) , although theoretically possible, is not presented in any of the textbooks for MLC.
4.8. INSURANCES WITH VARIABLE BENEFITS 67
Benefit at time t (bt )

4
1
0 1 2 3 4
t
The graph of the function above is bt = t + 1. Thus, we can write

x = t + 1v t fx (t) dt.
(I A) (4.69)
0
3. (IA)
x is the APV of a continuous whole life insurance for (x) (implied by the Ax ). The
so that at any time t, the insurance
increase is also happening continuously (implied by the I),
pays t. (Notice that the benefit amount starts off at 0 and increases continuously.) The APV
of this insurance is given by

(IA)
x = tv t fx (t) dt. (4.70)
0
The concepts here can easily be extended to insurances besides whole life insurances.
Instead of the I, we can also use D.14 Note that D can only be used for insurances which
have a finite term. D, as you may recall from exam FM/2, refers to a decrease of some amount
D, D(m) .15 The same interpretations for the different
each period. We can manipulate D like so: D,
forms of I apply to the analogous forms for D. We present only one example here; extensions can
easily be made to other types of decreasing insurances.
Example.
1. (DA) 1 is an n-year continuous term insurance given to x. If (x) dies in year 1, the benefit
xn
pays n at the moment of death; if (x) dies in year 2, the benefit pays n 1 at the moment
of death; and so on, until if (x) dies in the nth year, the benefit pays 1 at the moment of
death. In general, it can be shown that the insurance pays n t + 1 at the moment of death
at time t.
14
AMLCR does not cover decreasing insurances, interestingly enough.
15
Like with I (m) , D(m) is not presented in any of the textbooks for MLC.
4.9 Recursive Relationships

In this section, we will only be covering discrete and mthly insurances, as these are the only ones
covered in the texts.
I would advise not memorizing these recursive formulas, as they can be easily derived using the
definitions in p. 45 and p. 62 of this text.
Consider the following formulas:

Ax = v k k1 qx
k=1

= v k k1 px qx+k1
k=1
= vqx + v 2 px qx+1 + v 3 2 px qx+2 + (4.71)

Ax+1 = v k k1 qx+1
k=1

= v k k1 px+1 qx+k
k=1
= vqx+1 + v 2 px+1 qx+2 + v 3 2 px+1 qx+2 + . (4.72)
Notice that we can write
Ax = vqx + v 2 px qx+1 + v 3 2 px qx+2 +

= vqx + vpx (vqx+1 + v 2 px+1 qx+2 + )
= vqx + vpx Ax+1 . (4.73)
(4.73) is the recursive relationship of whole life insurances for (x). For mthly insurances, we have:

(m)
Ax = [v(k)]j j1 1 qx
m m
j=1
= v(k)1/m qx + [v(k)]2 1/m px 1/m qx+1/m + [v(k)]3 2/m px 1/m qx+2/m + (4.74)

(m)
Ax+1/m = [v(k)]j j1 1 qx+1/m
m m
j=1
= v(k)1/m qx+1/m + [v(k)]2 1/m px+1/m 1/m qx+2/m + [v(k)]3 2/m px+1/m 1/m qx+3/m + . (4.75)
We can write
(m)
Ax = v(k)1/m qx + [v(k)]2 1/m px 1/m qx+1/m + [v(k)]3 2/m px 1/m qx+2/m +
= v(k)1/m qx + v(k)1/m px {v(k)1/m qx+1/m + [v(k)]2 1/m px+1/m 1/m qx+2/m + }
(m)
= v(k)1/m qx + v(k)1/m px Ax+1/m . (4.76)
4.10. ACTUARIAL ACCUMULATED VALUE 69
4.10 Actuarial Accumulated Value

This topic will find its primary uses when we get to the topic on reserves; however, we will present
the basic vocabulary here.
Recall from FM/2 that we can find accumulated values of deposits made in an account at time
0 which follows an effective annual interest rate i by using the rule Present Value = (Accumulated
Value at time n) v n , or Present Value (1 + i)n = Accumulated Value at time n. Similarly, we
can find accumulated costs of insurances. We will refer to the accumulated cost of an insurance as
the actuarial accumulated value (AAV) of an insurance.
However, in exam MLC, we cannot accumulate solely based on interest. We must also take into
account mortality. Suppose we have a whole life insurance given to (x). To find the accumulated
value of this particular insurance, we can look at the APV of this insurance as the present value
of a pure endowment paying the accumulated amount of the insurance at time n.16 So we have
APV of Insurance = (AAV of Insurance at time n) n Ex .
Hence, we have
APV of Insurance
= AAV of Insurance at time n.17 (4.77)
E
n x
Note that (4.77) will only apply to insurances with a finite term.
Throughout the course, you will notice that n Ex will function like a discount factor for MLC,
as v did for FM/2. Using this intuition, you can derive the following formulas:
Ax = Ax+n n Ex (4.78)
Ax = Ax+n n Ex . (4.79)
16
Credit goes to Prof. Herschel Day for providing me with this intuition.
17
MQR uses t kx to represent the AAV of a term insurance with term t years, and t kx to represent the AAV of
a continuous term insurance with term t years. See [1, p. 224] and [1, p. 229]. However, none of these symbols are
mentioned in the Notation and Terminology used on Exam MLC note.

Relevant Questions: SOA 309: #3, 4, 17, 34, 56, 63, 64, 107, 109, 176, 197, 215, 226, 231, 286,
308; April 2012: #24; November 2012: #11, 14, 15; April 2013: #7, 8, 23.
One nice fact to recall is the following integral from exam P/1: for n N and a > 0,

n ax n!
x e dx = an+1 . (4.80)
0
As you go through these questions, when in doubt, use the most general formulas given in chapter
4.8.1.

Be sure to print out the tables in pp. 45, 46, and 62 in addition to this formula sheet.
Theorem. Following the AMLCR/SOA convention, let Z be the PV random variable of an insur-
ance in either the Table of Discrete or Continuous Insurance Types. The kth moment of the PV
random variable of any insurance with annual (level) benefit b > 0, force of interest = ln(1 + i),
and expected value E[Z] = A() is given by E[(bZ)k ] = bk A(k), given that each moment ex-
ists and is finite. Equivalently, if E[Z] = A(i), where i is the effective annual interest rate, then
E[(bZ)k ] = bk A[(1 + i)k 1].
Actuarial Present Values
Exponential (Constant Force) Distribution
Notice that none of these formulas rely on the age x. Hence, they are equivalent for all ages.
n Ex = e(+)n
[e(+)a e(+)b ]
General Continuous Equation
+

Ax =
+
Axn = Ax (1 n Ex )
1
u A
1 = u Ex A1
xn xn
1 e(+)(ba+1)
General Discrete Equation (e 1)e(+)a [ ]
1 e(+)
qx
Ax =
qx + i
1
Axn = Ax (1 n Ex )
1
u Axn = u Ex A1xn
Uniform Distribution (de Moivres Law)
ea eb
General Continuous Equation
( x)
a
x
Ax =
x
a
n
A1xn =
x
1 u 1
u Axn = e Axn
v a1
General Discrete Equation ( )a
x ba+1
ax
Ax =
x
an
A1xn =
x
1 u 1
A
u xn = v Axn
General Cases
b
Continuous APV = bt v t fx (t) dt

a
b
Discrete APV = bk v k k1 px qx+k1
k=a
b
mthly APV = bj [v(k)]j j1 px 1 qx+ j1
m m m
j=a
UDD (Non-integral Ages)

For any insurance which has a level present value random variable for one straight (and possibly
infinite) period:
i
Continuous EPV = Discrete EPV

2 (1 + i)2 1
Continuous EPV = 2 Discrete EPV [ ]
2
i
mthly EPV = Discrete EPV
i(m)
mthly Insurances
(m) 1
Kx = mTx
m
(m)
Jx = mKx + 1
(m)
P (Kx = k) = k 1 qx
m
P (Jx = j) =
j1 1 qx
m m
1
v(k) =
i(m)
1+
m
Recursive Relationships
Ax = vqx + vpx Ax+1

(m) (m)
Ax+1/m = v(k)1/m qx + v(k)1/m px Ax+1/m
Other Equations
APV of Insurance
= AAV of Insurance at time n
n Ex
1
Cov(Zxn , Z xn1 ) = A1xn n Ex
Ax = A1 + n Ax
xn
Ax = A1xn
+ n Ax
Ax = Ax+n n Ex
Ax = Ax+n n Ex

n ax n!
x e dx = an+1
0
4.13 Appendix: Fully-Variable Insurances

This is a topic which is well beyond the scope of exam MLC, but is here to serve as a good way
for understanding the pricing of insurances. Insurances have four variables which need to be taken
into account in order to compute their actuarial present values. These are:
1. The interest rate(s);
2. The mortality model(s);
3. The time(s) at which the benefit is paid;
4. The rate(s) at which the benefit is paid.
How do we price continuous and discrete insurances with all four of these variables non-constant?18
Suppose that at time t, we have a non-constant force of interest t . From exam FM/2, the present
value of a payment of 1 at time t is given by
t

exp r dr .

0
Suppose that for a discrete insurance, P (Kx = k) = k1 qx and for a continuous insurance, Tx has
probability density function fx (t).
Suppose now that the discrete insurance pays at times k1 , k2 , . . . , kn , with n and kn possibly being
infinite. Also, suppose T = {[t1 , t2 ], [t3 , t4 ], [t4 , t5 ], . . . , [tn1 , tn ]}, where n and tn can possibly be
infinite, is the set of intervals during which the continuous insurance could pay a benefit. Let bk
be the benefit at time k (for a discrete insurance) and bt be the benefit at time t (for a continuous
insurance).
In general, we can write
k

APVDiscrete = bk exp r dr k1 qx (4.81)
k=k1 ,k2 ,...,kn
0
t

APVContinuous = bt exp r dr fx (t) dt. (4.82)

T 0
where means to sum over all ki , i = 1, 2, . . . , n, and means to integrate over all intervals
k=k1 ,k2 ,...,kn T
in T .
Finding the actuarial accumulated value (or AAV) of a very general insurance is even more com-
plicated. As was said in section 4.10, we would divide by n Ex . However, the force of interest is not
constant. Recall that the AAV of an insurance can only be computed if the term of the insurance
is finite. Instead of dividing by n Ex , using the discrete model, we would have to divide by some
form of kn Ex . For continuous insurances, we would need to divide by some form of tn Ex .
18
Notice here - I am not including mthly insurances in this discussion. Actually, mthly insurances are just discrete
insurances paid at a different frequency.
4.13. APPENDIX: FULLY-VARIABLE INSURANCES 75
The formulas for these expressions would be:

kn

kn Ex = exp r dr kn px (4.83)

0
tn

tn Ex = exp r dr tn px . (4.84)

0
Therefore,
APVDiscrete
AAVDiscrete (kn ) = (4.85)
kn Ex
APVContinuous
AAVContinuous (tn ) = , (4.86)
tn Ex
where (kn ) and (tn ) are used to denote the times at which the AAV is valued (at times kn and tn ,
respectively).
Chapter 5
Valuation of Annuities
5.1 Review from FM/2

5.1.1 Discrete Annuities
Recall from exam FM/2 that an annuity is an agreement that pays a stream of payments for a
certain (usually constant) time frequency.1 Two particular types of annuities are important.
1. The annuity-immediate pays at the end of each year. Below is an example of a three-year
annuity-immediate which pays 1 each year.
Payment 1 1 1
Time 0 1 2 3
a3
v2
v3
The present value of this particular annuity-immediate, assuming annual effective annual
interest rate i 0, is
1 v3
a3 = v + v 2 + v 3 = .
i
Of course, if i = 0, then the present value is simply 3.
1
Remember: insurances are single payments, whereas annuities are streams of payments.
77
78 CHAPTER 5. VALUATION OF ANNUITIES
2. The annuity-due pays at the beginning of each year. Below is an example of a three-year
annuity-due which pays 1 each year.
Payment 1 1 1
Time 0 1 2 3
a
3
v2
The present value of this particular annuity-due, assuming an annual effective annual interest
rate i 0, is
1 v3
3 = 1 + v + v 2 =
a ,
d
i
where d = . Of course, if i = 0, then the present value is simply 3.
1+i
In general, we can write for i 0,
1 vn
an = v + v 2 + + v n =
i
n1 1 vn
n = 1 + v + + v
a = .
d
For i = 0, an = a
n = n.
In general, for i 0, it can also be shown that
an1 + 1 = a
n
n 1 + v n .
an = a
The future value of the annuity-immediate is given by
(1 + i)n 1
sn = (1 + i)n an = ,
i
which is the value of an annuity paying 1 at the end of each year at the time of the last payment.
Payment 1 1 1
Time 0 1 2 3
s3
(1 + i)2
1+i
5.1. REVIEW FROM FM/2 79
For the three-year annuity immediate above,
(1 + i)3 1
s3 = (1 + i)2 + (1 + i) + 1 = .
i
The future value of the annuity-due is given by
(1 + i)n 1
sn = (1 + i)n a
n = ,
d
which is the value of the annuity paying 1 at the end of each year at the time after the last payment.
Payment 1 1 1
Time 0 1 2 3
(1 + i)3 s3
(1 + i)2
1+i
For the three-year annuity due above,
(1 + i)3 1
s3 = (1 + i)3 + (1 + i)2 + (1 + i) = .
d
5.1.2 Continuous Annuities

We assume that continuous annuities start paying at time 0. Consider the three-year continuous
annuity below.
Payment 1 1 1
Time 0 1 2 3
The present value of this annuity is found by discounting 1 at each infinitesimally small time
period, or
3
1 v3
3 = v t dt =
a ,

0
where is the force of interest. The future value of this annuity is found by multiplying a
3 by
3
(1 + i) , or
(1 + i)3 1
s3 = (1 + i)3 a
3 = .

In general, for 0 (or equivalently, i 0), we write

n
1 vn
n = v t dt =
a

0
and
(1 + i)n 1
sn = (1 + i)n a
n = .

For = 0, a
n = n.
5.1.3 mthly annuities

Recall that for any m > 0,
m m
i(m) d(m)
(1 + ) = (1 ) = 1 + i.
m m
1 1
Let m 1. An mthly annuity which makes payments of at the beginning of every th of a
m m
year for a total of n years has present value
(m) 1 1 vn
a
n = (1 + v 1/m + v 2/m + + v n1/m ) = (m) .
m d
1 1
If the mthly annuity pays at the end of every th of a year for a total of n years, the annuity
m m
has present value
(m) 1 1 vn
an = (v 1/m + v 2/m + + v n/m ) = (m) .
m i
5.2 Introduction
We approach pricing annuities much like how we price insurances. Insurances, as we saw in
chapter 4, make a single payment due to death of a person. However, annuities make payments
if the person is still alive at the time the payment is made.
Consider (x), whose death is to occur 25.5 years from now. Suppose (x) purchases an annuity-
immediate which pays 1 annually until his or her death. Annuities which pay only if the purchasers
are alive are known as life annuities. If (x) dies 25.5 years from now, the price of the annuity
is given by a25 , as this is the present value of 25 payments - one at the end of each year during
which (x) is still alive.
But, as with insurances, there is no way to know when (x) will die. So how do we price a life
annuity?
Similar to insurances, we will have to introduce the random variables Tx , Kx and Kx somewhere
in the pricing formulas.
5.3. WHOLE-LIFE ANNUITIES 81
5.3 Whole-Life Annuities

We expect that you have mastered the material from chapter 4, so we will be approaching the
discussion on annuities differently than we did on insurances.
We define the random variables
Yx = a
Kx +1 = a
Kx (5.1)
Yx = aKx = aKx 1 (5.2)
=aKx +1 1 = a
Kx 1
= Yx 1 (5.3)
Yx = a
Tx (5.4)
(m) (m)
Yx = a (5.5)
Jx /m
(m) (m) 1
Yx = Yx .2 (5.6)
m
Alternatively, using the notation in section 4.6, we could write
(m) 1
Yx = a (5.7)
m Jx k
(m) (m) 1
Yx = aJx 1k = Yx , (5.8)
m
i(m)
where k indicates that the rate used to value the annuity is k = , and instead of v, v(k) is used
m
(as defined in section 4.6).
The expected values of these variables are given by
E[Yx ] = a
x (5.9)
E[Yx ] = ax (5.10)
E[Yx ] = a
x (5.11)
(m) (m)
E[Yx ] = a x (5.12)
(m) (m)
E[Yx ] = ax . (5.13)
(5.9) through (5.13) are actuarial present values (APVs) of annuities. (5.9) is the APV of a
whole-life annuity-due, (5.10) is the APV of a whole-life annuity-immediate, (5.11) is the APV of
a whole-life continuous annuity, (5.12) is the APV of a whole-life mthly annuity-due, and (5.13) is
the APV of a whole-life mthly annuity-immediate.
2
I am currently working on trying to find the formula for this random variable in terms of the mthly annuity-
immediate. MQR does write this formula but in confusing notation. AMLCR does not present this formula.
5.4 Whole Life Annuity-Insurance Relationships and Mo-

ments

1 v Kx
Since Yx = a
Kx = , we can write for all Kx ,
d
1 Zx
Yx = . (5.14)
d
Hence
1
E[Yx ] = a
x = E[1 Zx ]
d
1 Ax
= . (5.15)
d
We can also use (5.16) to compute the variance of Yx .
1
V [Yx ] = 2 V [1 Zx ]
d
1
= 2 V [Zx ]
d
2 A (A )2
x x
= 2
. (5.16)
d
(5.16) is due to the fact that V [Zx ] = E[(Zx )2 ] (E[Zx ])2 = 2 Ax (Ax )2 .
Since Yx = Yx 1, it follows that
ax = ax 1 (5.17)
V [Yx ] = V [Yx ]. (5.18)
1 v Kx 1

It is also possible to write Yx in terms of Zx . Since Yx = aKx 1 = ,

i
1 (1 + i)Zx
Yx = since v 1 = 1 + i. (5.19)
i
Using (5.19), we find that
1 (1 + i)Ax
E[Yx ] = ax = (5.20)
i
(1 + i)2 Ax
V [Yx ] = . (5.21)
i2
I suggest that if you are studying for exam MLC, do not memorize (5.19) through (5.21) and
memorize the relationships given by (5.17) and (5.18) to get the same values as (5.20) and (5.21).
1 v Tx
Since Yx = a
Tx = , since Zx = v Tx for all Tx (0, ),

1 Zx
Yx = . (5.22)

5.5. NON-INSURANCE ANNUITY APV FORMULAS 83
Using (5.22), we find that
1 Ax
E[Yx ] = a
x = (5.23)

2Ax (Ax )2
V [Yx ] = . (5.24)
2
(m) 1 1 1 [v(k)]Jx
As Yx = a Jx k = ( ), we can write
m m d(k)
(m)
(m) 1 1 Zx
Yx =
m d(k)
(m)
(m) 1 1 Ax
a
x =
m d(k)
2A (m) (m)
(m) x (Ax )2
V [Yx ] = ,
[m d(k)]2
k
where d(k) = .
1+k
(m)
Use the relationship given by (5.8) to find formulas for Yx .
5.5 Non-Insurance Annuity APV Formulas

A perhaps more direct way of finding for the expectations given in (5.9) through (5.13) would be
to use the expected value formulas from exam P/1; that is, if g is a function of x,

E[X] = g(x)fX (x) if X is discrete, and
x=

E[X] = g(x)fX (x) dx if X is continuous.

k = 1 + v + v 2 + + v k1 , this would imply that

Using the fact that a

E[Yx ] = a k P (Kx = k)
x = a (5.25)
k=1

= a
k k1 qx
k=1
= qx + (1 + v)1 qx + (1 + v + v 2 )2 qx + (1 + v + v 2 + v 3 )3 qx +
= qx + 1 qx + 2 qx + + v(1 qx + 2 qx + 3 qx + ) + v 2 (2 qx + 3 qx + ) +
= v 0 (qx + 1 qx + 2 qx + ) + v(1 qx + 2 qx + 3 qx + ) + v 2 (2 qx + 3 qx + ) + .

As P (Kx = k) is a probability mass function, P (Kx = k) = k1 qx = 1. If we increase the
k=1 k=1

starting index by 1, that is, find k1 qx , we get
k=2

k1 qx = k1 qx 11 qx
k=2 k=1
= 1 qx
= px .
If we increase the starting index to k = 3, we get

k1 qx = k1 qx 21 qx 11 qx
k=3 k=1
= 1 1 qx qx
= 1 px qx+1 qx
= 1 qx px qx+1
= px px qx+1
= px (1 qx+1 )
= px px+1
= 2 px .
In general, it can be shown that

k1 qx = k 1 px . (5.26)
k=k
Therefore,

v 0 (qx + 1 qx + 2 qx + ) +v (1 qx + 2 qx + 3 qx + ) +v 2 (2 qx + 3 qx + ) + = v t t px .
t=0
px 2 px
k1 qx =1=0 px
k=1
Therefore, we conclude that

x = v t t px .
a (5.27)
t=0
This equation makes intuitive sense. If (x) survives to time t (with probability t px ), (x) receives a
payment of 1, which has present value v t . As a
x is the APV of a life-annuity due, (x) is guaranteed
one payment at the beginning of the year, so t = 0 is the starting index (with present value v 0 = 1).
Using the intuition we have developed, we can find that

ax = v t t p x , (5.28)
t=1
where t = 1 is the starting index, as the present value of the first payment received is v 1 .
5.6. kTH MOMENTS OF ANNUITIES 85
The intuition we have developed can also be extended to continuous annuities. We show that

x = v t t px dt.
a (5.29)
0
Using the expected value approach, we have

a
x = a
t fx (t) dt
0

= a
t t px x+t dt
0

d
= a
t ( [t px ]) dt.
dt
0
1 et et d
We approach using integration by parts. If u = a
t = , du = = et = v t . If dv = [t px ],
dt
v = t px . So

d
a
( [
t dt t xp ]) dt = a
t ( p
t x ) (t px )v t dt
t=0
0 0

0 0 px ] + v t t px dt.
at t px ) a
= [lim (
t
0
1
Intuitively speaking, lim t px = 0, as (x) cannot survive infinitely. Also, lim a t = .
t t
1
Hence lim ( at t px ) = (0) = 0. We also find that a
0 = 0 and 0 px = 1. So the term
t
at t px ) a
[lim ( 0 0 px ] = 0.
t
Hence we get (5.29). We could also find formulas for mthly annuities that follow a similar format,
but they are extremely messy and will not be presented in this text. The main point to get
from this section is that (x) will receive an annuity payment if (x) is alive at the time
the payment is made.
5.6 kth Moments of Annuities

Bibliography
[1] Cunningham, Robin J., Herzog, Thomas N., and London, Richard L., Models for Quantifying
Risk, 4th edition (2011), ACTEX Publications.
[2] Cunningham, Robin J., Herzog, Thomas N., and London, Richard L., Supplement Note for
Candidates using Models for Quantifying Risk, Fourth Edition, 2012, ACTEX Publications.
[3] Dickson, David C.M., Hardy, Mary R., and Waters, Howard R., Actuarial Mathematics for Life
Contingent Risks, 1st edition (2009), Cambridge University Press.
[4] Dickson, David C.M., Hardy, Mary R., and Waters, Howard R., Supplementary Notes for
Actuarial Mathematics for Life Contingent Risks, 2011.
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Exam MLC Preparation Notes

1 Continuous Survival Models 9

2 Discrete Survival Models 25

July 18, 2013

Continuous Survival Models

1.1 CDFs, Survival Functions, x+t

Fx (t) Fx (0) = fx (u) du

Fx (t) = fx (u) du (1.4)

Sx (t) = 1 fx (u) du.

fx (u) du = 1 fx (u) du = Sx (t)

Hence, we can write

Sx (t) = fx (u) du.1 (1.5)

Fx (t) = P (Tx t) = P (T0 x + tT0 > x). (1.6)

P (T0 x + t T0 > x) P (x < T0 x + t)

Using CDFs, we can write

Using survival functions, we can write

Taking the complement of this, we have

We can also write

Solving for Sx (t), we get

[ln Sx (t)] = x+s ds

1.2 Parametric Survival Models

1.2.1 Uniform Distribution (de Moivres Law)

1.2.2 Exponential Distribution

1.2.3 Gompertz Distribution

x+t = Bcx+t (1.28)

where B (0, 1) and c > 1. The survival function is given by

1.2.4 Makeham Distribution

x+t = A + Bcx+t (1.30)

where B > 0, c > 1, and A > B. The survival function is given by

1.3 kth Moments (Exam P/1 Review)

E[X ] = xk fX (x) dx.

V [X] = E[(X E[X])2 ] = E[X 2 2XE[X] + E[X]2 ]

E[X] = a + Sx (x) dx.6 (1.37)

Now consider Tx . The kth moment of Tx is given by

E[(Tx ) ] = tk fx (t) dt.

Using the fact that FX (b) = 1 and FX (a) = 0, we have

In particular, if X (0, b), then

provided that the moments exist and are finite.

In particular, since Tx (0, ), we can write, by equation (1.36),

E[Tx ] = Sx (t) dt (1.39)

E[(Tx )k ] = k tk1 Sx (t) dt (1.40)

1.4 International Actuarial Notation: Tx

Age x x+u x+u+t

Age x x+u x+u+t

Age x x+u x+u+t

As a notational convention, if t = 1, t px , t qx , and ut qx are written as px , qx , and u qx respectively.

Using these new notations, we can write:

t qx = t px x+t dt by equations (1.4), (1.44) (1.46)

t px = t px x+t dt by equations (1.5), (1.44) (1.47)

that E[Tx ] exists and is finite,

= tt px x+t dt by equation (1.44) (1.49)

= Sx (t) dt by equation (1.39)

E[(Tx ) ] = k tk1 t px dt.

1.5 More Formulas to Know

t+u px = t px u px+t . (1.53)

1.6 SOA Released Questions

1.7 Formula Summary Sheet

Uniform Distribution (de Moivres Law):

Relationships among formulas:

Discrete Survival Models

2.1 Commonly Used Symbols

1. The set of integers is denoted Z, which is the set {, 3, 2, 1, 0, 1, 2, 3, }. Z is the set of

Let x R and R Z be defined by x = max{k Zk x}.5 is known as the floor function,

Let x R and R Z be defined by x = min{k Zk x}. is known as the ceiling function,