3.

1 Introduction

Under a life insurance contract t he benefit insured consist s of a single payment , the sun
insured. The time and amount of t his payment may be functions ofthe random variable T that
has been introduced in Chapter 2. Thus the time and amount of t he payment may be random
variables t hemselves.

The present value of t he payment is denoted by Z ; it is calculated on t he basis of à fixed

rate of int erest i (the technical rate of interest ). The expected present value of t he payment ,
E(Z ), is t he net single premium of t he contract . This premium , however , does not in any way
refl ect t he risk to be carried by the insurer . In order to assess this one requires furt her charact
erist ics of the distribution of t he random variable Z , for exam ple its variance.

3.2 Elementary Insurerance Types

3.1.2 Whole life and Term Insured

Let us consider a whole life insurance; his provides for payment of 1 unit at the end of the year
of death. In this case the amount of t he payment is fixed, while the time of payment

(K + 1) is random . It is present value is

𝒁 = 𝒗𝑲+𝟏 (3.2.1)

The random variable Z ranges over t he values v, 𝑣2 𝑣3 ,, . . ., and t he disribution of Z is

determined by (3.2.1) and t he dist ribut ion of K :

Pr (𝒁 = 𝒗𝑲+𝟏 ) = Pr (K = k) 𝒌𝑷𝒙 𝒒𝒙+𝒌 (3.2.2)

for K = 0 , 1, 2, . The net single premium is denoted by 𝐴𝑧 , and given by

𝑨𝒛 = E(𝒗𝑲+𝟏 ) = ∑∞
𝒌=𝟎 𝒗
𝑲+𝟏
𝒌𝑷𝒙 𝒒𝒙+𝒌 (3.2.3)

The variance of Z may be calculated by the identity

Var(Z) = E(Z2) - 𝑨𝟐𝒙 (3.2.4)

Replacing v by e-5 we see that

𝐸(𝑍2 ) = 𝐸𝑒−25(𝐾+1) (3.2.5)

which is t he net single premium calculated at twice t he original force of interest . Thus calculat
ing the var iance is no more difficult than calculatig the net single premium .
An insurance which provides for payment only if death occurs within n years is known as
a term insuranceof duration n . For example 1 unit is payable only if deat h occurs during t he
first n years, the actual time of payment still being the end of the year of death. One has
𝒗𝑲+𝟏 𝒇𝒐𝒓 𝑲 = 𝟎, 𝟏, … , 𝒏 − 𝟏
Z={ (3.2.6)
𝟎 𝒇𝒐𝒓 𝑲 = 𝒏, 𝒏 + 𝟏, 𝒏 + 𝟐, . ..

The net sigle premium is denoted by 𝐴1𝑥:𝑛 . It is

𝑨𝟏𝒙:𝒏 . = ∑𝒏−𝟏
𝒌=𝟎 𝒗
𝑲+𝟏
𝒌𝑷𝒙 𝒒𝒙+𝒌 (3.2.7)

Again the second moment E(Z2) equals the net single premium at twice t he
original force of interest , as is seen from
𝒗(−𝟐𝟔𝑲+𝟏) 𝒇𝒐𝒓 𝑲 = 𝟎, 𝟏, … , 𝒏 − 𝟏
Z2 = { (3.2.8)
𝟎 𝒇𝒐𝒓 𝑲 = 𝒏, 𝒏 + 𝟏, 𝒏 + 𝟐, . ..
3.2.2 Pure Endowments
A pure endowment of duration n provides for payment of t he sum insured only if t he insured is
alive at t he end of n years:
𝟎 𝒇𝒐𝒓 𝑲 = 𝟎, 𝟏, … , 𝒏 − 𝟏
Z={ (3.2.9)
𝒗𝒏 𝒇𝒐𝒓 𝑲 = 𝒏, 𝒏 + 𝟏, 𝒏 + 𝟐, . ..

The net sigle premium is denoted by 𝐴1𝑥:𝑛 . And is given by

𝐴1𝑥:𝑛 . = 𝒗𝒏 𝒌𝑷𝒙 (3.2.10)

Th e form ul a for the variance of a Bernoull i random variable gives

Var(Z) = 𝒗𝟐𝒏 𝒏𝑷𝒙 𝒏𝒒𝒙 (3.2.11)

3.2.3 Endowments

Assume that t he sum insured is payable at the end of the year of death, if t his occurs within the
first n years, otherwise at the end of then nth year :

𝒗𝒌+𝟏 𝒇𝒐𝒓 𝑲 = 𝟎, 𝟏, … , 𝒏 − 𝟏
Z={ (3.2.12)
𝒗𝒏 𝒇𝒐𝒓 𝑲 = 𝒏, 𝒏 + 𝟏, 𝒏 + 𝟐, . ..
 The net sigle premium is denoted by 𝐴1𝑥:𝑛 . denoting the present value of (3.2.6) by Z1 and that
of (3.2.9) by Z2 one may obviously write.
𝑍 = 𝑍1 + 𝑍2 (3.2.13)

As a consequence

𝑨𝒙:𝒏 . = 𝑨𝟏𝒙:𝒏 .+ 𝑨𝟏𝒙:𝒏 . (3.2.14)

And
Var (Z) = Var(𝒁𝟏 ) + 2 Cov ( 𝒁𝟏 𝒁𝟐 ) + Var (𝒁𝟐 ) (3.2.15)

The product 𝑍1 𝑍2 is always zero, hence

Cov (𝒁𝟏 𝒁𝟐 ) = E(𝒁𝟏 𝒁𝟐 ) - E(𝒁𝟏 )𝑬(𝒁𝟐 ) = 𝑨𝟏𝒙:𝒏 . 𝑨𝟏𝒙:𝒏 . (3.2.16)

The variance of Z is thus given by

Var (Z) = Var(𝒁𝟏 ) + Var ( 𝒁𝟐 ) -2𝑨𝟏𝒙:𝒏 . 𝑨𝟏𝒙:𝒏 . (3.2.17)

As a consequence of t he last identity, the risk in selling an endowment policy, measured by t he

variance, is less t han that in selling a term insurance to one person and a pure endowment to
another .

So far , for simplicity, we have assumed a sum insured of 1. If t he sum insured is C , t hen the
net single premium is obtained by multiplying with C ,and the variance by multiplying with C2.

Let us finally consider an m year deferred whole Life insurance. It s present value is

𝟎 𝒇𝒐𝒓 𝑲 = 𝟎, 𝟏, … , 𝒎 − 𝟏
Z={ (3.2.18)
𝒗𝑲+𝟏 𝒇𝒐𝒓 𝑲 = 𝒎, 𝒎 + 𝟏, 𝒎 + 𝟐, . ..
The net single premium is denoted by 𝑚𝐴𝑥 . Alternative formulae for its net single premium are
𝑚𝐴𝑥 = 𝑚𝑃𝑥 𝑉 𝑚 𝐴𝑥+𝑚 (3.2.19)
And
𝑚𝐴𝑥 = 𝐴𝑥 − 𝐴1𝑥:𝑚 (3.2.20)

The second moment E (𝑍2 ) again equals the net single premium at twice the original force of
interest.
3.3 Insurances Payable at the Moment of Death
 In the previous section it was assumed that the sum insured was payable at the end of the
year of death. This assumption does not reflect insurance practice in a m, but has the advantage
that the formulae may be evaluated directly from a life table.
Let us now assume that the sum insured becomes payable at the instant of death, i.e. at
time T. The present value of a payment of 1 payable immediately on death is
𝑍 = 𝑣𝑇 3.3.1
The net single premium is denoted by 𝐴𝑥 . Using (2.2.2) we find that
∞ 𝒕
𝐴𝑥 . = ∫𝟎 𝒗 𝒕 𝑷 𝒙 𝒙𝝁 𝒙 + 𝒕𝒅𝒕 3.3.2

A practical approximation may be derived under Assumption a of Section 2.6

Writing
T = K + S = (K + 1) – (1 – S) 3.3.3
and making use of the assumed independence of K and S, as well as the uniform distribution of S,
so that
𝟏 𝒊
𝑬[(𝟏 + 𝒊)𝟏−𝒔 ] = ∫𝟎 (𝟏 + 𝒊)𝒖 𝒅𝒖 = 𝒔𝟏 = 𝜹 3.3.4

we find
𝟏−𝒔 𝒊
𝐴𝑥 = 𝑬[𝒗𝑲+𝟏 ]𝑬 [(𝟏 + 𝒊) ] = 𝜹 𝑨𝒛 3.3.5
Thus the calculation of is a simple extension of that of 𝐴𝑥 .
A similar formula may be derived for term insurances. For endowments the factor i/𝛿 is
only used in the term insurance part
𝟏
̅ 𝒙:𝒏 = 𝑨
𝑨 ̅ 𝒙:𝒏 +𝑨𝒙:𝒏

𝒊 𝟏
= 𝜹𝑨 + 𝑨𝒙:𝒏
𝒙:𝒏
𝒊
= 𝑨𝒙:𝒏 + (𝜹 − 𝟏) + 𝑨𝟏𝒙:𝒏 (3.3.6)
Let us finally assume that the sum insured is payable at the end of the mth part of the year
in which death occurs, i.e. time K + 𝑆(𝑚) in the notation of Section 2.4. The present value of a
whole life insurance of 1 unit then becomes
(𝑚)
𝑍 = 𝑣𝐾+𝑆 (3.3.7)
For calculation of the net single premium we again use the Assumption a of Section 2.6. We
write
𝐾 + 𝑆 (𝑚) = (𝑘 + 1) − (1 − 𝑆 (𝑚) ) (3.3.8)
in (3.3.7) and use the assumed independence of K and 𝑆(𝑚) , as well as the equation
(𝒎) (𝑚) 𝑖
𝑬 [(𝟏 + 𝒊)𝟏−𝒔 ] = 𝑠1 = (3.3.9)
𝒊(𝒎)

Then we obtain
(𝑚) 𝟏−𝒔(𝒎) 𝑖
𝐴1 = [𝒗𝑲+𝟏 ]𝑬 [(𝟏 + 𝒊) ]= 𝐴𝑥 (3.3.10)
𝒊(𝒎)

Equation (3.3.5) may be verifed by letting m → ∞ in (3.3.10)