Faculty of Actuaries Institute of Actuaries

EXAMINATION

28 September 2007 (am)

Subject CT5 — Contingencies

Core Technical

Time allowed: Three hours

INSTRUCTIONS TO THE CANDIDATE

1. Enter all the candidate and examination details as requested on the front of your answer
booklet.

2. You must not start writing your answers in the booklet until instructed to do so by the
supervisor.

3. Mark allocations are shown in brackets.

4. Attempt all 14 questions, beginning your answer to each question on a separate sheet.

5. Candidates should show calculations where this is appropriate.

Graph paper is not required for this paper.

AT THE END OF THE EXAMINATION

Hand in BOTH your answer booklet, with any additional sheets firmly attached, and this
question paper.

In addition to this paper you should have available the 2002 edition of the
Formulae and Tables and your own electronic calculator.

© Faculty of Actuaries
CT5 S2007 © Institute of Actuaries
1 Calculate t+1Vx given the following:

Px = 0.017
tVx = 0.468
i = 0.03
qx+t = 0.024 [2]

2 In a special mortality table with a select period of one year, the following
relationships are true for all ages:

0.5 q[ x ] = (0.33)qx
0.5 q[ x ]+ 0.5 = (0.5)qx

Express p[ x ] in terms of px . [3]

3 A twelve-year life insurance contract has the following profit signature before any
non-unit reserves are created:

(+1, -1, +1, +1, +1, -1, 0, -1, +1, -1, +1, +1)

Non-unit reserves are to be set up to zeroise the negative cash flows.

Write down the revised profit signature, ignoring interest. [3]

4 An annuity makes monthly payments in arrear to a life aged 65 exact where each
payment is 1.0039207 times greater than the one immediately preceding. The first
monthly amount is £1,000.

Calculate the expected present value of the annuity using the following basis:

Mortality: PFA92C20
Interest: 9% per annum [4]

5 (i) Write down the formula for a directly standardised mortality rate. [2]

(ii) State the main disadvantage of this rate and outline how is it overcome in
practice. [2]
[Total 4]

CT5 S2007—2
6 For a certain group of pensioners, q75 = 0.05 and q76 = 0.06.

Calculate the probability that a pensioner aged 75 exact will die between ages 75.5
and 76.5 assuming:

(a) a uniform distribution of deaths between consecutive birthdays

(b) a constant force of mortality between consecutive birthdays. [5]

7 A life insurance company sells two whole life contracts to lives aged 40 exact at
entry. Level monthly premiums are payable in advance until the death of the life
assured. Death benefits are paid at the end of the year of death.

Under policy A, the sum assured is £100,000 during the first year and it increases by
£5,000 at the end of each year for surviving policyholders.

Policy B is a with profit policy with initial sum assured of £100,000. The company
intends to declare simple annual reversionary bonuses of 5% of the original sum
assured each year, vesting at the end of each policy year.

After ten years, the total declared bonuses under the with profit policy amount to
£50,000.

Calculate the net premium reserve required for each policy after ten years.

Basis:

Mortality: AM92 Select

Interest: 4% per annum [6]

8 Explain the following terms and give an example of each:

(a) class selection

(b) spurious selection
(c) time selection. [6]

CT5 S2007—3 PLEASE TURN OVER

9 A life office issues an annuity to a woman aged 65 exact and a man aged 68 exact.
The annuity of £20,000 per annum is payable annually in arrears for as long as either
of the lives is alive.

The office values this benefit using the following basis:

Interest: 4% per annum

Mortality: Female: PFA92C20
Males: PMA92C20

(i) Calculate the expected present value of this benefit. [2]

(ii) Calculate the probability that the life office makes a profit in this case if it
charges a single premium of £320,000. [4]
[Total 6]

10 A policy provides a benefit of £500,000 immediately on the death of (y) if she dies
after (x).

(i) Write down an expression in terms of Tx and Ty (random variables denoting

the complete future lifetimes of (x) and (y) respectively) for the present value
of the benefit under this policy. [2]

(ii) Write down an expression for the expected present value of the benefit in
terms of an integral. [2]

(iii) Suggest, with a reason, the most appropriate term for regular premiums to be
payable under this policy. [2]
[Total 6]

11 Let X be a random variable representing the present value of the benefits of a pure
endowment contract and Y be a random variable representing the present value of the
benefits of a term assurance contract which pays the death benefit at the end of the
year of death. Both contracts have unit sum assured, a term of n years and were
issued to the same life aged x.

(i) Derive and simplify as far as possible using standard actuarial notation an
expression for the covariance of X and Y. [4]

(ii) Hence or otherwise, derive an expression for the variance of (X+Y) and
simplify it as far as possible using standard actuarial notation. [4]
[Total 8]

CT5 S2007—4
12 On 1 January 1992 a life insurance company issued a number of 20-year pure
endowment policies to a group of lives aged 40 exact. In each case, the sum assured
was £75,000 and premiums were payable annually in advance.

On 1 January 2006, 500 policies were still in force. During 2006, 3 policyholders
died, and no policy lapsed for any other reason.

The office calculates net premiums and net premium reserves on the following basis:

Interest: 4% per annum

Mortality: AM92 Select

(i) Calculate the profit or loss from mortality for this group for the year ending
31 December 2006. [7]

(ii) Explain why the mortality profit or loss has arisen. [2]
[Total 9]

13 A life insurance company issues a 35-year endowment assurance contract to a life

aged 30 exact. The sum assured of £200,000 is payable at maturity or at the end of
the year of death if earlier. Level premiums are payable annually in advance for the
duration of the contract.

(i) Show that the annual premium is approximately £2,007, using the following
basis:

Interest: 6% p.a.
Mortality: AM92 Ultimate
Expenses: Initial: £300 plus 50% of the annual premium
Renewal: 2% of the second and subsequent annual premiums
Claim: £600 on death; £200 on maturity [6]

(ii) Write down the gross premium future loss random variable after 25 years,
immediately before the premium then due is paid. [3]

(iii) Calculate the retrospective policy reserve after 25 years, using the same basis
as in (i), but with 4% p.a. interest. [6]

(iv) Explain whether the reserve in (iii) would have been smaller, the same or
greater than in (iii) if the office had used the prospective gross premium
reserve, on the same basis. [3]
[Total 18]

CT5 S2007—5 PLEASE TURN OVER

14 A life office uses the following three-state model to calculate premiums for a 2-year
accelerated critical illness policy issued to healthy policyholders aged 63 exact at
entry.

H: Healthy C: Critically ill

D: Dead

In return for a single premium payable at entry, the office will pay benefits of:

£100,000 if the policyholder dies from the healthy state;

£60,000 if he is diagnosed as having a critical illness;
£40,000 if he dies from the critically ill state.

All benefits are payable at the end of the relevant policy year.

Let St represent the state of the policyholder at age 63 + t, so that S0 = H and for t = 1,
2, St = H, C or D. The transition probabilities are defined as follows:

ij
p63 +t = Pr(St+1= j | St = i ).

Their values are:

t HC
p63 HD
p63 CD
p63
+t +t +t

0 0.04 0.02 0.25

1 0.06 0.03 0.33

(i) Identify all 6 possible outcomes under this policy. [3]

(ii) Calculate the net present value at entry of the benefits assuming a rate of
interest of 10% per annum for each of the outcomes in (i). [3]

(iii) Calculate the probability that each outcome occurs. [3]

(iv) Calculate the mean and variance of the present value at entry of the total
benefits per policy. [5]

(v) The office expects to sell 10,000 of these policies. The single premium is set
at a level which will ensure that the probability that the office makes a profit is
0.95. Calculate the amount of the single premium, assuming the profit is
normally distributed. [6]
[Total 20]

END OF PAPER

CT5 S2007—6