Chapter 3: Life Insurance

1. 1-Year Insurance Payable At The End of The Year of

Death
▶ In the symbol A 1 , the subscript “x” denotes the issue age, the subscript
x:1̄|
“: 1̄|” denotes the term of the policy (1 year in this case), and the “1” above
the “x” indicates that this is a term insurance policy which pays only if (x)
dies before the 1 year term is over. Suppose the policy is issued at age x with
a death benefit of 1 payable at the end of the year of death. From the
insurer’s point of view, exactly one of two outcomes will occur:
(i) the insurer pays 1 at the end of the policy year, or
(ii) the insurer pays nothing.
The present value of what the insurer pays can be expressed as the random
variable

v, if death occurs before age x + 1, i.e., if Kx = 0, probability qx ,
Z=
0, if the individual survives to age x + 1, i.e., if Kx ≥ 1, probability px .

The two outcomes of Z depend on Kx . The mean is E[Z ] = vqx + 0 = vqx .

▶ Z is referred as present value random variable. The expected value or mean of

a present value random variable is called an expected present value (EPV), an
actuarial present value (APV) or net single premium (NSP). A death benefit
payable at the end of the year of death is referred to as a discrete death
benefit, and the insurance is called discrete insurance.
1. 1-Year Insurance Payable At The End of The Year of
Death

▶ Let us review some compound interest relationships in the life

insurance and life annuity formulations.
▶ The algebraic relationships linking equivalent rates for annual
effective rate of interest i, force of interest δ and annual effective
rate of discount d, are e δ = 1 + i, e −δ = v = 1+i 1
= 1 − d.
▶ Example: if i = 0.06, present value factor: v = 1+i1
= 0.943396,
equivalent force of interest: δ = ln(1.06) = 0.058269, equivalent
i
annual effective rate of discount: d = 1+i = 0.056604.
▶ Suppose we consider an annual effective interest rate of 0.1236.
1
Present value factor: 1.1236 = 0.889996, force of interest:
ln(1.1236) = 0.116538, discount rate: 0.1236
1.1236 = 0.110004. The force
of interest is 0.116538 = 2δ, the annual effective rate of interest is
0.1236 = 2i + i 2 and the annual effective rate of discount is
0.11004 = 2d − d 2 .
1. 1-Year Insurance Payable At The End of The Year of
Death
▶ These relationships can be validated in the following way: suppose
that δ and i are equivalent force of interest and annual effective
interest rate, so that e δ = 1 + i. If force of interest is doubled to 2δ,
the accumulation of an initial investment of 1 becomes after 1 year
e 2δ = (e δ )2 = (1 + i)2 = 1 + 2i + i 2 , so that the equivalent annual
effective rate of interest changes from i (equivalent to δ) to 2i + i 2
(equivalent to 2δ).

▶ In a similar way, it can be shown that the equivalent annual effective

rate of discount changes from d to 2d − d 2 .

▶ If the force of interest is doubled, the present value factor is

v 2 = e −2δ , so that the present value factor is squared. These are all
equivalent conditions:
for equivalences δ ⇔ i ⇔ d ⇔ v , we also have equivalences
2δ ⇔ 2i + i 2 ⇔ 2d − d 2 ⇔ v 2 .
1. 1-Year Insurance Payable At The End of The Year of
Death

▶ For variance, we have E[Z 2 ] = v 2 qx , Var[Z ] = v 2 qx − (vqx )2 . We

have that E[Z 2 ] = e −2δ qx and we have just seen that vi2 = (1+i) 1
2 is
1
the same as v2i+i 2 = 1+(2i+i 2 ) . So that we have
E[Z 2 ] = vi2 qx = vj qx = A 1 with valuation rate j = 2i + i 2 . We
x:1̄|j
can see E[Z 2 ] as the actuarial present value of a one-year term
insurance at the rate of interest 2i + i 2 . The actuarial notation used
to denote E[Z 2 ] is 2A 1 = vi2 qx = e −2δ qx .
x:1̄|

▶ The motivation behind the superscript “2” at the upper left of “A”
is that v 2 is equivalent to a force of interest of 2δ; the force of
interest has been doubled. The symbol 2A 1 denotes the APV of a
x:1̄|
one-year term insurance at a doubled force of interest.
1. 1-Year Insurance Payable At The End of The Year of
Death
2. Term and Whole Life Insurance Payable at the End of
the Year of Death
▶ The present value random variable (PVRV) related to the two-year term
insurance is

 v , if death occurs in the first year, i.e., if Kx = 0, probability qx ,
Z= v 2 , if death occurs in the second year, i.e., if Kx = 1, probability 1| qx ,
0, if (x) survives two years, i.e., if Kx ≥ 2, probability 2 px .


and we have A 1 = E[Z ].

x:2̄|

▶ E[Z 2 ] = v 2 qx + v 4 1| qx = 2A 1 is the APV of a two-year term insurance

x:2̄|
using annual force of interest 2δ.

▶ The variance is Var[Z ] = 2A 1 − (A 1 )2 .

x:2̄| x:2̄|
2. Term and Whole Life Insurance Payable at the End of
the Year of Death

▶ For an n-year term insurance with face amount 1 and with death
benefit payable at the end of the year of death, if (x) survives
integer k years and dies between ages x + k and x + k + 1, the
insurer pays 1 at the end of year k + 1 provided that death occurs
before age x + n. If the policy holder survives to age x + n, the
policy and the insurer’s obligation terminates.
2. Term and Whole Life Insurance Payable at the End of
the Year of Death
▶ The present value random variable is
 K +1
v x , if Kx = 0, 1, . . . , n − 1,
Z=
0, if Kx ≥ n.

The actuarial present value is

n−1
X n−1
X
A1 = E[Z ] = v k+1 k px qx+k = e −δ(k+1) k| qx ,
x:n̄|
k=0 k=0

and
n−1
X n−1
X
E[Z 2 ] = v 2(k+1) k px qx+k = e −2δ(k+1) k| qx ,
k=0 k=0

▶ It is possible to find probabilities involving a PVRV Z . For example, suppose

t
that S0 (t) = 1 − 10 for 0 ≤ t ≤ 10 (survival follows a uniform distribution on
(0, 10)). Suppose that x = 2 and i = 0.06. If we consider a 4-year term
insurance issued to (2), there are five possible values of Z . For example, the
probability that Z is less or equal to 0.8 can be translated into a probability
involving K2 and P[Z ≤ 0.8] = P[K2 ≥ 3] = 0.625.
2. Term and Whole Life Insurance Payable at the End of
the Year of Death
2. Term and Whole Life Insurance Payable at the End of
the Year of Death
▶ Whole life insurance of 1 issued to (x) payable at the end of the year
of death: We can think of whole life insurance as the extension of a
n-year term insurance as n becomes the full future lifetime of (x) as
n = ∞ = ω − x − 1. The insurer pays 1 at the end of the year in
which death occurs, no matter what year it is. If (x) survives to age
x + k years and dies before age x + k + 1, a benefit of 1 is paid at
age x + k + 1, and on the policy issue date, the present value of the
death benefit is v k+1 .

▶ The present value random variable is Z = v Kx +1 = e −δ(Kx +1) for

Kx ≥ 0. The APV is
∞=ω−x−1
X ∞
X
Ax = E[Z ] = v k+1 k| qx = v k+1 k px qx+k ,
k=0 k=0

and
∞=ω−x−1
X ∞
X
2
Ax = E[Z 2 ] = v 2(k+1) k| qx = e −2δ(k+1) k px qx+k ,
k=0 k=0
3. Pure Endowment and Other Life Insurance Payable at
the End of the Year of Death

▶ We now consider an important policy type for which the payment is

dependent on and is triggered by the survival of (x) for a specified
number of years. This is the pure endowment.

▶ n-year pure endowment of 1: The insurer pays 1 at time n (age

x + n) if (x) survives to that point. If (x) dies before time n, there is
no payment made. It is irrelevant how long (x) survives beyond age
x + n, all that matters is whether or not (x) survives to time n.
Therefore, the PVRV is a random variable defined by

v = e −nδ ,
 n
if Kx ≥ n with prob. n px ,
Z=
0, if Kx ≤ n − 1 with prob. n qx .

The APV is A 1 = E[Z ] = v n n px and

x:n̄|
Var[Z ] = v 2n n px − (v n n px )2 = e −2nδ n px n qx .
3. Pure Endowment and Other Life Insurance Payable at
the End of the Year of Death

▶ Another notation of A 1 is n Ex . The “1” above the “n̄|” indicates

x:n̄|
that the expiry of the n-year period triggers the payment of 1, but
only if the expiry of n-years occurs before (x)’s death. This is the
same as saying that (x) must survive to age x + n in order for the
endowment payment to be made.

▶ Example: For a 20-year pure endowment of 1 on (x), you are given:

(i) Z is the present value random variable at issue of the benefit
payment (ii) Var[Z ] = 0.05E[Z ] and (iii) 20 px = 0.65. Calculate i.
3. Pure Endowment and Other Life Insurance Payable at
the End of the Year of Death

▶ Solution: E[Z ] = v 20 20 px = 0.65v 20 ,

Var[Z ] = v 40 20 px (1 − 20 px ) = (0.65)(0.35)v 40 . So
E[Z ] 1 0.65v 20 (1+i)20 20
Var[Z ] = 0.05 = 20 = (0.65)(0.35)v 40 = 0.35 . Therefore (1 + i) =7
and i = 0.102.

▶ n-year endowment insurance of 1: A combination of n-year term

insurance of 1 and n-year pure endowment of 1 is called n-year
endowment insurance of 1. The term insurance component of n-year
endowment insurance pays at the end of the year of (x)’ death if (x)
dies before age x + n, and the pure endowment component pays at
age x + n if (x) survives to that age. The insurance will pay no later
than age x + n.
3. Pure Endowment and Other Life Insurance Payable at
the End of the Year of Death
▶ We have that

v Kx +1 ,

if Kx ≤ n − 1 with prob. K | qx ,
Z = Zterm +Zend = v min[Kx +1,n]
v = e −nδ ,
n
if Kx ≥ n with prob. n px .

We have
E[Z ] = Ax:n̄| = A 1 +A 1
x:n̄| x:n̄|

and
E[Z 2 ] = 2Ax:n̄| = 2A 1 + 2A 1
x:n̄| x:n̄|
3. Pure Endowment and Other Life Insurance Payable at
the End of the Year of Death
▶ Sometimes, we will see situations in which a benefit is “deferred”, which
means that the benefit is available or payable at a specific point in the future,
usually contingent on survival to that specific point in time. For a deferred
benefit whose value is B payable at time n to survivors to age x + n, the APV
at age x is the same as a pure endowment of amount B. This is Bv n n px .

▶ n-year deferred insurance of 1: For an n-year deferred insurance of 1, the

insurer pays 1 at the end of the year of death if (x) dies after age x + n. In
order for a death benefit to be payable, the policyholder must survive to age
x + n. Anytime after that, when death occurs, the insurer pays 1 at the end
of the year of death. If we combine this insurance with n-year term insurance,
the result is a whole life insurance of 1: the term insurance covers payment
for death before age x + n and the deferred insurance covers payment for
death after age x + n.
3. Pure Endowment and Other Life Insurance Payable at
the End of the Year of Death
▶ The PVRV is Z = Zwhole life − Zterm = v Kx +1 if Kx ≥ n and the APV is
∞
X
E[Z ] = n|Ax = v k+1 k px qx+k = Ax − A 1 = v n n px Ax+n
x:n̄|
k=n

and Var[Z ] = n|2Ax − ( n|Ax )2 .

▶ The APV at age x of the insurer’s obligation is found by applying the APV
factor (the pure endowment factor) v n n px , so that the APV at age x is
v n n px Ax+n . This applies to any n-year deferred benefit; we find the value of
the benefit at age x + n for a survivor, then multiply by v n n px to get the
APV at age x. Note that
∞
X n−1
X ∞
X
Ax = v k+1 k| qx = v k+1 k| qx + v k+1 k| qx = A 1 + n|Ax .
x:n̄|
k=0 k=0 k=n
3. Pure Endowment and Other Life Insurance Payable at
the End of the Year of Death
▶ This can also be expressed in the relationship involving whole life, term and
deferred insurances:
Ax = A 1 + v n n px Ax+n .
x:n̄|

Moreover, we also have

2
Ax = 2A 1 + v 2n n px 2Ax+n .
x:n̄|

When n = 1, we get the important special case:

Ax = A 1 + vpx Ax+1 = vqx + vpx Ax+1 .

x:1̄|

▶ n-year deferred j year term insurance of 1 : This insurance pays a benefit if

death occurs after attaining age x + n but on or before attaining age x + n + j.
It is a j year term insurance that doesn’t begin until age x + n. The APV is
n+j−1
X
A1 ¯ = v k+1 k px qx+k = A 1 − A1 = v n n px A 1
¯
.
n| x:j| x:n+j| x:n̄| x+n:j|
k=n
3. Pure Endowment and Other Life Insurance Payable at
the End of the Year of Death
▶ Suppose an insurance policy is issued to (x) for which the death benefit is
bk+1 paid at time k + 1 if death occurs between ages x + k and x + k + 1.

▶ The PVRV is Z = bKx +1 · v Kx +1 , where bKx +1 is the amount paid at time

Kx + 1, if death occurs in the Kx + 1-th year.

▶ If death occurs before the end of the first year (Kx = 0), the amount paid at
the end of the first year is b1 . If death occurs after the start of the second
year but before the end of the second year (Kx = 1), the amount paid at the
end of the second year is b2 l and the pattern continues in this way.

▶ If death occurs after the start of the k + 1-th year but before the end of the
k + 1-th year (Kx = k), the amount paid at the end of the k + 1 year is bk+1
(keep in mind that the k + 1-th year starts at time k and ends at time k + 1).
3. Pure Endowment and Other Life Insurance Payable at
the End of the Year of Death
▶ Z is a random variable with possible values b1 v , b2 v 2 , b3 v 3 , . . . and
with probability function P[Z = bk+1 v k+1 ] = P[Kx = k] = k| qx . We
have
∞
X ∞
X
E[Z ] = bk+1 v k+1 k px qx+k = bk+1 e −δ(k+1) k| qx ,
k=0 k=0

and
∞
X ∞
X
E[Z 2 ] = 2
bk+1 v 2(k+1) k px qx+k = 2
bk+1 e −2δ(k+1) k| qx ,
k=0 k=0
4. Insurance Payable at the Moment of Death
▶ In practice, it is more likely that a death benefit is paid as soon as possible
after death occurs. The insurance payable at the moment of death is also
called the continuous insurance.

▶ General life insurance payable at the moment of death: Suppose an insurance

policy is issued to (x) so that if death occurs at time t (age x + t), then the
benefit paid at the moment of death is bt . We will assume that present value
is based on compound interest at some constant annual effective rate of
interest, say i, so that the present value over t years is
vt = v t = (1 + i)−t = e −δt .

▶ For insurance payable at the end of the year of death we only needed to know
the integer year in which death occurs, which is related to the curtate life
random variable Kx . For insurance paid at the moment of death we need to
know the exact time of death Tx . The present value of death benefit paid out
for death at time t is represented by the present value function, which is equal
to bt v t = bt e −δt . As time of death Tx is a random variable, the present value
of the death benefit is a PVRV Z = bT v T = bT e −δT .
4. Insurance Payable at the Moment of Death
▶ The expected value of the PVRV Z is
Z ∞ Z ∞
E[Z ] = bt v t t px µx+t dt = bt e −δt t px µx+t dt,
0 0

and as in the discrete insurance case, it is referred to as either

(i) the expected present value (EPV) of the insurance
(ii) the actuarial present value (APV) of the insurance or
(iii) the net single premium for the insurance.
Note thatR ∞from basic principles, Z is a function of Tx , say Z = g (Tx ) and
E[Z ] = 0 g (t)fx (t)dt. For the variance, we know that
Z ∞
E[Z 2 ] = bt2 v 2t t px µx+t dt.
0
4. Insurance Payable at the Moment of Death
4. Insurance Payable at the Moment of Death
▶ n-year term life insurance of 1: This insurance policy has a death benefit of 1
paid at the moment of death, if death occurs within n years, and a benefit of
0 is death occurs after n years. So we can write

v x = e −δTx ,
 T
if Tx ≤ n,
Z=
0 if Tx > n.
Rn
The APV is Ā 1 v t t px µx+t dt. The second moment of Z for
= E[Z ] = 0
x:n̄| Rn
the n-year term insurance of 1 is E[Z 2 ] = 2Ā 1 = 0 v 2t t px µx+t dt and
x:n̄|
Var[Z ] = 2Ā 1 − (Ā 1 )2 .
x:n̄| x:n̄|
4. Insurance Payable at the Moment of Death
▶ Whole life insurance of 1: The death benefit of 1 is paid at the moment of
death, whenever that occurs. We have R ∞ the PVRV is Z = v T = e −δT for
t
T > 0. The APV is Āx = E[Z ] = 0 v t px µx+t dt and
Var[Z ] = 2Āx − (Āx )2 . If i = 0, then Āx = 1 and it can be shown that
d
dx Āx = −µx + Āx [µx + δ] under a non-select mortality model.

▶ As Z represents a present value, as in the term insurance case, the

distribution of Z is linked to the distribution of T in an “inverse” way so that
log a
P[Z < a] = P[e −δT < a] = P[T > − ] = b px ,
δ

where b = − logδ a .
4. Insurance Payable at the Moment of Death
▶ The n-year continuous endowment insurance is a combination of n-year term
insurance and n-year pure endowment, so that the benefit is paid at death if
(x) dies before time n and it is paid at time n if (x) survives to time n. The
PVRV is the sum of the PVRV for term insurance and pure endowment.
There is no continuous version of the n-year pure endowment, it is a benefit
contingent on survival. We have

v = e −δT ,
 T
if T ≤ n,
Z = Zterm + Zend =
v n = e −nδ , if T > n.

Also, we have E[Z ] = Āx:n̄| = Ā 1 +A 1 and

x:n̄| x:n̄|
E[Z 2 ] = 2Āx:n̄| = 2Ā 1 + 2A 1 . Z has a distribution, continuous on the
x:n̄| x:n̄|
region 0 < T < n with 1 > Z > e −δn and with discrete point of probability
P[Z = e −δn ] = n px . The minimum possible value of Z is e −δn .
4. Insurance Payable at the Moment of Death
▶ n-year deferred insurance of 1: This insurance pays only if (x) dies after time
n. As in the discrete insurance case, the PVRV is the difference between
whole life and term insurances PVRVs.

0, if T ≤ n,
Z = Zwhole life − Zterm =
v T = e −δT , if T > n.

R∞
▶ We also have E[Z ] = n|Āx = Āx − Ā 1 = n
v t t px µx+t dt = v n n px Āx+n and
x:n̄|
2
Var[Z ] = n| Āx − n|Āx 2 .

▶ Z has a part discrete, part continuous distribution, with

P[Z = 0] = n qx = P[T ≤ n] and v n > Z if T > n.

▶ Varying Benefit Continuous Insurance: not frequently encountered.

5. Additional Insurance Relationships
5. Additional Insurance Relationships
5. Additional Insurance Relationships
▶ Recursion Relationships for Insurance: The level benefit insurance APV’s that
we have considered satisfy recursion relationships that link the insurance value
at age x to the value at age x + 1. We can establish the recursion
relationships for discrete whole life insurance as follows:
∞
X ∞
X ∞
X
Ax = v k+1 k px qx+k = vqx + v k+1 k px qx+k = vqx + v j+1+1 j+1 px qx+j+1
k=0 k=1 j=0

where we apply j = k − 1. Then, using the relationship j+1 px = px · j px+1 ,

the expression becomes
∞
X X∞
vqx + v ·v j+1 px ·j px+1 qx+j+1 = vqx +vpx · v j+1 j px+1 qx+j+1 = vqx +vpx ·Ax+1 .
j=0 j=0
5. Additional Insurance Relationships
▶ The following is a summary of the recursion relationships for the main level
benefit insurances that have been considered:
▶ Ax = vqx + vpx Ax+1
▶ A 1 = vqx + vpx A 1
x:n̄| x+1:n−1|
▶ Ax:n̄| = vqx + vpx Ax+1:n−1|
▶ Āx = Ā 1 + vpx Āx+1
x:1̄|
▶ Ā 1 = Ā 1 + vpx Ā 1
x:n̄| x:1̄| x+1:n−1|
▶ Āx:n̄| = Ā 1 + vpx Āx+1:n−1|
x:1̄|

▶ Suppose that we consider a general whole life insurance policy in which the
death benefit is bk+1 if (x) survives to age x + k and dies before age
x + k + 1.
PIt was seen that APV at age x of the death benefit is
∞
APVx = k=0 bk+1 v k+1 k| qx . So we have
APVx = b1 vqx + vpx · (b2 vqx+1 + b3 v 2 1| qx+1 + · · · ). Suppose that the
individual survives to age x + 1. The APV at age x + 1 of the future benefit is
the expression in parentheses. Then we can write
APVx = b1 vqx + vpx · APVx+1 , where APVx+1 denotes the actuarial present
value at age x + 1 of future benefit to be paid on the policy.
5. Additional Insurance Relationships
5. Additional Insurance Relationships
▶ Relation between insurance payable at the moment of death and at the end of
the year of death: Suppose that we consider a 1-year continuous insurance of
R1
1. The APV is Ā 1 = 0 e −δt t px µx+t dt. If UDD is assumed, then
x:1̄|
p µx+t = qx for 0 < t < 1, and the integral becomes
Rt 1x −δt
0
e qx dt = qx · ā1̄| = vqx · s̄1̄| = vqx · δi = δi A 1 . We have a summary of
x:1̄|
useful formulas under the assumption of UDD:
▶ Āx = i Ax , Ā 1 = δi A 1
δ x:n̄| x:n̄|
▶ Āx:n̄| = i
A1
δ x:n̄|
+A 1
x:n̄|
▶ 2Āx = 2i+i 2 2i+i 2
2δ
· 2Ax , 2
Ā 1 = 2δ
· 2A 1
x:n̄| x:n̄|

▶ The definition of covariance between Z1 and Z2 is

Cov[Z1 , Z2 ] = E[Z1 Z2 ] − E[Z1 ]E[Z2 ]. For PVRV’s Z1 and Z2 , we have
E[Z1 Z2 ] = 0 in cases in which Z1 ’s benefit ends before Z2 ’s begins (such as
Z1 is n-year term insurance and Z2 is n-year deferred insurance). We have
other cases:
▶ Z1 is whole life and Z2 is n-year term, then Cov[Z1 , Z2 ] = 2Ā 1 − Āx · Ā 1 .
x:n̄| x:n̄|
▶ Z1 is n-year term insurance and Z2 is n-year pure endowment, then
Cov[Z1 , Z2 ] = 0 − Ā 1 · A 1
x:n̄| x:n̄|
▶ Z1 is n-year endowment insurance and Z2 is n-year deferred insurance, we have
Cov[Z1 , Z2 ] = v n n|Āx − Āx:n̄| · n|Āx
5. Additional Insurance Relationships