INSTITUTE AND FACULTY OF ACTUARIES

EXAMINATION
26 April 2011 (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. You must not start writing your answers in the booklet until instructed to do so by the supervisor. Mark allocations are shown in brackets. Attempt all 13 questions, beginning your answer to each question on a separate sheet. Candidates should show calculations where this is appropriate.

2.

3. 4. 5.

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 from the approved list.

CT5 A2011

Institute and Faculty of Actuaries

Give a different example of selection shown by each of the following mortality tables: (a) (b) (c) ELT15 PMA92 AM92 [3]

Calculate: (a) (b) (c)

23 p65

10|5 q60

65:10 s

Basis: Mortality Rate of interest

PMA92C20 4% per annum

[4]

Calculate ( Ia ) x Basis: x = 0.02 for all x = 4% per annum [4]

4 5

Outline the benefits that are usually provided by a pension scheme on retirement due to ill health. [5] A pension scheme uses the following model to calculate probabilities, where the transition intensities are = 0.05 and = 0.08.

Active

Retired

Dead

Calculate: (a) (b) the dependent probability of retirement the independent probability of death from active service [5]

using the Kolmogorov equations.

CT5 A20112

(i) (ii)

Define uniform distribution of deaths Using the method in (i) above calculate 1.25q65.5 ELT15(Males)

[2] [4]

Basis: Mortality

[Total 6]

7 8

Explain how education influences morbidity.

[6]

A life insurance company issues a with profits whole life assurance policy to a life aged 40 exact. The sum assured of 100,000 plus declared reversionary bonuses are payable immediately on death. Level premiums are payable annually in advance to age 65 or until earlier death. A simple bonus, expressed as a percentage of the sum assured, is added to the policy at the start of each year (i.e. the death benefit includes the bonus relating to the policy year of death). The following basis is used to price this policy: Mortality Rate of Interest Initial expenses Renewal commission Claim expense AM92 Select 4% per annum 300 plus 50% of the first annual premium, incurred at the policy commencement date 2.5% of each premium from the start of the second policy year 350 at termination of the contract

Using the principle of equivalence, calculate the level simple bonus rate that can be supported each year on this policy if the annual premium is 3,212. [6]

CT5 A20113

PLEASE TURN OVER

A male life aged 52 exact and a female life aged 50 exact take out a whole life assurance policy. The policy pays a sum assured of 100,000 immediately on first death. Premiums are payable for a period of five years, monthly in advance. Calculate the monthly premium payable. Basis: Mortality PMA92C20 (male life), PFA92C20 (female life) Rate of interest 4% per annum Expenses Nil

[7]

10

Calculate the expected present value and variance of the present value of an endowment assurance of 1 payable at the end of the year of death for a life aged 40 exact, with a term of 15 years. Basis: Mortality Rate of interest Expenses AM92 Select 4% per annum Nil

[8]

11

A life insurance company issues a 4-year unit-linked endowment policy to a life aged 61 exact under which level premiums of 2,500 are payable yearly in advance throughout the term of the policy or until earlier death. In the first policy year 40% of the premium is allocated to units, while in the second and subsequent policy years 110% of the premium is allocated to units. The unit prices are subject to a bid-offer spread of 5%. If the policyholder dies during the term of the policy, the death benefit of 10,000 or the bid value of the units, whichever is higher, is payable at the end of the policy year of death. The policyholder may surrender the policy, in which case a value equal to a fixed percentage of the total premiums paid on the policy is payable at the end of the policy year of surrender. The percentage is based on the policy year of surrender as follows:

Policy year
1 2 3 4

% of total premiums payable as a surrender value

0 25 50 75

On maturity, 105% of the bid value of units is payable. An annual management charge of 0.5% of the bid value of units is deducted at the end of each policy year before death, surrender and maturity benefits are paid.

CT5 A20114

The company uses the following assumptions in carrying out profit tests of this contract: Rate of growth on assets in the unit fund Rate of interest on non-unit fund cash-flows Independent rate of mortality Independent rate of surrender Initial expenses Renewal expenses Initial commission Renewal commission Risk discount rate (i) 4.25% per annum 3.5% per annum AM92 Select 6% per annum 325 74 per annum on the second and subsequent premium dates 10% of first premium 2.5% of the second and subsequent years premiums 5.5% per annum

Construct a multiple decrement table for this policy assuming that there is a uniform distribution of both decrements over each year of age in the single decrement table. [3] Construct tables showing the growth of the unit fund and the non-unit fund. Include all commissions in the non-unit fund. [7] Calculate the profit margin for this policy on the assumption that the company does not zeroise future expected negative cashflows. [3] [Total 13]

(ii) (iii)

CT5 A20115

PLEASE TURN OVER

12

On 1 April 1988, a life insurance company issued a 25-year term assurance policy to a life then aged 40 exact. The initial sum assured was 75,000 which increased by 4% per annum compound at the beginning of the second and each subsequent policy year. The sum assured is payable immediately on death and level monthly premiums are payable in advance throughout the term of the policy or until earlier death. The company uses the following basis for calculating premiums and reserves: Mortality Rate of interest Initial commission Initial expenses Renewal commission Renewal expenses AM92 Select 4% per annum 50% of the total premium payable in the first policy year 400 paid at the policy commencement date 2.5% of each premium from the start of the second policy year 75 per annum, inflating at 4% per annum compound, at the start of the second and subsequent policy years (the renewal expense quoted is as at the start of the policy and the increases due to inflation start immediately) 300 on termination (the claim expense is fixed over the duration of the policy) [10]

Claim expense (i) (ii)

Show that the monthly premium for the policy is approximately 56.

Calculate the gross premium prospective reserve as at 31 March 2011. [6] [Total 16]

CT5 A20116

13

(i)

Explain, including formulae, the following expressions assuming that the sum assured is payable at the end of the year of death: death strain at risk expected death strain actual death strain

[6]

(ii)

A life insurance company issues the following policies: 25-year term assurances with a sum assured of 200,000 25-year endowment assurances with a sum assured of 100,000

The death benefit under each type of policy is payable at the end of year of death. On 1 January 2000, the company sold 10,000 term assurance policies to male lives then aged 40 exact and 20,000 endowment assurance policies to male lives then aged 35 exact. For each type of policy, premiums are payable annually in advance. During the first ten years, there were 145 actual deaths from the term assurance policies written and 232 actual deaths from the endowment assurance policies written. (a) Calculate the death strain at risk for each type of policy during 2010.

During 2010, there were 22 actual deaths from the term assurance policies and 36 actual deaths from the endowment assurance policies. Assume that there were no lapses/withdrawals on each type of policy during the first eleven years. (b) (c) Calculate the total mortality profit or loss to the office in the year 2010. Comment on the results obtained in (b) above. Basis: Mortality AM92 Ultimate Rate of interest 4% per annum Expenses Nil [11] [Total 17]

END OF PAPER

CT5 A20117

INSTITUTE AND FACULTY OF ACTUARIES

EXAMINERS REPORT
April 2011 examinations

Subject CT5 Contingencies Core Technical

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

T J Birse Chairman of the Board of Examiners July 2011

Institute and Faculty of Actuaries

Subject CT5 (Contingencies Core Technical) Examiners Report, April 2011

(a) (b) (c)

Time selection because it is based on a period of three calendar years Class selection applies only to male pensioners Temporary initial selection as there are select rates

Other valid answers acceptable This question was generally done well. However some students did not supply different selection types for each part and this was penalised.

(a)

23 p65
10|5 q60

(b)
(c)

l88 3534.054 = = 0.366307 l65 9647.797 (l l ) (9238.134 8405.160) = 70 75 = = 0.084771 l60 9826.131
65:10 (1 + i )10 a
10 p65

65:10 = s

65 v10 10 p65 a 75 ) (1 + i )10 (a 10 p65

(1.04)10 (13.666 (1.0410 ) 8, 405.160

(8, 405.160 9, 647.797)

9, 647.797

) 9.456)

= 1.48024 (13.666 0.67556 0.87120 9.456) / 0.87120 = 13.764 This question was generally done well for parts (a) and (b) but students struggled more with part (c).

3
( Ia ) x = v t t p x dt + 2 v t t p x dt + 3 v t t p x dt + .......
0 1 2 3 1 .02 2

Now vp x = e Hence

.04

*e

=e

.06

throughout.

( Ia ) x = (1 + 2e 0.06 + 3( e .06 )2 + 4( e .06 )3 + .........)a 1 at force of interest 6% = (1/(1 e .06 ))2 ((1 e .06 ) / .06) = 294.8662 0.970591 = 286.19 This question was not done well. The majority of students failed to realise that the increasing function I was not continuous, although the payment is continuous. Instead most attempted to compute ( Ia ) x = tvt t px dt . Only minimal credit was given for this.
0

Page 2

Subject CT5 (Contingencies Core Technical) Examiners Report, April 2011

Schemes usually allow members to retire on grounds of ill-health and receive a pension benefit after a minimum length of scheme service. Benefits are usually related to salary at the date of ill-health retirement in similar ways to age retirement benefits. However, pensionable service is usually more generous than under age retirement with years beyond those served in the scheme being credited to the member e.g. actual pensionable service subject to a minimum of 20 years, or pensionable service that would have been completed by normal retirement age. A lump sum may be payable on retirement and a spouse pension on death after retirement.

Other valid points were credited. Generally this bookwork question was done well.

The Kolmogorov equations in this case are:

r (+)t t (aq ) x = e t d (+)t t (aq ) x = e t For the case where t = 1 the solution for the dependent probability of retirement is: ( aq) r x = (1 e (+ ) ) +

Hence the dependent probability of retirement is

(aq) r x =

0.08 (1 e (0.05+0.08) ) 0.08 + 0.05 = 0.07502

The formula for the independent probability of death is

d qx = 1 e

Hence the independent probability of death is:

d qx = 1 e 0.05 = 0.04877

Generally this question was completed satisfactorily by well prepared students.

Page 3

Subject CT5 (Contingencies Core Technical) Examiners Report, April 2011

(i)

The definition of the uniform distribution of deaths (UDD) is s qx = s.qx (alternatively t px x +t is constant). We have
1.25 p65.5

(ii)

0.5 p65.5 0.75 p66 0.5 p65.5

= (1 0.5 q65.5 ) = (1 (0.5q65 / (1 0.5q65 ))) by UDD = (1 ((0.5 0.02447) / (1 0.5 0.02447))) = 0.98761
0.75 p66

= 1 0.75 q66 = 1 0.75 q66 = 1 0.75 0.02711 = 0.97967

Hence
1.25 p65.5

= 0.98761 0.97967 = 0.96753 = 0.03247

1.25 q65.5 = 1 1.25 p65.5 = 1 0.96753

A straightforward question that was generally done well.

Education influences the awareness of a healthy lifestyle, which reduces morbidity. Education includes formal and informal processes, such as public health awareness campaigns. Shows in: Increased income Better diet Increased exercise Better health care Reduced alcohol and tobacco consumption Lower levels of illicit drug use Safer sexual practices

Some effects are direct (e.g. drug use); some are indirect (e.g. exercise)

Students generally scored on a range of points but in most cases did not write enough of them to gain all the marks. Students who mentioned over indulgence risks for the better educated were given credit.

Page 4

Subject CT5 (Contingencies Core Technical) Examiners Report, April 2011

Let b be the simple bonus rate (expressed as a percentage of the sum assured). Then the equation of value at 4% p.a. interest is (where P = 3,212):
[40]:25 + 0.025) = (100, 000 + 350) A[40] + 1, 000b( IA)[40] + 300 + 0.5 P P(.975a

P(.975 15.887 + 0.025) =

(100, 000 + 350) (1.04 )
0.5

0.23041 + 1, 000b (1.04 )

0.5

7.95835 + 300 + 0.5 P

49,833.6179 = 23,579.5423 + 8,115.9564b + 1,906 24,348.0756 = 3.00 b= 8,115.9564 i.e. a simple bonus rate of 3% per annum

Generally done well although some students treated b as not vesting in the first year.

Value of benefits using premium conversion

100,000 A52:50 = 100,000 (1.04)1/2 A52:50 52:50 ) = 100,000 (1.04)1/2 (1 (0.04 / 1.04) a = 101,980.4 (1 0.0384615 17.295) = 34,143.89 Value of monthly premium of P 12 P (12) (12) 5 l57:55 (12) = 12 P 52:50 v l52:50 57:55

52:50:5

(12) 52:50 = 52:50 11/ 24 = 17.295 0.458 = 16.837 (12) 57:55 = 57:55 11/ 24 = 15.558 0.458 = 15.100

v5 l57:55 = (0.82193 9,880.196 9,917.623) / (9,930.244 9,952.697) l 52:50 = 0.81491 Hence 12 P (12) Therefore: P = 34,143.89 / 54.3823 = 627.85 There was an anomaly in this question in that it was not fully clear that the premium paying period ceased on 1st death within the 5 year period. Even though the vast majority of students (12) 5 i.e. who completed this question used the above solution a small minority used 12 Pa ignoring the joint life contingency. This was credited.
52:50:5

= 12 P(16.837 0.81491 15.100) = 54.3823P

Page 5

Subject CT5 (Contingencies Core Technical) Examiners Report, April 2011 None the less many students struggled with this question

10

Expected present value is A [40]:15 where

1 A [40]:15 = A[40]:15 + A[40]:1 15

= A[40] v15 15 p [40] A55 + v15 15 p [40] 9,557.8179 9,557.8179 = 0.23041 0.55526 0.38950 + 0.55526 9,854.3036 9,854.3036
= 0.23041 0.20977 + 0.53855

= 0.55919

Variance = 2 A [40]:15 ( A [40]:15 )2

2 1 A [40]:15 = 2 A[40]:15 + 2 A[40]:1 15

= 2 A[40] (v 2 )15 15 p [40] 2 A55 + (v 2 )15 15 p [40] 9,557.8179 9,557.8179 = 0.06775 0.30832 0.17785 + 0.30832 9,854.3036 9,854.3036
= 0.06775 0.05318 + 0.29904 = 0.31361

So variance = 0.31361 0.559192 = 0.000917 Note answers are sensitive to number of decimal places used. Question done well by well prepared students. Many students failed to realise that the endowment function needed to be split into the term and pure endowment portions.

Page 6

Subject CT5 (Contingencies Core Technical) Examiners Report, April 2011

11

Summary of assumptions: Annual premium Risk discount rate Interest on investments Interest on sterling provisions Minimum death benefit 2,500.00 5.5% 4.25% 3.5% 10,000.00 325 74 Allocation % (1st yr) Allocation % (2nd yr +) Man charge B/O spread Maturity benefit % prm 10.0% 2.5% Total 575 136.5 40% 110% 0.5% 5.0% 105%

Initial expense Renewal expense (i) Multiple decrement table: x 61 62 63 64 x 61 62 63 64 (ii)

d qx s qx

0.006433 0.009696 0.011344 0.012716 (aq) d x 0.006240 0.009405 0.011004 0.012335

0.06 0.06 0.06 0.06 (aq) s x 0.05981 0.05971 0.05966 0.05962 (ap) 0.933953 0.930886 0.929337 0.928047
t 1 ( ap )

1.000000 0.933953 0.869404 0.807969

Unit fund (per policy at start of year)

yr 1
value of units at start of year alloc B/O interest management charge value of units at year end 0.00 1,000.00 50.00 40.37 4.95 985.42

yr 2
985.42 2,750.00 137.50 152.91 18.75 3,732.08

yr 3
3,732.08 2,750.00 137.50 269.65 33.07 6,581.15

yr 4
6,581.15 2,750.00 137.50 390.73 47.92 9,536.46

Page 7

Subject CT5 (Contingencies Core Technical) Examiners Report, April 2011

Non-unit fund (per policy at start of year)

yr 1
unallocated premium B/O spread expenses/commission interest man charge extra death benefit extra surrender benefit extra maturity benefit end of year cashflow (iii) probability in force discount factor expected p.v. of profit premium signature expected p.v. of premiums profit margin 1 0.947867
419.03

yr 2
250.00 137.50 136.50 8.72 18.75 58.95 148.20 0.00 149.71

yr 3
250.00 137.50 136.50 8.72 33.07 37.62 168.91 0.00 93.36

yr 4
250.00 137.50 136.50 8.72 47.92 5.72 121.41 442.51 536.62

1,500.00 50.00 575.00 34.12 4.95 56.25 58.94 0.00 1,016.76

0.933953 0.898452

0.869404 0.851614

0.807969 0.807217

2,500.00
8,386.15 5.00%

2,213.16

1,952.79

1,720.19

Credit was given to students who showed good understanding of the processes involved even if the calculations were not correct. Generally well prepared students did this question quite well.

12

(i)

Let P be the monthly premium. Then: EPV of premiums:

(12) 12 Pa
[40]:25

@ 4% = 186.996 P

where
(12) [40]:25 [40]:25 a =a

11 1 25 p[40]v 25 24

= 15.887
= 15.583

11 8821.2612 0.37512 1 24 9854.3036

Page 8

Subject CT5 (Contingencies Core Technical) Examiners Report, April 2011 EPV of benefits:
75, 000(q[40]v 0.5 + q[40] (1 + b)v1.5 + ... +
1 24

q[40] (1 + b) 24 v 24.5 )

where b = 0.04
= 75, 000 (1 + i )0.5 75, 000 (1 + i )0.5 1 A[40]:25 @ i/ = A[40] 25 p [40] v 25 A65 @ i/ (1 + b) (1 + b)

75, 000 8821.2612 1 1 1 0.5 (1.04) 9854.3036

= 7709.6880

where i/ = 1.04 1 = 0.00 i.e. i / = 0% 1+ b

EPV of expenses (at 4% unless otherwise stated

(12) (12) [40]:25 [40]:1 @0% 1 = 0.5 12 P + 400 + 0.025 12 Pa 0.025 12 Pa + 75 a [40]:25 1 +300 A[40]:25

= 6 P + 400 + 0.025 12 P 15.583 0.025 12 P 0.982025 + 75 23.27542 +300 0.05422 = 6 P + 400 + 4.6749 P 0.2946 P + 1745.6558 + 16.266 = 10.3803P + 2161.9218 where 11 1 p[40]v [40]:1 24 11 9846.5384 = 1 1 0.96154 = 0.982025 24 9854.3036
(12) = a [40]:1 a
@0% [40]:25 1 = a

1 l[40]

(l

[40]+1

+ .... + l64 ) = e[40]

l64 e64 l[40]

= 39.071

8934.8771 17.421 = 23.27541 9854.3036

Page 9

Subject CT5 (Contingencies Core Technical) Examiners Report, April 2011 l 1 1 = 1.040.5 A[40]:25 = 1.040.5 A[40]:25 v 25 65 A[40]:25 l[40] 8821.2612 = 1.040.5 0.38896 0.37512 = 0.05422 9854.3036

Equation of value gives: 186.996 P = 7709.6880 + 10.3803P + 2161.9218 9871.6098 P= = 55.89 176.6157 (ii) Gross prospective policy value at t = 23 (calculated at 4%) is given by:
63:2

(12) V prospective = 75, 000 (1.04) 23 v 0.5 [ q63 + (1.04) p63q64 v ] + 300v 0.5 [ q63 + p63q64v ] + 0.025 12 Pa +75 (1.04)
23

[1 + (1.04) p63v ]

(12) 12 Pa 63:2

= 184,853.66 0.98058 [ 0.011344 + (1.04) 0.988656 0.012716 0.96154] +300 0.98058 [ 0.011344 + 0.988656 0.012716 0.96154] + 0.025 12 55.89 1.90629 +184.854 [1 + (1.04) 0.988656 0.96154] 12 55.89 1.90629 11 11 8821.2612 2 l65 1 v = 1.951 1 0.92456 = 1.90629 24 24 9037.3973 l63

(12) = a 63:2 where a

63:2

= 4,335.0628 + 6.8932 + 31.9628 + 367.6104 1, 278.5106 = 3, 463.02

This question was generally not done well especially part (ii). In part (i) although it was commonly recognised that a resultant rate of interest of 0% emerged students did not often seem to know how to progress from there.

13

(i)

The death strain at risk for a policy for year t + 1 (t = 0, 1, 2) is the excess of the sum assured (i.e. the present value at time t + 1 of all benefits payable on death during the year t + 1) over the end of year provision. i.e. DSAR for year t + 1 = S t +1V The expected death strain for year t + 1 (t = 0, 1, 2) is the amount that the life insurance company expects to pay extra to the end of year provision for the policy. i.e. EDS for year t + 1 = q ( S t +1V )

Page 10

Subject CT5 (Contingencies Core Technical) Examiners Report, April 2011 The actual death strain for year t + 1 (t = 0, 1, 2) is the observed value at t+1 of the death strain random variable i.e. ADS for year t + 1 = ( S t +1V ) if the life died in the year t to t+1 = 0 if the life survived to t + 1 Note: Full credit given if definition of death strain is given for a block of policies rather than for a single policy as per above. (ii) (a) Annual premium for endowment assurance with 100,000 sum assured given by: P EA = 100, 000 100, 000 A35:25 = 0.38359 = 2,393.40 35:25 a 16.027

Annual premium for term assurance with 200,000 sum assured given by: P
TA

1 200,000 A40:25

40:25 a

1 where A40:25 = A40:25 v 25 25 p40

= 0.38907 0.37512 PTA =

8,821.2612 = 0.38907 0.33573 = 0.05334 9,856.2863

200,000 0.05334 = 671.62 15.884

Reserves at the end of the 11th year: for endowment assurance with 100,000 sum assured given by: V 11
EA

46:14 = 100,000 A46:14 P EAa

= 100,000 0.58393 2,393.40 10.818 = 58,393.0 25,891.8 = 32,501.2 for term assurance with 200,000 sum assured given by:

Page 11

Subject CT5 (Contingencies Core Technical) Examiners Report, April 2011

V 11
TA 1 51:14 = 200, 000 A51:14 PTA a

1 where A51:14 = A51:14 v14 14 p51

= 0.58884 0.57748

8,821.2612 = 0.58884 0.52583 = 0.06301 9, 687.7149

V 11

TA

= 200, 000 0.06301 671.62 10.69

= 12, 602.0 7,179.6 = 5, 422.4

Therefore, sums at risk are: Endowment assurance: DSAR = 100,000 32,501.2 = 67,498.8 Term assurance: (b) DSAR = 200,000 5,422.4 = 194,577.6

Mortality profit = EDS ADS For endowment assurance

EDS = 19768 q45 67, 498.8 = 19768 0.001465 67, 498.8 = 1,954, 773.3 ADS = 36 67, 498.8 = 2, 429,956.8

mortality profit = 475,183.5 (i.e. a loss) For term assurance

EDS = 9,855 q50 194,577.6 = 9,855 .002508 194,577.6 = 4,809, 246.1 ADS = 22 194,577.6 = 4, 280,707.2 mortality profit = 528,538.9 Hence, total mortality profit = 528,538.9 475,183.5 = 53,355.4 (c) Although there is an overall mortality profit in 2010, the actual number of deaths for the endowment assurances is approximately 25% higher than expected, which is a concern. Further investigation would be required to determine reasons for poor mortality experience for the endowment assurances, e.g. there may have been limited underwriting requirements applied to this type of contract when they were written.

Generally (a) was done well. The most common error in (b) was to assume reserves at 10 years rather than 11. On the whole well prepared students coped with (b) well. Many students did not attempt (c) or at best gave a somewhat sketchy answer.

END OF EXAMINERS REPORT

Page 12