Actuarial Science 3431B/9007B

January 10, 2014

Lecture Slides

Plan for Todays Class

Review of formulas for probabilities Intuitive justication of Kolmogorovs forward equations Numerical evaluation of probabilities Examples

Review of formulas for probabilities

ij ii x+sds . t px = exp 0 j =0,j =i

When repeat visits to states are not possible,

ij t px = jj ik kj s px x+s ts px+s ds for j = i. k=0,k=j 0 n

Kolmogorovs forward equations

n ) ( d ij jk kj ij ik t px x+t tpx x+t , x, t 0, i, j = 0, 1, . . . n. t px = dt k=0,k=j

Why does this make sense?

Numerical evaluation of probabilities We can use the fact that

ij ij t+h px = t px h n k=0,k=j

( ) jk kj ij ik t px x+t t px x+t + o(h).

Choose a small h, such as 1/12. Let 0pii x = 1 and 0 px = 0 for j = i. Then calculate the hpx values using the above equation (ignoring o(h)). Next, calculation the 2hpx values... This is known as Eulers method.
ij ij ij

Example 1 Consider the permanent disability model with states 0. Active, 1. Disabled, and 2. Dead. Suppose we have the following constant forces of transition: 01 x+t = 0.2 02 x+t = 0.1 12 x+t = 0.3.

Lets calculate the probability that an active life will be disabled in one year, i.e. 1p01 x .

Example 1 Kolmogorovs forward equations are

( ) d 00 00 01 02 x+t + x+t , t p x = t p x dt

and d 01 01 12 00 01 t px = t px x+t t px x+t . dt Therefore, we use

( ) 01 02 00 00 00 x+t + x+t , t+h px = t px h t px

and

( ) 01 01 00 01 01 12 t+h px = t px + h t px x+t t px x+t ,

01 with 0p00 x = 1 and 0px = 0.

Example 1 We can calculate the probability exactly using

01 = 1 px

1
0 1 0

00 01 11 spx x+s 1s px+s ds

e(0.2+0.1)s (0.2) e0.3(1s)ds

= 0.2 e0.3 = 0.1481636.

Example 2 Now consider the disability income insurance model with states 0. Healthy, 1. Sick, and 2. Dead. Suppose we have the following constant forces of transition: 01 x+t = 0.2 10 x +t = 1 02 x +t = 0 . 1 12 x+t = 0.3.

01 (a) Write the Kolmogorov forward equations for tp00 x and t px .

(b) Apply 2 steps Eulers method with a step size of 1/12, i.e. determine the probabilities with t = 2/12.

Example 3 Next consider the permanent disability model with states 0. Active, 1. Disabled, and 2. Dead. Suppose we have the following forces of transition: 01 x+t = 0.2 t
t 02 x+t = 0.1(1.08) t 12 x+t = 0.3(1.08) .

(a) Write an exact expression for 1p01 x as an integral.

(b) Evaluate the integral in (a) using repeated Simpsons rule with h = 1/12.

(c) Calculate the probability in (a) by solving Kolmogorovs forward equations using Eulers method.

For Monday
Review the lecture slides from January 6, 8 and 10. Complete problems 1 to 5 on Assignment 1.

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