Actuarial Society of India

EXAMINATIONS
8th November 2004

Subject 106 Actuarial Mathematics II

Time allowed: Three Hours (10.30 am 13.30 pm)

INSTRUCTIONS TO THE CANDIDATES

1. Do not write your name anywhere on the answer scripts. You have only to write your
Candidates Number on each answer script.

2. Mark allocations are shown in brackets.

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

4. Fasten your answer sheets together in numerical order of questions. This, you may
complete immediately after expiry of the examination time.

5. In addition to this paper you should have available graph paper, Actuarial Tables and an
electronic calculator.

AT THE END OF THE EXAMINATION

Hand in both your answer scripts and this question paper to the supervisor.
 ASI 106 1104

Q.1 Each of r independent risks has a probability 0.25 that a claim is made in a year and
0.75 that no claim is made. Claim sizes are independent with mean 500 and variance
125.
Determine the expected value and the variance of the total amount claimed in a year. [3]

Q.2 The number of patients treated by a hospital emergency unit is Poisson with mean
parameter . The prior distribution of this parameter is gamma with mean 100 and
variance 50.
(a) If 200 patients are treated by the unit on a single day, determine the posterior
distribution of , based on this data. [3]
(b) What is the Bayes estimate of based on the above data? [1]
(c) What is the maximum likelihood estimate of ? [1]
Total [5]
Q.3 The difference in the price of a particular share at the beginning of consecutive days
can be positive or negative (indicating increase or decrease in price) with probability p
and 1p, respectively. The series of differences also happen to be independent. A trader
buys a share on a particular day and decides to sell it off on the first day that its opening
price is less than the previous days opening price. Let N be the number of days the
trader keeps the stock.
(a) Describe the distribution of N. [1]
(b) Show that P(N = n) can be written in the exponential family form

exp [{n b()}/a() + c(n,)]

and identify the natural parameter , the function b() and the function a(). [2]
(c) Express E(N) in terms of the natural parameter. [1]
(d) The trader wishes to predict N via a generalised linear model, using the price of another
stock as an explanatory variable. Describe the data needed for this analysis and state
the prediction model precisely in terms of the canonical link function. [3]
Total [7]

Q.4 A company has decided to introduce a No Claims Discount system for a certain class of
business. This system will have 5 levels of discount: 0%, 15%, 30%, 50% and 75%.
The rules for moving between these levels of discount will be:

following a year with one or more claims, a policyholder will move down one level
of discount, or remain at the 0% level of discount;
following a claim free year, a policyholder will move up one level of discount, or
remain at the 75% level of discount.

The company believes that the probability of a policyholder having a claim free year is
0.85.

What proportion of policyholders at each level of discount should the company expect
once these proportions have become stable?
[8]

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 ASI 106 1104

Q.5 An insurer wants to model the aggregate claims from a certain portfolio. Each claim is
believed to have a Pareto distribution with parameters 100 and 3 . The insurer
incurs a claim expense for each claim that can be modelled as a uniform distribution on
the interval (0,10). Claim numbers are negative binomial with parameters k = 4 and p =
0.9. Expense amounts are independent of claim sizes.

(a) Find the mean and variance of the aggregate payment distribution including the
kq
expenses. You are given that a negative binomial distribution has mean p
and
kq
variance p 2 ; the variance of a continuous uniform distribution on the interval (a,b) is
(b a ) 2
.
12 [4]
(b) What premium should the insurer charge overall if it wishes to reduce the probability of
an overall loss on the portfolio in a given year to below 10%. Assume that the
aggregate payment distribution is approximately normal.
[4]
Total [8]

Q.6 A stock-trader has the option of selling one of three stocks that she owns s1 , s 2 , s 3 on a
particular day of trading. She believes that the markets are equally likely to rise sharply
( 1 ), be range-bound ( 2 ) or crash ( 3 ). Her estimates of the profits under each
possible scenario are set out below:

1 2 3
s1 26 18 7
s2 12 28 10
s3 0 3 36
(a) Determine the minimax solution to this problem. [2]
(b) The stock-traders boss disagrees with the minimax approach and suggests instead that
the stock to sell should be selected on the basis of maximising the maximum profit.
Which stock would the stock-traders boss select to sell based on these predicted
profits? [1]
(c) Determine the Bayes criterion solution to this problem. [2]

(d) The stock-traders boss believes that the markets are equally likely to crash or rise but
believes that there is more than a 50% chance of the market remaining range-bound. By
sketching a graph of the Bayes risk for each of the three possible decisions against the
probability of the market being range-bound (p), or otherwise, determine the revised
Bayes criterion solution. [4]
Total [9]

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 ASI 106 1104

Q.7 An insurance company has a group life insurance policy which covers two classes of
employees. The sum insured payable in the event of death is twice the annual salary of
the employee. Within each class of employee, annual salaries are assumed to be
normally distributed and all are of the same age. The relevant data are given in the
following table:

Class of Number of Probability of Mean Annual

Standard
Employee Employees Death Salary Deviation of
Salaries
1 1000 0.0001 10000 2000
2 500 0.0005 20000 3000
(a) Derive the moment generating function of aggregate claims, stating any assumptions
made. [6]
(b) Calculate the mean and variance of aggregate claims. [4]
Total [10]

Q.8 The tables below show the cumulative cost of incurred claims and the number of claims
reported each year for a certain cohort of insurance policies. The claims are assumed to
be fully run-off at the end of development year 2.
Cumulative cost of incurred claims (in Rupees):

Development Year
Accident Year 0 1 2
0 288 634 893
1 465 980
2 773

Numbers of claims reported in each year:

Development Year
Accident Year 0 1 2
0 110 85 55
1 167 113
2 285
Calculate the outstanding claims reserve using the average cost per claim method. You
are given that the total amount paid in claims to date, relating to accident years 0, 1 and
2, is Rs2,750. [11]

Q.9 An employer provides group medical coverage to its employees. The number of claims
is a Poisson process with rate 1500 per year. The claim sizes are independent and
exponentially distributed with mean Rs400. The employer uses a 25% loading factor
for calculating premiums. The employer is considering proportional reinsurance of the
portfolio, with retention proportion from a reinsurer who calculates the reinsurance
premium with a loading factor of 40%.
(a) If = 0.5, what is the expected payment made by the reinsurer over a period of six
months? [2]
(b) What is the minimum value of needed to avert certain ruin for the employer? [2]
(c) Calculate the adjustment coefficient in terms of the retention fraction. [5]
(d) Determine the value of that would maximize the adjustment coefficient. [3]
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 ASI 106 1104

Total [12]

Q.10 An accident insurer has engaged a reinsurer to cover losses in excess of Rs10,000. The
claim size distribution is exponential with mean Rs5,000. A new reinsurer offers the
direct insurer proportional reinsurance so that the expected retention and loading factor
are exactly the same as in the case of the existing reinsurer.

(a) What is the retention proportion for the proposed reinsurance? [2]
(b) What is the variance of the direct insurers share of a particular claim when excess-of-
loss reinsurance is used? [3]
(c) Will the variance of the direct insurers share reduce if he switches to proportional
reinsurance? [2]
(d) Claims occur according to a Poisson process with rate 10 per month, the premium
loading factor is 30% and the initial surplus is Rs20,000.
Calculate the probability of ruin for the direct insurer at the end of one year, using
normal approximation of the total claim and assuming continuation of excess of loss
reinsurance. [3]
(e) Repeat the calculations of part (d) under the proportional reinsurance offered by the
new reinsurer. [3]
Total [13]

Q.11 The aggregate claims X each year, arising from a portfolio of general insurance
policies, are assumed to follow the normal distribution with unknown mean and
known variance 2 . Prior information suggests that has a normal distribution with
known mean and known 2 . Independent aggregate claims over the last n years are
denoted x1 , x 2 , x3 ....x n . The following annual aggregate claims have been observed
for two general insurers over the past five years:

Insurer
Year A B
1 150 205
2 162 215
3 178 198
4 185 236
5 195 242

(a) Determine the Bayes credibility estimate of the risk premium for each of the two
insurers in the two cases based on the following parameters:
Case 1. Case 2.
A B A B
2
400 400 2
400 400
270 260 270 260
2 2500 2500 2
225 225
[5]
(b) Comment on the effect of the value of 2 on the credibility estimates. [5]
(c) Determine the empirical Bayes credibility estimate of the risk premium for each of the
two insurers. [1]

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 ASI 106 1104

(d) During an audit, it was discovered that insurer B had consistently underestimated its
claims for the last five years by 10%. Further, it has been established that prior
information on the distribution of is invalid.
Describe how the premiums charged by insurers A and B under (c) above will change
by taking allowance of the new information. You do not need to perform any further
calculations.
[2]
Total [14]

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