Mathematics of Insurance L3

Introduction
Insurance is an operation by which a person (the insurer) commits to carrying out a
performance, as part of an insurance contract, for the benefit of an individual upon the occurrence
of a risk. In return for this service, the insured pays a premium or a contribution to
the insurer. This amount corresponds to the cost of risk and the operating expenses of
the insurer.
Risk is the subject of insurance. An insured person takes out insurance to protect themselves.
against damaging events (illness, fire, theft, death...) or against risks
related to certain objects he owns (automobile, housing...).
In the event of a risk occurring, the insurer is obliged to pay a benefit in the form of money
either to the insured, or to a third party, or to the beneficiary as part of alife insurance.
Life insurance, the subject of this course, is the branch of insurance where the insurer takes on
random financial commitments for a very long term and related to the human lifespan. From this
Indeed, its technical functioning is primarily based on quite complex notions of
life probability and financial mathematics whose understanding is fundamental for
a good exploitation of the life branch.
This course consists of five parts:
Survival model: this first part provides an introduction to the notion of
lifetime probabilities, mortality rates, and actuarial notation of probabilities.

Modeling of traditional life insurance contracts: this section addresses

of mathematical modeling and actuarial notation of insurance contracts in
case of life, in case of death, or both.

Annuities in life insurance: This chapter deals with the different annuities in life insurance
and their actuarial evaluation.
Calculation of bonuses and setting of rates: this involves describing and applying the principle.
of calculating the premiums of life insurance contracts

The provisioning in insurance: deals with the actuarial evaluation of so-called provisions
mathematical provisions.

Practical case
Chapter I: Introduction to the survival model
Life insurance operations being linked to the duration of human life, their implementation
absolutely requires the calculation of probabilities of death or survival. These related probabilities
To the duration of human life are called life probabilities.
Furthermore, for death contracts, the insurer agrees to pay the beneficiary of the insured.
a sum of money (called benefit) upon the death of the individual. The date of death of the insured
Not being known in advance, the insurer does not know exactly the date of payment.
Thus, in order to estimate this date, the insurer needs a human survival model.
allowing him to determine the probabilities of survival and death. This chapter provides
an introduction to survival modeling. We represent the lifespan of an individual by a
random variable, then we define the probabilities of death and survival, as well as the strength of
mortality. Then, actuarial notations and the mortality table are introduced.

1. Notations
Throughout the rest of the course, we refer to:
( )an individual of age for everythingx ≥ 0,
the random variable equal to the remaining lifetime at age ,
+ , the age of( ) at the time of death,
0the remaining life expectancy at birth.

Illustration (Make a graph to illustrate the random variable)

2. Definitions

2.1. Distribution of lifespan( )

We call the remaining lifespan distribution at age the distribution function of the
continuous random variable rated and defined by:
( ) = [ ≤ ] , pour tout x ≥ 0

( ) represents the probability that( ) does not live more than + years, or even the
probability that at the age he still lives at most years later: it is the probability of
to die between the age and + .

2.2. The probability density function of

By definition, the probability density function of is defined by:

( ) = ( )
2.3. The survival function
We call the survival function of( ), the noted function and defined by:

( ) = 1 - F ( )= [ > ,] pour tout t ≥ 0.

( ) designates the probability that( ) survive at least years: it is the probability of

survive at least between the age and + .

3. Corollary
For everythingt > 0, on a :
[ ≤ ]= [ 0≤ + | 0> ]
Illustration
More generally, for all( + ) , with + designating the random variable equal to its
future lifespan, we have:
[ + ≤ ]= [ ≤ + | > ], , greater than zero

Illustration
4. Properties

4.1. Reminder of the formula for conditional probabilities

Let it be and two events such as 0,[ then
] we had:
[ ∩ ]
[ | ]=
[ ]

Illustration
Let's consider the following Venn diagram:

S
B
A

A B

Event B having occurred, there can be no other occurrence outside of B. Thus

the set of achievements reduces to set B. It follows that the probability
that the set A occurs given that B has occurred is the proportion of the probability of
simultaneous realization of sets A and B with respect to the probability of realization of
the set B. However, the probability that sets A and B occur is equal to [ ∩ ]Where from
the result.
4.2. Properties

[ < 0≤ + ]
i. ≤[ = ] ,
[ 0> ]

0( +)−0( )
ii. ( =)
0 ( )

iii. 0 +
( =) 0 . ( )( )

iv. (+ =) (. ) + ( )

Proof
Note:
From previous properties, we deduce that, knowing the survival probability at the
At birth, one can calculate the probability of survival at any age.

4.3. Properties of the survival function

( ) is a survival function of an individual( ) if and only if she satisfies the

following conditions:

i. ( 0) =1,

ii. lim S ( ) = 0for everythingx ≥ 0,

→ +∝

iii. ( ) is a function of decreasing and continuous to the right.

EXERCISE :
We give:
1
6
( ) = 1 −(1 − ) pour 0 ≤ t ≤ 120
120

1. Calculate the probability that a newborn will survive at least 30 years.

2. Calculate the probability that a 30-year-old individual will die before the age of 50.
3. Calculate the probability that a 40-year-old individual will survive beyond 65 years.
5. The force of mortality
The force of mortality or instantaneous mortality rate is a fundamental concept in
modeling of an individual's survival.
Let us consider an individual with a survival function at birth. 0[≤ . ]

5.1. Definition

We note the mortality rate of an individual.( ) by , and we define by :

[ 0≤ + | 0> ]
lim
→0+

5.2. Properties

We ask ( )= ( )= − ( )

1− ( )
i. μ = lim + ,
→0

1 0( )
ii. μ = − ( ). 0 (= ) ,
0 0 ( )

1
iii. μ + = − ( ). ( )

1 ( )
iv. μ = − ( ). ( =) ,
0 ( )

v. S(t)
0 = exp(- ∫0 )

vi. ( ) = exp(− ∫ 0 + )

Evidence
6. Actuarial Notations
The International Actuarial Association was established in Brussels in 1985 on the occasion of the
First International Congress of Actuaries.
During the second congress held in London, a standard actuarial notation was adopted.
unanimously. Actuarial notation is a method that allows actuaries to define
mathematical formulas, function of interest rates and mortality rates.
6.1. Notations

i. Probability of surviving at least between the age and +

= [ > ]= ( )
 ii. Probability of death between the age and +

= [ ≤ ]= ( )

iii. Deferred probability

| = [ < ≤ + ]= ( ) − ( + )
Note: is the| probability that an individual of age survival years, then passes away
in the following years, meaning that the death occurs between the age + and + + .
It is said to be a deferred probability because it is the probability that death occurs in
a range following a deferred period.

iv. Simplified notations

= 1 is the probability of survival at age , or probability of survival between
the age and the agex + 1
= 1 is the probability of death at age
| = |1 is the probability that death occurs between the age
+ andx + u + 1

6.2. Properties

For everything , 0on a :

i. + = 1,

ii. + = × +,

iii. = × +1× ⋯× -1,

iv. | = − + = × +

v. + =−

vi. ( ) = . +

vii. = exp(− ∫ 0 + )

viii. = exp(− ∫ 0 + )

Illustrate the last point with a graph

 Discreet case
Throughout the rest of the course, we consider the random variable defined by :
= ⌊ (the
⌋ integer part of ).
is the random variable equal to the number of years of life (in whole numbers) between the age and the death.

7.1. Definition

[ = ]= . + , k>0

7.2. Life expectancy of( )

[ ]= ∑
=
8. Mortality table
In life insurance, the actuary must be able to estimate the number of deaths or survivals.
group of individuals over a given period. To do this, it relies on mortality statistics
presented in the form of a table called 'mortality table'.

Mortality tables are therefore essential elements that lie at the heart of everything.
the activities of a life insurance company as they allow the insurer to estimate the
probabilities of death or survival of the insured for the determination of rates and provisions.

Given a survival model, with survival probabilities one can build a

mortality table for the model from an initial age 0and an age limit She gives
for each age and this until the age limit .:

the number of survivors at the age noted

the number of deaths recorded at age noted

The age limit being the age beyond which there are no more survivors.

8.1. Definition

Let's consider a survival model, with a probability of survival. and 0

the number of survivors of age
0radix call

For everything , as such0 ≤ t ≤ ω - x0 we define:

i. the number of survivors at age 0+ by :

0 + = 0
. 0
 ii. the number of deaths by age 0and 0+ by :

0+
= −0 +0

8.2. Corollary

For ≥ 0, on a :

+ = . + = − +

8.3. Probability of survival based on

Fort ≥ 0, on a :

+
=
8.4. Number of deaths between the age of death at age based on and

8.5 Presentation of the mortality tables used in the CIMA area

In accordance with the resolutions of the general meetings on life insurance, the Monitoring Committee has
launched in July 2009 a process of creating new mortality tables specific to
the CIMA area. The mortality tables used until then were the "TD CIMA" tables for
death insurances and 'TV CIMA' for life insurances (art.338 and
334-4 of the CIMA Insurance Code). At the conclusion of this work, two new tables based
on the experience of mortality in the CIMA zone have been implemented:
The "CIMA H" table for death insurance
The "CIMA F" table for life insurance
These two new tables have come into force since (...)

8.6. Survival probability for fractional ages

Mortality tables allow for the calculation of probabilities of survival and death at different ages.
integers. However, in practice, it sometimes requires the calculation of probabilities at non
integers, such as0,75 30,5Additional hypotheses are therefore necessary
to calculate probabilities at non-integer ages. In this section, we introduce,
the hypothesis of the uniform distribution of deaths, which is the most familiar hypothesis.
 For every integer and for everything0 ≤ < 1we adopt the assumption that:

i. = ,

ii. + = − .
EXERCISE

The following mortality table is provided:

Calculate:

1. 40
2. 10
30
3. 35
4. 530
5. The probability that an individual aged 30 will die between the ages of 35 and 36.
6.Ccalculate 30.6
0.4
Example 3.8 P 77
Chapter II: Modeling of traditional life insurance contracts
In the previous chapter, we introduced the survival model and actuarial notations.
survival and death probabilities. In this chapter, we focus on modeling the
classic life insurance contracts. By combining the time value of money and
life probabilities, we will assess the probable present values (the payments
contingents) of the insurer's commitment related to a traditional life insurance contract. We
let's consider in particular, the contracts in case of death whole life, temporary death, the
contracts in case of life and mixed insurance contracts, understanding of which is fundamental
to develop the different models of modern life insurance.
We determine the probable current value of the insurer's commitment, in the case
continue using the random variable and in the discrete case with the random variable .
We are introducing new notations and the variable ( ) which will be used to evaluate the payments
contingents in the periodic case.
1. Hypotheses and Notations

1.1. Hypotheses in the continuous case

Contingent payments related to death occur at the time of the event of the
death (at the exact time of death)
The payments in annuities occur at an infinitesimal time interval.( , +
). 1 F per year is paid per infinitesimal unit of1dtin each interval
( , + ).

1.2. Hypotheses in the discrete case

Contingent payments related to death are paid at the end of the death period.
Annuities are paid at the beginning or at the end of the period.

1.3. Technical Hypotheses

Technical hypotheses refer to a set of hypotheses used in life insurance or
in retirement. In this chapter, we consider the pedagogical technical assumptions
following :
The standard survival model: 0.00022+ 2.7× 10-6× 1.124
The interest rate is constant

1.4. Financial Hypotheses

It is noted and defined by:

the annual interest rate

( ) the nominal interest rate (capitalized once a year

( )
(1 + )=1+i

the interest rate continues

 =1+i
the annual discount factor:

1 −
= =
1+i

1.5. Cash flow notations

We will note that:

(, )a cash flow amount payable on the date .

( , )a cash flow amount payable on the date .
The cash flow ( , )it is also noted ( , )
, and designate deterministic or random values. In this course, they represent
deterministic values.

2. Determination of the probable present value of the insurer's commitment

2.1. Contracts with Constant Guaranteed Capital

2.1.1. Case of a whole life immediate death benefit

In an immediate whole life insurance contract, the insurer agrees to pay a capital benefit upon death of
the insured, regardless of its date of occurrence.

Continuing case
Activity 1
We consider an insurance contract taken out by (on) the date = 0 and guaranteeing the
payment of1as of the date .
Give the notation of this cash flow
(b) We note by the likely current value of the guarantee. Express depending on and
.
(c) Express the mathematical expectation of based on , and +

Solutions
(a) 1,
( T )

(b) = = −

−) ∞ −
(c) ( )= ( = ∫0 + .

( ) is also called actuarial value or Probable Current Value (PCV) of

the insurer's commitment.
Note: Create a graphic illustration
Actuarial notation: ( =) ̅
ii. Discrete case (annual)
Activity 2
We consider an insurance contract taken out by (on) the datet = 0 and guaranteeing the
payment of1to the date + 1.
(a) Provide the notation for this cash flow
(b) We note by the likely current value of the guarantee. Express depending on and
.
(c) Express the mathematical expectation of depending on , , then
| based on
, and + fork ≥ 0.

Solution
(a)1,(K + 1 )

(b) = +1

∞ +1
(c) ( )= ( +1 ) ∑= =0 |

Actuarial notation : ( =)
Note: Create a graphic illustration
Recursive formula
= + +1

Proof: Make a graph

Activity 3
We consider an insurance contract taken out by (to) datet = 0 and guaranteeing the
payment of on the date + 1.
Provide the notation of the corresponding cash flow, then determine the probable present value.
of the insurer's commitment depending on (. )
2.1.2. In the case of a temporary death contract.

Through a temporary death contract, the insurer guarantees the payment of a capital amount fixed in advance.
to a designated beneficiary, if the insured person dies before the due date of the contract. If the insured person
is alive at the end, the insurer pays nothing.
There are two forms of temporary death contracts:
Temporary death insurance with constant capital: the guaranteed capital is constant regardless of
the date of occurrence of death.
Temporary death benefits with variable capital: The capital depends on the date of
survival of death. The most marketed contracts of this form are the
 degressive capital contracts, which are used to secure loans: we then talk about
temporary death coverage in loan or banking contract credits or
borrower death insurance contract.

Continuous case

Activity 4
We consider an insurance contract taken out by (to )the datet = 0 and guaranteeing the
payment of1on the date yes ≤ .
(a) Provide the notation for this cash flow
(b) We note by the likely present value of the guarantee. Express depending on ,
, and .
Express the mathematical expectation of depending on , , + and .

Solution
(a)(1{ ≤ }, )

(b) = − 1{ ≤ }

(c) ( )= ∫ 0 −
+

Note: Create a graphic illustration

1̅
Actuarial notation: ( =) : | ̅̅̅

ii. Discrete case

Activity 5
We consider an insurance contract subscribed by ( on
) the datet = 0 and guaranteeing the
payment of1on the date + 1yes + 1 ≤
Give the notation of this cash flow
(b) We note by the probable current value of this guarantee. Express based on
and .
(c)Express the mathematical expectation of depending on , , then
| depending on
, and + fork ≥ 0.
Solution
(d)(1{ +1≤ }, + 1)

(a) = +1 1
{ +1≤ }

1 +1 1 -1 +1
(b) ( )= : ̅̅̅ | = ( { +1≤ }) = ∑ =0 |

Note: Make a graphical illustration

1
Actuarial Notation: ( =) : | ̅̅̅
Activity 5
We consider an insurance contract subscribed by ( at) the datet = 0 and ensuring the
payment of at the date + 1yes + 1 ≤
Provide the notation for the corresponding cash flow, then determine the probable present value
of the insurer's commitment depending on (. )
2.1.3. Contract in case of life: deferred capital without counter insurance (pure endowment)
It is a life insurance contract by which the insurer guarantees the payment of a capital.
to a designated beneficiary or to the insured himself, if the insured is alive on a fixed date
the advance. In case of the insured's death before the set date, the insurer pays nothing and the premiums
payments remain acquired to him.

Activity 7
We consider an insurance contract taken out by (to )the date = 0 and guaranteeing the
payment of an amount of1on the date provided that > .
(a) Give the notation of this cash flow
(b) We denote by the probable current value of the guarantee. Express depending on ,
, and .
(c) Express the mathematical expectation of based on , , and .
Solution
(a) (1{ ,> } )

(b) = 1{ > }

(c) ( )= ,

Actuarial notation: ( =)
2.1.4.Mixed insurance contract
It is a contract by which the insurer commits to pay a capital amount to the designated beneficiary.
at the death of the insured, if it occurs during the term of the contract, or at the end of
contract, if the insured is still alive at that time.
The mix actually corresponds to the juxtaposition of a temporary death and a deferred capital.
In general, the capital planned in case of death is identical to the capital planned in case of life.
In this case, we are talking about a Mixed contract in the strict sense.

However, one may want to prioritize either the death component or the component
life by offering a formula where the death benefit is more or less high compared to the
life insurance. In this case, we are talking about a combined mixed contract.
i. Continuous case

Activity 8
We consider an insurance contract taken out by (to )the datet = 0 and guaranteeing the
payment of an amount of1at the date ≤ and an amount of 1 on the date yes >
Give the notation of this cash flow
(b) We note by the likely current value of the guarantee. Express depending on ,
, and .
Give the expression for the actuarial value of this commitment.
Solution
(d)(1{ ≤ }, ) + (1{ > }, )

(a) = men( , )

1̅
(b) ( )= : ̅̅̅ | +

ii. Discrete case

Activity 9
We consider an insurance contract taken out by (on) the date = 0 and guaranteeing the
payment of an amount of1at the date + 1 + 1 ≤ aand an amount of 1 on the date yes
+1> .
(a) Give the notation for this cash flow
(b) We denote by the probable current value of the guarantee. Express depending on ,
, and .
(c) Give the expression for the actuarial value of this commitment.
Solution
(a)(1{ +1≤ }, + 1) + (1{ +1> }, )

(b) = men( +1, )

1
(c) ( )= : ̅̅̅ | +

Actuarial Notation: ( =) : | ̅̅̅

2.1.5. Case of a contract in the event of death of a whole life deferred

In a deferred whole life insurance contract, the insurer commits to pay a capital sum upon death.
the insured, regardless of the date of occurrence beyond a given period referred to as deferred. If
The death occurs during the deferral period, the insurer pays nothing.
 Continuous case

Activity 10
We consider an insurance contract subscribed by ( to) date = 0 and ensuring the
payment of an amount of1on the date yes < ≤ +
(a) Provide the notation for this cash flow
(b) We note by the probable current value of the guarantee. Express depending on ,
, and .
(c) Provide the expression for the actuarial value of this commitment.
Solution
(a)(1{ < ≤ + }, )

(b) = − 1{ < ≤ + }

1̅
(c) ( =) | :̅̅̅ | = ∫ −
+

ii. Discrete case

Activity 11
We consider an insurance contract taken out by (at )the datet = 0 and guaranteeing the
payment of an amount of1as of the date + 1yes < +1≤u+ɡ
(a) Provide the notation for this cash flow
(b) It is noted by the current likely value of the guarantee. Express depending on ,
, and .
(c) Give the expression for the actuarial value of this commitment.
Solution
(a)(1{ < +1≤ + }, + 1)

(b) = +1∗ 1{ < +1≤ + }

1 + -1
(c) ( )= | :̅̅̅ | = ∑ = +
 Corollaries
1̅ ̅ 1 1 1
i. | : |̅̅̅ = ∗ + :̅̅̅ | and | = ̅̅̅ ∗: | ̅̅̅ + : |

1̅ 1̅ 1̅ 1 1 1
ii. | :̅̅̅ | = :̅̅̅̅̅̅̅ + |− :̅̅̅ | and | =:̅̅̅ | :̅̅̅̅̅̅̅ + |− :̅̅̅ |

1̅ 1̅ 1 1
iii. | :̅̅̅ | = ∑ = | ̅
:1| and | :̅̅̅ | = ∑ = | ̅
:1|

1̅ -1 1̅ 1 -1 1
iv. : ̅̅̅ | = ∑ =0 | ̅ and
:1| ̅̅̅ : =
| ∑ 0 | ̅
:1|

v. =̅ ∑∞ =0 |
1̅
̅
:1|

1
vi. : ̅̅̅ | = − =
| ∗ +

Proof: Making graphic illustrations

2.2. Contracts with variable capital

2.2.1. Temporary contract for increasing capital death in arithmetic progression

Activity 12
We consider an insurance contract subscribed by ( at) the date = 0 and guaranteeing the
payment of an amount of + 1at the date + 1yes + 1 ≤ ɡ
a) Provide the notation for this cash flow
(b) We note by the probable current value of the guarantee. Express depending on ,
, and .
(c) Give the expression of the actuarial value of this commitment.
Solution
(a)( ( + 1∗ )1{ +1≤ }, + 1)

(b) ( + 1∗ ) +1 1
{ +1≤ }

(c) ( )= ( 1) -1 +1
:̅̅̅ | = ∑ =0( k+1) |

2.2.2. Temporary contract decreasing death benefit

These types of contracts are used to secure loans and are also called death contracts.
borrower.
Activity 13

Let's consider an individual of agetaking out a loan of a value of 0on the datet = 0to a
interest rate for a duration of years. The borrowed capital is therefore repaid over the
years with interest and principal repayment. It is noted by the remaining capital to
payer (remaining principal) as of the date = 0, 12, … , before the refund on the date .

Express the actuarial value of this commitment in terms of , , and + and .

Solution

EXERCISES