Chapter 5

Chapter 5: Life Annuities

5.1 & 5.2 Introduction and summary

• What is an Annuity?
A regular series of payments, e.g., Mortgage payments, Pension, etc.

• What is a Life Annuity?

A series of payments to (or from) an individual as long as the individual (or annuitant) is
alive on the payment time.

– Payments are contingent on survival

• There are many different life annuity types and applications, including

– Retail product
– Life insurance premium & benefit determinations (Chapter 6)
∗ Most policy premiums are payable annually or monthly
– Pension plans benefit (and funding of benefits) at retirement
∗ Covered later in textbook (and in upper-year courses)
– Disability insurance

• We will review various types of life annuities, their IAN (International Actuarial Nota-
tion), how to value them, relationship to insurances, and relationship between different
annuity types and approximations used

– Material builds upon annuity-certain concepts covered in AS 2553

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• General types of life annuities

1. Whole life annuities payments for as long as person is living

2. Term (or temporary) life annuities payments for at most n years, as long as living
3. Deferred whole life annuities whole life annuities with the 1st payment deferred u years
4. Deferred Term (or temporary) life annuities term life annuity with at most n-year of
payments, where 1st payment deferred u years

We can look at categorizing each of the above types further:

– Payment frequency: Annual (5.4), continuously (5.5) or 1/mthly (5.6)

– If discrete, are payments at beginning (due) or end (immediate) of the period?
– Varying payments (step-rate, geometric, arithmetic or others)

• Majority of life annuities are payable more frequently than annually, so often need approxi-
mations for fractional periods

• Similar to life insurance, annuity values can be generated recursively and select mortality
rates can be used

• Life annuities are also often sold with a guarantee period and this can be readily handled for
any type of life annuity

5.3 Review of Annuity-Certain Formulas

• An annuity-certain is one annuity where the amount, the number and the timing of the
payments are fixed, not contingent on any other factors.

Let’s review the formulas for annuity-certain (including annuity-due and annuity-immediate):

• For example, annuity-due denoted by ä n is the Present Value (PV) of an annuity-certain of

$1 payable annually in advance for n years.

0 1 2 3 ··· n−1 n Time

$1 $1 $1 $1 $1

Annuity-immediate denoted by a n is the Present Value (PV) of an annuity-certain of $1

payable annually in arrear for n years.

0 1 2 3 ··· n−1 n Time

$1 $1 $1 $1 $1

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• Pay more frequently than once a year

1
For example, 1-year annuity-due (certain) payable m
thly:

0 1 2 3 ··· m−1 1 Time

m m m m
$ m1 $ m1 $ m1 $ m1 $ m1

1
For example, 1-year annuity-immediate (certain) payable m
thly:

0 1 2 3 ··· m−1 1 Time

m m m m
$ m1 $ m1 $ m1 $ m1 $ m1

• Formulas

1 − vn i
ä n = 1 + v + v 2 + v 3 + · · · + v n−1 = where d = ,
d 1+i

1 − vn
an = v + v2 + v3 + v4 + · · · + vn = = ä n − 1 + v n ,
i

(m) 1 1 1 1 1 1 − vn
ä n = + v 1/m + v 2/m + v 3/m + · · · + v n−1/m = (m) ,
m m m m m d

(m) 1 1/m 1 1 1 1 1 − vn
an = v + v 2/m + v 3/m + v 4/m + · · · + v n = (m) ,
m m m m m i
Z n
1 − vn
ā n = v t dt = .
0 δ

• Others:
¯ n =
Z n
ā n − n v n
(Iā) t v t dt = ,
0 δ
as well as (Ia) n , (Iä) n , (Da) n , (Dä) n .
(12)
Example 5.1 For an annuity notation 1500 ä 5 , how many payments are there, and how much is
each payment?

Answer. Total # of payments is 5 × 12 = 60. Each monthly payment is $1500/12 = $125.

Life annuities notation (IAN) builds upon some of notation above. Also, life annuities with a
guarantee period will be valued in part with a term certain.

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5.4 Annual life annuities

We will look at various types of life annuities with annual payments, including annuities-due,
annuities-immediate and guaranteed annuities.

Throughout this Chapter, we use Y to denote the Present Value Random Variable of a life annuity.

5.4.1 Whole Life Annuities-Due

Payments: $1 per year is payable annually in advance up to death of the annuitant

(a) Present Value Random Variable (PVRV)

0 1 2 3 ··· Kx Kx + 1 Time
$1 $1 $1 $1 $1

Note that
# of life annuity payments = Kx + 1.
The PVRV for a $1 whole life annuity-due is given by

Kx 1 − v Kx +1
PVRV = Y = 1 + v + · · · + v = ä Kx +1 = . (5.1)
d

(b) Expected Present Value (EPV)

A special Actuarial Notation is used to denote the EPV:

def
h i 1 − v Kx +1
äx = EPV = E[Y ] = E ä Kx +1 = E[ ].
d

- Three methods to calculate äx :

• Method 1: Connected to Insurance
Since
1 − v Kx +1 1 − E[v Kx +1 ]
äx = E[ ]= ,
d d
we have
1 − Ax
äx = . (5.2)
d
Hence, we relate the whole life annuity to whole life insurance, or equivalently

Ax = 1 − däx , or 1 = däx + Ax .

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• Method 2: Aggregate method

h i ∞
X
äx = E[Y ] = E ä Kx +1 = ä k+1 P[Kx = k].
k=0

Therefore,
∞
X ∞
X
äx = ä k+1 k| qx = ä k+1 k px qx+k .
k=0 k=0

• Method 3: Current payment method

Recall that X
EPV = E[Y ] = amount × discount × probability.

Therefore,
∞
v k k px .
X
äx =
k=0

(c) Calculation of Var[Y ]

• Method 1: Connected to Insurance
Since
1 − v Kx +1 Var[v Kx +1 ]
Var(Y ) = Var[ ]= ,
d d2
we have
2
Ax − (Ax )2
Var(Y ) = . (5.3)
d2

Again, we relate the whole life annuity to whole life insurance.

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• Method 2: Aggregate method Since the second moment is

h i ∞
E(Y 2 ) = E (ä Kx +1 )2 = (ä k+1 )2 k| qx .
X

k=0

Therefore,
∞
Var(Y ) = E(Y 2 ) − (EY )2 = (ä k+1 )2 k| qx − (äx )2 .
X

k=0

• Method 3: Current payment method (can not be used for variance)

Let Yi be the payment for the ith year, and we can show that

cov(Yi , Yj ) ̸= 0.

[TBC]

(d) Recursive formula

äx = 1 + v px äx+1 . (5.4)
Proof. Based on Method 3, the current payment method,
∞
v k k px
X
äx =
k=0
= v 0 0 px + v 1 px + v 2 2 px + v 3 3 p x + · · ·
 
= 1 + v px 1 + v 1 px+1 + v 2 2 px+1 + · · ·
= 1 + v px äx+1 .

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5.4.2 n-year Term (or Temporary) Life Annuities-Due

Payments: $1 per year is payable annually in advance until the earlier of death of the annuitant or
n years.

(a) Present Value Random Variable (PVRV)

Note that
# of life annuity payments = min(Kx + 1, n).
The PVRV for a $1 term life annuity-due is given by

 ä , 0 ≤ Kx ≤ n − 1,
PVRV = Y =  Kx +1 . (5.5)
ä n , Kx ≥ n,

or equivalently
1 − v min(Kx +1,n)
PVRV = Y = ä min(Kx +1,n) = . (5.6)
d

(b) Expected Present Value (EPV)

A special Actuarial Notation is used to denote the EPV:
" #
def
h i 1 − v min(Kx +1,n)
äx:n = EPV = E[Y ] = E ä min(Kx +1,n) =E .
d

- Three methods to calculate äx:n

• Method 1: Connected to Insurance
Since " #
1 − v min(Kx +1,n) 1 − E[v min(Kx +1,n) ]
äx:n = E = ,
d d
we have
1 − Ax:n
äx:n = . (5.7)
d
Hence, we relate the term life annuity to endowment life insurance!

Ax:n = 1 − d äx:n , or 1 = d äx:n + Ax:n .

• Method 2: Aggregate method
h i n−1
X
äx:n = E[Y ] = E ä min(Kx +1,n) = ä k+1 P[Kx = k] + ä n P[Kx ≥ n].
k=0

Therefore,
n−1
X
äx:n = ä k+1 k| qx + ä n n px .
k=0

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• Method 3: Current payment method

Recall that X
EPV = E[Y ] = amount × discount × probability.

Therefore,
n−1
v k k px .
X
äx:n =
k=0

(c) Calculation of Var[Y ]

• Method 1: Connected to Insurance
Since
1 − v min(Kx +1,n) Var[v min(Kx +1,n) ]
Var(Y ) = Var[ ]= ,
d d2
we have
 2
2
Ax:n − Ax:n
Var(Y ) = . (5.8)
d2

Again, we relate the term life annuity to endowment life insurance!

• Method 2: Aggregate method

Var(Y ) = E(Y 2 ) − (EY )2 ,

where the second moment is

h i n−1
2 2
(ä k+1 )2 k| qx + (ä n )2 n px .
X
E(Y ) = E (ä min(Kx +1,n) ) =
k=0

(d) Recursive formula

äx:n = 1 + v px äx+1:n−1 . (5.9)

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Example 5.2 For a whole life annuity-due issued to (50) that pays $10,000 annually. Determine
the standard deviation of the PVRV for this policy given i = 6% and the corresponding calculated
values:
2
ä50 = 13.26683, A50 = 0.2490475, A50 = 0.0947561.

[TBC]

x
Example 5.3 You are given S0 (x) = 1 − 80 for 0 ≤ x ≤ 80 and i = 5%. Y is the PVRV for a
3-year temporary life annuity-due of $1 per year.
Find (i) E(Y ) and (ii) Var(Y ) when x = 30.

[TBC]

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Example 5.4 For a whole life annuity-due of $1 on (x) payable annually:

qx = 0.01, qx+1 = 0.05, i = 5%, äx+1 = 6.951.

Calculate the change in the EPV of this annuity-due if px+1 increased by 0.03.

[TBC]

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5.4.3 u-year Deferred Whole Life Annuity-Due

A deferred annuity is an annuity under which the first payment occurs at some specified future time,
i.e., there is no payment made during the deferred period.

(a) Present Value Random Variable (PVRV)

Assume that each payment is $1. If (x) dies before time u, no payment will be made.

If (x) survives to time u, we have

0 1 ··· u u+1 ··· Kx Kx + 1 Time

$1 $1 $1

The PVRV for a $1 u-year deferred whole life annuity-due is given by


0, 0 ≤ Kx ≤ u − 1,
PVRV = Y =  u . (5.10)
v ä Kx +1−u , Kx ≥ u,

(b) Expected Present Value (EPV)

A special Actuarial Notation is used to denote the EPV:

def
u| äx = EPV = E[Y ],

which can be found using Method 2 and Method 3, respectively

∞ ∞
v u ä k+1−u v k k px .
X X
u| äx = k| qx , and u| äx =
k=u k=u

Alternative methods:
u| äx = äx − äx:u . (5.11)

u| äx = u Ex äx+u . (5.12)

Based on the two formulas above, what is the relationship between term life annuity and whole life
annuity? [TBC]

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Example 5.5 A whole life annuity-due is issued to (50) that provides for annual payments. The first
10 payments are $1,000 and every payment thereafter is $2,000.
You are given life annuity-due and pure endowment factors (based on i = 6%)

ä50 = 13.26683, ä60 = 11.14535, 10 E50 = 0.51086421.

(a) Calculate the EPV of this life annuity.

(b) What is the EPV if the first 10 payments are guaranteed to be made?

[TBC]

5.4.4 Guaranteed Whole Life Annuities-Due

• Whole life annuity with a n-year guarantee (first n years of payments are guaranteed,
payments thereafter contingent on survival)

(a) Present Value Random Variable (PVRV)


 ä
n, 0 ≤ Kx ≤ n − 1,
PVRV = Y = . (5.13)
 ä
Kx +1 , Kx ≥ n,

(b) Expected Present Value (EPV)

A special Actuarial Notation is used to denote the EPV:

def
äx:n = EPV = E[Y ],

we have
äx:n = ä n + n| äx , (5.14)
where the n-year deferred whole life annuity-due is discussed in the previous subsection.

*Note: any type of life annuity can have a guarantee period (e.g., see Example 5.8).

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More Examples:

Example 5.6 Calculate the EPV of a three-year term life annuity-due of $100 on (75). You are
given i = 5% and Z x
µt dt = 0.01x1.2 , x > 0.
0

[TBC]

Example 5.7 (Policy with two benefits) For a special 30-year deferred whole life annuity-due of
$200 paid annually on (30), you are given

(i) The single benefit premium is refunded without interest at the end of year of death if death
occurs during the deferral period
(ii) From the mortality table, A30 = 0.10248, A60 = 0.36913, 30 E30 = 0.150044.
(iii) i = 6%.

Calculate the single benefit premium for this policy.

(Note: Single benefit premium = EPV of benefits. This is the so-called net premium, which will be
discussed further in Chapter 6.)

[TBC]

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Example 5.8 A 20-year term life annuity due is issued on (35) that provides for annual payments
of $6,000. The first 5 payments are guaranteed. Calculate the Expected present value (EPV) of this
annuity. Assume i = 5% and that mortality follows the SOA-FAM-L Standard Ultimate Life Table.

[TBC]

Example 5.9 (Exercise) A whole life annuity due that provides for annual payments of $10,000 is
purchased by (60). You are given that i = 5% and that mortality follows the SOA-FAM-L Standard
Ultimate Life Table except in the first two years where the mortality rates are higher denoted by q ∗ .
∗ ∗
You are given that q60 = 0.003 and q61 = 0.0035. Calculate the expected present value (EPV) of
this annuity.

[Answer: 14.91346] (Similar to Example 5.4)

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5.4.5 Immediate Life Annuities

• Payments are made at the end of the period (end of year for annual annuities)

(a) Whole Life Annuity-Immediate:

– Present Value Random Variable (PVRV)

0 1 2 3 ··· Kx Kx + 1 Time
$1 $1 $1 $1

The PVRV for a $1 whole life annuity-immediate is given by

PVRV = Y = v + · · · + v Kx = a Kx .

– Expected Present Value (EPV)

The Actuarial Notation for EPV is ax :

ax = äx − 1. (5.15)

Or using Method 1 (connected to insurance),

v − Ax
ax = .
d
Or using Method 3 (current payment method),
∞
v k k px .
X
ax =
k=1

– Variance
Since Y = a Kx = ä Kx +1 − 1, the variance of whole life annuity-immediate is the same
is the variance of whole life annuity-due:
2
Ax − (Ax )2
Var(Y ) = . (5.16)
d2

(b) Term Life Annuity-Immediate:

– Present Value Random Variable (PVRV)

The PVRV for a $1 term life annuity-immediate is given by

a , Kx ≤ n − 1,
PVRV = Y = v + · · · + v min(Kx ,n) = a min(Kx ,n) =  Kx .
an , Kx ≥ n,

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– Expected Present Value (EPV)

The Actuarial Notation for EPV is ax:n :

ax:n = äx:n − 1 + v n n px . (5.17)

Or note that a m = ä m+1 − 1 (the relationship between annuity-immediate and annuity-

due), we have
Y = a min(Kx ,n) = ä min(Kx +1,n+1) − 1, (5.18)
therefore, we relate the n-year term life annuity-immediate to (n + 1)-year term life
annuity-due,
ax:n = äx:n+1 − 1. (5.19)

Or using Method 3 (current payment method,

n
v k k px .
X
ax:n =
k=1

– Variance
Using (5.18), the variance of n-year term life annuity-immediate is the same is the
variance of (n + 1)-year term life annuity-due:

2
Ax:n+1 − (Ax:n+1 )2
Var(Y ) = . (5.20)
d2

(c) u-year deferred whole life annuity-immediate

EPV = u| ax = ax − ax:u = u Ex ax+u .

(d) u-year deferred n-year term life annuity-immediate

EPV = u| ax:n = ax:u+n − ax:u = u Ex ax+u:n .

(e) n-year guaranteed life annuity-immediate

EPV = ax:n = a n + n| ax = a n + n Ex ax+n .

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Example 5.10 Determine the EPV of a life annuity issued to (50) that pays $12,000 at the end of
each year for 10 years. You are given i=6% and the corresponding calculated values:

ä50 = 13.26683, ä60 = 11.14535, v 10 10 p50 = 0.51086421

[TBC]

Example 5.11 Assume that

20 Ex = 0.35, 20 qx = 0.3, Ax:20

1 = 0.5.

Find ax:20 .

[TBC]

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5.5 Life Annuities Payable Continuously

• Payments are made at a continuous rate of $1 per year contingent on survival.
Note that:
1
If annuity (of $1 per year) is payable weekly, each annuity payment is $ 52 ;
1
If annuity (of $1 per year) is payable daily, each annuity payment is $ 365 ;
If annuity (of $1 per year) is payable continuously, each annuity payment for an infinites-
imal interval (t, t + dt)is $dt.

5.5.1 Whole Life Continuous Annuity

• Payments are made at a continuous rate of $1 per year up to the death of the annuitant

(a) Present Value Random Variable (PVRV)

The PVRV for a $1 whole life continuous annuity is given by
Z Tx
1 − v Tx
PVRV = Y = v t dt = ā Tx = . (5.21)
0 δ

(b) Expected Present Value (EPV)

A special Actuarial Notation is used to denote the EPV:

1 − v Tx
" #
def
h i
āx = EPV = E[Y ] = E ā Tx =E .
δ

– Method 1: Connected to Insurance

1 − Āx
āx = . (5.22)
δ
– Method 2: Aggregate method Recall the density of Tx is f (t) = t px µx+t
h i Z ∞
āx = E ā Tx = ā t t px µx+t dt. (5.23)
0

– Method 3: Current payment method

Z
EPV = E[Y ] = amount × discount × probability.

Z ∞ Z ∞
āx = v t t px dt = e−δt t px dt. (5.24)
0 0

See the diagram in the next page.

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*Note that when δ = 0, āx = e̊x the complete expectation of life.

(c) Variance

– Method 1: Connected to Insurance

Since
1 − v Tx Var[v Tx ]
Var(Y ) = Var[ ]= ,
δ δ2
we have
 2
2
Āx − Āx
Var(Y ) = . (5.25)
δ2
– Method 2: Aggregate method
Var(Y ) = E(Y 2 ) − (EY )2 ,
where the second moment is
h i Z ∞
2 2
E(Y ) = E (ā Tx ) = (ā t )2 t px µx+t dt.
0

5.5.2 Term Life Continuous Annuity

(a) Present Value Random Variable (PVRV)
The PVRV for a $1 term life continuous annuity is given by

Z min(Tx ,n)  ā
Tx , 0 < Tx < n,
PVRV = Y = v t dt = ā min(Tx ,n) = .
0  ā
n, Tx ≥ n,

(b) Expected Present Value (EPV) A special Actuarial Notation is used to denote the EPV:

1 − v min(Tx ,n)
" #
def
h i
āx:n = EPV = E[Y ] = E ā min(Tx ,n) =E .
δ

– Method 1: Connected to Insurance

1 − Āx:n
āx:n = . (5.26)
δ

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– Method 2: Aggregate method

h i Z n
āx:n = E ā min(Tx ,n) = ā t t px µx+t dt + ā n n px . (5.27)
0

– Method 3: Current payment method

Z n Z n
āx:n = v t t px dt = e−δt t px dt. (5.28)
0 0

*Note that when δ = 0, āx:n = e̊x:n the n-year term expectation of life.

(c) Variance

2
Āx:n − ( Āx:n )2
Var(Y ) = . (5.29)
δ2

Other types of continuous annuities are similar.

Example 5.12 Consider a continuous whole life annuity of $1 on (x). Assume the constant force of
mortality µ = 0.06 and the constant force of interest δ = 0.04. Calculate the probability that the
present value of the annuity payments is larger than its EPV.

[TBC]

Example 5.13 Find the Var(Y ) where Y = ā Tx . You are given µx+t = c, δ = 8% and Āx = 0.3443.

[TBC]

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1
5.6 Life Annuities Payable m thly
• $1 per year is payable 1
m
thly contingent on survival.
Note that:
1
If annuity (of $1 per year) is payable weekly, each annuity payment is $ 52 ;
1
If annuity (of $1 per year) is payable daily, each annuity payment is $ 365 ;

• Note that when m = 1, it becomes the life annuity with annual payment; when m → ∞, it
becomes the life continuous annuity.

1
5.6.1 Whole life annuity-due payable m
thly:
• Payments of 1
m
made at the beginning of each 1
m
th of a year for as long as (x) lives

(a) Present Value Random Variable (PVRV)

Recall that the random variable Kx(m) :

1
Kx(m) = ⌊m Tx ⌋ = the future lifetime of (x) in years rounded to the lower 1/m of a year
m

Time 0 1 2 3 ··· 1
m m m Kx(m) Kx(m) + m
1 1 1 1 1
Payments m m m m m

1
The PVRV for a $1 whole life annuity-due payable m
thly is given by

(m) 1
1 1 1 1 (m) (m) 1 − v Kx +m
PVRV = Y = + v m + · · · + v Kx = ä (m) 1 = . (5.30)
m m m Kx + m d(m)

(b) Expected Present Value (EPV)

A special Actuarial Notation is used to denote the EPV:
(m) 1
def
h
(m)
i 1 − v Kx +m
ä(m)
x = EPV = E[Y ] = E ä = E[ ].
(m)
Kx 1
+m d(m)

– Method 1: Connected to Insurance

1 − A(m)
x
ä(m)
x = . (5.31)
d(m)

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– Method 2: Aggregate method

∞ ∞
(m) k (m)
ä(m) P[Kx(m) =
X X
x = ä k 1
]= ä k 1 k 1
| qx .
k=0 m
+m m k=0 m m
+ m m

– Method 3: Current payment method

∞
1 k
ä(m)
X
x = vm k px .
k=0 m m

(c) Calculation of Var[Y ]

– Method 1: Connected to Insurance

 2
2
A(m)
x − A(m)
x
Var(Y ) = . (5.32)
(d(m) )2
– Method 2: Aggregate method
∞
(m)
Var(Y ) = E(Y 2 ) − (EY )2 = )2 qx − (ä(m) 2
X
(ä k 1
k 1
| x ) .
m
+m m m
k=0

(d) Recursion formula

1 1 (m)
ä(m)
x = + vm 1 px äx+ 1 .
m m m

• Whole life annuity-immediate payable 1

m
thly:
1 1
- Payments of m
made at the end of each m
th of a year for as long as (x) lives

1
a(m)
x = ä(m)
x − . (5.33)
m
1
(Only difference is that m
is not paid at time t = 0.)

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1
5.6.2 Term life annuity-due payable m
thly
• Payments of m1 made at the beginning of each 1
m
th of a year until the earlier of n years
(maximum of nm payments) or when (x) dies.
(a) Present Value Random Variable (PVRV)
1
The PVRV for a $1 n-year term life annuity-due payable m
thly is given by
(m) 1
,n)
(m) 1 − v min(Kx +m
PVRV = Y = ä = . (5.34)
min(Kx
(m) 1
+m ,n) d(m)

(b) Expected Present Value (EPV)

– Method 1: Connected to Insurance

(m)
(m) 1 − Ax:n
äx:n = . (5.35)
d(m)
– Method 2: Aggregate method
nm−1
(m) X (m) (m)
äx:n = ä k 1
k 1
| qx + ä n n px .
m
+m m m
k=0

– Method 3: Current payment method

nm−1
(m) X 1 k
äx:n = vm k px .
k=0 m m

(c) Calculation of Var[Y ] using Method 1: Connected to Insurance

(m) 2
 
2 (m)
Ax:n − Ax:n
Var(Y ) = . (5.36)
(d(m) )2

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• n-year term life annuity-immediate payable 1

m
thly:
-Payments of m1 made at the end of each 1
m
th of a year until the earlier of n years (maximum
of nm payments) or when (x) dies.

(m) (m) 1 1 n
ax:n = äx:n − + v n px . (5.37)
m m

(The differences happen at time 0 and time n.)

1
Other types of life annuities payable m
thly are similar.

5.7 Comparison of annuities by payment frequency

• For each age group, the following holds

ax < a(m)
x < āx < ä(m)
x < äx (5.38)

• Text Table 5.1:

Note: same ordering occurs with term life annuities (see text Table 5.2).

• There are two reasons for this ordering.

– Due to the payments timing.

The payments under the annuity-due are paid earlier.
– Due to the payment amount in the year of death.
Under the annual annuity-due, the full year’s payment of $1 is paid, as the life is alive at
the payment date. However, the annual annuity-immediate has no payment made at the
end of the year of death.

• We will cover how to approximate continuous annuity and annuity payable 1

m
thly from annual
annuities in Section 5.11.

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5.8 Deferred Annuities

• Material was covered earlier in Section 5.4, which can be extended to other types of annuities
covered as well. For example, a u-year deferred n-year term life annuity-due

u| äx:n = äx:u+n − äx:u ,

or
u| äx:n = u Ex äx+u:n

• Any n-year term life annuity can be valued as a series of n one year deferred life annuities,
for example
n−1
X
äx:n = u| äx:1 .
u=0

Example 5.14 You are given that 10 p30 = 0.99611, 10 p40 = 0.99233, i = 6%, and also

ä30:10 = 7.79064, ä40:10 = 7.78144, ä50 = 15.1511.

Find (a) 10 E30 ; (b) ä30:20 ; (c) ä30 .

[TBC]

Example 5.15 (Exercise) You are given the force of interest δ = 0.06 and the force of mortality

0.01, 0<t<5
µx (t) =
0.02, t ≥ 5.

Find āx .

(Hint: separate the whole life annuity into a term life annuity and a deferred whole life annuity.)
[Answer: 13.027]

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5.9 Guaranteed Annuities

• Material was covered earlier in Section 5.4, which can be extended to other types of annuities
covered as well.

Example 5.16 (Textbook Example 5.4) A pension plan member is entitled to benefit of $1,000 pear
month, in advance, for life from age 65, with no guarantee. She can opt to take a lower benefit, with
a 10-year guarantee. The revised benefit is calculated to have equal EPV at age 65 to the original
benefit. Calculate the revised monthly benefit using
(12) (12)
ä65 = 13.087, ä75 = 9.854, 10 p65 = 0.876938

with interest at 5% per year.

d(m) m
Note that (1 − m
) = 1
1+i
, or equivalently d(m) = m[1 − (1 + i)−1/m ]. [TBC]

Example 5.17 (Exercise) A person (40) wins $10,000 in a lottery. Rather than receiving the money
at once, the winner is offered an equivalent option of receiving an annual payment of $K at the
beginning of each year guaranteed for 10 years and continuing thereafter for the whole life. Assume
payments are made at the beginning of each year.
You are given
1
d = 0.05, A40 = 0.30, A50 = 0.35, A40:10 = 0.09.
Find K.

[Answer: 631.90]

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5.10 Varying Annuities

• Their EPVs can always be valued using Method 3: Current Payment Method as a sum of
varying pure endowments,

Rk v k k px , where Rk is the payment amount at time k.

X
EPV =

• Life annuities that vary in step-rate fashion can be split and valued using term life annuities
and deferred life annuities, and you should be able to work with these types of problems (e.g.,
Examples 5.5 and 5.20)

• Text focuses on arithmetically and geometrically increasing annuities

5.10.1 Arithmetically increasing annuities

• We can look in theory at any life annuity type varying arithmetically

(1) Annually increasing whole life annuity-due:

∞
(k + 1) v k k px
X
EPV = (Iä)x = (5.39)
k=0

(2) Annually increasing n-year term life annuity-due:

n−1
(k + 1) v k k px
X
EPV = (Iä)x:n = (5.40)
k=0

(3) Annually increasing n-year term continuous life annuity:

n−1
X Z k+1
EPV = (Iā)x:n = (k + 1) v t t px dt (5.41)
k=0 k
R1 R2
For example, (Iā)x:2 = 0 v t t px dt + 2 1 v t t px dt.

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 Chapter 5

(4) Continuously increasing continuous whole life annuity:

Z ∞
¯ x=
EPV = (Iā) t v t t px dt (5.42)
0

(5) Annually decreasing n-year term life annuity-due:

n−1
(n − k) v k k px
X
EPV = (Dä)x:n = (5.43)
k=0

Also, note that

(Iä)x:n + (Dä)x:n = (n + 1)äx:n .

5.10.2 Geometrically increasing annuities

• We can look in theory at any life annuity type varying geometrically (more common than
the arithmetic case).
• It could be used to offset the effect of inflation on the purchasing power of the payments
received by the annuitant.
• Consider a whole life annuity-due varying geometrically

∞
(1 + j)k v k k px = ä∗x ,
X
EPV = (5.44)
k=0

where ä∗x is the whole life annuity-due evaluated at v ∗ = (1 + j)v, or equivalently,

1+i i−j
i∗ = −1= .
1+j 1+j
• Similarly, for a n-year term life annuity-due varying geometrically
n−1
(1 + j)k v k k px = ä∗x:n ,
X
EPV = (5.45)
k=0

i−j
where ä∗x:n is the n-year term life annuity-due evaluated at i∗ = 1+j
.

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 Chapter 5

Example 5.18
¯ x . Can you connect it to (I¯Ā)x ?
(a) Write out the PV random variable for (Iā)
¯ x directly.
(b) Given µ = 0.04 and δ = 0.06, calculate (Iā)

[TBC]

Example 5.19 A five year life annuity due is purchased by (50).The first payment is $2,000 and
each successive payment increases by 3%. Assuming i=4.5% and given mortality determine the
EPV for this life annuity.

q50 = 0.00376, q51 = 0.00406, q52 = 0.00447, q53 = 0.00492

[TBC]

Example 5.20 Determine an expression for the EPV for a life annuity-due issued to a person age
30 if the benefits are:
$10,000 per year from age 30 to 39;
$25,000 per year from age 40 to 49; and
$40,000 thereafter

[TBC]

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 Chapter 5

5.11 Evaluating Annuity Functions

5.11.1 Recursions
• We have covered backward recursion formulas earlier in Sections 5.4 and 5.6, such as

äx = 1 + v px äx+1 ,

and
1 1 (m)
ä(m)
x = + vm 1 px äx+ 1 ,
m m m

• If there is an integer limiting age ω so that qω−1 = 1. First set äω−1 = 1. Then use the
backward recursion for x = ω − 2, ω − 3, . . ., we can construct äx in the spreadsheet. (Similar
to Chapter 4)

5.11.2 Approximations
• Approximations for annuities payable more frequently than annually

– UDD within each year of age

– Woolhouse’s formula

(a) Method 1: applying UDD assumption

Recall that, under the UDD assumption
i i
Āx = Ax , A(m)
x = Ax .
δ i(m)
Using
1 − A(m)
x 1 − Ax
ä(m)
x = , äx = ,
d(m) d
we can show that, under the UDD assumption

ä(m)
x = α(m)äx − β(m), (5.46)

where
id i − i(m)
α(m) = , β(m) = .
i(m) d(m) i(m) d(m)
*Note that α(m) and β(m) are given in the distribution table.

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 Chapter 5

Example 5.21 For an annuity payable semi-annually, you are given:

(i) Death are uniformly distributed over each year of age.
(ii) q69 = 0.03, i = 0.05, 1000Ā70 = 530.
(2)
Find ä69 . [TBC]

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 Chapter 5

(b) Method 2: Woolhouse’s formula

• Woolhouse’s formula is a method of calculating the EPV of annuities payable more frequently
than annually that is not based on a fractional age assumption.

• It express ä(m)
x in terms of äx using the first three term from Euler-Maclaurin formula. The
Euler-Maclaurin formula is a numerical integration method (see Appendix B in the textbook).

• Woolhouse’s formula (W3 formula)

m − 1 m2 − 1
ä(m)
x ≈ äx − − (δ + µx ), (5.47)
2m 12m2

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 Chapter 5

Example 5.22 Given corresponding life annuity due factors below and assuming i=5%:

ä40 = 14.81661, ä70 = 8.56925, 30 E40 = 0.12369.

(i) Calculate the following assuming UDD (within each year of age)
(12) (12) (12)
(a) ä40 , (b) ä40:30 , (c) 30| ä40 .

(ii) Calculate the above using Woolhouse’s formula with 2 terms (W2). [TBC]

Example 5.23 Given that using the Woolhouse’s formula (W3)

(2) (4)
ä80 = 8.29340, ä80 = 8.16715,
(12)
find ä80 under the W3 formula. [TBC]

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5.12 Numerical illustrations

Comparison of approximation methods to exact calculations (textbook Tables 5.3 and 5.4)

• Woolhouse’s formula with 3 terms (W3) is the best method; gives excellent results and is
more efficient than exact calculations (Less calculations required)

• UDD is also very good, but W3 is better at older ages

• W2 is worst approximation

• W3* in text is W3 with µx approximation:

1
µx ≈ − (ln px−1 + ln px ).
2

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 Chapter 5

5.13 Functions for select lives

• Select mortality can be readily reflected in annuity calculations

Example 5.24 (Exercise)

Assume i = 5% and the following mortality rates

Issue age x q[x] q[x]+1 q[x]+2 qx+3 Attained age x + 3

70 0.0175 0.0250 0.0315 0.0375 73
71 0.0190 0.0275 0.0345 0.0425 74
72 0.0210 0.0300 0.0375 0.0465 75

(a) Determine 10(Dä)[71]+1:4 .

(b) Determine the variance for the contract in Part (a).
(c) What is the EPV for a 2 year deferred 3 year term life annuity-due issued to [71]? Assume that
the annual payment amount is $2,500. [TBC]

[Answer: (a) 92.585 ; (c)5,966.52]

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