BWRR3023: Actuarial Science

Topic 3: Annuities & Life Annuities

Mdm Rodziah Ahmad College of Business Univerisiti Utara Malaysia Semester II 2010/2011

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Contents
3.1 Introduction 3.2 Types of Annuities with compound interest 3.3 Relationship between Annuities Due/ Immediate 3.4 Perpetuity 3.5 Deferred Annuities 3.6 Life Annuities 3.7 Discrete Life Annuities 3.8 Continuous Life Annuities 3.9 Life Annuities with monthly payments

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3.1 Introduction
y y y

y y

An annuity is a series of payments made at equal intervals Ex: a car loan is repaid with equal instalment A retiree purchases an annuity from insurance company upon his retirement A life insurance policy is purchased with monthly premiums. For discussion purpose, we assume the annuities with fixed amount, no default risk
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3.2 Types of Annuities with compound interest

y

3.2.1 Annuities immediate

payment at the end of interval 0 1 2 .. n-1 n

3.2.2 Annuities-due :
Payments due at the beginning of period

0 1 2

..

n-1 n

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3.2.13.2.1-1 Annuities Immediate (PV)

Consider an annuity with payments of 1 unit each made at the end of every year until n-years. y PV of the annuity
y

an | ! v  v  v  ...  v 1 v ! i
n

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3.2.13.2.1-2 Annuities Immediate (FV)

y

The accumulated value of annuity at time n (future value of a )

n|

sn !

a n * (1  i ) n i

(1  i ) n  1 ! i

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3.2.13.2.1-3 Annuities Immediate (Regular payment,P) payment,P)

If the annuity is a regular payment of P, y PV !Pa | n
y y

FV ! Psn |

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3.2.13.2.1-4 Annuities Immediate (Example I)

Calculate the present value of an annuity immediate of amount $100 paid annually for 5 years at the rate of interest of 9%. Also calculate its future value at time 5 y Solutions: 5
y

1  1.09 PV 100  a5 ! 100  0.09 ! $388.97 FV 100  s5 ! a5 1.095 ! $598.47

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3.2.13.2.1-4 Annuities Immediate (Example II)

y

A man borrows a loan of $20,000 to purchase a car at annual nominal rate of interest of 6%. He will pay back the loan through monthly installments over 5 years, with the first installment to be made one month after the release of the loan. What is the monthly installment he needs to pay?
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3.2.13.2.1-4 Annuities Immediate (Example II)

y

$20,000 ! P  a6 0 0.05

Solutions: The rate of interest per payment period is (6/12)% = 0.5%. Let P be the monthly installment. As there are 5x12 = 60 payments:

1  (1.005)  60 ! P  51.7256 $20,000 ! P  0.005 $20,000 ! $386.66 P! 51.7256

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3.2.13.2.1-4 Annuities Immediate (Example III)

y

A man wants to save $100,000 to pay for his sons education overseas in 10 years time. An education fund requires the investors to deposit equal installments annually at the end of each year. If interest of 7.5% is paid, how much does the man need to save each year in order to meet his target?
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3.2.13.2.1-4 Annuities Immediate (Example III)

y

Solutions: We first calculate, future value:

s1 0
y

(1.075)10  1 ! ! 14.1471 0.075

Then the required amount of installment, P is

$100,000 $100,000 P! ! ! $7,068.59 s1 0 14.1471
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3.2.23.2.2-1 Annuities Due (PV)

y

Consider an annuities with payments of 1 unit each made at the beginning of every years until n-years:
  an

n ! 1  v  ...  v n 1  a 1 vn 1 vn ! ! d 1 v
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3.2.23.2.2-2 Annuities Due (FV)

 | ! an | * (1  i ) n  s  n (1  i )  1 ! d
n

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3.2.2- Annuities3.2.2-3 Annuities-Due (Example)

y

A company wants to provide a retirement plan for an employee who is aged 55 now. The plan will provide her with an annuityimmediate of $7,000 every year for 15 years upon her retirement at the age of 65. The company is funding this plan with an annuitydue of 10 years. If the rate of interest is 5%, what is the amount of installment the company should pay?
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3.2.2- Annuities3.2.2-3 Annuities-Due (Example)

Solution: y We first calculate the PV of the retirement annuity. This is equal to:
y

$7,000a1 5
y

1  (1.05) 15 ! $7,000 v ! $72,657.61 0.05

 P 0| s1 This amount should be equal to the FV of the company installments, P which is

(1.05)10 1  P 0| ! P v s1 ! P v13.2068! $72,657.61 1 (1.05)1 P ! $72,657.61 ! $5,501.53 13.2068
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3.3 Relationship between Annuities Due and Immediate

  an | ! (1  i )an | and  | ! (1  i ) sn | s n

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3.4 Perpetuity
Perpetuity is an annuity with no termination date. n 1@ n p g ;v p 0 yn v As 1  vn an| ! i 1 ag| ! i 1 g a | ! d
y
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3.5 Deferred Annuities

Of one for which the first payment is made sometime in the future. y n-period annuity-immediate:
y

An annuity with n payments for which the first payment is to be made at time m+1. The PV of this annuity is
1 vn v an | ! v i ! a m  n|  a m |
m m

a m  n| ! a m |  v m a n |
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3.6 Life Annuities

A life annuity is a series of payments made at equal intervals during the future lifetime of a given individual y It is contingent upon the survival of the recipient (annuitant) y PV of the annuities that involve the contingent payment is Actuarial Present Value.
y
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3.7.1 Discrete n-year Temporary nlife annuity

a) Discrete n-year temporary life annuity-immediate with a payment of 1 unit n
a x:n| ! v k k p x
k !1

b) Discrete n-year temporary life annuity-due

  a x:n| ! v k k p x
k !0 n 1

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3.7.1 Discrete n-year Temporary nlife annuity

y

Relationship between (a) and (b)

  a x:n| ! 1  a x:n 1|

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3.7.1 Discrete n-year Temporary nlife annuity

Example: Find APV of 3 years temporary life annuities immediate issued to a person aged 45 from this life table. With interest rate =5%
x 45 46 47 48 lx 964,187 962,106 959,855 957,421
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3.7.1 Discrete n-year Temporary nlife annuity

Solutions:
3

a45:3| ! vk k p45
k !1

! v1 p45 v2 2 p45 v3 3 p45

l46 2 l47 3 l48 ! v v v l45 l45 l45 962106 , , , 2 959855 3 957421 )  (1.05) ( )  (1.05) ( ) ! (1.05) ( 964187 , 964187 , 964187 , ! 0.95032 0.90295 0.85778   ! 2.71105
1
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3.7.2 Discrete Whole Life Annuities

a) Discrete whole life annuityimmediate that makes payments at the end of every year as long as the annuitant survives. g
a x ! v k *k p x

b) Discrete whole life annuity-due that makes payments at the beginning of every year as long as the annuitant survives. g

k !1

x ! v k *k p x  a
k !0

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3.7.2 Discrete Whole Life Annuities

y

Relationship between a x and a x 1    

    a x ! 1  v * p x * a x 1

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3.7.3 Discrete Deferred Life Annuities

y

Discrete n-year deferred whole life annuity-due

n|

  a x ! v *k p x
k k !n

Discrete n-year deferred whole life annuity-immediate

g
n|

ax !

v * p
k k k ! n 1

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3.7.3 Discrete Deferred Life Annuities

y

Discrete n-year certain and whole life annuity-due

g

        a x:n | ! an |  v k *k p x !an |  n| a x
k !n

Discrete n-year certain and whole life annuity-immediate

a x:n | ! an |  v k *k p x !an |  n| a x
k ! n 1
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3.7.3 Discrete Deferred Life Annuities

y

Actuarial accumulated value of an n-year temporary annuity-due paying 1 every year while life (x) survives is denoted by:

x:n | !  ! s E x k !0 n
n 1

  a x:n |

1 nk Exk
n

Whereby
n

E x ! v *n p x
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3.8 Continuous Life Annuities

y

Continuous Whole life annuity

payments are made continuously, with a momentary payment of dt made at every time, t.

a x ! v *t p x dt 0 y Continuous n-year temporary life annuity

t

Payments at most up to time n (if the annuitant survives until time n)

a x:n | ! v *t p x dt
t 0
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3.8 Continuous Life Annuities

y

Relationship between a x and a x 1

a x ! a x:1|  vp x * a x 1

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Example:
y

A continuous whole and temporary life annuities pays 1*dt in benefits at each time, t. A 5-y-o can get either one-year temporary life annuity with PV of 0.67 or a whole life annuity with PV of 5.6. The annual force of interest =0.2. A 5y-o has a probability of 0.77 to survive to age 6. Find the APV of this product available to a 6-y-o.
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Solutions:
y

We use ax ! ax:1|  vpx * ax 1

a5 ! 5.6 and a5:1| ! 0.67 v!e
 0.2

a x 1

? !

and p5 ! 0.77 a x  a x:1|

vp x

(5.6  0.67) ! 7.82015 a6 !  0.2 e * 0.77

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3.9 Life Annuities with monthly payments

y

If we have series of payment with P, times the P with the relevant annuities

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