Faculty of Actuaries Institute of Actuaries

EXAMINATIONS

5 April 2001 (am)

Subject 106 — Actuarial Mathematics 2

Time allowed: Three hours

INSTRUCTIONS TO THE CANDIDATE

1. Write your surname in full, the initials of your other names and your
Candidate’s Number on the front of the answer booklet.

2. Mark allocations are shown in brackets.

3. Attempt all 9 questions, beginning your answer to each question on a

separate sheet.

Graph paper is not required for this paper.

AT THE END OF THE EXAMINATION

Hand in BOTH your answer booklet and this question paper.

In addition to this paper you should have available

Actuarial Tables and an electronic calculator.

ã Faculty of Actuaries
106—A2001 ã Institute of Actuaries
1 The triangle below shows incremental claims for a portfolio of general insurance
policies. The data have already been adjusted to take account of inflation effects.
Calculate the basic chain ladder development factors, and the implied grossing-
up factors.

2,541 1,029 217

2,824 790
1,981 [5]

2 A generalised linear model has independent Binomial responses Z1 , …, Zk with

E(Zi) = nµ, Var(Zi) = nµ(1 − µ) for 0 < µ < 1.

(i) Show that Yi = Zi /n belongs to an exponential family. [2]

(ii) Identify the natural parameter and the canonical link function, and derive
the variance function. [4]
[Total 6]

3 The aggregate claims process for a particular risk is a compound Poisson process
with λ = 20. Individual claim amounts are £100 with probability ¼, £200 with
probability ½, or £250 with probability ¼. The initial surplus is £1,000. Using a
Normal approximation, calculate approximately the smallest premium loading
factor θ such that the probability of ruin at time 3 is at most 0.05. [7]

4 (i) Let S = X1 + … + XN , where X1 , X2 , … are independent, identically

distributed random variables, and N is a random variable independent of
the Xi’s. Derive an expression for the moment generating function of S in
terms of the probability generating function of N and the moment
generating function of Xi . [2]

(ii) In a group of policies, the monthly number of claims for a single policy has
a Poisson distribution with parameter λ, where λ is a random variable
with density f(λ) = 2e−2λ, λ > 0.

(a) Show that the probability of n claims on a policy picked at random

2
from the group is n+1 , n = 0, 1, 2, …
3

(b) Find the moment generating function for the aggregate claims
distribution if the claims have a gamma distribution with mean 2
and variance 2. [6]
[Total 8]

106 A2001—2
5 A company is considering setting up a new class of insurance. All risks will be at
one of four possible levels of intensity, I1 , I2 , I3 and I4. The company has to
decide at what level to set the premium, which will attract differing amounts of
business as follows:

Annual premium £85 £81 £79

No. of policies (‘000s) 100 150 200

The company has annual fixed costs of £1.5 million plus annual per policy
expenses of £18. Under each level of intensity the company expects to pay out an
average in claims per policy of:

Level of intensity I1 I2 I3 I4
Average cost (£) 40 45 57 60

(i) Determine the minimax solution based on annual profits. [7]

(ii) Given the probability distribution p(I1) = 0.1, p(I2) = 0.4, p(I3) = 0.3,
p(I4) = 0.2, determine the Bayes criterion solution based on annual profits.
[2]
[Total 9]

6 An insurance company is monitoring the length of time staff take to pick up

telephones after they first ring. It is assumed that the time follows an
exponential distribution with parameter θ.

10 calls are monitored at random and the average response time is calculated as
3.672 seconds.

(i) (a) Show that the gamma distribution is the conjugate prior
distribution for θ .

(b) Assuming that the prior distribution for θ has mean 0.315 and
standard deviation 0.251, derive the posterior distribution of θ and
calculate the Bayesian estimator of θ under quadratic loss. [7]

(ii) A further 70 calls are monitored and have the same average response time
of 3.672 seconds. Calculate the Bayesian estimator of θ under quadratic
loss using all the data collected. [2]

(iii) Comment on your answers in (i) and (ii) [2]

[Total 11]

106 A2001—3 PLEASE TURN OVER

7 A no claims discount system has four levels, 0%, 25%, 50% and 75%. The rules
for moving between levels are as follows:

If no claims are made in one year, the policyholder moves to the next
higher level, or remains at the 75% level;

If one claim is made in one year, the policyholder moves down one level, or
remains at the 0% level;

If two or more claims are made, the policyholder moves straight down to,
or remains at, the 0% level.

Policyholders at different levels are found to experience different rates of

claiming. The number of claims made per year follow a Poisson distribution with
parameter λ as follows:

Level 0% 25% 50% 75%

λ 0.29 0.22 0.18 0.10

(i) Derive the transition matrix. [6]

(ii) Calculate the proportions at each different level when the system reaches
a steady state. [9]
[Total 15]

8 For each of m independent policies, the probability of one claim in a year is

θ (0 < θ < 1) and the probability of no claims in a year is 1 − θ. The total number
of claims in one year is a random variable X. Independent observations x1 , …, xn
of X are available. The prior distribution of θ has density f(θ) ∝ {θ(1 − θ)}β−1,
0 < θ < 1, for some constant β > 0.

(i) (a) Derive the posterior distribution of θ given x1 , …, xn .

(b) Derive the maximum likelihood estimate of θ, g ( x ).


(c) Derive the Bayesian estimate of θ under quadratic loss, and show
that it takes the form of a credibility estimate,

Zg ( x ) + (1 − Z) µ

where µ is a quantity you should specify in terms of the prior
distribution of θ.

(d) Explain what happens to Z as the number of data points increases.

[11]

106 A2001—4
 (ii) Calculate the Bayesian estimate of θ and the value of Z if n = 6, m = 10
and x1 = 1, x2 = 4, x3 = 2, x4 = 1, x5 = 1, x6 = 3, when

(a) β=1

(b) β=4

By considering the prior variance, comment on the effect on Z of

increasing β, and relate this effect to the quality of the prior information
about θ in each case. [6]
[Total 17]

9 (i) A random variable X has the lognormal distribution with density function
f(x) and parameters µ and σ. Show that for a > 0

∞
æ σ2 ö æ æ log a − µ − σ2 ö ö
ò
a
xf ( x )dx = exp ç µ +
è
÷ çç1 − Φ ç
2 øè è σ
÷ ÷÷
øø

where Φ is the cumulative distribution function of the standard normal

distribution. [4]

(ii) Claims under a particular class of insurance follow a lognormal

distribution with mean 9.070 and standard deviation of 10.132 (figures in
£000s). In any one year 20% of policies are expected to give rise to a
claim.

An insurance company has 200 policies on its books and wishes to take
out individual excess of loss reinsurance to cover all the policies in the
portfolio. The reinsurer has quoted premiums for two levels of
reinsurance as follows (figures in £000s):

Retention Limit Premium

25 48.5
30 38.2

(a) Calculate the probability, under each reinsurance arrangement,

that a claim arising will involve the reinsurer.

(b) By investigating the average amount of each claim ceded to the

reinsurer, calculate which of the retention levels gives the best
value for money (ignoring the insurer’s attitude to risk).

(c) The following year, assuming all other things equal, the insurer
believes that inflation will increase the mean and standard
deviation of the claims in its portfolio by 8%. If the reinsurer
charges the same premiums as before, which of the retention levels
will be best value for money next year?
[18]
[Total 22]

106 A2001—5