ACTL 5106 INSURANCE RISK MODELS

Quiz 1
Wednesday, 24th August 2005
Time Allowed: 1 hour
Total Marks: 100 Marks
Total Assessment credit: 7.5%

Please write your name and student number at the spaces provided:

Name: Student ID:

There are four (4) questions here and you are to answer all four.

Provide details of your workings.

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not return it.

Anyone caught writing after time has expired will be given a mark of zero.

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Question No. 1: [25 points]

Consider aggregate claims of an insurer over a period of one year, S, on a portfolio of 100
general insurance policies:
S = X1 + + X100
where for each individual claim, i = 1, 2, ..., 100, it is being modeled as Xi = Ii Bi with
P (Ii = 1) = 0.01 and Bi has a uniform distribution with c.d.f.

FBi (x) = 0.1x, for 0 < x $10.

The insurer agreed with a stop-loss reinsurance with a retention of $5. The annual aggregate
claims paid by the reinsurer can then be modeled as

SR = (X1 5)+ + + (X100 5)+ .

a. For each individual claim, compute the mean E (X 5)+ and the variance V ar (X 5)+ .
[15 points]

b. Suppose SR is approximated by a Normal distribution, using the Central Limit The-

orem as an argument. Compute the probability that the reinsurers annual claims
payment will exceed 2. [10 points]

Question No. 2: [25 points]

A direct insurer faces a random loss X that has p.d.f.

fX (x) = 0.02e0.02x , for x > 0.

A reinsurer agrees for a stop-loss coverage in excess of a deductible of 75.

a. Determine the expected loss that is retained by the direct insurer. [10 points]

b. Determine the expected loss to be paid by the reinsurer. [10 points]

c. Explain when this stop-loss coverage is considered an optimal strategy by the direct
insurer. [5 points]

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Question No. 3: [20 points]

An insurance company believes that claim amounts, X, on its portfolio of general insurance
policies follow an exponential distribution with mean $200.

A reinsurance policy is arranged such that the reinsurer pays XR , where

0, if X $50
XR = X 50, if $50 < X M .

M 50, if X > M

Calculate the value of M such that E (XR ) = $100.

Question No. 4: [30 points]

An insurer has a portfolio of general insurance policies where the total claims S is believed
to have a distribution with c.d.f. as follows:

FS (s) = 1 es , for s > 0.

The insurer has utility function uI (w) = 0.25e0.25w .

For the right price, a reinsurer is willing to share in the insurers total claims. The reinsurer
proposes an excess-of-loss reinsurance which will pay

SR = (S 0.50)+ .

The reinsurer has utility function uR (w) = 0.5e0.5w .

a. Briefly explain why the insurer is considered less risk-averse than the reinsurer. [3
points]

b. Determine the maximum amount of premium the insurer is willing to pay for the
proposed reinsurance. [12 points]

c. Determine the minimum amount of premium the reinsurer is willing to accept the
proposed reinsurance. [12 points]

d. Can a reinsurance arrangement be reached between the insurer and the reinsurer?
Explain. [3 points]

- end of Quiz 1 questions -