Welcome to the hotseat. We've prepared a guide if you'd like to read more about how it works.

The covariance between a whole-life and term assurance proof

0 votes
asked Jun 25, 2017 in BUS 3018F - Models by Natank (680 points)

I am looking for the proof for the co-variance between a term assurance and whole life assurance, this is needed to calculate the variance of a deferred assurance, see my attempt and explanation in the attached photo.image

1 Answer

+1 vote
answered Jun 26, 2017 by Njabulo.Dube (2,950 points)
selected Jun 27, 2017 by Natank
Best answer
You are on the correct path. The relationship comes from the fact that:

$$cov(X,Y) = \mathbb{E}[XY] - \mathbb{E}[X]\mathbb{E}[Y]$$

Letting \( X \) and \( Y\) be the present values of a whole life and term assurance respectively such that

\( X \)  is defined as \(X = v^{K_{x}+1}\) when \( K_x = 0, 1, ...\) and \(0\) otherwise.
\( Y \)  is defined as \(X = v^{K_{x}+1}\) when \( K_x < n\) and \(0\) otherwise.

Then  \(XY = v^{2(K_{x}+1)}\) when \( K_x < n\) and \(0\) otherwise.

Applying the covariance formula above will yield the result.