‘Suppose a man becomes ill, gets worse and dies. His death is instantaneous but the cause of his death—deterioration of health—may have been progressing for some time. Death takes place because his health has deteriorated beyond a certain limit.’ So wrote C. D. Rich (1940) in introducing his ‘General theory of mortality’ which can also be regarded as a theory of sickness, although Rich does not develop this aspect of it. The point in the gradual deterioration of health at which death takes place is unmistakable but the point at which sickness begins is hazy and ill defined, as also is the point at which recovery from sickness takes place when health is improving. As Stocks (1949) says ‘The distinction between the living and the dead is clear cut, but no such frontier line between sickness and health can be said to exist except in the case of acute illness caused immediately and directly by an external agent. There is a zone between the two states in which the decision whether the subject is sick or not depends on definitions or standards of good health and also on who decides.’

The theory surrounding sickness rates has received little attention in the United Kingdom during the past two decades. This may be a consequence of the assumption by the British Government of the role of principal insurer against sickness, and the resulting reduction in numbers of those who otherwise might have turned to the traditional friendly society for sickness insurance. It is unfortunate that the decline in interest in sickness rates should have coincided with the burgeoning of the theory of stochastic processes, for sickness is a stochastic process.

Corporate bonds and privately placed loans constitute a large proportion of the portfolios of several financial institutions. When bonds of a corporation are purchased in the market or loans are granted by some other arrangement, the lender evaluates the risk relating to the investment in question. Determination of the level of risk is important, among other things, for facilitating comparison between different investments, setting the terms of loan agreements and making a rational decision concerning the acceptance or rejection of a loan proposal. Since evaluation of risk is very important for rational investment decision-making, the nature of risk in bond investment is examined briefly in the next section. In the subsequent sections, the prevailing techniques of evaluation of risk will be reviewed and the cash flow simulation model presented.