Optimal reinsurance and dividends with transaction costs and taxes under thinning structure

TL;DR

This paper develops an explicit solution for optimal dividend and reinsurance strategies in a risk model with thinning dependence, transaction costs, and taxes, using a diffusion approximation and quasi-variational inequalities.

Contribution

It introduces a tractable diffusion model for a complex risk process and derives explicit optimal strategies with closed-form value functions.

Findings

Optimal reinsurance is an excess-of-loss strategy.

Optimal dividends follow a barrier policy with upper and lower thresholds.

Explicit formulas for the value function are provided.

Abstract

In this paper, we investigate the problem of optimal strategies of dividend and reinsurance under the Cram\'{e}r-Lundberg risk model embedded with the thinning-dependence structure which was firstly introduced by Wang and Yuen (2005), subject to the optimality criteria of maximizing the expected accumulated discounted dividends paid until ruin. To enhance the practical relevance of the optimal dividend and reinsurance problem, non-cheap reinsurance is considered and transaction costs and taxes are imposed on dividends, which converts our optimization problem into a mixed classical-impulse control problem. For the purpose of better mathematical tractability and neat, explicit solutions of our control problem, instead of the Cram\'er-Lundberg framework we study its approximated diffusion model with two thinly dependent classes of insurance businesses. Using a method of quasi-variational inequalities, we show that the optimal reinsurance follows a two-dimensional excess-of-loss reinsurance strategy, and, the optimal dividend strategy turns out to be an impulse dividend strategy with an upper and a lower barrier, i.e., every thing above the lower barrier is paid as dividends each time the surplus is above the upper barrier, otherwise no dividends are paid. Closed-form expression for the value function associated with the optimal dividend and reinsurance strategy is also given. In addition, some numerical examples are presented to illustrate the optimality results.