Dynamic optimal reinsurance and dividend-payout in finite time horizon

TL;DR

This paper develops a mathematical framework for an insurance company's optimal reinsurance and dividend strategies over a finite period, using advanced control theory and PDE analysis to identify optimal risk and payout barriers.

Contribution

It introduces a novel control model with a fully nonlinear Hamilton-Jacobi-Bellman equation and characterizes the optimal reinsurance and dividend policies through risk-dependent barriers.

Findings

Identification of a risk-dependent reinsurance barrier

Derivation of a dividend-payout barrier based on surplus levels

Establishment of a smooth value function and numerical scheme

Abstract

This paper studies a dynamic optimal reinsurance and dividend-payout problem for an insurance company in a finite time horizon. The goal of the company is to maximize the expected cumulative discounted dividend payouts until bankruptcy or maturity which comes earlier. The company is allowed to buy reinsurance contracts dynamically over the whole time horizon to cede its risk exposure with other reinsurance companies. This is a mixed singular-classical control problem and the corresponding Hamilton-Jacobi-Bellman equation is a variational inequality with a fully nonlinear operator and subject to a gradient constraint. We obtain the $C^{2,1}$ smoothness of the value function and a comparison principle for its gradient function by the penalty approximation method so that one can establish an efficient numerical scheme to compute the value function. We find that the surplus-time space can be divided into three non-overlapping regions by a risk-magnitude and time-dependent reinsurance barrier and a time-dependent dividend-payout barrier. The insurance company should be exposed to a higher risk as its surplus increases; be exposed to the entire risk once its surplus upward crosses the reinsurance barrier; and pay out all its reserves exceeding the dividend-payout barrier. The estimated localities of these regions are also provided.