Optimal control problem for an insurance surplus model with debt liability

Abstract

For an insurance company with a debt liability, they could make some management actions, such as reinsurance, paying dividends, and capital injection, to balance the profitability and financial bankruptcy. Our objective is to determine risk retention rate, dividend, and capital injection strategy so as to maximize the expected discounted dividends minus the discounted cost of capital injection until the time of ruin. We assume that the dividend payments and capital injection should occur with both fixed and proportional costs. We obtain explicit expressions of the optimal value functions as well as the corresponding optimal joint strategies by routine procedures in a comprehensive basic model using a new technique to solve the related equations. Our results show that whether recapitalizing is profitable or not depends on the costs of capital raising and that the firm injects capital only when the reserves are zero and recapitalizes to the optimal reserves level if the cost of external capital is low. Copyright © 2013 John Wiley & Sons, Ltd.