Optimal Investment-Reinsurance Policy with Stochastic Interest and Inflation Rates

Abstract

The aim of this paper is to study a classic problem in actuarial mathematics, namely, an optimal reinsurance-investment problem, in the presence of stochastic interest and inflation rates. This is of relevance since insurers make investment and risk management decisions over a relatively long horizon where uncertainty about interest rate and inflation rate may have significant impacts on these decisions. We consider the situation where three investment opportunities, namely, a savings account, a share, and a bond, are available to an insurer in a security market. In the meantime, the insurer transfers part of its insurance risk through acquiring a proportional reinsurance. The investment and reinsurance decisions are made so as to maximize an expected power utility on terminal wealth. An explicit solution to the problem is derived for each of the two well-known stochastic interest rate models, namely, the Ho-Lee model and the Vasicek model, using standard techniques in stochastic optimal control theory. Numerical examples are presented to illustrate the impacts of the two different stochastic interest rate modeling assumptions on optimal decision making of the insurer.