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📐 '''Capital model''' is a quantitative framework used by [[Definition:Insurance carrier | insurers]] and [[Definition:Reinsurance | reinsurers]] to estimate the amount of [[Definition:Capital resources | capital]] needed to remain [[Definition:Solvency | solvent]] across a defined range of adverse scenarios, typically calibrated to a specific confidence level over a one-year time horizon. Unlike simple factor-based formulas, a modern capital model simulates the full distribution of potential outcomes — encompassing [[Definition:Underwriting risk | underwriting risk]], [[Definition:Reserving risk | reserve risk]], [[Definition:Market risk | market risk]], [[Definition:Credit risk | credit risk]], and [[Definition:Operational risk | operational risk]] — to produce an integrated view of an insurer's economic capital requirement.

⚙️ Building a capital model involves assembling granular assumptions about loss frequency and severity for each [[Definition:Line of business | line of business]], correlating those assumptions across perils and portfolios, and layering in asset-side volatility and counterparty exposures. Many carriers run [[Definition:Stochastic model | stochastic simulations]] — often tens of thousands of Monte Carlo iterations — to generate a probability distribution of total outcomes. Under [[Definition:Solvency II | Solvency II]] in Europe, firms may apply for approval to use an [[Definition:Internal model | internal model]] in place of the [[Definition:Standard formula | standard formula]], giving them a bespoke capital target that better reflects their unique risk profile. [[Definition:Lloyd's of London | Lloyd's]] requires every [[Definition:Lloyd's syndicate | syndicate]] to submit its own capital model to the [[Definition:Lloyd's capital model | Lloyd's Capital Model]] process, where the results are loaded to set each syndicate's [[Definition:Economic capital assessment (ECA) | economic capital assessment]].

🔍 A well-constructed capital model does far more than satisfy [[Definition:Insurance regulator | regulatory]] minimums — it becomes a strategic decision-making engine. Senior leadership uses model outputs to evaluate [[Definition:Risk appetite | risk appetite]] boundaries, optimize [[Definition:Reinsurance program | reinsurance purchasing]], price [[Definition:Catastrophe risk | catastrophe-exposed]] business, and allocate capital across divisions. [[Definition:Rating agency | Rating agencies]] such as A.M. Best and S&P Global also run their own proprietary capital models to benchmark an insurer's capitalization, and any material divergence between an insurer's internal view and the agency's assessment can trigger rating pressure. As [[Definition:Climate risk | climate risk]], [[Definition:Cyber risk | cyber risk]], and other emerging perils grow in significance, the assumptions feeding capital models face constant scrutiny, making model governance and validation an area of increasing regulatory and board-level attention.

'''Related concepts:'''
{{Div col|colwidth=20em}}
* [[Definition:Internal model]]
* [[Definition:Solvency II]]
* [[Definition:Economic capital assessment (ECA)]]
* [[Definition:Risk appetite]]
* [[Definition:Standard formula]]
* [[Definition:Capital setting]]
{{Div col end}}

Definition:Capital model - Revision history

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