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💲 '''Cost of capital''' represents the minimum rate of return an [[Definition:Insurance carrier | insurance company]] must earn on the [[Definition:Capital | capital]] it holds to satisfy investors, maintain its [[Definition:Credit rating | credit rating]], and justify the economic risk of writing [[Definition:Insurance policy | policies]]. Because insurers must set aside substantial [[Definition:Surplus | surplus]] and [[Definition:Reserving | reserves]] to guarantee they can pay future [[Definition:Claim | claims]], the cost of tying up that capital — rather than deploying it elsewhere — is a central input to [[Definition:Pricing | pricing]], [[Definition:Product design | product design]], and strategic planning.

📐 Quantifying the cost of capital typically involves blending the expected return demanded by equity holders with the interest rate on any [[Definition:Debt | debt]] the insurer has issued, weighted by their respective shares of the company's [[Definition:Capital structure | capital structure]] — a framework known as the [[Definition:Weighted average cost of capital (WACC) | weighted average cost of capital]]. For specific [[Definition:Line of business | lines of business]], actuaries often allocate a capital charge that reflects the tail risk of that line: [[Definition:Catastrophe risk | catastrophe-exposed]] property business, for example, requires more capital per dollar of [[Definition:Premium | premium]] than stable short-tail lines, and therefore must generate a higher underwriting margin to clear the hurdle. Regulatory regimes such as [[Definition:Solvency II | Solvency II]] explicitly incorporate a cost-of-capital method when calculating the [[Definition:Risk margin | risk margin]] on technical provisions.

📊 Understanding cost of capital is what separates disciplined [[Definition:Underwriting | underwriting]] from opportunistic volume chasing. A carrier that writes business at a [[Definition:Combined ratio | combined ratio]] of 98 percent may appear profitable on an accounting basis, yet if it fails to cover its cost of capital, it is actually destroying shareholder value. [[Definition:Private equity | Private-equity]] investors entering the insurance space pay close attention to this metric when evaluating acquisitions, and [[Definition:Insurtech | insurtech]] start-ups raising venture capital face their own version of the question — can the business deliver risk-adjusted returns that justify the capital consumed? Across the industry, the cost of capital acts as a gravitational force pulling pricing, [[Definition:Reinsurance | reinsurance]] purchasing, and portfolio composition toward rational economic outcomes.

'''Related concepts'''
{{Div col|colwidth=20em}}
* [[Definition:Risk-based capital (RBC)]]
* [[Definition:Solvency II]]
* [[Definition:Return on equity (ROE)]]
* [[Definition:Risk margin]]
* [[Definition:Capital allocation]]
* [[Definition:Weighted average cost of capital (WACC)]]
{{Div col end}}

Definition:Cost of capital - Revision history

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