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🧮 '''Economic capital assessment''' is the process by which an [[Definition:Insurance carrier | insurance]] or [[Definition:Reinsurance | reinsurance]] company estimates the amount of [[Definition:Capital | capital]] it needs to hold in order to remain [[Definition:Solvency | solvent]] at a chosen confidence level, given the full spectrum of risks on its books. Unlike [[Definition:Regulatory capital | regulatory capital]] requirements — which are set by supervisory formulas such as those under [[Definition:Solvency II | Solvency II]] or the [[Definition:Risk-based capital (RBC) | NAIC risk-based capital]] framework — economic capital reflects the company's own internal view of its risk profile, incorporating [[Definition:Underwriting risk | underwriting risk]], [[Definition:Reserving risk | reserving risk]], [[Definition:Market risk | market risk]], [[Definition:Credit risk | credit risk]], and [[Definition:Operational risk | operational risk]] in an integrated model.

⚙️ Carriers typically build economic capital models using stochastic simulations that generate thousands of scenarios across all major risk drivers simultaneously, capturing diversification benefits and tail dependencies that simpler regulatory formulas may overlook. The output is a probability distribution of potential losses over a defined time horizon — often one year — from which the company identifies the capital needed to survive losses at a specified confidence level, such as 99.5% (equivalent to a 1-in-200-year event). Management then compares economic capital to available capital to evaluate [[Definition:Risk appetite | risk appetite]] utilization, identify which [[Definition:Line of business | lines of business]] or [[Definition:Peril | perils]] consume disproportionate capital, and inform decisions about [[Definition:Reinsurance program | reinsurance purchasing]], [[Definition:Asset allocation | asset allocation]], and growth strategy. Under Solvency II, European insurers that gain supervisory approval for an [[Definition:Internal model | internal model]] effectively enshrine their economic capital framework as the basis for regulatory compliance.

💡 Beyond satisfying regulators, a robust economic capital assessment gives senior leadership and boards a common language for discussing risk and return. It enables risk-adjusted performance measurement — such as [[Definition:Return on risk-adjusted capital (RORAC) | return on risk-adjusted capital]] — so that [[Definition:Underwriting | underwriting]] teams can compare the profitability of disparate portfolios on an apples-to-apples basis. [[Definition:Rating agency | Rating agencies]] like AM Best, S&P, and Moody's incorporate their own economic capital benchmarks when assigning [[Definition:Financial strength rating | financial strength ratings]], meaning a carrier's internal assessment often feeds directly into external perceptions of creditworthiness. For [[Definition:Insurtech | insurtech]] ventures and [[Definition:Managing general agent (MGA) | MGAs]] seeking [[Definition:Capacity | capacity]] from capital providers, understanding how their programs affect a carrier's economic capital consumption can be the difference between securing support and being declined.

'''Related concepts:'''
{{Div col|colwidth=20em}}
* [[Definition:Solvency II]]
* [[Definition:Risk-based capital (RBC)]]
* [[Definition:Internal model]]
* [[Definition:Risk appetite]]
* [[Definition:Return on risk-adjusted capital (RORAC)]]
* [[Definition:Regulatory capital]]
{{Div col end}}

Definition:Economic capital assessment - Revision history

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