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📉 '''Historical simulation''' is a [[Definition:Risk modeling | risk modeling]] technique used in insurance and [[Definition:Reinsurance | reinsurance]] that estimates potential future outcomes by replaying actual historical scenarios against a current portfolio, rather than relying on assumed probability distributions. In an industry built on projecting uncertain futures, this method grounds the analysis in events that genuinely occurred — past [[Definition:Catastrophe | catastrophes]], financial market crises, or [[Definition:Loss | loss]] spikes — and asks what the financial impact would be if those conditions repeated today. It is widely applied in [[Definition:Enterprise risk management (ERM) | enterprise risk management]], [[Definition:Solvency | solvency]] testing, and [[Definition:Investment risk | investment risk]] assessment for insurer asset portfolios.

⚙️ The approach works by taking a defined window of historical observations — such as daily market returns over ten years or annual [[Definition:Catastrophe loss | catastrophe losses]] over several decades — and applying each observation to the current exposure base without imposing parametric assumptions about the shape of the loss distribution. For an insurer's investment portfolio, this means recalculating the portfolio's value under every historical daily scenario to construct a distribution of potential gains and losses, from which [[Definition:Value at risk (VaR) | value at risk (VaR)]] or [[Definition:Tail value at risk (TVaR) | tail value at risk (TVaR)]] metrics are extracted. On the underwriting side, historical simulation can feed [[Definition:Stress test | stress testing]] exercises by projecting how a 1992-magnitude hurricane or a 2008-style financial collapse would affect today's [[Definition:Reserve | reserves]], [[Definition:Capital | capital]], and [[Definition:Liquidity | liquidity]] positions.

🎯 One significant advantage of this method is its transparency — stakeholders and [[Definition:Insurance regulator | regulators]] can point to specific historical events driving the results, making the analysis intuitive and defensible. However, it carries an inherent limitation: it assumes the past adequately represents the range of future possibilities. Emerging risks like [[Definition:Cyber risk | cyber risk]] or [[Definition:Climate risk | climate change]]-driven perils may have no meaningful historical precedent, which is why sophisticated insurers often combine historical simulation with [[Definition:Stochastic model | stochastic models]] and [[Definition:Scenario analysis | scenario analysis]] to capture both known and hypothetical extremes. As [[Definition:Regulatory framework | regulatory frameworks]] like [[Definition:Solvency II | Solvency II]] and the [[Definition:Own Risk and Solvency Assessment (ORSA) | ORSA]] process demand rigorous quantification of risk, historical simulation remains a foundational tool in the actuary's and risk manager's toolkit.

'''Related concepts:'''
{{Div col|colwidth=20em}}
* [[Definition:Stochastic model]]
* [[Definition:Value at risk (VaR)]]
* [[Definition:Stress test]]
* [[Definition:Scenario analysis]]
* [[Definition:Catastrophe model]]
* [[Definition:Enterprise risk management (ERM)]]
{{Div col end}}

Definition:Historical simulation - Revision history

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