Economic Capital Defined Economic capital is the capital required to support all risks carried by a firm at its target level of financial strength. The firm's desired financial strength–or solvency standard–is expressed as a probability of ruin.
To provide firms with intuition around acceptable probabilities of ruin, we look to corporate bond default rates. The reasons for choosing corporate bond default rates are that there is a long history of default data from the rating agencies and that people have good intuition about how bond ratings relate to financial strength.
From historical bond default data, we know that the probability of a single-A bond defaulting is .07 percent or 7 basis points. If an insurer seeks a solvency standard of 7 basis points, then it can express this as a "single-A" solvency standard. One can see how "I would like to be as financially strong as an A-rated company" has more intuitive appeal than "I would like my companys probability of ruin to be 7 basis points."
Want to continue reading?
Become a Free PropertyCasualty360 Digital Reader
Your access to unlimited PropertyCasualty360 content isn’t changing.
Once you are an ALM digital member, you’ll receive:
- Breaking insurance news and analysis, on-site and via our newsletters and custom alerts
- Weekly Insurance Speak podcast featuring exclusive interviews with industry leaders
- Educational webcasts, white papers, and ebooks from industry thought leaders
- Critical converage of the employee benefits and financial advisory markets on our other ALM sites, BenefitsPRO and ThinkAdvisor
Already have an account? Sign In Now
© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.
