While there doesn't seem to be one single definition for economic capital, common definitions refer to an amount of capital required to support the retained risks of an organization and to absorb large or severe losses, with economic capital models typically defined as those that model aggregated risks on an enterprisewide basis.

Moody's, in its special comment today, said there has been significant growth in such models, which were initially used solely for the purpose of comparing required capital to existing capital or regulatory requirements. Now, such models are being used to improve product pricing and allocate resources among businesses, Moody's said.

Propelling their development is "the increasing convergence between regulatory capital standards and economic capital principles (such as Solvency II in Europe), Moody's said, noting that economic capital will likely become one of the primary tools of public disclosure of risks--for large groups--within three-to-five years.

Steve Hunnisett, a Moody's vice president and senior analyst who co-authored the special comment, also attributed the quickened pace of the development to "an overall trend to improve risk management and avoid a repeat of the early part of this decade when adverse experience severely weakened many insurers' balance sheets."

In addition to considering the degree of sophistication and how well embedded the model is in the financial management of a firm, in order to garner positive ratings implications, Moody's said it would expect a model "to be a clearly demonstrable part of the day-to-day risk management of the business and highly influential on any capital-related decisions."

The report contains a list of a dozen characteristics that would prompt Moody's to have high confidence in model outputs.

Moody's, in contrast to Fitch, cast a strong vote against the development of a single global rating agency economic capital model in its report. Moody's suggests that such a model would oversimplify the "particular circumstances of the business being considered."

Highlighting complexities of insurance assets and liabilities, and the wide range of regulatory and accounting systems to which insurers are exposed, Moody's said that even if it were possible to develop a global rating agency model, "the majority of the discussion would revolve around differences between the Moody's result and the company's own result rather than address the really substantive analytical issues."

Rather than trying to replicate insurers' models, Moody's intends to use an "interrogation approach" to vet the internal models. The Moody's report includes a list of questions it will ask to understand the models.

Likewise, Fitch, in one of two reports released last week, gave insurers a glimpse into potential questions analysts will ask about in-house models.