Economic capital
The amount of own funds a company judges necessary for its own risk appetite, distinct from regulatory capital, computed on its own horizon and threshold.
Article 101 of the Solvency II Directive (2009/138/EC) calibrates the solvency capital requirement to the value at risk of basic own funds at a 99.5% level over one year. That is the supervisor's question: will obligations be met. Economic capital answers management's question: what amount lets the company hold its target rating and ride out a cycle without raising equity at the worst moment. The two almost always differ, and the nature of the gap is informative. An insurer targeting an A rating from an agency often calibrates beyond the 99.5th percentile, sometimes at 99.9%. It also works over a multiyear rather than annual horizon, because downgrade threatens it well before ruin does. It adds risks the standard formula ignores: strategic risk, reputation risk, liquidity risk. ORSA, provided for by Article 45 of the same directive, is where the gap between the two figures must be explained, and where never having one becomes the anomaly.
Midsize European non-life insurer, 2026 ORSA. Standard formula SCR 480M EUR, coverage ratio 172%. Internal economic capital calibrated at 99.7% over three years and including 40M EUR of strategic risk: 605M EUR. Management steers to an internal target ratio of 140% of that latter figure, that is 847M EUR of own funds, which explains why a dividend can be refused while the regulatory ratio looks comfortable.
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