This is encouraged by three important developments. First of all, the current low interest rate environment has increased the insurer’s awareness of the guarantees embedded in the products that have been sold to policyholders. Secondly, changing accounting principles (e.g. IFRS) and market discipline (e.g. European Embedded Value) will force insurance also to report results – including embedded guarantees – on a marked-to-market basis. Last but not least, European insurance regulations will move towards a risk-based architecture (e.g. Solvency 2, Swiss Solvency Test) under which an insurer can be rewarded if well-functioning risk-oriented controlling processes are in place. In order to achieve this reward, it is crucial to have appropriate risk measurement and management tools in place.

Economic capital, or risk based capital, has become the industry standard to measure risks that an insurance company is exposed to. It estimates the capital required to absorb, with a given level of certainty, any unexpected losses resulting from all kinds of risks.

Since actuaries are highly involved in risk management issues, they have to be thoroughly familiar with the concept of economic capital and its implications.