Well, there's plenty of examples of countries that have gone on fighting after the capital fell, and some have even won the war in the end. I agree that losing one's capital should be a bigger blow than it is now, but it should not be the effective end of one's empire.
An idea that has been repeatedly suggested is that when you lose your capital, your FP becomes a regular Palace. If you have no FP, you instead get some kind of "temporary seat of government" that does not give the full corruption-busting effects of a proper Palace. You'd, of course, be able to rebuild your Palace eventually.