Zurich reinforces its strategic direction designed to generate sustained and profitable growth.
Zurich reports net income of USD 702 million (since restated to USD 730 million) for the first three months of 2004.
applications in the US, UK, Switzerland and Germany to Computer Sciences Corporation (CSC).
A financial strength rating is a third-party assessment of an insurance company’s financial security, based on its ability to meet policyholder claims. As of December 31, 2004, Zurich had the following ratings: Business Year 2004
Zurich’s key market positions 2nd largest in general corporate business worldwide1 4th largest general insurer in the US2 4th largest general insurer in Europe3
Zurich appoints four banks to lead a USD 3 billion revolving credit facility. Market interest is strong and the facility is over-subscribed.
Insurance, Zurich has a diversified portfolio of businesses across global corporate, commercial and personal customer segments and geographical regions.
Strong growth in net income for the first nine months of 2004 to USD1,902 million is reported, despite the impact of the most severe hurricane season in more than a century.
Contacts 2 Letter to Shareholders 6 The Way Forward 13 One Team. One Zurich.
26 Risk Management 31 Corporate Responsibility 33 Group Financial Review 45 Segmental Financial Analysis 63 Consolidated Financial Statements 63 Consolidated operating statements 64 Consolidated balance sheets 66 Consolidated statements of cash flows 68 Consolidated statements of shareholders’ equity 70 Notes to the consolidated financial statements 109 Significant subsidiaries 111 Report of the Group auditors 112 Embedded Value Results – Life Insurance 116 Corporate Governance Report 130 Remuneration Report 135 Zurich Financial Services Holding Company – Financial Statements 142 Shareholder Information 142 Zurich Financial Services registered share data 143 Financial calendar and contacts
The Group continued to strengthen its capital base and reserve position. Shareholders’ equity grew by 17 percent to USD 22.2 billion and total financial capital in support of our operations increased by 18 percent to
USD 28.1 billion. We strengthened our net insurance loss reserves by USD 2.0 billion.
North America Corporate was mitigated by reserve releases in other regions without departing from our overall conservative stance.
USD 37.0 billion at the end of 2003. These actions contributed to a significant strengthening of the Group’s balance sheet.
America – extraordinary catastrophes in 2004 and the impact of the poor underwriting record in the years 1997 to 2001.
Our response was swift and determined. We improved our performance by focusing on the fundamentals of our business. We are committed to perform in the industry’s top tier, based on our underwriting performance and competitive advantage as a major provider of general and life insurance services with a well-diversified mix of business, both by line of business and geography.
In 2004, we continued to make substantial progress in improving our Group’s profitability.
We strengthened our balance sheet and positioned Zurich for sustained profitable growth.
USD 2.6 billion. This generated a return on equity of 13.3 percent, an increase of 1.2 percentage points compared with 2003.
Services and an excellent investment performance. It was a challenging year, but we demonstrated our ability to absorb earnings shortfalls in some areas while dealing with extraordinary events.
Caribbean leading to record insurance industry losses of more than USD 22 billion. And just before the end of the year, a powerful tsunami destroyed vast coastal areas from Indonesia to East Africa, leaving a tragic toll of death and destruction. In the wake of these unparalleled events, Zurich recognized claims payments net of reinsurance and taxes of USD 585 million.
Group Executive Committee. Geoff Riddell leads our Global Corporate business and Dieter
Pictured from left to right: R. Watter, G. Schulmeyer, P. Pidoux, T. Escher, L. van Wachem, D. Mead, V. Sankey, R. Gilmore, A. Meyer
Pictured from left to right: J. Amore, M. Feinstein, P. O’Sullivan, P. van de Geijn, J. Schiro, G. Riddell, P. Eckert, D. Wasserman, A. Lehmann, D. Wemmer
To drive excellence forward, a critical factor will be the dedication and professionalism of our people – characteristics demonstrated by them every day of the week.
Way, which we see as a vital aid in transforming the way we do business, both operationally and culturally. We are convinced it will help us to perform in the top tier of our industry, delivering sustainable value to shareholders and giving our customers consistent, distinctive and predictable service wherever they are.
The core of our business is General Insurance and Life Insurance. Our culture is centered on helping our customers manage their risks and savings. We provide innovative solutions to customers from large global corporations to small businesses as well as differentiated services to personal lines customers. Our capital allocation is geared towards improving earnings by focusing on the most attractive sectors.
In General Insurance, our primary geographic focus is on North America and Europe. In the
Way. During 2004, we identified and developed common methodologies, standards and business tools to help us achieve best practices in our operations and core processes. Seven major project initiatives, or workstreams, led by and composed of some of our best operational experts, were charged with developing blueprints for achieving consistent and sustained performance improvements.These workstreams include personal lines underwriting, corporate and commercial underwriting, claims management, distribution, life operations, finance, and talent management.
Operational efficiency and professional integrity are inseparable, and our principles for doing business are firmly anchored in our core values, as expressed in Zurich Basics.These values guide us to do not only the right things, but also in the right way.The success of our business depends as much on the trust of our customers as on our ability to provide value. We will continue to work hard to keep that trust by serving our customers with fairness and integrity.
Clearly, having the right people with the right skills in the right place at the right time is critical to our success. One element of
8 Zurich Financial Services Group . Annual Report 2004 underwriter acumen by changing the culture.
The finance workstream helped the Group enhance financial discipline during the 2005 planning and budgeting process. Each of the other six workstreams performed at least two pilot tests of process improvements designed to implement The Zurich Way. Based on the lessons learned from these pilots, more than 100 projects will run through 2005, each carefully monitored and with monthly reviews.
Far from being simple cost savings, most of the improvements will come from better processes firmly anchored in shared Zurich values. For example, we have identified underwriting measures that will consistently improve our ability to get the right price for the risks we accept. A wide range of actions will improve the efficiency of our claims handling processes and ensure that claims are settled speedily, fairly and at the right price.
In Life Insurance, initiatives based on a program to develop sales excellence showed a high rate of success in the pilot phase.
Far from being simple cost savings, most of the improvements will come from better processes firmly anchored in shared Zurich values.
Milan, which began in July 2002 and continued until late 2004. We also insured other major public works in Italy, including the construction of the Salerno-Reggio Calabria highway and high-speed rail links between Novara and Turin.
In the UK, our small business proposition now offers 24-hour Internet access for brokers.
Demand for this service has expanded rapidly, and more than half of new business was written in this way in 2004. Zurich is now among the top three players in this sector in the UK.
California, in a wildfire. Mrs. Shapiro wrote: “Our family was devastated, but before the last embers of that fire died, Farmers contacted us. We have never been so impressed with an insurance company and the high caliber of personnel as we were through this experience.
In Europe, we can build on a strong network of 40,000 agents, brokers and financial advisers, offering both general and life insurance products and services. We also offer complete cover through direct contact in all our major
European markets. We work with brokers and intermediaries, and have powerful wholesale partnerships with customer organizations.These include Deutsche Bank across our major
Personal customers can deal with us in a variety of ways, either through brokers or agents, direct by telephone or on the Internet. In Germany, we are the market leader with 42 percent market share in motor direct business. A quarter of new business is generated via the Internet.
10 Zurich Financial Services Group . Annual Report 2004 relationships with major corporations.The active management of this network allows us to serve global customers in more than 120 countries. It also helps us to ensure a uniform standard of service and expertise as we continuously move towards one Zurich.
We have the flexibility to provide solutions in the way our customers want. One of our more unusual assignments came when McDonald’s
Hurricanes Frances, Ivan and Jeanne followed in swift succession, we sent a further 600 claims representatives. An emergency field operation was set up in Tampa, Florida, and our claims center in Colorado stayed open 24 hours a day to process claims.These were then passed to our Catastrophe Center near Chicago, which grew from 14 people to more than 80 to respond to the emergency.
Exchanges. In Continental Europe, we see great market potential and opportunities through our
Our International Program System enables us to provide major customers with information about their worldwide operations that would be almost impossible to gather manually.This includes underwriting, premium, claims and accounting data.
In the UK, we are introducing a new model that will allow the different parts of our life business to develop separately. Our Zurich
Advice Network of franchisees will become a retail distribution company called Openwork, a key business partner for Zurich that will sell third-party products as well as our own.
We are introducing a sales excellence program to improve the productivity of our tied sales force across the Group, based on our best practices in all major countries as well as from other industries.
needs, we have organized risk management councils of customers whom we meet several times a year in the US and Europe. We also organize unique risk engineering workshops for customers and brokers, to provide a comprehensive view of the hazards that can affect an organization. Our International
Risk Engineering training course is accredited by the Institute of Risk Management in the UK, an internationally recognized body.
This approach has proved to be popular and effective. Taiwan-based Powerchip
Another customer, Tony Rodolakis, vice president, Risk Management for Starwood Hotels
The ingredients for success are all there. We have the will, the skills and the people. We are now focusing on bringing them together in a way that builds on many of the best practices already in place. We want The Zurich Way to be a way of life, with a common approach to business firmly embedded in our business units everywhere.
We offer quality products and services from standard car or household insurance to sophisticated solutions for some of the world’s best-known international companies. In every case, our aim is the same: to ensure that all our customers, wherever they are and whatever their needs, receive the same level of service and expertise.That’s why we are transforming the way we do business, both operationally and culturally.
This will help us in our ambition to become the leading global general and life insurer in our chosen markets.The Zurich Way will be instrumental to our success and will move us even closer to being one Zurich. With common business processes, shared values and a shared culture, we are confident we can serve our customers better and generate sustainable growth and profit for our shareholders.
Naperville, Illinois. Gary believes that the lasting value of coaching is teaching people that a committed team effort can achieve any goal.
Zurich. The goal is to get people to believe in their abilities enough to be willing to take chances and try out new tools and skills.”
Throughout his career in insurance underwriting, Gary has put this simple principle to work. As the former underwriting program executive for North America’s Strategic Initiatives
His goal was to improve Zurich’s underwriting performance and profitability through disciplined risk selection and technical pricing.
“rapid-results initiatives”, a technique that galvanizes teams to achieve a challenging objective in a short space of time. And as the leader of
“I didn’t set out to do it or dream about it in advance, but once I had the opportunity, I was really excited. I like that kind of challenge.”
Angela has been part of the team that has transformed Small Business at Zurich over the past several years and is instrumental in making our small business strategy successful.
Home life, too, gives her plenty of opportunity to make a difference. Her husband Greg is a former professional football player who coaches their children’s football and softball teams. As
“team mom”, she organizes team rosters and practice dates and helps keep everyone on track.
I’m simply trying to help others to learn how to do things for themselves.”
Angela believes this holds true at work and at home. “I always say the best thing you can do for yourself and the people around you is to take time to listen to them and provide honest feedback. That’s not always easy in professional life, but sometimes even in a work environment, you have to be able to listen to people’s personal concerns in order to help them develop and be productive. A team is most successful when you recognize and leverage the strength of its members.”
Angela chose her career because it allowed her to develop and apply the technical and people management skills needed to solve real business problems. Managers recognized her leadership abilities from the beginning, and by the age of 25, she was head actuary of a Zurich subsidiary.
“Along the way you can bring out the best in others.”
And I try to put something on canvas every day.” A completely self-taught artist, he has been painting now for 20 years and has held countless exhibitions in hotels and restaurants throughout
Peter employs the same sense of perspective and eye for detail in meeting the needs of his customers – making his professional commitment a self-portrait rendered in
Peter knows that providing cover for the security of individuals and families is firmly based on trust, with customers sharing intimate financial and private details in order to reach the best solution. Particularly in the area of life insurance, or similar long-term investments, in-person advice from a friendly and knowledgeable adviser is paramount for many customers.
That’s why Zurich firmly believes in using its agents and sales forces to explain products and solutions first hand. Peter also realizes that to every customer, he is the face of Zurich and how he serves them will determine how they view our organization.
As Peter says “I’ve always liked dealing with people, and the personal touch is very important to me. I make a point of always treating my customers as equal partners in shaping a solution to their needs.” It’s an outlook that has paid dividends in hard business terms. In the past year, he has achieved 250 percent of his target in sales of retirement products and 120 percent in general insurance sales.
Back in London, Sarah draws on the experience in her day-to-day work with Zurich Professional, a business that specializes in professional indemnity cover for solicitors. “Those four weeks gave me time to focus on self-management: you have to be flexible and adaptable in your personal as well as professional life. The assignment exceeded my expectations, and it was a real energizer. I now know there is a lot more I can do, and it has given my confidence a real boost.”
Zurich Community Trust, an initiative at the heart of community involvement for our UK
employees. The aim was to help the women’s group restructure so that they could be far more effective in asserting their rights in the face of a growing problem – domestic violence.
“You have to be flexible and adaptable in your personal as well as professional life.”
“We’re investing in the future of an entire generation and of our country.”
“You need that drive to succeed, plus a passion to win and tenacity to keep on going no matter what. So many times on a course, as in business, something happens that you didn’t plan for.
President of Customer Advocacy with Farmers, which provides insurance and financial services for more than 10 million households in the US.
“Trust and a stable relationship carry you through the tough times.”
In 2004, we enhanced our risk management framework with the creation of Reporting
Group-wide risk management policies specify risk tolerance boundaries and authorities, reporting requirements, and procedures for referring risk issues to senior management.
In addition to risk-specific monitoring and modeling, we take a holistic view with riskbased capital (RBC) modeling.This type of modeling measures the difference between what we expect in a normal business operating environment and worst-case scenarios. We define risk-based capital as the capital needed to protect our policyholders against the worst-case loss (which we define as a one-in-2000 event occurring in one year). We have refined and expanded our RBC model to incorporate leading-edge methodologies and to give us a better view of our entire risk landscape.
This modeling helps us make critical business decisions, such as allocating capital to lines of business.
Effectively managing these risks is critical if we are to sustain the strength and resources to be there for our customers when they need us.
Group-wide approach for identifying, understanding, measuring and managing our business risks. These include: • Insurance – risk transferred to us by customers through the underwriting process
• Operational – risk associated with the processes and internal control of the company
Zurich Financial Services Group . Annual Report 2004 27 property policies located in the most hazard prone areas. We look at risk down to the policy level in most cases, using state-of-the-art probabilistic models developed by industry-leading providers of natural catastrophe models.The models are simulation tools that use a number of random variables to arrive at an estimate of risk exposure.
These models principally address tornadoes, hail, windstorms, earthquakes, and flooding. We review our list of monitored regions and perils annually for changes in exposure. We also keep abreast of new developments or improvements in catastrophe models that may allow us to better estimate the risks we face.With these estimates in hand, we review how we manage total risk accumulations in the modeled areas. Actions may include modifying our underwriting, setting limits on exposure accumulations, and adjusting our purchase of reinsurance.
We take care to set appropriate pricing guidelines. We also centralize the management of reinsurance and closely monitor emerging issues that may affect our overall risk exposures, such as new areas of liability. Finally, we model and estimate risk associated with natural and man-made catastrophes, allowing us to manage these significant areas of insurance risk with a high degree of sophistication.
Since 1997, we have used a stochastic modeling process to quantify natural catastrophe risk across the Zurich organization. In this annual exercise, we assess the total risk represented by Zurich
In order to support the continuity of our business, we focus on keeping our business continuity plans up-to-date.This includes analyzing our most critical processes and setting priorities for recovery in case of disruptions. We are primarily concerned with being able to recover from unexpected events, such as a natural catastrophe. As an example, the unusual 2004 hurricane season led to several potential high degree of uncertainty about what events might actually occur, our accumulation monitoring and analyses contain a number of assumptions about the potential characteristics of the threat. We review and aggregate workers’
injury and property exposures to identify areas of significant concentration.The resulting data allows our underwriters, particularly in
USD 23 billion, of which 44 percent was collateralized. We rigorously manage this significant asset. We have centralized the purchase of reinsurance, and only conduct business with companies authorized by our Corporate Reinsurance
(including applicable loans) is AA+. We manage accumulations in these investments by issuer, industry and credit rating, and closely monitor changes. Any investment in securities that are below investment grade requires explicit approval.The largest concentration in our debt portfolio is in governments and supra-nationals, at 55 percent.The next largest concentration is in financial institutions, at 19 percent, of which 50 percent is secured by government guarantee or other collateral.
Derivative financial instruments, such as interest rate swaps, options, futures and forward contracts are intended to limit risks in investments and financing. Zurich uses derivatives mainly to hedge certain economic risks. We address the risks posed by derivatives through a stringent policy that requires approval of derivative programs before transactions are initiated.
Chief Investment Officer approve derivative programs related to the investment portfolio; the Chief Risk Officer and the Group Finance
Zurich Financial Services Group . Annual Report 2004 31 employees regarding compliance and ethical obligations generally. Inspired by Zurich Basics, these initiatives include multimedia awareness campaigns, specific training in detailed regulatory areas, and learning initiatives related to areas such as conflicts of interest, business practices and ethical decision-making.
To improve the management of corporate citizenship activities globally, we established in 2003 a Group-level Corporate Citizenship
The goal is to ensure that Zurich employees and managers worldwide understand how much the company’s ability to deliver sustainable financial results also depends on how well we perform in these important areas. Governance as described in the Corporate Governance Report on pages 116–129 completes our efforts.
With regulation in most countries becoming more complex and expensive, there can be a business advantage for companies able to develop the capabilities and structures to meet these obligations more effectively and efficiently than their competitors. Zurich’s compliance strategy is based on this recognition, as well as on our own values commitment to do what is right.
An important tool is our compliance performance standards that apply to our business units worldwide and help advance common foundations and processes. We also work to deepen the understanding of managers and
Zurich shares qualify for various indexes and funds that focus on companies making progress in corporate responsibility and long-term orientation, including the Dow Jones World and STOXX Sustainability and the FTSE4Good Global and Europe indexes.
32 Zurich Financial Services Group . Annual Report 2004 33 Group Financial Review 45 Segmental Financial Analysis 63 Consolidated Financial Statements 63 Consolidated operating statements 64 Consolidated balance sheets 66 Consolidated statements of cash flows 68 Consolidated statements of shareholders’ equity 70 Notes to the consolidated financial statements 109 Significant subsidiaries 111 Report of the Group auditors 112 Embedded Value Results – Life Insurance 116 Corporate Governance Report 130 Remuneration Report 135 Holding Company – Financial Statements 142 Shareholder Information 142 Zurich Financial Services share data 143 Financial calendar and contacts
Diluted earnings per share rose 18% to CHF 22.18 compared with CHF18.86 in 2003. For 2004, the return on equity based on net income was 13.3%, an increase of 1.2 percentage points over 2003. Our after-tax business operating profit return on equity was 11.5%, an increase of 1.7 percentage points compared with the 2003 year return.
Performance Overview Gross written premiums of USD 49.3 billion in 2004 showed an increase of 1% while in local currency there was a decrease of 4%. In General Insurance, premiums remained level after adjusting for the effects of exchange rate movements and the effects of the sale of certain general insurance businesses. Premiums in Life Insurance increased by 3% after eliminating the effects of the redesign of the group pension business model in Switzerland, the sale of certain life operations and the effects of exchange rate movements.
Business operating profit increased by USD 827 million, or 36%, over 2003 to USD 3,143 million in 2004 driven by the improved performance in Life Insurance and Other Businesses and the continued consistent profit contribution by Farmers Management Services, partially offset by a lower result in General Insurance. The total expected claims costs, net of reinsurance and before tax, arising from the four hurricanes and the tsunami were USD 700 million and USD 90 million, respectively.
• Farmers Management Services increased business operating profit by USD 107 million to USD 1.1 billion. This continued improvement is driven by the increase in management fee income, which in turn is based on higher premiums in the Farmers Exchanges, which we manage but do not own. Farmers Management Services has also continued its focus on expense controls.
• Corporate Center, which supports the Group through funding and governance oversight, reduced its net costs improving business operating profit by USD 184 million, based on stable gross headquarter expenses, as well as an improved recovery for services rendered to other segments.
• The after-tax business operating profit return on equity improved by 1.7 percentage points to 11.5% in 2004, compared with 9.8% in 2003.
Net income improved by USD 578 million, or 29%, to USD 2,587 million in 2004 compared with net income of USD 2,009 million in 2003. In addition to the factors mentioned above, net income was affected by the following: • Net capital gains on investments and impairments of Group investments increased by USD 137 million to USD 948 million.This movement was primarily due to lower impairments as compared with the prior year. • The underlying investment return on our Group Investments in 2004 was 5.9% compared with 4.9% in 2003; the investment result is analyzed in the “Investment Performance” section.
Diluted earnings per share, reflecting the increase in net income, improved by 18% to CHF 22.18 in 2004 compared with CHF18.86 in 2003.
• Group investments increased by USD 15.1 billion due to a positive operating cash flow, higher market valuations and the effects of foreign currency translation, partially offset by the divestment of certain operations in 2004, the redesign of the group pension business model in Switzerland and the restructuring of Zurich Capital Markets.
• Gross insurance reserves increased by USD 12.8 billion, or 7%, in 2004. General Insurance reserves increased by USD 9.3 billion to USD 69.3 billion following growth in gross written premiums, net reserve strengthening and exchange rate movement partially offset by the sale of General Insurance businesses during 2004. Gross Life Insurance reserves, excluding reserves for unit-linked products, increased by USD 6.2 billion to USD 103.0 billion after the effects of the redesign of the group pension business model in Switzerland as well as divestments of life businesses during 2004. Other Businesses reserves decreased by USD 3.6 billion.
• Total financial debt and shareholders’ equity increased by USD 4.3 billion to USD 28.1 billion. USD 3.2 billion arose from the increase in shareholders’ equity mainly as a result of our profit in the year and favorable currency translation effects. A further USD 1.1 billion was attributable to the issuance of a 10-year senior debt of EUR 1 billion (USD1.3 billion at December 31, 2004) partially offset by the repayment of a zero coupon bond of CHF 539 million (USD 427 million) on its maturity.
Reinsurance The Group completed a review of various reinsurance arrangements whereby certain risks were ceded by local business units of the Group to third-party reinsurers, who in turn partly or fully retroceded such risks to other business units of the Group.The scope of the review was to determine the impact, if any, for financial or regulatory reporting.The review included in-force arrangements as well as arrangements that had existed previously but had been commuted or otherwise terminated. As a result of this review, the Group determined, with the concurrence of its external auditors, that it was not necessary to restate the comparative financial statements.
The Group has reported these transactions to appropriate regulatory bodies and is cooperating with all regulatory inquiries. In addition, the Group has strengthened processes in order to address the accounting for and reporting of reinsurance arrangements appropriately on an ongoing basis.
Business operating profit reflects adjustments for taxes, net capital gains on investments and impairments (except for the capital markets and banking operations included in Other Businesses), policyholders’ share of investment results for the life business, non-operational foreign exchange movements, and significant items arising from special circumstances including gains and losses on divestments of businesses. Non-operational foreign exchange movements arise from intercompany foreign currency hedging and the corporate financing of subsidiaries which are not a reflection of local operating activities and are, therefore, not included in the calculation of business operating profit. Business operating profit is not a substitute for net income as determined in accordance with International Financial Reporting Standards (IFRS).
Reconciliation of net income to business operating profit in USD millions, for the years ended December 31 2004 2003
The table below indicates the utilization of and other changes in the restructuring provisions between January1 and December 31, 2004.
We consider the combined ratio and business operating profit to be the key performance indicators for our General Insurance operations.
Overall, the combined ratio increased by 3.7 percentage points to 101.6% for 2004 reflecting net underwriting losses of USD 469 million for 2004 compared with a profit of USD 578 million in 2003. The combined ratio was impacted by the claims relating to the hurricanes of USD 680 million and to the tsunami of USD 82 million as well as from the strengthening of loss reserves relating to prior years of USD 2.1 billion.The net underwriting result of our North America Consumer, Continental Europe, UKISA and Rest of World regions, together posted an increase of USD 1.1 billion to USD 1.5 billion in 2004. North America Corporate recorded a net underwriting loss of USD 1.8 billion, a decrease of USD 1.9 billion in 2004.
Business operating profit was affected by these same factors and decreased by USD 766 million to USD 1.4 billion in 2004. North America Consumer, Continental Europe, UKISA and Rest of the World regions almost doubled business operating profit from USD1.3 billion in 2003 to USD 2.5 billion in 2004.
General Insurance – business operating profit in USD millions, for the years ended December 31
We consider new business profit margin, embedded value after-tax operating return, and business operating profit to be the key performance indicators for our Life Insurance operations.
Operating return on embedded value after tax and before currency effects was 10.8% for 2004, 0.3 percentage point above last year. The embedded value operating profit after tax was USD1.4 billion for 2004 compared with USD 928 million in 2003, an improvement of 56%.
Life Insurance – business operating profit in USD millions, for the years ended December 31 2004 2003 Change
Foreign Currency Impact The Group operates worldwide in multiple currencies. The Group seeks to match its foreign exchange exposures on an economic basis. However, because the Group has chosen the US dollar as its reporting currency, differences arise when local operating currencies are translated into the Group’s reporting currency. The general decline of the US dollar as compared to the Swiss franc, the euro and British pound in 2004 had a positive impact on shareholders’ equity of approximately USD 741 million. Net income in 2004 benefited from these translation effects by approximately USD 176 million.
The tables below show the key financial highlights for the year ended December 31, 2004 translated at the same average exchange rates as applied for the year ended December 31, 2003 to eliminate the foreign currency impact when compared to the prior period. The principal exchange rates are set out in note 2 of the Consolidated Financial Statements.
Life Insurance – embedded value operating return, after tax in %, for the years ended December 31
Life Insurance – foreign currency impact on key financial highlights % change in % change Variance over the prior period, for the year ended 2004 local currency in USD
Gross written premiums and policy fees in Life Insurance decreased by 6% (–13% in local currency) to USD11.0 billion in 2004 mainly resulting from the sale of life operations in the second half of 2003, particularly Zurich Life US, Zurich Life UK and certain other European operations, and the redesign of the group pension business model in Switzerland, which has been partially transferred to an external foundation. Excluding these factors, as well as foreign exchange movements, premiums increased by 3%.
Investment performance of Group investments in USD millions, for the years ended December 31 2004 2003 Change
Movements in unrealized gains on investments included in shareholders’ equity 2,059 151 nm
Net investment income for Group investments increased by 6% to USD 7.4 billion from USD 7.0 billion in 2003. This improvement was a result of higher short-term interest rates in the US and UK, the lengthening of bond portfolio durations, partially offset by lower income due to the reduction in the asset base caused by the redesign of the group pension business model in Switzerland.
Unit-trusts (debt securities, real estate, short-term investments) 2,710 1.4% 2,270 1.4%
Trading equity portfolios in capital markets and banking activities 2,773 1.5% 4,303 2.4%
Divestments During 2004, the Group continued to divest businesses in markets where we did not have a significant presence or which were no longer part of our business strategy. We completed several transactions during the year that generated cash proceeds of USD 2.5 billion compared with USD 2.7 billion in the prior year.
The transaction that generated most of the cash proceeds was the transfer of certain derivative transactions, credit facilities and related assets of Zurich Capital Markets to BNP Paribas. Other significant transactions during 2004 include the sale of Turegum Insurance Company and the life and general insurance operations in Belgium and Luxembourg.
Net reserves for losses and loss adjustment expenses 37,013 30,366 22%
We establish reserves for losses and loss adjustment expenses for estimates of future payments of reported and unreported claims for losses and related expenses with respect to insured events that have occurred. Reserving is a complex process dealing with uncertainty and requiring the use of informed estimates and judgments. Any changes in estimates are reflected in the results of operations in the period in which estimates are changed.
In 2004, we refined our reserving process through a program of continuous and progressive review of different lines of business. In aggregate, we have strengthened reserves because of adverse prior year development by USD 2.0 billion which compares with USD1.9 billion in 2003. Strengthening of USD 2.6 billion in North America Corporate was mitigated by reserve redundancies of approximately USD 600 million arising across all our other regions including our Centre operations. These net reserve redundancies arise from both claims settlements below the reserved amounts as well as from reassessment of reserving requirements for claims payable in the future.
Capitalization and Indebtedness in USD millions, as of December 31 2004 2003 Change
Debt related to capital markets and banking activities 3,880 5,961 (35%)
Indebtedness As of December 31, 2004 total operational debt was USD 13.0 billion, a decrease of USD 1.4 billion since December 31, 2003. As of December 31, 2004, we had USD 4.1 billion of collateralized loans, which were secured by mortgage loans of the same amount given as collateral to the counterparties compared with USD 4.7 billion as of December 31, 2003. Debt relating to capital markets and banking activities decreased by USD 2.1 billion following the transfer of certain derivative transactions, credit facilities and related assets of Zurich Capital Markets (ZCM) to BNP Paribas in accordance with an agreement signed in 2003 as part of the wind-down of ZCM activities. This decrease was partially offset by an increase of USD 1.3 billion in our obligation to repurchase securities to USD 5.0 billion, resulting from increased short-term activities in the Repo market in the normal course of business as part of our investment and liquidity management.
The increase in total financial debt of USD 1.1 billion, or 23%, arose mainly from the issuance of EUR 1 billion (USD1.3 billion) of 10-year senior debt by Zurich Finance (USA), under the “Euro Medium Term Note Programme” for Zurich Insurance Company, partially offset by the repayment on maturity by the Zurich International (Bermuda) Ltd of its zero coupon bond of CHF 539 million (USD 427 million) in July 2003.
The reduction in minority interests of USD 123 million, or 13%, resulted primarily from ZCM which no longer has any minority shareholder interests in its business.
Shareholders’ equity in USD millions, for the year ended December 31, 2004
Change in net unrealized gains on investments excluding translation adjustments 386
Shareholders’equity increased by USD 3.2 billion to USD 22.2 billion as of December 31, 2004.The increase from our net income after tax of USD 2.6 billion in 2004 and favorable currency translation effects were partially offset by the nominal value reduction of common stock and the initial application of the legislation for the mandatory participation in profits for policyholders in Switzerland (“legal quote”).
Regulated entities of the Group are required to submit returns to their local regulators, usually on an annual basis but in some countries more frequently.These returns show the compliance of the reporting entity with local solvency requirements and include information on eligible funds and admissible assets.
Effect of exchange rate changes on cash and cash equivalents 683 809
Cash and cash equivalents as of January1 (opening balance) 15,677 10,033
Our cash flow from operating activities consists of cash flow arising from our insurance businesses, after payments to reinsurers (net premiums, policy fees and deposits received less net claims after recoveries from reinsurers, benefit payments, policy surrenders and operating expenses) and investment income received (dividends, interest and rents) less interest paid and tax payments.
Our financing activities result from our corporate funding and borrowing arrangements, capital raising and repayment and payments to shareholders.
Cash and cash equivalents increased in 2004 by USD 1.3 billion compared with USD 5.6 billion in 2003. Cash flow provided by operating activities reduced to USD 8.3 billion in 2004 from USD13.2 billion in 2003.Transfers to investment activities and financing repayments were together USD 7.7 billion in 2004 compared with USD 8.3 billion in 2003.
Basis of Current and Future Presentation and Comparability The Accounting Standards Executive Committee (AcSEC) of the American Institute of Certified Public Accountants (AICPA) issued Statement of Position 03-01 (“SOP 03-01”), Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts. SOP 03-01 has resulted in three significant changes in the treatment of certain life contracts, which have been adopted retrospectively, in accordance with IAS 8: i) Recognition of additional liabilities for guaranteed minimum death benefits, guaranteed retirement income benefits and benefits in respect of annuitization options on an accrual basis, primarily for life policies in the United States. The recognition of guarantee liabilities resulted in a write-down of deferred policy acquisition costs, due to a reduction in future estimated gross profits supporting these reserves.
iii) “Investments held on account and at risk of life insurance policyholders”, which are not bankruptcy protected from other creditors, and “Insurance reserves for life insurance where the investment risk is carried by policyholders”were reclassified to total investments and insurance reserves in the amount of approximately USD 50 billion.This change also resulted in the inclusion in the consolidated operating statements of additional investment result arising from the reclassified investments and a substantially corresponding charge in “Policyholder dividends and participation in profits.” As a result, there is no material net impact on the Group’s operating results.
In 2004, we have made the following restatement for the implementation of SOP 03-01 as published in the Half Year Report 2004.
The Group has been reporting under standards issued by the International Accounting Standards Board (IASB) since 1998. As set out in note1 to the Consolidated Financial Statements, we refer to accounting principles generally accepted in the United States (US GAAP) for guidance in particular on accounting for insurance.
We continue to monitor developments in the interpretation of the changes to be implemented in 2005 and will determine our position for reporting for the first three months of 2005. We are also working with the accounting professionals and our peer group of insurance companies in Europe through the CFO Forum to assist the IASB in developing a comprehensive standard for the accounting of insurance products.
Primary segments: In 2005, the Group will continue to report segment information using the same primary segments as for 2004. The segments are: General Insurance, Life Insurance, Farmers Management Services, Other Businesses and Corporate Center.
Secondary segments: In 2005 the Group’s secondary format for segment information will continue to be geographic. The geographical segments will be North America, Europe, International Businesses and Centrally Managed Businesses.
Net income before income taxes and minority interests 1,119 981 1,204 307
In the following sections we discuss the results of operations for each of our segments. It should be noted that results for 2003 in this Segmental Financial Analysis are restated for the implementation of a new accounting standard. Business operating profit figures for 2003 have been restated to conform with the current year presentation. Details are set out in the sections “Basis of Current and Future Presentation and Comparability” and “Investment Performance” in the Group Financial Review. The analysis of the results for the year ended December 31, 2004 is made against the restated results of the prior year period, unless otherwise stated.
Adjusted for: Net capital (gains) on investments and impairments, excluding capital markets and banking activities (87) (4,525) (1) (43) (115) (4,771)
Tax expense, adjusting for life policyholder tax 1 219 392 52 149 813
Net loss / (gain) on divestments of businesses 34 (37) – (32) (53) (88)
Implementation of Swiss “legal quote” – 54 – – – 54
Adjusted for: Net capital (gains) on investments and impairments, excluding capital markets and banking activities (278) (4,380) – (138) (180) (4,976)
Policyholder allocation of net capital gains – 4,150 – 104 – 4,254
Net loss / (gain) on divestments of businesses 89 (427) – (13) – (351)
Our businesses have continued to take advantage of attractive, though competitive, rates. We have maintained our disciplined underwriting approach and, where in some lines of business the rates were not adequate to meet our technical price targets, we have continued to choose not to write that business. The benign catastrophe experience of the last two years came to an end when the four hurricanes struck the US and the Caribbean in the third quarter and this was followed by the tragic events of the tsunami in South Asia. These events brought out the best in us in meeting the needs of our customers.
We have commenced many programs to further improve our operational excellence, some of which have evolved from The Zurich Way initiatives to develop the highest operational standards using a consistent approach across all our businesses. In underwriting, these include the targeting of key customer segments, the improvement of workflow processes to improve productivity, re-underwriting and re-pricing of certain books of business. In claims management, we seek ways to improve our effectiveness. Examples of this are our European motor claims handling process, the introduction of a systematic fraud detection system using voice monitoring and reviews of our claims handling legal expenses. We are also constantly seeking ways to reduce our cost base through sharing of services, improvements in structure and improved procurement processes.
During 2004, we have put in place the management and structure to implement the geographical and line of business focus that we announced in April. In 2005, we will report based on this organization which geographically will consist of North America, Europe and International Businesses (consisting of Asia Pacific, Latin America and Southern Africa). In addition, we will manage and report our results based on our customer segments which are Global Corporate, Commercial and Personal.
These initiatives, our continued focus on our core disciplines of underwriting and claims management, our diversified portfolio across geographies and lines of business and our new operational structure should enable us to further develop our business in 2005.
Combined ratio 101.6% 97.9% (3.7 pts) 1 Including policyholder dividends and participation in profits.
North America Corporate (1,165) 664 nm (506) 671 nm 1 Centrally Managed Businesses includes internal reinsurance and businesses in run-off.
Business operating profit decreased by USD 766 million from USD 2.1 billion to USD1.4 billion for 2004. Our strong underwriting performance in the North America Consumer, Continental Europe, UKISA and Rest of the World regions as well as higher net investment income, were more than offset by large losses due to the hurricanes that struck the US and the Caribbean, the December tsunami and further reserve strengthening in North America Corporate relating to prior years.
Eliminations (1,091) (1,703) nm – – nm 1 Centrally Managed Businesses includes internal reinsurance and businesses in run-off.
Net underwriting result and combined ratio by geographic region Net underwriting result Combined ratio in USD millions, for the years ended December 31 2004 2003 Change 2004 2003 Change
The Group’s diversified portfolio across geographies, segments and lines of businesses softened the impact on the underwriting losses arising from the four hurricanes which struck the US and the Caribbean, the December tsunami, and the adverse prior year reserve strengthening in North America Corporate.The strong operational performance of our North America Consumer, Continental Europe, UKISA and other operations throughout Rest of the World was mainly the result of our disciplined approach to underwriting and pricing, which partially compensated for the losses in North America Corporate.The net underwriting result declined from a profit of USD 578 million in 2003 to a loss of USD 469 million in 2004.The combined ratio was 101.6% in 2004, an increase of 3.7 percentage points compared with 97.9% in 2003.The hurricanes and the tsunami caused 2.5 percentage points of this increase.
Expense ratio by significant geographic region1 for the years ended December 31 2004 2003 Change
The expense ratio improved by 0.8 percentage point to 24.0% in 2004. Total net technical expenses increased by USD 526 million, or 8%, from USD 6.7 billion for 2003 to USD 7.2 billion for 2004. This increase was below the growth rate of net earned premiums, reflecting the reduction in commission expenses. Administration expenses were lower due to expense management initiatives.
Combined ratio 117.3% 99.0% (18.3 pts) 1 Including policyholder dividends and participation in profits.
Net income decreased by USD 1.2 billion to a loss of USD 506 million in 2004. In addition to the factors that affected business operating profit, net income included tax benefits partially offset by a decline in net capital gains on investments.
The growth of gross written premiums and policy fees of USD 233 million, or 2%, to USD 15.7 billion in 2004 arose from rate increases compared to 2003. Average rate increases were 2.6% in 2004 over 2003 compared with nearly 16% in 2003 over 2002. Volumes slightly decreased, as we have chosen not to write business that does not meet our technical price targets.
The growth in net earned premiums of 17% to USD 10.6 billion in 2004 is mainly attributable to the reduction of premiums ceded to reinsurers as well as earnings from premium growth in prior periods now being earned as revenue.
The net underwriting result declined by USD 1.9 billion to a negative technical result of USD 1.8 billion for 2004 as a result of the hurricanes, the tsunami and the reserve strengthening. The combined ratio increased by 18.3 percentage points to 117.3%, of which 5.8 percentage points is attributable to the hurricanes and 24.3 percentage points to the reserve strengthening. Overall, the loss ratio increased from 78.2% in 2003 to 97.8% in 2004. The improvement in the expense ratio was driven mainly by the results of initiatives to improve expense and commission management.
The amounts reported in our North America Consumer region represent the gross written premiums and related financial results from quota share reinsurance treaties assumed from the Farmers Exchanges, which we manage but do not own. The decline in net earned premiums and total benefits, losses and expenses relate to a reduction in the premiums ceded in one of those treaties as compared with the prior year. The net underwriting result and the combined ratio improvement resulted mainly from the underlying business performance assumed from the Farmers Exchanges.
The growth in net earned premiums of 8% to USD 9.2 billion slightly outpaced the increase in gross written premiums and policy fees in this region, benefiting from the growth in net written premiums in 2003 earned as revenue in 2004 and from a reduction in premiums ceded as reinsurance.
The net underwriting result for Continental Europe almost quadrupled to USD 550 million for the year 2004. Each of our largest markets contributed to the improvement in the technical insurance result.The combined ratio improved by 4.3 percentage points to 94.0%.
In Switzerland, the underwriting result improved from a loss of USD 75 million in 2003 to a positive technical result of USD 46 million in 2004. We have benefited from the tightened underwriting standards associated with the profit improvement initiatives, partially offset by losses from the large hailstorms in July and August 2004. Germany’s net underwriting result increased by 25% mainly due to ongoing realization of cost saving initiatives and lower frequency of claims. Spain benefited from the absence of large claims, lower frequency of claims and lower average losses, as well as the positive prior year loss development resulting in a significant improvement in the underwriting result.The positive development of Italy’s net underwriting result was mainly the result of achieved cost savings. CEC’s net underwriting result more than doubled reflecting the improved losses resulting from strict underwriting policy and favorable loss development.
Combined ratio 87.8% 97.5% 9.7 pts 1 Including policyholder dividends and participation in profits.
Business operating profit more than doubled to USD1.1 billion in 2004 driven by the improved underwriting result and an increase in net investment income following positive cash flow generation in both 2003 and 2004.
The region experienced a USD195 million, or 3%, increase in gross written premiums and policy fees to USD 6.5 billion for 2004, benefiting from the appreciation of the British pound sterling (12%) in the UK, the euro (10%) in Ireland and the rand (17%) in South Africa against the US dollar. Excluding exchange rate movements, gross written premiums and policy fees decreased by 8%.The decrease predominantly reflects reductions in fronted business although this has been partially offset by positive development in personal lines. Despite increasing competition, the region experienced stable rates compared to 2003 reflecting our adherence to rigorous underwriting standards.
Combined ratio 93.5% 93.4% (0.1 pts) 1 Including policyholder dividends and participation in profits.
Gross written premiums and policy fees increased by 3% to USD 2.2 billion in 2004.The largest increases in gross written premiums and policy fees were experienced in Australia, Japan and Venezuela. In Venezuela, we recorded strong growth in local currency benefiting particularly from sales in the automobile line of business. The Australian dollar appreciated 13% and the Japanese yen 7% against the US dollar, which also contributed to the overall reported growth in gross written premiums and policy fees expressed in US dollars.
The increase in net earned premiums to USD1.5 billion represented an improvement of USD 227 million, or 18%, compared with USD1.2 billion in 2003.This development was significantly above the growth rate of gross written premiums and was mainly driven by changes in our ceded reinsurance arrangements, which led to higher retention of premiums particularly in Taiwan, Venezuela and Mexico.
Insurance benefits and losses increased by 21% to USD 842 million in 2004.The loss ratio increased by 1.3 percentage points to 57.4% for 2004 mainly caused by the extraordinary typhoon losses in Japan and the December tsunami costs partially offset by favorable claims experience elsewhere, particularly in Australia and Taiwan.The expense ratio improved by 1.2 percentage points to 36.1% in 2004 reflecting the strict financial discipline instilled in our businesses in this region.
Business operating profit declined from USD173 million in 2003 to USD 25 million in 2004 and net income to USD 60 million for 2004 as compared with USD 260 million in 2003 substantially affected by our operations in run-off.
The USD 326 million, or 41%, decrease in gross written premiums and policy fees to USD 470 million is primarily the consequence of the gradual transfer, starting in 2003, of our intra-group reinsurance transactions to the regions that wrote the underlying premiums as well as further optimization of our reinsurance purchasing. This development was partially offset by businesses put into run-off during 2004, which were allocated to Centrally Managed Businesses and were still earning residual premiums.
Our Zurich Way initiatives will enable us to build on this momentum. Our Zurich Way Sales Excellence program aims to improve the productivity of our tied agents. Also under The Zurich Way, we are looking at further opportunities for efficiencies and cost savings. And we will continue to develop innovative products focused in market niches where we have competitive advantage. Despite the encouraging progress we face continuing challenges in the future. Our markets are highly competitive with margins under pressure. Our lack of scale in certain markets remains a concern as does increasing regulatory focus on our industry. Nonetheless we believe we have laid solid foundations for the future.
The adoption of the new accounting standard (SOP 03-01), which affected mainly the Life Insurance business, resulted in a restatement of 2003 comparative figures.The main impacts of this restatement were on North America Consumer and UKISA.The impact of new accounting standards is set out in note 3 of the Consolidated Financial Statements and in the Group Financial Review.
Life Insurance achieved an increase in business operating profit of USD 207 million, or 24%, to USD 1.1 billion compared with USD 856 million for 2003. UKISA and Continental Europe recorded the largest increase, partially offset by lower business operating profit in North America Consumer.
Breakdown of premiums Gross written premiums Total GWP and by geographic region and policy fees (GWP) Insurance deposits insurance deposits in USD millions, for the years ended December 31 2004 2003 2004 2003 2004 2003
Gross written premiums and policy fees decreased by USD 646 million, or 6% (–13% in local currency), from USD11.6 billion for 2003 to USD11.0 billion in 2004.This decrease was due to the sale of certain life operations in the second half of 2003, particularly Zurich Life US and Zurich Life UK, as well as the redesign of Switzerland’s group pension business model which has been partially transferred to an external foundation. Excluding these factors and exchange rate movements, premiums increased by 3%.
Total benefits, losses and expenses decreased by USD 413 million, or 2% (–11% in local currency), from USD 21.0 billion in 2003 to USD 20.6 billion in 2004.This decrease was driven by the reduction in insurance benefits and losses in Switzerland related to the redesign of the group pension business model and to the divestment of businesses in other parts of the world.This development was partially offset by increased policyholder dividends and participation in profits mainly due to improved investment results.
Shareholders’ Intangibles and Recoverability Although not a measure of current profitability, an important factor to consider when evaluating the sustainability of Life Insurance earnings is the recoverability of deferred policy acquisition costs (DAC) and other intangibles that have been capitalized.The following table sets out the amount of shareholders’ intangibles to be recovered.
DAC asset included in Life Insurance segment balance sheet 11.0 9.6
Present value of future profits (linked to acquisitions) and other intangible assets 1.1 1.2
Investments, less reserves for Life Insurance where the investment risk is carried by the policyholders (1.1) (1.3)
DAC consists of the costs of acquiring new business, including commissions, underwriting and policy issue expenses, which vary with and are directly related to the production of new business.The present value of future profits is the discounted value of the profit on acquired insurance contracts to be amortized over the expected life of these contracts.These are defined in note 2 of the Consolidated Financial Statements.
Some charges assessed against policyholders’ balances have been deferred as unearned revenue (“deferred front-end fees”) and will be recognized in income over the period for which benefits accrue, using similar assumptions as those used to amortize DAC.
Certain life insurance policies are established to meet specific investment objectives of policyholders who bear the investment risk. In these cases, investment income and investment gains and losses accrue directly to those policyholders. Under the Group’s IFRS accounting policies, the benefit of surrender charges cannot be reflected in the liability for policyholder benefits and hence a mismatch arises between invested assets and reserves for those life insurance contracts where the investment risk is carried by the policyholder.
Embedded Value Results Embedded value highlights are set out below. Further details are set out in the Embedded Value section which follows the Consolidated Financial Statements.
Embedded Value – highlights in USD millions, for the years ended December 31 2004 2003 Change
Gross new business premiums, measured on an annual equivalent (APE) basis (new annual premiums plus 10% of single premiums) increased by USD 269 million to USD 2.4 billion. In local currency APE decreased by 2% compared with 2003, which was largely a result of certain life company divestments. Adjusted for businesses divested and discontinued in 2003 and 2004, and the redesign of the group pension model in Switzerland, APE increased by 15% in local currency. This improvement can be attributed to the effect of higher volumes in Continental Europe and UKISA.
Gross written premiums, policy fees and insurance deposits 1,115 2,434 (54%)
Business operating profit decreased by USD10 million, or 4%, from USD 245 million in 2003 to USD 235 million for 2004. Net income increased by USD 103 million, or 184%, from a profit of USD 56 million in 2003 to USD159 million in 2004 due to the divestment of Zurich Life US which negatively influenced 2003 net income of North America Consumer. Adjusting for the effect of the after-tax loss on divestment, net income remained stable. Operating performance has been driven by stronger investment performance compared to 2003 as well as growth in universal life and traditional business largely offset by higher amortization of deferred policy acquisition costs.
Excluding the impact of divestment and reclassification, the region showed an increase in gross written premiums and policy fees of USD 38 million.This favorable development was driven by increases in traditional renewal products and in policy fees from universal life insurance. Insurance deposits experienced a decrease of 4% in 2004 on a comparable basis.This was primarily a result of lower fixed annuity sales due to the lower interest rate environment.
Total benefits, losses and expenses decreased by USD 481 million, or 46%, from USD1.0 billion in 2003 to USD 559 million in 2004 which is in line with the decrease in premiums following the divestment and reclassification in 2003. Insurance benefits and losses, excluding the divestment and reclassification, remained stable at USD 221 million. Underwriting and acquisition expenses were USD 30 million higher than in 2003 on a comparable basis due to higher gross margins in 2004 leading to correspondingly higher amortizations in deferred policy acquisition costs.
In North America Consumer sales dropped by 48% due primarily to the divestment of Zurich Life US which contributed USD111 million to APE in 2003. Excluding the effect of the divestment, APE production for 2004 increased by 2% to USD120 million compared with 2003 following higher sales volume of level term products.
Gross written premiums, policy fees and insurance deposits 9,098 9,790 (7%)
Business operating profit increased by USD 61million, or 21%, from USD 294 million in 2003 to USD 355 million for 2004. Net income decreased by USD159 million, or 33%, from USD 482 million in 2003 to USD 323 million in 2004.The improved result for our operations in Germany, Italy and Spain partially offset the decline of net income in Switzerland. Additionally, in 2003 after-tax gains on divestments of USD113 million were realized relating to the sale of certain life businesses.
Breakdown of premiums Gross written premiums Total GWP and by market and policy fees (GWP) Insurance deposits insurance deposits in USD millions, for the years ended December 31 2004 2003 2004 2003 2004 2003
Continental Europe experienced a decrease in gross written premiums and policy fees of USD 649 million, or 8% (16% in local currency), from USD 8.2 billion in 2003 to USD 7.6 billion in 2004.This change was mainly caused by the redesign of the group pension business model in Switzerland as well as the sale of certain businesses in 2003 and during 2004, partially offset by favorable exchange rate movements. Insurance deposits decreased by USD 43 million, or 3%, from USD1.6 billion in 2003 to USD1.5 billion for 2004 (–11% in local currency).
In Germany, gross written premiums and policy fees decreased by 9% in local currency, mainly due to decreases in single premiums products following the close of underperforming distribution channels, whereas insurance deposits were at the same level as last year in local currency. A change in product mix in favor of unit-linked business gained momentum in the fourth quarter of 2004. Switzerland’s gross written premiums and policy fees decreased by USD 564 million, or 17% (–23% in local currency), largely due to the partial transfer of the group pension business to an external foundation. In individual life business, Switzerland experienced only a small decrease impacted by a sales rally in 2003, in anticipation of the technical interest rate being lowered. In Italy, gross written premiums and policy fees demonstrated a significant increase of 10% in local currency arising from the growth in sales of single premium products through the agent channel. The increase in insurance deposits (4% in local currency) was driven by stronger sales in index products. Spain recorded a slight decrease in gross written premiums and policy fees in local currency of 2% mainly due to lower sales of unit-linked and group savings products.
Gross written premiums, policy fees and insurance deposits 7,864 6,571 20%
Business operating profit significantly increased by USD131 million, or 48%, from USD 271 million for 2003 to USD 402 million in 2004 mainly due to improved investment returns, reduced expenses and the favorable effect of exchange rate movements. Net income decreased by USD 227 million, or 40%, from USD 564 million in 2003 to USD 337 million in 2004. In 2003, net income included USD 416 million of after-tax gains arising from divestments of businesses compared to USD 20 million in 2004. After excluding this impact net income improved by USD169 million in 2004.
Insurance deposits increased by USD 753 million or 15% (3% in local currency) from USD 4.9 billion in 2003 to USD 5.6 billion in 2004 reflecting higher volume of sales of our investment bond products.
UKISA saw strong new business growth with APE reaching USD1.0 billion, an increase of USD154 million over 2003, corresponding to an increase in local currency of 5%. This was primarily the result of a large increase in single premium sales due to strong sales of investment bond products in Zurich Assurance through the IFA network.
An operating return on embedded value of 4.7%, corresponding to an operating profit, after tax, of USD 264 million, has been achieved for 2004. An increase in provisions for settling customer complaints relating to past sales of mortgage endowment and other contracts has negatively impacted the operating profit by USD 208 million. Without this effect, the after-tax operating return was 8.4%.
The region recorded a decrease of USD 96 million, or 14% (–22% in local currency), in insurance deposits from USD 670 million in 2003 to USD 574 million in 2004 which arose from cessation of annuity business in Japan, partially offset by a strong increase of 52% in the insurance deposit business in Australia, our largest remaining life business in this region.
Total benefits, losses and expenses reduced by USD 92 million, or 11%, from USD 862 million in 2003 to USD 770 million for 2004, mainly as a result of our portfolio divestment in Taiwan in 2004.
Rest of the World – embedded value highlights in USD millions, for the years ended December 31 2004 2003 Change
Gross new business premiums (APE) for Rest of the World reduced by USD 36 million or 15% (–28% in local currency), to USD 207 million in 2004, mainly because significant sales of bancassurance products in one of our Asia Pacific businesses during 2003 were not repeated in 2004.
For 2004, new business profit, after tax, was USD 6 million, an improvement of USD 7 million from a loss of USD 1 million in 2003. This positive development is due to an increased volume of more profitable products in Asia Pacific, particularly in Hong Kong.
Farmers Management Services Farmers Group, Inc. and its subsidiaries (FGI) provide non-claims related management services to the Farmers Exchanges, prominent writers of personal lines and small commercial lines business in the US. While premiums are written and claims are paid by the Farmers Exchanges, which we manage but do not own, FGI provides nonclaims related management services to the Farmers Exchanges and receives management fees for these services.
Farmers Management Services achieved strong results in 2004 with growing revenues and controlled expenses. Numerous actions were taken to accelerate marketing momentum and drive revenue growth as a result of which new business policies of the Farmers Exchanges grew by 13.1% in 2004.The introduction of more sophisticated marketing and retention programs, such as customized mailings to over four million customers, contributed to growth in every major line. A total of 1,770 agents were added (a net gain of nearly 600) and the average production of full time agents increased by 5% over 2003. More structured and intensive training for agents was also introduced through the launch of the University of Farmers and this contributed to a significant increase in the success rate of new agents. A multi-year business process re-engineering effort was launched achieving a 7% employee productivity increase. Implementation of self-service tools and new technologies further aided cost control, while our focus on customer experience increased customer satisfaction by 4.4 percentage points over 2003.
Net income of USD 686 million in 2004 was 14% higher than the USD 604 million in 2003 reflecting the consistent growth in business operating profit.
Management fees and other related revenue increased by USD 100 million, or 5%, from USD 1.9 billion in 2003 to USD 2.0 billion in 2004. This increase arises primarily from higher gross premiums earned by the Farmers Exchanges. In 2004, gross earned premiums were USD 14.0 billion as compared with USD 13.7 billion in 2003. Premiums from continuing lines of business grew by USD 495 million, or 4%, over 2003. This was largely attributable to higher premiums in the specialty, commercial and fire lines of business of the Farmers Exchanges. However, the decision by the Farmers Exchanges to exit the medical malpractice business reduced the overall premium growth rate to 3%. Furthermore, the motor line of business experienced higher fees than in 2003 as a result of revisions to the fee structure effective from January 2004. Additionally, other revenues such as Flexabill service fees, fire inspection fees, service charges and membership fees, which are sensitive to premium levels, also increased.
Expenses were USD 55 million, or 6%, higher in 2004 compared with 2003. This increase was driven by variable expenses related to growing revenues, as well as higher IT and employee benefit costs. As a result, the gross operating margin of Farmers Management Services decreased by 0.4 percentage point to 51.9% for 2004, which is closer to our long-term historical margin of approximately 50%.
Other Businesses – highlights in USD millions, for the years ended December 31 2004 2003 Change
Due to the relative importance of Centre to the Other Businesses segment, key financial data for Centre is shown below.
Centre and other operations Centre Other operations in USD millions, for the years ended December 31 2004 2003 2004 2003
Insurance benefits and losses, including policyholder dividends 858 2,088 323 331
Corporate Center The Corporate Center segment includes Group holding and financing companies, Corporate Center operations and alternative investments.This segment also includes some Group internal reinsurance operations that are not attributable to a specific segment but are managed on a global basis.
The loss recorded in Business operating profit for Corporate Center improved by USD 184 million over 2003 to a loss of USD 514 million for 2004 from a loss of USD 698 million in 2003. Net costs have also improved, decreasing by USD15 million to net costs of USD 495 million for 2004 as a result of controlling costs, combined with the favorable effect of foreign exchange gains.
The increase in total revenues of USD 379 million was primarily attributable to an improved recovery for services rendered to other segments. Additionally, net gain on divestments of businesses contributed USD 53 million to this increase in total revenues at the Corporate Center.
Trading equity portfolios in capital markets and banking activities 2,773 4,303
Investments held on account and at risk of life insurance policyholders 7 24,189 21,980
Consolidated statements of cash flows in USD millions, for the years ended December 31
Cash and cash equivalents comprise the following: in USD millions 2004 2003
Balance as of December 31, 2002, as previously reported 144,006,955 1,096
Change in net unrealized gains / (losses) on investments (excluding translation adjustments) – –
Common (nominal paid-in gains/(losses) translation Retained shareholders’ stock value) capital on investments adjustment earnings equity
Certain amounts recorded in the consolidated financial statements reflect estimates and assumptions made by management about insurance liability reserves, investment valuations, interest rates and other factors. Significant estimates are discussed in the notes. Actual results may differ from the estimates made.
A new accounting standard, discussed in note 3, resulted in restatement of 2003 consolidated financial statements. In addition, certain reclassifications have been made to prior year amounts and segment disclosures to conform to the current year presentation. These reclassifications have no effect on the previously reported net income.
Segment information The Group is managed on a matrix basis, reflecting both line of business and geography. Accordingly, segment information is presented in two formats. The primary format is based on the operating businesses of the Group and how they are strategically managed to offer different products and services to specific customer groups. The Group’s primary segments are defined as follows: General Insurance: General Insurance operations write substantially all lines of property and casualty business.
Farmers Management Services: Farmers Group, Inc. and its subsidiaries (“FGI”) provide non-claims related management services to the Farmers Exchanges. The Farmers Exchanges operate in the US property and casualty insurance industry and consist of the Farmers Insurance Exchange, Fire Insurance Exchange, Truck Insurance Exchange (each an “Exchange” and collectively, the “Exchanges”), their respective subsidiaries, Farmers Texas County Mutual (“FTCM”), Foremost County Mutual Insurance Company and Foremost Lloyds of Texas. The Farmers Exchanges are owned by the policyholders of the Exchanges, FTCM and Foremost County Mutual Insurance Company as well as the underwriters of Foremost Lloyds of Texas. Accordingly, the Group has no ownership interest in the Farmers Exchanges. FGI receives a fee for the management services provided which is based primarly on a percentage of the gross earned premiums of the Farmers Exchanges.
Capital markets and banking activities consist primarily of Zurich Capital Markets which has a portfolio of hedge fund-based investment vehicles, asset-based financing and credit structures, instruments to manage investment risk, customized strategies to structure or manage financial assets, and administrative services for hedge funds and hedge fund investors.
Centre operations: Centre’s portfolio of business consists of property and casualty reinsurance, credit enhancement and life & health business.
(b) Revenue recognition Premiums: Premiums from the sale of general insurance products are recorded when written and are accreted to earnings on a pro-rata basis over the term of the related policy coverage. However, for those contracts for which the period of risk differs significantly from the contract period, premiums are recognized over the period of risk in proportion to the amount of insurance protection provided. The unearned premium reserve represents the portion of the premiums written relating to the unexpired terms of coverage.
Other revenue: Fee revenue for the provision of non-claims related management services to the Farmers Exchanges is calculated primarily as a percentage of gross premiums earned by the Farmers Exchanges.
Farmers Group Inc. and its subsidiaries (“FGI“) provide the following non-claims related management services to the Farmers Exchanges: risk selection, preparation and mailing of policy forms and invoices, premium collection, management of the investment portfolios and certain other administrative and managerial functions. The Farmers Exchanges are responsible for their own claims functions, including the settlement and payment of claims and claims adjustment expenses. They are also responsible for the payment of agent commissions and bonuses and the payment of their premium and income taxes.
Future life policyholders’ benefits and policyholders’ contract deposits: These represent the estimated future policyholder benefit liability for traditional life insurance policies and certain unit-linked investment contracts, respectively.
Future life policyholders’ benefits for other traditional life insurance policies are calculated using a net level premium valuation method based on actuarial assumptions as to mortality, persistency, expenses and investment return including a margin for adverse deviation. The assumptions are established at policy issue and remain unchanged except where premium deficiency occurs.
“Investments held on account and at risk of life insurance policyholders” and ”Insurance reserves for life insurance where the investment risk is carried by policyholders”: These represent trading portfolios maintained to meet specific investment objectives of policyholders who bear the investment risk and which are bankruptcy protected from other creditors. Investment income and investment gains and losses accrue directly to policyholders. The assets and liabilities are carried at fair value. Deposits, withdrawals, net investment income, and realized and unrealized capital gains and losses are included in this position and are not reflected in the consolidated operating statement. The costs of insurance, policy administration, investment management, surrender charges and certain policyholder taxes assessed against the policyholders’ account balances are included within policy fee revenue.
Reinsurance contracts are assessed to ensure that underwriting risk, defined as the reasonable possibility of significant loss, and timing risk, defined as the reasonable possibility of a significant variation in the timing of cash flows, are transferred by the ceding company to the reinsurer. Those contracts that do not transfer both risks, referred to in total as insurance risk, are accounted for using the deposit method. A deposit asset or liability is recognized based on the consideration paid or received less any explicitly identified premiums or fees to be retained by the ceding company. Deposits for contracts that transfer only significant underwriting risk are subsequently measured based on the unexpired portion of coverage until a loss is incurred, after which the present value of expected future cash flows under the contract is added to the remaining unexpired portion of coverage. Changes in the deposit amount are recorded in the operating statement as an incurred loss. Interest on deposits that transfer only timing risk, or no risk at all, are accounted for using the interest method. Future cash flows are estimated to calculate the effective yield, and revenue and expense are recorded as interest income or expense.
(f) Investments Financial assets are classified either as “held-to-maturity”, “trading”, “available-for-sale”, or “loans originated by the Group”. Held-tomaturity financial assets are debt securities which the Group has the ability and positive intent to hold to maturity. Trading financial assets are debt and equity securities which the Group buys with the intention to resell in the near term. The remaining debt and equity securities are classified as available-for-sale. Loans originated by the Group, such as mortgage loans, policyholders’ collateral and other loans, include loans where money is provided directly to the borrower, other than those that are originated with the intent to be sold in the short term, which are recorded in the trading category.
The realized gain or loss on divestment is based on the difference between the proceeds received and the carrying value of the investment plus any unrealized gains or losses of the investment recorded in shareholders’ equity using the specific identification method. When available-for-sale financial assets are sold, impaired or otherwise disposed of, the cumulative gains and losses previously recognized in shareholders’ equity are included in the current period income. The amortization of premium and accretion of discount on available-forsale and held-to-maturity investments in debt securities is computed using the effective interest method and is recognized in current period income. Dividends on equity securities are recorded as revenue on the ex-dividend date, the date that the dividends become payable to the holders of record. Interest income on financial assets is recognized when earned.
For quoted available-for-sale financial assets the decision to make an impairment provision is based on review of the issuer’s current financial position and future prospects and an assessment of the probability that the current market price will recover to former levels within the foreseeable future. The recoverable amount is determined by reference to the market price. For non-quoted available-for-sale financial assets the Group takes into consideration the issuer’s current financial position and future prospects in determining whether an impairment provision is required. The recoverable amount is determined by applying recognized valuation techniques. When a decline in the fair value of an available-for-sale asset has been recognized directly in shareholders’ equity and there is objective evidence that the asset is impaired, the cumulative loss that had been recognized directly in shareholders’ equity is removed from equity and recognized in current period income even though the asset has not been de-recognized. The amount of the cumulative loss that is removed from shareholders’ equity and recognized in current period income is the difference between acquisition cost (net of any principal repayment and amortization) and current fair value, less any impairment loss on that asset instrument previously recognized in income.
In addition to the derivative financial instruments described above, the Group enters into contracts that are not considered derivative financial instruments in their entirety but that include embedded derivative features. Such embedded derivatives are assessed at inception of the contract and, depending on their characteristics, are accounted for as separate derivative financial instruments pursuant to IAS 39.
To qualify for hedge accounting, the hedging relationship must meet several strict conditions on documentation, probability of occurrence, hedge effectiveness and reliability of measurement. If these conditions are not met, then the relationship does not qualify for hedge accounting. In this case the hedging instrument and the hedged item are reported independently as if there was no hedging relationship. In particular, derivative financial instruments are reported at fair value, with changes in fair value charged to current period income.
(h) Securities lending Certain entities within the Group participate in securities lending arrangements whereby specific securities are loaned to other institutions, primarily major brokerage firms, for short periods of time. Under the terms of the securities lending agreements, the loaned securities remain under the Group’s control and thus do not get de-recognized.
To the extent that there is a change in this relationship, the Group would re-evaluate the value of this intangible asset.
Taxes paid by UK life insurance businesses are based on investment income less allowable expenses. To the extent that these taxes exceed the amount that would have been payable in respect of the shareholders’ share of taxable profits, it is normal practice for UK life businesses to recover this tax from policyholders. While in the Group’s case the relevant company has the contractual right to charge policyholders for the taxes attributable to their share of investment income less expenses, the obligation to pay the tax authority rests with the company and therefore, the full amount of tax including that charged to policyholders is accounted for as an income tax. Income tax expense therefore includes an element attributable to policyholders. In addition, deferred tax on unrealized gains on “Investments held on account and at risk of life insurance policyholders” related to certain UK unit-linked policies is included as income tax expense and an accrual for future policy fees to recover the tax charge is included in gross written premiums and policy fee revenue.
(o) Share-based payment transactions Expenses for share-based payment transactions are recognized during the vesting period in the operating statement. These expenses recognize the fair value of the shares or options granted. A corresponding amount is reflected in additional paid-in capital.
(q) Leases Leases in which a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases. Payments made under operating leases are charged to the operating statement on a straight-line basis over the lease term.
(r) Provisions Provisions are recognized when the Group has a present obligation (legal or constructive) as a result of a past event, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation and a reliable estimate can be made of the amount of the obligation.
The table below summarizes the principal exchange rates that have been used for translation purposes. Net gains and (losses) on foreign currency transactions included in the consolidated operating statements were USD153 million and USD (125) million for the years ended December 31, 2004 and 2003, respectively.
The Accounting Standards Executive Committee (AcSEC) of the American Institute of Certified Public Accountants (AICPA) issued Statement of Position 03-01 (“SOP 03-01”), Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts. SOP 03-01 has resulted in three significant changes in the treatment of certain life contracts, which have been adopted retrospectively, in accordance with IAS 8: i) Recognition of additional liabilities for guaranteed minimum death benefits, guaranteed retirement income benefits and benefits in respect of annuitization options on an accrual basis, primarily for life policies in the United States. The recognition of guarantee liabilities resulted in a write-down of deferred policy acquisition costs, due to a reduction in future estimated gross profits supporting these reserves.
The impact of the new standard is summarized in the tables below.
Net income before income taxes and minority interests 3,746 (135) 3,611
Investments held on account and at risk of life insurance policyholders 71,936 (49,956) 21,980
Table 3.3 Summary of restatement of key consolidated statement of cash flows items due to implementation of a new accounting standard As previously Restatement Restated in USD millions, for the year ended December 31, 2003 reported adjustment 2003
Sales and maturities: Purchases: Net cash used in investing activities (2,815) (3,598) (6,413)
Cash and cash equivalents as of January1 (opening balance) 8,444 1,589 10,033
In 2004, amounts for the Group’s internal reinsurance transactions have been allocated to the specific regions that wrote the underlying business, whereas in 2003 those results were recorded in the Centrally Managed Businesses region. The 2003 amounts have been reclassified to conform to this presentation.
Forthcoming changes in accounting policy For 2005 reporting, the Group will adopt new and amended accounting standards.
The International Accounting Standards Board (IASB) issued IFRS 4 “Insurance Contracts” on March 31, 2004. The publication of this standard provides, for the first time, guidance on accounting for insurance contracts. This standard applies to all insurance contracts (including reinsurance contracts) that an entity issues and to reinsurance contracts that it holds, except for specified contracts covered by other IFRS standards. In accordance with the transitional provisions of the standard the Group will adopt IFRS 4 as of January1, 2005. The most significant change as a result of the adoption of the standard is the re-classification of certain contracts as financial instruments and hence application of IAS 39 to these contracts. The adoption of IFRS 4 does not provide comprehensive guidance on the accounting treatment for insurance contracts and as such the Group will continue to apply US GAAP in certain circumstances where IFRS is silent.
The IASB issued IFRS 3 “Business Combinations” on March 31, 2004. In accordance with the transitional provisions of the standard, the Group has applied this standard to business combinations for which the agreement date is on or after March 31, 2004. The remaining requirements of IFRS 3 will be adopted as of January1, 2005. The most significant changes required by this standard are: • All business combinations within its scope are to be accounted for using the purchase method, previously IAS22 permitted business combinations to be accounted for using the pooling of interests method in certain circumstances.
IAS 36 “Impairment of Assets” and IAS 38 “Intangible Assets” were revised in March 2004 by the IASB as part of the Business Combinations Project. Consistent with the Group’s adoption of IFRS 3, the revised standards will be adopted as of January1, 2005.
The IASB issued IFRS 5 “Non-current Assets Held for Sale and Discontinued Operations” on March 31, 2004. The standard adopts the classification “held for sale”, introduces the concept of a disposal group, and specifies that assets or disposal groups that are classified as held for sale are carried at the lower of carrying amount and fair value less costs to sell. It also replaces IAS 35 regarding the accounting treatment for discontinued operations. In accordance with the transitional provisions of IFRS 5 the standard will be adopted by the Group as of January1, 2005. The most significant impact for the Group may be the re-classification of some of its assets as “held for sale.”
IAS 39 “Financial Instruments: Recognition and Measurement” was revised in December 2003 as part of the IASB’s project to improve IAS 32 “Financial Instruments: Disclosure and Presentation” and IAS 39. A further amendment was made in March 2004. This change related to Fair Value Hedge Accounting for a Portfolio Hedge of Interest Rate Risk. IAS 39 “Financial Instruments: Recognition and Measurement” should be applied for annual periods beginning on or after January 1, 2005. The most significant changes are as follows: • The standard clarifies that the evaluation of the transfer of risks and rewards of ownership precedes the evaluation of the transfer of control for all derecognition transactions • The standard permits an entity to designate any financial asset or financial liability on initial recognition as one to be measured at fair value, with changes in fair value recognized in profit or loss. To impose discipline on this categorization, an entity is precluded from reclassifying financial instruments into or out of this category
• The standard provides additional guidance about how to determine fair values using valuation techniques • The standard clarifies that an impairment loss is recognized only when it has been incurred. It also provides additional guidance on what events provide objective evidence of impairment for investments in equity instruments • Hedges of firm commitments are to be treated as fair value hedges rather than cash flow hedges. However, the standard clarifies that a hedge of the foreign currency risk of a firm commitment can be treated as either a cash flow hedge or a fair value hedge.
The Group has not yet quantified the impact these changes will have on the Group’s financial position or results.
During the years ended December 31, 2004 and 2003, the Group completed divestments of several businesses and recognized postcompletion adjustments. The total net gain on all divestments made during the year before tax was USD 88 million and USD 351 million, and the after-tax net gain on divestments was USD 71 million and USD 334 million for 2004 and 2003, respectively. Total cash consideration received was USD 2,488 million in 2004 and USD 2,737 million in 2003.
The Group’s most significant transactions affecting the scope of consolidation during the years ended December 31, 2004 and 2003 were as described below.
Changes in 2004 In Belgium and Luxembourg, the Group completed the sale to P&V Assurances of its life insurance operations (both consumer and commercial), its workers’ compensation portfolio and its general insurance operations in the consumer and small commercial segments, recognizing a loss of USD 30 million before tax.
The Group completed several other divestments with a net gain of USD 23 million before tax. These included the sale of its interests in Thai Zurich Insurance Company, life insurance policies written by the Group’s Taiwanese branch, Turegum Insurance Company, the real-estate investment company Zürich Atrium B.V., Zurich Insurance (Singapore) Pte. Ltd, Zürich Krankenversicherung AG (Deutschland) as well as its stake in Globale Krankenversicherungs-AG, Zurich Life Philippines and McMillan Shakespeare Australia Pty Limited.
The companies and businesses divested in 2004 contributed, before their sale, a net loss of USD19 million to the Group’s 2004 results compared to a net income of USD19 million in 2003.
During 2004, the Group has also recognized several post-completion adjustments for divestments closed in 2003. The total aggregate post completion gain was USD 95 million. The most significant impacts were from the finalization of the sale of Threadneedle Asset Management Holdings Ltd., Rüd, Blass & Cie AG and the transfer of certain derivative transactions, credit facilities and related assets of Zurich Capital Markets to BNP Paribas.
On October 31, 2003, the Group completed the sale of Zurich Life Assurance Company (Zurich Life), one of the UK Life businesses, to Swiss Re, recognizing a gain of USD128 million before tax.
On September 30, 2003, the Group completed the sale of Threadneedle Asset Management Holdings Ltd. to American Express Financial Corporation, recognizing a gain on divestment of USD 325 million before tax.
The Group completed the sale of Zurich Life, part of its US life and annuity operations, to Bank One Corporation on September 3, 2003, recognizing a loss on divestment of USD165 million before tax. Kemper Investors Life Insurance Company was not part of the sale and is retained by the Group.
On September1, 2003, the Group completed the sale of parts of its Dutch operations to SNS Reaal Groep N.V., recognizing a gain on divestment of USD114 million before tax. SNS Reaal acquired all of the Group’s life insurance operations as well as general insurance operations in the consumer and small business segments in the Netherlands.
In 2003, the companies and businesses divested contributed USD131 million to the Group’s net income.
Other investments: Investments held by investment companies 14 11 140 113 154 124
Mortgage loans, policyholders’ collateral and other loans 1,075 785 187 74 1,262 859 1 Impairments on total investments amounted to USD175 million in 2004 and USD1,067 million in 2003. 2 Including net capital gains / (losses) on derivative financial instruments of USD (5) million in 2004 and USD (419) million in 2003. 3 Including rental operating expense for real estate held for investment of USD 182 million in 2004 and USD118 million in 2003.
Breakdown of investments USD % USD % as of December 31 millions of total millions of total
Common stock portfolios backing the participating with-profit policyholder contracts 2,074 0.8% 1,695 0.8%
Trading equity portfolios in capital markets and banking activities 2,773 1.1% 4,303 1.9%
Mortgage and asset-backed securities 13,954 11,668 334 469 (62) (99) 14,226 12,038
Table 6.6 Realized capital gains/(losses) and impairments on available-for-sale debt and equity securities Debt securities Equity securities Total in USD millions, for the years ended December 31 2004 2003 2004 2003 2004 2003
Gross realized capital gains – available-for-sale 765 1,891 626 1,405 1,391 3,296
Gross realized capital losses – available-for-sale (173) (304) (753) (1,402) (926) (1,706)
Table 6.7 Net capital gains/(losses) on trading debt and equity securities Debt securities Equity securities Total in USD millions, for the years ended December 31 2004 2003 2004 2003 2004 2003
Capital Z Financial Services Fund II LP, United States 379 371 66 59 29.43% 29.41%
Table 6.9 Real estate held for investment in USD millions 2004 2003
Table 6.10 Unrealized gains/(losses) on investments included in shareholders’ equity in USD millions, as of December 31 2004 2003
Less amount of net unrealized (gains) / losses on investments attributable to: Life policyholder dividends and other policyholder liabilities (2,248) (638)
Table 7 Investments held on account and at risk of life insurance policyholders and insurance reserves for life insurance where the investment risk is carried by policyholders in USD millions, as of December 31 2004 2003
The implementation of SOP 03-01, as discussed in note 3, resulted in a reclassification of the assets and reserves for products sold in certain countries, predominantly the UK, to their respective investment categories and insurance reserves as they do not meet the criteria for classification as “separate accounts”. The effects are disclosed in note 3. The remaining balances represent products that consist primarily of variable life insurance and annuity products for which the policyholder directly bears the investment risk of the related assets.
• Investments held by investment companies: Estimated fair values are determined by the investment managers. • Real estate held for investment: Fair value is determined on a regular basis with reference to current market conditions. • Mortgage loans: Fair values of loans on real estate are estimated using discounted cash flow calculations based upon the Group’s current incremental lending rates for similar types of loans.
• Short-term investments: Carrying amounts approximate fair values. • Cash and cash equivalents: Carrying amounts approximate fair values.
• Derivative trading assets and liabilities: Fair values are based on quoted market prices, dealer price quotations, discounted cash flow models and option pricing models.
• Debt: Fair values are estimated using discounted cash flow calculations based upon the Group’s current incremental borrowing rates for similar types of borrowings with maturities consistent with those remaining for the debt being valued. • Obligations to repurchase securities: Carrying amounts approximate fair value.
(a) Principles The Group uses derivative financial instruments to manage risks related to its capital, assets and liabilities and its commitments to third parties.The Group, due to its multinational operations, has foreign currency exposure and, due to the long-term nature of some of its insurance reserves, has exposure to interest rate and reinvestment risks.The Group uses derivative financial instruments to mitigate the risks posed by changes in foreign exchange rates and interest rates.Therefore, derivative financial instruments are part of insurance, investment, asset-liability management, capital raising or cash management activities and must conform to the general guidelines of the Group for these activities, which are documented and reviewed for compliance by the Group. If the Group were required to settle outstanding derivative positions, the sum of gains and losses would not be material to the Group as of December 31, 2004.
Zurich Capital Markets (“ZCM”) has a portfolio of derivative products for the benefit of its customers. ZCM does not engage in proprietary trading. ZCM’s positions on derivative financial instruments are separately reported in subsection (d) of this note.
For interest rate caps, floors and swap transactions, forward and futures contracts and options written, only the potential market value of the instruments represents a credit risk to the Group.The Group controls the credit risk of its interest rate swap agreements and forward and futures contracts through credit approvals, limits and monitoring procedures.
(b) Derivative financial instruments used Interest rate and currency swaps: Interest rate swaps are contractual agreements between two parties to exchange periodic payments in the same currency, each of which is computed on a different interest rate basis, on a specified notional amount. Most interest rate swaps involve the net exchange of payments calculated as the difference between the fixed and floating interest payments. Currency swaps, in their simplest form, are contractual agreements that involve the exchange of both periodic and final amounts in two different currencies. Exposure to loss on both types of swap contracts will increase or decrease over their respective lives as a function of maturity dates, interest and foreign exchange rates, and the timing of payments. The Group uses currency swaps to manage the currency and interest rate risk of its debt issuances.
Interest rate futures, forwards and options contracts: Interest rate futures are exchange-traded instruments and represent commitments to purchase or sell a designated security or money market instrument at a specified future date and price. Interest rate forward agreements are traded over-the-counter (“OTC”) where two parties agree on an interest rate and other terms that will become a reference point in determining, in concert with an agreed notional principal amount, a net payment to be made by one party to the other, depending on what rate in fact prevails at a future point in time. Interest rate options, which consist primarily of caps and floors, are interest rate protection instruments that involve the obligation of the seller to pay the buyer an interest rate differential in exchange for a premium paid by the buyer. This differential represents the difference between the current rate and an agreed rate applied to a notional amount. Exposure to loss on interest rate contracts will increase or decrease over their respective lives as interest rates fluctuate. For interest rate futures and exchange-traded options, the Group’s exposure to off-balance sheet credit risk is limited, as these transactions are executed on organized exchanges that assume the obligation of the counterparty and generally require security deposits and daily settlement of margins.
Futures/forwards of which: derivative trading asset 560 431 derivative trading liability (570) (592)
Table 10.1 Breakdown of insurance benefits, losses and expenses Gross Ceded Net in USD millions, for the years ended December 31 2004 2003 2004 2003 2004 2003
Losses and loss adjustment expenses 28,429 25,196 (4,959) (4,068) 23,470 21,128
Life insurance death and other benefits 13,320 10,672 (278) (435) 13,042 10,237
(Decrease) / increase in future life policyholders’ benefits (1,650) 2,051 (362) (157) (2,012) 1,894
Table 10.2 Breakdown of policyholder dividends and participation in profits Gross Ceded Net in USD millions, for the years ended December 31 2004 2003 2004 2003 2004 2003
The Group establishes loss reserves, which are estimates of future payments of reported and unreported claims for losses and related expenses, with respect to insured events that have occurred. Reserving is a complex process dealing with uncertainty, requiring the use of informed estimates and judgments. Any changes in estimates are reflected in the operating statements in the period in which estimates are changed.
Management has considered environmental and latent injury claims and claims expenses in establishing the reserves for losses and loss adjustment expenses. The Group continues to be advised of claims asserting injuries from toxic waste, hazardous materials and other environmental pollutants and alleged damages to cover the clean-up costs of hazardous waste dumpsites relating to policies written in prior years and indemnity claims asserting injuries from asbestos. Coverage and claim settlement issues, such as determination that coverage exists and the definition of an occurrence, may cause the actual loss development to exhibit more variation than the remainder of the Group’s book of business. Such claims cannot be estimated with traditional reserving techniques and, accordingly, the uncertainty with respect to the ultimate cost of these types of claims has been greater than the uncertainty relating to standard lines of business.
Table 11.4 Future life policyholders’ benefits and policyholders’ contract deposits and other funds (gross of reinsurance) in USD millions, as of December 31 2004 2003
Long-duration contract liabilities included in future life policyholders’ benefits result primarily from traditional participating and nonparticipating life insurance products. Short-duration contract liabilities are primarily accident and health insurance products. The liability for future life policyholder benefits has been established based upon the following: • Interest rates which vary by territory, year of issuance and product • Mortality rates based on published mortality tables adjusted for actual experience by geographic area and modified to allow for variations in policy form • Surrender rates based upon actual experience by geographic area and modified to allow for variations in policy form.
In Switzerland, the “legal quote” legislation was adopted on April 1, 2004. It relates to the regulated pension business in Switzerland and provides for mandatory participation in profits by policyholders. A minimum dividend rate of 90% of the calculated gross surplus must be allocated to policyholders as the surplus arises, where previously such allocations occurred when bonuses were declared.
Table 11.5 Information on guarantee liabilities arising from minimum death benefits (“GMDB”), retirement income benefits (“GRIB”) as well as annuitization options (“GAO”) in USD millions (except average age) 2004 2003
Account balance for products with guarantee features as of December 31
The Group’s exposure after reinsurance recoveries under these policies at the balance sheet date as of December 31, 2004 would be USD 451 million (USD 463 million as of December 31, 2003).The Group believes the crystallization of such liability is not likely.
Balance as of December 31 (closing balance) 78 53 12. Income taxes
Table 12.1 Income tax expense in USD millions, for the years ended December 31 2004 2003
Table 12.2 Expected and actual income tax expense in USD millions, for the years ended December 31 2004 2003
The table above illustrates the factors that cause the actual income tax expense to differ from the expected amount computed by applying the expected rate.
The expected weighted average tax rate for the Group was 30.2% and 32.3% for the years 2004 and 2003, respectively. These rates were derived by obtaining a weighted average of the applicable statutory income tax rate in relation to the operating income/loss generated in the main taxable territories in which the Group operates.
Table 12.3 Deferred income taxes in USD millions, as of December 31 2004 2003
Insurance reserves for life insurance where the investment risk is carried by policyholders (232) (59)
As of December 31, 2004 and 2003, respectively, the Group had income tax loss carryforwards of USD 4,835 million and USD 3,251 million available (subject to various statutory restrictions) for use against future taxable income. Deferred tax assets for loss carryforwards of USD 3,300 million and USD 2,218 million were recognized as of December 31, 2004 and 2003, respectively. No deferred tax assets were recognized in respect of the remaining USD1,535 million and USD1,033 million as of December 31, 2004 and 2003, respectively. The majority of the income tax loss carryforwards expire after five years.
The recoverability of the deferred tax asset of each taxpayer is based on its ability to utilize the deferred tax asset over a reasonable period of time. This analysis considers the projected taxable income to be generated by the taxpayer, as well as the ability to offset deferred tax assets with deferred tax liabilities. As of December 31, 2004, the following taxpayer groups carry a net deferred tax asset position on their balance sheets.
Deferred tax assets, Table 12.4 net of valuation Deferred tax assets by taxpayer group Gross deferred allowance and in USD millions, as of December 31, 2004 tax assets other tax liabilities
The North America Corporate group of companies has reported tax losses in three of the last four years, thus creating a significant net operating loss carryforward of approximately USD 2,280 million, which is utilizable over a 15 year period. In addition, revenue streams originated by the North America Corporate group of companies also support the recoverability of the Centre group of companies’ deferred tax asset. Based on the current taxable income projections for the North America Corporate group of companies and the other taxpayer groups noted above, management believes that the carrying values of the deferred tax assets as of December 31, 2004 are fully recoverable.
Table 14 Reinsurance assets in USD millions, as of December 31 2004 2003
Net insurance reserves were USD 224,897 million and USD 202,532 million as of December 31, 2004 and 2003, respectively, after deducting the amount of reinsurance ceded to reinsurers.
Table 15 General Life Other Deferred policy acquisition costs Insurance Insurance segments1 Total
Acquisition costs deferred and transfers 2,226 2,127 1,571 1,322 (15) 6 3,782 3,455
Increase/ (decrease) due to currency translation 85 (21) 644 779 3 27 732 785
As of December 31 (closing balance) 2,265 2,085 10,995 9,564 84 135 13,344 11,784 1 Including eliminations of intersegment transactions.
The fire insurance value of the Group’s own-use real estate, investment real estate and further fixed assets totaled USD10,160 million and USD12,173 million as of December 31, 2004 and 2003, respectively.
Table 18.1 Debt in USD millions, as of December 31 2004 2003 a) Debt related to capital markets and banking activities
Zurich International (Bermuda) Ltd. Zero coupon CHF exchangeable bond, due July 2004 – 427
Zurich Capital Trust I 8.376% USD Capital Securities, due June 2037 1,000 1,000
Zurich Finance (UK) p.l.c. 6.625% GBP bond, undated notes 848 795
(c) Subordinated debt The USD 1,000 million Capital Securities, issued by Zurich Capital Trust I, a wholly-owned subsidiary of Zurich Holding Company of America, will mature in 2037. The Group has the option at any time on or after June1, 2007 to redeem the securities in whole or in part at a price of 104.188%, decreasing each year to a price of 100% on June 1, 2017.
Table 18.2 Maturity schedule of outstanding debt in USD millions 2004
Table 18.3 Interest expense on debt in USD millions, for the years ended December 31 2004 2003
Loan facilities On April 21, 2004, a USD 3 billion syndicated revolving credit facility was signed to replace the USD 1.5 billion facility, which was due to mature on May 28, 2004. The credit facility consists of two equal tranches maturing in 2007 and 2009. Zurich Group Holding, together with Zurich Insurance Company and Farmers Group, Inc. are guarantors of the facility and can draw up to USD 1.25 billion, USD 1.5 billion and USD 250 million, respectively. No borrowings were outstanding as of December 31, 2004. Farmers Group, Inc. cancelled their USD 250 million credit facility, which was due to mature in September 2004.
Eagle Star Holdings Ltd.’s GBP 400 million revolving credit facility matured on August 18, 2004.
Zurich Capital Markets’ USD1.27 billion syndicated revolving credit facility which was in place as of December 31, 2003 as a backstop for the USD 2.5 billion Commercial Paper Program mentioned above, was terminated as per March12, 2004.
In addition, there are facilities in place for Dunbar Bank as mentioned above under (a) Debt related to capital markets and banking activities.
Table 19 Other liabilities in USD millions, as of December 31 2004 2003
Minority interests include third-party equity interests, preferred securities and similar instruments issued by consolidated subsidiaries of the Group in connection with providing structured financial solutions to its customers.
In December1999, Zurich Financial Services (Jersey) Limited, a subsidiary of Zurich Group Holding (formerly Zurich Financial Services), issued 12,000,000 perpetual non-voting, non-cumulative Series A Preference Shares on the Euromarket with a par value of EUR 25 (EUR 300,000,000). The securities benefit from a subordinated support agreement of Zurich Group Holding and carry a fixed coupon of 7.125%, payable quarterly. The securities are, subject to certain conditions, redeemable at the option of the issuer in whole, but not in part, from time to time on or after five years from the issue date. Proceeds from the issue were used to refinance existing intercompany debt and for general corporate purposes.With this issue, the Group was able to reinforce its capital base while raising equity-like but non-dilutive long-term funds.
As of December 31, 2004, and 2003, minority interests in Zurich Capital Markets (“ZCM”) totaled USD nil million and USD 212 million, respectively. These minority interests primarily represented third-party equity interests in consolidated alternative investment vehicles arising from ZCM’s managed asset business.
Table 21.1 Common and treasury stock number of shares, as of December 31 2004 2003
(a) Issued stock At the Annual General Meeting of April 16, 2004, shareholders approved a share capital reduction in the form of a capital nominal value reduction of each registered share from CHF 9 to CHF 6.50. As a result of this reduction, the share capital was reduced by CHF 360,017,387.50 from CHF1,296,062,595 to a new total of CHF 936,045,207.50. In the previous year, shareholders approved, at the Annual General Meeting of April 30, 2003, a share capital reduction in the form of a capital nominal value reduction of each registered share from CHF10 to CHF 9. As a result of that reduction, the share capital was reduced by CHF144,006,955 from CHF 1,440,069,550 to CHF1,296,062,595.
(c) Contingent stock Capital market instruments and option rights to shareholders: The share capital of Zurich Financial Services may be increased by an amount not exceeding CHF 35,631,882 by issuing up to 5,481,828 fully paid registered shares with a nominal value of CHF 6.50 each (1) through the exercise of conversion and/or option rights which are granted in connection with the issuance of bonds or similar debt instruments by Zurich Financial Services or one of its Group companies in national or international capital markets and/or (2) by the exercise of option rights which are granted to the shareholders. When issuing bonds or similar debt instruments connected with conversion and/or option rights, the pre-emptive rights of the shareholders will be excluded. The current owners of conversion and/or option rights shall be entitled to subscribe for the new shares.The conversion and/or option conditions are to be determined by the Board.
Employee participation: The share capital may be increased by an amount not exceeding CHF 9,750,000 by issuing up to 1,500,000 fully paid registered shares with a nominal value of CHF 6.50 each to employees of Zurich Financial Services and Group companies. The pre-emptive rights of the shareholders, as well as the right for advance subscription, are excluded. The issuance of shares or respective option rights to employees shall be subject to one or more regulations to be issued by the Board of Directors and taking into account performance, functions, levels of responsibility and criteria of profitability. Shares or option rights may be issued to the employees at a price lower than that quoted on the stock exchange.
(e) Additional paid-in capital (capital reserve) This reserve is not ordinarily available for distribution.
Insurance enterprises in European Union member countries are required to maintain minimum solvency margins. The required minimum solvency margin for general insurers is the greater of 16% of premiums written for the year or 23% of a three-year average of claims, subject to the first tranche (EUR 50 million) of premiums being at 18% and the first tranche (EUR 35 million) of claims at 26%. Life insurance companies are required to maintain a minimum solvency margin of generally 4% of insurance reserves (up to 1% of “insurance reserves for life insurance where the investment risk is carried by policyholders”) plus 0.3% of the amount at risk under insurance policies. The same minimum capital requirements are applicable for insurance enterprises operating in Switzerland. In addition, in certain European countries further requirements may apply.
Zurich Financial Services is further subject to certain solvency and its own fund requirements based on a Decree on the Consolidated Supervision of the Zurich Financial Services Group issued by the Swiss Federal Office of Private Insurance on April 23, 2001.
As of December 31, 2004, the subsidiaries were substantially in compliance with applicable regulatory capital adequacy requirements.
(h) Earnings per share Table 21.3 Net income Number of Per share Per share Earnings per share (in USD millions) shares (USD) (CHF)1
Effect of potentially dilutive shares related to share-based compensation plans – 1,025,296 (0.10) (0.14)
The Group operates a number of active retirement benefit arrangements for pensions. The majority of employees belong to defined benefit plans. Other employees participate in defined contribution plans providing benefits equal solely to contributions paid plus investment returns.
(a) Defined benefit plans Defined benefit pension plans: Employees of the Group’s operating companies are covered under various pension plans. Certain companies run defined benefit plans, some of which provide benefits related to final pensionable earnings and others provide cash balance plans, where the participants receive the benefit of annual contributions and a credit for the investment return achieved on the assets. Eligibility for participation in the various plans is either based on completion of a specified period of continuous service or date of hire. Benefits are generally based on the employees’ years of credited service and average compensation in the years preceding retirement. Annual funding requirements are determined based on actuarial cost methods.
Most of the Group’s defined benefit plans are funded through the Group making contributions to trusts or foundations independent of the Group’s finances. In these cases, the annual funding requirements are determined in accordance with local funding and actuarial cost methods. Where plans are not specifically funded, for example, as is usual in the case of pension plans in Germany, a liability for the accrued pension obligations is recognized in the Group’s balance sheet.
Other defined Table 22.2 Defined benefit post-employment Status of funded defined benefit plans pension plans benefits in USD millions, as of December 31 2004 2003 2004 2003
Other defined Table 22.3 Defined benefit post-employment Status of unfunded defined benefit plans pension plans benefits in USD millions, as of December 31 2004 2003 2004 2003
The summary of the amounts recognized in the consolidated operating statements is given below.
The actual returns on defined benefit pension plan assets for the years ended December 31, 2004 and 2003 were USD 637 million and USD 778 million, respectively. The actual returns on other defined post-employment plan assets were USD nil million and USD1 million for the years ended December 31, 2004 and 2003, respectively.
Other defined Table 22.5 Defined benefit post-employment Summary of balance sheet movements pension plans benefits
Liability in the consolidated balance sheets as of December 31 (closing balance) (571) (368) (226) (197)
(b) Defined contribution pension plans Certain of the Group’s operating companies sponsor various defined contribution plans. Eligibility for participation in the various plans is either based on completion of a specified period of continuous service or date of hire.The plans provide for voluntary contributions by employees and contributions by employer which typically range from 3% to 15% of annual salaries, depending on the employees’ years of service. The Group’s contributions under these plans amounted to USD13 million and USD12 million in 2004 and 2003, respectively.
(a) Cash incentive plans Various businesses throughout the Group operate short-term incentive programs for executives, management and, in some cases, for employees of that business unit. Awards are made in cash, based on the accomplishment of both organizational and individual performance objectives.The expenses recognized for these cash incentive plans amounted to USD 242 million and USD 213 million for the years ended December 31, 2004 and 2003, respectively.
(b) Share-based compensation plans for employees The Group encourages employees to own shares of Zurich Financial Services and has set up a framework based on the implementation of either share options and/or performance share programs. Actual plans are tailored to meet local market requirements.
Table 23.1 Expenses recognized in the operating statements in USD millions, for the years ended December 31 2004 2003
The explanations below give a more detailed overview of the plans of the Group.
Share option plans for UK employees UK Sharesave Plan: The plan is open to employees in the United Kingdom. Participants enter into a savings contract with a bank for the accumulation of contributions of between GBP 5 and GBP 250 per month for a period of three or five years. An interest bonus is credited at the end of the savings period. Participants are granted options to acquire Zurich Financial Services shares at a pre-determined price, which is not less than 80% of the market price prior to grant. Options under the plan can normally be exercised for a period of six months after the end of the savings period. Early exercise, limited to the value of shares that can be acquired with accrued savings, is permitted in certain circumstances.There were a total of 2,409 and 3,303 participants in this plan as of December 31, 2004 and 2003, respectively. The first grants were made in March1999.
Share Incentive Plans for employees in Switzerland: In 2004, a new Employee Incentive Plan was introduced for employees in Switzerland that combined the features of the annual cash-based incentive plan and the previous employee performance share plan. Under this new plan employees who receive an incentive payment under the Employee Incentive Plan have the option to acquire sales-restricted shares at a 30% discount on the market value, with the maximum value of the discount being CHF1,500. During 2004, 6,115 employees participated in the Employee Incentive Plan. As of December 31, 2004, 4,613 employees received shares under the 2003 employee performance share plan.
(c) Share based compensation plans for executives The Group operates long-term incentive plans for selected executives.These plans comprise the allocation of a target number of share options grants and/or shares grants with the vesting of these option/share grants being subject to the achievement of specific financial performance goals.The Group can also make Restricted Share grants to selected employees, which provide share awards if the individual remains employed with the Group on selected dates in the future.
Executive long-term performance share plans Selected executives are granted annually performance shares which vest over a period of three years, either on an annual basis or at the end of the three-year period. Specific performance parameters are established for each of the business divisions and include, for example, return on equity or business operating profit objectives.The actual number of performance shares granted at the beginning of the performance period is determined such that the economic value is defined percentage of the annual salary in the year of allocation. Actual awards under these plans are made fully in shares of Zurich Financial Services, of which 50% are sales-restricted/deferred for a further period of three years. There were a total of 535 and 497 participants in this plan as of December 31, 2004 and 2003, respectively.
Table 23.2 under option (in CHF) Movements in options granted under the various equity participation plans 2004 2003 2004 2003
As certain plan participants elected in 2002 to take their option award in the form of Share Appreciation Rights, the above table includes in the number of shares under option, outstanding as of December 31, 2004, 77,234 shares under option which will be settled through cash payments rather than through actual shares.
Table 23.4 Number date (in CHF) Options and shares granted during the period 2004 2003 2004 2003
Options granted during the period1 477,022 597,894 67 47 1 Number of options granted is shown as the number of shares under option granted during the period.
The fair value of the options granted to senior executives is estimated using the Black-Scholes option pricing model, with the following assumptions.
Farmers Group, Inc. and its subsidiaries (“FGI”) provide certain non-claims related management services to the Farmers Exchanges. In addition, the Group has the following relationships with the Farmers Exchanges.
Certificates of contribution and surplus notes of the Farmers Exchanges As of December 31, 2004 and 2003, FGI and other Group companies held the following surplus note and certificates of contribution of the Farmers Exchanges. Originally these were purchased by FGI in order to supplement the policyholders’ surplus of the Farmers Exchanges.
in USD millions 2004 2003 6.15% surplus note, due December 2013 (in 2003: 8.5%, due February 2005) 88 88 6.15% certificates of contribution, due December 2013 524 –
Effective December 31, 2002, Farmers Re and ZIC entered into a 10% All Lines Quota Share reinsurance treaty with the Farmers Exchanges under which each reinsured a percentage of all lines of business written by the Farmers Exchanges. Under this treaty, Farmers Re assumes a 2% quota share of the premiums written and the ultimate net losses sustained in all lines of business written by the Farmers Exchanges (ZIC reinsures 8% under this agreement after the APD reinsurance treaty has been applied). Losses assumed are subject to a maximum combined ratio of 112.5% (except in Texas where they are subject to a combined ratio of 116.2%) as well as USD 800 million of catastrophe losses and a minimum combined ratio of 93.5%.The reinsurance agreement, which can be terminated after 60 days notice by any of the parties, also provides for the Farmers Exchanges to receive a provisional ceding commission of 22% of premiums for acquisition expenses and 14.1% of premiums for other expenses with additional experience commissions that depend on loss experience. As of December 31, 2004, this All Lines Quota Share reinsurance treaty was increased from 10% to 12%.
For the year ended December 31, 2004, Group companies assumed USD1,269 million of gross written premiums (USD1,056 million in the prior year) from the Farmers Exchanges under this treaty.
For the year ended December 31, 2004, Group companies assumed USD 859 million of gross written premiums (USD1,019 million in the prior year) from the Farmers Exchanges under this treaty.
Table 26.1 Quantifiable commitments and contingencies in USD millions, as of December 31 2004 2003
Future rent commitments The Group has entered into various operating leases as lessee for office space and certain computer and other equipment. Rent expenses for these items totaled USD190 million and USD197 million for the years ended December 31, 2004 and 2003, respectively.
Table 26.2 Future payments under non-cancellable operating leases with terms in excess of one year Rental in USD millions payments 2010 and thereafter 763
Indemnity agreements The Group, through certain of its subsidiaries, has agreed to arrangements that cap Converium’s net exposure for losses arising out of the September11, 2001 event at USD 289 million. Additionally, the Group has provided Converium with coverage for net losses in excess of USD 59 million, including non-performance of the retrocessionaire, related to Amerisafe business ceded to the Unicover pool. As of December 31, 2004, the Group has recorded provisions in respect of both arrangements of USD162 million and USD13 million, respectively.
Pledged assets Total assets pledged including securities pledged in respect of securities repurchase agreements amounted to USD 5,048 million and USD 4,133 million as of December 31, 2004 and December 31, 2003, respectively. Assets pledged were financial assets.
Other contingent liabilities The Group has received notices from various tax authorities asserting deficiencies in taxes for various years.The Group believes that it has meritorious legal defenses to those claims and believes that the ultimate outcome of the cases will not result in a material impact on the Group’s consolidated results of operation or financial position.
In common with other groups with life assurance businesses in the UK, the Group remains exposed to a number of Conduct of Business issues which are currently under review by the UK Financial Services Authority. While provisions are maintained which reflect management’s evolving best estimate of the probable costs and expenses of resolving these matters, significant uncertainty regarding the ultimate costs remains.The main area of uncertainty concerns sales advice related complaints.The key assumptions used to derive the complaint provision are the volume of complaints, both those already recorded and an assumption as to the future complaint levels, the percentage of complaints which will be successful (the uphold rate), the average redress payable per complaint and the expenses of reviewing each case or complaint. The assumptions used to set the provision have been based on actual experience over the past three years weighted towards more recent experience.
Litigation The Group and its subsidiaries are continuously involved in legal proceedings, claims and litigation arising, for the most part, in the ordinary course of its business operations.The Group and its subsidiaries are also involved in a number of regulatory investigations.These investigations involve certain business practices between insurance brokers and insurance companies, the purchase and sale of “non-traditional” products, certain reinsurance transactions engaged in by the Group and its subsidiaries and other matters.The Group has been conducting its own internal reviews with respect to these matters and is cooperating fully in these investigations.
The outcome of such current legal proceedings, claims, litigation and investigations could have a material effect on operating results and/or cash flows when resolved in a future period. However, in the opinion of management these matters would not materially affect the Group's consolidated financial position.
Table 27.1 General Life Operating statements by business segment Insurance Insurance in USD millions, for the years ended December 31 2004 2003 2004 2003
Net gain / (loss) on divestments of businesses (34) (89) 37 427
Losses and loss adjustment expenses, net of reinsurance 23,249 19,617 89 76
Significant non-cash expenses: Depreciation and impairments of fixed assets 101 171 68 101
Investments held on account and at risk of life insurance policyholders – 6 8,272 6,916
Reserves for losses and loss adjustment expenses, gross 54,121 45,337 116 85
Policyholders’ contract deposits and other funds, gross 1,038 1,058 16,251 13,968
Insurance reserves for life insurance where the investment risk is carried by policyholders – – 8,345 7,004
Reserves for unit-linked products, net – – 61,034 51,127 106 Zurich Financial Services Group . Annual Report 2004
Table 27.4 Purchases of fixed and intangible assets by geographical segment Fixed assets Intangible assets in USD millions, for the years ended December 31 2004 2003 2004 2003
Rest of the World 16 6 11 4 108 Zurich Financial Services Group . Annual Report 2004
Deutscher Herold Lebensversicherung AG Bonn Life Insurance 76.83 76.83 EUR 46.2
Zürich Lebensversicherung AG (Deutschland) Frankfurt /Main Life Insurance 100.00 100.00 EUR 13.4
Zürich Versicherung AG (Deutschland) Frankfurt /Main General Insurance 100.00 100.00 EUR 106.5
SA Fire House Limited Bryanston General Insurance 100.00 100.00 ZAR 0.0006
South African Eagle Insurance Company Limited Bryanston General Insurance 83.61 83.61 ZAR 3.0
Zurich España, Compañía de Seguros y Reaseguros, S.A. Barcelona General Insurance 99.78 99.78 EUR 33.6
Zurich Vida, Compañía de Seguros y Reaseguros, S.A. Madrid Life Insurance 100.00 100.00 EUR 50.4 1 The segments are defined in the Notes to the consolidated financial statements, note1, basis of presentation.
La Genevoise, Compagnie d’Assurances sur la Vie Geneva Life Insurance 100.00 100.00 CHF 17.0
Zurich Life Insurance Company Limited Zurich Corporate Center 100.00 100.00 CHF 60.0
Zurich Insurance (Taiwan) Ltd. Taipei General Insurance 91.68 91.68 TWD 2,000.0
Allied Zurich Holdings Limited Jersey, Channel Islands Corporate Center 100.00 100.00 GBP 90.7
Dunbar Group p.l.c. London, England Other Businesses 100.00 100.00 GBP 60.3
Eagle Star Group Services Limited London, England Corporate Center 100.00 100.00 GBP 0.000002
Eagle Star Holdings Limited London, England Corporate Center 100.00 100.00 GBP 553.7
Zurich International (UK) Limited Fareham, England General Insurance 100.00 100.00 GBP 40.0
Zurich Whiteley Investment Trust Limited Fareham, England Other Businesses 100.00 100.00 GBP 10.2
Centre Reinsurance Holdings (Delaware) Limited Wilmington, DE Other Businesses 100.00 100.00 USD 0.0196
Crown Management Services Limited Wilmington, DE Corporate Center 100.00 100.00 USD 0.00003
Farmers New World Life Insurance Company Mercer Island, WA Life Insurance 100.00 100.00 USD 6.6
Farmers Reinsurance Company Los Angeles, CA General Insurance 100.00 100.00 USD 5.0
Universal Underwriters Life Insurance Company Overland Park, KA General Insurance 100.00 100.00 USD 2.5
Zurich American Insurance Company (and subsidiaries) Schaumburg, IL General Insurance 100.00 100.00 USD 5.0
Zurich Finance (USA), Inc. Schaumburg, IL Corporate Center 100.00 100.00 USD 0.000001
As auditors of the Group, we have audited the consolidated financial statements (operating statement, balance sheet, statement of cash flows, statement of shareholders’ equity and notes on pages 63 to 110) of Zurich Financial Services for the year ended December 31, 2004.
Our audit was conducted in accordance with auditing standards promulgated by the Swiss profession and with International Standards on Auditing, which require that an audit be planned and performed to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. We have examined on a test basis evidence supporting the amounts and disclosures in the consolidated financial statements. We have also assessed the accounting principles used, significant estimates made and the overall consolidated financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements give a true and fair view of the financial position, the result of operations and the cash flows in accordance with International Financial Reporting Standards (IFRS) and comply with Swiss law.
Embedded Value Results – Life Insurance (unaudited) Embedded Value Results – Life Insurance
North America Consumer in USD millions, for the years ended December 31 2004 2003
After-tax return on opening embedded value before foreign currency translation effects 14.5% 11.4%
Embedded value notes: The above information should be read in conjunction with additional notes on the following page.
External Review: Deloitte & Touche LLP (“Deloitte”), our consulting actuaries, have reviewed the choice of methodology together with the assumptions and calculations made by Zurich Financial Services Group (“the Group”) in the calculation of the embedded value results of its Life Insurance business as of December 31, 2004. Deloitte have reported to the Group that they consider that the methodology is appropriate, the Group’s assumptions are together reasonable and that the embedded value results as published above have been properly compiled on the basis of the methodology and assumptions chosen. For the purpose of this report, Deloitte have performed certain checks on data provided by the Group, but have not verified and have relied on financial information underlying the Group’s financial statements.
Additional notes to the embedded value results 1. The after-tax operating return and after-tax return on opening embedded value have been calculated to reflect the incidence of capital movements in and out of the embedded value. 2. The 2003 year-end embedded value included the value of certain life operations which are now centrally managed outside the Life
Insurance segment. The IFRS financial statements as of December 31, 2004 reflect this change and these operations are included in “Other Businesses” for IFRS reporting.The life embedded value results as of December 31, 2004, assume that these operations have been transferred out of the Life Insurance segment at their embedded value as of January1, 2004 (USD 770 million).The regions affected by this change are North America Consumer and Continental Europe. In the UKISA region during 2004 there was a large capital inflow of assets in exchange for a holding of a general insurance company.These assets were brought in to the embedded value at their locked in value.
3. The Life Insurance segment includes some non-insurance subsidiary companies. Where appropriate, we have included the value of these companies in accordance with our embedded value methodology. For those companies for which no embedded value has been calculated, these have been included at their shareholders’ equity value, as calculated in accordance with IFRS, which represents approximately 2% of our total published embedded value.
4. The UK Life business distribution network generated an additional USD 16 million of new business profit for the Group relating to a product accounted for in a non-insurance subsidiary which from year-end 2004 is not included in the life value of new business. In 2003, sales of this product accounted for USD 20 million of new business profit, without which the new business margin would have been 4.6% for UKISA and 8.1% for the total Group.
5. The UKISA operating profit, after tax, for 2004 has been adversely affected by an increase in provisions for settling customer complaints relating to past sales of mortgage endowment and other contracts (reducing the operating profit by USD 208 million). Without this effect, the after-tax operating return on embedded value would have been 8.4% for UKISA and 12.8% for the total Group.
6. The published embedded value assumes that at least the locally required minimum statutory capital is held to support the business. In some countries, a higher amount has been locked in where this is in line with management strategy or market practice. In 2004, the amount of shareholder capital used to meet these requirements was USD 5.0 billion, which produced an associated shareholder economic cost of USD 1.6 billion.
7. In 2004, the capital strain on writing new business was approximately USD 0.7 billion.The after-tax internal rate of return on new business is 11 to 12%.The new business profit before cost of solvency is USD 352 million.
8. For both 2003 and 2004 the new business profit and new business premium information are shown gross of any minority holdings although the embedded value is shown net of minority holdings.The minorities share of new business profit is reversed out through the line “operating variance, after tax” in the table of embedded value results on the preceding pages. Most of the minorities share of new business profit relates to our subsidiary Deutscher Herold Lebensversicherung AG in Continental Europe.The new business profit and APE net of minority holdings for 2004 are USD 254 million and USD 2,243 million, respectively.
Embedded value sensitivities The following tables show the sensitivity of our 2004 embedded value and value of new business to changes in several key assumptions: Discount Discount Investment Investment MV of Renewal Demorate rate return return equities expenses graphy Lapses in USD millions increase decrease increase decrease decrease decrease worsening worsening
Change in new business value (62) 75 59 (57) 70 21 (29) (46)
Please note that the figures shown above are “sensitivities” – for each assumption change, all other assumptions have remained unchanged. The exceptions to this are the investment return sensitivities.The investment return sensitivity assumes a change to future new money rates for fixed interest securities and a change to returns on both existing assets and future new money rates for equities and properties. These sensitivities reflect the change to embedded value in this changed investment environment. For example, where appropriate, changes to statutory valuation bases or policyholder bonuses have been reflected accordingly. In addition, changes to the market values of fixed interest assets have been reflected where appropriate. However, these investment return sensitivities assume that the risk discount rates remain unaffected.
Embedded value methodology The embedded value represents the shareholders’ interest, excluding any value from future new business, in the entities included in the Life Insurance segment as per the IFRS financial statements. It is the total of the shareholders’ interest in the net assets of these life insurance entities and the present value of the projected releases to shareholders arising from the business in-force, less a charge for the cost of capital supporting the solvency requirements of the business. The discount rate used to value the in-force business in each country reflects long term government bond rates at the valuation date plus a risk margin.The assumptions for mortality, persistency and expenses reflect recent and expected experience. All changes in assumptions not classified as “economic” are included in the “operating assumption changes” line item. Gross new business annual premium equivalent (APE) is calculated as new annual premiums plus 10% of single premiums.
Embedded value profit consists of the following components, the first two of which in aggregate are referred to as operating profit: • new business profit, after tax, which represents the value added by new business written during the period, including allowance for the cost of holding solvency capital, and is valued at point of sale using the applicable discount rate • the operating profit from existing business, which is equal to: – the profit expected from the in-force business and net assets, after tax, including allowance for the cost of holding solvency capital, – the experience variances caused by the differences between the actual experience during the period and the expected experience assumed in the prior-year embedded value, and – the impact of changes in assumptions of future operating experience; • the economic variance, which is equal to: – the investment variance caused by differences between the actual and the expected experience over the reporting period, and – the change in future economic assumptions, such as changes in discount rates and future investment rates. This also includes, where appropriate, changes in legislation.
The calculation of embedded values necessarily makes numerous assumptions with respect to economic conditions, operating conditions, taxes, and other matters, many of which are beyond the Group’s control. Although the assumptions used represent estimates which the Group and Deloitte believe are together reasonable, actual future experience may vary from that assumed in the calculation of the embedded value results, and such variation may be material. Deviations from assumed experience are normal and are to be expected. The embedded value results have been prepared using generally accepted actuarial methods that use deterministic projections that do not allow for all of the cost of options and guarantees on a market consistent basis.
Zurich Financial Services is committed to effective governance for the benefit of its shareholders, customers and counterparties, employees and other stakeholders based on the principles of fairness, transparency and accountability. Structures, rules and processes are designed to provide for proper organization and conduct of the business within the Group and to define the powers and responsibilities of its corporate bodies and employees.
This report follows the recommended structure outlined by the Directive of the SWX Swiss Exchange, except for the chapter on compensation, shareholdings and loans, which is newly included in a separate report, the “Remuneration Report”, following this Corporate Governance Report.
The Group’s primary business segments are General Insurance and Life Insurance. While General Insurance substantially writes all lines of property and casualty and specialty business, Life Insurance offers a broad range of life insurance, annuity and investment-type policies to individuals and groups. For reporting purposes, Farmers Management Services, Other Businesses and Corporate Center represent further business segments. Farmers Management Services consists of the management services provided by Farmers Group, Inc. and its subsidiaries to Farmers Exchanges, which the Group manages but does not own. Other Businesses includes capital markets and banking activities, the Centre operations and centrally managed insurance operations, while Corporate Center consists of Group holding and financing companies, operations at the headquarters in Zurich and alternative investments.
A detailed review of the respective business segment and division results and activities during 2004 can be found in the sections Group Financial Review and Segmental Financial Analysis starting on page 33.
The Group’s significant subsidiaries are listed on pages 109 to 110.
On November 15, 2002, Zurich Financial Services was notified by Brandes Investment Partners L.P., San Diego, California, USA (“Brandes”) that as of November11, 2002, Brandes beneficially held 11,831,383 registered shares or 8.22% of the voting rights in Zurich Financial Services (7,600,409 registered shares of Zurich Financial Services and 42,309,740 American Depositary Receipts of Zurich Financial Services representing 4,230,974 registered shares of Zurich Financial Services) on behalf of Brandes’ clients. In the period since, Zurich Financial Services has not received a notification from Brandes regarding any change in their holding of Zurich Financial Services shares in accordance with Art. 20 of the Swiss Federal Act on Stock Exchanges and Securities Trading. Brandes has not applied for inscription into the share register of Zurich Financial Services.
Except as set out above, Zurich Financial Services is not aware of any person, who as of December 31, 2004, directly or indirectly, has an interest as beneficial owner in the registered shares of Zurich Financial Services representing 5% or more of its issued registered shares. It is also not aware of any persons who, as of December 31, 2004, directly or indirectly, alone or with others, exercise or are party to any arrangements to exercise control over Zurich Financial Services.
Capital structure As of December 31, 2004, the ordinary share capital of Zurich Financial Services amounted to CHF 936,045,207.50 divided into 144,006,955 fully paid registered shares with a nominal value of CHF 6.50 each. The Board of Directors will propose to the shareholders at the Annual General Meeting on April 19, 2005 to reduce the nominal value per registered share by CHF 4.00 from CHF 6.50 to CHF 2.50.
For further information on the capital structure and the authorized and contingent capital, see note 21 on pages 95 to 97. For information on changes of share capital during 2004 and 2003, see pages 68 to 69 and page 137. For information on changes of capital during 2002, see the Annual Report 2003 of Zurich Financial Services, pages 52 to 53 and page 118.
Bonus certificates 1 As part of the unification of the holding structure in 2000, former holders of Allied Zurich p.l.c. ordinary shares received Zurich Financial Services shares, delivered in the form of CREST Depository Interests, or CDIs, in CREST, the system for the paperless settlement of trades in securities and the holding of uncertificated securities in the United Kingdom. CREST Depository holds the registered shares in trust and issued dematerialized depository interests representing entitlements to Zurich Financial Services registered shares known as CDIs. As CDI holders are not the legal owners of the registered shares represented by the CDIs, they are not able to directly enforce or exercise rights that a holder of registered shares can. CDI holders will, however, have a beneficial interest in the registered shares represented by the CDIs and be allowed as such to give instructions to CREST Depository on the exercise of certain non-economic rights attached to the registered shares. Each CDI represents one Zurich Financial Services registered share.
The Articles of Incorporation do not provide for limitations on transferability except as to formalities for the transfer of undocumented shares.
Registration as a shareholder requires a declaration that the shareholder has acquired the shares in his or her own name and for his or her own account. Nominees holding Zurich Financial Services’ registered shares may for the benefit of, or as nominee for, another person be registered for up to 200,000 registered shares with voting rights notwithstanding that the Nominee does not disclose the identity of the beneficial owner. A Nominee is, however, entitled to be registered as shareholder with voting rights of more than 200,000 registered shares if the Nominee undertakes to disclose the identity of each beneficial owner and to inform the beneficial owners about corporate actions, to consult as to the exercise of voting rights and pre-emptive rights, to transfer dividends and to act in the interests and in accordance with the instructions of the beneficial owner.
There are special provisions relating to the registration of, and exercise of rights attaching to, registered shares by CREST International Nominees Ltd. on behalf of CDI holders, including Lloyds TSB Corporate Nominee Limited, and by The Bank of New York in connection with the Zurich Financial Services’ ADR program.
Lodewijk van Wachem Dutch 73 Chairman Chairman of the Nominations Committee Member of the Remuneration Committee 19931 2005
Dana Mead American 69 Director Member of the Nominations Committee Chairman of the Remuneration Committee 19971 2005
Armin Meyer Swiss 55 Director Member of the Nominations Committee Member of the Remuneration Committee 2001 2007
Vernon Sankey British 55 Director Member of the Nominations Committee Member of the Remuneration Committee 19981 2006
All Directors are non-executive, independent of management, and have never held an executive position in the Group. With the exception of Thomas Escher, who joined the Board on April 16, 2004, all of the Directors have served on the Board throughout the year 2004. Markus Granziol resigned from the Board of Directors with effect as of the Annual General Meeting held on April 16, 2004.
As of April 16, 2004, all Directors are also members of the board of directors of Zurich Insurance Company. Previously, only Messrs. Mead, Meyer, Pidoux, van Wachem and Watter were members of the board of directors of Zurich Insurance Company. Mr. van Wachem also serves as chairman of that board.
Lodewijk Christiaan van Wachem graduated from Delft University of Technology in the Netherlands and joined the Royal Dutch/Shell Group in 1953, working in Latin America, Africa, the Far East and Europe. He became a director of Royal Dutch Shell Group in 1977, president in 1982 and chairman of the committee of managing directors in 1985. He served in that capacity until 1992, when he was appointed chairman of the supervisory board of the Royal Dutch Petroleum Company. He held this function until 2002. Until 2002 he also served on the supervisory boards of Akzo Nobel, BMW and Bayer as well as on the board of IBM. He is currently chairman of the supervisory board of Royal Philips Electronics N.V., and of Global Crossing Ltd., as well as a member of the board of ATCO (Canada) Ltd. and of the executive board of Rand Europe.
Philippe Olivier Pidoux graduated from the University of Lausanne, Switzerland, with a doctorate in law, and also holds a master’s degree in comparative jurisprudence from the University of Texas. He is partner in the law firm Bourgeois, Muller, Pidoux & Associates in Lausanne, Switzerland. Mr. Pidoux was a member of the Government of the Canton of Vaud from 1986 until 1994, and a member of the Swiss Parliament between 1983 and 1999. From 1991 until 2003 he was a member of the board and as of 1999 vice chairman of the Swiss National Bank. He is chairman of Publigroupe AG.
Rosalind Edith Jean Gilmore graduated with a BA degree from London University and an MA degree from Cambridge University. Her career included twenty-six years in the UK Treasury where she held various senior appointments, specializing in international and domestic monetary policy and the structure of the UK financial sector. She also worked in the World Bank and as marketing director for the UK Girobank. She completed her Government career as executive chairman (First Commissioner) of the regulatory commission for the UK mortgage and savings industry. She was a director of the UK Securities and Investments Board, and member of the Lloyds of London Regulatory Board and of the Banking Advisory Committee of the European Union. She has held a variety of part time directorships in the public, academic and corporate sectors (including BAT Industries), and is now a director of Trades Union Fund Managers Ltd., of the Leadership Foundation, Inc. (Washington DC), of Cranfield University (working with its Business School) and of the Royal College of Music; and is on investment, remuneration and audit committees. She has honorary fellowships in both her former universities.
Dana George Mead graduated from the US Military Academy at West Point and has a PhD from Massachusetts Institute of Technology. After serving in the US Army from 1957 to 1978, he held various senior management positions and was a member of the board of International Paper Company in New York. In 1992, he was appointed president and member of the board of directors of Tenneco Inc., becoming its chairman and chief executive officer two years later. After a spin-off of Tenneco subsidiaries in 1999, he was chairman of Tenneco Automotive and Pactiv Corporation until March 2000. He serves on the board of Pfizer Inc. He also heads the Business Advisory Council for the United Nations Office for Project Services. He is chairman of the MIT Corporation. Mr. Mead is president of the Royal Shakespeare Company (RSC) America and a member of the board of RSC London. He also serves on the board of the Boys and Girls Clubs of America.
Rolf Urs Watter graduated from the University of Zurich with a doctorate in law and holds a master of laws degree from Georgetown University in the US. He is admitted to the bar of the Canton of Zurich. Since 1994 he has been a partner in the law firm Baer and Karrer in Zurich and is a member of its executive board. He also teaches as a part time professor at the University of Zurich’s Law School. He is non-executive chairman of the parent company of the Cablecom Group (and its operating entity Cablecom GmbH) and the designated chairman of Forbo Holding AG (and its subsidiary Forbo Finanz AG) and a member of the boards of directors of Syngenta AG, UBS Alternative Portfolio AG and A.W. Faber-Castell (Holding) AG. In addition, he serves on the board of the Swiss Lawyers Association and is a member of the SWX Admission Board and of the Disclosure Commission of Experts of the SWX Swiss Exchange.
There are no arrangements whereby any of the Directors of Zurich Financial Services serve on another company’s board in return for Zurich Financial Services agreeing that any of that other company’s directors serve on the Board of Zurich Financial Services.
The Articles of Incorporation require that the Board shall consist of not less than seven and not more than 13 members. The ordinary term of office is three years. On the expiration of their terms of office, Directors may be re-elected immediately. The Articles of Incorporation require elections to be organized in such a way as to ensure that no more than four Directors complete their term of office at any one general shareholder meeting. The election of a member of the Board is effected on an individual basis. Directors are elected by a majority of the votes cast. Zurich Financial Services rules provide that no individual of 70 years of age or more shall be nominated as a Director. Exceptions may, however, be made under special circumstances. Such exception has been duly made in the case of Mr. van Wachem and is being proposed with a view to the re-election of Mr. Mead.
At the Annual General Meeting to be held on April 19, 2005, Mr. van Wachem will retire from the Board of Directors with effect as of the Annual General Meeting after having served the Group for 12 years.
At the same date, the term of office of Mrs. Gilmore and Messrs. Mead and Schulmeyer will expire and they have been nominated for re-election by the nominations committee. Mrs. Gilmore and Mr. Mead will stand for re-election for a term of two years and Mr. Schulmeyer will stand for re-election for a term of three years.
Manfred Gentz has been nominated as a member of the Board of Directors of Zurich Financial Services with a term of three years. Upon election, the Board intends to elect Mr. Gentz as Chairman, succeeding Mr. van Wachem.
The audit committee has five members, all of whom meet relevant requirements with respect to independence and qualification. The audit committee charter provides that the audit committee as a whole should have (i) an understanding of IFRS and financial statements, (ii) the ability to assess the general application of such principles in connection with the accounting for estimates, accruals and reserves, (iii) experience preparing, auditing, analyzing or evaluating financial statements that present a breadth and level of complexity of accounting issues that are generally comparable to those of Zurich Financial Services, or experience actively supervising one or more persons engaged in these activities, (iv) an understanding of internal controls and procedures for financial reporting, and (v) an understanding of audit committee functions. The audit committee met eight times in 2004 (of which one was by teleconference). It serves as a focal point for communication and oversight regarding financial accounting and reporting, internal control, actuarial, compliance and risk management among Management, the internal and external auditors, group chief actuary, corporate risk management, legal and compliance functions. The audit committee is responsible for reviewing the Group’s auditing process (including establishing the basic principles relating to and making proposals with respect to the auditing of Zurich Financial Services and the Group) and reviews the internal control systems. The external auditors, the internal auditors and appropriate members of the GEC, the GMB and other executives attend such meetings in order to, among other things, discuss the auditors’ reports, to review and assess the auditing concept and the examination process, and to coordinate the activities of external and internal auditors. The audit committee reviews the standards of internal control, including the activities, plans, organization and the quality of internal audit, corporate risk management and group compliance. It also discusses on a regular basis with the external auditors the quality of the Group’s financial and accounting function and any recommendations that the external auditors may have. Topics considered during such discussions include strengthening internal financial controls, the selection of accounting principles, and management reporting systems. The audit committee also reviews the annual, half year and quarterly financial results of the Group before submission to the Board. It is responsible for making a nomination to the Board regarding the proposal for election of the external auditors by shareholders, for approving of the remuneration and overseeing the work of the external auditors. The audit committee reviews, at least annually, the qualifications, performance and independence of the external auditors. It establishes guidelines for the retention of the external auditors for any permissible non-audit services and reviews any matters that may impair their objectivity and independence. It also annually reviews the staffing, scope and general extent of the external auditors’ examination and suggests, if desired, areas requiring special emphasis. Statements regarding internal control and the procedures in place regarding internal control according to the UK Turnbull Guidance are given below. The audit committee regularly reports to the Board.
In addition to determining the overall strategy of the Group and the supervision of senior management, the Board addresses key matters in the area of strategy, finance, structure and organization and business development (subject to the matters reserved for the shareholder meeting by law). The Board approves the Group strategic plan and the annual financial plans developed by Management and reviews and approves the annual, half year and quarterly financial statements of Zurich Financial Services and of the Group. It establishes guidelines for overall business policies and capital allocation and approves major changes in the Group’s business activities, including major lending and borrowing transactions, and major business developments such as acquisitions or disposals of business or assets, investments or new businesses, mergers, joint ventures and co-operations. The Board also considers other matters of strategic importance to the Group.
Management Board To the extent not reserved to the Board, Management is delegated to the CEO. The CEO, and under his supervision, the GEC is responsible for dealing with strategic, financial and business policy issues of Group-wide relevance, including consolidated performance, capital allocation and mergers and acquisitions.
As of January 1, 2005, a standing committee of the GEC is the GEC Finance and Balance Sheet Committee, chaired by the CEO. This committee attends to key financial matters resulting from implementation of the strategy, the developments of the financial environment and the financial condition of the Group and is charged with approving specific transactions or business changes not reflected in the Group financial plan that impact the Group’s balance sheet under delegations approved by the Board of Directors.
The members of the GEC as of December 31, 2004, were as follows: Name Nationality Age Position held
Paul van de Geijn Dutch 58 Chief Executive Officer Global Life Insurance
With the exception of Messrs. Riddell and Wemmer, who joined the GEC on November1, 2004, all other members of the GEC served throughout the year 2004. Mr. Feinstein will retire as Chief Executive Officer of Farmers Group Inc. and as a member of the GEC effective March 31, 2005. He will be succeeded in his role as Chief Executive Officer of Farmers Group Inc. and as a member of the GEC by Paul Hopkins.
All members of the GEC are employed under contracts which include a notice period of one year or less. For further information on termination benefits, see page 127.
Peter Eckert graduated with a Diploma in Business Administration and worked in various areas of both insurance and reinsurance before joining Zurich in 1980, in charge of the Group’s Portuguese subsidiary, Companhia de Seguros Metrópole SA, Lisbon. In 1988 he was appointed chief executive officer of Zurich’s operations in Australia. He was consecutively appointed to the former Group Executive Board in 1991, and two years later became CEO for Zurich Switzerland. In July 2001, he became head of the Continental Europe business division and in March 2002, he was appointed Chief Operating Officer. Mr. Eckert is currently vice-chairman of the board of Deutsche Bank (Suisse) S.A. He is a member of the board of “economiesuisse” and a member of the board of the foundation “Avenir Suisse”. He was previously a member of the boards of the respective insurance associations in Portugal, Australia and Switzerland. From 1995 to 2004, he was a member of the Presidential Council of the European Insurance Association (CEA), being its president from 1998 to 2000.
John J. Amore graduated with a degree in management from Embry-Riddle Aeronautical University, Daytona Beach (USA), and with an MBA in Finance from New York University. Before joining Zurich, he was vice-chairman of the Commerce and Industry Insurance Company, a member company of American International Group (AIG). He later became chief executive officer of the Zurich U.S. Specialties business unit and was appointed chief executive officer of Zurich US in December 2000. He was CEO of Zurich’s North America Corporate business division until August 31, 2004. In April 2004 he was appointed CEO of the General Insurance business segment. Mr. Amore is vice chairman of the board of directors of the American Insurance Association.
Dieter Wemmer holds a PhD and a Master’s degree in mathematics from the University of Cologne. From 1983 until 1986, he worked in pure mathematics at the universities of Cologne and Oxford. In 1986 he joined Zurich Re (Cologne), at that time a reinsurance subsidiary of Zurich’s German operation Agrippina, as a pricing actuary for life reinsurance. He became Head of Life Reinsurance and Chief Actuary five years later. From 1992 until 1996, Mr. Wemmer held various positions with Agrippina, joining the management board in 1995 responsible for Controlling/Planning, Communication and Real Estate management. He was seconded to Zurich’s Corporate Center in 1996 as project manager for the implementation of International Accounting Standards (IAS) and US Generally Accepted Accounting Principles (US GAAP). One year later he became Head of Financial Controlling. From 1999 until May 2003, he was Head of Mergers and Acquisitions, with additional responsibility for capital management and General and Life Actuarial from 2002. He became Chief Operating Officer of the Europe General Insurance business division in May 2003. Since November 2004, he has been CEO Europe General Insurance and a member of the Group Executive Committee.
John Lynch 2 American 53 Chief Executive Officer US Small Business
Martin South 2 British 40 Chief Executive Officer International Businesses division
Shareholders’ participation rights Each registered share entered into the share register provides for one vote. There are no voting right restrictions.
A shareholder with voting rights can attend the shareholder meeting of Zurich Financial Services in person. He or she may also authorize in writing another shareholder with voting rights or any person permitted under the Articles of Incorporation and a more detailing directive of the Board to represent him or her at the shareholder meeting. Based on the Articles of Incorporation, minors or wards may be represented by their legal representatives, married persons by their spouses and a legal entity may be represented by a person authorized to bind it by his or her signature even if such persons are not shareholders. Furthermore, authority of representation may be given to the Independent Representative of Shareholders, to a statutory representative or to representatives of bank accounts who do not need to be shareholders themselves. Zurich Financial Services may under certain circumstances authorize the beneficial owners of the registered shares that are held by professional persons as nominees (such as a trust company, bank, professional asset manager, clearing organization, investment fund or other entity recognized by Zurich Financial Services) to attend the shareholder meetings and exercise votes as proxy of the relevant nominee. For further details, see page 118.
Pursuant to the Articles of Incorporation, a quorum is constituted in the shareholder meeting regardless of the number of shareholders present or the number of registered shares represented. Resolutions and elections generally require the approval of a simple majority of the votes exercised, excluding abstentions, blank and invalid votes, unless respective provisions in the Articles of Incorporation (of which there are none) or mandatory legal provisions stipulate otherwise. Article 704 of the Swiss Code of Obligations provides for a two-thirds majority of votes cast representing an absolute majority of nominal values of shares represented for certain important matters such as the change of the company purpose and domicile, the dissolution of the company without liquidation, and matters relating to capital increases. In the event of the votes being equally divided, the decision rests with the Chairman.
General meetings of shareholders are convened by the Board of Directors, or, if necessary, by the auditors and other bodies in accordance with the provisions set out in Article 699 and 700 of the Swiss Code of Obligations. Shareholders with voting rights representing at least ten percent of the share capital may call a shareholder meeting indicating the matters to be discussed and the corresponding proposals. The convocation period consists of at least 20 calendar days, whereby Zurich Financial Services usually posts the invitations to shareholders at least 20 working days before the meeting and publishes it in the Swiss Official Gazette of Commerce and several newspapers.
Mr. Roger Marshall of PricewaterhouseCoopers AG is the lead auditor, responsible since January1, 2003.
OBT AG has been elected as a special auditor to undertake the special audits for increases in share capital required under the Articles 652f, 653f and 653i of the Swiss Code of Obligations. At the Annual General Meeting of shareholders on May 16, 2002, OBT was re-elected by the shareholders for a three year term. OBT AG has assumed this mandate since October 2000. The Board of Directors proposes that OBT be re-elected as special auditor for a further three-year term.
The audit committee has approved a written policy on the use of external auditors for non-audit services which sets forth the rules for providing such services and related matters. Allowable non-audit services need pre-approval and require, among other things, an engagement letter specifying the services to be provided and making reference to external auditor’s obligation to comply with this policy.
For addresses and further upcoming important dates, please refer to the financial calendar on page 143.
Employees The Group’s employment policy includes a commitment to recruit people solely on the basis of their ability. The Group actively encourages employee involvement via print and online publications, team briefings and regular meetings with employees’ representatives. The Group is party to a voluntary agreement within the scope of the European Works Council Directive. In some countries the Group has established broad-based employee share compensation and incentive plans to encourage employees to become shareholders in the Group (see pages 99 to 101).
Going Concern The Directors are satisfied that, having reviewed the performance of the Group and forecasts for the forthcoming year, the Group has adequate resources to enable it to continue in business for the foreseeable future. For this reason, the Directors have adopted the going concern basis for the preparation of the financial statements.
Management is responsible for the identification and evaluation of significant risks. Periodic risk assessments are conducted using “the total risk profiling tool.” Every quarter, the operating units report key risks and prepare action plans to mitigate these risks at the local level. These quarterly risk reports are then used to identify significant risks and the consequent actions taken at the business unit level are reported to the Board.
Processes and controls in the organization are subject to regular reviews by Management, Group Audit and Group Risk Management. The Board, through the audit committee, receives periodic reports from the Chief Risk Officer, Group Audit and Management on the adequacy of the control structure in place to execute the Group’s strategy.
The Board is satisfied that the review was conducted in accordance with the Turnbull Guidance. The assessment included the consideration of the effectiveness of the Group’s ongoing process for identifying, evaluating and managing the risks of the business and a review of the annual reports of internal control and business risks completed by the businesses. Such review was conducted by Group Audit and performed at the geographic regional level, and by function, reflecting the level at which internal control is tactically managed in the Group.
Further details of the performance share and share option plans are set out on pages 132 to 134.
As of December 31, 2004, all of the Directors of Zurich Financial Services are non-executives, independent of management. The compensation for Directors and for members of the Group Executive Committee is therefore disclosed separately in accordance with the requirements of the Directive of the SWX Swiss Exchange.
All Directors, except the current Chairman and Vice-Chairman are remunerated on the basis of an annual fee of USD 125,000 together with an additional fee of USD 25,000 in respect of each committee on which they served. Directors who reside in the United States receive an additional fee of USD 10,000 per annum. With effect from July1, 2003, it was agreed that the chairman of the audit committee would receive an additional fee of USD 10,000 per annum.
The current Chairman of Zurich Financial Services received an annual fee of USD 500,000 in 2004. The current Vice-Chairman received an annual fee of USD 250,000 in 2004. These were the same levels as received in 2003. None of the Directors’ fees is pensionable.
1 Joined the Board of Directors on April 16, 2004. 2 Resigned from the Board of Directors on April 16, 2004.
Group Executive Committee Remuneration The total aggregate remuneration paid to the members of the GEC was USD 27 million during 2004 (USD 20 million during 2003). Aggregate remuneration consists of the base salary paid, any cash awards received under the short and long-term incentive plans and the estimated value of other compensation-related items, for example, the value of pension benefits accruing during the year, overseas allowances, perquisites, cars and mortgage loans. Aggregate remuneration includes the remuneration payments received during the period that the executive is a member of the GEC. Equity based remuneration is addressed below.
The increase in aggregate remuneration arises predominantly from the increase in cash based incentive awards paid in 2004 for the performance achievements in 2003 relative to the awards paid in 2003 for the 2002 performance year. Incentive awards for the 2002 performance year were significantly reduced following the loss incurred in that year. Furthermore, the modest increase in the average membership and the changes in exchange rates also impacted the aggregate remuneration over the period.
Included in aggregate remuneration is approximately USD 4 million in 2004 (USD 3 million in 2003) to provide for accrued pension, retirement and similar benefits for the GEC members. The members of the GEC participate in various pension plans, typically providing benefits based on final salary and the number of years of service with the Group. Normal retirement ages vary from age 60 to age 65. Accrual rates vary in line with practice in each country and typically lead to overall pension levels of between 40% and 67% of the defined final pensionable salary.
Termination arrangements for members of the Group Executive Committee who gave up their functions during the year One member of the GEC gave up his function during 2004. In line with his contractual agreements, an amount of USD 2.6 million was available to the individual and this was predominantly used to increase the member’s pension benefits. The payment was made subject to compliance with certain post employment obligations. No termination arrangements were entered into with members of the Board of Directors, who left in 2004.
Under the Group’s Long-Term Performance Share Plan running for the period January1, 2001, to December 31, 2003, the actual number of shares to be awarded in 2004 was dependent on the financial performance of the Group during the period relative to defined hurdles. Based on the financial performance of the Group over the three-year period, no awards were made under this Group Long-Term Performance Share Plan in 2004. However, for those members joining the GEC during the performance period, pro rata awards could be made to such members if the business division plans in which they participated paid awards for this performance period.
Relevant share price at beginning of performance cycle CHF 120 to 448 CHF 627
Under the share option program, the total number of shares under option for the GEC members as of December 31, 2004 is set out in the table below.
Year of grant vested unvested under option CHF Year of expiry
The performance based share options granted in 2004 will be considered for vesting on a uniform basis during 2005, 2006 and 2007. The actual level of vesting each year (0 to 150% of the allocation) will depend upon the Group’s performance in relation to the ROE achievement and the positioning of the Group’s total return to shareholders compared to a global industry peer group of insurance companies.
No other guarantees and/or outstanding loans, advances or credits have been granted to the members of the Board of Directors or the GEC. Except as disclosed above, the Directors and the members of the GEC of Zurich Financial Services have no interest in any transactions which are or were unusual in the nature of their conditions or significant to the business of the Group.
Zurich Financial Services presents its financial statements in accordance with Swiss law.
(b) Investments in subsidiaries Investments in subsidiaries are equity interests, which are held on a long-term basis for the purpose of the holding company’s business activities.They are carried at a value no higher than their cost price less adjustments for impairment.
Investments in subsidiaries include a 57% interest in Zurich Group Holding with a carrying value of CHF 6,064,302,120 (prior year CHF 6,064,302,120) and a 100% interest in Allied Zurich p.l.c., with a carrying value of CHF 4,595,865,096 (prior year CHF 4,595,865,096). Allied Zurich p.l.c. holds a 43% interest in Zurich Group Holding. Additionally, Zurich Financial Services holds 49,000 shares of Zurich Insurance Company with a carrying value of CHF 2,750,192 (prior year CHF 2,750,190).
Furthermore, Zurich Financial Services has entered into various guarantees and a support agreement for the benefit of its subsidiaries. These contingencies amounted to CHF 319 million as of December 31, 2004 (CHF 413 million as of December 31, 2003).
Issued stock At the Annual General Meeting of April 16, 2004, shareholders approved a share capital reduction in the form of a capital nominal value reduction of each registered share from CHF 9 to CHF 6.50. As a result of this reduction, the share capital was reduced by CHF 360,017,387.50 from CHF1,296,062,595 to a new total of CHF 936,045,207.50. In the previous year, shareholders approved, at the Annual General Meeting of April 30, 2003, a share capital reduction in the form of a capital nominal value reduction of each registered share from CHF10 to CHF 9. As a result of that reduction, the share capital was reduced by CHF144,006,955 from CHF1,440,069,550 to CHF1,296,062,595.
As of December 31, 2004 and 2003, Zurich Financial Services had 144,006,955 shares of CHF 6.50 par value and CHF 9 par value, respectively, common stock issued and fully paid.
The Board of Directors is authorized, when issuing bonds or similar debt instruments connected with conversion and/or option rights, to restrict or withdraw the right of shareholders for advance subscription in cases where such bonds are issued for the financing or re-financing of a takeover of an enterprise, of parts of an enterprise, or of participations. If the right for advance subscription is withdrawn by the Board, the convertible bond or warrant issues are to be offered at market conditions (including standard dilution protection provisions in accordance with market practice) and the new shares are issued at then current convertible bond or warrant issue conditions. The conversion rights may be exercisable during a maximum of 10 years and option rights for a maximum of seven years from the time of the respective issue.The conversion or option price or its calculation methodology shall be determined in accordance with market conditions, whereby for shares of Zurich Financial Services the quoted share price is to be used as a basis.
Employee participation: The share capital may be increased by an amount not exceeding CHF 9,750,000 by issuing up to 1,500,000 fully paid registered shares with a nominal value of CHF 6.50 each to employees of Zurich Financial Services and Group companies.The preemptive rights of the shareholders, as well as the right for advance subscription, are excluded.The issuance of shares or respective option rights to employees shall be subject to one or more regulations to be issued by the Board of Directors and taking into account performance, functions, levels of responsibility and criteria of profitability. Shares or option rights may be issued to the employees at a price lower than that quoted on the stock exchange.
This reserve fund corresponds to the purchase value of all Zurich Financial Services shares held by Group companies of Zurich Financial Services as shown in the table below.
Decrease due to nominal value reduction of common stock – (1,164) – (1,940)
According to the information available to us, Brandes Investment Partners L.P., San Diego, USA, represented an important shareholder holding more than 5% and less than 10% of common stock as specified in article 663c of the Swiss Code of Obligations, on December 31, 2004 and 2003, respectively.
Proposed/approved appropriation of available earnings Zurich Financial Services Holding Company – Financial Statements
Appropriation of available earnings as proposed by the Board of Directors
The Board of Directors proposes to the Annual General Meeting to appropriate the available earnings in accordance with the table above.
On behalf of the Board of Directors of Zurich Financial Services
In our opinion, the accounting records and financial statements and the proposed appropriation of available earnings (on page 140) comply with Swiss law and the company’s articles of incorporation.
Market capitalization (in CHF millions at end of period) 27,304 25,633
Authorized stock, CHF 6.501 and CHF 9.002 nominal value, respectively, number of shares 6,000,000 6,000,000
Contingent stock, CHF 6.501 and CHF 9.002 nominal value, respectively, number of shares 6,981,828 6,981,828 in CHF 2004 2003
The Bank of New York ADR level I ZFSVY.PK/ZFSVY US 10:1
Zurich share performance (indexed) since September 4, 2002 09/2002 03/2003 09/2003 03/2004 09/2004
Payout of nominal value reduction Expected to be at the beginning of July 2005, subject to approval by the Annual General Meeting of shareholders and subject to the fulfilment of the necessary requirements and the entry of the share capital reduction in the Commercial Register of the Canton of Zurich.
Results Reporting for the Nine Months to September 30, 2005 November16, 2005
Media Inquiries Corporate Communications, Media and Public Relations Zurich Financial Services, Switzerland
Corporate Citizenship/ Group Corporate Responsibility & Compliance Responsibility Inquiries Zurich Financial Services, Switzerland
Securities Custody Service Zurich Financial Services Custody Accounts c/o SAG SIS Aktienregister AG P. O. Box 4601 Olten, Switzerland
General CDI Inquiries CRESTCo Limited 33 Cannon Street London EC4M 5SB, United Kingdom CREST Service Desk: 0845 964 5648
Zurich Financial Services is an insurance-based financial services provider with a global network that focuses its activities on its key markets in North America and Europe. Founded in 1872, Zurich is headquartered in Zurich, Switzerland. Zurich has offices in more than 50 countries and employs about 57,000 people.
2ème souscripteur d’assurances dommages multirisques pour les entreprises1 2ème assureur dans le domaine de la responsabilité de produits 2 3ème assureur dans les branches d'activités de particuliers1
2ème assureur dommages en Suisse1 3ème assureur vie en Suisse1 2ème assureur de produits «unit-linked» en Allemagne 2 4ème assureur dommages et vie en Allemagne 3 3ème assureur dommages au Royaume-Uni 4 4ème assureur domestique au Royaume-Uni 5 4ème assureur automobile au Royaume-Uni 5
Ce faisant, nous allons créer de fortes relations avec nos clients, nos agents et nos courtiers ainsi que des opportunités de récompenser nos employés.
La Zurich renforce sa direction stratégique en vue de générer une croissance durable et rentable. La Zurich se concentre principalement sur l’assurance dommages et l’assurance vie et possède un portefeuille diversifié d’activités dans les secteurs grandes entreprises, petites et moyennes entreprises et particuliers ainsi que dans des régions géographiques.
La Zurich annonce un bénéfice net de 702 millions de dollars pour les trois premiers mois de 2004
de ses applications informatiques aux Etats-Unis, au Royaume-Uni, en Suisse et en Allemagne auprès de Computer Sciences Corporation (CSC).
Au premier semestre 2004, la Zurich a pratiquement doublé son bénéfice net à 1.448 millions de dollars.
La Zurich annonce son intention de lever un emprunt prioritaire à taux fixe sur l’euromarché à des fins de refinancement et pour des objectifs généraux d’entreprise. La transaction a permis de lever 1 milliard d’euros et a été sur-souscrite plus de trois fois.
Zurich lance un programme de don de 1 million de dollars en faveur des pays affectés par la catastrophe et double les contributions charitables fournies par des milliers de ses employés jusqu’à concurrrence de 1 million de dollars.
Une notation de solidité financière est une évaluation par un tiers de la sécurité financière d’une société d’assurance, basée sur sa capacité à satisfaire aux sinistres de ses preneurs d’assurance. Au 31 décembre 2004, la Zurich avait reçu les notations suivantes: Exercice 2004
1 sur la base des primes émises, affaires directes 2003 Source: Office fédéral des assurances privées 2 sur la base des primes des nouvelles affaires 2003 Source: Tillinghast 3 sur la base des primes émises brutes 2003 Source: Kölner Institut für Versicherungsinformation 4 sur la base des primes acquises nettes 2003 Source: Moody’s Insurance Statistical Supplement 5 sur la base des primes acquises brutes 2003 Source: Datamonitor UK Insurance Reports 2003 6 Source: recherches et analyses internes de la Zurich
Consolidated operating statements in USD millions, for the years ended December 31 2004 2003 Change
Life Insurance key performance indicators for the years ended December 31
New business profit margin (as % of APE) 11.4% 9.0% 2.4 pts
Business operating profit (after tax) return on equity 11.5% 9.8% 1.7 pts
Total General Life Farmers Other Corporate Insurance Insurance Mgmt Businesses Center Services 2, 2, 1,
General Insurance combined ratio in %, for the years ended December 31
Business operating profit in USD millions, for the years ended December 31
Total General Life Farmers Other Corporate Insurance Insurance Mgmt Businesses Center Services 3, 2, 1, 2, 1,