Group performance review Operating and financial review 84 Risk review 111
• The Farmers Exchanges 1 continue their eastward expansion in the U.S. and strengthen their network of exclusive agents
Business operating profit 4,075) 4,243 (4%) Net income attributable to shareholders 3,878) 3,750 3%
General Insurance gross written premiums and policy fees 35,610) 34,572 3% Global Life gross written premiums, policy fees and insurance deposits 30,259) 27,711 9% Farmers Management Services management fees and other related revenues 2,846) 2,767 3% Farmers Re gross written premiums and policy fees 4,361) 3,529 24%
General Insurance business operating profit 2,097) 2,247 (7%) General Insurance combined ratio 98.4%) 98.9% 0.5 pts
Farmers business operating profit 1,414) 1,486 (5%) Farmers Management Services gross management result 1,378) 1,333 3% Farmers Management Services managed gross earned premium margin 7.3% 4 7.3% –
Average Group investments 203,192) 196,788 3% Net investment result on Group investments 8,911) 9,367 (5%) Net investment return on Group investments 5 4.4%) 4.8% (0.4 pts) Total return on Group investments 5 7.0%) 5.3% 1.7 pts
3 Does not include any contribution from the insurance businesses acquired from Banco Santander S.A. (Zurich Santander) or from the acquisition of Zurich Insurance Malaysia Berhad (ZIMB). 4 Calculated based on gross earned premiums of the Farmers Exchanges of USD 18.8 billion, which excludes the return of USD 74 million in premiums as a result of the anticipated settlement of a lawsuit with the State of Texas.
Performance overview 1 All references to “Farmers Exchanges” mean Farmers Insurance Exchange, Fire Insurance Exchange, Truck Insurance Exchange and their subsidiaries and affiliates. The three Exchanges are California domiciled interinsurance exchanges owned by their policyholders with governance oversight by their Boards of Governors.
North America In 2012, Zurich celebrated its 100 year anniversary of providing insurance in the U.S.
Asia-Pacific Zurich has operations in Australia, China, Hong Kong, Indonesia, Japan, Malaysia, Singapore and Taiwan.
Middle East & Africa Our business spans the region with key operations in the Middle East, South Africa, Morocco and Turkey.
Business: Management services related to property and casualty insurance Market segments of the Farmers Exchanges1: Individual and commercial customers Distribution channels of the Farmers Exchanges1: Agents, direct Geography: United States 1 All references to “Farmers Exchanges” mean Farmers Insurance Exchange, Fire Insurance Exchange, Truck Insurance Exchange and their subsidiaries and affiliates. The three Exchanges are California domiciled interinsurance exchanges owned by their policyholders with governance oversight by their Boards of Governors.
We take a global approach to our resources and capabilities. We have the flexibility and speed to adapt our product and geographic mix to meet changing market conditions. Global processes and systems allow us to get the most from our strengths.
AA–/stable Standard & Poor’s financial strength rating of Zurich Insurance Company Ltd (December 31, 2012)
Our Group strategy is designed to deliver profitable growth by leveraging the strength of our global business, making the best use of our resources and building our reputation as a trusted brand. This strategy is based on three simple concepts: ‘who we are, what we do and how we do it’.
Dr. Josef Ackermann and Martin Senn of doing business in 2012, and with the successful integration of our acquired insurance businesses in high-potential growth markets in Latin America and Malaysia.
General Insurance: Strong revenue growth and underlying profits General Insurance business operating profit decreased by USD 150 million to USD 2.1 billion in 2012. However, underlying profits and revenue growth were strong.
General Insurance gross written premiums and policy fees increased by USD 1 billion to USD 35.6 billion in 2012. The segment achieved average rate increases of 4 percent, mirroring our strategic focus on selective, profitable growth, while continuing a disciplined approach to underwriting. Overall premium growth was strong, especially in International Markets through both organic growth and acquisitions, as well as in North America, while European results continue to be affected by lower levels of economic activity, particularly in some of the larger markets such as the UK, Spain and Italy.
Global Life gross written premiums, policy fees and insurance deposits increased by USD 2.5 billion to USD 30.3 billion as a result of the inclusion of Zurich Santander.
New business value after tax, including Zurich Santander and Zurich Insurance Malaysia Berhad, increased by 11 percent to USD 1.1 billion. Zurich Santander and Zurich Insurance Malaysia Berhad contributed USD 195 million, while new business value after tax, excluding these recent acquisitions, declined by USD 90 million to USD 890 million. The strategy of diversifying geographically into target markets and diversifying product mix into protection and fee-based offerings is offsetting the volume and margin pressures being experienced in Europe.
Farmers Management Services business operating profit increased by USD 71 million to USD 1.4 billion or by 5 percent, primarily driven by the increase in gross earned premiums in the Farmers Exchanges, which are managed but not owned by Farmers Group, Inc., a wholly owned subsidiary of the Group. Farmers Re business operating profit deteriorated by USD 142 million to a loss of USD 26 million, primarily due to the absence of favorable development of reserves established in prior years, which benefited Farmers Re during 2011.
Regulatory challenges Worldwide, public policy issues are prompting reactions from both global and national insurance regulators. Zurich takes a constructive approach by working closely with regulators to develop stronger policy frameworks. The most significant current initiatives from governments and supervisory bodies are responses to the consequences of the financial crisis and include: Potential designation as a global systemically important insurer (G-SII) Several financial conglomerates at the heart of the financial system became casualties of the global economic crisis due to excess debt ratios and weak risk management functions. In response to the systemic risk posed by failures of large interconnected firms, regulators are framing policies designed to avoid a similar situation.
The International Association of Insurance Supervisors is participating in a global initiative to identify potential G-SIIs, whose distress or disorderly failure, because of their size, complexity and interconnectedness, would cause significant disruption to the global financial system and economic activity.
If a company is designated as a G-SII this may lead to additional financial and regulatory requirements. Organizations that fall into the G-SII category could be required to increase capital to absorb potential losses and to submit formal recovery and resolution plans. Further, they would also have to present a proposal on how they would reduce their systemic risk.
National budget deficits driving protectionist laws High national budget deficits in some countries are beginning to drive measures that affect foreign market participants more than local participants. Examples of these include Argentinian investment and Brazilian reinsurance regulations.
The impact has been reinforced by the new supervisory architecture that is being implemented in several countries, for example in the UK and Italy. In these countries, prudential insurance supervision is being centralized at their central banks and a special agency for consumer protection has been created. These agencies are not required to take into account prudential or solvency considerations in relation to the cost that additional protection measures may impose.
The most significant current initiatives from governments and supervisory bodies are responses to the consequences of the financial crisis.”
Security and cyber risk A digitally connected society presents new and evolving dangers to all organizations; threats from information technology infrastructure attacks and cyber-crime pose a constant threat with material consequences.
Board members and executive management are increasingly recognizing the risks of a wide range of exposures such as lost or stolen data, violation of privacy laws, intellectual property infringement, social media, mobile devices and cloud computing. Not only do violations of data security present reputational dangers for insurers, but also potential sanctions from regulators.
The outlook is expected to improve as political uncertainty subsides and governments turn their focus towards growth rather than austerity.”
Zurich’s Group strategy framework – set out below – is a new articulation of the strategic principles that Zurich has pursued for many years. It clarifies our strategic direction for all our stakeholders and ensures that within the organization, we are all aligned around a common purpose. This new strategic framework is based on three simple concepts: ‘Who we are, what we do and how we do it’.
We aim: • to grow our business organically where we can do so profitably; • to make use of our capital strength in order to grow through selective acquisitions, joint-ventures and alliances in mature markets, and accessible highpotential growth markets.
Our Group strategy is designed to deliver profitable growth by leveraging the strength of our global business.
In order to reach this goal, we are upgrading our service infrastructure and adopting tools and techniques that will give us more insight into our customers’ needs.
We aim: • to expand our product and service offerings; • to identify profitable opportunities within the industry and to redefine the value chain.
We aim: • to upgrade or reinvent our processes and systems in order to reduce complexity and satisfy changing customer expectations effectively; • to enhance our technical capabilities continuously and establish value-adding shared services to support new business initiatives.
Our next generation operating landscape will recognize distinct customer needs while leveraging global scale.
We aim: • to leverage The Zurich Way (TZW) in its original intention to select, improve and systematically roll out core target capabilities across the Group; • to create global standards that all our employees can embrace: standards that represent the way we do business at Zurich.
We are developing and piloting global capabilities that will provide uniform work practices across Zurich.
For more information on corporate responsibility at Zurich, see our Annual Review 2012, which is available on www.zurich.com, as well as the corporate responsibility section of our website (within ‘About us’).
Measuring our performance In addition to our Group strategic aspirations there are targets for each of our three segments.
Global Life • 30% of NBV from Asia-Pacific and Middle East (APME) and Latin America • Top 5 European-based global insurer by New Business Value (NBV) • Cash generative while self-funding organic growth
Farmers • Maintain top quartile growth performance among the 12 largest U.S. personal lines companies
Group • Reduce run-rate costs by USD 500 m in mature markets at YE 2013 to strengthen our position in growth markets
• This increase was driven by continued premium growth in all lines of business primarily as a result of ongoing rate actions undertaken to improve profitability.
• General insurance has delivered the bulk of Group savings so far. Group Operations implemented two of the largest IT outsourcing initiatives in the insurance industy. Restructuring projects in Global Life are expected to become visible in 2013.
Zurich delivered solid results and generated strong cash flows while maintaining its strong capital position. This enabled the Board of Directors to propose an attractive dividend of CHF 17.00 per share, demonstrating the Group’s sustained commitment to shareholder value.
The execution of the Group’s strategy and focus on its core insurance business enabled strong growth and improved underlying profitability, which are critical to offset lower investment income due to the persisting low-yield environment.
The strategic acquisitions made towards the end of 2011 have now been integrated into the Group, with Zurich Santander contributing USD 5.2 billion to the growth of gross written premiums and insurance deposits and a business operating profit of USD 165 million.
3 percent was due to the currency translation impact, as the U.S. dollar was on average stronger against the Swiss franc in 2012 than in 2011.
Group investments increased by USD 11.0 billion or by 6 percent to USD 208.7 billion since December 31, 2011. The Group’s asset and liability management strategy remains disciplined and the Group continues to reduce risks which it believes are not rewarded. The quality of the Group’s investment portfolio remains high. Investment grade securities continue to comprise 98 percent of the Group’s debt securities.
The Group’s capital and solvency positions remain strong, underpinned by continued focus on risk management in its disciplined investment and underwriting strategies. Shareholders’ equity increased by USD 3.0 billion to USD 34.5 billion since the year ended December 31, 2011, after recording the total cost of USD 2.8 billion for the dividends paid in April 2012.
The Swiss Solvency Test (SST) became fully effective and mandatory as of January 1, 2011. Under SST, the Group is required to use a company-specific internal model to calculate risk-bearing and target capital and to file SST reports half yearly. For July 1, 2012 the Group filed, on a consolidated basis, an SST capitalization ratio of 178 percent, compared with 183 percent as of January 1, 2012 following a review by FINMA. The internal model continues to be subject to approval by FINMA.
General Insurance General Insurance business operating profit decreased by USD 150 million or by 7 percent to USD 2.1 billion, due to a decline in investment income, partly offset by the improved net underwriting result.
The net underwriting result benefited from an improved underlying loss ratio, which more than compensated for the decrease in favorable development of reserves established in prior years, mainly arising in Germany from an increase in loss reserves for certain long-tail lines of business written in prior years and higher commission expenses, as the mix of business shifts toward products with higher commissions.
General Insurance gross written premiums and policy fees increased by USD 1.0 billion or by 3 percent to USD 35.6 billion, mainly as the result of rate increases.
Premiums continued to increase in the mature North American market. While part of this increase was attributable to adjustments to premiums for prior year policies as initial estimated insured risks were increased to reflect actual exposures, there have also been improvements in both customer retention and new business.
Global Life Global Life business operating profit remained broadly flat at USD 1.3 billion, with a positive contribution from Zurich Santander of USD 105 million net of non-controlling interests and earn-out charges. This was largely offset by a lower contribution from Europe, mainly as a result of one-off expenses in Germany.
Global Life gross written premiums, policy fees and insurance deposits increased by USD 2.5 billion or by 9 percent to USD 30.3 billion, benefitting from the contribution of Zurich Santander as well as higher volumes of single premium products in Corporate Life & Pensions and Private Client Banking Solutions, partly offset by a reduction in Spain where the product mix continued to shift from savings toward higher-margin protection products.
Farmers Farmers business operating profit decreased by USD 72 million or by 5 percent to USD 1.4 billion, mainly due to a net underwriting loss incurred by Farmers Re.
Farmers Management Services business operating profit increased by USD 71 million or by 5 percent to USD 1.4 billion, mainly as a result of the increase in gross earned premiums in the Farmers Exchanges, which are managed but not owned by Farmers Group, Inc., a wholly owned subsidiary of the Group.
Farmers Re business operating profit deteriorated by USD 142 million to a loss of USD 26 million, mainly reflecting the absence of favorable development of loss reserves established in prior years compared with 2011, as well as weather-related losses that were once again well above historic levels. This was partly offset by a year-on-year improvement in the underlying loss ratio.
Gross written premiums in the Farmers Exchanges increased by USD 637 million or by 3 percent to USD 18.9 billion. This increase was due to continued premium growth in all lines of business primarily as a result of ongoing rate actions undertaken to improve profitability, which resulted in a small decrease in policies in force.
• Swiss Code of Best Practice for Corporate Governance, issued in 2002 by economiesuisse, as amended in October 2007.
Zurich Insurance Group Ltd is listed on the SIX Swiss Exchange. Certain Group companies have listed debt issued under the Euro Medium Term Note Program and other financial instruments.
The Zurich Insurance Group has been under group supervision by the Swiss Financial Market Supervisory Authority (FINMA) and its predecessor authority the Federal Office for Private Insurance (FOPI) since a decree of April 2001. In its decree of December 28, 2011, FINMA stated that Zurich is subject to insurance group supervision according to article 64 et seq. of the Swiss Insurance Supervision Law (“ISL”) and no longer qualifies as a conglomerate. Furthermore, the Joint Committee of the European Supervisory Authorities has re-designated the Group from an insurance conglomerate to an insurance group given the small size of its non-insurance activities. The ISL requires Swiss insurance companies and groups to establish and maintain strong governance and risk management systems as well as effective internal control systems that are appropriate to their business activities. It prescribes the calculation of a risk-based solvency margin at Group and legal entity level, pursuant to the Swiss Solvency Test (SST) and also a Solvency I margin (expected to become redundant when Swiss insurance supervision is acknowledged as equivalent to the EU’s Solvency II regulations). The reporting of all major intra-group transactions is also part of Swiss group supervision. In addition to the group supervision exercised by FINMA and its supervision over Zurich Insurance Company Ltd and Zurich Life Insurance Company Ltd, the insurance subsidiaries and remaining financial services entities of the Group are supervised by relevant local supervisory authorities.
• Simplified organizational structure at Head Office: - discontinued role of Chief Administrative Officer (CAO)
• Ann Haugh appointed to new position of Chief of Staff
Group structure and shareholders Operational Group structure Zurich Insurance Group Ltd, the Group’s holding company, is a Swiss corporation organized in accordance with the laws of Switzerland. In recent years, Zurich has streamlined its business portfolio to concentrate on insurance. In recognition of this strategic focus, the Board proposed to replace the reference to financial services in the company name by emphasizing the insurance activity of the Group instead. Accordingly, at the Annual General Meeting on March 29, 2012, the Board proposed that the company name be changed to Zurich Insurance Group Ltd. The proposed name was approved by the shareholders.
• Farmers provides, through Farmers Group, Inc. and its subsidiaries (FGI), non-claims related management services to the Farmers Exchanges. FGI receives fee income for the provision of services to the Farmers Exchanges, which are managed but not owned by Farmers Group, Inc. a wholly owned subsidiary of the Group. This segment also includes all reinsurance assumed from the Farmers Exchanges by the Group. Farmers Exchanges are prominent writers of personal and small commercial lines of business in the U.S.
At a secondary level, the General Insurance segment is managed based on market-facing businesses, including: Global Corporate, North America Commercial, Europe, Latin America and Asia-Pacific, Middle East and Africa. The Global Life segment is managed on a regionally based structure within a global framework, including: North America, Latin America, Europe and Asia-Pacific and Middle East.
A list of the Group’s significant subsidiaries, including additional information on significant subsidiaries that are listed, can be found on pages 283 to 285. For further information on the share listing of Zurich Insurance Group Ltd, see the Shareholder Information on pages 348 to 350.
Significant shareholders According to the rules regarding the disclosure of significant shareholdings of Swiss companies listed in Switzerland, disclosure has to be made if certain thresholds starting at three percent are reached or if the shareholding subsequently falls below those thresholds. Call options and other financial instruments are added to any share position, even if they allow for cash settlement only. Under this regime, disclosure must be made separately for purchase positions (including shares, long call options and short put options) and sale positions (including long put options and short call options). The percentage thresholds are calculated on the basis of the total amount of voting rights according to the entry in the commercial register.
Zurich Insurance Group Ltd is obliged to announce shareholdings by third parties in its shares when notification is received from a third party that a threshold has been reached. During 2012 the Group received several notifications by third parties that they have either exceeded or subsequently fallen below the threshold of three percent as a result of purchases or sales.
Latin America 0.1 0.1 Rest of the World 4.0 13.6 as of December 31, 2012Number of shares held as of December 31, 2012Registered shareholders by type as of December 31, 2012Registered shareholders by geography
Capital structure Share capital As of December 31, 2012, the ordinary share capital of Zurich Insurance Group Ltd amounted to CHF 14,830,012.30 divided into 148,300,123 fully paid registered shares with a nominal value of CHF 0.10 each. The Board will propose to the shareholders at the Annual General Meeting on April 4, 2013 a dividend of CHF 17.00 per share. As the dividend payment is planned from the capital contribution reserve, it will be exempt from Swiss withholding tax.
Authorized and contingent share capital As of December 31, 2012, as specified in Article 5bis(1) of the articles of incorporation, the Board of Zurich Insurance Group Ltd is authorized to increase the share capital by up to CHF 1,000,000 representing 10,000,000 fully paid registered shares with a nominal value of CHF 0.10 each until March 29, 2014. The contingent share capital of Zurich Insurance Group Ltd, as specified in Article 5ter(1a) of the articles of incorporation, may be increased by an amount not exceeding CHF 1,000,000 by issuing up to 10,000,000 fully paid registered shares with a nominal value of CHF 0.10 each by exercising conversion and/or option rights which are granted in connection with the issuance of bonds or similar debt instruments by Zurich Insurance Group Ltd or one of its Group companies in national or international capital markets and/or option rights which are granted to the shareholders. Moreover, there is an additional contingent share capital of CHF299,513.60 as specified in Article 5ter(2a) of the articles of incorporation, representing 2,995,136 fully paid registered shares with a nominal value of CHF 0.10 each, which may be issued to employees of the Group. For further information on the capital structure and the authorized and contingent share capital, see the audited Consolidated financial statements, note 22 on pages 237 and 238.
Changes of share capital during 2011 During 2011, a total of 798,926 shares were issued to employees out of contingent capital. As a result, on December 31, 2011, share capital amounted to CHF 14,738,582.20 (147,385,822 shares) and both the authorized capital and the contingent share capital (as specified in Article 5bis(1) and in Article 5ter(1a) of the articles of incorporation, respectively) amounted to CHF 1,000,000 (10,000,000 shares) and the other contingent share capital (as specified in Article 5ter(2a) of the articles of incorporation) amounted to CHF 390,943.70 (3,909,437 shares).
Shares and participation certificates Zurich Insurance Group Ltd’s shares are registered shares with a nominal value of CHF 0.10 each. The shares are fully paid. Pursuant to Article 14 of the articles of incorporation, each share carries one vote at shareholders’ meetings and entitles the registered holder to exercise all other membership rights in respect of that share.
Profit sharing certificates Zurich Insurance Group Ltd has not issued any profit sharing certificates.
Limitations on transferability and nominee registrations The articles of incorporation do not provide for any limitations on transferability except for the following: 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 Insurance Group Ltd shares may for the benefit of, or as nominee for, another person be registered for up to 200,000 shares with voting rights notwithstanding that the nominee does not disclose the identity of the beneficial owner. A nominee, however, is entitled to be registered as shareholder with voting rights of more than 200,000 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 of 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 shares by The Bank of New York Mellon Corporation in connection with the Zurich Insurance Group Ltd ADR program.
1 Josef Ackermann Chairman of the Board, Chairperson of the Governance and Nominations Committee, Member of the Remuneration Committee 2 Tom de Swaan Vice-Chairman of the Board, Chairperson of the Risk Committee, Member of the Governance and Nominations Committee 3 Susan Bies Director, Member of the Audit Committee, Member of the Risk Committee 4 Alison Carnwath Director, Member of the Remuneration Committee 5 Victor L.L. Chu Director, Member of the Governance and Nominations Committee 6 Rafael del Pino Director, Member of the Remuneration Committee 7 Thomas K. Escher Director, Chairperson of the Remuneration Committee 8 Fred Kindle Director, Member of the Audit Committee 9 Armin Meyer Director, Member of the Governance and Nominations Committee, Member of the Risk Committee 10 Don Nicolaisen Director, Chairperson of the Audit Committee, Member of the Risk Committee 11 Rolf Watter Director, Member of the Audit Committee
Board of Directors and its Committees as of December 31, 2012 * Chairman of Board or Board Committee, respectively
Susan Bies American 1947 Director Member of the Audit Committee Member of the Risk Committee
Victor L.L. Chu British 1957 Director Member of the Governance and Nominations Committee
Rafael del Pino Spanish 1958 Director Member of the Remuneration Committee
All Directors of Zurich Insurance Group Ltd are also members of the board of directors of Zurich Insurance Company Ltd. Mr. Ackermann also serves as chairman of that board. In addition, Mr. de Swaan is a member of the boards of directors of Zurich Insurance plc and Zurich Life Assurance plc in Ireland. Mr. Nicolaisen and Ms. Bies are members of the board of directors of Zurich Holding Company of America, Inc. (ZHCA). With the exception of Ms. Bies, Mr. Nicolaisen and Mr. de Swaan, the Directors have no further board memberships within the Group.
Currently, the Board includes members of five nationalities. The Board members gained their business experience in a broad range of jurisdictions resulting in a profound collective knowledge of international business practices. The Board also benefits from its members’ broad cultural, educational and professional backgrounds, which include financial services, manufacturing, engineering and legal and regulatory.
The Board nominated Ms. Monica Mächler for election at the Annual General Meeting on April 4, 2013 as an additional member of the Board of Zurich Insurance Group Ltd, proposing thereby to add Ms. Mächler’s skills, deep knowledge of the insurance industry and her overall experience to the Board, which, if elected, will increase the percentage of women representation on the Board to 27.2 percent.
For details with regard to the current Board composition as of December 31, 2012 in terms of length of tenure and gender representation please see the following: Less than 5 years Between 5 and 10 years
Tom de Swaan (1946), Dutch Citizen Vice-Chairman of the Board Skills and experience: Mr. de Swaan has served in the banking industry of The Netherlands for over 40 years. He joined De Nederlandsche Bank N.V. in 1972 and from 1986 until 1998 was a member of the governing board. In January 1999, he became a member of the managing board and chief financial officer of ABN AMRO Bank. He retired from ABN AMRO in May 2006, but continued as an advisor to the managing board until June 2007. Between 1987 and 1988, Mr. de Swaan was chairman of the Amsterdam Financial Center and from 1995 to 1997 chairman of the banking supervisory sub-committee of the European Monetary Institute. He was also a member of the Basel Committee on Banking Supervision from 1991 to 1996, its chairman from 1997 to 1998 and a non-executive director on the board of the UK’s Financial Services Authority from January 2001 until the end of 2006. Committee membership: Risk Committee (Chairperson), Governance and Nominations Committee Other directorships within the Group: Zurich Insurance Company Ltd, Zurich Insurance plc, Zurich Life Assurance plc
Alison Carnwath (1953), British Citizen Member of the Board Skills and experience: Ms. Carnwath has substantial financial industry experience. She began her career with Peat Marwick Mitchell, now KPMG, in 1975 to 1980 and practiced as a chartered accountant. From 1980 to 1982, she worked as a corporate financier for Lloyds Bank International. From 1982 to 1993, she was Assistant Director, then Director at J. Henry Schroder Wagg & Co in London and New York. From 1993 to 1997, Ms. Carnwath was a Senior Partner at the financial advisory firm Phoenix Partnership. The firm was taken over by Donaldson Lufkin Jenrette (DLJ) in late 1997; Ms. Carnwath continued working for DLJ until 2000. Ms. Carnwath has held several board offices. From 2000 to 2005, she was the Chairman of the board of Vitec Group plc, from 2001 to 2006 a director of Welsh Water, from 2004 to 2007 of Friends Provident plc, from 2004 to 2007 of Gallaher Group and from 2007 to 2010, she was the independent Chairman of MF Global Inc. Further, she also served on the board of directors of Barclays from 2010 to 2012.
External appointments: Mr. Chu has been chairman of First Eastern Investment Group, a leading direct investment firm focusing on China and Asia-related opportunities, since 1988. He has also been chairman of First Eastern Investment Bank Limited since 2006 and of FE Securities Limited since 1994. He is currently a foundation board member of the World Economic Forum and co-chairs the Forum’s International Business Council. Mr. Chu is also chairman of the Hong Kong/ European Union Business Cooperation Committee, vice-chairman of Asia House in London and a member of the Mayor of London’s International Business Advisory Council. Educational background: Mr. Chu graduated with a LL.B. from the University College London where he is now a Honorary Fellow. He was awarded the 2011 Global Economy Prize by the Kiel Institute for the World Economy.
Rafael del Pino (1958), Spanish Citizen Member of the Board Skills and experience: Mr. del Pino possesses more than 30 years of international management experience. He began his career with Ferrovial before becoming a consultant with Boston Consulting Group in Paris and returned in 1986. From 1992 to 1999, he was CEO of Grupo Ferrovial and in 1999, he was appointed executive vice-chairman. In 2000, Mr. del Pino assumed the position of executive chairman and managing director of Ferrovial S.A. During his career at Ferrovial he has transformed the company from a mostly domestic construction company to a leading provider of infrastructure services around the world. In addition, Mr. del Pino was a member of the board of Banesto (Banco Español de Crédito S.A.) from 2003 to 2012.
Thomas K. Escher (1949), Swiss Citizen Member of the Board Skills and experience: Mr. Escher has extensive experience in the fields of information technology and banking. He joined IBM in 1974 and had managerial responsibility for several international markets. In 1996, Mr. Escher joined Swiss Bank Corporation as a member of the executive board and was CEO for the major market region in Switzerland and for the information technology organization. Following the merger of Swiss Bank Corporation and Union Bank of Switzerland to form UBS AG in 1998, he headed the IT business area of the wealth management and business banking division until mid-2005 as a member of the group managing board.
Mr. Escher assumed the function of vice-chairman in the Business Group Global Wealth Management & Swiss Bank of UBS AG in 2005. Committee membership: Remuneration Committee (Chairperson) Other directorships within the Group: Zurich Insurance Company Ltd External appointments: Mr. Escher has been a member of the board of directors of Silent-Power AG of Cham, Switzerland, a company in the alternative energy field, since 2012. Educational background: Mr. Escher graduated in electrical engineering and in Business Administration from the Swiss Federal Institute of Technology (ETH).
Fred Kindle (1959), Citizen of Liechtenstein and Switzerland Member of the Board Skills and experience: Mr. Kindle possesses broad professional experience, acquired in various roles. He began working as a marketing project manager with Hilti AG in Liechtenstein from 1984. From 1988 until 1992, he was a consultant with McKinsey & Company in New York and Zurich. He then joined Sulzer Chemtech AG in Switzerland as the head of the Mass Transfer Department and in 1996 became the head of the Product Division. In 1999, he was appointed CEO of Sulzer Industries, one of the two operating groups of Sulzer AG. Two years later he became CEO of Sulzer AG, where he also served as a board member. After joining ABB Ltd. in 2004, Mr. Kindle was appointed CEO of ABB Group in January 2005, a position he held until February 2008. He then became a partner of Clayton, Dubilier & Rice LLP, a private equity firm based in New York and London. Committee membership: Audit Committee Other directorships within the Group: Zurich Insurance Company Ltd External appointments: In his capacity as a partner of Clayton, Dubilier & Rice, Mr. Kindle has served as a chairman of Exova Ltd., Scotland since 2008, chairman of BCA Group, United Kingdom since 2010 and as a director of Rexel SA, France since 2009. He has also been on the board of VZ Holding Ltd., Zurich since 2002 and Stadler Rail AG, Bussnang since 2008. Educational background: Mr. Kindle graduated from the Swiss Federal Institute of Technology (ETH) in Zurich with a master’s degree in engineering and holds an MBA from Northwestern University, Evanston, United States.
Armin Meyer (1949), Swiss Citizen Member of the Board Skills and experience: Mr. Meyer has an extensive management track record, acquired at international industrial organizations. He joined BBC Brown Boveri in 1976 as a development engineer and became head of research and development for industrial motors in 1980. He took over as head of the international business unit for electrical power generators in 1984. Mr. Meyer became president of ABB Drives Ltd. in 1988 and president of ABB Power Generation Ltd. in 1992. From 1995 until 2000, he was executive vice-president of ABB Ltd. and a member of that group’s executive committee. In 1997, he became a member of the board of directors of Ciba Specialty Chemicals at the time of its spin-off from Novartis. He became chairman of the board of Ciba Specialty Chemicals in autumn 2000 and served in that role until April 2009. From January 2001 until December 2007, he also acted as chief executive officer. Mr. Meyer was a member of the executive committee and the foundation board of the international Institute for Management Development, IMD, in Lausanne, Switzerland until December 2011. From 2001 to 2008, he was a member of the European Chemical Industry Council (Cefic) in Brussels, Belgium. Committee membership: Governance and Nominations Committee, Risk Committee Other directorships within the Group: Zurich Insurance Company Ltd External appointments: Mr. Meyer became a member of the board of directors of Amcor Limited in Melbourne, Australia in 2010. Educational background: Mr. Meyer graduated with a PhD in electrical engineering from the Swiss Federal Institute of Technology (ETH).
Committee membership: Audit Committee (Chairperson), Risk Committee Other directorships within the Group: Zurich Insurance Company Ltd, Zurich Holding Company of America, Inc. External appointments: Mr. Nicolaisen has been a member of the board of directors of Verizon Communications Inc. since 2005, Morgan Stanley since 2006 and MGIC Investment Corporation since 2006. In addition, he serves on the board of advisors for the University of Southern California Leventhal School of Accounting. Educational background: Mr. Nicolaisen graduated from the University of Wisconsin-Whitewater with a BBA degree.
Elections and terms of office The articles of incorporation require that the Board shall consist of not fewer 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. According to the Group’s internal guidelines, in general, the maximum tenure of Board members may not exceed twelve years and no individual of 70 years of age or older shall be nominated or stay in office as a Director, although exceptions may be made under special circumstances.
At the Annual General Meeting on March 29, 2012, Messrs. Ackermann, Escher and Nicolaisen were re-elected to the Board for a term of three years and Ms. Alison Carnwath and Mr. Rafael del Pino were elected to the Board for a term of two years.
The Board consists entirely of Directors who are non-executive, independent from the Management and who have never held an executive position in the Group. The Governance and Nominations Committee annually reviews the independence of the Board members and reports its findings to the Board for final determination. Board members are also subject to rules and regulations to avoid conflicts of interest and the use of inside information.
Given the separation of roles of the Chairman and the CEO and the fact that the Board entirely consists of nonexecutive members, there is no requirement for a lead director to be appointed under the Swiss Code of Best Practice.
The Board elects the Chairman and the Vice-Chairman from its members and appoints the Secretary.
The Board is required to meet at least six times each year. During 2012 it held 10 meetings (of which seven were partly attended by tele-/videoconference and one was held over two days). One meeting was fully dedicated to the discussion of strategic topics. Five meetings lasted four or more hours during the course of a day, four meetings took about three hours on average and one meeting lasted about half an hour. In addition, the Board approved one circular resolution.
From 2010 to 2012, Ms. Mächler chaired the Technical Committee of the International Association of Insurance Supervisors (IAIS). She has been a member of several Swiss federal expert commissions on regulatory projects and is regularly speaking, lecturing as well as publishing on international business law and regulation and their impact. External appointments: Ms. Mächler has been a member of the Supervisory Board of Directors of Deutsche Börse AG since May 2012. Educational background: She earned her JD at the University of Zurich’s Law School and attended programs on UK, U.S. and private international law. Monica Mächler is admitted to the bar of the Canton of Zurich.
The Board is responsible for the ultimate management of Zurich Insurance Group Ltd and, to the extent legally permissible, of the Group as well as for the supervision of the Management. In particular, it is responsible for taking actions in the following areas: • Group Strategy: The Board regularly reviews and discusses in particular the Group’s business portfolio including its target market, acquisition, customer and intermediaries strategy and its HR strategy; • Finance: The Board particularly approves the financial and operating plan annually, establishes guidelines for capital allocation and financial planning. Further, the Board reviews and approves the annual and interim consolidated financial statements of Zurich Insurance Group Ltd and the Group. Above certain thresholds, the Board approves major lending and borrowing transactions; • Structure and Organization of the Group: The Board determines and regularly reviews the basic principles of the Group’s structure and major changes in the Group’s management organization including major changes of management functions. In this respect, the Board particularly discusses the Group’s corporate governance framework and its remuneration system. The Board also adopts and regularly reviews the basic principles of conduct, compliance and risk management for the Group. Further, as part of its duty to convene the shareholders’ meeting and submit proposals to the shareholders’ meeting, it discusses the dividend policy and the Board’s proposal for the payment of dividends. Within its authorities the Board also resolves on capital increases and the certification of capital increases and respective amendments to the articles of incorporation; • Business Development: Above certain thresholds, the Board regularly discusses and approves acquisitions and disposals of businesses and assets, investments, new businesses, mergers, joint ventures, co-operations and restructurings of business units or books of businesses.
Besides discussing the above-mentioned matters on a regular basis, in 2012, the Board specifically focused on the following areas: • risk management and investment management in the light of the Eurozone crisis; • the consequences of the low interest environment on inter alia the product mix in the Global Life segment and investment management; • regulatory developments regarding liquidity, capital requirements and solvency management; • developments with regard to corporate governance and remuneration-related matters, their potential effect on Zurich and corresponding preparatory measures.
The Board may appoint committees for specific areas from among its members and establish terms of reference and rules with respect to delegated tasks and responsibilities and reporting to the Board. The committees assist the Board in performing its duties. They discuss and propose matters to the Board to take appropriate actions and pass resolutions unless they are authorized to take resolutions in specific areas on their own. In 2012, committee meetings lasted between one and three hours on average.
Governance and Nominations Committee Composition and membership: The Governance and Nominations Committee consists of at least four Board members. Currently, Messrs. Josef Ackermann (Chairperson), Armin Meyer, Tom de Swaan and Victor L.L. Chu serve on this committee.
• developments with regard to corporate governance related matters and their potential effect on Zurich; • succession planning for the Board resulting in its recommendation to the Board to nominate Ms. Monica Mächler for election at the Annual General Meeting on April 4, 2013; • management succession planning, including a review of the leadership team and talent and diversity management; and,
Remuneration Committee Composition and membership: Zurich Insurance Group Ltd’s Organizational Rules require the Remuneration Committee to consist of at least four non-executive Board members. Currently, Messrs. Thomas Escher (Chairperson), Josef Ackermann, Rafael del Pino and Ms. Alison Carnwath serve on this committee.
• evaluates regularly the Group’s remuneration system and the Remuneration Rules and, if appropriate, proposes respective amendments to the Board which is responsible for the design, implementation and monitoring of the Group’s remuneration architecture.
Activities 2012: During 2012, the Remuneration Committee met seven times – attendance at meetings was 100 percent. It particularly discussed
• serves as a focal point for communication and oversight regarding financial accounting and reporting, internal control, actuarial practice and compliance; • reviews the Group’s auditing process (including establishing the basic principles relating to and making proposals with respect to the audit of Zurich Insurance Group Ltd and the Group); • at least annually, reviews the standards of internal control, including the activities, plans, organization and the quality of internal audit and Group Compliance. For statements regarding internal control and the procedures in place regarding internal control according to the Internal Control: Revised Guidance to Directors on the UK Corporate Governance Code (formerly known as UK Turnbull Guidance) as of October 2005 see pages 53 and 54; and,
• accounting policy changes (for example IFRS 10 which will be adopted in 2013); • reserving policies and matters; • the effectiveness of the internal control framework; • Group Audit work plans, Group Audit findings and management implementation of remediation actions; • the work of the external auditors, the terms of their engagement and the external auditor’s findings on key judgments and estimates in financial statements; and,
To facilitate an ongoing exchange of information between the Risk Committee and the Audit Committee, the Chairperson of the Audit Committee is a member of the Risk Committee and a member of the Risk Committee is a member of the Audit Committee. The Chairman of the Board regularly participates in both the Audit and Risk Committee meetings as a guest.
• in the annual joint meeting with the Remuneration Committee risk management aspects of the Group’s remuneration architecture.
Moreover, from a segment and regional risk perspective, the Risk Committee dealt with: • General Insurance risks and controls, in particular reinsurance program aspects and catastrophe accumulation management; • Global Life risks and controls such as product approvals/new products and limits; • investment and asset/liability management risks and controls; and,
• on the occasion of deep-dive sessions, risks and controls from a regional and business specific perspective, for instance the Eurozone contingency planning and Zurich North America and Latin America in general.
The internal audit function, the external auditors and the compliance function also assist the Board in exercising its controlling and supervisory duties. Information on major areas of activities of these functions is set out on pages 51 to 53.
Group General Counsel 5 Kevin Hogan Chief Executive Officer Global Life 6 Michael Kerner 3
The GEC is headed by the CEO. As of December 31, 2012, members of the GEC included the Chief Financial Officer, the Chief Investment Officer, the Chief Risk Officer, the Group Head of Operations and the Group General Counsel; in order to reflect both, lines of business and geography, the CEOs of the business segments General Insurance, Global Life and Farmers, as well as the CEO of North America Commercial are also members of the GEC. Further, members of the GEC also act as the Regional Chairmen of Europe, North America and Asia-Pacific and Middle East.
Key tasks and responsibilities: • acts as a cross-functional body for financial and risk management matters in the context of the strategy and the overall business activity of the Group; • oversees financial implications of business decisions and the effective management of the Group’s overall risk profile, including risks related to insurance, financial markets, asset/liability management, credit and operational risks and the interaction among these risks; and,
The Group Reinsurance Committee, chaired by the Global Head of Group Reinsurance, leads the reinsurance business process of the Group and is responsible for defining and executing the Group’s reinsurance strategy in alignment with the Group’s risk framework. It also governs the reinsurance activities among the segments and ensures that they have access to needed re-insurance capacity at economic terms.
Panels To enhance its understanding and assessment of the challenges and risks Zurich may face, the Group continues to seek external expertise and perspective. As of the end of 2012, the Group had three panels of leading academics, business and industry experts to provide feedback and insight. They are not corporate bodies of the Group and have no decision-making powers. These panels provide expertise and advice to senior management or certain functions of the Group. In particular, the International Advisory Council is mandated to provide an external perspective and expertise to the CEO and to members of the GEC on the Group’s growth and public policy strategies. The Investment Management Advisory Council offers feedback on Zurich’s investment results and strategy and on achieving superior risk-adjusted returns relative to the liabilities for the Group’s invested assets. The Natural Catastrophe Advisory Council provides insight into the patterns of occurrence, predictability and destructiveness of catastrophes and feedback about Zurich’s approach to such catastrophes in order to help improve the effectiveness of its underwriting and reinsurance purchasing.
External appointments: Mr. Senn serves in a senior capacity with numerous business and industry organizations, including Avenir Suisse, the Zurich Association of Economics, the Swiss-American Chamber of Commerce, the Geneva Association and the Institute of International Finance (IIF). Besides that, he is a representative of the Property and Casualty CEO Roundtable, a member of the Pan European Insurance Forum (PEIF), the European Financial Services Roundtable (EFR), the advisory board of Tsinghua School of Economics and Management and of the international advisory board of the Atlantic Council. Mr. Senn is also a member of the board of trustees for the Lucerne Festival and serves as a Honorary Consul of the Republic of Korea in Zurich. Educational background: Mr. Senn received a Commercial and Banking diploma from the Business School in Basel, Switzerland and completed an International Executive Program at INSEAD in Fontainebleau as well as an Advanced Management Program at Harvard Business School.
Jeff Dailey (1957), U.S. Citizen CEO of Farmers Group, Inc. Skills and experience: Mr. Dailey has extensive experience within the insurance industry. In 1980, he began his career with Mutual Service Insurance Company and also worked for Progressive Insurance Company. He went on to form Reliant Insurance Company, an auto insurance start-up owned by Reliance Group Holdings, which was sold to Bristol West Holdings Inc. in 2001. From 2001 until 2004, Mr. Dailey was COO of Bristol West and, in 2004, he was named President of Bristol West, following the firm’s IPO on the New York Stock Exchange. In 2006, he became CEO of Bristol West. Mr. Dailey joined Farmers in 2007 as President of Personal Lines for
Farmers when Farmers acquired Bristol West where he served as Bristol West CEO. In January 2011, he was promoted to the position of President and Chief Operating Officer (COO) of Farmers Group, Inc. He became a member of the Board of Farmers Group, Inc. in February 2011. Mr Dailey was appointed to his current role of CEO of Farmers Group, Inc. and became a member of the GEC in January 2012. External appointments: None Educational background: Mr. Dailey graduated from the University of Wisconsin-Madison with a bachelor’s degree in Economics and has an MBA from the University of Wisconsin-Milwaukee.
Mike Foley (1962), U.S. Citizen CEO North America Commercial and Regional Chairman of North America Skills and experience: Mr. Foley joined the financial management training program of Armtek Corporation in New Haven, Connecticut, in 1984. After graduating from Kellogg in 1989, Mr. Foley joined the Deerpath Group in Lake Forest, Illinois, as an associate. He later became vice president responsible for managing a portfolio of equity investments in various acquired businesses. In 1993 he joined Electrocal, Inc. in Connecticut as president. In 1996, Mr. Foley joined McKinsey & Company in Chicago, Illinois, where he later became a principal and led its North American property/casualty insurance practice. He joined Zurich in 2006 as Chief Operating Officer of its North America Commercial business division and in January 2008 was appointed CEO of that division and a member of the GEC. Mr. Foley is also the Regional Chairman of North America and Chairman of the Board of Zurich Holding Company of America, Inc. (ZHCA). External appointments: Mr. Foley has been chairman of the Board of the American Insurance Association since 2012. Educational background: Mr. Foley graduated with a Bachelor of Science from Fairfield University, in Fairfield, Connecticut in 1984 and a Masters degree from the JL Kellogg Graduate School of Management at Northwestern University in Evanston, Illinois in 1989.
Kevin Hogan (1962), U.S. Citizen CEO Global Life Skills and experience: Kevin Hogan started his career in 1984 at AIG with American International Underwriters (AIU) in New York and subsequently held management positions in Chicago, Tokyo, Hong Kong and Singapore. In 1998, he was appointed president of AIG’s Accident & Health Division in New York and was elected an AIG vice president in 2001. In 2002, he also became chief operating officer at AIU. Mr. Hogan moved to Beijing as a senior executive of AIG’s partnership with the People’s Insurance Company of China in 2003. In 2005, he became AIG’s senior life division executive for China and Taiwan, where he was responsible for AIA China and
Nan-Shan. In 2008, he returned to New York as AIG’s Chief Distribution Officer, Foreign Life and Retirement Services. He joined Zurich in December 2008 as CEO Global Life Americas. In this role he led Zurich’s Life insurance business in North and South America with accountability for Farmers Life, Zurich American Life Insurance Company (formerly KILICO) and Zurich’s Latin America Life Operations. He became CEO Global Life and member of the GEC in July 2010. External appointments: Mr Hogan has served as a Vice-Chairman of the WEF Global Agenda Council on Social Security Systems since 2012. Educational background: Mr. Hogan is a graduate of Dartmouth College in Hanover, New Hampshire.
Michael Kerner (1965), U.S. Citizen CEO General Insurance Skills and experience: Mr. Kerner joined Zurich in 1992 from the Continental Insurance Company and since then he has held a number of senior executive positions. These include Chief Operations Officer for Zurich North America Specialties and Head of Ceded Reinsurance for Zurich North America from 2002 to 2005. From January 2006 to June 2007, he served as the Global Head of Group Reinsurance and between 2007 and 2009, Mr.
Pierre Wauthier (1960), French and British Citizen Chief Financial Officer Skills and experience: Mr. Wauthier began his career in 1982 at KPMG. He then worked for two years at the French Ministry of Foreign Affairs. He joined J.P. Morgan in Paris in 1985 and held various senior positions. In 1994, he joined J.P. Morgan’s office in London as Vice-President and was responsible for the Insurance Product Group. Mr. Wauthier joined Zurich in 1996 as Corporate Credit and Investment Risk Manager, served from 1999 to 2002 as Head of Investor Relations and Rating Agency Management and became Executive Vice-President and Chief Financial Officer of Zurich’s wholly owned subsidiary Farmers Group, Inc. in 2002. In 2007, he became Group Treasurer and in 2010 Head of Centrally Managed Businesses. He assumed his current role in October 2011. External appointments: Mr. Wauthier has been a member of the European Insurance CFO Forum since 2011. Educational background: Mr. Wauthier holds a Masters in International Finance from l’Ecole des Hautes Etudes Commerciales in Paris and a master’s degree in Private Law from the Sorbonne University in Paris.
Shareholders’ participation rights Voting rights restrictions and representation Each share entered into the share register entitles the holder to one vote. There are no voting right restrictions.
Furthermore, authority of representation may be given to the independent voting proxy, to a statutory representative or to a bank as the proxy holder of deposited shares who do not need to be shareholders themselves. In addition, for the first time Zurich offers to its shareholders the option to give voting instructions for the AGM 2013 via the online platform Sherpany. All shareholders that signed and returned the respective Sherpany account opening form by February 17, 2013 will be able to use this online option starting on March 8, 2013 to electronically mandate either the independent voting proxy or the company proxy to vote on their behalf at the AGM 2013. New shareholders and those that missed to enroll this year will have the opportunity to register in the coming years.
Statutory quora Pursuant to the articles of incorporation, the shareholders’ meeting constitutes a quorum irrespective of the number of shareholders present and shares represented. Resolutions and elections generally require the approval of a simple majority of the votes cast, 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 a change of the company purpose and domicile, a dissolution of the company and matters relating to capital increases. In the event of the votes being equally divided, the decision rests with the Chairman of the Board.
Convocation of shareholders’ meetings Shareholders’ meetings are convened by the Board or, if necessary, by the auditors and other bodies in accordance with the provisions set out in articles 699 and 700 of the Swiss Code of Obligations. Shareholders with voting rights representing at least 10 percent of the share capital may call a shareholders’ meeting, indicating the matters to be discussed and the corresponding proposals. The invitation to shareholders is mailed at least 20 calendar days before the meeting is held and, in addition, is published in the Swiss Official Gazette of Commerce and in several newspapers.
Zurich Insurance Group Ltd maintains a regular dialogue with investors through its Investor Relations department and responds to questions and issues raised by institutional and private individual shareholders. In addition, Zurich Insurance Group Ltd organizes investor days for institutional investors and analysts to provide comprehensive information on its businesses and strategic direction. Such presentations can be followed via webcast or conference call. In 2012, the investors’ day was held in Zurich on November 29, focused on progress on the delivery of the Group’s 2013 targets and included presentations by the CEO and the CEOs of the business segments. The CFO provided an update on capital and cash flows and the CFO of the Global Life segment provided insights into life business cash flows. Finally, the management team for Latin America presented the business opportunities in their region. Another investor day is planned for 2013. A wide range of information on the Group and its businesses, including the aforementioned results reporting documents and the full documentation distributed at investor days, is also available on the Investor Relations section of Zurich’s website www.zurich.com (
Zurich Insurance Group Ltd will hold its Annual General Meeting on April 4, 2013. The meeting will be conducted in the Hallenstadion in Zurich-Oerlikon. An invitation setting out the agenda for this meeting and an explanation of the proposed resolutions will be issued to the shareholders at least 20 days before the meeting.
Employees The Group is committed to provide equal opportunities when recruiting and promoting people, whereby ability, experience, skills, knowledge, integrity and diversity are the guiding principles. The Group actively encourages employee involvement in its activities through printed and online publications, team briefings and regular meetings with employees’ representatives. Further, the Group is party to a voluntary agreement with employee representatives of the Group’s companies in Europe. For further information on the Group’s people management activities, see the Annual Review starting on page 12, also available on Zurich’s website www.zurich.com ( sitecollectiondocuments/financial-reports/annual-review-2012-en.pdf).
Clauses on changes of control Employment agreements have been entered into with members of the GEC, setting out the terms and conditions on which they are employed. The longest notice period for members of the GEC is 12 months. No other benefits are provided in the case of a change of control.
These regulations provide that in the case of a change of control, the Plan Administrator (the Remuneration Committee or the CEO, as applicable) has the right to roll over the existing share obligations into new share rights or to provide consideration for such obligations that are not rolled over. Participants who lose their employment as a result of a change of control have the right to the vesting of share obligations. No other benefits are provided to members of the Group’s senior management in case of a change of control.
Assurance at Zurich Insurance Group At Zurich, various governance and control functions coordinate to help ensure that risks are identified and appropriately managed and internal controls are in place and operating effectively. This coordination is referred to as “integrated assessment and assurance”. The Board is ultimately responsible for the supervision of these assurance activities. Although, each assurance provider maintains its distinct mandate and responsibilities, the assurance providers are closely aligned and co-operate with each other through a regular exchange on information, planning and other activities. This approach supports management in its responsibilities and provides confidence that risks are appropriately taken care of and that adequate mitigation actions are implemented.
Group Compliance is responsible for providing assurance to management that compliance risks within its mandate are appropriately identified and managed. The Group Compliance Officer regularly reports to the Audit Committee and has also an additional reporting line to the Chairman of the Audit Committee and appropriate access to the Chairman of the Board.
Independent Assurance: Group Audit is responsible for auditing risk management, control and governance processes. The Head of Group Audit regularly meets with the Chairman of the Board and attends each meeting of the Audit Committee.
External Auditors Duration of the mandate and term of office of the auditor-in-charge PricewaterhouseCoopers AG, Birchstrasse 160, in 8050 Zurich (PwC), is Zurich Insurance Group Ltd’s external auditor.
Audit fees Total audit fees (including expenses and value added taxes) charged by PwC in the year 2012 amounted to USD 43.9 million (USD 38.0 million in 2011).
Total non-audit fees 6.4 4.6 – Tax advice 0.8 0.5 – Legal advice 0.0 0.0 – Transaction consulting incl. due diligence 0.1 0.1 – Audit-related advice 4.0 2.3
Supervision and control over the external audit process The Audit Committee regularly meets with the external auditors, at least four times a year. During 2012, the Audit Committee met with the external auditors seven times. The external auditors regularly have private sessions with the Audit Committee without Management present. Based on written reports, the Audit Committee discusses 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 of internal financial controls, applicable accounting principles and management reporting systems. In connection with the audit, the Audit Committee obtains from the external auditors a timely report relating to the audited financial statements of Zurich Insurance Group Ltd and the Group.
The Audit Committee proposes to the Board the external auditors for election by shareholders and is responsible for approving the audit fees. A proposal for fees for audit services is submitted by the external auditors to and validated by Management, before it is submitted to the Audit Committee for approval. Such a proposal is mainly based on an analysis of existing reporting units and expected changes to the legal and operational structure during the year.
Group Audit The internal audit function of the Group (Group Audit) is tasked with providing independent and objective assurance to the Board, the Audit Committee, the CEO and Management and to the boards and audit Committees of subsidiary companies. This is accomplished by developing a risk-based plan which is updated continuously as the risks faced by the business changes. The plan is based on the full spectrum of business risks including concerns and issues raised by the Audit Committee, Management and other stakeholders. Group Audit executes the plan in accordance with defined operating standards, which incorporate and comply with the International Standards for the Practice of Internal Auditing, issued by the Institute of Internal Auditors (IIA). Key issues raised by Group Audit are communicated to the responsible management function, the CEO and the Audit Committee using a suite of reporting tools.
The Audit Committee, boards and audit committees of subsidiary companies and CEO are regularly informed of important audit findings, including ineffective opinions, mitigation actions and attention provided by Management. Group Audit is responsible for ensuring that issues that could impact the Group’s operations are brought to the attention of the Audit Committee and appropriate levels of management and that timely follow up action occurs. This is supported by the attendance of the Head of Group Audit at each meeting of the Audit Committee.
The Audit Committee approves the Group Audit Plan annually, reviews reports from the function on its activities and significant risk, control and governance issues, at least every quarter. The Head of Group Audit reports functionally to the Audit Committee and administratively to the CEO and regularly meets with the Chairman of the Board. Group Audit has no operational responsibilities over the areas it reviews and, to ensure independence, all Group Audit staff globally report (via audit managers) to the Head of Group Audit.
The Group’s compliance function consisting of compliance professionals around the world is overseen by the Group Compliance Officer who reports to the Group General Counsel and regularly reports to the Audit Committee. The Group Compliance Officer has an additional reporting line to the Chairman of the Audit Committee and appropriate access to the Chairman of the Board.
• the Risk Committee – with oversight over risk management; and
Local management, led by the legal entity CEO, is responsible to maintain appropriate controls in place and to appropriately identify and address risks. They meet frequently with risk management and other assurance functions to ensure an effective system of risk identification and mitigation and maintenance of sound internal controls. In addition, regular review of reporting by risk and other assurance functions is carried out by (1) subsidiary boards or subsidiary board audit committees and, additionally, (2) regional oversight committees that oversee subsidiaries in Latin America, Asia Pacific, Middle East and parts of Europe. The subsidiary board audit committees comprise directors of the legal entities concerned, including in some instances, independent non-executive directors. The regional oversight committees include a majority of independent members from Group executive management who do not have a direct or indirect operating responsibility for the business carried out by the relevant subsidiary. In addition, assurance providers participate as attendees. The results of such reviews are reported to the Group CEO, the Risk, and the Audit Committees of the Board as well as the Board, as appropriate.
Processes and controls in the organization are subject to risk-based reviews by Management, Group Audit, Group Compliance and Group Risk Management. Management reviews include the effective implementation of policies and procedures including claims, investment, underwriting, actuarial, treasury, accounting and reporting, as well as effectiveness of control for significant operations and information technology systems. The Board, the Audit and Risk Committees of the Board receive regular and, as needed, special reports from the Chief Risk Officer, Group General Counsel, Head of Group Compliance, Group Chief Financial Officer and Group Controller, Head of Group Audit and financial and business senior management. In addition, the external auditors regularly report their conclusions, observations and recommendations arising from their independent audit process.
The reports relate to matters such as a) significant changes in risks, the business and the external environment; b) management’s monitoring of risks and the effectiveness of control systems; c) risk and control monitoring communications; d) significant control issues, if any; and e) the effectiveness of the Group’s external reporting process.
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.
In 2012, the Board of Directors continued to oversee and take decisions on the design and implementation of the remuneration principles, rules and architecture. The previous assessment that these are aligned with the delivery of the Group’s strategy and reflect current international best practices in terms of governance, plan design, and disclosure continues to be confirmed. The Group’s remuneration architecture is simple, transparent and market competitive, promotes a high performance culture, is aligned with our risk management principles and has an orientation towards the long-term for Key Risk Takers.
Zurich Insurance Group Annual Report 2012 57Remuneration report 2012 Remuneration summary
Zurich operates a balanced and effectively managed remuneration system which is aligned with risk-considerations and provides for competitive total remuneration opportunities that attract, retain, motivate and reward employees to deliver outstanding performance. Total remuneration for an individual employee is influenced by factors including the scope and complexity of the role, business performance and affordability, individual performance, internal relativities, external competitiveness and legal requirements. Target opportunities are benchmarked to median levels in clearly defined markets and take into account the internal structures. Depending on the role, the relevant market can be global, regional or local and will reflect practices in either the insurance, the financial services or the general industry.
To further align their interests with those of shareholders, the Board and the GEC build their ownership position in the company. As of December 31, 2012, Directors held 65,620 shares and members of the GEC held 118,899 shares and 439,520 options. Share ownership guidelines are in place and these are discussed further on page 62. To meet the share obligations under the share-based compensation plans, Zurich issued 914,301 new shares in 2012, and 798,926 new shares in 2011. Further details on the dilution impact of the share-based compensation plans are set out on page 60.
Summary of further key remuneration aspects in 2012 In addition to the remuneration context and outcomes described, further key aspects for 2012 are outlined below: • The remuneration system as set out in the Remuneration report for 2011 was subject to a non-binding advisory shareholder vote at the Annual General Meeting on March 29, 2012 with 84.8 percent votes in favor. • Following the retirement of Mr. Manfred Gentz and Mr. Vernon Sankey in March 2012, the Annual General Meeting approved the election of Ms. Alison Carnwath and Mr. Rafael del Pino to the Board. The two new members replaced the leaving members and joined Mr. Josef Ackermann and Mr. Thomas Escher on the Remuneration Committee. Mr. Thomas Escher was appointed as the new Chairman of the Remuneration Committee in 2012.
• The Committee reviewed the performance measurements under the short- and long-term incentive plans for 2012. • With regard to the KRT positions, the criteria and processes used for the identification and performance assessment of those positions were reviewed and improved. In particular, additional processes were implemented to include risk-based factors in the performance assessment of KRTs. The Group has expanded the number of KRT positions.
Remuneration highlights in USD million, for the year ended December 31Key financial figures
The structure of the Remuneration report is in alignment with the requirements of the Swiss Code of Obligations, the SIX Directive, the Swiss Code of Best Practice and the FINMA Circular on Remuneration Schemes.
The first part of the report describes the general principles and the governance framework, and the second part provides details of each of the remuneration elements. The members of the Board of Zurich Insurance Group Ltd are all independent non-executives, therefore the information has been presented with the complete remuneration details of the Board contained in one section, those of the GEC shown in the next section, and then by a section including the information required by the FINMA Circular on Remuneration Schemes for all employees.
Remuneration governance Remuneration architecture The Board is responsible for the design and implementation of Zurich’s remuneration principles and remuneration rules (together the “Remuneration Rules”). To support the Board in performing these duties it has established a Remuneration Committee. The Remuneration Committee comprises four members of the Board, all of whom are experienced in the area of remuneration. On an annual basis the Remuneration Committee evaluates the remuneration architecture and the Remuneration Rules and proposes to the Board any amendments to them, if appropriate.
During 2012, the Board continued to monitor the remuneration architecture and operational implementation, and a joint meeting of the Remuneration Committee and the Risk Committee was held in September 2012. Overall the Board continues to be firmly of the opinion that the existing remuneration architecture is aligned with the delivery of the Group’s strategy and reflects current international best practices in terms of governance, plan design and disclosure.
• A further meeting took place between the Remuneration Committee and the Governance and Nominations Committee to discuss potential implications of the “Minder Initiative” and the “Indirect Counterproposal”.
• During the annual process to help align remuneration with the Group’s risk-taking capacity, Group Risk Management consulted with other control, governance and assurance functions and provided the CEO with a review of risk factors to consider when overall performance for the funding of incentives was being assessed. The Chief Risk Officer is available to discuss these findings with the Remuneration Committee and the Board. Among other factors the CEO takes into account the assessment by Group Risk Management when presenting his proposals for the funding of the short-term and long-term incentive pools to the Remuneration Committee, which in turn makes its recommendation to the Board for final approval.
• With regard to the operational implementation of the remuneration architecture across the Group, Group Audit is carrying out a thorough assessment including a review of the implementation of Zurich’s Remuneration Rules.
• Further, information is also provided on the share dilution impact arising from the issuance of shares to meet the obligations under the Group’s share-based compensations plans. Zurich meets the share obligations arising from compensation plans by either issuing new shares from the contingent capital that has been authorized by the shareholders or by using Zurich shares purchased in the market.
In 2012, the company issued 914,301 shares (0.62 percent of capital based on 147,385,822 registered shares eligible for dividends as of December 31, 2011) to meet the share obligations arising from the vesting of shares and the exercise of share options during the year (in 2011, 798,926 shares or 0.54 percent of capital based on 146,586,896 registered shares eligible for dividends as of December 31, 2010).
As of December 31, 2012, the total number of unvested target shares was 886,483 which are made up from the grants made in 2010, 2011 and 2012. If these unvested shares vest at the 100 percent target level over the period 2013 to 2015, this would require the issuance of 0.60 percent of the share capital based on 147,385,822 registered shares eligible for dividends as of December 31, 2011.
As of December 31, 2012, the total number of vested but unexercised share options was 2,261,239. In addition, there were 243,345 unvested target options which are due to vest in April 2013. The exercise prices for these options range from CHF 198.10 to CHF 355.75. If all mentioned vested and unvested options were to be exercised in the future, the number of shares required represents 1.70 percent of the share capital which is based on 147,385,822 registered shares eligible for dividends as of December 31, 2011. If only those options in the money at December 31, 2012 (share price CHF 243.30) were exercised the number of shares required would be 255,683 or 0.17 percent of the share capital based on 147,385,822 registered shares eligible for dividends as of December 31, 2011.
In the meetings of the Remuneration Committee and the Board where decisions are made on the remuneration of the Chairman, the Chairman is not present. In making decisions on the remuneration of the CEO, the CEO is not present. Where decisions are made on the remuneration of other members of the GEC, those members are also not present at the meetings. The Remuneration Committee does not include any members who also serve on one or more boards of the Group’s subsidiaries. See page 26 in the Corporate governance report for further details of the Remuneration Committee’s responsibilities.
For Directors: Remuneration Committee For all employees: Remuneration Committee based on proposals by the CEO
In addition to the above, and in line with the requirements of the FINMA Circular on Remuneration Schemes, the Board also approves the aggregate amount of variable remuneration for the performance year for the entire Group (“Total Variable Remuneration Pool”) taking into account the long-term economic performance of the Group. For further details on the calculation of the Total Variable Remuneration Pool see pages 79 and 80.
Benchmark studies and external advisors to the Board To assist decision making on both Board and GEC remuneration, benchmarking studies are carried out regularly. To assess market practices and market remuneration levels, the remuneration structures and practices of the largest insurance companies are analyzed, using the companies in the Dow Jones Titan Insurance Index as a basis. This Index comprises the largest insurance companies throughout the world, predominantly in Europe and in the United States. This analysis is supplemented by additional benchmarking studies as appropriate, e.g. by reviewing practices within the large Swiss Market Index (SMI) companies in Switzerland or similar sized companies in other countries. The resulting industry peer group includes such companies as AXA, Allianz, AIG, Munich Re, Aviva, ING Group, Prudential Plc, Met Life, Aegon, Ace, Travelers Cos. Inc., Manulife Financial Corp., Prudential Financial Inc., and Swiss Re. The Remuneration Committee reviews this peer group regularly.
Involvement of shareholders As last year, Zurich will provide shareholders with the opportunity to express their views on the remuneration architecture through an advisory vote at the Annual General Meeting to be held on April 4, 2013. As the ultimate decision on remuneration is within the powers of the Board, such a vote is non-binding in nature.
Remuneration philosophy Directors Recognizing that Zurich is a global insurance company, the level of Directors’ fees has been established to ensure the Group’s ability to attract and retain high caliber individuals.
Zurich is committed to providing competitive total remuneration opportunities that attract, retain, motivate and reward employees to deliver outstanding performance. The remuneration philosophy is an integral part of the overall offering to employees. Zurich has a clearly defined global performance management process which supports the achievement of the overall business strategy and operating plans, and links individual pay with business and personal performance. This is delivered through the remuneration framework overseen by the GEC, the Remuneration Committee and the Board itself.
• The structure and level of total remuneration are aligned with the Group’s risk policies and risk-taking capacity.
• The Group links variable remuneration awards to key performance factors which can include the performance of the Group, the business segments, business divisions, business units, functions as well as individual achievements.
• The structure of the long-term incentive plans links remuneration with the future development of performance and risk by including features for deferred remuneration.
Vesting is determined based on the Group’s relative total shareholder return (TSR) and return on common shareholders’ equity (ROE) achievements over the three calendar years prior to the vesting date
• The actual funding for the STIP pool, as a percentage of the target pool, is assessed at the end of the performance year. The Board has approved a STIP performance grid, which links business performance to the potential size of the actual funding pool. Taking into account the relevant business performance and risk considerations, the CEO makes recommendations on the size of the various STIP funding pools to the Remuneration Committee, which then discusses and seeks approval from the Board.
• The allocation of the STIP funding pool to individual participants is then based on the size of the funding pool available, the results of the unit that the individual is working in and the performance achievements of the individual participant during the year. Any violations of internal or external rules or requirements by an individual are taken into account in the individual performance rating. The individual performance achievements are assessed through the Group’s performance management process. This process utilizes an individual rating scale between 1 and 5, with 5 being the highest rating, and a target distribution guideline for each of the ratings. This ensures that there is clear differentiation both in ratings and in STIP payments, based on personal performance.
• Depending on the size of the Group STIP funding pool and the individual performance rating, short-term incentive awards can vary between 0 percent and 200 percent of the individual target award level.
Deferral of the long-term incentives is achieved by: • pro-rata vesting of the long-term incentive grants in one third installments over the three years following the year of grant, and
Where the actual ROE lies in between the values in the table, the vesting percentage is determined by interpolating the figures in the above matrix. As an example, with the relative TSR in the second quartile and an average ROE of 14 percent over the three year period, the vesting percentage would be 117 percent of the target grant.
The right to modify individual awards to reflect specific circumstances is reserved for the CEO except for modifications regarding members of the GEC where such right is reserved for the Remuneration Committee and the Board. An adjustment of +/–25 percent to the regular vesting level may be applied before distribution. However, if performance under exceptional or unusual circumstances so warrants it, exceptions to the +/- 25 percent adjustment may be made. In this respect the company reserves the right to adjust and even set the vesting percentage to zero for an individual to reflect specific circumstances (e.g. in connection with a breach of internal or external rules) during the period prior to vesting, but any such adjustment is reserved exclusively for the Remuneration Committee and the Board.
The Group’s variable pay plans are reviewed annually both as to their content and participants. The plans can be terminated, modified, changed or revised.
Remuneration and shareholdings of the members of the Board and the Group Executive Committee As of December 31, 2012, all of the Directors of Zurich Insurance Group Ltd are non-executives, independent of management. The remuneration for Directors and for members of the GEC, as well as their shareholdings, is disclosed separately.
The following tables set out the fees paid to the Directors for 2012 and 2011 in CHF.
Total fees of which paid in cash 5 of which allocated in shares 4, 5
Total fees of which paid in cash 5 of which allocated in shares 4, 10 1 The remuneration shown in the tables is gross, based on the accrual principle and does not include any business-related expenses incurred in the performance of the Directors’ services.
3 Committee chairs receive an annual fee of CHF 30,000 (CHF 30,000 in 2011) and the chair of the Audit Committee receives an additional CHF 10,000 (CHF 10,000 in 2011). The committees on which the Directors serve and the chairs are set out in the Corporate governance report on page 26.
9 At the Annual General Meeting on March 29, 2012 Mr. Gentz and Mr. Sankey retired from the Board and Ms. Carnwath and Mr. del Pino were elected to the Board. Mr. Ackermann was appointed Chairman and Mr. de Swaan Vice-Chairman of the Board of Directors.
Special payments for new members of the Board At the Annual General Meeting on March 29, 2012, Ms. Carnwath and Mr. del Pino were elected new members of the Board. No special payments (i.e. “golden handshakes”) or other benefits were provided.
Share plans for Directors The members of the Board of Zurich Insurance Group Ltd and Zurich Insurance Company Ltd do not participate in any of the share-based incentive plans established for executive management. However, part of the fees of the Directors of Zurich Insurance Group Ltd is allocated as three-year sales restricted shares. As mentioned above, the shares provided to Directors are part of the overall fee and are not subject to the achievement of any defined performance targets.
Shareholdings of Directors The shareholdings of the Directors, who held office at the end of the year, in shares of Zurich Insurance Group Ltd are shown in the following table. All interests shown are beneficial and include sales restricted shares allocated to the Directors as part of their fee and shares held by parties related to the Directors.
J. Ackermann, Chairman 23,271 806 M. Gentz, Chairman n / a 6,868 T. de Swaan, Vice Chairman 2,079 1,529 S. Bies, Member 1,632 1,246 A. Carnwath, Member 292 n / a V.L.L. Chu, Member 1,632 1,246 R. del Pino, Member 292 n / a Th. Escher, Member 9,470 7,084 F. Kindle, Member 16,915 16,529 A. Meyer, Member 3,239 2,853 D. Nicolaisen, Member 1,915 1,529 V.L. Sankey, Member n / a 2,699 R. Watter, Member 4,883 4,497 1 None of the Directors together with parties related to them held more than 0.5 percent of the voting rights of Zurich Insurance Group Ltd shares as of December 31, 2012 or 2011, respectively.
Number of Zurich Insurance Group Ltd shares1, as of December 31Directors’ shareholdings
Additional honoraria and remuneration for Directors None of the Directors received any remuneration or benefits-in-kind from the Group or from any of the Group’s companies other than as set out above.
Personal loans for Directors Unrelated to his Board membership and on terms and conditions available to other customers, Mr. Watter had a collateralized policy loan in the amount of CHF 2.5 million outstanding as of December 31, 2012 and 2011. The annual interest rate charged on the loan is 4 percent. Other than the loan for Mr. Watter, none of the Directors had outstanding loans, advances or credits as of December 31, 2012 or 2011.
Base salaries and annual cash incentives paid for 2012 The total amount of base salaries and annual cash incentive awards earned under the Group STIP for 2012 was USD 24.3 million. This comprised USD 12.0 million in base salaries and USD 12.3 million in annual cash incentive awards to be paid in 2013 for 2012 performance. As set out on page 65 the annual cash incentive awards are determined individually and are performance based.
Equity grants made to members of the Group Executive Committee under the Group LTIP in 2012 As described above, in 2012 members of the GEC received an annual grant of performance shares under the Group LTIP. In extraordinary circumstances, restricted share grants may also be made. For members of the GEC, including the CEO, the value of the target grants in 2012 was set between 100 percent and 225 percent of each member’s base salary.
As in previous years, the target grants for 2012 were made on the third working day in April, i.e. on April 3, 2012. The target number of performance shares was calculated by dividing the monetary value of the grant by the share price on the day prior to the grant respectively.
The vesting of the grants and the performance criteria are set out on pages 66 to 67. The following equity grants under Group LTIP were made in 2012: Performance share grants The total number of target performance share grants made to members of the GEC during 2012 was 67,296. This compares with an equivalent figure of 63,787 made for 2011. The value of the target performance share grants made on April 3, 2012 to members of the GEC was USD 16.8 million at the date of grant based on the assumption of 100 percent vesting, a share price of CHF 225.90 on the day prior to the grant and a foreign exchange rate of 1 CHF = 0.90315 USD. For those members of the GEC who joined during 2012, the number and the value of the share grants is based on the grant for 2012 pro-rated for the time spent as a member of the GEC during the year.
Value of other remuneration paid in 2012 Members of the GEC received other remuneration in 2012 in relation to employee benefits, expatriate allowances, perquisites, benefits-in-kind and any other payments due under each member’s employment contract. The total value of other remuneration in 2012 was USD 2.0 million. Benefits-in-kind have been valued using market rates.
Summary of total remuneration for the Group Executive Committee By reference to the above figures, the total remuneration of the members of the GEC, comprising cash compensation, the value of target equity grants for 2012, pensions and the value of other remuneration was USD 46.4 million, for 2011 it was USD 50.3 million, divided as follows: Base salaries 12.0 12.7 Cash incentive awards earned for the year 12.3 14.0 Value of target performance share grants 4 16.8 16.8 Service costs for pension benefits 5 3.3 3.4 Value of other remuneration 6 2.0 3.4 Total in USD 7 46.4 50.3 Total in CHF 8 42.6 45.4 1 The remuneration shown in the table is gross, based on the accrual principle and does not include any business related expenses incurred in the performance of the members’ services.
7 In line with applicable laws where the executives are employed, Zurich paid the company-related portion of contributions to social security systems, which amounted to USD 1.7 million in 2012 and USD 2.2 million in 2011. Since the contributions are based on full earnings, whereas benefits are capped, there is not a direct correlation between the costs paid to the social security system and the benefits received by the executives.
Special payments for members of the Group Executive Committee who took on their functions during the year During 2012, three members were appointed to the GEC. No special payments (i.e. “golden handshakes”) or other benefits were provided to the new members.
Summary of total outstanding share commitments for members of the Group Executive Committee under the Group LTIP Share grants Performance share grants As of December 31, 2012, the total number of target performance share grants outstanding for members of the GEC under the Group LTIP was 98,257 (77,273 as of December 31, 2011). A summary of the outstanding grants as of December 31, 2012 is set out in the table below: Performance period
Under the share option program, the total number of shares under option for the members of the GEC as of December 31, 2012, and 2011, respectively, is set out in the tables below.
M. Senn, Chief Executive Officer 29,719 103,447 20,936 81,362 J. Dailey, CEO of Farmers Group, Inc. 3 2,373 14,987 n / a n / a M. Foley, Chief Executive Officer North America Commercial and Regional Chairman of the Americas 9,306 52,710 9,726 41,348 M. Greco, Chief Executive Officer General Insurance 4 n / a n / a 7,847 36,885 Y. Hausmann, Group General Counsel 5 3,728 7,301 n / a n / a K. Hogan, Chief Executive Officer Global Life 3,080 13,032 1,466 8,185 M. Kerner, CEO General Insurance 6 8,469 24,432 n / a n / a A. Lehmann, Chief Risk Officer and Regional Chairman of Europe 23,128 84,640 18,671 86,713 C. Orator, Chief Administrative Officer 7 n / a n / a 5,868 12,987 C. Reyes, Chief Investment Officer 4,823 22,012 2,555 15,123 G. Riddell, Regional Chairman of Asia-Pacific & Middle East 25,002 73,136 22,182 62,685 K. Terryn, Group Head of Operations 4,324 20,540 2,239 16,391 P. Wauthier, Chief Financial Officer 4,947 23,283 3,936 25,061 1 None of the GEC members together with parties related to them held more than 0.5 percent of the voting rights as at December 31, 2012 or 2011, either directly or through share options.
4 Mr. Greco left the function on June 4, 2012 and his employment contract terminated on July 31, 2012. 5 Mr. Hausmann was appointed to the GEC as of July 1, 2012.
The following tables show how the totals of the vested share options owned by members of the GEC are distributed according to the grants identified in the tables “Summary of outstanding options” as of December 31, 2012 and 2011, respectively.
Year of grant Total 1 Mr. Wauthier was appointed to the GEC as of October 1, 2011.
Trading plans To facilitate the sale of shares and the exercise of options for the members of the GEC, the Board approved the implementation of trading plans effective as of 2008. These plans allow members to sell shares and/or exercise share options under a pre-defined transaction program. Trading plans can only be established at a time when the individual does not possess unpublished price-sensitive information with regard to the Group. Further, the first transaction under a trading plan can only occur three months following the date it is established. The terms and conditions of the transactions have to be defined and they cannot be changed. All trading plans of members require the approval of the Chairman of the Board. Once established, transactions take place on a monthly basis including during close periods. The establishment of a trading plan by a GEC member is reported to the SIX Swiss Exchange according to the rules on disclosure of management transactions. In 2011, the Board approved the extension of the trading plan concept to selected executives who are often prohibited from being able to deal in Zurich securities because of the nature of their function. As of December 31, 2012, there were no trading plans in place. Further, no trading plans were entered into in 2012 and 2011 and the one trading plan that was entered into in 2010 ended in 2011.
All employees The following section includes information regarding the total remuneration earned by employees for the financial year 2012 across the Group, including remuneration for members of the GEC. The information provided is set out in accordance with the additional disclosure requirements defined in the FINMA Circular on Remuneration Schemes, applicable for the first time in 2010. The Group had 52,722 and 52,648 employees (full-time equivalents) as of December 31, 2012 and 2011, respectively.
Fixed remuneration Fixed remuneration comprises base salaries, other remuneration and service costs for pension benefits.
• The value of the target long-term incentive grants made during the year on the assumption that the grants will vest in the future at the 100 percent level.
2 Includes sign-on payments in shares. 3 The share grants will vest in the future according to achievement of defined performance conditions. The value of the shares assumes that the grant will vest in the future at 100 percent of the target level with the valuation of the target performance share grants based on the share price on the day prior to the grants (CHF 225.90 for 2012 and CHF 243.60 for 2011). The charges in the financial statements may be calculated on different vesting basis.
The total number of beneficiaries receiving variable remuneration is approximately 46,000 in 2012 (48,000 in 2011). For 2012, the Group STIP overall expenditure resulted in 91 percent of target and the Group LTIP vesting level for the three years 2010 to 2012 was set at 97 percent of target.
Total remuneration Combining the fixed and variable remuneration the total remuneration for all employees is as follows: Cash – fixed 4,036 4,025 Cash – variable1 474 482
Value of outstanding deferred remuneration The Group’s remuneration system includes instruments for the deferral of remuneration, and the following table provides an overview of the overall value of the outstanding deferred remuneration at December 31, 2012 and 2011: Unvested performance share grants 225 203 Unvested performance option grants 7 22 Unvested restricted share grants 7 6 Vested but sales restricted shares 140 143 Value of overall outstanding deferred remuneration 379 374 in USD million, for the year ended December 31Variable remuneration in USD million, for the year ended December 31Total remuneration in USD million, for the year ended December 31Value of outstanding deferred remuneration
Sign-on and severance payments for Key Risk Takers As mentioned above, the Group as a principle does not grant sign-on or severance payments. However, if circumstances in the Group’s interest warrant such payments, these can be approved through a clear governance process. With regard to the disclosure of sign-on and severance payments for the individuals considered to be KRTs for the Group, the following sign-on and severance payments were committed to this group of individuals in 2012 and in 2011: Amount
3 “Payments” in this respect include cash, shares, benefits, and incentives foregone with a previous employer or anything else of monetary value.
Global Life business operating profit 1,338 1,353 (1%) Global Life new business annual premium equivalent (APE) 4,030 3 3,992 1% Global Life new business margin, after tax (as % of APE) 22.1% 3 24.5% (2.5 pts) Global Life new business value, after tax 890 3 980 (9%)
Return on common shareholders’ equity (ROE) 11.8% 11.9% (0.2 pts) Business operating profit (after tax) return on common shareholders’ equity (BOPAT ROE) 9.3% 10.2% (0.9 pts)
3 Does not include any contribution from Zurich Santander or from the acquisition of Zurich Insurance Malaysia Berhad (ZIMB). 4 Calculated based on gross earned premiums of the Farmers Exchanges of USD 18.8 billion, which excludes the return of USD 74 million in premiums as a result of the anticipated settlement of a lawsuit with the State of Texas.
The Group delivered solid results and generated stable cash flows while maintaining its strong capital position. This enabled the Board of Directors to propose an attractive dividend of CHF 17.00 per share, demonstrating the Group’s sustained commitment to shareholder value.
The Group’s capital and solvency positions remain strong, underpinned by continued focus on risk management, in both its disciplined investment and underwriting strategies. Shareholders’ equity has increased by USD 3.0 billion to USD 34.5 billion since December 31, 2011, after recording the total cost of USD 2.8 billion for dividends paid in April 2012.
The strategic acquisitions towards the end of 2011 have now been integrated into the Group where Zurich Santander contributed USD 5.2 billion to the growth of gross written premiums and insurance deposits and a business operating profit of USD 165 million.
• General Insurance business operating profit decreased by USD 150 million to USD 2.1 billion, or by 7 percent in U.S. dollar terms and 5 percent on a local currency basis. Progress on strategic targets was reflected by an improvement in the underlying results, underpinned by disciplined underwriting and expense management. However, this improvement was offset by overall declining investment income and decreases in favorable development of reserves established in prior years, mainly in Germany.
• Global Life business operating profit remained broadly flat at USD 1.3 billion in U.S. dollar terms and increased by 5 percent on a local currency basis, with a positive contribution from Zurich Santander of USD 105 million net of non-controlling interests and earn-out charges. This was largely offset by a lower contribution from Europe, primarily as a result of one-off expenses in Germany included in special operating items. Other movements in sources of profit were largely neutral in aggregate, with improved risk and expense margins benefiting from the continued shift to protection and unit-linked products, offset by reductions in the investment margin due to lower investment yields.
• Farmers business operating profit decreased by USD 72 million to USD 1.4 billion, or by 5 percent, primarily due to a net underwriting loss incurred by Farmers Re. Farmers Management Services business operating profit of USD 1.4 billion increased by USD 71 million, or by 5 percent, mainly driven by the increase in gross earned premiums in the Farmers Exchanges, which are managed but not owned by Farmers Group, Inc., a wholly owned subsidiary of the Group. Farmers Re business operating profit deteriorated by USD 142 million to a loss of USD 26 million, mainly reflecting the absence of favorable development of loss reserves established in prior years compared with 2011 as well as weather-related losses that were once again well above historical levels. This was partially offset by a year over year improvement in the underlying loss ratio.
Business volumes for the core business segments, comprising gross written premiums, policy fees, insurance deposits and management fees, increased by USD 4.5 billion to USD 73.1 billion, or by 7 percent in U.S. dollar terms and 11 percent on a local currency basis. This growth arose as follows: • General Insurance gross written premiums and policy fees increased by USD 1.0 billion to USD 35.6 billion, or by 3 percent in U.S. dollar terms and 7 percent on a local currency basis, primarily as a result of rate increases. Selective and profitable growth remains the key focus area and leading premium indicators were favorable even as average rates increased by 4 percent. Overall premium growth was strong, particularly in International Markets through both organic growth and acquisitions, as well as in North America, while European results continued to be affected by lower levels of economic activity.
• Farmers Management Services management fees and other related revenues of USD 2.8 billion increased by USD 79 million, or by 3 percent, driven by the 3 percent increase in gross earned premiums in the Farmers Exchanges. The 24 percent increase to USD 4.4 billion in gross written premiums of Farmers Re reflected the changes in the All Lines quota share reinsurance agreement with the Farmers Exchanges (All Lines agreement) as well as the 3 percent gross written premiums growth in the Farmers Exchanges.
Business operating profit decreased by USD 349 million to USD 699 million, or by 33 percent driven by the deterioration in the underwriting result and lower levels of investment income. Lower investment income reflected lower yields and capital repatriation to the Group, which also reduced interest payable included in non-technical expenses, partially compensated by hedge fund gains in the U.S.
Business operating profit decreased by USD 259 million to USD 687 million, or by 27 percent in U.S. dollar terms and 27 percent on a local currency basis. The decrease was driven by lower investment income due to both lower yields and a reduced asset base, higher non-technical expenses related to one-off charges and lower net underwriting result.
Gross written premiums and policy fees decreased by USD 1.1 billion to USD 11.9 billion, or by 8 percent in U.S. dollar terms and 2 percent on a local currency basis. The lower volume was driven largely by the economic environment that remained challenging in many European countries and by actions taken on specific products in selected markets to improve overall profitability. These impacts were most visible in personal lines motor in the UK, Italy and Spain. Overall average rate increases of 3 percent were achieved in 2012.
Gross written premiums and policy fees 5,603 4,425 27% Net underwriting result 55 (265) nm Business operating profit 166 (156) nm Loss ratio 60.3% 72.9% 12.6 pts Expense ratio 38.4% 34.9% (3.4 pts) Combined ratio 98.7% 107.8% 9.1 pts
1 New business amounts are calculated on embedded value principles, details of which are included in the Embedded value report. 2 New business amounts do not include Zurich Santander and ZIMB. As set out in the Embedded value report, these businesses generated USD 195 million of new business value for the twelve months of 2012.
3 In 2012, new business has been determined including a liquidity premium in the discount rate applied to the time value of options and guarantees, but with no restatement of the 2011 comparative figures.
BOP before special operating items (266) (169) 1,587 1,397 1,320 1,228 1 See glossary for an explanation of profit by source.
Business operating profit remained broadly flat at USD 1.3 billion in U.S. dollars terms, and increased by 5 percent on a local currency basis, with a positive contribution from Zurich Santander of USD 105 million net of non-controlling interests and earn-out charges being largely offset by a decrease in Europe, primarily as a result of special operating items in Germany. Other sources of profit remained largely flat in aggregate, with improvements in the risk and expense margins benefiting from the continued shift to protection and unit-linked products, offset by reductions in the investment margin due to lower investment yields.
Before special operating items, business operating profit increased by USD 93 million or by 8 percent in U.S. dollar terms and 12 percent on a local currency basis.
Gross written premiums and policy fees increased by USD 2.0 billion to USD 13.6 billion, or by 17 percent in U.S. dollar terms and 25 percent on a local currency basis, with the increase resulting from the inclusion of Zurich Santander.
Asia-Pacific and Middle East 2 125 136 464 524 26.9% 25.9% 135 124
1 Business operating profit for 2012, included USD 105 million of profit from Zurich Santander, earned between the dates of acquisition and December 31, 2012, calculated after deducting non-controlling interests and USD 21 million for an increase to the liability for future earn-out payments. Details of the overall IFRS impact are set out in note 5 to the Consolidated financial statements.
Overall, Global Life continued to benefit in 2012 from its investment in organic growth in target markets, while maintaining focus on shifting its product mix from traditional savings business towards protection and unit-linked products and leveraging its global strength in Corporate Life & Pensions and Bank Distribution.
The recent acquisitions of Zurich Santander in Latin America and ZIMB in Asia-Pacific further strengthened the position of Global Life in those regions, generating USD 195 million of new business value for the twelve months of 2012 which has not been included in the new business figures in the tables above.
NBV, APE, NBM and BOP by region in USD millions, for the years ended December 31NBV and APE by pillar 2, 3
In Europe, the overall reduction of USD 93 million in new business value was primarily driven by a combination of lower volumes and margin pressure experienced in Germany as a result of lower interest rates and reducing spreads on traditional business. In Switzerland, product mix changes reduced exposure to interest rates and strong volumes towards the end of the year in both individual and corporate business led to an increase in new business value of USD 16 million, or 179 percent in U.S. dollar terms. In the UK, new business value increased by USD 41 million, or by 27 percent in U.S. dollar terms, driven by margin improvements in protection business. In Spain, where over 90 percent of the business arises from Bank Distribution, new business value decreased by USD 13 million to USD 94 million. This reduction resulted from the continued shift from lower margin savings business to higher margin protection business, leading to significantly lower new business APE, albeit with a higher new business margin, which more than doubled to 62.9 percent.
North America experienced an increase in both new business value and new business APE in the Retail pillars compared with 2011. The increase in new business value was mainly driven by strong margin improvements in the protection business as a result of price increases and improved utilization of reinsurance. New business APE increased by 13 percent compared with the same period of 2011 as the expansion strategy in the IFA/Brokers pillar and growth initiatives in the Agents pillar began to gain traction.
In Retail pillars, new business value decreased by USD 81 million to USD 519 million, or by 14 percent in U.S. dollar terms and 10 percent on a local currency basis. The majority of this decrease occurred in the Bank Distribution pillar in Europe and was partially offset by growth in the Agents pillar in North America.
Private Banking Client Solutions increased new business value by USD 4 million to USD 24 million. This increase in new business value was mainly driven by final placements of tranches of an investment bond through bank distribution partners in the UK, which also contributed USD 39 million to the overall growth in new business APE of USD 48 million.
Farmers business operating profit decreased by USD 72 million to USD 1.4 billion, or by 5 percent, primarily reflecting the absence of favorable development of loss reserves established in prior years in Farmers Re compared with 2011. This deterioration was partially offset by higher business operating profit in Farmers Management Services due to higher management fee revenues driven by a 3 percent increase in gross earned premiums in the Farmers Exchanges, which are managed but not owned by Farmers Group, Inc., a wholly owned subsidiary of the Group.
Other net income 62 36 71% Business operating profit 1,441 1,370 5% Managed gross earned premium margin 7.3% 1 7.3% –
Business operating profit of USD 1.4 billion increased by USD 71 million, or by 5 percent, primarily driven by an increase in management fee revenues.
Gross written premiums and policy fees 4,361 3,529 24% Net underwriting result (163) (23) nm Business operating profit (26) 116 nm Loss ratio 72.4% 70.5% (1.8 pts) Expense ratio 31.3% 30.2% (1.1 pts) Combined ratio 103.7% 100.8% (2.9 pts)
Gross written premiums and policy fees increased by USD 832 million, or by 24 percent, to USD 4.4 billion mainly as a result of the changes in the All Lines agreement as well as the 3 percent gross written premiums growth in the Farmers Exchanges. The changes were an increase to 20 percent effective December 31, 2011 from 12 percent throughout 2011 and a decrease to 18.5 percent effective December 31, 2012, subject to the approval of the California Department of Insurance.
The net underwriting result deteriorated by USD 140 million to a loss of USD 163 million. This deterioration, which was exacerbated by the increased participation rate in the All Lines agreement, was mainly due to higher assumed losses from the Farmers Exchanges in 2012. Despite the impact of Storm Sandy the underwriting result returned to profit in the second half of 2012.
Gross earned premiums in the Farmers Exchanges increased by USD 554 million to USD 18.7 billion, or by 3 percent, driven by continued increases in gross written premiums in all lines of business during the year. Furthermore, the 2012 results are net of the return of USD 74 million of premiums as a result of the anticipated settlement of a lawsuit with the State of Texas. Excluding this return gross earned premiums were USD 18.8 billion, or 3 percent higher than 2011.
Other run-off, which largely comprises U.S. life insurance and annuity portfolios, reported a business operating profit of USD 100 million. This profit was mainly driven by a reassessment of liabilities on certain life run-off policies as well as by favorable reserve movements reflecting reduced market volatility.
Common stocks, including equity unit trusts 9,388 8,477 78,587 70,576 Unit trusts (debt securities, real estate and short-term investments) 2,418 3,675 21,557 18,958 Common stock portfolios backing participating with-profit policyholder contracts 534 498 – –
Group investments increased by USD 11.0 billion to USD 208.7 billion, or by 6 percent in U.S. dollar terms since December 31, 2011. On a local currency basis, total Group investments increased by USD 7.7 billion, or by 4 percent, mainly due to positive revaluations of debt securities and cash flows invested in debt securities.
Total net investment income decreased by 7 percent in U.S. dollar terms to USD 6.7 billion and by 2 percent on a local currency basis compared with 2011, due to lower reinvestment yields on debt securities.
Total net capital gains on investments and impairments marginally increased to USD 2.2 billion in 2012 compared with 2011 driven by higher net capital gains from active management.
Net capital gains from active management contributed USD 2.1 billion compared with USD 1.1 billion in 2011, which included a gain of USD 441 million from the sale of part of the Group’s share in New China Life Insurance Co. Ltd.
Investments booked at fair value through profit or loss, including derivatives used for hedging, contributed gains of USD 286 million in 2012 compared with gains of USD 1.5 billion in 2011.
Impairments at USD 208 million in 2012 were USD 250 million lower than in 2011.
Net investment return on Group investments was 4.4 percent, 0.4 percentage points lower compared with 2011.
Total return, net of investment expenses, on average Group investments was a strong 7.0 percent, an increase of 1.7 percentage points compared with 2011.
in USD millions, for the years ended December 31Performance of Group investments
Total return on unit-linked investments 8.6% (3.2%) 11.8 pts 1 After deducting investment expenses of USD 508 million and USD 610 million for the years ended December 31, 2012 and 2011, respectively. 2 Restated as set out in note 1 of the Consolidated financial statements.
The majority of the Group’s reserves for losses and loss adjustment expenses are attributable to General Insurance. The remaining reserves mostly relate to Farmers Re and to Non-Core Businesses.
Net reserves for losses and loss adjustment expenses 55,341 1 56,180 53,1161 52,838
Net losses and loss adjustment expenses paid (23,378) (22,909) (20,412) (20,301)
Acquisitions/(divestments) and transfers 960 181 1,300 177 Foreign currency translation effects 693 (576) 682 (517)
The net reserves for loss and loss adjustment expenses for the Group increased by USD 2.0 billion to USD 57.4 billion compared with December 31, 2011 of which USD 693 million related to the effects of foreign currency translation. Acquisitions/(divestments) and transfers include USD 1.2 billion from the reclassification of annuity reserves related to claims that were previously included as policyholders contract deposits and other funds. Details of reserve development emerging from reserves established in prior years are set out in note 8 of the Consolidated financial statements. The reduction in favorable development of USD 731 million to USD 571 million primarily arose from the further strengthening of reserves for losses arising in prior years in Germany and a reduction in favorable development in North America Commercial. During 2012, reserves for losses arising in prior years in Germany were strengthened by USD 476 million. This strengthening relates to long-tail liability business in Germany that takes approximately 8 to 12 years on average to settle and still carries a high level of uncertainty going forward. The Group has placed certain parts of this business into run-off.
1 The Germany prior years adjustment, as set out in note 1 of the Consolidated financial statements, is reflected as a restatement of the 2011 in the year net loss ratio. For the accident years 2003 to 2010 the adjustment is included in the latest year development.
This table represents the loss ratio development for individual accident years for the Group, with General Insurance being the primary driver. Individual accident years are affected by the level of large catastrophe losses which had the following impact on the loss ratios: • 2004: Hurricanes Charley, Frances, Jeanne and Ivan in Florida increased the loss ratio by 2.8 percentage points; • 2005: Hurricanes Katrina, Rita and Wilma in the U.S. and floods in Europe increased the loss ratio by 4.6 percentage points; • 2007: The winter storm Kyrill in Europe and the floods in the UK increased the loss ratio by 2.5 percentage points; • 2008: Hurricane Gustav and Hurricane Ike in the U.S. increased the loss ratio by 1.8 percentage points; • 2010: The earthquake in Chile and the floods in Australia increased the loss ratio by 0.8 percentage points; • 2011: Floods in Australia, earthquakes in New Zealand, the earthquake and subsequent tsunami in Japan, Hurricane
The development of 2003 and subsequent years demonstrates the Group’s philosophy of taking a prudent view on reserving.
The majority of the Group’s reserves for life insurance contracts and liabilities for investment contracts are attributable to Global Life. Life insurance reserves in other segments relate predominantly to businesses that are in run-off or are centrally managed, and are included only in this first table below.
Net reserves as of January 1 195,951 1 187,196 18,027 17,331 213,978 1 204,527
The following provides further detail on the development and composition of reserves and liabilities in the Global Life business.
Increases/(decreases) recorded in other comprehensive income 4 (6) 2,425 730 2,429 724
As of December 31, 2011, as previously reported 31,636 2,380 34,017 Total adjustments due to restatement 1 (153) 109 (44) As of December 31, 2011, as restated 31,484 2,489 33,973 Proceeds from issuance of share capital 221 – 221 Proceeds from treasury share transactions 30 – 30
Share-based payment transactions (34) – (34) Change of ownership with no loss of control (5) – (5) Total comprehensive income 4,721 136 4,856
Total equity as restated increased by USD 2.9 billion to USD 36.9 billion, or by 9 percent. This increase was generated principally from total comprehensive income of USD 4.9 billion including USD 4.0 billion from net income after taxes and USD 890 million of net other recognized income. This increase was offset by the deduction of USD 2.8 billion for the dividend of CHF 17.00 per share, which was approved at the Annual General Meeting on March 29, 2012, to be paid out of the capital contribution reserve. Of this USD 2.8 billion, USD 1.9 billion has been included as dividends and USD 840 million has been included in other comprehensive income as cumulative foreign currency translation adjustments. Net other comprehensive income included net unrealized gains on investments of USD 1.7 billion, offset by net actuarial losses on pension plans of USD 451 million and cumulative foreign currency translation adjustment losses of USD 415 million, after including the loss effect of the cumulative translation adjustment on the dividend. The overall decrease of USD 121 million in non-controlling interests arose mainly from the impact of adjustments to the valuation of Zurich Santander and the effects on non-controlling interests from the loss of control over a subsidiary.
The Group also continues to be subject to Solvency I requirements based on the Swiss Insurance Supervision Law. The Solvency I ratio as of December 31, 2012, increased to 278 percent from 232 percent as of December 31, 2011, after restatement.
in USD millions, for the years ended December 31Summary of cash flows
The Group operates worldwide in multiple currencies and seeks to match foreign exchange exposures on an economic basis.
Gross written premiums and policy fees (2,176) (4%) Insurance benefits and losses, gross of reinsurance 1,522 4% Net income attributable to shareholders (45) (1%) Business operating profit (71) (2%)
The Consolidated income statements are translated at average exchange rates. Throughout 2012, the U.S. dollar has on average been stronger against the euro, Swiss franc and British pound, compared with 2011. The net impact on the result has been a reduction in U.S. dollar terms with a decrease in gross written premiums and policy fees partially offset by a decrease in U.S. dollar terms in insurance benefits and losses.
Total investments 5,904 2% Reserves for insurance contracts, gross 3,555 1% Cumulative translation adjustment in shareholders’ equity 1 (440) (1%)
1 Restated as set out in note 1 of the Consolidated financial statements.
The Consolidated balance sheets are translated at end-of-period rates. The U.S. dollar has weakened against the British pound, Swiss franc and the euro as of December 31, 2012 compared with December 31, 2011, resulting in an increase in U.S. dollar terms for most balance sheet items. The effects of changes of the major currencies were partially offset by U.S. dollar appreciation against the Brazilian real.
variance over the prior period, for the year ended December 31, 2012Selected Group income statement line items variance over December 31, 2011, as of December 31, 2012Selected Group balance sheet line items
The Risk review is an integral part of the Consolidated financial statements (except for the “Swiss Solvency Test Requirement,” “Internal Model Capital Adequacy” and “Conclusion” sections presented on pages 153–161).
Analysis by risk type Risk type description 117 Strategic risk 117 Insurance risk 118 Market risk 127 Credit risk 135 Liquidity risk 143 Operational risk 146 Risks to the Group’s reputation 147
At the heart of the risk management framework is a governance process with clear responsibilities for taking, managing, monitoring and reporting risks. The Group articulates the roles and responsibilities for risk management throughout the organization, from the Board of Directors and the Chief Executive Officer (CEO) to its businesses and functional areas, thus embedding risk management in the business (see the “Risk governance and risk management organization” section in the Risk review).
An important element of the Group’s risk management framework is a well-balanced and effectively managed remuneration program. This includes a Group-wide remuneration philosophy, robust short- and long-term incentive plans, strong governance and links to the business planning, performance management and risk policies of the Group. Based on the Group’s Remuneration Rules, the Board establishes the structure and design of the remuneration arrangements so that they do not encourage inappropriate risk taking. The Group Chief Risk Officer (Group CRO) consults with the other assurance, control and governance functions to provide the Chief Executive Officer with a review of risk factors to consider in the annual process to determine variable compensation. In 2012, the Group CRO strengthened the process through which the assurance, control and governance functions provide risk and compliance information about each Group Key Risk Taker as part of the annual individual performance assessment. For more information on Zurich’s remuneration system, see the “Remuneration report (unaudited).”
The Group also seeks external expertise from its International Advisory Council and Natural Catastrophe Advisory Council to better understand and assess risks, particularly regarding areas of complex change. For more information on these councils, see the “Corporate governance report (unaudited).” In addition, the Investment Management Advisory Council provides feedback to Investment Management on achieving superior risk-adjusted returns versus liabilities for the Group’s invested assets.
Zurich is a main contributor to the Global Risk Report that is produced by the World Economic Forum in cooperation with external partners (Swiss Re, Marsh & McLennan Companies and the Wharton Center for Risk Management). The report’s assessment of the most pressing global risks and the interconnections among them provides valuable information for risk mitigation across the globe. Supporting the report is also part of the Group’s commitment to corporate responsibility by sharing Zurich’s expertise to help businesses, nations and society.
Board of Directors level The Board of Directors of Zurich Insurance Group Ltd has ultimate oversight responsibility for the Group’s risk management. It establishes the guidelines for the Group’s risk management framework and key principles, particularly as articulated in the Zurich Risk Policy, and decides on changes to such guidelines and key principles, as well as transactions reaching specified thresholds.
Group Executive level The Chief Executive Officer, together with the Group Executive Committee (GEC), oversees the Group’s performance with regard to risk management and control, strategic, financial and business policy issues of Group-wide relevance. This includes monitoring adherence to and further development of the Group’s risk management policies and procedures. The Group Balance Sheet Committee and the Group Finance and Risk Committee regularly review and make recommendations on the Group’s risk profile and significant risk-related issues.
• General Insurance Global Underwriting Committee (GUC) – acts as a focal point for underwriting policy and related risk controls for General Insurance and is chaired by the Global Chief Underwriting Officer for General Insurance.
In addition to the risk management network, the Group has audit and oversight committees at the major business and regional levels. The committees are responsible for providing oversight of the risk management and control functions. This includes monitoring adherence to policies and periodic risk reporting. At the local level, these oversight activities are conducted through risk and control committees or quarterly meetings between senior executives and the local heads of governance functions.
The Zurich Economic Capital Model quantifies the internal capital for insurance, market, credit and operational risks. See section “Internal model capital adequacy (unaudited)” starting on page 155.
Insurance risk is the inherent uncertainty regarding the occurrence, amount or timing of insurance liabilities. The exposure is transferred to Zurich through the underwriting process. Zurich actively seeks to write those risks it understands and that provide a reasonable opportunity to earn an acceptable profit. As Zurich assumes certain customer risks, it aims to manage that transfer of risk, and minimize unintended underwriting risks, through such means as: • Establishing limits for underwriting authority • Requiring specific approvals for transactions involving new products or where established limits of size and complexity may be exceeded • Using a variety of reserving and modeling methods to address the various insurance risks inherent in the Group’s insurance business • Ceding insurance risk through proportional, non-proportional and specific risk reinsurance treaties. The Group centrally manages reinsurance treaties.
The Group closely monitors potential new emerging risk exposures. Zurich has an Emerging Risk Group (ERG), with cross-functional expertise from core insurance functions such as underwriting, claims and risk engineering in order to identify, assess and recommend actions for such risks on a Group level. In 2012, Group Risk Management also established a Group-wide network of functional experts to support the ERG in covering topics outside the underwriting scope such as political, legal and macro-economic trends or scenarios that may trigger the emergence of risks.
Table 1.a in USD millions, for the year ended December 31, 2012
General Insurance – Direct written premiums and policy fees by line of business and by region – current period
Table 1.b in USD millions, for the year ended December 31, 2011
+1% in net loss ratio Net income before tax (55) (76) (118) (43)
Table 2.b in USD millions, for the year ended December 31, 2011
Risks from man-made catastrophes Man-made catastrophes include such risks as industrial accidents and all types of terrorism attacks. Zurich’s experience in monitoring potential exposures from natural catastrophes is also applicable to threats posed by man-made catastrophes, particularly terrorism.
• flows from the business written, potentially impacting its ability to recover deferred acquisition expenses. • Expense risk is the risk that expenses incurred in acquiring and administering policies are higher than expected. • Market risk is the risk associated with the Group’s balance sheet positions where the value or cash flow depends on financial markets, which is analyzed in the “Market risk” section in the Risk review.
Table 3 shows the Group’s concentration of risk within the life business by region and line of business based on reserves for life Insurance on a net basis. The Group’s exposure to life insurance risks varies significantly by geographic region and line of business and may change over time.
Reinsurance for general insurance and life insurance The Group’s objectives for purchasing reinsurance are to provide market-leading capacity for customers while protecting the balance sheet and optimizing the Group’s capital efficiency. The Group follows a centralized purchasing strategy for both segments, General Insurance and Global Life, and bundles programs where appropriate to benefit from diversification and economies of scale. These efforts for General Insurance have led to a decreasing expenditure for treaty reinsurance while growth in the General Insurance Global Corporate business has increased premium cessions to captives and co-reinsurers, resulting in an overall stable cession rate.
Due to its strong balance sheet, Zurich is able to structure and align its reinsurance programs to achieve an optimum risk/ reward ratio. Zurich has managed its central reinsurance purchasing according to these principles for General Insurance since 2003 and for Global Life since 2008. The Group is therefore able to manage its risks to retain a significant and stable portion of premium, as shown in the charts below.
Ceded premium – trend (% of general insurance gross written premium ceded to reinsurers)
Table 3 in USD millions, as of December 31Reserves, net of reinsurance, by region
In 2012, the only major natural catastrophe event to affect the Group was Storm Sandy; the Group’s reinsurance covers allowed Zurich to limit the pre-tax net impact to USD 756 million. (This figure includes the reinstatement premium payable to reinsurers and the impact from Farmers Re.)
• USD 1,100 million reinsurance protection for U.S. includes a bilateral risk swap of USD 142 million.
All natural catastrophe losses in excess of the franchise deductible of USD 35 million occurring in a single calendar year are aggregated
The Group applies processes to manage market risk scenarios to test and analyze market hotspots, and risk mitigation actions are taken if necessary to manage fluctuations affecting asset/liability management and risk-based capital.
Risk from equity securities and real estate The Group is exposed to various risks resulting from price fluctuations on equity securities and real estate. Risks arising from equity securities and real estate could affect the Group’s liquidity, reported income, surplus and regulatory capital position. The exposure to equity risk includes common stocks, including equity unit trusts; common stock portfolios backing participating-with-profit policyholder contracts, and equities held for employee benefit plans. The exposure to real estate risk includes direct holdings in real estate, listed real estate company shares and funds, as well as real estate debt securities such as commercial and residential mortgages, commercial and residential mortgage-backed securities
Risk review continued and mezzanine debt. Returns on unit-linked contracts, whether classified as insurance or investment contracts, may be exposed to risks from equity and real estate, but these risks are borne by policyholders. However, the Group is indirectly exposed to market movements from unit-linked contracts both with respect to earnings and with respect to economic capital. Market movements impact the amount of fee income earned when the fee income level is dependent on the valuation of the asset base. Therefore, the value of in-force business for unit-linked business can be negatively impacted by adverse movements in equity and real estate markets.
Risk from interest rate and credit spread Interest rate risk is the risk of loss resulting from changes in interest rates, including changes in the shape of yield curves. The Group is exposed to interest rate risk including from debt securities, reserves for insurance contracts, liabilities for investment contracts, employee benefit plans and loans and receivables. Changes in interest rates affect the Group’s held-to-maturity floating-rate debt securities and unhedged floating-rate borrowings through fluctuations in interest income and interest expense. Changes in interest rates affect the Group’s held-for-trading debt securities and fair value hedged borrowings through periodic recognition of changes in their fair values through the income statement. Changes in interest rates affect the Group’s available-for-sale debt securities through periodic recognition of changes in their fair values through shareholders’ equity. The Group also manages credit spread risk, which describes the sensitivity of the values of assets and liabilities due to changes in the level or the volatility of credit spreads over the risk-free interest rate yield curves.
Tables 4.a, 4.b, 6.a and 6.b show the estimated economic market risk sensitivities of Group investments, including real estate for own use, liabilities, including insurance and financial liabilities, and the net impact for General Insurance and the rest of the businesses. Positive values represent an increase of the balance, whereas values in parentheses represent a decrease of the balance. Increases in the value of liabilities and decreases in the value of assets represent an economic risk for the Group. The net impact is the difference between the impact on Group investments and liabilities. The net impact represents the economic risk the Group faces related to changes in market risk factors. This is in line with management’s monitoring of the Group’s investment and liabilities base. In order to limit the economic impact of interest rate, equity and real estate risk, Zurich has limits on holdings in real assets and limits on deviations of asset interest rate sensitivities from liability interest rate sensitivities.
For 2011, it is calculated at 24.1 percent. For the Non-Core Businesses with life insurance characteristics, specific tax rates have been applied.
Limitations of the analysis: • The sensitivities show the effects of a change in certain risk factors, while other assumptions remain unchanged, except where they are directly affected by the revised conditions.
Analysis of economic sensitivities for interest rate risk Tables 4.a through 6.b show the estimated impacts of a 100 basis point increase/decrease in yield curves of the major currencies U.S. dollar (USD), euro (EUR), British pound (GBP), Swiss franc (CHF) and “other currencies” after consideration of hedges in place, as of December 31, 2012 and 2011, respectively.
Other currencies Total 100 basis points increase in the interest rate yield curves Group investments (1,314) (578) (352) (341) (186) (2,772)
100 basis points decrease in the interest rate yield curves Group investments 1,005 490 351 237 184 2,266
100 basis points decrease in the interest rate yield curves Total impact on Embedded Value 61 365 111 (140) 68 465
Table 5.a in USD millions, as of December 31, 2012Economic interest rate sensitivities for the Global Life business – current period
Other currencies Total 100 basis points increase in the interest rate yield curves Total impact on Embedded Value (79) 520 (17) 255 (100) 578 100 basis points decrease in the interest rate yield curves Total impact on Embedded Value (9) (1,095) (19) (309) 83 (1,349)
Table 5.b in USD millions, as of December 31, 2011Economic interest rate sensitivities for the Global Life business – prior period
10% decline in stock markets Group investments (456) (473) Liabilities – – Net impact before tax (456) (473) Tax impact 113 115 Net impact after tax (343) (359)
Analysis of economic sensitivities for credit spread risk Tables 10.a through 12.b show the estimated impacts from a 100 basis points increase in corporate credit spreads, as of December 31, 2012 and 2011, respectively. Credit spread risk is modeled on Group investments only, and does not impact the liabilities. The Group uses a risk-free rate for the valuation of its liabilities.
Table 11.a in USD millions, as of December 31, 2012Economic credit spread sensitivities for the Global Life business – current period
Table 12.b in USD millions, as of December 31, 2011Economic credit spread sensitivities for the rest of the businesses – prior period
Table 13 shows the sensitivity of the total IFRS equity to changes in exchange rates for the main functional currencies to which the Group is exposed. Positive values represent an increase in the value of the Group’s total equity. The sensitivity analysis does not take into account management actions that might be taken to mitigate such changes. The sensitivities show the effects of a change of the exchange rates only, while other assumptions remain unchanged. The sensitivities do not indicate a probability of such events occurring in the future. They do not necessarily represent Zurich’s view of expected future market changes. While table 13 shows the effect of a 10 percent increase in currency exchange rates, a decrease of 10 percent would have the converse effect.
Table 13 in USD millions, as of December 31Sensitivity of the Group’s total IFRS equity to exchange rate fluctuations
Credit risk is the risk associated with a loss or potential loss from counterparties failing to fulfill their financial obligations. The Group’s exposure to credit risk is derived from the following main categories of assets: • Cash and cash equivalents • Debt securities • Reinsurance assets • Mortgage loans and mortgage loans given as collateral • Other loans • Receivables • Derivatives
The Group regularly tests and analyzes credit risk scenarios and prepares possible contingency measures, which may be implemented should the credit risk environment worsen. Zurich adjusts the scenarios if market conditions warrant.
Although the Group actively uses collateral to mitigate credit risks, the principle is nevertheless to manage the underlying credit risks independently from the collateral. The Group has limits and quality criteria to identify acceptable letter of credit providers. Letters of credit enable Zurich to limit the risks embedded in reinsurance captives, deductibles, trade credit and surety.
The maximum exposure to credit risk consists mainly of on-balance sheet exposures. Off-balance sheet exposures are primarily related to collateral, such as letters of credit, used to protect the underlying credit exposures on the balance sheet. The Group also has off-balance sheet exposures related to undrawn loan commitments of USD 20 million and USD 57 million as of December 31, 2012 and 2011, respectively. See note 25 of the Consolidated financial statements for undrawn loan commitments.
Rest of Eurozone 974 607 Eurozone Supranationals & similar 1,058 782
The Group’s Corporate Reinsurance Security Committee manages the credit quality of cessions and reinsurance assets. The Group typically cedes new business to authorized reinsurers with a minimum rating of “A–.” 58 percent and 57 percent of the business ceded to reinsurers that fall below “A–” or are not rated is collateralized, as of December 31, 2012 and 2011, respectively. Of these percentages, 50 percent and 52 percent are ceded to captive insurance companies, in 2012 and 2011, respectively.
Reinsurance assets in table 16 are shown before taking into account collateral such as cash or letters of credit from banks rated at least “A,” which can be converted into cash and deposits received under ceded reinsurance contracts.
Compared to December 31, 2011, collateral decreased by USD 100 million to USD 8.1 billion.
The risk-weighted average credit quality of reinsurance assets (including receivables, but after deduction of collateral) was “A” as of December 31, 2012 and 2011. Credit factors to determine the risk-weighted average credit quality of reinsurance assets are based on historical insurance impairment statistics, consistent with the prior year. For credit risk assessment purposes, collateral has been taken into account at nominal value as an approximation for fair value. For collateral, the Group applies minimum requirements, such as a minimum rating for the issuers of letters of credit and guarantees, and for pledged assets a minimum coverage ratio of 100 percent.
millions total 1 The value of the collateral received amounts to USD 8.1 billion and USD 8.2 billion as of December 31, 2012 and 2011, respectively.
In Switzerland, the residential property market has seen steady price growth since 2000 and fast growth in the past five years, raising concerns about the development of a price bubble. Residential property price increases have been strongest in the main economic centers and more moderate in the rest of the country; residential prices in the Lake Geneva region have more than doubled since 2000, and in the Cantons of Zurich and Zug have increased by 60% and 95% respectively in the same period. In 2012, outstanding mortgages in the Lake Geneva region represent approximately 32% of the Swiss portfolio. Mortgages in the Canton of Zurich and in the Canton of Zug represent 35% and 1.6% of the Swiss portfolio respectively. The bulk of those mortgages was granted before 2008 and is therefore not affected by price developments in the last five years. In Germany, residential prices have started to rise in the major cities, and in line with the Group’s investment policy, mortgage exposure has been reduced. To mitigate the impact of potential bubbles in the portfolio, the Group has a process to regularly review regional property markets, and to tighten underwriting standards in areas with strong price appreciation. Zurich’s German and Swiss mortgage portfolios remain strong and well managed; LTV lending buffers are generally strong, and loss impairments and losses remain low.
The next largest portfolio comprises loans granted by Dunbar Assets Ireland (including the UK property loans of Dunbar Assets plc) of USD 1.1 billion (after provisions) in the UK and Ireland. They consist of residential and commercial property development financing or investment loans, secured as either property under development or completed developments. In 2010, these entities ceased originating new business in this market following the significant deterioration in economic conditions and the drop in property values in the UK and Ireland. Provisions at Dunbar Assets Ireland now stand at a significant USD 711 million (USD 631 million in 2011) or 39 percent and 31 percent of the portfolio as of December 31, 2012 and December 31, 2011 respectively; this accordingly reduces the carrying balance of net loans outstanding. Property valuations at Dunbar Assets Ireland are reviewed regularly as part of the continual assessment of the appropriateness of provisioning on a portfolio that is largely impaired. For more details, see table 18.a and 18.b.
Mortgage loans given as collateral were related to a single bank borrowing that expired in 2012. At the expiration date of the loan, the mortgages were returned to Zurich Deutscher Herold Lebensversicherung AG, and as of December 31, 2012 there are no mortgages given as collateral outstanding. See note 15 of the Consolidated financial statements.
Past due but not impaired receivables should be regarded as unsecured, but some of these receivable positions may be offset by collateral. The Group reports internally on Group past due receivable balances and strives to keep the balance of past due positions as low as possible, while taking into account customer satisfaction. In 2012, the Group continued efforts to reduce past due receivables through both short- and long-term initiatives to improve processes and systems. In addition, a stricter policy and standardized monitoring were implemented.
To limit credit risk, derivative financial instruments are typically executed with counterparties rated “A–” or better by an external rating agency. In addition, it is the Group standard to only transact derivatives with counterparties where the Group has an ISDA Master Agreement with a Credit Support Annex in place. This mitigates credit exposures from over-the-counter transactions due to close-out netting and requires the counterparty to post collateral when the derivative position is beyond an agreed threshold. The Group mitigates credit exposures from derivative transactions further by using exchange-traded instruments whenever possible.
Increase/(Decrease) in allowance for impairments 103 – 42 Amounts written-off (33) (1) (31)
The Group has Group-wide liquidity management policies and specific guidelines as to how local businesses have to plan, manage and report their local liquidity. These include regularly conducting stress tests for all major carriers within the Group. The stress tests use a standardized set of internally defined stress events, and are designed to provide an overview of the potential liquidity drain the Group would face if it had to recapitalize local balance sheets.
At the Group level, similar guidelines apply and detailed liquidity forecasts based on the local businesses’ input and the Group’s own forecasts are regularly performed. As part of its liquidity management, the Group maintains sufficient cash and cash equivalents and high quality, liquid investment portfolios to meet expected outflows including those for maturing debt obligations. In addition, the Group maintains internal liquidity sources that cover the Group’s potential liquidity needs, including those that might arise under stressed conditions. The Group takes into account the amount, permanence of availability and speed of accessibility of the sources. The Group centrally maintains committed borrowing facilities, as well as access to diverse funding sources to cover contingencies. Funding sources include asset sales, external debt issuances and use of letters of credit. The Group maintains a broad range of maturities for external debt securities. A possible concentration risk could arise from a downgrade of the Group’s credit rating. This could impact the Group’s commitments and guarantees, thus potentially increasing the Group’s liquidity needs.
See note 21 of the Consolidated financial statements for additional information on debt obligation maturities and on credit facilities and note 25 of the Consolidated financial statements for information on commitments and guarantees. The Group’s regular liquidity monitoring includes monthly reporting to the executive management and quarterly reporting to the Risk Committee of the Board, covering aspects such as the Group’s actual and forecasted liquidity, possible adverse scenarios that could affect the Group’s liquidity and possible liquidity needs from the Group’s main subsidiaries, including under stressed conditions.
Tables 20.a and 20.b provide an analysis of the expected maturity profile of reserves for insurance contracts, net of reinsurance, based on expected cash flows without considering the surrender values as of December 31, 2012 and 2011. Reserves for unit-linked insurance contracts amounting to USD 74.1 billion and USD 68.8 billion as of December 31, 2012 and 2011, respectively, are not included, as policyholders can generally surrender their contracts at any time, at which point the underlying unit-linked assets would be liquidated. Risks from the liquidation of unit-linked assets are borne by the policyholders of unit-linked contracts.
Tables 21.a and 21.b provide an analysis of the maturity of liabilities for investment contracts based on expected cash flows as of December 31, 2012 and 2011. The undiscounted contractual cash flows for liabilities for investment contracts are USD 58.3 billion and USD 51.3 billion as of December 31, 2012 and December 31, 2011, respectively. Liabilities for unit-linked investment contracts amount to USD 50.9 billion and USD 44.2 billion as at December 31, 2012 and 2011, respectively. The policyholders of unit-linked investment contracts can generally surrender their contracts at any time, at which point the underlying unit-linked assets would be liquidated. Risks from the liquidation of unit-linked assets are borne by the policyholders of unit-linked investment contracts. Certain non-unit-linked contracts also allow for surrender of the contract by the policyholder at any time. Liabilities for such contracts amounted to USD 958 million and USD 950 million as of December 31, 2012 and 2011 respectively. The Group actively manages the Global Life in-force business to improve persistency and retention.
Table 21.a in USD millions, as of December 31, 2012Expected maturity profile for liabilities for investment contracts – current period
Table 21.b in USD millions, as of December 31, 2011Expected maturity profile for liabilities for investment contracts – prior period
Issues identified, including financial adjustments in the General Insurance business in Germany, have been communicated to the Board and either have been or are being addressed by the Group.
The Group considers controls to be key instruments for monitoring and managing operational risk. Although primarily focused on important controls over financial reporting, internal control efforts also include related operational and compliance controls. Therefore, the Group continues to strengthen the robustness, consistency, documentation and assessment of internal controls for significant entities and business processes. Operational effectiveness of key controls is assessed by self assessment and independent testing on controls supporting the financial statements. For more details, see the “Risk management and internal control statement” in the “Corporate governance report (unaudited).”
Zurich’s policy is to manage its capital position by allocating capital to businesses earning the highest risk-adjusted returns and pooling risks and capital as much as possible to operationalize its global risk diversification, subject to local and Group regulatory solvency requirements and rating agency capital adequacy constraints.
The Group seeks to maintain the balance between higher returns for shareholders on equity held, which may be possible with higher levels of borrowing, and the security provided by a sound capital position. The payment of dividends, share buy-backs, and issuances and redemption of debt have an important influence on capital levels. In 2012, the Group paid a dividend out of the capital contribution reserve, repaid outstanding preferred securities and refinanced with subordinated debt securities, and replaced maturing senior debt with new senior debt.
Zurich Insurance Group Ltd is not subject to legal restrictions on the amount of dividends it may pay to its shareholders other than under the Swiss Code of Obligations. The Swiss Code of Obligations provides that dividends may only be paid out of freely distributable reserves or retained earnings and that 5 percent of annual retained earnings must be allocated to a general legal reserve until such reserve in the aggregate has reached 20 percent of the paid-in share capital; therefore the earnings allocated to those reserves are restricted. As of December 31, 2012, the amount of the general legal reserve exceeded 20 percent of the paid-in share capital of the Group. Similarly, company laws in many countries in which the Group’s subsidiaries operate may restrict the amount of dividends payable by those subsidiaries to their parent companies.
The Group maintained its strong rating level and its stable outlook in 2012. As of December 31, 2012 the IFSR of Zurich Insurance Company Ltd, the main operating entity of the Group, was rated “AA–/stable” by Standard and Poor’s, “Aa3/stable” by Moody’s and “A+ (superior)/stable” by A.M. Best.
At a Group level, Zurich endeavors to pool risk and capital as much as possible and thereby create diversification benefits for the Group. This also allows the Group to take into account the benefits that arise from this pooling in those regions where these benefits are recognized under the capital adequacy regime, e.g. in the U.S., Ireland, and Switzerland.
Regulatory requirements in Switzerland In Switzerland, under the Swiss Solvency Test (SST), groups, conglomerates and reinsurers are required to use companyspecific internal models to calculate risk-bearing and target capital. Internal models must be approved by the Swiss Financial Market Supervisory Authority (FINMA). In 2012, Zurich continued to further enhance and refine its internal model to meet evolving regulatory requirements. The model approval process continues with FINMA, which has approved on a provisional basis the use of Zurich’s internal model for 2012, without prejudicing the final approval of the internal model. Zurich has filed an SST ratio with FINMA in excess of the regulatory requirements, both as of January 1, 2012 and as of July 1, 2012. For more details, see the “Swiss Solvency Test requirement” section in the Risk review.
On November 25, 2009 the directive on Solvency II was adopted. Solvency II aims to reflect the latest developments in prudential supervision, actuarial methods and risk management. It includes economic risk-based solvency requirements, which are more risk sensitive and more sophisticated than Solvency I. Solvency II capital requirements also consider all material risks and their interactions. As part of the risk management system, all EU/EEA insurance and reinsurance entities will be required to conduct their own risk and solvency assessment, including the assessment of the overall solvency needs reflecting their specific risk profiles. As part of the disclosure provisions, companies will have to publicly report their solvency and financial condition.
Zurich is fully engaged in an extensive program of work in order to meet Solvency II requirements when they enter into force. The Group intends to use its internal model, which aligns the Solvency II approach with that used for the SST, for Zurich Insurance plc (Ireland). The Group has started the pre-application process in order to gain regulatory approval for the internal model from the Central Bank of Ireland, the Group’s EU lead regulator.
Regulatory requirements in the U.S. In the U.S., required capital is determined to be the “company action level risk-based capital” calculated with the risk-based capital model of the National Association of Insurance Commissioners. This method, which builds on regulatory accounts, measures the minimum amount of capital for an insurance company to support its overall business operations by taking into account its size and risk profile. The calculation is based on risk-sensitive factors that are applied to various asset, premium, claim, expense and reserve items.
Solvency I requirements at Group level The Group continues to be subject to Solvency I requirements based on the Swiss Insurance Supervisory Law. Table 22 sets out the Solvency I position as drafted for filing with the Swiss regulator for 2012 and a restated position for 2011. See Note 1 of the Consolidated financial statements for more information.
2 Amount for dividend reflects the proposed dividend for the financial year 2012, not yet approved by the Annual General Meeting.
Risk review continued 1 The credit spread sensitivity is applied to corporate debt, mortgages and euro currency government debt (excluding Germany).
Monetary impact on total IFRS equity 2012 totaI IFRS equity: USD 36.9bn
Swiss Solvency Test requirement Since January 1, 2011, the Swiss Solvency Test (SST) capital requirements are binding in Switzerland. The Group uses an adaptation of its internal Zurich Economic Capital Model (Z-ECM) to comply with the SST requirements and runs a full SST calculation twice a year. The model is still subject to FINMA approval. For more details about Z-ECM, see the “Internal model capital adequacy (unaudited)” section in the Risk review. For more details about the SST model approval process see the “Regulatory requirements in Switzerland” section in the Risk review.
The Group has filed with FINMA an SST ratio of 178 percent as of July 1, 2012, which is a slight deterioration compared to January 1, 2012 when the ratio was 183 percent.
1 After FINMA adjustment to remove USD 500m hybrid bond issued on 18 January 2012
The following chart shows the estimated impact on the Group’s SST ratio of a one percentage point increase/decrease in yield curves, a separate 25 percent rise/decline in all stock markets, after consideration of hedges in place and a separate one percentage point change in credit spreads, as of July 1, 2012. The sensitivities are considered separate but instantaneous scenarios.
2 The credit spread sensitivity is applied to corporate debt, mortgages and Euro currency government debt (excluding Germany). The credit spread sensitivity does not take into account the buffering effect of policyholder participation.
Sensitivity of the Group’s SST ratio to changes in: SST ratio
Internal model capital adequacy Group’s Risk Tolerance >120% Consider increased risk taking or remedial actions
No action required as within stated objective and equivalent to “AA” rating 90-100% Position may be tolerated for a certain time depending on the risk environment
1 In the Circular “Temporary Adjustments to the Swiss Solvency Test (SST)“, in force since January 1, 2013, FINMA allows insurers to use swap rates minus 10 bps as a reference rate.
1 The transaction with Zurich Santander and the acquisition of Zurich Insurance Malaysia Berhad is included in the total Z-ECM capital required.
The chart below shows an analysis of the composition of the Group’s Z-ECM available financial resources as of July 1, 2012.
Analysis of the Group’s Z-ECM available financial resources and Z-ECM capital required in USD billions
M&A due diligence: This risk scenario covers the possible risk of poor execution of the due diligence process leading to understatement of liabilities, required investment, operational or legal risks in the acquired business; these understatements result in an inadequate transaction decision.
Risk scenarios contributing to the Z-ECM capital required for operational risk
The following chart shows a split of the Z-ECM capital required allocated to the segments as of July 1 and as of January 1, 2012. As of July 1, 2012, the largest proportion of Z-ECM capital required is allocated to General Insurance, which comprises 51 percent of the total, followed by Global Life with 34 percent of the total. Total allocated capital as of July 1, 2012 equals USD 35 billion Z-ECM capital required plus USD 2 billion direct allocation to Farmers.
1 The transaction with Zurich Santander and the acquisition of Zurich Insurance Malaysia Berhad is included in the total capital allocated, but is not considered in the allocation by segment.
Total capital allocated, by segment %, as of July 1 and January 1, 2012
1 Does not include sensitivities to the underlying assets and liabilities related to the transaction with Zurich Santander (for more information, see note 5 of the Consolidated financial statements). The impact of sensitivities on changes to the Z-ECM available financial resources is only approximated and only taken into account on Market/ALM risk.
In addition to the sensitivities shown above, the Group also evaluates certain stress scenarios on the Z-ECM ratio. Scenarios are defined as events that have a very small probability of occurrence and that could, if realized, negatively affect the Group’s Z-ECM available financial resources. The chart on the following page shows three groups of scenarios: market and credit risk-specific, general insurance risk-specific and life insurance risk-specific. In the current market environment, the market and credit risk-specific scenarios particularly focus on peripheral EU debt exposure and adverse financial market impact on equity markets and interest rates in the EU. The general insurance risk-specific scenarios present the three largest natural catastrophe events to which the Group is exposed. Lapse risk represents the Group’s largest life insurance risk-specific exposure.
As of July 1, 2012, insurance-related and business risks contributes to 51% of the Z-ECM capital required. 56% of the total capital allocated to the segments goes to General Insurance, 26% to Global Life and 9% to Farmers.
The Group focused on information security, business continuity management, anti-fraud and internal control initiatives, to manage operational risk.
Well within the Group’s target capital level that is calibrated to a ‘AA’ financial strength
As of December 31, 2012, Zurich Insurance Company Ltd was rated AA– by Standard and Poor’s, with a stable outlook.
AA–/stable Standard & Poor’s financial strength rating of Zurich Insurance Company Ltd (as of December 31, 2012)
The report’s assessment of the most pressing global risks and the interconnections among them provide valuable information for risk mitigation across the globe.
Revenues Gross written premiums 51,285 47,748 Policy fees 2,692 2,452 Gross written premiums and policy fees 53,977 50,200 Less premiums ceded to reinsurers (6,481) (6,550) Net written premiums and policy fees 47,496 43,650 Net change in reserves for unearned premiums 11 (741) (751) Net earned premiums and policy fees 46,755 42,899 Farmers management fees and other related revenues 14 2,846 2,767 Net investment result on Group investments 6 8,911 9,367
Net investment income on Group investments 6,711 7,185 Net capital gains/(losses) and impairments on Group investments 2,201 2,182
Net investment result on unit-linked investments 6 10,268 (3,544) Net gain/(loss) on divestments of businesses (34) 6 Other income 1,669 1,488 Total revenues 70,414 52,983 Benefits, losses and expenses Insurance benefits and losses, gross of reinsurance 11 37,271 38,132 Less ceded insurance benefits and losses 11 (3,519) (5,052) Insurance benefits and losses, net of reinsurance 11 33,752 33,080 Policyholder dividends and participation in profits, net of reinsurance 11 11,479 (2,685) Underwriting and policy acquisition costs, net of reinsurance 11 10,014 8,516 Administrative and other operating expense 13 8,661 8,270 Interest expense on debt 21 570 586 Interest credited to policyholders and other interest 475 479 Total benefits, losses and expenses 64,951 48,246 Net income before income taxes 5,462 4,738 Income tax expense 20 (1,496) (963)
Basic earnings per share 22 26.44 25.70 Diluted earnings per share 22 26.31 25.50 in CHF
Basic earnings per share 22 24.79 22.69 Diluted earnings per share 22 24.66 22.52 in USD millions, for the years ended December 31
Total comprehensive income 2011 Comprehensive income for the period, as restated 3,750 332 176 (1,461) (954) 54 (933) (879) (1,832) 1,918 (37) 1,881 Details of movements during the period
Change (before reclassification, tax and foreign currency translation effects and after allocation to policyholders) 866 207 (1,418) (345) 73 (1,328) (1,255) (1,601) Reclassification to income statement (before tax and foreign currency translation effects and after allocation to policyholders) (644) 53 (43) (633) – – – (633) Deferred income tax (before foreign currency translation effects) 113 (71) – 43 (19) 352 333 376 Foreign currency translation effects (4) (13) – (18) – 44 44 26 2012 Comprehensive income for the period 3,878 1,724 6 (440) 1,290 – (447) (447) 843 4,721 136 4,856 Details of movements during the period
Change (before reclassification, tax and foreign currency translation effects and after allocation to policyholders) 3,875 32 (484) 3,422 – (471) (470) 2,952 Reclassification to income statement (before tax and foreign currency translation effects and after allocation to policyholders) (1,724) (35) 44 (1,715) – – – (1,715) Deferred income tax (before foreign currency translation effects) (514) 4 – (511) – 101 101 (409) Foreign currency translation effects 87 6 – 93 – (78) (78) 15 in USD millions, for the years ended December 31
Accrued investment income 2,414 2,589 2,749 Receivables and other assets 18 18,423 17,828 17,671 Mortgage loans given as collateral 15 – 223 743
1 As of December 31, 2012 included land and buildings formerly classified as real estate held for investment and held for own use amounting to USD 89 million and USD 10 million, respectively. As of December 31, 2011 there are assets relating to the sale of a company in Bolivia (see note 5).
Liabilities Reserve for premium refunds 706 611 518 Liabilities for investment contracts 9 58,131 50,958 50,667 Deposits received under ceded reinsurance contracts 1,558 1,560 1,362 Deferred front-end fees 6,073 5,720 5,626 Reserves for insurance contracts 8 265,233 253,207 242,885 Obligations to repurchase securities 1,539 1,794 3,330
Common shareholders’ equity 34,494 31,484 31,243 Preferred securities 22 – – 475
Total liabilities and equity 409,267 386,971 375,529 1 As of December 31, 2011 included liabilities relating to the sale of a company in Bolivia (see note 5).
Net capital (gains)/losses on total investments and impairments (10,632) 3,119 Net change in trading securities and derivatives (169) (13) Net change in money market investments 341 1,645 Sales and maturities
Cash flows from investing activities Sales of property and equipment 95 49 Purchases of property and equipment (226) (199) Disposal of equity method accounted investments, net 2 42 Acquisitions of companies, net of cash acquired (97) (977) Divestments of companies, net of cash balances (14) 20 Dividends from equity method accounted investments 6 3 Net cash provided by/(used in) investing activities (234) (1,062) Cash flows from financing activities Dividends paid (2,704) (2,835) Issuance of share capital 96 83 Net movement in treasury shares and preferred securities 30 7 Redemption of preferred securities and transactions with non-controlling interests – (476) Issuance of debt 1,575 2,645 Repayments of debt outstanding (1,315) (1,863) Net cash provided by/(used in) financing activities (2,318) (2,439) Foreign currency translation effects on cash and cash equivalents 187 48 Change in cash and cash equivalents 197 436 Cash and cash equivalents as of January 1 10,162 9,726 Cash and cash equivalents as of December 31 10,359 10,162 of which: – cash and cash equivalents – Group investments 9,098 8,882 – cash and cash equivalents – unit linked 1,261 1,280
Cash and cash equivalents comprise the following: Cash at bank and in hand 6,953 5,410 Cash equivalents 3,406 4,751
As of December 31, 2012 and 2011, cash and cash equivalents held to meet local regulatory requirements were USD 1,345 million and USD 1,685 million, respectively.
Total comprehensive income for the period, net of tax – – 332 176 (1,461) 54 2,814 1,914 4 1,918 (37) 1,881
Net changes in capitalization of non-controlling interests – – – – – – – – – – 1,213 1,213
Change in ownership interests with no loss of control – – – – – – (5) (5) – (5) – (5) Total comprehensive income for the period, net of tax – – 1,724 6 (440) – 3,431 4,721 – 4,721 136 4,856
Share-based payment transactions – 22 – – – – – 22 – 22 – 22
Balance as of December 31, 2011, as previously reported 10 9,907 2,800 232 (2,632) 180 21,139 31,636 – 31,636 2,380 34,017 Total adjustments due to restatement – – – – 51 – (203) (153) – (153) 109 (44) Balance as of December 31, 2011, as restated 10 9,907 2,800 232 (2,581) 180 20,936 31,484 – 31,484 2,489 33,973
Share-based payment transactions – (34) – – – – – (34) – (34) – (34)
Net income – – – – – – 3,878 3,878 – 3,878 Net unrealized gains/(losses) on available-for-sale investments – – 1,724 – – – – 1,724 – 1,724 Cash flow hedges – – – 6 – – – 6 – 6 Cumulative foreign currency translation adjustment – – – – (440) – – (440) – (440) Net actuarial gains/(losses) on pension plans – – – – – – (447) (447) – (447)
Net changes in capitalization of non-controlling interests – – – – – – – – – – (214) (214)
1 The number of common shares issued as of December 31, 2012 was 148,300,123 (December 31, 2011: 147,385,822; December 31, 2010: 146,586,896). 2 As approved by the Annual General Meeting on March 31, 2011, the dividend of CHF 17 per share was paid out of the capital contribution reserve. The difference of
3 As approved by the Annual General Meeting on March 29, 2012, the dividend of CHF 17 per share was paid out of the capital contribution reserve. The difference of USD 840 million between the dividend at transaction day exchange rates amounting to USD 2,763 million and the dividend at historical exchange rates amounting to USD 1,923 million is reflected in the cumulative foreign currency translation adjustment.
Zurich Insurance Group Ltd and its subsidiaries (collectively the “Group”) is a provider of insurance-based products. The Group also distributes non-insurance products, such as mutual funds, mortgages and other financial services products, from selected third-party providers. The Group operates mainly in Europe, the USA, Latin America and Asia Pacific through subsidiaries, branch offices and representations.
Zurich Insurance Group Ltd (formerly known as Zurich Financial Services Ltd), a Swiss corporation, is the holding company of the Group and is listed on the SIX Swiss Exchange. Zurich Insurance Group Ltd was incorporated on April 26, 2000, in Zurich, Switzerland. It is recorded in the Commercial Register of the Canton of Zurich under its registered address at Mythenquai 2, 8002 Zurich. On April 4, 2012, Zurich Financial Services Ltd was renamed to Zurich Insurance Group Ltd in line with the streamlining of its business to concentrate on insurance. The Swiss regulator FINMA and the Joint Committee of the European Supervisory Authority have also re-designated the Group from an insurance conglomerate to an insurance group. Throughout this document, Zurich Insurance Group Ltd is used consistently even if reference is made to facts that occurred prior to the renaming of the Company.
Disclosures under IFRS 4 “Insurance Contracts” and IFRS 7 “Financial Instruments: Disclosures” relating to the nature and extent of risks, and capital disclosures under IAS 1 “Presentation of Financial Statements” have been included in the Risk Review on pages 111 to 161, and they form an integral part of the Consolidated financial statements.
The following balances are generally considered to be non-current: equity securities, real estate held for investment, investments in associates and joint ventures, deferred policy acquisition costs on life insurance contracts, deferred tax assets, property and equipment, goodwill, other intangible assets and deferred tax liabilities.
Maturity tables have been provided for the following balances: reserves for insurance contracts (tables 20a and 20b in the Risk review), liabilities for investment contracts (tables 21a and 21b in the Risk review), debt securities (table 6.4), derivative assets and derivative liabilities (tables 7.1 and 7.2), collateralized loans (table 15), other financial liabilities (table 19.2) and outstanding debt (table 21.4).
Restatements and reclassifications In 2011, the Group completed the acquisition of the life insurance, pension and general insurance operations of Banco Santander S.A. (Santander) in Brazil, Argentina, Chile, Mexico and Uruguay (see note 5). In the Group’s Consolidated financial statements 2011, total assets of USD 15.6 billion and total liabilities of USD 13.2 billion were initially included in receivables and other assets and other liabilities, respectively. The Consolidated financial statements as of December 31, 2012 include restated amounts as of December 31, 2011 to reallocate the preliminary numbers to individual balance sheet line items and for the subsequent reassessment of the initial purchase accounting. Table 1.3 shows the impact of the reclassifications as well as the updates to the initial purchase accounting on the consolidated balance sheet. Consolidated balance sheets, consolidated statements of changes in equity, consolidated statements of cash flows and notes 6, 8, 9, 12, 16, 17, 18, 19, 20, 26 and 29 have been restated accordingly.
In the course of the review related to the strengthening of reserves for losses and loss adjustment expenses in the General Insurance business in Germany, the Group determined that improper case reserving practices had resulted in errors which led to insufficient reserves for losses estimated in previous years. Additionally, the Group determined that deferred policy acquisition costs were overstated due to a system error in Germany. In aggregate, the errors identified were deemed material and have resulted in a restatement reducing total equity by USD 198 million and USD 188 million as of December 31, 2011 and January 1, 2011, respectively. For the year ended December 31, 2011 the impact on net income after taxes was a loss of USD 17 million and on business operating profit a loss of USD 18 million. The impact on various line items as of December 31, 2011 in the consolidated income statement and the consolidated balance sheet are set out in the restatement tables 1.2 and 1.3, respectively. Consolidated income statements, consolidated balance sheets, consolidated statements of comprehensive income, consolidated statements of changes in equity, consolidated statements of cash flows and notes 8, 11, 12, 20, 22 and 29 have been restated accordingly.
The Group erroneously classified certain life insurance products. The classification was corrected in 2012 as the impact on the Group’s consolidated income statement was not material. The reclassifications in the consolidated balance sheet between liabilities for investment contracts and reserves for unit-linked contracts, and between deferred policy acquisition costs and deferred origination costs are set out in notes 8, 9 and 12.
The Group previously classified certain liabilities relating to non-life insurance annuities (mainly accident insurance) as policyholder contract deposits and other funds. The classification was prospectively changed in 2012 as the reclassification has no impact on the Group’s consolidated balance sheet or income statement. The reclassifications from policyholder contract deposits and other funds to reserves for losses and loss adjustment expenses as well as future life policyholders’ benefits are set out in note 8.
Net investment income on Group investments 7,185 – 7,185 Net capital gains/(losses) and impairments on Group investments 2,182 – 2,182
attributable to policyholders 242 – 242 attributable to shareholders (1,206) 2 (1,204)
Net income after taxes 3,792 (17) 3,775 attributable to non-controlling interests 25 – 25 attributable to shareholders 3,766 (16) 3,750 in USD
Basic earnings per share 25.81 (0.11) 25.70 Diluted earnings per share 25.61 (0.11) 25.50 in CHF
Table 1.3 in USD millions, as of December 31, 2011Restatement and reclassifications of the consolidated balance sheet
Standards, amendments and interpretations effective or early adopted as of January 1, 2012 and relevant for the Group’s operations The following amendments to accounting standards and interpretations of standards relevant to the Group have been implemented for the financial year beginning January 1, 2012. The impact of adoption on the Group’s Consolidated financial statements is disclosed in table 2.1.
IFRS 12 Disclosure of Interests in Other Entities 1 1 January 2013 2013 IFRS 13 Fair Value Measurement 3 1 January 2013 2013
IAS 27 Separate Financial Statements 1 1 January 2013 2013 IAS 28 Investments in Associates and Joint Ventures 1 1 January 2013 2013
IAS 32 Offsetting Financial Assets and Financial Liabilities 1 1 January 2014 2014 1 Not expected to have a significant impact on the Consolidated financial statements.
Additionally, impact from past service cost is immaterial. 5 The impact on the Consolidated financial statements will be assessed in conjunction with the revised standard IFRS 4 "Insurance Contracts". Changes to the IFRS timetable may impact this approach
Zurich Insurance Group Annual Report 2012 179Consolidated financial statements 3. Summary of significant accounting policies
Investments in associates and partnerships where the Group has the ability to exercise significant influence but not control, as well as joint ventures where there is joint control, are accounted for using the equity method. Significant influence is presumed to exist when the Group owns, directly or indirectly, between 20 percent and 50 percent of the voting rights. Under the equity method of accounting, these investments are initially recognized at cost, including attributable goodwill, and adjusted thereafter for post-acquisition changes in the Group’s share of the net assets of the investment.
b) Foreign currency translation and transactions Foreign currency translation Due to the Group’s economic exposure to the U.S. dollar (USD), the presentation currency of the Group’s consolidated financial statements is USD. Many Group companies use a different functional currency, being the currency of the respective primary economic environment in which these companies operate. Assets and liabilities are translated into the presentation currency at end-of-period exchange rates, while income statements and statements of cash flows are translated at average exchange rates for the period. The resulting translation differences are recorded directly in other comprehensive income (OCI) as cumulative translation adjustments.
• foreign currency translation differences arising on monetary items that form part of net investments in foreign operations are included directly in OCI as cumulative foreign currency translation adjustment.
Consolidated financial statements continued c) Insurance contracts and investment contracts with discretionary participating features (DPF) Classification Contracts issued under which the Group accepts significant insurance risk and obligations arising from investment contracts with DPF are accounted for as insurance contracts.
Premiums General insurance Premiums from the sale of short-duration general insurance products are recorded when written and normally are accreted to earnings in relation to the insurance coverage provided. The unearned premium reserve represents the portion of the premiums written relating to the unexpired coverage period.
Reserves for losses and loss adjustment expenses Losses and loss adjustment expenses are charged to income as incurred. Reserves for losses and loss adjustment expenses represent estimates of future payments of reported and unreported claims for losses and related expenses with respect to insured events that have occurred. The Group does not discount its loss reserves, other than for settled claims with fixed payment terms. Any changes in estimates are reflected in the results of operations in the period in which estimates are changed.
The reserves for life benefits for participating traditional life insurance policies are calculated using a net level premium valuation method based on actuarial assumptions taking into account guaranteed mortality and interest rates.
For products managed on a dynamic basis, an option in IFRS 4 is used to measure the insurance liabilities using current financial and non-financial assumptions, to better reflect the way that these products are managed. Financial assets relating to these liabilities are designated as “fair value through profit or loss”.
DAC for investment type insurance contracts such as universal life, unit-linked and unitized with-profits contracts is amortized over the life of the contracts based on estimated gross profits expected to be realized over the life of the contract. Estimated gross profits are updated for actual and anticipated future experience using either the interest rate in effect at the inception of the contracts or the latest revised interest rate for the remaining benefit period, depending on whether crediting is based on the policyholder’s or on the reporting entity’s investment performance. Resultant deviations are reflected in income.
General insurance For general insurance contracts, unearned premiums are tested to determine whether they are sufficient to cover related expected losses, loss adjustment expenses, policyholder dividends, unamortized DAC and maintenance expenses using current assumptions and considering anticipated investment returns. If a premium deficiency is identified, the DAC asset for the respective grouping of contracts is written down by the amount of the deficiency. If, after writing down the DAC asset to nil, a premium deficiency still exists for the respective grouping of contracts, then a premium deficiency reserve is established for the amount of the remaining deficiency.
Loans and receivables Loans and receivables are financial assets with fixed or determinable payments that are not quoted in an active market and are not classified in any of the other categories.
Consolidated financial statements continued short-term investments with maturities of three months or less from the date of acquisition. Cash and cash equivalents also includes cash received as collateral for securities lending. Cash and cash equivalents are stated at face value.
Impairment of financial assets (excluding derivative financial instruments) General The Group assesses at each reporting date whether there is objective evidence that loss events occurred which negatively affect the estimate future cash flows of a financial asset or group of financial assets.
Objective evidence of impairment exists if it is probable that the Group will not be able to collect principal and/or interest due according to the contractual terms of the instrument. When impairment is determined to have occurred, the carrying amount of held-to-maturity investments, loans or receivables is reduced through the use of an allowance account, and the movement in the impairment allowance is recognized as an impairment loss in income. The impairment allowance of financial assets carried at amortized cost is measured as the difference between the amortized cost of the assets and the present value of estimated future cash flows, calculated using the original effective interest rate, for fixed rate financial assets, or current effective interest rate, for variable rate financial assets. If the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment loss was recognized, the impairment loss is reversed through income. The amount of reversal is limited so that it does not result in a carrying amount exceeding the amortized cost that would have been calculated at the date of reversal had the impairment not been previously recognized.
Net investment hedges Measurement of hedge effectiveness is based on changes in forward rates. Gains and losses on the designated hedging derivative relating to the effective portion of the hedge are directly recognized in OCI whereas the ineffective portion is immediately recognized in income. The accumulated gains and losses on the hedging instrument in OCI are reclassified to income on disposal of the foreign operation.
The securities delivered under a repurchase agreement are not derecognized from the balance sheet when all or substantially all of the risk and rewards are retained. The proceeds received are reported as a liability under obligation to repurchase securities. Interest expense is charged to income using the effective interest rate method over the life of the agreement.
In cases such as events of default by a third party, it may be determined that the risks and rewards of ownership over the collateral have been obtained by the Group. At such point in time, the securities held under the reverse repurchase agreement would be recognized on the balance sheet at fair value and the original receivable as collateral would be derecognized. Any shortfall is recorded as a loss in income.
Intangible assets with definite lives are carried at cost less accumulated amortization and impairments. They are amortized using the straight-line method over their useful lives and reviewed for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.
Intangible assets with indefinite lives are not subject to amortization but are tested for impairment annually and whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.
Goodwill on the acquisition of subsidiaries is capitalized as a separate line and reviewed for impairment annually, or more frequently if impairment indicators are observed. For the purpose of impairment testing, goodwill is allocated to cash generating units (CGU) based on the level at which management monitors operations and makes decisions relating to the continuation or disposal of assets and operations. On this basis, as of January 1, 2011, the Group aggregates CGUs on a General Insurance segment level. Within the segments Global Life and Farmers, CGUS are identified at either business unit level or individual reporting entity level.
Present value of future profits from acquired insurance contracts (PVFP) An intangible asset representing the PVFP arises from the acquisition of life insurance businesses. Such an asset has a definite life and is amortized over the expected life of the acquired contracts, following the same rules outlined for deferred acquisition costs. The carrying value of the PVFP asset is tested periodically for impairment as part of the liability adequacy test for insurance contracts.
k) Provisions, contingent liabilities, commitments and financial guarantees Provisions, contingent liabilities, commitments and financial guarantees are recognized when the Group has a present obligation (legal or constructive) as a result of a past event, it is more likely than not 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 such an obligation. Provisions are discounted when the effect of the time value of money is considered material.
Rental income from real estate held for investment is recognized on an accrual basis.
Under the Group’s equity-settled share-based compensation plans, the fair value of the employee services received in exchange for the grant is determined by reference to the fair value of the shares and/or options previously granted and is recognized as an expense in income over the vesting period, with a corresponding amount recorded in additional paid-in capital.
Non-market vesting conditions (for example, profitability and revenue growth targets) are included in assumptions to determine the number of shares and/or previously options that are expected to be issued or become exercisable. At each balance sheet date, the Group revises its estimates of the number of shares and/or options that are expected to be issued or become exercisable. It recognizes the impact of the revision to original estimates, if any, in income with a corresponding adjustment to additional paid-in capital. However, no subsequent adjustment to total additional paid-in capital is made after the vesting date.
a) Reserves for insurance contracts and deferred acquisition costs The Group is required to establish reserves for payment of losses and loss adjustment expenses that arise from the Group’s general insurance products and the run-off of its former third party reinsurance operations. These reserves represent the expected ultimate cost to settle claims occurring prior to, but still outstanding as of, the balance sheet date. The Group establishes its reserves by product line, type and extent of coverage and year of occurrence. There are two categories of loss reserve: reserves for reported losses and reserves for incurred but not reported (IBNR) losses. Additionally, reserves are held for loss adjustment expenses, which contain the estimated legal and other expenses expected to be incurred to finalize the settlement of the losses.
The Group uses a number of accepted actuarial methods to estimate and evaluate the amount of reserves recorded. The nature of the claim being reserved for and the geographic location of the claim influence the techniques used by the Group’s actuaries. Additionally, the Group’s Corporate Center actuaries perform periodic reserve reviews of the Group’s businesses throughout the world. Management considers the results of these reviews and adjusts its reserves for losses and loss adjustment expenses, where necessary.
The reserves for future life policyholders’ benefits and policyholders’ contract deposits and other funds contain a number of assumptions regarding mortality or longevity, lapses, surrenders, expenses and investment returns. These assumptions can vary by country, year of issuance and product and are determined with reference to past experience adjusted for new trends, current market conditions and future expectations. As such the liabilities for future life policyholders’ benefits and policyholders’ contract deposits may not represent the ultimate amounts paid out to policyholders. For example: • The estimated number of deaths determines the value of the benefit payments. The main source of uncertainty arises because of the potential for pandemics and wide-ranging lifestyle changes, such as changes in eating, smoking and exercise habits, which could result in earlier deaths for age groups in which the Group has significant exposure to mortality risk.
• Assumptions are determined with reference to current and historical client data, as well as industry data. Interest rate assumptions reflect expected earnings on the assets supporting the future policyholder benefits. The information used by the Group’s qualified actuaries in setting such assumptions includes, but is not limited to, pricing assumptions, available experience studies and profitability analysis.
In determining the fair values of available-for-sale financial assets and financial assets at fair value through profit or loss, the Group makes extensive use of third party pricing providers and only in rare cases places reliance on prices that are derived from internal models. One of the objectives of the Group’s control environment and the process of selection of pricing providers is to ensure that fair values of investments are sourced only from independent, reliable and reputable third party pricing providers that have proper processes and controls in place to guarantee that the price quality meets the high standards that the Group expects.
Investment accounting, operations and process functions, are completely independent from those responsible for buying and selling the assets, and are responsible for receiving, challenging and verifying values provided by third party pricing providers to ensure that fair values are reliable and comply with applicable accounting and valuation policies. The quality control procedures used depend on the nature and complexity of the invested assets and include regular reviews of valuation techniques and inputs used by pricing providers (for example, default rates of collateral for asset backed securities), variance and stale price analysis and comparisons with fair values of similar instruments and with alternative values obtained from asset managers and brokers.
Fair values of debt instruments issued by government entities and corporate entities are obtained from third party pricing providers. The fair value received from these pricing providers may be based on quoted prices in an active market for identical assets, alternative pricing methods such as matrix pricing or alternatively, based on an income approach employing discounted cash flow models.
The Group holds certain asset classes that are not actively traded, in particular hedge funds and private equity investments. Fair values of such instruments are obtained from net asset value information and audited financial statements provided by the issuing hedge funds and private equity funds. Performance of these investments and determination of their fair value are monitored closely by the Group’s in-house investment professionals.
Fair value of real estate held for investment is based on valuations performed annually by internal valuation specialists and generally on a rotation basis at least once every three years by an independent qualified appraiser. The valuation methods applied are income capitalization, discounted cash flow analysis, and market comparables taking into account the actual letting status and observable market data.
Fin an cial info rm atio n c) Fair values of assets and liabilities attributable to business combinations Acquired businesses are accounted for using the purchase method of accounting which requires that the assets acquired and liabilities assumed are recorded at the date of acquisition at their respective fair values. Fair values of financial assets and liabilities and insurance liabilities are determined as described in the respective sections above.
Table 4.1 sets out the applied discount rates and the perpetual nominal growth rates (PGR) beyond the projection period which are dependent on country specific growth rate and inflation expectations for the major CGUs.
Distribution agreements The recoverable amount for General Insurance intangible assets reflecting distribution agreements is determined on the basis of value-in-use calculations. These calculations use cash flow projections in line with the terms and conditions of the underlying distribution agreements. For Global Life business distribution agreements, the recoverable amount is determined based on projected cash flows and discount rates consistent with the data used for actuarial valuations.
Table 4.2 sets out the applied discount rates and the PGR beyond the projection period which are dependent on country specific growth rate and inflation expectations for the major distribution agreements.
For impairment testing purposes these distribution agreements are assessed as single assets by counterparty.
In light of the current economic conditions in Spain the Group, in particular, monitors whether the actual performance of the distribution agreements with Banco Sabadell S.A. are in line with the business plans.