Operational highlights Solid balance sheet refl ected by the Group’s Solvency I ratio of more than 150 percent
Discipline-fi rst investment strategy produces 1.0 percent total investment return despite historically challenging conditions
Growth in all business segments, including acquisitions to fuel further growth in Brazil, Russia, Spain and Turkey
Delivering when it matters Our customers know that we are there when they need us, around the world or around the corner, to help them manage their risks in an uncertain world.
Diluted earnings per share (in USD) 21.63 39.29 (45%) Diluted earnings per share (in CHF) 23.35 47.11 (50%) Book value per share (in CHF) 167.92 229.39 (27%)
Return on common shareholders’ equity (ROE) 12.1% 21.3% (9.2 pts) Business operating profi t (after tax) return on common shareholders’ equity 16.8% 18.9% (2.1 pts)
Functions 1 Restated because of the change in accounting policy for three disability blocks of business, at Centre.
General Insurance – combined ratio in %, for the years ended December 31
General Insurance is the biggest of our three segments. It provides property and casualty products and services for individual and commercial customers. Its business model is to provide a global platform – including product management, claims management, distribution management, underwriting and customer relationship services – for local business delivery.
Through Farmers Management Services, our Group manages the Farmers, Foremost and Bristol West range of products in the United States. Farmers also provides business insurance, with a focus on the small commercial market.
#2 in direct auto insurance in Japan based on gross written premiums 2007 Source: Fiscal results 2007
#3 in commercial insurance in the U.S. (including Farmers Exchanges) based on direct premiums written 2007 Source: A.M. Best 6835_p004-017.indd 46835_p004-017.indd 4 27/2/09 13:20:2727/2/09 13:20:27
#1 in worldwide expatriate protection based on APE 2007 Source: NBER
#1 in unit-linked savings in Germany based on APE 2007 Source: GDV and Tillinghast FLV Update 2007
#2 in unit-linked single premiums in Switzerland based on gross written premiums 2007 Source: SVV
Provides homeowner, auto and life insurance for individuals in the U.S. We manage, but do not own, the Farmers Exchanges in the U.S.
Zurich’s success amidst these historic market conditions rests on its long-standing commitment to fi nancial discipline and operational excellence. As we apply those strengths to profi table growth, we are systematically pursuing customer, product and distribution strategies that build on the Group’s global strengths and give focus to our market efforts. Delivering these strategies is a world-class talent pool, strengthened by a brand that continues to gain in recognition, and underpinned by a robust enterprise-wide risk management framework that serves as the foundation for an informed and disciplined decision-making process.
Our roughly USD 185 billion investment portfolio generated a positive 1.0 percent total return in 2008, demonstrating the value of our investment management philosophy. This result, in our opinion, is outstanding given the adverse market conditions.
In a diffi cult market environment each of our three business segments posted impressive profi table growth gains, with General Insurance showing encouraging signs of targeted growth, Global Life overcoming an unsettled customer base to meet its double-digit APE targets, and the Farmers Exchanges, which we manage but do not own, outpacing its peers with strong profi table growth.
Even against historically challenging market conditions, our strategy holds us in good stead, building solid value for shareholders – and an enhanced competitive position for Zurich.
The Zurich Way exceeded its target of USD 800 million in planned benefi ts for 2008, setting the stage for an increase and expansion of the targets over the next three years. Furthermore, the consistency of The Zurich Way operating platforms is creating signifi cant value in our post-acquisition integration efforts, as the 15 transactions announced over the past two years benefi t from our best-practice approaches and serve as sources of new knowledge for the broader Group.
In anticipation of continued turbulence in the global fi nancial markets, it will remain critical that we preserve the strength of our balance sheet. As an insurer, our capital base supports our strategy, and in order for us to continue delivering for our customers we must remain vigilant in our operating and fi nancial discipline.
In closing, we must express our pride in the people who delivered Zurich’s strategy in 2008, despite the most disruptive fi nancial market in generations. It is because of those people that we remain confi dent in our ability to turn adversity into opportunity and emerge from this period of market disruption as a true global leader.
Market review 2008 saw the destruction of wealth on a staggering scale. As the prices of U.S. homes started to falter, doubts arose throughout the global fi nancial system. Banks became weaker, private credit markets stopped functioning, and by the end of the year it was clear that the world had sunk into a global recession. In addition to the challenging fi nancial environment, insurers will remember 2008 as a year when natural and man-made catastrophes caused more than USD 200 billion in losses, making it the third most expensive year for catastrophe losses in our industry’s history.
So through our markets as well as our environment, 2008 proved beyond doubt that we are living in a world of unprecedented globalization, interdependence and change. At Zurich we have long recognized this fact, so we have long been at work in building a company that is fi t for the challenge, demonstrating a deep appreciation for risk in all its forms. Our customers rely on us as their ultimate bearer of risk, and it is our duty to be prepared to deliver when it matters, no matter what.
At Zurich risk tolerances are known throughout the Group, specifi ed in our policies and followed by our procedures, consistently across all businesses and geographies. The authority to take specifi ed risks is entrusted to clearly designated offi ces, and the procedures for communicating risk issues to our Management and our Board are clear. We assess known or new risks systematically and strategically, continually strengthening our policies and procedures by absorbing new insights. We are proud of the living culture of disciplined risk taking in which we at Zurich all take part, a culture which both informs and protects our business.
our investments relative to liabilities, targeting superior risk-adjusted returns and executing through a clear, structured and disciplined investment process. Our centrally driven investment strategy is based on a clear and shared investment philosophy that draws on the capabilities of external asset managers and our own risk management capabilities. We strive to ensure not only that risks in the portfolio are well balanced and diversifi ed, but that every risk we take is fully understood and adequately rewarded. Avoiding short-term trading and opportunistic investing, our continuing commitment to fi nancial discipline and risk management has served us well during the recent market dislocation. In the face of further market uncertainty we remain committed to investing according to this proven strategy.
The way ahead Our Group Chief Economist projects that, for 2009, the globally synchronized downturn will likely be severe and protracted. The impact of this downturn will affect different lines in different ways. Greater demand for private savings should favor our Life business, which has been a leader in our Group in responding to market conditions. The more price-sensitive segments of the general insurance market will likely benefi t from moderating or improving rate environments, as the effects of capital constraints, catastrophe losses and rising claims expenses combine to increase the cost of risk, primarily in the commercial and corporate sectors.
The conditions for success across all these fronts change continuously, so we focus our operational capabilities on four strategic cornerstones, each one embedded deep across our Group through an institutional commitment to excellence: Profi table growth focuses on customer, proposition, and distribution excellence and on growth in our target markets, organically and through acquisitions.
Operational transformation is the planned and systematic evolution of how we execute, focusing on customers, effectiveness and effi ciency.
People management means placing the right people with the right skills in the right place at the right time.
Knowing that we have taken a systematic view on risk, we are then free to deploy our operational capabilities to pursue those opportunities that best refl ect our strategy, and where external conditions are most encouraging. Once those opportunities are identifi ed, we systematically drill down to the tactics that can help us establish lasting leadership in those chosen markets.
While our outlook on the external environment was inescapably colored by the fi nancial crisis in 2008, our vision goes well beyond the headlines.
We monitor major long-term trends to help us defi ne our strategic choices. For example, some of the issues that factored into our planning in 2008 included the rise of major emerging markets, aging in industrialized countries, the scarcity of talent, and other trends from both within and outside our industry that are likely to shape the competitive landscape for years to come.
That effort has been highly successful in its immediate aims, refi ning our analysis of growth opportunities and instilling a confi dent approach to decision-making, but its more lasting contribution has been to bolster our Group with an infrastructure for the steady and systematic pursuit of profi table growth, led by senior management across our three segments and reaching deep into the businesses where profi table growth is ultimately achieved.
Through operational transformation we continue to build strength at our core – in such areas as risk management, investment management, underwriting and reserving – while maintaining fl exibility, dynamism and innovation in our chosen markets. Operational transformation is now deeply embedded in the Zurich culture, operating at fundamental, strategic, and tactical levels. The foundation for operational transformation was laid fi ve years ago with The Zurich Way, where we set out a vision of common language, common measures, common behaviors and shared services across our Group.
At the end of 2008 our organization is truly living the spirit of operational transformation by beginning the process all over again. Now that our organization is in shape to deliver in a coordinated fashion, our global leaders are looking across their businesses, outlining where they see their units going over the next fi ve years – what their operations will look like, and what they need the rest of the Group to do for them. This process of articulating target operating models is the fi rst step of our journey for the next fi ve years.
Zurich is a global company engaged in a very competitive, very complex people-oriented business. That means that while we enjoy the advantage of offering exceptionally mobile career paths (both geographically and professionally), the challenge of creating consistent global standards and managing our workforce strategically is substantial.
We are also constantly working on building a workforce that refl ects our customer population. As we expand our business into an ever greater diversity of markets, we need to keep building the talent to match. Eighteen nationalities are represented in our Group’s key positions, and we are committed to increasing that number as our business expands.
Board of Directors 1 Manfred Gentz Chairman of the Board, Chairman of the Governance and Nominations Committee, Member of the Remuneration Committee 2 Philippe O. Pidoux Vice Chairman of the Board, Member of the Governance and Nominations Committee, Member of the Remuneration Committee 3 Susan Bies Director, Member of the Risk Committee 4 Victor L.L. Chu Director, Member of the Governance and Nominations Committee 5 Thomas K. Escher Director, Member of the Remuneration Committee 6 Fred Kindle Director, Member of the Audit Committee 7 Armin Meyer Director, Member of the Risk Committee, Member of the Governance and Nominations Committee 8 Don Nicolaisen Director, Chairman of the Audit Committee, Member of the Risk Committee 9 Vernon L. Sankey Director, Chairman of the Remuneration Committee 10 Tom de Swaan Director, Member of the Audit Committee, Chairman of the Risk Committee 11 Rolf Watter Director, Member of the Audit Committee
7 Axel P. Lehmann Group Chief Risk Offi cer 8 Patrick O’Sullivan Chief Growth Offi cer 9 Geoff Riddell Chief Executive Offi cer 2 Global Corporate 10 Martin Senn Chief Investment Offi cer 11 Dieter Wemmer Chief Financial Offi cer 12 Paul van de Geijn Chief Executive Offi cer Global Life 3
Governance18 Financial Report 2008 Zurich Financial Services Group Annual Report 2008
An effective structure is in place providing for cooperation between the Board of Directors, Management and internal control functions. This structure establishes checks and balances and is designed to provide for institutional independence of the Board of Directors from the Group Chief Executive Offi cer (CEO) and the Group Executive Committee (GEC), responsible for managing the Group on a day-to-day basis. The Board of Directors of Zurich Financial Services is composed entirely of independent non-executive members. The roles of Chairman of the Board of Directors and CEO are separated, thus providing for separation of powers between the functions and ensuring the autonomy of the Board.
Group structure and shareholders Operational Group structure Zurich Financial Services, the Group’s holding company, is a Swiss corporation organized in accordance with the laws of Switzerland.
Farmers Management Services which through Farmers Group, Inc. and its subsidiaries (FGI) provides non-claims related management services to the Farmers Exchanges, prominent writers of personal lines and small commercial lines business in the United States. FGI receives fee income for the provision of services to the Exchanges, which we manage, but do not own, and to their customers.
A detailed review of the respective business segment and division results during 2008 can be found in the Financial review starting on page 64. Furthermore, an overview of the Group’s business strengths and activities is contained in the Business Review, available on Zurich’s Web site www.zurich.com ( business_review_2008_en.pdf).
Zurich Financial Services is listed on the SIX Swiss Exchange. Certain Group companies have listed debt issues under the Euro Medium Term Note Programme and other fi nancial instruments.
A list of the Group’s signifi cant subsidiaries including additional information on signifi cant subsidiaries that are listed can be found in this Financial Report on pages 236 to 238. For further information on the share listing of Zurich Financial Services, please refer to the shareholder information on pages 292 to 293.
Significant shareholders As of December 1, 2007 the rules regarding disclosure of signifi cant shareholdings in Swiss companies listed in Switzerland were amended. Since that date, disclosure has to be made if certain thresholds are reached or fallen below, starting at 3 percent. Call options and other fi nancial instruments are to be added to any position in shares, 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.
Capital structure Share capital As of December 31, 2008, the ordinary share capital of Zurich Financial Services amounted to CHF 14,212,262.00 divided into 142,122,620 fully paid registered shares with a nominal value of CHF 0.10 each. The Board of Directors will propose to the shareholders at the Annual General Meeting on April 2, 2009 a regular dividend of CHF 11.00 per share before tax.
Authorized and contingent share capital As of December 31, 2008, the Board of Directors of Zurich Financial Services has authority to increase the share capital by CHF 600,000, representing 6,000,000 registered shares with a nominal value of CHF 0.10 each by no later than June 1, 2010. Zurich Financial Services also has a contingent share capital of CHF 548,182.80 representing 5,481,828 registered shares with a nominal value of CHF 0.10 each to increase its share capital by exercising conversion and/or option rights which are granted in connection with the issuance of bonds or similar debt instruments by Zurich Financial Services or one of its Group companies in national or international capital markets; and/or option rights which are granted to the shareholders. Moreover, there is an additional contingent share capital of CHF 319,427.90, representing 3,194,279 registered shares with a nominal value of CHF 0.10 each, which may be issued to employees of the Group.
During the year 2007, 797,421 shares were issued to employees. As a result, on December 31, 2007, the share capital amounted to CHF 14,554,682.00 (145,546,820 shares) and the contingent share capital amounted to CHF 548,182.80 (5,481,828 shares) and CHF 320,257,90 (3,202,579 shares), respectively.
During the year 2008, 8,300 shares were issued to employees out of contingent share capital. As a result, on December 31, 2008 the share capital amounted to CHF 14,212,262.00 (142,122,620 shares) and the contingent share capital amounted to CHF 548,182.80 (5,481,828 shares) and CHF 319,427.90 (3,194,279 shares), respectively.
Capital reduction by canceling shares that have been bought back under the share buyback program announced on February 15, 2007 343,250.00 3,432,500 0.10 Newly issued shares from contingent capital 830 8,300 0.10
2 Zurich Financial Services has established an American Depositary Share, or ADS, level 1 program in the United States. Under the program, The Bank of New York Mellon issues the ADSs. Each ADS represents the right to receive one-tenth of one Zurich Financial Services share. Each ADS also represents securities, cash or other property deposited with The Bank of New York Mellon but not distributed to ADS holders. ADSs are traded over the counter (OTC) and evidenced by American Depositary Receipts, or ADRs. ADS holders are not treated as shareholders of Zurich Financial Services and are not able to directly enforce or exercise shareholder rights. Only the Bank of New York Mellon as depositary may exercise voting rights with respect to instructions received from benefi cial owners of ADRs.
Registration as a shareholder requires a declaration that the shareholder has acquired the shares in his or her own name and for his or her own account. Nominees holding Zurich Financial Services’ shares may for the benefi t 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 benefi cial owner. A nominee is, however, 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 benefi cial owner and to inform the benefi cial owners about corporate actions, to consult as to the exercise of voting rights and pre-emptive rights, to transfer dividends and to act in the interests and in accordance with the instructions of the benefi cial owner.
Vernon Sankey British 59 Director Chairman of the Remuneration Committee 19981 2009
Rolf Watter Swiss 50 Director Member of the Audit Committee 2002 2010 1 Mr. Pidoux has served on the board of Zurich Insurance Company since 1997. In 1998, after the merger between B.A.T. Financial Services and Zurich Insurance Company (the “Merger”), he assumed offi ce as member of one or more boards of the then Group holding structure consisting of Zurich Group Holding (then called Zurich Financial Services), Allied Zurich p.l.c. and Zurich Allied AG. The Group structure was reorganized in October 2000 (“Unifi cation”). Mr. Sankey was also a member of several boards of the Group holding structure that was established with the Merger. Since Unifi cation both have served on the Board of Zurich Financial Services.
Members of the Board of Directors, as of 6836_p018-043.indd 256836_p018-043.indd 25 27/2/09 13:23:5927/2/09 13:23:59
Thomas Konrad Escher graduated in electrical engineering and in business administration from the Swiss Federal Institute of Technology (ETH) and joined IBM in 1974. In subsequent years, his career led him through various managerial line functions with responsibilities for markets and client relationships overseas, in different European countries and in Switzerland. In 1996, Mr. Escher joined Swiss Bank Corporation and was – as a member of the executive board – CEO for the major market region in Switzerland and for the information technology organization. Since 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 through mid-2005 as a member of the group managing board. As of July 1, 2005, Mr. Escher assumed the function of vice chairman in the Business Group Global Wealth Management & Business Banking of UBS AG. In addition, Mr. Escher is a member of the board of the Greater Zurich Area Foundation. This organization engages in the active marketing of the City of Zurich and its relevant environment as domicile to foreign business.
Armin Meyer graduated with a PhD in electrical engineering from the Swiss Federal Institute of Technology (ETH) and joined BBC Brown Boveri Ltd. in 1976 as a development engineer. In 1980, he became head of research and development for industrial motors, and in 1984, he took over as head of the international business unit for electrical power generators. In 1988, Mr. Meyer became president of ABB Drives Ltd. and in 1992, president of ABB Power Generation Ltd. 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. From Janaury 1, 2001 until December 31, 2007 he in addition acted as chief executive offi cer. Mr. Meyer is a member of the foundation board of the International Institute for Management Development, IMD, in Lausanne, Switzerland, and of the board of the European Chemical Industry Council (Cefi c) in Brussels, Belgium.
Tom de Swaan graduated from the University of Amsterdam with a master’s degree in economics. 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 fi nancial offi cer of ABN AMRO Bank. He retired from ABN AMRO on May 1, 2006, but continued as an advisor to the managing board until June 2007. Mr. de Swaan is a nonexecutive member of the board of GlaxoSmithKline Plc and chairman of its audit committee. He is a member of the supervisory board of Royal DSM, a Netherlands-based chemical group. Since May 3, 2007, he is also the vice-chairman of the supervisory board of Royal Ahold, a global retail chain, and since May 10, 2007, he is chairman of the supervisory board of Van Lanschot NV, the holding company of F. van Lanschot Bankiers, an independent Dutch bank. From 1987 to 1988, he 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. Mr. de Swaan is also a director of a number of non-profi t organizations. Among others he is treasurer of the board of the Royal Concertgebouw Orchestra, the Netherlands Cancer Institute and the International Franz Liszt Piano Competition. Moreover, he chairs the advisory board of the Rotterdam School of Management.
The Board consists entirely of Directors who are non-executive, independent of 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 fi ndings to the Board for fi nal determination. Board members are also subject to rules and regulations to avoid confl icts of interest and the use of inside information. A self-assessment of the full Board is carried out once a year. In 2008, the Board’s self-assessment was carried out on the basis of a comprehensive questionnaire. A detailed report was produced for and considered by the Board.
The CEO attends the Board meetings ex offi cio. By invitation, Board meetings are attended by the members of the GEC on a regular basis. Other executives attend these meetings from time to time. The majority of Board meetings include private sessions of the Board, without the participation of Management.
The Board may appoint committees for specifi c areas from among its members and establish terms of reference and rules with respect to delegated authority and to reporting to the Board. The committees assist the Board in performing its duties. To the extent that the committees are not authorized to take resolutions, they discuss and propose matters to the Board for taking the appropriate actions and passing resolutions before such matters are brought to the Board. The Board has the following standing committees, which regularly report to the Board and submit proposals for resolutions to the Board. On average, committee meetings lasted between one and three hours.
Areas of responsibility of the Board and Management In addition to determining the overall strategy of the Group and the supervision of senior management, the Board addresses key matters in the area of strategy, fi nance, structure and organization and business development. The Board approves the Group strategic plan and the annual fi nancial plans developed by Management and reviews and approves the annual, half-year and quarterly fi nancial statements of Zurich Financial Services and the Group. It establishes guidelines for overall business policies and capital allocation and approves major changes in the Group’s business activities, including major lending and borrowing transactions and major business developments, such as acquisitions or disposals of businesses or assets, investments or new businesses, mergers, joint ventures and cooperations. The Board also considers other matters of strategic importance to the Group.
Subject to the powers reserved to the Board as set out above, the Board has delegated the management of the Group to the CEO. The CEO and, under his leadership, the GEC are responsible for the development and execution of the strategic and fi nancial plans approved by the Board. The CEO has specifi c powers and duties relating to strategic, fi nancial and other matters as well as to the structure and organization of the Group and manages, supervises and coordinates the activities of the members of the GEC. The CEO ensures that appropriate management tools for the Group are developed and implemented and represents the overall interests of the Group against third parties. The CEO holds delegated authority to approve certain acquisitions and divestments of businesses and assets, investments and the establishment of new businesses, mergers, joint ventures or cooperations.
The Group has an information and fi nancial reporting system in place. The annual plan for the Group, which includes a summary of fi nancial and operational metrics, is reviewed by the GEC in detail and approved by the Board. Monthly plan updates are prepared to compare actual performance to the plan. Full-year forecasts are revised if necessary to refl ect changes in sensitivities and risks that may impact the results of the Group. Action is taken, where appropriate, when variances arise. This information is reviewed by the GEC on a monthly basis and by the Board on a quarterly basis.
Furthermore, the Group has adopted and implemented a coordinated, formalized and consistent approach to risk management and control. Information concerning the Group’s risk management processes is included in the Risk review starting on page 90.
The process and the results of this approach are further described on page 41 under the Internal control statement.
The GEC is headed by the CEO. As of December 31, 2008 members of the GEC included the Chief Financial Offi cer, the Chief Investment Offi cer, the Chief Growth Offi cer, the Group Chief Risk Offi cer and the heads of the business segments – General Insurance, Global Life and Farmers Management Services. In addition, the heads of the following businesses are members of the GEC: North America Commercial, Global Corporate and Europe General Insurance.
In addition, to enhance its understanding and assessment of the challenges and risks Zurich may face, the Group increasingly seeks external expertise and perspective. As of the end of 2008 the Group had four 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. They 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 and GMB 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. The Group’s Climate Change Advisory Council provides insight and advice on issues associated with climate change.
All current members of the GEC served throughout the year 2008.
Biographies James J. Schiro graduated from St. John’s University, New York, with a bachelor’s degree in business administration. He holds an honorary Doctor of Commercial Science degree from the same university. After qualifying as a certifi ed public accountant, he joined Price Waterhouse in 1967 and held various management positions before becoming chairman and senior partner of the U.S. fi rm in 1994. After the merger of Price Waterhouse and Coopers & Lybrand in 1998, he became global chief executive offi cer of PricewaterhouseCoopers. He joined Zurich in March 2002 as Chief Operating Offi cer – Group Finance and was appointed Chief Executive Offi cer of the Group two months later. He is a member of the board of directors of PepsiCo. and the supervisory board of Royal Philips Electronics. He is also a member of the boards of the Swiss American Chamber of Commerce, The Geneva Association, and the Institute of International Finance, as well as a member of the European Financial Services Round Table and the Business Council of the World Economic Forum. Additionally, he serves as vice chairman of the American Friends of the Lucerne Festival and is a member of the board of trustees of the Lucerne Festival. Furthermore, he is a member of the boards of trustees of St. John’s University, New York, the Institute of Advanced Study in Princeton, New Jersey, and sits on the advisory board of the Tsinghua School of Economics and Management in Beijing, China, as well as on various other boards.
John J. Amore graduated with a degree in management from Embry-Riddle Aeronautical University, Daytona Beach (U.S.), and with an MBA in fi nance from New York University. Before joining Zurich in 1992, he was vice chairman of the Commerce and Industry Insurance Company, a member company of American International Group (AIG). He later became Chief Executive Offi cer of the Zurich U.S. Specialties business unit and was appointed Chief Executive Offi cer of Zurich U.S. in December 2000. In July 2001 he became a member of the GEC and was appointed CEO of Zurich North America Corporate business division. He held this position until end of August 2004. In April 2004 he was appointed CEO of the General Insurance business segment, and since September 2004 he has been concentrating on this global leadership role. Mr. Amore served as chairman of the American Insurance Association and was a member of its board from 2001 until March 2008. He serves as a member of the board of overseers for the School of Risk Management, Insurance and Actuarial Science at St. John’s University in New York. He is an elected partner for the Partnership for New York City, an organization dedicated to maintaining the city’s position as a global center of commerce and innovation and serves on the U.S. Chamber of Commerce’s board of directors.
offi cer, remaining in the position for four years. He was appointed head of Allianz’s Life Sustainability business in Munich in 2004, and later that year he was appointed to Allianz AG’s executive board, with responsibility for France, Italy, Spain, Portugal, Greece and Turkey. In April 2005, he joined the Sanpaolo IMI Group in Milan as the chief executive offi cer of EurizonVita, formerly named Aip, as part of a project to build up the Group’s insurance and asset management businesses. In October 2005, he was appointed chief executive offi cer of EFG, the company holding the Sanpaolo IMI Group’s investments in EurizonVita and Banca Fideuram, and Eurizon Capital. He joined Zurich on October 1, 2007 as the designated CEO Global Life and became a member of the GEC. He is also a member of the Board of Directors of Editoriale l’Espresso Group, Indesit, Saras and Bocconi University, Milan.
Axel P. Lehmann graduated with an MBA and PhD from the University of St. Gallen in Switzerland. After several U.S. research studies, he wrote a post-doctorate certifi cation at the University of St. Gallen and subsequently completed the Wharton Advanced Management Program. He was a lecturer at several universities and institutes and became vice president of the Institute of Insurance Economics at the University of St. Gallen and the European Center responsible for Consulting and Management Development. He was head of Corporate Planning and Corporate Controlling for Swiss Life before he joined Zurich in 1996 and held various executive management and corporate development positions within Zurich Switzerland. He became a member of the Group Management Board responsible for Group-wide Business Development functions in November 2000. In September 2001, he was appointed Chief Executive Offi cer of the former Northern European region and subsequently Chief Executive Offi cer of the Zurich Group, Germany. In March 2002, he became CEO of the Continental Europe business division and a member of the GEC. In 2004, he was in charge of the consolidation of the United Kingdom and Ireland division with the Continental Europe division and assumed responsibility as CEO for the creation of the integrated Europe General Insurance business division. In September 2004, he became CEO of Zurich North America Commercial in Schaumburg/Chicago. In January 2008 he assumed his current role as Group Chief Risk Offi cer with additional responsibility for Group IT. Mr. Lehmann is an honorary professor for business administration and service management and chairman of the board of the Institute of Insurance Economics at the University of St. Gallen in Switzerland.
Dieter Wemmer holds a PhD and a master’s degree in mathematics from the University of Cologne. From 1983 until 1986, he worked in pure mathematics at the universities of Cologne and Oxford. In 1986, he joined Zurich Re (Cologne), at that time a reinsurance subsidiary of Zurich’s German operation Agrippina, as a pricing actuary for life reinsurance. He became Head of Life Reinsurance and Chief Actuary fi ve years later. From 1992 until 1996, Mr. Wemmer held various positions with Agrippina, joining the management board in 1995 responsible for Controlling/ Planning, Communication and Real Estate management. He was seconded to Zurich’s Corporate Center in 1996 as project manager for the implementation of International Accounting Standards (IAS) and US Generally Accepted Accounting Principles (US GAAP). One year later, he became Head of Financial Controlling. From 1999 until May 2003, he was Head of Mergers and Acquisitions, with additional responsibility for capital management and General and Life 6836_p018-043.indd 366836_p018-043.indd 36 25/2/09 14:26:1325/2/09 14:26:13
Actuarial from 2002. He became Chief Operating Offi cer of the Europe General Insurance business division in May 2003. In November 2004, he was appointed CEO Europe General Insurance and became a member of the Group Executive Committee. Since March 2007, he has assumed his current role as Chief Financial Offi cer of Zurich Financial Services Group. Mr. Wemmer is a member of the board of economiesuisse.
Group Management Board Members of the GEC are also part of the Group Management Board (GMB), which includes the heads of certain business units and Group functions. The GMB primarily focuses on communication, capability building and development of the Group, represents the businesses and functions and serves to foster horizontal collaboration throughout the Group.
Markus Hongler, was appointed to the GMB as of May 29, 2008 and became CEO of Zurich Insurance plc. (ZIP; formerly Zurich Insurance Ireland Limited) as of January 1, 2009. He remained CEO of Zurich Switzerland until his appointment as CEO ZIP became effective. Mario Vitale was appointed to the GMB as Deputy CEO of Global Corporate and CEO Global Corporate in North America effective July 1, 2008. As from January 1, 2009, Mario Vitale assumed the function of CEO Global Corporate. Thomas Buess, Chief Operating Offi cer, Global Life, resigned from the GMB as of July 31, 2008. Franz Wipfl i, Head of Organizational Transformation Management, retired from the Group and the GMB effective May 31, 2008.
Additional members of the GMB, as of 6836_p018-043.indd 376836_p018-043.indd 37 27/2/09 13:24:5627/2/09 13:24:56
A shareholder with voting rights can attend shareholders’ meetings of Zurich Financial Services in person. He or she may also authorize, in writing, another shareholder with voting rights or any person permitted under the Articles of Incorporation and a more detailed directive of the Board to represent him or her at the shareholders’ meeting. Based on the Articles of Incorporation, minors or wards may be represented by their legal representatives, married persons by their spouses and a legal entity may be represented by a person authorized to bind it by his or her signature, even if such persons are not shareholders. Furthermore, authority of representation may be given to the Independent Representative of Shareholders, to a statutory representative or to representatives of bank accounts who do not need to be shareholders themselves. Zurich Financial Services may under certain circumstances authorize the benefi cial owners of the shares that are held by professional persons as nominees (such as a trust company, bank, professional asset manager, clearing organization, investment fund or other entity recognized by Zurich Financial Services) to attend the shareholders’ meetings and exercise votes as proxy of the relevant nominee. For further details, see page 24.
Agenda The Board of Directors is responsible for developing the agenda and sending it to the shareholders. Shareholders with voting rights who together represent shares with a nominal value of at least CHF 10,000 may request in writing, no later than 45 days before the day of the meeting, that specifi c proposals be included on the agenda.
Changes of control and defense measures Duty to make an offer The Articles of Incorporation of Zurich Financial Services do not provide for an opting out or opting up in the meaning of Articles 22 and 32 of the Federal Act on Stock Exchanges and Securities Trading. Therefore, mandatory offers have to be submitted when a shareholder or a group of shareholders acting in concert exceed 33 1/3 percent of the issued and outstanding share capital.
PwC and its predecessor organizations, Coopers & Lybrand and Schweizerische Treuhandgesellschaft AG, have served as external auditors of Zurich Financial Services and its predecessor organizations since May 11, 1983. As in 2000, the Group conducted in 2007 a tender process, inviting all major auditing fi rms to submit their work programs and tender offers for 2008 and subsequent years. After a thorough review, the Group came to the conclusion that PwC’s work program and offer prevailed.
Patrick Shouvlin of PricewaterhouseCoopers AG is the lead auditor, responsible since January 1, 2008. The Group requires rotation every fi ve years for the lead auditor.
OBT AG has been elected as a special auditor to perform special audits for increases in share capital required under Articles 652f, 653f and 653i of the Swiss Code of Obligations. At the Annual General Meeting of shareholders on April 3, 2008, OBT was re-elected by the shareholders for a three-year term. OBT AG originally assumed this mandate in October 2000.
Additional fees Total fees (including expenses and value added taxes) in the year 2008 for additional services (e.g., tax services or special audits required by local law or regulatory bodies) performed by PwC and parties associated with them for Zurich Financial Services or one of the Group’s companies amounted to USD 2.8 million (USD 3.7 million in 2007).
The Audit Committee annually approves the Group Audit Plan and quarterly reviews reports from the function on its activities as well as signifi cant risk, control and governance issues. The head of Group Audit reports to both the Chairman of the Audit Committee and the CEO and regularly meets with the Chairman of the Board.
Governance the Risk Committee – with oversight over risk management, and the Audit Committee – with oversight over internal control matters.
The Group has adopted a coordinated and formalized approach to risk management and internal control. The Group‘s core risk management and internal control systems and policies are generally established at the Group level with subsequent Group wide implementation. The principal focus of the approach is on major risks that might impact the achievement of the Group‘s business objectives and on the activities to control and monitor these risks and to contribute to control effectiveness. Thus, a risk-aware and control-conscious environment is fostered in the Group and reinforced by communication and training.
Management is responsible for the identifi cation, evaluation and control of signifi cant risks. The Group manages risks throughout the organization, under direction of the senior management. Zurich has Group-wide risk management policies, common methods and tools for assessing and modeling risks. The Group risk assessment processes are aligned with the Group planning process and are reviewed by the Group Executive Committee and the Board Risk Committee. Signifi cant risks, the results of the assessment and modeling processes and the relevant actions arising are reported regularly to the Risk Committee of the Board. Periodic local risk assessments are conducted using Zurich’s Total Risk Profi ling® tool and business units are required, at least quarterly, to report key risks and implement action plans to mitigate them.
Processes and controls in the organization are subject to risk-based reviews by Management, the Group’s internal audit function (“Group Audit”) 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 control activities for signifi cant locations and Group information technology systems. The Board, the Audit and Risk Committees, receive regular and as needed special reports from the Group Chief Risk Offi cer, Group General Counsel, Head of Group Compliance, Head of Group Audit and fi nancial and business senior management on the adequacy of the control structure in place. 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) signifi cant changes in risks, the business and the external environment; b) management’s monitoring and control systems; c) signifi cant control issues, if any; and d) the effectiveness of the Group’s external reporting process.
The Risk Committee has reviewed the Group’s risk capacity and overseen Zurich’s enterprise-wide risk governance framework and the Audit Committee has reviewed the effectiveness of the system of internal control operated by the Group related to the calendar year 2008 up to the date of the annual report and have reported to the Board accordingly. The Board is satisfi ed that the reviews were conducted in accordance with the U.K. Turnbull Guidance (as revised in October 2005). The assessment included the consideration of the effectiveness of the Group’s ongoing process for identifying, evaluating, controlling and managing the risks of the business, including the scope and frequency of reports on both risk and control that were received and reviewed during the year by the Risk and Audit Committees and the Board, the important internal control matters discussed and associated actions taken by
management. Issues identifi ed by this process have been communicated to the Board and are being addressed by the Group.
Zurich Financial Services 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 Financial Services organizes investors days for institutional investors to provide comprehensive information on its businesses and strategic direction. Such presentations can be followed via webcast or conference call. The investors day in 2008 focused on the Global Life’s Strategy Update (held on May 23, 2008). Further investors days are planned for 2009 on topics of interest to the investment market. A wide range of information on the Group and its businesses, including the aforementioned results reporting documents and the full documentation distributed at the investors day, is also available on the Investor Relations section of Zurich Financial Services’ Web site, www.zurich.com ( com/main/investors/introduction.htm).
Zurich Financial Services will hold its Annual General Meeting on April 2, 2009. As part of the agenda, the Chairman, the CEO and the Chief Financial Offi cer will present a review of the business of the Group for the year 2008. 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 shareholders by Zurich Financial Services at least 20 days before the meeting.
For addresses and further upcoming important dates, please refer to the Financial calendar on page 294.
This Remuneration report provides all the information that is outlined in chapter fi ve of the Directive on Information Relating to Corporate Governance of the SIX Swiss Exchange and the Swiss Code of Best Practice, as amended with effect from January 1, 2007 and October 15, 2007, respectively. Included is also all information required by articles 663bbis and 663c paragraph 3 of the Swiss Code of Obligations that were applicable for the fi rst time for the business year 2007. The structure of the Remuneration report is in alignment with the requirements of the Swiss Code of Obligations and the changes made to the above mentioned SIX Directive and Swiss Code of Best Practice. The fi rst 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 fees paid to members of the Board of Directors of Zurich Financial Services comprise a fi xed cash element and an award in Zurich Financial Services shares. The shares awarded are sales-restricted for three years.
Group Executive Committee and all other employees For the members of the Group Executive Committee and all other employees throughout the Group, a compensation philosophy has been implemented as part of The Zurich Way initiatives.
Guiding principles The guiding principles are as follows: Promote a high performance culture by differentiating total compensation based on the relative performance of businesses and individuals.
Clearly defi ne the expected performance through a structured system of performance management and use this as the basis for compensation decisions.
Long-term (3 years) incentives are for a defi ned group of executives and senior managers, whose specifi c roles focus on the performance drivers of long-term shareholder value. The instruments used are primarily performance share and performance-based share options. The performance share and share option grants only vest if certain performance conditions are met. One third of the target grant is assessed for vesting in each of the three years following the grant date based on the Group’s performance achievements in terms of the Group’s return on common shareholders’ equity (ROE) and the position of the Group’s total shareholder return (TSR) compared with an international peer group of 28 insurance companies that are included in the Dow Jones Titan Insurance Index. Based on the actual ROE and TSR achievements, the vesting percentage can vary between 0 percent and 175 percent of the target grants. For the grants made in 2008 and 2007, these are assessed for vesting on the basis of considering three years of ROE and TSR performance, previous grants are assessed on the basis of performance during the calendar year prior to vesting. Further details on the plans are set out in the section covering the actual remuneration of Group Executive Committee members.
Employee benefi ts The Group provides employee benefi ts which are designed by reference to local market practice. Employees are normally required to contribute to the cost of these benefi ts, and the overall benefi ts offering is based on the relevant market median.
Based on this structure, the total aggregate fees allocated to the Directors of Zurich Financial Services and Zurich Insurance Company for the year ended December 31, 2008, amounted to USD 3,291,875. This included USD 2,408,767 in cash and a value at the grant date of USD 883,108 in three-year sales-restricted shares. The share price at the grant date was CHF 284.00. The corresponding amount for 2007 was USD 3,089,167, which comprised of USD 2,279,167 in cash and a value at the grant date of USD 810,000 in three-year sales-restricted shares. The share price at the grant date in 2007 was CHF 389.50.
Of which allocated in Shares 6, 14 1 The remuneration shown in the tables do not include any business-related expenses incurred in the performance of the Board members’ services. 2 Committee members receive a cash fee of USD 40,000 for all Committees on which they serve, irrespective of the number. The Committees on which the Board members serve are set out in the Corporate governance report on page 25.
4 Directors who reside in the United States receive a fee of USD 10,000 per annum. 5 The cash fees are defi ned in U.S. dollars, but paid in the actual currencies where the Board members reside, based on the relevant exchange rate at the dates of the payment. 6 The shares allocated to the Directors are sales-restricted for three years. 7 As of June 30, 2008, Mr. Gentz was allocated 861 shares and the other members 252 shares based on a full year’s membership. The share price (CHF 284.00) and the exchange rate (USD / CHF 1.0476) as of June 15, 2008, were adopted to calculate the number of shares based on the fi xed portion of the fee allocated in shares for the respective members. Where the value of the allocated shares did not equal the value of the portion of the fee to be allocated in shares, the difference was paid in cash. The amounts shown in the table above refl ects the fi xed amount in USD of the portion of the fee to be allocated in shares.
10 Mr. Nicolaisen became Chairman of the Audit Committee on April 3, 2008 following the retirement of Mr. Schulmeyer. He received a pro rata fee for being Chair. Prior to that he was Chairman of the Risk Committee.
13 In line with applicable laws, Zurich paid the company-related portion of contributions to social security systems, which amounted to USD 69,304 in 2008. The corresponding contributions amounted to USD 68,439 in 2007. Any personal contributions of the Directors to social security systems are included in the amounts shown in the table above.
16 In addition to the remuneration set out in the table, the company paid contributions for Ms. Gilmore into a group health insurance plan in the UK until her retirement in April 2007 at a cost of USD 631.
Share plans for Directors The members of the Board of Directors of Zurich Financial Services and Zurich Insurance Company do not participate in any of the share-based incentive plans established for executive management. However, as mentioned above, part of the fees of the Directors of Zurich Financial Services are allocated to 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 defi ned performance targets.
V. Chu, Member 187 n.a. Th. Escher, Member 5,470 4,218 F. Kindle, Member 10,470 2,218 A. Meyer, Member 1,794 1,542 D. Nicolaisen, Member 470 218 V.L. Sankey, Member 1,640 1,388 G. Schulmeyer, Member n.a. 2,218 T. de Swaan, Member 470 218 R. Watter, Member 3,438 3,186 1 None of the Directors together with related parties to them held more than 0.5 percent of the voting rights as of December 31, 2008 or 2007, respectively.
Share options held by Directors The members of the Boards of Directors of Zurich Financial Services and Zurich Insurance Company do not participate in any share option plan for executive management. Hence, no share options have been allotted in the year under review or in earlier years. None of the Directors, nor any related parties to them, held any share options or conversion rights over Zurich Financial Services shares as of December 31, 2008 or as of December 31, 2007.
Additional honoraria and remuneration for Directors None of the Directors received any other compensation or benefi ts-in-kind from the Group or from any of the Group’s companies other than that set out above.
Personal loans for Directors Unrelated to his Board membership and on terms and conditions available to other customers, Mr. Watter received a collateralized policy loan in the amount of CHF 2.5 million during 2008. 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, 2008. None of the Directors had outstanding loans, advances or credits as of December 31, 2007.
Personal loans for former Directors As of December 31, 2008, and 2007, respectively, no former Director had outstanding loans, advances or credits.
Related parties to the Directors or to former members of the Board No benefi ts (or waiver of claims) have been provided to related parties of the Directors or related parties of former members of the Boards during the year 2008 and 2007, respectively. Neither had any related party of the Directors or of former members of the Boards outstanding loans, advances or credits as of December 31, 2008 and 2007.
The compensation structure and the mix of the individual compensation elements for Group Executive Committee members are determined by taking into account market practices and internal relativities.
The distribution of the total remuneration in 2008 between the individual compensation elements is set out in the following charts. This is on the basis of the target values for the performance related compensation.
The individual compensation elements are described in more detail below (the amounts for the highest paid executive are included): Value of total remuneration The total value of the various compensation elements earned by the members of the Group Executive Committee in 2008 was USD 53.9 million. This compares with an equivalent fi gure of USD 57.6 million earned in 2007 calculated on the same basis. The reduction in the value of total remuneration from 2007 to 2008 is explained by a decrease of USD 6.6 million in annual cash incentive award payments and an increase of USD 2.9 million due mainly to movements in exchange rates over the two years and the fact that in 2007 only 10 individuals were members of the Group Executive Committee for the full year.
The total value for 2008 comprises the following elements (the comparative fi gures for 2007 are shown in the table on total remuneration for all GEC members): Base compensation and annual cash incentives paid for 2008 The total amount of base compensation and annual cash incentive awards earned under the Short-Term Incentive Plan for 2008 was USD 26.9 million. This comprised USD 13.4 million in base compensation and USD 13.5 million in annual cash incentive awards, which refl ect the amounts to be paid in 2009 for 2008 performance. The annual cash incentive awards are determined individually and are performance based. Overall funding for the incentives is based on overall profi t performance in 2008 and funds are allocated to individuals based on a combination of factors, including the results of the business that the Group Executive Committee member is responsible for, the accomplishment of growth initiatives and their individual contribution to the accomplishment of strategic objectives during the year. For members of the Group Executive Committee the target levels under the Short-Term Incentive Plan for 2008 were set at 100 percent of the base compensation, the same level as in 2007. The maximum award is 200 percent of the target level.
Value of other remuneration paid in 2008 Members of the Group Executive Committee received other remuneration in 2008 in relation to employee benefi ts, expatriate allowances, perquisites, benefi ts-in-kind and any other payments due under each member’s employment contract. The total value of the other remuneration elements in 2008 was USD 2.9 million. Benefi ts-in-kind have been valued using market rates.
Equity grants made to the Group Executive Committee under the Long-Term Incentive Plan in 2008 Remuneration components for Group Executive Committee members under the Long-Term Incentive Plan comprise an annual grant of performance shares and performance options. In extraordinary circumstances, restricted share grants may also be made. For members of the Group Executive Committee, the overall value of the target annual grants in 2008 ranged from 100 percent to 125 percent of the base compensation. For the Chief Executive Offi cer the overall value was set at 300 percent of the base compensation.
The target grants for the year are made on the third working day in April of that year. Thus, the target grants in 2008 were made on April 3, 2008. The target performance share and share option grants only vest if certain performance conditions are met. One-third of the target grant made in 2008 is assessed for vesting in each of the three years 2009, 2010 and 2011 based on the Group’s performance achievements in terms of the Group’s return on common shareholders’ equity (ROE) and the position of Group’s total shareholder return (TSR) compared with an international peer group of 28 insurance companies that are included in the Dow Jones Titan Insurance Index. Based on the actual ROE and TSR achievements, the vesting percentage can vary between 0 percent and 175 percent of the target grants. For the grants made in 2008, these are assessed for vesting on the basis of considering three years of TSR and ROE performance, this is the same as for the 2007 grant, whereas previous grants to this are assessed on the basis of performance during the calendar year prior to vesting.
If the actual performance is below the minimum levels, there will be no vesting and the awards will be lost. However, if the Group’s ROE achivements are above the minimum level and the relative TSR is below the second quartile, the Board, based on a recommendation of the Remuneration Committee, will determine whether, due to exceptional circumstances, a partial vesting of the shares and/or options is appropriate. The Board, based on a recommendation of the Remuneration Committee, can further increase or decrease the calculated vesting level for specifi c members to refl ect individual circumstances.
in %Long-Term Incentive Plan Vesting Matrix in %Long-Term Incentive Plan Vesting Matrix 6837_p044-061.indd 536837_p044-061.indd 53 25/2/09 14:23:4225/2/09 14:23:42
No restricted share grants were made to members of the Group Executive Committee during 2008. This compares with a total number of 7,280 restricted shares granted in 2007 with a value of USD 2.0 million at the date of grant and the assumption of 100 percent vesting.
Share option grants The total number of target share option grants made to members of the Group Executive Committee during 2008 was 148,154. This compares with an equivalent fi gure of 142,690 for 2007. The value of the target share option grants made on April 3, 2008 was USD 9.8 million at the date of grant, based on the assumption of 100 percent vesting and the Black-Scholes valuation of the options at the date of grant.
Summary of total remuneration for the Group Executive Committee By reference to the above fi gures, the total remuneration of the Group Executive Committee members, comprising cash compensation, pensions, the value of other remuneration and the value of target equity grants for 2008 was USD 53.9 million, divided as follows: Base compensation 13.4 11.3 Cash incentive awards earned for the year 13.5 20.1 Service Costs for pension benefi ts 4 4.5 3.9 Value of other remuneration 5 2.9 3.6 Value of target performance share and restricted share grants 6 9.8 10.7 Value of target performance option grants 6 9.8 8.0 1 The remuneration shown in the table does not include any business related expenses incurred in the performance of the members’ services. 2 On the basis of 12 GEC members, all of whom served for the full year 2008. 3 On the basis of 12 GEC members of whom 10 served during the full year 2007.
5 Includes employee benefi ts, expatriate allowances, perquisites, benefi ts-in-kind and any other payments due under employment contract. Benefi ts-in-kind have been valued using market rates.
6 The share and share option grants will vest in the future according to achievement of defi ned performance conditions. The value of the share and share options assumes that the grant will vest in the future at 100 percent of the target level with the valuation of the options based on the Black-Scholes option pricing model as set out in Note 24 to the consolidated fi nancial statements, the valuation of the target performance share grants based on the share price on the day prior to the grants (CHF 336.50 for 2008 and CHF 355.75 for 2007) and the valuation of the restricted share grants based on the share price on the date of the grants.
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 3.4 million in 2008 and to USD 2.6 million in 2007. Since the contributions are based on full earnings, whereas benefi ts are capped, there is not a direct correlation between the costs paid to the social security system and the benefi ts received by the executives.
Based on these fi gures, the value of the total remuneration for all members comprises 39 percent (prior year 33 percent) in fi xed compensation elements (comprising base compensation, service costs for pension benefi ts and other remuneration) and 61 percent (prior year 67 percent) in performance related components (comprising the cash incentive awards under the Short-Term Incentive Plan together with the value of the target performance share grants, restricted share grants and share option grants).
The following table specifi es the total remuneration paid to the highest paid Group Executive Committee member: Base compensation 1.50 1.50 Cash incentive awards earned for the year 2.25 3.00 Service Costs for pension benefi ts 2 0.80 0.90 Value of other remuneration 3 0.50 0.40 Value of target performance share and restricted share grants 4 2.25 2.25 Value of target performance option grants 4 2.25 2.25 1 The remuneration shown in the table does not include any business related expenses incurred in the performance of the CEO’s services. 2 The amounts refl ect the total value of pension benefi ts, calculated on the basis of the Service Costs for the company as assessed under IAS 19 accounting principles. Service
Share grants Performance share grants The total number of target performance share grants outstanding as of December 31, 2008 under the Group’s Long-Term Incentive Plan was 59,583 (56,399 as of December 31, 2007). A summary of the outstanding grants as of December 31, 2008 is set out in the table below: Performance period
Within the context of the Group’s Long-Term Incentive Plan, these performance share grants are considered for vesting in one-third instalments during the three years after the grant. The actual level of vesting is determined in accordance with the remuneration principles set out above on pages 44 to 46 and the Long-Term Incentive Plan Vesting Matrix as described on page 53.
Share option grants Under the share option program for senior management, the Group can issue share options to individuals within prescribed rules. The fi rst share option grant was made in 1999 and regular annual grants have been made since then. Prior to 2003, option grants were typically made on the basis of a seven-year option term, a three-year vesting period and an exercise price set at a 10 percent premium to the market rate during the month prior to the grant date. Under the rules of the plan, other parameters are allowed for option grants made under the share option program. In connection with the re-design of the Long-Term Incentive Program in 2003, the exercise price for the options granted since then has been set at the market price on the day prior to the date of grant. The performance based option grants are considered for vesting in one-third instalments during the three years after the grant. The actual level of vesting is determined under the performance in accordance with the remuneration principles set out above on pages 44 to 46 and the Long-Term Incentive Plan Vesting Matrix as described on page 53. Option grants are currently made each year on the third working day in April.
Summary of outstanding options as of 6837_p044-061.indd 576837_p044-061.indd 57 25/2/09 14:23:4525/2/09 14:23:45
Number of vested shares and vested share options 1Share and vested share option holdings of the GEC members as of December 31 6837_p044-061.indd 586837_p044-061.indd 58 25/2/09 14:23:4525/2/09 14:23:45
The following tables show how the totals of the vested share options owned by the Group Executive Committee members are distributed according to the grants identifi ed in the tables “Summary of outstanding options” as of December 31, 2008 and 2007, respectively.
1 Joined the Group on January 15, 2007. 2 Joined the GEC on January 1, 2008, but joined the Group on September 1, 2006. 3 Joined the Group on October 1, 2007.
Personal loans for members of the Group Executive Committee As of December 31, 2008, the total of loans, advances or credits outstanding for Group Executive Committee members was CHF 1,082,000 (prior year CHF 1,091,000). These loans represent mortgage loans in Swiss francs, the terms of which are similar to those available to all employees in Switzerland. Mortgage loans are issued with a reduced interest rate of up to one percentage point less than the prevailing market interest rates on mortgage balances, up to a maximum of CHF 1,500,000. As at December 31, 2008, and 2007 respectively, the highest mortgage loan was held by Mr. Lehmann (Group Chief Risk Offi cer), in the amount of CHF 782,000 (CHF 791,000 in 2007) which had an overall interest rate of 2.6 percent (2.3 percent in 2007).
Personal loans for former members of the Group Executive Committee Former members of the Group Executive Committee are eligible to continue their mortgage loans following retirement on similar terms as when they were employed, in line with the terms available to employees in Switzerland as stated above. In this respect, one former member, Mr. Eckert, held an outstanding mortgage loan of CHF 3,000,000 as at December 31, 2008 and 2007, respectively, with a reduced interest rate of 2.5 percent (2.25 percent in 2007) applying on the fi rst CHF 1,500,000. Apart from this, no former members of the Group Executive Committee had any outstanding loans, advances or credits as of December 31, 2008 and 2007, respectively.
Related parties of Group Executive Committee members or of former members of the Group Executive Committee No benefi ts (or waiver of claims) have been provided to related parties of GEC members or related parties of former members of the GEC during the year 2008 and 2007. Neither had any related party of GEC members or of former members of the GEC outstanding loans, advances or credits as of December 31, 2008 and 2007.
Business operating profi t 5,186 6,707 (23%) Net income attributable to shareholders 3,039 5,714 (47%)
General Insurance gross written premiums and policy fees 37,151 35,650 4% Global Life gross written premiums, policy fees and insurance deposits 21,863 21,703 1% Farmers Management Services management fees and other related revenues 2,458 2,266 8%
Our fi nancial performance for the year ended December 31, 2008 was affected by the global fi nancial crisis. The crisis has primarily impacted our investment portfolio as well as certain liabilities, particularly in Other Businesses, which are sensitive to changes in certain capital market prices. Deteriorating equity markets, widening credit spreads as well as defaults and potential defaults by certain fi nancial institutions have resulted in net capital losses on Group investments of USD 2.9 billion for the year ended December 31, 2008 compared with gains of USD 1.5 billion for the same period in 2007, of which losses of USD 2.0 billion and capital gains of USD 1.1 billion were attributable to shareholders in 2008 and 2007 respectively. In addition, net investment valuations included in shareholders’ equity have decreased by USD 3.1 billion since December 31, 2007. Nonetheless, our balance sheet is still strong and our business operating profi t (after tax) return on common shareholders’ equity (BOPAT ROE) for the year ended December 31, 2008 of 16.8 percent remains above our target over the cycle of 16 percent.
Business operating profi t decreased by USD 1.5 billion or 23 percent to USD 5.2 billion resulting mainly from the effects of the turbulent fi nancial markets, particularly on our Other Businesses segment. Our core businesses have continued to make strong contributions to business operating profi t.
General Insurance business operating profi t of USD 3.5 billion decreased by USD 489 million or by 12 percent, driven by a decrease of USD 712 million in the net underwriting result to USD 593 million largely attributable to lower premium rate levels, claims infl ation and slightly higher catastrophe, large and other weather-related losses compared with 2007.
Farmers Management Services business operating profi t of USD 1.2 billion decreased by USD 69 million, primarily resulting from the decrease in other net income which refl ects a reduction in net investment income following dividends paid to the Group and one-time gains of USD 47 million realized on the sale of own use properties in 2007. This was partially offset by an improved gross management result, with the underlying business in the Farmers Exchanges, which we manage but do not own, increasing by 6 percent, due to the combination of organic and inorganic growth.
2009 will be a challenging year as fi nancial markets are expected to remain diffi cult and the extended effect of the credit crisis and worldwide recession affects the wider economy.
The Group’s strategy has been to build businesses which operate effi ciently and with discipline in all market conditions. Overall the Group will continue to drive greater operating effi ciency through The Zurich Way initiatives which are targeted to achieve USD 900 million of effi ciency gains a year through 2009 to 2011. In addition, we will thrive to realize further cost contingencies of USD 400 million through 2009 as we respond to evolving market conditions.
Ongoing turmoil in the fi nancial markets has resulted in a highly challenging environment for the U.S insurance industry, a trend that is expected to continue through 2009 into 2010. Despite these challenges, we expect the Farmers Exchanges to continue to outperform current market leaders without sacrifi cing profi tability. This is expected to support the stability in the fee income stream generated by Farmers Management Services.
A net dividend of CHF 9.75 per share was paid from April 8, 2008, after the Annual General Meeting approved a gross dividend of CHF 15.00 per share on April 3, 2008. This gross dividend represented a 36 percent increase over the 2007 total gross dividend to shareholders of CHF 11.00, and was recognized through shareholders’ equity in the second quarter of 2008.
The Board of Zurich Financial Services will propose for approval at the Annual General Meeting on April 2, 2009 a gross dividend of CHF 11.00.
Gross written premiums and policy fees 37,151 35,650 4% Net earned premiums and policy fees 30,922 29,731 4% Insurance benefi ts and losses, net of reinsurance (22,441) (20,966) (7%) Net underwriting result 593 1,305 (55%) Net investment income 3,712 3,662 1% Net non-technical result (889) (1,056) 16% Business operating profi t 3,535 4,024 (12%) Loss ratio 72.6% 70.5% (2.1 pts) Expense ratio 25.5% 25.1% (0.4 pts)
Business operating profi t decreased by 12 percent or USD 489 million to USD 3.5 billion and by 14 percent on a local currency basis for the year ended December 31, 2008 compared with the prior year. This decrease was the result of a lower net underwriting result, partially offset by improved net investment income and net non-technical result. The underwriting result decreased by 55 percent to a profi t of USD 593 million compared with USD 1.3 billion in the prior year. The main drivers of this decrease were higher attritional loss ratios as a result of lower premium rate levels, claims infl ation as well as slightly higher catastrophe, large and other weather-related losses. The impact of lower premium rates was however moderated by continuing operational improvements and our underwriting discipline. The improvement in investment income of USD 50 million was mainly a result of a higher asset base. The improved net nontechnical result of USD 167 million was driven by a variety of items with foreign exchange benefi ts and lower funding costs from Group Treasury being the major stand-alone items.
The net underwriting result decreased by USD 712 million to USD 593 million, refl ected in the 2.5 percentage point increase in the combined ratio to 98.1 percent attributable to an increase in the loss ratio of 2.1 percentage points to 72.6 percent, and in the expense ratio of 0.4 percentage points. The increase in the overall loss ratio arose mainly from increased attritional losses driven by lower premium rates particularly in Global Corporate in North America and North America Commercial. The total of catastrophe, other weather-related and large losses increased slightly compared with the previous year.
The expense ratio increased overall by 0.4 percentage points to 25.5 percent with the underlying increase resulting mainly from higher commissions driven by the change in business mix as we maintain our focus on profi table lines of business in a highly competitive environment and from the impact of recent acquisitions. These increases were partially in USD millions, for the years ended December 31 in USD millions, for the years ended December 31 in USD millions, for the years ended December 31 in USD millions, for the years ended December 31 6839_p064-089.indd 686839_p064-089.indd 68 25/2/09 14:20:4325/2/09 14:20:43
Gross written premiums and policy fees increased by USD 291 million, or 4 percent, in U.S. dollar terms and by USD 55 million, or 1 percent, on a local currency basis. We experienced rate declines across all regions in 2008, with the greatest pressures being experienced in North America while there were more moderate reductions in Europe and Asia. However, we have seen the improving trend in rates through the year accelerating in the fourth quarter, with Global Corporate able to achieve a small overall rate increase on business written in this period. The rate environment resulted in total premiums for our North American unit declining compared with prior year, with a higher amount of business lost in cases where customers did not accept the offered premiums required to meet the technical price. However, premiums in our European and Asian units increased in local currency terms as a result of higher new business levels.
in USD millions, for the years ended December 31 in USD millions, for the years ended December 31 6839_p064-089.indd 696839_p064-089.indd 69 25/2/09 14:20:4325/2/09 14:20:43
Business operating profi t decreased by USD 222 million, or 15 percent, to USD 1.2 billion, attributable to a lower net underwriting result. An increase of 3.3 percentage points in the loss ratio, which was primarily attributable to a higher level of catastrophe and large losses, was partially offset by an improvement of 0.4 percentage points in the expense ratio.
Gross written premiums and policy fees decreased by USD 317 million, or 3 percent, to USD 11.2 billion, largely attributable to a continued decline in rates in the U.S commercial lines market which was also clearly slowing in the fourth quarter. This decline in rates was partially offset by a slight increase in retention ratios, while new business results remained fl at when compared with the prior year. These results were achieved during one of the most diffi cult economic environments in recent history; sharp declines in automotive sales and new house starts creating pressure on top-line growth in business segments where premium is closely tied to these economic indicators. Through its market segmentation approach, North America Commercial targets specifi c, profi table segments for growth, whilst pulling back on those segments falling below our profi tability hurdles. Gross written premium in these targeted growth segments increased by 5 percent while gross written premium in all other segments declined by 7 percent.
The net underwriting result decreased by USD 278 million to USD 243 million corresponding to a 2.9 percentage point increase in the combined ratio to 97.4 percent. The loss ratio increased by 3.3 percentage points to 70.3 percent. A signifi cant increase in catastrophe losses, resulting from both a higher frequency of tornadoes and hailstorms and from hurricanes Gustav and Ike, was a major driver of the increase in the loss ratio. Total large and weather-related losses were USD 345 million in 2008 compared with USD 54 million in 2007, equivalent to 3.1 percentage points of the 2008 loss ratio. A deterioration in the attritional loss ratio driven by lower premium rates and claims infl ation was mitigated by favorable development of reserves established for prior years. The expense ratio decreased 0.4 percentage points to 27.1 percent, as a slight increase in commission rates was more than offset by a decrease in other underwriting and operating expenses resulting from proactive actions taken by North America Commercial during the course of the year to manage its expense base.
in USD millions, for the years ended December 31 in USD millions, for the years ended December 31 6839_p064-089.indd 706839_p064-089.indd 70 25/2/09 14:20:4425/2/09 14:20:44
Gross written premiums and policy fees 15,293 13,852 10% Net underwriting result 776 440 76% Business operating profi t 1,833 1,453 26% Loss ratio 69.8% 72.7% 2.9 pts Expense ratio 24.8% 23.9% (0.9 pts) Combined ratio 94.5% 96.6% 2.1 pts
Business operating profi t increased by USD 380 million, or 26 percent, to USD 1.8 billion, attributable to an improvement in the net underwriting result of USD 336 million and an increase in net investment income of USD 69 million, driven by higher investment yields.
Gross written premiums and policy fees increased by USD 1.4 billion or 10 percent in U.S. dollars terms to USD 15.3 billion, and by 7 percent on a local currency basis driven by a combination of organic growth and acquisitions. Underlying growth of 3 percent was generated by strong new business production in selected markets, despite competitive market conditions. Pressure on rates in commercial lines continued, although variable by country, with the strongest decrease in Ireland. In Italy, gross written premiums increased by 12 percent on a local currency basis primarily as a result of strong new business production in personal lines supported by the expansion of the tied agent network. In the UK, an organic increase of 2 percent on a local currency basis was primarily a function of strong action in personal motor lines and professional liability. In Germany, both the impact of acquisitions and improved new business contributed to the overall 4 percent increase in gross written premiums on a local currency basis. Overall, acquisitions contributed 3 percent on a local currency basis, primarily those in Spain, Turkey and Germany in 2008 augmented by a full year contribution from Russia which has also underlying growth.
Gross written premiums and policy fees 3,402 3,103 10% Net underwriting result 86 27 nm Business operating profi t 232 165 41% Loss ratio 63.2% 65.3% 2.1 pts Expense ratio 33.5% 33.5% – Combined ratio 96.6% 98.8% 2.2 pts
Business operating profi t increased by USD 67 million, or 41 percent, to USD 232 million resulting from improvements in the net underwriting result driven by a stronger combined ratio. Investment income also increased across most regions, but most signifi cantly in Latin America and Australia. The acquisition of Minas Brazil which was completed in November 2008 is not yet included in this result; however, the integration is progressing well and we expect to realize benefi ts from this acquisition starting in 2009.
Gross written premiums and policy fees increased by USD 299 million or 10 percent in both U.S. dollar terms and on a local currency basis. The increases arose as a result of strong rate increases particularly in Australia, where Zurich also benefi ted from higher new business levels in motor and property lines. By implementing new product lines and distribution channels particularly in Latin America as well as driving rate increases in response to infl ationary pressures particularly in South Africa and Latin America, we were further able to increase our top-line. The Asian business of International Businesses benefi ted from the re-entry into the Singapore market.
The net underwriting result improved by USD 59 million to USD 86 million, primarily as a result of the improved loss ratio, which decreased by 2.1 percentage points to 63.2 percent. This improvement was largely driven by decreases in weather-related and large losses in Latin America, Greater China and Australia as well as rate increases fl owing through to premiums earned.
Gross written premiums and policy fees 10,784 9,623 12% Net investment income on Group investments 4,496 4,226 6% Insurance benefi ts and losses, net of reinsurance (9,211) (694) 1 nm Underwriting and policy acquisition costs, net of reinsurance (1,880) (1,629) (15%) Administrative and other operating expenses (2,400) (1,962) (22%) Business operating profi t 1,480 1,443 3%
1 In 2007, ceded insurance benefi ts and losses included USD 7.1 billion relating to the reinsurance of an annuity portfolio in the UK. 2 Assets under management comprise Group and unit-linked investments that are included in the Global Life balance sheet plus assets that are managed by third parties, for which we earn fees.
Throughout the year ended December 31, 2008, Global Life faced challenging market conditions in its core markets from falling and volatile equity markets and from consumer reactions to the global fi nancial crisis. Despite the increasingly challenging conditions, new business APE and business operating profi t increased compared with the prior year. The acquisitions in Spain, completed in the third quarter, contributed to the results recorded for the year.
Business operating profi t increased by USD 37 million to USD 1.5 billion, an increase of 3 percent in U.S. dollar terms, and by 1 percent on a local currency basis. The improved performance, on a local currency basis, in the UK and Germany, moderated the negative impact from falling asset values that reduced asset-based fees and accelerated amortization of deferred acquisition costs and intangible assets.
in USD millions, for the years ended December 31 in USD millions, for the years ended December 31 6839_p064-089.indd 736839_p064-089.indd 73 27/2/09 13:27:4627/2/09 13:27:46
Business operating profi t increased by USD 37 million to USD 1.5 billion, an increase of 3 percent in U.S. dollar terms, and by 1 percent on a local currency basis. The performance of our UK business, in local currency, has benefi ted from external and intra-group transactions reducing its exposure to non-core annuities. These transactions improved UK capital effi ciency as well as the business mix for UK policyholder tax purposes. The benefi ts were partially offset by the effects of the current market environment that have reduced asset values resulting in accelerated amortization of deferred acquisition costs and intangible assets, and lower asset-based fees. The improvement in business operating profi t in Germany is mainly attributable to the introduction of a new law that has changed the basis for determining policyholder participation. In the U.S. business operating profi t decreased by USD 83 million primarily due to an increase in deferred policy acquisition costs in 2008 compared with 2007. In 2008, deferred policy acquisition costs were reduced by USD 41 million resulting from reduced maintenance costs compared with the reduction of USD 106 million in 2007 resulting from improved mortality experience.
New business annual premium equivalent (APE) increased by USD 314 million to USD 3.3 billion, or 11 percent in U.S. dollar terms, and by 10 percent on a local currency basis during the year ended December 31, 2008. The growth in Spain of USD 228 million was achieved through the successful integration of the businesses acquired in the third quarter. In Germany, APE increased by 21 percent in U.S. dollar terms, and by 13 percent on a local currency basis, driven by growth in unit-linked pensions. APE in Emerging Markets decreased by 2 percent in U.S. dollar terms, and increased by 3 percent on a local currency basis primarily through strong growth of corporate business in Zurich International Solutions (ZIS) and growth across Latin America, partially offset by a reduction in Hong Kong as 2007 included the impact of a sales campaign. In the UK, APE decreased by 5 percent in U.S. dollar terms and increased by 2 percent on a local currency basis, primarily driven by strong growth in mutual funds that more than offset a reduction in unit-linked savings. APE in the Rest of the World increased by 1 percent in U.S. dollar terms, and decreased by in USD millions, for the years ended December 31 in USD millions, for the years ended December 31 6839_p064-089.indd 746839_p064-089.indd 74 25/2/09 14:20:4625/2/09 14:20:46
Group performance review 5 percent on a local currency basis primarily as a result of a decrease in investment business in Italy in the fourth quarter. Switzerland increased by 19 percent in U.S. dollar terms, and by 7 percent on a local currency basis, with improvements in group sales offsetting a decrease in individual business. In the U.S, a reduction in individual business has resulted in lower new business APE of 15 percent. In Ireland, APE increased by 9 percent in U.S. dollar terms, and by 1 percent on a local currency basis, driven by growth in pension sales offset by a reduction in single premium savings product sales.
Private Banking Clients 1 – – – – – 1 –
Independent Financial Advisors (IFA)/Brokers distribution reduced by USD 182 million to USD 942 million, or by 16 percent in U.S. dollar terms, and by 15 percent on a local currency basis during the year. Sales in the UK reduced as a result of legislative changes impacting unit-linked bonds as well as from the fi nancial crisis. These effects were partially offset by growth in unit-linked sales in Germany, where the broker channel increased its overall new business by 41 percent in local currency, and now represents 25 percent of new business distribution in Germany.
Tied Agents distribution reduced by USD 14 million to USD 537 million, or 3 percent in U.S. dollar terms, and by 7 percent on a local currency basis during the year. While sales in many countries proved resilient to the developing fi nancial crisis, the average case size of unit-linked sales in our Hong Kong domestic business reduced and in the U.S. Farmers protection sales also decreased.
International/Expats pillar decreased by USD 66 million to USD 323 million, or 17 percent in U.S. dollar terms, and by 8 percent on a local currency basis during the year as a result of the fi nancial crisis that has reduced consumer confi dence impacting sales of investment products especially in Hong Kong, partly offset by the USD 31 million or 65 percent growth from the second year of operations in Singapore.
Direct and central initiatives increased by USD 206 million to USD 298 million during the year ended December 31, 2008 mainly attributable to customer offers, in the UK, targeted at improving the persistency and retention of the in-force business.
Management fees and other related revenues 2,458 2,266 8% Management and other related expenses (1,317) (1,210) (9%) Gross management result 1,141 1,056 8%
Other net income 61 215 (72%) Business operating profi t 1,202 1,271 (5%) Managed gross earned premium margin 6.9% 6.8% 0.1 pts
Management fees and other related revenues increased by USD 192 million to USD 2.5 billion, primarily driven by the 6 percent increase in gross earned premiums (excluding the Zurich Small Business Solutions (SBS) portfolio transfer) at the Farmers Exchanges, which we manage but do not own. Bristol West, which was acquired in July 2007, contributed USD 94 million to the increase in management fees and other related revenues, while SBS, for which the rights to renew policies were acquired by the Farmers Exchanges from Zurich North America Commercial in June 2008, contributed USD 66 million. Management and other related expenses increased by USD 107 million, including USD 49 million related to Bristol West and USD 65 million related to SBS. As a result of these changes and underlying improvements, the gross management result improved by USD 85 million to USD 1.1 billion, while the managed gross earned premium margin improved to 6.9 percent from 6.8 percent in the prior year.
Gross earned premiums in the Farmers Exchanges, which we manage but do not own increased by USD 994 million, of which USD 437 million related to Bristol West and USD 411 million related to SBS, acquired from Zurich North America Commercial in June 2008.
Business operating profi t: Farmers Re 154 173 (11%) Centre (106) 252 nm Centrally Managed Businesses (487) 291 nm Rest of Other Businesses 179 63 nm Total business operating profi t (260) 779 nm
Farmers Re business operating profi t decreased by USD 19 million to USD 154 million refl ecting lower investment income and an increase in weather-related and catastrophe losses partially offset by the Group’s increase in its participation in the All Lines Quota Share reinsurance contract with the Farmers Exchanges from 5 percent to 25 percent, effective September 30, 2008. Centre decreased by USD 358 million due to negative investment returns relating to capital losses from negative mark to market movements on debt and other securities and due to a reduction of profi table commutations and other run-off transactions compared with the prior year. Centrally Managed Businesses, which largely comprise portfolios that we proactively manage to achieve a profi table run-off over time, decreased by USD 778 million to a loss of USD 487 million, primarily driven by the impact of adverse equity market movements and widening credit spreads on Group investments as well as on the strengthening of certain insurance liabilities. USD 322 million of the decrease was attributable to the valuation of hedge fund investments mainly carried by Zurich Capital Markets. The Rest of Other Businesses increased by USD 116 million to USD 179 million following an improved result in banking and certain run-off positions carried at Group.
in USD millions, for the years ended December 31 in USD millions, for the years ended December 31 in USD millions, for the years ended December 31 in USD millions, for the years ended December 31 6839_p064-089.indd 786839_p064-089.indd 78 25/2/09 14:20:4925/2/09 14:20:49
Group investments have decreased by 7 percent or USD 14.0 billion to USD 179.6 billion since December 31, 2007. After excluding the effect of foreign currency translation, Group investments decreased by 1 percent. This decrease was primarily driven by investments related to Global Life and was consistent with the corresponding development of life insurance liabilities.
Unit-linked investments have decreased by USD 43.9 billion or 36 percent in U.S. dollars terms to USD 78.2 billion since December 31, 2007. After excluding the effect of foreign currency translation, unit-linked investments decreased by 22 percent, primarily as a result of lower equity valuations following adverse market movements. This decrease is refl ected in lower liabilities for investment and unit-linked liabilities.
Our investment policy remains conservative; investment grade securities comprise 99.4 percent of our debt securities, of which 59.4 percent are rated AAA. U.S sub-prime mortgage-backed securities comprise 0.1 percent of Group investments, with 35 percent of these securities rated AAA. USD 14 million of impairments on U.S sub-prime investments have been recognized in the year ended December 31, 2008.
in USD millions, as ofBreakdown of investments in USD millions, as ofBreakdown of investments 6839_p064-089.indd 796839_p064-089.indd 79 25/2/09 14:20:4925/2/09 14:20:49
Net investment result 5,832 10,094 (42%) Net investment return on Group investments 3.1% 5.3% (2.1 pts) Movements in net unrealized gains/(losses) on investments included in total equity (3,902) (2,659) (47%) Total investment result, net of investment expenses 1 1,930 7,435 (74%)
Total return (net of investment expenses) on average Group investments was positive 1.0 percent, a decrease of 2.8 percentage points compared with the prior year due to the reduced overall performance of our debt portfolio and other investments. Debt securities, which are invested to match our insurance liability profi les, returned positive 2.5 percent. Equity securities returned negative 26.8 percent largely as a consequence of progressive deterioration in the markets during 2008. Other investments, mainly real estate and mortgages, returned a positive 8.0 percent.
Total net capital losses on investments and impairments were USD 2.9 billion, which included both losses of USD 739 million arising from the sale of investments and USD 2.2 billion of negative revaluations. These negative revaluations were driven by impairments of USD 2.5 billion, a further USD 1.1 billion of negative revaluations on equities booked as fair value through income and USD 168 million of negative revaluations on debt securities also booked as fair value through income. The impairments of USD 2.5 billion were attributable to USD 1.2 billion of equity impairments and USD 1.2 billion of impairments on debt securities. These adverse impacts from revaluations and impairments were offset by positive revaluations from derivatives of USD 1.3 billion, including hedges on equity securities of USD 983 million, and gains from real estate of USD 210 million.
in USD millions, for the years ended December 31Performance of unit-linked investments in USD millions, for the years ended December 31Performance of unit-linked investments 6839_p064-089.indd 816839_p064-089.indd 81 25/2/09 14:20:5025/2/09 14:20:50
Gross reserves for losses and loss adjustment expenses 67,890 64,535 Reinsurers’ share (13,179) (13,722) Net reserves for losses and loss adjustment expenses 54,712 50,814
Total net losses and loss adjustment expenses paid (22,150) (19,856) Acquisitions/(divestments) 77 51 Foreign currency translation effects (3,798) 1,548
The majority of the Group’s gross reserves for losses and loss adjustment expenses are attributable to the General Insurance segment.
This table represents the loss ratio development for individual accident years for the Group, with the General Insurance segment 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: the 2004 and 2005 hurricanes impacted the loss ratios by 2.8 and 4.6 percentage points, the winter storm Kyrill and the UK fl oods in 2007 impacted the loss ratio by 2.5 percentage points, and in 2008 the impact of hurricanes Gustav and Ike was 1.8 percentage points. The Zurich Way of Reserving adopts a conservative view across accident years suggesting that most years would develop favorably over time.
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 companies that are in run-off or are centrally managed, and are included only in this fi rst table.
Interest and bonuses credited to policyholders (18,615) 6,682 1,927 3,685 (16,689) 10,367
Changes recorded in shareholders’ equity 9 (31) 177 (1,615) 187 (1,646)
As of December 31 1 Includes reserves for unit-linked contracts, the net amounts of which were USD 35.1 billion and USD 54.3 billion, and liabilities for investment contracts, the net amounts of which were USD 36.2 billion and USD 54.7 billion as of December 31, 2008 and 2007, respectively 2 Includes reserves for future life policyholders’ benefi ts, the net amounts of which were USD 70.8 billion and USD 68.0 billion and policyholders’ contract deposits and other funds, the net amounts of which were USD 12.5 billion and USD 14.0 billion as of December 31, 2008 and 2007, respectively 3 In 2007, reinsurers’ share of reserves for insurance contracts included USD 7.1 billion related to the reinsurance of a UK annuity portfolio. Subsequent to the approval from the UK High Court on June 30, 2008, the underlying contracts were transferred to the reinsurer, resulting in a reduction of gross reserves for insurance contracts and the related reinsurers’ share.
Unit-linked insurance and investment contracts, net of reinsurance, decreased by 35 percent, and by 17 percent after excluding the impact of currency translation, compared with December 31, 2007. The reduction of USD 19.3 billion from foreign currency translation was due to the strong appreciation of the U.S. dollar against the British pound and the euro since December 31, 2007. Falling equity market movements resulted in a decrease in interest and bonuses credited to policyholders across all countries. The liabilities were also reduced by an excess of policyholder benefi ts paid over premiums of USD 1.5 billion that was driven by the overall maturity of the UK portfolio and the challenging market conditions reducing sales of single premium unit-linked products in the UK and Ireland. The increase in Spain was driven by the inclusion of reserves for the business acquired.
Total indebtedness which decreased in the year by 10 percent to USD 15.8 billion, consists of debt related to capital markets and banking activities, senior and subordinated debt. Details on the composition of our debt and its contribution to operational and fi nancial debt are set out in footnote 21 of our consolidated fi nancial statements.
Operational debt decreased by 28 percent or USD 2.4 billion, primarily due to a reduction in collateralized loans from the repurchase of mortgages associated with these loans and a reduction in loans received as obligations to repurchase securities in order to reduce exposure to these securities.
Financial debt increased by 7 percent or USD 634 million in U.S. dollar terms and by 9 percent on a local currency basis. During the year, the Group has taken the opportunity to restructure elements of its fi nancial debt and raise funds when market conditions were favorable. In terms of redemptions, ECAPS of USD 128 million were repaid in March and December giving rise to pre-tax gains of USD 41 million and a senior bond of CHF 300 million matured in July 2008. Issuances by the Group in September 2008, under its existing European Medium Term Note (EMTN) program, were senior bonds of CHF 300 million with a maturity in November 2011 and CHF 500 million with a maturity in September 2013.
Redemption of preferred securities (124) – (124) Share-based payment transactions 48 – 48 Treasury share transactions (812) – (812) Total recognized income and expense, net of tax (3,858) 6 (3,853)
Details of share capital and treasury share transactions are set out in note 22 of the consolidated fi nancial statements.
Change in cash and cash equivalents excluding change in cash received as collateral for securities lending 1,161 (4,243)
Change in cash received as collateral for securities lending (1,700) (1,943)
in USD millions, for the years ended December 31Summary of cash fl ows in USD millions, for the years ended December 31Summary of cash fl ows 6839_p064-089.indd 876839_p064-089.indd 87 25/2/09 14:20:5425/2/09 14:20:54
Gross written premiums and policy fees 1,300 3% Insurance benefi ts and losses, gross of reinsurance (1,538) (5%) Net income attributable to shareholders 26 1% Business operating profi t 34 1%
The income statements are translated at average exchange rates. Over the course of 2008, the U.S. dollar has been on average weaker despite its substantial strengthening against the British pound and the euro in the latter part of the year. The result is an increase in U.S. dollar terms in most income statement line items.
The balance sheets are translated at end-of-period rates. The strengthening of the U.S. dollar especially against the British pound and the euro as of December 31, 2008, compared with December 31, 2007, resulted in a decrease in U.S. dollar terms in most balance sheet line items.
The “Risk review” is an integral part of the consolidated fi nancial statements (except for “Economic capital adequacy” on pages 123-125).
The mission of Zurich’s Enterprise Risk Management is to promptly identify, measure, manage, report and monitor risks that affect the achievement of our strategic, operational and fi nancial objectives. This includes adjusting the risk profi le in line with the Group’s stated risk tolerance to respond to new threats and opportunities in order to optimize returns.
In order to achieve our mission and objectives, the Group relies on its risk management framework.
Risk management framework At the heart of the risk management framework is a robust governance process with clear responsibilities for risk taking, managing, monitoring and reporting. We articulate the roles and responsibilities for risk management throughout the organization, from the Board of Directors and the Chief Executive Offi cer to our businesses and functional areas, thus embedding risk management in the business (see Risk governance and risk management organization).
One of the key elements of the Group’s risk management framework is to foster risk transparency by establishing risk reporting standards throughout the Group. We regularly report on our risk profi le, current risk issues, adherence to our risk policies and improvement actions both at a local and on a Group level. The Group has procedures in place for the timely referral of risk issues to senior management and the Board of Directors.
Risk management is not only embedded in our business but is also aligned with the Group’s strategic and operational planning process. We assess risks systematically and from a strategic perspective through our proprietary Total Risk Profi ling® (TRP) process, which allows us to identify and then evaluate the probability of a risk scenario occurring, as well as the severity of the consequences should it occur. We then develop, implement and monitor appropriate improvement actions. The TRP process is integral to how we deal with change, and is particularly suited for evaluating both strategic risks and risks to our reputation. At Group level this process is performed on an annual basis and is closely tied to the planning process.
Through these processes, responsibilities and policies, we embed a culture of disciplined risk taking across the Group. We benefi ted from this disciplined approach to risk taking in 2008, and we continue to consciously take risks, for which we expect an adequate return. This approach requires sound judgment and an acceptance that certain risks can and will materialize in the future.
Organizational changes At the beginning of 2008 the position of Group Chief Risk Offi cer was elevated to the Group Executive Committee level. The Group Chief Risk Offi cer reports directly to the Chief Executive Offi cer (CEO) and the Risk Committee of the Board. The former Group Finance Committee was transformed into the Group Finance and Risk Committee (GFRC); this management committee now plays a key role in monitoring risk management activities including changes to the Group’s risk profi le, changes to the Zurich Risk Policy, material changes to the Group’s Risk Based Capital methodology and M&A transactions. The Group Risk Management function at Corporate Center level has been grouped into two centers of expertise: risk analytics and risk operations (see Risk governance and risk management organization).
At a business division level risk management is now organized as a shared service. During 2008 the shared services approach was implemented in Europe; the position of the Chief Risk Offi cer for North America was established, overseeing Farmers, North America Commercial and Global Corporate in North America.
Various external stakeholders, among them ratings agencies, regulators, investors and accounting bodies, are placing increasing emphasis on the importance of sound risk management in our industry.
Ratings agencies are increasingly interested in risk management as a factor in evaluating companies. Standard & Poor’s, a ratings agency with a separate rating for Enterprise Risk Management, confi rmed our Group’s Enterprise Risk Management rating as “strong” in 2008. Only 14 percent of rated European insurers were rated “strong” or better.
We also seek external expertise from our International Advisory Council, Natural Catastrophe Advisory Council and Climate Change Advisory Council to better understand and assess our risks, particularly regarding areas of complex change. For discussion of these councils please see the Corporate governance report (unaudited). In addition, the Investment Management Advisory Council provides feedback to Investment Management on achieving superior riskadjusted returns versus liabilities for the Group’s invested assets.
We are also involved in a number of international industry organizations engaged in furthering the regulatory dialogue pertaining to insurance and fi nancial services.
In addition, Zurich is a contributing partner to the annual Global Risks report, a collaborative effort under the auspices of the World Economic Forum (WEF) and produced in conjunction with the WEF Global Risk Network.
Board of Directors level The Board of Directors of Zurich Financial Services has ultimate oversight responsibility for the Group’s risk management. It establishes the guidelines for the Group’s risk management framework and key principles as articulated in the Zurich Risk Policy.
Group executive level The Chief Executive Offi cer (CEO), together with the GEC, oversees the Group’s performance with regard to risk management, strategic, fi nancial and business policy issues of Group-wide relevance. This includes monitoring adherence to and further development of the Group’s risk management policies. The Group Finance and Risk Committee and the Group Balance Sheet Committee report regularly to the CEO and make recommendations on signifi cant risk related issues.
Representatives of Group Risk Management are members of all these technical committees.
In addition to the risk management network, the Group has a set of audit, risk and control committees that encompass the major business reporting areas and business units. Each committee has terms of reference tailored to its specifi c business area and local requirements. In particular, the committees are responsible for providing oversight of activities, organization and quality of the risk management and control functions. This includes monitoring adherence to policies and periodic risk reporting.
In 2008, the Group has experienced a challenging market environment in which many of the market risks mentioned above materialized, resulting in reduced asset valuations. Equity prices and credit spreads were particularly affected coupled with an economic downturn in many countries in which the Group operates. In this environment the Group’s approach to market risk management generally worked effectively, although the Group did not stay unaffected by the lower asset valuations arising from changes in fi nancial markets. For more information on the Group’s investment result, including impairments and the treatment of selected fi nancial instruments please refer to note 6 of the consolidated fi nancial statements.
The Group manages its risks from equity securities and real estate as part of the overall investment risk management process by applying limits as expressed in our policies and guidelines. Specifi cally we have established limits for holdings in real assets, which cover holdings in equities, real estate and alternative investments.
For additional information on equity securities and real estate held for investment please refer to note 6 of the consolidated fi nancial statements.
Interest rate risk 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 benefi t plans and loans and receivables. Changes in interest rates affect the Group’s held-to-maturity fl oating rate debt securities and unhedged fl oating rate borrowings through fl uctuations 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. We also manage the 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.
Analysis of economic sensitivities – Global Life The sensitivity of the value of the Global Life business to fi nancial market movements is provided in the Embedded value report. In modeling these exposures, where appropriate, allowance has been made for dynamic actions that would be taken by management or by policyholders. For contracts with fi nancial options and guarantees, such as some participating business, movements in fi nancial markets can change the nature and value of these benefi ts. The dynamics of these liabilities are captured so that this exposure is quantifi ed, monitored, managed and where appropriate, mitigated.
Some limitations to the sensitivity analysis in the Embedded value report apply: 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. The sensitivities do not consider the correlations among the volatilities of risk factors. The market risk scenarios in the Embedded value report assume a concurrent movement of all stock markets and an unrelated parallel shift of all interest rates in different currencies. The scenario of a 10 percent stock market decline includes a 10 percent fall in property market values. The assumptions on policyholder behavior, such as lapses, included in the sensitivity analysis for Global Life may be different from actual behavior. Therefore, the actual impact may deviate from the analysis.
Analysis of economic sensitivities – General Insurance and rest of the business Basis of presentation The following tables show the estimated economic impacts of market risk sensitivities on Group investments, including real estate for own use, liabilities, including insurance and fi nancial liabilities, and the net impact for General Insurance and the rest of the business. 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, which is in line with management’s monitoring of the Group’s investment and liabilities base. As mentioned above, we have established limits on holdings in real assets and our asset/liability mismatches, which limit the economic impact of interest rate and equity risk.
The basis of the presentation below is an economic valuation represented by the fair value for Group investments, IFRS insurance liabilities discounted at market rates to refl ect the present value of insurance liability cash fl ows and other liabilities, for example own debt. Own debt does not include subordinated debt, which we consider available to protect policyholders in a worst-case situation. The payment patterns used to determine the expected cash outfl ow for insurance liabilities are based on an analysis as of September 30, which is considered representative as of December 31. For determining the sensitivities investments and liabilities are fully re-valued in the given scenarios. Each instrument is re-valued separately taking the relevant product features into account. Non-linear effects, where they exist, are fully refl ected in the model. The sensitivities of the analysis are shown before tax.
The presentation has expanded compared with last year’s disclosure where the impact assessment of market risk sensitivities was solely based on an IFRS valuation. The additional information refl ects the way we measure, monitor, report and mitigate market risks.
The sensitivities show the effects to a change of certain risk factors, while other assumptions remain unchanged.
The interest rate scenarios assume a parallel shift of all interest rates in the respective currencies. They do not take into account the possibility that interest rate changes might differ by rating class (credit spread risk).
The stock market scenarios assume a concurrent movement of all stock markets.
Analysis of economic sensitivities for interest rate risk The tables below show the estimated impacts of a one percentage point increase/decrease in yield curves of the major currencies U.S. dollar (USD), euro (EUR), British pounds (GBP), Swiss francs (CHF) and ‘other currencies’ after consideration of hedges in place, as of December 31, 2008 and 2007, respectively. The impact is shown in USD.
Other currencies Total 1% increase in the interest rate yield curves Group Investments (1,199) (548) (341) (211) (141) (2,440)
Table 1.a in USD millions, as of December 31, 2008Economic interest rate sensitivities for the Group’s General Insurance business
Table 1.b in USD millions, as of December 31, 2007Economic interest rate sensitivities for the Group’s General Insurance business
Table 1.b in USD millions, as of December 31, 2007Economic interest rate sensitivities for the Group’s General Insurance business 6840_p090-125.indd 996840_p090-125.indd 99 25/2/09 14:17:5625/2/09 14:17:56
1% decrease in the interest rate yield curves Group Investments 641 48 256 1 51 997
Other currencies Total 1% increase in the interest rate yield curves Group Investments (507) (147) (199) (1) (2) (856)
Table 3 in USD millions, as of December 31Economic equity price sensitivities for the General Insurance business
Table 4 in USD millions, as of December 31Economic equity price sensitivities for the rest of the business
Analysis of IFRS sensitivities for equity and interest rate risk In addition to the economic sensitivities shown above, the following table shows the estimated impacts on Group investments and own use real estate of a one percentage point increase/decrease in yield curves and a separate 10 percent decline in all stock markets after consideration of hedges in place, as of December 31, 2008 and 2007, respectively. The sensitivities of these two separate but instantaneous scenarios are shown for both net income before tax and net assets, using the Group actual income tax rate. For the purposes of the tables below net assets represent total shareholders’ equity before non-controlling interests. The tables exclude sensitivities on unit-linked assets, as policyholders bear the investment risk.
General Insurance reserves are generally not discounted; therefore, the dependency to interest rate risk, equity and the IFRS insurance reserves is not considered to be signifi cant, and thus not disclosed.
1% increase in the interest rate yield curves Group Investments (1,853) (2,412) Net income before tax (1) – Net assets (1,501) (1,816)
Table 5 in USD millions, as of December 31IFRS sensitivities for the General Insurance business
1% increase in the interest rate yield curves Group Investments (3,865) (3,670) Net income before tax (243) (273) Net assets (3,130) (2,764)
1% decrease in the interest rate yield curves Group Investments 4,383 4,208 Net income before tax 352 372 Net assets 3,550 3,168 10% decline in stock markets Group Investments (361) (590) Net income before tax (49) 63 Net assets (292) (445)
Note that the positive impact from the decline in stock markets on the Global Life net income before tax for 2007 is related to investments classifi ed as trading. These investments include derivative positions that are held for hedging purposes. The market value of such derivative instruments can increase if equity markets fall, while the change in the underlying equity investments might be refl ected in the unrealized gains and losses.
To the extent that the segments in the rest of the business include life insurance contracts, the related sensitivities are included in the analysis of economic sensitivities for equity and interest rate risk of the rest of the business, as discussed above.
1% decrease in the interest rate yield curves Group Investments 986 852 Net income before tax 489 394 Net assets 799 641 10% decline in stock markets Group Investments (332) (357) Net income before tax (181) (84) Net assets (269) (269)
Using constant exchange rates from one year to the next, the Group’s 2008 net income attributable to shareholders would have been lower by USD 26 million (applying 2007 exchange rates to the 2008 result). In 2007 the result would have been lower by USD 199 million (applying 2006 exchange rates to the 2007 results).
Please refer to note 1 and 3 of the consolidated fi nancial statements for additional information on foreign currency translation and transactions.
Table 8 in USD millions, as of December 31Net income after tax before minorities by major functional currencies
In 2008, the Group faced a considerable worsening in the credit risk environment and impaired exposures to certain counterparties for which it has become unlikely that they will fulfi ll their fi nancial obligations to the Group (for more information on its impairments see note 6 of the consolidated fi nancial statements).
Despite these exceptional losses, the credit risk management processes worked effectively in this challenging year. Building on these established processes, the Group has increased the frequency of credit risk analysis and reporting as a basis to take corrective actions more quickly if required. The Group tests and analyzes credit risk scenarios on a regular basis and has broadened the set of scenarios tested. As one consequence the Group has given a stronger focus to the credit quality of our reinsurance providers. Possible contingency measures, which might become necessary in a further worsening credit risk environment, are prepared accordingly.
Credit risk concentration The Group regularly monitors and limits credit exposures by individual counterparty and related counterparties by the aggregated exposure across the various types of credit risk for that counterparty. The Group’s exposure to counterparties’ parent companies and subsidiaries across sources of credit risk is aggregated to include reinsurance assets, investments, certain insurance products and derivatives. Best estimates, based on statistical data and own assessment, are used to assign loss-given-default percentages and loss dependency factors refl ecting, for example, double default events. The aggregated exposure information is compared with the Group’s limits. The limits vary based on the underlying rating category of the counterparty. There was no exposure in excess of the limits at December 31, 2008. The Group Chief Risk Offi cer routinely reports the largest exposures by rating category to the Risk Committee of the Board.
The maximum exposure to credit risk consists mainly of on-balance sheet and a relatively small amount of off-balance sheet exposures. The largest amount of off-blance sheet exposure to credit risk arises from property lending related to undrawn loan commitments of Zurich Bank of USD 561 million und USD 794 million as of December 31, 2008 and 2007, respectively.
The overall weighted average rating of the Group’s debt securities portfolio is AA+. As of December 31, 2008 the largest concentration in the Group’s debt securities portfolio is in government and supranational debt securities at 41.5 percent. A total of USD 38,187 million or 55.2 percent of the non-government and non-supranational debt securities are secured. As of December 31, 2007, 40.4 percent of the Group’s debt portfolio was invested in governments and supranationals and a total of USD 42,522 million or 57.7 percent of the non-government and non-supranational debt securities was secured.
In accordance with the Group’s investment policy, investment grade securities comprise 99.3 percent of the Group’s debt securities, and 59.3 percent are rated AAA as of December 31, 2008. As of December 31, 2007, investment grade securities comprised 98.8 percent of our debt securities, and 63.1 percent were rated AAA. Please refer to note 6 of the consolidated fi nancial statements for additional information on the Group’s exposure to U.S. asset backed securities (ABS) and mortgage backed securities (MBS).
Debt securities by rating of issuer 6840_p090-125.indd 1056840_p090-125.indd 105 27/2/09 22:54:3727/2/09 22:54:37
Reinsurance assets include reinsurance recoverables of USD 18,595 million and USD 26,970 million as of December 31, 2008 and 2007, respectively, which are the reinsurers’ share of reserves for insurance contracts, and receivables arising from ceded reinsurance of USD 1,166 million and USD 1,372 million as of December 31, 2008 and 2007, respectively. Expected reserves for uncollectable amounts of reinsurance assets amount to USD 206 million and USD 239 million as of December 31, 2008 and 2007, respectively.
Reinsurance assets in the table below are shown before taking into account the fair value of credit default swaps, bought by the Group to mitigate credit risks of the reinsurance exposure, and other 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. The decrease of reinsurance assets in 2008 compared with 2007 is mainly attributable to the sale of a pension annuity portfolio to the reinsurer, subsequent to the approval from the UK High Court, effective on June 30, 2008.
The weighted average credit quality of reinsurance assets (including receivables, but after deduction of collateral) was ‘A’ as of December 31, 2008 and 2007, respectively. For credit risk assessment purposes collateral has been taken into account at nominal value as an approximation for fair value. For collateral we apply 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.
% of total 1 The value of the collateral received amounts to USD 8,662 million and USD 16,702 million as of December 31, 2008 and 2007, respectively.
Credit risk relating to mortgage loans and mortgage loans given as collateral Mortgage loans and mortgage loans given as collateral expose the Group to credit risk. The mortgage business is dependent on local property market conditions and local legislation. Portfolio allocations made to mortgages consider these factors and are within the framework of the strategic asset allocation defi ned by the Group Asset/Liability Management Investment Committee and adapted and approved by local investment committees. The Group’s mortgage loan portfolios are mainly European-based with the largest portfolios in Germany, Switzerland and the UK. The loss experience on these portfolios benefi ts positively from the diversifi cation of a large volume of loans within
Table 10 as of December 31Reinsurance premiums ceded and reinsurance assets by rating of reinsurer
Table 10 as of December 31Reinsurance premiums ceded and reinsurance assets by rating of reinsurer 6840_p090-125.indd 1066840_p090-125.indd 106 25/2/09 14:18:0025/2/09 14:18:00
The credit risk arising from other loans and policyholders’ collateral is assessed and monitored together with the fi xed income securities portfolio. 79.3 percent of the reported loans are to government or supranational institutions, of which the majority, 78.5 percent, is owed by the German Central Government or the German Federal States. The table below shows the composition of the loan portfolio by rating class. A total of USD 10,083 million or 80.5 percent of loans are secured as of December 31, 2008. As of December 31, 2007, a total of USD 11,457 million or 88.6 percent of loans were secured.
Please refer to note 15 of the consolidated fi nancial statements for additional information on receivables.
Credit risk relating to derivatives The positive replacement value of outstanding derivatives, such as interest rate, currency, total return and equity swaps, forward contracts and purchased options represents a credit risk to the Group. In addition there is a potential exposure arising from possible changes in replacement value. The Group regularly monitors credit risk exposures arising from derivative transactions. Outstanding positions with external counterparties are managed through an approval process embedded in derivative programs.
To limit credit risk, derivative fi nancial instruments are typically executed with counterparties rated A- or better by an external ratings agency. In addition, it is the Group standard to only transact derivatives with counterparties where we have an ISDA Master Agreement with a Credit Support Annex in place. This mitigates credit exposures from OTC transactions due to close-out netting and requires the counterparty to post collateral when the derivative position is beyond an agreed threshold. We mitigate credit exposures from derivative transactions further by using exchange traded instruments whenever possible.
Table 11 as of December 31Other loans by rating of issuer 6840_p090-125.indd 1076840_p090-125.indd 107 25/2/09 14:18:0125/2/09 14:18:01
Analysis of fi nancial assets 6840_p090-125.indd 1086840_p090-125.indd 108 25/2/09 14:18:0225/2/09 14:18:02
Past due but not impaired fi nancial assets. Past due by: 1 – 90 days – – – – 1,813 1,813
Less: impairment allowance Impairment allowances on individually assessed fi nancial assets – 26 1 1 164 192 Impairment allowances on collectively assessed fi nancial assets – 8 – – 391 399 1 Available for sale debt securities are included net of USD 81 million of impairment charges recognized during 2007.
Liquidity risk is the risk that the Group does not have suffi cient liquid fi nancial resources to meet its obligations when they fall due, or would have to incur excessive costs to do so. Maintaining suffi cient available liquid assets to meet the Group’s obligations as they fall due is an important part of the Group’s fi nancial management practice. For this purpose the Group has established liquidity management policies and specifi c guidelines as to how local businesses have to plan, manage and report their local liquidity.
At Group level, similar guidelines apply and detailed liquidity forecasts based on the local businesses’ input as well as the Group’s own forecasts are regularly performed. As part of its liquidity management, the Group also maintains suffi cient cash and cash equivalents to meet expected outfl ows including those for maturing debt. In addition, the Group centrally maintains a liquidity buffer and committed borrowing facilities as well as access to diverse funding sources to cover contingencies. Funding sources include asset sales, external debt issuances and usage of Letters of Credit. The Group maintains a broad range of maturities for external debt securities. Refer to note 21 of the consolidated fi nancial statements for information on our debt maturities. 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. These contingencies are also considered in the Group’s liquidity management. Refer to note 21 of the consolidated fi nancial statements for additional information on credit facilities and to note 25 of the consolidated fi nancial statements for information on commitments and guarantees.
As a response to the tightening fi nancial market environment, the Group has increased the intensity of monitoring and analyzing its liquidity and its liquidity risk building on established processes, systems and tools. This intensifi ed monitoring includes weekly reporting to the Group Finance and Risk Committee, executive management and the
The Group has committed to contribute capital to subsidiaries and third parties that engage in making investments in direct private equity and private equity funds. Commitments may be called by the counterparty over the term of the investment (generally three to fi ve years) and must be funded by the Group on a timely basis.
Expected maturity profi le for liabilities for investment contracts 6840_p090-125.indd 1116840_p090-125.indd 111 25/2/09 14:18:0425/2/09 14:18:04
Insurance risk is the inherent uncertainty regarding the occurrence, amount or timing of insurance liabilities. The exposure is transferred to the Group through the underwriting process. We actively seek to write those risks we understand and that provide a reasonable opportunity to earn an acceptable profi t. As we assume certain customer risks, we aim to manage that transfer of risk, and minimize unintended underwriting risks, through such means as: Establishing limits for underwriting authority Requiring specifi c 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 our insurance business Ceding insurance risk through proportional, non-proportional and specifi c risk reinsurance treaties. The Group centrally manages reinsurance treaties.
The risks associated with life insurance include: Mortality risk is the risk that actual policyholder death experience on life insurance policies is higher than expected.
A more diversifi ed portfolio of risks is less likely to be affected across the board by a change in any subset of the risks. As a result, the offsetting effects of life and general insurance, as well as between unit-linked and traditional business, reduce some of the risk associated with life insurance business.
The following table 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 signifi cantly by geographic region and line of business and may change over time.
Table 15 as of December 31Reserves, net of reinsurance, by region
Table 15 as of December 31Reserves, net of reinsurance, by region 6840_p090-125.indd 1136840_p090-125.indd 113 25/2/09 14:18:0525/2/09 14:18:05
Other life insurance liabilities include traditional life insurance products, which include protection products and life annuity products. Protection products carry mortality, longevity and morbidity risk as well as market risk. The most signifi cant factors that could increase the frequency of mortality claims are epidemics, such as AIDS and avian infl uenza, or lifestyle changes such as eating, drinking and exercise habits, resulting in earlier or more claims than expected. Morbidity claims experience would not only be affected by the factors mentioned above, but because disability is defi ned in terms of the ability to perform an occupation, it could also be affected by economic conditions. In order to reduce cross-subsidies in the pricing basis, premiums are differentiated by product, age, genders and smoker status. The policy terms and conditions and the disclosure requirements contained in insurance applications are designed to mitigate the risk arising from non-standard and unpredictable risks that may result in severe fi nancial loss.
In addition to the specifi c risks listed above, all lines of business expose the Group to policyholder behavior and expense risks. Policyholder behavior risk is mitigated by product designs which match revenue and expenses associated with the contract as closely as possible. Expense risk is mitigated by careful control of expenses and by regular expense analyses and allocation exercises.
Sensitivities analysis for life insurance risk The Group reports sensitivities of life insurance contracts on Embedded Value and New Business Value to changes in economic and operating risk factors. The operating factors include, but are not limited to, discontinuance rates, expenses, mortality and morbidity. The Embedded Value methodology adopted by the Group is based on a “bottom up” market consistent approach to allow explicitly for market risks. Please refer to the Embedded value report for more information on the sensitivities of Life insurance contracts to economic and operating risk factors.
General insurance risk The Group’s underwriting strategy is to take advantage of the diversifi cation of risks across industries and geographic regions in which the Group operates. The Group seeks to optimize shareholder value by achieving its mid-term return on equity goals. Doing so necessitates a prudent, stable underwriting philosophy that aims to take advantage of its competitive strengths while avoiding risks with disruptive volatility. At the core of the Group’s underwriting is a robust governance process. Our four major processes for underwriting governance – underwriting strategy, authorities, referrals and reviews – are implemented at Group and local levels.
General Insurance reserves represent a risk to the Group as actual losses emerging on claims provisions may be higher than anticipated. Because of this uncertainty General Insurance reserves are regularly measured, reviewed and monitored. The total loss and loss adjustment expense reserves are calculated based on work performed locally by qualifi ed and experienced actuaries. To arrive at their reserve estimates, the actuaries take into consideration, among other things, the latest available facts, historical trends and patterns of loss payments, exposure growth, court decisions, economic conditions and public attitudes that may affect the ultimate cost of settlement. In most instances these analyses are made several times a year, usually at each quarter-end. Analyses are performed by product line, type and extent of coverage and year of occurrence. The Group total loss and loss adjustment expense reserves are the consolidation of the locally calculated reserves which are then discussed and approved by Corporate Center actuaries and Group management. As with any projection there is an inherent uncertainty in the estimation of claim reserves due to the fact that the ultimate liability for claims will be impacted by trends as yet unknown including future changes in the likelihood of claimants bringing suit, the size of court awards, and the attitudes of claimants toward settlement of their claims.
General insurance risk includes the reasonable possibility of signifi cant loss due to uncertainty in the frequency of the occurrence of the insured events as well as in the severity of the resulting claims. The following provides an overview of the Group’s main lines of business: Motor includes automobile physical damage, loss of the insured vehicle and automobile third party liability insurance.
Property includes fi re risks (for example fi re, explosion and business interruption), natural perils (for example earthquake, windstorm and fl ood), engineering lines (for example boiler explosion, machinery breakdown and construction) and marine (cargo and hull). Liability includes general/public and product liability, excess and umbrella liability, professional liability including medical malpractice, directors and offi cers liability and errors and omissions liability. Special lines include credit and surety, crime and fi delity, accident and health, and crop. Worker injury includes workers compensation and employers liability.
In addition to the specifi c risks insured, each line of business could expose the Group to losses that could arise from natural and man-made catastrophes. The main concentrations of risks arising from natural catastrophes are regularly reported to senior management. The most important peril regions and risks are European windstorms, California earthquake, the U.S. and Caribbean windstorms and the UK river fl oods.
The table below shows the Group’s concentration of risk within the General Insurance business by region and line of business based on direct written premiums before reinsurance. The Group’s exposure to general insurance risks varies signifi cantly by geographic region and may change over time. Premiums ceded to reinsurers (including retrocessions) amounted to USD 5,646 million and USD 5,345 million for the years ended December 31, 2008 and 2007, respectively. Reinsurance programs such as catastrophe covers are managed on a global basis, and therefore, net premium after reinsurance is monitored on an aggregated basis.
Sensitivities analysis for General Insurance risk The following table shows the sensitivity of net income before tax and the sensitivity of net assets, using the Group actual income tax rate, as a result of adverse development in the net loss ratio by one percentage point. Such an increase could arise from either higher frequency of the occurrence of the insured events or from an increase in the severity of resulting claims or from a combination of frequency and severity. The sensitivities do not indicate a probability of such an event and do not consider any non-linear effects of reinsurance. Based on the assumptions applied in the presentation of the sensitivity analysis in the table below, each additional percentage point increase in the loss ratio would lead to a linear impact on net income before tax and net assets applying the assumptions as for this table. In addition, the Group monitors insurance risk by evaluating extreme scenarios, taking into account non-linear effects of reinsurance contracts.
+1% in net loss ratio Net income before tax (48) (93) (142) (26)
Modeling natural catastrophes Understanding the potential effects of natural catastrophes is a critical component of our risk management for General Insurance. While specifi c catastrophes are unpredictable, modeling helps to determine potential losses should catastrophes occur. We use a combination of third party and in-house models to manage our underwriting and accumulations in modeled areas so that we stay within intended exposure limits and to guide the levels of reinsurance we buy.
We model at the local and Group level to assess and aggregate our exposures. We centrally oversee our modeling for consistency in approach and from a global perspective on our accumulations. We have technical centers embedded within the business which help to improve the overall quality of our data. We model potential losses from our property policies located in the most hazard-prone areas and adjust for non-property related losses. These assessments principally address climate-induced perils such as windstorms, river fl oods, tornadoes, and hail, and geo-risk perils such as earthquakes. We constantly seek to improve our modeling, fi ll in gaps in models with additional assessments and increase the granularity of our data collection in order to increase the accuracy and utility of our information.
Table 17.a in USD millions, for the year ended December 31, 2008
Insurance risk sensitivity for the General Insurance business 6840_p090-125.indd 1176840_p090-125.indd 117 25/2/09 14:18:0725/2/09 14:18:07
To support this common approach we have established a comprehensive framework to identify, assess, quantify, mitigate and report operational risks within the Group. Within this framework we conduct operational risk assessments. As part of this process operational risks are identifi ed for our key business areas and are qualitatively assessed. Risks identifi ed and assessed above a certain threshold must be evaluated for mitigation. Any resulting plans for improvement actions are documented and tracked on an ongoing basis. Business units that are largest in terms of risk-based capital consumption are required to conduct operational risk assessments for all of their business areas. Additionally we use a scoping exercise to determine for which additional units and Group-wide functional areas operational risk assessments need to be conducted.
We use a scenario-based approach to quantify and allocate risk based capital for operational risk for all business units.
We have put specifi c processes and systems in place to focus continuously on high priority operational matters such as outsourcing, information technology and managing business continuity. A key task is keeping our business continuity plans up-to-date, with an emphasis on recovery from unexpected events such as natural catastrophes and the possibility of a pandemic. In 2008, we particularly focused on testing and exercising our plans, and on improving the granularity and consistency of the plans throughout the Group by rolling out a new framework for business impact analysis.
Strategic business decisions by nature involve risks. We work to reduce the unintended risks of those decisions through our risk assessment processes and tools, including the Total Risk Profi ling® process. The Group Executive Committee regularly assesses key strategic risk scenarios for the Group as a whole, and we specifi cally evaluate the risks of M&A transactions. The Group further manages such risks by assigning clear responsibilities, authorities and limits for review and approval of strategic decisions. In 2008, we strengthened our policies and procedures regarding M&A transactions, especially for valuation methodology, data confi dentiality and integrity, and integration planning. Additionally, we conduct risk assessments after M&A transactions to evaluate risks specifi cally related to the integration of acquired businesses.
The Group’s capital management strategy is to maximize long term shareholder value by optimizing capital allocation while managing the balance sheet at ‘AA’ level and in accordance with regulatory, solvency and rating agency requirements. In particular, the Group endeavors to manage its capital such that the Group and all of its regulated entities are adequately capitalized according to the respective regulatory capital adequacy requirements.
Zurich’s policy is to manage its capital position by allocating capital to businesses earning the highest returns and pooling risks and capital as much as possible to operationalize our global risk diversifi cation subject to local and Group regulatory solvency requirements and ratings agency capital adequacy constraints.
We manage capital and solvency through an integrated and comprehensive framework of principles, governance structures as well as methodology, monitoring and reporting processes. At a Group executive level, the Group Balance Sheet Committee defi nes the capital management strategy and sets the principles, standards and policies for the execution of the strategy. Group Treasury and Capital Management is responsible for the execution of the capital management strategy within the mandate, set by the Group Balance Sheet Committee.
Capital management program Our capital management program comprises various measures to optimize shareholders’ return and to meet capital needs, while enabling Zurich to take advantage of growth opportunities as they arise. Such measures are used as and when required and include effi cient balance sheet structuring as well as cash dividends, share buy-backs, special dividends, issuances of shares or senior and subordinated debt and purchase of reinsurance.
The Group seeks to maintain the balance between higher returns for shareholders on equity raised, which may be possible with higher levels of borrowing, and the security provided by a sound capital position.
An important infl uence on the capital levels is the payment of dividends and share buy-backs. On February 13, 2008 the Board of Zurich Financial Services authorized a share buy-back program of up to CHF 2.2 billion over the course of 2008. 3,750,000 fully paid shares, with a nominal value CHF 0.10, were bought back as of December 31, 2008 at an average price of CHF 293 per share and a total cost of USD 1.1 billion.
In EU countries, insurance entities are required to maintain minimum solvency margins according to the existing Solvency I legislation. Solvency I capital is calculated as a fi xed percentage of premiums, claims, reserves and/or net amounts at risk. The required minimum solvency margin for general insurers is the greater of 16 percent of premiums written for the year or 23 percent of a three-year average of claims incurred, subject to the fi rst tranche (EUR 50 million) of premiums being at 18 percent and the fi rst tranche (EUR 35 million) of claims at 26 percent. In these calculations, premiums and claims for certain liability lines are increased by 50 percent. A reduction is given for reinsurance based on reinsurance claims recoveries over three years as a percentage of gross claims in those years, limited to a maximum of 6840_p090-125.indd 1216840_p090-125.indd 121 25/2/09 14:18:1125/2/09 14:18:11
The Group continues to be subject to Solvency I requirements based on the Swiss Insurance Supervisory Law. The following table sets out the Solvency I position as fi led with the Swiss regulator for 2007 and as drafted for fi ling with the Swiss regulator for 2008.
Throughout 2007 and 2008, the Group and all its material, regulated subsidiaries complied with the applicable regulatory minimum capital requirements.
The fi nancial strength ratings of the Group’s main operating entities are an important element of our competitive position. Moreover, the Group’s credit ratings derived from the fi nancial strength ratings affect the cost of capital. As of December 31, 2008 the fi nancial strength rating of Zurich Insurance Company and other key operating entities of the Group was rated by Standard and Poor’s as ‘AA -,’ by A.M. Best as ‘A,’ by Fitch as ‘A+’ and by Moody’s as ‘A1.’
Table 18 in USD millions, as of December 31The Group’s solvency as of December 31
The largest proportion of RBC arises from general insurance insurance risk, followed by market and credit risk. Life insurance risk only includes biometric risks such as mortality and morbidity risk.
For the beginning of 2009 we estimate our AFR to amount to USD 27 billion, including the deduction of the proposed dividend for the respective fi nancial year, not yet approved by the Annual General Meeting. The estimates for our internal risk based capital requirements amount to USD 28 billion for the calendar year 2009. The reduction in AFR arose mainly from the severe fi nancial market turmoil, specifi cally relating to losses related to our equity holdings, impairments on our debt securities and widening of credit spreads. The reduction in RBC is mainly driven by changes in economic parameters such as interest rates and exchange rates. The economic capital adequacy ratio would be at 95 percent. These estimates are based on preliminary numbers which are not yet fi nal.
126 Zurich Financial Services Group Annual Report 2008Financial Report 2008Financial information 6841_p126-169.indd 126 25/2/09 14:15:16
III 1. Report of Group auditors 234 6841_p126-169.indd 1286841_p126-169.indd 128 28/2/09 11:48:1228/2/09 11:48:12
Net investment income on Group investments 8,725 8,591 Net capital gains/(losses) and impairments on Group investments (2,893) 1,503
attributable to policyholders 20 1,184 83 attributable to shareholders 20 (732) (1,874)
Net income after taxes 3,116 5,797 attributable to non-controlling interests 77 83 attributable to shareholders 3,039 5,714 in USD
The notes to the consolidated fi nancial statements are an integral part of these consolidated fi nancial statements.
Notes 6 2007 Comprehensive income for the period 5,714 (609) Detail of movements during the period –
Change (excluding tax, reclassifi cation and currency translation effects and after allocation to policholders) (6,316) Reclassifi cation to income statement 2,071 Foreign currency translation effects 121 Deferred income tax 965 in USD millions, for the years ended December 31 in USD millions, for the years ended December 31 6841_p126-169.indd 1306841_p126-169.indd 130 25/2/09 14:15:2525/2/09 14:15:25
Reinsurers’ share of reserves for insurance contracts 1 8 18,595 26,970 Deposits made under assumed reinsurance contracts 2,397 1,359 Deferred policy acquisition costs 12 14,323 14,941 Deferred origination costs 12 770 1,003 Accrued investment income 2,429 2,593
in USD millions, as of December 31Assets in USD millions, as of December 31Assets 6841_p126-169.indd 1326841_p126-169.indd 132 25/2/09 14:15:2725/2/09 14:15:27
Liabilities Reserve for premium refunds 620 625 Liabilities for investment contracts 9 35,979 54,485 Deposits received under ceded reinsurance contracts 1,619 1,739 Deferred front-end fees 4,695 5,791 Reserves for insurance contracts 1 8 222,179 252,740 Obligations to repurchase securities 3,608 5,370 Accrued liabilities 2,820 2,755
in USD millions, as of December 31Liabilities and equity in USD millions, as of December 31Liabilities and equity
Cash fl ows from operating activities Net income attributable to shareholders 3,039 5,714 Adjustments for: Net (gain)/loss on divestments of businesses (16) (118) Share of equity in income from investments in associates (8) (13) Depreciation, amortization and impairments of fi xed and intangible assets 654 515 Other non-cash items 1,373 310
Reserves for insurance contracts, gross 1 (19,773) 2,319) Reinsurers’ share of reserves for insurance contracts 1 7,056 (6,403) Liabilities for investment contracts (9,486) 2,213) Deferred policy acquisition costs (975) (928) Deferred origination costs 8 (166) Deposits made under assumed reinsurance contracts (1,307) 715) Deposits received under ceded reinsurance contracts (110) (1,096)
Purchases Debt securities (69,913) (64,327) Equity securities (63,314) (73,044) Other (primarily other investments) (43,783) (32,955)
Proceeds from sale and repurchase agreements (443) (865) Movements in receivables and payables (3,174) 350 Net changes in debt for capital markets and banking activities 1,035 (279) Net changes in other operational assets and liabilities 509 (1,611) Deferred income tax, net (1,705) 357 Net cash provided by operating activities 7,050 (1,580)
Other interest income received 8,859 8,519 Dividend income received 2,943 3,136 Other interest expense paid (1,478) (1,603) Income tax paid (1,253) (1,998)
Cash and cash equivalents comprise the following: Cash at bank and in hand 7,737 5,567 Cash equivalents 8,482 9,492 Cash held as collateral for securities lending 177 1,877 in USD millions, for the years ended December 31 in USD millions, for the years ended December 31 in USD millions, as of December 31Cash and cash equivalents in USD millions, as of December 31Cash and cash equivalents
Balance as of December 31, 2006, as previously reported 10 10,448 819 Total adjustments due to restatement – – (8) Balance as of December 31, 2006, as restated 10 10,448 811 Issuance of share capital – 147 – Dividends to shareholders – – – Share-based payment transactions – 30 – Treasury share transactions 1 – (335) –
Net income – – – Net unrealized gains/(losses) on available-for-sale investments – – (609) Cash fl ow hedges – – – Cumulative translation adjustment – – – Revaluation reserve – – – Net actuarial gains/(losses) on pension plans – – –
of which: share buy-back program – (245) – Total comprehensive income for the period, net of tax – – (3,159)
Net income – – – Net unrealized gains/(losses) on available-for-sale investments – – (3,159) Cash fl ow hedges – – – Cumulative translation adjustment – – – Revaluation reserve – – – Net actuarial gains/(losses) on pension plans – – –
Zurich Financial Services, a Swiss corporation, is the holding company of the Group and is listed on the SIX Swiss Exchange. Zurich Financial Services 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 February 4, 2009 the Board of Directors of Zurich Financial Services authorized these consolidated fi nancial statements for issue. These fi nancial statements will be submitted for approval to the Annual General Meeting of Shareholders to be held on April 2, 2009.
During the year, the presentation of certain items in the consolidated fi nancial statements has been amended in order to better refl ect their economic substance. These changes in presentation have no effect on the previously reported net income or shareholders’ equity and comparative amounts have been amended accordingly. Material changes in presentation are described as follows: Investments held by investment companies, previously reported under other investments and amounting to USD 1,827 million as of December 31, 2007 are now presented under equity securities at fair value through profi t or loss, as this presentation better refl ects the nature and measurement basis of these investments. This change in presentation is refl ected in the consolidated balance sheet, consolidated statement of cash fl ows, note 6 and note 25.
Recurring payments made to distributors of life products after the initial sale, over the lifetime of the policy, are now presented as part of administrative and other operating expense. They were previously reported as part of underwriting and policy acquisition costs and amounted to USD 266 million for the year ended December 31, 2007. This change in presentation is refl ected in the consolidated income statement, note 11 and note 13.
Amortization and impairments of intangible assets, previously reported separately in the consolidated income statement and amounting to USD 302 million for the year ended December 31, 2007, are now included in administrative and other operating expense. This change in presentation is also refl ected in note 13.
Movements shown in the development tables throughout the consolidated fi nancial statements have been translated at average rather than end-of-period foreign exchange rates as they were presented in previous years.
The following balances are generally considered to be non-current: equity securities, investments in associates, real estate held for investment, deferred policy acquisition costs on life insurance contracts, deferred tax assets, goodwill, other intangible assets, property and equipment, and deferred tax liabilities.
The following balances are mixed in nature (including both current and non-current portions): debt securities, mortgage loans, other loans, other investments, reinsurers’ share of reserves for insurance contracts, deposits made under assumed reinsurance contracts, deferred front-end fees, deferred origination costs, other assets, mortgage loans given as collateral, reserves and investments for unit-linked contracts, liabilities for investment contracts, deposits received under ceded reinsurance contracts, reserves for losses and loss adjustment expenses, reserves for unearned premiums, future life policyholders’ benefi ts, policyholders’ contract deposits and other funds, other liabilities, collateralized loans, debt related to capital markets and banking activities, and senior and subordinated debt.
All amounts in the consolidated fi nancial statements are shown in USD millions, rounded to the nearest million unless otherwise stated with the consequence that the rounded amounts may not add to the rounded total in all cases.
USD per foreign currency unit, as of or for the year ended December 31Principal exchange rates 6841_p126-169.indd 1396841_p126-169.indd 139 28/2/09 11:46:5828/2/09 11:46:58
Change in accounting policies in 2008 The accounting policy for three run-off blocks of disability business in Centre, included in Other Businesses, has been changed by exercising the option in IFRS 4 to remeasure designated insurance liabilities using current fi nancial and non-fi nancial assumptions. All fi nancial assets related to these insurance liabilities are designated as “at fair value through profi t or loss.” This is a better refl ection of the way these blocks of business are managed. As a consequence of this change in accounting policy, prior year fi gures have been restated to ensure comparability as shown in the following tables.
Table 1.3 in USD millions 6841_p126-169.indd 1406841_p126-169.indd 140 27/2/09 18:38:1727/2/09 18:38:17
Sale of North America Commercial Small Business Solutions (SBS) On June 13, 2008, effective on June 1, 2008, the Group completed the sale of the rights to access renewals of its North America Commercial Small Business Solutions (SBS) book of business to Truck Insurance Exchange (TIE), one of the Farmers Exchanges, which the Group manages but does not own. As part of the transaction, the Group has entered into a 100% quota share reinsurance agreement for the in-force business as of June 1, 2008. This resulted in the Group paying TIE the balance of unearned premium reserve related to the business ceded to TIE of USD 425 million and TIE compensating the Group for its deferred acquisition cost balance as of the effective date of the transaction by paying a ceding commission of USD 120 million. In addition, the management of the in-force SBS book of business has been transferred together with certain assets and liabilities to Farmers Group, Inc. This transaction had no impact on the scope of consolidation.
Segment information The Group is managed on a matrix basis, refl ecting both line of business and geography. Accordingly, segment information is presented in two formats. The primary format is based on the operating businesses of the Group and how they are strategically managed to offer different products and services to specifi c customer groups. The Group’s primary business segments are as follows: General Insurance serves the property-casualty insurance needs of a wide range of customers, from individuals to small and medium-size businesses, commercial enterprises and major multinational corporations.
Farmers Management Services which through Farmers Group, Inc. and its subsidiaries (FGI) provides non-claims related management services to the Farmers Exchanges, are prominent writers of personal lines and small commercial lines business in the United States. FGI receives fee income for the provision of services to the Farmers Exchanges, which we manage, but do not own, and to their customers.
Other Businesses includes Farmers Re which provides reinsurance to the Farmers Exchanges, Centre and capital markets and banking activities. This segment also includes certain businesses which are centrally managed and are not considered to be core businesses of the Group.
Corporate Functions includes Group holding and fi nancing companies, Corporate Center operations and certain alternative investments.
To be consistent with the Group’s geographic structure, the following immaterial transfer between secondary segments has been made for 2008 fi nancial reporting: Zurich Eurolife S.A. from Central Region to Europe
The accounting policies of the segments are the same as those described in the summary of signifi cant accounting policies. The Group accounts for inter-segment revenues and transfers as if the transactions were with third parties at current market prices, with the exception of dividends, realized capital gains as well as gains and losses on transfer of net assets, which are eliminated against equity.
Standards published and effective as of January 1, 2008 and relevant for the Group’s operations IFRIC 14 “IAS 19 – The limit on a defi ned benefi t asset, minimum funding requirements and their interaction” has been implemented for the fi nancial year beginning January 1, 2008 and had no signifi cant impact on the Group’s fi nancial position or performance.
Amendments effective as of July 1, 2008 and relevant for the Group’s operations In October 2008, the IASB issued amendments to IAS 39 “Financial Instruments: Recognition and Measurement” and IFRS 7 “Financial Instruments: Disclosures”. The amendments in IAS 39 permit an entity to reclassify certain nonderivative fi nancial assets out of the “fair value through profi t or loss” and “available-for-sale” categories in limited circumstances. The amendment to IFRS 7 requires additional disclosures for such non-derivative fi nancial assets reclassifi ed out of the “fair value through profi t or loss” and “available-for-sale” categories. The Group has not made any such reclassifi cations.
In November 2006, the IASB issued IFRS 8 “Operating Segments”. IFRS 8 is mandatory for reporting periods beginning on or after January 1, 2009. The standard sets out the requirements for disclosure of an entity’s operating segments on the same basis as internal reporting used by management for decision making, as well as disclosures of the entity’s products and services, the geographical areas in which it operates, and its major customers.
In January 2008, the IASB issued the revised IFRS 3 “Business Combinations”. The standard is mandatory for reporting periods beginning on or after July 1, 2009. The revised standard continues to apply the acquisition method to business combinations, with some signifi cant changes. For example, all payments to purchase a business are to be recorded at fair value at the acquisition date, with contingent payments classifi ed as debt and subsequently re-measured at fair value through the income statement. There is a choice on an acquisition-by-acquisition basis to measure the noncontrolling interest in the acquiree either at fair value or at the non-controlling interest’s proportionate share of the acquiree’s net assets. All acquisition-related costs must be expensed.
Additionally, the IASB issued several minor amendments as part of the IASB’s annual improvements project. The amendments are mandatory for reporting periods beginning on or after January 1, 2009 with the exception of the amendment regarding IFRS 5 “Non-current Assets Held for Sale and Discontinued Operations” which is mandatory for reporting periods beginning on or after July 1, 2009.
a) Consolidation principles The Group’s consolidated fi nancial statements include the assets, liabilities, equity, revenues, expenses and cash fl ows of Zurich Financial Services and its subsidiaries. A subsidiary is an entity in which Zurich Financial Services owns, directly or indirectly, more than 50 percent of the outstanding voting rights, or which it otherwise has the power to control and is accounted for using the purchase method. The results of subsidiaries acquired are included in the consolidated fi nancial statements from the date of acquisition. The results of subsidiaries that have been divested during the year are included up to the date control ceased. All signifi cant intercompany balances, profi ts and transactions are eliminated in full.
Investments in associates and partnerships where the Group has the ability to exercise signifi cant infl uence but not control, as well as joint ventures where there is joint control, are accounted for using the equity method. Signifi cant infl uence 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, investments in associates, partnerships or joint ventures are 6841_p126-169.indd 1446841_p126-169.indd 144 27/2/09 18:38:1927/2/09 18:38:19
The consolidated fi nancial statements are prepared as of December 31 based on individual company fi nancial statements at the same date. In some cases information is included with a time lag of up to three months. The effects on the Group’s consolidated fi nancial statements are not material.
Investment contracts are those contracts that transfer fi nancial risk with no signifi cant insurance risk.
The Group applies the same accounting policies for the recognition and measurement of obligations arising from insurance contracts and from investment contracts with DPF. These recognition and measurement criteria apply to obligations arising from the contract, deferred acquisition costs and other related intangible assets.
Premiums from traditional life insurance contracts, including participating contracts and annuity policies with life contingencies, are recognized as revenue when due from the policyholder. Benefi ts and expenses are provided against such revenue to recognize profi ts over the estimated life of the policies. Moreover, for single premium and limited pay contracts, premiums are recognized in income when due with any excess profi t deferred and recognized in income in a constant relationship to the insurance in-force or, for annuities, the amount of expected benefi t payments.
Deferred policy acquisition costs (DAC) The costs of acquiring new business, including commissions, underwriting and policy issue expenses, which vary with and are directly related to the production of new business, are deferred. Certain direct response marketing costs for efforts which solicit a direct response that is specifi c and quantifi able are also deferred, when it can be demonstrated that such marketing results in future economic benefi ts. Future investment income is taken into account in assessing recoverability.
DAC for participating traditional life insurance contracts is amortized over the expected life of the contracts as a constant percentage of estimated gross margins. Estimated gross margins include anticipated premiums and investment results less benefi ts and administration expenses, changes in the net level premium reserve and expected policyholder dividends, as appropriate. Estimated gross margins are re-estimated regularly with the impact of deviations in the actual result from estimated experience on the amortization of DAC refl ected in earnings.
DAC for other traditional life insurance and annuity policies is amortized over the expected life of the contracts as a constant percentage of expected premiums. Expected premiums are estimated at the date of policy issue and are consistently applied throughout the life of the contract unless premium defi ciency occurs.
The DAC asset is adjusted to equal the effect that realization of unrealized gains or losses on investments would have had on its measurement. This change is recorded as a direct offset to unrealized gains or losses at the balance sheet date (shadow accounting).
DAC for general insurance contracts is amortized over the period in which the related premiums written are earned.
For traditional life insurance policies, interest rate assumptions can vary by country, year of issuance and product. The mortality rate assumptions are based on published mortality tables and are adjusted for actual experience by geographic area and modifi ed to allow for variations in policy form. The surrender assumptions are based on actual experience by geographic area and modifi ed to allow for variations in policy form.
Where unrealized gains or losses on the revaluation of available-for-sale assets arise they are recorded directly in equity in accordance with the Group’s accounting policy for such assets, the corresponding adjustments to future life policyholders’ benefi ts and related assets are also recognized directly in equity.
The policyholders’ share of unrealized gains or losses, which may be paid in the future, in respect of assets, is included in future life policyholders’ benefi ts.
Reserves for unit-linked contracts are recorded at an amount equal to the consideration received plus accumulated investment yield less any fees charged or dividends paid to the policyholder.
For products containing guarantees in respect of minimum death benefi ts (GMDB), retirement income benefi ts (GRIB) and/or annuitization options (GAO), additional liabilities are recorded in proportion to the receipt of the contracted revenues.
Reinsurance assets are assessed for impairment on a regular basis for any events that may trigger impairment. Triggering events may include legal disputes with third parties, changes in capital and surplus levels, change in credit ratings of a counterparty and historical experience regarding collectibility from specifi c reinsurers.
In addition to assessing whether signifi cant insurance risk has been transferred, reinsurance contracts are further assessed to ensure that underwriting risk, defi ned as the reasonable possibility of signifi cant loss, and timing risk, defi ned as the reasonable possibility of a signifi cant variation in the timing of cash fl ows, are transferred by the ceding or assuming company to the reinsurer. Those contracts that do not transfer both risks, referred to in total as insurance risk, are accounted for using the deposit method. A deposit asset or liability is recognized based on the consideration paid or received less any explicitly identifi ed premiums or fees to be retained by the ceding company. Deposits for contracts that transfer only signifi cant underwriting risk are subsequently measured based on the unexpired portion of coverage until a loss is incurred, after which the present value of expected future cash fl ows under the contract is added to the remaining unexpired portion of coverage. Changes in the deposit amount are recorded in the consolidated income statements as an incurred loss. Interest on deposits that transfer only timing risk, or no risk at all, are accounted for using the effective interest rate method. Future cash fl ows are estimated to calculate the effective yield, and revenue and expense are recorded as interest income or expense. Premiums paid under retroactive contracts are included in reinsurance recoverables in the balance sheet. If the amount of gross claims provisions reinsured is higher than the premium paid, reinsurance receivables are increased by the difference, and the gain is deferred and amortized over the period in which the underlying claims are paid.
c) Investment contracts (without DPF) The Group issues investment contracts without fi xed terms (unit-linked) and investment contracts with fi xed and guaranteed terms (fi xed interest rate).
Liabilities for investment contracts (unit-linked) These represent portfolios maintained to meet specifi c investment objectives of policyholders who bear the credit and market and liquidity risks related to those investments. The liabilities are carried at fair value, with fair value of the liabilities determined by reference to the underlying fi nancial assets. The related assets held under unit-linked investments contracts are classifi ed as designated at fair value through profi t or loss in order to reduce measurement inconsistencies. Changes in the fair value of the assets and liabilities are recorded in income. The costs of policy administration, investment management, surrender charges and certain policyholder taxes assessed against the policyholders’ account balances are included in policy fee revenue.
As of each reporting date, the Group re-estimates the expected future cash fl ows and recalculates the carrying amount of the fi nancial liability by computing the present value of estimated future cash fl ows using the original effective interest rate for the fi nancial liability. Any adjustment is immediately recognized as income or expense in the income statement.
Deferred origination costs (DOC) The costs of acquiring new investment contracts with investment management services, including commissions and other incremental expenses directly related to the issuance of each new contract, are capitalized and amortized in line with the revenue generated by the investment management service. DOC is tested for recoverability at each reporting date.
d) Other revenue recognition Fees for the provision of non-claims related management services by FGI to the Farmers Exchanges are calculated primarily as a percentage of gross premiums earned by the Farmers Exchanges. FGI provides non-claims related management services to the Farmers Exchanges, including risk selection, preparation and mailing of policy forms and invoices, premium collection, management of the investment portfolios and certain other administrative and managerial functions. The Farmers Exchanges are directly responsible for their own claims functions, including the settlement and payment of claims and claims adjustment expenses, as well as for the payment of agent commissions and bonuses and the payment of premium and income taxes.
The Group charges its customers for asset management and other related services using the following different approaches: Front-end fees charged to the customer at inception are used particularly for single premium contracts. The consideration received is deferred as a liability and recognized over the life of the contract on a straight-line basis.
Regular fees charged to the customer periodically (monthly, quarterly or annually) either directly or by making a deduction from invested funds are billed in advance and recognized on a straight-line basis over the period in which the service is rendered. Fees charged at the end of the period are accrued as a receivable and are offset against the fi nancial liability when charged to the customer.
Investment income primarily consists of dividend income on equity securities, interest income on fi nancial assets other than equity securities, rental income earned on real estate held for investment and income earned on investments that are accounted for by using the equity method of accounting.
f) Investments Investments include cash and cash equivalents, non-derivative fi nancial instruments, real estate held for investment, investments in associates and short-term investments.
Financial assets at fair value through profi t or loss are sub-classifi ed into fi nancial assets held for trading and those designated at fair value through profi t or loss at inception.
Financial assets designated at fair value through profi t or loss at inception are mainly fi nancial assets backing unit-linked insurance and unit-linked investment contracts. Reserves relating to unit-linked insurance contracts and liabilities for unit-linked investment contracts are carried at fair value, which is determined by reference to these assets with changes in the fair value of both the asset and liability recognized in income. The designation of these assets at fair value through profi t or loss eliminates or signifi cantly reduces a measurement inconsistency that would otherwise arise from measuring assets or from recognizing the resultant gains and losses on them on a different basis to the liability. The fair value designation, once made, is irrevocable.
Held-to-maturity fi nancial assets are non-derivative fi nancial assets with fi xed or determinable payments and fi xed maturities other than those that meet the defi nition of loans and receivables, and for which the Group’s management has the positive intention and the ability to hold to maturity.
Loans and receivables are non-derivative fi nancial assets with fi xed or determinable payments that are not quoted in an active market other than those that the Group intends to sell in the short term or that it has designated at fair value through profi t or loss or is holding as available-for-sale. Loans and receivables include loans where money is provided directly to the borrower, such as mortgage loans, policyholder loans and other loans.
Measurement of investments General The Group recognizes regular way purchases and sales of fi nancial assets on the trade date, which is the date on which the Group commits to purchase or sell the asset.
Short-term investments are investments with an original maturity date between three months and twelve months. The carrying values of short-term investments approximate to fair values.
Impairments of non-derivative fi nancial instruments General The Group assesses at each balance sheet date whether there is objective evidence that a fi nancial asset or group of fi nancial assets is impaired. A fi nancial asset or group of fi nancial assets is impaired as a result of one or more events that have occurred after the initial recognition of the asset (a ’loss event’) and that loss event (or events) has an impact on the estimated future cash fl ows of the fi nancial asset or group of fi nancial assets that can be reliably estimated. Objective evidence that a fi nancial asset or group of assets is impaired includes observable data that comes to the attention of the Group about the following events: a) signifi cant fi nancial diffi culty of the issuer or debtor; b) a breach of contract, such as a default or delinquency in payments; 6841_p126-169.indd 1526841_p126-169.indd 152 27/2/09 18:38:2227/2/09 18:38:22
The Group fi rst assesses whether objective evidence of impairment exists for fi nancial assets that are individually signifi cant. If the Group determines that no objective evidence of impairment exists for an individually assessed fi nancial asset, whether signifi cant or not, it includes the asset in a group of fi nancial assets with similar credit risk characteristics and collectively assesses them for impairment. Assets that are individually assessed for impairment and for which an impairment loss is or continues to be recognized are not included in a collective assessment of impairment.
Fair values are obtained from quoted market prices, dealer price quotations, discounted cash fl ow models and option pricing models, which use various inputs including current market and contractual prices for the underlying instrument, time to expiry, correlations, yield curves, prepayment rates and volatility of the underlying instrument. Such inputs used in pricing models are generally market observable or derived from market observable data.
Cash fl ow hedges In a cash fl ow hedge relationship the effective portion of the gain or loss on the re-measurement of the cash fl ow hedging instrument is recognized directly in shareholders’ equity. The ineffective portion is recognized immediately in income. The accumulated gains and losses on the hedged instrument in shareholders’ equity are transferred to income in the same period in which gains or losses on the item hedged are recognized in income.
Discontinued hedges Where hedge accounting is applied, the Group formally documents all relationships between hedging instruments and hedged items, including the risk management objectives and strategy for undertaking hedge transactions. At inception of a hedge and on an ongoing basis, the hedge relationship is formally assessed in order to determine whether the hedging instruments that are used in hedging transactions are highly effective in offsetting changes in fair values or cash fl ows of hedged items attributable to the hedged risk. The Group discontinues hedge accounting prospectively in the following circumstances: it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash fl ows of a hedged item (including forecast transactions); the derivative expires or is sold, terminated, or exercised; the derivative is no longer designated as a hedging instrument because it is unlikely that the forecast transaction will occur; or the Group otherwise determines that designation of the derivative as a hedging instrument is no longer appropriate.
h) Derecognition of financial assets and liabilities Financial assets are derecognized when the right to receive cash fl ows from the assets has expired, or when the Group has transferred its contractual right to receive the cash fl ows from the fi nancial asset, and either substantially all the risks and rewards of ownership have been transferred; or substantially all the risks and rewards have not been retained or transferred, but control has been transferred.
j) Securities lending Certain entities within the Group participate in securities lending arrangements whereby specifi c securities are loaned to other institutions, primarily banks and brokerage fi rms, for short periods of time. Under the terms of the securities lending agreements, the Group retains substantially all the risks and rewards of ownership of these loaned securities, and also retains contractual rights to cash fl ows therefrom. These securities are therefore not derecognized from the Group’s balance sheet. Cash received as colleteral for loaned securities is recorded as an asset and a corresponding liability is established.
In a reverse repurchase agreement, the securities that serve as a collateral are not recognized on the balance sheet, as long as the risk and rewards of ownership have not been obtained by the Group. The cash delivered is derecognized and a corresponding receivable is recorded. Interest income is recognized in income using the effective interest rate method over the life of the agreement.
l) Borrowings Borrowings (debt issued) are recognized initially at fair value, net of transaction costs incurred. Borrowings are subsequently carried at amortized cost; any difference between the proceeds (net of transaction costs) and the redemption value is recognized in income over the period of the borrowings using the effective interest rate method.
m) Interest expense Interest expense for all fi nancial instruments except for those classifi ed as held for trading or designated at fair value is recognized in income using the effective interest method.
The test for goodwill impairment is performed annually or whenever there is an indication that the cash generating unit may be impaired. Goodwill is carried at cost less accumulated impairment losses. Impairments are recorded in income if the recoverable amount is less than the carrying amount including goodwill of the CGU. Gains and losses on the divestment of an entity are calculated including the carrying amount of any goodwill relating to the entity sold.
The useful lives of computer software licenses and capitalized software development costs generally do not exceed 5 years. In some exceptional circumstances, capitalized software development costs may be amortized over a period of up to 10 years, taking into account the effects of obsolescence, technology, competition and other economic and legal factors.
Other intangible assets are amortized using the straight-line method over their useful life. They are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.
An impairment loss is recorded in income when the carrying value of the asset exceeds its recoverable amount. The recoverable amount is the higher of the fair value less selling costs of an asset and its value in use.
to the extent it is probable that the losses can offset future taxable income and is allowed by the applicable local tax laws and regulations.
Taxes payable by either the company or its subsidiaries on expected distributions to the holding company of the profi ts of subsidiaries are not recognized as deferred income taxes unless a distribution of those profi ts is intended in the foreseeable future.
Taxes paid by certain of our life insurance businesses are based on the investment result less allowable expenses. To the extent that these taxes exceed the amount that would have been payable in respect of the shareholders’ share of taxable profi ts, it is normal practice for certain of our businesses to recover this tax from policyholders. While the relevant company has the contractual right to charge policyholders for the taxes attributable to their share of the investment result less expenses, the obligation to pay the tax authority rests with the company and therefore, the full amount of tax including that policyholders is accounted for as income tax. Income tax expense therefore includes an element attributable to policyholders. In addition, deferred tax on unrealized gains on investment contracts with DPF related to certain unit-linked contracts is included as income tax expense and an accrual for future policy fees to recover the tax charge is included in gross written premiums as policy fee revenue.
Other post-employment benefi ts Other defi ned post-employment benefi ts, such as medical care and life insurance, are also provided for certain employees and are primarily funded internally. Similar to retirement benefi ts, the cost of such benefi ts is accrued over the service period of the employees based on the actuarially determined cost for the period.
s) Finance and operating leases Agreements which transfer to counterparties substantially all the risks and rewards incidental to the ownership of assets, but not necessarily legal title, are classifi ed as fi nance leases. Leases in which a signifi cant portion of the risks and rewards of ownership are retained by the lessor are classifi ed as operating leases. Payments made under operating leases (net of any incentives received from the lessor) are charged to income on a straight-line basis over the period of the lease, unless another systematic basis is representative of the time pattern of the user’s benefi t even if the payments are not on that basis.
t) Provisions Provisions 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 outfl ow of resources embodying economic benefi ts will be required to settle the obligation and a reliable estimate can be made of the amount of the obligation. Provisions are discounted when the effect of the time value of money is considered material.
u) Treasury shares Zurich Financial Services shares held by the Group are classifi ed as treasury shares and are deducted from share capital at nominal value. The difference between the nominal value and the amount paid for acquiring, or received for disposing of treasury shares, is recorded as an adjustment to additional paid-in capital to the extent that additional paid-in capital is available. Any premium or discount above the available additional paid-in capital is recorded directly in retained earnings.
Foreign currency transactions Foreign currency monetary items and foreign currency non-monetary items, which are carried at fair value, are translated at end-of-period exchange rates. Foreign currency non-monetary items which are carried at historical cost are translated at historical exchange rates. The resulting exchange differences are recorded in income, except when the gain or loss on a non-monetary item measured at fair value is recognized directly in equity in which case any exchange component of that gain or loss is also recognized directly in equity. Revenues and expenses are translated using the exchange rate at the date of the transaction or, for practical reasons, a weighted average rate, if exchange rates do not fl uctuate signifi cantly.
The Group’s reserves for reported losses and loss adjustment expenses are based on estimates of future payments to settle reported general insurance claims and claims from the run-off of its former third party reinsurance operations. The Group bases such estimates on the facts available at the time the reserves are established. The Group generally establishes these reserves on an undiscounted basis to recognize the estimated costs of bringing pending claims to fi nal settlement, taking into account infl ation, as well as other factors that can infl uence the amount of reserves required, some of which are subjective and some of which are dependent on future events. In determining the level of reserves, the Group considers historical trends and patterns of loss payments, pending levels of unpaid claims and types of coverage. In addition, court decisions, economic conditions and public attitudes may affect the ultimate cost of settlement and, as a result, the Group’s estimation of reserves. Between the reporting and fi nal settlement of a claim circumstances may change, which would result in changes to established reserves. Items such as changes in law and interpretations of relevant case law, results of litigation, changes in medical costs, as well as costs of vehicle and home repair materials and labor rates can substantially impact ultimate settlement costs. Accordingly, the Group reviews and re-evaluates claims and reserves on a regular basis. Amounts ultimately paid for losses and loss adjustment expenses can vary signifi cantly from the level of reserves originally set.
asbestos and product liability, can take years to develop and additional time to settle. For long-tail claims, information concerning the event, such as the required medical treatment for bodily injury claims and the measures and costs required to clean up pollution, may not be readily available. Accordingly, the reserving analysis of long-tail lines of business is generally more diffi cult and subject to greater uncertainties than for short-tail claims.
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 infl uence 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.
Under certain contracts, the Group has offered product guarantees (or options to take up product guarantees), including fi xed minimum interest rate or mortality rate returns. In determining the value of these options and/or benefi ts, estimates have been made as to the percentage of contract holders that may exercise them. Changes in investment conditions could result in signifi cantly more contract holders exercising their options and/or benefi ts than has been assumed.
Estimates are also made as to future investment income arising from the assets backing long-term insurance contracts. These estimates are based on current market returns as well as expectations about future economic and fi nancial developments.
Assumptions are determined with reference to current and historical client data, as well as industry data. Interest rate assumptions refl ect expected earnings on the assets supporting the future policyholder benefi ts. The information used by the Group’s qualifi ed actuaries in setting such assumptions includes, but is not limited to, pricing assumptions, available experience studies and profi tability analysis.
Refer to notes 8 and 11 for further information on future life policyholders’ benefi ts and policyholders’ contract deposits and other funds.
Fair values of debt and equity securities are based on quoted market prices when available. If such prices are not available, then fair values are estimated on the basis of pricing models, discounted cash fl ow models or other recognized valuation techniques or information from external pricing sources.
Discounted cash fl ow models are used for mortgage and other loans and long term receivables. The discount rates used in these models are either current interest rates charged by the Group on these instruments or a calculated rate that refl ects the return a market participant would expect to receive on instruments with similar remaining maturity, cash fl ow pattern, currency, credit risk, collateral and interest basis.
Fair values of derivative instruments are obtained from quoted market prices, dealer price quotations, discounted cash fl ow models and option pricing models, which use various inputs including current market and contractual prices for underlying instruments, time to expiry, correlations, yield curves, prepayment rates and volatility of underlying instruments. Such inputs used in pricing models are generally market observable or derived from market observable data.
Fair value of liabilities related to unit-linked investment contracts equals the fair value of fi nancial assets backing these liabilities. Fair values of liabilities related to other investment contracts are determined using discounted cash fl ow models. A variety of factors are considered in the Group’s valuation techniques, including credit risk, embedded derivatives (such as unit-linking features), volatility factors (including contract holder behavior), servicing costs and surrenders of similar instruments.
The Group makes extensive use of third party pricing providers in determining fair values of invested assets and only in rare cases places reliance on prices that are derived from internal models. The Group’s control environment and the process of selection of pricing providers ensures that fair values of invested assets are sourced only from independent, reliable and reputable third party pricing providers.
In cases where signifi cant reliance is placed on an independent price provider, the Group has engaged with that price provider to ensure that the control environment conforms to the high standards that the Group expects. In addition, the Group ensures that independently sourced prices are determined based on valuation techniques that incorporate all factors that market participants would consider in setting a price and are consistent with best practice methodologies for pricing fi nancial instruments. Such models make maximum use of market inputs such as benchmark yields, reported trades and broker/dealer quotes. 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 based on regular reports from 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.
d) Impairment of assets Assets are subject to regular impairment reviews under the relevant IFRS standard.