performance (indexed) since September 4, 2002 09/2002 03/2003 09/2003 03/2004 09/2004 03/2005 09/2005
Life Insurance – 1 new business profit margin, after tax (in % of APE)
The Financial Report consists of the audited consolidated financial statements, including the notes, as well as the audited financial statements of the Zurich Financial
Switzerland (for shareholders, except in the UK) and from Lloyds TSB Registrars,
(for CDI-holders and shareholders in the UK) or on our Web site under Investor Relations.
Consolidated operating statements in USD millions, for the years ended December 31 Notes 2005 2004
Underwriting and policy acquisition costs, net of reinsurance 10 7,253 7,390
Assets in USD millions, as of December 31 Notes 2005 2004
Debt related to capital markets and banking activities 22 2,139 3,880
Adjustments for: Net capital gains on investments and impairments (13,382) (6,542)
Depreciation, amortization and impairments of fixed and intangible assets 447 677
Foreign currency translation effects on cash and cash equivalents (1,661) 683
Change in cash and cash equivalents excluding change in cash received as collateral for securities lending 1,651 1,410
Change in cash received as collateral for securities lending (626) 5,158
Cash and cash equivalents as of December 31, including cash received as collateral for securities lending 23,482 22,457
Cash and cash equivalents comprise the following: Cash at bank and in hand 5,075 8,728
Total adjustment due to implementation of new and revised IFRS accounting standards 1 – – –
Change in net unrealized gains/losses on investments not recognized in the operating statement – – –
The number of common shares issued was 144,006,955 as of December 31, 2005, 2004 and 2003.
The Board of Directors of Zurich Financial Services has authorized on February 15, 2006 these consolidated financial statements for issue. These financial statements will be submitted for approval to the Annual General Meeting of Shareholders to be held on April 20, 2006.
The new and revised accounting standards, discussed in note 3, resulted in the restatement of 2004 consolidated financial statements. In addition, certain reclassifications have been made to prior year amounts and segment disclosures to conform to the current year presentation. These reclassifications have no effect on the previously reported net income.
The following balances are of a mixed nature (including both current and non-current portions): debt securities, mortgage loans, policyholders’ collateral and other loans, other investments - other, reinsurers’ share of reserves for insurance contracts, deposits made under assumed reinsurance contracts, deferred front-end fees, deferred origination costs, derivative trading assets and other assets, mortgage loans given as collateral, fixed assets, liabilities for investment contracts, deposits received under ceded reinsurance contracts, reserves for losses and loss adjustment expenses, reserves for unearned premiums, future life policyholders’ benefits, policyholders’ contract deposits and other funds, obligation to repurchase securities, derivative liabilities and other liabilities, collateralized loans, debt related to capital markets and banking activities, and senior and subordinated debt.
• The reinsurance business of various Group entities from Corporate Functions to Other Businesses or General Insurance
The Group’s secondary format for segment information is geographic: • North America
In 2004, these secondary segments were North America Corporate, North America Consumer, Continental Europe, UKISA, Rest of the World and Centrally Managed Businesses. For 2005 financial reporting, these regions have been aligned to better reflect management responsibility. The 2004 results have been restated to reflect these changes.
A number of insurance and investment contracts contain discretionary participation features (DPF) which entitle the contract holder to receive, as a supplement to guaranteed benefits, additional benefits: • whose amount or timing is contractually at the discretion of the Group; and
Premiums from traditional life insurance contracts, including participating contracts and annuity policies with life contingencies, are recognized as revenue when due from the policyholder. Benefits and expenses are provided against such revenue to recognize profits over the estimated life of the policies. Moreover, for single premium and limited pay contracts, premiums are recorded as income when due with any excess profit deferred and recognized in income in a constant relationship to the insurance in-force or, for annuities, the amount of expected benefit payments.
Deferred policy acquisition costs for participating traditional life insurance contracts are 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 benefits and administration expenses, changes in the net level premium reserve and expected policyholder dividends, as appropriate. Estimated gross margins are reestimated regularly with the impact of deviations of actual result from estimated experience on the amortization of deferred acquisition costs reflected in earnings.
Liability adequacy testing is performed by portfolio of contracts, in accordance with the Group’s manner of acquiring, servicing and measuring the profitability of its insurance contracts. Net unearned premiums are tested to determine whether they are sufficient to cover related expected claims, loss adjustment expenses, policyholder dividends, commission, amortization and maintenance expenses. If there is a premium deficiency, the deferred policy acquisition cost asset is written down by the amount of the deficiency. If, after writing down the deferred policy acquisition cost asset to nil (for the portfolio of contracts), a premium deficiency still exists, then a premium deficiency reserve is recorded to provide for the deficiency in excess of the deferred policy acquisition cost asset written down.
Future life policyholders’ benefits and policyholders’ contract deposits These represent the estimated future policyholder benefit liability for traditional life insurance policies and for certain unit-linked contracts, respectively.
Future life policyholders’ benefits for participating traditional life insurance policies are calculated using a net level premium method based on actuarial assumptions equal to guaranteed mortality and interest rates.
The minimum mandated amounts, which are to be paid to policyholders plus any declared additional benefits, are recorded in liabilities. Undeclared discretionary balances are recorded in shareholders’ equity until such time as the allocation is determined and a bonus is declared.
c) Investment contracts (without discretionary participating features) The Group issues investment contracts without fixed terms (unit-linked) and investment contracts with fixed and guaranteed terms (fixed interest rate).
Valuation techniques are used to establish the fair value at inception and each reporting date.
Certain upfront payments received for asset management services (“front-end fees”) are deferred and amortized in proportion to the stage of completion of the service for which they were paid.
Interest income on financial assets that are not classified as fair value through profit or loss is recognized using the effective interest method. When a receivable is impaired, the Group reduces the carrying amount to its recoverable amount, being the estimated future cash flow discounted at the original effective interest rate of the instrument and continues unwinding the discount as interest income.
Classification Financial assets are classified either as “held-to-maturity”, “fair value through profit or loss”, “available-forsale ”, or “loans originated by the Group”. The classification depends on the purpose for which the investments were acquired.
The fair value of available for sale debt securities may fall temporarily below their carrying value, but, provided there is no risk resulting from changes in financial standing, an impairment is not recorded for such securities.
For held-to-maturity financial assets and loans originated by the Group the impairment is considered to have taken place if it is probable that the Group will not be able to collect principal and interest due according to the contractual terms of the instrument. When impairment is determined to have occurred, the carrying amount of the held-to-maturity financial assets is decreased through a charge to current period income. The amount of the impairment loss is the difference between the asset’s carrying value and the present value of expected future cash flows discounted at the security’s original effective interest rate.
i) Obligation to repurchase securities Sales of securities under agreements to repurchase are accounted for as collateralized borrowing transactions and are recorded at their contracted repurchase amount plus accrued interest at the balance sheet date.
k) Interest expense Interest expense is recognized when incurred on an amortized cost basis.
Indications that goodwill related to a cash generating unit may be impaired include events or changes in circumstances that may have a significant negative impact on the operations of the cash generating unit, or material adverse changes in the assumptions used in determining its recoverable amount.
Current and deferred tax assets and liabilities are offset when the income taxes are levied by the same taxation authority and when there is a legally enforceable right to offset them.
Taxes paid by certain of our life insurance businesses are based on investment income less allowable expenses. To the extent that these taxes exceed the amount that would have been payable in respect of the shareholders’ share of taxable profits, it is normal practice for 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 investment income less expenses, the obligation to pay the tax authority rests with the company and therefore, the full amount of tax including that charged to policyholders is accounted for as an income tax. Income tax expense therefore includes an element attributable to policyholders. In addition, deferred tax on unrealized gains on investment contracts with DPF related to certain unit-linked policies is included as income tax expense and an accrual for future policy fees to recover the tax charge is included in gross written premiums and policy fee revenue.
Retirement benefits The operating companies in the Group provide employee retirement benefits through both defined benefit plans providing specified benefits and defined contribution plans. The assets of these plans are generally held separately from the Group’s general assets in trustee-administered funds. Defined benefit plan obligations and contributions are determined annually by qualified actuaries using the projected unit credit method. The Group’s expense related to these plans is accrued over the employees’ service periods based upon the actuarially determined cost for the period. Actuarial gains and losses are recognized as income or expense when the net cumulative unrecognized actuarial gains and losses for each individual plan at the end of the previous reporting year exceeded 10% of the higher of the defined benefit obligation and the fair value of plan assets at that date. These gains or losses are then recognized over the expected average remaining working lives of the employees participating in the plans. Contributions to defined contribution pension plans are charged to the operating statement as they become due.
The proceeds received net of any directly attributable transaction costs are credited to share capital (nominal value) and share premium when the shares are delivered or options are exercised.
q) Leases Leases in which a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases. Payments made under operating leases are charged to the operating statement on a straight-line basis over the lease term.
Foreign currency translation In view of the international nature of the Group there are many individual entities with different functional currencies. A functional currency is the currency of the primary economic environment in which the entity operates. Therefore, a common presentation currency is required. Due to the Group’s economic exposure to the US dollar (USD), the presentation currency of the Group has been determined to be the US dollar. Assets and liabilities of Group companies with functional currencies other than US dollars are translated at end-of-period exchange rates, while operating statements are translated at average exchange rates for the period. The resulting translation differences are recorded directly in shareholders’ equity as cumulative translation adjustments.
Foreign currency transactions Foreign currency monetary items are translated at end-of-period exchange rates, non-monetary items which are carried at historical cost denominated in a foreign currency are translated at historical rates. Revenues and expenses are translated using the exchange rate at the date of the transaction or a weighted average rate. The resulting exchange differences are recorded in the consolidated operating statement.
Balance and cash flows sheets for the years as of ended 12/31/05 12/31/04 12/31/05 12/31/04 3. Implementation of new accounting standards and adjustments in 2005 (IFRS restatement)
The Group has implemented several new and revised accounting standards within the International Financial Reporting Standards (IFRS) framework (as listed in the table below), which became effective January 1, 2005. The main restatement adjustments for the Group result from the adoption of IFRS 4, which relates to the definition of an insurance contract. They primarily affect the accounting treatment of the Group’s life business with impacts on both the Group’s consolidated balance sheet and operating statement.
The International Accounting Standards Board (IASB) issued IFRS 4 “Insurance Contracts” on March 31, 2004. The standard applies to all insurance contracts (including reinsurance contracts) that an entity issues and to reinsurance contracts that it holds, except for specified contracts covered by other IFRS standards. The most significant change as a result of the adoption of the standard is the reclassification of certain contracts as financial instruments and hence application of IAS 39 to these contracts. IFRS 4 does not provide comprehensive guidance on the accounting treatment for insurance contracts and as such the Group will continue to apply US GAAP in certain circumstances where IFRS is silent.
IAS 39 “Financial Instruments: Recognition and Measurement” was revised in December 2003 as part of the IASB’s project to improve IAS 32 “Financial Instruments: Disclosure and Presentation” and IAS 39. Further amendments were made in 2005 and 2004. These changes related to Fair Value Hedge Accounting for a Portfolio Hedge of Interest Rate Risk. The major changes are as follows: • The standard clarifies that the evaluation of the transfer of risks and rewards of ownership precedes the evaluation of the transfer of control for all derecognition transactions.
• The standard clarifies that an impairment loss is recognized only when it has been incurred. It also provides additional guidance on what events provide objective evidence of impairment for investments in equity instruments.
• Hedges of firm commitments are treated as fair value hedges rather than cash flow hedges. However, the standard clarifies that a hedge of the foreign currency risk of a firm commitment can be treated as either a cash flow hedge or a fair value hedge.
The IASB issued IFRS 3 “Business Combinations” on March 31, 2004. In accordance with the transitional provisions of the standard, the Group has applied this standard to business combinations for which the agreement date is on or after March 31, 2004. The remaining requirements of IFRS 3 were adopted as of January 1, 2005. The most significant changes required by this standard are: Zurich Financial Services Group · Annual Report 2005
• All business combinations within its scope are to be accounted for using the purchase method, previously IAS 22 permitted business combinations to be accounted for using the pooling of interests method in certain circumstances.
• The acquiree’s identifiable assets, liabilities and contingent liabilities are to be recognized as part of allocating the cost of the combination to be measured initially by the acquirer at their fair values at the acquisition date. Therefore, any minority interest in the acquiree is stated at the minority’s proportion of the net fair values of those items.
• Goodwill acquired in a business combination is to be measured after initial recognition at cost less any accumulated impairment losses. Therefore, the goodwill is not amortized and instead must be tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be impaired. Negative goodwill is recognized immediately in the operating statement.
Upon adoption of IFRS 3, the Group wrote back USD 23 million of negative goodwill.
IAS 36 “Impairment of Assets” and IAS 38 “Intangible Assets” were revised in March 2004 by the IASB as part of the Business Combinations project. Consistent with the group’s adoption of IFRS 3, the revised standards were adopted as of January 1, 2005.
The IASB issued IFRS 5 “Non-current Assets Held for Sale and Discontinued Operations” on March 31, 2004. The standard adopts the classification “held for sale”, introduces the concept of a disposal group, and specifies that assets or disposal groups that are classified as held for sale are carried at the lower of carrying amount and fair value less costs to sell. It also replaces IAS 35 “Discontinuing Operations” regarding the accounting treatment for discontinued operations.
All changes in accounting policies have been made in accordance with transitional provisions in the respective standards and the impact is summarized in the following tables.
Net capital gains on investments and impairments 4,934 1,596 12 6,542
Interest credited to policyholders and other interest 1,009 (3) – 1,006
Net income attributable to shareholders 2 2,587 (121) – 2,466 1 As published in the Annual Report 2004. 2 Revised IAS 1 changed the description “Net income” to “Net income attributable to shareholders”.
Debt related to capital markets and banking activities 3,880 – – 3,880
Forthcoming changes in accounting standards In August 2005 the IASB released IFRS 7 “Financial Instruments: Disclosures”. IFRS 7 is effective January 1, 2007, however earlier application is encouraged. IFRS 7 applies to all risks arising from all financial instruments, except those covered by another more specific standard such as interests in subsidiaries, associates and joint venture, post-employment benefits, share-based payment and insurance contracts. IFRS 7 requires disclosure of: Zurich Financial Services Group · Annual Report 2005
a) the significance of financial instruments for an entity’s financial position and performance. These disclosures incorporate many of the requirements previously in IAS 32.
The Group has not yet fully analyzed the impact of these changes on its financial position, results or disclosures.
During the years ended December 31, 2005 and 2004, the Group completed divestments of several businesses and recognized post-completion adjustments on divestments made in the previous year.
During 2005, the Group divested businesses in markets where it did not have a significant presence or which were no longer part of its business strategy. The Group’s principal transactions affecting the scope of consolidation during the years ended December 31, 2005 and 2004 are described below.
Changes in 2005 The Group completed the following sales: 100% of the share capital of Claims Management Group Limited, the Group’s equity stake in ZC Sterling Corporation, 10% of the total issued share capital of South African Eagle Insurance Company Limited (SA Eagle) and the Group’s interest in Zurich National Life Assurance Company Limited in Thailand.
Additionally, the Group acquired the life business portfolio of ING Insurance Argentina.
In 2005, the companies and businesses divested did not contribute materially to the Group’s net income attributable to shareholders.
Critical accounting estimates are those which involve the most complex or subjective judgments or assessments, and relate to general insurance and life insurance reserves, the determination of fair value for financial assets and liabilities, impairment charges, deferred policy acquisition costs and deferred taxes. In each case, the determination of these items requires management to make complex judgments based on information and financial data that may change in future periods.
Since the Group does not establish reserves for catastrophes in advance of the occurrence of such events, these events may cause volatility in the levels of its incurred losses and reserves, subject to the effects of reinsurance recoveries.
The Group uses a number of accepted actuarial methods to estimate and evaluate the amount of reserves recorded. The nature of the claim being reserved for and the geographic location of the claim influence the techniques used by the Group’s actuaries. Additionally, the Group’s Corporate Center actuaries perform periodic reserve reviews of the Group’s businesses throughout the world. Management considers the results of these reviews and adjusts its loss and loss adjustment expense reserves, where necessary.
Refer to notes 10 and 11 for further information on future life policyholders’ benefits and policyholders’ contract deposits.
Changes in assumptions for any of these factors could affect the reported fair value of these financial instruments. The extent that actual surrenders are different from the Group’s estimates is the most critical factor in the fair valuation process. Increased surrender volumes may not be fully recognized in the valuation of investment contract liabilities owing to the requirement to maintain the fair value of financial liabilities above the amount payable on demand.
For quoted available-for-sale financial assets the decision to make an impairment provision is based on a review of the issuer’s current financial position and future prospects and an assessment of the probability that the current market price will recover to former levels within the foreseeable future. The recoverable amount is determined by reference to the market price. For non-quoted available-for-sale financial assets the Group takes into consideration the issuer’s current financial position and future prospects in determining whether an impairment provision is required. The recoverable amount is determined by applying recognized valuation techniques.
The Board of Directors establishes the Group’s corporate risk management framework. In turn, the Audit Committee of the Board assesses whether management is addressing risk and control issues in a timely and appropriate manner. The Audit Committee of the Board receives regular reports regarding the Group’s risk profile and mitigation actions.
The Group has additional audit or risk committees at all levels of the organization that regularly review risks. The Management Audit Committees established in 2004 and implemented in 2005 at a business division level is providing a particularly good forum for systematically reviewing risks in the Group’s various businesses and ensuring appropriate management attention.
The Chief Executive Officer, together with the Group Executive Committee, oversees the Group’s performance with regard to its risk management policies as well as the further development of these policies when required. The Chief Risk Officer reports to the Chief Executive Officer. The Group also benefits from the cooperation of its network of risk management and functional specialists within each business as well as at Corporate Center, where it has dedicated managers for various types of risk.
Group-wide risk management policies specify risk tolerance boundaries and authorities, reporting requirements, and procedures for referring risk issues to senior management. The Group regularly monitors its risks through analyses and reports, and through relevant risk modeling.
The Group systematically and regularly identifies a wide range of possible risk scenarios in the business units and the centralized Group functions. Through its Total Risk Profiling process, the Group assesses each risk scenario strategically for its probability of occurrence and for the severity of the consequences should it occur. The Group then develops, monitors and implements appropriate action plans.
In addition to risk-specific monitoring and modeling, the Group takes a holistic view with risk-based capital (RBC) modeling. This type of modeling measures the difference between what the Group expects in a normal business-operating environment and worst-case scenarios. The Group defines risk-based capital as the capital needed to protect the Group’s policyholders against the worst-case loss (which the Group defines as an event with a one-in-2000 probability of occurring in one year). The Group continues to embed RBC modeling into its organization and decision-making, such as allocating capital to lines of business.
a) Insurance risk As an insurer, the Group assumes certain of its customers’ risks, and therefore must carefully manage that transfer of risk including the setting of limits on underwriting authority and requiring specific approvals for transactions involving new products or where established limits of size and complexity may be exceeded. The Group’s underwriting strategy reflects the variety of industries and geographic regions in which the Group operates.
• Property includes, but is not limited to, fire and flood risks.
• Third Party Liability includes, but is not limited to, the liability risks, such as workers injury, from the Group’s customers, such as workers injury. Premiums underwritten in this line of business have included cover for risks such as asbestos and environmental risks. The reserves arising from these risks are shown in note 11. These exposures demonstrate how the frequency and severity of losses in certain lines of business can be difficult to predict. Further, the legal and tort environment, including the development of class actions, previously have had an impact on the frequency and severity of losses in the third party liability line of business.
• Accident and Health includes, but is not limited to, the accident and health insurance risks from the Group’s Personal customer segment.
The main risks in each line of business are as follows: • Individual annuity includes, but is not limited to, longevity and interest rate risks arising on personal annuity insurance contracts. Longevity risk is the risk that an annuitant may live longer than expected.
• Individual capital includes, but is not limited to, mortality, morbidity and interest rate risks arising on personal capital insurance contracts. Mortality risk is the risk that the policyholder dies sooner than expected. Morbidity risk is the risk that the policyholder suffers a total and permanent disability.
• Unit-linked includes, but is not limited to, significant mortality risks. However on unit-linked products, the interest rate or equity market risk is largely passed on to the policyholder.
Investment risk Debt securities represent 64.3% of the Group’s investment portfolio (excluding unit-linked assets), and within these, the largest concentration is in government and supra-national securities at 44.3%.
Concentrations of investments are managed by issuer, industry, geography and credit rating.
Financial and insurance liabilities risk The Group is exposed to interest rate risk on its reserves for insurance contracts, liabilities for investment contracts and floating rate borrowings.
The table 6.5 below shows, both for the general insurance businesses and life insurance businesses, the estimated impacts on the total investments, reserves for insurance contracts and liabilities for investment contracts (including unit-linked contracts) and net assets of a one percentage point increase in yield curves and a 10% decline in all stock markets as of December 31, 2005. All amounts shown are before taxation effects, except for net assets of the life insurance business.
Interest rate and in USD millions, as of December 31, 2005 equity market sensitivities for the Group’s general insurance and life insurance businesses
General Life Insurance Insurance Business Business 1% increase in the interest rate yield curves
Most of the Group’s debt is subject to fixed interest rates, which may be adjustable during the course of the term. No adjustments are made to the principal value of the debt for change in the yield curve. However, an increase in interest rates would result in an increase to the Group’s interest expense on floating rate debt.
To manage this risk the Group has centralized the purchase of treaty reinsurance, and only conducts business with companies authorized by its Corporate Reinsurance Security Committee. The Group also limits its maximum credit exposure by reinsurance group.
In addition to reinsurers, another source of credit risk for the Group is third party brokers, agents and other intermediaries. The Group’s credit risk exposures to third party brokers, agents and other intermediaries arise where those intermediaries collect premiums from customer to be paid to the Group or pay claims to customers on behalf of the Group. For details of the amount receivable from brokers, agents and other intermediaries refer to note 16.
The reinsurance assets in the table below are shown net of collateral. The Group only accepts high quality collateral such as cash or letters of credit of banks rated A and above.
The Group is also exposed to credit risk from third party companies where the Group holds debt and equity securities issued by those companies. The credit risk related to investment assets is monitored and assessed, and the Group limits maximum exposures.
Debt securities by in USD millions, as of December 31, 2005 rating of investee
In the case of derivatives, such as interest rate or currency swaps, forward contracts and purchased options, the replacement value of the outstanding derivatives represents a credit risk to the Group. The Group controls the credit risk of its outstanding positions with external counterparties through approval process embedded in derivative programs.
To limit credit risk, derivative financial instruments are typically executed with counterparties rated A- or better by an external rating agency. Wherever possible collateral is requested.
Asset and liability mismatch risk In order to have adequate liquid assets available to fund liability cash flows when they come due, the Group manages its overall asset/liability matching exposure and oversees the activities of local asset/liability management committees. The Group monitors relative asset and liabilty durations at both a business and a Group level. This process enables the Group to manage its exposures to interest rates, equity market risks and other financial risks, in particular for insurance and investment contracts.
Currency risk As an international group, the Group is exposed to various foreign currency risks. Most prominently, those risks can affect its liquidity, its reported profits and losses, its reported equity, its regulatory capital position and the economic value of its firm. The Group attempts to minimize its foreign currency risk by matching foreign currency positions on local balance sheets, and by managing the currency composition of its available capital. Because the Group holds a portfolio of risks from its businesses denominated in various currencies, the Group also holds its available capital in various currencies. The Group does not hedge emerging surpluses. The Group does not take speculative positions on foreign currency market movements. Foreign currency is a centrally managed risk type, with hedging coordinated at the Corporate Center.
The table below shows the Group’s top three functional currencies, other than the US dollar, and the approximate effect on net assets and on shareholders’ equity of an instantaneous adverse movement in currency exchange rates of 10%.
Effect on Effect on net assets shareholders’ of a 10% equity of a 10%
A summary of net investment income and net capital gains and losses on investments and impairments is given below.
Net capital gains/ Net investment (losses) on investments income and impairments 1 Investment result
3 Including rental operating expenses for real estate held for investment of USD 146 million and USD 182 million for the years ended December 31, 2005 and 2004, respectively.
Details of the investment balances as of December 31, 2005 and 2004 are given in the following tables by measurement category.
Unrealized gains on available-for-sale instruments are included in shareholders’ equity as disclosed further below.
Debt securities in USD millions, as of December 31 maturity schedule
Amortized cost Estimated fair value Fair value through Held-to-maturity Available-for-sale profit or loss
The amortized cost and estimated fair values of debt securities held-to-maturity, available-for-sale and fair value through profit or loss are shown by contractual maturity. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or pre-pay certain obligations with or without call or pre-payment penalties.
Cost or Gross Gross Estimated amortized cost unrealized gains unrealized losses fair value
(losses) on trading for the years ended December 31 debt and equity securities
Investments in USD millions, in associates for the years ended December 31
Unrealized in USD millions, as of December 31 gains/losses on investments included in shareholders’ equity
Debt and equity securities: fair values are based on quoted market prices when available. If quoted market prices are not available, then fair values are estimated on the basis of pricing models, discounted cash flow or other recognized valuation techniques.
Real estate held for investment: fair value is determined on a regular basis with reference to current market conditions.
Investments held by investment companies: estimated fair values are determined by the investment managers.
The Group uses derivative financial instruments for economic hedging purposes. In limited circumstances these instruments may also meet the definition of an effective hedge for accounting purposes. Where this is the case, hedge accounting is applied. Derivatives that do not meet the definition of an effective hedge for accounting purposes are classified as derivative financial instruments held at fair value through profit or loss. For further details of the Group’s derivative financial instruments refer to table 9.1 and 9.2.
Total insurance benefits and losses 38,261 39,677 (5,842) (5,565) 32,419 34,112
Development of in USD millions reserves for losses and loss adjustment expenses
As of January 1 (opening balance) 57,765 51,007 (14,278) (14,036) 43,487 36,971
Divestments of companies and businesses (47) (952) 10 209 (37) (743)
As of December 31 (closing balance) 60,425 57,765 (14,231) (14,278) 46,194 43,487
The Group establishes loss reserves, which are estimates of future payments of reported and unreported claims for losses and related expenses, with respect to insured events that have occurred. Reserving is a complex process dealing with uncertainty, requiring the use of informed estimates and judgments. Any changes in estimates are reflected in the consolidated operating statement in the period in which estimates are changed.
Gross reserves re-estimated as of December 31, 2005 48,732 53,355 56,221 58,842
Management has considered environmental and latent injury claims and claims expenses in establishing the reserves for losses and loss adjustment expenses. The Group continues to be advised of claims asserting injuries from toxic waste, hazardous materials and other environmental pollutants and alleged damages to cover the clean-up costs of hazardous waste dump sites relating to policies written in prior years and indemnity claims asserting injuries from asbestos. Coverage and claim settlement issues, such as determination that coverage exists and the definition of an occurrence, may cause the actual loss development to exhibit more variation than in other lines of the Group’s business. Such claims cannot be estimated with traditional reserving techniques and, accordingly, the uncertainty with respect to the ultimate cost of these types of claims has been greater than the uncertainty relating to standard lines of business.
The uncertainties arise out of changes or potential changes in various laws or the interpretation of laws. While the Group believes that it has made adequate provision for these claims, it is possible that future adverse development could have a material effect on the Group’s results of operations, cash flows and financial position. The net reserve amounts related to the above claims were USD 2,907 million and USD 2,919 million as of December 31, 2005 and 2004, respectively.
As of January 1 (opening balance) 22,763 20,625 (3,594) (3,694) 19,169 16,931
As of January 1 (opening balance) 51,920 43,875 – – 51,920 43,875
Maturity schedule in USD millions, as of of reserves for December 31, 2005 insurance contracts
Future life policyholder benefits increased by USD 585 million after reinsurance (USD 421 million in 2004) due to the recognition of changes in assumptions. In particular, the 2005 net changes include the following significant movements: • USD 177 million related to changes in interest rate assumptions; • USD 205 million related to changes in morbidity assumptions, primarily related to termination rate experience on disability; • USD 116 million related to a change in the United Kingdom pensions legislation regarding maximum limits, which has resulted in higher payouts and reserves for certain policyholders.
Guarantees arising from minimum death benefits (“GMDB”), retirement income benefits (“GRIB”) and annuitization options (“GAO”) The Group sells products for which policyholders bear the full investment risk associated with the underlying invested funds selected by them. Certain of these products contain guarantees for which liabilities have been recorded for additional benefits and minimum guarantees, primarily in the subsidiary Kemper Investors Life Insurance Company which has written variable annuity contracts that provide annuitants with certain guarantees related to minimum death and income benefits. The determination of these liabilities is based on models that involve a range of scenarios and assumptions, including those regarding expected market rates of return and volatility, contract surrender rates, annuitization elections and mortality experience. The assumptions used are consistent with those used in determining estimated gross profits for purposes of amortizing deferred policy acquisition costs.
guarantee liabilities arising from minimum death benefits (“GMDB”), retirement income benefits (“GRIB”) as well as annuitization options (“GAO”)
Liabilities related to investment contracts with discretionary participation features 5,995 6,887
The movements in the liabilities arising from investment contracts with DPF are summarized below: Zurich Financial Services Group · Annual Report 2005
Certain investment and insurance contracts sold by the Group contain benefit features for which the amount and timing of declaration and payment are at the discretion of the Group. The table below shows the change in the amount of undeclared funds surplus recorded in shareholders’ equity after minimum mandated allocations to policyholder liabilities.
Initial application of the “legal quote” in Switzerland as of June 30, 2004 – (226)
As of December 31 1 Net of eliminations of intersegment transactions.
2 Change in accounting classification increased the acquisition costs deferred by USD 450 million as of December 31, 2005, and amortization by USD 194 million for the year ended December 31, 2005.
As of December 31 (closing balance) 690 736 1 Deferred origination costs are fully attributable to the Life Insurance segment.
Income tax in USD millions, for the years ended December 31 expense – policyholders/ shareholders split
The 2005 and 2004 numbers are shown before the netting of timing differences that reverse in the same period of USD 1,993 million and USD 1,765 million, respectively.
The current income tax payable (net of income tax receivable) was USD 982 million and USD 971 million as of December 31, 2005 and 2004, respectively.
Deferred tax charge included in shareholders’ equity amounted to USD 384 million and USD 539 million for the years ended December 31, 2005 and 2004, respectively.
As of December 31, 2005 and 2004, respectively, the Group had income tax loss carryforwards of USD 5,258 million and USD 4,835 million available (subject to various statutory restrictions) for use against future taxable income. However, deferred tax assets for loss carryforwards of USD 3,150 million and USD 3,300 million were recognized as of December 31, 2005 and December 31, 2004, respectively. The difference represents unrecognized income tax loss carryforwards. The majority of the income tax loss carryforwards expire in a period between five and fifteen years.
As of December 31, 2005 and 2004, the following taxpayer groups carry a net deferred tax asset position on their balance sheets.
Deferred tax in USD millions, as of December 31 assets by taxpayer group
Zurich Holding Company of America taxpayer group 1,381 1,441 1,252 1,250
The fire insurance value of the Group’s own-use real estate, investment real estate and other fixed assets totaled USD 8,252 million and USD 10,160 million as of December 31, 2005 and 2004, respectively.
Present value of profits of acquired insurance Other intangible Attorney-in-fact contracts assets relationships Total
Amounts due to reinsurers, agents and other insurance companies 2,942 3,238
Refer to note 9 for details on derivative financial instruments. Refer to note 25 for further details of the provision for defined post employment benefits.
EUB Holdings Limited Notes and loans payable, due in the following year 779 919
Zurich Finance (USA), Inc. 2.75% CHF bond, due July 2006 381 438 3.5% CHF bond, due July 2008 228 263 4.5% EUR bond, due September 2014 1,173 1,342
Zurich Finance (UK) p.l.c 6.625% GBP bond, undated notes 762 848
Zurich Finance (USA), Inc. 5.75% EUR bond, due October 2023 583 668 4.5% EUR bond, due June 2025 586 –
Debt relating to the new banking unit amounted to USD 878 million as of December 31, 2005, compared to USD 1,063 million as of December, 2004.
b) Senior debt The Group’s Euro Medium Term Note Programme (EMTN Programme), which allows for the potential issuance of senior and subordinated notes, was increased on March 10, 2005 from a maximum of USD 4 billion to a maximum of USD 6 billion. Issuing entities under the EMTN Programme include Zurich Finance (USA), Inc. and Zurich Finance (UK) p.l.c.
c) Subordinated debt On June 15, 2005, Zurich Finance (USA), Inc. issued under the EMTN Programme a 4.5% EUR 500 million bond, guaranteed by Zurich Insurance Company on a subordinated basis, due 2025 and callable beginning in 2015. The proceeds were swapped into 6-month floating rate US dollars until the call date under fair-value hedge accounting treatment. The bond pays a fixed-rate coupon of 4.5% until June 15, 2015, and a variable rate of 3-month Euribor plus a spread of 2.2% thereafter.
On December 9, 2005 ZFS Finance (USA) Trust I and ZFS Finance (USA) Trust II respectively issued 6.15% USD 600 million of Series I and 6.45% USD 700 million of Series II Fixed / Adjustable Rate Enhanced Capital Advantaged Preferred Securities (ECAPS), and on December 22, 2005 ZFS Finance (USA) Trust III issued USD 400 million of Series III Floating Rate ECAPS. These trust preferred securities were sold to a number of qualified institutional buyers and qualified purchasers under the exemption of rule 144A of the United States Securities Act (1933). Each Trust benefits from a subordinated support agreement of Zurich Financial Services and Zurich Group Holding. Distributions are payable quarterly or semiannually in arrears but may at any time be deferred at the Group’s option. Distributions will be mandatory deferred if the Group fails to meet certain financial tests. If distributions are not paid in full after a certain period of time and during any mandatory deferral period, the Group must use commercially reasonable efforts to issue and/or sell share capital to fund accumulated and unpaid distributions. The Group has the option to call the securities after five or ten years from the issuance depending on the series. Each of the three Trusts will dissolve no later than December 15, 2065.
Distributions to holders of ECAPS are based on the following: Table 22.2 6.15% payable semiannually until December 15, 2010 and then reset quarterly to the
6.45% payable semiannually until June 15, 2016 and then reset quarterly to the
* Adjustable Rate is equal to the greatest of (i) the 3-month LIBOR rate; (ii) the 10-year Treasury CMT (Constant Maturity Treasury) Rate; and (iii) the 30-year Treasury CMT Rate, subject to a maximum under (ii) and (iii) of 13.25% Series I and 13% for Series II.
Interest expense in USD millions, for the years ended December 31 on debt
At the Annual General Meeting on April 19, 2005, shareholders approved a share capital reduction in the form of a nominal value reduction of each registered share from CHF 6.50 to CHF 2.50. As a result of this reduction, the share capital was reduced by CHF 576,027,820 from CHF 936,045,207.50 to a new total of CHF 360,017,387.50. In the previous year, shareholders approved, at the Annual General Meeting on April 16, 2004, a share capital reduction in the form of a nominal value reduction of each registered share from CHF 9 to CHF 6.50. As a result of that reduction, the share capital was reduced by CHF 360,017,387.50 from CHF 1,296,062,595 to CHF 936,045,207.50.
Employee participation: The share capital may be increased by an amount not exceeding CHF 3,750,000 by issuing up to 1,500,000 fully paid registered shares with a nominal value of CHF 2.50 each to employees of Zurich Financial Services and Group companies. The pre-emptive rights of the shareholders, as well as the right for advance subscription, are excluded. The issuance of shares or respective option rights to employees shall be subject to one or more regulations to be issued by the Board of Directors and shall take into account performance, functions, levels of responsibility and criteria of profitability. Shares or option rights may be issued to the employees at a price lower than that quoted on the stock exchange.
f) Dividend restrictions and capital and solvency requirements Zurich Financial Services is not subject to legal restrictions on the amount of dividends it may pay to its shareholders other than under the Swiss Code of Obligations. The Swiss Code of Obligations provides that dividends may only be paid out of freely distributable reserves or retained earnings and that 5% of annual retained earnings must be allocated to the general legal reserve until such reserve in the aggregate has reached 20% of the paid-in share capital. As of December 31, 2005, the amount of the general legal reserve exceeded 20% of the paid-in share capital of Zurich Financial Services. Similarly, the company laws of many countries in which Zurich Financial Services’ subsidiaries operate may restrict the amount of dividends payable by such subsidiaries to their parent companies.
Several regulatory changes came into force in Switzerland on January 1, 2006. Amongst others the capital requirements were changed to include risk based target capital for insurance companies and insurance groups (Swiss Solvency Test). Risk-bearing and target capital have to be determined building on a risk based capital model by 2008 for groups, conglomerates, reinsurers and small companies. However, large legal entities must carry out the calculations starting already in 2006 as part of a compulsory field test. Within this time the companies may develop their own risk based capital model to be approved by the Federal Office of Private Insurance (FOPI) if they do not opt for the standard model. Groups, conglomerates and reinsurers will have to use company specific internal models. The same applies for companies for which the standard model is not applicable. Zurich will adopt and extend the existing internal risk-based capital model for the Group and Zurich Insurance Company in close consultation with the FOPI to make it compliant with new regulatory requirements which are expected to be further detailed by FOPI. The new target capital must be built up until beginning of 2011.
Meanwhile Zurich Financial Services continues to be subject to certain solvency requirements based on a Decree on the Consolidated Supervision of the Group issued by FOPI on April 23, 2001. It is expected that this decree will be replaced by a new decree to be issued by FOPI in the first half of 2006.
As of December 31, 2005, the subsidiaries were substantially in compliance with applicable regulatory capital adequacy requirements.
Effect of potentially dilutive shares related to share-based compensation plans – 1,597,527 (0.24) (0.30)
Diluted earnings per share 2,428 144,644,484 16.79 20.83 1 The translation from USD into CHF has been done for information purposes only at the Group’s average exchange rates for the years ended December 31, 2005 and 2004, respectively.
Preferred securities in USD millions, as of December 31 and minority interests
Minority interests include third-party equity interests, preferred securities and similar instruments issued by consolidated subsidiaries of the Group in connection with the provision of structured financial solutions to its customers.
The Group operates a number of active retirement benefit arrangements for pensions. The majority of employees belong to defined benefit plans. Other employees participate in defined contribution plans, which provide benefits equal to amounts contributed by both the employer and the employee plus investment returns.
The status of the defined benefit plans and other defined post-employment benefits is given below.
Defined benefit pension plans Employees of the Group’s operating companies are covered under various pension plans. Certain companies run defined benefit plans, some of which provide benefits related to final pensionable earnings and others provide cash balance plans, where the participants receive the benefit of annual contributions made by both employer and employee and a credit for the investment return achieved on the assets. Eligibility for participation in the various plans is either based on completion of a specified period of continuous service or from the date of commencement of employment. Benefits are generally based on each employee’s years of credited service and average compensation in the years preceding retirement. Annual funding requirements are determined based on actuarial cost methods.
Most of the Group’s defined benefit plans are funded through contributions by the Group to trusts or foundations independent of the Group’s finances. In these cases, the annual funding requirements are determined in accordance with local funding and actuarial cost methods. Where plans are not specifically funded, for example, as is usual in the case of pension plans in Germany, a liability for the accrued pension obligations is recognized in the Group’s balance sheet.
Status of funded in USD millions, as of December 31 defined benefit plans
The funded status shows the deficit of the balance of pension plan assets at fair values less the pension liability based on the present value of obligation. Pensions, however, are long-term by nature. Short-term variations between long-term actuarial assumptions and actual experience may be positive or negative, resulting in actuarial gains or losses. Such actuarial gains or losses are not recognized under IAS 19 as it is expected that such actuarial gains and losses will equalize over time. Only unrecognized actuarial gains or losses exceeding certain “corridors” as defined in IAS 19 are amortized through the operating statement (see table 25.4 below, “Net actuarial losses recognized in year”).
On June 16, 2005, the Boards of Trustees of the pension plans for the Group’s employees based in Switzerland adopted new pension plan arrangements that reflect the changed economic and demographic environment. The principal changes to the pension plans, which became effective January 1, 2006, were the conversion from a defined benefit to a defined contribution system and the separation of the pension plan as an autonomous foundation. Employees transferred to the new arrangements, and future benefits at normal retirement for current active participants are targeted to be similar to those under the former arrangements. However, following a transition period of three years, the current additional benefits that are provided on early retirement will gradually be phased out over a nine-year period. The calculation of the reduced long-term obligation under IAS 19 resulted in a one-time non-cash gain of USD 103 million.
Status of unfunded in USD millions, as of December 31 defined benefit plans
Liability as of January 1 (opening balance) (2,621) (2,345) (226) (197)
b) Defined contribution pension plans Certain of the Group’s operating companies sponsor defined contribution plans. Eligibility for participation in such plans is either based on completion of a specified period of continuous service or date of commencement of employment. The plans provide for voluntary contributions by employees and contributions by the employer which typically range from 3% to 15% of annual salaries, depending on the employees’ years of service. The Group’s contributions under these plans amounted to USD 11 million and USD 13 million in 2005 and 2004, respectively.
a) Cash incentive plans Various businesses throughout the Group operate short-term incentive programs for executives, management and, in some cases, for employees of that business unit. Awards are made in cash, based on the accomplishment of both organizational and individual performance objectives. The expenses recognized for these cash incentive plans amounted to USD 296 million and USD 242 million for the years ended December b) Share based compensation plans for employees The Group encourages employees to own shares of Zurich Financial Services and has set up a framework based on the implementation of either share options and/or performance share programs. Actual plans are tailored to meet local market requirements.
UK Sharesave Plan The plan is open to employees in the United Kingdom. Participants enter into a savings contract with a bank for the accumulation of contributions of between GBP 5 and GBP 250 per month for a period of three or five years. An interest bonus is credited at the end of the savings period. Participants are granted options to acquire Zurich Financial Services shares at a pre-determined price, which is not less than 80% of the market price prior to grant. Options under the plan can normally be exercised for a period of six months after the end of the savings period. Early exercise, limited to the value of shares that can be acquired with accrued savings, is permitted in certain circumstances. There were a total of 864 and 2,409 participants in this plan as of December 31, 2005 and 2004, respectively. There have been no new grants under this plan since 2002.
c) Share based compensation plans for executives The Group operates long-term incentive plans for selected executives. These plans comprise the allocation of a target number of share options grants and/or share grants with the vesting of these option/share grants being subject to the achievement of specific financial performance goals. The Group can also make Restricted Share grants to selected employees, which provide share awards if the individual remains employed with the Group on selected dates in the future.
Senior Executive long-term incentive plans Each year, Senior Executives are granted performance options and performance shares, which vest on an annual basis over the subsequent three year period. The actual level of vesting, which can be between 0% and 150% of the original number of options and/or shares granted, depends on the performance of the Group during the previous calendar year. The current performance metrics are the Group’s return on equity (ROE) and position of the Group’s total shareholder return against an international peer group of insurance companies. One-half of the shares that actually vest are sales-restricted for a further period of three years. The options have a seven year term from the date of grant. Grants under the plan are made annually on April 3. The actual number of performance options and performance shares granted is determined such that the economic value is a defined percentage of annual salary in the year of allocation. During 2005 and 2004, a total of 185 and 186 participants were granted shares and options under this plan.
Certain plan participants elected in 2002 to take their option award in the form of Share Appreciation Rights. Included in the number of shares under option in the table above are 70,902 and 77,234 shares as of December 31, 2005 and 2004, respectively, which will be settled through cash payments rather than through delivery of shares.
Weighted average Weighted average contractual remaining expected life in years life in years
Options and shares for the years ended December 31 granted during the period
The fair value of options granted are estimated using the Black-Scholes option pricing model, with the following assumptions.
FGI provides certain non-claims related management services to the Farmers Exchanges. In addition, the Group has the following relationships with the Farmers Exchanges.
b) Quota share reinsurance treaties with the Farmers Exchanges The Farmers Exchanges cede risk through quota share reinsurance treaties to Farmers Reinsurance Company (‘‘Farmers Re’’), a wholly owned subsidiary of FGI, and Zurich Insurance Company (“ZIC”).
Effective January 1, 2004, Farmers Re assumes annually USD 200 million and ZIC assumes USD 800 million of gross written premiums under an Auto Physical Damage (“APD”) Quota Share reinsurance agreement with the Farmers Exchanges. In addition, Farmers Re and ZIC assume a quota share percentage of ultimate net losses sustained by the Farmers Exchanges in their APD lines of business. The agreement, which can be terminated after 30 days’ notice by any of the parties, also provides for the Farmers Exchanges to receive a ceding commission of 18% of premiums, with additional experience commissions that depend on loss experience. This experience commission arrangement limits Farmers Re and ZIC’s potential underwriting gain on the assumed business to 2.5% of premiums assumed.
Effective December 31, 2004, Farmers Re and ZIC entered into a 12% All Lines Quota Share reinsurance treaty under which they each assume a percentage of all lines of business written by the Farmers Exchanges, prospectively. Under this treaty, which amended the 10% All Lines Quota Share reinsurance treaty in effect since December 31, 2002, Farmers Re and ZIC assume a 2.4% and 9.6% respective quota share of the premiums written and the ultimate net losses sustained in all lines of business written by the Farmers Exchanges after the APD reinsurance agreement has been applied. Underwriting results assumed are subject to a maximum combined ratio of 112.5% and a minimum combined ratio of 93.5%. In addition, under this treaty the Farmers Exchanges’ catastrophe losses are subject to a maximum of USD 800 million. Farmers Re and ZIC assumed USD 19.2 million and USD 76.8 million respectively of maximum annual catastrophe losses. This reinsurance agreement, which can be terminated after 60 days’ notice by any of the parties, also provides for the Farmers Exchanges to receive a provisional ceding commission of 22% of premiums for acquisition expenses, 8.8% of premiums for unallocated loss adjustment expenses and 5.3% of premiums for other expenses with additional experience commissions potentially payable depending on loss experience. For the year ended December 31, 2005, Group companies assumed USD 1,153 million of gross written premiums (USD 1,269 million in the prior year) from the Farmers Exchanges under the All Lines Quota Share reinsurance agreement.
The Group has provided guarantees or commitments to external parties, associates, partnerships and joint ventures. These arrangements include commitments under certain conditions to make liquidity advances to cover delinquent principal and interest payments, make capital contributions or provide equity financing.
The Group leases its real estate held for investment to outside parties under operating leases.
Pledged assets Total assets pledged including securities pledged in respect of securities repurchase agreements amounted to USD 5,679 million and USD 5,048 million as of December 31, 2005 and December 31, 2004, respectively. Assets pledged were financial assets.
In common with other groups with life assurance businesses in the United Kingdom, the Group remains exposed to a number of Conduct of Business issues, some of which are currently under review by the Financial Services Authority in the United Kingdom. While provisions are maintained which reflect management’s best evolving estimate of the probable costs and expenses of resolving these matters, significant uncertainty regarding the ultimate cost remains. The main area of uncertainty concerns sales advice related complaints. The key assumptions used to derive the complaint provision are the volume of complaints, both those already recorded and an assumption as to the level of future complaints, the percentage of complaints which will be successful (the uphold rate), the average redress payable per complaint and the expenses of reviewing each case or complaint. The assumptions used to set the provision have been based on actual experience over the past three years weighted towards more recent experience.
On December 11, 2001, the Group divested its third party reinsurance business operated under the “Zurich Re” brand name by offering the shares of the newly established Converium Holding AG to the public. As part of the formation of Converium Holding AG and the subsequent public offering of its shares, the Group entered into various contracts with Converium Holding AG and its subsidiaries, including certain Quota Share Retrocession Agreements. These Quota Share Retrocession Agreements, together with subsequent amendments, provide for the reinsurance premium to Converium to be retained by the Group on a “funds withheld” basis. Converium may call for payment in cash certain amounts of the funds withheld on pre-determined dates. If Converium calls for such payments on July 1, 2006, the maximum amount that would be payable by the Group is estimated to be in the range of approximately USD 200 million to USD 250 million.
Litigation and regulatory investigations The Group and its subsidiaries are continuously involved in legal proceedings, claims and litigation arising, for the most part, in the ordinary course of their business operations. The Group and its subsidiaries are also involved in a number of industry-wide civil and criminal investigations by various State Insurance Departments and State Attorneys General in the United States, the United States Attorney’s Office for the Southern District of New York, the United States Securities and Exchange Commission, other United States authorities and supervisory bodies and other non-United States authorities regarding certain business practices involving insurance brokers and insurance companies, the purchase and sale of “non-traditional” products, certain reinsurance transactions engaged in by the Group and its subsidiaries, and other matters, such as financing hedge funds engaged in mutual-fund market-timing activities. The Group has been conducting its own internal reviews with respect to some of these matters and is cooperating fully in these investigations.
The outcome of such current legal proceedings, claims, litigation and investigations could have a material effect on operating results and/or cash flows when resolved in a future period. At this time the Group is unable to predict the potential effects, if any, that the investigations and related actions may have upon the insurance and the reinsurance markets and industry business practices or what, if any, changes may be made to laws and regulations regarding the industry. Any of the foregoing could adversely affect the Group’s business, results of operations and financial condition. Management is, however, not aware that these matters would materially affect the Group’s consolidated financial position.
Operating in USD millions, for the years ended December 31 statements by business segment
Net change in reserves for unearned premiums (376) (241) 1 (1)
Net capital gains/(losses) on investments and impairments 327 86 11,518 5,070
Life insurance death and other benefits, net of reinsurance 100 123 9,781 11,995
Underwriting and policy acquisition costs, net of reinsurance 4,506 4,100 1,561 1,508
Significant non-cash expenses: Depreciation and impairments of fixed assets 83 100 42 68
Policyholders’ contract deposits and other funds, gross 862 1,038 13,854 14,603
Reserves for losses and loss adjustment expenses, net 42,196 39,344 110 95
Policyholders’ contract deposits and other funds, net 846 1,011 13,741 14,582
Reserves for insurance contracts, net 54,506 51,695 120,455 127,936 1 Other related intangible assets consists of the present value of profits of acquired insurance contracts and attorney-in-fact relationships.
Purchases of fixed in USD millions, for the years ended December 31 and intangible assets by geographical segment
On February 10, 2006 the Group announced that it has exercised its option to redeem EUR 300 million of Series A Preference Shares issued by Zurich Financial Services (Jersey) Ltd. in December 1999 on the Euromarket. The 12,000,000 Preference Shares of EUR 25 par value each carry a coupon of 7.125% and are listed on the Luxembourg Stock Exchange. The Preference Shares will be repaid on March 16, 2006 together with the preference dividend accrued up to and including the redemption date.
Significant subsidiaries as of December 31, 2005 Book value of common stock (in Voting Ownership local currency
Chilena Consolidada Seguros de Vida S.A. Santiago Life Insurance 98.95 98.95 CLP 24,484.0
as of December 31, 2005 Book value of common stock (in Voting Ownership local currency
South African Eagle Insurance Company Limited 3 Bryanston General Insurance 73.61 73.61 ZAR 3.0
Genevoise, Compagnie d’Assurances sur la Vie SA Geneva Life Insurance 100.00 100.00 CHF 17.0
Zurich Life Insurance Company Limited Zurich Corporate Functions 100.00 100.00 CHF 60.0
Openwork Holdings Limited Swindon, England Life Insurance 100.00 25.00 GBP 0.01 3 Listed on the Johannesburg Stock Exchange. On December 31, 2005, the company had a market capitalization of ZAR 2,253 million (ISIN Number 000006243).
as of 31 December 2005 Book value of common stock (in Voting Ownership local currency
Zurich Employment Services Limited Fareham, England Life Insurance 100.00 100.00 GBP 9.0
Zurich International Life Limited Douglas, Isle of Man Life Insurance 100.00 100.00 GBP 55.6
Zurich Specialties London Limited London, England General Insurance 100.00 100.00 GBP 150.0
Zurich Holding Company of America, Inc. Dover, DE Corporate Functions 100.00 100.00 USD 0.6
Embedded value methodology The embedded value represents the shareholders’ interest, excluding any value from future new business, in the entities included in the Life Insurance segment as set out in the Group financial statements. It is the total of the shareholders’ interests in the net assets of these life insurance entities and the present value of the projected future releases to shareholders arising from the business in-force, less a charge for the cost of capital supporting the solvency requirements of the business. The discount rate used to value the in-force business in each country reflects long term government bond rates at the valuation date plus a risk margin. The assumptions for mortality, persistency and expenses reflect recent and expected experience. All changes in assumptions not classified as “economic” are included in the “Operating assumption changes” line item. Gross new business annual premium equivalent (APE) is calculated as new annual premiums plus 10% of single premiums.
Embedded value profit consists of the following components, the first two of which in aggregate are referred to as operating profit: • new business profit, after tax, which represents the value added by new business written during the period, including allowance for the cost of holding solvency capital, and is valued at point of sale using the applicable discount rate; • the operating profit from existing business, which is equal to: • the profit expected from in-force business and net assets, after tax, including allowance for the cost of holding solvency capital,
• the impact of changes in assumptions of future operating experience; • the economic variance, which is equal to: • the investment variance caused by differences between the actual and the expected experience over the reporting period, and
• the change in future economic assumptions, such as changes in discount rates and future investment rates including, where appropriate, the effect of changes in legislation.
The calculation of embedded values necessarily makes numerous assumptions with respect to economic conditions, operating conditions, taxes, and other matters, many of which are beyond the Group’s control. Although the assumptions used represent estimates which the Group and Deloitte believe are together reasonable, actual future experience may vary from that assumed in the calculation of the embedded value results, and such variation may be material. Deviations from assumed experience are normal and are to be expected. The embedded value results have been prepared using generally accepted actuarial methods that use deterministic projections which do not allow for all of the cost of options and guarantees on a market consistent basis.
Operating return, after tax and before currency translation effects 14.1% 15.0%
Return, after tax, on opening embedded value before currency translation effects 12.7% 14.5%
Notes to the embedded value results 1. To improve transparency and to reflect management responsibilities, the presentation of the embedded value results has been enhanced. In particular, additional information on the countries within Europe has been disclosed. The information for the United Kingdom includes the Isle of Man.
2. The after-tax operating return and after-tax return on opening embedded value have been calculated reflecting the incidence of capital movements in and out of the embedded value.
4. For several companies in Life Insurance, no embedded value has been calculated but these companies have been included in the embedded value results at their shareholders’ equity value, as calculated in accordance with IFRS. The contribution from these companies to the Group’s total published embedded value is approximately 2%.
5. Following the launch during 2005 of our United Kingdom distribution unit, Openwork, the results of this entity have been fully consolidated within our UK embedded value results. 25% of the operating loss, after excluding one-off costs, is attributable to new business, in line with the Group’s long term financial interest in this entity. The remainder of the operating loss has been allowed for in the operating result for the United Kingdom.
10. The published embedded value assumes that at least the locally required minimum statutory capital is held to support the business. In some countries, a higher amount has been locked-in where this is in line with management strategy or market practice. In 2005, the amount of shareholder capital used to meet these requirements was USD 4.2 billion, which produced an associated shareholder economic cost of USD 1.2 billion.
Invest- Invest- Market Discount Discount ment ment value of Renewal Demorate rate return return equities expenses graphy Lapses increase decrease increase decrease decrease decrease worsening worsening
Invest- InvestDiscount Discount ment ment Initial Renewal Demorate rate return return expenses expenses graphy Lapses increase decrease increase decrease decrease decrease worsening worsening
The exceptions to this are the investment return sensitivities which assume a change to future new money rates for fixed interest securities and a change to returns on both existing assets and future new money rates for equities and properties. These sensitivities reflect the change to embedded value in such a changed investment environment. For example, where appropriate, changes to statutory valuation bases or policyholder bonuses have been reflected accordingly. In addition, changes to the market values of fixed interest assets have been reflected where appropriate. However, these investment return sensitivities assume that the risk discount rates remain unaffected.
Its principal activity is the holding of subsidiaries. Revenues consist mainly of dividends and interests. The net income of Zurich Financial Services was CHF 781,121,406 for 2005 (CHF 530,597,277 for 2004).
in CHF thousands, for the years ended December 31 Notes 2005 2004
Assets in CHF thousands as of December 31 Notes 2005 2004
3. Administrative expense Administrative expense consists mainly of directors’ fees of CHF 2,634,268 (prior year CHF 2,455,679), and Management fees of CHF 8,000,000.
7. Shareholders’ equity a) Issued share capital At the Annual General Meeting on April 19, 2005, shareholders approved a share capital reduction in the form of a nominal value reduction of each registered share from CHF 6.50 to CHF 2.50. As a result of this reduction, the share capital was reduced by CHF 576,027,820 from CHF 936,045,207.50 to a new total of CHF 360,017,387.50. In the previous year, shareholders approved, at the Annual General Meeting on April 16, 2004, a share capital reduction in the form of a nominal value reduction of each registered share from CHF 9 to CHF 6.50. As a result of that reduction, the share capital was reduced by CHF 360,017,387.50 from CHF 1,296,062,595 to CHF 936,045,207.50.
The Board is further authorized to restrict or withdraw the pre-emptive rights of shareholders and to allocate them to third-parties if the shares are to be used (i) for the take-over of an enterprise, or parts of an enterprise or of participations or if issuing shares for the financing including re-financing of such transactions; or (ii) for the purpose of expanding the scope of shareholders in connection with the quotation of shares on foreign stock exchanges.
Decrease due to nominal value reduction of share capital (1,053) – (1,164)
According to the information available to us on December 31, 2005, no shareholder of Zurich Financial Services held more than 5% of the issued share capital.
The Board of Directors proposes to the Annual General Meeting a total payout of CHF 7.00 per registered share for 2005. The proposed total payout to shareholders of CHF 7.00 per registered share is comprised of a regular dividend of CHF 4.60 and a payout of CHF 2.40 in form of a reduction of the nominal value of each share from CHF 2.50 to CHF 0.10.
• Subject to the approval of the dividend, the payment of CHF 4.60 per share, after deductions of 35% Swiss withholding tax, is expected around the beginning of July 2006, free of charge and in accordance with dividend payment instructions.
In our opinion, the accounting records and financial statements and the proposed appropriation of available earnings on page 107 comply with Swiss law and the company’s articles of incorporation.
General CDI Inquiries CRESTCo Limited 33 Cannon Streeet London EC4M 5SB, United Kingdom CREST Service Desk: 0845 964 5648
For more information call BNY's ADR Services Center in the USA +1-888-bny-adrs or outside the USA on +1-610-382-7836. ADR holder assistance may also be obtained from BNY at www.adrbny.com.
The Annual Report 2005 of Zurich Financial Services Group consists of the two publications: the Corporate Review and the Financial Report.
Both reports are available on our Web site and can be downloaded at www.zurich.com
The Financial Report is published in English and German. In the case of inconsistencies in the German translation, the English original version shall prevail.
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