Foreign currency transactions and balances Foreign currency transactions are translated into the functional currency using the spot exchange rate at the date of the transaction or, for practical reasons, a weighted average rate, if exchange rates do not fluctuate significantly. 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 foreign currency translation differences are recorded in income, except for the following: • when the gain or loss on non-monetary items measured at fair value, such as available-for-sale equity securities, is recognized directly in OCI, any foreign currency component of that gain or loss is also recognized directly in OCI; • changes in the fair value of monetary items denominated in foreign currency, such as debt securities, that are classified as available-for-sale, are analyzed between foreign currency translation differences resulting from changes in the amortized cost of the security and other fair value changes in the security. Foreign currency translation differences related to changes in amortized cost are recognized in income, and those related to other changes in fair value are recognized in OCI; and
– the net income of the company, fund or other entity that issues the contract. 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 intangibles.
As a consequence, no gain or loss is recognized as a result of the reclassification of a contract from investment to insurance.
Cash flows from certain universal life-type contracts in the Group‘s Spanish operations are recognized as gross written premiums and insurance benefits and losses instead of deposits.
The reserves for life benefits for participating traditional life insurance policies are calculated using a net level premium valuation method based on actuarial assumptions equal to guaranteed mortality and interest rates.
Future life policyholders’ benefits include the value of accumulated declared bonuses or dividends that have vested to policyholders.
The policyholders’ share of unrealized gains or losses, which may be paid in the future, in respect of assets, is included in the reserves for life benefits.
For products managed on a dynamic basis, the option in IFRS 4 to measure the insurance liabilities using current financial and non financial assumptions is used, to better reflect the way these products are managed. Financial assets relating to these liabilities are designated as “fair value through profit or loss”.
Deferred policy acquisition costs (DAC) Costs that vary with and are directly related to the acquisition of new and renewal business, including for example commissions and underwriting and policy issue expenses, are deferred and subsequently amortized over a defined period. Certain direct response marketing costs for efforts which solicit a direct response that is specific and quantifiable are also deferred, when it can be demonstrated that such marketing results in future economic benefits.
For traditional participating and investment type life insurance contracts the DAC asset is adjusted for the impact of unrealized gains/(losses) on allocated investments that are recorded in OCI (shadow accounting).
Life insurance For life insurance contracts, the carrying amount of the existing reserve for life benefits, including any deferred front-end fees, reduced by the unamortized balance of DAC or present value of future profits of acquired insurance contracts (PVFP), is compared with the reserve for life benefits, calculated using revised assumptions for actual and anticipated experience as of the valuation date. If a deficiency is identified, the DAC or PVFP for the respective grouping of contracts is written down by the amount of the deficiency. If, after writing down the DAC or PVFP to nil, a deficiency still exists for the respective grouping of contracts, the reserve for life benefits is increased by the amount of the remaining deficiency.
Reinsurance assets include balances expected to be recovered from reinsurance companies for ceded paid and unpaid losses and loss adjustment expenses, ceded unearned premiums and ceded future life policy benefits. Amounts recoverable from reinsurers are estimated in a manner consistent with the liability associated with the reinsured policy. Reinsurance is recorded gross in the consolidated balance sheet.
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 or changes in credit ratings of a counterparty, and historical experience regarding collectibility from specific reinsurers. An impairment is considered to have occurred if it is probable that the Group will not be able to collect the amounts expected from reinsurers. If there is objective evidence that a reinsurance asset is impaired, the carrying amount of the asset is reduced to its recoverable amount, through the use of an allowance account, and the amount of the impairment loss is recognized in income. If a decrease in the impairment loss can be related objectively to an event occurring after the impairment loss was initially recognized, the impairment loss is reversed through income.
Investment contracts at amortized cost Liabilities for investment contracts with fixed and guaranteed terms are measured at amortized cost, using the effective interest rate method. Transaction costs are deducted from the initial amount and form part of the effective yield.
As of each reporting date, the Group re-estimates the expected future cash flows and re-calculates the carrying amount of the financial liability by computing the present value of estimated future cash flows using the original effective interest rate for the financial liability. Any adjustment is immediately recognized as income or expense.
Deferred origination costs (DOC) The costs of acquiring new investment contracts with investment management services, such as 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 as of each reporting date.
Categories and measurement of non-derivative investments Non-derivative financial assets are classified as available for sale, financial assets at fair value through profit or loss, held-to-maturity investments or loans and receivables. Management determines the classification of these investments at initial recognition, depending on the purpose for which the investments were acquired.
Financial assets at fair value through profit or loss Financial assets at fair value through profit or loss include financial assets held for trading and those designated at fair value through profit or loss at inception.
Available-for-sale financial assets When there is objective evidence that an available-for-sale debt security is impaired, the cumulative loss that had been recognized directly in OCI is recognized in income as an impairment loss. The impairment loss is the difference between the acquisition cost (net of any principal repayment and amortization) and current fair value, less any impairment loss on that security previously recognized in income. If the fair value of a debt security increases in a subsequent period, and the increase can be objectively related to an event occurring after the impairment loss was recognized in income, the impairment loss is reversed through income, up to the amount of the previously recognized impairment loss, as adjusted for any amortization already recognized in income. Any further gains are recognized directly in OCI. Any subsequent losses, to the extent that they do not represent impairment losses, are also recognized in OCI.
Objective evidence of impairment exists for an available-for-sale equity security when its fair value is below the weighted-average cost by a significant amount. Impairment thresholds are determined each quarter on the basis of the underlying price volatility of securities within the various equity markets in which the Group invests (such as North America, UK, Switzerland, Rest of Continental Europe, Asia Pacific). Additionally, the Group considers an equity security to be impaired when its fair value has been below the weighted-average cost for a prolonged period of 24 consecutive months or longer.
f) Derivative financial instruments and hedge accounting Derivative financial instruments held by the Group include interest rate, currency and total return swaps, futures, forwards and option contracts, all of which derive their value mainly from changes in underlying interest rates, foreign exchange rates, commodity values or equity instruments. A derivative contract may be traded on an exchange or over-the-counter (OTC). Exchange-traded derivatives are standardized and include futures and certain option contracts. OTC derivative contracts are individually negotiated between contracting parties and include forwards, caps, floors and swaps. Derivative financial instruments are subject to various risks similar to those related to the underlying financial instruments, including market, credit and liquidity risk.
Derivative financial instruments that qualify for hedge accounting Derivatives are used by the Group to economically hedge risks. In limited circumstances derivatives are designated as hedging instruments for accounting purposes: • fair value hedges which hedge the exposure to changes in the fair value of a recognized asset or liability; • cash flow hedges which hedge exposure to variability in cash flows that is either attributable to a particular risk associated with a recognized asset or liability or a highly probable forecast transaction; or
• substantially all the risks and rewards have not been retained or transferred, but control has been transferred.
In cases such as events of default by a third party, it may be determined that the risks and rewards of ownership over the collateral have been obtained by the Group. At such point in time, the securities held under the reverse repurchase agreement would be recognized on the balance sheet at fair value and the original receivable as collateral derecognized. Any shortfall is recorded as a loss in income.
j) Property and equipment Own use property is defined as property held by the Group for use in the supply of services or for administrative purposes. Buildings held for own use and equipment are carried at cost less accumulated depreciation and any accumulated impairment loss. These assets are depreciated usually on a straight-line basis to income over the following estimated useful lives: • buildings 25 to 50 years; • furniture and fixtures five to ten years; and
Consolidated financial statements continued k) Intangible assets Intangible assets include goodwill, present value of future profits from acquired insurance contracts (PVFP), attorney-in-fact relationships (AIF), distribution agreements and other intangible assets, such as customer relationships and contracts, affinity partnerships, computer software licenses and capitalized software development costs.
Other intangible assets with indefinite lives are not subject to amortization but are tested for impairment annually and whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.
The test for goodwill impairment is performed annually or whenever there is an indication that the CGU 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 of the CGU including goodwill. Gains and losses on the divestment of an entity are calculated including the carrying amount of any goodwill relating to the entity sold.
Indications that goodwill related to a CGU may be impaired include events or changes in circumstances that may have a significant negative impact on the operations of the CGU, or material adverse changes in the assumptions used in determining its recoverable amount.
Farmers Exchanges, which are managed but not owned by Farmers Group Inc. (FGI), a wholly owned subsidiary of the Group. In determining that these relationships have an indefinite useful life, the Group considered the organizational structure of inter-insurance exchanges, under which subscribers exchange contracts with each other and appoint an attorney-in-fact to provide certain management services, and the historical AIF between FGI and the Farmers Exchanges.
Dividend income is recognized when the right to receive payment is established, which is usually the ex-dividend date.
For Group investments, interest income is recognized using the effective interest method. Interest income on impaired financial assets is recognized using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss.
Investment expenses Investment expenses consist of operating expenses for real estate held for investment and other investment expenses. These expenses are recognized on an accrual basis.
The total amount to be expensed over the vesting period is determined by reference to the fair value of the shares and/ or options granted. Non-market vesting conditions (for example, profitability and premium income growth targets) are included in assumptions about the number of shares and/or options that are expected to be issued or become exercisable. At each balance sheet date, the Group revises its estimates of the number of shares and/or options that are expected to be issued or become exercisable. It recognizes the impact of the revision to original estimates, if any, in income with a corresponding adjustment to OCI. However, no subsequent adjustment to total OCI is made after the vesting date.
Retirement benefits Operating companies in the Group provide employee retirement benefits through both defined benefit plans and defined contribution plans. The assets of these plans are generally held separately from the Group’s assets in trusteeadministered funds. Defined benefit plan obligations and contributions are determined annually by qualified actuaries using the projected unit credit method. The Group’s expense relating 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 in full in the period in which they occur and are presented on a separate line in the consolidated statement of comprehensive income. Actuarial gains and losses result from experience adjustments (the effects of differences between the previous actuarial assumptions and what has actually occurred during the accounting period), changes in actuarial assumptions since the previous balance sheet date, and differences between the expected and actual returns on plan assets. Unrecognized past service costs represent non-vested benefits on the date of a change in the amount of benefits following an amendment to the plan and are amortized on a straight-line basis over the average vesting period.
Finance leases, where the Group is the lessee, are capitalized at the commencement of the lease at the fair value of the leased property or, if lower, at the present value of the minimum lease payments. Lease payments are apportioned between finance charges and reduction of the lease liability so as to achieve a constant rate of interest on the remaining balance of the liability. Finance charges are recognized in income. Contingent rents are recognized as expenses in the period in which they are incurred.
Taxes paid by certain of the Group’s life insurance businesses are based on the investment result less allowable expenses. To the extent these taxes exceed the amount that would have been payable in relation to the shareholders’ share of taxable profits, it is normal practice for certain of the Group’s businesses to recover this portion 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 the portion attributable to 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.
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 asset and liabilities, impairment charges, the determination of fair values of assets and liabilities attributable to business combinations, deferred policy acquisition costs, deferred taxes, employee benefits and share-based compensation and cash incentive plans. In each case, the determination of these items requires management to make informed judgments based on information and financial data that may change in future periods. Because of the uncertainties involved in such judgments, actual outcomes and results may differ from assumptions and estimates made by management.
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. These reserves are generally established on an undiscounted basis to recognize the estimated costs of bringing pending claims to final settlement. The reserve calculation takes into account inflation, as well as other factors that can influence 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 final 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 significantly from the level of reserves originally set.
The Group establishes IBNR reserves, generally on an undiscounted basis, to recognize the estimated cost of losses for events which have already occurred but which have not yet been notified. These reserves are established to recognize the estimated costs required to bring such claims to final settlement. As these losses have not yet been reported, the Group relies upon historical information and statistical models, based on product line, type and extent of coverage, to estimate its IBNR liability. The Group also uses reported claim trends, claim severities, exposure growth, and other factors in estimating its IBNR reserves. These reserves are revised as additional information becomes available and as claims are actually reported. The time required to learn of and settle claims is an important consideration in establishing the Group’s reserves.
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
c) Fair value of financial assets and liabilities As described in note 3, all financial assets and liabilities are recorded initially at fair value. Subsequently, available-forsale financial assets, financial assets and liabilities at fair value through profit or loss and derivative financial instruments are carried at fair value, as of the reporting date. All other financial instruments are carried at amortized cost, with their fair values disclosed in note 27.
In determining fair values of investments, the Group makes extensive use of third party pricing providers and only in rare cases places reliance on prices that are derived from internal models. One of the objectives of the Group’s control environment and the process of selection of pricing providers is to ensure that fair values of investments are sourced only from independent, reliable and reputable third party pricing providers.
The Group employs third party asset managers who manage a significant percentage of assets on behalf of the Group, but are not responsible for determining the fair values reported in the Consolidated financial statements. Investment accounting and operations functions, are completely independent from those responsible for buying and selling the assets, and are responsible for receiving, challenging and verifying values provided by third party pricing providers to ensure that fair values are reliable and comply with the applicable accounting and valuation policies. The quality control procedures used depend on the nature and complexity of the invested assets and include regular reviews of valuation techniques and inputs used by pricing providers (for example, default rates of collateral for asset backed securities), variance and stale price analysis and comparisons with fair values of similar instruments and with alternative values obtained from asset managers and brokers.
Refer to notes 6, 7 and 27 for further information on the fair value of financial assets and liabilities.
The recoverable amount of the intangible assets with an infinite life related to the Farmers segment (i.e. attorney-in-fact (AIF) relationships and goodwill) is determined on the basis of value-in-use calculations. These calculations use cash flow projections based on business plans and the development of surplus in the Farmers Exchanges. Business plans are approved by management and typically cover a three-year period. Cash flows beyond that three-year period are extrapolated for 20 years assuming zero growth.
The discount rates used in those calculations for the General Insurance and Farmers segments consider the base rates, starting with the U.S. Dollar, euro and British pound swap rates for the respective mature markets, adjusted for inflation differential expectations in emerging markets. These rates are further adjusted for equity risk premium and appropriate beta.
Perpetual nominal growth rates beyond the three-year planning period vary and are dependent on country specific growth rate and inflation expectations.
Fair values of identifiable intangible assets are based on market-participant assumptions and applicable valuation techniques, depending on the nature of the assets valued. For customer relationship and contract intangibles, including bancassurance agreements, the multi-period excess earnings or cash flow method is applied, using pre-tax future cash flows expected to be generated from such assets and discounting at applicable market rates. For brand intangibles the relief from royalty method is generally applied and resulting cash flows are discounted at applicable market rates. For information technology intangibles the replacement cost method is generally applied.
See note 5 for further information on the fair value of assets and liabilities attributable to business combinations.
g) Deferred taxes Deferred tax assets are recognized if sufficient future taxable income, including income from the reversal of existing taxable temporary differences and available tax planning strategies, are available for realization. The utilization of deferred tax assets arising from temporary differences depends on the generation of sufficient taxable profits in the period in which the underlying asset or liability is recovered or settled. As of each balance sheet date, management evaluates the recoverability of deferred tax assets and if it is considered probable, that all or a portion of the deferred tax asset will not be utilized, then a valuation allowance is recognized.
h) Employee benefits The Group provides defined benefit pension plans and other post-employment plans. In assessing the Group’s liability for these plans, critical judgments include estimates of mortality rates, rates of employment turnover, disability, early retirement, discount rates, expected long-term rates of return on plan assets, future salary increases, future pension increases and increases in long-term healthcare costs. The discount rate for the significant plans is based on a yield curve approach. The Group sets the discount rate by creating a hypothetical portfolio of high quality corporate bonds for which the timing and amount of cash outflows approximate the estimated payouts of the defined benefit plan. These assumptions may differ from actual results due to changing economic conditions, higher or lower withdrawal rates or longer or shorter life spans of participants. These differences may result in variability of pension income or expense recorded in future years.
See note 25 for further information on share-based compensation and cash incentives plans.
On November 1, 2010 the Group completed the acquisition of 80.0 percent of PT Zurich Topas Life (formerly PT Mayapada Life), a life insurer based in Indonesia focused on the distribution of group and individual life and health plans. Mayapada Group will continue to hold 20.0 percent of PT Zurich Topas Life. Through this transaction, the Group established its presence in the Indonesian life insurance market. As of December 31, 2010, the Group was still in the process of preparing the initial accounting and, therefore, the initial purchase price was recorded as an unconsolidated investment in other assets.
Divestments and loss of control On February 15, 2010, Royal Bafokeng Finance (Pty) Limited (RBF), an investment company based in South Africa and wholly owned by Royal Bafokeng Holdings (Pty) Limited, based in South Africa and responsible for the management and development of the commercial assets of the Royal Bafokeng Nation, increased its share holding in Zurich Insurance Company South Africa Limited (ZICSA), of which the Group owned 73.61 percent, by 15.1 percent from 10.0 percent to 25.1 percent against USD 32 million in cash with option rights to increase up to 51.0 percent or sell the entire stake back to the Group. To appropriately reflect the nature of the put and the call options on the shares, the Group has reclassified the 25.1 percent non-controlling interest of RBF as a liability measured at fair value in the consolidated financial statements. Following this transaction and the acquisition of 0.44 percent of ZICSA shares, the Group owned 58.95 percent of ZICSA shares as of December 31, 2010.
As of December 31, 2010 the Group no longer has control in Futuro de Bolivia S.A. Administradora de Fondos de Pensiones following changes in the regulatory environment. The Group has derecognized the assets and liabilities at their carrying amount and recorded a net loss of USD 16 million within net gain on divestments of businesses.
Divestments During the year ended December 31, 2009, the Group sold all of its shares in Paofoong Insurance Company (Hong Kong) Limited based in Hong Kong and in Constellation Reinsurance Company based in New York, recording a pre-tax loss on disposal in aggregate of USD 5 million. Total cash and net assets divested in 2009 were in aggregate USD 18 million and USD 12 million, respectively. The total consideration received in 2009, net of immaterial transaction costs, amounted in aggregate to USD 7 million.
Rental operating expenses for real estate held for investment included in investment expenses for total investments amounted to USD 201 million and USD 211 million for the years ended December 31, 2010 and 2009, respectively.
Investment result, gross for Group investments 7,317 7,748 898 (1,576) 8,215 6,171 Investment expenses for Group investments (225) (243) – – (225) (243) Investment result, net for Group investments 7,092 7,505 898 (1,576) 7,990 5,929 1 Net capital gains/(losses) arise entirely from derivative financial instruments, of which net capital gains/(losses) on derivatives attributable to cash flow hedge ineffectiveness amounted to USD 10 million and USD 33 million for the years ended December 31, 2010 and 2009, respectively.
For the years ended December 31, 2010 and 2009, respectively, impairment charges on Group investments included in net capital losses amounted to USD 1,001 million and USD 1,394 million, of which impairment charges on mortgage loans, other loans and equity method accounted investments comprised USD 407 million and USD 231 million, respectively. Impairment charges on mortgage loans in both years are primarily attributable to the Group’s banking activities.
Real estate held for investment 325 341 188 (483) 513 (142)
Securities at fair value through profit or loss: 8,476 11,273 643 239 9,120 11,512 Net capital gains/(losses) on Group investments 294 474 373 (149) 667 325
Securities designated at fair value through profit or loss 258 405 369 (146) 628 258
Net capital gains/(losses) for unit-linked contracts 8,182 10,800 270 387 8,452 11,187
Realized capital gains on Group investments 610 323 1,468 988 2,078 1,312 Realized capital losses on Group investments (122) (471) (514) (955) (636) (1,425)
Cash and cash equivalents 15,721 5.2 16,882 5.7 Equity securities: Fair value through profit or loss 89,695 29.5 83,329 28.3 of which: Trading securities 473 0.2 879 0.3 Securities designated at fair value through profit or loss 89,223 29.4 82,449 28.0
Debt securities: Fair value through profit or loss 16,245 5.3 17,878 6.1 of which: Trading securities 43 0.0 82 0.0 Securities designated at fair value through profit or loss 16,202 5.3 17,797 6.0
Equity method accounted investments 188 0.1 232 0.1 1 Includes a 20 percent investment in New China Life Insurance Company Ltd., in which the Group has no significant influence.
Debt securities: Fair value through profit or loss 6,869 3.5 7,684 3.9 of which: Securities designated at fair value through profit or loss 6,826 3.5 7,602 3.9
Table 6.3a as of December 31Details of total investments by category
Table 6.3b as of December 31Details of Group investments by category
Securities under security lending and short-term sale and repurchase agreements As of December 31, 2010 and 2009, investments included USD 5,873 million and USD 5,073 million, respectively, of loaned securities. These loaned securities were mainly debt securities. Cash and cash equivalents included USD 493 million of cash received as collateral for loaned securities as of December 31 2009. Liabilities for cash collateral received for securities lending comprised USD 485 million and USD 508 million as of December 31, 2010 and 2009, respectively. Non-cash collateral received for loaned securities comprised mainly equity and debt securities and amounted to USD 5,663 million and USD 5,046 million as of December 31, 2010 and 2009, respectively. The Group can sell or repledge the collateral only in the event of a default by a counterparty.
Investments held under unit-linked investments contracts are classified as designated at fair value through profit or loss.
Debt securities Swiss federal and cantonal governments 3,082 2,788 262 199 (9) (2) 3,335 2,986
millions of which: common stock portfolios backing participating with profit policyholder contracts 516 4.8 674 5.3 – – 516 674
Mortgage and asset- backed securities 1,017 9.4 1,222 9.6 265 308 1,282 1,530
Associates: DKN Financial Group Limited 33 60 2 (3) 30.51% 30.99%
Joint ventures: MCIS Zurich Insurance Berhad 36 37 3 1 40.00% 40.00%
Table 6.8 in USD millionsReal estate held for investment (total investments)
Less: amount of net unrealized gains/(losses) on investments attributable to: Life policyholder dividends and other policyholder liabilities (662) (904) Life deferred acquisition costs (154) (97) Deferred income taxes (869) (312) Non-controlling interests (9) (15)
1 Net unrealized gains/(losses) include net gains/(losses) arising on cash flow hedges of USD 56 million and USD (9) million as of December 31, 2010 and 2009, respectively.
Table 7.1 shows the fair value and notional amounts for instruments which do not qualify for hedge accounting as of December 31, 2010 and 2009, respectively. Whilst these notional amounts express the extent of the Group’s involvement in derivative transactions, they are not however representative of amounts at risk. Fair values for derivatives are included in the consolidated balance sheets in other assets and other liabilities.
Interest rate contracts: OTC Swaps 30 878 2,146 3,054 187 (84) 1,064 102 (11)
Equity contracts: OTC Swaps 281 – – 281 – (1) – – –
Exchange traded Puts 74 – – 74 3 – – – –
Foreign exchange contracts: OTC Cross Currency Swaps – 425 – 425 – (26) 737 21 –
Interest rate contracts Interest rate contracts are used to hedge risks from changes in interest rates and to manage asset liability mismatches. Whenever possible the Group enters into exchange traded contracts, which are standardized and regulated. Furthermore, because of the structure of the Exchanges, exchange traded contracts are not considered to carry counterparty risk. Over the counter (OTC) contracts are otherwise applied and comprise swaps, swaptions and caps.
In terms of notional amounts, the major change compared with December 31, 2009 related to long receiver swaptions entered into during 2010 to protect one of the Group’s large life insurance books against falling interest rates.
Foreign exchange contracts Foreign exchange contracts consist mainly of forward contracts which are used to hedge the Group’s foreign currency exposures and manage balance sheet mismatches.
Credit contracts The change in credit default swaps, purchased by the Group to protect reinsurance assets, related to matured positions.
The following table sets out details of fair value and cash flow hedges: Maturity by notional amount Notional principal amounts
Cash flow hedges: – Options on interest rate swaps 712 – 3,143 3,855 331 – 3,474 171 –
Fair value hedges Designated fair value hedges consist of cross currency interest rate swaps used to protect the Group against changes in foreign currency exposure and interest rate exposure of Euro-denominated debt issued by the Group.
A fair value hedge relationship on the EUR 500 million 4.5 percent subordinated bond due June 2025 issued by Zurich Finance (USA), Inc. (see note 22), was entered into at the issuance of the debt instrument in 2005 and will end on June 15, 2015.
A fair value hedge relationship on 20 percent of the EUR 1 billion 4.5 percent senior debt due for repayment in 2014 issued by Zurich Finance (USA), Inc. (see note 22), was entered into on January 1, 2007 and will end at maturity of the underlying debt instrument in 2014.
A fair value hedge relationship on the USD 750 million 3.25 percent senior bond due for repayment in September 2013 issued by Zurich Finance (Luxembourg), S.A. (see note 22), was entered into on April 8, 2010 and will end at maturity of the underlying debt instrument in 2013.
The Group also uses currency swaps for cash flow hedging to protect against exposures to variability of cash flows. The change in the fair value of the hedging instrument is recognized directly in comprehensive income. The ineffective portion of the change in fair value is recognized directly in income within administrative and other operating expense. The effective portion, related to spot rate changes in fair value of the hedging instrument, is reclassified to income within administrative and other operating expense as an offset to foreign currency revaluation on the underlying hedged debt.
As of December 31, 2010 the following cash flow hedge relationships were in place (see note 22): • 80 percent of the EUR 1 billion 4.5 percent senior bond due 2014 issued by Zurich Finance (USA), Inc. entered on January 1, 2007 ending September 17, 2014.
A net gain of USD 10 million and USD 32 million for the years ended December 31, 2010 and 2009, respectively, was recognized in net capital gains/(losses) and impairments due to a hedge ineffectiveness and changes in the time value of the option.
Reserves for losses and loss adjustment expenses 68,069 68,086 (12,093) (12,182) 55,976 55,903
Losses and loss adjustment expenses incurred: Current year 28,917 28,308 (3,930) (2,610) 24,987 25,698
1 The 2010 net movement includes USD (2) million related to loss of control (see note 5).
North America Commercial favorable development of USD 434 million arose mostly from specialties, program, middle market commercial and surety business. These favorable developments were partially offset by unfavorable development in workers compensation.
Gross reserves for losses and loss adjustment expenses 37,694 45,306 51,068 57,765 60,425 64,535 67,890 65,218 68,086 68,069
Net reserves re-estimated as of December 31: One year later 26,908 32,239 38,977 43,627 45,976 49,594 53,441 51,927 54,537 Two years later 28,471 34,471 40,413 45,006 45,827 48,642 52,559 50,645 Three years later 30,636 36,118 42,004 45,325 45,297 48,127 51,872 Four years later 31,784 37,691 42,254 45,294 45,249 47,814 Five years later 33,326 37,880 42,470 45,604 45,153 Six years later 33,799 38,282 43,017 45,682 Seven years later 34,004 38,951 43,108 Eight years later 34,716 39,086 Nine years later 34,844
Losses and loss adjustment expenses incurred 61 20 7 4 Losses and loss adjustment expenses paid (51) (38) (61) (40) Foreign currency translation effects 1 – 1 1
Reserves for asbestos claims decreased by USD 196 million gross and USD 135 million net during 2010. This decrease was driven by the re-estimation of the ultimate liability for asbestos as well as the normal payout of claims. As a significant portion of the Group’s reserves is held in British pounds, the strengthening of the U.S. dollar also impacted the decrease significantly.
Reserves for environmental claims increased by USD 10 million gross but decreased by USD 19 million net during 2010. The difference in gross and net movements is explained by the increase in ceded reserves, largely the result of the re-estimation of reserves in North America.
Fee income and other expenses (1,689) (2,938) 118 240 (1,571) (2,698) Interest and bonuses credited to policyholders 2,650 2,752 (70) (68) 2,580 2,683
Fee income and other expenses (360) (291) 14 4 (347) (288) Interest and bonuses credited to policyholders 993 879 (82) (90) 912 789 Changes in assumptions (3) – – – (3) –
(Decrease)/increase recorded in other comprehensive inome (185) 1,045 – – (185) 1,045 1 The 2010 net movement includes USD (1,733) million related to the transfer from other reserves categories (see note 1) and USD (7) million related to loss of control in Caixa Sabadell (see note 5).
Fee income and other expenses (692) (513) Interest and bonuses charged/(credited) to policyholders 5,267 5,864
Increase/(decrease) recorded in other comprehensive income (35) 28 Foreign currency translation effects (1,590) 3,465 As of December 31 50,667 46,124 1 The 2010 movement includes USD (884) million related to the transfer to and from reserves for insurance contracts (see note 1).
As of January 1 1,837 1,221 Net unrealized (losses)/gains on investments (39) 381 Current period profit 194 192 Foreign currency translation effects 176 44 As of December 31 2,168 1,837
Consolidated financial statements continued 11. Gross and ceded insurance revenues and expenses
Losses and loss adjustment expenses 27,098 27,375 (3,478) (2,736) 23,620 24,639 Life insurance death and other benefits 11,004 11,816 (456) (460) 10,548 11,356 Change in future life policyholders’ benefits 488 (887) (172) (5) 316 (892) Total insurance benefits and losses 38,591 38,304 (4,106) (3,201) 34,484 35,103
Change in policyholders’ contract deposits and other funds 809 483 (4) – 805 484 Change in reserves for unit-linked products 5,287 6,911 – – 5,287 6,911 Change in liabilities for investment contracts – unit-linked 4,830 5,623 – – 4,830 5,623 Change in liabilities for investment contracts – other 215 206 – – 215 206 Change in unit-linked liabilities related to UK capital gains tax (337) (364) – – (337) (364) Total policyholder dividends and participation in profits 10,805 12,859 (4) – 10,801 12,859
Change in reserves for unearned premiums (1,018) 826 (208) (80) (1,227) 746
Consolidated financial statements 12. Deferred policy acquisition costs and deferred origination costs
Amortization charged/ (credited) to other comprehensive income – – (74) (291) – 1 (74) (290)
As of January 1 856 770 Origination costs deferred 142 96
The above numbers reflect the costs by nature after allocation of certain costs, in particular wages and salaries as well as other employee benefits, on a functional basis.
Farmers Group, Inc. (FGI) through its attorney-in-fact (AIF) relationship with the Farmers Exchanges, which are managed but not owned by Farmers Group, Inc. (FGI), a wholly owned subsidiary of the Group, is contractually permitted to receive a management fee of 20 percent (25 percent in the case of the Fire Insurance Exchange) of the gross premiums earned by the Farmers Exchanges.
Consolidated financial statements 16. Mortgage loans given as collateral and collateralized loans
The table below shows the maturity schedule of collateralized loans as of December 31, 2010 and 2009, respectively.
As of December 31, 2010, the intangible assets related to non-controlling interests were USD 145 million from present value of future profits (PVFP) of acquired insurance contracts, USD 1,055 million from distribution agreements and USD 6 million from software.
Gross carrying value as of January 1, 2009 1,696 2,617 3,075 1,025 2,791 247 11,451
Amortization charged to other comprehensive income – (65) – – – – (65)
Gross carrying value as of December 31, 2009 2,331 2,749 3,426 1,025 3,430 224 13,186
As of December 31, 2009, the intangible assets related to non-controlling interests were USD 224 million from present value of future profits (PVFP) of acquired insurance contracts, USD 1,484 million from distribution agreements and USD 8 million from software.
Impairment charges of USD 94 million were recorded in income comprising impairments on goodwill of USD 12 million mainly related to the Spanish General Insurance operations, USD 30 million of PVFP in the Spanish Life operations and USD 29 million for distribution agreements related to Italian Life operations as well as USD 15 million of software mainly related to Banking operations.
Other Operating Businesses 5 – – – 218 – 223 Non-Core Businesses – – – – 9 – 9 Net carrying value as of December 31, 2009 2,297 1,137 3,174 1,025 1,569 139 9,342
As of January 1 119 88 Provisions made during the period 111 101 Provisions used during the period (77) (86) Provisions reversed during the period – (3) Foreign currency translation effects 2 4 Net changes due to acquisitions / divestments – 17 Other changes – (1) As of December 31 155 119
During the year ended December 31, 2010, the Group entered into several restructuring programs, recording a total charge to income of USD 62 million. A further USD 49 million was recorded in respect of restructuring programs initiated in prior years. The largest restructuring program was initiated as part of the new strategy of the Group’s General Insurance segment. The UK Direct operations are now integrated into the UK business to create operational synergies and the focus of the Direct insurance efforts are on Germany, Italy and Switzerland. The related restructuring costs amount to USD 20 million. In addition, the Group recorded USD 114 million of software impairments as outlined in note 18.
During the year ended December 31, 2009, the Group entered into several restructuring programs, recording a total charge to income of USD 86 million. A further USD 15 million was recorded in respect to restructuring programs initiated in prior years. The largest restructuring program in 2009 related to the integration of the management services business of 21st Century into the Group’s Farmers business division. A restructuring plan was announced involving office closures and a reduction in workforce will occur. The impact was predominantly headcount related, with costs approximating USD 28 million. As a result of the 21st Century transaction, the Group also assumed already existing restructuring provisions of USD 17 million for on-going restructuring activities.
Table 20.2 in USD millions, as of December 31Maturity schedule – other financial liabilities1
Net income before income taxes 4,868 5,537 Less: income tax (expense)/benefit attributable to policyholders (462) (387) Net income before income taxes attributable to shareholders 4,406 5,150 Expected income tax expense attributable to shareholders computed at the Swiss statutory tax rate 22.0% 969 22.0% 1,133 Increase/(reduction) in taxes resulting from: Tax rate differential in foreign jurisdictions 55 220 Tax exempt and lower taxed income (119) (53) Non-deductible expenses 63 79 Tax losses previously unrecognized or no longer recognized 33 40 Prior year adjustments and other (108) (252)
Actual income tax expense attributable to shareholders 20.3% 893 22.7% 1,167 Plus: income tax expense/(benefit) attributable to policyholders 462 387 Actual income tax expense/(benefit) 27.8% 1,355 28.1% 1,553
The table above sets out the factors that cause the actual income tax expense to differ from the expected expense computed by applying the Swiss Statutory tax rate of 22.0 percent, which is the rate applicable in the jurisdiction where the ultimate parent company is resident.
Table 21.1 in USD millions, for the years ended December 31Income tax expense – current / deferred split
Table 21.5 in USD millions, as of December 31Deferred tax assets and liabilities
Table 21.7 in USD millions, as of December 31Deferred taxes – policyholder/ shareholder attribution
Deferred acquisition and origination costs 90 (2,784) 56 (2,762) Depreciable and amortizable assets 147 (2,023) 101 (2,116) Life policyholders’ benefits and deposits 1 808 (722) 529 (741) Unrealized (gains)/losses on available-for-sale investments and cash flow hedges 249 (1,019) 344 (580)
Reserves for losses and loss adjustment expenses 78 (335) 339 (478) Reserves for unearned premiums 34 (96) 59 (64) Deferred front-end fees 717 – 747 – Pensions and other employee benefits 344 (43) 366 (32)
Tax loss carryforwards 173 – 244 – Gross deferred tax assets/(liabilities) before valuation allowance 3,589 (8,162) 3,819 (8,241) Valuation allowance (11) – (23) – Gross deferred tax assets/(liabilities) after valuation allowance 3,578 (8,162) 3,796 (8,241) Deferred tax liabilities (4,585) (4,445)
Table 21.8 in USD millions, as of December 31Deferred tax assets/(liabilities) analysis by source
For which deferred tax assets have been recognized, expiring < 5 years 358 160 > 20 years or with no time limitation 203 1,095
The tax rates applicable to tax losses for which a deferred tax asset has not been recognized are 22.4 percent and 24.0 percent for the years 2010 and 2009, respectively.
The recoverability of the deferred tax asset for each taxpayer is based on the taxpayer’s ability to utilize the deferred tax asset over a reasonable period of time. This analysis considers the projected taxable income to be generated by the taxpayer, as well as its ability to offset the deferred tax asset against deferred tax liabilities.
Management assesses the recoverability of the deferred tax asset carrying values based on future years taxable income projections and believes that the carrying values of the deferred tax assets as of December 31, 2010, are recoverable.
Zurich Finance (Luxembourg) S.A. 3.25% USD 750 bond, due September 2013 5, 6 765 747 Zurich Insurance Company Ltd 3.875% CHF 1,000 bond, due July 2011 1,071 965
Various debt instruments payable within 1 year – 200 Other Various debt instruments payable within 1 year – 5 Various debt instruments payable in more than 1 year 141 149 Senior debt 6,053 6,277 Subordinated debt Zurich Insurance Company Ltd 12.0% EUR 143 capital notes, undated 6 190 203 4.25% CHF 700 bond, undated 6 736 Zurich Finance (UK) plc 6.625% GBP 450 bond, undated notes 4, 6 692 717 Zurich Finance (USA), Inc. 5.75% EUR 500 bond, due October 2023 6 661 707
ZFS Finance (USA) Trust I Series I 6.15% USD 600 ECAPS, due December 2065 – 567 ZFS Finance (USA) Trust II Series II 6.45% USD 700 ECAPS, due December 2065 673 672
ZFS Finance (USA) Trust III Series III Floating Rate USD 400 ECAPS, due December 2065 – 200
ZFS Finance (USA) Trust V Series V 6.5% USD 1,000 Trust Preferred Securities, due May 2067 497 496
4 The holders of these notes benefit from the Replacement Capital Covenant which states that if Series IV and V Fixed / Floating Trust Preferred Securities, issued by ZFS Finance
5 These bonds are part of qualifying fair value hedges. 6 Issued under the Group’s Euro Medium Term Note Programme (EMTN Programme).
Senior and subordinated debt To facilitate the issuance of debt, the Group has in place a Euro Medium Term Note Programme (EMTN Programme) allowing for the issuance of senior and subordinated notes up to a maximum of USD 15 billion. All issuances under this programme are either issued or guaranteed by Zurich Insurance Company Ltd. The Group has also issued debt instruments outside this programme when deemed appropriate.
i) Senior debt Senior debt decreased from USD 6.3 billion to USD 6.1 billion primarily due to the USD 200 million repayment of debt drawn under a credit facility for the sole purpose of financing surplus notes issued by the Leschi Life Assurance Company (Leschi), which expired in June 2010.
On November 26, 2010, Zurich Insurance Company Ltd issued CHF 700 million of subordinated notes under the EMTN Programme. These subordinated bonds carry a fixed annual coupon of 4.25%, are first callable in 2016 and are undated.
4.25% CHF 700 bond, undated notes 4.25% payable annually up to May 26, 2016 and then reset quarterly to 3-month CHF-Libor plus 3.046%.
1 Reset rate of interest is equal to the gross redemption yield on the benchmark five-year Gilt as determined by the Calculation Bank, plus 2.85% per annum. 2 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
Interest expense on debt In aggregate, interest expense on debt remained stable in 2010 compared with 2009. The change in interest expense on debt related to capital markets and on senior debt is related to lower interest rates and foreign exchange fluctuations.
Credit facilities The Group has access to a syndicated revolving credit facility of USD 3 billion that terminates in September 2012. Zurich Insurance Company Ltd and Farmers Group, Inc. are guarantors of the facility and can draw up to USD 2.75 billion and USD 250 million, respectively. No borrowings were outstanding under this facility as of December 31, 2010 or December 31, 2009.
Issued share capital As of December 31, 2008 14,212,262 142,122,620 0.10 New shares issued from authorized capital in 2009 480,000 4,800,000 0.10 New shares issued from contingent capital in 2009 55,045 550,448 0.10
Share capital reduction as approved by the Annual General Meeting in 2010 (183,640) (1,836,404) 0.10 New shares issued from contingent capital in 2010 95,023 950,232 0.10
Authorized, contingent and issued share capital As of December 31, 2009 16,531,690 165,316,899 0.10 a) Issued share capital At the Annual General Meeting on March 30, 2010, the shareholders approved a share capital reduction of CHF 183,640.40 from CHF 14,747,306.80 to CHF 14,563,666.40 by canceling 1,836,404 registered shares. The effective date of the capital reduction was June 15, 2010. In addition, the shareholders approved an increase in the authorized share capital to a new maximum of CHF 1,000,000, allowing for enhanced financial flexibility of the company for future capital management and an increase in the contingent share capital to a new maximum of CHF 500,000 which can be issued to employees of Zurich Financial Services Ltd and its subsidiaries in connection with employee participation plans. During the year 2010, a total of 950,232 shares were issued to employees from contingent capital.
b) Authorized share capital Until March 30, 2012, the Board of Zurich Financial Services Ltd is authorized to increase the share capital by an amount not exceeding CHF 1,000,000 by issuing up to 10,000,000 fully paid registered shares with a nominal value of CHF 0.10 each. An increase in partial amounts is permitted. The Board would determine the date of issue of any such new shares, the issue price, type of payment, conditions for exercising pre-emptive rights, and the beginning of dividend entitlement.
c) Contingent share capital Capital market instruments and option rights to shareholders The share capital of Zurich Financial Services Ltd may be increased by an amount not exceeding CHF 1,000,000 by the issuance of up to 10,000,000 fully paid registered shares with a nominal value of CHF 0.10 each (i) 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 Ltd or one of its Group companies in national or international capital markets; and/or (ii) by
Consolidated financial statements continued exercising option rights which are granted to current shareholders. When issuing bonds or similar debt instruments connected with conversion and/or option rights, the pre-emptive rights of the shareholders will be excluded. The current owners of conversion and/or option rights shall be entitled to subscribe for the new shares. The conversion and/or option conditions are to be determined by the Board.
Preferred securities bought back by group companies 2 (99,390,000) (99,390) 1,000 1 The amount is gross of issuance costs of USD 14 million as of December 31, 2010, 2009 and 2008. 2 The amount shows the nominal amount of preferred securities bought back by group companies. The respective movement in the balance sheet deviates from this amount by USD 14 million, representing the gain on this transaction which has been recognized within the same line item.
In February 2001, the Group placed six series of Trust Capital Securities (Zurich RegCaPS) for a total amount of USD 1,125 million (USD 1,096 million net of issuance costs) with a limited number of qualified institutional and corporate U.S. investors. The securities, which were issued under Rule 144A in the U.S., are perpetual, non-cumulative and have a par value of USD 1,000 each. They have no voting rights, except in certain specified circumstances and are linked to Farmers Group, Inc. Class C shares. On March 30, 2006, April 11, 2006 and April 18, 2008, the Group redeemed the Series I, III and IV of the Zurich RegCaPS, respectively. The liquidation amounts totaled USD 550 million in aggregate. Of the remaining series totaling USD 575 million, one has a fixed rate coupon of 6.58 percent and two have floating rate coupons at LIBOR +71 basis points. These coupon rates step up after the first call dates. In the
Treasury shares comprise shares acquired in the market, primarily held to cover employee and share option plans. At the end of 2009 treasury shares also included the remaining shares repurchased under the share buy-back program 2008. The number of treasury shares amounted to 1,399,080 and 3,269,338 as of December 31, 2010 and 2009, respectively.
The Group had 54,934 and 56,668 employees (full-time equivalents) as of December 31, 2010 and 2009, respectively. Personnel and other related costs incurred for the year ended December 31, 2010 and 2009, were USD 5,257 million and USD 5,399 million, including wages and salaries of USD 4,346 million and USD 4,423 million, respectively.
The Group also operates post-employment plans, mainly in the U.S., which provide employees with certain defined post-employment benefits such as medical care and life insurance.
For the defined benefit pension plans, total contributions to funded pension plans and benefit payments by the Group are currently estimated at USD 496 million for 2011 compared with USD 456 million estimated in the previous year for 2010. The actual amounts may differ.
Unrecognized past service cost (1) – (1) – 2 – – – – – Cumulative impact of asset ceiling (3) (15) (7) (62) – – – – – –
Present value of unfunded obligations (260) (230) (210) (207) (985) (295) (205) (183) (208) (196)
Table 24.3 in USD millions, as of December 31Status of funded and unfunded defined benefit plans
Mortgage loans 441 396 Cash and cash equivalents 236 181 Equity securities 3,903 3,598 Debt securities 8,410 7,740 Real estate 795 701 1 UK annuity policies.
As a matter of policy, pension plan investment guidelines do not permit investment in any assets in which the Group or its subsidiaries have an interest, including shares or other financial instruments issued and real estate held for own use.
Table 24.4 in USD millions, as of December 31Expense recognized in income
Table 24.6 in USD millionsMovement in funded and unfunded defined benefit plan obligation
The actual returns on defined benefit pension plan assets for the years ended December 31, 2010 and 2009 were gains of USD 1,110 million and USD 937 million, respectively.
Change in liability due to asset ceiling 11 (7) – – Actuarial gain/(loss) included in other comprehensive income (210) 329 (4) (7) Effects of business combinations and other transfers – (1) – 2 Foreign currency translation effects (1) (51) (7) (21)
Table 24.7 in USD millionsMovement in fair value of plan assets – funded plans
Table 24.8 in USD millionsMovement in liability for funded and unfunded plans
The movements in actuarial gains and losses due to differences between actual and expected experience on the Group’s plan assets and defined benefit obligations, together with the impact of changes in actuarial assumptions to reflect economic conditions at the year end are summarized below: Actuarial gain/(loss) as of January 1 (2,672) (2,907) (1,308) (1,870) (2,420) Experience adjustments on plan liabilities 205 (37) (147) (118) (375) Experience adjustments on plan assets 388 318 (1,485) 188 447 Changes due to discount rate assumptions (742) (103) 223 975 – Changes due to other actuarial assumptions (65) 144 (392) (345) 528
Total actuarial gain/(loss) as of December 31 (2,914) (2,672) (2,907) (1,308) (1,870) Total actuarial gain/(loss) net of policyholder participation and taxes as of December 31 (1,924) (1,762) (1,934) (818) (1,286)
Table 24.10 as of December 31Assumptions used in determining the actuarial liabilities for major defined benefit pension plans
Discount rate 5.0% 5.5% Expected increase in long-term health cost – initial rate 7.8% 8.4% Expected increase in long-term health cost – ultimate rate 4.8% 4.8%
The actuarial assumptions for healthcare cost trend rates have an impact on the amounts recognized. A one percentage point change in the health care cost trend rates would have the effects on amounts recognized as set out in table 24.12.
Consolidated financial statements continued 25. Share-based compensation and cash incentive plans
Total option-based expenses 55 42 Total share-based expenses 128 119 Total expenses 183 161
Employee share plans Share Incentive Plan for employees in the UK The Group established an Inland Revenue approved Share Incentive Plan and launched the partnership shares element of this plan in 2003, which enabled participating employees to make monthly purchases of Zurich Financial Services Ltd shares at the prevailing market price out of their gross earnings. There were 274 and 374 participants in the plan as of December 31, 2010 and 2009, respectively. The Group also operates the profit-sharing element of the Share Incentive Plan (reward shares) which was launched in 2004 with annual share allocations being made in May each year subject to business performance. The awards are based on the participating employee’s business unit’s business operating profit (BOP) after tax for the year, subject to a maximum individual award of 5 percent of a participant’s base salary (before any flexible benefit adjustments) or a maximum of GBP 3,000. The total number of participating employees in the reward share element of the plans as of December 31, 2010 and 2009 was 4,775 and 5,569 respectively.
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 grants and/or share option grants with the vesting of these share and option grants being subject to the achievement of specific financial performance goals, such as net income after tax and BOP. 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.
Table 25.1 in USD millions, as of December 31Expenses recognized in income
Certain plan participants elected in 2002 to take their option award in the form of Share Appreciation Rights (SAR). The plan expired on April 30, 2009.
The average share price for Zurich Financial Services Ltd shares in 2010 and 2009 was CHF 241.41 and CHF 209.33 respectively
The fair value of options granted is estimated using the Black-Scholes option pricing model, with the assumptions shown in table 25.6.
The risk-free interest rate was determined by using the seven year CHF swap rate applicable in 2010 and 2009. The implied volatility was determined based on the average of a number of several independent quotes.
Table 25.5 for the year ended December 31Options and shares granted during the period
Consolidated financial statements 26. Contingent liabilities, contractual commitments and financial guarantees
Guarantees and letters of credit USD 8,726 million of the USD 9,544 million for financial guarantees and letter of credit in 2010 relate to guarantees in the aggregate amount of GBP 5,595 million provided to the directors of a fully owned subsidiary in connection with the rationalization of the Group’s top legal holding structure which resulted in the merger of Zurich Group Holding into Zurich Financial Services Ltd in December 2009. These guarantees will expire in August 2015.
Table 26.2 in USD millions, as of December 31Future payments under non-cancelable operating leases with terms in excess of one year
The Group has commitments to provide collateral on certain contracts in the event of Zurich Insurance Company Ltd’s financial strength downgrading from currently AA- by Standard & Poor’s. Should the rating fall to A+ by Standard & Poor’s, the additional collateral based on information available on December 31, 2010 is estimated to amount to approximately USD 168 million.
In common with other groups writing life assurance business in the UK, the Group remains exposed to a number of Conduct of Business issues. 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 recent experience.
A similar action entitled A.P.I., Inc. Asbestos Settlement Trust, et al. v. Zurich American Insurance Company, et al., was filed in March 2009 in the District Court for the Second Judicial District, County of Ramsey, Minnesota. ZAIC and two of its insurance company subsidiaries were named as defendants (the “Original Defendants”). The Original Defendants removed the case to the U.S. District Court for the District of Minnesota, where it is now pending. The plaintiffs subsequently amended their complaint to add ZIC, Orange Stone and two additional ZAIC subsidiaries as defendants (the “Newly-Added Defendants”). As in the Fuller-Austin cases, plaintiffs allege that A.P.I., Inc. is an insured under policies issued by Home, primarily in the 1970s. The complaint seeks to hold defendants liable for Home’s policy obligations under various theories of vicarious liability tied to the recapitalization of Home, and it also alleges that defendants are liable for damages under theories of fraudulent transfer and tortious interference with contract.
Prior to the filing of the amended complaint, the Original Defendants moved to dismiss the case. After the amended complaint was filed, all defendants, including the Newly-Added Defendants, moved again to dismiss the amended complaint. On March 31, 2010, the court ruled on the original dismissal motion, and dismissed plaintiffs’ claims against the Original Defendants under theories of fraudulent transfer and tortious interference with contractual relations, as well as a consumer fraud claim. On September 30, 2010, the court ruled on the motion to dismiss the amended complaint, and dismissed plaintiffs’ claims against all defendants under theories of fraudulent transfer and tortious interference, as well as a consumer fraud claim. The motion - consistent with the court’s March 31 2010 ruling - was denied as to the remaining claims, as the court found that plaintiffs’ vicarious liability theories could not be disposed of on a motion to dismiss. Pretrial discovery is continuing. According to the court’s scheduling order, summary judgment motions are scheduled to be filed on or about April 22, 2011, with additional briefing and argument to follow. The action is to be “trial ready” in May 2011. The Group maintains that the Fuller-Austin and API cases are without merit and intends to continue to defend itself vigorously.
In 2006, the Group settled with various U.S. state attorneys general and state insurance regulators in connection with investigations in the U.S. concerning certain business practices involving insurance brokers and insurance companies. In July 2006, the Group also entered into a settlement agreement to resolve consolidated class-action litigation concerning those matters. Final judgment has been entered approving the settlement, and the appellate court has upheld the settlement approval. A number of individual claims not covered by the class action settlement remain pending against the Group. The Group’s defendants did not admit to any violation of U.S. or state laws as part of this settlement.
On November 12, 2010, the Amsterdam Court of Appeal provisionally ruled that it has jurisdiction to consider the petition for approval of the settlement. The Amsterdam Court of Appeal directed the parties to notify the class about the proposed settlement and will hold a hearing on October 3 and 4, 2011 to consider whether to declare the proposed settlement binding on the class.
Consolidated financial statements 27. Fair value of financial assets and financial liabilities
The following tables compare the fair value of financial assets and financial liabilities with their carrying value.
Cash and cash equivalents 8,558 11,041 8,558 11,041 Available-for-sale securities Debt securities 128,257 123,896 128,257 123,896
Total securities at FV through profit or loss 10,799 12,702 10,799 12,702
Financial liabilities at FV through profit or loss Trading: Obligation to repurchase securities (3,330) (3,976) (3,330) (3,976)
Table 27.1a in USD millions, as of December 31Fair value (FV) and carrying value of financial assets and financial liabilities – Group investments and other Non-unit-linked
Cash and cash equivalents 7,163 5,840 7,163 5,840 Investments at FV through profit or loss Designated at FV
Loans and receivables Total 103,970 95,368 103,970 95,368 Financial liabilities at FV through profit or loss Designated at FV
Liabilities related to unit-linked investment contracts (44,941) (40,143) (44,941) (40,143) Derivative liabilities (3) – (3) –
Level 3 – this category includes financial assets and liabilities for which fair values are determined using valuation techniques with at least one significant input not being based on observable market data. In circumstances when there is little, if any, market activity for a certain instrument, a valuator is required to develop internal valuation inputs based on the best information available about the assumptions that market participants would use when pricing the asset or liability. This would normally apply in the case of investments in hedge funds, private equity funds, asset-backed securities for which currently very limited market activity is observed, and long-dated derivatives. The effect of changes in the internal valuation inputs to reasonably possible alternative values is disclosed under “Sensitivity of fair values reported for Level 3 instruments to changes in key assumptions”.
Table 27.1b in USD millions, as of December 31Fair value (FV) and carrying value of financial assets and financial liabilities – unit-linked
Group investments and other Non-unit linked financial instruments carried at fair value
Total securities at FV through profit or loss 3,404 5,227 2,169 10,799
Total securities at FV through profit or loss 3,627 5,706 3,369 12,702
Table 27.2a in USD millions, as of December 31, 2010Fair Value Hierarchy – current period
Realized gains/(losses) recognized in income 1 22 12 2 11 47 – – Unrealized gains/(losses) recognized in income 1 (81) (72) (3) 32 106 5 12 Unrealized gains/(losses) recognized in other comprehensive income 545 727 – – – – –
Table 27.3a in USD millionsRoll forward analysis for financial instruments classified under Level 3 – current period
The sensitivity analysis is intended to reflect the uncertainty inherent in the valuation of these investments, under the current market conditions, and its results cannot be extrapolated due to non-linear effects that changes in valuation assumptions may have on the fair value of the investments. Furthermore, the analysis does not indicate a probability of such changes occurring and it does not necessarily represent the Group’s view of expected future changes in fair value of these investments. Any management actions that may be taken to mitigate the inherent risks are not reflected in this analysis.
Key assumptions Discount margins +20% (105) –20% 110 Prepayment rates –20% (35) +20% 33 Recovery rates –20% (32) +20% 31 Default rates +20% (6) –20% 3
As of December 31, 2010 and 2009, the Group also classified under Level 3 investments in hedge funds and private equity funds amounting to USD 2.2 billion and USD 3.3 billion, respectively. These investments are valued based on regular reports from the issuing funds and fair values are reviewed by a team of in-house investment professionals and may be adjusted based on their understanding of the circumstances of individual investments. Investments in hedge funds and private equity funds have not been included in the sensitivity analysis due to the large number of valuation assumptions that while, in total, have a significant effect on the fair value of these investments, when considered individually, the impact of changing them to reasonably possible alternative values would not be significant.
Table 27.4a as of December 31, 2010Sensitivity analysis of Level 3 ABSs to changes in key assumptions – current period
Total investments at FV through profit or loss 52,084 32,636 4,709 89,429 Derivative assets – 98 – 98
Table 27.5a in USD millions, as of December 31, 2010Fair Value Hierarchy – current period
Table 27.5b in USD millions, as of December 31, 2009Fair Value Hierarchy – prior period
Sales / Redemptions (29) (167) Net transfers into / out of Level 3 1 (19) Foreign currency translation effects (4) (7)
1 Presented under ”Net investment result on unit-linked investments” in the Consolidated income statements.
The table below sets out related party transactions with equity method accounted investments, as well as other related parties, such as the Group’s distribution partners of the jointly owned companies in Spain, reflected in the consolidated income statements and consolidated balance sheets.
Consolidated balance sheets as of December 31 Cash and cash equivalents 475 158 Other loans 537 1,095 Total unit-linked investments 3,196 2,349
Remuneration of key personnel of the Group Cash compensation, current benefits and fees 30 29 Post-employment benefits 3 4 Share-based compensation 20 31 Termination benefits 2 – Total remuneration of key personnel 55 64
a) Surplus note and certificates of contribution issued by the Farmers Exchanges As of December 31, 2010 and 2009, FGI and other Group companies held the following surplus note and certificates of contribution issued by the Farmers Exchanges. Originally these were purchased by FGI in order to supplement the policyholders’ surplus of the Farmers Exchanges.
6.15% surplus note, due December 2013 88 88 6.15% certificates of contribution, due December 2013 523 523 6.15% certificates of contribution, due August 2014 296 296 4.65% certificates of contribution, due December 2013 1 150 300 Various other certificates of contribution 23 23 1 On August 1, 2010, USD 150 million of the USD 300 million surplus note with the Farmers Exchanges was redeemed. In addition, the interest rate on the remaining USD 150 million surplus note was reset to 4.65 percent from 10.30 percent.
Auto Physical Damage Quota Share reinsurance agreement The Auto Physical Damage (APD) Quota Share reinsurance agreement (APD agreement) with the Farmers Exchanges provides for annual ceded premiums of USD 1 billion of gross written premiums with 20.0 percent assumed by Farmers Re Co (USD 200 million) and 80.0 percent assumed by ZIC (USD 800 million), a 25.8 percent ceding commission for acquisition expenses, and an 8.2 percent ceding commission for unallocated loss adjustment expense. In addition, Farmers Re Co and ZIC assume a quota share percentage of ultimate net losses sustained by the Farmers Exchanges in their APD lines of business. The APD agreement also includes provisions for additional experience commissions that will depend on loss experience and recoveries below a specified ratio for each year. This experience commission arrangement limits Farmers Re Co and ZIC’s potential underwriting gain on the assumed business to 2.0 percent of premiums assumed plus 20.0 percent of the underwriting gain resulting from a combined ratio under 98.0 percent. The APD agreement, which can be cancelled after 90 days notice by any of the parties, was renewed with the same terms on January 1, 2009 and has a termination date of December 31, 2011.
Loss recoveries are subjected to a maximum ratio. In addition, under this treaty the Farmers Exchanges’ catastrophe losses are subject to a maximum of USD 800 million. The All Lines agreement also provided for the Farmers Exchanges to receive a provisional ceding commission of 22.0 percent of premiums for acquisition expenses which are recognized as ceded premiums are written, and 8.8 percent of premiums for unallocated loss adjustment expenses and 5.3 percent of premiums for other expenses which are both recognized as premiums are earned, with additional experience commissions potentially payable depending on loss experience.
Effective December 31, 2009, the All Lines agreement was modified and the participation ratio was decreased by 2.5 percent to 35 percent. In addition to this change, the provisional ceding commission for acquisition expenses was increased from 25.0 percent to 25.7 percent, and the ceding commission for unallocated loss adjustment expense increased from 8.8 percent to 9.0 percent. Unearned premiums totaling USD 159 million were transferred from Farmers Re Co and ZIC to the Farmers Exchanges as a result of their decreased participation in the All Lines agreement effective December 31, 2009. In addition, the Farmers Exchanges remitted USD 41 million of reinsurance commissions to Farmers Re Co and ZIC for acquisition expenses due to the decreased participation in the All Lines agreement.
Based on the results for 2010 and 2009, Farmers Exchanges’ share of recoveries were USD 3,059 million and USD 3,239 million, respectively. For the years ended December 31, 2010 and 2009, Farmers Exchanges’ share of ceded premiums earned were USD 4,574 million and USD 4,722 million, respectively. Farmers Exchanges’ share of ceding commissions was USD 1,418 million and USD 1,461 million for the years ended December 31, 2010 and 2009, respectively.
Farmers provides through Farmers Group, Inc. and its subsidiaries (FGI) non-claims related management services to the Farmers Exchanges. FGI receives fee income for the provision of services to the Farmers Exchanges, which are managed but not owned by Farmers Group, Inc. a wholly owned subsidiary of the Group. This segment also includes all reinsurance assumed from the Farmers Exchanges by the Group. Farmers Exchanges are prominent writers of personal lines and small commercial lines business in the U.S.
The Group also manages its business on a geographic structure. The Group’s identified regions are as follows: Americas
Gross written premiums and policy fees 33,066 34,157 12,292 12,440 4,194 6,615 137 142 531 700 (256) (237) 49,965 53,817 Less premiums ceded to reinsurers (5,100) (5,222) (754) (769) – – (54) (52) (32) (39) 256 237 (5,683) (5,844)
Net earned premiums and policy fees 27,837 29,071 11,513 11,677 5,574 5,722 84 90 502 666 (1) – 45,509 47,227 Farmers management fees and other related revenues – – – – 2,778 2,690 – – – – – – 2,778 2,690 Net investment result on Group investments 2,913 3,181 4,390 4,032 156 174 525 461 377 333 (857) (880) 7,506 7,301
Losses and loss adjustment expenses, net 19,773 20,590 76 53 3,708 3,904 2 5 62 49 – 38 23,620 24,639 Life insurance death and other benefits, net 22 40 9,773 10,577 – – 69 82 683 656 – 1 10,548 11,356 (Decrease)/increase in future life policyholders’ benefits, net 1 1 (8) 291 (36) – – – – 24 (808) – (39) 316 (892)
Net investment result on unit-linked investments – – 9,639 11,697 – – – – 454 778 – – 10,093 12,475 of which: inter-segment revenues (414) (385) (296) (294) (70) (90) (1,191) (1,312) (113) (77) 2,083 2,157 – – Benefits, losses and expenses Insurance benefits and losses, net 19,795 20,622 10,140 10,594 3,708 3,904 72 86 769 (103) – – 34,484 35,103
2 As outlined in note 1, business operating profit (BOP) has not been restated for the change in the current value of certain insurance liabilities and assets amounting to USD 1,006 million in order to ensure a fair reflection of sustainable operating profit and comparability.
Table 30.1 in USD millions, for the years ended December 31Business operating profit by business segment
General Insurance Global Life Farmers Other Operating Businesses Non-Core Businesses Total
Revenues/(expenses) not included in BOP: Net capital gains/(losses) on investments and impairments, net of policyholder allocation 281 (674) 14 (441) (9) (50) 168 (62) 31 (145) 484 (1,372) Net gain/(loss) on divestments of businesses 5 (2) 33 – – – – – 1 (3) 38 (5)
Add back: Business operating profit attributable to non-controlling interests 22 (3) 42 15 – – (1) – 1 1 64 12 Net income before shareholders’ taxes 2,674 2,614 1,384 931 1,074 1,470 (622) (592) (104) 727 4,406 5,150 Income tax expense/(benefit) attributable to policyholders – – 462 387 – – – – – – 462 387
2 Includes USD 570 million settlement costs related to the FOGEL case (see note 26).
Investments for unit-linked contracts – – 96,139 87,430 – – – – 11,808 11,737 – – 107,947 99,167
Table 30.3 in USD millions, as of December 31Assets and liabilities by business segment
Gross written premiums and policy fees 7,624 7,602 9,728 9,864 13,273 14,556 3,011 2,695 557 486 (1,127) (1,046) 33,066 34,157 Net earned premiums and policy fees 4,902 4,738 7,580 8,331 13,089 13,894 2,198 2,057 68 51 – – 27,837 29,071 Insurance benefits and losses, net 3,662 3,540 5,102 5,711 9,410 10,230 1,502 1,265 120 (124) – – 19,795 20,622 Policyholder dividends and participation in profits, net (2) 3 8 8 (3) 4 – – – – – – 3 15
Table 30.4 in USD millions, for the years ended December 31General Insurance – Customer segment overview
Southern Africa 634 650 Rest of Europe & Africa 1,663 1,899
Southern Africa 25 22 Rest of Europe & Africa 1,245 1,437
Americas United States 232 216 Rest of North America 8 6 Latin America 183 164
Asia-Pacific & Middle East Asia-Pacific Mature Markets 114 93 China & South East Asia 27 24
Table 30.6 in USD millions, as of December 31General Insurance – Assets by region
Net investment result on unit-linked investments 86 146 6,551 6,618 893 1,689 (1) 54 784 1,138 60 324 1,011 1,042 255 686 – – 9,639 11,697
Benefits, losses and expenses Insurance benefits and losses, net 1 760 646 596 365 3,956 3,604 1,521 1,539 225 61 2,302 3,613 102 109 678 657 – – 10,140 10,594 Policyholder dividends and participation in profits, net 91 150 6,393 6,472 1,471 1,948 100 198 828 1,128 64 340 1,004 1,011 353 771 – – 10,302 12,018 Income tax expense/(benefit) attributable to policyholders – – 404 311 37 50 – – 19 20 – – – – 1 6 – – 462 387 Underwriting and policy acquisition costs, net 208 63 444 249 318 317 160 152 75 106 29 53 143 76 128 129 (1) – 1,503 1,145 Administrative and other operating expense (excl. depreciation / amortization) 243 205 437 412 292 335 199 222 68 80 106 99 84 109 460 370 (7) (3) 1,883 1,827 Interest credited to policyholders and other interest 173 169 11 11 152 160 15 16 42 43 3 2 29 28 1 17 – – 428 444 Restructuring provisions and other items not included in BOP (1) 1 (114) (56) (3) – (12) (21) (4) – (37) (45) – 10 (9) (9) – – (179) (119) Total BOP benefits, losses and expenses 1,473 1,233 8,172 7,764 6,224 6,414 1,983 2,105 1,253 1,438 2,467 4,062 1,362 1,343 1,613 1,941 (8) (3) 24,539 26,296 Business operating profit (before interest, depreciation and amortization) 353 458 413 311 418 387 250 243 51 39 244 286 80 72 115 169 – – 1,922 1,965 Depreciation and impairments of property and equipment 2 2 10 10 11 12 3 4 1 1 – – 4 4 1 1 – – 32 34 Amortization and impairments of intangible assets 27 (8) 47 30 67 41 – – 1 1 134 203 3 4 24 75 – – 303 346
Table 30.7 in USD millions, for the years ended December 31Global Life – Overview
Table 30.9 in USD millions, for the years ended December 31Other Operating Businesses – Overview
Table 30.10 in USD millions, for the years ended December 31Non-Core Businesses – Overview
The Group is still assessing the impact of both Australian flooding events which occurred in January 2011. The first event in the Brisbane area in the second week of January 2011 and the second event in the Victoria area in the latter half of the month. Total incurred losses are not yet known, but are likely to be more severe than the December 2010 Australian floods, for which the Group estimated a pre-tax loss of USD 100 million.
Opinion In our opinion, the consolidated financial statements for the year ended December 31, 2010 give a true and fair view of the financial position, the results of operations and the cash flows in accordance with the International Financial Reporting Standards (IFRS) and comply with Swiss law.
Australia Zurich Australia Limited Sydney Global Life 100 100 AUD 0.5 Zurich Australian Insurance Limited Sydney General Insurance 100 100 AUD 6.6 Zurich Financial Services Australia Limited Sydney General Insurance 100 100 AUD 22.8 Austria Zürich Versicherungs-Aktiengesellschaft Vienna General Insurance 99.98 99.98 EUR 12.0 Bermuda Centre Group Holdings Limited Hamilton Non-Core Businesses 100 100 USD 0.3 CMSH Limited Hamilton Non-Core Businesses 100 100 USD 0.3 ZCM Holdings (Bermuda) Limited Hamilton Non-Core Businesses 100 100 USD 137.0
ZG Investments Ltd. Hamilton Other Operating Businesses 100 100 USD 0.01
Zurich Insurance plc Dublin General Insurance 100 100 EUR 8.2 Italy Zurich Investments Life S.p.A. Milan Global Life 100 100 EUR 74.0 Zurich Life and Pensions S.p.A. Milan Global Life 100 100 EUR 40.5 Zurich Life Insurance Italia S.p.A. Milan Global Life 100 100 EUR 25.9 1 The segments are defined in the notes to the Consolidated financial statements, note 30, Segment information. 2 Zurich Insurance Holding (Cyprus) Ltd holds 99.9% of Zurich Insurance Company Ltd. in Russia which is a fully owned subsidiary of the Group. 3 In addition buy out options exist which allow the minority shareholders to sell another 15.17 percent of the shares of Deutscher Herold Aktiengesellschaft to the Group.
Luxembourg Zurich Eurolife S.A. Howald Global Life 100 100 EUR 12.0
Zurich Life Insurance Company Ltd 6 Zurich Other Operating Businesses 100 100 CHF 60.0
“Zurich” Investment Management AG Zurich Other Operating Businesses 100 100 CHF 10.0
Eagle Star Insurance Company Limited Fareham, England Non-Core Businesses 100 100 GBP 40.0
United States of America Farmers Group, Inc. Reno, NV Farmers 98.28 100 USD 0.001
Farmers Reinsurance Company Los Angeles, CA Farmers 98.28 100 USD 5.0 Farmers Services LLC 7 Wilmington, DE Farmers 100 100 USD – Zurich American Corporation Wilmington, DE Non-Core Businesses 100 100 USD 0.00001 Zurich American Life Insurance Company Schaumburg, IL Non-Core Businesses 100 100 USD 2.5
Zurich Holding Company of America, Inc. Wilmington, DE Other Operating Businesses 100 100 USD 0.0 7 This entity is a LLC that has no share capital.
This report describes the development of the embedded value of the Zurich Financial Services Group (the Group) for the year ended December 31, 2010.
The majority of this report, Sections 1 to 7, relates to Global Life, but summary information relating to the non-core life business is given in Section 8 and to the total Group in Section 9.
Closing embedded value 16,141 16,752 (611) Embedded value operating earnings 1,574 1,921 (347)
Embedded value operating earnings excluding the impact of new business were USD 757 million. Of this, USD 622 million was the expected emergence in value from the in-force business.
Total embedded value earnings were USD 1.0 billion generating a return on embedded value of 6.2 percent which is less than in the prior year due to the absence of the significant positive economic variance of USD 1.3 billion arising from early stages of the economic recovery in 2009.
All the figures above and in this report reflect a zero liquidity premium. However it is the intention of the Group to alter its Embedded Value assumptions in 2011 to reflect a liquidity premium in the key major operating currencies. In addition, for greater consistency with other European Insurers, the cost of capital applied to residual non hedgeable risks will be increased from 2.5% to 4%. If these assumptions had been applied in 2010 the embedded value would have increased from USD 16.1 billion to USD 16.5 billion (USD 631 million from liquidity premium less USD 300 million from change in cost of capital) and the new business value would have increased from USD 817 million to USD 862 million (USD 76 million from liquidity premium less USD 32 million from change in cost of capital).
New business net of non-controlling interests 1 (122) (701) (823) 1,586 763 Expected contribution at reference rate 27 69 96 120 216 Expected contribution in excess of reference rate 17 25 42 364 406
1 As noted in section 10 c) the UK’s required capital and free surplus allow for a Pillar 2 basis.
Dividends & capital movements end of period (42) (121) (163) 173 10
The Group has applied the CFO Forum Market Consistent Embedded Value (‘MCEV’) Principles© for its embedded value calculations for the year ended December 31, 2010.
4 TVFOG is the time value of financial options and guarantees. 5 CRNHR is the cost of residual non-hedgeable risk (see Section 10 for further details). 6 ZIS is Zurich International Solutions, the international business based in the Isle of Man.
Embedded value by territory, 2010 in USD millions, as of December 31, 2009
operating earnings 1 ZIS is Zurich International Solutions, the international business based in the Isle of Man.
New business margin (as % APE) 21.9% 23.7% 23.0% 20.4% 22.1% 20.6% 21.4% 23.1% 20.5% 21.3% New business margin (as % PVNBP) 2.6% 2.7% 2.9% 2.3% 2.6% 2.5% 2.9% 2.9% 2.4% 2.6%
1 ZIS is Zurich International Solutions, the international business based in the Isle of Man.
New business value in the Americas declined, primarily as a result of the change in the interest rate environment in the U.S. and the change in persistency assumptions lowering new business value on protection business. Latin America recorded an increase in new business value with higher sales of profitable protection business.
In Germany, APE increased during the year through the sale of lower margin single premium products. As a result of the revised profit sharing assumptions and changes to acquisition service fee arrangements the new business value improved leading to higher margins.
In Ireland, the domestic business achieved a recovery in sales of long-term savings products leading to an increased market share. In addition and more importantly, sales of products manufactured in the European hub rose strongly emanating largely from Italy (Finanza e Futuro broker channel) and the UK through a bank partnership. The new business margin has however fallen slightly as it was negatively impacted by lower margins on annuity business.
Embedded value report continued 3. Expected contribution and transfer to shareholder net assets a) Expected contribution at reference rate The expected contribution at reference rate is the projected change in the embedded value over the year using risk-free investment returns applicable at the start of the year. Expected contributions were lower in 2010 compared with 2009 due to the lower interest rate environment applying at the start of the year.
c) Transfer to free surplus The expected transfer to shareholders’ net assets shows the profits expected to emerge during the period in respect of business that was in force at the start of the year. The net effect is zero, as the reduction in value of business in force is offset by the increase in shareholders’ net assets.
Operating variances Operating variance measures the difference between actual experience during the period and that implied by the operating assumptions. Experience variations occur in the normal course of business as short-term experience fluctuates around the long-term assumptions. Operating variance also includes the impact of changes in assumptions about future operating experience.
Embedded value Split of operating experience variance (in USD millions, for the year ended December 31)
Embedded value Split of operating assumption changes (in USD millions, for the year ended December 31)
Mortality experience increased the embedded value by USD 19 million, primarily arising in Chile where the actual experience on a Disability and Survivorship scheme has turned out to be better than originally anticipated. There have also been additional small positive experience gains in Spain and Ireland which were offset by negative experience in Farmers. As a result of regular reviews of mortality in Global Life, the Group has updated its mortality assumptions in Switzerland, Japan and Spain, the net effect of this was to increase the embedded value by USD 25 million.
Persistency experience decreased the embedded value by USD 94 million with a further USD 135 million reduction in value arising from changes to future expected persistency assumptions. In the U.S., 2010 was the first year where the level term 2000 policies moved from the level premium to the yearly renewable stage enabling the business to gain a better view of persistency in this less predictable phase. Since the persistency experience was worse than expected the embedded value has reduced due to higher lapses in the period as well as from the more significant change to future persistency assumptions, which reduced value by USD 221 million. In Germany, enhanced lapse rate analysis was introduced including more explicit allowance for premium suspension on Riester business. Overall these assumption changes have increased embedded value by USD 120 million. In ZIS, persistency was worse than expected causing an experience loss of USD 38 million, exacerbated by the conversion of a large corporate scheme into a lower margin product. Revisions to persistency assumptions in Spain decreased the embedded value by USD 20 million, where transfers between pensions business and life business in Banco Sabadell have now been treated as lapses instead of replacement contracts.
Expense overruns decreased the embedded value by USD 24 million. The main contributors to this were Switzerland where business volumes have been lower than plan and Luxembourg where start up costs exceed the expense allowances while the business develops scale. Expense assumption changes led to positive impacts in the UK, Germany and Ireland with negative impacts in Switzerland, Italy and Japan, giving an overall minor negative impact of USD 9 million.
Other assumption changes increased the embedded value by USD 280 million. In Switzerland, there was a benefit from the change in profit sharing rules and an increase in fees on unit-linked funds. In Germany, adjustments were made to the profit sharing allocation rates to more appropriately reflect the impact of 2008 legislative changes now that they have been analysed in more detail, and as industry views have evolved.
During the year, risk-free interest rates as measured by swap rates decreased in developed economies in which the business operates. This reduction has adversely affected the value of spread business, including traditional participating business. This impact has been exacerbated by the increase in sovereign credit spreads in Ireland, Italy and Spain since the market consistent methodology that the Group uses assumes that spread reflects default premium. Protection business, on the other hand, benefits from the reduction in interest rates hence the Farmers business in particular benefited from these conditions. The net effect of the economic variances has been a reduction in value of USD 846 million.
Embedded value report 5. Adjustments a) Non-controlling interests The adjustment to embedded value to remove non-controlling interests from the new business value is included here, and largely arose from the interests of the non-controlling shareholders in the Spain operations.
The UK life business paid a dividend of USD 294 million. A further USD 92 million of value was transferred to a noncovered entity to close the acquisition of a block of life business that took place at the end of 2009.
A review of the capital arrangements of the Spain Life business has been completed, including changes to the internal debt and equity mix. For changes where regulatory approval is expected to be completed early in 2011, their impact has been reflected in the December 31, 2010 embedded value.
c) Foreign currency translation effects Foreign currency translation effects represent the impact of adjusting values to end-of-period exchange rates. The strengthening of the U.S. dollar against the Euro and British pound during the year had a negative impact on embedded value partially offset by a stronger Swiss franc.
Embedded value report continued 6. Reconciliation of IFRS equity to embedded value
Valuation differences 5 (1.1) Embedded value shareholders’ net assets 6 6.6 Value of business in force 7 9.5 Embedded value 16.1 1 Global Life balance sheet value.
2 Includes Spanish and other non-controlling interests. 3 Since pension scheme liabilities are included in IFRS equity but not EV shareholders’ net assets. 4 Actuarial intangibles (after allowance for tax and ph sharing), goodwill and other intangibles. 5 Unrealised gains / losses on investments, statutory vs IFRS reserving requirements. 6 EV shareholders’ net assets net of non-controlling interests. 7 EV value of business in force.
Operating sensitivities 10% increase in initial expenses n / a n / a n / a (45) 10% decrease in maintenance expenses – 359 359 44 10% increase in voluntary discontinuance rates – (519) (519) (83) 10% decrease in voluntary discontinuance rates – 603 603 97 5% improvement in mortality and morbidity for assurances – 266 266 46 5% improvement in mortality for annuities – (117) (117) (10) Required capital set equal to minimum solvency capital – 85 85 1
Economic sensitivities 100 basis points increase in risk free yield curve (424) 260 (164) 88 100 basis points decrease in risk free yield curve 307 (904) (598) (207) 10% fall in equity market values (65) (197) (261) (7) 10% fall in property market values (33) (261) (294) (4) 25% increase in implied volatilities for risk free yields 30 (229) (199) (16) 25% decrease in implied volatilities for risk free yields (32) 266 234 20 25% increase in implied volatilities for equities and properties – (131) (131) (11) 25% decrease in implied volatilities for equities and properties – 109 109 7
In each sensitivity calculation, all other assumptions remain unchanged except where they are directly affected by the revised conditions. The results include any impact of the assumption changes on the time value of financial options and guarantees. The 100 basis points decrease in risk free yield curve increases the value of some products, such as term assurance, with fixed cash flows that are discounted at lower rates. This increase is offset by the reduction in the value of other products, such as those with profit sharing, due to the lower assumed investment returns on investment of net cash flows. The Group has also estimated the effect on the embedded value of allowing for a liquidity premium of 10 basis points. The estimated impact would be an increase of USD 175 million and has been based on the assumptions referred to in Section 11a).
Shareholders’ net assets 1.0 1.0 Certainty equivalent value (0.1) 0.1 Time value of financial options and guarantees (0.1) (0.0) Frictional costs 0.0 (0.0) Cost of residual non-hedgeable risk (0.1) (0.1)
The Group implemented a dynamic hedge strategy for a closed U.S. life book of variable annuity products in March of 2010. This has reduced the sensitivity of the non-core life business embedded value to changes in interest rates and equity market returns.
The Group MCEV is presented in the following table as the Global Life covered business which is valued under the MCEV principles and the non-covered business which is valued as the unadjusted IFRS net asset value. Non-covered business includes the non-core life businesses managed outside Global Life and the remaining Group non-life business.
The Group has applied the Market Consistent Embedded Value Principles issued by the CFO Forum in October 2009, for its Embedded Value (EV) Report for the companies and businesses in its Global Life segment (the covered business) for the twelve months ended December 31, 2010. This report primarily relates to Global Life, but information relating to the Non-Core Life Businesses is given in Section 8 and to the total Group in Section 9. The embedded value methodology adopted by the Group is based on a “bottom-up” market consistent approach to allow explicitly for market risk. In particular: • asset and liability cash flows are valued using risk discount rates consistent with those applied to similar cash flows in the capital markets; and
• options and guarantees are valued using market consistent models calibrated to observable market prices. Where markets exhibit a limited capacity, the valuation is based on historical averages.
For the UK, a dual capital regime exists with the second pillar currently more stringent than the first pillar which is a solvency one basis. Under the Pillar two basis the value of in force is counted as an admissable asset with a subsequent risk charge. Under this basis, when the Group writes new business with an in force value greater than the risk charge, the level of required capital decreases. Similarly, when in force value emerges into shareholders net assets, a portion of this release needs to be allocated to required capital to offset the now reduced value of in force asset. This required capital impact is a feature of an economic capital mechanism which differs markedly from the current solvency one basis.
Certainty equivalent value is the value calculated using discount rates consistent with those applied to the underlying cash flows in the capital markets. It includes the intrinsic value but excludes the time value of financial options and guarantees which is allowed for separately, as described below.
Frictional costs reflect a deduction for the cost of holding shareholder capital. Under the Group’s market consistent framework, these frictional costs represent tax in respect of future investment income on total required capital plus investment management costs. In Germany, the policyholders share of investment income on the capital is also included.
Time value of financial options and guarantees represents additional costs in excess of the intrinsic value of options and guarantees which are already allowed for in the certainty equivalent value. These are based on the variability of investment returns which need to be allowed for explicitly under the Market Consistent Embedded Value Principles. The time value has been calculated on a market consistent basis using stochastic modeling techniques, and making allowance for expected management and policyholder behavior.
Where appropriate, the calculation of the time value of financial options and guarantees makes allowance for: • dynamic actions that would be taken by management under different economic simulations, for example to implement a life business’ investment strategy; and
It is calculated as a charge on the capital held for residual non-hedgeable risks. This is calculated according to Zurich’s internal risk based capital model by applying 1 in 2000 shocks to the embedded value assumptions. To align with the MCEV Principles the risk based capital is scaled to 99.5 percent confidence level by using empirical distributions where available, or assuming probability distributions as appropriate.
The capital is projected over the lifetime of the business using appropriate risk drivers for each risk type. The present value of the risk capital is calculated by applying the swap curve as at the valuation date. The CRNHR allows for diversification across risk types and across geographical segments. It complies with all areas of the MCEV Principles except Guidance 9.7, because it allows for diversification between covered and non-covered business, which is consistent with the management view of the business and adds an estimated USD 221 million to embedded value.
Germany has followed an approach where liability model points were set up in advance, using the structure of a previous run, and then projected to December 31, 2010 values, by scaling to match the expected balance sheet figures. The new business model points were set up at September 30, 2010, and scaled along the expected development of the APE.
The calculations of the time value of financial options and guarantees are based on stochastic simulations using an Economic Scenario Generator provided by Barrie & Hibbert. The outputs (“simulations”) have been calibrated to conform to the economic parameters specified by the Group.
The simulations used for calculation of time value of financial options and guarantees reflect the actual yield curves and implied volatilities observable as of December 31, 2010.
Embedded value report continued k) Consolidation adjustments Where a reassurance arrangement exists between two life companies within Global Life, the value of the reassurance is shown in the embedded value of the ceding company.
In Germany, the majority of distribution and administration is provided by service companies. These are valued on a “look through” basis. These companies also provide limited services to companies outside Global Life. The value of business in force and new business value reflect the services provided to companies within Global Life. Net asset value consists, however, of the full statutory equity of these service companies.
n) Employee pension schemes Actuarial gains and losses arising from defined benefit pension and other defined benefit post-retirement plans are recognized in full in the period in which they occur and are presented on a separate line in the statement of comprehensive income in the Group’s consolidated financial statements, with a liability recognized for Employee Benefit deficits under IAS19. This adjustment has not been made in the detailed embedded value described in this embedded value report. If the adjustment had been made the embedded value as of December 31, 2010 would have been lower by USD 282 million. The actuarial and economic assumptions used for this adjustment are consistent with those used for the equivalent allowance made in the Group’s Consolidated financial statements.
q) Translation to Group presentation currency To align embedded value reporting with the Group’s consolidated IFRS financial statements, relevant results have been translated to the Group presentation currency, U.S. dollar, using average exchange rates for the period. This applies to new business value, new business volumes (APE and PVNBP) for the current period and comparative figures for December 31, 2009. This approach has also been applied to the analysis of movement. Valuations as at a specified date are translated at end-of-period exchange rates.
The rates can be found in note 1 of the Consolidated financial statements.
A 10 percent fall in equity and property market values was assessed for embedded value only. This is not applicable for new business.
A 25 percent increase in implied equity and property volatilities means that, for example, a volatility of 20 percent p.a. would increase to 25 percent p.a.
Projections of future shareholder cash flows expected to emerge from covered business and for new business are determined using best estimate operating assumptions. These assumptions, including mortality, morbidity, persistency and expenses, reflect recent experience and are actively reviewed. Allowance is made for future improvements in annuitant mortality based on experience and externally published data. Favorable changes in operating efficiency are not anticipated in the assumptions – in particular for expenses and persistency.
Expected asset returns in excess of the risk free rate have no bearing on the calculated embedded value other than in the expected return used for the analysis of movement. The expected return for equities comprises an equity risk premium added to the start of period one year swap rate. The expected return on corporate bonds is equal to the start of period one year swap rate plus a risk premium estimated by comparing the market yield on corporate bonds with the swap rates for equivalent durations. In addition, a reduction must be made to the yield to allow for the expected level of defaults.
Implied asset volatility The Group’s embedded value model is based on market consistent assumptions. Interest volatility is derived from the implied volatility of interest rate swaptions. Swaption implied volatilities vary both by the term of the option and also the term of the underlying swap contract, a fact that is reflected in the economic scenarios. The equity volatilities are based on at-the-money forward European options on capital indices, consistent with traded options in the market. Volatility of property investments is derived from relevant historical return data for each modelled economy.
Inflation Inflation assumptions have been derived from the yields on index linked bonds relative to the risk free yield curve, where index linked bonds exist. Elsewhere, a statistical approach based on past inflation has been used. Appropriate allowance has been made for expense inflation to exceed the assumed level of price inflation as life company expenses include a large element of salary related expenses.
The Group has continued its previous market-consistent approach with a liquidity premium of zero for 2010.
However, the impact of the inclusion of a non-zero liquidity premium on year end MCEV and NBV, calculated on the basis below, has been included as additional information.
For equity assets for units where there is a substantial equity allocation, the investment return assumption is based on the long term “real world” expected return allowing for reversion to the mean over a period of five years. For equity assets for units without a material equity allocation the investment return assumption is based on the 1 year swap rate at the beginning of period plus a margin to reflect the additional risk associated with investment in this asset class.
“Return on opening embedded value” (as shown in the Embedded value key results) The return on opening embedded value is calculated as the sum of the annualised new business value, annualized expected contributions, economic variance for the year to date and operating and non-operating variances for the year to date divided by the opening embedded value less start of period dividend and capital movements.
Expense assumptions Management expenses have been analyzed between expenses related to acquisition of new business, the maintenance of in force business and, where appropriate, one-off project costs. Future expense assumptions allow for expected levels of maintenance expenses. In addition, Corporate Center expenses relating to covered business have been allocated to business units and are reflected in assumed future expenses.
The maintenance expense assumptions allow for the expected cost of providing future service benefits in respect of the Group staff pension schemes. An adjustment to the embedded value is noted in Section 10.n for pension scheme liabilities under IAS 19 and no allowance is made in the expense assumptions for any contributions as a result of past service benefits.
Where significant development work is perfomed in one county that is intended to have wider application across Global Life, that cost is shown under “Global Development Expenses”.
Embedded value information: Opening embedded value 3,154 2,570 3,672 2,895 2,401 1,627 2,010 1,284 1,251 1,086 816 657 1,677 1,328 1,770 1,371 16,752 12,818 Dividends and capital movements start of period 13 71 (381) 3 (47) 47 (12) (28) – – – (4) 12 (2) (13) (15) (427) 72
New business value Global Life 120 136 145 95 171 144 4 24 80 69 107 111 117 128 74 75 817 782
Dividends and capital movements end of period (86) (7) (5) 147 (207) (105) (35) (15) – – (625) – (1) (12) 7 2 (952) 10
New business margin (as % of APE) 40.2% 52.4% 15.0% 12.1% 26.2% 23.1% 3.9% 20.1% 21.6% 22.4% 21.0% 15.7% 24.0% 24.2% 22.3% 22.4% 22.1% 21.3% New business margin (as % of PVNBP) 6.2% 7.6% 1.7% 1.4% 2.5% 2.9% 0.4% 2.2% 2.6% 2.9% 2.4% 1.7% 5.4% 5.0% 2.3% 2.3% 2.6% 2.6%
in USD millions, for the year ended December 31Embedded value results Americas, Emerging Markets in Asia and Rest of the World
United States Latin America Total ZIS Hong Kong Other Total Italy Other Total
Embedded value information: Opening embedded value 2,655 2,271 499 299 3,154 2,570 1,360 1,002 339 336 (22) (9) 1,677 1,328 762 539 1,008 831 1,770 1,371 Dividends and capital movements start of period (34) 69 47 2 13 71 – – 13 (2) – – 12 (2) (2) – (11) (15) (13) (15)
Dividends and capital movements end of period (86) (7) – – (86) (7) (2) – 1 (12) (2) – (1) (12) – 5 7 (3) 7 2 Non-controlling interests – – (2) – (2) – – – – – – – – – – – – – – –
The methodology and assumptions underlying the report are described in Sections 10 and 11.
In our opinion, the EV Report of Zurich Financial Services Ltd for the year ended December 31, 2010 has been properly prepared in accordance with the MCEV Principles and Guidance.
Zurich Financial Services Ltd was incorporated on April 26, 2000 and is the holding company for the Zurich Financial Services Group with a principal activity of holding subsidiary companies. The company is listed on the SIX Swiss Exchange.
The Annual General Meeting on March 30, 2010, approved a gross dividend of CHF 16.00 per share. This gross dividend has been recognized through shareholders’ equity. Additionally the Annual General Meeting approved the destruction of the remaining 1,836,404 shares from the share buyback program authorized by the Board of Directors on February 13, 2008. The effective date of the capital reduction was June 15, 2010.
A new tax legislation based on the Swiss Corporate Tax reform II became effective as of January 1, 2011. It allows payments free of Swiss withholding tax to shareholders out of a new capital contribution reserve. Therefore CHF 14,000 million of the reserves have been reclassified to the new capital contribution reserve.
Net income for the year and the dividend paid in 2010 resulted in a decrease in shareholders’ equity to CHF 17,943 million as of December 31, 2010 from CHF 20,383 million as of December 31, 2009. The Board will propose a dividend from the capital contribution reserve of CHF 17 per share in respect of the year 2010 for approval at the Annual General Meeting to be held on March 31, 2011.
Revenues Interest income 187,218 249,729 Dividend income 36,482 1,500,594 Other financial income 3 128,897 2,704,381 Other income 29,010 – Total revenues 381,607 4,454,704 Expenses Administrative expense 4 (19,694) (55,279) Other financial expense 5 (285,202) (306,687)
Short-term liabilities Loans from subsidiaries 2,014,308 2,086,058 Other liabilities to subsidiaries 449 – Other liabilities to third parties 1,456 35,632 Other liabilities to shareholders 304 239 Accrued liabilities to subsidiaries 13,683 15,179 Accrued liabilities to third parties 26,416 400 Derivatives with subsidiaries 17,409 3,585 Total short-term liabilities 2,074,025 2,141,093 Long-term liabilities Long-term loans from subsidiaries 488,923 542,555 Provisions – 31,092 Total long-term liabilities 488,923 573,647 Total liabilities 2,562,948 2,714,740 Shareholders’ equity (before appropriation of available earnings) Share capital 10 14,659 14,747 Legal reserves: Capital contribution reserve 11 14,000,000 – General legal reserve – 10,551,524 Reserve for treasury shares 12 341,140 887,906
Free reserve 332,986 3,425,820 Retained earnings: As of January 1 5,502,586 2,930,181
As of January 1, adjusted for appropriations 3,184,567 1,420,180 Net income 69,718 4,082,406 Retained earnings, as of December 31 3,254,285 5,502,586 Total shareholders’ equity (before appropriation of available earnings) 17,943,070 20,382,584 Total liabilities and shareholders’ equity 20,506,018 23,097,324 1 Dividends paid in the year, proposed in respect of the 2009 result 2 Dividends paid in the year, proposed in respect of the 2008 result in CHF thousands, as of December 31Assets
Notes to the financial statements 1. Basis of Presentation Zurich Financial Services Ltd (the Company) presents its financial statements in accordance with Swiss law.
2. Summary of significant accounting policies a) Exchange rates Unless otherwise stated, assets and liabilities expressed in currencies other than Swiss francs are translated at year-end exchange rates. Revenues and expenses are translated using the exchange rate at the date of the transaction. Unrealized exchange losses are recorded in the statement of income and unrealized exchange gains are deferred until realized.
c) Own shares Own shares are held at lower of cost or market value.
3. Other financial income Other financial income amounted to CHF 129 million for 2010 and CHF 2,704 million for 2009. The decrease is mainly driven by the net realized capital gain in 2009 of CHF 2,642 million resulting from the restructuring of the Company’s immediate subsidiary holding companies, Zurich Group Holding and Allied Zurich Limited.
The guarantee with the Superintendent of Financial Institutions, Canada, has been revoked in 2010. Zurich Financial Services Ltd no longer has to provide additional capital in case the applicable capital adequacy tests for the Canadian business are not met or to provide assistance in case of liquidity issues.
Zurich Financial Services Ltd knows of no event that would require it to satisfy any of these guarantees or to take action under a support agreement.
10. Shareholders’ equity a) Issued share capital At the Annual General Meeting on March 30, 2010, the shareholders approved a share capital reduction of CHF 183,640.40 from CHF 14,747,306.80 to CHF 14,563,666.40 by canceling 1,836,404 registered shares. The effective date of the capital reduction was June 15, 2010. In addition, the shareholders approved an increase in the authorized share capital to a new maximum of CHF 1,000,000, allowing for enhanced financial flexibility of the company for future capital management, and an increase in the contingent share capital to a new maximum of CHF 500,000 which can be issued to employees of Zurich Financial Services Ltd and its subsidiaries in connection with employee participation plans. During the year 2010, a total of 950,232 shares were issued to employees out of the contingent capital.
At the Annual General Meeting on April 2, 2009 the shareholders approved an increase in both authorized and contingent share capital to a new maximum of CHF 1,000,000 each, allowing for enhanced financial flexibility of the company for future capital management. On April 17, 2009, Zurich Financial Services Ltd placed 4,800,000 new shares issued under its authorized share capital and 1,914,096 existing treasury shares, bought back under the share buy-back program authorized in 2008, with institutional investors via an accelerated bookbuild. This capital increase reduced the authorized capital to CHF 520,000. The proceeds from the accelerated bookbuild were used in connection with the funding of the 21st Century acquisition completed on July 1, 2009. During the year 2009, a total of 550,448 shares were issued to employees out of the contingent capital.
Holding company b) Authorized share capital Until March 30, 2012, the Board of Zurich Financial Services Ltd is authorized to increase the share capital by an amount not exceeding CHF 1,000,000 by issuing up to 10,000,000 fully paid registered shares with a nominal value of CHF 0.10 each. An increase in partial amounts is permitted. The Board determines the date of issue of such new shares, the issue price, type of payment, conditions for exercising pre-emptive rights, and the beginning of dividend entitlement.
Employee participation On January 1, 2009, the contingent share capital, to be issued to employees of Zurich Financial Services Ltd and Group companies, amounted to CHF 319,428 or 3,194,279 fully paid registered shares with a nominal value of CHF 0.10 each. On January 1, 2010, the contingent share capital, to be issued to employees of Zurich Financial Services Ltd and Group companies, amounted to CHF 264,383 or 2,643,831 fully paid registered shares with a nominal value of CHF 0.10 each. At the Annual General Meeting on March 30, 2010, the shareholders approved the proposed increase of the contingent share capital for the issuance of new shares to employees of the Group to a new maximum of CHF 500,000. This increase was approved and registered with the Commercial Register on April 1, 2010.
Holding company continued 11. Capital contribution reserve As of January 1, 2011 a new Swiss tax regulation based on the Swiss Corporate Tax reform II became effective, allowing for payments free of Swiss withholding tax to shareholders out of new capital contribution reserve, created out of additional paid in capital since January 1, 1997. The Federal Tax Administration has approved that CHF 15,255,112 of capital contribution qualify under this law as of September 30, 2010. As a consequence Zurich Financial Services Ltd made the following reclassifications within reserves: General legal reserve
12. Reserve for treasury shares This reserve fund corresponds to the purchase value of all Zurich Financial Services Ltd shares held by companies in the Zurich Financial Services Group as shown in the table below.
Additions during the year – – 1,410,162 343,345 Sales during the year (33,854) (8,243) (3,360,627) (1,030,907) Decrease due to share cancellation (1,836,404) (538,886) – –
Average purchase price of additions, in CHF – 243 Average selling price, in CHF 281 212 1 in CHF thousands 2 The cost value of the treasury shares held by Zurich Insurance Company Ltd has been adjusted in 2010.
13. Shareholders The shares registered in the share ledger as of December 31, 2010, were owned by 121,715 shareholders of which 115,840 were private individuals holding 22.5% of the shares (or 14.0% of all outstanding shares), 2,055 were foundations and pension funds holding 7.3% of the shares (or 4.6% of all outstanding shares), and 3,820 were other legal entities holding 70.1% of the shares (or 43.5% of all outstanding shares).
Information required by art. 663c paragraph 3 of the Swiss Code of Obligations on the share and option holdings of the members of the Board of Directors and the members of the Group Executive Committee are disclosed in note 16.
15. Remuneration of the Board of Directors and the Group Executive Committee This note sets out details of the compensation of the Board of Directors and of the members of the Group Executive Committee (GEC) in accordance with the information required by article 663bbis of the Swiss Code of Obligations. This information should be read in connection with the unaudited Remuneration Report, set out on pages 46 to 65, in which additional details of the remuneration principles and architecture can be found.
9 Neither the Chairman nor the Vice Chairman receive any additional fees for their Committee work. 10 At the Annual General Meeting on March 30, 2010 Mr Pidoux retired from the Board and Mr Ackermann was elected to the Board and was appointed Vice Chairman. 11 In addition to the fees received as Directors of Zurich Financial Services Ltd and Zurich Insurance Company Ltd, Mrs Bies, Mr Nicolaisen and Mr de Swaan earned fees for their board memberships of the following Zurich Financial Services Group companies: – In 2010, Mrs Bies and Mr Nicolaisen earned an annual fee of USD 40,000 for their membership of the board of Zurich Holding Company of America (ZHCA). In 2009 both received a pro rata fee of USD 10,000 for their membership on the board of Zurich Holding Company of America (ZHCA) from October 19, 2009 (based on an annual fee of USD 40,000). In 2010 and 2009, the amounts shown in the table also include a U.S. Residence Fee of USD 10,000. – In 2010 and 2009, Mr de Swaan earned an annual fee of USD 40,000 for his membership of the board of Zurich Insurance plc and of the board of Zurich Life Assurance plc (from January 1, 2010) and an annual fee of USD 10,000 for being chair of the audit committees of these companies.
13 As of June 30, 2009, Mr Gentz was allocated 1,296 shares and the other Board members were allocated 380 shares based on a full year’s membership. The share price (CHF 197.10) and the exchange rate (USD / CHF 1.0942) as of June 15, 2009, were adopted to calculate the number of shares based on the fixed 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 reflect the fixed amount in U.S. dollars (translated into Swiss francs) of the portion of the fee to be allocated in shares.
The Directors’ fees are not pensionable. None of the Directors received any benefits-in-kind or any other compensation other than that set out in the tables above.
No benefits (or waiver of claims) have been provided to former members of the Board during the year 2010, or during the year 2009. Neither had any former member of the Board outstanding loans, advances or credits as of December 31, 2010 or 2009.
4 On the basis of 11 GEC members, of whom 10 served during the full year 2009. 5 The amounts reflect the total value of pension benefits accruing to members of the GEC during 2010 and 2009, respectively, calculated on the basis of the Service Costs for the company as assessed under IAS 19 accounting principles. Service Costs value the amount of the pension benefits accruing during the year and for defined contribution plans takes the amount of the company contribution paid during the year. Service Costs do not include the interest cost on accrued benefits, adjustments for actuarial gains and losses, nor the expected return on any assets held.
6 Includes employee benefits, expatriate allowances, perquisites, benefits-in-kind and any other payments due under employment contracts including a total amount of CHF 2.2 million in respect of termination payments accrued during the year 2010 for the one member who gave up the function during the year 2010. Benefits-in-kind have been valued using market rates.
7 The share and share option grants will vest in the future according to achievement of defined performance conditions. The value of the share and share options assumes that the grant will vest in the future at 100% of the target level with the valuation of the options based on the Black-Scholes option pricing model as set out in note 25 to the Consolidated financial statements, the valuation of the target performance share grants based on the share price on the day prior to the grants (CHF 259.90 for 2010 and CHF 198.10 for 2009) and the valuation of the restricted share grants based on the share price on the date of the grants.
8 In line with applicable laws where the executives are employed, Zurich Financial Services Ltd paid the company related portion of contributions to social security systems, which amounted to USD 2.1 million (CHF 2.1 million) in 2010 and to USD 1.9 million (CHF 2.0 million) in 2009. Since the contributions are based on full earnings, whereas benefits are capped, there is not a direct correlation between the costs paid to the social security systems and the benefits received by the executives.
in CHF million1, 2 for the years ended December 31All GEC members (incl. the highest paid)
Base compensation 1.60 1.60 Cash incentive awards earned for the year 2.40 4.20 Service Costs for pension benefits 3 0.20 1.00 Value of other remuneration 4 0.10 0.95 Value of target performance share and restricted share grants 5 1.40 2.55 Value of target performance option grants 5 1.40 2.55 Total in CHF million 7.10 12.85 Total in USD million as shown in the Remuneration report 7.00 11.85 1 The figures have been translated for Mr Schiro from U.S. dollars into Swiss francs using the relevant exchange rates throughout the year. 2 The remuneration shown in the table does not include any business related expenses incurred in the performance of the CEO’s services. 3 The amounts reflect the total value of pension benefits, calculated on the basis of the Service Costs for the company as assessed under IAS 19 accounting principles. Service
5 The share and share option grants will vest in the future according to achievement of defined performance conditions. The value of the share and share options assumes that the grant will vest in the future at 100% of the target level with the valuation of the options based on the Black-Scholes option pricing model as set out in note 25 to the Consolidated financial statements, the valuation of the target performance share grants based on the share price on the day prior to the grants (CHF 259.90 for 2010 and CHF 198.10 for 2009) and the valuation of the restricted share grants based on the share price on the date of the grants.
As of December 31, 2010, there were no loans, advances or credits outstanding from GEC members. As of December 31, 2009, the total of loans, advances or credits outstanding from GEC members was CHF 1,073,000. These loans represented mortgage loans, 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 of December 31, 2009 the highest mortgage loan was held by Mr Lehmann (Chief Risk Officer), in the amount of CHF 773,000, which had an overall interest rate of 2.1 percent.
In connection with the transition of duties from the former Chief Executive Officer, James J. Schiro to Martin Senn, Zurich entered into an agreement with Mr Schiro for him to provide expertise and advice during the first six months of 2010. For these services Mr Schiro received fees and benefits in the amount of CHF 0.3 million. Besides these payments, no benefits (or waiver of claims) have been provided to former members of the GEC during the year 2010, nor during the year 2009.
Former members of the GEC are eligible to continue their mortgage loans following retirement on similar terms to those when they were employed, in line with the terms available to employees in Switzerland as stated above. As of December 31, 2010 no former member of the Group Executive Committee had any outstanding loans, advances or credits. As of December 31, 2009 one former member, Mr Eckert, held an outstanding mortgage loan of CHF 2,500,000, with a reduced interest rate of 2.0 percent applying on the first CHF 1,000,000. Apart from this, no former members of the GEC had any outstanding loans, advances or credits as of December 31, 2009.
M. Gentz, Chairman 5,345 4,274 Ph. Pidoux, Vice Chairman 2 n.a. 2,850 J. Ackermann, Vice Chairman 2 235 n.a.
All interests are beneficial, include sales-restricted shares allocated to the Directors as part of their fees and shares held by related parties of the Directors.
All interests are beneficial and include Zurich Financial Services Ltd shares or share options held by parties related to the GEC members. One vested option gives the right to one share with normal voting and dividend rights. Further details on the overall number of share options allocated under the Group’s Long-Term Incentive Plan and the terms of the options are set out in the tables “Summary of outstanding options”.
P. Hopkins, Chairman of the Board of Farmers Group, Inc. and Regional Chairman Americas 7,733 48,381 5,932 33,662 A. Lehmann, Chief Risk Officer 16,711 64,628 15,174 56,257 Ch. Orator, Chief Administrative Officer 7 5,026 14,035 n.a. n.a.
C. Reyes, Chief Investment Officer 8 1,333 6,002 n.a. n.a. G. Riddell, Regional Chairman Asia-Pacific and Middle East 19,071 67,640 16,918 52,533 K. Terryn, Group Head of Operations 1,187 10,233 n.a. n.a.
D. Wemmer, Chief Financial Officer and Regional Chairman Europe 17,102 67,816 12,612 48,868 1 None of the GEC members together with parties related to them held more than 0.5% of the voting rights as at December 31, 2010 or 2009, either directly or through share options.
8 Ms Reyes took on the function on April 1, 2010. 9 Mr Terryn took on the function on July 1, 2010.
Year of expiry as of December 31, 2010Summary of outstanding options, 2010 as of December 31, 2009Summary of outstanding options, 2009
Transfer to capital contribution reserve (1,275,702) 2 – Balance carried forward 1,978,583 3,184,567 1 1 These figures are based on the issued share capital on April 7, 2010. The proposed dividend published in the Annual Report 2009 was CHF 2,359,569 thousand resulting in a balance carried forward of CHF 3,143,017 thousand. The difference is due to the issuance of shares out of contingent capital for employees after the balance sheet date (see note 10). Treasury shares are not entitled to dividends.
Transfer to free reserve for dividend payment out of capital contribution reserve (2,491,977) 2
2 These figures are based on the issued share capital as of December 31, 2010. They may change following the issuance of shares out of contingent capital for employees after the balance sheet date (see note 10). Treasury shares are not entitled to dividends.
We further confirm that the proposed appropriation of available earnings (page 307) complies with Swiss law and the company’s articles of incorporation. We recommend that the financial statements submitted to you be approved.
Richard Burger Emel Can-Harrison Audit expert Audit expert Auditor in charge
Confirmation in respect of the contingent capital increase According to your engagement, we have audited the issuance of new shares during the period from January 1, 2010 to December 31, 2010 based on the resolutions of the general meetings of Zurich Financial Services Ltd as of October 16, 2000, April 3, 2007 and March 30, 2010 in accordance with the provisions of the Swiss Code of Obligations (CO), article 653f. para 1.
The issuance of new shares in accordance with the provisions of the articles of association is the responsibility of the Board of Directors. Our responsibility is to express an opinion whether the issuance of new shares is in accordance with the provisions of Swiss law and the articles of association. We confirm that we meet the legal requirements concerning professional qualification and independence.
Number of shares issued 146,586,896 147,473,068 Number of dividend-bearing shares 1 146,586,896 147,473,068 Market capitalization (in CHF millions at end of period) 35,503 33,403 Authorized capital, number of shares 10,000,000 5,200,000 Contingent capital, number of shares 14,708,363 12,643,831 1 Treasury shares are not entitled to dividends.
Dividend / nominal value reduction 2005 7.00 July 4, 2006 Nominal value reduction 2004 4.00 July 4, 2005 Nominal value reduction 2003 2.50 July 1, 2004 Nominal value reduction 2002 1.00 July 15, 2003 1 Proposed dividend, subject to approval by shareholders at the Annual General Meeting 2011; expected payment date as from April 7, 2011.
Zurich Financial Services Ltd shares are listed on the SIX Swiss Exchange and traded on the SIX Swiss Exchange Blue Chip Segment; ticker symbol: ZURN; the Swiss security number (Valorennummer) is 1107539. Trading in Zurich Financial Services Ltd shares on the Blue Chip Segment is conducted in Swiss francs.
The shares registered in the share ledger as of December 31, 2010, were owned by 121,715 shareholders of whom 115,840 were private individuals holding 23% of the registered shares (14% of all issued shares), 2,055 were foundations and pension funds holding 7% of the registered shares (or 5% of all issued shares), and 3,820 were other legal entities holding 70% of the registered shares (or 44% of all issued shares).
As of December 31, 2010 Zurich Financial Services Ltd is not aware of any person or institution, other than the following, who, directly or indirectly, had an interest as beneficial owner in shares, option rights and/or conversion rights relating to shares of Zurich Financial Services Ltd representing 3% or more of its issued shares: • BlackRock, Inc., 40 East 52nd Street, New York, 10022, U.S.A., along with its subsidiaries, reported as per December 15, 2009, a purchase position of 3.39% of registered Zurich Financial Services Ltd shares.
Corporate Responsibility Zurich Financial Services Ltd, Switzerland Telephone: +41 (0)44 625 24 04 E-mail: corporate.responsibility@zurich.com
For more information please contact the appropriate office below, or visit our Web site at www.zurich.com.
Investments Total investments on our consolidated balance sheets includes Group investments and investments for unitlinked products. Our Group investments are those for which we bear part or all of the investment risk. They also include investments related to investment policies with discretionary participation features. Average invested assets exclude cash collateral received for securities lending. We manage our diversified Group investments portfolio to optimize benefits for both shareholders and policyholders while ensuring compliance with local regulatory and business requirements under the guidance of our Asset/Liability Management and Investment Committee.
Operational debt is a non-IFRS term referring to debt items that are excluded from ratings agency leverage calculations such as collateralized loans, debt related to banking activities and obligations to repurchase securities.
Return on common shareholders’ equity (ROE) is a measure that indicates the level of profit or loss relative to resources provided by common shareholders. It is calculated as net income after taxes attributable to common shareholders, annualized on a linear basis, divided by the average value of common shareholders’ equity on a simple basis using the value at the beginning and end of the period.
New business value, after tax is a measure that reflects the value added by new business written during the period, including allowing for frictional costs, time value of options and guarantees, and the cost of non-market risk, and is valued at the point of sale. It is calculated as the present value of the projected after-tax profit from life insurance contracts sold during the period.
Farmers provides through Farmers Group, Inc. and its subsidiaries (FGI) non-claims related management services to the Farmers Exchanges. FGI receives fee income for the provision of services to the Farmers Exchanges, which are managed but not owned by Farmers Group, Inc., a wholly owned subsidiary of the Group. This segment also comprises the Farmers Re business which includes all reinsurance assumed from the Farmers Exchanges by the Group. The Farmers Exchanges are prominent writers of personal lines and small commercial lines business in the United States.
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