Group overview Financial highlights 1 Zurich at a glance 2 Message from the Chairman and CEO 4 Market environment 6 Our strategy 8 Our strategy – measuring our performance 10 Our performance 12
Zurich is a leading multi-line insurance provider with a global network of subsidiaries and offices. With about 60,000 employees, we deliver a wide range of general insurance and life insurance products and services for individuals, small businesses, and mid-sized and large companies, including multinational corporations, in more than 170 countries.
Our cover Street scene in São Paulo, Brazil, where Zurich is helping to meet demand for insurance from a growing middle class and thriving business sector.
in USD millions, for the years ended December 31, unless otherwise stated 2012 2011 1 Change 2
Global Life business operating profit 1,338) 1,353 (1%) Global Life new business annual premium equivalent (APE) 4,030 3 3,992 1% Global Life new business margin, after tax (as % of APE) 22.1% 3 24.5% (2.5 pts) Global Life new business value, after tax 890 3 980 (9%)
Diluted earnings per share (in CHF) 24.66) 22.52 10% Book value per share (in CHF) 214.79) 202.17 6%
Return on common shareholders’ equity (ROE) 11.8%) 11.9% (0.2 pts) Business operating profit (after tax) return on common shareholders’ equity (BOPAT ROE) 9.3%) 10.2% (0.9 pts)
5 Calculated on average Group investments. 6 Ratios as of July 1, 2012 and January 1, 2012, respectively, are calculated based on the Group’s internal model which is subject to the review and approval of the Group’s regulator, the Swiss Financial Market
Europe We have major operations in Germany, Italy, Spain, Switzerland and the UK and a significant presence in five other countries.
USD 30,259 m Gross written premiums, policy fees and insurance deposits
Business: Property and casualty insurance and services Market segments: Individual, commercial and corporate customers Distribution channels: Agents, banks, brokers, direct Geography: Global
Business: Life insurance, savings, investment and pension solutions Market segments: Individual, commercial and corporate customers Distribution channels: Agents, banks, brokers, employee benefit consultants, direct Geography: Global
Zurich is a profitable, well capitalized and resilient global insurance provider. Our success is built on the dedication of our people and a combination of financial and underwriting discipline, customer centricity and operational excellence. But to maintain our momentum in an increasingly volatile economic and social environment, we must do more.
More about our Group strategy: see pages 8–9 of this Annual Report.
The Zurich Story We are Zurich, one global company, with one mission, one ambition, one set of shared values and a clearly articulated commitment to our stakeholders: our customers, our people, our shareholders, and the communities in which we live and work.
The Zurich Way Create a competitive edge by sharing best practices.
We are pleased to present our financial results for the full year 2012, which demonstrate strong underlying profitability driven by our focus on pricing discipline and portfolio management. Our proposed dividend of CHF 17.00 reflects the confidence we have in our business strategy as well as our strong cash generation capabilities and capital base.
Business operating profit for the period was USD 4.1 billion, down 4 percent compared with 2011. Net income attributable to shareholders for the full year was USD 3.9 billion, up 3 percent compared with the previous year. Business operating profit after tax return on common shareholders’ equity was 9.3 percent, down from 10.2 percent in 2011.
We are able to report solid profitability in 2012 despite a challenging market environment, the occurrence of Storm Sandy and a disappointing result in our German General Insurance business. We continue to execute our proven strategy, with a disciplined approach to growing our business in emerging markets while delivering a resilient performance in mature markets.
During 2012, we continued to expand our bank distribution agreements, through alliances in the Middle East, Italy, Spain and Indonesia. We are particularly pleased with the performance in the U.S. where we celebrated 100 years
This reflects General Insurance’s sustained focus on underwriting discipline and expense management, and is evident in the improvement in the underlying loss ratio of 2.9 percentage points to 61.4 percent.
The overall performance was adversely affected by a second consecutive year of above average catastrophe and weather-related losses, including Storm Sandy, as well as the previously announced financial adjustments in Germany. As a result of the review of the German General Insurance business, the Group further strengthened its claims provisions in the fourth quarter by approximately USD 60 million for the lines impacted in the previous quarter and by approximately USD 70 million for other business lines. The German General Insurance segment has now reverted to business as usual where the risk of adverse development should be balanced by the possibility of favorable development.
Global Life: Continued progress against strategic objectives Global Life maintained profitability levels while continuing to show growth in gross written premiums, policy fees and insurance deposits.
Global Life business operating profit remained broadly flat at USD 1.3 billion, with a positive contribution from the insurance businesses acquired from Banco Santander S.A. (Zurich Santander) of USD 105 million, largely offset by a lower contribution from special operating items.
Farmers Management Services management fees and other related revenues increased by USD 79 million to USD 2.8 billion or by 3 percent, which was driven by the 3 percent increase in gross earned premiums in the Farmers Exchanges. The 24 percent increase to USD 4.4 billion in gross written premiums at Farmers Re was mainly as a result of changes in the All Lines agreement from 2011 levels as well as the 3 percent gross written premiums growth in the Farmers Exchanges.
Strength and commitment to pay sustainable and attractive dividends Zurich continues to generate strong underlying profitability. We have increased our revenues by defending our position in mature markets and diversifying into target emerging markets. Our investment performance was strong, delivering a total return of 7 percent in 2012.
We were able to deliver these solid financial results in 2012 despite economic uncertainty around the world. We are proud to have talented employees who work hard each and every day to help our customers understand and protect themselves from risk; we are thankful to our customers and recognize that we have to earn their trust by delivering excellent products and services that meet their needs; and we are grateful for the support of our shareholders, who recognize that Zurich strives to provide stable and sustainable returns in a challenging environment.
Zurich is engaged at all levels of the organization in response to the regulatory, economic and operational challenges it faces. It continues to have a dialogue with policy makers, supervisors, standard setters and regulators. Zurich is confident that it will successfully navigate these challenges in the best interests of its stakeholders.
Consumer protection laws impose stricter regulations Since the financial crisis began in 2008 there has been a new thrust towards enhanced consumer protection and regulation of distribution. These are a consequence to some extent of adverse experiences that arose during the crisis, where policy holders were sold supposedly safe products that led to losses from individual pensions and other savings products.
Tensions between global and local regulatory measures Global and local insurance regulators have different objectives. In general, global supervisors consider the status of insurance organizations in terms of broad financial impacts, while local bodies look solely at legal entities in their jurisdiction, focusing on narrower governance, compliance and solvency considerations. This has the potential to create tensions between Zurich’s central management organizational goals and local legal entity requirements. For example, resource allocation decisions could be distorted where limits are placed on the free movement of capital.
Economic and market outlook The global macroeconomic environment in 2013 offers brighter prospects than in 2012 although downside risks clearly remain. The outlook is expected to improve as political uncertainty subsides and governments turn their focus towards growth rather than austerity. Growth is expected to be higher than in 2012, but below trend as consumers and financial institutions continue to reduce spending and borrowing.
Policy makers have begun to take a more pragmatic approach to current economic problems, and this pattern is likely to continue. In the EU, fears of a Greek exit from the monetary union and Spanish borrowing pressures subsided following the employment of cyclically-adjusted targets instead of the imposition of rigid goals. Likewise, progress has been made with the U.S. fiscal deficit issue following compromises between Republicans and Democrats. This tendency towards resolution has begun to instill confidence in investors and foster a degree of normalization in markets.
This gradual process of economic improvement should support the environment for risk assets as investors regain confidence and return to capital markets. Equity, credit and peripheral sovereign bonds are the most likely beneficiaries while core sovereign bonds and traditional safe-haven assets are most likely to see outflows. Inflation is likely to remain contained as banks continue to apply higher credit standards before lending. Furthermore, unemployment remains high so wage pressures are not likely to be a problem.
Although the economic environment is gradually improving, Zurich remains vigilant to potential risks that could affect the proper functioning of capital markets and is prepared for scenarios as diverse as liquidity constraints, foreign currency exposures and related contagion effects.
Although the strategies for addressing these risks vary, more and more organizations are adopting an enterprisewide – or at least a multi-departmental – approach to information security and cyber liability risk management. Increasingly, insurance is also becoming a part of more organizations’ cyber risk management strategies.
Data protection is paramount for Zurich. Although complete data security can never be assured, we have made significant capital investments in robust IT architecture solutions to help prevent potential breaches and maintain system infrastructure using high standards of IT security.
Who we are Zurich is a leading multi-line insurance provider with a global network of subsidiaries and offices. With about 60,000 employees, we deliver a wide range of general insurance and life insurance products and services for individuals, small businesses, and mid-sized and large companies, including multinational corporations, in more than 170 countries.
Our Mission is to help our customers understand and protect themselves from risk. Our Ambition is to be the best global insurer as measured by our customers, employees and shareholders. Our Values, as defined by our code of conduct, Zurich Basics, shape our culture and define our behaviors. They are: integrity, customer centricity, excellence, sustainable value creation and teamwork.
To do this we are enhancing in-house capabilities that will enable us to identify and capture new opportunities as they arise.
This will involve taking a more customer-centric approach to product development and tailoring our offering to the individual stages of our customers’ lives.
How we do it We know what it takes to achieve our goals. We need the best and most skilled people in the industry and a culture that enables them to perform at their best. We need to develop and leverage best practices and provide support for Zurich’s transformation into a more customerdriven organization.
We aim: • to develop industry leading people management capabilities in order to attract, retain and develop the best people in our industry; • to foster a culture of excellence in which all employees are challenged, motivated and proud to be part of Zurich.
We will progress towards these goals by introducing a global approach to people management and talent acquisition while improving workplace diversity and career development.
For Zurich, corporate responsibility (CR) is a key ingredient of our strategy. It is about sustainable value creation, one of our core values, as set out in Zurich Basics, our code of conduct. We aim to create sustainable value for each of our main stakeholder groups by proactively addressing relevant environmental, social and governance issues.
Foundation • Environment, health and safety management in our office buildings • Diversity and inclusion in our workforce • Responsible supply chain management
To ensure that we execute on our CR strategy, the Group Executive Committee has formed a CR Working Group to advise it on strategy, priorities and objectives, and to track our performance. Our three business segments and key functions such as Group Operations and Investment Management are represented, to ensure that CR is embedded in our business. The CR Working Group is chaired by a member of the Group Executive Committee, Kevin Hogan, CEO of our Global Life business segment.
• Improve combined ratio by 3–4 points relative to global competitors by 2013 • Reduce expenses (excluding commissions) by 7% or at least USD 350 m on a run-rate basis by 2013 (included in the USD 500m Group target) • Hold market position without compromising on profitability
Zurich maintains its strategic ambition to achieve a business operating profit after tax return on equity of 16% over the long term. In the current low interest rate environment, a return of around 2 percentage points below this number is more realistic.
Share of new business value, after tax, in APME and Latin America
• Underlying profitability was sustained by contributions from Global Life and Farmers, as well as the strong underlying underwriting performance in General Insurance.
• Zurich has clearly outperformed the benchmark Global Insurance Titans index in TSR terms since 2008 by approximately 37 percent in Swiss franc terms, or about 60 percent in U.S. dollar or 74 percent in euro terms.
• Across the portfolio, the business continued to execute against its strategic targets with an improvement in the underlying loss ratio.
• Global Life continued to benefit in 2012 from its investment in organic growth in target markets. Including the Zurich Santander and Zurich Insurance Malaysia Berhad acquisitions the share of NBV would be close to 40%.
The improved underlying profitability was sustained by contributions from Global Life and Farmers, as well as the strong underlying underwriting performance in General Insurance. The overall performance of General Insurance was affected by above-average levels of catastrophe, large and weather-related losses, including Storm Sandy, as well as the adverse impact of the review of our business in Germany.
Business operating profit decreased by USD 169 million or by 4 percent to USD 4.1 billion. Net income attributable to shareholders increased by USD 128 million or 3 percent to USD 3.9 billion.
Business volumes for the core business segments, comprising gross written premiums, policy fees, insurance deposits and management fees, increased by USD 4.5 billion or by 7 percent to USD 73.1 billion.
Return on equity (ROE) was 11.8 percent for 2012, compared with 11.9 percent for 2011. This decrease was driven by the increase in shareholders’ equity. Business operating profit (after tax) return on equity (BOPAT ROE) of 9.3 percent decreased 0.9 percentage points.
Diluted earnings per share increased by 10 percent to CHF 24.66 for the year ended December 31, 2012, compared with CHF 22.52 in 2011. The increase in diluted earnings per share of 10 percent compared with the increase in net income attributable to shareholders of
The execution of the Group’s strategy and focus on its core insurance business enabled strong growth and improved underlying profitability.
Selective and profitable growth remains the key focus area and the business continued to capitalize on the favorable rate environment across all regions, achieving average rate increases of 4 percent.
In International Markets, Zurich Santander and Zurich Insurance Malaysia Berhad (ZIMB) contributed to the growth in premiums along with organic growth from the existing businesses. In Europe, premium volumes remain under pressure as a result of the economic environment in all significant markets as well as profit improvement efforts in selected portfolios such as personal lines motor.
Other sources of profit remained largely flat overall, with improvements in the risk and expense margins benefitting from the continued shift to protection and unit-linked products, offset by reductions in the investment margin due to lower investment yields.
Farmers Management Services management fees and other related revenues increased by USD 79 million or by 3 percent to USD 2.8 billion, driven by the 3 percent increase in gross earned premiums in the Farmers Exchanges.
The 24 percent increase to USD 4.4 billion in gross written premiums of Farmers Re reflected the changes in the All Lines quota share reinsurance agreement with the Farmers Exchanges (All Lines agreement) as well as the increase in gross written premiums in the Farmers Exchanges.
The Group’s capital and solvency position remains strong, underpinned by continued focus on risk management.”
Good corporate governance helps Zurich create sustainable value for the benefit of its shareholders, customers, employees and other stakeholders.
Introduction 17 Group structure and shareholders 18 Capital structure 21 Board of Directors 24 Group Executive Committee 40 Shareholders’ participation rights 48 Information Policy 49 Employees 49 Changes of control and defense measures 49 Assurance at Zurich Insurance Group 50 External Auditors 51 Group Audit 52 Group Compliance 53 Risk Management and Internal Control Statement 53 Going concern 54
• The Group continues to publish a Risk Management and Internal Control Statement (see pages 53 and 54) in accordance with the Internal Control: Revised Guidance to Directors on the UK Corporate Governance Code (formerly known as UK Turnbull Guidance) as of October 2005.
The principles of corporate governance and the standards described above are incorporated and are reflected in a number of corporate documents, in particular in the articles of incorporation, the Organizational Rules and the Charters of the Board Committees. The Governance and Nominations Committee, which oversees the Group’s governance, regularly reviews the Group’s corporate governance against best practice standards and ensures compliance with corporate governance requirements.
An effective structure is in place providing for cooperation between the Board of Directors of Zurich Insurance Group Ltd (Board), Management and internal control functions. This structure establishes checks and balances and is designed to provide for institutional independence of the Board from the Group Chief Executive Officer (CEO) and the Group Executive Committee (GEC) responsible for managing the Group on a day-to-day basis. The Board of Zurich Insurance Group Ltd is composed entirely of non-executive members independent from the Management. The roles of Chairman of the Board and CEO are separated, thus providing for separation of powers between the functions and ensuring the autonomy of the Board.
This report essentially follows the recommended structure outlined in the Directive on Information Relating to Corporate Governance of the SIX Swiss Exchange. The chapter on compensation, shareholdings and loans to Directors and the members of the GEC is dealt with in a separate report, the Remuneration report (see pages 56 to 81), which complements this Corporate governance report and also includes the information as required by the Circular 2010/1 on remuneration schemes (minimum standards for remuneration schemes of financial institutions) issued by the Swiss Financial Market Supervisory Authority (FINMA) on October 21, 2009 as amended on June 1, 2012.
• Vernon Sankey, member and former Chairman of the Remuneration Committee
Regions Non-core business segmentsCore business segments *For General Insurance this includes Africa
The Group pursues a customer-centric strategy and is managed on a matrix basis, reflecting both lines of business and geography. The GEC is headed by the CEO. The CEOs of the business segments General Insurance, Global Life and Farmers as well as the Chief Financial Officer (CFO), the Chief Investment Officer (CIO), the Chief Risk Officer (CRO), the Group Head of Operations and the Group General Counsel are members of the GEC. The geographic regions of Europe, North America, Latin America and Asia-Pacific and Middle East including Africa are represented by Regional Chairmen – of which those for Europe, North America and Asia-Pacific and Middle East including Africa are currently members of the GEC – who focus on stakeholder management and business development in their regions. For further information on the GEC see pages 40 to 48.
A detailed review of the respective business segment results during 2012 can be found in the Operating and financial review starting on page 84. Furthermore, an overview of the Group’s business strengths and activities is contained in the Annual Review, available on Zurich’s website www.zurich.com ( sitecollectiondocuments/financial-reports/annual-review-2012-en.pdf).
As of December 31, 2012, Zurich Insurance Group Ltd is not aware of any person or institution, other than BlackRock, Inc., New York and Norges Bank, Oslo which, directly or indirectly, had an interest as a beneficial owner in shares, option rights and/or conversion rights relating to shares of Zurich Insurance Group Ltd representing three percent or more of its issued shares.
Some interests in shares are held by investors in the form of American Depositary Receipts (ADRs) 1. As of December 31, 2012, investors held 24,376,020 ADRs (representing 2,437,602 Zurich Insurance Group Ltd shares).
1 Zurich Insurance Group Ltd has established an American Depositary Share, or ADS, level 1 program in the United States. Under the program, The Bank of New York Mellon Corporation issues the ADSs. Each ADS represents the right to receive one-tenth of one share of Zurich Insurance Group Ltd. Each ADS also represents securities, cash or other property deposited with The Bank of New York Mellon Corporation but not distributed to ADS holders. Zurich’s ADSs are traded over the counter (OTC) and are evidenced by American Depositary Receipts, or ADRs. Since 1st July 2010, Zurich’s ADRs are traded on “OTCQX”, an electronic platform operated by OTC Markets Group Inc. (formerly “Pink OTC Markets Inc.”) under the symbol ZURVY. ADS holders are not treated as shareholders of Zurich Insurance Group Ltd and are not able to directly enforce or exercise shareholder rights. Only The Bank of New York Mellon Corporation as Depositary of the level 1 program may exercise voting rights with respect to instructions received from beneficial owners of ADRs.
The Board, under the leadership of the Chairman, is responsible for determining the overall strategy of the Group and the supervision of senior management. It holds the ultimate decision-making authority for Zurich Insurance Group Ltd, except for those decisions reserved to the shareholders.
The members of the Board are elected by the shareholders at the shareholders’ meeting. After each shareholders’ meeting, the Board constitutes itself in its first meeting and appoints a Chairman and a Vice-Chairman from among its members. All current members are non-executive directors, independent from the Management.
Chairman of the Board Chairperson of the Governance and Nominations Committee Member of the Remuneration Committee
Tom de Swaan Dutch 1946 Vice-Chairman of the Board Chairperson of the Risk Committee Member of the Governance and Nominations Committee
Armin Meyer Swiss 1949 Director Member of the Governance and Nominations Committee Member of the Risk Committee
Except for Ms. Carnwath and Mr. del Pino whose terms of office commenced in March 2012, all of the current Directors served on the Board throughout 2012. Mr. Gentz, the former Chairman of Zurich Insurance Group Ltd and Mr. Sankey retired from the Board at the Annual General Meeting 2012.
Board Composition Diversity is a key success factor in today’s fast changing global environment. Zurich’s Board consists of individuals with wide-ranging relevant backgrounds, experiences, skills and knowledge resulting in a favorable balance that enables the Board as a group to exercise its tasks and responsibilities while fully taking into account today’s business needs.
External appointments: Mr. de Swaan has been a non-executive member of the board of GlaxoSmithKline Plc and chairman of its audit committee since 2006. He has been a member of the supervisory board of Royal DSM, a Netherlands based nutrition group, since 2006. He has been the vice-chairman of the supervisory board of Royal Ahold, a global retail chain, since 2007. Mr. de Swaan has been chairman of the supervisory board of Van Lanschot NV, the holding company of F. van Lanschot Bankiers, an independent Dutch bank, since 2008. He has also been a member of the public interest committee of KPMG ELLP since 2010 and a member of the International Advisory Board of the National Bank of Kuwait. In addition, Mr. de Swaan is a director of a number of non-profit organizations. He is chairman of the board of the Netherlands Cancer Institute, a member of the board of the International Franz Liszt Piano Competition and chairman of the advisory board of the Rotterdam School of Management. Educational background: Mr. de Swaan graduated from the University of Amsterdam with a master’s degree in economics.
Committee membership: Remuneration Committee Other directorships within the Group: Zurich Insurance Company Ltd External appointments: Ms. Carnwath has been a Senior Advisor of Evercore Partners since 2011 and an independent Chairman of ISIS Equity Partners LLP since 2000. She has been a Chairman of the Board of Land Securities Group plc since 2008 and a member of the board of Man Group plc since 2001 and PACCAR Inc. since 2005. Educational background: Ms. Carnwath graduated in economics and German from the University of Reading.
Victor L.L. Chu (1957), British Citizen Member of the Board Skills and experience: Mr. Chu has expertise in the field of corporate, commercial and securities laws spanning 30 years, with special emphasis on China and regional investment transactions. From 1995 to 2000, Mr. Chu was deputy secretary-general of the International Bar Association. Over the past 25 years he has served at various times as director and council member of the Hong Kong Stock Exchange, a member of the Hong Kong Takeovers and Mergers Panel, a member of the Hong Kong Securities and Futures Commission’s advisory committee and a part-time member of the Hong Kong Government’s Central Policy Unit. He is admitted to practice law in England and Hong Kong. Committee membership: Governance and Nominations Committee Other directorships within the Group: Zurich Insurance Company Ltd
Committee membership: Remuneration Committee Other directorships within the Group: Zurich Insurance Company Ltd External appointments: Mr. del Pino has been a member of the International Advisory Board of Blackstone since 2007. He also maintains contact with the academic world through membership on the MIT Corporation, the International Advisory Board of IESE and the European Advisory Board of Harvard Business School. Educational background: Mr. del Pino graduated in civil engineering from the Universidad Politécnica Madrid and obtained an MBA from MIT Sloan School of Management.
The articles of incorporation require elections to be organized in such a way as to ensure that no more than four Directors complete their term of office at any one shareholders’ meeting. The election of a member of the Board is effected on an individual basis. Directors are elected by a majority of the votes cast.
At the Annual General Meeting to be held on April 4, 2013, the terms of office of Ms. Bies and Messrs. Chu, Meyer and Watter will expire. Ms. Bies has been proposed for re-election by the Board for a term of three years and Mr. Chu has been proposed for re-election by the Board for a term of one year. Since the Group’s internal guidelines provide for a maximum tenure of twelve years, Mr. Watter has been proposed for re-election by the Board for a term of one year as he will have served the maximum tenure of office at the Annual General Meeting 2014. Mr. Meyer who has served the maximum tenure of office at the Annual General Meeting on April 4, 2013 will not stand for re-election to the Board.
Ms. Monica Mächler has been nominated for election at the Annual General Meeting on April 4, 2013 as an additional member of the Board of Zurich Insurance Group Ltd for a term of three years. For details as to Ms. Monica Mächler’s biography, see the following: Rolf Watter (1958), Swiss Citizen Member of the Board Skills and experience: Mr. Watter possesses extensive experience in the field of corporate law, particularly complex cross-border transactions and corporate governance questions and has been a partner at Bär & Karrer AG in Zurich since 1994. He was a member of its executive board from 2000 and an executive director upon the incorporation of Bär & Karrer AG in 2007 until September 2009. Mr. Watter serves as a part-time professor at the Law School of the University of Zurich. He was formerly a non-executive chairman of Cablecom Holding AG from 2004 to 2008. Mr. Watter was also a non-executive director of Syngenta AG from 2000 to 2012, of Centerpulse AG from 2002 to 2003, of Forbo Holding AG from 1999 to 2005 and of Feldschlösschen Getränke AG from 2001 to 2004. Committee membership: Audit Committee
Internal organizational structure and responsibilities The Board is chaired by the Chairman, or in his absence the Vice-Chairman. It has a program of topics that is presented at its meetings throughout the year. It is regularly informed of developments regarding the Group and is provided with timely information in a form and of a quality appropriate to the discharge of its duties in accordance with the standards of care set out in Article 717 of the Swiss Code of Obligations.
A self-assessment of the full Board is carried out once a year. In 2012, considering the changes in the composition of the Board (new chairman, two new members, changes in the composition of the Board Committees) it was decided that the Board’s self-assessment would be based on a more condensed questionnaire than in previous years. The questionnaire encompassed topics such as time spent by the Board members on given topics, strategy-related questions (clarity of strategy, opinion building process on strategy, monitoring of strategy implementation), board composition and participation, effectiveness and efficiency of meetings, quality of meeting preparation, general effectiveness (atmosphere, interaction with senior management, etc.). A detailed report on the findings was produced and considered by the Board.
The CEO attends Board meetings ex officio. Members of the GEC are regularly invited by the Board to attend Board meetings. Other executives attend these meetings from time to time at the invitation of the Board. Most Board meetings include private sessions of the Board without the participation of Management.
In 2012, average attendance at Board meetings was 87 percent. The members of the Board spent additional time participating in Board Committee meetings and preparing for meetings in order to discharge their duties.
Monica Mächler (1956), Swiss Citizen Skills and experience: Monica Mächler served as Vice-Chair of the Board of Directors to the Swiss Financial Market Supervisory Authority (FINMA) from 2009 to 2012, after having been the Director of the Swiss Federal Office of Private Insurance from 2007 to 2008. Joining Zurich Insurance Group in 1990, she assumed the roles of Group General Counsel and Head of the Board Secretariat from 1999 to 2006 and was appointed a member of the Group Management Board in 2001. During the years 1985 to 1990 she was in private practice specializing in banking and business law.
The Board has the following standing committees, which regularly report to the Board and submit proposals for resolution by the Board:
Key tasks and responsibilities: In general, the Governance and Nominations Committee
• oversees the Group’s governance and measures it against best practice with a view to ensuring that the rights of the shareholders are fully protected; • develops and proposes to the Board guidelines for corporate governance and reviews them from time to time; • ensures compliance with corporate governance disclosure requirements as well as legal and regulatory requirements; • is entrusted with the succession planning for the Board, the CEO and members of the GEC. In this regard, it proposes the principles for the nomination and ongoing qualification of members of the Board and makes proposals to the Board on the composition of the Board, the appointment of the Chairman, the Vice-Chairman, the CEO and members of the GEC. Final decisions for nominations and appointments are made by the Board, subject to shareholder approval, where required; and,
Activities 2012: During 2012, the Governance and Nominations Committee met five times – average attendance at meetings was 90 percent. It particularly discussed
Further details of the Group’s remuneration governance and the Remuneration Rules are given in the Remuneration report on pages 56 to 81; • proposes the Directors’ remuneration to the Board for approval; • based on the Remuneration Rules, negotiates the terms and conditions of employment of the CEO and reviews those of other members of the GEC, as negotiated by the CEO, before submitting them to the Board for approval; • liaises with the CEO on other important employment, salary and benefit matters; • reviews performance relating to the senior management’s short-term and long-term incentive plans. In addition, in order to help align remuneration with the Group’s risk-taking capacity, Group Risk Management consults with the other governance, control and assurance functions to provide a review of risk factors for consideration when overall
Corporate governance report continued performance for annual incentives is assessed and the Chief Risk Officer is available to discuss these findings with the Remuneration Committee and the Board.
• the performance of the Group, the segments and the GEC and the approval of STIP and LTIP awards for 2011 including the approval of the Total Variable Remuneration Pool for 2011; • the regulatory environment such as implications from the FINMA Circular 2010/1 Remuneration Schemes and remuneration aspects raised by Ethos and ISS; • developments for remuneration-related matters and their potential effect on Zurich; • topics related to proxy advisors such as Ethos or ISS; • the share ownership levels of the members of the Board and the GEC (for more details see the Remuneration report on page 70 and 77); • in the annual joint meeting with the Risk Committee, risk management aspects of the Group’s remuneration architecture; • in its annual review, the Remuneration report, the Remuneration Rules and the Remuneration Committee rules and approved them; and,
The Remuneration Committee has retained its own independent advisors, Meridian Compensation Partners, LLC and Aon Hewitt to assist in reviewing the remuneration structures and practices.
The external auditors, the internal auditors and appropriate members of the GEC and other executives attend its meetings in order to, among other things, discuss the auditors’ reports, review and assess the auditing concept and the examination process and assess the activities of internal and external auditors. Private sessions with external and internal auditors are scheduled at the majority of the Audit Committee meetings to enable discussions without Management present.
• reviews the annual, half-year and quarterly financial results of the Group before submission to the Board.
Activities 2012: During 2012, the Audit Committee met seven times – attendance at meetings was 100 percent. It particularly discussed
• the Annual Group Compliance Plan, which it approved and against which it monitored progress during the year. The Audit Committee also discussed compliance issues and trends, such as the evolving regulatory expectations with regard to the compliance function.
• oversees the Group’s risk management, in particular the Group’s risk tolerance, including agreed limits that the Board regards as acceptable for Zurich to bear, the aggregation of agreed limits across the Group, the measurement of adherence to agreed risk limits and the Group’s risk tolerance in relation to anticipated capital levels; • further oversees the Group-wide risk governance framework, including risk management and control, risk policies, their implementation and the risk strategy and the monitoring of operational risks; • reviews the methodologies for risk measurement and the Group’s adherence to its risk limits and reviews the performance of the risk management function; • reviews, with business management and the Group risk management function, the Group’s general policies and procedures and satisfies itself that effective systems of risk management are established and maintained; and,
• receives periodic reports from Group risk management function and assesses whether significant issues of a risk management and control nature are being appropriately addressed by management in a timely manner.
For further information on risk governance see the Risk Review on pages 111 to 161.
Areas of responsibility of the Board and Management The Board determines the overall strategy of the Group, supervises senior management and addresses key matters in the area of strategy, finance, structure and organization and business development. Particularly, the Board approves the Group’s strategic plan and the annual financial plans developed by Management and reviews and approves the annual, half-year and quarterly financial statements of Zurich Insurance Group Ltd and the Group. For more details with regard to the responsibilities of the Board see page 33 and 34.
The Group has an information and financial reporting system. The annual plan for the Group, which includes a summary of financial and operational metrics, is reviewed by the GEC in detail and approved by the Board. Monthly updates are prepared to compare actual performance to the plan. Full-year forecasts are revised if necessary to reflect changes in sensitivities and risks that may impact the results of the Group. Action is taken, where appropriate, when variances arise. This information is reviewed monthly by the GEC and quarterly by the Board.
The Group has adopted and implemented a coordinated, formalized and consistent approach to risk management and control. Information concerning the Group’s risk management processes is included in the Risk Review starting on page 111. The Risk Management & Internal Control Statement describes on pages 53 and 54 the Group’s approach with regard to risk management and internal control according to the Internal Control: Revised Guidance to Directors on the UK Corporate Governance Code (formerly known as UK Turnbull Guidance) as of October 2005.
3 Mike Foley Chief Executive Officer North America Commercial, Regional Chairman of North America 4 Yannick Hausmann 2
Chief Executive Officer General Insurance 7 Axel P. Lehmann Chief Risk Officer, Regional Chairman of Europe 8 Cecilia Reyes Chief Investment Officer 9 Geoff Riddell Regional Chairman of Asia-Pacific & Middle East 10 Kristof Terryn Group Head of Operations 11 Pierre Wauthier Chief Financial Officer 1 Assumed role of Chief Executive Officer of Farmers Group, Inc. on January 1, 2012 and was appointed to the Group Executive Committee as of the same date 2 Appointed to the Group Executive Committee as of July 1, 2012 3 Assumed role of Chief Executive Officer General Insurance on September 1, 2012 and was appointed to the Group Executive Committee as of the same date
The Group continued simplifying its global organizational structure at the Head Office and therefore decided to discontinue the Chief Administrative Officer role. Specific areas of that office’s responsibility were integrated into other functions. Further, the Group General Counsel was appointed to the GEC overseeing Legal, Compliance, Government and Industry Affairs across the Group and the Board Secretariat for Zurich Insurance Group Ltd, Zurich Insurance Company Ltd and Zurich Life Insurance Company Ltd.
For key areas, the following cross-functional committees have been established to facilitate the coordination and alignment of recommendations to the CEO for approval on specific subject matters.
Members: Chief Executive Officer (Chair), Chief Financial Officer (Deputy Chair), Chief Investment Officer, Chief Risk Officer, Chief Executive Officer General Insurance, Chief Executive Officer Global Life.
Key tasks and responsibilities: • acts as a cross-functional body whose main function is to control the activities that materially affect the balance sheets of the Group and its subsidiaries; and,
• responsible for setting the annual capital and balance sheet plans for the Group based on the Group strategy and financial plans and recommending specific transactions or unplanned business changes to the Group’s balance sheet;
• reviews and formulates recommendations for future courses of action with respect to potential M&A transactions and topics relating to finance and risk management.
The Asset/Liability Management Investment Committee, chaired by the Chief Investment Officer, acts as a cross-divisional body and has primary responsibility for monitoring and reviewing the Group’s asset/liability management and the strategic asset allocation of Zurich’s invested assets.
The General Insurance Global Underwriting Committee, chaired by the Chief Underwriting Officer, General Insurance, is the focal point for the underwriting function within General Insurance. In particular, it approves underwriting and related control policy, develops and agrees the Group’s underwriting strategy, monitors the accumulation control and approves mitigation plans, when necessary. The Committee is also responsible for approving new captive transactions (or renewals) and new products . Finally, it also oversees and monitors technical underwriting reviews.
Regional Chairman of North America Yannick Hausmann Swiss 1967 Group General Counsel Kevin Hogan American 1962 Chief Executive Officer Global Life Michael Kerner American 1965 Chief Executive Officer General Insurance Axel Lehmann Swiss 1959 Chief Risk Officer and Regional Chairman of Europe Cecila Reyes Swiss / Philippine 1959 Chief Investment Officer Geoff Riddell British 1956 Regional Chairman of Asia-Pacific and Middle East Kristof Terryn Belgian 1967 Group Head of Operations Pierre Wauthier French / British 1960 Chief Financial Officer
All current members of the GEC served on the GEC throughout 2012 except for Yannick Hausmann and Michael Kerner. Yannick Hausmann was appointed as a member of the GEC effective July 1, 2012. Michael Kerner was appointed Chief Executive Officer, General Insurance and as a member of the GEC effective September 1, 2012 succeeding Mario Greco who had resigned from the GEC and his position as the Chief Executive Officer, General Insurance effective June 4, 2012. Christian Orator retired from the GEC and his position as Chief Administrative Officer effective June 30, 2012.
For information on contractual termination benefits, see pages 49 and 50.
Yannick Hausmann (1967), Swiss Citizen Group General Counsel Skills and experience: Mr. Hausmann started his career in 1995 at a law firm in Basel. From 1998 to 2000, he was Associate in the tax and legal department of Arthur Andersen AG and Andersen Legal in Zurich. He was a member of the Legal and Compliance Group of the Swiss Insurance Association for several years. Mr. Hausmann joined the Zurich Corporate Center Litigation and Investigation Team in 2000. He has held his current position since December 2009 and was promoted to be a member of the GEC in July 2012. He oversees the Legal, Compliance and GAIA (Government and Industry Affairs) functions worldwide across the Zurich Group as well as the Board Secretariat.
External appointments: Since 2009, Mr. Hausmann has been a member of the Legal Committees of the SwissAmerican Chamber of Commerce and of economiesuisse. In 2011, he joined the Board of Trustees of the Museum Haus Konstruktiv in Zurich. Educational background: Mr. Hausmann received a doctorate in Law from the University of Basel in 1995 and was admitted to the Bar in Switzerland (Canton of Basel) in 1997. He earned a Master of Laws (LL.M.) from the New York University School of Law in 2003 and attended the Advanced Management Program at Harvard Business School in 2012.
Africa with the Continental Europe division. In September 2004, he became CEO of Zurich American Insurance Company and Zurich North America Commercial business division in Schaumburg, Illinois. In January 2008, he assumed his current role as Chief Risk Officer and assumed additional responsibility for Group IT until 2010. He became Chairman of the Board of Directors of Farmers Group, Inc. from July 2011 and Chairman of Europe from October 2011. External appointments: Mr. Lehmann is a member of the board of directors of UBS AG and is a member and former Chairman of the CRO Forum. He is an Honorary Professor for Business Administration and Service Management and Chairman of the Board of the Institute of Insurance Economics (I.VW-HSG) at the University of St. Gallen in Switzerland. Mr. Lehmann is also a member of the board of directors of economiesuisse. Educational background: Mr. Lehmann holds a PhD and Masters in Economics and Business Administration from the University of St. Gallen, Switzerland where he also received his habilitation. He is a graduate of the Wharton School Advanced Management Program. His doctorate was awarded the Peter Werhahn Prize for the best PhD thesis in the area of management science and academic theory. He did his research study at Harvard Business School and Arizona State University.
Investments with responsibility for North America and became Regional Manager for Europe and International Businesses in 2004. From April 2006 until March 2010, she was Head of Investment Strategy Implementation. In April 2010, she assumed her current role as Chief Investment Officer. External appointments: Ms. Reyes has been a member of the Advisory Board of the Department of Banking and Finance at the University of Zurich since 2011. Educational background: Ms. Reyes holds a PhD in Finance from London Business School and an MBA from the University of Hawaii, U.S.
Kristof Terryn (1967), Belgian Citizen Group Head of Operations Skills and experience: Mr. Terryn began his career in 1993 in the banking industry, where he worked in capital markets. In 1997, he joined McKinsey & Company where he held various positions within the financial services practice in Brussels and Chicago. He joined Zurich in 2004 as Head of Planning and Performance Management. In 2007, he became Chief Operating Officer for the Global Corporate business division and in 2009 was named Chief
Changes to the GEC as from January 1, 2013 There have been no changes to the GEC as from January 1, 2013.
Zurich Insurance Group Ltd may under certain circumstances authorize the beneficial owners of the shares that are held by professional persons as nominees (such as a trust company, bank, professional asset manager, clearing organization, investment fund or another entity recognized by Zurich Insurance Group Ltd) to attend the shareholders’ meetings and exercise votes as proxy of the relevant nominee. For further details, see page 22.
Zurich Insurance Group Ltd provided electronic voting devices to its shareholders for all the resolutions taken at the AGM on March 29, 2012. In accordance with Swiss practice, Zurich Insurance Group Ltd informs all shareholders at the beginning of the shareholders’ meeting of the aggregate number of proxy votes received.
Registrations in the share register With a view to ensure an orderly process, shortly before the shareholders’ meeting, the Board determines the date at which a shareholder needs to be registered in the share register in order to exercise his or her participation rights by attending the shareholders’ meeting. Such date is published, together with the invitation to the shareholders’ meeting, in the Swiss Official Gazette of Commerce and in several newspapers.
The Group’s share-based compensation programs include regulations regarding the impact of a change of control.
PwC assumes all auditing functions which are required by law and by the articles of incorporation of Zurich Insurance Group Ltd. The external auditors are elected by the shareholders of Zurich Insurance Group Ltd annually. At the Annual General Meeting on March 29, 2012, PwC was re-elected by the shareholders of Zurich Insurance Group Ltd. The Board proposes that PwC be re-elected at the upcoming Annual General Meeting as external auditors for the business year 2013. PwC fulfils all necessary requirements under the Swiss Federal Act on the Admission and Oversight of Auditors and has been admitted as a registered auditing company by the Federal Audit Oversight Authority.
Mr. Richard Burger of PricewaterhouseCoopers AG has been the lead auditor, responsible since the beginning of 2011 and to the end of the business year 2012. He has been the auditor-in-charge for regulatory and statutory audit work since 2008. The Group requires rotation of the lead auditors after they have served Zurich for five years. Mr. Stephen O’Hearn has replaced Mr. Patrick Shouvlin as the Global Relationship Partner and has co-signed the auditors’ report for 2012.
Non-audit fees Total fees (including expenses and value added taxes) in the year 2012 for additional services (e.g., tax and legal services, transaction consulting services or special audits required by local law or regulatory bodies) performed by PwC and parties associated with them for Zurich Insurance Group Ltd or a Group company amounted to USD 6.4 million (USD 4.6 million in 2011). Non-audit fees were as follows: Total audit fees 43.9 38.0
The Audit Committee oversees the work of the external auditors. It reviews, at least annually, the qualification, performance and independence of the external auditors and reviews any matters that may impair their objectivity and independence based on a written report by the external auditors describing the firm’s internal quality control in USD millions, as of December 31Audit and non-audit fee amounts
Corporate governance report continued procedures, any material issues raised and all relationships between the external auditors and the Group and/or its employees that could be considered to bear on the external auditors’ independence. The Audit Committee evaluates the cooperation of the external auditors during their audit examination. It elicits the comments of Management regarding the auditors’ performance (based on criteria such as their understanding of Zurich’s business, technical knowledge and expertise, etc.) and the quality of the working relationship (responsiveness of the external auditors to the needs of Zurich Insurance Group Ltd and the Group and the clarity of communication). The Audit Committee reviews, prior to the commencement of the annual audit, the scope and general extent of the external audit and suggests areas requiring special emphasis.
The Audit Committee has approved a written policy on the use of external auditors for non-audit services, which sets out the rules for providing such services and related matters (including a list of prohibited services). Allowable non-audit services may include tax advice and services, comfort and consent letters, certifications and attestations, due diligence and audit support in proposed transactions, to the extent that such work complies with applicable legal and regulatory requirements and does not compromise the independence or objectivity of the external auditors. In order to avoid conflicts of interest, all allowable non-audit services need pre-approval from the Audit Committee (Chairman), the Chief Financial Officer or the local CFO, depending on the level of the expected fee. This policy further requires, among other things, an engagement letter specifying the services to be provided and making reference to the external auditors’ obligation to comply with the policy.
Group Compliance The Group’s core values are founded on the principle that it acts lawfully and seeks to do what is right. Sound compliance in everything the Group does helps to protect Zurich’s reputation and supports the achievement of the Group’s ambitious goals.
Risk Management and Internal Control Statement The Board is responsible for overseeing the Group’s risk management and internal control systems, for which Management is responsible. The systems are designed to manage rather than eliminate the risk of failure to achieve business objectives and can provide only reasonable, and not absolute, assurance against material financial misstatement or loss. There are two committees at the Board level that have primary risk management and internal control oversight responsibilities
• the Audit Committee – with oversight over internal control matters.
The internal control system focuses on key financial reporting, operational and compliance controls. The system encompasses the policies, processes and activities that contribute to the reliability of financial reporting, the effectiveness and efficiency of operations and compliance with laws and regulations. In 2012, further progress was made to develop and improve the Group’s control system while maintaining the focus on the effectiveness of the overall internal control environment.
The Group’s annual business plan includes risk management considerations, as well as strategic and business direction, financial information and key indicators. During the year, the Board, the Audit and Risk Committees of the Board and Group Management receive regular reports summarizing financial condition, financial and operating performance, as compared to plan, and key risk exposures.
The Risk Committee has reviewed the effectiveness of the Group’s risk management system, including the Group’s risk tolerance and the enterprise-wide risk governance framework, and the Audit Committee has reviewed the effectiveness of the system of internal control operated by the Group related to the calendar year 2012 up to the date of the Annual Report and have reported to the Board accordingly. The Board is satisfied that the reviews by the Audit and Risk Committees of the Board were conducted in accordance with the UK Turnbull Guidance (as revised in October 2005). The assessment included the consideration of the effectiveness of the Group’s ongoing process for identifying, evaluating, controlling and managing the risks of the business, including the scope and frequency of reports on both risk management and internal control that were received and reviewed during the year by the Risk and Audit Committees and the Board, important risk and control matters discussed and associated actions taken by Management. Issues identified, including the financial adjustments in the General Insurance business in Germany, have been communicated to the Board and either have been or are being addressed by the Group.
The Remuneration report describes the principles and governance framework relating to the remuneration of the members of the Board of Directors, the Group Executive Committee and all employees. It also provides details of each remuneration element, and reports on the work of the Remuneration Committee.
Contents 2012 Remuneration summary 57 2012 Remuneration report 59 Remuneration governance 59 Remuneration philosophy 62 Remuneration and shareholdings of the Board of Directors 68 Remuneration and shareholdings of the Group Executive Committee 71 Remuneration of employees 79
The following summary provides an overview of the most important aspects of Zurich’s remuneration in 2012.
Variable remuneration is structured such that on average there is a higher weighting towards longer term sustainable performance for the most senior employees of the Group, including those positions considered as key risk taker positions (“Key Risk Takers”, “KRT”). This ensures that for KRTs a significant portion of the variable pay is deferred.
2012 Remuneration For 2012 remuneration decisions an appropriate balance was made between all relevant factors including business performance, market considerations, regulatory requirements, the long-term overall focus as well as risk considerations. For the Board no changes were made to the fee structure in 2012 and no changes will be implemented in 2013. Remuneration changes for members of the GEC in 2012, where applicable, were focused on increasing the long-term part of variable remuneration, to achieve at least 60 percent of the variable remuneration as deferred and subject to long-term performance conditions. Balancing the overall structure of remuneration with company performance, market, risk and regulatory considerations was also important for employee remuneration decisions.
Total remuneration 1 For all employees equals the cash incentives earned for the year. 2 Includes the fees allocated as sales restricted shares for Directors. 3 Includes other employee benefits, pension benefits and other remuneration costs. 4 Actual, gross and for cash amounts based on the accrual principle.
Remuneration expenditure should be considered in the context of Zurich‘s overall revenues, capital base and profitability. The key figures are set out in the table below and reflect data for 2012 and 2011: Gross written premiums and fees 2 56,823 52,967 Business operating profit 4,075 4,243 Net income attributable to shareholders 3,878 3,750 Shareholders’ equity 34,494 31,484 Return on common shareholders’ equity 11.8% 11.9% Dividends to shareholders 3 2,763 2,706 Total variable remuneration pool for all employees gross before tax 608 618 – as a percentage of gross written premiums and fees 1% 1% – as a percentage of shareholders’ equity 2% 2% 1 December 31, 2011 has been restated as set out in note 1 of the Consolidated financial statements. 2 Consists of USD 53,977 gross written premiums and policy fees as well as USD 2,846 Farmers management fees and other related revenues. 3 Dividend at transaction day exchange rate in 2012, respectively 2011.
As can be seen from these metrics, relative to Zurich’s overall revenues and capital position, expenditure on variable remuneration is relatively small. Among other factors, in determining the amount of the total variable remuneration pool (please refer to pages 61 and 79) for all employees, the Board also considers the long-term economic performance of the Group. In this respect, the Group has generated economic profit over the long-term which exceeds the actual expenditure on variable pay. For 2012, the Group Short-Term Incentive Plan (Group STIP) overall expenditure resulted in 91 percent of target and the Group Long-Term Incentive Plan (Group LTIP) vesting level for the three years 2010 to 2012 was set at 97 percent of target.
Zurich Insurance Group Annual Report 2012 59Remuneration report 2012 Remuneration report
All other information which is to be disclosed according to the SIX Directive is included in the Corporate governance report preceding this Remuneration report.
In 2012, a number of actions were implemented (which will continue going forward): • A joint meeting between the Remuneration Committee and the Risk Committee took place to discuss a risk review of the remuneration architecture and the remuneration governance framework. For this joint meeting, the Group Risk Management function evaluated the remuneration architecture and reported its findings on whether and how the remuneration architecture is consistent with effective risk management and does not encourage inappropriate risk taking that exceeds the Group’s level of tolerated risk.
• Long-term incentive grants were made solely in the form of performance shares. Options were discontinued as of 2011 and option grants made in the period up to and including 2010 continue to earn out in accordance with the terms and conditions of those grants. This recognizes market trends and the Board is of the opinion that performance shares best align the ultimate rewards to individuals with actual performance achievements.
• In order to further enhance transparency, additional information regarding the share ownership guidelines for the Board and for members of the Group Executive Committee is being disclosed. This is set out on page 62.
As part of a remuneration review in 2012, all KRT positions for the Group were reviewed. These positions cover the three business segments of General Insurance, Global Life and Farmers as well as Group Operations and all other principle functions. In 2012, the processes and criteria of identifying KRT positions have been further clarified and documented, in order to facilitate the annual reassessment. The criteria are based on factors that materially affect risk-taking within the Group, such as overall governance, capital consumption for each risk type as determined by the internal model, strategy and reputation. The criteria are then applied to those who take as well as to those who control the specific risks at the level of the Group where the risks are most material. In particular, Group Risk Management, together with other control and assurance functions, provides risk and compliance information about each KRT as part 1 For a definition of the “Farmers Exchanges” see page 19 in the Corporate governance report. 2 Total Shareholder Return (TSR) is the theoretical growth in value of a shareholding assuming that dividends and any capital distributions are reinvested to purchase additional units of an equity at the closing price applicable on the ex-dividend/capital distribution date.
Zurich Insurance Group Annual Report 2012 61Remuneration report of the annual individual performance assessment. The remuneration arrangements for KRTs include both short-term and long-term incentive plans with a greater emphasis towards long-term and therefore deferred remuneration.
In reviewing remuneration structures and practices on a regular basis, the Remuneration Committee and the Board receive independent advice from the executive compensation practice at Meridian Compensation Partners LLC (Meridian) as well as at Aon Hewitt, part of Aon Corporation (Aon Hewitt). The Remuneration Committee reviews the mandates and fees, and evaluates ongoing performance. Both, Meridian and Aon Hewitt provide advice to the Board, with the lead consultant employed by Meridian. Meridian does not provide any other services to the Group. Although certain practices within Aon Hewitt – a large, international brokerage and human resources firm – undertake work for the Group from time to time, the Remuneration Committee does not consider the independence and integrity of the advice it receives from Aon Hewitt to be compromised by these separate assignments.
Guidelines on share ownership requirements for Directors and members of the Group Executive Committee To align the interests of the Board and the GEC with those of shareholders, Directors and members of the GEC build their ownership position in the company and have to meet a certain ownership requirement. Share ownership guidelines for members of the Board have been established at the level of 1 times the basic annual fee. For members of the GEC, share ownership guidelines with regard to vested awards have been established at the level of 5 times base salary for the CEO and of 2.5 times base salary for other members of the GEC. Directors achieve this requirement through part of their fee payment being made in three-year sales restricted shares and market purchases. Members of the GEC achieve this through their participation in long-term incentive plans and market purchases. Directors, the CEO and other members of the GEC have a period of five years to meet their ownership requirement and the Remuneration Committee monitors compliance with these guidelines on an annual basis.
Based on their role on the Board and the fee structure described on page 69, fee levels are established for each member of the Board of Zurich Insurance Group Ltd. Fees are paid in cash and in shares with approximately one-third of the basic fee being provided in three-year sales restricted shares of Zurich Insurance Group Ltd.
Group Executive Committee and all other employees For the members of the GEC including the CEO, and all other employees throughout the Group, a number of key elements have been implemented to provide a well balanced and effectively managed remuneration program. These elements include a group-wide remuneration philosophy, robust short-term and long-term incentive plans, effective governance, and strong links to the business planning and risk policies of the Group.
• The Group clearly defines the expected performance through a structured system of performance management and uses this as the basis for remuneration decisions.
Total remuneration Total remuneration for an individual employee is influenced by a number of factors such as the scope and complexity of the role, business performance and affordability, individual performance, internal relativities, and legal requirements. As described on pages 57 and 61, target opportunities are benchmarked to median levels in clearly defined markets. The remuneration mix between base salary and variable pay is also aligned with local market practices and internal structures. Zurich is transparent in the communication of how the reward structure and the processes used for decision making are defined. Total remuneration includes the following elements: Element Type Description
Target grants are made annually and each annual grant is divided into 3 equal tranches
• The relevant business performance is assessed against the business plan that is approved by the Board in December of the year prior to the performance year. The financial measures to fund the pools typically include the Group’s Net Income for the Leadership Team, and the relevant Business Operating Profit (BOP) for the business segments; for Farmers the business performance of the Farmers Exchanges is now also taken into account. Depending on actual achievements, the Group STIP funding pools can vary between 0 percent and 175 percent of the target pools. If the business performance is on target, the potential available Group STIP funding as percent of target awards is around 100 percent. However, if business performance is below target, the potential available Group STIP funding as a percent of target awards is normally below 100 percent and can be zero. In assessing the business results, the financial performance of the area and a review of risk considerations by the Chief Risk Officer are taken into account.
• In this way, short-term incentive awards are differentiated based on the performance achievements of the business and the individual. The funding is fully based on the business performance and given that the funding is available the payout is then based on the individual performance.
In recent years, more than 10,000 employees have been transferred from local incentive plans to Group STIP. For 2013 and 2014, it is foreseen to continuously analyze the possibility to transfer employees from local incentive plans to Group STIP taking into account the legal and market environment.
• moreover, for those share awards that vest, one half are sales restricted for a period of three years from the date of vesting.
• For performance based grants, these grants only vest if certain Group performance conditions are met in terms of the absolute return on common shareholders’ equity (ROE) and the position of the Group’s total shareholder return (TSR) compared with an international peer group of insurance companies based on the Dow Jones Titan Insurance Index. Performance is measured over a three year calendar period prior to the vesting date and the vesting percentage, based on the actual ROE and TSR achievements, can vary between 0 percent and 175 percent of the target grants. If the minimum performance thresholds are met, then the Group performance conditions are taken equally into account. If the minimum performance thresholds are not met, the target grants will not vest. The vesting percentage is proposed by the CEO to the Remuneration Committee and the Committee makes a recommendation to the Board for final approval. The vesting matrix is as follows: Level of vesting for share and share option target grants
The underlying performance matrix was reviewed by the Board and it was decided not to make any changes. The Board may exercise discretion in order to take the current environment into account when assessing the overall levels of vesting. Adjustments of +/–25 percent to the calculated level may be applied and can be positive or negative depending on extraordinary market circumstances for example with regard to interest rates, exchange rates etc. For the performance period 2010 to 2012, the Board has decided not to exercise any discretion.
Directors Directors’ fees All Directors receive a fee, which is paid partly in cash and partly by allocation of three-year sales restricted Zurich Insurance Group Ltd shares, for their memberships of the Boards of Zurich Insurance Group Ltd and Zurich Insurance Company Ltd. The shares are provided as part of the overall fee which is not subject to the achievement of any defined performance targets.
In 2012, no changes were made to the fee structure established in 2011. The Board has also decided not to make any changes in 2013.
Except for the Chairman and Vice Chairman, Directors are remunerated with an annual basic fee of CHF 240,000 in 2012 (CHF 240,000 in 2011). One-third of this annual basic fee, i.e. CHF 80,000 in 2012 (CHF 80,000 in 2011), is allocated to sales restricted Zurich Insurance Group Ltd shares. The fee is pro-rated for members leaving or joining during the year. Committee members receive an additional cash fee of CHF 50,000 in 2012 (CHF 50,000 in 2011) for all committees on which they serve, irrespective of the number of committees. In addition, the chair of each committee receives an annual fee of CHF 30,000 for 2012 (CHF 30,000 for 2011) and the chair of the Audit Committee receives an additional CHF 10,000 in 2012 (CHF 10,000 in 2011). The committees on which the Directors serve are set out in the Corporate governance report on page 26.
Where a Director is also a member of one or more subsidiary boards of Zurich Insurance Group Ltd, the Director is entitled to an additional fee of CHF 50,000 in 2012 (CHF 50,000 in 2011) per annum plus CHF 10,000 in 2012 (CHF 10,000 in 2011) per annum if he or she also chairs an audit committee of such a board.
The annual basic fee for the Vice Chairman during 2012 was CHF 375,000 (CHF 375,000 in 2011), of which an amount of CHF 125,000 in 2012 (CHF 125,000 in 2011) is allocated to sales restricted Zurich Insurance Group Ltd shares. The annual basic fee for the Chairman of the Board of Zurich Insurance Group Ltd during 2012 was CHF 1,000,000 (CHF 1,000,000 in 2011) and one-third of the total amount, i.e. CHF 333,500 in 2012 (CHF 333,500 in 2011) is allocated to sales restricted Zurich Insurance Group Ltd shares. Neither the Chairman nor the Vice Chairman receives any additional fees for their committee work.
Based on this structure, the total aggregate fees allocated to the Directors of Zurich Insurance Group Ltd and Zurich Insurance Company Ltd for the year ended December 31, 2012, amounted to CHF 4,244,246. This included CHF 3,166,298 in cash and a value at the allocation date of CHF 1,077,948 in three-year sales restricted shares. The share price at the allocation date was CHF 207.10. The corresponding amount for 2011 was CHF 4,257,500, which comprised CHF 3,079,000 in cash and a value at the allocation date of CHF 1,178,500 in three-year sales restricted shares. The share price at the grant date in 2011 was CHF 218.90. The Directors’ fees are not pensionable.
2 Committee members receive a cash fee of CHF 50,000 (CHF 50,000 in 2011) for all committees on which they serve, irrespective of the number. The committees on which the Directors serve are set out in the Corporate governance report on page 26.
8 In line with applicable laws, Zurich paid the company-related portion of contributions to social security systems, which amounted to CHF 160,340 in 2012. The corresponding contributions amounted to CHF 142,832 in 2011. Any personal contributions of the Directors to social security systems are included in the amounts shown in the table above.
10 As of June 30, 2011, Mr. Gentz was allocated 1,523 shares, Mr. Ackermann was allocated 571 shares, and the other Board members were allocated 365 shares based on a full year’s membership. The share price (CHF 218.90) as of June 15, 2011 was 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.
Termination arrangements for members of the Board who gave up their functions At the Annual General Meeting on March 29, 2012, the terms of office of Mr. Gentz and of Mr. Sankey expired and they did not stand for re-election. No termination payments (i.e. “golden parachutes”) were made and no other benefits such as waiver of lock-up periods for equities, shorter vesting periods or additional contributions to occupational pension schemes were provided.
Remuneration for former Directors No benefits (or waiver of claims) have been provided to former Directors during the year 2012, nor were any provided during the year 2011.
Share options held by Directors The members of the Boards of Zurich Insurance Group Ltd and Zurich Insurance Company Ltd do not participate in any share option plan for executive management. Hence, no share options have been allotted in the year under review or in earlier years. None of the Directors, nor any related parties to them, held any share options or conversion rights over Zurich Insurance Group Ltd shares as of December 31, 2012 or 2011.
Personal loans for former Directors As of December 31, 2012, and 2011, respectively, no former Director had outstanding loans, advances or credits.
Related parties to the Directors or to former members of the Board No benefits (or waiver of claims) have been provided to related parties of the Directors or related parties of former members of the Board during the years 2012 and 2011 nor had any related party of the Directors or of former members of the Board any outstanding loans, advances or credits as of December 31, 2012 and 2011.
Group Executive Committee Remuneration of the Group Executive Committee The total remuneration of the members of the GEC for 2012 comprised the value of cash remuneration (including short-term cash incentives), the target equity grants made under the Group’s LTIP in 2012, pensions and other remuneration.
The distribution of the total remuneration in 2012 between the individual remuneration elements is set out in the following chart and is based on the target values for the performance related remuneration.
The individual remuneration elements are described in more detail below (the amounts for the highest paid executive are also included): Value of total remuneration The total value of the various remuneration elements earned by the members of the GEC in 2012 was USD 46.4 million, a change of USD 3.9 million compared with USD 50.3 million earned in 2011 calculated on the same basis. The decrease is due to changes in the membership of the GEC and to lower expenditure on cash incentive awards earned for the year. In Swiss francs the total value declined from CHF 45.4 million to CHF 42.6 million.
The total value for 2012 comprises the following elements (the comparative figures for 2011 are shown in the table on total remuneration for all members of the GEC):
Overall funding for the incentives is based on the overall Group profit performance in 2012 and actual awards to individuals are based on a combination of factors, including the results of the business that the GEC member is responsible for and their individual performance with regard to the accomplishment of strategic objectives during the year. For members of the GEC, including the CEO, the target levels under the Group STIP for 2012 vary between 75 percent and 100 percent of the base salary. The maximum award for all members of the GEC, including the CEO, is 200 percent of the target level.
Share option grants The number of share option awards that vested in 2012 to members of the GEC serving in 2012 from the share option grants made in 2009 and 2010 was 91,747. This represented a basic vesting level of 110 percent of target given the actual ROE and TSR performance achievements.
Value of pension benefits accruing during 2012 Members of the GEC participate in the pension plan arrangements of the entities where they are employed. The Group’s philosophy is to provide pension benefits through cash balance and/or defined contribution plans where funds are accumulated throughout a career to provide retirement benefits. The majority of GEC members participate in such plans and, over time, all future GEC members will participate in such plans. The remaining members of the GEC participate in defined benefit plans that provide retirement benefits based on final pensionable earnings and the number of years of service. Normal retirement ages vary from 60 to 65. The total value of pension benefits accruing to members of the GEC during 2012, calculated on the basis of the service costs for the company as assessed under IAS 19 accounting principles, was USD 3.3 million. Service costs value the amount of the pension benefits accruing during the year and for defined contribution plans take the amount of the company contribution paid during the year.
2 On the basis of 13 GEC members, of whom 9 served during the full year 2012. 3 On the basis of 12 GEC members, of whom 9 served during the full year 2011. 4 The share grants will vest in the future according to achievement of defined performance conditions. The value of the shares assumes that the grant will vest in the future at 100 percent of the target level with the valuation of the target performance share grants based on the share price on the day prior to the grants (CHF 225.90 for 2012 and CHF 243.60 for 2011).
5 The amounts reflect the total value of pension benefits accruing to members of the GEC during 2012 and 2011, 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 costs on accrued benefits, adjustments for actuarial gains and losses, nor the expected return on any assets held.
8 The amounts have been translated to Swiss francs at the relevant exchange rates throughout the year and the cash incentive to be paid in 2013 has been translated at the year-end rate in 2012.
Based on these figures, the value of the total remuneration for all members of the GEC comprises 37 percent (39 percent in 2011) in fixed remuneration elements (comprising base salaries, service costs for pension benefits and other remuneration) and 63 percent (61 percent in 2011) in performance related components (comprising the cash incentive awards under the Group STIP together with the value of the target performance share grants).
in USD million, for the year ended December 31All GEC members (incl. the highest paid)
Member of the Group Executive Committee with the highest total remuneration The highest paid remuneration for the GEC members was CHF 7.6 million for Mr. Senn, the Group’s CEO. This amount reflects his 2012 base salary, the cash incentive earned for 2012, the value of the target performance shares granted in 2012, the value of pension benefits and other remuneration. This compares with an amount of CHF 7.9 million in 2011. All Mr. Senn’s remuneration is paid in Swiss francs.
The following table specifies the total remuneration paid to the highest paid GEC member: Base salary 1.60 1.60 Cash incentive awards earned for the year 2.00 2.40 Value of target performance share grants 2 3.60 3.60 Service costs for pension benefits 3 0.30 0.20 Value of other remuneration 4 0.10 0.10 Total in CHF 7.60 7.90 Total in USD 5 8.30 8.60 1 The remuneration shown in the table is gross, based on the accrual principle and does not include any business related expenses incurred in the performance of the CEO’s services.
Termination arrangements for members of the Group Executive Committee who gave up their functions during the year During 2012, two members of the GEC left the Group. Agreements with the departing members provided remuneration in accordance with their employment contracts. No termination payments (i.e. “golden parachutes”) were made and no other benefits such as agreements concerning special notice periods or longer term contracts (exceeding 12 months in duration), waiver of lock-up periods for equities, shorter vesting periods or additional contributions to occupational pension schemes were provided.
Remuneration for former members of the Group Executive Committee As described in previous reports a member who retired at the end of 2010, after long service with the Group, was retained as a consultant in 2011 and 2012. Recognizing the prior contractual obligations, adherence to postemployment obligations and the provision of services in 2012 the member received remuneration in the amount of USD 2.4 million during 2012. No other former members of the GEC received remuneration in 2012.
in CHF millions, for the year ended December 31Highest paid executive, Chief Executive Officer, Martin Senn in 2012 and 2011
Within the context of the Group LTIP, these performance share grants are considered for vesting in one-third installments during the three years after the grant and further half of the vested shares are sales restricted for a three year period. The actual level of vesting is determined in accordance with the remuneration principles set out above on page 63 and the LTIP vesting matrix as described on page 67.
In connection with the re-design of the Group LTIP in 2003, option grants were made in each year on the third working day in April. Further, the exercise price for the options granted in the past was set at the market price on the day prior to the date of grant. The performance based option grants are considered for vesting in one-third installments during the three years after the grant. The actual level of vesting is determined by the Group LTIP vesting matrix as described on page 67.
In order to prevent executives from losing the value of their options, in 2011, the Board approved an automatic exersale for all options being in the money at the end of the exercise period. A loss would otherwise occur if the executive was prohibited from dealing due to being in possession of price-sensitive information.
All options mentioned above entitle the holder to purchase one share of Zurich Insurance Group Ltd at the exercise price stated with normal voting and dividend rights.
as of December 31, 2012Summary of outstanding options, 2012 as of December 31, 2011Summary of outstanding options, 2011
6 Mr. Kerner was appointed to the GEC as of September 1, 2012. 7 Mr. Orator left the function on June 30, 2012 and his employment contract terminated on December 31, 2012.
Additional honoraria and remuneration for members of the Group Executive Committee None of the members of the GEC received any remuneration from the Group or from any of the Group’s companies in 2012 and 2011 other than as set out above.
As of December 31, 2012 and 2011, no former member of the GEC had any outstanding loans, advances or credits.
Related parties to members or former members of the Group Executive Committee No benefits (or waiver of claims) have been provided to related parties of GEC members or related parties of former members of the GEC during the years 2012 and 2011. Neither had any related party of GEC members or of former members of the GEC outstanding loans, advances or credits as of December 31, 2012 and 2011.
Base salaries 4,036 4,025 Value of other remuneration1 628 578 Service costs for pension benefits2 474 451 Total fixed remuneration 5,138 5,054 1 Includes employee benefits like health and dental insurance and other fringe benefits etc. 2 This represents the increase in the present value of the defined benefit pensions arising from employee service over the accounting period. The amount shown is calculated using actuarial factors and can vary year on year as economic conditions change.
• The total amount of sign-on incentive payments committed in the performance year. These payments were committed to people whose hire date was in 2012.
• The total amount of severance payments committed in the performance year. These payments were committed to people whose termination date was in 2012.
The figures do not include any charges or credits that originate from remuneration paid out during the financial year 2012 that derive from previous financial years.
In determining the amount of the Total Variable Remuneration Pool, the Board considers the long-term economic performance of the Group as well as other relevant factors. The average economic profit is calculated by subtracting the required return on capital, based on the weighted average cost of capital, from the adjusted Business Operating Profit after Tax. In this respect, the Group has generated economic profit over the long-term which exceeds the actual expenditure on variable pay.
Cash incentive awards earned for the year1 474 482 Value of target performance share grants made in the year2,3 134 136 Total Variable Remuneration Pool 608 618 1 Includes sign-on and severance payments in cash.
Total remuneration 5,746 5,672 1 Includes cash incentive awards, sign-on and severance payments in cash. 2 Includes performance share grants and sign-on payment in shares. 3 Includes other remuneration and pension benefits.
Impact on net income in 2012 and 2011 from remuneration granted in prior years Under the Group LTIP, a calculation is made at the date of vesting each year to determine the actual number of shares and options to be awarded to plan participants relative to the number that was expected to be awarded at the grant date. Any difference in value is reflected in the consolidated income statement in the year of vesting. For shares and options vesting in 2012 and in 2011, there was no material difference in the actual and estimated amounts.
Sign-on payments paid / number of beneficiaries1 3 6 3 7 Severance payments paid / number of beneficiaries2 2 5 3 7 1 “Sign-on payments” are payments (whether paid immediately or over time) that are agreed on the execution of an employment contract.
In this section Operating and financial review 84 Risk review 111
The information contained within the Operating and financial review is unaudited and presents the consolidated results of the Group for the years ended December 31, 2012 and 2011 and the financial position as of December 31, 2012 and December 31, 2011. All amounts are shown in U.S. dollars and rounded to the nearest million unless otherwise stated with the consequence that the rounded amounts may not add up to the rounded total in all cases. All ratios and variances are calculated using the underlying amount rather than the rounded amount. This document should be read in conjunction with the Annual Report 2012 of the Group and with its Consolidated financial statements as of December 31, 2012. Certain comparative figures have been restated, as set out in note 1 of the Consolidated financial statements. Details of the financial results from the dates of acquisition to December 31, 2012, for the Latin American insurance operations of Banco Santander S.A. (Zurich Santander) and for other acquisitions and divestments are set out in note 5 of the Consolidated financial statements.
In addition to the figures stated according to the International Financial Reporting Standards (IFRS), the Group uses business operating profit (BOP), new business measures and other performance indicators to enhance the understanding of its results. Details of these additional measures are set out in the Glossary These should be viewed as complementary to, and not as substitute to the IFRS figures. For a reconciliation of BOP to net income after income taxes see note 29 of the Consolidated financial statements.
Financial highlights 85 Performance overview 86 General Insurance 88 Global Life 93 Farmers 97 Other Operating Businesses 99 Non-Core Businesses 99 Investment position and performance 100 Insurance and investment contract liabilities 103 Capitalization 107 Cash flows 108 Currency translation impact 109
Business operating profit 4,075 4,243 (4%) Net income attributable to shareholders 3,878 3,750 3%
General Insurance gross written premiums and policy fees 35,610 34,572 3% Global Life gross written premiums, policy fees and insurance deposits 30,259 27,711 9% Farmers Management Services management fees and other related revenues 2,846 2,767 3% Farmers Re gross written premiums and policy fees 4,361 3,529 24%
General Insurance business operating profit 2,097 2,247 (7%) General Insurance combined ratio 98.4% 98.9% 0.5 pts
Farmers business operating profit 1,414 1,486 (5%) Farmers Management Services gross management result 1,378 1,333 3% Farmers Management Services managed gross earned premium margin 7.3% 4 7.3% –
Diluted earnings per share (in CHF) 24.66 22.52 10% Book value per share (in CHF) 214.79 202.17 6%
1 December 31, 2011 has been restated as set out in note 1 of the Consolidated financial statements. 2 Parentheses around numbers represent an adverse variance.
5 Calculated on average Group investments. 6 Ratios as of July 1, 2012 and January 1, 2012, respectively, are calculated based on the Group’s internal model which is subject to the review and approval of the Group’s regulator, the Swiss Financial Market Supervisory Authority (FINMA). The SST Ratio for January 1, 2012 has been restated following FINMA’s review of the Annual SST Report.
The execution of the Group’s strategy and focus on its core insurance business enabled strong growth and improved underlying profitability, which are critical to offset lower investment income due to a persisting low yield environment. Improved underlying profitability was sustained by contributions from Global Life and Farmers, as well as the strong underlying underwriting performance in General Insurance. The overall performance of General Insurance was negatively impacted by above average levels of catastrophe, large and weather-related losses, including Storm Sandy, as well as the extraordinary adverse impact relating to a review in Germany.
Business operating profit decreased by USD 169 million to USD 4.1 billion, or by 4 percent in U.S. dollar terms and 2 percent on a local currency basis.
Other Operating Businesses reported an increase in its business operating loss of USD 68 million to USD 903 million, mainly driven by the absence of favorable impacts from foreign currency movements compared with 2011.
• Global Life gross written premiums, policy fees and insurance deposits increased by USD 2.5 billion to USD 30.3 billion, or by 9 percent in U.S. dollar terms and 16 percent on a local currency basis, benefiting from the contribution from Zurich Santander as well as higher volumes of single premium products in Corporate Life & Pensions and Private Banking Client Solutions, partially offset by a reduction in Spain where the product mix continued to shift from savings towards higher margin protection products.
Net income attributable to shareholders increased by USD 128 million to USD 3.9 billion or by 3 percent. The benefit from net capital gains on investments as well as the absence of litigation and other one-off expenses which negatively impacted 2011, more than offset the decrease in business operating profit. The shareholders’ effective tax rate was 24.7 percent for 2012, compared with 24.2 percent for 2011, primarily as a result of adverse fluctuations in the geographic profit mix in 2012, which also impacted 2011 albeit to a lesser extent.
Gross written premiums and policy fees 35,610 34,572 3% Net earned premiums and policy fees 29,195 29,076 – Insurance benefits and losses, net of reinsurance (20,527) (20,939) 2% Net underwriting result 463 324 43% Net investment income 2,516 2,799 (10%) Net non-technical result (excl. items not included in BOP) (901) (886) (2%) Business operating profit 2,097 2,247 (7%) Loss ratio 70.3% 72.0% 1.7 pts Expense ratio 28.1% 26.9% (1.2 pts) Combined ratio 98.4% 98.9% 0.5 pts 1 Restated as set out in note 1 of the Consolidated financial statements.
Business operating profit decreased by USD 150 million to USD 2.1 billion or by 7 percent driven by a decline in investment income, partly offset by the improved net underwriting result. The net underwriting result benefitted from an improved underlying loss ratio, which more than compensated for the decrease in favorable development on reserves established in prior years, mainly arising in Germany from an increase of loss reserves for certain long-tail lines of business written in prior years, and higher commission expenses as the mix of business shifts toward products with higher commissions. Investment income decreased by USD 283 million or by 10 percent mainly due to lower yields and capital repatriation to the Group. This was partially compensated by an increase in hedge fund gains in the U.S.
Gross written premiums and policy fees increased by USD 1.0 billion to USD 35.6 billion, or by 3 percent in U.S. dollar terms and 7 percent on a local currency basis. The business remained focused on profitable growth and continued to capitalize on the favorable rate environment across all regions, achieving average rate increases of 4 percent. Premiums continued to increase in the mature North American market and, while part of this increase was attributable to adjustments to premiums for prior year policies as initial estimated insured risks were increased to reflect actual exposures, there have also been improvements in both customer retention and new business. In International Markets, Zurich Santander and Zurich Insurance Malaysia Berhad (ZIMB) contributed to the growth in premiums along with organic growth from the existing businesses. In Europe, premium volumes remain under pressure as a result of the economic environment in all significant markets as well as profit improvement efforts in selected portfolios such as personal lines motor.
The net underwriting result increased by USD 139 million to USD 463 million reflected in the improvement of 0.5 percentage points in the combined ratio to 98.4 percent. Across the portfolio, the business continued to execute against its strategic targets with an improvement in the underlying loss ratio of 2.9 percentage points following sustained increases in rates and focused actions to defend profit margins. Additionally, while the impact of Storm Sandy was significant, the overall catastrophe, large and weather-related events experienced throughout 2011 were more severe. Zurich Santander also contributed favorably to the overall result, improving the loss ratio by 0.7 percentage points. These improvements were partially offset by adverse development of reserves established in prior years mainly for certain long tail lines of business written in Germany. The expense ratio deteriorated by 1.2 percentage points to 28.1 percent. This was mainly driven by a higher commission ratio attributable to fluctuations in the business mix including business from Zurich Santander which carries a higher commission rate. The other underwriting expense ratio was virtually flat compared with 2011 in spite of continued investment in International Markets as well as higher pension expenses, as pension calculation assumptions were changed at the beginning of 2012 to recognize the economic environment. These increases were mostly offset by the continued execution of the strategic goal to reduce the expense base in mature markets.
in USD millions, for the years ended December 31 in USD millions, for the years ended December 31
Gross written premiums and policy fees 8,609 1 7,949 8% Net underwriting result 48 (300) nm Business operating profit 496 169 nm Loss ratio 78.0% 85.3% 7.3 pts Expense ratio 21.1% 20.3% (0.8 pts) Combined ratio 99.1% 105.6% 6.5 pts 1 net of internal business transfers
Business operating profit increased by USD 327 million to USD 496 million primarily as a result of the improvement in the underwriting result. Investment income was lower than in 2011 with the impact of lower yields across the portfolio partially compensated by hedge fund gains in the U.S. Non-technical expenses were slightly higher than in 2011 as a result of one-off charges in 2012 and the impact of a non-recurring benefit included in 2011, partially offset by gains on foreign currency transactions.
Gross written premiums and policy fees increased by USD 660 million to USD 8.6 billion, or by 8 percent in U.S. dollar terms and 12 percent on a local currency basis (after internal business transfers from North America Commercial) with higher average rate levels, particularly in energy, U.S. workers’ compensation, international property and European motor, and new business across the portfolio, which continued to drive growth. Renewal retention also remained strong, slightly higher compared with 2011 despite rate increases in targeted segments as the business continued to improve profitability. Focus remained on disciplined underwriting and pricing with average rate increases of 5 percent across all regions, and in particular overall average rate increases of 8 percent achieved in North America, an increase of 2 percentage points compared with 2011.
The net underwriting result improved by USD 348 million to a profit of USD 48 million reflected in the 6.5 percentage points improvement in the combined ratio to 99.1 percent. While 2012 includes the impact of Storm Sandy, the impact was less severe compared with the major catastrophe events that occurred during 2011. The favorable development in the loss ratio also included an improved underlying loss ratio, reflecting the impact of rate increases adding to the result and continued focus on improving overall profitability. The expense ratio was higher with a lower other underwriting expense ratio more than offset by an increase in the commission ratio resulting from a change in reinsurance programs which reduced ceding commissions and by increased volumes of products with higher commissions.
Gross written premiums and policy fees 10,003 1 9,777 2% Net underwriting result 26 315 (92%) Business operating profit 699 1,048 (33%) Loss ratio 71.4% 67.0% (4.4 pts) Expense ratio 28.2% 28.8% 0.6 pts Combined ratio 99.7% 95.9% (3.8 pts)
Gross written premiums and policy fees increased by USD 226 million to USD 10.0 billion, or by 2 percent (after internal business transfers to Global Corporate). Premium growth was attributable to the improving market environment that continued to support rate increases despite competitive pressures. The business continued to execute its ratetiering strategies and has achieved average rate increases of 5 percent, while realizing benefits from strategic growth initiatives. These included real estate, technology and financial institutions as well as certain products including auto warranty, specialty products, program business and captives. Premiums also benefited from higher adjustments for prior year policies as initial estimated insured risks were increased to reflect actual exposures.
The net underwriting result decreased by USD 289 million to USD 26 million, as reflected in the deterioration of 3.8 percentage points in the combined ratio to 99.7 percent. Substantial benefits continued to be generated by favorable underlying property results, increasing rates and the impact of the continued focus on profitability, particularly in workers’ compensation. The underwriting result also benefited from the earned effect of increases to premium for prior year policies. These improvements were offset, however, by a lower level of favorable development on reserves established in prior years, the impact of Storm Sandy, a higher incidence of large losses and losses related to crop businesses as a result of the drought in the U.S. The expense ratio improved by 0.6 percentage points as a result of efforts to improve operational efficiency.
The net underwriting result deteriorated by USD 50 million to USD 310 million, reflected in the deterioration in the combined ratio of 0.2 percentage points to 97.4 percent. The underlying loss ratio benefited from the continued implementation of profit improvement strategies. These were offset by lower levels of favorable development on reserves established in prior years, mainly in Germany, and an increase in severity of large losses. The increase in the expense ratio of 1.4 percentage points mainly arose from the movement of deferred policy acquisition costs and one-off charges in Germany. In addition, a change in pension calculation assumptions due to the economic environment increased the overall pension expenses, particularly in the UK.
Gross written premiums and policy fees increased by USD 1.2 billion to USD 5.6 billion, or by 27 percent in U.S. dollar terms and 34 percent on a local currency basis. Growth in Latin America was 72 percent on a local currency basis mainly attributable to the positive contribution from Zurich Santander as well as from underlying growth in motor lines in Brazil, Mexico and Argentina together with a positive contribution from insurance product sales through retail outlets in Brazil. Asia-Pacific achieved growth of 15 percent on a local currency basis benefiting from the newly acquired ZIMB as well as from underlying growth in Japan and Australia.
The net underwriting result improved by USD 320 million to a profit of USD 55 million reflected in the 9.1 percentage points improvement in the combined ratio to 98.7 percent. The loss ratio improved by 12.6 percentage points to 60.3 percent reflecting a lower level of catastrophe and weather-related events compared with significant events in Japan, New Zealand and Australia in 2011, as well as a favorable underlying loss experience in 2012 including a 4.3 percentage points improvement from the inclusion of Zurich Santander. These improvements were offset to some extent by a higher frequency of large losses and lower levels of favorable development of reserves established in prior years, following an inflation adjustment which increased the reserves for motor third party liability in Argentina. The higher expense ratio was mainly driven by higher commissions from the inclusion of Zurich Santander and growth in other higher commission products in Latin America, as well as higher other underwriting expenses linked to continuing investments in target markets and products in International Markets.
Gross written premiums and policy fees 13,590 11,583 17% Net investment income on Group investments 3,991 4,146 (4%) Insurance benefits and losses, net of reinsurance (9,592) (9,503) (1%)
Total reserves for life insurance contracts, net of reinsurance, and liabilities for investment contracts (net reserves) 2 214,676 195,951 10%
1 Business operating profit for 2012 included USD 105 million of profit from Zurich Santander earned between the dates of acquisition and December 31, 2012, calculated after deducting non-controlling interests and USD 21 million for an increase to the liability for future earn-out payments. Details of the overall IFRS impact are set out in note 5 to the Consolidated financial statements.
2 Restated as set out in note 1 of the Consolidated financial statements. 3 Assets under management comprise Group and unit-linked investments that are included in the Global Life balance sheet plus assets that are managed by third parties, on which fees are earned. 4 Net policyholder flows are defined as the sum of gross written premiums and policy fees and deposits, less policyholder benefits.
BOP before interest, depreciation and amortization (266) (169) 2,006 1,757 1,740 1,588 Interest, depreciation and amortization (273) (334) (273) (334)
The net expense margin improved by USD 62 million benefiting from increased fee income arising from an ongoing shift towards unit-linked products. The net risk margin improved by USD 7 million, with the positive impact from the increasing level of protection products offset by currency translation effects. The net investment margin reduced by USD 48 million, significantly impacted by currency translation effects, with the decrease in local currency driven by lower yields in North America, whilst realization of investment gains in Germany towards the end of 2012 significantly reduced the indirect strain experienced earlier in the year from the “Zinszusatzreserve” requirements. Other profit margins improved by USD 199 million, contributing USD 82 million to business operating profit, and included USD 225 million business operating profit from Zurich Santander, before the effect of non-controlling interests and earn-out charges, earned between the dates of acquisition in late 2011 and December 31, 2012. Furthermore the impact of acquisition deferrals decreased by USD 68 million resulting from a change in the method for deferring commissions introduced as of September 2011 primarily in Germany, offset by lower interest, depreciation and amortization costs.
Special operating items contributed USD 18 million to business operating profit, a decrease of USD 108 million compared with 2011. They included a charge of USD 74 million related to recent rulings by the German Federal Court of Justice, which impacted the local insurance industry, clarifying the application and effect of certain policyholder terms and conditions in the event of early contract termination.
Insurance deposits increased by USD 542 million to USD 16.7 billion, or by 3 percent in U.S. dollar terms and 10 percent on a local currency basis. An increase of USD 2.5 billion relating to the inclusion of Zurich Santander was partially offset by USD 1.4 billion lower insurance deposits in Spain as product mix shifted from savings to higher margin protection products.
Net reserves increased by USD 18.7 billion, or by 10 percent in U.S. dollar terms and 7 percent on a local currency basis compared with December 31, 2011, driven by favorable market movements in Europe. Assets under management increased by USD 22.5 billion, or by 10 percent in U.S. dollar terms and 7 percent on a local currency basis compared with December 31, 2011, also benefiting from favorable market movements in Europe. Net policyholder flows remained positive at USD 1.4 billion with net outflows in Europe being more than offset by net inflows in all other regions.
2 New business amounts do not include Zurich Santander and ZIMB. As set out in the Embedded value report, these businesses generated USD 195 million of new business value for the twelve months of 2012.
4 A refinement in methodology for calculating new business value for corporate protection business was introduced in 2011. This has a transitional impact over two years from the implementation date relating to renewals of business in-force at the date of the change. The renewed business contributed USD 68 million of new business value in 2012 compared with USD 126 million in 2011.
APE (excluding the recent acquisitions) increased by USD 38 million to USD 4.0 billion, or by 1 percent in U.S. dollar terms and 5 percent on a local currency basis, also benefiting from volume increases in North America, Latin America and Switzerland. In Latin America, the main driver of the increase was the successful participation in the social security (SIS) biennial bid process in Chile.
New business margin (excluding the recent acquisitions) decreased by 2.5 percentage points to 22.1 percent, mainly driven by a reduction of 1.4 percentage points related to the transitional impact of the methodology refinement for corporate protection renewals and a reduction of 2.0 percentage points related to the impact from the high volume and lower margin SIS transaction in Chile. These impacts were partly offset by increases driven by higher margin protection business, particularly in North America, Spain and the UK.
In Corporate Life & Pensions, new business value reduced by USD 8 million to USD 285 million. This reduction resulted from the decrease of USD 58 million in the transitional impact from the refinement in methodology for corporate protection renewals, offset by an increase of USD 51 million, or 30 percent, in underlying new business value. This increase was driven by the successful conclusion of the SIS transaction in Chile and the leverage of global relationships with major employee benefit consultants, particularly in the UK, where the increase in new business value was exceptionally strong at 68 percent in total for both corporate savings and corporate protection business. New business APE increased by USD 528 million, or 45 percent, mainly resulting from strong volume growth in corporate protection business in Chile and Switzerland.
1 Calculated based on gross earned premiums of the Farmers Exchanges of USD 18.8 billion, which excludes the return of USD 74 million in premiums as a result of the anticipated settlement of a lawsuit with the State of Texas.
Management fees and other related revenues of USD 2.8 billion increased by USD 79 million, or by 3 percent, driven by the higher management fee income from increased gross earned premiums in the Farmers Exchanges, which grew across all lines of business. Management and other related expenses of USD 1.5 billion increased by USD 34 million, or by 2 percent, compared with 2011. This increase was primarily due to higher costs associated with employee benefits and business transformation. Other net income and expenses of USD 62 million increased by USD 26 million, mainly driven by a benefit recognized due to the settlement of a portion of the pension liability related to vested plan participants who are no longer employed by the company.
The gross management result of USD 1.4 billion increased by USD 45 million, while the managed gross earned premium margin remained constant at 7.3 percent.
Business operating profit deteriorated by USD 142 million to a loss of USD 26 million. This deterioration was primarily due to the absence of favorable development of reserves established in prior years, which benefited Farmers Re during 2011. Investment income and other income decreased by USD 2 million, or by 2 percent, primarily due to lower yields which have more than offset the increase from the larger asset base created by the higher All Lines agreement participation rate.
The loss ratio increased by 1.8 percentage points compared with 2011. The 2011 result reflected favorable development of reserves established in prior years. Although weather-related losses were only slightly higher than 2011 they remained significantly above historical levels. This arose from high weather-related losses during the first half of 2012 relating to a series of tornados and hailstorms in the Midwest U.S. and severe wildfires in Colorado. However, weather-related losses were significantly lower in the second half of the year despite Storm Sandy. These adverse effects were partially offset by an improved underlying loss ratio in 2012 when compared with 2011. The expense ratio increased by 1.1 percentage points driven by a change in the reinsurance commissions.
Gross written premiums 18,935 18,297 3% Gross earned premiums 18,703 18,149 3%
Gross written premiums in the Farmers Exchanges, which are managed but not owned by Farmers Group, Inc., a wholly owned subsidiary of the Group, increased by USD 637 million to USD 18.9 billion, or by 3 percent. This increase was driven by continued premium growth in all lines of business primarily as a result of ongoing rate actions undertaken to improve profitability, which resulted in a small decrease in policies in force. Furthermore, the 2012 results are net of the return of USD 74 million of premiums as a result of the anticipated settlement of a lawsuit with the State of Texas and excluding this return gross written premiums were USD 19.0 billion, or 4 percent higher than 2011.
Other run-off 100 3 nm Total business operating profit 128 (8) nm 1 Banking activities includes Dunbar Asset Ireland, formerly known as Zurich Bank. On December 14, 2012, the Central Bank of Ireland approved Zurich Bank’s request to revoke its banking license. This change does not affect Zurich Bank International Limited which continues to operate in the Isle of Man nor Dunbar Assets plc which continues to operate in the UK.
Centrally managed businesses, which comprise run-off portfolios that are managed with the intention to proactively reduce risk and release capital, reported a business operating profit of USD 29 million compared with a loss of USD 11 million in 2011. Business operating profit for Centre improved by USD 15 million to USD 75 million mainly driven by reserve releases from the settlement of claims, partially offset by reduced favorable movements in financial markets on Centre’s insurance portfolio where both assets and liabilities are carried at fair value. Banking activities’ business operating loss improved by USD 18 million mainly reflecting lower charges for loan loss provisions compared with 2011. Other centrally managed businesses recorded a USD 26 million profit, which was mainly driven by the impact of the reinsurance agreement put in place as a first step for the transfer of a UK general insurance portfolio predominantly consisting of U.S. asbestos, pollution and health risks to a third party.
The Group’s asset and liability management strategy remains disciplined and the Group continues to reduce risks which it believes are not rewarded, such as foreign currency, interest rate and concentration risks. The quality of the Group’s investment portfolio remains high. Investment grade securities continue to comprise 98 percent of the Group’s debt securities.
of which: net capital gains/(losses) on investments and impairments attributable to shareholders 1,687 1,515 11%
Net investment result on Group investments 1 8,911 9,367 (5%) Net investment return on Group investments 4.4% 4.8% (0.4 pts) Movements in net unrealized gains/(losses) on investments included in total equity 5,349 1,090 nm Total investment result on Group investments 1 14,261 10,458 36%
Total return on Group investments 7.0% 5.3% 1.7 pts 1 After deducting investment expenses of USD 252 million for the years ended December 31, 2012 and 2011. 2 Restated as set out in note 1 of the Consolidated financial statements.
Net unrealized gains/losses on investments included in total equity increased by USD 5.3 billion since December 31, 2011. This mainly reflects higher net unrealized gains on debt securities of USD 4.7 billion resulting from the tightening of credit spreads and falling yields on government securities. Rising equity markets contributed net unrealized gains on equities of USD 606 million since December 31, 2011.
Net investment income 1,836 1,757 5% Net capital (losses)/gains on investments and impairments 8,431 (5,302) nm Net investment result, net of investment expenses 1 10,268 (3,544) nm
Total return on unit-linked investments was a positive 8.6 percent compared with a negative 3.2 percent in 2011. The improvement in the total return was due to net capital gains of USD 8.4 billion compared with net capital losses of USD 5.3 billion in 2011, reflecting stronger equity and debt markets in 2012 compared with those in 2011. Net investment income increased by USD 79 million.
Net losses and loss adjustment expenses incurred 23,769 22,465 20,547 20,919
Net reserves for losses and loss adjustment expenses 57,385 55,341 55,234 53,116
Gross reserves for losses and loss adjustment expenses 69,986 67,762 66,542 64,311 1 Restated as set out in note 1 of the Consolidated financial statements.
One year later 66.1% 64.2% 68.1% 66.2% 71.7% 74.1% 72.0% 73.2% 74.0% Two years later 65.4% 63.5% 66.6% 64.8% 70.6% 72.4% 70.7% 72.1% Three years later 65.5% 63.7% 65.0% 63.3% 69.4% 72.3% 70.6% Four years later 65.7% 62.9% 63.8% 62.6% 68.6% 72.1% Five years later 65.0% 62.2% 63.2% 61.6% 68.0% Six years later 64.6% 62.1% 62.6% 61.0% Seven years later 64.4% 61.9% 62.3% Eight years later 64.5% 61.9% Nine years later 64.5%
Irene in the U.S. and the floods in Thailand increased the loss ratio by a net 2.6 percentage points, after the Group’s aggregate catastrophe reinsurance recovery; • 2012: Storm Sandy in the north east of the U.S. increased the loss ratio by 2.5 percentage points.
Net reserves as of December 31 214,676 195,951 16,789 18,027 231,464 213,978 1 Restated as set out in note 1 of the Consolidated financial statements.
Total reserves and liabilities for insurance and investment contracts, net of reinsurance, increased by USD 18.7 billion, or by 10 percent in U.S. dollar terms and 7 percent on a local currency basis, compared with December 31, 2011. This increase was mainly driven by the impact of favorable market movements on investments in Europe. The increase in acquisition in 2011 is mainly related to Zurich Santander.
Asia-Pacific and Middle East 11,315 10,265 3,035 3,005 14,350 13,269 1 Restated as set out in note 1 of the Consolidated financial statements.
Unit-linked insurance and investment contracts, net of reinsurance, increased by USD 12.1 billion, or by 11 percent in U.S. dollar terms and 9 percent local currency terms, compared with December 31, 2011, mainly driven by the impact of favorable market movements on investments in Europe.
Other life insurance liabilities, net of reinsurance, increased by USD 6.6 billion, or by 8 percent in U.S. dollar terms and 6 percent on a local currency basis, compared with December 31, 2011, also mainly driven by the impact of favorable market movements on investments in Europe.
in USD millions, as ofGlobal Life – Reserves and liabilities, net of reinsurance, by region
Previously presented details of debt issuances in the Operating and financial review are now set out in note 21 of the Consolidated financial statements.
Net income after taxes 3,878 89 3,967 Net other recognized income and expenses 843 47 890
The Swiss Solvency Test (SST) became fully effective and mandatory as of January 1, 2011. Under SST, the Group is required to use a company-specific internal model to calculate risk-bearing and target capital and to file SST reports half yearly. For July 1, 2012 the Group filed, on a consolidated basis, an SST capitalization ratio of 178 percent, while the SST capitalization ratio as of January 1, 2012 amounted to 183 percent following a review by FINMA. The internal model continues to be subject to approval by FINMA.
Cash and cash equivalents as of January 1 10,162 9,726 Cash and cash equivalents as of December 31 10,359 10,162 1 Restated as set out in note 1 of the Consolidated financial statements.
Net cash and cash equivalents increased by USD 197 million for the year ended December 31, 2012 compared with an increase of USD 436 million in 2011. Net cash provided by operating activities, which included cash movements in and out of, as well as within total investments, was USD 2.6 billion for the year ended December 31, 2012. Net cash used in investing activities of USD 234 million related to the increase in the beneficial interest in Zurich Insurance Company South Africa Limited and to payments of deferred purchase price components related to the acquisition of ZIMB in 2011, as well as to sales and purchases of property and equipment. Net cash outflows from financing activities of USD 2.3 billion were primarily related to the payment of the dividend of USD 2.7 billion partially offset by the net issuance of debt of USD 260 million.
As the Group has chosen the U.S. dollar as its presentation currency, differences arise when functional currencies are translated into the Group’s presentation currency. The table below shows the effect of foreign currency rates on the translation of selected line items.
Zurich’s approach to risk management aims to protect the Group’s capital, enhance value creation, optimize its risk-return profile, support decision making and protect Zurich’s reputation and brand. The Risk review describes the Group’s risk management framework and risk governance, presents an analysis of its main risks, and reports on capital management and capital adequacy.
Risk management Mission and objectives of risk management 112 Risk management framework 112 External perspectives 113 Risk governance and risk management organization 114
Capital management and analysis of capital adequacy Capital management 148 Analysis of capital adequacy 149
Risk management is not only embedded in Zurich’s business but is also aligned with the Group’s strategic and operational planning process. The Group assesses risks systematically and from a strategic perspective through its proprietary Total Risk Profiling™ (TRP) process, which allows Zurich to identify and then evaluate the probability of a risk scenario occurring, as well as the severity of the consequences should it occur. The Group then develops, implements and monitors appropriate improvement actions. The TRP process is integral to how Zurich deals with change, and is particularly suited for evaluating strategic risks as well as risks to its reputation. At Group level this process is performed annually, reviewed regularly and tied to the planning process.
In addition to this qualitative approach the Group regularly measures and quantifies material risks to which it is exposed. The Zurich Economic Capital Model (Z-ECM) provides a key input into the Group’s strategic planning process as it allows an assessment as to whether the Group’s risk profile is in line with the Group’s risk tolerance. In particular, Z-ECM forms the basis for optimizing the Group’s risk-return profile by providing consistent risk measurement across the Group. See “Internal model capital adequacy (unaudited)” on page 155 for more information about the Group Risk Tolerance.
Regulatory regimes, such as the Swiss Solvency Test in Switzerland and the regulatory principles of Solvency II in the European Union, emphasize a risk-based and economic approach, based on comprehensive quantitative and qualitative assessments and reports.
Rating agencies are interested in risk management as a factor in evaluating companies. Standard & Poor’s, a rating agency with a separate rating for Enterprise Risk Management, has rated Zurich’s overall Enterprise Risk Management as “strong.” Reinsurance and credit risk controls remain “excellent.” Market, asset/liability management, reserving, catastrophe and operational risk controls, as well as strategic and emerging risk management, are seen as “strong.” Zurich is rated either “excellent” or “strong” in all of Standard & Poor’s dimensions for Enterprise Risk Management.
The Group is also involved in a number of international industry organizations engaged in advancing the regulatory dialogue and sound risk management practices pertaining to insurance. Zurich is also a standing member of and actively contributes to the Emerging Risk Initiative of the CRO Forum (an organization composed of the chief risk officers of major insurance companies and financial conglomerates that focuses on developing and promoting industry best practices in risk management).
The section below gives an overview of the Group’s risk governance and risk management organization.
Risk Management Network (including segment/regional Chief Risk Officers and Local Risk Officers)
The Risk Committee of the Board serves as a focal point for oversight regarding the Group’s risk management, in particular the Group’s risk tolerance, including agreed limits that the Board regards as acceptable for Zurich to bear, the aggregation of these limits across the Group, the measurement of adherence to risk limits, and the Group’s risk tolerance in relation to anticipated capital levels. The Risk Committee further oversees the Group-wide risk governance framework, including risk management and control, risk policies and their implementation, as well as risk strategy and the monitoring of operational risks. The Risk Committee also reviews the methodologies for risk measurement and the Group’s adherence to risk limits. The Risk Committee further reviews, with business management and the Group Risk Management function, the Group’s general policies and procedures and satisfies itself that effective systems of risk management are established and maintained. It receives regular reports from Group Risk Management and assesses whether significant issues of a risk management and control nature are being appropriately addressed by management in a timely manner. The Risk Committee assesses the independence and objectivity of the Group Risk Management function, approves its terms of reference, reviews the activities, plans, organization and quality of the function, and reviews key risk management principles and procedures.
To facilitate information exchange between the Audit Committee of the Board and the Risk Committee of the Board, at least one board member is a member of both committees. The Risk Committee met seven times in 2012 (once jointly with the Remuneration Committee).
Group Risk Management organization The Chief Risk Officer leads the Group Risk Management function, which develops methods and processes for identifying, measuring, managing, monitoring and reporting risks throughout the Group. Group Risk Management proposes changes to the risk management framework and the Group’s risk policies; it makes recommendations on the Group’s risk tolerance and assesses the risk profile. The Chief Risk Officer is responsible for the oversight of risks across the Group; he regularly reports risk matters to the Chief Executive Officer, senior management committees and the Risk Committee of the Board.
At Group level there are two centers of expertise: risk analytics and risk and control. The risk analytics department quantitatively assesses insurance, financial market and asset/liability, credit and operational risks and is the Group’s center of excellence for risk quantification and modeling. The risk and control department includes operational risk management, internal control framework, risk reporting, risk governance, and risk operations. The risk management network consists of the Chief Risk Officers (CROs) of the Group’s segments and regions, and the Local Risk Officers (LROs) of the business units and functions and their staff. While their primary focus is on operational and businessrelated risks, they are responsible for providing a holistic view of risk for their area. The risk officers are part of the management teams in their respective businesses and therefore are embedded in the business. The LROs also report to the segment or regional CROs, who in turn report to the Group’s Chief Risk Officer. The CROs of the Group’s segments and regions are members of the leadership team of the Group’s Chief Risk Officer.
Risk considerations are a key element in the strategic decision-making process. The Group assesses the implications of strategic decisions on risk-based return measures and risk-based capital in order to optimize the risk-return profile and to take advantage of economically profitable growth opportunities as they arise.
The Group faces the risk that actual losses emerging on claims provisions may be higher than anticipated. Because of this uncertainty, general insurance reserves are regularly measured, reviewed and monitored. The total loss and loss adjustment expense reserves are based on work performed by qualified and experienced actuaries at the local, regional and Group level.
To arrive at their reserve estimates, the actuaries take into consideration, among other things, the latest available facts, historical trends and patterns of loss payments, exposure growth, court decisions, economic conditions, in particular inflation, and public attitudes that may affect the ultimate cost of settlement. Inflation is monitored on a country basis; the monitoring process relies on both Zurich’s economic view on inflation and specific claims activity, and feeds into actuarial models and Zurich’s underwriting processes such as technical price reviews.
In most instances these actuarial analyses are made at least twice a year for on-going business according to agreed timetables. Analyses are performed by product line, type and extent of coverage and year of occurrence. The Group has reserve committees to facilitate communications and reporting regarding reserve opinions. A series of reserve committees feeds from the local level to regions and segments and into a Group reserve committee, where the Group’s total loss and loss adjustment expense reserves are consolidated and recommended for approval by Group management. As with any projection there is an inherent uncertainty in the estimation of claim reserves due to the fact that the ultimate liability for claims will be impacted by trends as yet unknown including future changes in the likelihood of claimants bringing suit, the size of court awards, and the attitudes of claimants toward settlement of their claims.
Tables 1.a and 1.b show the Group’s concentration of risk within the General Insurance business by region and line of business based on direct written premiums before reinsurance. The Group’s exposure to general insurance risks varies significantly by geographic region and may change over time. General insurance premiums ceded to reinsurers (including retrocessions) amounted to USD 5.9 billion and USD 5.3 billion for the years ended December 31, 2012 and 2011, respectively. Reinsurance programs such as catastrophe covers are managed on a global basis, and therefore, net premium after reinsurance is monitored on an aggregated basis.
Table 2.a in USD millions, for the year ended December 31, 2012
The Group models exposures in a center of excellence for consistency in approach and to form a global perspective on accumulations. The center of excellence for catastrophe modeling works with the local businesses to help improve the overall quality of data, by analyzing and comparing data quality levels, providing priorities for data quality improvements and supporting implementation with advice and external data, where required. The Group models potential losses from property policies located in hazard-prone areas with material exposure and adjusts for nonproperty related losses. These assessments principally address climate-induced perils such as windstorms, river floods, tornadoes and hail, and geologically induced perils such as earthquakes. The Group constantly seeks to improve its modeling, fill in gaps in models with additional assessments and increase the granularity of data collection in order to increase the accuracy and utility of the information.
The Group continues to improve the “Zurich view” of catastrophe risk by using output from multiple catastrophe models, by using internal and external expertise, for instance through the Natural Catastrophe Advisory Council, a group of scientists associated with research organizations such as the U.S. National Center for Atmospheric Research, the United States Geological Survey and the Intergovernmental Panel on Climate Change. Zurich further validates modeling results through comparisons with claims experience. In addition, Zurich continues its effort to extend assessments by evaluating potential non-modeled catastrophe hotspots and including appropriate modeling or loadings for non-modeled lines.
Georisks (earthquake) Climate-induced (includes one or more of windstorm, river flood, tornado/hail) Georisks and climate-induced
Life insurance risk The risks associated with life insurance include: • Mortality risk is the risk that actual policyholder death experience on life insurance policies is higher than expected. • Longevity risk is the risk that annuitants live longer than expected. • Morbidity risk is the risk that policyholder health-related claims are higher than expected. • Policyholder behavior risk is the risk that policyholders’ behavior in discontinuing and reducing contributions or withdrawing benefits prior to the maturity of the contract is worse than expected. Poor persistency rates may lead to fewer policies remaining on the books to defray future fixed expenses and therefore reduce the future positive cash
The Group’s use of market-consistent embedded value reporting principles allows Zurich to further understand and report on the risk profile of its life products and how risks would change in differing market conditions. Embedded value is the measure that markets use to value life businesses and is considered industry best practice. For more information, see the “Embedded value report.”
Certain life insurance contracts contain guarantees for which liabilities have been recorded for additional benefits and minimum guarantees. These arise primarily in the subsidiary Zurich American Life Insurance Company (ZALICO) (formerly known as KILICO) which in the past wrote variable annuity contracts that provide policyholders with certain guarantees related to minimum death and income benefits. After 2001, ZALICO no longer issued new policies with such features. The Group has a dynamic hedging strategy to manage its economic exposure and reduce the volatility associated with its closed book of variable annuities products within its U.S. life business. New Life products developed with financial guarantees are subject to review and approval by the Group-level product approval committee.
Zurich is exposed to two main types of concentration risk in its Global Life business: • From a market risk perspective, interest rate guarantees in Germany and Switzerland expose Zurich to financial losses that may arise as a result of adverse movements in financial markets. The Group also wrote a small book of variable annuity business in the U.S. with minimum guaranteed death benefits, but ceased writing new business in 2012. The management of these guarantees is a combination of asset-liability matching and hedging; see the “Market risk” section in the Risk review.
Sensitivities analysis for life insurance risk The Group reports sensitivities for the Global Life business on Embedded Value and New Business Value to changes in economic and operating risk factors. The operating factors include discontinuance rates, expenses, mortality and morbidity. The embedded value methodology adopted by the Group is based on a market-consistent approach to allow explicitly for market risks. See the “Embedded value report” for more information on the sensitivities for the Global Life business to economic and operating risk factors.
Asia-Pacific and Middle East 3,371 2,420 3,035 3,005 6,406 5,424 1 See note 29 of the Consolidated financial statements for additional information on the Group’s segments.
Ceded premium – trend (% of life insurance gross written premium ceded to reinsurers)
The Group uses reinsurance to manage risk to unusually severe or unusually frequent events, as illustrated on the following page, through the main in-force reinsurance covers as of December 31, 2012 for natural catastrophe events. The Group participates in the underlying risks through its retention and through its participation in the excess layers. The contracts are on a risk-occurrence basis except the aggregate catastrophe cover which operates on an annual aggregate basis. In addition to these covers, the Group has per risk programs, local catastrophe covers, bilateral risk swaps and catastrophe bonds in place. These covers are reviewed continuously and are subject to change going forward. The current covers are placed annually: January 1 for the U.S. Program and the Global Aggregate Catastrophe Cover; April 1 for the European Program and July 1 for the Rest of the World Program.
Reinsurance for natural catastrophes – unusually severe natural catastrophe events (in USD millions, as of December 31, 2012)
Losses retained for an individual event Amount of reinsurance secured under catastrophe treaties
Reinsurance for natural catastrophes – unusually frequent natural catastrophe events (in USD millions, as of December 31, 2012)
Variable retention between USD 900 million and USD 1,100 million, depending on the details of the catastrophe events i.e. which peril regions are hit and with what frequency
*On a co-participation basis, as summarized below: Global Aggregate Catastrophe Cover (USD 250 million)
Risk management initiatives during 2012 Throughout the year, the Group closely monitored the investment risk taken in a challenging financial market environment, and several actions were taken in order to reduce risks from equities, interest rates, and credit spreads. On equity risk, macro hedges have been implemented to reduce the tail risk to Asian, European and U.S. markets. On interest rate risk, duration mismatch has been further reduced through duration lengthening, in particular in Europe.
Analysis of market risk sensitivities Basis of presentation – General Insurance and rest of the businesses The basis of the presentation below is an economic valuation represented by the fair value for Group investments, IFRS insurance liabilities discounted at risk-free market rates (the Group describes risk-free market rates as swap rates) to reflect the present value of insurance liability cash flows and other liabilities, for example own debt. In the sensitivities, own debt does not include subordinated debt, which Zurich considers available to protect policyholders in a worstcase situation.
For determining the sensitivities, investments and liabilities are fully re-valued in the given scenarios. Each instrument is re-valued separately taking the relevant product features into account. Non-linear effects, where they exist, are fully reflected in the model. The sensitivities are shown after tax. They do not include the impact of Group- internal transactions.
Table 4.a in USD millions, as of December 31, 2012Economic interest rate sensitivities for the General Insurance business – current period
Table 4.b in USD millions, as of December 31, 2011Economic interest rate sensitivities for the General Insurance business – prior period
Other currencies Total 100 basis points increase in the interest rate yield curves Group investments (831) (148) (22) (36) (1) (1,037)
100 basis points decrease in the interest rate yield curves Group investments 895 111 22 26 1 1,055
Table 6.a in USD millions, as of December 31, 2012Economic interest rate sensitivities for the rest of the businesses – current period
Table 6.b in USD millions, as of December 31, 2011Economic interest rate sensitivities for the rest of the businesses – prior period
Analysis of economic sensitivities for equity risk Tables 7 through 9 show the estimated impacts from a 10 percent decline in stock markets, after consideration of hedges in place, as of December 31, 2012 and 2011, respectively.
10% decline in stock markets Total impact on Embedded Value (246) (298)
Net impact before tax (205) (174) Tax impact 49 42 Net impact after tax (156) (132)
Other currencies Total 100 basis points increase in credit spreads Net impact before tax (964) (334) (172) (143) (132) (1,744)
Table 10.a in USD millions, as of December 31, 2012Economic credit spread sensitivities for the General Insurance business – current period
Table 10.b in USD millions, as of December 31, 2011Economic credit spread sensitivities for the General Insurance business – prior period
Other currencies Total 100 basis points increase in credit spreads Total Impact on Embedded Value (189) (282) (100) (250) (130) (951)
Other currencies Total 100 basis points increase in credit spreads Total impact on Embedded Value (191) (612) (113) (224) (88) (1,229)
Other currencies Total 100 basis points increase in credit spreads Net impact before tax (521) (17) (11) (3) (1) (553)
Table 11.b in USD millions, as of December 31, 2011Economic credit spread sensitivities for the Global Life business – prior period
Table 12.a in USD millions, as of December 31, 2012Economic credit spread sensitivities for the rest of the businesses – current period
Because the Group has chosen the U.S. dollar as its presentation currency, differences arise when functional currencies are translated into the presentation currency. In December 2012, the Group started to apply net investment hedge accounting in order to protect against the effects of changes in certain exchange rates on selected net investments. The Group does not take speculative positions on foreign currency market movements. Using constant exchange rates from one year to the next, the Group’s 2012 net income attributable to shareholders would have been higher by USD 45 million (applying 2011 exchange rates to the 2012 result). In 2011 the result would have been lower by USD 78 million (applying 2010 exchange rates to the 2011 results).
10% increase in EUR / USD rate 877 769 GPB / USD rate 389 354 CHF / USD rate (253) (309) Other currencies / USD rates 774 752 1 Restated as set out in note 1 of the Consolidated financial statements.
The Group manages individual exposures as well as credit risk concentrations. The Group’s objective in managing credit risk exposures is to maintain them within parameters that reflect the Group’s strategic objectives and risk tolerance. Sources of credit risk are assessed and monitored, and the Group has policies to manage the specific risks within the various subcategories of credit risk. To assess counterparty credit risk, the Group uses the ratings assigned by external rating agencies, qualified third parties, such as asset managers, and internal rating assessments. When there is a difference among external rating agencies, the Group assesses the reasons for the inconsistencies and applies the lowest of the respective ratings unless other indicators of credit quality justify the assignment of alternative internal credit ratings. The Group maintains counterparty credit risk databases, which record external and internal sources of credit intelligence.
Macro review of the credit risk environment During 2012, the European government-debt crisis led to ongoing downgrades of governments and governmentrelated financial institutions. Spain and Italy and their financial institutions were downgraded by several notches. The negative trend spilled over to stronger governments such as France, which was downgraded by Moody’s in November and the UK, which was placed on watch negative. Nevertheless, credit risk pressures have diminished significantly as reflected in improved implied ratings for sovereign debt markets. Zurich continues to assess the potential effect of remaining uncertainties, as actions by policymakers are the main determinants of credit market valuations for governments and related institutions.
Credit risk concentration The Group regularly monitors and limits credit exposures by individual counterparty and related counterparties by the aggregated exposure across various types of credit risk for that counterparty. The Group’s exposure to counterparties’ parent companies and subsidiaries across sources of credit risk is aggregated to include reinsurance assets, investments, certain insurance products and derivatives. Best estimates, based on statistical data and own assessments, are used to assign loss-given-default percentages and loss dependency factors reflecting, for example, double default events. The aggregated exposure information is compared with the Group’s credit limits. The limits vary based on the underlying rating category of the counterparty. There was no material exposure in excess of the Group’s limits for counterparty aggregation as of December 31, 2012 and December 31, 2011, respectively. The Chief Risk Officer routinely reports the largest exposures to the Risk Committee of the Board.
Cash and cash equivalents amounted to USD 9.1 billion as of December 31, 2012 and USD 8.9 billion as of December 31, 2011. The risk-weighted average rating of the overall cash portfolio has decreased from “A+” to “A” in 2012 due to downgrades of several large financial institutions. 60 percent of the total was with the ten largest global banks, whose average rating was “A+” as of December 31, 2012 and December 31, 2011, respectively.
The Group measures the average issuer credit rating both with a linear and a risk-weighted scale. Despite the ongoing de-risking of the fixed income portfolio, the risk-weighted average issuer credit rating of the Group’s debt securities portfolio is “A–/BBB+” (2011: “A+”). This is mainly due to ongoing downgrades of governments and governmentrelated financial institutions in 2012 and the increase in value of the affected investments. Based on the linear scale, the average rating is “AA–“(2011: “AA”) and therefore in line with the “AA–” target rating as set out in the Group’s risk policy.
As shown in table 15, the Group had debt exposure to Eurozone nations of USD 34.2 billion and USD 29.7 billion as of December 31, 2012 and 2011, respectively. Exposure to Greece, Ireland, Italy, Portugal and Spain amounted to USD 11.3 billion and USD 10.6 billion as of December 31, 2012 and 2011, respectively, with the increase primarily driven by tightening credit spreads. In line with the Group’s risk strategy, the Group capped cross-border investments in governments in the peripheral countries of Europe, while retaining in those countries government exposures that back underlying business. In addition to the debt exposure, the Group had sovereign loan exposure of USD 4.7 billion and USD 4.9 billion to Germany as of December 31, 2012 and 2011, respectively.
The second largest concentration in the Group’s debt securities portfolio is to financial institutions (including banks), at 22.0 percent, of which 48.7 percent is secured. In response to the European government-debt crisis, the Group identified and selectively reduced unsecured and subordinated credit exposure issued by banks with weak credit profiles, and credit exposure to banks supported by weaker governments.
Table 15 in USD millions, as of December 31The Group’s debt exposure to Eurozone government & supranationals & similar
The third largest concentration in the Group’s debt securities portfolio is to structured finance securities (mortgage backed securities (MBS)/asset backed securities (ABS) and similar). Although credit risks of the underlying securities are diverse in nature, the Group also considers macro impacts that may affect structured finance sub-categories (e.g. auto or credit card ABS’s) in its credit assessments. Structured finance exposures are assessed on a look-through basis prior to acquisition and not merely on the strength of prevailing credit ratings or credit profiles.
Reinsurance assets include reinsurance recoverables of USD 19.7 billion and USD 19.5 billion as of December 31, 2012 and 2011, respectively, which are the reinsurers’ share of reserves for insurance contracts, and receivables arising from ceded reinsurance, gross of allowance for impairment, of USD 1.1 billion and USD 1.2 billion as of December 31, 2012 and 2011, respectively. Reserves for potentially uncollectible amounts of reinsurance assets amount to USD 206 million as of December 31, 2012 and 2011. The Group’s policy on impairment charges takes into account both specific charges for known situations (e.g. financial distress or litigation) and a general, prudent provision for unanticipated impairments.
Credit risk related to mortgage loans and mortgage loans given as collateral Mortgage loans and mortgage loans given as collateral expose the Group to credit risk. The mortgage business is dependent on local property market conditions and local legislation. Investment portfolio allocations made to mortgages consider these factors and are within the framework of the strategic asset allocation defined by the Group and adapted and approved by local investment committees. Conservative lending criteria (i.e. maximum mortgage loan to property value ratios) and the diversification of loans across many single borrowers, particularly in Germany and in Switzerland, help reduce potential loss. Dunbar Assets Ireland (formerly Zurich Bank) has, however, suffered from concentrations to a smaller number and type of borrowers, such as property developers and investors. Furthermore, business units are required to clearly state criteria for determining borrower and collateral quality in their local mortgage policies. The Group specifies requirements for the local policies and sets monitoring and reporting standards. The Group closely monitors the performance of the portfolios in terms of impairments and losses.
The Group’s largest mortgage loan portfolios are in Germany (USD 4.8 billion) and in Switzerland (USD 4.1 billion); these are predominantly secured against residential property. In Switzerland, the underlying properties of individual loans are revalued every 10 years. In Germany, the property valuation is not generally reassessed after the granting of the mortgage loan. A less frequent or no revaluation of the underlying property means that reported loan-to-value (LTV) ratios will be higher (lower) than they would be if property prices have risen (fallen) since their valuation.
Credit risk related to other loans The credit risk arising from other loans is assessed and monitored together with the fixed income securities portfolio. 66.1 percent of the reported loans are to municipalities or government or supranational institutions, of which 97.6 percent are to the German Central Government or the German Federal States. Table 17 shows the composition of the loan portfolio by rating class. As of December 31, 2012, a total of USD 8.0 billion or 68.3 percent of loans are secured. As of December 31, 2011, a total of USD 7.6 billion or 72.9 percent of loans were secured.
Receivables from ceded reinsurance form part of the reinsurance assets and are managed accordingly.
Analysis of financial assets Tables 18.a through 19.b provide an analysis, for non unit-linked businesses, of the age of financial assets that are past due but not impaired and of financial assets that are individually determined to be impaired.
Past due but not impaired financial assets – 537 – – 2,024 2,561
Less: impairment allowance Impairment allowances on individually assessed financial assets – 696 – – 117 814 Impairment allowances on collectively assessed financial assets – 37 – – 210 247 1 Available-for-sale debt securities are included net of USD 12 million of impairment charges recognized during the year. 2 USD 385 million past due but not impaired and USD 1.4 billion impaired mortgage loans relate to the run-off property loans at Dunbar Assets Ireland.
Table 18.a in USD millions, as of December 31, 2012Analysis of financial assets – current period
Neither past due nor impaired financial assets 144,050 9,867 215 11,943 14,173 180,248 Past due but not impaired financial assets. Past due by: 1 to 90 days – 242 4 1 1,086 1,333
Less: impairment allowance Impairment allowances on individually assessed financial assets – 618 – – 117 735 Impairment allowances on collectively assessed financial assets – 27 – – 203 230 1 Available-for-sale debt securities are included net of USD 55 million of impairment charges recognized during 2010. 2 USD 399 million past due but not impaired and USD 1.3 billion impaired mortgage loans relate to the run-off property loans at Dunbar Assets Ireland.
Tables 19.a and 19.b show how the allowances for impairments of financial assets in tables 18.a and 18.b have developed over the 2011 and 2012 financial years.
Increase/(Decrease) in allowance for impairments 69 13 39 Amounts written-off (4) (13) (37) Transfers – – – Foreign currency translation effects 23 – 5
Table 18.b in USD millions, as of December 31, 2011Analysis of financial assets – prior period
Table 19.a in USD millionsDevelopment of allowance for impairments – current period
1 Due to the reclassification to held for sale of the Group’s operations in Bolivia. (See note 5 of the Consolidated financial statements.)
The Group limits the percentage of the investment portfolio that is not readily realizable, and regularly monitors exposures to take action if necessary to maintain an appropriate level of asset liquidity. During 2012, the Group was within its limits for asset liquidity. The fair value hierarchy tables in note 26 to the Consolidated financial statements segregate financial assets into three levels to reflect the basis of the determination of fair value. These tables indicate the high liquidity of the Group’s investments.
Table 19.b in USD millionsDevelopment of allowance for impairments – prior period
Table 20.a in USD millions, as of December 31, 2012Expected maturity profile for reserves for insurance contracts, net of reinsurance – current period
Table 20.b in USD millions, as of December 31, 2011Expected maturity profile for reserves for insurance contracts, net of reinsurance – prior period
See note 6 of the Consolidated financial statements for information on the maturity of debt securities for total investments.
Within this framework, the Group: • Uses a scenario-based approach to assess, model and quantify the capital required for operational risk for business units under extreme circumstances (internal model calibrated to a confidence level of 99.95 percent over a one-year time horizon). This approach allows comparison of information across the Group and highlights the main scenarios contributing to the Z-ECM capital required. See chart “Z-ECM capital required for operational risk split by risk scenarios (unaudited)” on page 157 for more information.
In the area of information security the Group continued to focus on its global improvement program with special emphasis on protecting customer information, improving security with its suppliers and monitoring that access to information is properly controlled. This helps the Group to better protect information assets and ensure compliance with regulation and policies.
A key task is maintaining and developing capability of the Group’s business continuity with an emphasis on recovery from events such as natural catastrophe and the possibility of a pandemic. The Group continued to develop its existing business continuity capability by further implementing a more globally consistent approach to business continuity and crisis management.
Addressing the risk of claims and non-claims fraud continues to be of importance. In 2012, the Group continued its global anti-fraud initiative to further improve the Group’s ability to prevent, detect and respond to fraud. While claims fraud is calculated as part of insurance risk and non-claims fraud is calculated as part of operational risk for risk-based capital, both are part of the common framework for assessing and managing operational risks.
Eligible equity Total equity 36,862 33,973 Net of intangibles and other assets (8,501) (8,851) Free reserves for policyholder dividends 5,238 3,032
Deferred policyholder acquisition costs non-life insurance (3,088) (3,043) Dividends, share buy-back and nominal value reduction (2,730) 2 (2,647) Total eligible equity 33,488 27,317 Total required solvency capital 12,031 11,789 Excess margin 21,458 15,528 Solvency I ratio 278% 232%
As of December 31, 2012 and 2011 respectively, the Group and its material, regulated subsidiaries complied with the applicable regulatory minimum capital requirements.
The following chart shows the estimated impact on the Group’s solvency position of a one percentage point increase/ decrease in yield curves, a separate 20 percent rise/decline in all stock markets, after consideration of hedges in place and a separate one percentage point change in credit spreads, as of December 31, 2012. The sensitivities are considered separate but instantaneous scenarios.
• The interest rate scenarios assume a parallel shift of all interest rates. • The equity market scenario assumes a concurrent movement of all stock markets.
• The Group effective tax rate is assumed to be 24.7 percent in 2012. For the Non-Core Businesses with life insurance characteristics, specific tax rates have been applied.
Sensitivities for the Group’s Solvency I ratio and IFRS equity (as of December 31, 2012)
1 Does not include sensitivities to the underlying assets and liabilities related to the transaction with Zurich Santander. (For more information, see note 5 of the Consolidated financial statements.) The impact of sensitivities on changes to the SST Target Capital is only approximated and only taken into account on Market/ALM risk.
While the Z-ECM and the SST models are overall very similar, below is a summary of the main differences between the two approaches.
The Group uses Z-ECM to assess the economic capital consumption of its business on a one-balance-sheet approach. The Z-ECM framework is an integral part of how the Group is managed. The Z-ECM framework is embedded in the Group’s organization and decision making, and is used in capital allocation, business performance management, pricing, reinsurance purchasing, transaction evaluation, risk optimization, regulatory, investor, and rating agency communication. Z-ECM quantifies the capital required for insurance-related risk (including premium and reserve, natural catastrophe, business and life insurance), market risk (market/ALM), credit risk (including reinsurance credit and investment credit) and operational risks.
Results in either higher capital requirements or lower available financial resources, or both.
The chart below shows the development of the Group’s Z-ECM available financial resources, Z-ECM capital required and Z-ECM ratio over time.
January 1, 2010 January 1, 2011 July 1, 2011 January 1, 2012 July 1, 2012
The chart below shows a split of the Z-ECM capital required split by risk type as of July 1 and as of January 1, 2012 respectively. As of July 1, 2012, the largest proportion of Z-ECM capital required arises from Market/ALM risk which comprises 32 percent of the total. Premium & Reserve risk is the second largest, comprising 22 percent.
1 The transaction with Zurich Santander and the acquisition of Zurich Insurance Malaysia Berhad is included in the total Z-ECM capital required, but is not considered in the split by risk type.
As part of Z-ECM, the Group uses a scenario-based approach to assess, model and quantify the capital required for operational risk for business units under extreme circumstances and a very small probability of occurrence (internal model calibrated to a confidence level of 99.95 percent over a one-year time horizon). The chart below shows the operational risk scenarios that have the highest impact on Z-ECM capital required. See “Operational risk (audited)” on page 146 for more information.
Z-ECM capital required split by risk type %, as of July 1 and January 1, 2012
Regulatory compliance: This risk scenario covers the possible risk of non-compliance with applicable laws and regulations leading to a range of consequences including fines and penalties, litigations, compensation to policyholders, increased regulatory scrutiny, financial losses and increased cost of compliance.
Market abuse: This risk scenario covers the possibility of investigation and possible sanction or fines imposed on Zurich as a company or any member of staff as a result of market abuse.
Conduct of business: This risk scenario covers the possible risk that staff, processes and systems may act in ways that lead to inappropriate conduct of business in relation to the customer. This covers all activities undertaken by Zurich employees and its agents and other authorized parties acting on Zurich’s behalf in the solicitation, sale or procurement, settlement, surrender or inspection of a Zurich product or service. ‘Treating Customers Fairly’ is a subset of this category.
2 Greece, Ireland, Italy, Portugal and Spain 3 The general insurance risk-specific scenarios relate to natural catastrophe events that are estimated on a modeled 250-year net aggregate loss (equivalent to a 99.6%
probability of non-exceedance). 4 The second assumption under the lapse risk scenario, “increase in base lapse rates of 50% for all future years,” is applied in a similar manner as the Embedded Value sensitivity, “10% increase in voluntary discontinuance rates”; however the former is pre-tax while the latter is post-tax. (For more details, see the “Embedded value report.”) Also, combining the assumptions in the lapse risk scenario introduces potential non-linear effects, which makes it difficult to directly compare the scenario with the Embedded Value sensitivity.
Impact of market, credit, and insurance scenarios on Z-ECM1 as of July 1, 2012
Conclusion Zurich’s risk management framework is well embedded in the business. It sets clear responsibilities for taking, managing, monitoring and reporting risks, and is based on a transparent risk tolerance and risk limit system approved by the Board. A very strong financial condition enabled Zurich to safely navigate a broad range of regulatory, economic and operational challenges in 2012.
Insurance-related and business risks: main drivers of the Group’s required capital
In 2012, Zurich conducted more than 150 Total Risk ProfilingTM exercises, allowing for a systematic assessment of risk from a strategic perspective. The Zurich Risk Policy was strengthened for various areas, including outsourcing.
Processes for a well-balanced and effectively managed remuneration program were strengthened.
The Group participates in a number of international industry organizations focusing on promoting best practices in risk management, and is a main contributor to the World Economic Forum’s Global Risk Report.
In this section Consolidated financial statements 164 Embedded value report 288 Holding company 326 Shareholder information 348 Contact information 351 Glossary 352
Consolidated income statements 165 Consolidated statements of comprehensive income 166 Consolidated balance sheets 168 Consolidated statements of cash flows 170 Consolidated statements of changes in equity 172 1. Basis of presentation 174 2. New accounting standards and amendments to published accounting standards 178 3. Summary of significant accounting policies 179 4. Critical accounting judgments and estimates 190 5. Acquisitions and divestments 196 7. Derivative financial instruments and hedge accounting 206 8. Reserves for insurance contracts and reinsurers’ share of reserves for insurance contracts 211 9. Liabilities for investment contracts 218 10. Equity component relating to contracts with DPF 218 11. Gross and ceded insurance revenues and expenses 219 12. Deferred policy acquisition costs and deferred origination costs 220 13. Administrative and other operating expense 221 14. Farmers management fees and other related revenues 222 15. Mortgage loans given as collateral and collateralized loans 222 16. Property and equipment 223 17. Goodwill and other intangible assets 224 18. Receivables and other assets 227 19. Other liabilities 227 20. Income taxes 229 21. Senior and subordinated debt 233 22. Shareholders’ equity 237 23. Employee benefits 239 24. Share-based compensation and cash incentive plans 245 25. Contingent liabilities, contractual commitments and financial guarantees 248 26. Fair value of financial assets and financial liabilities 251 27. Related party transactions 258 28. Farmers Exchanges 260 29. Segment information 262 30. Significant subsidiaries 283 Report of the statutory auditor 286
Reinsurers’ share of reserves for insurance contracts 8 19,753 19,592 18,816 Deposits made under assumed reinsurance contracts 2,588 2,711 2,837 Deferred policy acquisition costs 12 18,346 17,420 16,187
Additional paid-in capital 22 8,172 9,907 11,630 Net unrealized gains/(losses) on available-for-sale investments 4,523 2,800 2,468 Cash flow hedges 238 232 56 Cumulative foreign currency translation adjustment (3,022) (2,581) (1,120)
Cash flows from operating activities Net income attributable to shareholders 3,878 3,750 Adjustments for: Net (gain)/loss on divestments of businesses 34 (6) (Income)/expense from equity method accounted investments (18) (12) Depreciation, amortization and impairments of fixed and intangible assets 1,085 996 Other non-cash items 134 123
Proceeds from sale and repurchase agreements (332) (1,572) Movements in receivables and payables (2,081) 494 Net changes in other operational assets and liabilities 389 (573) Deferred income tax, net 463 (135) Net cash provided by/(used in) operating activities 2,563 3,888 in USD millions, for the years ended December 31
Other interest income received 6,852 7,270 Dividend income received 1,843 1,778 Other interest expense paid (1,147) (1,104) Income taxes paid (1,231) (1,098)
in USD millions, for the years ended December 31 in USD millions, for years ended December 31Cash and cash equivalents
4 Zurich RegCaPS Funding Trusts II, V and VI redeemed USD 575 million of Trust Capital Securities II, V and VI on March 30, 2011 (Series II), on April 4, 2011 (Series V) and on April 25, 2011 (Series VI) respectively.
5 The number of treasury shares deducted from equity as of December 31, 2012 amounted to 1,348,395 (December 31, 2011: 1,373,392; December 31, 2010: 1,399,080).
Net income – – – – – – 3,746 3,746 4 3,750 Net unrealized gains/(losses) on available-for-sale investments – – 332 – – – – 332 – 332 Cash flow hedges – – – 176 – – – 176 – 176 Cumulative foreign currency translation adjustment – – – – (1,461) – – (1,461) – (1,461) Revaluation reserve – – – – – 54 – 54 – 54 Net actuarial gains/(losses) on pension plans – – – – – – (933) (933) – (933)
USD 795 million between the dividend at transaction day exchange rates amounting to USD 2,706 million and the dividend at historical exchange rates amounting to USD 1,912 million is reflected in the cumulative foreign currency translation adjustment.
On February 13, 2013 the Board of Directors of Zurich Insurance Group Ltd authorized these Consolidated financial statements for issue. These financial statements will be submitted for approval to the Annual General Meeting of Shareholders to be held on April 4, 2013.
General information The Consolidated financial statements of the Group have been prepared in accordance with International Financial Reporting Standards (IFRS) and comply with Swiss law. Where IFRS does not contain clear guidance governing the accounting treatment of certain transactions including those that are specific to insurance and reinsurance products, IFRS permits reference to another comprehensive body of accounting principles that uses a similar conceptual framework. The Group’s accounting policies for insurance and reinsurance contracts are therefore based on those developed by the Group before the adoption of IFRS 4 in areas where IFRS 4 did not include specific requirements. Before the time of adoption, the Group typically applied U.S. GAAP pronouncements issued by the Financial Accounting Standards Board (FASB) on insurance and reinsurance contracts. Any subsequent changes to such pronouncements are not reflected in the Group’s accounting policies. In case of business combinations, the Group may decide to maintain the local statutory treatment if this does not distort the fair presentation of the financial position of the Group. If significant, the impact of such cases is described elsewhere in the notes to these Consolidated financial statements.
Certain amounts recorded in the Consolidated financial statements reflect estimates and assumptions made by management about insurance liability reserves, investment valuations, interest rates and other factors. Critical accounting judgments and estimates are discussed in note 4. Actual results may differ from the estimates and assumptions made.
All amounts in the Consolidated financial statements, unless otherwise stated, are shown in USD, rounded to the nearest million with the consequence that the rounded amounts may not add to the rounded total in all cases. All ratios and variances are calculated using the underlying amounts rather than rounded amounts.
Table 1.1 summarizes the principal exchange rates used for translation purposes. Net gains/(losses) on foreign currency transactions included in the consolidated income statements were USD 79 million and USD 112 million for the years ended December 31, 2012 and 2011, respectively. Foreign currency exchange forward and swap gains/(losses) included in these amounts were USD 130 million for both of the years ended December 31, 2012 and 2011.
Revenues Gross written premiums 47,748 – 47,748 Policy fees 2,452 – 2,452 Gross written premiums and policy fees 50,200 – 50,200 Less premiums ceded to reinsurers (6,550) – (6,550) Net written premiums and policy fees 43,650 – 43,650 Net change in reserves for unearned premiums (751) – (751) Net earned premiums and policy fees 42,899 – 42,899 Farmers management fees and other related revenues 2,767 – 2,767 Net investment result on Group investments 9,367 – 9,367
Net investment result on unit-linked investments (3,544) – (3,544) Net gain/(loss) on divestments of businesses 6 – 6 Other income 1,488 – 1,488 Total revenues 52,983 – 52,983 Benefits, losses and expenses Insurance benefits and losses, gross of reinsurance 38,106 25 38,132 Less ceded insurance benefits and losses (5,052) – (5,052) Insurance benefits and losses, net of reinsurance 33,054 25 33,080 Policyholder dividends and participation in profits, net of reinsurance (2,685) – (2,685) Underwriting and policy acquisition costs, net of reinsurance 8,523 (7) 8,516 Administrative and other operating expense 8,270 – 8,270 Interest expense on debt 586 – 586 Interest credited to policyholders and other interest 479 – 479 Total benefits, losses and expenses 48,227 19 48,246 Net income before income taxes 4,757 (19) 4,738 Income tax expense (965) 2 (963)
Table 1.2 in USD millions, for the year ended December 31, 2011Restatement of the consolidated income statement
Real estate held for investment 8,468 4 – 8,472 Mortgage loans 11,058 – – 11,058
Reinsurers’ share of reserves for insurance contracts 19,361 231 – 19,592 Deposits made under assumed reinsurance contracts 2,711 – – 2,711 Deferred policy acquisition costs 16,864 641 (85) 17,420 Deferred origination costs 824 – – 824 Accrued investment income 2,589 – – 2,589 Receivables and other assets 32,766 (14,938) – 17,828 Mortgage loans given as collateral 223 – – 223 Deferred tax assets 2,076 – – 2,076 Assets held for sale 54 – – 54 Property and equipment 1,579 1 – 1,580
Liabilities Reserve for premium refunds 554 58 – 611 Liabilities for investment contracts 50,661 297 – 50,958 Deposits received under ceded reinsurance contracts 1,543 17 – 1,560 Deferred front-end fees 5,720 – – 5,720 Reserves for insurance contracts 240,811 12,211 185 253,207 Obligations to repurchase securities 1,794 – – 1,794
Liabilities held for sale 55 – – 55 Senior debt 6,541 – – 6,541 Subordinated debt 5,476 – – 5,476
Equity Share capital 10 – – 10 Additional paid-in capital 9,907 – – 9,907 Net unrealized gains/(losses) on available-for-sale investments 2,800 – – 2,800 Cash flow hedges 232 – – 232
Consolidated financial statements continued 2. New accounting standards and amendments to published accounting standards
Amended Standards IFRS 7 Disclosures – Transfer of Financial Assets 1 1 July 2011 IAS 12 Deferred Tax – Recovery of Underlying Assets 1 1 January 2012 1 Adoption has no significant impact on the Consolidated financial statements
IAS 1 Presentations of Components of Other Comprehensive Income (OCI) 1 1 July 2012 2013
IFRS 7 Disclosures – Offsetting Financial Assets and Financial Liabilities 1 1 January 2013 2013
2 Expected to result in an immaterial net deconsolidation impact resulting from the additional consolidation of certain structured entities that are currently accounted for as associates and the deconsolidation of silo-structures and funds.
a) Consolidation principles The Group’s Consolidated financial statements include the assets, liabilities, equity, revenues, expenses and cash flows of Zurich Insurance Group Ltd and its subsidiaries. A subsidiary is an entity in which Zurich Insurance Group Ltd owns, directly or indirectly, more than 50 percent of the outstanding voting rights, or which it otherwise has the power to control. The results of subsidiaries acquired are included in the Consolidated financial statements from the date of acquisition. The results of subsidiaries that have been divested during the year are included up to the date control ceased. All significant intercompany balances, profits and transactions are eliminated in full.
The Consolidated financial statements are prepared as of December 31 based on individual company financial statements at the same date. In some cases information is included with a time lag of up to three months. The effect on the Group’s Consolidated financial statements is not material.
Where unrealized gains or losses on the revaluation of available-for-sale assets arise they are recorded directly in OCI in accordance with the Group’s accounting policy for such assets, with the corresponding adjustments to the reserves for life benefits and related assets also recognized directly in OCI.
Deferred acquisition costs (DAC) Costs that vary with and are directly related to the acquisition of new and renewal business, including for example commissions and certain 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.
DAC for other traditional life insurance and annuity contracts is amortized over the life of the contracts based on expected premiums. Expected premiums are estimated at the date of policy issue for application throughout the life of the contract, unless a premium deficiency subsequently occurs.
Reinsurance is recorded gross in the consolidated balance sheet. 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 assets are assessed for impairment on a regular basis for any events that may trigger impairment. If 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.
Unit-linked investment contracts These represent portfolios maintained to meet the specific investment objectives of policyholders who bear the credit, market and liquidity risks related to the investments. The liabilities are carried at fair value, with fair value being determined by reference to the underlying financial assets and changes in fair value are recorded in income. The related assets for unit-linked investment contracts are classified as designated at fair value through profit or loss in order to reduce measurement inconsistencies.
Categories and measurement of investments (excluding derivative financial instruments) 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.
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 irrevocably designated at fair value through profit or loss at inception.
Financial assets irrevocably designated at inception at fair value through profit or loss are mainly financial assets backing unit-linked insurance contracts, unit-linked investment contracts and certain life insurance contracts with participation features. The designation of these assets at fair value through profit or loss eliminates or significantly reduces a measurement inconsistency that would otherwise arise from measuring assets or from recognizing the resultant gains and losses on them on a different basis to the liabilities.
Financial assets at fair value through profit or loss are carried at fair value. Realized and unrealized gains and losses arising from changes in the fair value are recognized in income within net capital gains/(losses) on investments and impairments, in the period in which they arise.
Real estate held for investment is initially recorded at cost (including transaction costs) and is subsequently measured at fair value with changes in fair value recognized in income. The gain or loss on disposal of real estate held for investment is the difference between the net proceeds received and the carrying amount of the investment and is recognized in the consolidated income statement when the disposal is completed.
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. 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 further 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 quarterly 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, other European countries and 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.
When there is objective evidence that an available-for-sale equity security is impaired, the cumulative loss that had been recognized directly in OCI, including any portion attributable to foreign currency changes, is recognized in income as an impairment loss. The impairment loss is the difference between the weighted-average acquisition cost (less any impairment loss on that security previously recognized in income) and the current fair value. Impairment losses on equity securities are not reversed through income, instead, when the fair value of a previously impaired equity security increases, the resulting unrealized gains are recognized through OCI. Any further decrease in fair value recorded subsequent to recognition of an impairment loss is also reclassified from OCI to income as impairment losses, together with any portion attributable to foreign currency changes, until the equity security is derecognized.
Held-to-maturity investments and loans and receivables Generally, significant held-to-maturity financial assets are individually assessed to determine whether or not objective evidence of impairment exists. If no objective evidence of impairment exists the asset is included in a group of financial assets with similar credit risk characteristics that are collectively assessed for impairment.
f) Derivative financial instruments and hedge accounting Derivative financial instruments, except those designated under a qualifying hedge relationship are classified as held for trading assets or liabilities and carried at fair value on the balance sheet with changes in fair value recognized in income. Derivative financial instruments include embedded derivative features which are assessed at inception of the contract and, depending on their characteristics, are measured and presented as separate derivative financial instruments.
Derivative financial instruments that qualify for hedge accounting Derivative financial instruments are used by the Group to economically hedge risks. In limited circumstances derivative financial instruments 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
All hedge relationships are formally documented, including the risk management objectives and strategy for undertaking hedge transactions. At inception of a hedge and on an ongoing basis, the hedge relationship is formally assessed in order to determine whether the hedging instruments are highly effective in offsetting changes in fair values or cash flows of hedged items attributable to the hedged risk. If these conditions are not met, then the relationship does not qualify for hedge accounting, in which case the hedging instrument and the hedged item are reported independently in accordance with the respective accounting policy as if there was no hedging designation. Where hedge accounting conditions are met, the accounting treatments are as follows: Fair value hedges Gains or losses from re-measuring the derivative financial instruments that are designated and qualify as fair value hedges are recognized immediately in the same line item of the consolidated income statement as the offsetting change in fair value of the hedged item attributable to the risk being hedged.
Financial liabilities are derecognized when they are extinguished, which is when the obligation is discharged, cancelled or has expired.
Consolidated financial statements continued lending agreements, the Group retains substantially all the risks and rewards of ownership of these loaned securities, and also retains contractual rights to the cash flows therefrom. These securities are therefore not derecognized from the Group’s balance sheet. Cash received as collateral for loaned securities is recorded as an asset and a corresponding liability is established.
Under a reverse repurchase agreement, the securities received are not recognized on the balance sheet, as long as the risk and rewards of ownership have not been transferred to the Group. The cash delivered is derecognized and a corresponding receivable is recorded and reported within “Receivables and other assets”. Interest income is recognized in income using the effective interest rate method over the life of the agreement.
j) Intangible assets Intangible assets include goodwill, present value of future profits from acquired insurance contracts, attorney-in-fact relationships, distribution agreements and other intangible assets, such as computer software licenses and capitalized software development costs.
Goodwill on the acquisition of associates and jointly controlled entities is included in the value of equity method accounted investments and is tested for impairment as part of the overall measurement of the carrying amount of those investments.
Distribution agreements Distribution agreements may have useful lives extending up to 30 years which are estimated based on the period of time over which they are expected to provide economic benefits, but no longer than the contractual term, after taking into account all economic and legal factors such as stability of the industry, competitive position and the period of control over the assets.
Software Costs associated with research and maintenance of internally developed computer software are expensed as incurred. Costs incurred during the development phase are capitalized. Software under development is tested for impairment annually.
Acquired computer software licenses are capitalized on the basis of the costs incurred to acquire and bring to use the specific software.
Restructuring provisions comprise employee termination costs and costs related to onerous contracts. Restructuring provisions are recognized when the Group has a present obligation as a result of a detailed formal plan, which has been announced to those affected and the amount can be reasonably estimated.
Consolidated financial statements continued l) Treasury shares Zurich Insurance Group Ltd shares held by the Group are classified as treasury shares and are deducted from shareholders’ equity, net of transaction costs and tax. The nominal value of treasury shares is deducted from share capital. The difference between the nominal value and the amount paid to acquire the treasury shares, is allocated between additional paid-in capital and retained earnings. No gain or loss is recognized in the consolidated income statements on the purchase, sale, issue or cancellation of treasury shares.
n) Net investment income Net investment income includes investment income earned and investment expenses incurred.
Investment expenses Investment expenses consist of costs relating to investment management services and operating expenses for real estate held for investment. These expenses are recognized on an accrual basis.
o) Employee benefits Share-based compensation and cash incentive plans The Group operates long-term incentive plans which comprise the allocation of a target number of shares and/or share options. With effect from 2011, share option grants were discontinued.
q) Income taxes The Group provides current tax expense according to the tax laws of each jurisdiction in which it operates. Deferred income taxes are recognized using the asset and liability method. Deferred income taxes are recorded for temporary differences, which are based on the difference between financial statement carrying amounts and income tax bases of assets and liabilities using enacted income tax rates and laws. Losses for tax purposes are treated as deferred tax assets to the extent it is probable that they can be utilized against future taxable income in the respective jurisdictions.
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 related to certain investment contracts with DPF 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.
The application of certain accounting policies necessitates critical accounting estimates that involve discretionary judgments and the use of assumptions which are susceptible to change due to inherent uncertainties. Because of the uncertainties involved, actual results could differ significantly from the assumptions and estimates made by management. Such critical accounting estimates are of significance to insurance reserves and deferred acquisition costs, the determination of fair value for financial assets and liabilities, the determination of fair values of assets and liabilities attributable to business combinations, impairment charges, deferred taxes and employee benefits.
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 may 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.
See note 8 for further information on reserves for insurance contracts and note 12 for deferred policy acquisition costs. Also refer to the insurance risk section of the Risk Review.
b) Fair value measurement All financial assets and liabilities are recorded initially at fair value. Subsequently, available-for-sale 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 26.
In addition, the Group’s policy is to ensure that independently sourced prices are developed by making maximum use of current observable market inputs derived from orderly transactions and by employing widely accepted valuation techniques and models. When third party pricing providers are unable to obtain adequate observable information for a particular financial instrument, the fair value is determined either requesting selective non-binding broker quotes or using internal valuation models.
Fair values of equity securities are generally based on quoted prices in an active market (i.e., exchange or dealer market) for identical assets. If such quoted prices are not available, then fair values are estimated on the basis of information from external pricing providers or internal pricing models (for example, discounted cash flow models or other recognized valuation techniques).
Discounted cash flow models are used for mortgage and other loans and long term receivables. The discount yields in these models use either current interest rates charged by the Group on these instruments or calculated rates that reflect the return a market participant would expect to receive on instruments with similar remaining maturity, cash flow pattern, currency, credit risk, collateral and interest rates.
Fair values of derivative instruments are obtained from quoted market prices, dealer price quotations, discounted cash flow models and option pricing models, which use various inputs including current market and contractual prices for underlying instruments, time to expiry, correlations, yield curves, prepayment rates and volatility of underlying instruments. Such inputs used in pricing models are generally market observable or derived from market observable data.
See notes 6, 7 and 26 for further information on the fair value of financial assets and liabilities.
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 bank distribution agreements, the multi-period excess earnings or cash flow method is applied, using future cash flows expected to be generated from such assets discounted at applicable market rates. For information technology intangibles the replacement cost method is generally applied.
Financial assets A financial asset is considered impaired if there is objective evidence of impairment as a result of one or more occurred loss events that have an impact on the estimated future cash flows of the financial asset. The decision to record an impairment is based on a review of such evidence, for example, the issuer’s current financial position and its future prospects and the national or economic conditions that correlate with defaults on the assets reviewed for impairment.
Goodwill and Attorney-in-fact relationships (AiF) Goodwill is allocated to the Cash Generating Units (CGU) which represent the lowest level at which goodwill is monitored for internal management purposes. For goodwill the recoverable amount is the higher of its fair value less costs to sell and its value-in-use. Fair value at a CGU level is determined, considering quoted market prices, current share values in the market place for similar publicly traded entities, and recent sale transactions of similar businesses. Value-in-use is determined using the present value of estimated future cash flows expected to be generated from or used by the CGU. Cash flow projections are based on financial budgets, which are approved by management, typically covering a three-year period or if appropriate, a longer period. Cash flows beyond this period are extrapolated using amongst others estimated perpetual growth rates. The discount rates applied reflect the respective risk free interest rate adjusted for the relevant risk factors to the extent they have not already been considered in the underlying cash flows.
CGUs are defined separately for the three main business segments, General Insurance, Global Life and Farmers. General Insurance and Farmers are considered as single worldwide CGUs. For Global Life CGUs are defined on a lower level in line with management’s view of the business.
The recoverable amount of the intangible assets with an indefinite life related to the Farmers segment (i.e. attorney-infact (AIF) relationships and goodwill) is determined on the basis of value-in-use calculations. These calculations use cash flow projections based on business plans which are approved by management and typically cover a three-year period.
Zurich Assurance Ltd and Openwork Holdings Ltd Life 109 5.9 5.8 – –
Sensitivity tests have been performed on goodwill and typically comprised of an analysis for a decrease in cash flows of up to 30 percent, a decrease in the perpetual growth rate of up to 1.0 percentage point or an increase in the discount rate of up to 3.5 percentage points in order to reflect current adverse market conditions. No impairments were identified on this basis.
Banco Sabadell S.A. entities in Spain 1,763 9.0 4.8 – 8.3 2.5 2.5 Banco Santander S.A. entities in Latin America 1,852 7.8 – 20.1 n / a n / a n / a
Sensitivity tests have been performed on distribution agreements and typically comprised of an analysis for a decrease in cash flows, a decrease in the perpetual growth rate or an increase in the discount rate, applying reasonably possible changes. No impairments were identified on this basis.
Fin an cial info rm atio n e) 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, is 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. The utilization of deferred tax assets arising from unused tax losses or tax credits depends on the generation of sufficient taxable profits before the unused tax losses or tax credits expire. 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.
Transactions in 2012 Acquisitions On May 25, 2012, the Group increased its shareholding in Zurich Insurance Company South Africa Limited, a partially owned subsidiary, to 84.05 percent by purchasing a 25.1 percent shareholding from Royal Bafokeng Finance (Pty) Limited (RBF) for a purchase price of approximately USD 75 million. With this purchase of 25.1 percent the Group’s controlled interest for the Consolidated financial statements is now in line with its legal ownership. The put option right granted to RBF in 2010 to sell back its entire shareholding to the Group also ceased to exist.