Financial Highlights 2 Key Performance Indicators 3 Shareholder Letter 4 Zurich at a Glance 6 Challenge and Opportunity 8 A Strategy for Profitable Growth 10 Board of Directors 14 Group Executive Committee 16
Risk Management 20 Corporate Responsibility 26 Corporate Governance 30 Remuneration Report 54
We aspire to become the leading global insurance group in our chosen general and life insurance markets, consistently delivering top-tier results for our shareholders. By so doing, we will create strong relationships with our customers, agents and brokers, and provide rewarding opportunities for our employees.
• Strong risk management culture results in immaterial exposure to sub-prime financial crisis
Share Data 260 Financial Calendar 262 Contact Information 262 Glossary 263
The following table presents the summarized consolidated results of the Group for the years ended December 31, 2007. The 2006 amounts have been restated for the adoption of the SoRIE option under IAS 19 Employee Benefits.
in USD millions, for the years ended December 31 2007 2006 Change 1
General Insurance gross written premiums and policy fees 35,650 34,123 4%
Global Life gross written premiums, policy fees and insurance deposits 21,703 21,022 3%
Global Life new business annual premium equivalent (APE) 2,947 2,500 18%
Global Life new business margin, after tax (as % of APE) 24.7% 21.6% 3.1 pts
Group investments return (as % of average invested assets) 5.3% 5.1% 0.2 pts
Total Insurance Global Life Services Businesses Functions 5’000 4’000 3’000 2’000 1’000
(1’000) 1 Restated because of the change in accounting policy in accordance with IAS 19 Employee Benefits.
Success in this era of tightening credit, fragile equity markets and competitive insurance rates demands a deep commitment to financial discipline and risk management. It requires a profound understanding of the risks one assumes – on both the asset and liability sides of the ledger – and the operational processes to ensure consistency of execution.
We continue to identify and pursue the most promising growth opportunities globally, systematically expanding our customer base, enhancing our product offerings, and broadening our distribution capabilities. Each of these has been pursued through organic means and acquisitions, both in emerging and mature markets, and as we look into 2008 we see promising opportunities to continue this targeted approach to profitable growth.
Each of these profitability levers is applied across our general and life insurance businesses in a differentiated manner, targeting growth where the opportunities are right or margin where market conditions suggest otherwise. This approach underpins our commitment to maximize the value of our diverse portfolio, generating sustained shareholder value and superior financial results.
Zurich Financial Services (Zurich) is an insurance-based financial services provider with a global network of subsidiaries and offices in North America and Europe as well as in Asia Pacific, Latin America and other markets. Founded in 1872, the Group is headquartered in Zurich, Switzerland. It employs approximately 60,000 people serving customers in more than 170 countries.
Our core business is insurance. We offer a comprehensive range of general and life insurance products and services for individuals, small businesses, mid-sized and large companies, and global corporations seeking domestic or international cover.
The General Insurance business model is built on global functions (including underwriting, claims management, risk engineering, reinsurance, customer relationship, distribution management and product management) and practices (including global specialties), providing a global platform for local business delivery.
Global Life concentrates on three regions – Europe, the United States and emerging markets. Its global focus is on unit-linked and protection products. It also serves customer segments in family protection, equity-based savings, pension provision, post-retirement, wealth accumulation, wealth protection and inheritance.
Propositions are distributed through agents, brokers, independent financial advisers, banks and credit unions. Global Life benefits from strong positions in all key markets, as well as extensive distribution networks in the United Kingdom and United States. In Germany, Italy and Spain, it partners with Deutsche Bank, which positions Zurich as its exclusive supplier of life insurance products. In key emerging markets, Global Life is one of the fastest growing providers of life insurance and savings products, particularly for international investors and global expatriate populations.
Farmers is our Group’s main market brand for personal insurance in the United States, providing homeowners, auto and life insurance, with more than 20 million policies. Farmers also provides business insurance, with a focus on the small commercial market. Farmers Management Services consists of the management services provided by Farmers Group, Inc. and its subsidiaries to the Farmers Exchanges, which we manage but do not own.
We take a global approach to our core businesses of general and life insurance. We have a strong presence in the world’s most attractive insurance markets, and use our scale and financial strength to deliver international service.
Profitable growth We rigorously apply operational and financial discipline throughout our organization, as proven factors in promoting profitable growth.
Operational transformation We increasingly share knowledge and best practice, continue to develop more global platforms, enhance data quality and improve our expense ratios.
Talent management We are committed to mentoring and developing our people, to identifying and fostering talent throughout our organization, and to providing a stimulating and rewarding environment for all employees.
As an innovative insurer, we have looked forward and outward since our earliest days 135 years ago. Over the years we have spread our reach and now have strong positions on both sides of the Atlantic as well as in Asia Pacific, Latin America and other markets.
While determined to strengthen our leadership in existing markets, we are also adopting a focused approach to the world’s emerging markets, with the long-term aim of achieving a significant position in our chosen businesses. These emerging markets are a strategic priority to help us deliver substantial future value and establish Zurich as one of the top global insurers.
We are already present in many of these markets, for example China, where we have been represented since 1993. As the home of an economy that has grown ten percent year on year for two decades, China offers huge potential.
We are also strengthening our presence in eastern Europe and beyond, entering the Russian personal lines market in 2007 and acquiring Turkish general insurer TEB Sigorta A.S. in January 2008.
In Latin America, we have operations in Argentina, Bolivia, Brazil, Chile, Mexico and Venezuela, and are now developing microinsurance programs in these countries to help the less-advantaged sections of the population protect their income and their future.
The Zurich Way, which unifies our approach to business and to our customer, is a vital and basic element in binding our organization together as we develop further.
Our Growth Office has established a prioritization framework for expansion to ensure a coordinated and effective use of resources. In the emerging markets of Asia, Latin America and Eastern Europe, General Insurance will aim to achieve high growth and establish strategic market positions, thereby making a substantial contribution to both top and bottom lines. Global Life, with a growth in emerging markets of 50 percent in 2007, will continue to follow its strategy of leveraging best-in-breed products through innovative distribution channels in targeted market segments, thereby ensuring success in achieving its annual premium equivalent and new business value growth objectives.
Combining this focus on emerging markets with our traditionally strong presence on both sides of the Atlantic helps us to understand many of the key risk issues facing today’s world. As the World Economic Forum points out in its Global Risks Report for 2008, of which Zurich is a sponsor, uncertainty about the short- and medium-term future is as high as it has been for a decade.
The report identifies four emerging issues as shaping the global risk landscape: systemic financial risk, food security, supply chains and the role of energy. All four are central to the functioning of the world economy and to the well-being of global society.
Progress on understanding and managing global risks is taking place, and with understanding will come collaborative solutions involving all segments of society. Once again, though, on so many of these issues the world’s focus returns to emerging markets, where major economies have increasingly demonstrated their impact on the global economy and their willingness to assume a leadership role.
Our strategy also draws on other strengths and synergies such as capital and risk management, talent recruitment and management, and the continued building of our global brand.
We remain determined to transform efficiency and effectiveness of delivery of services to our customers through operational transformation. We will continue to systematically assess our core processes for ways to drive additional efficiency and capability gains.
Global Life has achieved double-digit growth and expects to sustain growth in the coming years, supported by a deep inventory of profitable growth and operational transformation initiatives along with the appetite for strategic acquisitions if attractive opportunities present themselves. Having established a strong platform for future growth since 2003, it now has a well-diversified portfolio and a growing share in most of its main markets. It has rebalanced distribution, increased exposure to the fast-growing bank and broker channels, and shifted the focus to growing new business volume while maintaining healthy margins.
Farmers’ aspiration is to maintain current levels of margin while growing the size of the business and its profitability. Farmers is now positioned as one of the fastest growing personal and small business insurers in the US with a focus on excellence in customer experience, product management and distribution.
In following our strategic objectives, we are supported and guided by The Zurich Way, which is designed to create common methodologies, metrics and toolboxes for the core processes within our Group. It transforms the way we do business every day and helps us provide better services to customers in a consistent and recognizably “one Zurich” way.
Since The Zurich Way’s introduction in 2004, we have made hundreds of process improvements, delivering quantifiable and sustainable operational benefits. The financial benefits achieved comfortably exceeded the 2007 target of USD 700 million after tax, and further benefits of USD 2.4 billion after tax are expected from more than 500 initiatives over the next three years. All combine to provide a firm foundation for profitable growth.
We target growth where opportunities exist, or margin enhancement where market conditions are more restrictive. We deploy capital in areas that offer a higher return.
Throughout our organization, employees are embracing an entrepreneurial spirit that encourages them to suggest areas for growth, improvement and innovation. At all times, they follow the precepts of Zurich Basics, our core values from which The Zurich Way was developed. This leads to an immeasurably valuable global exchange of ideas.
Financial discipline remains paramount. We have diligently and rigorously measured our performance over the past five years, and will continue to do so. Nowhere was our commitment to this principle better demonstrated in 2007 than in the area of investment management, a critical function that manages Zurich’s Group investments of more than USD 190 billion. The key to our success is that Zurich manages its assets centrally using a structured and disciplined framework. The fundamental tenet of the strategy is recognizing that assets must be managed relative to liabilities and that any risk in the asset portfolio must be well understood and compensated for through a reasonable return. In this way, we focus on maximizing economic value creation for policyholders and shareholders.
We pursue a similar philosophy throughout all our core functions, and ensure a consistent and prudent approach to risk management. This centralized approach to risk is not possible without state-of-the-art technology solutions. Investment Management has been developing and enhancing its investment information system over the past eight years, bringing together data on shares, bonds and other investments with more than 43,000 positions spread over more than 200 balance sheets globally.
Effective risk management underpins our own business as well as that of our customers. We see it as a fundamental element of any business strategy, not merely a reaction to external influences.
Tom de Swaan Director, member of the Risk Committee, member of the Governance and Nominations Committee
We define enterprise risk management as the structured, Group-wide way of identifying, measuring, managing, reporting and responding to risks that affect the achievement of our strategic and financial objectives. We look at the risks and the opportunities on both sides of the balance sheet.
Our risk management goals are to protect the capital base, enhance value creation, support decision-making and protect our reputation and brand by building a culture of risk awareness.
Our main categories of risk include: • Insurance – risk transferred to us from customers through the underwriting process
• Operational – risk associated with the people, processes and systems of the company, and external events
• Reputation – risk that an act or omission by the company or any of our employees could result in damage to our reputation or loss of trust among our stakeholders
• Credit – risk associated with a loss or potential loss from a counterparty failing to fulfill its financial obligations
For details regarding credit and market risks, and additional aspects of insurance risk, please see the Consolidated Financial Statements, note 26 Risk Management.
Various external stakeholders, among them rating agencies and accounting bodies, are placing increasing emphasis on the importance of sound risk management in our industry.
New International Financial Reporting Standards require that certain risk management information be subjected to audit in the annual Consolidated Financial Statements. For information related to our credit and market risks, and additional aspects of insurance risk, please see the Consolidated Financial Statements, note 26 Risk Management.
Also, we are intensively involved in the CRO Forum (an organization composed of the chief risk officers of major European insurance companies and financial conglomerates), which focuses on developing and promoting industry best practices in risk management. We were particularly involved in 2007 in the Forum’s efforts to help shape European solvency requirements.
The Group has additional audit or risk committees at all levels of the organization that regularly and systematically review risks in the Group’s various businesses and ensure appropriate management attention.
The Chief Executive Officer, together with the Group Executive Committee, oversees the Group’s performance with regard to its risk management policies as well as the further development of these policies when required. At the end of 2007, the Group appointed a member of the Group Executive Committee as our Group Chief Risk Officer, reflecting the enhanced role for risk management in today’s complex environment, and the strategic significance we place on risk management.
We manage risks throughout the organization, from the Chief Executive Officer to our businesses and functional areas, in alignment with our matrix organization. We have centers of expertise at the Corporate Center for some risk types, such as credit and market, with decentralized management of risks that occur mainly at the local level.
We also maintain a dialog with rating agencies regarding the assessment of our capital adequacy.
The financial strength ratings of the Group’s main operating entities are an important element of our competitive position. Moreover, the Group’s credit ratings derived from the financial strength ratings affect the cost of capital. In June 2007 Standard & Poor’s upgraded the financial strength rating of Zurich Insurance Company and other key operating entities of the Group to ‘AA-.’ In October and December 2007 Fitch and A.M. Best, respectively, changed the outlook on their ‘A+’ and ‘A (excellent)’ financial strength rating on Zurich Insurance Company from ‘stable’ to ‘positive.’
We work to ensure that all of our regulated subsidiaries meet local regulatory capital requirements at all times. Our primary capital management tool is our internal risk-based capital model (RBC). We use RBC to assess the economic capital consumption of our business on a one-balance sheet approach. We define risk-based capital as the capital needed to protect the Group’s policyholders against the worst-case loss (which we calibrate according to our financial strength target of AA, as an event with a one-in-2000 probability of occurring over a one year time horizon; this translates to a 99.95 percent confidence level). The RBC framework is an integral part of how we manage the Group. It continues to be embedded into our organization and decision-making, such as capital allocation, business performance management, pricing, reinsurance purchasing, transaction evaluation, risk optimization, and regulatory and rating agency communication.
Our use of the European Embedded Value reporting principles allows us to further understand and report on the risk profile of our Life products and how risks would change in differing market conditions. Embedded value is the measure markets use to value life businesses; we are using a market-consistent approach, which is considered industry best practice. For more information, please see the Embedded Value Report.
A fundamental component of managing our risks is underwriting discipline. We set limits on underwriting capacity, and cascade authority to individuals based on their specific expertise. Through The Zurich Way, we set appropriate pricing guidelines with a focus on consistent technical price across the organization. Technical reviews confirm whether underwriters perform within authorities and adhere to our underwriting philosophies and policies. Our global line of business networks share best practices across the globe, providing additional guidance and governance. As with life insurance products, we have governance procedures to review potential new products to evaluate whether the risks are well understood and justified by the rewards.
Understanding the potential effects of natural catastrophes is a critical component of our risk management for General Insurance. While specific catastrophes are unpredictable, modeling helps us determine potential losses should catastrophes occur. We use a combination of third-party and in-house models to help manage our underwriting and accumulations in modeled areas so that we stay within intended exposure limits and to help guide the reinsurance we buy.
Generally, all risks contain some aspect of operational risk. The Zurich Way initiatives help us manage operational risks through standardization of processes. In addition, we have been working to more precisely identify key operational risks, by applying a common approach across the Group, and by leveraging information from other sources of risk information such as internal controls and Total Risk Profiling®. We are conducting operational risk assessments, which are a qualitative evaluation of such risks, and we are building a loss-event data base. Analyzing such losses helps us make changes where needed.
In 2007, we rolled out our operational risk framework to major business units. We also piloted a scenariobased approach to quantifying operational risk early in the year and then used the methodology for our riskbased capital calculations.
As with operational risk, every risk type has potential consequences for Zurich’s reputation. Therefore, effectively managing each type of risk also helps us reduce threats to our reputation. Additionally, we endeavor to preserve our reputation by adhering to applicable laws and regulations, and by following the core values and principles of Zurich Basics, which include integrity and good business practice. We centrally manage certain aspects of reputation risk, for example, communications, through functions with the appropriate expertise.
Strategic business decisions by nature involve risks. We work to reduce the unintended risks of those decisions through our risk assessment tools, including the Total Risk Profiling® process. The Group Executive Committee regularly assesses key strategic risk scenarios for the Group as a whole, and we evaluate the risks in specific merger & acquisition transactions. The Group further manages such risks by assigning clear responsibilities, authorities and limits for review and approval of strategic decisions.
Corporate responsibility is about how we do business. Therefore, you will find relevant information, including information about our commitment to excellence in serving our customers and employees, two key stakeholders, throughout the Business Review 2007.
Microinsurance combines the core skills and sophistication of insurance and risk management with new learning, research and innovation in order to appropriately and expediently serve low-income populations. Its aim is sustainability; the products and services must provide benefits to the customer in a commercially viable way for the provider.
We partnered this year with governmental and nongovernmental agencies, multilateral organizations and academic institutions, identifying the best and most promising developments in the field. We began active participation in the joint working group on microinsurance established by the Consultative Group to Assist the Poor and the International Association of Insurance Supervisors. We also began a financial education pilot with Microfinance Opportunities in South Africa, education being a critical component of microinsurance success.
As a global leader in risk management, we have established an initiative to develop products and services that address the evolving risks associated with climate change. At the same time, we are taking steps to manage our own carbon footprint.
• A Climate Change Advisory Council, consisting of internal functional leaders and external experts, to advise Zurich’s management on strategic and operational issues associated with climate change
• An applied research program with organizations and institutions to examine the critical economic, finance and policy issues associated with climate change.
As the first partnership in this third element, Zurich will fund a distinguished visitors program at the Donald Bren School of Environmental Science and Management at the University of California. The school will assess our carbon footprint to help us manage carbon emissions in a meaningful and sustainable manner.
This report describes the Group’s approach to corporate governance and illustrates the main elements of corporate governance within the Zurich Financial Services Group. It includes the information required by the Directive on Information Relating to Corporate Governance of the SWX Swiss Exchange (effective January 1, 2007). It also explains how, in 2007, the Group complied with the Swiss Code of Best Practice for Corporate Governance, issued in 2002 by the Swiss Business Federation, as amended in October 2007. Furthermore, the Group continues to publish an Internal Control Statement (see page 51) in accordance with the UK Turnbull Guidance.
This report follows the recommended structure outlined by the Directive of the SWX Swiss Exchange. The chapter on compensation, shareholdings and loans of the Directors and the members of the GEC is the subject of a separate report, the Remuneration Report (see pages 54 to 67), which complements this Corporate Governance Report.
Zurich Financial Services, the Group’s holding company, is a Swiss corporation, organized in accordance with the laws of Switzerland.
This management structure leads to the reporting of the Group based on the following primary business segments: • General Insurance serves the property-casualty needs of a wide range of customers, from individuals to small and medium-size businesses, commercial insurance enterprises and major multinational corporations.
A list of the Group’s significant subsidiaries including additional information on significant subsidiaries that are listed can be found in this Financial Report on pages 204 to 207. For further information on the share listings of Zurich Financial Services, see shareholder information on pages 259 to 261.
Zurich Financial Services is not aware of any person who, directly or indirectly, had an interest as beneficial owner in shares, option rights and/or conversion rights relating to shares of Zurich Financial Services representing 5% or more of its issued shares as of November 30, 2007. As of December 1, 2007, Barclays Plc, 1 Churchill Place, London, E14 5HP, UK, along with its subsidiaries, had a purchase position of 4.25% of registered Zurich Financial Services shares. Besides Barclays Plc, Zurich Financial Services is not aware of any person who, directly or indirectly, had an interest as beneficial owner in shares, option rights and/or conversion rights relating to shares of Zurich Financial Services representing 3% or more of its issued shares as of December 31, 2007. Zurich Financial Services is also not aware of any persons who, as of November 30, 2007, or December 31, 2007, respectively, directly or indirectly, alone or with others, exercised or were a party to any arrangements to exercise control over Zurich Financial Services.
In 2007 Zurich Financial Services did not receive any notifications under the old disclosure regime.
In addition, the following notifications have been made after December 1, 2007: • JPMorgan Chase & Co, 270 Park Avenue, New York, NY 100017, USA, along with its subsidiaries, reported as per December 1, 2007, a purchase position of 3.62% and a sale position of 1.43% of registered Zurich Financial Services shares. As of December 28, 2007 it reported that both purchase and sale positions had fallen below the threshold of 3%.
• Credit Suisse Group, Paradeplatz 8, P.O. Box, 8070 Zurich, Switzerland, along with its subsidiaries, reported as of December 1, 2007, a purchase position of 3.32% and a sale position of 3.4% of registered Zurich Financial Services shares. Subsequently, it reported that its purchase and sale positions had fallen below the threshold of 3% as of December 21, 2007 and December 27, 2007, respectively.
Zurich Financial Services has no interest in any other company exceeding 5% of the voting rights of that other company, where that other company has an interest in Zurich Financial Services exceeding 5% of the voting rights in Zurich Financial Services.
As of December 31, 2007, the ordinary share capital of Zurich Financial Services amounted to CHF 14,554,682.00 divided into 145,546,820 fully paid registered shares with a nominal value of CHF 0.10 each. The Board of Directors will propose to the shareholders at the Annual General Meeting on April 3, 2008 a regular dividend of CHF 15.00 per share before tax.
On February 15, 2007, it was announced that a repurchase of CHF 1.25 billion worth of shares of Zurich Financial Services over the course of 2007 was authorized by the Board of Directors; this share buyback program was completed on July 2, 2007. At the Annual General Meeting on April 3, 2008, shareholders will be asked to approve the cancellation of 3,432,500 Zurich Financial Services shares repurchased under this program and to reduce the ordinary share capital accordingly.
For further information on the capital structure and the authorized and contingent share capital, see the consolidated financial statements, note 21 on pages 160 to 162.
Share Capital Number Nominal Value in CHF of Shares in CHF
Financial Report 2007 1 As part of the unification of the holding structure in 2000, former holders of Allied Zurich p.l.c. ordinary shares received
Financial Services shares known as CDIs. As CDI holders are not the legal owners of the shares represented by the CDIs, they are not able to directly enforce or exercise rights that a holder of shares can. CDI holders will, however, have a beneficial interest in the shares represented by the CDIs and be allowed as such to give instructions to CREST Depository on the exercise of certain non-economic rights attached to the shares. Each CDI represents one Zurich Financial Services share.
The Bank of New York Mellon but not distributed to ADS
holders. ADSs are traded over the counter (OTC) and evidenced by American Depositary Receipts, or ADRs. ADS
Some interests in shares are held by investors in the form of CREST Depository Interests (CDIs)1 or American Depositary Receipts (ADRs)2. As of December 31, 2007, investors held 639,596 CDIs (representing 639,596 Zurich Financial Services shares) and 24,212,600 ADRs (representing 2,421,260 Zurich Financial Services shares).
Zurich Financial Services had no public convertibles or options outstanding as of December 31, 2007. For information on employee share option plans, refer to the consolidated financial statements, note 23 on pages 168 to 171.
Fred Kindle Swiss 48 Member of the Remuneration Committee 2006 2008
Armin Meyer Swiss 58 Member of the Risk Committee 2001 2010
Vernon Sankey British 58 Chairman of the Remuneration Committee 1998 1 2009
All of the current Directors have served on the Board throughout the year 2007. Mrs. Gilmore and Mr. Mead retired from the Board of Directors with effect from the Annual General Meeting held on April 3, 2007.
All Directors of Zurich Financial Services are also members of the board of directors of Zurich Insurance Company. Mr. Manfred Gentz also serves as chairman of that board.
Thomas Konrad Escher graduated in electrical engineering and in business administration from the Swiss Federal Institute of Technology (ETH) and joined IBM in 1974. In subsequent years, his career led him through various managerial line functions with responsibilities for markets and client relationships overseas, in different European countries and in Switzerland. In 1996, Mr. Escher joined Swiss Bank Corporation and was – as a member of the executive board – CEO for the major market region in Switzerland and for the information technology organization. Since the merger of Swiss Bank Corporation and Union Bank of Switzerland to form UBS AG in 1998, he headed the IT business area of the wealth management and business banking division through mid-2005 as a member of the group managing board. As of July 1, 2005, Mr. Escher assumed the function of vice chairman wealth management UBS.
Fred Kindle graduated from the Swiss Federal Institute of Technology (ETH) in Zurich with a master’s degree in engineering. He joined Hilti AG in Liechtenstein in 1984 as a marketing projects manager, and two years later enrolled at Northwestern University, Evanston, in the United States, where he earned an MBA. From 1988 until 1992 he was an associate and engagement manager with McKinsey & Company in New York and Zurich. He then joined Sulzer Chemtech AG in Switzerland as the head of the Mass Transfer Department and in 1996 became the head of the Product Division. In 1999 he was appointed CEO of Sulzer Industries, one of the two operating groups of Sulzer AG. Two years later he became CEO of Sulzer. After joining ABB Ltd. in fall 2004, Mr. Kindle was appointed CEO of ABB Group worldwide in January 2005, a position he held until February 2008. He is a director of the Swiss American Chamber of Commerce and also serves on the board of VZ Holding Ltd., Zurich.
Armin Meyer graduated with a PhD in electrical engineering from the Swiss Federal Institute of Technology (ETH) and joined BBC Brown Boveri Ltd. in 1976 as a development engineer. In 1980, he became head of research and development for industrial motors, and in 1984, he took over as head of the international business unit for electrical power generators. In 1988, he became president of ABB Drives Ltd. and in 1992, president of ABB Power Generation Ltd. From 1995 until 2000, he was executive vice president of ABB Ltd. and a member of that group’s executive committee. In 1997, he became a member of the board of directors of Ciba Specialty Chemicals at the time of its spin-off from Novartis. He became chairman of the board of Ciba Specialty Chemicals in autumn 2000. From Janaury 1, 2001 until December 31, 2007 he in addition acted as chief executive officer. He is a member of the foundation board of the International Institute for Management Development, IMD, in Lausanne, Switzerland, and of the board of the European Chemical Industry Council (Cefic) in Brussels, Belgium.
Gerhard Hans Schulmeyer graduated from Frankfurt Technical College with a BSc in electronic engineering and from the University of Frankfurt with a BSc in international business. He also holds an MSc in management science from the Massachusetts Institute of Technology. After holding various management positions with Braun, Sony Wega and Motorola, in 1989 he became president and chief executive officer of ABB USA and a member of the executive board of ABB Ltd. From 1994 until 1998, he was president and CEO of Siemens Nixdorf in Germany, and between 1999 and December 2001, he was president and CEO of Siemens Corporation in the US. From January 2002 until March 2006, he was Professor of Practice at the Sloan School of Management of the Massachusetts Institute of Technology and until October 2007, he was a non-executive director on the public boards of Alcan Inc. He is a non-executive director of Ingram Micro Inc. and Korn/Ferry International. He is also a board member of Invest In Germany and a member of the foundation board of the US National Chamber Foundation.
Victor L.L. Chu, 50, British, graduated with a LL.B from the University College London in 1979. He is admitted to practise law in England and Hong Kong. Since 1982 he has practised in the field of corporate, commercial and securities laws, with special emphasis on China and regional investment transactions. From 1995 to 2000, Mr Chu was deputy secretary-general of the International Bar Association. Since 1988 he has served as chairman of First Eastern Investment Group, a leading direct investment firm focusing on China. He is also chairman of First Eastern Investment Bank Limited and FE Securities Limited. Over the past 20 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 currently a foundation board member of the World Economic Forum and co-chairs the Forum’s International Business Council. He is also an executive board member of the International Chamber of Commerce, for which he chairs the Commission on Financial Services and Insurance. Mr Chu is a trustee of the International Crisis Group in Brussels and the WWF in Hong Kong. He is a member of the governing council of University College, London, the dean’s council of the Kennedy School at Harvard, and the board of the Foreign Affairs University of China. Mr. Chu’s other civic associations include service on the advisory bodies of Asia House, Asia Foundation, Beijing Music Festival Foundation, the East Asia Institute of Cambridge University and the Atlantic Council of the USA.
The Board consists entirely of directors who are non-executive, independent of management, and who have never held an executive position in the Group. The Governance and Nominations Committee annually reviews the independence of the Board members and reports its findings to the Board for final determination. Board members are also subject to rules and regulations to avoid conflicts of interest and the use of inside information. A self-assessment of the full Board is carried out once a year. In 2007, the Board’s self-assessment was carried out on the basis of a comprehensive questionnaire. A detailed report was produced for and considered by the Board.
The CEO attends the Board meetings ex officio. By invitation, Board meetings are attended by the members of the GEC on a regular basis. Other executives attend these meetings from time to time. The majority of Board meetings include private sessions of the Board, without the participation of Management.
In 2007, up until the Annual General Meeting held on April 3, 2007, on average, 83% of the members of the Board attended Board meetings. After the Annual General Meeting the number of Board members decreased from 12 to ten and average attendance at Board meetings was 94%. The members of the Board spend additional time to participate in Board Committee meetings, to prepare for meetings and to discharge their responsibilities.
The Audit Committee serves as a focal point for communication and oversight regarding financial accounting and reporting, internal control, actuarial, and compliance among the Management. It is responsible for reviewing the Group’s auditing process (including establishing the basic principles relating to and making proposals with respect to the audit of Zurich Financial Services and the Group) and reviews the internal control systems. The external auditors, the internal auditors and appropriate members of the GEC, the GMB and other executives attend its meetings in order to, among other things, discuss the auditors’ reports, to review and assess the auditing concept and the examination process and to assess the activities of internal and external auditors. For more information on the supervision and control over the external audit process, see page 50. The Audit Committee, at least annually, reviews the standards of internal control, including the activities, plans, organization and the quality of internal audit and Group compliance.
The Audit Committee also reviews the annual, half-year and quarterly financial results of the Group before submission to the Board. Private sessions with external auditors and internal audit as well as the head of actuarial are scheduled at most of the Audit Committee meetings to enable discussions without Management present.
Statements regarding internal control and the procedures in place regarding internal control according to the UK Turnbull Guidance are given on page 51.
Subject to the powers reserved to the Board as set out above, the Board has delegated the management of the Group to the CEO. The CEO and, under his leadership, the GEC are responsible for the development and execution of the strategic and financial plans approved by the Board. The CEO has specific powers and duties relating to strategic, financial and other matters as well as to the structure and organization of the Group and manages, supervises and coordinates the activities of the members of the GEC. The CEO ensures that appropriate management tools for the Group are developed and implemented and represents the overall interests of the Group against third parties. The CEO holds delegated authority to approve certain acquisitions and divestments of businesses and assets, investments and the establishment of new businesses, mergers, joint ventures or cooperations.
Furthermore, the Group has adopted and implemented a coordinated, formalized and consistent approach to risk management and control. Information concerning the Group’s risk management processes is included in the Risk Management section starting on page 20 and in note 26 of the consolidated financial statements on page 176.
The internal audit function and the external auditors as well as the compliance function also assist the Board in exercising its controlling and supervisory duties. Information on major areas of activities of these functions is set out on pages 49 to 51.
For key areas specific committees have been established to facilitate the coordination and alignment of recommendations to the CEO for approval on specific subject matters that are often of cross-divisional and cross-functional nature.
More technical committees include the Asset/Liability Management (ALM), chaired by the Chief Investment Officer, the Group Reinsurance Committee, chaired by the Head of Group Reinsurance and the Group Pension Committee, chaired by the CEO Global Life.
James J. Schiro graduated from St. John’s University, New York, with a bachelor’s degree in business administration. He holds an honorary Doctor of Commercial Science degree from the same university. After qualifying as a certified public accountant, he joined Price Waterhouse in 1967 and held various management positions before becoming chairman and senior partner of the US firm in 1994. After the merger of Price Waterhouse and Coopers & Lybrand in 1998, he became global chief executive officer of PricewaterhouseCoopers. He joined Zurich in March 2002 as Chief Operating Officer – Group Finance and was appointed Chief Executive Officer of the Group two months later. He is a member of the board of directors of PepsiCo. and the supervisory board of Royal Philips Electronics. He is also chairman of the Swiss American Chamber of Commerce, a member of the board of The Geneva Association, a member of the European Financial Services Round Table, a member of the Business Council of the World Economic Forum and since February 2008 a member of the board of directors of the Institute of International Finance (IIF). Additionally, he serves as vice chairman of the American Friends of the Lucerne Festival and is a member of the board of trustees of the Lucerne Festival. Furthermore, he is a member of the boards of trustees of St John’s University, New York, and the Institute of Advanced Study in Princeton, New Jersey, as well as various other boards.
Mario Greco earned an undergraduate degree in Economics from the University of Rome and completed a Master in International Economics and Monetary Theory at Rochester University, New York (USA). Mario Greco started his professional career in management consulting, working with McKinsey & Company’s Milan office from 1986 until 1994, becoming a partner in 1992 and a partner leader in the insurance segment. In 1995, he joined RAS (Allianz Group) in Milan as head of Claims Division. He became general manager in charge of the insurance business the following year, and in 1998 was appointed managing director. In 2000, he became the company’s chief executive officer, remaining in the position for four years. He was appointed head of Allianz’s Life Sustainability business in Munich in 2004, and later that year he was appointed to Allianz AG’s executive board, with responsibility for France, Italy, Spain, Portugal, Greece and Turkey. In April 2005, he joined the Sanpaolo IMI Group in Milan as the chief executive officer of EurizonVita, formerly named Aip, as part of a project to build up the Group’s insurance and asset management businesses. In October 2005, he was appointed chief executive officer of EFG, the company holding the Sanpaolo IMI Group’s investments in Eurizon Vita and Banca Fideuram, and Eurizon Capital. He joined Zurich on October 1, 2007 as the designated CEO Global Life and became a member of the GEC. He is also a member of the Board of Directors of Editoriale l’Espresso Group, Indesit, Saras and Bocconi University, Milan.
Paul N. Hopkins holds a Bachelor of Science degree in business from the Eastern Illinois University and completed the Advanced Executive Education program of the Wharton Business School. He joined the Farmers organization in 1978 as an agent and subsequently became a Farmers employee, where he held positions of increasing responsibility in the sales and marketing area. In 1992 he transferred to the Los Angeles Regional Office as Assistant Vice President, Regional Operations. He became Vice President Agencies in 1995, and Senior Vice President Agencies two years later. In 1998, he was made Senior Vice President and Chief Marketing Officer, a position he held until January 1, 2000, when he was appointed Senior Vice President of State Operations. His next assignment, as Senior Vice President of Strategic Alliances, became effective in April 2001. In August 2002 he was promoted to Executive Vice President, Market Management, and two years later became President of Farmers Group, Inc. Mr. Hopkins was appointed a member of Zurich’s Group Management Board in December 2004. Since April 2005, he has been Chief Executive Officer of Farmers Group, Inc. and a member of Zurich’s Group Executive Committee. He also serves on the Board of Farmers Group, Inc. and is Chairman of the Board of Farmers New World Life Insurance Company. In 2006, Mr. Hopkins was named as Chairman of the Board of ZFUS Services, LLC, Zurich’s North American shared services platform. Mr. Hopkins also serves as a member of the Board of Trustees for the American Institute for Chartered Property Casualty Underwriters, as well as a member of the Board of the Insurance Information Institute.
Axel P. Lehmann graduated with an MBA and PhD from the University of St Gallen in Switzerland. After several US research studies, he wrote a post-doctorate certification at the University of St Gallen and subsequently completed the Wharton Advanced Management Program. He was a lecturer at several universities and institutes and became vice president of the Institute of Insurance Economics at the University of St Gallen and the European Center responsible for Consulting and Management Development. He was head of Corporate Planning and Corporate Controlling for Swiss Life before he joined Zurich in 1996 and held various executive management and corporate development positions within Zurich Switzerland. He became a member of the Group Management Board responsible for Group-wide Business Development functions in November 2000. In September 2001, he was appointed Chief Executive Officer of the former Northern European region and subsequently Chief Executive Officer of the Zurich Group, Germany. In March 2002, he became CEO of the Continental Europe business division and a member of the GEC. In 2004, he was in charge of the consolidation of the United Kingdom and Ireland division with the Continental Europe division and assumed responsibility as CEO for the creation of the integrated Europe General Insurance business division. In September 2004, he became CEO of Zurich North America Commercial in Schaumburg/Chicago. In January 2008 he assumed his current role as Group Chief Risk Officer with additional responsibility for Group IT. Mr. Lehmann is an honorary professor for business administration and service management and chairman of the board of the Institute for Insurance Economics at the University of St Gallen in Switzerland.
Geoff Riddell holds a MA degree in natural sciences (chemistry) from Oxford University (The Queen’s College) and later qualified as a chartered accountant. He started his career with Price Waterhouse in 1978 and four years later moved to AIG, where he held various roles, including country manager for Hong Kong, Belgium and France. He joined Zurich in 2000, initially as managing director of Zurich Commercial in the UK, and then became managing director of the UK Corporate and Government businesses. In November 2002, he became CEO of the General Insurance business in the UK, Ireland and South Africa. In 2004, he became CEO Global Corporate and was appointed to the Group Executive Committee. Mr. Riddell is a former member of the General Insurance Council of the Association of British Insurers and for three years chaired its
liability committee. From 1990 to 1995, he was a member of the Hong Kong Federation of Insurers Council. He became a director of Pool Re in February 2005 and of the Forum for Global Health Protection in 2007. He is a member of the Foundation Board of IMD, Lausanne. He is also a member of the Confederation of the British Industry International Advisory Board, a member of the City EU Advisory Committee and of the Lord Mayor of London’s Advisory Committee.
Dieter Wemmer holds a PhD and a master’s degree in mathematics from the University of Cologne. From 1983 until 1986, he worked in pure mathematics at the universities of Cologne and Oxford. In 1986, he joined Zurich Re (Cologne), at that time a reinsurance subsidiary of Zurich’s German operation Agrippina, as a pricing actuary for life reinsurance. He became Head of Life Reinsurance and Chief Actuary five years later. From 1992 until 1996, Mr. Wemmer held various positions with Agrippina, joining the management board in 1995 responsible for Controlling/Planning, Communication and Real Estate management. He was seconded to Zurich’s Corporate Center in 1996 as project manager for the implementation of International Accounting Standards (IAS) and US Generally Accepted Accounting Principles (US GAAP). One year later, he became Head of Financial Controlling. From 1999 until May 2003, he was Head of Mergers and Acquisitions, with additional responsibility for capital management and General and Life Actuarial from 2002. He became Chief Operating Officer of the Europe General Insurance business division in May 2003. In November 2004, he was appointed CEO Europe General Insurance and became a member of the Group Executive Committee. Since March 2007, he has assumed his current role as Chief Financial Officer of Zurich Financial Services Group. Mr Wemmer is a member of the board of “economiesuisse”.
John Lynch, Head of US Small Business retired from the Group and the GMB effective June 30, 2007
Employment agreements have been entered into with the members of the GEC, setting out the terms and conditions on which they are employed. With regard to termination benefits, the longest period of severance for members of the GEC is two years, including the notice period, and no additional severance benefits are provided in the case of a change of control.
For the members of the Board of Directors no benefits are provided in case of a change of control.
Roger Marshall of PricewaterhouseCoopers AG is the lead auditor, responsible since January 1, 2003 and to the end of the business year 2007. The Group requires rotation every five years for the lead auditor. Accordingly, Patrick Shouvlin of PricewaterhouseCoopers AG will become the new lead auditor for the next business year starting as of January 1, 2008.
OBT AG has been elected as a special auditor to perform special audits for increases in share capital required under Articles 652f, 653f and 653i of the Swiss Code of Obligations. At the Annual General Meeting of shareholders on April 19, 2005, OBT was re-elected by the shareholders for a three-year term. OBT AG originally assumed this mandate in October 2000. The Board proposes to the Annual General Meeting to be held on April 3, 2008, that OBT be re-elected as special auditor for a further three-year term.
The Audit Committee proposes to the Board the external auditors for election by shareholders and is responsible for approving the audit fees. A proposal for fees for audit services is submitted by PwC to and validated by Management at the beginning of each year, before it is submitted to the Audit Committee for approval. Such a proposal is mainly based on an analysis of existing reporting units and expected changes to the legal and operational structure during the year.
The Audit Committee has approved a written policy on the use of external auditors for non-audit services, which sets forth the rules for providing such services and related matters. 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 their independence or objectivity as external auditors. All allowable non-audit services need pre-approval from the Audit Committee (Chairman), the Group Chief Financial Officer or the local CFO, depending on the level of expected fee. They further require, among other things, an engagement letter specifying the services to be provided and making reference to the external auditors’ obligation to comply with this policy.
The Audit Committee and the CEO are regularly informed of important findings, including ineffective opinions, mitigation actions and attention provided by Management. Group Audit has unrestricted access to all accounts, records and documents and must be provided with all data and information needed in order to fulfil its duties. Group Audit works in close-cooperation with external audit, sharing risk assessments, work plans, audit reports and updates on audit actions. Group Audit and external audit meet regularly at all levels of the organization to optimize assurance provision and efficiency.
The Audit Committee assesses the independence of Group Audit, and reviews its activities, plans, organization and quality as well as its mutual co-operation with the external auditors. In 2007, the Group commissioned an independent party to perform a review of Group Audit’s effectiveness. The results confirmed Group Audit’s practices meet or exceed the professional requirements of the Institute of Internal Audit (IIA), and in a high proportion of cases are consistent with global internal audit leading practices. Notwithstanding this positive result, Group Audit will continue to constantly challenge its operation to further increase its effectiveness, efficiency and value contribution.
The Board is overseeing the Group‘s risk management and internal control system, which Management has set up and which is 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 and control oversight responsibilities: Zurich Financial Services Group Annual Report 2007
• the Risk Committee – with oversight over risk issues and • the Audit Committee – with oversight over control issues.
The Group has adopted a coordinated and formalized approach to risk management and internal control. The Group‘s core risk and control systems and policies are generally established at the Group level with subsequent Group wide implementation. The principal focus of the approach is on major risks that might impact the achievement of the Group‘s business objectives, and focus on the activities to control and monitor these risks and to contribute to control effectiveness. Thus, a risk-aware and control-conscious environment is fostered in the Group and reinforced by communication and training.
Management is responsible for the identification, evaluation and control of significant risks. The Group manages risks throughout the organization, under direction of the senior management. Zurich has Groupwide risk management policies, common methods and tools for assessing and modeling risks. The Group risk assessment processes are aligned with the Group planning process and are reviewed by the Group Executive Committee and the Board Risk Committee. Significant risks, the results of the assessment and modeling processes and the relevant actions arising are reported regularly to the Risk Committee of the Board. Periodic local risk assessments are conducted using Zurich’s Total Risk Profiling® tool and business units are required, at least quarterly, to report key risks and implement action plans to mitigate them.
The Group’s annual business plan includes risk management considerations, as well as strategic and business direction, financial data and key indicators. During the year, 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 Group’s risk capacity and overseen Zurich’s enterprise-wide risk governance framework and the Audit Committee has reviewed the effectiveness of the system of internal control operated by the Group related to the calendar year 2007 up to the date of the annual report and have reported to the Board accordingly. The Board is satisfied that the reviews were conducted in accordance with the U.K. Turnbull Guidance (as revised in October 2005). The assessment included the consideration of the effectiveness of the Group’s ongoing process for identifying, evaluating, controlling and managing the risks of the business, including the scope and frequency of reports on both risk and control that were received and reviewed during the year by the Risk and Audit Committees and the Board, the important internal control matters discussed and associated actions taken by management. Issues identified by this process have been communicated to the Board and are being addressed by the Group.
The Directors are satisfied that, having reviewed the performance of the Group and forecasts for the forthcoming year, the Group has adequate resources to enable it to continue in business for the foreseeable future. For this reason, the Directors have adopted the going concern basis for the preparation of the financial statements.
The Group is committed to provide equal opportunities when recruiting and promoting people, whereby ability, experience, skills, knowledge and diversity are the guiding principles. The Group actively encourages employee involvement in its activities via print and online publications, team briefings and regular meetings with employees’ representatives.
Zurich Financial Services maintains a regular dialogue with investors through its Investor Relations department and responds to questions and issues raised by institutional and private individual shareholders. In addition, Zurich Financial Services organizes investors days for institutional investors to provide comprehensive information on its businesses and strategic direction. Such presentations can be followed via webcast or conference call. The three investors days in 2007 focused on Capital Management (held on March 28, 2007), Strategy Update (May 23, 2007), and Investment Management (December 6, 2007). Further investors days are planned for 2008 on topics of interest to the investment market. A wide range of information on the Group and its businesses, including the aforementioned reports and the full documentation distributed at the investors days, is also available on the Investor Relations section of Zurich Financial Services’ Web site, www.zurich.com
Zurich Financial Services will hold its Annual General Meeting on April 3, 2008. As part of the agenda, the Chairman, the CEO and the Chief Financial Officer will present a review of the business of the Group for the year 2007. The meeting will be conducted in the Hallenstadion in Zurich-Oerlikon. An invitation setting out the agenda for this meeting and an explanation of the proposed resolutions will be issued to shareholders by Zurich Financial Services at least 20 days before the meeting.
For addresses and further upcoming important dates, please refer to the Financial Calendar on page 262.
The rest of the information to be disclosed according to the Directive of the SWX Swiss Exchange is included in the Corporate Governance Report preceding this Remuneration Report.
Recognizing that Zurich Financial Services is a global insurance-based financial services organization, the level of Directors’ fees has been established to ensure the Group’s ability to attract and retain high caliber individuals.
• Clearly define the expected performance through a structured system of performance management and use this as the basis for compensation decisions.
Total compensation is influenced by a number of factors such as business performance and affordability, individual performance, internal equity, and legal requirements. Target opportunities are benchmarked to median levels in clearly defined markets and take into account internal equity considerations. The compensation mix between base salary and variable pay is also aligned with local market practices and internal relativities. Zurich is open in the communication of how the reward structure is defined and the processes used for decision making. Total compensation includes the following elements: Base salary
Incentive plans are designed to provide a range of award opportunities linked to levels of performance. Business and individual performance may result in superior awards above target for superior performance, and reduced or no awards for performance below expectations. Variable pay opportunities are provided, in markets where this is the norm, to motivate employees to achieve key short and long-term business goals to increase shareholder value. Variable pay opportunities may include both short-term and long-term incentives: • Short-term incentives are performance driven based on relevant factors which can include the performance of the Zurich Group and the business areas as well as individual performance achievements. Key performance measures are determined annually and focus on business priorities. They typically include profitability measures, such as group net income after tax (NIAT) and business operating profit (BOP).
Zurich’s variable pay plans are reviewed annually both as to their content and participants. The plans can be terminated, modified, changed or revised at any time.
Zurich provides employee benefits which are designed by reference to local market practice. Employees are normally required to contribute to the cost of these benefits, and the overall benefits offering is based on the relevant market median.
The Board of Directors defines the remuneration principles based on proposals of the Remuneration Committee. Based on these remuneration principles the Remuneration Committee is responsible for proposing to the Board on an annual basis the remuneration payable to the Directors, to the Chief Executive Officer (CEO) and to the other members of the GEC. For the other members of the GEC, these recommendations are based on proposals made by the CEO. The remuneration is approved by the Board of Directors. The Remuneration Committee does not include members with interlinked company mandates. For further details of its responsibilities see page 39 in the Corporate Governance Report.
To assist decision making on both Board and GEC remuneration, benchmarking studies are carried out regularly. To assess market practices and market compensation levels, the companies in the Dow Jones Titan Insurance Index are analyzed. This Index comprises the largest insurance companies based in both Europe and in the United States. This analysis is supplemented by additional benchmarking studies as appropriate, e.g. by looking at practices within the large Swiss Market Index (SMI) companies in Switzerland or at similar sized companies in other countries.
The results of the benchmarking studies are taken into account in setting fee levels for Directors and compensation structures for members of the GEC. In analyzing the results, factors considered are the market practices in the various countries and the internal relativities between positions. Overall positioning of the compensation structures is towards the median levels.
In reviewing compensation structures and practices on a regular basis, the Remuneration Committee has appointed its own independent adviser, Hewitt Associates, and the CEO is supported by Mercer HR Consulting. As both companies operate in the field of international compensation and benefits, they do have other mandates with Zurich.
Except for the Chairman and Vice Chairman, Directors are remunerated with a basic annual fee of USD 205,000. One-third of this annual basic fee, i.e. USD 68,500 is allocated to sales-restricted Zurich Financial Services shares. Committee members receive an additional cash fee of USD 40,000 for all Committees on which they serve, irrespective of the number. In addition, the chair of each Committee receives an annual fee of USD 20,000 and the chair of the Audit Committee receives an additional USD 10,000. Directors who reside in the United States receive an additional fee of USD 10,000 per annum. The Committees on which the members serve is set out in the Corporate Governance Report on page 35.
Neither the Chairman nor the Vice Chairman receive any additional fees for their Committee work.
The following table sets out the fees paid to the Directors in 2007: Directors’ fees in USD 2007 1
US Of which Of which Committee Residence Total paid allocated 6,
4 Directors who reside in the United States receive a fee of USD 10,000 per annum. 5 The cash fees are defined in US dollars, but paid in the actual currencies where the members reside, based on the relevant exchange rate at the dates of the payment.
6 Mr Gentz was allocated 617 shares and the other members 218 shares as per June 30, 2007. The share price (CHF 389.50) and the exchange rate (USD/CHF
9 Mrs Gilmore and Mr Mead retired from the Board of Directors on April 3, 2007 and received pro rata fees for their Board work up to that date. 10 In addition to the remuneration set out in the table, the company paid contributions for Mrs Gilmore into a group health insurance plan in the UK until her retirement in April 2007 at a cost of USD 631.
Any personal contributions of the Directors to social security systems are included in the amounts shown in the table above.
The members of the Board of Directors of Zurich Financial Services and Zurich Insurance Company do not participate in any of the share-based incentive plans established for executive management. However, as mentioned above, part of the fees of the Board of Directors of Zurich Financial Services are allocated to three-year sales-restricted shares with effect from January 1, 2007. As mentioned above, the shares provided to Directors are part of the overall fee and are not subject to the achievement of any defined performance targets.
As of December 31, 2007, none of the Directors had outstanding loans, advances or credits.
As of December 31, 2007, no former Director had outstanding loans, advances or credits.
Related parties to the Directors or to former members of the Board
The total remuneration of the members of the GEC for 2007 comprised the value of cash compensation, pensions, other remuneration and the equity grants made under the Group’s Long-Term Incentive Plan in
The compensation structure and the mix of the individual compensation elements for GEC members are determined by taking into account market practices and internal relativities. These elements are described below (the amounts for the highest paid executive are included): Value of total remuneration
The total value of the various compensation elements earned by the members of the GEC in 2007 was USD 57.6 million. This compares with an equivalent figure of USD 48.2 million earned in 2006 calculated on the same basis. The increase in overall remuneration can be explained by two main issues. Firstly through an increase in the performance related Short-Term Incentive Plan payments awarded to members given the record results in 2007 and secondly through an increase in the value of the Long-Term Incentive Plan grants made in 2007.
The total value for 2007 comprises the following elements: Base salary and annual cash incentives paid for 2007
Members of the GEC participate in the pension plan arrangements of the business units in which 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 other GEC members continue to participate in defined benefit plans that provide retiremement benefits based on final pensionable earnings and the number of years of service. The normal retirement ages vary from 60 to 65. The total value of pension benefits accruing to members of the GEC during 2007, calculated on the basis of the Service Costs for the company as assessed under IAS 19 accounting principles, was USD 3.9 million. 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.
Equity grants made to the GEC under the Long-Term Incentive Plan in 2007
Remuneration components for GEC Members under the Long-Term Incentive Plan comprise an annual grant of performance shares and performance options. In extraordinary circumstances, restricted share grants may also be made. For members of the GEC, the overall value of the target annual grants in 2007 ranged from 100% to 125% of the base salary. For the Chief Executive Officer the overall value was set at 300% of the base salary.
The performance share and share option grants only vest if certain performance conditions are met. One third of the target grant is assessed for vesting in each of the three years 2008, 2009 and 2010 based on the Group’s performance achievements in terms of the Group’s return on common shareholders’ equity (ROE) and the position of Zurich’s total shareholder return (TSR) compared with an international peer group of 28 insurance companies that are included in the Dow Jones Titan Insurance Index. Based on the actual ROE and TSR achievements, the vesting percentage can vary between 0% and 200% of the target grants. For the grants made in 2007, these are assessed for vesting on the basis of considering three years of TSR and ROE performance, previous grants are assessed on the basis of performance during the calendar year prior to vesting.
The total number of target performance share grants made to members of the GEC during 2007 was 29,845. This compares with an equivalent figure of 27,409 made for 2006. The value of the target performance share grants made to members of the GEC in 2007 was USD 8.7 million at the date of grant based on the assumption of 100% vesting and a share price of CHF 355.75 on the day prior to the grant.
Restricted share grants supplement the regular long-term incentive grants and are used in extraordinary circumstances mainly for new hires to compensate for the loss of their equity rights with their previous employer.
The total number of restricted share grants made to members of the GEC during 2007 was 7,280. These restricted shares vest over the following three years and are forfeited if the holders of such shares leave voluntarily before the vesting date and the employment relationship terminates.
The value of the restricted share grants made in 2007 was USD 2.0 million at the date of grant on the assumption of 100% vesting.
The value of the option grants made in 2007 was USD 8.0 million at the date of grant, based on the assumption of 100% vesting and the Black Scholes valuation of the options at the date of grant.
Value of target performance share and restricted share grants 5 10.7
The highest paid remuneration for the GEC members was USD 10.3 million for Mr. James J. Schiro, the Group’s Chief Executive Officer. This amount reflects his 2007 base salary, the cash incentive earned for 2007, the value of pension benefits, other remuneration and the value of the target performance shares and share options granted in 2007.
Value of target performance share and restricted share grants 4 2.25
Summary of total outstanding share commitments for GEC members under the Group’s Long-Term Incentive Plans
Within the context of the Group’s Long-Term Incentive Plan, these performance share grants are considered for vesting in one-third instalments during the three years after the grant. The actual level of vesting is determined in accordance with the remuneration principles set out above on pages 54 to 56.
Under the share option program for senior management, the Group can issue share options to individuals within prescribed rules. The first share option grant was made in 1999 and regular annual grants have been made since then. Prior to 2003, option grants were typically made on the basis of a seven-year option term, a three-year vesting period and an exercise price set at a 10% premium to the market rate during the month prior to the grant date. Under the rules of the plan, other parameters are allowed for option grants made under the share option program. In connection with the re-design of the long-term incentive program in 2003, the exercise price for the options granted since then, which include performance based vesting criteria, has been set at the market price on the day prior to the date of grant. The performance based option grants are considered for vesting in one-third instalments during the three years after the grant. The actual level of vesting is determined under the performance in accordance with the remuneration principles set out above on pages 54 to 56. Option grants are currently made each year on the third working day in April.
Under the share option program, the total number of shares under option for the GEC members as of December 31, 2007 is set out in the table below.
Number Number Total number Exercise price of options of options of shares per share Year
Each of the above options entitles the holder to subscribe for one share of Zurich Financial Services at the exercise price stated.
All interests are beneficial and include shares or share options held by related parties to the GEC members. One vested option gives the right to one share with normal voting and dividend rights.
P. van de Geijn, Chief Executive Officer Global Life 6,993 24,889
2 The distribution of the vested options according to the grants identified in the table “Summary of outstanding options” is shown in the table below. 3 Includes an amount of 2,000 shares for Mr. Schiro which are held by family run charitable foundations. 4 Joined the Group on January 15, 2007. 5 Joined the Group on October 1, 2007.
1 The distribution of Mr. Amore’s options for 2001 comprises 9,142 under grant b and 2’450 under grant a.
None of the members of the GEC received any compensation from the Group or from any of the Group’s companies other than as set out above.
Former members of the GEC are eligible to continue their mortgage loans following retirement on similar terms as when they were employed, in line with the terms available to employees in Switzerland as stated above. In this respect, one former member, Mr. Eckert, held an outstanding mortgage loan of USD 2,500,000 as at December 31, 2007, with a reduced interest rate of 2.25% applying on the first USD 1,250,000. Apart from this, no former members of the GEC had any outstanding loans, advances or credits as of December 31, 2007.
Related parties to GEC members or to former members of the GEC
Financial Review 70 Consolidated Financial Statements 89 Report of Group Auditors 202 Significant Subsidiaries 204 Embedded Value Report 208 Holding Company 242 Report of Statutory Auditors 256
Services Group Annual Report 2007. Certain comparatives in the Financial Review have been restated as a result of the adoption of the SoRIE
Financial highlights in USD millions, for the years ended December 31 2007 2006 Change 1
Business operating profit (after tax) return on common shareholders’ equity 18.7% 19.5% (0.8 pts)
1 Parentheses around numbers represent an adverse variance. 2 Farmers Management Services managed gross earned premium margin is calculated as gross operating profit of Farmers Management Services divided by the gross earned premiums of the Farmers Exchanges, which we manage, but do not own.
Business operating profit increased by 10 percent to USD 6.6 billion demonstrating the strength of our diversified portfolio in difficult market conditions.
• Global Life business operating profit increased by USD 243 million, or 20 percent, to USD 1.4 billion, primarily resulting from increases in the US, benefiting from lower amortization of acquisition costs, the UK and Germany. New business value, after tax, increased by 35 percent in US dollar terms (28 percent on a local currency basis), reflecting both selective growth and margin improvements in accordance with our strategic priorities.
Other Businesses business operating profit increased by USD 110 million with strong results contributed by Farmers Re, Centre and Centrally Managed Businesses. The Corporate Functions result decreased by USD 38 million mainly due to increased funding expenses.
Business volumes in our core operating segments developed as follows: • General Insurance gross written premiums and policy fees increased by 4 percent in US dollar terms, while remaining flat on a local currency basis, reflecting both underwriting discipline in all our General Insurance businesses in a competitive market environment and our ability to capitalize on attractive growth opportunities.
• Global Life insurance deposits increased by 12 percent in US dollar terms, and by 3 percent on a local currency basis, while gross written premiums and policy fees decreased by 6 percent in US dollar terms, and by 12 percent on a local currency basis. These movements reflect the strategic shift in business mix from traditional to unit-linked products. New business annual premium equivalent (APE) increased by 18 percent in US dollar terms, and by 11 percent on a local currency basis, with increases across most regions, in particular in Ireland and at Zurich International Solutions, our international expatriate business based in the Isle of Man.
Return on common shareholders’ equity increased by 0.6 percentage points to 21.0 percent as the prior year was affected by the costs of regulatory settlements in the US. These regulatory settlement costs were excluded from business operating profit, resulting in a decrease in business operating profit (after tax) return on common shareholders’ equity of 0.8 percentage points to 18.7 percent.
General Insurance highlights in USD millions, for the years ended December 31 2007 2006 Change
in USD millions, for the years ended December 31 Business operating profit Combined ratio
Business operating profit increased by USD 220 million, or 6 percent, to USD 4.0 billion for the year ended December 31, 2007, driven by Global Corporate, North America Commercial and positive claims experience within Group Reinsurance. Our businesses continued to demonstrate underlying strength and have benefited from our reserving policy with positive development emerging from reserves established in prior years. This positive development, together with higher investment income, which reflects both an increase in the average invested asset base and higher interest rates in Europe, more than offset losses arising from Winter storm Kyrill and the UK floods in June and July.
Gross written premiums and policy fees increased by USD 1.5 billion, or 4 percent in US dollar terms, to USD 35.7 billion, while remaining flat on a local currency basis, which reflects our continued ability to maintain underwriting discipline and manage different business areas for margin and/or volume. The market environment continued to be competitive with pressure on rates, although the picture was mixed by geography and by line of business, with the commercial lines of business in North America, the UK and Ireland most affected.
The net underwriting result decreased by USD 427 million to USD 1.3 billion driven by the impact of losses associated with Winter storm Kyrill and UK floods in June and July amounting to USD 677 million for Europe General Insurance and USD 73 million for Global Corporate. Together these two events increased the overall loss ratio and combined ratio by 2.5 percentage points. In 2006 we reported no comparable catastrophe losses. Favorable development emerging from reserves established in prior years reduced the loss ratio by 3.6 percentage points in 2007. Net technical expenses increased by USD 685 million, and by USD 345 million on a local currency basis, primarily as a result of higher commissions and increased investments in growth and operational transformation initiatives, driving an overall 1.3 percentage point increase in the expense ratio.
Global Corporate in USD millions, for the years ended December 31 2007 2006 Change
Business operating profit increased by USD 44 million, or 6 percent, to USD 736 million for the year ended December 31, 2007. A decrease in the net underwriting result was more than offset by a USD123 million increase in net investment income driven by a higher average invested asset base and higher interest rates.
Gross written premiums and policy fees increased by 1 percent in US dollar terms to USD 7.5 billion, while decreasing by 2 percent on a local currency basis primarily as a result of continued rate pressures across most major portfolios, particularly in North America and the UK. The increased level of customer renewals continued, with some new business growth achieved on targeted lines.
North America Commercial in USD millions, for the years ended December 31 2007 2006 Change
Gross written premiums and policy fees decreased by USD 324 million, or 3 percent, to USD 11.5 billion. Our focus on disciplined growth through our market segmentation strategy has enabled us to maintain an effective market presence within our chosen customer segments despite continued market pressure together with changing economic conditions within a few key segments.
Europe General Insurance in USD millions, for the years ended December 31 2007 2006 Change
Business operating profit decreased by USD 11 million, or 6 percent, to USD 167 million for the year ended December 31, 2007, driven by the decrease in the net underwriting result.
Gross written premiums and policy fees increased by USD 330 million, or 11 percent, and by 10 percent on a local currency basis, to USD 3.2 billion, with increases across all regions despite rate pressures in Australia and Asia. The primary drivers of the increase were Latin America with an increase in new business written, and Africa due to rate increases.
Net underwriting result decreased by USD 14 million to USD 28 million. The combined ratio increased by 0.7 percentage points, a combination of a 1.6 percentage point increase in the loss ratio and 0.9 percentage point decrease in the expense ratio. The increase in the loss ratio was primarily driven by a number of businesses incurring higher weather-related losses and an increase in the number of large losses. The expense ratio improved by 0.9 percentage points as a consequence of growth in premiums.
Global Life highlights in USD millions, for the years ended December 31 2007 2006 Change
In 2007, Global Life achieved its growth targets with an 18 percent increase in APE (11 percent on a local currency basis) and an increase in new business margin of 3.1 percentage points to 24.7 percent, which led to an increase in new business value of 35 percent (28 percent on a local currency basis) to USD 729 million.
During 2007, the majority of the UK annuity liabilities were reinsured as the first step in a transaction in which, subject to local regulatory and court approvals, the policies will be commuted to the reinsurer. This transaction reduced our exposure to longevity risk and reduced economic capital requirements.
New business annual premium equivalent (APE) increased by 18 percent (11 percent on a local currency basis), primarily reflecting the continued success of our unit-linked range of products.
The independent broker sector was the main growth driver in 2007, providing 49 percent of total APE volumes. Openwork, our exclusive multi-tied distribution network in the UK, produced 8 percent of total APE and the Farmers Exchanges tied-agent network in the US produced 4 percent. Other tied-agent distribution contributed 16 percent with an increasing proportion coming from our tied-agent networks in emerging markets. Distribution through bank partnerships contributed 23 percent of total APE volumes.
The APE increase of 5 percent in the US was driven by an innovative simple protection proposition launched late in 2006, which also contributed to a record number of new policies issued in one year. In the UK, APE increased by 13 percent, and by 4 percent on a local currency basis, benefiting in the latter half of the year from a range of new propositions and enhancements including e-enablement. The UK also won a number of group pension schemes. In Germany, APE increased by 1 percent, while decreasing by 7 percent on a local currency basis in an overall declining market, while new unit-linked business increased by 21 percent, and by 11 percent on a local currency basis, driven by the success of our new unit-linked tax-advantaged pension product. APE in Switzerland increased by 16 percent, and by 11 percent on a local currency basis, with strong growth in individual unit-linked business following the introduction of new propositions. In Ireland, APE increased by 43 percent, and by 31 percent on a local currency basis. Momentum from 2006 carried through into 2007 with particularly strong growth in regular and single premium pension business in both unit-linked and individual savings products.
Financial Report 2007 in USD millions, for the years ended December 31
New business Business operating New business margin, after tax profit value, after tax (as % of APE)
of which: of which: Business operating profit in the US increased by USD 83 million, benefiting from lower amortization of deferred policy acquisition costs (USD 106 million) partially offset by higher mortality claims. An increase in the in-force business drove the underlying increase of USD 10 million. In the UK, business operating profit improved by USD 134 million as a result of lower insurance benefits and losses before reinsurance and improved performance in Openwork. Business operating profit in Germany increased due to continued efficiency gains from the merger of our life entities. Business operating profit in Switzerland decreased due to the continued transfer of group life business to the independent pension foundations.
New business value, after tax, increased by USD 190 million, as a result of the US and Germany, due mainly to higher margins, and from Ireland, ZIS and Southeast Asia, mainly due to higher APE.
New business margin, after tax, increased by 3.1 percentage points, mainly due to strong improvements in the US and Germany and a small increase in our largest market, the UK. The improvement in the US mainly reflected a restructuring of our reinsurance program in that market. The improvement in Germany reflected the synergy benefits following the merger of our life entities. The decreased margin in Switzerland was due to increased selling expenses from the individual business line.
Management fees and other related revenues increased by USD 133 million, or 6 percent, driven by an increase in management fees, including USD 64 million related to the recently acquired Bristol West Holdings, Inc. (Bristol West). The increase was driven by an overall 6 percent increase in gross earned premiums at the Farmers Exchanges, which we manage but do not own, in line with growth initiatives. Management and other related expenses increased by USD 148 million as a result of the increased volumes generated by the Exchanges, continued investments in growth and IT-related initiatives, as well as USD 41 million related to the first time inclusion of Bristol West. As a result, the gross operating margin decreased to 46.6 percent.
We are introducing an alternative measure of Farmers Management Services’ profitability relative to the gross earned premiums of the Farmers Exchanges as they are the relevant indicator for the volumes managed by Farmers Management Services, managed gross earned premium margin. Farmers Management Services continues to evolve its business model through additional product lines and distribution channels, such as Foremost and Bristol West. As a consequence, a measure of its profitability against the underlying insurance businesses in the Farmers Exchanges will provide a relevant view of its profitability over time. For the year ended December 31, 2007, the managed gross earned premium margin decreased by 0.5 percentage points to 6.8 percent, due to the continued investments in growth and IT-related initiatives by Farmers Management Services.
Other Businesses highlights in USD millions, for the years ended December 31 2007 2006 Change
Farmers Re contributed USD 173 million to business operating profit reflecting the development of business with the Farmers Exchanges, which we manage but do not own. Centre business operating profit decreased by USD 82 million to USD 167 million due to reserve strengthening in the disability business. Centrally Managed Businesses,which largely comprise portfolios that we proactively manage to achieve a profitable run-off, decreased by USD 14 million to USD 291 million. Gains on commutations and increases in net investment income were offset by lower premiums and reinsurance commissions as a result of the successful run-off of these businesses. The result in the rest of Other Businesses benefited from the absence of reserve strengthening compared with 2006, as well as higher net investment income.
Headquarter expenses, after allocations to operating businesses and excluding foreign currency impacts (168) (189) 11%
Reflecting our outlook for the economy and the capital markets, our equity allocation during the greater part of 2007 was close to neutral, and we continued our underweight stance to debt security exposure relative to our long-term strategic benchmark. Fixed maturity debt securities are invested in accordance with the profile of the liabilities to limit the overall economic interest rate exposure of the Group. Derivative instruments are primarily used to improve the management of interest rate risk and to provide equity downside protection in Life withprofit funds.
Our investment policy remains conservative; investment grade securities comprise 99 percent of our debt securities, of which 63 percent are rated AAA. US sub-prime mortgage-backed securities comprise approximately 0.2 percent of Group investments, with 78 percent of these securities being rated AAA, and only USD 16 million of impairments recognized in the current period.
1 After deducting investment expenses of USD 247 million and USD 265 million for the years ended December 31, 2007 and 2006, respectively. 2 Excluding average cash received as collateral for securities lending of USD 2.8 billion and USD 4.2 billion in the years ended December 31, 2007 and 2006, respectively.
Total net capital gains on investments and impairments were USD 1.5 billion, a decrease of USD 38 million compared with the prior year. Realized gains on sales of securities of USD 790 million were USD 127 million less than 2006 largely as a result of increased realized losses from the sale of debt securities at higher interest rate levels. Net gains from market revaluations of USD 708 million were USD 89 million higher than 2006. Hedge funds and private equity investments were the main drivers, contributing USD 702 million, a net increase of USD 240 million over 2006. This increase was offset by decreased gains from equities and increased impairments on equity and debt securities. The net gains from market revaluations included USD 136 million of impairments, an increase of USD 110 million over 2006. Debt securities contributed USD 81 million to the 2007 total, while equity securities contributed a further USD 44 million.
Net unrealized gains decreased by USD 2.7 billion since December 31, 2006. Net unrealized gains on debt securities decreased by USD 1.5 billion to a net loss of USD 1.4 billion as interest rates rose across major markets except in the US during the first part of 2007. Net unrealized gains on equity securities decreased by USD 1.1 billion mainly due to the realization of USD 1.1 billion of gains following sales in positive markets in the first half of the year to maintain the desired asset allocation to equities.
Performance of in USD millions, for the years ended December 31 unit-linked investments
Net investment result, net of investment expenses 1 7,142 11,587 (38%)
Net investment income on unit-linked investments increased by 26 percent, primarily attributable to dividends on unit trust equity and short-term securities and a higher average invested asset base. Net capital gains on investments decreased by 55 percent as a result of negative market revaluations on preferred equity securities, as a result of comparatively lower rate of market appreciation in the UK, and on real estate.
Reserves for losses and loss adjustment expenses in USD millions 2007 2006
As of December 31, 2007, net reserves for losses and loss adjustment expenses increased by USD 3.9 billion, or 8 percent, to USD 54.7 billion compared with USD 50.8 billion as of December 31, 2006. Net loss and loss adjustment expenses incurred in the current year are impacted by foreign currency effects and higher catastrophe losses, in addition to increases in underlying exposure and claims inflation. Favorable prior year development arose primarily from our General Insurance business (USD 1.1 billion) across a number of countries and lines of business.
This table represents the loss ratio development for individual accident years for the Group, with the General Insurance segment being the primary driver. Individual accident years are affected by the level of large catastrophe losses. In the General Insurance segment, excluding the effects of the hurricanes in 2004 and 2005
Financial Report 2007 of 2.8 and 4.6 percentage points, respectively, and the 2007 Winter storm Kyrill and the UK floods of 2.5 percentage points, the underlying loss ratios year-on-year would have been relatively more stable. The Zurich Way of Reserving adopts a conservative view in the initial accident year, suggesting that most years would develop favorably over time as is demonstrated by accident years 2003 to 2006.
Group reserves for in USD millions life insurance contracts, net of reinsurance, and liabilities for investment contracts
Interest and bonuses credited to policyholders 6,798 10,151 3,864 3,673 10,662 13,824
Decreases recorded in shareholders’ equity (33) (31) (1,691) (1,118) (1,724) (1,149)
1 For more information on financial debt, refer to note 20 in the consolidated financial statements.
Total operational debt was USD 8.6 billion as of December 31, 2007, a decrease of 9 percent compared with December 31, 2006, primarily attributable to reduced repo activities in our UK Life business.
Total financial debt was USD 9.0 billion as of December 31, 2007, an increase of 3 percent compared with December 31, 2006. As market conditions allowed for lower borrowing costs, we redeemed a USD 1 billion subordinated debt issuance early at a total pre-tax cost of USD 52 million and replaced it with two lower cost, hybrid debt issuances totaling USD 1.5 billion.
As of December 31, 2006, as previously reported 26,531 525 27,056
Total recognized income and expense, net of tax 6,030 90 6,120
Total recognized income and expense included in total equity, after minority interests, was USD 6.1 billion. The major drivers were net income after taxes of USD 5.7 billion, an increase in cumulative translation adjustments of USD 572 million and reductions in net unrealized gains/(losses) on investments of USD 635 million, which offset an improvement in actuarial gains/(losses) on pension plans of USD 476 million.
Foreign currency translation effects on cash and cash equivalents 642 1,637
Cash and cash equivalents excluding cash received as collateral for securities lending 15,061 19,302
Cash and cash equivalents as of January 1, including cash received as collateral for securities lending 23,122 23,482
Selected Group variance over the prior period, for the year ended December 31, 2007 income statement items in USD millions in %
Selected Group variance over December 31, 2006, as of December 31, 2007 balance sheet items in USD millions in %
The balance sheets are translated at end-of-period rates. The weakness of the US dollar as of December 31, 2007, compared with December 31, 2006, resulted in an increase in most balance sheet positions.
Consolidated income statements in USD millions, for the years ended December 31 Notes 2007 2006
Diluted earnings per share 21 46.37 39.52 1 The Group’s life operations in the UK entered into a reinsurance agreement to transfer the risk associated with a significant annuities portfolio as of January 1, 2007. The initial impact of this transaction was an increase of USD 7.3 billion in premiums ceded to reinsurers and an increase of USD 7.0 billion in ceded insurance benefits and losses in the Global Life business.
Total recognized income and expense 6,120 5,724 1 Amounts are net of tax; total tax effect is included in table 19.6.
Assets in USD millions, as of December 31 Notes 2007 2006
Reinsurers’ share of reserves for insurance contracts 1 8 26,977 20,108
Total assets 389,344 374,781 1 The Group’s life operations in the UK entered into a reinsurance agreement to transfer the risk associated with a significant annuities portfolio as of January 1, 2007. The initial impact of this transaction was a decrease of USD 7.4 billion in total investments and associated other assets and an increase of USD 7.1 billion in reinsurers’ share of reserves for insurance contracts in the Global Life business.
Consolidated statements of cash flows in USD millions, for the years ended December 31 2007 2006
Share of equity in income from investments in associates (13) (85)
Depreciation, amortization and impairments of fixed and intangible assets 515 460
Net cash provided by/(used in) operating activities (1,580) 640 1 The Group’s life operations in the UK entered into a reinsurance agreement to transfer the risk associated with a significant annuities portfolio as of January 1, 2007. The main initial impact of this transaction were proceeds of USD 6.3 billion from the sale of debt securities, a reduction in cash and cash equivalents of USD 0.6 billion and an increase in reinsurers’ share of reserves for insurance contracts of USD 7.0 billion.
Redemption of preferred securities and repayments to minority interests – (802)
Cash and cash equivalents as of December 31, excluding cash received as collateral for securities lending 15,061 19,302
As of December 31, 2007 and 2006, cash and cash equivalents restricted as to use were USD 3,049 million and USD 423 million, respectively. Cash and cash equivalents held for the benefit of policyholders in connection with unit-linked products amounted to USD 2,993 million and USD 5,685 million as of December 31, 2007 and 2006, respectively.
Cash and cash in USD millions, as of December 31 equivalents
Cash and cash equivalents comprise the following: Cash at bank and in hand 5,567 4,912
Balance as of December 31, 2005, as previously reported 186 10,316
4 Roundend amounts may not add to the rounded total in all cases.
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 products, the IFRS Framework permits reference to another comprehensive body of accounting principles. In these cases, the Group typically refers to accounting principles generally accepted in the United States (US GAAP) for guidance.
The Group’s balance sheet is not presented using a current/non-current classification. However, the following balances are generally considered to be current: cash and cash equivalents, short-term investments, deferred policy acquisition costs on general insurance contracts, accrued investment income, receivables, reserve for premium refunds, accrued liabilities and obligation to repurchase securities.
Change in accounting policies in 2007 For 2007 reporting, the Group has adopted the Statement of Recognized Income and Expense (SORIE) option under IAS 19 “Employee Benefits” to recognize actuarial gains and losses arising from defined benefit pension and other defined benefit post-retirement plans as a liability with a corresponding adjustment to shareholders’ equity after allowing for deferred taxes. As a result, the Group has reversed the charge recorded in the 2006 income statement for the unrecognized actuarial gains and losses. In previous years, the net cumulative unrecognized actuarial gains and losses exceeding ten percent of the higher of the defined benefit obligation and the fair value of plan assets were not recognized on the balance sheet, but rather through income over the expected average remaining working lives of the employees participating in the plan (corridor approach). Therefore 2006 figures have been restated to reflect this change as follows: Table 1 in USD millions Amount of As reported restatement As restated as of December 31, 2006 for the year ended December 31, 2006
Net income attributable to shareholders 4,527 93 4,620 1 Balances as at the date of restatement, excluding certain subsequent balance sheet reclassifications to conform with current year’s presentation.
• Farmers Management Services which through Farmers Group, Inc. and its subsidiaries (FGI) provides nonclaims related management services to the Farmers Exchanges, prominent writers of personal lines and small commercial lines business in the United States. FGI receives fee income for the provision of services to the Exchanges, which we manage, but do not own, and to their customers.
• The Group’s businesses in Russia and Morocco from International Businesses to Europe
The following interpretations issued by the International Financial Reporting Interpretations Committee (IFRIC) became effective in 2007: IFRIC 7 “Applying the Restatement Approach under IAS 29 financial Reporting in Hyperinflationary Economies”, IFRIC 8 “Scope of IFRS 2”, IFRIC 9 “Reassessment of Embedded Derivatives”, and IFRIC 10 “Interim Financial Reporting and Impairment”. The Group has adopted these interpretations with no material effect on its financial results or financial position.
Standards that are not yet effective and have not been early adopted by the Group The following standards, and amendments and interpretations to existing published standards are not yet effective but are relevant to the Group’s operations. They have not been early adopted by the Group.
In November 2006, the IASB issued IFRS 8 “Operating Segments” which replaces IAS 14 “Segment Reporting”. IFRS 8 is mandatory for reporting periods beginning on or after January 1, 2009. The standard sets out the requirements for disclosure of an entity’s operating segments on the basis of internal reports used by management for decision making, as well as disclosures of the entity’s products and services, the geographical areas in which it operates, and its major customers.
In March 2007, the IASB issued amendments to IAS 23 “Borrowing Costs”. The amendments are mandatory for reporting periods beginning on or after January 1, 2009. The amendments eliminate the option available under the previous version of IAS 23 to recognize all borrowing costs immediately as an expense.
In September 2007, the IASB issued the revised IAS 1 “Presentation of Financial Statements”. The revised Standard is mandatory for reporting periods beginning on or after January 1, 2009. The changes require information in financial statements to be aggregated on the basis of shared characteristics and introduce a statement of comprehensive income.
The Group is currently evaluating the impact of adopting these standards and interpretations.
Investments in associates and partnerships where the Group has the ability to exercise significant influence but not control, as well as joint ventures where there is joint control, are accounted for using the equity method. Significant influence is presumed to exist when the Group owns, directly or indirectly, between 20 percent and 50 percent of the outstanding voting rights. Under the equity method of accounting, investment in an associate, partnership or joint venture is initially recognized at cost and adjusted thereafter for the postacquisition change in the Group’s share of net assets of the investee.
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 Group also issues products containing an embedded option to the policyholder to switch all or part of the current and future invested funds into another product issued by the Group, usually from a unit-linked product into a unitized with-profits contract or similar. Certain of these products allow policyholders to switch back to the previous product at their convenience. Where this results in the reclassification of an investment product to a product that meets the definition of an insurance contract, the previously held reserve and the related deferred origination costs are also reclassified and are accounted for in accordance with the accounting policies for such products on a prospective basis.
Once a contract has been classified as an insurance contract no reclassification is done subsequently.
DAC for other traditional life insurance and annuity policies are amortized over the expected life of the contracts as a constant percentage of expected premiums. Expected premiums are estimated at the date of policy issue and are consistently applied throughout the life of the contract unless premium deficiency occurs.
DAC for contracts such as universal life, unit-linked and unitized with-profits contracts are amortized over the expected life of the contracts based on a constant percentage of the present value of estimated gross profits expected to be realized over the life of the contract. Estimated gross profits include expected amounts to be assessed for mortality, administration, investment and surrender, less benefit claims in excess of policyholder balances, administrative expenses and interest credited. Estimated gross profits are revised regularly and the interest rate used to compute the present value of revised estimates of expected gross profits is the latest revised rate applied to the remaining benefit period. Deviations of actual results from estimated experience are reflected in earnings.
Future life policyholders’ benefits and policyholders’ contract deposits These represent the estimated future policyholder benefit liability respectively for traditional life insurance policies and for certain unit-linked contracts.
For traditional life insurance policies, interest rate assumptions can vary by country, year of issuance and product. The mortality rate assumptions are based on published mortality tables and are adjusted for actual experience by geographic area and modified to allow for variations in policy form. The surrender assumptions are based on actual experience by geographic area and modified to allow for variations in policy form.
Where unrealized gains or losses on the revaluation of available-for-sale assets arise and are recorded directly in equity in accordance with the accounting policy for such assets, the corresponding adjustments to future life policyholders’ benefits and related assets are also recognized directly in equity.
For products containing discretionary participation features the amount of the discretionary participation feature is deemed to be the investment return on all related assets where the apportionment between the shareholder and the policyholder has not yet been determined. The liability includes certain elements of unrealized gains and portions of retained earnings attributable to the DPF, based on the mandated rates applied to these gains and earnings on the assumption that they had been realized at the balance sheet date.
The minimum mandated amounts, which are to be paid to policyholders plus any declared additional benefits, are recorded in liabilities. The remainder of undeclared discretionary balances are not included in the liability but are included in shareholders’ equity until such time as the discretionary element of a bonus is determined and declared.
If there is objective evidence that a reinsurance asset is impaired, the carrying amount of the asset is reduced to its recoverable amount. The impairment is considered to have taken place if it is probable that the Group will not be able to collect the amounts due from reinsurers. The carrying amount of a reinsurance asset is reduced through the use of an allowance account, and the amount of the impairment loss is recognized in income.
In addition to assessing whether significant insurance risk has been transferred, reinsurance contracts are further assessed to ensure that underwriting risk, defined as the reasonable possibility of significant loss, and timing risk, defined as the reasonable possibility of a significant variation in the timing of cash flows, are transferred by the ceding or assuming company to the reinsurer. Those contracts that do not transfer both risks, referred to in total as insurance risk, are accounted for using the deposit method. A deposit asset or liability is recognized based on the consideration paid or received less any explicitly identified premiums or fees to be retained by the ceding company. Deposits for contracts that transfer only significant underwriting risk are subsequently measured based on the unexpired portion of coverage until a loss is incurred, after which the present value of expected future cash flows under the contract is added to the remaining unexpired portion of coverage. Changes in the deposit amount are recorded in the consolidated income statements as an incurred loss. Interest on deposits that transfer only timing risk, or no risk at all, are accounted for using the effective interest rate method. Future cash flows are estimated to calculate the effective yield, and revenue and expense are recorded as interest income or expense. Premiums paid under the retroactive contracts are included in reinsurance recoverables in the balance sheet. If the amount of gross claims provisions reinsured is higher than the premium paid, reinsurance receivables are increased by the difference, and the gain is deferred and amortized over the period in which the underlying claims are paid.
Liabilities for investment contracts (unit-linked) These represent portfolios maintained to meet specific investment objectives of policyholders who bear the credit and market risks. The liabilities are carried at fair value with changes recognized in income. The related assets held under unit-linked investments contracts are classified as designated at fair value through profit or loss in order to reduce measurement inconsistencies. The related liabilities are carried at fair value with changes recognized in income. The costs of policy administration, investment management, surrender charges and certain policyholder taxes assessed against the policyholders’ account balances are included in policy fee revenue.
Liabilities for investment contracts (amortized cost) Liabilities for investment contracts are measured at amortized cost, using the effective interest rate method. Transaction costs are deducted from the initial amount and form part of the effective yield. Future assumptions, except for the effective interest rate, are reviewed each reporting period. Changes in the liability due to changes in future assumptions are recognized in income.
The Group re-estimates at each reporting date the expected future cash flows and recalculates the carrying amount of the financial liability by computing the present value of estimated future cash flows using the financial liability’s original effective interest rate. Any adjustment is immediately recognized as income or expense in the income statement.
d) Other revenue recognition Fee revenue for the provision of non-claims related management services to the Farmers Exchanges is calculated primarily as a percentage of gross premiums earned by the Farmers Exchanges. FGI provides non-claims related management services to the Farmers Exchanges, including risk selection, preparation and mailing of policy forms and invoices, premium collection, management of the investment portfolios and certain other administrative and managerial functions. The Farmers Exchanges are responsible for their own claims functions, including the settlement and payment of claims and claims adjustment expenses. They are also responsible for the payment of agent commissions and bonuses and the payment of premium and income taxes.
Investment income primarily consists of dividend income on equity securities, interest income on financial assets other than equity securities, rental income earned on real estate held for investment and income earned on investments that are accounted for by using the equity method of accounting.
Interest income on financial assets that are not classified as held for trading or designated at fair value through profit or loss is recognized using the effective interest method. When a receivable is impaired, the Group reduces the carrying amount to its recoverable amount, being the estimated future cash flow discounted at the original effective interest rate of the instrument and continues unwinding the discount as interest income.
Rental income earned on real estate held for investment is recognized on the accrual basis.
f) Investments Investments include cash and cash equivalents, non-derivative financial instruments, real estate held for investment, investments in associates and joint ventures, short-term investments and investments held by investment companies.
Categories of non-derivative financial instruments Non-derivative financial instruments are classified as financial assets at fair value through profit or loss, financial assets held-to-maturity, loans and receivables, and financial assets available-for-sale. The classification depends on the purpose for which the investments were acquired. Management determines the classification of these investments at initial recognition with reference to its long-term investment objectives.
Financial assets at fair value through profit or loss are sub-classified into financial assets held for trading and those designated at fair value through profit or loss at inception.
Held-to-maturity financial assets are non-derivative financial assets with fixed or determinable payments and fixed maturities other than those that meet the definition of loans and receivables, and for which the Group’s management has the positive intention and the ability to hold to maturity.
Available-for-sale financial assets are non-derivative financial assets that are either designated as such or are not classified in any of the other categories.
Investments backing certain life insurance policies with participation features are held as at fair value through profit or loss in order to reduce measurement inconsistencies. Movements in the carrying value of these assets that are recognized in the current period investment income are offset by equivalent movements attributable to policyholders.
Loans and receivables Loans and receivables are subsequently carried at amortized cost using the effective interest rate method, less provision for impairment.
Unrealized gains and losses on securities classified as available-for-sale are analyzed between differences resulting from foreign currency translation, differences resulting from changes in the amortized cost and other fair value changes. Foreign currency translation differences on monetary available-for-sale investments, such as debt securities, are recognized in income. Foreign currency translation differences on non-monetary assets, such as equity securities, are recognized directly in equity. Other unrecognized gains and losses on available-for-sale investments are recognized directly in equity.
Other items Cash and cash equivalents includes cash in hand, deposits held at call with banks, other short-term highly liquid investments with original maturities of three months or less, which are held for cash management purposes. Cash and cash equivalents also includes cash received as collateral for securities lending as well as cash and cash equivalents held for the benefit of policyholders in connection with unit-linked products. Cash and cash equivalents are stated at face value.
Real estate held for investment purposes is initially recorded at cost (including transaction costs) and is subsequently measured at fair value with changes in fair value recognized in current period income. No depreciation is recorded for real estate held for investment. The gain or loss on disposal of real estate held for investment is based on the difference between the proceeds received and the carrying value of the investment.
Investments held by investment companies are carried at fair value as they are managed on a fair value basis.
General Financial assets are assessed for impairment on a regular basis. A financial asset is impaired if its carrying value exceeds the estimated recoverable amount and there is objective evidence of impairment to the financial asset.
The Group assesses at each balance sheet date whether there is objective evidence that a financial asset or group of financial assets is impaired. A financial asset or group of financial assets is impaired and impairment losses are incurred only if there is objective evidence of impairment as a result of one or more events that have occurred after the initial recognition of the asset (a ’loss event’) and that loss event (or events) has an impact on the estimated future cash flows of the financial asset or group of financial assets that can be reliably estimated. Objective evidence that a financial asset or group of assets is impaired includes observable data that comes to the attention of the Group about the following events: a) significant financial difficulty of the issuer or debtor; b) a breach of contract, such as a default or delinquency in payments; c) it becomes probable that the issuer or debtor will enter bankruptcy or other financial reorganization; d) the disappearance of an active market for that financial asset because of financial difficulties; or e) observable data indicating that there is a measurable decrease in the estimated future cash flow from a group of financial assets since the initial recognition of those assets, although the decrease cannot yet be identified with the individual financial assets in that group, including: • adverse changes in the payment status of issuers or debtors in that group; or
The Group first assesses whether objective evidence of impairment exists for financial assets that are individually significant. If the Group determines that no objective evidence of impairment exists for an individually assessed financial asset, whether significant or not, it includes the asset in a group of financial assets with similar credit risk characteristics and collectively assesses them for impairment. Assets that are individually assessed for impairment and for which an impairment loss is or continues to be recognized are not included in a collective assessment of impairment.
Derivative financial instruments that are not part of a qualifying accounting hedge relationship are classified as held for trading assets or liabilities and carried at fair value on the balance sheet.
Fair values are obtained from quoted market prices, dealer price quotations, discounted cash flow models and option pricing models, which incorporate current market and contractual prices for the underlying instrument, time to expiry, yield curves and volatility of the underlying instrument. Inputs used in pricing models are generally market observable or can be derived from market observable data. Derivative financial instruments with positive fair values are recorded as derivative trading assets and those with negative fair values are recorded as derivative trading liabilities. Apart from derivative financial instruments designated as qualifying cash flow hedging instruments. Changes in fair value are recognized in income.
Derivative financial instruments that qualify for hedge accounting For the purpose of hedge accounting, hedging instruments are classified as 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 hedges of the net investment in a foreign operation.
To qualify for hedge accounting, the relationship of the hedging instrument to the underlying transaction must meet several strict conditions on documentation, probability of occurrence, hedge effectiveness and reliability of measurement. 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 relationship. Where these conditions are met, the accounting treatments are as follows: Fair value hedges Gains or losses from re-measuring the derivatives 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 risk being hedged. Offsetting gains or losses on the fair value hedged item attributable to the hedged risk are adjusted against the carrying amount of the hedged item and recognized in income.
• the Group otherwise determines that designation of the derivative as a hedging instrument is no longer appropriate.
When the Group discontinues fair value hedge accounting because it determines that the derivative no longer qualifies as an effective fair value hedge, the derivative will be carried separately on the consolidated balance sheet at its fair value, and the value of the hedged asset or liability will no longer be adjusted for changes in fair value attributable to the hedged risk. Interest-related fair value adjustments made to the underlying hedged items will be amortized in income over the remaining life of the hedged item. Any unamortized interest-related fair value adjustment is recorded in income upon sale or extinction of the hedged asset or liability, respectively. Any other fair value hedge adjustments remain part of the carrying amount of the hedged asset or liability and are recognized in income upon disposition of the hedged item as part of the gain or loss on disposal.
Financial Report 2007 be highly probable, in which case the related cumulative gains and losses on the hedging instrument remain in other recognized income and expense within shareholders’ equity until the forecast transaction occurs or is no longer expected to occur. At that point, the gains and losses will be treated as described above.
h) Derecognition of financial assets and liabilities Financial assets are derecognized when the right to receive cash flows from the assets has expired, or when the Group has transferred its contractual right to receive the cash flows from the financial asset, and either
j) Securities lending Certain entities within the Group participate in securities lending arrangements whereby specific securities are loaned to other institutions, primarily banks and brokerage firms, for short periods of time. Under the terms of the securities lending agreements, the Group retains substantially all the risks and rewards of ownership of these loaned securities, and also retains contractual rights to cash flows therefrom. These securities are therefore not derecognized from the Group’s balance sheet. Cash collateral received as security for loaned securities is recorded as an asset and the related liability is recorded in liabilities for cash collateral received for securities lending.
k) Obligation to repurchase securities Sales of securities under agreements to repurchase are accounted for as collateralized borrowing transactions and any difference between the amount of consideration received at initial recognition and the purchase value is recognized in income over the period of lending using the effective interest rate method.
l) Borrowings Borrowings (debt issued) are recognized initially at fair value, net of transaction costs incurred. Borrowings are subsequently stated at amortized cost; any difference between the proceeds (net of transaction costs) and the redemption value is recognized in income over the period of the borrowings using the effective interest rate method.
The recoverable amount of a cash generating unit is the higher of its fair value less costs to sell and its value in use. Fair value less costs to sell is based on the best information available to reflect the amount that the Group could obtain, at the balance sheet date, from the disposal of the cash generating unit on an arm’s length basis between knowledgeable, willing parties, after deducting the costs of disposal. The information considered in assessing fair value may include quoted market prices, current share values in the market place for similar publicly traded entities, and recent sale transactions of similar entities or businesses in the market place. Value in use is determined using the present value of estimated future cash flows expected to be generated from or used by the cash generating unit. The estimated future cash flows are based on best estimate assumptions, such as revenue and expense projections, growth rate, interest rates and investment yields, and inflation rate.
Other intangible assets Other intangible assets acquired in a business combination are recognized separately from goodwill at the acquisition date if it is probable that the expected future economic benefits that are attributable to these assets will flow to the entity, and that the cost of these assets can be measured reliably, and, if these assets are separable or arise from contractual or other legal rights.
Such assets include brand names, customer relationships and contracts, affinity partnerships, computer software licenses and capitalized development costs.
Intangible assets that have an indefinite useful life are not subject to amortization but are tested for impairment annually and whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Intangible assets that have a finite useful life are amortized using the straight-line method over the useful life. They are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.
Attorney-in-fact relationships (AIF) The asset representing the AIF reflects the ability of the Group to generate future revenues based on the Group’s relationship with the Farmers Exchanges. In determining that these relationships have an indefinite useful life, the Group considered the organizational structure of inter-insurance exchanges, under which subscribers exchange contracts with each other and appoint an attorney-in-fact to provide certain management services and the historical AIF between FGI and the Farmers Exchanges. Similar to goodwill, an impairment test for AIF is performed on an annual basis or whenever there is a change in circumstances that may have an adverse effect.
Taxes paid by certain of our life insurance businesses are based on the investment result less allowable expenses. To the extent that these taxes exceed the amount that would have been payable in respect of the shareholders’ share of taxable profits, it is normal practice for certain of our businesses to recover this tax from policyholders. While the relevant company has the contractual right to charge policyholders for the taxes attributable to their share of the investment result less expenses, the obligation to pay the tax authority rests with the company and therefore, the full amount of tax including that charged to policyholders is accounted for as income tax. Income tax expense therefore includes an element attributable to policyholders. In addition, deferred tax on unrealized gains on investment contracts with DPF related to certain unit-linked contracts is included as income tax expense and an accrual for future policy fees to recover the tax charge is included in gross written premiums as and policy fee revenue.
Retirement benefits The operating companies in the Group provide employee retirement benefits through both defined benefit plans providing specified benefits and defined contribution plans. The assets of these plans are generally held separately from the Group’s general assets in trustee-administered funds. Defined benefit plan obligations and contributions are determined annually by qualified actuaries using the projected unit credit method. The Group’s expense related to these plans is accrued over the employees’ service periods based upon the actuarially determined cost for the period.
Other post-employment benefits Other defined post-employment benefits, such as medical care and life insurance, are also provided for certain employees and are primarily funded internally. Similar to retirement benefits, the cost of such benefits is accrued over the service period of the employees based on the actuarially determined cost for the period.
q) Share-based compensation and cash incentive plans Under the Group’s equity-settled, share-based compensation plan, the fair value of the employee services received in exchange for the grant of shares and/or options is recognized as an expense in income over the vesting period, with a corresponding amount recorded in additional paid-in capital.
As the fair value of the options which the Group uses for its employee schemes cannot be compared to the ones in the market, the Group estimates the fair value using the Black-Scholes model. This model requires inputs such as share price, exercise price, implied volatility, risk-free interest rate, expected dividend rate and the expected life of the option.
r) Property and equipment Own use property is defined as property held by the Group for use in the supply of services or for administrative purposes. Buildings held for own use and equipment are carried at cost less accumulated depreciation and any accumulated impairment loss. The costs of these assets are depreciated principally on a straight-line basis to income over the following estimated useful economic lives: • buildings 25 to 50 years; • furniture and fixtures five to ten years; and
Maintenance and repair costs are charged to income as incurred. Costs of systems purchased from third party vendors are carried as fixed assets and amortized over expected useful lives. Gains and losses on the disposal of property and equipment and property held for own use are determined by comparing the proceeds with the carrying amounts and recorded in other income.
Property and equipment is reviewed for impairment whenever events or changes in circumstances indicate that the balance sheet carrying amount may not be recoverable.
Impairment of non-financial assets Assets that have an indefinite useful life, for example land, are not subject to amortization and are tested regularly for impairment. Assets that are subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognized for the amount by which the carrying value of the asset exceeds its expected recoverable amount. The recoverable amount is the higher of fair value less costs to sell and value in use. For the purposes of assessing impairment, assets are grouped on a cash generating unit level.
s) Finance and operating leases Agreements which transfer to counterparties substantially all the risks and rewards incidental to the ownership of assets, but not necessarily legal title, are classified as finance leases. Leases in which a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases. Payments made under operating leases (net of any incentives received from the lessor) are charged to income on a straight-line basis over the period of the lease.
t) Provisions Provisions are recognized when the Group has a present obligation (legal or constructive) as a result of a past event, it is more likely than not that an outflow of resources embodying economic benefits will be required to settle the obligation and a reliable estimate can be made of the amount of the obligation. Provisions are only discounted where the effect of the time value of money is considered material.
Financial Report 2007 u) Treasury shares Zurich Financial Services shares held by the Group are classified as treasury shares and are deducted from equity at nominal value. The difference between the nominal value and the amount paid for acquiring, or received for disposing of treasury shares, is recorded as an adjustment to additional paid-in capital to the extent that additional paid-in capital is available. Any premium or discount above the available additional paid-in capital is recorded directly in retained earnings.
Foreign currency translation In view of the international nature of the Group, there are many individual entities with different functional currencies. A functional currency is the currency of the primary economic environment in which the entity operates. Therefore, a common presentation currency is required. Due to the Group’s economic exposure to the US dollar (USD), the presentation currency of the Group has been determined to be the USD. Assets and liabilities of Group companies with functional currencies other than USD are translated into the presentation currency at end-of-period exchange rates, while income statements are translated at average exchange rates for the period. The resulting translation differences are recorded directly in shareholders’ equity as cumulative translation adjustments.
Foreign currency transactions Foreign currency monetary items and foreign currency non-monetary items, which are carried at fair value are translated at end-of-period exchange rates. Foreign currency non-monetary items which are carried at historical cost are translated at historical rates. Revenues and expenses are translated using the exchange rate at the date of the transaction or a weighted average rate. The resulting exchange differences are recorded in the consolidated income statement, except when the gain or loss on a non-monetary item measured at fair value is recognized directly in equity in which case any exchange component of that gain or loss is also recognized directly in equity.
Principal USD per foreign currency unit, as of or for the year ended December 31 exchange rates
Financial Report 2007 a) Reserves for losses and loss adjustment expenses The Group is required by applicable insurance laws, regulations and IFRS to establish reserves for payment of losses and loss adjustment expenses that arise from the Group’s general insurance products and the run-off of its former third party reinsurance operations. These reserves represent the expected ultimate cost to settle claims occurring prior to, but still outstanding as of, the balance sheet date. The Group establishes its reserves by product line, type and extent of coverage and year of occurrence. Loss reserves fall into two categories: reserves for reported losses and reserves for incurred but not reported (IBNR) losses. Additionally, reserves are held for loss adjustment expenses, which contain the estimated legal and other expenses expected to be incurred to finalize the settlement of the losses.
d) Impairment of assets Assets are subject to regular impairment reviews under the relevant IFRS standard. A financial asset is considered impaired if its carrying value exceeds the estimated recoverable amount and there is objective evidence of impairment to the financial asset.
For a non-derivative financial asset, the decision to record an impairment is based on a review of objective evidence, such as the issuer’s current financial position and future prospects and the national or economic conditions that may correlate with defaults on the asset, as well as the availability of an active financial market for that financial assets. For a quoted available-for-sale asset the impairment decision is further based onan assessment of the probability that the current market price will recover to former levels within the foreseeable future. The recoverable amount is determined by reference to the market price. For non-quoted available-forsale financial assets, the recoverable amount is determined by applying recognized valuation techniques.
For held-to-maturity financial assets and loans and receivable, the recoverable amount is determined by reference to the present value of the estimated future cash flows. The carrying amount of mortgage loans and receivables is reduced through an allowance account, and the allowance is determined using an analytical method based on knowledge of each loan group or receivable. The method is normally based on historical statistics, adjusted for known or anticipated trends in the group of financial assets or individual accounts. As judgement is involved in the process of evaluating the impairment of such assets, actual outcomes could vary significantly from the forecasted future cash flows.
Refer to notes 3, 6, 14, 16 and 17 for further information on impairments of assets.
f) Deferred policy acquisition costs Deferred policy acquisition costs generally consist of commissions, underwriting expenses and policy issuance costs. The amount of acquisition costs to be deferred is dependent on management’s judgment as to which issuance costs are directly related to and vary with the acquisition. Further, once the costs are deferred, the related asset is amortized over the estimated life of the contract.
g) Deferred taxes Deferred tax assets are recognized if sufficient future taxable income, including income from the reversal of existing taxable temporary differences and available tax planning strategies, are available for realization. The utilization of deferred tax assets arising from temporary differences depends on the generation of sufficient taxable profits in the period in which the underlying asset or liability is recovered or settled. As of each balance sheet date, management evaluates the recoverability of deferred tax assets and if it is considered probable, that all or a portion of the deferred tax asset will not be utilized, then a valuation allowance would be recognized.
Refer to note 23 for further information on share-based compensation and cash incentives plans.
Acquisitions On January 2, 2007, the Group purchased all of the remaining shares in the insurance intermediary Endsleigh Limited (Endsleigh) in the UK for a total of USD 84 million including transaction costs. Since 2002 the Group had owned 45 percent of Endsleigh. An asset revaluation surplus arose from revaluation of tangible and intangible assets of Endsleigh acquired by the Group in 2002 to the fair values of the initial accounting in 2007. Residual goodwill arose in this business combination in the amount of USD 90 million due to the expected growth opportunities and synergies within the Group. Identifiable intangibles net of deferred tax amounted to USD 63 million the major part of which related to contractual relationships.
On July 2, 2007, the Group acquired a 24.51 percent equity interest in Best Harmonious Insurance Brokers Company, Ltd., a nationally licensed Chinese insurance brokerage firm domiciled in Beijing for a total consideration of USD 11 million. This interest corresponds to a profit share of 91.44 percent and gives the Group effective control. The residual goodwill related to this acquisition amounts to USD 2 million.
On July 3, 2007, the Group, through its fully owned subsidiary FGI completed the acquisition of 100 percent of Bristol West Holdings, Inc. (Bristol West) in the US. As part of this transaction, FGI sold the underlying insurance business, consisting of non-standard auto insurance, to the Farmers Exchanges (which FGI manages but does not own). Net of the business sold to the Farmers Exchanges, FGI incurred total acquisition costs of USD 353 million (including transaction costs of USD 9 million). Net assets acquired amounted to negative USD 32 million due to the assumption of a debt obligation of USD 50 million. The residual goodwill arising from the acquisition amounted to USD 385 million and reflects the economic benefit of the management services which remained with FGI. This transaction did not affect the Group’s scope of consolidation.
On December 17, 2007, the Group announced it has entered into an agreement to acquire 100 percent of DWS Vita SpA, a life insurer located in Italy, for approximately USD 140 million. This transaction did not affect the Group’s scope of consolidation as it is expected to close in the first half of 2008, subject to the approval of the relevant insurance regulatory and antitrust authorities.
Business In USD millions, for the year ended December 2007 combinations
In 2007, the Group recorded a gain on divestments before tax of USD 118 million. This gain includes an amount of USD 32 million for a purchase price adjustment related to contractually agreed profit participation from the sale of Zurich Atrium BV in the Netherlands in 2004. Total cash and net assets divested in 2007 were USD 64 million and USD 52 million, respectively. The total consideration received in 2007, net of transaction costs of USD 9 million, amounted to USD 175 million.
Net gain/(loss) in USD millions, for the years ended December 31 on divestments
The investment result for the years ended December 31, 2007 and 2006 comprised the following: Table 6.1a
Real estate held for investment 927 836 (419) 1,130 508 1,966
Investments held by investment companies 1 5 475 283 477 288
Investment result, gross for Group investments 8,838 8,164 1,498 1,536 10,336 9,699
Investment result, net for Group 1 Including net capital losses on derivative financial instruments of USD 33 million and USD 44 million for the years ended December 31, 2007 and 2006, respectively, of which net capital losses on derivatives attributable to cash flow hedges ineffectiveness of USD 9 million for the year ended December 31, 2007 are included.
Net capital gains/ Net investment (losses) on Investment income investments result
Total net capital in USD millions, for the years ended December 31 gains, losses and impairments on equity and debt securities
Securities at fair value through profit or loss: 5,379 8,880 (337) (351) 5,042 8,529 of which: trading securities
Realized capital losses on Group investments (137) (166) (813) (397) (950) (564)
Equity securities: Fair value through profit or loss 4,042 2.1 4,383 2.2 of which: trading equity portfolios in capital markets
Debt securities: Fair value through profit or loss 8,387 4.3 8,650 4.4
Other investments: Investments held by investment companies 1,827 0.9 1,862 1.0
There were no material reclassifications between the categories of financial instruments in 2007 and 2006.
Securities under security lending and short-term sale and repurchase agreements As of December 31, 2007 and 2006, investments included USD 12,204 million and USD 11,512 million, respectively, of loaned securities. These loaned securities were mainly debt securities. Cash and cash equivalents included USD 1,877 million and USD 3,820 million of cash received as collateral for loaned securities as of December 31, 2007 and 2006, respectively. Liabilities for cash collateral received for securities lending comprised USD 1,889 million and USD 3,918 million as of December 31, 2007 and 2006, respectively. Non-cash collaterals received for loaned securities comprised USD 10,911 million and USD 7,654 million as of December 31, 2007 and 2006, respectively. Non-cash collaterals comprised mainly equity and debt securities. The Group can sell or repledge the collateral only in the event of a default of a counterparty.
As of December 31, 2007 and 2006, respectively, debt securities with a carrying value of USD 5,370 million and USD 6,144 million have been sold to financial institutions under short-term sale and repurchase agreements. These securities continue to be recognized as investments in the balance sheets. Obligations to repurchase these securities comprised USD 5,370 million and USD 6,144 million as of December 31, 2007 and 2006, respectively. The Group retains the rights to the risks and rewards of ownership of loaned securites and securities under short-term sale and repurchase agreements. These risks and rewards include changes in market values and income earned, respectively.
The table below presents the carrying value of debt securities for total investments by maturity: Table 6.4
The following table provides an analysis of available-for-sale securities which applies to both total and Group investments.
Cost or Gross Gross amortized cost unrealized gains unrealized losses Fair value
The following table provides an analysis of securities for both Group investments and investments for unit-linked products at fair value through profit or loss.
Fair value through as of December 31 profit or loss securities
USD % of USD % of USD USD USD USD millions total millions total millions millions millions millions
Equity securities of which: trading equity portfolios in capital markets and banking of which: common stock portfolios backing participating with profit policyholder
Debt securities of which: trading debt securities in capital markets and banking
Investments in associates as of December 31, 2007 and 2006 comprised the following: Table 6.9
Unrealized net gains/(losses) on investments included in the shareholders’ equity comprised the following: Table 6.10
Less: amount of net unrealized gains/(losses) on investments attributable to: Life policyholder dividends and other policyholder liabilities 459 (1,038)
1 The unrealized gains/(losses) include net losses arising on cash flow hedges in the amount of USD 103 milion.
Financial Report 2007 a) Derivative financial instruments held for economic hedging purposes
Total return equity swaps – – – – – – (2)
Options of which: financial assets 122 107 financial liabilities (74) (75)
Maturity profile of in USD millions, as of December 31 notional principal amounts and market values of derivative financial instruments
Cross currency interest rate swaps – – 1,022 1,022 924 118 24
Gains and losses arising from fair value hedges are as follows: Table 7.4
on hedging instruments 1 72 38 on hedged debt issued attributable to the hedged risk (71) (34)
1 Excluding current interest income, which is booked in the same line as interest expense on the hedged debt.
The Group also uses currency swaps in a cash flow hedge to protect against exposures to variability in cash flows due to changes in the exchange rate of the euro against the reporting currency of the Group on 80 percent of the 4.50% EUR 1 billion debt issued by Zurich Finance (USA), Inc (see note 20). The change in the fair value of the hedging instruments is recognized directly in shareholders’ equity and the effective portion, related to spot rate changes in fair value of the hedging instrument, together with ineffectiveness are then recognized in current period income in the same line as the foreign currency revaluation on the underlying hedged debt issued. This hedge relationship is in place until the maturity of the debt in September 2014.
Reinsurers’ share of reserves for insurance contracts, gross 2 (27,140) (20,347)
2 Gross of allowance for uncollectible amounts of USD 164 million and USD 239 million as of December 31, 2007 and 2006, respectively.
Losses and loss adjustment expenses incurred: Losses and loss adjustment expenses paid: Acquisitions / (divestments) of companies
Significant delays may occur in the notification and settlement of claims, and a substantial measure of experience and judgment is involved in assessing outstanding liabilities, the ultimate cost of which cannot be known with certainty as of the balance sheet date. The reserves for losses and loss adjustment expenses are determined on the basis of information currently available; however, it is inherent in the nature of the business written that the ultimate liabilities may vary as a result of subsequent developments.
Net reserves re-estimated as of: Four years later 31,784 37,691 42,254
Development of in USD millions reserves for losses and loss adjustment expenses for asbestos and environmental claims
Interest and bonuses credited to policyholders 1,264 1,010 (120) (134) 1,144 876
Interest and bonuses credited to policyholders 4,403 6,184 – – 4,403 6,184
The net amount at risk is the present value of payouts exceeding the current policyholder account balance assuming the payout criteria in all policies are collectively triggered as of the balance sheet date. We do not provide for this amount but follow the accretion guidance in the US Statement of Principle 03-1 “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts”. Under this guidance future fees are taken into account in determining the net loss to be provided. The net amount at risk is not the same as the fair value of these benefits, as it does not fully take into account the option value accruing to the policyholder.
As of December 31 1,309 1,414 11. Gross and ceded insurance revenues and expenses
Losses and loss adjustment expenses 24,951 24,506 (2,796) (3,276) 22,155 21,230
Total insurance benefits and losses 1 35,014 33,875 (11,636) (3,668) 23,378 30,207 1 The Group’s life operations in the UK entered into a reinsurance agreement to transfer the risk associated with a significant annuities portfolio as of January 1, 2007. The initial impact on ceded insurance benefits and losses amounted to USD 7.0 billion in the Global Life business.
Policyholder in USD millions, for the years ended December 31 dividends and participation in profits
Change in reserves for unit-linked products 4,077 6,476 – – 4,077 6,476
Underwriting and in USD millions, for the years ended December 31 policy acquisition costs
Underwriting and policy acquisition costs 8,521 7,821 (932) (841) 7,589 6,980
Farmers in USD millions, for the years ended December 31 management fees and other related revenues
FGI, through its AIF relationship with the Farmers Exchanges, which the Group manages but does not own, is contractually permitted to receive a management fee of up to 20% (25% in the case of the Fire Insurance Exchange) of the gross premiums earned by the Farmers Exchanges. To enable the Farmers Exchanges to maintain appropriate capital and surplus while offering competitive insurance rates, FGI has historically charged a lower management fee than the maximum allowed. The range of fees has varied by line of business over time and from year to year. During the past five years, aggregate management fees have averaged between 12% and 13% of gross premiums earned by the Farmers Exchanges. The gross earned premiums of the Farmers Exchanges were USD 15,547 million and USD 14,721 million for the twelve months ended December 31, 2007 and 2006, respectively.
The table below shows the movement in allowance for impairments deducted from receivables in 2007 and 2006.
Development of in USD millions allowance for impairments (deducted from receivables)
The table below shows the maturity schedule of collateralized loans as of December 31, 2007 and 2006, respectively.
Gross carrying value as of January 1, 2007 385 1,500 398 666 577 3,525
Additions, capital improvements and transfers 3 95 32 97 117 343
Gross carrying value as of January 1, 2006 355 1,341 378 684 510 3,267
Gross carrying value as of January 1, 2007 672 2,329 2,041 1,024 6,066
Net carrying value as of January 1, 2007 660 775 626 1,024 3,085
In addition to goodwill increases related to business combination of USD 886 million as disclosed in note 5, goodwill has increased by USD 127 million due to a change in the Group’s interest in Deutscher Herold AG from 76.88 percent to 95 percent as a result of the recognition of buy out options and an acquisition of shares by the Group from minority shareholders. The remainder is due to foreign currency impacts.
Gross carrying value as of January 1, 2006 605 2,117 1,770 1,024 5,516
Net carrying value as of January 1, 2006 605 740 491 1,024 2,860
Net carrying value as of 1 Other intangibles include internally generated capitalised software development costs as well as intangible assets at fair value on acquisitions.
When testing for impairment for goodwill, the recoverable amount of a cash generating unit is determined on the basis of value-in-use calculations. These calculations use cash flow projections based on financial budgets, which are approved by management, typically covering a five-year period. Cash flows beyond the five year period are extrapolated using the estimated growth rates. The estimated growth rate does not exceed the longterm average past growth rate for the insurance business in which the CGU operates. The discount rates applied reflect the respective risk free interest rate adjusted for the risk factors which are reflective of the risk inherent in the underlying cash flows.
In 2007 impairment charges of USD 46 million were recorded in the income statement comprising impairment of other intangible assets of USD 34 million mainly relating to software capitalized in the UK life business and impairment of goodwill of USD 12 million as a result of updated cash flow assumptions in the Spanish life operations.
In 2006, impairment charges of USD 12 million were recorded in the income statement. USD 6 million of the 2006 impairment charge relates to entities in Australia and USD 6 million to the Spanish life operations.
USD 18,291 million and USD 19,367 million as of December 31, 2007, and 2006, respectively, are considered financial liabilities. USD 1,967 million and USD 3,435 million as of December 31, 2007, and 2006, respectively, are considered non-financial liabilities. The undiscounted amounts are not materially different from the carrying amounts.
Increase/(reduction) in taxes resulting from: Tax exempt and lower taxed income (517) (637)
The table above illustrates the factors that cause the actual income tax expense to differ from the expected amount computed by applying the weighted average statutory income tax rate.
The expected weighted average statutory income tax rate for the Group is 30.3 percent and 30.2 percent for the years ended December 31, 2007 and 2006, respectively. These rates were derived by obtaining a weighted average of the applicable statutory income tax rates in relation to the net income before income tax attributable to shareholders generated in the taxable territories in which the Group operates.
A credit of USD 145 million resulting from the reduction of corporate income tax rates in the UK, Germany and Italy is included in the line “prior years adjustments and other” for the year 2007. Also included in this line are withholding and local taxes amounting to USD 113 million and USD 119 million for the years 2007 and 2006, respectively.
The cumulative amount of deferred tax credited to shareholders’ equity amounted to USD 328 million and USD 272 million for the years ended December 31, 2007 and 2006, respectively.
Expiring after 20 years or with no time limitation 110 587
The tax rates applicable to tax losses for which a deferred tax asset has not been recognized are 35 percent and 31 percent for the years 2007 and 2006, respectively.
As of December 31, 2007 and 2006, the net deferred tax positions by taxpayer groups are as follows.
Other taxpayer groups carrying net deferred tax assets 249 268 250 234
Other taxpayer groups carrying net deferred tax liabilities (3,722) (3,775) (3,729) (3,950)
Debt in USD millions, as of December 31 2007 2006 a) Debt related to capital markets and banking activities
Various debt instruments payable in more than 1 year 48 45
Centre Solutions (Bermuda) Ltd. Various debt instruments payable in more than 1 year – 56
Zurich Insurance Company 3.875% CHF 1,000 bond, due July 2011 884 822
Various debt instruments payable in more than 1 year 111 143
Zurich Finance (UK) p.l.c. 6.625% GBP 450 bond, undated notes 3 879 867
Zurich Finance (USA), Inc. 5.75% EUR 500 bond, due October 2023 720 651
ZFS Finance (USA) Trust I Series I 6.15% USD 600 ECAPS, due December 2065 595 593
ZFS Finance (USA) Trust II Series II 6.45% USD 700 ECAPS, due December 2065 690 690
Other Various debt instruments payable in more than 1 year 29 –
None of the debt instruments listed above were in default as of December 31, 2007 and 2006.
b) Senior debt The Group’s Euro Medium Term Note Programme (EMTN Programme) allows for the issuance of senior and subordinated notes up to a maximum of USD 6 billion. Zurich Finance (USA), Inc. and Zurich Finance (UK) p.l.c. are issuing entities under the EMTN Programme, which have debt outstanding as of December 31, 2007 and 2006.
On May 9, 2007, ZFS Finance (USA) Trust IV and ZFS Finance (USA) Trust V issued USD 500 milion of Series IV and USD 1 billion of Series V Fixed / Floating Rate Trust Preferred Securities. Series IV is a 5.875 percent USD 500 million tranche maturing in 2062, callable from 2012, and Series V is a 6.5 percent USD 1 billion tranche maturing in 2067, callable from 2017. These trust preferred securities were sold to a number of qualified institutional buyers and qualified purchasers under the exemption from Rule 144A of the United States Securities Act (1933). Each Trust benefits from a subordinated support agreement from Zurich Financial Services and Zurich Group Holding. See table 20.2 for details of redemption conditions.
d) Hedged debt The Group uses cross-currency interest rate swaps and currency swaps to manage the risks inherent in certain debt issues. Where the relationship qualifies for hedge accounting (see notes to table 20.1), such hedge accounting is applied as described in notes 3 and 7.
The objective of the fair value hedges on debt issued is to protect against changes in the foreign currency exposure and interest rate exposure of euro denominated debt issuances, while the objective of the cash flow hedge on debt is to hedge changes in US dollar cash flows of the euro denominated debt resulting from changes in euro/US dollar exchange rate.
6.45% payable semi-annually Series II 6.45% until June 15, 2016 Redeemable in whole Fixed / Adjustable Rate and then reset quarterly or in part at par USD 700 ECAPS, to the adjustable rate Quarterly on plus any accumulated and due December 2065 plus 2.00%. 2 or after June 15, 2016 unpaid distributions.
Series III Floating Rate until December 15, 2010 or in part at par USD 400 ECAPS, and then 3-month LIBOR Quarterly on or plus any accumulated and due December 2065 plus 2.15%. after December 15, 2010 unpaid distributions.
6.5% payable semi-annually Series V 6.5% until May 9, 2017 Redeemable in whole USD 1,000 Fixed / Floating and then reset quarterly or in part at par Trust Preferred Securities, to 3-month LIBOR Quarterly on plus any accumulated and due May 2067 plus 2.285%. or after May 9, 2017 unpaid distributions.
1 Reset rate of interest is equal to the gross redemption yield on the benchmark five-year Gilt as determined by the Calculation Bank, plus 2.85% per annum. 2 Adjustable Rate is equal to the greatest of (i) the 3-month LIBOR rate; (ii) the 10-year Treasury CMT (Constant Maturity Treasury) Rate; and (iii) the 30-year
Maturity schedule in USD millions, as of December 31 of outstanding debt
Credit facilities The Group has access to a syndicated revolving credit facility of USD 3 billion that terminates in 2012. Zurich Group Holding, together with Zurich Insurance Company and Farmers Group, Inc. are guarantors of the facility and can draw up to USD 1.25 billion, USD 1.5 billion and USD 250 million, respectively. No borrowings were outstanding under this facility as of December 31, 2007.
Dunbar Bank and Zurich Bank have access to various committed credit facilities totaling GBP 420 million and GBP 250 million, respectively. No borrowings were outstanding under these facilities as of December 31, 2007.
Financial debt Financial debt consists of all debt items that are included in financial leverage calculations of rating agencies. As of December 31, 2007 and 2006 financial debt consisted of the following components.
Authorized, contingent and issued share capital, CHF 0.10 par value 160,231,227 156,988,783 a) Issued share capital As of December 31, 2007, Zurich Financial Services had 145,546,820 issued and fully paid registered shares of CHF 0.10 par value, amounting to total issued share capital of CHF 14,554,682.00. As of December 31, 2006, the share capital amounted to CHF 14,474,939.90, divided into 144,749,399 fully paid registered shares of CHF 0.10 par value.
In 2006, the Board of Directors approved on February 15, 2006, the issuance of a maximum of 1,000,000 out of the 1,500,000 dividend-paying shares from the contingent share capital to employees. At the Annual General Meeting on April 20, 2006, shareholders approved a share capital reduction in the form of a nominal value reduction of each share from CHF 2.50 to CHF 0.10. At the effective date of the nominal value reduction on July 3, 2006, Zurich Financial Services had 144,565,255 issued and fully paid shares, including 558,300 shares issued out of the contingent capital. As a result of this reduction, the share capital was reduced by CHF 346,956,612.00 from CHF 361,413,137.50 to a new total of CHF 14,456,525.50. As of December 31, 2006 a total of 742,444 shares were issued to employees from contingent share capital. As a consequence, 144,749,399 fully paid shares with a nominal value of CHF 0.10 were issued as of December 31, 2006, amounting to a share captital of CHF 14,474,939.90.
b) Authorized share capital Until June 1, 2008, the Board of Zurich Financial Services is authorized to increase the share capital by an amount not exceeding CHF 600,000 by issuing up to 6,000,000 fully paid registered shares with a nominal value of CHF 0.10 each. An increase in partial amounts is permitted. The Board determines the date of issue of such new shares, the issue price, type of payment, conditions for exercising pre-emptive rights, and the beginning of the dividend entitlement. The Board may issue such new shares by means of a firm underwriting by a banking institution or syndicate with subsequent offer of those shares to current shareholders. The Board may allow the expiry of pre-emptive rights which have not been exercised, or it may place these rights as well as shares, the pre-emptive rights of which have not been exercised, at market conditions.
Capital market instruments and option rights to shareholders The share capital of Zurich Financial Services may be increased by an amount not exceeding CHF 548,182.80 by the issuance of up to 5,481,828 fully paid registered shares with a nominal value of CHF 0.10 each (i) by exercising of conversion and/or option rights which are granted in connection with the issuance of bonds or similar debt instruments by Zurich Financial Services or one of its Group companies in national or international capital markets; and/or (ii) by exercising option rights which are granted to current shareholders. When issuing bonds or similar debt instruments connected with conversion and/or option rights, the pre-emptive rights of the shareholders will be excluded. The current owners of conversion and/or option rights shall be entitled to subscribe for the new shares. The conversion and/or option conditions are to be determined by the Board.
In February 2001, the Group placed six series of Trust Capital Securities (Zurich RegCaPS) for the total amount of USD 1,125 million (USD 1,096 million net of issuance costs) with a limited number of qualified institutional and corporate US investors. The securities, which were issued under Rule 144A in the United States, are perpetual, non-cumulative and have a par value of USD 1,000 each. They have no voting rights, except for certain specified circumstances and are linked to Farmers Group, Inc. Class C shares. On March 30, 2006, and April 11, 2006, the Group redeemed the Series I and III of the Zurich RegCaPS, respectively. The liquidation amounts totaled USD 425 million in aggregate. Of the remaining series totaling USD 700 million, one has a fixed rate coupon (6.58 percent) and three have a floating rate coupon (between LIBOR +53 bps and +71 bps). These coupon rates step up after the first call dates. The Group has the option to call Series IV floating rate securities in 2008 and Series II fixed rate and Series V and VI floating rate securities in 2011. Subsequent to year-end the Group announced the redemption of the Series IV of the Zurich RegCaPS amounting to USD 125 million at par.
On February 14, 2007 the Board of Zurich Financial Services authorized a share buy-back program. 3,432,500 fully paid shares, with a nominal value of CHF 0.10, were bought back at an average price of CHF 364 per share, at a total cost of USD 1 billion. A proposal to cancel these repurchased shares will be submitted to the shareholders at the Annual General Meeting on April 3, 2008.
Earnings per share Net income attributable to common Weighted shareholders average (in USD number of Per share Per share millions) shares (USD) (CHF) 1
Diluted earnings per share 4,576 145,096,156 31.53 39.52 1 The translation from USD into CHF has been done for information purposes only at the Group’s average exchange rates for the years ended December 31, 2007 and 2006, respectively.
The Group had 58,220 and 52,286 employees (full-time equivalents) as of December 31, 2007 and 2006, respectively. Personnel and other related costs incurred for the year ended December 31, 2007 and 2006, were USD 4,922 million and USD 4,757 million, including wages and salaries of USD 4,181 million and USD 3,954 million, respectively.
As described in note 1, the Group has adopted the SORIE option under IAS 19. As a result prior year numbers have been restated as appropriate.
Defined benefit pension plans Employees of the Group’s operating companies are covered under various pension plans, the largest ones of which are in the UK, US, Germany and Switzerland. Certain companies run defined benefit plans, some of which provide benefits related to employee’s service periods and final pensionable earnings and others provide cash balance plans, where the participants receive the benefit of annual contributions made by both employer and employee and a credit for the investment return achieved on the assets. Eligibility for participation in the various plans is either based on completion of a specified period of continuous service or from the date of commencement of employment.
Most of the Group’s defined benefit pension plans are funded through contributions by the Group and, in some cases, the employee to trusts or foundations independent of the Group’s finances. In these cases, the annual funding requirements are determined in accordance with local funding and actuarial cost methods. Where plans are not specifically funded, a liability for the accrued pension obligations is recognized in the Group’s balance sheet.
Other defined post-employment benefits Certain of the Group’s operating companies provide post-employment benefit programs covering medical care and/or life insurance. Eligibility in the various plans is generally based on completion of a specified period of eligible service and reaching a specified age. The programs typically pay a stated percentage of medical expenses subject to deductibles and other factors. The cost of post-employment benefits is accrued during the employees’ service periods. The method of accounting and the frequency of valuations are similar to those for defined benefit pension plans.
For several of the Group’s wholly unfunded defined benefit pension plans there are assets within the Group that are designated, but not legally separated, to meet the liabilities of those plans. Consequently, in accordance with IAS 19 these are not recognized as plan assets. However, to arrive at an economic net liability for these unfunded pension plans these assets would have to be netted against the present value of obligations. The significant change from 2006 to 2007 mainly relates to the implementation of a contractual trust arrangement set up in Germany in the second quarter of 2007, which transferred the plan to a funded defined benefit pension plan.
Movement in in USD millions funded and unfunded defined benefit pension plan obligation
Change in liability due to asset ceiling (62) – – –
The movements in actuarial gains and losses due to differences between actual and expected experience on the Group’s plan assets and defined benefit obligations, together with the impact of changes in actuarial assumptions to reflect economic conditions at the year end are summarized below: Table 22.8
The Group has adopted various share-based compensation and cash incentive plans to attract, retain and motivate executives and employees. The plans are designed to reward employees for their contribution to the performance of the Group and to encourage employee share ownership. Share-based compensation plans include plans under which shares and options to purchase shares, based on the performance of the businesses, are awarded. Share-based plans are based on the provision of the Group’s shares.
a) Cash incentive plans Various businesses throughout the Group operate short-term incentive programs for executives, management and, in some cases, for employees of that business unit. Awards are made in cash, based on the accomplishment of both organizational and individual performance objectives. The expenses recognized for these cash incentive plans amounted to USD 365 million and USD 358 million for the years ended December
Share Incentive Plan for employees in the UK The Group established an Inland Revenue approved Share Incentive Plan and launched the partnership shares element of this plan in 2003. This plan enables participating employees to make monthly purchases of Zurich Financial Services shares at the prevailing market price out of their gross earnings. There were 439 and 494 participants in the partnership element of the plan as of December 31, 2007 and 2006 respectively. The Group also operates the profit-sharing element of the Share Incentive Plan (reward shares) which was launched in 2004 with annual share allocations being made in May each year subject to business performance. The awards are based on the performance of the participating employee’s business unit for the year, subject to a maximum award of 5 percent of participant’s base salary (before any flexible benefit adjustments) or GBP 3,000. The total number of participating employees in the reward share element of the plans as of December 31, 2007 and 2006 was 6,952 and 6,620 respectively.
Share Incentive Plans for employees in Switzerland The Employee Incentive Plan introduced for employees in Switzerland continued to operate in 2007. Under this plan, employees have the option to acquire sales-restricted shares at a 30 percent discount to the market value. The maximum permitted investment in shares is CHF 3,500 per employee. During 2007, 6,369 employees participated in the Employee Incentive Plan compared with 5,811 in 2006. For the year ended December 31, 2007, 1,929 employees received shares under the 2006 employee performance share plan. For the year ended December 31, 2006, 1,830 employees received shares under the 2005 employee performance share plan.
Share-based compensation plans for executives The Group operates long-term incentive plans for selected executives. These plans comprise the allocation of a target number of share grants and/or share option grants with the vesting of these share and option grants being subject to the achievement of specific financial performance goals. The Group can also make restricted share grants to selected employees, which provide share awards if the individual remains employed with the Group on selected dates in the future.
Senior Executive long-term incentive plans Each year, Senior Executives are granted performance shares and performance options, which vest on an annual basis over the subsequent three year period. The actual level of vesting, which can be between 0 percent and 175 percent, with an additional discretion to increase vesting to a maximum of 200 percent, of the original number of shares and/or options granted, depends on the performance of the Group during the previous calendar year. The current performance metrics are the Group’s return on equity (ROE) and the position of its total annual relative shareholder return measured against an international peer group of insurance companies. One-half of the shares that actually vest are sales-restricted for a further period of three years. The options have a seven year term from the date of grant. Grants under the plan are made annually each April. The actual number of performance shares and performance options granted is determined such that the economic value is a defined percentage of annual salary in the year of allocation. There were a total of 159 and 174 participants in this plan as of December 31, 2007 and 2006, respectively.
Executive long-term performance share plans Each year, selected executives are granted performance shares which vest over a period of three years, either on an annual basis or at the end of the three year period. Specific performance parameters are established for each of the Business Divisions and include, for example, return on equity or business operating profit objectives. The actual number of performance shares granted at the beginning of the performance period is determined such that the economic value is a defined percentage of the annual salary in the year of allocation. Actual awards under these plans are made fully in shares of Zurich Financial Services, of which 50 percent are sales-restricted for a further period of three years. There were a total of 746 and 640 participants in this plan as of December c) Further information on performance share and option plans
Certain plan participants elected in 2002 to take their option award in the form of Share Appreciation Rights (SAR). Included in table 23.2 and 23.3 are 61,318 and 67,801 as of December 31, 2007 and 2006, respectively, which will be settled through cash payments rather than through delivery of shares.The fair value of the SAR at grant date is determined using Black-Scholes formula. The model inputs were the same as used for calculating value of the share options.
The shares and options granted during the period are the target allocations made under the performance option and performance share plans together with any restricted share awards granted during the year. Whether these grants become vested or not will depend on whether the performance achievements are met. The expense is adjusted when shares and options vest.
Financial Report 2007 24. Contingent liabilities, contractual commitments and financial guarantees
Contractual commitments under lease agreements The Group has entered into various operating leases as lessee for office space and certain computer and other equipment. Lease expenses totaled USD 203 million and USD 163 million for the years ended December 31, 2007 and 2006, respectively.
Future payments in USD millions, as of December 31, 2007 under non-cancelable operating leases with terms in excess of one year
Other contingent liabilities The Group has received notices from various tax authorities asserting deficiencies in taxes for various years. The Group is of the view that the ultimate outcome of these reviews would not materially affect the Group’s consolidated financial position.
In common with other groups writing life assurance business in the UK, the Group remains exposed to a number of Conduct of Business issues. While provisions are maintained which reflect management’s best evolving estimate of the probable costs and expenses of resolving these matters, significant uncertainty regarding the ultimate cost remains. The main area of uncertainty concerns sales advice related complaints. The key assumptions used to derive the complaint provision are the volume of complaints, both those already recorded and an assumption as to the level of future complaints, the percentage of complaints which will be successful (the uphold rate), the average redress payable per complaint and the expenses of reviewing each case or complaint. The assumptions used to set the provision have been based on actual experience over the past three years weighted towards more recent experience.
In 2003, the Group completed the divestment of various asset management operations. As part of these agreements, the Group has guaranteed certain minimum levels of “assets under management” to the acquirers. The guarantees provide that if the “assets under management” fall below those defined levels under certain conditions, the Group may be required to compensate for these shortfalls.
Financial Report 2007 company for USD 30 million, subject to court approval. The US federal court presiding over the litigation preliminarily approved the proposed settlement on September 4, 2007. The court is expected to hold a final hearing on the proposed settlement in the second half of 2008.
Other loans: fair values are estimated on the basis of discounted cash flow, pricing models, or other recognized valuation techniques.
Derivative trading assets and liabilities: fair values are based on quoted market prices, dealer price quotations, discounted cash flow models and option pricing models.
Liabilities related to unit-linked investment contracts: fair values for financial liabilities for unit-linked contracts are determined based on the underlying fair value of the financial assets backing these liabilities.
Liabilities related to investment contracts: fair values for financial liabilities related to investment contracts are determined using discounted cash flow calculations.
Liabilities related to investment contracts with DPF: fair values of liabilities related to investment contracts with DPF are based on current economic conditions and other performance factors.
Securities at FV through profit or loss: Trading: Designated at FV: Total securities at FV through profit or loss 123,774 113,464 123,774 113,464
Financial liabilities at FV through profit or loss: Trading: Obligation to repurchase securities (5,370) (6,144) (5,370) (6,144)
The Board of Directors establishes the Group’s corporate risk management framework. The Risk Committee of the Board serves as a focal point for oversight regarding risk management. It reviews the Group’s enterprisewide risk governance framework, including risk management methodologies, policies, models, reporting and risk strategy. Group-wide risk management policies specify risk limits and authorities, reporting requirements, and procedures for referring risk issues to senior management. The Group regularly monitors its risks through analyses and reports, and through relevant risk modelling.
Insurance risk Insurance risk is the inherent uncertainty as to the occurrence, amount and timing of insurance liabilities. The exposure is transferred to the Group through the underwriting process.
The Group assumes certain customer risks, and therefore must manage the transfer of risk including the establishment of limits for underwriting authority and the requirement for specific approvals for transactions involving new products or where established limits of size and complexity may be exceeded. The Group’s underwriting strategy is to exploit the diversification of risks across industries and geographic regions in which the Group operates. The Group seeks to optimize shareholder value by achieving its mid-term return on equity goals. Doing so necessitates a prudent, stable underwriting philosophy that takes advantage of competitive strengths while avoiding risks with disruptive volatility. At the core of the Group’s underwriting is a robust governance process. It includes strategy, establishment of goals, delegation of authorities, financial monitoring, underwriting reviews and remedial actions to facilitate continuous improvement. The Group has policies that provide the boundaries within which employees and managers carry out their underwriting duties and the Group’s business.
The Group uses a variety of reserving and modeling methods to address the various insurance risks inherent in its insurance business.
As part of its overall risk management strategy, the Group cedes insurance risk through proportional, nonproportional and specific risk reinsurance treaties. The Group has centralized the management of treaty reinsurance for General Insurance. In 2007 the Group developed a concept to centralize the management of reinsurance for Life Insurance and started the implementation.
General insurance risk General insurance risk includes the reasonable possibility of significant loss due to uncertainty in the frequency of the occurrence of the insured events as well as in the severity of the resulting claims. The following provides an overview of the risks inherent in the Group’s main lines of business:
• Motor includes, but is not limited to, automobile physical damage, loss of the insured vehicle and automobile third party liability insurance; • Property includes, but is not limited to, fire risks (e.g. fire, explosion and business interruption), natural perils (e.g. earthquake, windstorm and flood), engineering lines (e.g. boiler explosion, machinery breakdown and construction) and marine (cargo and hull); • Liability includes, but is not limited to, general/public and product liability, excess and umbrella liability, professional indemnity, directors and officers liability and errors and omissions liability, including medical malpractice; • Special lines include, but are not limited to, credit and surety, crime and fidelity, accident and health, and crop; • Worker injury includes, but is not limited to, workers compensation and employers liability; In addition to the specific risks insured, each line of business could expose the Group to losses that could arise from natural and man-made catastrophes.
The Group assesses natural catastrophe risk by modeling potential losses from its property policies located in the most hazard prone areas and adjusting for non-property related losses. These assessments principally address the risk of tornadoes, hail, windstorms, earthquake, and river floods. Man-made catastrophes include, but are not limited to, such risks as train collisions, hotel fires and terrorism. Man-made catastrophe risks present challenges for the Group to assess due to the high degree of uncertainty about what events might actually occur. The Group monitors potential exposures by analyzing certain accumulations in some geographic areas, using a number of assumptions about the potential characteristics of the threat.
Direct written ended December 31, 2007 premiums and policy fees by line of business and by region
Special Worker Motor Property Liability lines injury Total 1 Including intercompany eliminations.
The table below shows the sensitivity of net income before tax and the sensitivity of net assets, considering the Group actual income tax rate, against an adverse development in the net loss ratio by one percentage point. Such an increase could arise from either higher frequency of the occurrence of the insured events or from an increase in the severity of the resulting claims or from a combination of frequency and severity. The sensitivities do not indicate a probability of such an event and do not consider any non-linear effects of reinsurance. Based on the assumptions applied in the presentation of the sensitivity analysis in the table below, each additional percentage point increase in the loss ratio would lead to a linear impact on net income before tax and net assets applying the assumptions as for this table. In addition, the Group monitors insurance risk by evaluating extreme scenarios, taking also non-linear effects of reinsurance contracts into account.
Insurance risk in USD millions, sensitivity for the for the year ended December 31, 2007
Insurance risk in USD millions, sensitivity for the for the year ended December 31, 2006
• Policyholder behavior risk, which includes persistency experience. Poor persistency rates may lead to fewer policies remaining on the books to help cover fixed expenses and reduce the future positive cash flows from the business written. Poor persistency can impact all types of products.
• Risk due to movements in financial markets, i.e. investment returns and interest rate risk which are managed as part of market risk.
2 Including individual annuity and individual life policies. 3 Including policy fees of USD 1.9 billion (United States USD 271 million, Europe USD 1.5 billion and International Businesses USD 143 million). 4 Including fees charged to policyholders relating to the recovery of policyholder taxes, which amount to a USD 128 million credit.
2 Including individual annuity and individual life policies. 3 Including policy fees of USD 2.3 billion (United States USD 256 million, Europe USD 1.9 billion and International Businesses USD 153 million). 4 Including fees charged to policyholders relating to the recovery of policyholder taxes, which amount to a USD 320 million charge.
At a Group level certain life insurance contracts contain guarantees for which liabilities have been recorded for additional benefits and minimum guarantees, primarily in the subsidiary Kemper Investors Life Insurance Company which has written variable annuity contracts that provide annuitants with certain guarantees related to minimum death and income benefits. The determination of IFRS liabilities for these contracts is based on SOP 03-1 “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts” and involves a range of scenarios and assumptions, including those regarding expected market rates of return and volatility, contract surrender rates, annuitization elections and mortality experience. The assumptions used are consistent with those used in determining estimated gross profits for purposes of amortizing deferred policy acquisition costs. The carrying value of these liabilities does not represent their fair value.
The Group reports sensitivities of Life insurance contracts on Embedded Value and New Business Value to changes in economic and operating risk factors. The operating factors include, but are not limited to, discontinuance rates, expenses, mortality and morbidity. The Embedded Value methodology adopted by the Group is based on a “bottom up” market consistent approach to allow explicitly for market risks. Refer to the Embedded Value Report for more information on the sensitivities of Life insurance contracts to economic and operating risk factors.
Credit risk Credit risk is the risk associated with a loss or potential loss from a counterparty failing to fulfill its financial obligations related to, but not limited to the investment portfolio of debt securities, reinsurance assets, loans, receivables and derivatives. To assess counterparty credit risk, the Group relies on the ratings assigned by external rating agencies, qualified third parties, such as asset managers, and internal rating assessments. The Group maintains counterparty credit risk databases, recording external and internal sources of credit intelligence.
The Group’s investment policy prohibits speculative grade investments, unless specifically authorized and under exceptional circumstances. The Group identifies and implements appropriate corrective action on investments expected to be downgraded to below investment grade.
Credit risk relating to reinsurance assets The reinsurance assets include reinsurance recoverables of USD 26,977 million and USD 20,108 million as of December 31, 2007 and 2006, respectively, which are the reinsurer’s share of reserves for insurance contracts, and receivables arising from ceded reinsurance of USD 1,372 million and USD 1,445 million as of December 31, 2007 and 2006, respectively. Bad debt allowances on reinsurance receivables amount to USD 239 million and USD 204 million as of December 31, 2007 and 2006, respectively.
As part of its overall risk management strategy, the Group cedes insurance risk through proportional, nonproportional and specific risk reinsurance treaties. While these cessions mitigate insurance risk, the recoverables from reinsurers and receivables arising from ceded reinsurance expose the Group to credit risk.
Credit risk relating to mortgage loans and mortgage loans given as collateral Mortgage loans and mortgage loans given as collateral expose the Group to credit risk. The Group’s mortgage loan portfolios are principally European-based with the largest portfolios in Germany, Switzerland and the UK. The portfolios’ loss experience benefits positively from the diversification of having many loans within each portfolio as well as being underwritten using conservative lending criteria. Loans are secured by first mortgages only and maximum mortgage loan to property value ratios (LTV) are applied. The Group undertakes economic research on the three principal markets and closely monitors the portfolios’ performance in terms of impairments and losses.
Credit risk relating to derivatives For derivatives, such as interest rate or currency swaps, forward contracts and purchased options, the replacement value of the outstanding derivatives represents a credit risk to the Group. In addition there is a potential exposure arising from possible changes in the replacement value. The Group regularly monitors credit risk exposures arising from derivative transactions. Outstanding positions with external counterparties are managed through an approval process embedded in derivative programs.
Refer to note 20 for additional information on debt securities and loans and note 14 for additional information on receivables.
Credit risk concentration The Group routinely monitors and limits credit exposures by individual counterparty and related counterparties by the aggregated exposure across the various types of credit risk. The Group’s exposure from counterparties’ parents companies and subsidiaries across such sources of credit risk as reinsurance assets, various types of investments, certain insurance products, derivatives and treasury instruments is then aggregated. Best estimates, based on statistics and experience, are used to assign loss-given-default percentages and loss dependency factors reflecting e.g. double default events. The aggregated exposure information is compared with the Group’s limits. The limits vary based on the underlying rating category of the counterparty. There was no exposure in excess of the limits at December 31, 2007. The Group Chief Risk Officer regularly reports the largest exposures by rating category to the Risk Committee of the Board.
Market risk The Group’s exposure to market risk includes, but is not limited to, changes in interest rates, equity prices, real estate markets, and currency exchange rates, as these changes can affect the Group’s net income and the value of the Group’s assets and liabilities. The Group has policies and limits to manage market risk. The Group aligns its strategic asset allocation to the Group’s risk-taking capacity.
The Group regularly measures and manages its market risk exposure. The Group has established limits on its concentration in investments by single issuers and certain asset classes as well as on asset/liability mismatches. The Group’s Asset Liability Management and Investment Committee sets the Group’s Strategic Asset Allocation, determines boundaries for tactical asset allocation and manages the Group’s asset/liability exposure. The Group oversees the activities of local Asset Liability Management and Investment Committees and regularly assesses financial market risks both at a Group and at a local business level. Risk assessment includes quantification of the contributions to financial market risk from all major risk drivers.
Financial Report 2007 estate, but are at the risk of policyholders. However, the Group is exposed to market movements in so far as they impact the amount of fees assessed against the policyholder.
The Group manages its risks from equity securities and real estate as part of the overall investment risk management process by applying limits as expressed in its policies and guidelines.
Refer to note 16 for additional information on equity securities and real estate held for investment.
Returns on unit-linked contracts, whether classified as insurance or investment contracts, are at the risk of the policyholder, however, the Group is exposed to fluctuations in so far as they impact the amount of fee income received.
The sensitivity analysis is presented on the basis of IFRS and does not take into account actions that might be taken to mitigate losses, as the Group uses an active strategy to manage these risks. This strategy may involve changing the asset allocation e.g. through the selling and buying of assets.
The sensitivities show the effects of a change of certain risk factors, while other assumptions remain unchanged. The sensitivities do not consider the correlation between the volatility of risk factors. The two scenarios assume a concurrent movement of all stock markets and an unrelated parellel shift of all interest rates in different currencies.
The major markets where the Group invests are the US and Europe. The major interest rate exposures are to US dollar and euro denominated assets and liabilities. The sensitivities do not indicate a probability of such events and do not necessarily represent the Group’s view of expected future market changes. Debt securities are primarily exposed to interest rate risk while equity securities are primarily exposed to equity market risk. Debt securities can also be affected by spread-widening due to changes in credit quality. Additional impairments as a result of such changes are not considered in the following analysis.
The sensitivities provided for Global Life’s business in the following table are on Group investments and own used real estate only and thus exclusive of the impact on insurance liabilities. The Embedded Value Report details the sensitivity of the value of the Life business to financial market movements. In modeling these exposures, where appropriate, allowance has been made for dynamic actions that would be taken by management or by policyholders. For contracts with financial options and guarantees, such as some participating business, movements in financial markets can change the nature and value of these benefits. The dynamics of these liabilities are captured so that this exposure is quantified, monitored, managed and where appropriate, mitigated. The assumptions on policyholder behavior, such as lapses, included in the sensitivity analysis for Global Life may be different from actual behavior. Therefore, the actual impact may deviate from the analysis. Refer to the Embedded Value Report for more information.
The table on sensitivities for the rest of the businesses include Farmers, Other Businesses and Corporate Functions. To the extent those segments include life insurance contracts, the related sensitivities are included in the Embedded Value Report.
Sensitivities for the in USD millions, as of December 31 rest of the businesses 1% increase in the interest rate yield curves
Currency risk Currency risk is the risk of loss resulting from changes in exchange rates. The Group operates internationally and therefore is exposed to the financial impact arising from changes in the exchange rates of various currencies. The Group’s reporting currency is the US dollar, but its assets, liabilities, income and expenses are denominated in many currencies, with significant amounts in the euro, Swiss franc, British pound sterling, as well as the US dollar.
The table below shows the approximate effect of an instantaneous depreciation of the US dollar compared with the euro, Swiss franc and British pound sterling, respectively, by 10% on net income before tax, net assets, reserves for insurance contracts and liabilities for investment contracts upon translation of the net assets into the presentation currency of the Group. The impact on net assets is primarily driven by currency translation adjustments. An appreciation of the US dollar would have the opposite impact. The sensitivities do not include dependencies among the currencies, but rather show isolated exchange rate movements. The effect is indicative of how the Group’s financial statements would be impacted by exchange rate movements. The scenarios do not indicate a probability of such shifts and do not represent the Group’s view of expected future currency exchange rate movements.
Impact on net income before tax 93 50 10 90 42 (3)
Impact on reserves for insurance contracts and 1 Negative values indicate a decrease of the balance. Positive values indicate an increase of the balance.
Liquidity risk Liquidity risk is the risk that the Group does not have sufficient liquid financial resources to meet its obligations when they fall due, or would have to incur excessive costs to do so. Maintaining sufficient available liquid assets to meet the Group’s obligations as they fall due is an important part of the Group’s financial management practice. For this purpose the Group has established Group liquidity management policies and specific guidelines as to how local businesses have to plan, manage and report their local liquidity.