The following table presents the summarized consolidated results of the Group for the years ended December 31, 2005 and 2004 and the financial positions as of December 31, 2005 and 2004. The 2004 amounts have been restated for the implementation of new and revised accounting standards. Certain prior year amounts have also been reclassified to conform to the 2005 presentation.
Consolidated operating statements in USD millions, for the years ended December 31
of which: Net investment income on Group investments 7,782 7,460 4%
In September 2002, Zurich announced a comprehensive action plan to improve the Group’s profitability and strengthen its balance sheet. The figure depicts Zurich's share price development since the launch of the program.
United United Rest of International Total States Kingdom Germany Switzerland Europe Businesses 1 In %, for the years ended December 31, not adjusted for foreign currency translation effects.
The Annual Report 2005 of Zurich Financial Services Group consists of two publications: the Corporate Review and the Financial Report.
The Corporate Review contains a detailed description of the Group’s performance and way forward, risk management report, corporate governance and remuneration reports, the financial review, which provides an overview of the Group’s business in 2005, and some Group financial information (balance sheets, operating statements, cash flow statements and shareholders’ equity statements). The Corporate Review is published in English, German and French.
Services holding company. The Financial Report is published in English and German.
Both reports are available on our Web site and can be downloaded at www.zurich.com.
Alternatively, printed copies can be ordered in writing, including language version preference, from Zurich Financial Services, Logistik-Hotline, Postfach 8002 Zurich,
The Causeway, Goring by Sea, Worthing, West Sussex BN996DA United Kingdom
Policyholder dividends and participation in profits, net of reinsurance 10 14,432 8,752
Changes in operational assets and liabilities: Deferred policy acquisition costs (1,085) (755)
Cash and cash equivalents as of January 1, including cash received as collateral for securities lending 22,457 15,889
Balance as of December 31, 2003, as previously reported 923 (6) 10,208
Balance as of December 31, 2004, as previously reported 635 (1) 10,288
Net unrealized Cumulative Common Total gains/losses translation Retained shareholders’ Preferred shareholders’ Minority Total on investments adjustment earnings equity securities equity interests equity
The Group’s balance sheet is not presented using a current/non-current classification. However, the following balances would generally be classified as current: cash and cash equivalents, short-term investments, deferred policy acquisition costs on general insurance contracts, accrued investment income, receivables, reserve for premium refunds, deferred profit on inception of reinsurance contracts, and accrued liabilities.
The following balances will generally be classified as non-current: equity securities, investments in associates, investments held by investment companies, real estate held for investment, deferred policy acquisition costs on life insurance contracts, deferred tax assets, goodwill, other intangible assets, reserves for unit-linked products, liabilities for investment contracts and deferred tax liabilities.
Segment information The Group is managed on a matrix basis, reflecting both line of business and geography. Accordingly, segment information is presented in two formats. The primary format is based on the operating businesses of the Group and how they are strategically managed to offer different products and services to specific customer groups. The Group’s primary segments are defined as follows: Zurich Financial Services Group · Annual Report 2005
In 2004, the Group’s primary reporting segments were defined as General Insurance, Life Insurance, Farmers Management Services, Other Businesses and Corporate Center. The only change to these primary segments in 2005 was to rename Corporate Center to Corporate Functions. However, to be consistent with the Group’s management structure, the following transfers between primary segments have been made for 2005 financial reporting: • Farmers Re business from General Insurance to Other Businesses
• Group Reinsurance business relating to certain European run-off operations from Corporate Functions to Other Businesses
• Certain investments of Farmers New World Life from Life Insurance to Farmers Management Services
The principal accounting policies applied in the presentation of these consolidated financial statements are set out below. These policies have been consistently applied to all the years presented unless otherwise stated.
a) Consolidation principles The Group’s consolidated financial statements include the assets, liabilities, equity, revenues, expenses and cash flows of Zurich Financial Services and its subsidiaries. A subsidiary is an entity in which Zurich Financial Services owns, directly or indirectly, more than 50% of the outstanding voting rights, or which it otherwise has the power to control. The results of subsidiaries acquired are included in the consolidated financial statements from the date of acquisition. The results of subsidiaries that have been sold during the year are included up to the date control ceased. All significant intercompany balances, profits and transactions are eliminated.
The Group applies the same accounting policies for the recognition and measurement of obligations arising from insurance contracts and from investment contracts with DPF. These recognition and measurement criteria apply to obligations arising from the contract, deferred acquisition costs and other related intangible assets. The Group developed its accounting policies for insurance contracts before the adoption of IFRS 4 and in the absence of a specific standard for insurance contracts. Management used their judgment in developing a set of accounting policies for the recognition and measurement of rights and obligations arising from insurance contracts issued and reinsurance contracts held that provide the most useful information to users of the Group’s financial statements. In making this judgment, Management primarily considered the pronouncements of the Financial Accounting Standards Board (US GAAP) on insurance and reinsurance contracts.
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 the policyholder to switch back to the previous product at his convenience. Where this results in a change to a product whose classification as insurance or investment is different to that currently, this is then reflected in the accounts according to the nature of the product which is purchased and the amounts so transferred.
Premiums Premiums from the sale of general insurance products are recorded when written and are accreted to earnings on a pro-rata basis over the term of the related policy coverage. However, for those contracts for which the period of risk differs significantly from the contract period, premiums are recognized over the period of risk in proportion to the amount of insurance protection provided. The unearned premium reserve represents the portion of the premiums written relating to the unexpired terms of coverage.
Losses and loss adjustment expenses Losses and loss adjustment expenses are charged to income as incurred. Reserves for losses and loss adjustment expenses represent the accumulation of estimates for ultimate losses and include provisions for losses incurred but not yet reported (IBNR). The reserves represent estimates of future payments of reported and unreported claims for losses and related expenses with respect to insured events that have occurred. Reserving is a complex process dealing with uncertainty, requiring the use of informed estimates and judgments. The Group does not discount its loss reserves, other than for settled claims with fixed payment terms. Any changes in estimates are reflected in results of operations in the period in which estimates are changed.
Future life policyholders’ benefits include the value of accumulated declared bonuses or dividends that have been vested to policyholders.
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 contract holder has not yet been determined. This includes certain elements of unrealized gains and portions of retained earnings.
Reinsurance contracts are 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 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 operating 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.
Liabilities for investment contracts (unit linked) These represent portfolios maintained to meet specific investment objectives of policyholders who bear the investment risk. The assets are classified as fair value through the profit and loss. The liabilities are carried at fair value. 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.
The liability held for unit-linked products with capital units is measured at the funded value of those units. At issue, the difference between the funded and unfunded value of units is treated as deferred revenue.
Liabilities for investment contracts (amortized cost) These represent contracts which are not unit-linked. Liabilities 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 reflected in the income statement.
If the investment contract is subject to a put or surrender option, the fair value of the financial liability is never less than the amount payable on surrender, discounted for the required notice period, where applicable.
Subsequent measurement of investment contracts at amortized cost uses the effective interest method. This method requires the determination of an interest rate (the effective interest rate) that exactly discounts to the net carrying amount of the financial liability the estimated future cash payments or receipts through the expected life of the financial instrument or, when appropriate, a shorter period if the holder has the option to redeem the instrument before maturity.
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. Farmers Group, Inc. and its subsidiaries (“FGI”) provides the following non-claims related management services to the Farmers Exchanges: 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.
• Regular fees charged to the customer periodically (monthly, quarterly or annually) either directly or by making a deduction from invested funds. Regular charges billed in advance are recognized on a straight-line basis over the billing period; fees charged at the end of the period are accrued as a receivable that is offset against the financial liability when charged to the customer.
Held-to-maturity financial assets are debt securities which the Group has the ability and positive intent to hold to maturity. Fair value through profit or loss has two sub-categories: financial assets held for trading and those designated at fair value through profit and loss at inception. Derivatives are also classified as held for trading unless they are designated as hedges. Trading financial assets are debt and equity securities which the Group buys with the principal intention to resell in the near term. The remaining debt and equity securities are classified as available-for-sale.
Measurement Financial assets are initially recorded at cost, net of transaction costs directly attributable to the acquisition. Held-to-maturity financial assets are subsequently carried at amortized cost using the effective interest rate method. Fair value through profit or loss financial assets are subsequently carried at fair value, with changes in fair value recognized in the current period income. Available-for-sale financial assets are subsequently carried at fair value, with unrealized changes in fair value recorded in shareholders’ equity. The cumulative unrealized gains or losses recorded in shareholders’ equity are net of cumulative deferred income taxes, certain life policyholder liabilities, certain life deferred acquisition costs and minority interests. The realized gain or loss on divestment is based on the difference between the proceeds received and the carrying value of the investment plus any unrealized gains or losses on the investment recorded in shareholders’ equity using the specific identification method. When available-for-sale financial assets are sold, impaired or otherwise disposed of, the cumulative gains and losses previously recognized in shareholders’ equity are included in the current period income. The amortization of premium and accretion of discount on available-for-sale and held-to-maturity investments in debt securities is computed using the effective interest method and is recognized in current period income.
Investments backing certain life insurance policies with participation features are held as fair value through profit or loss. Movements in the carrying value of these assets are recognized in current period income to match the offsetting amounts attributable to policyholders.
Loans originated by the Group are initially recorded at cost and are subsequently measured at amortized cost using the effective interest rate method, less allowances for doubtful accounts.
The Group considers an available for sale equity for impairment when the fair value of the security has been not insignificantly below the weighted-average cost for more than 12 months. Additionally, the Group considers an available for sale equity for impairment when the fair value has been below the weighted-average cost by more than 50% for any period of time.
When a decline in the fair value of an available-for-sale asset has been recognized directly in shareholders’ equity and there is objective evidence that the asset is impaired, the cumulative loss that had been recognized directly in shareholders’ equity is removed from equity and recognized in current period income. The amount of the cumulative loss that is removed from shareholders’ equity and recognized in current period income is the difference between acquisition cost (net of any principal repayment and amortization) and current fair value, less any impairment loss on that asset instrument previously recognized in income.
Derivative financial instruments include interest rate, currency and total return swaps, futures, forwards and option contracts, all of which derive their value mainly from underlying interest rates, foreign exchange rates, commodity values or equity instruments. A derivative contract may be traded on an exchange or over-thecounter (“OTC”). Exchange-traded derivatives are standardized and include futures and certain option contracts. OTC derivative contracts are individually negotiated between contracting parties and include forwards, caps, floors and swaps. Derivative financial instruments are subject to various risks similar to those related to the underlying financial instruments, including market, credit and liquidity risk.
Gains or losses from re-measuring hedging instruments are recognized immediately in the operating statement. 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 the operating statement. Where the adjustment is to the carrying amount of a hedged interest-bearing financial instrument carried at amortized cost, the adjustment is amortized to current period income such that it is fully amortized by maturity.
The portion of gain or loss on the cash flow hedging instrument is recognized directly in shareholders’ equity. The ineffective portion is recognized in current period income. When the hedged firm commitment results in the recognition of an asset or a liability, then, at the time the asset or liability is recognized, the associated gains or losses that had previously been recognized in shareholders’ equity are included in the initial measurement of the acquisition cost or other carrying amount of the asset or liability. For other cash flow hedges, the gains or losses that are recognized in shareholders’ equity are transferred to the operating statement in the same period in which the item hedged affects the net profit and loss, for example, when the future sale actually occurs.
Hedge accounting is discontinued when the hedging instrument expires or is sold, terminated or exercised, or no longer qualifies for hedge accounting. At that point in time, cumulative gains or losses on the hedging instrument recognized in shareholders’ equity remain in shareholders’ equity until the forecasted transaction occurs. If the hedged transaction is no longer expected to occur, the net cumulative gain or loss recognized in shareholders’ equity is transferred to current period income.
h) 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 loaned securities remain under the Group’s control and therefore are not derecognized from the Group’s balance sheet.
j) Debt issued Debt issued by the Group is initially measured at cost, which is the fair value of the consideration received, net of transaction costs incurred. Subsequent measurement is at amortized cost, using the effective interest rate method to amortize cost at inception to the redemption value over the life of the debt.
Goodwill Acquisitions of subsidiaries and associates are accounted for under the purchase method, whereby the purchase price is allocated to the fair value of assets and liabilities acquired at the date of acquisition with any residual amount allocated to goodwill. Goodwill is tested annually for impairment and carried at cost less accumulated impairment losses. Goodwill is allocated to cash generating units for the purpose of impairment testing. The Group’s cash generating units, at which impairment losses are assessed, are the reporting units. If impairment indications exist, the recoverable amount of the cash generating unit will be determined. An impairment loss will be recorded if the recoverable amount is less than the carrying amount of the cash generating unit, including goodwill.
The recoverable amount for a cash generating unit is determined using net selling price, if available, or value in use, whichever is higher. Net selling price for a cash generating unit is determined based on various factors, including 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.
Present value of profits of acquired insurance contracts (“PVFP”) PVFP is amortized over the expected life of the policies acquired, based on a constant percentage of the present value of estimated gross profits (margins) expected to be realized, or over the premium recognition period, as appropriate.
Attorney-in-fact relationships (“AIF”) At the date of the acquisition of FGI in 1988, a portion of the purchase price was assigned to the attorney-infact relationships. The asset representing the attorney-in-fact relationships represents the ability of FGI 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 interinsurance exchanges, under which subscribers exchange contracts with each other and appoint an attorney-infact to provide certain management services. In addition, the Group considered the historical attorney-in-fact relationship between FGI and the Farmers Exchanges. To the extent that there is a change in these circumstances, the Group would reevaluate the value of this intangible asset.
Other intangibles Other intangible assets are carried at cost less accumulated amortization and consist primarily of acquired brand names and software costs that meet the recognition criteria for capitalization. The costs of these assets are amortized using the straight-line method over the following estimated economic lives: brand names 20 years; software three to five years.
m) Income taxes The Group provides current tax expense according to the tax laws of each jurisdiction in which it operates. Income taxes are recognized using the asset and liability method. Deferred income taxes are recorded for temporary differences, which are based on the difference between financial statement carrying amounts and income tax bases of assets and liabilities using enacted income tax rates and laws. Losses for tax purposes are treated as deferred tax assets to the extent it is probable that the losses can offset future taxable income and is allowed by the applicable local tax laws and regulations.
Other post-retirement benefits Other defined post-employment benefits, such as medical care and life insurance, are also provided for certain employees and are primarily funded internally. The cost of such benefits is accrued over the service period of the employee based upon the actuarially determined cost for the period.
o) Share based compensation 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 the consolidated operating statement over the vesting period. A corresponding amount is recorded in additional paid-in capital.
The total amount to be expensed over the vesting period is determined by reference to the fair value of the shares and/or options granted, excluding the impact of any non-market vesting conditions (for example, profitability and premium income growth targets). Non-market vesting conditions are included in assumptions about the number of shares and/or options that are expected to be issued or become exercisable. At each balance sheet date, the Group revises its estimates of the number of shares and/or options that are expected to be issued or become exercisable. It recognizes the impact of the revision of original estimates, if any, in the income statement, and a corresponding adjustment to equity over the remaining vesting period.
p) Fixed assets Real estate (buildings) held for own use and other fixed assets are carried at cost less accumulated depreciation and any necessary write-downs due to impairment. The costs of these assets are depreciated principally on a straight-line basis over the following estimated useful economic lives: buildings 25 to 50 years; furniture and fixtures five to ten years; and computer equipment three to five years. Real estate (land) is carried at cost less any necessary write-downs. Maintenance and repair costs are charged to income as incurred. Costs of systems purchased from outside vendors and developed internally are deferred and amortized over expected useful lives up to five years. Gains and losses on the disposal of fixed assets and real estate held for own use are determined based on their respective carrying amounts and recorded in income.
r) Provisions Provisions are recognized when the Group has a present obligation (legal or constructive) as a result of a past event, it is probable 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.
s) Treasury shares Zurich Financial Services shares held by the Group are classified as treasury shares and are deducted from equity at its nominal value. The differences between the nominal value and the amount paid for acquiring, or received for disposing of treasury shares, are recorded as an adjustment to additional paid-in capital in shareholders’ equity.
The table below summarizes the principal exchange rates that have been used for translation purposes. Net gains and (losses) on foreign currency transactions included in the consolidated operating statements were USD (71) million and USD 124 million for the years ended December 31, 2005 and 2004, respectively. Foreign currency exchange forward and swap gains and (losses) included in the amounts above were USD (453) million and USD 477 million for the years ended December 31, 2005 and 2004, respectively.
• The standard permits an entity to designate certain financial assets or financial liabilities on initial recognition as one to be measured at fair value, with changes in fair value recognized in profit or loss. To impose discipline on this categorization, an entity is precluded from reclassifying financial instruments into or out of this category.
• The standard provides additional guidance about how to determine fair values using valuation techniques.
The accounting policy for securities lending has been changed, primarily driven by the revised IFRS which led the Group to review its previous policy and make changes to the criteria for recognizing collateral received as part of securities lending arrangements. As a result of the Group having future economic benefits and retaining significant risk and rewards of the cash collateral received, the Group now recognizes both cash collateral and an equal and offsetting liability related to the cash collateral. No income effect resulted from the change in this policy.
Consolidated in USD millions for the year ended December 31, 2004 operating statement for the year ended
Net change in reserves for unearned premiums 125 (1) – 124
Insurance benefits and losses, net of reinsurance 34,500 (388) – 34,112
Policyholder dividends and participation in profits, net of reinsurance 7,014 1,726 12 8,752
Underwriting and policy acquisition costs, net of reinsurance 7,243 147 – 7,390
in USD, for the year ended December 31, 2004 Dividends As preferred reported1 IFRS 4 securities Restated
Consolidated in USD millions, as of December 31, 2004 balance sheet as of
Reinsurers’ share of reserves for insurance contracts 21,046 122 – 21,168
Reserves for insurance contracts for life insurance where the investment risk is carried by policyholders 24,261 (24,261) – –
In December 2004 the IASB released a revised version of IAS 19 “Employee Benefits”. The amendment to IAS 19 introduces an additional option for actuarial gains and losses arising in post-employment defined benefit plans to be recognized outside profit or loss providing all of the actuarial gains and losses for all defined benefit plans are recognized in the period in which they occur.
Net gain on in USD millions, for the years ended December 31 divestments
Changes in 2004 During 2004, the Group completed the following sales: Zurich Atrium B.V., Turegum Insurance Company, Thai Zurich Insurance Company, Zurich Insurance (Singapore) Pte.Ltd., Zürich Krankenversicherung AG (Deutschland), the Group’s stake in Globale Krankenversicherungs-AG, the insurance portfolio of its subsidiary Zurich Life Philippines, Inc, McMillan Shakespeare Australia Pty Limited, and the general insurance (consumer and small commercial lines) and life insurance (consumer and commercial lines) operations in Belgium.
The Group also recognized several post-completion adjustments for divestments completed during or prior to 2004, realizing a net gain before tax of USD 95 million.
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.
c) Fair value of financial assets and liabilities Certain of the Group’s assets and liabilities are recorded at fair value on the balance sheet. Fair value determinations for financial assets and liabilities are based generally on listed market prices or broker or dealer price quotations. If prices are not readily determinable, fair value is based on either internal valuation models or management estimates of amounts that could be realized under current market conditions. Fair values of certain financial instruments, including over-the-counter (“OTC”) derivative instruments, are determined using pricing models that consider, among other factors, contractual and market prices, correlations, yield curves, credit spreads volatility factors and/or prepayment rates of the underlying positions. The use of different pricing models and assumptions could lead to different estimates of fair value.
Impairments are recorded in the current period operating statement when they occur.
e) 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 dependant 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.
f) 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 more likely than not that all or a portion of the deferred tax asset will not be utilized, then a valuation allowance would be recognized.
g) Pension plans The Group operates a number of defined benefit pension plans. In assessing the Group’s liability for these plans, critical judgments include estimates of mortality rates, rates of employment turnover, disability, early retirement, discount rates, expected long-term rates of return on plan assets, future salary increases, future pension increases and increases in long-term healthcare costs. These assumptions may differ from actual results due to changing economic conditions, higher or lower withdrawal rates or longer or shorter life spans of participants. These differences may result in variability of pension income or expense recorded in future years.
As a major, global insurance carrier, the Group helps customers around the world to manage a broad range of business and personal risks. In turn, the Group faces a number of risks. These risks include, but are not limited to: • Insurance risk - risk transferred to us by customers through the underwriting process.
• Investment and credit risk – risk associated with the Group’s investment portfolio, reinsurance agreements and other counterparty credit risk.
• Financial risk – risk associated with currency fluctuations and management of the relative duration of assets and liabilities.
Group Risk Management monitors the risk issues identified and reports regularly to senior management and the Group’s audit and risk committees.
The Group has centralized the management of reinsurance and closely monitors emerging issues that may affect its overall risk exposures, such as new areas of liability. The Group models and estimates risk associated with natural catastrophes and monitors potential exposures to man-made catastrophes.
The Group focuses on a disciplined approach to underwriting and pricing. Further, because the Group manages a diversified portfolio across geographies, segments and lines of business, the effects of underwriting losses arising from specific events or adverse reserve developments may be moderated.
Direct written ended December 31, 2004 premiums by line of business and by region
The main risks in each line of business are as follows: • Motor includes, but is not limited to, the auto physical damage and auto third-party liability risks.
As well as the specific risks insured, all these lines expose the Group to natural and man-made catastrophes, such as terrorism.
The Group assesses natural catastrophe risk represented by Zurich property policies located in the most hazard prone areas. These assessments principally address the risk of tornadoes, hail, windstorms, earthquakes, and river floods. In recent years the Group has been particularly impacted by the exceptional claims arising from windstorms in North America.
The table below shows the Group’s concentration of risk within the life insurance segment by region based on direct written premiums. The Group’s exposure to life insurance risks varies significantly by geographic region and may change over time.
Individual Individual Accident Annuity Capital Group and Health Unit-Linked 1 Including intercompany eliminations
Certain of the products above contain guarantees for which liabilities have been recorded for additional benefits and minimum guarantees, primarily in the subsidiary Kemper Investors Life Insurance Company which has written variable annuity contracts that provide annuitants with certain guarantees related to minimum death and income benefits. The determination of these liabilities is based on models that involve a range of scenarios and assumptions, including those regarding expected market rates of return and volatility, contract surrender rates, annuitization elections and mortality experience. The assumptions used are consistent with those used in determining estimated gross profits for purposes of amortizing deferred policy acquisition costs.
Debt securities are primarily exposed to interest rate risk while equity securities are primarily exposed to equity market risk. Some of the following impacts have been estimated after taking into account changes that would be absorbed by policyholders.
Returns on unit-linked contracts, whether classified as insurance or investment contracts, are for the risk of the contract holder, therefore interest rate risks to the Group on these liabilities are not significant.
Reserves for insurance contracts and liabilties for investment contracts – (3,156)
Reserves for insurance contracts and liabilties for investment contracts – (6,702)
Credit risk As part of its overall risk management strategy, the Group cedes insurance risk via proportional, nonproportional and specific risk reinsurance treaties. While these cessions mitigate insurance risk the recoverable from reinsurers exposes the Group to credit risk.
The Group cedes new business to authorized reinsurers that are rated at least BBB. The premiums ceded shown in the table below that are below investment grade relate to former transactions, pools and captives, and to a lesser extent, broker business.
Reinsurance in USD millions, for the year ended December 31, 2005 premiums ceded and assets by rating of reinsurer
Rating 1 Including receivables from reinsurers. 2 Including collateral of USD 9,836 million.
c) Financial risk The Group is exposed to the risk that the proceeds from its financial assets are not sufficient to fund the obligations arising from its insurance and investment contracts, as well as risk from currency and interest rate changes.
Effect of a 10% adverse movement in the exchange rate on the net assets of the Group’s top 3 functional currencies other than the US dollar
Net gains and losses on foreign currency transactions included in the consolidated operating statements for the years ended December 31, 2005 and 2004 are shown in note 2 t).
Derivative financial instruments The Group uses derivative financial instruments to manage risks related to its capital, assets and liabilities and its commitments to third parties. The Group uses derivative financial instruments to mitigate the risks posed by changes in foreign currency rates and interest rates. The Group addresses the risks posed by derivatives through a stringent policy that requires approval of a derivative program before transactions are initiated, and by monitoring open positions. If the Group were required to settle outstanding derivative positions, the sum of gains and losses would not be material to the Group as of December 31, 2005.
Zurich Capital Markets (“ZCM”) has portfolios of derivative products, including total return swaps, for the benefit of their customers and their investment books. ZCM’s positions on derivative financial instruments are separately reported in note 9.
Debt securities: Fair value through profit or loss 15,876 5.7% 17,641 6.3%
of which: Real estate held for investment 12,702 4.6% 12,541 4.4%
Other investments: Investments held by investment companies 1,928 0.7% 1,789 0.6%
As of December 31, 2005 and 2004 investments included USD 12,486 million andUSD 15,687 million, respectively, of loaned securities. Cash and cash equivalents contained USD 4,571 million and USD 5,197 million of cash received as collateral for loaned securities as of December 31, 2005 and 2004, respectively. Non-cash collateral received for loaned securities was USD 8,262 million and USD 12,543 million as of December 31, 2005 and 2004, respectively.
Cash and investments with a carrying value of USD 4,786 million and USD 7,781 million were deposited with regulatory authorities as of December 31, 2005 and 2004, respectively.
One year through five years 1,456 1,195 32,787 32,759 3,046 2,528
Six years through ten years 313 948 23,449 30,601 3,597 2,540
USD % of USD % of millions total millions total thereof: Trading equity portfolios in capital markets and banking activities 2,026 2.1% 2,773 3.0%
Mortgage loans: fair values of loans backed by real estate are estimated using discounted cash flow calculations based on the Group’s current incremental lending rates for similar types of loans.
Investments in associates: these investments are accounted for using the equity method. Accordingly, these participations are effectively carried at the Group’s proportional interest of shareholders’ equity of the associate. The fair value of these entities, particularly for publicly traded entities, may differ from the carrying value.
Fair value and in USD millions, as of December 31 carrying value of financial instruments
1 This hedging instrument mitigates the Group’s foreign currency risk exposure to the 4.5% EUR 500 million bond under the EMTN programme. For further details refer to note 22.
Losses and loss adjustment expenses 28,124 28,428 (5,518) (4,935) 22,606 23,493
Life insurance death and other benefits 10,811 13,139 (275) (268) 10,536 12,871
The table below presents changes in the historical general insurance reserves net of reinsurance, that the Group established in 2001 and subsequent years. The top line of the table shows the estimated reserves for unpaid losses and loss adjustment expenses as of each balance sheet date, which represents the estimated amount of future payments for losses occurring in that year and in prior years. The upper, or paid, portion of the table presents the cumulative amounts paid through each subsequent year in respect of the reserves established at each year end. The lower or reserve re-estimated, portion of the table shows the re-estimation of the initially recorded reserve as of each succeeding year end. Changes to estimates are made as more information becomes known about the actual losses for which the initial reserves were established. The cumulative deficiency is equal to the initial net reserves less the liability re-estimated as of December 31, 2005. Conditions and trends that have affected the development of our reserves for losses and loss adjustment expenses in the past may or may not necessarily occur in the future, and accordingly, conclusion about future results may not be derived from the information presented in the tables below.
Development of in USD millions, as of December 31 insurance losses, net
Net reserves re-estimated as of: Two years later 28,471 34,471 40,413
As of January 1 (opening balance) 81,350 78,232 (1,418) (977) 79,932 77,255
Interest and bonuses credited to policyholders 2,758 3,319 (50) (55) 2,708 3,264
Interest and bonuses credited to policyholders 1,353 2,086 (136) (146) 1,217 1,940
Interest and bonuses credited to policyholders 6,897 4,355 – – 6,897 4,355
As of December 31, 2005 (closing balance) 55,691 51,920 – – 55,691 51,920
Reserves Rerserves Rerserves for losses for losses for losses Future life Future life Future life and loss and loss and loss policy- policy- policyadjustment adjustment adjustment holders’ holders’ holders’
Long-duration contract liabilities included in future life policyholders’ benefits result primarily from traditional participating and non-participating life insurance products. Short-duration contract liabilities are primarily accident and health insurance products. The liability for future life policyholder benefits has been established based upon the following: • interest rates which vary by country, year of issuance and product; • mortality rates based on published mortality tables adjusted for actual experience by geographic area and modified to allow for variations in policy form; • surrender rates based upon actual experience by geographic area and modified to allow for variations in policy form.
As of January 1, 2006, the policyholder’s participation for the individual life business in Switzerland becomes subject to regulatory guidelines whereby the statutory policyholders’ dividend fund has to be distributed to the policyholders at least in an amount of 20% of the account balance on the statutory accounts.
As of December 31 (closing balance) 40,999 39,260 13. Equity component of discretionary participation features
As of December 31 (closing balance) 1,399 1,425 14. Farmers management fees
The preceding table 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 32.3% and 30.1% for the years ended December 31, 2005 and 2004, respectively. These rates were derived by obtaining a weighted average of the applicable statutory income tax rate in relation to the net income before income tax attributable to shareholders generated in the taxable territories in which the Group operates.
The recoverability of the deferred tax asset for each taxpayer is based on its ability to utilize the deferred tax asset over a reasonable period of time. This analysis considers the projected taxable income to be generated by the taxpayer, as well as the ability to offset deferred tax assets with deferred tax liabilities.
Additions, capital improvements and transfers 14 12 7 105 101 239
Gross carrying value as of January 1 (opening balance) 744 1,285
Net carrying value as of December 31 (closing balance) 605 744
Gross carrying value as of December 31 (closing balance) 605 1,342 1 This intangible asset relates to insurance contracts only. 2 Other intangibles include internally generated capitalised software development costs and other costs.
When testing for impairment, the recoverable amount of a CGU is determined based on value-in-use calculations. These calculations use cash flow projections based on financial budgets approved by management covering a five-year period. Cash flows beyond the five-year period are extrapolated using estimated growth rates. The growth rate does not exceed the long-term average past growth rate for the insurance business in which the CGU operates and discount rates range between 6.0% and 10.4%.
Derivative in USD millions, as of December 31 liabilities and other liabilities
Debt in USD millions, as of December 31 2005 2004 a) Debt related to capital markets and banking activities
Zurich Capital Markets Notes and loans payable, due in the following year 653 1,973
Debt related to capital markets and banking activities 2,139 3,880 b) Senior debt
Zurich Insurance Company 3.875% CHF bond, due July 2011 763 880
Total debt 9,679 9,751 1 Net of unamortized transaction costs: USD 990 million.
a) Debt related to capital markets and banking activities During the year, a restructuring was effected to combine the Zurich Bank and Dunbar Bank into a single banking unit under Zurich Financial Services EUB Holdings Limited. To aid comparison, the 2004 figures presented for ZCM exclude debt related to Zurich Bank, which was transferred to the new banking unit. Similarly, Dunbar Bank’s 2004 debt is included under the new banking unit.
ZCM’s debt reduced by USD 1,509 million to USD 1,196 million as of December 31, 2005 from USD 2,705 million as of December 31, 2004. The reduction resulted from the redemption of capital in Zurich Bank of USD 400 million, a reduction in liquidity levels of USD 191 million, with the remainder of the reduction attributable to the ongoing wind-down of ZCM’s business.
3-month LIBOR plus 1.15% reset quarterly until December 15, 2010 and then
Credit facilities The Group has access to a syndicated revolving credit facility of USD 3 billion which was put in place in April 2004. This credit facility consists of two equal tranches maturing in 2007 and 2009. 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, 2005.
Dunbar Bank has access to various committed credit facilities totaling GBP 465 million. GBP 10 million of borrowings were outstanding under these facilities as of December 31, 2005.
Issued share capital, CHF 2.50 and CHF 6.50 par value, respectively 144,006,955 144,006,955
Preferred securities in USD millions, as of December 31 2005 2004
Preferred securities, USD 1,000 par value 1,125 1,125 a) Issued share capital As of December 31, 2005 and 2004, Zurich Financial Services had 144,006,955 issued and fully paid registered shares of CHF 2.50 par value and CHF 6.50 par value, respectively.
e) Additional paid in capital This reserve is not ordinarily available for distribution.
In the United States, restrictions on payment of dividends may be imposed by the insurance laws or regulations of an insurer’s state of domicile. For general insurance subsidiaries, dividends are generally limited over a twelve month period to 10% of the previous year’s policyholders’ surplus or previous year’s net income. For life, accident and health insurance subsidiaries, dividends are generally limited over a twelve month period to 10% of the previous year’s policyholders’ surplus or the previous year’s net gain from operations. Dividends paid in excess of statutory limitations require prior approval from the Insurance Commissioner of the insurer’s state of domicile.
Effect of potentially dilutive shares related to share-based compensation plans – 1,067,047 (0.13) (0.15)
In December 1999, Zurich Financial Services (Jersey) Limited, a subsidiary of Zurich Group Holding (formerly Zurich Financial Services), issued 12,000,000 perpetual non-voting, non-cumulative Series A Preference Shares on the Euromarket with a par value of EUR 25 (EUR 300,000,000). The securities benefit from a subordinated support agreement from Zurich Group Holding and carry a fixed coupon of 7.125%, payable quarterly. The securities are, subject to certain conditions, redeemable at the option of the issuer in whole, but not in part, from time to time on or after five years from the issue date. Proceeds from the issue were used to refinance existing intercompany debt and for general corporate purposes. With this issue, the Group was able to reinforce its capital base while raising equity-like but non-dilutive long-term funds.
The Group had 52,010 and 53,246 employees (full time equivalents) as of December 31, 2005 and 2004, respectively. Personnel and other related costs incurred for the year ended December 31, 2005 and 2004 were USD 4,884 million and USD 4,462 million, respectively. This includes wages and salaries of USD 3,903 million and USD 3,759 million, respectively.
The funded status of the Group’s funded defined benefit plans moved to a deficit of USD 2,015 million as of December 31, 2005 from a deficit of USD 4,054 million as of December 31, 2004. The assets held by the pension plans for the Group’s employees in Switzerland did not qualify as plan assets under IFRS 4. Therefore the funded status as of December 31, 2004 was restated to reflect the adoption of IFRS 4. The result was an increase to the deficit of USD 1,865 million. However, as per December 31, 2005 the funded status recovered due to a cash payment made to the plan during 2005.
The actual returns on defined benefit pension plan assets for the years ended December 31, 2005 and 2004 were USD 1,026 million and USD 611 million, respectively. The actual returns on other defined post-employment plan assets were USD 1 million and USD nil million for the years ended December 31, 2005 and 2004, respectively.
The summary of the balance sheet movements in relation to defined benefit plans and other defined postemployment benefits is given below.
Liability in the consolidated balance sheets as of December 31 (closing balance) (881) (2,621) (233) (226)
Expenses in USD millions, for the years ended December 31 recognized in the operating statements
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 422 and 500 participants in the partnership element of the plan as of December 31, 2005 and 2004 respectively. The Group also operates the profit-sharing element of the Share Incentive Plan (reward shares) which were 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% 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, 2005 and 2004 was 6,680 and 6,149, respectively.
Share Incentive Plans for employees in Switzerland In 2005, the Employee Incentive Plan introduced for employees in Switzerland continued to operate. Employees under this plan have the option to acquire sales-restricted shares at a 30% discount to the market value, with the maximum value of the discount being CHF 1,500. During 2005, 6,002 employees participated in the Employee Incentive Plan compared with 6,115 in 2004. For the year ended December 31, 2005, 1,870 employees received shares under the 2004 employee performance share plan. For the year ended December 31, 2004, 4,613 employees received shares under the 2003 employee performance share plan.
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% are sales-restricted for a further period of three years. There were a total of 787 and 535 participants in this plan as of December 31, 2005 and 2004, respectively.
Movements in for the years ended December 31 options granted under the various equity participation plans
Weighted average Number of shares exercise price under option (in CHF)
The average share price for Zurich Financial Services shares in 2005 and 2004 was CHF 221.19 and CHF 188.76, respectively.
Options granted during the period 1 705,882 477,022 44 67 1 Number of options granted is shown as the number of shares under option granted during the period.
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 for actual grants made.
Contracted option life 7 years 7 years 1 Share price as at date of granting, April 4, 2005 and April 2, 2004, respectively.
The risk-free interest rate was determined by using the seven year CHF swap rate applicable in 2005 and 2004. The fair value of any other share options granted during the year has been determined using the same methodology.
In the normal course of business, the Group enters into various transactions with related companies, including various reinsurance and cost-sharing arrangements. These transactions are not considered material to the Group, either individually or in aggregate. Parties are considered to be related if one party has the ability to control or exercise significant influence over the other party in making financial or operational decisions. The table below sets forth related party transactions reflected in the consolidated operating statement and consolidated balance sheet.
The table below summarizes related transactions with key personnel reflected in the consolidated financial statements. Key personnel includes directors of Zurich Financial Services, directors of Zurich Insurance Company and members of the Group Executive Committee.
Remuneration paid to the members of the Board of Directors of Zurich Financial Services and Zurich Insurance Company in 2005 and 2004 was USD 2.8 million and USD 2.7 million, respectively.
a) Certificates of contribution and surplus notes of the Farmers Exchanges As of December 31, 2005 and 2004, FGI and other Group companies held the following surplus note and certificates of contribution issued by the Farmers Exchanges. Originally these were purchased by FGI in order to supplement the policyholders’ surplus of the Farmers Exchanges.
Surplus Notes in USD millions, as of December 31 2005 2004 6.15% surplus note, due December 2013 88 88 6.15% certificates of contribution, due December 2013 524 524 6.15% certificates of contribution, due August 2014 296 296 6.00% certificates of contribution, due September 2006 107 107
Conditions governing payment of interest and repayment of principal are outlined in the certificates of contribution and the surplus note. Generally, repayment of principal may be made only when the issuer has an appropriate amount of surplus, and then only after approval is granted by the issuer’s governing Board and the appropriate state insurance regulatory department in the United States. In addition, payment of interest may generally be made only when the issuer has an appropriate amount of surplus and then only after approval is granted by the appropriate state insurance regulatory department in the United States.
Other commitments and contingent liabilities 312 271 1 Guarantee features embedded in life insurance products are not included. For such guarantee features refer to note 11 on insurance reserves.
Commitments under investment agreements The Group has committed to contribute capital to subsidiaries, associates and third parties that engage in making investments in direct private equity, private equity funds, emerging market funds and hedge funds. Included in the remaining commitments is USD 331 million to Capital Z Investments II, L.P., USD 110 million to Capital Z Investments, L.P. and USD 71 million to Gresham. Part of these commitments may be called at any time and in any amount, based on various criteria. The remaining commitments also include a minimum allocation for hedge fund investments.
Guarantees, surety bonds, letters of credit The Group knows of no event of default that would require it to satisfy guarantees. Irrevocable letters of credit and surety bonds were issued to secure certain reinsurance contracts.
Future rent commitments The Group has entered into various operating leases as lessee for office space and certain computer and other equipment. Rent expenses for these items totaled USD 155 million and USD 190 million for the years ended December 31, 2005 and 2004, respectively.
Indemnity agreements The Group, through certain of its subsidiaries, has agreed to arrangements that cap Converium’s net exposure for losses arising out of the September 11, 2001 event at USD 289 million. Additionally, the Group has provided Converium with coverage for net losses in excess of USD 59 million, including non-performance of the retrocessionaire, related to Amerisafe/Unicover pool business. As of December 31, 2005, the Group has recorded provisions in respect of both arrangements of USD 128 million and USD 24 million, respectively.
Various Group subsidiaries are also defendants in corporate class action litigation, and they intend to defend such actions vigorously. Certain of these putative class actions consolidated before a US District Court were brought by private parties based on matters that have been the subject of the investigation regarding business practices involving insurance brokers and insurance carriers. By entering into a Memorandum of Understanding with the plaintiffs in this consolidated class action subject to various contingencies, Zurich Financial Services and certain of its United States subsidiaries have created a platform to negotiate a settlement with these plaintiffs that could be terminated or changed in material respects if efforts to negotiate satisfactory separate settlements with State Insurance Departments and State Attorneys General in the United States are unsuccessful. Zurich Financial Services is also a defendant in class action lawsuits brought on behalf of the holders of securities issued by Converium Holding AG.
Losses and loss adjustment expenses, net of reinsurance 20,961 21,323 109 89
Insurance benefits and losses, net of reinsurance 21,068 21,455 9,100 9,757
Interest credited to policyholders and other interest 204 154 716 755
Assets and liabilities in USD millions, as of December 31 by business segment General Life
Reinsurers’ share of reserves for insurance contracts 13,974 14,753 1,561 1,609
Reserves for losses and loss adjustment expenses, gross 54,716 52,162 130 116
Gross written premiums and policy fees for Total revenues for Total assets the years ended the years ended as of December 31 December 31 December 31
As auditors of the Group, we have audited the consolidated financial statements (operating statement, balance sheet, statement of cash flows, statement of changes in equity and notes on pages 3 to 85) of Zurich Financial Services for the year ended December 31, 2005.
Zurich International (France) Cie d’Assurances S.A. 2 Levallois-Perret General Insurance 99.99 99.99 EUR 20.2
Deutscher Herold Lebensversicherung Aktiengesellschaft Bonn Life Insurance 76.83 76.83 EUR 46.2
Zürich Versicherung Aktiengesellschaft (Deutschland) Frankfurt / Main General Insurance 100.00 100.00 EUR 106.5 1 The segments are defined in the notes to the Consolidated Financial Statements, note 1, Basis of presentation. 2 Liquidated on January 5, 2006.
Zurich Vida, Compañía de Seguros y Reaseguros, S.A. Madrid Life Insurance 100.00 100.00 EUR 50.4
Zurich Insurance (Taiwan) Ltd. Taipei General Insurance 91.87 91.87 TWD 2,000.0
Allied Zurich Holdings Limited Jersey, Channel Islands Corporate Functions 100.00 100.00 GBP 90.7
Eagle Star Insurance Company Limited Fareham, England General Insurance 100.00 100.00 GBP 591.7
Zurich Assurance Ltd. Swindon, England Life Insurance 100.00 100.00 GBP 879.9
Zurich Invest (Jersey) Ltd. Jersey, Channel Islands General Insurance 100.00 100.00 GBP 0.1
(and subsidiaries) New York, NY General Insurance 100.00 100.00 USD 5.0
Consulting actuaries review Deloitte & Touche LLP (“Deloitte”), our consulting actuaries, have reviewed the choice of methodology together with the assumptions and calculations made by Zurich Financial Services Group (“the Group”) in the calculation of the embedded value results of its Life Insurance business as of December 31, 2005. Deloitte have reported to the Group that they consider that the methodology is appropriate, the Group’s assumptions are together reasonable and that the embedded value results as published above have been properly compiled on the basis of the methodology and assumptions chosen. For the purpose of this report, Deloitte have performed certain checks on data provided by the Group, but have not verified and have relied on financial information underlying the Group’s financial statements.
Embedded value profit is the change in the embedded value over the year, after adjustment for any dividends and capital movements. The profit is calculated on an after-tax basis.
• the experience variances caused by the differences between the actual experience during the period and the expected experience assumed in the prior year embedded value, and
Operating profit expected from in-force business and net assets, after tax 151 176
The above information should be read in conjunction with the notes on the following pages.
The above information should be read in conjunction with the notes below and on the following pages.
3. Life Insurance includes some non-insurance service companies and our distribution units in the United Kingdom and Germany. In line with our embedded value methodology, we have included the present value of future profits of these companies in both the Group’s embedded value and new business profit. New business profit arises in these companies through servicing of the Group’s life insurance business as well as that of general insurance Group companies and third parties. The contribution to new business profit from servicing of general and third party business is USD 15 million in Germany, and a loss of USD 2 million in the United Kingdom. There is however no contribution to the annual premium equivalent in respect of general and third party new business. Removing the value of this new business from the new business profit would reduce the new business margin in Germany to 13.8%, increase the new business margin in the United Kingdom to 9.0% and reduce the new business margin of the Group to 13.9%.
6. Where the Group has a majority interest in a subsidiary company, the new business profit and new business premium information are shown gross of minority holdings although the embedded value is shown net of minority holdings. The minorities’ share of new business profit is eliminated through “Operating variance, after tax”. The minorities’ share of new business profit mostly relates to our subsidiaries in Germany. For Life Insurance in total, the new business profit and gross new business annual premium equivalent (APE) net of minority holdings for 2005 are USD 315 million and USD 2’198 million, respectively.
8. In April 2004, the Group changed the organizational structure of its business units in line with its strategy. As a result, certain life insurance operations have been reclassified as Other Businesses. One of these, Kemper Investors Life Insurance Company (KILICO), has written variable annuity contracts that provide annuitants with certain guarantees related to minimum death and income benefits. The Group has recorded provisions for these embedded guarantee features in accordance with its accounting policy. The embedded value related to KILICO as of January 1, 2004 was USD 357 million. The Group has not determined embedded value results for this company since its reclassification into Other Businesses.
9. In 2005, wholesale investment products, for which only administration services are provided, have not been classified as new business and hence have been excluded from both the new business profit and the annual premium equivalent. This has impacted the results in our International Businesses.
11. In 2005, the capital strain on writing new business was approximately USD 0.9 billion. The after-tax internal rate of return on new business was approximately 11% and the new business profit before cost of solvency was USD 396 million.
Zurich Financial Services Group · Annual Report 2005 98 Embedded Value Statistics
Embedded value sensitivities The following tables show the sensitivity of our 2005 embedded value and value of new business to changes in several key assumptions: Change in in USD millions embedded value
The figures shown above are “sensitivities” - for each assumption change, all other assumptions have remained unchanged.
Zurich Financial Services is the holding company of the Group with a primary listing on the SWX Swiss Exchange and a secondary listing on the London Stock Exchange. Zurich Financial Services was incorporated on April 26, 2000, with a share capital of CHF 100,000. As of December 31, 2005, the shareholders’ equity totaled CHF 16,472,848,630 (December 31, 2004: CHF 16,267,755,044).
2. Summary of significant accounting policies a) Exchange rates Assets and liabilities expressed in currencies other than Swiss francs are translated at year-end exchange rates. Revenues and expenses are translated using the exchange rate at the date of the transaction. Unrealized exchange losses are recorded in the statement of income and unrealized exchange gains are deferred until realized.
5. Investments in subsidiaries Investments in subsidiaries include a 57% interest in Zurich Group Holding with a carrying value of CHF 6,064,302,120 (prior year CHF 6,064,302,120) and a 100% interest in Allied Zurich p.l.c., with a carrying value of CHF 4,595,865,096 (prior year CHF 4,595,865,096). Allied Zurich p.l.c. holds the remaining 43% interest in Zurich Group Holding. Additionally, Zurich Financial Services holds 49,000 shares of Zurich Insurance Company with a book carrying value of CHF 2,750,190 (prior year CHF 2,750,192).
6. Commitments and contingencies Zurich Financial Services has provided an unlimited guarantee in support of various entities belonging to the Zurich Capital Markets group of companies. In addition, Zurich Financial Services has agreed with the Superintendent of Financial Institutions, Canada, to provide additional capital in case the applicable capital adequacy tests for the Canadian business are not met and to provide assistance in case of liquidity issues.
Furthermore, Zurich Financial Services has entered into various support agreements and a guarantee for the benefit of its subsidiaries. These contingencies amounted to CHF 4,118 million as of December 31, 2005 (CHF 319 million as of December 31, 2004).
As of December 31, 2005 and 2004, Zurich Financial Services had 144,006,955 issued and fully paid registered shares of CHF 2.50 par value and CHF 6.50 par value, respectively.
b) Authorized share capital Until June 1, 2007, the Board of Zurich Financial Services is authorized to increase the share capital by an amount not exceeding CHF 15,000,000 by issuing up to 6,000,000 fully paid registered shares with a nominal value of CHF 2.50 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 the 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 13,704,570 by issuing up to 5,481,828 fully paid registered shares with a nominal value of CHF 2.50 each (1) through the exercise 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 (2) by the exercise of option rights which are granted to the 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.
Employee participation: The share capital may be increased by an amount not exceeding CHF 3,750,000 by issuing up to 1,500,000 fully paid registered shares with a nominal value of CHF 2.50 each to employees of Zurich Financial Services and Group companies. The pre-emptive rights of the shareholders, as well as the right for advance subscription, are excluded. The issuance of shares or respective option rights to employees shall be subject to one or more regulations to be issued by the Board of Directors and taking into account performance, functions, levels of responsibility and criteria of profitability. Shares or option rights may be issued to the employees at a price lower than that quoted on the stock exchange.
Average selling price, in CHF 204 182 1 in CHF thousands 9. Shareholders The shares registered in the share ledger as of December 31, 2005, were owned by 116,098 shareholders of which 110,205 were private individuals holding 20.3% of the shares (or 12.5% of all outstanding shares), 2,271 were foundations and pension funds holding 8.7% of the shares (or 5.4% of all outstanding shares), and 3,622 were other legal entities holding 71% of the shares (or 43.95 of all outstanding shares).
Shares eligible as of February 15, 2006 and February 16, 2005, respectively 144,006,955 144,006,955 in CHF thousands 2005 2004 (Proposed) (Approved)
• Subject to the approval of the nominal value reduction and the fulfilment of all necessary requirements, the payment of CHF 2.40 per share is expected around the beginning of July 2006, free of charge and in accordance with dividend payment instructions. The proposed nominal value reduction would reduce the share capital by CHF 345,616,6921.
As statutory auditors, we have audited the accounting records and the financial statements (statements of income, balance sheets and notes on page 102 to 106 of Zurich Financial Services for the year ended
Securities Custody Service Zurich Financial Services, Custody Accounts c/o S A G SIS Aktienregister AG P. O. Box, 4601 Olten, Switzerland
Lloyds TSB Registrars The Causeway, Worthing West Sussex, BN99 6DA, United Kingdom Nominee Service helpline: 0870 600 3970 Lloyds TSB share dealing helpline: 0870 242 4244
Hard of hearing (text phone, domestic): 0870 600 3915 Web site: www.shareview.co.uk
Certain statements in this Annual Report are forward-looking statements, including, but not limited to, statements that are predications of or indicate future events, trends, plans or objectives. Forward-looking statements include statements regarding our targeted profit improvement, return on equity targets, expense reductions, pricing conditions, dividend policy and underwriting claims improvements. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties and can be affected by other factors that could cause actual results and Zurich Financial Services’ plans and objectives to differ materially from those expressed or implied in the forward looking statements (or from past results). Factors such as (i) general economic conditions and competitive factors, particularly in our key markets; (ii) performance of financial markets; (iii) levels of interest rates and currency exchange rates; (iv) frequency, severity and development of insured claims events; (v) mortality and morbidity experience; (vi) policy renewal and lapse rates; (vii) changes in laws and regulations and in the policies of regulators may have a direct bearing on Zurich Financial Services’ results of operations and on whether Zurich Financial Services will achieve its targets. Zurich Financial Services undertakes no obligation to publicly update or revise any of these forwardlooking statements, whether to reflect new information, future events or circumstances or otherwise.
Zurich Financial Services Group (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 55,000 people serving customers in more than 120 countries.
Printed end of February 2006 by St Ives Burrups Ltd., England