The time required to learn of and settle claims is an important consideration in establishing the Group’s reserves. Short-tail claims, such as those for automobile and property damage, are normally reported soon after the incident and are generally settled within months following the reported incident. Long-tail claims, such as bodily injury, pollution, asbestos and product liability, can take years to develop and additional time to settle. For long-tail claims, information concerning the event, such as the required medical treatment for bodily injury claims and the measures and costs required to clean up pollution, may not be readily available. Accordingly, the reserving analysis of long-tail lines of business is generally more difficult and subject to greater uncertainties than for short-tail claims.
b) Future life policyholders’ benefits and policyholders’ contract deposits The reserves for future life policyholders’ benefits and policyholders’ contract deposits and other funds contain a number of assumptions regarding mortality (or longevity), lapses, surrenders, expenses and investment returns. These assumptions are determined with reference to past experience adjusted for new trends, current market conditions and future expectations. As such the liabilities for future life policyholders’ benefits and policyholders’ contract deposits may not represent the ultimate amounts paid out to policyholders. For example: • The estimated number of deaths determines the value of the benefit payments. The main source of uncertainty arises because of the potential for pandemics and wide-ranging lifestyle changes, such as changes in eating, smoking and exercise habits, which could result in earlier deaths for age groups in which the Group has significant exposure to mortality risk.
c) Fair value of financial assets and liabilities As described in note 3, all financial assets and liabilities are recorded initially at fair value. Subsequently, available-forsale financial assets, financial assets and liabilities at fair value through profit or loss and derivative financial instruments are carried at fair value, as of the reporting date. All other financial instruments are carried at amortized cost, with their fair values disclosed in note 26.
Fair values of debt and equity securities are based on quoted market prices. If such quoted prices are not available, then fair values are estimated on the basis of information from external pricing providers or internal pricing models (for example, discounted cash flow models or other recognized valuation techniques).
In cases where significant reliance is placed on an independent pricing provider, the Group’s policy is to engage with that provider to ensure that proper processes and controls are in place to guarantee that the price quality meets the high standards that the Group expects. In addition, the Group’s policy is to ensure that independently sourced prices are determined based on valuation techniques that incorporate all factors that market participants would consider in setting a price and are consistent with best practice methodologies for pricing financial instruments. Such models make maximum use of market inputs such as benchmark yields, reported trades and broker/dealer quotes. The Group holds certain asset classes that are not actively traded, in particular hedge funds and private equity investments. Fair values of such instruments are based on regular reports from the issuing hedge funds and private equity funds. Performance of these investments and determination of their fair value are monitored closely by the Group’s in-house investment professionals.
A financial asset is considered impaired if there is objective evidence of impairment as a result of one or more occurred loss events that have an impact on the estimated future cash flows of the financial asset. The decision to record an impairment is based on a review of such evidence, for example, the issuer’s current financial position and its future prospects and the national or economic conditions that correlate with defaults on the assets reviewed for impairment.
For goodwill the recoverable amount is the higher of its fair value less costs to sell and its value-in-use. Fair value at a CGU level is determined, considering quoted market prices, current share values in the market place for similar publicly traded entities, and recent sale transactions of similar businesses. Value-in-use is determined using the present value of estimated future cash flows expected to be generated from or used by the CGU. Cash flow projections are based on financial budgets, which are approved by management, typically covering a three-year period or if appropriate, a longer period. Cash flows beyond this period are extrapolated using amongst others estimated perpetual growth rates. The discount rates applied reflect the respective risk free interest rate adjusted for the relevant risk factors to the extent, they have not already been considered in the underlying cash flows.
The recoverable amount of the intangible assets with an indefinite life related to the Farmers segment (i.e. attorney-infact (AIF) relationships and goodwill) is determined on the basis of value-in-use calculations. These calculations use cash flow projections based on business plans and the development of surplus in the Farmers Exchanges. Business plans are approved by management and typically cover a three-year period. Cash flows beyond that three-year period are extrapolated for 20 years assuming zero growth.
For the 2011 goodwill impairment testing, the applied discount rate of 7.9 percent for the General Insurance segment represents a weighted rate based on the underlying business operation profit (BOP) by region. The perpetual growth rate was assumed to be zero.
Consolidated financial statements e) Fair values of assets and liabilities attributable to business combinations Acquired businesses are accounted for using the purchase method of accounting which requires that the assets acquired and liabilities assumed are recorded at the date of acquisition at their respective fair values. Fair values of financial assets and liabilities and insurance liabilities are determined as described in the respective sections above.
Fair values of identifiable intangible assets are based on market-participant assumptions and applicable valuation techniques, depending on the nature of the assets valued. For customer relationship and contract intangibles, including bancassurance agreements, the multi-period excess earnings or cash flow method is applied, using future cash flows expected to be generated from such assets discounted at applicable market rates. For information technology intangibles the replacement cost method is generally applied.
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 judgments as to which issuance costs are directly related to and vary with the acquisition. The related asset is amortized over the premium earning pattern for non-life and certain traditional life products. For most life products, amortization is based on the estimated profitability of the contract throughout its life. The estimation of profitability considers both historical experience and future expectations as regards assumptions, such as expenses, lapse rates or investment income.
i) Share-based compensation and cash incentive plans The Group has adopted various share-based compensation and cash incentive plans to attract, retain and motivate executives and employees. Share-based compensation plans include plans under which shares and, until 2010, options to purchase shares, based on the performance of the businesses, are awarded. The fair value of options granted is estimated using the Black-Scholes option pricing model. The key factors involve, but are not limited to, the expected share price volatility, expected changes in dividend rate and the contracted option life. These assumptions may differ from actual results due to changes in economic conditions.
See note 24 for further information on share-based compensation and cash incentives plans.
The initial consideration paid by the Group amounted to approximately USD 1.2 billion, subject to final purchase price and other adjustments. The Group and Santander also entered into loan agreements with several of the acquired companies, whereby total funds of USD 0.5 billion where provided to the insurance operations, split in line with the participation rights between the Group and Santander. In addition to the initial consideration, both an earn-out component based on the future profitability under the distribution agreements and a protection mechanism for the Group’s initial consideration, which is based on a similar future profitability criteria, have been agreed. Under the earn-out arrangement, payments are scheduled to be made after every five year period starting January 1, 2011 until December 31, 2035 by the Group, subject to the achievement of the profitability criteria. The earn-out payments are scheduled to increase over the 25 year period up to a cumulative maximum total amount of USD 1.6 billion, based on December 31, 2011 foreign exchange rates. The fair value of the earn-out component is still being assessed and is therefore not reflected in the Consolidated financial statements as of December 31, 2011.
Transactions in 2010 Acquisitions On November 1, 2010 the Group completed the acquisition of 80.0 percent of PT Zurich Topas Life (formerly PT Mayapada Life), a life insurer based in Indonesia focused on the distribution of group and individual life and health plans. Mayapada Group will continue to hold 20.0 percent of PT Zurich Topas Life. Through this transaction, the Group established its presence in the Indonesian life insurance market. Total acquisition costs amounted to less than USD 1 million. PT Zurich Topas Life has been included in the Group’s Consolidated financial statements as of January 1, 2011.
On December 1, 2010 the Group completed the acquisition of 99.99 percent of Compagnie Libanaise d’Assurances SAL, a composite insurer based in Lebanon with branch operations in the United Arab Emirates, Kuwait and Oman. With this
Real estate held for investment 859 791 (33) 216 825 1,007
1 Net capital gains/(losses) on derivatives attributable to cash flow hedge ineffectiveness amounted to USD (13) million and USD 10 million for the years ended December 31, 2011 and 2010, respectively.
Rental operating expenses for real estate held for investment included in investment expenses for total investments amounted to USD 203 million and USD 201 million for the years ended December 31, 2011 and 2010, respectively.
Real estate held for investment 531 466 46 28 576 494
For the years ended December 31, 2011 and 2010, respectively, impairment charges on Group investments included in net capital gains/(losses) amounted to USD 458 million and USD 1,001 million, including USD 133 million and USD 407 million, respectively, for impairment charges on mortgage loans, other loans and investments in associates and joint ventures.
Real estate held for investment 328 325 (79) 188 249 513
Investment result, gross for unit-linked contracts 2,367 2,093 (5,302) 8,533 (2,934) 10,626 Investment expenses for unit-linked contracts (610) (532) – – (610) (532) Investment result, net unit-linked contracts 1,757 1,561 (5,302) 8,533 (3,544) 10,093
Securities at fair value through profit or loss: (5,472) 8,476 777 643 (4,695) 9,120 Net capital gains/(losses) on Group investments 33 294 541 373 574 667
Net capital gains/(losses) for unit-linked contracts (5,505) 8,182 236 270 (5,269) 8,452
Realized capital gains on Group investments 705 610 1,278 1,468 1,983 2,078 Realized capital losses on Group investments (156) (122) (841) (514) (997) (636)
Debt securities: Fair value through profit or loss 19,845 6.6 16,245 5.3 of which: Trading securities 50 0.0 43 0.0 Securities designated at fair value through profit or loss 19,795 6.6 16,202 5.3
Cash and investments with a carrying value of USD 6,227 million and USD 5,176 million were deposited on behalf of regulatory authorities as of December 31, 2011 and 2010, respectively.
Securities under security lending and short-term sale and repurchase agreements As of December 31, 2011 and 2010, investments included USD 6,298 million and USD 5,873 million, respectively, of loaned securities. These loaned securities were mainly debt securities. Liabilities for cash collateral received for securities lending comprised USD 159 million and USD 485 million as of December 31, 2011 and 2010, respectively. Non-cash collateral received for loaned securities comprised mainly equity and debt securities and amounted to USD 6,474 million and USD 5,663 million as of December 31, 2011 and 2010, respectively. The Group can sell or repledge the collateral only in the event of a default by a counterparty.
As of December 31, 2011 and 2010, respectively, debt securities with a carrying value of USD 1,807 million and USD 3,383 million have been sold to financial institutions under short-term sale and repurchase agreements. These securities continue to be recognized as investments in the Group’s consolidated balance sheets. Obligations to repurchase these securities amounted to USD 1,794 million and USD 3,330 million as of December 31, 2011 and 2010, respectively.
Accrued interest on unit-linked investments included in accrued investment income amounted to USD 303 million and USD 247 million as of December 31, 2011 and December 31, 2010, respectively.
millions of which: common stock portfolios backing participating with profit policyholder contracts 420 3.7 516 4.8 – – 420 516
As of January 1 12,355 11,686 Additions and improvements 267 340 Acquisitions 115 –
Market value revaluation 40 261 Transfer from assets held for own use 116 77 Transfer to assets held for sale – (12) Foreign currency translation effects (133) 193 As of December 31 12,365 12,355
1 Disposed of in October 2011. 2 The Group has several special purpose entities (SPEs) in the U.S. which are consolidated using the equity method as a reasonable approximation, as the equity pick up is usually 99% and the investment balance approximates the value of the SPE’s assets. These entities were specifically designed to facilitate U.S. commercial property sale and leaseback transactions.
In certain circumstances these instruments may meet the requirements of an effective hedge for accounting purposes. Where this is the case, hedge accounting may be applied. Financial information for these instruments are set out in table 7.2.
Table 7.1 shows the fair value and notional amounts for instruments which do not qualify for hedge accounting as of December 31, 2011 and 2010, respectively. Whilst these notional amounts express the extent of the Group’s involvement in derivative transactions, they are not however representative of amounts at risk. Fair values for derivatives are included in the consolidated balance sheets in other assets and other liabilities.
Interest rate contracts: OTC Swaps 686 430 3,158 4,274 307 (14) 3,054 187 (84)
Foreign exchange contracts: OTC Cross Currency Swaps – 423 – 423 – (28) 425 – (26)
The notional amounts of foreign exchange forwards decreased by USD 208 million between December 31, 2010 and December 31, 2011, as a result of market movements.
Credit contracts The decrease in notional for credit default swaps, purchased by the Group to protect reinsurance assets, related to matured positions.
Cash flow hedges: Options on interest rate swaps – 901 2,229 3,130 414 – 3,855 331 –
Fair value hedges Designated fair value hedges consist of cross currency interest rate swaps used to protect the Group against changes in foreign currency exposure and interest rate exposure of Euro and U.S. dollar – denominated debt issued by the Group.
A fair value hedge relationship on 20 percent of the EUR 1 billion 4.5 percent senior debt due for repayment in 2014 issued by Zurich Finance (USA), Inc. (see note 21), was entered into on January 1, 2007 and will end on the maturity of the underlying debt instrument in 2014.
A fair value hedge relationship on the USD 750 million 3.25 percent senior bond due for repayment in September 2013 issued by Zurich Finance (Luxembourg), S.A. (see note 21), was entered into on April 8, 2010 and will end on the maturity of the underlying debt instrument in 2013.
Gains and losses arising from fair value hedges are as follows: Gains/(losses) on hedging instruments 1 (6) (52) on hedged items attributable to the hedged risk – 44 1 Excluding current interest income, which is booked on the same line as an offset to the interest expense on the hedged debt.
Cash flow hedges Designated cash flow hedges, such as options on interest rate swaps are used to protect the Group against variability of future cash flows due to changes in interest rates associated with expected future purchases of debt securities (during the years 2016, 2021 and 2026) required for certain life insurance policies. The effective portion of the gains and losses on these swaps are initially recognized in other comprehensive income. Subsequently the gains or losses will be recycled to income between the years ended December 31, 2012 and 2036. The gains and losses relating to the ineffective portion of these hedges are recognized immediately in income within net capital gains/losses on investments and impairments.
As of December 31, 2011 the following cash flow hedge relationships were in place (see note 21): • 80 percent of the EUR 1 billion 4.5 percent senior bond due 2014 issued by Zurich Finance (USA), Inc. entered on January 1, 2007 ending September 17, 2014.
The net gains deferred in other comprehensive income on derivatives designated as cash flow hedges were USD 245 million and USD 74 million before tax for the years ended December 31, 2011 and 2010, respectively.
A loss of USD 13 million and a gain of USD 10 million for the years ended December 31, 2011 and 2010, respectively, was recognized in net capital gains/(losses) and impairments due to ineffectiveness of a hedge and changes in the time value of the option.
Favorable development in Europe of USD 186 million resulted primarily from favorable experience in Switzerland of USD 365 million, mostly in motor, while most other countries reported small favourable amounts. On the other hand, Germany reported USD 242 million of adverse development, driven by the medical and professional liability lines of business.
The remaining favorable development emerged from Group Reinsurance, International Markets, and the assumed business from the Farmers Exchanges.
Gross reserves for losses and loss adjustment expenses 45,306 51,068 57,765 60,425 64,535 67,890 65,218 68,126 68,107 67,525
Initial net reserves for losses and loss adjustment expenses 30,366 37,013 43,486 46,194 50,814 54,712 52,986 55,944 56,014 55,124
Cumulative paid as of December 31: One year later (8,923) (9,930) (9,464) (11,423) (11,237) (12,551) (13,047) (12,716) (13,092) Two years later (14,472) (15,550) (16,273) (18,044) (18,362) (19,660) (19,909) (19,821) Three years later (18,001) (20,407) (21,234) (23,077) (23,421) (24,428) (24,693) Four years later (21,390) (23,941) (24,945) (26,850) (26,839) (27,735) Five years later (23,814) (26,616) (27,798) (29,425) (29,224) Six years later (25,799) (28,668) (29,810) (31,189) Seven years later (27,442) (30,245) (31,148) Eight years later (28,672) (31,274) Nine years later (29,482)
Cumulative incurred as of December 31: One year later 1,873 1,964 141 (218) (1,219) (1,271) (1,059) (1,378) (1,302) Two years later 4,105 3,400 1,520 (367) (2,171) (2,152) (2,350) (2,565) Three years later 5,752 4,991 1,839 (897) (2,686) (2,844) (3,048) Four years later 7,325 5,241 1,808 (945) (3,003) (3,533) Five years later 7,514 5,457 2,118 (1,044) (3,438) Six years later 7,916 6,004 2,194 (1,184) Seven years later 8,585 6,094 2,254 Eight years later 8,719 6,223 Nine years later 8,819
Net reserves re-estimated as of December 31: One year later 32,239 38,977 43,627 45,976 49,594 53,441 51,927 54,565 54,711 Two years later 34,471 40,413 45,006 45,827 48,642 52,559 50,637 53,379 Three years later 36,118 42,004 45,325 45,297 48,127 51,868 49,939 Four years later 37,691 42,254 45,294 45,249 47,811 51,179 Five years later 37,880 42,470 45,604 45,150 47,376 Six years later 38,282 43,017 45,680 45,010 Seven years later 38,951 43,107 45,740 Eight years later 39,085 43,236 Nine years later 39,185
Gross reserves re-estimated as of December 31, 2011 57,201 59,768 61,192 59,867 60,585 63,437 61,281 64,538 66,458 Cumulative (deficiency)/ redundancy of gross reserves (11,895) (8,700) (3,427) 558 3,950 4,453 3,937 3,588 1,650 Cumulative (deficiency)/ redundancy as a percentage of initial gross reserves (26.3%) (17.0%) (5.9%) 0.9% 6.1% 6.6% 6.0% 5.3% 2.4%
Reserves for environmental claims decreased by USD 8 million gross and USD 17 million net, and increased by USD 10 million gross but decreased by USD 19 million net during the years ended December 31, 2011 and 2010, respectively. For the year ended December 31, 2010, the difference in gross and net movements is explained by the increase in ceded reserves, largely the result of the re-estimation of reserves in North America.
Fee income and other expenses (2,072) (1,689) 87 118 (1,985) (1,571) Interest and bonuses credited to policyholders 3,257 2,650 (161) (70) 3,096 2,580
(Decreases)/increases recorded in other comprehensive income 252 (8) – – 252 (8)
1 The 2011 net movement mainly included reclassifications of USD 212 million transferred from other liabilities to future life policyholders’ benefits, partly offset by USD (27) million transferred to liabilities for investment contracts (see note 1). Additionally, it included the future life policyholders’ benefits acquired with MAA (see note 5) of USD 1,361 million. The 2010 net movement included USD 2,730 million related to the transfer to other reserves categories and USD (1,508) million related to loss of control in Caixa Sabadell (see note 5).
The net impact of changes in assumptions on net future life policyholders’ benefits was USD 400 million and USD 170 million for the years ended December 31, 2011 and 2010, respectively. The net changes include the following significant movements: Interest rates 451 216
Fee income and other expenses (344) (360) 7 14 (337) (347) Interest and bonuses credited to policyholders 628 993 (79) (82) 549 912
(Decrease)/increase recorded in other comprehensive income 477 (185) – – 477 (185)
1 The 2011 net movement mainly included an increase for policyholders’ contract deposits and other funds acquired with MAA (see note 5) of USD 268 million. The 2010 net movement included decreases for the transfer to other reserves categories of USD (1,733) and a decrease of USD (7) million related to loss of control in Caixa Sabadell (see note 5).
Fee income and other expenses (1,689) (1,496) – (1) (1,689) (1,497) Interest and bonuses credited/(charged) to policyholders (1,274) 5,395 – – (1,274) 5,395
1 The 2011 net movement mainly included a reclassification of USD 119 million from liabilities for investment contracts to reserves for unit-linked contracts, partly offset by a reclassification of USD (259) million to liabilities for investment contracts (see note 1). Additionally, it included the reserves for unit-linked insurance contracts acquired with MAA (see note 5) of USD 223 million. The 2010 net movement included USD (12) million related to the transfer to other reserves categories and USD (160) million related to loss of control in Caixa Sabadell (see note 5).
Fee income and other expenses (573) (692) Interest and bonuses charged/(credited) to policyholders (1,431) 5,267
Change in policyholders’ contract deposits and other funds 643 809 – (4) 643 805 Change in reserves for unit-linked products (1,826) 5,287 – – (1,826) 5,287 Change in liabilities for investment contracts – unit-linked (1,801) 4,830 – – (1,801) 4,830 Change in liabilities for investment contracts – other 224 215 – – 224 215 Change in unit-linked liabilities related to UK capital gains tax 75 (337) – – 75 (337) Total policyholder dividends and participation in profits (2,685) 10,805 – (4) (2,685) 10,801
Amortization of deferred acquisition costs 5,365 5,365 (506) (439) 4,860 4,926 Amortization of deferred origination costs 135 119 – – 135 119 Commissions and other underwriting and acquisition expenses 1 3,809 3,865 (280) (261) 3,529 3,604 Total underwriting and policy acquisition costs 9,309 9,349 (786) (700) 8,523 8,649 1 Net of additions related to deferred acquisition and origination costs.
Change in reserves for unearned premiums 932 (1,019) (181) (215) 751 (1,234)
Table 13 in USD millions, for the years ended December 31Administrative and other operating expenses
Impairment charges of USD 1 million on mortgage loans given as collateral were recorded in income for the year ended December 31, 2010. There were no impairment charges in 2011.
The table below shows the maturity schedule of collateralized loans as of December 31, 2011 and 2010, respectively.
Net carrying value as of December 31, 2011 325 709 152 95 299 1,579
Gross carrying value as of December 31, 2011 325 1,057 575 559 694 3,209 1 Related to the acquisition of Malaysian Assurance Alliance Bhd (see note 5).
Gross carrying value as of January 1, 2010 364 1,249 475 871 794 3,754
Net carrying value as of December 31, 2010 352 777 107 96 357 1,689
The fire insurance value of the Group’s own-use property and equipment totaled USD 2,917 million and USD 3,344 million as of December 31, 2011 and 2010, respectively.
Other Operating Businesses – – – – 286 – 286 Non-Core Businesses – – – – 1 – 1 Net carrying value as of December 31, 2011 2,060 879 2,149 1,025 1,616 104 7,834
Gross carrying value as of January 1, 2010 2,331 2,749 3,426 1,025 3,430 224 13,186
Net carrying value as of January 1, 2010 2,297 1,137 3,174 1,025 1,569 139 9,342
As part of its annual impairment testing the Group has compared the carrying amount of its intangible assets with the recoverable amount, generally based on a value-in-use calculation. Based on management’s best estimate and after taking into consideration sensitivity analysis of the current conditions, an impairment of USD 104 million has been recorded for the goodwill of the General Insurance operations in Russia.
The decision to decentralize its Direct insurance efforts in the Group’s General Insurance operations in Europe resulted in an impairment of USD 114 million for software which will no longer be used.
Financial assets Derivative assets 2,126 1,777 Receivables from policyholders 2,957 3,042 Receivables from insurance companies, agents and intermediaries 5,495 5,343 Receivables arising from ceded reinsurance 1,155 1,195 Reverse repurchase agreements 814 1,171 Amounts due from investment brokers 321 395 Other receivables 1,880 2,371 Allowance for impairments 1 (320) (323) Other assets 134 132 Non-financial assets Current tax receivables 789 740 Accrued premiums 684 748 Prepaid expenses 286 254 Prepaid insurance benefits 432 441 Other assets 404 385 Assets related to Santander insurance operations in Latin America 2 15,611 – Total receivables and other assets 32,766 17,671 1 Allowance for impairments includes USD 81 million and USD 101 million as of December 31, 2011 and 2010, respectively, for receivables arising from ceded reinsurance. 2 See note 5.
Table 19.2 shows the maturity schedule of other financial liabilities as of December 31, 2011 and 2010, respectively.
As of January 1 155 119 Provisions made during the period 223 111 Provisions used during the period (112) (77) Provisions reversed during the period (2) – Foreign currency translation effects (11) 2 As of December 31 254 155
Total income tax expense/(benefit) attributable to policyholders (242) 462 Total income tax expense attributable to shareholders 1,206 894 Total income tax expense 965 1,355
Net income before income taxes 4,757 4,862 Less: income tax (expense)/benefit attributable to policyholders 242 (462) Net income before income taxes attributable to shareholders 4,998 4,400 Expected income tax expense attributable to shareholders computed at the Swiss statutory tax rate 22.0% 1,100 22.0% 968 Increase/(reduction) in taxes resulting from: Tax rate differential in foreign jurisdictions 240 57 Tax exempt and lower taxed income (82) (119) Non-deductible expenses 75 63 Tax losses previously unrecognized or no longer recognized 5 33 Prior year adjustments and other (131) (109)
Deferred tax assets 2,076 2,067 Deferred tax liabilities (4,049) (4,554) Net deferred tax liabilities (1,973) (2,487)
The cumulative amount of deferred tax credited to shareholders’ equity, net of foreign currency translation effects, amounted to USD 404 million and USD 28 million for the years ended December 31, 2011 and 2010, respectively.
Reserves for losses and loss adjustment expenses 109 (268) 109 (355) Reserves for unearned premiums 39 (64) 34 (96) Deferred front-end fees 634 – 717 – Pensions and other employee benefits 457 (37) 344 (43)
The Group’s deferred tax assets and liabilities are recorded by its tax paying entities throughout the world, which may include several legal entities within each tax jurisdiction. Legal entities are grouped as a single taxpayer only when permitted by local legislation and when deemed appropriate. The first part of the table above includes single taxpayers with a net deferred tax asset position and the second part includes single taxpayers with a net deferred tax liability position.
As of December 31, 2011 and 2010 the aggregate amount of temporary differences associated with investments in subsidiaries, branches and associates and interests in joint ventures, for which deferred tax liabilities have not been recognized amount to approximately USD 21 billion and UDS 19 billion, respectively. In the remote scenario in which these temporary differences were to reverse simultaneously, the resulting tax liabilities would be very limited due to participation exemption rules.
The tax rates applicable to tax losses for which a deferred tax asset has not been recognized are 20.6 percent and 22.4 percent for the years 2011 and 2010, respectively.
ZFS Finance (USA) Trust II Series II 6.45% USD 700 million Trust Preferred Securities (ECAPS), due December 2065 674 673
ZFS Finance (USA) Trust IV Series IV 5.875% USD 500 million Trust Preferred Securities, due May 2062 250 250
Other Various debt instruments payable in more than 1 year 44 44 Subordinated debt 5,476 5,004 Total senior and subordinated debt 12,017 11,457 1 The bond is economically hedged, but hedge accounting treatment has not been applied. 2 The bond is part of a qualifying cash flow hedge (80 percent of the total) and fair value hedge (20 percent of the total). 3 The bond is part of a qualifying cash flow hedge (100 percent).
5 These bonds are part of qualifying fair value hedges (100 percent). 6 Issued under the Group’s Euro Medium Term Note Programme (EMTN Programme). 7 In 2011 the Group applied the cash flow hedge methodology to hedge the foreign currency exposure and deferred the attributable basis spreads in shareholders’ equity, whereas the fair value hedge methodology was used to hedge the interest rate exposure with changes in the fair value being recorded through the income statement.
None of the debt instruments listed above was in default as of December 31, 2011 and 2010, respectively.
These new issuances were almost fully offset by the repayments of USD 400 million commercial paper notes in July, 2011 by Zurich Capital Markets, the CHF 1 billion senior notes issued by Zurich Insurance Company Ltd, which matured on July 27, 2011 and the CHF 300 million senior notes issued by Zurich Finance (USA), Inc. which matured on November 23, 2011.
Subordinated debt increased to USD 5,476 million as of December 31, 2011, from USD 5,004 million as of December 31, 2010, mainly as a result of a new CHF 500 million issue under the EMTN Programme in March 2011 to refinance the early redemption of hybrid debt that were classified as preferred securities in shareholders’ equity as of December 31, 2010 and the translation effects of the U.S. dollar against the currencies in which the notes were issued.
6.625% GBP 450 million, perpetual notes 6.625% payable annually up to October 2, 2022 and then reset every 5 years to the reset rate of interest plus 2.85%. 1
Series IV 5.875% USD 500 million Fixed / Floating Trust Preferred Securities, due May 2062 5.875% payable semi-annually until May 9, 2012 and then reset quarterly to 3-month LIBOR plus 1.815%.
Interest expense on debt Interest expense on debt increased to USD 586 million as of December 31, 2011, from USD 556 million as of December 31, 2010. The higher interest expense was mainly due to foreign exchange fluctuations and the issuance of new debt under the EMTN Programme offset by the positive impact of early redemptions in December 2010 and the expired 3.875% CHF 1 billion senior notes in July 2011.
In addition, the Group has access to four other revolving credit facilities totaling USD 441 million expiring in 2014. No borrowings were outstanding under these four facilities as of December 31, 2011 or 2010, respectively.
New shares issued from contingent capital in 2011 79,893 798,926 0.10
Authorized, contingent and issued share capital As of December 31, 2010 17,129,526 171,295,259 0.10 a) Issued share capital At the Annual General Meeting on March 30, 2010 the shareholders approved a share capital reduction of CHF 183,640.40 from CHF 14,747,306.80 to CHF 14,563,666.40 by cancelling 1,836,404 registered shares. The effective date of the capital reduction was June 15, 2010. In addition, the shareholders approved an increase in the authorized share capital to a new maximum of CHF 1,000,000, allowing for enhanced financial flexibility for the company in its future capital management and an increase in the contingent share capital to a new maximum of CHF 500,000 which can be issued to employees of Zurich Financial Services Ltd and its subsidiaries in connection with employee participation plans. During the years 2011 and 2010, a total of 798,926 shares and 950,232 shares, respectively, were issued to employees from contingent capital.
The Board of Directors is authorized, when issuing bonds or similar debt instruments connected with conversion and/or option rights, to restrict or withdraw the right of shareholders for advance subscription in cases where such bonds are issued for the financing or re-financing of a takeover of an enterprise, of parts of an enterprise, or of participations. If the right for advance subscription is withdrawn by the Board, the convertible bond or warrant issues are to be offered
Preferred securities bought back by group companies 2 (99,390,000) (99,390) 1,000
On March 30, 2006, April 11, 2006 and April 18, 2008, the Group redeemed Series I, III and IV of the Zurich RegCaPS, respectively. The liquidation amounts totalled USD 550 million in aggregate. In 2010, the Group repurchased but did not retire securities of Series V in the total amount of USD 47 million and of Series VI in the total amount of USD 53 million. The three remaining series of Zurich RegCaPS were redeemed by the Group on March 30, 2011 (USD 150 million of Series II), on April 4, 2011 (USD 200 million of Series V) and on April 25, 2011 (USD 225 million of Series VI) respectively.
Consolidated financial statements e) Additional paid-in capital This reserve is not ordinarily available for distribution. However, as of January 1, 2011 a Swiss tax regulation based on the Swiss Corporate Tax reform II became effective, allowing for payments free of Swiss withholding tax to shareholders out of a so called capital contribution reserve, created out of additional paid-in capital. Therefore, amounts qualifying under this regulation can be paid out of additional paid-in capital.
Treasury shares comprise shares acquired in the market, primarily held to cover employee and share option plans.
Effect of potentially dilutive shares related to share-based compensation plans 1,103,836 (0.19) (0.17) Diluted earnings per share 3,763 146,893,848 25.61 22.62
Effect of potentially dilutive shares related to share-based compensation plans 1,142,920 (0.18) (0.19) Diluted earnings per share 3,416 145,987,835 23.40 24.33 1 Excludes the net income attributable to preferred shareholders of USD 4 million and USD 11 million for the years ended December 31, 2011 and 2010, respectively. 2 The translation from USD to CHF is shown for information purposes only and has been calculated at the Group’s average exchange rates for the years ended December 31, 2011 and 2010, respectively.
The Group operates a number of retirement benefit arrangements for employees, the majority of employees belong to defined benefit plans. Other employees participate in defined contribution plans, which provide benefits equal to amounts contributed by both the employer and the employee plus investment returns.
For the defined benefit pension plans, total contributions to funded pension plans and benefit payments by the Group are currently estimated at USD 479 million for 2012 compared with USD 496 million estimated in the previous year for 2011. The actual amounts may differ.
Present value of funded obligations (17,189) (14,978) (13,966) (12,680) (13,653) (1) – (70) (93) (66) Fair value of plan assets 14,902 13,791 12,622 10,879 13,285 – – – – 5
Pensions are long-term by nature. However, short-term variations between long-term actuarial assumptions and actual experience may be positive or negative, resulting in actuarial gains or losses, which are recognized in full in the period in which they occur, and are included in OCI.
Present value of unfunded obligations (289) (260) (230) (210) (207) (301) (295) (205) (183) (208)
Mortgage loans 465 441 Cash and cash equivalents 193 236 Equity securities 3,233 3,903 Debt securities 10,151 8,410 Real estate 854 795 1 UK annuity policies.
Table 23.5 in USD millions, as of December 31Fair value of assets held in funded defined benefit plans
Effect of curtailments or settlements – (56) – – Foreign currency translation effects (105) 79 – – Fair value of plan assets as of December 31 14,902 13,791 – –
Change in liability due to asset ceiling – 11 – – Actuarial gain/(loss) included in other comprehensive income (1,333) (210) (4) (4) Foreign currency translation effects 58 (1) (5) (7)
Total actuarial gain/(loss) as of December 31 (4,200) (2,914) (2,672) (2,907) (1,308) Total actuarial gain/(loss) net of policyholder participation and taxes as of December 31 (2,857) (1,924) (1,762) (1,934) (818)
The principal financial assumptions used to calculate the Group’s major defined benefit pension and defined postemployment benefit obligations and the Group’s pension expenses are as follows: Switzerland
Table 23.10 as of December 31Assumptions used in determining the actuarial liabilities for major defined benefit pension plans
Discount rate 5.0% 5.0% Expected increase in long-term health cost – initial rate 7.7% 7.8% Expected increase in long-term health cost – ultimate rate 4.8% 4.8%
Total option-based expenses 35 55 Total share-based expenses 141 128 Total expenses 176 183
Share Incentive Plans for employees in Switzerland 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 equivalent to CHF 3,500 per employee per annum. During 2011, 5,448 employees participated in the Employee Incentive Plan compared with 5,488 in 2010. For the years ended December 31, 2011 and 2010, 1,084 and 1,372 employees, respectively, received shares under the 2010 and 2009 employee performance share plan.
The Group long-term incentive Plan Participants in this Plan are granted a target number of performance shares in shares of Zurich Financial Services Ltd in April each year, such that the economic value is a defined percentage of the annual salary of each participant in the year of grant. Performance shares vest on an annual basis over the subsequent three year period, with the actual level of vesting being between 0 percent and 175 percent of the original shares granted, with an additional discretion to increase vesting to a maximum of 200 percent, depending on the performance of the Group over the previous three calendar years. Performance metrics used to determine the level of vesting are the Group’s return on equity 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 three years. As of December 31, 2011 and December 31, 2010 there were 1,152 and 947 participants in the Plan, respectively.
Prior to 2011, for selected senior executives, the target granted was allocated between performance shares and share options in shares of Zurich Financial Services Ltd. Vesting of the share options is based on the same criteria as those for performance shares over the subsequent three year period, with the same potential multiple of the share options granted dependent on the achievement of the same performance metrics. Share options, once vested, may be exercised by the participant over the the period up to seven years from the date of grant. In 2010, 168 senior executives received a target grant of performance shares and share options.
Commitments under investment agreements The Group has committed to contribute capital to subsidiaries and third parties that engage in making investments in direct private equity and private equity funds. Commitments may be called by the counterparty over the term of the investment (generally three to five years) and must be funded by the Group on a timely basis.
The Group carries certain disposal-related contingencies as it sometimes provides the acquirer of a business with certain indemnification provisions, which can vary by counterparty in scope and duration. The terms of these indemnification provisions cover ordinary contractual guarantees related to disposals and shift the potential risk of certain unquantifiable and unknown loss contingencies from the acquirer to the seller.
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 141 million and USD 187 million for the years ended December 31, 2011 and 2010, respectively.
Indemnity agreements The Group, through certain of its subsidiaries, has agreed to arrangements that cap Converium’s (now Scor Holding (Switzerland) AG) and its successor companies’ net exposure for losses arising out of the September 11, 2001 World Trade Center event in New York. As of December 31, 2011 the Group has recorded provisions of USD 44 million, for losses in excess of USD 289 million.
An action entitled Fuller-Austin Asbestos Settlement Trust, et al. v. Zurich American Insurance Company (ZAIC), et al., was filed in May 2004 in the Superior Court for San Francisco County, California. Three other similar actions were filed in 2004 and 2005 and have been coordinated with the Fuller-Austin action (collectively, the Fuller-Austin Case). In addition to ZAIC and four of its insurance company subsidiaries, Zurich Insurance Company Ltd (ZIC) and Orange Stone Reinsurance
Table 25.2 in USD millions, as of December 31Future payments under non-cancelable operating leases with terms in excess of one year
Dublin (Orange Stone) are named as defendants. The plaintiffs, who are historical policyholders of the Home Insurance Company (Home), plead claims for fraudulent transfer, alter ego liability and unfair business practices relating to the recapitalization of Home, which occurred in 1995 following regulatory review and approval. The plaintiffs allege that pursuant to the recapitalization and subsequent transactions, various Zurich entities took assets of Home without giving adequate consideration in return, and contend that this forced Home into liquidation. The plaintiffs further allege that the defendants should be held responsible for Home’s alleged obligations under their Home policies. The trial judge designated the plaintiffs’ claims for constructive fraudulent transfer for adjudication before all other claims; he subsequently ordered an initial bench trial on certain threshold elements of those fraudulent transfer claims and on certain of defendants’ affirmative defenses. The trial commenced on November 1, 2010, and trial testimony has now concluded. Closing arguments are scheduled for February 2012.
A similar action entitled API, Inc. Asbestos Settlement Trust (API), et al. v. ZAIC, et al., was filed in March 2009 in the District Court for the Second Judicial District, County of Ramsey, Minnesota (API Case). ZAIC and two of its insurance company subsidiaries were named as defendants. The defendants removed the case to the U.S. District Court for the District of Minnesota, where it is now pending. The plaintiffs subsequently amended their complaint to add ZIC, Orange Stone and two additional ZAIC subsidiaries as defendants. As in the Fuller-Austin Case, the plaintiffs allege that API is an insured under policies issued by Home, primarily in the 1970s. The complaint seeks to hold the defendants liable for Home’s policy obligations under various theories of vicarious liability tied to the recapitalization of Home, and it also alleges that the defendants are liable for damages under theories of fraudulent transfer and tortious interference with contract. The court ruled on the defendants’ motions to dismiss the amended complaint, and dismissed the plaintiffs’ fraudulent transfer, tortious interference with contract and consumer fraud claims against all the defendants. The motions were denied as to the remaining claims, as the court found that the plaintiffs’ vicarious liability theories could not be disposed of on a motion to dismiss. Pretrial discovery has substantially concluded. Summary judgment motions were filed by both plaintiffs and defendants on July 1, 2011 and oral argument on the motions was heard on November 22, 2011. A decision is pending. If the case is not decided on summary judgment, a trial will follow. The Group maintains that the Fuller-Austin and API Cases are without merit and intends to continue to defend itself vigorously.
ZFS is a defendant in a putative class action pending in California state court captioned Benjamin Fogel v. Farmers Group, Inc (Fogel Case). The case, originally filed in August 2003, is brought on behalf of a putative class of all policyholders of the Farmers Exchanges from 1999 to the present. The plaintiff alleges that Farmers Group, Inc. and certain of its affiliates (Farmers), which acted as the attorneys-in-fact for policyholders of the Farmers Exchanges, collected excessive and unreasonable management fees. The complaint seeks, amongst other things, disgorgement, as well as damages and injunctive relief. In February 2005, the trial court granted Farmers’ motion for summary judgment, and the plaintiff appealed. In 2008, a California appellate court reversed the trial court’s ruling and reinstated the litigation. On September 9, 2009, the plaintiff filed a motion seeking to certify a nationwide class of all policyholders of the Farmers Exchanges since August 1, 1999. On October 7, 2010, the Group announced that it had agreed in principle to a proposed nationwide settlement of the Fogel Case. Under the terms of the proposed settlement, a sum of USD 455 million will be made available to approximately 12.5 million policyholders who may qualify for a distribution under the settlement, with any residual amount going to the Farmers Exchanges. The Group will also pay attorneys’ fees to class action counsel of up to USD 90 million, as well as the costs of administering the settlement. On December 12, 2010, the parties executed the settlement agreement, all terms of which are subject to the court’s final approval. On January 12, 2011, the parties filed a motion seeking preliminary approval of the proposed settlement. On February 3, 2011, the court granted a motion to intervene by a class member who objects to certain aspects of the proposed settlement. The hearing on the motion for preliminary approval was held on March 2, 2011, and the court granted the motion. Notices were mailed and published to class members, and a number of objections and opt-out requests were submitted. On October 31, 2011, the court granted a motion by the State of Montana to intervene so it could object to certain aspects of the proposed settlement. On December 21, 2011, the court granted final approval of the settlement,
Consolidated financial statements continued and it reduced the total award of attorneys’ fees, expenses, and incentive awards to approximately USD 74 million (instead of USD 90 million). A 60-day appeal period commenced following entry of the court’s judgment on December 21, 2011. Notices of appeal have been filed by intervenor State of Montana and one class member.
Total available-for-sale securities 137,279 138,055 137,279 138,055 Securities at FV through profit or loss Trading
Held-to-maturity debt securities 6,182 5,582 5,535 5,129 Investments in associates and joint ventures 161 186 161 188 Loans and receivables
Deposits made under assumed reinsurance contracts 2,703 2,817 2,711 2,837 Mortgage loans given as collateral 223 739 223 743
Cash and cash equivalents 1,280 1,544 1,280 1,544 Investments at FV through profit or loss Designated at FV
Level 1 – this category includes financial assets for which fair values are determined based on quoted prices (unadjusted) in active markets for identical instruments. A market is considered active only if transactions take place with sufficient frequency and volume to provide pricing information on an ongoing basis. The Group has classified under Level 1 the majority of common stocks, government bonds and certain corporate bonds and investments in unit trusts that are traded in very liquid markets.
Level 2 – this category includes financial assets and liabilities for which fair values are determined using valuation techniques with all significant inputs based on observable market data. Depending on the nature of the instruments and the market in which they are traded, examples of observable market data may include quoted prices, broker quotes, interest rates, yield curves etc. The Group has classified under Level 2 the majority of corporate bonds, investments in unit trusts, agency-backed and senior tranches of asset-backed securities, and OTC derivatives. While markets for these instruments do not meet the strict requirements to be classified as active, they offer sufficient transaction volumes and, therefore, observable market data to enable the Group to determine their fair value. The Group has also classified under Level 2 liabilities related to unit-linked investment contracts and obligations to repurchase securities.
Total available-for-sale securities 43,383 90,657 3,239 137,279 Securities at FV through profit or loss Trading
Table 26.2b in USD millions, as of December 31, 2010Fair Value Hierarchy – prior period
Transfers out of Level 3 (104) – – (12) – – –
Table 26.3a in USD millionsRoll forward analysis for financial instruments classified under Level 3 – current period
Table 26.3b in USD millionsRoll forward analysis for financial instruments classified under Level 3 – prior period
The sensitivity analysis is intended to reflect the uncertainty inherent in the valuation of these investments, under the current market conditions, and its results cannot be extrapolated due to non-linear effects that changes in valuation assumptions may have on the fair value of these investments. Furthermore, the analysis does not indicate a probability of such changes occurring and it does not necessarily represent the Group’s view of expected future changes in the fair value of these investments. Any management actions that may be taken to mitigate the inherent risks are not reflected in this analysis.
Total investments at FV through profit or loss 44,981 49,712 4,733 99,426
Total investments at FV through profit or loss 52,065 45,464 4,793 102,322
Table 26.5a in USD millions, as of December 31, 2011Fair Value Hierarchy – current period
Table 26.5b in USD millions, as of December 31, 2010Fair Value Hierarchy – prior period
1 Presented as net investment result on unit-linked investments in the Consolidated income statements.
Table 27.2 summarizes related party transactions with key personnel reflected in the Consolidated financial statements. Key personnel includes Members of the Board of Directors of Zurich Financial Services Ltd and Zurich Insurance Company Ltd and Members of the Group Executive Committee.
Farmers Group, Inc. and its subsidiaries (FGI) provide certain non-claims related management services to the Farmers Exchanges, which are managed but not owned by Farmers Group, Inc. a wholly owned subsidiary of the Group. In addition, the Group has the following relationships with the Farmers Exchanges.
6.15% surplus note, due June 2021 1 707 – 6.15% surplus note, due June 2021 1 140 – 6.15% surplus note, due June 2021 1 60 – 6.15% surplus note, due December 2013 1 – 88 6.15% certificates of contribution, due December 2013 1 – 523 6.15% certificates of contribution, due August 2014 1 – 296 4.65% certificates of contribution, due December 2013 150 150 Various other certificates of contribution 23 23 1 On June 30, 2011 three surplus notes totaling USD 907 million were cancelled and subsequently reissued by the Farmers Exchanges under the same terms and conditions, but maturing June 2021, and in different amounts, although total amount remains unchanged.
Auto Physical Damage Quota Share reinsurance agreement The Auto Physical Damage (APD) Quota Share reinsurance agreement (APD agreement) with the Farmers Exchanges provides for annual ceded premiums of USD 1 billion with 20.0 percent assumed by Farmers Re Co (USD 200 million) and 80.0 percent assumed by ZIC (USD 800 million), a 25.8 percent ceding commission for acquisition expenses, and an 8.2 percent ceding commission for unallocated loss adjustment expenses. In addition, Farmers Re Co and ZIC assume a quota share percentage of ultimate net losses sustained by the Farmers Exchanges in their APD lines of business. The APD agreement also includes provisions for additional experience commissions that will depend on loss experience and recoveries below a specified ratio for each year. This experience commission arrangement limits Farmers Re Co and ZIC’s potential underwriting gain on the assumed business to 2.0 percent of premiums assumed plus 20.0 percent of the underwriting gain resulting from a combined ratio under 98.0 percent. The APD agreement terminated as of December 31, 2011 and was renewed thereafter.
Farmers Exchanges’ share of ceded premiums amounted to USD 1 billion for both the years ended December 31, 2011 and 2010. Ceded incurred losses and loss adjustment expenses totaled USD 709 million and USD 648 million for the years ended December 31, 2011 and 2010, respectively. Farmers Exchanges’ share of the total experience commission income was USD 268 million and USD 315 million for the years ended December 31, 2011 and 2010, respectively.
All Lines Quota Share reinsurance agreement Certain of the Farmers Exchanges participate in an All Lines Quota Share reinsurance agreement (All Lines agreement) with Farmers Re Co and ZIC which has been amended over the years, with the participation ratio at 35 percent as
Consolidated financial statements continued of December 31, 2009. The All Lines agreement provided for a cession of a quota share of the premiums written and the ultimate net losses sustained in all lines of business written by the Farmers Exchanges after the APD agreement has been applied. Effective June 30, 2010, the All Lines agreement was cancelled subsequent to which Farmers Re Co and ZIC entered into a new 25.0 percent All Lines agreement under which each assumes a percentage of all lines of business written by the Farmers Exchanges, prospectively. Under this new All Lines agreement, Farmers Re Co and ZIC assumed a 5.0 percent and 20.0 percent respective quota share of the premiums written and the ultimate net losses sustained in all lines of business written by the Farmers Exchanges after the APD agreement has been applied. In addition, under the All Lines agreement, the Farmers Exchanges catastrophe losses are subject to a maximum of USD 1 billion. As a result, Farmers Re Co and ZIC are subject to a maximum annual catastrophe loss of USD 50 million and USD 200 million, respectively. The All Lines agreement, which can be terminated after 90 days notice by any of the parties, also provides for the Farmers Exchanges to receive a provisional ceding commission of 25.7 percent of premiums for acquisition expenses, 9.0 percent of premiums for unallocated loss adjustment expenses and 5.3 percent of premiums for other expenses. Unearned premiums totaling USD 614 million were transferred from Farmers Re Co and ZIC to the Farmers Exchanges as a result of their decreased participation in the All Lines agreement through June 30, 2010. In addition, the Farmers Exchanges remitted USD 158 million of reinsurance commissions to Farmers Re Co and ZIC for acquisition expenses due to the decreased participation in the All Lines agreement.
Global Life pursues a strategy of providing market-leading unit-linked, protection and corporate propositions through global distribution and proposition pillars to develop leadership positions in its chosen segments.
Farmers provides through Farmers Group, Inc. and its subsidiaries (FGI) non-claims related management services to the Farmers Exchanges. FGI receives fee income for the provision of services to the Farmers Exchanges, which are managed but not owned by Farmers Group, Inc. a wholly owned subsidiary of the Group. This segment also includes the Farmers Re business, which includes only reinsurance assumed from the Farmers Exchanges by the Group. Farmers Exchanges are prominent writers of personal lines and small commercial lines business in the U.S.
Other Operating Businesses predominantly consist of the Group´s Headquarter and Holding and Financing activities. Certain alternative investment positions not allocated to business operating segments are included within Holding and Financing.
Non-Core Businesses include insurance businesses that the Group does not consider core to its operations and that are therefore mostly managed to achieve a beneficial run-off. In addition, Non-Core Businesses includes the Group’s banking activities. Non-core businesses are mainly situated in the U.S., Bermuda, the United Kingdom and Ireland.
The Global Life segment is managed on a regional-based structure within a global framework, including: • North America
The segment information includes the Group’s internal performance measure, business operating profit (BOP). This measure is the basis on which business units are managed. It indicates the underlying performance of the business units by eliminating the impact of financial market volatility and other non-operational variables. BOP reflects adjustments for shareholders’ taxes, net capital gains on investments and impairments (except for the capital markets and banking operations included in Non-Core Businesses and investments in hedge funds and certain securities held for specific economic hedging purposes), policyholders’ share of investment results for the life businesses, non-operational foreign exchange movements, and significant items arising from special circumstances, including restructuring charges, charges for litigation outside the ordinary course of business and gains and losses on divestments of businesses.
Gross written premiums and policy fees 34,572 33,066 11,583 12,292 3,529 4,194 141 137 594 531 (220) (256) 50,200 49,965 Less premiums ceded to reinsurers (5,325) (5,100) (682) (754) – – (59) (54) (704) (32) 220 256 (6,550) (5,683)
Net written premiums and policy fees 29,247 27,966 10,901 11,539 3,529 4,194 82 84 (110) 499 – – 43,650 44,282 Net change in reserves for unearned premiums (171) (122) (36) (26) (545) 1,380 1 – 2 2 – (1) (751) 1,234
Business operating profit before non-controlling interests 2,264 2,689 1,380 1,516 1,486 1,686 (835) (802) (7) (157) – – 4,288 4,934
Supplementary information Additions and capital improvements to property, equipment and intangible assets 402 299 296 96 171 236 124 91 – 24 – – 994 747 1 The Global Life segment includes approximately USD 891 million and USD 1,514 million of gross written premiums and future life policyholders‘ benefits for certain universal life-type contracts in the Group’s Spanish operations for the years ended December 31, 2011 and 2010, respectively (see note 3).
Net earned premiums and policy fees 29,076 27,844 10,865 11,513 2,984 5,574 83 84 (108) 502 – (1) 42,899 45,516 Farmers management fees and other related revenues – – – – 2,767 2,778 – – – – – – 2,767 2,778 Net investment result on Group investments 2,807 2,913 4,575 4,390 133 156 524 525 987 377 (847) (857) 8,180 7,506
Net investment income on Group investments 2,799 2,867 4,146 3,892 133 156 524 525 429 509 (847) (857) 7,185 7,092 Net capital gains/(losses) and impairments on Group investments 8 46 429 498 – – – – 558 (131) – – 995 413
Net investment result on unit-linked investments – – (3,548) 9,639 – – – – 4 454 – – (3,544) 10,093 of which: inter-segment revenues (576) (414) (343) (296) (67) (70) (1,336) (1,191) (59) (113) 2,381 2,083 – – Benefits, losses and expenses Insurance benefits and losses, net 1 20,914 19,795 9,503 10,140 2,105 3,708 58 72 475 769 – – 33,054 34,484
Net income after taxes 3,792 3,507 1 Includes USD 570 million settlement costs related to the FOGEL case (see note 25). 2 Includes USD 100 million charitable commitment to the Zurich Foundation. 3 The impact on Group level relates to foreign currency translation differences. 4 Includes USD 85 million and USD 114 million as of December 31, 2011 and 2010, respectively, of software impairments related to a restructuring program impacting several
Revenues/(expenses) not included in BOP: Net capital gains/(losses) on investments and impairments, net of policyholder allocation 526 281 407 14 (12) (9) 230 168 37 31 1,187 484 Net gain/(loss) on divestments of businesses (5) 5 16 33 – – (5) – – 1 6 38
Net income before income taxes 2,547 2,668 1,431 1,845 1,464 1,074 (716) (622) 31 (104) 4,757 4,862 Income tax expense (attributable to policyholders and shareholders) (965) (1,355)
Investments in associates and joint ventures 6 6 65 97 – – 6 5 84 80 – – 161 188
Equity Common shareholders’ equity 31,636 31,429 Preferred securities – 475 Shareholders’ equity 31,636 31,905 Non-controlling interests 2,380 1,336 Total equity 34,017 33,241 Total liabilities and equity 385,869 375,623 1 The General Insurance and Global Life segments include assets held for sale amounting to USD 38 million and USD 17 million, respectively. See note 5. 2 The General Insurance and Global Life segments include liabilities held for sale amounting to USD 41 million and USD 14 million, respectively. See note 5.
Total assets (after cons. of investments in subsidiaries) 117,770 119,654 236,372 223,476 10,023 10,581 21,525 23,097 30,906 32,575 (30,727) (33,759) 385,869 375,623 Liabilities Liabilities for investment contracts – – 50,661 50,912 – – – – – – – (246) 50,661 50,667 Reserves for insurance contracts, gross 80,462 80,242 136,248 138,536 2,728 2,711 39 57 21,972 22,194 (637) (1,021) 240,811 242,719
Gross written premiums and policy fees 7,949 7,624 9,777 9,728 12,932 12,427 4,425 3,854 401 574 (912) (1,142) 34,572 33,066 Net earned premiums and policy fees 5,350 4,902 7,644 7,580 12,647 12,393 3,377 2,902 58 68 – – 29,076 27,844 Insurance benefits and losses, net 4,564 3,662 5,126 5,102 8,955 8,958 2,462 1,954 (192) 120 – – 20,914 19,795 Policyholder dividends and participation in profits, net – (2) 8 8 – (3) – – – – – – 9 3
Net capital gains/(losses) and impairments on investments 2 11 8 35 (1) 1 – – – – – – 8 46 Net non-technical result (excl. items not included in BOP) (132) (41) (255) (230) (351) (438) (118) (39) (44) (41) 15 (6) (885) (796) Business operating profit before non-controlling interests 169 742 1,048 1,118 954 768 (147) 110 240 (49) – – 2,264 2,689
Africa South Africa 539 634 Morocco 130 109 Subtotal Africa 669 743 – – Latin America Argentina 278 224 Brazil 571 412 Chile 270 220 Mexico 291 258 Venezuela 244 225 Rest of Latin America 34 34 Subtotal Latin America 1,687 1,374 – – North America United States 11,494 11,281 Rest of North America 930 920 Subtotal North America 12,424 12,201 2,838 2,671 Asia-Pacific Australia 1,114 943 Hong Kong 182 154 Japan 736 606 Taiwan 126 119 Rest of Asia-Pacific 288 205 Subtotal Asia-Pacific 2,446 2,027 590 481 Europe United Kingdom 3,878 4,069 Germany 3,387 3,106 Switzerland 3,408 2,961 Italy 2,122 2,175 Spain 1,671 1,709 Rest of Europe 2,750 2,605 Subtotal Europe 17,215 16,624 4,150 4,088
Rest of Asia-Pacific 4 2 Subtotal Asia-Pacific 140 141 Europe United Kingdom 199 212
Table 29.6 in USD millions, as of December 31General Insurance – Non-current assets by region
Gross written premiums and policy fees 793 772 674 670 9,355 10,197 686 614 106 92 (30) (53) 11,583 12,292 Net earned premiums and policy fees 579 558 645 597 8,961 9,777 580 516 100 71 – (6) 10,865 11,513
Net investment result on unit-linked investments (47) 19 (16) 68 (2,572) 8,454 (840) 1,043 (74) 55 – – (3,548) 9,639
Benefits, losses and expenses Insurance benefits and losses, net 1 339 318 447 442 8,455 9,190 216 149 47 41 – – 9,503 10,140 Policyholder dividends and participation in profits, net (24) 24 (13) 66 (1,920) 9,103 (801) 1,057 (69) 58 – (6) (2,826) 10,302 Income tax expense/(benefit) attributable to policyholders – – – – (255) 460 14 1 – – – – (242) 462 Underwriting and policy acquisition costs, net 123 111 132 96 1,507 1,023 156 191 111 81 1 – 2,029 1,503 Administrative and other operating expense (excl. depreciation / amortization) 129 129 142 114 1,562 1,164 340 283 225 196 (5) (4) 2,394 1,883 Interest credited to policyholders and other interest 137 168 5 5 224 224 28 30 – – – – 395 428 Restructuring provisions and other items not included in BOP 1 (1) 3 – (127) (177) (7) (1) – – – – (130) (179) Total BOP benefits, losses and expenses 704 750 717 724 9,446 20,988 (53) 1,710 314 377 (4) (10) 11,123 24,539 Business operating profit (before interest, depreciation and amortization) 256 269 61 84 1,327 1,482 131 87 6 – – – 1,781 1,922 Depreciation and impairments of property and equipment 1 1 2 1 23 25 4 4 – 1 – – 30 32 Amortization and impairments of intangible assets 26 25 2 2 279 267 3 4 4 5 – – 315 303
Business operating profit before non-controlling interests 227 241 49 81 981 1,121 123 79 – (6) – – 1,380 1,516 1 Europe includes approximately USD 891 million and USD 1,514 million of gross written premiums and future life policyholders‘ benefits for certain universal life-type contracts in the Group’s Spanish operations for the years ended December 31, 2011 and 2010, respectively (see note 3).
Gross written premiums and policy fees from external customers Life insurance deposits
1 Mainly includes business written through licenses into Asia-Pacific and Middle East.
North America United States 174 193 Subtotal North America 174 193 Latin America Chile 21 20
Subtotal Europe 3,378 3,629 Asia-Pacific and Middle East Hong Kong 7 3 Indonesia 3 – Australia – 1
Farmers Management Services Management fees and other related revenues 2,767 2,778 Management and other related expenses 1,434 1,440 Gross management result 1,333 1,338 Other net income (excl. items not included in BOP) 36 27 Business operating profit before non-controlling interest 1,370 1,365 Business operating profit 1,370 1,365 Farmers Re Gross written premiums and policy fees 3,529 4,194 Net earned premiums and policy fees 2,984 5,574 Insurance benefits and losses, net (2,105) (3,708) Total net technical expenses (903) (1,733) Net underwriting result (23) 134 Net non-technical result (excl. items not relevant for BOP) 58 84 Net investment result income 82 104 Business operating profit before non-controlling interests 116 321 Business operating profit 116 321 Farmers business operating profit 1,486 1,686
Gross written premiums and policy fees 133 129 8 8 – – 141 137 Net earned premiums and policy fees 74 76 8 8 – – 83 84
Business operating profit before non-controlling interests (589) (663) (246) (138) – – (835) (802) Non-controlling interests – (1) – – – – – (1)
Zürich Versicherungs-Aktiengesellschaft Vienna General Insurance / Global Life 99.98 99.98 EUR 12.0
Bermuda Centre Group Holdings Limited Hamilton Non-Core Businesses 100 100 USD 0.3 CMSH Limited Hamilton Non-Core Businesses 100 100 USD 0.3 ZCM Holdings (Bermuda) Limited Hamilton Non-Core Businesses 100 100 USD 137.0
Zurich International (Bermuda) Ltd. Hamilton Non-Core Businesses 100 100 USD 9.9 Brazil Zurich Minas Brasil Seguros S.A. Belo Horizonte General Insurance 100 100 BRL 370.8 Chile Chilena Consolidada Seguros de Vida S.A. Santiago Global Life 98.98 98.98 CLP 24,484.0 Cyprus Zurich Insurance Holding (Cyprus) Ltd. 2 Nicosia General Insurance 100 100 RUB 3.4 Germany Deutscher Herold Aktiengesellschaft 3 Bonn Global Life 79.83 79.83 EUR 18.4 Zürich Beteiligungs-Aktiengesellschaft (Deutschland) Frankfurt / Main General Insurance 100 100 EUR 152.9 Zurich Deutscher Herold Lebensversicherung Aktiengesellschaft Bonn Global Life 100 100 EUR 68.5 Ireland Zurich Life Assurance plc Dublin Global Life 100 100 EUR 17.5 Zurich Financial Services EUB Holdings Limited Dublin Non-Core Businesses 100 100 GBP 0.001
Zurich Global Funding Limited Dublin Other Operating Businesses 100 100 EUR 0.001
Zurich Holding Ireland Limited Dublin Other Operating Businesses 100 100 EUR 0.1
Zurich Insurance plc Dublin General Insurance 100 100 EUR 8.2 Italy Zurich Investments Life S.p.A. Milan Global Life 100 100 EUR 74.0 Zurich Life and Pensions S.p.A. Milan Global Life 100 100 EUR 40.5 Zurich Life Insurance Italia S.p.A. Milan Global Life 100 100 EUR 85.9 1 The segments are defined in the notes to the Consolidated financial statements, note 29, Segment information. 2 Zurich Insurance Holding (Cyprus) Limited holds indirectly 99.9% of Zurich Insurance Company Limited in Russia which is a wholly owned subsidiary of the Group. 3 In addition buy out options exist which allow the minority shareholders to sell 15.17 percent of the shares of Deutscher Herold Aktiengesellschaft to the Group.
Zurich Finance (Luxembourg) S.A. Luxembourg Other Operating Businesses 100 100 EUR 0.1
6 The results of the operating activities are included in the General Insurance segment, whereas the headquarter’s activities are included in Other Operating Businesses. 7 The results of the operating activities are included in the Global Life segment, whereas the headquarter’s activities are included in Other Operating Businesses.
Farmers New World Life Insurance Company Mercer Island, WA Global Life 100 100 USD 6.6
Zurich Holding Company of America, Inc. Wilmington, DE Other Operating Businesses 100 100 USD 20.2 8 These entities are LLCs and have no share capital.
Consolidated financial statements continued 31. Events after the balance sheet date
We recommend that the consolidated financial statements submitted to you be approved.
Zurich produces and reports Market Consistent Embedded Value to provide an economic view of the value of the life business to shareholders to support financial management and strategic decision making. This report provides an overview of the movement in the Market Consistent Embedded Value over the previous year and New Business Value added from new sales during the same period, including further splits into constituent parts and geographical regions.
Key results in USD millions, for the twelve months ended December 31
1 A refinement in methodology for calculating new business value for corporate protection business was introduced in 2011, see embedded value methodology section. 2 In 2011, new business value and embedded value as of December 31 have been determined including a liquidity premium in the discount rate and, for greater consistency with other European Insurers, a cost of capital applied to residual non-hedgeable risks of 4 percent. The 2010 comparatives have been restated to reflect these changes. 3 Figures have been determined without a liquidity premium in the discount rate and a cost of capital applied to residual non-hedgeable risks of 2.5 percent.
From the beginning of 2011 the Group refined its assumptions for greater consistency towards industry standards in respect of liquidity premium and the cost of capital rate applied to non-hedgeable risks. For further alignment to industry standards the liquidity premium was also applied to the time value of financial options and guarantees as at December 31, 2011. See embedded value methodology section for further details.
All 2010 figures in this section have been restated to include a liquidity premium in the discount rate and a cost of capital applied to residual non-hedgeable risks of 4 percent to be consistent with the 2011 figures, unless otherwise stated.
Embedded value development 2011 in USD millions, for the twelve months ended December 31
Dividends & capital movements start of period (143) (357) (500) (25) (525) New business value Global Life (110) 1 (654) (764) 1,743 980
Dividends & capital movements start of period (18) (284) (303) (124) (427) New business value Global Life (86) (743) (829) 1,646 817
Value of business in force Total of which: Asia-Pacific and Middle East 695 259 121.4% 953 1,685 (76) (19) (79) 1,512 2,465 1 SM is the local minimum solvency margin. 2 CE is the certainty equivalent value of business in force. 3 FC is the frictional cost.
4 TVFOG is the time value of financial options and guarantees including the application of a liquidity premium. 5 CRNHR is the cost of residual non-hedgeable risk (see section 12 for further details).
4 TVFOG is the time value of financial options and guarantees without the application of a liquidity premium. 5 CRNHR is the cost of residual non-hedgeable risk (see section 12 for further details).
Closing embedded value of which: Asia-Pacific and Middle East 2,548 (25) (31) (56) (40) 12 2,465
Present value of new business premiums (PVNBP) 2 7,249 8,382 7,011 10,756 33,399 6,942 7,677 6,256 10,523 31,399
New business margin (% of APE) 27.1% 26.8% 24.9% 20.5% 24.5% 22.7% 24.5% 23.6% 22.7% 23.3% New business margin (% of PVNBP) 3.2% 3.4% 3.1% 2.3% 2.9% 2.7% 2.8% 2.9% 2.6% 2.7%
1 In 2011, new business value and embedded value as of December 31 have been determined including a liquidity premium in the discount rate and, for greater consistency with other European Insurers, a cost of capital applied to residual non-hedgeable risks of 4 percent. The 2010 comparatives have been restated to reflect these changes.
2 The term over which group protection business is valued now includes the term over which the business is expected to be retained, see section 12 for further details.
New business value in North America declined despite increasing volumes as a result of changes in mortality and persistency assumptions. For protection business this was somewhat offset by lower interest rates.
Latin America recorded strong growth in new business value mainly supported by increased sales of profitable individual protection and unit-linked business, partially offset by non-renewal of a large government managed scheme in Chile.
In Ireland, the domestic business suffered from the challenging domestic market and the Group’s unwillingness to compete with uneconomic pricing of domestic savings products. Furthermore cross-border sales reduced in both margin and value. New business value reduced by 26 percent on a local currency basis compared with 2010.
In 2011 the Group acquired businesses in Malaysia and Latin America. The impact of these transactions is not included in the Global Life embedded value results as MCEV reporting, as of December 31, 2011, has not been fully implemented in the local business units.
The business acquired in Malaysia is included in the Group consolidated IFRS accounts as of December 31, 2011 and therefore the value of this business has been included in the non-covered business which is consolidated in the Group MCEV, see section 11 Group MCEV. The value included there is the unadjusted IFRS net asset value.
In Latin America the Group acquired a 51 percent stake in the insurance operations of Banco Santander S.A. (Santander) in Argentina, Brazil, Uruguay, Chile and Mexico. As part of the acquisition the Group also entered into a long term distribution agreement with Santander in Latin America. The value of this acquired business has also been included in the non-covered business in the Group MCEV. The value included there is the unadjusted IFRS net asset value.
Embedded value report 4. Expected contribution and transfer to shareholder net assets a) Expected contribution at reference rate The expected contribution at reference rate is the projected change in the embedded value over the year using risk-free investment returns applicable at the start of the year. Expected contribution in relation to risk-free rates was lower in 2011 compared with 2010 due to the lower interest rate environment applying at the start of the year.
b) Expected contribution in excess of reference rate The expected contribution in excess of reference rate is the additional value expected to be created if “real world” expected investment returns emerge. The expected return in excess of the risk-free rate on sovereign debt in some European countries has increased compared with 2010.
Operating variances and assumption changes Operating variances measure the difference between actual experience during the year and that implied by the operating assumptions. Experience variations occur in the normal course of business as short-term experience fluctuates around the long-term assumptions. Operating variances also include the impact of changes in assumptions about future operating experience.
Other operating experience variances were minor and other assumption changes reduced the embedded value by USD 14 million.
Embedded value Split of operating experience variance in USD millions, for the twelve months ended December 31, 2011
Embedded value Split of operating assumption changes in USD millions, for the twelve months ended December 31, 2011
Refinements to models were made in a number of countries resulting in an increase of USD 124 million in embedded value. In the UK the expense model was updated and a protection model was improved, increasing overall embedded value by USD 140 million. In North America a model improvement related to the Universal Life product reduced embedded value by USD 76 million. In Switzerland, an expense review reduced embedded value by USD 60 million. Germany implemented market dependent interest rates for annuitizations in the model, which increased embedded value by USD 105 million.
Outside Europe falling equity markets reduced unit-linked fund values which resulted in a lower embedded value in Asia-Pacific and Middle East of USD 114 million. This impact was mainly offset by reduced interest rates on protection business, which increases value as future profits are discounted at lower rates. For this reason protection business in Australia and North America was positively affected by economic variance. These two effects mainly offset and the net impact of economic variances outside Europe reduced embedded value by an immaterial amount.
Other non-operating variances Other non-operating variances included the impact of legal, tax and regulatory changes in the year as well as other significant one-off items.
Total other non-operating variances made a positive contribution of USD 160 million. The main positive effect was in the UK where changes to corporate tax rates were announced increasing embedded value.
Embedded value report 6. Adjustments a) Non-controlling interests The adjustment to embedded value to remove non-controlling interests from new business value is included here, and largely arose from the interests of non-controlling shareholders in the Spanish and German operations.
Dividend and capital movements that occurred in the first and second halves of the year are shown as “start of period” and “end of period” movements respectively.
Changes in value for Global Life arising from dividend and capital movements are offset by equal and opposite value changes in the non-covered businesses of the Group and therefore have no impact on Group MCEV as shown in section 11.
c) Foreign currency translation effects Foreign currency translation effects represent the impact of adjusting values to end-of-period exchange rates. The strengthening of the U.S. dollar against other currencies reduced the U.S. dollar embedded value by USD 194 million.
The value in-force (VIF) maturity profile shows when the value in force profits are expected to emerge as free surplus, but do not include the release of required capital to free surplus which usually accompanies the emergence of the VIF profit. The VIF emergence is after frictional costs, cost of residual non-hedgeable risk and the time value of financial options and guarantees.
The VIF maturity profile shows that 32 percent of the VIF should emerge as free surplus in the first 5 years and 57 percent within the first 10 years.
in USD millions, for the year ended December 31, 2011VIF maturity profile
Valuation differences 5 (1.9) Embedded value shareholders’ net assets 6 6.4 Value of business in force 7 9.5 Embedded value 15.8 1 Global Life balance sheet value not including businesses in Malaysia and Latin America described in section 3. 2 Includes Spanish and other non-controlling interests. 3 Since pension scheme liabilities are included in IFRS equity but not EV shareholders’ net assets. 4 Actuarial intangibles (after allowance for tax and policyholder sharing), goodwill and other intangibles. 5 Unrealized gains / losses on investments, statutory vs IFRS reserving requirements. 6 EV shareholders’ net assets net of non-controlling interests. 7 EV value of business in force.
Actual embedded value 15,846 980 Operating sensitivities 10% increase in initial expenses n / a (6%) 10% decrease in maintenance expenses 4% 8% 10% increase in voluntary discontinuance rates (4%) (13%) 10% decrease in voluntary discontinuance rates 6% 17% 5% improvement in mortality and morbidity for assurances 2% 8% 5% improvement in mortality for annuities (2%) (1%) Required capital set equal to minimum solvency capital – –
USD 1,796 million and new business value by USD 238 million.
In each sensitivity calculation, all other assumptions remain unchanged except where they are directly affected by the revised conditions. The results include the impact of assumption changes on the time value of financial options and guarantees. The 100 basis points decrease in risk free yield curve increases the value of some products, such as term assurance, with fixed future cash flows discounted at lower rates. This increase is offset by the reduction in the value of other products, such as those with profit sharing, due to the lower assumed investment returns on investment of net cash flows.
In addition to the above sensitivity the impact of a new methodology has been calculated to derive liquidity premium for euro currency liabilities. The difference to the current method is mainly a change to the credit spread data used in the calculations. For euros, the original credit spread data provider changed their method from January 1, 2012. The new method removes distortions arising, in particular, from the recent increases in the French sovereign spread. Under the current method the liquidity premium is 61 basis points and under the new method the liquidity premium has been estimated to be 108 basis points. If the new method is applied to the closing embedded value as at December 31, 2011 the impact has been estimated to be an increase of approximately 5 percent. For prior years and earlier quarters in 2011 the impact would be much less material.
Shareholders’ net assets 0.5 1.0 Value of business in force 0.2 (0.1)
Embedded value 0.7 0.9 in USD billions, as of December 31Estimated embedded value of life businesses in Non-Core Businesses
The Group has applied the Market Consistent Embedded Value (MCEV) Principles issued by the European Insurance CFO Forum in October 2009, for its Embedded Value (EV) Report for the companies and businesses in its Global Life segment (the covered business). This report primarily relates to Global Life excluding the recently acquired businesses in Malaysia and Latin America, but information relating to the life business included in Non-core life businesses is given in section 10 and to the total Group in section 11. The embedded value methodology adopted by the Group is based on a “bottom-up” market consistent approach to allow explicitly for market risk. In particular, asset and liability cash flows are valued using risk discount rates consistent with those applied to similar cash flows in the capital markets and options and guarantees are valued using market consistent models calibrated to observable market prices. Where markets exhibit a limited capacity, the valuation is based on historical averages.
Recent refinements to methodology include: • As of December 31, 2011 the liquidity premium is also applied to the calculation of the time value of financial options and guarantees. The impact has been estimated to be an increase of embedded value as of December 31, 2011 by USD 0.3 billion.
• A refinement in methodology for calculating new business value for corporate protection business was introduced in 2011. This contributed USD 119 million to new business value, of which USD 116 million relates to international group protection business included in Other businesses, and 3.0 percent to new business margin, in 2011. The refinement results from the inclusion of the value expected to be generated over the entire life of the contract in corporate protection business rather than the value expected to be generated up to the next renewal date in those contracts. See section 13 b) for further details.
b) Reporting of embedded value In line with the MCEV Principles, the embedded value is split between shareholders’ net assets, including free surplus and required capital; and, the value of business in-force.
Time value of financial options and guarantees (TVFOG) represents additional costs in excess of the intrinsic value of options and guarantees which are already allowed for in the certainty equivalent value. These are based on the variability of investment returns which need to be allowed for explicitly under the MCEV Principles. The time value is calculated on a market consistent basis using stochastic modeling techniques, and making allowance for expected management and policyholder behavior.
For products with significant guarantees, the time value has been calculated on a market consistent basis by deducting the average present value of shareholder cash flows using at least 1,000 stochastic economic simulations from the certainty equivalent value (both for the value of business in-force and separately for new business value).
The capital is projected over the lifetime of the business using appropriate risk drivers for each risk type. The present value of the risk capital is calculated by applying the swap curve as at the valuation date. The CRNHR allows for diversification across risk types and across geographical segments. This approach complies with all areas of the MCEV Principles except Guidance 9.7, because it allows for diversification between covered and non-covered business, which is consistent with the management view of the business and adds an estimated USD 434 million to embedded value.
e) New business New business covers new contracts sold during the reporting period and includes recurring single premiums, new premiums written during the period on existing contracts and variations to premiums on existing contracts where these premiums and variations have not previously been assumed to be part of business in-force. Where recurring single premiums are projected over time to derive the corresponding new business value, they are treated as annual premium for the volume definition. Group Life business which is valued with a renewal assumption of the contracts is treated as annual premium.
The new business is valued at the point of sale. Explicit allowance is made for frictional costs, time value of financial options and guarantees, and CRNHR. New business value is valued using actual new business volumes, except in Germany. See section 12 f) for details.
In certain profit sharing funds, the new business written can affect the TVFOG for business written in prior years. This effect is taken into account in the new business value by valuing on a marginal approach, the difference between embedded value with and without new business. This captures the effect of cross-subsidies between in-force and new business due to, for example, different interest rate guarantees operating in a shared common pool of assets.
Embedded value report continued f) Asset and liability data The majority of the Group’s embedded value has been calculated using a “hard close” approach. This means that all asset and liability data reflect the actual position as of the valuation date.
h) Economic scenario generator All operations use actual yield curves observable as at the valuation date for the calculation of the certainty equivalent value of business in-force.
j) Holding companies Holding companies that are allocated to Global Life have been consolidated in the embedded value at their local statutory net asset value. Related expenses are small and so have been excluded from the projection assumptions. Holding companies outside Global Life are not included in the embedded value of the covered business.
Embedded value report k) Consolidation adjustments Where a reassurance arrangement exists between two life companies within Global Life, the value of the reassurance is shown in the embedded value of the ceding company.
A 10 percent increase in initial expenses was considered for new business values only.
A 25 percent increase in implied risk free volatilities means that, for example, a volatility of 20 percent per annum would increase to 25 percent per annum.
A 25 percent increase in implied equity and property volatilities means that, for example, a volatility of 20 percent per annum would increase to 25 percent per annum.
Future economic assumptions, for example, investment returns and inflation, are based on period end conditions and assumed risk discount rates are consistent with these. For new business, the future economic (and operating) assumptions are based on conditions at the start of the relevant quarter.
Implied asset volatility and correlations The Group’s embedded value model is based on market consistent assumptions. Interest volatility is derived from the implied volatility of interest rate swaptions. Swaption implied volatilities vary both by the term of the option and also the term of the underlying swap contract, a fact that is reflected in the economic scenarios. The equity volatilities are based on at-the-money forward European options on capital indices, consistent with traded options in the market. Volatility of property investments is derived from relevant historical return data for each modeled economy. Assumptions for long-term equity volatility and long-term correlations between equity, property and bond indices are prepared with reference to historical analysis.
Inflation Inflation assumptions have been derived from the yields on index linked government bonds relative to the corresponding nominal government yield curve, where such index linked government bonds exist. Where appropriate, allowance has been made for expense inflation to exceed the assumed level of price inflation reflecting the contribution of salary related expenses to life company expenses. In Switzerland, no index linked government bonds exist, so reference has been made to the Swiss National Bank’s published target of price stability.
Liquidity premiums The CFO Forum engaged Barrie & Hibbert who estimated a liquidity premium proxy to be equal to 50 percent times the (credit spread over swaps less 40 basis points) where credit spreads over swaps is equal to credit spread on a representative corporate bond index less the swap rate for each particular currency.
“Expected return” for the analysis of embedded value earnings – investment return assumptions The expected return for the analysis of embedded value earnings is based on a projection from the start of period to end of period. This requires assumptions regarding the investment returns expected to be achieved over the period on different asset classes. The investment return assumptions (for this purpose only) are based on the “real world” returns expected by the Group. The use of real world investment assumptions gives a more realistic basis for the expected return calculation and allows for the risk underlying each asset. Any under or over performance will be reported through economic variance.
For fixed interest assets, the “real world” investment return assumptions are based on the gross redemption yield on the assets, less an allowance for defaults where appropriate, together with an adjustment to reflect the change over the period implied in the yield curve assumptions.
“Return on opening embedded value” (as shown in the Embedded value key results) The return on opening embedded value is calculated as the sum of the annualized new business value, annualized expected contributions, economic variance for the year to date and operating and non-operating variances for the year to date divided by the opening embedded value less the start of period dividend and capital movements.
The term over which group protection business policies are valued has been changed from the term up to the date of the first renewal option under the contract to a term equal to the period over which the policy is expected to be retained, i.e. the expected life time value of the policy. The life time value is only included for those businesses where reliable data exists so that renewal rates can be reasonably assessed and/or where renewals are not based on regular re-negotiations. Over years 2011 and 2012, and for smaller blocks of business beyond 2012, the life time value is included in new business when the policies renew such that this period will show an elevated level of new business value for this time period. After the in-force book has fully renewed the new business value will only be based on new policies and extraordinary premium increases or contract expansions.
North America Latin America Europe Asia-Pacific and Middle East Other Global Life
Dividends and capital movements end of period (198) (86) 1 – 174 (867) (33) 5 2 (4) (55) (952)
Present value of new business premiums (PVNBP) 1,024 941 1,320 994 26,784 26,071 2,943 2,588 1,328 803 33,399 31,399
Dividends and capital movements end of period 54 – (105) (207) – (35) 28 – (23) (625) 219 – 174 (867)
Present value of new business premiums (PVNBP) 11,830 8,730 5,530 6,909 1,593 823 2,720 3,164 3,328 4,502 1,782 1,943 26,784 26,071
New business margin (% of APE) 12.5% 13.6% 29.1% 26.2% 6.0% 3.9% 20.2% 21.8% 29.2% 21.0% 18.0% 16.8% 19.0% 18.9% New business margin (% of PVNBP) 1.3% 1.5% 3.1% 2.5% 0.6% 0.4% 2.5% 2.6% 3.2% 2.4% 2.1% 1.8% 2.0% 2.0%
Embedded value information: Opening embedded value 3,633 3,685 2,047 2,401 2,323 2,010 1,256 1,286 279 816 794 997 10,334 11,195 Dividends and capital movements start of period (344) (375) 31 (47) (162) (12) – – – – 11 (13) (464) (447)
New business value Global Life 154 131 171 171 9 4 67 82 107 107 38 34 547 529
In our opinion, the EV Report of Zurich Financial Services Ltd for the year ended December 31, 2011 has been properly prepared in accordance with the MCEV Principles and Guidance.
Zurich Financial Services Ltd was incorporated on April 26, 2000, and is the holding company for the Zurich Financial Services Group with a principal activity of holding subsidiary companies. The company is listed on the SIX Swiss Exchange.
The Annual General Meeting on March 31, 2011, approved a gross dividend of CHF 17.00 per share. The change in the tax legislation based on the Swiss Corporate Tax reform II, that became effective as of January 1, 2011, allowed for the payment of the dividend free of Swiss withholding tax to shareholders out of a newly formed capital contribution reserve.
Revenues Interest income 241,003 187,218 Dividend income 1,521,569 36,482 Other financial income 3 100,735 128,897 Other income 110 29,010 Total revenues 1,863,417 381,607 Expenses Administrative expense 4 (94,927) (19,694) Other financial expense 5 (800,204) (285,202)
Total expenses (902,731) (311,889) Net income after taxes 960,686 69,718 in CHF thousands, for the years ended December 31
Non-current assets Investments in subsidiaries 7 11,854,569 11,851,474 Subordinated loans to subsidiaries 8 4,876,097 8,013,379 Total non-current assets 16,730,666 19,864,853 Current assets Cash and cash equivalents 13,432 17,372 Loans to subsidiaries 491,300 612,471 Receivables from third parties 856 3,390 Accrued income from third parties 14 – Accrued income from subsidiaries 207,579 3,227 Derivatives with subsidiaries 4,084 4,706 Total current assets 717,265 641,166 Total assets 17,447,931 20,506,018
Free reserve, as of December 31 332,986 332,986 Retained earnings: As of January 1 3,254,285 5,502,586 Dividends paid – (2,318,019) 2
Transfer to capital contribution reserve (1,275,702) – Adjusted for appropriations 1,978,583 3,184,567
3. Other financial income Other financial income includes primarily foreign exchange gains and net gains on derivatives with subsidiaries.
Additionally, impairments on investments in subsidiaries amount to CHF 256 million in 2011 and CHF 80 million in 2010, respectively.
The investment in Zurich Financial Services EUB Holdings Limited was increased through a capital contribution of GBP 95 million (CHF 136 million), and subsequently impaired by CHF 256 million.
As part of the liquidation of its investments, after the redemption of the remaining Trust Capital Securities, Zurich Financial Services received the Farmers Group, Inc. class C shares that were linked to these securities.
8. Subordinated loans to subsidiaries Subordinated loans, which include loans to Zurich Insurance Company Ltd, decreased by CHF 3,137 million to CHF 4,876 million as of December 31, 2011, from CHF 8,013 million as of December 31, 2010, mainly due to the repayment of a loan to Zurich Insurance Company Ltd.
The Board of Directors is authorized, when issuing bonds or similar debt instruments connected with conversion and/or option rights, to restrict or withdraw the right of shareholders for advance subscription in cases where such bonds are issued for the financing or re-financing of a takeover of an enterprise, of parts of an enterprise, or of participations. If the right for advance subscription is withdrawn by the Board, the convertible bond or warrant issues are to be offered at market conditions (including standard dilution protection provisions in accordance with market practice) and the new shares are issued at the current convertible bond or warrant issue conditions. The conversion rights may be exercisable during a maximum of ten years and option rights for a maximum of seven years from the time of the respective issue. The conversion or option price or its calculation methodology shall be determined in accordance with market conditions, whereby for shares of Zurich Financial Services Ltd the quoted share price is to be used as a basis.
Transfer from retained earnings 1,275,702 – Transfer to free reserve for dividend payment (2,479,883) –
12. Capital contribution reserve (reserve for treasury shares) This reserve fund corresponds to the purchase value of all Zurich Financial Services Ltd shares held by companies in the Zurich Financial Services Group as shown in the table below.
Additions during the year 100 20 – – Sales during the year (25,788) (6,250) (33,854) (8,243) Decrease due to share cancellation – – (1,836,404) (538,886)
Of which allocated in Shares 6, 7 in CHF 1Directors’ fees 2011
Of which allocated in Shares 6,12 1 The remuneration shown in the tables is gross, based on the accrual principle and does not include any business-related expenses incurred in the performance of the Directors’ services.
6 The shares allocated to the Directors are sales-restricted for three years. 7 As of June 30, 2011, Mr Gentz was allocated 1,523 shares, Mr Ackermann was allocated 571 shares, and the other Board members were allocated 365 shares based on a full year’s membership. The share price (CHF 218.90) as of June 15, 2011 was adopted to calculate the number of shares based on the fixed portion of the fee allocated in shares for the respective members. Where the value of the allocated shares did not equal the value of the portion of the fee to be allocated in shares, the difference was paid in cash. The amounts shown in the table above reflect the fixed amount in Swiss francs for 2011 and in U.S. dollars for 2010 (translated into Swiss francs) of the portion of the fee to be allocated in shares.
10 In line with applicable laws, Zurich paid the company-related portion of contributions to social security systems, which amounted to CHF 142,832 in 2011. The corresponding contributions amounted to USD 85,136 (or CHF 88,527 respectively) in 2010. Any personal contributions of the Directors to social security systems are included in the amounts shown in the table above.
No Director gave up his or her function in 2011. Mr Pidoux retired from the Board at the Annual General Meeting during 2010. No termination payments were made to him.
No benefits (or waiver of claims) have been provided to former members of the Board during the year 2011 or during the year 2010. Neither had any former member of the Board outstanding loans, advances or credits as of December 31, 2011 or 2010.
Remuneration of Group Executive Committee The total remuneration of the members of the GEC for 2011 comprised the value of cash compensation, pensions, other remuneration and the value of the target equity grants made under the Group’s Long-Term Incentive Plan in 2011 and is calculated based on the same methodology as in 2010. Overall compensation of the GEC members in total and the overall compensation of the highest paid executive are set out in the following tables: Base salaries 11.20 11.90 Cash incentive awards earned for the year 12.70 13.10 Service costs for pension benefits 4 3.00 3.20 Value of other remuneration 5 3.00 3.80 Value of target performance share and restricted share grants 6 15.50 7.60 Value of target performance option grants 6,7 – 7.60 Total in CHF million 8 45.40 47.20 Total in USD million 50.30 45.80 1 The remuneration shown in the table is gross, based on the accrual principle and does not include any business related expenses incurred in the performance of the members’ services.
6 The share and share option grants will vest in the future according to achievement of defined performance conditions. The value of the share and share options assumes that the grant will vest in the future at 100 percent of the target level with the valuation of the options based on the Black-Scholes option pricing model as set out in Note 24 to the consolidated financial statements, the valuation of the target performance share grants based on the share price on the day prior to the grants (CHF 243.60 for 2011 and CHF 259.90 for 2010).
CHF 2.0 million in 2011 and USD 2.1 million (CHF 2.1 million) in 2010. Since the contributions are based on full earnings, whereas benefits are capped, there is not a direct correlation between the costs paid to the social security system and the benefits received by the executives.
Base salary 1.60 1.60 Cash incentive awards earned for the year 2.40 2.40 Service costs for pension benefits 2 0.20 0.20 Value of other remuneration 3 0.10 0.10 Value of target performance share and restricted share grants 4 3.60 1.40 Value of target performance option grants 4, 5 – 1.40 Total in CHF million 7.90 7.10 Total in USD million 8.60 7.00 1 The remuneration shown in the table is gross, based on the accrual principle and does not include any business related expenses incurred in the performance of the CEO’s services.
3 Includes employee benefits, perquisites, benefits-in-kind and any other payments due under the employment contract. Benefits-in-kind have been valued using market rates. 4 The share and share option grants will vest in the future according to the achievement of defined performance conditions. The value of the share and share options assumes that the grant will vest in the future at 100% of the target level with the valuation of the options based on the Black-Scholes option pricing model as set out in Note 24 to the consolidated financial statements, the valuation of the target performance share grants based on the share price on the day prior to the grants (CHF 243.60 for 2011 and CHF 259.90 for 2010).
As of December 31, 2011 and 2010, there were no loans, advances or credits outstanding from GEC members.
No benefits (or waiver of claims) have been provided to related parties of GEC members or related parties of former members of the GEC during the year 2011 or 2010. Neither had any related party of GEC members or of former members of the GEC outstanding loans, advances or credits as of December 31, 2011 or 2010.
in CHF millions1, 2, for the year ended December 31Highest paid executive, Chief Executive Officer, Martin Senn
4 Mr Hopkins retired on June 30, 2011. 5 Mr Wauthier was appointed on October 1, 2011.
The following tables show how the totals of vested share options owned by GEC members as of December 31, 2011 and 2010, are distributed according to the grants identified in the tables “Summary of outstanding options.”
Number of vested shares and vested share options 1, as of December 31Share and vested share option holdings of the GEC members
Year of grant Total 1 Mr Hopkins retired on June 30, 2011. Mr Dailey was appointed as CEO of Farmers and member of the GEC as of January 1, 2012. 2 Mr Wauthier took on the function on October 1, 2011.
The following tables set out additional details of the options outstanding for members of the GEC as at December 31, 2011 and 2010, respectively. Further details can be found in the unaudited Remuneration report, pages 48 to 73.
Balance carried forward 2,939,269 1,978,583 1 The Board of Directors proposes to transfer CHF 1,275,702 thousand from retained earnings to capital contribution reserve. Due to this transfer the capital contribution reserve reaches CHF 15,275,702 thousand which includes the approved capital contribution by the Federal Tax Administration as of September 30, 2010, and the capital contribution from shareholders through contingent capital from October 1, 2010 to December 31, 2010 of CHF 20,590 thousand.
On behalf of the Board of Directors of Zurich Financial Services Ltd
Opinion In our opinion, the financial statements for the year ended December 31, 2011, comply with Swiss law and the company’s articles of incorporation.
We further confirm that the proposed appropriation of available earnings (page 333) complies with Swiss law and the company’s articles of incorporation. We recommend that the financial statements submitted to you be approved.
To the Board of Directors of Zurich Financial Services Ltd, Zurich
In our opinion, the issuance of 798,926 registered shares with a par value of CHF 79,892.60 complies with Swiss law and the company’s articles of incorporation.
Basic earnings per share 22.79 24.53 Diluted earnings per share 22.62 24.33 Book value per share, as of December 31 203.15 202.18 Nominal value per share 0.10 0.10 Price at end of period 212.50 242.20 Price period high 274.50 271.20 Price period low 144.90 223.30 1 Proposed dividend, subject to approval by shareholders at the Annual General Meeting 2012; expected payment date as from April 5, 2012. As the dividend payment will be paid from the capital contribution reserve, it will be exempt from Swiss withholding tax.
Dividend / nominal value reduction 2005 7.00 July 4, 2006 Nominal value reduction 2004 4.00 July 4, 2005 Nominal value reduction 2003 2.50 July 1, 2004 Nominal value reduction 2002 1.00 July 15, 2003 1 Proposed dividend, subject to approval by shareholders at the Annual General Meeting 2012; expected payment date as from April 5, 2012.
The shares registered in the share ledger as of December 31, 2011 were owned by 124’920 shareholders of which 119’021 were private individuals holding 23.9% of the shares (or 14.9% of all outstanding shares), 2’051 were foundations and pension funds holding 7.6% of the shares (or 4.7% of all outstanding shares), and 3’848 were other legal entities holding 68.5% of the shares (or 42.6% of all outstanding shares).
Zurch Financial Services Ltd is not aware of any person or institution which, as of December 31, 2011, directly or indirectly, alone or with others, exercised or was a party to any arrangements to exercise control over Zurich Financial Services Ltd.
Share Register Services Zurich Financial Services Ltd, Switzerland Telephone: +41 (0)44 625 22 55 E-mail: shareholder.services@zurich.com www.zurich.com/investors/ shareholderinformation/
American Depositary Receipts Zurich Financial Services Ltd has an American Depositary Receipt program with The Bank of New York Mellon (BNY). For information relating to an ADR account, please contact BNY Mellon’s Shareowner Services in the USA on 1-888-BNY-ADRS (toll free) (1-888-269-2377) or outside the USA on +1 201 680 6825 or by email to shrrelations@bnymellon.com. General information on the company’s ADR-program can be obtained from The Bank of New York Mellon at www.adrbnymellon.com
Business operating profit (BOP) is a measure that is the basis on which the Group manages all its business units. It indicates the underlying performance of the Group’s business units by eliminating the impact of financial market volatility and other non-operational variables. BOP reflects adjustments for shareholders’ taxes, net capital gains on investments and impairments (except for the capital markets and banking operations included in Non-Core Businesses and investments in hedge funds and certain securities held for specific economic hedging purposes), policyholders’ share of investment results for the life businesses, non-operational foreign exchange movements, and significant items arising from special circumstances, including restructuring charges for litigation outside the ordinary course of business and gains and losses on divestments of businesses. Business operating profit before interest, depreciation and amortization (BOPBIDA) is BOP before interest expense on debt, depreciation of property and equipment and amortization and impairment of goodwill and other intangibles, but inlcuding amortization of DAC and DOC. Adjusted business operating profit is adjusted for notional investment income on the difference between the average actual International Financial Reporting Standards (IFRS) equity and the average allocated IFRS equity using one global swap rate. Allocated IFRS equity is equal to a segment’s pro rata share of the Group’s total IFRS equity allocated based on the segment’s proportion of the Group’s risk-based capital (RBC) at the respective period end.
Investments Total investments in the consolidated balance sheets includes Group investments and investments for unitlinked products. Group investments are those for which the Group bears part or all of the investment risk. They also include investments related to investment policies with discretionary participation features. Average invested assets exclude cash collateral received for securities lending. The Group manages its diversified investments portfolio to optimize benefits for both shareholders and policyholders while ensuring compliance with local regulatory and business requirements under the guidance of our Asset/Liability Management and Investment Committee.
Managed gross earned premium margin is a performance measure calculated as gross operating profit of Farmers Management Services divided by the gross earned premiums of the Farmers Exchanges, which are managed but not owned by Farmers Group, Inc. a wholly owned subsidiary of the Group.
Disclaimer & Cautionary Statement Certain statements in this document 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, return on equity targets, expenses, pricing conditions, dividend policy and underwriting and claims results, as well as statements regarding our understanding of general economic, financial and insurance market conditions and expected developments. 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 plans and objectives of Zurich Financial Services Ltd or the Zurich Financial Services Group (the “Group”) 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) the risk of a global economic downturn, in the financial services industries in particular; (iii) performance of financial markets; (iv) levels of interest rates and currency exchange rates; (v) frequency, severity and development of insured claims events; (vi) mortality and morbidity experience; (vii) policy renewal and lapse rates; and (viii) changes in laws and regulations and in the policies of regulators may have a direct bearing on the results of operations of Zurich Financial Services Ltd and its Group and on whether the targets will be achieved. Zurich Financial Services Ltd undertakes no obligation to publicly update or revise any of these forward-looking statements, whether to reflect new information, future events or circumstances or otherwise.
It should be noted that past performance is not a guide to future performance.
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