High-severity, low-frequency events like Hurricane Katrina are an integral part of our business; providing cover for natural catastrophes is fundamental to Swiss Re’s value proposition. Our many years of experience in this area show that, despite considerable variability, this business is profitable over time. Current market conditions offer a competitive advantage to players like Swiss Re who have a strong balance sheet and the capacity to act as a net underwriter.
Many of our clients have long-term needs; our obligations to them are therefore also long-term. Both clients and regulatory authorities rely on our prudent risk and balance sheet management to meet these obligations. Swiss Re therefore tends to be conservatively capitalised, which implies a higher capital cost factor for the Group. We are willing to carry this cost as it is the necessary counterpart for the right level of responsiveness to our clients. The volatility buffer we offer to insurance providers helps reduce the overall
Networks devoted to subjects of strategic importance. These networks unite Swiss Re experts across business functions and countries and are an integral component of the Group’s knowledge landscape.
The recent sigma study “Insurers’ cost of capital and economic value creation” describes how the cost of capital relates to shareholder value in insurance companies. The cost of capital is what investors expect to earn when they put capital at risk into a company, having compared expected returns from other investments with a similar risk profile. The cost of capital of the US property and casualty industry declined from about 15% in the 1980s to about 7−8% today, due to a significant reduction in risk-free interest rates, equity risk premium and the percentage of assets invested in equities.
Interest rates remained at historically low levels. US government bond yields drifted upwards at the year’s end, while eurodenominated yields retreated slightly. Credit spreads between government and corporate bonds, which shrank significantly in 2003, remained narrow in 2004 and 2005. European and Japanese stock markets rose substantially during the year, as did the US to a lesser extent.
Primary insurance premium volumes in industrialised countries are set to grow with the long-term GDP trend (between 3% and 4% per year). In emerging markets, premium increases should outpace overall economic growth of more than 5% in real terms. Demand for risk transfer will continue to rise, particularly private and occupational pension products in the life segment and covers related to health care, third-party liability and pecuniary losses in the property and casualty segment. Reinsurers will continue to benefit from these underlying growth fundamentals.
21 January Swiss Re completes securitisation of in-force life insurance policies Swiss Re successfully completed its first securitisation of future profits from a portfolio of US life insurance policies (Queensgate transaction). The USD 245 million issue benefits Swiss Re by transferring insurance risk to the capital markets, thereby increasing capital efficiency.
Net investment income was CHF 5.4 billion, compared to CHF 4.9 billion in 2004 – a 10% rise over the previous year. This favourable development is a combination of the continuing attractive yields earned on fixed income securities as well as growth in invested assets due to strong operating cash flows.
Net realised investment gains on publicly traded equities decreased to CHF 568 million from CHF 667 million in 2004, whereas net unrealised gains on the bal-
Investment expenses Investment expenses increased from CHF 478 million to CHF 608 million, mainly due to the increase in interest credited to third parties as a result of securitisation transactions undertaken during the year.
Risk Prudent risk management ensured that excellent investment results were achieved while financial market risk was maintained within established ranges. Average aggregate Value at Risk (VaR) usage in the investment portfolio remained stable. Assets Assets Minimum risk portfolio
liability and professional indemnity cases. The number and size of security class action filings significantly decreased in 2005 and are now below the 1996–2004 average.
1998 and prior, the run-off was neutral, while years 1999 to 2001 still experienced adverse development for US liability lines. Encouraging are the positive developments emerging for years 2002 to 2004, reflecting the sound basis that the business has been written on in recent years.
Swiss Re reduced its facultative and corporate portfolios due to softening rates in the first half of the year, especially in liability and large property risks. In the nontraditional portfolio, a few large propor-
In contrast, pricing on the new business written was satisfactory and profitability was maintained. The development of more recent underwriting years showed that significant improvements have been achieved.
The management expense ratio increased from 5.2% in 2004 to 5.6% in 2005, reflecting the increased share of Admin ReSM business (CNA and LAHC for twelve months), which carries higher expenses associated with direct business, as well as systems investments to improve the traditional business administration platforms.
Net investment income increased to CHF 3.3 billion, largely due to the first full year of income on the 2004 Admin ReSM acquisitions offset by the impact of the Queensgate securitisation. This securitisation is in the form of a retrocession arrangement, thereby ceding premiums, net investment income and claims. The retrocession reduced the growth in operating revenues, as CHF 181 million of premiums and CHF 111 million of net investment income were retroceded to Queensgate. Excluding the impact of this retrocession the net investment income of the Life & Health business would have increased by 6%.
The SMM structure offers significant benefits – particularly for life insurers in Continental Europe, where future profit margins may not be recognised in regulatory returns. “Mortality margins” are the difference between the rates set prudently by the regulator and the actual mortality rates expected by the insurer and reinsurer. By selling these margins to the reinsurer, SMM enables the insurer to recognise their value as an asset for which, subject to regulatory approval, it can take immediate credit at the inception of the reinsurance arrangement. As these mortality margins are realised over the years, they are ceded to the reinsurer.
Operating income rose 15% to CHF 366 million, with strong performance by Credit Solutions offsetting lower trading revenues. The new Insurance Risk Transformation unit sharpens Swiss Re’s focus on capital markets.
Risk management principles At Swiss Re, risk management is based on four guiding principles that are applied throughout the Group: Controlled risk taking: financial strength is important to Swiss Re’s business. The Group’s overall risk limits are clearly defined. Within these limits risk-taking activities target businesses that provide shareholders with attractive risk-adjusted returns.
One widely used measure for summarising the risk distribution and defining the base capital requirement is the 99% Value at Risk (VaR): a maximum loss likely to be exceeded in only one year out of a hun-
For planning purposes, the WHO uses a range of 2 million to 7.4 million deaths worldwide. For these types of events, the additional claims Swiss Re could experience worldwide are estimated at between CHF 0.2 and CHF 3.4 billion, depending on the age groups affected. The higher end of the range estimate for Swiss Re arises if one assumes that 7.4 million deaths are evenly distributed over all markets and all age groups, ie that mortality in the young population (which typically constitutes the majority of the insured population) is increasing stronger relative to its base level than for other age groups. The estimate based on this assumption is considered a conservative (ie high) estimate.
a cyclical period of higher hurricane activity which is expected to last up to another 10–20 years. Swiss Re has adjusted its models to reflect this assessment. Scientific findings suggest that, in addition to this natural climate variability, humaninduced global warming will affect the severity of hurricanes.
The chart above shows the number of days on which market risk related revenues fell within particular ranges. Daily revenue was positive on 69% of the trading days during the year. The average daily revenue was USD 0.7 million and the largest daily loss was USD 5.2 million.
Life & Health Risk Management is responsible for the Group-wide reporting and monitoring of life and health risks. The Global Products function also plays a major role in actively managing life and health risks by supporting and closely monitoring new product development. Where appropriate, Swiss Re also uses insurance-linked securities as a means of reducing peak exposures. The Vita indexlinked security transactions, for example, were arranged to provide protection against extreme mortality events.
³ Includes EUR 672 million mandatory convertible security issued in July 2004, which received full equity credit from Moody’s and Standard & Poor’s
In funded transactions, foreign exchange and interest rate risks are typically offset. They do not significantly affect Swiss Re’s overall financial market profile.
Walter B. Kielholz Executive Vice Chairman Walter B. Kielholz Executive Vice Chairman
Ms Gibson Brandon was elected to Swiss Re’s Board of Directors in June 2000. Her mandate was renewed in 2004 for a further four year term. She has been a professor of financial economics at the Swiss Banking Institute of the University of Zurich since March 2000. Ms Gibson Brandon was previously a professor of finance at the University of Lausanne. She is also a director of the National Centre of Competence in Research (NCCR) “Financial Valuation and Risk Management” research network, and an adviser to scientific councils of various educational institutions. She was a member of the Swiss Federal Banking Commission until the end of 2004.
Mr Hentsch was elected to Swiss Re’s Board of Directors in 1993. His mandate was renewed in 1997, 2001 and 2005, each time for a further four year term. He was a general partner of Darier Hentsch & Cie, Private Bankers, Geneva, from 1985 until 2001 and chaired the Swiss Private Bankers Association from 1998 until 2001. In 2004, he founded GEM – Global Estate Managers – as well as Banque Bénédict Hentsch & Cie S.A., both entities dedicated to global wealth management. He is a member of the board of the ISC Foundation and the MLE-Stiftung, both at the University of St. Gallen.
Mr Villiger joined Swiss Re’s Board of Directors in 2004 for a four year term. As an entrepreneur, Mr Villiger co-owned and managed two businesses from 1966 until 1989. Simultaneously, Mr Villiger had several political positions, first in the parliament of canton Lucerne and, from 1982, in the Swiss Federal Parliament. He became a Federal Councillor in 1989. He initially served as Defence Minister, with responsibility for the Federal Military Department. He then became Finance Minister in 1995, charged with running the Federal Department of Finance. He continued in this function until his retirement at the end of 2003. Mr Villiger was President of the Swiss Confederation in 1995 and 2002. Mr Villiger is also on the board of directors of Nestlé and the newspaper “Neue Zürcher Zeitung”.
a. Allocation of tasks within the Board of Directors Chairman of the Board of Directors The Chairman of the Board of Directors (the “Board”) exercises ultimate supervision of the executive management on behalf of the Board; he attends the meetings of the Executive Committee and the Executive Board and receives all related documentation and minutes; he is responsible for Group Internal Audit and appoints its head, subject to confirmation by the Audit Committee; he convenes meetings of the Board and its committees; he makes preparations for, and presides at, the meetings of the Board; he presides at the General Meetings of shareholders; he ensures adequate reporting to the Board by the Board committees, the Executive Committee and the Executive Board; he coordinates the activities of the Board committees; he receives comments from the directors as to the Board’s performance and reports annually to the Board with an assessment of the Board’s performance; he represents the Group in matters involving shareholders; in cases of doubt, he makes decisions concerning the authority of the Board or its committees and about the application and interpretation of the Corporate Bylaws.
In personnel matters, the Committee makes proposals that ensure an adequate size and a well-balanced composition of the Board and further ensure that a majority of the Board is independent; it ensures the development and maintenance of guidelines for selecting candidates for election or re-election to the Board, or to fill vacancies on the Board, as well as for the appointment to the Executive Board; it evaluates Board member candidates and makes recommendations to the Board; it evaluates proposals made to the Board for the appointment and removal of members of the Executive Board; it approves employment contracts with the Chairman, the Executive Vice Chairman, the CEO and the members of the Executive Board; and it ensures the effectiveness of executive succession and emergency planning processes.
The attendance rate at the regular Board meetings was 97% throughout the year. Even when including the extraordinary meetings that had been convened at relatively short notice, the attendance rate was 95%.
To further protect the independence of the external auditor, the Audit Committee has put in place a detailed policy on the provision of non-audit services by the external auditor and a pre-approval policy is required to pre-approve all non-audit services to be provided by the external auditor. In addition, proposals to employ former senior executives of the external auditor, previously involved in the external audit, must be reviewed and approved in advance by the Audit Committee.
Mr Mumenthaler started his professional career in 1997 as an Associate at the Boston Consulting Group, before joining Swiss Re in 1999 as a manager in Group Strategic Planning. Between 1999 and 2002, Mr Mumenthaler was responsible for a number of key projects for the company including innovative securitisation solutions. In 2002 he established a new unit, Group Retro and Syndication, which is responsible for optimising the Group’s risk and capital base through retrocession and securitisation. He was appointed Group Chief Risk Officer and Head of Risk & Knowledge Division effective 1 January 2005. At the same time he became a member of both the Group’s Executive Board and the Executive Committee. In September 2005, he became Head of Global Risk Management.
News release and telephone conference 9 May 141st Annual General Meeting Meeting in Zurich and news release 2 June Structure and responsibilities adapted to fit strategic objectives
Additional Net unrealised Foreign Common paid-in Treasury gains/ losses, currency Retained Reserve for CHF millions stock capital shares net of tax translation earnings own shares Total
Change in unrealised gains/losses on securities, net (note 2) 654 654
Cash and cash equivalents as of 31 December 9 504 8 126
Basic earnings per common share are determined by dividing net income available to shareholders by the weighted average number of common shares entitled to dividends during the year. Diluted earnings per common share reflect the effect on earnings and average common shares outstanding associated with dilutive securities.
The Group enters into long- and short-term debt arrangements to obtain funds for general corporate use and specific transaction financing. The Group defines long-term debt as debt having a maturity at the balance sheet date of greater than one year. The Group’s long-term debt as of 31 December 2005 was as follows: Senior debt Book value Nominal Interest in CHF Maturity Instrument Issued in Currency in millions rate millions 2007 Trust-preferred Stock (Trups)¹ 1997 USD 42 8.72% 65 2007 EMTN 2005 GBP 30 3M Libor
Subordinated debt Book value Nominal Interest ...to first in CHF Maturity Instrument Issued in Currency in millions rate… reset in millions
In May 1998, the Group issued CHF 1 010 million of multi-currency subordinated debt with a perpetual term, bearing interest at the rate of six-month Libor plus 37.5 basis points for the first tranche of CHF 300 million, six-month Libor plus 40 basis points for a tranche of DEM 340 million, six-month Libor plus 45 basis points for a tranche of DEM 110 million, payable semi-annually, and 5.71% for a tranche of DEM 400 million, payable annually. The loan is subordinated in the event of liquidation to all senior creditors of Swiss Re Zurich, but will be paid in priority to all holders of its equity.
The Group introduced a restricted share plan during 2004 to complement the fixed option plan. In addition, restricted bonus shares were issued during 2004 and 2005.
Other operating costs and expenses –920 –771 –706 –401 –475 148 –3 125
Claims and claim adjustment expenses; life and health benefits –13 408 –9 331 –445 –23 184
Unpaid claims and claim adjustment expenses, liabilities for life and health policy benefits and unearned premiums are reported gross in the Group’s balance sheet. Gross and retroceded amounts for these and other items were as follows: 2004 Property & Life & Financial CHF millions Casualty Health Services Total
VIEs – significant variable interest As of 31 December 2005, the total assets and estimated maximum exposure to loss in VIEs in which the Group holds a significant variable interest amounted to CHF 9 951 million and CHF 8 171 million, respectively.
The following commentary on the 2005 financial year of the parent company therefore complements the review of the financial year of the Swiss Re Group.
The nominal share capital of the company amounted to CHF 32 million on 31 December 2005.
The 2005 financial year comprises the accounting period from 1 January to 31 December 2005.
The result of property and casualty reinsurance is based on actuarial estimates over the contract life. In addition to the recognition of the reinsurance accounts as reported by the ceding companies, empirical experience is taken into consideration. The allocation to the business year is in relation to the amount of reinsurance coverage provided.
Swiss Reinsurance Company, Zurich, sold as part of a strategic restructuring its direct investment in Swiss Re Finance (Bermuda) Ltd. to Swiss Re Finance (Malta) Ltd., a newly formed 100% subsidiary of Swiss Re Treasury (Luxembourg) S.A. at fair value.
As statutory auditors, we have audited the accounting records and the financial statements (income statement, balance sheet and notes/pages 59 to 70) of Swiss Reinsurance Company for the year ended 31 December 2005.
Liabilities for life and health policy benefits 9 963 15 143 23 279 29 300 41 370 37 269 37 244 43 239 49 579