Insurance – Zurich: Diversification works

“We avoid concentration risk” Martin Senn, Zurich

To what do you attribute Zurich’s ability to be profitable over 2008, and remain well capitalized, while others in the insurance industry are having to raise capital or turn to state funding?

The companies that have been forced to take those routes have different reasons for doing so but the biggest issue seems to be where their focus shifted to non-core activities. Zurich’s business model is diversified, and that has worked. Our business mix is about two-thirds general insurance and one-third life insurance. The property and casualty business is a much more defensive business to be in during a financial crisis. We also have a strict investment philosophy, which has benefited us substantially.

How has diversification helped?

Zurich is well balanced geographically, through life, general and farmers and has adopted a disciplined approach to investments and risk management. Even in these difficult times, we demonstrated an ability to grow profitably through targeted customer, product and distribution strategies. Our general insurance increased new premiums by 2%. Global life grew its annual premium equivalent to 10% and farmers’ fee income was up 8%.

That your investment portfolio managed to return a positive 1% over 2008 is impressive given the losses most investors had. How does Zurich manage its investment portfolio?

We manage our investments relative to our liabilities on a risk-adjusted basis and have defined an investment philosophy that is consistently applied to all investment activities. We don’t invest in products we don’t understand and only take risks that are expected to provide returns relative to liabilities. We cannot predict markets but we do know our liabilities and our risk capacity. We had minimal exposure to sub-prime investments and CDOs. A CDO has a lot of leverage built into it, and as an insurance company we already have leverage on the balance sheet. We avoid concentration risk and strive for optimal diversification. Close to 70% of our assets are outsourced to external managers, this also reduces operational risk. All core competencies at investment management are managed centrally and our state of the art information technology enables us to measure all investment risks and returns at high frequency.

How are your hedging programmes working out?

Our equity exposure after hedging is well controlled and amounted to 3.3% of group investments as of December 31 2008. Our hedging programmes protect about 15% of our equity exposure. These programmes have been in existence for several years and are an integral aspect of our disciplined asset allocation process. Currently, we are employing put options to hedge our equity exposure in a number of cases. Each hedging decision is reviewed thoroughly before implementation; naturally the cost of continuing to roll hedges in current markets is a crucial factor in the decision-making process.

Is it becoming more difficult to convince shareholders that the insurance industry is solid?

When you generate profits of $3 billion and a return on equity of 16%, it is clear to shareholders that our strategy works even in this stressed financial environment. There is no doubt that the insurance industry, with regards to market capitalization of the largest insurance companies, has been impacted. The playing field is more balanced than two years ago, where the largest insurer had a $200 billion market capitalization, the next four were about half that size, and those left in the top 10, half that size again. The largest have shrunk dramatically, and it is those insurers with a strong balance sheet, good business model and clear strategy that will manoeuvre best through this crisis. They will have a good starting point to expand their business and seize new opportunities. The key is to remain focused on customers. This crisis is far from over as there are macroeconomic developments that will have to be worked through, and we will have to live with high volatility in the marketplace for some time. Insurance companies are not immune to those developments.

How do you foresee the regulatory environment for insurers?

Clearly we are facing a major regulatory reform across financial markets. There is a need for more capital requirements and higher levels of transparency as well as liquidity in new business activities. I see these developments affecting the banking industry more than the insurance sector. Europe is way ahead of the US in moving towards a regulatory convergence that would ultimately benefit global insurers. The EU, through Solvency II and other directives, has demonstrated the ability to establish effective regulatory regimes that balance regional and local concern. US regulators should take note.

Martin Senn is chief investment officer of Zurich Financial Services Group (Zurich).