Zurich Reports 29% Net Income Increase to $2.6 Billion; Rating Agency Comments

Swiss-based Zurich Financial Services (ZFS) reported strong financial results for 2004, tempered by increased loss reserves in the U.S. A.M. Best Co. saw no reason to change the Group’s “A” (Excellent) rating, indicating that the results were in line with its expectations. Standard & Poor’s Ratings Services, however, reacted by placing ZFS’ “A+” ratings on its CreditWatch with negative implications, as the reserve strengthening had exceeded S&P’s expectations.

Commenting on the results CEO James J. Schiro stated: “We are pleased to report a 29 percent increase in net income to $2.6 billion reflecting our well diversified portfolio and the strong underlying profitability of our businesses. Current operations in General Insurance were strong in all regions, with excellent underwriting results in particular in Continental Europe, the United Kingdom and our International Businesses.”

“I am particularly pleased with the ongoing improvements of our Life insurance operations. Our businesses in the United Kingdom and Switzerland continued their recovery and, based on our strong distribution platform, Germany recorded one of the best years ever. At the same time we continued to strengthen our balance sheet by adding to our reserves and growing our equity base.”

Earnings highlights included the following:
— Net income of $2.587 billion, generating a return on equity (ROE) of 13.3 percent
— Business operating profit (BOP) of $3.143 billion, up 36 percent from 2003. BOP ROE after tax increased from 9.8 percent to 11.5 percent
— Gross written premiums in General Insurance of $37.6 billion; combined ratio at 101.6 percent including hurricane and tsunami impact of 2.5 percentage points
— Gross written premiums and policy fees in Life Insurance of $11 billion; new business profit margin improved by 2.4 percentage points to 11.4 percent
— Net income at Farmers Management Services of $686 million, up 14 percent from 2003
— Net insurance loss reserves of $43.5 billion, an increase of $6.5 billion of which $2.0 billion was prior year strengthening
— Total shareholders’ equity of $22.2 billion compared with $ 18.9 billion at December 31, 2003
— Proposed payout of CHF 4.00 [$3.38] per share in form of a reduction of the nominal value. Earnings per share (diluted) of CHF 22.18 [$18.75]

Commenting on the investigations that have shaken the industry, ZFS said: “Last year, the insurance industry, including Zurich, came under heightened scrutiny by public authorities and regulators concentrating primarily on certain business practices involving insurance carriers and brokers, the use of non-traditional products and reinsurance. We proactively performed our internal reviews and have taken remedial actions where necessary. In particular, we completed our response to the information requests relating to certain business practices involving insurance brokers and insurance carriers. In addition, we finalized our internal review of reinsurance arrangements that the Group placed externally, where such risks were partially or fully retroceded to the Group, and have taken the appropriate accounting actions. The Group has also reported these transactions to appropriate regulatory bodies and is cooperating with all regulatory inquiries. We continue to strengthen our processes and are committed to comply with laws, regulations and ethical standards as embodied in Zurich Basics, our internal guideline defining the principles and values of our Group.”

Commenting on Farmers Management Services, ZFS noted that the 14 percent rise in earnings was a record profit for the sector, management fees and other related revenue increasing by 5 percent to $2 billion. The premium volume of the Farmers Exchanges, which Zurich manages but does not own, grew by 3 percent to $14.2 billion and the Farmers Exchanges increased their surplus by $462 million.

The complete report, as well as ZFS presentation to analysts and investors is available on the group’s website at: www.zurich.com.

While ZFS seemed well pleased with the results, S&P’s rating actions raised a cautionary note. The $1.6 billion fourth quarter increase in prior-year reserves for its North American corporate business ($2.6 billion for full-year 2004), mainly to cover workers’ compensation and liability lines in the U.S. exceeded the rating agencies’ expectations.

“The CreditWatch placement reflects mounting concerns about the group’s continued reserve strengthening for past accident years, in excess of our expectations,” indicated S&P credit analyst Antonello Aquino. The rating agency said it expects to resolve ZFS status after discussions with the company. But Aquino warned that “upon resolution of the CreditWatch placement, Standard & Poor’s may decide to lower the ratings on ZFS and related entities, although it is unlikely that the ratings will be lowered by more than one notch.”

S&P also indicated, however, that ZFS’ U.S. operations (ZUS) “could be lowered by two notches,” If S&P decides to reclassify the unit as a strategically important subsidiary. S&P said it was mainly concerned about the increased reserves “resulting impact on ZUS’ capital adequacy and earnings.” It currently considers ZUS as a core unit of ZFS, and pool members are therefore currently rated at the same level as other core group companies.

S&P said it will “review the level of group support factored into its ratings on ZUS,” and that it “understands that management remains committed to the U.S. operations and expects ZFS to continue to demonstrate strong financial backing. Although the announced reserve increases show management’s determination to continue to take all necessary actions to restore full balance-sheet integrity, they also increase concerns on management’s past reserving methodologies.”

In contrast to S&P, Best’s bulletin noted that ZFS’ earnings increase had been achieved “in spite of a deterioration in the reported consolidated combined ratio for the year to 101.6 percent (97.9 percent for 2003), predominantly as a consequence of a strong reserve strengthening on U.S. prior years.” Best said it would continue “to monitor ZFS’ reserves development, particularly asbestos and U.S. prior years, and does not anticipate significant reserve strengthening in 2005.”