Zurich Financial Rebounds From Insurance Industry Crisis

The financial crisis has been painful to the insurance industry, with losses on subprime mortgage securities and other bad assets pushing most major companies into the red in 2008. But for Zurich Financial Services, the lessons learned in overcoming past adversity have paid off handsomely in the recent turmoil.

Not content with the company’s century­-old status as a leading if unexciting insurer, in the 1990s former CEO Rolf Hüppi went on a massive expansion spree into asset management and investment banking and made a geographical push into the U.S., hoping to turn Zurich into a leading global financial services conglomerate. Instead, he badly overextended the company. In 2002, as Zurich was racking up $3.4 billion in losses, the company replaced Hüppi with American executive James Schiro, who pared the company back to its insurance roots by selling or spinning off a variety of businesses, including the U.S. business of Kemper Corp., mutual fund manager Scudder, Stevens & Clark and its reinsurance arm, Converium.

“We decided we didn’t have the capabilities to assess risk in those other businesses, so we focused instead on our core insurance business,” says Schiro, 63, a former CEO of PricewaterhouseCoopers. Schiro also attacked Zurich’s cost problems with an accountant’s discipline, slashing the payroll, de­-risking an investment portfolio that suffered big losses on equities in the 2001 market setback and insisting that his underwriters strive for profit margins rather than market share. When he stepped down as CEO in January, the company had recorded 27 consecutive profitable quarters.

“Zurich has behaved very much in reaction to its 2001–’03 crisis,” says Markus Engels, Frankfurt-based senior analyst for global insurance at Allianz Global Investors. “It learned the basic lesson that underwriting earnings should not be used to speculate on the equity market.”

Today, Zurich is one of the most profitable and best-­capitalized insurers in the industry. And at a time when the industry’s improved fortunes are prompting some competitors to make aggressive moves, such as Prudential of the U.K.’s proposed $35.5 billion acquisition of American International Group’s Asian business, Zurich so far appears content to stick with its conservative approach. In recent months, for instance, the company has hiked auto insurance premiums sharply in the U.K., in response to adverse trends, deciding that profitability remains more important than market share.

Martin Senn, the former chief investment officer who succeeded Schiro as CEO, summed up the strategy in presenting Zurich’s 2009 results earlier this year: “We took our foot off the gas pedal, as we always do when it gets a bit blurry out there.”

Such careful handling has steered Zurich well through the crisis. The company is the only major global insurer that stayed in the black through every quarter of the past three years. In 2009, Zurich, the world’s fifth-­largest insurer, with $69.5 billion in gross written premiums and fees, boosted net income to $3.22 billion, from $3.04 billion the year before.

The company trailed the industry’s top two. Germany’s Allianz, the world’s largest insurer, with €97.4 billion ($122.4 billion) in premiums and fees, earned €4.3 billion last year, compared with a loss of €2.2 billion in 2008; and France’s AXA, which had €90.1 billion in premiums and fees, increased net income to €3.6 billion, from €1.24 billion in 2008. But Zurich’s profitability surpassed that of Italy’s Generali, the third-­largest insurer, which had €70.5 billion in premiums and fees and which boosted net income to €1.31 billion, from €860.9 million in 2008. The U.K.’s Aviva, the fourth-­largest insurer, with £45.1 billion ($71.8 billion) in premiums and fees, returned to the black with earnings of £1.3 billion, compared with a year-­earlier loss of £885 million. On the other side of the Atlantic, AIG, now the sixth-­largest insurer, with $60.4 billion in premiums and fees, reported a $10.9 billion loss in 2009, compared with its record $99.3 billion loss the year before.

No major insurer was more generous to shareholders last year than Zurich. The company startled analysts in February by increasing its dividend by 45 percent, to Sf16 ($13.92), its highest payout in a decade and equivalent to a yield of 6.6 percent on the share price at the time. Historically, European insurers have doled out measly dividends, yielding less than 2 percent, on average. But with the global crisis reducing valuations and earnings multiples, “insurers are under strong pressure to return capital to shareholders,” says Engels, “and Zurich has raised the bar.” Allianz lifted its dividend by 17 percent, to €4.10, equivalent to a yield of 5.2 percent, and AXA increased its dividend by 38 percent, to €0.55, yielding 4.1 percent.

Sustaining such strong profits will be difficult, though, for Zurich and its rivals. Declining credit spreads helped insurers post solid gains on their investment portfolios, which are allocated predominantly to fixed-­income securities, making 2009 a great recovery year. But as insurers’ bonds reach maturity, companies will have to make new investments at considerably lower interest rates. “There won’t be many gains this year because bond spreads are very low and most insurers have very little equity exposure,” says Reiner Klöcker, Frankfurt-­based portfolio manager for Union Investment.

On the underwriting side, Zurich, like the rest of the industry, benefited from an unusually low number of natural disasters and other catastrophes last year. Such events caused losses amounting to $50 billion worldwide in 2009, of which $22 billion was insured, down sharply from $200 billion in losses, of which $50 billion was insured, the year before. But the disaster toll looks set to rise this year because of Chile’s earthquake, the BP oil spill in the Gulf of Mexico and bad weather in the U.S. and Europe. Slow economic growth, moreover, is likely to suppress demand for insurance products.

In this difficult environment, Zurich will have to maintain its trademark combination of price discipline and cost-cutting. The company was able to increase net income by 5.9 percent last year even as its gross written premiums fell by 8 percent. But at some point declining market share can push even the most disciplined insurer to stretch to win business. “The challenges of recent times have only served to temporarily subdue this urge which seems to be in every insurer’s DNA,” says Kevin Ryan, London-based director of equity research for ING Wholesale Banking.

At Zurich memories of the painful costs of overweening ambition are still fresh. The company expanded aggressively under Hüppi, a Zurich veteran who took over as CEO in 1991 and, in keeping with the times, sought to transform the staid insurer into a financial services conglomerate. In 1995, Zurich bought Chicago-­based insurer and asset manager Kemper Corp. for $2 billion; two years later it acquired 70 percent of Scudder, the Boston-­based mutual fund manager, for $1.6 billion. Then in 1998, Zurich spent $18.6 billion to acquire the financial division of British-­American Tobacco, which included the Eagle Star group of insurance companies and mutual funds in the U.K. and Farmers Group, the third-­largest personal­-lines property and casualty insurer in the U.S.

Hüppi was unable to manage his new empire effectively, though. By the turn of the millennium, Zurich was hemorrhaging money and clients. Like the rest of the insurance industry, the company suffered through the financial crisis in 2001–’03 brought on by the 9/11 terrorist attacks and the bursting of the dot-com bubble. Zurich’s problems ran much deeper, though, and were largely self-­inflicted. The integration of Kemper and Scudder was plagued by turf battles, prompting an exodus of Kemper executives and client withdrawals of $5 billion of the combined firm’s $300 billion in funds under management during 2000. A year later, Zurich sold Scudder to Deutsche Bank for $2.5 billion. Zurich suffered a net loss of $387 million in 2001, and its market capitalization shrank by almost two thirds that year. The company was awash in red ink the following year.

The mounting losses forced Hüppi to resign under pressure in May 2002. Schiro, who had joined the company only two months earlier as co–chief operating officer, was appointed CEO and wasted no time in cutting Zurich down to size. In his first year as CEO, Schiro lopped 4,500 people off the company payroll. The company shed an additional 9,000 employees over the next seven years, reducing its work force to 60,000 by the start of this year.

Schiro then set about unwinding much of Hüppi’s empire and strengthening Zurich’s capital base. He sold Threadneedle Asset Management, a U.K. fund manager acquired in the BAT deal, to American Express for £340 million (then worth $565 million); sold U.K.-­based Zurich Life Assurance to Swiss Re for £286 million; and sold Zurich Life, part of its U.S. life and annuity business, to Bank One Corp. (now part of JPMorgan Chase & Co.) for $500 million. The company also raised capital by making a $2.5 billion rights issue in 2002 and issuing $1.3 billion in subordinated debt in 2003.

Schiro’s scalpel produced quick results. In 2003, Zurich’s nonlife insurance business’s combined ratio, which measures costs and claims as a proportion of premiums, improved by 5.6 percentage points, to 97.9 percent. A level below 100 percent indicates that a company is actually making money on its insurance underwriting. It was the first time in five years that Zurich had done so. Overall, the company rebounded to post net income of $2.1 billion in 2003.

Property and casualty insurance accounted for 57 percent of Zurich’s gross written premiums and fees last year, compared with 43 percent for life insurance. Western Europe generated 38 percent of premiums and fees, the U.S. provided 28 percent, and Asia chipped in just 2 percent. The company gets the remainder of its revenues from the rest of the Americas, Eastern Europe, the Middle East and Africa.

Zurich executives insist they want to expand in Asia — if the price is right. “First, an opportunity has to arrive, so you are not just spending money because you have to spend,” CFO Dieter Wemmer said at the company’s results presentation in February.

The company did expand its footprint in the U.S. last year, paying $1.9 billion to acquire AIG’s U.S. Personal Auto Group, an entity that includes 21st Century Insurance Co., which insures more than 4 million vehicles. The deal made Zurich the third-­largest auto insurer in the U.S., behind State Farm and Allstate, with 7.4 percent of the market.

Senn, 53, joined Zurich as CIO in 2006, after three years in the same post at Swiss Life Group. Previously, he had a 27-year banking career, working as a treasurer and manager at Swiss Bank Corp. in Asia before moving to Credit Suisse, where he rose to head the bank’s trading and investment services division. At Swiss Life he was a key member of the team, led by former CEO Rolf Dörig, that restored profitability at the insurer after big equity losses and an investment scandal at the start of the decade. They did so using a cost-­cutting and divestment strategy similar to the one Schiro used at Zurich.

“Martin is quite suited to be at the top at Zurich,” says Jim O’Neill, London-­based head of global economic research at Goldman Sachs Group, who has known Senn since they both worked at Swiss Bank in the 1980s. “He can quickly figure out what issues matter and which don’t.” One looming issue is expanding Zurich’s minimal presence in Asia. The fast-­growing region is expected to generate some $950 billion in life insurance premiums in 2012, up from $632 billion in 2007. “That’s where he probably has to take things further,” says O’Neill.

But for now, Senn sounds as risk-­averse as his predecessor. The executive declined requests for an interview, saying he will talk to the media only when he has a track record of his own. But in presenting the company’s 2009 results in February, Senn indicated he would be following very much in Schiro’s footsteps. “You should expect continuity in our strategy going forward,” he said, adding that maintaining high dividends, rather than making acquisitions, would remain the company’s top priority.

Senn will face a challenge in maintaining Zurich’s record of profitability. According to a 2009 study by Swiss Re, the giant reinsurer headquartered just up the block from Zurich, the insurance industry worldwide generated underwriting profits this decade only in the years from 2004 to 2007. With potential investment income now severely curtailed by bond interest rates near zero, insurers will need combined ratios of at most 95 percent to achieve the same return on equity, Swiss Re contended.

Last year, Zurich had a combined ratio of 96.8 percent, better than Allianz’s 97.4 percent, Generali’s 98.3 percent and AXA’s 99 percent. Losses incurred during the first three months of this year because of the Chile earthquake and storms in the U.S. and Europe caused those ratios to deteriorate. Zurich’s combined ratio rose to 99 percent in the first quarter, from 95.8 percent a year earlier, and its nonlife operating profit declined 30.1 percent, to $621 million. Thanks to a hefty increase in life insurance and investment returns, Zurich’s net income for the quarter jumped 76 percent, to $935 million.

To lower its combined ratio in future, Zurich will have to charge higher rates to property and casualty clients, even at the risk of losing more of their business. “They have been prepared to do so up until now,” says Charles Graham, a London-­based insurance analyst at ING Wholesale Banking. In U.S. property and casualty insurance, Zurich raised its premium rates by 3 percent last year, while competitors dropped their prices by more than 4 percent in an effort to maintain market share. Those actions helped drive down the company’s U.S. combined ratio by half a percentage point, to 96.9 percent, a sharp contrast to the industry’s average ratio, which was 105 percent. As a result, although the Swiss company saw gross written premiums in the U.S. decline by 12 percent last year, to $9.9 billion, it managed to keep operating profits stable at $1.2 billion.

Worldwide property and casualty premiums — the biggest part of Zurich’s business — fell 8 percent last year, to $34.2 billion. Inga Beale, Zurich’s global chief underwriting officer, contends that most of the decline in p/c business took place in less profitable insurance lines. The company doesn’t provide a breakdown by sector, but Beale says Zurich retained its market share among global corporate customers, which bring in high income and require constant attention by the company’s underwriters and risk analysts. “It may take months to understand their business and what they need out of their insurance coverage,” says Beale. “Every time we lose one of these customers, we have to find a new one — and that gets expensive.”

Lost market share in personal lines such as automobile insurance is much easier to swallow. Zurich, like other insurers, uses algorithms rather than individual underwriters to decide how much insurance to write in a given market. If a negative trend arises, the company can react quickly. This happened last year in the U.K. “We have seen the claims ratio there moving in the wrong direction for us, which means up,” says Beale. According to Zurich, there was a 30 percent increase in reported injuries from car accidents in the U.K. in 2009, the sort of rise that is typical in recessions when people run short of money. The insurer responded by increasing its U.K. auto rates by 20 percent in March, well ahead of the 4.3 percent average rate rise in the U.K. market in the first quarter.

Zurich has also moved more swiftly than competitors in setting up bulk-purchase policies and shared technology platforms, in an attempt to cut costs. After a severe hailstorm in July 2009 generated more than Sf700 million in damage claims for the industry, Zurich used prearranged contracts with auto garages to repair cars; the arrangement cut costs per claim to 25 percent below the market average.

No matter how good Zurich is at achieving cost efficiency and maintaining high underwriting fees, however, it needs solid investment returns to ensure longer­-term financial health. Traditionally, investment gains account for more than 70 percent of income in the industry. “That’s why the real story is yet to come,” says ING’s Ryan. “Insurers cannot survive on interest rates of zero percent or just above.”

Zurich executives insist that the company can do just fine in today’s market as long as they make sure that every insurance claim is covered by a specific investment portfolio. “We operate the same way in a low-­interest­-rate environment as in a high-­interest­-rate environment because, as long as assets and liabilities are moving in parallel, it doesn’t really matter,” says Peter Teuscher, the company’s head of investment strategy and analysis.

Teuscher provides a glimpse of Zurich’s top-down approach to managing investments throughout its 150-plus business units around the world. One U.S.-based nonlife subsidiary, for example, currently backs its policies with a portfolio that invests roughly 91 percent in fixed-­income securities (of which 15 percent are government bonds, 40 percent are corporate bonds, and 45 percent are asset-­backed securities), 2 percent in equities, 3 percent in real estate and 3 percent in alternative investments. The short average duration of the policies — three and a half years — explains the weighting toward bonds. By contrast, a European life unit with policies having an average duration of more than seven years was backed by a portfolio containing 59 percent fixed-­income instruments (of which 34 percent are government bonds, 55 percent are corporate bonds, and 11 percent are asset-backed securities) and 35 percent real estate and mortgages, with the remaining 6 percent divided equally between equities and alternatives.

Overall, Zurich had just 2.9 percent of its $188 billion securities portfolio invested in equities at the end of 2009, down from more than 25 percent at the start of the decade, when the company was investing heavily in technology stocks, a policy that contributed to its big losses in 2001 and 2002. Unlike most of its leading rivals, which consider asset management to be a core part of their business, Zurich has outsourced most of its investment management since breaking up Hüppi’s financial services conglomerate. Fully 70 percent of the company’s securities portfolio was handled by external asset managers last year. By comparison, Allianz, which owns the world’s second-­largest bond manager, Pacific Investment Management Co., managed more than 90 percent of the €584 billion securities portfolio backing its insurance policies internally. AXA, Generali and Aviva also manage the vast bulk of their portfolios themselves.

Zurich’s distinctive approach served it well during the crisis; investors will be hoping that CEO Senn can keep the company on an equally profitable path through today’s challenges.