Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Debra Broek - Head of Investor Relations and Rating Agency Management

Martin Senn - Chief Executive Officer, Member of Group Executive Committee and Interim Chief Executive Officer of General Insurance

Pierre Wauthier - Chief Financial Officer and Member of Group Executive Committee

Analysts

Spencer Horgan - Deutsche Bank AG, Research Division

Farooq Hanif - Morgan Stanley, Research Division

Andrew Ritchie - Autonomous Research LLP

Andrew Broadfield - Barclays Capital, Research Division

Stefan Schürmann - Bank Vontobel AG, Research Division

Jason Kalamboussis - Societe Generale Cross Asset Research

Ralph Hebgen - Keefe, Bruyette & Woods Limited, Research Division

Vinit Malhotra - Goldman Sachs Group Inc., Research Division

Michael Huttner - JP Morgan Chase & Co, Research Division

Fabrizio Croce - Kepler Capital Markets, Research Division

Raphael Caruso - Raymond James Euro Equities

Daniel Bischof - Helvea SA, Research Division

Zurich Insurance Group AG (OTC:ZFSVY) Q2 2012 (H1 2012) Earnings Call August 16, 2012 7:00 AM ET

Operator

Ladies and gentlemen, good morning or good afternoon. Welcome to the Zurich Insurance Group Half Year Results Reporting 2012 Analyst and Media Presentation. I'm Goran, the Chorus Call operator. [Operator Instructions] The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Mrs. Debra Broek. Please go ahead, madam.

Debra Broek

Thank you, and good day to everyone. Welcome to our half year 2012 results. And it's my pleasure to be here with our CEO, Martin Senn; and our CFO, Pierre Wauthier. And I would now turn it over to Martin Senn for introductory remarks, and then we will move into Q&A time.

Martin Senn

Thank you very much, Debra, and good morning and good afternoon to all of you, and thank you all for joining us today for Zurich Insurance Group's results presentation for the first 6 months of 2012. I'm very pleased to tell you that Zurich continued to perform strongly in the first half of 2012, thanks to an excellent underwriting performance and our continuing focus on pricing and portfolio management. We have delivered top line performance in our growth target markets, Latin America, the Middle East and Asia-Pacific, taking an increased contribution to business volumes. The integration of the business units acquired through our alliance with Banco Santander is progressing well and delivering results. This alliance will support our future growth strategy. We have also seen promising performance in mature markets, especially in North America. Each of our business segments have continued to execute on their strategies for growth. And in addition, we have delivered a total investment return of 3.2%. This is non-annualized but thanks to our disciplined risk management and effective investment management. As a result, we improved our strong capital position within our AA target range, and we are well positioned to continue delivering sustainable profit growth.

Talking about GI, I'm also very pleased to have announced yesterday our new CEO for General Insurance, Mike Kerner. Mike is a 20-year veteran of our company, a 25-year veteran to the insurance industry, I should add. Mike combines great people management and business skills with deep industry knowledge and the proven ability to drive forward our ambitious and, as today's results show, successful GI strategy. And I am pretty sure that over time, as you get to know Mike, you also will appreciate his professionalism and his personality.

In summary, we have achieved strong profitability and growth in shareholder equity in a very challenging environment. We have continued to successfully execute our strategy and remain on course to meet our targets for 2012 -- for 2013, excuse me.

And with that, Pierre and I will be very happy to take your questions and to have a good dialogue. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Mr. Spencer Horgan from Deutsche Bank.

Spencer Horgan - Deutsche Bank AG, Research Division

Two questions, please. The first one is on the derisking you've carried out, I think you pointed to a $2 billion saving of risk capital under the Zurich ECM model, which is about 5% of the year-end capital requirement. Would it be fair to roughly assume that the same actions will reduce the Solvency Test capital requirement also by around 5%, or is that a different number? And the second one is on the Zinszusatzreserve. Thank you very much for the slide you've put in on there, which will suggest that the addition to that reserve in the second half should be similar to the first if everything else stays stable. If everything stays stable, would you be able to say anything about the amounts that might be required in 2013? And also, could you just remind me how much remaining RFB there is in Germany?

Pierre Wauthier

So Spencer, I'll take the question. This is Pierre. Thank you for these 2 questions. So yes, your assumption is essentially correct. Just $2 billion compared to an RBC of 37 billion would actually be slightly higher than 6 points. But indeed, these derisking actions would flow directly through into the RBC and, therefore, would improve it, which is why we indicated -- or I indicated in my speaker notes that we see a stronger solvency ratio from a Z-ECM perspective as a result of these actions. With regards to the Zinszusatzreserve, 2 points that I'd like to make. First is that this impact on earnings is already included in our RBC. So it does not affect our economic capital as we recognize where interest rates currently are, that this is purely something that is recognized on an IFRS perspective. And essentially, the way you rephrased your question, the answer would be yes, but let me clarify. What I mean by that is that, indeed, this increase in -- or this impact on what is really caused by the lower reference rates of this Zinszusatzreserve and assuming that the rate of decline remains the same, then the amount of provision taken would be comparable.

Spencer Horgan - Deutsche Bank AG, Research Division

Okay. And I guess...

Pierre Wauthier

The free RFB is around EUR 400 million currently.

Operator

The next question is from Mr. Farooq Hanif from Morgan Stanley.

Farooq Hanif - Morgan Stanley, Research Division

Just a few questions. Firstly, you said that your risk reduction actions with the $2 billion reduction in RBC isn't going to affect your investment result. I was wondering if you could just explain this. I mean, how can it not have a cost? And if the situation was that you were taking market risk without upside beforehand, it just doesn't make sense that, that was sort of allowed to happen. Second question is on Farmers, you talked about a 9%, I guess, cat loss in the first half, which brings you down to sort of 99% combined ratio. But you also mentioned a lack of reserve releases. Could you talk a little bit about what you would expect sort of going forward to get to a sort of a more normalized combined ratio? And I guess the third question is you talked about lower investment income in your nonlife business because of low reinvestment yield. But you also said it was due to capital repatriation to the group. Could you explain what could that mean and how much capital was repatriated?

Pierre Wauthier

Farooq, that was 3 questions. So I think -- no, but that's really because I make notes. Can you please repeat the last question because that one was too quick. I was still writing the first 2.

Farooq Hanif - Morgan Stanley, Research Division

Okay, sorry about that. Yes, so you talked about lower investment income in your nonlife business being affected by low reinvestment yield but also capital repatriation to the group. Could you explain what you meant by this and how much capital you’ve repatriated to the group? I'm referring to a comment you made in your webcast.

Pierre Wauthier

Yes, that's low income in GI, right?

Farooq Hanif - Morgan Stanley, Research Division

Yes, that's right, yes.

Pierre Wauthier

Yes, yes, yes. Okay, all right, fine. So the first question was how does your risk reduction not have an impact on your investment result. There are 2 key elements there. One is in the strategic asset allocation, where we rebalance and reduce the risk, there's a series of events. So while we did indeed reduce our exposure to credit risk, we also adjusted the duration. And in essence, what has happened is as these 2 elements were happening, they have more or less -- or they've significantly reduced the impact on the investment income. Now it's not 0, but it is actually relatively small is really what we wanted to highlight. With regards to the tail-risk Eurozone, this is a purchase of an options or a series of options to hedge us against the risk. So this is then a derivative that goes through fair market valuation. And obviously, the result of that derivative will depend on where the market develops. It will be a great result if, as we hope -- as we don't hope, actually, something happens and what we are more expecting indeed, the result of that derivative would be lower in case we've got a good resolution of the Eurozone and a clear continuation of the Eurozone.

Farooq Hanif - Morgan Stanley, Research Division

Sorry, just to come back on the derivatives, I mean, have you also sold some upside to reduce the cost?

Pierre Wauthier

Did we have some…

Debra Broek

Sold some upside to reduce the cost.

Martin Senn

If I took -- I was just going to in -- and Farooq, this is Martin -- and talk to enhance as well of what Pierre has said, a part of the hedge, and that's about reserve of $1 billion of capital where reduction was the full hedge of the equity portfolio by means of bank reductions. So the point that is not going to have an impact on the investment income is up or just not immaterial, let's put it, is absolutely correct. But obviously, the equity hedge, this cost was a payment of option premium. And that option premium has an economic impact but not an impact on the business operating profits, the economic impact being over the tenure of the option a reduction of net income attributable to shareholders. I think that should answer then your follow-up question. I was just going to have a dialogue, the 3 of us, on that note as well to make sure we understand that derisking has 2 components: strategic asset allocation and tail-risk reduction by acquisition of options.

Pierre Wauthier

And it was a clean purchase of options, Farooq, so there's no options sold to reduce the cost. With regards to Farmers, I think your question, ultimately, was yes indeed, last year, there was some higher reserve development, which helped the result this year. It was pretty much neutral. We're not planning for reserve releases. More importantly is where does this go? We really are taking a series of actions not only on the rate increases which, just a reminder, were essentially 5% in auto, 6% in home, and by the way, we also are filing for more rate increases. In addition to that, we're taking also re-underwriting actions both in homeowners and in auto such as, for example, much stricter guidelines in the nonstandard auto, and particularly in states where the combined ratio is higher, as well as further and stricter enforce [ph] efforts in personal injury protection, as well as a better accumulation management in wind-prone areas such as Florida. Altogether, I think it's important to keep the strategic perspective. We think these actions will have a significant impact, and our goal is to go back to the long-term combined ratio of 98%, and this is what these actions are meant to achieve. With regard now to your last question, the lowest spot income in GI, essentially 2 reasons. One is a very simple one is as we have maturing bonds and reinvest them, we reinvest them at the current yield. And as a result, this has an impact on the investment income reported. And then with regards to capital repatriation, as you may remember from prior presentations, we paid -- or GI paid last year $2.4 billion in capital repatriation. This was actually in -- slightly in excess of the capital generation simply through the net income after taxes that also had an impact simply in terms of where the asset base is going by lowering the net income -- sorry, the investment income.

Farooq Hanif - Morgan Stanley, Research Division

Right, I see, yes, okay. So that's just referring to the retrospective dividend that you paid up, and therefore, your asset -- your starting asset was lower. That's the point you were making.

Pierre Wauthier

Right.

Operator

The next question is from Mr. Mark Taylor [ph] from Mediobanca.

Unknown Analyst

My first question is related to the life insurance division. There have been 570 million of net outflows in the second quarter. And I was wondering if there was any specific region or a specific reason for this, and how do you expect that to develop in the coming quarters? My second question is related to D&O insurance. Do you anticipate any visible losses following the LIBOR and money laundering settlements? And what's your appetite to increase exposures going forward?

Pierre Wauthier

Okay, so I'll answer the first question. So the net outflows is partly due to our strategy. We've seen this net outflow primarily coming from single premiums, which is typically savings products; also, to some extent, unit-linked, but where the fees are lower. So this is, if you want, part of our strategy to de-emphasize that. I think it's also fair to say that in Europe, where there's a recession, conditions are difficult and the whole market is more declining than increasing, and this is also affecting our operations. Expectations going forward, as you have seen, I think we've been, I think, really successfully growing our risk and protection business, as well as the expense or fee-based businesses. But that will continue to be the focus. And we certainly are focusing on increasing the BOP from that perspective. The net inflows and outflows, I think, will continue to be determined by the continuation, therefore, of our strategy and really what is happening in the Eurozone and whether there's a change in sentiment, which is not necessarily completely correlated, by the way, to GDP growth. So we'll see, but we're optimistic on our capabilities. We continue to grow the protection and the risk business. With regards to D&O insurance, I think it's really too early to have any predictions on that. Just as a reminder, we are present in the D&O insurance, but really the bulk of it is more in the U.S., and we really focus on the smaller institutions. So I would say that relative to other big writers, we're not really in the same camp there. But clearly, we will be assessing the situation as it evolves and develops.

Operator

The next question is from Mr. Andrew Ritchie from Autonomous Research.

Andrew Ritchie - Autonomous Research LLP

I'm not sure if you mentioned this in your video. I don't think you did. Can you just give us a sense if there's any meaningful exposure to -- I know you write multi-parallel crop insurance through various joint ventures, but any meaningful exposure to the current drought situation? Just give us a flavor of your exposure there. Second question, what more on retention in U.S. Commercial -- I mean, your -- the degree of rate increase has increased again a little bit in the second quarter. It's hard to judge what's happening in retention just from the premium growth because I know there’s some historic premium additions are happening. Can you give us a sense of what's happening in your retention rates on Commercial, U.S. Commercial, with these rate increases, and how that retention rate – has it improved, has it deteriorated, has it been easier to put through rate increases and not have an adverse impact on retention?

Pierre Wauthier

Okay, Andrew. So on the crop insurance, just -- and I know Farmers is called Farmers, but actually, Farmers is not active in the crop business. So that was the first. With regards to NAC, we have a limited exposure. It's only 2% of our premiums so the impact there, we would expect any way to be limited. And also just as a reminder, the structure of these insurance contracts are revenue-based. So while I think clearly everyone expects this to have an impact on the production, there also will be at least some compensation on the price side. We’ve seen the commodity price increases. That's really the net impact that has an influence on the insurance. I think it's too early to say where both are going, but in any case, our exposure is limited. With regard to rate increases, you're absolutely right. We have been accelerating rates in the U.S. pretty much across all lines of business. It continues to be strong, particularly also workers' comps, where we continue to have double-digit increase. You may have noticed market scouts also reporting that the rates are continuing to be still low single digit but at sustained level as a result probably of that but I would also hope our good underwriting customer relationship. We actually have seen retention rates increasing pretty much across the board which, also as a reminder, was already a trend we had observed in the first quarter and is, obviously, a key driver in the fact that we've also been growing premiums as a result in North American Commercial.

Operator

The next question is from Andy Broadfield from Barclays Capital.

Andrew Broadfield - Barclays Capital, Research Division

Two questions actually. One on Farmers. Just trying to reconcile for Zurich the process that Farmers is going to go through to try and correct its margins, the underwriting margins at the moment, and what that would mean to the growth. I think Farmers is growing for some time ahead of the market in various -- for various reasons organically and inorganically. But if you're correcting for some of the, I think, slightly disappointing performance there and I appreciate some of that's catastrophe, but even with that in context, that still, I think, underperformed. Should we anticipate some sort of loss of market share and, therefore, an impact to the Farmers fee business? And just attached to Farmers as well, the development of 21st Century, the growth there in 2Q looks like it stalled relative year-on-year. I was just wondering if you’ve got any update on that. And I’m being a bit cheeky; that’s one question. And then the second question just on developing trends you're seeing on -- in terms of economic impact on them. And I'm thinking you use, I think, significant right to a surety in the U.S. I just wonder whether that U.S. -- and actually, globally, whether that is anything we should be concerned about on those lines, or any other economic consequences coming through on, perhaps, some longer-tail stuff.

Pierre Wauthier

Okay. Thank you, Andy. So I noted 3 questions: one is the underwriting measures, the rate increases, et cetera, that we're taking, that mean a loss of market share; could I comment on 21st Century where growth seems to be stalling; and do we see, I guess, from the economic environment any indications with regards to our surety business. So with regards to the actions we're taking, actually, we're seeing a lot of our competitors who are also taking corrective actions, and therefore, we, at this stage at least, do not expect that it would have a significant impact on growth. In other words, we -- the growth actually has continued to be strong. But what we're seeing is that we're not necessarily misaligned to the market. And actually, the July results were encouraging, but one month clearly doesn't make a trend. With regards to 21st Century, I think you have to just keep in mind that the growth was 5.6% in the first half so it continues to be strong. What is happening is that it's not accelerating as it was last year. We have a somewhat lower budget that we have implemented but we see a continuing success in the cross-sell, and that is continuing to grow. So we don't necessarily see a further acceleration of the growth rate, but we feel at this stage that the growth in 21st Century is healthy. On the surety business, it's difficult to really comment where this is going. I think all we can say today is that this continues to be a really profitable business, and we're really happy with the way it is developing.

Andrew Broadfield - Barclays Capital, Research Division

So just to come back on the 21st Century, I’m referring to the policies in force actually on the auto sides, which I think on – in the slides in the appendix, it's suggesting that in the half year, they were only up 0.3% half year on the year-end. And I think quarter-on-quarter, it's actually down, on the next slide. So that's what I was referring to with 21st Century Direct so not so much premiums as policies in force.

Pierre Wauthier

Okay. Well, yes, it's not growing as fast as it was. I mean, to some extent, as I said, we've pared done a little bit on the marketing expenses, which last year were very strong so that probably has an impact. We're continuing to work actively, however, on the marketing. And don't forget that we're also seeing some benefit of the 21st still coming through in the cross-sell because the cross-sell, actually, while it is a 21st Century benefit, actually flows through the Farmers Exchanges. So from that perspective, I think you need to also to look at it globally.

Operator

Next question is from Mr. Stefan Schürmann from Bank Vontobel.

Stefan Schürmann - Bank Vontobel AG, Research Division

I have 2 questions. The first one is on Europe nonlife. You had some negative growth. Can you give us some feeling of what's really happening, especially in the markets now being in recession, like Italy or U.K. or Spain, in terms of top line and the claims re consumer nonlife side? And the second question relates to Switzerland only. I think you stated a very strong combined ratio below 80% despite I think some hailstorm claims. Basically, question is how much basically is reserve releases, and is that -- is there more to come here on that?

Pierre Wauthier

Okay. Well spotted, Mr. Schürmann. So Europe nonlife first. Those, I think Ireland, Italy, Spain are markets that are actually, from a global market perspective, in decline. I think the reasons are obvious. These countries are in a recession so simply what customers are doing, they're buying less. That is clearly one impact. The other impact is as you know, particularly in the U.K. and in Italy we've been taking strong underwriting actions. We’re actually really pleased with the progress we've made in terms of improving the profitability of our Personal Lines portfolio, where we've been having improvement. And while the profitability has increased, it has had indeed a negative impact on the premiums overall. So that would be the second of the strength, which is perfectly in line with our strategy. And therefore, we're quite happy with the way it's developing. As we have always said, the GI strategy is really to focus on improving the combined ratio, both the loss and the expense ratio. With regard to Switzerland, you're absolutely right. The result is excellent, and it did benefit from prior year reserve releases, which are linked to the whiplash statements. This is something that we have observed, frankly, over the last 2 years. But since this is a changing trend, we have been quite cautious in recognizing that trend in the numbers. So again, this is something voluntary. Could there be more to come? I mean, it will come to an end, but we feel at this stage, we're conservatively reserved. And if the next question is then how does your -- how do your numbers look like? If you take the whiplash out, then I'd say it's a good return. It's a healthy return. It is by no means an exceptionally low return that we should be ashamed of either.

Operator

The next question is from Mr. Jason Kalamboussis from Société Générale.

Jason Kalamboussis - Societe Generale Cross Asset Research

Question, the one on Farmers Reit [indiscernible] the second quarter, the quota share treaties that you have has a lot of physical damage, and that is what cost you quite probably in the second quarter. I just wanted to have some more comments on it, and if you will change anything on it. And I think you said 25% growth this year. And the other thing is on Farmers. When I'm looking at the quarter that you had and when we're looking at the second quarter this year and last year, it seems that you have high frequency, low severity. When looking at the repossession agreement that you have -- the reinsurance agreement that you have, it doesn't seem that you have an aggregate cover. Is it something that you would consider given that Santander already figures with high frequency?

Pierre Wauthier

I will repeat your questions just to make sure that I understood. The first question was what was the result on -- of these big catastrophes on our auto physical damage quota share with Farmers? And the second question was that we do not seem to have an aggregate cover for Farmers Exchanges, why not and what are our thoughts about it? So to the first question, you're right. The exceptional hailstorms, particularly the one in Texas, in Dallas, which happened at the time of rush hour, and you had golf to softball hail size caused massive damage in auto only. And there were some other hailstorm events which did cause the APD treaty to recognize a loss, which is -- may even have been the first time, but we couldn't go all the way back. But the point of this is this is a treaty as opposed to transfer risk. It does, and we had really, if you look back in history, a very exceptional quarter from the auto physical damage perspective. Overall, and if you look over time, unless it's a complete change in the patterns, we feel that this is a fulltime, a treaty that has really worked well, and it's doing its job right now.

Jason Kalamboussis - Societe Generale Cross Asset Research

So you don't have any concerns? Sorry for me, and you don't have any concerns about auto repair costs going up and things like that? You have no tenure deterioration also on that front?

Pierre Wauthier

There is some increases in repair costs, but that is more of a trend that we observe closely and that we're pricing in a rate increase in auto. So that would then be automatically covered through the APD treaty. With regard to the aggregate cover, it's something that we look at on a regular basis. Last year, we felt that the cost of this aggregate cover relative to the risk relief was not economic, and therefore, we didn't do anything. This is obviously something that we monitor on a regular basis and we'll continue to monitor going forward.

Operator

The next question is from Mr. Ralph Hebgen from KBW.

Ralph Hebgen - Keefe, Bruyette & Woods Limited, Research Division

I have got 2 points. One, is you mentioned -- Pierre, you mentioned on the -- in the videoconference that there is a limit to All Lines quota share contact existing between the Farmers Re and the Exchanges. Would you be able to comment on what that limit is, and also how much has been used up year-to-date? And the second question relates to sensitivities of your internal solvency ratio, the Z-ECM ratio, and perhaps also the SST ratio. The sensitivities given are the same as that -- as were in place as at the end of last year, but I believe that the presence of the equity market hedge will change these sensitivities. Again, would you be able to comment on sensitivities with the equity market hedge present?

Pierre Wauthier

Okay. So thank you, Ralph. With regards to the limit, there is indeed a limit. A big portion of that limit has already been absorbed in the first half as the amount of catastrophe has been much higher than average. And therefore, while there is still some cover at this point in time, it is very -- or it remains quite limited, such that indeed, if you have another repeat of this first half year, the impact on the Farmers Re would be much lower as a result of exhausting this cat cover. With regard to the Z-ECM, yes, you're right that the lower exposure on equity would reduce the sensitivity. And we will provide that update on sensitivities for the 2 -- 3Q results when we will update you on all the Z-ECM, SST and Solvency I ratio.

Operator

The next question is from Mr. Vinit Malhotra from Goldman Sachs.

Vinit Malhotra - Goldman Sachs Group Inc., Research Division

Just if I can start with the Global Corporate. You mentioned in your comments that energy is one of the lines where you increased pricing. And I've heard from some other insurers as well that energy in the corporate side is something that people are cleaning up. Could you just remind us what exactly has been the issue with energy? Is it just pricing; is it terms and conditions; and why does it need this kind of price improvement? Because workers' comp, we can understand, but energy was something, if you could comment on. And second question is on the choice of derisking. So for example, when you're talking about Eurozone tail-risk, you've chosen to hedge the equities rather than cut your Spanish exposure in terms of programs or covered bonds or -- and is that something that there was a debate, and what was the deciding factor of this debate, if I can ask that? And then on Farmers, just last question, sorry, on Farmers. What would -- could you just remind us at what point would you think about increasing the All Lines quota share, given that Farmers is now at 36% of that ratio?

Pierre Wauthier

Okay. So thank you very much for these questions. With regards to energy, this is a very competitive line of business and has been the case. So what we have done is really review our strategy and how we can improve the profitability. And this improvement of the profitability goes through typically the 2 same actions as we've taken throughout in GI: one which is some strong rate increases especially for those customers where we thought that could be adjusted; but also, we've been paring down the portfolio as a result of that so that we can continue in that business, and we can continue beneficially for all parties. The Eurozone tail-risk, actually, I forgot what the question was.

Vinit Malhotra - Goldman Sachs Group Inc., Research Division

Decision on hedge.

Pierre Wauthier

The decision on the hedge, yes, and maybe Cecilia or Martin can comment further with regard to the strategy. But more on the technical point of why the equity put options was chosen rather than credit spread, there's a very high correlation between the 2. First of all, there's a very important factor. And then when you compare the 2 and the costs of the 2, doing some hedges on the credit is much harder because you've got higher spreads, more illiquidity, and you have to do it in a much bigger size. So when we looked at reducing the risk, which is what really we've been focusing on, we found that the most effective way of doing that is -- was through that strategy. And then, Martin, perhaps you can have some comments.

Martin Senn

Yes, thanks. Just to add to what Pierre has just explained, of course, there was a debate that time, as there's always a good debate about any such decision we have taken. Let me stress as well, this has not been a change of our scenario, i.e., we still believe that the Eurozone will hold up, but as the risk has increased substantially beginning of the second quarter, end of last -- end of the first quarter we have looked at it and made an assessment, whether our capital is really effectively placed in order to get the right bang for shareholders, and that was not any more the case. As expected, returns will be lower to its levels at the time. And the very specific decision then we have to take is as we have been alluding to, where you sort of get the maximum benefit for any risk hedging, i.e., not threatening too much of potential return expectations, what the macro hedge consideration. And at the time of that debate, there was a bit of a mispricing, i.e., equity did not really price in that risk. So the equity hedge was much more economical relative to a hedge of any fixed income exposure in any of the respective big countries. And that's really the main reasoning, and I think we feel very good with the way we have implemented that now.

Vinit Malhotra - Goldman Sachs Group Inc., Research Division

Sure. I mean, the fixed income hedging would be expensive, but actually, reducing the underlying would have -- may have also been an option, that what I...

Martin Senn

Yes, but then you look for investment alternative, right, then you go soon into cash, and then it becomes more into equity, which you have to hedge again then. So that was, I think, fairly well done by our investment colleagues.

Pierre Wauthier

And I think you had the last question, which was our thoughts about the increasing of All Lines quota share and our surplus. So just as a reminder, the surplus ratio of the Exchanges, currently at 36%, so it's well within our range of 32% to 40%, which we communicated earlier. And therefore, it's quite comfortable -- quite comfortable within that range. We look at the All Lines quota share on a regular basis, and then clearly, we will review that as part of that exercise. But currently, there are no plans in changing that, at least for this year.

Operator

The next question is from Mr. Michael Huttner from JPMorgan.

Michael Huttner - JP Morgan Chase & Co, Research Division

I like the underlying loss ratio. On that, can you say -- you remember when Mario Greco, about some bit years ago, said you want to beat the -- I think it was combined ratio of peers by 3% to 4% by 2013, I think it was. Have you actually reached the target now? It feels like you have, but I just wondered and maybe give us a feel, Mario Greco’s departure, what does it change or not change, I don't know. And then on the Farmers Re, in that nice chart where you show the underlying or the implicit business operating, tax business operating profit, ROEs of each division, you also show Farmers at 40.7% in the first half. Now working backwards on that, it means the capital is about 2 and a little bit billion, maybe $2.2 billion. Today, you have $2 billion of sub debt, which you've kind of lent to Farmers, which implies that Farmers Re has 0 capital, is that right? Or $200 million on premiums of $4 billion, just to get a feel for it?

Martin Senn

This is Martin. Let me take the first question, as you referred to a former great professional and good colleague and friend, Mario Greco. What I can say has not changed. This is the strategy, and the strategy remains intact, as it has been our strategy since setting out. They're not dependent on any individual, but really in -- on the interest of the firm. And with that, that target we have described back in -- end of 2009 at the Investor Day to achieve 3 to 4 percentage points better combined ratio relative to peers is still intact. Keep in mind, that's a target defined for end of next year. Also, our efficiency targets are still intact there, I should say. It's more than a feeling if we are on course or not. I think we are probably ahead of it. We will update you at the Investor Day later on this year on details about that. Overall, on the combined ratio, the sensing, I think we're doing well. The underlying attrition loss ratio shows that we could just take that somehow of the guideline benchmarking against that combined ratio expression, I would say it feels good to be on track. I hope that gives a bit of a flavor how our feelings are expressed, Michael.

Pierre Wauthier

And on to your second question with regards to the BOPAT ROE, so we are allocating some capital to Farmers Re, so it's -- I think you don't have -- while your overall reasoning is correct, you'd have to go finer into the details to really see how much is allocated. For example, the surplus is not 2 billion; it's 1.9 billion, and there are some other elements there. However, what I would also highlight is while the capital to Farmers Re is not 0, it is not that big either. And the key reason is that the APD actually has a limited -- when you look at the range of outcomes, it is a typically less risky type of treaty than others. And therefore, the capital allocation on that one is low. Also, as we have mentioned, there is a limit on the cat All Lines quota share treaty, which also reduces the risk. So all-in-all, when you look at the specific features of the quota shares, the capital consumption relative to the premium is typically lower than it definitely would be if you did the same exercise for the Exchanges. But the Exchanges, as you know, are third party. And because also we are largely in Personal Life, Personal Lines is also an area where the capital consumption is quite small.

Operator

The next question is from Mr. Fabrizio Croce from Kepler Capital Markets.

Fabrizio Croce - Kepler Capital Markets, Research Division

I have 2 questions. The first one is -- I think one actually is about bridging your -- so if a figure at all astonish me during this result is that you have enormous large claims actually in the same amount than last year in terms of percentage points of the combined ratio. But last year, you had Japan, New Zealand, Australia. This year, I mean, if you add up what you said in the presentation, I come to some 170 million, but the figure there is 1,276 million. So my question is if you could give me some more detail or in order that I could bridge this figure, understand what else is in because I have a gap of some 1.1 billion. And the second one, if I look to your intangible position, it increased pretty dramatically from some 6 billion to 8 billion, and here looking forward 2 or 3 years from now, what should we expect this figure to be?

Pierre Wauthier

Okay. So Fabrizio, thank you very much for your question. The question on the large losses, so all the events that you're referring to, such as New Zealand and Japan earthquake, as well as the Australian floods and other cats that we had, were actually reported in cats, so the catastrophes, where the impact last year was 4% or almost -- or close to $600 million. And this year, the impact of cats was 0. So there's a massive difference here indeed in terms of big, major natural catastrophes. The large losses do not include any of that. And typically, our policy has been anything above 100 million qualifies for major cat and not anything below. What -- for the large losses, we would never expect them to be 0, and typically, they range between 7% and 9% if you look at the last few years. And we would be -- these losses are $2 million, $3 million, a $10 million loss that we start to notice. But we would always expect to have large losses. So we've had that, and it's been a bit lower this year than last year. But we would still expect to have there part of the large losses that had an impact this year was, as I mentioned in the video, hailstorms that we had both in Germany and Switzerland, sorry. And we had also if you look at the first half year, you may remember the winter was very, very cold. That also had an impact. And the last is although that was more of third good quarter than second quarter, it was relatively wet in England by now. But at least there is no crops, right, in the U.K.

Debra Broek

The intangibles.

Pierre Wauthier

And the intangibles, the answer is yes, you're right, it did increase substantially. That is, in essence, due to the Santander joint venture, where a large part of our purchase was recorded in intangible assets.

Fabrizio Croce - Kepler Capital Markets, Research Division

Yes, but is there any plan? I mean, this -- will this figure stay stable going forward for the next 2, 3 years? Or I know that the external auditors tells you that this is all reliable and nothing needs to be written down and so on. Still, will there be some adjustments to this figure within the next 2, 3 years?

Pierre Wauthier

Okay. So this figure is typically driven by the acquisitions we make. So if we don't make any other acquisition, that number would actually decline. Part of the intangible asset consists of a distribution agreement. That's true also for Citadel [ph]. These are typically amortized over the time of the distribution agreement. So in the case of Santander, it will be 25 years. So that number, over time, will go down. And then of course, we'll review on the quarterly high level and then on a detailed basis, annual basis, whether the value of that intangible asset is still justifiable. This is essentially doing what you guys do extremely well, which is discounted cash flow analysis using an appropriate discount rate of the value of that. And then if the value based on this discount out of the cash flow analysis is lower than what is booked, then that would cause an impairment. We are making -- just on that point perhaps, we're making very good progress in the operation of Santander. As you may have seen on Slide 15, I believe we're growing our statutory profit by 18%. The corporation is working really well, and we're very pleased with the way it's going, and it's really according to our expectations.

Operator

[Operator Instructions] The next question is from Mr. Raphael Caruso from Raymond James.

Raphael Caruso - Raymond James Euro Equities

You've partly answered some of my questions, so sorry for that. First of all, what are your expectation regarding the General Insurance expense ratio? Are you expecting any strengthening, decreasing, increasing rates there? Secondly, do you expect the All Lines quota share treaty of Farmers to be back to 12% in Q3? And finally, in Q1 and Q2, international businesses generated between 3% and 5% of your General Insurance business operating profits, are you happy with the current contribution of international businesses, or do you expect an increasing contribution as it was the target for the group, both in life and nonlife sense?

Pierre Wauthier

So thank you very much. With regards to the expense ratio, what we're seeing in line with our strategy is we've been focusing on -- first, actually, we've been focusing on reducing expenses in mature markets. So with regard -- within the expense ratio, the other underwriting expenses was as we're focusing on reducing expenses, we would expect that to also have a positive impact on the technical expenses. You should keep in mind that we're looking at really the overall expenses. So that program has an impact both in the technical expense, as well as the non-technical expense, as well as in the loss adjustment expenses. So it's a bit as it were, but I'm pleased to report that on that, we're making very good progress on our target to 2013 to reduce the overall expense by 500 million, as we have communicated, and we'll give you some further update at our Investor Day. With regard to the commission ratio, that ratio has been affected by the fact that the commission structure in Santander is higher than the group average. That has had an impact of increasing the commission ratio, and that we would expect to continue at least for the next 25 years, given our agreement with Santander. But that is not necessarily something we're worried because the business overall is profitable, so we're happy to continue that association. With regard to the quota share, as I mentioned early in the questions, the quota share is currently at 20%, and we have no plans to change it, at least for this year. So no for 12% going forward, at least not this year. And then the International Markets, we clearly -- as you know, we are focusing on growing in International Markets we've identified. And a lot of these markets are in Latin America, as well in Asia. We're very pleased with the growth that we're experiencing. You can see, in particular in GI, that most of the growth actually comes from that International Markets. And then clearly, as the business develops and grows, we would expect the bulk contribution to grow as well. And Martin maybe you [indiscernible].

Martin Senn

Just maybe to add as well, Raphael, on that question you asked, are we happy with the development, we definitely are very satisfied because this is exactly in line with the strategy. I really look for profitable growth opportunity into new markets. And if you see for the first 6 months, I take not to speak out GI as an example, 27% up in International Markets versus 2% down in Europe. And this is nearly 4x overcompensating. We are relatively early in that -- into that sort of joint venture on distribution with Santander in Latin America, next to our organic own pipeline. We’re relatively early into the acquisition in Malaysia. The same strategy we obviously pursue as well in life, and that is also kicking in now in Latin America. So I would expect, over time, on the assumption that the economic growth in mature market is going to remain low. It might level off somehow as well in emerging markets, but it's going to remain positive. In Europe, we’re fighting a recession, full stop, and I do not see that to have -- to change over the next 2 quarters, frankly. So I would see that this trend we're showing here will continue. We will find the base in Europe, and then I also see that we're going to grow back into Europe, as we, at the moment, grow well in North America, with 5% in GI, and the Global Corporates, 3% all together. That includes also mature markets. So the numbers we're showing here are exactly in line what we have defined in the strategy. And with that, we are very pleased.

Operator

The next question is from Mr. Daniel Bischof from Helvea.

Daniel Bischof - Helvea SA, Research Division

Actually just one question left on pricing in GI. You achieved the price increase of 4.1% in Q2 after 3.1% in Q1. Can you just remind us again what portion of this price increase you expect to translate into an actual improvement of the underlying loss ratio?

Pierre Wauthier

So the rate increases, we expect to exceed the claims inflation. So as a result, we expect an improvement in the underlying loss ratio. But clearly, the pure rate increase is not going to flow through 1 for 1 into the loss ratio given the claims inflation.

Daniel Bischof - Helvea SA, Research Division

Would 1/3 be a good assumption?

Pierre Wauthier

Would 1/3 be -- no. Look, I think there is -- it varies by business, and the trends change. So that's why we're really careful in giving you an indication there. We're satisfied to tell you that the rate increases do exceed the loss cost inflation. Giving you a percentage, I think, is going to be dangerous. But I would still say that the claims inflation is running -- how should I express that? One, just that only 1/3 of the rate increases would be absorbed by loss cost would still be too low because then you're implying that your loss cost inflation is only 1% or very slightly above 1%, which it is higher in certain markets. But again, you really need to look at it on a line-by-line business because we're seeing in certain lines of business virtually 0 to 1%. But then in those lines where the combined ratio is really good, then we may not necessarily take some rate increases, and that would be completely appropriate. So when you go into the details, it becomes more complicated.

Operator

Ladies and gentlemen, that was the last question for today.

Pierre Wauthier

Impressive discipline.

Martin Senn

I want to take then this occasion to thank you all for joining us today and for your questions. Also, on behalf of Pierre, of course, let me just quickly end with some messages, and as I said earlier, we believe that these are solid strong results in a really challenging environment, we do remain profitable, we are well capitalized, we improved solvency and we are on track to deliver on our targets for this year and for 2013. We are very pleased with this performance, and we do remain very confident that we are on the right track and that we are well positioned to deal with any situation whatever the future may hold. We will continue to focus on the execution of the strategy, which is clearly working, not only this year, but throughout the last 5 years since the crisis started. And with that, we are continue doing that the Zurich way, which is with discipline and focus. And I'm very much looking, together with Pierre and all my colleagues, to soon catch up with you again in person or latest at our 9-months results reporting in not too much later than today. And with that, I thank you all. I wish you a nice day and good luck in the markets. Thank you.

Operator

Ladies and gentlemen, the conference is now over. Thank you for choosing the Chorus Call facility, and thank you for participating in the conference. You may now disconnect your lines. Goodbye.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Zurich Insurance Group AG Management Discusses Q2 2012 (H1 2012) Results - Earnings Call Transcript
This Transcript
All Transcripts