Financial year Financial Markets
Financial Markets results 2006
CHF millions Credit and rates
Equities and
alter-native investments Other Total
Net investment income 6 327 575 –11 6 891
Net realised gains/losses –182 904 43 765
Fees, commissions and other revenues 201 201
Total revenues 6 346 1 479 32 7 857
Expenses –556 –262 –18 –836
Total operating income 5 790 1 217 14 7 021
Return on investments in % 5.0
2007
CHF millions Credit and rates
Equities and
alter-native investments Other Total
Net investment income 8 696 696 9 392
Net realised gains/losses –1 518 1 631 –1 294 –1 181
Fees, commissions and other revenues 125 125
Total revenues 7 303 2 327 –1 294 8 336
Expenses –697 –283 – 24 –1 004
Total operating income 6 606 2 044 –1 318 7 332
Return on investments in %¹ 4.9
¹ The return on investments includes currency exchange rate remeasurements and designated trading portfolios.
The designated trading portfolios comprise trading fixed income securities denominated in foreign currency, which back certain liabilities denominated in foreign currency. The overal impact of the currency exchange remeasurements was CHF –61 million in 2006 and CHF –476 million in 2007.
Net investment income grew 37% to CHF 8.7 billion. Net realised losses on credit and rates investments were CHF 1.5 billion in 2007, compared to net gains of CHF 0.2 billion in 2006.
Net realised losses in 2007 included mark-to-market losses on investments classified as trading, impairments, as well as the replacement of lower yielding securities with higher yielding investments. Net realised losses relating to assets backing liabilities were CHF –415 million in 2007. The average running yield on Swiss Re’s portfolio increased from 4.8% in 2006 to 5.2%.
Fees and expenses decreased in 2007 compared to 2006, as the prior year included Fox-Pitt, Kelton which was sold on 28 June 2006.
Swiss Re provides asset management services for insurance clients under the Conning Asset Management brand in the US, Canada, Bermuda and Europe. Third-party assets under man-agement increased to CHF 92.8 billion at the end of 2007 from CHF 85.4 billion at the end of 2006.
Expenses increased CHF 141 million, in line with the growth in assets under management and increased securities lending activity. Expenses in relation to proprietary assets under manage-ment were 25 basis points in both 2006 and 2007. Net unrealised gains of CHF 1.1 billion at the end of 2006 increased to CHF 1.9 billion at the end of 2007.
Equities and alternative investments
In 2007, Swiss Re increased its gross exposure from CHF 19.1 billion at the end of 2006 to CHF 23.2 billion at the end of 2007, mainly in private equity investments and a diversified portfolio of hedge funds. The net exposure was substantially lower as a result of active use of equity derivative instruments.
Net investment income and net realised gains increased to CHF 2.3 billion from CHF 1.5 bil-lion in 2006. This reflects the higher asset base, but also the excellent performance of public and private equities and hedge funds, as well as the sale of the London office building at 30 St Mary Axe.
Expenses increased CHF 21 million, in line with the growth in assets under management. Net unrealised gains on the balance sheet were CHF 3.1 billion at the end of 2006, compared to CHF 3.0 billion at the end of 2007.
Other
Net realised losses relate to the mark-to-market loss on two related credit default swap trans-actions which was announced in November 2007 and is discussed in more detail in the letter to shareholders on pages 3 – 4.
Risk management
Swiss Re actively manages its exposure to financial market risks. At the end of 2007, the credit spread exposure – as measured by a stress scenario – was reduced by means of credit default swaps from a gross exposure of CHF 2.2 billion to a net stress exposure of CHF 1.7 billion.
Similarly, Swiss Re’s equity market exposure was actively reduced by means of equity deriva-tives. Measured in terms of the equity market stress scenario that assumes a 30% fall in equity markets with a simultaneous increase in volatility, the gross stress exposure of CHF 3.9 billion was reduced to a net stress exposure of CHF 2.7 billion by the end of 2007.
Investments by currency as of 31 December 2007 Total CHF 176.0 billion
USD
Financial year Financial Markets
Asset-liability management at Swiss Re
Asset-liability management (ALM) is an integral part of how Swiss Re monitors and man-ages financial market risk. It involves splitting Swiss Re’s economic balance sheet into two virtual balance sheets: one exposed to insurance risk and the other to financial market risk.
The insurance risk balance sheet shows the market-consistent value of insurance liabilities and capital on the liability side and a notional “minimum risk portfolio” on the asset side.
This notional portfolio represents investments – typically cash and fixed income instruments replicating the risk characteristics of future liability cash flows – that minimise financial market risk relative to the liabilities.
The market risk balance sheet shows the Group’s actual investments on the asset side and the minimum risk portfolio as a liability, which is then used as the basis for setting the benchmark for Swiss Re’s investment activities. Combining both balance sheets repro-duces the full Group balance sheet.
Group balance sheet
Assets Liabilities Minimum risk portfolio
Liabilities Assets Minimum risk portfolio
Capital Capital
Insurance risk Market risk
= +
In particular, the Group monitors the potential impact from interest rate changes on its investment and minimum risk portfolios. Interest rate exposure is measured in terms of the change in value of interest rate-sensitive instruments from an upward shift of key interest rates by 1 basis point. In addition, interest rate risk is assessed by scenario analysis, and quantified in terms of Value at Risk (VaR) and Tail VaR (expected shortfall) for various confi-dence levels and holding periods.
The Group manages its interest rate risk relative to the minimum risk portfolio. As of 31 December 2007, assets and liabilities were closely matched, resulting in moderate interest rate risk for the Group.
30 20
10 5
3 2
1 2 3 5 10 20 30
1 2 3 5 10 20 30
1
Asset-liability match of Swiss Re Group as of 31 December 2007 Price value of 1 basis point
Maturity of key interest rates in years
Investment risk portfolio
Minimum risk portfolio
NetBusiness developments
Swiss Re is well prepared for softening property and casualty rates in the reinsurance market.
The Group will not deviate from its strict focus on underwriting discipline and economic profit growth. At the same time, Swiss Re will continue its share buy-back programme started in March 2007 and expanded in January 2008. Due to current share price levels, combined with reduced risk capital requirements resulting from lower premium volumes, the buy-back is likely to be completed ahead of the original schedule. At the same time, Swiss Re is convinced that upcoming Admin Re® transactions and growth in new lines of business, such as longevity and variable annuity solutions, will offer further opportunities for attractive capital returns.
The January 2008 renewals of Swiss Re’s traditional non-life portfolio showed signs of price softening in most sectors; however, margins in general are still at satisfactory levels. Overall, prices on our renewed portfolio decreased 3%, but remained above the technical reference price for both proportional and non-proportional business. Swiss Re’s disciplined underwriting and careful risk selection is reflected in a reduction in volume of 12%.
Property and specialty market conditions are expected to soften further in the near-term. How-ever, an increased focus on pricing transparency, a rising industry trend towards returning surplus capital to shareholders and volatility in the investment markets might make the current cycle shorter than in the past.
The casualty market will remain challenging. In 2008, Swiss Re expects the subprime and credit crisis, which is currently focused on the US, to deteriorate further, with knock-on effects outside the US. The crisis will also have an impact on professional liability insurance, although it is still difficult to estimate the extent, and may potentially lead to legal reforms. Swiss Re will continue to carefully manage exposures and take appropriate pre-emptive action. Since 2004, the Group has materially reduced its exposure to US directors’ and officers’, errors and omis-sions, and professional indemnity business. Swiss Re thus has a low exposure to possible liability risks from the subprime and credit crisis.
Many EU member states are still reviewing their draft laws for transposing the Environmental Liability Directive. These will be enacted in the course of 2008 and beyond, leading to an increased demand for environmental insurance and reinsurance support.
The Group remains fully committed to capturing value across all property, casualty and specialty lines through active cycle management, and reiterates its emphasis on quality over quantity.