5 Risk Management Policies and Procedures

The Group’s core business is life insurance and pensions. A life insurance and pensions contract represents a long-term promise to the policyholder. To fulfil its future payment obligations to the policyholders, the insurance entities of the Group must be financially sound over an extended period of time. The ability to remain financially healthy and strong depends on a number of risk factors. The Group risk map can be broadly divided into financial, insurance, strategic and operational risks. All of these risk categories can impact the financial stability of the Group.

Risks must be identified, assessed, managed and monitored locally. Half-yearly reports covering interest rate risk, equity price risk, currency risk, credit risk and insurance risk are prepared on a consolidated basis. Additionally, market risks and financial risk limits are reported on a monthly basis for the largest operations in the insurance business. Strategic and operational risks are assessed and reported on an annual basis.

The risk appetite for the largest operations in the insurance business is defined with the help of local risk budgets which are used as a basis for the determination of the individual risk limits. These limits are used as a framework for the asset and liability management process, the objective of which is to define a strategic asset allocation and distribution scheme for all stakeholders.

Risk management functions are fulfilled at several levels by different bodies within the Swiss Life Group, such as the Investment and Risk Committee at the level of the Board of Directors of the Swiss Life Group and the Group Risk Committee at the level of the Corporate Executive Board of the Swiss Life Group. The risk management functions at the level of the individual operations of the Swiss Life Group are organised accordingly.

Group risk management produces a consolidated risk report which consolidates the main quantitative elements of the risk management of the Swiss Life Group’s operations.

The information below focuses first on the risk budgeting and asset and liability management process before covering in an extensive way the principal risk categories faced by the Swiss Life Group.


 
5.1 Contracts for the account and risk of the Swiss Life Group’s customers

The assets relating to certain life insurance and investment contracts are managed for the account and risk of the Swiss Life Group’s customers (separate account/unit-linked contracts, private placement life insurance). They are segregated and managed to meet specific investment objectives of the policyholders. The assets back the insurance liabilities and the financial liabilities arising from these contracts. The fair values of the liabilities reflect the fair values of the assets. Certain contracts with unit-linking features contain guaranteed minimum insurance benefits. The liabilities relating to this part are included in the insurance liabilities.

The assets and liabilities from separate account/unit-linked contracts and private placement life insurance are generally excluded from the Swiss Life Group’s financial risk management considerations to the extent that the risks are borne by the customers.

Assets for the account and risk of the Swiss Life Group’s customers
In CHF million 
Notes  31.12.200931.12.2008
Cash and cash equivalents
  1 9101 287
Derivatives
9  106
Financial assets at fair value through profit or loss
 
Debt instruments
10  5 0773 120
Equity securities
10  2 616805
Investment fund units
10  7 3555 723
Other
10  1 6931 484
Total assets for the account and risk of the Swiss Life Group's customers
  18 66112 425


Liabilities for the account and risk of the Swiss Life Group’s customers
In CHF million 
Notes  31.12.200931.12.2008
Financial liabilities at fair value through profit or loss
10  15 1019 727
Investment contracts
19  2 7881 725
Insurance liabilities
22  742952
Total liabilities for the account and risk of the Swiss Life Group's customers
  18 63112 404


The financial result for the years ended 31 December for the account and risk of the Swiss Life Group and the Swiss Life Group’s customers was as follows:

In CHF million 
  For the account and risk of the Swiss Life GroupFor the account and risk of the Swiss Life Group's customers Total
  200920082009200820092008
Investment income
  4 2074 563004 2074 563
Net gains/losses on financial assets
  –118–6 0100–118–6 010
Net gains/losses on financial instruments at fair value through profit or loss (FVPL)
  291 1 790 24 63 315 1 853
Net gains/losses on investment property
  184194184194
Share of results of associates
  6–1496–149
Financial result
  4 57038824634 594451
 
The financial result for the account and risk of the Swiss Life Group's customers consists of
 
net gains/losses on financial assets at FVPL
  1 512–3 060
net gains/losses on financial liabilities at FVPL
  –1 4883 123



 
5.2 Risk budgeting and limit setting

The risk capacity and the risk appetite of the Swiss Life Group’s insurance operations are primarily defined based on economic principles. Consequently, the market values or best estimates of both the assets and the liabilities are obtained by discounting the cash flows generated by these assets and liabilities with an appropriate discount rate. The risk capital available is defined as the difference of the economic value of the assets compared to liabilities. The available risk capital is used to cover the different risks to which the Swiss Life Group’s insurance operations are exposed by the nature of their activities. The final decision on the risk appetite for each insurance operation rests with the Corporate Executive Board.

Risk and exposure limits are defined to control and limit the exposure to these risks. The limit systems and processes are set in a way that the sublimits are not utilised simultaneously in full.

The main focus of these limits is on overall market risk, credit risk and, more specifically, on interest rate risk as well as on currency risk and equity price risk.


 
5.3 Asset and liability management (ALM)

The main objective of the ALM process is to ensure that the Swiss Life Group’s insurance operations can meet their commitments to policyholders at all times while also adequately compensating shareholders for making risk capital available. Based on the economic principles of risk management and on the risk appetite definition applied in the risk budgeting process, ALM comprises the following main activities: strategic asset allocation and distribution policy with regard to surplus generated on investments.

The ALM process is centrally coordinated at Group level by means of local asset and liability management committees with representatives from local senior management and representatives from Group level. The local units are in charge of implementing the decisions. The process requires the involvement of investment management, finance, actuarial and risk functions.

Compliance with external constraints — Aspects other than the purely economic view must also be considered in the ALM process, such as regulatory requirements including statutory minimum distribution ratios (“legal quote”), funding ratios, solvency, local accounting rules and International Financial Reporting Standards, liquidity requirements and rating targets. Some of these views may lead to results that are not aligned with the economic approach, but nevertheless need to be taken into account.

Depending on the regulatory framework in which the Swiss Life Group’s insurance operations evolve, the asset portfolios might need to be split to reflect the different categories of insurance products. The asset portfolios of the insurance operations in Switzerland have been separated to distinguish between individual life and group life. As a consequence, such separation is also reflected in the ALM process.

Strategic asset allocation — Strategic asset allocation is the first major task of the ALM process and aims at achieving an efficient risk capital allocation, i.e. optimising the returns on the asset portfolio for the available risk capital defined within the risk budgeting process, taking into account all known constraints.

The liabilities are largely predefined in terms of amount and timing of the payments and the associated assumptions are regularly reviewed. The corresponding asset portfolios mainly comprise fixed-income instruments. This way, the impact of interest rate fluctuations and the risk capital consumption are strategically optimised under a risk/return point of view, thus ensuring that the policyholders receive the benefits they were promised. Policyholders benefit from the ensuing investment returns in the form of discretionary participation, while shareholders benefit from an increase in the value of their investment in the Swiss Life Group.

The strategic asset allocation is therefore determined on the basis of the individual existing commitments and the risk capacity of the Swiss Life Group’s insurance operations. The strategic asset allocation is reviewed at least once a year and adjusted if necessary.

The ALM process has been applied in all relevant insurance operations of the Swiss Life Group.

Distribution policy — The distribution policy seeks to harmonise the interests of the different groups of stakeholders. Holders of traditional life insurance policies favour a guaranteed minimum interest rate coupled with regular and appropriate discretionary participation whereas shareholders place greater emphasis on returns commensurate with the level of risk they are exposed to. Internal guidelines have been developed which define the policies for the allocation of policyholder participation with regard to annual bonus and terminal bonus. The focus of the Swiss Life Group lies on the sustainability of the business model and should balance the policyholders’ and shareholders’ expectations.

External constraints must be considered in the definition of the distribution policy. Important elements which influence such policy are minimum guaranteed interest rates and the statutory minimum distribution ratio (“legal quote”), which strongly depend on the regulatory environments of the Swiss Life Group’s insurance operations.

Product design — The targets of risk management are supported by product design principles. Product design defines which guarantees and benefits are built into a specific product to respond to the demand from and expectations of customers. The actuarial bases used for this purpose should ensure that each individual product generates a sufficient contribution margin. To ensure that the Group’s principles are observed, guidelines on product management and underwriting have been introduced to harmonise the local guidelines and to ensure that they are in line with the guidelines of the Group. As the Group’s insurance entities operate in a number of different countries, the local regulatory constraints may have an impact on the business unit organisation and product range. These constraints must always be obeyed.


 
5.4 Financial risk management objectives and policies

The Group is exposed to financial risk through its financial assets, financial liabilities (primarily investment contracts and borrowings), reinsurance assets and insurance liabilities. In particular, the key financial risk is that the proceeds from the financial assets are not sufficient to fund the obligations arising from the insurance and investment contracts, as well as from borrowings and other liabilities. The most important components of the financial risk are interest rate risk, equity price risk, credit risk, currency risk and liquidity risk.

The risk budgeting and limit setting described above ensure that interest rate risk, equity price risk, currency risk and credit risk remain under control. The corresponding market risk capital, interest rate risk capital, currency risk capital and credit risk capital limits as well as exposure limits for currencies and net equity for each relevant insurance operation are defined based on the risk appetite. These limits are assessed and reported on a monthly basis.

Insurance liabilities with embedded derivatives not separated and fair valued
In CHF million 
  31.12.200931.12.2008
Interest rate risk
  86 13584 744
Equity price risk
  2
Elimination of duplications
  –2
Total insurance liabilities with embedded derivatives not separated and fair valued
  86 13584 744
Other insurance liabilities
  5 4405 328
Insurance liabilities for the account and risk of the Swiss Life Group's customers
  742952
Total insurance liabilities
  92 31791 024


Hedging — The Swiss Life Group uses derivatives within the strict limits set by the applicable insurance legislation and by internal guidelines. Derivatives are primarily used to manage the exposure to equity securities, interest rates, counterparties and foreign exchange rates. The main instruments include index futures and option structures in stock markets, bond futures and swaps in order to manage duration, currency forwards in order to manage currency risk and credit default swaps in order to manage counterparty risk. Within certain limits, derivatives are used to enhance returns on the existing portfolio. The types of derivatives generally permitted for usage within the Swiss Life Group as well as the list of allowed over-the-counter trading partners have been approved by the Group Risk Committee.

Hedging strategies involve hedge accounting as well as “economic hedging”. “Economic hedges” comprise financial assets and financial liabilities which share a risk with derivatives and give rise to opposite changes in fair value that tend to offset each other.

Interest rate risk relating to financial instruments and insurance contracts — The Group’s primary interest rate exposure is to contracts with guaranteed benefits and the risk that the interest rates of the financial assets purchased with the consideration received from the contract holders is insufficient to fund the guaranteed benefits and expected discretionary participation payable to them.

Interest-SENSITIVE insurance liabilities
In CHF million 
  CHFEUROtherTotal
 
Carrying amounts as at 31 December 2009
 
Minimum guaranteed interest rate 0 – < 2%
  11 3742 927014 301
Minimum guaranteed interest rate 2 – < 3%
  25 9275 497431 428
Minimum guaranteed interest rate 3 – < 4%
  19 38010 6556530 100
Minimum guaranteed interest rate 4 – < 5%
  8089 4332910 270
Minimum guaranteed interest rate 5 – < 6%
  22527
Minimum guaranteed interest rate 6 – 8%
  99
Total interest-sensitive insurance liabilities
  57 48928 53411286 135
Non-interest-sensitive insurance liabilities
  5 440
Insurance liabilities for the account and risk of the Swiss Life Group's customers
  742
Total insurance liabilities
  92 317


Carrying amounts as at 31 December 2008
 
Minimum guaranteed interest rate 0 – < 2%
  1 1013 89104 992
Minimum guaranteed interest rate 2 – < 3%
  34 7284 469539 202
Minimum guaranteed interest rate 3 – < 4%
  20 7589 3316330 152
Minimum guaranteed interest rate 4 – < 5%
  8349 5023310 369
Minimum guaranteed interest rate 5 – < 6%
  14620
Minimum guaranteed interest rate 6 – 8%
  99
Total interest-sensitive insurance liabilities
  57 42127 20711684 744
Non-interest-sensitive insurance liabilities
  5 328
Insurance liabilities for the account and risk of the Swiss Life Group's customers
  952
Total insurance liabilities
  91 024


The insurance liabilities with minimum guaranteed interest rates between 0% and 4% are primarily denominated in Swiss francs and euros, and the insurance liabilities with minimum guaranteed interest rates between 4% and 8% are primarily denominated in euros.

Most life insurance products with a savings component and investment contracts are subject to minimum guaranteed interest rates. The guaranteed rate differs according to the type of contract. In Switzerland for instance the minimum guaranteed interest rate for the occupational pensions segment (BVG) stood at 2% in 2009 and will remain at 2% for 2010.

In addition to these fixed and guaranteed payments which are exposed to interest rate risk, contractual rights exist for certain contracts to receive additional benefits whose amount and/or timing is contractually at the discretion of the issuer. The determination of the discretionary participation is highly dependent on future investment returns.

The Group manages interest rate risk by managing the interest rate sensitivity of key rate exposures of its investment portfolio against the interest sensitivity of key rate exposures of liabilities issued. The key rate exposure of the liabilities is determined by projecting the expected cash flows from the contracts using best estimates of mortality, disability, expenses, surrender and exercise of policyholder options. The ALM process defines the strategic asset allocation optimising the net interest rate sensitivity of the investment and liability portfolios. To the extent that this is not practicable, swap contracts and other instruments are used to hedge interest rate risk. In certain markets receiver swaptions are used to hedge the risk of interest rates decreasing below guaranteed interest rates. Payer swaptions are used to hedge the risk of fair value changes of interest-sensitive financial assets. Strategically, a minimum interest rate risk will remain, since a perfect interest rate hedge can either not be achieved or would not be targeted.

In addition to the strategic optimisation of the net interest rate risk exposure at an economic level, the Group has designated a portion of assets to be held to maturity and matching the maturity profile of the associated liabilities to minimise the interest risk arising from these positions. The assets to be held to maturity fund the insurance and investment contracts that will not be surrendered or will not require the payment of a death benefit.

Regarding interest rate risk exposure existing on contracts with guaranteed benefits where the risk is that the interest rates earned on the assets are insufficient to fund the guaranteed payments, puttable bonds are used to counter the impact of falling interest rates. To increase the convexity of interest-rate-sensitive assets, which is generally lower than the convexity of the insurance liabilities, receiver bonds are part of the asset portfolios in certain countries.

In certain businesses, a large part of the impact of interest rate changes is for the account and risk of the policyholders based on the specific profit-sharing systems.

Equity price risk — A decline in the equity market may lead to a reduction of the Swiss Life Group’s realised and unrealised gains/losses, which also negatively affects the Swiss Life Group’s results of operations and financial condition.

Hedges in place with respect to the Swiss Life Group’s equity investments are designed to reduce the exposure to declines in equity values but would not prevent an impairment loss in the event that the impairment criteria were met.

A portion of Swiss Life’s investment portfolio comprises investments in funds which hold securities issued by non-public companies (private equity). These investments may be illiquid or may only be disposed of over time or at a loss, and they may not produce adequate returns or capital gains. If Swiss Life were required to liquidate some or all of the investments in its private equity portfolio, the proceeds of such liquidation may be significantly less than the amount paid for, or the carrying amount of, such investments.

Swiss Life’s investment portfolios also include investments in hedge funds. The liquidity of such investments can vary according to market conditions, and the investment styles of such hedge funds could amplify any factors affecting the performance of any particular class of funds or investments.

Credit risk — The Group is exposed to credit risk, which is the risk that a counterparty will be unable to pay amounts in full when due. Key areas where the Group is exposed to credit risk are:

Counterparty risk with respect to bonds purchased
Counterparty risk with respect to loans and mortgages granted
Counterparty risk with respect to money market and cash positions
Counterparty risk with respect to derivative transactions
Reinsurance share of insurance liabilities
Amounts due from reinsurers in respect of claims already paid
Amounts due from insurance contract holders
Amounts due from insurance intermediaries

To reduce the credit exposure relating to derivatives a collateral management process has been established. Contractually all outstanding positions must be fully collateralised if they reach a very low agreed minimum transfer amount. The collateral is called at least weekly, but in times of turbulent markets the frequency is increased. As leverage is not permitted, certain coverage rules apply with regard to cash or long positions. Counterparties for derivative transactions, over-the-counter and exchange-traded, have to be approved by both the Group Chief Risk Officer and the Group Chief Investment Officer. The minimum rating for a counterparty is A– (Standard & Poor’s or equivalent) for the Swiss Life Group’s insurance operations. During the ongoing period of market turmoil reliance on ratings is of limited value; therefore an additional qualitative and quantitative counterparty monitoring process has been established to allow for immediate proactive measures.

Counterpary risk is managed through the holding of credit default swaps or credit default swap indices. A credit default swap provides insurance to the debt holder against a default of the debt issuer. It is traded over-the-counter and itself underlies the collateral management process described above. The credit default swap index is a hedge on credit risk of a basket of counterparties and is an exchange-traded derivative.

The Group is also exposed to credit risk associated with reinsurance recoverables. As a consequence, the financial strength of reinsurers is monitored. The creditworthiness of reinsurers is considered on an annual basis by reviewing their financial strength prior to any contract being signed. The general policy of the Swiss Life Group is to reinsure its insurance risks only with counterparties rated A– or above (Standard & Poor’s or equivalent). In exceptional cases, reinsurers with a lower rating may be considered. Additionally, the Group holds substantial collateral under related reinsurance agreements in the form of deposited funds and securities.

No single reinsurer is a material reinsurer to the Group, nor is the Group’s business substantially dependent upon one single reinsurer.

For fixed-income assets the total exposure per counterparty is aggregated and reported to the Group Risk Committee. The individual operations maintain records of the payment history for the significant contract holders with whom they conduct regular business. Ratings and single positions above a certain level with regard to fixed-income assets are reported to management on a regular basis. The exposure to individual counterparties is also managed by other mechanisms such as the right to offset where counterparties are both debtors and creditors of the Group. In addition, limits regarding single counterparty exposure are in place which depend on the rating and amount of exposure in relation to total investments. Information reported to management includes assessment of bad debts. Where there exists a certain exposure to individual policyholders, or homogenous groups of policyholders, a financial analysis equivalent to that conducted for reinsurers is carried out.

The non-rated loans primarily comprise mortgages and policy loans. In certain countries, specific additional guidelines and rules have been defined locally to monitor credit risk. Such guidelines cover investments in fixed-income securities whereby the average rating of the fixed-income portfolio (calculated by weighting in accordance with the Standard & Poor’s method) must be AA– or higher (Standard & Poor’s or equivalent). Minimum and maximum thresholds apply with regard to permitted investments in non-government bonds. For these investments additional exposure limits are in place. For certain businesses, credit risk is monitored and controlled with a risk limit framework whereby maximum limits are reviewed and at least approved annually. The majority of the bond portfolio is invested in government bonds (including supranational and sovereigns) and bonds issued by the financial sector covered by collateral or government guarantees.

Maximum exposure to credit risk
In CHF million 
  For the account and risk of the Swiss Life GroupFor the account and risk of the Swiss Life Group's customers Total
  31.12.200931.12.200831.12.200931.12.200831.12.200931.12.2008
 
Debt instruments
 
Debt instruments at fair value through profit or loss
  2 6343 2275 0773 1207 7116 347
Debt instruments available for sale
  47 16638 27347 16638 273
Loans and receivables
  34 12537 02934 12537 029
Financial assets held to maturity
  6 4327 1596 4327 159
Debt instruments pledged as collateral
  330330
Total debt instruments
  90 68785 6885 0773 12095 76488 808
 
Other assets
 
Cash and cash equivalents
  6 7738 1211 9101 2878 6839 408
Derivatives
  7801 3431067901 349
Reinsurance assets
  412447412447
Total other assets
  7 9659 9111 9201 2939 88511 204
 
Unrecognised items
 
Financial guarantees
  362446362446
Loan commitments
  100118100118
Total unrecognised items
  462564462564
 
Total exposure to credit risk
  99 11496 1636 9974 413106 111100 576


Exposure to credit risk of debt instruments
In CHF million 
  At fair value
through
profit or loss

Available
for sale

Loans and
receivables

Held to
maturity

Pledged as
collateral


Total
 
Categories by counterparty as at 31 December 2009
 
Governments
  45022 9914 8685 17812133 608
Sovereign/supranational
  1 6581241 782
Corporates
  2 12319 12016 0361 25438 533
Collateralised debt
  503 36010 84220914 461
Other debt
  11372 2552 303
Total
  2 63447 16634 1256 43233090 687


Categories by counterparty as at 31 December 2008
 
Governments
  36420 0543 8945 56629 878
Sovereign/supranational
  1 4521 452
Corporates
  2 69911 71417 9541 59333 960
Collateralised debt
  9477911 31112 184
Other debt
  705 7262 4188 214
Total
  3 22738 27337 0297 15985 688


Exposure to credit risk of debt instruments
In CHF million 
 
AAA

AA

A

BBB
Below BBB
or not rated
Past due or
impaired

Total
 
Credit rating by counterparty as at 31 December 2009
 
Governments
  25 9664 2821 7791 1873603433 608
Sovereign/supranational
  1 6176955591 782
Corporates
  4 4626 36114 7858 3204 5545138 533
Collateralised debt
  7 98981116336 1578514 461
Other debt
  24717625011 584452 303
Total
  40 28110 90617 0259 54612 71421590 687


Credit rating by counterparty as at 31 December 2008
 
Governments
  26 0622 896853491829 878
Sovereign/supranational
  823208132371 452
Corporates
  4 2575 29813 1756 0334 99520233 960
Collateralised debt
  5 62273442436 05714512 184
Other debt
  4 0818379251232 227218 214
Total
  40 0229 18615 3177 26113 53436885 688


Financial assets past due (not impaired)
In CHF million 
  Up to
3 months

3–6 months

6–12 months
More than
1 year

Total
 
Age analysis by counterparty as at 31 December 2009
 
Collateralised debt
  9153532
Total
  9153532
 
Fair value of collateral and credit enhancements
  36
Financial assets with renegotiated terms
  2


Age analysis by counterparty as at 31 December 2008
 
Collateralised debt
  231033
Total
  231033
 
Fair value of collateral and credit enhancements
  14


Financial assets individually determined as impaired
In CHF million 
  Gross amountImpairment lossesCarrying amount
  31.12.200931.12.200831.12.200931.12.200831.12.200931.12.2008
 
Analysis by counterparty
 
Governments
  450–11034
Corporates
  158989–107–78751202
Collateralised debt
  98146–45–3453112
Other debt
  59624–551–34521
Total
  8971 159–714–824183335
 
Fair value of collateral and credit enhancements
  58109


The fair value of collateral and credit enhancements primarily consists of collateral for mortgage loans.

Financial assets individually determined as impaired
In CHF million 
 

Balance as at
1 January



Reclassification

Impairment
losses
recognised


Write-offs
and disposals
Foreign
currency
translation
differences


Balance as at
end of period
 
Impairment loss allowance by counterparty 2009
 
Governments
  0110011
Corporates
  787–55447–1741107
Collateralised debt
  3415–4045
Other debt
  3554–4–20551
Total
  82469–1801714


Impairment loss allowance by counterparty 2008
 
Governments
  000
Corporates
  652149–7–7787
Collateralised debt
  48–12–1–134
Other debt
  3003
Total
  700140–8–8824


Exposure to credit risk OF OTHER ASSETS
In CHF million 
 
AAA

AA

A

BBB
Below BBB
or not rated

Total
 
Credit rating as at 31 December 2009
 
Cash and cash equivalents
  4 0588811 41004246 773
Derivatives
  185528611113780
Reinsurance assets
  345661412
Total
  4 0761 7781 502115987 965
of which collateralised  115


Credit rating as at 31 December 2008
 
Cash and cash equivalents
  2 5709264 42961908 121
Derivatives
  31 20313611 343
Reinsurance assets
  39453447
Total
  2 5732 5234 56562449 911
of which collateralised  4


Exposure to credit risk OF UnRECOGNISED ITEMS
In CHF million 
 
AAA

AA

A

BBB
Below BBB
or not rated

Total
 
Credit rating as at 31 December 2009
 
Financial guarantees
  01026290362
Loan commitments
  100100
Total
  010262190462
of which collateralised  56


Credit rating as at 31 December 2008
 
Financial guarantees
  10263710363446
Loan commitments
  118118
Total
  102637103181564
of which collateralised  75


Currency risk — The Swiss Life Group operates internationally and its exposures to currency risk primarily arise with respect to the euro, US dollar and British pound. Most of the investments and liabilities are denominated in Swiss francs, euros and US dollars, the values of which are subject to exchange rate fluctuations. The Group operates with various functional currencies (predominantly Swiss francs and euros). Its financial position and earnings could be significantly affected by a weakening of said foreign currencies against the Swiss franc.

The Swiss Life Group’s European insurance and investment operations (excluding Switzerland) generally invest in assets denominated in the same currency as their insurance and investment liabilities, which mitigates the currency risk for these operations. As a result, currency risk arises from recognised assets and liabilities denominated in other currencies and net investments in foreign operations. Although the Swiss Life Group actively engages in currency management to reduce the effect of exchange rate fluctuations on its assets and liabilities, particularly by hedging against the risk of such movements in relation to part of its investments denominated in euros and in US dollars, significant movements in exchange rates could adversely affect the Swiss Life Group’s earnings and financial position, including the value of its investment portfolio. Foreign exchange exposure is hedged to a large extent in line with the strategic asset allocation. The Group’s hedging arrangements are directed at covering its exposure mainly from an economic perspective. The instruments which the Swiss Life Group uses to hedge exposure may not be perfectly correlated to the related assets, so the Group will still be exposed to losses if the value of the hedge and the value of the underlying asset or liability do not correspond appropriately.

The Swiss Life Group is further required to bear expenses and costs in establishing such hedging arrangements.

Exposure to currency risk
In CHF million 
 



CHF




EUR




USD




GBP




Other
For the account
and risk of the
Swiss Life
Group's
customers




Total
 
Carrying amounts as at 31 December 2009
 
Monetary assets
 
Cash and cash equivalents
  4 3052 21217133521 9108 683
Derivatives
  15520314527710790
Debt instruments at fair value through profit or loss
  892 5455 0777 711
Debt instruments available for sale
  16 68225 4444 5564513347 166
Loans and receivables
  8 00420 5585 425449434 125
Financial assets held to maturity
  6 4326 432
Debt instruments pledged as collateral
  330330
Reinsurance assets
  29383412
Total monetary assets
  29 26458 10710 2975284566 997105 649
 
Monetary liabilities
 
Derivatives
  –14–153–114–10–282
Debt instruments at fair value through profit or loss
  –15 101–15 101
Investment contracts
  –908–8 342–49–2–2 788–12 089
Borrowings
  –362–2 369–2 731
Other financial liabilities
  –3 556–2 789–9–19–12–6 385
Insurance liabilities
  –61 055–30 377–75–67–1–742–92 317
Policyholder participation liabilities
  –1 687–1 42200–3 109
Total monetary liabilities
  –67 582–45 452–247–89–13–18 631–132 014
 
Balance sheet currency gap
  –38 31812 65510 050439443–11 634–26 365


Carrying amounts as at 31 December 2008
 
Total monetary assets
  30 90955 1939 1242081654 413100 012
Total monetary liabilities
  –67 292–43 503–139–96–15–12 404–123 449
Balance sheet currency gap
  –36 38311 6908 985112150–7 991–23 437


Due to the limitations of the Swiss capital market with regard to liquidity, investments in Switzerland are also made in currencies other than the Swiss franc. The balance sheet currency gap is to a large extent hedged on an economic basis using foreign currency derivatives. In the other countries, the assets are normally denominated in euros, which is the same currency as the insurance liabilities.

Liquidity risk — Liquidity risk is the risk that not enough cash resources may be available to pay obligations when due (primarily obligations arising from the insurance business and debt) at a reasonable cost. The Swiss Life Group is exposed to liquidity risk which primarily arises on calls on its cash resources from claims, amounts payable at maturity and surrenders arising from insurance and investment contracts. The Swiss Life Group faces the risk of not being able to refinance its debt obligations due to unexpected long-term market disruptions.

At operational level, rolling forecasts are in place to address situational liquidity risk, which primarily arises on unexpected calls on cash resources from claims, amounts payable at maturity and surrenders arising from insurance and investment contracts. To overcome unexpected liquidity shortfalls at times asset disposals are not desired, repurchase agreements are used to ensure short-term refinancing at minimal cost.

Liquidity risk is considered in the strategic asset allocation. At a strategic level, the Swiss Life Group holds sufficient liquidity and uses proactive debt maturity planning to ensure full financial flexibility and efficient liquidity management.

The liquidity analysis of financial liabilities and commitments is based on undiscounted cash flows by remaining contractual maturities, whereas insurance and policyholder participation liabilities are analysed by estimated timing of net cash outflows. The analysis is made for amounts for the account and risk of the Swiss Life Group.

Exposure to liquidity risk as at 31 December 2009
In CHF million 
  Cash flows
  Carrying
amount

Up to 1 month

1–3 months

3–12 months

1–5 years
More than
5 years
 
Financial liabilities
 
Derivatives: contractual outflows
  2821 0091 4002 3363 53598
Derivatives: contractual inflows
  –989–1 355–2 104–3 165
Financial liabilities at fair value through profit or loss
  9009510
Investment contracts with discretionary participation
  8 86829512742 1306 384
Investment contracts without discretionary participation
  43329772732628
Borrowings
  2 7312301831 6781 563
Other financial liabilities
  6 3857241354 221420885
Total financial liabilities
  19 5998253086 1344 6248 958
 
Insurance and policyholder participation liabilities
 
Insurance liabilities
  91 5753113313 2597 95279 722
Policyholder participation liabilities
  3 10924329981 265790
Total insurance and policyholder participation liabilities
  94 6843353634 2579 21780 512
 
Guarantees and Commitments
 
Loan commitments
  45550
Capital commitments
  3033960
Financial guarantees
  6326273
Total guarantees and commitments
  348118422273


Exposure to liquidity risk as at 31 December 2008
In CHF million 
  Cash flows
  Carrying
amount

Up to 1 month

1–3 months

3–12 months

1–5 years
More than
5 years
 
Financial liabilities
 
Derivatives
  34633481629119
Financial liabilities at fair value through profit or loss
  1 0781 254
Investment contracts with discretionary participation
  9 05530522832 1186 572
Investment contracts without discretionary participation
  3553413917237
Borrowings
  3 1237232252 0372 011
Other financial liabilities
  6 6727371184 465817584
Total financial liabilities
  20 6298102456 5285 2359 223
 
Insurance and policyholder participation liabilities
 
Insurance liabilities
  90 0723142873 3417 99378 137
Policyholder participation liabilities
  1 4223213239543316
Total insurance and policyholder participation liabilities
  91 4946352903 5808 53678 453
 
Guarantees and Commitments
 
Loan commitments
  33769
Capital commitments
  3821534590
Financial guarantees
  49397
Total guarantees and commitments
  415229508406


Current and Non-Current Assets and Liabilities — The table below shows the expected recovery or settlement of assets and liabilities. Assets are classified as current if they are expected to be realised within twelve months after the balance sheet date. Liabilities are classified as current if they are due to be settled within twelve months after the balance sheet date. All other assets and liabilities are classified as non-current.

In CHF million 
  Current Non-currentFor the account and risk of the Swiss Life Group's customers Total
  31.12.200931.12.200831.12.200931.12.200831.12.200931.12.200831.12.200931.12.2008
 
Assets
 
Cash and cash equivalents
  6 7738 1211 9101 2878 6839 408
Derivatives
  6961 26984741067901 349
Assets held for sale
  2424
Financial assets at fair value through profit or loss
  1 9983 8793 2581 90516 74111 13221 99716 916
Financial assets available for sale
  3 7354 37548 12038 78851 85543 163
Loans and receivables
  6 4426 99327 68330 03634 12537 029
Financial assets held to maturity
  1146746 3186 4856 4327 159
Financial assets pledged as collateral
  330330
Investment property
  13 29212 66313 29212 663
Investments in associates
  7143771437
Reinsurance assets
  3714014146412447
Property and equipment
  696802696802
Intangible assets including intangible insurance assets
  4 5764 6514 5764 651
Current income tax assets
  26112611
Deferred income tax assets
  80978097
Other assets
  414490167165581655
Total assets
  20 57126 217104 71696 14918 66112 425143 948134 791
 
Liabilities
 
Derivatives
  2133016945282346
Financial liabilities at fair value through profit or loss
  9001 07815 1019 72716 00110 805
Investment contracts
  7325128 5698 8982 7881 72512 08911 135
Borrowings
  989742 6332 1492 7313 123
Other financial liabilities
  5 1345 2681 2511 4046 3856 672
Insurance liabilities
  3 9168 56587 65981 50774295292 31791 024
Policyholder participation liabilities
  1 0535712 0568513 1091 422
Employee benefit liabilities
  89752 0322 0102 1212 085
Current income tax liabilities
  286229286229
Deferred income tax liabilities
  756648756648
Provisions
  12346784720193
Other liabilities
  4005092548425557
Total liabilities
  12 94418 128105 12897 60718 63112 404136 703128 139



 
5.5 Insurance risk management objectives and policies

Insurance contracts are contracts under which one party (the insurer) agrees to compensate the other party (the policyholder) if a specified uncertain future event affects the policyholder. The Group’s insurance entities neither generally accept nor generally deny insurance coverage to applicants, but ensure that all the insurance risks are identified and thoroughly assessed, and that the insurance premiums accurately reflect the risk taken. The amount of risk taken must be in line with the Group’s strategy and risk policy, and must also meet the profitability targets.

Nature of insurance risk — When designing a new product or reviewing an existing one, care has to be taken that the product neither includes systemic risk nor provides incentives for adverse selection. The product should meet the market’s needs. The Swiss Life Group generally favours transparent and simple product design with minimised model risk and a reliable pricing basis with sufficient statistical data available. Insurance risk arises when biometric parameters deviate adversely from expectations and thus from the premium rates agreed with the policyholder. The uncertainty in the estimation of future benefit payments and premium receipts for long-term insurance contracts is due to the unpredictability of long-term changes in overall levels of mortality and disability, for instance. Furthermore, deviations from the expected outcome of a portfolio can also arise because of random fluctuations. The impact of random fluctuations depends on the extent of diversification within a portfolio of contracts, that is, on the size of the portfolio.

The quantification of life insurance risk is based on a sensitivity analysis. Insurance risk is thus measured as the deviation of (the realisations of) the insurance risk factors from the corresponding best estimate values. Life insurance risk factors include mortality rates, disability rates and longevity, among others.

The nature of insurance risk can be summarised as follows:

Mortality and longevity — Mortality and longevity risks respectively reflect the financial consequences of insured people living longer or dying sooner than expected. For example, a life insurer with an annuity portfolio making payments to the policyholders until their death is financially exposed to those individuals who live longer than expected. Conversely, an insurer writing life insurance business that pays out amounts contingent on death of the policyholders is exposed to increases in mortality levels.

In Switzerland, the Swiss occupational pensions (BVG) segment of the group life insurance business is a significant part of the Group’s overall life insurance business. The BVG business provides an example of a minimum return guarantee. The guarantee takes the form of the right to convert an assured sum into a life annuity at a guaranteed conversion rate: The prevalent annuity conversion rates for the mandatory part of the BVG business is set at 7.00% for men (retirement age 65) and 6.95% for women (retirement age 64) for retirements in 2010 (7.05% for men and 7.00% for women for retirements in 2009). Under an amendment to the BVG legislation, which took effect on 1 January 2005, the rate will be reduced in stages to 6.8% by 2014.

Risk concentration per product category with regard to mortality and longevity is as follows:

Annuities payable per annum by type of annuity – individual life
In CHF million 
  31.12.200931.12.2008
Life annuities – in payment
  582562
Life annuities – deferred
  892876
Annuities certain – in payment
  1820
Annuities certain – deferred
  4951
Disability income and other annuities – in payment
  296306
Disability income and other annuities – deferred
  7 9647 679
Total individual life
  9 8019 494


Annuities payable per annum by type of annuity – group life
In CHF million 
  31.12.200931.12.2008
Retirement annuities – in payment
  566540
Retirement annuities – deferred
  474486
Survivors' annuities – in payment
  106104
Survivors' annuities – deferred
  2 1032 051
Disability income and other annuities – in payment
  379368
Disability income and other annuities – deferred
  13 90714 040
Total group life
  17 53517 589


Life benefits insured by type of insurance – individual life
In CHF million 
  31.12.200931.12.2008
Pure endowment
  1 5622 017
Mixed endowment
  47 35449 275
Whole life
  384443
Term life
  12 34513 850
Universal life
  1010
Unit-linked contracts
  11 2186 635
Disability lump-sum payment
  2628
Other
  5 9705 651
Total individual life
  78 86977 909


Life benefits insured by type of insurance – group life
In CHF million 
  31.12.200931.12.2008
Endowment and related
  13 39114 056
Term life
  84 72985 375
Swiss BVG
  135 544135 275
Disability lump-sum payment
  780739
Other
  1 5712 029
Total group life
  236 015237 474


Morbidity and disability — Disability risk reflects the financial consequences of groups of individuals getting disabled more often and/or recovering less quickly than expected. The most significant disability risk factors are epidemics or widespread changes in lifestyle, such as eating, smoking and exercise habits.

Embedded Options — The ability of a policyholder to pay reduced or no future premiums under a contract, to terminate the contract completely or to exercise a guaranteed annuity option means that the insurer’s liability is also subject to policyholder behaviour to a certain extent. On the assumption that a certain part of policyholders will make decisions rationally, overall insurance risk can be assumed to be aggravated by such behaviour. For example, it is likely that policyholders whose health has deteriorated significantly will be less inclined to terminate contracts insuring disability or death benefits than those policyholders remaining in good health, thus resulting in an increasing trend in the expected mortality of policyholders, as the portfolio of insurance contracts is reduced due to surrender (adverse selection).

Underwriting strategy — Underwriting is the process of selecting and classifying insurable risks. The underwriting strategy attempts to ensure that the risks underwritten are well diversified in terms of type of risk and level of insured benefits. Life insurance underwriting is performed to ensure that the premiums and the general conditions of the insurance policies are consistent with the risks to be insured. The first step in the underwriting process is to determine which individual risks can be accepted. The second step is to place the accepted risks into groups of roughly equivalent levels of risk. Both processes must be conducted objectively and consistently. The Group sets limits for the acceptance of insurance coverage arising from new and renewal business. Medical selection is part of the Group’s underwriting procedures, whereby premiums are charged to reflect the health condition and family medical history of the applicants. The limits relate to sums at risk, maximum insured losses or present value of premiums at the contract or insured person level. Depending on the type of business and the limit exceeded, the new or renewed contract must be approved by a specific investment and risk committee or senior management. Contracts exceeding the set limits must be tested for profitability according to predefined procedures before approval. Certain contracts which include specific risks relating to derivatives or demographic risk factors for which no reliable data is available must be submitted for approval irrespective of the amount of coverage offered. Insurance coverage exceeding set limits is subject to regular internal reporting requirements. Additionally, it must be ensured that the underwriting practices are in line with local laws.

For certain group life business, local law is relevant with regard to medical examinations required before any business is written. For certain individual life business, agreements exist with regard to medical examinations of applicants before business is written. If the risk is assessed as high, exclusion of specific risks, premium adjustments and reinsurance are considered.

In the accident and health business, the underwriting strategy comprises biometric and financial data of the persons to be insured, type of contract and experience.

Non-life — The Swiss Life Group has non-life operations in France covering risks associated with accident and health (disability) as well as property and casualty.

Claims arising from the accident and health business primarily cover refunds for medical treatment, daily allowances in the case of sick leave, annuities and long-term medical care. The most significant factors that could increase the overall liabilities in health insurance are the increase in the claim frequency due to an increase in the average age of the insured persons and negative economic and social factors. The insurance liabilities arising from accident and health insurance contracts must consider outstanding claims and claims incurred but not reported (IBNR). A large part of the insurance liabilities arising from these contracts relates to IBNR, and experience shows that health insurance contracts are sensitive to late reporting of claims (both number of claims and amounts).

The Group manages the risks arising from these contracts by means of its underwriting strategy and reinsurance arrangements.

Development of claims under non-life insurance contracts
In CHF million 
  Estimate of ultimate claim costs by accident year
  200120022003200420052006200720082009Total
At end of accident year
  535447454447407519474388437n/a
1 year later
  586496458425461436414427n/a
2 years later
  565463432449420404383n/a
3 years later
  550451461428387389n/a
4 years later
  548480563380368n/a
5 years later
  581470465366n/a
6 years later
  530450435n/a
7 years later
  492445n/a
8 years later
  490n/a
Current estimate of cumulative claims
  4904454353663683893834274373 740
Cumulative payments to date
  –431–375–363–284–278–286–258–252–173–2 700
Liabilities before discounting
  59707282901031251752641 040
Effect of discounting
 
Liabilities for the current and 8 previous years
  59707282901031251752641 040
Liabilities for prior years
  157
Total gross claims under non-life insurance contracts
  1 197


The development of claims under non-life insurance contracts comprises the non-life business in France. CEAT, Paris, is no longer included in the figures above due to the sale in 2009.

Acceptance rules for risks are consistent with both the Code des Assurances and the French regulations. Underwriting guidelines and tariffs are reviewed on an annual basis.

The monitoring of the risks taken is made on a monthly basis with regard to related premiums and claims. An automated claims supervision system is used for the adjustment of tariffs for risks with loss ratios above a certain level.

Reinsurance — Reinsurance is used to limit the Group’s exposure to insurance risk. This does not, however, discharge the Group’s liability as a primary insurer, and, if a reinsurer fails to pay a claim, the Group remains liable for the payments to the policyholder. A loss allowance would be recognised for any estimated unrecoverable reinsurance.

In addition, the Group holds substantial collateral under related reinsurance agreements in the form of deposited funds and securities. Amounts recoverable from reinsurers are estimated in a manner consistent with the assumptions used for the underlying policy benefits and are presented in the balance sheet as a component of the reinsurance assets.

Management reviews reinsurance programmes covering treaty, type, risks covered and retention on a regular basis. A process, competencies and limits are set up for the approval of reinsurance programmes and their modification. To ensure that the Group’s principles are observed, guidelines on reinsurance have been introduced.

The life insurance operations limit exposure to loss on any single life. Retention limits vary by country. For the coverage of loss accumulation in the life insurance business, reinsurance contracts covering catastrophe risk are in place. This type of reinsurance cover is organised at Group level. In the non-life insurance business, reinsurance coverage of loss accumulation is organised at the level of the individual insurance operations.

As far as non-life insurance is concerned, the reinsurance arrangements mostly include non-proportional coverage on any single risk and/or event, adapted to the specifications of each contract. This includes excess of loss, stop-loss and catastrophe coverage. Facultative reinsurance is also written for protection against specific risks.

No single reinsurer is a material reinsurer to the Group, nor is the Group’s business substantially dependent upon one single reinsurer.

Approximately 2.0% of insurance in force from continuing operations in terms of earned insurance premiums was ceded as at 31 December 2009 (2008: 2.2%).

Other risk transfer — Risk transfer primarily takes the form of reinsurance. Alternative forms of risk transfer (such as securitisation) require the formal approval of the Group Risk Committee. No significant alternative form of risk transfer is used by the Group at present.

Insurance risks are regularly reported to the Group Risk Committee.

Sensitivity analysis — The Swiss Life Group uses the market consistent embedded value (MCEV) following the guidelines of the European Insurance CFO Forum Market Consistent Embedded Value Principles ©1 , as one of the main management tools, for its sensitivity analysis with regard to insurance risk and market risk. From the shareholders’ point of view, the embedded value serves as an indicator of the value of the existing insurance portfolios. It is composed of two components: the net asset value (NAV) attributable to shareholders and the value of in-force business (VIF). Future new business is not included.

1 Copyright © Stichting CFO Forum Foundation 2008

The market consistent embedded value of the Swiss Life Group amounted to CHF 6.9 billion as at 31 December 2009 (2008: CHF 6.3 billion). Due to different valuation principles, changes in the embedded value are typically not reflected to the same extent in the consolidated balance sheet and consolidated statement of income of the Swiss Life Group and vice versa.

The market consistent embedded value calculations are based on economic scenarios which are calibrated to market conditions at valuation date. Best estimate assumptions were made regarding a number of factors, in particular asset allocation, policyholder participation, development of costs and claims, policyholder behaviour, mortality and morbidity. Business is assumed to be continuing at the same level (going concern) and the current cost ratios – adjusted for inflation – are thus assumed to hold good for the future as well. Future costs for maintaining classic solvency capital funded by the shareholders and which underpins the insurance business are charged to the MCEV. The Swiss Life Group calculates the embedded value for all its life and health insurance companies. All other companies are taken into account at their IFRS net asset value. As a consequence, embedded value sensitivities do not affect the value of these companies.

An analysis of sensitivity indicates to what extent the embedded value is affected by variations in risk factors. The analysis is based on changes in the assumptions used in the embedded value calculation whereby a specific risk factor is changed while holding all other assumptions constant. In practice, this is unlikely to occur and changes in some of the assumptions may be correlated. In the event of a change in a specific risk factor, the effect of different allocations to policyholder participation as a consequence is considered in the analysis. The changes in a specific risk factor are applied to the entire projection period.

The sensitivity analysis relating to continuing operations with regard to insurance risk is as follows:

Higher overall mortality would have a significant positive effect on the embedded value of life annuities (survival risk) whereas the negative effect on the embedded value of contracts with mortality risk is comparatively limited due to respective reductions in policyholder bonuses. Therefore, this sensitivity is considered not significant as an adverse risk for the embedded value.

At 31 December 2009, if the longevity improvement parameter had increased by 5%, the embedded value would have been CHF 50 million lower (2008: CHF 42 million lower).

At 31 December 2009, if morbidity had been 5% higher, the embedded value would have been CHF 107 million lower (2008: CHF 87 million lower).

At 31 December 2009, if morbidity had been 5% lower, the embedded value would have been CHF 105 million higher (2008: CHF 96 million higher).

The sensitivity analysis with regard to market risk is as follows:

The MCEV calculations of the Swiss Life Group are based on economic scenarios which are calibrated to market conditions at valuation date. At 31 December 2009, if the interest rates had been 100 basis points higher, the embedded value would have been CHF 982 million higher (2008: CHF 1020 million higher).

At 31 December 2009, if the interest rates had been 100 basis points lower, the embedded value would have been CHF 1535 million lower (2008: CHF 1747 million lower).

At 31 December 2009, if the swaption implied volatilities had been 25% higher, the embedded value would have been CHF 347 million lower (2008: CHF 376 million lower).

At 31 December 2009, if the swaption implied volatilities had been 25% lower, the embedded value would have been CHF 345 million higher (2008: CHF 284 million higher).

At 31 December 2009, if the market value of equity securities and property had been 10% higher, the embedded value would have been CHF 901 million higher (2008: CHF 909 million higher).

At 31 December 2009, if the market value of equity securities and property had been 10% lower, the embedded value would have been CHF 997 million lower (2008: CHF 1057 million lower).

At 31 December 2009, if the equity securities and property implied volatilities had been 25% higher, the embedded value would have been CHF 392 million lower (2008: CHF 274 million lower).

At 31 December 2009, if the equity securities and property implied volatilities had been 25% lower, the embedded value would have been CHF 302 million higher (2008: CHF 193 million higher).

At 31 December 2009, if the euro had strengthened by 10% against the Swiss franc, the embedded value would have been CHF 249 million higher (2008: CHF 229 million higher).

At 31 December 2009, if the euro had weakened by 10% against the Swiss franc, the embedded value would have been CHF 249 million lower (2008: CHF 229 million lower).

The sensitivity of insurance liabilities is also analysed on an economic basis for internal risk management purposes and to satisfy regulatory requirements (Swiss Solvency Test).




 
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