New Strategic Asset Allocation Framework

Deep-dive session –
Investment Management

Cecilia Reyes
Chief Investment Officer
© Zurich Financial Services Ltd

Key messages – Investment Management

A clear mission, and a disciplined and structured approach are the
basis for long term value creation

We continuously refine our investment approach to manage risks
and use capital more efficiently

Our framework allows us to deal proactively with the challenges
of persistently low yields and the debt crisis

We are well positioned to deal with market uncertainties and
preserve the strength of our balance sheet

December 1, 2011 Investors' Day - Focus on Execution 83

Our ALM-focused investment strategy results
in consistent and sustainable excess returns
relative to liabilities…
Cumulative total investment return against the minimum risk investment strategy

50%
45% 46.1%
40% 41.0%
35%
30%
25%
20%
15%
10%
5%
0%
Q1 03

Q4 03

Q3 04

Q2 05

Q1 06

Q4 06

Q3 07

Q2 08

Q1 09

Q4 09

Q3 10

Q2 11

Total return on minimum risk investment strategy
Total return on investment strategy


… also compared to peers throughout the
crisis

Peer Benchmarking Q1 2007 – HY 20111
Performance based on return and risk
Ranking based on information ratio4
1 Peer 1 -0.09 1st on volatility of
Return2 excess return basis
2 ZFS -0.11
0%
3 Peer 2 -0.12
4 Peer 3 -0.13 Peer 1
5 Peer 4 -0.18 ZFS
-5% Peer 2 Peer 5 3rd on
6 Peer 5 -0.23 Peer 4 Peer 7 excess
Peer 8
7 Peer 6 -0.29 return
Peer 3 Peer 6 Peer 10
8 Peer 7 -0.32 -10% basis
Peer 11
9 Peer 8 -0.37
Peer 9
10 Peer 9 -0.38 Peer 14
-15% Peer 15
11 Peer 10 -0.44 Peer 13
12 Peer 11 -0.47 Peer 12 Peer 16
13 Peer 12 -0.48 -20%
14 Peer 13 -0.50 Peer 17
15 Peer 14 -0.65
16 Peer 15 -0.68 -25% Peer 18
17 Peer 16 -0.69

Risk3
18 Peer 17 -0.86

-30%
19 Peer 18 -1.39
1,5 2,0 2,5 3,0 3,5 4,0 4,5 5,0 5,5 6,0
Source: companies’ website, financial reports
Note: peer universe defined as DJ Global Insurance Titans. Some peers were not included in the analysis due to data availability and quality issues
1 The analysis performed is based on quarterly returns 2007 - 2011. Prior data not available in required quality
2 Return = Cumulative excess returns (chain linked)
3 Risk = Standard deviation of excess returns
4 Modified information ratio is used to account for negative returns

Our mission provides a clear focus to steer
the portfolio through a turbulent market
environment

Investment Management’s mission

Achieve superior risk-adjusted investment returns
relative to liabilities


We invest based on a clear and shared
investment philosophy and through a
structured and disciplined approach

Clear Systematic
investment philosophy and disciplined

Manage assets relative
Maximize economic value
to liabilities

Capital markets generally Diversify sources of risk
do work and return

Clear governance structure

State-of-the-art investment information solutions


Allocation of capital to market/ALM and
investment credit risk stands at the
beginning of the investment process
Risk Allocation of Zurich, as of 1 January 2011

Total RBC estimate: USD 34 billion

8% USD 15.3bn
Risk Based
13% Market/ALM risk
Capital allocated
37% Investment credit risk to Investment
Business risk Management
1%
4% P&R risk3 (IM)
Re-ins credit risk
Life insurance risk
Natural cat risk
23%
6% Operational risk
8%

1 Total allocated capital = USD 34bn RBC plus USD 2bn direct allocation to Farmers
2 Includes Other Operating Businesses and Non-Core Businesses
3 Premium & reserving risk

We continuously refine our investment
approach to manage risks and capital more
efficiently
Investment Management value chain

Asset Liability Analysis

Strategic Asset Allocation

Tactical Asset Allocation

Manager Selection

Local Adaptation and
Portfolio Construction
Security Selection and
Trade Execution

Asset Manager Oversight &
Investment Reporting


We are taking our ALM/SAA framework one
step further by fully integrating risk factors
directly into both assets and liabilities
Risk factors Typical insurance balance sheet exposures

Assets1 Liabilities1 Zurich net exposure

Equity Risk
Liquidity
Risk Equity
Liquidity Risk Risk
8%
Interest Rate Risk 21%
Interest
Term Structure Risk 9% Rate
Risk
48%
14%
Commodity Risk Term
Credit Structure
(Spread) Risk
Credit (Spread) Risk Risk

1 Darker shades indicate higher exposures

The framework allows the management of
investments based on risk factor exposures
and expected alpha in a fully integrated way
Risk factors Translation into selected asset classes1
Passive Active Sovereign Corporate Real
Equities Equities Bonds Bonds Estate TAA2

Equity Risk

Liquidity Risk

Interest Rate Risk

Term Structure Risk

Commodity Risk

Credit (Spread) Risk

Alpha
1 Simplified illustration with some asset classes missing
2 Tactical Asset Allocation

The enhanced framework will lead to more
comprehensive, transparent and explicit
SAA decisions
Risk factors Asset classes

Optimize Beta Risk Factor Exposure Optimize Alpha (Budget Allocation)

Equity Risk
Tracking Error Budget
Liquidity Risk (relative to risk factors)

Interest Rate Risk Excess return
+ = relative to
Term Structure Risk liabilities

Information Ratios by (active)
Commodity Risk
Asset Class

Credit (Spread) Risk

Capital
All risk factors ‘compete’ for
Beta budget + All asset classes ‘compete’ for
Alpha budget
 allocated to
investments

Managing economic risks on a more granular
basis under the enhanced framework allows
to protect the strength of our balance sheet
Risk factors Examples

Exposure Assets Liabilities Net
Delta Long Short Long
Equity Risk
Vega Long Short Short
Liquidity Risk

Interest Rate Risk Delta1 Long Short Short

Gamma2 Long Short Short
Term Structure Risk
Vega3 Long Short Short
Commodity Risk

Credit (Spread) Risk Delta Long Short Long

1 First order sensitivity to underlying risk factor
2 Second order sensitivity to underlying risk factor (convexity)
3 Sensitivity to implied volatility

Where securities cannot be used to hedge
ALM risk, derivatives are used selectively

Interest rate convexity in the German Life book

USD USD USD USD
MCEV (excl.
MCEV (RHS)
Swaptions)

Swaptions

MVA (LHS)

+ = MCEV (incl.
Swaptions)

MVL (LHS)

-150 -100 -50 0 50 100 150 -150 -100 -50 0 50 100 150 -150 -100 -50 0 50 100 150
Interest rate shock in bps
MCEV: Market consistent embedded value; MVA: Market value of assets; MVL: Market value of liabilities;
RHS: Right hand scale; LHS: Left hand scale

The enhanced ALM/SAA approach…

Provides a comprehensive, robust and transparent framework for
investment decisions
Captures risk factors such as liquidity and term structure risk that
are highly relevant in an insurance context
Requires us to be explicit about risk and return expectations,
e.g. alpha potential for actively managed asset classes
Enables us to manage economic risks more accurately through
selective use of derivatives where cash securities are ineffective


Key messages – Investment Management

A clear mission, and a disciplined and structured approach are the
basis for long term value creation

We continuously refine our investment approach to manage risks
and use capital more efficiently

Our framework allows us to deal proactively with the challenges
of persistently low yields and the debt crisis

We are well positioned to deal with market uncertainties and
preserve the strength of our balance sheet


Appendix – IM achieves transparency of
and focus on core capabilities through a
clearly defined value chain
Value Chain and Core Competences

Earn risk-free investment return by understanding Create effective
Asset Liability Analysis the risk-free investment position and efficient
governance for
Define the long-term SAA based on allocated risk
investments
Strategic Asset Allocation capital
Manage strategic
Earn market risk premia
innovation and
Generate skill-based returns based on market leverage central
Tactical Asset Allocation strategies value levers

Operations
Select high performing asset managers at right Define and
price implement HR
Manager Selection Systematically monitor and act on manager strategy
performance Define and
Local Adaptation and Ensure efficient implementation of investment implement
Portfolio Construction strategies Communication
strategy
Security Selection and Monitor alpha generation by internal and external Effective
Trade Execution specialist asset managers investment

planning and
Asset Manager Oversight & Provide timely, high quality information for management of
Investment Reporting decision making in the investment process budgets


Appendix – Where securities cannot be
used to manage certain ALM/Market risks
effectively, derivatives are used selectively
Examples of specific ALM/Market-related implementation action using derivatives

Starting Point Implementation
1 Very long-dated interest rate risk Systematic portfolio restructuring
German
traditional with- Liability analysis revealed substantial and purchase of long-dated EUR
profits endow- negative convexity zero-coupon government bonds
ment book (since 2008)
Swaption programme (started 2010)
2 Long-dated and convex interest rate Long term CHF receiver swaptions
Swiss traditional
with-profits risk due to long-dated CHF liabilities portfolio (started 2006)
endowment book with embedded options

3 Large and convex exposure to both Dynamic equity and interest rate
US run-off variable
annuity book interest rates and equity markets hedging (started 2010)

4 Future fee income from unit-linked Short forwards on major equity indices
UK unit-linked fee
assets is exposed to declining equity (started 2009)

income
markets
5 Asymmetric risk profile of Eurozone Purchase of EuroStoxx 50 equity puts
Eurozone tail risk
sovereign debt crisis tail risk event (started 2011)
equity hedge
Timely implementation required


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