The global economy and financial markets. Global growth remained moderate in 2012, restrained by the ongoing. The recession in many European economies

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1 Financial year Market environment The eurozone debt crisis dominated financial market developments. High uncertainty and sluggish growth further lowered benchmark government bond yields. The global economy and financial markets Global growth remained moderate in 2012, restrained by the ongoing recession in many European economies, while the eurozone debt crisis dominated financial market developments. Benchmark government bond yields rose during the first quarter, but dropped subsequently as the eurozone debt crisis intensified. After the peak of the debt crisis in July, equity markets rallied and bond yields increased slightly. Credit spreads narrowed for most of the year as investors sought higher yields. Global economy The recession in many European economies continued or even intensified in Tight fiscal policies, restrictive credit conditions and high uncertainty weighed on economic activity, particularly in Europe s periphery, where fears of a euro exit or break-up also led to capital flight. Moderate growth continued in Germany, supported by extremely low interest rates and robust exports to emerging markets. In the UK, the economy contracted further before growth resumed in the second half of the year. Growth was more robust in the US, but remained fairly moderate despite support in the second half from a recovery in the housing market. Uncertainty regarding the fiscal cliff weighed on sentiment and likely affected hiring and investment. Reconstruction spending from the 2011 earthquake and tsunami continued to support the ese economy during the first half of the year, but weak global demand hampered economic activity in the second half. Growth in emerging markets remained relatively robust, although it was burdened by sluggish demand in Europe and the US and a slowdown in China due to a tightening of credit conditions (see economic indicators table on page 15). 1.3% German 10-year government bond yield end 2012 (2011: 1.8%) Interest rates for 10-year ten-year government bonds bonds in % 2.2% US real GDP growth 2012 (2011: 1.8%) United States United Kingdom Germany Switzerland Source: Datastream States United Kingdom Germany Switzerland Source: Datastream Spreads for 10-year government bond bond yields yields versus versus German German benchmark benchmark in % points Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Ireland Italy Portugal Spain Source: Datastream Source: Datastream 14 Swiss Re 2012 Financial Report

2 Consumer price inflation declined during the first half of the year, mainly because oil prices stabilised. By year-end, inflation was close to central banks target rates both in the eurozone and the US. Inflation moderated in most emerging markets, with the main exception of India. Interest rates Extremely loose monetary policies continued in The US Federal Reserve (the Fed) and the Bank of England kept interest rates close to zero, while the European Cental Bank (ECB) lowered rates to 0.75% in July. The Bank of England also increased the size of its government bond purchase programme, while the Fed increased its purchases of longer-dated government bonds at the expense of shorter securities ( Operation Twist ). In September, the Fed also started to purchase mortgage-backed securities to support mortgage markets. Yields on US, UK, and Stock markets German government bonds increased slightly during the first few months of the year, but then fell sharply as increased risk aversion and central banks commitment to maintain low interest rates boosted demand for relatively creditworthy government bonds. During the second half of the year, bond yields rose slightly with improving market sentiment, but ended the year well below their January levels (see interest rates chart). The spreads of Spanish, Irish and Italian sovereign bond yields initially narrowed against the German benchmark, then widened sharply on increased euro exit or break-up fears, to narrow again in the second half of the year (see bond spread chart). Yield spreads between investment grade corporate bonds and government bonds followed a similar pattern, narrowing significantly over the course of the year. 31 December = United States (S (S& & P P 500) 500) United Kingdom (FTSE 100) DJ Euro STOXX 50 United Kingdom (FTSE 100) DJ Euro STOXX 50 (TOPIX) (TOPIX) Switzerland (SMI) Switzerland (SMI) Source: Datastream Source: Datastream Economic indicators USA Eurozone UK China Real GDP growth Inflation Long-term interest rate Per 100 units of foreign currency, as of USD CHF Yearly average 2 Year-end Source: Swiss Re Economic Research & Consulting, Datastream, CEIC Stock market performance The eurozone debt crisis continued to drive stock market performance in Early in the year, stock markets profited from several positive developments: the March agreement on the second Greek bailout averted any imminent risk of a disorderly Greek sovereign default and euro exit or break-up. The accompanying debt restructuring left private investors less exposed to Greece, mitigating contagion risk from potential future Greek defaults. The ECB's unlimited liquidity provision to European banks also averted the risk of a liquidity-driven bank failure. This, plus increasing evidence that the US economy would avoid recession, helped boost stock market performance (see stock markets chart). Risk appetite diminished in the second quarter as European economic indicators deteriorated and elections in Greece favoured radical parties that opposed the adjustment programme that had been agreed with the EU, the IMF and the ECB. This aggravated fears of a Greek exit from the euro, leading to widespread contagion and capital flight from Europe s peripheral economies. Only the ECB s forceful commitment at the end of July to do whatever it takes to preserve the single currency managed to contain the turmoil. Political agreement on increased fiscal and banking sector integration and the ECB s commitment to act as governments lender of last resort restored market confidence. The major stock markets showed positive 2012 performance ranging from 6% (FTSE 100) to 18% (TOPIX). Currency movements During the first few months of the year, the US dollar weakened slightly against the euro, the British pound, and the Swiss franc, before strengthening significantly as the escalating debt crisis weighed on these currencies (see currency section of economic indicators table). Towards yearend, the US dollar weakened again reflecting rising market confidence to end the year slightly weaker versus the euro (2%), the Swiss franc (3%) and the British pound (5%). On the other hand the dollar gained 11% against the ese yen on expectations of significant monetary easing by the Bank of. Swiss Re 2012 Financial Report 15

3 Primary non-life Commercial insurance grows in emerging markets The main generator of growth in non-life insurance is the pace of general economic development: when wealth increases, so does insurance demand. As described in Swiss Re s sigma (issue 5/2012, Insuring ever-evolving commercial risks ), commercial insurance premiums are growing about three times faster in emerging markets than in advanced markets. This growth stems not only from an expanding economy, but also from increasing market penetration, as expanding multinationals seek to protect themselves against more complex risks and smaller companies enhance their risk awareness. In the past three decades, emerging markets in Asia, particularly China and India, have transformed their agriculture-based economies, establishing and expanding manufacturing capacities, and developing domestic and export-led service sectors. Each development stage increases insurance demand. The global non-life industry generated around USD billion of premium income in 2012, of which around 18% was generated in emerging markets. Non-life insurance extends from standardised motor and household insurance to sophisticated tailor-made liability and property covers, including specialty commercial and industrial risk insurance. Growth in non-life insurance business further accelerated in In advanced markets this was due primarily to moderate rate increases in some countries, with exposure growth generally weakening with the slowing global economy. In emerging markets growth remained at a much higher level than in advanced markets, though moderating slightly compared to Underwriting results recovered from record catastrophe losses in Nevertheless, adjusting for catastrophe losses and positive reserve developments from earlier accident years, underlying underwriting profitability continued to erode due to rising claims and several years of softening rates. The gradual improvement in premium rates in some key markets has not yet been able to change the general soft market picture. The industry also saw weak investment returns, partly due to record low interest rates and feeble capital gains or capital losses. The eurozone debt crisis also lowered the mark-to-market valuations of some fixed income securities. Squeezed from all sides, the average profitability for the industry was low, with a return on equity for 2012 of only 5% % Estimated average return on equity in 2012 Global economic forecasts for 2013 are more positive and the demand for non-life insurance should increase. Strong premium growth is expected to continue in emerging markets, although growth will slow due to weaker macroeconomic conditions in Latin America and Asia. 1 See Swiss Re s 02/13 sigma on natural catastrophes and man-made disasters in 2012; available April Swiss Re 2012 Financial Report

4 Reinsurance non-life Global non-life reinsurance premiums in 2012 totalled about USD 180 billion, 25% of which stemmed from ceding companies in emerging markets. In general, reinsurance demand is a function of the size and capital resources of primary insurance companies, as well as of the risk profile of the insurance products provided. Aside from the financial crisis and the soft underwriting cycle, natural catastrophes are leaving the most substantial mark on earnings for the reinsurance sector. In the first three quarters of 2012, the global reinsurance industry enjoyed a good, though not strong, performance. The fourth quarter, however, saw multi-billion-dollar claims from Hurricane Sandy. Based on currently available information, we estimate a combined ratio of below 95% for the reinsurance industry in 2012, an improvement over 2011 with 110%, but in the same range as the 96% combined ratio in Nevertheless, underwriting profitability in reinsurance markets held up better than in many primary markets. The industry still benefits from the hard market years of 2002 and 2003, and from the more benign claims of the 2009 and 2010 recession years. Releases from loss reserves in prior years are currently helping to improve underwriting results. Like primary insurers, reinsurers have suffered from the eurozone debt crisis, low interest rates and weak equity markets. Their investment income is down this year. Squeezed from underwriting and investment, their overall profitability was also down: most expect a return on equity of above 10% for the full year, up from 4% in % Estimated average return on equity in 2012 The reinsurers capital base remains strong, but capital requirements have increased due to hikes in risk charges associated with reserves, higher modelled exposures to natural catastrophes, and riskier assets. Additional uncertainties relate to Solvency II requirements which are also likely to raise capital requirements further renewals are expected to be stable to slightly firmer. Significant hardening is expected to be limited to lines and segments that have recently experienced high losses. Assuming average catastrophe losses, we expect the combined ratio to be around 97% in This estimate is based on a scenario that assumes a moderate rate increase, a less benign claims environment than the last three years and declining reserve releases. The overall profitability outlook for 2013 and 2014 is moderate: we expect an average return on equity for the reinsurance industry of 8% to 9%. Exposure to natural catastrophes increases The demand for re/insurance cover for natural catastrophes has risen significantly in the past ten years. It is likely to increase further as economic development continues in emerging markets and as property and commercial values accumulate in high-risk coastal areas. Emerging markets represent a rising proportion of insured assets, reflecting their growing share of the global economy and increasing risk awareness. As demand for property catastrophe treaties is rising, the global reinsurance business is also increasingly exposed to the performance volatility associated with extreme weather events which, evidence suggests, may be aggravated by climate change going forward. Swiss Re 2012 Financial Report 17

5 Primary life Savings and retirement products under pressure from low interest rates The current low interest rate environment has reduced profitability throughout the industry, particularly in longterm business where investment income is a major source of earnings. Life insurers are more affected than non-life insurers, especially in savings products that provide performance guarantees to policyholders. Policy terms such as the option to withdraw money without penalty also increase the strain on profits. Insurers have limited room to respond to low interest rates for in-force business because policy terms cannot be changed. However, new life insurance products need to be adapted to the current investment environment. Appropriate pricing and guarantee levels should be supplemented by product redesign that aids hedging against interest rate risks, so that all parties are better prepared for any future interest rate scenario. Global life insurance premiums totalled about USD billion in 2012, of which around 15% was generated in emerging markets. About 85% of premium income derives from savings and retirement products. Protection products, which cover mortality and morbidity risks, have a declining share in premium income. Global life insurance premium income stagnated in 2012 in real terms, declining in most advanced markets. The only advanced markets with strong growth were in Asia:, Hong Kong, Singapore, South Korea and Taiwan. In emerging markets, premium income increased: growth was strongest in Latin America and Eastern Europe, followed by Africa. In emerging Asia, aggregate premium income remained unchanged, mainly due to a slight decline in China and India: in both countries, regulatory changes constrained sales. Sales of protection products are traditionally much less volatile than insurance savings products. Protection products held up relatively well during the crisis, with stable premiums in the UK and US after years of contraction, and increased volumes of new business in other important markets, particularly in Asia. Most companies reported respectable results, but the situation remains challenging. Low interest rates, volatile financial markets, regulatory changes and weak demand especially for life insurance savings and accumulation products have created a demanding business environment. Nevertheless opportunities remain for life insurers able to generate sales from the large and persistent protection gap. Despite its recovery after the financial crisis, profitability has declined steadily since the end of Average return on equity is now close to 10%, down from 12% in 2010 and % Estimated global premium growth in 2012 The future of the life insurance industry depends principally on the macroeconomic environment, financial markets and interest rates. In the short term, the outlook is clearly challenging: premium income is expected to recover only slowly and profitability is not expected to improve soon, not only because of low interest rates and weak sales, but also because of high hedging costs and more onerous capital requirements. 18 Swiss Re 2012 Financial Report

6 Life reinsurance Global life reinsurance premiums totalled slightly over USD 50 billion, 70% of which came from the US, Canada and the UK. Ceding companies from emerging countries accounted for only 6% of global demand. Life reinsurers are increasingly diversifying away from traditional mortality business, which is currently flat. Unlike the stagnating primary life insurance industry, the life reinsurance industry saw an increase in premium income of 4%. Although life reinsurance is mostly linked to the relatively stable protection business, business volume was boosted by increasing demand for non-traditional reinsurance transactions, such as block deals, longevity risk transfer and capital relief solutions. Block transactions help primary insurers to unwind those parts of their portfolios that they no longer sell. The market for longevity risk transfer continues to show strong growth, albeit from low volumes. There is also substantial demand for reinsurance solutions as a means to manage the capital strain put on primary life and health insurers by the macroeconomic environment. Nevertheless results are suffering from adverse capital market conditions, with dwindling investment income eroding overall profitability. In 2012, the industry average life reinsurance pre-tax operating result declined to about 8% of net premiums earned, compared to 10% in 2011 and 9% in % Estimated global premium growth in 2012 On fundamentals, the outlook for 2013 is unchanged from A volatile macroeconomic environment will make it difficult to improve life reinsurance profitability. On the other hand, increasing pressure on a number of primary life insurers is expected to generate a steady demand for capital solutions and other forms of non-traditional reinsurance. Longevity creates new source of demand The market for longevity risk transfer continues to show strong momentum, as reinsurers develop new solutions for private and public pension plans as well as for primary companies with annuity business. During 2012, clients transferred more than USD 20 billion in longevity liabilities through publicly disclosed longevity reinsurance and swap transactions; this compares to USD 9 billion for the full year in 2010 and USD 15 billion for The market is most active in the UK, although there have been large deals in continental Europe and transactions with Australian and Canadian insurers. Longevity reinsurance activity is expected to grow in other markets as well, including the Netherlands, Switzerland and the US, where there is significant potential demand, particularly from pension funds. Swiss Re 2012 Financial Report 19

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