In 2013, Swiss Re remained strongly capitalised. We aim to combine this capital strength with financial flexibility, maximising return on equity within our risk tolerance targets.
Our management is confident of the Group’s overall risk profile and capitalisation.
In 2013, we actively increased our overall risk exposure by pursuing business growth and re-balancing our investment portfolio. Swiss Re’s management is confident of the Group’s overall risk profile and capitalisation, both of which lie within the boundaries of our self-imposed Group-wide risk tolerance. We continue to hold excess capital under all applicable external capital adequacy requirements, as well as surplus liquidity and capital relative to our own, more conservative risk tolerance criteria.
Changes in our risk profile
Throughout 2013, Swiss Re’s overall risk increased as a result of higher financial market and credit risk. This reflected continued re-balancing of the investment portfolio with an increased allocation to high-quality corporate bonds and equities, along with the implementation of the short duration position. The other driver of the increase in Swiss Re’s overall risk was the higher property and casualty risk, driven by a reduction in hedging including, eg, the expiry of a major quota share retrocession agreement and some business growth. Life and health risk decreased mainly due to the rise in long-term interest rates. Swiss Re’s portfolio of risks from underwriting and investment activities remains widely diversified.
During 2013, Swiss Re maintained its strong capitalisation, directed excess capital flows from subsidiaries to parent companies and further optimised its capital structure at the Group level. Swiss Re continues to hold excess capital under all applicable external capital adequacy requirements, including the Swiss Solvency Test (SST), Solvency I, and Standard & Poor’s AA rating. We are following and implementing the requirements of the forthcoming Solvency II regime for our European entities. These are broadly in line with those of the SST.
We have made significant progress in optimising our capital structure. As announced at our Investor’s Day in June 2013, this incorporates three main activities. First, we continued to reduce senior leverage, including letters of credit (LOCs). This involved the repurchase of senior notes and the maturing of senior debt, which supports our target to reduce Swiss Re’s leverage by more than USD 4 billion by 2016. Second, Swiss Re continues to issue new hybrid instruments in the form of contingent capital (two of them in 2013) that combine high capital quality with flexibility and fungibility. For the most part, these instruments replace traditional subordinated debt. Third, we continue to direct excess capital flows from our legal entities to their respective parent companies and ultimately to Swiss Re Ltd. This enhances the financial flexibility of the Group, thereby supporting our commitment to an attractive and sustainable external dividend policy (see Share performance).
Our internal target capital adequacy ratios established under our Group risk tolerance framework are more conservative than those used by external agencies. They are set to fulfil three aims: to meet all regulatory requirements and expectations; to maintain capital and liquidity levels that compare favourably with those of our peers and are attractive to clients; and to ensure our ability to write business even after a large loss event, an extremely adverse year in the financial markets, or both together.
Our core insurance and reinsurance operations generate liquidity primarily through premium income. Our exposure to liquidity risk stems mainly from two sources: the need to cover potential extreme loss events and regulatory constraints that limit the flow of funds within the Group.
The amount of liquidity held is largely determined by internal liquidity stress tests, which estimate the potential funding requirements stemming from extreme loss events. Based on these internal liquidity stress tests, we estimate that the Swiss Reinsurance Company Ltd liquidity pool, the primary liquidity pool of the Group, holds surplus liquidity.
Swiss Re’s Risk Management function forms an integral part of our business model. Risk Management is involved in all of Swiss Re’s risk-taking activities and is mandated to support both the Group and the Business Units. Risk Management is embedded throughout our business, through dedicated risk functions and Chief Risk Officers for each Business Unit. Each of them has a duty to analyse and challenge business decisions; their independence is maintained by a direct reporting line to the Group Chief Risk Officer. They apply a consistent Enterprise Risk Management approach to ensure a fully integrated view of risk, thus sustaining long-term stability and growth.
Our proprietary integrated risk model provides a meaningful assessment of the risks to which the company is exposed and is an important tool for managing our business. It determines the capital requirements for internal purposes and forms the basis for regulatory reporting under the SST.
The regulatory agenda continued to accelerate in 2013. Swiss Re remains actively engaged in regulatory discussions and is well prepared to implement new regulatory requirements such as Solvency II, capital market reforms, the Own Risk and Solvency Assessment and group supervision that are approaching implementation in most markets.