ZAIC2012-1 - Zurich Producer Compensation

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ANNUAL STATEMENT FOR THE YEAR 2012 OF THE ZURICH AMERICAN INSURANCE COMPANY 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A. Accounting Practices The accompanying financial statements of <strong>Zurich</strong> American Insurance Company (ZAIC or the Company) have been prepared in conformity with the National Association of Insurance Commissioners'Accounting Practices and Procedures Manual (NAIC SAP) and in conformity with accounting practices prescribed or permitted by the New York State Department of Financial Services (the “Department”). A reconciliation of the Company's net income and capital and surplus between NAIC SAP and practices prescribed and permitted by the State of New York are shown below: State of Domicile 2012 2011 1. Net Income New York state basis New York $ 1,156,546,825 $ 960,441,660 2. State Prescribed Practices (Income) New York 0 0 3. State Permitted Practices (Income) New York 0 0 4. Net Income, NAIC SAP New York $ 1,156,546,825 $ 960,441,660 5. Statutory Surplus New York state basis New York $ 7,642,260,323 $ 7,018,779,407 6. State Prescribed Practices (Surplus) New York 0 0 7. State Permitted Practices (Surplus) New York 0 0 8. Statutory Surplus, NAIC SAP New York $ 7,642,260,323 $ 7,018,779,407 B. Use of Estimates in the Preparation of the Financial Statements The preparation of financial statements in conformity with Annual Statement instructions and NAIC SAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities. It also requires disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the period. Actual results could differ from those estimates. As discussed further below, significant estimates and assumptions affect various provisions including losses. The liabilities for losses and loss adjustment expenses, although supported by actuarial analysis and other data, are ultimately based on management's reasoned expectations of future events. C. Accounting Policies Premiums are primarily earned on a daily prorata basis over the term of the policies and are net of reinsurance placed with reinsurers. Unearned premium reserves are established to cover unexpired portion of premiums written and are stated after deductions for related reinsurance amounts. Such reserves are computed on a prorata basis for direct business and are based on reports received from ceding companies for reinsurance. Policy acquisition costs such as commissions, premium taxes, and other underwriting and agency expenses are charged to income as incurred. The Company provides a liability for losses based upon aggregate case-basis estimates for losses reported, estimates received from ceding reinsurers, and estimates of incurred but not reported (IBNR) losses related to direct and assumed business, less reinsured amounts. Reserves for unreported losses are established using various statistical and actuarial techniques reflecting historical patterns of development of paid and reported losses adjusted for current trends. Certain liabilities for unpaid losses related to workers'compensation pension cases and long-term disability losses are discounted to present value. Because the ultimate settlement of claims is subject to future events, no single loss or loss adjustment expense (LAE) reserve can be considered accurate with certainty. The Company's analysis of the reasonableness of loss or LAE reserve estimates includes an analysis of the amount of variability in the estimate. The Company develops its estimate considering a range of reserve estimates bounded by a high and a low estimate. The high and low ends of the range do not correspond to an absolute best-and-worst case scenario of ultimate settlements because such estimates may be the result of unlikely assumptions. Management's best estimate therefore does not include the set of all possible outcomes but only those outcomes that are considered reasonable. The Company provides a liability for loss adjustment expenses by estimating future expenses to be incurred in settlement of the claims provided for in the liability for losses, which is stated after deduction for ceded reinsurance. Changes to previous estimates for loss and LAE reserves are reflected in the current year's underwriting results. The Company reflects its liability for losses net of anticipated salvage and subrogation recoveries. Salvage and subrogation received and changes in estimates of future recoveries are reflected in the current year's underwriting results. To control exposures to large property-casualty losses, the Company utilizes a variety of reinsurance agreements including, (i) facultative reinsurance, in which reinsurance is provided for all or a portion of the insurance provided by a single policy; (ii) treaty reinsurance, in which reinsurance is provided for a specified type or category of risks; (iii) catastrophe reinsurance, in which the ceding company is indemnified for an amount of loss in excess of a specified retention with respect to losses resulting from a catastrophic event; and (iv) aggregate excess of loss reinsurance, in which the ceding company is indemnified against additional covered loss and LAE in excess of a pre-defined loss ratio or loss retention for each accident year, as specified in the reinsurance agreements. Realized gains or losses on the sale of investments, the recognition of other-than-temporary decline in value or circumstances where the Company has made a decision to sell a security at an amount below its carrying value, are determined on the basis of specific identification of the acquisition lots of the respective investment sold, written down or expected to be sold, and are reflected as a component of income. In the case of realized gains or losses on the sale of investments, the amount is reflected as a component of income, net of tax. Unrealized gains or losses on changes in the fair value of investments are credited or charged to unassigned surplus, net of deferred taxes. The Company does not accrue interest income on fixed income securities which are deemed to be impaired on an other-thantemporary basis, when a determination is made that the likelihood of collection of such interest is doubtful. Assets included in the statutory statement of admitted assets, liabilities and surplus are at admitted asset value. Non-admitted assets, principally deferred tax assets, agents'balances over 90-days past due, computer software, other equipment, and 10% of unsecured accrued retrospective premiums, are excluded from total assets and are reflected as a charge against surplus. 14
ANNUAL STATEMENT FOR THE YEAR 2012 OF THE ZURICH AMERICAN INSURANCE COMPANY In addition, the Company uses the following accounting policies: 1. Short-term investments are stated at amortized cost. 2. Bonds not backed by other loans are stated at amortized cost except for bonds rated NAIC 3 or below, which are carried at the lower of amortized cost or fair value. The amortized cost of bonds, which is determined using the interest method, is adjusted for amortization of premium and accretion of discount using a level effective yield to maturity. Such amortization or accretion is included in investment income. Bonds that are classified as non-investment grade where it is determined that the collection of all contractual cash flows is not probable, are written down to the current market value and the difference is recorded as a realized loss. 3. Investments in unaffiliated common stocks are generally carried at fair market value, with the unrealized gains or losses reflected in unassigned surplus. The cost basis of common stocks is written down to market value and recorded as a realized loss when market value has been significantly below cost for an extended length of time and a determination is made that the financial condition or future prospects of the investee has deteriorated such that the decline in value is considered other-thantemporary. 4. Redeemable preferred stocks are stated at amortized cost. The amortized cost of the preferred stock is adjusted for amortization of premiums and accretion of discounts using a level of effective yield to maturity method. Such amortization or accretion is included in investment income. Preferred stock that are classified as non-investment grade where it is determined that collection of all contractual cash flows is not probable, are written down to the current market value and the difference is recorded as a realized loss. 5. The Company has no investments in mortgage loans. 6. Loan-backed securities are stated at amortized cost except for such securities rated NAIC 3 or below which are stated at the lower of amortized cost or fair market value. Amortization of discount or premium on mortgage-backed and asset-backed securities is recognized based on the estimated timing and amount of prepayments of the underlying assets. For all securities, except interest only securities or other securities where the yield has become negative, the amortization of discount or premium is adjusted using the retrospective method to reflect differences which arise between the prepayments originally anticipated and the actual prepayments received and currently anticipated. To the extent the estimated lives of such securities change as a result of changes in prepayment rates, the adjustment is included in investment income. For all interest only securities or other securities where the yield has become negative, the Company uses the prospective method for amortization of discount or premium. Loan backed securities with evidence of deterioration of credit quality where the Company has the intent and ability to hold, and for which it is probable that the Company will be unable to collect all contractual cashflows, are written down to the present value of expected cash flows calculated using the discount rate at the original acquisition. 7. Investments in common stock of U.S. based affiliated insurance companies are carried at the underlying statutory equity as reflected in the respective entity’s financial statements. Investments in common stock of non-U.S. based insurance companies are carried at the underlying audited U.S. Generally Accepted Accounting Principles (GAAP) equity of the investee, adjusted to a statutory basis of accounting. 8. The Company has minor ownership interests in joint ventures and partnerships. The Company carries these interests based on the underlying audited GAAP equity of the investee. 9. The Company has no investments in derivatives. 10. The Company anticipates investment income as a factor in determining premium deficiency reserves. As of December 31, 2012, the Company did not record a premium deficiency reserve. 11. See Note 1C, paragraphs 2 and 3 above for Company’s methodologies for estimating liabilities for losses and loss/claim adjustment expenses. 12. The Company has not modified its capitalization policy from the prior year. 13. The Company has no pharmaceutical rebate receivables. 2. ACCOUNTING CHANGES AND CORRECTIONS OF ERRORS Effective January 1, 2012, the Company adopted SSAP No. 101, Income Taxes, A Replacement of SSAP No. 10R and SSAP No. 10. SSAP No. 101 contains changes to accounting for current and deferred federal income taxes. This guidance provides that the deferred tax asset admissibility guidance is no longer elective, and the reversal and surplus limitation parameters in the admissibility tests are determined based on the risk-based capital level. It also requires gross deferred tax assets to be reduced by a statutory valuation allowance if it is more likely than not that some portion or all of the gross deferred tax assets will not be realized. The guidance also sets a more likely than not threshold for the recording of contingent tax liabilities. The cumulative effect of adopting this pronouncement is $0. Effective December 31, 2012, the Company adopted changes to SSAP No. 62R, Property and Casualty Reinsurance. SSAP No. 62R contains changes to accounting for reinsurance ceded to certified reinsurers. This guidance defines a certified reinsurer as "an assuming insurer that does not meet the requirements to be considered authorized in the domestic state of the ceding insurer, but has been certified by such state and is required to provide collateral as security for its reinsurance obligations incurred under contracts entered into or renewed on or after the effective date of certification." As a result, ceding reinsurers are allowed to accept less collateral from certified reinsurers without incurring an additional provision for reinsurance liability. The cumulative effect of adopting this updated pronouncement is $0. 3. BUSINESS COMBINATIONS AND GOODWILL None 4. DISCONTINUED OPERATIONS None 5. INVESTMENTS A. The Company has no investments in mortgage loans. B. The Company did not have any debt restructuring during 2012. 14.1
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ZAIC2012-1 - Zurich Producer Compensation

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