Notes to the Annual Financial Statements

The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) and its interpretations issued by the International Accounting Standards Board (IASB) that are effective at 31 December 2005. An explanation of how the transition to IFRS has affected the reported financial position and financial performance of the Group is provided in note 2.

The financial statements are prepared under the historical cost convention as modified by the revaluation of investments and investment properties.

The financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) for the first time. IFRS 1: First-time Adoption of International Financial Reporting Standards has been applied. Comparative information for 2004 has been restated.

The Group has adopted the following International Financial Reporting Standards, which are relevant to its operations and which have necessitated a change in recognition, measurement or presentation in these financial statements:

• IAS 1: Presentation of Financial Statements
• IAS 16: Property, Plant and Equipment
• IAS 17: Leases
• IAS 24: Related Party Disclosures
• IAS 27: Consolidated and Separate Financial Statements
• IAS 33: Earnings per Share
• IFRS 4: Insurance Contracts

The preparation of the financial statements in conformity with IFRS requires management to make estimates and assumptions in the valuation of certain assets and liabilities. This is specifically true for the valuation of liabilities from insurance contracts. The estimates and associated assumptions are based on historical experience and various other factors that are believed to be relevant under the circumstances. Actual results may, however, differ from these estimates. Revisions to accounting estimates and assumptions are recognised in the year in which the estimate is revised.

The Company has changed its accounting policy for investments in subsidiaries. Investments in subsidiaries were previously shown at net asset value, but are now shown at cost in accordance with IAS 27: Consolidated and Separate Financial Statements.

The adoption of IFRS 4: Insurance Contracts had an impact on the presentation and accounting of assets and liabilities in respect of insurance contracts at 31 December 2005. The Group has re-evaluated its presentation for insurance cells following the implementation of IFRS 4: Insurance Contracts. The results of insurance contracts underwritten in cells where the risks and rewards accrue to the cell owner are no longer included in Group profit.

Property and equipment have been accounted for in accordance with IAS 16: Property, Plant and Equipment. The depreciable amount of property and equipment is now cost less residual value. In addition, the useful lives of assets and residual value have been reviewed at the balance sheet date.

Operating lease expenses are now spread evenly over the lease period in accordance with IAS 17: Leases and are no longer expensed as paid.

The accounting policies set out below have been applied consistently to all years presented in these consolidated financial statements and in preparing an opening IFRS balance sheet at 1 January 2004 for the purposes of the transition to IFRS.

The consolidated financial statements include the Company and its subsidiaries. The results of the subsidiaries are included from the effective dates of control up to the effective dates that control ceases. Subsidiaries are those entities for which the Company, directly or indirectly, has the power to govern the financial and operating policies of the entity so as to obtain benefits from its activities.

Associated companies are those entities in which the Group has significant influence, but not control, over the financial and operating policies. The consolidated financial statements include the Group’s share of the total recognised gains and losses of associates on an equity accounted basis, from the date that significant influence commences until the date that significant influence ceases.

The accounting policies have been applied consistently by Group entities. All inter-company transactions, balances and unrealised gains and losses on transactions between Group entities have been eliminated. Unrealised gains arising from transactions with associates are eliminated to the extent of the Group’s interest in the entity. Unrealised losses are eliminated in the same way as unrealised gains, but only to the extent that there is no evidence of impairment.

The primary basis for identifying business segments of the Group is to group together related products and services with similar business risks and returns while the secondary basis reflects geographic regions.

Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity operates. The consolidated financial statements are presented in thousands of Rands, which is the Group’s presentation currency.

Transactions in foreign currencies are translated at the foreign exchange rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are translated to South African Rand at the foreign exchange rate ruling at that date. Foreign exchange differences arising on translation are recognised in the income statement. Non-monetary assets and liabilities that are measured in terms of historical cost in a foreign currency are translated using the exchange rate at the date of the transaction. Non-monetary assets and liabilities denominated in foreign currencies that are stated at fair value are translated to Rand at foreign exchange rates ruling at the dates the fair value was determined and are reported as part of the fair value gain or loss.

The assets and liabilities of foreign operations, including goodwill and fair value adjustments arising on consolidation, are translated to Rand at foreign exchange rates ruling at the balance sheet date. The revenues and expenses of foreign operations are translated to Rand at rates approximating the foreign exchange rates ruling at the dates of the transactions. Foreign exchange differences arising on retranslation are recognised directly in a separate component of equity.

The Group issues contracts that transfer insurance risk or financial risk or both. Contracts under which the Group accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder or other beneficiary if a specified uncertain future event (the insured event) adversely affects the policyholder are classified as insurance contracts. Insurance risk is risk other than financial risk. Financial risk is the risk of a possible future change in one or more of a specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates, a credit rating or credit index or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract. Insurance contracts may also transfer some financial risk.

Contracts under which the transfer of insurance risk to the Group from the policyholder is not significant are classified as investment contracts.

Premiums received under third party cell captive business are included in gross premium revenue in the income statement. These premiums are subsequently ceded to insurance cells and are reflected as such in the income statement. A liability in the balance sheet represents the amounts payable to cell shareholders and includes the cash component of assets due to the cell shareholders, which is included in cash and cash equivalents on the balance sheet.

Primary risk policies are treated as insurance contracts with amounts due to policyholders from underwriting and investment income reflected as an expense in the income statement and as a liability in the balance sheet where these amounts have not been paid to the policyholder.

The insurance contracts that the Group underwrites are classified and described in note 4.

Written premiums comprise the premiums on contracts entered into during the year, irrespective of whether they relate in whole or in part to a later accounting period and are disclosed gross of commission payable to intermediaries. Premiums written include adjustments to premiums written in prior accounting periods and estimates for ‘pipeline premiums’ (premiums written relating to current accounting period but not reported by the balance sheet date).

Premiums are earned from the date the risk attaches, over the indemnity period, based on the pattern of the risk underwritten. Unearned premiums, which represent the proportion of premiums written in the current year which relate to risks that have not expired by the end of the financial year, are calculated on the 365th basis for even risk business and other bases that best represent the unearned risk profile for uneven risk business.

Outward reinsurance premiums are recognised as an expense in accordance with the pattern of reinsurance service received.

Claims incurred consist of claims and claims handling expenses paid during the financial year together with the movement in the provision for outstanding claims.

The provision for outstanding claims comprise the Group’s estimate of the undiscounted ultimate cost of settling all claims incurred but unpaid at the balance sheet date whether reported or not and related internal and external claims handling expenses. Related anticipated reinsurance recoveries are disclosed separately as assets. These estimated reinsurance and other recoveries are assessed in a manner similar to the assessment of claims outstanding.

Whilst the Directors consider that the gross provisions for claims and the related reinsurance recoveries are fairly stated on the basis of the information currently available to them, the ultimate liability will vary as a result of subsequent information and events and may result in significant adjustments to the amounts provided. Adjustments to the amounts of claims provisions established in prior years are reflected in the financial statements for the period in which the adjustments are made, and disclosed separately. The methods used to value these provisions, and the estimates made, are reviewed regularly.

Provision is made for unexpired risks where the expected value of claims and expenses attributable to the unexpired periods of policies in force at the balance sheet date exceeds the unearned premiums provision in relation to such policies after the deduction of any deferred acquisition costs. The provision for unexpired risks is calculated separately by reference to classes of business that are managed together, after taking into account the relevant investment returns.

Insurance contracts are tested for adequacy by discounting current estimates of all future contractual cash flows and comparing this amount to the carrying value of the liabilities net of deferred acquisition costs and any related assets or investment income from those assets. Where a shortfall is identified, an additional provision is made and the Group recognises the deficiency in income for the year.

The Group cedes reinsurance in the normal course of business for the purpose of limiting its net loss potential. Reinsurance arrangements do not relieve the Group from its direct obligations to its policyholders.

Amounts recoverable under reinsurance contracts are assessed for impairment at each balance sheet date. Such assets are deemed impaired if there is objective evidence, as a result of an event that occurred after its initial recognition, that the Group may not recover all amounts due and that there is a reliably measurable impact on the amounts that the Group will receive from the reinsurer. Impairment losses are recognised in the income statement.

Only contracts that give rise to a significant transfer of insurance risk are accounted for as reinsurance. Amounts recoverable under such contracts are recognised in the same year as the related claim. Contracts that do not transfer significant insurance risk (i.e. financial reinsurance) are accounted for as financial assets.

The benefits to which the Group is entitled under its reinsurance contracts held are recognised as reinsurance assets. These assets consist of short-term balances due from reinsurers as well as longer-term receivables that are dependent on the expected claims and benefits arising under the related reinsured insurance contracts. Amounts recoverable from or due to reinsurers are measured consistently with the amounts associated with the reinsured insurance contracts and in accordance with the terms of each reinsurance contract. Reinsurance liabilities are primarily premiums payable for reinsurance contracts and are recognised as an expense when due.

The costs of acquiring new and renewal insurance business that is primarily related to the production of that business are deferred and recognised as an intangible asset. Deferred acquisition costs are amortised on a pro rata basis over the contract term. Similarly, any reinsurance commissions received are deferred and recognised as income over the term of the reinsurance contract.

Receipts and payments under investment contracts are not classified as insurance transactions in the income statement but are deposit accounted in the balance sheet. The deposit liability recognised in the balance sheet represents the expected amounts payable to the holders of the investment contracts inclusive of allocated investment income.

Motor vehicles, furniture, office equipment, computer equipment and systems are stated at cost less accumulated depreciation and impairment losses. Depreciation is provided on a straight-line basis at rates required to write off the costs of fixed assets over their estimated useful lives to their estimated residual values. Computer equipment and systems are depreciated over three years, motor vehicles and office equipment over five years and furniture over ten years.

Certain items of property and equipment that had been revalued to fair value on or prior to 1 January 2004, the date of transition to IFRS, are measured on the basis of deemed cost, being the revalued amount at the date of that revaluation.

Where the carrying amount of an asset is greater than its estimated recoverable amount, it is written down immediately to its recoverable amount. The residual values and useful lives are reviewed at each balance sheet date and adjusted if appropriate.

Gains and losses on disposals, which are included in operating profit, are determined by comparing the proceeds with the carrying amounts.

The financial assets are classified into four categories, depending on the purpose for which the assets were acquired. The categories are financial assets at fair value through income, held-to-maturity, available-for-sale as well as loans and receivables.

Financial assets at fair value through income
Financial assets at fair value through income are financial assets held for trading, which on initial recognition, are designated by the Group as being at fair value through income. A financial asset is classified into this category at inception if acquired principally for the purpose of selling in the short term, if it forms part of a portfolio of financial assets in which there is evidence of short term profit-taking, or if so designated by management.

Held-to-maturity financial assets
Held-to-maturity financial assets are non-derivative financial assets with fixed or determinable payments and fixed maturities that are held with the positive intent and ability to hold to maturity.

Available-for-sale financial assets
Available-for-sale financial assets are non-derivative financial assets intended to be held for an indefinite period of time and which may be sold in response to needs for liquidity, changes in interest rates or market conditions.

Loans and receivables
Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. Interest-bearing staff housing loans and other loans are included in this category.

Purchases of investments are recognised on the trade date, which is the date of commitment to purchase the asset. Investments are derecognised when contractual rights to receive cash flows from the assets expire, or where the assets, together with substantially all the risks and rewards of ownership, have been transferred.

Investments are initially measured at fair values plus, in the case of all financial assets not at fair value through income, transaction costs that are directly attributable to their acquisition.

After initial recognition, the Group measures investments at fair value through income and available-for-sale financial assets at fair value, without any deduction for transaction costs it may incur on disposal. The fair value of quoted investments is their quoted bid prices at the balance sheet date. For unquoted investments the Group establishes fair values by using valuation techniques. These include the use of recent arm’s length market transactions, references to another instrument that is substantially the same, discounted cash flow analysis and option pricing models. If the fair value of equity instruments cannot be reliably measured, they are measured at cost.

Held-to-maturity investments are measured at amortised cost using the effective interest method. Loans and receivables are also measured at amortised cost using the effective interest method.

Investments in subsidiaries are measured at cost in the Company’s financial statements.

Realised gains and losses, and unrealised gains and losses arising from changes in the fair value of financial assets at fair value through income, are included in the profit or loss in the period in which they arise.

Unrealised gains and losses arising from changes in the fair value of available-for-sale financial assets are recognised directly in equity except for impairment losses. When available-for-sale financial assets are sold or impaired, the cumulative gains or losses previously recognised in equity are recognised in profit or loss. Where these investments are interest-bearing, interest calculated using the effective interest method is recognised in profit or loss.

Receivables are stated at cost less impairment losses. Payables are stated at cost.

The carrying amounts of the Group’s assets are reviewed at each balance sheet date to determine whether there is any indication of impairment. If any such indication exists, the carrying value is reduced to the estimated recoverable amount by means of a charge to the income statement.

Objective evidence that a financial asset or group of assets is impaired includes observable data that comes to the attention of the Group about the following events:

(i)	significant financial difficulty of the issuer or debtor;
(ii)	a breach of contract, such as a default or delinquency in payments;
(iii)	it becoming probable that the issuer or debtor will enter bankruptcy or other financial reorganisation;
(iv)	the disappearance of an active market for that financial asset because of financial difficulties; or
(v)	observable data indicating that there is a measurable decrease in the estimated future cash flow from a group of financial assets since the initial recognition of those assets, although the decrease cannot yet be identified with the individual financial assets in the group, including:
	•	adverse changes in the payment status of issuers or debtors in the Group; or
	•	national or local economic conditions that correlate with defaults on the assets in the Group.

The Group first assesses whether objective evidence of impairment exists individually for financial assets that are individually significant. If the Group determines that no objective evidence of impairment exists for an individually assessed financial asset, whether significant or not, it includes the asset in a group of financial assets with similar credit risk characteristics and collectively assesses them for impairment. Assets that are individually assessed for impairment and for which an impairment loss is or continues to be recognised are not included in a collective assessment of impairment.

The recoverable amount of the Group’s investments in held-to-maturity securities and receivables carried at amortised cost is calculated as the present value of estimated future cash flows, discounted at the original effective interest rate (i.e. the effective interest rate computed at initial recognition of these financial assets). Receivables with a short duration are not discounted.

The recoverable amount of other assets is the greater of their net selling price and value in use. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. For an asset that does not generate largely independent cash inflows, the recoverable amount is determined for the cash-generating unit to which the asset belongs.

An impairment loss in respect of a held-to-maturity security or receivable carried at amortised cost is reversed if the subsequent increase in recoverable amount can be related objectively to an event occurring after the impairment loss was recognised.

The Group assesses at each balance sheet date whether there is objective evidence that an available-for-sale financial asset is impaired, including in the case of equity investments classified as available-for-sale, a significant or prolonged decline in the fair value of the security below its cost. If any such evidence exists for available-for-sale financial assets, the cumulative loss – measured as the difference between the acquisition cost and current fair value, less any impairment loss on the financial asset previously recognised in profit or loss – is removed from equity and recognised in the income statement. Impairment losses recognised in the income statement on equity instruments are not subsequently reversed. The impairment loss is reversed through the income statement, if in a subsequent period the fair value of a debt instrument classified as available-for-sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised in profit or loss.

In respect of other assets, an impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount. The reversal is recognised in profit or loss.

An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortisation, if no impairment loss had been recognised.

Provisions are recognised when the Group has a present legal or constructive obligation as a result of past events, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation and a reliable estimate of the amount of the obligation can be made.

Investment properties are properties which are held either to earn rental income or for capital appreciation, or for both. Investment properties are measured initially at cost, including transaction costs. After initial recognition investment properties are measured at fair value. An external, independent valuer, having an appropriate recognised professional qualification and recent experience in the location and category of property being valued, values the properties annually. The fair values are based on market values, being the estimated amount for which a property could be exchanged on the date of valuation between a willing buyer and a willing seller in an arm’s length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion.

Any gain or loss arising from a change in fair value is recognised in the income statement.

Leases of assets under which the lessor effectively retains all the risks and benefits of ownership are classified as operating leases. Payments made under operating leases are recognised in the income statement on a straight-line basis over the term of the lease.

The accounting policy in relation to revenue from insurance contracts is disclosed in note 1.5.

Interest on investments is accounted for on the accrual basis using the effective interest method. Dividends are recognised at the last day for registration in respect of quoted shares and when declared in respect of unquoted shares.

Rental income from investment properties is recognised in the income statement on a straight-line basis over the term of each lease.

Fee income arising on Risk Financing business is recognised in the income statement as earned.

Income tax on the profit or loss for the year comprises current and deferred tax. Income tax is recognised in the income statement except to the extent that it relates to items recognised directly in equity, in which case the related income tax is also recognised in equity.

Current tax is the expected tax payable on the taxable profit for the year, using tax rates enacted or substantially enacted at the balance sheet date, and any adjustment to tax payable in respect of previous years.

Deferred tax is provided in full, using the balance sheet liability method, providing for temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes, and the amounts used for taxation purposes. The amount of deferred tax provided is based on the expected manner of realisation or settlement of the carrying amount of assets and liabilities, using tax rates enacted or substantially enacted at the balance sheet date.

A deferred tax asset is recognised only to the extent that it is probable that future taxable profits will be available against which the asset can be utilised. Deferred tax assets are reduced to the extent that it is no longer probable that the related tax benefit will be realised.

Secondary Tax on Companies that arise from the distribution of dividends are recognised at the same time as the liability to pay the related dividend.

Group companies operate various pension schemes and have both defined benefit and defined contribution plans. A defined benefit plan is a pension plan that defines an amount of pension benefit that an employee will receive on retirement. A defined contribution plan is a pension plan under which the Group pays fixed contributions into a separate entity. The Group has no legal or constructive obligation to pay further contributions if the fund does not hold sufficient assets to pay all employees the benefits relating to service in the current and prior periods.

The Group’s net obligation in respect of defined benefit pension plans is the present value of the defined benefit obligation less the fair value of any plan assets, together with adjustments for unrecognised actuarial gains or losses and past service cost. The present value of the defined benefit obligation is determined by discounting the estimated future cash outflows of the benefits that will be paid to employees and using interest rates of government bonds that have terms to maturity approximating the terms of the related pension obligations. The calculation is performed by a qualified actuary using the projected unit credit method.

Actuarial gains and losses arising from experience adjustments and changes in actuarial assumptions are charged or credited to income over the average remaining service lives of the related employees except in the case of retired employees, where such amounts are recognised immediately.

Past-service costs are recognised immediately in income, unless the changes to the pension plan are conditional on the employees remaining in service for a specified period of time (the vesting period), in which case the past-service costs are amortised on a straight-line basis over the vesting period.

Obligations for contributions to defined contribution pension plans are recognised as an expense in the income statement as incurred.

The Group provides post-retirement healthcare benefits to current and future pensioners, except in the case of employees who joined the Group after 30 September 2002 from which date these employees are no longer entitled to this benefit. The entitlement to the post-retirement healthcare benefits is conditional on the employee remaining in service up to retirement age. The expected costs of these benefits are accrued over the period of employment using the projected unit credit method. Actuarial gains and losses arising from experience adjustments and changes in actuarial assumptions are charged or credited to income over the expected average remaining working lives of the related employees. Independent qualified actuaries value these obligations annually.

Where key business performance targets are met, certain Directors and senior executives of the Group receive Zurich Financial Services shares. Based on a three-year plan cycle, performance is measured against agreed criteria. Target shares allocated to executive members, are a notified percentage value of the base salary as at 1 April (excluding bonuses, incentives and expense allowances). The share price for allocation is the closing price of Zurich Financial Services shares as at allocation date. The exchange rate used to convert a salary to Swiss Franc is the closing Bloomberg exchange rate as at allocation date. The target share allocation is not an award, but a translation of the Long Term Performance Share Plan (LTPSP) incentive salary at target into a number of shares at target.

One third of the target shares allocated will be assessed for vesting on each of three anniversary dates following the grant date. One half of the shares awarded under the Plan cannot be sold for a period of three years after vesting. A proportion of the allocated target shares will be transferred to executives in April following each performance period and these shares will be payable on the vesting date. The cost of the shares is charged to the Group by Zurich Financial Services and expensed as paid.

The annual adjustment to the statutory contingency reserve stems from premium increases or decreases during the year and is reflected as an appropriation to or from retained earnings.

Cash and cash equivalents includes cash in hand, deposits held at call with banks, other short-term highly liquid investments with original maturities of three months or less and investment contracts of short duration.

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