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Zurich Economic Capital Model

In addition to a qualitative approach to measuring risks, Zurich regularly measures and quantifies material risks to which it is exposed through both TRP and the Zurich Economic Capital Model (Z-ECM). This model provides a key input into the strategic planning process, as it allows an assessment as to whether its risk profile is in line with its risk tolerance level. In particular, Z-ECM forms the basis for optimizing Zurich's risk/retum profile by providing consistent risk measurement across the Group.

Zurich uses Z-ECM to assess the economic capital consumption of its business with a balance sheet approach. Under the balance sheet approach one looks at the change in stockholders' or owners' equity to determine the amount of net income during the period between balance sheets. The Z-ECM framework is embedded in Zurich's risk culture and plays a critical role in decision making, and is used in capital allocation, business performance management, pricing, reinsurance purchasing, transaction evaluation, and risk optimization, as well as regulatory, investor, and rating agency communication. Z-ECM quantifies the capital required for insurance-related risk (including premium and reserve, natural catastrophe, business, and life insurance), market risk (market/ALM [asset/liability management]), credit risk (including reinsurance credit and investment credit), and operational risks.

At the Group level, Zurich compares Z-ECM capital required to the Z-ECM available financial resources (Z-ECM AFR) to derive an economic solvency ratio (Z-ECM ratio). Z-ECM AFR reflects financial resources available to cover policyholder liabilities in excess of their expected value. It is derived by adjusting the International Financial Reporting Standards (IFRS) shareholders' equity to reflect the full economic capital base available to absorb any unexpected volatility in Zurich's business activities. As part of Z-ECM, Zurich uses a scenario-based approach to assess, model, and quantify the capital required for operational risk for business units under extreme circumstances and a very small probability of occurrence (internal model calibrated to a confidence level of 99.95 percent over a one-year time horizon).

Analysis of Capital Adequacy

Zurich maintains interactive relationships with three global rating agencies: Standard & Poor's, Moody's, and A.M. Best. The Insurance Financial Strength Rating (IFSR) of Zurich's main operating entity is an important element of its competitive position. Moreover, Zurich's credit ratings that are derived from its financial strength rating do, in fact, affect its cost of capital, just like any other credit-rated company.

In each country in which Zurich operates, the local regulator specifies the minimum amount and type of capital that each of the regulated entities must hold in relation to its liabilities. In addition to maintaining the minimum capital required to comply with the solvency requirements, Zurich targets holding an adequate buffer of capital reserves to ensure that each of its regulated subsidiaries meets the local capital requirements. Zurich is subject to different capital requirements depending on the country in which it operates. The main areas are Switzerland and European Economic Area countries, and the United States.

Since January 1, 2011, the Swiss Solvency Test (SST) capital requirements are binding in Switzerland. The Group uses an adaptation of its internal Risk-Based Capital (RBC) model to comply with the SST requirements and runs a full SST calculation twice a year. The model is still subject to Swiss Financial Market Supervisory Authority (FINMA) approval.

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