The benefits of budgeting: A Zurich case study

Introduction
Zurich Insurance Group is a leading global provider of insurance services.
Zurichs mission is to help customers understand and protect themselves
from risk. The company employs 60,000 staff and serves customers in 170
countries around the world.
Zurich offers General Insurance and Life Insurance products, for example:

General Insurance: car insurance, home buildings and contents

insurance
Life assurance: life insurance, investment and pension plans.

Zurich offers its products to retail customers (mainly individuals) and

corporate customers (i.e. businesses).
Life is full of uncertainty. The building you work in could catch fire. Your
computer could be stolen. You may have an accident. These are all risks with
a small but real probability that they may occur. Insurance provides
protection against that risk. In return for a fee (a premium) it provides a
financial payment in the event of financial/personal loss.
Supporting the brand
So what makes Zurich one of the leading insurance companies? It starts with
Zurichs brand, reputation for quality customer service and solid financial
strength. The insurance industry is tightly regulated, requiring strict
standards and highly skilled finance professionals. Zurich, therefore, aims to
attract the best graduates. Zurichs ethos is underpinned by its core values:

A key component of Zurichs values is corporate responsibility. Being a

responsible company is fundamental to Zurichs long-term sustainability. For
example, Zurich Community Trust in the UK actively helps over 600 charities
make a difference to the lives of thousands every year.
Insurance is an extremely competitive market. Customers will obtain quotes
to find the best value either from Zurich directly or through a financial
adviser. This case study shows how Zurichs careful approach to budgeting is
a contributory factor in gaining competitive advantage.
What is a budget?
An organisation must earn enough revenue so that after all costs have been
subtracted, there is a profit remaining. One of the most useful financial tools
is the budget. A budget is a business plan expressed in financial terms.
Budgets can be drawn up for sales, costs or investment spending. A budget
will include a degree of prediction of performance which is usually based on
past data, e.g. sales.
It is important that it is a realistic financial plan that the business can fulfil.
Managers at all levels will have their own budget plans, designed to coordinate with and contribute to the overall plan or master budget. Therefore,
managers need to be involved in contributing information to the budget to
which they will be committed.

Budgets should be stretching but achievable. They should enable companies

to meet both short and long-term financial and strategic objectives, whilst
providing motivational targets (potentially linked to bonus payments) for
managers to promote the right behaviours. All budgets must be carefully
monitored, reviewed and, if appropriate, re-assessed as internal factors (e.g.
a major project costs significantly less or more than expected) and external
factors (e.g. regulatory developments) change.
Core business segments
Zurich has three core business segments: General Insurance (e.g. car,
home), Global Life (e.g. life assurance, pensions and investments) and
Farmers (core North-American business). These segments are divided into
regions, for example, Europe, and then into business units, for example, UK

Life. Through discussion with various stakeholders, budgets are set for each
business unit, with the combined budgets supporting Zurichs overall
corporate aims.
For example, the table below shows the revenue and expense budgets for UK
Life. The expenses budget is broken down by function. (All figures are for
illustration only.)

Benefits of budgeting
Budgets are a financial representation of an organisations strategy. The
process of budgeting requires managers to plan ahead, for example, to
identify the resources required to meet targets. This is particularly important
in the insurance industry due to the complex nature of the products offered.
Insurance generally addresses medium- and long-term needs of customers.
Decisions taken now are likely to have financial implications for many years
to come.
For example, in the UK, Zurich offers a protection product which provides a
payment in the event of the death of the policyholder to pay off an
outstanding mortgage. Typically, this product offers protection for 15 to 25
years. Zurich guarantees a price to the policyholder for the whole term. If the
outcome is different to that which was assumed when the price was set (e.g.
fewer or more deaths occur or fewer or more policies are cancelled than
expected), Zurich will either make a profit or a loss on that product. Due to
the long-term nature of these products any profit will emerge over many
years.

Analysing Variances
The budgeting process can be used for monitoring and control of financial
performance. Results can be reviewed as frequently as necessary against
budgets to identify good and poor performance areas. Managers need to
investigate the difference or variance between budgeted and actual results.
Where actual figures are worse than budgeted, these are called adverse
variances. Adverse variances may suggest problems. Where budgets are not
being met, action can be taken. Budget targets can be highly motivational
and staff who meet or exceed budgeted targets may be rewarded with
bonuses.
Challenges of effective budgeting
Suppose sales volume, prices and costs were all projected to rise annually by
10% (incremental budgeting). This would make budgeting easy, but it is
highly unlikely. To increase sales may require price reductions and discounts.
Successive rises in sales volume might bring economies of scale, but might
need investment to expand production in order to meet that demand.
Effective budgeting is full of challenges. Whilst financial accounts relate to
the past, budgets are about the future. All data is therefore planned rather
than actual, probable rather than definite.
Assumptions
Budgets are based on a number of assumptions. Some of these are explicit,
such as what the cost of labour and raw materials will be or what market
research results indicate about likely customer demand. Others are more
implicit. A change in leadership in the sales team, a good relationship with a
new supplier or changes in the organisation's external environment could all
affect budget projections.
Zurich may face unanticipated changes in legal or financial regulations or a
change in market dynamics brought about by economic factors or the
actions of competitors. An insurer needs to predict the risks its insurance
policies protect against, both short-term risks, such as floods and
earthquakes and longer-term risks, such as mortality rates. Budgets also
need to reflect the business need to invest in specific projects or long-term
improvements.

Zurich Business Partners

Budgets may also cause conflict between departments. For example, the
allocation of additional budget to sales and marketing could result in
operational areas receiving a reduced budget. Within Zurich, conflict
between departments is resolved with the help of Business Partners. These
work with the different departments to achieve an appropriate and fair
division of the budget, in line with the business and senior managements
objectives.
Analysing budgeting data may uncover opportunities that would otherwise
have remained hidden. Therefore budgets must be set using the best
information available but have flexibility in order to respond to the changing
business environment.
Setting and using budgets
Having established the core financial objectives, often referred to as key
performance indicators, the strategies to achieve them can be set in one of
two main ways. The budgeting process can be:

'top-down' - i.e. set by senior managers and directed downwards, often

based on previous results

bottom-up - i.e. evolving upwards from middle managers, through the

use of detailed analysis, for confirmation by senior management.

In practice, at Zurich there are elements of both approaches. Senior

management undertakes the topdown 'ambition setting'. This gives the
strategic context. Managers then consider historical data, prevailing trends
and any new drivers in order to formulate proposed budgets.

Zurich Business Partners help to ensure 'joined-up budgeting' between areas

of the business:

Revenue centres generate income. They prepare sales budgets.

Cost centres generate expenses. They prepare operating or production

budgets.

The profit budget draws together all the budgets for revenues and
costs to meet overall financial objectives.

Zero-based budgeting
An alternative approach to incremental budgeting is zero-based budgeting.
This means that each expenditure budget starts with a zero allocation each
year. Managers must justify each element of the budget they propose. This
has the advantage of making managers think proactively about what funds
they need. It also avoids the tendency simply to add a percentage of the
previous years budget or assume that expenditure will remain the same.
However, one major disadvantage of this approach is the increased demand
on staff time, which is an expensive resource with an opportunity cost.
Monitoring the budget
The first results against budget may show that the business is not exactly on
target. The budget then becomes a dashboard to assess all the factors and
make the necessary changes to reach goals. Variance analysis is used to
identify differences between budgeted and actual figures. This can be
demonstrated using the illustrative expenditure budget for UK Life.

Results better than or on budget are 'green' and represent no immediate

problem. They may be worth investigation to understand new practices or to
exploit new opportunities.

Results that are only mildly outside expectations are 'amber'. These may
need attention particularly if there is a worsening trend. Finally, there are the
adverse (red) results. Red areas demand immediate investigation and
remedial action to bring performance back to budget. All results should be
investigated based on the level of risk each deviation poses to meeting the
overall business goals, but priority should be given to red areas.
Zurich Business Partners assist managers in understanding and explaining
current performance by identifying the root causes of any deviations from
the budget. They also look forward known as forecasting to assess how
those deviations will affect the performance compared to the budget over
the remainder of the period and in the context of overall objectives.
A deviation may be explained by an unforeseen event; it may be the
beginning of a major adverse trend that requires a counter-strategy.
Analysing recent trends can act as an early warning system and may
indicate how the business performance will evolve in the future.
Conclusion
The Zurich brand is associated with trust and reliability. Quality is at the
heart of its customer appeal.
However, it is also about innovation and being an industry leader, both in its
operations and responding quickly to emerging risks and opportunities. This
allows Zurich to deliver what matters when it matters.
The budgeting process is a source of competitive advantage. Effective
budgeting requires careful research and realistic planning as well as
collaboration. It can help to set high objectives or move the business into

new territory. The level of stretch or challenge in a budget will depend on an

organisations culture and ambition. Some businesses may be prepared to
accept a higher risk profile for a better return. This in turn will depend on the
influence of key stakeholders, such as shareholders.
To ensure the company has the capability to achieve its aims, Zurich
employs graduates and finance professionals who are skilled in managing
and interpreting budget dashboards.