UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2002
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from __________ to __________
Commission File No. 1-11778 I.R.S. Employer Identification No. 98-0091805
ACE LIMITED
(Incorporated in the Cayman Islands)
ACE Global Headquarters
17 Woodbourne Avenue
Hamilton HM 08
Bermuda
Telephone 441-295-5200
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
YES X NO
---------- ---------
The number of registrant's Ordinary Shares ($0.041666667 par value)
outstanding as of May 9, 2002 was 262,204,835.
ACE LIMITED
INDEX TO FORM 10-Q
Part I. FINANCIAL INFORMATION
Page No.
Item 1. Financial Statements:
Consolidated Balance Sheets
March 31, 2002 (Unaudited) and December 31, 2001 3
Consolidated Statements of Operations (Unaudited)
Three Months Ended March 31, 2002 and 2001 4
Consolidated Statements of Shareholders' Equity (Unaudited)
Three Months Ended March 31, 2002 and 2001 5
Consolidated Statements of Comprehensive Income (Unaudited)
Three Months Ended March 31, 2002 and 2001 7
Consolidated Statements of Cash Flows (Unaudited)
Three Months Ended March 31, 2002 and 2001 8
Notes to Interim Consolidated Financial Statements (Unaudited) 9
Item 2. Management's Discussion and Analysis of Results
of Operations and Financial Condition 26
Part II. OTHER INFORMATION
Item 5. Other Information 48
Item 6. Reports on Form 8-K 48
2
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31 December 31
2002 2001
--------------- --------------
(Unaudited)
(in thousands of U.S. dollars
except share and per share data)
Assets
Investments and cash
Fixed maturities available for sale, at fair value
(amortized cost - $12,945,691 and $12,794,444) $ 13,036,688 $ 13,000,165
Equity securities, at fair value (cost - $557,737 and $516,028) 513,528 467,566
Short-term investments, at fair value 1,401,308 1,205,795
Other investments, (cost - $523,581 and $569,045) 551,809 591,006
Cash 820,009 671,381
-------------- --------------
Total investments and cash 16,323,342 15,935,913
Accrued investment income 218,264 213,821
Insurance and reinsurance balances receivable 3,161,734 2,521,562
Accounts and notes receivable 235,278 242,724
Reinsurance recoverable 11,370,444 11,398,446
Deferred policy acquisition costs 725,070 679,281
Prepaid reinsurance premiums 1,462,510 1,222,795
Goodwill 2,772,276 2,772,094
Deferred tax assets 1,239,506 1,250,835
Other assets 978,864 949,293
-------------- --------------
Total assets $ 38,487,288 $ 37,186,764
============== ==============
Liabilities
Unpaid losses and loss expenses $ 20,514,757 $ 20,728,122
Future policy benefits for life and annuity contracts 404,593 382,730
Unearned premiums 4,675,459 3,853,429
Premiums received in advance 45,052 57,486
Insurance and reinsurance balances payable 1,717,338 1,418,001
Contract holder deposit funds 96,859 101,187
Accounts payable, accrued expenses and other liabilities 1,352,935 1,466,127
Dividends payable 42,350 42,044
Short-term debt 399,329 495,408
Long-term debt 1,848,641 1,349,473
Trust preferred securities 875,000 875,000
-------------- --------------
Total liabilities 31,972,313 30,769,007
-------------- --------------
Commitments and contingencies
Mezzanine equity 311,050 311,050
-------------- --------------
Shareholders' equity
Ordinary Shares ($0.041666667 par value, 300,000,000
shares authorized; 261,897,433 and 259,861,205
shares issued and outstanding) 10,912 10,828
Additional paid-in capital 3,767,727 3,710,698
Unearned stock grant compensation (64,941) (37,994)
Retained earnings 2,473,681 2,321,576
Deferred compensation obligation 18,850 16,497
Accumulated other comprehensive income 16,546 101,599
Ordinary Shares issued to employee trust (18,850) (16,497)
-------------- --------------
Total shareholders' equity 6,203,925 6,106,707
-------------- --------------
Total liabilities, mezzanine
equity and shareholders' equity $ 38,487,288 $ 37,186,764
============== ==============
See accompanying notes to the interim consolidated financial statements
3
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the three months ended March 31, 2002 and 2001
(Unaudited)
2002 2001
-------------- ------------
(in thousands of U.S. dollars,
except per share data)
Revenues
Gross premiums written
Property and casualty premiums $ 3,088,948 $ 2,560,698
Life and annuity premiums 29,198 940
-------------- ------------
3,118,146 2,561,638
Reinsurance premiums ceded (1,132,118) (826,520)
-------------- ------------
Net premiums written
Property and casualty premiums 1,957,749 1,734,178
Life and annuity premiums 28,279 940
-------------- ------------
1,986,028 1,735,118
Change in unearned premiums (626,219) (366,002)
-------------- ------------
Net premiums earned
Property and casualty premiums 1,331,397 1,368,176
Life and annuity premiums 28,412 940
-------------- ------------
1,359,809 1,369,116
Net investment income 203,935 204,430
Net realized gains (losses) on investments (25,881) (19,375)
-------------- ------------
Total revenues 1,537,863 1,554,171
-------------- ------------
Expenses
Losses and loss expenses 853,145 951,293
Life and annuity benefits 22,996 653
Policy acquisition costs 197,795 166,690
Administrative expenses 196,204 193,293
Interest expense 46,002 54,324
Amortization of goodwill - 19,880
-------------- ------------
Total expenses 1,316,142 1,386,133
-------------- ------------
Income before income tax and cumulative effect
of adopting a new accounting standard 221,721 168,038
Income tax expense 23,916 26,974
-------------- ------------
Income before cumulative effect of adopting a
new accounting standard 197,805 141,064
Cumulative effect of adopting a new accounting
standard (net of income tax) - (22,670)
-------------- ------------
Net income $ 197,805 $ 118,394
============== ============
Basic earnings per share before cumulative effect
of adopting a new accounting standard $ 0.74 $ 0.58
============== ============
Basic earnings per share $ 0.74 $ 0.48
============== ============
Diluted earnings per share before cumulative
effect of adopting a new accounting standard $ 0.70 $ 0.55
============== ============
Diluted earnings per share $ 0.70 $ 0.46
============== ============
See accompanying notes to the interim consolidated financial statements
4
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the three months ended March 31, 2002 and 2001
(Unaudited)
2002 2001
------------ ------------
(in thousands of U.S. dollars)
Ordinary Shares
Balance - beginning of period $ 10,828 $ 9,681
Shares issued 33 1
Exercise of stock options 59 14
Issued under Employee Stock Purchase Plan (ESPP) 5 4
Cancellation of Ordinary Shares (13) (15)
Repurchase of Shares - (44)
------------ ------------
Balance - end of period 10,912 9,641
------------ ------------
Additional paid-in capital
Balance - beginning of period 3,710,698 2,637,085
Ordinary Shares issued 34,482 487
Exercise of stock options 30,111 6,931
Ordinary Shares issued under ESPP 3,725 2,806
Cancellation of Ordinary Shares (11,289) (10,870)
Repurchase of Ordinary Shares - (12,088)
------------ ------------
Balance - end of period 3,767,727 2,624,351
------------ ------------
Unearned stock grant compensation
Balance - beginning of period (37,994) (29,642)
Stock grants awarded (32,332) (17,294)
Stock grants forfeited 3,124 59
Amortization 2,261 1,963
------------ ------------
Balance - end of period (64,941) (44,914)
------------ ------------
Retained earnings
Balance - beginning of period 2,321,576 2,733,633
Net income 197,805 118,394
Dividends declared on Ordinary Shares (39,285) (30,080)
Dividends declared on FELINE PRIDES (6,415) (6,348)
Repurchase of Ordinary Shares - (23,148)
------------ ------------
Balance - end of period 2,473,681 2,792,451
------------ ------------
Deferred compensation obligation
Balance - beginning of period 16,497 14,597
Net increase to obligation 2,353 1,900
------------ ------------
Balance - end of period $ 18,850 $ 16,497
------------ ------------
See accompanying notes to the interim consolidated financial statements
5
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (cont'd.)
For the three months ended March 31, 2002 and 2001
(Unaudited)
2002 2001
------------- -------------
(in thousands of U.S. dollars)
Accumulated other comprehensive income
Net unrealized appreciation (depreciation)
on investments
Balance - beginning of period $ 136,916 $ 102,335
Change in period, net of tax (84,182) 52,078
------------- -------------
Balance - end of period 52,734 154,413
------------- -------------
Cumulative translation adjustments
Balance - beginning of period (35,317) (32,881)
Net adjustment for period, net of tax (871) 3,755
------------- -------------
Balance - end of period (36,188) (29,126)
------------- -------------
Accumulated other comprehensive income 16,546 125,287
------------- -------------
Ordinary Shares issued to employee trust
Balance - beginning of period (16,497) (14,597)
Net increases in Ordinary Shares (2,353) (1,900)
------------- -------------
Balance - end of period (18,850) (16,497)
------------- -------------
Total shareholders' equity $ 6,203,925 $ 5,506,816
============= =============
See accompanying notes to the interim consolidated financial statements
6
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the three months ended March 31, 2002 and 2001
(Unaudited)
2002 2001
------------- --------------
(in thousands of U.S. dollars)
Net income $ 197,805 $ 118,394
Other comprehensive income (loss)
Net unrealized appreciation (depreciation) on investments
Unrealized appreciation (depreciation) on investments (106,050) 76,386
Less: reclassification adjustment for net realized (gains)
losses included in net income 1,744 (9,925)
------------- --------------
(104,306) 66,461
Cumulative translation adjustments (4,760) 1,860
------------- --------------
Other comprehensive income (loss), before income tax (109,066) 68,321
Income tax benefit (expense) related to other comprehensive
income items 24,013 (12,488)
------------- --------------
Other comprehensive income (loss) (85,053) 55,833
------------- --------------
Comprehensive income $ 112,752 $ 174,227
============= ==============
See accompanying notes to the interim consolidated financial statements
7
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended March 31, 2002 and 2001
(Unaudited)
2002 2001
------------ ------------
(in thousands of U.S. dollars)
Cash flows from operating activities
Net income $ 197,805 $ 118,394
Adjustments to reconcile net income to net cash provided by
operating activities:
Unpaid losses and loss expenses, net of reinsurance
recoverable (168,047) 180,382
Future policy benefits for life and annuity contracts 21,227 653
Unearned premiums 828,269 574,914
Prepaid reinsurance premiums (239,715) (243,579)
Deferred income taxes 24,429 (7,750)
Net realized (gains) losses on investments 25,881 19,375
Amortization of premium/discounts on fixed maturities 7,798 (3,626)
Deferred policy acquisition costs (47,419) (50,057)
Insurance and reinsurance balances receivable (657,066) (226,991)
Premiums received in advance (12,434) 7,680
Insurance and reinsurance balances payable 299,974 120,025
Accounts payable, accrued expenses and other liabilities (120,748) (118,490)
Other (16,097) (24,801)
Cumulative effect of adopting a new accounting standard - 22,670
Amortization of goodwill - 19,880
------------ ------------
Net cash flows from operating activities $ 143,857 $ 388,679
------------ ------------
Cash flows from investing activities
Purchases of fixed maturities (4,123,556) (4,319,684)
Purchases of equity securities (90,123) (36,028)
Sales of fixed maturities 3,715,037 4,019,993
Sales of equity securities 44,823 50,949
Maturities of fixed maturities 26,783 73,558
Net realized gains (losses) on financial futures contracts (3,307) (28,220)
Other 43,532 (19,412)
------------ ------------
Net cash used for investing activities $ (386,811) $ (258,844)
------------ ------------
Cash flows from financing activities
Dividends paid on Ordinary Shares (38,907) (29,995)
Dividends paid on FELINE PRIDES (6,487) (6,415)
Net proceeds from (repayment) of short-term debt (96,079) 7,103
Proceeds from exercise of options for Ordinary Shares 30,170 6,945
Proceeds from shares issued under ESPP 3,730 2,810
Proceeds from long-term debt 499,155 -
Repurchase of Ordinary Shares - (35,280)
------------ ------------
Net cash from (used for) financing activities $ 391,582 $ (54,832)
------------ ------------
Net increase in cash 148,628 75,003
Cash - beginning of period 671,381 608,069
------------ ------------
Cash - end of period $ 820,009 $ 683,072
============ ============
See accompanying notes to the interim consolidated financial statements
8
ACE LIMITED AND SUBSIDIARIES
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. General
The interim unaudited consolidated financial statements, which include the
accounts of the Company and its subsidiaries, have been prepared in accordance
with accounting principles generally accepted in the United States of
America and, in the opinion of management, reflect all adjustments
(consisting of normally recurring accruals) necessary for a fair
presentation of results for such periods. The results of operations and
cash flows for any interim period are not necessarily indicative of results
for the full year. These financial statements should be read in conjunction
with the consolidated financial statements, and related notes thereto,
included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2001.
ACE Limited ("ACE" or "the Company") is a holding company incorporated with
limited liability under the Cayman Islands Companies Law and maintains its
principal business office in Bermuda. The Company, through its various
subsidiaries, provides a broad range of insurance and reinsurance products
to insureds worldwide. In addition, ACE, through ACE Global Markets,
provides funds at Lloyd's, primarily in the form of letters of credit, to
support underwriting capacity for Lloyd's syndicates managed by Lloyd's
managing agencies, which are wholly owned subsidiaries of ACE. Following
changes in executive management responsibilities, the Company reassessed
and changed its reporting segments from the individual operating
units to lines of business. The four reporting segments are: Insurance -
North American, Insurance - Overseas General, Global Reinsurance and
Financial Products. These segments are described in Note 14.
The following table summarizes the Company's gross premiums written by
geographic region for the three months ended March 31, 2002 and 2001.
Allocations have been made on the basis of location of risk:
North Australia & Asia
Three Months Ended America Europe New Zealand Pacific Latin America
March 31, 2002 58% 28% 2% 7% 5%
March 31, 2001 56% 30% 1% 5% 8%
2. New accounting pronouncements
In June 2001, the Financial Accounting Standard Board ("FASB") issued
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" ("FAS 142"). FAS 142 primarily addresses the accounting
for goodwill and intangible assets subsequent to their acquisition. As
required, the Company adopted FAS 142 on January 1, 2002 and ceased
amortizing goodwill at that time. All goodwill recognized in the Company's
consolidated balance sheet at January 1, 2002 was assigned to one or more
reporting units. Goodwill in each reporting unit should be tested for
impairment by June 30, 2002. Any impairment loss recognized as a result of a
transitional impairment test of goodwill should be reported as the
cumulative effect of a change in accounting principle. There was no
impairment in goodwill recognized on initial adoption. As discussed in Note
14 "Segment information", we do not allocate assets to our new segments
therefore changes in goodwill will not be disclosed by segment
9
The following table provides a reconciliation of the prior-year quarter's
reported net income to adjusted net income had FAS 142 been applied at the
beginning of fiscal 2001:
Three Months Ended
March 31
2002 2001
----------------------
(in thousands of U.S.
dollars, except per
share data)
Reported net income $ 197,805 $ 118,394
Add back: Goodwill amortization - 19,880
--------- ---------
Adjusted net income $ 197,805 $ 138,274
========= =========
Basic earnings per share:
Reported earnings per share $ 0.74 $ 0.48
Add back: Goodwill amortization - 0.09
--------- ---------
Adjusted earning per share $ 0.74 $ 0.57
========= =========
Diluted earnings per share:
Reported earnings per share $ 0.70 $ 0.46
Add back: Goodwill amortization - 0.08
--------- ---------
Adjusted earning per share $ 0.70 $ 0.54
========= =========
3. Securities on loan
We participate in a securities lending program whereby certain securities
from our portfolio are loaned to other institutions for short periods of
time. The market value of the loaned securities is monitored on a daily
basis with additional collateral obtained or refunded as the market value
of the loaned securities fluctuates. Our policy is to require initial cash
collateral equal to 102 percent of the fair value of the loaned securities. The
proceeds from the collateral are invested in short-term investments and are
reported on the balance sheet. We maintain full ownership rights to the
securities loaned, and continue to earn interest on them. We share a portion
of the interest earned on these short-term investments with the lending agent.
In addition, we have the ability to sell the securities while they are on loan.
We have an indemnification agreement with the lending agents in the event a
borrower becomes insolvent or fails to return securities. Securities lending
collateral of $247 million is recorded net in short-term investments. The fair
value of the securities on loan of $241 million is reported in fixed maturities
at March 31, 2002. There were no securities loaned in 2001.
4. Commitments and contingencies
The Company has considered asbestos and environmental claims and claims
expenses in establishing the liability for unpaid losses and loss expenses.
The Company has developed reserving methods, which incorporate new sources
of data with historical experience to estimate the ultimate losses arising
from asbestos and environmental exposures. The reserves for asbestos and
environmental claims and claims expenses represent management's best
estimate of future loss and loss expense payments and recoveries which are
expected to develop over the next several decades. The Company continuously
monitors evolving case law and its effect on environmental and latent
injury claims. While reserving for these claims is inherently uncertain,
the Company believes that the reserves carried for these claims are
adequate based on known facts and current law.
5. Restricted stock awards
Under the Company's long-term incentive plans, 800,150 restricted Ordinary
Shares were awarded during the three months ended March 31, 2002, to
officers of the Company and its subsidiaries. These shares vest at various
dates through February 2006.
At the time of grant the market value of the shares awarded under these
grants is recorded as unearned stock grant compensation and is presented as
a separate component of shareholders' equity. The unearned compensation is
charged to income over the vesting period.
10
ACE LIMITED AND SUBSIDIARIES
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd)
(Unaudited)
6. Earnings per share
The following table sets forth the computation of basic and diluted
earnings per share:
Three Months Ended
March 31
2002 2001
------------- -------------
(in thousands of U.S. dollars,
except share and per share data)
Numerator:
Net income before cumulative effect of adopting a new accounting
standard $ 197,805 $ 141,064
Dividends on FELINE PRIDES (6,415) (6,348)
------------- -------------
Net income available to holders of Ordinary Shares before
cumulative effect 191,390 134,716
Cumulative effect of adopting a new accounting standard - (22,670)
------------- -------------
Net income available to holders of Ordinary Shares $ 191,390 $ 112,046
============= =============
Denominator:
Denominator for basic earnings per share:
Weighted average shares outstanding 258,586,011 232,473,310
Dilutive effect of FELINE PRIDES 4,094,287 3,396,241
Effect of other dilutive securities 8,846,955 7,197,415
------------- -------------
Denominator for diluted earnings per share:
Adjusted weighted average shares outstanding and
assumed conversions 271,527,253 243,066,966
============= =============
Basic earnings per share:
Earnings per share before cumulative effect of adopting a new
accounting standard $ 0.74 $ 0.58
============= =============
Earnings per share $ 0.74 $ 0.48
============= =============
Diluted earnings per share:
Earnings per share before cumulative effect of adopting a new
accounting standard $ 0.70 $ 0.55
============= =============
Earnings per share $ 0.70 $ 0.46
============= =============
7. Credit facilities
In April 2002, the Company renewed its $800 million, 364-day revolving
credit facility. This facility, together with the Company's $250 million,
five-year revolving credit facility, which was last renewed in May 2000,
are available for general corporate purposes and each of the facilities may
also be used as commercial paper back-up. The five-year facility also
permits the issuance of letters of credit. In 2000, an amount of $25
million was drawn under the five-year facility. This remained outstanding
at March 31, 2002, and was repaid in April 2002.
ACE Tempest Re also maintained an uncollateralized, syndicated revolving
credit facility in the amount of $72.5 million, which was guaranteed by the
Company. This facility expired in February 2002 and was not renewed.
11
ACE LIMITED AND SUBSIDIARIES
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd)
(Unaudited)
8. Debt
The following table outlines the Company's consolidated debt position at
March 31, 2002 and December 31, 2001:
March 31 December 31
2002 2001
-------------- --------------
(in millions of U.S. dollars)
Short-term debt
ACE INA commercial paper $ 299 $ -
ACE Financial Services Note 25 25
ACE Financial Services Debentures due 2002 75 75
Reverse Repurchase Agreements - 395
--------- ---------
$ 399 $ 495
========= =========
Long-term debt
ACE INA Notes due 2004 $ 400 $ 400
ACE INA Notes due 2006 299 299
ACE Limited Senior Notes due 2007 499 -
ACE US Holdings Senior Notes due 2008 250 250
ACE INA Subordinated Notes due 2009 300 300
ACE INA Debentures due 2029 100 100
--------- ---------
$ 1,848 $ 1,349
========= =========
Trust Preferred Securities
ACE INA RHINO Preferred Securities due 2002 $ 400 $ 400
Capital Re LLC Monthly Income
Preferred Securities due 2044 75 75
ACE INA Trust Preferred Securities due 2029 100 100
ACE INA Capital Securities due 2030 300 300
--------- ---------
$ 875 $ 875
========= =========
a) Commercial paper and money market facilities
In 1999, the Company arranged certain commercial paper programs. The
programs use revolving credit facilities as back-up facilities and provide
for up to $2.8 billion in commercial paper issuance (subject to the
availability of back-up facilities, which currently total $1.05 billion)
for ACE and for ACE INA.
In October 2001, the Company and certain subsidiaries executed securities
repurchase agreements with various counterparties. Under these repurchase
agreements, the Company agreed to sell securities and repurchase them at a
date in the future for a predetermined price. The amounts due to brokers
under the repurchase agreements at December 31, 2001 of $395 million were
repaid during the current quarter using proceeds from commercial paper
raised during the quarter. The average cost of borrowing using commercial
paper was 2.0 percent for the current quarter. Subsequent to March 31, 2002,
the Company repaid $150 million of expiring commercial paper and the $25
million bank note.
b) ACE Limited Senior Notes
In March 2002, ACE Limited issued $500 million of 6.0 percent notes due
April 1, 2007. The notes are not redeemable before maturity and do not have
the benefit of any sinking fund. These senior unsecured notes rank equally
with all of the Company's other senior obligations and contain a customary
limitation on lien provisions as well as customary events of default
provisions which, if breached, could result in the accelerated
maturity of such senior debt.
12
ACE LIMITED AND SUBSIDIARIES
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd)
(Unaudited)
9. Mezzanine Equity
On April 12, 2000, the Company publicly offered and issued 6,000,000 FELINE
PRIDES. On May 8, 2000, exercise of the underwriter's over allotment option
resulted in the issuance of an additional 221,000 FELINE PRIDES, for
aggregate net proceeds of approximately $311 million. Each FELINE PRIDE
initially consists of a unit referred to as an Income PRIDE. Each Income
PRIDE consists of (i) one 8.25 percent Cumulative Redeemable Preferred
Share, Series A, liquidation preference $50 per share, of the Company, and
(ii) a purchase contract pursuant to which the holder of the Income PRIDE
agrees to purchase from the Company, on May 16, 2003, Ordinary Shares at
the applicable settlement rate. On May 16, 2003 pursuant to the purchase
contract, the holders of the FELINE PRIDES will be required to purchase
$311 million of our Ordinary Shares. Each preferred share is pledged
to the Company to secure the holders obligations under the purchase
contract. A holder of an Income PRIDE can obtain the release of the
preferred share by substituting certain zero-coupon treasury securities as
security for performance under the purchase contract. The resulting unit
consisting of the zero-coupon treasury security and the purchase contract
is a Growth PRIDE, and the preferred shares would be a separate security. A
holder of a Growth PRIDE can convert it back into an Income PRIDE by
depositing preferred shares as security for performance under the purchase
contract and thereby obtain the release of the zero-coupon treasury
securities.
The aggregate liquidation preference of the 8.25 percent Cumulative
Redeemable Preferred Shares is $311 million. Unless deferred by the
Company, the preferred shares pay dividends quarterly at a rate of 8.25
percent per year to May 16, 2003, and thereafter at the reset rate
established pursuant to a remarketing procedure. If the Company elects to
defer dividend payments on the preferred shares, the dividends will
continue to accrue and the Company will be restricted from paying dividends
on its Ordinary Shares and taking certain other actions. The preferred
shares are not redeemable prior to June 16, 2003, on which date they must
be redeemed by the Company in whole.
10. Reinsurance
The Company purchases reinsurance to manage various exposures including
catastrophe risks. Although reinsurance agreements contractually obligate
the Company's reinsurers to reimburse it for the agreed upon portion of its
gross paid losses, they do not discharge the primary liability of the
Company. The amounts for net premiums written and net premiums earned in
the statements of operations are net of reinsurance. Direct, assumed and
ceded amounts for these items for the three months ended March 31, 2002 and
2001 are as follows:
2002 2001
------------- -------------
(in thousands of U.S. dollars)
Premiums written
Direct $ 2,115,127 $ 1,806,099
Assumed 1,003,019 755,539
Ceded (1,132,118) (826,520)
------------- -------------
Net premiums written $ 1,986,028 $ 1,735,118
============= =============
Premiums earned
Direct $ 1,711,920 $ 1,478,423
Assumed 571,078 493,688
Ceded (923,189) (602,995)
------------- -------------
Net premiums earned $ 1,359,809 $ 1,369,116
============= =============
13
ACE LIMITED AND SUBSIDIARIES
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd)
(Unaudited)
The composition of the Company's reinsurance recoverable at March 31, 2002 and
December 31, 2001, is as follows:
March 31 December 31
2002 2001
------------- --------------
(in thousands of U.S. dollars)
Reinsurance recoverable on paid losses and loss expenses, (net of
provision for uncollectible balances - $65,822 and $62,493) $ 1,018,293 $ 1,004,003
Reinsurance recoverable on future policy benefits 5,972 5,335
Reinsurance recoverable on unpaid losses and loss expenses 11,075,372 11,115,552
Provision for uncollectible balances on reinsurance recoverable (729,193) (726,444)
------------- --------------
Reinsurance recoverable $ 11,370,444 $ 11,398,446
============= ==============
The Company evaluates the financial condition of its reinsurers and
potential reinsurers on a regular basis and also monitors concentrations of
credit risk with reinsurers. The allowance for unrecoverable reinsurance is
required principally due to the failure of reinsurers to indemnify ACE,
primarily because of disputes under reinsurance contracts and insolvencies.
Reinsurance disputes continue to be significant, particularly on larger and
more complex claims, such as those related to asbestos and environmental
pollution and London reinsurance market exposures. Allowances have been
established for amounts estimated to be uncollectible.
11. Deferred compensation obligation
The Company maintains a rabbi trust for deferred compensation plans for key
employees and executive officers. In accordance with EITF 97-14,
"Accounting for Deferred Compensation Agreements Where Amounts Earned are
Held in a Rabbi Trust and Invested", assets of the rabbi trust are to be
consolidated with those of the employer, and the value of the employer's
stock held in the rabbi trust should be classified in shareholders' equity
and accounted for at historical cost in a manner similar to treasury stock.
The shares issued by the Company to the rabbi trust are recorded in
Ordinary Shares issued to employee trust and the obligation has been
recorded in deferred compensation obligation, both are components of
shareholders' equity.
12. Taxation
Under current Cayman Islands law, the Company is not required to pay any
taxes in the Cayman Islands on its income or capital gains. The Company has
received an undertaking that, in the event of any taxes being imposed, the
Company will be exempted from taxation in the Cayman Islands until the year
2013. Under current Bermuda law, the Company and its Bermuda subsidiaries
are not required to pay any taxes in Bermuda on its income or capital
gains. The Company has received an undertaking from the Minister of Finance
in Bermuda that, in the event of any taxes being imposed, the Company will
be exempt from taxation in Bermuda until March 2016.
Income from the Company's operations at Lloyd's is subject to United
Kingdom corporation taxes. Lloyd's is required to pay U.S. income tax on
U.S. connected income ("U.S. income") written by Lloyd's syndicates.
Lloyd's has a closing agreement with the IRS whereby the amount of tax due
on this business is calculated by Lloyd's and remitted directly to the IRS.
These amounts are then charged to the personal accounts of the
Names/Corporate Members in proportion to their participation in the
relevant syndicates. The Company's Corporate Members are subject to this
arrangement but, as UK domiciled companies, will receive UK corporation tax
credits for any U.S. income tax incurred up to the value of the equivalent
UK corporation income tax charge on the U.S. income.
ACE INA, ACE US Holdings and ACE Financial Services are subject to income
taxes imposed by U.S. authorities and file U.S. tax returns. Certain
international operations of the Company are also subject to income taxes
imposed by the jurisdictions in which they operate.
There can be no assurance that there will not be changes in applicable
laws, regulations or treaties, which might require the Company to change
the way it operates or become subject to taxation.
14
ACE LIMITED AND SUBSIDIARIES
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd)
(Unaudited)
The income tax provision for the three months ended March 31, 2002 and 2001
is as follows:
Three Months Ended
March 31
2002 2001
--------- ---------
(in thousands of U.S. dollars)
Current tax expense (benefit) $ (513) $ 34,724
Deferred tax expense (benefit) 24,429 (7,750)
--------- ---------
Provision for income taxes $ 23,916 $ 26,974
========= =========
The weighted average expected tax provision has been calculated using pre-tax
accounting income (loss) in each jurisdiction multiplied by that jurisdiction's
applicable statutory tax rate. A reconciliation of the difference between
the provision for income taxes and the expected tax provision at the weighted
average tax rate for the three months ended March 31, 2002 and 2001 is
provided below.
2002 2001
---------- ----------
(in thousands of U.S. dollars)
Expected tax provision at weighted
average rate $ 24,555 $ 21,288
Permanent differences
Tax-exempt interest (4,146) (3,835)
Goodwill - 5,782
Other (22) 413
Net withholding taxes 3,529 3,326
--------- ---------
Total provision for income taxes $ 23,916 $ 26,974
========= =========
The components of the net deferred tax asset at March 31, 2002 and
December 31, 2001 are as follows:
March 31 December 31
2002 2001
------------- -------------
(in thousands of U.S. dollars)
Deferred tax assets
Loss reserve discount $ 518,509 $ 523,195
Foreign tax credits 147,051 155,079
Policyholder dividends 47,832 47,509
Net operating loss carry forward 480,524 495,048
Other 287,731 299,068
------------ ------------
Total deferred tax assets 1,481,647 1,519,899
------------ ------------
Deferred tax liabilities
Deferred policy acquisition costs 56,523 66,454
Unrealized appreciation on investments 12,389 28,570
Other 37,637 38,448
------------ ------------
Total deferred tax liabilities 106,549 133,472
------------ ------------
Valuation allowance 135,592 135,592
------------ ------------
Net deferred tax asset $ 1,239,506 $ 1,250,835
============ ============
15
ACE LIMITED AND SUBSIDIARIES
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd)
(Unaudited)
The valuation allowance of $135.6 million at March 31, 2002 and
December 31, 2001, reflects management's assessment, based on available
information, that it is more likely than not that a portion of the deferred
tax asset will not be realized due to the inability of certain foreign
subsidiaries to generate sufficient taxable income. Adjustments to the
valuation allowance are made when there is a change in management's
assessment of the amount of deferred tax asset that is realizable.
At March 31, 2002, the Company has net operating loss carryforwards for
U.S. federal income tax purposes of approximately $1.4 billion which are
available to offset future U.S. federal taxable income through 2021.
13. Subsidiary Issuer Information
The following tables present condensed consolidating financial
information for ACE Limited (the "Parent Guarantor"), ACE INA Holdings,
Inc. and ACE Financial Services, Inc. (formerly Capital Re Corporation),
(the "Subsidiary Issuers") at March 31, 2002 and December 31, 2001 and
for the three months ended March 31, 2002 and 2001. The Subsidiary Issuers
are indirect wholly-owned subsidiaries of the Parent Guarantor.
Investments in subsidiaries are accounted for by the Parent Guarantor and
the Subsidiary Issuers under the equity method for purposes of the
supplemental consolidating presentation. Earnings of subsidiaries are
reflected in the Parent Guarantor's investment accounts and earnings. The
Parent Guarantor fully and unconditionally guarantees certain of the debt
of the Subsidiary Issuers.
16
ACE LIMITED AND SUBSIDIARIES
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd)
(Unaudited)
Condensed Consolidating Balance Sheet as at March 31, 2002
(in thousands of U.S. dollars)
ACE INA ACE Financial Other ACE
ACE Limited Holdings, Inc. Services, Inc. Limited
(Parent Co. (Subsidiary (Subsidiary Subsidiaries and Consolidating ACE
Guarantor) Issuer) Issuer) Eliminations (1) Adjustments(2) Consolidated
---------- ------- ------- ---------------- -------------- ------------
Assets
Total investments and cash $ 492,756 $ 6,489,028 $ 907,519 $ 8,434,039 $ - $16,323,342
Insurance and reinsurance
balances receivable - 1,988,853 19,893 1,152,988 - 3,161,734
Reinsurance recoverable - 9,020,157 619 2,349,668 - 11,370,444
Goodwill - 2,186,324 96,723 489,229 - 2,772,276
Investments in subsidiaries 6,076,530 - 152,000 (152,000 (6,076,530) -
Due from subsidiaries and
affiliates, net 480,803 (147,145) (54,508) 201,653 (480,803) -
Other assets 35,484 3,560,882 212,419 1,050,707 - 4,859,492
--------------------------------------------------------------------------------------------------
Total assets $ 7,085,573 $23,098,099 $ 1,334,665 $13,526,284 $(6,557,333) $38,487,288
==================================================================================================
Liabilities
Unpaid losses and loss
expenses $ - $14,069,524 $ 72,607 $ 6,372,626 $ - $20,514,757
Future policy benefits
for life and
annuity contracts - - - 404,593 - 404,593
Unearned premiums - 2,470,112 336,624 1,868,723 - 4,675,459
Short-term debt - 299,340 99,989 - - 399,329
Long-term debt 499,155 1,099,486 - 250,000 - 1,848,641
Trust preferred securities - 800,000 75,000 - - 875,000
Other liabilities 71,443 2,498,504 94,380 590,207 - 3,254,534
--------------------------------------------------------------------------------------------------
Total liabilities 570,598 21,236,966 678,600 9,486,149 - 31,972,313
--------------------------------------------------------------------------------------------------
Mezzanine equity 311,050 - - - - 311,050
--------------------------------------------------------------------------------------------------
Total shareholders' equity 6,203,925 1,861,133 656,065 4,040,135 (6,557,333) 6,203,925
--------------------------------------------------------------------------------------------------
Total liabilities,
mezzanine equity and
shareholders' equity $ 7,085,573 $23,098,099 $ 1,334,665 $13,526,284 $(6,557,333) $ 38,487,288
===================================================================================================
(1) Includes all other subsidiaries of ACE Limited and intercompany eliminations.
(2) Includes ACE Limited parent company eliminations.
17
ACE LIMITED AND SUBSIDIARIES
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd)
(Unaudited)
Condensed Consolidating Balance Sheet as at December 31, 2001
(in thousands of U.S. dollars)
Other ACE
ACE INA ACE Financial Limited
ACE Limited Holdings, Inc. Services, Inc. Subsidiaries
(Parent Co. (Subsidiary (Subsidiary and Consolidating ACE
Guarantor) Issuer) Issuer) Eliminations(1) Adjustments (2) Consolidated
---------- ------- ------- --------------- --------------- ------------
Assets
Total investments and cash $ 489,596 $ 6,443,230 $ 901,905 $ 8,101,182 $ - $ 15,935,913
Insurance and reinsurance balances
receivable - 1,715,873 24,075 781,614 - 2,521,562
Reinsurance recoverable - 9,259,608 8,194 2,130,644 - 11,398,446
Goodwill - 2,186,142 96,723 489,229 - 2,772,094
Investments in subsidiaries 5,621,604 - 152,000 (152,000) (5,621,604) -
Due from subsidiaries and
affiliates, net 348,372 (478,645) (11,862) 490,507 (348,372) -
Other assets 64,570 3,313,941 184,509 995,729 - 4,558,749
---------------------------------------------------------------------------------------------
Total assets $ 6,524,142 $22,440,149 $ 1,355,544 $12,836,905 $(5,969,976) $ 37,186,764
=============================================================================================
Liabilities
Unpaid losses and loss expenses $ - $14,468,024 $ 75,823 $ 6,184,275 $ - $ 20,728,122
Future policy benefits for life
and annuity contracts - - - 382,730 - 382,730
Unearned premiums - 2,055,459 323,951 1,474,019 - 3,853,429
Short-term debt - - 99,980 395,428 - 495,408
Long-term debt - 1,099,473 - 250,000 - 1,349,473
Trust preferred securities - 800,000 75,000 - - 875,000
Other liabilities 106,385 2,395,745 138,586 444,129 - 3,084,845
---------------------------------------------------------------------------------------------
Total liabilities 106,385 20,818,701 713,340 9,130,581 - 30,769,007
---------------------------------------------------------------------------------------------
Mezzanine equity 311,050 - - - - 311,050
---------------------------------------------------------------------------------------------
Total shareholders' equity 6,106,707 1,621,448 642,204 3,706,324 (5,969,976) 6,106,707
---------------------------------------------------------------------------------------------
Total liabilities, mezzanine equity
and shareholders' equity $ 6,524,142 $22,440,149 $ 1,355,544 $12,836,905 $(5,969,976) $ 37,186,764
=============================================================================================
(1) Includes all other subsidiaries of ACE Limited and intercompany eliminations.
(2) Includes ACE Limited parent company eliminations.
18
ACE LIMITED AND SUBSIDIARIES
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd)
(Unaudited)
Condensed Consolidating Statement of Operations
For the three months ended March 31, 2002
(in thousands of U.S. dollars)
ACE INA ACE Financial Other ACE
ACE Limited Holdings, Inc. Services, Inc. Limited
(Parent Co. (Subsidiary (Subsidiary Subsidiaries and Consolidating ACE
Guarantor) Issuer) Issuer) Eliminations (1) Adjustments(2) Consolidated
---------- ------- ------- ---------------- -------------- ------------
Net premiums written $ - $ 823,094 $ 10,868 $ 1,152,066 $ - $ 1,986,028
Net premiums earned - 609,487 21,708 728,614 - 1,359,809
Net investment income 16,450 80,186 11,490 106,600 (10,791) 203,935
Equity in earnings of
subsidiaries 192,050 - - - (192,050) -
Net realized gains
(losses) on investments 7,275 (25,793) 4,841 (12,204) - (25,881)
Losses and loss expenses - 421,449 2,729 428,967 - 853,145
Life and annuity benefits - - - 22,996 - 22,996
Policy acquisition costs
and administrative expenses 14,104 163,170 10,568 207,038 (881) 393,999
Interest expense 1,690 41,626 3,309 3,840 (4,463) 46,002
Income tax expense 2,176 11,951 5,228 4,561 - 23,916
--------------------------------------------------------------------------------------------------
Net income $ 197,805 $ 25,684 $ 16,205 $ 155,608 $ (197,497) $ 197,805
==================================================================================================
Condensed Consolidating Statement of Operations
For the three months ended March 31, 2001
(in thousands of U.S. dollars)
ACE INA ACE Financial Other ACE
ACE Limited Holdings, Inc. Services, Inc. Limited
(Parent Co. (Subsidiary (Subsidiary Subsidiaries and Consolidating ACE
Guarantor) Issuer) Issuer) Eliminations (1) Adjustments(2) Consolidated
---------- ------- ------- ---------------- -------------- -------------
Net premiums written $ - $ 600,180 $ 15,267 $ 1,119,671 $ - $ 1,735,118
Net premiums earned - 504,706 18,860 845,550 - 1,369,116
Net investment income 13,669 98,946 12,178 86,267 (6,630) 204,430
Equity in earnings of
subsidiaries 116,728 - - - (116,728) -
Net realized gains (losses)
on investments - (3,153) 6,304 (22,526) - (19,375)
Losses and loss expenses - 345,800 2,816 603,330 - 951,946
Policy acquisition costs and
administrative expenses 12,845 165,480 10,049 171,609 - 359,983
Amortization of goodwill - 14,490 1,051 4,339 - 19,880
Interest expense (2,831) 48,903 3,371 5,886 (1,005) ` 54,324
Income tax expense 1,989 13,806 7,204 3,975 - 26,974
--------------------------------------------------------------------------------------------------
Income (loss) excluding the
cumulative effect of
adopting a new accounting
standard 118,394 12,020 12,851 120,152 (122,353) 141,064
Cumulative effect of adopting
a new accounting standard
(net of income tax) - (50) (22,800) 180 - (22,670)
--------------------------------------------------------------------------------------------------
Net income (loss) $ 118,394 $ 11,970 $ (9,949) $ 120,332 $(122,353) $ 118,394
==================================================================================================
(1) Includes all other subsidiaries of ACE Limited and intercompany eliminations.
(2) Includes ACE Limited parent company eliminations.
19
ACE LIMITED AND SUBSIDIARIES
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd)
(Unaudited)
Condensed Consolidating Statement of Cash Flows
For the three months ended March 31, 2002
(in thousands of U.S. dollars)
ACE INA ACE Financial Other ACE
ACE Limited Holdings, Inc. Services, Inc. Limited
(Parent Co. (Subsidiary (Subsidiary Subsidiaries and Consolidating ACE
Guarantor) Issuer) Issuer) Eliminations (1) Adjustments(2) Consolidated
---------- ------- ------- ---------------- -------------- -------------
Net cash flows from (used for)
operating activities $ (164,177) $ (82,251) $ 10,199 $ 380,086 $ - $ 143,857
--------------------------------------------------------------------------------------------
Cash flows from investing activities
Purchases of fixed maturities (21,977) (532,899) (157,287) (3,411,393) - (4,123,556)
Purchases of equity securities - (21,682) - (68,441) - (90,123)
Sales of fixed maturities 11,364 548,571 143,307 3,011,795 - 3,715,037
Sales of equity securities - 24,149 - 20,674 - 44,823
Maturities of fixed maturities - - - 26,783 - 26,783
Net realized gains (losses) on
financial futures contracts - - - (3,307) - (3,307)
Other investments - - 5,908 37,624 - 43,532
---------------------------------------------------------------------------------------------
Net cash from (used for)
investing activities $ (10,613) $ 18,139 $ (8,072) $ (386,265) $ - $ (386,811)
--------------------------------------------------------------------------------------------
Cash flows from financing activities
Dividends paid on Ordinary Shares (38,907) - - - - (38,907)
Dividends paid on FELINE
PRIDES (6,487) - - - - (6,487)
Proceeds from short term debt - 299,340 - (395,419) - (96,079)
Proceeds from long term debt 499,155 - - - - 499,155
Advances to affiliates 42,293 (389,177) - 346,884 - -
Proceeds from exercise of options
for Ordinary Shares 30,170 - - - - 30,170
Proceeds from shares issued
under ESPP 3,730 - - - - 3,730
Capitalization of subsidiary (496,639) 277,785 - 218,854 - -
Dividends received from subsidiaries 130,000 - - (130,000) - -
--------------------------------------------------------------------------------------------
Net cash from (used for) financing
activities $ 163,315 $ 187,948 $ - $ 40,319 $ - $ 391,582
--------------------------------------------------------------------------------------------
Net increase (decrease) in cash (11,475) 123,836 2,127 34,140 - 148,628
Cash - beginning of period 32,525 355,327 1,027 282,502 - 671,381
--------------------------------------------------------------------------------------------
Cash - end of period $ 21,050 $ 479,163 $ 3,154 $ 316,642 $ - $ 820,009
============================================================================================
(1) Includes all other subsidiaries of ACE Limited and intercompany eliminations.
(2) Includes ACE Limited parent company eliminations.
20
ACE LIMITED AND SUBSIDIARIES
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd)
(Unaudited)
Condensed Consolidating Statement of Cash Flows
For the three months ended March 31, 2001
(in thousands of U.S. dollars)
Other ACE
ACE INA ACE Financial Limited
ACE Limited Holdings, Inc. Services, Inc. Subsidiaries
(Parent Co. (Subsidiary (Subsidiary and Consolidating ACE
Guarantor) Issuer) Issuer) Eliminations(1) Adjustments (2) Consolidated
---------- ------- ------- --------------- --------------- ------------
Net cash flows from (used for)
operating activities $ (29,805) $ (85,460) $ 15,963 $ 487,981 $ - $ 388,679
-------------------------------------------------------------------------------------------
Cash flows from investing activities
Purchases of fixed maturities (8,622) (443,617) (399,604) (3,467,841) - (4,319,684)
Purchases of equity securities - (27,701) - (8,327) - (36,028)
Sales of fixed maturities - 553,529 375,013 3,091,451 - 4,019,993
Sales of equity securities - 44,649 - 6,300 - 50,949
Maturities of fixed maturities - - 4,500 69,058 - 73,558
Net realized gains (losses) on
financial futures contracts - - - (28,220) - (28,220)
Other investments - (183) (578) (18,651) - (19,412)
-------------------------------------------------------------------------------------------
Net cash from (used for)
investing activities $ (8,622) $ 126,677 $ (20,669) $ (356,230) $ - $ (258,844)
-------------------------------------------------------------------------------------------
Cash flows from financing activities
Dividends paid on Ordinary Shares (29,995) - - - - (29,995)
Dividends paid on FELINE PRIDES (6,415) - - - - (6,415)
Proceeds from short term debt, net - 7,103 - - - 7,103
Advances to affiliates (898) - - 898 - -
Proceeds from exercise of options
for Ordinary Shares 6,945 - - - - 6,945
Proceeds from shares issued
under ESPP 2,810 - - - - 2,810
Repurchase of Ordinary Shares (35,280) - - - - (35,280)
Dividends received from subsidiaries 65,000 - - (65,000) - -
-------------------------------------------------------------------------------------------
Net cash from (used for)
financing activities $ 2,167 $ 7,103 $ - $ (64,102) $ - $ (54,832)
-------------------------------------------------------------------------------------------
Net increase (decrease) in cash (36,260) 48,320 (4,706) 67,649 - 75,003
Cash - beginning of period 46,516 253,447 26,576 281,530 - 608,069
-------------------------------------------------------------------------------------------
Cash - end of period $ 10,256 $ 301,767 $ 21,870 $ 349,179 $ - $ 683,072
===========================================================================================
(1) Includes all other subsidiaries of ACE Limited and intercompany eliminations.
(2) Includes ACE Limited parent company eliminations.
21
ACE LIMITED AND SUBSIDIARIES
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd)
(Unaudited)
14. Segment information
During the quarter ended March 31, 2002, following changes in executive
management responsibilities, the Company reassessed and changed its reporting
segments from the individual operating units to the following lines of
business: Insurance - North American, Insurance - Overseas General, Global
Reinsurance and Financial Products.
Insurance - North American includes the operations of ACE USA and ACE
Bermuda, excluding the Financial Solutions business in both the U.S. and
Bermuda which is now included in the new Financial Products segment, and
ACE Canada. ACE USA primarily comprises the domestic U.S. and Canadian
operations of ACE INA, which were acquired on July 2, 1999 and the
operations of ACE US Holdings, which were acquired on January 2, 1998.
These operations provide property and casualty insurance and reinsurance
coverage, including excess liability, professional lines, satellite, excess
property and political risk, to a diverse group of industrial, commercial
and other enterprises.
Insurance - Overseas General includes the operations of ACE International,
including ACE Europe, ACE Japan, ACE Far East and ACE Latin America. ACE
International primarily comprises the international operations of ACE INA,
which were acquired on July 2, 1999. ACE International provides property
and casualty insurance, accident and health insurance and consumer-oriented
products to individuals, mid-sized firms and large commercial clients. In
addition, ACE International provides customized and comprehensive insurance
policies and services to multinational firms and their cross-border
subsidiaries. Insurance - Overseas General also includes the insurance
operations of ACE Global Markets, which primarily encompasses the Company's
operations in the Lloyd's market (including for segment purposes Lloyd's
operations owned by ACE Financial Services). ACE Global Markets provides
funds at Lloyd's to support underwriting by the Lloyd's syndicates managed
by Lloyd's managing agencies which are owned by the Company. The
reinsurance operation of ACE Global Markets is included in the new Global
Reinsurance segment.
Global Reinsurance comprises the operations of ACE Tempest Re, ACE Tempest
US and ACE Tempest UK and the reinsurance operations of ACE Global Markets.
These subsidiaries primarily include property catastrophe reinsurance
provided worldwide to insurers of commercial and personal property. Global
Reinsurance also includes the operations of ACE Tempest Life Reinsurance.
The principal business of ACE Tempest Life Reinsurance Ltd. is to provide
reinsurance coverage to other life insurance companies. The life
reinsurance business completed its first full year of operations in 2001.
Financial Products includes the financial guaranty business of ACE Guaranty
Re and ACE Capital Re International ("ACE Financial Services"). Financial
Products also includes the financial solutions business in the U.S. and
Bermuda. ACE Financial Services provides value-added reinsurance products
in several specialty insurance markets. ACE Financial Services has two
principal divisions: financial guaranty and financial risks. The financial
guaranty division is comprised of municipal and non-municipal financial
guaranty reinsurance and credit default swaps. The financial risks division
is comprised of mortgage guaranty reinsurance, trade credit reinsurance and
title reinsurance. The financial solutions business includes insurance and
reinsurance solutions to complex risks that generally can not be adequately
addressed by the traditional insurance marketplace.
a) The following tables summarize the operations by segment for the three
months ended March 31, 2002 and 2001.
b) For segment reporting purposes, certain items have been presented in a
different manner than in the consolidated financial statements. For
segment reporting purposes, items considered non-recurring in nature
have been aggregated and shown separately net of related taxes, and
net realized gains (losses) have been presented net of related taxes.
22
ACE LIMITED AND SUBSIDIARIES
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd)
(Unaudited)
Supplemental Information by Segment
For the three months ended March 31, 2002
Insurance - Insurance -
North Overseas Global Financial ACE
American General Reinsurance Products Consolidated
-------- ------- ----------- -------- ------------
(in thousands of U.S. Dollars)
Operations Data
Property and Casualty
Gross premiums written $ 1,265,078 $ 962,272 $ 373,966 $ 487,632 $ 3,088,948
Net premiums written 512,863 614,208 354,322 476,356 1,957,749
Net premiums earned 472,946 509,245 114,905 234,301 1,331,397
Losses and loss expenses 327,497 291,760 39,188 194,700 853,145
Policy acquisition costs 41,982 113,685 16,452 18,543 190,662
Administrative expenses 70,307 86,598 6,450 9,800 173,155
Corporate administrative expenses - - - - 22,210
----------------------------------------------------------------------
Underwriting income 33,160 17,202 52,815 11,258 92,225
-----------------------------------------------------------------------
Life
Gross premiums written - - 29,198 - 29,198
Net premiums written - - 28,279 - 28,279
Net premiums earned - - 28,412 - 28,412
Life and annuity benefits - - 22,996 - 22,996
Policy acquisition costs - - 7,133 - 7,133
Administrative expenses - - 839 - 839
Net investment income - - 6,267 - 6,267
-----------------------------------------------------------------------
Underwriting income - - 3,711 - 3,711
-----------------------------------------------------------------------
Net investment income -
property and casualty 197,668
Interest expense 46,002
Income tax expense 31,747
-------------
Income excluding net realized gains
(losses) 215,855
Net realized gains (losses)
(net of income tax) (18,050)
-------------
Net income $ 197,805
=============
23
ACE LIMITED AND SUBSIDIARIES
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd)
(Unaudited)
Supplemental Information by Segment
For the three months ended March 31, 2001
Insurance - Insurance -
North Overseas Global Financial ACE
American General Reinsurance Products Consolidated
-------- ------- ----------- -------- ------------
(in thousands of U.S. Dollars)
Operations Data
Property and Casualty
Gross premiums written $ 935,898 $ 826,319 $ 234,635 $ 563,846 $ 2,560,698
Net premiums written 421,721 543,023 214,699 554,735 1,734,178
Net premiums earned 400,715 491,880 78,252 397,329 1,368,176
Losses and loss expenses 266,272 306,358 20,561 358,102 951,293
Policy acquisition costs 39,219 97,796 14,677 14,817 166,509
Administrative expenses 75,410 77,194 6,567 14,639 173,810
Corporate administrative expenses - - - - 19,032
----------------------------------------------------------------------
Underwriting income 19,814 10,532 36,447 9,771 57,532
----------------------------------------------------------------------
Life
Gross premiums written - - 940 - 940
Net premiums written - - 940 - 940
Net premiums earned - - 940 - 940
Life and annuity benefits - - 653 - 653
Policy acquisition costs - - 181 - 181
Administrative expenses - - 451 - 451
----------------------------------------------------------------------
Underwriting income (loss) - - (345) - (345)
----------------------------------------------------------------------
Net investment income 204,430
Amortization of goodwill 19,880
Interest expense 54,324
Income tax expense 23,580
--------------
Income excluding net realized gains
(losses) and cumulative effect 163,833
Net realized gains (losses) (22,769)
--------------
Net income before cumulative effect 141,064
Cumulative effect of adopting a new
accounting standard (net of income tax) (22,670)
--------------
Net income $ 118,394
==============
24
ACE LIMITED AND SUBSIDIARIES
NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd)
(Unaudited)
The following tables summarize the revenues of each segment by product offering
for the three months ended March 31, 2002 and 2001:
Net premiums earned by type of premium
Three months ended March 31, 2002
- ---------------------------------
Life,
Property & Accident Financial Financial ACE
Casualty & Health Services Solutions Consolidated
-------- -------- -------- --------- ------------
(in thousands of U.S. dollars)
Insurance - North American $ 451 $ 22 $ - $ - $ 473
Insurance - Overseas General 369 140 - - 509
Global Reinsurance 112 32 - - 144
Financial Products - - 49 185 234
--------- --------- --------- --------- ----------
$ 932 $ 194 $ 49 $ 185 $ 1,360
========= ========= ========= ========= ==========
Three months ended March 31, 2001
- ---------------------------------
Life,
Property & Accident Financial Financial ACE
Casualty & Health Services Solutions Consolidated
-------- -------- -------- --------- ------------
(in thousands of U.S. dollars)
Insurance - North American $ 397 $ 4 $ - $ - $ 401
Insurance - Overseas General 371 118 - 3 492
Global Reinsurance 78 1 - - 79
Financial Products - - 38 359 397
--------- --------- --------- ---------- ----------
$ 846 $ 123 $ 38 $ 362 $ 1,369
========= ========= ========= ========== ==========
Property and casualty underwriting assets are reviewed in total by management
for purposes of decision-making. We do not allocate assets to our new
segments. Assets are specifically identified for our life segment and
corporate holding companies.
The following table summarizes the identifiable assets at March 31, 2002 and
December 31, 2001:
March 31 December 31
2002 2001
-------------- -------------
(in millions of U.S. dollars)
Property and casualty $ 34,902 $ 34,198
Life reinsurance 507 480
Other 3,078 2,509
------------ -----------
Total assets $ 38,487 $ 37,187
============ ===========
25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The following is a discussion of our results of operations, financial
condition, liquidity and capital resources as of and for the three months
ended March 31, 2002. Our results of operations and cash flows for any interim
period are not necessarily indicative of our results for the full year. This
discussion should be read in conjunction with our consolidated financial
statements and related notes and the Management's Discussion and Analysis of
Results of Operations and Financial Condition included in our Annual Report on
Form 10-K for the year ended December 31, 2001.
Safe Harbor Disclosure
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements. Any written or oral statements made by or on
behalf of ACE may include forward-looking statements which reflect our current
views with respect to future events and financial performance. These
forward-looking statements are subject to certain uncertainties and other
factors that could cause actual results to differ materially from such
statements. These uncertainties and other factors (which are described in more
detail elsewhere herein and in other documents we file with the Securities and
Exchange Commission) include, but are not limited to, (i) the impact of the
September 11th tragedy and its aftermath on ACE's insureds and reinsureds, on
the insurance and reinsurance industry and on the economy in general and
uncertainties relating to governmental responses to the tragedy, (ii) the
ability to collect reinsurance recoverable and any delays with respect
thereto, (iii) the occurrence of catastrophic events or other insured or
reinsured events with a frequency or severity exceeding our estimates, (iv)
the uncertainties of the loss reserving process, including the difficulties
associated with assessing environmental damage and latent injuries, (v)
uncertainties relating to government and regulatory policies such as
subjecting ACE to insurance regulation or taxation in additional jurisdictions
or amending, revoking or enacting any laws, regulations or treaties affecting
our current operations and other legal, regulatory and legislative
developments, (vi) the actual amount of new and renewal business and market
acceptance of our products, (vii) risks associated with the introduction of
new products and services, (viii) the competitive environment in which we
operate, related trends and associated pricing pressures, market perception,
and developments, (ix) actions that rating agencies may take from time to
time, (x) developments in global financial markets, which could affect our
investment portfolio and financing plans, (xi) changing rates of inflation and
other economic conditions, (xii) losses due to foreign currency exchange rate
fluctuations, (xiii) loss of the services of any of our executive officers
without suitable replacements being recruited in a reasonable time frame,
(xiv) the ability of technology to perform as anticipated, (xv) the amount of
dividends received from subsidiaries, and (xvi) management's response to
these factors. The words "believe", "anticipate", "estimate", "project",
"should", "plan", "expect", "intend", "hope", "will likely result" or "will
continue" and variations thereof and similar expressions identify
forward-looking statements. Readers are cautioned not to place undue reliance
on these forward-looking statements, which speak only as of their dates. We
undertake no obligation to publicly update or review any forward-looking
statements, whether as a result of new information, future events or
otherwise.
New Reporting Segments
During the quarter ended March 31, 2002, following changes in executive
management responsibilities, we reassessed and changed our reporting
segments from the individual operating units to four lines of business:
Insurance - North American, Insurance - Overseas General, Global
Reinsurance and Financial Products. We believe that these new segments
better represent the way we manage our operations and measure our
performance. Insurance - North American includes the operations of ACE USA,
ACE Bermuda and ACE Canada, excluding the financial solutions divisions in
both the U.S. and Bermuda which are included in the new Financial Products
segment. Insurance - Overseas General includes the operations of ACE
International, including ACE Europe, ACE Japan, ACE Far East and ACE Latin
America, and the
26
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
insurance operations of ACE Global Markets. The reinsurance operations of
ACE Global Markets is now included in the new Global Reinsurance segment
together with ACE Tempest Re, ACE Tempest US and our life reinsurance
operation, which is disclosed separately. The Financial Products segment
includes the financial guaranty business of ACE Guaranty Re and ACE Capital
Re International and the financial solutions business in the U.S. and
Bermuda.
Critical Accounting Policies
Certain amounts in our consolidated financial statements are the result of
transactions that are inherently subjective in nature and require us to use
our best estimates and assumptions to determine our reported values. These
amounts could ultimately be materially different than what has been
provided for in our consolidated financial statements. We consider the
assessment of our property and casualty loss reserves, the fair value of
our investment portfolio including derivatives and the reinsurance recoverable
to be the values requiring the most subjective and complex estimates. As such,
we deem our accounting policies for these amounts to be critical. The Property
and Casualty Loss Reserves, the Investments and Cash, the Derivatives and the
Reinsurance sections below provide more information regarding the estimates and
assumptions required for these amounts.
September 11th 2001 Tragedy
The terrorist attacks on September 11, 2001 ("the September 11th tragedy")
resulted in the largest insured loss in history and had a substantial impact
on our 2001 results. We continue to monitor our total potential liability
based upon individual insurance and reinsurance policy language, legal and
factual developments in underlying matters involving its insureds as well as
legislative developments in the U.S. involving the terrorist attack. If our
current assessments of future developments are proved wrong, the financial
impact of any of them, singularly or in the aggregate, could be material. For
example, business interruption insurance claims could materialize in the
future with greater frequency than we have anticipated or provided for in our
estimates, or, insureds that we expect will not be held responsible for
injuries resulting from the attack, are ultimately found to be responsible at
a financial level that impacts our insurance or reinsurance policies.
In February 2002, we announced that one of our Bermuda subsidiaries, ACE
Bermuda Insurance Ltd. ("ACE Bermuda") agreed to settle its property insurance
claim with Silverstein Properties, Inc., ("Silverstein") arising from the
World Trade Center disaster. The settlement is based upon a single occurrence
and comprised payment of only one policy limit. ACE Bermuda and Silverstein
have agreed to dismiss all litigation and arbitration pending between them.
The settlement amount is within the reserve previously established for this
event and does not affect the remaining group reserves for other claims
arising from the September 11th tragedy. To date we have paid gross losses of
$490 million and net losses of $75 million with respect to the September 11th
tragedy and have collected approximately 98 percent of the related
recoverable.
27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Results of Operations - Three months ended March 31, 2002 and 2001
The following table provides an analysis of both our after-tax income
excluding net realized losses on investments and the cumulative effect of
adopting a new accounting standard and our net income.
Three Months Ended
March 31
2002 2001
----------- -----------
(in millions of U.S. dollars)
Income excluding net realized
losses on investments and
cumulative effect of adopting a
new accounting standard $ 216 $ 164
Net realized losses on investments
(net of income tax) (18) (23)
---------- ---------
Income excluding cumulative effect of
adopting a new accounting standard 198 141
Cumulative effect of adopting a new
accounting standard (net of income tax) - (23)
---------- ---------
Net income $ 198 $ 118
========== =========
Income excluding net realized losses on investments and the cumulative effect
of adopting a new accounting standard increased by 32 percent to $216 million
for the three months ended March 31, 2002, compared with $164 million for the
three months ended March 31, 2001. During the quarter, we ceased amortizing
goodwill as a result of our adoption of FAS 142 on January 1, 2002. Excluding
the goodwill amortization in 2001, income excluding net realized losses on
investments and the cumulative effect of adopting a new accounting standard
increased by 17 percent. The increase in income was primarily due to better
loss experience which is reflected in our combined ratio for the quarter of
93.1 percent compared with 95.8 percent last year.
Net realized losses on investments (net of income tax) were $18 million for
the three months ended March 31, 2002 compared with net realized losses of
$23 million for the three months ended March 31, 2001. The net realized
losses were generated primarily as a result of losses realized on fixed
maturities and short-term investments as well as an after-tax loss of $13
million reflecting fair value adjustments on derivatives, which we include
in net realized losses.
We recorded an expense for the first quarter of 2001 relating to the
cumulative effect of adopting this standard of $23 million, net of income
tax of $12 million. The cumulative effect of adopting this standard
primarily related to market value adjustments on the credit default swap
portfolio held by ACE Financial Services.
28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Underwriting Results by Segment
The following table provides an analysis of our consolidated underwriting
results:
Three Months Ended
March 31
2002 2001
------------------ ------------------
(in millions of U.S. dollars)
Gross premiums written $ 3,118 $ 2,561
Net premiums written 1,986 1,735
Net premiums earned 1,360 1,369
Losses and loss expenses 853 951
Life and annuity benefits 23 1
Policy acquisition costs 198 167
Administrative expenses 196 193
-------- --------
Underwriting income $ 90 $ 57
-------- --------
Loss and loss expense ratio* 64.1% 69.5%
Underwriting and administrative
expense ratio* 29.0% 26.3%
Combined ratio* 93.1% 95.8%
* Ratios exclude life reinsurance business
Overall, gross premiums written increased by 22 percent to $3.1 billion for
the first quarter of 2002 compared with the same quarter last year. We
experienced steady growth in gross premiums written in the quarter due to
new business opportunities, price increases on renewing business and
positive results from new business initiatives. During 2001, we wrote
several large retroactive contracts in the form of loss portfolio transfer
contracts ("LPTs"). In the first quarter of 2002 we did not write any LPTs.
When these contracts are written in a quarter, they cause large variations
in premium volume. These contracts are discussed in more detail in the
Financial Products segment discussion. Excluding the LPTs, which amounted
to $252 million in the first quarter of 2001, gross premiums written
increased by 35 percent.
Net premiums written, which reflect the premiums we retain after purchasing
reinsurance protection, increased by 14 percent to $2 billion for the first
quarter of 2002. Net premiums written did not increase at the same rate as
gross premiums written for several reasons. As with gross premiums written,
the LPTs had a distorting effect on net premiums written. Also in ACE USA,
we had a one-time aviation reinsurance cession to cover the in-force
aviation business prior to our joining the United States Aircraft Insurance
Group Aviation Pool and in ACE Global Markets additional reinsurance was
purchased, principally to cover several areas put into run-off. Net
premiums earned, which reflect the portion of net premiums written recorded
as revenues for the period, were relatively unchanged for this quarter
compared with the same quarter last year. Again, the LPTs which were both
written and earned during the prior year quarter distort the comparison.
Excluding the LPTs, net premiums earned increased by 22 percent.
The underwriting results of property and casualty business are discussed by
reference to the combined ratio, loss and loss expense ratio and underwriting
and administrative expense ratio. We calculate these ratios by dividing the
relevant expense amounts by net premiums earned. The combined ratio is the sum
of the loss and loss expense ratio and the underwriting and administrative
expense ratio. A combined ratio under 100 percent indicates underwriting
income and a combined ratio exceeding 100 percent indicates underwriting
losses.
29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
We establish reserves for unpaid losses and loss expenses, which are estimates
of future payments of reported and unreported claims for losses and related
expenses, with respect to insured events that have occurred. The process of
establishing reserves for property and casualty claims continues to be a
complex and imprecise process, requiring the use of informed estimates and
judgments. Our estimates and judgments may be revised as additional experience
and other data becomes available and are reviewed, as new or improved
methodologies are developed or as current laws change. Any such revisions
could result in future changes in estimates of losses or reinsurance
recoverable, and would be reflected in our results of operations for the
period in which the estimates are changed.
In addition, catastrophe losses may have a significant effect on the
insurance and reinsurance industry. Our Global Reinsurance segment and
other segments of our group have exposure to windstorm, hail, earthquake
and other catastrophic events, all of which are managed using measures
including underwriting controls, occurrence caps as well as modeling,
monitoring and managing our accumulations of potential losses across the
group. We use retrocessional programs to limit our net losses from
catastrophes. However, property catastrophe loss experience is generally
characterized as low frequency but high severity short-tail claims, which
may add volatility to our financial results.
The loss and loss expense ratio decreased to 64.1 percent for the quarter
ended March 31, 2002 compared with 69.5 percent for the same quarter of 2001.
The decrease is principally due to the fact that no LPTs were written in the
current quarter. These contracts are typically recorded at higher loss ratios
than our other lines of business.
Underwriting and administrative expenses are comprised of policy
acquisition costs, which include commissions, premium taxes, underwriting
and other costs that vary with and are primarily related to the production
of premium, and administrative expenses which include all other operating
costs. The underwriting and administrative expense ratio increased from
26.3 percent for the quarter ended March 31, 2001 to 29.0 percent for the
current quarter. Again, the principal reason for the change is the impact
of the LPTs.
We assess the performance of our life reinsurance business based on net
operating income, which is net income excluding net realized gains and
losses from the sale of investments. For the current quarter, this division
generated net operating income of $3.7 million compared with nil for the
same quarter last year.
Segment Results
Insurance - North American:
- ---------------------------
The Insurance - North American segment is comprised of our property and
casualty insurance operations in the U.S., Bermuda and Canada excluding the
financial solutions business in the U.S. and Bermuda. This segment writes a
variety of insurance products including property, liability, professional
risk (directors and officers liability, ("D&O") and errors and omissions
coverages, ("E&O")), marine, program business, political risk, accident and
health, warranty, aerospace and other specialty lines. The following table
outlines the underwriting results for this segment:
30
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Three Months Ended Percentage
March 31 Change
2002 2001 From Prior Year
------------ ------------ ---------------
(in millions of U.S. dollars)
Gross premiums written $ 1,265 $ 936 35%
Net premiums written 513 422 22
Net premiums earned 473 401 18
Losses and loss expenses 328 266 23
Underwriting and
administrative expenses 112 115 (2)
--------- -------- -----
Net underwriting income $ 33 $ 20 67%
--------- -------- -----
Loss and loss expense ratio 69.2% 66.4%
Underwriting and administrative
expense ratio 23.8% 28.6%
Combined ratio 93.0% 95.0%
This segment's underwriting income grew by 67 percent to $33 million
compared with $20 million for the same quarter last year. Gross premiums
written increased by 35 percent to $1.26 billion for the quarter ended
March 31, 2002 compared with the same quarter last year.
Within this segment, ACE USA's gross premiums written increased by 30
percent to $1.2billion. Most of ACE USA's operating divisions experienced
strong premium growth this quarter with the ACE Risk Management Group
("ARM"), our national accounts business, and Westchester Specialty, our
wholesale oriented excess and surplus lines group, substantially
contributing to the increase. As the markets continue to harden,
opportunities in the excess and surplus lines market traditionally outpace
those in the standard admitted lines market. As a result, we are seeing a
significant increase in new business submissions in Westchester Specialty.
Pricing continues to be strong across all lines with large property
accounts and excess casualty lines showing the strongest increases. The
recent insolvency of several large publicly held companies has fueled
increases in E&O and D&O rates. Overall, price increases across commercial
lines in the first quarter for ACE USA were in the 20 to 40 percent range.
In addition, there continues to be general improvement in policy terms and
conditions. Our growth this quarter was achieved despite offering
significantly reduced limits and higher attachment points.
New initiatives in the U.S. group also yielded positive results. Gross
premiums written in the professional risks lines increased from $24 million
to $46 million from the prior period and our expansion into accident and
health in the latter part of 2001 produced $24 million of gross premiums
written in the quarter.
ACE Bermuda also had a successful first quarter of 2002 experiencing strong
premium growth in their core lines of excess liability, professional lines
and excess property. Gross premiums written at ACE Bermuda increased by $55
million to $87 million for the 2002 quarter compared with the prior period.
This growth resulted from a combination of rate increases and new business
written. In addition to the rate increases, ACE Bermuda also secured
improved terms and conditions that have improved the risk profile of the
in-force book.
Net premiums written for the segment increased by 22 percent for the
quarter. Growth in net premiums written was negatively impacted by a
one-time aviation reinsurance cession to cover the in-force aviation
business prior to our joining the United States Aircraft Insurance Group
Aviation Pool. Without this cession, net premiums written would have
increased by 28 percent. The ratio of net premiums written to gross
premiums written was also impacted by a change in business mix with a
larger proportion of premiums written this quarter coming from lines that
traditionally use more reinsurance.
31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Net premiums earned increased by 18 percent to $473 million for the quarter
compared with the 2001 quarter. This increase is principally due to the
earning out of higher premiums written in previous quarters. While a small
portion of the net premiums written this quarter are earned, most will be
earned out in future quarters.
The loss and loss expense ratio increased to 69.2 percent of earned
premiums written in the current quarter compared with 66.4 percent last
year. ACE Bermuda's results were negatively impacted by approximately $15
million of satellite and aviation losses, the latter being in run-off,
arising from prior period risks. These losses added 3 percentage points to
the loss ratio. The underwriting and administrative expense ratio declined
to 23.8 percent for the current quarter compared with 28.6 for the same
quarter last year principally because expenses were relatively unchanged
despite the increase in net premiums earned in the quarter.
Insurance - Overseas General
- ----------------------------
The Insurance - Overseas General segment comprises ACE International, our
network of indigenous insurance operations and the insurance operations of
ACE Global Markets, our Lloyd's operation. Like the North American
insurance segment, this segment writes a variety of insurance products
including property, liability, professional risk (D&O and E&O), marine,
political risk, accident and health, aerospace and consumer oriented products.
The following table outlines the underwriting results for this segment:
Three Months Ended Percentage
March 31 Change
2002 2001 From Prior Year
-------- -------- ---------------
(in millions of U.S.
dollars)
Gross premiums written $ 962 $ 826 16%
Net premiums written 614 543 13
Net premiums earned 509 492 4
Losses and loss expenses 292 306 (5)
Underwriting and administrative
expenses 200 175 14
------- ------- ------
Net underwriting income $ 17 $ 11 63%
------- ------- ------
Loss and loss expense ratio 57.3% 62.3%
Underwriting and administrative
expense ratio 39.3% 35.6%
Combined ratio 96.6% 97.9%
Underwriting income increased by 63 percent to $17 million for the quarter
compared with last year. Gross premiums written increased by 16 percent for
the quarter to $962 million. Adjusting for foreign currency rate changes,
gross premiums written actually increased by 20 percent.
Gross premiums written in ACE International increased by 18 percent in
local currency. Geographically, the growth was broad based. Europe had
growth of 37 percent while Latin America increased by 9 percent and Asia
Pacific grew by 45 percent. In original currency, ACE Japan also had growth
of 8 percent.
ACE Global Markets had an increase of 24 percent in gross premium written
for the current quarter compared with the same quarter last year. In 2002,
we increased our percentage participation in syndicate 2488 to 99.6 percent
from 90 percent for the 2001 year of account. We expect to own 100 percent
for the 2003 year of account. In addition, we are achieving significant
changes in both rates and underwriting terms with rate increases averaging
30 percent. At the same time, this operation is
32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
currently adjusting its underwriting strategy and moving from a gross line
underwriter (where large gross limits are written on the basis that most of
the risk is then reinsured) to a net line underwriter (where much smaller
gross limits are written and much less reliance is placed on reinsurance)
in keeping with our underwriting standards. As a consequence, in certain
lines of business that do not fit this strategy, net limits per risk have been
reduced, in some cases by half or more and other lines of business have been
placed in run-off.
Net premiums written for the segment increased by 13 percent or 18 percent
after adjusting for currency. Net premiums written in ACE International
increased by 24 percent in local currency. Net premiums written in ACE
Global Markets were unchanged year over year primarily due to the cost of
reinsurance to protect us on run-off exposures discussed previously.
Net premiums earned increased by 4 percent in the quarter on a reported
basis. On a currency-adjusted basis, ACE International net premiums earned
increased by 13 percent. The loss and loss expense ratio decreased to 57.3
percent for the current quarter compared with 62.3 percent for the same
quarter last year principally due to better loss experience on business
earned in the quarter. The underwriting and administrative expense ratio
increased to 39.3 percent for the current quarter compared with 35.6
percent for the quarter ended March 31, 2001. The principal reason for the
increase is an increase in the underwriting expense ratio at ACE Global
Markets due to lower net earned premiums as a result of increased
reinsurance costs.
Global Reinsurance
- ------------------
The Global Reinsurance segment consists of ACE Tempest Re, ACE Tempest USA
and ACE Global Market's property and casualty reinsurance operations as
well as our life reinsurance operations which are disclosed separately. The
property and casualty reinsurance group writes catastrophe, marine,
casualty, and nuclear products.
Property and Casualty
- ---------------------
The following table outlines the underwriting results of our global property
and casualty reinsurance division:
Three Months Ended Percentage
March 31 Change
2002 2001 From Prior Year
-------- ------- ---------------
(in millions of U.S.
dollars)
Gross premiums written $ 374 $ 235 59%
Net premiums written 354 215 65
Net premiums earned 115 78 47
Losses and loss expenses 39 21 91
Underwriting and administrative
expenses 23 21 8
------- ------- ------
Net underwriting income $ 53 $ 36 45%
------- ------- ------
Loss and loss expense ratio 34.1% 26.3%
Underwriting and administrative
expense ratio 19.9% 27.1%
Combined ratio 54.0% 53.4%
Underwriting income increased by 45 percent to $53 million for the quarter
compared with the same quarter last year.
Gross premiums written for the quarter increased by 59 percent to $374 million
from $235 million last year. Overall, reinsurance underwriting conditions
remain favorable. The reinsurance market continues to show
discipline in both pricing and underwriting terms. In fact, in certain
classes, rates are continuing to increase.
33
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
In ACE Tempest Re, where we write most of the property catastrophe
business, net premiums written increased by 57 percent. On average, premium
rates in our portfolio increased over 25 percent in the quarter and rate
levels are being maintained as the year progresses. In the property
catastrophe business, risk modeling and selection capabilities are
extremely important. While we deem current prices adequate to achieve a
reasonable risk adjusted return, we still declined a substantial amount of
business because of what we deem inadequate market pricing.
ACE Tempest U.K. which is principally focused on specialty reinsurance
products had a successful quarter increasing its net premiums written by 95
percent to $81 million for the current quarter compared with $41 million
for the same quarter last year. ACE Tempest U.S. which was established in
2000 with an initial focus on writing property per risk and casualty
reinsurance increased its net premiums written for the current quarter by
over 200 percent to $32 million compared with last year.
The loss and loss expense ratio increased from 26.3 percent for the first
quarter of 2001 to 34.1 percent for the current quarter due to the change in
business mix as a result of the growth in the non-property catastrophe area.
There was no significant loss activity in the same quarter last year.
The underwriting and administrative expense ratio decreased to 19.9 percent
for the current quarter compared with 27.1 percent for the quarter ended
March 31, 2001. This decrease is primarily the result of higher property
and casualty net premiums earned combined with underwriting and
administrative expenses that were essentially unchanged from last year.
Life Reinsurance
- ----------------
Our principal business in this division is to provide reinsurance coverage
to life insurance companies. In 2001, we concluded our first full year of
operations for our life division. We price this reinsurance using
sophisticated actuarial and investment models that incorporate a number of
factors, including assumptions for mortality, morbidity, expenses,
demographics, persistency, investment returns and inflation. We assess the
performance of our life reinsurance business based on net operating income,
which is net income excluding net realized gains and losses from the sale
of investments. The use of combined ratios is not an appropriate measure of
the underwriting results of life reinsurance business.
The following table sets out the underwriting results of our life
reinsurance division:
Three Months Ended
March 31
2002 2001
------------ ------------
(in millions of U.S.
dollars)
Gross premiums written $ 29 $ 1
Net premiums written 28 1
Net premiums earned 28 1
Life and annuity benefits 23 1
Underwriting and administrative expenses 8 -
Net investment income 6 -
Net underwriting income ------ -----
$ 3 $ -
------ -----
During the first quarter, the life reinsurance group wrote $29 million of
new business derived principally from treaty business as opposed to
one-time single premium transactions. We are focused on writing risk
transfer treaty business where the principal risk is mortality and
morbidity based. Our current product portfolio focuses mainly on long term
disability, life and variable products. We are also engaged in writing
one-time portfolio transactions where the requirements of the client are
risk transfer and capital management motivated. Earnings from these
transactions are recognized over the life of the contract.
34
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Financial Products
- ------------------
The Financial Products segment consists of two broad categories: financial
guaranty business and financial solutions business. The financial guaranty
business includes municipal and non-municipal financial guaranty
reinsurance, title cover, single-name and portfolio credit default swaps,
mortgage guaranty reinsurance, trade credit reinsurance and residual value
reinsurance. The financial solutions business includes insurance and
reinsurance solutions to complex risks that generally can not be adequately
addressed by the traditional insurance marketplace. Each financial
solutions contract is unique and specifically tailored for an individual
client, but generally they are multi-year and contain some form of client
participation. Due to the nature of the financial solutions business,
premium volume can vary significantly from period to period and therefore
premiums written in any one quarter are not indicative of premiums to be
written in future quarters.
We also write retroactive contracts, including LPTs, which indemnify ceding
companies for events that have occurred in prior years. While these types
of contracts are generally written in the Financial Products segment, they
can also be written in other segments, including the life reinsurance
group. These contracts, which meet the established criteria for reinsurance
accounting, are recorded in the statement of operations when written and
generally result in large one-time written and earned premiums with
comparable incurred losses. These contracts, when written, can cause
significant variances in gross premiums written, net premiums written, net
premiums earned, net incurred losses as well as the loss and loss expense
ratio and underwriting and administrative expense ratio. At the time one of
these contracts is written, we make certain assumptions with respect to the
ultimate amount and timing of payments in order to establish loss and loss
expense reserves. As with most loss reserves, the actual amount and timing
of payments may result in losses and loss expenses which are significantly
greater or less than the reserves initially provided.
It is generally expected that losses ultimately paid under retroactive
contracts will exceed the premiums received, in some cases by large
margins. Premiums are based in part on time-value-of money concepts because
loss payments may occur over lengthy time periods. However, retroactive
contracts do not have a significant impact on reported earnings in the
period of inception. When writing a retroactive contract, the excess of the
estimated ultimate losses over the premiums received is established as a
deferred charge and amortized against income over the estimated future
claim settlement period. While we expect that these contracts will produce
significant underwriting losses over time, we also expect that this
business will be profitable due to expected earnings on the premiums
received.
The following table outlines the underwriting results for this segment:
Three Months Ended Percentage
March 31 Change
2002 2001 From Prior Year
-------- -------- ---------------
(in millions of U.S.
dollars)
Gross premiums written $ 488 $ 564 (14)%
Net premiums written 476 555 (14)
Net premiums earned 234 397 (41)
Losses and loss expenses 195 358 (46)
Underwriting and administrative
expenses 28 29 (4)
------- ------- -----
Net underwriting income $ 11 $ 10 15%
------- ------- -----
Loss and loss expense ratio 83.1% 90.1%
Underwriting and administrative
expense ratio 12.1% 7.4%
Combined Ratio 95.2% 97.5%
35
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Gross premiums written for the quarter ended March 31, 2002, declined by 14
percent to $488 million compared with $564 million for the same quarter
last year.
Our financial guaranty operations reported an increase in underwriting
income of $2 million. We benefited from an increase in municipal refunding
coupled with a robust housing market, principally in the U.S. In addition,
market demand for credit derivatives was strong in the quarter so we were
able to increase our writings in this area.
The financial solutions area had net premiums earned of $185 million for the
quarter, a 47 percent decline over last year. This area was successful in
writing numerous transactions during the quarter, however, the premium in
last year's first quarter was bolstered by several LPTs, aggregating $252
million. By their nature, LPTs are non-recurring. Excluding the LPT
contracts, net premiums earned increased by 75 percent for the current
quarter compared to the same quarter last year. This increase is mainly due
to several new financial solutions contracts written during the quarter in
both Bermuda and the U.S. While there is currently strong demand for LPTs
in the market, these deals are usually large and complex and take time to
conclude. It is difficult to predict the amount or timing of the writing of
LPT transactions.
The absence of LPTs also impacted the loss and loss expense ratio. The loss
and loss expense ratio improved from 90.1 percent for the quarter ended
March 31, 2001 to 83.1 percent for the current quarter. Despite the
underwriting and administrative expenses remaining stable for the current
quarter compared with the same quarter last year, the decrease in net
premiums earned caused an increase in the underwriting and administrative
expense ratio.
Net Investment Income
Three Months Ended Percentage
March 31 Change
2002 2001 From Prior Year
---------- ---------- ---------------
(in millions of U.S.
dollars)
Net investment income $ 204 $ 204 -
======== ======== ===========
Net investment income is influenced by a number of factors, including the
amounts and timing of inward and outward cash flows, the level of interest
rates as well as changes in overall asset allocation. Net investment income
was unchanged in the current quarter compared with the same quarter last year.
Our equity offering in the fourth quarter of 2001, combined with increased
assets from our life reinsurance business and positive cash flow during the
quarter resulted in increases in investment income of approximately $29
million for the current quarter compared with the same quarter last year.
However, due to the timing, the net proceeds from our debt offering late in
the quarter ended March 31, 2002, had no effect on our investment income in
the first quarter of 2002.
Offsetting the increase in investment income from the higher asset base were
the lower interest rates during the current quarter compared with the same
quarter in 2001. Lower yields on cash and short term deposits as well as the
rollover of our portfolio at lower current yields resulted in decreases in
investment income of approximately $29 million which resulted in investment
income remaining flat for the current quarter compared with the same quarter
last year.
36
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Net Realized Gains (Losses) on Investments
Three Months Ended
March 31
2002 2001
---------- ----------
(in millions of U.S.
dollars)
Fixed maturities and short-term investments $ (14) $ 8
Equity securities (2) 13
Financial futures, options and interest rate swaps 4 (29)
Fair value adjustment on derivatives (13) 4
Currency (1) (4)
Other investments - (11)
-------- -------
Total net realized gains (losses) on investments $ (26) $ (19)
======== =======
Our investment strategy takes a long-term view and our portfolio is
actively managed to maximize total return within certain specific
guidelines, which minimize risk. Our investment portfolio is reported at
fair value. However, the effect of market movements on our portfolio only
impact income (through net realized gains (losses) on investments) when
securities are sold or other than temporary impairments are recorded on
invested assets. Changes in unrealized gains and losses, which result from
the revaluation of securities held, are reported as a separate component of
accumulated other comprehensive income.
Net realized losses on fixed maturities include losses related to
write-downs of certain securities in our investment portfolio that had what
we believe to be an other than temporary decline in their fair value. The
write down for these permanent impairments for the current quarter was $17
million.
We use foreign currency forward contracts to minimize the effect of
fluctuating foreign currencies on the value of non-U.S. dollar holdings
currently held in the portfolio not specifically targeted to match the
currency of liabilities. These contracts are not designated as specific
hedges and therefore, realized and unrealized gains and losses recognized
on these contracts are recorded as net realized gains (losses) in the
quarter in which the fluctuations occur, together with net foreign currency
gains (losses) recognized when non-U.S. dollar securities are sold.
We use fixed income futures contracts and interest rate swaps to manage
duration exposure. Gains of $7 million were recognized on interest rate swaps
during the first quarter of 2002. Net realized losses generated by our equity
and fixed income index futures and option contracts amounted to $3 million for
the same quarter, bringing the total net realized gains attributable to
financial futures and option contracts and interest rate swaps to $4 million
compared with losses of $29 million for the same quarter in 2001.
We implemented FAS 133 on January 1, 2001, which requires that all derivatives
be recognized as either assets or liabilities in the consolidated balance sheet
and measured at fair value. The change in fair value of our derivatives for the
quarter ended March 31, 2002 was a loss of $13 million compared with a gain of
$4 million for the same quarter in 2001. The level of such gains and losses is
dependent upon a number of factors including changes in interest rates, credit
spreads and other market factors.
37
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Other Expenses
Three Months Ended Percentage
March 31 Change
2002 2001 From Prior Year
---------- ---------- ---------------
(in millions of U.S. dollars)
Interest expense $ 46 $ 54 (15)%
========== ==========
Income tax expense $ 24 $ 27 (11)%
========== ==========
Amortization of goodwill $ - $ 20 -
========== ==========
Interest expense decreased by 15 percent for the current quarter compared with
the quarter ended March 31, 2001. This decrease is primarily attributed to
lower short-term interest rates on our floating rate debt for the current
quarter as compared with the same quarter last year.
We recorded income tax expense of $24 million for the quarter ended March 31,
2002 compared with an expense of $27 million for the same quarter last year.
This decline is due to the decrease in income in taxable jurisdictions for the
current quarter.
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" ("FAS 142"). FAS 142 primarily addresses the accounting for
goodwill and intangible assets subsequent to their acquisition. As required,
we adopted FAS 142 on January 1, 2002 and have ceased amortizing goodwill.
Investments and Cash
Our principal investment objective is to ensure that funds will be
available to meet our insurance and reinsurance obligations. Within this
broad liquidity constraint, our investment portfolio's structure seeks to
maximize return subject to specifically approved guidelines of overall
asset classes, credit quality, liquidity and volatility of expected
returns. As such, our investment portfolio is invested primarily in fixed
income securities of the highest credit quality and is externally managed
by independent professional investment managers.
At March 31, 2002, total investments and cash were $16.3 billion compared with
$15.9 billion at December 31, 2001, an increase of $400 million. The increase
in total investments and cash is primarily resulting from the net proceeds of
our debt offering at the end of the quarter and strong premium volume.
Offsetting these increases, we paid dividends of $45 million during the
quarter.
Our other investments principally comprise direct investments, investments
in investment funds and investments in limited partnerships. For direct
investments that meet the requirements for equity accounting, we accrue our
portion of the net income or loss of the investment. We carry other direct
investments at fair value. Where fair values are not publicly available,
the investments are carried at estimated fair value. Our investments in
investment funds are carried at the net asset value as advised by the fund.
We account for investments in limited partnerships using the equity method.
The following table identifies our invested assets at fair value, by type held
at March 31, 2002 and December 31, 2001:
March 31 December 31
2002 2001
---------- -----------
(in millions of U.S. dollars)
Fixed maturities available for sale $ 13,037 $ 13,000
Equity securities 514 468
Short-term investments 1,401 1,206
Other investments 551 591
Cash 820 671
--------- ----------
Total investments and cash $ 16,323 $ 15,936
========= ==========
38
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Property and Casualty Loss Reserves
We establish reserves for the estimated unpaid ultimate liability for
losses and loss expenses under the terms of our policies and agreements.
These reserves include estimates for both claims that have been reported
and those that have been incurred but not reported ("IBNR"), and include
estimates of expenses associated with processing and settling these claims.
The reserve for unpaid losses and loss expenses was $20.5 billion at March
31, 2002, compared with $20.7 billion at December 31, 2001, and includes
$12.6 billion of case and loss expense reserves. The process of
establishing reserves for property and casualty claims continues to be a
complex and imprecise one, requiring the use of informed estimates and
judgements. Our estimates and judgements may be revised as additional
experience and other data become available and reviewed, as new or improved
methodologies are developed or as current laws change. As part of our
evaluation process of loss reserves, we engage independent actuarial firms
to review the methods and assumptions we use in estimating the unpaid
losses and loss expenses. We continually evaluate our estimate of reserves
in light of developing information and in light of discussions and
negotiations with our insureds. While we believe that our reserve for
unpaid losses and loss expenses at March 31, 2002 is adequate, future
developments may result in ultimate losses and loss expenses significantly
greater or less than the reserve provided.
Reinsurance
One of the ways we manage our loss exposure is through the use of
reinsurance. While reinsurance arrangements are designed to limit our
losses from large exposures and to permit recovery of a portion of direct
losses, reinsurance does not relieve us of our liability to our insureds.
Accordingly, our loss reserves represent total gross losses, and
reinsurance recoverable represents anticipated recoveries of a portion of
those losses as well as amounts recoverable from reinsurers with respect to
claims, which we have already paid. Reinsurance recoverable at March 31,
2002 was relatively unchanged from the balance at December 31, 2001,
remaining at $11.4 billion.
We evaluate the financial condition of our reinsurers and potential
reinsurers on a regular basis and also monitor concentrations of credit
risk with reinsurers. The allowance for unrecoverable reinsurance is
required principally due to the failure of reinsurers to indemnify us,
primarily because of disputes under reinsurance contracts and insolvencies.
Reinsurance disputes continue to be significant, particularly on larger and
more complex claims, such as those related to asbestos and environmental
pollution and London reinsurance market exposures. Allowances have been
established for amounts estimated to be uncollectible. Our allowance for
unrecoverable reinsurance is $795 million at March 31, 2002 compared with
$789 million at December 31, 2001.
Asbestos and Environmental Claims
Included in our liabilities for losses and loss expenses are liabilities for
asbestos, environmental and latent injury damage claims and expenses ("A&E
exposures"). These claims are principally related to claims arising from
remediation costs associated with hazardous waste sites and bodily injury
claims related to asbestos products and environmental hazards. These amounts
include provision for both reported and IBNR claims. With respect to survival
ratios for A&E exposures, we feel this is a very simplistic measure of a very
complicated issue. However, we understand this ratio is used as a means to
compare companies with A&E exposures. Thus, if we average the last 3 years of
claim payments and expect payments to continue at the same pace, our survival
ratio is 7.8 years. Using the 2001 calendar year payments, our survival ratio
increases to 9.1 years. These ratios take into account the remaining coverage
under the National Indemnity Company reinsurance contract.
We continuously evaluate our estimates of liabilities and related
reinsurance recoverable for A&E exposures. While most of these liabilities
for such claims arise from exposures in North America, we have also
provided for international A&E exposures.
We have considered asbestos and environmental claims and claims expenses in
establishing the liability for unpaid losses and loss expenses. We have
developed reserving methods, which incorporate new sources of data with
historical experience to estimate the ultimate losses arising from asbestos
and environmental exposures. The reserves for asbestos and environmental
39
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
claims and claims expenses represent our best estimate of future loss and
loss expense payments and recoveries which are expected to develop over the
next several decades. We continuously monitor evolving case law and its
effect on environmental and latent injury claims. While reserving for these
claims is inherently uncertain, we believe that the reserves carried for
these claims are adequate based on known facts and developing law.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Liquidity is a measure of a company's ability to generate sufficient cash
flows to meet the short-term and long-term cash requirements of its
business operations. As a holding company, ACE's assets consist primarily
of the investments in its subsidiaries as well as other investments. In
addition to investment income, its cash flows currently depend primarily on
dividends or other statutorily permissible payments from its Bermuda-based
operating subsidiaries (the "Bermuda subsidiaries"). During the quarter
ended March 31, 2002, ACE was able to meet all of its obligations,
including the payment of dividends declared on its Ordinary Shares and
FELINE PRIDES, with its net cash flow and the dividends received.
Should the need arise, we have access to the debt markets and other
available credit facilities which are discussed below.
There are currently no legal restrictions on the payment of dividends from
retained earnings by the Bermuda subsidiaries, as the minimum statutory
capital and surplus requirements are satisfied by the share capital and
additional paid-in capital of each of the Bermuda subsidiaries. However,
the payment of dividends or other statutorily permissible distributions by
the Bermuda subsidiaries is subject to the need to maintain shareholders'
equity at levels adequate to support the insurance and reinsurance
operations. During the current quarter, ACE Bermuda declared dividends of
$130 million. ACE Tempest Re did not declare any dividends during the
quarter ended March 31, 2002. ACE expects that a majority of its cash
inflows for the remainder of 2002 will be from its Bermuda subsidiaries.
Management assesses which companies to draw dividends from based on among
other things, regulatory and legal restrictions and the company's financial
condition particularly its ability to provide dividends without
compromising its operations.
The payments of dividends from ACE's non-Bermuda based operating
subsidiaries are also subject to laws and regulations, which vary by
jurisdiction. The payment of any dividends from ACE Global Markets or its
subsidiaries would be subject to applicable United Kingdom insurance laws
and regulations including those promulgated by the Society of Lloyd's. ACE
INA's and ACE Financial Services' U.S. insurance subsidiaries may pay
dividends, without prior regulatory approval, only from earned surplus and
subject to the maintenance of a minimum capital requirement without prior
regulatory approval. ACE INA's international subsidiaries are also subject
to various insurance laws and regulations in the countries in which they
operate. These laws and regulations include restrictions that limit the
amount of dividends that can be paid without prior approval of the
insurance regulatory authorities.
During the quarter ended March 31, 2002, ACE did not receive any dividends
from ACE Global Markets, ACE INA or ACE Financial Services nor does ACE
expect to receive dividends from these subsidiaries during 2002. Under the
Lloyd's accounting model, syndicates in Lloyd's operate each year as an
annual venture. Each "year of account" is held open for three years. At the
end of three years, the "year of account" purchases reinsurance from the
next open year (this purchase is known as "reinsurance to close" or "RITC")
and distributes the remaining funds to the investors in the syndicate. ACE
Global Markets has historically reinvested these funds in operations, which
have expanded each year. ACE INA has issued debt to provide partial
financing for the ACE INA Acquisition and for other operating needs. This
debt is serviced by dividends paid by ACE INA's insurance subsidiaries to
ACE INA as well as other group resources. ACE Financial Services' U.S.
insurance subsidiaries are limited in their dividend paying abilities due
to their need to maintain their AA and AAA financial strength ratings.
40
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Our consolidated sources of funds consist primarily of net premiums written,
investment income and proceeds from sales and maturities of investments. Funds
are used primarily to pay claims, operating expenses and dividends and for the
purchase of investments. After satisfying our cash requirements, excess cash
flows from these underwriting and investing activities are used to build the
investment portfolio and thereby increase future investment income.
Our insurance and reinsurance operations provide liquidity in that premiums
are received in advance, generally substantially in advance, of the time
claims are paid. Our consolidated net cash flow from operating activities
was $142 million for the current quarter compared with $388 million for the
same quarter last year. Generally cash flows are affected by claim payments
which, due to the nature of our operations, may comprise large loss
payments on a limited number of claims and therefore can fluctuate
significantly from year to year. The irregular timing of these loss
payments, for which the source of cash can be from operations, available
net credit facilities or routine sales of investments, can create
significant variations in cash flows from operations between quarters. Net
loss and loss expense payments were $977 million for the quarter ended
March 31, 2002 compared with $945 million for the same quarter last year.
We believe that we have sufficient liquidity to meet our anticipated cash
flow obligations, including those resulting from the September 11th
tragedy. During the current quarter we made gross claim payments of $389
million with respect to the September 11th tragedy. On a net basis, our
payment with respect to this claim was $50 million during the current
quarter and approximately 98 percent of the related recoverable has been
collected. Although ongoing operations continue to generate positive cash
flows, our cash flows are currently impacted by a large book of loss
reserves from businesses in run-off. The run-off operations generated
negative cash flows of $147 million for the current quarter compared with
$261 million for the same quarter last year, primarily due to claim
payments. The run-off book of business continues to require cash to meet
its liabilities and cash flows are very dependent on the timing of claim
settlements.
41
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Both internal and external forces influence our financial condition, results of
operations and cash flows. Claim settlements, premium levels and investment
returns may be impacted by changing rates of inflation and other economic
conditions. In many cases, significant periods of time, ranging up to several
years or more, may lapse between the occurrence of an insured loss, the
reporting of the loss to us and the settlement of the liability for that loss.
We believe that our cash balances, cash flow from operations, routine sales of
investments and the liquidity provided by our credit facilities (discussed
below) are adequate to meet expected cash requirements.
Capital Resources
Capital resources consist of funds deployed or available to be deployed to
support our business operations. The following table summarizes the components
of our capital resources at March 31, 2002 and December 31, 2001:
March 31 December 31
2002 2001
-------- -----------
(in millions of U.S. dollars)
Shareholders' equity $ 6,204 $ 6,107
Mezzanine equity 311 311
Trust preferred securities 875 875
Long-term debt 1,848 1,349
Short-term debt 399 495
--------- ----------
Total capitalization $ 9,637 $ 9,137
========= ==========
Debt to total capitalization 23% 20%
========= ==========
Our financial strength provides us with the flexibility and capacity to
obtain funds externally through debt or equity financing on both a
short-term and long-term basis. We have accessed both the debt and equity
markets from time to time. Historically, this has primarily been in
connection with acquisitions, although we did issue Ordinary Shares in
October 2001 to provide additional capital to support growth in our
operations. Also, in March 2002 we issued $500 million of senior debt,
primarily to repay our short-term debt and for general corporate purposes.
We reduced commercial paper by $100 million during the quarter from the
proceeds of the debt offering and repaid an additional $175 million of
commercial paper during April 2002. We will use $75 million to repay the
ACE Financial Services debt that matures later this year. Our ability to
access the capital markets is dependent on among other things market
conditions and our perceived financial strength.
In 1999, we filed a registration statement with the Securities and Exchange
Commission ("SEC") utilizing a "shelf" registration process relating to a
number of different types of debt and equity securities. Under this shelf
process, we may sell the securities described in the registration statement
up to a total offering price of $4 billion. We have utilized the shelf to
issue the mezzanine equity, the trust preferred securities, the short-term
and long-term debt, as well as the equity offerings of $400 million in 2000
and $1.1 billion in 2001. At March 31, 2002, the amount available under the
shelf filing was $127 million. We are in the process of filing another
registration statement with the SEC allowing us to sell securities up to a
total offering price of $1.5 billion.
Shareholders' Equity
Fully diluted book value per share was $23.78 at March 31, 2002, compared
with $23.59 at December 31, 2001, reflecting an increase in shareholders'
equity during the quarter. Shareholder's equity increased by $97 million
during the quarter ended March 31, 2002, due primarily to our net income,
which was offset by dividend payments and unrealized depreciation on the
investment portfolio.
42
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
As part of our capital management program, in November 2001, our Board of
Directors authorized the repurchase of any ACE issued debt or capital
securities including Ordinary Shares, up to an aggregate total of $250
million. As of March 31, 2002, this authorization had not been utilized.
On January 11, 2002 and April 12, 2002, we paid dividends of 15 cents per
share to shareholders of record on December 31, 2001 and March 29, 2002,
respectively. We have paid dividends each quarter since we became a public
company in 1993. However, the declaration, payment and value of future
dividends is at the discretion of our Board of Directors and will be
dependent upon our profits, financial requirements and other factors,
including legal restrictions on the payment of dividends and such other
factors as our Board of Directors deems relevant.
Mezzanine Equity
On April 12, 2000, we publicly offered and issued 6,000,000 FELINE PRIDES.
On May 8, 2000, exercise of the underwriter's over allotment option
resulted in the issuance of an additional 221,000 FELINE PRIDES, for
aggregate net proceeds of approximately $311 million. Each FELINE PRIDE
initially consists of a unit referred to as an Income PRIDE. Each Income
PRIDE consists of (i) one 8.25 percent Cumulative Redeemable Preferred
Share, Series A, liquidation preference $50 per share, and (ii) a purchase
contract pursuant to which the holder of the Income PRIDE agrees to
purchase from us, on May 16, 2003, $311 million of Ordinary Shares at the
applicable settlement rate. At a market price of our Ordinary Shares above
$26.33, upon redemption, we would issue 11,800,000 shares in exchange for the
FELINE PRIDES.
The aggregate liquidation preference of the 8.25 percent Cumulative
Redeemable Preferred Shares is $311 million. Unless deferred by us, the
preferred shares pay dividends quarterly at a rate of 8.25 percent per year
to May 16, 2003, and thereafter at the reset rate established pursuant to a
remarketing procedure. If we elect to defer dividend payments on the
preferred shares, the dividends will continue to accrue and we will be
restricted from paying dividends on our Ordinary Shares and taking certain
other actions. The preferred shares are not redeemable prior to June 16,
2003, on which date they must be redeemed by us in whole.
Contractual Obligations and Commitments
The table below shows our contractual obligations and commitments including our
payments due by period:
Payments Due By Period
(in millions of U.S. dollars)
Total Less 1-3 4-5 After
than Years Years 5 Years
1 Year
Short-term debt $ 399 $ 399
Long-term debt 1,848 400 798 650
Trust preferred securities 875 400 475
-------- ------- ------ ------- -------
Total contractual obligations
and commitments $ 3,122 $ 799 $ 400 $ 798 $1,125
======== ======= ====== ======= =======
During the quarter, we issued $500 million, 5-year senior debt, with a
coupon rate of 6.0 percent, due April 1, 2007. These senior unsecured notes
rank equally with all of our other senior obligations. The agreement
governing this senior debt contains a customary limitation on liens as well
as customary events of default provisions, which if breached could
accelerate the maturity of such senior debt. The primary purpose of this
debt issue was to repay commercial paper. The proceeds were used to reduce
short-term debt to approximately $400 million prior to quarter end. The
notes are not redeemable before maturity and do not have the benefit of any
sinking fund.
43
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Following the September 11th tragedy, our ability to access the commercial
paper markets was disrupted, partly because certain of our debt ratings
were placed on "negative watch". During the fourth quarter of 2001, as an
alternative to raising commercial paper, we entered into securities
repurchase agreements with various counterparties to raise short-term
funds. Under these repurchase agreements, we agreed to sell securities and
repurchase them at a date in the future for a predetermined price, thereby
creating liquidity. The "negative watches" on our debt ratings were lifted
during the quarter and our access to the commercial paper markets was
restored. We raised commercial paper and the amounts due to brokers under
the repurchase agreements at December 31, 2001 of $395 million were repaid
during the current quarter. The average cost of borrowing using commercial
paper during the quarter was 2.0 percent.
At March 31, 2002, short-term debt consisted of $299 million in commercial
paper, $25 million in bank borrowings by ACE Financial Services and the ACE
Financial Services $75 million 7.75 percent debentures which matures in
November 2002. Subsequent to March 31, 2002 we repaid $150 million of
expiring commercial paper and the $25 million bank note using proceeds from
the debt offering. We have the ability to either repay the debenture or
obtain alternative financing in the capital markets upon maturity. We
intend to repay the debt using proceeds from the March 2002 debt offering.
The remaining debt proceeds will be used for other general corporate
purposes.
We continue to have access to substantial liquidity resources. In the event
of any future disruption to the commercial paper markets, we have access to
our cash resources, short-term investments and our substantial investment
portfolio. We also have the ability to draw down on our existing $1.05
billion of credit facilities. In addition, we have the ability to enter
into repurchase agreements to provide liquidity. The covenants of our
existing credit facilities limit our borrowing under repurchase agreements
to $800 million.
The Auction Rate Reset Preferred Securities ("Rhino Preferred Securities")
were issued in June 1999 and mature on September 30, 2002. In September
2000, we issued $400 million of Ordinary Shares, the proceeds of which
support ACE's guarantee of the $412 million principal amount of the
Subordinated Notes held by a business trust wholly owned by us. These
proceeds are available to repay the RHINO Preferred Securities upon
maturity.
Credit Facilities
In April 2002, we renewed, at substantially the same terms, our $800
million, 364-day revolving credit facility. This facility, together with
our $250 million, five-year revolving credit facility, which was last
renewed in May 2000, is available for general corporate purposes and each
of the facilities may also be used as commercial paper back-up facilities.
The five-year facility also permits the issuance of letters of credit. In
2000, an amount of $25 million was drawn under the five-year facility. This
remained outstanding at March 31, 2002, but was repaid in April 2002.
In November 2001, to fulfill the requirements of Lloyd's for open years of
account, we renewed and increased a syndicated uncollateralized, five-year
letter of credit ("LOC") facility in the amount of (pound)440 million
(approximately $625 million). This facility was originally arranged in
1998.
As our Bermuda-based subsidiaries are not admitted insurers and reinsurers
in the United States, the terms of certain insurance and reinsurance
contracts require them to provide LOCs to clients. ACE Global Markets are
required to satisfy certain United States regulatory trust fund
requirements which can be met by the issuance of LOCs. In August 2001, we
arranged a $450 million unsecured syndicated, one year LOC facility for
general business purposes, including the issuance of insurance and
reinsurance letters of credit. This facility replaced an LOC facility
originally arranged in September 1999 and renewed in September 2000. Usage
under this facility was $421 million at March 31, 2002 compared with $373
million at December 31, 2001. In December 2001, we arranged a $500 million
secured syndicated, one year LOC facility for general business purposes,
including the issuance of insurance and reinsurance letters of credit. This
additional capacity was required to meet the increased requirements for
LOCs arising principally from ACE Tempest Re's growing life reinsurance
operations and U.S. regulatory trust fund requirements of ACE Global
44
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Markets arising from the September 11th tragedy. Usage under this facility
was $130 million at March 31, 2002 and at December 31, 2001. The LOCs
issued under these facilities are principally used to support unpaid losses
and loss expenses already reflected in our balance sheet.
The facilities require that we maintain certain covenants. These covenants
include:
(i) a minimum consolidated net worth covenant of $3.6 billion
plus 25 percent of cumulative net income since March 31, 2000 and;
(ii) maximum debt to total capitalization of 35 percent. Under this
covenant, debt does not include trust preferred securities or
mezzanine equity except where the ratio of the sum of trust preferred
securities and mezzanine equity to total capitalization is greater
than 15 percent. In this circumstance, the surplus greater than 15
percent would be included in the debt to total capitalization ratio.
Our failure to meet these covenants would result in an event of default and we
could be required to repay any outstanding borrowings under these facilities.
The covenants also provide that failure to meet commitments of $25 million or
more under any of these facilities would result in default of the other
facilities.
At March 31, 2002, the minimum consolidated net worth requirement under the
covenant was $3.8 billion and our actual consolidated net worth as
calculated under the covenant was $6.1 billion and our ratio of debt to
total capitalization was 23 percent.
ACE Tempest Re also maintained an uncollateralized, syndicated revolving credit
facility in the amount of $72.5 million, which was guaranteed by us. This
facility expired in February of 2002 and was not renewed. No amounts had been
drawn on this facility.
At March 31, 2002, ACE Guaranty Re Inc. was party to a non-recourse
credit facility which provides up to $150 million specifically designed to
provide rating agency qualified capital to further support ACE Guaranty Re
Inc.'s claims-paying resources. In 2001, the facility's expiry date was
extended to October 2008. ACE Guaranty Re Inc. has not borrowed under this
credit facility.
We provide funds at Lloyd's, primarily in the form of letters of credit, to
support underwriting capacity for Lloyd's syndicate 2488 managed by Lloyd's
managing agencies that we own. Syndicate 2488 has a 2002 capacity of 900
million pounds. We also maintain various other LOC facilities, both
collateralized and uncollateralized, for general corporate purposes. At
March 31, 2002, the aggregate availability under these facilities was $546
million and usage was $445 million.
More information regarding our contractual obligations, commitments and
credit facilities can be found in our consolidated financial statements,
related notes thereto and the Management's Discussion and Analysis of
Results of Operations and Financial Condition included in our Annual Report
on Form 10-K for the year ended December 31, 2001.
MARKET SENSITIVE INSTRUMENTS AND RISK MANAGEMENT
Market risk represents the potential for loss due to adverse changes in the
fair value of financial instruments. We are exposed to potential loss to
various market risks, including changes in interest rates and foreign
currency exchange rates. Our investment portfolio consists of both fixed
income and equity securities, denominated in both U.S. and foreign
currencies, which are sensitive to changes in interest rates, equity prices
and foreign currency exchange rates. Therefore earnings would be effected
by changes in interest rates, equity prices and foreign currency exchange
rates. We use investment derivative instruments such as futures, options,
interest rate swaps, and foreign currency forward contracts for duration
management and management of foreign currency exposures. These instruments
are sensitive to changes in interest rates and foreign currency exchange
rates. The portfolio includes other market sensitive instruments which are
subject to changes in market values, with changes in interest rates.
45
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Duration Management and Market Exposure Management
We utilize financial futures, options, interest rate swaps and foreign
currency forward contracts for the purpose of managing certain investment
portfolio exposures. These instruments are recognized as assets or
liabilities in our consolidated financial statements and changes in market
value are included in net realized gains or losses on investments in the
consolidated statements of operations.
Our exposure to interest rate risk is concentrated in our investment
portfolio, and to a lessor extent, our debt obligations. A hypothetical
adverse parallel shift in the treasury yield curve of 100 basis points
would have resulted in a decrease in total return of 3.1 percent on our
fixed income portfolio for the current quarter compared with 3.2 percent
for the quarter ended December 31, 2001. This equates to a decrease in
market value of approximately $438 million on a fixed income portfolio
valued at $14.3 billion at March 31, 2002, and $452 million on a fixed
income portfolio valued at $14.2 billion at December 31, 2001. An immediate
time horizon was used as this presents the worst case scenario.
Our portfolio of equity securities, which we carry on our balance sheet at
fair value, has exposure to price risk. This risk is defined as the
potential loss in fair value resulting from adverse changes in stock
prices. In addition, we attain exposure to the equity markets through the
use of derivative instruments which also have exposure to price risk. Our
U.S. equity exposure in the portfolio is highly correlated with the
Standard and Poor's 500 index and changes in this index would approximate
the impact on our portfolio. Our international equity portfolio has
exposure to a broad range of non-U.S. equity markets, primarily in those
countries where we have insurance operations. These portfolios are
correlated to movement in each country's broad equity market. The combined
equity exposure through both our equity portfolio and derivative
instruments was valued at $859 million at March 31, 2002. A hypothetical 10
percent decline in the price of each stock in these portfolios and the
index correlated to the derivative instruments would have resulted in an
$86 million decline in fair value. Changes in fair value of these
derivative instruments are recorded as realized gains or losses in the
consolidated statements of operations. Changes in the fair value of our
equity portfolio are recorded as unrealized appreciation (depreciation) and
are included as other comprehensive income in shareholder's equity.
Our exposure to foreign exchange risk is concentrated in our net invested
assets denominated in foreign currencies. Our international operations use
cash flows to purchase these investments to hedge insurance reserves and
other liabilities denominated in the same currencies. At March 31, 2002,
our net asset exposure to foreign currencies was not material.
DERIVATIVES
As of January 1, 2001, we adopted FAS 133 which establishes accounting and
reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts (collectively referred
to as derivatives), and for hedging activities. FAS 133 requires that an
entity recognize all derivatives as either assets or liabilities in the
consolidated balance sheet and measure those instruments at fair value. If
certain conditions are met, a derivative may be specifically designated as
a fair value, cash flow or foreign currency hedge. The accounting for
changes in the fair value of a derivative (that is, gains and losses)
depends on the intended use of the derivative and the resulting
designation. Upon initial application of FAS 133, hedging relationships
must be designated anew and documented pursuant to the provisions of this
statement. As of March 31, 2002, we had no derivatives that were designated
as hedges.
We maintain investments in derivative instruments such as futures, options,
interest rate swaps and foreign currency forward contracts for which the
primary purposes are to manage duration and foreign currency exposure,
yield enhancement or to obtain an exposure to a particular financial
market. We have historically recorded the changes in market value of these
instruments as realized gains or losses in our consolidated statement of
operations and, accordingly, FAS 133, as amended, did not have a
significant impact on the results of operations, financial condition or
liquidity in future periods as it relates to these instruments.
46
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Certain products (principally credit protection oriented) issued by ACE
Financial Services have been determined to meet the definition of a
derivative under FAS 133. These products consist primarily of credit
default swaps, index-based instruments and certain financial guarantee
coverages. Effective January 1, 2001, we record these products at their
fair value, which is determined principally through obtaining quotes from
independent dealers and counterparties.
During the first quarter of 2001 we recorded an expense related to the
cumulative effect of adopting this standard of $23 million, net of income
tax of $12 million. We have recorded in net realized gains (losses) on
investments during the current quarter, a pretax loss of $13 million to
reflect the change in the fair value of derivatives during the quarter. The
level of gains and losses resulting from changes in the fair value of
derivatives on a prospective basis is dependent upon a number of factors
including changes in interest rates, credit spreads and other market
factors. Our involvement with derivative instruments and transactions is
primarily to offer protection to others or to mitigate our own risk and is
not considered speculative in nature.
NEW ACCOUNTING PRONOUNCEMENT
In June 2001, FASB issued FAS 142. FAS 142 primarily addresses the
accounting for goodwill and intangible assets subsequent to their
acquisition. As required, we have adopted FAS 142 on January 1, 2002, and
ceased amortizing goodwill at that time. All goodwill recognized in our
consolidated balance sheet at January 1, 2002 was assigned to one or more
reporting units. Goodwill in each reporting unit should be tested for
impairment by June 30, 2002. Any impairment loss recognized as a result of
a transitional impairment test of goodwill should be reported as the
cumulative effect of a change in accounting principle. There was no
impairment in goodwill recognized on initial adoption.
47
ACE LIMITED
PART II OTHER INFORMATION
ITEM 5. OTHER INFORMATION
- --------------------------
1. On March 1, 2002, the Company declared a quarterly dividend of $0.15
per Ordinary Share payable on April 12, 2002 to shareholders of record
on March 29, 2002.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- -----------------------------------------
1. Reports on Form 8-K
The Company filed a Form 8-K current report (date of earliest event
reported: March 19, 2002) pertaining to an agreement for ACE Limited
to sell in a public offering $500 million of 6% Notes due 2007.
48
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ACE LIMITED
--------------------------------------------
/s/ Brian Duperreault
May 14, 2002 --------------------------------------------
Brian Duperreault
Chairman and Chief
Executive Officer
/s/ Robert A. Blee
May 14, 2002 --------------------------------------------
Robert A. Blee
Chief Accounting Officer
49