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 June 30, 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 August 9, 2002 was 262,403,174.
ACE LIMITED
INDEX TO FORM 10-Q
Part I. FINANCIAL INFORMATION
--------------------- Page No.
--------
Item 1. Financial Statements:
Consolidated Balance Sheets
June 30, 2002 (Unaudited) and December 31, 2001 3
Consolidated Statements of Operations (Unaudited)
Three and Six Months Ended June 30, 2002 and 2001 4
Consolidated Statements of Shareholders' Equity (Unaudited)
Six Months Ended June 30, 2002 and 2001 5
Consolidated Statements of Comprehensive Income (Unaudited)
Six Months Ended June 30, 2002 and 2001 7
Consolidated Statements of Cash Flows (Unaudited)
Six Months Ended June 30, 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 31
Part II. OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings 71
Item 4. Submission of Matters to a Vote of Security Holders 71
Item 5. Other Information 71
Item 6. Exhibits and Reports on Form 8-K 72
2
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30 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 - $12,535,308 and $12,794,444) $ 12,833,569 $ 13,000,165
Equity securities, at fair value (cost - $566,666 and $516,028) 462,075 467,566
Securities on loan, at fair value (cost - $411,023 and $0) 410,636 -
Short-term investments, at fair value 1,774,437 1,205,795
Other investments, (cost - $601,090 and $569,045) 628,234 591,006
Cash 877,779 671,381
------------ ------------
Total investments and cash 16,986,730 15,935,913
Accrued investment income 194,505 213,821
Insurance and reinsurance balances receivable 3,181,242 2,521,562
Accounts and notes receivable 248,916 242,724
Reinsurance recoverable 11,636,647 11,398,446
Deferred policy acquisition costs 781,264 679,281
Prepaid reinsurance premiums 1,373,065 1,222,795
Goodwill 2,716,513 2,772,094
Deferred tax assets 1,188,405 1,250,835
Other assets 1,015,929 949,293
------------ ------------
Total assets $ 39,323,216 $ 37,186,764
============ ============
Liabilities
Unpaid losses and loss expenses $ 20,661,359 $ 20,728,122
Future policy benefits for life and annuity contracts 392,625 382,730
Unearned premiums 4,936,803 3,853,429
Premiums received in advance 53,711 57,486
Insurance and reinsurance balances payable 1,708,094 1,418,001
Contract holder deposit funds 90,660 101,187
Securities lending collateral 419,446 -
Accounts payable, accrued expenses and other liabilities 1,619,847 1,466,127
Dividends payable 47,647 42,044
Short-term debt 224,364 495,408
Long-term debt 1,798,803 1,349,473
Trust preferred securities 675,000 875,000
------------ ------------
Total liabilities 32,628,359 30,769,007
------------ ------------
Commitments and contingencies
Mezzanine equity 311,050 311,050
------------ ------------
Shareholders' equity
Ordinary Shares ($0.041666667 par value, 500,000,000 shares authorized;
262,247,758 and 259,861,205 shares issued and outstanding) 10,927 10,828
Additional paid-in capital 3,775,079 3,710,698
Unearned stock grant compensation (52,289) (37,994)
Retained earnings 2,526,584 2,321,576
Deferred compensation obligation 18,850 16,497
Accumulated other comprehensive income 123,506 101,599
Ordinary Shares issued to employee trust (18,850) (16,497)
------------ ------------
Total shareholders' equity 6,383,807 6,106,707
------------ ------------
Total liabilities, mezzanine equity and shareholders' equity $ 39,323,216 $ 37,186,764
============ ============
See accompanying notes to the interim consolidated financial statements
3
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the three and six months ended June 30, 2002 and 2001
(Unaudited)
Three Months Ended Six Months Ended
June 30 June 30
2002 2001 2002 2001
------------ ------------ ------------ ------------
(in thousands of U.S. dollars, except per share data)
Revenues
Gross premiums written
Property and casualty premiums $ 2,901,242 $ 2,372,622 $ 5,990,190 $ 4,933,320
Life and annuity premiums 27,713 30,039 56,911 30,979
------------ ------------ ------------ ------------
2,928,955 2,402,661 6,047,101 4,964,299
Reinsurance premiums ceded (1,053,577) (932,016) (2,185,695) (1,758,536)
------------ ------------ ------------ ------------
Net premiums written
Property and casualty premiums 1,848,707 1,440,606 3,806,456 3,174,784
Life and annuity premiums 26,671 30,039 54,950 30,979
------------ ------------ ------------ ------------
1,875,378 1,470,645 3,861,406 3,205,763
Change in unearned premiums (299,671) (85,458) (925,890) (451,460)
------------ ------------ ------------ ------------
Net premiums earned
Property and casualty premiums 1,549,398 1,355,148 2,880,795 2,723,324
Life and annuity premiums 26,309 30,039 54,721 30,979
------------ ------------ ------------ ------------
1,575,707 1,385,187 2,935,516 2,754,303
Net investment income 200,804 196,267 400,939 400,697
Other income (expense) (12,068) 1,088 (7,269) 2,685
Net realized gains (losses) on investments (139,721) 15,564 (165,602) (3,811)
------------ ------------ ------------ ------------
Total revenues 1,624,722 1,598,106 3,163,584 3,153,874
------------ ------------ ------------ ------------
Expenses
Losses and loss expenses 960,949 954,841 1,814,094 1,906,134
Life and annuity benefits 23,311 28,152 46,307 28,805
Policy acquisition costs 234,208 187,640 432,003 354,330
Administrative expenses 229,726 208,194 426,929 403,084
Interest expense 51,952 49,640 97,954 103,964
Amortization of goodwill - 19,872 - 39,752
------------ ------------ ------------ ------------
Total expenses 1,500,146 1,448,339 2,817,287 2,836,069
------------ ------------ ------------ ------------
Income before income tax and cumulative effect
of adopting a new accounting standard 124,576 149,767 346,297 317,805
Income tax expense 20,676 18,250 44,592 45,224
------------ ------------ ------------ ------------
Income before cumulative effect of adopting a
new accounting standard 103,900 131,517 301,705 272,581
Cumulative effect of adopting a new accounting
standard (net of income tax) - - - (22,670)
------------ ------------ ------------ ------------
Net income $ 103,900 $ 131,517 $ 301,705 $ 249,911
============ ============ ============ ============
Basic earnings per share before cumulative effect
of adopting a new accounting standard $ 0.37 $ 0.54 $ 1.11 $ 1.12
============ ============ ============ ============
Basic earnings per share $ 0.37 $ 0.54 $ 1.11 $ 1.02
============ ============ ============ ============
Diluted earnings per share before cumulative
effect of adopting a new accounting standard $ 0.36 $ 0.52 $ 1.06 $ 1.07
============ ============ ============ ============
Diluted earnings per share
$ 0.36 $ 0.52 $ 1.06 $ 0.98
============ ============ ============ ============
See accompanying notes to the interim consolidated financial statements
4
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the six months ended June 30, 2002 and 2001
(Unaudited)
2002 2001
------------ ------------
(in thousands of U.S. dollars)
Ordinary Shares
Balance - beginning of period $ 10,828 $ 9,681
Shares issued 35 7
Exercise of stock options 74 35
Issued under Employee Stock Purchase Plan (ESPP) 5 4
Cancellation of Shares (15) (21)
Repurchase of Shares - (63)
----------- ------------
Balance - end of period 10,927 9,643
----------- ------------
Additional paid-in capital
Balance - beginning of period 3,710,698 2,637,084
Ordinary Shares issued 35,598 2,567
Exercise of stock options 37,466 16,439
Ordinary Shares issued under ESPP 3,739 2,806
Cancellation of Ordinary Shares (12,422) (13,522)
Repurchase of Ordinary Shares - (17,195)
----------- ------------
Balance - end of period 3,775,079 2,628,179
----------- ------------
Unearned stock grant compensation
Balance - beginning of period (37,994) (29,642)
Stock grants awarded (37,313) (18,474)
Stock grants forfeited 6,111 133
Amortization 16,907 4,541
----------- ------------
Balance - end of period (52,289) (43,442)
----------- ------------
Retained earnings
Balance - beginning of period 2,321,576 2,733,633
Net income 301,705 249,911
Dividends declared on Ordinary Shares (83,867) (64,797)
Dividends declared on FELINE PRIDES (12,830) (12,763)
Repurchase of Ordinary Shares - (32,422)
----------- ------------
Balance - end of period 2,526,584 2,873,562
----------- ------------
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 six months ended June 30, 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 22,695 (4,846)
Balance - end of period ------------ -----------
159,611 97,489
------------ -----------
Cumulative translation adjustments
Balance - beginning of period (35,317) (32,881)
Change in period, net of tax (788) (7,712)
------------ -----------
Balance - end of period (36,105) (40,593)
------------ -----------
Accumulated other comprehensive 123,506 56,896
income ------------ -----------
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 $ 6,383,807 $ 5,524,838
============ ===========
See accompanying notes to the interim consolidated financial statements
6
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the six months ended June 30, 2002 and 2001
(Unaudited)
2002 2001
------------ ------------
(in thousands of U.S. dollars)
Net income $ 301,705 $ 249,911
Other comprehensive income (loss)
Net unrealized appreciation
(depreciation) on investments
Unrealized appreciation (depreciation) on investments 29,633 11,100
Less: reclassification adjustment for net realized
(gains) losses included in net income 14,874 (9,167)
---------- ----------
44,507 1,933
Cumulative translation adjustments (358) (15,965)
---------- ----------
Other comprehensive income (loss), before income tax 44,149 (14,032)
Income tax benefit (expense) related to other comprehensive
income items (22,242) 1,474
---------- ----------
Other comprehensive income (loss) 21,907 (12,558)
---------- ----------
Comprehensive income $ 323,612 $ 237,353
========== ==========
See accompanying notes to the interim consolidated financial statements
7
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the six months ended June 30, 2002 and 2001
(Unaudited)
2002 2001
------------ ------------
(in thousands of U.S. dollars)
Cash flows from operating activities
Net income $ 301,705 $ 249,911
Adjustments to reconcile net income to net cash provided by
operating activities:
Unpaid losses and loss expenses, net of reinsurance
recoverable (315,530) 154,694
Future policy benefits for life and annuity contracts 8,021 28,881
Unearned premiums 1,070,943 686,575
Prepaid reinsurance premiums (150,270) (224,703)
Deferred income taxes 39,735 16,107
Net realized losses on investments 119,929 3,811
Amortization of premium/discounts on fixed maturities 17,563 (3,534)
Deferred policy acquisition costs (98,525) (90,373)
Insurance and reinsurance balances receivable (666,713) (333,000)
Premiums received in advance (3,775) 1,876
Insurance and reinsurance balances payable 287,278 33,422
Accounts payable, accrued expenses and other liabilities (8,353) (52,737)
Other (30,913) (60,007)
Cumulative effect of adopting a new accounting standard - 22,670
Amortization of goodwill - 39,752
----------- -----------
Net cash flows from operating activities $ 571,095 $ 473,345
----------- -----------
Cash flows from investing activities
Purchases of fixed maturities (8,712,886) (7,689,345)
Purchases of equity securities (128,903) (115,970)
Sales of fixed maturities 8,373,776 7,383,010
Sales of equity securities 84,287 113,672
Maturities of fixed maturities 139,875 24,000
Net realized losses on financial futures contracts (60,800) (17,695)
Acquisition of subsidiaries, net of cash acquired 54,728 -
Other (43,250) (37,246)
----------- -----------
Net cash used for investing activities $ (293,173) $ (339,574)
----------- -----------
Cash flows from financing activities
Dividends paid on Ordinary Shares (78,264) (60,070)
Dividends paid on FELINE PRIDES (12,830) (12,835)
Net proceeds from (repayment of) short-term debt (271,044) 38,780
Repayment of trust preferred securities (200,000) -
Proceeds from exercise of options for Ordinary Shares 37,540 16,474
Proceeds from shares issued under ESPP 3,744 2,810
Proceeds from long-term debt 449,330 -
Repurchase of Ordinary Shares - (49,680)
----------- -----------
Net cash used for financing activities $ (71,524) $ (64,521)
----------- -----------
Net increase in cash 206,398 69,250
Cash - beginning of period 671,381 608,069
----------- -----------
Cash - end of period $ 877,779 $ 677,319
=========== ===========
See accompanying notes to the interim consolidated financial statements
8
ACE LIMITED AND SUBSIDIARIES
Notes to 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. During the first quarter of 2002, 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 six months ended June 30, 2002 and 2001. Allocations
have been made on the basis of location of risk:
Six Months North Australia & Asia
Ended America Europe New Zealand Pacific Latin America
June 30, 2002 62% 24% 2% 8% 4%
June 30, 2001 58% 25% 2% 9% 6%
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. FAS 142 requires that goodwill in each reporting unit 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. Management has
determined that there was no impairment in goodwill as a result of the
test. As discussed in Note 14 "Segment information", we do not allocate
assets to our new segments, therefore, changes in goodwill are not
disclosed by segment. The following table details the movement in goodwill
during the six months ended June 30, 2002. The reduction in goodwill is
primarily a result of the settlement of a lawsuit involving a prior
acquisition.
ACE
Consolidated
--------------
Goodwill at beginning of year $ 2,772,094
Adjustment to purchased goodwill (55,581)
--------------
Goodwill at end of year $ 2,716,513
==============
9
ACE LIMITED AND SUBSIDIARIES
Notes to interim consolidated Financial Statements (cont'd)
(Unaudited)
The following table provides a reconciliation of prior year reported net income
to adjusted net income had FAS 142 been applied at the beginning of fiscal 2001:
Three Months Ended Six Months Ended
June 30 June 30
2002 2001 2002 2001
------------ ------------ ------------ ------------
(in thousands of U.S. dollars, except per share data)
Reported net income $ 103,900 $ 131,517 $ 301,705 $ 249,911
Add back: Goodwill amortization - 19,872 - 39,752
---------- ---------- ---------- ==========
Adjusted net income $ 103,900 $ 151,389 $ 301,705 $ 289,663
========== ========== ========== ==========
Basic earnings per share:
Reported earnings per share $ 0.37 $ 0.54 $ 1.11 $ 1.02
Add back: Goodwill amortization - 0.09 - 0.17
---------- ---------- ---------- ----------
Adjusted earning per share $ 0.37 $ 0.63 $ 1.11 $ 1.19
========== ========== ========== ==========
Diluted earnings per share:
Reported earnings per share $ 0.36 $ 0.52 $ 1.06 $ 0.98
Add back: Goodwill amortization - 0.08 - 0.16
---------- ---------- ---------- ----------
Adjusted earning per share $ 0.36 $ 0.60 $ 1.06 $ 1.14
========== ========== ========== ==========
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 changes. 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 $419 million is recorded in short-term investments and in liabilities. The
fair value of the securities on loan of $411 million at June 30, 2002 is
reported on a separate line in total investments and cash. 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.
10
ACE LIMITED AND SUBSIDIARIES
Notes to interim consolidated Financial Statements (cont'd)
(Unaudited)
5. Restricted stock awards
Under the Company's long-term incentive plans, 832,150 restricted Ordinary
Shares were awarded during the six months ended June 30, 2002, to officers of
the Company and its subsidiaries. These shares vest at various dates through
June 2006. In addition, during the period, 12,588 restricted Ordinary Shares
were awarded to outside directors under the terms of the 1995 Outside
Directors Plan. These shares vest in May 2003.
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.
6. Earnings per share
The following table sets forth the computation of basic and diluted earnings
per share:
Three Months Ended Six Months Ended
June 30 June 30
2002 2001 2002 2001
------------ ------------ ------------ ------------
(in thousands of U.S. dollars, except per share data)
<s> <c> <c> <c> <c>
Numerator:
Net income before cumulative effect of adopting
a new accounting standard $ 103,900 $ 131,517 $ 301,705 $ 272,581
Dividends on FELINE PRIDES (6,415) (6,415) (12,830) (12,763)
------------ ------------ ------------ ------------
Net income available to holders of Ordinary
Shares before cumulative effect 97,485 125,102 288,875 259,818
Cumulative effect of adopting a new accounting
standard - - - (22,670)
------------ ------------ ------------ ------------
Net income available to holders of Ordinary
Shares $ 97,485 $ 125,102 $ 288,875 $ 237,148
============ ============ ============ ============
Denominator:
Denominator for basic earnings per share:
Weighted average shares outstanding 259,863,879 231,175,889 259,460,287 231,790,182
Dilutive effect of FELINE PRIDES 3,416,695 3,256,112 3,758,796 3,326,176
Effect of other dilutive securities 7,900,655 6,695,811 8,030,284 6,785,925
------------ ------------ ------------ ------------
Denominator for diluted earnings per share:
Adjusted weighted average shares outstanding
and assumed conversions 271,181,229 241,127,812 271,249,367 241,902,283
============ ============ ============ ============
Basic earnings per share:
Earnings per share before cumulative effect
of adopting a new accounting standard $ 0.37 $ 0.54 $ 1.11 $ 1.12
============ ============ ============ ============
Earnings per share $ 0.37 $ 0.54 $ 1.11 $ 1.02
============ ============ ============ ============
Diluted earnings per share:
Earnings per share before cumulative effect
of adopting a new accounting standard $ 0.36 $ 0.52 $ 1.06 $ 1.07
============ ============ ============ ============
Earnings per share $ 0.36 $ 0.52 $ 1.06 $ 0.98
============ ============ ============ ============
11
ACE LIMITED AND SUBSIDIARIES
Notes to interim consolidated Financial Statements (cont'd)
(Unaudited)
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, $25 million was drawn
under the five-year facility 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. No amounts had been
drawn on this facility.
At June 30, 2002, ACE Guaranty Re Inc. was party to a 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.
8. Debt
The following table outlines the Company's consolidated debt position at June
30, 2002 and December 31, 2001:
June 30 December 31
2002 2001
------------ -------------
(in millions of U.S. dollars)
<s> <c> <c>
Short-term debt
ACE INA commercial paper $ 149 $ -
ACE Financial Services Debentures due 2002 75 75
ACE Financial Services Note - 25
Reverse Repurchase Agreements - 395
------- -------
$ 224 $ 495
======= =======
Long-term debt
ACE INA Notes due 2004 $ 400 $ 400
ACE INA Notes due 2006 300 299
ACE Limited Senior Notes due 2007 499 -
ACE US Holdings Senior Notes due 2008 250 250
ACE INA Subordinated Notes due 2009 250 300
ACE INA Debentures due 2029 100 100
------- -------
$ 1,799 $ 1,349
======= =======
Trust Preferred Securities
ACE INA RHINO Preferred Securities due 2002 $ 200 $ 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
------- --------
$ 675 $ 875
======= ========
12
ACE LIMITED AND SUBSIDIARIES
Notes to interim consolidated Financial Statements (cont'd)
(Unaudited)
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 first quarter of 2002 using proceeds from commercial
paper raised during that quarter. In addition, the Company repaid $150
million of expiring commercial paper and the $25 million ACE Financial
Services bank note. The average cost of borrowing using commercial paper
was 2.0 percent for the three and six months ended June 30, 2002.
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.
c) ACE INA subordinated notes
In 1999, ACE INA issued $300 million 11.2 percent unsecured subordinated notes
maturing in December 2009. The subordinated notes are callable subject to
certain call premiums. During the quarter, the Company repaid $50 million of
these notes and incurred debt prepayment expense of $11 million ($7 million, net
of tax), which is reported as other expenses in the statement of operations.
d) ACE INA RHINO preferred securities
In 1999, ACE RHINOS Trust sold in a private placement, $400 million of
Auction Rate Reset Preferred Securities ("Preferred Securities"). The sole
assets of the Trust consist of $412 million of Auction Rate Reset
Subordinated Notes Series A ("Subordinated Notes") issued by ACE INA.
Proceeds of the Ordinary Share Offering of September 12, 2000 which was
completed in satisfaction of a related agreement with Bank of America
Securities, were used to support our guarantee of the Subordinated Notes.
During the quarter the Company repaid $200 million in principal amount of
Preferred Securities. The Company also expects to repay the remaining $200
million of these Preferred Securities during the quarter ending
September 30, 2002.
9. Mezzanine Equity
In April 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
13
ACE LIMITED AND SUBSIDIARIES
Notes to interim consolidated Financial Statements (cont'd)
(Unaudited)
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 and six months ended June 30, 2002 and 2001 are as follows:
Three Months Ended Six Months Ended
June 30 June 30
2002 2001 2002 2001
------------- ------------- ------------- -------------
(in thousands of U.S. dollars)
<s> <c> <c> <c> <c>
Premiums written
Direct $ 2,347,328 $ 1,968,344 $ 4,462,455 $ 3,774,443
Assumed 581,627 434,317 1,584,646 1,189,856
Ceded (1,053,577) (932,016) (2,185,695) (1,758,536)
------------- ------------ ------------- -------------
Net premiums written $ 1,875,378 $ 1,470,645 $ 3,861,406 $ 3,205,763
============= ============ ============= =============
Premiums earned
Direct $ 2,130,803 $ 1,900,568 $ 3,842,723 $ 3,378,991
Assumed 517,318 422,007 1,088,396 915,695
Ceded (1,072,414) (937,388) (1,995,603) (1,540,383)
------------- ------------ ------------- -------------
Net premiums earned $ 1,575,707 $ 1,385,187 $ 2,935,516 $ 2,754,303
============= ============ ============= =============
14
ACE LIMITED AND SUBSIDIARIES
Notes to interim consolidated Financial Statements (cont'd)
(Unaudited)
The composition of the Company's reinsurance recoverable at June 30, 2002 and
December 31, 2001, is as follows:
June 30 December 31
2002 2001
-------------- -------------
(in thousands of U.S. dollars)
<s> <c> <c>
Reinsurance recoverable on paid losses and loss expenses $ 1,253,378 $ 1,066,495
Reinsurance recoverable on unpaid losses and loss expenses 11,180,944 11,120,888
------------ -------------
Total reinsurance recoverable 12,434,322 12,187,383
Bad debt provision (797,675) (788,937)
------------ -------------
Net reinsurance recoverable $ 11,636,647 $ 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 provision 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, including those related to asbestos and environmental
pollution. Provisions 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.
15
ACE LIMITED AND SUBSIDIARIES
Notes to interim consolidated Financial Statements (cont'd)
(Unaudited)
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.
The income tax provision for the three and six months ended June 30, 2002 and 2001 is as follows:
Three Months Ended Six Months Ended
June 30 June 30
2002 2001 2002 2001
----------- ------------ ------------ ------------
(in thousands of U.S. dollars)
<s> <c> <c> <c> <c>
Current tax expense $ 5,370 $ 6,669 $ 4,857 $ 29,117
Deferred tax expense 15,306 11,581 39,735 16,107
----------- ----------- ----------- -----------
Provision for income taxes $ 20,676 $ 18,250 $ 44,592 $ 45,224
=========== =========== =========== ===========
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 and six months ended June 30, 2002 and 2001, is provided
below.
Three Months Ended Six Months Ended
June 30 June 30
2002 2001 2002 2001
------------ ------------ ------------- -------------
(in thousands of U.S. dollars)
<s> <c> <c> <c> <c>
Expected tax provision at weighted
average rate $ 19,237 $ 11,856 $ 43,792 $ 35,969
Permanent differences
Tax-exempt interest (2,939) (3,806) (7,082) (7,641)
Goodwill - 4,458 - 8,913
Other 586 2,248 561 1,163
Net withholding taxes 3,792 3,494 7,321 6,820
----------- ----------- ------------ -----------
Provision for income taxes $ 20,676 $ 18,250 $ 44,592 $ 45,224
=========== =========== ============ ===========
16
ACE LIMITED AND SUBSIDIARIES
Notes to interim consolidated Financial Statements (cont'd)
(Unaudited)
The components of the net deferred tax asset at June 30, 2002 and December 31,
2001 are as follows:
June 30 December 31
2002 2001
--------------- ---------------
(in thousands of U.S. dollars)
Deferred tax assets
Loss reserve discount $ 497,255 $ 523,195
Foreign tax credits 150,742 155,079
Policyholder dividends 48,054 47,509
Net operating loss carry forward 479,026 495,048
Other 282,754 299,068
------------ ------------
Total deferred tax assets 1,457,831 1,519,899
------------ ------------
Deferred tax liabilities
Deferred policy acquisition costs 51,934 66,454
Unrealized appreciation on investments 58,726 28,570
Other 23,174 38,448
------------ ------------
Total deferred tax liabilities 133,834 133,472
------------ ------------
Valuation allowance 135,592 135,592
------------ ------------
Net deferred tax asset $ 1,188,405 $ 1,250,835
============ ============
The valuation allowance 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 June 30, 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.
17
ACE LIMITED AND SUBSIDIARIES
Notes to interim consolidated Financial Statements (cont'd)
(Unaudited)
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 June 30, 2002
and December 31, 2001 and for the three and six months ended June 30, 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.
Condensed Consolidating Balance Sheet as at June 30, 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
---------- ------- ------- ---------------- -------------- ------------
<s> <c> <c> <c> <c> <c> <c>
Assets
Total investments and cash $ 354,545 $ 6,856,881 $ 956,397 $ 8,818,907 $ - $ 16,986,730
Insurance and reinsurance
balances receivable - 1,999,622 24,329 1,157,291 - 3,181,242
Reinsurance recoverable - 9,362,078 815 2,273,754 - 11,636,647
Goodwill - 2,130,561 96,723 489,229 - 2,716,513
Investments in subsidiaries 6,654,784 - 152,000 (152,000) (6,654,784) -
Due from subsidiaries and
affiliates, net 235,453 (139,236) (49,159) 188,395 (235,453) -
Other assets 38,463 3,330,542 212,131 1,250,948 - 4,802,084
----------- ----------- ----------- ----------- ------------ ------------
Total assets $ 7,283,245 $23,510,448 $ 1,393,236 $14,026,524 $ (6,890,237) $ 39,323,216
=========== =========== =========== =========== ============ ============
Liabilities
Unpaid losses and loss expenses $ - $14,182,277 $ 75,426 $ 6,403,656 $ - $ 20,661,359
Future policy benefits for life
and annuity contracts - - - 392,625 - 392,625
Unearned premiums - 2,642,874 343,241 1,950,688 - 4,936,803
Short-term debt - 149,365 - - - 224,364
Long-term debt 499,197 1,049,606 74,999 250,000 - 1,798,803
Trust preferred securities - 600,000 75,000 - - 675,000
Other liabilities 89,191 2,425,120 130,055 1,295,039 - 3,939,405
----------- ------------ ----------- ----------- ------------ ------------
Total liabilities 588,388 21,049,242 698,721 10,292,008 - 32,628,359
----------- ------------ ----------- ----------- ------------ ------------
Mezzanine equity 311,050 - - - - 311,050
----------- ------------ ----------- ----------- ------------ ------------
Total shareholders' equity 6,383,807 2,416,206 694,515 3,734,516 (6,890,237) 6,383,807
----------- ------------ ----------- ----------- ------------ ------------
Total liabilities, mezzanine
equity and shareholders' equity $ 7,283,245 $23,510,448 $ 1,393,236 $14,026,524 $ (6,890,237) $ 39,323,216
=========== ============ =========== =========== ============ ============
(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 interim consolidated Financial Statements (cont'd)
(Unaudited)
Condensed Consolidating Balance Sheet as at December 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
---------- ------- ------- ---------------- -------------- ------------
<s> <c> <c> <c> <c> <c> <c>
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 - - 25,000 395,428 - 495,408
Long-term debt - 1,099,473 74,980 250,000 - 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.
19
ACE LIMITED AND SUBSIDIARIES
Notes to interim consolidated Financial Statements (cont'd)
(Unaudited)
Condensed Consolidating Statement of Operations
For the three months ended June 30, 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
---------- ------- ------- ---------------- -------------- ------------
<s> <c> <c> <c> <c> <c> <c>
Net premiums written $ - $ 988,125 $ 34,882 $ 852,371 $ - $ 1,875,378
Net premiums earned - 759,974 26,708 789,025 - 1,575,707
Net investment income 12,626 80,066 11,961 88,213 7,938 200,804
Other income (expenses) - (11,071) - (997) - (12,068)
Equity in earnings of subsidiaries 148,903 - - - (148,903) -
Net realized gains (losses) on
investments (29,959) (8,680) (23,762) (77,320) - (139,721)
Losses and loss expenses - 526,724 3,113 431,112 - 960,949
Life and annuity benefits - - - 23.311 - 23,311
Policy acquisition costs and
administrative expenses 18,985 208,972 12,709 224,149 (881) 463,934
Interest expense 6,436 39,006 3,238 5,415 (2,143) 51,952
Income tax expense 2,249 14,194 (3,789) 8,022 - 20,676
---------- ----------- ----------- ----------- ----------- -----------
Net income (loss) $ 103,900 $ 31,393 $ (364) $ 106,912 $ (137,941) $ 103,900
========== =========== =========== =========== =========== ===========
Condensed Consolidating Statement of Operations
For the three months ended June 30, 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
---------- ------- ------- ---------------- -------------- ------------
<s> <c> <c> <c> <c> <c> <c>
Net premiums written $ - $ 609,595 $ 28,171 $ 832,879 $ - $ 1,470,645
Net premiums earned - 619,706 19,501 745,980 - 1,385,187
Net investment income 13,741 88,208 11,485 89,716 (6,883) 196,267
Other income - - - 1,088 - 1,088
Equity in earnings of subsidiaries 134,832 - - - (134,832) -
Net realized gains (losses) on
investments - (26,800) 17,354 25,010 - 15,564
Losses and loss expenses - 445,435 2,960 506,446 - 954,841
Life and annuity benefits - - - 28,152 - 28,152
Policy acquisition costs and
administrative expenses 17,417 185,087 9,227 184,500 (397) 395,834
Amortization of goodwill - 14,490 1,051 4,331 - 19,872
Interest expense (2,417) 44,529 3,275 5,319 (1,066) 49,640
Income tax expense 2,056 519 7,548 8,127 - 18,250
--------- ------------ ---------- ------------ ----------- -----------
Net income (loss) $ 131,517 $ (8,946) $ 24,279 $ 124,919 $ (140,252) $ 131,517
========= ============ ========== ============ =========== ===========
(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 interim consolidated Financial Statements (cont'd)
(Unaudited)
Condensed Consolidating Statement of Operations
For the six months ended June 30, 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
---------- ------- ------- ---------------- -------------- ------------
<s> <c> <c> <c> <c> <c> <c>
Net premiums written $ - $ 1,811,219 $ 45,750 $ 2,004,437 $ - $ 3,861,406
Net premiums earned - 1,369,461 48,416 1,517,639 - 2,935,516
Net investment income 29,076 160,252 23,451 206,889 (18,729) 400,939
Other income (expense) - (11,071) - 3,802 - (7,269)
Equity in earnings of subsidiaries 340,953 - - - (340,953) -
Net realized gains (losses) on
investments (22,684) (34,473) (18,921) (89,524) - (165,602)
Losses and loss expenses - 948,173 5,842 860,079 - 1,814,094
Life and annuity benefits - - - 46,307 - 46,307
Policy acquisition costs and
administrative expenses 33,089 372,142 23,277 432,186 (1,762) 858,932
Interest expense 8,126 80,632 6,547 9,255 (6,606) 97,954
Income tax expense 4,425 26,145 1,439 12,583 - 44,592
----------- ----------- ---------- ----------- ---------- -----------
Net income $ 301,705 $ 57,077 $ 15,841 $ 278,396 $ (351,314) $ 301,705
=========== =========== ========== =========== ========== ===========
Condensed Consolidating Statement of Operations
For the six months ended June 30, 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
---------- ------- ------- ---------------- -------------- ------------
<s> <c> <c> <c> <c> <c> <c>
Net premiums written $ - $ 1,209,775 $ 43,438 $ 1,952,550 $ - $ 3,205,763
Net premiums earned - 1,124,412 38,361 1,591,530 - 2,754,303
Net investment income 27,410 187,154 23,663 175,983 (13,513) 400,697
Other income - - - 2,685 - 2,685
Equity in earnings of subsidiaries 251,560 - - - (251,560) -
Net realized gains (losses) on
investments - (29,953) 23,658 2,484 - (3,811)
Losses and loss expenses - 791,235 5,776 1,109,123 - 1,906,134
Life and annuity benefits - - - 28,805 - 28,805
Policy acquisition costs and 19,276
administrative expenses 30,262 350,567 357,706 (397) 757,414
Amortization of goodwill - 28,980 2,102 8,670 - 39,752
Interest expense (5,248) 93,432 6,646 11,205 (2,071) 103,964
Income tax expense 4,045 14,325 14,752 12,102 - 45,224
----------- ----------- ---------- ----------- ---------- -----------
Income before cumulative effect of
adopting a new accounting standard 249,911 3,074 37,130 245,071 (262,605) 272,581
Cumulative effect of adopting a new
accounting standard (net of
income tax) - (50) (22,800) 180 - (22,670)
----------- ----------- ---------- ----------- ---------- -----------
Net income $ 249,911 $ 3,024 $ 14,330 $ 245,251 $ (262,605) $ 249,911
=========== =========== ========== =========== ========== ===========
(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 interim consolidated Financial Statements (cont'd)
(Unaudited)
Condensed Consolidating Statement of Cash Flows
For the six months ended June 30, 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
---------- ------- ------- ---------------- -------------- ------------
<s> <c> <c> <c> <c> <c> <c>
Net cash flows from (used for)
operating activities $ (105,282) $ (112,983) $ 23,392 $ 765,968 $ - $ 571,095
---------- ------------ ----------- ----------- ---------- ------------
Cash flows from investing activities
Purchases of fixed maturities 1,705 (1,151,900) (325,832) (7,236,859) - (8,712,886)
Purchases of equity securities - (45,513) - (83,390) - (128,903)
Sales of fixed maturities 73,708 1,065,093 289,961 6,945,014 - 8,373,776
Sales of equity securities - 44,234 - 40,053 - 84,287
Maturities of fixed maturities - - - 139,875 - 139,875
Net realized gains (losses) on
financial futures contracts - - - (60,800) - (60,800)
Acquisition of subsidiaries - - - 54,728 - 54,728
Other - - 3,537 (46,787) - (43,250)
---------- ------------ ----------- ----------- ---------- ------------
Net cash from (used for) investing
activities $ 75,413 $ (88,086) $ (32,334) $ (248,166) $ - $ (293,173)
---------- ------------ ----------- ----------- ---------- ------------
Cash flows from financing activities
Dividends paid on Ordinary Shares (78,264) - - - - (78,264)
Dividends paid on FELINE
PRIDES (12,830) - - - - (12,830)
Proceeds from short term debt - (375,436) (25,000) 129,393 - (271,044)
Proceeds from long term debt 499,155 (50,000) - 175 - 449,330
Advances to (from) affiliates 224,052 - 9,847 (233,899) - -
Proceeds from exercise of options
for Ordinary Shares 37,540 - - - - 37,540
Proceeds from shares issued under
ESPP 3,744 - - - - 3,744
Repayment of trust preferred
securities - (200,000) - - - (200,000)
Capitalization of subsidiary (869,276) 916,852 25,000 (72,576) - -
Dividends received from subsidiaries 195,000 - - (195,000) - -
---------- ------------ ----------- ---------- ---------- ------------
Net cash used for financing
activities $ (879) $ 291,416 $ 9,847 $ (371,908) $ - $ (71,524)
---------- ------------ ----------- ---------- ---------- ------------
Net increase in cash (30,748) 90,347 905 145,894 - 206,398
---------- ------------ ----------- ---------- ---------- ------------
Cash - beginning of period 32,525 355,327 1,027 282,502 - 671,381
---------- ------------ ----------- ---------- ---------- ------------
Cash - end of period $ 1,777 $ 445,674 $ 1,932 $ 428,396 $ - $ 877,779
========== ============ =========== ========== ========== ============
(1) Includes all other subsidiaries of ACE Limited and intercompany eliminations.
(2) Includes ACE Limited parent company eliminations.
22
ACE LIMITED AND SUBSIDIARIES
Notes to interim consolidated Financial Statements (cont'd)
(Unaudited)
Condensed Consolidating Statement of Cash Flows
For the six months ended June 30, 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
---------- ------- ------- ---------------- -------------- ------------
<s> <c> <c> <c> <c> <c> <c>
Net cash flows from (used for) $ (9,708) $ (460,163) $ 59,043 $ 884,173 $ - $ 473,345
Operating activities ----------- ----------- ----------- ------------- ---------- ------------
Cash flows from investing activities
Purchases of fixed maturities (13,988) (1,067,197) (498,929) (6,109,231) - (7,689,345)
Purchases of equity securities - (69,294) - (46,676) - (115,970)
Sales of fixed maturities - 1,528,351 466,513 5,388,146 - 7,383,010
Sales of equity securities - 76,346 37,326 - 113,672
Maturities of fixed maturities - - 4,500 19,500 - 24,000
Net realized gains (losses) on
financial futures contracts - - - (17,695) - (17,695)
Other 833 (3,372) - (34,707) - (37,246)
----------- ----------- ----------- ------------- ---------- ------------
Net cash from (used for) investing
activities $ (13,155) $ 464,834 $ (27,916) $ (763,337) $ - $ (339,574)
----------- ----------- ----------- ------------- ---------- ------------
Cash flows from financing activities
Dividends paid on Ordinary Shares (60,070) - - - - (60,070)
Dividends paid on FELINE PRIDES (12,835) - - - - (12,835)
Proceeds from short term debt, net - 38,784 - (4) - 38,780
Advances to affiliates (129,405) - - 129,405 - -
Proceeds from exercise of options
for Ordinary Shares 16,474 - - - - 16,474
Proceeds from shares issued under
ESPP 2,810 - - - - 2,810
Repurchase of Ordinary Shares (49,680) - - - - (49,680)
Dividends received from subsidiaries 223,691 - - (223,691) - -
----------- ----------- ----------- ------------- ---------- ------------
Net cash from (used for) financing
activities $ (9,015) $ 38,784 $ - $ (94,290) $ - $ (64,521)
----------- ----------- ----------- ------------- ---------- ------------
Net increase (decrease) in cash (31,878) 43,455 31,127 26,546 - 69,250
Cash - beginning of period 46,516 253,447 26,576 281,530 - 608,069
----------- ----------- ----------- ------------- ---------- ------------
Cash - end of period $ 14,638 $ 296,902 $ 57,703 $ 308,076 $ - $ 677,319
=========== =========== =========== ============= ========== ============
(1) Includes all other subsidiaries of ACE Limited and intercompany eliminations.
(2) Includes ACE Limited parent company eliminations.
23
ACE LIMITED AND SUBSIDIARIES
Notes to interim consolidated Financial Statements (cont'd)
(Unaudited)
14. Segment information
Following changes in executive management responsibilities, during the
first quarter of 2002, 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 and
six months ended June 30, 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.
24
ACE LIMITED AND SUBSIDIARIES
Notes to interim consolidated Financial Statements (cont'd)
(Unaudited)
Statement of Operations by Segment
For the three months ended June 30, 2002
Insurance - Insurance - Corporate
North Overseas Global Financial and ACE
American General Reinsurance Products Other(1) Consolidated
-------- ------- ----------- -------- ----- ------------
(in thousands of U.S. Dollars)
<s> <c> <c> <c> <c> <c> <c>
Operations Data
Property and Casualty
Gross premiums written $ 1,427,608 $ 941,103 $ 214,209 $ 318,322 $ - $ 2,901,242
Net premiums written 718,301 616,378 197,510 316,518 - 1,848,707
Net premiums earned 605,985 565,339 149,921 228,153 - 1,549,398
Losses and loss expenses 396,135 345,313 52,491 167,010 - 960,949
Policy acquisition costs 50,346 127,838 29,217 21,876 - 229,277
Administrative expenses 86,612 87,857 9,430 16,922 27,110 227,931
----------- ----------- ---------- ----------- ----------- ------------
Underwriting income 72,892 4,331 58,783 22,345 (27,110) 131,241
----------- ----------- ---------- ----------- ----------- ------------
Life
Gross premiums written - - 27,713 - - 27,713
Net premiums written - - 26,671 - - 26,671
Net premiums earned - - 26,309 - - 26,309
Life and annuity benefits - - 23,311 - - 23,311
Policy acquisition costs - - 4,931 - - 4,931
Administrative expenses - - 1,795 - - 1,795
Net investment income - - 5,930 - - 5,930
----------- ----------- ---------- ----------- ----------- ------------
Underwriting income - - 2,202 - - 2,202
----------- ----------- ---------- ----------- ----------- ------------
Net investment income -
property and casualty 103,383 27,615 23,182 46,119 (5,425) 194,874
Other income (expense) (674) 22 - (345) - (997)
Interest expense 8,080 479 4,465 3,278 35,650 51,952
Income tax expense 41,134 4,987 1,858 7,927 (16,845) 39,061
----------- ----------- ---------- ----------- ----------- ------------
Income excluding net realized gains
(losses) & non-recurring expenses 126,387 26,502 77,844 56,914 (51,340) 236,307
Debt prepayment expenses* - - - - (7,196) (7,196)
----------- ----------- ---------- ----------- ----------- ------------
Income excluding net realized gains
(losses) 126,387 26,502 77,844 56,914 (58,536) 229,111
Net realized gains (losses)* (28,586) (4,386) (26,439) (35,841) (29,959) (125,211)
----------- ----------- ---------- ----------- ----------- ------------
Net income $ 97,801 $ 22,116 $ 51,405 $ 21,073 $ (88,495) $ 103,900
=========== =========== ========== =========== =========== ============
* Shown net of income tax
(1) Includes ACE Limited, ACE INA Holdings and intercompany eliminations.
25
ACE LIMITED AND SUBSIDIARIES
Notes to interim consolidated Financial Statements (cont'd)
(Unaudited)
Statement of Operations by Segment
For the three months ended June 30, 2001
Insurance - Insurance - Corporate
North Overseas Global Financial and ACE
American General Reinsurance Products Other(1) Consolidated
-------- ------- ----------- -------- ----- ------------
(in thousands of U.S. Dollars)
<s> <c> <c> <c> <c> <c> <c>
Operations Data
Property and Casualty
Gross premiums written $ 1,142,367 $ 861,785 $ 104,567 $ 263,903 $ - $ 2,372,622
Net premiums written 524,975 566,771 84,984 263,876 - 1,440,606
Net premiums earned 481,171 492,778 85,528 295,671 - 1,355,148
Losses and loss expenses 347,231 299,016 50,660 257,934 - 954,841
Policy acquisition costs 52,360 108,842 15,776 9,668 - 186,646
Administrative expenses 80,651 78,664 5,482 12,857 23,469 201,123
----------- ----------- ----------- ----------- ----------- ------------
Underwriting income 929 6,256 13,610 15,212 (23,469) 12,538
----------- ----------- ----------- ----------- ----------- ------------
Life
Gross premiums written - - 30,039 - - 30,039
Net premiums written - - 30,039 - - 30,039
Net premiums earned - - 30,039 - - 30,039
Life and annuity benefits - - 28,152 - - 28,152
Policy acquisition costs - - 994 - - 994
Administrative expenses - - 698 - - 698
Net investment income - - 335 - - 335
----------- ----------- ----------- ----------- ----------- ------------
Underwriting income (loss) - - 530 - - 530
----------- ----------- ----------- ----------- ----------- ------------
Net investment income -
property and casualty 105,428 29,025 17,449 41,954 2,076 195,932
Other income (expense) 826 (183) - 445 - 1,088
Amortization of goodwill (90) 919 3,502 1,051 14,490 19,872
Interest expense 8,089 631 - 3,282 37,638 49,640
Income tax expense (benefit) 26,927 6,137 3,875 5,628 (17,423) 25,144
----------- ----------- ----------- ----------- ----------- ------------
Income excluding net realized gains
(losses) and non-recurring expenses 72,257 27,411 24,212 47,650 (56,098) 115,432
Non-recurring expenses* - (3,970) (491) - - (4,461)
----------- ----------- ----------- ----------- ----------- ------------
Income excluding net realized gains
(losses) 72,257 23,441 23,721 47,650 (56,098) 110,971
Net realized gains (losses)* 5,381 (8,906) 1,353 22,718 - 20,546
----------- ----------- ----------- ----------- ----------- ------------
Net income $ 77,638 $ 14,535 $ 25,074 70,368 $ (56,098) $ 131,517
=========== =========== =========== =========== =========== ============
* Shown net of income tax
(1) Includes ACE Limited, ACE INA Holdings and intercompany eliminations.
26
ACE LIMITED AND SUBSIDIARIES
Notes to interim consolidated Financial Statements (cont'd)
(Unaudited)
Statement of Operations by Segment
For the six months ended June 30, 2002
Insurance - Insurance - Corporate
North Overseas Global Financial and ACE
American General Reinsurance Products Other(1) Consolidated
-------- ------- ----------- -------- ----- ------------
(in thousands of U.S. Dollars)
<s> <c> <c> <c> <c> <c> <c>
Operations Data
Property and Casualty
Gross premiums written $ 2,692,686 $ 1,903,375 $ 588,175 $ 805,954 $ - $ 5,990,190
Net premiums written 1,231,164 1,230,586 551,832 792,874 - 3,806,456
Net premiums earned 1,078,931 1,074,584 264,826 462,454 - 2,880,795
Losses and loss expenses 723,632 637,073 91,679 361,710 - 1,814,094
Policy acquisition costs 92,328 241,523 45,669 40,419 - 419,939
Administrative expenses 157,573 174,455 15,880 27,067 49,320 424,295
----------- ----------- ---------- ----------- ----------- ------------
Underwriting income 105,398 21,533 111,598 33,258 (49,320) 222,467
----------- ----------- ---------- ----------- ----------- ------------
Life
Gross premiums written - - 56,911 - - 56,911
Net premiums written - - 54,950 - - 54,950
Net premiums earned - - 54,721 - - 54,721
Life and annuity benefits - - 46,307 - - 46,307
Policy acquisition costs - - 12,064 - - 12,064
Administrative expenses - - 2,634 - - 2,634
Net investment income - - 12,197 - - 12,197
----------- ----------- ---------- ----------- ----------- ------------
Underwriting income - - 5,913 - - 5,913
----------- ----------- ---------- ----------- ----------- ------------
Net investment income -
property and casualty 205,301 48,590 47,365 94,876 (7,390) 388,742
Other income (expense) (20) 3,822 - - - 3,802
Interest expense 16,692 921 4,692 7,254 68,395 97,954
Income tax expense (benefit) 74,066 12,538 1,951 16,942 (34,689) 70,808
----------- ----------- ---------- ----------- ----------- ------------
Income excluding net realized gains
(losses) & non-recurring expenses 219,921 60,486 158,233 103,938 (90,416) 452,162
Debt prepayment expenses* - - - - (7,196) (7,196)
----------- ----------- ---------- ----------- ----------- ------------
Income excluding net realized gains
(losses) 219,921 60,486 158,233 103,938 (97,612) 444,966
Net realized gains (losses)* (39,725) (8,397) (30,483) (41,972) (22,684) (143,261)
----------- ----------- ---------- ----------- ----------- ------------
Net income $ 180,196 $ 52,089 $ 127,750 $ 61,966 $ (120,296) $ 301,705
=========== =========== ========== =========== =========== ============
* Shown net of income tax
(1) Includes ACE Limited, ACE INA Holdings and intercompany eliminations.
27
ACE LIMITED AND SUBSIDIARIES
Notes to interim consolidated Financial Statements (cont'd)
(Unaudited)
Statement of Operations by Segment
For the six months ended June 30, 2001
Insurance - Insurance - Corporate
North Overseas Global Financial and ACE
American General Reinsurance Products Other (1) Consolidated
-------- ------- ----------- -------- ---------- ------------
(in thousands of U.S. Dollars)
<s> <c> <c> <c> <c> <c> <c>
Operations Data
Property and Casualty
Gross premiums written $2,106,191 $1,688,104 $ 332,612 $ 806,413 $ - $ 4,933,320
Net premiums written 968,032 1,109,794 299,683 797,275 - 3,174,784
Net premiums earned 881,886 984,658 163,780 693,000 - 2,723,324
Losses and loss expenses 613,503 605,374 71,221 616,036 - 1,906,134
Policy acquisition costs 91,579 206,638 30,453 24,485 - 353,155
Administrative expenses 157,166 155,755 12,049 28,091 42,501 395,562
----------- ----------- ------------ ----------- ------------ ------------
Underwriting income 19,638 16,891 50,057 24,388 (42,501) 68,473
----------- ----------- ------------ ----------- ------------ ------------
Life
Gross premiums written - - 30,979 - - 30,979
Net premiums written - - 30,979 - - 30,979
Net premiums earned - - 30,979 - - 30,979
Life and annuity benefits - - 28,805 - - 28,805
Policy acquisition costs - - 1,175 - - 1,175
Administrative expenses - - 1,149 - - 1,149
Net investment income - - 335 - - 335
----------- ----------- ------------ ----------- ------------ ------------
Underwriting income - - 185 - - 185
----------- ----------- ------------ ----------- ------------ ------------
Net investment income -
property and casualty 220,121 56,731 34,531 83,782 5,197 400,362
Other income (expense) 1,931 (286) - 1,040 - 2,685
Amortization of goodwill (180) 1,845 7,005 2,102 28,980 39,752
Interest expense 16,795 1,425 - 7,228 78,516 103,964
Income tax expense (benefit) 54,581 12,549 7,378 10,923 (36,707) 48,724
----------- ----------- ------------ ----------- ------------ ------------
Income excluding net realized gains
(losses), non-recurring expenses and
cumulative effect 170,494 57,517 70,390 88,957 (108,093) 279,265
Non-recurring expenses* - (3,970) (491) - - (4,461)
----------- ----------- ------------ ----------- ------------ ------------
Income excluding net realized gains
(losses) and cumulative effect 170,494 53,547 69,899 88,957 (108,093) 274,804
Net realized gains (losses)* (3,721) (4,348) (18,160) 24,006 - (2,223)
----------- ----------- ------------ ----------- ------------ ------------
Income excluding cumulative effect of
adopting a new accounting standard 166,773 49,199 51,739 112,963 (108,093) 272,581
Cumulative effect of adopting a new
accounting standard (50) 441 539 (23,600) - (22,670)
----------- ----------- ------------ ----------- ------------ ------------
Net income $ 166,723 $ 49,640 $ 52,278 $ 89,363 $ (108,093) $ 249,911
=========== =========== ============ =========== ============ ============
* Shown net of income tax
(1) Includes ACE Limited, ACE INA Holdings and intercompany eliminations.
28
ACE LIMITED AND SUBSIDIARIES
Notes to interim consolidated Financial Statements (cont'd)
(Unaudited)
The following tables summarize the revenues of each segment by product offering
for the three and six months ended June 30, 2002 and 2001:
Net premiums earned by type of premium
Three months ended June 30, 2002
Life,
Property & Accident Financial Financial ACE
Casualty & Health Services Solutions Consoidated
------------- ------------- ------------ ------------ ------------
(in millions of U.S. dollars)
<s> <c> <c> <c> <c> <c>
Insurance - North American $ 586 $ 20 $ - $ - $ 606
Insurance - Overseas General 433 133 - - 566
Global Reinsurance 150 26 - - 176
Financial Products - - 77 151 228
-------------- ------------- ------------ ------------ ------------
$ 1,169 $ 179 $ 77 $ 151 $ 1,576
============== ============= ============ ============ ============
Three months ended June 30, 2001
Life,
Property & Accident Financial Financial ACE
Casualty & Health Services Solutions Consoidated
-------------- ------------- ------------- ------------ --------------
(in millions of U.S. dollars)
Insurance - North American $ 481 $ - $ - $ - $ 481
Insurance - Overseas General 371 122 - - 493
Global Reinsurance 85 30 - - 115
Financial Products - - 96 200 296
-------------- ------------- ------------ ------------ ------------
$ 937 $ 152 $ 96 $ 200 $ 1,385
============== ============= ============ ============ ============
Six months ended June 30, 2002
Life,
Property & Accident Financial Financial ACE
Casualty & Health Services Solutions Consoidated
-------------- ------------- ------------ ------------ --------------
(in millions of U.S. dollars)
Insurance - North American $ 1,036 $ 43 $ - $ - $ 1,079
Insurance - Overseas General 818 257 - - 1,075
Global Reinsurance 265 55 - - 320
Financial Products - - 126 336 462
-------------- ------------- ------------ ------------ ------------
$ 2,119 $ 355 $ 126 $ 336 $ 2,936
============== ============= ============ ============ ============
Six months ended June 30, 2001
Life,
Property & Accident Financial Financial ACE
Casualty & Health Services Solutions Consoidated
-------------- ------------- ------------ ------------ -------------
(in millions of US. dollars)
Insurance - North American $ 878 $ 4 $ - $ - $ 882
Insurance - Overseas General 742 240 - 3 985
Global Reinsurance 163 31 - - 194
Financial Products - - 134 559 693
-------------- ------------- ------------ ------------ ------------
$ 1,783 $ 275 $ 134 $ 562 $ 2,754
============== ============= ============ ============ ============
29
ACE LIMITED AND SUBSIDIARIES
Notes to interim consolidated Financial Statements (cont'd)
(Unaudited)
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 June 30, 2002 and
December 31, 2001:
June 30 December 31
2002 2001
---------------- ----------------
(in millions of U.S. dollars)
Property and casualty $ 36,234 $ 34,198
Life reinsurance 510 480
Other 2,579 2,509
--------------- ----------------
Total assets $ 39,323 $ 37,187
=============== ================
30
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 and six
months ended June 30, 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, credit developments of reinsurers,
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
asbestos related 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) judicial decisions and legal
tactics, (vii) the actual amount of new and renewal business and market
acceptance of our products, (viii) risks associated with the introduction of
new products and services, (ix) the competitive environment in which we
operate, related trends and associated pricing pressures, market perception,
and developments, (x) actions that rating agencies may take from time to time,
(xi) developments in global financial markets, which could affect our
investment portfolio and financing plans, (xii) changing rates of inflation
and other economic conditions, (xiii) losses due to foreign currency exchange
rate fluctuations, (xiv) loss of the services of any of our executive officers
without suitable replacements being recruited in a reasonable time frame, (xv)
the ability of technology to perform as anticipated, (xvi) the amount of
dividends received from subsidiaries, and (xvii) 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
Following changes in executive management responsibilities, during the
quarter ended March 31, 2002, 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 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.
31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Critical Accounting Policies
Certain amounts in our consolidated financial statements are the result of
transactions that 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 ("P&C")
loss reserves, the fair value of our investment portfolio including
derivatives and the reinsurance recoverable to be the values requiring the
most inherently subjective and complex estimates. As such, we deem our
accounting policies for these amounts to be of critical importance to our
consolidated financial statements. More information regarding the estimates
and assumptions required to arrive at these amounts can be found below in
the sections entitled, Investments and Cash, Property and Casualty Loss
Reserves, Reinsurance, Asbestos and Environmental Claims and Derivatives.
September 11th 2001 Tragedy
The terrorist attacks on September 11, 2001 ("the September 11th tragedy")
resulted in the largest insured loss in history. 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. There were no
substantial payments in connection to the September 11th tragedy in the
current quarter. As of June 30, 2002 we have paid gross losses of $524
million and net losses of $89 million with respect to the September 11th
tragedy and have collected approximately 95 percent of the related
recoverable. We believe our reserve in connection with the September 11th
tragedy is adequate at June 30, 2002.
Results of Operations - Three months ended June 30, 2002 and 2001
Three Months Ended
June 30
2002 2001
---------- -----------
(in millions of U.S. dollars)
Net operating income $ 236 $ 115
Debt prepayment expense (net of income tax) (7) -
Non-recurring expenses (net of income tax) - (4)
Net realized gains (losses) on investments
(net of income tax) (125) 20
---------- ---------
Net income $ 104 $ 131
========== =========
32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Net operating income is comprised of income excluding net realized gains
(losses), debt prepayment expense and non-recurring expenses. Net
operating income increased by $121 million to $236 million for the three
months ended June 30, 2002, compared with $115 million for the three months
ended June 30, 2001. We adopted FAS 142 on January 1, 2002 and accordingly
have not amortized any goodwill in the current quarter, compared with $20
million of goodwill amortized for the quarter ended June 30, 2001. The
current quarter was also aided by the absence of high level catastrophe
losses. For the same quarter last year, we incurred $55 million in
catastrophe losses related to storms in the Mid-Western United States.
Excluding the catastrophe losses and goodwill amortization in 2001, net
operating income increased by 24 percent. The increase in income was
primarily due to growth in net premiums earned combined with better loss
experience over the same quarter last year.
The debt prepayment expense of $7 million (net of income tax) incurred in the
current quarter was as a result of the prepayment of a portion of the ACE INA
Subordinated Notes due in 2009. This cost was mostly attributable to the
decrease in interest rates since the original note was issued. During the
three months ended June 30, 2001, we incurred non-recurring expenses of $4
million (net of income tax) relating to a contractual obligation due to a
departing employee.
Net realized gains (losses) on investments (net of income tax) were $125
million for the three months ended June 30, 2002 compared with net realized
gains of $20 million for the three months ended June 30, 2001. The net
realized losses were generated primarily as a result of losses realized on
fixed maturities, financial futures and interest rate swaps as well as an
after-tax loss of $33 million reflecting fair value adjustments on
derivatives.
Consolidated Operating Results
Three Months Ended
June 30
2002 2001
-------------- -------------
(in millions of U.S. dollars)
Cross premiums written $ 2,929 $ 2,403
Net premiums written 1,875 1,470
Net premiums earned 1,576 1,385
Losses and loss expenses 961 955
Life and annuity benefits 23 28
Policy acquisition costs 234 187
Administrative expenses 231 202
----------- -----------
Underwriting income $ 127 $ 13
----------- -----------
Net investment income 201 196
Other income (expense) (1) 1
Interest expense 52 50
Income tax expense 39 25
Amortization of goodwill - 20
----------- -----------
Net operating income $ 236 $ 115
----------- -----------
Loss and loss expense ratio* 62.0% 70.5%
Underwriting and administrative expense ratio* 29.5% 28.6%
Combined ratio* 91.5% 99.1%
* Ratios exclude life reinsurance business
33
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
We continued to experience widespread firming of prices on new and renewing
business this quarter, which translated into steady growth in our gross
premiums written and a significant increase in our underwriting income.
Gross premiums written increased by 22 percent to $2.9 billion for the
second quarter of 2002 compared with the same quarter last year.
Underwriting income increased to $127 million for the current quarter
compared with $13 million for the quarter ended June 30, 2001. Our net
operating income increased by $121 million to $236 million for the quarter
ended June 30, 2002 compared with $115 million for the same quarter last
year.
Excluding our Financial Products segment, gross premiums written increased
by 23 percent. During the quarter ended June 30, 2001, our financial
products segment wrote two large retroactive contracts in the form of loss
portfolio transfer contracts ("LPTs") for $165 million, whereas our LPT
activity in the current quarter was $25 million. When LPT contracts are
written in a quarter, they cause large variations in premium volume. LPTs
are discussed in more detail in the Financial Products segment discussion.
Net premiums written, which reflect the premiums we retain after purchasing
reinsurance protection, increased by 28 percent to $1.9 billion for the
quarter ended June 30, 2002 compared with $1.5 billion last year. Exclusive
of our Financial Products segment, net premiums written increased by 29
percent for the current quarter compared with the quarter ended June 30,
2001.
Net premiums earned, which reflect the portion of net premiums written
recorded as revenues for the period, increased by 14 percent to $1.6
billion for this quarter compared with $1.4 billion for the same quarter
last year. Excluding the LPTs, net premiums earned increased by 27 percent.
The underwriting results of P&C 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.
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 P&C 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 the claims develop
and 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.
34
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
The loss and loss expense ratio decreased to 62.0 percent for the quarter
ended June 30, 2002 compared with 70.5 percent for the same quarter of
2001. The decrease is principally due to the low level of catastrophe
losses and the fact that no LPTs of significant value were written in the
current quarter. LPT contracts are typically recorded at higher loss ratios
than our other lines of business. More information regarding LPTs is
provided in the Financial Products segment discussion.
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
28.6 percent for the quarter ended June 30, 2001 to 29.5 percent for the
current quarter. The principal reason for the change is the impact of the
LPTs, which increased net premiums earned in 2001, thereby reducing the
underwriting and administrative expense ratio.
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 $2 million compared with $1 million for
the same quarter last year.
Segment Results
Insurance - North American
The Insurance - North American segment is comprised of our
P&C 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.
35
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Three Months Ended Percentage
June 30 Change
2002 2001 From Prior Year
------------ ----------------------------------
(in millions of U.S. dollars)
<s> <c> <c> <c>
Gross premiums written $ 1,428 $ 1,143 25%
Net premiums written 718 525 37
Net premiums earned 606 481 26
Losses and loss expenses 396 347 14
Underwriting and administrative expenses 137 133 3
---------- ---------- -------------
Underwriting income $ 73 $ 1 NM
---------- ---------- -------------
Net investment income 103 105 (2)
Other income (expense) (1) 1 -
Interest expense 8 8 -
Income tax expense 41 27 53
---------- ---------- -------------
Net operating income $ 126 $ 72 75%
---------- ---------- -------------
Loss and loss expense ratio 65.4% 72.1%
Underwriting and administrative expense ratio 22.6% 27.7%
Combined ratio 88.0% 99.8%
NM - not meaningful
This segment's underwriting income grew by $72 million. Gross premiums
written increased by 25 percent to $1.4 billion for the quarter ended June
30, 2002 compared with $1.1 billion for the same quarter last year.
Overall, the North American insurance market has continued to experience
accelerating increases in insurance prices and we believe this current
environment is sustainable as insurers reduce availability of insurance in
reaction to negative loss trends and economic conditions. In addition, policy
terms and conditions, capacity and policy attachment points are moving in a more
favorable direction and should positively impact future profitability.
ACE USA, which comprises the majority of this segment, increased gross
premiums written by 23 percent to $1.3 billion. Westchester Specialty, ACE
USA's wholesale oriented excess and surplus lines group continued to
experience tremendous demand for its products as both standard line
companies and program managers have lost significant capacity and are
looking to us to fill in the shortfall. As a result, Westchester Specialty
has been able to successfully demand increases in rates in excess of 50 percent
and improve its policy terms and conditions. As overall markets continue to
harden, opportunities in the excess and surplus lines market traditionally
outpace those in the standard admitted lines market. Also contributing to
the increase this quarter is ACE USA's Professional Risk Group, which
provides insurance policies that protect against management liability and
professional liability as well as surety, aviation and satellite risks.
Spurred by recent corporate failures, demand for E&O, D&O and surety
coverage, continues to be strong translating to new and renewal business
with large price increases, dramatically lower policy limits and more
favorable policy terms.
ACE Bermuda increased its gross premiums written by 55 percent to $113
million for the current quarter. Significant rate increases were achieved
on both new and renewal business across their core lines - excess
liability, professional lines and excess property.
36
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Net premiums written for the North American segment increased by 37 percent
for the quarter, outpacing the gross premiums written due to our strategic
decision to reduce our reliance on reinsurance. Net premiums earned increased
by $125 million to $606 million for the current quarter compared with $481
million for the 2001 quarter. This increase is principally due to the earning
out of higher premiums written in previous quarters. While a portion of the
net premiums written this quarter are earned, most will be earned out in
future quarters.
The loss and loss expense ratio decreased to 65.4 percent for the current
quarter compared with 72.1 percent last year. This decrease is a result of
higher net premiums earned combined with lower loss activity, partially
achieved by changes in business mix in the current quarter compared with
the prior year.
The underwriting and administrative expense ratio declined to 22.6 percent
for the current quarter compared with 27.7 percent for the same quarter
last year principally because expenses were relatively unchanged while net
premiums earned increased significantly.
Net investment income decreased by $2 million to $103 million for the
quarter ended June 30, 2002 compared with $105 million for the same quarter
last year. As discussed later in this report, this decrease is principally
a result of lower interest rates for the current quarter compared with last
year. Net operating income increased by 75 percent for the quarter ended
June 30, 2002 compared with the same quarter last year due to the increase
in underwriting income offset by increased income tax expense at ACE USA.
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.
Three Months Ended Percentage
June 30 Change
2002 2001 From Prior Year
------------ -----------------------------------
(in millions of U.S.
dollars)
<s> <c> <c> <c>
Gross premiums written $ 941 $ 862 9%
Net premiums written 616 566 9
Net premiums earned 566 493 15
Losses and loss expenses 345 299 15
Underwriting and administrative expenses 217 188 15
---------- ---------- -------------
Underwriting income $ 4 $ 6 (31)%
---------- ---------- -------------
Net investment income 28 29 (5)
Interest expense 1 1 -
Income tax expense 5 6 (19)
Amortization of goodwill - 1 -
---------- ---------- -------------
Net operating income $ 26 $ 27 (3)%
---------- ---------- -------------
Loss and loss expense ratio 61.1% 60.6%
Underwriting and administrative expense ratio 38.1% 38.1%
Combined ratio 99.2% 98.7%
37
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Underwriting income for the Overseas General segment decreased by $2
million to $4 million for the quarter ended June 30, 2002 compared with $6
million for the same quarter last year. Gross premiums written increased by
9 percent for the quarter to $941 million compared with $862 million for
the quarter ended June 30, 2001.
Gross premiums written for ACE International increased by 15 percent to
$627 million for the current quarter compared with $547 million last year.
Europe and Asia contributed the most to this increase reporting 60 percent
and 40 percent growth in gross premiums written respectively. These
increases were offset by the 31 percent decline in gross premiums written
in Latin America. ACE International breaks down into two major categories
of business - P&C and accident and health ("A&H"). Both A&H and P&C had
good quarters reporting increases in net premiums written of 20 percent and
31 percent, respectively. All regions of the world, with the exception of
Japan, continued to experience price firming across most classes of
business. Rates overall, excluding Japan, have increased in excess of 40
percent in the quarter compared with last year. Japan's premium rates
increased approximately 2 percent predominantly in A&H, personal lines and
a small commercial portfolio of business. Adjusting for foreign exchange,
Japan increased its net premiums written by 7 percent in the current
quarter.
ACE Global Markets reported $314 million in gross premiums written for the
quarter ended June 30, 2002, which was relatively unchanged compared with
last year's $315 million. This operation is 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) to conform with
our underwriting strategies and standards. As a consequence, in certain lines
of business that do not fit strategies, 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, requiring us to purchase reinsurance to cover the run-off. We will be
reducing our capacity at Lloyd"s to 652 million pounds for the 2003 year of
account from 900 million pounds for the 2002 year of account. Our current
production activity is very strong, and rates in the second quarter increased
an average of 41 percent as all classes are continuing to harden. We remain
firmly committed to this operation and expect it to contribute to our earnings
growth in the future.
Net premiums written for the segment increased by 9 percent to $616 million
for the quarter ended June 30, 2002 compared with $566 million last year. Net
premiums written in ACE International increased by 27 percent while net
premiums written in ACE Global Markets decreased by 23 percent primarily
due to the cost of reinsurance to protect run-off exposures, as discussed
previously.
Net premiums earned increased by 15 percent for the current quarter
principally on the strength of ACE International's 20 percent increase in
net premiums earned over last year. The loss and loss expense ratio was
stable at 61.1 percent for the current quarter compared with 60.6 percent
for the same quarter last year. The underwriting and administrative expense
ratio remained at 38.1 percent as policy acquisition costs and
administrative expenses increased proportionately with net premiums earned.
Administration expenses increased due to increased Lloyd's Central
Guarantee Fund costs, Lloyd's premium levies and business expansion in
certain lines of business. Net operating income decreased by 3 percent for
the current quarter compared with last year.
Global Reinsurance
The Global Reinsurance segment consists of ACE Tempest Re, ACE Tempest USA
and ACE Global Market's P&C reinsurance operations as well as our life
reinsurance operations which are disclosed separately. The P&C reinsurance
group writes catastrophe, marine, casualty, and nuclear products.
38
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Property and Casualty
Three Months Ended Percentage
June 30 Change
2002 2001 From Prior Year
------------- ------------------------------------
(in millions of U.S.dollars)
<s> <c> <c> <c>
Gross premiums written $ 214 $ 104 105%
Net premiums written 197 85 132
Net premiums earned 150 85 75
Losses and loss expenses 53 51 4
Underwriting and administrative expenses 38 21 82
---------- ----------- -------------
Underwriting income $ 59 $ 13 332%
---------- ----------- -------------
Net investment income 23 17 33
Interest expense 4 - -
Income tax expense 2 4 (52)
Amortization of goodwill - 3 -
---------- ----------- -------------
Net operating income $ 76 $ 23 219%
---------- ----------- -------------
Loss and loss expense ratio 35.0% 59.2%
Underwriting and administrative expense ratio 25.8% 24.9%
Combined ratio 60.8% 84.1%
Due to the low level of catastrophe losses in 2002 and a favorable
underwriting environment, Global Reinsurance reported underwriting income
of $59 million for the quarter ended June 30, 2002 compared with $13
million for the same quarter last year.
Gross premiums written for the quarter increased by 105 percent to $214
million from $104 million last year. The reinsurance market continues to
show discipline in both pricing and underwriting terms and prices in the
property classes continue to increase although reinsurance rate increases
are beginning to stabilize.
39
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
reinsurance business, net premiums written increased by 85 percent and generally
prices continue to increase at rates that we expect will lead to returns on
equity in excess of 25 percent. 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 that we believed was
inadequately priced.
ACE Tempest U.K. which is principally focused on specialty reinsurance
products increased its net premiums written by 152 percent to $57 million
for the current quarter compared with $23 million for the same quarter last
year. ACE Tempest U.S., established in 2000 with an initial focus on
writing P&C reinsurance, increased its net premiums written to $47 million
for the current quarter compared with $12 million for the same quarter last
year.
The loss and loss expense ratio improved from 59.2 percent for the quarter
ended June 30, 2001 to 35.0 percent for the current quarter due to the
absence of any significant loss activity in the quarter and the increase in
net premiums earned.
The underwriting and administrative expense ratio increased to 25.8 percent
for the current quarter compared with 24.9 percent for the quarter ended
June 30, 2001. This slight increase is due to an increase in policy
acquisition costs relative to net premiums earned caused by a change in the
mix of business written. Net operating income increased by 219 percent to
$76 million for the current quarter compared with the quarter ended June
30, 2001 principally due to the increase in underwriting income from all
divisions.
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 life reinsurance using 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.
Three Months Ended
June 30
2002 2001
------------- ------------
(in millions of U.S.
dollars)
Gross premiums written $ 28 $ 30
Net premiums written 27 30
Net premiums earned 26 30
Life and annuity benefits 23 28
Underwriting and administrative expenses 7 2
Net investment income 6 1
---------- -----------
Net operating income $ 2 $ 1
---------- -----------
40
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
The life reinsurance group wrote $28 million of business for the quarter
ended June 30, 2002 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 life and
variable products. During the quarter, we made the decision to cease
pursuing large, one-time transaction business and the long-term disability
business as we no longer believe our efforts in these areas justify the
potential returns.
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 cannot 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
under United States generally accepted accounting principles ("GAAP"), 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 loss 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. We expect that these contracts will produce
significant underwriting losses over time, but we also expect that this
business will be profitable due to expected investment earnings on the
premiums received.
41
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Three Months Ended Percentage
June 30 Change
2002 2001 From Prior Year
------------ ----------------------------------
(in millions of U.S. dollars)
<s> <c> <c> <c>
Gross premiums written $ 318 $ 264 21%
Net premiums written 317 264 20
Net premiums earned 228 296 (23)
Losses and loss expenses 167 258 (35)
Underwriting and administrative expenses 39 22 73
---------- ---------- -------------
Underwriting income $ 22 $ 16 47%
---------- ---------- -------------
Net investment income 46 42 10
Interest expense 3 3 -
Income tax expense 8 6 41
Amortization of goodwill - 1 -
---------- ---------- -------------
Net operating income $ 57 $ 48 19%
---------- ---------- -------------
Loss and loss expense ratio 73.2% 87.2%
Underwriting and administrative expense ratio 17.0% 7.6%
Combined ratio 90.2% 94.8%
Net operating income for this segment increased by 19 percent to $57 million
for the quarter ended June 30, 2002 compared with $48 million for the same
quarter last year. Our combined ratio improved to 90.2 percent for the
current quarter compared with 94.8 percent last year. Better pricing terms
and changes in our business mix achieved this favorable decline in our
combined ratio. Net premiums earned declined by 23 percent to $228 million
for the quarter compared with $296 million for the same quarter last year.
This significant decrease is due to the decline in LPT business recorded in
the current quarter compared with last year. We wrote $25 million of LPTs
in the current quarter, compared with $165 million in the same quarter last
year. This decrease had the effect of reducing our net premiums earned, as
LPTs are generally earned when written.
Our financial guaranty operation reported a 17 percent increase in net
operating income for the current quarter compared with the quarter ended
June 30, 2001. This was achieved primarily on the strength of new trade
credit insurance business. Our trade credit business, which protects
sellers of goods and services from the risk of non-payment of trade
receivables increased gross premiums written by $8 million in the current
quarter. We are taking advantage of new business opportunities arising due
to a broad based credit spread widening and a demand for credit protection
caused by market volatility.
Financial solutions also had a successful quarter reporting a 25 percent
increase in underwriting income. In the U.S. operation, we wrote several
prospective, multi-year programs where we provide first loss protection on
synthetic collateralized debt obligations. These transactions contributed $107
million to gross premiums written and will be earned evenly over their five-year
contract term. 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.
42
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
The absence of any significant LPTs in the quarter has impacted the loss
and loss expense ratio as well as the underwriting and administrative
expense ratio. The loss and loss expense ratio improved from 87.2 percent
for the quarter ended June 30, 2001 to 73.2 percent for the current
quarter. The underwriting and administrative expenses increased for the
current quarter compared with the same quarter last year due to increased
policy acquisition costs as a result of a change in the mix of business
written. The decrease in net premiums earned caused an increase in the
underwriting and administrative expense ratio.
Results of Operations - Six months ended June 30, 2002 and 2001
Six Months Ended
June 30
2002 2001
----------- -----------
(in millions of U.S. dollars)
<s> <c> <c>
Net operating income $ 452 $ 279
Debt prepayment expense (net of income tax) (7) -
Non-recurring expenses (net of income tax) - (4)
Net realized losses on investments (net of income tax) (143) (2)
Cumulative effect of adopting a new accounting
standard (net of income tax) - (23)
----------- -----------
Net income $ 302 $ 250
=========== ===========
Net operating income increased by $173 million to $452 million for the six
months ended June 30, 2002, compared with $279 million for the same period
last year. We adopted FAS 142 on January 1, 2002 and accordingly have not
amortized any goodwill in the current period which compares to $40 million
of goodwill amortized for the six months ended June 30, 2001. In addition,
there were no significant catastrophe losses in the current period. For the
same period last year, we incurred $55 million in catastrophe losses
related to storms in the Mid-Western United States. Excluding the
catastrophe losses and goodwill amortization in 2001, net operating income
increased by 21 percent for the six months ended June 30, 2002 compared
with the same period last year. This increase in income was primarily due
to growth in net premiums earned combined with better loss experience over
the same period last year.
The debt prepayment expense of $7 million (net of income tax) was incurred
in the second quarter as a result of the prepayment of a portion of the ACE
INA Subordinated Notes due in 2009. During the six months ended June 30,
2001, we incurred non-recurring expenses of $4 million (net of income tax)
relating to a contractual obligation due to a departing employee.
Net realized losses on investments (net of income tax) were $143 million
for the six months ended June 30, 2002 compared with net realized losses of
$2 million last year. The net realized losses were generated primarily as a
result of losses realized on fixed maturities, financial futures and
interest rate swaps as well as an after-tax loss of $46 million reflecting
fair value adjustments on derivatives, which we include in net realized
losses.
43
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Consolidated Operating Results
Six Months Ended
June 30
2002 2001
--------------- -------------
(in millions of U.S. dollars)
Gross premiums written $ 6,047 $ 4,964
Net premiums written 3,861 3,205
Net premiums earned 2,936 2,754
Losses and loss expenses 1,814 1,906
Life and annuity benefits 46 29
Policy acquisition costs 432 354
Administrative expenses 428 397
----------- -----------
Underwriting income $ 216 $ 68
----------- -----------
Net investment income 401 401
Other income 4 3
Interest expense 98 104
Income tax expense 71 49
Amortization of goodwill - 40
----------- -----------
Net operating income $ 452 $ 279
----------- -----------
Loss and loss expense ratio* 63.0% 70.0%
Underwriting and administrative expense ratio* 29.2% 27.5%
Combined ratio* 92.2% 97.5%
*Ratios exclude life reinsurance business
Overall, underwriting income increased by 213 percent to $216 million for
the six months ended June 30, 2002 compared with $68 million for the same
period last year. This significant increase was driven principally by an
increase in prices across most lines of business and the absence of any
significant catastrophe losses during the period. Net operating income
increased to $452 million for the current period compared with $279 million last
year.
Gross premiums written increased by 22 percent to $6.0 billion for the six
months ended June 30, 2002 compared with $4.9 billion for the same period
last year. During the six months ended June 30, 2001, we wrote several
large retroactive contracts in the form of LPTs totaling $417 million
compared with $25 million for the current period. When these contracts are
written they cause large variations in premium volume.
44
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Net premiums written increased by 20 percent to $3.9 billion for the six
months ended June 30, 2002 compared with $3.2 billion last year. Net
premiums earned increased by 7 percent to $2.9 billion for the period
compared with $2.8 billion last year. Excluding the LPTs, net premiums
earned increased by 24 percent.
The loss and loss expense ratio decreased to 63.0 percent for the six
months ended June 30, 2002 compared with 70.0 percent for the same period
in 2001. This decrease is principally due to the absence of significant
catastrophe losses in 2002 and the fact that no LPTs of significant value
were written in the current period. LPT contracts are typically recorded at
higher loss ratios than our other lines of business.
The underwriting and administrative expense ratio increased from 27.5
percent last year to 29.2 percent for the six months ended June 30, 2002.
The principal reason for the change is the impact of the LPTs which
increased net premiums earned and reduced the expense ratio in 2001. In
addition, our increased participation in the Lloyd's market through ACE
Global Markets resulted in increased Lloyd's Central Guarantee Fund costs,
and Lloyd's premium levies and we incurred costs related to business
expansion in certain lines of business.
We assess the performance of our life reinsurance business based on net
operating income. For the six months ended June 30, 2002, this division
generated net operating income of $6 million compared with a break-even result
for the same period last year.
Segment Results
Insurance - North American
Six Months Ended Percentage
June 30 Change
2002 2001 From Prior Year
------------ --------------------------------
(in millions of U.S.dollars)
<s> <c> <c> <c>
Gross premiums written $ 2,693 $ 2,106 28%
Net premiums written 1,231 967 27
Net premiums earned 1,079 882 22
Losses and loss expenses 723 614 18
Underwriting and administrative expenses 250 248 1
---------- ---------- ----------
Underwriting income $ 106 $ 20 437%
---------- ---------- ----------
Net investment income 205 220 (7)
Other income - 2 -
Interest expense 17 17 -
Income tax expense 74 55 36
---------- ---------- ----------
Net operating income $ 220 $ 170 40%
---------- ---------- ----------
Loss and loss expense ratio 67.1% 69.5%
Underwriting and administrative expense ratio 23.1% 28.2%
Combined ratio 90.2% 97.7%
45
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Underwriting income for the six months ended June 30, 2002 was $106 million
compared with $20 million for the same period last year. Significant growth
was achieved across most product lines as this segment reported an increase
in gross premiums written of 28 percent for the six months ended June 30,
2002 compared with last year.
Within this segment, ACE USA's gross premiums written increased by 26
percent to $2.5 billion. Most of ACE USA's operating divisions experienced
strong premium growth for the six months ended June 30, 2002. ACE Risk
Management Group ("ARM"), Westchester Specialty and the Professional Risk
Group contributed the most to this growth. We benefited substantially from
rising prices on large property accounts and excess casualty lines while
recent corporate failures have fuelled increases in E&O and D&O rates. In
addition, there continues to be general improvement in policy terms and
conditions.
ACE Bermuda had an increase in gross premiums written of 57 percent to $200
million for the six months ended June 30, 2002. Significant rate increases
were achieved on both new and renewal business across the core lines of
excess liability, professional and excess property. In addition to the rate
increases, ACE Bermuda also secured better terms and conditions which have
improved the risk profile of the in-force book.
Net premiums earned increased by 22 percent to $1.1 billion compared with
the six months ended June 30, 2001. This increase is principally due to the
earning out of higher premiums written in previous quarters.
The loss and loss expense ratio decreased to 67.1 percent for the six
months ended June 30, 2002 compared with 69.5 percent last year. This
decrease is a result of higher earned premiums partially achieved by price
increases. The underwriting and administrative expense ratio declined to 23.1
percent for the six months ended June 30, 2002 compared with 28.2 last year
principally because expenses were relatively unchanged and net premiums
earned increased. Net operating income increased by 40 percent due to
increased underwriting income in all divisions offset by reduced net
investment income.
46
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Insurance - Overseas General
Six Months Ended Percentage
June 30 Change
2002 2001 From Prior Year
------------ --------------------------------
(in millions of U.S. dollars)
<s> <c> <c> <c>
Gross premiums written $ 1,903 $ 1,688 13%
Net premiums written 1,230 1,110 11
Net premiums earned 1,075 985 9
Losses and loss expenses 637 605 5
Underwriting and administrative expenses 417 363 15
---------- ---------- ---------
Underwriting income $ 21 $ 17 27%
---------- ---------- ---------
Net investment income 49 57 (14)
Other income 4 - -
Interest expense 1 1 -
Income tax expense 13 13 -
Amortization of goodwill - 2 -
---------- ---------- ---------
Net operating income $ 60 $ 58 5%
---------- ---------- ---------
Loss and loss expense ratio 59.3% 61.5%
Underwriting and administrative expense ratio 38.7% 36.8%
Combined ratio 98.0% 98.3%
Underwriting income increased by 27 percent to $21 million for the six
months ended June 30, 2002 compared with $17 million for the same period
last year. Gross premiums written increased by 13 percent for the period to
$1.9 billion compared with $1.7 billion for the six months ended June 30,
2001.
ACE International increased its gross premiums written by 14 percent to
$1.3 billion for the current period compared with $1.1 billion last year.
For the six months ended June 30, 2002, all regions, with the exception of
Japan, reported continued firming in both rates and underwriting terms.
Geographically, Europe and Asia contributed the most growth, reporting
increases in gross premiums written of 48 percent and 40 percent
respectively. Growth in these areas was principally driven by strong rate
increases in both the P&C and A&H businesses. Offsetting these increases is
the performance of Latin America, which reported a decrease in gross
premiums written of 13 percent for the six months ended June 30, 2002
compared with the same period last year.
47
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
ACE Global Markets reported $615 million in gross premiums written for the
six months ended June 30, 2002, which is a 10 percent increase over last
year's gross premiums written of $557 million. As previously noted
in the three-months discussion, this operation is 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.
Net premiums written for the segment increased by 11 percent to $1.2
billion for the six months ended June 30, 2002 compared with $1.1 billion
last year. Net premiums written at ACE International increased by 22
percent, again driven by Europe and Asia which reported increases in net
premiums written of 46 percent and 33 percent, respectively. Net premiums
written at ACE Global Markets decreased by 13 percent primarily due to the
cost of reinsurance to protect us on run-off exposures, as discussed
previously.
Net premiums earned increased by 9 percent for the six months ended June 30,
2002 compared with last year. The loss and loss expense ratio decreased
to 59.3 percent for the current period compared with 61.5 percent for the
same period last year. The underwriting and administrative expense ratio
increased to 38.7 percent for the current period compared with 36.8 percent
for the six months ended June 30, 2001 due to increased Lloyd's Central
Guarantee Fund costs, Lloyd's premium levies and business expansion. Net
operating income increased by 5 percent for the six months ended June 30,
2002 compared with the same period last year.
Global Reinsurance
Property and Casualty
Six Months Ended Percentage
June 30 Change
2002 2001 From Prior Year
------------ ---------------------------------
(in millions of U.S. dollars)
<s> <c> <c> <c>
Gross premiums written $ 588 $ 333 77%
Net premiums written 552 300 84
Net premiums earned 265 163 62
Losses and loss expenses 92 71 29
Underwriting and administrative expenses 61 43 45
---------- ---------- ----------
Underwriting income $ 112 $ 49 123%
---------- ---------- ----------
Net investment income 47 35 37
Interest expense 5 - -
Income tax expense 2 7 (74)
Amortization of goodwill - 7 -
---------- ---------- ----------
Net operating income $ 152 $ 70 117%
---------- ---------- ----------
Loss and loss expense ratio 34.6% 43.5%
Underwriting and administrative expense ratio 23.2% 25.9%
Combined ratio 57.8% 69.4%
48
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
On the strength of a favorable underwriting environment and an absence of
any significant loss activity, the Global Reinsurance segment increased its
underwriting income by 123 percent to $112 million for the six months ended
June 30, 2002 compared with $49 million for the six months ended June 30, 2001.
The reinsurance market continues to show discipline in both pricing and
underwriting terms and prices in the property classes continue to increase
although reinsurance rate increases are beginning to stabilize. Gross
premiums written increased by 77 percent to $588 million compared with $333
million last year.
In ACE Tempest Re, where we write most of the property catastrophe
business, net premiums written increased by 64 percent and prices continue
to increase at rates that we expect will lead to returns on equity in
excess of 25 percent.
ACE Tempest U.K., which is principally focused on specialty reinsurance
products, increased its net premiums written by 83 percent to $137 million
for the six months ended June 30, 2002 compared with $75 million for the
same period last year. ACE Tempest U.S., increased its net premiums written
to $79 million for the current period compared with $20 million for the
same period last year.
The loss and loss expense ratio improved from 43.5 percent for the six
months ended June 30, 2001 to 34.6 percent for the current period due to
the absence of any significant loss activity and the increase in net
premiums earned in the current period. The underwriting and administrative
expense ratio decreased to 23.2 percent for the six months ended June 30,
2002 compared with 25.9 percent last year despite increased policy
acquisition costs and administrative expenses, due to a change in the mix
of business and increased costs due to business expansion at ACE Tempest
U.S. and ACE Tempest U.K. This decrease is due to the increase in net
premiums earned this period. Net operating income increased by 117 percent
due to the increase in underwriting income from all the divisions.
Life Reinsurance
Six Months Ended
June 30
2002 2001
----------- -------------
(in millions of U.S. dollars)
Gross premiums written $ 57 $ 31
Net premiums written 55 31
Net premiums earned 55 31
Life and annuity benefits 46 29
Underwriting and administrative expenses 15 2
Net investment income 12 -
---------- -----------
Net operating income $ 6 $ -
---------- -----------
During the six months ended June 30, 2002, the life reinsurance group
reported $6 million in net operating income compared with nil for the same
period last year. 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 life and variable products.
49
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Financial Products
Six Months Ended Percentage
June 30 Change
2002 2001 From Prior Year
------------ -----------------------------------
(in millions of U.S. dollars)
<s> <c> <c> <c>
Gross premiums written $ 806 $ 806 -
Net premiums written 793 797 (1)
Net premiums earned 462 693 (33)
Losses and loss expenses 362 616 (41)
Underwriting and administrative expenses 67 53 (28)
---------- ---------- -------------
Underwriting income $ 33 $ 24 36%
---------- ---------- -------------
Net investment income 95 84 13
Other income - 1 -
Interest expense 7 7 -
Income tax expense 17 11 55
Amortization of goodwill - 2 -
---------- ---------- -------------
Net operating income $ 104 $ 89 17%
---------- ---------- -------------
Loss and loss expense ratio 78.2% 88.9%
Underwriting and administrative expense ratio 14.6% 7.5%
Combined ratio 92.8% 96.4%
This segment's net operating income increased by 17 percent to $104 million
for the six months ended June 30, 2002 compared with $89 million for the
same period last year. This increase was principally driven by
changes in our business mix which reduced our combined ratio for this
segment to 92.8 percent compared with 96.4 percent last year. Gross premiums
written were flat compared with the same period last year. However, last year
included $417 million of LPTs which were written and earned in the same period.
Our financial guaranty operations reported an increase of 17 percent in net
operating income for the six months ended June 30, 2002 compared with the
six months ended June 30, 2001. During the period, 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
and trade credit insurance was strong so we were able to increase our
writings in both these areas.
50
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
The financial solutions operations had net premiums earned of $336 million for
the six months ended June 30, 2002, a 29 percent decline over the same period
last year. This unit was successful in writing several large multi-year,
prospective, structured programs during the period, however, the premium
for the same period last year was bolstered by several LPTs.
As previously stated, LPTs are typically recorded at higher loss ratios
than our other lines of business and as a result the absence of any
significant LPTs in the six months ended June 30, 2002 had the effect of
reducing our loss and loss expense ratio compared with last year. The loss
and loss expense ratio improved from 88.9 percent for the six months ended
June 30, 2001 to 78.2 percent for the current period. The underwriting and
administrative expense ratio was lower in 2001, comared with 2002, due to the
high level of earned premiums for the LPTs in 2001.
Net Investment Income
The following table provides an analysis of our net investment income by
segment for the three and six months ended June 30, 2002 and 2001:
Three Months Ended Six Months Ended
June 30 June 30
2002 2001 2002 2001
--------- --------- -------- --------
(in millions of U.S. dollars)
Insurance - North American $ 103 $ 105 $ 205 220
Insurance - Overseas General 28 29 49 57
Global Reinsurance - P&C 23 17 47 35
Global Reinsurance - Life 6 1 12 -
Financial Products 46 42 95 84
Corporate and other (1) (5) 2 (7) 5
-------- -------- -------- ------
Net investment income $ 201 $ 196 $ 401 401
======== ======== ======== ======
(1) Includes ACE Limited, ACE INA Holdings and intercompany eliminations.
Net investment income is influenced by a number of factors, including the
amounts and timing of inward and outward cash flows, the market level of
interest rates as well as overall asset allocation. Net investment income
increased by 2 percent to $201 million for the quarter ended June 30, 2002
compared with $196 million for the same quarter last year.
The proceeds from our sale of Ordinary Shares in the fourth quarter of 2001
and positive cash flow over the past four quarters resulted in an increase
in net investment income of approximately $26 million for the current
quarter compared with the same quarter last year. This increase was offset
by a decrease of $21 million in investment income principally due to
reinvesting at lower yields on cash and short-term deposits, the rollover
of our portfolio at lower current yields and the use of funds to reduce our
current debt levels.
Net investment income was unchanged at $401 million for the six months
ended June 30, 2002 and 2001. The proceeds from our equity offering in the
fourth quarter of 2001 and positive cash flow resulted in an increase in net
investment income of approximately $54 million for the current period
compared with the same period last year. This increase was offset by a $54
million decrease in investment income for the same reasons discussed above.
51
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Net Realized Gains (Losses) on Investments
Our investment strategy takes a long-term view and our portfolio is
actively managed to maximize total return within certain specific
guidelines, which are designed to minimize risk. Our investment portfolio
is reported at fair value, however the effect of market movements on our
portfolio impact income (through net realized gains (losses) on
investments) when securities are sold, when permanent impairments are
recorded on invested assets or when financial futures, options and interest
rate swaps are marked to market. 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. The following
table presents our net realized gains (losses) on investments for the three
and six months ended June 30, 2002 and 2001:
Three Months Ended Six Months Ended
June 30 June 30
2002 2001 2002 2001
------------ ------------ ------------ -----------
(in millions of U.S. dollars)
<s> <c> <c> <c> <c>
Fixed maturities and short-term investments $ (25) $ (19) $ (39) $ (11)
Equity securities 4 11 (2) 24
Financial futures, options and interest rate swaps (88) 11 (80) (18)
Fair value adjustment on derivatives (33) 11 (46) 15
Currency 3 - 2 (4)
Other investments - 2 - (10)
-------- -------- --------- ---------
Total net realized gains (losses) on investments $ (139) $ 16 $ (165) $ (4)
======== ======== ========= =========
Net realized losses on fixed maturities during the second quarter of 2002
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 the current quarter was $24 million.
Net realized losses on investments of $165 million included write-downs
for the six months ended June 30, 2002 of $42 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. Losses of $30 million were recognized on interest rate
swaps during the second quarter of 2002. Net realized losses generated by
our equity and fixed income index futures and option contracts amounted to
$58 million for the current quarter, bringing the total net realized losses
attributable to financial futures and option contracts and interest rate
swaps to $88 million compared with gains of $11 million for the same
quarter in 2001.
52
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
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 June 30, 2002 was a loss of
$33 million compared with a gain of $11 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.
Other Expenses
Three Months Ended Six Months Ended
June 30 June 30
2002 2001 2002 2001
------- -------- ---------- ---------
(in millions of U.S. dollars)
Other (income) expense $ 12 $ (1) $ 7 $ 3
====== ======= ======= =======
Interest expense $ 52 $ 50 $ 98 $ 104
====== ======= ======= =======
Income tax expense $ 21 $ 18 $ 45 $ 45
====== ======= ======= =======
Amortization of goodwill $ - $ 20 $ - $ 40
====== ======= ======= =======
Other (income) expense includes $11 million ($7 million, net of income tax)
in debt prepayment expense incurred in the second quarter as a result of
the prepayment of a portion of the ACE INA Subordinated Notes due in 2009.
Interest expense increased by $2 million for the current quarter compared
with the quarter ended June 30, 2001, primarily because we issued $500
million of debt (discussed in the Capital Resources section below) late in
the first quarter of 2002. The impact of this was offset by lower
short-term interest rates on our floating rate debt.
The effective tax rate on net operating income calculated at June 30, 2002 was
14.2 percent compared with 17.9 percent last year due to higher net operating
income in non-taxable jurisdictions in 2002. Realized losses on investments
for the current quarter were primarily in non-taxable jurisdictions resulting
in an effective tax rate on net income of 16.6 percent compared with 12.2
percent in 2001. The effective tax rate on net operating income for the six
months ended June 30, 2002 was 13.5 percent compared with 14.9 percent for the
same period last year due to higher net operating income in taxable
jurisdictions in 2002. The effective tax rate on net income for the six months
ended June 30, 2002 was 12.9 percent compared with 14.2 percent last year due
to the impact of taxable benefits on realized losses in both years.
53
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
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 adopted FAS 142 on January 1, 2002 and ceased amortizing goodwill
as at that date.
Interest expense decreased by 6 percent for the six months ended June 30,
2002 compared with the six months ended June 30, 2001. This decrease is
primarily attributed to lower short-term interest rates on our floating
rate debt for the current period as compared with the same period last
year.
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 with an average credit quality of AA as rated by Standard
and Poor's ("S&P"). The portfolio is externally managed by independent
professional investment managers. The average duration of our fixed income
securities is 3.2 years at June 30, 2002.
At June 30, 2002, total investments and cash were $16.9 billion compared
with $15.9 billion at December 31, 2001, an increase of $1 billion. The
increase in total investments and cash primarily results from the net
proceeds of our debt offering at the end of the first quarter, securities
lending collateral of $419 million and strong operating cash flows.
Offsetting these increases, we paid dividends of $91 million during the
period. 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. We evaluate the carrying value of our investments
and if they experience a decline in value that we consider other than
temporary, we record a realized loss in the statement of operations.
On May 28, 2002 we announced our intent to acquire 22 percent of the
outstanding shares of Huatai Insurance Company of China ("Huatai"), for
total consideration of approximately $150 million. Huatai is China's first
nationally licensed joint stock P&C insurer. To comply with Chinese
regulations, our investment was made by three of our subsidiary companies:
ACE INA Holdings Inc., ACE Tempest Re and ACE US Holdings Inc.
The following table identifies our invested assets at fair value, by type
held at June 30, 2002 and December 31, 2001:
June 30 December 31
2002 2001
---------------- ---------------
(in millions of U.S. dollars)
Fixed maturities available for sale $ 12,834 $ 13,000
Equity securities 462 467
Short-term investments 1,774 1,206
Other investments 628 591
Securities on loan 411 -
Cash 878 672
----------- ----------
Total investments and cash $ 16,987 $ 15,936
=========== ==========
54
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
The following tables identify our fixed income securities, short-term
investments, securities on loan and cash and cash equivalents at June 30,
2002. The first table shows the amount of items by type while the second table
shows them by S&P credit rating.
June 30, 2002 Percentage
Market Value Of Total
---------------- ---------------
(in millions of U.S. dollars)
Treasury $ 878 5.5%
Agency 1,012 6.4%
Corporate 6,632 41.7%
Mortgage-backed securities 2,078 13.1%
Asset-backed securities 326 2.1%
Municipal update 1,115 7.0%
Non-US 1,406 8.8%
Cash and cash equivalents 2,450 15.4%
----------- ----------
Total $ 15,897 100%
=========== ==========
June 30, 2002 Percentage
Market Value Of Total
----------------- ---------------
(in millions of U.S. dollars)
AAA $ 6,518 41%
AA 3,796 24%
A 2,874 18%
BBB 1,520 9%
BB 568 4%
B 580 4%
Other 41 0%
----------- -----------
Total $ 15,897 100%
=========== ===========
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 table below presents a reconciliation of our unpaid losses and loss
expenses for the six months ended June 30, 2002:
55
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
<table>
<caption>
Reinsurance
Unpaid Losses and Loss Expenses Gross Recoverable Net
(in millions of U.S. dollars)
<s> <c> <c> <c>
Balance at December 31, 2001 $ 20,728 $ 10,327 $ 10,401
Losses and loss expenses incurred 3,405 1,591 1,814
Losses and loss expenses paid (3,531) (1,580) (1,951)
Foreign exchange revaluation 59 38 21
------------ ---------- ----------
Balance at June 30, 2002 $ 20,661 $ (10,376) $ 10,285
============ ========== ==========
The reserve for unpaid losses and loss expenses was relatively unchanged at
June 30, 2002, and December 31, 2001, and includes $12.8 billion of case
and loss expense reserves. The process of establishing reserves for P&C
claims continues to be a complex and imprecise one, requiring the use of
informed estimates and judgments. Our estimates and judgments may be
revised as claims develop and 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
June 30, 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 unpaid 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 unpaid losses as well
as amounts recoverable from reinsurers with respect to claims, which we have
already paid. The table below presents our net reinsurance recoverable at June
30, 2002 and December 31, 2001.
56
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
June 30, December 31,
2002 2001
--------------- ---------------
(in millions of U.S. dollars)
<s> <c> <c>
Net Reinsurance Recoverable
Reinsurance recoverable on paid losses and loss expenses $ 1,253 $ 1,066
Reinsurance recoverable on future policy benefits 7 5
Reinsurance recoverable on unpaid losses and loss expenses 11,174 11,116
----------- ------------
Total reinsurance recoverable 12,434 12,187
Bad debt provision (797) (789)
----------- ------------
Net reinsurance recoverable $ 11,637 $ 11,398
=========== ============
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 provision 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, including those related to asbestos and environmental
pollution. Provisions have been established for amounts estimated to be
uncollectible.
Following is a breakdown of our reinsurance recoverable on paid losses at
June 30, 2002:
Category Amount Bad Debt Provision and %
----------------------------------------------------------------
(in millions of U.S.
dollars)
Current $ 717 $ 33 4.6%
Other 536 349 65.1
----------- ---------- ---------
Total $ 1,253 $ 382 30.5%
=========== ========== =========
The current category represents amounts in process of collection in the
normal course of business, for which we have no indication of dispute or
credit issues. We provide bad debt provisions based primarily on the
application of historical loss experience to credit categories and
historical dispute statistics.
57
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
The other category includes amounts recoverable that are in dispute, or are
from companies, who are in supervision, rehabilitation or liquidation. Our
estimation of this provision considers the credit quality of the reinsurer,
based on independent assessments provided by rating agencies and whether we
have received collateral or other credit protections such as letters of
credit. In addition, we also consider any information we may have regarding
the reinsurers plans to dispute amounts recoverable and make judgments
based on our knowledge and experience regarding the specific items in
dispute.
The following tables provide a listing of our largest reinsurers with the
first category representing the top 10 and the second category representing
the next 20 in terms of the levels of reinsurance recoverable. Our bad debt
provision in the first two categories is principally based on an analysis of
the credit quality of the reinsurer, and collateral balances. The third
category includes amounts due from over 2,500 companies each having balances
of less than $20 million. The next category, mandatory pools and government
agencies, are amounts backed by the Government. Insurance companies are
required by law to participate. We have assumed no bad debts or disputed
amounts for this category. Structured settlements are annuities purchased from
life insurance companies to settle workers compensation claims. These amounts
are assigned principally to large, highly rated life insurance companies.
Since we retain the ultimate liability in the event that the assigned company
fails to pay, we reflect the amount as a liability and a recoverable for GAAP
purposes. These amounts are not subject to dispute and we establish our bad
debt provision based on the credit quality of the life insurers, as assessed
by rating agencies. The next category, captives, are companies established by
our insurance clients to assume a significant portion of their direct
insurance risk from us (i.e. they are structured to allow clients to
self-insure a portion of their own risk). It is our policy to obtain
collateral equal to expected losses. Our final category, other, includes
amounts recoverable that are in dispute, or are from companies that are in
supervision, rehabilitation, or liquidation. This category of our recoverables
is analyzed very carefully. We establish our bad debt provision for these
categories based on a case by case analysis of individual situations,
including credit and collateral analysis and consideration of our collection
experience in similar situations. Another consideration we make in
establishing our bad debt provision relates to the reinsurance protection
purchased from National Indemnity Company (NICO) in the Westchester Specialty
and CIGNA P&C acquisitions. In both instances, the coverage provides
reimbursement for amounts uncollectible from reinsurers. The remaining limits
under these contracts are available for both future loss reserve development
and uncollectible recoverables.
Breakdown of Reinsurance Bad Debt
Recoverable December 31 Provision and %
---------------------- ----------- -----------------
2001
Categories
Top 10 reinsurers $ 5,835 $ 51 0.9%
Next 20 reinsurers 1,054 32 3.0
Individual balances less than $20 million 1,860 194 10.4
Mandatory pools and government agencies 903 - 0.0
Structured settlements 682 3 0.5
Captives 924 - 0.0
Other 929 509 54.8
--------- ------- -------
Total $ 12,187 $ 789 6.5%
========= ======= =======
58
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Top 10 Reinsurers Next 20 Reinsurers
----------------- ------------------
AXA AIG Markel
Berkshire Group CNA Group Overseas Partners
Employers Re Eagle Star Re PMA Reins Corp
Equitas Eureko BV QBE
Hannover Re Everest Rein Co Renaissance Reins. Ltd.
Lloyd's Fairfax Holdings Royal & Sun Alliance Ins.
Munich Re Gerling Global Scan Re
Swiss Re Hartford SCOR
XL Capital IRB - Brasil Re St. Paul
Zurich Ins. Corp Liberty Mutual TOA
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,
that are referred to as A&E. 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.
The table below presents loss reserve details for A&E exposures at June 30,
2002 and December 31, 2001:
June 30, 2002 December 31, 2001
Gross Net Gross Net
---------------- ---------------- --------------- ---------------
(in millions of U.S. dollars)
<s> <c> <c> <c> <c>
Asbestos $ 1,129 $ 115 $ 1,119 $ 149
Environmental and Other 961 372 1,089 452
------------ ------------ ------------ -----------
Total $ 2,090 $ 487 $ 2,208 $ 601
============ ============ ============ ===========
Survival ratios attempt to measure the adequacy of A&E loss reserves by
taking the current ending loss reserve and dividing by the average annual
claim payments for the prior three years. We believe 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 our last 3 years of A&E 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 is 9.1 years. These
ratios take into account the remaining coverage under the NICO
reinsurance contract. More information relating to our asbestos exposure
including our asbestos reserving process follows.
Background
Our exposure to asbestos principally arises out of liabilities acquired
when we purchased the P&C business of CIGNA in 1999 and when we purchased
Westchester Specialty from Talegen in 1998. While we certainly have other
insurance operations, exposure to asbestos liabilities are concentrated in
these two areas of our business. Of these two areas of business, the larger
exposure is contained within the liabilities acquired from the CIGNA
acquisition. These liabilities reside in the various subsidiaries of
Brandywine Holdings ("Brandywine"), which was created in 1995 by the
restructuring of ACE INA's domestic operations into separate ongoing and
run-off operations.
59
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
As part of the acquisition of the CIGNA P&C business, NICO provided
reinsurance protection against adverse development for the aggregate
liabilities of Brandywine, including environmental and asbestos
liabilities. As part of the acquisition of the Westchester business, NICO
provided $750 million (75% quota share of $1 billion) of reinsurance
protection for adverse development for all losses occurring prior to 1997.
As of June 30, 2002 the remaining limit in the NICO reinsurance cover
protecting Brandywine is $533 million. ACE Bermuda has a 10 percent
retrocession from NICO that would equate to a $53.3 million participation
in the remaining limits. As of June 30, 2002 the remaining limit in the
NICO reinsurance cover protecting Westchester was approximately $600
million.
Paying for the unimpaired
A large majority of current asbestos cases are dominated by claimants who are
not physically sick by any accepted medical standard. Reports of pending
claims by two major asbestos manufacturers in 2001 indicate that at least
two-thirds are for harmless conditions with no evidence of impairment.
Court decisions and legislation have begun to recognize the unfairness of
the situation and the strain it puts on resources available to compensate
truly impaired claimants. For instance, the federal judge presiding over
all federal asbestos cases has dismissed any and all claims that do not
have an actual medical diagnosis of any asbestos-related disease. In
addition, states such as Massachusetts, Maryland and Pennsylvania defer
unimpaired claims until actual injury is demonstrated. New York, Ohio,
Indiana and Texas are considering similar approaches to address the
unimpaired problem.
Traditional tort common law prohibits compensation for emotional injuries
without proof of objective manifestation of the injury. To date, unimpaired
claimants have tended to receive compensation as part of large settlement
pools where unimpaired claimants are packaged by plaintiffs' lawyers along
with seriously injured claimants whose presence in the pool yields
heightened compensation for the entire pool. We believe that a high level
of concern by (1) a judiciary facing dockets swamped with asbestos claims;
(2) some prominent plaintiffs' lawyers worrying about fair compensation for
the truly injured who are becoming a diminishing percentage of all asbestos
claims, and, (3) defendants with peripheral contact to asbestos facing
financial ruin, will force unimpaired claimants to prove injury under
traditional common law standards. In addition, we believe that many
unimpaired claimants who cannot meet the traditional evidentiary standard
will ultimately be removed from the judicial system until there is
objective proof of onset of actual disease.
Peripheral and unidentified asbestos defendants
The inability of the tort system to manage and resolve asbestos cases
fairly has resulted in an alarming number of bankruptcies, nearly 60 at
last count. Bankruptcy courts may provide a rational and workable claim
administration facility for many asbestos defendants overwhelmed with
claims, the majority of which are filed on behalf of unimpaired claimants.
When the most culpable asbestos defendants file for bankruptcy, the
remaining defendants become targets. Since the bankruptcy process may
eliminate the defendants with the highest percentage of asbestos- related
liability, claimants proceed against the peripheral co-defendants to force
them to pick up the bankrupt shares.
60
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
The issue for the co-defendants is whether the applicable state law makes
them liable on a joint and several basis for the entire claim, including
the bankrupt shares. Most states have enacted laws limiting at least some
of the financial exposure for marginally responsible parties to the
percentage of fault actually assigned those parties at trial. And in the
context of the Federal Employers' Liability Act, the United States Supreme
Court, in the Norfolk & Western Railway v. Ayers case, is considering
whether to limit the liability of peripheral defendants as well as
compensation for the unimpaired. We believe that a positive ruling from the
US Supreme Court in Ayers would help present a road map for other courts in
refocusing dollars for the truly impaired claimants to be paid by the
defendants based on their actual percentage of liability.
Claimants' lawyers have been looking for new sources of compensation to
relieve the pressure on limited resources caused by bankruptcies and
unimpaired claims far beyond the original asbestos and building material
defendants. A report of the RAND Institute for Civil Justice estimates that
over 6,000 different defendants representing peripheral industries such as
manufacturers of food and beverage, textiles, paper, glass, iron and steel
and durable metal goods have already been sued. In view of the large number
of defendants already identified in hugely diverse industries after years
of research, we believe that most legitimate defendants with serious
asbestos liability have been identified although we are unable to predict
the extent to which other peripheral defendants with decreasing degrees of
potential liability may be named in future suits. We believe that some
claims against peripheral defendants will also be pushed towards trial
situations where rules limiting liability for tangential responsibility
apply and that the anticipated reduction in the exposure to unimpaired
claims will help relieve the pressure to find new defendants.
High profile defendants
We have provided various levels of liability coverage for 48 of the
original group of target defendants generally thought to have the most
serious asbestos exposure. The status of the 21 policyholders (out of the
48) with the greatest asbestos exposure is as follows: 13 have been
resolved by us and the remaining 8 are reserved at or near actual policy
limits or limits agreed to with the policyholder. Of the remaining 27
policyholders, 20 are resolved or reserved for ultimate potential exposure
at a level we are confident will have little variability. Three of the
remaining policyholders are fully reserved based on the law as we believe
it is developing and our experience and judgment and there is a possibility
(but low probability) of a high level of variability around the potential
outcomes. The final four policyholders involve excess policies subject to
the resolutions of liability and coverage issues by and with underlying
insurers. Additional reserves have been established for target
policyholders where exposure exists for potential operations or
non-products exposures beyond the product liability limits.
Reserving process
We conduct a reserve review of our asbestos reserves on a
quarterly basis. This reserve review includes a detailed individual claim
review and analysis of the policies at issue, legal precedents, as well as
factual and investigative developments. In the context of our asbestos
reviews, many risk factors are considered, including paying for unimpaired
claimants and targeting of peripheral defendants. We also consider multiple
recoveries by claimants for various defendants; the ability of a claimant
to bring a claim in a State in which they have no residency or exposure;
the ability of a policyholder to claim the right to non-products coverage;
and whether high level excess policies have the potential to be accessed
given the policyholders claim trends and liability situation. It should be
noted that results in other asbestos cases announced by other carriers may
very well have little or no relevance to us because other coverage
exposures are highly dependent upon the specific facts of individual
coverage and resolution status of disputes among carrier, policyholder and
claimants.
61
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
Based on the policies, the facts, the law and a careful analysis of the
impact that these risk factors will likely have on any given account, we
estimate the potential liability for indemnity, policyholder defense costs
and coverage litigation expense. There are many complex variables (such as
variables associated with the issues discussed above) that are considered when
estimating the reserves for our inventory of asbestos accounts. The variables
involved may directly impact the predicted outcome. Sometimes, the outcomes
change dramatically based on a small change in one risk factor related to just
one account.
Our current asbestos reserves are based upon an assessment of our policies,
legal precedents and investigative facts, and how the various risk factors
are likely to be played out as those issues are litigated. If our
assessments prove to be somewhat less favorable than believed, we have
adequate protection in our NICO cover. Our reserve review process involves
a continual evaluation of cases taking into account all currently known
information as well as reasonable assumptions related to unknown
information. When facts and circumstances change, including the impact of
the risk factors, we change our reserves to best reflect our estimate of
ultimate reserves. While reserving for these claims is inherently
uncertain, we believe that the reserves carried for these claims are
adequate based on known facts and current laws. See Note 4 of the
Consolidated Financial Statements.
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 net investment income, its cash flows currently depend
primarily on dividends or other statutorily permissible payments from its
Bermuda-based operating subsidiaries. During the six months ended June 30, 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 six month ended June 30, 2002, ACE Bermuda declared
dividends of $195 million. ACE Tempest Re did not declare any dividends
during the period. ACE expects that a majority of its cash inflows for the
remainder of 2002 will be from its Bermuda subsidiaries. Management
assesses which subsidiaries to draw dividends from based on among other
things, regulatory and legal restrictions and the subsidiary'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. 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.
62
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
During the six months ended June 30, 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.
Our consolidated sources of funds consist primarily of net premiums
written, net 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 net 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 $571 million for the six months ended June 30, 2002 compared with $473
million for the six months ended June 30, 2001. 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 $2.0 billion and $1.9 billion for the
six months ended June 30, 2002 and 2001, respectively. We believe that we
have sufficient liquidity to meet our anticipated cash flow obligations,
including those resulting from the September 11th tragedy. During the six
months ended June 30, 2002 we made gross claim payments of $426 million
with respect to the September 11th tragedy. On a net basis, our payment
with respect to this claim was $64 million during the current period and
approximately 95 percent of the related recoverable has been collected.
Although our 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 $309 million for the six months ended June 30, 2002 compared with
negative cash flows of $413 million for the same period 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.
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.
63
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
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 June 30, 2002 and December 31, 2001:
June 30 December 31
2002 2001
-------------- ------------------
(in millions of U.S. dollars)
Shareholders' equity $ 6,384 $ 6,107
Mezzanine equity 311 311
Trust preferred securities 675 875
Long-term debt 1,799 1,349
Short-term debt 224 495
---------- ----------
Total capitalization $ 9,393 $ 9,137
========== ==========
Debt to total capitalization 21.5% 20.2%
We believe 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.
As of June 30, 2002 we had reduced short-term debt by $271 million from the
level at December 31, 2001. In addition, $50 million of ACE INA
Subordinated Notes due 2009 was repaid during the quarter. An after tax
premium of $7 million was paid to retire the ACE INA Notes. This cost was
mostly attributable to the decrease in interest rates since the original
note was issued. We expect to continue to reduce our long-term debt over the
next several quarters, which may result in additional debt prepayment
expense but which will also reduce our interest expense. We will also use
$75 million from the debt proceeds to repay the ACE Financial Services debt
which matures in November 2002. Our ability to access the capital markets
is dependent on among other things market conditions and our perceived
financial strength.
In 1999, ACE RHINOS Trust sold in a private placement, $400 million of
Auction Rate Reset Preferred Securities ("Preferred Securities"). The sole
assets of the Trust consist of $412 million of Auction Rate Reset
Subordinated Notes Series A ("Subordinated Notes") issued by ACE INA.
Proceeds of an Ordinary Share Offering in September 2000, were used to support
our guarantee of the Subordinated Notes. During the quarter ended June 30, 2002
we repaid $200 million in principal amount of Preferred Securities. We will
repay the remaining $200 million of these Preferred Securities when they become
due during the quarter ending September 30, 2002.
64
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
In addition, 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 June 30,
2002, the amount available under this 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 $24.21 at June 30, 2002, compared
with $23.59 at December 31, 2001, reflecting an increase of 3 percent
during the period. Shareholder's equity increased by $277 million during
the six months ended June 30, 2002, due primarily to our net income, which
was partially offset by dividends declared during the period.
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 $250 million. As of June 30, 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. On July 12, 2002 we paid dividends of 17 cents per share to
shareholders of record on June 28, 2002. On August 8, 2002, we declared a
quarterly dividend of 17 cents per share payable on October 11, 2002 to
shareholders of record on September 27, 2002. 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.
65
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
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)
Less After
than 1-3 4-5 5 Years
Total 1 Year Years Years
<c> <c> <c> <c>
Short-term debt $ 224 $ 224 $ - $ - $ -
Long-term debt 1,799 - 400 799 600
Trust preferred securities 675 200 - - 475
-------- --------- --------- --------- ---------
Total contractual obligations and commitments $ 2,698 $ 424 $ 400 $ 799 $ 1,075
======== ========= ========= ========= =========
During the first quarter of 2002, we issued $500 million, five 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 event of default provisions, which if breached
could accelerate the maturity of such senior debt. The proceeds were used
for general corporate purposes and to reduce other debt as described in
Capital Resources. The notes are not redeemable before maturity and do not
have the benefit of any sinking fund.
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 first quarter of 2002 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 first quarter of 2002.
At June 30, 2002, short-term debt consisted of $149 million in commercial
paper and the ACE Financial Services $75 million 7.75 percent debentures
which mature in November 2002. We have the ability to either repay the
debentures or obtain alternative financing in the capital markets upon
maturity. We intend to repay the debt using proceeds from the March 2002
debt offering.
66
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
We continue to have access to substantial liquidity resources. In the event
of any future disruption in the commercial paper markets, we have access to
our cash resources, our 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.
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 for 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 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 $673 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 $446 million at June 30, 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
Markets arising from the September 11th tragedy. Usage under this facility
was $130 million at June 30, 2002 and at December 31, 2001. The LOCs issued
under both of these facilities are principally used to support unpaid losses and
loss expenses already reflected in our balance sheet.
All of the facilities described above require that we maintain certain
covenants. These covenants include:
67
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
(i) a minimum consolidated net worth of $3.6 billion plus 25 percent of
cumulative net income since March 31, 2000 and;
(ii) a maximum debt to total capitalization ratio of 0.35 to 1. 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 comply with the covenants under any credit facility would
(subject to grace periods in the case of certain covenants) result in an
event of default and we could be required to repay any outstanding
borrowings (or to cash collateralize letters of credit) under such
facility. An event of default under one or more credit facilities with
outstanding credit extensions of $25 million or more would result in an
event of default under all of the facilities described above.
At June 30, 2002, the minimum consolidated net worth requirement under the
covenant was $3.9 billion and our actual consolidated net worth as
calculated under the covenant was $6.2 billion and our ratio of debt to
total capitalization was 0.215 to 1.
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 June 30, 2002, ACE Guaranty Re Inc. was party to a 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
(pound)900 million. We also maintain various other LOC facilities; both
collateralized and uncollateralized, for general corporate purposes. At
June 30, 2002, the aggregate availability under these facilities was $521
million and usage was $396 million.
More information regarding our contractual obligations, commitments and
credit facilities can be found in our consolidated financial statements, and
related notes and 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.
68
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 lesser extent, our debt obligations. A hypothetical
adverse parallel shift in the yield curve of 100 basis points would have
resulted in a decrease in total return of 3.1 percent on our fixed income
portfolio at June 30, 2002 compared with 3.2 percent at December 31, 2001.
This equates to a decrease in market value of approximately $442 million on
a fixed income portfolio valued at $14.6 billion at June 30, 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 $1 billion at June 30, 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 a
$100 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 shareholders' 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 June 30, 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 June 30, 2002, we had no derivatives that were designated
as hedges.
69
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.)
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.
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 values, which are 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. During the six months ended June 30, 2002, we have
recorded in net realized gains (losses) on investments, a pretax loss of
$46 million to reflect the change in the fair value of derivatives. 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 "Goodwill and Other Tangible Assets". 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 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. FAS 142 requires that goodwill in
each reporting unit 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. Management has determined there was no impairment in
goodwill as a result of the test.
70
ACE LIMITED
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Our insurance subsidiaries are subject to claims litigation involving
disputed interpretations of policy coverages and in some jurisdictions,
direct actions by allegedly injured persons seeking damages from
policyholders. These lawsuits involving claims on policies issued by our
subsidiaries which are typical to the insurance industry in general and in
the normal course of business, are considered in our loss and loss expense
reserves which are discussed in the property and casualty loss reserves
discussion. In addition to claims litigation, we and our subsidiaries are
subject to lawsuits and regulatory actions in the normal course of business
that do not arise from or directly relate to claims on insurance policies.
This category of business litigation typically involves, inter alia,
allegations of underwriting errors or misconduct, employment claims,
regulatory activity or disputes arising from our business ventures. While
the outcomes of the business litigation involving us cannot be predicted
with certainty at this point, we are disputing and will continue to dispute
allegations against us that are without merit and believe that the ultimate
outcomes of matters in this category of business litigation will not have a
material adverse effect on our financial condition, future operating
results or liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
1. The Annual General Meeting was held on May 16, 2002.
2. The following matters were voted on at the Annual General Meeting:
a) The following directors were elected.
Shares with Shares with
Term Expiring Votes in Favor Votes Withheld
Dominic J. Frederico 2005 229,034,301 1,744,217
Donald Kramer 2005 229,088,811 1,689,707
John A. Krol 2005 229,073,397 1,705,121
Robert G. Mendoza 2005 229,085,808 1,692,710
Walter A. Scott 2005 229,089,113 1,689,405
The number of shares obstained and the number of broker non-votes was
nil.
b) The appointment of PricewaterhouseCoopers LLP as independent
accountants for the Company for the year ended December 31, 2002
was ratified and approved.
The holders of 226,778,023 shares voted in favor, 3,237,484
shares voted against and 763,011 shares abstained. There were no
broker non-votes.
ITEM 5. OTHER INFORMATION
1. On May 16, 2002, the Company declared a quarterly dividend of $0.17
per Ordinary Share payable on July 12, 2002 to shareholders of record
on June 28, 2002.
2. On August 8, 2002, the Company declared a quarterly dividend of $0.17
per Ordinary Share payable on October 11, 2002 to shareholders of
record on September 27, 2002.
3. On August 8, 2002, the Company announced that Evan Greenberg has been
appointed to its Board of Directors, effective immediately. Evan
Greenberg joined ACE as Vice Chairman of ACE Limited and CEO of ACE
Tempest Re in November 2001. In February 2002, he also assumed
responsibility for all of ACE's international insurance operations.
71
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
1. Exhibits
10.1 Second Amendment and Restatement dated as of April 5, 2002, amending
the credit agreement dated as of May 8, 2000, among ACE Limited,
certain subsidiaries, various lenders and J.P. Morgan Securities Inc.
10.2 Third Amendment dated as of April 5, 2002, amending the Amended
and Restated Five Year Credit Agreement dated as of May 8, 2000,
and as amended October 23, 2000 among ACE Limited, certain
subsidiaries, various lenders and JP Morgan Chase Bank (formerly
known as Morgan Guaranty Trust Company of New York).
10.3 Second Amendment dated as of April 5, 2002, amending the
Reimbursement agreement dated as of August 24, 2001 and as amended
October 23, 2001 among ACE Limited, certain subsidiaries, various
lenders and Wachovia Bank, National Association (formerly known as
First Union National Bank).
10.4 * The ACE Limited 1995 Outside Directors Plan (As amended through the
fifth amendment)
* Management Contract or Compensation Plan
2. There were no reports on Form 8K filed during the quarter.
72
ACE LIMITED
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
-----------------------------------------
August 13, 2002 /s/ Brian Duperreault
-----------------------------------------
Brian Duperreault
Chairman and Chief
Executive Officer
August 13, 2002 /s/ Phillip V. Bancroft
-----------------------------------------
Phillip V. Bancroft
Chief Financial Officer
73
ACE LIMITED
EXHIBIT INDEX
Exhibit Description Numbered
Number Page
1. Exhibits
10.1 Second Amendment and Restatement dated as of April 5, 2002,
amending the credit agreement dated as of May 8, 2000, among
ACE Limited, certain subsidiaries, various lenders and J.P.
Morgan Securities Inc.
10.2 Third Amendment dated as of April 5, 2002, amending the
Amended and Restated Five Year Credit Agreement dated as of
May 8, 2000, and as amended October 23, 2000 among ACE
Limited, certain subsidiaries, various lenders and JP Morgan
Chase Bank, formerly known as Morgan Guaranty Trust Company
of New York.
10.3 Second Amendment dated as of April 5, 2002, amending the
Reimbursement agreement dated as of August 24, 2001 and as amended
October 23, 2001 among ACE Limited, certain subsidiaries, various
lenders and Wachovia Bank, National Association (formerly known as
First Union National Bank).
10.4 The ACE Limited 1995 Outside Directors Plan (As amended through
the fifth amendment)*
* Management Contract or Compensation Plan
74