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 September 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 November 8, 2002 was 262,650,978.
ACE LIMITED
INDEX TO FORM 10-Q
Part I. FINANCIAL INFORMATION Page No.
- ------------------------------ --------
Item 1. Financial Statements:
Consolidated Balance Sheets
September 30, 2002 (Unaudited) and December 31, 2001 3
Consolidated Statements of Operations (Unaudited)
Three and Nine Months Ended September 30, 2002 and 2001 4
Consolidated Statements of Shareholders' Equity (Unaudited)
Nine Months Ended September 30, 2002 and 2001 5
Consolidated Statements of Comprehensive Income (Unaudited)
Nine Months Ended September 30, 2002 and 2001 7
Consolidated Statements of Cash Flows (Unaudited)
Nine Months Ended September 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
Item 3. Quantitative and Qualitative Disclosures about Market Risk 67
Item 4. Controls and Procedures 68
Part II. OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings 69
Item 6. Exhibits and Reports on Form 8-K 69
2
ITEM 1. Financial Statements
- ----------------------------
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 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 -
$12,991,777 and $12,794,444) $ 13,504,458 $ 13,000,165
Equity securities, at fair value (cost - $560,583 and $516,028) 401,142 467,566
Securities on loan, at fair value (amortized cost - $518,177 and $0) 532,876 -
Short-term investments, at fair value 2,004,144 1,205,795
Other investments (cost - $619,077 and $569,045) 645,164 591,006
Cash 649,774 671,381
------------- --------------
Total investments and cash 17,737,558 15,935,913
Accrued investment income 212,342 213,821
Insurance and reinsurance balances receivable 3,208,065 2,521,562
Accounts and notes receivable 240,088 242,724
Reinsurance recoverable 11,889,368 11,398,446
Deferred policy acquisition costs 823,374 679,281
Prepaid reinsurance premiums 1,646,301 1,222,795
Goodwill 2,716,860 2,772,094
Deferred tax assets 1,151,937 1,250,835
Other assets 1,203,892 949,293
------------- --------------
Total assets $ 40,829,785 $ 37,186,764
============= ==============
Liabilities
Unpaid losses and loss expenses $ 21,641,231 $ 20,728,122
Future policy benefits for life and annuity contracts 419,041 382,730
Unearned premiums 5,525,634 3,853,429
Premiums received in advance 44,585 57,486
Insurance and reinsurance balances payable 1,826,319 1,418,001
Contract holder deposit funds 93,136 101,187
Securities lending collateral 546,385 -
Accounts payable, accrued expenses and other liabilities 1,483,048 1,466,127
Dividends payable 47,689 42,044
Short-term debt 220,280 495,408
Long-term debt 1,748,869 1,349,473
Trust preferred securities 475,000 875,000
------------- --------------
Total liabilities 34,071,217 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;
262,495,210 and 259,861,205 shares issued and outstanding) 10,937 10,828
Additional paid-in capital 3,780,132 3,710,698
Unearned stock grant compensation (47,390) (37,994)
Retained earnings 2,419,034 2,321,576
Deferred compensation obligation 18,630 16,497
Accumulated other comprehensive income 284,805 101,599
Ordinary Shares issued to employee trust (18,630) (16,497)
------------- --------------
Total shareholders' equity 6,447,518 6,106,707
------------- --------------
Total liabilities, mezzanine equity and shareholders' equity $ 40,829,785 $ 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 nine months ended September 30, 2002 and 2001
(Unaudited)
Three Months Ended Nine Months Ended
September 30 September 30
2002 2001 2002 2001
------------- ------------- -------------- -------------
(in thousands of U.S. dollars, except per share data)
Revenues
Gross premiums written
Property and casualty premiums $ 3,470,196 $ 2,470,195 $ 9,460,386 $ 7,403,515
Life and annuity premiums 58,529 32,176 115,440 63,155
------------- ------------- -------------- -------------
3,528,725 2,502,371 9,575,826 7,466,670
Reinsurance premiums ceded (1,305,938) (1,197,304) (3,491,633) (2,955,840)
Net premiums written ------------- ------------- -------------- -------------
Property and casualty premiums 2,165,939 1,272,891 5,972,395 4,447,675
Life and annuity premiums 56,848 32,176 111,798 63,155
------------- ------------- -------------- -------------
2,222,787 1,305,067 6,084,193 4,510,830
Change in unearned premiums (297,208) 94,362 (1,223,098) (357,098)
Net premiums earned ------------- ------------- -------------- -------------
Property and casualty premiums 1,868,731 1,367,253 4,749,526 4,090,577
Life and annuity premiums 56,848 32,176 111,569 63,155
------------- ------------- -------------- -------------
1,925,579 1,399,429 4,861,095 4,153,732
Net investment income 199,740 192,909 600,679 593,606
Other income (expense) ` (14,032) (1,858) (21,301) 827
Net realized losses on investments (235,282) (58,843) (400,884) (62,654)
------------- ------------- -------------- -------------
Total revenues 1,876,005 1,531,637 5,039,589 4,685,511
------------- ------------- -------------- -------------
Expenses
Losses and loss expenses 1,327,792 1,541,627 3,141,886 3,447,761
Life and annuity benefits 59,697 29,706 106,004 58,511
Policy acquisition costs 253,013 204,666 685,016 558,996
Administrative expenses 250,668 205,531 677,597 608,615
Interest expense 48,679 49,130 146,633 153,094
Amortization of goodwill - 19,912 - 59,664
------------- ------------- -------------- -------------
Total expenses 1,939,849 2,050,572 4,757,136 4,886,641
------------- ------------- -------------- -------------
Income (loss) before income tax and cumulative
effect of adopting a new accounting standard (63,844) (518,935) 282,453 (201,130)
Income tax expense (benefit) (7,334) (76,345) 37,258 (31,121)
Income (loss) before cumulative effect of adopting ------------- ------------- -------------- -------------
a new accounting standard (56,510) (442,590) 245,195 (170,009)
Cumulative effect of adopting a new accounting
standard (net of income tax) - - - (22,670)
------------- ------------- -------------- -------------
Net income (loss) $ (56,510) $ (442,590) $ 245,195 $ (192,679)
============= ============= ============== =============
Basic earnings (loss) per share before cumulative
effect of adopting a new accounting standard $ (0.24) $ (1.95) $ 0.87 $ (0.82)
============= ============= ============== =============
Basic earnings (loss) per share $ (0.24) $ (1.95) $ 0.87 $ (0.92)
============= ============= ============== =============
Diluted earnings (loss) per share before cumulative
effect of adopting a new accounting standard $ (0.24) $ (1.95) $ 0.84 $ (0.82)
============= ============= ============== =============
Diluted earnings (loss) per share $ (0.24) $ (1.95) $ 0.84 $ (0.92)
============= ============= ============== =============
See accompanying notes to the interim consolidated financial statements
4
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the nine months ended September 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 36 8
Exercise of stock options 81 41
Issued under Employee Stock Purchase
Plan (ESPP) 10 9
Cancellation of Shares (18) (24)
Repurchase of Shares - (282)
------------- -------------
Balance - end of period 10,937 9,433
------------- -------------
Additional paid-in capital
Balance - beginning of period 3,710,698 2,637,085
Ordinary Shares issued 36,509 3,206
Exercise of stock options 40,642 19,729
Ordinary Shares issued under ESPP 7,462 7,054
Cancellation of Ordinary Shares (15,179) (15,145)
Repurchase of Ordinary Shares - (76,849)
------------- -------------
Balance - end of period 3,780,132 2,575,080
------------- -------------
Unearned stock grant compensation
Balance - beginning of period (37,994) (29,642)
Stock grants awarded (39,106) (18,503)
Stock grants forfeited 7,830 813
Amortization 21,880 7,203
------------- -------------
Balance - end of period (47,390) (40,129)
------------- -------------
Retained earnings
Balance - beginning of period 2,321,576 2,733,633
Net income (loss) 245,195 (192,679)
Dividends declared on Ordinary Shares (128,491) (98,756)
Dividends declared on FELINE PRIDES (19,246) (19,179)
Repurchase of Ordinary Shares - (102,315)
------------- -------------
Balance - end of period 2,419,034 2,320,704
------------- -------------
Deferred compensation obligation
Balance - beginning of period 16,497 14,597
Net increase to obligation 2,133 1,900
------------- -------------
Balance - end of period $ 18,630 $ 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 nine months ended September 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 income tax 182,553 84,629
------------ -----------
Balance - end of period 319,469 186,964
------------ -----------
Cumulative translation adjustments
Balance - beginning of period (35,317) (32,881)
Change in period, net of income tax 653 (1,391)
------------ -----------
Balance - end of period (34,664) (34,272)
------------ -----------
Accumulated other comprehensive income 284,805 152,692
------------ -----------
Ordinary Shares issued to employee trust
Balance - beginning of period (16,497) (14,597)
Net increases in Ordinary Shares (2,133) (1,900)
------------ -----------
Balance - end of period (18,630) (16,497)
------------ -----------
Total shareholders' equity $ 6,447,518 $5,017,780
============ ===========
See accompanying notes to the interim consolidated financial statements
6
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the nine months ended September 30, 2002 and 2001
(Unaudited)
2002 2001
------------ ------------
(in thousands of U.S. dollars)
Net income (loss) $ 245,195 $ (192,679)
Other comprehensive income (loss)
Net unrealized appreciation (depreciation)
on investments
Unrealized appreciation (depreciation)
on investments 227,651 137,718
Less: reclassification adjustment for
net realized (gains) losses
included in net income 42,654 (15,334)
----------- ------------
270,305 122,384
Cumulative translation adjustments 4,150 (6,297)
----------- ------------
Other comprehensive income, before
income tax 274,455 116,087
Income tax expense related to other
comprehensive income items (91,248) (32,849)
----------- ------------
Other comprehensive income 183,207 83,238
----------- ------------
Comprehensive income (loss) $ 428,402 $ (109,441)
=========== ============
See accompanying notes to the interim consolidated financial statements
7
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended September 30, 2002 and 2001
(Unaudited)
2002 2001
------------- -------------
(in thousands of U.S. dollars)
Cash flows from operating activities
Net income (loss) $ 245,195 $ (192,679)
Adjustments to reconcile net income to net cash provided by
operating activities:
Unpaid losses and loss expenses, net of reinsurance
recoverable 377,390 750,610
Future policy benefits for life and annuity contracts 34,238 56,732
Unearned premiums 1,639,827 753,329
Prepaid reinsurance premiums (423,506) (376,271)
Deferred income taxes 9,089 (69,604)
Net realized losses on investments 400,884 62,654
Amortization of premium/discounts on fixed maturities 28,364 (5,166)
Deferred policy acquisition costs (135,932) (115,426)
Insurance and reinsurance balances receivable (670,472) (375,967)
Premiums received in advance (12,901) (5,143)
Insurance and reinsurance balances payable 411,633 244,558
Accounts payable, accrued expenses and other liabilities (88,061) 92,028
Other (223,841) 59,333
Cumulative effect of adopting a new accounting standard - 22,670
Amortization of goodwill - 59,664
------------- --------------
Net cash flows from operating activities $ 1,591,907 $ 961,322
------------- --------------
Cash flows from investing activities
Purchases of fixed maturities (12,751,573) (10,914,332)
Purchases of equity securities (154,835) (158,103)
Sales of fixed maturities 11,468,572 10,371,634
Sales of equity securities 110,377 153,871
Maturities of fixed maturities 249,426 39,190
Net realized losses on financial futures contracts (117,580) (44,060)
Acquisition of subsidiary, net of cash acquired 54,380 -
Other (102,411) (83,821)
------------- --------------
Net cash used for investing activities $ (1,243,644) $ (635,621)
------------- --------------
Cash flows from financing activities
Dividends paid on Ordinary Shares (122,846) (94,279)
Dividends paid on FELINE PRIDES (19,246) (19,251)
Net proceeds from (repayment of) short-term debt (275,128) 86,961
Repayment of trust preferred securities (400,000) -
Proceeds from exercise of options for Ordinary Shares 40,723 19,770
Proceeds from shares issued under ESPP 7,472 7,063
Proceeds from long-term debt 399,155 -
Repurchase of Ordinary Shares - (179,446)
------------- --------------
Net cash used for financing activities $ (369,870) $ (179,182)
------------- --------------
Net increase (decrease) in cash (21,607) 146,519
Cash - beginning of period 671,381 608,069
------------- --------------
Cash - end of period $ 649,774 $ 754,588
============= ==============
See accompanying notes to the interim consolidated financial statments
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 Services. These segments are described
in Note 14.
The following table summarizes the Company's gross premiums written by
geographic region for the nine months ended September 30, 2002 and 2001.
Allocations have been made on the basis of location of risk:
Nine Months North Australia & Asia
Ended America Europe New Zealand Pacific Latin America
September 30, 2002 64% 22% 2% 8% 4%
September 30, 2001 62% 22% 2% 9% 5%
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 nine months ended September 30, 2002. The reduction in goodwill
is a result of the settlement of a lawsuit involving a prior acquisition.
ACE
Consolidated
--------------
Goodwill at beginning of period $ 2,772,094
Adjustment to purchased goodwill (55,234)
--------------
Goodwill at end of period $ 2,716,860
==============
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 Nine Months Ended
September 30 September 30
2002 2001 2002 2001
----------- ----------- ----------- -----------
(in thousands of U.S. dollars, except per share data)
Reported net income (loss) $ (56,510) $ (442,590) $ 245,195 $ (196,679)
Add back: Goodwill amortization - 19,912 - 59,664
----------- ----------- ----------- -----------
Adjusted net income (loss) $ (56,510) $ (422,678) $ 245,195 $ (137,015)
=========== =========== =========== ===========
Basic earnings (loss) per share:
Reported earnings (loss) per share $ (0.24) $ (1.95) $ 0.87 $ (0.92)
Add back: Goodwill amortization - 0.09 - 0.26
----------- ----------- ----------- -----------
Adjusted earnings (loss) per share $ (0.24) $ (1.86) $ 0.87 $ (0.66)
=========== =========== =========== ===========
Diluted earnings (loss) per share:
Reported earnings (loss) per share $ (0.24) $ (1.95) $ 0.84 $ (0.92)
Add back: Goodwill amortization - 0.09 - 0.26
----------- ----------- ----------- -----------
Adjusted earnings (loss) per share $ (0.24) $ (1.86) $ 0.84 $ (0.66)
=========== =========== =========== ===========
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 $546 million is recorded in short-term investments and fixed maturities and
in liabilities. The fair value of the securities on loan of $533 million at
September 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. 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
circumstance change, including the impact of the risk factors, changes are
made to reflect overall reserve adequacy. It is possible that adverse
10
ACE LIMITED AND SUBSIDIARIES
Notes to Interim Consolidated Financial Statements (cont'd)
(Unaudited)
developments could cause us to re-evaluate our assumptions, which could lead
us to increase our asbestos related reserves. The National Indemnity Company
("NICO") reinsurance cover protecting Brandywine provides a layer of
protection against such adverse developments. In the event the remaining NICO
cover is insufficient to cover future adverse loss development, such
development could have a material adverse effect on future operating results.
5. Restricted stock awards
Under the Company's long-term incentive plans, 848,950 restricted Ordinary
Shares were awarded during the nine months ended September 30, 2002, to officers
of the Company and its subsidiaries. These shares vest at various dates through
September 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 Nine Months Ended
September 30 September 30
2002 2001 2002 2001
------------ ------------ ------------ ------------
(in thousands of U.S. dollars, except share and per share data)
Numerator:
Net income (loss) before cumulative effect of
adopting a new accounting standard $ (56,510) $ (442,590) $ 245,195 $ (170,009)
Dividends on FELINE PRIDES (6,416) (6,416) (19,246) (19,179)
------------- ------------- ------------- -------------
Net income (loss) available to holders of Ordinary
Shares before cumulative effect (62,926) (449,006) 225,949 (189,188)
Cumulative effect of adopting a new accounting
standard - - - (22,670)
------------- ------------- ------------- -------------
Net income (loss) available to holders of Ordinary
Shares $ (62,926) $ (449,006) $ 225,949 $ (211,858)
============= ============= ============= =============
Denominator:
Denominator for basic earnings per share:
Weighted average shares outstanding 260,264,791 230,610,425 259,810,039 231,390,682
Dilutive effect of FELINE PRIDES - - 3,137,944 -
Effect of other dilutive securities - - 7,247,792 -
------------- ------------- ------------- -------------
Denominator for diluted earnings per share:
Adjusted weighted average shares outstanding
and assumed conversions 260,264,791 230,610,425 270,195,775 231,390,682
============= ============= ============= =============
Basic earnings per share:
Earnings (loss) per share before cumulative effect
of adopting a new accounting standard $ (0.24) $ (1.95) $ 0.87 $ (0.82)
============= ============= ============= =============
Earnings (loss) per share $ (0.24) $ (1.95) $ 0.87 $ (0.92)
============= ============= ============= =============
Diluted earnings per share:
Earnings (loss) per share before cumulative effect
of adopting a new accounting standard $ (0.24) $ (1.95) $ 0.84 $ (0.82)
============= ============== ============= =============
Earnings (loss) per share $ (0.24) $ (1.95) $ 0.84 $ (0.92)
============= ============== ============= =============
11
ACE LIMITED AND SUBSIDIARIES
Notes to Interim Consolidated Financial Statements (cont'd)
(Unaudited)
The denominator for diluted loss per share for the three months ended
September 30, 2002 and the three and nine months ended September 30, 2001
does not include the dilutive effect of FELINE PRIDES and other dilutive
securities. The incremental shares from assumed conversions are not
included in computing diluted loss per share amounts as these shares are
considered anti-dilutive. The dilutive effect of FELINES PRIDES for the
three months ended September 30, 2002 is 1,614,340 shares. The dilutive
effect of FELINES PRIDES for the three and nine months ended September 30,
2001 is 2,462,861 shares and 3,067,185 shares, respectively. Other dilutive
securities totaled 6,383,065 shares for the three months ended September
30, 2002. Other dilutive securities totaled 5,907,562 shares and 6,440,916
shares for the three and nine months ended September 30, 2001,
respectively.
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. In September 2002, the Company reduced the
availability under the 364-day facility from $800 million to $500 million.
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 September 30, 2002, ACE Guaranty Corp. 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 Corp's claims-paying
resources. In 2001, the facility's expiry date was extended to October 2008.
ACE Guaranty Corp. has not borrowed under this credit facility.
In September 2002, the Company arranged a $500 million unsecured syndicated,
one year LOC facility for general business purposes, including the issuance of
insurance and reinsurance letters of credit. This facility replaced a then
existing LOC facility in the amount of $450 million, which was last renewed in
August 2001. Usage under this facility was $449 million at September 30, 2002.
In September 2002, the Company also arranged a $350 million secured,
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 December 2001 in the amount of
$500 million. Usage under this facility was $213 million at September 30,
2002.
12
8. Debt
The following table outlines the Company's consolidated debt position at
September 30, 2002 and December 31, 2001:
September 30 December 31
2002 2001
------------ ------------
(in millions of U.S. dollars)
Short-term debt
ACE INA commercial paper $ 145 $ -
ACE Financial Services Debentures due 2002 75 75
ACE Financial Services Note - 25
Reverse Repurchase Agreements - 395
---------- ----------
$ 220 $ 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 200 300
ACE INA Debentures due 2029 100 100
---------- ----------
$ 1,749 $ 1,349
========== ==========
Trust Preferred Securities
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
ACE INA RHINO Preferred Securities due 2002 - 400
---------- ----------
$ 475 $ 875
========== ==========
13
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
Company repaid the $75 million ACE Financial Services Debentures during
October 2002. The average cost of borrowing using commercial paper was 1.9
percent and 2.0 percent for the three and nine months ended September 30,
2002, respectively.
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. The Company repaid $50 million of these notes during
the quarter ended June 30, 2002 and $50 million during the quarter ended
September 30, 2002. The Company incurred debt prepayment expense of $25
million ($17 million, net of income tax), which is reported as other expense
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 consisted of $412 million of Auction Rate Reset
Subordinated Notes Series A ("Subordinated Notes") issued by ACE INA.
Proceeds of the an 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.
The Company repaid $200 million in principal amount of Preferred Securities
during the quarter ended June 30, 2002 and 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
14
ACE LIMITED AND SUBSIDIARIES
Notes to Interim Consolidated Financial Statements (cont'd)
(Unaudited)
performance under the purchase contract. The resulting unit consisting of the
zero-coupon treasury security and the purchase contract is a Growth PRIDE, and
the preferred shares would be a separate security. A holder of a Growth PRIDE
can convert it back into an Income PRIDE by depositing preferred shares as
security for performance under the purchase contract and thereby obtain the
release of the zero-coupon treasury securities.
The aggregate liquidation preference of the 8.25 percent Cumulative Redeemable
Preferred Shares is $311 million. Unless deferred by the Company, the preferred
shares pay dividends quarterly at a rate of 8.25 percent per year to May 16,
2003, and thereafter at the reset rate established pursuant to a remarketing
procedure. If the Company elects to defer dividend payments on the preferred
shares, the dividends will continue to accrue and the Company will be restricted
from paying dividends on its Ordinary Shares and taking certain other actions.
The preferred shares are not redeemable prior to June 16, 2003, on which date
they must be redeemed by the Company in whole.
10. Reinsurance
The Company purchases reinsurance to manage various exposures including
catastrophe risks. Although reinsurance agreements contractually obligate the
Company's reinsurers to reimburse it for the agreed upon portion of its gross
paid losses, they do not discharge the primary liability of the Company. The
amounts for net premiums written and net premiums earned in the statements of
operations are net of reinsurance. Direct, assumed and ceded amounts for these
items for the three and nine months ended September 30, 2002 and 2001 are as
follows:
Three Months Ended Nine Months Ended
September 30 September 30
2002 2001 2002 2001
------------- ------------- ------------- -------------
(in thousands of U.S. dollars)
Premiums written
Direct $ 2,731,725 $ 1,923,847 $ 7,194,180 $ 5,698,290
Assumed 797,000 578,524 2,381,646 1,768,380
Ceded (1,305,938) (1,197,304) (3,491,633) (2,955,840)
------------- ------------- ------------- -------------
Net premiums written $ 2,222,787 $ 1,305,067 $ 6,084,193 $ 4,510,830
============= ============= ============= =============
Premiums earned
Direct $ 2,225,720 $ 1,776,333 $ 6,068,443 $ 5,155,324
Assumed 721,531 694,181 1,809,927 1,609,875
Ceded (1,021,672) (1,071,085) (3,017,275) (2,611,467)
------------- ------------- ------------- -------------
Net premiums earned $ 1,925,579 $ 1,399,429 $ 4,861,095 $ 4,153,732
============= ============= ============= =============
The composition of the Company's reinsurance recoverable at September 30, 2002
and December 31, 2001, is as follows:
September 30 December 31
2002 2001
------------- --------------
(in thousands of U.S. dollars)
Reinsurance recoverable on paid losses and loss expenses $ 1,190,315 $ 1,066,495
Reinsurance recoverable on unpaid losses and loss expenses 11,495,491 11,120,888
------------- --------------
Gross reinsurance 12,685,806 12,187,383
Bad debt reserve (796,438) (788,937)
------------- --------------
Net reinsurance recoverable $ 11,889,368 $ 11,398,446
============= ==============
15
ACE LIMITED AND SUBSIDIARIES
Notes to Interim Consolidated Financial Statements (cont'd)
(Unaudited)
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. Allowances have
been established for amounts estimated to be uncollectible.
11. Deferred compensation obligation
The Company maintains a rabbi trust for deferred compensation plans for key
employees and executive officers. In accordance with EITF 97-14, "Accounting for
Deferred Compensation Agreements Where Amounts Earned are Held in a Rabbi Trust
and Invested", assets of the rabbi trust are to be consolidated with those of
the employer, and the value of the employer's stock held in the rabbi trust
should be classified in shareholders' equity and accounted for at historical
cost in a manner similar to treasury stock. The shares issued by the Company to
the rabbi trust are recorded in Ordinary Shares issued to employee trust and the
obligation has been recorded in deferred compensation obligation, both are
components of shareholders' equity.
12. Taxation
Under current Cayman Islands law, the Company is not required to pay any taxes
in the Cayman Islands on its income or capital gains. The Company has received
an undertaking that, in the event of any taxes being imposed, the Company will
be exempted from taxation in the Cayman Islands until the year 2013. Under
current Bermuda law, the Company and its Bermuda subsidiaries are not required
to pay any taxes in Bermuda on its income or capital gains. The Company has
received an undertaking from the Minister of Finance in Bermuda that, in the
event of any taxes being imposed, the Company will be exempt from taxation in
Bermuda until March 2016.
Income from the Company's operations at Lloyd's is subject to United Kingdom
corporation taxes. Lloyd's is required to pay U.S. income tax on U.S. connected
income ("U.S. income") written by Lloyd's syndicates. Lloyd's has a closing
agreement with the IRS whereby the amount of tax due on this business is
calculated by Lloyd's and remitted directly to the IRS. These amounts are then
charged to the personal accounts of the Names/Corporate Members in proportion to
their participation in the relevant syndicates. The Company's Corporate Members
are subject to this arrangement but, as UK domiciled companies, will receive UK
corporation tax credits for any U.S. income tax incurred up to the value of the
equivalent UK corporation income tax charge on the U.S. income.
ACE INA, ACE US Holdings and ACE Financial Services are subject to income taxes
imposed by U.S. authorities and file U.S. tax returns. Certain international
operations of the Company are also subject to income taxes imposed by the
jurisdictions in which they operate.
There can be no assurance that there will not be changes in applicable laws,
regulations or treaties, which might require the Company to change the way it
operates or become subject to taxation.
The income tax provision for the three and nine months ended September 30, 2002
and 2001 is as follows:
Three Months Ended Nine Months Ended
September 30 September 30
2002 2001 2002 2001
------------ ------------ ------------ ------------
(in thousands of U.S. dollars)
Current tax expense $ 23,312 $ 9,366 $ 28,169 $ 38,483
Deferred tax expense (benefit) (30,646) (85,711) 9,089 (69,604)
------------ ------------ ------------ ------------
Provision for income taxes $ (7,334) $ (76,345) $ 37,258 $ (31,121)
============ ============ ============ ============
16
ACE LIMITED AND SUBSIDIARIES
Notes to Interim Consolidated Financial Statements (cont'd)
(Unaudited)
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 nine months ended September 30, 2002 and
2001, is provided below.
Three Months Ended Nine Months Ended
September 30 September 30
2002 2001 2002 2001
------------ ------------ ------------ ------------
(in thousands of U.S. dollars)
Expected tax provision at weighted
average rate $ (10,461) $ (76,306) $ 33,331 $ (41,517)
Permanent differences
Tax-exempt interest (6,507) (3,739) (13,589) (11,380)
Goodwill - 7,247 - 17,340
Other 5,605 (7,223) 6,166 (6,060)
Net withholding taxes 4,029 3,676 11,350 10,496
------------- ------------ ------------ ------------
Provision for income taxes $ (7,334) $ (76,345) $ 37,258 $ (31,121)
============= ============ ============ ============
The components of the net deferred tax asset at September 30, 2002 and December
31, 2001 are as follows:
September 30 December 31
2002 2001
------------ ------------
(in thousands of U.S. dollars)
Deferred tax assets
Loss reserve discount $ 486,085 $ 523,195
Foreign tax credits 174,278 155,079
Policyholder dividends 48,524 47,509
Net operating loss carryforward 446,430 495,048
Other 310,587 299,068
------------ ------------
Total deferred tax assets 1,465,904 1,519,899
------------ ------------
Deferred tax liabilities
Deferred policy acquisition costs 44,082 66,454
Unrealized appreciation on investments 98,863 28,570
Other 35,430 38,448
------------ ------------
Total deferred tax liabilities 178,375 133,472
------------ ------------
Valuation allowance 135,592 135,592
------------ ------------
Net deferred tax asset $ 1,151,937 $ 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.
17
ACE LIMITED AND SUBSIDIARIES
Notes to Interim Consolidated Financial Statements (cont'd)
(Unaudited)
At September 30, 2002, the Company has net operating loss carryforwards for
U.S. federal income tax purposes of approximately $1.3 billion which are
available to offset future U.S. federal taxable income through 2021.
13. Subsidiary Issuer Information
The following tables present condensed consolidating financial information for
ACE Limited (the "Parent Guarantor"), ACE INA Holdings, Inc. and ACE Financial
Services, Inc. (formerly Capital Re Corporation), (the "Subsidiary Issuers")
at September 30, 2002 and December 31, 2001 and for the three and nine months
ended September 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 September 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
---------- ------- ------- ---------------- -------------- ------------
Assets
Total investments and cash $ 181,469 $ 7,256,362 $ 1,002,573 $ 9,297,154 $ - $ 17,737,558
Insurance and reinsurance balances
receivable - 2,149,518 27,397 1,031,150 - 3,208,065
Reinsurance recoverable - 9,399,216 1,142 2,489,010 - 11,889,368
Goodwill - 2,130,908 96,723 489,229 - 2,716,860
Investments in subsidiaries 7,002,502 - 152,000 (152,000) (7,002,502) -
Due from subsidiaries and
affiliates, net 156,748 (194,915) (51,395) 246,310 (156,748) -
Other assets 17,892 3,779,195 223,844 1,257,003 5,277,934
------------ ------------- ------------ ------------- ------------- -------------
Total assets $ 7,358,611 $ 24,520,284 $ 1,452,284 $ 14,657,856 $ (7,159,250) $ 40,829,785
============ ============= ============ ============= ============= =============
Liabilities
Unpaid losses and loss expenses $ - $ 14,370,086 $ 69,404 $ 7,201,741 $ - $ 21,641,231
Future policy benefits for life and
annuity contracts - - - 419,041 - 419,041
Unearned premiums - 3,145,797 353,104 2,026,733 - 5,525,634
Short-term debt - 145,280 75,000 - - 220,280
Long-term debt 499,239 999,630 - 250,000 - 1,748,869
Trust preferred securities - 400,000 75,000 - - 475,000
Other liabilities 100,804 2,648,952 168,216 1,123,190 - 4,041,162
------------ ------------- ------------ ------------- ------------- -------------
Total liabilities 600,043 21,709,745 740,724 11,020,705 - 34,071,217
------------ ------------- ------------ ------------- ------------- -------------
Mezzanine equity 311,050 - - - - 311,050
------------ ------------- ------------ ------------- ------------- -------------
Total shareholders' equity 6,447,518 2,810,539 711,560 3,637,151 (7,159,250) 6,447,518
------------ ------------- ------------ ------------- ------------- -------------
Total liabilities, mezzanine equity
and shareholders' equity $ 7,358,611 $ 24,520,284 $ 1,452,284 $ 14,657,856 $ (7,159,250) $ 40,829,785
============ ============= ============ ============= ============= =============
(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
---------- ------- ------- ---------------- -------------- ------------
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 September 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
---------- ------- ------- ---------------- -------------- ------------
Net premiums written $ - $ 1,075,787 $ 42,887 $ 1,104,113 $ - $ 2,222,787
Net premiums earned - 863,326 29,613 1,032,640 - 1,925,579
Net investment income 12,872 76,737 11,703 106,491 (8,063) 199,740
Other income (expense) - (14,516) - 484 - (14,032)
Equity in earnings of subsidiaries 17,301 - - - (17,301) -
Net realized gains (losses) on
investments (55,564) (47,386) (33,012) (99,320) - (235,282)
Losses and loss expenses - 609,457 4,976 713,359 - 1,327,792
Life and annuity benefits - - - 59,697 - 59,697
Policy acquisition costs and
administrative expenses 20,174 235,300 13,487 235,601 (881) 503,681
Interest expense 8,619 35,742 3,017 5,227 (3,926) 48,679
Income tax expense (benefit) 2,326 (2,815) (7,103) 258 - (7,334)
------------ ------------ ------------ ------------ ----------- ------------
Net income (loss) $ (56,510) $ 477 $ (6,073) $ 26,153 $ (20,557) $ (56,510)
============ ============ ============ ============ =========== ============
Condensed Consolidating Statement of Operations
For the three months ended September 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
---------- ------- ------- ---------------- -------------- ------------
Net premiums written $ - $ 662,841 $ (1,229) $ 643,455 $ - $ 1,305,067
Net premiums earned - 639,010 17,688 742,731 - 1,399,429
Net investment income 14,605 88,546 11,542 86,161 (7,945) 192,909
Other income (expense) - - - (1,858) - (1,858)
Equity in earnings of subsidiaries (417,958) - - - 417,958 -
Net realized gains (losses) on
investments (25,065) (9,709) (8,879) (15,190) - (58,843)
Losses and loss expenses - 461,693 16,038 1,063,896 - 1,541,627
Life and annuity benefits - - - 29,706 - 29,706
Policy acquisition costs and
administrative expenses 15,080 199,828 8,161 187,326 (198) 410,197
Amortization of goodwill - 14,490 1,051 4,371 - 19,912
Interest expense (3,034) 43,808 3,840 5,564 (1,048) 49,130
Income tax expense (benefit) 2,126 3,295 (12,100) (69,666) - (76,345)
------------- ------------- ----------- ------------- ----------- ------------
Net income (loss) $ (442,590) $ (5,267) $ 3,361 $ (409,353) $ 411,259 $ (442,590)
============= ============= =========== ============= =========== ============
(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 nine months ended September 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
---------- ------- ------- ---------------- -------------- ------------
Net premiums written $ - $ 2,887,006 $ 88,637 $ 3,108,550 $ - $ 6,084,193
Net premiums earned - 2,232,787 78,029 2,550,279 - 4,861,095
Net investment income 41,948 236,989 35,154 313,380 (26,792) 600,679
Other income (expense) - (25,587) - 4,286 - (21,301)
Equity in earnings of subsidiaries 358,254 - - - (358,254) -
Net realized gains (losses) on
investments (78,248) (81,859) (51,933) (188,844) - (400,884)
Losses and loss expenses - 1,557,630 10,818 1,573,438 - 3,141,886
Life and annuity benefits - - - 106,004 - 106,004
Policy acquisition costs and
administrative expenses 53,263 607,442 36,764 667,787 (2,643) 1,362,613
Interest expense 16,745 116,374 9,564 14,482 (10,532) 146,633
Income tax expense 6,751 23,330 (5,664) 12,841 - 37,258
------------ ------------ ------------ ------------- ------------ ------------
Net income $ 245,195 $ 57,554 $ 9,768 $ 304,549 $ (371,871) $ 245,195
============ ============ ============ ============= ============ ============
Condensed Consolidating Statement of Operations
For the nine months ended September 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
---------- ------- ------- ---------------- -------------- ------------
Net premiums written $ - $ 1,872,616 $ 42,209 $ 2,596,005 $ - $ 4,510,830
Net premiums earned - 1,763,422 56,049 2,334,261 - 4,153,732
Net investment income 42,015 275,700 35,205 262,144 (21,458) 593,606
Other income - - - 827 - 827
Equity in earnings of subsidiaries (166,398) - - - 166,398 -
Net realized gains (losses) on
investments (25,065) (39,662) 14,779 (12,706) - (62,654)
Losses and loss expenses - 1,252,928 21,814 2,173,019 - 3,447,761
Life and annuity benefits - - - 58,511 - 58,511
Policy acquisition costs and 27,437
administrative expenses 45,342 550,395 545,032 (595) 1,167,611
Amortization of goodwill - 43,470 3,153 13,041 - 59,664
Interest expense (8,282) 137,240 10,486 16,769 (3,119) 153,094
Income tax expense (benefit) 6,171 17,620 2,652 (57,564) - (31,121)
------------ ------------ ------------ ------------ ------------ ------------
Income before cumulative effect of 148,654
adopting a new accounting standard (192,679) (2,193) 40,491 (164,282) (170,009)
Cumulative effect of adopting a new
accounting standard (net of income
tax) - (50) (22,800) 180 - (22,670)
------------ ------------ ------------ ------------ ------------ ------------
Net income (loss) $ (192,679) $ (2,243) $ 17,691 $ (164,102) $ 148,654 $ (192,679)
============ ============ ============ ============ ============ ============
(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 nine months ended September 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
---------- ------- ------- ---------------- -------------- ------------
Net cash flows from (used for)
operating activities $ (148,253) $ 127,199 $ 36,047 $ 1,576,914 $ - $ 1,591,907
------------ ------------ ------------ ------------- ------------- ------------
Cash flows from investing activities
Purchases of fixed maturities (149,170) (2,231,174) (480,079) (9,891,150) - (12,751,573)
Purchases of equity securities - (60,165) (94,670) - (154,835)
Sales of fixed maturities 342,097 1,842,602 436,144 8,847,729 - 11,468,572
Sales of equity securities - 54,512 - 55,865 - 110,377
Maturities of fixed maturities - - - 249,426 - 249,426
Net realized gains (losses) on
financial futures contracts - - - (117,580) - (117,580)
Acquisition of subsidiaries - 54,380 - - - 54,380
Other - - 1,129 (103,540) - (102,411)
------------ ------------ ------------ ------------- ------------- -------------
Net cash from (used for) investing
activities $ 192,927 $ (339,845) $ (42,806) $ 1,053,920) $ - $ (1,243,644)
------------ ------------ ------------ ------------- ------------- -------------
Cash flows from financing activities
Dividends paid on Ordinary Shares (122,846) - - - - (122,846)
Dividends paid on FELINE PRIDES (19,246) - - - (19,246)
Proceeds from short term debt - (383,109) (25,000) 132,981 - (275,128)
Proceeds from long term debt 499,155 (100,000) - - - 399,155
Advances to (from) affiliates 359,103 - 9,891 (368,994) - -
Proceeds from exercise of options
for Ordinary Shares 40,723 - - - - 40,723
Proceeds from shares issued under
ESPP 7,472 - - - - 7,472
Repayment of trust preferred
securities - (400,000) - - - (400,000)
Capitalization of subsidiary (1,098,896) 1,185,956 25,000 (112,060) - -
Dividends received from subsidiaries 260,000 - - (260,000) - -
------------ ------------ ------------ ------------- ------------- -------------
Net cash used for financing
activities $ (74,535) $ 302,847 $ 9,891 $ (607,073) $ - $ (369,870)
------------ ------------ ------------ ------------- ------------- -------------
Net increase (decrease) in cash (29,861) 90,201 3,132 (85,079) - (21,607)
Cash - beginning of period 32,525 355,327 1,027 282,502 - 671,381
------------ ------------ ------------ ------------- ------------- -------------
Cash - end of period $ 2,664 $ 445,528 $ 4,159 $ 197,423 $ - $ 649,774
============ ============ ============ ============= ============= =============
(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 nine months ended September 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
---------- ------- ------- ---------------- -------------- ------------
Net cash flows from (used for)
operating activities $ (8,893) $ (270,099) $ 51,909 $ 1,188,405 $ - $ 961,322
------------ ------------ ------------ -------------- ------------- ------------
Cash flows from investing activities
Purchases of fixed maturities (119,715) (1,245,557) (819,018) (8,730,042) - (10,914,332)
Purchases of equity securities - (94,569) - (63,534) - (158,103)
Sales of fixed maturities 96,274 1,598,007 664,717 8,012,636 - 10,371,634
Sales of equity securities - 101,501 52,370 - 153,871
Maturities of fixed maturities - - 6,500 32,690 - 39,190
Net realized gains (losses) on
financial futures contracts - - - (44,060) - (44,060)
Other - (3,876) 68,178 (148,123) - (83,821)
------------ ------------ ------------ -------------- -------------- ------------
Net cash from (used for) investing
activities $ (23,441) $ 355,506 $ (79,623) $ (888,063) $ - $ (635,621)
------------ ------------ ------------ -------------- -------------- ------------
Cash flows from financing activities
Dividends paid on Ordinary Shares (94,279) - - - - (94,279)
Dividends paid on FELINE PRIDES (19,251) - - - - (19,251)
Proceeds from short term debt, net - 86,961 - - - 86,961
Advances to affiliates 8,697 (41,861) 41,346 (8,182) - -
Proceeds from exercise of options
for Ordinary Shares 19,770 - - - - 19,770
Proceeds from shares issued under
ESPP 7,063 - - - - 7,063
Repurchase of Ordinary Shares (179,446) - - - - (179,446)
Dividends received from subsidiaries 258,691 - - (258,691) - -
------------ ------------ ------------ -------------- -------------- ------------
Net cash from (used for) financing
activities $ 1,245 $ 45,100 $ 41,346 $ (266,873) $ - $ (179,182)
------------ ------------ ------------ -------------- -------------- ------------
Net increase (decrease) in cash (31,089) 130,507 13,632 33,469 - 146,519
Cash - beginning of period 46,516 253,447 26,576 281,530 - 608,069
------------ ------------ ------------ -------------- -------------- ------------
Cash - end of period $ 15,427 $ 383,954 $ 40,208 $ 314,999 $ - $ 754,588
============ ============ ============ ============== ============== ============
(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 lines of business. The
Company operates through four business segments: Insurance - North
American, Insurance - Overseas General, Global Reinsurance and Financial
Services.
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 Services 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 Services includes the financial guaranty business of ACE Guaranty
Corp. and ACE Capital Re International ("ACE Financial Services"). Financial
Services 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 nine months ended September 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 income taxes,
and net realized gains (losses) have been presented net of related
income 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 September 30, 2002
Insurance - Insurance - Corporate
North Overseas Global Financial and ACE
American General Reinsurance Services Other(1) Consolidated
---------- ---------- ----------- --------- --------- ------------
(in thousands of U.S. Dollars)
Operations Data
Property and Casualty
Gross premiums written $ 1,783,574 $ 1,007,923 $ 185,474 $ 493,225 $ - $ 3,470,196
Net premiums written 869,008 689,318 131,008 476,605 - 2,165,939
Net premiums earned 654,003 647,308 194,307 373,113 - 1,868,731
Losses and loss expenses 452,643 445,900 101,069 328,180 - 1,327,792
Policy acquisition costs 54,493 140,860 37,339 17,132 - 249,824
Administrative expenses 86,031 107,031 10,174 15,912 29,894 249,042
------------ ------------ ----------- ------------ ---------- ------------
Underwriting income (loss) 60,836 (46,483) 45,725 11,889 (29,894) 42,073
------------ ------------ ----------- ------------ ----------- ------------
Life
Gross premiums written - - 58,529 - - 58,529
Net premiums written - - 56,848 - - 56,848
Net premiums earned - - 56,848 - - 56,848
Life and annuity benefits - - 59,697 - - 59,697
Policy acquisition costs - - 3,189 - - 3,189
Administrative expenses - - 1,626 - - 1,626
Net investment income - - 6,927 - - 6,927
------------ ------------ ----------- ------------ ----------- ------------
Underwriting income (loss) - - (737) - - (737)
------------ ------------ ----------- ------------ ----------- ------------
Net investment income -
property and casualty 101,500 28,519 23,863 45,615 (6,684) 192,813
Other income (expense) (271) (230) 554 431 - 484
Interest expense 7,595 493 4,565 3,103 32,923 48,679
Income tax expense (benefit) 41,661 (3,141) (1,432) 6,761 (16,349) 27,500
------------ ------------ ----------- ------------ ----------- ------------
Income excluding net realized gains
(losses) & non-recurring expense 112,809 (15,546) 66,272 48,071 (53,152) 158,454
Debt prepayment expense* - - - - (9,436) (9,436)
Net realized gains (losses)* (51,006) (13,850) (26,564) (58,544) (55,564) (205,528)
------------ ------------ ----------- ------------ ----------- ------------
Net income (loss) $ 61,803 $ (29,396) $ 39,708 $ (10,473) $ (118,152) $ (56,510)
============ ============ =========== ============ =========== ============
* 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 September 30, 2001
Insurance - Insurance - Corporate
North Overseas Global Financial and ACE
American General Reinsurance Services Other(1) Consolidated
---------- ---------- ----------- --------- --------- ------------
(in thousands of U.S. Dollars)
Operations Data
Property and Casualty
Gross premiums written $ 1,317,724 $ 673,035 $ 94,787 $ 384,649 $ - $ 2,470,195
Net premiums written 550,063 423,689 36,708 262,431 - 1,272,891
Net premiums earned 478,321 445,103 69,348 374,481 - 1,367,253
Losses and loss expenses 468,366 378,568 228,996 465,697 - 1,541,627
Policy acquisition costs 58,028 114,013 18,465 13,601 - 204,107
Administrative expenses 74,929 82,386 11,246 13,339 22,181 204,081
------------ ----------- ---------- ----------- ----------- ------------
Underwriting income (loss) (123,002) (129,864) (189,359) (118,156) (22,181) (582,562)
------------ ----------- ---------- ----------- ----------- ------------
Life
Gross premiums written - - 32,176 - - 32,176
Net premiums written - - 32,176 - - 32,176
Net premiums earned - - 32,176 - - 32,176
Life and annuity benefits - - 29,706 - - 29,706
Policy acquisition costs - - 559 - - 559
Administrative expenses - - 1,450 - - 1,450
Net investment income - - 119 - - 119
------------ ----------- ---------- ----------- ----------- ------------
Underwriting income - - 580 - - 580
------------ ----------- ---------- ----------- ----------- ------------
Net investment income -
property and casualty 105,617 24,896 16,847 43,469 1,961 192,790
Other income (expense) (1,147) (94) - (617) - (1,858)
Amortization of goodwill (90) 958 3,503 1,051 14,490 19,912
Interest expense 8,798 653 4,409 35,270 49,130
Income tax expense (benefit) 13,145 (37,728) (33,433) 7,035 (18,997) (69,978)
Net realized gains (losses)* (1,401) 1,653 (4,624) (23,039) (25,065) (52,476)
------------ ----------- ----------- ------------ ----------- ------------
Net income (loss) $ (41,786) $ (67,292) $ (146,626) $ (110,838) $ (76,048) $ (442,590)
============ =========== =========== =========== =========== ============
* 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 nine months ended September 30, 2002
Insurance - Insurance - Corporate
North Overseas Global Financial and ACE
American General Reinsurance Services Other(1) Consolidated
---------- ---------- ----------- --------- --------- ------------
(in thousands of U.S. Dollars)
Operations Data
Property and Casualty
Gross premiums written $ 4,476,260 $ 2,911,298 $ 773,649 $ 1,299,179 $ - $ 9,460,386
Net premiums written 2,100,172 1,919,904 682,840 1,269,479 - 5,972,395
Net premiums earned 1,732,934 1,721,892 459,133 835,567 - 4,749,526
Losses and loss expenses 1,176,275 1,082,973 192,748 689,890 - 3,141,886
Policy acquisition costs 146,821 382,383 83,008 57,551 - 669,763
Administrative expenses 243,604 281,486 26,054 42,979 79,214 673,337
------------ ------------- ------------ ------------ ----------- ------------
Underwriting income (loss) 166,234 (24,950) 157,323 45,147 (79,214) 264,540
------------ ------------- ------------ ------------ ----------- ------------
Life
Gross premiums written - - 115,440 - - 115,440
Net premiums written - - 111,798 - - 111,798
Net premiums earned - - 111,569 - - 111,569
Life and annuity benefits - - 106,004 - - 106,004
Policy acquisition costs - - 15,253 - - 15,253
Administrative expenses - - 4,260 - - 4,260
Net investment income - - 19,124 - - 19,124
------------ ------------- ------------ ------------ ----------- ------------
Underwriting income - - 5,176 - - 5,176
------------ ------------- ------------ ------------ ----------- ------------
Net investment income -
property and casualty 306,801 77,109 71,228 140,491 (14,074) 581,555
Other income (expense) (291) 3,592 554 431 - 4,286
Interest expense 24,286 1,414 9,257 10,358 101,318 146,633
Income tax expense (benefit) 115,728 9,397 519 23,702 (51,038) 98,308
------------ ------------- ------------ ------------ ----------- ------------
Income excluding net realized gains
(losses) & non-recurring expenses 332,730 44,940 224,505 152,009 (143,568) 610,616
Debt prepayment expense* - - - - (16,632) (16,632)
Net realized gains (losses)* (90,731) (22,247) (57,047) (100,516) (78,248) (348,789)
------------ ------------- ------------ ------------ ----------- ------------
Net income (loss) $ 241,999 $ 22,693 $ 167,458 $ 51,493 $ (238,448) $ 245,195
============ ============= ============ ============ =========== ============
* 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 nine months ended September 30, 2001
Insurance - Insurance - Corporate
North Overseas Global Financial and ACE
American General Reinsurance Services Other(1) Consolidated
---------- ---------- ----------- --------- --------- ------------
(in thousands of U.S. Dollars)
Operations Data
Property and Casualty
Gross premiums written $ 3,423,915 $ 2,361,139 $ 427,399 $ 1,191,062 $ - $ 7,403,515
Net premiums written 1,518,095 1,533,483 336,391 1,059,706 - 4,447,675
Net premiums earned 1,360,207 1,429,761 233,128 1,067,481 - 4,090,577
Losses and loss expenses 1,081,869 983,942 300,217 1,081,733 - 3,447,761
Policy acquisition costs 149,607 320,651 48,918 38,086 - 557,262
Administrative expenses 232,095 238,141 23,295 41,430 64,682 559,643
------------ ----------- ----------- ----------- ------------ ------------
Underwriting income (loss) (103,364) (112,973) (139,302) (93,768) (64,682) (514,089)
------------ ----------- ----------- ----------- ------------ ------------
Life
Gross premiums written - - 63,155 - - 63,155
Net premiums written - - 63,155 - - 63,155
Net premiums earned - - 63,155 - - 63,155
Life and annuity benefits - - 58,511 - - 58,511
Policy acquisition costs - - 1,734 - - 1,734
Administrative expenses - - 2,599 - - 2,599
Net investment income - - 454 - - 454
------------ ----------- ----------- ----------- ------------ ------------
Underwriting income - - 765 - - 765
------------ ----------- ----------- ----------- ------------ ------------
Net investment income -
property and casualty 325,738 81,627 51,378 127,251 7,158 593,152
Other income (expense) 784 (380) - 423 - 827
Amortization of goodwill (270) 2,803 10,508 3,153 43,470 59,664
Interest expense 25,593 2,078 - 11,637 113,786 153,094
Income tax expense (benefit) 67,726 (25,179) (26,055) 17,958 (55,704) (21,254)
------------ ----------- ----------- ----------- ------------ ------------
Income excluding net realized gains
(losses), non-recurring expenses
and cumulative effect 130,109 (11,428) (71,612) 1,158 (159,076) (110,849)
Non-recurring expenses* - (3,970) (491) - - (4,461)
Net realized gains (losses)* (5,122) (2,695) (22,784) 967 (25,065) (54,699)
Cumulative effect of adopting a
new accounting standard (50) 441 539 (23,600) - (22,670)
------------ ----------- ----------- ----------- ------------ ------------
Net income (loss) $ 124,937 $ (17,652) $ (94,348) $ (21,475) $ (184,141) $ (192,679)
============ =========== =========== =========== ============ ============
* 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 nine months ended
September 30, 2002 and 2001:
Net premiums earned by type of premium
Three months ended September 30, 2002
- ------------------------------------- Life,
Property & Accident Financial Financial ACE
Casualty & Health Services Solutions Consolidated
---------- -------- --------- --------- ------------
(in millions of U.S. dollars)
Insurance - North American $ 637 $ 17 $ - $ - $ 654
Insurance - Overseas General 489 158 - - 647
Global Reinsurance 194 57 - - 251
Financial Services - - 42 331 373
----------- --------- ---------- ---------- -----------
$ 1,320 $ 232 $ 42 $ 331 $ 1,925
=========== ========= ========== ========== ===========
Three months ended September 30, 2001
- ------------------------------------- Life,
Property & Accident Financial Financial ACE
Casualty & Health Services Solutions Consolidated
---------- -------- --------- --------- ------------
(in millions of U.S. dollars)
Insurance - North American $ 478 $ - $ - $ - $ 478
Insurance - Overseas General 319 126 - - 445
Global Reinsurance 70 32 - - 102
Financial Services - - 44 330 374
----------- ---------- ---------- ---------- -----------
$ 867 $ 158 $ 44 $ 330 $ 1,399
=========== ========== ========== ========== ===========
Nine months ended September 30, 2002
- ------------------------------------- Life,
Property & Accident Financial Financial ACE
Casualty & Health Services Solutions Consolidated
---------- -------- --------- --------- ------------
(in millions of U.S. dollars)
Insurance - North American $ 1,673 $ 60 $ - $ - $ 1,733
Insurance - Overseas General 1,307 415 - - 1,722
Global Reinsurance 459 112 - - 571
Financial Services - - 168 667 835
----------- ---------- ---------- ---------- -----------
$ 3,439 $ 587 $ 168 $ 667 $ 4,861
=========== ========== ========== ========== ===========
Nine months ended September 30, 2001
- ------------------------------------- Life,
Property & Accident Financial Financial ACE
Casualty & Health Services Solutions Consolidated
---------- -------- --------- --------- ------------
(in millions of U.S. dollars)
Insurance - North American $ 1,356 $ 4 $ - $ - $ 1,360
Insurance - Overseas General 1,061 366 - 3 1,430
Global Reinsurance 233 63 - - 296
Financial Services - - 266 801 1,067
----------- ---------- ---------- ---------- -----------
$ 2,650 $ 433 $ 266 $ 804 $ 4,153
=========== ========== ========== ========== ===========
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 September 30, 2002
and December 31, 2001:
September 30 December 31
2002 2001
------------ ------------
(in millions of U.S. dollars)
Property and casualty $ 37,910 $ 34,198
Life reinsurance 554 480
Other 2,366 2,509
------------- ------------
Total assets $ 40,830 $ 37,187
============= ============
30
ITEM 2. 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 nine
months ended September 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 and claims settlement processes, including the
difficulties associated with assessing environmental damage and asbestos
related latent injuries, (v) actual loss experience, (vi) 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, (vii) judicial decisions and legal tactics, (viii) the actual
amount of new and renewal business and market acceptance of our products,
(ix) risks associated with the introduction of new products and services
and with entering new markets, (x) the competitive environment in which we
operate, related trends and associated pricing pressures, market
perception, and developments, (xi) actions that rating agencies may take
from time to time, (xii) developments in global financial markets, which
could affect our investment portfolio and financing plans, (xiii) changing
rates of inflation and other economic conditions, (xiv) losses due to
foreign currency exchange rate fluctuations, (xv) loss of the services of
any of our executive officers without suitable replacements being recruited
in a reasonable time frame, (xvi) the ability of technology to perform as
anticipated, (xvii) the amount of dividends received from subsidiaries,
(xviii) economic and political conditions, and (xix) 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.
Reporting Segments
During the quarter ended March 31, 2002, following changes in executive
management responsibilities, we reassessed and changed our reporting
segments from individual operating units to lines of business: We operate
through four business segments: Insurance - North American, Insurance -
Overseas General, Global Reinsurance and Financial Services (previously
known as Financial Products). We believe that these 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 Financial Services segment. Insurance -
Overseas General includes the operations of ACE International, including
31
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 are now included in the Global Reinsurance segment
together with ACE Tempest Re, ACE Tempest US and our life reinsurance
operation which is disclosed separately. The Financial Services segment
includes the financial guaranty business of ACE Guaranty Corp. and
ACE Capital Re International and the financial solutions business in the
U.S. and Bermuda.
Critical Accounting Policies
Certain amounts in our consolidated financial statements are the result of
transactions that 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, including asbestos 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. During the
current quarter we paid gross losses of $61 million and net losses of $43
million for this event. As of September 30, 2002 we have paid gross losses
of $585 million and net losses of $132 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 September 30, 2002.
32
Results of Operations - Three months ended September 30, 2002 and 2001
The discussions that follow include tables, which show our consolidated and
segment operating results for the three and nine months ended September 30,
2002 and 2001. To enhance comparability between reporting periods we have
presented last year's results both including and excluding the September
11th tragedy. The "as reported" column shows our prior year results
including the effects of the September 11th tragedy and the "ex WTC" column
shows how our results would have been presented excluding this event. The
"percentage change from prior year" column compares our current year's
results with our results from 2001, including the September 11th tragedy.
Consolidated Operating Results
Three Months Ended Percentage
September 30 change from
2002 2001 2001 prior year
------------ ------------ ------------ ------------
(as reported) (ex WTC) (as reported)
(in millions of U.S. dollars)
Gross premiums written $ 3,528 $ 2,502 $ 2,380 41%
Net premiums written 2,223 1,305 1,254 70
Net premiums earned 1,925 1,399 1,385 38
Losses and loss expenses 1,328 1,542 892 (14)
Life and annuity benefits 60 29 29 107
Policy acquisition costs 253 205 204 23
Administrative expenses 250 205 205 22
---------- ---------- --------- ------
Underwriting income (loss) $ 34 $ (582) $ 55 NM
---------- ---------- --------- ------
Net investment income 199 192 192 4%
Other income (expense) - (2) (2) NM
Interest expense 48 49 49 (2)
Amortization of goodwill - 19 19 NM
Income tax expense (benefit) 27 (70) 8 NM
---------- ---------- --------- ------
Net operating income (loss) $ 158 $ (390) $ 169 NM
---------- ---------- --------- ------
Debt prepayment expense (net of income tax) (10) -
Net realized gains (losses) on investments (net of
income tax) (205) (52)
---------- ----------
Net loss $ (57) $ (442)
========== ==========
Loss and loss expense ratio* 71.0% 112.7% 65.9%
Underwriting and administrative expense ratio* 26.7% 29.8% 30.1%
Combined ratio* 97.7% 142.5% 96.0%
* Ratios exclude life reinsurance business
NM - not meaningful
Our gross premiums written increased by 41 percent for the current quarter
compared with the comparable quarter last year and our net premiums written,
which reflect the premiums we retain after purchasing reinsurance protection,
increased by 70 percent. Our net premiums earned, which reflect the portion
of net premiums written recorded as revenues for the quarter, increased by
38 percent for this quarter compared with the same quarter last year. These
increases are discussed in each segment section. The large increases are
due to a combination of price increases on renewal business and new
business opportunities. While these very high rates of growth are not
sustainable over the long term, we believe our increasing position of
importance in the global property and casualty marketplace, demonstrated by
the breadth of premium increases over the entire range of our products, is
sustainable.
During the current quarter, our Financial Services segment wrote several
large contracts, including a large retroactive contract in the form of a
33
loss portfolio transfer contract ("LPT") for $178 million, bringing the
total LPT business for the quarter to $187 million. Our LPT activity for
the same quarter last year was $135 million. When LPT contracts are written
in a quarter, they can cause variations in premium volume compared with
other quarters, particularly in net premiums earned as the entire written
premium is fully earned in the quarter it is written, LPTs are discussed in
more detail in the Financial Services segment.
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.
Our loss and loss expense ratio was 71.0 percent for the current quarter
compared with 112.7 percent for the same quarter of 2001. Our current
quarter loss ratio was impacted by an accumulation of losses incurred with
respect to the floods in Europe in the quarter. These series of floods
caused $3 billion of industry insurance losses. We incurred $100 million of
pre tax losses ($90 million after tax) from these events. Our loss ratio
for the quarter ended September 30, 2001 was substantially impacted by the
September 11th tragedy. If you remove the impact of the flood losses and
the September 11th tragedy losses from our loss ratios, the ratios would
have been 65.7 percent for the current quarter and 65.9 percent last year.
This ratio is also influenced by changes in the mix of business written,
particularly in the Financial Services segment where LPTs can cause
variations in the loss ratio. Excluding the Financial Services segment, our
loss ratios would have been 60.1 percent for the current quarter compared
with 62.5 percent for the same quarter last year.
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 was 26.7 percent
this quarter compared with 29.8 percent for the quarter ended September 30,
2001. The principal reason for the decline is the increase in net premiums
earned for the current quarter. However, this ratio is also influenced by
changes in the mix of business written. Excluding the Financial Services
segment, our underwriting and administrative expense ratios would have been
31.2 percent compared with 38.4 percent.
As discussed later in this report, net investment income increased by 4
percent for the current quarter compared with the same quarter last year.
Our net operating income, which is comprised of income excluding net
realized gains (losses), debt prepayment expense and non-recurring expenses,
was $158 million for the current quarter compared with a net operating loss
of $390 million for the same quarter last year. Removing the effects of the
floods in Europe in the current quarter and the September 11th tragedy last
year, our net operating income would have been $248 million and $169
million for the quarters ended September 30, 2002 and 2001, respectively, a
47 percent increase. We adopted FAS 142 on January 1, 2002 and accordingly
have not amortized any goodwill in the current quarter, compared with $19
million of goodwill amortized for the quarter ended September 30, 2001.
The debt prepayment expense of $10 million (net of income tax) resulted
from our decision to prepay a portion of the ACE INA Subordinated Notes due
in 2009. These subordinated notes bear interest at 11.2 percent. This cost
was mostly attributable to the decrease in interest rates since the
original note was issued.
Net realized losses on investments (net of income tax) were $205 million
for the three months ended September 30, 2002 compared with net realized
losses of $52 million for the three months ended September 30, 2001. The
net realized losses incurred in the current quarter are discussed in detail
in the net realized gains (losses) on investments section.
34
Segment Operating 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.
Three Months Ended Percentage
September 30 change from
2002 2001 2001 prior year
------------ ------------ ------------ ------------
(as reported) (ex WTC) (as reported)
(in millions of U.S. dollars)
Gross premiums written $ 1,783 $ 1,318 $ 1,318 35%
Net premiums written 869 551 573 58
Net premiums earned 654 478 500 37
Losses and loss expenses 453 468 349 (3)
Underwriting and administrative expenses 141 133 133 6
---------- ---------- ------------ --------
Underwriting income (loss) $ 60 $ (123) $ 18 NM
---------- ---------- ------------ --------
Net investment income 101 106 106 (5)%
Other income (expense) - (1) (1) NM
Interest expense 7 9 9 (22)
Income tax expense 41 13 29 215
---------- ---------- ------------ --------
Net operating income (loss) $ 113 $ (40) $ 85 NM
---------- ---------- ------------ --------
Loss and loss expense ratio 69.2% 97.9% 69.8%
Underwriting and administrative expense ratio 21.5% 27.8% 26.6%
Combined ratio 90.7% 125.7% 96.4%
NM - not meaningful
Gross premiums written for the segment increased by 35 percent for the
quarter compared with the same quarter last year. ACE USA and ACE Bermuda
benefited from a reduced supply of reinsurance in the marketplace, which
resulted in increased premium prices and underwriting opportunities for
both operations.
Gross premiums written in ACE USA, which is the major component of this
segment, increased by 33 percent to $1.7 billion for the current quarter
compared with $1.3 billion last year. The majority of this growth stems
from ACE USA's Westchester Specialty, Diversified Risk (formerly
Professional Risk) and Accident and Health Groups. The main driver of the
increase in Westchester Specialty is their excess and surplus lines
division that has been able to capitalize on current market conditions to
significantly increase its pricing as well as obtain improved policy terms
and conditions. This is principally due to a decline in available insurance
capacity due to a decrease of available reinsurance in the market and the
fact that capacity in the admitted market has been shrinking (partly
because terrorism coverage exclusions have not been approved by a large
number of U.S. states). The Diversified Risk Group (formerly known as the
Professional Risk Group) provides insurance coverages for management and
professional liability including E&O, D&O, as well as surety, aviation and
satellite risks. Recent high profile corporate failures as well as
allegations of public company management impropriety have greatly increased
demand for E&O, D&O, and surety coverage and this has resulted in
significant increases in price combined with much lower policy limits and
improvements in policy terms. The Accident and Health Group also
contributed to ACE USA's growth this quarter producing $31 million in gross
premiums written mainly from new business initiated late in 2001 and
earlier this year.
35
ACE Bermuda reported $110 million in gross premiums written for the quarter
compared with $63 million last year, a 75 percent increase. This
significant increase is due primarily to growth in core lines of business
as gross premiums written for excess liability increased by over 30
percent, excess property by over 44 percent and professional lines more
than doubled.
Net premiums written for the Insurance - North American segment increased
by 58 percent for the current quarter compared with the same quarter last
year. Growth in net premiums written outpaced our growth in gross premiums
written partly due to our decision to purchase less reinsurance in the
current market conditions. Net premiums earned increased by 37 percent for
the current quarter compared with the same quarter last year, reflecting
the strong growth in premiums written.
The loss and loss expense ratio was 69.2 percent for the current quarter
compared with 97.9 percent last year. The loss ratio last year was impacted
by losses we incurred from the September 11th tragedy. Excluding the impact
of the September 11th tragedy, the loss and loss expense ratio would have
been 69.8 percent for the quarter ended September 30, 2001. This slight
decrease resulted from the general improvement in insurance pricing, offset
somewhat by a change in business mix at ACE USA and higher losses in the
ACE Bermuda professional liability book.
The underwriting and administrative expense ratio declined from 27.8 percent
last year to 21.5 percent for the current quarter. This decline is primarily a
result of reduced policy acquisition costs for the segment due to a shift
to lower commission products like D&O and E&O from higher commission
professional risk and property business. Administrative expenses increased
in the current quarter principally due to the growth in new product lines
and increased volume in existing product lines.
Net underwriting income for the Insurance - North American segment was $60
million for the quarter compared with an underwriting loss of $123 million
for the same quarter last year. Even if we excluded the impact of the
September 11th tragedy on last year's results, our underwriting income in
this segment would have increased by 233 percent, from $18 million last
year to $60 million this year. This increase is primarily the result of
growth in net premiums earned and a decline in the combined ratio in the
current quarter compared with the quarter ended September 30, 2001.
Net operating income increased due to the substantial increase in
underwriting income in the current year and the effects of the September
11th tragedy in the prior year. Excluding the September 11th tragedy, net
operating income increased by 33 percent.
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.
36
Three Months Ended Percentage
September 30 change from
2002 2001 2001 prior year
------------ ------------ ------------ ------------
(as reported) (ex WTC) (as reported)
(in millions of U.S. dollars)
Gross premiums written $ 1,008 $ 673 $ 693 50%
Net premiums written 690 423 469 63
Net premiums earned 647 445 491 45
Losses and loss expenses 446 379 312 18
Underwriting and administrative expenses 247 196 196 26
----------- ----------- ----------- --------
Underwriting loss $ (46) $ (130) $ (17) NM
----------- ----------- ----------- --------
Net investment income 28 25 25 12%
Other income (expense) (1) - - NM
Interest expense 1 1 1 -
Amortization of goodwill - 1 1 NM
Income tax benefit (4) (38) (11) NM
----------- ----------- ----------- --------
Net operating income (loss) $ (16) $ (69) $ 17 NM
----------- ----------- ----------- --------
Loss and loss expense ratio 68.9% 85.1% 63.3%
Underwriting and administrative expense ratio 38.3% 44.1% 40.0%
Combined ratio 107.2% 129.2% 103.3%
NM - not meaningful
Gross premiums written for the segment increased by 50 percent for the current
quarter compared with the same quarter last year. As with Insurance - North
American, this segment benefited from the favorable current market
conditions.
ACE International benefited from higher premium rates on new and renewal
business and a weaker U.S. dollar in posting a 44 percent increase in gross
premiums written to $683 million for the current quarter compared with $474
million last year. ACE Europe, ACE Latin America and ACE Far East and ACE
Asia Pacific all contributed to the increase. ACE Europe had a 73 percent
increase in net premiums written for the current quarter compared with last
year, primarily due to rate increases on new and renewal business and the
appreciation of the Euro and the pound sterling relative to the U.S.
dollar. ACE Latin America and ACE Asia Pacific had increases of net
premiums written of 50 percent and 73 percent, respectively for the current
quarter driven by rate increases and the strengthening of the underlying
currencies relative to the U.S. dollar. ACE Far East also had an increase
in net premiums written of 6 percent in a market that had no growth in the
period.
Gross premiums written at ACE Global Markets increased by 63 percent to
$325 million for the current quarter compared with $199 million last year.
This significant increase is primarily due to rate increases in the
property, professional and marine lines and new business written. We also
increased our participation in Lloyd's syndicate 2488 from 90 percent in
2001 to 99.6 percent in 2002. ACE Global Markets has continued with its
strategy to move 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 smaller gross limits are written and less reliance
is placed on reinsurance).
37
ACE Overseas General is very committed to ACE Global Markets as our excess
and surplus underwriter. For the 2003 year of account, syndicate 2488 will
be reducing its capacity at Lloyd's to (pound)652 million ($1 billion) from
(pound)900 million ($1.4 billion) for the 2002 year of account.
Traditionally, we have underwritten excess and surplus business through our
Lloyd's syndicates. We now have the ability to write business through our
admitted company network as well as syndicate 2488. With the exception of
marine and aviation, we feel the majority of the business lends itself to
our admitted company paper. Our plan is to migrate business from the
syndicate to the ACE International network of companies (namely ACE INA UK)
over a three year period, at which time the syndicate will be about
one-third of its current size and contain primarily marine and aviation
business. The shift of the business to our company paper will also allow us
to reduce our operating costs.
The loss and loss expense ratio was 68.9 percent for the current quarter
compared with 85.1 percent last year. This segment incurred $68 million in
losses relating to the European floods in the current quarter and $67
million in losses relating to the September 11th tragedy last year.
Removing the impact of the European floods and the September 11th tragedy,
the loss and loss expense ratio would have been 58.4 percent and 63.3
percent for the current quarter and last year, respectively.
The underwriting and administrative expense ratio for this segment was 38.3
percent for the current quarter compared with 44.1 percent last year.
Excluding the impact of the September 11th tragedy, the underwriting and
administrative expense ratio would have been 40.0 percent for the same
quarter last year. The principal reason for the decline is the increase in
net premiums earned for the current quarter.
This segment reported an underwriting loss of $46 million for the quarter
compared with an underwriting loss of $130 million for the same quarter
last year. Again, excluding the floods and the September 11th tragedy, we
would have had underwriting income of $22 million for the current quarter
and an underwriting loss of $17 million for the same quarter last year.
This segment had net operating losses in both the current quarter and for
the quarter ended September 30, 2001 due to the floods and the September
11th tragedy as discussed. Excluding the September 11th tragedy last year
and the European floods in the current quarter, net operating income would
have been $17 million last year and $45 million for the current quarter.
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
Property and Casualty
Three Months Ended Percentage
September 30 change from
2002 2001 2001 prior year
------------ ------------ ------------ ------------
(as reported) (ex WTC) (as reported)
(in millions of U.S. dollars)
Gross premiums written $ 186 $ 94 $ 94 98%
Net premiums written 131 36 59 264
Net premiums earned 194 70 92 177
Losses and loss expenses 101 229 16 (56)
Underwriting and administrative expenses 48 30 29 6
--------- ---------- --------- ---------
Underwriting income (loss) $ 45 $ (189) $ 47 NM
--------- ---------- --------- ---------
Net investment income 24 16 16 50%
Other income (expense) 1 - - NM
Interest expense 4 - - NM
Amortization of goodwill - 3 3 NM
Income tax expense (benefit) (1) (33) 2 NM
--------- ---------- --------- ----------
Net operating income (loss) $ 67 $ (143) $ 58 NM
--------- ---------- --------- ----------
Loss and loss expense ratio 52.0% 330.2% 17.7%
Underwriting and administrative expense ratio 24.4% 42.8% 31.8%
Combined ratio 76.4% 373.0% 49.5%
NM - not meaningful
Gross premiums written increased by 98 percent for the current quarter
compared with the same quarter last year. All three of the ACE Global
Reinsurance operations (Bermuda, U.S. and London) contributed to the
growth. ACE Tempest Re, where we write most of the property catastrophe
business, had a 51 percent increase in gross premiums written to $80
million. Catastrophe related rates overall remained firm during the
quarter, with rates up approximately 8 percent over the prior year. As
returns on this business generally are adequate, we expect rates to remain
essentially flat over the next several quarters barring any major
catastrophe claim activity. Some of the business in the market continues to
have inadequate rates and terms, and as such we continue to decline more
business than we write. ACE Tempest U.K. which is principally focused on
specialty reinsurance products had an increase in gross premiums written of
80 percent to $36 million for the current quarter compared with $20 million
last year. ACE Tempest U.S., established in 2000 with an initial focus on
writing P&C reinsurance, had an increase in gross premiums written of 229
percent to $69 million for the current quarter compared with $21 million
last year.
Net premiums written increased to $131 million for the quarter compared
with $36 million last year ($59 million if we exclude the impact of accrued
reinsurance ceded premiums related to the September 11th tragedy last
year). This significant increase is primarily a result of the growth in
gross premiums written in a segment that retains most of the gross premium
that it writes.
39
The loss and loss expense ratio was 52.0 percent for the current quarter
compared with 330.2 percent last year. This segment incurred $32 million in
losses relating to the European floods in the current quarter and $213
million in losses relating to the September 11th tragedy last year.
Removing the impact of the European floods and the September 11th tragedy,
the loss and loss expense ratio would have been 35.5 percent and 17.7
percent for the current quarter and last year, respectively. This increase
is primarily a result of changes in the mix of business as this segment
transforms from a property catastrophe writer to a multi-line writer. The
underwriting and administrative expense ratio declined to 24.4 percent for
the current quarter from 42.8 percent last year. Excluding the impact of
the September 11th tragedy, the underwriting and administrative expense
ratio would have been 31.8 percent last year. This improvement is primarily
the result of the increase in net premiums earned.
Underwriting income for the Global Reinsurance segment increased to $45
million for the quarter compared with an underwriting loss of $189 million
for the same quarter last year. Excluding the impact of the two events
mentioned above, underwriting income would have increased to $77 million for
the current quarter compared with $47 million last year. This increase is
primarily a result of higher premium rates in the P&C insurance and reinsurance
market since the September 11th tragedy.
Net operating income increased to $67 million for the current quarter
compared with a net operating loss of $143 million last year. Removing the
impact of the European floods and the September 11th tragedy, net operating
income would have improved to $96 million for the current quarter compared
with $58 million last year. The increase is a result of higher underwriting
income from all the divisions during the current quarter.
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 Percentage
September 30 change from
2002 2001 prior year
----------- ----------- ------------
(in millions of U.S. dollars)
Gross premiums written $ 58 $ 32 81%
Net premiums written 57 32 78
Net premiums earned 57 32 78
Life and annuity benefits 60 29 107
Underwriting and administrative expenses 5 2 150
Net investment income 7 - NM
---------- --------- ----------
Net operating income (loss) $ (1) $ 1 NM
----------- --------- ----------
NM - not meaningful
40
The life reinsurance group wrote $58 million of business for the quarter
ended September 30, 2002 compared with $32 million last year. The quarter
ended September 30, 2001 included $7 million of recurring business compared
with $28 million of recurring business in the current quarter. We continue
to be 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. We recently 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 Services
The Financial Services 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. Both units write
structured finance transactions which are recorded at higher loss and loss
expense ratios than other business. These transactions are typically longer
term contracts where profit emerges over the term of the contract and relies
on investment income as a component of profitability. 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 Services 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
Three Months Ended Percentage
September 30 change from
2002 2001 2001 prior year
------------ ------------ ------------ ------------
(as reported) (ex WTC) (as reported)
(in millions of U.S. dollars)
Gross premiums written $ 493 $ 385 $ 243 28%
Net premiums written 476 263 121 81
Net premiums earned 373 374 270 -
Losses and loss expenses 328 466 215 (30)
Underwriting and administrative expenses 33 26 26 27
---------- ---------- --------- ----------
Underwriting income (loss) $ 12 $ (118) $ 29 NM
---------- ---------- --------- ----------
Net investment income 46 43 43 7%
Other income (expense) - (1) (1) NM
Interest expense 3 4 4 (25)
Amortization of goodwill - 1 1 NM
Income tax expense 7 7 7 -
----------- --------- --------- ----------
Net operating income (loss) $ 48 $ (88) $ 59 NM
----------- --------- --------- ----------
Loss and loss expense ratio 88.0% 124.4% 79.4%
Underwriting and administrative expense ratio 8.8% 7.2% 9.9%
Combined ratio 96.8% 131.6% 89.3%
NM - not meaningful
The Financial Services' net operating income increased by $136 million to
$48 million for the current quarter compared with a net operating loss of
$88 million last year. This segment was significantly affected by the
September 11th tragedy during the quarter ended September 30, 2001.
Excluding this event, net operating income would have been $59 million last
year and on this basis net operating income decreased by $11 million or 19
percent compared with last year. The combined ratio decreased from 131.6
percent last year to 96.8 percent in the current quarter. Excluding the
September 11th tragedy, the combined ratio increased in the current quarter
compared with 89.3 percent last year. This increase is attributed primarily
to increased LPTs and structured finance business which are recorded at
higher loss and loss expense ratios than other business.
The financial guaranty operation reported an increase in net operating
income of 21 percent to $29 million for the current quarter, compared with
$24 million for the quarter ended September 30, 2001. Gross premiums
written increased by 285 percent to $144 million compared with $37 million
for the same quarter last year. Most divisions contributed to the increased
business during the current quarter. The structured finance operation wrote
four, multi-year programs where we provide first loss protection on
synthetic collateralized debt obligations totaling $103 million.
Financial solutions reported net operating income of $19 million for the
current quarter, a $131 million increase compared with net operating loss
of $112 million for the quarter ended September 30, 2001. This operation
was heavily impacted by the September 11th tragedy. Excluding the impact of
this event, net operating income last year would have been $35 million.
This decrease relates primarily to the increase in LPT volume from $135
million last year to $187 million for the current quarter. As previously
stated, these transactions are recorded at higher loss and loss expense
ratios than our other business. In addition, during the current quarter, we
wrote a $38 million securitization transaction, which is being reserved at
100 percent loss ratio.
42
The loss and loss expense ratio decreased from 124.4 percent last year to
88.0 percent for the current quarter. Excluding the impact of the September
11th tragedy, the loss and loss expense ratio would have been 79.4 percent
last year, reflecting an increase in the current quarter due to the impact
of higher LPT volume and structured finance business. The increase in LPTs
and the structured finance business also affected the underwriting and
administrative expense ratio in the current quarter as these transactions
typically incur lower commission costs than other business. The
underwriting and administrative ratio decreased from 9.9 percent last year,
excluding the September 11th tragedy, to 8.8 percent for the current
quarter.
Results of Operations - Nine months ended September 30, 2002 and 2001
Consolidated Operating Results
Nine Months Ended Percentage
September 30 change from
2002 2001 2001 prior year
------------ ------------ ------------ ------------
(as reported) (ex WTC) (as reported)
(in millions of U.S. dollars)
Gross premiums written $ 9,575 $ 7,466 $ 7,344 28%
Net premiums written 6,084 4,510 4,459 35
Net premiums earned 4,861 4,153 4,139 17
Losses and loss expenses 3,142 3,448 2,798 (9)
Life and annuity benefits 106 58 58 83
Policy acquisition costs 685 559 558 23
Administrative expenses 678 602 602 12
---------- --------- ---------- ----------
Underwriting income (loss) $ 250 $ (514) $ 123 NM
---------- --------- ---------- ----------
Net investment income 600 593 593 1%
Other income (expense) 4 1 1 300
Interest expense 146 153 153 (5)
Amortization of goodwill - 59 59 NM
Income tax expense 98 (21) 57 NM
---------- --------- ---------- ----------
Net operating income (loss) $ 610 $ (111) $ 448 NM
---------- --------- ---------- ----------
Debt prepayment expense (net of income tax) (17) -
Non-recurring expenses (net of income tax) - (4)
Net realized losses on investments (net of income tax) (348) (54)
Cumulative effect of adopting a new accounting standard (net
of income tax) - (23)
---------- ---------
Net income (loss) $ 245 $ (192)
========== =========
Loss and loss expense ratio* 66.1% 84.3% 68.6%
Underwriting and administrative expense ratio* 28.3% 28.3% 28.4%
Combined ratio* 94.4% 112.6% 97.0%
* Ratios exclude life reinsurance business
NM - not meaningful
Gross premiums written increased by 28 percent for the nine months ended
September 30, 2002 compared with the same period last year and our net
premiums written, which reflect the premiums we retain after purchasing
reinsurance protection, increased by 35 percent. During the nine months
ended September 30, 2001, we wrote several large retroactive contracts in
the form of LPTs totaling $552 million compared with $212 million for the
current period. Our net premiums earned, which reflect the portion of net
premiums written recorded as revenues for the period, increased by 17
percent for the period compared with the same period last year. These
increases are discussed in each segment section, but generally are due to a
combination of price increases on renewal business and new business
opportunities.
43
Certain operating entities within the Financial Services segment may write
large multi-year contracts, including retroactive contracts in the form of
LPTs. These contracts may make the comparison of premium trends more
difficult. Excluding the Financial Services segment, gross written, net
written and net earned premiums increased by 31 percent, 39 percent and 29
percent, respectively.
The loss and loss expense ratio was 66.1 percent for the current period
compared with 84.3 percent last year. Our current year loss ratio was
impacted by an accumulation of losses incurred with respect to the floods
in Europe in the third quarter. Our loss ratio for the nine months of 2001
was substantially impacted by the September 11th tragedy. If you remove the
impact of the flood losses and our September 11th tragedy losses from our
loss ratios, the ratios would have been 64 percent for the current period
and 68.6 percent last year. This ratio is also influenced by changes in the
mix of business written, particularly in the Financial Services segment
where LPTs can cause variations in the loss ratio. Excluding the Financial
Services segment, our loss ratios would have been 60.1 percent compared
with 63.2 percent.
The underwriting and administrative expense ratio was unchanged at 28.3
percent for the nine months ended September 30, 2002 and 2001.
Underwriting income increased by $764 million to $250 million for the nine
months of 2002 compared with an underwriting loss of $514 million during
the same period last year. Excluding the September 11th tragedy, last
year's underwriting income would have $123 million. This significant
increase is principally a result of increased prices across most lines of
business and a reduction in our combined ratio.
Our net investment income was $600 million for the current period compared
with $593 million last year. Investment income from strong operating cash
flows have essentially been offset by lower reinvestment rates.
Net operating income was $610 million for the nine months ended September
30, 2002 compared with a net operating loss of $111 million last year. As
previously noted, the September 11th tragedy reduced our net operating
income by $559 million, after tax, for the period ended September 30, 2001.
Excluding the impact of this catastrophic event, net operating income would
have been $448 million last year. This translates to a 36 percent increase
in net operating income which was primarily due to growth in net premiums
earned for the nine months ended September 30, 2002 compared with the same
period last year. Additionally, we adopted FAS 142 on January 1, 2002 and
accordingly have not amortized any goodwill in the current period, compared
with $59 million of goodwill amortized for the period ended September 30,
2001.
The debt prepayment expense of $17 million (net of income tax) incurred
during the period resulted from our decision to prepay a portion of the ACE
INA Subordinated Notes due in 2009. These subordinated notes bear interest
at 11.2 percent. During 2001, we had 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 $348 million
for the nine months ended September 30, 2002 compared with net realized
losses of $54 million for the nine months ended September 30, 2001. The net
realized losses incurred in the current period are discussed in detail in the
net realized gains (losses) on investments section. As discussed later in this
report, on January 1, 2001 we adopted FAS 133 and recorded an expense related
to the cumulative effect of adopting this standard of $23 million, net of
income tax of $12 million.
44
Segment Operating Results
Insurance - North American
Nine Months Ended Percentage
September 30 change from
2002 2001 2001 prior year
------------ ------------ ------------ --------------
(as reported) (ex WTC) (as reported)
(in millions of U.S. dollars)
Gross premiums written $ 4,476 $ 3,424 $ 3,424 31%
Net premiums written 2,100 1,518 1,540 38
Net premiums earned 1,733 1,360 1,382 27
Losses and loss expenses 1,176 1,082 963 9
Underwriting and administrative expenses 391 381 381 3
---------- ---------- --------- --------
Underwriting income (loss) $ 166 $ (103) $ 38 NM
---------- ---------- --------- --------
Net investment income 306 326 326 (6)%
Other income (expense) - 1 1 -
Interest expense 24 26 26 (8)
Income tax expense 115 68 84 69
---------- ---------- --------- ---------
Net operating income $ 333 $ 130 $ 255 156%
---------- ---------- --------- ---------
Loss and loss expense ratio 67.9% 79.5% 69.7%
Underwriting and administrative expense ratio 22.5% 28.1% 27.6%
Combined ratio 90.4% 107.6% 97.3%
NM - not meaningful
Gross premiums written for the segment increased by 31 percent for the
period compared with the same period last year. Both ACE USA and ACE
Bermuda have contributed to the increase. ACE USA's gross premiums written
increased by 29 percent to $4.1 billion for the nine months ended September
30, 2002 compared with $3.2 billion for the same period last year. Most of
ACE USA's operating divisions experienced strong premium growth during the
period, attributed largely to rising prices which is a result of the
reduced availability of insurance for larger property accounts and excess
casualty coverages. In addition, demand and pricing have increased for E&O
and D&O coverage due to recent corporate failures and allegations of public
company management misconduct. These market conditions have also led to
generally favorable changes in policy terms and conditions.
ACE Bermuda has been successful in growing its core lines of business,
reporting an increase in gross premiums written of 64 percent to $310
million for the period compared with $190 million last year. This
significant increase is primarily a result of rate increases in the
insurance and reinsurance market in general, due to the September 11th
tragedy and recent corporate failures.
This segment's loss and loss expense ratio was 67.9 percent for the current
period compared with 79.5 percent for the same period last year. Excluding
the impact of the September 11th tragedy, last year's loss ratio would have
been 69.7 percent. This reduction is principally due to higher levels of
net premiums earned, partially achieved by rate increases.
The underwriting and administrative expense ratio declined to 22.5 percent
from 28.1 percent last year. This decline is primarily a result of a change
in product mix, as more E&O and D&O business with lower commission was
written during the period. In addition, at ACE USA, Westchester Specialty
generated commissions from reinsurance ceded to other insurance companies
in order to reduce volatility in this unit's growing casualty and umbrella
coverages. Administrative expenses increased in the current period
principally due to the growth in new product lines and increased volume in
existing product lines.
45
Underwriting income was $166 million for the nine months compared with an
underwriting loss of $103 million for the same period last year. Excluding
the September 11th tragedy, the Insurance-North American segment would have
produced underwriting income of $38 million for the period ended September
30, 2001. The large increase in net earned premiums was principally
responsible for the large increase in underwriting income.
Net operating income has increased 156 percent for the period compared with
last year. Excluding the impact of the September 11th tragedy, net
operating income would have increased by 31 percent. This significant
increase in net operating income in the current period is due to the
increase in underwriting income in the segment.
Insurance - Overseas General
Nine Months Ended Percentage
September 30 change from
2002 2001 2001 prior year
------------ ------------ ------------ ------------
(as reported) (ex WTC) (as reported)
(in millions of U.S. dollars)
Gross premiums written $ 2,911 $ 2,361 $ 2,381 23%
Net premiums written 1,920 1,533 1,579 25
Net premiums earned 1,722 1,430 1,476 20
Losses and loss expenses 1,083 984 917 10
Underwriting and administrative expenses 664 559 559 19
---------- ---------- ---------- -----------
Underwriting income (loss) $ (25) $ (113) $ - NM
---------- ---------- ---------- -----------
Net investment income 77 82 82 (6)%
Other income (expense) 3 - - NM
Interest expense 2 2 2 -
Amortization of goodwill - 3 3 NM
Income tax expense (benefit) 9 (25) 2 NM
---------- ---------- ---------- -----------
Net operating income (loss) $ 44 $ (11) $ 75 NM
---------- ---------- ---------- -----------
Loss and loss expense ratio 62.9% 68.8% 62.1%
Underwriting and administrative expense ratio 38.5% 39.1% 37.8%
Combined ratio 101.4% 107.9% 99.9%
NM - not meaningful
Gross premiums written for the segment increased by 23 percent for the
period compared with the same period last year. ACE International's gross
premiums written increased by 23 percent to $2 billion for the nine months
ended September 30, 2002 compared with $1.6 billion last year.
Geographically, Europe and Asia contributed the most to this growth,
principally driven by strong rate increases in both the P&C and A&H
businesses and additionally by the strengthening of foreign currencies
relative to the U.S. dollar.
ACE Global Markets' gross premiums written increased by 24 percent to $940
million for the nine months ended September 30, 2002 compared with $756
million last year. This significant increase is primarily due to rate
increases in the property, professional and marine lines and new business
written. We also increased our participation in Lloyd's syndicate 2488 from
90 percent in 2001 to 99.6 percent in 2002.
46
The loss and loss expense ratio declined to 62.9 percent for the nine
months ended September 30, 2002 compared with 68.8 percent for the same
period last year. This segment incurred $68 million in losses relating to
the European floods in the current year and $67 million in losses relating
to the September 11th tragedy last year. Removing the impact of the
European floods and the September 11th tragedy, the loss and loss expense
ratio would have been 58.9 percent and 62.1 percent for the current period
and last year, respectively.
The underwriting and administrative expense ratio for this segment was
relatively stable at 38.5 percent for the nine months ended September 30,
2002 compared with 39.1 percent last year.
Net operating income for the current period was $44 million compared with a
net operating loss of $11 million last year. Last year's results were
impacted by the September 11th tragedy. Excluding this event there would
have been net operating income of $75 million last year. The decrease is
attributable to the underwriting loss for the current period.
Global Reinsurance
Property and Casualty
Nine Months Ended Percentage
September 30 change from
2002 2001 2001 prior year
------------ ------------ ------------ -------------
(as reported) (ex WTC) (as reported)
(in millions of U.S. dollars)
Gross premiums written $ 774 $ 427 $ 427 81%
Net premiums written 683 336 359 103
Net premiums earned 459 233 255 97
Losses and loss expenses 193 300 87 (36)
Underwriting and administrative expenses 109 73 72 49
--------- --------- -------- -------
Underwriting income (loss) $ 157 $ (140) $ 96 NM
--------- --------- --------- -------
Net investment income 71 51 51 37%
Other income (expense) 1 - - NM
Interest expense 9 - - NM
Amortization of goodwill - 10 10 NM
Income tax expense 1 (26) 9 NM
--------- --------- -------- -------
Net operating income (loss) $ 219 $ (73) $ 128 NM
--------- --------- -------- -------
Loss and loss expense ratio 42.0% 128.8% 34.2%
Underwriting and administrative expense ratio 23.7% 31.0% 28.0%
Combined ratio 65.7% 159.8% 62.2%
NM - not meaningful
Gross premiums written increased by 81 percent for the nine months ended
September 30, 2002, compared with the same period last year. ACE Tempest
Re, ACE Tempest U.K. and ACE Tempest U.S. all contributed to this
significant increase. ACE Tempest Re reported a 58 percent increase in
gross premiums written to $429 million compared with $271 million for the
nine months ended September 30, 2001. ACE Tempest U.K. increased its gross
premiums written by 70 percent to $196 million for the current period
compared with $115 million last year. At ACE Tempest U.S., gross premiums
written grew by 260 percent to $148 million for the current period compared
with $41 million for the nine months ended September 30, 2001.
47
Net premiums written more than doubled for the nine months ended September
30, 2002 compared with last year. Excluding the impact of the September
11th tragedy, net premiums written would have been $359 million for the
nine months ended September 30, 2001. This increase is primarily a result
of the growth in gross premiums written and additionally due to the reduced
level of reinsurance purchased by ACE Tempest U.K.
The loss and loss expense ratio improved from 128.8 percent last year to 42.0
percent in the current period. Removing the impact of the September 11th
tragedy, the loss and loss expense ratio would have been 34.2 percent last
year. This increase is due to losses associated with the European floods in
the current period. The underwriting and administrative expense ratio declined
to 23.7 percent for the nine months ended September 30, 2002, from 31.0
percent last year. Excluding the September 11th tragedy, the underwriting and
administrative expense ratio would have been 28.0 percent last year. The
improvement is a result of higher premium production levels during the period.
This segment's underwriting income increased to $157 million for the nine
months ended September 30, 2002, compared with an underwriting loss of $140
million for the same period last year. Excluding the impact of the
September 11th tragedy, underwriting income would have been $96 million
last year. This significant increase is primarily a result of higher
premium rates in the P&C insurance and reinsurance market since the
September 11th tragedy, although these increases are now beginning to
stabilize.
Net operating income increased to $219 million for the current period
compared with a net operating loss of $73 million last year. Removing the
impact of the European floods and the September 11th tragedy, net
operating income would have improved to $248 million for the current period
compared with $128 million last year. This increase is a result of higher
underwriting income from all the divisions and the increase in net
investment income.
Life Reinsurance
Nine Months Ended Percentage
September 30 change from
2002 2001 prior year
------------ ------------ ------------
(in millions of U.S. dollars)
Gross premiums written $ 115 $ 63 83%
Net premiums written 112 63 77
Net premiums earned 112 63 77
Life and annuity benefits 106 58 83
Underwriting and administrative expenses 20 4 400
Net investment income 19 - NM
--------- --------- --------
Net operating income $ 5 $ 1 400%
--------- --------- --------
NM - not meaningful
48
For the nine months ended September 30, 2002, the life reinsurance group
reported $5 million in net operating income compared with $1 million 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.
Financial Services
Nine Months Ended Percentage
September 30 change from
2002 2001 2001 prior year
------------ ------------ ------------ ------------
(as reported) (ex WTC) (as reported)
(in millions of U.S. dollars)
Gross premiums written $ 1,299 $ 1,191 $ 1,049 9%
Net premiums written 1,269 1,060 918 20
Net premiums earned 835 1,067 963 (22)
Losses and loss expenses 690 1,082 831 (36)
Underwriting and administrative expenses 100 79 79 27
---------- ---------- ---------- ---------
Underwriting income (loss) $ 45 $ (94) $ 53 NM
---------- ---------- ---------- ---------
Net investment income 141 127 127 11%
Interest expense 10 11 11 (9)
Amortization of goodwill - 3 3 NM
Income tax expense 24 18 18 33
---------- ---------- ---------- ---------
Net operating income $ 152 $ 1 $ 148 151%
---------- ---------- ---------- ---------
Loss and loss expense ratio 82.6% 101.3% 86.2%
Underwriting and administrative expense ratio 12.0% 7.5% 8.3%
Combined ratio 94.6% 108.8% 94.5%
NM - not meaningful
This segment's net operating income increased to $152 million for the nine
months ended September 30, 2002 compared with $1 million for the same
period last year. Last year's results were significantly affected by the
September 11th tragedy. Excluding the impact of this event, net operating
income would have been $148 million for the nine months ended September 30,
2001. Gross premiums written increased by 9 percent to $1.3 billion for the
current period compared with $1.2 billion last year. This increase reflects
the increased demand for credit derivatives partially offset by lower LPT
volume experienced during the period.
The financial guaranty operations were successful in increasing net
operating income by 20 percent to $83 million for the nine months ended
September 30, 2002 compared with $69 million for the same period last year.
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.
The financial solutions operations had net premiums earned of $667 million
for the nine months ended September 30, 2002, a 20 percent decline over the
same period last year, which reported net premiums earned of $801 million.
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. The nine months ended
September 30, 2001 included $552 million of LPTs compared with $212 million
in the current period.
49
As previously stated, LPTs are typically recorded at higher loss ratios
than our other lines of business and as a result the reduction in LPT
business written in the nine months ended September 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 101.3 percent for the nine months
ended September 30, 2001 to 82.6 percent for the current period. Excluding
the September 11th tragedy, the loss and loss expense ratio was 86.2
percent last year. The underwriting and administrative expense ratio was
12.0 percent for the period ended September 30, 2002 compared with 7.5
percent last year. This increase is primarily attributed to the decrease in
LPT volume in the current period compared with last year. LPTs typically
incur lower commission costs than our other lines of business.
Net Investment Income
The following table provides an analysis of our net investment income by
segment for the three and nine months ended September 30, 2002 and 2001:
Three Months Ended Nine Months Ended
September 30 September 30
2002 2001 2002 2001
------------ ------------ ------------ ------------
(in millions of U.S. dollars)
Insurance - North American $ 101 $ 106 $ 306 $ 326
Insurance - Overseas General 28 25 77 82
Global Reinsurance - P&C 24 16 71 51
Global Reinsurance - Life 7 - 19 -
Financial Services 46 43 141 127
Corporate and other (1) (7) 2 (14) 7
---------- --------- --------- ---------
Net investment income $ 199 $ 192 $ 600 $ 593
========== ========= ========= =========
(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 4 percent for the quarter ended September 30, 2002 compared
with the same quarter last year.
The proceeds from our sale of Ordinary Shares in the fourth quarter of 2001
and positive operating cash flow over the past five quarters resulted in an
increase in net investment income of approximately $28 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
investing 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 increased by 1 percent for the nine months ended
September 30, 2002 compared with the same period last year. Again, the
proceeds from our equity offering in the fourth quarter of 2001 and
50
positive operating cash flow resulted in an increase in net investment
income of approximately $69 million for the current period compared with
the same period last year. This increase was offset by a $62 million
decrease in investment income for the same reasons discussed above.
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 other than temporary
impairments are recorded on invested assets or when derivatives, including
financial futures and options, interest rate swaps and credit default 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 pre-tax net realized gains (losses) on investments for the
three and nine months ended September 30, 2002 and 2001:
Three Months Ended Nine Months Ended
September 30 September 30
2002 2001 2002 2001
------------ ------------ ------------ ------------
(in millions of U.S. dollars)
Fixed maturities and short-term investments $ (16) $ 12 $ (55) $ 1
Equity securities (55) 9 (53) 33
Financial futures, options and interest rate swaps (113) (26) (197) (44)
Fair value adjustment on credit derivatives (51) (29) (97) (14)
Currency (2) (2) - (6)
Other investments 2 (23) 2 (33)
------- ------- -------- ---------
Total net realized gains (losses) on investments $ (235) $ (59) $ (400) $ (63)
======= ======= ======== =========
Net realized losses on fixed maturities and equity securities during the
current quarter include regular trading losses and losses related to
write-downs of certain fixed income and equity securities in our investment
portfolio that were judged to have an other than temporary decline in their
fair value. The write-down from the recognition of impairments was $84
million for the current quarter. Total net realized losses were
substantially offset by $226 million of net unrealized gains. The
write-down from the recognition of impairments for the nine months ended
September 30, 2002 was $126 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 $56 million were recognized on interest rate
swaps during the third quarter of 2002. These losses were a result of the drop
in interest rates that resulted in unrealized gains of $282 million in our
fixed income portfolio. Net realized losses generated by our equity and fixed
income index futures and option contracts amounted to $57 million for the
current quarter, bringing the total net realized losses attributable to
financial futures and option contracts and interest rate swaps to $113 million
compared with losses of $26 million for the same quarter in 2001.
The change in fair value of our credit derivatives, which principally comprise
credit default swaps, for the quarter ended September 30, 2002 was a loss of
$51 million compared with a loss of $29 million for the same quarter in 2001.
51
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. (See "Derivatives" below for additional information)
Other Income and Expense Items
- ------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
2002 2001 2002 2001
------------ ------------ ------------ ------------
(in millions of U.S. dollars)
Other (income) expense $ 14 $ 2 $ 21 $ (1)
============ =========== =========== ============
Interest expense $ 48 $ 49 $ 146 $ 153
============ =========== =========== ============
Income tax expense (benefit) $ (7) $ (76) $ 37 $ (31)
============ =========== =========== ============
Amortization of goodwill $ - $ 19 $ - $ 59
============ =========== =========== ============
Other (income) expense includes $25 million ($17 million, net of income
tax) in debt prepayment expense incurred in the second and third quarters
of the current year 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.
Interest expense was relatively flat at $48 million for the quarter ended
September 30, 2002 compared with last year. An increase in interest expense
due to our issuance of $500 million of debt (discussed in the Capital
Resources section below) late in the first quarter of 2002 was offset by
lower short-term interest rates on our floating rate debt and a reduction
in the debt outstanding. For the nine months ended September 30, 2002
interest expense decreased by 4 percent compared with last year. 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.
For 2003, we expect that our effective tax rate will increase somewhat and
be in the 18 percent to 20 percent range. Our effective tax rate is
dependent upon the mix of earnings from different jurisdictions with
various tax rates. In 2003, we expect higher growth in taxable
jurisdictions. A different geographic mix of actual earnings would change
the effective tax rate.
In June 2001, FASB issued FAS 142 which 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.
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 S&P. The
portfolio is externally managed by independent professional investment
managers. The average duration of our fixed income securities, including
the effect of interest rate swaps, is 3.1 years at September 30, 2002.
At September 30, 2002, total investments and cash were $17.7 billion
compared with $15.9 billion at December 31, 2001, an increase of $1.8
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 $546 million and strong operating cash
flows on the strength of increased net premiums written. Offsetting these
increases, we paid dividends of $142 million during the period and repaid
$100 million of long-term debt and reduced our trust preferred security
balance by $400 million. 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
52
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 September 30, 2002 and December 31, 2001:
September 30 December 31
2002 2001
------------ ------------
(in millions of U.S. dollars)
Fixed maturities available for sale $ 13,504 $ 13,000
Equity securities 401 467
Short-term investments 2,004 1,206
Other investments 645 591
Securities on loan 533 -
Cash 650 672
------------ ------------
Total investments and cash $ 17,737 $ 15,936
============ ============
The following tables identify our fixed income portfolio, short-term
investments, securities on loan and cash and cash equivalents at September
30, 2002. The first table shows the amount of these items by type while the
second table shows them by credit rating, as rated by S&P.
September 30
2002 Percentage
Market Value of Total
------------- -----------
(in millions of
U.S. dollars)
Treasury $ 938 6%
Agency 986 6
Corporate 5,940 36
Mortgage-backed securities 3,193 19
Asset-backed securities 428 2
Municipal update 1,162 7
Non-US 1,861 11
Cash and cash equivalents 2,183 13
------------ -----------
Total $ 16,691 100%
============ ===========
September 30
2002 Percentage
Market Value of Total
------------- -----------
(in millions of
U.S. dollars)
AAA $ 7,861 47%
AA 3,438 21
A 2,856 17
BBB 1,318 8
BB 565 3
B 636 4
Other 17 -
----------- -----------
Total $ 16,691 100%
=========== ===========
53
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 nine months ended September 30, 2002:
Gross Reinsurance
Losses Recoverable Net
---------- ------------ -----------
(in millions of U.S. dollars)
Balance at December 31, 2001 $ 20,728 $ 10,327 $ 10,401
Losses and loss expenses incurred 5,582 2,440 3,142
Losses and loss expenses paid (4,879) (2,120) (2,759)
Other (including foreign exchange revaluation) 210 45 165
---------- ----------- -----------
Balance at September 30, 2002 $ 21,641 $ 10,692 $ 10,949
========== = ========== ===========
The reserve for unpaid losses and loss expenses increased by $913 million to
$21.6 billion at September 30, 2002 compared with $20.7 billion at December
31, 2001. The balance at September 30, 2002 includes $13.2 billion of case and
loss expense reserves compared with $13.3 billion at December 31, 2001. 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 an independent actuarial firm
once a year to review the methods and assumptions we use in estimating the
unpaid losses and loss expenses. This annual review covers different portions
of our loss reserves on a rotating basis each year and is one of the factors
we use to set our loss reserves. In addition, the Insurance Department of the
Commonwealth of Pennsylvania required a biannual external actuarial review
when Brandywine was established. That review is underway and is expected to be
completed during the fourth quarter. We continually evaluate our estimates 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 September 30, 2002 is adequate, future
developments may result in ultimate losses and loss expenses significantly
greater or less than the reserve provided, which could have a material adverse
effect on future operating results. See "Asbestos and Environmental Claims".
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 and loss expense reserves on our balance
sheet represents our total unpaid gross losses and reinsurance
recoverables on our balance sheet represents anticipated recoveries of a
portion of those gross 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 September 30, 2002 and
December 31, 2001.
54
September 30 December 31
2002 2001
------------ ------------
(in millions of U.S. dollars)
Reinsurance recoverable on paid
losses and loss expenses $ 1,190 $ 1,066
Reinsurance recoverable on unpaid
losses and loss expenses 11,488 11,116
Reinsurance recoverable on future policy
benefits 7 5
---------- -----------
Gross reinsurance recoverable 12,685 12,187
Bad debt reserve (796) (789)
---------- -----------
Net reinsurance recoverable $ 11,889 $ 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
September 30, 2002:
Bad Debt % of
Category Amount Reserve Total Reserve
------------------- -------------- ------------- ---------------
(in millions of U.S. dollars)
General collections $ 720 $ 37 5.1%
Other 470 303 64.5
------------ ---------- -----------
Total $ 1,190 $ 340 28.6%
============ ========== ===========
General collections balances represent amounts in the process of collection
in the normal course of business, for which we have no indication of
dispute or credit issues. We provide bad debt reserves based primarily on
the application of historical loss experience to credit categories and
historical dispute statistics.
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 reserve considers the credit quality of the reinsurer,
and whether we have received collateral or other credit protections such as
parental guarantees. 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 reinsurers and the second category
representing the remaining reinsurers with balances greater than $20 million.
The third category includes amounts due from over 2,500 companies each having
balances of less than $20 million. Our bad debt reserve in the three
categories is principally based on an analysis of the credit quality of the
reinsurer, and collateral balances. The next category, mandatory pools and
government agencies, are amounts backed by the U.S. 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 reserve based on the credit quality of the life
insurers. 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 insurance risk). It is generally our policy to obtain
55
collateral equal to expected losses. Where appropriate, limited exceptions are
granted but only with review and sign-off at a senior officer level. Our final
category, other, includes amounts recoverable that are in dispute, or are from
companies that are in supervision, rehabilitation, or liquidation. We
establish our bad debt reserve 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 and the
reinsurance protection we purchased from National Indemnity Company ("NICO")
in both the Westchester Specialty and CIGNA P&C acquisitions. The remaining
limits under these contracts are available for both future loss reserve
development and uncollectible recoverables.
June 30
Breakdown of Reinsurance Recoverable 2002 Bad Debt Reserve % of Gross
------------------------------------ -------- ----------------- ----------
(in millions of U.S. dollars)
Categories
Top 10 reinsurers $ 5,664 $ 47 0.8%
Other reinsurers balances greater than $20 million 1,114 37 3.3
Other reinsurers balances less than $20 million 2,492 233 9.5
Mandatory pools and government agencies 811 - -
Structured settlements 730 3 0.4
Captives 794 4 0.5
Other 829 473 57.1
---------- -------- ---------
Total $ 12,434 $ 797 6.4%
========== ======== =========
Top 10 Reinsurers Other Reinsurers Balances Greater Than $20 million
----------------- --------------------------------------------------
AXA AIG Overseas Partners
Berkshire Group CNA Group PMA Reins Corp
Employers Re Everest Rein Co Renaissance Reinsurance Ltd.
Equitas Fairfax Holdings Royal & Sun Alliance Ins.
Hannover Re Gerling Global Scan Re
Munich Re Hartford SCOR
St. Paul IRB - Brasil Re TOA
Swiss Re Liberty Mutual White Mountain
XL Capital Lloyd's
Zurich Ins. Corp
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
September 30, 2002 and December 31, 2001:
September 30, 2002 December 31, 2001
Gross Net Gross Net
------------------ ------------------ ------------------ -----------------
(in millions of U.S. dollars)
Asbestos $ 1,097 $ 90 $ 1,119 $ 149
Environmental and other latent
exposures 911 347 1,089 452
------------ ----------- ----------- -----------
Total $ 2,008 $ 437 $ 2,208 $ 601
============ =========== =========== ===========
56
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.
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
reinsurance protection for adverse development for all losses occurring prior
to 1997.
As of September 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 September 30, 2002 the remaining limit in
the NICO reinsurance cover protecting Westchester was approximately $600
million.
Paying for the unimpaired
A large majority of 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 address the unimpaired
claimants 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 without prejudice
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.
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 crowded 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, should result in unimpaired claimants being required to
prove injury under traditional common law standards.
57
Peripheral and unidentified asbestos defendants
The inability of the tort system to manage and resolve asbestos cases
fairly has resulted in a large number of bankruptcies of asbestos
defendants, nearly 60 at last count. Bankruptcy courts may provide a
rational and workable claims 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 bankrupts' shares of liability.
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 bankrupts' shares of liability. 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 ("FELA"), 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 Supreme Court ruling
on the merits of the claims and supporting analysis could be influential on
state courts dealing with similar issues.
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 2002 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 peripheral defendants with decreasing degrees
of potential liability may be named in future suits.
High profile insureds
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 eight 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 believe will have little variability. Three of the
remaining policyholders are fully reserved based on our view of legal
precedent and our experience and judgment; however, there is a low
likelihood of a risk that the potential outcome could have a high level of
variability. 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.
58
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 addition, the normal biannual outside
actuary review required by the Pennsylvania regulator when Brandywine was
established is underway to be completed during the fourth quarter. In the
context of our asbestos reviews, many risk factors are considered. For the
purpose of establishing our asbestos reserves, significant variables are
our assumptions with respect to payments to unimpaired claimants and the
liability of peripheral defendants. In calculating our reserves, we assume
that relatively small amounts will be paid to unimpaired claimants and that
the liability of peripheral defendants will be relatively moderate, with
some court ordered or legislative limitation reflecting tangential
responsibility. These assumptions are based, in part, on our view that the
legislative and litigation situation will improve for defendants in the
next few years.
We also consider multiple recoveries by claimants against 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.
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,
management estimates the potential liability for indemnity, policyholder
defense costs and coverage litigation expense. There are many complex
variables 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 significantly 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. While reserving
for these claims is inherently uncertain, we believe that the net reserves
carried for these claims are adequate. 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 circumstance change, including the impact of
the risk factors, changes are made to reflect overall reserve adequacy. It
is possible that adverse developments could cause us to re-evaluate our
assumptions, which could lead us to increase our asbestos related reserves.
The NICO reinsurance cover protecting Brandywine provides a layer of
protection against such adverse developments. In the event the remaining
NICO cover is insufficient to cover future adverse loss development, such
development could have a material adverse effect on future operating
results.
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 nine months ended
September 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.
59
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 quarter ended September 30, 2002, ACE Bermuda
declared dividends of $65 million bringing the total dividends declared by
ACE Bermuda during the nine months ended September 30, 2002 to $260
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.
During the nine months ended September 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. Because
of the debt service requirements, ACE INA does not pay dividends to ACE.
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.
60
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 $1 billion for the three months ended September 30, 2002 bringing the
total for 2002 to $1.6 billion compared with $961 million for the nine
months ended September 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 unchanged at $2.8 billion for the nine
months ended September 30, 2002 and 2001. We believe that we have
sufficient liquidity to meet our anticipated cash flow obligations,
including those resulting from the September 11th tragedy. During the nine
months ended September 30, 2002, we made gross claim payments of $487
million with respect to the September 11th tragedy. On a net basis, our
payment with respect to this claim was $107 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 impacted by a large book of loss reserves
from businesses in run-off. The run-off operations generated negative cash
flows of $415 million for the nine months ended September 30, 2002 compared
with negative cash flows of $516 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.
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 September 30, 2002 and December 31,
2001:
September 30 December 31
2002 2001
------------ ------------
(in millions of U.S. dollars)
Shareholders' equity $ 6,448 $ 6,107
Mezzanine equity 311 311
Trust preferred securities 475 875
Long-term debt 1,749 1,349
Short-term debt 220 495
------------ -----------
Total capitalization $ 9,203 $ 9,137
============ ===========
Ratio of debt to total
capitalization 21.4% 20.2%
61
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. Our ability to access the capital
markets is dependent on among other things market conditions and our
perceived financial strength. 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 September 30, 2002 we had reduced short-term debt by $275 million
from the level at December 31, 2001. In addition, $50 million of ACE INA
Subordinated Notes due 2009 were repaid during each of the second and third
quarters of 2002 for a total repayment amount of $100 million. After tax
premiums of $7 million and $10 million were paid to retire the ACE INA
Notes in the second and third quarters, respectively. These costs were
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. During October
2002, we repaid the $75 million of ACE Financial Services debt, which was
due to mature in November 2002.
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 repaid the remaining $200 million of these Preferred
Securities during the quarter ended September 30, 2002, reducing our trust
preferred security balance to $475 million.
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 September
30, 2002, the amount available under this shelf filing was $127 million.
Another registration statement was filed with the SEC on May 16, 2002
allowing us to sell securities up to a total offering price of $1.5
billion.
Shareholders' Equity
Fully diluted book value per share increased to $24.37 at September 30,
2002, compared with $23.59 at December 31, 2001. In calculating our diluted
book value per share we include our in-the-money options together with the
expected number of shares to be issued upon conversion of the Feline Prides
in the denominator and the expected proceeds from these items in the
numerator. Shareholder's equity increased by $341 million during the nine
months ended September 30, 2002, due primarily to our net income and
unrealized gains on our investment portfolio, 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 September
30, 2002, this authorization had not been utilized.
62
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 and October 11, 2002 we paid dividends of 17
cents per share to shareholders of record on June 28, 2002 and September
27, 2002 respectively. We have paid dividends each quarter since we became
a public company in 1993. However, the declaration, payment and value of
future dividends is at the discretion of our Board of Directors and will be
dependent upon our profits, financial requirements and other factors,
including legal restrictions on the payment of dividends and such other
factors as our Board of Directors deems relevant.
Mezzanine Equity
On April 12, 2000, we publicly offered and issued 6,000,000 FELINE PRIDES.
Underwriters exercised their over allotment option which resulted in the
issuance of an additional 221,000 FELINE PRIDES on May 8, 2000 for
aggregate net proceeds of $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 maturity on May 16, 2003, if the market price of our Ordinary Shares is:
o less than $18.9563, then we will issue 16.4 million Ordinary Shares,
representing an issuance of 1.8991 Ordinary Shares per preferred share.
o between $18.9563 and $26.3281, then we will issue Ordinary Shares at
market price, representing a 1:1 issuance of Ordinary Shares to
preferred shares.
o more than $26.3281, then we will issue 11.8 million Ordinary Shares,
representing an issuance of 2.637 Ordinary Shares per preferred share.
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
re-marketing procedure. Under the re-marketing procedure, if a holder of a
preferred share does not wish to cash settle his purchase contract
obligation, he may return the preferred share to be re-marketed, which
essentially means the preferred share is re-priced and sold into the market
for one month. The proceeds of the sale are then used to satisfy the
purchase contract obligation. The holder can also choose to cash settle,
keep the preferred share and receive the new rate established for the month
on the trust-preferred securities. 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.
63
There will be no net cash flows to ACE as the cash received from the sale
of the Ordinary Shares in the remarketing procedure will be equal to the
cash required to redeem the preferred shares one month later.
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
than 1-3 4-5 After
Total 1 Year Years Years 5 Years
Operating leases $ 466 $ 83 $ 148 $ 85 $ 150
Short-term debt 220 220 - - -
Long-term debt 1,749 - 400 799 550
Trust preferred securities 475 - - - 475
--------- --------- --------- --------- --------
Total contractual obligations and commitments $ 2,910 $ 303 $ 548 $ 884 $ 1,175
========= ========= ========= ========= ========
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 September 30, 2002, short-term debt consisted of $145 million in
commercial paper and the ACE Financial Services $75 million, 7.75 percent
debentures. The debentures were repaid in October 2002.
We continue to have access to substantial liquidity resources. During the
year, we have substantially reduced our use of commercial paper. However,
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 revolving credit facilities which currently total $850 million
as described below. 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.
64
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 September 2002, we reduced the availability under
the 364-day facility from $800 million to $500 million. The higher amount
was no longer required given our decreased use of commercial paper and our
access to repurchase agreement financing.
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 $682 million). This facility was originally arranged in 1998.
In addition to the covenants noted below, the facility requires that
collateral be posted if the financial strength rating of the guarantor, ACE
Bermuda, falls to S&P BBB+ or less. As previously noted, we will be reducing
our capacity at Lloyd's to (pound)652 million ($1 billion) for the 2003 year
of account from (pound)900 million ($1.4 billion) for the 2002 year of
account. We are currently renegotiating this facility and expect renewal
during November 2002.
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. In addition, ACE Global
Markets are required to satisfy certain United States regulatory trust fund
requirements which can be met by the issuance of LOCs. In September 2002 we
arranged a $500 million unsecured syndicated, one year LOC facility for
general business purposes, including the issuance of insurance and
reinsurance letters of credit. This facility replaced a then existing LOC
facility in the amount of $450 million. Usage under this facility was $449
million at September 30, 2002 compared with $373 million at December 31,
2001. In September 2002 we also arranged a $350 million secured,
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 December 2001 in the amount
of $500 million. Usage under this facility was $213 million at September
30, 2002 and $130 million at December 31, 2001. The LOCs issued under both
of these facilities principally support unpaid losses and loss expenses
already included on our balance sheet.
All of the facilities described above require that we maintain certain
covenants. These covenants include:
(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 facility with
outstanding credit extensions of $25 million or more would result in an
event of default under all of the facilities described above.
At September 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 $6.1 billion and our ratio of debt to
total capitalization was 0.214 to 1.
65
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 September 30, 2002, ACE Guaranty Corp. 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
Corp.'s claims-paying resources. This facility expires in October
2008. ACE Guaranty Corp. has not borrowed under this credit facility.
ACE Guaranty Corp. is currently renegotiating this facility and
extending the maturity date to 2009, so that it may continue to qualify as
rating agency capital.
We provide funds at Lloyd's, primarily in the form of letters of credit, to
support underwriting capacity for Lloyd's syndicate 2488. Syndicate 2488
has a 2002 capacity of (pound)900 million ($1.4 billion). We also maintain
various other LOC facilities; both collateralized and uncollateralized, for
general corporate purposes. At September 30, 2002, the aggregate
availability under these facilities was $521 million and usage was $367
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.
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.
66
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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 to manage the
duration of our investment portfolio and 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.
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 September 30, 2002 compared with 3.2 percent at December 31,
2001. This equates to a decrease in market value of approximately $462
million on a fixed income portfolio valued at $15.1 billion at September
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 S&P 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 $575 million
at September 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 $57 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 September 30,
2002, our net asset exposure to foreign currencies was not material.
67
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 on the consolidated
balance sheet and measure those instruments at fair value. 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. 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 application of FAS 133,
hedging relationships must be designated and documented pursuant to the
provisions of this statement. As of September 30, 2002, we had no derivatives
that were designated as hedges.
Certain products (principally credit protection oriented) issued by the
Financial Services segment 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 nine months ended September 30, 2002, we have recorded in net
realized gains (losses) on investments, a pretax loss of $97 million to
reflect the change in the fair value of derivatives. During the nine months
ended September 30, 2001, we recorded in net realized gains (losses) on
investments, a pretax loss of $14 million to reflect the change in the fair
value of derivatives, excluding $23 million recorded in the first quarter of
2001 related to the cumulative effect of adopting FAS 133. 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.
ITEM 4. CONTROLS AND PROCEDURES
Our disclosure controls and procedures are designed to ensure that
information required to be disclosed in reports filed under the Securities and
Exchange Act of 1934 is recorded, processed, summarized and reported within
time periods specified in the rules and forms of the SEC. The Chief Executive
Officer and the Chief Financial Officer have reviewed the effectiveness of
our disclosure controls and procedures within the last ninety days and
have concluded that the disclosure controls and procedures are effective.
There were no significant changes our internal controls or in
other factors that could significantly affect these controls subsequent to the
last day they were evaluated by the Chief Executive Officer and the Chief
Financial Officer.
68
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, although an adverse resolution of a number of these
items could have a material adverse effect on our results of operations in
a particular quarter or fiscal year.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
1. Exhibits
10.1 Reimbursement agreement for $500,000,000 Letter of Credit
Facility dated as of September 30, 2002, among ACE Limited, certain
subsidiaries, various lenders and Wachovia Securities, Inc.
10.2 Reimbursement agreement for $350,000,000 Secured Letter of Credit
Facility dated as of September 30, 2002, by ACE Limited, certain
subsidiaries, various lenders and Wachovia Securities, Inc.
99.1 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant
to Section 906 of The Sarbanes-Oxley Act of 2002.
99.2 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant
to Section 906 of The Sarbanes-Oxley Act of 2002.
2. Reports on Form 8K
The Company filed a Form 8-K current report (date of earliest event
reported: August 13, 2002) in connection with the filing of the
certifications and voluntary sworn statements of Brian Duperreault, Chief
Executive Officer, and Philip V. Bancroft, Chief Financial Officer,
required pursuant to 18 U.S.C. ss. 1350 and to voluntarily comply with the
Order issued by the Commission on June 27, 2002, ("Order Requiring the
Filing of Sworn Statements Pursuant to Section 21(a)(1) of the Securities
Exchange Act of 1934," File No. 4-460).
69
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
November 13, 2002 /s/ Brian Duperreault
--------------------------------------------
Brian Duperreault
Chairman and Chief Executive Officer
November 13, 2002 /s/ Philip V. Bancroft
--------------------------------------------
Philip V. Bancroft
Chief Financial Officer
70
ACE LIMITED
CERTIFICATION PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
I, Brian Duperreault, certify that:
1) I have reviewed this quarterly report on Form 10-Q of ACE Ltd.
2) Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4) The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date") and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5) The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function);
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6) The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date November 13, 2002
/s/ Brian Duperreault
- ------------------------------------
Chairman and Chief Executive Officer
71
ACE LIMITED
CERTIFICATION PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
I, Philip V. Bancroft, certify that:
1) I have reviewed this quarterly report on Form 10-Q of ACE Ltd.
2) Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4) The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date") and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5) The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function);
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6) The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date November 13, 2002
/s/ Philip V. Bancroft
- --------------------------
Chief Financial Officer
72
ACE LIMITED
EXHIBIT INDEX
Exhibit Description Numbered
Number Page
1 . Exhibits
10.1 Reimbursement agreement for $500,000,000
Letter of Credit Facility dated as of September 30,
2002, among ACE Limited, certain subsidiaries, various
lenders and Wachovia Securities, Inc.
10.2 Reimbursement agreement for $350,000,000 Secured Letter
of Credit Facility dated as of September 30, 2002, by
ACE Limited, certain subsidiaries, various lenders and
Wachovia Securities, Inc.
99.1 Certification Pursuant to 18 U.S.C. Section 1350,
As Adopted Pursuant to Section 906 of The Sarbanes-Oxley
Act of 2002.
99.2 Certification Pursuant to 18 U.S.C. Section 1350,
As Adopted Pursuant to Section 906 of The Sarbanes-Oxley
Act of 2002.
73