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 December 31, 1998
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)
The ACE Building
30 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 February 10, 1999 was 193,725,126.
ACE LIMITED
INDEX TO FORM 10-Q
Part I. FINANCIAL INFORMATION
Page No.
Item 1. Financial Statements:
Consolidated Balance Sheets
December 31, 1998 (Unaudited) and September 30, 1998 3
Consolidated Statements of Operations (Unaudited)
Three Months Ended December 31, 1998 and December 31, 1997 4
Consolidated Statements of Shareholders' Equity (Unaudited)
Three Months Ended December 31, 1998 and December 31, 1997 5
Consolidated Statements of Comprehensive Income (Unaudited)
Three Months Ended December 31, 1998 and December 31, 1997 6
Consolidated Statements of Cash Flows (Unaudited)
Three Months Ended December 31, 1998 and December 31, 1997 7
Notes to Interim Consolidated Financial Statements (Unaudited) 8
Item 2. Management's Discussion and Analysis of Results of Operations
and Financial Condition 14
Part II. OTHER INFORMATION
Item 4. Submission of matters to a vote of security holders 25
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 26
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, September 30,
1998 1998
---- ----
(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 - $4,784,412 and $4,910,792) $ 4,866,366 $ 5,056,807
Equity securities, at fair value (cost - $196,375 and $198,447) 220,843 189,717
Short-term investments, at fair value
(amortized cost - $757,788 and $480,236) 757,804 480,190
Other investments, at fair value (cost-$128,119 and $156,758) 129,331 156,646
Cash 240,556 317,714
------------- -------------
Total investments and cash 6,214,900 6,201,074
Goodwill 535,920 540,355
Premiums and insurance balances receivable 347,810 377,307
Reinsurance recoverable 1,159,270 1,116,753
Accrued investment income 54,491 57,153
Deferred acquisition costs 67,502 76,445
Prepaid reinsurance premiums 201,529 205,022
Deferred income taxes 42,796 25,264
Other assets 210,087 189,380
------------- -------------
Total assets $ 8,834,305 $ 8,788,753
============= =============
Liabilities
Unpaid losses and loss expenses $ 3,678,269 $ 3,737,869
Unearned premiums 705,712 773,702
Premiums received in advance 62,671 53,794
Insurance and reinsurance balances payable 72,993 75,898
Accounts payable and accrued liabilities 137,383 165,527
Dividend payable 17,700 17,693
Bank debt 250,000 250,000
------------- -------------
Total liabilities 4,924,728 5,074,483
============= =============
Commitments and contingencies
Shareholders' equity
Ordinary Shares ($0.041666667 par value, 300,000,000 shares authorized;
193,687,126 and 193,592,519 shares issued and outstanding) 8,070 8,066
Additional paid-in capital 1,767,188 1,765,261
Unearned stock grant compensation (15,087) (6,181)
Retained earnings 2,040,664 1,819,554
Accumulated other comprehensive income 108,742 127,570
------------- -------------
Total shareholders' equity 3,909,577 3,714,270
------------- -------------
Total liabilities and shareholders' equity $ 8,834,305 $ 8,788,753
============= =============
See accompanying notes to interim consolidated financial statements
3
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months Ended December 31, 1998 and 1997
(Unaudited)
1998 1997
------------- ------------
(in thousands of U.S. dollars,
except per share data )
Revenues
Gross premiums written $ 254,068 $ 207,456
Reinsurance premiums ceded (99,965) (54,307)
------------ ------------
Net premiums written 154,103 153,149
Change in unearned premiums 63,904 52,181
------------ ------------
Net premiums earned 218,007 205,330
Net investment income 85,095 63,672
Net realized gains on investments 130,154 27,493
------------ ------------
Total revenues 433,256 296,495
------------ ------------
Expenses
Losses and loss expenses 111,169 122,255
Acquisition costs 27,812 24,828
Administrative expenses 41,218 19,802
Amortization of goodwill 4,435 2,271
Interest expense 4,741 1,361
------------ ------------
Total expenses 189,375 170,517
------------ ------------
Income before income taxes 243,881 125,978
Income taxes 5,342 3,768
------------ ------------
Net income $ 238,539 $ 122,210
============ ============
Basic earnings per share $ 1.23 $ 0.68
============ ============
Diluted earnings per share $ 1.21 $ 0.67
============ ============
See accompanying notes to interim consolidated financial statements
4
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the Three Months Ended December 31, 1998 and 1997
(Unaudited)
1998 1997
------------ ------------
(in thousands of U.S. dollars)
Ordinary Shares
Balance at beginning of period $ 8,066 $ 7,508
Exercise of stock options 4 2
Repurchase of shares - (104)
------------ ------------
Balance at end of period 8,070 7,406
------------ ------------
Additional paid-in capital
Balance at beginning of period 1,765,261 1,177,954
Exercise of options 1,927 424
Repurchase of shares - (16,446)
------------ ------------
Balance at end of period 1,767,188 1,161,932
------------ ------------
Unrealized stock grant compensation
Balance at beginning of period (6,181) (1,993)
Stock grants awarded (9,924) (3,123)
Amortization 1,018 866
------------ ------------
Balance at end of period (15,087) (4,250)
------------ ------------
Retained earnings
Balance at beginning of period 1,819,554 1,403,463
Net income 238,539 122,210
Dividends declared (17,429) (13,085)
Repurchase of Ordinary Shares - (59,954)
------------ ------------
Balance at end of period 2,040,664 1,452,634
------------ ------------
Accumulated other comprehensive income
Net unrealized appreciation (depreciation) on investments
Balance at beginning of period 127,845 196,655
Change in period, net of taxation (25,574) (23,227)
------------ ------------
Balance at end of period 102,271 173,428
------------ ------------
Cumulative translation adjustments
Balance at beginning of period (275) 1,568
Change in period 6,746 (369)
------------ ------------
Balance at end of period 6,471 1,199
------------ ------------
Accumulated other comprehensive income 108,742 174,137
------------ ------------
Total shareholders' equity $ 3,909,577 $ 2,791,859
============ ============
See accompanying notes to interim consolidated financial statements
5
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Three Months Ended December 31, 1998 and 1997
(Unaudited)
1998 1997
------------ ------------
(in thousands of U.S. dollars)
Net income $ 238,539 $ 122,210
Other comprehensive income (loss)
Unrealized appreciation (depreciation) on investments
Unrealized appreciation (depreciation) on investments (4,158) 8,207
Less: reclassification adjustment for realized gains
included in net income (25,319) (31,434)
------------ ------------
(29,477) (23,227)
Cumulative translation adjustments 6,746 (369)
------------ ------------
Other comprehensive income (loss), before income taxes (22,731) (23,596)
Income taxes related to other comprehensive income items 3,903 -
------------ ------------
Other comprehensive income (loss) (18,828) (23,596)
------------ ------------
Comprehensive income $ 219,711 $ 98,614
============ ============
See accompanying notes to interim consolidated financial statements
6
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended December 31, 1998 and 1997
(Unaudited)
1998 1997
--------------- ---------------
(in thousands of U.S. dollars)
Cash flows from operating activities
Net income $ 238,539 $ 122,210
Adjustments to reconcile net income to net cash provided by
operating activities:
Unearned premiums (67,990) (51,449)
Unpaid losses and loss expenses, net of reinsurance (102,117) (13,557)
recoverable
Prepaid reinsurance premiums 3,493 (11,013)
Deferred income taxes (17,532) 6,588
Net realized gains on investments (130,154) (27,493)
Amortization of premium/discounts on fixed maturities (1,958) (867)
Amortization of goodwill 4,435 431
Deferred acquisition costs 8,943 20,742
Premiums and insurance balances receivable 29,497 45,628
Premiums received in advance 8,877 18,334
Insurance and reinsurance balances payable (2,905) 12,214
Accounts payable and accrued liabilities (28,144) 18,971
Other (14,375) (22,065)
--------------- --------------
Net cash flows (used for) from operating activities (71,391) 118,674
--------------- --------------
Cash flows from investing activities
Purchases of fixed maturities (3,169,088) (1,407,957)
Purchase of equity securities (29,015) (89,533)
Sales of fixed maturities 3,032,461 1,430,276
Sales of equity securities 25,338 85,537
Maturities of fixed maturities 4,310 13,000
Net realized gains (losses) on financial future contracts 121,542 8,687
Other investments 26,103 (7,547)
--------------- --------------
Net cash provided by investing activities 11,651 32,463
--------------- --------------
Cash flows from financing activities
Repurchase of Ordinary Shares - (76,504)
Dividends paid (17,422) (12,165)
Repayment of bank debt (250,000) -
Proceeds from bank debt 250,000 -
Proceeds from exercise of options for ordinary shares 4 426
--------------- --------------
Net cash used for financing activities (17,418) (88,243)
--------------- --------------
Net (decrease) increase in cash (77,158) 62,894
Cash - beginning of period 317,714 165,865
=============== ==============
Cash - end of period $ 240,556 $ 228,759
=============== ==============
See accompanying notes to interim consolidated financial statements
7
ACE LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. General
The interim consolidated financial statements, which include the accounts
of the Company and its subsidiaries, have been prepared on the basis of
accounting principles generally accepted in the United States of America
and, in the opinion of management, reflect all adjustments (consisting of
normal 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
1998 Annual Report on Form 10-K.
On January 12, 1999, the Company announced that it had agreed to acquire
the international and domestic property and casualty businesses of CIGNA
Corporation for $3.45 billion in cash. Under the terms of the agreement the
Company, through a newly created U.S. holding company, ACE INA Holdings
Inc. (ACE INA), will acquire CIGNA's domestic property and casualty
insurance operations including its run-off business and also its
international property and casualty insurance companies and branches,
including most of the accident and health business written through those
companies. In connection with the acquisition, National Indemnity, a
subsidiary of Berkshire Hathaway, will provide $1.25 billion of protection
against adverse development with respect to the loss and loss adjustment
expense reserves of the operations to be acquired. The acquisition,
which is subject to receipt of necessary regulatory approvals and other
customary closing conditions, is expected to be completed by the end of
ACE's fiscal 1999 third quarter. The Company expects to finance this
transaction with a combination of available cash and newly issued equity,
debt and preferred and mandatorily convertible securities (see "Management's
Discussion and Analysis - Liquidity and Capital Resources").
At December 31, 1998, approximately 48 percent of the Company's written
premiums came from companies headquartered in North America with
approximately 19 percent coming from companies headquartered in the United
Kingdom and continental Europe and approximately 33 percent from companies
headquartered in other countries.
2. Significant Accounting Policies
a) Comprehensive Income
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 "Reporting Comprehensive Income"
("SFAS 130"), which is effective for fiscal years beginning after December
15, 1997. SFAS 130 establishes standards for the reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. As of October 1, 1998, the Company adopted SFAS 130;
however, the adoption of this statement had no impact on the Company's net
income or shareholders' equity. SFAS 130 requires unrealized gains or
losses on the Company's available-for-sale securities and cumulative
translation adjustments, which prior to adoption were reported separately
in shareholders' equity, to be included in other comprehensive income.
Prior year financial statements have been reclassified to conform to the
requirements of SFAS 130.
b) New accounting pronouncements
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"), which is effective for
years beginning after December 15, 1997. SFAS 131 establishes standards for
the way that public business enterprises report information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports. It also establishes standards for related disclosures about
products and services, geographic areas, and major customers. Because SFAS
131 in not required to be applied to interim financial statements in the
initial year of adoption, the Company is not required to disclose segment
information in accordance with SFAS 131 until its September 1999 annual
report. In the Company's first quarter 2000 report, and in subsequent
quarters, it will present the interim disclosures required by SFAS 131 for
both 1999 and 2000.
8
ACE LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. Commitments and Contingencies
A number of the Company's insureds have given notice of claims relating to
breast implants or components or raw material thereof that had been
produced and/or sold by such insureds. Lawsuits including class actions,
involving thousands of implant recipients have been filed in both state and
federal courts throughout the United States. Most of the federal cases have
been consolidated pursuant to the rules for Multidistrict Litigation to a
Federal District Court in Alabama, although cases are in the process of
being transferred back to federal courts or remanded to state courts.
In October 1995, negotiators for three of the major defendants agreed on
the essential elements of a revised individual settlement plan for U.S.
claimants with at least one implant from any of those manufacturers ("the
Settlement"). In November 1995, the Settlement was approved by the three
major defendants and in December 1995 the multidistrict litigation judge
approved the Settlement. In addition, two other defendants became part of
the Settlement, although certain of their settlement terms are different.
At June 30, 1994, the Company increased its then existing reserves relating
to breast implant claims. Although the reserve increase was partially
satisfied by an allocation from existing IBNR, it also required an increase
in the Company's total reserve for unpaid losses and loss expenses at June
30, 1994 of $200 million. The increase in reserves was based on information
made available in conjunction with the lawsuits and information made
available from the Company's insureds and was predicated upon an allocation
between coverage provided before and after the end of 1985 (when the
Company commenced underwriting operations). No additional reserves relating
to breast implant claims have been added since June 30, 1994.
The Company continually evaluates its reserves in light of developing
information and in light of discussions and negotiations with its insureds.
The Company has made payments to date of approximately $470 million with
respect to breast implant claims, which includes a payment of $100 million
made during the quarter ended December 31, 1998. These payments, along with
commitments to make additional future payments, are made pursuant to
agreements reached with a majority of the Company's significant breast
implant insureds. These agreements had the effect of limiting the Company's
exposure to breast implant claims to amounts which were anticipated in the
Company's reserves. While the Company is unable at this time to determine
whether additional reserves, which could have a material adverse effect
upon the financial condition, results of operations and cash flows of the
Company, may be necessary in the future, the Company believes that its
reserves for unpaid losses and loss expenses including those arising from
breast implant claims are adequate as at December 31, 1998.
The Company has considered asbestos and environmental claims and claims
expenses in establishing the liability for unpaid losses and loss expenses.
The estimation of ultimate losses arising from asbestos and environmental
exposures has presented a challenge because traditional actuarial reserving
methods, which primarily rely on historical experience, are inadequate for
such estimation. The problem of estimating reserves for asbestos and
environmental exposures resulted in the development of reserving methods
which incorporate new sources of data with historical experience. The
Company believes that the reserves carried for these claims are adequate
based on known facts and current law.
4. Restricted Stock Awards
Under the terms of the 1995 Long-Term Incentive Plan 335,000 restricted
Ordinary Shares were awarded during the current quarter to officers of the
Company and its subsidiaries. These shares vest at various dates through
November 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 operations over the vesting period.
9
ACE LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
5. Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share.
- --------------------------------------------------------------------------------------------------------------------------
December 31
1998 1997
---- ----
(in thousands of U.S. dollars,
except share and per share data)
Numerator:
Net Income $ 238,539 $ 122,210
Denominator:
Denominator for basic earnings per share -
weighted average shares 193,642,270 178,979,488
Effect of dilutive securities 3,707,086 4,028,982
Denominator for diluted earnings per share -
adjusted weighted average shares and assumed conversions 197,349,356 183,008,470
Basic earnings per share $ 1.23 $ 0.68
Diluted earnings per share $ 1.21 $ 0.67
- --------------------------------------------------------------------------------------------------------------------------
6. Credit Facilities
In December 1997, the Company arranged certain syndicated credit
facilities. J.P. Morgan Securities, Inc. and Mellon Bank N.A. acted as
co-arrangers in the arranging, structuring and syndication of these credit
facilities. Each facility requires that the Company and/or certain of its
subsidiaries maintain specific covenants, including a consolidated tangible
net worth covenant and a maximum leverage covenant. The facilities provide:
|X| A $200 million 364 day revolving credit facility and a $200 million
five year revolving credit facility which together make up a combined
$400 million committed, unsecured syndicated revolving credit
facility. In December 1998, the expiry date of the 364 day revolving
credit facility was extended to March 31, 1999. At December 31, 1998,
the five-year revolving credit facility had a $150 million letter of
credit ("LOC") sub-limit (increased from $50 million during
September 1998).
|X| A syndicated fully secured five year LOC facility totaling
approximately (pound)154 million ($262 million) which was used to
fulfill the requirements of Lloyd's to support underwriting capacity
on Lloyd's syndicates in which the Company participates. As discussed
below, this facility was replaced on November 27, 1998.
|X| A syndicated $250 million seven year amortizing term loan facility,
which was used on January 2, 1998 to partially finance the acquisition
of ACE USA. The interest rate on the term loan was LIBOR plus an
applicable spread. As discussed below, this term loan was refinanced
on October 27, 1998.
10
ACE LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
6. Credit Facilities (cont'd)
On October 27, 1998, ACE US Holdings, Inc. ("ACE US") refinanced the
outstanding $250 million term loan with the proceeds from the issuance of
$250 million in aggregate principal amount of unsecured credit sensitive
senior notes maturing in October 2008. Interest payments, based on the
initial fixed rate coupon on these notes of 8.63 percent, are due
semi-annually in arrears. Total interest expense to be recorded by ACE US
including amortized fees and hedging costs will initially be $23.3 million
per year. The indenture related to these notes includes certain events of
default for ACE US. The senior notes are callable subject to certain
breakage costs, however, ACE US has no current intention of calling the
debt. Simultaneously, the Company has entered into a notional $250 million
credit default swap transaction that has the economic effect of reducing
the cost of debt to the consolidated group, excluding fees and expenses, to
6.47 percent for 10 years. Certain assets totaling approximately $90
million are pledged as security in connection with the swap transaction. In
the event that the Company terminates the credit default swap prematurely,
the Company would be liable for certain transaction costs. However, the
Company has no current intention of terminating the swap. The swap
counter-party is a major financial institution with a long- term S&P Senior
Debt Rating of AA- and the Company does not anticipate non-performance.
On November 27, 1998, the Company arranged a new syndicated partially
secured five year LOC facility in the amount of (pound)270 million
(approximately $450 million) to fulfill the requirements of Lloyd's for the
1999 year of account. This new facility was arranged by Citibank N.A., with
ING Barings and Barclays Bank PLC acting as co-arrangers, and replaced the
facility arranged in December 1997. This new LOC facility requires that the
Company continue to maintain certain covenants, including a minimum
consolidated tangible net worth covenant and a maximum leverage covenant.
Certain assets totaling approximately $201 million are pledged as partial
security for this facility, replacing the security pledged in connection
with the December 1997 facility.
The Company also maintains an unsecured, syndicated revolving credit
facility in the amount of $72.5 million. This facility was put in place by
CAT prior to its acquisition by the Company and in September 1998, was
assigned to Tempest Re. At September 30, 1998, no amounts have been drawn
down under this facility. The facility requires that Tempest Re comply with
specific covenants.
7. Reinsurance
The Company purchases reinsurance to manage various exposures including
catastrophic risks. Although reinsurance agreements contractually obligate
the Company's reinsurers to reimburse it for the agreed upon portion of its
gross paid losses, they do not discharge the primary liability of the
Company. The amounts for net premiums written and net premiums earned in
the statements of operations are net of reinsurance. Direct, assumed and
ceded amounts for these items for the three months ended December 31, 1998
and 1997 are as follows:
1998 1997
------------ ------------
(in thousands)
Premiums written
Direct $ 208,501 $ 184,985
Assumed 45,567 22,471
Ceded (99,965) (54,307)
============ ===========
Net $ 154,103 $ 153,149
============ ===========
Premiums earned
Direct $ 233,567 $ 211,985
Assumed 97,850 46,622
Ceded (113,410) (53,277)
============ ===========
Net $ 218,007 $ 205,330
============ ===========
11
ACE LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7. Reinsurance (cont'd)
The Company's provision for reinsurance recoverable at December 31, 1998
and September 30, 1998 is as follows:
December 31 September 30
1998 1998
--------------- --------------
(in thousands )
Reinsurance recoverable on paid losses and loss expenses $ 58,806 $ 57,225
Reinsurance recoverable on unpaid losses and loss expenses 1,184,978 1,143,121
Provision for uncollectable balances on unpaid losses and loss expenses (84,514) (83,593)
============== =============
Reinsurance recoverable $ 1,159,270 $ 1,116,753
============== =============
8. Taxation
Under current Cayman Islands law, the Company is not required to pay any
taxes 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 exempt 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 on their income or capital gains. The Company and
its Bermuda subsidiaries will be exempt from taxation in Bermuda until
March 2016.
Income from the Company's operations at Lloyd's are subject to United
Kingdom corporation taxes. ACE USA is subject to income taxes imposed by
U.S. authorities.
The provision for income taxes detailed below represents the Company's
estimate of tax liability in respect of the Company's operations at Lloyd's
and at ACE USA and is calculated at rates equal to the statutory income tax
rate in each jurisdiction.
The income tax provision for the three months ended December 31, 1998 and
1997 is as follows:
1998 1997
---- ----
(in thousands )
Current tax (benefit) expense $ (476) $ 2,062
Deferred tax expense 5,818 1,706
-------------- -------------
Provision for income taxes $ 5,342 $ 3,768
============== =============
12
ACE LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
8. Taxation (cont'd)
The components of the net deferred tax asset as of December 31, 1998 and
September 30, 1998 is as follows:
December 31 September 30
1998 1998
----------------- -----------------
(in thousands)
Deferred tax assets
Loss reserve discount $ 47,649 $ 50,581
Unearned premium adjustment 3,849 3,874
Uncollectable reinsurance 6,685 5,185
Other 66,626 49,646
------------ ---------------
Total deferred tax assets 124,809 109,286
------------ ---------------
Deferred tax liabilities
Deferred policy acquisition costs 3,753 3,741
Unrealized appreciation on investments 5,379 9,282
Other 46,247 43,696
------------ ---------------
Total deferred tax liabilities 55,379 56,719
------------ ---------------
Valuation allowance 26,634 27,303
============ ===============
Net deferred tax asset $ 42,796 $ 25,264
============ ===============
9. Reclassification
Certain items in the prior period financial statements have been
reclassified to conform with the current period presentation.
13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
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 the Company may include forward-looking statements which
reflect the Company's 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 in documents filed by
the Company with the Securities and Exchange Commission) include, but are
not limited to, (i) uncertainties relating to government and regulatory
policies (such as subjecting the Company to insurance regulation or
taxation in additional jurisdictions), (ii) the occurrence of catastrophic
events with a frequency or severity exceeding the Company's estimates,
(iii) the legal environment, (iv) the uncertainties of the reserving
process, (v) loss of the services of any of the Company's executive
officers, (vi) changing rates of inflation and other economic conditions,
(vii) losses due to foreign currency exchange rate fluctuations, (viii)
ability to collect reinsurance recoverables, (ix) the competitive
environment in which the Company operates, (x) the impact of mergers and
acquisitions, (xi) the impact of Year 2000 related issues, (xii)
developments in global financial markets which could affect the Company's
investment portfolio, (xiii) risks associated with the global financial
markets which could affect the Company's investment portfolio, and (xiv)
risks associated with the introduction of new products and services. The
words "believe", "anticipate", "project", "plan", "expect", "intend", "will
likely result" or "will continue" 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. The Company undertakes no obligation to publicly update or revise
any forward-looking statements, whether as a result of new information,
future events or otherwise.
General
The following is a discussion of the Company's results of operations,
financial condition, liquidity and capital resources as of and for the
three months ended December 31, 1998. The results of operations and cash
flows for any interim period are not necessarily indicative of results for
the full year. This discussion should be read in conjunction with the
consolidated financial statements, related notes thereto and the
Management's Discussion and Analysis of Results of Operations and Financial
Condition included in the Company's 1998 Annual Report on Form 10-K.
ACE Limited ("ACE") is a holding company which, through its Bermuda-based
operating subsidiaries, ACE Bermuda Insurance Ltd. (formerly A.C.E.
Insurance Company, Ltd.) ("ACE Bermuda"), Corporate Officers & Directors
Assurance Ltd. ("CODA"), Tempest Reinsurance Company Limited ("Tempest Re")
and CAT Limited ("CAT") and its Dublin, Ireland based subsidiaries, ACE
Insurance Company Europe Limited and ACE Reinsurance Company Europe Limited
provides a broad range of insurance and reinsurance products to a diverse
group of international clients. Following the acquisition of CAT, the CAT
business was integrated into the Tempest Re book of business and effective
January 1, 1999 CAT was actually merged into Tempest Re. Through its U.S.
based subsidiary, ACE USA, Inc. ("ACE USA"), the Company provides insurance
products to a broad range of clients in the United States. In addition,
since 1996 the Company has provided funds at Lloyd's, primarily in the form
of letters of credit, to support underwriting capacity for Lloyd's
syndicates managed by Lloyd's managing agencies which are indirect wholly
owned subsidiaries of ACE. Underwriting capacity is the maximum amount of
gross premiums that a syndicate at Lloyd's can underwrite in a given year
of account. Unless the context otherwise indicates, the term "Company"
refers to one or more of ACE and its consolidated subsidiaries. The
operations of the Company in the Lloyd's market are collectively referred
to herein as "ACE Global Markets".
14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
General (cont'd)
On January 12, 1999, the Company announced that it had agreed to acquire
the international and domestic property and casualty businesses of CIGNA
Corporation for $3.45 billion in cash. Under the terms of the agreement the
Company, through a newly created U.S. holding company, ACE INA Holdings
Inc. (ACE INA), will acquire CIGNA's domestic property and casualty
insurance operations and also its international property and casualty
insurance companies and branches, including most of the accident and health
business written through those companies. In connection with the
acquisition, National Indemnity, a subsidiary of Berkshire Hathaway, will
provide $1.25 billion of protection against adverse development with
respect to the loss and loss adjustment expense reserves of the operations
to be acquired. The acquisition, which is subject to receipt of necessary
regulatory approvals and other customary closing conditions is expected to
be completed by the end of ACE's fiscal 1999 third quarter. The Company
expects to finance this transaction with a combination of available cash
and newly issued equity, debt and preferred and mandatorily convertible
securities (see "Liquidity and Capital Resources").
The Company will continue to evaluate potential new product lines and other
opportunities in the insurance and reinsurance markets. In addition, the
Company regularly evaluates potential acquisitions of other companies and
businesses and holds discussions with potential acquisition candidates. As
a general rule, the Company publicly announces such acquisitions only after
a definitive agreement has been reached.
Results of Operations - Three Months ended December 31, 1998
- --------------------------------------------------------------------------------
Net Income
Three Months Ended % Change
December 31 from
1998 1997 Prior year
---- ---- ----------
(in millions)
Income excluding net realized
gains on investments $ 108.4 $ 94.7 14.5%
Net realized gains on investments 130.1 27.5 N.M.
----- ------ -------
Net income $ 238.5 $122.2 N.M.
===== ======= =======
(N.M. - Not meaningful)
- --------------------------------------------------------------------------------
Income excluding net realized gains on investments for the first quarter of
fiscal 1999 increased by 14.5 percent compared with the first quarter of
fiscal 1998. This increase is due in part to the inclusion, this quarter,
of the results of ACE USA and CAT which were acquired on January 2, 1998
and April 1, 1998, respectively. These acquisitions increased the asset
base of the company resulting in an increase in investment income for the
first quarter of 1998 compared with the first quarter of 1997.
Positive movements in the investment markets produced net realized gains on
investments in both the current quarter and the first quarter of fiscal
1998 and are described in detail under "net realized gains on investments".
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Results of Operations - Three Months ended December 31, 1998 (cont'd)
- --------------------------------------------------------------------------------
Premiums
Three Months ended % Change
December 31 from
1998 1997 Prior year
---- ---- ----------
(in millions)
Gross premiums written:
ACE Bermuda $ 125.6 $ 127.5 (1.5)%
ACE Global Markets 87.9 80.0 9.9%
Tempest Re 7.4 - N.M.
ACE USA 33.2 - N.M.
------------ -------- --------
$ 254.1 $ 207.5 22.5%
============ ========= ========
Net premiums written:
ACE Bermuda $ 87.7 $ 94.8 (7.5)%
ACE Global Markets 41.5 58.3 (28.8)%
Tempest Re 4.3 - N.M.
ACE USA 20.6 - N.M.
------------ --------- --------
$ 154.1 $ 153.1 0.6%
============ ========= =========
Net premiums earned:
ACE Bermuda $ 82.6 $ 113.3 (27.1)%
ACE Global Markets 65.1 63.6 2.4%
Tempest Re 48.4 28.4 70.3%
ACE USA 21.9 - N.M.
============ =========== =========
$ 218.0 $ 205.3 6.2%
============ =========== =========
(N.M. - Not meaningful)
- --------------------------------------------------------------------------------
During the quarter, most insurance markets faced significant competitive
pressures as a result of relatively low loss activity over the past several
years and excess capital in these markets. This has resulted in continuing
price pressure on most insurance and reinsurance lines.
Gross premiums written increased by $46.6 million or 22.5 percent to $254.1
million from $207.5 million in the quarter ended December 31, 1997, despite
these continuing competitive market conditions. The increase is primarily the
result of the inclusion of the results of ACE USA for the current quarter.
ACE USA contributed $33.2 million to gross premiums written for the quarter
ended December 31, 1998. Gross premiums written in ACE Bermuda were at
comparable levels with last year. New business in the financial lines
division resulted in significant growth over last year. This growth was
offset by declines in the excess liability and directors and officers
liability divisions which both continue to face difficult markets.
Satellite and excess property divisions also experienced declines during
the quarter. The Company recorded an increase of $8.0 million in gross
premiums written with respect to the Company's participation in the Lloyd's
syndicates managed by ACE Global Markets. This growth was a result of the
Company's increased participation in the syndicates under management.
Tempest Re renewals occur primarily in January and July each year and
therefore premium transactions are not significant for Tempest Re during
this quarter. With respect to the January 1999 renewals, Tempest Re was
offered renewals on substantially all of the CAT business as well as the
Tempest Re business. However, merger and acquisition activity among clients
and the downward trend in pricing resulted in some declines in premium at
Tempest Re.
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Results of Operations - Three Months ended December 31, 1998 (cont'd)
Net premiums written increased by $1.0 million to $154.1 million for the
quarter ended December 31, 1998 compared with $153.1 million for the
quarter ended December 31, 1997. The property division's premium levels at
ACE USA contributed significantly to the net premiums written for the
quarter. This was offset by a decrease in net premiums written in ACE
Bermuda and ACE Global Markets, primarily the result of an increase in the
use of reinsurance. ACE Bermuda continued its use of reinsurance with this
quarter seeing the restructuring of its satellite reinsurance program.
Negotiations were also finalized on the expansion of the excess liability
reinsurance program at ACE Bermuda, which increased the quota share to 50
percent effective January 1, 1999.
Net premiums earned increased by $12.7 million or 6.2 percent compared to
the comparable quarter last year. The increase in net earned premiums is
primarily due to the inclusion of the results of ACE USA and the CAT book
of business during the current quarter and an increase in net premiums
earned by ACE Global Markets as a result of the Company's increased share
of capacity. These increases were offset somewhat by a decline in net
premiums earned by ACE Bermuda as a result of declining net written
premiums.
- -------------------------------------------------------------------------------
Net Investment Income
Three Months ended % Change
December 31 from
1998 1997 Prior year
---- ---- ----------
(in millions)
Net investment income $ 85.1 $ 63.7 33.6%
==== ==== =====
- --------------------------------------------------------------------------------
Net investment income increased 33.6 percent to $85.1 million compared with
$63.7 million in the quarter ended December 31, 1997. This increase is due
to a larger investable asset base primarily due to the inclusion of ACE USA
and CAT this quarter compared to the same quarter last year and the
reinvestment of funds generated by the portfolio. The average yield on the
investment portfolio remained relatively unchanged in the quarter ended
December 31, 1998 compared with the quarter ended December 31, 1997.
- --------------------------------------------------------------------------------
Net Realized Gains on Investment
Three Months ended
December 31
1998 1997
---- ----
(in millions)
Fixed maturities and short-term investments $ 14.5 $ 21.4
Equity securities 2.0 7.3
Financial futures and option contracts 121.3 8.7
Other investments (7.4) -
Currency (0.3) (9.9)
========= ----------
$ 130.1 $ 27.5
========= ==========
- --------------------------------------------------------------------------------
17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Results of Operations - Three Months ended December 31, 1998 (cont'd)
The Company's investment strategy takes a long-term view and the portfolio
is actively managed to maximize total return within certain specific
guidelines which minimize risk. The portfolio is reported at fair value.
The effect of market movements on the investment portfolio will directly
impact net realized gains (losses) on investments when securities are sold.
Changes in unrealized gains and losses, which result from the revaluation
of securities held, are reported as a separate component of other
comprehensive income.
During the first quarter of fiscal 1999, the fair market value of the
Company's investment portfolio increased primarily due to the strength in
equity markets. In the first fiscal quarter, the S&P 500 Stock Index rose
21.3 percent and generated net realized gains on the Company's equity index
futures contracts of $124.9 million. Net realized gains on the sale of
equity securities amounted to $2.0 million for the quarter.
Fixed income markets were stable relative to the volatility seen in recent
quarters. The sales proceeds for fixed maturity securities were generally
higher than their amortized cost during the quarter resulting in net
realized gains of $14.5 million being recognized on fixed income and
short-term investments. Certain of the company's fixed income investment
portfolios utilize fixed income futures contracts to manage duration
exposure, and losses of $3.6 million were recognized on these during the
quarter.
During the quarter the Company sold a private investment held by CAT, which
resulted in a realized loss of $7.4 million.
- -------------------------------------------------------------------------------
Combined Ratio
Three months ended
December 31
1998 1997
--------- -------
Loss and loss expense ratio 51.0% 59.5%
Underwriting and administrative expense ratio 31.7% 21.7%
========= --------
Combined ratio 82.7% 81.2%
========= ========
- -------------------------------------------------------------------------------
The underwriting results of a property and casualty insurer are discussed
frequently by reference to its loss and loss expense ratio, underwriting
and administrative expense ratio and combined ratio. Each ratio is derived
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 the administrative expense ratio. A combined ratio under
100 percent indicates underwriting income and a combined ratio exceeding
100 percent indicates underwriting losses. Property catastrophe reinsurance
companies generally expect to have overall lower combined ratios as
compared with other reinsurance companies with long-tail exposures.
However, property catastrophe loss experience is generally characterized by
low frequency but high severity short-tail claims which may result in
significant volatility in results.
Several aspects of the Company's operations, including the low frequency
and high severity of losses in the high excess layers in certain lines of
business in which the Company provides insurance and reinsurance,
complicate the actuarial reserving techniques utilized by the Company.
Management believes, however, that the Company's reserves for unpaid losses
and loss expenses, including those arising from breast implant litigation,
are adequate to cover the ultimate cost of losses and loss expenses
incurred through December 31, 1998. Since such provisions are necessarily
based on estimates, future developments may result in ultimate losses and
loss expenses significantly greater or less than such amounts (see "Breast
Implant Litigation").
18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Results of Operations - Three Months ended December 31, 1998 (cont'd)
For the quarter ended December 31, 1998, the loss and loss expense ratio
decreased to 51.0 percent compared with 59.5 percent for the first quarter
of fiscal 1998. This decrease is the result of the changing mix of premiums
written and earned by the Company, highlighted by the inclusion of ACE USA
and CAT whose loss ratios are lower than the Company's traditional book of
business. During the quarter, the Company incurred significant property
catastrophe losses through Tempest Re in the quarter, ending a calendar
1998 year which is considered the third worst year for catastrophe losses.
Industry sources have estimated U.S. insurers will pay policyholders in
excess of $10.0 billion for 1998 catastrophes. These losses were offset by
very favorable loss and loss expenses in ACE Bermuda for the quarter,
primarily the result of a large multi-year financial lines contract written
by ACE Bermuda, where the original policy term ended in 1998. The policy
was not renewed and the program generated significant earnings during the
quarter.
Underwriting and administrative expenses increased in the quarter compared to
the first quarter of fiscal 1998 primarily due to the inclusion of
underwriting and adminstrative expenses from ACE USA and CAT since their
acquisition. The underwriting and administrative expense ratio also increased,
from 21.7 percent in 1997 to 31.7 percent in the current quarter. The increase
in this ratio is primarily due to the change in the mix of business,
highlighted by the inclusion of administrative costs of ACE USA and our
increased participation in the Lloyd's market. The underwriting and
administrative expense ratios in ACE USA and ACE Global Markets is generally
higher than the Company's traditional book of business and thus contributed to
the increase in the underwriting and administrative expense ratio.
LIQUIDITY AND CAPITAL RESOURCES
As a holding company, ACE's assets consist primarily of the stock of its
subsidiaries as well as other investments. In addition to investment income,
its cash flows currently depend primarily on dividends or other statutorily
permissible payments from its Bermuda-based operating subsidiaries (the
"Bermuda subsidiaries"). 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
shareholder's equity at a level adequate to support the level of insurance and
reinsurance operations. ACE received a dividend of $300 million from ACE
Bermuda in November 1998.
The payment of any dividends from the Company's UK subsidiaries would be
subject to applicable United Kingdom insurance law including those promulgated
by the Society of Lloyd's. Under various U.S. insurance laws to which ACE US's
insurance subsidiaries are subject, ACE US's insurance subsidiaries may pay a
dividend only from earned surplus subject to the maintenance of a minimum
capital requirement, without prior regulatory approval. No dividends were
received from ACE US or ACE Global Markets during fiscal 1998 and the Company
does not anticipate receiving dividends from ACE US or ACE Global Markets
during fiscal 1999.
The Company's consolidated sources of funds consist primarily of net premiums
written, investment income, and proceeds from sales and maturities of
investments. Funds are used primarily to pay claims, operating expenses and
dividends and for the purchase of investments.
The Company's insurance and reinsurance operations provide liquidity in that
premiums are normally received substantially in advance of the time claims are
paid. For the three months ended December 31, 1998, the Company's consolidated
net cash flow from operating activities was $(71.4) million, compared with
$118.7 million for the three months ended December 31, 1997. Cash flows are
affected by claim payments, which due to the nature of the Company's
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 periods. For the
three month periods ended December 31, 1998 and 1997, loss and loss expense
payments amounted to $216.4 million (of which $100 million related to breast
implant payments) and $126.4 million respectively. Total loss and loss expense
payments amounted to $583.8 million, $421.9 million and $115.0 million in
fiscal 1998, 1997 and 1996, respectively, of which approximately $250 million
and $120 million in fiscal 1998 and 1997, respectively, related to breast
implant payments.
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES (cont'd)
The Company maintains loss reserves for the estimated unpaid ultimate
liability for losses and loss expenses under the terms of its policies and
agreements. The reserve for unpaid losses and loss expenses of $3.7 billion
at December 31, 1998 includes $1.4 billion of case and loss expense
reserves. While the Company believes that its reserve for unpaid losses and
loss expenses at December 31, 1998 is adequate, future developments may
result in ultimate losses and loss expenses significantly greater or less
than the reserve provided.
At December 31, 1998 and September 30, 1998 total investments and cash
amounted to approximately $6.2 billion. The Company's investment portfolio
is structured to provide a high level of liquidity to meet insurance
related or other obligations. The consolidated investment portfolio is
externally managed by independent professional investment managers and is
invested in high quality investment grade marketable fixed income and
equity securities, the majority of which trade in active, liquid markets.
The Company believes that its cash balances, cash flow from operations,
routine sales of investments and the liquidity provided by its credit
facilities (discussed below) are adequate to allow the Company to pay
claims within the time periods required under its policies.
In December 1997, the Company arranged certain syndicated credit facilities.
J.P. Morgan Securities, Inc. and Mellon Bank N.A. acted as co-arrangers in
the arranging, structuring and syndication of these credit facilities.
Each facility requires that the Company and/or certain of its subsidiaries
comply with specific covenants, including a consolidated tangible net worth
covenant and a maximum leverage covenant. The facilities provide:
|X| A $200 million 364 day revolving credit facility and a $200 million
five year revolving credit facility which together make up a combined
$400 million committed, unsecured syndicated revolving credit
facility. In December 1998, the expiry date of the 364 day revolving
credit facility was extended to March 31, 1999. At December 31, 1998,
the five-year revolving credit facility had a $150 million letter of
credit ("LOC") sub-limit (increased from $50 million during September
1998). As discussed below, the Company drew down $385 million on the
revolving credit facilities to finance the acquisition of CAT Limited
on April 1, 1998. The debt was subsequently repaid from a portion of
the proceeds from the sale of 16.5 million new Ordinary Shares of the
Company (discussed below).
|X| A syndicated fully secured five year LOC facility totaling
approximately (pound)154 million ($262 million) which was used to
fulfill the requirements of Lloyd's to support underwriting capacity
on Lloyd's syndicates in which the Company participates. As discussed
below, this facility was replaced on November 27, 1998.
|X| A syndicated $250 million seven year amortizing term loan facility,
which was used on January 2, 1998 to partially finance the acquisition
of ACE USA. The interest rate on the term loan was LIBOR plus an
applicable spread. As discussed below, this term loan was refinanced
on October 27, 1998.
On October 27, 1998, ACE US refinanced the outstanding $250 million term
loan with the proceeds from the issuance of $250 million in aggregate
principal amount of unsecured credit sensitive senior notes maturing in
October 2008. Interest payments, based on the initial fixed rate coupon on
these notes of 8.63 percent, are due semi-annually in arrears. Total
interest expense to be recorded by ACE US including amortized fees and
hedging costs, will initially be $23.3 million per year. The indenture
related to these notes include certain restrictive covenants applicable to
ACE US. The senior notes are callable subject to certain breakage costs,
however, ACE US has no current intention of calling the debt.
Simultaneously, the Company has entered into a notional $250 million credit
default swap transaction that has the economic effect of reducing the cost
of debt to the consolidated group, excluding fees and expenses, to 6.47
percent for 10 years. Certain assets totaling approximately $90 million are
pledged as security in connection with the swap transaction. In the event
that the Company terminates the credit default swap prematurely, the
Company would be liable for certain transaction costs. However, the Company
has no current intention of terminating the swap. The swap counter-party is
a major financial institution with a long- term S&P Senior Debt Rating of
AA- and the Company does not anticipate non-performance.
20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES (cont'd)
On November 27, 1998, the Company arranged a new syndicated partially
secured five year LOC facility in the amount of (pound)270 million
(approximately $450 million) to fulfill the requirements of Lloyd's for the
1999 year of account. This new facility was arranged by Citibank N.A., with
ING Barings and Barclays Bank PLC acting as co-arrangers, and will replace
the facility arranged in December 1997. This new LOC facility requires that
the Company continue to maintain certain covenants, including a minimum
consolidated tangible net worth covenant and a maximum leverage covenant.
Certain assets totaling approximately $201 million are pledged as partial
security for this facility, replacing the security pledged in connection
with the December 1997 facility.
The Company also maintains an unsecured, syndicated revolving credit
facility in the amount of $72.5 million. This facility was put in place by
CAT prior to its acquisition by the Company and in September 1998, was
assigned to Tempest Re. At December 31, 1998, no amounts have been drawn
down under this facility. The facility requires that Tempest Re comply with
specific covenants.
On January 12, 1999, the Company announced that it had agreed to acquire
the international and domestic property and casualty businesses of CIGNA
Corporation for $3.45 billion in cash. Under the terms of the agreement the
Company, through a newly created U.S. holding company, ACE INA Holdings
Inc. (ACE INA), will acquire CIGNA's domestic property and casualty
insurance operations and also its international property and casualty
insurance companies and branches, including most of the accident and health
business written through those companies. In connection with the
acquisition, National Indemnity, a subsidiary of Berkshire Hathaway, will
provide $1.25 billion of protection against adverse development with
respect to the loss and loss adjustment expense reserves of the operations
to be acquired. The acquisition, which is subject to receipt of necessary
regulatory approvals and other customary closing conditions is expected to
be completed by the end of ACE's fiscal 1999 third quarter. The Company
expects to finance this transaction as follows:
(a) approximately $700 million to $1 billion of available cash, which will
be contributed to ACE INA, and
(b) the remainder through the issuance of; (i) Ordinary Shares by the
Company, the proceeds of which will also be contributed to ACE INA;
(ii) preferred securities by ACE INA that are mandatorily convertible
into Ordinary Shares of the Company; (iii) capital securities (e.g.,
trust-preferred securities) by ACE INA; and (iv) senior debt by ACE
INA and together with the ACE Ordinary Shares, the ACE INA Mandatorily
Convertible Securities and the ACE INA (collectively, the "Permanent
Financing").
The Company or ACE INA will issue each of the Permanent Financing
instruments either before or after the closing of the transaction at the
time when the Company considers market conditions to be most favorable for
issuance. Accordingly, on behalf of itself and ACE INA, the Company has
secured interim bank financing sufficient to close the transaction.
On October 16, 1998 and January 15, 1999, the Company paid quarterly
dividends of 9 cents per share, respectively to shareholders of record on
September 30, 1998 and December 15, 1998. On February 5, 1999, the Board of
Directors declared a quarterly dividend of 9 cents per share payable on
April 16, 1999 to shareholders of record on March 31, 1999. The declaration
and payment of future dividends is at the discretion of the Board of
Directors and will be dependent upon the profits and financial requirements
of the Company and other factors, including legal restrictions on the
payment of dividends and such other factors as the Board of Directors deems
relevant.
Fully diluted net asset value per share was $20.18 at December 31, 1998,
compared with $19.14 at September 30, 1998.
21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES (cont'd)
The Company's financial condition, results of operations and cash flow are
influenced by both internal and external forces. Claims 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 elapse between the
occurrence of an insured loss, the reporting of the loss to the Company and
the settlement of the Company's liability for that loss. The liquidity of
its investment portfolio, cash flows and the credit facilities are, in
management's opinion, adequate to meet the Company's expected cash
requirements.
Breast Implant Litigation
A number of the Company's insureds have given notice of claims relating to
breast implants or components or raw material thereof that had been
produced and/or sold by such insureds. Lawsuits, including class actions,
involving thousands of implant recipients have been filed in both state and
federal courts throughout the United States. Most of the federal cases have
been consolidated pursuant to the rules for Multidistrict Litigation to a
Federal District Court in Alabama, although cases are in the process of
being transferred back to federal courts or remanded to state courts.
In October 1995, negotiators for three of the major defendants agreed on
the essential elements of an individual settlement plan for U.S. claimants
with at least one implant from any of those manufacturers (" the
Settlement"). In November 1995, the Settlement was approved by the three
major defendants and in December 1995 the multidistrict litigation judge
approved the Settlement. In addition, two other defendants became part of
the Settlement, although certain of their settlement terms are different
and more restricted than the plan offered by the original three defendants.
At June 30, 1994, the Company increased its then existing reserves relating
to breast implant claims. Although the reserve increase was partially
satisfied by an allocation from existing IBNR, it also required an increase
in the Company's total reserve for unpaid losses and loss expenses at June
30, 1994 of $200 million. The increase in reserves was based on information
made available in the pending lawsuits and information from the Company's
insureds and was predicated upon an allocation between coverage provided
before and after the end of 1985 (when the Company commenced underwriting
operations). No additional reserves relating to breast implant claims have
been added since June 30, 1994.
The Company continually evaluates its reserves in light of developing
information and in light of discussions and negotiations with its insureds.
The Company has made payments to date of approximately $470 million with
respect to breast implant claims, which includes a payment of $100 million
made during the quarter ended December 31, 1998. These payments, along with
commitments to make additional future payments, are made pursuant to
agreements reached with a majority of the Company's significant breast
implant insureds. Those agreements had the effect of limiting the Company's
exposure to breast implant claims to amounts which were anticipated in the
Company's reserves. While the Company is unable at this time to determine
whether additional reserves, which could have a material adverse effect
upon the financial condition, results of operations and cash flows of the
Company, may be necessary in the future, the Company believes that its
reserves for unpaid losses and loss expenses including those arising from
breast implant claims are adequate as at December 31, 1998.
IMPACT OF THE YEAR 2000 ISSUE
General
The management of ACE Limited, recognizing that the Year 2000 problem, if
left untreated, could have a material effect on the Company's business,
results of operations or financial condition, has in progress a project to
address this issue. It is the expectation of ACE's management that this
project will reduce the impact of the Year 2000 problem to an immaterial
level, although not all risks can be eliminated.
The Year 2000 problem stems from the inability, in some cases, of computer
programs and embedded microchips to correctly process certain data. The
problem is most evident because dates which fall in the year 2000 and in
later years may not be properly distinguished from those which fell in the
corresponding years of the present century.
22
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
IMPACT OF THE YEAR 2000 ISSUE (cont'd)
General (cont'd)
Although all ACE group companies had individually taken steps earlier
towards alleviating the Year 2000 problem, a formal group-wide project was
established in March 1998. At that time, an executive steering committee
was formed to oversee the project. This committee meets on a monthly basis
to review progress and take corrective action if necessary. In each of the
ACE subsidiary companies, a senior member of the management has been
appointed as Year 2000 coordinator. Each Year 2000 coordinator has
responsibility for ensuring the success of that part of the Year 2000 plan
relevant to its company. A detailed quarterly report on the status of the
Year 2000 project is delivered to the audit committee of the Board of
Directors.
A consultant who is an experienced project manager has been retained to
assist the Year 2000 coordinator. In addition, certain subsidiaries have
engaged external consultants to assist in monitoring their plans.
The project is substantially on schedule, though some components have been
finished earlier than expected and some are taking more time than
originally estimated. At the end of 1998, all ACE group companies were
running Year 2000 compliant versions of most of the IT systems that are
critical to the business. The replacement or remedy of the remaining
critical systems and some residual testing will continue during the first
and possibly the second quarter of calendar year 1999. One subsidiary (ACE
USA) has one critical business area for which a Year 2000 compliant
replacement system is now scheduled to go live in August 1999. A
contingency plan exists for this business area should the replacement
system be delayed or problematic.
The Company's Year 2000 project is divided into four sections: Underwriting;
Information Technology; Trading Partners; and Physical Plant.
Underwriting
Underwriting teams within each ACE group subsidiary have considered the
risks with respect to the Year 2000 problem that might be associated with
underwriting their various lines of business and have developed internal
guidelines which seek to minimize these risks. Compliance with these
guidelines is the subject of internal audits and/or peer reviews. These
guidelines are under regular review. In some cases, exclusionary language
has been added to policies and in all cases there is a requirement for
underwriters to consider information about our clients and potential
clients that is relevant to the Year 2000 problem and based on this, to
underwrite risks prudently or to decline them.
Information Technology
Each ACE subsidiary has a plan to ensure that all information technology
components such as hardware, software and network equipment that will be in
use in the Year 2000 (and beyond) for use by any business-critical function
will not suffer from the Year 2000 problem. Inventories have been prepared
of all such components, and appropriate action decided.
Most application software (such as insurance processing and accounting
systems) which is in use within the ACE group has been supplied as packages
(often tailored to meet ACE's needs) from various vendors. Several
application software packages have already been replaced with Year 2000
compliant versions. Testing of these is complete in some cases, in progress
for some systems and is scheduled for others. Remaining software packages
will be replaced, or, in a few cases, remedied to free them of Year 2000
problems.
Testing of hardware and network components has commenced and is scheduled
for completion before the end of March 1999. Testing of other software,
such as operating systems and PC desktop applications is in progress or
scheduled, though in a few cases we are relying on assurances from
established software manufacturers that their systems will operate
correctly.
23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
IMPACT OF THE YEAR 2000 ISSUE (cont'd)
Trading Partners and Physical Plant
The trading partners section of the project focuses on Year 2000 issues
relating to the Company's trading partners. Examples of the Company's
trading partners are: insurance brokers, banks, reinsurance companies,
vendors and service providers in information technology and general
suppliers.
The Physical Plant section of the project focuses on items such as
elevators, fire suppression systems, security systems, building management
systems (which may control air-conditioning, heating and lighting systems)
which may be controlled by software programs or embedded chips, and may
thus fail or act unpredictably in, or after the year 2000. Furthermore,
supply of electrical power and telecommunications services are considered
here.
All material trading partners and those vendors and service providers
connected with physical plant have been inventoried and questionnaires sent
to them soliciting information about their Year 2000 readiness. Responses
have not been provided in all cases, despite follow-up letters. ACE has
made significant progress in assessing those responses which have been
forthcoming. Some of these responses appear to give evidence of
satisfactory progress and others do not. In those cases where additional
follow-up fails to provide satisfactory responses, contingency plans will
be drawn up in early 1999 to minimize the effect of potential failure of a
trading partner.
Costs
The total cost of the Year 2000 project is not expected to be material to
the Company's financial position. The total estimated cost is approximately
$4 million, of which just over $2 million is for the information technology
component of the project. Total expenditure to date on the whole project is
approximately $1.2 million.
Risks
It is not feasible to assign probabilities to many of the events associated
with the Year 2000. The arrival of January 1, 2000 presents novel problems
about which there is no body of evidence upon which to base statistical
predictions. Furthermore, world infrastructure in areas such as
telecommunications, banking, law enforcement, energy production and
distribution, manufacturing, transportation and government and military
systems are inextricably linked in such a manner that a small failure in
one area could produce large and unexpected effects in others. Each
business has a dependence upon its customers and suppliers and through them
(or directly) upon many or all of the infrastructural areas noted above.
ACE management believes that the risks associated with its own information
technology project component are small. For reasons noted above, it is
impossible to quantify all risks associated with trading partners and
physical plant. Possibly the greatest risk for the Company lies in the
possibility of unpredictable events affecting insureds producing a number
of claims (valid or otherwise) which, if valid, are expensive to pay, or if
not, expensive in defense litigation costs.
24
ACE LIMITED
PART II - OTHER INFORMATION
---------------------------
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
1) The Annual General Meeting was held on February 5, 1999.
2) The following matters were voted on at the Annual General Meeting:
a) The following directors were elected.
Term Expiring Votes In Favor Votes Withheld
------------- --------------- --------------
Jeffrey W. Greenberg 2002 147,814,324 12,772,519
Meryl D. Hartzband 2002 157,650,530 2,936,313
Donald Kramer 2002 157,653,319 2,933,524
Walter A. Scott 2002 157,644,906 2,941,937
Sidney F. Wentz 2002 157,612,767 2,974,076
b) A special resolution was voted upon to approve the ACE Limited 1998
Long-Term Incentive Plan.
The holders of 127,409,320 shares voted in favor, 32,482,050
shares voted against and 695,473 shares abstained.
c) The appointment of PricewaterhouseCoopers LLP as independent
public accountants for the Company for the year ended September
30, 1999 was ratified and approved.
The holders of 160,527,588 shares voted in favor, 25,383 shares
voted against and 33,872 shares abstained.
ITEM 5. OTHER INFORMATION
- --------------------------
1) On February 5, 1999, the Company declared a dividend of $0.09 per
Ordinary Share payable on April 16, 1999 to shareholders of record on
March 31, 1999.
25
ACE LIMITED
PART II - OTHER INFORMATION
---------------------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- -----------------------------------------
1) Exhibits
10.1 Ace Limited 1998 Long-Term Incentive Plan (as amended
through the first amendment)
27 Financial Data Schedule
2) Reports on Form 8-K
The Company filed a Form 8-K current report (date of earliest event
reported: December 22,1998) announcing that the Company and CIGNA
Corporation were discussing a global strategic alliance, including
the possible acquisition of CIGNA'S international and domestic property
and casualty business by the Company.
The Company filed a Form 8-K current report (date of earliest event
reported : January 12, 1999) pertaining to its agreement to acquire
the international and domestic property and casualty insurance
businesses of CIGNA Corporation for $3.45 billion in cash.
26
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
--------------------------------------------
February 12, 1999 /s/ Brian Duperreault
--------------------------------------------
Brian Duperreault
Chairman, President and Chief
Executive Officer
February 12, 1999 /s/ Christopher Z. Marshall
--------------------------------------------
Christopher Z. Marshall
Chief Financial Officer
27
EXHIBIT INDEX
- -------------
Exhibit
Number Description Numbered Page
- --------- ------------ -------------
10.1 Ace Limited 1998 Long-Term Incentive Plan
(as amended through the first amendment)
27 Financial Data Schedule