Exhibit 13.1
ACE LIMITED SELECTED FINANCIAL DATA
For the three For the
For the years ended December 31, months ended year ended
(in thousands of U.S. dollars, except -------------------------------------------------- December 31, September 30,
share, per share data and selected data) 2002 2001 2000 1999 1998 1998
- --------------------------------------------------------------------------------------------------------------------------
OPERATIONS DATA:
Net premiums earned
Property and casualty premiums $ 6,672,227 $ 5,510,897 $ 4,534,763 $ 2,485,737 $ 218,007 $ 894,303
Life and annuity premiums 158,277 406,280 - - - -
- --------------------------------------------------------------------------------------------------------------------------
6,830,504 5,917,177 4,534,763 2,485,737 218,007 894,303
Net investment income 802,141 785,869 770,855 493,337 85,095 324,254
Other income (expense) (20,552) 452 2,942 - - -
Net realized gains (losses) on
investments (489,089) (58,359) (38,961) 37,916 130,154 188,385
Losses and loss expenses 4,906,510 4,552,456 2,936,065 1,639,543 111,169 516,892
Life and annuity benefits 158,118 401,229 - - - -
Policy acquisition costs and
administrative expenses 1,904,021 1,615,119 1,396,374 833,312 69,030 271,566
Interest expense 193,494 199,182 221,450 105,138 4,741 25,459
Income tax expense (benefit) (115,688) (78,674) 93,908 28,684 5,342 20,040
Amortization of goodwill - 79,571 78,820 45,350 4,435 12,834
- --------------------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative
effect of adopting a new
accounting standard 76,549 (123,744) 542,982 364,963 238,539 560,151
Cumulative effect of adopting
a new accounting standard
(net of income tax) - (22,670) - - - -
- --------------------------------------------------------------------------------------------------------------------------
Net income (loss) 76,549 (146,414) 542,982 364,963 238,539 560,151
Dividends on Mezzanine equity (25,662) (25,594) (18,391) - - -
- --------------------------------------------------------------------------------------------------------------------------
Net income (loss) available to
holders of Ordinary Shares $ 50,887 $ (172,008) $ 524,591 $ 364,963 $ 238,539 $ 560,151
==========================================================================================================================
Diluted earnings (loss) per share
before cumulative effect of
adopting a new accounting
standard $ 0.19 $ (0.64) $ 2.31 $ 1.85 $ 1.21 $ 2.96
- --------------------------------------------------------------------------------------------------------------------------
Diluted earnings (loss) per share/(1)/ $ 0.19 $ (0.74) $ 2.31 $ 1.85 $ 1.21 $ 2.96
==========================================================================================================================
/(1)/ Diluted earnings (loss) per share is calculated by dividing net income
(loss) available to holders of Ordinary Shares by weighted average shares
outstanding - diluted.
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For the three For the
For the years ended December 31, months ended year ended
(in thousands of U.S. dollars, except ---------------------------------------------------------- December 31, September 30,
share, per share data and selected data) 2002 2001 2000 1999 1998 1998
- ----------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA
(at end of period)
Total investments and cash $ 18,323,908 $ 15,935,913 $ 13,762,324 $ 12,875,535 $ 6,214,900 $ 6,201,074
Total assets 43,450,937 37,186,764 31,689,526 30,122,888 8,834,305 8,788,753
Net unpaid losses and loss expenses 11,318,018 10,339,014 9,330,950 8,908,817 2,577,805 2,678,341
Net future policy benefits for life
and annuity contracts 433,418 377,395 - - - -
Long-term debt 1,748,937 1,349,473 1,424,228 1,424,228 250,000 -
Trust preferred securities 475,000 875,000 875,000 575,000 - -
Total liabilities 36,751,201 30,769,007 25,958,265 25,672,328 4,924,728 5,074,483
Mezzanine equity 311,050 311,050 311,050 - - -
Shareholders' equity 6,388,686 6,106,707 5,420,211 4,450,560 3,909,577 3,714,270
Diluted book value per share $ 24.16 $ 23.59 $ 23.25 $ 20.28 $ 20.19 $ 19.14
SELECTED DATA
Loss and loss expense ratio /(2)/ 73.5% 82.6% 64.7% 66.0% 51.0% 57.8%
Underwriting and administrative
expense ratio /(3)/ 28.2% 29.0% 30.8% 33.5% 31.7% 30.4%
- ----------------------------------------------------------------------------------------------------------------------------------
Combined ratio /(4)/ 101.7% 111.6% 95.5% 99.5% 82.7% 88.2%
==================================================================================================================================
Net loss reserves to capital and
surplus ratio /(5)/ 183.9% 175.5% 172.2% 200.2% 65.9% 72.1%
Weighted average shares
outstanding - diluted 269,870,023 233,799,588 227,418,430 197,626,354 197,349,356 189,281,175
Cash dividends per share $ 0.66 $ 0.58 $ 0.50 $ 0.42 $ 0.09 $ 0.34
==================================================================================================================================
/(2)/ The loss and loss expense ratio is calculated by dividing the losses and
loss expenses by property and casualty net premiums earned.
/(3)/ The underwriting and administrative expense ratio is calculated by
dividing the policy acquisition costs and administrative expenses by
property and casualty net premiums earned.
/(4)/ The combined ratio is the sum of the loss and loss expense ratio and the
underwriting and administrative expense ratio.
/(5)/ The net loss reserves to capital and surplus ratio is calculated by
dividing the sum of the net unpaid losses and loss expenses and net future
policy benefits for life and annuity contracts by shareholders' equity.
The above table sets forth selected consolidated financial data of the Company
as of and for the years ended December 31, 2002, 2001, 2000 and 1999, the three
months ended December 31, 1998, and for the year ended September 30, 1998. These
selected financial and other data should be read in conjunction with the
consolidated financial statements and related notes and with "Management's
Discussion and Analysis of Financial Condition and Results of Operations",
presented on pages 58 to 110 and 19 to 57 respectively, of this annual report.
On July 2, 1999, the Company changed its fiscal year end from September 30 to
December 31. This change was implemented retroactively to December 31, 1998, so
that the 1999 fiscal year is for the twelve-month period ended December 31,
1999. In 1999 the Company, through a U.S. holding company, ACE INA, acquired
CIGNA Corporation'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.
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Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of
Operations is a discussion of ACE's results of operations, financial condition
and liquidity and capital resources. This discussion should be read in
conjunction with our consolidated financial statements, and related notes,
presented on pages 58 to 110 of this annual report.
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 our
behalf 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 ("SEC")) include, but are not limited to:
.. global political conditions, the occurrence of any terrorist attacks,
including any nuclear, biological or chemical events, or the outbreak and
effects of war, and possible business disruption or economic contraction that
may result from such events;
.. the effects of public company bankruptcies and/or accounting restatements, as
well as disclosures by and investigations of public companies relating to
possible accounting irregularities, and other corporate governance issues,
including the effects of such events on:
. the capital markets;
. the markets for directors and officers and errors and omissions insurance;
and
. claims and litigation arising out of such disclosures or practices by
other companies;
.. the ability to collect reinsurance recoverable, credit developments of
reinsurers and any delays with respect thereto;
.. the occurrence of catastrophic events or other insured or reinsured events
with a frequency or severity exceeding our estimates;
.. actual loss experience from insured or reinsured events;
.. the uncertainties of the loss reserving and claims settlement processes,
including the difficulties associated with assessing environmental damage and
asbestos-related latent injuries, the impact of aggregate policy coverage limits
and the impact of bankruptcy protection sought by various asbestos producers and
other related businesses;
.. judicial decisions and rulings, new theories of liability and legal tactics;
.. the impact of the September 11 tragedy and its aftermath on our insureds and
reinsureds, on the insurance and reinsurance industry, and on the economy in
general;
.. uncertainties relating to governmental, legislative and regulatory policies,
developments and treaties, which, among other things, could subject us to
insurance regulation or taxation in additional jurisdictions or affect our
current operations;
.. the actual amount of new and renewal business, market acceptance of our
products, and risks associated with the introduction of new products and
services and entering new markets;
.. the competitive environment in which we operate, including trends in pricing
or in policy terms and conditions, which may differ from our projections;
.. actions that rating agencies may take from time to time, such as changes in
our claims-paying, financial strength or credit ratings;
.. developments in global financial markets, including changes in interest rates,
stock markets and other financial markets, and foreign currency exchange rate
fluctuations, which could affect our investment portfolio and financing plans;
.. changing rates of inflation and other economic conditions;
.. the amount of dividends received from subsidiaries;
.. loss of the services of any of our executive officers without suitable
replacements being recruited in a reasonable time frame;
.. the ability of technology to perform as anticipated; and
.. management's response to these factors.
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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
In 2002, following changes in executive management responsibilities, we
reassessed and changed our reporting segments from individual operating units to
lines of business. We now operate through four business segments: Insurance -
North American, Insurance - Overseas General, Global Reinsurance and Financial
Services. 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 business 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 ACE Europe, ACE Asia Pacific, ACE Far East and
ACE Latin America, and the insurance operations of ACE Global Markets. The
Global Reinsurance segment comprises ACE Tempest Re Bermuda, ACE Tempest Re USA,
ACE Tempest Re Europe and our life reinsurance operation which is discussed
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
Our consolidated financial statements include amounts that, either by their
nature or due to requirements of accounting principles generally accepted in the
U.S. ("GAAP"), are determined using best estimates and assumptions to determine
the reported values. While we believe that the amounts included in our
consolidated financial statements reflect our best estimates and assumptions,
these amounts could ultimately be materially different from the amounts
currently provided for in our consolidated financial statements. We believe the
items requiring the most inherently subjective and complex estimates to be:
.. unpaid losses and loss expense reserves, including asbestos reserves;
.. reinsurance recoverable, including our bad debt provision;
.. impairments to the fair value of our investment portfolio;
.. the fair value of certain derivatives; and
.. the valuation of goodwill.
As such, we deem our accounting policies for these amounts to be of
critical importance to our consolidated financial statements. The following
discussion provides more information regarding the estimates and assumptions
required to arrive at these amounts and should be read in conjunction with the
sections entitled: Property and Casualty Loss Reserves, Asbestos and
Environmental Claims, Reinsurance, Investments and Cash, Net Realized Gains
(Losses) on Investments and Other Income and Expense Items.
UNPAID LOSSES AND LOSS EXPENSES
As an insurance and reinsurance company we are required, under GAAP, to
establish loss reserves for the estimated unpaid portion of the ultimate
liability for loss and loss expenses under the terms of our policies and
agreements with our insured and reinsured customers. 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. At December 31, 2002, the unpaid loss
and loss expense reserve was $24.3 billion. We use reserving methods based on
historical experience, claims reviews, negotiations with insureds, current
developments and laws. The process of establishing reserves for property and
casualty ("P&C") claims can be complex and imprecise as it requires the use of
informed estimates and judgments. These estimates and judgments are based on
numerous factors, and may be revised as additional experience and other data
become available and are reviewed, as new or improved methodologies are
developed or as current laws change. We have actuarial staff in each of our
operating segments who track insurance reserves and regularly evaluate the
levels of loss reserves, taking into consideration factors that may impact the
ultimate loss reserves. Any adjustments to previously established reserves,
20
resulting from a change in estimate, would be reflected in our results of
operations in the period in which we make the change in estimate. As part of our
evaluation process of loss reserves, we annually engage independent actuarial
firms to review the methods and assumptions we use in estimating loss and loss
expense reserves. These annual reviews cover different portions of our operating
businesses on a rotating basis within each year and are an independent check on
our loss reserves. The potential for variation in loss reserves is impacted by
numerous factors, which we explain in some detail below.
We are required to set loss reserves for all business we write. In most
cases, we do not have all the necessary information to adequately settle a claim
at the time we are required to accrue for the loss. As a result, historical
experience and other statistical information are used to estimate the ultimate
cost of the loss, depending on the type of business.
Short-tail business describes lines of business where losses are usually
known and paid shortly after the loss actually occurs. This would include, for
example, most property, aviation and automobile policies that are written.
Typically, there is less variability in these lines of business.
Long-tail business describes lines of business where specific losses may
not be known for some period and losses take much longer to emerge. This
includes most casualty lines such as general liability, directors and officers
liability ("D&O"), warranty and workers' compensation. Because the loss
settlement period can be many years in duration (in some cases, claims take
30-40 years to settle), these lines of business generally have more variability
in their loss reserves. As new information evolves, a company may be required to
increase or lower existing reserve levels.
The estimation of unpaid loss and loss expense reserves can also be
affected by the layer at which a particular contract or set of contracts is
written. In the case of direct insurance, where the insurer is taking on risk in
the lower value end of the particular contract, the experience will tend to be
more frequency driven. These lines of business allow for more traditional
actuarial methods to be used in determining loss reserve levels, as it is
customary to have more historical experience to rely upon. In the case of excess
of loss contracts, the experience will tend to be more of a severity nature, as
only a significant loss will enter the layer. Consequently, traditional
actuarial methods for setting loss reserves (such as loss development
triangles), have to be tempered with an analysis of each contract's terms,
original pricing information, subsequent internal and external analyses of the
ongoing contracts, market exposures and history and qualitative input from
claims managers.
Included in our liabilities for losses and loss expenses are liabilities
for asbestos, environmental and latent injury damage claims and expenses
("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.
In establishing reserves for periods prior to the fourth quarter of 2002,
we assumed that significant additional state judicial or legislative reform
would substantially eliminate payments to future claimants who are not
physically impaired. In January 2003, we announced additions to our fourth
quarter 2002 A&E reserves based on the more conservative assumption that there
will be no future state or federal asbestos reform. Therefore, our asbestos
reserves do not reflect any anticipated changes in the legal, social or economic
environment, or any benefit from future legislative reforms. The vast majority
of our reserve increase in the fourth quarter of 2002 is due to the
strengthening of the IBNR provision for peripheral defendants and future
increases in severity.
We believe the most significant variables relating to our A&E reserves
include assumptions with respect to payments to unimpaired claimants and the
liability of peripheral defendants. In establishing our A&E reserves, we
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. The
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.
21
Based on the policies, the facts, the law and a careful analysis of the
impact that these risk factors will likely have on any given account, we
estimate the potential liability for indemnity, policyholder defense costs and
coverage litigation expense. There are many complex variables that we consider
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.
For our financial guaranty business, the underwriting process is based on
multiple levels of credit review, actuarial analysis, stress-based modeling and
legal reviews. As these contracts are typically multi-year (generally 7 to 12
years in duration), the underwriting process is critical and the reviews noted
above continue for the duration of the contract. When a loss occurs, it is
generally not difficult to estimate losses in the financial guaranty business.
Losses are a function of debt service schedules in the case of insured bonds and
in the case of credit default swaps, losses are a function of the value of the
underlying instrument (typically a bond). Predicting financial guaranty losses,
however, is more difficult because of the lack of historical loss experience in
this line of business. Traditional property casualty actuarial methods are
generally not used since these methods are dependent on more homogeneous,
historical loss experience as predictors of future losses. For financial
guaranty reserves, we use historic bond default rates as a proxy for estimating
future losses.
With respect to our financial solutions business, each contract we write is
relatively large and unique, so each contract is reviewed and assessed
individually. Most contracts are multi-year in nature. As with our financial
guaranty business, traditional actuarial methods such as analysing and
extrapolating historical loss experience are not considered appropriate for
financial solutions business because of the relatively small number of large
contracts. Our loss estimates are based on contract terms (such as a requirement
to pay profit commissions), original pricing information, analysis and
comparison with external data and experience to date on the contract.
While reserving for claims is inherently uncertain, we believe that our net
loss and loss expense reserves 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. This could
lead us to further increase our loss and loss expense reserves, which could have
a material adverse effect on our future operating results.
REINSURANCE RECOVERABLE
One of the ways we manage our loss exposure is through the use of reinsurance.
While reinsurance agreements 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 sheets represents our total
unpaid gross losses, and reinsurance recoverable on our balance sheets
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. At December 31, 2002, our reinsurance recoverable balance was
$14.0 billion, which includes a bad debt reserve of $939 million, representing
6.3 percent of the amount. Of the total reinsurance recoverable balance, only
$1.4 billion is actually due for collection at December 31, 2002, as we only
collect from our reinsurers after we have made the claim payment. Although the
contractual obligation of individual reinsurers to pay their reinsurance
obligations is based on specific contract provisions, the collectibility of such
amounts requires significant estimation by management. The majority of the
balance we have accrued as recoverable will not be due for collection until
sometime in the future (in some cases up to 30 - 40 years from now). Over this
period of time, economic conditions and operational performance of a particular
reinsurer may impact their ability to meet these obligations and while they may
continue to acknowledge their contractual obligation to do so, they may not have
the financial resources to fully meet their obligation to us.
22
When we accrue a reinsurance recoverable and any related bad debt
provision, we make assumptions about the financial condition of our reinsurers
by applying historical loss experience to credit categories, as well as
assessing disputes under reinsurance contracts based on historical experience
and current knowledge. We evaluate the financial condition of our reinsurers on
a regular basis and also monitor concentrations of credit risk. For certain
reinsurance receivables, we require collateral, such as assets held in trust or
letters of credit. Additionally, for specific items in dispute, we make
judgments based on knowledge and experience with a particular reinsurer. To
assist in this complex process, we have an internal "Security Committee",
consisting of senior executive officers, that regularly reviews the financial
condition of reinsurers and maintains our list of approved reinsurers.
Reinsurers not on the list are considered on a case by case basis.
We group our reinsurance recoverable into categories, as the nature of the
reinsurance recoverable is an important consideration when establishing a bad
debt provision. These categories, including the amount of each, are shown in the
reinsurance section. We establish our bad debt provision for these categories
based on a case by case analysis of individual situations, including credit and
collateral analysis and consideration of our collection experience in similar
situations. Our bad debt provision assumes a certain level of bad debt for all
categories of reinsurance recoverable. If our assumptions regarding our
reinsurers' financial condition, willingness to pay amounts recoverable or
historical experience prove to be incorrect, our bad debt provision may be
understated. This would cause us to increase our bad debt provision, resulting
in a charge to earnings in the period recorded. Accordingly, this could have a
material adverse effect on our financial condition, results of operations and
liquidity. Additional information on reinsurance can be found in the section
entitled "Reinsurance".
INVESTMENTS
We record all investments in our portfolio at fair value, being the quoted
market price of these securities provided by either independent pricing
services, or when such prices are not available, by reference to broker or
underwriter bid indications. We regularly review our investments for possible
impairment. Our reviews depend on significant management judgment based on
several criteria including economic conditions, credit loss experience and other
issuer-specific developments. If there is a decline in a security's net
realizable value, we must determine whether that decline is temporary or "other
than temporary". If we believe a decline in the value of a particular investment
is temporary, we record the decline as an unrealized loss in our shareholders'
equity. If we believe the decline is "other than temporary", we write down the
carrying value of the investment and record a realized loss in our statement of
operations. The decision to recognize a decline in the value of a security
carried at fair value as "other than temporary" rather than temporary has no
impact on our book value. More information regarding our process for reviewing
our portfolio for possible impairments can be found in the section entitled "Net
Realized Gains (Losses) on Investments".
DERIVATIVES
We adopted Statement of Financial Accounting Standards ("FAS") No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"), as
of January 1, 2001. FAS 133 establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities. FAS 133 requires that all
derivatives be recognized as either assets or liabilities on the balance sheet
and be measured at fair value. We maintain investments in derivative instruments
such as futures, options, interest rate swaps and foreign currency forward
contracts primarily to manage duration and foreign currency exposure, enhance
our portfolio yield or obtain an exposure to a particular financial market.
These derivatives are either closed out or fair valued using market quotes or
valuations provided to us by third party investment managers using market data.
The total fair value related to these instruments at December 31, 2002, was $46
million and is included as a liability in accounts payable, accrued expenses and
other liabilities.
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. We
consider these instruments part of our financial guarantee business as we intend
to hold them to maturity and therefore, we would only pay out under these
contracts if there is a credit event in respect of a specific corporate entity
or a bond or loan issued by the entity identified in a contract. We establish
loss reserves
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for the estimated unpaid losses based on our credit default swap policies and
agreements in force. Net premiums earned relating to these products for the
years ended December 31, 2002 and 2001 were $145 million and $52 million,
respectively, with incurred losses of $148 million and $39 million,
respectively.
With effect from January 1, 2001, we are required to record credit default
swaps at their fair value. The fair value of these instruments is dependent on a
number of factors including credit spreads, changes in interest rates and the
credit quality of individual entities. To determine fair value, we may use
information from four different sources depending on the type of credit default
swap business written. The main sources are third party market pricing,
counterparty market pricing and rating agency models. In very limited
circumstances, where this information is not available or considered reliable,
we may extrapolate market adjustments to estimate fair value. For single name
credit default swaps, the majority are valued using the third party market
pricing (about 70 percent) and the remainder using counterparty market pricing.
For collateralized debt obligations ("CDOs"), which are a group of individual
credits packaged together and sold, we typically use a rating agency model
specifically designed to evaluate these instruments.
VALUATION OF GOODWILL
Goodwill represents the excess of the cost of acquisitions over the tangible net
assets acquired. At December 31, 2002, the balance in our financial statements
was $2.7 billion. In June 2001, the Financial Accounting Standards Board
("FASB") issued FAS 142, "Goodwill and Other Intangible Assets", which primarily
addresses the accounting for goodwill and intangible assets subsequent to their
acquisition. Prior to our adoption of FAS 142, we amortized goodwill to income
on a straight-line basis over a period of 25 to 40 years. Under FAS 142,
goodwill is no longer amortized to income but instead, is subject to impairment
tests, with an initial test required by June 30, 2002. As required, we adopted
FAS 142 on January 1, 2002 and ceased amortizing goodwill at that time. As part
of adopting FAS 142, we assigned all goodwill recognized in our consolidated
balance sheet at January 1, 2002 to one or more of our reporting units and
carried out the transitional impairment test of goodwill and determined that
there was no impairment in goodwill. In our impairment tests, we must assess
whether the current fair value of our operating units is at least equal to the
fair value used in the determination of goodwill. In doing this, we make
assumptions and estimates about profitability attributable to our operating
segments, as this is important in assessing whether an impairment has occurred.
As part of our ongoing management assessments, we regularly analyze our
operating companies in an effort to maximize future cash flows and
profitability. If, in the future, our assumptions and estimates made in
assessing the carrying value of goodwill prove to be incorrect, goodwill carried
on our balance sheet could be materially overstated. This would cause us to
write-down the carrying value of goodwill, resulting in a charge to earnings in
the period recorded. Accordingly, this could have a material adverse effect on
our financial condition, results of operations and liquidity.
SEPTEMBER 11, 2001
The terrorist attack on September 11, 2001 ("the September 11 tragedy") resulted
in the largest insured loss in history. We continue to evaluate our total
potential liability based upon individual insurance and reinsurance policy
language, legal and factual developments in underlying matters involving our
insureds and 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. The table
below shows the impact of the September 11 tragedy on each of our business
segments for the year ended December 31, 2001. Our estimate for the September 11
tragedy claims remains substantially unchanged from 2001 and we believe that our
estimate is reasonable and accurate based on information currently available.
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- -------------------------------------------------------------------------------------------------------------------
IMPACT OF SEPTEMBER 11, 2001 TRAGEDY
Year ended December 31, 2001
Insurance- Insurance-
North Overseas Global Financial ACE
(in millions of U.S. dollars) American General Reinsurance Services Consolidated
- -------------------------------------------------------------------------------------------------------------------
OPERATIONS DATA
Gross premiums written $ - $ (20) $ - $ 142 $ 122
Net premiums written (22) (46) (23) 142 51
Net premiums earned (22) (46) (22) 104 14
Losses and loss expenses 119 67 213 251 650
Policy acquisition costs - - 1 - 1
- -------------------------------------------------------------------------------------------------------------------
Underwriting income (141) (113) (236) (147) (637)
Income tax benefit (16) (27) (35) - (78)
- -------------------------------------------------------------------------------------------------------------------
Net loss $ (125) $ (86) $ (201) $ (147) $ (559)
===================================================================================================================
In February 2002, ACE announced that one of its Bermuda subsidiaries, 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 11 tragedy.
Our exposure to the tragedy is derived from losses incurred by our insured
and reinsured clients. Gross insured claims incurred by us with respect to the
tragedy are covered by significant amounts of reinsurance from high quality
reinsurers. In order to identify policies which may have been affected by the
September 11 tragedy, we conducted a review of our insurance and reinsurance
portfolios on a policy by policy basis, which included first-party, third-party,
reinsurance, retrocessional, financial guaranty and life reinsurance exposures.
Net losses and loss expenses of $650 million resulted from estimated gross
losses and loss expenses of approximately $1.8 billion, net of estimated
reinsurance recoveries of approximately $1.2 billion. As at December 31, 2002,
we have paid $711 million of losses and have collected $468 million of the $512
million recoverable from reinsurers.
RESULTS OF OPERATIONS - YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
The discussions that follow include tables, which show our consolidated and
segment operating results for the years ended December 31, 2002, 2001 and 2000.
In presenting our operating results, we have included and discussed certain
non-GAAP measures. These non-GAAP measures, which may be defined differently by
other companies, are important to an understanding of our overall results of
operations; however, they should not be viewed as a substitute for measures
determined in accordance with GAAP.
Underwriting income (loss) is a common performance measurement in the
insurance industry, representing net premiums earned less losses and loss
expenses, life and annuity benefits, policy acquisition costs and administrative
expenses. Net operating income (loss) is another common perfomance measurement
and is defined as net income (loss) excluding net realized gains (losses) on
investments, debt prepayment expense, non-recurring expenses, and, in 2001, the
cumulative effect of adopting FAS 133. Additionally, these items are shown net
of income tax. We believe this presentation of net operating income (loss)
enhances the understanding of our results of operations by highlighting the
underlying profitability of our insurance business. We exclude net realized
gains (losses) on investments from net operating income (loss) because the
amount of these gains (losses) is heavily influenced by, and fluctuates in part
according to, the availability of market opportunities. Debt prepayment expense
and non-recurring expenses are excluded from our calculation of net operating
income (loss) because we believe these amounts are largely independent of our
business and including them would distort the analysis of trends. Net operating
income (loss) should not be viewed as a substitute for net income determined in
accordance with GAAP.
25
CONSOLIDATING OPERATING RESULTS
2002 vs. 2001 vs.
(in millions of U.S. dollars) 2002 2001 2000 2001 2000
- ---------------------------------------------------------------------------------------------------------------------
Gross premiums written $ 12,819 $ 10,165 $ 7,586 26% 34%
Net premiums written 8,068 6,363 4,879 27 30
Net premiums earned 6,830 5,916 4,534 15 30
Losses and loss expenses 4,906 4,552 2,936 8 55
Life and annuity benefits 158 401 - (61) NM
Policy acquisition costs 960 785 651 22 21
Administrative expenses 944 823 745 15 10
- ---------------------------------------------------------------------------------------------------------------------
Underwriting income (loss) $ (138) $ (645) $ 202
- ---------------------------------------------------------------------------------------------------------------------
Net investment income 802 785 771
Other income 5 1 3
Interest expense 193 199 221
Income tax expense (benefit) (35) (68) 94
Amortization of goodwill - 79 79
- ---------------------------------------------------------------------------------------------------------------------
Net operating income (loss) $ 511 $ (69) $ 582
- ---------------------------------------------------------------------------------------------------------------------
Debt prepayment expense* (17) - -
Net realized losses on investments* (417) (50) (39)
Non-recurring expenses* - (4) -
Cumulative effect of adopting
a new accounting standard* - (23) -
- ---------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 77 $ (146) $ 543
=====================================================================================================================
Loss and loss expense ratio before
A&E (2002) and WTC (2001)**/(1)/ 65.8% 71.0% 64.7%
Impact of A&E (2002) and WTC (2001) 7.7% 11.6% -
Total loss and loss expense ratio/(1)/ 73.5% 82.6% 64.7%
Underwriting and administrative expense ratio/(1)/ 28.2% 29.0% 30.8%
Combined ratio/(1)/ 101.7% 111.6% 95.5%
=====================================================================================================================
* Net of income tax
** Excludes impact of asbestos and environmental reserve strengthening in
2002 and September 11 tragedy in 2001
/(1)/ Ratios exclude life reinsurance business
NM - not meaningful
Gross premiums written increased by 26 percent in 2002 compared with 2001 and
net premiums written, which reflect the premiums we retain after purchasing
reinsurance protection, increased by 27 percent. Net premiums earned, which
reflect the portion of net premiums written recorded as revenues for the period,
increased by 15 percent in 2002 compared with 2001. These increases are
discussed in each segment section below. The large increases are due to a
combination of price increases on renewal business and growth in new business
opportunities. Recently, we have noticed that property rate increases have begun
to stabilize while casualty lines, despite facing increased competition from new
entrants to the insurance market, are currently experiencing accelerating rate
increases that we expect to continue into the first half of 2003. Gross premiums
written increased by 34 percent to $10.2 billion in 2001 compared with $7.6
billion in 2000. This significant increase was due to new business opportunities
and price increases in 2001, increased LPT business and the start up of the life
reinsurance operation.
26
In 2002, our Financial Services segment wrote several large contracts,
including large retroactive contracts in the form of loss portfolio transfer
contracts ("LPTs") totaling $311 million in gross premiums written. LPTs
generated gross premiums written of $642 million and $362 million in 2001 and
2000, respectively. When LPT contracts are written in a period, they can cause
variations in premium volume compared with other periods, particularly in net
premiums earned as the entire written premium is fully earned in the period 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, the loss and loss expense ratio and the 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 73.5 percent in 2002 compared with 82.6
percent in 2001 and 64.7 percent in 2000. As discussed later in this report, our
results for the year ended December 31, 2002, were impacted by the increase to
our reserve for A&E exposure, which resulted in a net increase in our loss and
loss expenses of $516 million and added 7.7 percentage points to our loss and
loss expense ratio. Our share of losses in connection with the September 11
tragedy amounted to $650 million and added 11.6 percentage points to our loss
and loss expense ratio in 2001. Excluding the A&E reserve strengthening and the
September 11 tragedy, our loss and loss expense ratio declined by 5.2 percentage
points in the current year, which is a result of the combined effect of higher
net premiums earned in 2002 and the $170 million recorded in 2001 to strengthen
loss reserves. 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 and loss expense ratio. Excluding the Financial Services
segment, our loss and loss expense ratio would have been 71.4 percent in 2002,
77.3 percent in 2001 and 59.9 percent in 2000. LPTs are typically recorded at
higher loss ratios than our other lines of business. More information regarding
LPTs is provided in the Financial Services segment discussion.
Underwriting and administrative expenses comprise 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 has improved to 28.2 percent in 2002 from 29.0
percent in 2001 and 30.8 percent in 2000. The main reason for the decline is the
continued increase in net premiums earned in recent years. However, this ratio
is also influenced by changes in the mix of business written and, as described
further in the segment discussions, certain of our segments have experienced
shifts towards lower-commission business. Excluding the Financial Services
segment, our underwriting and administrative expense ratios would have been 31.6
percent in 2002, compared with 36.4 percent in 2001 and 34.3 percent in 2000.
As discussed later in this report, net investment income increased by two
percent in 2002 compared with 2001. We adopted FAS 142 on January 1, 2002, and
accordingly have not amortized any goodwill in 2002, compared with $79 million
of goodwill amortized in 2001 and 2000.
Our net operating income was $511 million in 2002 including an after tax
charge of $354 million for A&E reserve strengthening. Removing the effects of
the September 11 tragedy in 2001, our net operating income would have been $490
million in 2001. Our net operating income was $582 million in 2000.
The debt prepayment expense of $17 million (net of income tax) resulted
from our decision to prepay 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. These subordinated notes bear interest of 11.2
percent. More information regarding our debt is provided in the Liquidity and
Capital Resources discussion.
Net realized losses on investments (net of income tax) were $417 million in
2002 compared with net realized losses of $50 million in 2001 and $39 million in
2000. The net realized losses recorded in 2002, 2001 and 2000 are discussed in
detail in the net realized gains (losses) on investments section.
27
SEGMENT OPERATING RESULTS
INSURANCE - NORTH AMERICAN
The Insurance - North American segment comprises our P&C insurance operations in
the U.S., Bermuda and Canada excluding the financial solutions business in the
U.S. and Bermuda. The Insurance - North American segment writes a variety of
insurance products including property, liability, professional lines (D&O and
errors and omissions coverages ("E&O")), marine, program business, political
risk, accident and health ("A&H"), warranty, aerospace and other specialty
lines.
2002 vs. 2001 vs.
(in millions of U.S. dollars) 2002 2001 2000 2001 2000
- ------------------------------------------------------------------------------------------------------------------------
Gross premiums written $ 6,116 $ 4,521 $ 3,626 35% 25%
Net premiums written 2,919 1,986 1,891 47 5
Net premiums earned 2,475 1,816 1,734 36 5
Losses and loss expenses 2,200 1,373 1,128 60 22
Underwriting and administrative expenses 557 521 475 7 10
- ------------------------------------------------------------------------------------------------------------------------
Underwriting income (loss) $ (282) $ (78) $ 131
- ------------------------------------------------------------------------------------------------------------------------
Net investment income 406 426 446
Other income 1 1 4
Interest expense 32 37 35
Income tax expense (benefit) (4) 94 105
- ------------------------------------------------------------------------------------------------------------------------
Net operating income $ 97 $ 218 $ 441
========================================================================================================================
Loss and loss expense ratio before
A&E (2002) and WTC (2001)* 68.0% 68.2% 65.1%
Impact of A&E (2002) and WTC (2001) 20.9% 7.4% -
Total loss and loss expense ratio 88.9% 75.6% 65.1%
Underwriting and administrative expense ratio 22.5% 28.7% 27.3%
Combined ratio 111.4% 104.3% 92.4%
========================================================================================================================
* Excludes impact of asbestos and environmental reserve strengthening in
2002 and September 11 tragedy in 2001
Gross premiums written for the segment increased by 35 percent in 2002 compared
with 2001. Both ACE USA and ACE Bermuda have contributed to the increase. The
demand for our traditional P&C risk transfer business continues to rise. As a
result of higher rate levels, we have seen significant premium growth and
improvements in policy terms and conditions. Additionally, the new products we
introduced in this segment in 2002 - A&H, medical risk, excess casualty,
environmental and stand alone terrorism - have shown significant momentum,
generating $200 million in gross premiums written.
ACE USA's gross premiums written increased by 34 percent to $5.7 billion
for the year compared with $4.2 billion for 2001. Most of ACE USA's operating
divisions experienced strong premium growth in 2002, attributed largely to
rising prices, a result of the reduced availability of insurance for larger
property accounts and excess casualty coverages. Overall, rates increased by
over 75 percent for casualty business and 97 percent for D&O business. The large
rate increases in our casualty business, specifically professional lines,
accelerated in the second half of 2002. These large rate increases were not
fully reflected in our overall premium growth as this line is a growing, but not
yet high volume business compared to our property lines which experienced slower
rate increases in 2002. We expect casualty rate increases to continue to
accelerate into 2003 and property rates to further stabilize. We expect to
increase our volume of writings on the casualty lines, including professional
lines business in 2003 and this should translate to higher premium growth
overall. The September 11 tragedy resulted in concentrated losses by the major
participants in the reinsurance industry, which significantly reduced primary
insurance market capacity
28
in the lines of business where customer demand is now the strongest. 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. In
2001, ACE USA increased its gross premiums written by 30 percent to $4.2 billion
compared with $3.3 billion in 2000. During 2001, ACE USA experienced growth in
new business and higher pricing due to improved market conditions in the first
eight months of the year. Following the September 11 tragedy, significant
pricing increases were experienced primarily for large property accounts,
catastrophe-exposed property business and the excess casualty lines.
ACE Bermuda has been successful in growing its core lines of business,
reporting an increase in gross premiums written of 60 percent to $435 million in
2002 compared with $272 million in 2001. Excess liability increased by 78
percent, excess property increased by 72 percent and professional lines more
than doubled. These significant increases are primarily a result of rate
increases in the insurance and reinsurance market in general. We expect the
improved market conditions to continue into 2003. ACE Bermuda's gross premiums
written in 2001 decreased by 26 percent to $272 million compared with $369
million in 2000. Gross premiums written in 2000 included certain non-recurring
retroactive business as well as aviation and satellite business, much of which
was later moved to other units within ACE.
The loss and loss expense ratio for the Insurance - North American segment
was 88.9 percent in 2002 compared with 75.6 percent in 2001. The impact of the
asbestos reserve strengthening increased our net loss and loss expenses by $516
million and added 20.9 percentage points to this segment's current year loss and
loss expense ratio, while the September 11 tragedy added 7.4 percentage points
to the loss and loss expense ratio in 2001. Adjusted for these two events, our
loss and loss expense ratio was 68.0 percent in 2002 compared with 68.2 percent
in 2001. Changes in business mix and losses incurred in ACE Bermuda's satellite
book caused the loss and loss expense ratio to remain relatively unchanged
despite large rate increases on renewal business and growth in new business.
The underwriting and administrative expense ratio declined to 22.5 percent
in 2002 from 28.7 percent in 2001. This decline is primarily a result of
increased net premiums earned and a shift in mix of business at ACE USA towards
lower-commission E&O and D&O lines, which more than offset the increase in
administrative expenses. Administrative expenses increased in 2002, principally
due to the increased costs associated with servicing the growth in new product
lines and increased volume in existing product lines. This segment's
underwriting and administrative expense ratio was 27.3 percent in 2000.
An underwriting loss of $282 million was reported in 2002, compared with an
underwriting loss of $78 million in 2001. The increase in underwriting loss
relates primarily to the reserve strengthening for asbestos exposure in our
Brandywine Holdings operation ("Brandywine"), partially offset by the increase
in net premiums earned. The Insurance - North American segment had underwriting
income of $131 million in 2000, a year relatively free of major catastrophic
losses.
Net operating income was $97 million in 2002, compared with $218 million in
2001. The decrease is attributed to the increase in underwriting loss in 2002,
partially offset by the income tax benefit of $4 million in the current year
compared with an income tax expense of $94 million in 2001. Net operating income
was $441 million in 2000, as a result of the underwriting profit.
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. The Insurance - Overseas General segment
writes a variety of insurance products including property, liability,
professional risk (D&O and E&O), marine, political risk, A&H, aerospace and
consumer-oriented products.
29
2002 vs. 2001 vs.
(in millions of U.S. dollars) 2002 2001 2000 2001 2000
- ------------------------------------------------------------------------------------------------------------------------
Gross premiums written $ 4,114 $ 3,289 $ 2,822 25% 17%
Net premiums written 2,716 2,154 2,004 26 7
Net premiums earned 2,393 1,941 1,832 23 6
Losses and loss expenses 1,455 1,465 1,108 (1) 32
Underwriting and administrative expenses 923 772 710 20 9
- ------------------------------------------------------------------------------------------------------------------------
Underwriting income (loss) $ 15 $ (296) $ 14
- ------------------------------------------------------------------------------------------------------------------------
Net investment income 108 102 117
Other income (expense) 2 (1) (2)
Interest expense 3 2 5
Income tax expense (benefit) 6 (85) 15
Amortization of goodwill - 3 4
- ------------------------------------------------------------------------------------------------------------------------
Net operating income (loss) $ 116 $ (115) $ 105
========================================================================================================================
Loss and loss expense ratio 60.8% 75.5% 60.5%
Underwriting and administrative expense ratio 38.6% 39.7% 38.8%
Combined ratio 99.4% 115.2% 99.3%
========================================================================================================================
Gross premiums written for this segment increased by 25 percent in 2002 compared
with 2001. ACE International's gross premiums written increased by 26 percent to
$2.7 billion in 2002 compared with $2.1 billion in 2001. With the exception of
ACE Far East, ACE International continues to experience rapid growth in all
regions of the world. ACE Europe and ACE Asia Pacific accounted for most of this
increase, principally due to increased prices on renewing business and demand
for products in the P&C and A&H lines. ACE Latin America also contributed to
the increase on the strength of favorable price increases and new business
writings in the Mexican A&H book. In most regions of the world, property rates
continue to increase in 2003, though the rate of increase has slowed, while
casualty rates continue to increase at an accelerating rate.
ACE Global Markets' gross premiums written increased by 23 percent to $1.5
billion in 2002 compared with $1.2 billion in 2001. Improved market conditions
in 2002 have resulted in rate increases across most lines and growth in new
business written. With the exception of aviation, P&C rates increased in excess
of 40 percent in 2002. The magnitude of rate increases for professional risk are
expected to continue for the first half of 2003, while property and aviation
rate increases have begun to stabilize due to increasing capacity. ACE Global
Markets' retention ratio, (the ratio of net premiums written to gross premiums
written), has declined to 54 percent in 2002 compared with 60 percent in 2001.
This is a result of higher reinsurance cost (and ultimately reduced net premiums
written) following the September 11 tragedy. During 2002, we increased our
participation in Lloyd's Syndicate 2488 to 99.6 percent from 90 percent in 2001.
Gross premiums written increased by $258 million in 2001 to $1.2 billion
compared with $921 million in 2000. The increase was due to our higher level of
participation in Syndicate 2488 and higher premium levels across most of our
lines of business in 2001 due to rate increases.
Gross premiums written for Insurance - Overseas General increased by 17
percent to $3.3 billion in 2001 compared with $2.8 billion in 2000. The growth
in 2001 is attributed to growth in underlying P&C lines in both indigenous and
multinational programs and the A&H and consumer products business operations.
The loss and loss expense ratio for Insurance - Overseas General declined
to 60.8 percent in 2002 compared with 75.5 percent in 2001. The improvement is
attributed to the lack of catastrophic losses of the magnitude of the September
11 tragedy in 2001 and additionally due to $170 million of reserve strengthening
at ACE Global Markets and ACE International in 2001. The loss and loss expense
ratio was 60.5 percent in 2000.
30
The underwriting and administrative expense ratio for this segment was
relatively stable despite increased net premiums earned. The ratio was 38.6
percent in 2002 compared with 39.7 percent in 2001 and 38.8 percent in 2000.
Underwriting expenses at ACE Global Markets have increased due to higher Lloyd's
premium levies and processing fees as well as increased staffing costs due to
the expanding operations. ACE International's underwriting expenses have also
increased in all regions due to growth in operations.
Net operating income in 2002 was $116 million compared with a net operating
loss of $115 million in 2001. The results for 2001 were impacted by the
September 11 tragedy. Excluding this event there would have been a net operating
loss of $29 million in 2001. Net operating income was $105 million in 2000,
primarily the result of underwriting profit.
GLOBAL REINSURANCE
The Global Reinsurance segment comprises ACE Tempest Re Bermuda, ACE Tempest Re
USA, ACE Tempest Re Europe, and ACE Tempest Life Re ("ACE Life Re"), our
Bermuda-based life reinsurance operation (which is discussed separately).
Property and Casualty
2002 vs. 2001 vs.
(in millions of U.S. dollars) 2002 2001 2000 2001 2000
- --------------------------------------------------------------------------------------------------------------
Gross premiums written $ 887 $ 460 $ 337 93% 36%
Net premiums written 777 354 275 119 29
Net premiums earned 677 324 252 109 29
Losses and loss expenses 304 317 53 (4) 498
Underwriting and administrative expenses 163 97 63 68 54
- --------------------------------------------------------------------------------------------------------------
Underwriting income (loss) $ 210 $ (90) $ 136
==============================================================================================================
Net investment income 95 70 65
Other income 1 - -
Interest expense 14 1 -
Income tax expense (benefit) 1 (22) 17
Amortization of goodwill - 14 14
- --------------------------------------------------------------------------------------------------------------
Net operating income (loss) $ 291 $ (13) $ 170
==============================================================================================================
Loss and loss expense ratio* 44.9% 97.7% 21.0%
Underwriting and administrative expense ratio* 24.0% 30.0% 24.9%
Combined ratio* 68.9% 127.7% 45.9%
==============================================================================================================
*Ratios exclude life reinsurance business
The Global Reinsurance segment's gross premiums written increased by 93 percent
in 2002 compared with 2001. This substantial increase is a result of our
successful efforts to expand into a multi-line global reinsurer as well as
generally improved P&C reinsurance market conditions throughout 2002. ACE
Tempest Re Bermuda, ACE Tempest Re Europe and ACE Tempest Re USA all contributed
to this significant increase. ACE Tempest Re Bermuda reported a 56 percent
increase in gross premiums written to $423 million while ACE Tempest Re Europe
increased its gross premiums written by 92 percent to $230 million and ACE
Tempest Re USA grew its gross premiums written by 239 percent to $234 million.
On average, during 2002, property catastrophe premium rates were approximately
20 percent higher than in 2001 following significant rate improvements during
2001. We expect rates to remain relatively flat or decline slightly in 2003.
Premium rates on other P&C lines have increased significantly over the past year
and we expect rate increases to continue through 2003, particularly in casualty
lines. Premium rates and policy terms in certain areas of the market continue to
be inadequate and, as such, we continue to decline more business than we write.
The Global Reinsurance segment's gross premiums written increased by 36 percent
in 2001 compared with 2000. This increase was due to our business expansion and
improved pricing in the reinsurance market in 2001 compared with 2000.
31
Net premiums written more than doubled in 2002 compared with 2001. This
increase was primarily a result of the growth in gross premiums written and a
reduction in the level of reinsurance purchased by ACE Tempest Re Europe. Net
premiums written in 2001 increased by 29 percent to $354 million compared with
$275 million in 2000.
The loss and loss expense ratio improved from 97.7 percent in 2001 to 44.9
percent in 2002. Removing the impact of the September 11 tragedy, the loss and
loss expense ratio would have been 30.1 percent in 2001. The increase in our
loss and loss expense ratio (after adjusting for the September 11 tragedy) is
primarily due to changes in business mix at ACE Tempest Re as we transform from
a property catastrophe writer to a multi-line writer. Our portfolio is now
diversified as half of our business in 2002 was from non-catastrophe lines
generated by our London and U.S. operations with the other half coming from our
Bermuda catastrophe division. The loss and loss expense ratio in 2000 was 21.0
percent.
The underwriting and administrative expense ratio declined to 24.0 percent
in 2002 compared with 30.0 percent in 2001 and 24.9 percent in 2000. While our
operating costs grew due to the expanding infrastructure needed to manage our
expansion, our expense ratio improved as a result of higher premium production
levels in 2002.
The Global Reinsurance segment's underwriting income increased to $210
million in 2002, compared with an underwriting loss of $90 million in 2001.
Excluding the impact of the September 11 tragedy, underwriting income would have
been $146 million in 2001. This significant increase is primarily a result of
higher premium rates in the P&C insurance and reinsurance market since the
September 11 tragedy. Benefiting from relatively few catastrophic losses, this
segment reported underwriting income of $136 million in 2000.
Net operating income increased to $291 million in 2002 compared with a net
operating loss of $13 million in 2001. Removing the impact of the September 11
tragedy, net operating income would have been $188 million in 2001. This
increase is a result of higher underwriting income from all the divisions and
the increase in net investment income. Net operating income was $170 million in
2000.
Life Reinsurance
ACE Life Re was formed in 2001 as a niche player in the life reinsurance market.
Our strategic focus at ACE Life Re is to differentiate ourselves in our targeted
business, which is principally to provide reinsurance coverage to other life
insurance companies focusing on guarantees included in certain annuity products
(fixed and variable). We do not compete on a "traditional" basis for pure
mortality business. The reinsurance transactions we enter into typically help
clients (ceding companies) to manage mortality, morbidity, and/or lapse risks
embedded in their book of business. 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.
2002 vs.
(in millions of U.S. dollars) 2002 2001 2001
- -------------------------------------------------------------------------
Gross premiums written $ 165 $ 414 (60)%
Net premiums written 159 408 (61)
Net premiums earned 158 406 (61)
Life and annuity benefits 158 401 (61)
Underwriting and administrative expenses 22 10 120
Net investment income 27 9 200
- -------------------------------------------------------------------------
Net operating income $ 5 $ 4
=========================================================================
32
Our life reinsurance business is focused on writing risk transfer treaty
business where the principal risk is mortality and morbidity based. Our current
product portfolio focuses mainly on life and variable products. During 2002, we
made the decision to cease pursuing large, one-time transaction business and the
long-term disability business as we no longer believe our efforts in these areas
justify the potential returns. This decision is reflected in the 60 percent
reduction in gross premiums written to $165 million in 2002 from $414 million in
2001. Gross premiums written in 2001 included $334 million from non-recurring
deals.
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 rely 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 period are not indicative
of premiums to be written in future periods.
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
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, the loss and loss expense ratio and the 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.
Additionally, we have determined that certain products we issue in the
Financial Services segment (principally credit protection oriented) meet the
definition of a derivative under FAS 133, and are required to be recorded at
fair value. These products consist primarily of credit default swaps,
index-based instruments and certain financial guarantee coverages. We recorded
in net realized gains (losses) on investments, a loss of $77 million in 2002 due
to the change in fair value of these derivatives compared with a loss of $17
million in 2001. The level of such gains and losses is dependent upon a number
of factors including changes in interest rates, credit spreads and other market
factors.
33
2002 vs. 2001 vs.
(in millions of U.S. dollars) 2002 2001 2000 2001 2000
- ----------------------------------------------------------------------------------------------------------------
Gross premiums written $ 1,537 $ 1,481 $ 801 4% 85%
Net premiums written 1,497 1,461 709 2 106
Net premiums earned 1,127 1,429 716 (21) 99
Losses and loss expenses 947 1,397 647 (32) 116
Underwriting and administrative expenses 129 114 87 13 31
- ----------------------------------------------------------------------------------------------------------------
Underwriting income (loss) $ 51 $ (82) $ (18)
- ----------------------------------------------------------------------------------------------------------------
Net investment income 192 173 149
Other income 1 1 1
Interest expense 12 17 18
Income tax expense 30 21 22
Amortization of goodwill - 4 4
- ----------------------------------------------------------------------------------------------------------------
Net operating income $ 202 $ 50 $ 88
================================================================================================================
Loss and loss expense ratio 84.0% 97.8% 90.3%
Underwriting and administrative expense ratio 11.4% 7.9% 12.2%
Combined ratio 95.4% 105.7% 102.5%
================================================================================================================
The Financial Services segment's net operating income increased to $202 million
in 2002 compared with $50 million in 2001. The results for 2001 were
significantly affected by the September 11 tragedy. Excluding the impact of this
event, net operating income would have been $197 million in 2001. Gross premiums
written increased by four percent in 2002 compared with 2001. This increase
reflects the increased demand for credit derivatives and structured finance
transactions partially offset by lower LPT volume experienced in 2002. Gross
premiums written were $1.5 billion in 2001 compared with $801 million in 2000.
We wrote several large LPTs in 2001 totaling $642 million compared with $311
million in 2002 and $362 million in 2000.
The financial guaranty operations were successful in increasing net
operating income to $110 million in 2002 compared with $94 million in 2001.
Market demand for credit derivatives and trade credit insurance was strong in
2002. We increased our writing in both these areas. Gross premiums written
attributed to credit derivatives now comprise over two-thirds of the financial
guaranty operation's total gross premiums written, compared with 29 percent in
2001. ACE Guaranty Corp. was able to take advantage of reduced competition in
the trade credit insurance marketplace, and we increased our gross premiums
written in this area to $42 million in 2002 compared with $22 million in 2001.
Net operating income was $82 million in 2000.
The financial solutions operations reported an 18 percent decline in net
premiums earned to $883 million in 2002 compared with $1 billion in 2001. This
decrease is a result of a change in business mix in 2002 and additional premiums
of $104 million due under the terms of certain financial solutions reinsurance
programs in 2001 directly impacted by the September 11 tragedy. In 2002,
financial solutions increased its writings in multi-year, prospective,
structured programs which earn out over three- to five-year terms, and reported
a decrease in LPT business, which is earned when written. We expect to see
strong demand in 2003 for our products as companies continue to be faced with
pressure on self-insured retentions, changing insurance programs and the need to
mitigate balance sheet and income statement uncertainties.
The loss and loss expense ratio improved from 97.8 percent in 2001 to 84.0
percent in 2002. This decrease is primarily attributable to the absence of
losses in 2002 of the magnitude of the September 11 tragedy in 2001. The
underwriting and administrative expense ratio was 11.4 percent in 2002 compared
with 7.9 percent in 2001. This increase is primarily attributed to the decrease
in LPT volume during 2002 compared with 2001. LPTs typically incur lower
commission costs than our other lines of business. Due to relatively low net
premiums earned, the underwriting and administrative expense ratio was 12.2
percent in 2000.
34
NET INVESTMENT INCOME
Years ended December 31,
(in millions of U.S. dollars) 2002 2001 2000
- -------------------------------------------------------------------------------
Insurance - North American $ 406 $ 426 $ 446
Insurance - Overseas General 108 102 117
Global Reinsurance - P&C 95 70 65
Global Reinsurance - Life 27 9 -
Financial Services 192 173 149
Corporate and Other (26) 5 (6)
- -------------------------------------------------------------------------------
Net investment income $ 802 $ 785 $ 771
===============================================================================
Net investment income is influenced by a number of factors, including the
amounts and timing of inward and outward cash flows and the level of interest
rates as well as changes in overall asset allocation. Net investment income
increased by two percent in 2002 to $802 million compared to $785 million in
2001. Substantial positive operating cash flows during 2002 and positive
operating and financing cash flows in the later part of 2001 resulted in a
higher average investable asset base. The positive impact on investment income
due to the increased asset base was partially offset by a decline in the
investment portfolio's yield due to the impact of lower interest rates on
investing new cash and reinvesting maturing securities. The average yield on
fixed maturities declined to 4.4 percent in 2002 compared with 5.2 percent for
2001 and 6.3 percent for 2000.
Net investment income increased in 2001 by $14 million to $785 million
compared to $771 million in 2000. On a comparable basis, net investment income
declined by $14 million. The year ended December 31, 2000, includes only six
months of investment income from Commercial Insurance Services ("CIS") as this
unit was treated as a discontinued operation until July 2, 2000. The comparable
number assumes investment income from CIS was included for 12 months in 2000.
While we had substantial positive operating and financing cash flows in 2001,
these inflows were weighted toward the end of the year.
NET REALIZED GAINS (LOSSSES) ON IVESTMENTS
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 fair value or are settled. Changes in
unrealized appreciation and depreciation, which result from the revaluation of
securities held, are reported as a separate component of accumulated other
comprehensive income in shareholders' equity. The following table presents our
pre-tax net realized gains (losses) on investments for the years ended December
31, 2002, 2001 and 2000.
(in millions of U.S. dollars) 2002 2001 2000
- -------------------------------------------------------------------------------
Fixed maturities and short-term investments $ (58) $ (7) $ (82)
Equity securities (157) 27 114
Other investments (12) (38) (12)
Financial futures, options and interest rate swaps (188) (11) (48)
Fair value adjustment on credit derivatives (77) (17) -
Currency 3 (12) (11)
- -------------------------------------------------------------------------------
Total net realized gains (losses) on investments $ (489) $ (58) $ (39)
===============================================================================
We regularly review our investments for possible impairment based on criteria
including economic conditions, credit loss experience and other issuer-specific
developments. If there is a decline in a security's net realizable value, we
must determine whether that decline is temporary or "other than temporary". If
we believe a decline in the value of a particular investment
35
is temporary, we record the decline as an unrealized loss in our shareholders'
equity. If we believe the decline is "other than temporary", we write down the
carrying value of the investment and record a realized loss in our statement of
operations. The decision to recognize a decline in the value of a security
carried at fair value as "other than temporary" rather than temporary has no
impact on our book value.
During 2002, we recognized net realized losses of $227 million related to
fixed maturities, equity securities and other investments, compared to net
realized losses of $18 million during 2001. Our net realized losses in 2002
included $268 million of write-downs of fixed maturity investments, equity
securities and other investments as a result of conditions which caused us to
conclude the decline in fair value of the investment was "other than temporary".
Excluding the impairment charges, we recorded $41 million of net gains primarily
from the sales of fixed maturities.
Our net realized losses in 2001 related to fixed maturities, equity
securities and other investments was $18 million and included $81 million of
write-downs of fixed maturity investments and other investments as a result of
conditions which caused us to conclude the decline in fair value of the
investment was "other than temporary". Excluding the impairment charges, we
recorded $63 million of net gains from the sales of investments.
Given our overall total return objective for our investment portfolio, we
may sell securities at a loss for a number of reasons including changes in the
investment environment, our expectation that fair value may deteriorate further,
our desire to reduce our exposure to an issuer or an industry and changes in the
credit quality of the security.
FAS 133, which we implemented in January 2001, requires us to recognize all
derivatives as either assets or liabilities on our consolidated balance sheet
and measure them at fair value. We record the gains and losses resulting from
the fair value measurement of derivatives in net realized gains and losses. Our
involvement with derivative instruments and transactions is primarily to offer
protection to others or to mitigate our own risk and we do not consider our
derivative transactions to be speculative in nature.
We incurred net realized losses on financial futures and option contracts
and interest rate swaps of $188 million in 2002 compared with losses of $11
million and $48 million in 2001 and 2000, respectively. Our 2002 losses included
$81 million of losses from interest rate swaps as interest rates declined in the
year. These swaps are designed to reduce the negative impact of increases in
interest rates on our fixed maturity portfolio. We also incurred losses of $107
million on our Standard and Poor's ("S&P") equity index futures contracts as the
S&P 500 equity index declined 22 percent during the year. We use foreign
currency forward contracts to minimize the effect of fluctuating foreign
currencies on certain non-U.S. dollar holdings in our portfolio that are not
specifically matching foreign currency liabilities. These contracts are not
designated as specific hedges and, therefore, we record all realized and
unrealized gains and losses on these contracts as net realized gains (losses) in
the period in which the currency values change.
We have determined that certain products we issue (principally credit
protection oriented) 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. We incurred a loss of $77 million in 2002
due to the change in fair value of these derivatives compared with a loss of $17
million in 2001. The level of such gains and losses is dependent upon a number
of factors including changes in interest rates, credit spreads and other market
factors.
The process of determining whether a decline in value is temporary or
"other than temporary" is subjective and differs by type of security. In
addition to company-specific financial information and general market or
industry conditions, we also consider our ability and intent to hold a
particular security to maturity or until market value recovers to a level in
excess of cost. As a result of our periodic review process, we have determined
that there currently is no need to sell any of these securities to fund
anticipated payments. We have described below, by type of security, our process
for reviewing our investments for possible impairment.
FIXED MATURITIES AND SECURITIES ON LOAN
We review all of our fixed income securities, including securities on loan, for
potential impairment each quarter. In general, we focus on those fixed-maturity
securities with a market value of less than 80 percent of amortized cost for the
previous nine months.
36
Outlined below are the main factors we use in evaluating a fixed income
security for potential impairment:
.. the degree to which any appearance of impairment is attributable to an overall
change in market conditions (e.g., interest rates) rather than changes in the
individual factual circumstances and risk profile of the issuer;
.. the performance of the relevant industry sector;
.. whether an issuer is current in making principal and interest payments on the
debt securities in question;
.. the issuer's financial condition and our assessment (using available market
information) of its ability to make future scheduled principal and interest
payments on a timely basis; and
.. the current financial strength or debt rating and analysis and guidance
provided by rating agencies and analysts.
EQUITY SECURITIES AND SECURITIES ON LOAN
On a quarterly basis, these investments are also reviewed for impairment. In
general, we focus our attention on those equity securities with a market value
of less than 80 percent of cost for the previous nine months.
Outlined below are the main factors we use in evaluating an equity security
for potential impairment:
.. whether the decline appears to be related to general market or industry
conditions or is issuer-specific; and
.. the financial condition and near-term prospects of the issuer, including any
specific events that may influence the issuer's operations.
OTHER INVESTMENTS
With respect to publicly and non-publicly traded venture capital investments, on
a quarterly basis the portfolio managers, as well as our internal valuation
committee, review and consider a variety of factors in determining the potential
for loss impairment. Factors considered are:
.. the issuer's most recent financing events;
.. an analysis of whether fundamental deterioration has occurred; and
.. whether or not the issuer's progress has been substantially less than
expectations.
The following table summarizes, for all securities in an unrealized loss
position at December 31, 2002 (including Securities on loan), the aggregate fair
value and gross unrealized loss by length of time the amounts have been
continuously in an unrealized loss position.
December 31, 2002
Gross unrealized loss
Fair 0-6 7-12 Over 12
value months months months Total
------ ------ ------ ------- -----
(in million of U.S. dollars)
Fixed maturities $1,048 $ 31 $ 17 $ 11 $ 59
Equities 163 35 24 5 64
Other investments 88 1 - 3 4
------ ------ ------ ------- -----
Total $1,299 $ 67 $ 41 $ 19 $ 127
====== ====== ====== ======= =====
37
OTHER INCOME AND EXPENSE ITEMS
Years ended December 31,
(in millions of U.S. Dollars) 2002 2001 2000
- -------------------------------------------------------------------------------
Other income (expense) $ (20) $ 1 $ 3
===============================================================================
Interest expense $ 193 $ 199 $ 221
===============================================================================
Income tax expense (benefit) $ (116) $ (79) $ 94
===============================================================================
Amortization of goodwill $ - $ 79 $ 79
===============================================================================
Other income (expense) includes $25 million in debt prepayment expense incurred
in 2002 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 decreased by three percent in 2002 compared with 2001. The
decrease is a result of the combined effect of reducing our outstanding debt,
lower interest rates on our floating rate debt and repayment of $100 million of
ACE INA Subordinated Notes. The decrease in interest expense in 2001, as
compared with 2000, was also due to lower interest rates on our floating rate
debt. A full description of our outstanding debt, including interest rates and
terms, is included in Note 9 of the Consolidated Financial Statements.
The income tax benefit of $116 million in 2002 is primarily attributable to
the realized losses on investments offset by a lower underwriting loss in 2002.
In 2002, our effective tax rate was 7.4 percent. Excluding the impact of the A&E
reserve strengthening, the effective tax rate was 12.8 percent. For 2003, we
expect that our effective tax rate will 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. We reported an income tax benefit of $79 million
in 2001 compared with an expense of $94 million in 2000. This was primarily due
to the underwriting loss on the September 11 tragedy in 2001. For further
information on taxation, see Note 14 of the Consolidated Financial Statements.
In June 2001, FASB issued FAS 142 which primarily addresses the accounting
for goodwill and intangible assets subsequent to 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 the independent investment rating service 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 December 31, 2002, and 3.4 years
at December 31, 2001.
The following table identifies our invested assets at fair value, by type
held, at December 31, 2002 and 2001.
(in millions of U.S. dollars) 2002 2001
- -------------------------------------------------------------------
Fixed maturities $ 14,420 $ 13,000
Equity securities 411 468
Securities on loan 293 -
Short-term investments 1,885 1,206
Other investments 652 591
Cash 663 671
- -------------------------------------------------------------------
Total investments and cash $ 18,324 $ 15,936
===================================================================
38
At December 31, 2002, total investments and cash was $18.3 billion compared with
$15.9 billion at December 31, 2001. We also attain exposure to the equity
markets through the use of derivative instruments. The combined equity exposure
through both our equity portfolio and derivative instruments was valued at $603
million and $805 million at December 31, 2002 and 2001, respectively. The
increase of $2.3 billion in total investments and cash is primarily due to
positive cash flows from operations due to strong premium volume, and an
increase in unrealized appreciation on the fixed income portfolio caused by
declining interest rates during 2002 and 2001. Offsetting these increases, in
2002 we paid dividends of $193 million and reduced our overall debt levels by
$349 million. Our other investments principally comprise direct investments,
investments in investment funds and investments in limited partnerships. During
2002, we acquired 22 percent of the outstanding shares of Huatai Insurance
Company of China ("Huatai") for $111 million. Huatai is China's first nationally
licensed, joint stock P&C insurer.
The following tables show the market value of our fixed income portfolio,
short-term investments, securities on loan and cash and cash equivalents at
December 31, 2002, by type and by credit rating, as rated by S&P.
Percentage
(in millions of U.S. dollars) MARKET VALUE of Total
- -------------------------------------------------------------------
Treasury $ 842 5%
Agency 503 3
Corporate 6,929 40
Mortgage-backed securities 3,302 19
Asset-backed securities 352 2
Municipal 1,201 7
Non-U.S. 1,584 9
Cash and cash equivalents 2,548 15
- -------------------------------------------------------------------
Total $ 17,261 100%
===================================================================
AAA $ 8,566 49%
AA 2,880 17
A 2,920 17
BBB 1,314 8
BB 662 4
B 843 5
Other 76 -
- -------------------------------------------------------------------
Total $ 17,261 100%
===================================================================
At December 31, 2002, our fixed maturity investment portfolio included
non-investment grade securities and non-rated securities which in total,
comprised approximately nine percent of our fixed income portfolio.
Below-investment grade securities have different characteristics than investment
grade corporate debt securities. Risk of loss upon default by the borrower is
significantly greater with respect to below-investment grade securities than
with other corporate debt securities. Below-investment grade securities are
generally unsecured and are often subordinated to other creditors of the issuer.
Also, issuers of below-investment grade securities usually have higher levels of
debt and are more sensitive to adverse economic conditions, such as recession or
increasing interest rates, than are investment grade issuers. We attempt to
reduce the overall risk in the below-investment grade portfolio, as in all
investments, through careful credit analysis, strict investment policy
guidelines, and diversification by issuer and/or guarantor and by industry.
39
RESTRICTED ASSETS
We are required to maintain assets on deposit with various regulatory
authorities to support our insurance and reinsurance operations. These
requirements are generally promulgated in the statutory regulations of the
individual jurisdictions. The assets on deposit are available to settle
insurance and reinsurance liabilities. We also utilize trust funds in certain
large transactions where the trust funds are set up for the benefit of the
ceding companies and generally take the place of Letter of Credit ("LOC")
requirements. We also have investments in segregated portfolios primarily to
provide collateral or guarantees for LOCs and debt instruments (see Notes 8 and
9 of the Consolidated Financial Statements).
The following table identifies the value of restricted assets at
December 31, 2002 and 2001.
(in millions of U.S. dollars) 2002 2001
- ----------------------------------------------------------------------------
Deposits with U.S. regulatory authorities $ 650 $ 864
Deposits with non-U.S. regulatory authorities 1,070 735
Assets used for collateral or guarantees 1,230 1,030
Trust funds 1,381 852
- ----------------------------------------------------------------------------
$ 4,331 $ 3,481
============================================================================
The value of restricted assets increased by $850 million to $4.3 billion at
December 31, 2002, compared with $3.5 billion at December 31, 2001. The higher
value of restricted assets is a result of increased use of our secured credit
facility, higher use of trust funds in place of LOCs and our greater
participation in Syndicate 2488. The increase in restricted assets was partially
offset by the repayment of the ACE INA RHINO Preferred Securities, which removed
the need for a $400 million portfolio of restricted assets.
PROPERTY AND CAUSALTY 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 for 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 year ended December 31, 2002.
Gross Reinsurance
(in millions of U.S. dollars) Losses Recoverable Net
- ----------------------------------------------------------------------------------------------------
Balance, beginning of year $ 20,728 $ 10,629 $ 10,099
Losses and loss expenses incurred 10,113 5,206 4,907
Losses and loss expenses paid (6,903) (2,952) (3,951)
Other (including foreign exchange revaluation) 377 114 263
- ----------------------------------------------------------------------------------------------------
Balance, end of year $ 24,315 $ 12,997 $ 11,318
====================================================================================================
Note 6 of our Consolidated Financial Statements includes a reconciliation of our
beginning and ending net loss and loss adjustment expense reserves for each of
the three years ended December 31, 2002, 2001, and 2000. The reserve for unpaid
losses and loss expenses increased by $3.6 billion to $24.3 billion at December
31, 2002, compared with $20.7 billion at December 31, 2001. This increase is
attributed to the $2.2 billion in A&E reserve strengthening in the fourth
quarter of 2002, and the significant growth in business in 2002. The balance at
December 31, 2002, includes $13.2 billion of case and loss expense reserves
compared with $13.3 billion at December 31, 2001. Our net losses and loss
expenses incurred in 2002 were $4.9 billion and include $709 million of prior
year development. Of this amount, $516 million relates to a charge taken in the
fourth quarter of 2002 to strengthen our A&E reserves (see the section entitled
"Asbestos and Environmental Claims" for further discussion). All of the A&E
development was incurred in the Insurance - North American segment. An analysis
of the remaining $193 million of prior period development follows.
Incurred losses of $2.2 billion for Insurance - North American include $79
million of prior period development, $59 million from ACE USA and $20 million
from ACE Bermuda. In ACE USA, prior period development arose from several lines
of business
40
including $13 million from our ACE Risk Management business, $11 million from
the consumer solutions business and $35 million from two lines of business now
in run-off. ACE Risk Management, ACE USA's largest business line with over $1.3
billion of net loss reserves, is the large commercial package business that
includes workers' compensation and commercial automobile covers. During 2002, we
incurred $13 million to increase the workers' compensation, commercial
automobile and the health care asset management run-off books, principally for
the 2000 accident year, as a result of regular actuarial reviews of these lines
of business. The Consumer Solutions group incurred $11 million related to the
2001 accident year, principally from its warranty line as a result of an
actuarial study completed in late 2002. Of the $35 million from run-off
business, $18 million arose from the CIS line, which comprises middle market
casualty exposures. In 1999, we sold the renewal rights to this business and are
running off the existing reserves. $12 million relates to one adverse court
decision in the Financial Institutions business on a 2001 accident year claim
and the remaining $5 million relates to general reserve increases resulting from
actuarial reviews.
In ACE Bermuda, we incurred $45 million of prior year losses related to
aerospace losses, $31 million related to satellite losses and $14 million of
aviation losses. The satellite losses principally relate to three losses from
satellites launched between 1999 and 2001 that have subsequently experienced
problems. The aviation losses relate to increases in claims reserves on almost
300 claims in the 1997 through 2001 accident years. The remaining reserves on
this line principally relate to long-tail product liability policies. ACE
Bermuda discontinued the satellite business in 2002 and the aviation business in
2000. These increases were partially offset as excess liability reserves
improved by $28 million. We were successful in recovering subrogation on a loss
from the 1988 accident year and had positive development on a claim for the 1989
accident year. These two items accounted for an improvement of $45 million. This
was partially offset by claims development in 1995 and 1996. The remaining
$3 million relates to general reserve increases resulting from actuarial
reviews.
Incurred losses of $1.4 billion for Insurance - Overseas General include
$104 million of prior year losses, of which $36 million came from ACE Global
Markets and $68 million came from ACE International. In ACE Global Markets, $26
million of prior period development arose from aerospace losses in the 2000 and
2001 accident years, principally from the same satellite losses that impacted
ACE Bermuda. The remaining $10 million relates to a number of small losses
across several business lines. In ACE International, $44 million of prior period
development arose from developing casualty losses in Australia, Norway, Italy
and the Netherlands. The increases related to development on several large
claims caused by new information that changed the total value of these claims
from last year. In addition, ACE Europe incurred $14 million of D&O losses,
partly in response to specific large losses and partly due to a change in
assumptions as experience has changed from last year. The remaining $10 million
relates to small losses across several lines.
Total incurred losses of $304 million for Global Reinsurance include
positive development in prior period reserves of $20 million. Most of Global
Reinsurance's reserves at December 31, 2002 relate to short-tail, catastrophe
oriented lines where unpaid claims are set using a blend of market share
analysis on industry loss reports and reported claims from customers. Initial
loss reserve estimates are then revised as necessary to reflect the actual loss
experience of the customer. During 2002, Global Reinsurance determined that the
loss reserves carried on certain of its contracts related to the 1998 through
2001 accident years were in excess of the reserves required based on the latest
assessment. This resulted in favorable prior year loss development. There were
no changes in assumptions used in the reserving process in 2002.
Total incurred losses of $947 million for Financial Services include $30
million of prior period development principally from the ACE Financial Solutions
International book, which comprises large, unique transactions, including LPTs.
$12 million relates to the amortization of the deferred assets on the LPTs. The
remaining amount principally relates to three accounts where recent information
resulted in an increase in the total reserve positions for these accounts
primarily for the 1998 through 2001 accident years.
Net losses and loss expenses incurred for the year ended December 31, 2001
include $94 million of prior year development principally in the Insurance -
Overseas General segment. This development was reflected during the fourth
quarter of 2001 when we recorded additional reserves to strengthen our casualty
loss reserves.
Net losses and loss expenses incurred for the year ended December 31, 2000
include favorable development of reserves from prior periods of $60 million,
primarily from the Global Reinsurance and Insurance - North American segments,
partially offset by unfavorable development in the Financial Services segment.
41
The process of establishing reserves for P&C claims can be complex and
imprecise as it requires 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 are reviewed, as new or improved
methodologies are developed or as current laws change. As part of our evaluation
process of loss reserves, we annually engage independent actuarial firms to
review the methods and assumptions we use in estimating unpaid losses and loss
expenses. These annual reviews cover different portions of our operating
businesses on a rotating basis within each year and are an independent check on
our loss reserves. In addition, the Insurance Department of the Commonwealth of
Pennsylvania required a biennial, external actuarial review when Brandywine was
established. That review was completed during the first quarter of 2003. 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
December 31, 2002 is adequate, new information or trends may lead to future
developments 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.
REINSURANCE
One of the ways we manage our loss exposure is through the use of reinsurance.
While reinsurance agreements 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,
the loss and loss expense reserves on our balance sheet represent our total
unpaid gross losses and the reinsurance recoverable represents anticipated
recoveries of a portion of those gross unpaid losses as well as amounts
recoverable from reinsurers with respect to claims paid. The table below
presents our net reinsurance recoverable at December 31, 2002 and 2001.
(in millions of U.S. dollars) 2002 2001
- ----------------------------------------------------------------------------
Reinsurance recoverable on paid losses
and loss expenses $ 1,363 $ 1,067
Bad debt reserve on paid losses and loss
expenses (378) (302)
Reinsurance recoverable on future policy
benefits 9 5
Reinsurance recoverable on unpaid losses
and loss expenses 13,558 11,115
Bad debt reserve on unpaid losses and loss
expenses (561) (487)
- ----------------------------------------------------------------------------
Net reinsurance recoverable $ 13,991 $ 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. Provisions have been established
for amounts estimated to be uncollectible.
Following is a breakdown of our reinsurance recoverable on paid losses at
December 31, 2002:
Bad Debt % of Total
(in millions of U.S. Dollars) Amount Reserve Reserve
- ------------------------------------------------------------------------------
Category:
General collections $ 848 $ 43 5.1%
Other 515 335 65.0
- ------------------------------------------------------------------------------
Total $ 1,363 $ 378 27.7%
==============================================================================
42
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, for specific items in dispute, we make judments based
on our knowledge and experience with a particular reinsurer.
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,
includes 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. The fifth category, structured settlements, includes 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 as 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, includes companies established and owned 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 collateral equal to
expected losses; where appropriate, 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.
BREAKDOWN OF REINSURANCE RECOVERABLE
DECEMBER 31 Bad Debt
(in millions of U.S. dollars) 2002 Reserve % of Gross
- -----------------------------------------------------------------------------------------------
CATEGORIES
Top 10 reinsurers $ 7,732 $ 93 1.2%
Other reinsurers balances greater than $20 million 2,519 175 6.9
Other reinsurers balances less than $20 million 1,590 148 9.3
Mandatory pools and government agencies 771 4 0.5
Structured settlements 730 3 0.4
Captives 786 4 0.5
Other 802 512 63.8
- -----------------------------------------------------------------------------------------------
Total $ 14,930 $ 939 6.3%
===============================================================================================
43
TOP 10 REINSURERS
AXA Hannover Re SCOR Group
Berkshire Hathaway Insurance Group Lloyd's of London Swiss Re Group
Equitas Munich Re Zurich Financial Services Group
GE Global Insurance Group
- ------------------------------------------------------------------------------------------------------------------------
OTHER REINSURERS BALANCES GREATER THAN $20 MILLION
ABB Group Excess & Casualty Reinsurance Association PMA Capital Insurance Company
Allianz Group Fairfax Financial RenaissanceRe Holdings Ltd
Allstate Financial FM Global Group Royal & Sun Alliance
American International Group Gerling Group Insurance Group plc
Aviva plc Hartford Insurance Group Sompo Japan Insurance Inc
Chubb Group of Insurance Companies Independence Blue Cross (Amerihealth) St. Paul Companies
CNA Insurance Companies IRB - Brasil Resseguros S.A. Toa Reinsurance Company
Converium Group Liberty Mutual Insurance Companies Travelers Property Casualty Group
DaimlerChrysler Group Markel Corporation Group Trenwick Group
Dominion Ins. Co. Ltd. Overseas Partners Ltd. White Mountains Insurance Group
Dorinco Reinsurance Co. PartnerRe Group XL Capital Group
Everest Re Group
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. 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. In January 2003, we completed an internal review
of our A&E reserves. This review resulted in increasing our gross A&E reserve,
for the year ended December 31, 2002, by $2.2 billion, offset by $1.9 billion of
reinsurance recoverable, including $533 million of reinsurance purchased from
the National Indemnity Company ("NICO") as part of the acquisition of CIGNA's
P&C business (the "ACE INA Acquisition"). After an addition to our bad debt
provision of $145 million and our ten percent participation in the NICO cover,
our net increase in exposure was determined to be $516 million ($354 million
after income tax) and was recorded in the fourth quarter of 2002. The table
below presents selected loss reserve data for A&E exposures at December 31, 2002
and 2001.
DECEMBER 31, 2002 December 31, 2001
----------------------------- -----------------------------
(in millions of U.S. dollars) GROSS NET Gross Net
- -----------------------------------------------------------------------------------------------------
Asbestos $ 3,192 $ 446 $ 1,085 $ 149
Environmental and other latent exposures 1,352 403 1,037 452
- -----------------------------------------------------------------------------------------------------
Total $ 4,544 $ 849 $ 2,122 $ 601
=====================================================================================================
Survival ratios attempt to measure the adequacy of A&E loss reserves by taking
the current ending loss reserve and dividing by the average annual claim
payments for the prior three years. We believe this to be a 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
three years of A&E claim payments and expect payments to continue at the same
pace, our net survival ratio is 11.3 years. Using the 2001 calendar year
payments, our net survival ratio is 12.0 years. More information relating to our
asbestos exposure, including our asbestos reserving process follows.
44
BACKGROUND
Our exposure to asbestos principally arises out of liabilities acquired when we
purchased the P&C business of CIGNA in 1999 and Westchester Specialty from
Talegen in 1998. While we certainly have other insurance operations, exposure to
asbestos liabilities is concentrated in these two areas of our business. Of
these two areas, the larger and potentially more volatile exposure is contained
within the liabilities acquired in the CIGNA transaction. These liabilities
reside in the various subsidiaries of Brandywine, which was created in 1995 by
the restructuring of CIGNA's domestic operations into separate ongoing and
run-off operations. Certain competitors of ACE USA have challenged the
regulatory approvals resulting in the creation of Brandywine. In July 1999, the
Pennsylvania Supreme Court upheld the action of the Pennsylvania Insurance
Commissioner in granting such approvals. In December 1999, certain of our
competitors filed an action in the Superior Court of California alleging that
the restructuring did not meet the requirements of certain California statutes.
The case is in the preliminary stages of litigation.
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. In the fourth
quarter of 2002, we increased our A&E reserves, exhausting the NICO reinsurance
cover protecting Brandywine.
As part of the acquisition of the Westchester business, NICO provided
reinsurance protection for adverse development for all losses occurring prior to
1997. At December 31, 2002, the remaining limit in the NICO reinsurance cover
protecting ACE Westchester Specialty was approximately $600 million. None of the
recent increase to reserves is attributable to Westchester's asbestos
liabilities.
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
in which 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.
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 - over 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
bankrupt companies' 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. In the context
of the Federal Employers' Liability Act ("FELA"), the United States Supreme
Court, in the Norfolk & Western Railway v. Ayers case,
45
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.
INSUREDS
Information about our insureds with asbestos liability is set forth below (gross
paid and gross reserves are shown in millions of U.S. dollars).
Percentage Gross Three Year
Number of Gross Paid of Total Gross Reserves Net Survival
Policyholders 2000 - 2002 2000 - 2002 Dec 31, 2002 Ratio
- ------------------------------------------------------------------------------------------------------------------------------------
60 major asbestos manufacturers/producers
Resolved with payment 18 $ 112 17% $ - -
Reserved at policy limits or settlement amounts 15 71 10 192 8.1
Reserved at policy limits and provision for non-products 3 28 4 69 7.4
Other 14 84 12 230 8.2
No known policies 10 - - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Total 60 $ 295 43% $ 491 5.0
Other direct exposures with estimated
liability (greater than) $2 million 75 150 22 670 13.4
Other direct exposures with estimated
liability (less than) $2 million 1,491 49 7 65 4.0
Assumed reinsurance - 186 28 762 12.3
IBNR not allocated - - - 730 -
- ------------------------------------------------------------------------------------------------------------------------------------
Total 1,626 $ 680 100% $ 2,718 12.0
====================================================================================================================================
Three year net survival ratio eliminating the 60 major asbestos
manufacturers/producers 17.3
- ------------------------------------------------------------------------------------------------------------------------------------
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, and our asbestos settlement history as well
as factual and investigative developments. Our latest review by an internal task
force included a comprehensive re-evaluation of claims as of September 2002.
This included a review of:
.. the pending claim inventory and the projection of future filings;
.. the characterization of injury types and the projected future distribution by
injury type;
.. the total coverage profile for the account and our share of that
coverage profile;
.. products and non-products exposures;
.. bankruptcy status and jurisdiction; and
.. the external actuarial estimate of unpaid liabilities.
46
This evaluation process included a detailed review of assumptions relating
to projections of future new defendants and non-product exposures were
identified and reserved as part of the task force process.
In addition to our internal review of asbestos reserves, the normal,
biennial, reserve review by an internationally-known, actuarial consulting firm,
required by the Pennsylvania Insurance Department when Brandywine was
established, was recently completed. Our asbestos reserves, taking into account
the additions for the quarter ended December 31, 2002, represent the high end of
our internal task force's indication of range of liability and is consistent
with the best estimate of the external actuary retained by the Pennsylvania
Insurance Department.
In the context of our asbestos reviews, many risk factors are considered.
For the purpose of establishing our asbestos reserves, significant variables
include assumptions with respect to payments to unimpaired claimants and the
liability of peripheral defendants.
In establishing reserves for periods prior to the fourth quarter of 2002,
we assumed that significant additional state judicial or legislative reform
would substantially eliminate payments to future claimants who are not
physically impaired. The fourth quarter reserve additions were based on the more
conservative assumption that there will be no future state or federal asbestos
reform. Therefore, the booked asbestos reserves do not reflect any anticipated
changes in the legal, social or economic environment or any benefit from future
legislative reforms.
The vast majority of the reserve increase in the fourth quarter of 2002 is
due to the strengthening of the IBNR provision for peripheral defendants and
future increases in severity.
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. The 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 loss 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. This could lead us to further
increase our asbestos related reserves, which could have a material adverse
effect on our future operating results, financial position and liquidity.
INTER-COMPANY OBLIGATIONS
As stated above, our exposure to asbestos arises principally out of liabilities
acquired in connection with the CIGNA and Westchester transactions, with the
larger exposure resting in the various Brandywine subsidiaries. Pursuant to the
restructuring order that created Brandywine, the obligations of the active
insurance subsidiaries of ACE INA (which do not include the companies acquired
in the Westchester transaction) with respect to Brandywine's asbestos
liabilities are limited to specific amounts which are payable only if certain
conditions are met. The Brandywine restructuring order does not impose liability
for Brandywine obligations on any of our entities other than Brandywine and the
above-described regulatory requirements imposed on the active insurance
subsidiaries of ACE INA.
47
In accordance with the Brandywine restructuring order, INA Financial
Corporation has established a dividend retention fund consisting of $50 million,
plus investment earnings, which it must contribute to Century Indemnity, a
Brandywine subsidiary, if Century Indemnity's capital and surplus falls below
$25 million or if Century Indemnity lacks liquid assets with which to pay claims
as they become due. The dividend retention fund was created by withholding a
portion of the dividends paid by the active ACE INA insurance subsidiaries to
INA Financial Corporation, through their parent holding companies, and further
paid by INA Financial Corporation to its parent company, INA Corporation. At
December 31, 2002, Century Indemnity's capital and surplus fell below $25
million and the full balance of the dividend retention fund principal and the
interest was contributed to Century Indemnity. To the extent in the future that
dividends are paid by the active ACE INA insurance subsidiaries to INA Financial
Corporation through their parent holding companies, and to the extent that INA
Financial Corporation then pays such dividends to INA Corporation, a portion of
those dividends must be withheld to replenish the principal of the dividend
retention fund to $50 million within five years. The obligations to maintain the
dividend retention fund and to replenish the fund, to the extent future
dividends are paid, are ongoing until ACE INA receives prior written approval
from the Pennsylvania Commissioner of Insurance permitting termination of the
fund.
In addition, under the terms of the Brandywine restructuring order, the
active ACE INA insurance subsidiaries are obligated to provide reinsurance
coverage to Century Indemnity in the amount of $800 million under an aggregate
excess of loss reinsurance agreement if the capital and surplus of Century
Indemnity falls below $25 million or if Century Indemnity lacks liquid assets
with which to pay claims as they become due. The active ACE INA insurance
subsidiaries would first contribute amounts from the dividend retention fund to
Century Indemnity before the aggregate excess of loss reinsurance agreement
would be triggered, so the minimum capital and surplus level for reinsurance
purposes will be calculated after giving effect to the dividend retention fund
contribution. At December 31, 2002, coverage under the aggregate excess of loss
reinsurance agreement was triggered, following contribution of the dividend
retention fund. Approximately $466 million in losses were ceded to the aggregate
excess of loss reinsurance agreement at December 31, 2002, leaving a remaining
limit of coverage under the aggregate excess of loss reinsurance agreement of
approximately $334 million.
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 stock of
its subsidiaries as well as other investments. In addition to net investment
income, our cash flows currently depend primarily on dividends or other
statutorily permissible payments from our Bermuda-based operating subsidiaries,
("Bermuda subsidiaries"). During the year ended December 31, 2002, we were able
to meet all of our obligations, including the payment of dividends declared on
our Ordinary Shares and FELINE PRIDES, with our net cash flow and dividends
received. Should the need arise, we have access to the debt markets and other
available credit facilities which are discussed below.
There are currently no legal restrictions on the payment of dividends from
retained earnings by our 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 our Bermuda
subsidiaries is subject to the need to maintain shareholders' equity at levels
adequate to support the insurance and reinsurance operations. During 2002, ACE
Bermuda declared and paid dividends of $345 million, compared with $234 million
in 2001. ACE Tempest Life Re declared and paid dividends in 2002 of $140 million
compared with $105 million in 2001. We expect that a majority of our cash
inflows for 2003 will be from our Bermuda subsidiaries. We assess which
subsidiaries to draw dividends from based on a number of factors. Considerations
such as regulatory and legal restrictions as well as the subsidiary's financial
condition are paramount to the dividend decision.
48
The payments of dividends from our 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 U.K. 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 certain annual limitations and
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.
We did not receive any dividends in 2002 from ACE Global Markets, ACE INA
or ACE Financial Services nor do we expect to receive dividends from these
subsidiaries during 2003. 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. ACE INA has issued debt to provide partial financing for the ACE INA
Acquisition and for other operating needs. This debt is serviced by dividends
paid by ACE INA's insurance subsidiaries to ACE INA as well as other group
resources. ACE Financial Services' U.S. insurance subsidiaries are limited in
their dividend paying abilities due to their need to maintain their AA and AAA
financial strength ratings.
Our consolidated sources of funds consist primarily of net premiums
written, net investment income and proceeds from sales and maturities of
investments. Funds are used primarily to pay claims, operating expenses,
dividends and for the purchase of investments. After satisfying our cash
requirements, excess cash flows from these underwriting and investing activities
are used to build the investment portfolio and thereby increase future net
investment income.
Our insurance and reinsurance operations provide liquidity in that premiums
are received in advance, sometimes substantially in advance, of the time claims
are paid. Our consolidated net cash flow from operating activities was $2.4
billion in 2002 compared with $1.4 billion in 2001. The positive operating cash
flows were generated from an increase of $1.7 billion in net premiums written
and strong insurance and reinsurance balances receivable collections across all
of our business segments during the current year, offset by an increase in net
losses and loss expenses paid of $200 million. 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 can
create significant variations in cash flows from operations between periods.
Sources of liquidity include cash from operations, financing arrangements or
routine sales of investments. Although our ongoing operations continue to
generate positive cash flows, our cash flows are currently impacted by a large
book of loss reserves from businesses in run-off. The run-off operations
generated negative cash flows of $525 million and $614 million in 2002 and 2001,
respectively, due primarily 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.
49
ACE and its subsidiaries have debt and insurance ratings from
internationally recognized rating agencies, including S&P, A.M. Best, Moody's
Investors Service ("Moody's") and Fitch IBCA. The ratings issued on our
companies by any of these agencies are announced publicly and are available on
our website and from the agencies.
Financial strength (insurance) ratings represent the opinions of the rating
agencies on the financial strength of a company and its capacity to meet the
obligations of insurance policies. Independent ratings are one of the important
factors that establish our competitive position in the insurance markets. The
rating agencies consider many factors in determining a financial strength rating
of an insurance company, including the relative level of statutory surplus
necessary to support the business operations of the company. These ratings are
based upon factors relevant to policyholders, agents and intermediaries and are
not directed toward the protection of investors. Such ratings are not
recommendations to buy, sell or hold securities.
Debt ratings include ratings for short-term and long-term debt as well as
preferred stock. These ratings are assessments of the likelihood that we will
make timely payments of principal and interest as well as preferred stock
dividends.
It is possible that, in the future, one or more of the rating agencies may
reduce our existing ratings. If one or more of our ratings were downgraded, we
could incur higher borrowing costs and our ability to access the capital markets
could be impacted. In addition, our insurance and reinsurance operations could
be adversely impacted by a downgrade in our financial strength ratings,
including a possible reduction in demand for our products in certain markets.
Throughout 2002, all of our financial strength and debt ratings remained
unchanged. Following our announcement on January 27, 2003 that our fourth
quarter results would include a charge to strengthen A&E loss reserves, certain
rating agencies took actions with regard to our ratings.
.. On January 30, 2003, S&P placed our financial strength and debt ratings on
"watch with negative implications" and confirmed our existing commercial
paper rating. On March 21, 2003, S&P affirmed the financial strength
ratings of our ongoing operating subsidiaries while lowering the financial
strength rating of Century Indemnity, which is part of our Brandywine
run-off group. S&P also lowered our senior debt and issuer credit ratings
to reflect standard notching under S&P's criteria and their belief that our
earnings capacity has not been predictable enough for us to operate at an
additional (non-standard) financial risk level. We anticipated and accepted
the return to a standard notching between our financial strength and debt
ratings as a result of our growth in current market conditions.
.. On January 27, 2003, Moody's placed our debt ratings on "watch with
negative implications".
.. On January 29, 2003, Fitch placed all of the debt and financial strength
ratings of ACE INA Holdings and its subsidiaries on "ratings watch
negative". They also downgraded Brandywine.
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 December 31, 2002, 2001, and 2000.
(in millions of U.S. dollars) 2002 2001 2000
- --------------------------------------------------------------------------------------
Shareholder's equity $ 6,389 $ 6,107 $ 5,420
Mezzanine equity 311 311 311
Trust preferred securities 475 875 875
Long-term debt 1,749 1,349 1,424
Short-term debt 146 495 365
- --------------------------------------------------------------------------------------
Total capitalization $ 9,070 $ 9,137 $ 8,395
- --------------------------------------------------------------------------------------
Ratio of debt to total capitalization 20.9% 20.2% 21.3%
======================================================================================
50
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 been primarily 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
December 31, 2002, we had reduced short-term debt by $349 million from the level
at December 31, 2001. This decrease included the repayment of $75 million ACE
Financial Services debt, which matured in November 2002.
In addition, we repaid $100 million of ACE INA Subordinated Notes due 2009
during 2002. We paid prepayment premiums of $17 million (after tax) to retire
the ACE INA Notes. These costs were mostly attributable to the decrease in
interest rates since the original note was issued.
In January 2003, we announced our intention to issue between $300 million
and $500 million of additional debt or trust preferred securities. We expect to
issue the new securities following resolution of the current reviews by rating
agencies. We will use the proceeds from the issuance to increase the capital in
certain of our U.S. operating subsidiaries following our fourth quarter charge
to strengthen our A&E loss reserves.
In 1999, ACE RHINOS Trust sold, in a private placement, $400 million of
Auction Rate Reset Preferred Securities ("Preferred Securities") that became due
in September 2002. The sole assets of the Trust consisted of $412 million of
Auction Rate Reset Subordinated Notes Series A issued by ACE INA. During 2002,
we repaid the $400 million in principal amount of Preferred Securities reducing
our trust preferred security balance to $475 million.
In addition, in 1999, we filed a registration statement with the SEC
utilizing a "shelf" registration process relating to a number of different types
of debt and equity securities. 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 December 31, 2002, the amount available under this shelf filing was $127
million. In 2002, we filed a new shelf allowing us to sell securities up to a
total offering price of $1.5 billion. This became effective in February 2003.
SHAREHOLDERS' EQUITY
The following table analyzes the movements in our shareholders' equity for the
years ended December 31, 2002, 2001, and 2000.
(in millions of U.S. dollars) 2002 2001 2000
- ---------------------------------------------------------------------------------------------------
Balance - beginning of year $ 6,107 $ 5,420 $ 4,451
Net income (loss) 77 (147) 543
Change in net unrealized appreciation on investments 339 35 186
Dividends declared - Ordinary Shares (173) (138) (113)
Dividends declared - Mezzanine equity (26) (26) (18)
Other movements, net 65 15 (29)
Ordinary Shares issued in share offering - 1,127 400
Repurchase of Ordinary Shares - (179) -
- ---------------------------------------------------------------------------------------------------
Balance - end of year $ 6,389 $ 6,107 $ 5,420
===================================================================================================
51
Our diluted book value per share increased to $24.16 at December 31, 2002
compared with $23.59 at December 31, 2001. In calculating our diluted book value
per share, we include 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. Shareholders' equity
increased by $282 million during the year ended December 31, 2002, due primarily
to our net income and unrealized gains on our investment portfolio, offset by
dividends declared.
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. At December 31, 2002, this
authorization had not been utilized.
On January 11, 2002 and April 12, 2002, we paid dividends of 15 cents per
share to shareholders of record on December 31, 2001 and March 29, 2002,
respectively. On July 12, 2002, October 11, 2002, and January 10, 2003 we paid
dividends of 17 cents per share to shareholders of record on June 28, 2002,
September 27, 2002, and December 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:
.. less than $18.9563, then we will issue 16.4 million Ordinary Shares,
representing an issuance of 1.8991 Ordinary Shares per preferred share;
.. 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;
.. 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.
There will be no net cash flows to us 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.
52
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The table below shows our contractual obligations and commitments including our
payments due by period.
PAYMENTS DUE BY PERIOD
Less than After 5
(in millions of U.S. dollars) Total 1 Year 1-3 Years 4-5 Years Years
- -----------------------------------------------------------------------------------------------------------------------------
Contract holder deposit funds $ 90 $ 26 $ 31 $ 19 $ 14
Operating leases 418 75 132 73 138
Short-term debt 146 146 - - -
Long-term debt 1,749 - 400 799 550
Trust preferred securities 475 - - - 475
- -----------------------------------------------------------------------------------------------------------------------------
Total contractual obligations and commitments $ 2,878 $ 247 $ 563 $ 891 $ 1,177
=============================================================================================================================
CONTRACT HOLDER DEPOSIT FUNDS
Contract holder deposit funds represents a liability for investment contracts
sold that do not meet the definition of an insurance contract under FAS No. 97,
"Accounting and Reporting by Insurance Enterprises for Certain Long-Duration
Contracts". The investment contracts are sold with a guaranteed rate of return.
The proceeds are then invested with the intent of realizing a greater return
than is called for in the investment contracts.
OPERATING LEASE COMMITMENTS
We lease office space in most countries in which we operate under operating
leases that expire at various dates through January 2018. We renew and enter
into new leases in the ordinary course of business as required.
SHORT-TERM DEBT
In June 1999, we 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 $750 million) for ACE and for ACE INA. During
the year ended December 31, 2002, we substantially reduced our use of commercial
paper.
From time to time, we also use securities repurchase agreements as a source
of short-term liquidity. Under these repurchase agreements, we agree to sell
securities and repurchase them at a future date for a predetermined price,
thereby creating liquidity. The covenants of our existing credit facilities
limit our borrowing under repurchase agreements to $800 million. At December 31,
2001, we had $395 million in borrowings outstanding under repurchase agreements
with various brokers. We had used the proceeds of these repurchase transactions
to repay bank borrowings drawn subsequent to the September 11 tragedy and
maturing commercial paper. During 2002, we repaid the amounts owed to brokers
under securities repurchase transactions with the proceeds raised from the
issuance of commercial paper and internal liquidity. At December 31, 2002, there
were no amounts due to brokers under these arrangements.
LONG-TERM DEBT
Our total long-term debt of $1.7 billion is described in Note 9 of our
Consolidated Financial Statements. 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 the Capital Resources section. These notes are not redeemable
before maturity and do not have the benefit of any sinking fund.
53
The following instruments have specific collateral triggers. In 1998, ACE
US Holdings issued $250 million of unsecured senior notes that mature in October
2008. In December 1999, ACE INA issued $300 million of unsecured subordinated
notes that mature in December 2009. We repaid $100 million of this outstanding
amount during 2002. We have a $450 million credit default swap in place that has
the economic effect of reducing our cost of borrowing associated with these two
issuances. Fixed maturity securities totaling approximately $242 million are
pledged as collateral in connection with the credit default swap.
Under these two issuances, we would be required to provide collateral of
$250 million and $200 million, respectively, if S&P downgraded our debt rating
to BB+ or lower, or downgraded ACE Bermuda's financial strength rating to BBB-
or lower. Although there can be no assurance, we believe it is unlikely that
either of these two events will occur. In the event that we terminate either of
the swaps prematurely, we would be liable for certain transaction costs. The
counter-party in each swap is a highly rated major financial institution and
management does not anticipate non-performance.
TRUST PREFERRED SECURITIES
During 1999 and 2000, we issued $800 million of trust preferred securities of
which $400 million matured and was repaid in 2002. The funds generated from
these issues were used to partially finance the ACE INA Acquisition. The
securities outstanding consist of:
(i) $400 million company-obligated mandatorily redeemable preferred shares
($100 million and $300 million) issued by two business trusts wholly owned by
us, and
(ii) $75 million of monthly income preferred securities issued by one of
our subsidiary limited liability companies.
Each of the three remaining series of preferred securities was issued by a
special purpose entity that is wholly owned by us; two trusts and a limited
liability company. The sole assets of the special purpose entities are debt
instruments issued by one or more of our subsidiaries. The special purpose
entities look to payments on the debt instruments to make payments on the
preferred securities. We have guaranteed the payments on these debt securities.
The trustees of the trusts and the managers of the limited liability company
include one or more of our officers and at least one independent trustee or
manager, such as a bank or trust company. Our officers serving as trustees of
the trusts or managers of the limited liability company do not receive any
compensation or other remuneration for their services in such capacity. The full
$475 million of outstanding preferred stock is shown on our consolidated balance
sheet as a liability. Additional information with respect to the preferred
securities is contained in Note 9 of our Consolidated Financial Statements.
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. At December 31, 2002, the outstanding LOC
issued under this facility was $64 million and no other drawings or LOCs are
issued under this facility. In September 2002, we reduced the amount of our
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. We are currently negotiating the annual renewal
of our 364-day facility.
In November 2002, to fulfill the requirements of Lloyd's for open years of
account, we renewed our uncollateralized, five-year LOC facility for (pound)380
million (approximately $619 million). We provide funds at Lloyd's, primarily in
the form of LOCs, to support underwriting capacity for Lloyd's Syndicate 2488.
Syndicate 2488 has a 2003 capacity of (pound)725 million (approximately $1.2
billion). 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.
54
As our Bermuda subsidiaries are not admitted insurers and reinsurers in the
U.S., the terms of certain insurance and reinsurance contracts require them to
provide LOCs to clients. In addition, ACE Global Markets is required to satisfy
certain U.S. regulatory trust fund requirements which can be met by the issuance
of LOCs. In September 2002, we arranged a $500 million unsecured, one-year LOC
facility for general business purposes, including the issuance of insurance and
reinsurance LOCs. This facility replaced a then existing LOC facility in the
amount of $450 million. Usage under this facility was $455 million at December
31, 2002 compared with $373 million at December 31, 2001. In September 2002, we
also arranged a $350 million secured, one year LOC facility for general business
purposes, including the issuance of insurance and reinsurance LOCs. This
facility replaced an LOC facility originally arranged in December 2001 in the
amount of $500 million. Usage under this facility was $276 million at December
31, 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 in our balance sheet.
All of the facilities described above require that we maintain certain
covenants. These covenants include:
(i) maintenance of a minimum consolidated net worth covenant of not less
than $3.6 billion plus 25 percent of cumulative net income since March 31, 2000;
and
(ii) maintenance of a maximum debt to total capitalization ratio of not
greater than 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 amount greater than 15
percent would be included in the debt to total capitalization ratio.
At December 31, 2002, (a) the minimum consolidated net worth requirement
under the covenant described in (i) above was $3.8 billion and our actual
consolidated net worth as calculated under that covenant was $5.9 billion; and
(b) our ratio of debt to total capitalization was 0.209 to 1.
Our failure to comply with the covenants under any credit facility would
(subject to grace periods in the case of certain covenants) result in an event
of default and we could be required to repay any outstanding borrowings (or to
cash collateralize letters of credit) under such facility. An event of default
under one or more credit facilities with outstanding credit extensions of $25
million or more would result in an event of default under all of the facilities
described above.
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 December 31, 2002, ACE Guaranty Corp. was party to a non-recourse credit
facility which provides up to $175 million specifically supporting the company's
municipal portfolio and designed to provide rating agency qualified capital to
support ACE Guaranty Corp's. claims paying resources. During 2002, the
facility's expiry date was extended to November 2009. ACE Guaranty Corp. has not
borrowed under this credit facility. In 2002, ACE Guaranty Corp. entered into a
$100 million, 364-day revolving credit facility that expires on May 28, 2003.
The facility is available for general corporate purposes. ACE Guaranty Corp. has
not borrowed under this credit facility.
We also maintain various other LOC facilities, both collateralized and
uncollateralized, for general corporate purposes. At December 31, 2002, the
aggregate availability under these facilities was $521 million and usage was
$405 million.
55
Item 7A. 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 affected by changes in interest rates, equity prices
and foreign currency exchange rates. We use investment derivative instruments
such as financial 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 use 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 in 2002
compared with a decrease of 3.2 percent in 2001. This equates to a decrease in
market value of approximately $488 million on a fixed income portfolio valued at
$15.7 billion at December 31, 2002, and $452 million on a fixed income portfolio
valued at $14.2 billion at December 31, 2001. An immediate time horizon was used
as this presents the worst case scenario.
Our portfolio of equity securities, which we carry on our balance sheet at
fair value, has exposure to price risk. This risk is defined as the potential
loss in fair value resulting from adverse changes in stock prices. In addition,
we attain exposure to the equity markets through the use of derivative
instruments which also have exposure to price risk. Our U.S. equity exposure in
the portfolio is highly correlated with the 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 $603 million at December 31, 2002. A hypothetical 10 percent decline
in the price of each stock in these portfolios and the index correlated to the
derivative instruments would have resulted in a $60 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 December 31, 2002, our net
asset exposure to foreign currencies was not material.
DERIVATIVES
FAS 133 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,
and requires that an entity recognize all derivatives as either assets or
liabilities on the consolidated balance sheet and measure those instruments at
fair value.
56
We maintain investments in derivative instruments such as financial
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. We had no derivatives that were designated as
hedges at December 31, 2002 and 2001.
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 2002, we recorded in net realized gains (losses) on investments, a
pretax loss of $77 million to reflect the change in the fair value of
derivatives. During 2001, we recorded in net realized gains (losses) on
investments, a pretax loss of $17 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.
NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, FASB issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which requires consolidation of all
variable interest entities ("VIE") by the primary beneficiary, as these terms
are defined in FIN 46, effective immediately for VIEs created after January 31,
2003. The consolidation requirements apply to VIEs existing on January 31, 2003
for reporting periods beginning after June 15, 2003. In addition, it requires
expanded disclosure for all VIEs. We do not expect the adoption of FIN 46 to
have a material impact on our consolidated financial statements.
In December 2002, FASB issued FAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure" ("FAS 148"). FAS 148 provides
alternative methods of transitioning for a voluntary change to the fair-value
based method of accounting for stock-based employee compensation. In addition,
FAS 148 amends the disclosure requirements of FAS 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based compensation and the effect of the method used on
reported results. We continue to account for stock-based compensation plans in
accordance with Accounting Principles Board Opinion No. 25 ("APB 25").
In November 2002, FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"), which expands the disclosures
to be made by a guarantor in their consolidated financial statements and
generally requires recognition of a liability for the fair value of a guarantee
at its inception. The disclosure requirements of this interpretation are
effective for the Company for fiscal periods ending after December 15, 2002. The
measurement provisions of this interpretation are applicable on a prospective
basis to guarantees issued or modified after December 31, 2002. This
interpretation does not apply to guarantees issued by insurance companies
accounted for under insurance-specific accounting literature. We do not expect
the adoption of the measurement provisions of FIN 45 to have a material impact
on our consolidated financial statements.
In April 2002, FASB issued FAS No. 145, "Rescission of FASB Statements
No.4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections". The primary impact of FAS No. 145 was to rescind the requirement
to report the gain or loss from the extinguishment of debt as an extraordinary
item in the statement of operations. The provisions of this Statement are
generally effective for fiscal years beginning after May 15, 2002. During 2002,
we incurred debt prepayment expenses, which are reported as other expense in the
statement of operations.
57
Item 8. Financial Statements and Supplementary Data
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS
Management is responsible for the preparation, integrity and objectivity of the
consolidated financial statements and other financial information presented in
this annual report. The accompanying consolidated financial statements were
prepared in accordance with accounting principles generally accepted in the
United States, applying certain estimates and judgments as required.
The Company's internal controls are designed to provide reasonable
assurance as to the integrity and reliability of the financial statements and to
adequately safeguard, verify and maintain accountability of assets. Such
controls are based on established policies and procedures and are implemented by
trained, skilled personnel with an appropriate segregation of duties. The
Company's Internal Audit Department performs independent audits on the Company's
internal controls. The Company's policies and procedures prescribe that the
Company and all its employees are to maintain the highest ethical standards and
that its business practices are to be conducted in a manner which is above
reproach.
PricewaterhouseCoopers LLP, independent auditors, are retained to audit
the Company's financial statements. Their accompanying report is based on audits
conducted in accordance with auditing standards, generally accepted in the
United States, which includes the consideration of the Company's internal
controls to establish a basis for reliance thereon in determining the nature,
timing and extent of audit tests to be applied.
The Board of Directors exercises its responsibility for these financial
statements through its Audit Committee, which consists entirely of independent,
non-management Board members. The Audit Committee meets periodically with the
independent auditors, both privately and with management present, to review
accounting, auditing, internal controls and financial reporting matters.
/s/ Brian Duperreault /s/ Philip V. Bancroft
Brian Duperreault Philip V. Bancroft
Chairman and Chief Executive Officer Chief Financial Officer
58
REPORT OF INDEPENDENT ACCOUNTANTS
To The Board of Directors and Shareholders of ACE Limited
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, shareholders' equity, comprehensive
income and cash flows present fairly, in all material respects, the financial
position of ACE Limited and its subsidiaries at December 31, 2002 and 2001 and
the results of their operations and cash flows for the years ended December 31,
2002, 2001 and 2000, in conformity with accounting principles generally accepted
in the United States. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States, which require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used, and significant estimates made, by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Note 2f and Note 2n to the financial statements, the
Company changed its method of accounting for goodwill and derivatives in 2002
and 2001, respectively.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
New York, New York
February 3, 2003
59
CONSOLIDATED BALANCE SHEETS
ACE Limited and Subsidiaries
December 31, 2002 and 2001
(in thousands of U.S. dollars, except share and per share data) 2002 2001
- ------------------------------------------------------------------------------------------------------------------
ASSETS
Investments and cash
Fixed maturities, at fair value (amortized cost - $13,790,742 and $12,794,444) $ 14,419,741 $ 13,000,165
Equity securities, at fair value (cost - $442,266 and $516,028) 411,031 467,566
Securities on loan, at fair value (amortized cost/cost - $285,569) 292,973 -
Short-term investments, at fair value 1,884,760 1,205,795
Other investments (cost - $621,715 and $569,045) 652,048 591,006
Cash 663,355 671,381
- ------------------------------------------------------------------------------------------------------------------
Total investments and cash 18,323,908 15,935,913
Accrued investment income 216,941 213,821
Insurance and reinsurance balances receivable 2,653,990 2,521,562
Accounts and notes receivable 250,956 242,724
Reinsurance recoverable 13,991,453 11,398,446
Deferred policy acquisition costs 831,580 679,281
Prepaid reinsurance premiums 1,721,267 1,222,795
Funds withheld 300,106 197,642
Value of reinsurance business assumed 367,275 93,310
Goodwill 2,716,860 2,772,094
Deferred tax assets 1,287,983 1,250,835
Other assets 788,618 658,341
- ------------------------------------------------------------------------------------------------------------------
Total assets $ 43,450,937 $ 37,186,764
==================================================================================================================
LIABILITIES
Unpaid losses and loss expenses $ 24,315,182 $ 20,728,122
Unearned premiums 5,585,524 3,853,429
Future policy benefits for life and annuity contracts 442,264 382,730
Funds withheld 214,535 200,939
Insurance and reinsurance balances payable 1,870,264 1,418,001
Contract holder deposit funds 89,843 101,187
Securities lending collateral 301,016 -
Accounts payable, accrued expenses and other liabilities 1,514,972 1,322,674
Dividends payable 47,724 42,044
Short-term debt 145,940 495,408
Long-term debt 1,748,937 1,349,473
Trust preferred securities 475,000 875,000
- ------------------------------------------------------------------------------------------------------------------
Total liabilities 36,751,201 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;
262,679,356 and 259,861,205 shares issued and outstanding) 10,945 10,828
Additional paid-in capital 3,781,112 3,710,698
Unearned stock grant compensation (42,576) (37,994)
Retained earnings 2,199,313 2,321,576
Deferred compensation obligation 18,631 16,497
Accumulated other comprehensive income 439,892 101,599
Ordinary Shares issued to employee trust (18,631) (16,497)
- ------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 6,388,686 6,106,707
- ------------------------------------------------------------------------------------------------------------------
Total liabilities, mezzanine equity and shareholders' equity $ 43,450,937 $ 37,186,764
==================================================================================================================
See accompanying notes to consolidated financial statements
60
CONSOLIDATED STATEMENTS OF OPERATIONS
ACE Limited and Subsidiaries
For the years ended December 31,
(in thousands of U.S. dollars, except per share data) 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
REVENUES
Gross premiums written
Property and casualty premiums $ 12,653,872 $ 9,751,310 $ 7,586,771
Life and annuity premiums 165,099 414,052 -
- -------------------------------------------------------------------------------------------------------------------
12,818,971 10,165,362 7,586,771
Reinsurance premiums ceded (4,750,673) (3,801,748) (2,707,417)
- -------------------------------------------------------------------------------------------------------------------
Net premiums written
Property and casualty premiums 7,909,284 5,955,924 4,879,354
Life and annuity premiums 159,014 407,690 -
- -------------------------------------------------------------------------------------------------------------------
8,068,298 6,363,614 4,879,354
Change in unearned premiums (1,237,794) (446,437) (344,591)
- -------------------------------------------------------------------------------------------------------------------
Net premiums earned
Property and casualty premiums 6,672,227 5,510,897 4,534,763
Life and annuity premiums 158,277 406,280 -
- -------------------------------------------------------------------------------------------------------------------
6,830,504 5,917,177 4,534,763
Net investment income 802,141 785,869 770,855
Other income (expense) (20,552) 452 2,942
Net realized losses on investments (489,089) (58,359) (38,961)
- -------------------------------------------------------------------------------------------------------------------
Total revenues 7,123,004 6,645,139 5,269,599
===================================================================================================================
EXPENSES
Losses and loss expenses 4,906,510 4,552,456 2,936,065
Life and annuity benefits 158,118 401,229 -
Policy acquisition costs 960,688 784,664 650,741
Administrative expenses 943,333 830,455 745,633
Interest expense 193,494 199,182 221,450
Amortization of goodwill - 79,571 78,820
- -------------------------------------------------------------------------------------------------------------------
Total expenses 7,162,143 6,847,557 4,632,709
===================================================================================================================
Income (loss) before income tax and cumulative effect
of adopting a new accounting standard (39,139) (202,418) 636,890
Income tax expense (benefit) (115,688) (78,674) 93,908
- -------------------------------------------------------------------------------------------------------------------
Net income (loss) before cumulative effect of adopting a new
accounting standard 76,549 (123,744) 542,982
Cumulative effect of adopting a new accounting standard (net
of income tax) - (22,670) -
- -------------------------------------------------------------------------------------------------------------------
Net Income (Loss) $ 76,549 $ (146,414) $ 542,982
===================================================================================================================
Basic earnings (loss) per share before cumulative effect
of adopting a new accounting standard $ 0.19 $ (0.64) $ 2.37
Basic earnings (loss) per share $ 0.19 $ (0.74) $ 2.37
==================================================================================================================
Diluted earnings (loss) per share before cumulative
effect of adopting a new accounting standard $ 0.19 $ (0.64) $ 2.31
Diluted earnings (loss) per share $ 0.19 $ (0.74) $ 2.31
===================================================================================================================
See accompanying notes to consolidated financial statements
61
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
ACE Limited and Subsidiaries
For the years ended December 31,
(in thousands of U.S. dollars) 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------
ORDINARY SHARES
Balance - beginning of year $ 10,828 $ 9,681 $ 9,061
Exercise of stock options 93 69 76
Shares issued 37 1,380 542
Issued under Employee Stock Purchase Plan ("ESPP") 10 9 2
Cancellation of Shares (23) (29) -
Repurchase of Shares - (282) -
- ---------------------------------------------------------------------------------------------------------
Balance - end of year 10,945 10,828 9,681
=========================================================================================================
ADDITIONAL PAID-IN CAPITAL
Balance - beginning of year 3,710,698 2,637,085 2,214,989
Exercise of stock options 44,469 32,597 31,259
Ordinary Shares issued 37,503 1,135,328 406,561
Ordinary Shares issued under ESPP 7,462 6,065 1,232
Cancellation of Ordinary Shares (19,020) (22,698) -
Equity offering expenses - (830) (7,072)
Repurchase of Ordinary Shares - (76,849) -
Mezzanine equity issuance cost - - (9,884)
- ---------------------------------------------------------------------------------------------------------
Balance - end of year 3,781,112 3,710,698 2,637,085
=========================================================================================================
UNEARNED STOCK GRANT COMPENSATION
Balance - beginning of year (37,994) (29,642) (28,908)
Stock grants awarded (40,699) (22,559) (10,346)
Stock grants forfeited 7,370 4,533 -
Amortization 28,747 9,674 9,612
- ---------------------------------------------------------------------------------------------------------
Balance - end of year (42,576) (37,994) (29,642)
=========================================================================================================
RETAINED EARNINGS
Balance - beginning of year 2,321,576 2,733,633 2,321,570
Net income (loss) 76,549 (146,414) 542,982
Dividends declared on Ordinary Shares (173,150) (137,734) (112,528)
Dividends declared on Mezzanine equity (25,662) (25,594) (18,391)
Repurchase of Ordinary Shares - (102,315) -
- ---------------------------------------------------------------------------------------------------------
Balance - end of year 2,199,313 2,321,576 2,733,633
=========================================================================================================
DEFERRED COMPENSATION OBLIGATION
Balance - beginning of year 16,497 14,597 14,563
Increase to obligation 2,134 1,900 34
- ---------------------------------------------------------------------------------------------------------
Balance - end of year 18,631 16,497 14,597
=========================================================================================================
ACCUMULATED OTHER COMPREHENSIVE INCOME
Net unrealized appreciation (depreciation) on investments
Balance - beginning of year 136,916 102,335 (83,327)
Change in year, net of income tax 339,495 34,581 185,662
- ---------------------------------------------------------------------------------------------------------
Balance - end of year 476,411 136,916 102,335
- ---------------------------------------------------------------------------------------------------------
Cumulative translation adjustments
Balance - beginning of year (35,317) (32,881) 17,175
Net adjustment for period, net of income tax (1,202) (2,436) (50,056)
- ---------------------------------------------------------------------------------------------------------
Balance - end of year (36,519) (35,317) (32,881)
- ---------------------------------------------------------------------------------------------------------
Accumulated Other Comprehensive Income 439,892 101,599 69,454
=========================================================================================================
ORDINARY SHARES ISSUED TO EMPLOYEE TRUST
Balance - beginning of year (16,497) (14,597) (14,563)
Increases in Ordinary Shares (2,134) (1,900) (34)
- ---------------------------------------------------------------------------------------------------------
Balance - end of year (18,631) (16,497) (14,597)
=========================================================================================================
Total Shareholders' Equity $ 6,388,686 $ 6,106,707 $ 5,420,211
=========================================================================================================
See accompanying notes to consolidated financial statements
62
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
ACE Limited and Subsidiaries
For the years ended December 31,
(in thousands of U.S. dollars) 2002 2001 2000
- --------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ 76,549 $ (146,414) 542,982
OTHER COMPREHENSIVE INCOME (LOSS)
Net unrealized appreciation (depreciation) on investments
Unrealized appreciation on investments 357,963 65,168 220,901
Reclassification adjustment for net realized (gains) losses
included in net income 98,318 (16,303) (7,219)
- --------------------------------------------------------------------------------------------------------------
456,281 48,865 213,682
Cumulative translation adjustments (348) (6,646) (70,448)
- --------------------------------------------------------------------------------------------------------------
Other comprehensive income, before income tax 455,933 42,219 143,234
Income tax expense related to other comprehensive income items (117,640) (10,074) (7,628)
- --------------------------------------------------------------------------------------------------------------
Other comprehensive income 338,293 32,145 135,606
- --------------------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME (LOSS) $ 414,842 $ (114,269) $ 678,588
==============================================================================================================
See accompanying notes to consolidated financial statements
63
CONSOLIDATED STATEMENTS OF CASH FLOWS
ACE Limited and Subsidiaries
For the years ended December 31,
(in thousands of U.S. dollars) 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 76,549 $ (146,414) $ 542,982
Adjustments to reconcile net income (loss) to net cash flow
from (used for) operating activities:
Net realized losses on investments 489,089 58,359 38,961
Amortization of premium/discounts on fixed maturities 40,230 (2,019) (7,377)
Deferred income taxes (145,120) (118,058) 33,827
Unpaid losses and loss expenses 3,527,010 3,369,489 (174,213)
Unearned premiums 1,700,493 771,039 574,244
Future policy benefits for life and annuity contracts 59,534 382,730 -
Insurance and reinsurance balances payable 582,254 110,809 (415,310)
Accounts payable, accrued expenses and other liabilities 61,408 117,590 (375,025)
Insurance and reinsurance balances receivable (242,249) (449,585) (175,809)
Reinsurance recoverable (2,593,007) (2,403,506) (154,859)
Deferred policy acquisition costs (142,888) (112,714) (50,626)
Prepaid reinsurance premiums (498,472) (365,050) (256,501)
Funds withheld, net (88,868) 33,061 (12,505)
Value of reinsurance business assumed (273,965) (18,542) (4,065)
Other (127,010) 23,575 (69,716)
Amortization of goodwill - 79,571 78,820
Cumulative effect of adopting a new accounting standard - 22,670 -
- -----------------------------------------------------------------------------------------------------------------
Net cash flows from (used for) operating activities $ 2,424,988 $ 1,353,005 $ (427,172)
=================================================================================================================
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of fixed maturities $ (17,949,823) $ (16,847,920) $ (11,476,638)
Purchases of equity securities (218,852) (210,936) (411,022)
Sales of fixed maturities 15,948,421 14,733,578 11,521,678
Sales of equity securities 163,024 204,842 793,499
Maturities of fixed maturities 284,899 44,929 68,869
Net realized losses on financial futures contracts (105,429) (21,976) (48,227)
Settlement of an acquisition-related lawsuit 54,380 - -
Other (118,223) (89,115) (214,416)
- -----------------------------------------------------------------------------------------------------------------
Net cash flows from (used for) investing activities $ (1,941,603) $ (2,186,598) $ 233,743
=================================================================================================================
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid on Ordinary Shares $ (167,470) $ (128,745) $ (106,459)
Dividends paid on Mezzanine equity (25,662) (25,666) (15,254)
Net proceeds from (repayment of) short-term debt (349,468) 56,144 (710,076)
Net proceeds from long-term debt 399,155 - -
Net proceeds from (repayment of) trust preferred securities (400,000) - 300,000
Proceeds from exercise of options for Ordinary Shares 44,562 32,666 31,335
Proceeds from Ordinary Shares issued under ESPP 7,472 6,074 1,234
Repurchase of Ordinary Shares - (179,446) -
Net proceeds from issuance of Ordinary Shares - 1,135,878 400,320
Proceeds from issuance of Mezzanine equity - - 311,050
Issuance cost of Mezzanine equity - - (9,884)
- -----------------------------------------------------------------------------------------------------------------
Net cash flows from (used for) financing activities $ (491,411) $ 896,905 $ 202,266
=================================================================================================================
Net increase (decrease) in cash (8,026) 63,312 8,837
Cash - beginning of year 671,381 608,069 599,232
=================================================================================================================
CASH - END OF YEAR $ 663,355 $ 671,381 $ 608,069
=================================================================================================================
Supplemental cash flow information
Taxes paid $ 2,123 $ 28,513 $ 38,817
Interest paid $ 216,269 $ 220,155 $ 224,787
- -----------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
1. GENERAL
ACE Limited ("ACE" or the "Company") is a holding company incorporated with
limited liability under the Cayman Islands Companies Law and maintains its
business office in Bermuda. The Company, through its various subsidiaries,
provides a broad range of insurance and reinsurance products to insureds
worldwide. ACE operates through four reporting segments: Insurance - North
American, Insurance - Overseas General, Global Reinsurance and Financial
Services. These segments are described in Note 17.
2. SIGNIFICANT ACCOUNTING POLICIES
a) BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
("GAAP") and include the accounts of the Company and its majority-owned
subsidiaries. There are no entities other than majority-owned subsidiaries under
the Company's control or for which the Company retains substantially all the
risk and rewards. All significant intercompany accounts and transactions have
been eliminated. Certain items in the prior year financial statements have been
reclassified to conform with the current year presentation.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. The Company's principal estimates include:
.. unpaid losses and loss expense reserves, including asbestos reserves;
.. reinsurance recoverable, including the bad debt provision;
.. impairments to the fair value of the investment portfolio;
.. the fair value of certain derivatives; and
.. the valuation of goodwill.
While management believes that the amounts included in the consolidated
financial statements reflect our best estimates and assumptions, these amounts
could ultimately be materially different from the amounts currently provided for
in the consolidated financial statements.
b) PREMIUMS
Premiums are generally recognized as written upon inception of the policy. For
multi-year policies written which are payable in annual installments, due to the
ability of the insured/reinsured to commute or cancel coverage within the term
of the policy, only the annual premium is included as written at policy
inception. The remaining annual premiums are included as written at each
successive anniversary date within the multi-year term.
Reinsurance premiums from traditional life and annuity policies with life
contingencies are generally recognized as revenue when due from policyholders.
Traditional life policies include those contracts with fixed and guaranteed
premiums and benefits. Benefits and expenses are matched with such income to
result in the recognition of profit over the life of the contracts.
Premiums written are primarily earned on a pro rata basis over the terms of
the policies to which they relate. Accordingly, unearned premiums represent the
portion of premiums written which is applicable to the unexpired portion of the
policies in force. Premium estimates for retrospectively rated policies are
recognized within the periods in which the related losses are incurred.
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
Financial guarantee premiums that are received upon inception of the policy
are earned pro rata over the period of risk. Installment premiums are earned
over each installment period, generally one year or less.
The Company underwrites loss portfolio transfer contracts ("LPT"). These
contracts are evaluated to determine whether they meet the established criteria
for reinsurance accounting, and, if so, are recorded in the statement of
operations when written and generally result in large one-time written and
earned premiums with comparable incurred losses. The contracts can cause
significant variances in gross premiums written, net premiums written, net
premiums earned and net incurred losses in the years in which they are written.
Contracts not meeting the established criteria for reinsurance accounting are
recorded using the deposit method. There were no LPT contracts recorded using
the deposit method in 2002 or 2001.
Reinsurance premiums assumed are estimated based on information provided by
ceding companies. The information used in establishing these estimates is
reviewed and subsequent adjustments are recorded in the period in which they are
determined. These premiums are earned over the terms of the related reinsurance
contracts.
c) POLICY ACQUISITION COSTS
Policy acquisition costs consist of commissions, premium taxes, underwriting and
other costs that vary with, and are primarily related to, the production of
premium. Acquisition costs are deferred and amortized over the period in which
the related premiums are earned, or for annuities over the pattern of estimated
gross profit. Deferred policy acquisition costs are reviewed to determine if
they are recoverable from future income, including investment income. If such
costs are estimated to be unrecoverable, they are expensed.
d) REINSURANCE
In the ordinary course of business, the Company's insurance subsidiaries assume
and cede reinsurance with other insurance companies. These agreements provide
greater diversification of business and minimize the net loss potential arising
from large risks. Ceded reinsurance contracts do not relieve the Company of its
obligation to its insureds.
Reinsurance recoverable includes the balances due from reinsurance
companies for paid and unpaid losses and loss expenses that will be recovered
from reinsurers, based on contracts in force, and are presented net of a reserve
for uncollectible reinsurance that has been determined based upon a review of
the financial condition of the reinsurers and other factors. The method for
determining the reinsurance recoverable involves reviewing actuarial estimates
of gross unpaid losses and loss expenses to determine the Company's ability to
cede unpaid losses and loss expenses under its existing reinsurance contracts.
This method is continually reviewed and updated and any adjustments resulting
therefrom are reflected in earnings in the period identified.
Prepaid reinsurance premiums represent the portion of premiums ceded to
reinsurers applicable to the unexpired terms of the reinsurance contracts in
force.
e) INVESTMENTS
The Company's investments are considered to be "available for sale" under the
definition included in the Financial Accounting Standard Board's ("FASB")
Statement of Financial Accounting Standards ("FAS") No. 115, "Accounting for
Certain Investments in Debt and Equity Securities". The Company's investment
portfolio is reported at fair value, being the quoted market price of these
securities provided by either independent pricing services, or when such prices
are not available, by reference to broker or underwriter bid indications.
Short-term investments comprise securities due to mature within one year of date
of issue. Short-term investments include certain cash and cash equivalents,
which are part of investment portfolios under the management of external
investment managers.
66
Securities sold under agreements to repurchase (liabilities) are accounted
for as collateralized investments and borrowings and are recorded at the
contractual repurchase amounts plus accrued interest. Assets to be repurchased
are the same, or substantially the same, as the assets transferred and the
transferor, through right of substitution, maintains the right and ability to
redeem the collateral on short notice.
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, the Company accrues its
portion of the net income or loss of the investment. Other direct investments
are carried at fair value. Where fair values are not publicly available, the
investments are carried at estimated fair value. Investments in investment funds
are carried at the net asset value as advised by the fund. Investments in
limited partnerships for which the Company has partnership ownership interests
in excess of three percent are accounted for using the equity method. Limited
partnerships for which the Company has partnership ownership interests less than
three percent are carried at cost.
Realized gains or losses on sales of investments are determined on a
first-in, first-out basis. Unrealized appreciation (depreciation) on investments
is included as other comprehensive income in shareholders' equity. The Company
regularly reviews its investments for possible impairment based on criteria
including economic conditions, credit loss experience and other issuer-specific
developments. If there is a decline in a security's net realizable value, a
determination is made as to whether that decline is temporary or "other than
temporary". If it is believed that a decline in the value of a particular
investment is temporary, the decline is recorded as an unrealized loss in
shareholders' equity. If it is believed that the decline is "other than
temporary", the Company writes down the carrying value of the investment and
records a realized loss in the statement of operations.
The Company utilizes financial futures, options, interest rate swaps and
foreign currency forward contracts for the purpose of managing certain
investment portfolio exposures (see Note 8 for additional discussion of the
objectives and strategies employed). These instruments are recognized as assets
or liabilities in the accompanying consolidated financial statements and changes
in market value are included in net realized gains or losses on investments in
the consolidated statements of operations. Collateral held by brokers equal to a
percentage of the total value of open futures contracts is included in
short-term investments.
Net investment income includes interest and dividend income together with
amortization of market premiums and discounts and is net of investment
management and custody fees. For mortgage-backed securities, and any other
holdings for which there is a prepayment risk, prepayment assumptions are
evaluated and revised as necessary. Any adjustments required due to the
resultant change in effective yields and maturities are recognized
prospectively.
The Company engages 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. The Company's policy is to require fixed
maturities and initial cash collateral equal to 102 percent of the fair value of
the loaned securities. Securities lending collateral is recorded in fixed
maturities and short-term investments and in liabilities. The Company maintains
full ownership rights to the securities loaned, and continues to earn interest
on them. The Company shares a portion of the interest earned on the collateral
with the lending agent. In addition, the Company has the ability to sell the
securities while they are on loan. The Company has an indemnification agreement
with the lending agents in the event a borrower becomes insolvent or fails to
return securities. The fair value of the securities on loan is reported as a
separate line in total investments and cash.
67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
f) GOODWILL
In June 2001, FASB issued FAS 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 and at
least annually thereafter. 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.
g) VALUE OF REINSURANCE BUSINESS ASSUMED
The value of reinsurance business assumed represents the difference between the
estimated ultimate value of the liabilities assumed under retroactive
reinsurance contracts, including LPTs, and the consideration received under the
contract. The value of reinsurance business assumed is amortized to loss and
loss expenses based on the payment pattern of the losses assumed. The
unamortized value is reviewed regularly to determine if it is recoverable under
the terms of the contract. If such amounts are estimated to be unrecoverable,
they are expensed.
h) UNPAID LOSSES AND LOSS EXPENSES
Property and Casualty
A liability is established for the estimated unpaid losses and loss expenses of
the Company under the terms of, and with respect to, its policies and
agreements. Included in the Company's liabilities for losses and loss expenses
are liabilities for asbestos, environmental and latent injury damage claims and
expenses ("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 claims and incurred but not reported ("IBNR")
claims. The methods of determining such estimates and establishing the resulting
reserve are reviewed continuously and any adjustments are reflected in
operations in the period in which they become known. Future developments may
result in losses and loss expenses materially greater or less than the reserve
provided.
Financial Guaranty
Case basis reserves are established when specific issues are identified as
currently or likely to be in default. Such reserve is based on the present value
of the expected loss and loss adjustment payments, net of recoveries, under
salvage and subrogation rights. Reserves for losses and loss adjustment expenses
also include "portfolio reserves", which are management's best estimate of
expected losses related to the Company's entire reinsured portfolio. These
reserves are based on reports from ceding companies as well as historical
default statistics of municipal, asset-backed and corporate bonds, net of
expected recoveries. In accordance with industry practice, the financial
guaranty case basis reserves have been discounted using an average rate of six
percent in both 2002 and 2001, resulting in a discount of $14.9 million and $8
million, respectively.
Life Reinsurance
The development of life and annuity policy reserves requires management to make
estimates and assumptions regarding mortality, morbidity, lapse, expense and
investment experience. Such estimates are primarily based on historical
experience and information provided by ceding companies. Actual results could
differ materially from these estimates.
Management monitors actual experience, and where circumstances warrant, will
revise its assumptions and the related reserve estimates. These revisions are
recorded in the period they are determined.
68
i) CONTRACT HOLDER DEPOSIT FUNDS
Contract holder deposit funds represents a liability for investment contracts
sold that do not meet the definition of an insurance contract under FAS No. 97,
"Accounting and Reporting by Insurance Enterprises for Certain Long-Duration
Contracts". The investment contracts are sold with a guaranteed rate of return.
The proceeds are then invested with the intent of realizing a greater return
than is called for in the investment contracts.
j) TRANSLATION OF FOREIGN CURRENCIES
Financial statements of subsidiaries expressed in foreign currencies are
translated into U.S. dollars in accordance with FAS No. 52, "Foreign Currency
Translation" ("FAS 52"). Under FAS 52, functional currency assets and
liabilities are translated into U.S. dollars generally using period end rates of
exchange and the related translation adjustments are recorded as a separate
component of accumulated other comprehensive income. Functional currencies are
generally the currencies of the local operating environment. Statement of
operations amounts expressed in functional currencies are translated using
average exchange rates. Gains and losses resulting from foreign currency
transactions are recorded in net realized gains (losses) on investments in
current income.
k) INCOME TAXES
Income taxes have been provided in accordance with the provisions of FAS No.
109, "Accounting for Income Taxes", on those operations which are subject to
income taxes (see Note 14). Deferred tax assets and liabilities result from
temporary differences between the amounts recorded in the consolidated financial
statements and the tax basis of the Company's assets and liabilities. Such
temporary differences are primarily due to the tax basis discount on unpaid
losses and loss expenses, foreign tax credits, non-deductibility of deferred
policy acquisition costs and tax benefits of net operating loss carryforwards.
The effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date. A valuation
allowance against deferred tax assets is recorded if it is more likely than not
that all, or some portion, of the benefits related to deferred tax assets will
not be realized.
l) EARNINGS PER SHARE
Basic earnings per share is calculated using the weighted average shares
outstanding. All potentially dilutive securities including Mezzanine equity,
unvested restricted stock, stock options, warrants and convertible securities
are excluded from the basic earnings per share calculation. In calculating
diluted earnings per share, the weighted average shares outstanding is increased
to include all potentially 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. Basic and diluted earnings per
share are calculated by dividing income available to ordinary shareholders by
the applicable weighted average number of shares outstanding during the year.
m) CASH FLOW INFORMATION
Purchases and sales or maturities of short-term investments are recorded net for
purposes of the statements of cash flows and are included with fixed maturities.
69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
n) DERIVATIVES
The Company adopted FAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" ("FAS 133"), as of January 1, 2001. FAS 133 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. 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. The Company had no derivatives that were designated as hedges as
of December 31, 2002 and 2001.
The Company maintains 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. The
Company has historically recorded the changes in market value of these
instruments as realized gains or losses in the consolidated statements of
operations and, accordingly, FAS 133, as amended, did not have a significant
impact on the results of operations, financial condition or liquidity as it
relates to these instruments. At December 31, 2002, a liability of $46 million
representing the fair value of these instruments is included in accounts
payable, accrued expenses and other liabilities.
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. Net
premiums earned relating to these products for the years ended December 31, 2002
and 2001, were $145 million and $52 million, respectively, with incurred losses
of $148 million and $39 million, respectively. Effective January 1, 2001, the
Company records these products at their fair value, which is determined
principally through obtaining quotes from independent dealers and
counterparties. The changes in fair value are included in realized gains
(losses) on investments in the statement of operations. At December 31, 2002 and
2001, a liability representing the fair value of these instruments resulting
from the change in fair value of $129 million and $52 million was included in
accounts payable, accrued expenses and other liabilities.
The Company recorded an expense related to the cumulative effect of
adopting this standard of $23 million, net of income tax of $12 million. At
December 31, 2002 and 2001, the Company has recorded in net realized gains
(losses) on investments, a pretax loss of $77 million and $17 million,
respectively, to reflect the change in the fair value of derivatives during the
year. 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.
The Company's involvement with derivative instruments and transactions is
primarily to offer protection to others or to mitigate its own risk and is not
considered speculative in nature.
o) NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, FASB issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which requires consolidation of all
variable interest entities ("VIE") by the primary beneficiary, as these terms
are defined in FIN 46, effective immediately for VIEs created after January 31,
2003. The consolidation requirements apply to VIEs existing on January 31, 2003
for reporting periods beginning after June 15, 2003. In addition, it requires
expanded disclosure for all VIEs. The Company does not expect the adoption of
FIN 46 to have a material impact on the consolidated financial statements.
70
In December 2002, FASB issued FAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure" ("FAS 148"). FAS 148 provides
alternative methods of transitioning for a voluntary change to the fair-value
based method of accounting for stock-based employee compensation. In addition,
FAS 148 amends the disclosure requirements of FAS 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based compensation and the effect of the method used on
reported results. The Company continues to account for stock-based compensation
plans in accordance with Accounting Principles Board Opinion No. 25 ("APB 25").
In November 2002, FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"), which expands the disclosures
to be made by a guarantor in their consolidated financial statements and
generally requires recognition of a liability for the fair value of a guarantee
at its inception. The disclosure requirements of this interpretation are
effective for the Company for fiscal periods ending after December 15, 2002, and
accordingly, have been included in Note 8. The measurement provisions of this
interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002. This interpretation does not apply to
guarantees issued by insurance companies accounted for under insurance-specific
accounting literature. The Company does not expect the adoption of the
measurement provisions of FIN 45 to have a material impact on the consolidated
financial statements.
In April 2002, FASB issued FAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
The primary impact of FAS No. 145 was to rescind the requirement to report the
gain or loss from the extinguishment of debt as an extraordinary item in the
statement of income. The provisions of this Statement are generally effective
for fiscal years beginning after May 15, 2002. During 2002, the Company incurred
debt prepayment expenses, which are reported as other expense in the statement
of operations.
3. INVESTMENTS
a) FIXED MATURITIES
The fair values and amortized costs of fixed maturities at December 31, 2002 and
2001 are as follows:
2002 2001
----------------------------- -----------------------------
(in thousands of U.S. dollars) FAIR VALUE AMORTIZED COST Fair Value Amortized Cost
- -----------------------------------------------------------------------------------------------------------------------
U.S. Treasury and agency $ 1,320,965 $ 1,244,484 $ 1,344,076 $ 1,314,524
Non-U.S. governments 1,597,860 1,545,171 1,428,977 1,403,053
Corporate securities 7,039,636 6,730,915 6,743,090 6,687,887
Mortgage-backed securities 3,260,520 3,167,580 2,322,951 2,272,111
States, municipalities and political subdivisions 1,200,760 1,102,592 1,161,071 1,116,869
- -----------------------------------------------------------------------------------------------------------------------
$ 14,419,741 $ 13,790,742 $ 13,000,165 $ 12,794,444
=======================================================================================================================
The gross unrealized appreciation (depreciation) related to fixed maturities at
December 31, 2002 and 2001 is as follows:
2002 2001
----------------------------------- -----------------------------------
GROSS UNREALIZED GROSS UNREALIZED Gross Unrealized Gross Unrealized
(in thousands of U.S. dollars) APPRECIATION DEPRECIATION Appreciation Depreciation
- -----------------------------------------------------------------------------------------------------------------------------------
U.S. Treasury and agency $ 76,868 $ (387) $ 38,499 $ (8,947)
Non-U.S. governments 54,066 (1,377) 32,993 (7,068)
Corporate securities 358,658 (49,937) 179,028 (123,826)
Mortgage-backed securities 94,623 (1,683) 60,345 (9,505)
States, municipalities and political subdivisions 98,247 (79) 50,105 (5,903)
- -----------------------------------------------------------------------------------------------------------------------------------
$ 682,462 $ (53,463) $ 360,970 $ (155,249)
===================================================================================================================================
71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
Mortgage-backed securities issued by U.S. government agencies are combined with
all other mortgage derivatives held and are included in the category,
"mortgage-backed securities". Approximately 73 percent of the total mortgage
holdings at December 31, 2002, and 81 percent at December 31, 2001, are
represented by investments in U.S. government agency bonds. The remainder of the
mortgage exposure consists of collateralized mortgage obligations and
non-government mortgage-backed securities, the majority of which provide a
planned structure for principal and interest payments and carry an AAA rating
by the major credit rating agencies. Fixed maturities at December 31, 2002, by
contractual maturity, are shown below. Expected maturities could differ from
contractual maturities because borrowers may have the right to call or prepay
obligations, with or without call or prepayment penalties. The Company also
invests in interest rate swaps to manage the duration of the fixed maturity
portfolio. The average duration, including the effect of the interest rate
swaps, is 3.1 years at December 31, 2002 and 3.4 years at December 31, 2001.
(in thousands of U.S. dollars) Fair Value Amortized Cost
- --------------------------------------------------------------------------
MATURITY PERIOD
Less than 1 year $ 563,308 $ 620,462
1 - 5 years 4,405,293 4,167,231
5 - 10 years 3,532,696 3,298,014
Greater than 10 years 2,657,924 2,537,455
- --------------------------------------------------------------------------
$ 11,159,221 $ 10,623,162
Mortgage-backed securities 3,260,520 3,167,580
- --------------------------------------------------------------------------
Total fixed maturities $ 14,419,741 $ 13,790,742
==========================================================================
b) EQUITY SECURITIES
The gross unrealized appreciation (depreciation) on equity securities at
December 31, 2002 and 2001 is as follows:
(in thousands of U.S. dollars) 2002 2001
- --------------------------------------------------------------------------
Equity securities - cost $ 442,266 $ 516,028
Gross unrealized appreciation 24,018 41,043
Gross unrealized depreciation (55,253) (89,505)
- --------------------------------------------------------------------------
Equity securities - fair value $ 411,031 $ 467,566
==========================================================================
c) SECURITIES ON LOAN
The fair values and amortized cost/cost of securities on loan and the gross
unrealized appreciation (depreciation) related to these securities at December
31, 2002 are detailed below. There were no securities on loan at
December 31, 2001.
2002
--------------------------------------------------------------
Amortized Gross Unrealized Gross Unrealized
(in thousands of U.S. dollars) Fair Value Cost/Cost Appreciation Depreciation
- ----------------------------------------------------------------------------------------------------
Fixed maturities $ 272,084 $ 258,124 $ 19,728 $ (5,768)
Equity securities 20,889 27,445 2,866 (9,422)
- ----------------------------------------------------------------------------------------------------
Total $ 292,973 $ 285,569 $ 22,594 $ (15,190)
====================================================================================================
72
d) NET REALIZED GAINS (LOSSES) AND CHANGE IN NET UNREALIZED APPRECIATION
(DEPRECIATION) ON INVESTMENTS
The analysis of net realized gains (losses) on investments and the change in net
unrealized appreciation (depreciation) on investments for the years ended
December 31, 2002, 2001 and 2000 is as follows:
(in thousands of U.S. dollars) 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------
Fixed maturities
Gross realized gains $ 179,911 $ 189,751 $ 90,403
Gross realized losses (136,600) (144,220) (172,009)
Other than temporary impairments (101,075) (52,512) -
- -----------------------------------------------------------------------------------------------------------
(57,764) (6,981) (81,606)
Equity securities
Gross realized gains 22,832 58,779 170,243
Gross realized losses (27,340) (32,213) (56,199)
Other than temporary impairments (152,728) - -
- -----------------------------------------------------------------------------------------------------------
(157,236) 26,566 114,044
Other investments 1,964 (9,747) (12,114)
Write-down of other investments (14,067) (28,453) -
Currency gains (losses) 3,324 (12,061) (11,058)
Financial futures and option contracts and interest rate swaps (188,031) (10,843) (48,227)
Fair value adjustment on derivatives (77,279) (16,840) -
- -----------------------------------------------------------------------------------------------------------
Net realized losses on investments (489,089) (58,359) (38,961)
- -----------------------------------------------------------------------------------------------------------
Change in net unrealized appreciation (depreciation) on investments
Fixed maturities 423,278 125,349 310,971
Equity securities 17,227 (85,459) (115,759)
Securities on loan 7,404 - -
Other investments 8,372 8,975 16,389
Short-term investments - - 2,081
Change in deferred income taxes (116,786) (14,284) (28,020)
- -----------------------------------------------------------------------------------------------------------
Change in net unrealized appreciation on investments 339,495 34,581 185,662
- -----------------------------------------------------------------------------------------------------------
Total net realized losses and change in net unrealized appreciation
(depreciation) on investments $ (149,594) $ (23,778) $ 146,701
===========================================================================================================
e) NET INVESTMENT INCOME
Net investment income for the years ended December 31, 2002, 2001 and 2000 was
derived from the following sources:
(in thousands of U.S. dollars) 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------
Fixed maturities and short-term investments $ 833,436 $ 811,912 $ 766,312
Equity securities 6,778 9,837 12,268
Other investments 5,308 5,861 39,783
- -----------------------------------------------------------------------------------------------------------
Gross investment income 845,522 827,610 818,363
Investment expenses (43,381) (41,741) (47,508)
- -----------------------------------------------------------------------------------------------------------
Net investment income $ 802,141 $ 785,869 $ 770,855
===========================================================================================================
73
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
f) RESTRICTED ASSETS
The Company is required to maintain assets on deposit with various regulatory
authorities to support its insurance and reinsurance operations. These
requirements are generally promulgated in the statutory regulations of the
individual jurisdictions. The assets on deposit are available to settle
insurance and reinsurance liabilities. The Company also utilizes trust funds in
certain large transactions where the trust funds are set up for the benefit of
the ceding companies and generally take the place of Letter of Credit ("LOC")
requirements. The Company also has investments in segregated portfolios
primarily to provide collateral or guarantees for LOCs and debt instruments
described in Notes 8 and 9. The components of the fair value of the restricted
assets at December 31, 2002 and 2001 are as follows:
(in thousands of U.S. dollars) 2002 2001
- ---------------------------------------------------------------------------
Deposits with U.S. regulatory authorities $ 649,962 $ 863,589
Deposits with non-U.S. regulatory authorities 1,069,657 734,357
Assets used for collateral or guarantees 1,230,174 1,030,592
Trust funds 1,380,886 852,496
- ---------------------------------------------------------------------------
$ 4,330,679 $ 3,481,034
===========================================================================
4. GOODWILL
The following table details the movement in goodwill by segment during the year
ended December 31, 2002.
Insurance- Insurance-
North Overseas Global Financial ACE
(in thousands of U.S. dollars) American General Reinsurance Services Consolidated
- -----------------------------------------------------------------------------------------------------------------------------
Goodwill at beginning of year $ 1,162,308 $ 1,148,105 $ 364,958 $ 96,723 $ 2,772,094
Settlement of an acquisition-related lawsuit (28,765) (25,615) - - (54,380)
Adjustment to purchased goodwill - (854) - - (854)
- -----------------------------------------------------------------------------------------------------------------------------
Goodwill at end of year $ 1,133,543 $ 1,121,636 $ 364,958 $ 96,723 $ 2,716,860
=============================================================================================================================
The following table provides a reconciliation of prior years reported net income
to adjusted net income had FAS 142 been applied at the beginning of fiscal 2000.
For the years ended December 31,
(in thousands of U.S. dollars, except per share data) 2001 2000
- --------------------------------------------------------------------------------------
Reported net income (loss) $ (146,414) $ 542,982
Add back: goodwill amortization 79,571 78,820
- --------------------------------------------------------------------------------------
Adjusted net income (loss) $ (66,843) $ 621,802
======================================================================================
BASIC EARNINGS (LOSS) PER SHARE:
Reported earnings (loss) per share $ (0.74) $ 2.37
Add back: goodwill amortization 0.34 0.36
- --------------------------------------------------------------------------------------
Adjusted earnings (loss) per share $ (0.40) $ 2.73
======================================================================================
DILUTED EARNINGS (LOSS) PER SHARE:
Reported earnings (loss) per share $ (0.74) $ 2.31
Add back: goodwill amortization 0.34 0.34
- --------------------------------------------------------------------------------------
Adjusted earnings (loss) per share $ (0.40) $ 2.65
======================================================================================
74
5. SEPTEMBER 11, 2001
The terrorist attack on September 11, 2001 ("the September 11 tragedy") had a
substantial impact on the 2001 results of the Company. The Company continues to
evaluate its total potential liability based upon individual insurance and
reinsurance policy language, legal and factual developments in underlying
matters involving its insureds and legislative developments in the U.S.
involving the terrorist attack. If the Company's 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 the
Company has anticipated or provided for in its estimates, or insureds that the
Company expects will not be held responsible for injuries resulting from the
attack are ultimately found to be responsible at a financial level that impacts
the Company's insurance or reinsurance policies. Detailed below is an analysis
of the impact of the September 11 tragedy on each of the Company's business
segments, for the year ended December 31, 2001. The Company's estimate for the
September 11 tragedy claims remains substantially unchanged from 2001 and the
Company believes that its estimate is reasonable and accurate based on
information currently available.
IMPACT OF SEPTEMBER 11, 2001 TRAGEDY
Year ended December 31, 2001
Insurance- Insurance-
North Overseas Global Financial ACE
(in millions of U.S. dollars) American General Reinsurance Services Consolidated
- ---------------------------------------------------------------------------------------------------------
OPERATIONS DATA
Gross premiums written $ - $ (20) $ - $ 142 $ 122
Net premiums written (22) (46) (23) 142 51
Net premiums earned (22) (46) (22) 104 14
Losses and loss expenses 119 67 213 251 650
Policy acquisition costs - - 1 - 1
- ---------------------------------------------------------------------------------------------------------
Underwriting income (loss) (141) (113) (236) (147) (637)
Income tax benefit (16) (27) (35) - (78)
- ---------------------------------------------------------------------------------------------------------
Net loss $ (125) $ (86) $ (201) $ (147) $ (559)
=========================================================================================================
The analysis of the impact of the September 11 tragedy includes the effects of
intercompany reinsurance transactions. In estimating the impact of the tragedy
on the Company, premium payments required to reinstate reinsurance policies were
accrued. Premiums from insureds required to reinstate their insurance or
reinsurance coverage with the Company were not accrued in the estimate. The
premiums accrued in Financial Services represent additional premiums due under
the terms of certain financial solutions reinsurance programs directly impacted
by the tragedy.
In February 2002, ACE announced that one of its Bermuda subsidiaries, 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 11 tragedy.
The Company's exposure to the tragedy is derived from losses incurred by
insured and reinsured clients of the Company. Gross insured claims incurred by
the Company with respect to the tragedy are covered by significant amounts of
reinsurance from high quality reinsurers. In order to identify policies which
may have been affected by the September 11 tragedy, the Company conducted a
review of its insurance and reinsurance portfolios on a policy by policy basis,
which included first-party, third-party, reinsurance, retrocessional, financial
guaranty and life reinsurance exposures. Net losses and loss expenses of $650
million resulted from estimated gross losses and loss expenses of approximately
$1.8 billion, net of estimated reinsurance recoveries of approximately $1.2
billion. As at December 31, 2002, the Company has paid $711 million of losses
and has collected $468 million of the $512 million recoverable from reinsurers.
75
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
6. UNPAID LOSSES AND LOSS EXPENSES
PROPERTY AND CASUALTY
The Company establishes reserves for the estimated unpaid ultimate liability for
losses and loss expenses under the terms of its policies and agreements. These
reserves include estimates for both claims that have been reported and for IBNR,
and include estimates of expenses associated with processing and settling these
claims. The process of establishing reserves for property and casualty ("P&C")
claims can be complex and imprecise as it requires the use of informed
estimates and judgments. The Company's estimates and judgments may be revised as
additional experience and other data become available and are reviewed, as new
or improved methodologies are developed, or as current laws change. As part of
the evaluation process of loss reserves, the Company annually engages
independent actuarial firms to review the methods and assumptions used in
estimating loss and loss expense reserves. These annual reviews cover different
portions of our operating businesses on a rotating basis within each year and
are an independent check on the Company's loss reserves. In addition, the
Insurance Department of the Commonwealth of Pennsylvania requires a biennial,
external actuarial review as part of the acquisition of CIGNA's P&C operations
in 1999. That review was completed during the first quarter of 2003. The Company
continually evaluates its estimates of reserves in light of developing
information and in light of discussions and negotiations with its insureds.
While the Company believes that its reserve for unpaid losses and loss expenses
at December 31, 2002 is adequate, new information or trends may lead to future
developments in ultimate losses and loss expenses significantly greater or less
than the reserves provided. Any such revisions could result in future changes in
estimates of losses or reinsurance recoverable, and would be reflected in the
Company's results of operations in the period in which the estimates are
changed. The reconciliation of unpaid losses and loss expenses for the years
ended December 31, 2002, 2001 and 2000 is as follows:
(in thousands of U.S.dollars) 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------------
Gross unpaid losses and loss expenses at beginning of year $ 20,728,122 $ 17,388,394 $ 16,460,247
Reinsurance recoverable on unpaid losses (10,628,608) (8,323,444) (7,551,430)
- -----------------------------------------------------------------------------------------------------------------------------------
Net unpaid losses and loss expenses at beginning of year 10,099,514 9,064,950 8,908,817
Unpaid losses and loss expenses assumed in respect of reinsurance business acquired 202,920 300,204 169,537
Unpaid losses and loss expenses in respect of formerly discontinued operations _ - 1,269,914
- -----------------------------------------------------------------------------------------------------------------------------------
Total 10,302,434 9,365,154 10,348,268
- -----------------------------------------------------------------------------------------------------------------------------------
Net losses and loss expenses incurred in respect of losses occurring in:
Current year 4,197,829 4,457,986 2,996,429
Prior year 708,681 94,470 (60,364)
- -----------------------------------------------------------------------------------------------------------------------------------
Total 4,906,510 4,552,456 2,936,065
- -----------------------------------------------------------------------------------------------------------------------------------
Net losses and loss expenses paid in respect of losses occurring in:
Current year 1,265,880 1,345,699 1,205,110
Prior year 2,685,401 2,404,155 2,897,171
- -----------------------------------------------------------------------------------------------------------------------------------
Total 3,951,281 3,749,854 4,102,281
- -----------------------------------------------------------------------------------------------------------------------------------
Foreign currency revaluation 60,355 (68,242) (117,102)
- -----------------------------------------------------------------------------------------------------------------------------------
Net unpaid losses and loss expenses at end of year 11,318,018 10,099,514 9,064,950
Reinsurance recoverable on unpaid losses 12,997,164 10,628,608 8,323,444
- -----------------------------------------------------------------------------------------------------------------------------------
Gross unpaid losses and loss expenses at end of year $ 24,315,182 $ 20,728,122 $ 17,388,394
===================================================================================================================================
Net losses and loss expenses incurred for the year ended December 31,2002 of
$4.9 billion include $709 million of prior year development. Of this amount,
$516 million relates to charge taken in the fourth quarter of 2002 to strengthen
the Company's A&E reserves and is analysed in more detail below. All of the
A&E development was incurred in the Insurance - North American segment. An
analysis of the remaining $193 million of prior period development follows.
76
Insurance - North American's total incurred losses of $2.2 billion include
$79 million of prior period development, $59 million from ACE USA and $20
million from ACE Bermuda. In ACE USA, prior period development arose from
several lines of business including $13 million from its ACE Risk Management
business, $11 million from the Consumer Solutions business and $35 million from
two lines of business now in run-off. ACE Risk Management, ACE USA's largest
business line with over $1.3 billion of net loss reserves, is the large
commercial package business that includes workers' compensation and commercial
automobile covers. During 2002, the Company incurred $13 million to increase the
workers' compensation, commercial automobile and the health care asset
management run-off books, principally for the 2000 accident year, as a result of
regular actuarial reviews of these lines of business. The Consumer Solutions
group incurred $11 million related to the 2001 accident year, principally from
its warranty line as a result of an actuarial study completed in late 2002. Of
the $35 million from run-off business, $18 million arose from the Commercial
Insurance Service ("CIS") line, which comprises middle market casualty
exposures. In 1999, the Company sold the renewal rights to this business and is
running off the existing reserves. $12 million relates to one adverse court
decision in the Financial Institutions business on a 2001 accident year claim
and the remaining $5 million relates to general reserve increases resulting from
actuarial reviews.
In ACE Bermuda, the Company incurred $45 million of prior year losses
related to aerospace losses, $31 million related to satellite losses and $14
million of aviation losses. The satellite losses principally relate to three
losses from satellites launched between 1999 and 2001 that have subsequently
experienced problems. The aviation losses relate to increases in claims reserves
on almost 300 claims in the 1997 through 2001 accident years. The remaining
reserves on this line principally relate to long-tail product liability
policies. ACE Bermuda discontinued the satellite business in 2002 and the
aviation business in 2000. These increases were partially offset as excess
liability reserves improved by $28 million. The Company was successful in
recovering subrogation on a loss from the 1988 accident year and had a positive
development on a claim for the 1989 accident year. These two items accounted for
an improvement of $45 million. This was partially offset by claims development
in 1995 and 1996. The remaining $3 million relates to general reserve increases
resulting from actuarial reviews.
Insurance - Overseas General's total incurred losses of $1.4 billion
include $104 million of prior year losses, of which $36 million came from ACE
Global Markets and $68 million came from ACE International. In ACE Global
Markets, $26 million of prior period development arose from aerospace losses in
the 2000 and 2001 accident years, principally from the same satellite losses
that impacted ACE Bermuda. The remaining $10 million relates to a number of
small losses across several business lines. In ACE International, $44 million of
prior period development arose from developing casualty losses in Australia,
Norway, Italy and the Netherlands. The increases related to development on
several large claims caused by new information that changed the total value of
these claims from last year. In addition, ACE Europe incurred $14 million of D&O
losses, partly in response to specific large losses and partly due to a change
in assumptions as experience has changed from last year. The remaining $10
million relates to small losses across several lines.
Global Reinsurance's total incurred losses of $304 million include positive
development in prior period reserves of $20 million. Most of Global
Reinsurance's reserves at December 31, 2002 relate to short-tail, catastrophe-
oriented lines where unpaid claims are set using a blend of market share
analysis on industry loss reports and reported claims from customers. Initial
loss reserve estimates are then revised as necessary to reflect the actual loss
experience of the customer. During 2002, Global Reinsurance determined that the
loss reserves carried on certain of its contracts related to the 1998 through
2001 accident years were in excess of the reserves required based on the latest
assessment. This resulted in favorable prior year loss development. There were
no changes in assumptions used in the reserving process in 2002.
Total incurred losses of $947 million for Financial Services include $30
million of prior period development principally from the ACE Financial Solutions
International book, which comprises large, unique transactions, including LPTs.
$12 million relates to the amortization of the deferred assets on the LPTs. The
remaining amount principally relates to three accounts where recent information
resulted in an increase in the total reserve positions for these accounts
primarily for the 1998 through 2001 accident years.
Net losses and loss expenses incurred for the year ended December 31, 2001
include $94 million of prior year development principally in the Insurance -
Overseas General segment. This development was reflected during the fourth
quarter of 2001 when the Company recorded additional reserves to strengthen its
casualty loss reserves.
77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
Net losses and loss expenses incurred for the year ended December 31, 2000
include favorable development of reserves from prior periods of $60 million,
primarily from the Global Reinsurance and Insurance - North American segments,
partially offset by unfavorable development in the Financial Services segment.
ASBESTOS AND ENVIRONMENTAL
Included in the Company's liabilities for losses and loss expenses are
liabilities for asbestos, environmental and latent injury damage claims and
expenses. 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
provisions for both reported and IBNR claims.
In January 2003, the Company completed an internal review of its A&E
reserves. As a result of this review, the Company increased its gross A&E
reserve, for the year ended December 31, 2002, by $2.2 billion, offset by $1.9
billion of reinsurance recoverable, including $533 million of reinsurance
purchased from the National Indemnity Company ("NICO") as part of the
acquisition of CIGNA's P&C business. The Company also increased its bad debt
provision for reinsurance recoverable by $145 million. As a result of these two
items, together with ACE Bermuda's ten percent participation in the NICO cover,
the net increase in exposure was determined to be $516 million ($354 million
after income tax) and was recorded in the fourth quarter of 2002.
The following table presents selected loss reserve data for A&E exposures
at December 31, 2002 and 2001.
2002 2001
-------------------------- ----------------------
(in millions of U.S. dollars) GROSS NET Gross Net
- -------------------------------------------------------------------------------------------------
Asbestos $ 3,192 $ 446 $ 1,085 $ 149
Environmental and other latent exposures 1,352 403 1,037 452
- -------------------------------------------------------------------------------------------------
Total $ 4,544 $ 849 $ 2,122 $ 601
=================================================================================================
During the years ended December 31, 2002 and 2001, the Company made payments of
$308 million and $239 million, respectively, with respect to latent claims.
The Company's exposure to asbestos principally arises out of liabilities
acquired when the Company purchased the P&C business of CIGNA in 1999 and
Westchester Specialty from Talegen in 1998. While the Company certainly has
other insurance operations, exposure to asbestos liabilities is concentrated in
these two areas of business. Of these two areas, the larger and potentially more
volatile exposure is contained within the liabilities acquired in the CIGNA
transaction. These liabilities reside in the various subsidiaries of Brandywine
Holdings, Inc. ("Brandywine"), which was created in 1995 by the restructuring of
CIGNA'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. In the fourth
quarter of 2002, the Company increased its A&E reserves, exhausting the NICO
reinsurance cover protecting Brandywine.
As part of the acquisition of the Westchester business, NICO provided
reinsurance protection for adverse development for all losses occurring prior to
1997. At December 31, 2002, the remaining limit in the NICO reinsurance cover
protecting ACE Westchester Specialty was approximately $600 million. None of the
recent increase to reserves is attributable to Westchester's asbestos
liabilities.
The Company conducts a reserve review of its asbestos reserves on a
quarterly basis. This reserve review includes a detailed individual claim review
and analysis of the policies at issue, legal precedents, and the Company's
asbestos settlement history, as well as factual and investigative developments.
The most recent review, which was carried out by an internal task force,
included a comprehensive re-evaluation of claims as of September 2002. This
included a review of:
.. the pending claim inventory and the projection of future filings;
.. the characterization of injury types and the projected future distribution by
injury type;
.. the total coverage profile for the account and our share of that coverage
profile;
.. products and non-products exposures;
78
.. bankruptcy status and jurisdiction; and
.. the external actuarial estimate of unpaid liabilities.
This evaluation process included a detailed review of assumptions relating
to projections of future new defendants, and non-product exposures were
identified and reserved as part of the task force process.
In addition to the internal review of asbestos reserves, the normal,
biennial reserve review by an internationally-known actuarial consulting firm
required by the Pennsylvania Insurance Department was recently completed. At
December 31, 2002, taking into account the additions for the quarter ended
December 31, 2002, the Company's asbestos reserves represent the high end of the
Company's internal task force's indication of range of liability and is
consistent with the best estimate of the external actuary retained by the
Pennsylvania Insurance Department.
In the context of the Company's asbestos reviews, many risk factors are
considered. In establishing its asbestos reserves, the Company believes the most
significant variables include its assumptions with respect to payments to
unimpaired claimants and the liability of peripheral defendants.
In establishing its reserves for periods prior to the fourth quarter of
2002, the Company assumed that significant additional state judicial or
legislative reform would substantially eliminate payments to future claimants
who are not physically impaired. The fourth quarter reserve additions were based
on the more conservative assumption that there will be no future state or
federal asbestos reform. Therefore, the booked asbestos reserves do not reflect
any anticipated changes in the legal, social or economic environment, or any
benefit from future legislative reforms.
The vast majority of the reserve increase in the fourth quarter of 2002 is
due to the strengthening of the IBNR provision for peripheral defendants and
future increases in severity.
The Company also considers 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. The results in other asbestos cases announced by other carriers may
very well have little or no relevance to the Company 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, the
Company 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 its 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.
The Company's current asbestos reserves are based upon an assessment of its
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, the Company believes that
its net loss reserves for these claims are adequate. The Company's 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 the Company to re-evaluate its
assumptions. This could lead the Company to further increase its asbestos
related reserves, which could have a material adverse effect on future operating
results.
As stated above, the Company's exposure to asbestos arises principally out
of liabilities acquired in connection with the CIGNA and Westchester
transactions, with the larger exposure resting in the various Brandywine
subsidiaries, which were acquired as part of the acquisition of CIGNA's P&C
operations. Pursuant to the restructuring order that created Brandywine, the
obligations of the active insurance subsidiaries of ACE INA (which do not
include the companies acquired in the Westchester transaction) with respect to
Brandywine's asbestos liabilities, are limited to specific amounts which are
payable only if certain conditions are met. The Brandywine restructuring order
does not impose liability for Brandywine obligations on any of our entities
other than Brandywine and the above-described regulatory requirements imposed on
the active insurance subsidiaries of ACE INA.
79
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
In accordance with the Brandywine restructuring order, INA Financial
Corporation has established a dividend retention fund consisting of $50 million,
plus investment earnings, which it must contribute to Century Indemnity, a
Brandywine subsidiary, if Century Indemnity's capital and surplus falls below
$25 million or if Century Indemnity lacks liquid assets with which to pay claims
as they become due. The dividend retention fund was created by withholding a
portion of the dividends paid by the active ACE INA insurance subsidiaries to
INA Financial Corporation, through their parent holding companies, and further
paid by INA Financial Corporation to its parent company, INA Corporation. At
December 31, 2002, Century Indemnity's capital and surplus fell below $25
million and the full balance of the dividend retention fund principal and
interest was contributed to Century Indemnity. To the extent in the future that
dividends are paid by the active ACE INA insurance subsidiaries to INA Financial
Corporation through their parent holding companies, and to the extent that INA
Financial Corporation then pays such dividends to INA Corporation, a portion of
those dividends must be withheld to replenish the principal of the dividend
retention fund to $50 million within five years. The obligations to maintain the
dividend retention fund and to replenish the fund, to the extent future
dividends are paid, are ongoing until the Company receives prior written
approval from the Pennsylvania Commissioner of Insurance permitting termination
of the fund.
In addition, under the terms of the Brandywine restructuring order, the
active ACE INA insurance subsidiaries are obligated to provide reinsurance
coverage to Century Indemnity in the amount of $800 million under an aggregate
excess of loss reinsurance agreement if the capital and surplus of Century
Indemnity falls below $25 million or if Century Indemnity lacks liquid assets
with which to pay claims as they become due. The active ACE INA insurance
subsidiaries would first contribute amounts from the dividend retention fund to
Century Indemnity before the aggregate excess of loss reinsurance agreement
would be triggered, so the minimum capital and surplus level for reinsurance
purposes will be calculated after giving effect to the dividend retention fund
contribution. At December 31, 2002, coverage under the aggregate excess of loss
reinsurance agreement was triggered, following contribution of the dividend
retention fund. Approximately $466 million in losses were ceded to the aggregate
excess of loss reinsurance agreement at December 31, 2002, leaving a remaining
limit of coverage under the aggregate excess of loss reinsurance agreement of
approximately $334 million.
FINANCIAL GUARANTY
At December 31, 2002 and 2001, the Company's reinsured financial guaranty
portfolio was broadly diversified by bond type, geographic location and maturity
schedule, with no single risk representing more than 1.2 percent and 1.3
percent, respectively, of the Company's net exposure. The Company limits its
exposure to losses from reinsured financial guarantees by underwriting primarily
investment grade obligations and retroceding a portion of its risks to other
insurance companies.
The net financial guaranty exposure outstanding was approximately $81.8
billion and $74.2 billion at December 31, 2002 and 2001, respectively. At
December 31, 2002, the weighted average credit quality of this portfolio,
including credit default swaps, was A based on ratings assigned by Standard &
Poor's. The composition at December 31, 2002 and 2001, by type of issue and the
range of final maturities, is as follows:
TYPE OF ISSUE
Range of final
(in billions of U.S. dollars) 2002 2001 maturities
- --------------------------------------------------------------------------------
Non-municipal $ 31.7 $ 26.2 1 - 30 years
Tax-backed 19.6 17.9 1 - 30 years
Municipal utilities 10.4 11.3 1 - 30 years
Special revenue 8.6 7.4 1 - 30 years
Health care 5.8 5.7 1 - 30 years
Structured municipal 3.5 2.6 1 - 30 years
Other municipal 2.2 3.1 1 - 30 years
- --------------------------------------------------------------------------------
Total $ 81.8 $ 74.2
================================================================================
80
As part of its financial guaranty business, the Company participates in credit
default swap transactions whereby one counterparty pays a periodic fee in fixed
basis points on a notional amount in return for a contingent payment by the
other counterparty in the event one or more defined credit events occurs with
respect to one or more third party reference securities or loans. A credit event
is defined as a failure to pay, bankruptcy, cross acceleration (generally
accompanied by a failure to pay), repudiation, restructuring or similar
nonpayment event. The total notional amount of credit default swaps outstanding
at December 31, 2002 and 2001, included in the Company's financial guaranty
exposure above, was $20.7 billion and $15.5 billion, respectively.
At December 31, 2002 and 2001, the Company's net mortgage guaranty
insurance in force (representing the current principal balance of all mortgage
loans that are currently reinsured) was approximately $5.2 billion and $5.7
billion, respectively, and direct primary net risk in force was approximately
$3.0 billion and $2.6 billion, respectively.
7. 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 years ended December 31, 2002, 2001 and 2000 are as follows:
(in thousands of U.S. dollars) 2002 2001 2000
- ------------------------------------------------------------------------------
Premiums written
Direct $ 9,939,024 $ 7,629,233 $ 6,093,151
Assumed 2,879,947 2,536,129 1,493,620
Ceded (4,750,673) (3,801,748) (2,707,417)
- ------------------------------------------------------------------------------
Net $ 8,068,298 $ 6,363,614 $ 4,879,354
==============================================================================
Premiums earned
Direct $ 8,537,225 $ 6,980,359 $ 5,612,988
Assumed 2,525,388 2,359,241 1,361,254
Ceded (4,232,109) (3,422,423) (2,439,479)
- ------------------------------------------------------------------------------
Net $ 6,830,504 $ 5,917,177 $ 4,534,763
==============================================================================
The composition of the Company's reinsurance recoverable at December 31, 2002
and 2001, is as follows:
(in thousands of U.S. dollars) 2002 2001
- ---------------------------------------------------------------------------------
Reinsurance recoverable on paid losses
and loss expenses $ 1,363,247 $ 1,066,496
Bad debt reserve on paid losses and loss expenses (377,804) (301,993)
Reinsurance recoverable on future policy benefits 8,846 5,335
Reinsurance recoverable on unpaid losses
and loss expenses 13,558,623 11,115,552
Bad debt reserve on unpaid losses and loss expenses (561,459) (486,944)
- ---------------------------------------------------------------------------------
Net reinsurance recoverable $ 13,991,453 $ 11,398,446
=================================================================================
81
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
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. Provisions have been
established for amounts estimated to be uncollectible.
Following is a breakdown of the Company's reinsurance recoverable on paid
losses at December 31, 2002:
CATEGORY
Bad Debt % of Total
(in millions of U.S. dollars) Amount Reserve Reserve
- -------------------------------------------------------------------------------
General collections $ 848 $ 43 5.1%
Other 515 335 65.0
- -------------------------------------------------------------------------------
Total $ 1,363 $ 378 27.7%
===============================================================================
General collections balances represent amounts in the process of collection in
the normal course of business, for which the Company has no indication of
dispute or credit issues. The Company provides 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. The
Company's estimation of this reserve considers the credit quality of the
reinsurer and whether the Company has received collateral or other credit
protections such as parental guarantees. In addition, for specific items in
dispute, the Company makes judgments based on its knowledge and experience with
a particular reinsurer.
The following tables provide a listing of the Company's 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. The bad debt reserve for these 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, includes amounts backed by the U.S. Government. Insurance
companies are required by law to participate. The Company has assumed no bad
debts or disputed amounts for this category. The fifth category, structured
settlements, includes annuities purchased from life insurance companies to
settle workers' compensation claims. These amounts are assigned principally to
large, highly-rated life insurance companies. Since the Company retains the
ultimate liability in the event that the assigned company fails to pay, it
reflects the amount as a liability and a recoverable for GAAP purposes. These
amounts are not subject to dispute and the bad debt reserve is established based
on the credit quality of the life insurers. The next category, captives,
includes companies established and owned by the Company's insurance clients to
assume a significant portion of their direct insurance risk from the Company,
i.e., they are structured to allow clients to self-insure a portion of their
insurance risk. It is generally the Company's policy to obtain collateral equal
to expected losses; where appropriate, exceptions are granted but only with
review and sign-off at a senior officer level. The final category, other,
includes amounts recoverable that are in dispute or are from companies that are
in supervision, rehabilitation, or liquidation. The Company establishes its bad
debt reserve in this category based on a case by case analysis of individual
situations, including credit and collateral analysis and consideration of the
Company's collection experience in similar situations.
82
BREAKDOWN OF REINSURANCE RECOVERABLE
December 31 Bad Debt
(in millions of U.S. dollars) 2002 Reserve % of Gross
- -------------------------------------------------------------------------------------------------
CATEGORIES
Top 10 reinsurers $ 7,732 $ 93 1.2%
Other reinsurers balances greater than $20 million 2,519 175 6.9
Other reinsurers balances less than $20 million 1,590 148 9.3
Mandatory pools and government agencies 771 4 0.5
Structured settlements 730 3 0.4
Captives 786 4 0.5
Other 802 512 63.8
- -------------------------------------------------------------------------------------------------
Total $ 14,930 $ 939 6.3%
=================================================================================================
TOP 10 REINSURERS
AXA Hannover Re SCOR Group
Berkshire Hathaway Insurance Group Lloyd's of London Swiss Re Group
EQUITAS Munich Re Zurich Financial Services Group
GE Global Insurance Group
- ---------------------------------------------------------------------------------------------------------------------------
OTHER REINSURERS BALANCES GREATER THAN $20 MILLION
ABB Group Excess & Casualty Reinsurance Association PMA Capital Insurance Company
Allianz Group Fairfax Financial RenaissanceRe Holdings Ltd
Allstate Financial FM Global Group Royal & Sun Alliance Insurance Group plc
American International Group Gerling Group Sompo Japan Insurance Inc
Aviva plc Hartford Insurance Group St. Paul Companies
Chubb Group of Insurance Companies Independence Blue Cross (Amerihealth) Toa Reinsurance Company
CNA Insurance Companies IRB - Brasil Resseguros S.A. Travelers Property Casualty Group
Converium Group Liberty Mutual Insurance Companies Trenwick Group
DaimlerChrysler Group Markel Corporation Group White Mountains Insurance Group
Dominion Ins. Co. Ltd. Overseas Partners Ltd. XL Capital Group
Dorinco Reinsurance Co. PartnerRe Group
Everest Re Group
8. COMMITMENTS, CONTINGENCIES AND GUARANTEES
a) DERIVATIVE INSTRUMENTS
The Company maintains 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. The
Company currently records changes in market value of these instruments as
realized gains or losses in the consolidated statements of operations.
(i) Foreign currency exposure management
The Company uses foreign currency forward contracts to minimize the effect of
fluctuating foreign currencies. The forward currency contracts purchased are not
specifically identifiable against cash, any single security or groups of
securities denominated in those currencies, and therefore, do not qualify as
hedges for financial reporting purposes. All realized and unrealized contract
gains and losses are reflected currently in the statements of operations. The
contractual amount of the foreign currency forward contracts at December 31,
2002, was $82 million, the current fair value was $80 million and the unrealized
loss was $2 million.
83
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
(ii) Duration management and market exposure
Futures
A portion of the Company's equity exposure is attained using a synthetic equity
strategy, whereby equity index futures contracts are held in an amount equal to
the market value of an underlying portfolio comprised of short-term investments
and fixed maturities. This creates an equity market exposure equal in value to
the total amount of funds invested in this strategy. In addition, exchange
traded bond and note futures contracts may be used in fixed maturity portfolios
as substitutes for ownership of the physical bonds and notes without
significantly increasing the risk in the portfolio. Investments in financial
futures contracts may be made only to the extent that there are assets under
management, not otherwise committed.
Futures contracts give the holder the right and obligation to participate
in market movements, determined by the index or underlying security on which the
futures contract is based. Settlement is made daily in cash by an amount equal
to the change in value of the futures contract times a multiplier that scales
the size of the contract. At December 31, 2002, the contract amount of $441
million reflects the net extent of involvement the Company had in these
financial instruments.
Options
Option contracts may be used in the portfolio as protection against unexpected
shifts in interest rates, which would thereby affect the duration of the fixed
maturity portfolio. By using options in the portfolio, the overall interest rate
sensitivity of the portfolio can be reduced. Option contracts may also be used
as an alternative to futures contracts in the Company's synthetic equity
strategy as described above. An option contract conveys to the holder the right,
but not the obligation, to purchase or sell a specified amount or value of an
underlying security at a fixed price. The price of an option is influenced by
the underlying security, expected volatility, time to expiration and supply and
demand.
For long option positions, the maximum loss is the premium paid for the
option. The maximum credit exposure is represented by the fair value of the
options held. For short option positions, the potential loss is the same as
having taken a position in the underlying security. Short call options are
backed in the portfolio with the underlying, or highly correlated, securities
and short put options are backed by uncommitted cash for the in-the-money
portion.
Interest rate swaps
An interest rate swap is a contract between two counterparties in which interest
payments are made based on a notional principal amount, which itself is never
paid or received. At December 31, 2002, the notional principal amount was $1.2
billion. Under the terms of an interest rate swap, one counterparty makes
interest payments based on a fixed interest rate and the other counterparty's
payments are based on a floating rate. Interest rate swap contracts are used in
the portfolio as protection against unexpected shifts in interest rates, which
would affect the fair value of the fixed maturity portfolio. By using swaps in
the portfolio, the overall duration or interest rate sensitivity of the
portfolio can be reduced.
The credit risk associated with the above derivative financial instruments
relates to the potential for non-performance by counterparties. Non-performance
is not anticipated; however, in order to minimize the risk of loss, management
monitors the creditworthiness of its counterparties. The performance of exchange
traded instruments is guaranteed by the exchange on which they trade. For
non-exchange traded instruments, the counterparties are principally banks, which
must meet certain criteria according to the Company's investment guidelines.
These counterparties are required to have a minimum credit rating of AA- by
Standard and Poors or Aa3 by Moody's. In addition, certain contracts require
that collateral be posted once pre-determined thresholds are breached as a
result of market movements.
b) CONCENTRATIONS OF CREDIT RISK
The investment portfolio is managed following prudent standards of
diversification. Specific provisions limit the allowable holdings of a single
issue and issuers. The Company believes that there are no significant
concentrations of credit risk associated with its investments.
84
c) 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, is available for
general corporate purposes and as commercial paper back-up. The five-year
facility also permits the issuance of letters of credit. At December 31, 2002,
the outstanding letters of credit issued under this facility amounted to $64
million and there were no other drawings or letters of credit issued under this
facility. In September 2002, the Company reduced the availability under the
364-day facility from $800 million to $500 million. The higher amount was no
longer required given the Company's decreased use of commercial paper and its
access to repurchase agreement financing. The Company is currently negotiating
the annual renewal of its 364-day facility.
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 December 31, 2002, ACE Guaranty Corp. was party to a credit facility
which provides up to $175 million specifically supporting the company's
municipal portfolio and designed to provide rating agency qualified capital to
further support ACE Guaranty Corp.'s claims-paying resources. During 2002, the
facility's expiry date was extended to November 2009. ACE Guaranty Corp. has not
borrowed under this credit facility. In 2002, ACE Guaranty Corp. entered into a
$100 million, 364-day revolving credit facility that expires on May 28, 2003.
The facility is available for general corporate purposes. ACE Guaranty Corp. has
not borrowed under this credit facility.
d) LETTERS OF CREDIT
In November 2002, to fulfill the requirements of Lloyd's for open years of
account, the Company renewed and decreased a syndicated uncollateralized,
five-year LOC facility in the amount of (pound)380 million (approximately $619
million). This facility was originally arranged in 1998. This LOC facility
requires that the Company and/or certain of its subsidiaries continue to
maintain certain covenants, including a minimum consolidated net worth covenant
and a maximum leverage covenant.
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. Usage under this
facility was $455 million at December 31, 2002 compared with $373 million at
December 31, 2001. 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 $276 million at December
31, 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 in the Company's balance sheet.
The Company also maintains various other LOC facilities, both
collateralized and uncollateralized, for general purposes. At December 31, 2002,
the aggregate availability under these facilities was $521 million and usage was
$405 million.
e) LEGAL PROCEEDINGS
The Company's 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 the Company's loss and loss expense reserves. In
addition to claims litigation, the Company and its 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 business ventures. While the outcomes of the business litigation involving
the Company cannot be predicted with certainty at this point, the Company is
disputing, and will continue to dispute, allegations against it that are without
merit. The Company believes that the ultimate outcomes of matters in this
category of business litigation will not have a material adverse effect on the
financial condition, future operating results or liquidity of the Company,
although an adverse resolution of a number of these items could have a material
adverse effect on the Company's results of operations in a particular quarter or
fiscal year.
f) LEASE COMMITMENTS
The Company and its subsidiaries lease office space in the countries in which
they operate under operating leases which expire at various dates through
January 2018. The Company renews and enters into new leases in the ordinary
course of business as required. Total rent expense with respect to these
operating leases for the years ended December 31, 2002, 2001 and 2000 was
approximately $65 million, $62 million and $64 million, respectively.
85
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
Future minimum lease payments under the leases are expected to be as
follows:
Year ending
(in millions of U.S. dollars) December 31
- ----------------------------------------------------------------------------
2003 $ 75
2004 69
2005 63
2006 39
2007 34
Later years 138
- ----------------------------------------------------------------------------
Total minimum future lease commitments $ 418
============================================================================
(g) ACQUISITION OF BUSINESS ENTITIES
Pursuant to the restructuring order that created Brandywine, the active ACE INA
insurance subsidiaries are obligated to provide reinsurance coverage to Century
Indemnity in the amount of $800 million under an aggregate excess of loss
reinsurance agreement if the capital and surplus of Century Indemnity falls
below $25 million or if Century Indemnity lacks liquid assets with which to pay
claims as they become due. (See Note 6 for additional disclosure.)
9. DEBT
The following table outlines the Company's debt as of December 31, 2002 and
2001.
(in millions of U.S. dollars) 2002 2001
- --------------------------------------------------------------------------------
SHORT-TERM DEBT
ACE INA commercial paper $ 146 $ -
ACE Financial Services Note - 25
Reverse Repurchase Agreements - 395
ACE Financial Services Debentures - 75
- --------------------------------------------------------------------------------
$ 146 $ 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 - 400
- --------------------------------------------------------------------------------
$ 475 $ 875
================================================================================
86
a) SHORT-TERM DEBT
The Company arranged certain commercial paper programs in 1999. 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 $750 million as outlined in Note 8) for ACE
and for ACE INA. For the years ended December 31, 2002 and 2001, commercial
paper rates averaged 1.9 percent and 5.0 percent, respectively.
At December 31, 2001, the Company had $395 million in borrowings under
repurchase agreements outstanding 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 Company had used the
proceeds of these repurchase transactions to repay maturing commercial paper and
bank borrowings that were drawn subsequent to the September 11 tragedy. During
2002, the Company repaid the amounts owed to brokers under securities repurchase
transactions with the proceeds raised from the issuance of commercial paper and
internal liquidity. In addition, the Company repaid the $25 million ACE
Financial Services bank note. The Company also repaid the $75 million ACE
Financial Services Debentures in October 2002.
b) ACE LIMITED SENIOR NOTES
In March 2002, ACE Limited issued $500 million of 6.0 percent notes due April 1,
2007. The notes are not redeemable before maturity and do not have the benefit
of any sinking fund. These senior unsecured notes rank equally with all of the
Company's other senior obligations and contain a customary limitation on lien
provisions as well as customary events of default provisions which, if breached,
could result in the accelerated maturity of such senior debt.
c) ACE INA NOTES AND DEBENTURES
In 1999, ACE INA issued $400 million of 8.2 percent notes due August 15, 2004,
$300 million of 8.3 percent notes due August 15, 2006, and $100 million of 8.875
percent debentures due August 15, 2029. The notes and debentures are not
redeemable before maturity and do not have the benefit of any sinking fund.
These unsecured notes and debentures are guaranteed on a senior basis by the
Company and they rank equally with all of ACE INA's other senior indebtedness.
d) ACE US HOLDINGS SENIOR NOTES
In 1998, ACE US Holdings issued $250 million in aggregate principal amount of
unsecured senior notes maturing in October 2008. Interest payments, based on a
floating rate, averaged 8.6 percent during fiscal 2002 and fiscal 2001. The
senior notes are callable subject to certain call premiums. Simultaneously, the
Company entered into a notional $250 million 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 collateral in connection with
the swap transaction. In the event that the Company terminates the swap
prematurely, the Company would be liable for certain transaction costs. The swap
counterparty is a highly-rated major financial institution and the Company does
not anticipate non-performance.
e) 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. Simultaneously, the Company entered into a notional $300
million swap transaction that has the economic effect of reducing the cost of
debt to the consolidated group, excluding fees and expenses, to 8.41 percent for
10 years. Certain assets totaling approximately $105 million are pledged as
collateral in connection with the swap transaction. In the event that the
Company terminates the swap prematurely, the Company would be liable for certain
transaction costs. The swap counter party is a highly-rated major financial
institution and the Company does not anticipate non-performance. During 2002,
the Company repaid $100 million of these notes and swaps, and incurred debt
prepayment expenses of $25 million ($17 million, net of income tax) which is
reported as other expense in the statement of operations.
87
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
f) 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 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 the Company's
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 when they matured.
g) CAPITAL RE LLC MONTHLY INCOME PREFERRED SECURITIES
In 1994, ACE Financial Services, through Capital Re LLC, issued $75 million of
company obligated, mandatorily redeemable preferred securities. Capital Re LLC
exists solely for the purpose of issuing preferred and common shares. These
securities pay monthly dividends at a rate of 7.65 percent per annum, are
callable as of January 1999 at par and are mandatorily redeemable in January
2044. The Company has guaranteed all obligations of Capital Re LLC.
h) ACE INA TRUST PREFERRED SECURITIES
In 1999, ACE Capital Trust I, a Delaware statutory business trust ("ACE Capital
Trust I") issued $100 million, 8.875 percent Trust Originated Preferred
Securities (the "Trust Preferred Securities"). All of the common securities of
ACE Capital Trust I (the "ACE Capital Trust I Common Securities") are owned by
ACE INA.
The Trust Preferred Securities mature on December 31, 2029. The maturity
date may be extended for one or more periods but not later than December 31,
2048. Distributions on the Trust Preferred Securities are payable quarterly at a
rate of 8.875 percent. ACE Capital Trust I may defer these payments for up to 20
consecutive quarters (but no later than December 31, 2029, unless the maturity
date is extended). Any deferred payments would accrue interest quarterly on a
compounded basis if ACE INA defers interest on the subordinated debentures (as
defined below).
The sole assets of ACE Capital Trust I consist of $103,092,800 principal
amount of 8.875 percent Junior Subordinated Deferrable Interest Debentures (the
"Subordinated Debentures") issued by ACE INA. The Subordinated Debentures mature
on December 31, 2029. Interest on the Subordinated Debentures is payable
quarterly at a rate of 8.875 percent. ACE INA may defer such interest payments
(but no later than December 31, 2029, unless the maturity date is extended),
with such deferred payments accruing interest compounded quarterly. ACE INA may
redeem the Subordinated Debentures at 100 percent of the principal amount
thereof, plus accrued and unpaid interest to the redemption date, in whole or in
part, at any time on or after December 31, 2004, and in whole but not in part
prior to December 31, 2004, in the event certain changes in tax or investment
company law occur. The Trust Preferred Securities and the ACE Capital Trust I
Common Securities will be redeemed upon repayment of the Subordinated
Debentures.
The Company has guaranteed, on a subordinated basis, ACE INA's obligations
under the Subordinated Debentures and distributions and other payments due on
the Trust Preferred Securities. These guarantees, when taken together with the
Company's obligations under an expense agreement entered into with ACE Capital
Trust I, provide a full and unconditional guarantee of amounts due on the Trust
Preferred Securities.
i) ACE INA CAPITAL SECURITIES
In 2000, ACE Capital Trust II, a Delaware statutory business trust ("ACE Capital
Trust II"), issued and sold in a public offering $300 million, 9.7 percent
Capital Securities (the "Capital Securities"). All of the common securities of
ACE Capital Trust II (the "ACE Capital Trust II Common Securities") are owned by
ACE INA.
The Capital Securities mature on April 1, 2030, which may not be extended.
Distributions on the Capital Securities are payable semi-annually. ACE Capital
Trust II may defer these payments for up to 10 consecutive semi-annual periods
(but no later than April 1, 2030). Any deferred payments would accrue interest
semi-annually on a compounded basis if ACE INA defers interest on the
Subordinated Debentures due 2030 (as defined below).
88
The sole assets of ACE Capital Trust II consist of $309,280,000 principal
amount of 9.7 percent Junior Subordinated Deferrable Interest Debentures (the
"Subordinated Debentures due 2030") issued by ACE INA. The Subordinated
Debentures due 2030 mature on April 1, 2030. Interest on the Subordinated
Debentures due 2030 is payable semi-annually. ACE INA may defer such interest
payments (but no later than April 1, 2030), with such deferred payments accruing
interest compounded semi-annually. ACE INA may redeem the Subordinated
Debentures due 2030 in the event certain changes in tax or investment company
law occur at a redemption price equal to accrued and unpaid interest to the
redemption date plus the greater of (i) 100 percent of the principal amount
thereof, or (ii) the sum of the present value of scheduled payments of principal
and interest on the debentures from the redemption date to April 1, 2030. The
Capital Securities and the ACE Capital Trust II Common Securities will be
redeemed upon repayment of the Subordinated Debentures due 2030.
The Company has guaranteed, on a subordinated basis, ACE INA's obligations
under the Subordinated Debentures due 2030, and distributions and other payments
due on the Capital Securities. These guarantees, when taken together with the
Company's obligations under expense agreements entered into with ACE Capital
Trust II, provide a full and unconditional guarantee of amounts due on the
Capital Securities.
10. MEZZANINE EQUITY
On April 12, 2000, the Company publicly offered and issued 6,000,000 FELINE
PRIDES. On May 8, 2000, exercise of the 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. Each preferred share is
pledged to the Company to secure the holders obligations under the purchase
contract. A holder of an Income PRIDE can obtain the release of the preferred
share by substituting certain zero-coupon treasury securities as security for
performance under the purchase contract. The resulting unit consisting of the
zero-coupon treasury security and the purchase contract is a Growth PRIDE, and
the preferred shares would be a separate security. A holder of a Growth PRIDE
can convert it back into an Income PRIDE by depositing preferred shares as
security for performance under the purchase contract and thereby obtain the
release of the zero-coupon treasury securities.
The aggregate liquidation preference of the 8.25 percent Cumulative
Redeemable Preferred Shares is $311 million. Unless deferred by the Company, the
preferred shares pay dividends quarterly at a rate of 8.25 percent per year to
May 16, 2003, and thereafter at the reset rate established pursuant to a
remarketing procedure. If the Company elects to defer dividend payments on the
preferred shares, the dividends will continue to accrue and the Company will be
restricted from paying dividends on its Ordinary Shares and taking certain other
actions. The preferred shares are not redeemable prior to June 16, 2003, on
which date they must be redeemed by the Company in whole.
11. SHAREHOLDERS' EQUITY
a) SHARES ISSUED AND OUTSTANDING
Following is a table of changes in Ordinary Shares issued and outstanding for
the years ended December 31, 2002, 2001 and 2000:
2002 2001 2000
- -----------------------------------------------------------------------------------------------
Opening balance 259,861,205 232,346,579 217,460,515
Shares issued, net 332,547 32,415,912 13,008,419
Exercise of stock options 2,232,985 1,648,326 1,826,993
Shares issued under Employee Stock Purchase Plan 252,619 211,288 50,652
Repurchase of shares - (6,760,900) -
- -----------------------------------------------------------------------------------------------
262,679,356 259,861,205 232,346,579
===============================================================================================
ORDINARY SHARES ISSUED TO EMPLOYEE TRUST
Opening balance (713,475) (661,125) (659,625)
Shares issued (43,000) (52,350) (1,500)
- -----------------------------------------------------------------------------------------------
(756,475) (713,475) (661,125)
===============================================================================================
89
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
In 2002, under the terms of the Company's long-term incentive plans, 887,000
restricted Ordinary Shares were issued to officers and directors of the Company
and 554,453 restricted Ordinary Shares were cancelled. In October 2001, the
Company completed a public offering of 32.89 million Ordinary Shares (which
included the over-allotment option of 4.29 million shares) in which it raised
aggregate net proceeds of approximately $1.1 billion. The Company used the net
proceeds of the Ordinary Share offering to expand its net underwriting capacity
and for general corporate purposes. In addition, 474,088 restricted Ordinary
Shares of the Company were cancelled in connection with the Company's long-term
incentive plans during 2001.
In September 2000, the Company completed a public offering of 12.25 million
Ordinary Shares (which included exercise of the over-allotment option of 1.25
million shares) in which it raised aggregate net proceeds of approximately $400
million. The offering was made in satisfaction of a June 29, 1999, agreement
with Banc of America Securities LLC. In addition, the Company issued 758,419
restricted Ordinary Shares in connection with the Company's long term incentive
plans during 2000.
Ordinary Shares issued to employee trust are the shares issued by the
Company to a rabbi trust for deferred compensation obligations (see Note 12g).
b) ACE LIMITED SECURITIES REPURCHASE AUTHORIZATION
In November 2001, the Board of Directors authorized the repurchase of any ACE
issued debt or capital securities, including ACE's Ordinary Shares, up to an
aggregate total of $250 million. These purchases may take place from time to
time in the open market or in private purchase transactions. At December 31,
2002, this authorization has not been utilized. During 2001, the Company
repurchased and cancelled 6,760,900 Ordinary Shares under a previous repurchase
authorization for an aggregate cost of $179.4 million.
c) GENERAL RESTRICTIONS
The holders of the Ordinary Shares are entitled to receive dividends and are
allowed one vote per share provided that, if the controlled shares of any
shareholder constitute 10 percent or more of the outstanding Ordinary Shares of
the Company, only a fraction of the vote will be allowed so as not to exceed 10
percent. Generally, the Company's directors have absolute discretion to decline
to register any transfer of shares. All transfers are subject to the restriction
that they may not increase to 10 percent or higher the proportion of issued
Ordinary Shares owned by any shareholder.
d) DIVIDENDS DECLARED
Dividends declared on Ordinary Shares amounted to $0.66, $0.58 and $0.50 per
Ordinary Share for the years ended December 31, 2002, 2001 and 2000,
respectively. Dividends declared on Mezzanine equity amounted to $26 million for
the years ended December 31, 2002 and 2001 and $18 million for the year ended
December 31, 2000.
12. EMPLOYEE BENEFIT PLANS
a) PENSION PLANS
The Company provides pension benefits to eligible employees and their dependents
through various defined contribution plans and defined benefit plans sponsored
by the Company. These plans include a capital accumulation plan (401(k)) in the
United States.
Defined contribution plans (including (401(k))
Under these plans, employees contributions may be supplemented by ACE matching
donations based on the level of employee contribution. These contributions are
invested at the election of each employee in one or more of several investment
portfolios offered by a third party investment advisor. In addition, the Company
may provide additional matching contributions, depending on its annual financial
performance. Expenses for these plans totaled $43 million, $39 million and $37
million for the years ended December 31, 2002, 2001 and 2000, respectively.
90
Defined benefit plans
The plans are non-contributory, defined benefit plans and are based on
employees' years of service and compensation during final years of service. All
underlying defined benefit plans are subject to periodic actuarial valuation.
The Company funds the plans at least at the minimum amount required by FAS 87,
"Employers' Accounting for Pensions". The accumulated benefit obligation is
compared to plan assets, both as defined in FAS 87, and any resulting deficiency
is recorded as a liability in accounts payable, accrued expenses and other
liabilities.
The status of the defined benefit pension plans at December 31, 2002 and
2001, is as follows:
(in thousands of U.S. dollars) 2002 2001
- -------------------------------------------------------------------------------
Change in benefit obligation
Benefit obligation, at beginning of year $ 171,889 $ 166,356
Service cost 2,840 4,371
Interest cost 9,175 8,358
Actuarial gain 3,871 12,632
Benefits paid (6,141) (11,841)
Foreign currency losses 9,663 3,178
Amendments - (408)
Curtailment - (1,286)
Settlement - (9,470)
- -------------------------------------------------------------------------------
Benefit obligation, at end of year $ 191,297 $ 171,890
===============================================================================
- -------------------------------------------------------------------------------
Change in plan assets
Fair value of plan assets, at beginning of year $ 133,659 $ 109,660
Actual return on plan assets (37,407) 21,687
Employer contribution 5,882 8,582
Benefits paid (6,141) (11,841)
Foreign currency gains 10,155 5,571
- -------------------------------------------------------------------------------
Fair value of plan assets, at end of year $ 106,148 $ 133,659
- -------------------------------------------------------------------------------
Funded status $ (85,149) $ (38,231)
Unrecognized net actuarial (gain)/loss 50,823 (1,445)
- -------------------------------------------------------------------------------
Accrued benefit cost $ (34,326) $ (39,676)
- -------------------------------------------------------------------------------
Components of net benefit cost
Service cost $ 2,840 $ 4,371
Interest cost 9,175 8,358
Expected return on plan assets (11,011) (9,899)
Recognized net actuarial (gain)/loss 152 (9,529)
- -------------------------------------------------------------------------------
Net benefit cost $ 1,156 $ (6,699)
===============================================================================
The following are the key assumptions used in the actuarial determination of the
pension obligation:
2002 2001
- -------------------------------------------------------------------------------
Weighted-average assumptions as of December 31
Discount rate 5.06% 6.53%
Expected rate of return on plan assets 3.35% 4.22%
Rate of compensation increase 7.81% 8.16%
===============================================================================
91
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
b) OPTIONS AND STOCK APPRECIATION RIGHTS
In February 1996 and November 1998, shareholders of the Company approved the ACE
Limited 1995 Long-Term Incentive Plan and the ACE Limited 1998 Long-Term
Incentive Plan, respectively (the "Incentive Plans"), which incorporate stock
options, stock appreciation rights, restricted stock awards and stock purchase
programs. At December 31, 2002, there were 11.7 million Ordinary Shares of the
Company available for award under these Incentive Plans. Prior to the adoption
of the Incentive Plans, the Company adopted the Equity Linked Incentive Plan,
which incorporated both a Stock Appreciation Rights Plan and a Stock Option Plan
("Option Plan") which will continue to run off. Under the Option Plan,
generally, options expire ten years after the award date and are subject to a
vesting period of four years. Stock options granted under the Incentive Plan may
be exercised for Ordinary Shares of the Company upon vesting. Under the
Incentive Plans, generally, options expire ten years after the award date and
vest in equal portions over three years.
During 1999, the Company established the ACE Limited 1999 Replacement Stock
Plan. This plan was established to replace existing Capital Re employee benefits
in connection with the Capital Re acquisition, as well as to permit additional
grants to employees of the Company. The Company may grant options, stock
appreciation rights, stock units, performance shares, performance units,
restricted stock and restricted stock units. Any such award shall be subject to
such conditions, restrictions and contingencies as the Company determines. At
December 31, 2002, two million Ordinary Shares were available for grant under
this plan.
c) OPTIONS
(i) Options outstanding
Following is a summary of options issued and outstanding for the years ended
December 31, 2002, 2001 and 2000:
Year of Average Options for
Expiration Exercise Price Ordinary Shares
- -----------------------------------------------------------------------------------
Balance at December 31, 1999 13,964,760
Options granted 2010 $ 25.26 4,214,018
Options exercised 2003-2009 $ 35.71 (1,826,993)
Options forfeited 2006-2008 $ 25.30 (454,985)
- -----------------------------------------------------------------------------------
Balance at December 31, 2000 15,896,800
Options granted 2011 $ 35.63 3,821,615
Options exercised 2002-2010 $ 37.87 (1,648,326)
Options forfeited 2004-2011 $ 26.28 (999,459)
- -----------------------------------------------------------------------------------
Balance at December 31, 2001 17,070,630
Options granted 2012 $ 42.57 5,220,693
Options exercised 2003-2012 $ 40.01 (2,232,985)
Options forfeited 2006-2012 $ 33.22 (746,051)
- -----------------------------------------------------------------------------------
Balance at December 31, 2002 19,312,287
===================================================================================
The following table summarizes the range of exercise prices for outstanding
options at December 31, 2002.
Weighted Weighted Weighted
Range of Average Average Average
Exercise Options Remaining Exercise Options Exercise
Prices Outstanding Contractual Life Price Exercisable Price
- ------------------------------------------------------------------------------------------------------------
$ 7.45-$15.00 2,792,892 2.63 years $ 8.77 2,790,225 $ 8.76
$ 15.00-$30.00 7,873,618 5.93 years $ 22.43 7,759,852 $ 22.41
$ 30.00-$43.90 8,645,777 8.67 years $ 39.94 1,401,197 $ 35.68
- ------------------------------------------------------------------------------------------------------------
19,312,287 11,951,274
============================================================================================================
92
(ii) FAS 123 pro forma disclosures
In October 1995, FASB issued FAS No. 123, "Accounting for Stock-Based
Compensation" ("FAS 123"). FAS 123 established accounting and reporting
standards for stock-based employee compensation plans, which include stock
option and stock purchase plans. FAS 123 provides employers a choice: adopt FAS
123 accounting standards for all stock compensation arrangements which requires
the recognition of compensation expense for the fair value of virtually all
stock compensation awards; or continue to account for stock options and other
forms of stock compensation under APB 25, while also providing the disclosure
required under FAS 123. In December 2002, FASB issued FAS No. 148, "Accounting
for Stock-Based Compensation-Transition and Disclosure" ("FAS 148"). FAS 148
amends the disclosure requirements of FAS 123 to require prominent disclosures
in both annual and interim financial statements about the method of accounting
for stock-based compensation and the effect of the method used on reported
results. The Company continues to account for stock-based compensation plans in
accordance with APB 25. No compensation expense for options is reflected in net
income, as all options granted under those plans had an exercise price equal to
the market value of the underlying common stock on the date of the grant.
The following table outlines the Company's net income available to holders
of Ordinary Shares and diluted earnings per share for the years ended December
31, 2002, 2001 and 2000, had the compensation cost been determined in accordance
with the fair value method recommended in FAS 123.
(in thousands of U.S. dollars, except per share data) 2002 2001 2000
- ----------------------------------------------------------------------------------------------------
Net income (loss) available to holders of Ordinary Shares
As reported $ 50,887 $ (172,008) $ 524,591
Compensation expense, net of income tax $ 33,602 $ 15,776 $ 12,163
Pro Forma $ 17,285 $ (187,784) $ 512,428
BASIC EARNINGS (LOSS) PER SHARE:
As reported $ 0.19 $ (0.74) $ 2.37
Pro Forma $ 0.06 $ (0.80) $ 2.32
DILUTED EARNINGS (LOSS) PER SHARE:
As reported $ 0.19 $ (0.74) $ 2.31
Pro Forma $ 0.06 $ (0.80) $ 2.25
====================================================================================================
The fair value of the options issued is estimated on the date of grant using the
Black-Scholes option-pricing model, with the following weighted-average
assumptions used for grants in 2002, 2001 and 2000, respectively: dividend yield
of 1.43 percent, 1.65 percent and 2.23 percent; expected volatility of 35.2
percent, 42.8 percent and 40.1 percent; risk free interest rate of 4.01 percent,
4.84 percent and 6.37 percent and an expected life of four years for each year.
d) EMPLOYEE STOCK PURCHASE PLAN
The Company maintains an employee stock purchase plan ("ESPP"). Participation in
the plan is available to all eligible employees. Maximum annual purchases by
participants are limited to the number of whole shares that can be purchased by
an amount equal to 10 percent of the participant's compensation or $25,000,
whichever is less. Participants may purchase shares at a purchase price equal to
85 percent of the lesser of (i) the fair market value of the stock on first day
of the subscription period; or (ii) the fair market value of the stock on the
last day of the subscription period. Pursuant to the provisions of the ESPP,
during 2002, 2001 and 2000, employees paid $7.5 million, $6.1 million and $1.2
million, respectively to purchase 252,619 shares, 211,288 shares and 50,652
shares, respectively.
93
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
e) RESTRICTED STOCK AWARDS
Under the Company's long-term incentive plans 881,142 restricted Ordinary Shares
were awarded during the year ended December 31, 2002, to officers of the Company
and its subsidiaries. These shares vest at various dates through December 2006.
In addition, during the year, 12,588 restricted Ordinary Shares were awarded to
outside directors under the terms of the 1995 Outside Director Plan. These
shares vest in May 2003.
Under the Company's long-term incentive plans, 704,748 restricted Ordinary
Shares were awarded during the year ended December 31, 2001, to officers of the
Company and its subsidiaries. These shares vest at various dates through
December 2005. In addition, during the year, 12,650 restricted Ordinary Shares
were awarded to outside directors under the terms of the 1995 Outside Directors
Plan. These shares vested in May 2002.
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.
f) 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.
13. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share for the years ended December 31, 2002, 2001 and 2000.
(in thousands of U.S. dollars, except share and per share data) 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------------------
Numerator:
Net income (loss) before cumulative effect of adopting a new
accounting standard $ 76,549 $ (123,744) $ 542,982
Dividends on Mezzanine equity (25,662) (25,594) (18,391)
- ---------------------------------------------------------------------------------------------------------------------------
Net income (loss) available to holders of Ordinary Shares
before cumulative effect 50,887 (149,338) 524,591
Cumulative effect of adopting a new accounting standard - (22,670) -
- ---------------------------------------------------------------------------------------------------------------------------
Net income (loss) available to holders of Ordinary Shares $ 50,887 $ (172,008) $ 524,591
===========================================================================================================================
Denominator:
Denominator for basic earnings per share:
Weighted average shares outstanding 260,535,836 233,799,588 221,082,961
Dilutive effect of Mezzanine equity 2,874,870 - 1,099,226
Effect of other dilutive securities 6,459,317 - 5,236,243
- ---------------------------------------------------------------------------------------------------------------------------
Denominator for diluted earnings (loss) per share:
Adjusted weighted average shares outstanding and
assumed conversions 269,870,023 233,799,588 227,418,430
===========================================================================================================================
BASIC EARNINGS (LOSS) PER SHARE:
Earnings (loss) per share before cumulative effect of
adopting a new accounting standard $ 0.19 $ (0.64) $ 2.37
Earnings (loss) per share $ 0.19 $ (0.74) $ 2.37
===========================================================================================================================
DILUTED EARNINGS (LOSS) PER SHARE:
Earnings (loss) per share before cumulative effect
of adopting a new accounting standard $ 0.19 $ (0.64) $ 2.31
Earnings (loss) per share $ 0.19 $ (0.74) $ 2.31
===========================================================================================================================
94
The denominator for diluted loss per share for the year ended December 31, 2001
does not include the dilutive effect of Mezzanine equity 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 Mezzanine equity for the year ended
December 31, 2001 is 3,180,571 shares. Other dilutive securities totaled
8,085,418 shares for the year ended December 31, 2001.
14. 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 U.K. domiciled companies, will receive
U.K. corporation tax credits for any U.S. income tax incurred up to the value of
the equivalent U.K. corporation income tax charge on the U.S. income.
ACE Prime Holdings, ACE US Holdings and ACE Cap Re USA Holdings, and their
respective subsidiaries 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.
The Company is not subject to taxation other than as stated above. 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 years ended December 31, 2002, 2001 and
2000 is as follows:
(in thousands of U.S. dollars) 2002 2001 2000
- -------------------------------------------------------------------------------
Current tax expense $ 29,432 $ 39,384 $ 60,081
Deferred tax expense (benefit) (145,120) (118,058) 33,827
- -------------------------------------------------------------------------------
Provision for income taxes $ (115,688) $ (78,674) $ 93,908
===============================================================================
95
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
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 years ended December 31, 2002 and 2001, is
provided below.
(in thousands of U.S. dollars) 2002 2001
- ------------------------------------------------------------------------------------
Expected tax provision at weighted average rate $ (121,639) $ (92,276)
Permanent differences
Tax-exempt interest (16,917) (15,234)
Other 9,166 (8,570)
Goodwill - 23,113
Net withholding taxes 13,702 14,293
- ------------------------------------------------------------------------------------
Total provision for income taxes $ (115,688) $ (78,674)
====================================================================================
The components of the net deferred tax asset as of December 31, 2002, and 2001
are as follows:
(in thousands of U.S. dollars) 2002 2001
- ------------------------------------------------------------------------------------
Deferred tax assets
Loss reserve discount $ 500,061 $ 422,211
Unearned premium reserve 94,566 67,210
Foreign tax credits 133,811 155,079
Investments 123,410 63,459
Bad debts 177,197 129,280
Net operating loss carryforward 518,879 495,048
Other 199,461 254,822
- ------------------------------------------------------------------------------------
Total deferred tax assets 1,747,385 1,587,109
- ------------------------------------------------------------------------------------
Deferred tax liabilities
Deferred policy acquisition costs 148,811 133,664
Unrealized appreciation on investments 135,627 28,570
Other 39,372 38,448
- ------------------------------------------------------------------------------------
Total deferred tax liabilities 323,810 200,682
- ------------------------------------------------------------------------------------
Valuation allowance 135,592 135,592
- ------------------------------------------------------------------------------------
Net deferred tax asset $ 1,287,983 $ 1,250,835
====================================================================================
The valuation allowance of $135.6 million at December 31, 2002 and 2001,
reflects management's assessment, based on available information, that it is
more likely than not that a portion of the deferred tax asset will not be
realized due to the inability of certain foreign subsidiaries to generate
sufficient taxable income. Adjustments to the valuation allowances are made when
there is a change in management's assessment of the amount of deferred tax asset
that is realizable.
At December 31, 2002, the Company has net operating loss carryforwards for
U.S. federal income tax purposes of approximately $1.5 billion, which are
available to offset future U.S. federal taxable income through 2022.
96
15. STATUTORY FINANCIAL INFORMATION
The Company's insurance and reinsurance subsidiaries are subject to insurance
laws and regulations in the jurisdictions in which they operate. These
regulations include restrictions that limit the amount of dividends or other
distributions, such as loans or cash advances, available to shareholders without
prior approval of the insurance regulatory authorities. Statutory capital and
surplus of the Bermuda subsidiaries was $3.1 billion, $3.1 billion and $2.7
billion at December 31, 2002, 2001 and 2000, and statutory net income was $416
million, $55 million and $364 million for the years ended December 31, 2002,
2001 and 2000, respectively.
There are no statutory restrictions on the payment of dividends from
retained earnings by any of 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.
The Company's U.S. subsidiaries file financial statements prepared in
accordance with statutory accounting practices prescribed or permitted by
insurance regulators. In 1998, the National Association of Insurance
Commissioners ("NAIC") adopted the Codification of Statutory Accounting
Principles guidance, which replaces the current Accounting Practices and
Procedures manual as the NAIC's primary guidance on statutory accounting as of
January 1, 2001. The Codification provides guidance for areas where statutory
accounting has been silent and changes current statutory accounting in some
areas. All states and Puerto Rico have adopted the Codification guidance,
effective January 1, 2001.
Statutory accounting differs from generally accepted accounting policies in
the reporting of certain reinsurance contracts, investments, subsidiaries,
acquisition expenses, fixed assets, deferred income taxes and certain other
items. Combined statutory surplus of the Company's U.S. subsidiaries was $2.3
billion, $2.2 billion and $1.9 billion at December 31, 2002, 2001 and 2000,
respectively. The combined statutory net income (loss) of these operations was
$(78) million, $160 million and $(12) million for the years ended December 31,
2002, 2001 and 2000, respectively.
The Company's international subsidiaries prepare statutory financial
statements based on local laws and regulations. Some jurisdictions impose
complex regulatory requirements on insurance companies while other jurisdictions
impose fewer requirements. In some countries, the Company must obtain licenses
issued by governmental authorities to conduct local insurance business. These
licenses may be subject to reserves and minimum capital and solvency tests.
Jurisdictions may impose fines, censure, and/or criminal sanctions for violation
of regulatory requirements.
16. SUBSIDIARY ISSUER INFORMATION
The following tables present the 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 December 31, 2002 and 2001 and for the years ended December 31,
2002, 2001 and 2000. The Subsidiary Issuers are direct or 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 (see Note 9).
97
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
CONDENSED CONSOLIDATING BALANCE SHEET
At December 31, 2002
ACE INA ACE Financial Other ACE
ACE Limited Holdings, Inc. Services, Inc. Limited
(Parent Co. (Subsidiary (Subsidiary Subsidiaries and Consolidating ACE Limited
(in thousands of U.S. dollars) Guarantor) Issuer) Issuer) Eliminations/(1)/ Adjustments/(2)/ Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Total investments and cash $ 77,506 $ 7,413,714 $ 1,023,777 $ 9,808,911 $ - $ 18,323,908
Insurance and reinsurance
balances receivable - 1,729,439 28,252 896,299 - 2,653,990
Reinsurance recoverable - 11,616,228 11,420 2,363,805 - 13,991,453
Goodwill - 2,130,908 96,723 489,229 - 2,716,860
Investments in subsidiaries 7,095,429 - 152,000 (152,000) (7,095,429) -
Due from subsidiaries and
affiliates, net 162,314 50,967 (49,681) (1,286) (162,314) -
Other assets 42,703 4,235,625 210,477 1,275,921 - 5,764,726
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets $ 7,377,952 $ 27,176,881 $ 1,472,968 $ 14,680,879 $ (7,257,743) $ 43,450,937
====================================================================================================================================
LIABILITIES
Unpaid losses and loss
expenses $ - $ 17,057,979 $ 75,960 $ 7,181,243 $ - $ 24,315,182
Unearned premiums - 3,233,614 352,551 1,999,359 - 5,585,524
Future policy benefits for
life and annuity contracts - - - 442,264 - 442,264
Short-term debt - 145,940 - - - 145,940
Long-term debt 499,282 999,655 - 250,000 - 1,748,937
Trust preferred securities - 400,000 75,000 - - 475,000
Other liabilities 178,934 2,574,801 160,238 1,124,381 - 4,038,354
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities 678,216 24,411,989 663,749 10,997,247 - 36,751,201
- ------------------------------------------------------------------------------------------------------------------------------------
Mezzanine equity 311,050 - - - - 311,050
- ------------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 6,388,686 2,764,892 809,219 3,683,632 (7,257,743) 6,388,686
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities, mezzanine
equity and shareholders'
equity $ 7,377,952 $ 27,176,881 $ 1,472,968 $ 14,680,879 $ (7,257,743) $ 43,450,937
====================================================================================================================================
/(1)/ Includes all other subsidiaries of ACE Limited and intercompany
eliminations.
/(2)/ Includes ACE Limited parent company eliminations.
98
CONDENSED CONSOLIDATING BALANCE SHEET
At December 31, 2001
ACE INA ACE Financial Other ACE
ACE Limited Holdings, Inc. Services, Inc. Limited
(Parent Co. (Subsidiary (Subsidiary Subsidiaries and Consolidating ACE Limited
(in thousands of U.S. dollars) 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
Unearned premiums - 2,055,459 323,951 1,474,019 - 3,853,429
Future policy benefits for
life and annuity contracts - - - 382,730 - 382,730
Short-term debt - - 99,980 395,428 - 495,408
Long-term debt - 1,099,473 - 250,000 - 1,349,473
Trust preferred securities - 800,000 75,000 - - 875,000
Other liabilities 106,385 2,395,745 138,586 444,129 - 3,084,845
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities 106,385 20,818,701 713,340 9,130,581 - 30,769,007
- ------------------------------------------------------------------------------------------------------------------------------------
Mezzanine equity 311,050 - - - - 311,050
- ------------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 6,106,707 1,621,448 642,204 3,706,324 (5,969,976) 6,106,707
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities, mezzanine
equity and shareholders'
equity $ 6,524,142 $ 22,440,149 $ 1,355,544 $ 12,836,905 $ (5,969,976) $ 37,186,764
====================================================================================================================================
/(1)/ Includes all other subsidiaries of ACE Limited and intercompany
eliminations.
/(2)/ Includes ACE Limited parent company eliminations.
99
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
For the year ended December 31, 2002
ACE INA ACE Financial Other ACE
ACE Limited Holdings, Inc. Services, Inc. Limited
Parent Co. (Subsidiary (Subsidiary Subsidiaries and Consolidating ACE Limited
(in thousands of U.S. dollars) (Guarantor) Issuer) Issuer) Eliminations/(1)/ Adjustments/(2)/ Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Net premiums written $ - $ 3,919,544 $ 124,618 $ 4,024,136 $ - $ 8,068,298
Net premiums earned - 3,216,854 112,421 3,501,229 - 6,830,504
Net investment income 46,848 319,638 46,778 419,501 (30,624) 802,141
Other income (expense) - (28,362) - 7,810 - (20,552)
Equity in earnings of
subsidiaries 215,437 - - - (215,437) -
Net realized losses on
investments (79,480) (161,691) (29,681) (218,237) - (489,089)
Losses and loss expenses - 2,775,631 24,512 2,106,367 - 4,906,510
Life and annuity benefits - - - 158,118 - 158,118
Policy acquisition costs and
administrative expenses 71,018 847,766 49,699 939,302 (3,764) 1,904,021
Interest expense 27,431 149,065 11,892 20,658 (15,552) 193,494
Income tax expense (benefit) 7,807 (155,871) 5,908 26,468 - (115,688)
- ------------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 76,549 $ (270,152) $ 37,507 $ 459,390 $ (226,745) $ 76,549
====================================================================================================================================
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
For the year ended December 31, 2001
ACE INA ACE Financial Other ACE
ACE Limited Holdings, Inc. Services, Inc. Limited
(Parent Co. (Subsidiary (Subsidiary Subsidiaries and Consolidating ACE Limited
(in thousands of U.S. dollars) Guarantor) Issuer) Issuer) Eliminations/(1)/ Adjustments/(2)/ Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
Net premiums written $ - $ 2,616,489 $ 88,997 $ 3,658,128 $ - $ 6,363,614
Net premiums earned - 2,498,169 77,662 3,341,346 - 5,917,177
Net investment income 62,322 351,282 46,602 362,438 (36,775) 785,869
Other income (expense) - (1,078) - 1,530 - 452
Equity in earnings of
subsidiaries (136,456) - - - 136,456 -
Net realized gains (losses)
on investments (13,524) (52,441) 19,968 (12,362) - (58,359)
Losses and loss expenses - 1,970,727 22,854 2,558,875 - 4,552,456
Life and annuity benefits - - - 401,229 - 401,229
Policy acquisition costs and
administrative expenses 58,164 765,725 38,270 753,754 (794) 1,615,119
Interest expense (7,753) 179,505 14,013 20,492 (7,075) 199,182
Income tax expense (benefit) 8,345 (45,420) 8,229 (49,828) - (78,674)
Amortization of goodwill - 57,960 4,205 17,406 - 79,571
- -----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) before
cumulative effect of
adopting a new accounting
standard (146,414) (132,565) 56,661 (8,976) 107,550 (123,744)
Cumulative effect of adopting
a new accounting standard* - - (22,800) 130 - (22,670)
- -----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (146,414) $ (132,565) $ 33,861 $ (8,846) $ 107,550 $ (146,414)
===================================================================================================================================
/(1)/ Includes all other subsidiaries of ACE Limited and intercompany
eliminations.
/(2)/ Includes ACE Limited parent company eliminations.
* Shown net of income tax
100
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
For the year ended December 31, 2000
ACE INA ACE Financial Other ACE
ACE Limited Holdings, Inc. Services, Inc. Limited
(Parent Co. (Subsidiary (Subsidiary Subsidiaries and Consolidating ACE Limited
(in thousands of U.S. dollars) Guarantor) Issuer) Issuer) Eliminations/(1)/ Adjustments/(2)/ Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
Net premiums written $ - $ 2,437,811 $ 82,746 $ 2,358,797 $ - $ 4,879,354
Net premiums earned - 2,417,189 67,534 2,050,040 - 4,534,763
Net investment income 43,214 385,722 48,045 322,526 (28,652) 770,855
Other income (expense) - (1,868) - 4,810 - 2,942
Equity in earnings of subsidiaries 575,032 - - - (575,032) -
Net realized gains (losses)
on investments (1,623) (5,207) (37,836) 5,705 - (38,961)
Losses and loss expenses - 1,713,725 9,109 1,213,231 - 2,936,065
Policy acquisition costs and
administrative expenses 58,984 730,852 35,419 571,913 (794) 1,396,374
Interest expense 6,373 188,454 13,361 23,000 (9,738) 221,450
Income tax expense 8,284 45,232 15,910 24,482 - 93,908
Amortization of goodwill - 56,980 4,205 17,635 - 78,820
- -----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 542,982 $ 60,593 $ (261) $ 532,820 $ (593,152) $ 542,982
===================================================================================================================================
/(1)/ Includes all other subsidiaries of ACE Limited and intercompany
eliminations.
/(2)/ Includes ACE Limited parent company eliminations.
101
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the year ended December 31, 2002
ACE INA ACE Financial Other ACE
ACE Limited Holdings, Inc. Services, Inc. Limited
(Parent Co. (Subsidiary (Subsidiary Subsidiaries and ACE Limited
(in thousands of U.S. dollars) Guarantor) Issuer) Issuer) Eliminations/(1)/ Consolidated
- ---------------------------------------------------------------------------------------------------------------------
NET CASH FLOWS FROM (USED FOR)
OPERATING ACTIVITIES $ (175,655) $ (146,920) $ 67,146 $ 2,680,417 $ 2,424,988
- ---------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING
ACTIVITIES
Purchases of fixed maturities (53,613) (3,719,650) (651,029) (13,525,531) (17,949,823)
Purchases of equity securities - (85,164) - (133,688) (218,852)
Sales of fixed maturities 399,456 3,106,157 577,428 11,865,380 15,948,421
Sales of equity securities - 67,884 - 95,140 163,024
Maturities of fixed maturities - - - 284,899 284,899
Net realized losses on financial
futures contracts - - - (105,429) (105,429)
Settlement of an acquisition-
related lawsuit 54,380 - - - 54,380
Other - (16,238) - (101,985) (118,223)
- ---------------------------------------------------------------------------------------------------------------------
Net cash flows from (used for)
investing activities $ 400,223 $ (647,011) $ (73,601) $ (1,621,214) $ (1,941,603)
- ---------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING
ACTIVITIES
Dividends paid on Ordinary Shares (167,470) - - - (167,470)
Dividends paid on Mezzanine equity (25,662) - - - (25,662)
Proceeds from short-term debt, net - 145,940 (100,000) (395,408) (349,468)
Proceeds from long-term debt, net 499,155 (100,000) - - 399,155
Repayment of trust preferred
securities - (400,000) - - (400,000)
Advances to (from) affiliates 216,676 (9,866) 9,866 (216,676) -
Proceeds from exercise of options
for Ordinary Shares 44,562 - - - 44,562
Proceeds from Ordinary Shares
issued under ESPP 7,472 - - - 7,472
Capitalization of subsidiaries (1,314,676) 1,280,691 100,000 (66,015) -
Dividends received from
subsidiaries 485,000 - - (485,000) -
- ---------------------------------------------------------------------------------------------------------------------
Net cash flows from (used for)
financing activities $ (254,943) $ 916,765 $ 9,866 $ (1,163,099) $ (491,411)
- ---------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash (30,375) 122,834 3,411 (103,896) (8,026)
Cash - beginning of year 32,525 355,327 1,027 282,502 671,381
- ---------------------------------------------------------------------------------------------------------------------
Cash - end of year $ 2,150 $ 478,161 $ 4,438 $ 178,606 $ 663,355
=====================================================================================================================
/(1)/ Includes all other subsidiaries of ACE Limited and intercompany
eliminations.
102
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the year ended December 31, 2001
ACE INA ACE Financial Other ACE
ACE Limited Holdings, Inc. Services, Inc. Limited
(Parent Co. (Subsidiary (Subsidiary Subsidiaries and ACE Limited
(in thousands of U.S. dollars) Guarantor) Issuer) Issuer) Eliminations/(1)/ Consolidated
- ---------------------------------------------------------------------------------------------------------------------
NET CASH FLOWS FROM (USED FOR)
OPERATING ACTIVITIES $ 113,428 $ (328,591) $ (51,649) $ 1,619,817 $ 1,353,005
- ---------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of fixed maturities (125,733) (2,153,163) (848,263) (13,720,761) (16,847,920)
Purchases of equity securities - (122,778) - (88,158) (210,936)
Sales of fixed maturities 94,689 2,386,217 835,459 11,417,213 14,733,578
Sales of equity securities - 122,437 - 82,405 204,842
Maturities of fixed maturities - - 4,500 40,429 44,929
Net realized losses on financial
futures contracts - - - (21,976) (21,976)
Other (1,009) (60,594) (7,337) (20,175) (89,115)
- ---------------------------------------------------------------------------------------------------------------------
Net cash flows from (used for)
investing activities $ (32,053) $ 172,119 $ (15,641) $ (2,311,023) $ (2,186,598)
- ---------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid on Ordinary Shares (128,745) - - - (128,745)
Dividends paid on Mezzanine equity (25,666) - - - (25,666)
Repurchase of Ordinary Shares (179,446) - - - (179,446)
Proceeds from short-term debt, net - (335,708) - 391,852 56,144
Proceeds from issuance of
Ordinary Shares, net 1,135,878 - - - 1,135,878
Advances to (from) affiliates (174,000) 483,060 41,741 (350,801) -
Proceeds from exercise of options
for Ordinary Shares 32,666 - - - 32,666
Proceeds from Ordinary Shares
issued under ESPP 6,074 - - - 6,074
Capitalization of subsidiaries (1,101,000) 111,000 - 990,000 -
Dividends received from
subsidiaries 338,873 - - (338,873) -
- ---------------------------------------------------------------------------------------------------------------------
Net cash flows from (used for)
financing activities $ (95,366) $ 258,352 $ 41,741 $ 692,178 $ 896,905
- ---------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash (13,991) 101,880 (25,549) 972 63,312
Cash - beginning of year 46,516 253,447 26,576 281,530 608,069
- ---------------------------------------------------------------------------------------------------------------------
Cash - end of year $ 32,525 $ 355,327 $ 1,027 $ 282,502 $ 671,381
=====================================================================================================================
/(1)/ Includes all other subsidiaries of ACE Limited and intercompany
eliminations.
103
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the year ended December 31, 2000
ACE INA ACE Financial Other ACE
ACE Limited Holdings, Inc. Services, Inc. Limited
(Parent Co. (Subsidiary (Subsidiary Subsidiaries and Consolidating ACE Limited
(in thousands of U.S. dollars) Guarantor) Issuer) Issuer) Eliminations/(1)/ Adjustments/(2)/ Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
NET CASH FLOWS FROM (USED FOR)
OPERATING ACTIVITIES $ (49,024) $ (1,212,871) $ 58,605 $ 776,118 $ - $ (427,172)
- -----------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING
ACTIVITIES
Purchases of fixed maturities (618,049) (2,907,397) (722,539) (7,228,653) - (11,476,638)
Purchases of equity securities - (226,474) - (184,548) - (411,022)
Sales of fixed maturities 449,766 3,764,557 668,059 6,639,296 - 11,521,678
Sales of equity securities - 535,531 - 257,968 - 793,499
Maturities of fixed maturities - - 2,000 66,869 - 68,869
Net realized losses on financial
futures contracts - - - (48,227) - (48,227)
Sale (acquisition) of subsidiaries 82,244 - 10,200 (10,200) (82,244) -
Other 135 (1,495) 5,020 (218,076) - (214,416)
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash flows from (used for)
investing activities $ (85,904) $ 1,164,722 $ (37,260) $ (725,571) $ (82,244) $ 233,743
- -----------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING
ACTIVITIES
Dividends paid on Ordinary Shares (106,459) - - - - (106,459)
Dividends paid on Mezzanine equity (15,254) - - - - (15,254)
Repayment of short-term debt, net (424,886) (280,830) - (4,360) - (710,076)
Proceeds from issuance of trust
preferred securities - 300,000 - - - 300,000
Proceeds from issuance of
Mezzanine equity 311,050 - - - - 311,050
Issuance costs of Mezzanine equity (9,884) - - - - (9,884)
Advances to affiliates (95,513) - - 95,513 - -
Proceeds from exercise of options
for Ordinary Shares 31,335 - - - - 31,335
Proceeds from Ordinary Shares
issued under ESPP 1,234 - - - - 1,234
Capitalization of subsidiaries (27,103) - 5,000 22,103 - -
Dividends received from subsidiaries 101,147 - - (101,147) - -
Proceeds from issuance of
Ordinary Shares, net 400,320 - - - - 400,320
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash flows from (used for)
financing activities $ 165,987 $ 19,170 $ 5,000 $ 12,109 $ - $ 202,266
- -----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash 31,059 (28,979) 26,345 62,656 (82,244) 8,837
Cash - beginning of year 15,457 282,426 231 301,118 - 599,232
- -----------------------------------------------------------------------------------------------------------------------------------
Cash - end of year $ 46,516 $ 253,447 $ 26,576 $ 363,774 $ (82,244) $ 608,069
===================================================================================================================================
/(1)/ Includes all other subsidiaries of ACE Limited and intercompany
eliminations.
/(2)/ Includes ACE Limited parent company eliminations.
104
17. SEGMENT INFORMATION
In 2002, following changes in executive management responsibilities, the Company
reassessed and changed its reporting segments from individual operating units to
lines of business. The Company now operates through four business segments:
Insurance - North American, Insurance - Overseas General, Global Reinsurance and
Financial Services. These segments distribute their products through various
forms of brokers and agencies. Insurance - North American, Insurance - Overseas
General and Global Reinsurance utilize direct marketing programs to reach
clients, while Financial Services operates with major U.S. financial guaranty
insurers, mortgage guaranty insurers in the U.S., U.K. and Australia, title
insurers and European trade credit insurers. Additionally, Insurance - North
American has formed Internet distribution channels for some of its products and
Global Reinsurance and Financial Services have established relationships with
reinsurance intermediaries.
The Insurance - North American segment includes the operations of ACE USA,
ACE Canada and ACE Bermuda, excluding the financial solutions business in both
the U.S. and Bermuda, which are included in the Financial Services segment. ACE
USA comprises the U.S. and Canadian operations of ACE INA, which were acquired
in 1999 and the operations of ACE US Holdings, which were acquired in 1998.
These operations provide a broad range of P&C insurance and reinsurance
products, including excess liability, excess property, professional lines,
aerospace, A&H coverages and claim and risk management products and services, to
a diverse group of commercial and non-commercial enterprises and consumers. The
operations of ACE USA also include the run-off operations, which include
Brandywine, Commercial Insurance Services, residual market workers' compensation
business, pools and syndicates not attributable to a single business group, the
run-off of open market facilities and the run-off results of various other
smaller exited lines of business. Run-off operations do not actively sell
insurance products, but are responsible for the management of existing policies
and related claims.
The Insurance - Overseas General segment consists of ACE Global Markets and
ACE International. ACE International includes ACE INA's network of indigenous
insurance operations, which were acquired in 1999. The segment has four regions
of operations: ACE Asia Pacific, ACE Far East, ACE Latin America and the ACE
European Group (which comprises ACE Europe, ACE INA UK Limited and the insurance
operations of ACE Global Markets). 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 (including, for segment purposes,
Lloyd's operations owned by ACE Financial Services). The reinsurance operation
of ACE Global Markets is included in the Global Reinsurance segment. Companies
within the Insurance - Overseas General segment write a variety of insurance
products including property, primary and excess casualty, energy, professional
risk ("D&O" and "E&O"), marine, political risk, trade credit, A&H, aviation and
consumer oriented products. ACE International provides insurance coverage on a
worldwide basis.
The Global Reinsurance segment comprises ACE Tempest Re Bermuda, ACE
Tempest Re USA and ACE Tempest Re Europe. These subsidiaries primarily provide
property catastrophe reinsurance globally to insurers of commercial and personal
property. Global Reinsurance also includes the operations of ACE Tempest Life
Re. The principal business of ACE Tempest Life Re is to provide reinsurance
coverage to other life insurance companies. The life reinsurance business
completed its first full year of operations in 2001.
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. The financial guaranty businesses serve the
U.S. domestic and international financial guaranty insurance and reinsurance
markets. Their principal business is the insurance and reinsurance of investment
grade public finance and asset-backed debt issues (insured and ceded by the
primary bond insurance companies), and insurance and reinsurance of credit
default swaps. In addition to financial guaranty business, the companies provide
trade credit reinsurance and highly structured solutions to problems of
financial and risk management through reinsurance and other forms of credit
enhancement products, as well as mortgage guaranty reinsurance and title
reinsurance. The financial solutions business includes insurance and reinsurance
solutions to complex risks that generally cannot be adequately addressed by the
traditional insurance marketplace. It consists of securitization and risk
trading, finite and structured risk products, and retroactive contracts in the
form of LPTs.
105
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
a) The following tables summarize the operations by segment for the years
ended December 31, 2002, 2001 and 2000;
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.
STATEMENT OF OPERATIONS BY SEGMENT
For the year ended December 31, 2002
Insurance- Insurance-
North Overseas Global Financial Corporate ACE
(in thousands of U.S. dollars) American General Reinsurance Services and Other/(1)/ Consolidated
- --------------------------------------------------------------------------------------------------------------------------------
OPERATIONS DATA
Property and Casualty
Gross premiums written $ 6,116,356 $ 4,113,944 $ 887,069 $ 1,536,503 $ - $ 12,653,872
Net premiums written 2,918,540 2,716,372 777,524 1,496,848 - 7,909,284
Net premiums earned 2,475,390 2,392,721 676,690 1,127,426 - 6,672,227
Losses and loss expenses 2,200,091 1,455,038 303,952 947,429 - 4,906,510
Policy acquisition costs 216,442 533,003 122,610 72,080 - 944,135
Administrative expenses 340,392 390,309 40,256 56,452 110,522 937,931
- --------------------------------------------------------------------------------------------------------------------------------
Underwriting income (loss) (281,535) 14,371 209,872 51,465 (110,522) (116,349)
- --------------------------------------------------------------------------------------------------------------------------------
Life
Gross premiums written - - 165,099 - - 165,099
Net premiums written - - 159,014 - - 159,014
Net premiums earned - - 158,277 - - 158,277
Life and annuity benefits - - 158,118 - - 158,118
Policy acquisition costs - - 16,553 - - 16,553
Administrative expenses - - 5,402 - - 5,402
Net investment income - - 27,005 - - 27,005
- --------------------------------------------------------------------------------------------------------------------------------
Underwriting income - - 5,209 - - 5,209
- --------------------------------------------------------------------------------------------------------------------------------
Net investment income -
property and casualty 405,937 108,049 95,032 191,980 (25,862) 775,136
Other income 1,034 2,055 589 1,357 - 5,035
Interest expense 32,307 2,621 13,914 12,837 131,815 193,494
Income tax expense (benefit) (4,339) 5,834 892 30,413 (68,074) (35,274)
- --------------------------------------------------------------------------------------------------------------------------------
Income (loss) excluding net realized
losses and non-recurring expenses 97,468 116,020 295,896 201,552 (200,125) 510,811
Net realized losses* (156,480) (25,045) (57,123) (99,501) (79,481) (417,630)
Debt prepayment expense* - - - - (16,632) (16,632)
- --------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (59,012) $ 90,975 $ 238,773 $ 102,051 $ (296,238) $ 76,549
================================================================================================================================
/(1)/Includes ACE Limited, ACE INA Holdings and intercompany eliminations.
*Shown net of income tax
106
STATEMENT OF OPERATIONS BY SEGMENT
For the year ended December 31, 2001
Insurance- Insurance-
North Overseas Global Financial Corporate ACE
(in thousands of U.S. dollars) American General Reinsurance Services and Other/(1)/ Consolidated
- ----------------------------------------------------------------------------------------------------------------------------------
OPERATIONS DATA
Property and Casualty
Gross premiums written $ 4,521,276 $ 3,289,200 $ 460,049 $ 1,480,785 $ - 9,751,310
Net premiums written 1,986,001 2,154,222 354,323 1,461,378 - 5,955,924
Net premiums earned 1,816,731 1,940,814 324,567 1,428,785 - 5,510,897
Losses and loss expenses 1,373,255 1,464,964 317,019 1,397,218 - 4,552,456
Policy acquisition costs 206,064 444,809 68,259 57,680 - 776,812
Administrative expenses 315,473 326,828 29,054 55,357 94,583 821,295
- ----------------------------------------------------------------------------------------------------------------------------------
Underwriting income (loss) (78,061) (295,787) (89,765) (81,470) (94,583) (639,666)
- ----------------------------------------------------------------------------------------------------------------------------------
Life
Gross premiums written - - 414,052 - - 414,052
Net premiums written - - 407,690 - - 407,690
Net premiums earned - - 406,280 - - 406,280
Life and annuity benefits - - 401,229 - - 401,229
Policy acquisition costs - - 7,852 - - 7,852
Administrative expenses - - 2,787 - - 2,787
Net investment income - - 9,408 - - 9,408
- ----------------------------------------------------------------------------------------------------------------------------------
Underwriting income - - 3,820 - - 3,820
- ----------------------------------------------------------------------------------------------------------------------------------
Net investment income -
property and casualty 425,762 102,193 69,775 173,585 5,146 776,461
Other income (expense) 1,030 (1,078) - 500 - 452
Interest expense 37,163 2,591 733 16,776 141,919 199,182
Income tax expense (benefit) 93,841 (85,149) (22,050) 21,309 (76,699) (68,748)
Amortization of goodwill (360) 3,755 14,011 4,205 57,960 79,571
- ----------------------------------------------------------------------------------------------------------------------------------
Income (loss) excluding net realized
losses, non-recurring expenses
and cumulative effect 218,087 (115,869) (8,864) 50,325 (212,617) (68,938)
Net realized losses* (11,101) (3,221) (16,430) (6,069) (13,524) (50,345)
Non-recurring expenses* - (3,970) (491) - - (4,461)
Cumulative effect of adopting a
new accounting standard* (50) 441 539 (23,600) - (22,670)
- ----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 206,936 $ (122,619) $ (25,246) $ 20,656 $ (226,141) $ (146,414)
==================================================================================================================================
/(1)/Includes ACE Limited, ACE INA Holdings and intercompany eliminations.
* Shown net of income tax
107
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
STATEMENT OF OPERATIONS BY SEGMENT
For the year ended December 31, 2000
Insurance- Insurance-
North Overseas Global Financial Corporate ACE
(in thousands of U.S. dollars) American General Reinsurance Services and Other/(1)/ Consolidated
- --------------------------------------------------------------------------------------------------------------------------------
OPERATIONS DATA
Property and Casualty
Gross premiums written $ 3,626,317 $ 2,822,028 $ 337,241 $ 801,185 $ - $ 7,586,771
Net premiums written 1,890,592 2,004,305 274,757 709,700 - 4,879,354
Net premiums earned 1,733,524 1,832,710 251,992 716,537 - 4,534,763
Losses and loss expenses 1,128,249 1,108,138 52,921 646,757 - 2,936,065
Policy acquisition costs 194,819 369,953 44,934 41,035 - 650,741
Administrative expenses 279,506 340,120 17,993 46,799 61,215 745,633
- --------------------------------------------------------------------------------------------------------------------------------
Underwriting income (loss) 130,950 14,499 136,144 (18,054) (61,215) 202,324
- --------------------------------------------------------------------------------------------------------------------------------
Net investment income 446,413 116,756 65,228 148,730 (6,272) 770,855
Other income (expense) 3,598 (1,868) - 1,212 - 2,942
Interest expense 35,621 4,980 - 17,716 163,133 221,450
Income tax expense (benefit) 105,414 14,968 16,792 21,574 (64,841) 93,907
Amortization of goodwill (343) 3,968 14,010 4,205 56,980 78,820
- --------------------------------------------------------------------------------------------------------------------------------
Income excluding net realized
gains (losses) 440,269 105,471 170,570 88,393 (222,759) 581,944
Net realized gains (losses)* (17,939) 12,846 (38,363) 6,172 (1,678) (38,962)
- --------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 422,330 $ 118,317 $ 132,207 $ 94,565 $ (224,437) $ 542,982
================================================================================================================================
/(1)/Includes ACE Limited, ACE INA Holdings and intercompany eliminations.
* Shown net of income tax
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 reinsurance operations and
corporate holding companies, including ACE Limited and ACE INA Holdings.
The following table summarizes the identifiable assets at December 31, 2002
and 2001.
(in millions of U.S. dollars) 2002 2001
- ---------------------------------------------------------------------
Property and casualty insurance $ 40,651 $ 34,198
Life reinsurance 610 480
Corporate 2,190 2,509
- ---------------------------------------------------------------------
Total assets $ 43,451 $ 37,187
=====================================================================
108
The following tables summarize the revenues of each segment by product offering
for the years ended December 31, 2002, 2001 and 2000.
NET PREMIUMS EARNED BY TYPE OF PREMIUM
Property Life, Accident Financial Financial ACE
(in millions of U.S. dollars) & Casualty & Health Guaranty Solutions Consolidated
- ---------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2002
Insurance - North American $ 2,394 $ 81 $ - $ - $ 2,475
Insurance - Overseas General 1,817 576 - - 2,393
Global Reinsurance 677 158 - - 835
Financial Services - - 282 845 1,127
- ---------------------------------------------------------------------------------------------------------------
$ 4,888 $ 815 $ 282 $ 845 $ 6,830
===============================================================================================================
YEAR ENDED DECEMBER 31, 2001
Insurance - North American $ 1,812 $ 4 $ - $ - $ 1,816
Insurance - Overseas General 1,427 511 - 3 1,941
Global Reinsurance 324 406 - - 730
Financial Services - - 352 1,077 1,429
- ---------------------------------------------------------------------------------------------------------------
$ 3,563 $ 921 $ 352 $ 1,080 $ 5,916
===============================================================================================================
YEAR ENDED DECEMBER 31, 2000
Insurance - North American $ 1,734 $ - $ - $ - $ 1,734
Insurance - Overseas General 1,378 454 - - 1,832
Global Reinsurance 252 - - - 252
Financial Services - - 283 434 717
- ---------------------------------------------------------------------------------------------------------------
$ 3,364 $ 454 $ 283 $ 434 $ 4,535
===============================================================================================================
c) The following table summarizes the Company's gross premiums written by
geographic region. Allocations have been made on the basis of location of risk.
Year North Australia & Asia Latin
Ended America Europe New Zealand Pacific America Other
- ----------------------------------------------------------------------------
2002 64% 21% 2% 8% 5% -
2001 63% 21% 2% 9% 5% -
2000 63% 20% 7% 5% 4% 1%
============================================================================
109
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
ACE Limited and Subsidiaries
18. CONDENSED UNAUDITED QUARTERLY FINANCIAL DATA
2002
Quarter Ended Quarter Ended Quarter Ended Quarter Ended
(in thousands of U.S. dollars, except per share data) March 31, 2002 June 30, 2002 Sept. 30, 2002 Dec. 31, 2002
- ----------------------------------------------------------------------------------------------------------------------------
Net premiums earned $ 1,359,809 $ 1,575,707 $ 1,925,579 $ 1,969,409
Net investment income 200,135 200,804 199,740 201,462
Other income (expense) 4,799 (12,068) (14,032) 749
Net realized losses on investments (25,881) (139,721) (235,282) (88,205)
- ----------------------------------------------------------------------------------------------------------------------------
Total revenues $ 1,538,862 $ 1,624,722 $ 1,876,005 $ 2,083,415
============================================================================================================================
Losses and loss expenses $ 853,145 $ 960,949 $ 1,327,792 $ 1,764,624
- ----------------------------------------------------------------------------------------------------------------------------
Life and annuity benefits $ 22,996 $ 23,311 $ 59,697 $ 52,114
- ----------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 197,805 $ 103,900 $ (56,510) $ (168,646)
============================================================================================================================
Basic earnings (loss) per share $ 0.74 $ 0.37 $ (0.24) $ (0.67)
============================================================================================================================
Diluted earnings (loss) per share $ 0.70 $ 0.36 $ (0.24) $ (0.67)
============================================================================================================================
2001
Quarter Ended Quarter Ended Quarter Ended Quarter Ended
(in thousands of U.S. dollars, except per share data) March 31, 2001 June 30, 2001 Sept. 30, 2001 Dec. 31, 2001
- ----------------------------------------------------------------------------------------------------------------------------
Net premiums earned $ 1,369,116 $ 1,385,187 $ 1,399,429 $ 1,763,445
Net investment income 204,430 196,267 192,909 192,263
Other income (expense) 1,597 1,088 (1,858) (375)
Net realized gains (losses) on investments (19,375) 15,564 (58,843) 4,295
- ----------------------------------------------------------------------------------------------------------------------------
Total revenues $ 1,555,768 $ 1,598,106 $ 1,531,637 $ 1,959,628
============================================================================================================================
Losses and loss expenses $ 951,293 $ 954,841 $ 1,541,627 $ 1,104,695
- ----------------------------------------------------------------------------------------------------------------------------
Life and annuity benefits $ 653 $ 28,152 $ 29,706 $ 342,718
- ----------------------------------------------------------------------------------------------------------------------------
Net income (loss) before cumulative effect $ 141,064 $ 131,517 $ (442,590) $ 46,265
Cumulative effect of adopting a new accounting
standard (22,670) - - -
- ----------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 118,394 $ 131,517 $ (442,590) $ 46,265
============================================================================================================================
Basic earnings (loss) per share:
Earnings (loss) per share before cumulative effect
of adopting a new accounting standard $ 0.58 $ 0.54 $ (1.95) $ 0.16
Earnings (loss) per share $ 0.48 $ 0.54 $ (1.95) $ 0.16
============================================================================================================================
Diluted earnings (loss) per share:
Earnings (loss) per share before cumulative effect
of adopting a new accounting standard $ 0.55 $ 0.52 $ (1.95) $ 0.15
Earnings (loss) per share $ 0.46 $ 0.52 $ (1.95) $ 0.15
============================================================================================================================
110