ACE LIMITED AND SUBSIDIARIES
Exhibit 13.1
SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial data of the
Company as of and for each of the years in the five year period ended September
30, 1997. 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 Results of Operations and Financial
Condition" presented on pages 32 to 53 and 21 to 31 respectively, of this annual
report.
For the years ended September 30
1997 1996 1995 1994 1993
- ----------------------------------------------------------------------------------------------------------------------------------
(in thousands except share and per share data and selected other data)
Operations data:
Net premiums written $ 639,744 $ 602,707 $ 424,756 $ 385,926 $ 340,355
==================================================================================================================================
Net premiums earned 644,838 587,245 428,661 391,117 319,578
Net investment income 237,823 206,524 181,375 142,677 119,978
Net realized gains on investments 127,982 55,229 50,765 3,717 98,371
Losses and loss expenses (1) 435,941 464,824 350,653 520,556 262,117
Acquisition costs and administrative expenses 113,348 94,441 72,582 62,633 52,263
- ----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) (1) $ 461,354 $ 289,733 $ 237,566 $ (45,678) $ 223,547
==================================================================================================================================
Earnings (loss) per share (2) $ 8.02 $ 5.82 $ 5.05 $ (0.95) $ 5.50
==================================================================================================================================
Weighted average shares outstanding 57,493,671 49,813,628 47,059,006 48,202,545 40,641,263
Pro forma (3):
Earnings per share $ 4.49
===========
Weighted average shares outstanding $ 49,831,087
Cash dividends per share (4) $ 0.80 $ 0.64 $ 0.50 $ 0.42 $ 0.43
Balance sheet data (at end of period]:
Total investments and cash $ 4,474,765 $ 4,170,071 $ 3,132,200 $ 2,538,321 $ 2,211,230
Total assets 5,001,546 4,574,358 3,236,906 2,632,361 2,293,587
Unpaid losses and loss expenses (1) 1,869,995 1,836,113 1,437,930 1,160,392 650,180
Total shareholders' equity (1) 2,619,194 2,244,278 1,442,663 1,088,745 1,368,180
Book value per share (1) $ 47.37 $ 38.58 $ 31.29 $ 22.96 $ 27.47
Fully diluted book value per share (1) $ 47.14 $ 38.31 $ 31.19 $ 22.95 $ 27.46
Selected other data:
Loss and loss expense ratio (1) 67.6% 79.1% 81.8% 133.1% 82.0%
Underwriting and administrative expense ratio 17.6% 16.1% 16.9% 16.0% 16.4%
Combined ratio (1) 85.2% 95.2% 98.7% 149.1% 98.4%
Loss reserves to capital and surplus ratio (1) 71.4% 81.8% 99.7% 106.6% 47.5%
Ratio of net premiums written to
capital and surplus 0.24:1 0.27:1 0.29:1 0.35:1 0.25:1
- ----------------------------------------------------------------------------------------------------------------------------------
1. At June 30, 1994 the Company increased its then existing reserves relating
to breast implant claims. Although the reserve increase was partially
satisfied by an allocation from existing IBNR, it also required an increase
in the Company's total reserve for unpaid losses and loss expenses at June
30, 1994 of $200 million (see "Management's Discussion and Analysis - Breast
Implant Litigation").
2. Earnings (loss) per share are computed using net income (loss) divided by
the weighted average number of Ordinary Shares outstanding and, if dilutive,
shares issuable under outstanding options. There is no material difference
between primary and fully diluted earnings (loss) per share.
3. Pro forma earnings per share have been calculated by dividing net income by
the weighted average number of Ordinary Shares and Ordinary Share
equivalents outstanding as adjusted to reflect the recapitalization and the
repurchase of Ordinary Shares, effected in March 1933, and assumes the
recapitalization and repurchase of Ordinary Shares occurred at the beginning
of each year for which pro forma information is provided.
4. The dividends declared in 1993 included a special "RPII" dividend of $0.23
per Ordinary Share paid to shareholders of record on July 7, 1993.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
---------------------------------------------
The following is a discussion of the Company's financial condition, results of
operations, liquidity and capital resources. This discussion should be read in
conjunction with the consolidated financial statements, and related notes
thereto, presented on pages 32 to 53 of this annual report.
General
ACE Limited ("ACE") is a holding company which, through its Bermuda-based
operating subsidiaries, A.C.E. Insurance Company, Ltd. ("ACE Insurance"),
Corporate Officers & Directors Assurance Ltd. ("CODA") and Tempest Reinsurance
Company Limited ("Tempest"), provides insurance and reinsurance for a diverse
group of international clients. In addition, the Company provides funds at
Lloyd's to support underwriting by Lloyd's syndicates managed by Methuen
Underwriting Limited ("MUL"), ACE London Aviation Limited ("ALA") and ACE London
Underwriting Limited ("ALU"), its indirect wholly owned subsidiaries. The term
"the Company" refers to ACE and its subsidiaries excluding MUL, ALA and ALU.
On March 27, 1996, the Company acquired a controlling interest in Methuen
Group Limited ("Methuen"), the holding company for MUL. On November 26, 1996,
the Company acquired the remaining 49 percent interest in Methuen. Also on
November 26, 1996, the Company acquired Ockham Worldwide Holdings plc which
subsequently changed its name to ACE London Holdings Ltd. ("ACE London"). ACE
London owns two Lloyd's managing agencies, ALA and ALU. For the 1996, 1997 and
1998 years of account, the Company, through corporate subsidiaries, has or will
participate in the underwriting of these syndicates by providing funds at
Lloyd's, primarily in the form of a letter of credit, supporting approximately
$37 million, $229 million and $485 million, respectively, of underwriting
capacity. The syndicates managed by these agencies in which the Company
participates underwrite aviation, marine and non-marine risks. Underwriting
capacity is the amount of gross premiums that a syndicate at Lloyd's can
underwrite in a given year of account. However, a syndicate is not required to
fully utilize all of the capacity and it is not unusual for capacity utilization
to be significantly lower than 100 percent.
In March 1997, the Company, together with two other insurance companies,
formed a managing general agency in Bermuda to provide underwriting services to
the three organizations for political risk insurance coverage. The new company,
Sovereign Risk Insurance Ltd. ("Sovereign") issues subscription policies with
the Company assuming 50 percent of each risk underwritten. The Company
currently cedes 10 percent of all risks assumed from Sovereign. Sovereign
offers limits of up to $50 million per project and $100 million per country.
In April 1997, the Company announced that it had signed a quota share treaty
reinsurance agreement with the Multilateral Investment Guarantee Agency
("MIGA"), part of the World Bank Group. MIGA provides coverage for foreign
investments in developing countries. The agreement allows MIGA to provide
private investors and developing countries additional capacity to support
developmentally sound investment projects. The coverages offered will be the
same as those offered by MIGA's guarantee program, namely, transfer restriction,
expropriation, war and civil disturbance and breach of contract. The quota
share treaty offers limits of up to $25 million per contract with an aggregate
of $100 million per country.
On September 18, 1997, the Company announced it had executed a definitive
agreement for the acquisition, through a newly-created U.S. holding company, of
Westchester Specialty Group, Inc. ("WSG"), an indirect wholly owned subsidiary
of Xerox Corporation. WSG, through its insurance subsidiaries, provides
specialty commercial property and umbrella liability coverages in the U.S.
Under the terms of the agreement, the Company will purchase all of the
outstanding capital stock of WSG for aggregate cash consideration of
approximately $333 million. In connection with the acquisition, National
Indemnity, a subsidiary of Berkshire Hathaway, will provide $750 million (75
percent quota share of $1 billion) of reinsurance protection to WSG with respect
to their loss reserves for the 1996 and prior accident years. The acquisition,
which is subject to, among other matters, regulatory approval and other
customary closing conditions, is expected to close in early 1998. The Company
expects to finance this transaction with $250 million of bank debt and the
remainder with available cash (see "Liquidity and Capital Resources").
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
----------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
On September 30, 1997, the Company announced the incorporation of ACE Insurance
Company Europe Limited ("AICE"), as part of the International Financial Services
Centre in Dublin, Ireland. AICE has been granted a license to write all 18
classes of non-life insurance in all member states of the European Union.
The Company will continue to evaluate potential new product lines and other
opportunities in the insurance and reinsurance markets.
Results of Operations - Years ended September 30, 1997, 1996 and 1995
Net Income
1997 1996 1995
--------------------------------
(in millions)
Income excluding net realized
gains on investments $ 333.4 $ 234.5 $ 186.8
Net realized gains on investments 128.0 55.2 50.8
--------------------------------
Net income $ 461.4 $ 289.7 $ 237.6
================================
During the years ended September 30, 1997 and 1996, the Company has experienced
strong growth in income from insurance operations and net investment income. The
increase was partially offset by an increase in general and administrative
expenses. In fiscal 1997, Tempest contributed $119.8 million to income excluding
net realized gains on investments compared to $23.8 million for 1996. A full
year of operations for Tempest is included in the results for fiscal 1997 versus
one quarter of operations in 1996 as Tempest was purchased on July 1, 1996. For
1996, strong growth in income from insurance operations and net investment
income resulted in income excluding net realized gains on investments of $234.5
million compared to $186.8 million in 1995.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
Premiums
Percentage Percentage
1997 Change 1996 Change 1995
----------------------------------------------------
(in millions)
Gross premiums written
ACE Insurance (including CODA)
Excess liability $144.6 (31.2)% $210.2 (14.9)% $246.9
Financial lines 134.7 12.1 120.2 N.M. 9.2
Satellite 111.2 7.0 104.0 N.M. 44.9
Directors and officers liability 85.4 (12.4) 97.6 (7.3) 105.0
Aviation 35.5 6.6 33.3 N.M. 8.9
Excess property 25.4 53.4 16.5 N.M. 5.6
Other 7.4 (50.1) 14.8 (2.6) 15.3
Lloyd's syndicates 78.8 N.M. 14.4 N.M. -
Property catastrophe (Tempest) 119.6 N.M. 34.8 N.M. -
----------------------------------------------------
$742.6 15.0% $645.8 48.2% $435.8
====================================================
Net premiums written
ACE Insurance (including CODA)
Excess liability $139.6 (31.0)% $202.3 (15.4)% $239.1
Financial lines 117.2 (1.7) 119.2 N.M. 9.2
Satellite 68.1 (20.1) 85.3 89.7 45.0
Directors and officers liability 85.4 (12.4) 97.6 (7.1) 105.0
Aviation 27.0 (0.4) 27.1 N.M. 7.0
Excess property 24.2 74.0 13.9 N.M. 5.3
Other 7.1 (45.1) 12.8 (9.4) 14.2
Lloyd's syndicates 55.8 N.M. 9.7 N.M. -
Property catastrophe (Tempest) 115.3 N.M. 34.8 N.M. -
----------------------------------------------------
$639.7 6.2% $602.7 41.9% $424.8
====================================================
Net premiums earned
ACE Insurance (including CODA)
Excess liability $183.0 (23.2)% $238.2 (9.2)% $262.4
Financial lines 99.3 16.9 84.9 N.M. 0.8
Satellite 66.8 (14.1) 77.8 79.7 43.3
Directors and officers liability 85.3 (18.4) 104.5 (5.0) 110.1
Aviation 26.5 39.5 19.0 N.M. 1.5
Excess property 21.5 81.7 11.8 N.M. 1.0
Other 11.0 (12.6) 12.5 30.6 9.6
Lloyd's syndicates 27.5 N.M. 2.8 N.M. -
Property catastrophe (Tempest) 123.9 N.M. 35.7 N.M. -
----------------------------------------------------
$644.8 9.8% $587.2 37.0% $428.7
====================================================
N.M. = Not Meaningful
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
----------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
The Company's ability to make strategic acquisitions, develop new and existing
product lines and maintain a high level of policy renewals on existing business
despite continuing competitive pressure in certain markets, particularly the
excess liability and directors and officers liability markets, has resulted in
increases in gross and net premiums written and net premiums earned for the
years ended September 30, 1997 and 1996.
Gross premiums written increased by $96.8 million to $742.6 million in 1997 from
$645.8 million in 1996 despite continuing competitive pressures in most
insurance markets. The growth in gross premiums written is primarily
attributable to the inclusion of a full year of premiums for Tempest and the
increased participation in the Lloyd's syndicates managed by the Company. As
Tempest was purchased on July 1, 1996, the 1996 comparatives only include three
months of Tempest premiums. Tempest's gross written premiums for 1997 are down
by approximately 17 percent compared to their full year 1996 premiums primarily
due to rate reductions, increasing attachment points and some cancellations due
to pricing. The Company's portion of gross premiums written by the Lloyd's
syndicates in which the Company participates amounted to $78.8 million in 1997
compared to $14.4 million in 1996 primarily as a result of the Company's
increased participation in these syndicates. Satellite, aviation, excess
property and financial lines also contributed to the increase. These increases
in gross premiums written were offset by declines in excess liability and
directors and officers liability gross premiums written. The decline in excess
liability premiums of $65.6 million is mainly the result of continuing
competitive pressures in that market which have adversely affected the pricing
of the excess liability business but have also led to a reduction in the
Company's exposure and an improved risk profile as a result of higher average
attachment points and lower average limits. Directors and officers liability
premiums declined by $12.2 million as this line faces an extremely competitive
environment with its corresponding pressures on prices.
In 1996, gross premiums written increased by $210.0 million or 48.2 percent
compared to 1995. This growth was a result of a very strong year for the
Company's financial lines and satellite product lines together with the
increased contributions from aviation and excess property insurance which both
included a full year of underwriting in 1996. Gross premiums written in 1996
also included property catastrophe premiums written by Tempest from July 1,
1996, as well as premiums from the Company's participation in the Lloyd's
syndicates managed by the Company. These increases were offset by decreases in
excess liability and directors and officers liability premiums written in 1996
as a result of competitive pressures in these markets.
Net premiums written increased by $37.0 million in 1997 to $639.7 million
compared to $602.7 million for 1996. The inclusion of a full year of net
premiums written for Tempest, our increased participation in the Lloyd's
syndicates managed by the Company and growth in excess property premiums
contributed to the increase in net premiums written. These increases were
partially offset by declines in excess liability and directors and officers
liability premiums as discussed above. A portion of the decline in net premiums
written is also the result of the Company's use of reinsurance for the satellite
and financial lines product lines in 1997. Net premiums written for Tempest
were also reduced as a result of the purchase of a modest amount of
retrocessional cover during the current fiscal year. In 1996, net premiums
written increased by $177.9 million or 41.9 percent compared to 1995 as a result
of a very strong year for the Company's financial lines and satellite product
lines together with other factors discussed above in the analysis of gross
premiums written.
For 1997, net premiums earned increased by $57.6 million to $644.8 million from
$587.2 million in 1996. The growth in net premiums earned was primarily the
result of the inclusion of a full year of premiums earned for Tempest in 1997
compared to three months in 1996 and the Company's increased participation in
the Lloyd's syndicates managed by the Company. Aviation, excess property and
financial lines also experienced growth during the year. These increases were
offset by declines in excess liability, directors and officers liability and
satellite premiums earned. For 1996, net premiums earned increased by $158.5
million to $587.2 million compared with $428.7 million in 1995. The increase
was the result of contributions from the new lines of business, particularly
financial lines, together with the increase in satellite premiums earned
primarily from launch insurance, and the inclusion of Tempest earned premiums
since July 1, 1996, the date of acquisition, which amounted to $35.7 million.
These increases were offset by a decline in excess liability and directors and
officers liability premiums earned in the year.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
----------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
Net Investment Income
Percentage Percentage
1997 Change 1996 Change 1995
------------------------------------------------
(in millions)
Net investment income $237.8 15.2% $206.5 13.9% $181.4
=================================================
The average yield earned on the investment portfolio in 1997 was down slightly
compared to the yield generated in 1996. This is largely due to the fact that
during the first quarter of fiscal 1997 the Company increased the equity
exposure of the externally managed investment portfolio to 20 percent from 15
percent. The remainder of the portfolio is comprised of fixed maturity
securities. On average, the portfolio generated a lower yield in 1996 compared
to 1995 as a result of general market conditions. Despite the decreases in
yield, net investment income increased by $31.3 million in 1997 compared to 1996
and by $25.1 million in 1996 compared to 1995, primarily as a result of a larger
investable asset base. The increase in the investable asset base in 1997 and
1996 were due to positive cash flows from insurance operations, the
reinvestment of funds generated by the portfolio and the fact that the
consolidated investment portfolio included the Tempest portfolio for the entire
period of fiscal 1997 and for three months during fiscal 1996.
Net Realized Gains (Losses) on Investments
1997 1996 1995
--------------------------------
(in millions)
Fixed maturities and short-term investments $ 59.0 $14.4 $ 8.4
Equity securities 38.1 15.8 3.6
Financial futures and option contracts 57.1 26.7 39.8
Currency (26.2) (1.7) (1.0)
--------------------------------
$128.0 $55.2 $50.8
================================
The Company's investment strategy takes a long-term view and the portfolio is
actively managed to maximize total return within certain specific guidelines
which minimize risk. The portfolio is reported at fair value. The effect of
market movements on the investment portfolio will directly impact net realized
gains (losses) on investments when securities are sold. Changes in unrealized
gains and losses, which result from the revaluation of securities held, are
reported as a separate component of shareholders' equity.
The Company uses foreign currency forward and option contracts to minimize the
effect of fluctuating foreign currencies on the value of non-U.S. dollar
holdings. The contracts used are not designated as specific hedges and
therefore, realized and unrealized gains and losses recognized on these
contracts are recorded as a component of net realized gains (losses) on
investments in the period in which the fluctuations occur, together with net
foreign currency gains and losses recognized when non-U.S. dollar securities are
sold.
Sales proceeds for fixed maturity securities were generally higher than their
amortized costs during 1997 and 1996 which resulted in net realized gains on
sale of fixed maturities and short-term investments of $59.0 million in 1997
compared to gains of $14.4 million during 1996 and $8.4 million in 1995.
With strong equity markets and the increased equity exposure as discussed
above, net realized gains on sales of equity securities were $38.1 million in
1997 compared to $15.8 million in 1996. There were gains of $3.6 million in
1995.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
----------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
The realized gains on financial futures and options contracts were generated
from U.S. Treasury futures contracts and from the equity index futures contracts
held in the synthetic equity fund. Gains and losses on these instruments are
closely linked to fluctuations in the U.S. Treasury and equity markets and
therefore, realized gains would be expected during periods of broad market
improvements while losses are realized during periods of market declines. Net
realized gains on financial futures and option contracts of $57.1 million
recorded in 1997 were primarily generated by the equity index futures contracts
held, as a result of the rise in the S&P 500 Stock Index of nearly 40 percent
during the fiscal year. The realized gains of $26.7 million in 1996 were
generated from U.S. Treasury futures contracts and from the equity index futures
contracts held in the synthetic equity fund as a result of broad market
improvements during the year. The $39.8 million generated in 1995 arose from
gains in the S&P 500 stock index and gains recognized on futures contracts used
by certain of the Company's external managers of fixed income securities.
Currency losses for the year were $26.2 million compared to a loss of $1.7
million for 1996. During 1997 the Company increased its exposure to non-U.S.
dollar securities from 8 percent of its externally managed investment portfolio
to 12 percent. Currency markets generally suffered declines against the U.S.
dollar during the year. At September 30, 1997 there were unrealized currency
losses of $20.0 million on securities held in the portfolio compared to $7.2
million as at September 30, 1996. Unrealized currency losses are reflected in
net unrealized appreciation on investments in shareholders' equity. At September
30, 1995 there was an unrealized currency gain of $1.7 million in net unrealized
appreciation on investments in shareholders' equity.
The Company's externally managed investment portfolio contains certain market
sensitive instruments which may be adversely effected by changes in interest
rates and foreign currency exchange rates (for further discussion see "Market
Sensitive Instruments and Risk Management").
Combined Ratio
1997 1996 1995
--------------------------------------
Loss and loss expense ratio 67.6% 79.1% 81.8%
Underwriting and administrative expense ratio 17.6 16.1 16.9
--------------------------------------
Combined ratio 85.2% 95.2% 98.7%
======================================
The underwriting results of a property and casualty insurer are discussed
frequently by reference to its loss and loss expense ratio, underwriting and
administrative expense ratio and combined ratio. Each ratio is derived by
dividing the relevant expense amounts by net premiums earned. The combined ratio
is the sum of the loss and loss expense ratio, and the underwriting and
administrative expense ratio. A combined ratio under 100 percent indicates
underwriting profits and a combined ratio exceeding 100 percent indicates
underwriting losses.
Losses and Loss Expenses
Percentage Percentage
1997 Change 1996 Change 1995
--------------------------------------------------
(in millions)
Losses and loss expenses $435.9 (6.2)% $464.8 32.6% $350.6
==================================================
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
----------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
For the years ended September 30, 1997 and 1996, the loss and loss expense
ratios were 67.6 percent and 79.1 percent. These ratios have been favorably
impacted by the results of Tempest. Property catastrophe loss experience is
generally characterized as low frequency but high severity short-tail claims
which may result in significant volatility in results. For the year ended
September 30, 1997 and the three month period from July 1, 1996, the date of
acquisition to September 30, 1996, the loss and loss expense ratio for Tempest
was 8.8 percent and 36.4 percent, respectively. These favorable loss ratios are
the result of low loss activity in Tempest since July 1, 1996. Excluding
Tempest, the loss and loss expense ratios would have been 80.9 percent for 1997
and 81.8 percent for 1996. The loss and loss expense ratio for 1995 was 81.8
percent.
Several aspects of the Company's operations, including the low frequency and
high severity of losses in the high excess layers in certain lines of business
in which the Company provides insurance and reinsurance, complicate the
actuarial reserving techniques utilized by the Company. Management believes,
however, that the Company's reserve for unpaid losses and loss expenses,
including those arising from breast implant litigation, are adequate to cover
the ultimate cost of losses and loss expenses incurred through September 30,
1997. Since such provisions are necessarily based on estimates, future
developments may result in ultimate losses and loss expenses significantly
greater or less than such amounts (see "Breast Implant Litigation").
Underwriting and Administrative Expenses
Percentage Percentage
1997 Change 1996 Change 1995
------------------------------------------------------------------
(in millions)
Underwriting and administrative expenses $113.4 20.0% $94.4 30.0% $72.6
=========================================================================-
The underwriting and administrative expense ratio has increased to 17.6 percent
in 1997 compared to 16.1 percent in 1996, an increase of $19.0 million. This
increase is due to an increase in administrative expenses of $24.9 million in
1997 over 1996, which is partially offset by a decrease in acquisition costs.
The increase in administrative expenses is primarily due to the increased cost
base resulting from the strategic diversification by the Company over the past
two years, including the recent acquisition of Tempest, Methuen and ACE London
as well as the development of the newer insurance lines and products. Of the
$24.9 million increase in administrative expenses in 1997, $12.7 million relates
directly to Tempest and the Company's Lloyd's operations, compared to $3.1
million in 1996. Of these amounts, $5.1 million and $1.3 million for 1997 and
1996 respectively, relate to the amortization of goodwill resulting from the
acquisition of Tempest. The decrease in acquisition costs in 1997 to $47.0
million from $53.0 million in 1996 is due primarily to the continuing change in
the mix of business written by the Company.
Underwriting and administrative expenses increased by $21.8 million in 1996
compared to 1995 but the underwriting and administrative expense ratio actually
decreased to 16.1 percent from 16.9 percent in 1995. The increase in expenses is
a result of increases of $6.4 million of acquisition costs and $15.6 million of
administrative expenses. Acquisition costs increased as a result of the
significant increase in net premiums earned in 1996 versus 1995. However, the
acquisition cost ratio decreased to 9.0 percent from 10.9 percent primarily due
to the change in the mix of premiums earned in the year. As with 1997,
administrative expenses increased primarily due to the increased cost base
resulting from the strategic diversification by the Company over the past two
years, including the acquisition of Tempest and Methuen in 1996 as well as the
development of the new insurance lines and products. In addition, the Company
recorded expenses related to stock appreciation rights of $6.0 million in 1996
compared to $2.5 million in 1995. All stock appreciation rights were either
exercised or forfeited during 1997.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
----------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
As a holding company, ACE's assets consist primarily of the stock of its
subsidiaries as well as other investments. In addition to investment income, its
cash flows depend primarily on dividends or other statutorily permissible
payments from its Bermuda-based insurance and reinsurance subsidiaries (the
"Bermuda subsidiaries"). There are currently no legal restrictions on the
payment of dividends from retained earnings by the Bermuda subsidiaries as the
minimum statutory capital and surplus requirements are satisfied by the share
capital and additional paid-in capital of each of the Bermuda subsidiaries.
However, the payment of dividends or other statutorily permissible distributions
by the Bermuda subsidiaries is subject to the need to maintain shareholder's
equity at a level adequate to support the level of insurance and reinsurance
operations. On December 20, 1996, ACE received a dividend of $10 million from
ACE Insurance Management Limited and on May 30, 1997, ACE received a dividend of
$180 million from ACE Insurance.
The Company's consolidated sources of funds consist primarily of net premiums
written, investment income, and the proceeds from sales and maturities of
investments. Funds are used primarily to pay claims, operating expenses and
dividends, for the purchase of investments and for share repurchases.
For the years ended September 30, 1997, 1996 and 1995, the Company's
consolidated net cash flows from operating activities were $282.1 million,
$624.0 million and $437.0 million respectively. Cash flows are affected by claim
payments, which due to the nature of the Company's operations, may comprise
large loss payments on a limited number of claims and therefore can fluctuate
significantly from year to year. The irregular timing of these loss payments,
for which the source of cash can be from operations, available net credit
facilities or routine sales of investments, can create significant variations in
cash flows from operations between periods. Total loss and loss expense payments
amounted to $402.1 million, $101.4 million and $73.1 million in fiscal 1997,
1996 and 1995, respectively.
At September 30, 1997, total investments and cash amounted to $4.5 billion
compared with $4.2 billion at September 30, 1996. The increase is mainly
attributable to cash flows from operating activities, the reinvestment of funds
generated by the portfolio as well as market appreciation during the year. The
increase generated by these items was partially offset by share repurchases and
dividends paid during 1997.
The Company's consolidated investment portfolio is structured to provide a high
level of liquidity to meet insurance related or other obligations. During 1997,
an average of 9.4 percent of the externally managed investment portfolio was
held in short-term investments which mature in one year or less from date of
issue. Additionally, at September 30, 1997, 5.5 percent of the fixed maturity
portfolio had a maturity date within the succeeding twelve month period,
providing a further source of liquid funds. The consolidated investment
portfolio is externally managed by independent professional investment managers
and is invested in high quality investment grade marketable fixed income and
equity securities, the majority of which trade in active, liquid markets (see
note 4 of the Notes to Consolidated Financial Statements for a detailed analysis
of the portfolio). At September 30, 1997, 92.5 percent of the fixed maturity
portion of the portfolio was rated "A" or better by one or more nationally
recognized U.S. rating agencies. The Company believes that its cash balances,
cash flow from operations, routine sales of investments and the liquidity
provided under its committed line of credit (discussed below) are adequate to
allow the Company to pay claims within the time periods required under its
policies.
The Company has a $50 million committed unsecured line of credit provided by a
syndicate of banks, led by Morgan Guaranty Trust Company of New York ("Morgan").
In accordance with the Company's cash management strategy, this facility is
utilized when it is determined that borrowing on a short-term basis is
advantageous to the Company. Borrowings from this facility are generally repaid
from operating cash flows, primarily premium receipts. There were no drawdowns
on the facility during 1997 or 1996. The line of credit agreement requires the
Company to maintain consolidated tangible net worth of not less than $1.25
billion.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
----------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
The same syndicate of banks have also provided up to (Pounds)75 million
(approximately $113 million) for a five year, secured letter of credit
("LOC"), which is primarily used to provide funds at Lloyd's to support
underwriting capacity on Lloyd's syndicates in which the Company
participates.
Subsequent to September 30, 1997, the Company has put in place
syndicated credit facilities which replace the existing facilities described
in the preceding two paragraphs. J.P. Morgan Securities, Inc. and Mellon
Bank N.A. acted as co-arrangers in the arranging, structuring and
syndication of these credit facilities. The new facilities provide:
A $200 million 364 day revolving credit facility and a $200
million five year revolving credit facility which together make up a
combined $400 million committed, unsecured revolving credit facility. This
new five year revolving credit facility has a $50 million LOC sublimit.
A five year LOC facility of approximately (Pounds)154 million
(approximately $250 million). This facility will primarily be used on
fulfill the requirements of Lloyd's to provide funds to support underwriting
capacity on Lloyd's syndicates in which the Company participates. The
minimum consolidated tangible net worth covenant for ACE Insurance under
this LOC facility is $1.0 billion.
A $250 million seven year Amortizing Term Loan Facility which will
be used to partially finance the acquisition of WSG. The interest rate on
the term loan is LIBOR plus an applicable spread.
The revolving credit and term loan facilities require that the Company
maintain a minimum consolidated tangible net worth of $1.4 billion.
The Board of Directors has authorized the repurchase from time to time
of the Company's Ordinary Shares in open market and private purchase
transactions. During 1997, the Company repurchased 3,031,000 Ordinary
Shares under share repurchase programs for an aggregate cost of $182.6
million. On May 9, 1997, the Board of Directors terminated the then
existing share repurchase program and authorized a new program for up to
$300.0 million of the Company's Ordinary Shares. As at September 30, 1997,
approximately $268.0 million of the current Board authorization had not been
utilized. During the period October 1, 1997 through November 25, 1997 the
Company repurchased an additional 786,200 Ordinary Shares under the Share
Repurchase Program for an aggregate cost of $71.8 million, leaving
approximately $196 million of the May 9, 1997 Board authorization not
utilized. During 1996, the Company repurchased 1,268,000 Ordinary Shares
under share repurchase programs for an aggregate cost of $58.0 million.
On October 18, 1996, January 17, 1997 and April 18, 1997, the Company
paid quarterly dividends of 18 cents per share to shareholders of record on
September 30, 1996, December 29, 1996 and March 31, 1997. On July 18, 1997
the Company paid a quarterly dividend of 22 cents per share to shareholders
of record on June 30, 1997. On August 8, 1997 the Board of Directors
declared a quarterly dividend of 22 cents per share paid on October 17, 1997
to shareholders of record on September 30, 1997. On November 13, 1997, the
Board of Directors declared a quarterly dividend of 24 cents per share
payable on January 16, 1998, to shareholders of record on December 13, 1997.
The declaration and payment of future dividends is at the discretion
of the Board of Directors and will be dependent upon the profits and
financial requirements of the Company and other factors, including legal
restrictions on the payment of dividends and such other factors as the Board
of Directors deems relevant.
Fully diluted net asset value per share was $47.14 at September 30,
1997, compared with $38.31 at September 30, 1996.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
----------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
Changes in shareholders' equity for the years ended September 30, 1997 and 1996
were as follows:
1997 1996
-----------------------------
(in millions)
Balance, beginning of year $2,244 $1,443
Net income 461 290
Change in net unrealized appreciation (depreciation) on investments 135 (33)
Repurchase of Ordinary Shares (183) (58)
Dividends declared (45) (32)
Other 7 --
Value of Ordinary Shares and options issued in Tempest acquisition -- 634
-------------------------------
Balance, end of year $2,619 $2,244
===============================
The Company maintains loss reserves for the estimated unpaid ultimate liability
for losses and loss expenses under the terms of its policies and agreements. The
reserve for unpaid losses and loss expenses of $1.9 billion at September 30,
1997, includes $924.2 million of case and loss expense reserves. While the
Company believes that its reserve for unpaid losses and loss expenses at
September 30, 1997 is adequate, future developments may result in ultimate
losses and loss expenses significantly greater or less than the reserve
provided. A number of the Company's insureds have given notice of claims
relating to breast implants or components or raw material thereof that had been
produced and/or sold by such insureds. During fiscal 1997, the Company has made
certain payments to policyholders with respect to these claims. However, the
Company does not have adequate data upon which to anticipate the timing of
future payments relating to these liabilities, and it expects that the amount of
time required to determine the ultimate financial impact of the options selected
by claimants may extend well into 1998 and beyond (see "Breast Implant
Litigation").
The Company's financial condition, results of operations and cash flow are
influenced by both internal and external forces. Claims settlements, premium
levels and investment returns may be impacted by changing rates of inflation and
other economic conditions. In many cases, significant periods of time, ranging
up to several years or more, may elapse between the occurrence of an insured
loss, the reporting of the loss to the Company and the settlement of the
Company's liability for that loss. The liquidity of its investment portfolio,
cash flows and the line of credit are, in management's opinion, adequate to meet
the Company's expected cash requirements.
Breast Implant Litigation
A number of the Company's insureds have given notice of claims relating to
breast implants or components or raw material thereof that had been produced
and/or sold by such insureds. Lawsuits, including class actions, involving
thousands of implant recipients have been filed in both state and federal courts
throughout the United States. Most of the federal cases have been consolidated
pursuant to the rules for Multidistrict Litigation to a Federal District Court
in Alabama, although cases are in the process of being transferred back to
federal courts or remanded to state courts.
On May 15, 1995, the Dow Corning Corporation, one of the major defendants, filed
for protection under Chapter 11 of the U.S. Bankruptcy Code and claims against
Dow Corning remain stayed subject to the Bankruptcy Code.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
----------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
On October 1, 1995, negotiators for three of the major defendants agreed on the
essential elements of an individual settlement plan for U.S. claimants with at
least one implant from any of those manufacturers ("the Settlement"). In
general, under the Settlement, the amounts payable to individual participants,
and the manufacturers' obligations to make those payments, would not be affected
by the number of participants electing to opt out from the new plan. Also, in
general, the compensation would be fixed and not affected by the number of
participants, and the manufacturers would not have a right to walk away because
of the amount of claims payable. Finally, each settling defendant agreed to be
responsible only for cases in which its implant was identified, and not for a
percentage of all cases. By November 13, 1995, the Settlement was approved by
the three major defendants. In addition, two other defendants became part of the
Settlement, although certain of their settlement terms are different and more
restricted than the plan offered by the original three defendants. On December
22, 1995, the multidistrict litigation judge approved the Settlement and the
materials for giving notice to claimants although an appeal concerning the
Settlement is pending with the Eleventh Circuit Court of Appeals.
Beginning in mid-January, 1996, the three major defendants have each made
payments to a court-established fund for use in making payments under the
Settlement. The Settlement Claims Office had reported that as of August 29,
1997, it has sent out Notification of Status Letters to 361,377 non-opt-out
domestic implant recipients who had registered with the Settlement Claims
Office. As of August 31, 1997, approximately $518 million had been distributed
under the Settlement to implant recipients of the three major defendants.
Certain potential payments to claimants relating to other implants remain
suspended because of the pending appeals. The Settlement Claims Office has also
reported that approximately 32,500 domestic registrants (out of the 361,377
domestic registrants sent Notification of Status Letters) exercised opt-out
rights after receiving their status letters. Previously, approximately 19,000
other domestic implant recipients had exercised opt-out rights in 1994 and/or
before receiving status letters.
Although the Company has underwritten the coverage for a number of the defendant
companies including four of the companies involved in the Settlement, the
Company anticipates that insurance coverage issued prior to the time the Company
issued policies will be available for a portion of the defendants' liability. In
addition, the Company's policies only apply when the underlying liability
insurance policies or per occurrence retentions are exhausted.
Declaratory judgment lawsuits, involving four of the Company's insureds, have
been filed seeking guidance on the appropriate trigger for their insurance
coverage. None of the insureds have named the Company in such lawsuits, although
other insurers and third parties have sought to involve the Company in those
lawsuits. To date, one court has stayed a lawsuit against the Company by other
insurers; two courts have dismissed actions by other insurers against the
Company. Another court in Texas has ruled against the Company's arguments that
the court should dismiss the claims by other insurers and certain doctors
attempting to bring the Company into coverage litigation there. On appeal in the
Texas lawsuit, the appellate court affirmed the lower court's order refusing to
dismiss the claims against the Company; further appellate review in the Texas
Supreme Court is pending. In addition, further efforts are contemplated to stay
or dismiss the doctor's claims against the Company in the Texas lawsuit.
At June 30, 1994, the Company increased its then existing reserves relating to
breast implant claims. Although the reserve increase was partially satisfied by
an allocation from existing IBNR, it also required an increase in the Company's
total reserve for unpaid losses and loss expenses at June 30, 1994 of $200
million. The increase in reserves was based on information made available in the
pending lawsuits and information from the Company's insureds and was predicated
upon an allocation between coverage provided before and after the end of 1985
(when the Company commenced underwriting operations). No additional reserves
relating to breast implant claims have been added since June 30, 1994.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
----------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
The Company continually evaluates its reserves in light of developing
information and in light of discussions and negotiations with its insureds.
During 1997, the Company made payments of approximately $250 million with
respect to breast implant claims. These payments were included in previous
reserves and are consistent with the Company's belief that its reserves are
adequate. Significant uncertainties continue to exist with regard to the
ultimate outcome and cost of the Settlement and value of the opt-out claims.
While the Company is unable at this time to determine whether additional
reserves, which could have a material adverse effect upon the financial
condition, results of operations and cash flows of the Company, may be necessary
in the future, the Company believes that its reserves for unpaid losses and loss
expenses including those arising from breast implant claims are adequate as at
September 30, 1997.
Market Sensitive Instruments And Risk Management
In accordance with the Securities and Exchange Commission's Financial Reporting
Release No. 48, the following analysis presents hypothetical losses in cash
flows, earnings and fair values of derivative instruments and other market
sensitive instruments used in the Company's portfolio as at September 30, 1997.
The Company uses investment derivative instruments such as futures, options and
foreign currency forward and option contracts for duration management and
management of foreign currency exposures. These instruments are sensitive to
changes in interest rates and foreign currency exchange rates. The portfolio
includes other market sensitive instruments such as mortgage-backed securities
which are subject to prepayment risks and changes in market values, with changes
in interest rates. These mortgage-backed security instruments are held for
purposes other than trading and are classified as available for sale in the
Company's balance sheet.
Duration Management and Market Exposure Management
The Company uses financial futures and option contracts for the purpose of
managing certain investment portfolio exposures. Futures contracts are not
recognized in the financial statements as assets or liabilities and any changes
in fair value of these instruments due to changes in market interest rates would
be recognized in the statement of operations as realized gains or losses in
accordance with the our accounting policy. Option contracts are utilized in the
portfolio for the purposes of duration management, providing protection against
any unexpected shifts in interest rates. At September 30, 1997, the fair value
of the option contracts held and written was $178,000 and $(222,000)
respectively, and the market value of mortgage-backed securities, another
category of market sensitive instruments, was $1,342 million, or approximately
31 percent of the total investment portfolio. Mortgage-backed securities
include pass through mortgage bonds and collateralized mortgage obligations.
The aggregate hypothetical loss generated from an immediate adverse shift in
the treasury yield curve of 100 basis points would be a decrease in total return
of 4.5 percent which equates to a decrease in market value of approximately $167
million on a portfolio valued at $4.2 billion at September 30, 1997. An
immediate time horizon was used as this presents the worse case scenario.
Foreign Currency Exposure Management
Foreign currency forward and option contracts are used in the portfolio to
minimize the effect of fluctuating currencies on the non-U.S. dollar portfolio.
The value of premiums paid for the contracts represents approximately 9 percent
of the non-U.S. dollar portfolio. A hypothetical adverse change of the forward
exchange rate (a strengthening of the U.S. dollar) is assumed in order to
estimate the exposure risk. Potential losses in cash flows represent additional
cash requirements to be paid out, to settle those foreign currency forward
positions in the portfolio as at September 30, 1997. The hypothetical loss in
cash flows of the foreign currency contracts is estimated to be $1.4 million.
The loss was based on modeling assumptions using a two standard deviation move
in currency rates, and forward yield curves were determined using the implied
volatility, spot rates and forward rates of the contracts at September 30, 1997.
The foreign currency forward contracts are not considered hedges for financial
accounting purposes and have maturity dates of no more than six months.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
----------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
The hypothetical loss in cash flows from the foreign currency put options
assumes that the options were not exercised. For long option positions, the
maximum loss is the premium paid for the options and at September 30, 1997 the
hypothetical loss is approximately $400,000.
New Accounting Pronouncements
In February 1997, the Financial Accounting Standard Board ("FASB") issued
Statement of Financial Accounting Standards No. 128 "Earnings per Share" ("FAS
128"), effective for financial statements issued for periods ending after
December 15, 1997. This Statement establishes standards for computing and
presenting earnings per share ("EPS"). This Statement simplifies the standards
for computing EPS previously found in APB Opinion No. 15, Earnings per Share,
and makes them comparable to international EPS standards. It replaces the
presentation of primary EPS with a presentation of basic EPS. It also requires
dual presentation of basic and diluted EPS on the face of the income statement
for all entities with complex capital structures, which the Company is
considered to have, and requires a reconciliation of the numerator and
denominator of the basic EPS computation to the numerator and denominator of the
diluted EPS computation. This Statement requires restatement of all prior-
period EPS data presented. The Company anticipates presenting its EPS in
compliance with the dual presentation standards mandated by the Statement at
December 31, 1997.
The Company has calculated basic and diluted EPS, as defined in FAS 128 and
interpreted by the Company based on information currently available, and has
determined that such amounts do not differ materially from primary EPS, which is
reflected in the Company's statement of operations for the years presented.
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
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 generally accepted accounting principles, 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.
Coopers & Lybrand L.L.P., independent accountants, are retained to audit the
Company's financial statements. Their accompanying report is based on audits
conducted in accordance with generally accepted auditing standards, 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 accountants, both privately and with management present, to review
accounting, auditing, internal controls and financial reporting matters.
/s/ Brian Duperreault /s/ Christopher Z. Marshall
- ------------------------------ -------------------------------
Brian Duperreault Christopher Z. Marshall
Chairman, President and Chief Financial Officer
Chief Executive Officer
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Shareholders of ACE Limited:
We have audited the consolidated balance sheets of ACE Limited and Subsidiaries
as of September 30, 1997 and 1996, and the related consolidated statements of
operations, shareholders' equity, and cash flows for each of the three years in
the period ended September 30, 1997. 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of ACE Limited and
Subsidiaries as of September 30, 1997 and 1996, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended September 30, 1997, in conformity with generally accepted accounting
principles.
New York, New York
November 5, 1997
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 1997 and 1996
1997 1996
----------- -----------
(in thousands of U.S. dollars,
except share and per share data)
Assets
Investments and cash
Fixed maturities available for sale, at fair value
(amortized cost - $3,226,511 and $3,394,437)........................ $3,290,336 $3,389,762
Equity securities, at fair value (cost - $502,481 and $257,049)......... 634,970 323,005
Short-term investments, at fair value
(amortized cost - $364,552 and $376,680)............................ 364,432 376,680
Other investments, at cost.............................................. 78,691 27,250
Cash.................................................................... 106,336 53,374
---------- ----------
Total investments and cash............................................. 4,474,765 4,170,071
Goodwill on Tempest acquisition............................................ 196,667 201,742
Premiums and insurance balances receivable................................. 135,815 85,033
Accrued investment income.................................................. 40,581 42,728
Deferred acquisition costs................................................. 27,018 34,546
Prepaid reinsurance premiums............................................... 22,196 15,421
Other assets............................................................... 104,504 24,817
---------- ----------
Total assets........................................................ $5,001,546 $4,574,358
========== ==========
Liabilities
Unpaid losses and loss expenses............................................ $1,869,995 $1,836,113
Unearned premiums.......................................................... 400,689 398,731
Premiums received in advance............................................... 36,218 29,852
Accounts payable and accrued liabilities................................... 63,014 54,913
Dividend payable........................................................... 12,436 10,471
---------- ----------
Total liabilities................................................... 2,382,352 2,330,080
---------- ----------
Commitments and contingencies
Shareholders' equity
Ordinary Shares ($0.125 par value, 100,000,000 shares authorized;
55,293,218 and 58,170,755 shares issued and outstanding)................ 6,911 7,271
Additional paid-in capital................................................. 1,102,824 1,156,194
Unearned stock grant compensation.......................................... (1,993) (1,299)
Net unrealized appreciation on investments................................. 196,194 61,281
Cumulative translation adjustments......................................... 855 131
Retained earnings.......................................................... 1,314,403 1,020,700
---------- ----------
Total shareholders' equity.......................................... 2,619,194 2,244,278
---------- ----------
Total liabilities and shareholders' equity.......................... $5,001,546 $4,574,358
========== ==========
See accompanying notes to consolidated financial statements
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended September 30, 1997, 1996 and 1995
1997 1996 1995
----------- ---------- ----------
(in thousands of U.S. dollars,
except share and per share data)
Revenues
Gross premiums written............. $ 742,654 $ 645,800 $ 435,820
Reinsurance premiums ceded......... (102,910) (43,093) (11,064)
---------- ---------- ----------
Net premiums written............... 639,744 602,707 424,756
Change in unearned premiums........ 5,094 (15,462) 3,905
---------- ---------- ----------
Net premiums earned................ 644,838 587,245 428,661
Net investment income.............. 237,823 206,524 181,375
Net realized gains on investments.. 127,982 55,229 50,765
---------- ---------- ----------
Total revenues................. 1,010,643 848,998 660,801
---------- ---------- ----------
Expenses
Losses and loss expenses........... 435,941 464,824 350,653
Acquisition costs.................. 46,957 52,954 46,647
Administrative expenses............ 66,391 41,487 25,935
---------- ---------- ----------
Total expenses................. 549,289 559,265 423,235
---------- ---------- ----------
Net income............................ $ 461,354 $ 289,733 $ 237,566
========== ========== ==========
Earnings per share.................... $ 8.02 $ 5.82 $ 5.05
========== ========== ==========
Weighted average shares outstanding... 57,493,671 49,813,628 47,059,006
========== ========== ==========
See accompanying notes to consolidated financial statements
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the Years Ended September 30, 1997, 1996 and 1995
1997 1996 1995
---- ---- ----
(in thousands of U.S. dollars)
Ordinary Shares
Balance - beginning of year .................................................... $ 7,271 $ 5,764 $ 5,928
Shares issued in Tempest transaction............................................ -- 1,666 --
Issued under Employee Stock Purchase Plan (ESPP)................................ 1 --
Issued under Stock Appreciation Right (SAR) Plan................................ 8 --
Exercise of stock options....................................................... 9 -- 3
Repurchase of shares............................................................ (378) (159) (167)
---------- ---------- --------
Balance - end of year...................................................... 6,911 7,271 5,764
---------- ---------- --------
Additional paid-in capital
Balance - beginning of year..................................................... 1,156,194 548,513 564,198
Shares issued in Tempest acquisition............................................ -- 620,552 --
Options issued in Tempest acquisition........................................... -- 12,124 --
Exercise of stock options....................................................... 2,182 27 165
Cancellation of restricted stock awards......................................... (87) -- --
Issued under ESPP............................................................... 228 -- --
Issued under SAR Plan........................................................... 3,919 -- --
Repurchase of Ordinary Shares................................................... (59,612) (25,022) (15,850)
---------- ---------- --------
Balance - end of year...................................................... 1,102,824 1,156,194 548,513
---------- ---------- --------
Unearned stock grant compensation
Balance - beginning of year................................................... (1,299) (1,796) (412)
Stock grants awarded.......................................................... (3,244) (708) (2,413)
Stock grants forfeited........................................................ 79 60 --
Amortization.................................................................. 2,471 1,145 1,029
---------- ---------- --------
Balance - end of year...................................................... (1,993) (1,299) (1,796)
---------- ---------- --------
Net unrealized appreciation (depreciation) on investments
Balance - beginning of year..................................................... 61,281 94,694 (79,685)
Net appreciation (depreciation) during year..................................... 134,913 (33,413) 174,379
---------- ---------- --------
Balance - end of year...................................................... 196,194 61,281 94,694
---------- ---------- --------
Cumulative translation adjustments
Balance - beginning of year..................................................... 131 -- --
Net adjustment for year......................................................... 724 131 --
---------- ---------- --------
Balance - end of year......................................................... 855 131 --
---------- ---------- --------
Retained earnings
Balance - beginning of year..................................................... 1,020,700 795,488 598,716
Net income...................................................................... 461,354 289,733 237,566
Dividends declared.............................................................. (44,993) (31,699) (23,297)
Repurchase of Ordinary Shares................................................... (122,658) (32,822) (17,497)
---------- ---------- ----------
Balance - end of year...................................................... 1,314,403 1,020,700 795,488
---------- ---------- ----------
Total shareholders' equity............................................ $2,619,194 $2,244,278 $1,442,663
========== ========== ==========
See accompanying notes to consolidated financial statements
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For The Years Ended September 30, 1997, 1996 and 1995
1997 1996 1995
-------------- ------------ ------------
(in thousands of U.S. dollars)
Cash flows from operating activities
Net income............................................................. $ 461,354 $ 289,733 $ 237,566
Adjustments to reconcile net income to net cash provided
by operating activities:
Unearned premiums................................................. 1,958 14,247 (1,771)
Unpaid losses and loss expenses................................... 33,882 363,448 277,538
Deferred acquisition costs........................................ 7,528 9,262 3,016
Premiums and insurance balances receivable........................ (50,782) 3,460 (11,948)
Premiums received in advance...................................... 6,336 5,976 4,230
Prepaid reinsurance premiums...................................... (6,775) (11,267) (2,134)
Net realized gains on investments................................. (127,982) (55,229) (50,765)
Amortization of premium/discount.................................. (6,104) (7,847) (12,590)
Accounts payable and accrued liabilities.......................... (23,327) 11,308 1,029
Change in cumulative translation adjustments...................... (724) (131) --
Other............................................................. (13,271) 1,076 (7,148)
----------- ----------- -----------
Net cash flows from operating activities........................ 282,123 624,036 437,023
----------- ----------- -----------
Cash flows from investing activities
Purchases of fixed maturities..................................... (6,415,568) (8,781,390) (7,562,469)
Purchases of equity securities.................................... (603,598) (222,382) (325,509)
Sales of fixed maturities......................................... 6,640,245 8,220,230 7,336,706
Sales of equity securities........................................ 385,552 209,350 118,825
Maturities of fixed maturities.................................... 5,000 59,830 39,342
Net realized gains on financial futures and option contracts...... 57,076 26,678 39,788
Acquisition of subsidiaries, net of cash acquired................. (27,098) (11,572) (25,794)
Other investments................................................. (51,441) (2,676) --
----------- ----------- -----------
Net cash flows used for investing activities.................... (9,832) (501,932) (379,111)
----------- ----------- -----------
Cash flows from financing activities
Repurchase of Ordinary Shares..................................... (182,648) (58,003) (33,514)
Proceeds from exercise of options for shares...................... 2,191 28 168
Proceeds from shares issued under SAR Plan........................ 4,156 -- --
Dividends paid.................................................... (43,028) (27,684) (22,058)
----------- ----------- -----------
Net cash used for financing activities.......................... (219,329) (85,659) (55,404)
----------- ----------- -----------
Net increase in cash...................................................... 52,962 36,445 2,508
Cash - beginning of year.................................................. 53,374 16,929 14,421
----------- ----------- -----------
Cash - end of year........................................................ $ 106,336 $ 53,374 $ 16,929
=========== =========== ===========
See accompanying notes to consolidated financial statements
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization
ACE Limited ("ACE" or "the Company") is incorporated with limited liability
under the Cayman Islands Companies Law and maintains its principal business
office in Bermuda. The Company, through its Bermuda-based operating
subsidiaries, A.C.E. Insurance Company, Ltd. ("ACE Insurance"), Corporate
Officers & Directors Assurance Ltd. ("CODA") and Tempest Reinsurance Company
Limited ("Tempest"), provides insurance and reinsurance for a diverse group of
international clients. In addition, the Company, through corporate subsidiaries,
provides funds at Lloyd's to support underwriting by Lloyd's syndicates managed
by Methuen Underwriting Limited ("MUL"), ACE London Aviation Limited ("ALA") and
ACE London Underwriting Limited ("ALU"), its indirect wholly owned subsidiaries.
On March 27, 1996, the Company acquired a controlling interest in Methuen Group
Limited ("Methuen"), the holding company for MUL, a leading Lloyd's managing
agency. This acquisition has been recorded using the purchase method of
accounting and accordingly, the accompanying consolidated financial statements
include the results of Methuen since March 27, 1996, the date of acquisition.
Had the results of Methuen been included commencing with operations in 1995, the
reported results would not have been materially affected.
On July 1, 1996, the Company completed the acquisition of Tempest, a leading
Bermuda-based property catastrophe reinsurer (the "Tempest Acquisition"). Under
the terms of the Agreement and Plan of Amalgamation, Tempest shares outstanding
at the time of the acquisition were cancelled and converted into the right to
receive 13,333,247 Ordinary Shares of the Company. These shares were capitalized
at a value of $46 2/3 per share, which was determined in accordance with the
EITF 95-19 concensus that deals with the value of equity securities issued to
effect a purchase combination. In addition, options to acquire Tempest shares
were converted into 446,089 Company options at a total cost of $12.1 million.
The total value of the acquisition amounted to $638.7 million, which includes
the value of the shares and options issued as well as other transaction expenses
which amounted to $4.4 million. This acquisition has been recorded using the
purchase method of accounting and accordingly, the accompanying consolidated
financial statements include the results of Tempest since July 1, 1996, the date
of acquisition (see note 15 for pro forma financial information with respect to
the Tempest Acquisition).
On November 26, 1996, the Company acquired Ockham Worldwide Holdings plc which
subsequently changed its name to ACE London Holdings Ltd. ("ACE London"). ACE
London owns two Lloyd's managing agencies, ALA and ALU. The acquisition has been
recorded using the purchase method of accounting and accordingly, the
accompanying consolidated financial statements include the results of ACE London
since November 26, 1996, the date of acquisition. Had the results of ACE London
been included commencing with operations in 1996, the reported results would not
have been materially affected.
On November 26, 1996, the Company, also acquired the remaining 49 percent
interest in Methuen. The Company had originally acquired a 51 percent interest
in Methuen on March 27, 1996. The acquisition of the remaining 49 percent
interest has been recorded using the purchase method of accounting.
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
1. Organization (cont'd.)
On September 18, 1997, the Company announced it had executed a definitive
agreement for the acquisition, through a newly-created U.S. holding company, of
Westchester Specialty Group, Inc. ("WSG"), an indirect wholly owned subsidiary
of Xerox Corporation. WSG, through its insurance subsidiaries, provides
specialty commercial property and umbrella liability coverages in the U.S. Under
the terms of the agreement, the Company will purchase all of the outstanding
capital stock of WSG for aggregate cash consideration of approximately $333
million. In connection with the acquisition, National Indemnity, a subsidiary of
Berkshire Hathaway, will provide $750 million (75 percent quota share of $1
billion) of reinsurance protection to WSG with respect to their loss reserves
for the 1996 and prior accident years. The acquisition, which is subject to,
among other matters, regulatory approval and other customary closing conditions,
is expected to close in early 1998.
On September 30, 1997, the Company announced the incorporation of ACE Insurance
Company Europe Limited ("AICE"), as part of the International Financial Services
Centre in Dublin, Ireland. AICE has been granted a license to write all 18
classes of non-life insurance in all member states of the European Union.
2. Operations
a) Insurance operations
The Company, through ACE Insurance and CODA, writes excess liability insurance,
directors and officers liability insurance, satellite insurance, aviation
insurance, excess property insurance and financial lines products. At September
30, 1997 approximately 67 percent of the Company's written premiums with respect
to these lines of business came from North America with approximately 23 percent
coming from the United Kingdom and continental Europe and approximately 10
percent from other countries.
Two insurance brokers produced approximately 59 percent, 42 percent and 59
percent of the Company's insurance business for ACE Insurance and CODA in 1997,
1996 and 1995.
The Company writes excess liability coverage on an occurrence first reported
stand alone form to a maximum of $200 million per occurrence and annual
aggregate. The minimum attachment point for this excess liability coverage is
generally $100 million; however, for certain classes of non-U.S. domiciled
insureds the Company allows a minimum attachment point of $50 million. For all
new and renewal business, effective on or after December 15, 1994, the Company
reduced the maximum limits offered for integrated occurrences from $200 million
to $100 million. The Company maintains excess of loss clash reinsurance to
protect it from losses arising from a single set of circumstances (occurrence)
covered by more than one excess liability insurance policy. The reinsurance
provides protection to a maximum of $150 million, and in the aggregate excess of
$225 million, for each and every loss occurrence involving three or more
insureds. Integrated occurrences are specifically excluded. There have been no
reinsurance recoveries to date on this reinsurance. Total clash reinsurance
premiums expensed were $5.0 million for fiscal 1997, $7.9 million for fiscal
1996 and $7.8 million in fiscal 1995.
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
2. Operations (Cont'd.)
a) Insurance operations (Cont'd.)
The Company offers excess directors and officers liability coverage with a
maximum policy limit of $50 million and a minimum attachment point, in most
circumstances, of $25 million. This coverage is frequently written on a
following form basis to underlying policies. The Company also provides up to $75
million of either primary, excess or excess and difference-in-conditions
directors and officers liability coverage for claims with respect to losses not
covered by corporate reimbursement. In all cases coverage is on a claims made
basis. The Company does not purchase reinsurance for its directors and officers
liability risks.
The Company's satellite insurance operations offers separate gross limits of up
to $50 million per risk for launch insurance, including ascent to orbit and/or
initial testing and up to $50 million per risk for in-orbit insurance. The
Company has entered into a surplus treaty arrangement which provides for up to
$25 million of reinsurance on each risk. Prior to February 1996, the Company
offered separate limits of up to $25 million per risk, which was fully retained
by the Company.
The Company currently offers aviation insurance with limits of up to $150
million per insured, with no minimum attachment point. The Company reduces its
net exposure to approximately $50 million with a dedicated reinsurance program.
Classes of business written include aviation product liability, aircraft
manufacturer's hull and liability, airport liability, aviation refueling
operations and associated aircraft liability risks.
The Company offers global excess property "all risk" insurance, providing limits
of up to a maximum of $50 million per occurrence with a minimum attachment point
generally of $25 million. Coverage includes such perils as windstorm, earthquake
and fire, as well as explosion. Consequential business interruption coverage is
also offered. In certain circumstances, the Company uses reinsurance to
establish the retained net limit per risk.
The Company's financial lines product group offers specifically designed
financial, insurance and reinsurance solutions to address complex risk
management problems. The programs offered typically have the following common
characteristics: multi-year contract terms, broad coverage that includes stable
capacity and pricing for the insured, aggregate policy limits and insured
participation in the results of their own loss experience. Each contract is
unique because it is tailored to the insurance or reinsurance needs, specific
loss history and financial strength of the insured. Premium volume, as well as
the number of contracts written, can vary significantly from period to period
due to the nature of the contracts being written. Profit margins may vary from
contract to contract depending on the amount of underwriting risk and investment
risk assumed on each contract. The Company has purchased a multi-year
reinsurance contract which protects a number of financial lines inwards programs
exposed to natural perils.
In March 1997, the Company, together with two other insurance companies, formed
a managing general agency in Bermuda to provide underwriting services to the
three organizations for political risk insurance coverage. The new company,
Sovereign Risk Insurance Ltd. ("Sovereign") issues subscription policies with
the Company assuming 50 percent of each risk underwritten. The Company currently
cedes 10 percent of all risks assumed from Sovereign. Sovereign offers limits of
up to $50 million per project and $100 million per country.
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
2. Operations (Cont'd.)
b) Reinsurance operations
The Company, through Tempest, underwrites property catastrophe reinsurance on a
worldwide basis, emphasizing excess layer coverages, and has large aggregate
exposures to man-made and natural disasters. Tempest underwrites principally on
an excess of loss basis, with attachment points designed to minimize claims from
relatively high frequency and low severity events. For the year ended September
30, 1997, approximately 68 percent of Tempest's written premiums came from the
United States, approximately 13 percent came from United Kingdom, 6 percent from
Australia and New Zealand and 13 percent from other countries.
Two reinsurance brokers produced approximately 46 percent and 33 percent of
Tempest's reinsurance business for the year ended September 30, 1997 and the ten
month period ended September 30, 1996.
In April 1997, ACE Insurance signed a quota share treaty reinsurance agreement
with the Multilateral Investment Guarantee Agency ("MIGA"), part of the World
Bank Group. MIGA provides coverage for foreign investments in developing
countries. The agreement allows MIGA to provide private investors and developing
countries additional capacity to support developmentally sound investment
projects. The coverages offered will be the same as those offered by MIGA's
guarantee program, namely, transfer restriction, expropriation, war and civil
disturbance and breach of contract. The quota share treaty offers limits of up
to $25 million per contract with an aggregate of $100 million per country.
As discussed in note 2(a), the Company's financial lines product group also
offers reinsurance products and the Lloyd's syndicates in which the Company
participates also participate in certain reinsurance markets (see note 2 (c)).
c) Lloyd's operations
The Company, through corporate subsidiaries, participates in the underwriting of
syndicates managed by MUL, ALA and ALU by providing funds at Lloyd's, primarily
in the form of a letter of credit, supporting underwriting capacity. The
syndicates in which the Company participates underwrite aviation, marine and
non-marine risks. For the 1996, 1997 and 1998 years of account, the Company has
or will provide funds at Lloyd's to support up to approximately $37 million,
$229 million and $485 million, respectively, of underwriting capacity to
syndicates managed by MUL, ALA and ALU. Underwriting capacity is the amount of
gross premiums that a syndicate at Lloyd's can underwrite in a given year of
account. However, a syndicate is not required to fully utilize all of the
capacity and it is not unusual for capacity utilization to be significantly
lower than 100 percent.
3. 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 of
America ("GAAP") and include the accounts of the Company and its subsidiaries.
The Company records its proportionate share of the results of the Lloyd's
syndicates in which it participates. All significant intercompany balances and
transactions have been eliminated. Certain items in the prior year financial
statements have been reclassified to conform with the current year presentation.
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
3. Significant accounting policies (Cont'd.)
b) 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 No. 115 "Accounting for Certain
Investments in Debt and Equity Securities". Except for "other investments", 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. Realized gains or losses on sales of investments
are determined on a first-in, first-out basis and include adjustments to the net
realizable value of investments for declines in value that are considered to be
other than temporary. Unrealized gains and losses are reported as a separate
component of shareholders' equity.
Short-term investments comprise securities due to mature within one year of date
of issue.
Other investments comprise investments in entities for which there is no quoted
market value. It is not practicable to estimate the fair value of the
investments and thus they are carried at original cost.
The Company utilizes financial futures and option contracts and foreign currency
forward and option contracts for the purpose of managing certain investment
portfolio exposures (see note 7(a) for additional discussion of the objectives
and strategies employed). Futures contracts are not recognized as assets or
liabilities in the accompanying consolidated financial statements. Changes in
the market value of futures contracts produce daily cash flows, which are
included in net realized gains or losses on investments in the 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.
Option contracts that are designated as hedges of securities are marked-to-
market. Unrealized gains and losses on forward currency and option contracts
which are designated as specific hedges are recognized in the financial
statements as a component of shareholders' equity. Gains and losses resulting
from currency fluctuations on transactions which are not designated as specific
hedges against any single security or group of securities are recognized as a
component of income in the period in which the fluctuations occur. Premiums paid
or received on option contracts that have expired, been closed out or exercised,
are recognized as realized gains and losses on investments in the statements of
operations.
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 and loan expense. 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 in
current income.
c) 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.
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
3. Significant accounting policies (Cont'd.)
c) Premiums (Cont'd.)
Premiums written are primarily earned on a daily 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.
Property catastrophe reinsurance premiums written 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.
d) Acquisition costs
Acquisition costs, consisting primarily of commissions, are deferred and
amortized over the period in which the related premiums are earned. Deferred
acquisition costs are reviewed to determine that they do not exceed recoverable
amounts after considering investment income.
e) Losses and loss expenses
A reserve 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. 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 significantly greater or less than the
reserve provided.
f) Goodwill
The Company amortizes goodwill recorded in connection with its business
combinations on a straight-line basis over the lesser of the expected life of
the related operations acquired or forty years. Amortization of goodwill
amounting to $5.1 million and $1.3 million with respect to the Tempest
Acquisition is included in administrative expenses in the statements of
operations for the years ended September 30, 1997 and 1996, respectively.
g) Translation of foreign currencies
Financial statements of subsidiaries expressed in foreign currencies are
translated into U.S. dollars in accordance with Statement of Financial
Accounting Standards 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 shareholders' equity.
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 current income.
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
3. Significant accounting policies (Cont'd.)
h) Accounting estimates
The preparation of financial statements in conformity with GAAP 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 property and casualty loss and loss expense reserves and estimated
premiums for situations where the Company has not received ceding company
reports. Actual results may differ from these estimates.
i) Earnings per share
Earnings per share are computed using net income divided by the weighted
average number of Ordinary Shares outstanding and, if dilutive, shares
issuable under outstanding options. There is no material difference between
primary and fully diluted earnings per share.
j) 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.
4. Investments
a) Fixed maturities
The fair values and amortized costs of fixed maturities at September 30, 1997
and 1996 are as follows:
1997 1996
----------------------- -----------------------
Fair Amortized Fair Amortized
Value Cost Value Cost
---------- ---------- ---------- ----------
(in thousands)
U.S. Treasury and agency.... $ 505,783 $ 488,961 $ 973,362 $ 971,615
Non-U.S. governments........ 158,506 157,206 190,999 191,727
Corporate securities........ 1,283,606 1,255,837 950,532 948,694
Mortgage-backed securities.. 1,342,441 1,324,507 1,274,869 1,282,401
---------- ---------- ---------- ----------
Fixed maturities.......... $3,290,336 $3,226,511 $3,389,762 $3,394,437
========== ========== ========== ==========
The gross unrealized gains and losses related to fixed maturities at
September 30, 1997 and 1996 are as follows:
1997 1996
------------------------ ----------------------
Gross Gross Gross Gross
Unrealized Unrealized Unrealized Unrealized
Gains Losses Gains Losses
---------- ----------- ---------- ----------
(in thousands)
U.S. Treasury and agency.... $ 17,769 $ (947) $ 8,254 $ (6,507)
Non-U.S. governments........ 4,003 (2,703) 3,752 (4,480)
Corporate securities........ 29,800 (2,031) 11,271 (9,433)
Mortgage-backed securities.. 21,678 (3,744) 11,251 (18,783)
---------- ---------- --------- ----------
$ 73,250 $ (9,425) $ 34,528 $ (39,203)
========== ========== ========= ==========
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
4. Investments (Cont'd.)
a) Fixed maturities (Cont'd.)
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 67 percent of the total mortgage holdings at
September 30, 1997 and 72 percent at September 30, 1996 are represented by
investments in GNMA, FNMA and FHLMC bonds. The remainder of the mortgage
exposure consists of CMO's (Collaterialized Mortgage Obligations) and non-
government mortgage-backed securities, the majority of which provide a planned
structure for principal and interest payments and carry a "AAA" rating by the
major credit rating agencies. Fixed maturities at September 30, 1997, 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.
Fair Amortized
Value Cost
---------- ----------
(in thousands)
Maturity period
- ---------------
Less than 1 year......................................... $ 181,317 $ 180,289
1-5 years................................................ 459,568 455,704
5-10 years............................................... 608,143 599,972
Greater than 10 years.................................... 698,867 666,039
---------- ----------
1,947,895 1,902,004
Mortgage-backed securities............................... 1,342,441 1,324,507
---------- ----------
Total fixed maturities.............................. $3,290,336 $3,226,511
========== ==========
b) Equity securities
The gross unrealized gains and losses on equity securities at September 30,
1997 and 1996 are as follows:
1997 1996
--------- ---------
(in thousands)
Equity securities - cost................................. $ 502,481 $ 257,049
Gross unrealized gains................................... 152,406 81,935
Gross unrealized losses.................................. (19,917) (15,979)
--------- ---------
Equity securities - fair value....................... $ 634,970 $ 323,005
========= =========
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
4. Investments (Cont'd.)
c) Net realized gains and change in net unrealized appreciation (depreciation)
on investments
The analysis of net realized gains on investments and the change in net
unrealized appreciation (depreciation) on investments for the years ended
September 30, 1997, 1996 and 1995 is as follows:
1997 1996 1995
-------- -------- --------
(in thousands)
Fixed maturities
Gross realized gains..................................................... $ 83,933 $ 63,416 $ 78,021
Gross realized losses.................................................... (24,892) (48,963) (69,669)
-------- -------- --------
59,041 14,453 8,352
Equity securities
Gross realized gains..................................................... 70,449 39,768 15,371
Gross realized losses.................................................... (32,379) (23,985) (11,763)
-------- -------- --------
38,070 15,783 3,608
Currency losses............................................................ (26,204) (1,685) (983)
Financial futures and option contracts - net realized gains................ 57,075 26,678 39,788
-------- -------- --------
Net realized gains on investments...................................... 127,982 55,229 50,765
-------- -------- --------
Change in net unrealized appreciation (depreciation) on investments
Fixed maturities......................................................... 68,500 (56,226) 131,236
Equity securities........................................................ 66,533 22,813 43,143
Short-term investments................................................... (120) -- --
-------- -------- --------
Change in net unrealized appreciation (depreciation) on investments.... 134,913 (33,413) 174,379
-------- -------- --------
Total net realized gains and change in net unrealized appreciation
(depreciation) on investments............................................ $262,895 $ 21,816 $225,144
======== ======== ========
d) Net investment income
Net investment income for the years ended September 30, 1997, 1996 and 1995 was
derived from the following sources:
1997 1996 1995
-------- -------- --------
(in thousands)
Fixed maturities and short-term investments................................ $236,998 $210,517 $184,240
Equity securities.......................................................... 6,178 1,480 944
Other investments.......................................................... 2,300 1,840 1,736
Other...................................................................... 2,304 156 774
-------- -------- --------
Gross investment income.................................................. 247,840 213,993 187,694
Investment expenses........................................................ (9,800) (7,217) (5,662)
Loan expense............................................................... (217) (252) (336)
Amortization of acquisition liabilities.................................... -- -- (321)
-------- -------- --------
Net investment income.................................................... $237,823 $206,524 $181,375
======== ======== ========
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
5. Losses and loss expenses
The reserve for unpaid losses and loss expenses represents estimated ultimate
losses and loss expenses less paid losses and loss expenses and is comprised of
the following at September 30, 1997 and 1996:
1997 1996
---------- ----------
(in thousands)
Case and loss expense reserves............................................. $ 924,221 $ 993,671
IBNR loss reserves......................................................... 945,774 842,442
---------- ----------
Total unpaid losses and loss expenses.................................. $1,869,995 $1,836,113
========== ==========
The Company uses statistical and actuarial methods to reasonably estimate
ultimate expected losses and loss expenses using the Company's loss development
history, data obtained from underwriting applications, actuarial evaluations
and, in the case of excess liability reserves, research of large liability
losses. 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 the Company and the settlement of the Company's liability for the
loss. During the loss settlement period, additional facts regarding individual
claims and trends usually will become known. As these become apparent, case
reserves may be adjusted by allocation from IBNR loss reserves without any
change in the overall reserve. In addition, application of the statistical and
actuarial methods may require the adjustment of the overall reserves from time
to time.
The reconciliation of unpaid losses and loss expenses for the years ended
September 30, 1997, 1996 and 1995 is as follows:
1997 1996 1995
------------------------------------
(in thousands)
Unpaid losses and loss expenses at beginning of year....................... $1,836,113 $1,437,930 $1,160,392
Unpaid losses and loss expenses assumed in respect of acquired companies... -- 34,735 --
---------- ---------- ----------
Total.................................................................. 1,836,113 1,472,665 1,160,392
---------- ---------- ----------
Losses and loss expenses incurred in respect of losses occurring in:
Current year............................................................. 435,941 464,824 350,653
Prior years.............................................................. -- -- --
---------- ---------- ----------
Total.................................................................. 435,941 464,824 350,653
---------- ---------- ----------
Losses and loss expenses paid in respect of losses occurring in:
Current year............................................................. 52,547 39,567 14,394
Prior years.............................................................. 349,512 61,809 58,721
---------- ---------- ----------
Total.................................................................. 402,059 101,376 73,115
---------- ---------- ----------
Unpaid losses and loss expenses at end of year......................... $1,869,995 $1,836,113 $1,437,930
========== ========== ==========
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
5. Losses and loss expenses (Cont'd.)
A number of the Company's insureds have given notice of claims relating to
breast implants or components or raw material thereof that had been produced
and/or sold by such insureds. Lawsuits including class actions, involving
thousands of implant recipients have been filed in both state and federal
courts throughout the United States. Most of the federal cases have been
consolidated pursuant to the rules for Multidistrict Litigation to a Federal
District Court in Alabama.
On May 15, 1995, the Dow Corning Corporation, a significant defendant, filed
for protection under Chapter 11 of the U.S. Bankruptcy Code and claims
against Dow Corning remain stayed subject to the Bankruptcy Code.
On October 1, 1995, negotiators for three of the major defendants agreed on
the essential elements of a revised individual settlement plan for U.S.
claimants with at least one implant from any of those manufacturers ("the
Settlement"). In general, under the Settlement, the amounts payable to
individual participants, and the manufacturers' obligations to make those
payments, would not be affected by the number of claimants electing to opt
out from the new plan. Also, in general, the compensation would be fixed and
not affected by the number of participants, and the manufacturers would not
have a right to walk away because of the amount of claims payable. Finally,
each defendant agreed to be responsible only for cases in which its implant
was identified, and not for a percentage of all claims.
By November 13, 1995, the Settlement was approved by the three major
defendants. In addition, two other defendants became part of the Settlement,
although certain of their settlement terms are different and more restricted
than the plan offered by the original three defendants.
On December 22, 1995, the multidistrict litigation judge approved the
Settlement and the materials for giving notice to claimants although an
appeal concerning the Settlement is pending with the Eleventh Circuit Court
of Appeals. Beginning in mid-January, 1996, the three major defendants have
each made payments to a court-established fund for use in making payments
under the Settlement. The Settlement Claims Office had reported that as of
August 29, 1997, it has sent out Notification of Status Letters to 361,377
non-opt-out domestic implant recipients who had registered with the
Settlement Claims Office. As of August 31, 1997, approximately $518 million
had been distributed under the Settlement to implant recipients of the three
major defendants. Certain potential payments to claimants relating to other
implants remain suspended because of the pending appeals. The Settlement
Claims Office has also reported that approximately 32,500 domestic
registrants (out of the 361,377 domestic registrants sent Notification of
Status Letters) exercised opt-out rights after receiving their status
letters. Previously, approximately 19,000 other domestic implant recipients
had exercised opt-out rights in 1994 and/or before receiving status letters.
At June 30, 1994, the Company increased its then existing reserves relating
to breast implant claims. Although the reserve increase was partially
satisfied by an allocation from existing IBNR, it also required an increase
in the Company's total reserve for unpaid losses and loss expenses at June
30, 1994 of $200 million. The increase in reserves was based on information
made available in conjunction with the lawsuits and information made
available from the Company's insureds and was predicated upon an allocation
between coverage provided before and after the end of 1985 (when the Company
commenced underwriting operations). No additional reserves relating to breast
implant claims have been added since June 30, 1994.
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
5. Losses and loss expenses (Cont'd.)
The Company continually evaluates its reserves in light of developing
information and in light of discussions and negotiations with its insureds.
During 1997, the Company made payments of approximately $250 million with
respect to breast implant claims. These payments were included in previous
reserves and are consistent with the Company's belief that its reserves are
adequate. Significant uncertainties continue to exist with regard to the
ultimate outcome and cost of the Settlement and value of the opt-out claims.
While the Company is unable at this time to determine whether additional
reserves, which could have a material adverse effect upon the financial
condition, results of operations and cash flows of the Company, may be necessary
in the future, the Company believes that its reserves for unpaid losses and loss
expenses including those arising from breast implant claims are adequate as at
September 30, 1997.
6. Reinsurance
The Company purchases reinsurance to manage various exposures including
catastrophic risks. Although reinsurance agreements contractually obligate the
Company's reinsurers to reimburse it for the agreed upon portion of its gross
paid losses, they do not discharge the primary liability of the Company. The
Company evaluates the financial condition of its reinsurers through internal
reinsurance committees consisting of certain members of senior management. No
single reinsurer is a material reinsurer to the Company nor is the Company's
business dependent on any reinsurance contract. The statements of operations
amounts for net premiums written and net premiums earned are net of reinsurance.
Direct, assumed and ceded amounts for these items for the years ended September
30, 1997, 1996 and 1995 are as follows:
1997 1996 1995
---------- ---------- ----------
(in thousands)
Premiums written
Direct......... $ 611,633 $596,176 $416,040
Assumed........ 131,021 49,624 19,780
Ceded.......... (102,910) (43,093) (11,064)
--------- -------- --------
Net............ $ 639,744 $602,707 $424,756
========= ======== ========
Premiums earned
Direct......... $ 594,043 $566,293 $425,569
Assumed........ 140,942 51,201 12,024
Ceded.......... (90,147) (30,249) (8,932)
--------- -------- --------
Net............ $ 644,838 $587,245 $428,661
========= ======== ========
The Company's provision for loss recoveries on reinsurance ceded is not material
in each of the years ended September 30, 1997, 1996 and 1995.
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
7. Commitments and contingencies
a) Financial instruments with off-balance sheet risk
The Company's investment guidelines permit, subject to specific approval,
investments in derivative instruments such as futures, options and foreign
currency forward contracts for purposes other than trading. Their use is limited
to yield enhancement, duration management, foreign currency exposure management
or to obtain an exposure to a particular financial market.
(i) Foreign currency exposure management
The Company uses foreign currency forward and option contracts to minimize the
effect of fluctuating foreign currencies on the value of non-U.S dollar
securities currently held in the portfolio. Approximately $495 million is
invested in non-U.S. dollar fixed maturity and equity securities. The forward
currency contracts purchased are not specifically identifiable against any
single security or group of securities denominated in those currencies and
therefore do not qualify as hedges for financial reporting purposes. All
contract gains and losses, realized and unrealized, are reflected in the
statements of operations. At September 30, 1997, no foreign currency forward
or option contract had a maturity of more than six months. The table below
summarizes the notional amounts, the current fair values and the unrealized
gain or loss of the Company's foreign currency forward and option contracts as
at September 30, 1997.
Contractual/Notional Unrealized
Amount Fair Value Gains/(Losses)
-------------------- ---------- --------------
(in thousands)
Forward contracts.................. $ 43 $716 $ 673
Foreign currency option contracts.. 25,130 118 (293)
The fair value of the forward contracts represents the estimated cost to the
Company at September 30, 1997, of obtaining the specified currency to meet the
obligation of the contracts. The unrealized gain is a measure of the net
exposure to the Company of its use of forward contracts after any netting
agreements given current rates of exchange. The fair value of the options
represents the market price of the options at September 30, 1997. The
unrealized loss represents the difference between the fair value and the
premium paid.
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. For
forward contracts, the counterparties are principally banks which must meet
certain criteria according to the Company's investment guidelines.
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
7. Commitments and contingencies (Cont'd.)
(ii) Duration management and market exposure
Futures
A portion of the Company's investment portfolio is managed as a synthetic
equity fund, whereby S&P 500 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. Each
index futures contract held by the Company is rolled over quarterly into a
new contract with a later maturity, thereby maintaining a constant equity
market exposure. The value of this fund was $286 million and $305 million at
September 30, 1997 and 1996, respectively.
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. The contract amounts of $380 million and
$478 million reflect the net extent of involvement the Company had in these
financial instruments at September 30, 1997 and 1996, respectively.
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 account can be reduced. 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. To minimize the risk of non-performance, all brokers and dealers
used as counterparties must be approved. Additional performance assurance is
required where deemed necessary. 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 to be
backed by uncommitted cash for the in-the-money portion. Summarized below
are the notional amounts, the current fair values and the unrealized gains
of the options in the portfolio as at September 30, 1997.
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
7. Commitments and contingencies (Cont'd.)
Contractual/Notional Unrealized
Amount Fair Value Gains
--------------------- ----------- ----------
(in thousands)
Options held..... $ 374,000 $ 178 $ 88
Options written.. (742,400) (222) 579
The fair value of the options represents the market price of the options at
September 30, 1997. The unrealized gain represents the difference between
the fair value and the premium paid (received). The notional amounts
summarized in the above tables are not representative of amounts exchanged
by parties and, therefore, do not measure the exposure to the Company of its
use of derivatives.
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. All fixed maturity securities held must have an investment
grade rating. The Company believes that there are no significant concentrations
of credit risk associated with its investments.
c) Letters of credit
With effect from November 1996, the Company has a five year, secured letter of
credit, up to (Pounds)75 million (approximately $113 million) which is primarily
used to provide funds at Lloyd's to support underwriting capacity on Lloyd's
syndicates in which the Company participates (see note 9).
Tempest is not an admitted reinsurer in the United States. Accordingly, the
terms of certain reinsurance contracts require Tempest to provide letters of
credit ("LOCs") to Tempest's clients in respect of reported claims. Tempest has
a facility for the issuance of LOCs of up to $20 million. At September 30, 1997,
LOCs outstanding amounted to $6.9 million. Investments with a market value of
$8.0 million were pledged as collateral for these LOCs.
d) Lease commitments
The Company rents office space in The ACE Building in Hamilton, Bermuda under a
lease which expires in 2000, with one five year renewal option. The ACE Building
is 40 percent owned by the Company through a joint venture agreement. During
1994, the Company financed the cost of an addition to The ACE Building and
entered into a supplemental lease for the additional space for 14 years
effective October 1, 1994. The cost of the addition is being amortized as rent
expense over the period of the lease. Tempest also leases office space in
Hamilton, Bermuda under a non-cancelable lease expiring in 1998 with a three
year renewal option. Methuen currently leases office space in London, England
under a lease that expires in 2012. Methuen also leases an office in the 1986
Lloyd's Building in London, under a lease that expires in 2001. ACE London also
leases office space in London, England for its principal offices, under two
leases that expire in 2008. Total rent expense was approximately $4.7 million in
1997, $2.3 million in 1996 and $1.5 million in 1995. Subsequent to year end, the
Company consolidated the operations of Methuen and ACE London into one location
in London, England. The lease for this office space expires in 2012. As a result
of this consolidation, Methuen and ACE London will vacate their existing
premises and will either sublet the premises or surrender the leases. Future
minimum rental commitments under the leases, assuming the vacated premises are
sublet, are expected to be approximately $6.5 million per annum.
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
8. Shareholders' equity
a) Shares issued and outstanding
Following is a table of changes in Ordinary Shares issued and outstanding for
fiscal 1997, 1996 and 1995:
Ordinary
Shares
-----------
Balance at September 30, 1994........................ 47,423,976
Repurchase of shares.............................. (1,332,300)
Exercise of stock options......................... 19,509
----------
Balance at September 30, 1995........................ 46,111,185
Shares issued in Tempest acquisition.............. 13,333,247
Repurchase of shares............................ (1,268,600)
Exercise of stock options......................... 1,000
Cancellation of non-vested restricted stock....... (6,077)
----------
Balance at September 30, 1996........................ 58,170,755
Shares issued under Employee Stock Purchase Plan.. 9,801
Shares issued under SAR Plan...................... 61,364
Repurchase of shares.............................. (3,031,000)
Exercise of stock options......................... 84,798
Cancellation of non-vested restricted stock....... (2,500)
----------
Balance at September 30, 1997........................ 55,293,218
==========
b) Share repurchases
The Board of Directors has authorized the repurchase from time to time of the
Company's Ordinary Shares in open market and private purchase transactions.
During 1997, the Company repurchased 3,031,000 Ordinary Shares under share
repurchase programs for an aggregate cost of $182.6 million. On May 9, 1997, the
Board of Directors terminated the then existing share repurchase programs and
authorized a new program for up to $300.0 million of the Company's Ordinary
Shares. As at September 30, 1997, approximately $268.0 million of the current
Board authorization had not been utilized. During 1996 the Company repurchased
1,268,000 Ordinary Shares under share repurchase programs for an aggregate cost
of $58.0 million, and during 1995 1,332,300 Ordinary Shares were repurchased by
the Company for a total cost of $33.5 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.
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
8. Shareholders' equity (Cont'd.)
d) Dividends declared
Dividends declared amounted to $0.80, $0.64 and $0.50 per Ordinary Share for
fiscal 1997, 1996 and 1995, respectively.
e) Options
(i) Options outstanding
Following is a table of changes in options outstanding for 1997, 1996 and
1995:
Year Average Options for
of Exercise Ordinary
Expiration Price Shares
---------- -------- ------------
Balance at September 30, 1994................... 184,009
Options granted............................... 2005 $24.19 536,000
Options exercised............................. 1995 $ 8.59 (19,509)
Options forfeited............................. 2003-2005 $26.83 (15,000)
---------
Balance at September 30, 1995................... 685,500
Options granted............................... 2004-2005 $37.41 409,200
Options issued to holders of Tempest options.. 2004-2005 $23.69 446,089
Options exercised............................. 2003 $27.50 (1,000)
Options forfeited............................. 2003-2004 $25.64 (35,000)
---------
Balance at September 30, 1996................... 1,504,789
Options granted............................... 2006-2007 $59.23 743,850
Options issued under SAR Plan................. 2002-2003 $64.00 316,800
Options exercised............................. 2003-2004 $27.99 (84,798)
Options forfeited............................. 2003-2007 $30.28 (102,500)
---------
Balance at September 30, 1997................... 2,378,141
=========
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
8. Shareholders' equity (Cont'd.)
e) Options (Cont'd.)
(ii) FAS 123 pro forma disclosures
In October 1995, FASB issued Statement of Financial Accounting Standards
No. 123 "Accounting for Stock-Based Compensation" ("FAS 123"). FAS 123
establishes 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 Accounting Principles Board Opinion No.
25 ("APB 25"), while also providing the disclosure required under FAS 123.
The Company continues to account for stock-based compensation plans under
APB 25. Had the compensation cost for this plan been determined in
accordance with the fair value method recommended in FAS 123, the
Company's net income and earnings per share would have been $454.2 million
or $7.90 per share for 1997 and $289.0 million or $5.80 per share for
1996.
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 1997 and 1996, respectively:
dividend yield of 1.45 percent and 1.46 percent; expected volatility 26.2
percent and 22.5 percent; risk free interest rate of 5.92 percent and 5.67
percent; and an expected life of 3.5 years and 4.8 years.
9. Line of credit
With effect from November 1996, the Company has a $50 million committed
unsecured line of credit provided by a syndicate of banks, led by Morgan
Guaranty Trust Company of New York ("Morgan"). The line of credit agreement
requires the Company to maintain consolidated tangible net worth of not less
than $1.25 billion. This same syndicate of banks have also provided a secured
letter of credit (see note 7(c)). Prior to November 15, 1996 the Company had a
committed line of credit provided by a syndicate of banks, led by Morgan which
provided for unsecured borrowings up to an aggregate amount of $150 million.
10. Employee benefit plans
a) Pension plans
The Company has defined contribution pension plans for its Bermuda-based
employees, which are non-contributory and cover all full-time employees.
Contributions are based on a percentage of eligible compensation. Pension costs
amounted to $2,244,000, $1,741,000, and $1,206,000 for 1997, 1996 and 1995,
respectively.
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
10. Employee benefit plans (Cont'd.)
b) Options and Stock Appreciation Rights
In February 1996, shareholders of the Company approved the ACE Limited 1995
Long-Term Incentive Plan (the "Incentive Plan") which incorporates stock
options, stock appreciation rights, restricted stock awards and stock purchase
programs. There are 2,300,000 Ordinary Shares of the Company available for award
under this Incentive Plan. This Incentive Plan superseded and replaced the
existing Equity Linked Incentive Plan, which incorporated both a Stock
Appreciation Rights Plan ("SAR Plan") and a Stock Option Plan ("Option Plan")
which will continue to run off. Stock options granted under the Incentive Plan
may be exercised for Ordinary Shares of the Company upon vesting. Under the
Incentive Plan, generally, options expire ten years after the award date and
vest in equal portions over three years. During 1997, 743,850 options were
issued under the Incentive Plan. In addition, 316,800 options were issued under
the SAR Plan. During 1996, 409,200 options were issued under the Incentive Plan
and 446,089 options were issued with respect to the Tempest acquisition (see
note 8 (e)).
Under the Option Plan, generally, options expire ten years after the award date
and are subject to a vesting period of four years. During 1995, 236,000 options
were granted (see note 8(e)).
Of the outstanding options at September 30, 1997, 880,443 were vested. In
addition to the Option Plan, the Company entered into an Option and Restricted
Share Agreement and Plan in connection with the employment of its Chairman,
President and Chief Executive Officer whereby, during the year ended September
30, 1995, he was awarded 300,000 stock options at an exercise price of $22.63
which may be exercised for Ordinary Shares. These options expire ten years after
the award date and vest at various dates up to September 30, 1999. The Chairman
also received 100,000 restricted stock under this agreement (see note 10(d)).
With respect to the SAR plan, certain stock appreciation rights were forfeited
in return for cash during the year. All remaining stock appreciation rights were
exercised in return for options and cash and/or shares of the Company under the
terms of the Replacement Plan. Total expenses incurred during 1997 relating to
the SAR plan, including those incurred under the Replacement Plan, amounted to
$5,500,000. In 1996 and 1995, compensation expense of $6,023,000 and $2,465,000
was recorded, respectively. The SAR Plan entitled participants the right to
receive cash equal to the appreciation in value, as provided for in the plan, of
the rights represented by the grant. Rights vested over a period of up to six
years from the date of grant. Participants were entitled to receive cash
payments equal to the amount of dividends paid on an equivalent number of
shares. Compensation expense was accrued and recorded based on the change in the
value of the stock appreciation rights during the year and the applicable
vesting period.
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
10. Employee benefit plans (Cont'd.)
c) Employee Stock Purchase Plan
In February 1996, shareholders of the Company approved the ACE Limited Employee
Stock Purchase Plan. 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 closing market
price of the Company's shares on the last day of each subscription period.
Subscription periods run for six months. With respect to the year ending
September 30, 1997, 9,801 shares were subscribed for, resulting in an expense of
$74,000 to the Company.
d) Restricted stock awards
During 1997, 49,725 restricted Ordinary Shares were awarded to officers of the
Company and its subsidiaries. These shares vest at various dates through
November 1999. In addition, 5,028 restricted Ordinary Shares were awarded to
outside directors of the Company under the terms of the 1995 Outside Directors
Plan ("the Plan"). These shares vest in February 1998. Also during 1997, 2,500
restricted Ordinary Shares were forfeited due to resignations by officers of the
Company and its subsidiaries.
During 1996, 9,000 restricted Ordinary Shares were awarded to an officer of the
Company. These shares vest at various dates up to July 1999. Also, during 1996,
6,734 restricted Ordinary Shares were awarded to outside directors of the
Company under the terms of the Plan. These shares vested in February 1997. All
non-vested restricted Ordinary Shares issued to directors prior to approval of
the Plan in February 1996 were canceled upon approval of the Plan. Subsequently,
two directors resigned resulting in the forfeiture of their restricted Ordinary
Shares awards. During 1995, 102,400 restricted Ordinary Shares were awarded
principally to the Chairman and four directors of the Company. The Chairman's
award vests at various dates up to September 30, 1999. All restricted stock
awards contain restrictions relating to, among other things, transferability and
forfeiture under certain circumstances.
At the time of grant the market value of the shares awarded under these grants
is recorded as unearned stock grant compensation and is presented as a separate
component of shareholders' equity. The unearned compensation is charged to
operations over the vesting period.
11. Related party transactions
Included in net premiums written are amounts related to policies held by
shareholders of the Company of approximately $17 million, $31 million and $43
million for 1997, 1996 and 1995, respectively.
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
12. Taxation
Under current Cayman Islands law, the Company is not required to pay any taxes
on its income or capital gains. The Company has received an undertaking that, in
the event of any taxes being imposed, the Company will be 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 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 are subject to United Kingdom
corporation taxes.
13. Statutory financial data
Under the Bermuda Insurance Act 1978, (as amended by the Insurance Amendment Act
1995) and Related Regulations the Company's Bermuda-based insurance and
reinsurance subsidiaries ("the Bermuda subsidiaries") are required to file an
annual Statutory Financial Return and Statutory Financial Statements and to
maintain certain measures of solvency and liquidity during each year. Statutory
capital and surplus of the Bermuda subsidiaries was $2,265 million, $1,885
million and $1,327 million at September 30, 1997, 1996 and 1995 and statutory
net income was $489 million, $301 million and $249 million for 1997, 1996 and
1995, respectively. Statutory capital and surplus and statutory net income
include the results of Tempest from July 1, 1996, the date of acquisition by the
Company. The principal difference between statutory capital and surplus and
statutory net income of the Bermuda subsidiaries and shareholders' equity and
net income as reported in conformity with GAAP relates to deferred acquisition
costs of the subsidiaries, goodwill and assets and financial activity of the
parent company.
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.
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont'd.)
14. Condensed unaudited quarterly financial data
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(in thousands, except per share data)
1997
Net premiums earned......................... $164,400 $158,641 $163,605 $158,192
Net investment income....................... 59,738 58,094 59,545 60,446
Net realized gains (losses) on investments.. 41,723 (2,339) 45,786 42,812
-------- -------- -------- --------
Total revenues......................... $265,861 $214,396 $268,936 $261,450
======== ======== ======== ========
Losses and loss expenses.................... $110,150 $105,290 $111,380 $109,121
======== ======== ======== ========
Net income.................................. $125,741 $ 77,949 $130,038 $127,626
======== ======== ======== ========
Earnings per share.......................... $2.14 $1.34 $2.30 $2.26
======== ======== ======== ========
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(in thousands, except per share data)
1996
Net premiums earned......................... $115,984 $146,393 $145,897 $178,971
Net investment income....................... 47,126 48,312 50,641 60,445
Net realized gains (losses) on investments.. 44,602 5,261 (1,633) 6,999
-------- -------- -------- --------
Total revenues......................... $207,712 $199,966 $194,905 $246,415
======== ======== ======== ========
Losses and loss expenses.................... $ 92,924 $121,076 $120,438 $130,386
======== ======== ======== ========
Net income.................................. $ 93,536 $ 56,803 $ 52,476 $ 86,918
======== ======== ======== ========
Earnings per share.......................... $2.02 $1.22 $1.13 $1.46
======== ======== ======== ========
15. Condensed unaudited pro forma financial information relating to Tempest
Acquisition
The following pro forma information assumes the acquisition of Tempest occurred
at the beginning of each year presented. The pro forma financial information is
presented for informational purposes only and is not necessarily indicative of
the operating results that would have occurred had the Tempest Acquisition been
consummated at the beginning of each year presented, nor is it necessarily
indicative of future operating results.
1996 1995
---- ----
(in thousands, except
per share data)
Pro forma:
Net premiums earned.............................. $671,320 $580,850
Investment income................................ 225,331 213,068
Net income...................................... 373,755 360,776
Earnings per share............................... $ 6.23 $ 5.96