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, 1998. These selected financial and other data should be read in conjunction
with the consolidated financial statements and related notes and with
"Management's Discussion and Analysis of Results and Operations and Financial
Condition" presented on pages 39 to 74 and 18 to 38 respectively, of this annual
report. On July 9, 1998, the Company completed the acquisition of Tarquin
Limited which was accounted for on a pooling-of-interests basis. All prior
financial information presented has been restated to include the results of
operations and financial position of the combined entities. On March 2, 1998,
the Company effected a three-for-one split of the Company's Ordinary Shares. All
share and per share data has been adjusted, where necessary, to reflect the
stock split.
For the years ended September 30
1998 1997 1996 1995 1994
(in thousands except share and per share data and selected other data)
Operations data:
Net premiums written $ 880,973 $ 780,773 $ 781,884 $ 644,880 $ 385,926
================================ ================================================================================
Net premiums earned 894,303 805,372 755,840 473,133 391,117
Net investment income 324,254 252,440 213,701 184,041 142,677
Net realized gain on investments 188,385 127,702 56,229 50,765 3,717
Losses and loss expenses/1/ 616,892 486,140 620,277 366,322 620,556
Acquisition costs
and administration expenses 271,566 153,486 138,343 81,976 63,459
Amortization of goodwill 12,834 7,325 1,507 (437) (826)
Interest expense 25,459 11,667 10,481 6,036 --
Income taxes 20,040 25,181 26,543 7,673 --
- -------------------------------- --------------------------------------------------------------------------------
Net income (loss)/1/ $ 660,151 $ 602,728 $ 327,619 $ 247,360 $ (45,678)
================================ ================================================================================
Earnings (loss) per share/1/ $ 2.96 $ 2.69 $ 2.00 $ 1.59 $ (0.32)
================================ ================================================================================
Weighted average shares
outstanding-diluted 69,281,176 186,809,023 163,768,894 155,505,028 144,607,635
Cash dividends per share $0.34 $0.27 $0.21 $0.17 $0.14
Balance sheet data
(at end of period):
Total investments and cash $ 6,201,074 $ 4,787,916 $ 4,342,791 $ 3,225,786 $ 2,538,321
Total assets 8,788,753 5,647,596 5,077,780 3,514,946 2,632,361
Net unpaid losses
and loss expenses/1/ 2,678,341 2,006,873 1,892,302 1,452,299 1,160,392
Total shareholders' equity/1/ 3,714,270 2,785,155 2,367,063 1,524,123 1,088,745
Book value per share/1/ $ 19.19 $ 15.46 $ 12.53 $ 9.98 $ 7.65
Fully diluted book value
per share/1/ $ 19.14 $ 15.40 $ 12.46 $ 9.96 $ 7.65
Selected other data: 1998 1997 1996 1995 1994
Loss and loss expense ratio/1/ 57.8% 60.4% 58.8% 77.4% 133.1%
Underwriting and
administrative expense ratio 30.4% 19.0% 18.3% 17.2% 16.0%
Combined ratio/1/ 88.2% 79.4% 87.1% 94.6% 149.1%
Loss reserves to capital
and surplus ratio/2/ 72.1% 72.1% 79.9% 95.3% 106.6%
Ratio of net premiums written
to capital and surplus 0.24:1 0.28:1 0.33:1 0.36:1 0.35:1
/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 Litigaton").
/2/The earnings per share amounts prior to 1998 have been restated as required
to comply with Statement of Financial Accounting Standards No. 128, Earnings
Per Share. For further discussion of earnings per share and the impact of
Statement No. 128, see the notes to the consolidated financial statements
beginning on page 48.
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 39 to 74 of this annual report.
On March 2, 1998, the Company effected a three-for-one split of the Company's
Ordinary Shares. All share and per share data has been adjusted, where
necessary, to reflect the stock split.
General
ACE Limited ("ACE") is a holding company which, through its Bermuda-based
operating subsidiaries, A.C.E. Insurance Company, Ltd. ("ACE Bermuda"),
Corporate Officers & Directors Assurance Ltd. ("CODA"), Tempest Reinsurance
Company Limited ("Tempest Re") and CAT Limited ("CAT") and its Dublin, Ireland
based subsidiaries, ACE Bermuda Company Europe Limited and ACE Reinsurance
Company Europe Limited provides a broad range of insurance and reinsurance
products to a diverse group of international clients. Through its U.S. based
subsidiary, ACE USA, Inc. (formerly Westchester Speciality Group, Inc.) ("ACE
USA"), the Company provides insurance products to a broad range of clients in
the United States. In addition, since 1996 the Company has provided funds at
Lloyd's, primarily in the form of letters of credit, to support underwriting
capacity for Lloyd's syndicates managed by Lloyd's managing agencies which are
indirect wholly owned subsidiaries of ACE. Underwriting capacity is the maximum
amount of gross premiums that a syndicate at Lloyd's can underwrite in a given
year of account. Unless the context otherwise indicates, the term "Company"
refers to one or more of ACE and its consolidated subsidiaries. The operations
of the Company in the Lloyd's market are collectively referred to herein as "ACE
Global Markets".
On January 2, 1998, the Company completed the acquisition of ACE USA, through
its newly-created U.S. holding company, ACE US Holdings, Inc. ("ACE US"). Under
the terms of the acquisition agreement, the Company purchased all of the
outstanding capital stock of ACE USA for aggregate cash consideration of $338
million. In connection with the acquisition, National Indemnity, a subsidiary
of Berkshire Hathaway, provided $750 million (75 percent quota share of $1
billion) of reinsurance protection to ACE USA with respect to their loss
reserves for the 1996 and prior accident years (see "Liquidity and Capital
Resources"). ACE USA, through its insurance subsidiaries, provides commercial
property, umbrella liability, specialty program business, warranty, errors and
omissions, directors and officers liability coverages as well as a captive
management reinsurance facility.
On March 11, 1998, the Company announced the formation of a joint venture, ACE
Capital Re Limited, with Capital Re Corporation ("Capital Re"). ACE Capital Re
Limited, a Bermuda-domiciled insurance company, writes both traditional and
custom-designed programs covering financial guaranty, mortgage guaranty and a
broad range of financial risks. Operations are underwritten and managed in
Bermuda by a joint venture managing agency, ACE Capital Re Managers Ltd. The
Company and Capital Re each have a 50 percent economic interest in ACE Capital
Re Limited and ACE Capital Re Managers Ltd.
On April 1, 1998, the Company completed the acquisition of CAT Limited ("CAT"),
a privately held, Bermuda-based property catastrophe reinsurer. Under the terms
of the acquisition agreement, the Company purchased all of the outstanding
capital stock of CAT, for cash consideration of approximately $641 million. CAT
is being integrated with ACE's existing property catastrophe subsidiary, Tempest
Re, and going forward the combined property catastrophe reinsurance operations
will operate under the Tempest Re name.
On July 9, 1998, the Company completed the acquisition of Tarquin Limited
("Tarquin"), a UK-based holding company which owns Lloyd's managing agency
Charman Underwriting Agencies Ltd. ("Charman") and Tarquin Underwriting
Limited, its corporate capital provider. The Charman managed syndicates, 488
and 2488, are leading international underwriters of short-tail marine, aviation,
political risk and specialty property-casualty insurance and reinsurance.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
The Company will continue to evaluate potential new product lines and other
opportunities in the insurance and reinsurance markets. In addition, the
Company regularly evaluates potential acquisitions of other companies and
businesses and holds discussions with potential acquisition candidates. As a
general rule, the Company publicly announces such acquisitions only after a
definitive agreement has been reached.
Safe Harbor Disclosure
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements. Any written or oral statements made by or on
behalf of the Company may include forward-looking statements which reflect the
Company's current views with respect to future events and financial performance.
These forward-looking statements are subject to certain uncertainties and other
factors that could cause actual results to differ materially from such
statements. These uncertainties and other factors (which are described in more
detail elsewhere in documents filed by the Company with the Securities and
Exchange Commission) include, but are not limited to, (i) uncertainties relating
to government and regulatory policies (such as subjecting the Company to
insurance regulation or taxation in additional jurisdictions), (ii) the
occurrence of catastrophic events with a frequency or severity exceeding the
Company's estimates, (iii) the legal environment, (iv) the uncertainties of the
reserving process, (v) loss of the services of any of the Company's executive
officers, (vi) changing rates of inflation and other economic conditions, (vii)
losses due to foreign currency exchange rate fluctuations, (viii) ability to
collect reinsurance recoverables, (ix) the competitive environment in which the
Company operates, (x) the impact of mergers and acquisitions, (xi) the impact
of Year 2000 related issues, (xii) developments in global financial markets
which could affect the Company's investment portfolio, and (xiii) risks
associated with the introduction of new products and services. The words
"believe", "anticipate", "project", "plan", "expect", "intend", "will likely
result" or "will continue" and similar expressions identify forward-looking
statements. Readers are cautioned not to place undue reliance on these forward-
looking statements, which speak only as of their dates. The Company undertakes
no obligation to publicly update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise.
Results of Operations - Years ended September 30, 1998, 1997 and 1996
As previously noted, the Company completed the acquisition of Tarquin on July 9,
1998. This acquisition has been accounted for as a pooling-of-interests and
thus, information for all years presented has been restated to reflect the
results of the combined companies. Included in the results of fiscal 1998, 1997
and 1996 are certain non-recurring and transaction related expenses (hereinafter
referred to as the "non-recurring expenses") amounting to $46.6 million, $6.1
million and $5.0 million, respectively. These expenses include interest expense
and payments to employees as well as transaction costs including legal,
accounting and investment banking fees.
Net Income
1998 1997 1996
(IN MILLIONS)
Income excluding net realized gains on investments and non-recurring
expenses.................................................................... $418.4 $381.1 $277.4
Non-recurring expenses (net of income taxes)................................ (46.6) (6.1) (5.0)
Net realized gains on investments........................................... 188.4 127.7 55.2
------ ------ ------
Net income.................................................................. $560.2 $502.7 $327.6
====== ====== ======
For the year ended September 30, 1998, income excluding net realized gains on
investments and non-recurring expenses increased by $37.3 million or 9.8
percent, compared with fiscal 1997. This increase is predominantly the result of
the inclusion of the results of ACE USA following its acquisition on January 2,
1998 and the inclusion of the results of CAT following its acquisition on April
1, 1998.
2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
During 1997, the Company 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 Re
contributed $119.8 million to income excluding net realized gains on investments
and non-recurring expenses compared to $23.8 million for 1996. A full year of
operations for Tempest Re is included in the results for fiscal 1997 versus one
quarter of operations in 1996 as Tempest Re was purchased on July 1, 1996.
Premiums
Percentage Percentage
1998 Change 1997 Change 1996
-------- ------ ------ ------- -------
(In millions)
Gross premiums written:
ACE Bermuda (including CODA) $ 521.6 (0.3)% $523.2 (10.0)% $581.6
ACE Global Markets 436.3 37.9 316.5 29.9 243.6
Tempest Re (including CAT) 124.1 3.8 119.6 243.7 34.8
ACE USA 160.2 - - - -
-------- ------ ------
$1,242.2 29.5% $959.3 12.0% $860.0
======== ====== ======
Net premiums written:
ACE Bermuda (including CODA) $ 396.9 (11.3)% $447.6 (17.6)% $543.2
ACE Global Markets 312.0 37.6 226.8 11.2 203.9
Tempest Re (including CAT) 93.6 (18.8) 115.3 231.3 34.8
ACE USA 78.5 - - - -
-------- ------ ------
$ 881.0 11.6% $789.7 1.0% $781.9
======== ====== ======
Net premiums earned:
ACE Bermuda (including CODA) $ 393.5 (17.0)% $474.3 (11.9)% $538.1
ACE Global Markets 278.3 34.4 207.1 13.8 182.0
Tempest Re (including CAT) 151.7 22.4 123.9 247.1 35.7
ACE USA 70.8 - - - -
-------- ------ ------
$ 894.3 11.1% $805.3 6.6% $755.8
======== ====== ======
During 1998 and 1997, most insurance markets faced significant competitive
pressures as a result of relatively low loss activity and excess capital in
these markets. This has resulted in continuing price pressure in most insurance
and reinsurance lines. However, the Company's ability to make strategic
acquisitions, increase its participation on the syndicates in Lloyd's managed by
the Company, develop new and expand existing product lines and maintain a high
level of policy renewals on existing business, while maintaining its focus on
underwriting and pricing discipline, has resulted in increases in gross and net
premiums written and net premiums earned for the years ended September 30, 1998
and 1997.
During 1998, gross premiums written increased to $1,242.2 million compared with
$959.3 million in 1997, an increase of $282.9 million. The growth in gross
premiums written is mainly a result of the inclusion of nine months of premiums
from ACE USA and six months of premiums from CAT, following their acquisitions
on January 2, 1998 and April 1, 1998, respectively. The growth is also due to
the increased participation in the Lloyd's syndicates managed by the Company.
As previously noted, the Company continues to face competitive pressures in most
of the markets in which it operates. Gross premiums written by ACE Bermuda
decreased by $1.6 million compared with 1997. Within ACE Bermuda, increased
premium volume resulted from new business in financial lines, increased activity
in the satellite line and contributions from the joint ventures in which ACE
Bermuda participates. These increases were offset by continuing declines in the
excess liability and directors and officers lines of business. The decline in
excess liability premiums is mainly the result of the non-renewal of several
accounts due to soft market conditions and reduced premiums from pricing
changes. Increases in attachment points and decreases in limits provided have
resulted in decreased premiums but have led to a reduction in the Company's
exposure and an improved risk profile. The decline in the directors and officers
gross premiums is primarily a result of the continuing competitive pressures in
this market.
3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
Market conditions remain very competitive in the property catastrophe
reinsurance business as rates continue to decline in the absence of major loss
activity over the last several years. Tempest Re and CAT experienced continuing
price pressures during the year (although CAT was not acquired until April 1,
1998), including their January 1998 renewals which is their largest renewal
period. Tempest Re did not renew several of its accounts due to inadequate
pricing. While the combined Tempest Re and CAT operations recorded gross
premiums written of $124.1 million compared to $119.6 million for Tempest Re
alone in 1997, each company on an individual basis showed declines in gross
written premiums compared to the 1997 year.
ACE Global Markets continues to experience competitive conditions in the Lloyd's
market where rates continue to soften in most lines of business. This has
affected the writing of new business. In addition, the Company managed
syndicates have declined certain renewal business where prices or policy terms
were not considered adequate. However, as already noted, the Company's gross
premiums written have increased this year as a result of the Company's increased
participation in these syndicates.
ACE USA has also been impacted by significant competitive market forces during
the year. During this period, ACE USA has focused on maintaining its
underwriting and pricing discipline as well as developing its new product
divisions which were introduced during the year.
The Company expects that the current competitive market conditions will continue
and does not believe that recent loss activity in certain markets in which the
Company operates will significantly affect insurance and reinsurance prices in
the near term.
Gross premiums written increased by $99.3 million to $959.3 million in 1997 from
$860.0 million in 1996. The growth in gross premiums written is primarily
attributable to the inclusion of a full year of premiums for Tempest Re and the
increased participation in the Lloyd's syndicates managed by the Company. As
Tempest Re was purchased on July 1, 1996, the 1996 comparative only includes
three months of Tempest Re premiums. Tempest Re's gross premiums written 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 increased 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 is mainly the result of continuing
competitive pressures in that market which have adversely affected the pricing
of the excess liability business. This market pressure has caused ACE Bermuda,
in certain instances, to increase its average attachment points, lower its
average policy limits or decline business, which has had the effect of reducing
the Company's exposure and improving its risk profile. Directors and officers
liability premiums declined as a result of continuing competitive conditions.
Net premiums written increased by $91.3 million to $881.0 million in 1998
compared with $789.7 million in 1997. This increase, as with the increase in
gross premiums written, is the result of increases in the Company's
participation in the Lloyd's syndicates managed by ACE Global Markets as well as
the contributions of ACE USA and CAT during the year. Net premiums written in
ACE Bermuda decreased from $447.6 million in 1997 to $396.9 million in 1998.
This decline is primarily the result of continuing declines in directors and
officers liability and excess liability premiums, as described above in the
discussion of gross premiums written, offset somewhat by growth in net premiums
written from the satellite and financial lines divisions and in the joint
ventures business written by ACE Bermuda.
Net premiums written were also affected by an increase in the use of reinsurance
during 1998, predominantly in ACE Bermuda. In particular, during the second
quarter, the excess liability division of ACE Bermuda purchased a 25 percent
quota share reinsurance treaty and also put in place an excess of loss treaty
that limits the retained risk on a single occurrence to $100 million. In
addition, during 1998, the satellite division of ACE Bermuda and Tempest Re each
purchased additional reinsurance to cover catastrophic events.
4
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
Net premiums written increased in 1997 to $789.7 million compared to $781.9
million for 1996. The inclusion of a full year of net premiums written for
Tempest Re, the 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 Re were also reduced as a result of
the purchase of a modest amount of retrocessional cover during 1997.
For the year ended September 30, 1998, net premiums earned increased by $89.0
million to $894.3 million compared with $805.3 million last year, an increase of
11.1 percent. This increase was a result of the contributions from ACE USA and
CAT during the year following their acquisitions as well as an increase in net
premiums earned resulting from the Company's participation in the Lloyd's
syndicates under management. This increase was partially offset by declines in
net premiums earned in ACE Bermuda as a result of declines in net premiums
written.
For 1997, net premiums earned increased by $49.5 million to $805.3 million from
$755.8 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 Re in 1997
compared to three months in 1996 and the Company's increased participation in
the Lloyd's syndicates managed by the Company. At ACE Bermuda, 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.
Net Investment Income
- -------------------------------------------------------------------------------------------------------
Percentage Percentage
1998 Change 1997 Change 1996
(in millions)
Net investment income............. $324.3 27.9% $253.4 18.6% $213.7
===================================================================
- -------------------------------------------------------------------------------------------------------
Net investment income increased by $70.9 million or 27.9 percent in 1998
compared with 1997. This increase is primarily due to an increase in the
investable asset base resulting from the inclusion of the ACE USA and CAT
portfolios in the current year as well as positive cash flows from operations
and the reinvestment of funds generated by the portfolio. Consistent with the
overall decline in U.S. interest rates during the year, the average yield earned
on the investment portfolio in 1998 was down when compared with the yield
generated in 1997.
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. Despite the decreases in yield, net investment income increased by
$39.7 million in 1997 compared to 1996 primarily as a result of a larger
investable asset base. The increase in the investable asset base in 1997 and
1996 was 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 Re portfolio for the entire period of
fiscal 1997 and for three months during fiscal 1996.
Net Realized Gains (Losses) on Investments
- --------------------------------------------------------------------------------------------
1998 1997 1996
(in millions)
Fixed maturities and short-term investments........... $ 58.3 $ 58.7 $14.4
Equity securities..................................... 168.5 38.1 15.8
Financial futures and option contracts................ (9.3) 57.1 26.7
Currency.............................................. (29.1) (26.2) (1.7)
------ ------ -----
$188.4 $127.7 $55.2
====== ====== =====
- --------------------------------------------------------------------------------------------
5
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
--------------------------------------------------------
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 (for further discussion see "Market Sensitive Instruments and Risk
Management").
Sales proceeds for fixed maturity securities were generally higher than their
amortized costs during 1998 and 1997 which resulted in net realized gains on
sale of fixed maturities and short-term investments of $58.3 million in 1998 and
$58.7 million in 1997.
The liquidation of two domestic stock portfolios and the sale of a portion of
the non-U.S. dollar equity securities held during the year, contributed
significantly to net realized gains on sales of equity securities of $168.5
million in fiscal 1998. This compares with net realized gains on sales of equity
securities of $38.1 million in 1997 and $15.8 million in 1996.
Realized gains or losses on financial futures and option contracts are generated
from U.S. Treasury futures contracts and from 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 losses in financial futures and option contracts of $9.3 million in
1998 arose from net movements on fixed income and equity index futures contracts
held during the year. 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.
Currency losses were $29.1 million in 1998 compared with currency losses of
$26.2 million in 1997 and losses of $1.7 million for 1996. Currency markets
generally suffered declines against the U.S. dollar during 1998 and 1997. During
1998, the Company eliminated its 5 percent strategic allocation to non-U.S.
dollar fixed income securities. The Company maintained its 7 percent allocation
to non-U.S. dollar equities which it added in 1997. At September 30, 1998 there
were unrealized currency losses of $2.1 million on securities held in the
portfolio compared to $20.0 million as at September 30, 1997. Unrealized
currency losses are reflected 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
- ----------------------------------------------------------------------------------------
1998 1997 1996
Loss and loss expense ratio.............................. 57.8% 60.4% 68.8%
Underwriting and administrative expense ratio............ 30.4% 19.0% 18.3%
-------------------------
Combined ratio........................................... 88.2% 79.4% 87.1%
=========================
- ----------------------------------------------------------------------------------------
The underwriting results of a property and casualty insurer are discussed
frequently by reference to its loss and loss expense ratio, underwriting and
administrative expense ratio and combined ratio. Each ratio is derived by
dividing the relevant expense amounts by net premiums earned. The combined ratio
is the sum of the loss and loss expense ratio and the underwriting and the
administrative expense ratio. A combined ratio under 100 percent indicates
underwriting profits and a
6
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
combined ratio exceeding 100 percent indicates underwriting losses. Property
catastrophe reinsurance companies generally expect to have overall lower
combined ratios as compared with other reinsurance companies with long-tail
exposures.
Several aspects of the Company's operations, including the low frequency and
high severity of losses in the high excess layers in certain lines of business
in which the Company provides insurance and reinsurance, complicate the
actuarial reserving techniques utilized by the Company. Management believes,
however, that the Company's reserves for unpaid losses and loss expenses are
adequate to cover the ultimate cost of losses and loss expenses incurred through
September 30, 1998. Since such reserves 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").
Losses and Loss Expenses
Percentage Percentage
1998 Change 1997 Change 1996
-----------------------------------------------------------------
(in millions)
Losses and loss expenses.............................. $516.9 6.3% $486.1 (6.6)% $520.3
=================================================================
Losses and loss expenses have increased for the year ended September 30, 1998
compared to 1997 due to the inclusion of losses and loss expenses from ACE USA
and CAT since their acquisition as well as the Company's increased participation
in the Lloyd's syndicates under management. However, the loss and loss expense
ratio has decreased to 57.8 percent in 1998 compared with 60.4 percent in 1997.
This decrease is the result of the changing mix of premiums written and earned
by the Company, highlighted by the inclusion of ACE USA and CAT in this fiscal
year whose loss ratios are lower than the Company's traditional book of
business.
For the year ended September 30, 1997, the loss and loss expense ratio was 60.4
percent compared with 68.8 percent in 1996. This ratio was favorably impacted by
the results of Tempest Re.
Underwriting and Administrative Expenses
Percentage Percentage
1998 Change 1997 Change 1996
---------------------------------------------------------------
(in millions)
Underwriting and administrative expenses.............. $271.6 76.9% $153.5 11.0% $138.3
===============================================================
Underwriting and administrative expenses have increased for the year ended
September 30, 1998 compared to 1997 primarily due to the inclusion of the non-
recurring expenses previously described as well as the inclusion of underwriting
and administrative expenses from ACE USA and CAT since their acquisition. The
increase is also partly due to the increased underwriting and administrative
expenses generated by the Company's increased participation in Lloyd's. The
underwriting and administrative expense ratio also increased in the year from
19.0 percent in 1997 to 30.4 percent in 1998. Again, this increase is due
primarily to the inclusion of the non-recurring expenses. Excluding the non-
recurring expenses, the underwriting and administrative expense ratio would have
been 25.0 percent compared to 18.3 percent in 1997. The remaining increase is
primarily due to the costs associated with the Company's increased participation
in the Lloyd's market and the inclusion of administrative costs from ACE USA.
The underwriting and administrative expense ratio in ACE USA and ACE Global
Markets is generally higher than the Company's traditional book of business and
thus contributed to the increase in the underwriting and administrative expense
ratio.
The underwriting and administrative expense ratio increased to 19.0 percent in
1997 compared to 18.3 percent in 1996. This increase is due to an increase in
administrative expenses in 1997 over 1996, which is partially offset by a
decrease in acquisition costs. The increase in administrative expenses in
primarily due to the increased cost base resulting from the strategic
diversification by the Company over the past two years, including the
acquisitions of Tempest Re, the Lloyd's managing agencies as well as the
development of the newer insurance lines and products.
7
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 currently depend primarily on dividends or other statutorily
permissible payments from its Bermuda-based operating subsidiaries (the "Bermuda
subsidiaries"). There are currently no legal restrictions on the payment of
dividends from retained earnings by the Bermuda subsidiaries as the minimum
statutory capital and surplus requirements are satisfied by the share capital
and additional paid-in capital of each of the Bermuda subsidiaries. However, the
payment of dividends or other statutorily permissible distributions by the
Bermuda subsidiaries is subject to the need to maintain shareholder's equity at
a level adequate to support the level of insurance and reinsurance operations.
ACE received a dividend of $115 million from Tempest Re in December 1997 and a
dividend of $250 million from ACE Bermuda in April 1998.
At September 30, 1998, ACE US Holdings, Inc. ("ACE US") and ACE Global Markets
had shareholder's equity of approximately $115 million and $225 million,
respectively. The payment of any dividends from the Company's UK subsidiaries
would be subject to applicable United Kingdom insurance law including those
promulgated by the Society of Lloyd's. Under various U.S. insurance laws to
which ACE US's insurance subsidiaries are subject, ACE US's insurance
subsidiaries may pay a dividend only from earned surplus subject to the
maintenance of a minimum capital requirement, without prior regulatory approval.
No dividends were received from ACE US or ACE Global Markets during fiscal 1998
and the Company does not anticipate receiving dividends from them during fiscal
1999.
The Company's consolidated sources of funds consist primarily of net premiums
written, investment income, and proceeds from sales and maturities of
investments. Funds are used primarily to pay claims, operating expenses and
dividends and for the purchase of investments and for share repurchases.
The Company's insurance and reinsurance operations provide liquidity in that
premiums are normally received substantially in advance of the time claims are
paid. For the years ended September 30, 1998, 1997 and 1996, the Company's
consolidated net cash flows from operating activities were $66.8 million, $423.5
million and $724.1 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 $583.8 million, $421.9 million and $115.0 million in fiscal 1998,
1997 and 1996, respectively.
The Company maintains loss reserves for the estimated unpaid ultimate liability
for losses and loss expenses under the terms of its policies and agreements. The
reserve for unpaid losses and loss expenses of $3.7 billion at September 30,
1998, includes $1.4 billion of case and loss expense reserves. While the Company
believes that its reserve for unpaid losses and loss expenses at September 30,
1998 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. 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.
At September 30, 1998, total investments and cash amounted to approximately $6.2
billion, compared with $4.8 billion at September 30, 1997. The increase in total
cash and investments of $1.4 billion since September 30, 1997 is primarily the
result of the inclusion of the ACE USA and CAT investment portfolios following
the acquisitions of these companies by ACE during the current fiscal year. The
Company's investment portfolio is structured to provide a high level of
liquidity to meet insurance related or other obligations. The consolidated
investment portfolio is externally managed by independent professional
investment managers and is invested in high quality investment grade marketable
fixed income and equity securities, the majority of which trade in active,
liquid markets. The Company believes that its cash balances, cash flow from
8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
operations, routine sales of investments and the liquidity provided by its
credit facilities (discussed below) are adequate to allow the Company to pay
claims within the time periods required under its policies.
In December 1997, the Company arranged certain syndicated credit facilities.
J.P. Morgan Securities, Inc. and Mellon Bank N.A. acted as co-arrangers in the
arranging, structuring and syndication of these credit facilities. Each facility
requires that the Company and/or certain of its subsidiaries comply with
specific covenants, including a consolidated tangible net worth covenant and a
maximum leverage covenant. The facilities provide:
. A $200 million 364 day revolving credit facility and a $200 million five year
revolving credit facility which together make up a combined $400 million
committed, unsecured syndicated revolving credit facility. At September 30,
1998, the five-year revolving credit facility has a $150 million letter of
credit ("LOC") sub-limit (increased from $50 million during September 1998).
As discussed below, the Company drew down $385 million on the revolving
credit facilities to finance the acquisition of CAT Limited on April 1, 1998.
The debt was subsequently repaid from a portion of the proceeds from the sale
of 16.5 million new Ordinary Shares of the Company (discussed below).
. A syndicated fully secured five year LOC facility totaling approximately 154
million ($262 million) which was used to fulfill the requirements of Lloyd's
to support underwriting capacity on Lloyd's syndicates in which the Company
participates. Certain assets totalling approximately $300 million are pledged
as security for this facility.
. A syndicated $250 million seven year amortizing term loan facility, which was
used on January 2, 1998 to partially finance the acquisition of ACE USA. The
interest rate on the term loan was LIBOR plus an applicable spread. As of
September 30, 1998, $250 million was outstanding under this facility. The
average interest rate for the period January 2, 1998 through October 5, 1998
was 6.24 percent.
On October 27, 1998, ACE US refinanced the outstanding $250 million term loan
with the proceeds from the issuance of $250 million in aggregate principal
amount of unsecured credit sensitive senior notes maturing in October 2008.
Interest payments, based on the initial fixed rate coupon on these notes of 8.63
percent, are due semi-annually in arrears. Total interest expense to be recorded
by ACE US including amortized fees and hedging costs, will initially be $23.3
million per year. The indenture related to these notes include certain
restrictive covenants applicable to ACE US. The senior notes are callable
subject to certain breakage costs, however, ACE US has no current intention of
calling the debt. Simultaneously, the Company has entered into a notional $250
million credit default swap transaction that has the economic effect of reducing
the cost of debt to the consolidated group, excluding fees and expenses, to 6.47
percent for 10 years. Certain assets totaling approximately $90 million are
pledged as security in connection with the swap transaction. In the event that
the Company terminates the credit default swap prematurely, the Company would be
liable for certain transaction costs. However, the Company has no current
intention of terminating the swap. The swap counter-party is a major financial
institution with a long-term S&P Senior Debt Rating of AA- and the Company does
not anticipate non-performance.
The Company also maintains an unsecured, syndicated revolving credit facility in
the amount of $72.5 million. This facility was put in place by CAT prior to its
acquisition by the Company and in September 1998, was assigned to Tempest Re. At
September 30, 1998, no amounts have been drawn down under this facility. The
facility requires that Tempest Re comply with specific covenants.
On November 27, 1998, the Company arranged a new syndicated partially secured
five year LOC facility in the amount of 270 million (approximately $450 million)
to fulfill the requirements of Lloyd's for the 1999 year of account. This new
facility was arranged by Citibank N.A., with ING Barings and Barclays Bank PLC
acting as co-arrangers, and will replace the facility arranged in December 1997.
This new LOC facility requires that the Company continue to maintain certain
covenants, including a minimum consolidated tangible net worth covenant and a
maximum leverage covenant. Certain assets totaling approximately $201 million
are pledged as partial security for this facility, replacing the security
pledged in connection with the December 1997 facility.
On November 13, 1997, the Board of Directors approved a special resolution to
split each outstanding Ordinary Share of the Company into three Ordinary Shares.
The stock split was voted on and approved by the shareholders of the Company on
February 6, 1998. The record date for determining those shareholders entitled to
receive certificates representing additional
9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued
--------------------------------------------------------
shares pursuant to the Stock Split was as of close of business on February 17,
1998. Certificates representing the additional shares of stock were mailed on
March 2, 1998.
The Board of Directors had authorized the repurchase from time to time of the
Company's Ordinary Shares in open market and private purchase transactions. On
May 9, 1997 the Board of Directors terminated the then existing share repurchase
program and authorized a new share program for up to $300 million of the
Company's Ordinary Shares. During the first two quarters of fiscal 1998, the
Company repurchased 3,521,100 Ordinary Shares under the share repurchase program
for an aggregate cost of $107.6 million. No shares were repurchased after March
31, 1998. On July 6, 1998 the Executive Committee of the Board of Directors
rescinded all existing authorizations for the repurchase of the Company's
Ordinary Shares. During 1997, the Company repurchased 9,093,000 Ordinary Shares
under share repurchase programs for an aggregate cost of approximately $182.6
million.
On October 18, 1997 and January 16, 1998, the Company paid quarterly dividends
of 7.33 cents and 8 cents per share, respectively to shareholders of record on
September 30, 1997 and December 13, 1997. The Company paid quarterly dividends
on April 18, 1998 and July 17, 1998 of 8 cents and 9 cents per share,
respectively to shareholders of record on March 31, 1998 and June 30, 1998. On
October 16, 1998, the Board of Directors paid a quarterly dividend of 9 cents
per share to shareholders of record on September 30, 1998. On November 13, 1998,
the Board of Directors declared a quarterly dividend of 9 cents per share
payable on January 15, 1999 to shareholders of record on December 15, 1998. 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.
On January 2, 1998, the Company completed the acquisition of ACE USA, through
its newly-created U.S. holding company, ACE US, for an aggregate cash
consideration of $338 million. ACE US was capitalized by ACE Limited with $75
million and received $35 million from an inter-company loan. ACE US financed the
acquisition of ACE USA with $250 million of bank debt (see discussion of
syndicated credit facilities above) and the remaining $88 million came from
available funds.
On April 1, 1998, the Company completed the acquistion of CAT for an aggregate
cash consideration of approximately $641 million. The acquisition was financed
with $385 million of short-term bank debt (see discussion of credit facilities
above) and the remainder from available funds.
On April 14, 1998, the Company sold 16.5 million Ordinary Shares for net
proceeds of approximately $606 million after deducting expenses related to the
offering. A portion of the proceeds were used to repay $385.0 million of
indebtedness incurred by the Company in connection with the acquisition of CAT
on April 1, 1998. The remaining proceeds were added to the Company's investment
portfolio to be used for general corporate purposes, which may include
acquisitions.
On July 9, 1998, the Company completed the acquisition of Tarquin and issued
approximately 14.3 million Ordinary Shares to the shareholders of Tarquin. The
acquisition was accounted for on a pooling-of-interests basis and, as a result,
the consolidated financial statements of the Company have been restated to
include the historical shareholders' equity and results of operations of Tarquin
for all periods presented.
Fully diluted net asset value per share was $19.14 at September 30, 1998,
compared with $15.40 at September 30, 1997.
Changes in shareholders' equity for the years ended September 30, 1998 and 1997
were as follows:
1998 1997
-------------------
(in millions)
Balance, beginning of year....................................................... $2,785 $2,367
Net income....................................................................... 560 503
Change in net unrealized appreciation (depreciation) on investments.............. (69) 135
Repurchase of Ordinary Shares.................................................... (108) (183)
Dividends declared............................................................... (60) (45)
Value of Ordinary Shares issued in share offering................................ 606 -
Other............................................................................ - 8
------- -------
Balance, end of year............................................................. $3,714 $2,785
======= =======
10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued
--------------------------------------------------------
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.
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.
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 October 31,
1997, it has sent out Notification of Status Letters to more than 360,000 non-
opt-out domestic implant recipients who had registered with the Settlement
Claims Office. Distribution has begun on payments to claimants relating to other
implants since all appeals on the Settlement have been dismissed. In addition,
the multidistrict litigation judge has approved the detailed terms of a
settlement program being offered by the three major defendants to eligible
foreign claimants. Approximately 32,500 domestic registrants 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
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued
--------------------------------------------------------
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.
The Company continually evaluates its reserves in light of developing
information and in light of discussions and negotiations with its insureds. The
Company has made payments to date of approximately $370 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. 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, 1998.
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, 1998.
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 which are subject to changes in
market values, with changes in interest rates.
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 Company's accounting policy. Option contracts are utilized
in the portfolio for the purposes of duration management and to provide
protection against any unexpected shifts in interest rates. At September 30,
1998, the fair value of the option contracts held and written was $1,517,000 and
$(677,000) respectively, compared with $178,000 and $(222,000) at September 30,
1997. The market value of mortgage-backed securities, another category of market
sensitive instruments, was $1,752 million, or approximately 30 percent of the
total investment portfolio, compared with $1,342 million or 31 percent at
September 30,1997. Mortgage-backed securities include pass through mortgage
bonds and collateralized mortgage obligations.
The aggregate hypothetical loss generated from an immediate adverse parallel
shift in the treasury yield curve of 100 basis points would be a decrease in
total return of 4.2 percent which equates to a decrease in market value of
approximately $230 million on a portfolio valued at $5.7 billion at September
30, 1998. An immediate time horizon was used as this presents the worse case
scenario.
12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
Impact of the Year 2000 Issue
General
The management of ACE Limited, recognizing that the Year 2000 problem, if left
untreated, could have a material effect on the Company's business, results of
operations or financial condition, has in progress a project to address this
issue. It is the expectation of ACE's management that this project will reduce
the impact of the Year 2000 problem to an immaterial level, although not all
risks can be eliminated.
The Year 2000 problem stems from the inability, in some cases, of computer
programs and embedded microchips to correctly process certain data. The problem
is most evident because dates which fall in the year 2000 and in later years may
not be properly distinguished from those which fell in the corresponding years
of the present century.
Although all ACE group companies had individually taken steps earlier towards
alleviating the Year 2000 problem, a formal group-wide project was established
in March 1998. At that time, an executive steering committee was formed to
oversee the project. This committee meets on a monthly basis to review progress
and take corrective action if necessary. In each of the ACE subsidiary
companies, a senior member of the management has been appointed as Year 2000
coordinator. Each Year 2000 coordinator has responsibility for ensuring the
success of that part of the Year 2000 plan relevant to its company. A detailed
quarterly report on the status of the Year 2000 project is delivered to the
audit committee of the Board of Directors.
A consultant who is an experienced project manager has been retained to assist
the Year 2000 coordinator. In addition, certain subsidiaries have engaged
external consultants to assist in monitoring their plans.
The project is substantially on schedule, though some components have been
finished earlier than expected and some are taking more time than originally
estimated. It is expected that by the end of 1998 all ACE group companies will
be running Year 2000 compliant versions of most of the information technology
systems that are critical to the business. The replacement or remedy of the
remaining critical systems and some residual testing will continue during the
first and possibly the second quarter of calendar year 1999.
The Company's Year 2000 project is divided into four sections: Underwriting;
Information Technology; Trading Partners; and Physical Plant.
Underwriting
Underwriting teams within each ACE group subsidiary have considered the risks
with respect to the Year 2000 problem that might be associated with underwriting
their various lines of business and have developed internal guidelines which
seek to minimize these risks. Compliance with these guidelines is the subject of
internal audits and/or peer reviews. These guidelines are under regular review.
In some cases, exclusionary language has been added to policies and in all cases
there is a requirement for underwriters to consider information about our
clients and potential clients that is relevant to the Year 2000 problem and,
based on this to underwrite risks prudently or to decline them.
Information Technology
Each ACE subsidiary has a plan to ensure that all information technology
components such as hardware, software and network equipment that will be in use
in the Year 2000 (and beyond) for use by any business-critical function will not
suffer from the Year 2000 problem. Inventories have been prepared of all such
components, and appropriate action decided.
Most application software (such as insurance processing and accounting systems)
which is in use within the ACE group has been supplied as packages (often
tailored to meet ACE's needs) from various vendors. Several application software
packages have already been replaced with Year 2000 compliant versions. Testing
of these is complete in some cases, in progress for some systems and is
scheduled for others. Remaining software packages will be replaced, or, in a few
cases, remedied to free them of Year 2000 problems.
Testing of hardware and network components has commenced and is scheduled for
completion before the end of March 1999. Testing of other software, such as
operating systems and PC desktop applications is in progress or scheduled,
though in a few cases we are relying on assurances from major software
manufacturers that their systems will operate correctly.
13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
Trading Partners and Physical Plant
Examples of the Company's trading partners are: insurance brokers, banks,
reinsurance companies, vendors and service providers in information technology
and general suppliers.
The Physical Plant section of the project focuses on items such as elevators,
fire suppression systems, security systems, building management systems (which
may control air-conditioning, heating and lighting systems) which may be
controlled by software programs or embedded chips, and may thus fail or act
unpredictably in, or after the year 2000. Furthermore, supply of electrical
power and telecommunications services are considered here.
All material trading partners and those vendors and service providers connected
with physical plant have been inventoried and questionnaires sent to them
soliciting information about their Year 2000 readiness. Responses have not been
provided in all cases, despite follow-up letters. ACE has made significant
progress in assessing those responses which have been forthcoming. Some of these
responses appear to give evidence of satisfactory progress and others do not. In
those cases where additional follow-up fails to provide satisfactory responses,
contingency plans will be drawn up in early 1999 to minimize the effect of
potential failure of a Trading Partner.
Costs
The total cost of the Year 2000 project is not expected to be material to the
Company's financial position. The total estimated cost is approximately $4
million, of which just over $2 million is for the information technology
component of the project. Total expenditure to date on the whole project is
approximately $1 million.
Risks
It is not feasible to assign probabilities to many of the events associated with
the Year 2000. The arrival of January 1, 2000 presents novel problems about
which there is no body of evidence upon which to base statistical predictions.
Furthermore, world infrastructure in areas such as telecommunications, banking,
law enforcement, energy production and distribution, manufacturing,
transportation and government and military systems are inextricably linked in
such a manner that a small failure in one area could produce large and
unexpected effects in others. Each business has a dependence upon its customers
and suppliers and through them (or directly) upon many or all of the
infrastructural areas noted above.
ACE management believes that the risks associated with its own information
technology project component are small. For reasons noted above, it is
impossible to quantify all risks associated with trading partners and physical
plant. Possibly the greatest risk for the Company lies in the possibility of
unpredictable events affecting insureds producing a number of claims (valid or
otherwise) which, if valid, are expensive to pay, or if not, expensive in
defense litigation costs.
New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"), which is effective for years
beginning after December 15, 1997. SFAS 131 establishes standards for the way
that public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. The company will adopt the new
requirements retroactively in 1999.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and hedging activities. It requires
that an entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments of fair value.
SFAS 133 is effective beginning in the first quarter of fiscal 2000. The
14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
---------------------------------------
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
---------------------------------------------------------
Company is currently assessing the effect of adopting this statement on its
financial position and operating results, which as yet, has not been determined.
15
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
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.
PricewaterhouseCoopers LLP, 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.
_______________________________________ _____________________________________
Brian Duperreault Christopher Z. Marshall
Chairman, President and Chief Executive Chief Financial Officer
Officer
2
REPORT OF INDEPENDENT ACCOUNTANTS
To The Board of Directors and Shareholders of ACE Limited
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, shareholders' equity and cash flows
present fairly, in all material respects, the financial position of ACE Limited
and its subsidiaries at September 30, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 1998, in conformity with generally accepted accounting principles.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
New York, New York
November 4, 1998
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 1998 and 1997
1998 1997
---------- ----------
(in thousands of U.S. dollars)
(except share and per share data)
Assets
Investments and cash
Fixed maturities available for sale, at fair value
(amortized cost - $4,910,792 and $3,412,975) $5,056,807 $3,477,046
Equity securities, at fair value (cost - $198,447 and $518,852) 189,717 651,556
Short-term investments, at fair value (amortized cost -
$480,236 and $364,552) 480,190 364,432
Other investments, at fair value (cost-$156,758 and $78,691) 156,646 78,691
Cash 317,714 216,191
---------- ----------
Total investments and cash 6,201,074 4,787,916
Goodwill 540,355 301,953
Premiums and insurance balances receivable 377,307 239,446
Reinsurance recoverable 1,116,753 104,797
Accrued investment income 57,153 40,682
Deferred acquisition costs 76,445 51,191
Prepaid reinsurance premiums 205,022 49,299
Deferred income taxes 25,264 --
Other assets 189,380 72,312
---------- ----------
Total assets $8,788,753 $5,647,596
========== ==========
Liabilities
Unpaid losses and loss expenses $3,737,869 $2,111,670
Unearned premiums 773,702 510,231
Premiums received in advance 53,794 24,973
Insurance and reinsurance balances payable 75,898 11,245
Accounts payable and accrued liabilities 165,527 154,390
Dividend payable 17,693 12,436
Bank debt 250,000 --
Deferred income taxes -- 37,496
---------- ----------
Total liabilities 5,074,483 2,862,441
---------- ----------
Commitments and contingencies
Shareholders' equity
Ordinary Shares ($0.041666667 par value, 300,000,000 shares authorized;
193,592,519 and 180,207,664 shares issued and outstanding) 8,066 7,508
Additional paid-in capital 1,765,261 1,177,954
Unearned stock grant compensation (6,181) (1,993)
Net unrealized appreciation on investments (net of deferred 127,845 196,655
income tax)
Cumulative translation adjustment (275) 1,568
Retained earnings 1,819,554 1,403,463
---------- ----------
Total shareholders' equity 3,714,270 2,785,155
---------- ----------
Total liabilities and shareholders' equity $8,788,753 $5,647,596
========== ==========
See accompanying notes to consolidated financial statements
4
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended September 30, 1998, 1997 and 1996
1998 1997 1996
----------- ----------- ----------
(in thousands of U.S. dollars, except
per share data)
Revenues
Gross premiums written $ 1,242,159 $ 959,349 $ 859,989
Reinsurance premiums ceded (361,186) (169,576) (78,105)
----------- ----------- ----------
Net premiums written 880,973 789,773 781,884
Change in unearned premiums 13,330 15,599 (26,044)
----------- ----------- ----------
Net premiums earned 894,303 805,372 755,840
Net investment income 324,254 253,440 213,701
Net realized gains on investments 188,385 127,702 55,229
----------- ----------- ----------
Total revenues 1,406,942 1,186,514 1,024,770
----------- ----------- ----------
Expenses
Losses and loss expenses 516,892 486,140 520,277
Acquisition costs 105,654 85,762 96,518
Administrative expenses 165,912 67,724 41,825
Amortization of goodwill 12,834 7,325 1,507
Interest expense 25,459 11,657 10,481
----------- ----------- ----------
Total expenses 826,751 658,608 670,608
----------- ----------- ----------
Income before income taxes 580,191 527,906 354,162
Income taxes 20,040 25,181 26,543
----------- ----------- ----------
Net income $ 560,151 $ 502,725 $ 327,619
=========== =========== ==========
Basic earnings per share $ 3.03 $ 2.73 $ 2.02
=========== =========== ==========
Diluted earnings per share $ 2.96 $ 2.69 $ 2.00
=========== =========== ==========
See accompanying notes to consolidated financial statements
5
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the Years Ended September 30, 1998, 1997 and 1996
1998 1997 1996
------------ ------------ ------------
(in thousands of U.S. dollars)
Ordinary Shares
Balance--beginning of year, as previously
reported $ 7,508 $ 7,868 $ 5,764
Pooling-of-interests with Tarquin - - 597
---------- ---------- ----------
Balance--beginning of year, as restated 7,508 7,868 6,361
Shares issued in Tempest transactions - - 1,666
Ordinary Shares issued 688 - -
Issued under Employee Stock Purchase Plan (ESPP) 1 1 -
Issued under Stock Appreciation Right (SAR) Plan - 9 -
Exercise of stock options 16 8 -
Repurchase of shares (147) (378) (159)
---------- ---------- ----------
Balance--end of year 8,066 7,508 7,868
---------- ---------- ----------
Additional paid-in capital
Balance--beginning of year, as previously
reported 1,177,954 1,231,324 548,513
Pooling-of-interests with Tarquin - - 75,130
---------- ---------- ----------
Balance--beginning of year, as restated 1,177,954 1,231,324 623,643
Shares issued in Tempest transactions - - 620,552
Options issued in Tempest transactions - - 12,124
Ordinary Shares used 605,211 - -
Cancellation of restricted stock awards - (87) -
Issued under ESPP 954 228 -
Issued under SAR Plan - 3,919 -
Exercise of stock options 4,225 2,182 27
Repurchase of Ordinary Shares (23,083) (59,612) (25,022)
---------- ---------- ----------
Balance--end of year 1,765,261 1,177,954 1,231,324
---------- ---------- ----------
Unearned stock grant compensation
Balance--beginning of year (1,993) (1,299) (1,796)
Stock grants awarded (8,551) (3,244) (708)
Stock grants forfeited - 79 60
Amortization 4,363 2,471 1,145
---------- ---------- ----------
Balance--end of year (6,181) (1,993) (1,299)
---------- ---------- ----------
Net unrealized appreciation (depreciation) on
Investments
Balance--beginning of year 196,655 61,281 94,694
Net appreciation (depreciation) during year (59,528) 135,374 (33,413)
Change in deferred income taxes (9,282) - -
---------- ---------- ----------
Balance--end of year 127,845 196,655 61,281
---------- ---------- ----------
Cumulative translation adjustments
Balance--beginning of year, as previously
reported 1,568 (560) -
Pooling-of-interests with Tarquin - - (324)
---------- ---------- ----------
Balance--beginning of year, as restated 1,568 (560) (324)
Net adjustment for year (1,843) 2,128 (236)
---------- ---------- ----------
Balance--end of year (275) 1,568 (560)
---------- ---------- ----------
Retained earnings
Balance--beginning of year, as previously
reported 1,403,463 1,068,389 795,488
Pooling-of-interests with Tarquin - - 9,803
---------- ---------- ----------
Balance--beginning of year, as restated 1,403,463 1,068,389 805,291
Net income 560,151 502,725 327,619
Dividends declared (59,646) (44,993) (31,699)
Repurchase of Ordinary Shares (84,414) (122,658) (32,822)
---------- ---------- ----------
Balance--of year 1,819,554 1,403,463 1,068,389
---------- ---------- ----------
Total shareholders' equity $3,714,270 $2,785,155 $2,367,003
========== ========== ==========
See accompanying notes to consolidated financial statements
6
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended September 30, 1998, 1997 and 1996
1998 1997 1996
----------- ----------- -----------
(in thousands of U.S. dollars)
Cash flows from operating activities
Net income $ 560,151 $ 502,725 $ 327,619
Adjustments to reconcile net income to net cash provided by operating
activities:
Unearned premiums 18,168 (5,731) 32,195
Unpaid losses and loss expenses, net of reinsurance
Recoverables (96,361) 114,571 405,268
Prepaid reinsurance premiums (111,188) (2,881) (18,633)
Deferred income taxes 52,240 17,494 19,612
Net realized gains on investments (188,385) (127,702) (55,229)
Amortization of premium/discounts (22,530) (6,104) (7,847)
Amortization of goodwill 12,834 7,325 1,507
Deferred acquisition costs (8,025) 5,122 9,274
Premiums and insurance balances receivable (52,709) (49,977) (17,915)
Premiums received in advance 28,823 6,366 5,976
Insurance and reinsurance balances payable 62,153 11,245 -
Accounts payable and accrued liabilities (145,872) (42,078) 33,707
Other (42,529) (6,892) (11,423)
----------- ----------- -----------
Net cash flows from operating activities $ 66,770 $ 423,483 $ 724,111
----------- ----------- -----------
Cash flows from investing activities
Purchases of fixed maturities (7,865,794) (6,796,843) (8,781,390)
Purchases of equity securities (221,952) (603,598) (222,382)
Sales of fixed maturities 7,625,861 6,817,944 8,220,230
Sales of equity securities 688,261 385,552 209,350
Maturities of fixed maturities 147,093 5,000 59,830
Net realized gains (losses) on financial future contracts (9,287) 57,076 26,678
Other investments (60,735) (52,080) (2,676)
Acquisitions of subsidiaries, net of cash acquired (967,758) (27,098) (49,050)
----------- ----------- -----------
Net cash used for investing activities $ (664,311) $ (214,047) $ (539,410)
----------- ----------- -----------
Cash flows from financing activities
Repurchase of Ordinary Shares (107,644) (182,648) (58,003)
Dividends paid (54,389) (43,028) (27,684)
Net proceeds from issuance of Ordinary Shares 605,899 - 16,527
Proceeds from bank debt 635,000 - -
Repayment of bank debt (385,000) - -
Proceeds from exercise of options for ordinary shares 4,243 2,191 28
Proceeds from shares issued under Employee Stock Purchase Plan 955 - -
Proceeds from shares issued under Stock Appreciation Rights Plan - 4,156 -
----------- ----------- -----------
Net cash from (used for) financing activities $ 699,064 $ (219,329) $ (69,132)
----------- ----------- -----------
Net increase (decrease) in cash 101,523 (9,893) 115,569
Cash -- beginning of year 216,191 226,084 110,515
----------- ----------- -----------
Cash -- end of year $ 317,714 $ 216,191 $ 226,084
=========== =========== ===========
Supplemental cash flow information
Taxes paid (received) $ (48,848) $ 3,975 $ 67
Interest paid $ 41,513 $ 5,700 $ 5,139
See accompanying notes to consolidated financial statements
7
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization
ACE Limited ("ACE") is a holding company incorporated with limited liability
under the Cayman Islands Companies Law and maintains its principal business
office in Bermuda. The Company, through its Bermuda-based operating
subsidiaries, A.C.E. Insurance Company, Ltd. ("ACE Bermuda"), Corporate Officers
& Directors Assurance Ltd. ("CODA"), Tempest Reinsurance Company Limited
("Tempest Re") and CAT Limited ("CAT") and its Dublin, Ireland based
subsidiaries ACE Bermuda Company Europe Limited ("AICE") and ACE Reinsurance
Company Europe Limited ("ARCE") provides insurance and reinsurance for a diverse
group of international clients. Through its U.S. based subsidiary, ACE USA, Inc.
(formerly Westchester Specialty Group, Inc.) ("ACE USA"), the Company provides
insurance to a broad range of clients in the United States. In addition, the
Company provides funds at Lloyd's to support underwriting by Lloyd's syndicates
managed by Lloyd's managing agencies, which are indirect wholly owned
subsidiaries of ACE. Unless the context otherwise indicates, the term "Company"
refers to one or more of ACE and its consolidated subsidiaries. The operations
of the Company in the Lloyd's market are collectively referred to herein as "ACE
Global Markets".
2. Operations
a) ACE Bermuda
ACE Bermuda primarily writes excess liability insurance, directors and officers
liability insurance, satellite insurance, aviation insurance, excess property
insurance and financial lines products. In addition, through certain joint
ventures, ACE Bermuda writes financial guaranty and political risk insurance.
At September 30, 1998 approximately 66 percent of the written premiums in ACE
Bermuda with respect to these lines of business came from North America with
approximately 14 percent coming from the United Kingdom and continental Europe
and approximately 20 percent from other countries.
Two insurance brokers produced approximately 54 percent, 59 percent and 42
percent of the insurance business for ACE Bermuda in 1998, 1997 and 1996,
respectively.
b) Tempest Re
The Company's reinsurance activities are principally conducted through Tempest
Re, which was acquired in July 1996. On April 1, 1998, ACE Limited purchased
CAT Limited, another Bermuda based property catastrophe reinsurer. Underwriting
operations are being combined with the group's existing catastrophe reinsurance
subsidiary, Tempest Re, and going forward the combined entity will operate under
the Tempest Re name. Tempest Re underwrites property catastrophe reinsurance on
a worldwide basis. For the year ended September 30, 1998, approximately 79
percent of Tempest Re's written premiums came from the United States,
approximately 9 percent came from United Kingdom, 5 percent from Australia and
New Zealand and 7 percent from other countries.
Three reinsurance brokers produced approximately 63 percent, 56 percent and 44
percent of Tempest Re's reinsurance business for the years ended September 30,
1998 and 1997 and the ten month period ended September 30, 1996.
c) ACE Global Markets
The Company, through corporate subsidiaries, participates in the underwriting of
Lloyd's syndicates managed by Methuen Underwriting Limited, ACE London Aviation
Limited, ACE London Underwriting Limited and Charman Underwriting Agencies Ltd.
("Charman") 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.
8
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
2. Operations (cont'd.)
d) ACE USA
ACE USA, through its insurance subsidiaries, Westchester Fire Insurance Company,
Westchester Surplus Lines Insurance Company and Industrial Underwriters
Insurance Company writes property and casualty insurance, primarily within the
commercial specialty lines market to a broad range of clients in the US. These
subsidiaries specialize in providing property, umbrella and excess casualty
coverages. Premiums are written throughout the US mainly through a network of
US wholesale brokers. During 1998, ACE USA expanded its products offering and
has commenced writing specialty program business, warranty, errors and
omissions, directors and officers coverages and also set up a captive management
reinsurance facility.
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 accounted for the acquisition of Tarquin on a pooling-of-interests
basis and accordingly, the Company's financial statements have been restated to
include the results of Tarquin for all periods presented. 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.
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 certain "other
investments" where there is no quoted market value, 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.
A portion of the other investments comprise investments in entities for which
there is no quoted market value. In such cases, the investments are carried at
no more than original cost which is considered to be fair value.
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 8(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.
9
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
3. Significant accounting policies (cont'd.)
b) Investments (cont'd)
Net investment income includes interest and dividend income together with
amortization of market premiums and discounts and is net of investment
management and custody fees. For mortgage-backed securities, and any other
holdings for which there is a prepayment risk, prepayment assumptions are
evaluated and revised as necessary. Any adjustments required due to the
resultant change in effective yields and maturities are recognized 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.
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) Earnings per share
In 1997, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards ("SFAS") No. 128, "Earnings per Share". SFAS 128 replaced
the previously reported primary and fully diluted earnings per share with basic
and diluted earnings per share. Basic earnings per share are calculated
utilising weighted average shares outstanding and exclude any dilutive effects
of options, warrants and convertible securities. Diluted earnings per share
include the effect of dilutive securities outstanding. All earnings per share
amounts for all periods presented, where necessary, have been restated to
conform to the SFAS 128 requirements.
e) 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.
f) 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.
g) Goodwill
Goodwill represents the excess of the cost of acquisitions over the tangible net
assets acquired. The Company amortizes goodwill recorded in connection with its
business combinations on a straight-line basis over the estimated useful lives
which range from twenty-five to forty years.
10
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
3. Significant accounting policies (cont'd.)
h) Reinsurance
In the ordinary course of business, the Company's insurance subsidiaries assume
and cede reinsurance with other insurance companies. These arrangements provide
greater diversification of business and minimize the net loss potential arising
from large risks. Ceded reinsurance contracts do not relieve the Company of its
obligation to its insureds.
Reinsurance recoverables include the balances due from reinsurance companies for
paid and unpaid losses and loss expenses that will be recovered from reinsurers,
based on contracts in force. A reserve for uncollectible reinsurance has been
determined based upon a review of the financial condition of the reinsurers and
an assessment of other available information.
Prepaid reinsurance premiums represent the portion of premiums ceded to
reinsurers applicable to the unexpired terms of the reinsurance contracts in
force.
i) 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" ("SFAS 52"). Under
SFAS 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.
j) 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.
k) Income taxes
Income taxes have been provided in accordance with the provisions of SFAS No.
109, "Accounting for Income Taxes" on those operations which are subject to
income taxes (see note 12). Deferred tax assets and liabilities result from
temporary differences between the amounts recorded in the consolidated financial
statements and the tax basis of the Company's assets and liabilities. Such
temporary differences are primarily due to the tax basis discount on unpaid
losses, adjustment for unearned premiums, uncollectible reinsurance, and tax
benefits of net operating loss carryforwards. Additionally, the effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. A valuation allowance
against deferred tax assets is recorded if it is more likely than not, that all
or some portion of the benefits related to deferred tax assets will not be
realized.
l) Stock split
On March 2, 1998, the Company effected a three for one split of the Company's
Ordinary Shares. The par value of the Company's Ordinary Shares and all per
share data presented in the consolidated financial statements and the notes
thereto have been retroactively adjusted to reflect the effects of the stock
split.
11
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
3. Significant accounting policies (cont'd.)
m) Cash flow information
Purchases and sales or maturities of short-term investments are recorded net for
purposes of the statements of cash flows and are included with fixed maturities.
n) New accounting pronouncements
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"), which is effective for years
beginning after December 15, 1997. SFAS 131 establishes standards for the way
that public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. The Company will adopt the new
requirements retroactively in 1999.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and hedging activities. It requires
that an entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value.
SFAS 133 is effective beginning in the first quarter of fiscal 2000. The
Company is currently assessing the effect of adopting this statement on its
financial position and operating results, which as yet, has not been determined.
4. Acquisitions
On March 27, 1996, the Company acquired a controlling interest in Methuen Group
Limited ("Methuen"), the holding company for Methuen Underwriting Limited
("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. On November 26, 1996, the Company, also acquired
the remaining interest in Methuen. The acquisition of the remaining interest
has been recorded using the purchase method of accounting.
On July 1, 1996, the Company completed the acquisition of Tempest Re, a leading
Bermuda-based property catastrophe reinsurer (the "Tempest Re Acquisition").
Under the terms of the Agreement and Plan of Amalgamation, Tempest Re shares
outstanding at the time of the acquisition were cancelled and converted into the
right to receive 39,999,741 Ordinary Shares of the Company. These shares were
capitalized at a value of $15 5/9 per share, which was determined in accordance
with the EITF 95-19 consensus that deals with the value of equity securities
issued to effect a purchase combination. In addition, options to acquire
Tempest Re shares were converted into 1,338,267 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 Re
since July 1, 1996, the date of acquisition.
On November 26, 1996, the Company acquired Ockham Worldwide Holdings plc which
subsequently changed its name to ACE London Holdings Ltd. ("ACE London"). 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.
On January 2, 1998, the Company completed the acquisition of ACE USA, through
its newly-created U.S. holding company, ACE US Holdings, Inc ("ACE US"). Under
the terms of the agreement, the Company purchased all of the outstanding capital
stock of ACE USA for aggregate cash consideration of $338 million.
12
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
4. Acquisitions (cont'd.)
In connection with the acquisition, National Indemnity, a subsidiary of
Berkshire Hathaway, has provided $750 million (75 percent quota share of $1
billion) of reinsurance protection to ACE USA with respect to its loss reserves
for the 1996 and prior accident years. The Company financed the transaction
with $250 million of bank debt (see note 8c Credit Facilities) and the remainder
with available cash. The acquisition was recorded using the purchase method of
accounting. Under this method, the total purchase price is allocated to the
acquired assets and liabilities based on their fair values and accordingly, the
consolidated financial statements of the company include the results of ACE USA
and its subsidiaries from January 2, 1998, the date of acquisition (see note 15
for pro forma financial information with respect to the ACE USA acquisition).
On April 1, 1998, the Company completed the acquisition of CAT, a privately
held, Bermuda-based property catastrophe reinsurer, for an aggregate cash
consideration of approximately $641 million. The acquisition was financed with
$385 million of short-term bank debt (see note 8c - Credit Facilities) and the
remainder from available cash. The acquisition was recorded using the purchase
method of accounting. The total purchase price is allocated to the acquired
assets and liabilities based on their fair values and accordingly, the
consolidated financial statements of the Company include the results of CAT from
April 1, 1998, the date of acquisition (see note 15 for pro forma financial
information with respect to the CAT acquisition). Approximately $224 million of
goodwill was generated as a result of the acquisition.
On July 9, 1998, the Company completed the acquisition of Tarquin Limited
("Tarquin"), a UK-based holding company which owns Lloyd's managing agency
Charman Underwriting Ltd. ("Charman") and Tarquin Underwriting Limited, its
corporate capital provider. The Charman managed syndicates, 488 and 2488, are
leading international underwriters of short-tail marine, aviation, political
risk and specialty property-casualty insurance and reinsurance. Under the terms
of the acquisition, the Company issued approximately 14.3 million Ordinary
Shares to the shareholders of Tarquin. The acquisition has been accounted for
on a pooling-of-interests basis. Accordingly, all prior period consolidated
financial statements presented have been restated to include the combined
results of operations, financial position and cash flows of Tarquin as though it
had always been a part of the Company.
Prior to the acquisition, Tarquin's fiscal year ended on December 31. In
recording the business combination, Tarquin's prior period financial statements
have been restated to conform with the Company's fiscal year end. Certain
reclassifications were also made to the Tarquin financial statements to conform
to the Company's presentations.
The results of operations for the separate companies and the combined amounts
presented in the consolidated financial statements for the years ended September
30, 1998, 1997 and 1996 are as follows:
1998 1997 1996
---------- ---------- ----------
(in thousands)
Total Revenues
ACE $1,246,794 $1,010,643 $ 848,998
Tarquin 160,148 175,871 175,772
---------- ---------- ----------
Total Revenue $1,406,942 $1,186,514 $1,024,770
========== ========== ==========
Net Income
ACE $ 554,672 $ 461,354 $ 289,733
Tarquin 5,479 41,371 37,886
---------- ---------- ----------
Net Income $ 560,151 $ 502,725 $ 327,619
========== ========== ==========
Included in the results of fiscal 1998, 1997 and 1996 are certain non-recurring
and transaction related expenses (hereinafter referred to as the "non-recurring
expenses") amounting to $46.6 million, $6.1 million and $5.0 million,
respectively. These expenses include interest expense and payments to employees
as well as transaction costs including legal, accounting and investment banking
fees.
The Company will continue to evaluate potential new product lines and other
opportunities in the insurance and reinsurance markets. In addition, the
Company regularly evaluates potential acquisitions of other companies and
businesses and holds discussions with potential acquisition candidates. As a
general rule, the Company publicly announces such acquisitions only after a
definitive agreement has been reached.
13
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
5. Investments
a) Fixed maturities
The fair values and amortized costs of fixed maturities at September 30, 1998
and 1997 are as follows:
1998 1997
------------------------- -------------------------
Fair Amortized Fair Amortized
Value Cost Value Cost
---------- ---------- ---------- ----------
(in thousands)
U.S. Treasury and agency $ 796,535 $ 771,678 $ 565,003 $ 548,328
Non-U.S. governments 126,998 122,233 198,126 196,799
Corporate securities 2,339,786 2,265,755 1,342,767 1,314,635
Mortgage-backed securities 1,751,769 1,710,591 1,370,647 1,352,710
States, municipalities and
Political subdivisions 41,719 40,535 503 503
---------- ---------- ---------- ----------
Fixed maturities $5,056,807 $4,910,792 $3,477,046 $3,412,975
========== ========== ========== ==========
The gross unrealized gains and losses related to fixed maturities at September
30, 1998 and 1997 are as follows:
1998 1997
------------------------ -------------------------
Gross Gross Gross Gross
Unrealized Unrealized Unrealized Unrealized
Gains Losses Gains Losses
---------- ---------- ---------- ----------
(in thousands)
U.S. Treasury and agency $ 25,211 $ (354) $17,769 $(1,094)
Non-U.S. governments 5,447 (682) 4,051 (2,724)
Corporate securities 77,711 (3,680) 30,309 (2,177)
Mortgage-backed securities 43,742 (2,564) 21,691 (3,754)
States, municipalities and
political subdivisions 1,335 (151) - -
-------- ------- ------- --------
$153,446 $(7,431) $73,820 $(9,749)
======== ======= ======= ========
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 79 percent of the total mortgage holdings at
September 30, 1998 and 67 percent at September 30, 1997 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, 1998, 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.
14
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
5. Investments (cont'd.)
a) Fixed maturities (cont'd.)
Fair Amortized
Value Cost
---------- ----------
(in thousands)
Maturity period
- ---------------
Less than 1 year $ 237,277 $ 239,589
1 - 5 years 1,314,027 1,287,270
5 - 10 years 735,258 712,422
Greater than 10 years 1,018,479 960,920
---------- ----------
3,305,041 3,200,201
Mortgage-backed securities 1,751,766 1,710,591
---------- ----------
Total fixed maturities $5,056,807 $4,910,792
========== ==========
b) Equity Securities
The gross unrealized gains and losses on equity securities at September 30, 1998
and 1997 are as follows:
1998 1997
-------- --------
(in thousands)
Equity securities -- cost $198,447 $518,852
Gross unrealized gains 457 152,621
Gross unrealized losses (9,187) (19,917)
-------- --------
Equity securities -- fair value $189,717 $651,556
======== ========
15
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
5. 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, 1998, 1997 and 1996 is as follows:
1998 1997 1996
---------- --------- ---------
(in thousands)
Fixed Maturities
Gross realized gains $ 78,825 $ 83,957 $ 63,416
Gross realized losses (20,512) (25,200) (48,963)
--------- -------- --------
58,313 58,757 14,453
Equity securities
Gross realized gains 210,512 70,453 39,768
Gross realized losses (42,037) (32,379) (23,985)
--------- -------- --------
168,475 38,074 15,783
Currency losses (29,116) (26,204) (1,685)
Financial futures and option contract-net realized
(losses) gains (9,287) 57,075 26,678
--------- -------- --------
Net realized gains on investments 188,385 127,702 55,229
--------- -------- --------
Change in net unrealized appreciation (depreciation)
on investments
Fixed maturities 81,944 68,397 (56,226)
Equity securities (141,434) 67,097 22,813
Short-term investments 74 (120) -
Other investments (112) - -
Deferred income taxes (9,282) - -
--------- -------- --------
Change in net unrealized appreciation
(depreciation) on investments (68,810) 135,374 (33,413)
--------- -------- --------
Total net realized gains and change in net
unrealized appreciation (depreciation) on
investments $ 119,575 $263,076 $ 21,816
========= ======== ========
d) Net investment income
Net investment income for the years ended September 30, 1998, 1997 and 1996 was
derived from the following sources:
1998 1997 1996
-------- -------- --------
(in thousands)
Fixed maturities and short-term investments $325,308 $251,570 $217,149
Equity securities 5,920 7,385 2,029
Other investments 2,954 2,300 1,840
Other 1,853 2,364 156
-------- -------- --------
Gross investment income 336,035 263,619 221,174
Investment expenses (11,781) (10,179) (7,473)
-------- -------- --------
Net investment income $324,254 $253,440 $213,701
======== ======== ========
16
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
5. Investments (cont'd.)
e) Securities on deposit
Fixed maturity securities carried at fair value and cash totalling $141 million
at September 30, 1998 were on deposit with various regulatory authorities to
comply with various state (U.S.) and Lloyd's (UK) requirements.
6. 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, 1998 and 1997:
1998 1997
---------- ----------
(in thousands)
Case and loss expense reserves $1,406,358 $ 995,262
IBNR loss reserves 2,331,511 1,116,408
---------- ----------
Total unpaid losses and loss expenses $3,737,869 $2,111,670
========== ==========
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, 1998, 1997 and 1996 is as follows:
1998 1997 1996
---------- ---------- ----------
(in thousands)
Gross unpaid losses and loss expenses at beginning
of year $2,111,670 $1,977,680 $1,455,342
Reinsurance recoverable (104,797) (85,378) (3,043)
---------- ---------- ----------
Net unpaid losses and loss expenses at beginning
of year 2,006,873 1,892,302 1,452,299
Unpaid losses and loss expenses assumed in respect
of acquired companies 731,949 - 34,735
Unpaid losses and loss expenses assumed in respect
of reinsurance business acquired 6,403 50,326 -
---------- ---------- ----------
Total 2,745,225 1,942,628 1,487,034
---------- ---------- ----------
Losses and loss expenses incurred in respect
of losses occurring in:
Current year 534,021 486,140 520,277
Prior years (17,129) - -
---------- ---------- ----------
Total 516,892 486,140 520,277
---------- ---------- ----------
Losses and loss expenses paid in respect
of losses occurring in:
Current year 246,354 63,182 41,602
Prior years 337,422 358,713 73,407
---------- ---------- ----------
Total 583,776 421,895 115,009
---------- ---------- ----------
Net unpaid losses and loss expenses at end of year 2,678,341 2,006,873 1,892,302
Reinsurance recoverable on unpaid losses 1,059,528 104,797 85,378
---------- ---------- ----------
Gross unpaid losses and loss expenses at end of year $3,737,869 $2,111,670 $1,977,680
========== ========== ==========
17
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
6. Losses and loss expenses (cont'd)
The Company has considered asbestos and environmental claims and claims expenses
in establishing the liability for unpaid losses and loss expenses. The
estimation of ultimate losses arising from asbestos and environmental exposures
has presented a challenge because traditional actuarial reserving methods, which
primarily rely on historical experience, are inadequate for such estimation.
The problem of estimating reserves for asbestos and environmental exposures
resulted in the development of reserving methods which incorporate new sources
of data with historical experience. The Company believes that the reserves
carried for these claims are adequate based on known facts and current law.
The following table presents selected data on asbestos and environmental claims
and claims expenses as at September 30, 1998.
Gross Net
----- ---
(in thousands)
Asbestos $114,032 $ 46,201
Environmental 104,113 70,140
-------- --------
$218,145 $116,341
======== ========
During the nine month period to September 30, 1998 (since the acquisition of ACE
USA), the Company has made payments with respect to latent claims of $11.2
million. For calendar 1997, 1996 and 1995, ACE USA made average annual claim
payments of $9.8 million.
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 in state courts.
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 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 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 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. 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 October 31, 1997, it has sent out Notification of
Status Letters to more than 360,000 non-opt-out domestic implant recipients who
had registered with the Settlement Claims Office. Distribution has begun on
payments to claimants relating to other implants since all appeals on the
Settlement have been dismissed. In addition, the multidistrict litigation judge
has approved the detailed terms of a settlement program being offered by the
three major defendants to eligible foreign claimants. Approximately 32,500
domestic registrants 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.
18
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
6. Losses and loss expenses (cont'd)
At June 30, 1994, the Company increased its then existing reserves relating to
breast implant claims. Although the reserve increase was partially satisfied by
an allocation from existing IBNR, it also required an increase in the Company's
total reserve for unpaid losses and loss expenses at June 30, 1994 of $200
million. The increase in reserves was based on information made available in
conjunction with the lawsuits and information made available from the Company's
insureds and was predicated upon an allocation between coverage provided before
and after the end of 1985 (when the Company commenced underwriting operations).
No additional reserves relating to breast implant claims have been added since
June 30, 1994.
The Company continually evaluates its reserves in light of developing
information and in light of discussions and negotiations with its insureds. The
Company has made payments to date of approximately $370 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. 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, 1998.
7. Reinsurance
The Company purchases reinsurance to manage various exposures including
catastrophic risks. Although reinsurance agreements contractually obligate the
Company's reinsurers to reimburse it for the agreed upon portion of its gross
paid losses, they do not discharge the primary liability of the Company. The
amounts for net premiums written and net premiums earned in the statements of
operations are net of reinsurance. Direct, assumed and ceded amounts for these
items for the years ended September 30, 1998, 1997 and 1996 are as follows:
1998 1997 1996
------------ ----------- ------------
(in thousands)
Premiums written
Direct $ 864,529 $ 849,328 $ 825,365
Assumed 377,630 110,021 34,624
Ceded (361,186) (169,576) (78,105)
------------ ----------- ------------
Net $ 880,973 $ 789,773 $ 781,884
============ =========== ============
Premiums earned
Direct $ 875,154 $ 754,577 $ 734,888
Assumed 303,586 121,842 40,601
Ceded (284,437) (71,047) (19,649)
------------ ----------- ------------
Net $ 894,303 $ 805,372 $ 755,840
============ =========== ============
The Company's provision for reinsurance recoverables at September 30, 1998 and
September 30, 1997 are as follows:
1998 1997
------------ -----------
(in thousands)
Reinsurance recoverable on paid losses and loss expenses $ 57,225 $ --
Reinsurance recoverable on unpaid losses and loss expenses 1,143,121 104,797
Provision for uncollectable balances on unpaid losses and loss
expenses (83,593) --
------------ -----------
Reinsurance recoverable $ 1,116,753 $ 104,797
============ ===========
19
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
8. 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 $178 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, 1998, no foreign currency forward
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 contracts as at September 30, 1998.
Contractual/
Notional Unrealized
Amount Fair Value Gain/(Loss)
----------------- ----------------- -----------------
(in thousands)
Forward contracts $ 50 $ (735) $ (785)
The fair value of the forward contracts represents the estimated cost to the
Company at September 30, 1998, of obtaining the specified currency to meet the
obligation of the contracts. The unrealized loss 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 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.
(ii) Duration management and market exposure
Futures
A portion of the Company's investment portfolio is managed as synthetic equity
funds, whereby equity index futures contracts are held in an amount equal to
the market value of an underlying portfolio comprised of short-term
investments and fixed maturities. This creates an equity market exposure
equal in value to the total amount of funds invested in this strategy. 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 the funds invested in this strategy was $633 million
and $286 million at September 30, 1998 and 1997, 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.
20
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
8. Commitments and contingencies (cont'd.)
a) Financial instruments with off-balance sheet risk (cont'd.)
(ii) Duration management and market exposure (cont'd.)
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 $1,041 million and
$380 million reflect the net extent of involvement the Company had in these
financial instruments at September 30, 1998 and 1997, 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, 1998.
Contractual/
Notional Unrealized
Amount Fair Value Gain/(Loss)
------------ ---------- -------------
(in thousands)
Options held $ 735,200 $ 1,517 $ 926
Options written (121,000) (677) (303)
The fair value of the options represents the market price of the options at
September 30, 1998. 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. The Company believes that there are no significant
concentrations of credit risk associated with its investments.
21
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
8. Commitments and contingencies (cont'd.)
c) Credit Facilities
In December 1997, the Company arranged certain syndicated credit facilities.
J.P. Morgan Securities, Inc. and Mellon Bank N.A. acted as co-arrangers in the
arranging, structuring and syndication of these credit facilities. Each
facility requires that the Company and/or certain of its subsidiaries comply
with specific covenants, including a consolidated tangible net worth covenant
and a maximum leverage covenant. The 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 syndicated revolving credit facility. At
September 30, 1998, the five-year revolving credit facility has a $150
million letter of credit ("LOC") sub-limit (increased from $50 million
during September 1998). As discussed below, the Company drew down $385
million on the revolving credit facility to finance the acquisition of CAT
Limited on April 1, 1998. The debt was subsequently repaid from a portion of
the proceeds from the sale of 16.5 million new Ordinary Shares of the
Company (discussed below).
. A syndicated fully secured five year LOC facility totaling approximately 154
million ($262 million) which is used to fulfill the requirements of Lloyd's
to support underwriting capacity on Lloyd's syndicates in which the Company
participates.
. A syndicated $250 million seven year amortizing term loan facility, which
was used on January 2, 1998 to partially finance the acquisition of ACE USA.
The interest rate on the term loan was LIBOR plus an applicable spread. As
of September 30, 1998, $250 million was outstanding under this facility. The
average interest rate for the period January 2, 1998 through October 5, 1998
was 6.24 percent.
On October 27, 1998, ACE US Holdings, Inc. ("ACE US") refinanced the outstanding
$250 million term loan with the proceeds from the issuance of $250 million in
aggregate principal amount of unsecured credit sensitive senior notes maturing
in October 2008. Interest payments, based on the initial fixed rate coupon on
these notes of 8.63 percent, are due semi-annually in arrears. The indenture
related to these notes includes certain restrictive covenants applicable to ACE
US. The senior notes are callable subject to certain breakage costs, however,
ACE US has no current intention of calling the debt. Simultaneously, the
Company has entered into a notional $250 million credit default swap transaction
that has the economic effect of reducing the cost of debt to the consolidated
group, excluding fees and expenses, to 6.47 percent for 10 years. Certain
assets totaling approximately $90 million are pledged as security in connection
with the swap transaction. In the event that the Company terminates the credit
default swap prematurely, the Company would be liable for certain transaction
costs. However, the Company has no current intention of terminating the swap.
The swap counter-party is a major financial institution with a long- term S&P
Senior Debt Rating of AA- and the Company does not anticipate non-performance.
Tempest Re is not an admitted reinsurer in the United States. Accordingly, the
terms of certain reinsurance contracts require Tempest Re to provide letters of
credit ("LOCs") to Tempest Re's clients in respect of reported claims. Tempest
Re has facilities for the issuance of LOCs of up to $50 million. At September
30, 1998, LOCs outstanding amounted to $15.2 million. Investments with a market
value of $17.5 million were pledged as collateral for these LOCs. The Company
also maintains an unsecured, syndicated revolving credit facility in the amount
of $72.5 million. This facility was put in place by CAT prior to its
acquisition by the Company and in September 1998, was assigned to Tempest Re.
At September 30, 1998, no amounts have been drawn down under this facility.
22
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
8. Commitments and contingencies (cont'd.)
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. The Company also rents additional office
space in Hamilton, Bermuda under two separate non-cancelable leases which expire
in 2001 and 2003. Tempest Re leases office space in Hamilton, Bermuda under a
non-cancelable lease expiring in 2003 with a three year renewal option. ACE
Global Markets leases office space in London, England for its principal offices,
under two leases that expire in 2008. ACE USA leases office space in Georgia,
USA for its principal offices under a lease that expires in 2002. ACE USA also
leases additional office space in California, USA under a lease that expires in
2004. ACE USA also leases office space in New York, USA under a lease that
expires in 2009. Total rent expense was approximately $4.8 million in 1998, $4.9
million in 1997 and $2.5 million in 1996.
Future minimum lease payments under the leases are expected to be as follows (in
thousands):
Year ending September 30, 1999 $ 7,625
2000 9,749
2001 8,467
2002 6,893
2003 5,945
Later years 33,339
-------
Total minimum future lease commitments $72,018
=======
9. Shareholders' Equity
a) Shares issued and outstanding
Following is a table of changes in Ordinary Shares issued and outstanding for
fiscal 1998, 1997 and 1996:
Ordinary Shares
---------------
Balance at September 30, 1995--as previously reported 138,333,555
Adjustment for pooling-of-interests 14,328,010
---------------
Balance at September 30, 1995--as restated 152,661,565
Shares issued in Tempest Re acquisition 39,999,741
Repurchase of shares (3,805,800)
Exercise of stock options 3,000
Cancellation of non-vested restricted stock (18,231)
---------------
Balance at September 30, 1996 188,840,275
Shares issued under Employee Stock Purchase Plan 29,403
Shares issued under SAR Replacement Plan 184,092
Repurchase of shares (9,093,000)
Exercise of stock options 254,394
Cancellation of non-vested restricted stock (7,500)
---------------
Balance at September 30, 1997 180,207,664
Shares issued 16,500,000
Shares issued under Employee Stock Purchase Plan 27,517
Repurchase of shares (3,521,100)
Exercise of stock options 378,438
---------------
Balance at September 30, 1998 193,592,519
===============
On April 14, 1998, the Company sold 16.5 million Ordinary Shares for net
proceeds of approximately $606 million.
23
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
9. Shareholders' Equity (cont'd.)
b) Share repurchases
The Board of Directors had authorized the repurchase from time to time of the
Company's Ordinary Shares in open market and private purchase transactions. On
May 9, 1997 the Board of Directors terminated the then existing share repurchase
program and authorized a new share program for up to $300 million of the
Company's Ordinary Shares. During the first two quarters of fiscal 1998, the
Company repurchased 3,521,100 Ordinary Shares under the share repurchase program
for an aggregate cost of $107.6 million. No shares were repurchased after March
31, 1998. On July 6, 1998 the Executive Committee of the Board of Directors
rescinded all existing authorizations for the repurchase of the Company's
Ordinary Shares. During 1997, the Company repurchased 9,093,000 Ordinary Shares
under share repurchase programs for an aggregate cost of $182.6 million.
c) General restrictions
The holders of the Ordinary Shares are entitled to receive dividends and are
allowed one vote per share provided that, if the controlled shares of any
shareholder constitute 10 percent or more of the outstanding Ordinary Shares of
the Company, only a fraction of the vote will be allowed so as not to exceed 10
percent. Generally, the Company's directors have absolute discretion to decline
to register any transfer of shares. All transfers are subject to the restriction
that they may not increase to 10 percent or higher the proportion of issued
Ordinary Shares owned by any shareholder.
d) Dividends declared
Dividends declared amounted to $0.34, $0.27 and $0.21 per Ordinary Share for
fiscal 1998, 1997 and 1996, respectively.
e) Options
(i) Options outstanding
Following is a summary of options issued and outstanding for 1998, 1997 and
1996.
Year Average Options for
of Exercise Ordinary
Expiration Price Shares
---------- -------- -----------
Balance at September 30, 1995 2,056,500
Options granted 2004-2005 $12.47 1,227,600
Options issued to holders of Tempest options 2004-2005 $ 7.90 1,338,267
Options exercised 2003 $ 9.17 (3,000)
Options forfeited 2003-2004 $ 8.55 (105,000)
-----------
Balance at September 30, 1996 4,514,367
Options granted 2006-2007 $19.74 2,231,550
Options issued under SAR Plan 2002-2003 $21.33 950,400
Options exercised 2003-2004 $ 9.33 (254,394)
Options forfeited 2003-2007 $10.09 (307,500)
-----------
Balance at September 30, 1997 7,134,423
Options granted 2007-2008 $31.64 2,489,900
Options exercised 2003-2007 $11.21 (378,438)
Options forfeited 2006-2008 $27.51 (261,155)
-----------
Balance at September 30, 1998 8,984,730
===========
Of the outstanding options at September 30, 1998, 5,148,264 were vested.
24
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
9. Shareholders' Equity (cont'd.)
e) Options (cont'd.)
(ii) SFAS 123 Pro Forma disclosures
In October 1995, FASB issued Statement of Financial Accounting Standards No.
123 "Accounting for Stock-Based Compensation" ("SFAS 123"). SFAS 123
establishes accounting and reporting standards for stock-based employee
compensation plans which include stock option and stock purchase plans. SFAS
123 provides employers a choice: adopt SFAS 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 SFAS 123. The Company
continues to account for stock-based compensation plans under APB 25. The
following table outlines the Company's net income and earnings per share had
the compensation cost been determined in accordance with the fair value
method recommended in SFAS 123.
1998 1997
------- --------
(in thousands, except
per share data)
Net Income
As reported $560,151 $502,725
Pro Forma $550,894 $495,556
Diluted earnings per share
As reported $ 2.96 $ 2.69
Pro Forma $ 2.91 $ 2.65
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 1998 and 1997, respectively: dividend yield of
1.41 percent and 1.45 percent; expected volatility 24.9 percent and 26.2
percent; risk free interest rate of 5.61 percent and 5.92 percent and an
expected life of 4.0 years and 3.5 years.
10. Employee benefit plans
a) Pension plans
Substantially all of the Company's employees are covered by defined contribution
pension plans which are non-contributory. Contributions are based on a
percentage of eligible compensation. Pension expenses amounted to $5 million,
$2.2 million and $1.7 million for 1998, 1997 and 1996, respectively.
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 6,900,000 Ordinary Shares of the Company available for
award under this Incentive Plan. Prior to the adoption of the Incentive Plan,
the Company adopted the 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. Under the Option Plan, generally,
options expire ten years after the award date and are subject to a vesting
period of four years. Stock options granted under the Incentive Plan may be
exercised for Ordinary Shares of the Company upon vesting. Under the Incentive
Plan, generally, options expire ten years after the award date and vest in equal
portions over three years. During 1998, 2,489,900 options were issued under the
Incentive Plan. During 1997, 2,231,550 options were issued under the Incentive
Plan. In addition, 950,400 options were issued under the SAR Plan. During
1996, 1,227,600 options were issued under the Incentive Plan and 1,338,267
options were issued with respect to the Tempest Re acquisition (see note 9 (e)).
25
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
10. Employee benefit plans (cont'd.)
b) Options and Stock Appreciation Rights (Cont'd.)
With respect to the SAR plan, certain stock appreciation rights were forfeited
in return for cash during 1997. 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 which was implemented in 1997 pursuant to the
Equity Linked Incentive 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, compensation expense of $6,023,000 was recorded. The SAR
Plan entitled participants to 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.
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, 1998, 27,517 shares were subscribed for, resulting in an expense
of $143,000 to the Company.
d) Restricted stock awards
During 1998, 264,000 restricted Ordinary Shares were awarded to officers of the
Company and its subsidiaries. These shares vest at various dates through
November 2002. In addition, 14,952 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 1999.
During fiscal 1997, 149,175 restricted Ordinary Shares were awarded to officers
of the Company and its subsidiaries. These shares vest at various dates through
November 1999. Also, during fiscal 1997, 15,084 restricted Ordinary Shares were
awarded to outside directors of the Company under the terms of the Plan. These
shares vested in February 1998. Also during 1997, 7,500 restricted Ordinary
Shares were forfeited due to resignations by officers of the Company and its
subsidiaries. During 1996, 27,000 restricted Ordinary Shares were awarded to an
officer of the Company. These shares vest at various dates up to July 1999.
Also during 1996, 20,202 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. 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.
26
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
11. Earnings per share
The following table sets forth the computation of basic and diluted earnings per
share for the years ended September 30, 1998, 1997 and 1996.
1998 1997 1996
----------- ------------ ------------
(in thousands, except
share and per share data)
Numerator:
Net Income $ 560,151 $ 502,725 $ 327,619
Denominator:
Denominator for basic earnings per share -
Weighted average share outstanding 185,130,479 184,148,641 162,153,091
Effect of dilutive securities 4,150,696 2,660,382 1,615,803
------------ ------------ ------------
Denominator for diluted earnings per share -
Adjusted weighted average shares
outstanding and assumed conversions 189,281,175 186,809,023 163,768,894
============ ============ ============
Basic earnings per share $ 3.03 $ 2.73 $ 2.02
============ ============ ============
Diluted earnings per share $ 2.96 $ 2.69 $ 2.00
============ ============ ============
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 exempt from
taxation in the Cayman Islands until the year 2013. Under current Bermuda law,
the Company and its Bermuda subsidiaries are not required to pay any taxes on
their income or capital gains. The Company and its Bermuda subsidiaries will be
exempt from taxation in Bermuda until March 2016.
Income from the Company's operations at Lloyd's are subject to United Kingdom
corporation taxes. ACE USA is subject to income taxes imposed by U.S.
authorities.
The provision for income taxes detailed below represents the Company's estimate
of tax liability in respect of the Company's operations at Lloyd's and at ACE
USA and is calculated at rates equal to the statutory income tax rate in each
jurisdiction.
The income tax provision for the years ended September 30, 1998, 1997 and 1996
as follows:
1998 1997 1996
------------ ------------ -------------
(in thousands)
Current tax expense $ 3,265 $ 8,451 $ 14,547
Deferred tax expense 16,775 16,730 11,996
------------ ------------ ------------
Provision for income taxes $ 20,040 $ 25,181 $ 26,543
============ ============ ============
29
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
12. Taxation (Cont'd.)
The components of the net deferred tax asset and net deferred tax liability as
of September 30, 1998 and 1997 is a follows:
1998 1997
--------- ---------
(in thousands)
Deferred tax assets
Loss reserve discount $ 50,581 $ --
Unearned premium adjustment 3,874 --
Uncollectable reinsurance 5,185 --
Other 49,646 3,012
--------- ---------
Total deferred tax assets 109,286 3,012
--------- ---------
Deferred tax liabilities
Deferred policy acquisition costs 3,741 --
Unrealized appreciation of investments 9,282 --
Other 43,696 40,508
--------- ---------
Total deferred tax liabilities 56,719 40,508
--------- ---------
Valuation allowance 27,303 --
--------- ---------
Net deferred tax asset (liability) $ 25,264 $ (37,496)
========= =========
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 $2,785 million, $2,265
million and $1,885 million at September 30, 1998, 1997 and 1996 and statutory
net income was $592 million, $489 million and $301 million for 1998, 1997 and
1996, respectively. Statutory capital and surplus and statutory net income
include the results of Tempest from July 1, 1996, and CAT from April 1, 1998,
the dates 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 of the Bermuda subsidiaries
computed in accordance with GAAP relates to deferred acquisition costs of the
subsidiaries and goodwill.
There are no statutory restrictions on the payment of dividends from retained
earnings by any of the Bermuda subsidiaries as the minimum statutory capital and
surplus requirements are satisfied by the share capital and additional paid-in
capital of each of the Bermuda subsidiaries.
The Company's US Insurance Subsidiaries are subject to various state statutory
and regulatory restrictions that limit the amount of dividends that may be paid
without prior approval from regulatory authorities. These restrictions differ
by state, but are generally based on calculations incorporating statutory
surplus, statutory net income, and/or investment income. The US Insurance
Subsidiaries' combined statutory surplus amounted to $252 million at September
30, 1998. The combined statutory net result of the US Insurance Subsidiaries
was a loss of $98 million for the nine months ended September 30, 1998.
The payment of any dividends from the Company's UK subsidiaries would be subject
to applicable UK insurance law including those promulgated by the Society of
Lloyd's.
28
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
14. Condensed unaudited quarterly financial data
1998 First Second Third Fourth
Quarter Quarter Quarter Quarter
-------- -------- -------- --------
(in thousands, except per share data)
Adjusted for pooling-of-interests
Net premiums earned $205,330 $221,475 $246,350 $221,148
Net investment income 63,672 78,283 93,011 89,288
Net realized gains (losses)
on investments 27,493 145,616 69,448 (54,172)
-------- -------- -------- --------
Total revenues $296,495 $445,374 $408,809 $256,264
======== ======== ======== ========
Losses and loss expenses $122,255 $129,780 $146,233 $118,624
======== ======== ======== ========
Net income $122,210 $247,901 $176,528 $ 13,512
======== ======== ======== ========
Diluted Earnings per share $ 0.72 $ 1.48 $ 0.96 $ 0.07
======== ======== ======== ========
As originally reported
Net premiums earned $167,821 $184,746 $213,126 $221,148
Net investment income 58,413 73,129 88,151 89,288
Net realized gains (losses)
on investments 27,492 145,616 68,791 (54,172)
--------- -------- -------- --------
Total revenues $253,726 $403,491 $370,068 $256,264
======== ======== ======== ========
Losses and loss expenses $109,161 $116,265 $134,305 $118,624
======== ======== ======== ========
Net income $112,816 $236,205 $171,463 $ 13,512
======== ======== ======== ========
Diluted Earnings per share $ 0.67 $ 1.41 $ 0.95 $ 0.07
======== ======== ======== ========
1997 First Second Third Fourth
Quarter Quarter Quarter Quarter
-------- -------- -------- --------
(in thousands, except per share data)
Adjusted for pooling-of-interests
Net premiums earned $206,919 $199,150 $202,965 $196,338
Net investment income 62,867 61,160 64,303 65,110
Net realized gains (losses)
on investments 41,580 (2,480) 45,788 $ 42,814
-------- -------- -------- --------
Total revenue $311,366 $257,830 $313,056 $304,262
======== ======== ======== ========
Losses and loss expenses $123,019 $117,350 $123,900 $121,871
======== ======== ======== ========
Net income $138,443 $ 87,676 $139,915 $136,691
======== ======== ======== ========
Diluted Earnings per share $ 0.72 $ 0.46 $ 0.76 $ 0.74
======== ======== ======== ========
As originally reported
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
======== ======== ======== ========
Diluted Earnings per share $ 0.71 $ 0.45 $ 0.77 $ 0.75
======== ======== ======== ========
29
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd.)
15. Condensed unaudited pro forma information relating to the acquisitions of
ACE USA and CAT
The following pro forma information assumes the acquisitions 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 acquisition been
consummated at the beginning of each year presented, nor is it necessarily
indicative of future operating results.
1998 1997
------------ ------------
(in thousands, except per share
data)
Pro forma:
Net premiums earned $ 988,847 $ 1,054,060
Net Investment income 337,603 308,836
Net income 581,310 448,791
Diluted earnings per share $ 3.07 $ 2.40
30