The following is a discussion of our results of operations, financial condition,
and liquidity and capital resources as of and for the three and six months ended
June 30, 2012.
All comparisons in this discussion are to the corresponding prior year periods
unless otherwise indicated.
Our results of operations and cash flows for any interim period are not
necessarily indicative of our results for the full year. This discussion should
be read in conjunction with our consolidated financial statements and related
notes and our Management's Discussion and Analysis of Financial Condition and
Results of Operations included in our Annual Report on Form 10-K for the year
ended December 31, 2011 (2011 Form 10-K).
Effective January 1, 2012, we retrospectively adopted new accounting guidance
for costs associated with acquiring or renewing insurance contracts. Under the
new guidance, the definition of acquisition costs was modified to specify that a
cost must be directly related to the successful acquisition of a new or renewal
insurance contract in order to be deferred. Prior year amounts and ratios
contained in these consolidated financial statements have been adjusted to
reflect the impact of retrospective adjustments as a result of applying this new
accounting guidance.
In addition, effective January 1, 2012, we reclassified prior year segment
operating results in order to conform to certain organizational
realignments. These realignments resulted in a transfer of operating revenue and
underwriting results of our international direct-marketed and credit life
businesses from the Insurance - Overseas General segment to the Life segment.
These realignments have no impact on consolidated operating results; however,
prior year amounts and underwriting ratios contained in these consolidated
financial statements have been adjusted to conform to the current year
presentation.
Page
MD&A Index No.
Forward-Looking Statements 48
Overview 50
Financial Highlights 50
Consolidated Operating Results 51
Prior Period Development 55
Segment Operating Results 58
Other Income and Expense Items 66
Net Investment Income 66
Net Realized and Unrealized Gains (Losses) 67
Investments 69
Critical Accounting Estimates 76
Reinsurance Recoverable on Ceded Reinsurance 76
Unpaid Losses and Loss Expenses 76
Asbestos and Environmental (A&E) and Other Run-off Liabilities 77
Fair Value Measurements 77
Guaranteed Living Benefits (GLB) Derivatives 78
Catastrophe Management 82
Natural Catastrophe Property Reinsurance Program 83
Crop Insurance 83
Liquidity 83
Capital Resources 85
Recent Accounting Pronouncements 86
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Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements. Any written or oral statements made by us or on
our behalf may include forward-looking statements that reflect our current views
with respect to future events and financial performance. These forward-looking
statements are subject to certain risks, uncertainties, and other factors that
could, should potential events occur, cause actual results to differ materially
from such statements. These risks, uncertainties, and other factors (which are
described in more detail elsewhere herein and in other documents we file with
the SEC) include but are not limited to:
• developments in global financial markets, including changes in interest
rates, stock markets, and other financial markets, increased government
involvement or intervention in the financial services industry, the cost
and availability of financing, and foreign currency exchange rate
fluctuations (which we refer to in this report as foreign exchange and
foreign currency exchange), which could affect our statement of operations, investment portfolio, financial position, and financing plans;
• general economic and business conditions resulting from volatility in the
stock and credit markets and the depth and duration of recession;
• losses arising out of natural or man-made catastrophes such as hurricanes,
typhoons, earthquakes, floods, climate change (including effects on
weather patterns, greenhouse gases, sea, land and air temperatures, sea
levels, rain and snow), nuclear accidents or terrorism which could be
affected by:
• the number of insureds and ceding companies affected;
• the amount and timing of losses actually incurred and reported by insureds;
• the impact of these losses on our reinsurers and the amount and timing
of reinsurance recoverable actually received;
• the cost of building materials and labor to reconstruct properties or to perform environmental remediation following a catastrophic event;
and
• complex coverage and regulatory issues such as whether losses occurred
from storm surge or flooding and related lawsuits;
• actions that rating agencies may take from time to time, such as financial strength or credit ratings downgrades or placing these ratings on credit
watch negative or the equivalent;
• global political conditions, the occurrence of any terrorist attacks,
including any nuclear, radiological, biological, or chemical events, or
the outbreak and effects of war, and possible business disruption or
economic contraction that may result from such events;
• the ability to collect reinsurance recoverable, credit developments of
reinsurers, and any delays with respect thereto and changes in the cost,
quality, or availability of reinsurance;
• actual loss experience from insured or reinsured events and the timing of
claim payments;
• the uncertainties of the loss-reserving and claims-settlement processes,
including the difficulties associated with assessing environmental damage
and asbestos-related latent injuries, the impact of
aggregate-policy-coverage limits, and the impact of bankruptcy protection
sought by various asbestos producers and other related businesses and the
timing of loss payments;
• changes to our assessment as to whether it is more likely than not that we
will be required to sell, or have the intent to sell, available for sale
fixed maturities before their anticipated recovery;
• infection rates and severity of pandemics and their effects on our
business operations and claims activity;
• judicial decisions and rulings, new theories of liability, legal tactics, and settlement terms;
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• the effects of public company bankruptcies and/or accounting restatements,
as well as disclosures by and investigations of public companies relating
to possible accounting irregularities, and other corporate governance
issues, including the effects of such events on:
• the capital markets;
• the markets for directors and officers (D&O) and errors and omissions
(E&O) insurance; and
• claims and litigation arising out of such disclosures or practices by other companies;
• uncertainties relating to governmental, legislative and regulatory
policies, developments, actions, investigations and treaties, which, among
other things, could subject us to insurance regulation or taxation in
additional jurisdictions or affect our current operations;
• the actual amount of new and renewal business, market acceptance of our
products, and risks associated with the introduction of new products and
services and entering new markets, including regulatory constraints on
exit strategies;
• the competitive environment in which we operate, including trends in pricing or in policy terms and conditions, which may differ from our
projections and changes in market conditions that could render our
business strategies ineffective or obsolete;
• acquisitions made by us performing differently than expected, our failure
to realize anticipated expense-related efficiencies or growth from
acquisitions, the impact of acquisitions on our pre-existing organization
or announced acquisitions not closing;
• risks associated with being a Swiss corporation, including reduced flexibility with respect to certain aspects of capital management and the
potential for additional regulatory burdens;
• the potential impact from government-mandated insurance coverage for acts
of terrorism;
• the availability of borrowings and letters of credit under our credit facilities;
• the adequacy of collateral supporting funded high deductible programs;
• changes in the distribution or placement of risks due to increased
consolidation of insurance and reinsurance brokers;
• material differences between actual and expected assessments for guaranty funds and mandatory pooling arrangements;
• the effects of investigations into market practices in the property and
casualty (P&C) industry;
• changing rates of inflation and other economic conditions, for example, recession;
• the amount of dividends received from subsidiaries;
• loss of the services of any of our executive officers without suitable
replacements being recruited in a reasonable time frame;
• the ability of our technology resources to perform as anticipated; and
• management's response to these factors and actual events (including, but
not limited to, those described above).
The words "believe," "anticipate," "estimate," "project," "should," "plan,"
"expect," "intend," "hope," "feel," "foresee," "will likely result," or "will
continue," and variations thereof and similar expressions, identify
forward-looking statements. You are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of their dates. We
undertake no obligation to publicly update or review any forward-looking
statements, whether as a result of new information, future events or otherwise.
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Overview
ACE Limited is the Swiss-incorporated holding company of the ACE Group of
Companies. ACE opened its business office in Bermuda in 1985 and continues to
maintain operations in Bermuda. ACE, which is headquartered in Zurich,
Switzerland, and its direct and indirect subsidiaries, is a global insurance and
reinsurance organization, serving the needs of a diverse group of clients around
the world. We are predominantly a global property and casualty insurance company
with both a commercial and specialty product orientation. We offer commercial
insurance, specialty products and accident and health (A&H) solutions and are
expanding our personal lines and international life insurance businesses. As we
have grown, we have developed products and diversified our offerings to meet the
needs of our customers. At June 30, 2012, ACE had total assets of $91 billion
and shareholders' equity of $26 billion.
We operate through the following business segments: Insurance - North American,
Insurance-Overseas General, Global Reinsurance, and Life.
The Insurance - North American segment includes retail divisions ACE USA
(including ACE Canada), ACE Commercial Risk Services and ACE Private Risk
Services; our wholesale and specialty divisions ACE Westchester, ACE Agriculture
and ACE Bermuda; and various run-off operations, including Brandywine Holdings
Corporation (Brandywine). Our retail products range from commercial lines with
service offerings such as risk management, loss control and engineering
programs, and specialty commercial P&C and A&H to personal lines homeowners,
automobiles, liability, valuable articles and marine coverages. Our wholesale
and specialty products include excess and surplus property, professional
liability, inland marine, specialty property, specialty casualty, political
risk, and comprehensive multiple-peril crop and hail insurance products.
The Insurance - Overseas General segment comprises ACE International, our retail
business serving territories outside the U.S., Bermuda, and Canada; the
international A&H and life business of Combined Insurance (Combined); and the
wholesale insurance business of ACE Global Markets. ACE International has a
presence in major developed markets and growing economies serving multinational
clients and local customers. A significant amount of our global business is with
local companies, offering traditional and specialty P&C products including D&O
and professional liability, specialty personal lines, and energy products. Our
international A&H business primarily focuses on personal accident and
supplemental medical. ACE Global Markets offers specialty products including
aviation, marine, financial lines, energy, and political risk.
The Global Reinsurance segment represents our reinsurance operations, comprising
ACE Tempest Re Bermuda, ACE Tempest Re USA, ACE Tempest Re International, ACE
Tempest Re Canada, and the reinsurance operation of ACE Global Markets. Global
Reinsurance provides solutions for customers ranging from small commercial
insureds to multinational ceding companies. Global Reinsurance offers products
such as property and workers' compensation catastrophe, D&O, professional
liability, specialty casualty and specialty property.
The Life segment includes our international life operations (ACE Life), ACE
Tempest Life Re (ACE Life Re), and the North American supplemental A&H and life
business of Combined Insurance. For more information on each of our segments
refer to "Segment Information" in our 2011 Form 10-K.
On June 13, 2012, we announced that we and our local partner had signed a
definitive agreement to acquire PT Asuransi Jaya Proteksi (JaPro), one of
Indonesia's leading general insurers. This transaction, which is subject to
regulatory approvals and other closing conditions, is expected to be completed
by the end of 2012.
Financial Highlights for the Three Months Ended June 30, 2012
• Total company net premiums written increased 4.5 percent. On a
constant-dollar basis, total company net premiums written increased 6.5
percent.
• The P&C combined ratio was 88.7 percent compared with 92.7 percent in the
prior year period.
• Favorable prior period development pre-tax was $113 million, representing
3.4 percentage points of the combined ratio, compared with $146 million in
the prior year period.
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• Total pre-tax and after-tax catastrophe losses including reinstatement
premiums were $55 million and $41 million, respectively, compared with
$134 million and $101 million, respectively, in the prior year period.
• The current accident year combined ratio was 92.1 percent compared with
97.2 percent in the prior year period. Adjusting for catastrophe losses,
current accident year combined ratio was 90.4 percent compared with 93.1
percent.
• The P&C expense ratio for the quarter was 29.2 percent compared with 29.6 percent in the prior year period.
• Operating cash flow was $811 million for the quarter.
• Net investment income for the quarter decreased six percent to $537
million due to lower yields on new investments and the negative impact of
foreign exchange.
• Net realized losses from derivative accounting related to variable annuity
reinsurance were $397 million.
Consolidated Operating Results - Three and Six Months Ended June 30, 2012 and
2011
Six Months
Three Months Ended Ended
June 30 % Change June 30 % Change
Q-12 vs. YTD-12 vs.
2012 2011 Q-11 2012 2011 YTD-11
(in millions of U.S. dollars, except for percentages)
Net premiums written $ 4,130 $ 3,953 4 % $ 7,702 $ 7,399 4 %
Net premiums earned 3,783 3,757 1 % 7,164 7,066 1 %
Net investment income 537 569 (6 )% 1,081 1,113 (3 )%
Net realized gains (losses) (394 ) (73 ) NM (134 ) (118 ) (14 )%
Total revenues 3,926 4,253 (8 )% 8,111 8,061 1 %
Losses and loss expenses 2,119 2,226 (5 )% 3,923 4,489 (13 )%
Policy benefits 102 108 (6 )% 249 199 25 %
Policy acquisition costs 619 612 1 % 1,201 1,171 3 %
Administrative expenses 514 518 (1 )% 1,024 1,017 1 %
Interest expense 62 62 0 % 124 125 (1 )%
Other (income) expense 34 12 183 % 31 (1 ) NM
Total expenses 3,450 3,538 (2 )% 6,552 7,000 (6 )%
Income before income tax 476 715 (33 )% 1,559 1,061 47 %
Income tax expense 148 121 22 % 258 217 19 %
Net income $ 328 $ 594 (45 )% $ 1,301 $ 844 54 %
NM - not meaningful
The following table summarizes, by major product line, the approximate effect of
changes in foreign currency exchange rates on the growth of net premiums written
and earned for the periods indicated:
Three Months Ended Six Months Ended
June 30, 2012 June 30, 2012
P&C Life A&H
Total P&C Life A&H Total
Net premiums written:
Growth in original currency
7.8 % 2.1 % 3.5 %
6.5 % 5.6 % 15.1 % 2.7 % 5.5 %
Foreign exchange effect
(1.5 )% (2.9 )% (3.4 )%
(2.0 )% (1.1 )% (2.4 )% (2.1 )% (1.4 )%
Growth as reported in U.S. dollars 6.3 % (0.8 )% 0.1 %
4.5 % 4.5 % 12.7 % 0.6 % 4.1 %
Net premiums earned:
Growth in original currency 3.2 % 0.0 % 2.7 %
2.9 % 2.1 % 13.4 % 2.7 % 2.9 %
Foreign exchange effect
(1.8 )% (2.2 )% (3.5 )%
(2.2 )% (1.6 )% (2.2 )% (2.2 )% (1.5 )%
Growth as reported in U.S. dollars 1.4 % (2.2 )% (0.8 )%
0.7 % 0.5 % 11.2 % 0.5 % 1.4 %
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Net premiums written, which reflect the premiums we retain after purchasing
reinsurance protection, increased four percent in both the three and six months
ended June 30, 2012. In our Insurance - North American segment, retail premiums
grew primarily from new business opportunities, strong renewal retention,
increases in rates and exposure basis. This growth was partially offset by our
continued planned reductions in our U.S. general market risk transfer workers'
compensation business. The North American wholesale and specialty division grew
from increases in property, casualty and inland marine lines, partially offset
by lower agriculture premiums driven by reduced crop hail production. Our
Insurance - Overseas General segment reported an increase in international
retail premiums due to continued growth in our P&C and A&H lines of business.
This growth was partially offset by decreases in certain retail A&H production
in Combined's United Kingdom (U.K.) and Ireland regions. Combined Insurance
premiums continue to be hampered by the economic recession in its target
markets. Additionally, Combined's business in the U.K. and Ireland has been
impacted by changes in the regulatory environment as regulators in these two
countries have adopted a new stance regarding sales practices and customer
service. This has resulted in a need for us to re-evaluate our sales model and
to re-engineer our processes. We have put these two operations on a sales
moratorium while continuing to renew and service in-force policyholders. We have
decided to cease sales in our small Spanish branch indefinitely. We have
received regulatory approval to integrate all European operations of Combined
into our ACE European Group Limited subsidiary, incorporated in the U.K. We
expect to seek regulatory approval to re-commence sales in the U.K. and Ireland
in 2012. For the six months ended June 30, 2012, our Insurance - Overseas
General segment also benefited from the favorable impact of reinstatement
premiums expensed in the prior year related to first quarter 2011 catastrophe
activity. Our Global Reinsurance segment reported an increase in net premiums
written for the three months ended June 30, 2012 primarily due to improving
pricing conditions in our U.S. property catastrophe business. For the six months
ended June 30, 2012, this improvement was more than offset by competitive market
conditions experienced in the first quarter as well as from a non-recurring loss
portfolio transfer treaty written in the prior year. Our Life segment reported a
slight decrease in net premiums written for the three months ended June 30, 2012
primarily driven by the run-off of our Life reinsurance variable annuity
business and from lower A&H production. This decrease was offset by growth in
our Life insurance business primarily in our Asian markets. For the six months
ended June 30, 2012, our Life insurance business also benefited from prior year
acquisitions.
Net premiums earned reflect the portion of net premiums written that were
recorded as revenues for the period as the exposure periods expire. Net premiums
earned increased one percent in both the three and six months ended June 30,
2012. Our Insurance-North American segment reported an increase in net premiums
earned for the three months ended June 30, 2012 from growth in commercial and
personal lines in our retail division and growth in commercial and agriculture
lines in our wholesale and specialty division. This growth was partially offset
by our continued planned reduction of our U.S. general market risk transfer
workers' compensation business and by lower premiums associated with a couple of
large structured prospective risk management programs. Results for the six
months ended June 30, 2012 were relatively flat. In our Insurance - Overseas
General segment, results for the three months ended June 30, 2012 grew on a
constant-dollar basis driven by continued strong written premium production in
Latin American and Asia, though results reported in U.S. dollars were relatively
flat. Results for the six months ended June 30, 2012 increased on both a
constant-dollar and reported U.S. dollar basis from growth in retail P&C and A&H
lines and from the favorable impact of reinstatement premiums expensed in the
prior year. Our Global Reinsurance segment reported a decline in net premiums
earned due to consecutive lower net premiums written in prior quarters and to
the effect of a non-recurring loss portfolio transfer treaty written in the
prior year. Our Life segment reported decreased net premiums earned for the
three months ended June 30, 2012 due to the run off of our Life reinsurance
variable annuity business and from lower A&H premiums due to the effects of the
economy resulting in lower new business. Net premiums earned increased for the
six months ended June 30, 2012 primarily from business generated from prior year
acquisitions.
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The following table provides a consolidated breakdown of net premiums earned by
line of business for the periods indicated:
Three Months Ended % Change Six Months Ended % Change
June 30 Q-12 vs. June 30 YTD-12 vs.
2012 2011 Q-11 2012 2011 YTD-11
(in millions of U.S. dollars, except for percentages)
Property and all other $ 1,013 $ 940 8 % $ 1,983 $ 1,775 12 %
Agriculture 384 356 8 % 443 434 2 %
Casualty 1,289 1,352 (5 )% 2,559 2,732 (6 )%
Subtotal 2,686 2,648 1 % 4,985 4,941 1 %
Personal accident (A&H) 871 878 (1 )% 1,723 1,715 0 %
Life 226 231 (2 )% 456 410 11 %
Net premiums earned $ 3,783 $ 3,757 1 % $ 7,164 $ 7,066 1 %
2012 2011 2012 2011
% of total % of total % of total % of total
Property and all other 27 % 25 % 28 % 25 %
Agriculture 10 % 9 % 6 % 6 %
Casualty 34 % 36 % 36 % 39 %
Subtotal 71 % 70 % 70 % 70 %
Personal accident (A&H) 23 % 23 % 24 % 24 %
Life 6 % 7 % 6 % 6 %
Net premiums earned 100 % 100 % 100 % 100 %
In evaluating our segments excluding Life, we use the combined ratio, the loss
and loss expense ratio, the policy acquisition cost ratio, and the
administrative expense ratio. We calculate these ratios by dividing the
respective expense amounts by net premiums earned. We do not calculate these
ratios for the Life segment as we do not use these measures to monitor or manage
that segment. The combined ratio is determined by adding the loss and loss
expense ratio, the policy acquisition cost ratio, and the administrative expense
ratio. A combined ratio under 100 percent indicates underwriting income and a
combined ratio exceeding 100 percent indicates underwriting loss.
The following table shows our consolidated loss and loss expense ratio, policy
acquisition cost ratio, administrative expense ratio, and combined ratio for the
periods indicated:
Three Months Ended Six Months Ended
June 30 June 30
2012 2011 2012 2011
Loss and loss expense ratio 59.5 % 63.1 % 58.3 % 68.1 %
Policy acquisition cost ratio 16.1 % 16.1 % 16.7 % 16.3 %
Administrative expense ratio 13.1 % 13.5 % 13.9 % 14.1 %
Combined ratio 88.7 % 92.7 % 88.9 % 98.5 %
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The following table shows the impact of catastrophe losses and related
reinstatement premiums and the impact of prior period development on our
consolidated loss and loss expense ratio for the periods indicated:
Three Months Ended Six Months Ended
June 30 June 30
2012 2011 2012 2011
Loss and loss expense ratio,
as reported 59.5 % 63.1 % 58.3 % 68.1 %
Catastrophe losses and related
reinstatement premiums (1.7 )% (4.2 )% (1.2 )% (9.7 )%
Prior period development 3.4 % 4.5 % 3.3 % 3.9 %
Loss and loss expense ratio,
adjusted 61.2 % 63.4 % 60.4 % 62.3 %
Total net pre-tax catastrophe losses, excluding related reinstatement premiums,
were $55 million and $74 million for the three and six months ended June 30,
2012, compared with $142 million and $557 million for the prior year periods,
respectively. Catastrophe losses through June 30, 2012 were primarily related to
severe weather related events in the U.S. Catastrophe losses through June 30,
2011 included earthquakes in Japan and New Zealand, storms in Australia, and
severe weather-related events in the U.S.
Prior period development arises from changes to loss estimates recognized in the
current year that relate to loss reserves first reported in previous calendar
years and excludes the effect of losses from the development of earned premium
from previous accident years. We experienced net favorable prior period
development of $113 million and $206 million for the three and six months ended
June 30, 2012, respectively. This compares with net favorable prior period
development of $146 million and $239 million in the prior year periods,
respectively. Refer to "Prior Period Development" for additional information.
Net investment income for the three and six months ended June 30, 2012 was $537
million and $1.1 billion, compared with $569 million and $1.1 billion for the
prior year periods, respectively. Refer to "Net Investment Income" and
"Investments" for additional information.
Policy acquisition costs consist of commissions, premium taxes, and certain
underwriting costs related directly to the successful acquisition of a new or
renewal insurance contract. Administrative expenses include all other operating
costs. Our policy acquisition cost ratio was flat for the three months ended
June 30, 2012. Our policy acquisition cost ratio increased for the six months
ended June 30, 2012 primarily from growth in personal lines and A&H business
that carry a higher acquisition cost ratio as well as increased spending to
support future growth opportunities in our Insurance - North America segment.
This increase was partially offset by lower costs in our Global Reinsurance
segment. Our administrative expense ratio decreased in the three and six months
ended June 30, 2012 primarily driven by lower regulatory costs in the Insurance
- Overseas General segment.
Our effective income tax rate, which we calculate as income tax expense divided
by income before income tax, is dependent upon the mix of earnings from
different jurisdictions with various tax rates. A change in the geographic mix
of earnings would change the effective income tax rate. Our effective income tax
rate was 31 percent and 17 percent for the three and six months ended June 30,
2012, respectively, compared with 17 percent and 20 percent for the prior year
periods, respectively. The increase in our effective income tax rate for the
three months ended June 30, 2012 was primarily due to net realized losses on
derivatives generated in lower tax-paying jurisdictions during the current year
period. The decrease in our effective income tax rate for the six months ended
June 30, 2012 was primarily due to a smaller percentage of net realized losses
on derivatives generated in lower tax-paying jurisdictions and a higher
percentage of earnings being generated in lower tax-paying jurisdictions during
the current year.
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Prior Period Development
The favorable prior period development of $113 million and $206 million during
the three and six months ended June 30, 2012, respectively, was the net result
of several underlying favorable and adverse movements. In the sections following
the tables below, significant prior period movements within each reporting
segment are discussed in more detail. Long-tail lines include lines such as
workers' compensation, general liability, and professional liability; while
short-tail lines include lines such as most property lines, energy, personal
accident, aviation, and marine (including associated liability-related
exposures).
The following table summarizes (favorable) and adverse prior period development
by segment:
% of net
unpaid
Three Months Ended June 30 Long-tail
Short-tail Total reserves*
(in millions of U.S. dollars, except for percentages)
2012
Insurance - North American $ (24 ) $ (35 ) $ (59 ) 0.4 %
Insurance - Overseas General - (39 ) (39 ) 0.5 %
Global Reinsurance (15 ) - (15 ) 0.7 %
Total $ (39 ) $ (74 ) $ (113 ) 0.4 %
2011
Insurance - North American $ (46 ) $ (25 ) $ (71 ) 0.4 %
Insurance - Overseas General - (40 ) (40 ) 0.5 %
Global Reinsurance (35 ) - (35 ) 1.4 %
Total $ (81 ) $ (65 ) $ (146 ) 0.6 %
* Calculated based on the segment/total beginning of period net unpaid loss and
loss expenses reserves.
% of net
unpaid
Six Months Ended June 30 Long-tail Short-tail Total reserves*
(in millions of U.S. dollars, except for percentages)
2012
Insurance - North American $ (74 ) $ (45 ) $ (119 ) 0.7 %
Insurance - Overseas General - (61 ) (61 ) 0.8 %
Global Reinsurance (16 ) (10 ) (26 ) 1.1 %
Total $ (90 ) $ (116 ) $ (206 ) 0.8 %
2011
Insurance - North American $ (38 ) $ (68 ) $ (106 ) 0.7 %
Insurance - Overseas General (1 ) (83 ) (84 ) 1.2 %
Global Reinsurance (43 ) (6 ) (49 ) 2.2 %
Total $ (82 ) $ (157 ) $ (239 ) 0.9 %
* Calculated based on the segment/total beginning of period net unpaid loss and
loss expenses reserves.
Insurance - North American
Insurance - North American's operations experienced net favorable prior period
development of $59 million in the three months ended June 30, 2012, which was
the net result of several underlying favorable and adverse movements driven by
the following principal changes:
• Net favorable development of $24 million on long-tail business, including:
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• Net favorable development of $38 million on our national accounts
portfolios which consist of commercial auto liability, general liability,
and workers' compensation lines of business. This favorable development
was the net impact of favorable and adverse movements, including:
• Favorable development of $41 million on the 2011 accident year related
to our annual assessment of multi-claimant events including industrial
accidents. Consistent with prior years, we reviewed these potential
exposures after the close of the accident year to allow for late
reporting or identification of significant losses.
• Favorable development of $34 million in the 2007 accident year,
primarily in workers' compensation. Loss activity through March 31,
2012 was lower than expected and was included in the review completed
during the three months ended June 30, 2012, in which we have
increased the weighting on experienced-based methods. The favorable
development was the combined effect of this lower than expected
incurred loss activity and our change in method weights.
• Adverse development of $37 million affecting the 2006 and
prior
accident years largely in workers' compensation. The causes for this
adverse movement were numerous and included large increases in a small
number of claims, higher than expected loss activity in a few accident
years, changes in our weighting of experience-based methods, and a
refinement of our treatment of ceded reinsurance recoveries on a few
select treaties due to information which became known since our prior
review.
• Adverse development of $14 million in other long-tail business across
a number of lines and accident years, none of which was significant
individually or in the aggregate.
• Favorable development of $35 million on short-tail business, including:
• Favorable development of $23 million in our general aviation product
lines (both hull and liability) affecting the 2009 and prior accident
years. Actual paid and incurred loss activity continues to be lower
than expected based on long term historical averages leading to a
reduction in our estimate of ultimate losses; and
• Favorable development of $12 million in other short-tail business
across a number of lines and accident years, none of which was
significant individually or in the aggregate.
Insurance - North American experienced net favorable prior period development of
$71 million in the three months ended June 30, 2011, which was the net result of
several underlying favorable and adverse movements, driven by the following
principal changes:
• Net favorable development of $46 million on long-tail business, including:
• Favorable development of $56 million on our national accounts
portfolios which consist of commercial auto liability, general
liability, and workers' compensation lines of business. The favorable
development was the net impact of favorable and adverse movements,
including:
• Favorable development of $40 million on the 2010 accident year
relating to our annual assessment of multi-claimant events
including industrial accidents. Consistent with prior years, we
reviewed these potential exposures after the close of the accident
year to allow for late reporting or identification of significant
losses.
• Favorable development of $41 million on the 2003 through 2006
accident years, primarily in workers' compensation. Case activity
in these portfolios, especially in our excess and high deductible
products, has continued to be lower than expected. As these
accident years matured, greater weight has been given to
experience-based methods. The combination of this lower than
expected activity and shift in weighting methodology have produced
this favorable development.
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• Adverse development of $25 million on the 2002 and prior accident
years, primarily in workers' compensation. This adverse activity is
due in part to data refinements and analysis relating to these
accident periods.
• Adverse development of $10 million in other long-tail business across
a number of lines and accident years, none of which was significant
individually or in the aggregate.
• Favorable development of $25 million on short-tail business, including:
• Favorable development of $16 million in our general aviation product
lines (both hull and liability) primarily for the 2008accident year.
Actual paid and incurred loss activity continues to be lower than
expected based on long term historical averages leading to a reduction
in our estimate of ultimate losses.
• Favorable development of $9 million in other short-tail business
across a number of lines and accident years, none of which was
significant individually or in the aggregate.
Insurance - Overseas General
Insurance - Overseas General experienced net favorable prior period development
of $39 million in the three months ended June 30, 2012, which was the net result
of several underlying favorable and adverse movements, driven by the following
principal changes:
• There was no prior period development on long-tail business in the three
months ended June 30, 2012.
• Net favorable development of $39 million on short-tail business, including:
• Favorable development of $20 million on wholesale marine business.
Favorable loss emergence across much of the short-tail first party
marine business in accident years 2010 and 2011 led to lower
experienced-based indications. In addition, case reductions on
specific claims in older accident years drove reserve releases.
• Net favorable development of $15 million on short-tail property and
technical lines in Continental Europe, excluding catastrophes.
Favorable loss emergence in the boiler and machinery (B&M) business,
driven by better than expected loss activity on large accounts,
primarily in accident years 2010 and 2011 drove most of the reserve
release. Adverse movement in fire business in accident year 2011
driven by unfavorable loss emergence across the regionmitigated the
impact of the favorable B&M reserve release.
• Favorable development of $4 million in other short-tail business
across a number of lines and accident years, none of which was
significant individually or in the aggregate.
Insurance - Overseas General experienced net favorable prior period development
of $40 million in the three months ended June 30, 2011, which was the net result
of several underlying favorable and adverse movements, driven by the following
principal changes:
• There was no prior period development on long-tail business in the three
months ended June 30, 2011.
• Net favorable development of $40 million on short-tail business, including:
• Favorable development of $61 million in accident years 2009 and prior
for property, technical, and marine lines. Given the
short-tail nature
of these lines and the additional credibility and maturity provided by
the experience in the three months ended June 30, 2011, the observed
favorable development led to lower experience-based indications that
were recognized in the quarter.
• Adverse development of $31 million in accident year 2010 for property
and technical lines. This indication was driven predominantly by
individual large case reserve increases and higher claim estimates for
the December 2010 Australian floods.
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• Favorable development of $10 million in other short-tail business
across a number of lines and accident years, none of which was
significant individually or in the aggregate.
Global Reinsurance
Global Reinsurance experienced net favorable prior period development of $15
million in the three months ended June 30, 2012, which was the net result of
several underlying favorable and adverse movements, driven by the following
principal changes:
• Net favorable development of $15 million on long-tail business, including:
• Favorable development of $36 million in the casualty line of business
principally in treaty years 2007 and prior. Following the reserve
studies completed in the three months ended June 30, 2012, we
reflected a greater weighting towards experience-based
methods. Since
experience has tended to be generally favorable compared with
assumptions, the changes resulted in the favorable development
referenced above.
• Net adverse development of $18 million in the professional
liability/D&O line of business. There was $26 million of adverse
development related to treaty years 2006 to 2010 where the loss
experience has been unfavorable recently due to higher than expected
reported claims and greater reliance on experience-based methods.
There was also favorable development of $8 million in treaty years
2004 and prior, where experience has tended to be generally more
favorable.
• Adverse development of $3 million in other long-tail business across a
number of treaty years, none of which was significant
individually or
in the aggregate.
• There was no prior period development on short-tail business in the three months ended June 30, 2012.
Global Reinsurance experienced net favorable prior period development of $35
million in the three months ended June 30, 2011, which was the net result of
several underlying favorable and adverse movements, driven by the following
principal changes:
• Net favorable development of $35 million on long-tail business, including:
• Favorable development of $27 million in the casualty line of business
principally in treaty years 2002 to 2007. Following the reserve
studies completed in the three months ended June 30, 2011, we
reflected a greater weighting towards experience-based
methods. Since
experience has tended to be generally favorable compared with
assumptions, the changes resulted in the favorable development
referenced above.
• Favorable development of $13 million in the D&O line of business. $6
million relates to treaty years 2002 to 2004 where the loss experience
has been generally more favorable than previously anticipated, while
the remainder relates to treaty years 2006 to 2008, where the
potential subprime exposure has not materialized into reported losses
to the degree anticipated.
• Adverse development of $5 million in other long-tail business across a
number of treaty years, none of which was significant
individually or
in the aggregate.
• There was no prior period development on short-tail business in the three months ended June 30, 2011.
Segment Operating Results - Three and Six Months Ended June 30, 2012 and 2011
The discussions that follow include tables that show our segment operating
results for the three and six months ended June 30, 2012 and 2011.
We operate through the following business segments: Insurance - North American,
Insurance - Overseas General, Global Reinsurance, and Life. For additional
information on each of our segments refer to "Segment Information" in our 2011
Form 10-K.
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Insurance - North American
The Insurance - North American segment comprises our operations in the U.S.,
Canada, and Bermuda. This segment includes our retail divisions ACE USA
(including ACE Canada), ACE Commercial Risk Services, and ACE Private Risk
Services; our wholesale and specialty divisions ACE Westchester, ACE Agriculture
and ACE Bermuda; and various run-off operations, including Brandywine Holdings
Corporation (Brandywine).
Three Months Ended % Change Six Months Ended % Change
June 30 Q-12 vs. June 30 YTD-12 vs.
2012 2011 Q-11 2012 2011 YTD-11
(in millions of U.S. dollars, except for percentages)
Net premiums written $ 1,860 $ 1,735 7 % $ 3,153 $ 3,020 4 %
Net premiums earned 1,652 1,604 3 % 2,939 2,950 0 %
Losses and loss expenses 1,163 1,233 (6 )% 2,012 2,227 (10 )%
Policy acquisition costs 157 145 8 % 284 281 1 %
Administrative expenses 153 147 4 % 300 295 2 %
Underwriting income 179 79 127 % 343 147 133 %
Net investment income 271 300 (10 )% 545 595 (8 )%
Net realized gains (losses) 18 21 (14 )% 17 10 70 %
Interest expense 3 3 0 % 6 7 (14 )%
Other (income) expense 10 3 233 % 9 (13 ) NM
Income tax expense 107 95 13 % 198 184 8 %
Net income $ 348 $ 299 16 % $ 692 $ 574 21 %
Loss and loss expense ratio 70.4 % 76.9 % 68.5 % 75.5 %
Policy acquisition cost ratio 9.5 % 9.0 % 9.7 % 9.5 %
Administrative expense ratio 9.3 % 9.2 % 10.1 % 10.0 %
Combined ratio 89.2 % 95.1 % 88.3 % 95.0 %
Insurance - North American reported an increase in net premiums written of seven
percent and four percent for the three and six months ended June 30, 2012,
respectively. Our retail business grew as a result of several factors including
rate increases, strong renewal retention, increased new business opportunities
and higher exposure base. These factors contributed to growth in most of our
businesses, primarily in property, inland marine, professional, risk management,
specialty casualty, and A&H lines of business. In addition, we continued to
generate higher personal lines production from homeowner and automobile business
offered through ACE Private Risk Services. Growth in our retail division was
partially offset by lower premiums in certain casualty and program business from
adherence to our underwriting standards; in particular, we continued our planned
reduction in our U.S. general market workers' compensation business. Our
wholesale and specialty division reported growth in property, casualty and
inland marine lines. This growth was partially offset by reduced agriculture
premiums from lower crop hail production. The overall decrease in agriculture
premiums was partially offset by increased premiums from the November 2011
acquisition of Penn Millers Insurance Company (Penn Millers).
Insurance - North American reported a three percent increase in net premiums
earned for the three months ended June 30, 2012. Net premiums earned for the six
months ended June 30, 2012 was relatively flat. Net premiums earned increased
for the three months ended June 30, 2012 due to growth in our retail division
from higher premiums earned in our property, risk management, specialty casualty
and A&H lines of business, along with growth in our personal lines business from
continued expansion of the ACE Private Risk Services product offerings. These
increases were partially offset by lower premiums associated with a couple of
large structured prospective risk management programs and the continued planned
reduction in our U.S. general market workers' compensation business. Our
wholesale and specialty division also generated higher premiums earned primarily
in our agriculture business from the acquisition of Penn Millers in November
2011, as well as from higher premiums in wholesale property and inland marine
lines. For the six months ended June 30, 2012, the growth in premiums from these
retail and wholesale and specialty businesses was more than offset by the
decline in premiums from our U.S. general market workers' compensation business
and a couple of large structured prospective risk management programs.
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The following two tables provide a line of business breakdown of Insurance -
North American's net premiums earned for the periods indicated:
Three Months Ended % Change Six Months Ended % Change
June 30 Q-12 vs. June 30 YTD-12 vs.
2012 2011 Q-11 2012 2011 YTD-11
(in millions of U.S. dollars, except for percentages)
Property and all other $ 347 $ 292 19 % $ 669 $ 584 15 %
Agriculture 384 356 8 % 443 434 2 %
Casualty 828 865 (4 )% 1,645 1,755 (6 )%
Personal accident (A&H) 93 91 2 % 182 177 3 %
Net premiums earned $ 1,652 $ 1,604 3 % $ 2,939 $ 2,950 (0 )%
2012 2011 2012 2011
% of % of % of % of
Total Total Total TotalProperty and all other 21 % 18 % 23 % 20 %
Agriculture 23 % 22 % 15 % 15 %
Casualty 50 % 54 % 56 % 59 %
Personal accident (A&H) 6 % 6 % 6 % 6 %
Net premiums earned 100 % 100 % 100 % 100 %
The following table shows the impact of catastrophe losses and related
reinstatement premiums, and prior period development on our loss and loss
expense ratio for the periods indicated:
Three Months Ended Six Months Ended
June 30 June 30
2012 2011 2012 2011
Loss and loss expense ratio, as reported 70.4 % 76.9 % 68.5 % 75.5 %
Catastrophe losses and related
reinstatement premiums (2.9 )% (6.9 )% (2.2 )% (6.6 )%
Prior period development 3.6 % 4.4 % 4.0 % 3.6 %
Loss and loss expense ratio, adjusted 71.1 % 74.4 %
70.3 % 72.5 %
Insurance - North American's net catastrophe losses, excluding reinstatement
premiums, were $49 million and $65 million for the three and six months ended
June 30, 2012, compared with $110 million and $186 million for the prior year
periods, respectively. Catastrophe losses through June 30, 2012 were primarily
related to severe weather-related events in the U.S. Catastrophe losses through
June 30, 2011 were primarily related to severe weather-related events in the
U.S., including flooding in the Midwest, and the earthquake in Japan. Insurance
- North American experienced net favorable prior period development of $59
million and $119 million for the three and six months ended June 30, 2012,
compared with net favorable prior period development of $71 million and $106
million in the prior year periods, respectively. Refer to "Prior Period
Development" for additional information. The adjusted loss and loss expense
ratio decreased for the three and six months ended June 30, 2012 primarily due
to a reduction in the current accident year loss ratio for several of our
property, casualty and professional lines where execution of detailed portfolio
management plans has resulted in improved loss ratio performance.
Insurance - North American's policy acquisition cost ratio increased for the
three and six months ended June 30, 2012 due to growth in certain businesses,
including personal lines and A&H that carry a higher acquisition rate than our
other businesses, and increased spending for strategic initiatives to support
future growth opportunities.
Insurance - North American's administrative expense ratio increased slightly for
the three and six months ended June 30, 2012 primarily due to increased spending
required to support business growth primarily in our retail businesses,
including ACE Private Risk Services, and growth in spending due to the Penn
Millers acquisition.
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Insurance - Overseas General
The Insurance - Overseas General segment comprises ACE International, our retail
business serving territories outside the U.S., Bermuda, and Canada; the
international A&H and life business of Combined Insurance; and the wholesale
insurance business of ACE Global Markets, our London-based excess and surplus
lines business that includes Lloyd's Syndicate 2488. The reinsurance operation
of ACE Global Markets is included in the Global Reinsurance segment.
Three Months Ended % Change Six Months Ended % Change
June 30 Q-12 vs. June 30 YTD-12 vs.
2012 2011 Q-11 2012 2011 YTD-11
(in millions of U.S. dollars, except for percentages)
Net premiums written $ 1,475 $ 1,443 2 % $ 3,003 $ 2,853 5 %
Net premiums earned 1,420 1,415 0 % 2,811 2,693 4 %
Losses and loss expenses 703 721 (2 )% 1,408 1,573 (10 )%
Policy acquisition costs 332 335 (1 )% 667 636 5 %
Administrative expenses 233 239 (3 )% 462 462 0 %
Underwriting income 152 120 27 % 274 22 NM
Net investment income 128 137 (7 )% 259 268 (3 )%
Net realized gains (losses) 26 (10 ) NM 46 (19 ) NM
Interest expense 1 1 0 % 2 2 0 %
Other (income) expense 6 (5 ) NM 6 (7 ) NM
Income tax expense 51 39 31 % 89 56 59 %
Net income $ 248 $ 212 17 % $ 482 $ 220 119 %
Loss and loss expense ratio 49.6 % 51.0 % 50.1 % 58.4 %
Policy acquisition cost ratio 23.4 % 23.6 % 23.7 % 23.6 %
Administrative expense ratio 16.3 % 17.0 % 16.5 % 17.2 %
Combined ratio 89.3 % 91.6 % 90.3 % 99.2 %
Insurance - Overseas General conducts business internationally and in most major
foreign currencies.
The following table summarizes by major product line the approximate effect of
changes in foreign currency exchange rates on the growth of net premiums written
and earned for the periods indicated:
Three Months Ended Six Months Ended
June 30, 2012 June 30, 2012
P&C A&H Total P&C A&H Total
Net premiums written:
Growth in original currency 7.5 % 5.4 % 6.7 % 10.6 % 4.4 % 8.3 %
Foreign exchange effect (4.4 )% (4.9 )% (4.5)% (3.0 )% (3.1 )% (3.1 )%
Growth as reported in U.S. dollars 3.1 % 0.5 % 2.2 %
7.6 % 1.3 % 5.2 %
Net premiums earned:
Growth in original currency 6.2 % 4.3 % 5.5 % 10.0 % 4.4 % 7.9 %
Foreign exchange effect (5.1 )% (5.3 )% (5.2
)% (3.5 )% (3.4 )% (3.5 )%
Growth as reported in U.S. dollars 1.1 % (1.0 )% 0.3 %
6.5 % 1.0 % 4.4 %
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Insurance - Overseas General's net premiums written increased two percent and
five percent for the three and six months ended June 30, 2012, respectively.
Retail P&C net premiums written increased due to new business opportunities and
rate increases in Latin America, Asia, and Europe. In addition, A&H business
continues to experience strong growth primarily in Asia and Latin America. For
the six months ended June 30, 2012, net premiums written also benefited from
favorable impact of reinstatement premiums expensed related to the first quarter
2011 catastrophe activity. Growth in the three and six months ended June 30,
2012 was partially offset by continued decreases in certain retail A&H business
due to suspension of Combined sales in the U.K. and Ireland.
Insurance - Overseas General's net premiums earned grew six percent in original
currencies for the three months ended June 30, 2012, though growth in reported
U.S. dollars was relatively flat. The constant-dollar growth was driven by
continued strong written premium performance in Latin America and Asia Pacific.
Net premiums earned grew eight percent in original currencies and four percent
in reported U.S. dollars for the six months ended June 30, 2012, driven by
growth noted in Latin America and Asia Pacific as well as reinstatement premiums
expensed in the prior year period.
The following tables provide a line of business breakdown of Insurance -
Overseas General's net premiums earned for the periods indicated:
Three Months Ended % Change Six Months Ended % Change
June 30 Q-12 vs. June 30 YTD-12 vs.
2012 2011 Q-11 2012 2011 YTD-11
(in millions of U.S. dollars, except for percentages)
Property and all other $ 552 $ 533 4 % $ 1,090 $ 964 13 %
Casualty 338 348 (3 )% 671 690 (3 )%
Personal accident (A&H) 530 534 (1 )% 1,050 1,039 1 %
Net premiums earned $ 1,420 $ 1,415 0 % $ 2,811 $ 2,693 4 %
Three Months Ended Six Months Ended
June 30 June 30
2012 2011 2012 2011
% of % of % of % of
Total Total Total TotalProperty and all other 39 % 38 % 39 % 36 %
Casualty 24 % 24 % 24 % 26 %
Personal accident (A&H) 37 % 38 % 37 % 38 %
Net premiums earned 100 % 100 % 100 % 100 %
The following table shows the impact of catastrophe losses and related
reinstatement premiums and prior period development on our loss and loss expense
ratio for the periods indicated:
Three Months Ended Six Months Ended
June 30 June 30
2012 2011 2012 2011
Loss and loss expense ratio, as reported 49.6 % 51.0 % 50.1 % 58.4 %
Catastrophe losses and related
reinstatement premiums (0.4 )% (0.6 )% (0.2 )% (8.4 )%
Prior period development 2.7 % 2.8 % 2.1 % 3.1 %
Loss and loss expense ratio, adjusted 51.9 % 53.2 % 52.0 % 53.1 %
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Net catastrophe losses, excluding reinstatement premiums, were $5 million and $7
million for the three and six months ended June 30, 2012, compared with $10
million and $197 million in the prior year, respectively. Catastrophe losses
through June 30, 2012 were primarily as a result of flooding in the U.K.
Catastrophe losses through June 30, 2011 included earthquakes in New Zealand and
Japan and Australian storm events. Insurance - Overseas General experienced net
favorable prior period development of $39 million and $61 million for the three
and six months ended June 30, 2012 compared with $40 million and $84 million in
the prior year periods, respectively. Refer to "Prior Period Development" for
additional information. The adjusted loss and loss expense ratio decreased for
the three and six months ended June 30, 2012 due to the reduction in the current
accident year loss ratio across several lines of business in several regions.
Insurance - Overseas General's policy acquisition cost ratio decreased slightly
for the three months ended June 30, 2012. Insurance - Overseas General's policy
acquisition cost ratio remained relatively flat for the six months ended
June 30, 2012.
Insurance - Overseas General's administrative expense ratio decreased for the
three and six months ended June 30, 2012 due to lower regulatory costs for
Combined in the U.K. and Ireland.
Global Reinsurance
The Global Reinsurance segment represents our reinsurance operations comprising
ACE Tempest Re Bermuda, ACE Tempest Re USA, ACE Tempest Re International, and
ACE Tempest Re Canada. Global Reinsurance markets its reinsurance products
worldwide under the ACE Tempest Re brand name and provides a broad range of
coverage to a diverse array of primary P&C companies.
Three Months Ended % Change Six Months Ended % Change
June 30 Q-12 vs. June 30 YTD-12 vs.
2012 2011 Q-11 2012 2011 YTD-11
(in millions of U.S. dollars, except for percentages)
Net premiums written $ 309 $ 282 9 % $ 572 $ 597 (4 )%
Net premiums earned 237 254 (7 )% 467 514 (9 )%
Losses and loss expenses 102 112 (9 )% 204 391 (48 )%
Policy acquisition costs 42 47 (11 )% 85 93 (9 )%
Administrative expenses 13 14 (7 )% 25 26 (4 )%
Underwriting income 80 81 (1 )% 153 4 NM
Net investment income 70 71 (1 )% 141 143 (1 )%
Net realized gains (losses) (17 ) (14 ) 21 % (4 ) (27 ) (85 )%
Interest expense 1 1 0 % 2 1 100 %
Other (income) expense 3 1 200 % (2 ) (5 ) (60 )%
Income tax expense - 8 NM 6 18 (67 )%
Net income $ 129 $ 128 1 % $ 284 $ 106 168 %
Loss and loss expense ratio 42.5 % 44.1 % 43.5 % 76.1 %
Policy acquisition cost ratio 17.8 % 18.5 % 18.3 % 18.1 %
Administrative expense ratio 5.8 % 5.3 % 5.3 % 4.9 %
Combined ratio 66.1 % 67.9 % 67.1 % 99.1 %
Global Reinsurance reported a nine percent increase and a four percent decrease
in net premiums written for the three and six months ended June 30, 2012,
respectively. The increase in the three months ended June 30, 2012 was primarily
due to improving pricing conditions in our property catastrophe business. This
improvement is more than offset in our six months ended June 30, 2012 results
due to lower production in the three months ended March 31, 2012 from
competitive market conditions, adherence to underwriting standards and a
non-recurring loss portfolio transfer treaty written in the prior year.
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The following tables provide a line of business breakdown of Global
Reinsurance's net premiums earned for the periods indicated:
Three Months Ended % Change Six Months Ended % Change
June 30 Q-12 vs. June 30 YTD-12 vs.
2012 2011 Q-11 2012 2011 YTD-11
(in millions of U.S. dollars, except for percentages)
Property and all other $ 42 $ 40 5 % $ 84 $ 85 (1 )%
Casualty 123 139 (12 )% 243 287 (15 )%
Property catastrophe 72 75 (4 )% 140 142 (1 )%
Net premiums earned $ 237 $ 254 (7 )% $ 467 $ 514 (9 )%
2012 2011 2012 2011
% of % of % of % of
Total Total Total Total
Property and all other 18 % 16 % 18 % 17 %
Casualty 52 % 54 % 52 % 56 %
Property catastrophe 30 % 30 % 30 % 27 %
Net premiums earned 100 % 100 % 100 % 100 %
Global Reinsurance reported a decrease in net premiums earned of seven percent
and nine percent for the three and six months ended June 30, 2012, respectively,
primarily due to consecutive annual net decreases in production resulting from
competitive market conditions, particularly in casualty and other long-tail
lines.
The following table shows the impact of catastrophe losses and related
reinstatement premiums and prior period development on our loss and loss expense
ratio for the periods indicated:
Three Months Ended Six Months Ended
June 30 June 30
2012 2011 2012 2011
Loss and loss expense ratio, as
reported 42.5 % 44.1 % 43.5 % 76.1 %
Catastrophe losses and related
reinstatement premiums (0.7 )% (8.0 )% (0.5 )% (33.5 )%
Prior period development 6.5 % 14.0 % 5.5 % 9.6 %
Loss and loss expense ratio, adjusted 48.3 % 50.1 % 48.5 % 52.2 %
Global Reinsurance recorded net catastrophe losses, excluding reinstatement
premiums, of $1 million and $2 million for the three and six months ended
June 30, 2012, compared with net catastrophe losses of $22 million and $174
million in the prior year periods, respectively. The catastrophe losses in the
prior year were primarily related to earthquakes in Japan and New Zealand,
natural catastrophes in Australia and severe weather related events in the U.S.
Global Reinsurance experienced net favorable prior period development of $15
million and $26 million for the three and six months ended June 30, 2012,
respectively. This compares with net favorable prior period development of $35
million and $49 million in the prior year periods, respectively. Refer to "Prior
Period Development" for additional information. The adjusted loss and loss
expense ratio decreased through June 30, 2012 primarily due to an increase in
lower loss ratio property catastrophe business and the period over period impact
of a loss portfolio transfer treaty written in the prior year.
Global Reinsurance's policy acquisition cost ratio decreased for the three
months ended June 30, 2012 and remained relatively flat for the six months ended
June 30, 2012. Results for the three months ended June 30, 2012 reflected net
favorable adjustments on loss sensitive contract provisions.
Global Reinsurance's administrative expense ratio increased for the three and
six months ended June 30, 2012 as a result of the decline in net premiums
earned.
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Life
The Life segment includes our international life operations (ACE Life), ACE
Tempest Life Re (ACE Life Re) and the North American supplemental A&H and life
business of Combined Insurance. We assess the performance of our life business
based on life underwriting income, which includes net investment income and
(gains) losses from fair value changes in separate account assets that do not
qualify for separate account reporting under GAAP.
Three Months Ended % Change Six Months Ended % Change
June 30 Q-12 vs. June 30 YTD-12 vs.
2012 2011 Q-11 2012 2011 YTD-11
(in millions of U.S. dollars, except for percentages)
Net premiums written $486 $ 493 (1 )% $ 974 $ 929 5 %
Net premiums earned 474 484 (2 )% 947 909 4 %
Losses and loss expenses 151 159 (5 )% 299 297 1 %
Policy benefits 102 108 (6 )% 249 199 25 %
(Gains) losses from fair value
changes in separate account
assets(1) 14 - NM (4 ) - NM
Policy acquisition costs 88 85 4 % 164 161 2 %
Administrative expenses 78 78 0 % 156 152 3 %
Net investment income 62 60 3 % 123 106 16 %
Life underwriting income 103 114 (10 )% 206 206 0 %
Net realized gains (losses) (421 ) (68 ) NM (190 ) (81 ) 135 %
Interest expense 3 3 0 % 6 6 0 %
Other (income) expense(1) 5 11 (55 )% 14 17 (18 )%
Income tax expense 19 14 36 % 30 28 7 %
Net income $ (345) $ 18 NM $ (34 ) $ 74 NM
(1) (Gains) losses from fair value changes in separate account assets that do
not qualify for separate account reporting under GAAP are reclassified from
Other (income) expense for purposes of presenting Life underwriting income.
The following table provides a line of business breakdown of Life net premiums
written for the periods indicated:
Three Months Ended % Change Six Months Ended % Change
June 30 Q-12 vs. June 30 YTD-12 vs.
2012 2011 Q-11 2012 2011 YTD-11
(in millions of U.S. dollars, except for percentages)
Life reinsurance $ 76 $ 85 (11 )% $ 161 $ 174 (7 )%
Life insurance 166 159 4 % 326 258 26 %
A&H 244 249 (2 )% 487 497 (2 )%
Life net premiums written $ 486 $ 493 (1 )% $ 974 $ 929 5 %
Life insurance net premiums written increased for the three months ended
June 30, 2012 due to overall growth in the business, primarily driven by our
Asian markets. Net premiums written increased in the six months ended June 30,
2012 primarily due to prior year acquisitions. Life reinsurance net premiums
written decreased for the three and six months ended June 30, 2012 because no
new life reinsurance business is currently being written. A&H net premiums
written decreased for the three and six months ended June 30, 2012 due to the
continuing effects on the economy resulting in lower new business and renewals.
Net realized gains (losses), which are excluded from life underwriting income,
relate primarily to the change in the net fair value of reported GLB reinsurance
liabilities and changes in the fair value of derivatives used to
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partially offset the risk in the variable annuity guarantee portfolio. During
the three months ended June 30, 2012, realized losses were associated with an
increased value of GLB liabilities primarily due to falling equity levels and
interest rates partially offset by an increase in the value of the derivative
instruments, which increase in value when the S&P 500 index decreases. During
the six months ended June 30, 2012, realized losses were associated with an
increased value of GLB liabilities primarily due to falling interest rates and
the unfavorable impact of discounting future claims for two fewer quarters
partially offset by a decreased value of GLB liabilities due to rising equity
levels. In addition, for the six months ended June 30, 2012, we experienced a
decrease in the value of the derivative instruments, which decrease in value
when the S&P 500 index increases.
Other Income and Expense Items
Three Months Ended Six Months Ended
June 30 June 30
2012 2011 2012 2011
(in millions of U.S. dollars)
(Gains) losses from fair value changes in
separate account assets $ 14 $ - $ (4 ) $ -
Amortization of intangible assets 12 7 24 14
Equity in net (income) loss of
partially-owned entities 5 (6 ) (14 ) (36 )
Federal excise and capital taxes 5 4 9 9
Acquisition-related costs 1 - 3 3
Other (3 ) 7 13 9
Other (income) expense $ 34 $ 12 $ 31 $ (1 )
Other (income) expense includes (gains) losses from fair value changes in
separate account assets that do not qualify for separate account reporting under
GAAP. The offsetting movement in the separate account liabilities is included in
Policy benefits in the consolidated statements of operations. Equity in net
(income) loss of partially-owned entities includes our share of net (income)
loss related to investment funds, limited partnerships, partially-owned
investment companies, and partially-owned insurance companies. Certain federal
excise and capital taxes incurred as a result of capital management initiatives
are included in Other (income) expense in the consolidated statements of
operations. As these are considered capital transactions, they are excluded from
underwriting results.
Net Investment Income
Three Months Ended Six Months Ended
June 30 June 30
2012 2011 2012 2011
(in millions of U.S. dollars)
Fixed maturities $ 527 $ 557 $ 1,071 $ 1,091 Short-term investments 9 12 18 24
Equity securities 9 10 17 18
Other 20 14 28 31
Gross investment income 565 593 1,134 1,164
Investment expenses (28 ) (24 ) (53 ) (51 )
Net investment income $ 537 $ 569 $ 1,081 $ 1,113
Net investment income is influenced by a number of factors including the amounts
and timing of inward and outward cash flows, the level of interest rates, and
changes in overall asset allocation. Net investment income decreased six percent
and three percent for the three and six months ended June 30, 2012,
respectively. The decline in net investment income was primarily due to lower
yields on new investments and the negative impact of foreign exchange, partially
offset by positive operating cash flows and a higher overall average invested
asset base.
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The investment portfolio's average market yield on fixed maturities was 2.8
percent and 3.4 percent at June 30, 2012 and 2011, respectively. Average market
yield on fixed maturities represents the weighted average yield to maturity of
our fixed income portfolio based on the market prices of the holdings at that
date.
The yield on short-term investments reflects the global nature of our insurance
operations (1.5 percent-2.0 percent yield). For example, yields on short-term
investments in Malaysia, Korea, and Ecuador range from 2.7 percent-3.9 percent.
The yield on our equity securities portfolio is high relative to the yield on
the S&P 500 Index because we classify our strategic emerging debt portfolio,
which is a mutual fund, as equity (3.7 percent - 4.5 percent yield). The
strategic emerging debt portfolio represents approximately 60 percent of our
equity securities portfolio.
Net Realized and Unrealized Gains (Losses)
We take a long-term view with our investment strategy, and our investment
managers manage our investment portfolio to maximize total return within certain
specific guidelines designed to minimize risk. The majority of our investment
portfolio is available for sale and reported at fair value. Our held to maturity
investment portfolio is reported at amortized cost.
The effect of market movements on our available for sale investment portfolio
impacts net income (through net realized gains (losses)) when securities are
sold or when we record an Other-than-temporary impairment (OTTI) charge in net
income. For a discussion related to how we assess OTTI for all of our
investments, including credit-related OTTI, and the related impact on net
income, refer to Note 3 c) to the consolidated financial statements.
Additionally, net income is impacted through the reporting of changes in the
fair value of derivatives, including financial futures, options, swaps, and GLB
reinsurance. Changes in unrealized appreciation and depreciation on available
for sale securities, which result from the revaluation of securities held, are
reported as a separate component of Accumulated other comprehensive income in
shareholders' equity in the consolidated balance sheets.
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The following tables present our pre-tax net realized and unrealized gains
(losses) as well as a breakdown of our OTTI and other net realized gains
(losses) on investments for the periods indicated:
Three Months Ended Three Months Ended
June 30, 2012 June 30, 2011
Net Net Net Net
Realized Unrealized Realized Unrealized
Gains Gains Net Gains Gains Net
(Losses) (Losses) Impact (Losses) (Losses) Impact
(in millions of U.S. dollars)
Fixed maturities $ 68 $ 251 $ 319 $ 74 $ 202 $ 276
Fixed income derivatives (49 ) - (49 ) (48 ) - (48 )
Total fixed maturities 19 251 270 26 202 228
Public equity (5 ) (9 ) (14 ) 4 6 10
Other (3 ) (3 ) (6 ) (4 ) 3 (1 )
Subtotal 11 239 250 26 211 237
Derivatives
Fair value adjustment on
insurance derivatives (467 ) - (467 ) (70 ) - (70 )
S&P put option and futures 70 - 70 3 - 3
Fair value adjustment on
other derivatives 1 - 1 (2 ) - (2 )
Subtotal derivatives (396 ) - (396 ) (69 ) - (69 )
Foreign exchange losses (9 ) - (9 ) (30 ) - (30 )
Total gains (losses) $ (394 ) $ 239 $ (155 ) $ (73 ) $ 211 $ 138
Six Months Ended Six Months Ended
June 30, 2012 June 30, 2011
Net Net Net Net
Realized Unrealized Realized Unrealized
Gains Gains Net Gains Gains Net
(Losses) (Losses) Impact (Losses) (Losses) Impact
(in millions of U.S. dollars)
Fixed maturities $ 102 $ 494 $ 596 $ 123 $ 163 $ 286
Fixed income derivatives (7 ) - (7 ) (68 ) - (68 )
Total fixed maturities 95 494 589 55 163 218
Public equity (4 ) 29 25 11 8 19
Other (7 ) 1 (6 ) (5 ) 6 1
Subtotal 84 524 608 61 177 238
Derivatives
Fair value adjustment on
insurance derivatives (39 ) - (39 ) 1 - 1
S&P put option and futures (161 ) - (161 ) (68 ) - (68 )
Fair value adjustment on
other derivatives (4 ) - (4 ) (3 ) - (3 )
Subtotal derivatives (204 ) - (204 ) (70 ) - (70 )
Foreign exchange losses (14 ) - (14 ) (109 ) - (109 )
Total gains (losses) $ (134 ) $ 524 $ 390 $ (118 ) $ 177 $ 59
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Three Months Ended Three Months Ended
June 30, 2012 June 30, 2011
Other Other
Net Net Net Net
Realized Realized Realized Realized
Gains Gains Gains Gains
OTTI (Losses) (Losses) OTTI (Losses) (Losses)
(in millions of U.S. dollars)
Fixed maturities $ (1 ) $ 69 $ 68 $ (5 ) $ 79 $ 74
Public equity (4 ) (1 ) (5 ) - 4 4
Other (5 ) 2 (3 ) (3 ) (1 ) (4 )
Total $ (10 ) $ 70 $ 60 $ (8 ) $ 82 $ 74
Six Months Ended Six Months Ended
June 30, 2012 June 30, 2011
Other Other
Net Net Net Net
Realized Realized Realized Realized
Gains Gains Gains Gains
OTTI (Losses) (Losses) OTTI (Losses) (Losses)
(in millions of U.S. dollars)
Fixed maturities $ (8 ) $ 110 $ 102 $ (9 ) $ 132 $ 123
Public equity (5 ) 1 (4 ) - 11 11
Other (7 ) - (7 ) (3 ) (2 ) (5 )
Total $ (20 ) $ 111 $ 91 $ (12 ) $ 141 $ 129
Our net realized gains (losses) for the three and six months ended June 30,
2012, included write-downs of $10 million and $20 million, respectively, as a
result of an other-than-temporary decline in fair value of certain securities.
This compares with write-downs of $8 million and $12 million for the three and
six months ended June 30, 2011, respectively.
At June 30, 2012, our investment portfolios held by U.S. legal entities included
approximately $75 million of gross unrealized losses on fixed income
investments. Our tax planning strategy related to these losses is based on our
view that we will hold these fixed income investments until they recover their
cost. As such, we have recognized a deferred tax asset of approximately $26
million related to these fixed income investments. This strategy allows us to
recognize the associated deferred tax asset related to these fixed income
investments as we do not believe these losses will ever be realized.
We engage in a securities lending program which involves lending investments to
other institutions for short periods of time. ACE invests the collateral
received in securities of high credit quality and liquidity, with the objective
of maintaining a stable principal balance. Certain investments purchased with
the securities lending collateral declined in value resulting in an unrealized
loss of $6 million at June 30, 2012. The unrealized loss is attributable to
fluctuations in market values of the underlying performing debt instruments held
by the respective mutual funds, rather than default of a debt issuer. It is our
view that the decline in value is temporary.
Investments
Our investment portfolio is invested primarily in publicly traded, investment
grade fixed income securities with an average credit quality of A/Aa as rated by
the independent investment rating services Standard and Poor's (S&P)/ Moody's
Investors Service (Moody's). The portfolio is externally managed by independent,
professional investment managers and is broadly diversified across geographies,
sectors, and issuers. Other investments principally comprise direct investments,
investment funds, and limited partnerships. We hold no collateralized debt
obligations or collateralized loan obligations in our investment portfolio and
we provide no credit default protection. We have long-standing global credit
limits for our entire portfolio across the organization. Exposures
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are aggregated, monitored, and actively managed by our Global Credit Committee,
comprising senior executives, including our Chief Financial Officer, our Chief
Risk Officer, our Chief Investment Officer, and our Treasurer. We also have
well-established, strict contractual investment rules requiring managers to
maintain highly diversified exposures to individual issuers and closely monitor
investment manager compliance with portfolio guidelines.
The average duration of our fixed income securities, including the effect of
options and swaps, was 3.8 years at June 30, 2012 and 3.7 years at December 31,
2011. We estimate that a 100 basis point (bps) increase in interest rates would
reduce our book value by approximately $2.1 billion at June 30, 2012.
The following table shows the fair value and cost/amortized cost of our invested
assets:
June 30, 2012 December 31, 2011
Cost/ Cost/
Fair Amortized Fair Amortized
Value Cost Value Cost
(in millions of U.S. dollars)
Fixed maturities available for sale $ 44,386$ 42,316$ 41,967$ 40,450
Fixed maturities held to maturity 8,062 7,782 8,605 8,447
Short-term investments 2,260 2,260 2,301 2,301
54,708 52,358 52,873 51,198
Equity securities 729 724 647 671
Other investments 2,524 2,297 2,314 2,112
Total investments $ 57,961 $ 55,379 $ 55,834 $ 53,981
The fair value of our total investments increased $2.1 billion during the six
months ended June 30, 2012, primarily due to the investing of operating cash
flows and unrealized appreciation.
The following tables show the market value of our fixed maturities and
short-term investments at June 30, 2012 and December 31, 2011. The first table
lists investments according to type and the second according to S&P credit
rating:
June 30, 2012 December 31, 2011
Market Percentage Market Percentage
Value of Total Value of Total
(in millions of U.S. dollars, except for percentages)
Treasury $ 2,614 5 % $ 2,361 5 %
Agency 1,816 3 % 1,725 3 %
Corporate and asset-backed securities 17,581 32 % 17,030 32 %
Mortgage-backed securities 12,725 23 % 13,237 25 %
Municipal 3,495 7 % 2,888 6 %
Non-U.S. 14,217 26 % 13,331 25 %
Short-term investments 2,260 4 % 2,301 4 %
Total $ 54,708 100 % $ 52,873 100 %
AAA $ 9,132 17 % $ 9,284 18 %
AA 20,931 38 % 20,562 39 %
A 10,400 19 % 10,106 19 %
BBB 6,243 11 % 6,152 12 %
BB 4,298 8 % 3,755 7 %
B 3,217 6 % 2,428 4 %
Other 487 1 % 586 1 %
Total $ 54,708 100 % $ 52,873 100 %
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As part of our overall investment strategy, we may invest in states,
municipalities, and other political subdivisions fixed maturity securities
(Municipal). We apply the same investment selection process described previously
to our Municipal investments. The portfolio is highly diversified primarily in
state general obligation bonds and essential service revenue bonds including
education and utilities (water, power, and sewers). As of June 30, 2012, one
state, including political subdivisions and other municipal issuers within the
state, represented approximately 17 percent of our Municipal investments. A
majority of the single state exposure represents special revenue bonds. Over 68
percent of our Municipal investments carry an S&P rating of AA- or better and
none carry fair values that reflect a significantly different risk compared to
those ratings. These Municipal investments are split 42 percent and 58 percent
between general obligation and special revenue bonds, respectively.
Our exposure to the Euro results primarily from ACE European Group which is
headquartered in London and offers a broad range of coverages throughout the
European Union, Central, and Eastern Europe. ACE primarily invests in Euro
denominated investments to support its local currency insurance obligations and
required capital levels. ACE's local currency investment portfolios have strict
contractual investment guidelines requiring managers to maintain a high quality
and diversified portfolio to both sector and individual issuers. Investment
portfolios are monitored daily to ensure investment manager compliance with
portfolio guidelines.
Our non-U.S. investment grade fixed income portfolios are currency-matched with
the insurance liabilities of our non-U.S. operations. We have 78 percent of our
non-U.S. fixed income portfolio denominated in G7 currencies. The average credit
quality of our non-U.S. fixed income securities is A and 54 percent of our
holdings are rated AAA or guaranteed by governments or quasi-government
agencies. Within the context of these investment portfolios, our government and
corporate bond holdings are highly diversified across industries and
geographies. Issuer limits are based on credit rating (AA-two percent, A-one
percent, BBB-0.5 percent of the total portfolio) and are monitored on a daily
basis by us via an internal compliance system. Because of this investment
approach we do not have a direct exposure to troubled sovereign borrowers in
Europe. We manage our indirect exposure using the same credit rating based
investment approach. Accordingly, we do not believe our indirect exposure is
material.
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The table below summarizes the market value and amortized cost of our non-U.S.
fixed income portfolio by country/sovereign for non-U.S. government securities
at June 30, 2012:
Market Value Amortized Cost
(in millions of U.S. dollars)
United Kingdom $ 1,191 $ 1,152
Canada 939 906
Republic of Korea 488 456
Germany 409 401
Japan 378 376
Province of Ontario 230 219
Federative Republic of Brazil 201 196
Kingdom of Thailand 160 156
Province of Quebec 157 146
Commonwealth of Australia 150 134
France 134 130
State of Queensland 132 123
Swiss Confederation 128 121
People's Republic of China 120 117
Federation of Malaysia 117 116
United Mexican States 105 98
State of New South Wales 77 72
Taiwan 76 75
State of Victoria 60 56
Socialist Republic of Vietnam 54 50
Republic of Indonesia 50 49
Russian Federation 47 47
Republic of Colombia 40 39
Republic of Austria 40 39
Dominion of New Zealand 39 38
Other Non-U.S. Government(1) 734 707
Non-U.S. Government Securities 6,256 6,019
Eurozone Non-U.S. Corporate (excluding
United Kingdom)(2) 2,369 2,304
Other Non-U.S. Corporate 5,592 5,344
Total $14,217 $ 13,667
(1) Includes investments in Spain and Italy of $0.4 million. There are no
investments in Portugal, Ireland, or Greece. Our gross and net Eurozone
Non-U.S. Government Securities exposure is the same.
(2) Refer to the following table for further detail on Eurozone Non-U.S.
Corporate Securities. Our gross and net Eurozone Non-U.S. Corporate
Securities exposure is the same.
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The table below summarizes the market value and amortized cost of our Eurozone
fixed income portfolio (excluding United Kingdom) by industry at June 30, 2012:
Market Value by Industry
Bank Financial Industrial Utility Total Amortized Cost
(in millions of U.S. dollars)
Netherlands $ 225 $ 133 $ 320 $ 124 $ 802 $ 770
France 98 37 115 146 396 392
Germany 284 2 76 7 369 356
Luxembourg 11 2 243 95 351 347
Euro Supranational 197 - - - 197 189
Ireland 12 1 87 17 117 110
Spain 10 4 18 5 37 42
Italy 25 - 6 3 34 32
Austria 20 - 7 1 28 27
Finland 13 1 8 2 24 26
Belgium - - 12 1 13 12
Portugal - - 1 - 1 1
Eurozone Non-U.S. Corporate
Securities $ 895 $ 180 $ 893 $ 401 $ 2,369 $ 2,304
The table below summarizes the market value and amortized cost of the top 10
Eurozone bank exposures within our Eurozone fixed income portfolio (excluding
United Kingdom) at June 30, 2012:
Market Value Amortized Cost
(in millions of U.S. dollars)
European Investment Bank $ 166 $ 160
KFW 156 150
Rabobank Nederland NV 109 104
Deutsche Bank AG 46 45
Bank Nederlandse Gemeenten 41 40
ABN AMRO Group NV 32 30
Nederlandse Waterschapsbank NV 28 27
Credit Agricole Groupe 27 27
BNP Paribas SA 25 24
Erste Abwicklungsanstalt 23 23
The table below summarizes the market value and amortized cost of the top 10
Eurozone corporate exposures within our Eurozone fixed income portfolio
(excluding United Kingdom) at June 30, 2012:
Market Value Amortized Cost
(in millions of U.S. dollars)
EDF SA $ 79 $ 79
ING Groep NV 77 78
Intelsat SA 73 71
Deutsche Telekom AG 69 63
Royal Dutch Shell PLC 64 59
LyondellBasell Industries NV 55 51
France Telecom SA 41 39
Gazprom OAO 40 38
General Electric Co 38 35
Liberty Global Inc 38 35
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The table below summarizes our largest exposures to corporate bonds by market
value at June 30, 2012:
Market Value
(in millions of U.S. dollars)
General Electric Co $ 430
JP Morgan Chase & Co 426
Citigroup Inc 350
Bank of America Corp 314
The Goldman Sachs Group Inc 307
Verizon Communications Inc 278
Morgan Stanley 267
AT&T INC 223
Wells Fargo & Co 203
HSBC Holdings Plc 197
Comcast Corp 164
Kraft Foods Inc 164
Lloyds Banking Group Plc 162
Royal Bank of Scotland Group Plc 156
Time Warner Cable Inc 138
Barclays Plc 136
ConocoPhillips 127
BP Plc 123
Pfizer Inc 121
UBS AG 121
American Express Co 120
Credit Suisse Group 116
Anheuser-Busch InBev NV 111
Rabobank Nederland NV 109
Enterprise Products Partners LP 105
Mortgage-backed securities
Additional details on the mortgage-backed component of our investment portfolio
at June 30, 2012, are provided below:
Mortgage-backed securities
Market Value
(in millions of U.S. dollars)
S&P Credit Rating
BB
and
AAA AA A BBB below Total
Mortgage-backed securities
Agency residential mortgage-backed (RMBS) $ - $ 10,942 $ - $ - $ - $ 10,942
Non-agency RMBS 145 6 24 10 399 584
Commercial mortgage-backed 1,164 18 10 7 - 1,199
Total mortgage-backed securities $ 1,309 $ 10,966 $ 34 $ 17 $ 399 $ 12,725
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Mortgage-backed securities
Amortized Cost
(in millions of U.S. dollars)
S&P Credit Rating
BB
and
AAA AA A BBB below Total
Mortgage-backed securities
Agency RMBS $ - $ 10,480 $ - $ - $ - $ 10,480
Non-agency RMBS 145 6 24 11 476 662
Commercial mortgage-backed 1,090 16 9 6 - 1,121
Total mortgage-backed securities $ 1,235 $ 10,502 $ 33 $ 17 $ 476 $ 12,263
Our mortgage-backed securities are rated predominantly AA and comprise
approximately 23 percent of our fixed income portfolio. This compares with a 32
percent mortgage-backed weighting in representative indices of the U.S. fixed
income market at June 30, 2012. The minimum rating for our initial purchases of
mortgage-backed securities is AA for agency mortgages and AAA for non-agency
mortgages.
Agency RMBS represent securities which have been issued by Federal agencies
(Government National Mortgage Association, Federal National Mortgage
Association, and Federal Home Loan Mortgage Corporation) with implied or
explicit government guarantees. These represent 95 percent of our total RMBS
portfolio. Our non-agency RMBS are backed primarily by prime collateral and are
broadly diversified in over 47,000 loans. This portfolio's original
loan-to-value ratio is approximately 67 percent with an average Fair Isaac
Corporation (FICO) score of 730. With this conservative loan-to-value ratio and
subordinated collateral of five percent, the cumulative 5-year foreclosure rate
would have to rise to 15 percent from current levels before principal is
significantly impaired. The foreclosure rate of our non-agency RMBS portfolio at
June 30, 2012 was eight percent.
Our commercial mortgage-backed securities (CMBS) are rated predominantly AAA,
broadly diversified with over 13,000 loans with 47 percent of the portfolio
issued before 2006 and 38 percent issued after 2009. The average loan-to-value
ratio is approximately 64 percent with a debt service coverage ratio in excess
of 1.9 and weighted-average subordinated collateral of 30 percent. The
cumulative foreclosure rate would have to rise to 42 percent before principal is
impaired. The foreclosure rate for our CMBS portfolio at June 30, 2012 was
approximately 2.3 percent.
Below-investment grade corporate fixed income portfolio
Below-investment grade securities have different characteristics than investment
grade corporate debt securities. Risk of loss from default by the borrower is
greater with below-investment grade securities. Below-investment grade
securities are generally unsecured and are often subordinated to other creditors
of the issuer. Also, issuers of below-investment grade securities usually have
higher levels of debt and are more sensitive to adverse economic conditions,
such as recession or increasing interest rates, than are investment grade
issuers. At June 30, 2012, our corporate fixed income investment portfolio
included below-investment grade and non-rated securities which, in total,
comprised approximately 13 percent of our fixed income portfolio. Our
below-investment grade and non-rated portfolio includes over 990 issuers, with
the greatest single exposure being $95 million.
We manage high-yield bonds as a distinct and separate asset class from
investment grade bonds. The allocation to high yield bonds is explicitly set by
internal management and is targeted to securities in the upper tier of credit
quality (BB/B). Our minimum rating for initial purchase is BB/B. Six external
investment managers are responsible for high yield security selection and
portfolio construction. Our high yield managers have a conservative approach to
credit selection and very low historical default experience. Holdings are highly
diversified across industries and subject to a 1.5 percent issuer limit as a
percentage of high yield allocation. We monitor position limits daily through an
internal compliance system. Derivative and structured securities (e.g., credit
default swaps and collateralized loan obligations) are not permitted in the
high-yield portfolio.
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Critical Accounting Estimates
As of June 30, 2012, with the exception noted below, there were no material
changes to our critical accounting estimates. Refer to Note 1 to the
consolidated financial statements for additional information. For full
discussion of our critical accounting estimates, refer to Item 7 in our 2011
Form 10-K.
Effective January 1, 2012, we retrospectively adopted new accounting guidance
for costs associated with acquiring or renewing insurance contracts. Under the
new guidance, the definition of acquisition costs was modified to specify that a
cost must be directly related to the successful acquisition of a new or renewal
insurance contract in order to be deferred. Prior year amounts and ratios have
been adjusted to reflect the impact of retrospective adjustments as a result of
applying this new accounting guidance.
Reinsurance recoverable on ceded reinsurance
The following table shows a composition of our reinsurance recoverable for the
periods indicated:
June 30 December 31
2012 2011
(in millions of U.S. dollars)
Reinsurance recoverable on unpaid losses and
loss expenses, net of a provision for
uncollectible reinsurance $ 10,986 $ 11,602
Reinsurance recoverable on paid losses and loss
expenses, net of a provision for uncollectible
reinsurance 766 787
Net reinsurance recoverable on losses and loss
expenses $ 11,752 $
12,389
Reinsurance recoverable on policy benefits $ 257 $ 249
We evaluate the financial condition of our reinsurers and potential reinsurers
on a regular basis and also monitor concentrations of credit risk with
reinsurers. The provision for uncollectible reinsurance is required principally
due to the potential failure of reinsurers to indemnify us, primarily because of
disputes under reinsurance contracts and insolvencies. The provision for
uncollectible reinsurance is based on a default analysis applied to gross
reinsurance recoverables, net of approximately $2.8 billion of collateral at
June 30, 2012 and December 31, 2011. The decrease in net reinsurance recoverable
on losses and loss expenses was primarily due to collections relating to prior
period catastrophe events and run-off operations.
Unpaid losses and loss expenses
As an insurance and reinsurance company, we are required by applicable laws and
regulations and GAAP to establish loss and loss expense reserves for the
estimated unpaid portion of the ultimate liability for losses and loss expenses
under the terms of our policies and agreements with our insured and reinsured
customers. The estimate of the liabilities includes provisions for claims that
have been reported but are unpaid at the balance sheet date (case reserves) and
for obligations on claims that have been incurred but not reported (IBNR) at the
balance sheet date. IBNR may also include provisions to account for the
possibility that reported claims may settle for amounts that differ from the
established reserves. Loss reserves also include an estimate of expenses
associated with processing and settling unpaid claims (loss expenses). At
June 30, 2012, our gross unpaid loss and loss expense reserves were $36.9
billion and our net unpaid loss and loss expense reserves were $25.9 billion.
With the exception of certain structured settlements, for which the timing and
amount of future claim payments are reliably determinable, and certain reserves
for unsettled claims that are discounted in statutory filings, our loss reserves
are not discounted for the time value of money.
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The table below presents a roll-forward of our unpaid losses and loss expenses:
Gross Reinsurance Net
Losses Recoverable(1) Losses
(in millions of U.S. dollars)
Balance at December 31, 2011 $ 37,477 $ 11,602 $ 25,875
Losses and loss expenses incurred 5,212 1,289 3,923
Losses and loss expenses paid (5,792 ) (1,824 ) (3,968 )
Other (including foreign exchange translation) (47 ) (81 ) 34
Balance at June 30, 2012 $ 36,850 $ 10,986 $ 25,864
(1) Net of provision for uncollectible reinsurance
The process of establishing loss reserves for property and casualty claims can
be complex and is subject to considerable uncertainty as it requires the use of
informed estimates and judgments based on circumstances known at the date of
accrual.
The following table shows our total reserves (including loss expense reserves)
segregated between case reserves and IBNR reserves:
June 30, 2012 December 31, 2011
Gross Ceded Net Gross Ceded Net
(in millions of U.S. dollars)
Case reserves $ 16,590 $ 5,340 $ 11,250 $ 17,143 $ 5,681 $ 11,462
IBNR reserves 20,260 5,646 14,614 20,334 5,921 14,413
Total $ 36,850 $ 10,986 $ 25,864 $ 37,477 $ 11,602 $ 25,875
Asbestos and Environmental (A&E) and Other Run-off Liabilities
There was no unexpected A&E reserve activity during the six months ended
June 30, 2012. Refer to our 2011 Form 10-K for additional information.
Fair value measurements
The accounting guidance on fair value measurements defines fair value as the
price to sell an asset or transfer a liability in an orderly transaction between
market participants and establishes a three-level valuation hierarchy in which
inputs into valuation techniques used to measure fair value are classified.
The fair value hierarchy gives the highest priority to quoted prices in active
markets (Level 1 inputs) and the lowest priority to unobservable data (Level 3
inputs). Inputs in Level 1 are unadjusted quoted prices for identical assets or
liabilities in active markets. Level 2 includes inputs other than quoted prices
included within Level 1 that are observable for assets or liabilities either
directly or indirectly. Level 2 inputs include, among other items, quoted prices
for similar assets and liabilities in active markets, quoted prices for
identical or similar assets and liabilities in markets that are not active, and
inputs other than quoted prices that are observable for the asset or liability
such as interest rates and yield curves. Level 3 inputs are unobservable and
reflect our judgments about assumptions that market participants would use in
pricing an asset or liability.
We categorize financial instruments within the valuation hierarchy at the
balance sheet date based upon the lowest level of inputs that are significant to
the fair value measurement. Accordingly, transfers between levels within the
valuation hierarchy occur when there are significant changes to the inputs, such
as increases or decreases in market activity, changes to the availability of
current prices, changes to the transparency to underlying inputs, and whether
there are significant variances in quoted prices. Transfers in and/or out of any
level are assumed to occur at the end of the period.
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While we obtain values for the majority of the investment securities we hold
from one or more pricing services, it is ultimately management's responsibility
to determine whether the values obtained and recorded in the financial
statements are representative of fair value. We periodically update our
understanding of the methodologies used by our pricing services in order to
validate that the prices obtained from those services are consistent with the
GAAP definition of fair value as an exit price. Based on our understanding of
the methodologies, our pricing services only produce an estimate of fair value
if there is observable market information that would allow them to make a fair
value estimate. Based on our understanding of the market inputs used by our
pricing services, all applicable investments have been valued in accordance with
GAAP valuation principles. We have controls to review significant price changes
and stale pricing, and to ensure that prices received from pricing services have
been accurately reflected in the consolidated financial statements. We do not
typically adjust prices obtained from pricing services.
Additionally, the valuation of fixed maturity investments is more subjective
when markets are less liquid due to the lack of market based inputs (i.e., stale
pricing), which may increase the potential that the estimated fair value of an
investment is not reflective of the price at which an actual transaction would
occur. For a small number of fixed maturities, we obtain a quote from a broker
(typically a market maker). Due to the disclaimers on the quotes that indicate
that the price is indicative only, we include these fair value estimates in
Level 3.
At June 30, 2012, Level 3 assets represented four percent of assets that are
measured at fair value and two percent of total assets. Level 3 liabilities
represented 100 percent of liabilities that are measured at fair value and two
percent of our total liabilities. During the three and six months ended June 30,
2012, we transferred $47 million and $42 million, respectively, into our Level 3
assets. During the three and six months ended June 30, 2012, we transferred $5
million and $25 million, respectively, out of our Level 3 assets. Refer to Note
4 to the consolidated financial statements for a description of the valuation
techniques and inputs used to determine fair values for our financial
instruments measured or disclosed at fair value by valuation hierarchy (Levels
1, 2, and 3) as well as a roll-forward of Level 3 financial instruments measured
at fair value for the three and six months ended June 30, 2012 and 2011.
Guaranteed living benefits (GLB) derivatives
Under life reinsurance programs covering living benefit guarantees, we assumed
the risk of GLBs associated with variable annuity (VA) contracts. We ceased
writing this business in 2007. Our GLB reinsurance product meets the definition
of a derivative for accounting purposes and is therefore carried at fair value.
We believe that the most meaningful presentation of these derivatives is to
reflect cash inflows or revenue as net premiums earned, and to record estimates
of the average modeled value of future cash outflows as incurred losses.
Accordingly, we recognize benefit reserves consistent with the accounting
guidance related to accounting and reporting by insurance enterprises for
certain non-traditional long-duration contracts and for separate accounts.
Changes in the benefit reserves are reflected as Policy benefits expense, which
is included in life underwriting income. The incremental difference between fair
value and benefit reserves is reflected in Accounts payable, accrued expenses,
and other liabilities in the consolidated balance sheet and related changes in
fair value are reflected in Net realized gains (losses) in the consolidated
statement of operations. We intend to hold these derivative contracts to
maturity (i.e., the expiration of the underlying liabilities through lapse,
annuitization, death, or expiration of the reinsurance contract). At maturity,
the cumulative gains and losses will net to zero (excluding cumulative hedge
gains or losses) because, over time, the insurance liability will be increased
or decreased to equal our obligation. For a sensitivity discussion of the effect
of changes in interest rates, equity indices, and other assumptions on the fair
value of GLBs, and the resulting impact on our net income, refer to Item 3.
Refer to our 2011 Form 10-K for additional information.
The fair value of GLB reinsurance is estimated using an internal valuation
model, which includes current market information and estimates of policyholder
behavior from the perspective of a theoretical market participant that would
assume these liabilities. All of our treaties contain claim limits, which are
factored into the valuation model. The fair value depends on a number of
factors, including interest rates, current account value, market volatility,
expected annuitization rates and other policyholder behavior, and changes in
policyholder
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mortality. The model and related assumptions are continuously re-evaluated by
management and enhanced, as appropriate, based upon additional experience
obtained related to policyholder behavior and availability of more timely market
information, such as market conditions and demographics of in-force annuities.
Due to the inherent uncertainties of the assumptions used in the valuation
models to determine the fair value of these derivative products, actual
experience may differ from the estimates reflected in our Consolidated Financial
Statements, and the differences may be material.
The most significant policyholder behavior assumptions include lapse rates and
the guaranteed minimum income benefit (GMIB) annuitization rates. Assumptions
regarding lapse rates and GMIB annuitization rates differ by treaty but the
underlying methodologies to determine rates applied to each treaty are
comparable. The assumptions regarding lapse and GMIB annuitization rates
determined for each treaty are based on a dynamic calculation that uses several
underlying factors.
A lapse rate is the percentage of in-force policies surrendered in a given
calendar year. All else equal, as lapse rates increase, ultimate claim payments
will decrease. Key factors affecting the lapse rate assumption include
investment performance and policy duration. In general, the base lapse function
assumes low lapse rates (ranging from about 1 percent to 6 percent per annum)
during the surrender charge period of the variable annuity contract, followed by
a "spike" lapse rate (ranging from about 10 percent to 30 percent per annum) in
the year immediately following the surrender charge period, and then reverting
to an ultimate lapse rate (generally around 10 percent per annum), typically
over a 2-year period. This base rate is adjusted downward for policies with more
valuable (more "in the money") guarantees by multiplying the base lapse rate by
a factor ranging from 15 percent to 75 percent. Additional lapses due to partial
withdrawals and older policyholders with tax-qualified contracts (due to
required minimum distributions) are also included.
The GMIB annuitization rate is the percentage of policies for which the
policyholder will elect to annuitize using the guaranteed benefit provided under
the GMIB. All else equal, as GMIB annuitization rates increase, ultimate claim
payments will increase, subject to treaty claim limits. Key factors affecting
the GMIB annuitization rate include investment performance and the level of
interest rates after the GMIB waiting period, since these factors determine the
value of the guarantee to the policyholder. In general, we assume that GMIB
annuitization rates will be higher for policies with more valuable (more "in the
money") guarantees. In addition, we also assume that GMIB annuitization rates
are higher in the first year immediately following the waiting period (the first
year the policies are eligible to annuitize utilizing the GMIB) in comparison to
all subsequent years. We do not yet have a robust set of annuitization
experience because most of our clients' policyholders are not yet eligible to
annuitize utilizing the GMIB. However, for certain clients representing
approximately 36 percent of the total GMIB guaranteed value there are several
years of annuitization experience - for those clients the annuitization function
reflects the actual experience and has a maximum annuitization rate per annum of
8 percent (a higher maximum applies in the first year a policy is eligible to
annuitize utilizing the GMIB - it is over 13 percent). For most clients there is
not a credible amount of observable relevant behavior data and so we use a
weighted average (with a heavier weighting on the observed experience noted
previously) of three different annuitization functions with maximum
annuitization rates per annum of 8 percent, 12 percent, and 30 percent,
respectively (with significantly higher rates in the first year a policy is
eligible to annuitize utilizing the GMIB). As noted elsewhere, our GMIB
reinsurance treaties include claim limits to protect us in the event that actual
annuitization behavior is significantly higher than expected.
During the six months ended June 30, 2012, no material changes were made to
actuarial or behavior assumptions.
During the three months ended June 30, 2012, realized losses of $491 million
were associated with an increased value of GLB liabilities primarily due to
falling equity levels and interest rates. During the six months ended June 30,
2012, realized losses of $35 million were associated with an increased value of
GLB liabilities primarily due to falling interest rates and the unfavorable
impact of discounting future claims for two fewer quarters. This excludes
realized gains of $70 million and realized losses of $161 million during the
three and six months ended June 30, 2012 on derivative hedge instruments held to
partially offset the risk in the VA guarantee reinsurance
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portfolio. These derivatives do not receive hedge accounting treatment. Refer to
the "Net Realized and Unrealized Gains (Losses)" section for a breakdown of the
realized gains (losses) on GLB reinsurance and derivatives for the three and six
months ended June 30, 2012 and 2011.
ACE Tempest Life Re employs a strategy to manage the financial market and
policyholder behavior risks embedded in the reinsurance of VA guarantees. Risk
management begins with underwriting a prospective client and guarantee design,
with particular focus on protecting our position from policyholder options that,
because of anti-selective behavior, could adversely impact our obligation.
A second layer of risk management is the structure of the reinsurance contracts.
All VA guarantee reinsurance contracts include some form of annual or aggregate
claim limit(s). The different categories of claim limits are described below:
• Reinsurance programs covering guaranteed minimum death benefits (GMDB)
with an annual claim limit of 2 percent of account value. This category
accounts for approximately 65 percent of the total reinsured GMDB
guaranteed value. Approximately one percent of the guaranteed value in
this category has additional reinsurance coverage for GLB.
• Reinsurance programs covering GMDB with claim limit(s) that are a function
of the underlying guaranteed value. This category accounts for
approximately 22 percent of the total reinsured GMDB guaranteed value. The
annual claim limit expressed as a percentage of guaranteed value ranges
from 0.4 percent to 2 percent. Approximately 71 percent of guaranteed
value in this category is also subject to annual claim deductibles that
range from 0.1 percent to 0.2 percent of guaranteed value (i.e., our
reinsurance coverage would only pay total annual claims in excess of 0.1 percent to 0.2 percent of the total guaranteed value). Approximately 49
percent of guaranteed value in this category is also subject to an
aggregate claim limit which was approximately $380 million as of June 30,
2012. Approximately 75 percent of guaranteed value in this category has
additional reinsurance coverage for GLB.
• Reinsurance programs covering GMDB and guaranteed minimum accumulation
benefits (GMAB). This category accounts for approximately 18 percent of
the total reinsured GLB guaranteed value and 13 percent of the total
reinsured GMDB guaranteed value. These reinsurance programs are
quota-share agreements with the quota-share decreasing as the ratio of
account value to guaranteed value decreases. The quota-share is 100
percent for ratios between 100 percent and 75 percent, 60 percent for
additional losses on ratios between 75 percent and 45 percent, and 30 percent for further losses on ratios below 45 percent. Approximately 34
percent of guaranteed value in this category is also subject to a claim
deductible of 8.8 percent of guaranteed value (i.e., our reinsurance
coverage would only pay when the ratio of account value to guaranteed
value is below 91.2 percent).
• Reinsurance programs covering GMIB with an annual claim limit. This category accounts for approximately 49 percent of the total reinsured GLB
guaranteed value. The annual claim limit is 10 percent of guaranteed value
on over 98 percent of the guaranteed value in this category. Additionally,
reinsurance programs in this category have an annual annuitization limit
that ranges between 17.5 percent and 30 percent with approximately 42
percent of guaranteed value subject to an annuitization limit of 20 percent or under, and the remaining 58 percent subject to an annuitization
limit of 30 percent. Approximately 39 percent of guaranteed value in this
category is also subject to minimum annuity conversion factors that limit
the exposure to low interest rates. Approximately 42 percent of guaranteed
value in this category has additional reinsurance coverage for GMDB.
• Reinsurance programs covering GMIB with aggregate claim limit. This category accounts for approximately 33 percent of the total reinsured GLB
guaranteed value. The aggregate claim limit for reinsurance programs in
this category is approximately $1.9 billion. Additionally, reinsurance
programs in this category have an annual annuitization limit of 20 percent
and approximately 56 percent of guaranteed value in this category is also
subject to minimum annuity conversion factors that limit the exposure to
low interest rates. Approximately 44 percent of guaranteed value in this
category has additional reinsurance coverage for GMDB.
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A third layer of risk management is the hedging strategy which is focused on
mitigating long-term economic losses at a portfolio level. ACE Tempest Life Re
owned financial market instruments as part of the hedging strategy with a fair
value of ($44) million and $38 million at June 30, 2012 and December 31, 2011,
respectively. The instruments are substantially collateralized by our
counterparties, on a daily basis.
We also limit the aggregate amount of variable annuity reinsurance guarantee
risk we are willing to assume. The last substantive U.S. transaction was quoted
in mid-2007 and the last transaction in Japan was quoted in late 2007. The
aggregate number of policyholders is currently decreasing through policyholder
withdrawals and deaths at a rate of 5 percent -10 percent annually.
Note that GLB claims cannot occur for any reinsured policy until it has reached
the end of its "waiting period". The vast majority of policies we reinsure reach
the end of their "waiting periods" in 2013 or later, as shown in the table
below.
Percent of living benefit
Year of first payment eligibility account values
June 30, 2012 and prior 2 %
Remainder of 2012 6 %
2013 23 %
2014 18 %
2015 5 %
2016 5 %
2017 19 %
2018 16 %
2019 and after 6 %
Total 100 %
The following table provides the historical cash flows under these policies for
the periods indicated. The amounts represent accrued past premium received and
claims paid, split by benefit type.
Three Months Ended Six Months Ended
June 30 June 30
2012 2011 2012 2011
(in millions of U.S. dollars)
Death Benefits (GMDB)
Premium $ 21 $ 25 $ 43 $ 51
Less paid claims 26 23 52 49
Net $ (5 ) $ 2 $ (9 ) $ 2
Living Benefits (Includes GMIB and GMAB)
Premium $ 40 $ 41 $ 80 $ 82
Less paid claims 1 1 2 2
Net $ 39 $ 40 $ 78 $ 80
Total VA Guaranteed Benefits
Premium $ 61 $ 66 $ 123 $ 133
Less paid claims 27 24 54 51
Net $ 34 $ 42 $ 69 $ 82
Death Benefits (GMDB)
For premiums and claims from VA contracts reinsuring GMDBs, at current market
levels, we expect approximately $117 million of claims and $78 million of
premium on death benefits over the next 12 months.
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GLB (includes GMIB and GMAB)
Our GLBs predominantly include premiums and claims from VA contracts reinsuring
GMIB and GMAB. Substantially all of our living benefit reinsurance clients'
policyholders are currently ineligible to trigger a claim payment. The vast
majority of these policyholders become eligible in years 2013 and beyond. At
current market levels, we expect approximately $1 million of claims and $153
million of premium on living benefits over the next 12 months.
Collateral
In order for its U.S.-domiciled clients to obtain statutory reserve credit, ACE
Tempest Life Re holds collateral on behalf of its clients in the form of
qualified assets in trust or letters of credit, in an amount sufficient for them
to obtain statutory reserve credit. The timing of the calculation and amount of
the collateral varies by client according to the particulars of the reinsurance
treaty and the statutory reserve guidelines of the client's state of domicile.
Catastrophe management
We actively monitor our catastrophe risk accumulation around the world. The
following modeled loss information reflects our in-force portfolio and
reinsurance program at April 1, 2012.
The table below shows our modeled annual aggregate pre-tax probable maximum loss
(PML), net of reinsurance, for 100-year and 250-year return periods for U.S.
hurricanes and California earthquakes at June 30, 2012 and 2011. The table also
shows ACE's corresponding share of pre-tax industry losses for each of the
return periods for U.S. hurricanes and California earthquakes at June 30, 2012.
For example, according to the model, for the 1-in-100 return period scenario,
there is a one percent chance that our losses incurred in any year from U.S.
hurricanes could be in excess of $1.6 billion (or six percent of our total
shareholders' equity at June 30, 2012). We estimate that at such hypothetical
loss levels, ACE's share of aggregate industry losses would be approximately 1.0
percent.
U.S. Hurricanes California Earthquakes
June 30, June 30, June 30, June 30,
2012 2011 2012 2011
% of Total % of Total
Modeled Annual Aggregate Net Shareholders' % of Shareholders' % of
PML ACE Equity Industry ACE ACE Equity Industry ACE
(in millions of U.S. dollars, except for percentages)
1-in-100 $ 1,648 6 % 1.0 % $ 1,254 $ 778 3 % 1.9 % $ 803
1-in-250 $ 2,201 9 % 0.9 % $ 1,722 $ 995 4 % 1.6 % $ 948
The modeling estimates of both ACE and industry loss levels are inherently
uncertain owing to key assumptions. First, while the use of third-party
catastrophe modeling packages to simulate potential hurricane and earthquake
losses is prevalent within the insurance industry, the models are reliant upon
significant meteorology, seismology, and engineering assumptions to estimate
hurricane and earthquake losses. In particular, modeled hurricane and earthquake
events are not always a representation of actual events and ensuing additional
loss potential. Second, there is no universal standard in the preparation of
insured data for use in the models and the running of the modeling software.
Third, we are reliant upon third-party estimates of industry insured exposures
and there is significant variation possible around the relationship between our
loss and that of the industry following an event. Fourth, we assume that our
reinsurance recoveries following an event are fully collectible. These loss
estimates do not represent our potential maximum exposures and it is highly
likely that our actual incurred losses would vary materially from the modeled
estimates.
The above hurricane PMLs at June 30, 2012 reflect the findings from an in-depth
review of hurricane risk during 2011, including assessment of the latest
third-party hurricane models, implementation of the revised models through a
multi-model framework for risk assessment, and custom model output adjustments
to better reflect ACE's underlying exposure profile. The June 2011 hurricane
PMLs were based on the previous view of modeled risk.
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Natural catastrophe property reinsurance program
ACE's core property catastrophe reinsurance program provides protection against
natural catastrophes impacting its primary property operations (i.e., excluding
our Global Reinsurance and Life segments) and consists of two separate towers.
We regularly review our reinsurance protection and corresponding property
catastrophe exposures. This may or may not lead to the purchase of additional
reinsurance prior to a program's renewal date. In addition, prior to each
renewal date, we consider how much, if any, coverage we intend to buy and we may
make material changes to the current structure in light of various factors,
including modeled PML assessment at various return periods, reinsurance pricing,
our risk tolerance and exposures, and various other structuring considerations.
There were no significant changes to ACE's coverage under its North American
Core Program during the second quarter. However, the North American Calabash
program expired June 15, 2012 without renewal. With respect to our International
Property Catastrophe Program, we renewed the layers of reinsurance protection in
excess of $150 million on our Core Program for the period from July 1, 2012
through June 30, 2013 with no significant change in coverage from the expiring
program. Refer to our 2011 Form 10-K for additional information.
Crop insurance
ACE is one of the leading writers of crop insurance in the U.S. Our crop
insurance business primarily comprises two components - Multiple Peril Crop
Insurance (MPCI) and hail insurance. The MPCI program is a partnership with the
U.S. Department of Agriculture (USDA), which sets the terms and conditions of
the program under the annual Standard Reinsurance Agreement (SRA). Given the
crops covered in the program, we typically see a substantial written and earned
premium impact in the second and third quarters.
MPCI represents about 85 percent of our Agriculture net premiums written;
however, this percentage may change as a result of, among other things, growth
in our other non-MPCI agriculture lines and changes in commodity prices.
We purchase third party stop-loss reinsurance for our MPCI business to limit our
exposure. The attachment point for this stop-loss reinsurance is based upon the
ACE underwriting loss after the impact of the SRA risk sharing between ACE and
the Federal Crop Insurance Corporation. The attachment point is approximately
equal to a 104 percent combined ratio.
Given the drought conditions in the U.S. as of July 24, 2012, we expect we will
incur approximately $68 million of additional after-tax losses, in the second
half of 2012, for our MPCI business compared to what we contemplated as of April
2012 (when we publicly announced updated earnings guidance for the calendar
year). The increased losses would result in a loss ratio increase of
approximately five percentage points, i.e., 93 percent-94 percent combined ratio
for the 2012 MPCI business. If the drought conditions worsen and continue until
harvest (of covered crops), we believe our modeled worst case loss would be
approximately an additional $200 million after-tax, in excess of the $68 million
described above.
There were no changes to the SRA during the six months ended June 30,
2012. Refer to our 2011 Form 10-K for additional information.
In June 2012, the USDA'sRisk Management Agency (RMA) released the 2013 SRA for
the 2013 reinsurance year (i.e., July 1, 2012 through June 30, 2013) that
replaced the 2012 SRA. There were no significant changes in the terms and
conditions.
Liquidity
We anticipate that positive cash flows from operations (underwriting activities
and investment income) should be sufficient to cover cash outflows under most
loss scenarios through 2012. In addition to cash from operations, we
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have agreements with a third party bank provider which implemented two
international multi-currency notional cash pooling programs to enhance cash
management efficiency during periods of short-term timing mismatches between
expected inflows and outflows of cash by currency. The programs allow us to
optimize investment income by avoiding portfolio disruption. Should the need
arise, we generally have access to capital markets and available credit
facilities. At June 30, 2012, our available credit lines totaled $2.4 billion
and usage to support issued letters of credit was $1.5 billion. At July 31,
2012, usage to support issued letters of credit was $1.6 billion. Our access to
funds under existing credit facilities is dependent on the ability of the banks
that are parties to the facilities to meet their funding commitments. Our
existing credit facilities have remaining terms expiring between 2012 and 2015
and require that we maintain certain financial covenants, all of which we met at
June 30, 2012. Should any of our existing credit providers experience financial
difficulty, we may be required to replace credit sources, possibly in a
difficult market. There has also been recent consolidation in the banking
industry which could lead to increased reliance on and exposure to particular
institutions. If we cannot obtain adequate capital or sources of credit on
favorable terms, on a timely basis or at all, our business, operating results,
and financial condition could be adversely affected. To date, we have not
experienced difficulty accessing any of our credit facilities. Refer to "Credit
Facilities" in our 2011 Form 10-K.
The payments of dividends or other statutorily permissible distributions from
our operating companies are subject to the laws and regulations applicable to
each jurisdiction, as well as the need to maintain capital levels adequate to
support the insurance and reinsurance operations, including financial strength
ratings issued by independent rating agencies. During the six months ended
June 30, 2012, we were able to meet all of our obligations, including the
payments of dividends on our Common Shares, with our net cash flows.
We assess which subsidiaries to draw dividends from based on a number of
factors. Considerations such as regulatory and legal restrictions as well as the
subsidiary's financial condition are paramount to the dividend decision. The
legal restrictions on the payment of dividends from retained earnings by our
Bermuda subsidiaries are currently satisfied by the share capital and additional
paid-in capital of each of the Bermuda subsidiaries. ACE Limited received no
dividends from its Bermuda subsidiaries during the six months ended June 30,
2012. ACE Limited received dividends of $500 million from its Bermuda
subsidiaries during the six months ended June 30, 2011.
The payment of any dividends from ACE Global Markets or its subsidiaries is
subject to applicable U.K. insurance laws and regulations. In addition, the
release of funds by Syndicate 2488 to subsidiaries of ACE Global Markets is
subject to regulations promulgated by the Society of Lloyd's. The U.S. insurance
subsidiaries of ACE INA may pay dividends, without prior regulatory approval,
subject to restrictions set out in state law of the subsidiary's domicile (or,
if applicable, commercial domicile). ACE INA's international subsidiaries are
also subject to insurance laws and regulations particular to the countries in
which the subsidiaries operate. These laws and regulations sometimes include
restrictions that limit the amount of dividends payable without prior approval
of regulatory insurance authorities. ACE Limited did not receive any dividends
from ACE Global Markets or ACE INA during the six months ended June 30, 2012.
ACE Limited received dividends of $180 million from ACE Global Markets during
the six months ended June 30, 2011. ACE Limited received no dividends from ACE
INA during the six months ended June 30, 2011. Debt issued by ACE INA is
serviced by statutorily permissible distributions by ACE INA's insurance
subsidiaries to ACE INA as well as other group resources.
Cash Flows
Sources of liquidity include cash from operations, routine sales of investments,
and financing arrangements. The following is a discussion of our cash flows for
the six months ended June 30, 2012 and 2011.
Our consolidated net cash flows from operating activities were $1.4 billion in
the six months ended June 30, 2012, compared with $2.1 billion. Net loss and
loss expenses paid were $4.0 billion in the six months ended June 30, 2012,
compared with $3.8 billion. Operating cash flows decreased in the six months
ended June 30, 2012, primarily due to the $515 million unfavorable year over
year impact of cash collateral movements related to a large 2011 insurance
transaction. The receipt of $312 million cash collateral increased operating
cash flows for the six months ended June 30, 2011 while the return of $203
million cash collateral reduced operating cash flows during 2012.
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Our consolidated net cash flows used for investing activities were $1.3 billion
in the six months ended June 30, 2012, compared with $1.9 billion. Net investing
activities for the indicated periods were related primarily to net purchases of
fixed maturities.
Our consolidated net cash flows used for financing activities were $123 million
in the six months ended June 30, 2012, compared with $115 million. Financing
cash flows included $151 million of proceeds from issuance of short-term debt,
net of repayments, compared with $100 million. Dividends paid on Common Shares
were $318 million in the six months ended June 30, 2012, compared with $223
million.
Both internal and external forces influence our financial condition, results of
operations, and cash flows. Claim settlements, premium levels, and investment
returns may be impacted by changing rates of inflation and other economic
conditions. In many cases, significant periods of time, ranging up to several
years or more, may lapse between the occurrence of an insured loss, the
reporting of the loss to us, and the settlement of the liability for that loss.
In the current low interest rate environment, we utilize reverse repurchase
agreements as a low-cost alternative for short-term funding needs and to address
short-term cash timing differences without disrupting our investment portfolio
holdings. We subsequently settle these transactions with future operating cash
flows. At June 30, 2012, there were $1.4 billion in reverse repurchase
agreements outstanding.
Capital Resources
Capital resources consist of funds deployed or available to be deployed to
support our business operations. The following table summarizes the components
of our capital resources:
June 30 December 31
2012 2011
(in millions of U.S. dollars,
except for percentages)
Short-term debt $ 1,401 $ 1,251
Long-term debt 3,360 3,360
Total debt 4,761 4,611
Trust preferred securities 309 309
Total shareholders' equity 25,762 24,332
Total capitalization $ 30,832 $ 29,252
Ratio of debt to total capitalization 15.4 % 15.8 %
Ratio of debt plus trust preferred securities
to total capitalization 16.4 % 16.8 %
The following table reports the significant movements in our shareholders'
equity:
June 30, 2012
(in millions of
U.S. dollars)
Balance at December 31, 2011 $ 24,332
Net income 1,301
Change in net unrealized appreciation on investments, net of tax 451
Dividends on Common Shares (368 )
Exercise of stock options 48
Change in net cumulative translation, net of tax (23 )
Repurchase of shares (7 )
Other movements, net of tax 28
Balance at June 30, 2012 $ 25,762
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During January 2012, we repurchased $7 million of Common Shares in a series of
open market transactions under the August 2011 and November 2010 Board of
Directors authorizations. At June 30, 2012, $461 million in share repurchase
authorizations remained through December 31, 2012. At June 30, 2012 there were
3,771,527 Common Shares in treasury with a weighted average cost of $54.58 per
share.
We generally maintain the ability to issue certain classes of debt and equity
securities via an unlimited Securities and Exchange Commission (SEC) shelf
registration which is renewed every three years. This allows us capital market
access for refinancing as well as for unforeseen or opportunistic capital needs.
Our current shelf registration on file with the SEC expires in December 2014.
Dividends
We have paid dividends each quarter since we became a public company in 1993.
Under Swiss law, dividends must be stated in Swiss francs though dividend
payments are made by ACE in U.S. dollars. Following ACE's redomestication to
Switzerland in July 2008 through March 2011, dividends were distributed by way
of a par value reduction. At the May 2011 annual general meeting, our
shareholders approved dividend distributions from capital contributions reserves
(Additional paid-in capital) through the transfer of dividends from Additional
paid-in capital to Retained earnings. At the May 2012 annual general meeting,
our shareholders approved an annual dividend distribution for the following year
by way of a par value reduction equal to $1.96 per share, or CHF 1.80 per share,
calculated using the USD/CHF exchange rate as published in the Wall Street
Journal on May 10, 2012.
The annual dividend is payable in four quarterly installments, with each
installment equaling $0.49 per share, provided that the Swiss franc equivalent
of that amount per share (based on the then-current USD/CHF exchange rate),
taken together with the Swiss franc equivalents of all other installments of
this annual dividend, will not exceed 150 percent of CHF 1.80 (the aggregate
distribution cap). If the Swiss franc equivalent of an upcoming dividend
installment would cause the aggregate distribution cap to be exceeded, then that
dividend installment will be reduced to equal the Swiss franc amount remaining
available under the aggregate distribution cap, and the U.S. dollar amount
distributed for that installment will be the then-applicable U.S. dollar
equivalent of the remaining Swiss franc amount.
The following table represents dividends paid per Common Share to shareholders
of record on each of the following dates:
Shareholders of record as of: Dividends paid as of:
January 10, 2012 January 31, 2012 $0.47 (CHF 0.44)
March 30, 2012 April 20, 2012 $0.47 (CHF 0.42)
July 31, 2012 August 21, 2012 $0.49 (CHF 0.48)
Recent accounting pronouncements
Refer to Note 1 to the consolidated financial statements for a discussion of new
accounting pronouncements.
