ACE Limited (ACE or the Company) is a holding company incorporated in Zurich, Switzerland. The Company, through its various subsidiaries, provides a broad range of insurance and reinsurance products to insureds worldwide. ACE operates through the following business segments: Insurance – North American, Insurance – Overseas General, Global Reinsurance, and Life. Refer to Note 17.
On December 28, 2010, ACE acquired all the outstanding common stock of Rain and Hail Insurance Services, Inc. (Rain and Hail) not previously owned by ACE for approximately $1.1 billion. Headquartered in Johnston, Iowa, Rain and Hail has served America's farmers since 1919, providing comprehensive multiple peril crop and crop/hail insurance protection to customers in the U.S. and Canada. Prior to this transaction, ACE's 20.1 percent share in Rain and Hail was recorded in Investments in partially-owned insurance companies.
On December 1, 2010, ACE acquired all of the net assets of Jerneh Insurance Berhad (Jerneh), a general insurance company in Malaysia, for approximately $218 million. Refer to Note 3.
el2. Significant accounting policies
a) Basis of presentation
The accompanying consolidated financial statements, which include the accounts of the Company and its subsidiaries, have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and, in the opinion of management, reflect all adjustments (consisting of normally recurring accruals) necessary for a fair statement of the results and financial position for such periods. All significant intercompany accounts and transactions have been eliminated.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The Company's principal estimates include:
Amounts included in the consolidated financial statements reflect the Company's best estimates and assumptions; actual amounts could differ materially from these estimates.
Premiums are generally recognized as written upon inception of the policy. For multi-year policies for which premiums written are payable in annual installments, only the current annual premium is included as written at policy inception due to the ability of the insured/reinsured to commute or cancel coverage within the term of the policy. The remaining annual premiums are included as written at each successive anniversary date within the multi-year term.
For property and casualty (P&C) insurance and reinsurance products, premiums written are primarily earned on a pro-rata basis over the terms of the policies to which they relate. Unearned premiums represent the portion of premiums written applicable to the unexpired portion of the policies in force. For retrospectively-rated policies, written premiums are adjusted to reflect expected ultimate premiums consistent with changes to reported losses, or other measures of exposure as stated in the policy, and earned over the coverage period of the policy. For retrospectively-rated multi-year policies, the amount of premiums recognized in the current period is computed, using a with-and-without method, as the difference between the ceding enterprise's total contract costs before and after the experience under the contract at the reporting date. Accordingly, for retrospectively-rated multi-year policies, additional premiums are generally written and earned when losses are incurred.
Mandatory reinstatement premiums assessed on reinsurance policies are earned in the period of the loss event that gave rise to the reinstatement premiums. All remaining unearned premiums are recognized over the remaining coverage period.
Premiums from long duration contracts such as certain traditional term life, whole life, endowment, and long duration personal accident and health (A&H) policies are generally recognized as revenue when due from policyholders. Traditional life policies include those contracts with fixed and guaranteed premiums and benefits. Benefits and expenses are matched with such income to result in the recognition of profit over the life of the contracts.
Retroactive loss portfolio transfer (LPT) contracts in which the insured loss events occurred prior to the inception of the contract are evaluated to determine whether they meet the established criteria for reinsurance accounting. If reinsurance accounting is appropriate, written premiums are fully earned and corresponding losses and loss expenses recognized at the inception of the contract. The contracts can cause significant variances in gross premiums written, net premiums written, net premiums earned, and net incurred losses in the years in which they are written. Reinsurance contracts sold not meeting the established criteria for reinsurance accounting are recorded using the deposit method as described below in Note 2 k).
Reinsurance premiums assumed are based on information provided by ceding companies supplemented by the Company's own estimates of premium when the Company has not received ceding company reports. The information used in establishing these estimates is reviewed and adjustments are recorded in the period in which they are determined. These premiums are earned over the coverage terms of the related reinsurance contracts and range from one to three years.
c) Policy acquisition costs
Policy acquisition costs consist of commissions, premium taxes, and underwriting and other costs that vary with, and are primarily related to, the production of premium. A VOBA intangible asset is established upon the acquisition of blocks of long duration contracts and represents the present value of estimated net cash flows for the contracts in force at the time of the acquisition. Acquisition costs and VOBA, collectively policy acquisition costs, are deferred and amortized. Policy acquisition costs on P&C contracts are generally amortized ratably over the period in which premiums are earned. Policy acquisition costs on long duration contracts are amortized over the estimated life of the contracts in proportion to premium revenue recognized. Policy acquisition costs are reviewed to determine if they are recoverable from future income, including investment income. Unrecoverable costs are expensed in the period identified.
Advertising costs are expensed as incurred except for direct-response campaigns, principally related to A&H business produced by the Insurance – Overseas General segment, which are deferred and recognized over the expected future benefit period. For individual direct-response marketing campaigns that the Company can demonstrate have specifically resulted in incremental sales to customers and such sales have probable future economic benefits, incremental costs directly related to the marketing campaigns are capitalized. Deferred marketing costs are reviewed regularly for recoverability and amortized over five years, the expected economic future benefit period. The expected future benefit period is evaluated periodically based on historical results and adjusted prospectively. The amount of deferred marketing costs reported in deferred policy acquisition costs was $327 million, $333 million, and $300 million at December 31, 2010, 2009, and 2008, respectively. The amortization expense for deferred marketing costs was $152 million, $135 million, and $124 million for the years ended December 31, 2010, 2009, and 2008, respectively.
The Company assumes and cedes reinsurance with other insurance companies to provide greater diversification of business and minimize the net loss potential arising from large risks. Ceded reinsurance contracts do not relieve the Company of its primary obligation to its policyholders.
For both ceded and assumed reinsurance, risk transfer requirements must be met in order to obtain reinsurance status for accounting purposes, principally resulting in the recognition of cash flows under the contract as premiums and losses. To meet risk transfer requirements, a reinsurance contract must include insurance risk, consisting of both underwriting and timing risk, and a reasonable possibility of a significant loss for the assuming entity. To assess risk transfer for certain contracts, ACE generally develops expected discounted cash flow analyses at contract inception. Deposit accounting is used for contracts that do not meet risk transfer requirements. Deposit accounting requires that consideration received or paid be recorded in the balance sheet as opposed to recording premiums written or losses incurred in the statement of operations. Non-refundable fees on deposit contracts are earned based on the terms of the contract. Refer to Note 2 k).
Reinsurance recoverable includes the balances due from reinsurance companies for paid and unpaid losses and loss expenses and policy benefits that will be recovered from reinsurers, based on contracts in force. The method for determining the reinsurance recoverable on unpaid losses and loss expenses incurred but not reported (IBNR) involves actuarial estimates consistent with those used to establish the associated liability for unpaid losses and loss expenses as well as a determination of the Company's ability to cede unpaid losses and loss expenses under its existing reinsurance contracts.
Reinsurance recoverable is presented net of a provision for uncollectible reinsurance determined based upon a review of the financial condition of the reinsurers and other factors. The provision for uncollectible reinsurance is based on an estimate of the amount of the reinsurance recoverable balance that the Company will ultimately be unable to recover due to reinsurer insolvency, a contractual dispute, or any other reason. The valuation of this provision includes several judgments including certain aspects of the allocation of reinsurance recoverable on IBNR claims by reinsurer and a default analysis to estimate uncollectible reinsurance. The primary components of the default analysis are reinsurance recoverable balances by reinsurer, net of collateral, and default factors used to determine the portion of a reinsurer's balance deemed uncollectible. The definition of collateral for this purpose requires some judgment and is generally limited to assets held in an ACE-only beneficiary trust, letters of credit, and liabilities held with the same legal entity for which ACE believes there is a contractual right of offset. The determination of the default factor is principally based on the financial strength rating of the reinsurer. Default factors require considerable judgment and are determined using the current financial strength rating, or rating equivalent, of each reinsurer as well as other key considerations and assumptions. The more significant considerations include, but are not necessarily limited to, the following:
The methods used to determine the reinsurance recoverable balance and related provision for uncollectible reinsurance are regularly reviewed and updated and any resulting adjustments are reflected in earnings in the period identified.
Prepaid reinsurance premiums represent the portion of premiums ceded to reinsurers applicable to the unexpired coverage terms of the reinsurance contracts in force.
The value of reinsurance business assumed of $92 million and $111 million at December 31, 2010 and 2009, respectively, included in Other assets in the accompanying consolidated balance sheets, represents the excess of estimated ultimate value of the liabilities assumed under retroactive reinsurance contracts over consideration received. The value of reinsurance business assumed is amortized and recorded to losses and loss expenses based on the payment pattern of the losses assumed and ranges between 5 and 40 years. The unamortized value is reviewed regularly to determine if it is recoverable based upon the terms of the contract, estimated losses and loss expenses, and anticipated investment income. Unrecoverable amounts are expensed in the period identified.
Fixed maturity investments are classified as either available for sale or held to maturity. The available for sale portfolio is reported at fair value. The held to maturity portfolio includes securities for which the Company has the ability and intent to hold to maturity or redemption and is reported at amortized cost. Equity securities are classified as available for sale and are recorded at fair value. Short-term investments comprise securities due to mature within one year of the date of purchase and are recorded at fair value which typically approximates cost. Short-term investments include certain cash and cash equivalents, which are part of investment portfolios under the management of external investment managers.
Other investments principally comprise life insurance policies, policy loans, trading securities, other direct equity investments, investment funds, and limited partnerships.
Investments in partially-owned insurance companies primarily represent direct investments in which the Company has significant influence and, as such, meet the requirements for equity accounting. The Company reports its share of the net income or loss of the partially-owned insurance companies in Other (income) expense. Investments in partially-owned insurance companies over which the Company does not exert significant influence are carried at fair value.
Realized gains or losses on sales of investments are determined on a first-in, first-out basis. Unrealized appreciation (depreciation) on investments is included as a separate component of AOCI in shareholders' equity. The Company regularly reviews its investments for OTTI. Refer to Note 4.
With respect to securities where the decline in value is determined to be temporary and the security's value is not written down, a subsequent decision may be made to sell that security and realize a loss. Subsequent decisions on security sales are the result of changing or unforeseen facts and circumstances (i.e., arising from a large insured loss such as a catastrophe), deterioration of the credit-worthiness of the issuer or its industry, or changes in regulatory requirements. The Company believes that subsequent decisions to sell such securities are consistent with the classification of the majority of the portfolio as available for sale.
The Company uses derivative instruments including futures, options, swaps, and foreign currency forward contracts for the purpose of managing certain investment portfolio risks and exposures. Refer to Note 10. Derivatives are reported at fair value and recorded in the accompanying consolidated balance sheets in Accounts payable, accrued expenses, and other liabilities with changes in fair value included in Net realized gains (losses) in the consolidated statements of operations. Collateral held by brokers equal to a percentage of the total value of open futures contracts is included in the investment portfolio.
Net investment income includes interest and dividend income and amortization of fixed maturity market premiums and discounts and is net of investment management and custody fees. For mortgage-backed securities, and any other holdings for which there is a prepayment risk, prepayment assumptions are evaluated and revised as necessary. Any adjustments required due to the resultant change in effective yields and maturities are recognized prospectively. Prepayment fees or call premiums that are only payable when a security is called prior to its maturity are earned when received and reflected in Net investment income.
The Company participates in a securities lending program operated by a third party banking institution whereby certain assets are loaned to qualified borrowers and from which the Company earns an incremental return. Borrowers provide collateral, in the form of either cash or approved securities, of 102 percent of the fair value of the loaned securities. Each security loan is deemed to be an overnight transaction. Cash collateral is invested in a collateral pool which is managed by the banking institution. The collateral pool is subject to written investment guidelines with key objectives which include the safeguard of principal and adequate liquidity to meet anticipated redemptions. The fair value of the loaned securities is monitored on a daily basis, with additional collateral obtained or refunded as the fair value of the loaned securities changes. The collateral is held by the third party banking institution, and the collateral can only be accessed in the event that the institution borrowing the securities is in default under the lending agreement. As a result of these restrictions, the Company considers its securities lending activities to be non-cash investing and financing activities. An indemnification agreement with the lending agent protects the Company in the event a borrower becomes insolvent or fails to return any of the securities on loan. The fair value of the securities on loan is included in fixed maturities and equity securities. The securities lending collateral is reported as a separate line in total assets with a related liability reflecting the Company's obligation to return the collateral plus interest.
Similar to securities lending arrangements, securities sold under reverse repurchase agreements, whereby the Company sells securities and repurchases them at a future date for a predetermined price, are accounted for as collateralized investments and borrowings and are recorded at the contractual repurchase amounts plus accrued interest. Assets to be repurchased are the same, or substantially the same, as the assets transferred and the transferor, through right of substitution, maintains the right and ability to redeem the collateral on short notice. The fair value of the underlying securities is included in fixed maturities and equity securities. In contrast to securities lending programs, the use of cash received is not restricted. The Company reports its obligation to return the cash as short-term debt.
Refer to Note 15 for a discussion on the determination of fair value for the Company's various investment securities.
Cash includes cash on hand and deposits with an original maturity of three months or less at time of purchase. Cash held by external money managers is included in Short-term investments.
g) Goodwill and other intangible assets
Goodwill represents the excess of the cost of acquisitions over the fair value of net assets acquired and is not amortized. Goodwill is assigned at acquisition to the applicable reporting unit of the acquired entities giving rise to the goodwill. Goodwill impairment tests are performed annually, or more frequently if circumstances indicate a possible impairment. The Company estimates a reporting unit's fair value using a consistently applied combination of the following models: an earnings multiple, a book value multiple, a discounted cash flow or an allocated market capitalization model. The Company's earnings and book value models apply multiples of comparable publicly traded companies to forecasted earnings or book value of each reporting unit and consider current market transactions. The discounted cash flow model applies a discount to estimated cash flows including a terminal value calculation. The market capitalization model allocates the Company's market capitalization to each reporting unit. Where appropriate, the Company considers the impact of a control premium. Goodwill recorded in connection with investments in partially-owned insurance companies is recorded in Investments in partially-owned insurance companies and is also measured for impairment annually.
Indefinite lived intangible assets are not subject to amortization. Finite lived intangible assets are amortized over their useful lives, generally ranging from 4 to 20 years. The carrying amounts of intangible assets are regularly reviewed for indicators of impairment. Impairment is recognized if the carrying amount is not recoverable from its undiscounted cash flows and is measured as the difference between the carrying amount and fair value.
h) Unpaid losses and loss expenses
A liability is established for the estimated unpaid losses and loss expenses under the terms of, and with respect to, the Company's policies and agreements. These amounts include provision for both reported claims (case reserves) and IBNR claims. The methods of determining such estimates and establishing the resulting liability are reviewed regularly and any adjustments are reflected in operations in the period in which they become known. Future developments may result in losses and loss expenses materially greater or less than recorded amounts.
Except for net loss and loss expense reserves of $69 million net of discount held at December 31, 2010, representing structured settlements for which the timing and amount of future claim payments are reliably determinable, the Company does not discount its P&C loss reserves. Structured settlements represent contracts purchased from life insurance companies primarily to settle workers' compensation claims, where payments to the claimant by the life insurance company are expected to be made in the form of an annuity. The Company retains the liability to the claimant in the event that the life insurance company fails to pay. At December 31, 2010, the Company has a gross liability of $654 million for the amount due to claimants and reinsurance recoverables of $585 million for amounts due from the life insurance companies. For structured settlement contracts where payments are guaranteed regardless of claimant life expectancy, the amounts recoverable from the life insurance companies are included in Other Assets, as they do not meet the requirements for reinsurance accounting. At December 31, 2010, there was $69 million included in Other Assets relating to structured settlements.
Included in unpaid losses and loss expenses are liabilities for asbestos and environmental (A&E) claims and expenses. These unpaid losses and loss expenses are principally related to claims arising from remediation costs associated with hazardous waste sites and bodily-injury claims related to asbestos products and environmental hazards. The estimation of these liabilities is particularly sensitive to changes in the legal environment, including specific settlements that may be used as precedents to settle future claims. However, ACE does not anticipate future changes in laws and regulations in setting its A&E reserve levels.
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 premiums from previous accident years. With respect to crop business, prior to the acquisition of Rain and Hail, reports relating to the previous crop year(s) were normally received in subsequent calendar years and this typically resulted in adjustments to the previously reported premiums, losses and loss expenses, and profit share commission. Following the acquisition, such information is available before the close of the calendar year. Commencing with the quarter ended September 30, 2009, prior period development for the crop business includes adjustments to both crop losses and loss expenses and the related crop profit share commission.
For purposes of analysis and disclosure, management views prior period development to be changes in the nominal value of loss estimates from period to period and excludes changes in loss estimates that do not arise from the emergence of claims, such as those related to uncollectible reinsurance, interest, unallocated loss adjustment expenses, or foreign currency. Accordingly, specific items excluded from prior period development include the following: gains/losses related to foreign currency remeasurement; losses recognized from the early termination or commutation of reinsurance agreements that principally relate to the time value of money; changes in the value of reinsurance business assumed reflected in losses incurred but principally related to the time value of money; and losses that arise from changes in estimates of earned premiums from prior accident years. Except for foreign currency revaluation, which is disclosed separately, these items are included in current year losses.
i) Future policy benefits
The development of long duration contract reserves requires management to make estimates and assumptions regarding expenses, mortality, persistency, and investment yields. Such estimates are primarily based on historical experience and information provided by ceding companies and include a margin for adverse deviation. Interest rates used in calculating reserves range from one percent to seven percent at December 31, 2010 and 2009. Actual results could differ materially from these estimates. Management monitors actual experience, and where circumstances warrant, will revise its assumptions and the related reserve estimates. Revisions are recorded in the period they are determined.
j) Assumed reinsurance programs involving minimum benefit guarantees under annuity contracts
The Company reinsures various death and living benefit guarantees associated with variable annuities issued primarily in the United States and Japan. Each reinsurance treaty covers variable annuities written during a limited period, typically not exceeding two years. The Company generally receives a monthly premium during the accumulation phase of the covered annuities (in-force) based on a percentage of either the underlying accumulated account values or the underlying accumulated guaranteed values. Depending on an annuitant's age, the accumulation phase can last many years. To limit the Company's exposure under these programs, all reinsurance treaties include aggregate claim limits and many include an aggregate deductible.
The guarantees which are payable on death, referred to as guaranteed minimum death benefits (GMDB), principally cover shortfalls between accumulated account value at the time of an annuitant's death and either i) an annuitant's total deposits; ii) an annuitant's total deposits plus a minimum annual return; or iii) the highest accumulated account value attained at any policy anniversary date. In addition, a death benefit may be based on a formula specified in the variable annuity contract that uses a percentage of the growth of the underlying contract value. Liabilities for GMDBs are based on cumulative assessments or premiums to date multiplied by a benefit ratio that is determined by estimating the present value of benefit payments and related adjustment expenses divided by the present value of cumulative assessment or expected fees during the contract period.
Under reinsurance programs covering GLBs, the Company assumes the risk of guaranteed minimum income benefits (GMIB) and Guaranteed Minimum Accumulation Benefits (GMAB) associated with variable annuity contracts. The GMIB risk is triggered if, at the time the contract holder elects to convert the accumulated account value to a periodic payment stream (annuitize), the accumulated account value is not sufficient to provide a guaranteed minimum level of monthly income. The GMAB risk is triggered if, at contract maturity, the contract holder's account value is less than a guaranteed minimum value. The Company's GLB reinsurance product meets the definition of a derivative for accounting purposes and is carried at fair value with changes in fair value recognized in income and classified as described below. As the assuming entity, the Company is obligated to provide coverage until the earlier of the expiration of the underlying guaranteed benefit or the treaty expiration date. Premiums received under the reinsurance treaties are classified as premium. Expected losses allocated to premiums received are classified as policy benefits and valued similar to GMDB reinsurance. Other changes in fair value, principally arising from changes in expected losses allocated to expected future premiums, are classified as Net realized gains (losses). Fair value represents management's estimate of exit price and thus includes a risk margin. The Company may recognize a realized loss for other changes in fair value due to adverse changes in the capital markets (i.e., declining interest rates and/or declining equity markets) and changes in policyholder behavior (i.e., increased annuitization or decreased lapse rates) although the Company expects the business to be profitable. The Company believes this presentation provides the most meaningful disclosure of changes in the underlying risk within the GLB reinsurance programs for a given reporting period. Refer to Note 5 c).
k) Deposit assets and liabilities
Deposit assets arise from ceded reinsurance contracts purchased that do not transfer significant underwriting or timing risk. Under deposit accounting, consideration received or paid, excluding non-refundable fees, is recorded as a deposit asset or liability in the balance sheet as opposed to recording ceded premiums and losses in the statement of operations. Interest income on deposits, representing the consideration received or to be received in excess of cash payments related to the deposit contract, is earned based on an effective yield calculation. The calculation of the effective yield is based on the amount and timing of actual cash flows at the balance sheet date and the estimated amount and timing of future cash flows. The effective yield is recalculated periodically to reflect revised estimates of cash flows. When a change in the actual or estimated cash flows occurs, the resulting change to the carrying amount of the deposit asset is reported as income or expense. Deposit assets of $144 million and $55 million at December 31, 2010 and 2009, respectively, are reflected in Other assets in the balance sheets and the accretion of deposit assets related to interest pursuant to the effective yield calculation is reflected in Net investment income in the statement of operations.
Non-refundable fees are earned based on contract terms. Non-refundable fees paid but unearned are reflected in Other assets in the balance sheet and earned fees are reflected in Other (income) expense in the statement of operations.
Deposit liabilities include reinsurance deposit liabilities of $351 million and $281 million and contract holder deposit funds of $70 million and $51 million at December 31, 2010 and 2009, respectively. The reinsurance deposit liabilities arise from contracts sold for which there is not a significant transfer of risk. At contract inception, the deposit liability equals net cash received. An accretion rate is established based on actuarial estimates whereby the deposit liability is increased to the estimated amount payable over the contract term. The deposit accretion rate is the rate of return required to fund expected future payment obligations. The Company periodically reassesses the estimated ultimate liability and related expected rate of return. Changes to the amount of the deposit liability are reflected through Net investment income to reflect the cumulative effect of the period the contract has been in force, and by an adjustment to the future accretion rate of the liability over the remaining estimated contract term.
Contract holder deposit funds represent a liability for investment contracts sold that do not meet the definition of an insurance contract and are sold with a guaranteed rate of return. The liability equals accumulated policy account values, which consist of the deposit payments plus credited interest, less withdrawals and amounts assessed through the end of the period.
l) Foreign currency remeasurement and translation
The Company determines the functional currency for each of its foreign operations, which are generally the currency of the local operating environment. Transactions in currencies other than a foreign operation's functional currency are remeasured into the functional currency and the resulting foreign exchange gains and losses are reflected in Net realized gains (losses) in the consolidated statements of operations. Functional currency assets and liabilities are translated into the reporting currency, U.S. dollars, using period end rates of exchange and the related translation adjustments are recorded as a separate component of AOCI. Functional statement of operations amounts expressed in functional currencies are translated using average exchange rates. Gains and losses resulting from foreign currency transactions are recorded in Net realized gains (losses).
m) Administrative expenses
Administrative expenses generally include all operating costs other than policy acquisition costs. The Insurance – North American segment manages and utilizes an in-house third-party claims administrator, ESIS Inc. (ESIS). ESIS performs claims management and risk control services for domestic and international organizations that self-insure P&C exposures as well as internal P&C exposures. The net operating results of ESIS are included within administrative expenses and were $85 million, $26 million, and $34 million for the years ended December 31, 2010, 2009, and 2008, respectively.
n) Income taxes
Income taxes have been recorded related to those operations subject to income taxes. Deferred tax assets and liabilities result from temporary differences between the amounts recorded in the consolidated financial statements and the tax basis of the Company's assets and liabilities. Refer to Note 8. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance against deferred tax assets is recorded if it is more likely than not that all, or some portion, of the benefits related to deferred tax assets will not be realized. The valuation allowance assessment considers tax planning strategies, where applicable.
The Company recognizes uncertain tax positions deemed more likely than not of being sustained upon examination. Recognized income tax positions are measured at the largest amount that is greater than 50 percent likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs.
o) Earnings per share
Basic earnings per share is calculated using the weighted-average shares outstanding including participating securities with non-forfeitable rights to dividends such as unvested restricted stock. All potentially dilutive securities including stock options are excluded from the basic earnings per share calculation. In calculating diluted earnings per share, the weighted-average shares outstanding is increased to include all potentially dilutive securities. Basic and diluted earnings per share are calculated by dividing net income available to common shareholders by the applicable weighted-average number of shares outstanding during the year.
p) Cash flow information
Premiums received and losses paid associated with the GLB reinsurance products, which as discussed previously meet the definition of a derivative instrument for accounting purposes, are included within cash flows from operating activities in the consolidated statement of cash flows. Cash flows, such as settlements and collateral requirements, associated with all other derivative instruments are included on a net basis within cash flows from investing activities in the consolidated statement of cash flows. Purchases, sales, and maturities of short-term investments are recorded net for purposes of the consolidated statements of cash flows and are classified with cash flows related to fixed maturities.
The Company recognizes all derivatives at fair value in the consolidated balance sheets. The Company participates in derivative instruments in two principal ways:
(i) To sell protection to customers as an insurance or reinsurance contract that meets the definition of a derivative for accounting purposes. For 2010 and 2009, the reinsurance of GLBs was the Company's primary product falling into this category; and
(ii) To mitigate financial risks, principally arising from investment holdings, products sold, or assets and liabilities held in foreign currencies. For these instruments, changes in assets or liabilities measured at fair value are recorded as realized gains or losses in the consolidated statement of operations.
The Company did not designate any derivatives as accounting hedges during 2010, 2009, or 2008.
r) Share-based compensation
The Company measures and records compensation cost for all share-based payment awards at grant-date fair value. Compensation costs are recognized for share-based payment awards with only service conditions that have graded vesting schedules on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in substance, multiple awards. Refer to Note 13.
s) New accounting pronouncements
Adopted in 2010
Fair value measurements and disclosures
Accounting Standard Update (ASU) No. 2010-06, Improving Disclosures about Fair Value Measurements (ASU 2010-06) includes provisions that amend Accounting Standards Codification (ASC) Topic 820, Fair Value Measurements and Disclosures, (Topic 820) to require reporting entities to make new disclosures about recurring and nonrecurring fair value measurements including the amounts of and reasons for significant transfers into and out of Level 1 and Level 2 fair value measurements and separate disclosure of purchases, sales, issuances, and settlements in the reconciliation of Level 3 fair value measurements. ASU 2010-6 was effective for interim and annual reporting periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures which are effective for interim and annual periods beginning after December 15, 2010.
Consolidation of variable interest entities and accounting for transfers of financial assets
ASU No. 2009-16, Accounting for Transfers of Financial Assets (ASU 2009-16) and ASU No. 2009-17, Improvements to Financial Reporting by Enterprises Involved With Variable Interest Entities (ASU 2009-17) include provisions effective for interim and annual reporting periods beginning on January 1, 2010. ASU 2009-16 amends ASC Topic 860, Transfers and Servicing, by removing the exemption from consolidation for qualifying special purpose entities. This statement also limits the circumstances in which a financial asset, or portion of a financial asset, should be derecognized when the transferor has not transferred the entire original financial asset to an entity that is not consolidated with the transferor in the financial statements being presented and/or when the transferor has continuing involvement with the transferred financial asset. ASU 2009-17 amends ASC Topic 810, Consolidation, to eliminate the quantitative approach previously required for determining the primary beneficiary of a variable interest entity and requires ongoing qualitative reassessments of whether an enterprise is the primary beneficiary of a variable interest entity. The adoption of these provisions did not have a material impact on ACE's financial condition or results of operations.
Embedded credit derivatives
ASU No. 2010-11, Scope Exception Related to Embedded Credit Derivatives (ASU 2010-11) includes provisions effective for interim and annual reporting periods beginning on July 1, 2010. The provisions of ASU 2010-11 amend ASC Topic 815, Derivatives and Hedging, to provide clarification on the bifurcation scope exception for embedded credit derivative features. The adoption of these provisions did not have a material impact on ACE's financial condition or results of operations.
To be adopted after 2010
Accounting for costs associated with acquiring or renewing insurance contracts
In October 2010, the Financial Accounting Standards Board (FASB) issued ASU No. 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts (ASU 2010-26). The provisions of ASU 2010-26 modify the definition of acquisition costs 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. This guidance is effective for interim and annual reporting periods beginning on January 1, 2012, and may be applied prospectively or retrospectively. ACE is in the process of assessing the impact that the implementation of ASU 2010-26 will have on its financial condition and results of operations.
On December 28, 2010, ACE acquired all the outstanding common stock of Rain and Hail not previously owned by ACE for approximately $1.1 billion in cash. Rain and Hail has served America's farmers since 1919, providing comprehensive multiple peril crop and crop/hail insurance protection to customers in the U.S. and Canada. This acquisition is consistent with ACE's strategy to expand its specialty lines business and provides further diversification of ACE's global product mix.
Prior to the consummation of this business combination, ACE's 20.1 percent ownership in Rain and Hail was recorded in Investments in partially-owned insurance companies. In accordance with GAAP, at the date of the business combination, ACE was deemed to have disposed of its 20.1 percent ownership interest and recognized 100 percent of the assets and liabilities of Rain and Hail at acquisition date fair value. In connection with this deemed disposition, ACE recognized a $175 million gain in Net realized gains (losses) in the consolidated statement of operations, which represents the excess of acquisition date fair value of the 20.1 percent ownership interest over the cost basis. Acquisition date fair value of the 20.1 percent ownership interest was determined by first calculating the implied fair value of 100 percent of Rain and Hail based on the purchase price for the net assets not previously owned by ACE at the acquisition date. The implied fair value of the 20.1 percent ownership interest was then reduced to reflect a noncontrolling interest discount. The consolidated financial statements include the results of Rain and Hail from December 28, 2010.
The acquisition generated $135 million of goodwill, none of which is expected to be deductible for income tax purposes and $523 million of other intangible assets based on ACE's purchase price allocation. Goodwill and other intangible assets arising from this acquisition are included in the Insurance – North American segment. Legal and other expenses incurred to complete the acquisition amounted to $2 million and are included in Other (income) expense.
The following table presents ACE's best estimate of fair value of the assets and liabilities of Rain and Hail at December 28, 2010.
|Condensed Balance Sheet of Rain and Hail at December 28, 2010|
|(in millions of U.S. dollars)|
|Investments and cash||$||630|
|Insurance and reinsurance balances receivable||538|
|Goodwill and other intangible assets||658|
|Liabilities and Shareholder's Equity|
|Unpaid losses and loss expenses||$||124|
|Deferred tax liabilities||179|
|Total shareholder's equity||1,271|
|Total liabilities and shareholder's equity||$||1,927|
The following table presents unaudited pro forma information for the years ended December 31, 2010 and 2009, assuming the acquisition of Rain and Hail occurred on January 1, 2009. The pro forma financial information is presented for informational purposes only and is not necessarily indicative of the operating results that would have occurred had the acquisition been consummated on January 1, 2009, nor is it necessarily indicative of future operating results. Significant assumptions used to determine pro forma operating results include amortization of acquired intangible assets and the investment income opportunity cost related to the purchase price. Further, for pro forma information purposes, the gain recorded in connection with the deemed disposition discussed above is included in the year ended December 31, 2009.
|(in millions of U.S. dollars, except per share data) (unaudited)|
|Net premiums earned||$||14,208||$||14,040|
|Basic earnings per share||$||8.78||$||8.58|
|Diluted earnings per share||$||8.74||$||8.56|
On December 1, 2010, ACE acquired the net assets of Jerneh, a general insurance company in Malaysia, for approximately $218 million in cash. The acquisitions of Rain and Hail and Jerneh were financed with cash on hand and the use of reverse repurchase agreements of $1 billion. Refer to Note 9.
a) Transfers of securities
As part of the Company's fixed income diversification strategy, ACE has decided to hold certain additional securities to maturity. Because the Company has the intent to hold these securities to maturity, transfers of such securities with a total fair value of $6.8 billion were made during the third and fourth quarters of 2010 from Fixed maturities available for sale to Fixed maturities held to maturity. The net unrealized appreciation at the date of the transfer continues to be reported as a component of AOCI and is being amortized over the remaining life of the securities as an adjustment of yield in a manner consistent with the amortization of any premium or discount.
b) Fixed maturities
The following tables present the fair values and amortized costs of and the gross unrealized appreciation (depreciation) related to fixed maturities as well as related OTTI recognized in AOCI.
|December 31, 2010|
|Amortized Cost||Gross Unrealized Appreciation||Gross Unrealized Depreciation||Fair Value||OTTI Recognized in AOCI|
|(in millions of U.S. dollars)|
|Available for sale|
|U.S. Treasury and agency||$||2,904||$||74||$||(15)||$||2,963||$||-|
|States, municipalities, and political subdivisions||1,302||15||(30)||1,287||-|
|Held to maturity|
|U.S. Treasury and agency||$||1,105||$||32||$||(10)||$||1,127||$||-|
|States, municipalities, and political subdivisions||1,175||5||(18)||1,162||-|
|December 31, 2009|
|Amortized Cost||Gross Unrealized Appreciation||Gross Unrealized Depreciation||Fair Value||OTTI Recognized in AOCI|
|(in millions of U.S. dollars)|
|Available for sale|
|U.S. Treasury and agency||$||3,680||$||48||$||(19)||$||3,709||$||-|
|States, municipalities, and political subdivisions||1,580||52||(18)||1,614||-|
|Held to maturity|
|U.S. Treasury and agency||$||1,026||$||33||$||(2)||$||1,057||$||-|
|States, municipalities, and political subdivisions||676||11||(1)||686||-|
As discussed in Note 4 d), if a credit loss is indicated on an impaired fixed maturity, an OTTI is considered to have occurred and the portion of the impairment not related to credit losses (non-credit OTTI) is recognized in OCI. Included in the “OTTI Recognized in AOCI” columns above is the cumulative amount of non-credit OTTI recognized in OCI adjusted for subsequent sales, maturities, and redemptions. OTTI Recognized in AOCI does not include the impact of subsequent changes in fair value of the related securities. In periods subsequent to a recognition of OTTI in OCI, changes in the fair value of the related fixed maturities are reflected in Unrealized appreciation (depreciation) in the consolidated statement of shareholders' equity. For the years ended December 31, 2010 and 2009, $193 million and $196 million, respectively, of net unrealized appreciation related to such securities is included in OCI. At December 31, 2010 and 2009, AOCI includes net unrealized depreciation of $99 million and $162 million, respectively, related to securities remaining in the investment portfolio at those dates for which ACE has recognized a non-credit OTTI.
Mortgage-backed securities issued by U.S. government agencies are combined with all other to be announced mortgage derivatives held (refer to Note 10 a) (iv)) and are included in the category, “Mortgage-backed securities”. Approximately 79 percent and 69 percent of the total mortgage-backed securities at December 31, 2010 and 2009, respectively, are represented by investments in U.S. government agency bonds. The remainder of the mortgage exposure consists of collateralized mortgage obligations and nongovernment mortgage-backed securities, the majority of which provide a planned structure for principal and interest payments and carry a rating of AAA by the major credit rating agencies.
The following table presents fixed maturities at December 31, 2010 and 2009, by contractual maturity. Expected maturities could differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties.
|Amortized Cost||Fair Value||Amortized Cost||Fair Value|
|(in millions of U.S. dollars)|
|Available for sale; maturity period|
|Due in 1 year or less||$||1,846||$||1,985||$||1,354||$||1,352|
|Due after 1 year through 5 years||13,094||13,444||14,457||14,905|
|Due after 5 years through 10 years||10,276||10,782||9,642||10,067|
|Due after 10 years||2,818||2,812||3,474||3,359|
|Held to maturity; maturity period|
|Due in 1 year or less||$||400||$||404||$||755||$||766|
|Due after 1 year through 5 years||1,983||2,010||1,096||1,129|
|Due after 5 years through 10 years||2,613||2,524||108||115|
|Due after 10 years||694||677||82||82|
c) Equity securities
The following table presents the fair value and cost of and gross unrealized appreciation (depreciation) related to equity securities at December 31, 2010 and 2009.
|December 31||December 31|
|(in millions of U.S. dollars)|
|Gross unrealized appreciation||28||70|
|Gross unrealized depreciation||(2)||(1)|
d) Net realized gains (losses)
The Company adopted provisions included in ASC Topic 320, Investments-Debt and Equity Securities, (Topic 320) related to the recognition and presentation of OTTI on April 1, 2009. Under these provisions, when an OTTI related to a fixed maturity has occurred, ACE is required to record the OTTI in net income if the Company has the intent to sell the security or it is more likely than not that it will be required to sell the security before the recovery of its amortized cost. Further, in cases where the Company does not intend to sell the security and it is more likely than not that it will not be required to sell the security, ACE must evaluate the security to determine the portion of the impairment, if any, related to credit losses. If a credit loss is indicated, an OTTI is considered to have occurred and any portion of the OTTI related to credit losses must be reflected in net income while the portion of OTTI related to all other factors is recognized in OCI. For fixed maturities held to maturity, OTTI recognized in OCI is accreted from AOCI to the amortized cost of the fixed maturity prospectively over the remaining term of the securities. For fixed maturities, prior to this adoption, ACE was required to record OTTI in net income unless the Company had the intent and ability to hold the impaired security to recovery. These provisions do not have any impact on the accounting for OTTI for any other type of investment.
The cumulative effect of the adoption resulted in a reduction to AOCI and an increase to Retained earnings of $242 million. These adjustments reflect the net of tax amount ($305 million pre-tax) of OTTI recognized in net income prior to the adoption related to fixed maturities held at the adoption date that had not suffered a credit loss, the Company did not intend to sell, and it was more likely than not that ACE would not be required to sell before the recovery of their amortized cost. Retained earnings and Deferred tax assets at the adoption date were also reduced by $47 million as a result of an increase in the Company's valuation allowance against deferred tax assets, which was a direct effect of the adoption.
Each quarter, the Company reviews its securities in an unrealized loss position (impaired securities), including fixed maturities, securities lending collateral, equity securities, and other investments, to identify those impaired securities to be specifically evaluated for a potential OTTI.
For impaired fixed maturities, the Company assesses OTTI based on the provisions of Topic 320 as described above. The factors that the Company considers when determining if a credit loss exists related to a fixed maturity are discussed in “Evaluation of potential credit losses related to fixed maturities” below. Prior to the adoption, when evaluating fixed maturities for OTTI, the Company principally considered its ability and intent to hold the impaired security to the expected recovery period, the issuer's financial condition, and the Company's assessment (using available market information such as credit ratings) of the issuer's ability to make future scheduled principal and interest payments on a timely basis.
The Company reviews all non-fixed maturities for OTTI based on the following:
ACE, as a general rule, also considers that equity securities in an unrealized loss position for twelve consecutive months are impaired.
Evaluation of potential credit losses related to fixed maturities
ACE reviews each fixed maturity in an unrealized loss position to assess whether the security is a candidate for credit loss. Specifically, ACE considers credit rating, market price, and issuer-specific financial information, among other factors, to assess the likelihood of collection of all principal and interest as contractually due. Securities for which ACE determines that credit loss is likely are subjected to further analysis to estimate the credit loss recognized in net income, if any. In general, credit loss recognized in net income equals the difference between the security's amortized cost and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security. The specific methodologies and significant assumptions used by asset class are discussed below. All significant assumptions used in determining credit losses are subject to change as market conditions evolve.
U.S. Treasury and agency obligations (including agency mortgage-backed securities), foreign government obligations, and states, municipalities, and political subdivisions obligations
U.S. Treasury and agency obligations (including agency mortgage-backed securities), foreign government obligations, and states, municipalities, and political subdivisions obligations represent less than $160 million of gross unrealized loss at December 31, 2010. These securities were evaluated for credit loss primarily using qualitative assessments of the likelihood of credit loss considering credit rating of the issuers and level of credit enhancement, if any. ACE concluded that the high level of creditworthiness of the issuers coupled with credit enhancement, where applicable, supports recognizing no credit loss in net income.
Projected cash flows for corporate securities (principally senior unsecured bonds) are driven primarily by assumptions regarding probability of default and also the timing and amount of recoveries associated with defaults. ACE develops these estimates using information based on market observable data, issuer-specific information, and credit ratings. ACE developed its default assumption by using historical default data by Moody's Investors Service (Moody's) rating category to calculate a 1-in-100 year probability of default, which results in a default assumption in excess of the historical mean default rate. ACE believes that use of a default assumption in excess of the historical mean is reasonable in light of recent market conditions. The following table presents default assumptions by Moody's rating category (historical mean default rate provided for comparison).
|Moody's Rating Category||1-in-100 Year Default Rate||Historical Mean Default Rate|
|Below Investment Grade:|
Consistent with management's approach to developing default rate assumptions considering recent market conditions, ACE assumed a 25 percent recovery rate (the par value of a defaulted security that will be recovered) across all rating categories rather than using Moody's historical mean recovery rate of 40 percent. ACE believes that use of a recovery rate assumption lower than the historical mean is reasonable in light of recent market conditions.
Application of the methodology and assumptions described above resulted in credit losses recognized in net income for corporate securities for the year ended December 31, 2010, of $14 million. Credit losses recognized in net income for corporate securities from the date of adoption to December 31, 2009 amounted to $59 million.
For mortgage-backed securities, credit impairment is assessed using a cash flow model that estimates the cash flows on the underlying mortgages, using the security-specific collateral and transaction structure. The model estimates cash flows from the underlying mortgage loans and distributes those cash flows to various tranches of securities, considering the transaction structure and any subordination and credit enhancements that exist in that structure. The cash flow model incorporates actual cash flows on the mortgage-backed securities through the current period and then projects the remaining cash flows using a number of assumptions, including default rates, prepayment rates, and loss severity rates (the par value of a defaulted security that will not be recovered) on foreclosed properties.
ACE develops specific assumptions using market data, where available, and includes internal estimates as well as estimates published by rating agencies and other third-party sources. ACE projects default rates by mortgage sector considering current underlying mortgage loan performance, generally assuming:
These estimates are extrapolated along a default timing curve to estimate the total lifetime pool default rate. Other assumptions used contemplate the actual collateral attributes, including geographic concentrations, rating agency loss projections, rating actions, and current market prices. If cash flow projections indicate that losses will exceed the credit enhancement for a given tranche, then the Company does not expect to recover its amortized cost basis and recognizes an estimated credit loss in net income.
The following table presents the significant assumptions used to estimate future cash flows for specific mortgage-backed securities evaluated for potential credit loss at December 31, 2010, by sector and vintage.
|Range of Significant Assumptions Used|
|Sector(1)||Vintage||Default Rate(2)||Loss Severity Rate(2)|
|Prime||2003 and prior||11%||22%|
|ALT-A||2003 and prior||25%||41%|
|Option ARM||2003 and prior||25%||37%|
|Sub-prime||2003 and prior||48%||73%|
(1) Prime, ALT-A, and Sub-prime sector bonds are categorized based on creditworthiness of the borrower. Option ARM sector bonds are categorized based on the type of mortgage product, rather than creditworthiness of the borrower.
(2) Default rate and loss severity rate assumptions vary within a given sector and vintage depending upon the geographic concentration of the collateral underlying the bond and the level of serious delinquencies, among other factors.
Application of the methodology and assumptions described above resulted in credit losses recognized in net income for mortgage-backed securities for the year ended December 31, 2010, of $32 million. Credit losses recognized in net income for mortgage-backed securities from the date of adoption to December 31, 2009, were $56 million.
The following table presents, for the years ended December 31, 2010, 2009, and 2008, the Net realized gains (losses) and the losses included in Net realized gains (losses) and OCI as a result of conditions which caused the Company to conclude the decline in fair value of certain investments was “other-than-temporary” and the change in net unrealized appreciation (depreciation) on investments.
|(in millions of U.S. dollars)|
|OTTI on fixed maturities, gross||$||(115)||$||(536)||$||(760)|
|OTTI on fixed maturities recognized in OCI (pre-tax)||69||302||-|
|OTTI on fixed maturities, net||(46)||(234)||(760)|
|Gross realized gains excluding OTTI||569||591||654|
|Gross realized losses excluding OTTI||(143)||(398)||(740)|
|Total fixed maturities||380||(41)||(846)|
|OTTI on equity securities||-||(26)||(248)|
|Gross realized gains excluding OTTI||86||105||140|
|Gross realized losses excluding OTTI||(2)||(224)||(241)|
|Total equity securities||84||(145)||(349)|
|OTTI on other investments||(13)||(137)||(56)|
|Foreign exchange gains (losses)||(54)||(21)||23|
|Investment and embedded derivative instruments||58||68||(3)|
|Fair value adjustments on insurance derivative||(28)||368||(650)|
|S&P put options and futures||(150)||(363)||164|
|Other derivative instruments||(19)||(93)||83|
|Net realized gains (losses)||432||(196)||(1,633)|
|Change in net unrealized appreciation (depreciation) on investments:|
|Fixed maturities available for sale||451||2,723||(2,089)|
|Fixed maturities held to maturity||522||(6)||(2)|
|Income tax (expense) benefit||(152)||(481)||457|
|Change in net unrealized appreciation (depreciation) on investments||742||2,611||(2,302)|
|Total net realized gains (losses) and change in net unrealized appreciation (depreciation) on investments||$||1,174||$||2,415||$||(3,935)|
The following table presents, for the year ended December 31, 2010, and for the nine month period from the date of adoption of the then new OTTI standard to December 31, 2009, a roll-forward of pre-tax credit losses related to fixed maturities for which a portion of OTTI was recognized in OCI.
|Year Ended||Nine Months Ended|
|December 31,||December 31,|
|(in millions of U.S. dollars)|
|Balance of credit losses related to securities still held-beginning of period||$||174||$||130|
|Additions where no OTTI was previously recorded||34||104|
|Additions where an OTTI was previously recorded||12||11|
|Reductions reflecting amounts previously recorded in OCI but subsequently reflected in net income||-||(2)|
|Reductions for securities sold during the period||(83)||(69)|
|Balance of credit losses related to securities still held-end of period||$||137||$||174|
e) Other investments
The following table presents the fair value and cost of other investments at December 31, 2010 and 2009.
|Fair Value||Cost||Fair Value||Cost|
|(in millions of U.S. dollars)|
|Partially-owned investment companies||703||703||475||475|
|Life insurance policies||118||118||97||97|
Investment funds include one highly diversified funds investment as well as several direct funds that employ a variety of investment styles such as long/short equity and arbitrage/distressed. Included in limited partnerships and partially-owned investment companies are 53 individual limited partnerships covering a broad range of investment strategies including large cap buyouts, specialist buyouts, growth capital, distressed, mezzanine, real estate, and co-investments. The underlying portfolio consists of various public and private debt and equity securities of publicly traded and privately held companies and real estate assets. The underlying investments across various partnerships, geographies, industries, asset types, and investment strategies provide risk diversification within the limited partnership portfolio and the overall investment portfolio. Trading securities are comprised of $28 million of equity securities and $9 million of fixed maturities at December 31, 2010, compared with $31 million and $11 million, respectively, at December 31, 2009. The Company maintains rabbi trusts, the holdings of which include all of these trading securities in addition to life insurance policies. Refer to Note 12 f).
f) Investments in partially-owned insurance companies
The following table presents Investments in partially-owned insurance companies at December 31, 2010 and 2009.
|Carrying Value||Issued Share Capital||Ownership Percentage||Carrying Value||Issued Share Capital||Ownership Percentage||Domicile|
|(in millions of U.S. dollars, except percentages)|
|ACE Cooperative Ins. Co. - Saudi Arabia||7||27||30.0%||-||-||N/A||Saudi Arabia|
|Huatai Insurance Company||229||207||21.3%||220||202||21.3%||China|
|Huatai Life Insurance Company||112||179||20.0%||74||125||20.0%||China|
|Island Heritage||4||27||10.8%||4||27||10.8%||Cayman Islands|
|Intrepid Re Holdings Limited||-||-||N/A||-||0.2||38.5%||Bermuda|
|Rain and Hail||-||-||N/A||126||613||20.7%||United States|
Huatai Insurance Company and Huatai Life Insurance Company are China-based entities which provide a range of P&C, life, and investment products.
g) Gross unrealized loss
At December 31, 2010, there were 4,682 fixed maturities out of a total of 19,998 fixed maturities in an unrealized loss position. The largest single unrealized loss in the fixed maturities was $5 million. Fixed maturities in an unrealized loss position at December 31, 2010, were comprised of both investment grade and below investment grade securities for which fair value declined primarily due to widening credit spreads since the date of purchase and included mortgage-backed securities that suffered a decline in value since their original date of purchase.
The following tables present, for all securities in an unrealized loss position at December 31, 2010, and December 31, 2009 (including securities on loan), the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position.
|0 – 12 Months||Over 12 Months||Total|
|Fair Value||Gross Unrealized Loss||Fair Value||Gross Unrealized Loss||Fair Value||Gross Unrealized Loss|
|December 31, 2010||(in millions of U.S. dollars)|
|U.S. Treasury and agency||$||864||$||(24.6)||$||-||$||-||$||864||$||(24.6)|
|States, municipalities, and political subdivisions||1,115||(36.2)||79||(11.9)||1,194||(48.1)|
|Total fixed maturities||13,845||(292.2)||1,695||(258.5)||15,540||(550.7)|
|0 – 12 Months||Over 12 Months||Total|
|Fair Value||Gross Unrealized Loss||Fair Value||Gross Unrealized Loss||Fair Value||Gross Unrealized Loss|
|December 31, 2009||(in millions of U.S. dollars)|
|U.S. Treasury and agency||$||1,952||$||(19.4)||$||21||$||(1.1)||$||1,973||$||(20.5)|
|States, municipalities, and political subdivisions||455||(13.9)||60||(5.0)||515||(18.9)|
|Total fixed maturities||7,928||(264.4)||3,013||(551.3)||10,941||(815.7)|
h) Net investment income
The following table presents the source of net investment income for the years ended December 31, 2010, 2009, and 2008.
|(in millions of U.S. dollars)|
|Gross investment income||2,175||2,125||2,154|
|Net investment income||$||2,070||$||2,031||$||2,062|
i) Restricted assets
The Company is required to maintain assets on deposit with various regulatory authorities to support its insurance and reinsurance operations. These requirements are generally promulgated in the statutory regulations of the individual jurisdictions. The assets on deposit are available to settle insurance and reinsurance liabilities. The Company also utilizes trust funds in certain large reinsurance transactions where the trust funds are set up for the benefit of the ceding companies and generally take the place of letter of credit (LOC) requirements. The Company also has investments in segregated portfolios primarily to provide collateral or guarantees for LOCs and derivative transactions. Included in restricted assets at December 31, 2010, are fixed maturities and short-term investments totaling $12 billion and cash of $104 million. The following table presents the components of the restricted assets at December 31, 2010 and 2009
|December 31||December 31|
|(in millions of U.S. dollars)|
|Deposits with non-U.S. regulatory authorities||2,289||2,475|
|Deposits with U.S. regulatory authorities||1,384||1,199|
|Other pledged assets||190||245|
a) Consolidated reinsurance
The Company purchases reinsurance to manage various exposures including catastrophe risks. Although reinsurance agreements contractually obligate the Company's reinsurers to reimburse it for the agreed-upon portion of its gross paid losses, they do not discharge the primary liability of the Company. The amounts for net premiums written and net premiums earned in the consolidated statements of operations are net of reinsurance. The following table presents direct, assumed, and ceded premiums for the years ended December 31, 2010, 2009, and 2008.
|(in millions of U.S. dollars)|
For the years ended December 31, 2010, 2009, and 2008, the Company recorded reinsurance recoveries on losses and loss expenses incurred of $3.3 billion, $3.7 billion, and $3.3 billion, respectively.
b) Reinsurance recoverable on ceded reinsurance
The following table presents the composition of the Company's reinsurance recoverable on losses and loss expenses at December 31, 2010 and 2009.
|(in millions of U.S. dollars)|
|Reinsurance recoverable on unpaid losses and loss expenses, net of a provision for uncollectible reinsurance||$||12,149||$||12,745|
|Reinsurance recoverable on paid losses and loss expenses, net of a provision for uncollectible reinsurance||722||850|
|Net reinsurance recoverable on losses and loss expenses||$||12,871||$||13,595|
The Company evaluates the financial condition of its reinsurers and potential reinsurers on a regular basis and also monitors concentrations of credit risk with reinsurers. The provision for uncollectible reinsurance is required principally due to the failure of reinsurers to indemnify ACE, primarily because of disputes under reinsurance contracts and insolvencies. Provisions have been established for amounts estimated to be uncollectible. At December 31, 2010 and 2009, the Company recorded a provision for uncollectible reinsurance of $530 million and $582 million, respectively.
The following tables present a listing, at December 31, 2010, of the categories of the Company's reinsurers. The first category, largest reinsurers, represents all reinsurers where the gross recoverable exceeds one percent of ACE's total shareholders' equity. The provision for uncollectible reinsurance for the largest reinsurers, other reinsurers rated A- or better, and other reinsurers with ratings lower than A- is principally based on an analysis of the credit quality of the reinsurer and collateral balances. Other pools and government agencies include amounts backed by certain state and federal agencies. In certain states, insurance companies are required by law to participate in these pools. Structured settlements include annuities purchased from life insurance companies to settle claims. Since the Company retains the ultimate liability in the event that the life company fails to pay, it reflects the amount as a liability and a recoverable/receivable for GAAP purposes. Other captives include companies established and owned by the Company's insurance clients to assume a significant portion of their direct insurance risk from the Company (they are structured to allow clients to self-insure a portion of their insurance risk). It is generally the Company's policy to obtain collateral equal to expected losses. Where appropriate, exceptions are granted but only with review and approval at a senior officer level. The final category, Other, includes amounts recoverable that are in dispute or are from companies that are in supervision, rehabilitation, or liquidation. The Company establishes its provision for uncollectible reinsurance in this category based on a case by case analysis of individual situations including the merits of the underlying matter, credit and collateral analysis, and consideration of the Company's collection experience in similar situations.
|2010||Provision||% of Gross|
|Categories||(in millions of U.S. dollars, except percentages)|
|Other reinsurers balances rated A- or better||2,931||46||1.6%|
|Other reinsurers balances with ratings lower than A- or not rated||715||115||16.1%|
|Other pools and government agencies||147||8||5.4%|
|Berkshire Hathaway Insurance Group||Munich Re Group||Swiss Re Group|
|Everest Re Group||National Workers Compensation||Transatlantic Holdings|
|HDI Re Group (Hanover Re)||Reinsurance Pool||XL Capital Group|
|Lloyd's of London||Partner Re|
c) Assumed life reinsurance programs involving minimum benefit guarantees under annuity contracts
The following table presents income and expenses relating to GMDB and GLB reinsurance for the periods indicated. GLBs include GMIBs as well as some GMABs originating in Japan.
|(in millions of U.S. dollars)|
|Net premiums earned||$||109||$||104||$||124|
|Policy benefits and other reserve adjustments||$||99||$||111||$||183|
|Net premiums earned||$||164||$||159||$||150|
|Policy benefits and other reserve adjustments||29||20||31|
|Realized gains (losses)||(64)||368||(650)|
|Gain (loss) recognized in income||$||71||$||507||$||(531)|
|Effect of partial adoption of fair value measurements standard||$||-||$||-||$||4|
|Net cash received||$||160||$||156||$||150|
|Net (increase) decrease in liability||$||(89)||$||351||$||(685)|
At December 31, 2010, reported liabilities for GMDB and GLB reinsurance were $185 million and $648 million, respectively, compared with $212 million and $559 million, respectively, at December 31, 2009. The reported liability for GLB reinsurance of $648 million at December 31, 2010, and $559 million at December 31, 2009, includes a fair value derivative adjustment of $507 million and $443 million, respectively. Included in “Net realized gains (losses)” in the table above are gains (losses) related to foreign exchange and other fair value derivative adjustments; the gains (losses) related to foreign exchange for the years ended December 31, 2010, 2009, and 2008, were $(36) million, $8 million, and $(51) million, respectively. Reported liabilities for both GMDB and GLB reinsurance are determined using internal valuation models. Such valuations require considerable judgment and are subject to significant uncertainty. The valuation of these products is subject to fluctuations arising from, among other factors, changes in interest rates, changes in equity markets, changes in credit markets, changes in the allocation of the investments underlying annuitant's account values, and assumptions regarding future policyholder behavior. These models and the related assumptions are continually reviewed by management and enhanced, as appropriate, based upon improvements in modeling assumptions and availability of more information, such as market conditions and demographics of in-force annuities.
At December 31, 2010 and 2009, the Company's net amount at risk from its GMDB reinsurance programs was $2.9 billion and $3.8 billion, respectively. For GMDB reinsurance programs, the net amount at risk is defined as the present value of future claim payments under the following assumptions:
At December 31, 2010, if all of the Company's cedants' policyholders covered under GMDB reinsurance agreements were to die immediately, the total claim amount payable by the Company, taking into account all appropriate claims limits, would be approximately $1.4 billion. As a result of the annual claim limits on the GMDB reinsurance agreements, the claims payable are lower in this case than if all the policyholders were to die over time, all else equal.
At December 31, 2010 and 2009, the Company's net amount at risk from its GLB reinsurance programs was $719 million and $683 million, respectively. For GLB reinsurance programs, the net amount at risk is defined as the present value of future claim payments under the following assumptions:
The average attained age of all policyholders under all benefits reinsured, weighted by the guaranteed value of each reinsured policy, is approximately 66.
6. Intangible assets
Included in Goodwill and other intangible assets at December 31, 2010, are goodwill of $4 billion and other intangible assets of $634 million.
The following table presents a roll-forward of Goodwill by business segment for the years ended December 31, 2010 and 2009. On April 1, 2008, ACE acquired all outstanding shares of Combined Insurance Company of America and certain of its subsidiaries (Combined Insurance), generating $882 million of goodwill. The purchase price allocation adjustments in the following table reflect the final allocation of goodwill generated on the Combined Insurance acquisition to reporting segments.
|Insurance - North American||Insurance - Overseas General||Global Reinsurance||Life||ACE Consolidated|
|(in millions of U.S. dollars)|
|Balance at December 31, 2008||$||1,205||$||1,366||$||365||$||686||$||3,622|
|Purchase price allocation adjustments||-||(65)||-||61||(4)|
|Foreign exchange revaluation and other||-||196||-||-||196|
|Balance at December 31, 2009||$||1,205||$||1,497||$||365||$||747||$||3,814|
|Purchase price allocation adjustment||-||-||-||3||3|
|Acquisition of Rain and Hail||135||-||-||-||135|
|Acquisition of Jerneh||-||94||-||-||94|
|Foreign exchange revaluation and other||11||(27)||-||-||(16)|
|Balance at December 31, 2010||$||1,351||$||1,564||$||365||$||750||$||4,030|
Included in the other intangible assets balance at December 31, 2010, are intangible assets subject to amortization of $541 million and intangible assets not subject to amortization of $93 million. Intangible assets subject to amortization include agency relationships, software, client lists, and renewal rights, primarily attributable to the acquisitions of Rain and Hail and Combined Insurance. The majority of the balance of intangible assets not subject to amortization relates to Lloyd's of London (Lloyd's) Syndicate 2488 capacity. Amortization expense related to other intangible assets amounted to $9 million, $11 million, and $12 million for the years ended December 31, 2010, 2009, and 2008, respectively. Amortization expense related to other intangible assets is estimated to be between approximately $26 million and $37 million for each of the next five fiscal years.
The following table presents a roll-forward of VOBA, which was generated from the Combined Insurance acquisition, for the years ended December 31, 2010, 2009, and 2008.
|(in millions of U.S. dollars)|
|Balance, beginning of year||$||748||$||823||$||-|
|Acquisition of Combined Insurance||-||-||1,040|
|Foreign exchange revaluation||(3)||55||(133)|
|Balance, end of year||$||634||$||748||$||823|
The following table presents the estimated amortization expense related to VOBA for the next five years.
|(in millions of U.S. dollars)|
7. Unpaid losses and loss expenses
Property and casualty
The Company establishes reserves for the estimated unpaid ultimate liability for losses and loss expenses under the terms of its policies and agreements. These reserves include estimates for both claims that have been reported and for IBNR, and include estimates of expenses associated with processing and settling these claims. The process of establishing reserves for P&C claims can be complex and is subject to considerable variability as it requires the use of informed estimates and judgments. The Company's estimates and judgments may be revised as additional experience and other data become available and are reviewed, as new or improved methodologies are developed, or as current laws change. The Company continually evaluates its estimates of reserves in light of developing information and in light of discussions and negotiations with its insureds. While the Company believes that its reserves for unpaid losses and loss expenses at December 31, 2010, are adequate, new information or trends may lead to future developments in ultimate losses and loss expenses significantly greater or less than the reserves provided. Any such revisions could result in future changes in estimates of losses or reinsurance recoverable, and would be reflected in the Company's results of operations in the period in which the estimates are changed.
The following table presents a reconciliation of unpaid losses and loss expenses for the years ended December 31, 2010, 2009, and 2008.
|(in millions of U.S. dollars)|
|Gross unpaid losses and loss expenses, beginning of year||$||37,783||$||37,176||$||37,112|
|Reinsurance recoverable on unpaid losses (1)||(12,745)||(12,935)||(13,520)|
|Net unpaid losses and loss expenses, beginning of year||25,038||24,241||23,592|
|Acquisition of subsidiaries||145||-||353|
|Net losses and loss expenses incurred in respect of losses occurring in:|
|Net losses and loss expenses paid in respect of losses occurring in:|
|Foreign currency revaluation and other||(107)||323||(980)|
|Net unpaid losses and loss expenses, end of year||25,242||25,038||24,241|
|Reinsurance recoverable on unpaid losses(1)||12,149||12,745||12,935|
|Gross unpaid losses and loss expenses, end of year||$||37,391||$||37,783||$||37,176|
|(1) Net of provision for uncollectible reinsurance|
Net losses and loss expenses incurred includes $512 million, $579 million, and $814 million, of net favorable prior period development in the years ended December 31, 2010, 2009, and 2008, respectively. The following is a summary of prior period development for the periods indicated. The remaining net development for long-tail and short-tail business for each segment was comprised of numerous favorable and adverse movements across lines and accident years.
Insurance - North American
Insurance – North American's active operations experienced net favorable prior period development of $239 million in 2010, representing 1.5 percent of net unpaid reserves at December 31, 2009. Net prior period development was the net result of several underlying favorable and adverse movements. Net favorable development of $102 million on long-tail business included $49 million within the financial solutions business, primarily in the 2000 and prior accident years; favorable development of $105 million in the portfolios of D&O and E&O, primarily in the 2006 and prior accident years partially offset by adverse movements in the 2007-2009 years; and favorable development of $54 million on the national accounts portfolio primarily in the 2005, 2006, and 2009 accident years. Partially offsetting this favorable development was adverse development of $91 million in excess casualty businesses principally arising in the 2007 accident year; and adverse development of $30 million in small and middle market guaranteed cost workers' compensation portfolios on accident years 2008 and subsequent. Net prior period development also included favorable development of $15 million on other lines across a number of accident years, due primarily to following better than expected loss emergence. Net favorable development of $137 million on short-tail business included favorable development of $41 million in the crop/hail business associated with recording the most recent bordereaux for the 2009 and prior crop years; and favorable development of $96 million in property, aviation, inland and recreational marine, political risk, and other short-tailed exposures principally in accident years 2007-2009.
Insurance – North American's runoff operations experienced net adverse prior period development of $132 million in 2010, representing 0.8 percent of net unpaid reserves at December 31, 2009. Net prior period development was the net result of several underlying favorable and adverse movements, including adverse development of $114 million in the Westchester and Brandywine runoff operations, impacting accident years 1999 and prior, including $89 million related to the completion of the reserve review during 2010, and adverse development of $18 million on runoff CIS workers' compensation following emergence of higher than expected medical costs impacting accident years 2000 and prior.
Insurance – North American's active operations experienced net favorable prior period development of $267 million in 2009, representing 1.7 percent of net unpaid reserves at December 31, 2008. Net prior period development was the net result of several underlying favorable and adverse movements. Net favorable development of $162 million on long-tail business included favorable development of $42 million in foreign casualty product lines primarily impacting accident years 2004-2006; favorable development of $52 million on national accounts loss sensitive accounts unit impacting the 2005-2007 accident years; favorable development of $33 million on ACE Financial Solutions business unit concentrated in policies issued in the 2004-2006 years; and favorable development of $35 million on all other long-tail lines, including the programs division and medical risk business, concentrated within the 2006 and prior accident years. Net favorable development of $105 million on short-tail business included favorable development of $49 million mainly on political risk business, short-tail lines in the programs division, and recreational marine business, primarily relating to the 2004-2008 accident years; and favorable development of $56 million in other lines including property, crop, A&H, and other lines principally in accident years 2005-2007.
Insurance – North American's runoff operations experienced net adverse prior period development of $88 million in 2009, representing 0.5 percent of net unpaid reserves at December 31, 2008. Net prior period development was the net result of several underlying favorable and adverse movements, including adverse development of $80 million in the Brandywine operations impacting accident years 1999 and prior.
Insurance – North American experienced net favorable prior period development of $351 million in 2008, representing 2.4 percent of the segment's net unpaid loss and loss expense reserves at December 31, 2007.
Insurance – Overseas General
Insurance – Overseas General experienced net favorable prior period development of $290 million in 2010 representing 4.3 percent of net unpaid reserves at December 31, 2009. Net prior period development was the net result of several underlying favorable and adverse movements. Net favorable development of $159 million on long-tail business included favorable development of $241 million in casualty (primary and excess) and financial lines for accident years 2006 and prior, and adverse development of $82 million in the casualty (primary and excess) and financial lines book for accident years 2007-2009. Net favorable development of $131 million on short-tail business included property, marine, A&H, and energy lines across multiple geographical regions, and within both retail and wholesale operations, principally on accident years 2007-2009.
Insurance – Overseas General experienced net favorable prior period development of $255 million in 2009, representing 4.2 percent of net unpaid reserves at December 31, 2008. Net prior period development was the net result of several underlying favorable and adverse movements. Net favorable development of $140 million on long-tail business included favorable development of $201 million on the 2005 and prior accident years in casualty and financial lines, partially offset by $70 million of adverse development primarily relating to the 2008 accident year for financial lines. Net favorable development of $115 million on short-tail business included favorable development of $94 million in the property and energy, A&H, and marine lines of business mainly in accident years 2003-2008; and favorable development of $21 million on other lines including aviation relating to the 2005 and prior accident years.
Insurance – Overseas General experienced net favorable prior period development of $304 million in 2008, representing 4.7 percent of the segment's net unpaid loss and loss expense reserves at December 31, 2007.
Global Reinsurance experienced net favorable prior period development of $106 million in 2010 representing 4.7 percent of net unpaid reserves at December 31, 2009. Net prior period development was the net result of several underlying favorable and adverse movements. Net favorable development of $72 million on long-tail business included net favorable development of $96 million principally in treaty years 2003-2006 across a number of portfolios (professional liability, D&O, casualty, and medical malpractice). Net favorable development of $34 million on short-tail business, primarily in treaty years 2003-2008 across property lines, included property catastrophe, trade credit, and surety.
Global Reinsurance experienced net favorable prior period development of $142 million in 2009, representing 5.6 percent of net unpaid reserves at December 31, 2008. Net prior period development was the net result of several underlying favorable and adverse movements. Net favorable development of $93 million on long-tail business was principally related to treaty years 2003-2005 across a number of portfolios (professional liability, D&O, casualty and medical malpractice). Net favorable development of $49 million on short-tail business included property and trade credit-related lines.
Global Reinsurance experienced net favorable prior period development of $159 million in 2008, representing 5.9 percent of the segment's net unpaid loss and loss expense reserves at December 31, 2007.
Life experienced net favorable prior period development of $9 million in 2010 representing 4.0 percent of net unpaid reserves at December 31, 2009. Net prior period development was the net result of several underlying favorable and adverse movements. The favorable development was mainly related to accident year 2009 in short-tail A&H.
Life experienced net favorable prior period development of $3 million on short-tail A&H business in 2009, representing 1.4 percent of net unpaid reserves at December 31, 2008. Life experienced no net prior period development in 2008.
Asbestos and environmental (A&E) and other run-off liabilities
Included in ACE's liabilities for losses and loss expenses are amounts for A&E (A&E liabilities). The A&E liabilities principally relate to claims arising from bodily-injury claims related to asbestos products and remediation costs associated with hazardous waste sites. The estimation of ACE's A&E liabilities is particularly sensitive to future changes in the legal, social, and economic environment. ACE has not assumed any such future changes in setting the value of its A&E reserves, which include provisions for both reported and IBNR claims.
ACE's exposure to A&E claims principally arises out of liabilities acquired when it purchased Westchester Specialty in 1998 and the P&C business of CIGNA in 1999, with the larger exposure contained within the liabilities acquired in the CIGNA transaction. In 1996, prior to ACE's acquisition of the P&C business of CIGNA, the Pennsylvania Insurance Commissioner approved a plan to restructure INA Financial Corporation and its subsidiaries (the Restructuring) which included the division of Insurance Company of North America (INA) into two separate corporations:
(1) an active insurance company that retained the INA name and continued to write P&C business and
(2) an inactive run-off company, now called Century Indemnity Company (Century).
As a result of the division, predominantly all A&E and certain other liabilities of INA were allocated to Century and extinguished, as a matter of Pennsylvania law, as liabilities of INA.
As part of the Restructuring, most A&E liabilities of various U.S. affiliates of INA were reinsured to Century. Century and certain other run-off companies having A&E and other liabilities were contributed to Brandywine Holdings. As part of the 1999 acquisition of the P&C business of CIGNA, ACE acquired Brandywine Holdings and its various subsidiaries. For more information refer to “Brandywine Run-Off Entities” below.
During 2010, ACE conducted its annual internal, ground-up review of its consolidated A&E liabilities as at December 31, 2009. As a result of the internal review, the Company increased its net loss reserves for the Brandywine operations, including A&E, by $84 million (net of reinsurance provided by NICO), while the gross loss reserves increased by $247 million. In addition, the Company increased gross loss reserves for Westchester Specialty's A&E and other liabilities by $23 million, while the net loss reserves increased by $5 million. An internal review was also conducted during 2009 of consolidated A&E liabilities as at December 31, 2008. As a result of that internal review, the Company increased net loss reserves for the Brandywine operations, including A&E, by $44 million (net of reinsurance provided by NICO), while the gross loss reserves increased by $198 million. This review also resulted in the Company decreasing gross loss reserves for Westchester Specialty's A&E and other liabilities by $64 million, while the net loss reserves did not change.
In 2010, in addition to ACE's annual internal review, a team of external actuaries performed an evaluation as to the adequacy of the reserves of Century. This external review was conducted in accordance with the Brandywine Restructuring Order, which requires that an independent actuarial review of Century's reserves be completed every two years. Management takes full responsibility for the estimation of its A&E liabilities. The difference between the conclusions of the internal and external reviews is an immaterial amount on a net basis after giving effect to the reserve increases for the Brandywine operations described above.
ACE's A&E reserves are not discounted for GAAP reporting and do not reflect any anticipated future changes in the legal, social, or economic environment, or any benefit from future legislative reforms.
The table below presents a roll forward of ACE's consolidated A&E loss reserves (excluding other run-off liabilities), allocated loss expense reserves for A&E exposures, and the provision for uncollectible paid and unpaid reinsurance recoverables for the year ended December 31, 2010.