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1. General
ACE Limited (ACE or the Company) is a holding company which, until July 18, 2008, was incorporated with limited liability under the Cayman Islands Companies Law. On March 19, 2008, the Company announced that its Board of Directors (the Board) approved a proposal to move the Company’s jurisdiction of incorporation from the Cayman Islands to Zurich, Switzerland (the Continuation). On July 10, 2008, and July 14, 2008, during ACE’s annual general meeting, the Company’s shareholders approved the Continuation and ACE became a Swiss company effective July 18, 2008.
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 10.
On April 1, 2008, ACE acquired all outstanding shares of Combined Insurance Company of America (Combined Insurance) and certain of its subsidiaries from Aon Corporation for $2.56 billion. Combined Insurance is a leading underwriter and distributor of specialty individual accident and supplemental health insurance products targeted to middle income consumers and small businesses in North America, Europe, Asia Pacific, and Latin America. ACE recorded the acquisition using the purchase method of accounting. Based on ACE’s final purchase price allocation, $882 million of goodwill and $43 million of other intangible assets were generated as a result of the acquisition. Goodwill was apportioned to the Life and Insurance – Overseas General segments in the amounts of $750 million and $132 million, respectively. The acquisition also generated $1 billion of value of business acquired (VOBA) which represented the fair value of the future profits of the in-force contracts. VOBA is amortized over a period of approximately 30 years.
The interim unaudited 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. Certain items in the prior period financial statements have been reclassified to conform to the current period presentation. The results of operations and cash flows for any interim period are not necessarily indicative of the results for the full year. These financial statements should be read in conjunction with the consolidated financial statements, and related notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.
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2. Significant accounting policies
New accounting pronouncements
Adopted in the nine months ended September 30, 2009
Accounting Standards Codification
In June 2009, the Financial Accounting Standards Board (FASB) issued The FASB Accounting Standards CodificationTM embodied in Accounting Standards Codification (ASC) Topic 105, Generally Accepted Accounting Principles (the Codification). The Codification, which was launched on July 1, 2009, became the single source of authoritative nongovernmental U.S. GAAP, superseding existing FASB, American Institute of Certified Public Accountants, Emerging Issues Task Force, and related literature. The Codification establishes one level of authoritative guidance. All other literature is considered non-authoritative. The Codification is effective for financial statements issued for interim and annual periods ending after September 15, 2009.
Business combinations
ASC Topic 805, Business Combinations, contains certain provisions to be applied prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. These provisions establish standards that provide a definition of the “acquirer” and broaden the application of the acquisition method. They also establish how an acquirer recognizes and measures the assets, liabilities, and any noncontrolling interest in the “acquiree”; recognizes and measures goodwill or a gain from a bargain purchase; and require disclosures that enable users to evaluate the nature and financial effects of the business combination. The adoption of these provisions may have a material impact on any future business combinations consummated by ACE, but did not have any effect on previously consummated business acquisitions.
ASC Topic 805, Business Combinations, also contains certain provisions specifically related to accounting for assets acquired and liabilities assumed in a business combination that arise from contingencies that are effective for all business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. These provisions amend practices related to initial recognition and measurement, subsequent measurement, and disclosure of assets and liabilities arising from contingencies acquired in business combinations and require acquired contingencies to be recognized at acquisition date fair value if fair value can be reasonably estimated during the allocation period. Otherwise, acquired contingencies would typically be accounted for in accordance with ASC Topic 450, Contingencies. The adoption of these provisions may have a material impact on any future business combinations consummated by ACE, but did not have any effect on previously consummated business acquisitions.
ASC Topic 350, Intangibles-Goodwill and Other, contains certain provisions related to accounting for defensive intangible assets that are effective for intangible assets acquired on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. These provisions require fair value be assigned to acquired defensive intangible assets and a useful life be assigned to a defensive intangible asset based on the period over which the reporting entity expects the asset to contribute directly or indirectly to future cash flows. The adoption of these provisions may have a material impact on any future intangible assets acquired by ACE, but did not have any effect on any previously acquired intangible assets.
Noncontrolling interests
ASC Topic 810, Consolidation, contains certain provisions effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. These provisions establish accounting and reporting standards that require that ownership interests in subsidiaries held by parties other than the parent be presented in the consolidated statement of shareholders’ equity separately from the parent’s equity; the consolidated net income attributable to the parent and noncontrolling interest be presented on the face of the consolidated statements of operations; changes in a parent’s ownership interest while the parent retains controlling financial interest in its subsidiary be accounted for consistently; and disclosure that identifies and distinguishes between the interests of the parent and noncontrolling owners. The adoption of these provisions did not have a material impact on ACE’s financial condition or results of operations.
Disclosures about derivative instruments and hedging activities
ASC Topic 815, Derivatives and Hedging, contains certain provisions effective for fiscal years, and interim periods within those fiscal years, beginning on or after November 15, 2008. These provisions establish reporting standards that require enhanced disclosures about how and why derivative instruments are used, how derivative instruments are accounted for, and how derivative instruments affect an entity’s financial position, financial performance, and cash flows. ACE adopted these provisions effective January 1, 2009. Refer to Note 6.
Determination of the useful life of intangible assets
ASC Topic 350, Intangibles-Goodwill and Other, contains certain provisions related to the determination of the useful life of intangible assets effective for financial statements issued for fiscal years beginning after December 15, 2008, that must be applied prospectively to intangible assets acquired after the effective date. These provisions amend the factors considered in developing assumptions used to determine the useful life of an intangible asset with the intention of improving the consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value of the asset under ASC Topic 805, Business Combinations, and other applicable accounting literature. The adoption of these provisions may have a material impact on any future intangible assets acquired by ACE, but did not have a material impact on the useful lives of previously acquired intangible asset.
Financial guarantee insurance contracts
ASC Topic 944, Financial Services—Insurance, contains certain provisions that are effective for financial statements issued for fiscal years beginning after December 15, 2008, except for some disclosures about the insurance enterprise’s risk management activities. These provisions require that disclosures about the risk management activities of the insurance enterprise be effective for the first period beginning after issuance. Except for those disclosures, earlier application is not permitted. The provisions require that an insurance enterprise recognize a claim liability prior to an event of default when there is evidence that credit deterioration has occurred in an insured financial obligation. They also clarify the recognition and measurement to be used to account for premium revenue and claim liabilities, and require expanded disclosures about financial guarantee insurance contracts. ACE’s exposure to these provisions is principally through its investment in the common shares of Assured Guaranty Ltd (AGO). The adoption of these provisions did not have a material impact on ACE’s financial condition or results of operations.
Earnings per share
ASC Topic 260, Earnings Per Share, contains certain provisions effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2008. These provisions provide additional guidance in the calculation of earnings per share, and require unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) to be included in the computation of earnings per share pursuant to the two-class method. The adoption of these provisions did not have a material impact on ACE’s financial condition or results of operations.
Equity method accounting
ASC Topic 323, Investments-Equity Method and Joint Ventures, contains certain provisions that are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. These provisions provide guidance for equity method accounting for specific topics and require an equity method investor account for share issuances, and resulting dilutive effect, by an investee as if the investor had sold a proportionate share of its investment with the resulting gain or loss recognized in earnings. In connection with the adoption of these provisions, ACE recognized a $57 million pre-tax loss upon a June 2009 share issuance by AGO. Refer to Note 3 e).
Fair value measurements
ASC Topic 820, Fair Value Measurements and Disclosures, includes provisions that are effective for interim and annual periods ending after June 15, 2009. These provisions provide additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased. The adoption of these provisions did not have a material impact on ACE’s financial condition or results of operations.
Fair value disclosures
ASC Topic 825, Financial Instruments, includes new provisions that require disclosures about fair value of financial instruments for interim reporting periods as well as in annual financial statements. ACE adopted these provisions which were effective for interim and annual periods ending after June 15, 2009.
Other-than-temporary impairments
ASC Topic 320, Investments-Debt and Equity Securities, contains certain provisions that are effective for interim and annual periods ending after June 15, 2009 that amends OTTI guidance in existing GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of OTTI on debt and equity securities in the financial statements. The adoption of these provisions did not have a material impact on ACE’s financial condition or results of operations. Refer to Note 3.
Subsequent events
ASC Topic 855, Subsequent Events, contains certain provisions that are effective for interim and annual periods ending after June 15, 2009. These provisions set forth: 1) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; 2) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and 3) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. The adoption of these provisions did not impact ACE’s financial condition or results of operations.
To be adopted after September 30, 2009
Consolidation of variable interest entities and accounting for transfers of financial assets
In June 2009, the FASB issued Financial Accounting Standard (FAS) No. 166, Accounting for Transfers of Financial Assets—an amendment of FASB Statement No. 140 (FAS 166) and FAS No. 167, Amendments to FASB Interpretation No. 46(R) (FAS 167). FAS 166 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. FAS 167 amends 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. FAS 166 and FAS 167 are effective for interim and annual reporting periods beginning on January 1, 2010. ACE does not expect the adoption of these provisions to have a material impact on ACE’s financial condition or results of operations.
Fair value of alternative investments
In September 2009, the FASB issued Accounting Standards Update (ASU) No. 2009-12, Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent ) (ASU 2009-12). The provisions of ASU 2009-12 amend ASC 820-10, Fair Value Measurements and Disclosures – Overall, to provide additional guidance on estimating the fair value of certain alternative investments. These provisions create a practical expedient to measure the fair value of an alternative investment on the basis of the net asset value per share of the investment. These provisions also improve transparency by requiring additional disclosures about the attributes of alternative investments to enable users of the financial statements to understand the nature and risks of the investments. ASU 2009-12 is effective for interim and annual reporting periods beginning October 1, 2009. ACE does not expect the adoption of these provisions to have a material impact on ACE’s financial condition or results of operations.
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3. Investments
a) Transfers of securities
As part of the Company’s fixed income diversification strategy, ACE has decided to hold to maturity certain commercial mortgage-backed securities that have shorter term durations. Because the Company has the intent to hold these securities to maturity, a transfer of such securities with a fair value of $704 million was made during the three months ended June 30, 2009, from Fixed maturities available for sale to Fixed maturities held to maturity. The $4 million unrealized depreciation at the date of the transfer continues to be reported as a component of Accumulated other comprehensive income 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) Net realized gains (losses)
The Company adopted provisions included in ASC Topic 320, Investments-Debt and Equity Securities, related to the recognition and presentation of OTTI as of April 1, 2009. Under these provisions, when an OTTI related to a fixed maturity security 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. 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 included in other comprehensive income. For fixed maturities held to maturity, OTTI recognized in other comprehensive income is accreted from accumulated other comprehensive income 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 newly adopted 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 Accumulated other comprehensive income and an increase to Retained earnings of $242 million as of April 1, 2009. 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 have not suffered a credit loss, the Company does not intend to sell, and it is more likely than not that ACE will not be required to sell before the recovery of their amortized cost. These amounts include a $25 million adjustment ($44 million pre-tax) recorded by ACE in the third quarter of 2009. The $44 million pre-tax adjustment reflects the true-up of ACE’s prior estimate of reversals of non-credit OTTI for securities impaired prior to 2006 (Pre-2006 OTTI) for which a detailed review of securities held at the adoption date of the new OTTI standards was not completed until the third quarter of 2009. Upon completion of the detailed review of securities held at the adoption date, ACE determined that fewer Pre-2006 OTTI securities were held than previously estimated, which resulted in an overstatement of the original reversal estimate of non-credit OTTI on Pre-2006 OTTI. The adjustment resulted in an increase to Accumulated other comprehensive income and an offsetting decrease in Retained earnings with no impact on net income or shareholders’ equity.
Retained earnings and Deferred tax assets as of April 1, 2009, were also reduced by $47 million as a result of an increase in the Company’s valuation allowance against deferred tax assets, which is a direct effect of the adoption. Specifically, as a result of the reassessment of credit losses required by this adoption, ACE determined that certain previously impaired fixed maturity securities had suffered credit losses in excess of previously estimated amounts, which may give rise to additional future capital losses for tax purposes. Given the amount of available capital gains against which such additional capital losses could be offset, at the date of adoption, the Company expected that a portion of capital loss carry forwards would expire unused. Accordingly, ACE determined that an additional valuation allowance was necessary given that it was considered more likely than not that a portion of deferred tax assets related to previously impaired fixed income securities would not be realized.
Each quarter, the Company reviews its securities in an unrealized loss position (impaired securities), including fixed maturity securities, 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, 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, an OTTI is considered to have occurred. 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 evaluates the security to determine if a credit loss has occurred primarily based on a combination of qualitative and quantitative factors including a discounted cash flow model, where necessary. If a credit loss is indicated, an OTTI is considered to have occurred. 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 factors that the Company now considers when determining if a credit loss exists related to a fixed maturity security are discussed in “Evaluation of potential credit losses related to fixed maturities” below.
The Company reviews all non-fixed maturity investments 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 security 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 $30 million of gross unrealized loss as of September 30, 2009. 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 credit worthiness of the issuers coupled with credit enhancement, where applicable, supports recognizing no credit loss in net income.
Corporate securities
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. Default assumptions by Moody’s rating category are as follows (historical mean default rate provided for comparison):
| 1-in-100 Year | Historical Mean | |||
| Moody's Rating Category | Default Rate | Default Rate | ||
| Investment Grade: | ||||
| Aaa-Baa | 0.0%-1.4% | 0.0%-0.3% | ||
| Below Investment Grade: | ||||
| Ba | 4.8% | 1.1% | ||
| B | 12.8% | 3.4% | ||
| Caa-C | 51.6% | 13.1% |
Consistent with our 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 three months ended September 30, 2009, of $15 million and from the date of adoption to September 30, 2009, of $49 million, substantially all of which relates to below investment grade securities.
Mortgage-backed securities
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 significant assumptions used to estimate future cash flows for specific mortgage-backed securities evaluated for potential credit loss as of September 30, 2009, by sector and vintage are as follows:
| Range of Significant Assumptions Used | ||||||||
| Sector(1) | Vintage | Default Rate(2) | Loss Severity Rate(2) | |||||
| Prime | 2004 and prior | 7-29% | 35-54% | |||||
| 2005 | 7-42% | 45-62% | ||||||
| 2006 | 18-40% | 43-69% | ||||||
| 2007 | 11-58% | 48-71% | ||||||
| ALT-A | 2004 and prior | 14% | 50% | |||||
| 2005 | 5-27% | 46-65% | ||||||
| 2006 | 5-40% | 57-67% | ||||||
| 2007 | 25-42% | 60-69% | ||||||
| Sub-prime(3) | 2004 and prior | 56% | 63% | |||||
| 2005 | 74% | 74% | ||||||
| 2006 | 23-82% | 73-79% | ||||||
| 2007 | 25-82% | 75-78% | ||||||
| Option ARM | 2004 and prior | 43% | 45% | |||||
| 2005 | 57-82% | 55-62% | ||||||
| 2006 | 72-79% | 63-67% | ||||||
| 2007 | 68-71% | 61-63% | ||||||
(1) Prime, ALT-A, and Sub-prime sector bonds are categorized based on credit worthiness of the borrower. Option ARM sector bonds are categorized based on the type of mortgage product, rather than credit worthiness 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.
(3) The sub-prime population of securities in the portfolio is nominal. Accordingly, the default rate and loss severity rates are banded more tightly than for other sectors where the population of securities is larger and more diverse.
Application of the methodology and assumptions described above resulted in credit losses recognized in net income for mortgage-backed securities for the three months ended September 30, 2009, of $24 million and from the date of adoption to September 30, 2009, of $50 million. Given the variation in ratings between major rating agencies for the securities for which a credit loss was recognized in net income, ACE does not believe it is useful to provide the credit loss split between investment grade and below investment grade.
The following table shows, for the periods indicated, the Net realized gains (losses) and the losses included in Net realized gains (losses) and Other comprehensive income as a result of conditions which caused the Company to conclude the decline in fair value of certain investments was “other-than-temporary”. The impairments recorded in net income related to fixed maturities for the nine months ended September 30, 2009, were primarily due to securities with below investment grade credit ratings and intent to sell securities in an unrealized loss position. Impairments related to all other investments were primarily due to duration and severity of decline below cost.
| Three Months Ended | Nine Months Ended | ||||||||||
| September 30 | September 30 | ||||||||||
| 2009 | 2008 | 2009 | 2008 | ||||||||
| (in millions of U.S. dollars) | |||||||||||
| Fixed maturities: | |||||||||||
| OTTI on fixed maturities, gross | $ | (150) | $ | (196) | $ | (519) | $ | (495) | |||
| OTTI on fixed maturities included in other comprehensive income (pre-tax) | 111 | - | 302 | - | |||||||
| OTTI on fixed maturities, net | (39) | (196) | (217) | (495) | |||||||
| Net realized gains (losses) excluding OTTI | 38 | (76) | 97 | (80) | |||||||
| Total fixed maturities | (1) | (272) | (120) | (575) | |||||||
| Equity securities: | |||||||||||
| OTTI on equity securities | - | (28) | (26) | (103) | |||||||
| Net realized gains (losses) excluding OTTI | 1 | (98) | (154) | (64) | |||||||
| Total equity securities | 1 | (126) | (180) | (167) | |||||||
| OTTI on other investments | (19) | - | (121) | (25) | |||||||
| Net realized gains (losses) on other investments excluding OTTI | 3 | 4 | (12) | 6 | |||||||
| Foreign exchange gains (losses) | (7) | 15 | (31) | 33 | |||||||
| Investment and embedded derivative instruments | 28 | 15 | 62 | (10) | |||||||
| Fair value adjustments on insurance derivative | (65) | (189) | 218 | (319) | |||||||
| S&P put options and futures | (144) | 28 | (300) | 40 | |||||||
| Other derivative instruments | (19) | 15 | (85) | 28 | |||||||
| Net realized gains (losses) | $ | (223) | $ | (510) | $ | (569) | $ | (989) | |||
The following table provides, for the three months ended September 30, 2009, and for the six month period from the date of adoption to September 30, 2009, a roll forward of pre-tax credit losses related to fixed maturities for which a portion of OTTI was recorded in Other comprehensive income.
| Three Months Ended | Six Months Ended | ||||||||||||||
| September 30, 2009 | September 30, 2009 | ||||||||||||||
| (in millions of U.S. Dollars) | |||||||||||||||
| Balance of credit losses related to securities still held-beginning of period | $ | 188 | $ | 130 | |||||||||||
| Additions where no OTTI was previously recorded | 24 | 78 | |||||||||||||
| Additions where an OTTI was previously recorded | 15 | 21 | |||||||||||||
| Reductions reflecting amounts previously recorded in Other comprehensive income but subsequently reflected in net income | - | (2) | |||||||||||||
| Reductions for securities sold during the period | (10) | . | (10) | ||||||||||||
| Balance of credit losses related to securities still held-end of period | $ | 217 | $ | 217 | |||||||||||
c) 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 OTTI included in Accumulated other comprehensive income.
| September 30, 2009 | |||||||||||||||||
| Amortized Cost | Gross Unrealized Appreciation | Gross Unrealized Depreciation | Fair Value | OTTI Included in Accumulated Other Comprehensive Income | |||||||||||||
| (in millions of U.S. dollars) | |||||||||||||||||
| Available for sale | |||||||||||||||||
| U.S. Treasury and agency | $ | 3,417 | $ | 85 | $ | (7) | $ | 3,495 | $ | - | |||||||
| Foreign | 10,484 | 390 | (173) | 10,701 | (29) | ||||||||||||
| Corporate securities | 12,546 | 617 | (201) | 12,962 | (47) | ||||||||||||
| Mortgage-backed securities | 9,925 | 281 | (524) | 9,682 | (261) | ||||||||||||
| States, municipalities, and political subdivisions | 1,632 | 90 | (3) | 1,719 | - | ||||||||||||
| $ | 38,004 | $ | 1,463 | $ | (908) | $ | 38,559 | $ | (337) | ||||||||
| Held to maturity | |||||||||||||||||
| U.S. Treasury and agency | $ | 879 | $ | 41 | $ | - | $ | 920 | $ | - | |||||||
| Foreign | 28 | 1 | - | 29 | - | ||||||||||||
| Corporate securities | 340 | 11 | (1) | 350 | - | ||||||||||||
| Mortgage-backed securities | 1,495 | 41 | (11) | 1,525 | - | ||||||||||||
| States, municipalities, and political subdivisions | 697 | 12 | (1) | 708 | - | ||||||||||||
| $ | 3,439 | $ | 106 | $ | (13) | $ | 3,532 | $ | - | ||||||||
| December 31, 2008 | |||||||||||||||||
| Amortized Cost | Gross Unrealized Appreciation | Gross Unrealized Depreciation | Fair Value | ||||||||||||||
| (in millions of U.S. dollars) | |||||||||||||||||
| Available for sale | |||||||||||||||||
| U.S. Treasury and agency | $ | 1,991 | $ | 133 | $ | (2) | $ | 2,122 | |||||||||
| Foreign | 8,625 | 278 | (529) | 8,374 | |||||||||||||
| Corporate securities | 10,093 | 89 | (1,121) | 9,061 | |||||||||||||
| Mortgage-backed securities | 10,958 | 221 | (1,019) | 10,160 | |||||||||||||
| States, municipalities, and political subdivisions | 1,442 | 38 | (42) | 1,438 | |||||||||||||
| $ | 33,109 | $ | 759 | $ | (2,713) | $ | 31,155 | ||||||||||
| Held to maturity | |||||||||||||||||
| U.S. Treasury and agency | $ | 862 | $ | 61 | $ | - | $ | 923 | |||||||||
| Foreign | 38 | 1 | (1) | 38 | |||||||||||||
| Corporate securities | 405 | 2 | (15) | 392 | |||||||||||||
| Mortgage-backed securities | 877 | 11 | (62) | 826 | |||||||||||||
| States, municipalities, and political subdivisions | 678 | 9 | (1) | 686 | |||||||||||||
| $ | 2,860 | $ | 84 | $ | (79) | $ | 2,865 | ||||||||||
Fixed maturities at September 30, 2009, and December 31, 2008, by contractual maturity, are shown below. Expected maturities could differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties.
| September 30 | December 31 | ||||||||||
| 2009 | 2008 | ||||||||||
| Fair Value | Amortized Cost | Fair Value | Amortized Cost | ||||||||
| (in millions of U.S. dollars) | |||||||||||
| Available for sale; maturity period | |||||||||||
| Due in 1 year or less | $ | 1,173 | $ | 1,157 | $ | 1,047 | $ | 1,047 | |||
| Due after 1 year through 5 years | 14,422 | 13,999 | 9,706 | 9,868 | |||||||
| Due after 5 years through 10 years | 9,791 | 9,344 | 6,867 | 7,330 | |||||||
| Due after 10 years | 3,491 | 3,579 | 3,375 | 3,906 | |||||||
| 28,877 | 28,079 | 20,995 | 22,151 | ||||||||
| Mortgage-backed securities | 9,682 | 9,925 | 10,160 | 10,958 | |||||||
| $ | 38,559 | $ | 38,004 | $ | 31,155 | $ | 33,109 | ||||
| Held to maturity; maturity period | |||||||||||
| Due in 1 year or less | $ | 686 | $ | 674 | $ | 327 | $ | 325 | |||
| Due after 1 year through 5 years | 1,107 | 1,067 | 1,401 | 1,364 | |||||||
| Due after 5 years through 10 years | 130 | 120 | 227 | 212 | |||||||
| Due after 10 years | 84 | 83 | 84 | 82 | |||||||
| 2,007 | 1,944 | 2,039 | 1,983 | ||||||||
| Mortgage-backed securities | 1,525 | 1,495 | 826 | 877 | |||||||
| $ | 3,532 | $ | 3,439 | $ | 2,865 | $ | 2,860 | ||||
d) Equity securities
The fair value, cost of, and gross unrealized appreciation (depreciation) on equity securities at September 30, 2009, and December 31, 2008, are as follows:
| September 30 | December 31 | |||||||
| 2009 | 2008 | |||||||
| (in millions of U.S. dollars) | ||||||||
| Equity securities–cost | $ | 492 | $ | 1,132 | ||||
| Gross unrealized appreciation | 54 | 74 | ||||||
| Gross unrealized depreciation | - | (218) | ||||||
| Equity securities–fair value | $ | 546 | $ | 988 | ||||
e) Investment in AGO
AGO, a Bermuda-based holding company provides, through its operating subsidiaries, credit enhancement products to the public finance, structured finance, and mortgage markets. On July 1, 2009, AGO acquired Financial Security Assurance Holdings Ltd. from Dexia Holdings Inc., a subsidiary of Dexia S.A. The purchase price included approximately $546 million in cash and approximately 22.3 million AGO common shares, according to AGO’s public filings. AGO financed the cash portion of the purchase price partly through a June 2009 issuance of 38.5 million common shares before the exercise of any overallotment option (June 2009 issuance), according to AGO’s public filings. Prior to the June 2009 issuance, ACE included its investment in AGO in Investments in partially-owned insurance companies using the equity method of accounting. Effective with the June 2009 issuance, ACE was deemed to no longer exert significant influence over AGO for accounting purposes and accounts for the investment in AGO as an available-for-sale equity security. ACE accounted for AGO’s June 2009 issuance, and resulting dilutive effect, as if the Company had sold a proportionate share of the investment, and recognized a $57 million pre-tax loss in Net realized gains (losses). As of September 30, 2009, the fair value of the Company’s investment in AGO was $372 million and $37 million of unrealized gain on this investment is reflected in Accumulated other comprehensive income.
f) Gross unrealized loss
As of September 30, 2009, there were 3,741 fixed maturities out of a total of 17,981 fixed maturities in an unrealized loss position. The largest single unrealized loss in the fixed maturities was $28 million. The tightening of credit spreads in the six month period leading up to September 30, 2009, particularly during the three months ended September 30, 2009, resulted in a reduction to net unrealized losses. In addition, greater global demand-driven purchases of fixed income investments and a greater demand for risk-based assets contributed to this reduction. The fixed maturities in an unrealized loss position at September 30, 2009, 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.
The following tables summarize, for all securities in an unrealized loss position at September 30, 2009, and December 31, 2008 (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 | ||||||||||||
| September 30, 2009 | (in millions of U.S. dollars) | ||||||||||||||||
| U.S. Treasury and agency | $ | 405 | $ | (7.0) | $ | 6 | $ | (0.2) | $ | 411 | $ | (7.2) | |||||
| Foreign | 1,688 | (122.1) | 484 | (51.3) | 2,172 | (173.4) | |||||||||||
| Corporate securities | 1,084 | (74.3) | 1,453 | (128.1) | 2,537 | (202.4) | |||||||||||
| Mortgage-backed securities | 624 | (48.0) | 2,016 | (486.8) | 2,640 | (534.8) | |||||||||||
| States, municipalities, and political subdivisions | 84 | (0.7) | 67 | (2.9) | 151 | (3.6) | |||||||||||
| Total fixed maturities | 3,885 | (252.1) | 4,026 | (669.3) | 7,911 | (921.4) | |||||||||||
| Other investments | 196 | (25.3) | 190 | (68.5) | 386 | (93.8) | |||||||||||
| Total | $ | 4,081 | $ | (277.4) | $ | 4,216 | $ | (737.8) | $ | 8,297 | $ | (1,015.2) | |||||
Included in the “0 – 12 Months” and “Over 12 Months” aging categories at September 30, 2009, are fixed maturities held to maturity with combined fair values of $107 million and $263 million, respectively. The associated gross unrealized losses included in the “0 – 12 Months” and “Over 12 Months” aging categories are $1 million and $12 million, respectively. Fixed maturities in a gross unrealized loss position for over 12 months principally comprise non-credit losses on investment grade securities where management does not intend to sell and it is more likely than not that ACE will not be required to sell the security before recovery. For mortgage-backed securities in a gross unrealized loss position for over 12 months, management also considered credit enhancement in concluding the securities were not other-than-temporarily impaired. Gross unrealized gains as of September 30, 2009, were $2 billion.
| 0 – 12 Months | Over 12 Months | Total | |||||||||||||||
| Fair Value | Gross Unrealized Loss | Fair Value | Gross Unrealized Loss | Fair Value | Gross Unrealized Loss | ||||||||||||
| December 31, 2008 | (in millions of U.S. dollars) | ||||||||||||||||
| U.S. Treasury and agency | $ | 605 | $ | (2.5) | $ | - | $ | - | $ | 605 | $ | (2.5) | |||||
| Foreign | 2,488 | (335.7) | 587 | (194.4) | 3,075 | (530.1) | |||||||||||
| Corporate securities | 5,815 | (884.2) | 1,228 | (251.3) | 7,043 | (1,135.5) | |||||||||||
| Mortgage-backed securities | 4,242 | (880.0) | 319 | (200.1) | 4,561 | (1,080.1) | |||||||||||
| States, municipalities, and political subdivisions | 331 | (23.1) | 109 | (20.5) | 440 | (43.6) | |||||||||||
| Total fixed maturities | 13,481 | (2,125.5) | 2,243 | (666.3) | 15,724 | (2,791.8) | |||||||||||
| Equity securities | 694 | (217.7) | 13 | (0.5) | 707 | (218.2) | |||||||||||
| Other investments | 508 | (175.9) | 58 | (17.3) | 566 | (193.2) | |||||||||||
| Total | $ | 14,683 | $ | (2,519.1) | $ | 2,314 | $ | (684.1) | $ | 16,997 | $ | (3,203.2) | |||||
Included in the “0 – 12 Months” and “Over 12 Months” aging categories at December 31, 2008, are fixed maturities held to maturity with combined fair values of $729 million and $105 million, respectively. The associated gross unrealized losses included in the “0 – 12 Months” and “Over 12 Months” aging categories were $59 million and $20 million, respectively. Gross unrealized gains as of December 31, 2008 were $1.1 billion.
g) 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. At September 30, 2009, restricted assets of $12.5 billion are included in fixed maturities and short-term investments, with the balance included in equity securities and cash. The components of the fair value of the restricted assets at September 30, 2009, and December 31, 2008, are as follows.
| September 30 | December 31 | |||||||
| 2009 | 2008 | |||||||
| (in millions of U.S. dollars) | ||||||||
| Deposits with U.S. regulatory authorities | $ | 1,201 | $ | 1,165 | ||||
| Deposits with non-U.S. regulatory authorities | 2,524 | 1,863 | ||||||
| Other pledged assets | 628 | 805 | ||||||
| Trust funds | 8,376 | 7,712 | ||||||
| $ | 12,729 | $ | 11,545 | |||||
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4. Assumed life reinsurance programs involving minimum benefit guarantees under annuity contracts
The presentation of income and expenses relating to guaranteed minimum death benefits (GMDB) and guaranteed minimum income benefits (GMIB) reinsurance for the periods indicated, are as follows:
| Three Months Ended | Nine Months Ended | ||||||||||
| September 30 | September 30 | ||||||||||
| 2009 | 2008 | 2009 | 2008 | ||||||||
| (in millions of U.S. dollars) | |||||||||||
| GMDB | |||||||||||
| Net premiums earned | $ | 28 | $ | 31 | $ | 78 | $ | 95 | |||
| Policy benefits | $ | 29 | $ | 60 | $ | 94 | $ | 107 | |||
| GMIB | |||||||||||
| Net premiums earned | $ | 41 | $ | 37 | $ | 120 | $ | 109 | |||
| Policy benefits | $ | 6 | $ | (21) | $ | 14 | $ | (6) | |||
| Realized gains (losses) | $ | (65) | $ | (189) | $ | 218 | $ | (319) | |||
| Gain (loss) recognized in income | $ | (30) | $ | (131) | $ | 324 | $ | (204) | |||
| Effect of partial adoption of fair value measurements standard | $ | - | $ | - | $ | - | $ | 4 | |||
| Net cash received (disbursed) | $ | 41 | $ | 36 | $ | 119 | $ | 109 | |||
| Net (increase) decrease in liability | $ | (71) | $ | (167) | $ | 205 | $ | (317) | |||
At September 30, 2009, reported liabilities for GMDB and GMIB reinsurance were $220 million and $705 million, respectively, compared with $248 million and $910 million, respectively, at December 31, 2008. The reported liability for GMIB reinsurance of $705 million at September 30, 2009, and $910 million at December 31, 2008, includes a fair value derivative adjustment of $593 million and $811 million, respectively. Reported liabilities for both GMDB and GMIB 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 timely information, such as market conditions and demographics of in-force annuities.
GMDB reinsurance
At September 30, 2009, and December 31, 2008, the Company’s net amount at risk from its GMDB reinsurance programs was $4 billion and $4.7 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 September 30, 2009, 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 $1.3 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.
GMIB reinsurance
At September 30, 2009, the Company’s net amount at risk from its GMIB reinsurance programs was $924 million, compared with $2.1 billion at December 31, 2008. For GMIB, 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 65.
|
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5. Debt
The following table outlines the Company’s debt as of September 30, 2009, and December 31, 2008.
| September 30 | December 31 | |||||
| 2009 | 2008 | |||||
| (in millions of U.S. dollars) | ||||||
| Short-term debt | ||||||
| ACE INA subordinated notes due 2009 | $ | 200 | $ | 205 | ||
| ACE INA term loan due 2009 | - | 16 | ||||
| Reverse repurchase agreements | - | 250 | ||||
| $ | 200 | $ | 471 | |||
| Long-term debt | ||||||
| ACE European Holdings due 2010 | $ | 163 | $ | 149 | ||
| ACE INA term loan due 2011 | 50 | 50 | ||||
| ACE INA term loan due 2013 | 450 | 450 | ||||
| ACE INA senior notes due 2014 | 500 | 499 | ||||
| ACE INA senior notes due 2015 | 446 | 446 | ||||
| ACE INA senior notes due 2017 | 500 | 500 | ||||
| ACE INA senior notes due 2018 | 300 | 300 | ||||
| ACE INA senior notes due 2019 | 500 | - | ||||
| ACE INA debentures due 2029 | 100 | 100 | ||||
| ACE INA senior notes due 2036 | 298 | 298 | ||||
| Other | 14 | 14 | ||||
| $ | 3,321 | $ | 2,806 | |||
| Trust Preferred Securities | ||||||
| ACE INA capital securities due 2030 | $ | 309 | $ | 309 | ||
a) Short-term debt
The Company had executed reverse repurchase agreements with certain counterparties under which the Company agreed to sell securities and repurchase them at a future date for a predetermined price. All reverse repurchase agreements have been settled during 2009.
In September 2009, the Company repaid the $16 million ACE INA nine-month term loan.
b) ACE INA notes
In June 2009, ACE INA issued $500 million of 5.9 percent senior notes due June 2019. These notes are redeemable at any time at ACE INA’s option subject to a “make-whole” premium plus 0.40 percent. The notes are also redeemable at par plus accrued and unpaid interest in the event of certain changes in tax law. The notes do not have the benefit of any sinking fund. These senior unsecured notes are guaranteed on a senior basis by the Company and they rank equally with all of the Company’s other senior obligations. They also contain customary limitations on lien provisions as well as customary events of default provisions which, if breached, could result in the accelerated maturity of such senior debt.
|
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6. Commitments, contingencies, and guarantees
a) Derivative instruments
Derivative instruments employed
The Company maintains positions in derivative instruments such as futures, options, swaps, and foreign currency forward contracts for which the primary purposes are to manage duration and foreign currency exposure, yield enhancement, or to obtain an exposure to a particular financial market. Along with convertible bonds and to be announced mortgage-backed securities, discussed below, these are the most numerous and frequent derivative transactions.
ACE maintains positions in certain convertible bond investments that contain embedded derivatives. In addition, the Company purchases to be announced mortgage-backed securities (TBA) as part of its investing activities. These securities are included within the Company’s fixed maturities available for sale (FM AFS) portfolio.
Under reinsurance programs covering living benefit guarantees, the Company assumes the risk of GMIBs 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 Company’s GMIB reinsurance product meets the definition of a derivative instrument. Benefit reserves in respect of GMIBs are classified as Future policy benefits (FPB) while the fair value derivative adjustment is classified within Accounts payable, accrued expenses, and other liabilities (AP). The Company also maintains positions in certain exchange-traded equity futures contracts and options on equity market futures to limit equity and interest rate exposure in the GMDB and GMIB block of business.
In relation to certain long- and short-term debt issues, the Company has entered into interest rate swap transactions for the purpose of either fixing or reducing borrowing costs. ACE buys credit default swaps to mitigate global credit risk exposure, primarily related to reinsurance recoverable.
The Company carries all derivative instruments at fair value with changes in fair value recorded in Net realized gains (losses) in the consolidated statements of operations. None of the derivative instruments are used as hedges for accounting purposes.
The following table outlines the balance sheet locations, fair values in an asset or (liability) position, and notional values/payment provisions of the Company’s derivative instruments at September 30, 2009.
| September 30, 2009 | ||||||
| Consolidated Balance Sheet Location | Fair Value | Notional Value/ Payment Provision | ||||
| (in millions of U.S. dollars) | ||||||
| Investment and embedded derivative instruments | ||||||
| Foreign currency forward contracts | AP | $ | (3) | $ | 267 | |
| Futures contracts on money market instruments | AP | 4 | 5,389 | |||
| Futures contracts on notes and bonds | AP | 1 | 389 | |||
| Options on notes and bonds futures | AP | (1) | 78 | |||
| Convertible bonds | FM AFS | 341 | 594 | |||
| TBAs | FM AFS | 18 | 17 | |||
| $ | 360 | $ | 6,734 | |||
| Other derivative instruments | ||||||
| Futures contracts on equities | AP | $ | (15) | $ | 919 | |
| Options on equity market futures | AP | 64 | 250 | |||
| Interest rate swaps | AP | (26) | 500 | |||
| Credit default swaps | AP | 9 | 350 | |||
| Other | AP | 11 | 59 | |||
| $ | 43 | $ | 2,078 | |||
| GMIB(1) | AP/FPB | $ | (705) | $ | 924 | |
(1)Note that the payment provision related to GMIB is the net amount at risk. The concept of a notional value does not apply to the GMIB reinsurance contracts.
The following table outlines derivative instrument activity in the consolidated statement of operations for the three and nine months ended September 30, 2009. All amounts are reflected in Net realized gains (losses) in the consolidated statement of operations.
| Three Months Ended | Nine Months Ended | ||||||
| September 30, 2009 | September 30, 2009 | ||||||
| (in millions of U.S. dollars) | |||||||
| Investment and embedded derivative instruments | |||||||
| Foreign currency forward contracts | $ | (6) | $ | (20) | |||
| All other futures contracts and options | 11 | 7 | |||||
| Convertible bonds | 23 | 80 | |||||
| TBAs | - | (5) | |||||
| $ | 28 | $ | 62 | ||||
| GMIB and other derivative instruments | |||||||
| GMIB | $ | (65) | $ | 218 | |||
| Futures contracts on equities | (111) | (213) | |||||
| Options on equity market futures | (33) | (87) | |||||
| Interest rate swaps | (6) | (21) | |||||
| Credit default swaps | (15) | (67) | |||||
| Other | 2 | 3 | |||||
| $ | (228) | $ | (167) | ||||
Credit risk-related contingent features
Certain of the Company’s derivative instruments contain provisions that impact the amount of collateral that ACE is required to post and that allow the contract counterparty to cancel the contract contingent on the Company’s, and in certain cases subsidiaries of the Company’s, senior debt ratings (Ratings). The aggregate fair value of derivative instruments in a liability position with credit risk-related contingent features at September 30, 2009, was $25 million. In connection with these contracts, ACE has posted collateral of $15 million at September 30, 2009. The amount of collateral that ACE is required to post under these contracts would increase should the Company’s Ratings deteriorate. At September 30, 2009, the maximum amount of collateral that the Company would be required to post in respect of these derivative instruments, based on the contractual Ratings-based scales, is $25 million. The contract counterparties would be able to cancel the contracts if ACE’s Ratings fall to BBB- as measured by Standard and Poor’s (S&P) or Baa3 as measured by Moody’s.
Derivative instrument objectives
(i) Foreign currency exposure management
The Company uses foreign currency forward contracts (forwards) to minimize the effect of fluctuating foreign currencies. The forwards purchased are not specifically identifiable against cash, any single security, or groups of securities denominated in those currencies and, therefore, do not qualify as hedges for financial reporting purposes. All realized and unrealized contract gains and losses are reflected in Net realized gains (losses) in the consolidated statements of operations.
(ii) Duration management and market exposure
Futures
Exchange-traded bond and note futures contracts may be used in fixed maturity portfolios as substitutes for ownership of the bonds and notes without significantly increasing the risk in the portfolio. Investments in futures contracts may be made only to the extent that there are assets under management not otherwise committed. Exchange-traded equity futures contracts may be used to limit exposure to a severe equity market decline, which would cause an increase in expected claims and therefore, reserves for GMDB and GMIB reinsurance business. Futures contracts give the holder the right and obligation to participate in market movements, determined by the index or underlying security on which the futures contract is based. Settlement is made daily in cash by an amount equal to the change in value of the futures contract times a multiplier that scales the size of the contract.
Interest rate swaps
An interest rate swap is a contract between two counterparties in which interest payments are made based on a notional principal amount, which itself is never paid or received. Under the terms of an interest rate swap, one counterparty makes interest payments based on a fixed interest rate and the other counterparty’s payments are based on a floating rate. Interest rate swap contracts are used occasionally in the investment portfolio as protection against unexpected shifts in interest rates, which would affect the fair value of the fixed maturity portfolio. By using interest rate swaps in the portfolio, the overall duration or interest rate sensitivity of the portfolio can be reduced. The Company also employs interest rate swaps related to certain debt issues for the purpose of either fixing and/or reducing borrowing costs.
Credit default swaps
A credit default swap is a bilateral contract under which two counterparties agree to isolate and separately trade the credit risk of at least one third-party reference entity. Under a credit default swap agreement, a protection buyer pays a periodic fee to a protection seller in exchange for a contingent payment by the seller upon a credit event (such as a default or failure to pay) related to the reference entity. When a credit event is triggered, the protection seller either takes delivery of the assets for the principal amount or pays the protection buyer the difference between the fair value of assets and the principal amount. The Company buys credit default swaps to mitigate global credit risk exposure, primarily related to reinsurance recoverable.
Options
Option contracts are used in the investment portfolio as protection against unexpected shifts in interest rates, which would affect the duration of the fixed maturity portfolio. By using options in the portfolio, the overall interest rate sensitivity of the portfolio can be reduced. Option contracts may also be used as an alternative to futures contracts in the Company’s synthetic strategy as described above. Another use for option contracts may be to limit exposure to a severe equity market decline, which would cause an increase in expected claims and therefore, reserves for GMDB and GMIB reinsurance business. An option contract conveys to the holder the right, but not the obligation, to purchase or sell a specified amount or value of an underlying security at a fixed price. The price of an option is influenced by the underlying security, expected volatility, time to expiration, and supply and demand.
The credit risk associated with the above derivative financial instruments relates to the potential for non-performance by counterparties. Although non-performance is not anticipated, in order to minimize the risk of loss, management monitors the credit worthiness of its counterparties. The performance of exchange-traded instruments is guaranteed by the exchange on which they trade. For non-exchange-traded instruments, the counterparties are principally banks which must meet certain criteria according to the Company's investment guidelines.
(iii) Convertible security investments
A convertible bond is a debt instrument that can be converted into a predetermined amount of the issuer’s equity at certain times prior to the bond's maturity. The convertible option is an embedded derivative which is marked-to-market with changes in fair value recognized in Net realized gains (losses). The debt host instrument is classified in the investment portfolio as available for sale. The Company purchases convertible bonds for their total return and not specifically for the conversion feature.
(iv) To be announced mortgage-backed securities (TBA)
By acquiring a TBA, the Company makes a commitment to purchase a future issuance of mortgage-backed securities. For the period between purchase of the TBA and issuance of the underlying security, the Company’s position is accounted for as a derivative in the consolidated financial statements. The Company purchases TBAs both for their total return and for the flexibility they provide related to ACE’s mortgage-backed security strategy.
(v) GMIB
Under the GMIB program, as the assuming entity, the Company is obligated to provide coverage until the expiration of the underlying annuities. Premiums received under the reinsurance treaties are classified as premium. Expected losses allocated to premiums received are classified as future 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 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 GMIB reinsurance programs for a given reporting period.
b) Other investments
The Company invests in limited partnerships with a carrying value of $831 million included in Other investments. In connection with these investments, the Company has commitments that may require funding of up to $720 million over the next several years.
c) Taxation
The Internal Revenue Service (IRS) completed its field examination of the Company’s federal tax returns for 2002, 2003, and 2004 during the third quarter of 2007, and has proposed several adjustments principally involving transfer pricing and other insurance-related tax deductions. The Company subsequently filed a written protest with the IRS and the case is currently being reviewed by the IRS Appeals Division. The Company expects the appeals process to be completed within the next 12 months. While it is reasonably possible that a significant change in the Company’s unrecognized tax benefits could occur in the next twelve months, given the uncertainty regarding the possible outcomes of the appeals process, a current estimate of the range of reasonably possible changes cannot be made. However, the Company believes that the outcome would not have a material impact on ACE’s consolidated financial condition. The IRS commenced its field examination for tax years 2005 through 2007 during the second quarter of 2008 with no adjustments proposed as of September 30, 2009. With few exceptions, the Company’s significant U.K. subsidiaries remain subject to examination for tax years 2006 and later.
d) Letters of credit
In June 2009, the Company entered into a $500 million unsecured operational LOC facility expiring in June 2014. At September 30, 2009, $165 million of this facility was utilized. This facility requires that the Company and/or certain of its subsidiaries continue to maintain certain covenants, including a minimum consolidated net worth covenant and a maximum leverage covenant.
e) Legal proceedings
(i) Claims and other litigation
The Company’s insurance subsidiaries are subject to claims litigation involving disputed interpretations of policy coverage and, in some jurisdictions, direct actions by allegedly-injured persons seeking damages from policyholders. These lawsuits, involving claims on policies issued by the Company’s subsidiaries, which are typical to the insurance industry in general and in the normal course of business, are considered in the Company’s loss and loss expense reserves. In addition to claims litigation, the Company and its subsidiaries are subject to lawsuits and regulatory actions in the normal course of business that do not arise from, or directly relate to, claims on insurance policies. This category of business litigation typically involves, amongst other things, allegations of underwriting errors or misconduct, employment claims, regulatory activity, or disputes arising from business ventures. In the opinion of ACE’s management, ACE’s ultimate liability for these matters is not likely to have a material adverse effect on ACE’s consolidated financial condition, although it is possible that the effect could be material to ACE’s consolidated results of operations for an individual reporting period.
(ii) Business practices litigation
Beginning in 2004, ACE and its subsidiaries and affiliates received numerous subpoenas, interrogatories, and civil investigative demands in connection with certain investigations of insurance industry practices. These inquiries were issued by a number of attorneys general, state departments of insurance, and other authorities, including the New York Attorney General (NYAG) and the Pennsylvania Insurance Department. Such inquiries concerned underwriting practices and non-traditional or loss mitigation insurance products.
On April 25, 2006, ACE reached a settlement with the Attorneys General of New York, Illinois, and Connecticut and the New York Insurance Department pursuant to which ACE received from these authorities an Assurance of Discontinuance. On May 9, 2007, ACE and the Pennsylvania Insurance Department (Department) and the Pennsylvania Office of Attorney General (OAG) entered into a settlement agreement. This settlement agreement resolved the issues raised by the Department and the OAG arising from their investigation of ACE’s underwriting practices and contingent commission payments. On October 24, 2007, ACE entered into a settlement agreement with the Attorneys General of Florida, Hawaii, Maryland, Massachusetts, Michigan, Oregon, Texas, West Virginia, the District of Columbia, and the Florida Department of Financial Services and Office of Insurance Regulation. The agreement resolved investigations of ACE’s underwriting practices and contingent commission payments.
In June 2008, in an action filed by the NYAG against another insurer, the New York Appellate Division, First Department, confirmed the legality of contingent commission agreements – one of the focal points of the NYAG’s investigation. “Contingent commission agreements between brokers and insurers are not illegal, and, in the absence of a special relationship between parties, defendants[s] had no duty to disclose the existence of the contingent commission agreement.” New York v. Liberty Mut. Ins. Co., 52 A.D. 3d 378, 379 (2008) (citing Hersch v. DeWitt Stern Group, Inc., 43 A.D. 3d 644, 645 (2007).
ACE, ACE INA Holdings, Inc., and ACE USA, Inc., along with a number of other insurers and brokers, were named in a series of federal putative nationwide class actions brought by insurance policyholders. The Judicial Panel on Multidistrict Litigation (JPML) consolidated these cases in the District of New Jersey. On August 1, 2005, plaintiffs in the New Jersey consolidated proceedings filed two consolidated amended complaints – one concerning commercial insurance and the other concerning employee benefit plans. The employee benefit plans litigation against ACE has been dismissed.
In the commercial insurance complaint, the plaintiffs named ACE, ACE INA Holdings, Inc., ACE USA, Inc., ACE American Insurance Co., Illinois Union Insurance Co., and Indemnity Insurance Co. of North America. They allege that certain brokers and insurers, including certain ACE entities, conspired to increase premiums and allocate customers through the use of “B” quotes and contingent commissions. In addition, the complaints allege that the broker defendants received additional income by improperly placing their clients’ business with insurers through related wholesale entities that acted as intermediaries between the broker and insurer. Plaintiffs also allege that broker defendants tied the purchase of primary insurance to the placement of such coverage with reinsurance carriers through the broker defendants’ reinsurance broker subsidiaries. The complaint asserts the following causes of action against ACE: Federal Racketeer Influenced and Corrupt Organizations Act (RICO), federal antitrust law, state antitrust law, aiding and abetting breach of fiduciary duty, and unjust enrichment.
In 2006 and 2007, the Court dismissed plaintiffs’ first two attempts to properly plead a case without prejudice and permitted plaintiffs one final opportunity to re-plead. The amended complaint, filed on May 22, 2007, purported to add several new ACE defendants: ACE Group Holdings, Inc., ACE US Holdings, Inc., Westchester Fire Insurance Company, INA Corporation, INA Financial Corporation, INA Holdings Corporation, ACE Property and Casualty Insurance Company, and Pacific Employers Insurance Company. Plaintiffs also added a new antitrust claim against Marsh, ACE, and other insurers based on the same allegations as the other claims but limited to excess casualty insurance. On June 21, 2007, defendants moved to dismiss the amended complaint and moved to strike the new parties. The Court granted defendants’ motions and dismissed plaintiffs’ antitrust and RICO claims with prejudice on August 31, 2007, and September 28, 2007, respectively. The Court also declined to exercise supplemental jurisdiction over plaintiffs’ state law claims and dismissed those claims without prejudice. On October 10, 2007, plaintiffs filed a Notice of Appeal of the antitrust and RICO rulings to the United States Court of Appeals for the Third Circuit. The parties fully briefed the appeal and argued before the Third Circuit on April 21, 2009. The court took the case under advisement, but did not indicate when it would issue a decision.
There are a number of federal actions brought by policyholders based on allegations similar to the allegations in the consolidated federal actions that were filed in, or transferred to, the United States District Court for the District of New Jersey for coordination. All proceedings in these actions are currently stayed.
Three cases have been filed in state courts with allegations similar to those in the consolidated federal actions described above.
ACE was named in four putative securities class action suits following the filing of a civil suit against Marsh by the NYAG on October 14, 2004. The suits were consolidated by the JPML in the Eastern District of Pennsylvania and the Court appointed Sheet Metal Workers’ National Pension Fund and Alaska Ironworkers Pension Trust as lead plaintiffs. Lead plaintiffs filed a consolidated amended complaint on September 30, 2005, naming ACE, Evan G. Greenberg, Brian Duperreault, and Philip V. Bancroft as defendants. Plaintiffs allege that ACE’s public statements and securities filings should have revealed that insurers, including certain ACE entities, and brokers allegedly conspired to increase premiums and allocate customers through the use of “B” quotes and contingent commissions and that ACE’s revenues and earnings were inflated by these practices. Plaintiffs assert claims solely under Section 10(b) of the Securities Exchange Act of 1934 (the Exchange Act), Rule 10(b)-5 promulgated thereunder, and Section 20(a) of the Securities Act (control person liability). In 2005, ACE and the individual defendants filed a motion to dismiss. The Court heard oral argument on November 10, 2008, but did not rule on the motion. On December 16, 2008, the parties entered into a Stipulation of Settlement in which the parties agreed – contingent upon Court approval – that ACE would pay the plaintiffs $1.95 million in exchange for a full release of all claims. On June 9, 2009, the Court approved the settlement and dismissed the multidistrict litigation (including the four underlying suits) with prejudice.
ACE is named as a defendant in a derivative suit filed in Delaware Chancery Court by shareholders of Marsh seeking to recover damages for Marsh and its subsidiary, Marsh, Inc., against officers and directors of Marsh, American International Group Inc. (AIG), former AIG chief executive officer Maurice R. Greenberg, and ACE. The suit alleges that the defendants breached their fiduciary duty to and thereby damaged Marsh and Marsh, Inc. by participating in a bid rigging scheme and obtaining “kickbacks” in the form of contingent commissions, and that ACE knowingly participated in the alleged scheme.
ACE, ACE USA, Inc., ACE INA Holdings, Inc., and Evan G. Greenberg, as a former officer and director of AIG and current officer and director of ACE, are named in one or both of two derivative cases brought by certain shareholders of AIG. One of the derivative cases was filed in Delaware Chancery Court, and the other was filed in federal court in the Southern District of New York. The allegations against ACE concern the alleged bid rigging and contingent commission scheme as similarly alleged in the federal commercial insurance cases. Plaintiffs assert the following causes of action against ACE: breach of fiduciary duty, aiding and abetting breaches of fiduciary duties, unjust enrichment, conspiracy, and fraud. In Delaware, the shareholder plaintiffs filed an amended complaint (their third pleading effort), on April 14, 2008, which drops Evan Greenberg as a defendant (plaintiffs in the New York action subsequently dismissed Evan Greenberg as well). On June 13, 2008, ACE filed a motion to dismiss, and on April 20, 2009, the court heard oral argument on the motion. On June 17, 2009, the Court dismissed all claims against ACE with prejudice; final judgment in favor of ACE was entered on July 13, 2009. Plaintiffs recently filed an appeal; briefing on the appeal is now underway. The New York derivative action is currently stayed.
In all of the lawsuits described above, plaintiffs seek compensatory and in some cases special damages without specifying an amount. As a result, ACE cannot at this time estimate its potential costs related to these legal matters and, accordingly, no liability for compensatory damages has been established in the consolidated financial statements.
ACE’s ultimate liability for these matters is not likely to have a material adverse effect on ACE’s consolidated financial condition, although it is possible that the effect could be material to ACE’s consolidated results of operations for an individual reporting period.
(iii) Legislative activity
The State of New York, as part of the 2009-10 State budget, has adopted language that requires an insurer which (1) paid to the Workers' Compensation Board (WCB) various statutory assessments in an amount less than that insurer "collected" from insured employers in a given year and (2) "has identified and held any funds collected but not paid to the WCB, as measurable and available, as of January 1, 2009" to pay retroactive assessments to the WCB. The language, and impact, of this new law is at present uncertain because it uses terms and dates that are not readily identifiable with respect to insurers’ statutory financial statements and because the State has not promulgated implementing regulations or other explanatory materials. The Company’s understanding is that the law is intended to address certain inconsistencies in the New York State laws regulating the calculation of workers’ compensation assessments by insurance carriers and the remittance of those funds to the State. In July 2009, ACE received a subpoena from the NYAG requesting documents related to these issues, and in October 2009, ACE received a request from the WCB asking ACE to explain whether or not it was an “affected carrier” under the new law. Although the Company can not at this time predict the interpretation that will be afforded the language by the NYAG or the WCB, ACE is confident that it has complied with the law governing workers’ compensation surcharges and assessments. ACE has established a contingency based on the Company’s best estimate of the potential liability that could result from an adverse interpretation of the legislation or other events surrounding this topic, based on the facts and circumstances at this time. Such contingency will be increased or decreased as circumstances develop. The Company does not expect the legislation to have a material impact on its financial condition or results of operations.
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9. Fair value measurements
a) Fair value hierarchy
The Company partially adopted the provisions (specific provisions described below) of ASC Topic 820, Fair Value Measurements and Disclosures on January 1, 2008, and the cumulative effect of the adoption resulted in a reduction to retained earnings of $4 million related to an increase in risk margins included in the valuation of certain GMIB contracts. The Company fully adopted these provisions on January 1, 2009. The provisions define fair value as the price to sell an asset or transfer a liability in an orderly transaction between market participants and establishes a three-level valuation hierarchy in which inputs into valuation techniques used to measure fair value are classified. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. Inputs in Level 1 are unadjusted quoted prices for identical assets or liabilities in active markets. Level 2 includes inputs other than quoted prices included within Level 1 that are observable for assets or liabilities either directly or indirectly. Level 2 inputs include, among other items, quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and inputs other than quoted prices that are observable for the asset or liability such as interest rates and yield curves. Level 3 inputs are unobservable and reflect management’s judgments about assumptions that market participants would use in pricing an asset or liability. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
The following is a description of the valuation measurements used for the Company’s financial instruments carried or disclosed at fair value, as well as the general classification of such financial instruments pursuant to the valuation hierarchy.
Fixed maturities
Fixed maturities with active markets are classified within Level 1 as fair values are based on quoted market prices. For fixed maturities that trade in less active markets, including most corporate and municipal securities in ACE’s portfolio, fair values are based on the output of “pricing matrix models”, the significant inputs into which include, but are not limited to, yield curves, credit risks and spreads, measures of volatility, and prepayment speeds. These fixed maturities are classified within Level 2. Fixed maturities for which pricing is unobservable are classified within Level 3.
Equity securities
Equity securities with active markets are classified within Level 1 as fair values are based on quoted market prices. For non-public equity securities, fair values are based on market valuations and are classified within Level 2. As previously discussed, during the three months ended June 30, 2009, ACE’s investment in AGO was reclassified from Investments in partially-owned insurance companies to Equity securities. The fair value of the Company’s investment in AGO is based on a quoted market price and continues to be classified within Level 1.
Short-term investments
Short-term investments, which comprise securities due to mature within one year of the date of purchase, that are traded in active markets, are classified within Level 1 as fair values are based on quoted market prices. Securities such as commercial paper and discount notes are classified within Level 2 because these securities are typically not actively traded due to their approaching maturity and, as such, their cost approximating par value.
Securities lending collateral
The underlying assets included in Securities lending collateral are fixed maturities which are classified in the valuation hierarchy on the same basis as the Company’s other fixed maturities. Excluded from the valuation hierarchy is the corresponding liability related to the Company’s obligation to return the collateral plus interest.
Other investments
Fair values for other investments, principally other direct equity investments, investment funds, and limited partnerships, are based on the respective net asset values or financial statements and are included within Level 3. Equity securities and fixed maturities held in rabbi trusts maintained by the Company for deferred compensation plans, and included in Other investments, are classified within the valuation hierarchy on the same basis as the Company’s other equity securities and fixed maturities.
Investments in partially-owned insurance companies
Fair values for investments in partially-owned insurance companies based on the financial statements provided by those companies used for equity accounting are classified within Level 3.
Investment derivative instruments
For actively traded investment derivative instruments, including futures, options, and exchange-traded forward contracts, the Company obtains quoted market prices to determine fair value. As such, these instruments are included within Level 1. Forward contracts that are not exchange-traded are priced using a pricing matrix model principally employing observable inputs and, as such, are classified within Level 2. The Company’s position in interest rate swaps is typically classified within Level 3.
Guaranteed minimum income benefits
The liability for GMIBs arises from the Company’s life reinsurance programs covering living benefit guarantees whereby the Company assumes the risk of GMIBs associated with variable annuity contracts. For GMIB reinsurance, ACE estimates fair value using an internal valuation model which includes current market information and estimates of policyholder behavior. All of the treaties contain claim limits, which are factored into the valuation model. The fair value depends on a number of inputs, including changes in interest rates, changes in equity markets, credit risk, current account value, changes in market volatility, expected annuitization rates, changes in policyholder behavior, and changes in policyholder mortality. The model and related assumptions are continuously re-evaluated by management and enhanced, as appropriate, based upon additional experience obtained related to policyholder behavior and availability of more timely information, such as market conditions and demographics of in-force annuities. Based on the quarterly reserve review, no changes were made to actuarial or behavioral assumptions during the three months ended September 30, 2009. The most significant policyholder behavior assumptions include lapse rates and annuitization rates using the guaranteed benefit (GMIB annuitization rate). Assumptions regarding lapse rates and GMIB annuitization rates differ by treaty but the underlying methodology to determine rates applied to each treaty is comparable. The assumptions regarding lapse and GMIB annuitization rates determined for each treaty are based on a dynamic calculation that uses several underlying factors. A lapse rate is the percentage of in-force policies surrendered in a given calendar year. All else equal, as lapse rates increase, ultimate claim payments will decrease. The GMIB annuitization rate is the percentage of policies for which the policyholder will elect to annuitize using the guaranteed benefit provided under the GMIB. All else equal, as GMIB annuitization rates increase, ultimate claim payments will increase, subject to treaty claim limits. The effect of changes in key market factors on assumed lapse and annuitization rates reflect emerging trends using data available from cedants. For treaties with limited experience, rates are established in line with data received from other ceding companies adjusted as appropriate with industry estimates. The Company views the variable annuity reinsurance business as having a similar risk profile to that of catastrophe reinsurance, with the probability of a cumulative long-term economic net loss relatively small, at the time of pricing. However, adverse changes in market factors and policyholder behavior will have an adverse impact on net income, which may be material. Because of the significant use of unobservable inputs including policyholder behavior, GMIB reinsurance is classified within Level 3.
Short- and long-term debt and trust preferred securities
Where practical, fair values for short-term debt, long-term debt, and trust preferred securities are estimated using discounted cash flow calculations based principally on observable inputs including the Company’s incremental borrowing rates, which reflect ACE’s credit rating, for similar types of borrowings with maturities consistent with those remaining for the debt being valued. As such, these instruments are classified within Level 2.
Other derivative instruments
The Company maintains positions in other derivative instruments including exchange-traded equity futures contracts and option contracts designed to limit exposure to a severe equity market decline, which would cause an increase in expected claims and, therefore, reserves for GMDB and GMIB reinsurance business. The Company’s position in exchange-traded equity futures contracts is classified within Level 1. The fair value of the majority of the Company’s remaining positions in other derivative instruments is based on significant observable inputs including equity security and interest rate indices. Accordingly, these are classified within Level 2. The Company’s position in credit default swaps is typically included within Level 3.
The following tables present, by valuation hierarchy, the financial instruments carried or disclosed at fair value, and measured on a recurring basis, as of September 30, 2009, and December 31, 2008.
| Quoted Prices in Active Markets for Identical Assets or Liabilities Level 1 | Significant Other Observable Inputs Level 2 | Significant Unobservable Inputs Level 3 | Total | ||||||||
| (in millions of U.S. dollars) | |||||||||||
| September 30, 2009 | |||||||||||
| Assets: | |||||||||||
| Fixed maturities available for sale | |||||||||||
| U.S. Treasury and agency | $ | 1,491 | $ | 2,004 | $ | - | $ | 3,495 | |||
| Foreign | 340 | 10,314 | 47 | 10,701 | |||||||
| Corporate securities | 41 | 12,797 | 124 | 12,962 | |||||||
| Mortgage-backed securities | 3 | 9,639 | 40 | 9,682 | |||||||
| States, municipalities, and political subdivisions | - | 1,700 | 19 | 1,719 | |||||||
| 1,875 | 36,454 | 230 | 38,559 | ||||||||
| Fixed maturities held to maturity | |||||||||||
| U.S. Treasury and agency | 321 | 599 | - | 920 | |||||||
| Foreign | - | 29 | - | 29 | |||||||
| Corporate securities | - | 350 | - | 350 | |||||||
| Mortgage-backed securities | - | 1,477 | 48 | 1,525 | |||||||
| States, municipalities, and political subdivisions | - | 708 | - | 708 | |||||||
| 321 | 3,163 | 48 | 3,532 | ||||||||
| Equity securities | 451 | 86 | 9 | 546 | |||||||
| Short-term investments | 1,259 | 584 | 10 | 1,853 | |||||||
| Other investments | 28 | 351 | 1,145 | 1,524 | |||||||
| Securities lending collateral | - | 1,522 | - | 1,522 | |||||||
| Investments in partially-owned insurance companies | - | - | 478 | 478 | |||||||
| Investment derivative instruments | 1 | - | - | 1 | |||||||
| Other derivative instruments | (15) | 38 | 20 | 43 | |||||||
| Total assets at fair value | $ | 3,920 | $ | 42,198 | $ | 1,940 | $ | 48,058 | |||
| Liabilities: | |||||||||||
| GMIB | $ | - | - | 705 | $ | 705 | |||||
| Short-term debt | - | 208 | - | 208 | |||||||
| Long-term debt | - | 3,651 | - | 3,651 | |||||||
| Trust preferred securities | - | 309 | - | 309 | |||||||
| Total liabilities at fair value | $ | - | $ | 4,168 | $ | 705 | $ | 4,873 | |||
| Quoted Prices in Active Markets for Identical Assets or Liabilities Level 1 | Significant Other Observable Inputs Level 2 | Significant Unobservable Inputs Level 3 | Total | ||||||||
| (in millions of U.S. dollars) | |||||||||||
| December 31, 2008 | |||||||||||
| Assets: | |||||||||||
| Fixed maturities available for sale | $ | 872 | $ | 30,009 | $ | 274 | $ | 31,155 | |||
| Fixed maturities held to maturity | 332 | 2,532 | 1 | 2,865 | |||||||
| Equity securities | 962 | 5 | 21 | 988 | |||||||
| Short-term investments | 2,668 | 682 | - | 3,350 | |||||||
| Other investments | 37 | 226 | 1,099 | 1,362 | |||||||
| Other derivative instruments | - | 280 | 87 | 367 | |||||||
| Total assets at fair value | $ | 4,871 | $ | 33,734 | $ | 1,482 | $ | 40,087 | |||
| Liabilities: | |||||||||||
| Investment derivative instruments | $ | 3 | $ | - | $ | - | $ | 3 | |||
| GMIB | - | - | 910 | 910 | |||||||
| Total liabilities at fair value | $ | 3 | $ | - | $ | 910 | $ | 913 | |||
Level 3 financial instruments
The following tables provide a reconciliation of the beginning and ending balances of financial instruments carried or disclosed at fair value using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2009 and 2008.
| Balance-Beginning of Period | Net Realized Gains/ Losses | Change in Net Unrealized Gains (Losses) Included in Other Comprehensive Income | Purchases, Sales, Issuances, and Settlements, Net | Transfers Into (Out of) Level 3 | Balance-End of Period | Change in Net Unrealized Gains (Losses) Relating to Financial Instruments Still Held at September 30, 2009, included in Net Income | ||||||||||||||
| Three Months Ended | (in millions of U.S. dollars) | |||||||||||||||||||
| September 30, 2009 | ||||||||||||||||||||
| Assets: | ||||||||||||||||||||
| Fixed maturities available for sale | ||||||||||||||||||||
| Foreign | $ | 38 | $ | - | $ | 2 | $ | (5) | $ | 12 | $ | 47 | $ | 1 | ||||||
| Corporate securities | 100 | (2) | 8 | 2 | 16 | 124 | 5 | |||||||||||||
| Mortgage-backed securities | 42 | (2) | 5 | (3) | (2) | 40 | 3 | |||||||||||||
| States, municipalities, and political subdivisions | 3 | - | 1 | 10 | 5 | 19 | - | |||||||||||||
| 183 | (4) | 16 | 4 | 31 | 230 | 9 | ||||||||||||||
| Fixed maturities held to maturity | ||||||||||||||||||||
| Mortgage-backed securities | 51 | - | - | (3) | - | 48 | - | |||||||||||||
| 51 | - | - | (3) | - | 48 | - | ||||||||||||||
| Equity securities | 8 | - | - | - | 1 | 9 | - | |||||||||||||
| Short-term investments | 4 | - | - | 6 | - | 10 | - | |||||||||||||
| Other investments | 1,084 | (37) | 110 | (12) | - | 1,145 | (38) | |||||||||||||
| Investments in partially-owned insurance companies | 462 | - | 15 | 1 | - | 478 | - | |||||||||||||
| Other derivative instruments | 34 | (12) | - | (2) | - | 20 | (12) | |||||||||||||
| Total assets at fair value | $ | 1,826 | $ | (53) | $ | 141 | $ | (6) | $ | 32 | $ | 1,940 | $ | (41) | ||||||
| Liabilities: | ||||||||||||||||||||
| GMIB | $ | 634 | $ | 65 | $ | - | $ | 6 | $ | - | $ | 705 | $ | 65 | ||||||
| Balance-Beginning of Period | Net Realized Gains/ Losses | Change in Net Unrealized Gains (Losses) Included in Other Comprehensive Income | Purchases, Sales, Issuances, and Settlements, Net | Transfers Into (Out of) Level 3 | Balance-End of Period | Change in Net Unrealized Gains (Losses) Relating to Financial Instruments Still Held at September 30, 2008, included in Net Income | ||||||||||||||
| Three Months Ended | (in millions of U.S. dollars) | |||||||||||||||||||
| September 30, 2008 | ||||||||||||||||||||
| Assets: | ||||||||||||||||||||
| Fixed maturities available for sale | $ | 466 | $ | (5) | $ | (23) | $ | (30) | $ | (12) | $ | 396 | $ | (1) | ||||||
| Fixed maturities held to maturity | 2 | (2) | - | - | 1 | 1 | - | |||||||||||||
| Equity securities | 10 | - | - | 2 | (3) | 9 | - | |||||||||||||
| Other investments | 1,117 | - | (30) | 137 | - | 1,224 | - | |||||||||||||
| Other derivative instruments | 31 | 22 | - | (3) | - | 50 | 20 | |||||||||||||
| Total assets at fair value | $ | 1,626 | $ | 15 | $ | (53) | $ | 106 | $ | (14) | $ | 1,680 | $ | 19 | ||||||
| Liabilities: | ||||||||||||||||||||
| GMIB | $ | 375 | $ | 189 | $ | - | $ | (22) | $ | - | $ | 542 | $ | 189 | ||||||
| Balance-Beginning of Period | Net Realized Gains/ Losses | Change in Net Unrealized Gains (Losses) Included in Other Comprehensive Income | Purchases, Sales, Issuances, and Settlements, Net | Transfers Into (Out of) Level 3 | Balance-End of Period | Change in Net Unrealized Gains (Losses) Relating to Financial Instruments Still Held at September 30, 2009, included in Net Income | ||||||||||||||
| Nine Months Ended | (in millions of U.S. dollars) | |||||||||||||||||||
| September 30, 2009 | ||||||||||||||||||||
| Assets: | ||||||||||||||||||||
| Fixed maturities available for sale | ||||||||||||||||||||
| Foreign | $ | 45 | $ | (1) | $ | 2 | $ | (1) | $ | 2 | $ | 47 | $ | - | ||||||
| Corporate securities | 117 | (2) | 13 | (4) | - | 124 | 1 | |||||||||||||
| Mortgage-backed securities | 109 | (6) | 19 | (63) | (19) | 40 | (2) | |||||||||||||
| States, municipalities, and political subdivisions | 3 | - | 1 | 10 | 5 | 19 | - | |||||||||||||
| 274 | (9) | 35 | (58) | (12) | 230 | (1) | ||||||||||||||
| Fixed maturities held to maturity | ||||||||||||||||||||
| Mortgage-backed securities | - | - | - | 48 | - | 48 | - | |||||||||||||
| States, municipalities, and political subdivisions | 1 | - | - | (1) | - | - | - | |||||||||||||
| 1 | - | - | 47 | - | 48 | - | ||||||||||||||
| Equity securities | 21 | - | - | 4 | (16) | 9 | - | |||||||||||||
| Short-term investments | - | - | - | 10 | - | 10 | - | |||||||||||||
| Other investments | 1,099 | (120) | 130 | 37 | (1) | 1,145 | (121) | |||||||||||||
| Investments in partially-owned insurance companies | 435 | 8 | (2) | 37 | - | 478 | - | |||||||||||||
| Other derivative instruments | 87 | (64) | - | (3) | - | 20 | (64) | |||||||||||||
| Total assets at fair value | $ | 1,917 | $ | (185) | $ | 163 | $ | 74 | $ | (29) | $ | 1,940 | $ | (186) | ||||||
| Liabilities: | ||||||||||||||||||||
| GMIB | $ | 910 | $ | (218) | $ | - | $ | 13 | $ | - | $ | 705 | $ | (218) | ||||||
| Balance-Beginning of Period | Net Realized Gains/ Losses | Change in Net Unrealized Gains (Losses) Included in Other Comprehensive Income | Purchases, Sales, Issuances, and Settlements, Net | Transfers Into (Out of) Level 3 | Balance-End of Period | Change in Net Unrealized Gains (Losses) Relating to Financial Instruments Still Held at September 30, 2008, included in Net Income | ||||||||||||||
| Nine Months Ended | (in millions of U.S. dollars) | |||||||||||||||||||
| September 30, 2008 | ||||||||||||||||||||
| Assets: | ||||||||||||||||||||
| Fixed maturities available for sale | $ | 601 | $ | (18) | $ | (64) | $ | (2) | $ | (121) | $ | 396 | $ | (3) | ||||||
| Fixed maturities held to maturity | - | (2) | - | - | 3 | 1 | - | |||||||||||||
| Equity securities | 12 | - | - | (1) | (2) | 9 | - | |||||||||||||
| Other investments | 898 | (25) | (69) | 420 | - | 1,224 | - | |||||||||||||
| Other derivative instruments | 17 | 38 | - | (5) | - | 50 | 35 | |||||||||||||
| Total assets at fair value | $ | 1,528 | $ | (7) | $ | (133) | $ | 412 | $ | (120) | $ | 1,680 | $ | 32 | ||||||
| Liabilities: | ||||||||||||||||||||
| Investment derivative instruments | $ | (6) | $ | (5) | $ | - | $ | 11 | $ | - | $ | - | $ | - | ||||||
| GMIB | 225 | 319 | - | (2) | - | 542 | 319 | |||||||||||||
| Total liabilities at fair value | $ | 219 | $ | 314 | $ | - | $ | 9 | $ | - | $ | 542 | $ | 319 | ||||||
b) Fair value option
Effective January 1, 2008, the Company elected the fair value option provided within ASC Topic 825, Financial Instruments, for certain of its available for sale equity securities valued and carried at $161 million on the election date. The Company elected the fair value option for these particular equity securities to simplify the accounting and oversight of this portfolio given the portfolio management strategy employed by the external investment manager. The election resulted in an increase in retained earnings and a reduction to accumulated other comprehensive income of $6 million as of January 1, 2008. This adjustment reflects the net of tax unrealized gains ($9 million pre-tax) associated with this particular portfolio at January 1, 2008. Subsequent to this election, changes in fair value related to these equity securities were recognized in Net realized gains (losses). During the three months ended June 30, 2008, the Company sold the entire portfolio. Accordingly, the Company currently holds no assets for which this fair value option has been elected. For the three and six months ended June 30, 2008, the Company recognized net realized gains (losses) related to changes in fair value of these equity securities of $9 million and $(11) million, respectively, in the consolidated statements of operations. Throughout 2008 to the date of sale, all of these equity securities were classified within Level 1 in the fair value hierarchy.
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10. Segment information
The Company operates through the following business segments, certain of which represent the aggregation of distinct operating segments: Insurance – North American, Insurance – Overseas General, Global Reinsurance, and Life. These segments distribute their products through various forms of brokers, agencies, and direct marketing programs. All business segments have established relationships with reinsurance intermediaries.
The Insurance – North American segment comprises the P&C operation in the U.S., Canada, and Bermuda. This segment includes the operations of ACE USA (including ACE Canada), ACE Westchester, ACE Bermuda, ACE Private Risk Services, and various run-off operations. ACE USA is the North American retail operating division which provides a broad array of P&C, A&H, and risk management products and services to a diverse group of commercial and non-commercial enterprises and consumers. ACE Westchester specializes in the North American wholesale distribution of excess, surplus, and specialty P&C products in addition to crop insurance in the U.S. ACE Bermuda provides commercial insurance products on an excess basis to a global client base, covering risks that are generally low in frequency and high in severity. ACE Private Risk Services provides personal lines coverages (such as homeowners and automobile) for high net worth clients. The run-off operations include Brandywine Holdings Corporation, Commercial Insurance Services, residual market workers’ compensation business, pools and syndicates not attributable to a single business group, and other exited lines of business. Run-off operations do not actively sell insurance products, but are responsible for the management of existing policies and related claims.
The Insurance – Overseas General segment consists of ACE International (excluding its life insurance business), the wholesale insurance operations of ACE Global Markets, and the international A&H and life insurance business of Combined Insurance. ACE International, the ACE INA network of indigenous retail insurance operations, maintains a presence in every major insurance market in the world and is organized geographically along product lines that provide dedicated underwriting focus to customers. ACE Global Markets, the London-based excess and surplus lines business that includes Lloyd’s Syndicate 2488, offers products through its parallel distribution network via ACE European Group Limited (AEGL) and Lloyd’s Syndicate 2488. ACE provides funds at Lloyd’s to support underwriting by Syndicate 2488 which is managed by ACE Underwriting Agencies Limited. ACE Global Markets utilizes Syndicate 2488 to underwrite P&C business on a global basis through Lloyd’s worldwide licenses. ACE Global Markets utilizes AEGL to underwrite similar classes of business in the U.K. and Continental Europe, and in the U.S. where it is eligible to write excess & surplus business. The reinsurance operation of ACE Global Markets is included in the Global Reinsurance segment. Combined Insurance distributes specialty individual accident and supplemental health and life insurance products targeted to middle income consumers in Europe, Asia Pacific, and Latin America. The Insurance – Overseas General segment has four regions of operations: the ACE European Group (which comprises ACE Europe and ACE Global Markets branded business), ACE Asia Pacific, ACE Far East, and ACE Latin America. Companies within the Insurance – Overseas General segment write a variety of insurance products including property, casualty, professional lines (directors & officers and errors & omissions), marine, energy, aviation, political risk, specialty personal lines, consumer lines, A&H (principally accident and supplemental health), and life insurance.
The Global Reinsurance segment represents ACE’s reinsurance operations comprising ACE Tempest Re Bermuda, ACE Tempest Re USA, ACE Tempest Re Europe, and ACE Tempest Re Canada. These divisions provide a broad range of property catastrophe, casualty, and property reinsurance coverages to a diverse array of primary P&C companies. The Global Reinsurance segment also includes ACE Global Markets’ reinsurance operations.
The Life segment includes the operations of ACE Tempest Life Re (ACE Life Re), ACE Life, and the North American A&H and life business of Combined Insurance. ACE Life Re helps clients (ceding companies) manage mortality, morbidity, lapse, and/or capital market risks embedded in their books of business. ACE Life Re comprises two operations. The first is a Bermuda-based niche operation which provides reinsurance to primarily life insurers, focusing primarily on guarantees included in certain fixed and variable annuity products and also on more traditional mortality reinsurance protection. The second is a U.S.-based traditional life reinsurance company licensed in 49 states and the District of Columbia, offering reinsurance capacity for the individual life business utilizing yearly renewable term and coinsurance structures. ACE Life develops direct insurance opportunities in emerging markets, including Egypt, Indonesia, Taiwan, Thailand, Vietnam, and the United Arab Emirates, as well as in China through a partially-owned company. Combined Insurance distributes specialty individual accident and supplemental health and life insurance products targeted to middle income consumers in the U.S. and Canada.
Corporate and Other (Corporate) includes ACE Limited, ACE Group Management and Holdings Ltd., ACE INA Holdings, Inc., and intercompany eliminations. In addition, Corporate includes the Company’s proportionate share of AGO’s earnings reflected in Other (income) expense to the date that ACE was no longer deemed to exert significant influence over AGO. Included in Losses and loss expenses are losses incurred in connection with the commutation of ceded reinsurance contracts that resulted from a differential between the consideration received from reinsurers and the related reduction of reinsurance recoverable, principally related to the time value of money. Due to the Company’s initiatives to reduce reinsurance recoverable balances and thereby encourage such commutations, losses recognized in connection with the commutation of ceded reinsurance contracts are generally not considered when assessing segment performance and, accordingly, are directly allocated to Corporate. ACE also eliminates the impact of intersegment loss portfolio transfer transactions which are not reflected in the results within the statements of operations by segment.
For segment reporting purposes, certain items have been presented in a different manner than in the consolidated financial statements. Management uses underwriting income as the main measure of segment performance. ACE calculates underwriting income by subtracting losses and loss expenses, policy benefits, policy acquisition costs, and administrative expenses from net premiums earned. For the Life business, management also includes net investment income as a component of underwriting income. The following tables summarize the operations by segment for the periods indicated.
| Statement of Operations by Segment | |||||||||||||||||
| For the Three Months Ended September 30, 2009 | |||||||||||||||||
| (in millions of U.S. dollars) | |||||||||||||||||
| Insurance – North American | Insurance – Overseas General | Global Reinsurance | Life | Corporate and Other | ACE Consolidated | ||||||||||||
| Gross premiums written | $ | 2,730 | $ | 1,677 | $ | 215 | $ | 383 | $ | - | $ | 5,005 | |||||
| Net premiums written | 1,374 | 1,203 | 206 | 372 | - | 3,155 | |||||||||||
| Net premiums earned | 1,467 | 1,317 | 247 | 362 | - | 3,393 | |||||||||||
| Losses and loss expenses | 1,053 | 631 | 80 | 121 | - | 1,885 | |||||||||||
| Policy benefits | - | - | - | 79 | - | 79 | |||||||||||
| Policy acquisition costs | 142 | 316 | 50 | 59 | - | 567 | |||||||||||
| Administrative expenses | 146 | 204 | 15 | 51 | 35 | 451 | |||||||||||
| Underwriting income (loss) | 126 | 166 | 102 | 52 | (35) | 411 | |||||||||||
| Net investment income | 278 | 121 | 65 | 43 | 4 | 511 | |||||||||||
| Net realized gains (losses) including OTTI | (25) | 40 | (11) | (212) | (15) | (223) | |||||||||||
| Interest expense | - | - | - | - | 60 | 60 | |||||||||||
| Other (income) expense | 4 | 3 | (1) | - | 45 | 51 | |||||||||||
| Income tax expense (benefit) | 47 | 56 | 9 | 17 | (35) | 94 | |||||||||||
| Net income (loss) | $ | 328 | $ | 268 | $ | 148 | $ | (134) | $ | (116) | $ | 494 | |||||
| Statement of Operations by Segment | |||||||||||||||||
| For the Three Months Ended September 30, 2008 | |||||||||||||||||
| (in millions of U.S. dollars) | |||||||||||||||||
| Insurance – North American | Insurance – Overseas General | Global Reinsurance | Life | Corporate and Other | ACE Consolidated | ||||||||||||
| Gross premiums written | $ | 2,987 | $ | 1,678 | $ | 174 | $ | 381 | $ | - | $ | 5,220 | |||||
| Net premiums written | 1,461 | 1,293 | 174 | 348 | - | 3,276 | |||||||||||
| Net premiums earned | 1,583 | 1,425 | 257 | 344 | - | 3,609 | |||||||||||
| Losses and loss expenses | 1,356 | 731 | 178 | 104 | - | 2,369 | |||||||||||
| Policy benefits | - | 5 | - | 86 | - | 91 | |||||||||||
| Policy acquisition costs | 160 | 329 | 44 | 48 | - | 581 | |||||||||||
| Administrative expenses | 132 | 217 | 14 | 61 | 33 | 457 | |||||||||||
| Underwriting income (loss) | (65) | 143 | 21 | 45 | (33) | 111 | |||||||||||
| Net investment income | 278 | 136 | 83 | 40 | (17) | 520 | |||||||||||
| Net realized gains (losses) including OTTI | (284) | (58) | (2) | (180) | 14 | (510) | |||||||||||
| Interest expense | - | - | - | - | 68 | 68 | |||||||||||
| Other (income) expense | 3 | 6 | 1 | 2 | (6) | 6 | |||||||||||
| Income tax expense (benefit) | (7) | 10 | 9 | 15 | (34) | (7) | |||||||||||
| Net income (loss) | $ | (67) | $ | 205 | $ | 92 | $ | (112) | $ | (64) | $ | 54 | |||||
| Statement of Operations by Segment | |||||||||||||||||
| For the Nine Months Ended September 30, 2009 | |||||||||||||||||
| (in millions of U.S. dollars) | |||||||||||||||||
| Insurance – North American | Insurance – Overseas General | Global Reinsurance | Life | Corporate and Other | ACE Consolidated | ||||||||||||
| Gross premiums written | $ | 7,472 | $ | 5,080 | $ | 953 | $ | 1,152 | $ | - | $ | 14,657 | |||||
| Net premiums written | 4,220 | 3,795 | 894 | 1,085 | - | 9,994 | |||||||||||
| Net premiums earned | 4,319 | 3,747 | 726 | 1,061 | - | 9,853 | |||||||||||
| Losses and loss expenses | 3,054 | 1,879 | 223 | 366 | - | 5,522 | |||||||||||
| Policy benefits | - | 3 | - | 253 | - | 256 | |||||||||||
| Policy acquisition costs | 394 | 869 | 147 | 161 | - | 1,571 | |||||||||||
| Administrative expenses | 433 | 569 | 41 | 173 | 109 | 1,325 | |||||||||||
| Underwriting income (loss) | 438 | 427 | 315 | 108 | (109) | 1,179 | |||||||||||
| Net investment income | 816 | 355 | 210 | 132 | 6 | 1,519 | |||||||||||
| Net realized gains (losses) including OTTI | (242) | (40) | (47) | (95) | (145) | (569) | |||||||||||
| Interest expense | - | - | - | - | 169 | 169 | |||||||||||
| Other (income) expense | 9 | 12 | - | 1 | 22 | 44 | |||||||||||
| Income tax expense (benefit) | 219 | 131 | 38 | 37 | (105) | 320 | |||||||||||
| Net income (loss) | $ | 784 | $ | 599 | $ | 440 | $ | 107 | $ | (334) | $ | 1,596 | |||||
| Statement of Operations by Segment | |||||||||||||||||
| For the Nine Months Ended September 30, 2008 | |||||||||||||||||
| (in millions of U.S. dollars) | |||||||||||||||||
| Insurance – North American | Insurance – Overseas General | Global Reinsurance | Life | Corporate and Other | ACE Consolidated | ||||||||||||
| Gross premiums written | $ | 7,886 | $ | 5,332 | $ | 791 | $ | 913 | $ | - | $ | 14,922 | |||||
| Net premiums written | 4,332 | 4,081 | 788 | 827 | - | 10,028 | |||||||||||
| Net premiums earned | 4,302 | 4,087 | 777 | 811 | - | 9,977 | |||||||||||
| Losses and loss expenses | 3,187 | 2,039 | 403 | 214 | - | 5,843 | |||||||||||
| Policy benefits | - | 10 | - | 233 | - | 243 | |||||||||||
| Policy acquisition costs | 450 | 897 | 152 | 119 | - | 1,618 | |||||||||||
| Administrative expenses | 398 | 598 | 43 | 143 | 111 | 1,293 | |||||||||||
| Underwriting income (loss) | 267 | 543 | 179 | 102 | (111) | 980 | |||||||||||
| Net investment income | 829 | 387 | 235 | 95 | (5) | 1,541 | |||||||||||
| Net realized gains (losses) including OTTI | (450) | (199) | (67) | (302) | 29 | (989) | |||||||||||
| Interest expense | - | - | - | - | 176 | 176 | |||||||||||
| Other (income) expense | 6 | (14) | 2 | 6 | (104) | (104) | |||||||||||
| Income tax expense (benefit) | 222 | 95 | 24 | 25 | (83) | 283 | |||||||||||
| Net income (loss) | $ | 418 | $ | 650 | $ | 321 | $ | (136) | $ | (76) | $ | 1,177 | |||||
Underwriting assets are reviewed in total by management for purposes of decision-making. Other than goodwill, the Company does not allocate assets to its segments.
The following tables summarize the net premiums earned for each segment by product offering for the periods indicated.
| Property & All Other | Casualty | Life, Accident & Health | ACE Consolidated | ||||||||
| (in millions of U.S. dollars) | |||||||||||
| For the Three Months Ended September 30, 2009 | |||||||||||
| Insurance – North American | $ | 496 | $ | 904 | $ | 67 | $ | 1,467 | |||
| Insurance – Overseas General | 451 | 366 | 500 | 1,317 | |||||||
| Global Reinsurance | 134 | 113 | - | 247 | |||||||
| Life | - | - | 362 | 362 | |||||||
| $ | 1,081 | $ | 1,383 | $ | 929 | $ | 3,393 | ||||
| For the Three Months Ended September 30, 2008 | |||||||||||
| Insurance – North American | $ | 551 | $ | 969 | $ | 63 | $ | 1,583 | |||
| Insurance – Overseas General | 500 | 376 | 549 | 1,425 | |||||||
| Global Reinsurance | 139 | 118 | - | 257 | |||||||
| Life | - | - | 344 | 344 | |||||||
| $ | 1,190 | $ | 1,463 | $ | 956 | $ | 3,609 | ||||
| For the Nine Months Ended September 30, 2009 | |||||||||||
| Insurance – North American | $ | 1,361 | $ | 2,766 | $ | 192 | $ | 4,319 | |||
| Insurance – Overseas General | 1,293 | 1,038 | 1,416 | 3,747 | |||||||
| Global Reinsurance | 408 | 318 | - | 726 | |||||||
| Life | - | - | 1,061 | 1,061 | |||||||
| $ | 3,062 | $ | 4,122 | $ | 2,669 | $ | 9,853 | ||||
| For the Nine Months Ended September 30, 2008 | |||||||||||
| Insurance – North American | $ | 1,214 | $ | 2,903 | $ | 185 | $ | 4,302 | |||
| Insurance – Overseas General | 1,420 | 1,151 | 1,516 | 4,087 | |||||||
| Global Reinsurance | 396 | 381 | - | 777 | |||||||
| Life | - | - | 811 | 811 | |||||||
| $ | 3,030 | $ | 4,435 | $ | 2,512 | $ | 9,977 | ||||
|
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12. Information provided in connection with outstanding debt of subsidiaries
The following tables present condensed consolidating financial information at September 30, 2009, and December 31, 2008, and for the three and nine months ended September 30, 2009 and 2008, for ACE Limited (the Parent Guarantor) and its “Subsidiary Issuer”, ACE INA Holdings, Inc. The Subsidiary Issuer is an indirect 100 percent-owned subsidiary of the Parent Guarantor. Investments in subsidiaries are accounted for by the Parent Guarantor under the equity method for purposes of the supplemental consolidating presentation. Earnings of subsidiaries are reflected in the Parent Guarantor’s investment accounts and earnings. The Parent Guarantor fully and unconditionally guarantees certain of the debt of the Subsidiary Issuer.
| Condensed Consolidating Balance Sheet at | ||||||||||||||||
| September 30, 2009 | ||||||||||||||||
| (in millions of U.S. dollars) | ||||||||||||||||
| ACE Limited (Parent Guarantor) | ACE INA Holdings Inc. (Subsidiary Issuer) | Other ACE Limited Subsidiaries and Eliminations(1) | Consolidating Adjustments(2) | ACE Limited Consolidated | ||||||||||||
| Assets | ||||||||||||||||
| Investments | $ | 40 | $ | 23,853 | $ | 22,028 | $ | - | $ | 45,921 | ||||||
| Cash | 87 | 418 | 237 | - | 742 | |||||||||||
| Insurance and reinsurance balances receivable | - | 3,009 | 617 | - | 3,626 | |||||||||||
| Reinsurance recoverable on losses and loss expenses | - | 17,187 | (3,498) | - | 13,689 | |||||||||||
| Reinsurance recoverable on policy benefits | - | 728 | (383) | - | 345 | |||||||||||
| Value of business acquired | - | 786 | - | - | 786 | |||||||||||
| Goodwill and other intangible assets | - | 3,216 | 556 | - | 3,772 | |||||||||||
| Investments in subsidiaries | 17,971 | - | - | (17,971) | - | |||||||||||
| Due from (to) subsidiaries and affiliates, net | 771 | (546) | 546 | (771) | - | |||||||||||
| Other assets | 23 | 7,424 | 1,493 | - | 8,940 | |||||||||||
| Total assets | $ | 18,892 | $ | 56,075 | $ | 21,596 | $ | (18,742) | $ | 77,821 | ||||||
| Liabilities | ||||||||||||||||
| Unpaid losses and loss expenses | $ | - | $ | 30,038 | $ | 7,833 | $ | - | $ | 37,871 | ||||||
| Unearned premiums | - | 5,150 | 1,219 | - | 6,369 | |||||||||||
| Future policy benefits | - | 2,417 | 631 | - | 3,048 | |||||||||||
| Short-term debt | - | 200 | - | - | 200 | |||||||||||
| Long-term debt | - | 3,321 | - | - | 3,321 | |||||||||||
| Trust preferred securities | - | 309 | - | - | 309 | |||||||||||
| Other liabilities | 159 | 6,498 | 1,313 | - | 7,970 | |||||||||||
| Total liabilities | 159 | 47,933 | 10,996 | - | 59,088 | |||||||||||
| Total shareholders' equity | 18,733 | 8,142 | 10,600 | (18,742) | 18,733 | |||||||||||
| Total liabilities and shareholders' equity | $ | 18,892 | $ | 56,075 | $ | 21,596 | $ | (18,742) | $ | 77,821 | ||||||
| (1) Includes all other subsidiaries of ACE Limited and intercompany eliminations. | ||||||||||||||||
| (2) Includes ACE Limited parent company eliminations. | ||||||||||||||||
| Condensed Consolidating Balance Sheet at | ||||||||||||||||
| December 31, 2008 | ||||||||||||||||
| (in millions of U.S. dollars) | ||||||||||||||||
| ACE Limited (Parent Guarantor) | ACE INA Holdings Inc. (Subsidiary Issuer) | Other ACE Limited Subsidiaries and Eliminations(1) | Consolidating Adjustments(2) | ACE Limited Consolidated | ||||||||||||
| Assets | ||||||||||||||||
| Investments | $ | 143 | $ | 20,323 | $ | 19,249 | $ | - | $ | 39,715 | ||||||
| Cash | (52) | 442 | 477 | - | 867 | |||||||||||
| Insurance and reinsurance balances receivable | - | 2,944 | 509 | - | 3,453 | |||||||||||
| Reinsurance recoverable on losses and loss expenses | - | 16,880 | (2,963) | - | 13,917 | |||||||||||
| Reinsurance recoverable on policy benefits | - | 625 | (366) | - | 259 | |||||||||||
| Value of business acquired | - | 823 | - | - | 823 | |||||||||||
| Goodwill and other intangible assets | - | 3,199 | 548 | - | 3,747 | |||||||||||
| Investments in subsidiaries | 13,697 | - | - | (13,697) | - | |||||||||||
| Due from (to) subsidiaries and affiliates, net | 784 | (389) | 389 | (784) | - | |||||||||||
| Other assets | 12 | 7,398 | 1,866 | - | 9,276 | |||||||||||
| Total assets | $ | 14,584 | $ | 52,245 | $ | 19,709 | $ | (14,481) | $ | 72,057 | ||||||
| Liabilities | ||||||||||||||||
| Unpaid losses and loss expenses | $ | - | $ | 29,127 | $ | 8,049 | $ | - | $ | 37,176 | ||||||
| Unearned premiums | - | 4,804 | 1,146 | - | 5,950 | |||||||||||
| Future policy benefits | - | 2,249 | 655 | - | 2,904 | |||||||||||
| Short-term debt | - | 471 | - | - | 471 | |||||||||||
| Long-term debt | - | 2,806 | - | - | 2,806 | |||||||||||
| Trust preferred securities | - | 309 | - | - | 309 | |||||||||||
| Other liabilities | 138 | 5,932 | 1,925 | - | 7,995 | |||||||||||
| Total liabilities | 138 | 45,698 | 11,775 | - | 57,611 | |||||||||||
| Total shareholders' equity | 14,446 | 6,547 | 7,934 | (14,481) | 14,446 | |||||||||||
| Total liabilities and shareholders' equity | $ | 14,584 | $ | 52,245 | $ | 19,709 | $ | (14,481) | $ | 72,057 | ||||||
| (1) Includes all other subsidiaries of ACE Limited and intercompany eliminations. | ||||||||||||||||
| (2) Includes ACE Limited parent company eliminations. | ||||||||||||||||
| Condensed Consolidating Statement of Operations | ||||||||||||||||
| For the Three Months Ended September 30, 2009 | ||||||||||||||||
| (in millions of U.S. dollars) | ||||||||||||||||
| ACE Limited (Parent Guarantor) | ACE INA Holdings, Inc. (Subsidiary Issuer) | Other ACE Limited Subsidiaries and Eliminations(1) | Consolidating Adjustments (2) | ACE Limited Consolidated | ||||||||||||
| Net premiums written | $ | - | $ | 1,669 | $ | 1,486 | $ | - | $ | 3,155 | ||||||
| Net premiums earned | - | 1,943 | 1,450 | - | 3,393 | |||||||||||
| Net investment income | 1 | 262 | 248 | - | 511 | |||||||||||
| Equity in earnings of subsidiaries | 500 | - | - | (500) | - | |||||||||||
| Net realized gains (losses) including OTTI | (14) | (34) | (175) | - | (223) | |||||||||||
| Losses and loss expenses | - | 1,230 | 655 | - | 1,885 | |||||||||||
| Policy benefits | - | 19 | 60 | - | 79 | |||||||||||
| Policy acquisition costs and administrative expenses | 4 | 574 | 446 | (6) | 1,018 | |||||||||||
| Interest expense | (11) | 70 | (8) | 9 | 60 | |||||||||||
| Other (income) expense | 1 | 8 | 42 | - | 51 | |||||||||||
| Income tax expense (benefit) | (1) | 49 | 46 | - | 94 | |||||||||||
| Net income | $ | 494 | $ | 221 | $ | 282 | $ | (503) | $ | 494 | ||||||
| Condensed Consolidating Statement of Operations | ||||||||||||||||
| For the Three Months Ended September 30, 2008 | ||||||||||||||||
| (in millions of U.S. dollars) | ||||||||||||||||
| ACE Limited (Parent Guarantor) | ACE INA Holdings, Inc. (Subsidiary Issuer) | Other ACE Limited Subsidiaries and Eliminations(1) | Consolidating Adjustments (2) | ACE Limited Consolidated | ||||||||||||
| Net premiums written | $ | - | $ | 1,916 | $ | 1,360 | $ | - | $ | 3,276 | ||||||
| Net premiums earned | - | 2,151 | 1,458 | - | 3,609 | |||||||||||
| Net investment income | (7) | 273 | 254 | - | 520 | |||||||||||
| Equity in earnings of subsidiaries | 45 | - | - | (45) | - | |||||||||||
| Net realized gains (losses) including OTTI | 20 | (243) | (287) | - | (510) | |||||||||||
| Losses and loss expenses | - | 1,443 | 926 | - | 2,369 | |||||||||||
| Policy benefits | - | 35 | 56 | - | 91 | |||||||||||
| Policy acquisition costs and administrative expenses | 22 | 636 | 384 | (4) | 1,038 | |||||||||||
| Interest expense | (11) | 68 | 3 | 8 | 68 | |||||||||||
| Other (income) expense | (7) | - | 13 | - | 6 | |||||||||||
| Income tax expense (benefit) | - | 12 | (19) | - | (7) | |||||||||||
| Net income | $ | 54 | $ | (13) | $ | 62 | $ | (49) | $ | 54 | ||||||
| (1) Includes all other subsidiaries of ACE Limited and intercompany eliminations. | ||||||||||||||||
| (2) Includes ACE Limited parent company eliminations. | ||||||||||||||||
| Condensed Consolidating Statement of Operations | ||||||||||||||||
| For the Nine Months Ended September 30, 2009 | ||||||||||||||||
| (in millions of U.S. dollars) | ||||||||||||||||
| ACE Limited (Parent Guarantor) | ACE INA Holdings, Inc. (Subsidiary Issuer) | Other ACE Limited Subsidiaries and Eliminations (1) | Consolidating Adjustments (2) | ACE Limited Consolidated | ||||||||||||
| Net premiums written | $ | - | $ | 5,514 | $ | 4,480 | $ | - | $ | 9,994 | ||||||
| Net premiums earned | - | 5,533 | 4,320 | - | 9,853 | |||||||||||
| Net investment income | 1 | 754 | 764 | - | 1,519 | |||||||||||
| Equity in earnings of subsidiaries | 1,656 | - | - | (1,656) | - | |||||||||||
| Net realized gains (losses) including OTTI | (67) | (150) | (352) | - | (569) | |||||||||||
| Losses and loss expenses | - | 3,471 | 2,051 | - | 5,522 | |||||||||||
| Policy benefits | - | 61 | 195 | - | 256 | |||||||||||
| Policy acquisition costs and administrative expenses | 30 | 1,603 | 1,284 | (21) | 2,896 | |||||||||||
| Interest expense | (32) | 198 | (25) | 28 | 169 | |||||||||||
| Other (income) expense | 1 | 13 | 30 | - | 44 | |||||||||||
| Income tax expense (benefit) | (5) | 221 | 104 | - | 320 | |||||||||||
| Net income | $ | 1,596 | $ | 570 | $ | 1,093 | $ | (1,663) | $ | 1,596 | ||||||
| Condensed Consolidating Statement of Operations | ||||||||||||||||
| For the Nine Months Ended September 30, 2008 | ||||||||||||||||
| (in millions of U.S. dollars) | ||||||||||||||||
| ACE Limited (Parent Guarantor) | ACE INA Holdings, Inc. (Subsidiary Issuer) | Other ACE Limited Subsidiaries and Eliminations (1) | Consolidating Adjustments (2) | ACE Limited Consolidated | ||||||||||||
| Net premiums written | $ | - | $ | 5,475 | $ | 4,553 | $ | - | $ | 10,028 | ||||||
| Net premiums earned | - | 5,642 | 4,335 | - | 9,977 | |||||||||||
| Net investment income | (11) | 795 | 757 | - | 1,541 | |||||||||||
| Equity in earnings of subsidiaries | 1,183 | - | - | (1,183) | - | |||||||||||
| Net realized gains (losses) including OTTI | 38 | (433) | (594) | - | (989) | |||||||||||
| Losses and loss expenses | - | 3,521 | 2,322 | - | 5,843 | |||||||||||
| Policy benefits | - | 90 | 153 | - | 243 | |||||||||||
| Policy acquisition costs and administrative expenses | 72 | 1,681 | 1,170 | (12) | 2,911 | |||||||||||
| Interest expense | (29) | 180 | 4 | 21 | 176 | |||||||||||
| Other (income) expense | (11) | (14) | (79) | - | (104) | |||||||||||
| Income tax expense | 1 | 232 | 50 | - | 283 | |||||||||||
| Net income | $ | 1,177 | $ | 314 | $ | 878 | $ | (1,192) | $ | 1,177 | ||||||
| (1) Includes all other subsidiaries of ACE Limited and intercompany eliminations. | ||||||||||||||||
| (2) Includes ACE Limited parent company eliminations. | ||||||||||||||||
| Condensed Consolidating Statement of Cash Flows | |||||||||||||||
| For the Nine Months Ended September 30, 2009 | |||||||||||||||
| (in millions of U.S. dollars) | |||||||||||||||
| ACE Limited (Parent Guarantor) | ACE INA Holdings Inc. (Subsidiary Issuer) | Other ACE Limited Subsidiaries and Eliminations (1) | ACE Limited Consolidated | ||||||||||||
| Net cash flows from operating activities | $ | 307 | $ | 1,385 | $ | 640 | $ | 2,332 | |||||||
| Cash flows from (used for) investing activities | |||||||||||||||
| Purchases of fixed maturities available for sale | - | (14,312) | (16,646) | (30,958) | |||||||||||
| Purchases of fixed maturities held to maturity | - | (272) | (1) | (273) | |||||||||||
| Purchases of equity securities | - | (181) | (133) | (314) | |||||||||||
| Sales of fixed maturities available for sale | 95 | 11,008 | 13,928 | 25,031 | |||||||||||
| Sales of fixed maturities held to maturity | - | - | 1 | 1 | |||||||||||
| Sales of equity securities | - | 520 | 582 | 1,102 | |||||||||||
| Maturities and redemptions of fixed maturities available for sale | - | 1,416 | 1,279 | 2,695 | |||||||||||
| Maturities and redemptions of fixed maturities held to maturity | - | 298 | 77 | 375 | |||||||||||
| Net payments made on the settlement of investment derivatives | - | - | (23) | (23) | |||||||||||
| Other | 1 | (123) | 49 | (73) | |||||||||||
| Net cash flows from (used for) investing activities | 96 | (1,646) | (887) | (2,437) | |||||||||||
| Cash flows (used for) from financing activities | |||||||||||||||
| Dividends paid on Common Shares | (283) | - | - | (283) | |||||||||||
| Proceeds from exercise of options for Common Shares | 9 | - | - | 9 | |||||||||||
| Proceeds from Common Shares issued under ESPP | 10 | - | - | 10 | |||||||||||
| Net proceeds from (repayment of) short-term debt | - | (266) | - | (266) | |||||||||||
| Net proceeds from issuance of long-term debt | - | 500 | - | 500 | |||||||||||
| Advances (to) from affiliates | - | 1 | (1) | - | |||||||||||
| Net cash flows (used for) from financing activities | (264) | 235 | (1) | (30) | |||||||||||
| Effect of foreign currency rate changes on cash and cash equivalents | - | 2 | 8 | 10 | |||||||||||
| Net increase (decrease) in cash | 139 | (24) | (240) | (125) | |||||||||||
| Cash - beginning of period | (52) | 442 | 477 | 867 | |||||||||||
| Cash - end of period | $ | 87 | $ | 418 | $ | 237 | $ | 742 | |||||||
| (1) Includes all other subsidiaries of ACE Limited and intercompany eliminations. | |||||||||||||||
| Condensed Consolidating Statement of Cash Flows | |||||||||||||||
| For the Nine Months Ended September 30, 2008 | |||||||||||||||
| (in millions of U.S. dollars) | |||||||||||||||
| ACE Limited (Parent Guarantor) | ACE INA Holdings Inc. (Subsidiary Issuer) | Other ACE Limited Subsidiaries and Eliminations (1) | ACE Limited Consolidated | ||||||||||||
| Net cash flows from operating activities | $ | 1,124 | $ | 1,646 | $ | 370 | $ | 3,140 | |||||||
| Cash flows used for investing activities | |||||||||||||||
| Purchases of fixed maturities available for sale | (3) | (12,441) | (20,973) | (33,417) | |||||||||||
| Purchases of fixed maturities held to maturity | - | (303) | (13) | (316) | |||||||||||
| Purchases of equity securities | - | (409) | (425) | (834) | |||||||||||
| Sales of fixed maturities available for sale | - | 10,638 | 19,806 | 30,444 | |||||||||||
| Sales of equity securities | - | 640 | 361 | 1,001 | |||||||||||
| Maturities and redemptions of fixed maturities available for sale | - | 1,087 | 1,125 | 2,212 | |||||||||||
| Maturities and redemptions of fixed maturities held to maturity | - | 290 | 93 | 383 | |||||||||||
| Net proceeds from (payments made on) the settlement of investment derivatives | 11 | - | (26) | (15) | |||||||||||
| Advances (to) from affiliates | (275) | - | 275 | - | |||||||||||
| Acquisition of subsidiary (net of cash acquired of $19) | - | (2,522) | - | (2,522) | |||||||||||
| Other | (3) | (100) | (373) | (476) | |||||||||||
| Net cash flows used for investing activities | (270) | (3,120) | (150) | (3,540) | |||||||||||
| Cash flows (used for) from financing activities | |||||||||||||||
| Dividends paid on Common Shares | (276) | - | - | (276) | |||||||||||
| Dividends paid on Preferred Shares | (24) | - | - | (24) | |||||||||||
| Net proceeds from (repayment of) short-term debt | (51) | - | 16 | (35) | |||||||||||
| Net proceeds from issuance of long-term debt | - | 1,195 | - | 1,195 | |||||||||||
| Redemption of Preferred Shares | (575) | - | - | (575) | |||||||||||
| Proceeds from exercise of options for Common Shares | 88 | - | - | 88 | |||||||||||
| Proceeds from Common Shares issued under ESPP | 10 | - | - | 10 | |||||||||||
| Advances from (to) affiliates | - | 230 | (230) | - | |||||||||||
| Net cash flows (used for) from financing activities | (828) | 1,425 | (214) | 383 | |||||||||||
| Effect of foreign currency rate changes on cash and cash equivalents | - | (13) | (1) | (14) | |||||||||||
| Net increase (decrease) in cash | 26 | (62) | 5 | (31) | |||||||||||
| Cash - beginning of period | - | 310 | 200 | 510 | |||||||||||
| Cash - end of period | $ | 26 | $ | 248 | $ | 205 | $ | 479 | |||||||
| (1) Includes all other subsidiaries of ACE Limited and intercompany eliminations. | |||||||||||||||
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13. Subsequent events
The Company has performed an evaluation of subsequent events through November 6, 2009, which is the date that the financial statements were issued.
|