ACE LTD, 10-Q filed on 10/30/2013
Quarterly Report
Document and Entity Information
9 Months Ended
Sep. 30, 2013
Oct. 16, 2013
Entity Information [Line Items]
 
 
Document Type
10-Q 
 
Amendment Flag
false 
 
Document Period End Date
Sep. 30, 2013 
 
Document Fiscal Year Focus
2013 
 
Document Fiscal Period Focus
Q3 
 
Trading Symbol
ACE 
 
Entity Registrant Name
ACE Ltd 
 
Entity Central Index Key
0000896159 
 
Current Fiscal Year End Date
--12-31 
 
Entity Filer Category
Large Accelerated Filer 
 
Entity Common Stock, Shares Outstanding
 
340,065,071 
Consolidated Balance Sheets (USD $)
In Millions, unless otherwise specified
Sep. 30, 2013
Dec. 31, 2012
Assets
 
 
Fixed maturities available for sale, at fair value (amortized cost - $47,481 and $44,666) (includes hybrid financial instruments of $291 and $309)
$ 48,529 
$ 47,306 
Fixed maturities held to maturity, at amortized cost (fair value – $6,493 and $7,633)
6,306 
7,270 
Equity securities, at fair value (cost – $835 and $707)
831 
744 
Short-term investments, at fair value and amortized cost
1,774 
2,228 
Other investments (cost – $2,616 and $2,465)
2,902 
2,716 
Total investments
60,342 
60,264 
Cash
768 1 2
615 1 3
Securities lending collateral
1,517 
1,791 
Accrued investment income
563 
552 
Insurance and reinsurance balances receivable
5,089 
4,147 
Reinsurance recoverable on losses and loss expenses
11,477 
12,078 
Reinsurance recoverable on policy benefits
237 
241 
Deferred policy acquisition costs
2,224 
1,873 
Value of business acquired
554 
614 
Goodwill and other intangible assets
5,465 
4,975 
Prepaid reinsurance premiums
1,724 
1,617 
Deferred tax assets
584 
453 
Investments in partially-owned insurance companies (cost – $465 and $451)
468 
454 
Other assets
3,572 
2,871 
Total assets
94,584 
92,545 
Liabilities
 
 
Unpaid losses and loss expenses
37,882 
37,946 
Unearned premiums
7,794 
6,864 
Future policy benefits
4,596 
4,470 
Insurance and reinsurance balances payable
3,627 
3,472 
Securities lending payable
1,520 
1,795 
Accounts payable, accrued expenses, and other liabilities
4,917 
5,377 
Income taxes payable
12 
20 
Short-term debt
1,902 
1,401 
Long-term debt
3,807 
3,360 
Trust preferred securities
309 
309 
Total liabilities
66,366 
65,014 
Commitments and contingencies
   
   
Shareholders’ equity
 
 
Common Shares (CHF 27.49 and CHF 28.89 par value; 342,832,412 shares issued; 340,069,972 and 340,321,534 shares outstanding)
9,073 
9,591 
Common Shares in treasury (2,762,440 and 2,510,878 shares)
(222)
(159)
Additional paid-in capital
5,200 
5,179 
Retained earnings
12,793 
10,033 
Accumulated other comprehensive income (AOCI)
1,374 
2,887 
Total shareholders’ equity
28,218 
27,531 
Total liabilities and shareholders’ equity
$ 94,584 
$ 92,545 
Consolidated Balance Sheets (Parenthetical)
In Millions, except Share data, unless otherwise specified
Sep. 30, 2013
USD ($)
Sep. 30, 2013
CHF
Dec. 31, 2012
USD ($)
Dec. 31, 2012
CHF
Statement of Financial Position [Abstract]
 
 
 
 
Fixed maturities available for sale, at amortized cost
$ 47,481 
 
$ 44,666 
 
Fixed maturities available for sale, hybrid financial instruments
291 
 
309 
 
Fixed maturities held to maturity, at amortized cost
6,493 
 
7,633 
 
Equity securities, at cost
835 
 
707 
 
Other investments, cost
2,616 
 
2,465 
 
Investments in partially-owned insurance companies, cost
$ 465 
 
$ 451 
 
Common Shares, par value
 
 27.49 
 
 28.89 
Common Shares, shares issued
342,832,412 
342,832,412 
342,832,412 
342,832,412 
Common Shares, shares outstanding
340,069,972 
340,069,972 
340,321,534 
340,321,534 
Common Shares in treasury, shares
2,762,440 
2,762,440 
2,510,878 
2,510,878 
Consolidated Statements Of Operations and Comprehensive Income (USD $)
In Millions, except Per Share data, unless otherwise specified
3 Months Ended 9 Months Ended
Sep. 30, 2013
Sep. 30, 2012
Sep. 30, 2013
Sep. 30, 2012
Revenues
 
 
 
 
Net premiums written
$ 4,620 
$ 4,716 
$ 12,809 
$ 12,418 
Change in unearned premiums
(10)
(51)
(559)
(589)
Net premiums earned
4,610 
4,665 
12,250 
11,829 
Net investment income
522 
533 
1,587 
1,614 
Net realized gains (losses):
 
 
 
 
Other-than-temporary impairment (OTTI) losses gross
(4)
(10)
(14)
(30)
Portion of OTTI losses recognized in other comprehensive income (OCI)
Net OTTI losses recognized in income
(4)
(10)
(14)
(30)
Net realized gains (losses) excluding OTTI losses
44 
(50)
364 
(164)
Total net realized gains (losses)
40 
(60)
350 
(194)
Total revenues
5,172 
5,138 
14,187 
13,249 
Expenses
 
 
 
 
Losses and loss expenses
2,655 
3,047 
6,831 
6,970 
Policy benefits
138 
130 
379 
379 
Policy acquisition costs
678 
609 
1,957 
1,810 
Administrative expenses
563 
519 
1,641 
1,543 
Interest expense
72 
63 
205 
187 
Other (income) expense
(5)
(17)
22 
14 
Total expenses
4,101 
4,351 
11,035 
10,903 
Income before income tax
1,071 
787 
3,152 
2,346 
Income tax expense (includes $4 and $16 Income tax expense from reclassification of unrealized gains in the three and nine months ended September 30, 2013, respectively)
155 
147 
392 
405 
Net income
916 
640 
2,760 
1,941 
Other comprehensive income (loss)
 
 
 
 
Unrealized appreciation (depreciation)
16 
731 
(1,570)
1,369 
Reclassification adjustment for net realized gains included in net income
24 
56 
97 
147 
Other comprehensive income
(8)
675 
(1,667)
1,222 
Change in:
 
 
 
 
Cumulative translation adjustment
149 
190 
(237)
162 
Pension liability
(2)
(4)
17 
(5)
Other comprehensive income (loss), before income tax
139 
861 
(1,887)
1,379 
Income tax (expense) benefit related to OCI items
(25)
(185)
374 
(276)
Other comprehensive income (loss)
114 
676 
(1,513)
1,103 
Comprehensive income
1,030 
1,316 
1,247 
3,044 
Earnings per share
 
 
 
 
Basic earnings per share
$ 2.68 
$ 1.88 
$ 8.09 
$ 5.71 
Diluted earnings per share
$ 2.66 
$ 1.86 
$ 8.02 
$ 5.67 
Reclassification out of Accumulated Other Comprehensive Income [Member] |
Accumulated Net Unrealized Investment Gain (Loss) [Member]
 
 
 
 
Net realized gains (losses):
 
 
 
 
Total net realized gains (losses)
24 
 
97 
 
Expenses
 
 
 
 
Income tax expense (includes $4 and $16 Income tax expense from reclassification of unrealized gains in the three and nine months ended September 30, 2013, respectively)
$ 4 
 
$ 16 
 
Consolidated Statements Of Operations and Comprehensive Income Consolidated Statements of Operations and Comprehensive Income (Parenthetical) (USD $)
In Millions, unless otherwise specified
3 Months Ended 9 Months Ended
Sep. 30, 2013
Sep. 30, 2012
Sep. 30, 2013
Sep. 30, 2012
Net realized gains (losses)
$ 40 
$ (60)
$ 350 
$ (194)
Income tax expense (benefit)
155 
147 
392 
405 
Reclassification out of Accumulated Other Comprehensive Income [Member] |
Accumulated Net Unrealized Investment Gain (Loss) [Member]
 
 
 
 
Net realized gains (losses)
24 
 
97 
 
Income tax expense (benefit)
$ 4 
 
$ 16 
 
Consolidated Statements Of Shareholders' Equity (USD $)
In Millions
Total
Common Stock [Member]
Treasury Stock [Member]
Additional Paid-in Capital [Member]
Retained Earnings [Member]
Accumulated Net Unrealized Investment Gain (Loss) [Member]
Accumulated Translation Adjustment [Member]
Accumulated Defined Benefit Plans Adjustment [Member]
Accumulated Other Comprehensive Income (Loss) [Member]
Balance - beginning of period at Dec. 31, 2011
 
$ 10,095 
$ (327)
$ 5,326 
$ 7,327 
$ 1,715 
$ 258 
$ (62)
 
Dividends declared on Common Shares-par value reduction
 
(336)
 
 
 
 
 
 
 
Common Shares repurchased
 
 
(7)
 
 
 
 
 
 
Net shares redeemed under employee share-based compensation plans
 
 
147 
(102)
 
 
 
 
 
Exercise of stock options
 
 
 
(8)
 
 
 
 
 
Share-based compensation expense and other
 
 
 
93 
 
 
 
 
 
Funding of dividends declared to Retained earnings
 
 
 
(200)
 
 
 
 
 
Net income
1,941 
 
 
 
1,941 
 
 
 
 
Funding of dividends declared from Additional paid-in capital
 
 
 
 
200 
 
 
 
 
Dividends declared on Common Shares
 
 
 
 
(200)
 
 
 
 
Change in period, net of income tax benefit (expense) of $353 and $(234)
 
 
 
 
 
988 
 
 
 
Change in period, net of income tax benefit (expense) of $27 and $(44)
 
 
 
 
 
 
118 
 
 
Change in period, net of income tax benefit (expense) of $(6) and $2
 
 
 
 
 
 
 
(3)
 
Balance - end of period at Sep. 30, 2012
26,963 
9,759 
(187)
5,109 
9,268 
2,703 
376 
(65)
3,014 
Balance - beginning of period at Dec. 31, 2012
27,531 
9,591 
(159)
5,179 
10,033 
2,633 
339 
(85)
 
Dividends declared on Common Shares-par value reduction
 
(518)
 
 
 
 
 
 
 
Common Shares repurchased
 
 
(233)
 
 
 
 
 
 
Net shares redeemed under employee share-based compensation plans
 
 
170 
(129)
 
 
 
 
 
Exercise of stock options
 
 
 
(34)
 
 
 
 
 
Share-based compensation expense and other
 
 
 
184 
 
 
 
 
 
Funding of dividends declared to Retained earnings
 
 
 
 
 
 
 
 
Net income
2,760 
 
 
 
2,760 
 
 
 
 
Funding of dividends declared from Additional paid-in capital
 
 
 
 
 
 
 
 
Dividends declared on Common Shares
 
 
 
 
 
 
 
 
Change in period, before reclassification from AOCI, net of income tax benefit of $337
 
 
 
 
 
(1,233)
 
 
 
Amounts reclassified from AOCI, net of income tax benefit of $16
 
 
 
 
 
(81)
 
 
 
Change in period, net of income tax benefit (expense) of $353 and $(234)
 
 
 
 
 
(1,314)
 
 
 
Change in period, net of income tax benefit (expense) of $27 and $(44)
 
 
 
 
 
 
(210)
 
 
Change in period, net of income tax benefit (expense) of $(6) and $2
 
 
 
 
 
 
 
11 
 
Balance - end of period at Sep. 30, 2013
$ 28,218 
$ 9,073 
$ (222)
$ 5,200 
$ 12,793 
$ 1,319 
$ 129 
$ (74)
$ 1,374 
Consolidated Statements Of Shareholders' Equity (Parenthetical) (USD $)
In Millions, unless otherwise specified
9 Months Ended
Sep. 30, 2013
Sep. 30, 2012
Net unrealized appreciation on investments, Change in period, income tax (expense) benefit
$ 353 
$ (234)
Cumulative translation adjustment, Change in period, income tax(expense) benefit
27 
(44)
Pension liability adjustment, Change in period, income tax (expense) benefit
(6)
Accumulated Net Unrealized Investment Gain (Loss) [Member]
 
 
Unrealized appreciation on investments, Change in period before reclassification to AOCI, income tax (expense) benefit
(81)
 
Reclassification out of Accumulated Other Comprehensive Income [Member] |
Accumulated Net Unrealized Investment Gain (Loss) [Member]
 
 
Unrealized appreciation on investments, Change in period before reclassification to AOCI, income tax (expense) benefit
16 
 
Income tax expense from reclassification of unrealized gains
$ (337)
 
Consolidated Statements Of Cash Flows (USD $)
In Millions, unless otherwise specified
9 Months Ended
Sep. 30, 2013
Sep. 30, 2012
Cash flows from operating activities
 
 
Net income
$ 2,760 
$ 1,941 
Adjustments to reconcile net income to net cash flows from operating activities
 
 
Net realized (gains) losses
(350)
194 
Amortization of premiums/discounts on fixed maturities
207 
161 
Deferred income taxes
169 
46 
Unpaid losses and loss expenses
33 
430 
Unearned premiums
603 
708 
Future policy benefits
149 
109 
Insurance and reinsurance balances payable
163 
(174)
Accounts payable, accrued expenses, and other liabilities
(176)
252 
Income taxes payable
44 
Insurance and reinsurance balances receivable
(657)
(828)
Reinsurance recoverable on losses and loss expenses
550 
606 
Reinsurance recoverable on policy benefits
47 
Deferred policy acquisition costs
(391)
(260)
Prepaid reinsurance premiums
(69)
(115)
Other
(263)
(136)
Net cash flows from operating activities
2,736 
3,025 
Cash flows from investing activities
 
 
Purchases of fixed maturities available for sale
(15,835)
(17,348)
Purchases of to be announced mortgage-backed securities
(54)
(308)
Purchases of fixed maturities held to maturity
(374)
(217)
Purchases of equity securities
(217)
(114)
Sales of fixed maturities available for sale
7,982 
11,058 
Sales of to be announced mortgage-backed securities
30 
297 
Sales of equity securities
99 
57 
Maturities and redemptions of fixed maturities available for sale
5,538 
3,596 
Maturities and redemptions of fixed maturities held to maturity
1,233 
1,092 
Net derivative instruments settlements
(376)
(358)
Acquisition of subsidiaries (net of cash acquired of $38 and $8)
(977)
(98)
Other
(188)
(339)
Net cash flows used for investing activities
(3,139)
(2,682)
Cash flows from financing activities
 
 
Dividends paid on Common Shares
(343)
(484)
Common Shares repurchased
(233)
(11)
Proceeds from issuance of long-term debt
947 
Proceeds from issuance of short-term debt
1,721 
2,083 
Repayment of short-term debt
(1,720)
(1,932)
Proceeds from share-based compensation plans, including windfall tax benefits
112 
73 
Other
68 
Net cash flows from (used for) financing activities
552 
(271)
Effect of foreign currency rate changes on cash and cash equivalents
Net increase in cash
153 
76 
Cash – beginning of period
615 1 2
614 3
Cash – end of period
768 2 4
690 3
Supplemental cash flow information
 
 
Taxes paid
150 
323 
Interest paid
$ 169 
$ 156 
Consolidated Statements of Cash Flows (Parentheticals) (USD $)
In Millions, unless otherwise specified
9 Months Ended
Sep. 30, 2013
Sep. 30, 2012
Statement of Cash Flows (Parentheticals) [Abstract]
 
 
Net cash acquired
$ 38 
$ 8 
General
General
General

Basis of presentation
ACE Limited is a holding company incorporated in Zurich, Switzerland. ACE Limited, 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 P&C, Insurance – North American Agriculture, Insurance – Overseas General, Global Reinsurance, and Life. Refer to Note 10 for additional information.

The interim unaudited consolidated financial statements, which include the accounts of ACE Limited and its subsidiaries (collectively, ACE, we, us, or our), have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and, in the opinion of management, reflect all adjustments (consisting of normally recurring accruals) necessary for a fair statement of the results and financial position for such periods. All significant intercompany accounts and transactions have been eliminated.

The results of operations and cash flows for any interim period are not necessarily indicative of the results for the full year. These consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our 2012 Form 10-K.
Acquisitions
Acquisitions
Acquisitions

PT Asuransi Jaya Proteksi
We acquired 80 percent of PT Asuransi Jaya Proteksi (JaPro) on September 18, 2012 and our local partner acquired the remaining 20 percent on January 3, 2013. JaPro is one of Indonesia's leading general insurers. The total purchase price for 100 percent of the company was approximately $107 million in cash. JaPro operates in our Insurance – Overseas General segment.

Fianzas Monterrey
On April 1, 2013, we acquired Fianzas Monterrey, a leading surety lines company in Mexico offering administrative performance bonds primarily to clients in the construction and industrial sectors, for approximately $293 million in cash. This acquisition expands our global franchise in the surety business and enhances our existing commercial lines and personal accident insurance business in Mexico.

The acquisition generated $135 million of goodwill, attributable to expected growth and profitability, none of which is expected to be deductible for income tax purposes, and other intangible assets of $73 million, based on ACE's preliminary purchase price allocation. The other intangible assets primarily relate to customer lists. Amortization of other intangible assets is included in Other (income) expense in the consolidated statements of operations. Goodwill and other intangible assets arising from this acquisition are included in the Insurance – Overseas General segment.

ABA Seguros
On May 2, 2013, we acquired ABA Seguros, a property and casualty insurer in Mexico that provides automobile, homeowners, and small business coverages for approximately $690 million in cash.

The acquisition generated $283 million of goodwill, attributable to expected growth and profitability, none of which is expected to be deductible for income tax purposes, and other intangible assets of $140 million based on ACE’s preliminary purchase price allocation. The other intangible assets primarily relate to distribution channels. Amortization of other intangible assets is included in Other (income) expense in the consolidated statements of operations. Goodwill and other intangible assets arising from this acquisition are included in the Insurance – Overseas General segment.
Investments
Investments
Investments

a) Fixed maturities
The following tables present the amortized cost and fair value of fixed maturities and related OTTI recognized in AOCI:
 
September 30, 2013
Amortized
Cost

 
Gross
Unrealized
Appreciation

 
Gross
Unrealized
Depreciation

 
Fair
Value

 
OTTI Recognized
in AOCI

(in millions of U.S. dollars)
 
 
 
 
Available for sale
 
 
 
 
 
 
 
 
 
U.S. Treasury and agency
$
2,934

 
$
81

 
$
(36
)
 
$
2,979

 
$

Foreign
14,294

 
405

 
(98
)
 
14,601

 

Corporate securities
16,664

 
753

 
(151
)
 
17,266

 
(6
)
Mortgage-backed securities
10,294

 
234

 
(149
)
 
10,379

 
(36
)
States, municipalities, and political subdivisions
3,295

 
72

 
(63
)
 
3,304

 

 
$
47,481

 
$
1,545

 
$
(497
)
 
$
48,529

 
$
(42
)
Held to maturity
 
 
 
 
 
 
 
 
 
U.S. Treasury and agency
$
842

 
$
20

 
$
(3
)
 
$
859

 
$

Foreign
876

 
36

 

 
912

 

Corporate securities
1,960

 
87

 

 
2,047

 

Mortgage-backed securities
1,440

 
43

 

 
1,483

 

States, municipalities, and political subdivisions
1,188

 
19

 
(15
)
 
1,192

 

 
$
6,306

 
$
205

 
$
(18
)
 
$
6,493

 
$


December 31, 2012
Amortized
Cost

 
Gross
Unrealized
Appreciation

 
Gross
Unrealized
Depreciation

 
Fair
Value

 
OTTI Recognized
in AOCI

(in millions of U.S. dollars)
 
 
 
 
Available for sale
 
 
 
 
 
 
 
 
 
U.S. Treasury and agency
$
3,553

 
$
183

 
$
(1
)
 
$
3,735

 
$

Foreign
13,016

 
711

 
(14
)
 
13,713

 

Corporate securities
15,529

 
1,210

 
(31
)
 
16,708

 
(7
)
Mortgage-backed securities
10,051

 
458

 
(36
)
 
10,473

 
(84
)
States, municipalities, and political subdivisions
2,517

 
163

 
(3
)
 
2,677

 

 
$
44,666

 
$
2,725

 
$
(85
)
 
$
47,306

 
$
(91
)
Held to maturity
 
 
 
 
 
 
 
 
 
U.S. Treasury and agency
$
1,044

 
$
39

 
$

 
$
1,083

 
$

Foreign
910

 
54

 

 
964

 

Corporate securities
2,133

 
142

 

 
2,275

 

Mortgage-backed securities
2,028

 
88

 

 
2,116

 

States, municipalities, and political subdivisions
1,155

 
44

 
(4
)
 
1,195

 

 
$
7,270

 
$
367

 
$
(4
)
 
$
7,633

 
$


As discussed in Note 3 c), if a credit loss is indicated on an impaired fixed maturity, an OTTI is considered to have occurred and the portion of the impairment not related to credit losses (non-credit OTTI) is recognized in OCI. Included in the “OTTI Recognized in AOCI” columns above are the cumulative amounts of non-credit OTTI recognized in OCI adjusted for subsequent sales, maturities, and redemptions. OTTI recognized in AOCI does not include the impact of subsequent changes in fair value of the related securities. In periods subsequent to a recognition of OTTI in OCI, changes in the fair value of the related fixed maturities are reflected in Unrealized appreciation (depreciation) in the consolidated statement of shareholders’ equity. For the three and nine months ended September 30, 2013, $1 million of net unrealized depreciation and $24 million of net unrealized appreciation related to such securities is included in OCI. For the three and nine months ended September 30, 2012, $46 million and $130 million of net unrealized appreciation related to such securities is included in OCI. At September 30, 2013 and December 31, 2012, AOCI includes net unrealized depreciation of $4 million and $25 million, respectively, related to securities remaining in the investment portfolio at those dates for which ACE has recognized a non-credit OTTI.

Mortgage-backed securities (MBS) issued by U.S. government agencies are combined with all other to be announced mortgage derivatives held (refer to Note 7 a) (iv)) and are included in the category, “Mortgage-backed securities”. Approximately 84 percent and 85 percent, of the total mortgage-backed securities at September 30, 2013 and December 31, 2012, respectively are represented by investments in U.S. government agency bonds. The remainder of the mortgage exposure consists of collateralized mortgage obligations and non-government mortgage-backed securities, the majority of which provide a planned structure for principal and interest payments and carry a rating of AAA by the major credit rating agencies.

The following table presents fixed maturities by contractual maturity:
 
 
 
September 30

 
 
 
December 31

 
 
 
2013

 
 
 
2012

(in millions of U.S. dollars)
Amortized Cost

 
Fair Value

 
Amortized Cost

 
Fair Value

Available for sale
 
 
 
 
 
 
 
Due in 1 year or less
$
2,317

 
$
2,345

 
$
1,887

 
$
1,906

Due after 1 year through 5 years
13,978

 
14,450

 
13,411

 
14,010

Due after 5 years through 10 years
16,291

 
16,650

 
15,032

 
16,153

Due after 10 years
4,601

 
4,705

 
4,285

 
4,764

 
37,187

 
38,150

 
34,615

 
36,833

Mortgage-backed securities
10,294

 
10,379

 
10,051

 
10,473

 
$
47,481

 
$
48,529

 
$
44,666

 
$
47,306

Held to maturity
 
 
 
 
 
 
 
Due in 1 year or less
$
398

 
$
401

 
$
656

 
$
659

Due after 1 year through 5 years
2,335

 
2,417

 
1,870

 
1,950

Due after 5 years through 10 years
1,707

 
1,756

 
2,119

 
2,267

Due after 10 years
426

 
436

 
597

 
641

 
4,866

 
5,010

 
5,242

 
5,517

Mortgage-backed securities
1,440

 
1,483

 
2,028

 
2,116

 
$
6,306

 
$
6,493

 
$
7,270

 
$
7,633



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. 

b) Equity securities
The following table presents the cost and fair value of equity securities: 
 
September 30


December 31

(in millions of U.S. dollars)
2013


2012

Cost
$
835

 
$
707

Gross unrealized appreciation
53

 
41

Gross unrealized depreciation
(57
)
 
(4
)
Fair value
$
831

 
$
744



c) Net realized gains (losses)
In accordance with guidance related to the recognition and presentation of OTTI, when an impairment related to a fixed maturity has occurred, OTTI is required to be recorded in Net income if management has the intent to sell the security or it is more likely than not that we will be required to sell the security before the recovery of its amortized cost. Further, in cases where we do not intend to sell the security and it is more likely than not that we will not be required to sell the security, ACE must evaluate the security to determine the portion of the impairment, if any, related to credit losses. If a credit loss is indicated, an OTTI is considered to have occurred and any portion of the OTTI related to credit losses must be reflected in Net income while the portion of OTTI related to all other factors is recognized in OCI. For fixed maturities held to maturity, OTTI recognized in OCI is accreted from AOCI to the amortized cost of the fixed maturity prospectively over the remaining term of the securities.

Each quarter, securities in an unrealized loss position (impaired securities), including fixed maturities, securities lending collateral, equity securities, and other investments, are reviewed to identify impaired securities to be specifically evaluated for a potential OTTI.

For all non-fixed maturities, OTTI is evaluated based on the following:

the amount of time a security has been in a loss position and the magnitude of the loss position;

the period in which cost is expected to be recovered, if at all, based on various criteria including economic conditions and other issuer-specific developments; and

ACE’s ability and intent to hold the security to the expected recovery period.

As a general rule, we also consider that equity securities in an unrealized loss position for twelve consecutive months are other than temporarily impaired.

We review each fixed maturity in an unrealized loss position to assess whether the security is a candidate for credit loss. Specifically, we consider 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 we determine 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. All significant assumptions used in determining credit losses are subject to change as market conditions evolve.

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. We develop 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. We believe that use of a default assumption in excess of the historical mean is reasonable in light of current market conditions.

For the three and nine months ended September 30, 2013, credit losses recognized in Net income for corporate securities were $1 million and $8 million, respectively. For the three and nine months ended September 30, 2012, credit losses recognized in Net income for corporate securities were $5 million and $9 million, respectively.

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.

For the three and nine months ended September 30, 2013, there were no credit losses recognized in Net income for mortgage-backed securities. For the three and nine months ended September 30, 2012, credit losses recognized in Net income for mortgage-backed securities were $2 million and $5 million, respectively.
The following table presents the Net realized gains (losses) and the losses included in Net realized gains (losses) and OCI as a result of conditions which caused us to conclude the decline in fair value of certain investments was “other-than-temporary”: 
 
Three Months Ended
 
 
Nine Months Ended
 
 
September 30
 
 
September 30
 
(in millions of U.S. dollars)
2013

 
2012

 
2013

 
2012

Fixed maturities:
 
 
 
 
 
 
 
OTTI on fixed maturities, gross
$
(4
)
 
$
(10
)
 
$
(11
)
 
$
(18
)
OTTI on fixed maturities recognized in OCI (pre-tax)

 

 

 

OTTI on fixed maturities, net
(4
)
 
(10
)
 
(11
)
 
(18
)
Gross realized gains excluding OTTI
37

 
71

 
163

 
287

Gross realized losses excluding OTTI
(16
)
 
(14
)
 
(68
)
 
(120
)
Total fixed maturities
17

 
47

 
84

 
149

Equity securities:
 
 
 
 
 
 
 
OTTI on equity securities

 

 
(1
)
 
(5
)
Gross realized gains excluding OTTI
8

 
3

 
18

 
5

Gross realized losses excluding OTTI
(1
)
 
(1
)
 
(4
)
 
(2
)
Total equity securities
7

 
2

 
13

 
(2
)
OTTI on other investments

 

 
(2
)
 
(7
)
Foreign exchange gains (losses)
(26
)
 
(50
)
 
45

 
(64
)
Investment and embedded derivative instruments
4

 
4

 
62

 
(3
)
Fair value adjustments on insurance derivative
134

 
83

 
563

 
44

S&P put options and futures
(95
)
 
(147
)
 
(413
)
 
(308
)
Other derivative instruments
(1
)
 

 
(2
)
 
(4
)
Other

 
1

 

 
1

Net realized gains (losses)
$
40

 
$
(60
)
 
$
350

 
$
(194
)

 
The following table presents a roll-forward of pre-tax credit losses related to fixed maturities for which a portion of OTTI was recognized in OCI: 
 
Three Months Ended
 
 
Nine Months Ended
 
 
September 30
 
 
September 30
 
(in millions of U.S. dollars)
2013

 
2012

 
2013

 
2012

Balance of credit losses related to securities still held – beginning of period
$
40

 
$
47

 
$
43

 
$
74

Additions where no OTTI was previously recorded
1

 
1

 
5

 
3

Additions where an OTTI was previously recorded

 
6

 
3

 
11

Reductions for securities sold during the period
(3
)
 
(4
)
 
(13
)
 
(38
)
Balance of credit losses related to securities still held – end of period
$
38

 
$
50

 
$
38

 
$
50



d) Gross unrealized loss
At September 30, 2013, there were 6,038 fixed maturities out of a total of 24,746 fixed maturities in an unrealized loss position. The largest single unrealized loss in the fixed maturities was $3 million. There were 66 equity securities out of a total of 183 equity securities in an unrealized loss position. The largest single unrealized loss in the equity securities was $48 million. Fixed maturities in an unrealized loss position at September 30, 2013 comprised both investment grade and below investment grade securities for which fair value declined primarily due to widening credit spreads since the date of purchase. Equity securities in an unrealized loss position at September 30, 2013 included foreign fixed income securities held in a commingled fund structure for which fair value declined primarily due to widening credit spreads since the date of purchase.

The following tables present, for all securities in an unrealized loss position (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
 
September 30, 2013
Fair Value

 
Gross
Unrealized
Loss

 
Fair Value

 
Gross
Unrealized
Loss

 
Fair Value

 
Gross
Unrealized
Loss

(in millions of U.S. dollars)
 
 
 
 
 
U.S. Treasury and agency
$
1,436

 
$
(39
)
 
$

 
$

 
$
1,436

 
$
(39
)
Foreign
4,034

 
(93
)
 
112

 
(5
)
 
4,146

 
(98
)
Corporate securities
4,696

 
(142
)
 
67

 
(9
)
 
4,763

 
(151
)
Mortgage-backed securities
3,751

 
(139
)
 
132

 
(10
)
 
3,883

 
(149
)
States, municipalities, and political subdivisions
2,076

 
(77
)
 
3

 
(1
)
 
2,079

 
(78
)
Total fixed maturities
15,993

 
(490
)
 
314

 
(25
)
 
16,307

 
(515
)
Equity securities
500

 
(57
)
 

 

 
500

 
(57
)
Other investments
40

 
(9
)
 

 

 
40

 
(9
)
Total
$
16,533

 
$
(556
)
 
$
314

 
$
(25
)
 
$
16,847

 
$
(581
)
 
 
0 – 12 Months
 
 
Over 12 Months
 
 
Total
 
December 31, 2012
Fair Value

 
Gross
Unrealized
Loss

 
Fair Value

 
Gross
Unrealized
Loss

 
Fair Value

 
Gross
Unrealized
Loss

(in millions of U.S. dollars)
 
 
 
 
 
U.S. Treasury and agency
$
440

 
$
(1
)
 
$

 
$

 
$
440

 
$
(1
)
Foreign
1,234

 
(8
)
 
88

 
(6
)
 
1,322

 
(14
)
Corporate securities
1,026

 
(23
)
 
85

 
(8
)
 
1,111

 
(31
)
Mortgage-backed securities
855

 
(4
)
 
356

 
(32
)
 
1,211

 
(36
)
States, municipalities, and political subdivisions
316

 
(3
)
 
48

 
(4
)
 
364

 
(7
)
Total fixed maturities
3,871

 
(39
)
 
577

 
(50
)
 
4,448

 
(89
)
Equity securities
29

 
(4
)
 

 

 
29

 
(4
)
Other investments
68

 
(5
)
 

 

 
68

 
(5
)
Total
$
3,968

 
$
(48
)
 
$
577

 
$
(50
)
 
$
4,545

 
$
(98
)


e) Restricted assets
ACE 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. ACE is also required to restrict assets pledged under repurchase agreements. We also use 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. We also have investments in segregated portfolios primarily to provide collateral or guarantees for LOCs and derivative transactions. Included in restricted assets at September 30, 2013 and December 31, 2012, are fixed maturities and short-term investments totaling $16.3 billion and $16.6 billion, respectively, and cash of $129 million and $139 million, respectively.

The following table presents the components of restricted assets:
 
September 30

 
December 31

(in millions of U.S. dollars)
2013

 
2012

Trust funds
$
11,269

 
$
11,389

Deposits with non-U.S. regulatory authorities
1,999

 
2,133

Assets pledged under repurchase agreements
1,405

 
1,401

Deposits with U.S. regulatory authorities
1,333

 
1,338

Other pledged assets
394

 
456

 
$
16,400

 
$
16,717

Fair value measurements
Fair value measurements
Fair value measurements

a) Fair value hierarchy
Fair value of financial assets and financial liabilities is estimated based on the framework established in the fair value accounting guidance. The guidance defines fair value as the price to sell an asset or transfer a liability in an orderly transaction between market participants and establishes a three-level valuation hierarchy in which inputs into valuation techniques used to measure fair value are classified. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data.
 
The three levels of the hierarchy are as follows:

Level 1 – Unadjusted quoted prices for identical assets or liabilities in active markets;

Level 2 – Includes, among other items, inputs other than quoted prices that are observable for the asset or liability such as interest rates and yield curves, quoted prices for similar assets and liabilities in active markets, and quoted prices for identical or similar assets and liabilities in markets that are not active; and

Level 3 – Inputs that are unobservable and reflect management’s judgments about assumptions that market participants would use in pricing an asset or liability.

We categorize financial instruments within the valuation hierarchy at the balance sheet date based upon the lowest level of inputs that are significant to the fair value measurement. Accordingly, transfers between levels within the valuation hierarchy occur when there are significant changes to the inputs, such as increases or decreases in market activity, changes to the availability of current prices, changes to the transparency to underlying inputs, and whether there are significant variances in quoted prices. Transfers in and/or out of any level are assumed to occur at the end of the period.

We use one or more pricing services to obtain fair value measurements for the majority of the investment securities we hold. Based on management’s understanding of the methodologies used, these pricing services only produce an estimate of fair value if there is observable market information that would allow them to make a fair value estimate. Based on our understanding of the market inputs used by the pricing services, all applicable investments have been valued in accordance with GAAP. We do not typically adjust prices obtained from pricing services. The following is a description of the valuation techniques and inputs used to determine fair values for financial instruments carried at fair value, as well as the general classification of such financial instruments pursuant to the valuation hierarchy.

Fixed maturities
We use pricing services to estimate fair value measurements for the majority of our fixed maturities. The pricing services use market quotations for fixed maturities that have quoted prices in active markets; such securities are classified within Level 1. For fixed maturities other than U.S. Treasury securities that generally do not trade on a daily basis, the pricing services prepare estimates of fair value measurements using their pricing applications, which include available relevant market information, benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing. Additional valuation factors that can be taken into account are nominal spreads, dollar basis, and liquidity adjustments. The pricing services evaluate each asset class based on relevant market and credit information, perceived market movements, and sector news. The market inputs used in the pricing evaluation, listed in the approximate order of priority include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. The extent of the use of each input is dependent on the asset class and the market conditions. Given the asset class, the priority of the use of inputs may change or some market inputs may not be relevant. Additionally, the valuation of fixed maturities is more subjective when markets are less liquid due to the lack of market based inputs (i.e., stale pricing), which may increase the potential that the estimated fair value of an investment is not reflective of the price at which an actual transaction would occur. The overwhelming majority of fixed maturities are classified within Level 2 because the most significant inputs used in the pricing techniques are observable. For a small number of fixed maturities, we obtain a quote from a broker (typically a market maker). Due to the disclaimers on the quotes that indicate that the price is indicative only, we include these fair value estimates in Level 3. 

Equity securities
Equity securities with active markets are classified within Level 1 as fair values are based on quoted market prices. For equity securities in markets which are less active, fair values are based on market valuations and are classified within Level 2. Equity securities for which pricing is unobservable are classified within Level 3.

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 approximates fair value. Short-term investments for which pricing is unobservable are classified within Level 3.

Other investments
Fair values for the majority of Other investments including investments in partially-owned investment companies, investment funds, and limited partnerships are based on their respective net asset values or equivalent (NAV). The majority of these investments, for which NAV was used as a practical expedient to measure fair value, are classified within Level 3 because either ACE will never have the contractual option to redeem the investments or will not have the contractual option to redeem the investments in the near term. The remainder of such investments is classified within Level 2. Certain of our long duration contracts are supported by assets that do not qualify for separate account reporting under GAAP. These assets comprise mutual funds classified within Level 1 in the valuation hierarchy on the same basis as other equity securities traded in active markets. Other investments also includes equity securities and fixed maturities held in rabbi trusts maintained by ACE for deferred compensation plans, which are classified within the valuation hierarchy on the same basis as other equity securities and fixed maturities.

Securities lending collateral
The underlying assets included in Securities lending collateral in the consolidated balance sheets are fixed maturities which are classified in the valuation hierarchy on the same basis as other fixed maturities. Excluded from the valuation hierarchy is the corresponding liability related to ACE’s obligation to return the collateral plus interest as it is reported at contract value and not fair value in the consolidated balance sheets.

Investment derivative instruments
Actively traded investment derivative instruments, including futures, options, and exchange-traded forward contracts are classified within Level 1 as fair values are based on quoted market prices. The fair value of cross-currency swaps are based on market valuations and are classified within Level 2. Investment derivative instruments are recorded in Accounts payable, accrued expenses, and other liabilities in the consolidated balance sheets.

Other derivative instruments
We maintain 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 our guaranteed minimum death benefits (GMDB) and guaranteed living benefits (GLB) reinsurance business. Our position in exchange-traded equity futures contracts is classified within Level 1. The fair value of the majority of the 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. Our position in credit default swaps is typically included within Level 3. Other derivative instruments are recorded in Accounts payable, accrued expenses, and other liabilities in the consolidated balance sheets.

Separate account assets
Separate account assets represent segregated funds where investment risks are borne by the customers, except to the extent of certain guarantees made by ACE. Separate account assets comprise mutual funds classified in the valuation hierarchy on the same basis as other equity securities traded in active markets and are classified within Level 1. Separate account assets also include fixed maturities classified within Level 2 because the most significant inputs used in the pricing techniques are observable. Excluded from the valuation hierarchy are the corresponding liabilities as they are reported at contract value and not fair value in the consolidated balance sheets. Separate account assets are recorded in Other assets in the consolidated balance sheets.

Guaranteed living benefits
The GLB arises from life reinsurance programs covering living benefit guarantees whereby we assume the risk of guaranteed minimum income benefits (GMIB) and guaranteed minimum accumulation benefits (GMAB) associated with variable annuity contracts. GLB’s are recorded in Accounts payable, accrued expenses, and other liabilities and Future policy benefits in the consolidated balance sheets. For GLB 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 most significant policyholder behavior assumptions include lapse rates and the GMIB annuitization rates. Assumptions regarding lapse rates and GMIB annuitization rates differ by treaty but the underlying methodologies to determine rates applied to each treaty are comparable. The assumptions regarding lapse and GMIB annuitization rates determined for each treaty are based on a dynamic calculation that uses several underlying factors.

A lapse rate is the percentage of in-force policies surrendered in a given calendar year. All else equal, as lapse rates increase, ultimate claim payments will decrease. In general, the base lapse function assumes low lapse rates (ranging from about 1 percent to 6 percent per annum) during the surrender charge period of the GMIB contract, followed by a “spike” lapse rate (ranging from about 10 percent to 30 percent per annum) in the year immediately following the surrender charge period, and then reverting to an ultimate lapse rate (generally around 10 percent per annum), typically over a 2-year period. This base rate is adjusted downward for policies with more valuable guarantees (policies with guaranteed values far in excess of their account values) by multiplying the base lapse rate by a factor ranging from 15 percent to 75 percent. Additional lapses due to partial withdrawals and older policyholders with tax-qualified contracts (due to required minimum distributions) are also included.

The GMIB annuitization rate is the percentage of policies for which the policyholder will elect to annuitize using the guaranteed benefit provided under the GMIB. All else equal, as GMIB annuitization rates increase, ultimate claim payments will increase, subject to treaty claim limits. In general ACE assumes that GMIB annuitization rates will be higher for policies with more valuable guarantees (policies with guaranteed values far in excess of their account values). In addition, we also assume that GMIB annuitization rates are higher in the first year immediately following the waiting period (the first year the policies are eligible to annuitize using the GMIB) in comparison to all subsequent years. We do not yet have a robust set of annuitization experience because most of our clients’ policyholders are not yet eligible to annuitize using the GMIB. However, for certain clients representing approximately 37 percent of the total GMIB guaranteed value there are several years of annuitization experience. For these clients the annuitization function reflects the actual experience and has a maximum annuitization rate per annum of 8 percent (a higher maximum applies in the first year a policy is eligible to annuitize using the GMIB—it is over 13 percent). For most clients, there is not a credible amount of observable relevant behavior data and so we use a weighted-average (with a heavier weighting on the observed experience noted previously) of three different annuitization functions with maximum annuitization rates per annum of 8 percent, 12 percent, and 30 percent, respectively (with significantly higher rates in the first year a policy is eligible to annuitize using the GMIB). The GMIB reinsurance treaties include claim limits to protect ACE in the event that actual annuitization behavior is significantly higher than expected.

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 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 information, such as market conditions, market participant assumptions, and demographics of in-force annuities. During the three and nine months ended September 30, 2013, no material changes were made to actuarial or behavioral assumptions.

We view 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, GLB reinsurance is classified within Level 3.


The following tables present, by valuation hierarchy, the financial instruments measured at fair value on a recurring basis:
September 30, 2013
Level 1

 
Level 2

 
Level 3

 
Total

(in millions of U.S. dollars)
 
 
 
Assets:
 
 
 
 
 
 
 
Fixed maturities available for sale
 
 
 
 
 
 
 
U.S. Treasury and agency
$
1,615

 
$
1,364

 
$

 
$
2,979

Foreign
235

 
14,324

 
42

 
14,601

Corporate securities
1

 
17,144

 
121

 
17,266

Mortgage-backed securities

 
10,370

 
9

 
10,379

States, municipalities, and political subdivisions

 
3,304

 

 
3,304

 
1,851

 
46,506

 
172

 
48,529

Equity securities
375

 
452

 
4

 
831

Short-term investments
1,061

 
705

 
8

 
1,774

Other investments
292

 
221

 
2,389

 
2,902

Securities lending collateral

 
1,517

 

 
1,517

Investment derivative instruments
(18
)
 

 

 
(18
)
Other derivative instruments
7

 
8

 

 
15

Separate account assets
1,074

 
78

 

 
1,152

Total assets measured at fair value
$
4,642

 
$
49,487

 
$
2,573

 
$
56,702

Liabilities:
 
 
 
 
 
 
 
GLB(1)
$

 
$

 
$
514

 
$
514

(1) 
Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as Future policy benefits in the consolidated balance sheets. Refer to Note 5 for additional information.
 
December 31, 2012
Level 1

 
Level 2

 
Level 3

 
Total

(in millions of U.S. dollars)
 
 
 
Assets:
 
 
 
 
 
 
 
Fixed maturities available for sale
 
 
 
 
 
 
 
U.S. Treasury and agency
$
2,050

 
$
1,685

 
$

 
$
3,735

Foreign
222

 
13,431

 
60

 
13,713

Corporate securities
20

 
16,586

 
102

 
16,708

Mortgage-backed securities

 
10,460

 
13

 
10,473

States, municipalities, and political subdivisions

 
2,677

 

 
2,677

 
2,292

 
44,839

 
175

 
47,306

Equity securities
253

 
488

 
3

 
744

Short-term investments
1,503

 
725

 

 
2,228

Other investments
268

 
196

 
2,252

 
2,716

Securities lending collateral

 
1,791

 

 
1,791

Investment derivative instruments
11

 

 

 
11

Other derivative instruments
(6
)
 
30

 

 
24

Separate account assets
872

 
71

 

 
943

Total assets measured at fair value
$
5,193

 
$
48,140

 
$
2,430

 
$
55,763

Liabilities:
 
 
 
 
 
 
 
GLB(1)
$

 
$

 
$
1,119

 
$
1,119

(1) 
Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as Future policy benefits in the consolidated balance sheets. Refer to Note 5 for additional information.

There were no transfers from Level 1 to Level 2 during the the three months ended September 30, 2013. The transfers from Level 1 to Level 2 during the nine months ended September 30, 2013 were $19 million. The transfers from Level 1 to Level 2 were $34 million and $40 million during the three and nine months ended September 30, 2012, respectively. There were no transfers from Level 2 to Level 1 during the three and nine months ended September 30, 2013. The transfers from Level 2 to Level 1 during the three and nine months ended September 30, 2012 were $15 million.

Fair value of alternative investments
Included in Other investments in the fair value hierarchy at September 30, 2013 and December 31, 2012 are investment funds, limited partnerships, and partially-owned investment companies measured at fair value using NAV as a practical expedient. At September 30, 2013 and December 31, 2012, there were no probable or pending sales related to any of the investments measured at fair value using NAV. 

The following table presents, by investment category, the expected liquidation period, fair value, and maximum future funding commitments of alternative investments:
 
 
 
 
 
September 30

 
 
 
December 31

 
Expected
Liquidation
Period
 
 
 
2013

 
 
 
2012

(in millions of U.S. dollars)
Fair
Value

 
Maximum
Future Funding
Commitments

 
Fair
Value

 
Maximum
Future Funding
Commitments

Financial
5 to 9 Years
 
$
249

 
$
83

 
$
225

 
$
111

Real estate
3 to 9 Years
 
342

 
78

 
292

 
62

Distressed
6 to 9 Years
 
168

 
122

 
192

 
152

Mezzanine
6 to 9 Years
 
243

 
285

 
284

 
279

Traditional
3 to 8 Years
 
811

 
505

 
711

 
587

Vintage
1 to 3 Years
 
12

 

 
14

 

Investment funds
Not Applicable
 
415

 

 
395

 

 
 
 
$
2,240

 
$
1,073

 
$
2,113

 
$
1,191



Included in all categories in the above table except for Investment funds are investments for which ACE will never have the contractual option to redeem but receives distributions based on the liquidation of the underlying assets. Included in the “Expected Liquidation Period” column above is the range in years over which ACE expects the majority of underlying assets in the respective categories to be liquidated. Further, for all categories except for Investment funds, ACE does not have the ability to sell or transfer the investments without the consent from the general partner of individual funds.

Financial
Financial consists of investments in private equity funds targeting financial services companies such as financial institutions and insurance services around the world.

Real estate
Real estate consists of investments in private equity funds targeting global distress opportunities, value added U.S. properties, and global mezzanine debt securities in the commercial real estate market.

Distressed
Distressed consists of investments in private equity funds targeting distressed debt/credit and equity opportunities in the U.S.

Mezzanine
Mezzanine consists of investments in private equity funds targeting private mezzanine debt of large-cap and mid-cap companies in the U.S. and worldwide.

Traditional
Traditional consists of investments in private equity funds employing traditional private equity investment strategies such as buyout and venture with different geographical focuses including Brazil, Asia, Europe, and the U.S.

Vintage
Vintage consists of investments in private equity funds made before 2002 and where the funds’ commitment periods had already expired.

Investment funds
ACE’s investment funds employ various investment strategies such as long/short equity and arbitrage/distressed. Included in this category are investments for which ACE has the option to redeem at agreed upon value as described in each investment fund’s subscription agreement. Depending on the terms of the various subscription agreements, investment fund investments may be redeemed monthly, quarterly, semi-annually, or annually. If ACE wishes to redeem an investment fund investment, it must first determine if the investment fund is still in a lock-up period (a time when ACE cannot redeem its investment so that the investment fund manager has time to build the portfolio). If the investment fund is no longer in its lock-up period, ACE must then notify the investment fund manager of its intention to redeem by the notification date prescribed by the subscription agreement. Subsequent to notification, the investment fund can redeem ACE’s investment within several months of the notification. Notice periods for redemption of the investment funds range between 5 and 120 days. ACE can redeem its investment funds without consent from the investment fund managers.

Level 3 financial instruments
The fair value of assets and liabilities measured at fair value using significant unobservable inputs (Level 3) consist of various inputs and assumptions that management makes when determining fair value. Management analyzes changes in fair value measurements classified within Level 3 by comparing pricing and returns of our investments to benchmarks, including month-over-month movements, investment credit spreads, interest rate movements, and credit quality of securities.

The following table presents the significant unobservable inputs used in the Level 3 liability valuations. Excluded from the table below are inputs used to fair value Level 3 assets which are based on single broker quotes or net asset value and contain no quantitative unobservable inputs developed by management. 
(in millions of U.S. dollars, except for percentages)
Fair Value at
September 30, 2013

 
Fair Value at
December 31, 2012

 
Valuation
Technique
 
Significant
Unobservable Inputs
 
Ranges
GLB(1)
$
514

 
$
1,119

 
Actuarial model
 
Lapse rate
 
1% – 30%
 
 
 
 
 
 
 
Annuitization rate
 
0% – 50%
(1) 
Discussion of the most significant inputs used in the fair value measurement of GLB and the sensitivity of those assumptions is included within Note 4 a) Guaranteed living benefits.
The following tables present a reconciliation of the beginning and ending balances of financial instruments measured at fair value using significant unobservable inputs (Level 3): 
 
Assets
 
 
Liabilities

Three Months Ended
Available-for-Sale Debt Securities
Equity
securities

 
Short-term investments

 
Other
investments

 
GLB(1)

September 30, 2013
Foreign

 
Corporate
securities

 
MBS

 
 
(in millions of U.S. dollars)
 
 
 
 
Balance–Beginning of Period
$
48

 
$
114

 
$
9

 
$
4

 
$
9

 
$
2,349

 
$
652

Transfers into Level 3
1

 
12

 

 

 
1

 

 

Transfers out of Level 3
(8
)
 
(1
)
 

 

 
(2
)
 

 

Change in Net Unrealized Gains (Losses) included in OCI
2

 
(1
)