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| ACE > SEC Filings for ACE > Form 10-Q on 8-May-2009 | All Recent SEC Filings |
8-May-2009
Quarterly Report
The following is a discussion of our results of operations, financial condition, and liquidity and capital resources as of and for the three months ended March 31, 2009. Our results of operations and cash flows for any interim period are not necessarily indicative of our results for the full year. This discussion should be read in conjunction with our Consolidated Financial Statements and related notes and our Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2008.
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Any written or oral statements made by us or on our behalf may include forward-looking statements that reflect our current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks, uncertainties, and other factors that could, should potential events occur, cause actual results to differ materially from such statements. These risks, uncertainties, and other factors (which are described in more detail elsewhere herein and in other documents we file with the Securities and Exchange Commission (SEC)) include but are not limited to:
• developments in global financial markets, including changes in interest rates, stock markets, and other financial markets, increased government involvement or intervention in the financial services industry, the cost and availability of financing, and foreign currency exchange rate fluctuations, which could affect our statement of operations, investment portfolio, financial position, and financing plans;
• general economic and business conditions resulting from recent declines in the stock markets and tightening of credit and the depth and duration of the current recession;
• losses arising out of natural or man-made catastrophes such as hurricanes, typhoons, earthquakes, floods, or terrorism which could be affected by:
• the number of insureds and ceding companies affected,
• the amount and timing of losses actually incurred and reported by insureds,
• the impact of these losses on our reinsurers and the amount and timing of reinsurance recoverable actually received,
• the cost of building materials and labor to reconstruct properties following a catastrophic event, and
• complex coverage and regulatory issues such as whether losses occurred from storm surge or flooding and related lawsuits;
• actions that rating agencies may take from time to time, such as financial strength or credit ratings downgrades or placing these ratings on credit watch negative or the equivalent;
• global political conditions, the occurrence of any terrorist attacks, including any nuclear, radiological, biological, or chemical events, or the outbreak and effects of war, and possible business disruption or economic contraction that may result from such events;
• the ability to collect reinsurance recoverable, credit developments of reinsurers, and any delays with respect thereto and changes in the cost, quality, or availability of reinsurance;
• actual loss experience from insured or reinsured events and the timing of claim payments;
• the uncertainties of the loss-reserving and claims-settlement processes, including the difficulties associated with assessing environmental damage and asbestos-related latent injuries, the impact of aggregate-policy-coverage limits, and the impact of bankruptcy protection sought by various asbestos producers and other related businesses and the timing of loss payments;
• judicial decisions and rulings, new theories of liability, legal tactics, and settlement terms;
• the effects of public company bankruptcies and/or accounting restatements, as well as disclosures by and investigations of public companies relating to possible accounting irregularities, and other corporate governance issues, including the effects of such events on:
• the capital markets,
• the markets for directors and officers and errors and omissions insurance, and
• claims and litigation arising out of such disclosures or practices by other companies;
• uncertainties relating to governmental, legislative and regulatory policies, developments, actions, investigations and treaties, which, among other things, could subject us to insurance regulation or taxation in additional jurisdictions or affect our current operations;
• the actual amount of new and renewal business, market acceptance of our products, and risks associated with the introduction of new products and services and entering new markets, including regulatory constraints on exit strategies;
• the competitive environment in which we operate, including trends in pricing or in policy terms and conditions, which may differ from our projections and changes in market conditions that could render our business strategies ineffective or obsolete;
• acquisitions made by us performing differently than expected, our failure to realize anticipated expense-related efficiencies or growth from acquisitions, or the impact of acquisitions on our pre-existing organization;
• risks associated with our re-domestication to Switzerland, including possible reduced flexibility with respect to certain aspects of capital management and the potential for additional regulatory burdens;
• the potential impact from government-mandated insurance coverage for acts of terrorism;
• the availability of borrowings and letters of credit under our credit facilities;
• the adequacy of collateral supporting funded high deductible programs;
• changes in the distribution or placement of risks due to increased consolidation of insurance and reinsurance brokers;
• material differences between actual and expected assessments for guaranty funds and mandatory pooling arrangements;
• the effects of investigations into market practices in the property and casualty (P&C) industry;
• changing rates of inflation and other economic conditions, for example, recession;
• the amount of dividends received from subsidiaries;
• loss of the services of any of our executive officers without suitable replacements being recruited in a reasonable time frame;
• the ability of our technology resources to perform as anticipated; and
• management's response to these factors and actual events (including, but not limited to, those described above).
The words "believe," "anticipate," "estimate," "project," "should," "plan," "expect," "intend," "hope,", "feel", "will likely result," or "will continue," and variations thereof and similar expressions, identify forward-looking statements. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. We undertake no obligation to publicly update or review any forward-looking statements, whether as a result of new information, future events or otherwise.
Overview
ACE Limited is the holding company of the ACE Group of Companies. ACE opened its business office in Bermuda in 1985 and continues to maintain significant operations in Bermuda. ACE Limited, which is now headquartered in Zurich, Switzerland, and its direct and indirect subsidiaries (collectively, the ACE Group of Companies, ACE, the Company, we, us, or our) comprise a global insurance and reinsurance organization, with operating subsidiaries in more than 50 countries serving the needs of commercial and individual customers in more than 140 countries. We serve the P&C insurance needs of businesses of all sizes in a broad range of industries. We also provide specialized insurance products such as personal accident, supplemental health, and life insurance to individuals in select countries. Our reinsurance operations include both P&C and life companies. At March 31, 2009, ACE had total assets of $73 billion and shareholders' equity of $14.7 billion.
Our product and geographic diversification differentiates us from the vast majority of our competitors and has been a source of stability during periods of industry volatility. Our long-term business strategy focuses on sustained growth in book value achieved through a combination of underwriting and investment income. By doing so, we provide value to our clients and shareholders through the utilization of our substantial capital base in the insurance and reinsurance markets.
Redomestication to Zurich, Switzerland
In July 2008, our shareholders approved proposals submitted by our Board of Directors to transfer our domicile from the Cayman Islands to Zurich, Switzerland, our new jurisdiction of incorporation (the Continuation). As a result of the Continuation, we are deregistered in the Cayman Islands and are now subject to Swiss law. In connection with the Continuation, we changed the currency in which the par value of our Ordinary Shares was stated from U.S. dollars to Swiss francs. Upon the effectiveness of the Continuation, our Ordinary Shares became Common Shares. All Common Shares are registered shares with a current par value of CHF 32.84 each.
Notwithstanding the change of the currency in which the par value of Common Shares is stated, we continue to use U.S. dollars as our reporting currency for preparing our Consolidated Financial Statements. For the foreseeable future, we expect to pay dividends as a repayment of share capital in the form of a reduction in par value or qualified paid-in capital, which is not subject to Swiss withholding tax. Refer to "Liquidity and Capital Resources" below for more information, including proposed changes to the process by which we make distributions in the form of par value reductions.
The Combined Insurance Acquisition
On April 1, 2008, ACE acquired all of the outstanding shares of Combined Insurance Company of America (Combined Insurance) and certain of its subsidiaries from Aon Corporation for $2.56 billion. Combined Insurance, founded in 1919 is headquartered in Glenview, Illinois, and 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 Combined Insurance acquisition using the purchase method of accounting. Consolidated operating results for the quarter ended March 31, 2009, include the results of Combined Insurance.
Market Conditions
We are operating in a deep global recession, and the financial markets remain difficult. By our assessment, there was some improvement in both debt and equity market conditions in the latter part of the quarter ended March 31, 2009, and time will tell if this improvement, particularly in equity markets, is transient.
The quarter ended March 31, 2009, was the first quarterly period of growth for our Global Reinsurance segment since the second quarter of 2006, with net premiums written up four percent over the prior year quarter. Growth was due to a combination of firming prices - particularly in the North America and Bermuda markets - as well as
companies purchasing additional reinsurance due to capital management requirements. Catastrophe reinsurance pricing is continuing to firm, and so far in the second quarter of 2009, we are experiencing price increases in the 20-30 percent range. One theme clear to us for our Global Reinsurance segment is that counterparty security is more important to clients and, as a result, due to our financial strength, we are writing more business and at more favorable terms to ACE.
On the direct insurance side, P&C pricing during the quarter ended March 31, 2009, was generally in line or better than what we contemplated in our 2009 plans. Rates overall are generally firming, although not as fast as in reinsurance. In many classes of insurance rates are flat to up, and where prices are declining, they are doing so at a slower rate than recent experience. In our retail business we are experiencing a positive benefit from flight to both capability and safety, and that is resulting in growth for certain lines, particularly casualty-related products. The environment for our wholesale businesses (ACE Westchester and ACE Global Markets) is more competitive than for our retail businesses (ACE USA and ACE International).
At this time, there are countervailing forces at work related to pricing - some bode toward continued firming, others toward softening. On the demand side, client exposures are down due to recession, and that means less pressure on capital relative to exposure. Further, because of economic conditions, buyers have less ability to pay for price increases and are seeking cheaper alternatives to rate increases. On the supply side, we believe certain competitors are willing to cut prices in order to maintain or gain market share. However, countervailing pressures that push toward continued firming include current industry underwriting and investment results, weaker balance sheets, and a firming reinsurance market. In summary, we feel that rates are improving and the relationship between rates and risk-exposure is improving, but we cannot predict with any certainty how long these conditions will continue. We believe that the current recession is impacting exposures and clients' insurance budgets and this along with foreign exchange weakness relative to the U.S. dollar, will continue to negatively impact growth rates in 2009.
Refer to "Overview" in our "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the year ended December 31, 2008 (2008 Form 10-K).
Fair Value Measurements
We partially adopted the provisions of Financial Accounting Standard No. 157, Fair Value Measurements (FAS 157) on January 1, 2008. We fully adopted FAS 157 effective January 1, 2009. FAS 157 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. Inputs in Level 1 are unadjusted quoted prices for identical assets or liabilities in active markets. Level 2 includes inputs other than quoted prices included within Level 1 that are observable for assets or liabilities either directly or indirectly. Level 2 inputs include, among other items, quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and inputs other than quoted prices that are observable for the asset or liability such as interest rates and yield curves. Level 3 inputs are unobservable and reflect our judgments about assumptions that market participants would use in pricing an asset or liability. 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.
While the Company obtains values for the majority of the investment securities it holds from one or more pricing services, it is ultimately management's responsibility to determine whether the values obtained and recorded in the financial statements are representative of fair value. We periodically update our understanding of the methodologies used by our pricing services in order to validate that the prices obtained from those services are consistent with FAS 157 valuation principles. Based on our understanding of the methodologies used by our pricing services, all applicable investments have been valued in accordance with FAS 157. We do not typically adjust prices obtained from pricing services.
Volatility and widening credit spreads during the quarter ended March 31, 2009, adversely affected the values of certain of our securities. However, we believe there was sufficient market activity to price securities under FAS 157 in a manner consistent with prior periods.
At March 31, 2009, our Level 3 assets represented approximately three percent of our assets that are measured at fair value and less than two percent of our total assets. Our Level 3 liabilities represented approximately 98 percent of our liabilities that are measured at fair value and less than two percent of our total liabilities at March 31, 2009. During the quarter ended March 31, 2009, we transferred $44 million out of our Level 3 total assets at fair value. The following is a description of the valuation measurements used for our financial instruments (Levels 1, 2, and 3) carried or disclosed at fair value, as well as the general classification of such financial instruments pursuant to the valuation hierarchy.
• Fixed maturities with active markets such as U.S. Treasury and agency securities are classified within Level 1 as fair values are based on quoted market prices. For fixed maturities that trade in less active markets, including corporate and municipal securities, 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. Our pricing methodologies incorporate back-testing of valuation techniques as a standard part of our process. Fixed maturities for which pricing is unobservable are classified within Level 3.
• Equity securities with active markets are classified within Level 1 as fair values are based on quoted market prices. For nonpublic equity securities, fair values are based on market valuations and are classified within Level 2.
• 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.
• Fair values for other investments, principally other direct equity investments, investment funds, and limited partnerships, are based on the net asset value or financial statements and are included within Level 3. Equity securities and fixed maturities held in rabbi trusts maintained by ACE for deferred compensation plans, and included in Other investments, are classified within the valuation hierarchy on the same basis as our other equity securities and fixed maturities.
• The fair value of our investment in Assured Guaranty Ltd. (AGO) included in Investments in partially-owned insurance companies is based on a quoted market price and is classified within Level 1. 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.
• For actively traded investment derivative instruments, including futures, options, and exchange-traded forward contracts, we obtain 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. Our position in interest rate and credit default swaps is typically classified within Level 3.
• For GMIB reinsurance, we estimate fair value using an internal valuation model which includes current market information and estimates of policyholder behavior. All of our 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
• We maintain positions in other derivative instruments including option contracts designed to limit long-term exposure to a severe equity market decline or decrease in interest rates, which would cause an increase in expected claims and, therefore, reserves for GMDB and GMIB reinsurance business. The fair value of the majority of our 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.
Note 8 to our Consolidated Financial Statements presents a break-down of our
financial instruments carried or disclosed at fair value by valuation hierarchy
as well as a roll-forward of Level 3 financial instruments for the quarter ended
March 31, 2009.
In April 2009, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) No. FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (FSP FAS 157-4). FSP FAS 157-4 provides additional guidance for estimating fair value in accordance with FAS 157 when the volume and level of activity for the asset or liability have significantly decreased. FSP FAS 157-4 is effective for interim and annual periods ending after June 15, 2009. We plan to adopt FSP FAS 157-4 during the second quarter of 2009, and do not expect this to have a material impact on our financial condition or results of operations.
Guaranteed minimum income benefits derivatives (GMIB)
Under reinsurance programs covering living benefit guarantees, we assume the risk of GMIBs associated with variable annuity contracts. Our GMIB reinsurance product meets the definition of a derivative for accounting purposes and is therefore carried at fair value with changes in fair value recognized in net realized gains (losses) in the period of the change pursuant to Statement of Financial Accounting Standard No. 133, Accounting for Derivative Instruments and Hedging Activities (FAS 133). We believe that the most meaningful presentation of these derivatives is to reflect cash inflows or revenue as net premiums earned, and to record estimates of the average modeled value of future cash outflows as incurred losses. Accordingly, we recognize benefit reserves consistent with AICPA Statement of Position 03-1, Accounting and Reporting by Insurance Enterprises for Certain Non-traditional Long-duration Contracts and for Separate Accounts (SOP 03-1). Changes in this reserve
are included in life underwriting income. The incremental difference between fair value and SOP 03-1 benefit reserves is reflected in accounts payable, accrued expenses, and other liabilities in the balance sheet and related changes in fair value are reflected in net realized gains (losses) in the consolidated statement of operations. We intend to hold these derivative contracts to maturity (i.e., the expiration of the underlying annuities through lapses, annuitization, or death). At maturity, the cumulative gains and losses will net to zero because, over time, the insurance liability will be increased or decreased to equal our obligation. For a sensitivity discussion of the effect of changes in interest rates, equity indices and other assumptions on the fair value of GMIBs, and the resulting impact on our net income, refer to Item 3. Refer to Note 2 j) to the Consolidated Financial Statements, under Item 8 of our 2008 Form 10-K, for further description of this product and related accounting treatment.
The fair value of GMIB reinsurance is estimated using an internal valuation model which includes current market information and estimates of policyholder behavior from the perspective of a theoretical market participant. All of our treaties contain claim limits, which are factored into the valuation model. The fair value depends on a number of factors, including interest rates, current account value, market volatility, expected annuitization rates and other policyholder behavior, and changes in policyholder mortality. The model and related assumptions are continuously re-evaluated by management and enhanced, as appropriate, based upon additional experience obtained related to policyholder behavior and availability of more timely market information, such as market conditions and demographics of in-force annuities. Due to the inherent uncertainties of the assumptions used in the valuation models to determine the fair value of these derivative products, actual experience may differ from the estimates reflected in our Consolidated Financial Statements, and the differences may be material.
The most significant policyholder behavior assumptions include lapse rates and . . .
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