The following table sets forth selected consolidated financial data of the Company as of and for the years ended December 31, 2008, 2007, 2006, 2005, and 2004. These selected financial and other data should be read in conjunction with the Consolidated Financial Statements and related notes, under Item 8, and with
The following is a discussion of our results of operations, financial condition, and liquidity and capital resources as of and for the year ended December 31, 2008. This discussion should be read in conjunction with the Consolidated Financial Statements and related notes, under Item 8 of this Form 10-K.
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) are 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 property and casualty (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 December 31, 2008, ACE had total assets of approximately $72 billion and shareholders’ equity of approximately $14 billion.
As an insurance and reinsurance company, we generate gross revenues from two principal sources: premiums and investment income. Cash flow is generated from premiums collected and investment income received less paid losses and loss expenses, policy acquisition costs, and administrative expenses. Invested assets are substantially held in liquid, investment grade fixed income securities of relatively short duration. We invest in equity securities in the U.S. and international markets. A small portion of our assets are held in less liquid or higher risk assets in an attempt to achieve higher risk-adjusted returns. Claims payments in any short-term period are highly unpredictable due to the random nature of loss events and the timing of claims awards or settlements. The value of investments held to pay future claims is subject to market forces such as the level of interest rates, stock market volatility, and credit events such as corporate defaults. The actual cost of claims is also volatile based on loss trends, inflation rates, court awards, and catastrophes. We believe that our cash balance, our highly liquid investments, credit facilities, and reinsurance protection provide sufficient liquidity to meet unforeseen claim demands that might occur in the year ahead. Refer to “Liquidity and Capital Resources”.
On April 1, 2008, ACE acquired all of the outstanding shares of 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 in the U.S., Europe, Canada, and Asia Pacific. Combined Insurance serves close to four million policyholders worldwide. This acquisition has diversified our accident and health (A&H) distribution capabilities by adding a significant agent base, while almost doubling our A&H franchise. We believe this will provide significant long-term growth opportunities.
In North America, we are seeing substantially more opportunity to quote business as a result of market turmoil. Submissions are up significantly, though our quote-to-close ratios have dropped modestly given our pricing discipline. In those lines where rate is adequate, we are benefiting from the weakness of others by improving our position on accounts, moving into primary lead or first excess position - for example, in excess casualty, directors and officers’ liability (D&O), environmental and medical liability. We are also gaining new business in certain lines where we already enjoy a strong lead position such as our E&O business and risk management division. There are also classes where our retention rates and new business writings are being negatively impacted by continued inadequate pricing such as both large account and catastrophe-exposed property, E&S casualty, and due to recession, construction-related business. Our international business has also seen improvement - in the fourth quarter of 2008, our P&C business in original currency experienced its best quarter of the year, increasing six percent over the third quarter, while A&H was up 15 percent over the same period. We deliberately shrank our reinsurance business in 2008, due to the competitive market conditions. However, during the first quarter of 2009, Global Reinsurance experienced improved pricing in many classes, and although U.S. casualty remains competitive, we gained revenue from improved signings due to competitor weakness and more clients looking for a reinsurance solution to solve a capital need. In reinsurance, we are noticing more clients willing to pay more - though in most cases not dramatically more - to have ACE on their program.
Although, the relationship between rates and risk-exposure is improving and rates are improving, we cannot predict with any certainty how long these conditions will continue. We believe that the current recession is impacting exposures and client’s insurance budgets and this along with foreign exchange weakness relative to the U.S. dollar, will negatively impact growth rates in 2009.
We are continuing to invest in people and infrastructure to grow our presence in lines of businesses globally where we see an opportunity for ACE to grow market share at reasonable terms. We are also continuing to invest in our enterprise risk management capability, our systems and data environment, and our research and development capabilities.
• the assessment of risk transfer for certain structured insurance and reinsurance contracts;
We have actuarial staff within each of our operating segments who analyze loss reserves and regularly project estimates of ultimate losses and the required IBNR reserve. IBNR reserve estimates are generally calculated by first projecting the ultimate amount of expected claims for a product line and subtracting paid losses and case reserves for reported claims. The judgments involved in projecting the ultimate losses may involve the use and interpretation of various actuarial projection methods that place reliance on the extrapolation of actual historical data, loss development patterns and industry data as needed. The estimate of the IBNR reserve also requires judgment by actuaries and management to reflect the impact of more contemporary, qualitative, and subjective factors. Among some of the factors that might be considered are changes in business mix or volume, changes in ceded reinsurance structures, reported and projected loss trends, inflation, legal environment, and the terms and conditions of the contracts sold to our insured parties.
The standard actuarial reserving methods may include, but are not necessarily limited to, paid and reported loss development, expected loss ratio, and Bornhuetter-Ferguson methods. A general description of these methods is provided below. In the subsequent discussion on short and long-tail business, reference is also made where appropriate to how consideration in method selection impacted 2008 results. In addition to these standard methods, we may use other recognized actuarial methods and approaches depending upon the product line characteristics and available data. To ensure that the projections of future loss emergence based on historical loss development patterns are representative of the underlying business, the historical loss and premium data is required to be of sufficient homogeneity and credibility. For example, to improve data homogeneity, we may group product line data further by similar risk attribute (e.g., geography, coverage such as property versus liability exposure, or origin year), project losses for these homogenous groups and then combine these results to provide the overall product line estimate. The premium and loss data is aggregated by origin year (e.g., the year in which the losses were incurred or “accident year”) and annual or quarterly development periods subsequent to the origin year. Implicit in the standard actuarial methods that we generally utilize is the need for two fundamental assumptions: first, the expected loss ratio for each origin year (i.e., accident, report, or underwriting) and second, the pattern by which losses are expected to emerge over time for each origin year.
• Extent of internal historical loss data, and industry information where required;
• Historical variability of loss estimates compared with actual loss experience;
We do not calculate a range of loss reserve estimates for our individual loss reserve studies. Ranges are not necessarily a true reflection of the potential difference between loss reserves estimated at the balance sheet date and the ultimate settlement value of losses. This is due to the fact that an actuarial range is developed based on known events as of the valuation date whereas actual prior period development reported in subsequent Consolidated Financial Statements relates in part to events and circumstances that were unknown as of the original valuation date. While we believe that our recorded reserves are
reasonable and represent management’s best estimate for each product line as of the current valuation date, future changes to our view of the ultimate liabilities are possible. A five percent change in our net loss reserves equates to $1.2 billion and represents eight percent of shareholders’ equity at December 31, 2008. Historically, including A&E reserve charges, our reserves, at times, have developed in excess of 10 percent of recorded amounts. Refer to “Analysis of Losses and Loss Expense Development” under Item 1 for a summary of historical volatility between estimated loss reserves and ultimate loss settlements.
We perform internal loss reserve studies for all product lines at least once a year; the timing of such studies varies throughout the year. Additionally, each quarter for most product lines, we review the emergence of actual losses relative to expectations. If warranted from findings in loss emergence tests, we will accelerate the timing of our product line reserve studies. Finally, loss reserve studies are performed annually by external third-parties and the findings are used to test the reasonability of our internal findings.
For the 2008 origin year, the short-tail line loss reserves were typically established using the expected loss ratio method for the non-catastrophe exposures. Reserves were also established for losses arising on catastrophe activity during 2008. The underlying calculation for the non-catastrophe losses requires initial expected loss ratios by product line adjusted for actual experience during the 2008 calendar year. As previously noted, the derivation of initial loss ratios incorporates actuarial projections of prior years’ losses, past and future loss and exposure trends, rate adequacy for new and renewal business, and ceded reinsurance coverage and costs. We also considered our view of the impact of terms and conditions and the market environment, which by their nature tend to be more judgmental relative to other factors. For our short-tail businesses taken as a whole, overall loss trend assumptions did not differ significantly relative to prior years. Because there is some degree of random volatility of non-catastrophe loss experience from year to year, we considered average loss experience over several years when developing loss estimates for the current accident year. Therefore, while there has been favorable loss development in recent years on non-catastrophe exposures, the effect of this favorable development on expected loss ratios for the current accident year is relatively small. Further, other considerations, such as rate reductions and broadening of terms and conditions in a competitive market somewhat offset the impact of recent favorable loss development.
Long-tail business describes lines of business for which specific losses may not be known for some period and claims can take significant time to emerge. This includes most casualty lines such as general liability, D&O, and workers’ compensation. There are many factors contributing to the uncertainty and volatility of long-tail business. Among these are:
• Our historical loss data and experience is often too immature and lacking in credibility to rely upon for reserving purposes. Where this is the case, in our reserve analysis we rely on industry loss ratios or industry benchmark development patterns that we believe reflect the nature and coverage of the underwritten business and its future development, where available. For such product lines, actual loss experience may differ from industry loss statistics as well as loss experience for previous underwriting years;
For those long-tail product lines that are less claim frequency and more claim severity oriented, such as professional lines and high excess casualty, we placed more reliance upon expert legal and claims review of the specific circumstance underlying reported cases rather than loss development patterns. The assumptions used for these lines of business are updated over time to reflect new claim and legal advice judged to be of significance.
the key actuarial assumptions for the loss trend (aside from changes to inflation assumptions), exposure trend, and loss development patterns used to establish the 2008 accident year reserves relative to prior accident years.
To the extent that actual loss emergence in calendar year 2008 differed from our expectation for the more recent origin years, the deviation was not typically seen as sufficiently credible, particularly given the volatility and lengthy period for full loss emergence, to alter either our booked ultimate loss selections or the actuarial assumptions underlying the reserve reviews. Such judgments were made with due consideration to the factors impacting reserve uncertainty as discussed above. However, for some product lines, credibility was assigned to emerging loss experience and this is discussed further below and in the section entitled “Prior Period Development”. For the 2007 and 2008 origin years, our best estimate reflects what we believe to be our exposure to credit-crunch related claims (primarily E&O and D&O) based on information received to date.
Given the long reporting and paid development patterns, the tail factors used to project actual current losses to ultimate losses for claims covered by our inactive middle market workers’ compensation business requires considerable judgment that could be material to consolidated loss and loss expense reserves. Specifically, when applying the paid loss development method, a one percent change in the tail factor (i.e., 1.04 changed to either 1.05 or 1.03) would cause a change of approximately $45 million, either positively or negatively, for the projected net loss and loss expense reserves. This is relative to recorded net loss and loss expense reserves of approximately $270 million.
Certain long-tail lines, such as casualty and professional lines, are particularly susceptible to changes in loss trend and claim inflation. Heightened perceptions of tort and settlement awards around the world are increasing the demand for these products as well as contributing to the uncertainty in the reserving estimates. Our reserving methods rely on loss development patterns estimated from historical data and while we attempt to adjust such factors for known changes in the current tort environment, it is possible that such factors may not entirely reflect all recent trends in tort environments. For example, when applying the reported loss development method, the lengthening by six months of our selected loss development patterns would increase reserve estimates on long-tail casualty and professional lines for accident years 2000-2006 by approximately $254 million. This movement is relative to recorded net loss and loss expense reserves of approximately $1.7 billion for these years.
Typically, there is inherent uncertainty around the length of paid and reported development patterns, especially for certain casualty lines such as excess workers’ compensation or general liability, which may take up to 30 years to fully develop. This uncertainty is accentuated by the need to supplement client development patterns with industry development patterns due to the sometimes low credibility of the data. The underlying source and selection of the final development patterns can thus have a significant impact on the selected net losses and loss expenses ultimate. For example, a twenty percent shortening or lengthening of the development patterns used for U.S. long-tail lines would cause the loss reserve estimate derived by the reported Bornhuetter-Ferguson method for these lines to change by approximately $217 million. This movement is relative to recorded net loss and loss expense reserves of approximately $1.5 billion.
Included in our liabilities for losses and loss expenses are liabilities for asbestos and environmental claims and expenses. These claims are principally related to claims arising from remediation costs associated with hazardous waste sites and bodily-injury claims related to exposure to asbestos products and environmental hazards. The estimation of these liabilities is particularly sensitive to the recent legal environment, including specific settlements that may be used as precedents to settle future claims.
The results in asbestos cases announced by other carriers may well have little or no relevance to us because coverage exposures are highly dependent upon the specific facts of individual coverage and resolution status of disputes among carriers, policyholders, and claimants.
As part of purchase accounting related to the Combined Insurance acquisition, we applied fair value accounting to the future policy benefit reserves acquired. An additional liability resulted primarily as a result of using current interest rates and an adjusted risk margin. We applied this fair value adjustment by essentially “unlocking” the future policy benefit reserves and then “locking in” the new assumptions which will be subject to the same premium deficiency analysis as the original reserves.
As part of the Combined Insurance acquisition, we established an intangible asset related to VOBA. The valuation of VOBA is derived from similar assumptions to those used to establish the associated future policy benefit reserve. The most significant input in this calculation is the discount rate used to present value the net cash flows. We amortize deferred policy acquisition costs associated with long-duration contracts and VOBA (collectively DAC) over the estimated life of the contracts in proportion to premium revenue recognized. The estimated life is established at the inception of the contracts or upon acquisition and is based on current persistency assumptions. DAC is tested along with the future policy benefit reserves regularly for premium deficiencies of which we have not identified any significant deficiencies.
A significant portion of ACE Tempest Re USA’s business is written through quota share treaties (approximately $363 million of net premiums earned in 2008, comprised of $250 million of first dollar quota share treaties and $113 million of excess quota share treaties), a small portion of which are categorized as structured products. Structured quota share treaties typically contain relatively low aggregate policy limits, a feature that reduces loss coverage in some manner and a profit sharing provision.
The recognition of reinsurance recoverable requires two key judgments. The first judgment involves our estimation based on the amount of gross reserves and the percentage of that amount which may be ceded to reinsurers. Ceded IBNR, which is a major component of the reinsurance recoverable on unpaid losses and loss expenses, is generally developed as part of our loss reserving process and, consequently, this estimation is subject to similar risks and uncertainties as the estimation of gross reserves. Refer to “Critical Accounting Estimates - Unpaid losses and loss expenses”. The second judgment involves our estimate of the amount of the reinsurance recoverable balance that we may ultimately be unable to recover from reinsurers due to insolvency, contractual dispute, or for other reasons. Amounts estimated to be uncollectible are reflected in a provision that reduces the reinsurance recoverable asset and, in turn, shareholders’ equity. Changes in the provision for uncollectible reinsurance are reflected in net income.
To estimate the provision for uncollectible reinsurance, the reinsurance recoverable must first be determined for each reinsurer. This determination is based on a process rather than an estimate, although an element of judgment must be applied. As part of the process, ceded reserves are allocated to reinsurance contracts because ceded reserves are not generally calculated on a contract by contract basis. The allocations are generally based on premiums ceded under reinsurance contracts, adjusted for actual loss experience and historical relationships between gross and ceded losses. If actual experience varies materially from historical experience, including that used to determine ceded premium, the allocation of reinsurance recoverable by reinsurer will change. While such change is unlikely to result in a large percentage change in the provision for uncollectible reinsurance, it could, nevertheless, have a material effect on our net income in the period recorded.
payment durations conform to averages), the judgment exercised by management to determine the provision for uncollectible reinsurance of each reinsurer is typically limited because the financial rating is based on a published source and the default factor we apply is based on a default factor of a major rating agency applicable to the particular rating class. Default factors applied for financial ratings of AAA, AA, A, BBB, BB, B, and CCC, are 0.5 percent, 1.2 percent, 1.9 percent, 4.7 percent, 9.6 percent, 23.8 percent, and 49.7 percent, respectively. Because the model we use is predicated on capital charges previously applied by a major rating agency, we do not generally consider alternative factors. However, when a recoverable is expected to be paid in a brief period of time by a highly-rated reinsurer, such as certain property catastrophe claims, a default factor may not be applied;
• For balances recoverable from reinsurers that are both unrated by a major rating agency and for which management is unable to determine a credible rating equivalent based on a parent, affiliate, or peer company, we determine a rating equivalent based on an analysis of the reinsurer that considers an assessment of the creditworthiness of the particular entity, industry benchmarks, or other factors as considered appropriate. We then apply the applicable default factor for that rating class. For balances recoverable from unrated reinsurers for which we have not adopted a rating equivalent, we generally apply a default factor of 25 percent;
With respect to securities where the decline in value is determined to be temporary and the security’s value is not written down, a subsequent decision may be made to sell that security and realize a loss. Subsequent decisions on security sales are the result of changing or unforeseen facts and circumstances (e.g., arising from a large insured loss such as a catastrophe), deterioration of the credit-worthiness of the issuer or its industry, or changes in regulatory requirements. We believe that subsequent decisions to sell such securities are consistent with the classification of the majority of the portfolio as available for sale. The gross unrealized loss at December 31, 2008, for all securities in a loss position was $3.2 billion with $684 million in an unrealized loss position for over 12 months ($20 million was related to fixed maturities held to maturity). Our net realized losses in 2008 included write-downs of $1.1 billion of which $760 million was related to fixed maturities. This compares with write-downs of $141 million and $214 million in 2007 and 2006, respectively. The other-than-temporary impairments recorded in 2008 were primarily due to an increase in market interest rates resulting from volatility and widening credit spreads; issuer defaults, of which Lehman Brothers was the most significant to us; and significant declines in global equity markets. The other-than-temporary impairments recorded in 2007 and 2006 were primarily due to an increase in market interest rates from the date of security purchase and as such, were not credit-related.