Certain statements in this document, as well as certain statements incorporated by reference herein, may be considered to be “forward looking statements” as that term is defined in the Private Securities Litigation Reform Act of 1995. Words or phrases such as “will result”, “is expected to”, “will continue”, “is anticipated”, or similar expressions are intended to identify forward looking statements, although not all forward looking statements contain those identifying words. Such forward looking statements are subject to certain risks, uncertainties and assumptions about our business. The factors that could cause actual results to differ materially from those suggested by any such statements include but are not limited to those discussed or identified from time to time in the Corporation’s public filings with the Securities and Exchange Commission and specifically to risks or uncertainties associated with any one or more of the following:
global political conditions and the occurrence of any terrorist 	attacks, including any nuclear, biological or chemical events;
premium price increases and profitability or growth estimates 	overall or by lines of business, and related expectations with 	respect to the timing and terms of any required regulatory 	approvals;
our expectations with respect to cash flow projections and 	investment income and with respect to other income;
any changes in judicial or legislative decisions relating to 	coverage and liability for asbestos and toxic waste claims;
the effects on the energy markets and the companies that 	participate in them;
the effects on the capital markets and the markets for directors 	and officers and errors and omissions insurance;
changes in interest rates and the performance of the financial 	markets;
The Corporation assumes no obligation to update any forward looking information set forth in this document, as well as any statements incorporated by reference herein, which speak as of the respective dates thereof.
The consolidated financial statements include amounts based on informed estimates and judgments of management for those transactions that are not yet complete or for which the ultimate effects are uncertain. Such estimates and judgments affect the reported amounts in the financial statements. Those estimates and judgments that were most critical to the preparation of the financial statements involved the adequacy of loss reserves and, to a lesser extent, the fair value of credit derivative obligations and the recoverability of the carrying value of real estate properties. These estimates and judgments are discussed within the following analysis of our results of operations. If different estimates and judgments had been applied, materially different amounts might have been reported in the financial statements.
Net income, which includes realized investment gains and losses, was $112 million in 2001 compared with $715 million in 2000 and $621 million in 1999.
A summary of our property and casualty insurance operating results for the years ended December 31, 2001, 2000 and 1999 is included in the supplementary financial data on page 21 of the Corporation’s 2001 Annual Report to Shareholders. The summary on page 17 of our property and
We estimate that our gross claims and claim expenses from the September 11 attack were about $3 billion. Most of the claims were from property exposure and business interruption losses. We also had significant workers’ compensation losses. Our net claims and claim expenses of $665 million were significantly lower than the gross amount due to various reinsurance agreements. Our property exposures were protected by facultative reinsurance, a property per risk treaty that limited our net loss per risk, and our property catastrophe treaty. Our workers’ compensation losses were protected by a casualty catastrophe treaty and a casualty clash treaty. Based on our review of our reinsurance programs, we estimated the amount of reinsurance recoverable. We believe the estimate is reasonable based on information available at the present time. We have also modeled the estimated recoveries by individual reinsurer. Based on this analysis, we estimate that 98% of our reinsurance is with reinsurers or markets rated investment grade or rated A or better by A.M. Best Company.
Underwriting results by class of business for the years ended December 31, 2001, 2000 and 1999 are presented on page 22 of the Corporation’s 2001 Annual Report to Shareholders. In 2001, we formed three strategic business units: Chubb Personal Insurance, Chubb Commercial Insurance and Chubb Specialty Insurance. In conjunction with the formation of the strategic business units, we have
reclassified property and marine business from our specialty insurance segment to our commercial insurance segment and also reclassified some business that was included within executive protection to multiple peril. Prior year amounts have been reclassified.
Each of our underwriting segments was affected by the September 11 attack. However, the greatest impact by far was on our financial institutions business, which is part of our specialty insurance segment. Due to the distorting effect of the September 11 attack on our 2001 underwriting results, the remaining discussion and analysis of our underwriting results excludes the impact of the September 11 attack, unless otherwise noted. The following is a summary of our underwriting results for 2001 by class of business excluding the impact of the September 11 attack.
Includes the effect of net surety bond losses of 	$220 million related to Enron. Excluding the effect of the 	Enron surety losses, the combined loss and expense ratio was 	99.2% for other specialty, 95.3% for total specialty and 100.5% 	in total.
Net premiums written were $6.9 billion in 2001, an increase of 9% over 2000. Reported net premiums written increased 11% in 2000 compared with 1999. Reported premium growth in 2000 was affected by the inclusion of premiums written by Executive Risk Inc. since July 1999, the date it was acquired by the Corporation. Executive Risk was a specialty insurance company offering primarily directors and officers and errors and omissions coverages. Excluding the effect of the acquisition of Executive Risk, premium growth was 8% in 2000.
Personal coverages accounted for $2.0 billion or 29% of 2001 net premiums written, commercial coverages for $2.5 billion or 36% and specialty coverages for $2.4 billion or 35%.
Premium growth in personal lines was strong in both 2001 and 2000. In our commercial classes, which include multiple peril, casualty, workers’ compensation and property and marine, premiums decreased in 2000 as higher prices were more than offset by lower retention rates, the latter due in part to our pruning of underperforming accounts where we could not attain price adequacy. The marketplace continued to improve in 2001 with many of our competitors increasing rates even before
The tragic event of September 11 and its aftermath have accelerated changes in commercial insurance markets. In the wake of heavy insurance industry losses, many insurance companies have sought substantial price increases, raised deductibles, reduced coverage limits or declined outright to renew coverage. In this environment, we are seeing more opportunities to write new, high quality accounts and we are retaining more of our business. We are getting substantial rate increases on business we write, often with more restrictive policy terms and conditions. We expect that this trend will continue during 2002.
We expect that reinsurers will restructure our property per risk reinsurance to limit the amount of catastrophe risk covered by these treaties. Also, in many cases, we will have to retain a larger share of a loss before property per risk reinsurance applies. We may not renew certain reinsurance programs because the terms being offered are too restrictive or because the programs have become prohibitively expensive. In fact, effective in January 2002, we did not renew a casualty catastrophe program that had substantially reduced our net workers’ compensation losses from the September 11 attack. Our current property reinsurance program expires in April 2002. The potential increase in our net risk concentrations from a catastrophic event that would result from changes to our reinsurance arrangements may be offset to some degree by changes to our gross risk profile. In particular, we are making a concerted effort to reduce terrorism risk aggregations. A shortage of reinsurance capacity could constrain our ability to respond to business opportunities and could make our future operating results more volatile.
Excluding the effect of the Enron surety losses, the combined loss and expense ratio was 100.5% in 2001, similar to the 100.4% in the prior year.
there were no other individual catastrophes for which our losses exceeded the initial retention. Currently, our initial retention level for each catastrophic event is approximately $100 million in the United States and generally $25 million outside the United States. Our initial retention may increase when our catastrophe reinsurance program is renewed in 2002.
Our personal insurance business produced near breakeven underwriting results in 2001 compared with substantial profits in 2000 and 1999. The combined loss and expense ratio was 100.2% in 2001 compared with 92.9% in 2000 and 89.9% in 1999.
Homeowners results were unprofitable in 2001 compared with near breakeven results in 2000 and profitable results in 1999. Results deteriorated significantly in 2001 due primarily to a substantial increase in the frequency and severity of water damage claims, including those related to mold, as well as rate deficiencies in several states and inadequate insurance to value. Results deteriorated in 2000 compared with 1999 due to an increase in large non-catastrophe losses that more than offset a decrease in catastrophe losses. Catastrophe losses represented 5.4 percentage points of the loss ratio for this class in 2001 compared with 7.3 percentage points in 2000 and 11.8 percentage points in 1999. Homeowners results were unprofitable in Europe in each of the past three years as we are still building the critical mass necessary to absorb the costs of operating that franchise.
Our personal automobile business was profitable in each of the last three years. However, profitability decreased in 2000 and again in 2001 due to an increase in the frequency of losses in the liability component of this business. Results in each year benefited from stable loss severity.
Our commercial insurance business produced underwriting losses in each of the past three years, but has shown substantial improvement in each succeeding year. The improvement was due in large part to the cumulative effect of the pricing increases and more stringent risk selection in recent years. The combined loss and expense ratio was 106.1% in 2001 compared with 114.2% in 2000 and 120.4% in 1999.
Results for our casualty business improved considerably in 2001 compared with the prior two years, but remained unprofitable. The improvement in 2001 was primarily in the automobile component of this business and, to a lesser extent, the primary liability component. Results in 2000 were similar with those in 1999, as improvement in the primary liability component was offset by deterioration in the automobile component. The automobile component was modestly unprofitable in 2001 compared with highly unprofitable results in 2000 and 1999. The significant improvement in 2001 was due to higher rates and the culling of loss prone business, which resulted in a lower frequency of losses. Results had deteriorated in 2000 due to inadequate prices and an increased frequency of losses. Results for the primary liability component were unprofitable in each of the past three years, but improved in each succeeding year. The excess liability component was somewhat more unprofitable in 2001 compared with the previous two years. The severity of the large losses that are prevalent in this class has increased in recent years. Excess liability results in each of the past three years benefited from favorable development of prior year loss reserves. As noted above, casualty results in each of the past three years were adversely affected by incurred losses related to asbestos and toxic waste claims. Casualty results outside the United States were near breakeven in 2001 compared with unprofitable results in 2000 and profitable results in 1999.
Workers’ compensation results were highly profitable in 2001 compared with near breakeven results in 2000 and unprofitable results in 1999. The improvement each year was due to higher rates as well as a lower frequency of losses, resulting in large part from our disciplined risk selection during the past several years.
Our strategy of working closely with our customers and our ability to bring new products to market and differentiate such products continue to enable us to renew a considerable percentage of our executive protection and financial institutions business. However, executive protection premium growth was only 6% in 2001. Recent claim severity trends indicated the need for higher rates and
Financial institutions had solid premium growth of 14% in 2001 due to both new business and higher rates. Expansion of the standard commercial component of this business may be somewhat restrained in 2002 by our management of terrorism exposure concentrations.
Our specialty commercial underwriting results were unprofitable in 2001 due to the Enron surety losses, compared with highly profitable results in 2000 and 1999. The combined loss and expense ratio was 104.5% in 2001 compared with 91.3% in 2000 and 88.5% in 1999. Excluding the effect of the Enron surety losses, underwriting results were profitable in 2001 as evidenced by a 95.3% combined loss and expense ratio.
Surety results were highly profitable in 1999 and 2000 and, excluding the Enron surety losses, were highly profitable in 2001. As a result of disarray in the surety reinsurance market caused in large part by the Enron bankruptcy, the availability of surety reinsurance in the near term will be significantly reduced. As a result, our future surety results could be more volatile.
Loss reserves are our property and casualty subsidiaries’ largest liability. Loss reserves at December 31, 2001 included significant amounts related to the September 11 attack and to our Enron surety exposure. The components of loss reserves were as follows:
The process of establishing loss reserves is complex and imprecise as it reflects significant judgmental factors. This is true because claim settlements to be made in the future will be impacted by changing rates of inflation and other economic conditions, changing legislative, judicial and social environments and changes in our claim handling procedures.
In spite of the inherent imprecision in the loss reserving process, financial reporting requirements dictate that we and other insurance companies report a single amount as the estimate of loss reserves at each balance sheet date.
The uncertainties relating to asbestos and toxic waste claims on insurance policies written many years ago are exacerbated by inconsistent court decisions and judicial and legislative interpretations of coverage that in some cases have tended to erode the clear and express intent of such policies and in others have expanded theories of liability. The industry as a whole is engaged in extensive litigation over these coverage and liability issues and is thus confronted with a continuing uncertainty in its efforts to quantify these exposures.
The expanded focus of asbestos litigation beyond asbestos manufacturers and distributors to installers and premises owners has created in some instances conflicts among insureds, primary insurers and excess insurers, primarily involving questions regarding allocation of indemnity and expense costs and exhaustion of policy limits. These issues are generating costly coverage litigation with the potential for inconsistent results.
Federal legislation still appears to be the best vehicle for comprehensively addressing the asbestos problem. Any legislative solution would require the support of members of the plaintiffs’ bar.
Significant uncertainty remains as to our ultimate liability related to asbestos related claims due to such factors as the long latency period between asbestos exposure and disease manifestation and the resulting potential for involvement of multiple policy periods for individual claims as well as the increase in the volume of claims by plaintiffs who claim exposure but who have no symptoms of asbestos-related disease and an increase in claims filed under the non-aggregate premises or operations section of general liability policies.
Hazardous waste sites are another significant potential exposure. Under the federal “Superfund” law and similar state statutes, when potentially responsible parties (PRPs) fail to handle the clean-up at a site, regulators have the work done and then attempt to establish legal liability against the PRPs. Most PRPs named to date are parties who have been generators, transporters, past or present land owners or past or present site operators. The PRPs disposed of toxic materials at a waste dump site or transported the materials to the site. In many instances, these PRPs had proper government authorization. Most sites have multiple PRPs. Insurance policies issued to PRPs were not intended to cover the clean-up costs of pollution and, in many cases, did not intend to cover the pollution itself. Pollution was not a recognized hazard at the time many of these policies were written. In more recent years, however, policies specifically exclude such exposures.
There is great uncertainty involved in estimating our liabilities related to these claims. First, the liabilities of the claimants are extremely difficult to estimate. At any given site, the allocation of remediation costs among governmental authorities and the PRPs varies greatly depending on a variety of factors. Second, different courts have addressed liability and coverage issues regarding pollution claims and have reached inconsistent conclusions in their interpretation of several issues. These significant uncertainties are not likely to be resolved definitively in the near future.
Uncertainties also remain as to the Superfund law itself. Superfund’s taxing authority expired on December 31, 1995 and has not been re-enacted. Notwithstanding continued pressure by the insurance industry and other interested parties to achieve a legislative solution that would reform the liability provisions of the law, federal legislation appears to be at a standstill. At this time, it is not possible to predict the direction that any reforms may take, when they may occur or the effect that any changes may have on the insurance industry.
The following table presents loss reserve activity, net of reinsurance recoverable, related to asbestos and toxic waste claims. Reinsurance recoveries related to these claims are not significant.
Management believes that the aggregate loss reserves of the property and casualty subsidiaries at December 31, 2001 were adequate to cover claims for losses that had occurred, including both those known to us and those yet to be reported. In establishing such reserves, management considers facts currently known and the present state of the law and coverage litigation. However, given the expansion of coverage and liability by the courts and the legislatures in the past and the possibilities of similar interpretations in the future, particularly as they relate to asbestos and toxic waste claims, additional increases in loss reserves may emerge in future periods. Any such increases would have an adverse effect on future operating results. However, management does not expect that any such increases would have a material adverse effect on the Corporation’s consolidated financial condition or liquidity.
In recent years, we have invested in modeling technologies and concentration management tools that enable us to better monitor and control catastrophe exposures. We also continue to explore and analyze credible scientific evidence, including the impact of global climate change, that may affect our potential exposure under insurance policies.
Property and casualty investment income after taxes increased 2% in 2001 compared with 2000 and 6% in 2000 compared with 1999. Reported growth in 2000 was due in part to the inclusion of Executive Risk investment income for only six months in 1999. Excluding the effect of the acquisition of Executive Risk, growth was about 3% in 2000. Growth in 2001 and 2000 was due to an increase in invested assets, which reflected substantial cash flow from operations over the period. Growth was dampened by lower available reinvestment rates on fixed maturities that matured in each year. The effective tax rate on our investment income was 17.0% in 2001 compared with 16.4% in 2000 and 15.7% in 1999. The effective tax rate increased each year as a result of our holding a somewhat smaller proportion of our investment portfolio in tax-exempt securities.
New cash available for investment by the property and casualty subsidiaries was approximately $570 million in 2001 compared with $560 million in 2000 and $940 million in 1999. New cash available in 2001 and 2000 was lower than in 1999 due primarily to paid losses growing at a higher rate than premium receipts in these years.
In 2001, we invested new cash primarily in corporate bonds. In 2000, we invested new cash primarily in mortgage-backed securities. In 1999, new cash was invested in tax-exempt bonds and corporate bonds. During 1999, we reduced our equity securities portfolio by approximately $350 million with $145 million of the proceeds used to fund the purchase of a 28% interest in Hiscox plc, a U.K. personal and commercial specialty insurer. In each year, we tried to achieve the appropriate mix of taxable and tax-exempt securities in our portfolio to balance both investment and tax strategies.
We have evaluated our expected cash needs related to the settlement of claims from the September 11 attack. We expect to fund our obligations related to such claims from a combination of operating cash flows, maturity of fixed maturity securities and anticipated recovery of reinsurance. The period over which the payment of claims from the September 11 attack will be made is not yet determinable. Our property and casualty subsidiaries maintain investments in highly liquid, short-term and other marketable securities to provide for immediate cash needs. Should the need for additional liquidity develop, the Corporation could either sell a portion of its investment portfolio or draw down under its existing commercial paper or bank credit facilities.
In a typical credit default swap, CFSI participates in the senior or super senior layer of a structure designed to replicate the performance of a portfolio of securities, loans or other debt obligations. The structure of these credit default swaps generally requires CFSI to make payment to counterparties to the extent cumulative losses, related to numerous credit events, exceed a specified attachment point.
Loans receivable, which amounted to $98 million at December 31, 2001, are primarily purchase money mortgages. Such loans, which were issued in connection with our joint venture activities and other property sales, are generally collateralized by buildings and, in some cases, land. We continually evaluate the ultimate collectibility of such loans and establish appropriate reserves.
We periodically review the value of our invested assets for other than temporary impairment. If a decline in the fair value of an individual security is deemed to be other than temporary, the difference between cost and estimated fair value is charged to income as a realized investment loss.
In 2001, realized gains on sales of equity securities and fixed maturities of $46 million and $34 million, respectively, were substantially offset by writedowns due to the recognition of other than temporary impairment on certain securities. Sales of equity securities in 1999 resulted in net realized investment gains due primarily to the significant appreciation in United States equity markets. A primary reason for the sale of fixed maturities in each of the last three years has been to improve our after-tax portfolio return without sacrificing quality where market opportunities have existed to do so.
Fixed maturity securities which the Corporation and its insurance subsidiaries have the ability and intent to hold to maturity are classified as held-to-maturity. The remaining fixed maturities, which may be sold prior to maturity to support our investment strategies, such as in response to changes in interest rates and the yield curve or to maximize after-tax returns, are classified as available-for-sale. Fixed maturities classified as held-to-maturity are carried at amortized cost, while fixed maturities classified as available-for-sale are carried at market value. At December 31, 2001, 8% of the fixed maturity portfolio was classified as held-to-maturity compared with 10% at December 31, 2000 and 12% at December 31, 1999.
Changes in unrealized market appreciation or depreciation of fixed maturities were due primarily to fluctuations in interest rates.
Interest rate risk is the price sensitivity of a security that promises a fixed return to changes in interest rates. Changes in market interest rates directly affect the market value of our fixed income securities. We view the potential changes in price of our fixed income investments within the overall context of asset and liability management. Our actuaries estimate the payout pattern of our liabilities, primarily our property and casualty loss reserves, to determine their duration, which is the present value of the weighted average payments expressed in years. We set duration targets for our fixed income investment portfolios after consideration of the duration of these liabilities and other factors, which we believe mitigates the overall effect of interest rate risk for the Corporation and its property and casualty subsidiaries.
The following table provides information about our fixed maturity investments which are sensitive to changes in interest rates. The table presents cash flows of principal amounts and related weighted average interest rates by expected maturity dates at December 31, 2001 and 2000. The cash flows are based on the earlier of the call date or the maturity date or, for mortgage-backed securities, expected payment patterns. Actual cash flows could differ from the expected amounts.
Mortgage-backed securities comprised 33% and 37% of our taxable bond portfolio at year-end 2001 and 2000, respectively. About 50% of our mortgage-backed securities holdings at December 31, 2001 related to residential mortgages consisting of government agency pass-through securities, government agency collateralized mortgage obligations (CMOs) and AAA rated non-agency CMOs backed by government agency collateral or by single family home mortgages. The majority of the CMOs are actively traded in liquid markets and market value information is readily available from broker/dealers. An additional 30% of our mortgage-backed securities were call protected AAA rated commercial securities. The remaining mortgage-backed holdings were all in investment grade commercial mortgage-backed securities.
CFSI’s obligations with respect to its credit derivatives business are carried at estimated fair value. The fair value of our credit default swaps is subject to fluctuations arising from, among other factors, changes in credit spreads and interest rates. At December 31, 2001, the fair value of future obligations under CFSI’s credit derivatives business was approximately $48 million, which is included in accrued expenses and other liabilities. For any particular credit default swap, an increase in the estimated fair value of our obligation may occur as a result of changing market conditions even when the probability of an actual loss to CFSI remains unlikely. The occurrence of an extreme, widespread or persistent economic event that suggests an actual loss is possible could result in a material increase in the fair value of our obligations.
We review credit default swaps using quantitative analysis. When we enter into a credit default swap, we believe the credit quality in most instances is at least equal to the upper end of the investment grade credit spectrum. At December 31, 2001, CFSI’s aggregate exposure or retained risk, referred to as notional amounts, from its open credit default swaps was approximately $14.3 billion. The notional amounts are used to express the extent of involvement in swap transactions. The notional amounts are not a quantification of market risk or credit risk and are not recorded on the balance sheet. These amounts are used to calculate the exchange of contractual cash flows and are not necessarily representative of the potential for gain or loss. Since our position is senior to other subordinated interests and exposure to a single default within a referenced portfolio is limited, the severity of loss from our credit default swaps is likely to be lower than that of a similarly rated debt security portfolio valued at $14.3 billion.
In July 1998, the Board of Directors authorized the repurchase of up to 12,500,000 shares of the Corporation’s common stock. In June 2001, the Board of Directors authorized the repurchase of up to an additional 16,000,000 shares. The 1998 authorization has no expiration while the 2001 authorization will expire on June 30, 2003. As of December 31, 2001, 3,287,100 shares remained under the 1998 share repurchase authorization and 10,366,300 shares remained under the 2001 authorization. In the aggregate, the Corporation repurchased 7,971,600 shares in open-market transactions in 2001 at a cost of $556 million, 3,783,400 shares in 2000 at a cost of $242 million and 2,596,700 shares in 1999 at a cost of $145 million.
The Corporation’s financial strength provides the capacity and flexibility to raise funds in the capital markets. The Corporation filed a shelf registration statement in December 2001. When it is declared effective by the Securities and Exchange Commission, up to $1 billion of various types of securities may be issued by the Corporation.
The Corporation also has outstanding $300 million of unsecured 6.15% notes due in 2005 and $100 million of unsecured 6.60% debentures due in 2018. Chubb Capital Corporation, a wholly owned subsidiary, has outstanding $100 million of unsecured 6 7/8% notes due in 2003. The Chubb Capital notes are guaranteed by the Corporation.
The long term debt obligations of Executive Risk remained in place subsequent to its acquisition in 1999. Chubb Executive Risk Inc., a wholly owned subsidiary of the Corporation, has outstanding $75 million of unsecured 7 1/8% notes due in 2007. Executive Risk Capital Trust, wholly owned by Chubb Executive Risk, has outstanding $125 million of 8.675% capital securities. The sole assets of the Trust are debentures issued by Chubb Executive Risk. The capital securities are subject to mandatory redemption in 2027 upon repayment of the debentures. The capital securities are also subject to mandatory redemption under certain circumstances beginning in 2007. The Corporation has guaranteed the unsecured notes and the capital securities.
In August 2001, the Corporation entered into a cancelable interest rate swap in order to monetize the value of the call option embedded in the $125 million 8.675% capital securities. Under the terms of the interest rate swap, the Corporation receives 8.675% and pays the counterparty the 3-month LIBOR rate plus 204 basis points. As a result of entering into the swap, interest costs related to this portion of our debt will float with short term interest rates.
In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets. The Statement addresses how intangible assets should be accounted for upon their acquisition and how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Under SFAS No. 142, goodwill will no longer be amortized but rather will be tested at least annually for impairment. The provisions of SFAS No. 142 are effective for the Corporation for the year beginning January 1, 2002. The Statement will be applied to goodwill recognized in the Corporation’s financial statements at that date. SFAS No. 142 may not be applied retroactively to financial statements of prior periods. The elimination of goodwill amortization is expected to result in an increase in net income in 2002 of approximately $20 million. The Corporation is in the process of assessing the effect, if any, that the implementation of the other provisions of SFAS No. 142 will have on its consolidated financial position or results of operations.