The executive offices of the Corporation and the administrative offices of the Property and Casualty Insurance Group are in Warren, New Jersey. The Property and Casualty Insurance Group maintains zone administrative and branch offices in major cities throughout the United States and also has offices in Canada, Europe, Australia, the Far East and Latin America. Office facilities are leased with the exception of buildings in Branchburg, New Jersey and Simsbury, Connecticut. Management considers its office facilities suitable and adequate for the current level of operations. See Note (15) of the notes to consolidated financial statements incorporated by reference from the Corporation’s 2001 Annual Report to Shareholders.
our expectations relating to insurance losses from the September 	11 attack and related reinsurance recoverables;
any impact from the bankruptcy protection sought by various 	asbestos producers and other related businesses;
Operating income, which excludes realized investment gains and losses, was $111 million in 2001 compared with $681 million in 2000 and $565 million in 1999. Operating income in 2001 was adversely affected by two large loss events. In the third quarter, we incurred net costs of $645 million, or $420 million after-tax, related to the September 11 attack in the United States. Then, in the fourth quarter, we recognized net surety bond losses of $220 million, or $143 million after-tax, arising from the bankruptcy of Enron Corp.
Our property and casualty business incurred an operating loss before taxes of $53 million in 2001 compared with operating income of $803 million in 2000 and $626 million in 1999. Excluding the net costs of $645 million related to the September 11 attack and the net surety bond losses of $220 million related to Enron, operating income before taxes was $812 million in 2001, similar to that in 2000. The higher earnings in 2000 compared with 1999 were due primarily to an improvement in underwriting results, caused in large part by substantially lower catastrophe losses.
casualty insurance operating results for 2001 also presents such results excluding the impact of the September 11 attack and shows the impact of the September 11 attack separately.
The pre-tax costs of $645 million related to the September 11 attack had three components. First, in our insurance business, we incurred estimated net claims and claim expenses of $555 million plus reinsurance reinstatement costs of $50 million, for an aggregate cost of $605 million. Second, in our reinsurance business written through Chubb Re, which is included in other specialty results, we incurred estimated net claims and claim expenses of $110 million and recognized net reinstatement premium revenue of $80 million, for a net cost of $30 million. Finally, we recorded a $10 million charge, included in other charges, as our share of the losses publicly estimated by Hiscox plc, a U.K. insurer in which we have a 28% interest.
Business interruption claims from the September 11 attack will take some time to settle, while potential liability claims, if initiated, could take years to settle. Given that, we have no evidence of any emerging issues that would cause us to change our reserve estimates. While it is possible that our estimate of ultimate net losses related to the September 11 attack may change in the future, we do not expect that any such change would have a material effect on the Corporation’s consolidated financial condition or liquidity.
September 11. As a result, our commercial lines premiums began to increase in 2001, particularly in the fourth quarter, as we retained more of our business and wrote more new business. Premium growth in the specialty lines was restricted in 2001, primarily due to the lack of growth in our executive protection business caused by our writing fewer multi-year policies as well as our initiative to increase pricing and to not renew underperforming accounts.
At the same time, as a result of the substantial losses incurred by reinsurers, the cost of reinsurance in the marketplace is increasing significantly and reinsurance capacity for certain coverages, such as terrorism, is limited. We are operating under the assumption that our reinsurers will not cover most forms of terrorism. The insurance industry has asked for a government backstop for any future terrorist attacks. However, Congress has not enacted a legislative solution to terrorism related losses.
Underwriting results were unprofitable in 2001 due primarily to the Enron-related surety bond losses described below, compared with near breakeven results in 2000 and unprofitable results in 1999. The combined loss and expense ratio, the common measure of underwriting profitability, was 103.9% in 2001 compared with 100.4% in 2000 and 102.8% in 1999.
The surety losses arising from the Enron bankruptcy relate to bonds issued to various obligees in connection with Enron commitments. We recognized our maximum surety exposure of $220 million, net of reinsurance, in the fourth quarter of 2001. However, certain of these bonds are the subject of litigation. Management believes there are reasonable grounds for challenging the validity of our obligations under the bonds that are the subject of the litigation and intends to pursue the litigation vigorously. If we are successful in the litigation, any favorable development would be reflected in future operating results.
The loss ratio, excluding the effect of the Enron surety losses, was 67.7% in 2001 compared with 67.5% in 2000 and 70.3% in 1999. Catastrophe losses other than those related to the September 11 attack were $114 million in 2001 which represented 1.7 percentage points of the loss ratio compared with $72 million or 1.2 percentage points in 2000 and $225 million or 4.0 percentage points in 1999. Catastrophe losses affecting results each year resulted primarily from weather-related events in the United States, including in particular Tropical Storm Allison in the second quarter of 2001 and Hurricane Floyd in the third quarter of 1999. Other than reinsurance recoveries related to the September 11 attack, we did not have any recoveries from our catastrophe reinsurance program during the three year period since
Our expense ratio was 32.8% in 2001 compared with 32.9% in 2000 and 32.5% in 1999. The increase in the expense ratio in 2000 was due to overhead expenses growing at a somewhat higher rate than written premiums.
Net premiums from personal insurance increased 15% in 2001 compared with a 13% increase in 2000. We continued to grow our personal lines business with the in-force policy count for all coverages increasing. During 2001, our in-force policy count increased 14% for automobile, 8% for homeowners and 10% for other coverages. Personal lines premiums outside the United States grew significantly in 2001 and 2000, although from a small base. Much of this growth was in Europe where remedial actions to increase rates and improve the profitability of this business are in progress.
Other personal coverages, which include insurance for personal valuables and excess liability, produced highly profitable results in each of the past three years, as favorable loss experience has continued.
Net premiums from commercial insurance increased 7% in 2001 compared with a 2% decrease in 2000. The decrease in premiums in 2000 was the result of the strategy we put in place in late 1998 to increase the pricing in these classes and to not renew underperforming business where we could not attain price adequacy. As a result, retention levels were significantly below historical levels during 2000. On the business that was renewed, however, rates increased steadily. Rate increases remained firm in 2001. Premiums began to increase in 2001 as retention levels improved, particularly in the second half of the year. In addition, new business accelerated in the fourth quarter. Exposure growth, however, was minimal in 2001 due to the weak economy.
Commercial insurance results, particularly in the casualty classes, were adversely affected in each of the past three years by incurred losses related to asbestos and toxic waste claims. Such losses were $61 million in 2001, $31 million in 2000 and $47 million in 1999. The higher incurred losses in 2001 were the result of adverse trends in asbestos related exposure (see “Loss Reserves”).
Multiple peril results were near breakeven in 2001 compared with unprofitable results in 2000 and highly unprofitable results in 1999. The improvement in 2001 was principally in the liability component of this business due to a lower frequency and severity of losses. The improvement in 2000 occurred in both the property and liability components due to a lower frequency of large losses in both the United States and overseas. Results in the property component in 2000 also benefited from an absence of catastrophe losses. Conversely, results in 1999 were adversely affected by higher catastrophe losses. Catastrophe losses represented 3.0 percentage points of the loss ratio for this class in 2001 and 9.2 percentage points in 1999. There were virtually no catastrophe losses in 2000.
Property and marine results remained highly unprofitable over the past three years. The positive effect of the pricing initiative and the culling of unprofitable accounts was offset each year by a high frequency of large property losses. Overseas losses were significantly higher in 2001 and 2000. Results in 1999 were adversely affected by higher catastrophe losses. Catastrophe losses represented 5.4 points of the loss ratio for this class in 2001 compared with 1.7 points in 2000 and 10.2 points in 1999.
improved policy terms. As a result, we initiated a program to increase pricing and to not renew business that no longer meets our underwriting criteria. The low growth in 2001 was due to our writing fewer multi-year policies and the non-renewal of unprofitable business. Rates increased steadily in 2001, particularly for public company directors and officers liability business. As a result of the improved pricing, executive protection premiums increased 13% in the fourth quarter of 2001.
Executive protection results were profitable in each of the past three years due to favorable development of prior year loss reserves, particularly in the directors and officers and fiduciary liability components. However, profit margins have narrowed in the most recent accident years. Our employment practices liability business for large employers was unprofitable in each of the past three years. Overseas results were modestly unprofitable in 2001 due to several large directors and officers liability losses, compared with highly profitable results in the prior two years.
Our financial institutions business was profitable in each of the last three years due to favorable loss experience in the fidelity component of this business. Results from our errors and omissions business were unprofitable in 2001 due to an increase in loss severity. The standard commercial business written on financial institutions produced profitable results in 2001 compared with breakeven results in 2000 and unprofitable results in 1999.
Results in our other specialty classes were highly unprofitable in 2001 due to the Enron surety losses. Excluding the Enron surety losses, other specialty results were near breakeven in 2001 compared with unprofitable results in 2000 and profitable results in 1999. Our reinsurance assumed business generated by Chubb Re produced a modest underwriting loss in each of the past three years. Aviation results were highly unprofitable in each of these years. We have reduced our participation in aviation business which will reduce our exposure to any future losses.
We have in force several gas forward purchase surety bonds similar to those issued to Enron. The total amount of bonds with one principal is $570 million, which far exceeds the combined amount of all other similar surety bonds. The principals under these surety bonds continue to perform at this time and we have no reason to doubt their continued ability to perform.
Adjusted to exclude the loss reserves related to the September 11 attack and the Enron surety losses, loss reserves, net of reinsurance recoverable, increased by $211 million or 2% in 2001 compared with $302 million or 3% in 2000. Loss reserves for personal insurance and specialty insurance increased in 2001 and 2000 while loss reserves for commercial insurance decreased each year. Such decrease reflects the significant exposure reductions of the past several years and improved accident year results due to price increases and more stringent risk selection.
During 2001, we experienced overall favorable development of $196 million on loss reserves established as of the previous year-end. This compares with favorable development of $230 million in 2000 and $206 million in 1999. Such redundancies were reflected in operating results in these respective years. Each of the past three years benefited from favorable claim experience for certain liability classes, offset in part by losses incurred related to asbestos and toxic waste claims.
We use a variety of actuarial methods to estimate loss reserves. These methods generally utilize analyses of historical patterns of the development of paid and reported losses by accident year for each class of business. This process relies on the basic assumption that past experience, adjusted for the effects of current developments and likely trends, is an appropriate basis for predicting future outcomes.
Long-tail classes include directors and officers liability and other executive protection coverages, commercial excess liability and other liability classes. Most of our loss reserves relate to long tail liability classes of business. For many liability claims significant periods of time, ranging up to several years or more, may elapse between the occurrence of the loss, the reporting of the loss and the
settlement of the claim. The longer the time span between the incidence of a loss and the settlement of the claim, the more the ultimate settlement amount can vary. For the long tail liability classes, a relatively small proportion of net losses in the more recent accident years are reported claims and an even smaller proportion are paid losses. Therefore, a relatively large proportion of our net losses for these classes are reserves for incurred but not reported (IBNR) losses - claims that had not yet been reported to us, some of which were not yet known to the insured, and future development on reported claims. In fact, approximately 60% of our aggregate net loss reserves at December 31, 2001 were for IBNR.
Judicial decisions and legislative actions continue to broaden liability and policy definitions and to increase the severity of claim payments. As a result of this and other societal and economic developments, the uncertainties inherent in estimating ultimate claim costs on the basis of past experience have been exacerbated, further complicating the already complex loss reserving process.
Our other asbestos exposures are mostly peripheral defendants, including a mix of manufacturers, distributors and installers of certain products that contain asbestos as well as premises owners. Generally, these insureds are named defendants on a regional rather than a nationwide basis. As the financial resources of traditional asbestos defendants have been depleted, plaintiffs are targeting these peripheral parties with greater frequency and, in many cases, for larger awards. In addition, the plaintiffs’ bar continues to solicit new claimants through extensive advertising and through asbestos medical screenings. Litigation is then initiated even though many of the claimants do not show any signs of asbestos-related illness. Thus, new asbestos claims and new exposures on existing claims have continued unabated despite the fact that usage of asbestos has declined since the mid-1970’s. Based on published projections, we expect that we will continue receiving asbestos claims at the current rate for at least the next several years.
Reserves for asbestos and toxic waste claims cannot be estimated with traditional loss reserving techniques that rely on historical accident year loss development factors. We have established case reserves and expense reserves for costs of related litigation where sufficient information has been developed to indicate the involvement of a specific insurance policy. In addition, IBNR reserves have been established to cover additional exposures on both known and unasserted claims.
Reserves for asbestos and toxic waste claims are continually reviewed and updated. Further increases in such loss reserves in 2002 and future years are possible as legal and factual issues concerning these claims continue to be clarified. The amount cannot be reasonably estimated at the present time.
The Corporation’s property and casualty subsidiaries also have exposure to insured losses caused by hurricanes, earthquakes, winter storms, windstorms and other natural catastrophic events. The frequency and severity of natural catastrophes are unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in an area affected by the event and the severity of the event. We continually assess our concentration of underwriting exposures in catastrophe prone areas globally and develop strategies to manage this exposure through individual risk selection, subject to regulatory constraints, and through the purchase of catastrophe reinsurance.
In addition to the cash from operations, the Corporation contributed $750 million to the property and casualty subsidiaries in the fourth quarter of 2001, of which $250 million was used to fund the purchase of a 19% interest in Allied World Assurance Holdings, Ltd, a newly formed Bermuda-based insurer.
Corporate and other includes investment income earned on corporate invested assets, interest expense and other expenses not allocated to the operating subsidiaries, and the results of Chubb Financial Solutions and our real estate and other non-insurance subsidiaries. Corporate and other produced a loss before taxes of $14 million in 2001 compared with a loss of $4 million in both 2000 and 1999. Interest expense increased each year due to the inclusion of interest expense on the debt assumed in connection with the Executive Risk acquisition in July 1999 and the issuance of short term
and long term debt in 2001. In 2000, corporate and other included income of $10 million from a noncompete payment related to the sale of the Corporation’s 50% interest in Associated Aviation Underwriters, Inc. (AAU).
Chubb Financial Solutions (CFSI) was organized by the Corporation in 2000 to engage in developing and providing risk-financing services through the capital and insurance markets. Since its inception, CFSI’s non-insurance operations have been primarily in the credit derivatives business, principally as a counterparty to credit default swaps. The Corporation guarantees all of these obligations. Income before taxes from the non-insurance business of CFSI was $7 million in 2001 and $3 million in 2000, which amounts are included in the corporate and other results. Revenues from this business, consisting of earned fees, were $27 million and $12 million in 2001 and 2000, respectively.
Credit default swaps are derivatives and are carried at estimated fair value in the financial statements. Changes in fair value are included in income in the period of the change. Valuation models are used to estimate the fair value of our obligation in each credit default swap. Such valuations require considerable judgment and are subject to significant uncertainty. The fair value of our credit default swaps is subject to fluctuations arising from, among other factors, observable changes in credit spreads and interest rates. Increases in the fair value of obligations, which would result in a charge to income, could be material upon the occurrence of an extreme, widespread or persistent economic event that suggests an actual loss is possible. The market risks associated with our obligations under credit default swaps are discussed under “Market Risk - Credit Derivatives”.
The insurance and reinsurance solutions that CFSI develops to meet the risk management needs of its customers are written by our property and casualty subsidiaries. Results from this business are included within our insurance results. A property and casualty subsidiary issued a reinsurance contract to an insurer that provides financial guarantees on asset-backed transactions. At December 31, 2001, the amount of aggregate principal commitments related to the contract was approximately $400 million, all of which expire by 2023.
Real estate operations resulted in a loss before taxes of $4 million in each of the past three years, which amounts are included in the corporate and other results. In each year, we sold selected commercial properties as well as residential properties. Real estate revenues were $87 million in 2001, $75 million in 2000 and $97 million in 1999.
We own approximately $310 million of land that we expect will be developed in the future. In addition, we own approximately $185 million of commercial properties and land parcels under lease. We are continuing to explore the sale of certain of our remaining properties.
The recoverability of the carrying value of our real estate assets is assessed based on our ability to fully recover costs through a future revenue stream. The assumptions used reflect a continued improvement in demand for office space, an increase in rental rates and the ability and intent to obtain financing in order to hold and develop such remaining properties and protect our interests over the long term. Management believes that it has made adequate provisions for impairment of real estate assets. However, if the assets are not sold or developed as presently contemplated, it is possible that additional impairment losses may be recognized.
Decisions to sell securities are governed principally by considerations of investment opportunities and tax consequences. Thus, realized investment gains and losses on the sale of investments may vary significantly from year to year.
The Corporation and its property and casualty subsidiaries have consistently invested in high quality marketable securities. As a result, we believe that we have minimal credit quality risk. Taxable bonds in our domestic portfolio comprise U.S. Treasury, government agency, mortgage-backed and corporate securities. Approximately 55% of our taxable bonds are issued by the U.S. Treasury or U.S. government agencies or rated AA or better by Moody’s or Standard and Poor’s. Of the tax-exempt bonds, more than 90% are rated AA or better, with more than 60% rated AAA. Less than 3% of our bond portfolio is below investment grade. Our taxable bonds have an average maturity of six years, while our tax-exempt bonds mature on average in eight years.
Equity price risk is the potential loss arising from adverse changes in the value of equity securities. In general, equities have more year-to-year price variability than intermediate term high grade bonds. However, equity returns over longer time frames have been consistently higher. Our publicly traded equity securities are high quality, diversified across industries and readily marketable. Our portfolio also includes alternative investments, primarily investment partnerships. These investments by their nature are less liquid than our other investments. We actively manage our risk by allocating a comparatively small amount of funds to alternative investments, perform extensive research prior to investing in a new investment and monitor the performance of the entities in which we have invested. A hypothetical decrease of 10% in the market price of each of the equity securities held at December 31, 2001 and 2000 would have resulted in a decrease of $71 million and $83 million, respectively, in the fair value of the equity securities portfolio.
interest rates by maturity date. For the interest rate swap, the table presents the notional amount and related interest rates by maturity date.
In November 2001, the Corporation sold $400 million of unsecured 6% notes due in 2011 and $200 million of unsecured 6.8% debentures due in 2031 under a previously filed shelf registration. The proceeds were used for general corporate purposes.
The Corporation has two credit agreements with a group of banks that provide for unsecured borrowings of up to $500 million in the aggregate. The $200 million short term revolving credit facility,
which was to have terminated on July 4, 2001, was extended to July 2, 2002. The $300 million medium term revolving credit facility terminates on July 11, 2002. On the respective termination dates, any loans then outstanding become payable. There have been no borrowings under these agreements. Management anticipates that similar credit agreements will replace these agreements. These facilities are available for general corporate purposes and to support the Corporation’s commercial paper borrowing arrangement.
Consolidated financial statements of the Corporation at December 31, 2001 and 2000 and for each of the three years in the period ended December 31, 2001 and the Report of Independent Auditors thereon and the Corporation’s unaudited quarterly financial data for the two-year period ended December 31, 2001 are incorporated by reference from the Corporation’s 2001 Annual Report to Shareholders, pages 48 through 73.