Management’s Discussion and Analysis of Financial Condition and Results of Operations addresses the financial condition of the Corporation as of December 31, 2007 compared with December 31, 2006 and the results of operations for each of the three years in the period ended December 31, 2007. This discussion should be read in conjunction with the consolidated financial statements and related notes and the other information contained in this report.
claims and litigation arising out of stock option “backdating,” “spring loading” and other option grant practices by public companies;
claims and litigation arising out of practices in the financial services industry; and
the impact of legislative and regulatory developments on our business, including those relating to terrorism and catastrophes;
Net income was $2.8 billion in 2007 compared with $2.5 billion in 2006 and $1.8 billion in 2005. Net income in 2007 and 2006 benefited from substantially higher underwriting income in our property and casualty insurance business compared with 2005.
Underwriting results were significantly more profitable in 2007 and 2006 compared with 2005. Our combined loss and expense ratio was 82.9% in 2007 compared with 84.2% in 2006 and 92.3% in 2005. The impact of catastrophes accounted for 3.0 percentage points of the combined ratio in 2007 compared with 1.4 percentage points in 2006 and 5.6 percentage points in 2005. The greater catastrophe impact in 2005 was due to costs of $462 million related to Hurricane Katrina, including estimated net losses of $403 million and net reinsurance reinstatement premium costs of $59 million.
During 2007, we experienced overall favorable development of $697 million on loss reserves established as of the previous year end, due primarily to favorable loss trends in recent years in the professional liability classes, lower than expected emergence of losses in the homeowners and commercial property classes and better than expected reported loss activity in the run-off of our reinsurance assumed business. During 2006, we experienced overall favorable development of $296 million due primarily to lower than expected emergence of losses in the homeowners and commercial property classes. During 2005, we experienced overall unfavorable development of $163 million due to adverse development in the professional liability and commercial liability classes offset in part by favorable development in the homeowners and commercial property classes.
Net premiums written from our insurance business grew 1% in 2007 and 2% in 2006. Premiums in 2005 were reduced by reinsurance reinstatement premium costs of $102 million related to Hurricane Katrina. Premiums in 2006 benefited from a $20 million reduction of previously accrued reinsurance reinstatement premium costs. Premiums in the United States, which represent about 75% of our insurance premiums, decreased 1% in 2007 and increased 1% in 2006. Insurance premiums outside the U.S. grew 10% in 2007 and 4% in 2006. In both years, such growth was 3% when measured in local currencies.
The slight overall growth in net written premiums in our insurance business in both 2007 and 2006 reflected our continued emphasis on underwriting discipline in an increasingly competitive market environment. Rates were under competitive pressure that varied by class of business and geographic area. In both years, we retained a high percentage of our existing customers and renewed these accounts at prices we believe to be appropriate relative to the exposure. In addition, while we continued to be selective, we found opportunities to write new business at acceptable rates; however, we saw fewer such opportunities as 2007 progressed. We expect the competitive market environment to continue in 2008. We expect that overall premiums in our insurance business will be flat to modestly down in 2008 compared with 2007, with a modest increase for personal insurance and modest decreases for both commercial insurance and specialty insurance.
Net reinsurance assumed premiums written decreased by 65% in 2007 and 57% in 2006. Premiums in 2005 included net reinstatement premium revenue of $43 million related to Hurricane Katrina. The significant premium decline reflects the sale of our ongoing reinsurance assumed business to Harbor Point Limited in December 2005, which is discussed below.
Although property catastrophe reinsurance rates increased in 2006, our overall ceded reinsurance premiums for our insurance business, excluding the impact of reinstatement premiums related to Hurricane Katrina, were only modestly higher than in 2005 due to modifications to certain of our reinsurance treaties. On our casualty clash treaty, our initial retention remained at $75 million. We reduced our reinsurance coverage at the top of the program by $50 million and increased our participation in the program. On our commercial property per risk treaty, we increased our retention from $15 million to $25 million. Our property catastrophe treaty for events in the United States was modified to increase our initial retention from $250 million to $350 million and to increase our participation in the program. At the same time, we increased the insurance coverage in the northeastern part of the country by $400 million. Our property catastrophe treaty for events outside the United States was modified to increase our initial retention from $50 million to $75 million.
The structure of our property catastrophe program for events in the United States was modified in 2007 but the overall coverage is similar to the previous program. The principal catastrophe treaty provides coverage of approximately 70% of losses (net of recoveries from other available reinsurance) between $350 million and $1.3 billion, with additional coverage of 55% of losses between $1.3 billion and $2.05 billion in the northeastern part of the country, where we have our greatest concentration of catastrophe exposure.
We also purchased in April 2007 fully collateralized four-year reinsurance coverage for homeowners-related losses sustained from qualifying hurricane loss events in the northeastern part of the United States. This reinsurance was purchased from East Lane Re Ltd., a Cayman Islands reinsurance company, which financed the provision of reinsurance through the issuance of $250 million in catastrophe bonds to investors under two separate bond tranches. This reinsurance provides coverage of approximately 30% of covered losses between $1.3 billion and $2.05 billion.
We purchased additional reinsurance from the Florida Hurricane Catastrophe Fund, which is a state-mandated fund designed to reimburse insurers for a portion of their residential catastrophic hurricane losses. Our participation in the Fund limits our initial retention in Florida for homeowners related losses to approximately $150 million.
Our property catastrophe treaty for events outside the United States was renewed in 2007 with no modification of its terms. The treaty provides coverage of approximately 90% of losses (net of recoveries from other available reinsurance) between $75 million and $275 million.
Most of our ceded reinsurance arrangements consist of excess of loss and catastrophe contracts that protect against a specified part or all of certain types of losses over stipulated amounts arising from any one occurrence or event. Therefore, unless we incur losses that exceed our initial retention under these contracts, we do not receive any loss recoveries. As a result, in certain years, we cede premiums to other insurance companies and receive few, if any, loss recoveries. However, in a year in which there is a significant catastrophic event (such as Hurricane Katrina) or a series of large individual losses, we may receive substantial loss recoveries. The impact of ceded reinsurance on net premiums written and earned and on net losses and loss expenses incurred for the three years ended December 31, 2007 is presented in Note (11) of the Notes to Consolidated Financial Statements.
The loss ratio improved in 2006 and again in 2007, reflecting the favorable loss experience which we believe resulted from our disciplined underwriting in recent years as well as relatively mild loss trends in certain classes of business. The loss ratio in 2005 was adversely affected by higher catastrophe losses, primarily from Hurricane Katrina.
In 2007, net catastrophe losses incurred were $363 million, which represented 3.0 percentage points of the loss ratio. Net catastrophe losses incurred in 2006 were $173 million, which were offset in part by a $20 million reduction in previously accrued reinsurance reinstatement premium costs related to Hurricane Katrina. The net impact of catastrophes in 2006 accounted for 1.4 percentage points of the loss ratio. In 2005, we incurred $630 million of net catastrophe losses and $59 million in related net reinsurance reinstatement premium costs, which in the aggregate accounted for 5.6 percentage points of the loss ratio. The reinsurance reinstatement premium costs and a substantial portion of the catastrophe losses in 2005 related to Hurricane Katrina.
At the end of 2005, we estimated that our net losses from Hurricane Katrina were $403 million and our net reinsurance reinstatement premium costs related to the hurricane were $59 million. In our insurance business, estimated net losses were $335 million and reinstatement premium costs were $102 million, for an aggregate cost of $437 million. In our reinsurance assumed business, estimated net losses were $68 million and net reinstatement premium revenue was $43 million, for a net cost of $25 million. We estimated that our gross losses from Hurricane Katrina were about $1.2 billion. Almost all of the losses were from property exposure and business interruption claims. Our net losses of $403 million were significantly lower than the gross amount due to a property per risk treaty that limited our net loss per risk and our property catastrophe treaty.
During 2006, a large percentage of our claims from Hurricane Katrina were settled. As a result, there were many adjustments, both favorable and unfavorable, to our loss estimates for individual claims related to this event. These adjustments produced a reduction in our estimates for gross losses and reinsurance recoverable of $190 million and $175 million, respectively, as well as a $20 million reduction of previously accrued reinsurance reinstatement premium costs.
Other than the reinsurance recoverable related to Hurricane Katrina, we did not have any recoveries from our catastrophe reinsurance treaties during the three year period ended December 31, 2007 because there were no other individual catastrophes for which our losses exceeded our initial retention under the treaties.
In lieu of paying contingent commissions, beginning in 2007, we implemented a new guaranteed supplemental compensation program for agents and brokers in the United States with whom we previously had contingent commission agreements. Under this arrangement, agents and brokers are paid a percentage of written premiums on eligible lines of business in a calendar year based upon their prior performance. The total guaranteed supplemental compensation payout for 2007 will be substantially the same as the contingent commission payout for 2006. However, the change in our commission arrangements created a difference in the timing of expense recognition, which resulted in a one-time benefit to income during the 2007 transition year. The impact of the change in 2007 was to increase deferred policy acquisition costs by approximately $70 million. The change had no effect on the expense ratio.
Net premiums written from personal insurance, which represented 31% of our premiums written in 2007, increased by 5% in 2007 and 6% in 2006. Net premiums written for the classes of business within the personal insurance segment were as follows:
Personal automobile premiums in the U.S. decreased in 2007 and 2006 due to an increasingly competitive marketplace. The termination of a collector vehicle program also contributed to the decrease in 2007. The overall growth in personal automobile premiums in 2006 was due to selective initiatives outside the United States. The growth in our homeowners business in both years was due primarily to increased insurance-to-value. The in-force policy count for this class of business was relatively flat over the period. Homeowners premiums in 2005 were reduced by reinsurance reinstatement premium costs of $17 million related to Hurricane Katrina. Our other personal business includes insurance for excess liability, yacht and accident coverages. The substantial growth in this business in 2007 was due primarily to a significant increase in accident premiums, particularly outside the United States. Excess liability premiums also grew, due in part to a modest increase in rates.
Our personal automobile results were profitable in each of the past three years. Results in 2007 and 2006 were more profitable than in 2005 due to lower claim frequency and modest favorable prior year loss development.
Homeowners results were highly profitable in each of the last three years. Results in all three years reflected adequate pricing and a reduction in water damage losses primarily as a result of policy wording changes related to mold coverage and loss remediation measures that we have implemented over the past several years. Results in 2006 benefited from lower catastrophe losses. The impact of catastrophes accounted for 9.6 percentage points of the combined loss and expense ratio for this class in 2007 compared with 5.7 percentage points in 2006 and 9.8 percentage points in 2005.
Net premiums written from commercial insurance, which represented 43% of our premiums written in 2007, decreased by 1% in 2007 and increased by 2% in 2006. Net premiums written for the classes of business within the commercial insurance segment were as follows:
Retention levels of our existing customers remained steady over the last three years. New business volume was slightly higher in 2006 and again in 2007 compared with the respective prior years. The increase in 2006 came from business outside the U.S. The increase in 2007 was due to a few large accounts written in the first half of the year. New business volume in the second half of 2007 was down as it became more difficult to find new opportunities at acceptable rates.
Results for our casualty business were similarly profitable in each of the past three years. The automobile component of our casualty business deteriorated somewhat in 2007 but remained highly profitable. Results in the primary liability component were highly profitable in 2007 compared with marginally profitable results in 2006 and profitable results in 2005. Results in the excess liability component were profitable in 2007 compared with unprofitable results in 2006 and 2005. Excess liability results in 2007 benefited from favorable prior year loss development, whereas results in 2006 and 2005 were adversely affected by unfavorable loss development related to older accident years. Casualty results in 2007 were adversely affected by incurred losses related to asbestos and toxic waste claims. Our analysis of these exposures resulted in an increase in our estimate of the ultimate liabilities for a small number of our insureds. Such losses represented 5.3 percentage points of the combined loss and expense ratio for this class in 2007. The impact of such losses was not significant in 2006 or 2005.
Workers’ compensation results were highly profitable in each of the past three years. Results were more profitable in each succeeding year due to favorable claim cost trends, resulting in part from the positive effect of reforms in California. Results in all three years benefited from our disciplined risk selection during the past several years.
The decline of premiums in 2007 and 2006 for the professional liability classes of business was due to the increasingly competitive pressure on rates, particularly in the directors and officers liability component, and our commitment to maintain underwriting discipline in this environment. The decline in premiums in 2006 was exacerbated by the sale of renewal rights, effective July 1, 2005, on our hospital medical malpractice and managed care errors and omissions business.
Our specialty insurance business produced profitable underwriting results in each of the last three years. Results were significantly more profitable in each succeeding year. The combined loss and expense ratios for the classes of business within specialty insurance were as follows:
Results for our professional liability business improved substantially in 2006 and again in 2007, producing highly profitable results in 2007 compared with profitable results in 2006 and near breakeven results in 2005. The fidelity class was highly profitable in each of the past three years due to favorable loss experience. The results of the directors and officers liability, errors and omissions liability and fiduciary liability classes improved in 2006 and again in 2007. Results in 2007 and, to a much lesser extent, 2006 benefited from favorable prior year loss development due to the recognition of the increasingly favorable loss trends we have been experiencing in recent years. These trends were largely the result of a favorable business climate in recent years, lower policy limits and better terms
and conditions. Conversely, results in 2005 were adversely affected by unfavorable loss development related to accident years prior to 2003. This adverse development was predominantly from claims relating to corporate failures and allegations of management misconduct and accounting irregularities. For more information on prior year loss development, see “Property and Casualty Insurance - Loss Reserves, Prior Year Loss Development.”
Our surety business produced highly profitable results in each of the past three years due to favorable loss experience. This business tends to be characterized by infrequent but potentially high severity losses. When losses occur, they are mitigated, at times, by recovery rights to the customer’s assets, contract payments, collateral and bankruptcy recoveries.
The majority of our surety obligations are intended to be performance-based guarantees. We manage our exposure on an absolute basis and by specific bond type. We have substantial commercial and construction surety exposure for current and prior customers, including exposures related to surety bonds issued on behalf of companies that have experienced deterioration in creditworthiness since we issued bonds to them. We therefore may experience an increase in filed claims and may incur high severity losses. Such losses would be recognized if and when claims are filed and determined to be valid, and could have a material adverse effect on the Corporation’s results of operations.
For a transition period of about two years, Harbor Point underwrote specific reinsurance business on our behalf. We retained a portion of this business and ceded the balance to Harbor Point in return for a fronting commission. We receive additional payments based on the amount of business renewed by Harbor Point. These amounts are being recognized in income as earned.
Net premiums written from our reinsurance assumed business, which represented 1% of our premiums written in 2007, decreased by 65% in 2007 and 57% in 2006. The significant decrease in premiums in both years was expected in light of the sale of our ongoing reinsurance assumed business to Harbor Point. Premiums in 2005 included net reinsurance reinstatement premium revenue of $43 million related to Hurricane Katrina.
We have been involved in the investigations of certain business practices in the property and casualty insurance industry by various Attorneys General and other regulatory authorities of several states, the U.S. Securities and Exchange Commission, the U.S. Attorney for the Southern District of New York and certain non-U.S. regulatory authorities with respect to, among other things, (1) potential conflicts of interest and anti-competitive behavior arising from the payment of contingent commissions to brokers and agents and (2) loss mitigation and finite reinsurance arrangements. In
In December 2006, we settled with the Attorneys General of New York, Connecticut and Illinois all issues arising out of their investigations. As part of this settlement, we agreed to implement certain business reforms, including discontinuing the payment of contingent commissions in the United States on all insurance lines beginning in 2007.
In August 2007, the Attorney General of Ohio filed an action against us, as well as several other insurers and one broker, as a result of the Ohio Attorney General’s business practices investigation.
Although no other Attorney General or regulator has initiated an action against us, it is possible that such an action may be brought against us with respect to some or all of the issues that are the focus of the ongoing investigations described above.
Chubb and certain of its subsidiaries have been named in various legal proceedings brought by private plaintiffs arising out of these investigations. These legal proceedings and the litigation brought by the Ohio Attorney General referred to above are further described in Note (15) of the Notes to Consolidated Financial Statements.
As a precondition to recovery under TRIA, insurance companies with direct commercial insurance exposure in the United States for TRIA lines of business are required to make insurance for covered acts of terrorism available under their policies. Each insurer has a separate deductible that it must meet in the event of an act of terrorism before federal assistance becomes available. The deductible is based on a percentage of direct U.S. earned premiums for the covered lines of business in the previous calendar year. For 2008, that deductible is 20% of direct premiums earned in 2007 for these lines of business. For losses above the deductible, the federal government will pay for 85% of covered losses, while the insurer retains 15%. There is a combined annual aggregate limit for the federal government and all insurers of $100 billion. If acts of terrorism result in covered losses exceeding the $100 billion annual limit, insurers are not liable for additional losses. While the provisions of TRIA will serve to mitigate our exposure in the event of a large-scale terrorist attack, our deductible is substantial, approximating $1 billion in 2008.
For certain classes of business, such as workers’ compensation, terrorism insurance is mandatory. For those classes of business where it is not mandatory, policyholders may choose not to accept terrorism insurance, which would, subject to other statutory or regulatory restrictions, reduce our exposure.
In establishing the loss reserves of our property and casualty subsidiaries, we consider facts currently known and the present state of the law and coverage litigation. Based on all information currently available, we believe that the aggregate loss reserves at December 31, 2007 were adequate to cover claims for losses that had occurred as of that date, including both those known to us and those yet to be reported. However, as described below, there are significant uncertainties inherent in the loss reserving process. It is therefore possible that management’s estimate of the ultimate liability for losses that had occurred as of December 31, 2007 may change, which could have a material effect on the Corporation’s results of operations and financial condition.
Due to the inherent complexity of the loss reserving process and the potential variability of the assumptions used, the actual emergence of losses could vary, perhaps substantially, from the estimate of losses included in our financial statements, particularly when settlements may not occur until well into the future. Our net loss reserves at December 31, 2007 were $20.3 billion. Therefore, a relatively small percentage change in the estimate of net loss reserves would have a material effect on the Corporation’s results of operations.
Most of our loss reserves relate to long tail liability classes of business. Long tail classes include directors and officers liability, errors and omissions liability and other professional liability coverages, commercial primary and excess liability, workers’ compensation and other liability coverages. 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 to us and the settlement of the claim. As a result, loss experience in the more recent accident years for the long tail liability classes has limited statistical credibility because a relatively small proportion of losses in these accident years are reported claims and an even smaller proportion are paid losses. An accident year is the calendar year in which a loss is incurred or, in the case of claims-made policies, the calendar year in which a loss is reported. Liability claims are also more susceptible to litigation and can be significantly affected by changing contract interpretations and the legal environment. Consequently, the estimation of loss reserves for these classes is more complex and typically subject to a higher degree of variability than for short tail classes.
Expected loss ratio methods use loss ratios for prior accident years, adjusted to reflect our evaluation of recent loss trends, the current risk environment, changes in our book of business and changes in our pricing and underwriting, to determine the appropriate expected loss ratio for a given accident year. The expected loss ratio for each accident year is multiplied by the earned premiums for that year to calculate estimated ultimate losses.
Frequency/severity methods first project ultimate claim counts (using one or more of the other methods described above) and then multiply those counts by an estimated average claim cost to calculate estimated ultimate losses. The average claim costs are often estimated by fitting historical severity data to an observed trend. Generally, these methods work best for high frequency, low severity classes of business.
For short tail classes, the emergence of paid and incurred losses generally exhibits a reasonably stable pattern of loss development from one accident year to the next. Thus, for these classes, the loss development factor method is generally relatively straightforward to apply and usually requires only modest extrapolation. For long tail classes, applying the loss development factor method often requires more judgment in selecting development factors as well as more significant extrapolation. For those long tail classes with high frequency and relatively low per-loss severity (e.g. workers’ compensation), volatility will often be sufficiently modest for the loss development factor method to be given significant weight, except in the most recent accident years.
amount determined by our actuaries is an aggregate of the indicated reserve amounts for the individual classes of business. The ultimate outcome is likely to fall within a range of potential outcomes around this indicated amount, but the indicated amount is not expected to be precisely the ultimate liability.
In addition, we must consider the uncertain effects of emerging or potential claims and coverage issues that arise as legal, judicial and social conditions change. These issues have had, and may continue to have, a negative effect on our loss reserves by either extending coverage beyond the original underwriting intent or by increasing the number or size of claims. Recent examples of such issues include the number of directors and officers liability and errors and omissions liability claims arising out of the ongoing credit crisis, the number of directors and officers liability claims arising out of stock option “backdating” practices by certain public companies, the number and size of directors and officers liability and errors and omissions liability claims arising out of investment banking practices and accounting and other corporate malfeasance, and exposure to claims asserted for bodily injury as a result of long-term exposure to harmful products or substances. As a result of issues such as these, the uncertainties inherent in estimating ultimate claim costs on the basis of past experience have grown, further complicating the already complex loss reserving process.
As part of our loss reserving analysis, we take into consideration the various factors that contribute to the uncertainty in the loss reserving process. Those factors that could materially affect our loss reserve estimates include loss development patterns and loss cost trends, rate and exposure level changes, the effects of changes in coverage and policy limits, business mix shifts, the effects of regulatory and legislative developments, the effects of changes in judicial interpretations, the effects of emerging claims and coverage issues and the effects of changes in claim
handling practices. In making estimates of reserves, however, we do not necessarily make an explicit assumption for each of these factors. Moreover, all estimation methods do not utilize the same assumptions and typically no single method is determinative in the reserve analysis for a class of business. Consequently, changes in our loss reserve estimates generally are not the result of changes in any one assumption. Instead, the variability will be affected by the interplay of changes in numerous assumptions, many of which are implicit to the approaches used.
Reserves for the professional liability classes other than fidelity were $7.1 billion, net of reinsurance, at December 31, 2007. Based on a review of our loss experience, if the loss development factor for each accident year changed such that the cumulative loss development factor for the most recent accident year changed by 10%, we estimate that the net reserves for professional liability classes other than fidelity would change by approximately $700 million, in either direction. This degree of change in the reported loss development pattern is within the historical variation around the averages in our data.
Reserves for commercial excess liability (excluding asbestos and toxic waste claims) were $2.9 billion, net of reinsurance, at December 31, 2007. These reserves are included within commercial casualty. Based on a review of our loss experience, if the loss development factor for each accident year changed such that the cumulative loss development factor for the most recent accident year
changed by 15%, we estimate that the net reserves for commercial excess liability would change by approximately $250 million, in either direction. This degree of change in the reported loss development pattern is within the historical variation around the averages in our data.
We believe that the loss reserves carried at December 31, 2007 for asbestos and toxic waste claims were adequate. However, given the judicial decisions and legislative actions that have broadened the scope of coverage and expanded theories of liability in the past and the possibilities of similar interpretations in the future, it is possible that our estimate of loss reserves relating to these exposures may increase in future periods as new information becomes available and as claims develop.
bankruptcy impact; relevant judicial interpretations; and applicable coverage defenses, including asbestos exclusions.
There is substantial uncertainty involved in estimating our liabilities related to these claims. First, the liabilities of the claimants are extremely difficult to estimate. At any given waste 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.
Uncertainty remains as to our ultimate liability relating to toxic waste claims. However, toxic waste losses appear to be developing as expected due to relatively stable claim trends. In many cases, claims are being settled for less than initially anticipated due to more efficient site remediation efforts. In other cases, we have been successful at buying back our policies, thus removing the threat of additional losses in the future.
Ceded reinsurance contracts do not relieve our primary obligation to our policyholders. Consequently, an exposure exists with respect to reinsurance recoverable to the extent that any reinsurer is unable to meet its obligations or disputes the liabilities assumed under the reinsurance contracts. We are selective in regard to our reinsurers, placing reinsurance with only those reinsurers who we believe have strong balance sheets and superior underwriting ability, and we monitor the financial strength of our reinsurers on an ongoing basis. Nevertheless, in recent years, certain of our reinsurers have experienced financial difficulties or exited the reinsurance business. In addition, we may become involved in coverage disputes with our reinsurers. A provision for estimated uncollectible reinsurance is recorded based on periodic evaluations of balances due from reinsurers, the financial condition of the reinsurers, coverage disputes and other relevant factors.
A reconciliation of our beginning and ending loss reserves, net of reinsurance, for the three years ended December 31, 2007 is as follows:
The net favorable development of $697 million in 2007 was due to various factors. The most significant factors were:
there was sufficient evidence to modestly decrease the expected loss ratios for these accident years. The fact that our initial estimates for accident years 2003 and subsequent are developing favorably was recognized as one factor among several factors in the determination of loss reserves for the 2007 accident year for these classes. Other factors included the specific aspects of the current claim environment and the recent downward trend in prices.
We experienced favorable development of about $40 million in the fidelity class and $30 million in the surety class due to lower than expected reported loss emergence, mainly related to more recent accident years. Loss reserve estimates at the end of 2006 in these classes included an expectation of more large late reported losses than actually occurred in 2007. However, since we would still expect such losses to occur in a typical year, factors that resulted in the favorable development in 2007 were given only modest weight in our determination of carried fidelity and surety loss reserves at December 31, 2007.
We experienced adverse development of about $20 million in the commercial liability classes. Adverse development in accident years prior to 1997, mostly the $88 million related to asbestos and toxic waste claims, was largely offset by favorable development in these classes in the more recent accident years. The asbestos and toxic waste loss activity primarily related to specific individual excess liability claims and did not change our overall assessment of recent trends. Therefore, this adverse development had little overall effect on our determination of carried loss reserves for these classes at December 31, 2007.
We experienced favorable development of about $25 million in the personal automobile class. Case development during 2006 on previously reported claims was better than expected, reflecting improved case management. Also, the number of late reported claims was less than expected, reflecting a continuation of recent generally favorable frequency trends.
We experienced adverse development of about $200 million in the professional liability classes other than fidelity. The adverse development resulted from continued significant reported loss activity related to accident years 1998 through 2002, largely from claims related to corporate failures and allegations of management misconduct and accounting irregularities. As a result, we increased the expected loss ratios for these accident years. Offsetting this somewhat, reported loss activity related to accident years 2003 and 2004 was less than expected due to a favorable business climate, lower policy limits and better terms and conditions. While these accident years were somewhat immature, we concluded that there was sufficient evidence to modestly decrease the expected loss ratios for these accident years.
We experienced favorable development of about $160 million in the short tail homeowners and commercial property classes, primarily related to the 2004 accident year. The favorable development arose from the lower than expected emergence of late reported losses during 2005 relative to expectations used to establish our loss reserves at the end of 2004.
We experienced favorable loss development of about $60 million in the fidelity class due to lower than expected reported loss emergence, mainly related to more recent accident years.
Corporate and other comprises investment income earned on corporate invested assets, interest expense and other expenses not allocated to our operating subsidiaries, and the results of our real estate and other non-insurance subsidiaries, including Chubb Financial Solutions (CFS), which provided customized financial products to corporate clients and has been in run-off since April 2003.
Real estate operations resulted in a loss before taxes of $6 million in 2007 compared with losses of $3 million in 2006 and $41 million in 2005. The large loss in 2005 was due to the recognition of a significant impairment loss. During 2005, we committed to a plan to sell a parcel of land in New Jersey that we had previously intended to hold and develop. The decision to sell the property was based on our assessment of the current real estate market and our concern about zoning issues. As a result of our decision to sell this property, we reassessed the recoverability of its carrying value. Based on our reassessment, we recognized an impairment loss of $48 million during the year to reduce the carrying value of the property to its estimated fair value.
CFS’s business was primarily structured credit derivatives, principally as a counterparty in portfolio credit default swap contracts. In April 2003, the Corporation announced its intention to exit CFS’s business. Since that date, CFS has terminated early or run-off nearly all of its contractual obligations within its financial products portfolio.
CFS’s results were near breakeven in 2007 and 2006 compared with a loss before taxes of $9 million in 2005. The loss in 2005 related to the termination of a principal and interest guarantee contract.
The net realized gains on other invested assets represent the aggregate of distributions to us from the limited partnerships in which we have an interest and changes in our equity in the net assets of the partnerships based on valuations provided to us by the manager of each partnership. As a result of the timing of our receipt of valuation data from the investment managers, these investments are reported on a three month lag.
We regularly review those invested assets whose fair value is less than cost to determine if an other-than-temporary decline in value has occurred. In evaluating whether a decline in value of any investment is temporary or other than temporary, we consider various quantitative criteria and qualitative factors including the length of time and the extent to which the fair value has been less than the cost, the financial condition and near term prospects of the issuer, whether the issuer is current on contractually obligated interest and principal payments, our intent and ability to hold the investment for a period of time sufficient to allow us to recover our cost, general market conditions and industry or sector specific factors. 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. The fair value of the investment becomes its new cost basis. The decision to recognize a decline in the value of a security carried at fair value as other-than-temporary rather than temporary has no impact on shareholders’ equity.
During 2007, our investments in several equity securities and one fixed maturity holding were deemed to be other-than-temporarily impaired. We determined that the equity securities were not likely to recover to our cost basis over a near-term period and we were not likely to collect all contractually obligated amounts due us under the terms of the fixed maturity investment.
In February 2007, Executive Risk Capital Trust (Trust), wholly owned by Chubb Executive Risk Inc., a wholly owned subsidiary of Chubb, redeemed $125 million of its 8.675% capital securities using the funds it received from the repayment of debentures issued by Chubb Executive Risk to the Trust, which constituted the Trust’s sole assets. The redemption price of the capital securities included a make-whole premium of $5 million in the aggregate.
In March 2007, Chubb issued $1.0 billion of unsecured junior subordinated capital securities. The capital securities will become due on April 15, 2037, the scheduled maturity date, but only to the extent that Chubb has received sufficient net proceeds from the sale of certain qualifying capital securities. Chubb must use its commercially reasonable efforts, subject to certain market disruption events, to sell enough qualifying capital securities to permit repayment of the capital securities on the scheduled maturity date or as soon thereafter as possible. Any remaining outstanding principal amount will be due on March 29, 2067, the final maturity date. The capital securities bear interest at a fixed rate of 6.375% through April 14, 2017. Thereafter, the capital securities will bear interest at a rate equal to the three-month LIBOR rate plus 2.25%. Subject to certain conditions, Chubb has the right to defer the payment of interest on the capital securities for a period not exceeding ten consecutive years. During any such period, interest will continue to accrue and Chubb generally may not declare or pay any dividends on or purchase any shares of its capital stock.
In connection with the issuance of the capital securities, Chubb entered into a replacement capital covenant in which it agreed that it will not repay, redeem or purchase the capital securities before March 29, 2047, unless, subject to certain limitations, it has received proceeds from the sale of replacement capital securities, as defined. Subject to the replacement capital covenant, the capital securities may be redeemed, in whole or in part, at any time on or after April 15, 2017 at a redemption price equal to the principal amount plus any accrued interest or prior to April 15, 2017 at a redemption price equal to the greater of (i) the principal amount or (ii) a make-whole amount, in each case plus any accrued interest.
In 2003, Chubb issued $460 million of unsecured 2.25% senior notes due in 2008 and 18.4 million purchase contracts to purchase its common stock. The notes and purchase contracts were issued together in the form of 7% equity units, each of which initially represented $25 principal amount of notes and one purchase contract. In May 2006, the notes were successfully remarketed as required by their terms. The interest rate on the notes was reset to 5.472% from 2.25%, effective May 16, 2006. The remarketed notes mature on August 16, 2008. Each purchase contract obligated the holder to purchase, on or before August 16, 2006, for a settlement price of $25, a variable number of shares of Chubb’s common stock. The number of shares purchased was determined based on a formula that considered the market price of Chubb’s common stock immediately prior to the time of settlement in relation to the $29.75 per share sale price of the common stock at the time the equity units were offered. Upon settlement of the purchase contracts in August 2006, Chubb issued 12,883,527 shares of common stock and received proceeds of $460 million.
Chubb also has outstanding $225 million of 3.95% notes due in April 2008 as well as $400 million of 6% notes due in 2011, $275 million of 5.2% notes due in 2013, $100 million of 6.6% debentures due in 2018 and $200 million of 6.8% debentures due in 2031, all of which are unsecured.
Credit ratings assess a company’s ability to make timely payments of interest and principal on its debt. The following table summarizes the Corporation’s credit ratings from the major independent rating organizations as of February 26, 2008.
Financial strength ratings assess an insurer’s ability to meet its financial obligations to policyholders. The following table summarizes our property and casualty subsidiaries’ financial strength ratings from the major independent rating organizations as of February 26, 2008.
The Corporation’s liquidity requirements in the past have been met by funds from operations as well as the issuance of commercial paper and debt and equity securities. We expect that our liquidity requirements in the future will be met by these sources of funds or borrowings from our credit facility.
Our property and casualty subsidiaries maintain substantial investments in highly liquid, short-term marketable securities. Accordingly, we do not anticipate selling long-term fixed maturity investments to meet any liquidity needs.
LIBOR rate as of December 31, 2007. The table includes future interest payments through the scheduled maturity date, April 15, 2037. Interest payments for the period from the scheduled maturity date through the final maturity date, March 29, 2067, would increase the contractual obligation by $2.1 billion. It is our expectation that the capital securities will be redeemed at the end of the fixed interest rate period.
The above table excludes certain commitments totaling $1.3 billion at December 31, 2007 to fund limited partnership investments. These capital commitments can be called by the partnerships from time to time during the commitment period (generally five years or less), if and when needed by the partnerships to fund working capital needs or the purchase of new investments. It is uncertain whether and, if so, when we will be required to fund these commitments. There is no predetermined payment schedule.
The Corporation does not have any off-balance sheet arrangements that are reasonably likely to have a material effect on the Corporation’s financial condition, results of operations, liquidity or capital resources, other than as disclosed in Note (15) of the Notes to Consolidated Financial Statements.
Limited partnership investments by their nature are less liquid and involve more risk than other investments. We actively manage our risk through type of asset class and domestic and international diversification. At December 31, 2007, we had investments in about 80 separate partnerships. We review the performance of these investments on a quarterly basis and we obtain audited financial statements annually.
and limited partnerships, whereas we decreased our holdings of taxable bonds, principally U.S. Treasury securities. In 2005, we invested new cash primarily in tax-exempt bonds and taxable bonds. The taxable bonds we invested in were mortgage-backed securities and, to a lesser extent, corporate bonds. Our objective is to achieve the appropriate mix of taxable and tax exempt securities in our portfolio to balance both investment and tax strategies. At December 31, 2007, 66% of our U.S. fixed maturity portfolio was invested in tax exempt bonds compared with 65% at December 31, 2006 and 60% at December 31, 2005.
We classify those fixed maturity securities that 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, as available-for-sale. We classify those fixed maturities that we have the ability and intent to hold to maturity as held-to-maturity. Fixed maturities classified as available-for-sale are carried at market value while fixed maturities classified as held-to-maturity are carried at amortized cost. Only about 1% of the fixed maturity portfolio was classified as held-to-maturity at December 31, 2006 and 2005. During the fourth quarter of 2007, we transferred our remaining held-to-maturity securities to available-for-sale.
The unrealized appreciation before tax of investments carried at market value, which consists of fixed maturities classified as available-for-sale and equity securities, was $810 million, $603 million and $478 million at December 31, 2007, 2006 and 2005, respectively. Such unrealized appreciation is reflected in comprehensive income, net of applicable deferred income tax.
SFAS No. 158 required that any gains or losses and prior service cost that had not yet been included in net benefit costs at the end of the year in which the Statement was adopted be recognized as an adjustment of the ending balance of accumulated other comprehensive income, net of tax. The adoption of SFAS No. 158 reduced shareholders’ equity at December 31, 2006 by $281 million. Adoption of the Statement did not have any effect on the Corporation’s net income in 2006 and 2007 and will not in future years. The adoption of SFAS No. 158 is discussed further in Note (2)(a) of the Notes to Consolidated Financial Statements.