Management’s Discussion and Analysis of Financial Condition and Results of Operations addresses the financial condition of the Corporation as of December 31, 2011 compared with December 31, 2010 and the results of operations for each of the three years in the period ended December 31, 2011. This discussion should be read in conjunction with the consolidated financial statements and related notes and the other information contained in this report.
Certain statements in this document are “forward-looking statements” as that term is defined in the Private Securities Litigation Reform Act of 1995 (PSLRA). These forward-looking statements are made pursuant to the safe harbor provisions of the PSLRA and include statements regarding our loss reserve and reinsurance recoverable estimates; asbestos and toxic waste liabilities and related developments; the number and severity of surety-related claims; the impact of an improving economy on our business; the impact of changes to our reinsurance program in 2011 and the cost of reinsurance in 2012; the adequacy of the rates at which we renewed and wrote new business; premium volume, pricing and competition in 2012; actions we may take in connection with our estimates of our exposure to catastrophes; property and casualty investment income during 2012; cash flows generated by our fixed income investments; currency rate fluctuations; estimates with respect to our credit derivatives exposure; the repurchase of common stock under our share repurchase program; our capital adequacy and funding of liquidity needs; the expected impact of new guidance related to accounting for costs associated with acquiring or renewing insurance contracts; the funding and timing of loss payments; and the redemption of our capital securities. Forward-looking statements are made based upon management’s current expectations and beliefs concerning trends and future developments and their potential effects on us. These statements are not guarantees of future performance. Actual results may differ materially from those suggested by forward-looking statements as a result of risks and uncertainties, which include, among others, those discussed or identified from time to time in our public filings with the Securities and Exchange Commission and those associated with:
the effects of the outbreak or escalation of war or hostilities;
the impact of legislative, regulatory and similar developments on our business, including those relating to terrorism, catastrophes, the financial markets, solvency standards, capital requirements and accounting guidance;
any downgrade in our claims-paying, financial strength or other credit ratings;
changes in interest rates, market credit spreads and the performance of the financial markets;
securities and is therefore more meaningful for analysis purposes than investment income before income tax.
Net realized investment gains before tax were $288 million ($187 million after tax) in 2011 compared with $426 million ($277 million after tax) in 2010 and $23 million ($15 million after tax) in 2009. The net realized gains in 2011 and 2010 were primarily related to investments in limited partnerships, which generally are reported on a quarter lag.
Property and casualty income before tax was lower in 2011 than in 2010, which in turn was lower than in 2009. The successively lower level of income was due to a decrease in underwriting income. The decrease in underwriting income in 2011 compared with 2010 was primarily the result of a higher impact of catastrophes during 2011 and a decrease in current accident year underwriting profitability excluding the impact of catastrophes. The decrease in underwriting income in 2010 compared with 2009 was primarily attributable to a higher impact of catastrophes during 2010, offset in part by a modest improvement in current accident year underwriting profitability excluding the impact of catastrophes. Investment income in 2011 was flat and was slightly higher in 2010 compared with the respective prior year.
Premium growth continued to be constrained in both 2011 and 2010 by the general economic conditions in recent years. The amounts of coverage purchased or the insured exposures, both of which are bases upon which we calculate the premiums we charge, were down slightly or were flat for many classes of business in both 2011 and 2010 compared to the respective prior year. Also, in both 2011 and 2010, our ability to grow premiums was constrained by our emphasis on underwriting discipline in the highly competitive market environment. In 2010, the competitive environment placed pressure on renewal rates, resulting in overall average U.S. renewal rates in the personal, commercial and professional liability businesses being down slightly compared to 2009. While the market remained competitive in 2011, the pricing environment improved steadily during the year, primarily in the commercial classes. Overall average U.S. renewal rates in the commercial business in 2011 were up slightly while rates in the professional liability business were down slightly. Average renewal rates for our personal auto and homeowners business were close to flat.
Our premiums written are net of amounts ceded to reinsurers who assume a portion of the risk under the insurance policies we write that are subject to reinsurance. 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 reinsurance companies and receive few, if any, loss recoveries. However, in a year in which there is a significant catastrophic event or a series of large individual losses, we may receive substantial loss recoveries. The impact of ceded reinsurance on net premiums written and net premiums earned and on net losses and loss expenses incurred for the three years ended December 31, 2011 is presented in Note (9) of the Notes to Consolidated Financial Statements.
The catastrophe bond arrangements generally provide reinsurance coverage for specific types of losses in specific geographic locations. They are generally designed to supplement coverage provided under the North American catastrophe treaty. We currently have two catastrophe bond arrangements in effect: a $150 million reinsurance arrangement that expires in March 2012 that provides coverage for homeowners-related hurricane losses in Florida and a $475 million reinsurance arrangement, a portion of which expires in March 2014 and the remainder in March 2015, that provides coverage for homeowners and commercial exposures for loss events in the northeastern United States.
For catastrophic events in the northeastern United States, the combination of the North American catastrophe treaty, the supplemental catastrophe reinsurance and the $475 million catastrophe bond arrangement provides additional coverage of approximately 64% of losses (net of recoveries from other available reinsurance) between $1.65 billion and $3.55 billion.
For hurricane events in Florida, we have reinsurance from the Florida Hurricane Catastrophe Fund (FHCF), which is a state-mandated fund designed to reimburse insurers for a portion of their residential catastrophic hurricane losses. Our participation in this mandatory program limits our initial retention in Florida for homeowners-related losses to approximately $160 million and provides coverage of 90% of covered losses between approximately $160 million and $570 million. Additionally, the $150 million catastrophe bond arrangement provides coverage of approximately 60% of Florida homeowners-related hurricane losses between $750 million and $1.0 billion.
Our primary property catastrophe treaty for events outside the United States, including Canada, provides coverage of approximately 75% of losses (net of recoveries from other available reinsurance) between $100 million and $350 million. For catastrophic events in Australia and Canada, additional reinsurance provides coverage of 80% of losses between $350 million and $475 million.
In addition to our major property catastrophe and property per risk treaties, we purchase several smaller property treaties that only cover specific classes of business or locations having potential concentrations of risk.
The combined loss and expense ratio (or combined ratio), expressed as a percentage, is the key measure of underwriting profitability traditionally used in the property and casualty insurance business. Management evaluates the performance of our underwriting operations and of each of our business units using, among other measures, the combined loss and expense ratio calculated in accordance with statutory accounting principles. It is the sum of the ratio of losses and loss expenses to premiums earned (loss ratio) plus the ratio of statutory underwriting expenses to premiums written (expense ratio) after reducing both premium amounts by dividends to policyholders. When the combined ratio is under 100%, underwriting results are generally considered profitable; when the combined ratio is over 100%, underwriting results are generally considered unprofitable.
The loss ratio was higher in 2011 compared to 2010 due to a higher impact of catastrophes and a modest increase in the current accident year loss ratio excluding catastrophes. The loss ratio was higher in 2010 compared to 2009 also due primarily to a higher impact of catastrophes, but offset in part by a modest decrease in the current accident year loss ratio excluding catastrophes. In each of the last three years, the loss ratio reflected positive loss experience excluding catastrophes that we believe resulted from our disciplined underwriting in recent years. Results in all three years benefited to a similar extent from favorable prior year loss development. For more information on prior year loss development, see “Property and Casualty Insurance - Loss Reserves, Prior Year Loss Development.”
Our personal automobile results were profitable in 2011 and highly profitable in 2010 and 2009. Results in all three years benefited from moderate claim frequency and favorable prior year loss development.
Other personal business produced profitable results in each of the past three years, but less so in 2011. The less profitable results in 2011 compared to 2010 were primarily due to reduced profitability in the accident and health and excess liability components. Results for our excess liability business, however, were highly profitable in all three years and benefited from favorable prior year loss development as a result of better than expected loss trends. Our yacht business was also highly profitable in each of the past three years. Our accident and health business produced breakeven results in 2011 and 2009 compared with profitable results in 2010.
Retention levels of our existing policyholders remained strong over the last three years. New business volume was up modestly in 2011 compared with 2010, driven by activity outside the United States. New business volume was up modestly in 2010 compared with 2009.
We continued to maintain our underwriting discipline in the highly competitive market, renewing business and writing new business only where we believe we are securing acceptable rates and appropriate terms and conditions for the exposures.
Our commercial insurance business produced near breakeven underwriting results in 2011 compared to profitable results in 2010 and highly profitable results in 2009. Results in all three years benefited from favorable loss experience, disciplined risk selection and appropriate terms and conditions in recent years. Results were less profitable in each successive year mainly due to a higher impact of catastrophes. The impact of catastrophes accounted for 10.5 percentage points of the combined loss and expense ratio for our commercial insurance business in 2011, compared with 5.4 percentage points in 2010 and 1.2 percentage points in 2009. The less profitable results in 2011 compared with 2010 were also due to a higher current accident year loss ratio excluding catastrophes. Excluding the effect of catastrophes, our commercial insurance results were slightly more profitable in 2010 compared to 2009, due to a higher amount of favorable prior year loss development in 2010.
Multiple peril results were slightly unprofitable in 2011 compared with profitable results in 2010 and highly profitable results in 2009. The less profitable results in 2011 compared with 2010 were mainly due to a higher impact of catastrophes in the property component of this business, offset in part by more profitable results in the liability component due to a higher amount of favorable prior year loss development. The less profitable results in 2010 compared with 2009 were due primarily to a higher impact of catastrophes in the property component and, to a lesser extent, less profitable results in the liability component. The impact of catastrophes accounted for 15.1 percentage points of the combined loss and expense ratio for the multiple peril class in 2011 compared with 10.3 percentage points in 2010 and 1.6 percentage points in 2009. The property component reflected moderate non-catastrophe losses in all three years, particularly outside the United States in 2010.
Workers’ compensation results were profitable in each of the past three years reflecting our disciplined risk selection during the past several years. Results in 2011 benefited from modest favorable prior year loss development.
Property and marine results were highly unprofitable in 2011 compared with profitable results in 2010 and highly profitable results in 2009. The deterioration in results in each succeeding year was primarily due to higher catastrophe losses. Catastrophe losses accounted for 24.9 percentage points of the combined loss and expense ratio in 2011 compared with 8.9 percentage points in 2010 and 1.5 percentage points in 2009. Excluding the impact of catastrophes, the combined ratio was 89.8%, 81.6% and 81.8% in 2011, 2010 and 2009, respectively. On this basis, the worse result in 2011 compared to 2010 and 2009 primarily reflected a higher non-catastrophe loss ratio, including a higher frequency of large losses, in the current accident year.
Net premiums written from specialty insurance, which represented 23% of our premiums written in 2011, were flat in 2011 and 2010 compared with the respective prior year. Net premiums written for the classes of business within the specialty insurance segment were as follows:
Overall, the average renewal rates of our professional liability business written in the United States decreased in both 2011 and 2010, but less so in 2011. Rates were down in most lines of our professional liability business in 2010, with the most significant reduction in rates in our directors and officers liability business. However, in 2011, renewal rate reductions moderated throughout the year for most lines of professional liability business.
Our specialty insurance business produced highly profitable underwriting results in each of the last three years. The combined loss and expense ratios for the classes of business within specialty insurance were as follows:
Our professional liability business produced highly profitable results in each of the past three years. The profitability of our professional liability business was particularly strong outside the United States in all three years, especially in 2010. The fiduciary liability class produced highly profitable results in each of the three past years. The directors and officers liability class was profitable in all three years, particularly in 2011 and 2010. The fidelity class was profitable in each of the past three years, but less so in each successive year, primarily due to increased large loss activity resulting from alleged third party and insured-employee criminal activity in recent years. The employment practices liability class was near breakeven in 2011 compared with highly profitable results in 2010 and 2009. The less profitable results in 2011 in this class were due to deterioration in the current accident year loss ratio, while results in 2010 and 2009 benefited from favorable prior year loss development. Our errors and omissions liability business produced highly unprofitable results in each of the past three years partly reflecting the impact of the financial crisis and unfavorable prior year loss development.
Collectively, the results for the professional liability classes benefited from favorable prior year loss development in the past three years that was driven mainly by positive loss experience related to accident years 2008 and prior. The combined ratio for the current accident year in our professional liability business in 2011 and 2010 was near breakeven, while the combined ratio for the current accident year in 2009 was higher since that accident year was more affected by the crisis in the financial markets.
Our surety business produced highly profitable results in each of the past three years due to favorable loss experience. Our surety business tends to be characterized by losses that are infrequent but have the potential to be highly severe. When losses occur, they are mitigated, at times, by recovery rights to the customer’s assets, contract payments, collateral and bankruptcy recoveries.
In 2005, we transferred our ongoing reinsurance assumed business and certain related assets, including renewal rights, to a reinsurance company. The reinsurer generally did not assume our reinsurance liabilities relating to reinsurance contracts incepting prior to December 31, 2005. We retained those liabilities and the related assets.
Reinsurance assumed results were profitable in each of the past three years. Prior year loss development was favorable in all three years, but more so in 2009.
The extent of losses from a natural 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 regularly assess our concentration of risk exposures in natural catastrophe exposed areas globally and have strategies and underwriting standards to manage this exposure through individual risk selection, subject to regulatory constraints, and through the purchase of catastrophe reinsurance coverage. We use catastrophe modeling and a risk concentration management tool to monitor and control our accumulations of potential losses in natural catastrophe exposed areas in the United States, such as California and the gulf and east coasts, as well as in natural catastrophe exposed areas in other countries. The information provided by the catastrophe modeling and the risk concentration management tool has resulted in our non-renewing some accounts and refraining from writing others.
The September 11, 2001 attack changed the way the property and casualty insurance industry views catastrophic risk. That tragic event demonstrated that numerous classes of business we write are subject to terrorism related catastrophic risks in addition to the catastrophic risks related to natural occurrences. This, together with the limited availability of terrorism reinsurance, required us to change how we identify and evaluate risk accumulations. We have licensed a terrorism model that provides loss estimates under numerous event scenarios. Actual results may differ materially from those suggested by the model. The risk concentration management tool referred to above also enables us to identify locations and geographic areas that are exposed to risk accumulations. The information provided by the terrorism model and the risk concentration management tool has resulted in our non-renewing some accounts, subject to regulatory constraints, and refraining from writing others.
For certain classes of business, such as workers’ compensation, terrorism coverage is mandatory. For those classes of business where it is not mandatory, policyholders may choose not to purchase terrorism coverage, which would, subject to other statutory or regulatory restrictions, reduce our exposure.
Incurred but not reported (IBNR) reserve estimates are generally calculated by first projecting the ultimate cost of all claims that have occurred and then subtracting reported losses and loss expenses. Reported losses include cumulative paid losses and loss expenses plus case reserves. The IBNR reserve includes a provision for claims that have occurred but have not yet been reported to us, some of which are not yet known to the insured, as well as a provision for future development on reported claims. A relatively large proportion of our net loss reserves, particularly for long tail liability classes, are reserves for IBNR losses. In fact, about 70% of our aggregate net loss reserves at December 31, 2011 were for IBNR losses.
Loss reserves, net of reinsurance recoverable, increased by $428 million or 2% in 2011. The effect of catastrophes increased loss reserves by $285 million and the effect of foreign currency fluctuation increased reserves by $67 million, due to a weaker U.S. dollar at December 31, 2011 compared to December 31, 2010. Loss reserves related to our insurance business increased by $540 million. Loss reserves related to our reinsurance assumed business, which is in runoff, decreased by $112 million.
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, 2011 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, 2011 may change, which could have a material effect on the Corporation’s results of operations and financial condition.
Given 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 in those instances where settlements do not occur until well into the future. Our net loss reserves at December 31, 2011 were $21.3 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.
Reserves Other than Those Relating to Asbestos and Toxic Waste Claims. Our loss reserves include amounts related to short tail and long tail classes of business. “Tail” refers to the time period between the occurrence of a 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.
Senior management meets with our actuaries at the end of each quarter to review the results of the latest loss reserve analysis. Based on this review, management determines the carried reserve for each class of business. In making the determination, management considers numerous factors, such as changes in actuarial indications in the period, the maturity of the accident year, trends observed over the recent past and the level of volatility within a particular class of business. In doing so, management must evaluate whether a change in the data represents credible actionable information or an anomaly. Such an assessment requires considerable judgment. Even if a change is determined to be permanent, it is not always possible to determine the extent of the change until sometime later. As a result, there can be a time lag between the emergence of a change and a determination that the change should be reflected in the carried loss reserves. In general, changes are made more quickly to more mature accident years and less volatile classes of business.
changes in our estimates of the number and/or severity of claims that have been incurred but not reported as of the date of the financial statements,
Reserves Relating to Asbestos and Toxic Waste Claims. The estimation of loss reserves relating to asbestos and toxic waste claims on insurance policies written many years ago is subject to greater uncertainty than other types of claims due to inconsistent court decisions as well as judicial interpretations and legislative actions that in some cases have tended to broaden coverage beyond the original intent of such policies and in others have expanded theories of liability. The insurance industry as a whole is engaged in extensive litigation over coverage and liability issues and is thus confronted with a continuing uncertainty in its efforts to quantify these exposures.
Approximately 90 manufacturers and distributors of asbestos products have filed for bankruptcy protection as a result of asbestos related liabilities. A bankruptcy sometimes involves an agreement to a plan between the debtor and its creditors, including current and future asbestos claimants. Although the debtor is negotiating in part with its insurers’ money, insurers are generally given only limited opportunity to be heard. In addition to contributing to the overall number of claims, bankruptcy proceedings have also caused increased settlement demands against remaining solvent defendants.
The following table presents the number of policyholders for whom we have open asbestos case reserves and the related net loss reserves at December 31, 2011 as well as the net losses paid during 2011 by component.
plaintiffs’ expanding theories of liability and increased focus on peripheral defendants;
In each of the past three years, the analysis of our toxic waste exposures indicated that some of our insureds had become responsible for the remediation of additional polluted sites and that, as clean up standards continue to evolve as a result of technology advances, the estimated cost of remediation of certain sites had increased. Defense costs associated with some of these cases have also increased. Based on these developments, we increased our net toxic waste loss reserves by $50 million in 2011, $61 million in 2010 and $90 million in 2009.
A reconciliation of our beginning and ending loss reserves, net of reinsurance, for the three years ended December 31, 2011 is as follows:
We experienced favorable development of about $355 million in the aggregate in the personal and commercial liability classes. Favorable development in the more recent accident years, particularly in accident years 2004 to 2009, more than offset adverse development in accident years 2001 and prior, which included $72 million of incurred losses related to asbestos and toxic waste claims. The overall frequency and severity of prior period liability claims were lower than expected and
the effects of underwriting changes that affected these years have been more positive than expected, especially in the commercial excess liability class. These factors were reflected in the determination of the carried loss reserves for these classes at December 31, 2011.
We experienced overall favorable development of about $315 million in the professional liability classes other than fidelity, including about $190 million from our business outside the United States. The most significant amount of favorable development occurred in the directors and officers liability class, particularly from our business outside the United States, with additional favorable development in the fiduciary liability and employment practices liability classes, partially offset by adverse development in the errors and omissions liability class. The aggregate
reported loss activity related to accident years 2007 and prior was less than expected, reflecting a favorable business climate, lower policy limits and better terms and conditions.
We experienced favorable development of about $265 million in the aggregate in the personal and commercial liability classes. Favorable development, primarily in accident years 2004 to 2008, more than offset adverse development in accident years 2000 and prior, which included $61 million of incurred losses related to toxic waste claims. The overall frequency and severity of prior period liability claims were lower than expected and the effects of underwriting changes that affected these years have been more positive than expected, especially in the commercial excess liability class.
We experienced favorable development of about $340 million in the professional liability classes other than fidelity, including about $110 million from our business outside the United States. A significant amount of favorable development occurred in the directors and officers liability, fiduciary liability and employment practices liability classes. We had a modest amount of unfavorable development in the errors and omissions liability class, particularly from our business outside the United States. A majority of the favorable development in the professional liability classes was in accident years 2004 through 2006. Reported loss activity related to these accident years was less than expected reflecting a favorable business climate, lower policy limits and better terms and conditions.
In Item 1 of this report, we present an analysis of our consolidated loss reserve development on a calendar year basis for each of the ten years prior to 2011. The variability in reserve development over the ten year period illustrates the uncertainty of the loss reserving process. Conditions and trends that have affected reserve development in the past will not necessarily recur in the future. It is not appropriate to extrapolate future favorable or unfavorable reserve development based on amounts experienced in prior years.
Our U.S. property and casualty subsidiaries are required to file annual statements with insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities. These annual statements include an analysis of loss reserves, referred to as Schedule P, that presents accident year loss development information by line of business for the nine years prior to 2011. It is our intention to post the Schedule P for our combined U.S. property and casualty subsidiaries on our website as soon as it becomes available.
Other income and charges, which includes miscellaneous income and expenses of the property and casualty subsidiaries, was income of $21 million in 2011 compared with income of $2 million in 2010 and a loss of $3 million in 2009. The income in 2011 primarily included income from several small property and casualty insurance companies in which we have an interest.
CFS’s remaining derivative contracts at December 31, 2011 included a contract linked to an equity market index that terminates in 2012 and a few other insignificant contracts. We estimate that the notional amount under the remaining contracts was about $340 million and the fair value of our future obligations was $2 million at December 31, 2011.
In determining whether fixed maturities are other than temporarily impaired, prior to April 1, 2009, we considered many factors including the intent and ability to hold a security for a period of time sufficient to allow for the recovery of the security’s cost. When an impairment was deemed other than temporary, the security was written down to fair value and the entire writedown was included in net income as a realized investment loss. Effective April 1, 2009, the Corporation adopted new guidance that modified the previous guidance on the recognition and presentation of other-than-temporary impairments of debt securities. Under the new guidance, we are required to recognize an other-than-temporary impairment loss for a fixed maturity when we conclude that we have the intent to sell or it is more likely than not that we will be required to sell an impaired fixed maturity before the security recovers to its amortized cost value or it is likely we will not recover the entire amortized cost value of an impaired security. Also under this guidance, if we have the intent to sell or it is more likely than not we will be required to sell an impaired fixed maturity before the security recovers to its amortized cost value, the security is written down to fair value and the entire amount of the writedown is included in net income as a realized investment loss. For all other impaired fixed maturities, the impairment loss is separated into the amount representing the credit loss and the amount representing the loss related to all other factors. The amount of the impairment loss that represents the credit loss is included in net income as a realized investment loss and the amount of the impairment loss that relates to all other factors is included in other comprehensive income.
In determining whether equity securities are other than temporarily impaired, we consider our intent and ability to hold a security for a period of time sufficient to allow us to recover our cost. If a decline in the fair value of an equity security is deemed to be other than temporary, the security is written down to fair value and the amount of the writedown is included in net income as a realized investment loss.
In November 2011, Chubb repaid $400 million of outstanding 6% notes upon maturity.
Chubb has outstanding $275 million of 5.2% notes due in 2013, $600 million of 5.75% notes and $100 million of 6.6% debentures due in 2018, $200 million of 6.8% debentures due in 2031, $800 million of 6% notes due in 2037 and $600 million of 6.5% notes due in 2038, all of which are unsecured.
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 specified replacement capital securities. 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 on 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 2008 and 2009, the Board of Directors authorized the repurchase of up to 20,000,000 shares and 25,000,000 shares, respectively, of Chubb’s common stock. In June 2010, the Board of Directors authorized an increase of 14,000,000 shares of common stock to the authorization approved in 2009. In December 2010, the Board of Directors authorized the repurchase of up to an additional 30,000,000 shares of common stock.
Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet the short and long term cash requirements of its business operations.
Our strong underwriting and investment results generated substantial operating cash flows in 2011. In 2011, cash provided by the property and casualty subsidiaries’ operating activities declined compared to 2010 primarily as a result of higher loss payments partially offset by higher premium collections. Cash used by the property and casualty subsidiaries for financing activities (primarily the payment of
dividends to Chubb) exceeded the cash provided by operating activities by approximately $650 million. In 2011, dividends paid to Chubb by the property and casualty subsidiaries increased by $500 million compared to 2010. In 2010 and 2009, our strong underwriting and investment results also generated substantial operating cash flows. In 2010, cash provided by the property and casualty subsidiaries operating activities was flat compared to 2009 and included the impact of modestly higher loss payments. The cash provided by the property and casualty subsidiaries’ operating activities exceeded the cash used for financing activities (primarily the payment of dividends to Chubb) by approximately $250 million in 2010 and $1.3 billion in 2009. In 2010, dividends paid to Chubb by the property and casualty subsidiaries increased by $1.0 billion compared to 2009.
As a holding company, Chubb’s ability to continue to pay dividends to shareholders and to satisfy its debt obligations relies on the availability of liquid assets, which is dependent in large part on the dividend paying ability of its property and casualty subsidiaries. The timing and amount of dividends paid by the property and casualty subsidiaries to Chubb may vary from year to year. Our property and casualty subsidiaries are subject to laws and regulations in the jurisdictions in which they operate that restrict the amount and timing of dividends they may pay within twelve consecutive months without the prior approval of regulatory authorities. The restrictions are generally based on net income and on certain levels of policyholders’ surplus as determined in accordance with statutory accounting practices. Dividends in excess of such thresholds are considered “extraordinary” and require prior regulatory approval. The maximum dividend distributions that the subsidiaries could have paid to Chubb during 2011, 2010 and 2009 without prior approval were approximately $2.0 billion, $1.5 billion and $1.2 billion, respectively. During 2011, 2010 and 2009 these subsidiaries paid dividends to Chubb of $2.7 billion, $2.2 billion and $1.2 billion, respectively. Included in the dividends paid in 2011 and 2010 were $2.5 billion and $1.9 billion, respectively, of dividends deemed to be extraordinary under applicable insurance regulations due to the limitation on the amount of dividends that may be paid within twelve consecutive months. Regulatory approval was required and obtained for the payment of those dividends deemed extraordinary. As a result of the timing and/or amount of the dividends paid in 2011, any dividends the property and casualty subsidiaries pay to Chubb in the first six months of 2012 also will require regulatory approval. Whether dividends paid in the remainder of 2012 will require regulatory approval will depend on the amount and timing of dividend payments by the subsidiaries to Chubb during 2012. The maximum aggregate dividend distribution that may be made by the subsidiaries to Chubb during 2012 without prior regulatory approval is approximately $1.8 billion.
Junior subordinated capital securities of $1 billion bear interest at a fixed rate of 6.375% through April 14, 2017 and at a rate equal to the three-month LIBOR rate plus 2.25% thereafter. For purposes of the above table, interest after April 14, 2017 was calculated using the three-month LIBOR rate as of December 31, 2011. 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 $848 million. It is our expectation that the capital securities will be redeemed at the end of the fixed interest rate period.
Includes agreements with vendors to purchase various goods and services such as information technology, human resources and administrative services.
During 2011, cash used for financing activities exceeded cash provided by operating activities. As a result, our holdings of tax exempt fixed maturities and mortgage-backed securities both decreased slightly during the year, partly offset by a slight increase in our holdings of corporate bonds. In 2010, we invested new cash primarily in tax exempt fixed maturities and we reduced our holdings of mortgage-backed securities. In 2009, we invested new cash in tax exempt fixed maturities and taxable fixed maturities. The taxable fixed maturities we invested in were corporate bonds while we reduced our holdings of mortgage-backed securities. 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, 2011, 68% of our U.S. fixed maturity portfolio was invested in tax exempt securities compared with 67% at December 31, 2010 and December 31, 2009.
The net unrealized appreciation before tax of our fixed maturities and equity securities carried at fair value was $2.7 billion at December 31, 2011, $1.7 billion at December 31, 2010 and $1.6 billion at December 31, 2009. Such unrealized appreciation is reflected in accumulated other comprehensive income, net of applicable deferred income taxes.
Fair values for fixed maturities are determined by management, utilizing prices obtained from a third party, nationally recognized pricing service or, in the case of securities for which prices are not provided by a pricing service, from third party brokers. For fixed maturities that have quoted prices in active markets, market quotations are provided. For fixed maturities that do not trade on a daily basis, the pricing service and brokers provide fair value estimates using a variety of inputs including, but not limited to, benchmark yields, reported trades, broker/dealer quotes, issuer spreads, bids, offers, reference data, prepayment rates and measures of volatility. Management reviews on an ongoing basis the reasonableness of the methodologies used by the relevant pricing service and brokers. In addition, management, using the prices received for the securities from the pricing service and brokers, determines the aggregate portfolio price performance and reviews it against applicable indices. If management believes that significant discrepancies exist, it will discuss these with the relevant pricing service or broker to resolve the discrepancies.
We use a pricing service to estimate fair value measurements for approximately 99% of our fixed maturities. The prices we obtain from a pricing service and brokers generally are non-binding, but are reflective of current market transactions in the applicable financial instruments. At December 31, 2011 and December 31, 2010, we held an insignificant amount of financial instruments in our investment portfolio for which a lack of market liquidity impacted our determination of fair value.
In October 2010, the Financial Accounting Standards Board issued new guidance related to the accounting for costs associated with acquiring or renewing insurance contracts. The guidance identifies those costs relating to the successful acquisition of new or renewal insurance contracts that should be capitalized. This guidance is effective for the Corporation for the year beginning January 1, 2012 and may be applied prospectively or retrospectively. The Corporation expects to elect retrospective application of the guidance. Under retrospective application, deferred policy acquisition costs and related deferred taxes would be reduced as of the beginning of the earliest period presented in the financial statements with a corresponding reduction to shareholders’ equity. The adoption of the new guidance during the first quarter of 2012 is currently expected to reduce the Corporation’s deferred policy acquisition costs as of December 31, 2011 by approximately 22% to 27% and shareholders’ equity by approximately $250 million to $300 million.