The following table sets forth selected consolidated financial data of the Company as of and for the years ended December 31, 2007, 2006, 2005, 2004, and 2003. These selected financial and other data should be read in conjunction with the Consolidated Financial Statements and related notes, under Item 8, and with
The following is a discussion of our results of operations, financial condition, and liquidity and capital resources as of and for the year ended December 31, 2007. This discussion should be read in conjunction with the Consolidated Financial Statements and related notes, under Item 8 of this Form 10-K.
ACE Limited (ACE) is a Bermuda-based holding company incorporated with limited liability under the Cayman Islands Companies Law. ACE and its direct and indirect subsidiaries are a global property and casualty (P&C) insurance and reinsurance organization, servicing the insurance needs of commercial and individual customers in more than 140 countries and jurisdictions. Our product and geographic diversification differentiates us from the vast majority of our competitors and has been a source of stability during periods of industry volatility. Our long-term business strategy focuses on sustained growth in book value achieved through a combination of underwriting and investment income. By doing so, we provide value to our clients and shareholders through the utilization of our substantial capital base in the insurance and reinsurance markets.
Our senior management team is well-seasoned in the insurance industry and its attention to operational efficiency, maintaining balance sheet strength, and enforcing strong underwriting and financial discipline across the whole organization has laid the foundation for sustained earnings and book value growth. We are organized along a profit center structure by line of business and territory that does not necessarily correspond to corporate legal entities. Profit centers can access various legal entities, subject to licensing and other regulatory rules. Profit centers are expected to generate underwriting income and appropriate risk-adjusted returns. This corporate structure has facilitated the development of management talent by giving each profit center’s senior management team the necessary autonomy within underwriting authorities to make operating decisions and create products and coverages needed by its target customer base. We are an underwriting organization and senior management is focused on delivering underwriting profit. We strive to achieve underwriting income by only writing policies which we believe adequately compensate us for the risk we accept. We will not sacrifice underwriting income for growth. Distinction in service is an additional area of focus and a means to set us apart from our competition.
As an insurance and reinsurance company, we generate gross revenues from two principal sources: premiums and investment income. Cash flow is generated from premiums collected and investment income received less paid losses and loss expenses, policy acquisition costs, and administrative expenses. Invested assets are generally held in liquid, investment grade fixed income securities of relatively short duration. We invest in equity securities in the U.S. and international markets. A small portion of our assets are held in less liquid or higher risk assets in an attempt to achieve higher risk-adjusted returns. Claims payments in any short-term period are highly unpredictable due to the random nature of loss events and the timing of claims awards or settlements. The value of investments held to pay future claims is subject to market forces such as the level of interest rates, stock market volatility, and credit events such as corporate defaults. The actual cost of claims is also volatile based on loss trends, inflation rates, court awards, and catastrophes. We believe that our cash balance, our highly liquid investments, credit facilities, and reinsurance protection provide sufficient liquidity to meet any unforeseen claim demands that might occur in the year ahead.
On December 14, 2007, we entered into a stock purchase agreement with Aon Corporation, pursuant to which we have agreed to purchase all the outstanding shares of capital stock of Combined Insurance Company of America (Combined) and fourteen Combined subsidiaries. The all-cash purchase price is $2.4 billion, subject to certain post-closing adjustments. Combined, which was founded in 1919 and is headquartered in Glenview, Illinois, is a leading underwriter and distributor of specialty individual accident and supplemental health insurance products that are targeted to middle income consumers in the U.S., Europe, Canada, and Asia Pacific. Combined serves more than four million policyholders worldwide. We expect this transaction to be completed during the second quarter of 2008. We believe that this acquisition will add balance and capability to our existing accident and health (A&H) business and offers meaningful opportunity for future revenue and earnings growth.
The insurance industry is highly competitive with many companies offering similar coverage. The rates and terms and conditions related to the products we offer have historically changed depending on the timing of the insurance cycle. During periods of excess underwriting capacity, as defined by availability of capital, competition can result in lower pricing and less favorable terms and conditions. Pricing and terms and conditions are generally more favorable during periods of reduced underwriting capacity.
The P&C industry is currently in a period of excess underwriting capacity and, as a result, prices are declining globally. The rate of decline is accelerating in some classes and staying relatively flat in others. Overall, the market continues to become more competitive and, given these conditions, we are focused on maintaining the levels of our renewals and writing less new business. This is reflected in our net premiums written which decreased slightly in 2007, compared with 2006. Despite this downward trend, we continue to see opportunity to expand our P&C business in the short- and longer-term in many places as we adapt our business to take advantage of the macroeconomic trends (and the risks that accompany them) taking place around the world. With considerable balance sheet strength, we also have the ability to grow both organically and opportunistically though acquisitions. Our A&H business continues to do well, growing 18 percent in 2007, compared with 2006. We continue to see good long-term opportunity to grow our A&H franchise, particularly in the developing markets of Asia Pacific and Latin America, among other territories. Our life insurance and reinsurance business also had a very good year and together with A&H and the addition of Combined will represent close to 23 percent of our net premiums earned, on a pro-forma basis.
Information on the insurance industry investigations and related matters is set forth in Note 9 f) to the Consolidated Financial Statements, under Item 8.
• unpaid loss and loss expense reserves, including asbestos and environmental (A&E) reserves;
• the assessment of risk transfer for certain structured insurance and reinsurance contracts.
and Other Run-off Liabilities, Reinsurance Recoverable on Ceded Reinsurance, Investments, Net Realized Gains (Losses), and Other Income and Expense Items.
As an insurance and reinsurance company, we are required, by applicable laws and regulations and GAAP, to establish loss and loss expense reserves for the estimated unpaid portion of the ultimate liability for losses and loss expenses under the terms of our policies and agreements with our insured and reinsured customers. The estimate of the liabilities includes provision for claims that have been reported but unpaid at the balance sheet date (case reserves) and for future obligations from claims that have been incurred but not reported (IBNR) at the balance sheet date (IBNR may also include a provision for additional development on reported claims in instances where the case reserve is viewed to be insufficient). The reserves provide for liabilities on the premium earned on policies as of the balance sheet date. The loss reserve also includes an estimate of expenses associated with processing and settling these unpaid claims (loss expenses). At December 31, 2007, our unpaid loss and loss expense reserves were $37.1 billion. With the exception of certain structured settlements, for which the timing and amount of future claim payments are reliably determinable, our loss reserves are not discounted for time value. In connection with such structured settlements, we carry reserves of $117 million (net of discount).
We establish loss and loss expense reserves to reflect our liabilities from claims for all of the insurance and reinsurance business that we write. For those claims reported by insureds or ceding companies to us prior to the balance sheet date, case reserves are established by claims personnel as appropriate based on the circumstances of the claim(s), standard claim handling practices, and professional judgment. In respect of those claims that have been incurred but not reported prior to the balance sheet date, there is by definition limited actual information to form the reserve estimate and reliance is placed upon historical loss experience and actuarial methods to project the ultimate loss obligations and the corresponding amount of IBNR. Furthermore, for our assumed reinsurance operation, Global Reinsurance, an additional case reserve may sometimes be established above the amount notified by the ceding company if the notified case reserve is judged to be insufficient by Global Reinsurance’s claims department (refer to “Assumed reinsurance” below).
We have actuarial staff within each of our operating segments who analyze loss reserves and regularly project estimates of ultimate losses and the required IBNR reserve. IBNR reserve estimates are generally calculated by first projecting the ultimate amount of expected claims for a product line and subtracting paid losses and case reserves for reported claims. The judgments involved in projecting the ultimate losses may involve the use and interpretation of various actuarial projection methods as well
as more qualitative factors that may impact the ultimate value of the losses such as actual loss experience, loss development patterns, and industry data. In addition, since standard actuarial projection methods place reliance on the extrapolation of historical data and patterns, the estimate of the IBNR reserve also requires judgment by actuaries and management to consider the impact from more contemporary and subjective factors. Among some of the factors that might be considered are changes in business mix or volume, changes in ceded reinsurance structures, reported and projected loss trends, inflation, legal environment, and the terms and conditions of the contracts sold to our insured parties. Finally, adjustments may be required to ensure that the derived IBNR reflects the exposure arising on the earned portion of premium as at the balance sheet date.
The standard actuarial reserving methods may include, but are not necessarily limited to, paid and reported loss development, expected loss ratio, and Bornhuetter-Ferguson methods. A general description of these methods is provided below. In the subsequent discussion on short and long-tail business, reference is also made where appropriate to how consideration in method selection impacted 2007 results. In addition to these standard methods, we may use other recognized actuarial methods and approaches depending upon the product line characteristics and available data. To ensure that the projections of future loss emergence from historical loss development patterns are representative of the underlying business, the historical loss and premium data is required to be of sufficient homogeneity and credibility. For example, to improve data homogeneity, we may group product line data further by similar risk attribute (e.g., geography, coverage such as property versus liability exposure, or origin year), project losses for these homogenous groups and then combine these results to provide the overall product line estimate. The premium and loss data is aggregated by origin year (e.g., the year in which the losses were incurred or “accident year”) and annual or quarterly periods subsequent to the origin year. Implicit in the standard accepted actuarial methodologies that we generally utilize is the need for two fundamental assumptions: first, the expected loss ratio for each origin year (i.e., accident, report, or underwriting) and second, the pattern in which losses are expected to emerge over time for each origin year.
development methods which are favored at latter maturities. We usually apply this method using reported loss data although paid data may be used.
Our recorded reserves represent management’s best estimate of the provision for unpaid claims as of the balance sheet date. Each product line has an actuarial reserve review performed and an actuarial provisional estimate is established at the review’s conclusion. The process to select the actuarial provisional estimate, when more than one estimate is available, may differ across product lines. For example, an actuary may base the provisional estimate on loss projections developed using an incurred loss development approach instead of a paid loss development approach when reported losses are viewed to be a more credible indication of the ultimate loss compared with paid losses. The availability of estimates by different projection techniques will depend upon the product line, the underwriting circumstances, and the maturity of the loss emergence. For a well-established product line with sufficient volume and history, the actuarial provisional estimate may be drawn from a weighting of paid and reported loss development and/or Bornhuetter-Ferguson methods. However, for a new long-tail product line for which we have limited data and experience or a rapidly growing line, the emerging loss experience will unlikely have sufficient stability to allow selection of loss development or Bornhuetter-Ferguson methods and reliance will be placed upon the initial expected loss ratio method as the actuarial provisional estimate until the experience matures.
The actuarial provisional estimate is then developed into management’s best estimate with collaboration with underwriting, claims, legal, and finance departments and culminates with the input of reserve committees. Each business unit reserve committee includes the participation of the relevant parties from actuarial, finance, claims, and executive management and has the responsibility for finalizing and approving the estimate to be used as management’s best estimate. Reserves are further reviewed by ACE’s Chief Actuary and senior management. The objective of such a process is to determine a single estimate that we believe represents a better estimate than any other. Such an estimate is viewed by management to support the most likely outcome of ultimate loss settlements and is determined based on several factors including, but not limited to:
• Segmentation of data to provide sufficient homogeneity and credibility for loss projection methods;
• Extent of internal historical loss data, and industry where required;
We perform internal loss reserve studies for all product lines at least once a year; the timing of such studies varies throughout the year. External loss reserve studies are performed periodically and are compared to our internal results. Additionally, each quarter for each product line, we review the emergence of actual losses relative to expectations used in reserving. If warranted from findings in loss emergence tests, we will accelerate the timing of our product line reserve studies. Finally, external loss reserve studies are performed annually and are compared to our internal results to ensure reasonability of internal findings.
The time period between the date of loss occurrence and the final payment date of the ensuing claim(s) is referred to as the “claim-tail”. The following is a discussion of specific reserving considerations for both short-tail and long-tail product lines. In this section, we reference the nature of recent prior period development to give a high-level understanding of how these considerations translate through the reserving process into financial decisions. Refer to “Segment Operating Results” for more information on prior period development.
Short-tail business generally describes product lines for which losses are usually known and paid shortly after the loss actually occurs. This would include, for example, most property, personal accident, aviation hull, and automobile physical damage policies that are written. There are some exceptions on certain product lines (e.g., workers’ compensation catastrophe) or events (e.g., major hurricanes) where the event has occurred, but the final settlement amount is highly variable and not known with certainty for a potentially lengthy period. Due to the short reporting development pattern for these product lines, our estimate of ultimate losses from any particular accident period responds quickly to the latest loss data. We will typically assign credibility to methods that incorporate actual loss emergence, such as the paid and reported loss development and Bornhuetter-Ferguson methods, sooner than would be the case for long-tail lines at a similar stage of development from the origin year. The reserving process for short-tail losses arising from catastrophic events typically involves the determination by the claims department, in conjunction with underwriters and actuaries, of our exposure and likely losses immediately following an event and the subsequent regular refinement of those losses as our insureds provide updated actual loss information.
For the 2007 accident year, the short-tail line loss reserves were typically established using the expected loss ratio method for the non-catastrophe exposures. In addition, reserves were also established for losses arising on catastrophe activity during 2007. The underlying calculation for the non-catastrophe portion requires initial expected loss ratios by product line, as adjusted for actual experience during the progression of the 2007 calendar year. As previously noted, the derivation of initial loss ratios incorporates actuarial assumptions on projections of prior years’ loss experience, past and future loss, and exposure trends, rate adequacy of new and renewal business, and ceded reinsurance costs. In addition, we considered our view of terms and conditions and the market environment, which by their nature tend to be more judgmental relative to other factors. For our short-tail businesses taken as a whole, overall loss trend assumptions have not differed significantly relative to prior years. Because there is some random volatility of non-catastrophe loss experience from year to year, we considered average loss experience over several years when developing loss estimates for the current accident year. Therefore, while there has been favorable loss development in recent years on non-catastrophe exposures, the effect of this favorable development on expected loss ratios for the current accident year is relatively small. Further, other considerations, such as rate reductions and broadening of terms and conditions in a competitive market somewhat offset this favorable effect.
The process used to establish the 2007 year-end reserves for the 2004 and 2005 catastrophes involved a detailed review by the claims department of the causation and coverage issues of each underlying claim. Given the unique circumstances around the events, historical trends and loss development patterns are not applicable. As discussed in the prior period development discussions under “Segment Operating Results”, the actual claims experience was worse than anticipated and, as such, the ultimate loss estimates were revised to reflect that loss emergence. For the reserves covering the non-catastrophe- related exposures in the 2006 and prior accident years, the change in ultimate loss reflected recognition of actual favorable loss emergence rather than explicit changes to assumptions on the loss development patterns to project future loss emergence. The actual non-catastrophe related loss emergence over 2005-2007 calendar years has been favorable but within a range of expected outcomes and the experience from these years was considered when establishing the expectation of 2007 accident year losses. For a detailed analysis of changes in assumptions related to prior accident year reserves during calendar year 2007, refer to “Prior Period Development”.
Long-tail business describes lines of business for which specific losses may not be known for some period and claims can take significant time to emerge. This includes most casualty lines such as general liability, directors and officers’ liability (D&O) and workers’ compensation. There are many factors contributing to the uncertainty and volatility of long-tail business. Among these are:
For those long-tail product lines that are less claim frequency and more claim severity oriented, such as professional lines and high excess casualty, we placed more reliance upon expert legal and claims review of the specific circumstance underlying reported cases rather than loss development patterns. The assumptions used for these lines of business were updated in response to new claim and legal advice judged to be of significance.
For the 2007 accident year, loss reserves were typically established through the application of individual product line initial expected loss ratios that require contemplation of assumptions similar in nature to those noted in the short-tail line discussion. Our assumptions on loss trend and development patterns reflect reliance on our historical loss data provided the length of history and homogeneity afford credibility. Given the recent growth on a number of product lines, such as general casualty and financial lines, our historical loss data is less extensive and our assumptions require judgmental use of industry loss trends and development patterns. We note that industry patterns are not always available to match the nature of the business being written; this issue is particularly problematic for non-U.S. exposed lines. Given the underlying volatility of the long-tail product lines and the lengthy period required for full paid and reported loss emergence, we typically assign little to no credibility to actual loss emergence in the recent development periods. Accordingly, we generally used the initial expected loss ratio method for the 2007 and immediately preceding origin years to establish reserves by product line. We monitor actual paid and reported loss emergence with expected loss emergence for each key individual product line. While recent experience has generally been favorable relative to our internal expectations, we do not yet believe experience is sufficiently credible for us to consider moving to loss-based projection methods in setting reserves. Our best estimate based on information received to date for our 2007 loss ratios reflect what we believe is our exposure to sub-prime losses (E&O and D&O).
Typically for the 2004-2006 accident years, to the extent that actual loss emergence in calendar year 2007 differed from our expectation in the more recent origin years, the deviation was not seen as sufficiently credible, particularly given the volatility and lengthy period for full loss emergence, to alter either our booked ultimate loss selections or the set of actuarial assumptions underlying the reserving review for that particular portfolio. Such judgments were made with due consideration to the factors impacting reserve uncertainty as discussed above. However, for some product lines, credibility was assigned to emerging loss experience and this is discussed further below and in the section entitled “Prior Period Development”.
In contrast to short-tail lines, the prior period development in 2007 for long-tail lines of business arose across a number of accident years in the Insurance - North American and Insurance - Overseas General segments, typically more removed from the recent accident years. The movements were generally the result of actual loss emergence in calendar year 2007 that differed materially from the expected loss emergence and these deviations were significant enough in certain product lines to warrant revising the projections. The nature of the assumptions altered in 2007, and impacting the prior accident years, varies by the specifics of each product line. For example, in Insurance - North American the alterations to estimates for national account casualty and workers’ compensation lines involved retaining the original paid and reported loss development assumptions but assigning greater credibility to actual loss experience; i.e. more weight was given to paid and reported loss development and Bornhuetter-Ferguson methods rather than the expected loss ratio methods on the 2002-2004 accident years. This resulted in $21 million favorable development and $28 million adverse development for the casualty and workers’ compensation lines, respectively. Similarly, for Insurance - Overseas General, there was $23 million of favorable development on the 2003-2005 accident years as more weight was given to paid and reported loss development and Bornhuetter-Ferguson methods rather than the expected loss ratio methods. In addition, an update of our detailed annual evaluation of the excess exposures at Insurance - Overseas General resulted in net favorable prior period development of $20 million which comprised strengthening of $89 million in accident years 2003 and prior and $45 million in accident year 2006 and a release of $154 million in accident years 2004 and 2005.
Certain long-tail lines, such as casualty and professional lines, are particularly susceptible to changes in loss trend and claim inflation. Heightened perceptions of tort and settlement awards around the world are increasing the demand for these products as well as contributing to the uncertainty of the reserving estimates. Our reserving methods rely on loss development patterns estimated from historical data and while we attempt to adjust such factors for known changes in the current tort environment, it is possible that such factors may not entirely reflect all recent trends in tort environments. For example, when applying the reported loss development method, the lengthening by six months of our selected loss development patterns would increase reserve estimates on long-tail casualty and professional lines by approximately $271 million. This movement is relative to recorded net loss and loss expense reserves of approximately $3.4 billion.
Typically, there is inherent uncertainty around the length of paid and reporting development patterns, especially for certain casualty lines such as excess workers’ compensation or general liability, which may take up to 30 years to fully develop. This uncertainty is accentuated by the need to supplement client development patterns with industry development patterns as justified by the credibility of the data. The underlying source and selection of the final development pattern can thus have a significant impact on the selected net losses and loss expenses ultimate. For example, a twenty percent shortening or lengthening of the development patterns used for U.S. long-tail lines would cause the loss reserve estimate derived by the reported Bornhuetter-Ferguson method for these lines to change by approximately $140 million. This movement is relative to recorded net loss and loss expense reserves of approximately $1.7 billion.
At December 31, 2007, net unpaid losses and loss expenses for the Global Reinsurance segment aggregated to $2.8 billion, consisting of $750 million of case reserves and $2.0 billion of IBNR. In comparison, at December 31, 2006, net unpaid losses and loss expenses for the Global Reinsurance segment aggregated to $2.6 billion, consisting of $778 million of case reserves and $1.8 billion of IBNR.
On occasion, there will be differences between our carried loss reserves and unearned premiums reserves and the amount of loss reserves and unearned premiums reserves reported by the ceding companies. This is due to the fact that we receive consistent and timely information from ceding companies only with respect to case reserves. For IBNR, we use historical experience and other statistical information, depending on the type of business, to estimate the ultimate loss (see “Unpaid Losses and Loss Expenses” for more information). We estimate our unearned premiums reserve by applying estimated earning patterns to net premiums written for each treaty based upon that treaty’s coverage basis (i.e., risks attaching or losses occurring). At December 31, 2007, the case reserves reported to us by our ceding companies were $723 million, compared with the $750 million we recorded. Our policy is to post additional case reserves in addition to the amounts reported by our cedants when our evaluation of the ultimate value of a reported claim is different than the evaluation of that claim by our cedant.
Within the Insurance - North American segment, we also have exposure to certain liability reinsurance lines that have been in run-off since 1994. Unpaid losses and loss expenses relating to this run-off reinsurance business resides within the Brandywine Division of our Insurance - North American segment. Most of the remaining unpaid losses and loss expense reserves for the run-off reinsurance business relate to A&E claims. (Refer to “Asbestos and Environmental and Other Run-off Liabilities” for more information.)
Although the contractual obligation of individual reinsurers to pay their reinsurance obligations is based on specific contract provisions, the collectability of such amounts requires estimation by management. The majority of the balance we have accrued as recoverable will not be due for collection until sometime in the future, in some cases, several decades from now. Over this period of time, economic conditions and operational performance of a particular reinsurer may impact their ability to meet these obligations and while they may continue to acknowledge their contractual obligation to do so, they may not have the financial resources or willingness to fully meet their obligation to us.
• For reinsurers that maintain a financial strength rating from a major rating agency, and for which recoverable balances are considered representative of the larger population (i.e., default probabilities are consistent with similarly rated reinsurers and payment durations conform to averages), the judgment exercised by management to determine the provision for uncollectible reinsurance of each reinsurer is typically limited because the financial rating is based on a published source and the default factor we apply is based on a default factor of a major rating agency applicable to the particular rating class. Default factors applied for financial ratings of AAA, AA, A, BBB, BB, B, and CCC, are 0.5 percent, 1.2 percent, 1.9 percent, 4.7 percent, 9.6 percent, 23.8 percent and 49.7 percent, respectively. Because the model we use is predicated on the default factors of a major rating agency, we do not generally consider alternative factors. However, when a recoverable is expected to be paid in a brief period of time by a highly-rated reinsurer, such as certain property catastrophe claims, a default factor may not be applied;
ability and intent to hold the security through an expected recovery period, absent a significant change in facts that would be expected to have a material adverse effect on either the financial markets or the financial position of the issuer.
With respect to securities where the decline in value is determined to be temporary and the security’s value is not written down, a subsequent decision may be made to sell that security and realize a loss. Subsequent decisions on security sales could be made based on changes in liquidity needs (i.e., arising from a large insured loss such as a catastrophe), internal risk management considerations, the financial condition of the issuer or its industry, market conditions, and new investment opportunities. Day to day management of the majority of our investment portfolio is outsourced to third-party investment managers. The dynamic nature of portfolio management may result in a subsequent decision to sell the security and realize the loss based upon new circumstances such as those related to the changes described above. We believe that subsequent decisions to sell such securities are consistent with the classification of the majority of our portfolio as available for sale. The gross unrealized loss at December 31, 2007, for all securities in a loss position was $391 million with $6 million in an unrealized loss position for over 12 months ($4 million was related to fixed maturities held to maturity). Our net realized losses in 2007 included write-downs of $141 million of which $123 million was related to fixed maturities. This compares with write-downs of $214 million and $88 million in 2006 and 2005, respectively. The impairments recorded in 2007 and 2006 were primarily due to an increase in market interest rates from the date of security purchase and as such, were not credit-related.
Many of our insurance businesses operate in income tax-paying jurisdictions. Our deferred tax assets and liabilities primarily result from temporary differences between the amounts recorded in our Consolidated Financial Statements and the tax basis of our assets and liabilities. We determine deferred tax assets and liabilities separately for each tax-paying component (an individual entity or group of entities that is consolidated for tax purposes) in each tax jurisdiction.
At December 31, 2007, our net deferred tax asset was $1.1 billion. (Refer to Note 7 to the Consolidated Financial Statements, under Item 8, for more information). At each balance sheet date, management assesses the need to establish a valuation allowance that reduces deferred tax assets when it is more likely than not that all, or some portion, of the deferred tax assets will not be realized. The valuation allowance is based on all available information including projections of future taxable income from each tax-paying component in each tax jurisdiction, principally derived from business plans and available tax planning strategies. Projections of future taxable income incorporate several assumptions of future business and operations that are apt to differ from actual experience. If, in the future, our assumptions and estimates that resulted in our forecast of future taxable income for each tax-paying component proves to be incorrect, an additional valuation allowance could become necessary. This could have a material adverse effect on our financial condition, results of operations, and liquidity. At December 31, 2007, the valuation allowance of $41 million (including $24 million with respect to foreign tax credits) reflects management’s assessment that it is more likely than not that a portion of the deferred tax asset will not be realized due to the inability of certain foreign subsidiaries to generate sufficient taxable income or the inability to utilize foreign tax credits.