The executive offices of the Corporation and the administrative offices of the Property and Casualty Insurance Group are in Warren, New Jersey. The Property and Casualty Insurance Group maintains zone administrative and branch offices in major cities throughout the United States and also has offices in Canada, Europe, Australia, the Far East and Latin America. Office facilities are leased with the exception of buildings in Branchburg, New Jersey and Simsbury, Connecticut. Management considers its office facilities suitable and adequate for the current level of operations. See Note (14) of the notes to consolidated financial statements incorporated by reference from the Corporation's 1999 Annual Report to Shareholders.
Selected financial data for the five years ended December 31, 1999 are incorporated by reference from the Corporation's 1999 Annual Report to Shareholders, pages 36 through 39.
Operating income, which excludes realized investment gains and losses, was $565 million in 1999 compared with $615 million in 1998 and $701 million in 1997. Operating income in 1998 reflects a first quarter restructuring charge of $26 million after taxes related to the implementation of a cost control initiative.
Net income, which includes realized investment gains and losses, was $621 million in 1999 compared with $707 million in 1998 and $770 million in 1997.
In July 1999, The Chubb Corporation (Corporation) completed its acquisition of Executive Risk Inc. Executive Risk is a specialty insurance company offering primarily executive protection coverages, particularly directors and officers, errors and omissions and professional liability.
Executive Risk shareholders received 1.235 shares of the Corporation's common stock for each outstanding common share of Executive Risk. In addition, outstanding Executive Risk stock options were converted to stock options of the Corporation. Approximately 14.3 million shares of common stock of the Corporation were issued to Executive Risk shareholders and an additional 1.8 million shares of common stock of the Corporation were reserved for issuance upon exercise of the converted Executive Risk stock options.
Catastrophe losses were $225 million in 1999, $173 million in 1998 and $57 million in 1997. The 1998 amount was net of reinsurance recoveries of approximately $130 million related to Hurricane Georges. We did not have any recoveries from our catastrophe reinsurance program during 1999 or 1997 since there were no individual catastrophes for which our losses exceeded the initial retention. Our initial retention level for each catastrophic event is approximately $100 million in the United States and generally $25 million outside the United States.
After adjusting 1997 reported net premiums for the effects of the termination of the reinsurance agreements with Sun Alliance, net premiums written increased 4% in 1998 compared with 1997.
The loss ratio was 70.3% in 1999 compared with 66.3% in 1998 and 64.5% in 1997. Losses from catastrophes represented 4.0 percentage points of the loss ratio in 1999 compared with 3.3 percentage points in 1998 and 1.1 percentage points in 1997. Catastrophe losses affecting results in 1999 resulted primarily from weather-related events in the United States: winter storms in the first quarter, windstorms and tornadoes in the second quarter and Hurricane Floyd in the third quarter. The 1998 catastrophe losses resulted primarily from the winter ice storms in Canada in the first quarter, the wind and hail storms in the United States in the second quarter and Hurricane Georges in Puerto Rico in the third quarter.
Our expense ratio was 32.5% in 1999 compared with 33.5% in 1998 and 32.4% in 1997. The lower ratio in 1999 was due to salary and overhead expenses decreasing due to a cost control initiative discussed below and a change in accounting that resulted in the capitalization of certain costs incurred to develop computer software for internal use. The increase in the expense ratio in 1998 was due primarily to an increase in commission expense caused in part by higher contingent payments and also to written premiums growing at a somewhat lesser rate than overhead expenses.
In the first quarter of 1998, we recorded a restructuring charge of $40 million related to the implementation of the cost control initiative. Of the $40 million restructuring charge, $30 million was comprised of accruals for providing enhanced pension benefits and postretirement medical benefits to employees who accepted an early retirement incentive offer and $5 million was severance costs for employees who were terminated. The remainder of the charge was for other expenses such as the cost of outplacement services. The initiative was completed with no significant differences from the original estimates of the restructuring costs. The liabilities related to the enhanced pension and postretirement medical benefits were included in the pension and postretirement medical benefits liabilities, which will be reduced as benefit payments are made over time. Of the other restructuring costs, $1.5 million remained unpaid at December 31, 1999.
Our personal insurance business continued to produce exceptionally strong results in 1999, measured by both growth and profitability.
Reported net premiums from standard commercial insurance decreased 8% in 1999 compared with a 1% decrease in 1998. After adjusting 1997 reported net premiums for the effects of the termination of the reinsurance agreement with Sun Alliance, premiums increased 2% in 1998 compared with 1997. The decrease in premiums in 1999 was the result of the strategy we put in place in late 1998 to renew good business at adequate prices and not renew underperforming business where we cannot attain price adequacy. As a result, retention levels were lower in 1999 than in 1998. On the business that was renewed, rates have increased steadily throughout 1999 and we expect this trend to continue. We achieved premium growth in 1999 and 1998 in standard commercial lines outside the United States.
Our standard commercial insurance business produced substantial underwriting losses in each of the past three years, with results becoming increasingly unprofitable each year. The combined loss and expense ratio was 123.6% in 1999 compared with 118.0% in 1998 and 114.5% in 1997.
Multiple peril results were unprofitable in each of the past three years due, in large part, to inadequate prices. Such results were progressively more unprofitable each year. In the liability component of this class, results deteriorated in 1998 and again in 1999 due to increases in the severity of losses. Results in 1997 were adversely affected by substantial incurred losses relating to asbestos and toxic waste claims. Results for the property component deteriorated in 1998 due to higher catastrophe
Our strategy of working closely with our customers and our ability to differentiate our products continue to enable us to renew a large percentage of our executive protection and financial institutions business. However, a competitive market continues to put prices under pressure for this business. Excluding premiums written by Executive Risk, executive protection premiums increased 2% in 1999 while financial institutions premiums decreased 5%.
Executive protection results were highly profitable in each of the past three years due to favorable loss experience on business worldwide, particularly in the directors and officers and fiduciary components. However, such results were less profitable in 1999 due to the less adequate prices in recent years.
written on financial institutions was unprofitable in 1999 and 1997 compared with profitable results in 1998.
Our other commercial classes produced profitable results in 1999 and 1997 compared with near-breakeven results in 1998. The deterioration in 1998 was attributable to our aviation business, which produced highly unprofitable results. Our surety business produced highly profitable results in each of the past three years.
Reinsurance assumed is treaty reinsurance that was assumed from Sun Alliance. The reinsurance agreement with Sun Alliance was terminated effective January 1, 1997. However, due to the lag in our reporting of such business, our share of the Sun Alliance business for the last six months of 1996 was included in our results in the first quarter of 1997. Such results were near breakeven.
Loss reserves are our property and casualty subsidiaries' largest liability. At the end of 1999, gross loss reserves totaled $11.4 billion compared with $10.4 billion and $9.8 billion at year-end 1998 and 1997, respectively. Reinsurance recoverable on such loss reserves was $1.7 billion at year-end 1999 compared with $1.3 billion and $1.2 billion at the end of 1998 and 1997, respectively. At year end 1999, gross loss reserves of $1.0 billion and reinsurance recoverable of $390 million were related to Executive Risk. Executive Risk has historically utilized reinsurance to a greater extent because its size has limited the amount of risk it could retain.
Loss reserves, net of reinsurance recoverable, increased by $699 million or 8% in 1999 compared with $485 million or 6% in 1998. The increase in 1999 includes $606 million of net reserves assumed in July upon the acquisition of Executive Risk. The 1999 increase would have been $549 million greater except that loss reserves were reduced by payments in that amount during the year related to the settlement of asbestos-related claims against Fibreboard Corporation, which is discussed below. Excluding the Executive Risk reserves assumed and the Fibreboard payments, loss reserves increased 7% in 1999. Substantial reserve growth has occurred each year in those liability classes, primarily excess liability and executive protection, that are characterized by delayed loss reporting and extended periods of settlement.
During 1999, we experienced overall favorable development of $206 million on loss reserves established as of the previous year-end. This compares with favorable development of $218 million in 1998 and $65 million in 1997. Such redundancies were reflected in operating results in these respective years. Each of the past three years benefited from favorable claim experience for certain liability classes; this was offset in part by losses incurred relating to asbestos and toxic waste claims of $47 million, $68 million and $125 million in 1999, 1998 and 1997, respectively. The higher favorable development in 1999 and 1998 compared with 1997 was due to more favorable loss experience for executive protection and excess liability coverages as well as the substantially lower incurred losses related to asbestos and toxic waste claims.
The uncertainties relating to asbestos and toxic waste claims on insurance policies written many years ago are exacerbated by inconsistent court decisions and judicial and legislative interpretations of coverage that in some cases have tended to erode the clear and express intent of such policies and in others have expanded theories of liability. The industry is engaged in extensive litigation over these coverage and liability issues and is thus confronted with a continuing uncertainty in its efforts to quantify these exposures.
Our most costly asbestos exposure related to an insurance policy issued to Fibreboard Corporation by Pacific Indemnity Company in 1956. As a result of events during 1999 that are described below, management believes that Pacific Indemnity's exposure with respect to asbestos-related claims against Fibreboard has ended.
At the same time, Pacific Indemnity, Continental Casualty and Fibreboard entered into a trilateral agreement to settle all pending and future asbestos-related bodily injury claims resulting from insurance policies that were, or may have been, issued to Fibreboard by the two insurers. The trilateral agreement would be triggered if the global settlement agreement was ultimately disapproved. Pacific Indemnity's obligation under the trilateral agreement is therefore similar to, and not duplicative of, that under those agreements described above.
In July 1995, the United States District Court of the Eastern District of Texas approved the global settlement agreement and the trilateral agreement. The judgments approving these agreements were appealed to the United States Court of Appeals for the Fifth Circuit. In July 1996, the Fifth Circuit Court affirmed the 1995 judgments of the District Court. The objectors to the global settlement agreement appealed to the United States Supreme Court. In June 1999, the Supreme Court refused to affirm approval of the global settlement agreement. The case was returned to the United States District Court of the Eastern District of Texas for further proceedings. In September 1999, the District Court entered judgment disapproving the global settlement agreement. That judgment was not appealed and became final in November 1999.
In December 1999, the funds that had been held in the escrow account were paid to a trust established to pay future asbestos-related bodily injury claims against Fibreboard.
Uncertainty remains as to our ultimate liability relating to asbestos claims due to such factors as the long latency period between asbestos exposure and disease manifestation and the resulting potential for involvement of multiple policy periods for individual claims. Significant issues remain unresolved, adding to the complexity and uncertainty of asbestos litigation. These issues primarily involve questions regarding allocation of indemnity and expense costs and exhaustion of policy limits. We are involved in disputes with other insurers and with insureds over these issues, which increase the difficulty of settlement negotiations.
Hazardous waste sites are another significant potential exposure. Under the federal "Superfund" law and similar state statutes, when potentially responsible parties (PRPs) fail to handle the clean-up, regulators have the work done and then attempt to establish legal liability against the PRPs. The PRPs, with proper government authorization in many instances, disposed of toxic materials at a waste dump site or transported the materials to the site. Most sites have multiple PRPs. Insurance policies issued to PRPs were not intended to cover the clean-up costs of pollution and, in many cases, did not intend to cover the pollution itself. Pollution was not a recognized hazard at the time many of these policies were written. In more recent years, however, policies specifically exclude such exposures.
There is great uncertainty involved in estimating our liabilities related to these claims. First, the liabilities of the claimants are extremely difficult to estimate. At any given site, the allocation of remediation costs among governmental authorities and the PRPs varies greatly. 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.
The Superfund law does not address non-Superfund sites. For that reason, it does not cover all existing hazardous waste exposures, such as those involving sites that are subject to state law only. There remains significant uncertainty as to the cost of remediating the state sites. Because of the large number of state sites, such sites could prove even more costly in the aggregate than Superfund sites.
costs. This unlimited defense provided in the policies sometimes leads to the payment of defense costs substantially exceeding the indemnity exposure.
Management believes that the aggregate loss reserves of the property and casualty subsidiaries at December 31, 1999 were adequate to cover claims for losses that had occurred, including both those known to us and those yet to be reported. In establishing such reserves, management considers facts currently known and the present state of the law and coverage litigation. However, given the expansion of coverage and liability by the courts and the legislatures in the past and the possibilities of similar interpretations in the future, particularly as they relate to asbestos and toxic waste claims, as well as the uncertainty in determining what scientific standards will be deemed acceptable for measuring hazardous waste site clean-up, additional increases in loss reserves may emerge which would adversely affect results in future periods. The amount cannot reasonably be estimated at the present time.
The Corporation's property and casualty subsidiaries have an exposure to insured losses caused by hurricanes, earthquakes, winter storms, windstorms and other catastrophic events. The frequency and severity of catastrophes are unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in an area affected by the event and the severity of the event. We continually assess our concentration of underwriting exposures in catastrophe prone areas globally and develop strategies to manage this exposure through individual risk selection, subject to regulatory constraints, and through the purchase of catastrophe reinsurance. In recent years, we have used modeling technologies and concentration management tools that allow us to better monitor and control catastrophe exposures. We also continue to explore and analyze credible scientific evidence, including the impact of global climate change, that may affect our potential exposure under insurance policies.
Growth in investment income in 1999 and 1998 was primarily due to increases in invested assets, which reflected strong cash flow from operations over the period, partially offset by lower average yields on new investments. The effective tax rate on our investment income was 15.7% in 1999 compared with 15.3% in 1998 and 16.7% in 1997. The effective tax rate fluctuates each year as a result of changes in the percentage of our portfolio invested in tax-exempt bonds. Investment income after taxes increased 9% in 1999 compared with 1998 and 7% in 1998 compared with 1997. Excluding the investment income of Executive Risk, such growth was 5% in 1999.
Generally, premiums are received by our property and casualty subsidiaries months or even years before losses are paid under the policies purchased by such premiums. These funds are used first to make current claim and expense payments. The balance is invested together with the investment income generated by the existing portfolio to build the portfolio and thereby increase future investment income. Historically, cash receipts from operations, consisting of insurance premiums and
New cash available for investment by the property and casualty subsidiaries was approximately $940 million in 1999 compared with $860 million in 1998 and $1,260 million in 1997. New cash available in 1999 was not affected by the Fibreboard-related payments during the year since such payments were made from the escrow account that was funded in 1993. New cash in 1997 included approximately $330 million received as the net result of the portfolio transfers of unearned premiums and loss reserves as of January 1, 1997 related to the termination of the reinsurance agreements with Sun Alliance.
In 1999, new cash was invested in tax-exempt bonds and corporate bonds. Also, during 1999, we reduced our equity securities portfolio by approximately $350 million with $145 million of the proceeds used to fund the purchase of a 28% interest in Hiscox plc, a leading U.K. personal and commercial specialty insurer. In 1998, new cash was invested primarily in tax-exempt bonds and, to a lesser extent, equity securities. In 1997, new cash was invested in tax-exempt bonds and, to a lesser extent, corporate bonds and mortgage-backed securities. In addition, in the first quarter of 1997, $250 million of foreign denominated bonds were sold due to the reduction in foreign liabilities resulting from the termination of the reinsurance agreements with Sun Alliance, with the proceeds invested in U.S. dollar denominated securities. In each year, we tried to achieve the appropriate mix in our portfolio to balance both investment and tax strategies.
In October 1996, we announced that we were exploring the possible sale of all or a significant portion of our real estate assets. In November 1997, our real estate subsidiary sold a substantial portion of its commercial properties for $737 million, which included $628 million in cash and the assumption of $109 million in debt. The proceeds from the sale were used to repay outstanding short term debt and certain term loans and mortgages. In the fourth quarter of 1996, we had recorded an impairment loss of $255 million, or $160 million after taxes, to reduce the carrying value of these assets to their estimated fair value.
Revenues in 1997 included $380 million from the November sale of real estate properties. Proceeds received from that sale that related to mortgages receivable are not classified as revenues. In addition to the November 1997 sale, we sold selected commercial properties as well as residential properties in each of the past three years. Real estate revenues were $97 million in 1999, $82 million in 1998 and $616 million in 1997. Revenues in 1999 and 1998 reflect the reduced operating activity as a result of the sale of a substantial portion of our real estate assets in 1997.
The carrying value of the real estate assets we plan to dispose of in the near term is based on the estimated fair value of these assets. The recoverability of the carrying value of the remaining real estate assets is assessed based on our ability to fully recover costs through a future revenue stream. The assumptions used reflect a continued improvement in demand for office space, an increase in rental rates and the ability and intent to obtain financing in order to hold and develop such remaining properties and protect our interests over the long term. Management believes that it has made adequate provisions for impairment of real estate assets. However, if the assets are not sold or developed as presently contemplated, it is possible that additional impairment losses may be recognized.
Fixed maturity securities which the Corporation and its insurance subsidiaries have the ability and intent to hold to maturity are classified as held-to-maturity. The remaining fixed maturities, which may be sold prior to maturity to support our investment strategies, such as in response to changes in interest rates and the yield curve or to maximize after-tax returns, are classified as available-for-sale. Fixed maturities classified as held-to-maturity are carried at amortized cost while fixed maturities classified as available-for-sale are carried at market value. At December 31, 1999, 12% of the fixed maturity portfolio was classified as held-to-maturity compared with 15% at December 31, 1998 and 18% at December 31, 1997.
Market risk represents the potential for loss due to adverse changes in the fair value of financial instruments. The market risks of the Corporation and its property and casualty subsidiaries relate primarily to the investment portfolio, which exposes the Corporation to risks related to interest rates and, to a lesser extent, credit quality, prepayment, foreign currency exchange rates and equity prices. Analytical tools and monitoring systems are in place to assess each of these elements of market risk.
Equity price risk is the potential loss arising from adverse changes in the value of equity securities. In general, equities have more year-to-year price variability than intermediate term high grade bonds. However, returns over longer time frames have been consistently higher. Our equity securities are high quality, diversified across industries and readily marketable. A hypothetical decrease of 10% in the
The Year 2000 issue referred to the potential that certain information technology (IT) systems and applications as well as non-IT systems, such as equipment with embedded chips and microprocessors, would be unable to properly process data containing dates beginning with the year 2000. The issue existed because many computer systems used two digits rather than four to define the applicable year. Such systems, if not remediated, might have recognized the date "00" as the year 1900 rather than the year 2000, resulting in a system failure or miscalculation causing disruptions of normal business activities or other unforeseen problems.
In 1995, we initiated a project to ensure Year 2000 readiness of the Corporation's systems and applications. A significant focus of the project was the retirement, renovation or rewriting of those mainframe systems that were not Year 2000 ready. From 1995 through 1999, we completed remediation and testing procedures on all of our mainframe IT systems as well as our personal computers, servers and other non-mainframe computers and related software. Our Year 2000 compliance project also included developing a plan to evaluate the readiness of third parties with whom we interact, preparing contingency plans to address the noncompliance of any such third parties and physically testing electronic data interchanges with third parties for Year 2000 compliance.
As a result of these remediation efforts, our internal systems proved to be Year 2000 ready and we did not have any significant Year 2000 related difficulties interacting with any third party with whom we conduct business. We have not experienced any disruption of our business and therefore we have not needed to implement any contingency plans.
The Corporation has outstanding $300 million of unsecured 6.15% notes due in 2005 and $100 million of unsecured 6.60% debentures due in 2018. Chubb Capital has outstanding $100 million of unsecured 6 7/8 % notes due in 2003. The Chubb Capital notes are guaranteed by the Corporation.
The long term debt obligations of Executive Risk remained in place subsequent to the acquisition. Chubb Executive Risk Inc., a wholly owned subsidiary of the Corporation, has outstanding $75 million of unsecured 7 1/8 % notes due in 2007. Executive Risk Capital Trust, wholly owned by Chubb Executive Risk, has outstanding $125 million of 8.675% capital securities. The sole assets of the Trust are debentures issued by Chubb Executive Risk. The capital securities are subject to mandatory redemption in 2027 upon repayment of the debentures. The capital securities are also subject to mandatory redemption under certain circumstances beginning in 2007.