Short-tail business describes lines of business 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. Typically, there is less variability in these lines of business.
The recognition of reinsurance recoverable requires two key judgments. The first judgment involves our estimation of the amount of gross IBNR to be ceded to reinsurers. Ceded IBNR is generally developed as part of our loss reserving process and consequently, its estimation is subject to similar risks and uncertainties as the estimation of gross IBNR (see Critical Accounting Estimates - Unpaid losses and loss expenses). The second judgment involves our estimate of the amount of the reinsurance recoverable balance that we will ultimately be unable to recover from related reinsurers due to insolvency, contractual dispute, or for other reasons. Amounts estimated to be uncollectible are reflected in a bad debt provision that reduces the reinsurance recoverable balance and shareholders’ equity. Changes in the bad debt provision are reflected in net income. At December 31, 2003, the reinsurance recoverable balance includes $13.7 billion of reinsurance recoverable on unpaid losses and loss expenses, less a provision for bad debts of $557 million. The unpaid recoverable consist of ceded IBNR of $7.3 billion and ceded case reserves of $5.9 billion. Also included are $1.3 billion of reinsurance recoverable on paid loss and loss adjustment expenses, less a provision for bad debts of $403 million.
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 the Company’s investment portfolio is outsourced to third party investment managers. While these investment managers may, at a given point in time, believe that the preferred course of action is to hold securities with unrealized losses until such losses are recovered, 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 our portfolio as available for sale.
In addition to credit derivatives, through the Financial Services segment, we have entered into a few other, relatively illiquid, index-based derivative instruments that are reported at fair value. These instruments are principally linked to equity and real estate market indices. The determination of fair value for these derivatives requires considerable judgment as there is limited ability to trade the contracts since they are uniquely structured and the exposure period covers up to 30 years.
Results of Operations - Years Ended December 31, 2003, 2002 and 2001
Segment Operating Results - Years Ended December 31, 2003, 2002 and 2001
ACE Bermuda, which specializes in providing professional lines and excess liability coverage, reported an increase in net premiums earned of 62 percent for 2003, compared with 2002. ACE Bermuda benefited from both higher renewal rates and increased volume of new business.
Our investment strategy takes a long-term view, and our investment portfolio is actively managed to maximize total return within certain specific guidelines, designed to minimize risk. Our investment portfolio is reported at fair value. The effect of market movements on our investment portfolio impact income (through net realized gains (losses)) when securities are sold, when “other than temporary” impairments are recorded on invested assets or when derivatives, including financial futures and options, interest rate swaps and credit-default
For the financial guaranty reinsurance and mortgage guaranty reinsurance businesses, unpaid losses and loss expenses principally consist of case reserves and portfolio reserves. Incurred but not reported reserves are generally limited to mortgage guaranty reinsurance assumed through quota share treaties, which represent a relatively small portion of these businesses. Case reserves are established when specific insured obligations are in or near default. Case reserves represent the present value of expected future loss payments and loss expenses, net of estimated recoveries but before considering ceded reinsurance. Financial guaranty insurance and reinsurance case reserves are discounted at 6.0 percent, which is the approximate taxable equivalent yield on the investment portfolio in all periods presented.
transaction liabilities reside in various subsidiaries of Brandywine, which was created in 1995 by the restructuring of CIGNA’s domestic operations into separate ongoing and run-off operations.
Under these transactions, we would be required to provide collateral of $450 million if S&P downgraded our debt rating to BB+ or lower, or downgraded ACE Bermuda’s financial strength rating to BBB- or lower. Although there can be no assurance, we believe it is unlikely that either of these two events will occur. In the event that we terminate either of the swaps prematurely, we would be liable for certain transaction costs. The counter-party in each swap is a highly rated major financial institution and management does not anticipate non-performance.
Some of the facilities noted above require that we maintain certain covenants, all of which have been met at December 31, 2003. These covenants include:
(i) maintenance of a minimum consolidated net worth covenant of not less than $4.4 billion plus 25 percent of Consolidated Net Income for each fiscal quarter ending on or after March 31, 2003 for which such Consolidated Net Income is positive, plus 50 percent of net proceeds of any issuance of equity interests (other than the net proceeds from any issuance of equity interests in substitution and replacement of other equity interests to the extent such net proceeds do not exceed the amount of a substantially contemporaneous redemption of equity interests) subsequent to March 31, 2003; and