10-K 1 d10k.htm FORM 10-K Form 10-K
Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-K

x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2007

OR

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from             to             

Commission File No. 1-11778


ACE LIMITED

(Exact name of registrant as specified in its charter)

Cayman Islands    98-0091805
(State or other jurisdiction of incorporation or organization)    (I.R.S. Employer Identification No.)

ACE Global Headquarters

17 Woodbourne Avenue

Hamilton HM 08

Bermuda

(Address of principal executive offices, Zip Code)

(441) 295-5200

(Registrant’s telephone number, including area code)


Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class   Name of each exchange on which registered
Ordinary Shares, par value $0.041666667 per share   New York Stock Exchange
Depository Shares, each representing one-tenth of a share of 7.80 percent Cumulative
Redeemable Preferred Shares, Series C (Liquidation Preference $25.00 per Depository
Share)
  New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  YES  þ  NO  ¨

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  YES  ¨  NO  þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES  þ  NO  ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference into Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  þ             Accelerated filer  ¨            

 

Non-accelerated filer  ¨            (Do not check if a smaller reporting company) Smaller reporting company  ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)  YES  ¨  NO  þ

 

The aggregate market value of voting stock held by non-affiliates as of June 30, 2007 (the last business day of the registrant’s most recently completed second fiscal quarter), was approximately $21 billion. For the purposes of this computation, shares held by directors and officers of the registrant have been excluded. Such exclusion is not intended, nor shall it be deemed, to be an admission that such persons are affiliates of the registrant.

 

As of February 26, 2008, there were 329,888,123 Ordinary Shares par value $0.041666667 of the registrant outstanding.


 

Documents Incorporated By Reference

 

Certain portions of the registrant’s definitive proxy statement relating to its 2008 Annual General Meeting of Shareholders are incorporated by reference in Part III of this report.


Table of Contents

ACE LIMITED INDEX TO 10-K

 

PART I         Page
ITEM 1.   

Business

   3
ITEM 1A.   

Risk Factors

   18
ITEM 1B.   

Unresolved Staff Comments

   28
ITEM 2.   

Properties

   29
ITEM 3.   

Legal Proceedings

   29
ITEM 4.   

Submission of Matters to a Vote of Security Holders

   29
PART II          
ITEM 5.   

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   31
ITEM 6.   

Selected Financial Data

   33

ITEM 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   34

ITEM 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

   80

ITEM 8.

  

Financial Statements and Supplementary Data

   83

ITEM 9.

  

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

   83

ITEM 9A.

  

Controls and Procedures

   83

ITEM 9A(T).

  

Controls and Procedures

   83

ITEM 9B.

  

Other Information

   83

PART III

         

ITEM 10.

  

Directors, Executive Officers and Corporate Governance

   84

ITEM 11.

  

Executive Compensation

   84

ITEM 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   84

ITEM 13.

  

Certain Relationships and Related Transactions, and Director Independence

   86

ITEM 14.

  

Principal Accounting Fees and Services

   86

PART IV

         
ITEM 15.   

Exhibits, Financial Statement Schedules

   87


Table of Contents

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

 

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. Any written or oral statements made by us or on our behalf may include forward-looking statements that reflect our current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks, uncertainties and other factors that could, should potential events occur, cause actual results to differ materially from such statements. These risks, uncertainties and other factors (which are described in more detail elsewhere herein and in other documents we file with the Securities and Exchange Commission (SEC)) include but are not limited to:

• the failure of our acquisition of Combined Insurance Company of America (Combined) transaction to close, any difference in the performance by Combined and its subsidiaries from what is currently expected by us, or the failure to realize anticipated expense-related efficiencies from our acquisition of Combined;

• losses arising out of natural or man-made catastrophes such as hurricanes, typhoons, earthquakes, floods, hailstorms, windstorms, climate change, or terrorism which could be affected by:

• the number of insureds and ceding companies affected;

• the amount and timing of losses actually incurred and reported by insureds;

• the impact of these losses on our reinsurers and the amount and timing of reinsurance recoverables actually received;

• the cost of building materials and labor to reconstruct properties following a catastrophic event; and

• complex coverage and regulatory issues such as whether losses occurred from storm surge or flooding and related lawsuits.

• actions that rating agencies may take from time to time, such as changes in our claims-paying ability, financial strength, or credit ratings or placing these ratings on credit watch negative or the equivalent;

• global political conditions, the occurrence of any terrorist attacks, including any nuclear, radiological, biological, or chemical events, or the outbreak and effects of war, and possible business disruption or economic contraction that may result from such events;

• the ability to collect reinsurance recoverables, credit developments of reinsurers, and any delays with respect thereto and changes in the cost, quality, or availability of reinsurance;

• the occurrence of catastrophic events or other insured or reinsured events with a frequency or severity exceeding our estimates;

• actual loss experience from insured or reinsured events and the timing of claim payments;

• the uncertainties of the loss-reserving and claims-settlement processes, including the difficulties associated with large individual claims or catastrophe oriented results, assessing environmental damage and asbestos-related latent injuries, the impact of aggregate-policy-coverage limits, and the impact of bankruptcy protection sought by various asbestos producers and other related businesses and the timing of loss payments;

• judicial decisions and rulings, new theories of liability, legal tactics, and settlement terms;

• the effects of public company bankruptcies and/or accounting restatements, as well as disclosures by and investigations of public companies relating to possible accounting irregularities, and other corporate governance issues, including the effects of such events on:

• the capital markets;

• the markets for directors and officers (D&O) and errors and omissions (E&O) insurance; and

• claims and litigation arising out of such disclosures or practices by other companies;

• uncertainties relating to governmental, legislative, and regulatory policies, developments, actions, investigations, and treaties which, among other things, could subject us to insurance regulation or taxation in additional jurisdictions or affect our current operations;

• the actual amount of new and renewal business, market acceptance of our products, and risks associated with the introduction of new products and services and entering new markets, including regulatory constraints on exit strategies;

• the competitive environment in which we operate, including trends in pricing or in policy terms and conditions, which may differ from our projections and changes in market conditions that could render our business strategies ineffective or obsolete;

• developments in global financial markets, including changes in interest rates, stock markets and other financial markets, and foreign currency exchange rate fluctuations, which could affect our statement of operations, investment portfolio, and financing plans;

• the potential impact from government-mandated insurance coverage for acts of terrorism;

• the availability of borrowings and letters of credit under our credit facilities;

• changes in the distribution or placement of risks due to increased consolidation of insurance and reinsurance brokers;

• material differences between actual and expected assessments for guaranty funds and mandatory pooling arrangements;

 

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• the effects of investigations into market practices in the property and casualty (P&C) industry;

• changing rates of inflation and other economic conditions;

• the amount of dividends received from subsidiaries;

• loss of the services of any of our executive officers without suitable replacements being recruited in a reasonable time frame;

• the ability of our technology resources to perform as anticipated; and

• management’s response to these factors and actual events (including, but not limited, to those described above).

 

The words “believe”, “anticipate”, “estimate”, “project”, “should”, “plan”, “expect”, “intend”, “hope”, “will likely result”, or “will continue”, and variations thereof and similar expressions identify forward-looking statements. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. We undertake no obligation to publicly update or review any forward-looking statements, whether as a result of new information, future events, or otherwise.

 

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PART I

 


ITEM 1. Business

General Development of Business

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 (collectively, the ACE Group of Companies, the Company, we, us, or our) are a global property and casualty insurance and reinsurance organization. We provide a diversified range of products and services to commercial and individual customers in more than 140 countries and jurisdictions.

We have grown our business through increased premium volume, expansion of product offerings and geographic reach, and acquisition of other companies. 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 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.


Employees

At December 31, 2007, there were approximately 10,000 employees in the ACE Group of Companies. We believe that employee relations are satisfactory.


Customers

For most of the commercial lines of business that we offer, insureds typically use the services of an insurance broker. An insurance broker acts as an agent for the insureds, offering advice on the types and amount of insurance to purchase and also assisting in the negotiation of price and terms and conditions. We obtain business from the major international insurance brokers and typically pay a commission to brokers for any business accepted and bound. Loss of all or a substantial portion of the business provided by one or more of these brokers could have a material adverse effect on our business. We also use direct marketing techniques in our personal accident lines, selling to consumers through affinity partnerships and financial institutions. In our opinion, no material part of our business is dependent upon a single insured or group of insureds. We do not believe that the loss of any one insured would have a material adverse effect on our financial condition or results of operations and no one insured or group of affiliated insureds account for as much as 10 percent of our consolidated revenues.


Competition

Competition in the domestic and international insurance and reinsurance marketplace is substantial. Competition varies by type of business and geographic area. Competitors include other stock companies, mutual companies, alternative risk sharing groups (such as group captives and catastrophe pools), and other underwriting organizations. These companies sell through various distribution channels and business models, across a broad array of product lines, and with a high level of variation regarding geographic, marketing and customer segmentation. We compete for business not only on the basis of price, but also on the basis of availability of coverage desired by customers and quality of service. Our ability to compete is dependent on a number of factors, particularly our ability to maintain the appropriate financial strength ratings as assigned by independent rating agencies. Our strong capital position and global platform affords us opportunities for growth not available to smaller or less diversified insurance companies. Competitive information by segment is included in each of the segment discussions.


Trademarks and Trade Names

We use various trademarks and trade names in our business. These trademarks and trade names protect names of certain products and services we offer and are important to the extent they provide goodwill and name recognition in the insurance industry. We use commercially reasonable efforts to protect these proprietary rights, including various trade secret and trademark laws. One or more of the trademarks and trade names could be material to our ability to sell our products and services. We have taken appropriate steps to protect our ownership of key names and we believe it is unlikely that anyone would be able to prevent us from using names in places or circumstances material to our operations.

 

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Available Information

We make available free of charge through our Internet site (www.acelimited.com, under Investor Information / Financial Reports or Investor Information / SEC – Section 16 Filings) our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13 (a) or 15 (d) of the Exchange Act (15 U.S.C. 78m(a) or 78o(d)) as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

We also make available free of charge through our Internet site (under Investor Information / Corporate Governance) our Corporate Governance Guidelines, our Code of Conduct, and Charters for our Board Committees. These documents are also available in print to any shareholder who requests them from our Investor Relations Department by:

Telephone: (441) 299-9283

Facsimile: (441) 292-8675

E-mail: investorrelations@ace.bm

Nothing on our Internet site should be considered incorporated by reference into this report.


Segment Information

We operate through the following business segments: Insurance – North American, Insurance – Overseas General, Global Reinsurance, and Life Insurance and Reinsurance.

The following table sets forth an analysis of net premiums earned by segment for the years ended December 31, 2007, 2006, and 2005. Additional financial information about our segments, including gross premium written by geographic area, is included in Note 16 to the Consolidated Financial Statements, under Item 8.

 

(in millions of U.S. dollars)   2007 Net
Premiums
Earned
       Percentage
Change
         2006 Net
Premiums
Earned
      Percentage
Change
        2005 Net
Premiums
Earned

Insurance – North American

  $ 6,007        5 %        $ 5,719               $ 5,730

Insurance – Overseas General

    4,623        7 %          4,321       2 %         4,239

Global Reinsurance

    1,299        (14 )%          1,511       (1 )%         1,531

Life Insurance and Reinsurance

    368        34 %          274       10 %         248
    $ 12,297        4 %        $ 11,825               $ 11,748

 

Insurance – North American

 

Background

The Insurance – North American segment comprises our P&C operations in the U.S., Canada, and Bermuda. This segment, which accounted for approximately half of our consolidated 2007 net premiums earned, includes the operations of ACE USA (including ACE Canada), ACE Westchester Specialty Group (ACE Westchester), ACE Bermuda, and various run-off operations.

ACE USA, our retail business, operates through several insurance companies using a network of offices throughout the U.S. and Canada. These operations provide a broad array of P&C, A&H, and risk management products and services to a diverse group of commercial and non-commercial enterprises and consumers. ACE USA is this segment’s largest operation and represented approximately 70 percent of this segment’s net premiums earned in 2007.

ACE Westchester specializes in the wholesale distribution of excess, surplus, and specialty P&C products. ACE Bermuda provides commercial insurance products on an excess basis to a global client base, covering risks that are generally low in frequency and high in severity.

The run-off operations include Brandywine Holdings Corporation (Brandywine), Commercial Insurance Services (CIS), residual market workers’ compensation business, pools and syndicates not attributable to a single business group, and other exited lines of business. Run-off operations do not actively sell insurance products, but are responsible for the management of existing policies and related claims.

 

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Products and Distribution

ACE USA primarily distributes its insurance products through a limited number of brokers. In addition to using brokers, certain products are also distributed through channels such as general agents, independent agents, managing general agents, managing general underwriters, alliances, affinity groups, and direct marketing operations. These products include general liability, excess liability, property, workers’ compensation, commercial marine, automobile liability, professional lines (D&O and E&O), medical liability, aerospace, and A&H coverages, as well as claims and risk management products and services. ACE USA has also established internet distribution channels for some of its products.

ACE USA’s on-going operations are organized into distinct business units, each offering specialized products and services targeted at specific niche markets.

• ACE Risk Management offers a wide range of customized casualty products to respond to the needs of mid- to large-size companies, including national accounts, irrespective of industry. These programs are designed to help insureds address the significant costs of financing and managing risk for workers’ compensation and general and auto liability coverages. A variety of program structures are offered to support each client’s risk financing needs including: large deductible captives, third-party rent-a-captives, funded deductibles, and net present value and other risk financing structures. ACE Risk Management ceased assuming securitization and financial guarantee exposure in 2004.

• ACE Global Underwriting Group, specializing in global programs and specialty coverages, provides comprehensive risk management programs and services to mid- to large-size U.S.-based companies, not-for-profit, and government entities. The group’s key products include global property, corporate risk property, inland marine, foreign casualty, commercial marine, energy, and aerospace. In addition, this group provides specialty personal lines coverage for recreational marine distributed through a network of specialty agents.

• ACE Casualty Risk offers products and services to a broad range of customers, ranging from middle market to the large multinational clients. Key coverages offered by ACE Casualty Risk include umbrella and excess liability, environmental risk for commercial and industrial risks, and wrap-up programs which protect contractors and project sponsors with multi-risk coverage on large single- and multi-location construction projects. Small businesses can purchase workers’ compensation coverage through this unit’s internet-based ACE Completesm product.

• ACE Professional Risk (Professional Risk) provides management liability and professional liability (D&O and E&O), as well as surety products that are designed to meet the needs of our insureds.

• ACE Canada (ACE USA’s Canadian operations) offers a broad range of P&C products as well as Life and A&H coverage. ACE Canada specializes in providing customized P&C and A&H products to commercial and industrial clients as well as to groups and associations, operating nationally or internationally.

• ACE Accident & Health works with employers, travel agencies, and affinity groups to offer a variety of accident and other supplemental insurance programs. Key products include Employee Benefit Plans (basic and voluntary accidental death and dismemberment, limited medical insurance for vision, dental and prescription drugs), occupational accident, student accident, and worldwide travel accident and global medical programs. ACE Accident & Health also provides specialty personal lines products, including credit card enhancement programs (identity theft, rental car collision damage waiver, trip travel and purchase protection benefits), and disaster recovery programs distributed through affinity groups.

• ACE Medical Risk offers a wide range of liability products for the healthcare industry. These include primary coverages for professional liability and general liability for selected types of medical facilities, excess/umbrella liability for medical facilities, primary and excess coverages for products liability for biotechnology and specialty pharmaceutical companies, and liability insurance for human clinical trials.

• ESIS Inc. (ESIS), ACE USA’s in-house third-party claims administrator, performs claims management and risk control services for organizations that self-insure P&C exposures. These services include comprehensive medical managed care, integrated disability services and pre-loss control and risk management services. Additional insurance-related services are offered by ESIS’s Recovery Services International, which provides salvage and subrogation and health care recovery services.

ACE Westchester offers wholesale distribution of property, inland marine, casualty, professional lines, and environmental liability products. Through its Program division, ACE Westchester also provides coverage for agriculture business and specialty programs, writing a variety of commercial coverages through program agents, including sports/leisure activities, farm, and crop/hail insurance.

ACE Bermuda targets low-frequency, high-severity business on an excess of loss basis. Its principal lines of business are excess liability, professional lines, excess property, and political risk, the latter being written on a subscription basis by Sovereign Risk Insurance Ltd. (Sovereign), a wholly owned managing agent. ACE Bermuda accesses its clients primarily through the Bermuda offices of major, internationally recognized insurance brokers.

 

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Competitive Environment

ACE USA and ACE Westchester compete against a number of large, national carriers as well as regional competitors in certain territories. The markets in which ACE USA and ACE Westchester compete are subject to significant cycles of fluctuating capacity and wide disparities in price adequacy. We strive to offer superior service, which we believe has differentiated us from our competitors. The ACE USA and ACE Westchester operations pursue a specialist strategy and focus on market opportunities where we can compete effectively based on service levels and product design, while still achieving an adequate level of profitability. A competitive advantage is also achieved through ACE USA’s innovative product offerings and our ability to provide multiple products to a single client due to our nationwide local presence. An additional competitive strength of all our domestic commercial units is the ability to deliver global products and coverage to customers in concert with our Insurance – Overseas General segment. ACE USA has grown, in part, from the leveraging of cross-marketing opportunities with our other operations to take advantage of our organization’s global presence. ACE Bermuda competes against international commercial carriers writing business on an excess of loss basis.

 

Insurance – Overseas General

 

Background

The Insurance – Overseas General segment accounted for 38 percent of consolidated 2007 net premiums earned. Insurance – Overseas General consists of ACE International, our network of indigenous retail insurance operations, and the wholesale insurance operations of ACE Global Markets, our London-based excess and surplus lines business that includes Lloyd’s Syndicate 2488 (Syndicate 2488). ACE International maintains a presence in every major insurance market in the world and is organized geographically along product lines that provide dedicated underwriting focus to customers. ACE Global Markets offers an extensive product range through its unique parallel distribution of products via ACE European Group Limited (AEGL) and Syndicate 2488. ACE provides funds at Lloyd’s to support underwriting by Syndicate 2488, which is managed by ACE Underwriting Agencies Limited and had an underwriting capacity of £400 million in 2007. AEGL is London-based and regulated by the Financial Services Authority, the U.K. insurance regulator. AEGL underwrites U.K. and Continental Europe insurance and reinsurance business.

 

Products and Distribution

ACE International’s P&C business is generally written, on both a direct and assumed basis, through major international, regional, and local brokers. A&H and other consumer lines products are distributed through brokers, agents, direct marketing programs, and sponsor relationships. Property insurance products include traditional commercial fire coverage as well as energy industry-related and other technical coverages. Principal casualty products are commercial primary and excess casualty and general liability. ACE International provides D&O and professional indemnity coverages. Marine cargo and hull coverages are written in the London market as well as in marine markets throughout the world. The A&H insurance operations provide products that are designed to meet the insurance needs of individuals and groups outside of U.S. insurance markets. These products have been representing an increasing portion of ACE International’s business in recent years and include, but are not limited to, accidental death, medical and hospital indemnity, and income protection coverages. ACE International’s personal lines operations provide specialty products and services designed to meet the needs of specific target markets and include, but are not limited to, property damage, auto, homeowners, and personal liability.

Following is a discussion of Insurance – Overseas General’s four regions of operations: ACE European Group (which is comprised of ACE Europe and ACE Global Markets branded business), ACE Asia Pacific, ACE Far East, and ACE Latin America.

• ACE European Group is headquartered in London and offers a broad range of P&C and specialty coverages principally directed at large and mid-sized corporations, as well as individual consumers. ACE European Group operates in every major market in the European Union. Commercial products are principally distributed through brokers while consumer products (mainly A&H) are distributed through brokers as well as through direct marketing programs. ACE European Group also has operations in South Africa, Central and Eastern Europe, the Commonwealth of Independent States (the CIS), and the Middle East and North Africa. Our operations in South Africa write P&C and A&H business. Central and Eastern Europe and the CIS markets are serviced through our Warsaw and Moscow offices which were opened in 2005. The Middle East and North Africa region includes insurance subsidiaries and joint ventures in Egypt, Saudi Arabia, Pakistan, and Bahrain. ACE Global Markets primarily underwrites P&C insurance through Syndicate 2488 and AEGL. ACE Global Markets utilizes Syndicate 2488 to underwrite P&C business on a global basis through Lloyd’s worldwide licenses. ACE Global Markets utilizes AEGL to underwrite similar classes of business through its network of U.K. and Continental Europe licenses, and in the U.S. where it is eligible to write excess & surplus business. Factors influencing the decision to place business with Syndicate 2488 or AEGL

 

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include licensing eligibilities, capitalization requirements, and client/broker preference. All business underwritten by ACE Global Markets is accessed through registered brokers. The main lines of business include aviation, property, energy, professional lines, marine, political risk, and A&H.

• ACE Asia Pacific is headquartered in Singapore and has an extensive network of operations serving Australia, Hong Kong, India, Indonesia, Korea, Macau, Malaysia, New Zealand, the Philippines, Singapore, Taiwan, Thailand, and Vietnam. ACE Asia Pacific offers a broad range of P&C, A&H, and specialty coverages principally directed at large and mid-sized corporations as well as individual consumers. This region also provides management, underwriting, and administrative support to our equity investee, Huatai Insurance Company of China, Limited.

• ACE Far East is based in Tokyo and offers a broad range of P&C, A&H, and personal lines insurance products and services to businesses and consumers in Japan, principally delivered through an extensive agency network.

• ACE Latin America includes business operations throughout Latin America and the Caribbean, including offices in Argentina, Brazil, Chile, Colombia, Ecuador, Mexico, and Puerto Rico. ACE Latin America focuses on providing P&C, A&H, and specialty personal lines insurance products and services to both large and small commercial clients as well as individual consumers. ACE Latin America distributes its products through brokers (for its commercial business) and direct marketing and sponsored programs (for its consumer business).

 

Competitive Environment

ACE International’s primary competitors include U.S.-based companies with global operations, as well as non-U.S. global carriers and indigenous companies in regional and local markets. For the A&H lines of business, locally-based competitors include financial institutions and bank-owned insurance subsidiaries. Our international operations have the distinct advantage of being part of one of the few international insurance groups with a global network of licensed companies able to write policies on a locally admitted basis. The principal competitive factors that affect the international operations are underwriting expertise and pricing, relative operating efficiency, product differentiation, producer relations, and the quality of policyholder services. A competitive strength of our international operations is our global network and breadth of insurance programs, which assist individuals and business organizations to meet their risk management objectives. Insurance operations in over 50 countries also represent a competitive advantage in terms of depth of local technical expertise, accomplishing a spread of risk, and offering a global network to service multi-national accounts.

ACE Global Markets is one of the preeminent international specialty insurers in London and is an established lead underwriter on a significant portion of the risks underwritten, particularly within the aviation and marine lines of business. This leadership position allows ACE Global Markets to set the policy terms and conditions of many of the policies written. All lines of business face competition, depending on the business class, from Lloyd’s syndicates, the London market, and other major international insurers and reinsurers. Competition for international risks is also seen from domestic insurers in the country of origin of the insured. ACE Global Markets differentiates itself from competitors through long standing experience in its product lines, its multiple insurance entities (Syndicate 2488 and AEGL), and the quality of its underwriting and claims service.

 

Global Reinsurance

 

Background

The Global Reinsurance segment, which accounted for 11 percent of consolidated 2007 net premiums earned, represents ACE’s reinsurance operations comprising ACE Tempest Re Bermuda, ACE Tempest Re USA, ACE Tempest Re Europe, and ACE Tempest Re Canada. Global Reinsurance markets its reinsurance products worldwide under the ACE Tempest Re brand name and provides a broad range of coverages to a diverse array of primary P&C companies. Global Reinsurance has expanded beyond catastrophe lines to become a leading global multi-line reinsurance business with underwriting offices in Bermuda, Stamford, Montreal, London, and Zurich. This has reduced the volatility of ACE’s reinsurance operations by diversifying Global Reinsurance’s business to offer a comprehensive range of products to satisfy client demand. We consider an expanded product offering vital to competing effectively in the reinsurance market, but not at the expense of profitability.

 

Products and Distribution

Global Reinsurance services clients globally through its major units: ACE Tempest Re Bermuda, ACE Tempest Re USA, ACE Tempest Re Europe, and ACE Tempest Re Canada. Through these operations, we are able to provide a complete portfolio of products on a global basis to clients. Major international brokers submit business to one or more of these units’ underwriting teams who have built strong relationships with both key brokers and clients by explaining their approach and demonstrating consistently open, responsive, and dependable service.

 

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Through reinsurance intermediaries, ACE Tempest Re Bermuda principally provides property catastrophe reinsurance globally to insurers of commercial and personal property. Property catastrophe reinsurance on an occurrence basis protects a ceding company against an accumulation of losses covered by its issued insurance policies, arising from a common event or occurrence. ACE Tempest Re Bermuda underwrites reinsurance principally on an excess of loss basis, meaning that its exposure only arises after the ceding company’s accumulated losses have exceeded the attachment point of the reinsurance policy. ACE Tempest Re Bermuda also writes other types of reinsurance on a limited basis for selected clients. Examples include proportional property (reinsurer shares a proportional part of the premiums and losses of the ceding company) and per risk excess of loss treaty reinsurance (coverage applies on a per risk basis rather than per event or aggregate basis), together with specialty lines (catastrophe workers’ compensation and terrorism).

ACE Tempest Re USA writes all lines of traditional and specialty P&C reinsurance for the North American market, with a focus on writing property per risk and casualty reinsurance, including medical malpractice and surety, principally on a treaty basis, with a weighting towards casualty. This unit’s diversified portfolio is produced through reinsurance intermediaries.

ACE Tempest Re Europe provides treaty reinsurance of P&C business of insurance companies worldwide, with emphasis on non-U.S. and London market risks. ACE Tempest Re Europe writes all lines of traditional and specialty reinsurance including property, casualty, marine, aviation, and medical malpractice through our London- and Zurich-based divisions. The London-based divisions of ACE Tempest Re Europe focus on the development of business sourced through London market brokers and, consequently, write a diverse book of international business utilizing Lloyd’s global licensing and the Company market licensing. The Zurich-based division focuses on providing reinsurance to continental European insurers via continental European brokers.

ACE Tempest Re Canada commenced writing business in 2007, offering a full array of P&C reinsurance to the Canadian market. ACE Tempest Re Canada provides its coverage through its Canadian company platform and also offers its clients access to Lloyd’s Syndicate 2488.

 

Competitive Environment

The Global Reinsurance segment competes worldwide with major U.S. and non-U.S. reinsurers as well as reinsurance departments of numerous multi-line insurance organizations. Global Reinsurance is considered a lead reinsurer and is typically involved in the negotiation and quotation of the terms and conditions of the majority of the contracts in which it participates. Global Reinsurance competes effectively in P&C markets worldwide because of its strong capital position, the quality of service provided to customers, the leading role it plays in setting the terms, pricing, and conditions in negotiating contracts, and its customized approach to risk selection. The key competitors in our markets vary by geographic region and product line and we have also experienced clients who are increasing their retention. Further, over the last several years, capital markets participants have developed financial products intended to compete with traditional reinsurance. In addition, government sponsored or backed catastrophe funds can affect demand for reinsurance.

 

Life Insurance and Reinsurance

 

Background

Life Insurance and Reinsurance, which accounted for three percent of consolidated 2007 net premiums earned, includes the operations of ACE Tempest Life Re (ACE Life Re) and ACE International Life. ACE Life Re helps clients (ceding companies) manage mortality, morbidity, lapse, and/or capital market risks embedded in their books of business. ACE Life Re comprises two companies. The first is a Bermuda-based niche player in the life reinsurance market that provides reinsurance coverage to other life insurance companies, focusing on guarantees included in certain fixed and variable annuity products. The second is a U.S.-based traditional life reinsurance company licensed in 49 states and the District of Columbia, offering reinsurance capacity for the individual life business utilizing yearly renewable term and coinsurance structures. ACE International Life provides traditional life insurance protection and investment and savings products to individuals in several countries including China, Egypt, Taiwan, Thailand, Vietnam, the United Arab Emirates, and various Latin American countries.

 

Products and Distribution

ACE Life Re markets its products directly to clients as well as through reinsurance intermediaries. The marketing plan seeks to capitalize on the relationships developed by our executive officers and underwriters with members of the actuarial profession and executives at client companies. ACE Life Re targets potential ceding insurers that it believes would benefit from its reinsurance products based on analysis of publicly available information and other industry data. In addition, reinsurance transactions are often placed by reinsurance intermediaries and consultants. ACE Life Re works with such third party marketers in an effort to maintain a high degree of visibility in the reinsurance marketplace. ACE Life Re’s strategy and business does

 

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not depend on a single client or a few clients. To date, we have entered into reinsurance agreements with more than 30 clients. A significant percentage of our total revenue and income in Bermuda derives from our core line of business, which is reinsurance of variable annuity guarantees. Our primary focus in the Bermuda operation remains the variable annuity line of business, in which our main goals are to successfully manage the current portfolio while continuing expansion into international variable annuity products and potential opportunities in new variable annuity guarantees and variable life products. In the U.S., our core business is growing and is comprised of treaties with significant players in the U.S. individual life insurance market. We will continue to grow this line by entering into reinsurance agreements that are consistent with our underwriting and profit objectives.

ACE International Life offers a broad portfolio of products including whole life, endowment plans, individual term life, group term life, personal accident, universal life, and variable annuity contracts. The policies written by ACE International Life generally provide funds for dependents of insureds after death but many also have a savings component. ACE International Life sells to consumers through a variety of distribution channels including agency, bancassurance and telemarketing through affinity groups. We plan to continue to expand this business with a focus on opportunities in emerging markets that we believe will ultimately result in strong and sustainable operating profits as well as favorable return on capital commitments after an initial growth period.

 

Competitive Environment

Until recently, there had been little competition for ACE Life Re in the variable annuity reinsurance marketplace. After years of being the only major reinsurer actively writing new reinsurance of variable annuity guarantees, new entrants have emerged. We view the increased competition as a favorable development as long as the new entrants are rational and reasonable with their pricing and underwriting. We believe their entry will create a viable reinsurance market for these risks that will give direct writers the opportunity to evaluate reinsurance against alternative means of managing the variable annuity risk (such as hedging). The life reinsurance market for traditional mortality risk is highly competitive as most of the reinsurance companies are well established, have significant operating histories, strong claims-paying ability ratings, and long-standing client relationships through existing treaties with ceding companies. ACE Life Re competes effectively by leveraging the strength of its client relationships, underwriting expertise and capacity, and our brand name and capital position.

ACE International Life’s competition differs by location but generally includes multi-national insurers, and in some locations, local insurers, joint ventures, or state-owned insurers. ACE’s financial strength and reputation as an entrepreneurial organization with a global presence gives ACE International Life a strong base from which to compete.


Underwriting

ACE is an underwriting company and we strive to emphasize quality of underwriting rather than volume of business or market share. Our underwriting strategy is to employ consistent, disciplined pricing and risk selection in order to maintain a profitable book of business throughout market cycles. Clearly defined underwriting authorities, standards, and guidelines are in place in each of our local operations and global profit centers. Global product boards ensure consistency of approach and the establishment of best practices throughout the world. Our priority is to help ensure adherence to criteria for risk selection by maintaining high levels of experience and expertise in our underwriting staff. In addition, we employ a business review structure that helps ensure control of risk quality and conservative use of policy limits and terms and conditions.

Qualified actuaries in each region work closely with the underwriting teams to provide additional expertise in the underwriting process. We use sophisticated catastrophe loss and risk modeling techniques designed to ensure appropriate spread of risk and to analyze correlation of risk across different product lines and territories. This helps to ensure that losses are contained within our risk tolerances and appetite for individual products lines, businesses, and ACE as a whole. We also purchase reinsurance as a tool to diversify risk and limit the net loss potential of catastrophes and large or unusually hazardous risks. For more information refer to “Insurance and Reinsurance Markets”, under Item 1A, “Catastrophe Exposure Management” and “Natural Catastrophe Reinsurance Program”, under Item 7, and Note 4 to the Consolidated Financial Statements, under Item 8.

 

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Reinsurance Protection

As part of our risk management strategy, we purchase reinsurance protection to mitigate our exposure to losses, including catastrophes, to an acceptable level. Although reinsurance agreements contractually obligate our reinsurers to reimburse us for an agreed-upon portion of our gross paid losses, this reinsurance does not discharge our primary liability to our insureds and, thus, we remain liable for the gross direct loss. In certain countries, reinsurer selection is limited by local laws or regulations. In those areas where there is more freedom of choice, the counterparty is selected based upon its financial strength, management, line of business expertise, and its price for assuming the risk transferred. In support of this process, we maintain an ACE authorized reinsurer list that stratifies these authorized reinsurers by classes of business and acceptable limits. This list is maintained by our Reinsurance Security Committee (RSC), a committee comprised of senior management personnel, and a dedicated reinsurer security team. Changes to the list are authorized by the RSC and recommended to the Chair of the Group Risk Committee. The reinsurers on the authorized list and potential new markets are regularly reviewed, and the list may be modified following these reviews. In addition to the authorized list, there is a formal exception process that allows authorized reinsurance buyers to use reinsurers already on the authorized list for higher limits or different lines of business, for example, or other reinsurers not on the authorized list if their use is supported by compelling business reasons for a particular reinsurance program.

A separate policy and process exists for captive reinsurance companies. Generally, these reinsurance companies are established by our clients or our clients have an interest in them. It is generally our policy to obtain collateral equal to the expected losses that may be ceded to the captive. Where appropriate, exceptions to the collateral requirement are granted but only after senior management review. Specific collateral guidelines and an exception process are in place for ACE USA and Insurance – Overseas General, both of which have credit management units evaluating the captive’s credit quality and that of their parent company. The credit management units, working with actuarial, determine reasonable exposure estimates (collateral calculations), ensure receipt of collateral in a form acceptable to the Company, and coordinate collateral adjustments as and when needed. Currently, financial reviews and expected loss evaluations are performed annually for active captive accounts and as needed for run-off exposures. In addition to collateral, parental guarantees are often used to enhance the credit quality of the captive.

In general, we seek to place our reinsurance with highly rated companies with which we have a strong trading relationship. For more information refer to “Catastrophe Exposure Management” and “Natural Catastrophe Reinsurance Program”, under Item 7, and Note 4 to the Consolidated Financial Statements, under Item 8.


Unpaid Losses and Loss Expenses

We establish reserves for unpaid losses and loss expenses, which are estimates of future payments of reported and unreported claims for losses and related expenses, with respect to insured events that have occurred. The process of establishing loss reserves for P&C claims can be complex and is subject to considerable variability as it requires the use of informed estimates and judgments based on circumstances known at the date of accrual. These estimates and judgments are based on numerous factors, and may be revised as additional experience and other data become available and are reviewed, as new or improved methodologies are developed, or as current laws change. We have actuarial staff in each of our operating segments who analyze insurance reserves and regularly evaluate the levels of loss reserves, taking into consideration factors that may impact the ultimate settlement value of the unpaid losses and loss expenses. Any such revisions could result in future changes in estimates of losses or reinsurance recoverable and would be reflected in our results of operations in the period in which the estimates are changed. Losses and loss expenses are charged to income as incurred. The reserve for unpaid losses and loss expenses represents the estimated ultimate losses and loss expenses less paid losses and loss expenses, and comprises case reserves and incurred but not reported (IBNR) loss reserves. 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 these structured settlements, we carry reserves of $117 million, net of discount, at December 31, 2007.

We implicitly consider the impact of various forms of inflation, for example medical and judicial, in estimating the reserve for unpaid losses and loss expenses. There is no precise method for subsequently evaluating the adequacy of the consideration given to inflation, since claim settlements are affected by many factors.

During the loss settlement period, which can be many years in duration, additional facts regarding individual claims and trends often will become known. As these become apparent, case reserves may be adjusted by allocation from IBNR without any change in the overall reserve. In addition, the circumstances of individual claims or the application of statistical and

 

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actuarial methods to loss experience data may lead to the adjustment of the overall reserves upward or downward from time to time. Accordingly, the ultimate settlement of losses may be significantly greater than or less than reported loss and loss expense reserves.

We have considered asbestos and environmental (A&E) claims and claims expenses in establishing the liability for unpaid losses and loss expenses and have developed reserving methods which incorporate new sources of data with historical experience to estimate the ultimate losses arising from A&E exposures. The reserves for A&E claims and claims expenses represent management’s best estimate of future loss and loss expense payments and recoveries that are expected to develop over the next several decades. We continuously monitor evolving case law and its effect on environmental and latent injury claims and we monitor A&E claims activity quarterly and perform a full reserve review annually.

For each product line, management, in conjunction with internal actuaries, develops a “best estimate” of the ultimate settlement value of the unpaid losses and loss expenses that it believes provides a reasonable estimate of the required reserve. We evaluate our estimates of reserves quarterly in light of developing information and discussions and negotiations with our insureds. While we are unable at this time to determine whether additional reserves, which could have a material adverse effect upon our financial condition, results of operations, and cash flows, may be necessary in the future, we believe that our reserves for unpaid losses and loss expenses are adequate as of December 31, 2007.

For more information refer to “Critical Accounting Estimates – Unpaid losses and loss expenses”, under Item 7 and Note 6 to the Consolidated Financial Statements, under Item 8.

The “Analysis of Losses and Loss Expenses Development” table shown below presents for each balance sheet date over the period 1997-2007, the gross and net loss and loss expense reserves recorded at the balance sheet date and subsequent payments from the net reserves. The reserves represent the amount required for the estimated future settlement value of liabilities incurred at or prior to the balance sheet date and those estimates may change subsequent to the balance sheet date as new information emerges regarding the ultimate settlement value of the liability. Accordingly, the table also presents through December 31, 2007, for each balance sheet date, the cumulative impact of subsequent valuations of the liabilities incurred at the original balance sheet date. The data in the table is presented in accordance with reporting requirements of the SEC. This table should be interpreted with care by those not familiar with its format or those who are familiar with other triangulations arranged by origin year of loss such as accident or underwriting year rather than balance sheet date, as shown below. To clarify the interpretation of the table, we use the reserves established at December 31, 1999, in the following example.

The top two lines of the table show for successive balance sheet dates the gross and net unpaid losses and loss expenses recorded as provision for liabilities incurred at or prior to each balance sheet date. It can be seen that at December 31, 1999, a reserve of $9.057 billion net of reinsurance had been established.

The upper (paid) triangulation presents the net amounts paid as of periods subsequent to the balance sheet date. Hence in the 2000 financial year, $2.663 billion of payments were made from the December 31, 1999, reserve balance established for liabilities incurred prior to the 2000 financial year. At the end of the 2007 financial year this block of liabilities had resulted in cumulative net payments of $7.310 billion.

The lower triangulation within the table shows the revised estimate of the net liability originally recorded at each balance sheet date as of the end of subsequent financial years. With the benefit of actual loss emergence and hindsight over the intervening period, the net liabilities incurred as of December 31, 1999, are now estimated to be $10.492 billion, rather than the original estimate of $9.057 billion. One of the key drivers of this change has been adverse development on latent claims that we categorize as asbestos and environmental losses and other run-off liabilities covered under the National Indemnity Company (NICO) reinsurance treaties. Of the cumulative deficiency of $1.435 billion recognized in the seven years since December 31, 1999, $368 million relates to non-latent claims and $1.067 billion relates to latent claims. The deficiency of $1.435 billion was identified and recorded as follows; $45 million redundant in 2000, $8 million deficient in 2001, $558 million deficient in 2002, $149 million deficient in 2003, $874 million deficient in 2004, $121 million redundant in 2005, $41 million deficient in 2006, and $29 million redundant in 2007.

Importantly, the cumulative deficiency or redundancy for different balance sheet dates are not independent and therefore, should not be added together. In the last year, we have revised our estimate of the December 31, 1999, liabilities from $10.521 billion to $10.492 billion. This favorable development of $29 million will also be included in each column to the right of the December 31, 1999, column to recognize that this additional amount was also required in the reserves established for each annual balance sheet date from December 31, 2000, to December 31, 2007.

The loss development table shows that our original estimate of the net unpaid loss and loss expense requirement at December 31, 2006, of $22.008 billion has, with the benefit of actual loss emergence and hindsight, been revised to $21.791 billion at December 31, 2007. This favorable movement of $217 million is referred to as prior period development

 

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and is the net result of a number of underlying movements both favorable and adverse. The key underlying movements are discussed in more detail within the “Prior Period Development” section of Item 7.

In the table following certain recorded balances for accidents years 2006 and prior in Insurance – North American were re-classified across accident years. This resulted in favorable development of approximately $155 million on accident years 2003-2005 and adverse development of $153 million on accident years 2002 and prior. Within Insurance – Overseas General long-tail lines, there was $23 million of favorable development on the 2003-2005 accident years following a change in selection of actuarial 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 $45 million in accident year 2006 and $89 million in accident years 2003 and prior and a release of $154 million in accident years 2004 and 2005.

The bottom lines of the table show the re-estimated amount of previously recorded gross liabilities at December 31, 2007, together with the change in reinsurance recoverable. Similar to the net liabilities, the cumulative redundancy or deficiency on the gross liability is the difference between the gross liability originally recorded and the re-estimated gross liability at December 31, 2007. For example, with respect to the gross unpaid loss and loss expenses of $16.713 billion for 1999, by December 31, 2007, this gross liability was re-estimated to be $22.811 billion, resulting in the cumulative deficiency on the gross liability originally recorded for the 1999 balance sheet year of $6.098 billion. This deficiency relates primarily to U.S. liabilities, including A&E liabilities for 1995 and prior. The gross deficiency results in a net deficiency of $1.435 billion as a result of substantial reinsurance coverage that reduces the gross loss; approximately $2.2 billion was covered by reinsurance placed when the risks were originally written and $1.25 billion of the remaining liability has been ceded to NICO.

We do not consider it appropriate to extrapolate future deficiencies or redundancies based upon the table, as conditions and trends that have affected development of the liability in the past may not necessarily recur in the future. We believe that our current estimates of net liabilities appropriately reflect our current knowledge of the business profile and the prevailing market, social, legal and economic conditions while giving due consideration to historical trends and volatility evidenced in our markets over the longer term. The key issues and considerations involved in establishing our estimate of the net liabilities are discussed in more detail within the “Critical Accounting Estimates – Unpaid losses and loss expenses” section of Item 7.

On July 2, 1999, we changed our fiscal year-end from September 30 to December 31. As a result, the information provided for the 1999 year is actually for the 15-month period from October 1, 1998, through December 31, 1999. Prior to December 31, 1999, the net unpaid losses and loss expenses are in respect of annual periods ending on September 30 of each year. We acquired Tarquin (a Lloyds managing agency) on July 9, 1998. The Tarquin acquisition was accounted for using the pooling-of-interest method and, accordingly, loss experience prior to this acquisition is included in the table consistent with the reporting of loss reserves in our restated 1996 and 1997 consolidated financial statements, as presented subsequent to this acquisition. On January 2, 1998, we acquired ACE US Holdings; on April 1, 1998, we acquired CAT Limited; and on July 2, 1999, we acquired ACE INA (CIGNA’s P&C business). The unpaid loss information for ACE US Holdings, CAT Limited, and ACE INA has been included in the table commencing in the year of acquisition. As a result, 1999 includes net reserves of $6.8 billion related to ACE INA at the date of acquisition and subsequent development thereon. On April 28, 2004, we completed the sale of 65.3 percent of Assured Guaranty Ltd. (AGO). The historical loss information for AGO has been removed from the table.

 

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Analysis of Losses and Loss Expenses Development

 

   

Years ended

September 30

       

Years ended December 31

(in millions of U.S.
dollars)
  1997       1998         1999 (1)         2000         2001         2002         2003         2004         2005         2006         2007

Gross unpaid loss

  $ 2,112       $ 3,738         $ 16,713         $ 17,184         $ 20,555         $ 24,143         $ 26,605         $ 31,483         $ 35,055         $ 35,517         $ 37,112

Net unpaid loss

    2,007         2,677           9,057           9,075           10,226           11,546           14,203           17,517           20,458           22,008           23,592

Net paid

(Cumulative)

As Of:

                                                                                                                           

1 year later

    337         1,018           2,663           2,380           2,627           2,610           2,747           3,293           3,711           4,038 (2)          

2 years later

    925         1,480           4,023           3,798           4,598           4,185           4,770           5,483           6,487                        

3 years later

    1,066         1,656           5,081           5,111           5,468           5,622           6,318           7,222                                    

4 years later

    1,171         1,813           6,116           5,406           6,588           6,815           7,711                                                

5 years later

    1,197         1,979           6,225           6,094           7,395           7,838                                                            

6 years later

    1,235         2,035           6,742           6,528           7,913                                                                        

7 years later

    1,274         2,240           7,093           6,849                                                                                    

8 years later

    1,414         2,294           7,310                                                                                                

9 years later

    1,428         2,356                                                                                                            

10 years later

    1,475                                                                                                                      

Net Liability

Re-estimated

As Of:

                                                                                                                           

End of year

  $ 2,007       $ 2,677         $ 9,057         $ 9,075         $ 10,226         $ 11,546         $ 14,203         $ 17,517         $ 20,458         $ 22,008         $ 23,592

1 year later

    1,990         2,752           9,012           9,230           10,975           11,696           14,739           17,603           20,446           21,791            

2 years later

    1,915         2,747           9,020           9,883           11,265           12,731           14,985           17,651           20,366                        

3 years later

    1,853         2,719           9,578           10,139           12,249           12,993           15,249           17,629                                    

4 years later

    1,833         2,704           9,727           11,014           12,432           13,307           15,532                                                

5 years later

    1,815         2,688           10,601           10,947           12,588           13,669                                                            

6 years later

    1,828         2,826           10,480           11,112           12,720                                                                        

7 years later

    1,846         2,696           10,521           11,135                                                                                    

8 years later

    1,773         2,674           10,492                                                                                                

9 years later

    1,767         2,652                                                                                                            

10 years later

    1,779                                                                                                                      

Cumulative redundancy/ (deficiency) on net unpaid

    228         25           (1,435 )         (2,060 )         (2,494 )         (2,123 )         (1,329 )         (112 )         92           217            

Cumulative deficiency related to A&E

            (33 )         (1,067 )         (1,067 )         (1,062 )         (546 )         (546 )         (81 )         (81 )         (29 )          

Cumulative redundancy/ (deficiency) on net unpaid

    228         58           (368 )         (993 )         (1,432 )         (1,577 )         (783 )         (31 )         173           246            

Gross unpaid losses and loss expenses end of year

  $ 2,112       $ 3,738         $ 16,713         $ 17,184         $ 20,555         $ 24,143         $ 26,605         $ 31,483         $ 35,055         $ 35,517         $ 37,112

Reinsurance recoverable on unpaid losses

    105         1,061           7,656           8,109           10,329           12,597           12,402           13,966           14,597           13,509           13,520

Net unpaid losses and loss expenses

    2,007         2,677           9,057           9,075           10,226           11,546           14,203           17,517           20,458           22,008           23,592

Gross liability re-estimated

    1,799         4,255           22,811           23,875           27,807           28,875           29,958           32,070           34,409           34,972            

Reinsurance recoverable on unpaid losses

    20         1,603           12,319           12,740           15,087           15,206           14,426           14,441           14,043           13,181            

Net liability re-estimated

    1,779         2,652           10,492           11,135           12,720           13,669           15,532           17,629           20,366           21,791            

Cumulative redundancy/ (deficiency) on gross unpaid losses

    313         (517 )         (6,098 )         (6,691 )         (7,252 )         (4,732 )         (3,353 )         (587 )         646           545            

(1) The 1999 year is for the 15-month period ended December 31, 1999.

(2) This amount does not agree to the reconciliation of unpaid losses and loss expenses on the table following due to the accounting treatment of a novation of a retroactive assumed loss portfolio transfer from 2002 resulting in the elimination of the deferred asset of $79 million and the reduction of the related reserve.

 

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Reconciliation of Unpaid Losses and Loss Expenses

 

Years ended December 31

(in millions of U.S. dollars)

  2007        2006        2005 

Gross unpaid losses and loss expenses at beginning of year

  $ 35,517        $ 35,055        $ 31,483 

Reinsurance recoverable on unpaid losses

    (13,509)         (14,597)         (13,966)

Net unpaid losses and loss expenses at beginning of year

    22,008          20,458          17,517 

Sale of certain run-off subsidiaries

    –          (472)         – 

Total

    22,008          19,986          17,517 

Net losses and loss expenses incurred in respect of losses occurring in:

                         

Current year

    7,568          7,082          8,485 

Prior year

    (217)         (12)         86 

Total

    7,351          7,070          8,571 

Net losses and loss expenses paid in respect of losses occurring in:

                         

Current year

    1,975          1,748          2,076 

Prior year

    3,959          3,711          3,293 

Total

    5,934          5,459          5,369 

Foreign currency revaluation and other

    167          411          (261)

Net unpaid losses and loss expenses at end of year

    23,592          22,008          20,458 

Reinsurance recoverable on unpaid losses

    13,520          13,509          14,597 

Gross unpaid losses and loss expenses at end of year

  $ 37,112        $ 35,517        $ 35,055 

 

Net losses and loss expenses incurred for the year ended December 31, 2007, were $7.4 billion, compared with $7.1 billion and $8.6 billion in 2006 and 2005, respectively. Net losses and loss expenses incurred for 2007 and 2006 include $217 million and $12 million of net favorable prior period development, respectively, and 2005 includes $86 million of net adverse prior period development. For more information, refer to the “Prior Period Development” section of Item 7.

 

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Investments

 

Our principal investment objective is to ensure that funds will be available to meet our primary insurance and reinsurance obligations. Within this broad liquidity constraint, the investment portfolio’s structure seeks to maximize return subject to specifically-approved guidelines of overall asset classes, credit quality, liquidity, and volatility of expected returns. As such, our investment portfolio is invested primarily in investment-grade fixed-income securities as measured by the major rating agencies.

The management of our investment portfolio is the responsibility of ACE Asset Management. ACE Asset Management, an indirect wholly-owned subsidiary of ACE, operates principally to guide and direct our investment process. In this regard, ACE Asset Management:

• conducts formal asset allocation modeling for each of the ACE subsidiaries, providing formal recommendations for the portfolio’s structure;

• establishes recommended investment guidelines that are appropriate to the prescribed asset allocation targets;

• provides the analysis, evaluation, and selection of our external investment advisors;

• establishes and develops investment-related analytics to enhance portfolio engineering and risk control;

• monitors and aggregates the correlated risk of the overall investment portfolio; and

• provides governance over the investment process for each of our operating companies to ensure consistency of approach and adherence to investment guidelines.

For the portfolio, we determine allowable, targeted asset allocation and ranges for each of the operating segments. These asset allocation targets are derived from sophisticated asset and liability modeling that measures correlated histories of returns and volatility of returns. Allowable investment classes are further refined through analysis of our operating environment, including expected volatility of cash flows, overall capital position, regulatory, and rating agency considerations.

The Finance and Investment Committee of the Board of Directors approves asset allocation targets and reviews our investment policy to ensure that it is consistent with our overall goals, strategies, and objectives. Overall investment guidelines are reviewed and approved by the Finance and Investment Committee to ensure that appropriate levels of portfolio liquidity, credit quality, diversification, and volatility are maintained. In addition, the Finance and Investment Committee systematically reviews the portfolio’s exposures to capture any potential violations of investment guidelines.

Within the guidelines and asset allocation parameters established by the Finance and Investment Committee, individual investment committees of the operating segments determine tactical asset allocation. Additionally, these committees review all investment-related activity that affects their operating company, including the selection of outside investment advisors, proposed asset allocations changes, and the systematic review of investment guidelines.

For additional information regarding the investment portfolio, including breakdowns of the sector and maturity distributions, refer to Note 3 to the Consolidated Financial Statements, under Item 8.


Regulation

 

Our insurance and reinsurance subsidiaries conduct business globally, including in all 50 states of the United States and the District of Columbia. Our businesses in each of these jurisdictions are subject to varying degrees of regulation and supervision. The laws and regulations of the jurisdictions in which our insurance and reinsurance subsidiaries are domiciled require, among other things, that these subsidiaries maintain minimum levels of statutory capital, surplus and liquidity, meet solvency standards, and submit to periodic examinations of their financial condition. The complex regulatory environments in which ACE operates are subject to change and are regularly monitored. The following is an overview discussion of regulations for our operations in Bermuda, the U.S., and internationally.

 

Bermuda Operations

In Bermuda, our insurance subsidiaries are principally regulated by the Insurance Act 1978 (as amended) and related regulations (the Act). The Act imposes solvency and liquidity standards as well as auditing and reporting requirements, and grants the Bermuda Monetary Authority (the Authority) powers to supervise, investigate, and intervene in the affairs of insurance companies. Significant requirements include the appointment of an independent auditor, the appointment of a loss reserve specialist, and the filing of the Annual Statutory Financial Return with the Executive Member responsible for Insurance (the Executive). The Executive is the chief administrative officer under the Act. We must comply with provisions of the Companies Act 1981 regulating the payment of dividends and distributions. A Bermuda company may not declare or pay a dividend or

 

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make a distribution out of contributed surplus if there are reasonable grounds for believing that: (a) the company is, or would after the payment be, unable to pay its liabilities as they become due; or (b) the realizable value of the company’s assets would thereby be less than the aggregate of its liabilities and its issued share capital and share premium accounts. Further, an insurer may not declare or pay any dividends during any financial year if it would cause the insurer to fail to meet its relevant margins, and an insurer which fails to meet its relevant margins on the last day of any financial year may not, without the approval of the Minister of Finance, declare or pay any dividends during the next financial year. In addition, some of ACE’s Bermuda subsidiaries qualify as “Class 4” insurers and may not in any financial year pay dividends which would exceed 25 percent of their total statutory capital and surplus, as shown on their statutory balance sheet in relation to the previous financial year, unless they file a solvency affidavit at least seven days in advance.

The Executive may appoint an inspector with extensive powers to investigate the affairs of an insurer if he or she believes that an investigation is required in the interest of the insurer’s policyholders or persons who may become policyholders. In order to verify or supplement information otherwise provided to him, the Executive may direct an insurer to produce documents or information relating to matters connected with the insurer’s business. If it appears to the Executive that there is a risk of the insurer becoming insolvent, or that the insurer is in breach of the Act or any conditions of its registration under the Act, the Executive may direct the insurer not to take on any new insurance business, not to vary any insurance contract if the effect would be to increase the insurer’s liabilities, not to make certain investments, to realize certain investments, to maintain in, or transfer to the custody of a specified bank certain assets, not to declare or pay any dividends or other distributions, or to restrict the making of such payments and/or to limit its premium income.

The Act also requires the Authority to supervise persons carrying on insurance business, insurance managers, and intermediaries with the aim of protecting the interests of clients and potential clients of such persons.

The Act requires every insurer to appoint a principal representative resident in Bermuda and to maintain a principal office in Bermuda. The principal representative must be knowledgeable in insurance and is responsible for arranging the maintenance and custody of the statutory accounting records and for filing the annual Statutory Financial Return.

 

U.S. Operations

Our U.S. insurance subsidiaries are subject to extensive regulation and supervision by the states in which they do business. The laws of the various states establish departments of insurance with broad authority to regulate, among other things: the standards of solvency that must be met and maintained, the licensing of insurers and their producers, approval of policy forms and rates, the nature of and limitations on investments, restrictions on the size of the risks which may be insured under a single policy, deposits of securities for the benefit of policyholders, requirements for the acceptability of reinsurers, periodic examinations of the affairs of insurance companies, the form and content of reports of financial condition required to be filed, and the adequacy of reserves for unearned premiums, losses, and other purposes.

Our U.S. insurance subsidiaries are required to file detailed annual and quarterly reports with state insurance regulators in each of the states in which they do business. In addition, our U.S. insurance subsidiaries’ operations and accounts are subject to examination at regular intervals by state regulators.

All states have enacted legislation that regulates insurance holding companies. This legislation provides that each insurance company in the system is required to register with the insurance department of its state of domicile and furnish information concerning the operations of companies within the holding company system that may materially affect the operations, management, or financial condition of the insurers within the system. All transactions within a holding company system must be fair and equitable. Notice to the insurance departments is required prior to the consummation of transactions affecting the ownership or control of an insurer and of certain material transactions between an insurer and an entity in its holding company system; in addition, certain transactions may not be consummated without the department’s prior approval.

Statutory surplus is an important measure utilized by the regulators and rating agencies to assess our U.S. insurance subsidiaries’ ability to support business operations and provide dividend capacity. Our U.S. insurance subsidiaries are subject to various state statutory and regulatory restrictions that limit the amount of dividends that may be paid without prior approval from regulatory authorities. These restrictions differ by state, but are generally based on calculations incorporating statutory surplus, statutory net income, and/or investment income.

The National Association of Insurance Commissioners (NAIC) has a risk-based capital requirement for P&C insurance companies. This risk-based capital formula is used by many state regulatory authorities to identify insurance companies that may be undercapitalized and which merit further regulatory attention. These requirements are designed to monitor capital adequacy using a formula that prescribes a series of risk measurements to determine a minimum capital amount for an insurance company, based on the profile of the individual company. The ratio of a company’s actual policyholder surplus to its

 

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minimum capital requirement will determine whether any state regulatory action is required. There are progressive risk-based capital failure levels that trigger more stringent regulatory action. If an insurer’s policyholders’ surplus falls below the Mandatory Control Level (70 percent of the Authorized Control Level, as defined by the NAIC), the relevant insurance commissioner is required to place the insurer under regulatory control. However, an insurance commissioner may allow a P&C company operating below the Mandatory Control Level that is writing no business and is running off its existing business to continue its run-off. Brandywine is running off its liabilities consistent with the terms of an order issued by the Insurance Commissioner of Pennsylvania. This includes periodic reporting obligations to the Pennsylvania Insurance Department.

In November 2002, the U.S. Congress passed the Terrorism Risk Insurance Act (TRIA), which was amended and restated in 2005, and again in 2007. The 2007 TRIA extension renews the program for seven years, through 2014. TRIA was enacted to ensure the availability of insurance coverage for certain types of terrorist acts in the U.S. and requires that qualifying insurers offer terrorism insurance coverage in all P&C insurance policies on terms not materially different than terms applicable to other losses. The U.S. federal government covers 85 percent of the losses from covered certified acts of terrorism, in excess of a specified deductible amount calculated as a percentage of an affiliated insurance group’s prior year premiums on commercial lines policies covering risks in the U.S. This specified deductible amount is 20 percent of such premiums for losses occurring in the prior year. Further, to trigger coverage under TRIA, the aggregate industry P&C insurance losses resulting from an act of terrorism must exceed $100 million. In the 2007 extension, TRIA was expanded to apply to losses resulting from attacks that have been committed by individuals on behalf of a foreign person or foreign interest, as well as acts of domestic terrorism. Further, any such attack must be certified as an “act of terrorism” by the U.S. federal government, and such decision is not subject to judicial review.

Our U.S. subsidiaries are also subject to the general laws of the states and other jurisdictions in which they do business. Beginning in 2004, ACE and its subsidiaries and affiliates received numerous subpoenas, interrogatories, and civil investigative demands in connection with certain investigations of insurance industry practices. These inquiries have been issued by a number of attorneys general, state departments of insurance, and other authorities, including the New York Attorney General (NYAG), the Pennsylvania Department of Insurance, and the SEC. These inquiries seek information concerning underwriting practices and non-traditional or loss mitigation insurance products. To the extent they are ongoing, ACE is cooperating and will continue to cooperate with such inquiries. Information on the insurance industry investigations, including settlement agreements and related matters, is set forth in Note 9 to the Consolidated Financial Statements, under Item 8.

 

International Operations

The extent of insurance regulation varies significantly among the countries in which the non-U.S. ACE operations conduct business. While each country imposes licensing, solvency, auditing, and financial reporting requirements, the type and extent of the requirements differ substantially. For example:

• in some countries, insurers are required to prepare and file quarterly financial reports, and in others, only annual reports;

• some regulators require intermediaries to be involved in the sale of insurance products, whereas other regulators permit direct sales contact between the insurer and the customer;

• the extent of restrictions imposed upon an insurer’s use of foreign reinsurance vary;

• policy form filing and rate regulation vary by country;

• the frequency of contact and periodic on-site examinations by insurance authorities differ by country; and

• regulatory requirements relating to insurer dividend policies vary by country.

Significant variations can also be found in the size, structure, and resources of the local regulatory departments that oversee insurance activities. Certain regulators prefer close relationships with all subject insurers and others operate a risk-based approach.

ACE operates in some countries through subsidiaries and in some countries through branches of those subsidiaries. Local capital requirements applicable to a subsidiary generally include its branches. Certain ACE companies are jointly owned with local companies to comply with legal requirements for local ownership. Other legal requirements include discretionary licensing procedures, compulsory cessions of reinsurance, local retention of funds and records, and foreign exchange controls. ACE’s international companies are also subject to multinational application of certain U.S. laws.


Tax Matters

Refer to “Risk Factors”, under Item 1A below, and Note 2 m) to the Consolidated Financial Statements, under Item 8.

 

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ITEM 1A. Risk Factors

 

Factors that could have a material impact on our results of operations or financial condition are outlined below. Additional risks not presently known to us or that we currently deem insignificant may also impair our business or results of operations as they become known facts or as facts and circumstances change. Any of the risks described below could result in a significant or material adverse effect on our results of operations or financial condition.

 

Business

 

Our financial condition could be adversely affected by the occurrence of natural and man-made disasters.

We have substantial exposure to losses resulting from natural disasters, man-made catastrophes, and other catastrophic events. Catastrophes can be caused by various events, including hurricanes, typhoons, earthquakes, hailstorms, explosions, severe winter weather, fires, war, acts of terrorism, political instability, and other natural or man-made disasters. The incidence and severity of catastrophes are inherently unpredictable and our losses from catastrophes could be substantial. In addition, climate conditions, primarily global temperatures, may be increasing, which may in the future increase the frequency and severity of natural catastrophes and the losses resulting there from. The occurrence of claims from catastrophic events could result in substantial volatility in our results of operations or financial condition for any fiscal quarter or year. Increases in the values and concentrations of insured property may also increase the severity of these occurrences in the future. Although we attempt to manage our exposure to such events through the use of underwriting controls and the purchase of third-party reinsurance, catastrophic events are inherently unpredictable and the actual nature of such events when they occur could be more frequent or severe than contemplated in our pricing and risk management expectations. As a result, the occurrence of one or more catastrophic events could have a material adverse effect on our results of operations or financial condition. Refer to “Catastrophe Exposure Management”, under Item 7 for more information.

 

If actual claims exceed our loss reserves, our financial results could be adversely affected.

Our results of operations and financial condition depend upon our ability to assess accurately the potential losses associated with the risks that we insure and reinsure. We establish reserves for unpaid losses and loss expenses, which are estimates of future payments of reported and unreported claims for losses and related expenses, with respect to insured events that have occurred at or prior to the date of the balance sheet. The process of establishing reserves can be highly complex and is subject to considerable variability as it requires the use of informed estimates and judgments. These estimates and judgments are based on numerous factors, and may be revised as additional experience and other data become available and are reviewed, as new or improved methodologies are developed, as loss trends and claims inflation impact future payments, or as current laws or interpretations thereof change.

We have actuarial staff in each of our operating segments who analyze insurance reserves and regularly evaluate the levels of loss reserves. Any such evaluations could result in future changes in estimates of losses or reinsurance recoverable and would be reflected in our results of operations in the period in which the estimates are changed. Losses and loss expenses are charged to income as incurred. Reserves for unpaid losses and loss expenses represent the estimated ultimate losses and loss expenses less paid losses and loss expenses, and is comprised of case reserves and IBNR. During the loss settlement period, which can be many years in duration for some of our lines of business, additional facts regarding individual claims and trends often will become known. As these become apparent, case reserves may be adjusted by allocation from IBNR without any change in overall reserves. In addition, application of statistical and actuarial methods may require the adjustment of overall reserves upward or downward from time to time.

Included in our liabilities for losses and loss expenses are liabilities for latent claims such as A&E. These claims are principally related to claims arising from remediation costs associated with hazardous waste sites and bodily-injury claims related to exposure to asbestos products and environmental hazards. The estimation of these liabilities is subject to many complex variables including: the current legal environment; specific settlements that may be used as precedents to settle future claims; assumptions regarding multiple recoveries by claimants against various defendants; the ability of a claimant to bring a claim in a state in which they have no residency or exposure; the ability of a policyholder to claim the right to non-products coverage; whether high-level excess policies have the potential to be accessed given the policyholder’s claim trends and liability situation; payments to unimpaired claimants; and the potential liability of peripheral defendants.

Accordingly, the ultimate settlement of losses may be significantly greater or less than the loss and loss expense reserves held at the date of the balance sheet. If our loss reserves are determined to be inadequate, we will be required to increase loss reserves at the time of such determination and our net income will be reduced. If the increase in loss reserves is large enough,

 

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we could incur an operating loss and a reduction of our capital. Refer to “Asbestos and Environmental and Other Run-Off Liabilities”, under Item 7 and Note 6 to the Consolidated Financial Statements, under Item 8.

 

The effects of emerging claim and coverage issues on our business are uncertain.

As industry practices and legislative, regulatory, judicial, social, and other environmental conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect our business by either extending coverage beyond our underwriting intent or by increasing the frequency and severity of claims. In some instances, these changes may not become apparent until some time after we have issued insurance or reinsurance contracts that are affected by the changes. As a result, the full extent of liability under our insurance or reinsurance contracts may not be known for many years after a contract is issued.

 

The failure of any of the loss limitation methods we employ could have an adverse effect on our results of operations or financial condition.

We seek to limit our loss exposure by writing a number of our insurance and reinsurance contracts on an excess of loss basis. Excess of loss insurance and reinsurance indemnifies the insured against losses in excess of a specified amount. In addition, we limit program size for each client and purchase third-party reinsurance for our own account. In the case of our assumed proportional reinsurance treaties, we seek per occurrence limitations or loss and loss expense ratio caps to limit the impact of losses ceded by the client. In proportional reinsurance, the reinsurer shares a proportional part of the premiums and losses of the reinsured. We also seek to limit our loss exposure by geographic diversification. Geographic zone limitations involve significant underwriting judgments, including the determination of the area of the zones and the inclusion of a particular policy within a particular zone’s limits. Various provisions of our policies, such as limitations or exclusions from coverage or choice of forum negotiated to limit our risks, may not be enforceable in the manner we intend. As a result, one or more catastrophic or other events could result in claims that substantially exceed our expectations, which could have an adverse effect on our results of operations or financial condition.

 

We may be unable to purchase reinsurance, and if we successfully purchase reinsurance, we are subject to the possibility of non-payment.

We purchase reinsurance to protect certain ACE companies against catastrophes, to increase the amount of protection we can provide our clients, and as part of our overall risk management strategy. Our reinsurance business also purchases some retrocessional protection. A retrocessional reinsurance agreement allows a reinsurer to cede to another company all or part of the reinsurance that was originally assumed by the reinsurer. A reinsurer’s or retrocessionaire’s insolvency, or inability or unwillingness to make timely payments under the terms of its reinsurance agreement with us, could have an adverse effect on us because we remain liable to the insured. From time to time, market conditions have limited, and in some cases have prevented, insurers and reinsurers from obtaining the types and amounts of reinsurance or retrocessional reinsurance that they consider adequate for their business needs.

There is no guarantee our desired amounts of reinsurance or retrocessional reinsurance will be available in the marketplace in the future. In addition to capacity risk, the remaining capacity may not be on terms we deem appropriate or acceptable or with companies with whom we want to do business. Finally, we face some degree of counterparty risk whenever we purchase reinsurance or retrocessional reinsurance. Consequently, the insolvency, inability or unwillingness of any of our present or future reinsurers to make timely payments to us under the terms of our reinsurance or retrocessional agreements could have an adverse effect on us. At December 31, 2007, we had $14.4 billion of reinsurance recoverables, net of reserves for uncollectible recoverables.

As part of the restructuring of INA Financial Corporation and its subsidiaries that occurred in 1996, Insurance Company of North America (INA) was divided into two separate corporations: an active insurance company that retained the INA name and continued to write P&C business and an inactive run-off company, now called Century Indemnity Company (Century). The A&E exposures of substantially all of INA’s U.S. P&C companies, now our subsidiaries, were either allocated to Century (as a result of the restructuring) or reinsured to subsidiaries of Brandywine, primarily Century. Certain of our subsidiaries are primarily liable for A&E and other exposures they have reinsured to Century. As of December 31, 2007, the aggregate reinsurance balances ceded by our active subsidiaries to Century were $1.5 billion. Should Century experience adverse loss reserve development in the future and should Century be placed into rehabilitation or liquidation, the reinsurance recoverables due to Century’s affiliates would be payable only after the payment in full of certain expenses and liabilities, including administrative expenses and direct policy liabilities. Thus, the intercompany reinsurance recoverables would be at risk to the extent of the shortage of assets remaining to pay these recoverables. While we believe the intercompany reinsurance recoverables from

 

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Century are not impaired at this time, we cannot assure you that adverse development with respect to Century’s loss reserves will not result in Century’s insolvency, which could result in our recognizing a loss to the extent of any uncollectible reinsurance from Century. For further information regarding our reinsurance exposure to Century, refer to “Asbestos and Environmental and Other Run-Off Liabilities”, under Item 7.

 

Our net income may be volatile because certain products offered by our Life business expose us to reserve and fair value liability changes that are directly affected by market factors.

Under reinsurance programs covering variable annuity guarantees, we assume the risk of guaranteed minimum death benefits (GMDB) and guaranteed minimum income benefits (GMIB) associated with variable annuity contracts. Our net income is directly impacted by changes in the reserves calculated in connection with the reinsurance of GMDB and GMIB liabilities. In addition, our net income is directly impacted by the change in the fair value of the GMIB liability. The reserve and fair value liability calculations are directly affected by market factors, the most significant of which are equity levels, interest rate levels, and implied equity volatilities. ACE views our variable annuity reinsurance business as having a similar risk profile to that of catastrophe reinsurance, with the probability of a cumulative long term economic net loss relatively small. However, in the short run, adverse changes in market factors will have an adverse impact on both life underwriting income and our net income, which may be material. Refer to the “Critical Accounting Estimates – Guaranteed minimum income benefits derivatives”, under Item 7 and “Quantitative and Qualitative Disclosures about Market Risk – Reinsurance of GMIB and GMDB guarantees”, under Item 7A for more information.

 

A failure in our operational systems or infrastructure or those of third parties could disrupt business, damage our reputation, and cause losses.

ACE’s operations rely on the secure processing, storage, and transmission of confidential and other information in its computer systems and networks. ACE’s business depends on effective information systems and the integrity and timeliness of the data it uses to run its business. Our ability to adequately price products and services, to establish reserves, to provide effective and efficient service to our customers, and to timely and accurately report our financial results also depends significantly on the integrity of the data in our information systems. Although we take protective measures and endeavor to modify them as circumstances warrant, our computer systems, software, and networks may be vulnerable to unauthorized access, computer viruses or other malicious code, and other events that could have security consequences. If one or more of such events occur, this potentially could jeopardize ACE’s or our clients’ or counterparties’ confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in ACE’s, its clients’, its counterparties’, or third parties’ operations, which could result in significant losses or reputational damage. ACE may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured against or not fully covered by insurance maintained.

Despite the contingency plans and facilities we have in place, our ability to conduct business may be adversely affected by a disruption of the infrastructure that supports our business in the communities in which we are located. This may include a disruption involving electrical, communications, transportation, or other services used by ACE. These disruptions may occur, for example, as a result of events that affect only the buildings occupied by ACE or as a result of events with a broader effect on the cities where those buildings are located. If a disruption occurs in one location and ACE employees in that location are unable to occupy its offices and conduct business or communicate with or travel to other locations, our ability to service and interact with clients may suffer and we may not be able to successfully implement contingency plans that depend on communication or travel.

 

Employee error and misconduct may be difficult to detect and prevent and could adversely affect our business, results of operations, and financial condition.

Losses may result from, among other things, fraud, errors, failure to document transactions properly or to obtain proper internal authorization, or failure to comply with regulatory requirements. It is not always possible to deter or prevent employee misconduct and the precautions ACE takes to prevent and detect this activity may not be effective in all cases. Resultant losses could adversely affect our business, results of operations, and financial condition.

 

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Financial Strength Ratings

 

A decline in our ratings could affect our standing among brokers and customers and cause our premiums and earnings to decrease.

Ratings have become an increasingly important factor in establishing the competitive position of insurance and reinsurance companies. The objective of these rating systems is to provide an opinion of an insurer’s financial strength and ability to meet ongoing obligations to its policyholders. Our financial strength ratings reflect the rating agencies’ opinions of our claims paying ability, are not evaluations directed to investors in our securities, and are not recommendations to buy, sell, or hold our securities. If our financial strength ratings are reduced from their current levels by one or more of these rating agencies, our competitive position in the insurance industry could suffer and it would be more difficult for us to market our products. A downgrade, therefore, could result in a substantial loss of business as insureds, ceding companies, and brokers move to other insurers and reinsurers with higher ratings. We cannot give any assurance regarding whether or to what extent any of the rating agencies may downgrade our ratings in the future.

 

Loss of Key Executives

 

We could be adversely affected by the loss of one or more key executives or by an inability to attract and retain qualified personnel.

Our success depends on our ability to retain the services of our existing key executives and to attract and retain additional qualified personnel in the future. The loss of the services of any of our key executives or the inability to hire and retain other highly qualified personnel in the future could adversely affect our ability to conduct our business. We do not maintain key person life insurance policies with respect to our employees.

Many of our senior executives working in Bermuda, including our Chairman, President and Chief Executive Officer, our Chief Financial Officer, our Chief Accounting Officer, our Chief Actuary, and our General Counsel, are not Bermudian. Under Bermuda law, non-Bermudians (other than spouses of Bermudians and holders of permanent resident’s certificates) may not engage in any gainful occupation in Bermuda without an appropriate governmental work permit. Our success may depend in part on the continued services of key employees in Bermuda. A work permit may be granted or renewed upon showing that, after proper public advertisement, no Bermudian (or spouse of a Bermudian or holder of a permanent resident’s certificate) is available who meets the minimum standards reasonably required by the employer. The Bermuda government’s policy places a six-year term limit on individuals with work permits, subject to certain exemptions for key employees. A work permit may be issued with an expiry date that is one to five years later, and no assurances can be given that any work permit will be issued or, if issued, renewed upon the expiration of the relevant term. It is possible that Bermuda could change its laws or policies in a way that would make it more difficult for non-Bermudians to obtain work permits.

 

Reliance on Brokers

 

Since we depend on a few brokers for a large portion of our revenues, loss of business provided by any one of them could adversely affect us.

We market our insurance and reinsurance worldwide primarily through insurance and reinsurance brokers. Marsh, Inc. and its affiliates and Aon Corporation and its affiliates provided approximately 17 percent and 11 percent, respectively, of our gross premiums written in the year ended December 31, 2007. Loss of all or a substantial portion of the business provided by one or more of these brokers could have a material adverse effect on our business.

 

Our reliance on brokers subjects us to their credit risk.

In accordance with industry practice, we generally pay amounts owed on claims under our insurance and reinsurance contracts to brokers, and these brokers, in turn, pay these amounts over to the clients that have purchased insurance or reinsurance from us. Although the law is unsettled and depends upon the facts and circumstances of the particular case, in some jurisdictions, if a broker fails to make such a payment, we might remain liable to the insured or ceding insurer for the deficiency. Conversely, in certain jurisdictions, when the insured or ceding insurer pays premiums for these policies to brokers for payment over to us, these premiums might be considered to have been paid and the insured or ceding insurer will no longer be liable to us for those amounts, whether or not we have actually received the premiums from the broker. Consequently, we assume a degree of credit risk associated with brokers with whom we transact business. However, due to the unsettled and fact-specific nature of the law, we are unable to quantify our exposure to this risk. To date, we have not experienced any material losses related to these credit risks.

 

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Liquidity and Investments

 

Our investment performance may affect our financial results and ability to conduct business.

Our funds are invested by professional investment management firms under the direction of our management team in accordance with investment guidelines approved by the Finance and Investment Committee of the Board of Directors. Although our investment guidelines stress diversification of risks and conservation of principal and liquidity, our investments are subject to market risks, as well as risks inherent in individual securities. The volatility of our loss claims may force us to liquidate securities, which may cause us to incur capital losses. Investment losses could significantly decrease our book value, thereby affecting our ability to conduct business.

 

We may be adversely affected by interest rate changes.

Our operating results are affected by the performance of our investment portfolio. Our investment portfolio contains fixed income investments and may be adversely affected by changes in interest rates. Volatility in interest rates could also have an adverse effect on our investment income and operating results. For example, if interest rates decline, funds reinvested will earn less than the maturing investment.

Interest rates are highly sensitive to many factors, including monetary and fiscal policies, and domestic and international political conditions. Although we take measures to manage the risks of investing in a changing interest rate environment, we may not be able to effectively mitigate interest rate sensitivity. Our mitigation efforts include maintaining a high quality portfolio with a relatively short duration to reduce the effect of interest rate changes on book value. A significant increase in interest rates could have an adverse effect on our book value. Refer to “Quantitative and Qualitative Disclosures about Market Risk – Interest rate risk”, under Item 7A.

 

We may require additional capital in the future, which may not be available or may be available only on unfavorable terms.

Our future capital requirements depend on many factors, including our ability to write new business successfully and to establish premium rates and reserves at levels sufficient to cover losses. We may need to raise additional funds through financings. Any equity or debt financing, if available at all, may be on terms that are not favorable to us. In the case of equity financings, dilution to our shareholders could result, and in any case such securities may have rights, preferences, and privileges that are senior to those of our Ordinary Shares. If we cannot obtain adequate capital on favorable terms, or at all, our business, operating results, and financial condition could be adversely affected.

 

Our investment portfolio has exposure to below investment-grade securities that have a higher degree of credit or default risk which could adversely effect our results of operations and financial condition.

Our fixed income portfolio is primarily invested in high quality, investment-grade securities. However, we invest a smaller portion of the portfolio in below investment-grade securities. These securities, which pay a higher rate of interest, also have a higher degree of credit or default risk. These securities may also be less liquid in times of economic weakness or market disruptions. While we have put in place procedures to monitor the credit risk and liquidity of our invested assets, it is possible that, in periods of economic weakness, we may experience default losses in our portfolio. This may result in a reduction of net income and capital.

 

We could be adversely affected by a downgrade of the financial strength or financial enhancement ratings of any of AGO’s insurance subsidiaries, and our net income may be volatile because AGO assumes credit derivatives which are marked-to-market quarterly.

AGO is a Bermuda based holding company that provides, through its operating subsidiaries, credit enhancement products to the public finance, structured finance, and mortgage markets. Our relationship with AGO is limited to our equity investment, which had a carrying value of $392 million at December 31, 2007. We conduct no financial guaranty business directly or with AGO and we retain no financial guaranty exposures with AGO.

The ratings assigned by the major rating agencies to AGO’s insurance subsidiaries are subject to periodic review and may be downgraded by one or more of the rating agencies at any time. If the ratings of any of AGO’s insurance subsidiaries were reduced below current levels by any of the rating agencies, it could have an adverse effect on the affected subsidiary’s competitive position and its prospects for future business opportunities. In certain circumstances, a ratings downgrade may also entitle a ceding company to recapture business ceded to an AGO subsidiary or, alternatively, to retroactively increase cession commissions to an AGO subsidiary, either of which could result in a potentially significant negative impact to AGO earnings, and, therefore, our proportionate share thereof.

 

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AGO’s net income and, therefore, our proportionate share thereof, may be volatile because a portion of the credit risk AGO assumes is in the form of credit derivatives that are marked-to-market quarterly. Any event causing credit spreads on an underlying security referenced in a credit derivative in AGO’s portfolio either to widen or to tighten will affect the fair value of the credit derivative and may increase the volatility of AGO’s earnings and, therefore, our proportionate share (24 percent) thereof. For the year ended December 31, 2007, our other (income) expense included our equity in the net loss of AGO of $68 million, primarily due to mark-to-market losses in AGO’s credit derivatives portfolio, our portion of which was $122 million. These losses were recorded as realized losses by AGO.

 

Exchange Rates

 

Our operating results may be adversely affected by currency fluctuations.

Our functional currency is the U.S. dollar. Many of our non-U.S. companies maintain both assets and liabilities in local currencies. Therefore, foreign exchange risk is generally limited to net assets denominated in those foreign currencies. Foreign exchange risk is reviewed as part of our risk management process. Locally required capital levels are invested in home currencies in order to satisfy regulatory requirements and to support local insurance operations. The principal currencies creating foreign exchange risk are the British pound sterling, the euro, and the Canadian dollar. For the year ended December 31, 2007, approximately 10 percent of our net assets were denominated in foreign currencies. We may experience losses resulting from fluctuations in the values of non-U.S. currencies, which could adversely impact our results of operations and financial condition. Refer to “Quantitative and Qualitative Disclosures about Market Risk – Foreign currency exchange rate risk”, under Item 7A.

 

Regulatory and Other Governmental Developments

 

The regulatory regimes under which we operate, and potential changes thereto, could have an adverse effect on our business.

Our insurance and reinsurance subsidiaries conduct business globally, including in all 50 states of the United States and the District of Columbia. Our businesses in each of these jurisdictions are subject to varying degrees of regulation and supervision. The laws and regulations of the jurisdictions in which our insurance and reinsurance subsidiaries are domiciled require, among other things, that these subsidiaries maintain minimum levels of statutory capital, surplus, and liquidity, meet solvency standards, and submit to periodic examinations of their financial condition. In some jurisdictions, laws and regulations also restrict payments of dividends and reductions of capital. Applicable statutes, regulations, and policies may also restrict the ability of these subsidiaries to write insurance and reinsurance policies, to make certain investments, and to distribute funds. The purpose of insurance laws and regulations generally is to protect insureds and ceding insurance companies, not our shareholders. We may not be able to comply fully with, or obtain appropriate exemptions from, applicable statutes and regulations. Failure to comply with or to obtain appropriate authorizations and/or exemptions under any applicable laws and regulations could result in restrictions on our ability to do business or undertake activities that are regulated in one or more of the jurisdictions in which we conduct business and could subject us to fines and other sanctions. In addition, changes in the laws or regulations to which our insurance and reinsurance subsidiaries are subject could have an adverse effect on our business. In addition, our ability to consummate our anticipated acquisition of Combined, as well as the timing of such consummation, is subject to numerous regulatory approvals as well as other customary closing conditions.

 

Current legal and regulatory activities relating to insurance brokers and agents, contingent commissions and certain finite-risk insurance products could adversely affect our business, results of operations, and financial condition.

As described in greater detail in Note 9 to the Consolidated Financial Statements, under Item 8, ACE has received numerous regulatory inquiries, subpoenas, interrogatories, and civil investigative demands from regulatory authorities in connection with pending investigations of insurance industry practices. ACE is cooperating and will continue to cooperate with such inquiries. We cannot assure you that we will not receive any additional requests for information or subpoenas or what actions, if any, any of these governmental agencies will take as a result of these investigations. Additionally, at this time, we are unable to predict the potential effects, if any, that these actions may have upon the insurance and reinsurance markets and industry business practices or what, if any, changes may be made to laws and regulations regarding the industry and financial reporting. Any of the foregoing could adversely affect our business, results of operations, and financial condition.

 

Events may result in political, regulatory, and industry initiatives which could adversely affect our business.

Government intervention has occurred in the insurance and reinsurance markets in relation to terrorism coverage both in the U.S. and through industry initiatives in other countries. TRIA, which was enacted in 2002 to ensure the availability of

 

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insurance coverage for certain types of terrorist acts in the U.S., was extended in 2007 for seven years, through 2014. Refer to “Regulation – U.S. Operations” for more information.

Government intervention and the possibility of future interventions has created uncertainty in the insurance and reinsurance markets about the definition of terrorist acts and the extent to which future coverages will extend to terrorist acts. Government regulators are generally concerned with the protection of policyholders to the exclusion of other constituencies, including shareholders of insurers and reinsurers. While we cannot predict the exact nature, timing, or scope of possible governmental initiatives, such proposals could adversely affect our business by:

• providing insurance and reinsurance capacity in markets and to consumers that we target;

• requiring our participation in industry pools and guaranty associations;

• expanding the scope of coverage under existing policies;

• regulating the terms of insurance and reinsurance policies; or

• disproportionately benefiting the companies of one country over those of another.

The insurance industry is also affected by political, judicial, and legal developments that may create new and expanded theories of liability. Such changes may result in delays or cancellations of products and services by insurers and reinsurers, which could adversely affect our business.

 

Our operations in developing nations expose us to political developments that could have an adverse effect on our business, liquidity, results of operations, and financial condition.

Our international operations include operations in various developing nations. Both current and future foreign operations could be adversely affected by unfavorable political developments including law changes, tax changes, regulatory restrictions, and nationalization of ACE operations without compensation. Adverse actions from any one country could have an adverse effect on our business, liquidity, results of operations, and financial condition depending on the magnitude of the event and ACE’s net financial exposure at that time in that country.

 

Company Structure

 

Our ability to pay dividends and to make payments on indebtedness may be constrained by our holding company structure.

ACE Limited is a holding company and does not have any significant operations or assets other than its ownership of the shares of its operating insurance and reinsurance subsidiaries. Dividends and other permitted distributions from our insurance subsidiaries are our primary source of funds to meet ongoing cash requirements, including any future debt service payments and other expenses, and to pay dividends to our shareholders. Some of our insurance subsidiaries are subject to significant regulatory restrictions limiting their ability to declare and pay dividends. The inability of our insurance subsidiaries to pay dividends in an amount sufficient to enable us to meet our cash requirements at the holding company level could have an adverse effect on our operations and our ability to pay dividends to our shareholders and/or meet our debt service obligations.

 

ACE Limited is a Cayman Islands company with headquarters in Bermuda; it may be difficult for you to enforce judgments against it or its directors and executive officers.

ACE Limited is incorporated pursuant to the laws of the Cayman Islands, and our principal executive offices are located in Bermuda. In addition, certain of our directors and officers reside outside the United States, and all or a substantial portion of our assets and the assets of such persons are located in jurisdictions outside the United States. As such, it may be difficult or impossible to affect service of process within the United States upon those persons or to recover against us or them on judgments of U.S. courts, including judgments predicated upon civil liability provisions of the U.S. federal securities laws.

ACE has been advised by Maples and Calder, its Cayman Islands counsel, that there is doubt as to whether the courts of the Cayman Islands would enforce:

• judgments of U.S. courts based upon the civil liability provisions of the U.S. Federal securities laws obtained in actions against ACE or its directors and officers, who reside outside the United States; or

• original actions brought in the Cayman Islands against these persons or ACE predicated solely upon U.S. Federal securities laws.

ACE has also been advised by Maples and Calder that there is no treaty in effect between the United States and the Cayman Islands providing for this enforcement, and there are grounds upon which Cayman Islands courts may not enforce judgments of United States courts. Some remedies available under the laws of United States jurisdictions, including some remedies available under the U.S. Federal securities laws, would not be allowed in Cayman Islands courts as these could be contrary to that nation’s public policy.

 

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Insurance and Reinsurance Markets

 

Competition in the insurance and reinsurance markets could reduce our margins.

Insurance and reinsurance markets are highly competitive. We compete on an international and regional basis with major U.S., Bermuda, European, and other international insurers and reinsurers and with underwriting syndicates, some of which have greater financial, marketing, and management resources than we do. We also compete with new companies that continue to be formed to enter the insurance and reinsurance markets. In addition, capital market participants have recently created alternative products that are intended to compete with reinsurance products. Increased competition could result in fewer submissions, lower premium rates, and less favorable policy terms and conditions, which could reduce our margins.

 

Insurance and reinsurance markets are historically cyclical, and we expect to experience periods with excess underwriting capacity and unfavorable premium rates.

The insurance and reinsurance markets have historically been cyclical, characterized by periods of intense price competition due to excessive underwriting capacity as well as periods when shortages of capacity permitted favorable premium levels. An increase in premium levels is often offset by an increasing supply of insurance and reinsurance capacity, either by capital provided by new entrants or by the commitment of additional capital by existing insurers or reinsurers, which may cause prices to decrease. Any of these factors could lead to a significant reduction in premium rates, less favorable policy terms, and fewer submissions for our underwriting services. In addition to these considerations, changes in the frequency and severity of losses suffered by insureds and insurers may affect the cycles of the insurance and reinsurance markets significantly.

 

Charter Documents and Applicable Law

 

There are provisions in our charter documents that may reduce the voting rights and restrict the transfer of our Ordinary Shares.

Our Articles of Association generally provide that shareholders have one vote for each ordinary share held by them and are entitled to vote at all meetings of shareholders. However, the voting rights exercisable by a shareholder may be limited so that certain persons or groups are not deemed to hold 10 percent or more of the voting power conferred by our Ordinary Shares. Under these provisions, some shareholders may have the ability to exercise their voting rights limited to less than one vote per share. Moreover, these provisions could have the effect of reducing the voting power of some shareholders who would not otherwise be subject to the limitation by virtue of their direct share ownership. In addition, our Board of Directors may decline to register a transfer of any Ordinary Shares under some circumstances, including if a transfer would increase the ownership of our Ordinary Shares by certain persons or groups to 10 percent or more.

 

Applicable laws may make it difficult to effect a change of control of our company.

Before a person can acquire control of a U.S. insurance company, prior written approval must be obtained from the insurance commissioner of the state where the domestic insurer is domiciled. Prior to granting approval of an application to acquire control of a domestic insurer, the state insurance commissioner will consider such factors as the financial strength of the applicant, the integrity and management of the applicant’s Board of Directors and executive officers, the acquirer’s plans for the future operations of the domestic insurer, and any anti-competitive results that may arise from the consummation of the acquisition of control. Generally, state statutes provide that control over a domestic insurer is presumed to exist if any person, directly or indirectly, owns, controls, holds with the power to vote, or holds proxies representing 10 percent or more of the voting securities of the domestic insurer. Because a person acquiring 10 percent or more of our Ordinary Shares would indirectly control the same percentage of the stock of our U.S. insurance subsidiaries, the insurance change of control laws of various U.S. jurisdictions would likely apply to such a transaction.

We and certain of our U.K. subsidiaries are subject to the regulatory jurisdiction of the Council of Lloyd’s. Lloyd’s imposes an absolute prohibition on any person being a 10 percent controller of a corporate member without first notifying Lloyd’s and receiving their consent. Because a person acquiring 10 percent or more of our Ordinary Shares would indirectly control the same percentage of the stock of our subsidiary, that is a Lloyd’s corporate member, the Lloyd’s restrictions on becoming a controller of a corporate member would likely apply to such a transaction.

Laws of other jurisdictions in which one or more of our existing subsidiaries are, or a future subsidiary may be, organized or domiciled may contain similar restrictions on the acquisition of control of ACE.

While our Articles of Association limit the voting power of any shareholder to less than 10 percent, there can be no assurance that the applicable regulatory body would agree that a shareholder who owned 10 percent or more of our Ordinary Shares did not, because of the limitation on the voting power of such shares, control the applicable insurance subsidiary.

 

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These laws may discourage potential acquisition proposals and may delay, deter, or prevent a change of control of the Company, including transactions that some or all of our shareholders might consider to be desirable.

 

U.S. persons who own our Ordinary Shares may have more difficulty in protecting their interests than U.S. persons who are shareholders of a U.S. corporation.

The Companies Law (2004 Revision) of the Cayman Islands, which applies to us, differs in certain material respects from laws generally applicable to U.S. corporations and their shareholders. These differences include the manner in which directors must disclose transactions in which they have an interest, the rights of shareholders to bring class action and derivative lawsuits, and the scope of indemnification available to directors and officers.

 

Anti-takeover provisions in our charter and corporate documents could impede an attempt to replace our directors or to effect a change of control, which could diminish the value of our Ordinary Shares.

Our Articles of Association contain provisions that may make it more difficult for shareholders to replace directors and could delay or prevent a change of control that a shareholder might consider favorable. These provisions include a staggered Board of Directors, limitations on the ability of shareholders to remove directors other than for cause, limitations on voting rights, and restrictions on transfer of our Ordinary Shares. In addition, we have in place a shareholder rights plan which would cause extreme dilution to any person or group that attempts to acquire a significant interest in the Company without advance approval of our Board of Directors. These provisions may prevent a shareholder from receiving the benefit from any premium over the market price of our Ordinary Shares offered by a bidder in a potential takeover. Even in the absence of an attempt to effect a change in management or a takeover attempt, these provisions may adversely affect the prevailing market price of our Ordinary Shares if they are viewed as discouraging takeover attempts in the future.

 

Taxation

 

We may become subject to taxes in Bermuda after March 28, 2016, which may have an adverse effect on our results of operations and your investment.

The Bermuda Minister of Finance, under the Exempted Undertakings Tax Protection Act 1966 of Bermuda, as amended, has given each of ACE Limited and its Bermuda insurance subsidiaries a written assurance that if any legislation is enacted in Bermuda that would impose tax computed on profits or income, or computed on any capital asset, gain or appreciation, or any tax in the nature of estate duty or inheritance tax, then the imposition of any such tax would not be applicable to those companies or any of their respective operations, shares, debentures, or other obligations until March 28, 2016, except insofar as such tax would apply to persons ordinarily resident in Bermuda or is payable by us in respect of real property owned or leased by us in Bermuda. Given the limited duration of the Minister of Finance’s assurance, we cannot be certain that we will not be subject to any Bermuda tax after March 28, 2016.

 

We may become subject to taxes in the Cayman Islands after January 31, 2026, which may have an adverse effect on our results of operations and your investment.

Under current Cayman Islands law, we are not obligated to pay any taxes in the Cayman Islands on our income or gains. We have received an undertaking from the Governor in Cabinet of the Cayman Islands pursuant to the provisions of the Tax Concessions Law, as amended, that until January 31, 2026, (i) no subsequently enacted law imposing any tax on profits, income, gains, or appreciation shall apply to us and (ii) no such tax and no tax in the nature of an estate duty or an inheritance tax shall be payable on any of our Ordinary Shares, debentures, or other obligations. Under current law, no tax will be payable on the transfer or other disposition of our Ordinary Shares. The Cayman Islands currently impose stamp duties on certain categories of documents; however, our current operations do not involve the payment of stamp duties in any material amount. The Cayman Islands also currently impose an annual corporate fee upon all exempted companies incorporated in the Cayman Islands. Given the limited duration of the undertaking from the Governor in Cabinet of the Cayman Islands, we cannot be certain that we will not be subject to any Cayman Islands tax after January 31, 2026.

 

ACE Limited and our Bermuda-based subsidiaries may become subject to U.S. tax, which may have an adverse effect on our results of operations and your investment.

ACE Limited, ACE Bermuda Insurance Ltd., ACE Tempest Life Reinsurance Ltd., and our other Bermuda-based insurance subsidiaries operate in a manner so that none of these companies should be subject to U.S. tax (other than U.S. excise tax on insurance and reinsurance premium income attributable to insuring or reinsuring U.S. risks and U.S. withholding tax on some types of U.S. source investment income), because none of these companies should be treated as engaged in a trade or busi-

 

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ness within the United States. However, because there is considerable uncertainty as to the activities that constitute being engaged in a trade or business within the United States, we cannot be certain that the Internal Revenue Service (IRS) will not contend successfully that any of ACE Limited or its Bermuda-based subsidiaries is/are engaged in a trade or business in the United States. If ACE Limited or any of its Bermuda-based subsidiaries were considered to be engaged in a trade or business in the United States, such entity could be subject to U.S. corporate income and additional branch profits taxes on the portion of its earnings effectively connected to such U.S. business, in which case its results of operations and your investment could be adversely affected.

 

If you acquire 10 percent or more of ACE Limited’s shares, you may be subject to taxation under the “controlled foreign corporation” (the CFC) rules.

Under certain circumstances, a U.S. person who owns 10 percent or more of the voting power of a foreign corporation that is a CFC (a foreign corporation in which 10 percent U.S. shareholders own more than 50 percent of the voting power or value of the stock of a foreign corporation or more than 25 percent of a foreign insurance corporation) for an uninterrupted period of 30 days or more during a taxable year must include in gross income for U.S. federal income tax purposes such “10 percent U.S. Shareholder’s” pro rata share of the CFC’s “subpart F income”, even if the subpart F income is not distributed to such 10 percent U.S. Shareholder if such 10 percent U.S. Shareholder owns (directly or indirectly through foreign entities) any of our shares on the last day of our fiscal year. Subpart F income of a foreign insurance corporation typically includes foreign personal holding company income (such as interest, dividends, and other types of passive income), as well as insurance and reinsurance income (including underwriting and investment income) attributable to the insurance of risks situated outside the CFC’s country of incorporation.

We believe that because of the dispersion of our share ownership, provisions in our organizational documents that limit voting power, and other factors, no U.S. person or U.S. Partnership who acquires shares of ACE Limited directly or indirectly through one or more foreign entities should be required to include our subpart F income in income under the CFC rules of the IRS Code. It is possible, however, that the IRS could challenge the effectiveness of these provisions and that a court could sustain such a challenge, in which case your investment could be adversely affected if you own 10 percent or more of ACE Limited’s stock.

 

U.S. persons who hold shares may be subject to U.S. federal income taxation at ordinary income rates on their proportionate share of our Related Person Insurance Income (RPII).

If the RPII of any of our non-U.S. insurance subsidiaries (each a “Non-U.S. Insurance Subsidiary”) were to equal or exceed 20 percent of that company’s gross insurance income in any taxable year and direct or indirect insureds (and persons related to those insureds) own directly or indirectly through foreign entities 20 percent or more of the voting power or value of ACE Limited, then a U.S. person who owns any shares of ACE Limited (directly or indirectly through foreign entities) on the last day of the taxable year would be required to include in its income for U.S. federal income tax purposes such person’s pro rata share of such company’s RPII for the entire taxable year, determined as if such RPII were distributed proportionately only to U.S. persons at that date regardless of whether such income is distributed. In addition, any RPII that is includible in the income of a U.S. tax-exempt organization may be treated as unrelated business taxable income. We believe that the gross RPII of each Non-U.S. Insurance Subsidiary did not in prior years of operation and is not expected in the foreseeable future to equal or exceed 20 percent of each such company’s gross insurance income, and we do not expect the direct or indirect insureds of each Non-U.S. Insurance Subsidiary (and persons related to such insureds) to directly or indirectly own 20 percent or more of either the voting power or value of our shares, but we cannot be certain that this will be the case because some of the factors which determine the extent of RPII may be beyond our control. If these thresholds are met or exceeded, and if you are an affected U.S. person, your investment could be adversely affected.

 

U.S. persons who hold shares will be subject to adverse tax consequences if we are considered to be a Passive Foreign Investment Company (PFIC) for U.S. federal income tax purposes.

If ACE Limited is considered a PFIC for U.S. federal income tax purposes, a U.S. person who owns any shares of ACE Limited will be subject to adverse tax consequences, including subjecting the investor to a greater tax liability than might otherwise apply and subjecting the investor to tax on amounts in advance of when tax would otherwise be imposed, in which case your investment could be adversely affected. In addition, if ACE Limited were considered a PFIC, upon the death of any U.S. individual owning shares, such individual’s heirs or estate would not be entitled to a “step-up” in the basis of the shares which might otherwise be available under U.S. federal income tax laws. We believe that we are not, have not been, and currently do not expect to become, a PFIC for U.S. federal income tax purposes. We cannot assure you, however, that we will not be

 

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deemed a PFIC by the IRS. If we were considered a PFIC, it could have adverse tax consequences for an investor that is subject to U.S. federal income taxation. There are currently no regulations regarding the application of the PFIC provisions to an insurance company. New regulations or pronouncements interpreting or clarifying these rules may be forthcoming. We cannot predict what impact, if any, such guidance would have on an investor that is subject to U.S. federal income taxation.

 

U.S. tax-exempt organizations who own our shares may recognize unrelated business taxable income.

A U.S. tax-exempt organization may recognize unrelated business taxable income if a portion of our insurance income is allocated to the organization, which generally would be the case if either we are a CFC and the tax-exempt shareholder is a 10 percent U.S. shareholder or there is RPII, certain exceptions do not apply, and the tax-exempt organization, directly or indirectly through foreign entities, owns any shares of ACE Limited. Although we do not believe that any U.S. persons or U.S. Partnerships should be allocated such insurance income, we cannot be certain that this will be the case. Potential U.S. tax-exempt investors are advised to consult their tax advisors.

 

The Organization for Economic Cooperation and Development and the European Union are considering measures that might encourage countries to increase our taxes.

A number of multilateral organizations, including the European Union, the Organization for Economic Cooperation and Development (OECD), the Financial Action Task Force, and the Financial Stability Forum (FSF) have, in recent years, identified some countries as not participating in adequate information exchange, engaging in harmful tax practices, or not maintaining adequate controls to prevent corruption, such as money laundering activities. Recommendations to limit such harmful practices are under consideration by these organizations, and a report published on November 27, 2001 by the OECD at the behest of the FSF titled “Behind the Corporate Veil: Using Corporate Entities for Illicit Purposes”, contains an extensive discussion of specific recommendations. The OECD has threatened non-member jurisdictions that do not agree to cooperate with the OECD with punitive sanctions by OECD member countries, though specific sanctions have yet to be adopted by OECD member countries. It is as yet unclear what these sanctions will be, who will adopt them, and when or if they will be imposed. In an April 18, 2002 report, updated as of June 2004, Bermuda was not listed as an uncooperative tax haven jurisdiction by the OECD because it previously committed to eliminate harmful tax practices and to embrace international tax standards for transparency, exchange of information, and the elimination of regimes for financial and other services that attract businesses with no substantial domestic activity. We cannot assure you, however, that the action taken by Bermuda would be sufficient to preclude all effects of the measures or sanctions described above, which, if ultimately adopted, could adversely affect Bermuda companies such as us.

 

Changes in U.S. federal income tax law could adversely affect an investment in our shares.

Legislation is periodically introduced in the U.S. Congress intended to eliminate some perceived tax advantages of companies (including insurance companies) that have legal domiciles outside the United States but have certain U.S. connections. It is possible that legislative proposals could emerge in the future that could have an adverse impact on us or our shareholders. See following risk factor for currently proposed legislation.

 

Currently, there is proposed legislation in the U.S. that could exclude our shareholders from advantageous capital gains rates.

Under current law, individual U.S. holders of ACE Limited shares are taxed on dividends at advantageous capital gains rates rather than ordinary income tax rates. Currently, there is proposed legislation before both Houses of Congress that would exclude shareholders of foreign corporations from this advantageous capital gains rate treatment unless either (i) the corporation is organized or created in a country that has entered into a “comprehensive income tax treaty” with the U.S. or (ii) the stock of such corporation is readily tradable on an established securities market in the U.S. and the corporation is organized or created in a country that has a “comprehensive income tax system” that the U.S. Secretary of the Treasury determines is satisfactory for this purpose. ACE Limited would not satisfy either of these tests and, accordingly, if this legislation became law, individual U.S. shareholders would no longer qualify for the advantageous capital gains rates on ACE Limited dividends.


ITEM 1B. Unresolved Staff Comments

 

There are currently no unresolved SEC staff comments regarding our periodic or current reports.

 

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ITEM 2. Properties

 

We maintain office facilities around the world including in North America, Bermuda, the U.K., Europe, Latin America, Asia, and the Far East. Most of our office facilities are leased, although we own major facilities in Bermuda and Philadelphia. Management considers its office facilities suitable and adequate for the current level of operations.


ITEM 3. Legal Proceedings

 

Our insurance subsidiaries are subject to claims litigation involving disputed interpretations of policy coverages and, in some jurisdictions, direct actions by allegedly-injured persons seeking damages from policyholders. These lawsuits, involving claims on policies issued by our subsidiaries which are typical to the insurance industry in general and in the normal course of business, are considered in our loss and loss expense reserves which are discussed in the P&C loss reserves discussion. In addition to claims litigation, we and our subsidiaries are subject to lawsuits and regulatory actions in the normal course of business that do not arise from or directly relate to claims on insurance policies. This category of business litigation typically involves, among other things, allegations of underwriting errors or misconduct, employment claims, regulatory activity, or disputes arising from our business ventures.

While the outcomes of the business litigation involving us cannot be predicted with certainty at this point, we are disputing and will continue to dispute allegations against us that are without merit and believe that the ultimate outcomes of the matters in this category of business litigation will not have a material adverse effect on our financial condition, future operating results, or liquidity, although an adverse resolution of a number of these items could have a material adverse effect on our results of operations in a particular quarter or fiscal year.

More information relating to legal proceedings is set forth in Note 9 to the Consolidated Financial Statements, under Item 8.


ITEM 4. Submission of Matters to a Vote of Security Holders

 

No matters were submitted to a vote of stockholders during the fourth quarter of the fiscal year covered by this report.

 

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EXECUTIVE OFFICERS OF THE COMPANY

 

The table below sets forth the names, ages, positions, and business experience of the executive officers of ACE Limited.

 

Name    Age    Position

Evan G. Greenberg

   53    Chairman, President, Chief Executive Officer, and Director

John W. Keogh

   43    Chief Executive Officer, ACE Overseas General

Brian E. Dowd

   45    Chief Executive Officer, Insurance – North America

Philip V. Bancroft

   48    Chief Financial Officer

Robert F. Cusumano

   51    General Counsel and Secretary

Paul B. Medini

   50    Chief Accounting Officer

Evan G. Greenberg has been a director of ACE since August 2002. Mr. Greenberg was elected Chairman of the Board of Directors in May 2007. Mr. Greenberg was appointed to the position of President and Chief Executive Officer of ACE in May 2004, and in June 2003, was appointed President and Chief Operating Officer of ACE. Mr. Greenberg was appointed to the position of Chief Executive Officer of ACE Overseas General in April 2002. He joined ACE as Vice Chairman, ACE Limited, and Chief Executive Officer of ACE Tempest Re in November 2001. Prior to joining ACE, Mr. Greenberg was most recently President and Chief Operating Officer of American International Group (AIG), a position he held from 1997 until 2000.

John W. Keogh joined ACE as Chief Executive Officer of ACE Overseas General in April 2006. Prior to joining ACE, Mr. Keogh served as Senior Vice President, Domestic General Insurance of AIG, and President and Chief Executive Officer of National Union Fire Insurance Company, AIG’s member company that specializes in D&O and fiduciary liability coverages. Mr. Keogh joined AIG in 1986, and he had served in a number of senior positions there including as Executive Vice President of AIG’s Domestic Brokerage Group, and as President and Chief Operating Officer of AIG’s Lexington Insurance Company unit.

Brian E. Dowd was appointed Chief Executive Officer of Insurance – North America in May 2006. In January 2005, Mr. Dowd was named Chairman and Chief Executive Officer of ACE USA, Chairman of ACE Westchester and President of ACE INA Holdings Inc. From 2002 until 2005, Mr. Dowd was President and Chief Executive Officer of ACE Westchester. In January 2004, he was elected to the position of Office of the Chairman of ACE INA Holdings Inc. – a position which Mr. Dowd currently holds along with that of President. Mr. Dowd served as Executive Vice President, ACE USA Property Division from 1999 through 2001 when he was appointed President, ACE Specialty P&C Group. Mr. Dowd joined ACE in 1995.

Philip V. Bancroft was appointed Chief Financial Officer of ACE in January 2002. For nearly twenty years, Mr. Bancroft worked for PricewaterhouseCoopers LLP. Prior to joining ACE, he served as partner-in-charge of the New York Regional Insurance Practice. Mr. Bancroft had been a partner with PricewaterhouseCoopers LLP for 10 years.

Robert F. Cusumano was appointed General Counsel and Secretary of ACE in March 2005. Mr. Cusumano joined ACE from the international law firm of Debevoise & Plimpton LLP, where he was a partner and a member of the firm’s Litigation Department from 2003 to 2005. From 1990 to 2003, Mr. Cusumano was a partner with the law firm of Simpson Thatcher and Bartlett.

Paul B. Medini was appointed Chief Accounting Officer of ACE in October 2003. For twenty-two years, Mr. Medini worked for PricewaterhouseCoopers LLP. Prior to joining ACE, he served as a partner in their insurance industry practice.

 

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PART II

 


ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

(a) Our Ordinary Shares, par value $0.041666667 per share, have been listed on the New York Stock Exchange since March 25, 1993.

The following table sets forth the high and low closing sales prices of our Ordinary Shares per fiscal quarters, as reported on the New York Stock Exchange Composite Tape for the periods indicated:

 

    2007               2006        
    High       Low       High       Low

Quarter ending March 31

  $ 60.35       $ 53.22       $ 56.66       $ 52.01

Quarter ending June 30

  $ 62.54       $ 57.21       $ 55.54       $ 48.18

Quarter ending September 30

  $ 63.97       $ 54.23       $ 55.98       $ 48.99

Quarter ending December 31

  $ 63.33       $ 56.83       $ 61.16       $ 54.09

 

The last reported sale price of the Ordinary Shares on the New York Stock Exchange Composite Tape on February 26, 2008 was $58.97.

(b) The approximate number of record holders of Ordinary Shares as of February 26, 2008 was 3,092.

(c) The following table represents dividends paid per Ordinary Share to shareholders of record on each of the following dates:

 

Shareholders of Record as of:         Shareholders of Record as of:     

March 31, 2007

   $ 0.25    March 31, 2006    $ 0.23

June 30, 2007

   $ 0.27    June 30, 2006    $ 0.25

September 30, 2007

   $ 0.27    September 30, 2006    $ 0.25

December 31, 2007

   $ 0.27    December 31, 2006    $ 0.25

 

ACE Limited is a holding company whose principal source of income is investment income and dividends from its operating subsidiaries. The ability of the operating subsidiaries to pay dividends to us and our ability to pay dividends to our shareholders are each subject to legal and regulatory restrictions. The declaration and payment of future dividends will be at the discretion of the Board of Directors and will be dependent upon the profits and financial requirements of ACE and other factors, including legal restrictions on the payment of dividends and such other factors as the Board of Directors deems relevant. Refer to Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

(d) The following table provides information with respect to purchases by the Company of its Ordinary Shares during the three months ended December 31, 2007:

 

Issuer’s Purchases of Equity Securities

 

Period  

Total Number

of Shares

Purchased*

     

Average Price
Paid per

Share

     

Total Number

of Shares

Purchased as
Part of Publicly

Announced Plan**

     

Approximate Dollar
Value of Shares

that May Yet

Be Purchased
Under the Plan**

October 1, 2007 through October 31, 2007

  4,111       $ 61.30             $ 250 million

November 1, 2007 through November 30, 2007

  794       $ 57.93             $ 250 million

December 1, 2007 through December 31, 2007

  6,997       $ 59.66             $ 250 million

Total

  11,902                       $ 250 million

* For the three months ended December 31, 2007, this column represents the surrender to the Company of 11,902 Ordinary Shares to satisfy tax withholding obligations in connection with the vesting of restricted stock issued to employees.

** As part of ACE’s capital management program, in November 2001, the Company’s Board of Directors authorized the repurchase of any ACE issued debt or capital securities including Ordinary Shares, up to $250 million. At December 31, 2007, this authorization had not been utilized.

 

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(e) Set forth below is a line graph comparing the dollar change in the cumulative total shareholder return on the Company’s Ordinary Shares from December 31, 2002, through December 31, 2007, as compared to the cumulative total return of the Standard & Poor’s 500 Stock Index and the cumulative total return of the Standard & Poor’s Property-Casualty Insurance Index. The chart depicts the value on December 31, 2003, 2004, 2005, 2006, and 2007, of a $100 investment made on December 31, 2002, with all dividends reinvested.

 

LOGO

 

    Years ended December 31
    2002   2003   2004   2005   2006   2007

ACE Limited

  $ 100   $ 144   $ 152   $ 194   $ 223   $ 232

S&P 500 Index

  $ 100   $ 129   $ 143   $ 151   $ 174   $ 186

S&P 500 P&C Index

  $ 100   $ 126   $ 139   $ 160   $ 181   $ 156

 

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ITEM 6. Selected Financial Data

 

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 Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

 

(in millions of U.S. dollars, except share, per share data,
and selected data)
  2007         2006         2005         2004         2003  

Operations data:

                                                       

Net premiums earned

  $ 12,297         $ 11,825         $ 11,748         $ 11,110         $ 9,727  

Net investment income

    1,918           1,601           1,264           1,013           900  

Net realized gains (losses)

    (61 )         (98 )         76           197           265  

Losses and loss expenses

    7,351           7,070           8,571           7,690           6,167  

Life and annuity benefits

    168           123           143           175           182  

Policy acquisition costs and administrative expenses

    3,226           3,171           2,924           2,824           2,539  

Interest expense

    175           176           174           183           177  

Other (income) expense

    81           (35 )         (25 )         9           34  

Income tax expense

    575           522           273           286           311  

Income before cumulative effect

    2,578           2,301           1,028           1,153           1,482  

Cumulative effect of a change in accounting principle (net of income tax)

              4                                

Net income

    2,578           2,305           1,028           1,153           1,482  

Dividends on Preferred Shares

    (45 )         (45 )         (45 )         (45 )         (26 )

Dividends on Mezzanine equity

                                            (10 )

Net income available to holders of Ordinary Shares

  $ 2,533         $ 2,260         $ 983         $ 1,108         $ 1,446  

Diluted earnings per share before cumulative effect of a change in accounting principle

  $ 7.66         $ 6.90         $ 3.31         $ 3.88         $ 5.25  

Diluted earnings per share(1)

  $ 7.66         $ 6.91         $ 3.31         $ 3.88         $ 5.25  

Balance sheet data (at end of period):

                                                       

Total investments

  $ 41,779         $ 36,601         $ 31,842         $ 26,925         $ 22,555  

Cash

    510           565           512           498           559  

Total assets

    72,090           67,135           62,440           56,183           49,317  

Net unpaid losses and loss expenses

    23,592           22,008           20,458           17,517           14,674  

Net future policy benefits for life and annuity contracts

    537           508           510           494           477  

Long-term debt

    1,811           1,560           1,811           1,849           1,349  

Trust preferred securities

    309           309           309           412           475  

Total liabilities

    55,413           52,857           50,628           46,338           40,494  

Shareholders’ equity

    16,677           14,278           11,812           9,845           8,823  

Book value per share

  $ 48.89         $ 42.03         $ 34.81         $ 32.65         $ 29.53  

Selected data

                                                       

Loss and loss expense ratio(2)

    61.6%           61.2%           74.5%           70.7%           64.6%  

Underwriting and administrative expense ratio(3)

    26.3%           26.9%           25.0%           25.6%           26.4%  

Combined ratio(4)

    87.9%           88.1%           99.5%           96.3%           91.0%  

Net loss reserves to capital and surplus ratio(5)

    144.7%           157.7%           177.5%           182.9%           171.7%  

Weighted average shares outstanding – diluted

    330,447,721           327,232,022           297,299,883           285,485,472           275,655,969  

Cash dividends per share

  $ 1.06         $ 0.98         $ 0.90         $ 0.82         $ 0.74  

(1) Diluted earnings per share is calculated by dividing net income available to holders of Ordinary Shares by weighted average shares outstanding – diluted.

(2) The loss and loss expense ratio is calculated by dividing the losses and loss expenses by net premiums earned excluding life insurance and reinsurance premiums. Net premiums earned for life insurance and reinsurance were $368 million, $274 million, $248 million, $226 million, and $187 million for the years ended December 31, 2007, 2006, 2005, 2004, and 2003, respectively.

(3) The underwriting and administrative expense ratio is calculated by dividing the policy acquisition costs and administrative expenses by net premiums earned excluding life insurance and reinsurance premiums.

(4) The combined ratio is the sum of the loss and loss expense ratio and the underwriting and administrative expense ratio.

(5) The net loss reserves to capital and surplus ratio is calculated by dividing the sum of the net unpaid losses and loss expenses and net future policy benefits for life and annuity contracts by shareholders’ equity.

 

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ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

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.


Overview

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.

 

Outlook

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.

 

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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.

The financial markets crisis, which was triggered by defaults of sub-prime mortgages in the third quarter of 2007, continues to dominate the landscape and is spreading to other forms of credit and beyond the U.S. This is contributing to a significant slowdown in the U.S. economy, and possibly recession, and we believe this will have a global impact. At the same time, there is the specter of inflation, and efforts to stimulate the U.S. economy may well increase the risk of inflation. Inflation and recession can have an impact on P&C operating results (particularly revenue) and claims frequency and severity. The financial and economic conditions are deteriorating in the face of a soft and softening global P&C market. We are adjusting quickly to ensure all levels of our underwriting organization, with the support of our claims and actuarial groups, focus on and manage risk with a clear recognition of the environment. On the asset side of the balance sheet, our conservative investment posture has served us well. Our exposure to sub-prime asset-backed securities was $135 million at December 31, 2007, which represented less than one percent of our investment portfolio. Refer to “Investments” for more information. On the liability side of the balance sheet, the sub-prime crisis will be a sizable casualty event for the commercial P&C industry and particularly for those who have significant financial institution exposure. While we are underwriters of financial institution D&O and E&O business, it is not a significant part of our portfolio. In fact, we are relatively modest participants in this segment of the market. We estimate the size of the financial institutions market for D&O and E&O to be approximately $3-$4 billion in gross premiums written. ACE writes approximately $188 million of gross premiums in connection with U.S. exposed business which gives us less than a four percent market share. Our net premiums written are $143 million and our average net limit is $7.7 million for D&O and $3.2 million for E&O. All of the business is “claims made,” where determination of coverage is triggered by the date the insured first becomes aware of a claim or potential claim, and all legal defense expenses incurred by the insurer in defending the insured are covered under the policy. We may have losses from sub-prime-related events, and we have reflected that in our 2007 loss and loss expense ratios as appropriate.


Insurance Industry Investigations and Related Matters

Information on the insurance industry investigations and related matters is set forth in Note 9 f) to the Consolidated Financial Statements, under Item 8.


Critical Accounting Estimates

Our Consolidated Financial Statements include amounts that, either by their nature or due to requirements of accounting principles generally accepted in the U.S. (GAAP), are determined using best estimates and assumptions. While we believe that the amounts included in our Consolidated Financial Statements reflect our best judgment, actual amounts could ultimately materially differ from those currently presented. We believe the items that require the most subjective and complex estimates are:

• unpaid loss and loss expense reserves, including asbestos and environmental (A&E) reserves;

• reinsurance recoverable, including a provision for uncollectible reinsurance;

• impairments to the carrying value of our investment portfolio;

• the valuation of deferred tax assets;

• the valuation of derivative instruments related to guaranteed minimum income benefits (GMIB);

• the valuation of goodwill; and

• the assessment of risk transfer for certain structured insurance and reinsurance contracts.

 

We believe our accounting policies for these items are of critical importance to our Consolidated Financial Statements. The following discussion provides more information regarding the estimates and assumptions required to arrive at these amounts and should be read in conjunction with the sections entitled: Prior Period Development, Asbestos and Environmental

 

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and Other Run-off Liabilities, Reinsurance Recoverable on Ceded Reinsurance, Investments, Net Realized Gains (Losses), and Other Income and Expense Items.

 

Unpaid losses and loss expenses

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).

The table below presents a roll-forward of our unpaid losses and loss expenses for the indicated periods.

 

(in millions of U.S. dollars)  

Gross 

Losses 

     

Reinsurance 

Recoverable 

      Net Losses 

Balance at December 31, 2005

  $ 35,055        $ 14,597        $ 20,458 

Losses and loss expenses incurred

    9,902          2,832          7,070 

Losses and loss expenses paid

    (9,230)         (3,771)         (5,459)

Sale of certain run-off reinsurance subsidiaries

    (789)         (317)         (472)

Other (including foreign exchange revaluation)

    579          168          411 

Balance at December 31, 2006

    35,517        $ 13,509        $ 22,008 

Losses and loss expenses incurred

    10,831          3,480          7,351 

Losses and loss expenses paid

    (9,516)         (3,582)         (5,934)

Other (including foreign exchange revaluation)

    280          113          167 

Balance at December 31, 2007

  $ 37,112        $ 13,520        $ 23,592 

 

The process of establishing loss reserves for property and casualty claims can be complex and is subject to considerable variability as it requires the use of informed estimates and judgments based on circumstances known at the date of accrual. The following table shows our total reserves segregated between case reserves (including loss expense reserves) and IBNR reserves at December 31, 2007 and 2006.

 

    2007      

2006

(in millions of U.S. dollars)  

Gross

      Ceded      

Net

     

Gross

      Ceded      

Net

Case reserves

  $ 15,625       $ 6,077       $ 9,548       $ 15,592       $ 6,135       $ 9,457

IBNR

    21,487         7,443         14,044         19,925         7,374         12,551

Total

  $ 37,112       $ 13,520       $ 23,592       $ 35,517       $ 13,509       $ 22,008

 

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The following table segregates the loss reserves by line of business including property and all other, casualty, and personal accident (A&H) at December 31, 2007 and 2006. In the table, loss expenses are defined to include unallocated and allocated loss adjustment expenses. For certain lines, in particular ACE International and ACE Bermuda products, loss adjustment expenses are included in IBNR and not in loss expenses.

 

    2007       2006
(in millions of U.S. dollars)   Gross       Ceded       Net       Gross       Ceded       Net

Property and all other

                                                       

Case reserves

  $ 2,901       $ 1,256       $ 1,645       $ 3,137       $ 1,306       $ 1,831

Loss expenses

    230         55         175         167         34         133

IBNR

    2,824         1,095         1,729         2,509         979         1,530

Subtotal

    5,955         2,406         3,549         5,813         2,319         3,494

Casualty

                                                       

Case reserves

    8,747         3,150         5,597         8,889         3,255         5,634

Loss expenses

    3,348         1,544         1,804         3,023         1,469         1,554

IBNR

    18,070         6,193         11,877         16,926         6,268         10,658

Subtotal

    30,165         10,887         19,278         28,838         10,992         17,846

A&H

                                                       

Case reserves

    370         68         302         351         69         282

Loss expenses

    29         4         25         25         2         23

IBNR

    593         155         438         490         127         363

Subtotal

    992         227         765         866         198         668

Total

                                                       

Case reserves

    12,018         4,474         7,544         12,377         4,630         7,747

Loss expenses

    3,607         1,603         2,004         3,215         1,505         1,710

IBNR

    21,487         7,443         14,044         19,925         7,374         12,551

Total

  $ 37,112       $ 13,520       $ 23,592       $ 35,517       $ 13,509       $ 22,008

 

The judgments used to estimate unpaid loss and loss expense reserves require different considerations depending upon the individual circumstances underlying the insured loss. For example, the reserves established for an excess casualty claim, A&E claims, losses from major catastrophic events, or the IBNR for product lines will each require different assumptions and judgments to be made. Necessary judgments are based on numerous factors and may be revised as additional experience and other data become available and are reviewed, as new or improved methodologies are developed, or as current laws change. Hence, ultimate loss payments will differ from the estimate of the ultimate liability made at the balance sheet date. Changes to our previous estimates of prior period loss reserves can impact the reported calendar year underwriting results by worsening our reported results if the prior year reserves prove to be deficient or improving our reported results if the prior year reserves prove to be redundant. The potential for variation in loss reserves is impacted by numerous factors, which we explain below.

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

 

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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.

Typically, for each product line, one or more standard actuarial reserving methods may be used to estimate ultimate losses and loss expenses and from these estimates a single actuarial provisional estimate is selected. Exceptions to the use of standard actuarial projection methods occur for individual claims of significance that require complex legal, claims, and actuarial analysis and judgment (i.e., A&E account projections or high excess casualty accounts in litigation). In addition, claims arising from catastrophic events require evaluation based upon our exposure at the time of the event and the circumstances of the catastrophe and its post-event impact that do not utilize standard actuarial loss projection methods.

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.

The expected loss ratio for any particular origin year is selected giving consideration to a number of potential factors including historical loss ratios adjusted for intervening premium and loss trends, industry benchmarks, the results of policy level loss modeling at the time of underwriting, and other more subjective considerations of the product line and external environment as noted above. For the more recent origin years, the expected loss ratio for a given origin year is established at the start of the origin year as part of the planning process. This analysis is performed in conjunction with underwriters and management. The expected loss ratio method arrives at an ultimate loss estimate by taking this estimate of the initial expected ultimate loss ratio and multiplying by the corresponding premium base. This method is most commonly used for immature origin periods on product lines where the actual paid or reported loss experience is not yet credible enough to override our initial expectations of the ultimate loss ratio. In addition, the expected loss ratio may be modified should underlying assumptions such as loss trend or premium rate changes differ from the original assumptions.

Our assumed paid and reported development patterns provide a benchmark against which the actual emerging loss experience can be monitored. Where possible, development patterns are selected based on historical loss emergence by origin year with appropriate allowance for changes in business mix, claims handling process, or ceded reinsurance that are likely to lead to a discernible difference between the rate of historical and future loss emergence. For product lines where the historical data is viewed to have low statistical credibility, the selected development patterns will also reflect relevant industry benchmarks and/or experience from similar product lines written elsewhere within ACE. This typically arises for product lines that are relatively immature or with high severity/low frequency portfolios and for which our historical experience exhibits considerable volatility and/or lacks credibility. The paid and reported loss development methods convert the assumed loss emergence pattern to a set of multiplicative factors which are then applied to actual paid or reported losses to arrive at an estimate of ultimate losses for each period. Due to their multiplicative nature, the paid and reported loss development methods magnify deviations between actual and expected loss emergence. Therefore, these methods tend to be favored for more mature origin periods and for those portfolios where the loss emergence has been relatively consistent over time.

The Bornhuetter-Ferguson method is essentially a combination of the expected loss ratio method and the loss development method, under which the loss development method is given more weight as the origin year matures. This approach allows a logical transition between the expected loss ratio method which is generally utilized at earlier maturities and the loss

 

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development methods which are favored at latter maturities. We usually apply this method using reported loss data although paid data may be used.

The applicability of reserve methods will also be determined by the attachment point of the policy or contract with the insured or ceding company. In the case of low attachment points typical of primary or working layer reinsurance, the experience will tend to be more frequency driven. These product types allow for the standard actuarial methods to be used in determining loss reserve levels, as it is often customary to have the appropriate historical record and volume of claims experience to rely upon. In the case of high attachment points typical of excess insurance or excess of loss reinsurance, the experience will tend to be severity driven, as only a loss of significant size will enter the layer. For structured or unique contracts, most common to the financial solutions business (which we have ceased writing) and, to a lesser extent, our reinsurance business, the standard actuarial methods need to be tempered with an analysis of each contract’s terms, original pricing information, subsequent internal and external analyses of the ongoing contracts, market exposures and history, and qualitative input from claims managers.

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;

• Historical variability of loss estimates compared with actual loss experience;

• Perceived credibility of emerged loss experience; and

• Nature and extent of underlying assumptions.

Management does not build in any specific provision for uncertainty.

We do not calculate a range of loss reserve estimates for our individual loss reserve studies. In particular, ranges are not necessarily a true reflection of the potential volatility between loss reserves estimated at the balance sheet date and the ultimate settlement value of losses. This is due to the fact that an actuarial range is developed based on known events as of the valuation date whereas actual volatility or prior period development has historically been reported in subsequent Consolidated Financial Statements, in part from events and circumstances that were unknown as of the original valuation date. While we believe that our recorded reserves are reasonable and represent management’s best estimate for each product line as of the current valuation date, future changes to our view of the ultimate liabilities are possible. A five percent change in our net loss reserves equates to $1.1 billion and represents 37 percent of our net income before taxes for 2007 and seven percent of shareholders’ equity at December 31, 2007. Historically, including A&E reserve charges, our reserves, at times, have developed in excess of 10 percent of recorded amounts. Refer to “Analysis of Losses and Loss Expense Development”, under Item 1 for a summary of historical volatility between estimated loss reserves and ultimate loss settlements.

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.

 

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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

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.

In terms of prior accident years, the bulk of changes made in the 2007 calendar year arose from the 2006 and 2005 accident years. Specifically, the Insurance – Overseas General segment experienced $121 million of favorable development due to lower than anticipated loss emergence on the 2005 and 2006 accident years and the Insurance –North American segment experienced $115 million of adverse development related to 2004 and 2005 catastrophes. In both instances, these prior period movements were primarily the result of changes to the ultimate loss estimates for the respective 2004 to 2006 accident years to better reflect the latest reported loss data rather than any changes to underlying actuarial assumptions such as loss development patterns.

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”.

 

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Long-tail business

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:

• Our historical loss data and experience is often too immature and lacking in credibility to place reliance upon for reserving purposes. Instead, we place reliance in our reserve methods on industry loss ratios or industry benchmark development patterns that are anticipated to reflect the nature and coverage of the underwritten business and its future development. For such product lines, actual loss experience is apt to differ from industry loss statistics that are based on averages as well as loss experience of previous underwriting years;

• The inherent uncertainty around loss trends, claims inflation (e.g., medical and judicial) and underlying economic conditions;

• The inherent uncertainty of the estimated duration of the paid and reporting loss development patterns beyond the historical record requires that professional judgment be used in the determination of the length of the patterns based on the historical data and other information;

• The inherent uncertainty of assuming historical paid and reported loss development patterns on older origin years will be representative of subsequent loss emergence on newer origin years. For example, changes in establishing case reserves can distort reported loss development patterns or changes in ceded reinsurance structures by origin year can distort the development of paid and reported losses;

• The possibility of future litigation, legislative or judicial change that might impact future loss experience relative to prior loss experience relied upon in loss reserve analyses;

• Loss reserve analyses typically require loss or other data be grouped by common characteristics in some manner. If data from two combined lines of business exhibit different characteristics, such as loss payment patterns, the credibility of the reserve estimate could be affected. Additionally, since casualty lines of business can have significant intricacies in the terms and conditions afforded to the insured, there is an inherent risk as to the homogeneity of the underlying data used in performing reserve analyses; and

• The applicability of the price change data used to estimate ultimate loss ratios for most recent origin years.

As can be seen from the above, various factors are considered when determining appropriate data, assumptions, and methods used to establish the loss reserve for the long-tail product lines. These factors will also vary by origin year for given product lines. The derivation of loss development patterns from data and the selection of a tail factor to project ultimate losses from actual loss emergence require considerable judgment, particularly with respect to the extent of historical loss experience that provides credible support to changes in key reserving assumptions. Examples of the relationship between changes in historical loss experience and key reserving assumptions are provided below.

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).

Given the nature of long-tail casualty business and related reserving considerations, for the major long-tail lines in Insurance – North American, Insurance – Overseas General, and Global Reinsurance, no changes of significance were made to

 

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the key actuarial assumptions for the loss trend (aside from changes to inflation assumptions), exposure trend, and loss development patterns used to establish the 2007 accident year reserves relative to prior accident years.

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”.

For more mature accident years, typically 2003 and prior, we used paid and reported loss patterns in the reserve setting process on older accident years where sufficient credibility existed. For those lines lacking data credibility, we placed reliance upon the latest benchmark patterns (where available) from external industry bodies such as Insurance Services Office (ISO) or the National Council on Compensation Insurance, Inc. (NCCI). Accordingly, the assumptions used to project loss estimates will not fully reflect our own actual loss experience until credibility is determined.

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.

While we believe our reserve for unpaid losses and loss expenses at December 31, 2007, is adequate, new information or emerging trends different from assumptions may lead to future developments in ultimate losses and loss expenses significantly greater or less than the reserve provided, which could have a material effect on future operating results. As noted previously, our best estimate of required loss reserves for most portfolios is judgmentally selected for each origin year after considering the results from any number of reserving methodologies rather than being a purely mechanical process. Therefore, it is difficult to convey, in a simple and quantitative manner, the impact that a change to a single assumption will have on our best estimate. In the examples shown below, we attempt to give an indication of the potential impact by isolating a single change for a specific reserving method that would be pertinent in establishing the best estimate for the product line described. We consider each of the following sensitivity analyses to represent a reasonably likely deviation in the underlying assumption.

 

Insurance – North American

Given the long reporting and paid development pattern, the tail factors used to project actual current losses to ultimate losses for claims covered by our inactive middle market workers’ compensation business requires considerable judgment that could be material to consolidated loss and loss expense reserves. Specifically, when applying the paid loss development method, a one percent change in the tail factor (i.e., 1.04 changed to either 1.05 or 1.03) would cause a change of approximately $46 million, either positively or negatively, for the projected net loss and loss expense reserves. This is relative to recorded net loss and loss expense reserves of approximately $285 million.

Our ACE Bermuda operations write predominantly high excess liability coverage on an occurrence-first-reported basis (typically with attachment points in excess of $300 million and limits of $100 million gross or less) and D&O and other professional-liability coverage on a claims-made basis (typically with attachment points in excess of $100 million and limits of $50 million gross or less). Claims development for this business can vary significantly for individual claims and historically could vary by as much as $50 million per claim for professional liability and $100 million per claim for excess liability depending on the nature of the loss.

 

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Insurance – Overseas General

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.

 

Global Reinsurance

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.

 

Assumed reinsurance

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.

For catastrophe business, we principally estimate unpaid losses and loss expenses on an event basis by considering various sources of information, including specific loss estimates reported by our cedants, ceding company and overall industry loss estimates reported by our brokers, and our internal data regarding reinsured exposures related to the geographical location of the event. Our internal data analysis enables us to establish catastrophe reserves for known events with more certainty at an earlier date than would be the case if we solely relied on reports from third parties to determine carried reserves.

For our casualty reinsurance business, we generally rely on ceding companies to report claims and then use that data as a key input to estimate unpaid losses and loss expenses. Due to the reliance on claims information reported by ceding companies, as well as other factors, the estimation of unpaid losses and loss expenses for assumed reinsurance includes certain risks and uncertainties that are unique relative to our direct insurance business. These include, but are not necessarily limited to, the following:

• The reported claims information could be inaccurate;

• Typically, a lag exists between the reporting of a loss event to a ceding company and its reporting to us as a reinsurance claim. The use of a broker to transmit financial information from a ceding company to us increases the reporting lag. Because most of our reinsurance business is produced by brokers, ceding companies generally first submit claim and other financial information to brokers, who then report the proportionate share of such information to each reinsurer of a particular treaty. The reporting lag generally results in a longer period of time between the date a claim is incurred and the date a claim is reported compared with direct insurance operations. Therefore, the risk of delayed recognition of loss reserve development is higher for assumed reinsurance than for direct insurance lines; and

• The historical claims data for a particular reinsurance contract can be limited relative to our insurance business in that there may be less historical information available. Further, for certain coverages provided by products, such as excess of loss contracts, there may be relatively few expected claims in a particular year so the actual number of claims may be susceptible to significant variability. In such cases, the actuary often relies on industry data from several recognized sources.

We mitigate the above risks in several ways. In addition to routine analytical reviews of ceding company reports to ensure reported claims information appears reasonable, we perform regular underwriting and claims audits of certain ceding companies to ensure reported claims information is accurate, complete, and timely. As appropriate, audit findings are used to adjust claims in the reserving process. We also use our knowledge of the historical development of losses from individual ceding companies to adjust the level of adequacy we believe exists in the reported ceded losses.

 

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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.)

 

Asbestos and environmental reserves

Included in our liabilities for losses and loss expenses are liabilities for asbestos and environmental claims and expenses. These claims are principally related to claims arising from remediation costs associated with hazardous waste sites and bodily-injury claims related to exposure to asbestos products and environmental hazards. The estimation of these liabilities is particularly sensitive to the recent legal environment, including specific settlements that may be used as precedents to settle future claims.

During 2007, we conducted a review of our consolidated A&E liabilities as of June 30, 2007. As a result of the internal review, we concluded that our net loss reserves for the Brandywine operations, including A&E, were adequate and, therefore, no change to the carried reserve was required. An internal review was also conducted during 2006 for our consolidated A&E liabilities as of June 30, 2006. For that review, we concluded that our net loss reserves for the Brandywine operations, including A&E, were adequate and, therefore, no change to the carried net reserve was required, while the gross loss reserves increased by approximately $210 million.

In 2006, a team of external actuaries performed an evaluation as to the adequacy of the reserves of Century Indemnity Company (Century). This external review was conducted in accordance with the Brandywine Restructuring Order, which requires that an external actuarial review of Century’s reserves be completed every two years. The results of the external review were addressed with the Pennsylvania Insurance Department and no changes to statutory-basis loss reserves were deemed necessary. Our A&E reserves are not discounted and do not reflect any anticipated future changes in the legal, social, or economic environment, or any benefit from future legislative reforms.

There are many complex variables that we consider when estimating the reserves for our inventory of asbestos accounts and these variables may directly impact the predicted outcome. We believe the most significant variables relating to our A&E reserves include assumptions regarding trends with respect to claim severity and the frequency of higher severity claims, the ability of a claimant to bring a claim in a state in which they have no residency or exposure, the ability of a policyholder to claim the right to non-products coverage, whether high-level excess policies have the potential to be accessed given the policyholders claim trends and liability situation, and payments to unimpaired claimants and the potential liability of peripheral defendants. Based on the policies, the facts, the law, and a careful analysis of the impact that these factors will likely have on any given account, we estimate the potential liability for indemnity, policyholder defense costs, and coverage litigation expense.

The results in asbestos cases announced by other carriers may well have little or no relevance to us because coverage exposures are highly dependent upon the specific facts of individual coverage and resolution status of disputes among carriers, policyholders, and claimants.

Refer to “Asbestos and Environmental and Other Run-off Liabilities” for more information.

 

Reinsurance recoverable

Reinsurance recoverable includes the balances due to us from reinsurance companies for paid and unpaid losses and loss expenses, and is presented net of a provision for uncollectible reinsurance. The provision for uncollectible reinsurance is determined based upon a review of the financial condition of the reinsurers and other factors. Ceded reinsurance contracts do not relieve our primary obligation to our policyholders. Consequently, an exposure exists with respect to reinsurance recover-

 

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able to the extent that any reinsurer is unable to meet its obligations or disputes the liabilities assumed under the reinsurance contracts. We determine the reinsurance recoverable on unpaid losses and loss expenses using actuarial estimates as well as a determination of our ability to cede unpaid losses and loss expenses under existing reinsurance contracts.

The recognition of a reinsurance recoverable asset requires two key judgments. The first judgment involves our estimation based on the amount of gross reserves and the percentage of that amount which may be ceded to reinsurers. Ceded IBNR, which is a major component of the reinsurance recoverable on unpaid losses and loss expenses, 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 (refer to “Critical Accounting Estimates – Unpaid losses and loss expenses”). The second judgment involves our estimate of the amount of the reinsurance recoverable balance that we may ultimately be unable to recover from reinsurers due to insolvency, contractual dispute, or for other reasons. Amounts estimated to be uncollectible are reflected in a provision that reduces the reinsurance recoverable asset and, in turn, shareholders’ equity. Changes in the provision for uncollectible reinsurance are reflected in net income.

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.

To estimate the provision for uncollectible reinsurance, the reinsurance recoverable must first be determined for each reinsurer. This determination is based on a process rather than an estimate, although an element of judgment must be applied. As part of the process, ceded IBNR is allocated to reinsurance contracts because ceded IBNR is not generally calculated on a contract by contract basis. The allocations are generally based on premiums ceded under reinsurance contracts, adjusted for actual loss experience and historical relationships between gross and ceded losses. If actual experience varies materially from historical experience, including that used to determine ceded premium, the allocation of reinsurance recoverable by reinsurer will change. While such change is unlikely to result in a large percentage change in the provision for uncollectible reinsurance, it could, nevertheless, have a material effect on our net income in the period recorded.

Generally, we use a default analysis to estimate uncollectible reinsurance. The primary components of the default analysis are reinsurance recoverable balances by reinsurer, net of collateral, and default factors used to estimate the probability that the reinsurer may be unable to meet its future obligations in full. The definition of collateral for this purpose requires some judgment and is generally limited to assets held in an ACE-only beneficiary trust, letters of credit, and liabilities held by us with the same legal entity for which we believe there is a right of offset. We do not currently include multi-beneficiary trusts. However, we have several reinsurers that have established multi-beneficiary trusts for which certain of our companies are beneficiaries. The determination of the default factor is principally based on the financial strength rating of the reinsurer and a corresponding default factor applicable to the financial strength rating. Default factors require considerable judgment and are determined using the current financial strength rating, or rating equivalent, of each reinsurer as well as other key considerations and assumptions. Significant considerations and assumptions include, but are not necessarily limited to, the following:

• 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;

• For balances recoverable from reinsurers that are both unrated by a major rating agency and for which management is unable to determine a credible rating equivalent based on a parent, affiliate, or peer company, we determine a rating equivalent based on an analysis of the reinsurer that considers an assessment of the creditworthiness of the particular entity, industry benchmarks, or other factors as considered appropriate. We then apply the applicable default factor for that rating class. For balances recoverable from unrated reinsurers for which our ceded reserve is below a certain threshold, we generally apply a default factor of 25 percent;

 

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• For balances recoverable from reinsurers that are either insolvent or under regulatory supervision, we establish a default factor and resulting provision for uncollectible reinsurance based on specific facts and circumstances surrounding each company. Upon initial notification of an insolvency, we generally recognize expense for a substantial portion of all balances outstanding, net of collateral, through a combination of write-offs of recoverable balances and increases to the provision for uncollectible reinsurance. When regulatory action is taken on a reinsurer, we generally recognize a default factor by estimating an expected recovery on all balances outstanding, net of collateral. When sufficient credible information becomes available, we adjust the provision for uncollectible reinsurance by establishing a default factor pursuant to information received; and

• For captives and other recoverables, management determines the provision for uncollectible reinsurance based on the specific facts and circumstances.

The following table summarizes reinsurance recoverables and the provision for uncollectible reinsurance for each type of recoverable balance at December 31, 2007.

 

(in millions of U.S. dollars)   Total
Reinsurance
Recoverables
      Recoverables
(Net of Usable
Collateral)
      Provision for
Uncollectible
Reinsurance

Type

                         

Reinsurers with credit ratings

  $ 11,452       $ 10,561       $ 232

Reinsurers not rated

    708         583         259

Reinsurers under supervision and insolvent reinsurers

    195         181         128

Captives

    1,508         423         21

Other – structured settlements and pools

    1,185         1,185         46

Total

  $ 15,048       $ 12,933       $ 686

 

At December 31, 2007, the use of different assumptions within our approach could have a material effect on the provision for uncollectible reinsurance reflected in our Consolidated Financial Statements. To the extent the creditworthiness of our reinsurers were to deteriorate due to an adverse event affecting the reinsurance industry, such as a large number of major catastrophes, actual uncollectible amounts could be significantly greater than our provision for uncollectible reinsurance. Such an event could have a material adverse effect on our financial condition, results of operations, and our liquidity. Given the various considerations used to estimate our uncollectible provision, we cannot precisely quantify the effect a specific industry event may have on the provision for uncollectible reinsurance. However, based on the composition (particularly the average credit quality) of the reinsurance recoverable balance at December 31, 2007, we estimate that a ratings downgrade of one notch for all rated reinsurers (i.e, from A to A- or A- to BBB+) could increase our provision for uncollectible reinsurance by approximately $166 million or approximately one percent of the reinsurance recoverable balance, assuming no other changes relevant to the calculation. While a ratings downgrade would result in an increase in our provision for uncollectible reinsurance and a charge to earnings in that period, a downgrade in and of itself does not imply that we will be unable to collect all of the ceded reinsurance recoverable from the reinsurers in question. Refer to Note 4 to the Consolidated Financial Statements, under Item 8, for more information.

 

Investments

Our fixed maturity investments are classified as either “available for sale” or “held to maturity”. Our available for sale portfolio is reported at fair value with changes in fair value reflected in shareholders’ equity as a separate component of accumulated other comprehensive income. Fair value is determined using the quoted market price of these securities provided by either independent pricing services, or when such prices are not available, by reference to broker or underwriter bid indications. We regularly review our impaired investments (i.e., those debt securities for which fair value is below amortized cost or those equity securities for which fair value is below cost) for a possible “other-than-temporary” impairment. If we believe a decline in the value of a particular investment is temporary, we record the decline as an unrealized loss in our shareholders’ equity. If we believe the decline is “other-than-temporary”, we write down the book value of the investment and record a realized loss in our consolidated statement of operations. An impairment is considered “other-than-temporary” unless we have the ability and intent to hold the investment to recovery of the cost of the investment, and evidence indicating the cost of the investment is recoverable within a reasonable period outweighs evidence to the contrary. The determination as to whether or not the decline is “other-than-temporary” principally requires the following critical judgments: i) the circumstances that require management to make a specific assessment as to whether or not the decline is “other-than-temporary”, such as the time period an investment has been in a loss position and the significance of the decline; and ii) for those securities to be assessed, whether we have the

 

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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.

Because our investment portfolio is the largest component of consolidated assets and a multiple of shareholders’ equity, adverse changes in economic conditions subsequent to the balance sheet date could result in “other-than-temporary” impairments that are material to our financial condition and operating results. Such economic changes could arise from overall changes in the financial markets and specific changes to industries, companies, or foreign governments in which we maintain relatively large investment holdings. Further, an increase in interest rates could result in an increased number of fixed maturities for which we cannot support the intent to hold to recovery. More information regarding our process for reviewing our portfolio for possible impairments can be found in the section entitled “Net Realized Gains (Losses)”.

 

Deferred tax assets

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.

 

Guaranteed minimum income benefits derivatives

Under reinsurance programs covering living benefit guarantees, we assume the risk of guaranteed minimum income benefits associated with variable annuity contracts. Our GMIB reinsurance product meets the definition of a derivative for accounting purposes and is therefore carried at fair value with changes in fair value recognized in net realized gains (losses) in the period of the change pursuant to Statement of Financial Accounting Standard No. 133, Accounting for Derivative Instruments and Hedging Activities (FAS 133). We believe that the most meaningful presentation of these derivatives is to reflect cash inflows or revenue as net premiums earned, and to record estimates of the average modeled value of future cash outflows as incurred losses. For GMIB reinsurance, we recognize benefit reserves consistent with AICPA Statement of Position 03-1, Accounting and Reporting by Insurance Enterprises for Certain Non-traditional Long-duration Contracts and for Separate Accounts (SOP 03-1). Changes in this reserve are included in life underwriting income. The incremental difference between fair value and SOP 03-1 benefit reserves is reflected in other assets or other liabilities in the balance sheet and related changes in fair value are reflected in net realized gains (losses) in the consolidated statement of operations. We generally hold these derivative con-

 

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tracts to maturity. Where we hold a derivative to maturity, the cumulative gains and losses will net to zero. Refer to Note 2j) to the Consolidated Financial Statements, under Item 8, for further description of this product and related accounting treatment. For a sensitivity discussion of the effect of changes in interest rates and equity indices on the fair value of GMIBs, and the resulting impact on our net income, refer to Item 7A.

The fair value of GMIB reinsurance is estimated using an internal valuation model which includes the use of management estimates and current market information. All of our treaties contain claim limits, which are factored into the valuation model. The fair value depends on a number of factors, including changes in interest rates, changes in equity markets, changes in market volatility, changes in policyholder behavior, and changes in policyholder mortality. The model and related assumptions are continuously re-evaluated by management and enhanced, as appropriate, based upon improvements in modeling techniques and availability of more timely market information, such as market conditions and demographics of in-force annuities. Due to the inherent uncertainties of the assumptions used in the valuation models to determine the fair value of these derivative products, actual experience may differ from the estimates reflected in our Consolidated Financial Statements, and the differences may be material.

The two most significant policyholder behavior assumptions include lapse rates and annuitization rates using the guaranteed benefit (GMIB annuitization rate). Assumptions regarding lapse rates and GMIB annuitization rates differ by treaty but the underlying methodology to determine rates applied to each treaty is comparable. The assumptions regarding lapse and GMIB annuitization rates determined for each treaty are based on a dynamic calculation that uses several underlying factors. The effect of changes in key market factors on assumed lapse and annuitization rates is principally based on historical experience for variable annuity contracts as well as considerable judgment, particularly for newer benefits with limited historical experience.

A lapse rate is the percentage of in-force policies surrendered in a given calendar year. All else equal, as lapse rates increase, ultimate claim payments will decrease. The GMIB annuitization rate is the percentage of policies for which the customer will elect to annuitize using the guaranteed benefit provided under the GMIB. All else equal, as GMIB annuitization rates increase, ultimate claim payments will increase, subject to treaty claim limits.

Key factors affecting the lapse rate assumption include investment performance and policy duration. We generally assume that lapse rates increase with policy duration with a significant increase in rates after the end of the surrender charge period. As investment performance of underlying fund investments declines, and guarantees become more valuable, lapse rates are anticipated to decrease thereby increasing the expected value of claims on minimum guarantees and thus benefit reserves and the incremental fair value liability.

Key factors affecting the GMIB annuitization rate include investment performance and interest rates after the GMIB waiting period. As investment performance of underlying fund investments declines, the monthly income available to a policyholder who annuitizes their account value falls; this makes the GMIB more valuable. As the GMIB becomes more valuable, our modeling assumes that annuitization rates will increase, resulting in higher benefit reserves and fair value liability. The same is true in an environment where long-term interest rates are decreasing.

Net realized losses for 2007 included $185 million for GMIB reinsurance, compared with $nil in 2006 and net realized gains of $18 million in 2005, excluding changes in the fair value of specific derivative instruments held to partially offset the risk in the variable annuity guarantee reinsurance portfolio. These derivatives do not receive hedge accounting treatment. Refer to “Net Realized Gains (Losses)” for more information.

 

Goodwill

Goodwill, which represents the excess of the cost of our acquisitions over the fair value of net assets we acquired, was $2.7 billion at December 31, 2007. The ACE INA acquisition resulted in approximately 80 percent of this balance. Goodwill is not amortized but is subject to a periodic evaluation of impairment. It is our policy to test goodwill as well as other intangible assets for impairments on an annual basis. The impairment tests in 2007, in the aggregate, show a fair value in excess of the carrying value. Goodwill is assigned to applicable reporting units of acquired entities at acquisition. The most significant reporting units are the domestic and international divisions of ACE INA acquired in 1999; ACE Tempest Re’s catastrophe businesses acquired in 1996 and 1998; and Tarquin Limited acquired in 1998. There are other reporting units that resulted from smaller acquisitions that are also assessed annually. In our impairment tests, to estimate the fair value of a reporting unit, we principally use both an earnings model, which considers forecasted earnings and other financial ratios of the reporting unit as well as relevant financial data of comparable companies to the reporting unit such as the relationship of price to earnings for recent transactions and market valuations of publicly traded companies, and an analysis of the present value of estimated net cash flows. We must assess whether the current fair value of our operating units is at least equal to the fair value used in the determination of goodwill. In doing this, we make assumptions and estimates about the profitability attributable to our operat-

 

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ing segments, as this is important in assessing whether an impairment has occurred. If, in the future, our assumptions and estimates made in assessing the fair value of acquired entities change, goodwill could be materially adjusted. This would cause us to write-down the carrying value of goodwill and could have a material adverse effect on our results of operations in the period the charge is taken.

 

Risk transfer

In the ordinary course of business, we both purchase (or cede) and sell (or assume) P&C reinsurance protection. In 2002, as a matter of policy, we discontinued the purchase of all finite reinsurance contracts. For both ceded and assumed reinsurance, risk transfer requirements must be met in order to use reinsurance accounting, principally resulting in the recognition of cash flows under the contract as premiums and losses. If risk transfer requirements are not met, a contract is to be accounted for as a deposit, typically resulting in the recognition of cash flows under the contract through a deposit asset or liability and not as revenue or expense. To meet risk transfer requirements, a reinsurance contract must include both insurance risk, consisting of underwriting and timing risk, and a reasonable possibility of a significant loss for the assuming entity. We also apply similar risk transfer requirements to determine whether certain commercial insurance contracts should be accounted for as insurance or a deposit. Contracts that include fixed premium (i.e., premium not subject to adjustment based on loss experience under the contract) for fixed coverage generally transfer risk and do not require judgment.

Reinsurance and insurance contracts that include both significant risk sharing provisions, such as adjustments to premiums or loss coverage based on loss experience, and relatively low policy limits as evidenced by a high proportion of maximum premium assessments to loss limits, can require considerable judgment to determine whether or not risk transfer requirements are met. For such contracts, often referred to as finite or structured products, we require that risk transfer be specifically assessed for each contract by developing expected cash flow analyses at contract inception. To support risk transfer, the cash flow analyses must support the fact that a significant loss is reasonably possible, such as a scenario in which the ratio of the net present value of losses divided by the net present value of premiums equals or exceeds 110 percent. For purposes of cash flow analyses, we generally use a risk-free rate of return consistent with the expected average duration of loss payments. In addition, to support insurance risk, we must prove the reinsurer’s risk of loss varies with that of the reinsured and/or support various scenarios under which the assuming entity can recognize a significant loss.

To ensure risk transfer requirements are routinely assessed, quantitative risk transfer analyses and memoranda supporting risk transfer are developed by underwriters for all structured products. We have established protocols for structured products that include criteria triggering an accounting review of the contract prior to quoting. If any criterion is triggered, a contract must be reviewed by a committee established by each of our operating segments with reporting oversight, including peer review, from our global Structured Transaction Review Committee.

With respect to ceded reinsurance, we entered into a few multi-year excess of loss retrospectively-rated contracts, principally in 2002, some of which remain in-force. These contracts principally provide severity protection for specific product divisions. Because traditional one-year reinsurance coverage had become relatively costly, these contracts were generally entered into to secure a more cost-effective reinsurance program. All of these contracts transferred risk and have been accounted for as reinsurance. In addition, we maintain a few aggregate excess of loss reinsurance contracts that were principally entered into prior to 2003, such as the National Indemnity Company (NICO) contracts referred to in the section entitled, “Asbestos and Environmental and Other Run-off Liabilities”. Subsequent to the ACE INA acquisition, we have not purchased any retroactive ceded reinsurance contracts.

With respect to assumed reinsurance and insurance contracts, products giving rise to judgments regarding risk transfer were primarily sold by our financial solutions business. Although we have ceased writing financial solutions business, several contracts remain in-force and principally include multi-year retrospectively-rated contracts and loss portfolio transfers. Because transfer of insurance risk is generally a primary client motivation for purchasing these products, relatively few P&C insurance and reinsurance contracts have historically been written for which we concluded that risk transfer criteria had not been met. For certain insurance contracts that have been reported as deposits, the insured desired to self-insure a risk but was required, legally or otherwise, to purchase insurance so that claimants would be protected by a licensed insurance company in the event of non-payment from the insured.

A significant portion of ACE Tempest Re USA’s business is written through quota share treaties (approximately $461 million of net premiums earned in 2007, comprised of $324 million of first dollar quota share treaties and $137 million of excess quota share treaties), some of which are categorized as structured products. Structured quota share treaties typically contain relatively low aggregate policy limits, a feature that reduces loss coverage in some manner and a profit sharing provision. Accounting standard setters for both GAAP and statutory reporting have undertaken projects to re-evaluate risk transfer guidance, including accounting models that could ultimately require the bifurcation of structured quota share treaties into

 

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insurance and financing elements, and perhaps other quota share contracts not currently categorized as structured, into a reinsurance and financing component. New guidance in this area has the potential to have a significant impact on the amount of premiums and losses recognized under these contracts but we expect little impact to our net income.

 

Consolidated Operating Results – Years Ended December 31, 2007, 2006, and 2005

 

(in millions of U.S. dollars)   2007         2006         2005  

Net premiums written

  $ 11,979         $ 12,030         $ 11,792  

Net premiums earned

    12,297           11,825           11,748  

Net investment income

    1,918           1,601           1,264  

Net realized gains (losses)

    (61 )         (98 )         76  

Total revenues

  $ 14,154         $ 13,328         $ 13,088  

Losses and loss expenses

    7,351           7,070           8,571  

Life and annuity benefits

    168           123           143  

Policy acquisition costs

    1,771           1,715           1,663  

Administrative expenses

    1,455           1,456           1,261  

Interest expense

    175           176           174  

Other (income) expense

    81           (35 )         (25 )

Total expenses

    11,001           10,505           11,787  

Income before income tax

    3,153           2,823           1,301  

Income tax expense

    575           522           273  

Cumulative effect of a change in accounting principle

              4            

Net income

  $ 2,578         $ 2,305         $ 1,028  

 

Net premiums written, which reflect the premiums we retain after purchasing reinsurance protection, decreased slightly in 2007, compared with 2006. During 2007, we experienced competitive conditions, particularly in our Global Reinsurance segment, offset by favorable foreign exchange impact and growth in our international A&H business. Our ACE USA operations reported modest growth driven primarily by specialty casualty and energy lines as well as professional risk and a large assumed portfolio contract. ACE Westchester Specialty (ACE Westchester) reported a decrease in production due to very competitive conditions on P&C lines. Net premiums written increased two percent in 2006, compared with 2005. The increase was primarily driven by production gains in many of ACE USA’s and ACE Westchester’s businesses, A&H growth at ACE International, and increased rates on short-tail lines at ACE Global Markets. These increases were partially offset by a decline in international financial solutions business, which we have ceased writing. The 2005 year was impacted by net catastrophe-related reinstatement premiums, which reduced net premiums written and earned by $68 million.

The following table provides a consolidated breakdown of net premiums earned by line of business for the years ended December 31, 2007, 2006, and 2005.

 

(in millions of U.S. dollars)   2007      

% of

total

      2006      

% of

total

      2005      

% of

total

Property and all other

  $ 3,787       31%       $ 3,618       31%       $ 3,560       30%

Casualty

    6,464       52%         6,506       55%         6,698       57%

Personal accident (A&H)

    1,678       14%         1,427       12%         1,242       11%

Total P&C

    11,929       97%         11,551       98%         11,500       98%

Life

    368       3%         274       2%         248       2%

Net premiums earned

  $ 12,297       100%       $ 11,825       100%       $ 11,748       100%

 

Net premiums earned reflect the portion of net premiums written that were recorded as revenues for the period as the exposure period expires. Net premiums earned increased four percent in 2007, compared with 2006. This increase was primarily related to increased production at ACE USA and ACE International as well as our life operations, partially offset by decreased production at our Global Reinsurance segment. Net premiums earned were stable in 2006, compared with 2005 as increases in A&H were offset by significant decreases in financial solutions business, which we have ceased writing.

 

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Net investment income increased 20 percent in 2007, compared with 2006, and 27 percent in 2006, compared with 2005. These increases were primarily due to investment of positive operating cash flows and net proceeds from our approximately $1.5 billion public offering in October 2005, which have resulted in a higher overall average invested asset base.

In evaluating our P&C business, we use the combined ratio, the loss and loss expense ratio, the policy acquisition cost ratio, and the administrative expense ratio. We calculate these ratios by dividing the respective expense amounts by net premiums earned. We do not calculate these ratios for the life business as we do not use these measures to monitor or manage that business. The combined ratio is determined by adding the loss and loss expense ratio, the policy acquisition cost ratio, and the administrative expense ratio. A combined ratio under 100 percent indicates underwriting income and a combined ratio exceeding 100 percent indicates underwriting losses.

The following table shows our consolidated loss and loss expense ratio, policy acquisition ratio, administrative expense ratio, and combined ratio for the years ended December 31, 2007, 2006, and 2005.

 

    2007       2006       2005

Loss and loss expense ratio

  61.6%       61.2%       74.5%

Policy acquisition cost ratio

  14.5%       14.6%       14.2%

Administrative expense ratio

  11.8%       12.3%       10.8%

Combined ratio

  87.9%       88.1%       99.5%

 

The following table shows the impact of catastrophe losses and prior period development on our loss and loss expense ratio for the years ended December 31, 2007, 2006, and 2005.

 

    2007       2006       2005

Loss and loss expense ratio, as reported

  61.6 %       61.2 %       74.5 %

Catastrophe losses

  (1.3)%       (0.1)%       (11.4)%

Prior period development

  1.8 %       0.1 %       (0.7)%

Loss and loss expense ratio, adjusted

  62.1 %       61.2 %       62.4 %

 

We recorded $159 million in net catastrophe losses in 2007, compared with $17 million in 2006, and $1.4 billion in 2005. For 2007, our catastrophe losses were primarily related to floods in the U.K., Australia, and the U.S. and also include the impact of European windstorm Kyrill. In 2005, the catastrophe losses were primarily associated with Hurricanes Katrina, Rita, and Wilma.

Prior period development arises from changes to loss estimates recognized in the current year that relate to loss reserves first reported in previous calendar years and excludes the effect of losses from the development of earned premium from previous accident years. We experienced $217 million of net favorable prior period development in 2007. This compares with $12 million of net favorable prior period development in 2006, and $86 million of net adverse prior period development in 2005. The favorable prior period development in 2007 was the net result of several underlying favorable and adverse movements; refer to “Prior Period Development”. Our loss and loss expense ratio was negatively impacted by an increase in current year accident losses, reflecting current market conditions.

Our policy acquisition costs include commissions, premium taxes, underwriting, and other costs that vary with, and are primarily related to, the production of premium. Administrative expenses include all other operating costs. For 2007, our policy acquisition cost ratio was stable. A&H business typically incurs higher acquisition costs relative to other lines, and therefore, our growth in this area has had a negative impact on our policy acquisition cost ratio. This increasing trend on our policy acquisition costs was offset in 2007 by reduced ceding commission at ACE Tempest Re USA. Our policy acquisition cost ratio increased in 2006 primarily due to changes in business mix and the favorable impact in 2005 of net premiums earned on multi-year contracts in connection with the significant 2005 catastrophe losses which, generally, did not incur acquisition costs.

Our administrative expenses in 2007 were stable compared with 2006, despite an adverse impact of foreign exchange. We continue to focus on reducing expenses where possible. Our administrative expense ratio decreased in 2007, compared with 2006, due to the increase in net premiums earned. For 2006, the administrative expense ratio increased, compared with 2005, primarily due to global expansion, including staff additions and infrastructure enhancements at ACE USA, ACE Westchester, ACE Life, and ACE International. Administrative expenses in 2006 also include $80 million related to the settlement with certain governmental agencies from their investigations of various insurance industry practices. For 2005, administrative

 

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expenses were reduced by the release of an accrual in Insurance – North American and higher net profits from ACE USA’s ESIS (claims services) operation, which we include in administrative expenses.

Our effective income tax rate, which we calculate as income tax expense divided by income before income tax, is dependent upon the mix of earnings from different jurisdictions with various tax rates. A change in the geographic mix of earnings would change the effective income tax rate. Our effective tax rate on net income was 18 percent in 2007 and 2006, compared with 21 percent in 2005. We decreased our liability for unrecognized tax benefits in the amount of $39 million in 2007 due primarily to a change in tax regulation. In 2005, a substantial portion of our catastrophe losses occurred in jurisdictions where we do not incur income tax, causing our income to decline without a commensurate decrease in income tax expense.

The growth in our net income in 2007, compared with 2006, is reflective of the strength, diversity, and balance in our organization. All of our segments contributed to our net income.

 

Prior Period Development

The favorable prior period development of $217 million during the year ended December 31, 2007, was the net result of several underlying favorable and adverse movements. In the sections following the table below, significant prior period movements within each reporting segment are discussed in more detail.

The following table summarizes prior period development, (favorable) and adverse, by segment and claim-tail attribute for the years ended December 31, 2007 and 2006. Note that short-tail as used here includes the previously reported categories of short-tail and specialty.

 

(in millions of U.S. dollars, except for percentages)   Long-tail         Short-tail         Total         % of net
unpaid
reserves*
2007                                        

Insurance – North American

  $ 39         $ (30 )       $ 9         0.1%

Insurance – Overseas General

    (53 )         (139 )         (192 )       3.2%

Global Reinsurance

    13           (47 )         (34 )       1.3%

Total

  $ (1 )       $ (216 )       $ (217 )       1.0%

2006

                                       

Insurance – North American

  $ 60         $ 5         $ 65         0.5%

Insurance – Overseas General

    20           (92 )         (72 )       1.3%

Global Reinsurance

    (3 )         (2 )         (5 )       0.2%

Total

  $ 77         $ (89 )       $ (12 )       0.1%

* Calculated based on the segment beginning of period net unpaid loss and loss expense reserves.

 

Insurance – North American

Insurance – North American incurred net adverse prior period development of $9 million in 2007, representing 0.1 percent of the segment’s net unpaid loss and loss expense reserves at December 31, 2006. The net prior period development in 2007 was the net result of several underlying favorable and adverse movements, driven by the following principal changes:

• Net adverse development of $39 million on long-tail business including:

• Adverse development of $21 million due to an adjustment made in 2006 relating to IBNR reserves on commuted ceded reinsurance contracts, identified and resolved during 2007;

• Adverse development of $33 million on two related specialty claims from a runoff financial guaranty program affecting accident year 2000 due to adverse judicial rulings rendered during the 2007 calendar year;

• Adverse development on our estimates of future allocated claims expense on two separate portfolios of workers’ compensation insurance totaling $28 million. This change in estimate affected our national accounts workers’ compensation business (principally accident years 2002-2004) and a runoff portfolio of workers’ compensation servicing carrier business (covering accident years 1996 and prior). For the national accounts business, the change was principally in our high deductible portfolio. Based on analyses completed during 2007, we have increased our tail factor for allocated loss adjustment expenses (ALAE) as well as our ratios of ALAE to loss used in our projection methodologies. Small movements in these assumptions produce a leveraged increase in the loss estimates across a number of accident years;

• Adverse development on our estimates of ultimate loss on a collection of runoff professional liability and medical programs totaling $20 million. These increases were the direct result of a review of all open claims that was completed

 

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during 2007. This claims review identified a number of cases where adverse change in facts and circumstances led to a significant deviation from our estimates of ultimate claim value;

• Favorable development in our estimate of ultimate loss and ALAE of $18 million in our surety business. This improvement was heavily concentrated in the 2005 and 2006 accident years. In the 2007 calendar year, the level of late reported claims and development on known claims for this portfolio was significantly below historical levels for this line of business resulting in a reduction in all loss projection methods;

• Favorable development on our national accounts casualty business, primarily general liability, of $21 million for the 2002-2004 accident years. Development on these portfolios continues to be favorable relative to the original assumptions used to price the products. Actual paid and incurred loss activity in 2007 has been lower than assumed in our prior projections and we have modified our estimates accordingly; and

• Favorable development of $25 million on our foreign casualty portfolio for the 2004 and prior accident years. This is partly due to an adjustment for a reserve established in 2006 for a single large claim, but also due to low levels of reported and paid loss activity on our foreign captive business. This particular line has net exposure on a per occurrence basis excess of high deductibles/self-insured retentions and an aggregate basis excess of an aggregate attachment point. Expected loss emergence patterns used in our 2006 review projected higher loss development for the 2004 and prior accident years than emerged during 2007 prompting a reduction in our projection of ultimate losses.

• Net favorable development of $30 million on short-tail business including:

• Adverse development totaling $115 million relating to increases in our estimates of loss for the 2005 storms primarily in our ACE Westchester operation but also some modest development in our offshore energy business. This development was due primarily to a relatively small number of losses on excess policies with large exposed limits. These losses reached settlement during 2007 for amounts in excess of our case reserves prompting adjustments to our projections of ultimate losses. The claims handling associated with the 2005 hurricanes has involved complex and unique causation and coverage issues. These issues continue to be present and may have a further material adverse impact on our financial results;

• Favorable development of $33 million on ACE Westchester crop/hail business. This was the direct effect of recording the final settlement of the 2006 pool year from the bordereau received during the 2007 calendar year;

• Favorable development of $52 million in our workers’ compensation business due to the absence of multi-claimant events such as industrial accidents for the 2006 accident year. The majority of our exposure for these perils falls under our national accounts high deductible line of business. We evaluate this exposure annually after the accident year has closed allowing for the late identification of significant losses. Our review in 2007 of potential 2006 accident year losses has led to a decrease in our estimate of the required provision for these claims;

• Favorable development in our estimates of ultimate losses for first party lines including property and auto physical damage in our ACE Canada operations totaling $18 million, affecting primarily the 2006 accident year. Incurred loss development during calendar year 2007 on the 2006 accident year was lower than historical averages which formed the basis for our prior projections. Given the relatively short reporting pattern for this business, the actual loss emergence was assigned credibility and the ultimate loss estimates revised accordingly;

• Favorable development in our estimates of ultimate loss of $19 million on our Canadian A&H portfolio. We have limited historical experience for this product line. Losses were originally recorded using an expected loss ratio method. Actual loss emergence in calendar year 2007 has proven to be more favorable than our prior projections. Given the relatively short reporting pattern for this business, the actual loss emergence was assigned credibility and the ultimate loss estimates revised accordingly; and

• Favorable development in our estimates of ultimate loss of $28 million on short tail, non-catastrophe losses in our ACE Westchester property and inland marine product lines. Attritional incurred loss activity on the 2005 and 2006 accident years in the 2007 calendar year was lower than historical averages which formed the basis for our prior projections.

Insurance – North American incurred net adverse prior period development of $65 million in 2006, representing 0.5 percent of the segment’s net unpaid loss and loss expense reserves at December 31, 2005. The net prior period development in 2006 was the net result of several underlying favorable and adverse movements, driven by the following principal changes:

• Net adverse development of $60 million on long-tail business including:

• Adverse development of $57 million on a small number of run-off portfolios in the U.S. with predominantly middle market workers’ compensation exposures from accident years 1996 and prior. In 2006, we lengthened the selected tail factors due to an increasing trend observed in industry statistics published in 2006, and a modest deterioration in our claims experience related to the medical cost component of individual claims that emerged since the prior study;

 

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• Adverse development of $42 million on the ACE Bermuda D&O book from report years 2000-2002 driven by case estimate increases on large claims following significant events in the mediation process during 2006, including increased plaintiff demands, settlement conferences, and court proceedings;

• Favorable development of $29 million on the ACE Bermuda excess liability book driven by the settlement of a single claim in 2006 from the 1991 report year on terms more favorable than the assumptions used to establish the reserve. The reserve was released following receipt of the ruling’s terms in 2006; and

• Favorable development of $13 million on large national account workers’ compensation business written by ACE USA. We observed reported claims frequency in 2006 lower than anticipated.

• Net adverse development of $5 million on short-tail business including:

• Adverse development of $182 million related to property claims arising from 2005 catastrophes. The majority of this increase is related to property losses from Hurricane Katrina. The nature and extent of Hurricane Katrina resulted in some claims that increased over previously reported damage estimates. Factors leading to these increases included demand surge and some impact to previously unimpaired layers of excess coverage;

• Favorable development on ACE Westchester’s crop/hail business of $60 million due to recording of the final settlement of the 2005 crop results. In line with normal practice for this type of business, ACE did not receive final loss reports for the 2005 year until 2006. Therefore, the prior period movements were direct results of the loss amounts within the initial and final loss reports issued during the first and second quarters of 2006 being lower than our preliminary estimates;

• Favorable development of $51 million on ACE USA’s workers’ compensation short-tail catastrophe and industrial accident exposure arising from 2004 and 2005 accident years, due to favorable trends in reported loss development. For the 2004 and 2005 accident years, claims arising from industrial or travel accidents trended favorably in 2006 relative to how earlier accident years had developed at the same period of maturity; and

• Net favorable development of $46 million related to the 2004 and 2005 accident years. This favorable activity was primarily in our aerospace and surety lines of business. Both of these businesses are relatively new, in that as recently as 2002 our premium volume was minimal and we have grown these businesses significantly since then. During 2006, we concluded the loss experience had become sufficiently credible, due to the degree of elapsed time, for us to begin to consider loss based projection methods which resulted in favorable prior loss development of $14 million and $18 million, respectively.

We experienced $103 million of net adverse prior period development in 2005, representing 0.9 percent of the segment’s net unpaid loss and loss expense reserves at December 31, 2004.

 

Insurance – Overseas General

Insurance – Overseas General experienced net favorable prior period development of $192 million in 2007, representing 3.2 percent of the segment’s net unpaid loss and loss expense reserves at December 31, 2006. The net prior period development for 2007 was the net result of several underlying favorable and adverse movements, driven by the following principal changes:

• Net favorable development of $53 million on long-tail lines of business including:

• Net favorable development of $33 million in the 2006 and prior accident years for Insurance – Overseas General long-tail lines, primarily casualty and financial lines. This favorable prior period development was in response to the annual review of long-tail lines completed during the year. There was $23 million of net favorable development for Insurance – Overseas General on the 2003-2005 accident years driven by reductions in loss development method indications and greater credibility being assigned to Bornhuetter-Ferguson projections versus expected loss ratio methods. This shift in credibility weighting between reserving methods is common practice and allows for greater recognition of actual loss emergence as accident years mature;

• Net favorable development of $20 million as a result of an update of the detailed annual evaluation of the excess exposures in Insurance – Overseas General 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; and

• Adverse development of $11 million in ACE Global Markets’ long-tail professional lines, primarily in years of account 1999-2003. This adverse prior period development was largely in response to claims department recommendations on three accounts based on updated information received during the course of claim settlement in calendar year 2007.

• Net favorable development of $139 million on short-tail lines of business including:

• Favorable development of $84 million on short-tail property and fire lines primarily in the 2006 accident year in ACE International. The favorable development during the past year was due in large part to shifting credibility away from Bornhuetter-Ferguson methods and relying more heavily on loss development patterns as case incurred loss became a more accurate predictor of ultimate loss. This shift in credibility tended to reduce indicated ultimate losses since, with hindsight, our initial expected loss ratios have proven to be conservative;

 

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• Favorable development of $13 million on 2005 hurricane losses in ACE Global Markets. This adjustment was due to the fact that after 24 months of development, it was concluded that there would be no new reported claims;

• Favorable development of $30 million on specialty A&H primarily in the 2005 and 2006 accident years in ACE Europe. This favorable prior period development followed the completion of the regular reserve review and was driven by better than expected loss experience relative to prior reserving assumptions. The favorable experience arose in direct marketing A&H businesses across several countries with no particular underlying claim or loss emergence trend identifiable;

• Favorable development of $28 million on specialty marine, primarily in the 2005 and 2006 accident years in both ACE International and ACE Global Markets. This favorable prior period development was largely in response to claims department recommendations on several large claims based on updated information received during claim settlement in calendar year 2007; and

• Adverse development of $9 million on specialty consumer lines, primarily in accident year 2006. This adverse development was primarily driven by further deterioration of ACE International’s homeowner’s warranty business in Norway. The indicated ultimate loss was revised upwards in 2007 in response to several key claim metrics underlying the reserve estimate: number of reopened claims, loss adjustment expenses, and frequency and severity of late reported claims.

Insurance – Overseas General experienced net favorable prior period development of $72 million in 2006, representing 1.3 percent of the segment’s net unpaid loss and loss expense reserves at December 31, 2005. The net prior period development for 2006 was the net result of several underlying favorable and adverse movements, driven by the following principal changes:

• Net adverse development of $20 million on long-tail lines of business including:

• Adverse development of $29 million on the ACE Global Markets’ professional lines portfolio. In 2006, we continued to experience greater than expected reported loss activity related to years of account 2003 and prior, largely from claims related to corporate failures, allegations of management misconduct, and accounting irregularities. As a result, we have increased the expected ultimate loss ratios for these years in response to updated claim and legal information received in 2006 on specific cases;

• Adverse development of $14 million on asbestos liabilities, excluding a provision for uncollectible reinsurance, resulting from the completion of our annual analysis of our international A&E exposures by a joint legal and actuarial team during the fourth quarter of 2006; and

• Net favorable development of $23 million on ACE International’s non-A&E exposures from the 2002-2004 accident years. This movement was driven by continued favorable loss emergence, most notably on the U.K. casualty and Asia Pacific financial lines portfolios, as a result of favorable severity trends in 2006.

• Net favorable development of $92 million on short-tail lines of business including:

• Net favorable development of $111 million on short-tail property and fire lines, mainly related to accident years 2004 and 2005. The favorable development in 2006 was driven by lower than anticipated frequency and severity of late reported property claims that emerged during 2006, and favorable development and settlement of several previously reported large losses; and

• Net adverse development of $19 million on other short-tail business including aviation, A&H, marine, consumer lines, and political risk. Most of the adverse development was driven by higher than expected loss activity in 2006 at ACE Global Markets, primarily on accident years 2002 and prior.

We experienced $5 million of net adverse development in 2005, representing 0.1 percent of the segment’s net unpaid loss and loss expense reserves at December 31, 2004.

 

Global Reinsurance

Global Reinsurance experienced net favorable prior period development of $34 million in 2007, representing 1.3 percent of the segment’s net unpaid loss and loss expense reserves at December 31, 2006. The net prior period development recorded in 2007 was the net result of several underlying favorable and adverse movements. The largest adverse movement was related to long-tail lines of business for ACE Tempest Re USA of $13 million mainly as a result of higher than expected claims reported over the last few quarters primarily in the treaty years 2000-2005 for casualty and workers’ compensation business on several accounts. Favorable movements of $47 million largely related to claim closings on short-tail property and other short-tail lines of business primarily from treaty years 2005 and prior were recorded in 2007.

Global Reinsurance experienced net favorable prior period development of $5 million in 2006, representing 0.2 percent of the segment’s net unpaid loss and loss expense reserves at December 31, 2005. The net prior period development in 2006 was the net result of several underlying favorable and adverse movements. The largest adverse movement was related to catastrophes from the 2005 accident year of $29 million as a result of increased loss reports from cedants. Favorable movements

 

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largely related to property business from accident years prior to 2005 and a number of small movements on different specialty portfolios.

We experienced $22 million of net favorable prior period development in 2005, representing 1.4 percent of the segment’s net unpaid loss and loss expense reserves at December 31, 2004.

 

Segment Operating Results – Years Ended December 31, 2007, 2006, and 2005

The discussions that follow include tables, which show our segment operating results for the three years ended December 31, 2007, 2006, and 2005. In presenting our segment operating results, we have discussed our performance with reference to underwriting results, which is a non-GAAP measure. We consider this measure, which may be defined differently by other companies, to be important in understanding our overall results of operations. Underwriting results are calculated by subtracting losses and loss expenses, life and annuity benefits, policy acquisition costs, and administrative expenses from net premiums earned. We use underwriting results and operating ratios to monitor the results of our operations without the impact of certain factors, including net investment income, other (income) expense, interest expense, income tax expense, and net realized gains (losses). We believe the use of these measures enhances the understanding of our results of operations by highlighting the underlying profitability of our insurance and reinsurance businesses. Underwriting results should not be viewed as a substitute for measures determined in accordance with GAAP.

We operate through the following business segments: Insurance – North American, Insurance – Overseas General, Global Reinsurance, and Life Insurance and Reinsurance. For more information on each of our segments refer to “Segment Information”, under Item 1.


Insurance – North American

The Insurance – North American segment comprises our P&C operations in the U.S., Canada, and Bermuda. This segment includes the operations of ACE USA (including ACE Canada), ACE Westchester, ACE Bermuda, and various run-off operations, including Brandywine Holdings Corporation (Brandywine Holdings).

 

(in millions of U.S. dollars)   2007       2006         2005

Net premiums written

  $ 5,833       $ 5,940         $ 5,803

Net premiums earned

    6,007         5,719           5,730

Losses and loss expenses

    4,269         4,026           4,577

Policy acquisition costs

    515         530           503

Administrative expenses

    530         502           427

Underwriting income

    693         661           223

Net investment income

    1,034         876           698

Net realized gains (losses)

    125         (83 )         15

Other (income) expense

    11         (2 )         18

Income tax expense

    468         352           235

Net income

  $ 1,373       $ 1,104         $ 683

Loss and loss expense ratio

    71.1%         70.4%           79.9%

Policy acquisition cost ratio

    8.6%         9.2%           8.8%

Administrative expense ratio

    8.8%         8.8%           7.4%

Combined ratio

    88.5%         88.4%           96.1%

 

Net premiums written for the Insurance – North American segment decreased two percent in 2007, compared with 2006. This decrease was primarily due to a decline in new and renewal business at ACE Westchester, our wholesale operation, which experienced very competitive conditions on P&C lines. ACE Westchester also reported a decrease in retention of gross premiums written, primarily due to changes in business mix. ACE Bermuda reported a decrease in net premiums written primarily due to a decline in assumed loss portfolio business as well as excess liability and professional lines, partially offset by an increase in political risk writings in 2007, compared with 2006. ACE USA, this segment’s U.S.-based retail division, reported modest growth driven primarily by specialty casualty and energy lines as well as professional risk and a large assumed portfolio contract. These increases were partially offset by declines in production in ACE USA’s large account risk management unit and the curtailment of middle market workers’ compensation writings in response to unfavorable market

 

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conditions. Net premiums written increased two percent in 2006 compared with 2005. This increase was primarily driven by ACE USA which reported growth across many lines, including commercial property, energy, aerospace, and financial solutions. ACE Bermuda reported a significant decline in its financial solutions business as net premiums written in 2005 were bolstered by catastrophe-related reinstatement premiums on multi-year contracts. ACE Westchester reported modest growth driven primarily by primary and excess casualty, inland marine, environmental, and professional risk business.

The following two tables provide a line of business and entity/divisional breakdown of Insurance – North American’s net premiums earned for the years ended December 31, 2007, 2006, and 2005.

 

(in millions of U.S. dollars)   2007      

% of

total

      2006      

% of

total

      2005      

% of

total

Line of Business

                                                 

Property and all other

  $ 1,462       24%       $ 1,289       22%       $ 1,249       22%

Casualty

    4,298       72%         4,228       74%         4,299       75%

Personal accident (A&H)

    247       4%         202       4%         182       3%

Net premiums earned

  $ 6,007       100%       $ 5,719       100%       $ 5,730       100%

Entity/Division

                                                 

ACE USA

  $ 4,196       70%       $ 3,795       66%       $ 3,666       64%

ACE Westchester

    1,420       24%         1,465       26%         1,385       24%

ACE Bermuda

    391       6%         459       8%         679       12%

Net premiums earned

  $ 6,007       100%       $ 5,719       100%       $ 5,730       100%

 

ACE USA’s net premiums earned increased 11 percent in 2007, compared with 2006. The increase was primarily driven by the assumed loss portfolio contract noted above, as well as new business in the energy unit, and growth in specialty casualty lines, including professional risk, umbrella excess, custom casualty, and environmental. ACE USA’s curtailment of middle market worker’s compensation business partially offset these increases. ACE USA’s net premiums earned increased four percent in 2006, compared with 2005. This increase was primarily driven by growth in specialty casualty and commercial property lines.

ACE Westchester’s net premiums earned decreased three percent in 2007, compared with 2006. This decrease was primarily due to lower production in casualty lines resulting from more competitive market conditions, partially offset by increased crop/hail business, which benefited from higher commodity prices. ACE Westchester’s net premiums earned increased six percent in 2006, compared with 2005. This increase was primarily driven by increased primary and excess casualty, inland marine, environmental and professional risk business and also the negative impact of catastrophe-related reinstatement premiums on the 2005 year.

ACE Bermuda’s net premiums earned decreased 15 percent in 2007, compared with 2006. The decrease was primarily due to our curtailment of financial solutions business in 2006. ACE Bermuda’s net premiums earned decreased 32 percent in 2006, compared with 2005. This decrease was a result of the decline in financial solutions business, including the positive impact on the prior year of catastrophe-related reinstatement premiums on multi-year contracts.

Insurance – North American’s loss and loss expense ratio increased in 2007, compared with 2006. The following table shows the impact of catastrophe losses and prior period development on our loss and loss expense ratio for the years ended December 31, 2007, 2006, and 2005.

 

    2007       2006       2005

Loss and loss expense ratio, as reported

  71.1 %       70.4 %       79.9 %

Catastrophe losses

  (0.3)%             (8.9)%

Prior period development

  (0.2)%       (1.2)%       (1.8)%

Loss and loss expense ratio, adjusted

  70.6 %       69.2 %       69.2 %

 

Insurance – North American’s catastrophe losses were $16 million in 2007, compared with $nil in 2006, and $557 million in 2005. Current year catastrophe losses were primarily associated with floods in the U.S. Catastrophe losses in 2005 were significant and included losses from Hurricanes Katrina, Rita, and Wilma. Insurance – North American incurred net adverse prior period development of $9 million in 2007. This compares with net adverse prior period development of $65 million and $103 million in 2006 and 2005, respectively. Refer to “Prior Period Development” for more information. Insurance – North

 

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American’s loss and loss expense ratio was negatively impacted by an increase in current year accident losses, reflecting current market conditions.

Insurance – North American’s policy acquisition cost ratio decreased in 2007 compared with 2006. The decrease was primarily related to reductions in the policy acquisition cost ratio at ACE USA and ACE Westchester. For ACE USA, the decline reflects higher ceding commissions as well as lower premium taxes due to reassessment of obligations for premium-based assessments and guaranty funds. In addition, the assumed loss portfolio transfer contract, noted above, incurred low acquisition costs, which is typical for these transactions. For ACE Westchester, the decline in the policy acquisition cost ratio was primarily due to lower profit share commissions on crop business in 2007, compared with 2006. Insurance – North American’s policy acquisition cost ratio increased in 2006, compared with 2005, which benefited from premiums earned on multi-year contracts which generally do not incur acquisition costs.

Administrative expenses increased in 2007, compared with 2006. This increase was primarily due to increased staffing costs at ACE USA, as well as a $15 million decrease in net profits for ACE USA’s ESIS operation (third party claim services), which we include in administrative expenses. The administrative expense ratio was stable in 2007, compared with 2006, as net premiums earned increased. Administrative expenses increased in 2006, compared with 2005 as the 2005 year was favorably impacted by the reduction of $42 million in various accruals determined not to be needed. Additionally, net profits for ACE USA’s ESIS operation were $14 million lower in 2006, compared with 2005.


Insurance – Overseas General

The Insurance – Overseas General segment consists of ACE International, which comprises our network of indigenous insurance operations, and the wholesale insurance operations of ACE Global Markets, our London market underwriting unit including Lloyd’s Syndicate 2488. This segment has four regions of operations: ACE European Group, which is comprised of ACE Europe and ACE Global Markets branded business, ACE Asia Pacific, ACE Far East, and ACE Latin America.

 

(in millions of U.S. dollars)   2007         2006         2005

Net premiums written

  $ 4,568         $ 4,266         $ 4,195

Net premiums earned

    4,623           4,321           4,239

Losses and loss expenses

    2,420           2,259           2,583

Policy acquisition costs

    963           856           836

Administrative expenses

    669           609           566

Underwriting income

    571           597           254

Net investment income

    450           370           319

Net realized gains (losses)

    (69 )         (16 )         51

Other (income) expense

    (20 )         10           16

Income tax expense

    183           206           107

Net income

  $ 789         $ 735         $ 501

Loss and loss expense ratio

    52.4%           52.3%           60.9%

Policy acquisition cost ratio

    20.8%           19.8%           19.7%

Administrative expense ratio

    14.5%           14.1%           13.4%

Combined ratio

    87.7%           86.2%           94.0%

 

Insurance – Overseas General’s net premiums written increased seven percent in 2007, compared with 2006. Foreign exchange impact on ACE International’s results accounted for most of this increase as both the euro and the pound sterling strengthened significantly relative to the U.S. dollar during 2007 (refer to the table below for impact of foreign exchange on net premiums written and earned). ACE International reported growth in A&H business in virtually all of its regions of operation, particularly in Latin America, Europe, and Asia Pacific. On the P&C side, growth in continental Europe was more than offset by a decline in net premiums written in the U.K. and Asia Pacific due to competitive conditions for new accounts and adverse pricing on renewal business. ACE Global Markets reported increased reinsurance costs combined with rate decreases due to competition in aviation, property, and financial lines, partially offset by increased production in energy, political risk, and A&H lines. Insurance – Overseas General’s net premiums written increased two percent in 2006, compared with 2005. The 2005 year was impacted by catastrophe-related reinstatement premiums, which reduced net premiums written and earned by $38 million, primarily at ACE Global Markets.

 

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The following two tables provide a line of business and entity/divisional breakdown of Insurance – Overseas General’s net premiums earned for the years ended December 31, 2007, 2006, and 2005.

 

(in millions of U.S. dollars)   2007      

%of

total

      2006      

% of

total

      2005      

% of

total

Line of Business

                                                 

Property and all other

  $ 1,697       37%       $ 1,617       37%       $ 1,609       38%

Casualty

    1,495       32%         1,479       34%         1,570       37%

Personal accident (A&H)

    1,431       31%         1,225       29%         1,060       25%

Net premiums earned

  $ 4,623       100%       $ 4,321       100%       $ 4,239       100%

Entity/Division

                                                 

ACE Europe

  $ 1,999       43%       $ 1,819       42%       $ 1,865       44%

ACE Asia Pacific

    631       14%         590       14%         545       13%

ACE Far East

    365       8%         361       8%         378       9%

ACE Latin America

    633       14%         521       12%         416       10%

ACE International

    3,628       79%         3,291       76%         3,204       76%

ACE Global Markets

    995       21%         1,030       24%         1,035       24%

Net premiums earned

  $ 4,623       100%       $ 4,321       100%       $ 4,239       100%

 

Insurance – Overseas General reported a seven percent increase in net premiums earned in 2007, compared with 2006. This increase was primarily driven by a favorable foreign exchange impact on ACE International business. Net premiums earned for this segment increased two percent in 2006, compared with 2005. In 2006, this segment experienced growth in A&H business, offset by weakening market conditions for P&C business and higher reinsurance costs. Additionally, 2005 was impacted by catastrophe-related reinstatement premiums of $38 million.

ACE International’s net premiums earned increased 10 percent in 2007, compared with 2006, primarily due to the impact of foreign exchange. This segment continues to grow its A&H business which has offset weak market conditions for U.K. and Asia Pacific P&C business, and higher reinsurance costs for certain lines. ACE Asia Pacific and ACE Latin America reported increases in net premiums earned primarily driven by solid growth in A&H business. These regions have been successfully utilizing unique and innovative distribution channels to grow their A&H customer base. ACE International reported a three percent increase in net premiums earned in 2006, compared with 2005. This increase was primarily driven by growth of A&H business, partially offset by weakness in P&C lines in the U.K.

ACE Global Markets’ net premiums earned decreased three percent in 2007, compared with 2006. This decrease was primarily due to decreased production, higher reinsurance costs, and changes in business mix, specifically the growth of energy lines which earn over a longer period than other types of business. Net premiums earned for ACE Global Markets were stable in 2006, compared with 2005, as the decrease in catastrophe-related reinstatement premiums was offset by higher reinsurance costs in 2006, particularly on aviation, energy, property, and marine lines.

Insurance – Overseas General conducts business internationally and in most major foreign currencies. The following table summarizes the approximate effect of changes in foreign currency exchange rates on the growth of net premiums written and earned for the years ended December 31, 2007 and 2006.

 

    2007       2006

Net premiums written:

           

Growth in original currency

  0.6%       2.7 %

Foreign exchange effect

  6.5%       (1.0)%

Growth as reported in U.S. dollars

  7.1%       1.7 %

Net premiums earned:

           

Growth in original currency

  0.7%       2.3 %

Foreign exchange effect

  6.3%       (0.4)%

Growth as reported in U.S. dollars

  7.0%       1.9 %

 

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The following table shows the impact of catastrophe losses and prior period development on our loss and loss expense ratio for the years ended December 31, 2007, 2006, and 2005.

 

    2007       2006       2005

Loss and loss expense ratio, as reported

  52.4 %       52.3 %       60.9 %

Catastrophe losses

  (2.0)%       (0.1)%       (5.2)%

Prior period development

  4.2 %       1.7 %       (0.1)%

Loss and loss expense ratio, adjusted

  54.6 %       53.9 %       55.6 %

 

Net catastrophe losses for 2007 were $94 million, compared with $3 million and $201 million in 2006 and 2005, respectively. In 2005, the catastrophe losses were primarily associated with Hurricanes Katrina, Rita, and Wilma. Insurance – Overseas General incurred net favorable prior period development of $192 million and $72 million in 2007 and 2006, respectively. This compares with net adverse prior period development of $5 million in 2005. Refer to “Prior Period Development” for more information.

Insurance – Overseas General’s policy acquisition cost ratio has increased over the last three years primarily due to changes in business mix at ACE International, specifically the growth of A&H business, which typically attracts higher commission rates than other business. The increasing impact on policy acquisition costs from A&H growth was partially offset by increased ceding commissions on political, financial, and energy lines at ACE Global Markets. Insurance – Overseas General’s administrative expense ratio increased in 2007, compared with 2006, primarily due to the impact of foreign exchange. Additionally, ACE International reported increased costs associated with its entrance into emerging markets, specifically Eastern Europe and the Middle East, and in support of A&H growth at Asia Pacific. The increase in 2006, compared with 2005, was primarily due to investments in global expansion including staff additions and infrastructure enhancements at ACE International.


Global Reinsurance

The Global Reinsurance segment represents ACE’s reinsurance operations, comprising ACE Tempest Re Bermuda, ACE Tempest Re USA, ACE Tempest Re Europe, and ACE Tempest Re Canada. Global Reinsurance markets its reinsurance products worldwide under the ACE Tempest Re brand name and provides a broad range of coverages to a diverse array of primary P&C companies.

 

(in millions of U.S. dollars)   2007       2006       2005  

Net premiums written

  $ 1,197       $ 1,550       $ 1,546  

Net premiums earned

    1,299         1,511         1,531  

Losses and loss expenses

    664         784         1,402  

Policy acquisition costs

    248         303         300  

Administrative expenses

    64         62         60  

Underwriting income (loss)

    323         362         (231 )

Net investment income

    274         221         173  

Net realized gains (losses)

    21         10         (4 )

Interest expense

                    3  

Other (income) expense

    4         8         11  

Income tax expense

    32         38         11  

Net income (loss)

  $ 582       $ 547       $ (87 )

Loss and loss expense ratio

    51.1%         51.8%         91.6%  

Policy acquisition cost ratio

    19.1%         20.1%         19.6%  

Administrative expense ratio

    4.9%         4.1%         3.9%  

Combined ratio

    75.1%         76.0%         115.1%  

 

Global Reinsurance’s net premiums written decreased 23 percent in 2007, compared with 2006. During 2007, Global Reinsurance experienced intense competition across all of its regions of operations, which resulted in our not renewing several

 

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large policies, as well as clients increasing their retentions. Net premiums written for the Global Reinsurance segment were stable in 2006 compared with 2005. For 2006, this segment benefited from increased rates on property catastrophe coverages following two years of unprecedented hurricane activity, partially offset by lower casualty rates in Europe, and the cancellation of a large property account in the U.S. The year ended December 31, 2005, was impacted by catastrophe-related assumed reinstatement premiums, which increased net premiums written and earned by $46 million.

The following two tables provide a line of business and entity/divisional breakdown of Global Reinsurance’s net premiums earned for the years ended December 31, 2007, 2006, and 2005.

 

(in millions of U.S. dollars)   2007      

% of

total

      2006      

% of

total

      2005      

% of

total

Line of Business

                                                 

Property and all other

  $ 285       22%       $ 354       23%       $ 354       23%

Casualty

    671       52%         799       52%         829       54%

Property catastrophe

    343       26%         358       25%         348       23%

Net premiums earned

  $ 1,299       100%       $ 1,511       100%       $ 1,531       100%

Entity/Division

                                                 

ACE Tempest Re Bermuda

  $ 356       27%       $ 367       24%       $ 349       23%

ACE Tempest Re USA

    693       53%         872       58%         887       58%

ACE Tempest Re Europe

    241       19%         272       18%         295       19%

ACE Tempest Re Canada

    9       1%               –%               –%

Net premiums earned

  $ 1,299       100%       $ 1,511       100%       $ 1,531       100%

 

Global Reinsurance’s net premiums earned decreased 14 percent in 2007, compared with 2006. This decrease was primarily due to lower 2007 production at ACE Tempest Re Bermuda, ACE Tempest Re USA, and ACE Tempest Re Europe. ACE Tempest Re Canada commenced writing business in 2007. Global Reinsurance’s net premiums earned decreased one percent in 2006, compared with 2005, primarily due to reduced assumed reinstatement premiums at ACE Tempest Re Bermuda and ACE Tempest Re Europe and the cancellation of a large homeowner’s account at ACE Tempest Re USA.

The following table shows the impact of catastrophe losses and prior period development on our loss and loss expense ratio for the years ended December 31, 2007, 2006, and 2005.

 

    2007       2006       2005

Loss and loss expense ratio, as reported

  51.1 %       51.8 %       91.6 %

Catastrophe losses

  (3.8)%       (0.9)%       (37.7)%

Prior period development

  2.6 %       0.4 %       1.4 %

Loss and loss expense ratio, adjusted

  49.9 %       51.3 %       55.3 %

 

Global Reinsurance recorded net catastrophe losses of $49 million in 2007. This compares with net catastrophe losses of $14 million and $601 million in 2006 and 2005, respectively. In 2005, the catastrophe losses were primarily associated with Hurricanes Katrina, Rita, and Wilma. Global Reinsurance incurred net favorable prior period development of $34 million in 2007. This compares with net favorable prior period development of $5 million and $22 million in 2006 and 2005, respectively. Refer to “Prior Period Development” for more information. The remaining decreases to the loss and loss expense ratio in 2006 were primarily due to favorable current accident year experience on property business and changes in business mix. In 2006, there was a greater proportion of property and property catastrophe business and pro-rata business, which generally carries a lower loss ratio than excess of loss business.

Global Reinsurance’s policy acquisition cost ratio decreased in 2007, compared with 2006, primarily due to changes in business mix, and lower ceding commissions at ACE Tempest Re USA. The policy acquisition cost ratio increased for Global Reinsurance in 2006, compared with 2005, primarily due to higher ceding commissions at ACE Tempest Re USA and the impact on the prior year of catastrophe-related assumed reinstatement premiums, which do not generate acquisition costs. Administrative expenses have been stable over the last three years. The administrative expense ratio increased over the last three years primarily due to the decrease in net premiums earned.

 

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Life Insurance and Reinsurance

Life Insurance and Reinsurance includes the operations of ACE Tempest Life Re (ACE Life Re) and ACE International Life (ACE Life). We assess the performance of our life insurance and reinsurance business based on life underwriting income which includes net investment income.

 

(in millions of U.S. dollars)   2007         2006         2005  

Net premiums written

  $ 381         $ 274         $ 248  

Net premiums earned

    368           274           248  

Life and annuity benefits

    168           123           143  

Policy acquisition costs

    45           26           24  

Administrative expenses

    50           35