Unpaid losses and loss expenses

ACE establishes reserves for the estimated unpaid ultimate liability for losses and loss expenses under the terms of its policies and agreements. These reserves include estimates for both claims that have been reported and for IBNR, and include estimates of expenses associated with processing and settling these claims. These reserves are recorded in Unpaid losses and loss expenses in the consolidated balance sheets. The process of establishing loss and loss expense reserves for P&C claims can be complex and is subject to considerable uncertainty as it requires the use of informed estimates and judgments. Our estimates and judgments may be revised as additional experience and other data become available and are reviewed, as new or improved methodologies are developed, or as laws change. We continually evaluate our estimate of reserves in light of developing information and in light of discussions and negotiations with our insureds. While we believe that our reserves for unpaid losses and loss expenses at December 31, 2012 are adequate, new information or trends may lead to future developments in ultimate losses and loss expenses significantly greater or less than the reserves provided. 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.

The following table presents a reconciliation of unpaid losses and loss expenses:



	Years Ended December 31
(in millions of U.S. dollars)	2012				2011				2010
Gross unpaid losses and loss expenses, beginning of year		$	37,477			$	37,391			$	37,783
Reinsurance recoverable on unpaid losses⁽¹⁾		(11,602		)		(12,149		)		(12,745		)
Net unpaid losses and loss expenses, beginning of year		25,875				25,242				25,038
Acquisition of subsidiaries		14				92				145
Total		25,889				25,334				25,183
Net losses and loss expenses incurred in respect of losses occurring in:
Current year		10,132				10,076				8,082
Prior years		(479		)		(556		)		(503		)
Total		9,653				9,520				7,579
Net losses and loss expenses paid in respect of losses occurring in:
Current year		4,325				4,209				2,689
Prior years		4,894				4,657				4,724
Total		9,219				8,866				7,413
Foreign currency revaluation and other		224				(113		)		(107		)
Net unpaid losses and loss expenses, end of year		26,547				25,875				25,242
Reinsurance recoverable on unpaid losses⁽¹⁾		11,399				11,602				12,149
Gross unpaid losses and loss expenses, end of year		$	37,946			$	37,477			$	37,391
⁽¹⁾ Net of provision for uncollectible reinsurance.

Net losses and loss expenses incurred includes $479 million, $556 million, and $503 million, of net favorable prior period development in the years ended December 31, 2012, 2011, and 2010, respectively. The following is a summary of prior period development for the periods indicated. The remaining net development for long-tail and short-tail business for each segment comprises numerous favorable and adverse movements across lines and accident years.

Insurance – North American

Insurance – North American's active operations experienced net favorable prior period development of $360 million in 2012, representing 2.2 percent of net unpaid reserves at December 31, 2011. Net prior period development was the net result of several underlying favorable and adverse movements. Net favorable development of $245 million on long-tail business included favorable development of $73 million on umbrella and excess casualty business primarily affecting the 2007 and prior accident years; $67 million in the directors and officers (D&O) portfolio affecting the 2007 and prior accident years; $57 million on medical risk operations primarily affecting the 2007 and prior accident years; and $39 million on the national accounts portfolios (commercial auto liability, general liability, and workers' compensation lines of business). Net prior period development also included favorable development of $9 million across a number of lines and accident years, none of which was significant individually or in the aggregate. Favorable development of $115 million on short-tail business included favorable development of $88 million in the property, inland marine and commercial marine portfolios primarily arising on the 2009 through 2011 accident years and favorable development of $27 million on aviation product lines affecting the 2009 and prior accident years.

Insurance – North American's run-off operations incurred net adverse prior period development of $168 million in the Westchester and Brandywine run-off operations during 2012, which was the net result of adverse movements impacting accident years 2001 and prior, representing one percent of net unpaid reserves at December 31, 2011. Net adverse prior period development was driven by adverse development of $150 million related to the completion of the reserve review during 2012 and $18 million of unallocated loss adjustment expenses due to run-off operating expenses reserved and paid during 2012.

Insurance – North American's active operations experienced net favorable prior period development of $297 million in 2011, representing 1.9 percent of net unpaid reserves at December 31, 2010. Net prior period development was the net result of several underlying favorable and adverse movements. Net favorable development of $186 million on long-tail business included favorable development of $82 million in the D&O portfolio affecting the 2006 and prior accident years; $54 million in the excess casualty business affecting the 2005 and prior accident years; $43 million on medical risk operations; $28 million on the national accounts portfolio (commercial auto liability, general liability, and workers' compensation lines of business); and $26 million within the financial solutions business relating to a single account on the 2002 through 2010 accident years. Additional favorable development included $26 million in the foreign casualty product affecting the 2007 and prior accident years and $21 million on surety business primarily impacting the 2009 year. Partially offsetting this favorable development was adverse development of $40 million on errors and omissions coverage primarily affecting the 2007 and 2008 accident years and adverse development of $29 million within the environmental liability product line concentrated in the 2005 through 2007 accident years. Net prior period development also included adverse development of $25 million on other lines across a number of accident years, none of which was significant individually or in the aggregate. Net favorable development of $111 million on short-tail business included favorable development of $48 million in the property portfolios primarily affecting the 2009 and 2010 accident years and favorable development of $63 million on other lines across a number of accident years, primarily following better than expected loss emergence.

Insurance – North American's run-off operations incurred net adverse prior period development of $102 million in the Westchester and Brandywine run-off operations during 2011, which was the net result of adverse movements impacting the accident years 2000 and prior, representing 0.6 percent of net unpaid reserves at December 31, 2010. Net adverse prior period development was driven by adverse development of $82 million related to the completion of the reserve review during 2011 and $17 million of unallocated loss adjustment expenses due to operating expenses reserved and paid during 2011. Net prior period development also included $3 million of adverse development on other lines across a number of accident years, none of which was significant individually or in the aggregate.

Insurance – North American experienced net favorable prior period development of $107 million in 2010, representing 0.7 percent of the segment's net unpaid reserves at December 31, 2009.

Insurance – Overseas General

Insurance – Overseas General experienced net favorable prior period development of $226 million in 2012 representing 3.1 percent of net unpaid reserves at December 31, 2011. Net prior period development was the net result of several underlying favorable and adverse movements. Net favorable development of $121 million on long-tail business included favorable development of $150 million in casualty (primary and excess) and financial lines for accident years 2008 and prior, and adverse development of $29 million in the casualty (mainly primary) and financial lines for accident years 2009 through 2011. Favorable development of $105 million on short-tail business included property, marine, A&H, and personal lines across multiple geographical regions, and within both retail and wholesale operations, principally as a result of lower than expected loss emergence, mostly on accident years 2009 and 2010.

Insurance – Overseas General experienced net favorable prior period development of $290 million in 2011 representing 4.2 percent of net unpaid reserves at December 31, 2010. Net prior period development was the net result of several underlying favorable and adverse movements. Net favorable development of $154 million on long-tail business included favorable development of $337 million in casualty (primary and excess) and financial lines for accident years 2007 and prior, and adverse development of $183 million in the casualty (primary and excess) and financial lines book for accident years 2008 through 2010. Net favorable development of $136 million on short-tail business included property, marine, A&H, and energy lines across multiple geographical regions, and within both retail and wholesale operations, principally on accident years 2008 and 2009.

Insurance – Overseas General experienced net favorable prior period development of $290 million in 2010, representing 4.3 percent of the segment's net unpaid reserves at December 31, 2009.

Global Reinsurance

Global Reinsurance experienced net favorable prior period development of $61 million in 2012 representing 2.7 percent of net unpaid reserves at December 31, 2011. Net prior period development was the net result of several underlying favorable and adverse movements. Net favorable development of $32 million on long-tail business included favorable development of $54 million principally in treaty years 2008 and prior in casualty and medical malpractice lines. Net adverse development of $18 million on non-medical professional liability composed of favorable development on treaty years 2005 and prior, offset by adverse development on treaty years 2006 through 2011. Net prior period development also included $4 million of adverse development across a number of lines and treaty years, none of which was significant individually or in the aggregate. Net favorable development of $29 million on short-tail business, principally in treaty years 2010 and prior across property lines (including property catastrophe), trade credit, marine, and surety.

Global Reinsurance experienced net favorable prior period development of $71 million in 2011 representing 3.1 percent of net unpaid reserves at December 31, 2010. Net prior period development was the net result of several underlying favorable and adverse movements. Net favorable development of $58 million on long-tail business included net favorable development of $79 million principally in treaty years 2007 and prior across a number of portfolios (professional liability, D&O, casualty, and medical malpractice). Net favorable development of $13 million on short-tail business, primarily in treaty years 2009 and prior across property lines (including property catastrophe), trade credit, and surety.

Global Reinsurance experienced net favorable prior period development of $106 million in 2010, representing 4.7 percent of the segment's net unpaid reserves at December 31, 2009.

Asbestos and environmental (A&E) and other run-off liabilities

Included in liabilities for losses and loss expenses are amounts for A&E (A&E liabilities). The A&E liabilities principally relate to claims arising from bodily-injury claims related to asbestos products and remediation costs associated with hazardous waste sites. The estimation of A&E liabilities is particularly sensitive to future changes in the legal, social, and economic environment. ACE has not assumed any such future changes in setting the value of its A&E reserves, which include provisions for both reported and IBNR claims.

ACE's exposure to A&E claims principally arises out of liabilities acquired when it purchased Westchester Specialty in 1998 and CIGNA's P&C business in 1999, with the larger exposure contained within the liabilities acquired in the CIGNA transaction. In 1996, prior to ACE's acquisition of CIGNA's P&C business, the Pennsylvania Insurance Commissioner approved a plan to restructure INA Financial Corporation and its subsidiaries (the Restructuring) which included the division of Insurance Company of North America (INA) into two separate corporations:

(1) An active insurance company that retained the INA name and continued to write P&C business; and

(2) An inactive run-off company, now called Century Indemnity Company (Century).

As a result of the division, predominantly all A&E and certain other liabilities of INA were ascribed to Century and extinguished, as a matter of Pennsylvania law, as liabilities of INA.

As part of the Restructuring, most A&E liabilities of various U.S. affiliates of INA were reinsured to Century. Century and certain other run-off companies having A&E and other liabilities were contributed to Brandywine Holdings. ACE acquired Brandywine Holdings and its various subsidiaries as part of the 1999 acquisition of CIGNA's P&C business. For additional information, refer to “Brandywine Run-Off Entities” below.

During 2012, we conducted our annual internal, ground-up review of our consolidated A&E liabilities as of December 31, 2011. As a result of the internal review, we increased our gross loss reserves in 2012 for the Brandywine operations, including A&E, by $275 million, while the net loss reserves increased by $146 million. In addition, we increased gross loss reserves for Westchester Specialty's A&E and other liabilities by $17 million, while the net loss reserves increased by $4 million.

In 2012, in addition to our annual internal review, a team of external actuaries performed an evaluation as to the adequacy of Century's reserves. This external review was conducted in accordance with the Brandywine Restructuring Order, which requires that an independent actuarial review of Century's reserves be completed every two years. Management takes full responsibility for the estimation of its A&E liabilities.

An internal review was also conducted during 2011 of consolidated A&E liabilities as of December 31, 2010. As a result of that internal review, we increased gross loss reserves in 2011 for the Brandywine operations, including A&E, by $241 million while the net loss reserves increased by $76 million. In addition, we decreased gross loss reserves for Westchester Specialty's A&E and other liabilities by $29 million, while the net loss reserves increased by $6 million.

ACE's A&E reserves are not discounted for GAAP reporting and do not reflect any anticipated future changes in the legal, social, or economic environment, or any benefit from future legislative reforms.

The table below presents a roll-forward of consolidated A&E loss reserves (excluding other run-off liabilities), allocated loss expense reserves for A&E exposures, and the provision for uncollectible paid and unpaid reinsurance recoverables:



	Asbestos								Environmental								Total
(in millions of U.S. dollars)	Gross				Net				Gross				Net				Gross				Net
Balance at December 31, 2011⁽¹⁾		$	2,086			$	1,142			$	245			$	162			$	2,331			$	1,304
Incurred activity		211				95				40				39				251				134
Paid activity		(440		)		(275		)		(78		)		(61		)		(518		)		(336		)
Balance at December 31, 2012		$	1,857			$	962			$	207			$	140			$	2,064			$	1,102


⁽¹⁾	Balances at December 31, 2011 have been adjusted to present claims in a manner consistent with balances disclosed at December 31, 2012.

The A&E net loss reserves including allocated loss expense reserves and provision for uncollectible reinsurance at December 31, 2012, of $1.1 billion shown in the table above comprise $852 million in reserves in respect of Brandywine operations, $151 million of reserves held by Westchester Specialty, $84 million of reserves held by Insurance – Overseas General, $12 million of reserves held by ACE Bermuda, and $3 million of reserves held by Penn Millers. The incurred activity of $134 million is primarily the result of adverse activity in Brandywine and Westchester of $110 million and $22 million, respectively.

The net figures in the above table reflect third-party reinsurance other than reinsurance provided by National Indemnity Company (NICO) under two aggregate excess of loss contracts described below (collectively, the NICO contracts). ACE excludes the NICO contracts as they cover non-A&E liabilities as well as A&E liabilities. The split of coverage provided under the NICO contracts for A&E liabilities as compared to non-A&E liabilities is entirely dependent on the timing of the payment of the related claims. ACE's ability to make an estimate of this split is not practicable. ACE believes, instead, that the A&E discussion is best provided excluding the NICO contracts, while separately discussing the NICO contracts in relation to the total subject business, both A&E and non-A&E, covered by those contracts. With certain exceptions, the NICO contracts provide coverage for the net A&E incurred losses and allocated loss expenses within the limits of coverage and above ACE's retention levels. These exceptions include losses arising from certain operations of Insurance – Overseas General and participation by ACE Bermuda as a co-reinsurer or retrocessionaire in the NICO contracts.

Brandywine run-off - impact of NICO contracts on ACE's run-off liabilities

As part of the acquisition of CIGNA's P&C business, NICO provided $2.5 billion of reinsurance protection to Century on all Brandywine loss and allocated loss adjustment expense reserves and on the A&E reserves of various ACE INA insurance subsidiaries reinsured by Century (in each case, including uncollectible reinsurance). The benefits of this NICO contract (the Brandywine NICO Agreement) flowed to the other Brandywine companies and to the ACE INA insurance subsidiaries through agreements between those companies and Century. The Brandywine NICO Agreement was exhausted on an incurred basis in 2002.

The following table presents a roll-forward of net loss reserves, allocated loss expense reserves, and provision for uncollectible paid and unpaid reinsurance recoverables in respect of Brandywine operations only, including the impact of the Brandywine NICO Agreement for the year ended December 31, 2012:



	Brandywine													NICO Coverage					Net of NICO Coverage
(in millions of U.S. dollars)	A&E				Other				⁽¹⁾	Total				NICO Coverage				⁽²⁾	Net of NICO Coverage
Balance at December 31, 2011⁽³⁾		$	1,032			$	458				$	1,490			$	386			$	1,104
Incurred activity		110				19					129				—				129
Paid activity		(290		)		(56		)			(346		)		(368		)		22
Balance at December 31, 2012		$	852			$	421				$	1,273			$	18			$	1,255


⁽¹⁾	Other consists primarily of workers' compensation, non-A&E general liability losses, and provision for uncollectible reinsurance on non-A&E business.


⁽²⁾	NICO Coverage at December 31, 2011 was reduced to reflect $238 million of advances from NICO on uncollected inuring reinsurance recoverables as payments reducing the limit.


⁽³⁾	Balances at December 31, 2011 have been adjusted to present claims in a manner consistent with balances disclosed at December 31, 2012.

The incurred activity of $129 million primarily relates to the internal review of consolidated A&E liabilities as discussed above.

Westchester Specialty - impact of NICO contracts on ACE's run-off liabilities

As part of the Westchester Specialty acquisition in 1998, NICO provided a 75 percent pro-rata share of $1 billion of reinsurance protection on losses and loss adjustment expenses incurred on or before December 31, 1996, in excess of a retention of $721 million (the 1998 NICO Agreement). NICO has also provided an 85 percent pro-rata share of $150 million of reinsurance protection on losses and allocated loss adjustment expenses incurred on or before December 31, 1992, in excess of a retention of $755 million (the 1992 NICO Agreement). At December 31, 2012, the remaining unused incurred limit under the 1998 NICO Agreement was $492 million, which is only available for losses and loss adjustment expenses. The 1992 NICO Agreement was exhausted on a paid basis in 2009.

The following table presents a roll-forward of net loss reserves, allocated loss expense reserves, and provision for uncollectible paid and unpaid reinsurance recoverables in respect of 1996 and prior Westchester Specialty operations that are the subject business of the NICO covers for the year ended December 31, 2012:



	Westchester Specialty										NICO Coverage			Net of NICO Coverage
(in millions of U.S. dollars)	A&E			Other				Total			NICO Coverage			Net of NICO Coverage
Balance at December 31, 2011⁽¹⁾		$	144		$	54			$	198		$	165		$	33
Incurred activity		22			(6		)		16			12			4
Paid activity		(15)			(4)				(19)			(19)			—
Balance at December 31, 2012		$	151		$	44			$	195		$	158		$	37


⁽¹⁾	Balances at December 31, 2011 have been adjusted to present claims in a manner consistent with balances disclosed at December 31, 2012.

The incurred activity of $4 million primarily relates to the internal review of consolidated A&E liabilities as discussed above.

Brandywine run-off entities

In addition to housing a significant portion of ACE's A&E exposure, the Brandywine operations include run-off liabilities related to various insurance and reinsurance businesses. ACE's Brandywine insurance companies are Century (a Pennsylvania insurer) and Century International Reinsurance Company Ltd., a Bermuda insurer (CIRC). The Brandywine companies are direct or indirect subsidiaries of Brandywine Holdings.

The U.S.-based ACE INA companies assumed two contractual obligations in respect of the Brandywine operations in connection with the Restructuring: a dividend retention fund obligation and a surplus maintenance obligation in the form of the excess of loss (XOL) agreement.

INA Financial Corporation established and funded a dividend retention fund (the Dividend Retention Fund) consisting of $50 million plus investment earnings. Pursuant to an interpretation of the Brandywine Restructuring Order, the full balance of the Dividend Retention Fund was contributed to Century as of December 31, 2002. Under the Restructuring Order, while any obligation to maintain the Dividend Retention Fund is in effect, to the extent dividends are paid by INA Holdings Corporation to its parent, INA Financial Corporation, and to the extent INA Financial Corporation then pays such dividends to INA Corporation, a portion of those dividends must be withheld to replenish the principal of the Dividend Retention Fund to $50 million. During 2012 and 2011, nil and $35 million respectively, were withheld from such dividends and deposited in the Dividend Retention Fund by INA Financial Corporation. Effective January 28, 2011, the Pennsylvania Insurance Department clarified the scope of the Dividend Retention Fund that capital contributions from the Dividend Retention Fund to Century shall not be required until the XOL Agreement has less than $200 million of capacity remaining on an incurred basis for statutory reporting purposes. The amount of the capital contribution shall be the lesser of the amount necessary to restore the XOL Agreement remaining capacity to $200 million or the Dividend Retention Fund balance. The Dividend Retention Fund may not be terminated without prior written approval from the Pennsylvania Insurance Commissioner.

In addition, an ACE INA insurance subsidiary provided reinsurance coverage to Century in the amount of $800 million under an XOL, triggered if the statutory capital and surplus of Century falls below $25 million or if Century lacks liquid assets with which to pay claims as they become due.

Effective December 31, 2004, ACE INA Holdings contributed $100 million to Century in exchange for a surplus note. After giving effect to the contribution and issuance of the surplus note, the statutory surplus of Century at December 31, 2012 was $25 million and approximately $394 million in statutory-basis losses have been ceded to the XOL on an inception-to-date basis. Century reports the amount ceded under the XOL in accordance with statutory accounting principles, which differ from GAAP by, among other things, allowing Century to discount its liabilities, including certain asbestos related and environmental pollution liabilities. For GAAP reporting purposes, intercompany reinsurance recoverables related to the XOL are eliminated upon consolidation.

While ACE believes it has no legal obligation to fund losses above the XOL limit of coverage, ACE's consolidated results would nevertheless continue to include any losses above the limit of coverage for so long as the Brandywine companies remain consolidated subsidiaries of ACE.

Uncertainties relating to ACE's ultimate Brandywine exposure

In addition to the Dividend Retention Fund and XOL commitments described above, certain ACE entities are primarily liable for asbestos, environmental, and other exposures that they have reinsured to Century. Accordingly, if Century were to become insolvent and ACE were to lose control of Century, some or all of the recoverables due to these ACE companies from Century could become uncollectible, yet those ACE entities would continue to be responsible to pay claims to their insureds or reinsureds. At December 31, 2012 and 2011, the aggregate reinsurance balances ceded by the active ACE companies to Century were approximately $958 million and $877 million, respectively. At December 31, 2012 and 2011, Century's carried gross reserves (including reserves ceded by the active ACE companies to Century) were $2.1 billion and $2.4 billion, respectively. ACE believes the intercompany reinsurance recoverables, which relate to liabilities payable over many years (i.e., 25 years or more), are not impaired. A portion of the liabilities ceded to Century by its affiliates have, in turn, been ceded by Century to NICO and, at December 31, 2012 and 2011, remaining cover on a paid loss basis was approximately $18 million and $386 million, respectively. Should Century's loss reserves experience adverse development in the future and should Century be placed into rehabilitation or liquidation, the reinsurance recoverables due from Century to its 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. Losses ceded by Century to the active ACE companies and other amounts owed to Century by the active ACE companies were, in the aggregate, approximately $402 million and $171 million at December 31, 2012 and 2011, respectively.