Share-based compensation

ACE has share-based compensation plans which currently provide for awards of stock options, restricted stock, and restricted stock units to its employees and members of the Board.

ACE principally issues restricted stock grants and stock options on a graded vesting schedule. ACE recognizes compensation cost for restricted stock and stock option grants with only service conditions that have a graded vesting schedule on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in-substance, multiple awards. We incorporate an estimate of future forfeitures into the determination of compensation cost for both grants of restricted stock and stock options.

During 2004, we established the ACE Limited 2004 Long-Term Incentive Plan (the 2004 LTIP), which replaced our prior incentive plans except for outstanding awards. The 2004 LTIP will continue in effect until terminated by the Board. Under the 2004 LTIP, a total of 30,600,000 Common Shares of ACE are authorized to be issued pursuant to awards made as stock options, stock appreciation rights, performance shares, performance units, restricted stock, and restricted stock units. The maximum number of shares that may be delivered to participants and their beneficiaries under the 2004 LTIP shall be equal to the sum of: (i) 30,600,000 shares; and (ii) any shares that are represented by awards granted under the prior plans that are forfeited, expired, or are canceled after the effective date of the 2004 LTIP, without delivery of shares or which result in the forfeiture of the shares back to ACE to the extent that such shares would have been added back to the reserve under the terms of the applicable prior plan. At December 31, 2012, a total of 6,593,991 shares remain available for future issuance under this plan.

The 2004 LTIP also provides for grants of restricted stock and restricted stock units. ACE generally grants restricted stock and restricted stock units with a 4-year vesting period, based on a graded vesting schedule. The restricted stock is granted at market close price on the day of grant. Each restricted stock unit represents our obligation to deliver to the holder one Common Share upon vesting.

At our May 2012 Annual General Meeting, our shareholders approved a 1,500,000 increase to the maximum number of authorized shares to be issued under the ESPP under the 2004 LTIP. At December 31, 2012, a total of 1,491,053 Common Shares remain available for issuance under the ESPP.

ACE generally issues Common Shares for the exercise of stock options, restricted stock, and purchases under the ESPP from un-issued reserved shares and Common Shares in treasury.

The following table presents pre-tax and after-tax share-based compensation expense:



	Years Ended December 31
(in millions of U.S. dollars)	2012		2011		2010
Stock options and shares issued under ESPP:
Pre-tax	$	22	$	23	$	28
After-tax ⁽¹⁾	$	17	$	17	$	20
Restricted stock:
Pre-tax	$	109	$	108	$	111
After-tax	$	64	$	70	$	79

⁽¹⁾ Excludes windfall tax benefit (shortfall) for share-based compensation recognized as a direct adjustment to Additional paid-in capital of $18 million, $6 million and $(1) million for the years ended December 31, 2012, 2011 and 2010, respectively.

Unrecognized compensation expense related to the unvested portion of ACE's employee share-based awards was $119 million at December 31, 2012, and is expected to be recognized over a weighted-average period of approximately 1 year.

Stock options

ACE's 2004 LTIP provides for grants of both incentive and non-qualified stock options principally at an option price per share equal to the fair value of ACE's Common Shares on the date of grant. Stock options are generally granted with a 3-year vesting period and a 10-year term. The stock options vest in equal annual installments over the respective vesting period, which is also the requisite service period.

Included in ACE's share-based compensation expense in the year ended December 31, 2012, is a portion of the cost related to the 2009-2012 stock option grants. The fair value of the stock options was estimated on the date of grant using the Black-Scholes option-pricing model that uses the weighted-average assumptions noted below. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected life (estimated period of time from grant to exercise date) was estimated using the historical exercise behavior of employees. Expected volatility was calculated as a blend of (a) historical volatility based on daily closing prices over a period equal to the expected life assumption, (b) long-term historical volatility based on daily closing prices over the period from ACE's initial public trading date through the most recent quarter, and (c) implied volatility derived from ACE's publicly traded options.

The fair value of the options issued is estimated on the date of grant using the Black-Scholes option-pricing model. The following table presents the weighted-average model assumptions used for grants:



	Years Ended December 31
	2012		2011		2010
Dividend yield	2.7	%	2.2	%	2.5	%
Expected volatility	29.8	%	28.8	%	30.3	%
Risk-free interest rate	1.1	%	2.3	%	2.5	%
Forfeiture rate	6.5	%	6.5	%	7.5	%
Expected life	5.8 years		5.4 years		5.4 years

The following table presents a roll-forward of ACE's stock options:



(Intrinsic Value in millions of U.S. dollars)	Number of Options		Weighted-Average Exercise Price		Weighted-Average Fair Value		Total Intrinsic Value
Options outstanding, December 31, 2009	11,483,104		$	45.46
Granted	2,094,227		$	50.38	$	12.09
Exercised	(1,328,715	)	$	40.11			$	22
Forfeited	(305,723	)	$	49.77
Options outstanding, December 31, 2010	11,942,893		$	46.80
Granted	1,649,824		$	62.68	$	14.67
Exercised	(2,741,238	)	$	44.45			$	63
Forfeited	(271,972	)	$	51.33
Options outstanding, December 31, 2011	10,579,507		$	49.78
Granted	1,462,103		$	73.36	$	15.58
Exercised	(2,401,869	)	$	42.50			$	78
Forfeited	(190,082	)	$	61.87
Options outstanding, December 31, 2012	9,449,659		$	55.03			$	234
Options exercisable, December 31, 2012	6,446,407		$	50.26			$	190

The weighted-average remaining contractual term was 6.2 years for the stock options outstanding and 4.8 years for the stock options exercisable at December 31, 2012. The amount of cash received during the year ended December 31, 2012 from the exercise of stock options was $95 million.

Restricted stock and restricted stock units

ACE's 2004 LTIP provides for grants of restricted stock and restricted stock units with a 4-year vesting period, based on a graded vesting schedule. ACE also grants restricted stock awards to non-management directors which vest at the following year's annual general meeting. The restricted stock is granted at market close price on the date of grant. Each restricted stock unit represents our obligation to deliver to the holder one Common Share upon vesting. Included in our share-based compensation expense for the year ended December 31, 2012, is a portion of the cost related to the restricted stock granted in the years 2008 - 2012.

The following table presents a roll-forward of our restricted stock awards. Included in the roll-forward below are 25,669 restricted stock awards, 32,660 restricted stock awards, and 36,248 restricted stock awards that were granted to non-management directors during the years ended December 31, 2012, 2011, and 2010 respectively:



	Number of Restricted Stock		Weighted-Average Grant-Date Fair Value
Unvested restricted stock, December 31, 2009	4,873,429		$	48.25
Granted	2,461,076		$	51.09
Vested	(1,771,423	)	$	50.79
Forfeited	(257,350	)	$	47.93
Unvested restricted stock, December 31, 2010	5,305,732		$	48.74
Granted	1,808,745		$	60.01
Vested	(1,929,189	)	$	50.82
Forfeited	(333,798	)	$	47.46
Unvested restricted stock, December 31, 2011	4,851,490		$	52.20
Granted	1,589,178		$	73.46
Vested	(1,923,385	)	$	52.71
Forfeited	(262,436	)	$	58.40
Unvested restricted stock, December 31, 2012	4,254,847		$	59.53

During the years ended December 31, 2012, 2011, and 2010, ACE awarded 262,549 restricted stock units, 261,214 restricted stock units, and 326,091 restricted stock units, respectively, to employees and officers of ACE and its subsidiaries each with a weighted-average grant date fair value per share of $73.41, $62.85, and $50.36, respectively. At December 31, 2012, there were 637,085 unvested restricted stock units.

Prior to 2009, ACE granted restricted stock units with a 1-year vesting period to non-management directors. Delivery of Common Shares on account of these restricted stock units to non-management directors is deferred until six months after the date of the non-management directors' termination from the Board. At December 31, 2012, there were 196,431 deferred restricted stock units.

ESPP

The ESPP gives participating employees the right to purchase Common Shares through payroll deductions during consecutive subscription periods at a purchase price of 85 percent of the fair value of a Common Share on the exercise date (Purchase Price). Annual purchases by participants are limited to the number of whole shares that can be purchased by an amount equal to ten percent of the participant's compensation or $25,000, whichever is less. The ESPP has two six-month subscription periods, the first of which runs between January 1 and June 30 and the second of which runs between July 1 and December 31 of each year. The amounts that have been collected from participants during a subscription period are used on the exercise date to purchase full shares of Common Shares. An exercise date is generally the last trading day of a subscription period. The number of shares purchased is equal to the total amount, at the exercise date, that has been collected from the participants through payroll deductions for that subscription period, divided by the Purchase Price, rounded down to the next full share. Participants may withdraw from an offering before the exercise date and obtain a refund of the amounts withheld through payroll deductions. Pursuant to the provisions of the ESPP, during the years ended December 31, 2012, 2011, and 2010, employees paid $13 million, $12 million, and $10 million to purchase 198,244 shares, 205,812 shares, and 240,979 shares, respectively.