Commitments, contingencies, and guarantees

a) Derivative instruments

Derivative instruments employed

ACE maintains positions in derivative instruments such as futures, options, swaps, and foreign currency forward contracts for which the primary purposes are to manage duration and foreign currency exposure, yield enhancement, or to obtain an exposure to a particular financial market. ACE also maintains positions in convertible bond investments that contain embedded derivatives. These are the most numerous and frequent derivative transactions.

In addition, ACE from time to time purchases to be announced mortgage-backed securities (TBAs) as part of its investing activities.

Under reinsurance programs covering GLBs, ACE assumes the risk of GLBs, including GMIB and GMAB, associated with variable annuity contracts. The GMIB risk is triggered if, at the time the contract holder elects to convert the accumulated account value to a periodic payment stream (annuitize), the accumulated account value is not sufficient to provide a guaranteed minimum level of monthly income. The GMAB risk is triggered if, at contract maturity, the contract holder’s account value is less than a guaranteed minimum value. The GLB reinsurance product meets the definition of a derivative instrument. Benefit reserves in respect of GLBs are classified as Future policy benefits (FPB) while the fair value derivative adjustment is classified within Accounts payable, accrued expenses, and other liabilities (AP). ACE also maintains positions in exchange-traded equity futures contracts and options on equity market indices to limit equity exposure in the GMDB and GLB blocks of business.

In relation to certain debt issuances, ACE from time to time enters into interest rate swap transactions for the purpose of either fixing or reducing borrowing costs. Although the use of these interest rate swaps has the economic effect of fixing or reducing borrowing costs on a net basis, gross interest expense on the related debt issuances is included in Interest expense while the settlements related to the interest rate swaps are reflected in Net realized gains (losses) in the consolidated statements of operations. At December 31, 2013, ACE had no in-force interest rate swaps.

ACE from time to time buys credit default swaps to mitigate global credit risk exposure, primarily related to reinsurance recoverables. At December 31, 2013, ACE had no in-force credit default swaps.

All derivative instruments are carried at fair value with changes in fair value recorded in Net realized gains (losses) in the consolidated statements of operations. None of the derivative instruments are designated as hedges for accounting purposes.

The following table presents the balance sheet locations, fair values of derivative instruments in an asset or (liability) position, and notional values/payment provisions of our derivative instruments:



	December 31, 2013									December 31, 2012
	Consolidated Balance Sheet Location⁽¹⁾	Fair Value					Notional Value/ Payment Provision		Consolidated Balance Sheet Location	Fair Value					Notional Value/ Payment Provision
		Derivative Asset		Derivative (Liability)						Derivative Asset		Derivative (Liability)
(in millions of U.S. dollars)		Derivative Asset		Derivative (Liability)						Derivative Asset		Derivative (Liability)
Investment and embedded derivative instruments
Foreign currency forward contracts	OA / (AP)	$	3	$	(4	)	$	1,202	AP	$	—	$	—		$	620
Cross-currency swaps	OA / (AP)	—		—			50		AP	—		—			50
Futures contracts on money market instruments	OA / (AP)	3		—			3,910		AP	1		—			2,710
Futures contracts on notes and bonds	OA / (AP)	13		(2		)	871		AP	10		—			915
Convertible bonds	FM AFS	302		—			254		FM AFS	309		—			279
		$	321	$	(6	)	$	6,287		$	320	$	—		$	4,574
Other derivative instruments
Futures contracts on equities⁽²⁾	OA / (AP)	$	—	$	(60	)	$	1,692	AP	$	—	$	(6	)	$	2,308
Options on equity market indices⁽²⁾	OA / (AP)	6		—			250		AP	30		—			250
Other	OA / (AP)	—		(2		)	8		AP	—		—			—
		$	6	$	(62	)	$	1,950		$	30	$	(6	)	$	2,558
GLB⁽³⁾	(AP) / (FPB)	$	—	$	(427	)	$	277	AP / FPB	$	—	$	(1,352	)	$	1,100


⁽¹⁾	Other assets (OA), Fixed maturities available for sale (FM AFS)


⁽²⁾	Related to GMDB and GLB blocks of business.


⁽³⁾	Includes both future policy benefits reserves and fair value derivative adjustment. Refer to Note 5 c) for additional information. Note that the payment provision related to GLB is the net amount at risk. The concept of a notional value does not apply to the GLB reinsurance contracts.

On January 1, 2013, we adopted new accounting guidance that requires disclosure of financial instruments subject to a master netting agreement. At December 31, 2013 and December 31, 2012, derivative liabilities of $41 million and derivative assets of $35 million, respectively, included in the table above were subject to a master netting agreement. The remaining derivatives included in the table above were not subject to a master netting agreement.

At both December 31, 2013 and 2012, our repurchase obligations of $1,401 million were fully collateralized. At December 31, 2013 and 2012, our securities lending payable was $1,633 million and $1,795 million, respectively, and our securities lending collateral was $1,632 million and $1,791 million, respectively. The securities lending collateral can only be accessed in the event that the institution borrowing the securities is in default under the lending agreement. An indemnification agreement with the lending agent protects us in the event a borrower becomes insolvent or fails to return any of the securities on loan. In contrast to securities lending programs, the use of cash received is not restricted for the repurchase obligations.

The following table presents net realized gains (losses) related to derivative instrument activity in the consolidated statements of operations:



	Years Ended December 31
(in millions of U.S. dollars)	2013			2012			2011
Investment and embedded derivative instruments
Foreign currency forward contracts	$	11		$	(9	)	$	6
All other futures contracts and options	61			(22		)	(98		)
Convertible bonds	6			25			(50		)
TBAs	—			—			(1		)
Total investment and embedded derivative instruments	$	78		$	(6	)	$	(143	)
GLB and other derivative instruments
GLB⁽¹⁾	$	878		$	171		$	(779	)
Futures contracts on equities⁽²⁾	(555		)	(273		)	(12		)
Options on equity market indices⁽²⁾	(24		)	(24		)	8
Other	(2		)	(4		)	(4		)
Total GLB and other derivative instruments	$	297		$	(130	)	$	(787	)
	$	375		$	(136	)	$	(930	)


⁽¹⁾	Excludes foreign exchange gains (losses) related to GLB.


⁽²⁾	Related to GMDB and GLB blocks of business.

Derivative instrument objectives

(i) Foreign currency exposure management

A foreign currency forward contract (forward) is an agreement between participants to exchange specific foreign currencies at a future date. ACE uses forwards to minimize the effect of fluctuating foreign currencies.

(ii) Duration management and market exposure

Futures

Futures contracts give the holder the right and obligation to participate in market movements, determined by the index or underlying security on which the futures contract is based. Settlement is made daily in cash by an amount equal to the change in value of the futures contract times a multiplier that scales the size of the contract. Exchange-traded futures contracts on money market instruments, notes and bonds are used in fixed maturity portfolios to more efficiently manage duration, as substitutes for ownership of the money market instruments, bonds and notes without significantly increasing the risk in the portfolio. Investments in futures contracts may be made only to the extent that there are assets under management not otherwise committed.

Exchange-traded equity futures contracts are used to limit exposure to a severe equity market decline, which would cause an increase in expected claims and therefore, reserves for GMDB and GLB reinsurance business.

Options

An option contract conveys to the holder the right, but not the obligation, to purchase or sell a specified amount or value of an underlying security at a fixed price. Option contracts are used in the investment portfolio as protection against unexpected shifts in interest rates, which would affect the duration of the fixed maturity portfolio. By using options in the portfolio, the overall interest rate sensitivity of the portfolio can be reduced. Option contracts may also be used as an alternative to futures contracts in the synthetic strategy as described above.

Another use for option contracts is to limit exposure to a severe equity market decline, which would cause an increase in expected claims and therefore, reserves for GMDB and GLB reinsurance business.

The price of an option is influenced by the underlying security, expected volatility, time to expiration, and supply and demand.

The credit risk associated with the above derivative financial instruments relates to the potential for non-performance by counterparties. Although non-performance is not anticipated, in order to minimize the risk of loss, management monitors the creditworthiness of its counterparties and obtains collateral. The performance of exchange-traded instruments is guaranteed by the exchange on which they trade. For non-exchange-traded instruments, the counterparties are principally banks which must meet certain criteria according to our investment guidelines.

Cross-currency swaps

Cross-currency swaps are agreements under which two counterparties exchange interest payments and principal denominated in different currencies at a future date. We use cross-currency swaps to reduce the foreign currency and interest rate risk by converting cash flows back into local currency. We invest in foreign currency denominated investments to improve credit diversification and also to obtain better duration matching to our liabilities that is limited in the local currency market.

Other

Included within Other are derivatives intended to reduce potential losses which may arise from certain exposures in our insurance business. The economic benefit provided by these derivatives is similar to purchased reinsurance. For example, from time to time ACE may enter into derivative contracts to protect underwriting results in the event of a significant decline in commodity prices. Also included within Other are credit default swaps purchased and certain life insurance products that meet the definition of a derivative instrument for accounting purposes.

(iii) Convertible security investments

A convertible bond is a debt instrument that can be converted into a predetermined amount of the issuer’s equity at certain times prior to the bond’s maturity. The convertible option is an embedded derivative within the fixed maturity host instruments which are classified in the investment portfolio as available for sale. ACE purchases convertible bonds for their total return and not specifically for the conversion feature.

(iv) TBA

By acquiring TBAs, we make a commitment to purchase a future issuance of mortgage-backed securities. For the period between purchase of the TBAs and issuance of the underlying security, we account for our position as a derivative in the consolidated financial statements. ACE purchases TBAs both for their total return and for the flexibility they provide related to our mortgage-backed security strategy.

(v) GLB

Under the GLB program, as the assuming entity, ACE is obligated to provide coverage until the expiration or maturity of the underlying deferred annuity contracts or the expiry of the reinsurance treaty. Premiums received under the reinsurance treaties are classified as premium. Expected losses allocated to premiums received are classified as Future policy benefits and valued similar to GMDB reinsurance. Other changes in fair value, principally arising from changes in expected losses allocated to expected future premiums, are classified as Net realized gains (losses). Fair value represents management’s estimate of exit price and thus, includes a risk margin. We may recognize a realized loss for other changes in fair value due to adverse changes in the capital markets (e.g., declining interest rates and/or declining equity markets) and changes in actual or estimated future policyholder behavior (e.g., increased annuitization or decreased lapse rates) although we expect the business to be profitable. We believe this presentation provides the most meaningful disclosure of changes in the underlying risk within the GLB reinsurance programs for a given reporting period.

b) Concentrations of credit risk

Our investment portfolio is managed following prudent standards of diversification. Specific provisions limit the allowable holdings of a single issue and issuer. We believe that there are no significant concentrations of credit risk associated with our investments. Our three largest exposures by issuer at December 31, 2013, were JP Morgan Chase & Co., Goldman Sachs Group Inc., and General Electric Company. Our largest exposure by industry at December 31, 2013 was financial services.

We market our insurance and reinsurance worldwide primarily through insurance and reinsurance brokers. We assume a degree of credit risk associated with brokers with whom we transact business. During both years ended December 31, 2013 and 2012, and in the year ended December 31, 2011, approximately 11 percent and 12 percent, respectively, of our gross premiums written were generated from or placed by Marsh, Inc. This entity is a large, well established company and there are no indications that it is financially troubled at December 31, 2013. In addition, during the year ended December 31, 2011, approximately 10 percent of our gross premiums written were generated from or placed by Aon Corporation and its affiliates. No other broker and no one insured or reinsured accounted for more than 10 percent of gross premiums written in the years ended December 31, 2013, 2012, and 2011.

c) Other investments

At December 31, 2013, included in Other investments in the consolidated balance sheet are investments in limited partnerships and partially-owned investment companies with a carrying value of $1.9 billion. In connection with these investments, we have commitments that may require funding of up to $1.2 billion over the next several years.

d) Letters of credit

We have a $1.0 billion unsecured operational LOC facility (adjustable to $1.5 billion upon consent of the issuers) expiring in November 2017. We are allowed to use up to $300 million of this LOC facility as an unsecured revolving credit facility. At December 31, 2013, outstanding LOCs issued under this facility were $376 million. We also have a $500 million unsecured operational LOC facility expiring in June 2014. At December 31, 2013, this facility was fully utilized.

To satisfy funding requirements of ACE's Lloyd's Syndicate 2488 through 2014, we have a series of four bilateral uncollateralized LOC facilities totaling $425 million. LOCs issued under these facilities will expire no earlier than December 2017. Usage of this facility at December 31, 2013 was $352 million.

These facilities require that ACE Limited and/or certain of its subsidiaries continue to maintain certain covenants. ACE Limited is also required to maintain a minimum consolidated net worth covenant and a maximum leverage covenant, which have been met at December 31, 2013.

e) 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. In addition to claims litigation, we 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. In the opinion of management, our ultimate liability for these matters could be, but we believe is not likely to be, material to our consolidated financial condition and results of operations.

f) Lease commitments

We lease office space and equipment under operating leases which expire at various dates through 2033. Rent expense was $128 million, $112 million, and $114 million for the years ended December 31, 2013, 2012, and 2011, respectively. Future minimum lease payments under the leases are expected to be as follows:



For the year ending December 31
(in millions of U.S. dollars)
2014	$	106
2015	99
2016	86
2017	70
2018	49
Thereafter	124
Total minimum future lease commitments	$	534