ACE Limited — Q2 2011 Form 10-Q
Filing identity: The filing is for ACE Limited, the Swiss-incorporated insurance and reinsurance group, for the quarter and six months ended June 30, 2011. The filing describes four segments: Insurance—North American, Insurance—Overseas General, Global Reinsurance, and Life. Amounts are U.S. dollars unless noted. Interim results are not necessarily indicative of full-year results.
Business context and financial performance
ACE provides insurance and reinsurance products internationally. Results reflect substantial catastrophe losses in the first half of 2011 and the inclusion of New York Life’s Korea and Hong Kong operations in the Life segment.
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net premiums written | $3.953bn | $3.420bn | $7.399bn | $6.991bn |
| Net premiums earned | $3.757bn | $3.233bn | $7.066bn | $6.510bn |
| Net investment income | $569m | $518m | $1.113bn | $1.022bn |
| Total revenues | $4.253bn | $3.760bn | $8.061bn | $7.709bn |
| Net realized gains (losses) | $(73)m | $9m | $(118)m | $177m |
| Income before tax | $729m | $819m | $1.085bn | $1.698bn |
| Net income | $607m | $677m | $866m | $1.432bn |
| Diluted earnings per share | $1.77 | $1.98 | $2.54 | $4.21 |
| Combined ratio | 92.6% | 89.7% | 98.4% | 91.2% |
Premium growth was driven in part by acquisitions, international business and foreign exchange. Higher losses and loss expenses—up 24% in Q2 and 21% year to date—more than offset revenue growth. Management attributed the deterioration in underwriting results chiefly to catastrophe activity. Favorable prior-period reserve development was $146m in Q2 and $239m year to date. The company’s adjusted loss ratio, excluding catastrophe effects and prior-period development, was 63.2% in Q2 (61.2% a year earlier) and 62.0% year to date (61.1% a year earlier).
Financial position, cash flow and debt
- At June 30, 2011, total assets were $89.254bn, shareholders’ equity $24.113bn, and total liabilities $65.141bn. Equity was up from $22.974bn at year-end 2010.
- Cash was $833m, versus $772m at December 31, 2010. Six-month operating cash flow was $2.063bn, investing cash outflow $1.899bn, financing cash outflow $115m, and net cash increased $61m.
- Total debt was $4.760bn: $1.400bn short-term and $3.360bn long-term. Including $309m of trust preferred securities, debt plus trust preferred securities equaled 17.4% of total capitalization; debt alone was 16.3%.
- Available credit lines totaled $2.4bn, with $1.5bn used to support letters of credit. ACE reported meeting all financial covenants. It also had $1.4bn of reverse repurchase agreements outstanding at June 30.
- Investments totaled $55.189bn on the balance sheet. Fixed-income average duration was 3.8 years; management estimated a 100-basis-point rise in interest rates would reduce book value by approximately $2.0bn.
- Gross unpaid losses and loss expenses were $38.951bn; net reserves were $26.284bn. Net reinsurance recoverables on losses and loss expenses were $13.375bn.
Material changes and segment developments
- ACE acquired New York Life’s Korea and Hong Kong operations for approximately $425m in cash, adding about $123m of goodwill and $207m of intangible assets. Acquired businesses contributed to Life segment premium and revenue growth.
- In Q2, North American net premiums written rose 21% year over year, helped by the Rain and Hail crop insurance acquisition; segment net income fell 22% to $301m and its combined ratio increased to 95.0% from 90.3%.
- Overseas General Q2 net premiums written rose 14%, with favorable currency effects; segment net income was $216m, down 3%. Its year-to-date combined ratio rose to 98.9% from 93.0%.
- Global Reinsurance Q2 written premiums declined 2%; year-to-date they fell 10%. Segment net income declined to $128m in Q2 and $106m year to date, compared with $184m and $337m, respectively.
- Life Q2 net income was $25m, versus a $78m loss a year earlier; six-month net income was $88m, versus $37m. Life underwriting income increased, while fair-value losses on variable-annuity guarantee liabilities and related derivatives remained a source of volatility.
Outlook, risks and contingencies
- ACE reported net after-tax catastrophe losses, including reinstatement premiums, of $101m in Q2 and $544m for the first half. Events included earthquakes in Japan and New Zealand, Australian storms, and severe U.S. weather. Management cautioned that Japan earthquake estimates remain uncertain and actual losses could be materially higher or lower.
- Management said catastrophe losses were contributing to price increases in selected property classes, international marine and energy. Casualty pricing was described as firming, but without meaningful rate increases. ACE said it would maintain underwriting discipline and decline inadequately priced or exposed business. Management expected A&H business to continue growing through 2011.
- Combined Insurance operations in the U.K. and Ireland were under a sales moratorium while ACE re-evaluated sales practices and processes amid regulatory changes. ACE planned to seek approval to resume sales after integrating European operations; it decided to cease sales in a small Spanish subsidiary permanently.
- Variable-annuity living-benefit reinsurance is no longer being written, but remains exposed to equity markets, interest rates, credit spreads, and policyholder behavior. ACE’s valuation relies on internal models and significant unobservable assumptions; management warned adverse changes could materially affect income. Management made no actuarial or behavior assumption changes in its first-half 2011 review.
- ACE said operating cash flows should cover outflows under most loss scenarios through 2011, with capital markets and credit facilities as additional sources. This is management’s assessment, not formal earnings guidance.
- Pending business-practices litigation includes an Ohio action in which the plaintiff’s expert alleged $11.3m of overcharges and sought a $10.3m penalty; the overcharge claim could be trebled under Ohio law. ACE disputed the claims. The company could not estimate potential losses in several related cases, and stated that litigation could affect results in an individual period even if not expected to materially harm financial condition.
- Other risks include catastrophe severity and coverage disputes, reserve estimation, reinsurance collectability, investment-market and foreign-exchange movements, regulatory changes, and acquisition execution. ACE reported no material change to the risk factors in its 2010 Form 10-K.
Important facts for investors to verify
- How catastrophe losses and reserve development evolve, particularly the ultimate insured losses and coverage outcomes from the Japan earthquake.
- Whether premium growth translates into durable underwriting profitability; track combined ratios and results excluding catastrophe losses and prior-period development.
- How much of reported premium growth reflects acquisitions and foreign exchange, and the acquired Korea and Hong Kong businesses’ subsequent contribution.
- Changes in the level and collectability of reinsurance recoverables, including the quality and concentration of reinsurer exposures.
- Sensitivity of variable-annuity guarantee liabilities and earnings to markets and policyholder behavior, and the assumptions used in the internal valuation models.
- Credit availability, reverse-repo funding, and the effects of restricted assets and insurance-subsidiary dividend constraints on parent-company liquidity.
- Developments in the Combined Insurance U.K./Ireland sales pause and the pending business-practices and Ohio litigation.