Business context and reporting period
ACE Limited filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2009. The Switzerland-domiciled insurance and reinsurance group operated through Insurance–North American, Insurance–Overseas General, Global Reinsurance, and Life. Amounts are in U.S. dollars unless noted. The filing reports ACE Limited, not Chubb Ltd.
Financial performance and position
| Metric | Q3 2009 | Q3 2008 | Nine months 2009 | Nine months 2008 |
|---|---|---|---|---|
| Net premiums earned | $3.393 billion | $3.609 billion | $9.853 billion | $9.977 billion |
| Total revenues | $3.681 billion | $3.619 billion | $10.803 billion | $10.529 billion |
| Net income | $494 million | $54 million | $1.596 billion | $1.177 billion |
| Diluted earnings per share | $1.46 | $0.16 | $4.73 | $3.45 |
| Net investment income | $511 million | $520 million | $1.519 billion | $1.541 billion |
| Net realized losses | $(223) million | $(510) million | $(569) million | $(989) million |
- For property and casualty businesses, excluding Life, the combined ratio improved to 88.1% from 97.9% for the quarter and to 87.8% from 90.4% year to date. Lower catastrophe losses and favorable prior-period reserve development contributed; a ratio below 100% indicates underwriting income.
- Q3 net catastrophe losses were $45 million versus $411 million; nine-month losses were $114 million versus $500 million. Favorable prior-period development was $203 million in Q3 and $429 million year to date, versus $277 million and $562 million, respectively, in 2008.
- At September 30, total assets were $77.821 billion, shareholders’ equity $18.733 billion, and cash $742 million. Total investments were $45.921 billion on the balance sheet. Equity increased from $14.446 billion at year-end 2008, substantially reflecting $2.648 billion of after-tax unrealized investment appreciation and $1.596 billion of net income.
- Nine-month operating cash flow was $2.332 billion, compared with $3.140 billion. Investing activities used $2.437 billion; financing activities used $30 million. Cash decreased by $125 million over the period.
- Total debt was $3.521 billion, comprising $200 million short-term and $3.321 billion long-term debt; trust preferred securities were $309 million. Debt to total capitalization was 15.6%, down from 18.2% at year-end 2008. Credit facilities totaled about $2.49 billion, with $1.497 billion in use.
- Gross unpaid losses and loss expenses were $37.871 billion; net reserves were $25.071 billion. Net reinsurance recoverables were $13.689 billion, including a $585 million provision for uncollectible paid and unpaid recoverables.
Material changes versus prior comparable periods
- Q3 net income rose sharply from 2008, when catastrophe losses and investment impairments were substantially higher. Total revenues rose 2%, even as net premiums earned fell 6%; nine-month net income increased 36% while net premiums earned declined 1%.
- Premium trends were mixed: Q3 net premiums written declined 4% overall, while Global Reinsurance grew 18%; North American and Overseas General declined 6% and 7%. The nine-month total was nearly flat, with Combined Insurance’s full-period contribution and the annual crop settlement offsetting declines elsewhere.
- Net investment income declined 2% in Q3 and 1% year to date, which management attributed primarily to lower reinvestment yields and foreign exchange, partly offset by higher average invested assets.
- Fixed-maturity fair values improved: available-for-sale securities were $38.559 billion versus $31.155 billion at year-end 2008. Gross unrealized losses on fixed maturities fell to $921 million from $2.792 billion. Market recovery and tighter credit spreads drove much of the improvement.
- ACE issued $500 million of 5.9% senior notes due 2019 in June 2009; long-term debt increased from $2.806 billion to $3.321 billion. Short-term debt declined after repayment of reverse repurchase agreements and a term-loan tranche.
Outlook, management commentary, risks and unusual items
- Management described more competitive market conditions as financial markets and industry capital recovered. Rates rose modestly overall during Q3, but varied by line and softened as the quarter progressed. The recession and a stronger U.S. dollar pressured demand, pricing, and reported international premiums. No specific earnings or revenue guidance was provided.
- Management said operating cash flows, routine investment sales, and credit facilities were expected to meet working-capital and debt needs; it anticipated positive operating cash flows would cover cash outflows under most loss scenarios through 2009. Credit access depends on bank counterparties, and credit facilities include minimum-net-worth and maximum-leverage covenants.
- ACE adopted revised accounting for other-than-temporary impairments (OTTI) in April 2009. The adoption shifted certain non-credit impairments from retained earnings to other comprehensive income; the filing reports a $242 million cumulative accounting adjustment and a $47 million reduction to retained earnings and deferred tax assets for a related tax valuation allowance. Nine-month OTTI losses recognized in income were $364 million.
- Variable-annuity guarantees remain sensitive to equity markets, interest rates, credit spreads, volatility, and policyholder behavior. GMIB liabilities were $705 million at September 30, down from $910 million at year-end; management cautioned that model assumptions and actual experience could differ materially. ACE had stopped quoting new variable-annuity guarantee reinsurance opportunities in 2008 and the first nine months of 2009.
- Investment risks include $55 million of sub-prime asset-backed securities and a $1.6 billion estimated reduction in book value for a 100-basis-point increase in interest rates. Approximately $12.7 billion of assets were restricted or pledged. About $720 million of potential future funding commitments related to limited partnerships.
- Contingencies include an IRS tax examination and appeal, business-practices litigation, and a New York workers’ compensation assessment inquiry. Management said the New York matter was not expected to have a material financial impact and had established a contingency; it could not estimate potential damages for certain litigation. Management considered a material adverse effect on financial condition from the described litigation unlikely, while noting possible material effects on an individual reporting period.
- Other exposures include asbestos and environmental run-off liabilities, reinsurance collectability, catastrophe losses, and possible additional collateral requirements. The filing’s modeled net 1-in-100-year U.S. hurricane loss was approximately $1.2 billion and California earthquake loss approximately $899 million; management cautioned that modeled results are uncertain and not maximum exposures.
Important facts for investors to verify
- Whether the improvement in underwriting results persists after adjusting for catastrophe losses and favorable prior-period reserve releases, and how reserve estimates develop.
- The credit quality, impairment assumptions, and valuation of fixed-income and mortgage-backed securities, including the potential impact of market movements and revised OTTI accounting.
- GMIB/GMDB exposure, hedge effectiveness, and sensitivity to markets and policyholder behavior; confirm reserve and liability movements against subsequent disclosures.
- Reinsurance recoverable collectability, catastrophe accumulation, and the adequacy of collateral and available credit facilities under stressed conditions.
- Developments in tax, litigation, workers’ compensation assessment, and asbestos/environmental matters, including any changes to recorded contingencies.
- Comparability of premium trends, particularly the effects of foreign exchange, recession-related exposure declines, the crop settlement, and Combined Insurance’s differing inclusion in prior-year periods.