Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2008, for ACE Limited (referred to as "ACE" or the "Company"). ACE is a global insurance and reinsurance organization operating through four segments: Insurance – North American, Insurance – Overseas General, Global Reinsurance, and Life Insurance and Reinsurance. During the period, the Company completed its re-domestication from the Cayman Islands to Zurich, Switzerland, effective July 18, 2008. Additionally, the financial results include the operations of Combined Insurance Company of America, acquired on April 1, 2008, for $2.56 billion.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2008 | Nine Months Ended Sep 30, 2008 | Nine Months Ended Sep 30, 2007 |
|---|---|---|---|
| Net Premiums Earned | $3,609 million | $9,977 million | $9,240 million |
| Net Investment Income | $520 million | $1,541 million | $1,414 million |
| Net Realized Gains (Losses) | $(510) million | $(989) million | $5 million |
| Total Revenues | $3,619 million | $10,529 million | $10,659 million |
| Net Income | $54 million | $1,177 million | $2,006 million |
| Comprehensive Income (Loss) | $(915) million | $(609) million | $1,958 million |
| Basic EPS | $0.16 | $3.51 | $6.08 |
| Total Assets | $75,155 million | As of Sep 30, 2008 | |
| Total Shareholders' Equity | $15,356 million | As of Sep 30, 2008 | |
| Total Debt | $3,335 million | As of Sep 30, 2008 | |
| Combined Ratio | 97.9% | 90.4% | 87.8% |
Material Changes vs. Prior Period
- Net Income Decline: Net income for the nine months ended September 30, 2008, decreased to $1.177 billion from $2.006 billion in the prior year period. This decline was primarily driven by net realized losses of $989 million (compared to a gain of $5 million in 2007) and increased catastrophe losses.
- Investment Losses: The Company recorded significant net realized losses due to widening credit spreads in the fixed income portfolio and poor equity market performance. Approximately $150 million of the third-quarter fixed maturity impairments were related to Lehman Brothers debt.
- Catastrophe Losses: Net catastrophe-related pre-tax charges were $411 million for the quarter and $500 million for the nine months ended September 30, 2008, compared to $21 million and $136 million in the prior year periods. These losses were primarily attributed to Hurricanes Gustav and Ike.
- Acquisition Impact: The acquisition of Combined Insurance contributed $373 million to net premiums written in the quarter and $777 million for the nine months, significantly boosting the Accident & Health (A&H) segment.
- Equity Reduction: Total shareholders' equity decreased by approximately $1.3 billion during the nine-month period, largely due to a $1.7 billion decline in net unrealized appreciation on investments and the $575 million redemption of Preferred Shares.
Guidance, Outlook, and Risks
- Market Conditions: Management notes that global market and economic conditions have been severely disrupted, with potential impacts on demand, claims, and investment performance. The Company anticipates positive cash flows from operations will cover outflows through 2008.
- Variable Annuity Reinsurance: The Life Insurance and Reinsurance segment faces volatility due to GMIB (Guaranteed Minimum Income Benefits) liabilities. Net realized losses of $319 million were recorded for the nine months due to adverse financial market conditions. Management views this business as having a risk profile similar to catastrophe reinsurance but acknowledges short-term material impacts from market factors.
- Liquidity and Capital: The Company maintains $2 billion in available credit lines, with $1 billion utilized as of September 30, 2008. The Company redeemed all Preferred Shares in June 2008 and has authorized a $250 million share repurchase program (unused as of period end).
- Legal Proceedings: The Company is subject to ongoing investigations regarding underwriting practices and contingent commissions by various state and federal authorities. Management believes ultimate liability is not likely to have a material adverse effect on consolidated financial condition, though it could impact results for an individual period.
- Dividend Policy: Following the re-domestication to Switzerland, the Company intends to pay dividends as a repayment of share capital (par value reduction) to avoid Swiss withholding tax.
Key Facts for Investor Verification
- Investment Portfolio Quality: Verify the extent of unrealized losses in the fixed income portfolio ($1.78 billion gross unrealized loss on fixed maturities) and the Company's intent to hold these securities to maturity to avoid realizing losses.
- Reinsurance Recoverables: Confirm the collectibility of $14.2 billion in reinsurance recoverable on losses, particularly given the financial distress of some reinsurers during the 2008 crisis.
- Combined Insurance Integration: Assess the long-term profitability and integration costs of the Combined Insurance acquisition, which significantly altered the business mix toward A&H.
- GMIB Liability Sensitivity: Review the sensitivity of the Life segment's net income to changes in equity markets and interest rates, as a 10% drop in worldwide equities could reduce net income by $135 million.
- Credit Facility Covenants: Monitor compliance with debt covenants, specifically the minimum consolidated net worth ($11.97 billion required vs. $16.5 billion actual) and debt-to-capitalization ratios.