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ACE AVIATION HOLDING 10-Q 2008

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2008

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from              to             

 

Commission File No. 1-11778   I.R.S. Employer Identification No. 98-0091805

 

 

ACE LIMITED

(Incorporated in Switzerland)

 

 

Mainaustrasse 30

Zurich CH-8008, Switzerland

Telephone +41 (0)43 456 76 00

(Address of principal executive offices)

17 Woodbourne Avenue

Hamilton HM 08

Bermuda

Telephone 441-295-5200

(Former name, former address and former fiscal year if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

                                                         YES  x                                                 NO  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

  x        Accelerated filer   ¨  

Non-accelerated filer

  ¨     (Do not check if a smaller reporting company)   

Smaller reporting company

  ¨  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

                                                         YES  ¨                                                 NO  x

The number of registrant’s Common Shares (CHF 33.44 par value) outstanding as of November 4, 2008, was 333,581,968.

 

 

 


Table of Contents

ACE LIMITED

INDEX TO FORM 10-Q

 

              Page No.

Part I. FINANCIAL INFORMATION

  

Item 1.

  

Financial Statements:

  
  

Consolidated Balance Sheets (Unaudited)
September 30, 2008, and December 31, 2007

   3
  

Consolidated Statements of Operations and Comprehensive Income (Unaudited)
Three and Nine Months Ended September 30, 2008 and 2007

   4
  

Consolidated Statements of Shareholders’ Equity (Unaudited)
Nine Months Ended September 30, 2008 and 2007

   5
  

Consolidated Statements of Cash Flows (Unaudited)
Nine Months Ended September 30, 2008 and 2007

   7
  

Notes to the Interim Consolidated Financial Statements (Unaudited)

  
  

Note 1.

 

General

   8
  

Note 2.

 

Significant accounting policies

   8
  

Note 3.

 

Acquisition

   11
  

Note 4.

 

Fair value measurements

   13
  

Note 5.

 

Investments

   17
  

Note 6.

 

Assumed reinsurance programs involving minimum benefit guarantees under annuity contracts

   19
  

Note 7.

 

Goodwill and other intangible assets

   20
  

Note 8.

 

Debt

   21
  

Note 9.

 

Commitments, contingencies, and guarantees

   22
  

Note 10.

 

Preferred Shares

   26
  

Note 11.

 

Shareholders’ equity

   26
  

Note 12.

 

Share-based compensation

   27
  

Note 13.

 

Segment information

   27
  

Note 14.

 

Earnings per share

   33
  

Note 15.

 

Information provided in connection with outstanding debt of subsidiaries

   33
  

Note 16.

 

Subsequent events

   40

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   41

Item 3.

  

Quantitative and Qualitative Disclosures about Market Risk

   86

Item 4.

  

Controls and Procedures

   86

Part II. OTHER INFORMATION

  

Item 1.

  

Legal Proceedings

   87

Item 1A.

  

Risk Factors

   87

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

   90

Item 6.

  

Exhibits

   90

 

2


Table of Contents

ACE LIMITED

PART I FINANCIAL INFORMATION

Item 1. Financial Statements

ACE LIMITED AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

     September 30
2008
     December 31
2007
 
     (in millions of U.S. dollars,
except share and per share data)
 

Assets

     

Investments

     

Fixed maturities available for sale, at fair value (amortized cost – $34,609 and $32,994) (includes hybrid financial instruments of $257 and $282)

   $ 33,158      $ 33,184  

Fixed maturities held to maturity, at amortized cost (fair value – $2,852 and $3,015)

     2,881        2,987  

Equity securities, at fair value (cost – $1,336 and $1,618)

     1,229        1,837  

Short-term investments, at fair value and amortized cost

     3,014        2,631  

Other investments (cost – $1,327 and $880)

     1,529        1,140  
                 

Total investments

     41,811        41,779  

Cash

     479        510  

Securities lending collateral

     2,050        2,109  

Accrued investment income

     478        416  

Insurance and reinsurance balances receivable

     3,499        3,540  

Reinsurance recoverable on losses and loss expenses

     14,225        14,354  

Reinsurance recoverable on future policy benefits

     276        8  

Deferred policy acquisition costs

     1,263        1,121  

Value of business acquired

     923        —    

Prepaid reinsurance premiums

     1,770        1,600  

Goodwill and other intangible assets

     3,817        2,838  

Deferred tax assets

     1,457        1,087  

Investments in partially-owned insurance companies (cost—$786 and $686)

     867        773  

Income taxes receivable

     11        —    

Other assets

     2,229        1,955  
                 

Total assets

   $ 75,155      $ 72,090  
                 

Liabilities

     

Unpaid losses and loss expenses

   $ 38,373      $ 37,112  

Unearned premiums

     6,459        6,227  

Future policy benefits

     2,919        545  

Insurance and reinsurance balances payable

     2,754        2,843  

Deposit liabilities

     346        351  

Securities lending payable

     2,095        2,109  

Payable for securities purchased

     1,008        1,798  

Accounts payable, accrued expenses, and other liabilities

     2,201        1,825  

Income taxes payable

     —          111  

Short-term debt

     333        372  

Long-term debt

     3,002        1,811  

Trust preferred securities

     309        309  
                 

Total liabilities

     59,799        55,413  
                 

Commitments and contingencies

     

Shareholders’ equity

     

Preferred Shares ($1.00 par value, Nil and 2,300,000 shares authorized, issued, and outstanding)

     —          2  

Common Shares (CHF 33.44 and $0.041666667 par value, 500,000,000 shares authorized; 335,259,791 and 329,704,531 shares issued; 333,394,608 and 329,704,531 shares outstanding)

     10,913        14  

Common Shares in treasury (1,865,183 and nil shares)

     (3 )      —    

Additional paid-in capital

     5,415        6,812  

Retained earnings

     54        9,080  

Deferred compensation obligation

     3        3  

Accumulated other comprehensive (loss) income

     (1,023 )      769  

Common Shares issued to employee trust

     (3 )      (3 )
                 

Total shareholders’ equity

     15,356        16,677  
                 

Total liabilities and shareholders’ equity

   $ 75,155      $ 72,090  
                 

See accompanying notes to the interim consolidated financial statements

 

3


Table of Contents

ACE LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

For the three and nine months ended September 30, 2008 and 2007

(Unaudited)

 

     Three Months
Ended

September 30
    Nine Months
Ended
September 30
 
     2008     2007     2008     2007  
     (in millions of U.S. dollars,
except per share data)
 

Revenues

        

Gross premiums written

   $ 5,220     $ 4,463     $ 14,922     $ 13,596  

Reinsurance premiums ceded

     (1,944 )     (1,663 )     (4,894 )     (4,444 )
                                

Net premiums written

     3,276       2,800       10,028       9,152  

Change in unearned premiums

     333       350       (51 )     88  
                                

Net premiums earned

     3,609       3,150       9,977       9,240  

Net investment income

     520       492       1,541       1,414  

Net realized gains (losses)

     (510 )     —         (989 )     5  
                                

Total revenues

     3,619       3,642       10,529       10,659  
                                

Expenses

        

Losses and loss expenses

     2,369       1,910       5,843       5,563  

Future policy benefits

     91       39       243       108  

Policy acquisition costs

     581       463       1,618       1,314  

Administrative expenses

     457       358       1,293       1,070  

Interest expense

     68       44       176       132  

Other (income) expense

     6       32       (104 )     32  
                                

Total expenses

     3,572       2,846       9,069       8,219  
                                

Income before income tax

     47       796       1,460       2,440  

Income tax (benefit) expense

     (7 )     140       283       434  
                                

Net income

   $ 54     $ 656     $ 1,177     $ 2,006  
                                

Other comprehensive (loss) income

        

Unrealized (depreciation) appreciation arising during the period

     (1,522 )     218       (2,750 )     (136 )

Reclassification adjustment for net realized (gains) losses included in net income

     383       6       725       21  
                                
     (1,139 )     224       (2,025 )     (115 )

Change in:

        

Cumulative translation adjustments

     (155 )     58       (122 )     93  

Pension liability

     5       (1 )     6       (3 )
                                

Other comprehensive (loss) income, before income tax

     (1,289 )     281       (2,141 )     (25 )

Income tax benefit (expense) related to other comprehensive income items

     320       (28 )     355       (23 )
                                

Other comprehensive (loss) income

     (969 )     253       (1,786 )     (48 )
                                

Comprehensive (loss) income

   $ (915 )   $ 909     $ (609 )   $ 1,958  
                                

Basic earnings per share

   $ 0.16     $ 1.98     $ 3.51     $ 6.08  
                                

Diluted earnings per share

   $ 0.16     $ 1.95     $ 3.46     $ 5.98  
                                

See accompanying notes to the interim consolidated financial statements

 

4


Table of Contents

ACE LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

For the nine months ended September 30, 2008 and 2007

(Unaudited)

 

     Nine Months Ended
September 30
 
     2008     2007  
     (in millions of U.S.
dollars)
 

Preferred Shares

    

Balance – beginning of period

   $ 2     $ 2  

Preferred Shares redeemed

     (2 )     —    
                

Balance – end of period

     —         2  
                

Common Shares

    

Balance – beginning of period

     14       14  

Exercise of stock options

     1       —    

Common Shares stock dividend

     10,985       —    

Dividends declared on Common Shares-par value reduction

     (87 )     —    
                

Balance – end of period

     10,913       14  
                

Common Shares in treasury

    

Balance – beginning of period

     —         —    

Common Shares issued in treasury net of net shares redeemed under employee share-based compensation plans

     (3 )     —    
                

Balance – end of period

     (3 )     —    
                

Additional paid-in capital

    

Balance – beginning of period

     6,812       6,640  

Preferred Shares redeemed

     (573 )     —    

Net shares redeemed under employee share-based compensation plans

     (14 )     (15 )

Exercise of stock options

     87       54  

Share-based compensation expense

     93       75  

Common Shares stock dividend

     (990 )     —    
                

Balance – end of period

     5,415       6,754  
                

Retained earnings

    

Balance – beginning of period

     9,080       6,906  

Effect of partial adoption of FAS 157

     (4 )     —    

Effect of adoption of FAS 159

     6       —    

Effect of adoption of FIN 48

     —         (22 )

Effect of adoption of FAS 155

     —         12  
                

Balance – beginning of period, adjusted for effect of adoption of new accounting principles

     9,082       6,896  

Net income

     1,177       2,006  

Dividends declared on Common Shares

     (186 )     (260 )

Dividends declared on Preferred Shares

     (24 )     (33 )

Common Shares stock dividend

     (9,995 )     —    
                

Balance – end of period

     54       8,609  
                

Deferred compensation obligation

    

Balance – beginning and end of period

   $ 3     $ 4  
                

See accompanying notes to the interim consolidated financial statements

 

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Table of Contents

ACE LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (cont’d)

For the nine months ended September 30, 2008 and 2007

(Unaudited)

 

     Nine Months Ended
September 30
 
     2008     2007  
     (in millions of U.S.
dollars)
 

Accumulated other comprehensive (loss) income

    

Net unrealized appreciation (depreciation) on investments

    

Balance – beginning of period

   $ 596     $ 607  

Effect of adoption of FAS 159

     (6 )     —    

Effect of adoption of FAS 155

     —         (12 )
                

Balance – beginning of period, adjusted for effect of adoption of new accounting principles

     590       595  

Change in period, net of income tax (expense) benefit of $317 and $10

     (1,708 )     (105 )
                

Balance – end of period

     (1,118 )     490  
                

Cumulative translation adjustment

    

Balance – beginning of period

     231       165  

Change in period, net of income tax (expense) benefit of $40 and $(35)

     (82 )     58  
                

Balance – end of period

     149       223  
                

Pension liability adjustment

    

Balance – beginning of period

     (58 )     (56 )

Change in period, net of income tax (expense) benefit of $(2) and $2

     4       (1 )
                

Balance – end of period

     (54 )     (57 )
                

Accumulated other comprehensive (loss) income

     (1,023 )     656  
                

Common Shares issued to employee trust

    

Balance – beginning and end of period

     (3 )     (4 )
                

Total shareholders’ equity

   $ 15,356     $ 16,035  
                

 

See accompanying notes to the interim consolidated financial statements

 

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Table of Contents

ACE LIMITED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the nine months ended September 30, 2008 and 2007

(Unaudited)

 

     Nine Months Ended
September 30
 
     2008     2007  
     (in millions of U.S.
dollars)
 

Cash flows from operating activities

    

Net income

   $ 1,177     $ 2,006  

Adjustments to reconcile net income to net cash flows from operating activities:

    

Net realized (gains) losses

     989       (5 )

Amortization of premium/discount on fixed maturities

     19       (5 )

Deferred income taxes

     (30 )     (17 )

Unpaid losses and loss expenses

     1,224       958  

Unearned premiums

     236       (30 )

Future policy benefits

     123       9  

Insurance and reinsurance balances payable

     (262 )     124  

Accounts payable, accrued expenses, and other liabilities

     260       73  

Income taxes payable/receivable

     (83 )     (8 )

Insurance and reinsurance balances receivable

     47       303  

Reinsurance recoverable on losses and loss expenses

     40       473  

Reinsurance recoverable on future policy benefits

     3       1  

Deferred policy acquisition costs

     (168 )     (30 )

Prepaid reinsurance premiums

     (162 )     (58 )

Other

     (273 )     84  
                

Net cash flows from operating activities

     3,140       3,878  
                

Cash flows used for investing activities

    

Purchases of fixed maturities available for sale

     (33,417 )     (35,736 )

Purchases of fixed maturities held to maturity

     (316 )     (266 )

Purchases of equity securities

     (834 )     (684 )

Sales of fixed maturities available for sale

     30,444       29,767  

Sales of equity securities

     1,001       670  

Maturities and redemptions of fixed maturities available for sale

     2,212       2,444  

Maturities and redemptions of fixed maturities held to maturity

     383       320  

Net proceeds from (payments made on) the settlement of investment derivatives

     (15 )     (3 )

Acquisition of subsidiary (net of cash acquired of $19)

     (2,522 )     —    

Other

     (476 )     (244 )
                

Net cash flows used for investing activities

     (3,540 )     (3,732 )
                

Cash flows from (used for) financing activities

    

Dividends paid on Common Shares

     (276 )     (253 )

Dividends paid on Preferred Shares

     (24 )     (33 )

Net proceeds from (repayment of) short-term debt

     (35 )     (500 )

Net proceeds from issuance of long-term debt

     1,195       500  

Redemption of Preferred Shares

     (575 )     —    

Proceeds from exercise of options for Common Shares

     88       54  

Proceeds from Common Shares issued under ESPP

     10       9  
                

Net cash flows from (used for) financing activities

     383       (223 )
                

Effect of foreign currency rate changes on cash and cash equivalents

     (14 )     18  
                

Net decrease in cash

     (31 )     (59 )

Cash – beginning of period

     510       565  
                

Cash – end of period

   $ 479     $ 506  
                

See accompanying notes to the interim consolidated financial statements

 

7


Table of Contents

ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. General

ACE Limited (ACE or the Company) is a holding company which, until July 18, 2008, was incorporated with limited liability under the Cayman Islands Companies Law. On March 19, 2008, the Company announced that its Board of Directors (the Board) approved a proposal to move the Company’s jurisdiction of incorporation from the Cayman Islands to Zurich, Switzerland (the Continuation). On July 10, 2008, and July 14, 2008, during ACE’s annual general meeting, the Company’s shareholders approved the Continuation and ACE became a Swiss company effective July 18, 2008.

On April 1, 2008, ACE acquired all outstanding shares of Combined Insurance Company of America (Combined Insurance) and certain of its subsidiaries from AON Corporation (AON) for $2.56 billion. Combined Insurance is a leading underwriter and distributor of specialty individual accident and supplemental health insurance products targeted to middle income consumers in the U.S., Europe, Canada, and Asia Pacific. ACE recorded the acquisition using the purchase method of accounting. The interim consolidated financial statements include the results of Combined Insurance from April 1, 2008. Based on ACE’s preliminary purchase price allocation, $936 million of goodwill and other intangible assets was generated as a result of the acquisition. Refer to Note 3.

The Company, through its various subsidiaries, provides a broad range of insurance and reinsurance products to insureds worldwide. ACE operates through the following business segments: Insurance – North American, Insurance – Overseas General, Global Reinsurance, and Life Insurance and Reinsurance. Refer to Note 13.

The interim unaudited consolidated financial statements, which include the accounts of the Company and its subsidiaries, have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and, in the opinion of management, reflect all adjustments (consisting of normally recurring accruals) necessary for a fair statement of the results and financial position for such periods. All significant intercompany accounts and transactions have been eliminated. Certain items in the prior year financial statements have been reclassified to conform to the current period presentation. The results of operations and cash flows for any interim period are not necessarily indicative of the results for the full year. These financial statements should be read in conjunction with the consolidated financial statements, and related notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

2. Significant accounting policies

New accounting pronouncements

Adopted in the nine months ended September 30, 2008

Fair value measurements

In September 2006, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standard (FAS) No. 157, Fair Value Measurements (FAS 157). FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. FAS 157 focuses on how to measure fair value and establishes a three-level hierarchy for both measurement and disclosure purposes. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. Under FAS 157, fair value measurements are separately disclosed by level within the fair value hierarchy. FAS 157 does not expand the use of fair value measurement to any new circumstances. The Company adopted FAS 157, in part, as of January 1, 2008, and the cumulative effect of adoption resulted in a reduction to retained earnings of $4 million related to an increase in risk margins included in the valuation of certain guaranteed minimum income benefits (GMIB) contracts. For additional information regarding the partial adoption of FAS 157, refer to the following paragraph and Note 4.

In February 2008, the FASB issued FASB Staff Position (FSP) FAS 157-2, Effective Date of FASB Statement No. 157 (FSP FAS 157-2), which permits a one-year deferral of the application of FAS 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial

 

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Table of Contents

ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

statements on a recurring basis (at least annually). FSP FAS 157-2 is effective in conjunction with FAS 157 for interim and annual financial statements issued after January 1, 2008. Accordingly, the provisions of FAS 157 have not been applied to Goodwill and other intangible assets held by the Company which are measured annually for impairment testing purposes only.

In October 2008, the FASB issued FSP FAS 157-3, Determining Fair Value of a Financial Asset in a Market That is Not Active (FSP FAS 157-3). FSP FAS 157-3 clarifies the application of FAS 157 in an inactive market and provides examples to illustrate key considerations in determining the fair value of a financial asset in an inactive market. FSP FAS 157-3 is effective for the Company for the three months ended September 30, 2008. The adoption of FSP FAS 157-3 did not have a material impact on the Company’s financial condition or results of operations.

Fair value option for financial assets and financial liabilities

In February 2007, the FASB issued FAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (FAS 159). FAS 159 permits an entity to irrevocably elect fair value on a contract-by-contract basis as the initial and subsequent measurement attribute for many financial assets and liabilities and certain other items including insurance contracts. FAS 159 is effective for fiscal years beginning after November 15, 2007. Effective January 1, 2008, the Company elected the fair value option for certain of its available for sale equity securities. The Company elected the fair value option for these particular equity securities to simplify the accounting and oversight of this portfolio given the portfolio management strategy employed by the external investment manager. Since the equity securities were previously carried at fair value, the election did not have an effect on shareholders’ equity. However, the election resulted in an increase to retained earnings and a reduction to accumulated other comprehensive income of $6 million ($9 million pre-tax) as of January 1, 2008. Subsequent to this election, changes in fair value related to these equity securities were recognized in Net realized gains (losses) in the consolidated statement of operations. For additional information regarding the adoption of FAS 159, refer to Note 4.

Income tax benefits of dividends on share-based payment awards

In October 2006, the FASB issued Emerging Issues Task Force (EITF) Issue No. 06-11, Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards (EITF 06-11). EITF 06-11 provides guidance on the treatment of realized income tax benefits arising from dividend payments to employees holding equity shares, non-vested equity share units, and outstanding equity share options. EITF 06-11 is applied prospectively to the income tax benefits of dividends on equity-classified employee share-based payment awards that are declared in fiscal years beginning after December 15, 2007. The adoption of EITF 06-11 did not have a material impact on the Company’s financial condition or results of operations.

The Hierarchy of Generally Accepted Accounting Principles

In May 2008, the FASB issued FAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (FAS 162). FAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP. FAS 162 is effective September 28, 2008 (60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AICPA Professional Standards AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles). The adoption of FAS 162 did not have a material impact on the Company’s financial condition or results of operations.

 

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ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

To be adopted after September 30, 2008

Business combinations

In December 2007, the FASB issued FAS No. 141 (Revised), Business Combinations (FAS 141R). FAS 141R establishes standards that provide a definition of the “acquirer” and broaden the application of the acquisition method. FAS 141R also establishes how an acquirer recognizes and measures the assets, liabilities, and any noncontrolling interest in the “acquiree”; recognizes and measures goodwill or a gain from a bargain purchase; and requires disclosures that enable users to evaluate the nature and financial effects of the business combination. FAS 141R shall be applied prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company does not expect the adoption of FAS 141R to have a material impact on the Company’s financial condition or results of operations.

Noncontrolling interests

In December 2007, the FASB issued FAS No. 160, Noncontrolling Interests in Consolidated Financial Statements – an Amendment of ARB No. 51 (FAS 160). FAS 160 establishes accounting and reporting standards that require that ownership interests in subsidiaries held by parties other than the parent be presented in the consolidated statement of shareholders’ equity separately from the parent’s equity; the consolidated net income attributable to the parent and noncontrolling interest be presented on the face of the consolidated statements of operations; changes in a parent’s ownership interest while the parent retains controlling financial interest in its subsidiary be accounted for consistently; and sufficient disclosure that identifies and distinguishes between the interests of the parent and noncontrolling owners. FAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company does not expect the adoption of FAS 160 to have a material impact on the Company’s financial condition or results of operations.

Disclosures about derivative instruments and hedging activities

In March 2008, the FASB issued FAS No. 161, Disclosures About Derivative Instruments and Hedging Activities (FAS 161). FAS 161 establishes reporting standards that require enhanced disclosures about how and why derivative instruments are used, how derivative instruments are accounted for under FAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and how derivative instruments affect an entity’s financial position, financial performance, and cash flows. FAS 161 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after November 15, 2008.

Determination of the Useful Life of Intangible Assets

In April 2008, the FASB issued FSP No. FAS 142-3, Determination of the Useful Life of Intangible Assets (FSP FAS 142-3). FSP FAS 142-3 amends the factors considered in developing assumptions used to determine the useful life of an intangible asset under FAS No. 142, Goodwill and Other Intangible Assets (FAS 142). The intent of FSP FAS 142-3 is to improve the consistency between the useful life of a recognized intangible asset under FAS 142 and the period of expected cash flows used to measure the fair value of the asset under FAS 141R and other applicable accounting literature. FSP FAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and must be applied prospectively to intangible assets acquired after the effective date. The Company does not expect the adoption of FSP FAS 142-3 to have a material impact on the Company’s financial condition or results of operations.

Financial Guarantee Insurance Contracts

In May 2008, the FASB issued FAS No. 163, Accounting for Financial Guarantee Insurance Contracts – An interpretation of FASB Statement No. 60 (FAS 163). FAS 163 requires that an insurance enterprise recognize a

 

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ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

claim liability prior to an event of default when there is evidence that credit deterioration has occurred in an insured financial obligation. It also clarifies how FAS No. 60, Accounting and Reporting by Insurance Enterprises, applies to financial guarantee insurance contracts, including the recognition and measurement to be used to account for premium revenue and claim liabilities, and requires expanded disclosures about financial guarantee insurance contracts. FAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, except for some disclosures about the insurance enterprise’s risk management activities. FAS 163 requires that disclosures about the risk management activities of the insurance enterprise be effective for the first period beginning after issuance. Except for those disclosures, earlier application is not permitted.

Earnings Per Share

In June 2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (FSP EITF 03-6-1). FSP EITF 03-6-1 provides additional guidance in the calculation of earnings per share under FAS No. 128, Earnings Per Share, and requires unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) to be included in the computation of earnings per share pursuant to the two-class method. FSP EITF 03-6-1 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2008. The Company does not expect the adoption of FSP EITF 03-6-1 to have a material impact on the Company’s financial condition or results of operations.

3. Acquisition

On December 14, 2007, ACE entered into a stock purchase agreement with AON, pursuant to which ACE agreed to purchase all outstanding shares of capital stock of Combined Insurance and certain Combined Insurance subsidiaries. Combined Insurance is a leading underwriter and distributor of specialty individual accident and supplemental health insurance products targeted to middle income consumers in the U.S., Europe, Canada, and Asia Pacific. On April 1, 2008, ACE acquired all outstanding shares of Combined Insurance and certain of its subsidiaries from AON for $2.56 billion. This acquisition has diversified the Company’s A&H distribution capabilities by adding thousands of agents, while almost doubling the A&H franchise. ACE believes this will provide significant long-term growth opportunities.

ACE recorded the acquisition using the purchase method of accounting. The interim consolidated financial statements include the results of Combined Insurance from April 1, 2008. The most significant intangible asset is the value of business acquired (VOBA). VOBA represents the fair value of the future profits of the in-force long duration contracts and is amortized in relation to the profit emergence of the underlying contracts, in a manner similar to deferred acquisition costs, over a period of approximately thirty years. The VOBA calculation is based on many factors including mortality, morbidity, persistency, investment yields, expenses, and the discount rate with the discount rate being the most significant factor. The acquisition also generated $936 million of goodwill and other intangible assets (most, if not all, of which is expected to be deductible for income tax purposes) based on ACE’s preliminary purchase price allocation, which was apportioned to the Life Insurance and Reinsurance and Insurance – Overseas General segments in the amounts of $488 million and $448 million, respectively. The allocation of goodwill and other intangible assets to segments is preliminary and subject to change. Refer to Note 7. ACE financed the transaction through a combination of available cash ($811 million), reverse repurchase agreements ($1 billion), and new private and public long-term debt ($750 million). Refer to Note 8.

 

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ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following table summarizes ACE’s best estimate of fair value of the assets acquired and liabilities assumed from Combined Insurance at April 1, 2008. Upon the adoption of FAS 157, ACE elected to defer the fair value guidance applicable to valuing nonfinancial assets and nonfinancial liabilities that are not recognized or disclosed at fair value on a recurring basis. Accordingly, FAS 157 was not used to determine the fair values of the nonfinancial assets acquired and the nonfinancial liabilities assumed in this business combination. ACE expects to make further adjustments to its purchase price allocation during the quarter ending December 31, 2008, although ACE does not expect these changes to materially affect its financial position, results of operations, or cash flows.

Condensed Balance Sheet of Combined Insurance at April 1, 2008

(in millions of U.S. dollars)

 

Assets

  

Investments and cash

   $ 3,000

Insurance and reinsurance balances receivable

     38

Reinsurance recoverable on losses and loss expenses

     33

Reinsurance recoverable on future policy benefits

     271

Value of business acquired (preliminary)

     1,024

Goodwill and intangible assets (preliminary)

     936

Other assets (preliminary)

     159
      

Total assets (preliminary)

   $ 5,461
      

Liabilities and Shareholder’s Equity

  

Unpaid losses and loss expenses

   $ 386

Unearned premiums

     46

Future policy benefits

     2,256

Other liabilities (preliminary)

     232
      

Total liabilities (preliminary)

     2,920
      

Total shareholder’s equity (preliminary)

     2,541
      

Total liabilities and shareholder’s equity (preliminary)

   $ 5,461
      

 

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ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following table presents pro forma information for the periods indicated assuming the acquisition of Combined Insurance occurred on January 1st of each of the respective periods. The pro forma financial information is presented for informational purposes only and is not necessarily indicative of the operating results that would have occurred had the acquisition been consummated at the beginning of each period presented, nor is it necessarily indicative of future operating results. Significant assumptions used to determine pro forma operating results include amortization of VOBA and other intangible assets and recognition of interest expense associated with debt financing used to effect the acquisition.

 

     Three Months Ended
September 30
   Nine Months Ended
September 30
         2008            2007            2008            2007    
     (in millions of U.S. dollars)

Pro forma:

           

Net premiums earned

   $ 3,609    $ 3,532    $ 10,370    $ 10,367

Total revenues

   $ 3,619    $ 4,066    $ 10,961    $ 11,904

Net income

   $ 59    $ 703    $ 1,214    $ 2,114

Diluted earnings per share

   $ 0.18    $ 2.09    $ 3.58    $ 6.30

4. Fair value measurements

a) Fair value hierarchy

The Company partially adopted the provisions of FAS 157 on January 1, 2008, and the cumulative effect of adoption resulted in a reduction to retained earnings of $4 million related to an increase in risk margins included in the valuation of certain GMIB contracts. FAS 157 defines fair value as the price to sell an asset or transfer a liability in an orderly transaction between market participants and establishes a three-level valuation hierarchy in which inputs into valuation techniques used to measure fair value are classified. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. Inputs in Level 1 are unadjusted quoted prices for identical assets or liabilities in active markets. Level 2 includes inputs other than quoted prices included within Level 1 that are observable for assets or liabilities either directly or indirectly. Level 2 inputs include, among other items, quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and inputs other than quoted prices that are observable for the asset or liability such as interest rates and yield curves. Level 3 inputs are unobservable and reflect management’s judgments about assumptions that market participants would use in pricing an asset or liability. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

The following is a description of the valuation measurements used for the Company’s financial instruments carried or disclosed at fair value, as well as the general classification of such financial instruments pursuant to the valuation hierarchy.

Fixed maturities

Fixed maturities with active markets such as U.S. Treasury and agency securities are classified within Level 1 as fair values are based on quoted market prices. For fixed maturities that trade in less active markets, including corporate and municipal securities, fair values are based on the output of “pricing matrix models”, the significant inputs into which include, but are not limited to, yield curves, credit risks and spreads, measures of volatility, and prepayment speeds. These fixed maturities are classified within Level 2. Fixed maturities for which pricing is unobservable are classified within Level 3.

 

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ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Equity securities

Equity securities with active markets are classified within Level 1 as fair values are based on quoted market prices. For nonpublic equity securities, fair values are based on market valuations and are classified within Level 2.

Short-term investments

Short-term investments, which comprise securities due to mature within one year of the date of purchase that are traded in active markets, are classified within Level 1 as fair values are based on quoted market prices. Securities such as commercial paper and discount notes are classified within Level 2 because these securities are typically not actively traded due to their approaching maturity and, as such, their cost approximating par value.

Other investments

Fair values for other investments, principally other direct equity investments, investment funds, and limited partnerships, are based on the net asset value or financial statements and are included within Level 3. Equity securities and fixed maturities held in rabbi trusts maintained by the Company for deferred compensation plans, and included in Other investments, are classified within the valuation hierarchy on the same basis as the Company’s other equity securities and fixed maturities.

Investment derivative instruments

For actively traded investment derivative instruments, including futures, options, and exchange-traded forward contracts, the Company obtains quoted market prices to determine fair value. As such, these instruments are included within Level 1. Forward contracts that are not exchange-traded are priced using a pricing matrix model principally employing observable inputs and, as such, are classified within Level 2. The Company’s position in interest rate and credit default swaps is typically classified within Level 3.

Guaranteed minimum income benefits

The liability for GMIBs arises from the Company’s reinsurance programs covering living benefit guarantees whereby the Company assumes the risk of GMIBs associated with variable annuity contracts. The fair value of GMIB reinsurance is estimated using an internal valuation model which includes the use of management estimates and current market information. The fair value depends on a number of inputs, including changes in interest rates, changes in equity markets, changes in market volatility, changes in policyholder behavior, and changes in policyholder mortality. The model and related assumptions are continuously re-evaluated by management and enhanced, as appropriate, based upon improvements in modeling techniques and availability of more timely market information, such as market conditions and demographics of in-force annuities. Because of the significant use of unobservable inputs including policyholder behavior, GMIB reinsurance is classified within Level 3.

Other derivative instruments

The Company maintains positions in other derivative instruments including option contracts designed to limit exposure to a severe equity market decline, which would cause an increase in expected claims and, therefore, reserves for guaranteed minimum death benefits (GMDB) and GMIB reinsurance business. The fair value of the majority of the Company’s positions in other derivative instruments is based on significant observable inputs

 

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ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

including equity security and interest rate indices. Accordingly, these are classified within Level 2. The Company’s position in credit default swaps is typically included within Level 3.

The following table presents, by valuation hierarchy, the financial instruments carried or disclosed at fair value, and measured on a recurring basis, as of September 30, 2008.

 

September 30, 2008    Quoted Prices in
Active Markets for
Identical Assets or
Liabilities
Level 1
   Significant Other
Observable
Inputs
Level 2
   Significant
Unobservable
Inputs
Level 3
   Total
   (in millions of U.S. dollars)

Assets:

           

Fixed maturities available for sale

   $ 950    $ 31,812    $ 396    $ 33,158

Fixed maturities held to maturity

     318      2,533      1      2,852

Equity securities

     1,216      4      9      1,229

Short-term investments

     2,128      886      —        3,014

Other investments

     57      248      1,224      1,529

Other derivative instruments

     —        110      50      160
                           

Total assets at fair value

   $ 4,669    $ 35,593    $ 1,680    $ 41,942
                           

Liabilities:

           

Investment derivative instruments

   $ 2    $ —      $ —      $ 2

Guaranteed minimum income benefits

     —        —        542      542
                           

Total liabilities at fair value

   $ 2    $ —      $ 542    $ 544
                           

 

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ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Level 3 financial instruments

The following tables provide a reconciliation of the beginning and ending balances of financial instruments carried or disclosed at fair value using significant unobservable inputs (Level 3) for the periods indicated.

 

    Balance-
Beginning
of Period
    Net
Realized
Gains/
Losses
    Change in Net
Unrealized Gains
(Losses) Included
in Other
Comprehensive
Income
    Purchases,
Sales,
Issuances,
and
Settlements,
Net
    Transfers
Into (Out
of) Level 3
    Balance-
End of
Period
  Change in Net
Unrealized Gains
(Losses) Relating
to Financial
Instruments Still
Held at
September 30, 2008,
included in Net
Income
 
    (in millions of U.S. dollars)  

Three Months Ended

September 30, 2008

 

 

Assets:

             

Fixed maturities available for sale

  $ 466     $ (5 )   $ (23 )   $ (30 )   $ (12 )   $ 396   $ (1 )

Fixed maturities held to maturity

    2       (2 )     —         —         1       1     —    

Equity securities

    10       —         —         2       (3 )     9     —    

Other investments

    1,117       —         (30 )     137       —         1,224     —    

Other derivative instruments

    31       22       —         (3 )     —         50     20  
                                                     

Total assets at fair value

  $ 1,626     $ 15     $ (53 )   $ 106     $ (14 )   $ 1,680   $ 19  
                                                     

Liabilities:

             

Guaranteed minimum income benefits at fair value

  $ 375     $ 189     $ —       $ (22 )   $ —       $ 542   $ 189  
                                                     

Nine Months Ended

September 30, 2008

 

 

Assets:

             

Fixed maturities available for sale

  $ 601     $ (18 )   $ (64 )   $ (2 )   $ (121 )   $ 396   $ (3 )

Fixed maturities held to maturity

    —         (2 )     —         —         3       1     —    

Equity securities

    12       —         —         (1 )     (2 )     9     —    

Other investments

    898       (25 )     (69 )     420       —         1,224     —    

Other derivative instruments

    17       38       —         (5 )     —         50     35  
                                                     

Total assets at fair value

  $ 1,528     $ (7 )   $ (133 )   $ 412     $ (120 )   $ 1,680   $ 32  
                                                     

Liabilities:

             

Investment derivative instruments

  $ (6 )   $ (5 )   $ —       $ 11     $ —       $ —     $ —    

Guaranteed minimum income benefits

    225       319       —         (2 )     —         542     319  
                                                     

Total liabilities at fair value

  $ 219     $ 314     $ —       $ 9     $ —       $ 542   $ 319  
                                                     

 

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ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

b) Fair value option

Effective January 1, 2008, the Company elected the fair value option for certain of its available for sale equity securities valued and carried at $161 million on the election date. The Company elected the fair value option for these particular equity securities to simplify the accounting and oversight of this portfolio given the portfolio management strategy employed by the external investment manager. The election resulted in an increase in retained earnings and a reduction to accumulated other comprehensive income of $6 million as of January 1, 2008. This adjustment reflects the net of tax unrealized gains ($9 million pre-tax) associated with this particular portfolio at January 1, 2008. Subsequent to this election, changes in fair value related to these equity securities were recognized in Net realized gains (losses). During the three months ended June 30, 2008, the Company sold the entire portfolio. Accordingly, the Company currently holds no assets for which the provisions of FAS 159 have been elected. For the three and six months ended June 30, 2008, the Company recognized net realized gains (losses) related to changes in fair value of these equity securities of $9 million and $(11) million, respectively, in the consolidated statements of operations. Throughout 2008 to the date of sale, all of these equity securities were classified within Level 1 in the fair value hierarchy.

5. Investments

a) Gross unrealized loss

As of September 30, 2008, there were 9,691 fixed maturities out of a total of 14,178 fixed maturities in an unrealized loss position. The largest single unrealized loss in the fixed maturities was $13 million. There were 612 equity securities out of a total of 964 equity securities in an unrealized loss position. The largest single unrealized loss in the equity securities was $6.6 million. Most of the fixed maturities in an unrealized loss position were investment grade securities for which fair value declined primarily due to widening credit spreads on corporate and structured credit investments. The unrealized loss also reflects higher non–U.S. interest rates.

The following tables summarize, for all securities in an unrealized loss position at September 30, 2008, and December 31, 2007 (including securities on loan), the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position.

 

     0 - 12 Months     Over 12 Months     Total  
September 30, 2008    Fair
Value
   Gross
Unrealized
Loss
    Fair
Value
   Gross
Unrealized
Loss
    Fair
Value
   Gross
Unrealized
Loss
 
   (in millions of U.S. dollars)  

U.S. Treasury and agency

   $ 829    $ (10.3 )   $ —      $ —       $ 829    $ (10.3 )

Foreign

     5,828      (342.0 )     111      (21.3 )     5,939      (363.3 )

Corporate securities

     7,930      (746.3 )     287      (46.9 )     8,217      (793.2 )

Mortgage-backed securities

     6,543      (485.9 )     248      (78.9 )     6,791      (564.8 )

States, municipalities, and political subdivisions

     1,010      (40.4 )     15      (3.9 )     1,025      (44.3 )
                                             

Total fixed maturities

     22,140      (1,624.9 )     661      (151.0 )     22,801      (1,775.9 )

Equity securities

     824      (158.2 )     62      (29.0 )     886      (187.2 )

Other investments

     292      (65.0 )     —        —         292      (65.0 )
                                             

Total

   $ 23,256    $ (1,848.1 )   $ 723    $ (180.0 )   $ 23,979    $ (2,028.1 )
                                             

 

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ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Included in the “0 – 12 Months” and “Over 12 Months” aging categories at September 30, 2008, are fixed maturities held to maturity with combined fair values of $1.26 billion and $108 million, respectively. The associated gross unrealized losses included in the “0-12 Months” and “Over 12 Months” aging categories are $46 million and $17 million, respectively.

 

December 31, 2007    0 - 12 Months     Over 12 Months     Total  
   Fair
Value
   Gross
Unrealized
Loss
    Fair
Value
   Gross
Unrealized
Loss
    Fair
Value
   Gross
Unrealized
Loss
 
     (in millions of U.S. dollars)  

U.S. Treasury and agency

   $ 193    $ (2.5 )   $ 31    $ (0.1 )   $ 224    $ (2.6 )

Foreign

     3,435      (97.3 )     135      (0.9 )     3,570      (98.2 )

Corporate securities

     3,951      (138.5 )     235      (3.6 )     4,186      (142.1 )

Mortgage-backed securities

     2,967      (29.8 )     139      (1.7 )     3,106      (31.5 )

States, municipalities, and political subdivisions

     569      (7.1 )     16      (0.2 )     585      (7.3 )
                                             

Total fixed maturities

     11,115      (275.2 )     556      (6.5 )     11,671      (281.7 )

Equity securities

     589      (92.5 )     —        —         589      (92.5 )

Other investments

     101      (16.3 )     —        —         101      (16.3 )
                                             

Total

   $ 11,805    $ (384.0 )   $ 556    $ (6.5 )   $ 12,361    $ (390.5 )
                                             

Included in the “0 – 12 Months” and “Over 12 Months” aging categories at December 31, 2007, are fixed maturities held to maturity with combined fair values of $361 million and $318 million, respectively. The associated gross unrealized losses included in the “0 – 12 Months” and “Over 12 Months” aging categories were $3 million and $4 million, respectively.

 

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ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

b) Net realized gains (losses) and other- than- temporary impairments

The following table shows, for the periods indicated, the Net realized gains (losses) and the losses included in Net realized gains (losses) as a result of conditions which caused the Company to conclude the decline in fair value of certain investments was “other-than-temporary”. The impairments for the nine months ended September 30, 2008, were primarily due to increased equity market volatility and fixed income securities in an unrealized loss position reflecting global interest rate conditions, including widening credit spreads on corporate and structured credit investments. For the three months ended September 30, 2008, approximately $150 million was related to ACE’s holdings in Lehman Brothers debt.

 

     Three Months Ended
September 30
    Nine Months Ended
September 30
 
         2008             2007             2008             2007      
     (in millions of U.S. dollars)  

Fixed maturities

   $ (76 )   $ 7     $ (80 )   $ (27 )

Fixed maturity other-than-temporary impairments

     (196 )     (13 )     (495 )     (63 )

Equity securities

     (98 )     62       (64 )     149  

Equity securities other-than-temporary impairments

     (28 )     (5 )     (103 )     (7 )

Other investments

     4       6       6       20  

Other investments other-than-temporary impairments

     —         —         (25 )     (2 )

Foreign currency gains (losses)

     15       2       33       3  

Futures, option contracts, and swaps

     15       (9 )     (10 )     (14 )

Fair value adjustments on insurance derivatives

     (146 )     (50 )     (251 )     (54 )
                                

Total

   $ (510 )   $ —       $ (989 )   $ 5  
                                

6. Assumed reinsurance programs involving minimum benefit guarantees under annuity contracts

The presentation of income and expenses relating to GMDB and GMIB reinsurance for the periods indicated, is as follows:

 

     Three Months Ended
September 30
    Nine Months Ended
September 30
 
         2008             2007             2008             2007      
     (in millions of U.S. dollars)  

GMDB

        

Net premiums earned

   $ 31     $ 32     $ 95     $ 92  

Life and annuity benefits expense

   $ 60     $ 15     $ 107     $ 35  

GMIB

        

Net premiums earned

   $ 37     $ 27     $ 109     $ 78  

Life and annuity benefits expense

   $ (21 )   $ 5     $ (2 )   $ 9  

Realized gains (losses)

   $ (189 )   $ (63 )   $ (319 )   $ (60 )

Fair value components

        

Gain (loss) recognized in income

   $ (131 )   $ (41 )   $ (208 )   $ 9  

Net cash received (disbursed)

   $ 36     $ 27     $ 109     $ 78  

Net decrease (increase) in liability

   $ (167 )   $ (68 )   $ (317 )   $ (69 )

At September 30, 2008, reported liabilities for GMDB and GMIB reinsurance were $214 million and $542 million, respectively, compared with $137 million and $225 million, respectively, at December 31, 2007. The

 

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reported liability for GMIB reinsurance in 2008 and 2007 includes a fair value adjustment of $480 million and $157 million, respectively. Reported liabilities for both GMDB and GMIB reinsurance are determined using internal valuation models. Such valuations require considerable judgment and are subject to significant uncertainty. The valuation of these products is subject to fluctuations arising from, among other factors, changes in interest rates, changes in equity markets, changes in credit markets and, for GMIB reinsurance, changes in the allocation of the investments underlying annuitant’s account value and assumptions regarding future policyholder behavior. These models and the related assumptions are continually reviewed by management and enhanced, as appropriate, based upon improvements in modeling techniques and availability of more timely information, such as market conditions and demographics of in-force annuities.

At September 30, 2008, the Company’s net amount at risk from its GMDB and GMIB reinsurance programs was $6.5 billion and $539 million, respectively, compared with $1.5 billion and $14 million, respectively, at December 31, 2007. For the GMDB programs, the net amount at risk is defined as the excess, if any, of the current guaranteed value over the current account value. For the GMIB programs, the net amount at risk is defined as the excess, if any, of the present value of the minimum guaranteed annuity payments over the present value of the annuity payments assumed (under the terms of the reinsurance contract) to be available to each policyholder.

7. Goodwill and other intangible assets

Prior to June 30, 2008, the Company included intangible assets other than goodwill in Other assets in the consolidated balance sheet. Effective June 30, 2008, the Company presents the aggregate balance of these intangible assets and goodwill in Goodwill and other intangible assets. ACE reclassified other intangible assets in the prior year financial statements to conform to the current period presentation.

As discussed in Note 3, the acquisition of Combined Insurance generated $936 million of goodwill and other intangible assets based on ACE’s preliminary purchase price allocation, which was apportioned to the Life Insurance and Reinsurance and Insurance – Overseas General segments in the amounts of $488 million and $448 million, respectively.

The following table details Goodwill and other intangible assets by reporting segment.

 

     September 30
2008
   December 31
2007
     (in millions of U.S. dollars)

Insurance – North American

   $ 1,216    $ 1,194

Insurance – Overseas General

     1,748      1,276

Global Reinsurance

     365      365

Life Insurance and Reinsurance

     488      3
             
   $ 3,817    $ 2,838
             

 

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8. Debt

The following table outlines the Company’s debt as of September 30, 2008, and December 31, 2007.

 

     2008      2007
     (in millions of U.S. dollars)

Short-term debt

       

Australia Holdings due 2008

   $ 83      $ 87

ACE US Holdings senior notes due 2008

     250        250

Reverse repurchase agreements

     —          35
               
   $ 333      $ 372
               

Long-term debt

       

ACE INA subordinated notes due 2009

   $ 211      $ 201

ACE European Holdings due 2010

     184        199

ACE INA term loan due 2013

     450        —  

ACE INA senior notes due 2014

     499        499

ACE INA senior notes due 2015

     446        —  

ACE INA senior notes due 2017

     500        500

ACE INA senior notes due 2018

     300        —  

ACE INA debentures due 2029

     100        100

ACE INA senior notes due 2036

     298        298

Other

     14        14
               
   $ 3,002      $ 1,811
               

Trust preferred securities

       

ACE INA capital securities due 2030

   $ 309      $ 309
               

a) Reverse repurchase agreements

The Company has executed reverse repurchase agreements with certain counterparties under which the Company agreed to sell securities and repurchase them at a future date for a predetermined price. During the three months ended March 31, 2008, the Company executed reverse repurchase agreements totaling $1 billion as part of the financing of the Combined Insurance acquisition. At September 30, 2008, these reverse repurchase agreements had been settled.

b) ACE INA notes and term loan

In February 2008, as part of the financing of the Combined Insurance acquisition, ACE INA issued $300 million of 5.8 percent senior notes due March 2018. These notes are redeemable at any time at ACE INA’s option subject to a “make-whole” premium plus 0.35 percent. The notes are also redeemable at par plus accrued and unpaid interest in the event of certain changes in tax law. These notes do not have the benefit of any sinking fund. These senior unsecured notes are guaranteed on a senior basis by the Company and they rank equally with all of the Company’s other senior obligations. They also contain customary limitations on lien provisions as well as customary events of default provisions which, if breached, could result in the accelerated maturity of such senior debt.

In April 2008, as part of the financing of the Combined Insurance acquisition, ACE INA entered into a $450 million floating interest rate syndicated term loan agreement due April 2013. The floating interest rate is based

 

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on LIBOR plus 0.65 percent. Simultaneously, the Company entered into a $450 million swap transaction that has the economic effect of fixing the interest rate at 4.15 percent for the term of the loan. The swap counterparty is a highly-rated financial institution and the Company does not anticipate non-performance. The loan is unsecured and repayable on maturity and contains customary limitations on lien provisions as well as customary events of default provisions which, if breached, could result in the accelerated maturity of such debt. The obligation of the borrower under the loan agreement is guaranteed by ACE Limited.

In May 2008, ACE INA issued $450 million of 5.6 percent senior notes due May 2015. These notes are redeemable at any time at ACE INA’s option subject to a “make-whole” premium plus 0.35 percent. The notes are also redeemable at par plus accrued and unpaid interest in the event of certain changes in tax law. These senior unsecured notes are guaranteed on a senior basis by the Company and they rank equally with all of the Company’s other senior obligations. They also contain customary limitations on lien provisions as well as customary events of default provisions which, if breached, could result in the accelerated maturity of such senior debt. The proceeds from this debt offering, along with available cash, were used to redeem the Preferred Shares in June 2008. Refer to Note 10.

9. Commitments, contingencies, and guarantees

a) Other investments

The Company invests in limited partnerships with a carrying value of $831 million included in Other investments. In connection with these investments, the Company has commitments that may require funding of up to $968 million over the next several years.

b) Legal proceedings

(i) Claims and other litigation

The Company’s 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 the Company’s subsidiaries which are typical to the insurance industry in general and in the normal course of business, are considered in the Company’s loss and loss expense reserves. In addition to claims litigation, the Company and its subsidiaries 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, amongst other things, allegations of underwriting errors or misconduct, employment claims, regulatory activity, or disputes arising from business ventures. In the opinion of ACE’s management, ACE’s ultimate liability for these matters is not likely to have a material adverse effect on ACE’s consolidated financial condition, although it is possible that the effect could be material to ACE’s consolidated results of operations for an individual reporting period.

(ii) Subpoenas

Beginning in 2004, ACE and its subsidiaries and affiliates received numerous subpoenas, interrogatories, and civil investigative demands in connection with certain investigations of insurance industry practices. These inquiries have been issued by a number of attorneys general, state departments of insurance, and other authorities, including the New York Attorney General (NYAG), the Pennsylvania Department of Insurance, and the Securities and Exchange Commission (SEC). Such inquiries concern underwriting practices and non-traditional or loss mitigation insurance products. To the extent they are ongoing, ACE is cooperating and will continue to cooperate with such inquiries. ACE conducted its own investigation that encompassed the

 

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subjects raised by the NYAG and the other state and federal regulatory authorities. The investigation was conducted by a team from the firm of Debevoise & Plimpton LLP headed by former United States Attorney Mary Jo White and operated under and at the direction of the Audit Committee of the Board of Directors. ACE’s internal investigations pertaining to underwriting practices and non-traditional or loss mitigation insurance products are complete.

In June 2008, in an action filed by the NYAG against another insurer, the New York Appellate Division, First Department, confirmed the legality of contingent commission agreements – one of the focal points of the NYAG’s investigation. “Contingent commission agreements between brokers and insurers are not illegal, and, in the absence of a special relationship between parties, defendants[s] had no duty to disclose the existence of the contingent commission agreement.” New York v. Liberty Mut. Ins. Co., 52 A.D. 3d 378, 379 (2008) (citing Hersch v. DeWitt Stern Group, Inc., 43 A.D. 3d 644, 645 (2007).

(iii) Settlement agreements

On April 25, 2006, ACE reached a settlement with the Attorneys General of New York, Illinois, and Connecticut and the New York Insurance Department pursuant to which ACE received from these authorities an Assurance of Discontinuance (AOD). Under the AOD, these regulators agreed not to file certain litigation against ACE relating to their investigation of certain business practices, and ACE agreed to pay $80 million ($66 million after tax) without admitting any liability, and to adopt certain business reforms. Of the $80 million, $40 million was paid to the three settling Attorneys General as a penalty, and $40 million was distributed to eligible policyholders who executed a release of possible claims against ACE. A total of $80 million was recorded in administrative expenses in the quarter ended March 31, 2006.

On May 9, 2007, ACE and the Pennsylvania Insurance Department (Department) and the Pennsylvania Office of Attorney General (OAG) entered into a settlement agreement. This settlement agreement resolves the issues raised by the Department and the OAG arising from their investigation of ACE’s underwriting practices and contingent commission payments. As a result of this settlement agreement, ACE made a $9 million payment to the Department and agreed to comply with the business practice guidelines that ACE established in 2004 to assure ongoing antitrust compliance in its operations.

On October 24, 2007, ACE entered into a settlement agreement with the Attorneys General of Florida, Hawaii, Maryland, Massachusetts, Michigan, Oregon, Texas, West Virginia, the District of Columbia, and the Florida Department of Financial Services and Office of Insurance Regulation. The agreement resolves investigations of ACE’s underwriting practices and contingent commission payments. Under the agreement, ACE paid $4.5 million without admitting any liability, and agreed to keep in place certain business reforms already in effect.

(iv) Business practice-related litigation

ACE, ACE INA Holdings, Inc., and ACE USA, Inc., along with a number of other insurers and brokers, were named in a series of federal putative nationwide class actions brought by insurance policyholders. The Judicial Panel on Multidistrict Litigation (JPML) consolidated these cases in the District of New Jersey. On August 1, 2005, plaintiffs in the New Jersey consolidated proceedings filed two consolidated amended complaints – one concerning commercial insurance and the other concerning employee benefit plans. The employee benefit plans litigation against ACE has been dismissed.

In the commercial insurance complaint, the plaintiffs named ACE, ACE INA Holdings, Inc., ACE USA, Inc., ACE American Insurance Co., Illinois Union Insurance Co., and Indemnity Insurance Co. of North America.

 

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They allege that certain brokers and insurers, including certain ACE entities, conspired to increase premiums and allocate customers through the use of “B” quotes and contingent commissions. In addition, the complaints allege that the broker defendants received additional income by improperly placing their clients’ business with insurers through related wholesale entities that acted as intermediaries between the broker and insurer. Plaintiffs also allege that broker defendants tied the purchase of primary insurance to the placement of such coverage with reinsurance carriers through the broker defendants’ reinsurance broker subsidiaries. The complaint asserts the following causes of action against ACE: Federal Racketeer Influenced and Corrupt Organizations Act (RICO), federal antitrust law, state antitrust law, aiding and abetting breach of fiduciary duty, and unjust enrichment.

In 2006 and 2007, the Court dismissed plaintiffs’ first two attempts to properly plead a case without prejudice and permitted plaintiffs one final opportunity to re-plead. The amended complaint, filed on May 22, 2007, purported to add several new ACE defendants: ACE Group Holdings, Inc., ACE US Holdings, Inc., Westchester Fire Insurance Company, INA Corporation, INA Financial Corporation, INA Holdings Corporation, ACE Property and Casualty Insurance Company, and Pacific Employers Insurance Company. Plaintiffs also added a new antitrust claim against Marsh, ACE, and other insurers based on the same allegations as the other claims but limited to excess casualty insurance. On June 21, 2007, defendants moved to dismiss the amended complaint and moved to strike the new parties that plaintiffs attempted to add to that complaint. The Court granted defendants’ motions and dismissed plaintiffs’ antitrust and RICO claims with prejudice on August 31, 2007, and September 28, 2007, respectively. The Court also declined to exercise supplemental jurisdiction over plaintiffs’ state law claims and dismissed those claims without prejudice. On October 10, 2007, plaintiffs filed a Notice of Appeal of the antitrust and RICO rulings to the United States Court of Appeals for the Third Circuit. The appeal is fully briefed. Oral argument is tentatively scheduled for April 20, 2009, but the Third Circuit has not yet decided whether oral argument will in fact be heard.

There are a number of federal actions brought by policyholders based on allegations similar to the allegations in the consolidated federal actions that were filed in, or transferred to, the United States District Court for the District of New Jersey for coordination. All proceedings in these actions are currently stayed.

 

   

New Cingular Wireless Headquarters LLC et al. v. Marsh & McLennan Companies, Inc. et al. (Case No. 06-5120; D.N.J.), was originally filed in the Northern District of Georgia on April 4, 2006. ACE Ltd., ACE American Ins. Co., ACE USA, Inc., ACE Bermuda Ins. Co. Ltd., Illinois Union Ins. Co., Pacific Employers Ins. Co., and Lloyd’s of London Syndicate 2488 AGM, along with a number of other insurers and brokers, are named.

 

   

Avery Dennison Corp. v. Marsh & McLennan Companies, Inc. et al. (Case No. 07-00757; D.N.J.) was filed on February 13, 2007. ACE, ACE INA Holdings, Inc., ACE USA, Inc., and ACE American Insurance Co., along with a number of other insurers and brokers, are named.

 

   

Henley Management Co., Inc. et al v. Marsh, Inc. et al. (Case No. 07-2389; D.N.J.) was filed on May 27, 2007. ACE USA, Inc., along with a number of other insurers and Marsh, are named.

 

   

Lincoln Adventures LLC et al. v. Those Certain Underwriters at Lloyd’s, London Members of Syndicates 0033 et al. (Case No. 07-60991; D.N.J.) was originally filed in the Southern District of Florida on July 13, 2007. Supreme Auto Transport LLC et al. v. Certain Underwriters of Lloyd’s of London, et al. (Case No. 07-6703; D.N.J.) was originally filed in the Southern District of New York on July 25, 2007. Lloyd’s of London Syndicate 2488 AGM, along with a number of other Lloyd’s of London Syndicates and various brokers, are named in both actions. The allegations in these putative class-action lawsuits are similar to the allegations in the consolidated federal actions identified above, although these lawsuits focus on alleged conduct within the London insurance market.

 

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Sears, Roebuck & Co. et al. v. Marsh & McLennan Companies, Inc. et al. (Case No. 07-2535; D.N.J.) was originally filed in the Northern District of Georgia on October 12, 2007. ACE American Insurance Co., ACE Bermuda Insurance Ltd., and Westchester Surplus Lines Insurance Co., along with a number of other insurers and brokers, are named.

Three cases have been filed in state courts with allegations similar to those in the consolidated federal actions described above.

 

   

Van Emden Management Corporation v. Marsh & McLennan Companies, Inc., et al. (Case No. 05-0066A; Superior Court of Massachusetts), a class action in Massachusetts, was filed on January 13, 2005. Illinois Union Insurance Company, an ACE subsidiary, is named. The Van Emden case has been stayed pending resolution of the consolidated proceedings in the District of New Jersey or until further order of the Court.

 

   

Office Depot, Inc. v. Marsh & McLennan Companies, Inc. et al. (Case No. 502005CA004396; Circuit Court of the 15th Judicial Circuit in Palm Beach County Florida), a Florida state action, was filed on June 22, 2005. ACE American Insurance Co., an ACE subsidiary, is named. The trial court originally stayed this case, but the Florida Court of Appeals later remanded and the trial court declined to grant another stay. The court has denied motions to dismiss, and ACE American Ins. Co. has filed an answer. Discovery is ongoing.

 

   

State of Ohio, ex. rel. Marc E. Dann, Attorney General v. American Int’l Group, Inc. et al. (Case No. 07-633857; Court of Common Pleas in Cuyahoga County, Ohio) is an Ohio state action filed by the Ohio Attorney General on August 24, 2007. ACE INA Holdings, Inc., ACE American Insurance Co., ACE Property & Casualty Insurance Co., Insurance Company of North America, and Westchester Fire Insurance Co., along with a number of other insurance companies and Marsh, are named. Defendants filed motions to dismiss in November 2007. On July 2, 2008, the court denied all of the defendants’ motions. Discovery is ongoing.

ACE was named in four putative securities class action suits following the filing of a civil suit against Marsh by the NYAG on October 14, 2004. The suits were consolidated by the JPML in the Eastern District of Pennsylvania and the Court appointed Sheet Metal Workers’ National Pension Fund and Alaska Ironworkers Pension Trust as lead plaintiffs. Lead plaintiffs filed a consolidated amended complaint on September 30, 2005, naming ACE, Evan G. Greenberg, Brian Duperreault, and Philip V. Bancroft as defendants. Plaintiffs allege that ACE’s public statements and securities filings should have revealed that insurers, including certain ACE entities, and brokers allegedly conspired to increase premiums and allocate customers through the use of “B” quotes and contingent commissions and that ACE’s revenues and earnings were inflated by these practices. Plaintiffs assert claims solely under Section 10(b) of the Securities Exchange Act of 1934 (the Exchange Act), Rule 10(b)-5 promulgated thereunder, and Section 20(a) of the Securities Act (control person liability). In 2005, ACE and the individual defendants filed a motion to dismiss. Oral argument is scheduled for November 10, 2008.

ACE is named as a defendant in a derivative suit filed in Delaware Chancery Court by shareholders of Marsh seeking to recover damages for Marsh and its subsidiary, Marsh, Inc., against officers and directors of Marsh, American International Group Inc. (AIG), former AIG chief executive officer Maurice R. Greenberg, and ACE. The suit alleges that the defendants breached their fiduciary duty to and thereby damaged Marsh and Marsh, Inc. by participating in a bid rigging scheme and obtaining “kickbacks” in the form of contingent commissions, and that ACE knowingly participated in the alleged scheme.

ACE, ACE USA, Inc., ACE INA Holdings, Inc., and Evan G. Greenberg, as a former officer and director of AIG and current officer and director of ACE, are named in one or both of two derivative cases brought by certain

 

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shareholders of AIG. One of the derivative cases was filed in Delaware Chancery Court, and the other was filed in federal court in the Southern District of New York. The allegations against ACE concern the alleged bid rigging and contingent commission scheme as similarly alleged in the federal commercial insurance cases. Plaintiffs assert the following causes of action against ACE: breach of fiduciary duty, aiding and abetting breaches of fiduciary duties, unjust enrichment, conspiracy, and fraud. On April 14, 2008, the shareholder plaintiffs filed an amended complaint (their third pleading effort), which drops Evan Greenberg as a defendant. On June 13, 2008, ACE moved to dismiss the newly amended complaint. Briefing on ACE’s motion is complete and oral argument is tentatively scheduled for December 18, 2008. Discovery is currently stayed. The New York derivative action is stayed pending resolution of the Delaware derivative action.

In all of the lawsuits described above, plaintiffs seek compensatory and in some cases special damages without specifying an amount. As a result, ACE cannot at this time estimate its potential costs related to these legal matters and, accordingly, no liability for compensatory damages has been established in the consolidated financial statements.

ACE’s ultimate liability for these matters is not likely to have a material adverse effect on ACE’s consolidated financial condition, although it is possible that the effect could be material to ACE’s consolidated results of operations for an individual reporting period.

10. Preferred Shares

In 2003, the Company sold twenty million depositary shares in a public offering, each representing one-tenth of one of its 7.8 percent Cumulative Redeemable Preferred Shares, for $25 per depositary share. Underwriters exercised their over-allotment option which resulted in the issuance of an additional three million depositary shares.

The shares had an annual dividend rate of 7.8 percent with the first quarterly dividend paid on September 1, 2003. The shares were not convertible into or exchangeable for the Company’s Common Shares. The Company had the option to redeem these shares at any time after May 30, 2008, at a redemption value of $25 per depositary share or at any time under certain limited circumstances. On June 13, 2008, the Company redeemed all of the outstanding Preferred Shares for cash consideration of $575 million. Following the completion of the Preferred Share redemption, the New York Stock Exchange (NYSE) halted trading in and de-listed the shares from the NYSE.

11. Shareholders’ equity

In connection with the Continuation, the Company changed the currency in which the par value of Ordinary Shares is stated from U.S. dollars to Swiss francs and increased the par value of Ordinary Shares from $0.041666667 to CHF 33.74 (the New Par Value) through a conversion of all issued Ordinary Shares into “stock” and re-conversion of the stock into Ordinary Shares with a par value equal to the New Par Value (the Par Value Conversion). The Par Value Conversion was followed immediately by a stock dividend, to effectively return shareholders to the number of Ordinary Shares held before the Par Value Conversion. The stock dividend did not therefore have the affect of diluting earnings per share. Upon the effectiveness of the Continuation, the Company’s Ordinary Shares became Common Shares. All Common Shares are registered common shares under Swiss corporate law. Notwithstanding the change of the currency in which the par value of Common Shares is stated, the Company continues to use U.S. dollars as its reporting and functional currency for preparing the consolidated financial statements. For purposes of the consolidated financial statements, the increase in par value was accomplished by a corresponding reduction first to retained earnings and second to additional paid-in capital

 

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to the extent that the increase in par value exhausted retained earnings at the date of the Continuation. Under Swiss corporate law, dividends, including distributions through a reduction in par value (par value distributions), must be declared by ACE in Swiss francs though dividend payments are made by the Company’s transfer agent in USD converted at the USD/CHF exchange rate shortly before the payment date. For the foreseeable future, the Company expects to pay dividends as a repayment of share capital in the form of a reduction in par value or qualified paid-in capital, which would not be subject to Swiss withholding tax. For the three months ended September 30, 2008 and 2007, dividends declared per Common Share amounted to CHF 0.30 ($0.26) and $0.27, respectively. The par value distribution in the three months ended September 30, 2008, is reflected as such through Common Shares in the consolidated statement of shareholders’ equity and had the effect of reducing par value per Common Share to CHF 33.44. Dividends declared for the nine months ended September 30, 2008, were $0.82 per Common Share including the par value distribution declared in the three months ended September 30, 2008. Dividends declared per Common Share amounted to $0.79 for the nine months ended September 30, 2007.

Under Swiss corporate law, the Company may not generally issue Common Shares below their par value. In the event there is a need to raise common equity at a time when the trading price of the Company’s Common Shares is below par value, the Company will need to obtain shareholder approval to decrease the par value of the Common Shares.

In July of 2008, prior to the Continuation, the Company issued and placed 2,000,000 Common Shares in treasury principally for issuance upon the exercise of employee stock options. At September 30, 2008, 1,865,183 Common Shares remain in treasury after net shares redeemed under employee share-based compensation plans.

12. Share-based compensation

During 2004, the Company established the ACE Limited 2004 Long-Term Incentive Plan (the 2004 LTIP). The Company’s 2004 LTIP provides for grants of both incentive and non-qualified stock options principally at an option price per share of 100 percent of the fair market value of the Company’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. On February 27, 2008, the Company granted 1,545,072 stock options with a weighted-average grant date fair value of $17.56. The fair value of the options issued is estimated on the date of grant using the Black-Scholes option pricing model.

The Company’s 2004 LTIP also provides for grants of restricted stock and restricted stock units. The Company 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. On February 27, 2008, the Company granted 1,632,711 restricted stock awards and 204,295 restricted stock units to officers of the Company and its subsidiaries with a grant date fair value of $60.28. Each restricted stock unit represents the Company’s obligation to deliver to the holder one share of Common Shares upon vesting.

13. Segment information

The Company operates through the following business segments: Insurance – North American, Insurance – Overseas General, Global Reinsurance, and Life Insurance and Reinsurance. These segments distribute their products through various forms of brokers, agencies, and direct marketing programs. Additionally, Insurance – North American has formed internet distribution channels for some of its products. Global Reinsurance, Insurance – North American, and Life Insurance and Reinsurance have established relationships with reinsurance intermediaries. Segment operating results for the three and nine months ended September 30, 2008, include the

 

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results of Combined Insurance from April 1, 2008. Results from Combined Insurance’s North American operations are included in the Life Insurance and Reinsurance segment and the results from Combined Insurance’s international operations are included in the Insurance – Overseas General segment.

The Insurance – North American segment comprises the P&C operation in the U.S., Canada, and Bermuda. This segment includes the operations of ACE USA (including ACE Canada), ACE Westchester, ACE Bermuda, ACE Private Risk Services, and various run-off operations. ACE USA provides a broad array of P&C, A&H, and risk management products and services to a diverse group of commercial and non-commercial enterprises and consumers. ACE Westchester specializes in the wholesale distribution of excess, surplus, and specialty P&C products. ACE Bermuda provides commercial insurance products on an excess basis to a global client base, covering risks that are generally low in frequency and high in severity. ACE Private Risk Services provides personal lines coverages (homeowners, automobile) for high net worth clients. The run-off operations include Brandywine Holdings Corporation, Commercial Insurance Services, residual market workers’ compensation business, pools and syndicates not attributable to a single business group, and other exited lines of business. Run-off operations do not actively sell insurance products, but are responsible for the management of existing policies and related claims.

The Insurance – Overseas General segment consists of ACE International (excluding its life insurance business), the wholesale insurance operations of ACE Global Markets, and the international A&H and life insurance business of Combined Insurance. ACE International, our ACE INA network of indigenous retail insurance operations, maintains a presence in every major insurance market in the world and is organized geographically along product lines that provide dedicated underwriting focus to customers. ACE Global Markets, our London-based excess and surplus lines business that includes Lloyd’s Syndicate 2488 (2008 capacity of £330 million ($599 million)), offers an extensive product range through its unique parallel distribution of products via ACE European Group Limited (AEGL) and Lloyd’s Syndicate 2488. ACE provides funds at Lloyd’s to support underwriting by Syndicate 2488 which is managed by ACE Underwriting Agencies Limited. AEGL, our London-based, Financial Services Authority-U.K. regulated company, underwrites U.K. and Continental Europe insurance and reinsurance business. The reinsurance operation of ACE Global Markets is included in the Global Reinsurance segment. Combined Insurance distributes specialty individual accident and supplemental health and life insurance products targeted to middle income consumers in Europe and Asia Pacific. The Insurance – Overseas General segment has four regions of operations: the ACE European Group (which comprises ACE Europe and ACE Global Markets branded business), ACE Asia Pacific, ACE Far East, and ACE Latin America. Companies within the Insurance – Overseas General segment write a variety of insurance products including property, casualty, professional lines (Directors & Officers and Errors & Omissions), marine, energy, aviation, political risk, specialty personal lines, consumer lines products, A&H (principally accident and supplemental health), and life insurance products.

The Global Reinsurance segment represents ACE’s reinsurance operations comprising ACE Tempest Re Bermuda, ACE Tempest Re USA, ACE Tempest Re Europe, and ACE Tempest Re Canada. These divisions provide a broad range of property catastrophe, casualty, and property reinsurance coverages to a diverse array of primary P&C companies.

The Life Insurance and Reinsurance segment includes the operations of ACE Tempest Life Re (ACE Life Re), ACE International Life, and the domestic A&H and life business of Combined Insurance. ACE Life Re provides reinsurance coverage to other life insurance companies as well as marketing traditional life reinsurance products and services for the individual life business. ACE International Life provides traditional life insurance protection, investments, and savings products to individuals in several countries including China, Egypt, Thailand, the United Arab Emirates, Vietnam, and various Latin American countries. Combined Insurance distributes specialty

 

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ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

individual accident and supplemental health and life insurance products targeted to middle income consumers in the U.S. and Canada.

Corporate and Other (Corporate) includes ACE Limited, ACE Group Management and Holdings Ltd., ACE INA Holdings, Inc., and intercompany eliminations. In addition, Corporate includes the Company’s proportionate share of Assured Guaranty Ltd.’s earnings reflected in Other (income) expense. Included in Losses and loss expenses are losses incurred in connection with the commutation of ceded reinsurance contracts that resulted from a differential between the consideration received from reinsurers and the related reduction of reinsurance recoverable, principally related to the time value of money. Due to the Company’s initiatives to reduce reinsurance recoverable balances and thereby encourage such commutations, losses recognized in connection with the commutation of ceded reinsurance contracts are generally not considered when assessing segment performance and, accordingly, are directly allocated to Corporate. Additionally, the Company does not consider the development of loss reserves related to the September 11 tragedy in assessing segment performance as these loss reserves are managed by Corporate. As such, the effect of the related loss reserve development on net income is reported within Corporate.

For segment reporting purposes, certain items have been presented in a different manner than in the consolidated financial statements. The following tables summarize the operations by segment for the periods indicated.

Statement of Operations by Segment

For the Three Months Ended September 30, 2008

(in millions of U.S. dollars)

 

    Insurance –
North
American
    Insurance –
Overseas
General
    Global
Reinsurance
    Life
Insurance
and
Reinsurance
    Corporate
and Other
    ACE
Consolidated
 

Gross premiums written

  $ 2,987     $ 1,678     $ 174     $ 381     $ —       $ 5,220  

Net premiums written

    1,461       1,293       174       348       —         3,276  

Net premiums earned

    1,583       1,425       257       344       —         3,609  

Losses and loss expenses

    1,356       731       178       104       —         2,369  

Future policy benefits

    —         5       —         86       —         91  

Policy acquisition costs

    160       329       44       48       —         581  

Administrative expenses

    132       217       14       61       33       457  
                                               

Underwriting (loss) income

    (65 )     143       21       45       (33 )     111  
                                               

Net investment income (loss)

    278       136       83       40       (17 )     520  

Net realized gains (losses)

    (284 )     (58 )     (2 )     (180 )     14       (510 )

Interest expense

    —         —         —         —         68       68  

Other (income) expense

    3       6       1       2       (6 )     6  

Income tax expense (benefit)

    (7 )     10       9       15       (34 )     (7 )
                                               

Net (loss) income

  $ (67 )   $ 205     $ 92     $ (112 )   $ (64 )   $ 54  
                                               

 

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ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Statement of Operations by Segment

For the Three Months Ended September 30, 2007

(in millions of U.S. dollars)

 

    Insurance –
North
American
  Insurance –
Overseas
General
    Global
Reinsurance
  Life
Insurance
and
Reinsurance
    Corporate
and Other
    ACE
Consolidated

Gross premiums written

  $ 2,708   $ 1,427     $ 228   $ 100     $ —       $ 4,463

Net premiums written

    1,449     1,041       215     95       —         2,800

Net premiums earned

    1,595     1,141       319     95       —         3,150

Losses and loss expenses

    1,138     611       161     —         —         1,910

Future policy benefits

    —       —         —       39       —         39

Policy acquisition costs

    150     240       60     13       —         463

Administrative expenses

    129     170       14     13       32       358
                                         

Underwriting income (loss)

    178     120       84     30       (32 )     380
                                         

Net investment income (loss)

    260     116       69     14       33       492

Net realized gains (losses)

    29     (5 )     25     (51 )     2       —  

Interest expense

    —       —         —       —         44       44

Other (income) expense

    1     (12 )     —       —         43       32

Income tax expense (benefit)

    125     26       11     (3 )     (19 )     140
                                         

Net income (loss)

  $ 341   $ 217     $ 167   $ (4 )   $ (65 )   $ 656
                                         

Statement of Operations by Segment

For the Nine Months Ended September 30, 2008

(in millions of U.S. dollars)

 

    Insurance –
North
American
    Insurance –
Overseas
General
    Global
Reinsurance
    Life
Insurance
and
Reinsurance
    Corporate
and Other
    ACE
Consolidated
 

Gross premiums written

  $ 7,886     $ 5,332     $ 791     $ 913     $ —       $ 14,922  

Net premiums written

    4,332       4,081       788       827       —         10,028  

Net premiums earned

    4,302       4,087       777       811       —         9,977  

Losses and loss expenses

    3,187       2,039       403       214       —         5,843  

Future policy benefits

    —         10       —         233       —         243  

Policy acquisition costs

    450       897       152       119       —         1,618  

Administrative expenses

    398       598       43       143       111       1,293  
                                               

Underwriting income (loss)

    267       543       179       102       (111 )     980  
                                               

Net investment income (loss)

    829       387       235       95       (5 )     1,541  

Net realized gains (losses)

    (450 )     (199 )     (67 )     (302 )     29       (989 )

Interest expense

    —         —         —         —         176       176  

Other (income) expense

    6       (14 )     2       6       (104 )     (104 )

Income tax expense (benefit)

    222       95       24       25       (83 )     283  
                                               

Net income (loss)

  $ 418     $ 650     $ 321     $ (136 )   $ (76 )   $ 1,177  
                                               

 

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ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Statement of Operations by Segment

For the Nine Months Ended September 30, 2007

(in millions of U.S. dollars)

 

    Insurance –
North
American
  Insurance –
Overseas
General
    Global
Reinsurance
  Life
Insurance
and
Reinsurance
    Corporate
and Other
    ACE
Consolidated

Gross premiums written

  $ 7,566   $ 4,707     $ 1,041   $ 282     $ —       $ 13,596

Net premiums written

    4,460     3,399       1,023     270       —         9,152

Net premiums earned

    4,589     3,394       987     270       —         9,240

Losses and loss expenses

    3,265     1,789       509     —         —         5,563

Future policy benefits

    —       —         —       108       —         108

Policy acquisition costs

    394     694       190     36       —         1,314

Administrative expenses

    392     494       47     37       100       1,070
                                         

Underwriting income (loss)

    538     417       241     89       (100 )     1,185
                                         

Net investment income

    758     331       201     40       84       1,414

Net realized gains (losses)

    81     (58 )     24     (56 )     14       5

Interest expense

    —       —         —       —         132       132

Other (income) expense

    11     (8 )     3     —         26       32

Income tax expense (benefit)

    368     124       25     (4 )     (79 )     434
                                         

Net income (loss)

  $ 998   $ 574     $ 438   $ 77     $ (81 )   $ 2,006
                                         

Underwriting assets are reviewed in total by management for purposes of decision making. The Company does not allocate assets to its segments.

The following table shows the impact of the catastrophe losses by segment for the three months ended September 30, 2008.

 

     Insurance –
North
American
    Insurance –
Overseas
General
    Global
Reinsurance
    Consolidated  

Catastrophe Loss Charges - By Event

     (in millions of U.S. dollars)  

Gross loss

         $ 862  

Net loss

        

Hurricane – Gustav

   $ 50     $ 12     $ 6     $ 68  

Hurricane – Ike

     206       49       106       361  

Other (1)

     2       (12 )     (8 )     (18 )
                                

Total

   $ 258     $ 49     $ 104     $ 411  

Reinstatement premiums (earned) expensed

     16       4       (13 )     7  
                                

Total before income tax

     274       53       91       418  

Income tax benefit

     (86 )     (17 )     (4 )     (107 )
                                

Total after income tax

   $ 188     $ 36     $ 87     $ 311  
                                

 

(1)

Includes adjustments to catastrophe losses reported in the three months ended June 30, 2008, related to Midwest floods.

 

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ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following tables summarize the net premiums earned for each segment by product offering for the periods indicated.

 

     Property
& All Other
   Casualty    Life, Accident
& Health
   ACE
Consolidated
     (in millions of U.S. dollars)

Three Months Ended September 30, 2008

           

Insurance – North American

   $ 551    $ 969    $ 63    $ 1,583

Insurance – Overseas General

     500      376      549      1,425

Global Reinsurance

     139      118      —        257

Life Insurance and Reinsurance

     —        —        344      344
                           
   $ 1,190    $ 1,463    $ 956    $ 3,609
                           

Three Months Ended September 30, 2007

           

Insurance – North American

   $ 484    $ 1,054    $ 57    $ 1,595

Insurance – Overseas General

     427      359      355      1,141

Global Reinsurance

     155      164      —        319

Life Insurance and Reinsurance

     —        —        95      95
                           
   $ 1,066    $ 1,577    $ 507    $ 3,150
                           

Nine Months Ended September 30, 2008

           

Insurance – North American

   $ 1,214    $ 2,903    $ 185    $ 4,302

Insurance – Overseas General

     1,420      1,151      1,516      4,087

Global Reinsurance

     396      381      —        777

Life Insurance and Reinsurance

     —        —        811      811
                           
   $ 3,030    $ 4,435    $ 2,512    $ 9,977
                           

Nine Months Ended September 30, 2007

           

Insurance – North American

   $ 1,125    $ 3,303    $ 161    $ 4,589

Insurance – Overseas General

     1,251      1,090      1,053      3,394

Global Reinsurance

     472      515      —        987

Life Insurance and Reinsurance

     —        —        270      270
                           
   $ 2,848    $ 4,908    $ 1,484    $ 9,240
                           

 

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ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

14. Earnings per share

The following table sets forth the computation of basic and diluted earnings per share for the periods indicated.

 

     Three Months Ended
September 30
    Nine Months Ended
September 30
 
     2008    2007     2008     2007  
     (in millions of U.S. dollars, except share and per share data)  

Numerator:

         

Net income

   $ 54    $ 656     $ 1,177     $ 2,006  

Dividends on Preferred Shares

     —        (11 )     (24 )     (33 )
                               

Net income available to holders of Common Shares

   $ 54    $ 645     $ 1,153     $ 1,973  
                               

Denominator:

         

Denominator for basic earnings per share:

         

Weighted average shares outstanding

     329,017,376      325,201,688       328,264,771       324,670,960  

Denominator for diluted earnings per share:

         

Share-based compensation plans

     4,030,013      5,419,353       4,416,680       5,413,751  
                               

Adjusted weighted average shares outstanding and assumed conversions

     333,047,389      330,621,041       332,681,451       330,084,711  
                               

Basic earnings per share:

         

Earnings per share

   $ 0.16    $ 1.98     $ 3.51     $ 6.08  
                               

Diluted earnings per share:

         

Earnings per share

   $ 0.16    $ 1.95     $ 3.46     $ 5.98  
                               

Excluded from adjusted weighted average shares outstanding and assumed conversions is the impact of securities that would have been anti-dilutive during the respective periods. For the three months ended September 30, 2008 and 2007, the potential anti-dilutive share conversions were 892,049 and 255,163, respectively. For the nine months ended September 30, 2008 and 2007, the potential anti-dilutive share conversions were 545,331 and 268,501, respectively.

15. Information provided in connection with outstanding debt of subsidiaries

The following tables present condensed consolidating financial information at September 30, 2008, and December 31, 2007, and for the three and nine months ended September 30, 2008 and 2007, for ACE Limited (the Parent Guarantor) and its “Subsidiary Issuer”, ACE INA Holdings, Inc. The Subsidiary Issuer is an indirect 100 percent owned subsidiary of the Parent Guarantor. Investments in subsidiaries are accounted for by the Parent Guarantor under the equity method for purposes of the supplemental consolidating presentation. Earnings of subsidiaries are reflected in the Parent Guarantor’s investment accounts and earnings. The Parent Guarantor fully and unconditionally guarantees certain of the debt of the Subsidiary Issuer.

 

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ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Condensed Consolidating Balance Sheet at September 30, 2008

(in millions of U.S. dollars)

 

     ACE Limited
(Parent
Guarantor)
   ACE INA
Holdings, Inc.
(Subsidiary
Issuer)
    Other ACE
Limited
Subsidiaries and
Eliminations (1)
    Consolidating
Adjustments (2)
    ACE Limited
Consolidated

Assets

           

Investments

   $ 56    $ 22,345     $ 19,410     $ —       $ 41,811

Cash

     26      248       205       —         479

Insurance and reinsurance balances receivable

     —        2,951       548       —         3,499

Reinsurance recoverable on losses and loss expenses

     —        17,146       (2,921 )     —         14,225

Reinsurance recoverable on future policy benefits

     —        272       4       —         276

Value of business acquired

     —        923       —         —         923

Goodwill and other intangible assets

     —        3,252       565       —         3,817

Investments in subsidiaries

     14,854      —         —         (14,854 )     —  

Due from (to) subsidiaries and affiliates, net

     537      (325 )     325       (537 )     —  

Other assets

     28      7,908       2,189       —         10,125
                                     

Total assets

   $ 15,501    $ 54,720     $ 20,325     $ (15,391 )   $ 75,155
                                     

Liabilities

           

Unpaid losses and loss expenses

   $ —      $ 30,109     $ 8,264     $ —       $ 38,373

Unearned premiums

     —        5,214       1,245       —         6,459

Future policy benefits

     —        2,322       597       —         2,919

Short-term debt

     —        83       250       —         333

Long-term debt

     —        3,002       —         —         3,002

Trust preferred securities

     —        309       —         —         309

Other liabilities

     145      7,148       1,111       —         8,404
                                     

Total liabilities

     145      48,187       11,467       —         59,799
                                     

Total shareholders’ equity

     15,356      6,533       8,858       (15,391 )     15,356
                                     

Total liabilities and shareholders’ equity

   $ 15,501    $ 54,720     $ 20,325     $ (15,391 )   $ 75,155
                                     

 

(1)

Includes all other subsidiaries of ACE Limited and intercompany eliminations.

(2)

Includes ACE Limited parent company eliminations.

 

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ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Condensed Consolidating Balance Sheet at December 31, 2007

(in millions of U.S. dollars)

 

     ACE Limited
(Parent
Guarantor)
   ACE INA
Holdings, Inc.
(Subsidiary
Issuer)
   Other ACE
Limited
Subsidiaries and
Eliminations (1)
    Consolidating
Adjustments (2)
    ACE Limited
Consolidated

Assets

            

Investments

   $ 62    $ 20,671    $ 21,046     $ —       $ 41,779

Cash

     —        310      251       (51 )     510

Insurance and reinsurance balances receivable

     —        2,961      579       —         3,540

Reinsurance recoverable on losses and loss expenses

     —        16,742      (2,388 )     —         14,354

Reinsurance recoverable on future policy benefits

     —        —        8       —         8

Goodwill and other intangible assets

     —        2,267      571       —         2,838

Investments in subsidiaries

     16,669      —        —         (16,669 )     —  

Due from (to) subsidiaries and affiliates, net

     174      45      (45 )     (174 )     —  

Other assets

     14      6,333      2,714       —         9,061
                                    

Total assets

   $ 16,919    $ 49,329    $ 22,736     $ (16,894 )   $ 72,090
                                    

Liabilities

            

Unpaid losses and loss expenses

   $ —      $ 28,984    $ 8,128     $ —       $ 37,112

Unearned premiums

     —        4,930      1,297       —         6,227

Future policy benefits

     —        —        545       —         545

Short-term debt

     51      87      285       (51 )     372

Long-term debt

     —        1,811      —         —         1,811

Trust preferred securities

     —        309      —         —         309

Other liabilities

     191      6,199      2,647       —         9,037
                                    

Total liabilities

     242      42,320      12,902       (51 )     55,413
                                    

Total shareholders’ equity

     16,677      7,009      9,834       (16,843 )     16,677
                                    

Total liabilities and shareholders’ equity

   $ 16,919    $ 49,329    $ 22,736     $ (16,894 )   $ 72,090
                                    

 

(1)

Includes all other subsidiaries of ACE Limited and intercompany eliminations.

(2)

Includes ACE Limited parent company eliminations.

 

35


Table of Contents

ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Condensed Consolidating Statement of Operations

For the Three Months Ended September 30, 2008

(in millions of U.S. dollars)

 

     ACE Limited
(Parent
Guarantor)
    ACE INA
Holdings, Inc.
(Subsidiary
Issuer)
    Other ACE
Limited
Subsidiaries and
Eliminations (1)
    Consolidating
Adjustments (2)
    ACE Limited
Consolidated
 

Net premiums written

   $ —       $ 1,916     $ 1,360     $ —       $ 3,276  

Net premiums earned

     —         2,151       1,458       —         3,609  

Net investment income

     (7 )     273       254       —         520  

Equity in earnings of subsidiaries

     45       —         —         (45 )     —    

Net realized gains (losses)

     20       (243 )     (287 )     —         (510 )

Losses and loss expenses

     —         1,443       926       —         2,369  

Future policy benefits

     —         35       56       —         91  

Policy acquisition costs and administrative expenses

     22       636       384       (4 )     1,038  

Interest expense

     (11 )     68       3       8       68  

Other (income) expense

     (7 )     —         13       —         6  

Income tax expense (benefit)

     —         12       (19 )     —         (7 )
                                        

Net income

   $ 54     $ (13 )   $ 62     $ (49 )   $ 54  
                                        

Condensed Consolidating Statement of Operations

For the Three Months Ended September 30, 2007

(in millions of U.S. dollars)

 

     ACE Limited
(Parent
Guarantor)
    ACE INA
Holdings, Inc.
(Subsidiary
Issuer)
    Other ACE
Limited
Subsidiaries and
Eliminations (1)
    Consolidating
Adjustments (2)
    ACE Limited
Consolidated

Net premiums written

   $ —       $ 1,687     $ 1,113     $ —       $ 2,800

Net premiums earned

     —         1,886       1,264       —         3,150

Net investment income

     5       235       252       —         492

Equity in earnings of subsidiaries

     668       —         —         (668 )     —  

Net realized gains (losses)

     5       (1 )     (4 )     —         —  

Losses and loss expenses

     —         1,256       654       —         1,910

Future policy benefits

     —         10       29       —         39

Policy acquisition costs and administrative expenses

     21       482       325       (7 )     821

Interest expense

     (5 )     42       5       2       44

Other (income) expense

     5       3       24       —         32

Income tax expense

     1       111       28       —         140
                                      

Net income

   $ 656     $ 216     $ 447     $ (663 )   $ 656
                                      

 

(1)

Includes all other subsidiaries of ACE Limited and intercompany eliminations.

(2)

Includes ACE Limited parent company eliminations.

 

36


Table of Contents

ACE LIMITED AND SUBSIDIARIES

NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Condensed Consolidating Statement of Operations

For the Nine Months Ended September 30, 2008

(in millions of U.S. dollars)

 

     ACE Limited
(Parent
Guarantor)
    ACE INA
Holdings, Inc.
(Subsidiary
Issuer)
    Other ACE
Limited
Subsidiaries and
Eliminations (1)
    Consolidating
Adjustments (2)
    ACE Limited
Consolidated
 

Net premiums written

   $ —       $ 5,475     $ 4,553     $ —       $ 10,028  

Net premiums earned

     —         5,642       4,335       —         9,977  

Net investment income

     (11 )     795       757       —         1,541  

Equity in earnings of subsidiaries

     1,183       —         —         (1,183 )     —    

Net realized gains (losses)

     38       (433 )     (594 )     —         (989 )

Losses and loss expenses

     —         3,521       2,322       —         5,843  

Future policy benefits

     —         90       153       —         243  

Policy acquisition costs and administrative expenses

     72       1,681       1,170       (12 )     2,911  

Interest expense

     (29 )     180       4       21       176  

Other (income) expense

     (11 )     (14 )     (79 )     —         (104 )

Income tax expense

     1       232       50       —         283  
                                        

Net income

   $ 1,177     $ 314     $ 878     $ (1,192 )   $ 1,177  
                                        

Condensed Consolidating Statement of Operations

For the Nine Months Ended September 30, 2007

(in millions of U.S. dollars)

 

     ACE Limited
(Parent
Guarantor)
    ACE INA
Holdings, Inc.
(Subsidiary
Issuer)
    Other ACE
Limited
Subsidiaries and
Eliminations (1)
   Consolidating
Adjustments (2)