UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended September 30, 2001 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 the Cayman Islands) The ACE Building 30 Woodbourne Avenue Hamilton HM 08 Bermuda Telephone 441-295-5200 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 ---- ---- The number of registrant's Ordinary Shares ($0.041666667 par value) outstanding as of November 8, 2001 was 259,522,646.
ACE LIMITED INDEX TO FORM 10-Q Part I. FINANCIAL INFORMATION Page No. Item 1. Financial Statements: Consolidated Balance Sheets September 30, 2001 (Unaudited) and December 31, 2000 3 Consolidated Statements of Operations (Unaudited) Three Months and Nine Months Ended September 30, 2001 and 2000 4 Consolidated Statements of Shareholders' Equity (Unaudited) Nine Months Ended September 30, 2001 and 2000 5 Consolidated Statements of Comprehensive Income (Unaudited) Nine Months Ended September 30, 2001 and 2000 6 Consolidated Statements of Cash Flows (Unaudited) Nine Months Ended September 30, 2001 and 2000 7 Notes to Interim Consolidated Financial Statements (Unaudited) 8 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 27 Part II. OTHER INFORMATION - --------------------------- Item 5. Other Information 51 Item 6. Exhibits and Reports on Form 8-K 51
<TABLE> <CAPTION> ACE LIMITED AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS September 30 December 31 2001 2000 ---- ---- (unaudited) Assets (in thousands of U.S. dollars, except share and per share data) <S> <C> <C> Investments and cash Fixed maturities available for sale, at fair value (amortized cost - $11,051,756 and $10,640,937) $ 11,375,713 $ 10,721,309 Equity securities, at fair value (cost - $525,325 and $495,049) 427,929 532,046 Short-term investments, at fair value (amortized cost - $1,439,235 and $1,369,784) 1,439,235 1,369,784 Other investments, at fair value (cost - $568,745 and $518,130) 594,923 531,116 Cash 754,588 608,069 -------------- -------------- Total investments and cash 14,592,388 13,762,324 Accrued investment income 200,159 183,011 Insurance and reinsurance balances receivable 2,456,780 2,095,573 Accounts and notes receivable 242,532 388,996 Reinsurance recoverable 10,701,733 8,994,940 Deferred policy acquisition costs 680,642 572,757 Prepaid reinsurance premiums 1,234,016 857,745 Goodwill 2,790,986 2,846,709 Deferred tax assets 1,178,418 1,144,261 Other assets 831,621 843,210 -------------- -------------- Total assets $ 34,909,275 $ 31,689,526 ============== ============== Liabilities Unpaid losses and loss expenses $ 19,883,757 $ 17,388,394 Unearned premiums 3,777,915 3,035,288 Premiums received in advance 57,980 63,123 Insurance and reinsurance balances payable 1,563,766 1,319,091 Contract holder deposit funds 106,460 139,056 Accounts payable, accrued expenses and other liabilities 1,402,136 1,316,449 Dividends payable 37,532 33,127 Short-term debt 451,470 364,509 Long-term debt 1,424,429 1,424,228 Trust preferred securities 875,000 875,000 -------------- -------------- Total liabilities 29,580,445 25,958,265 -------------- -------------- Commitments and contingencies Mezzanine equity 311,050 311,050 -------------- -------------- Shareholders' equity Ordinary Shares ($0.041666667 par value, 300,000,000 shares authorized; 226,390,282 and 232,346,579 shares issued and outstanding) 9,433 9,681 Additional paid-in capital 2,575,080 2,637,085 Unearned stock grant compensation (40,129) (29,642) Retained earnings 2,320,704 2,733,633 Accumulated other comprehensive income 152,692 69,454 -------------- -------------- Total shareholders' equity 5,017,780 5,420,211 -------------- -------------- Total liabilities, mezzanine equity and shareholders' equity $ 34,909,275 $ 31,689,526 ============== ============== See accompanying notes to interim consolidated financial statements 3
<CAPTION> ACE LIMITED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS For the Three Months and Nine Months ended September 30, 2001 and 2000 (Unaudited) Three Months Ended Nine Months Ended September 30 September 30 2001 2000 2001 2000 ---- ---- ---- ---- (in thousands of U.S. dollars, except per share data) <S> <C> <C> <C> <C> Revenues Gross premiums written $ 2,502,371 $ 1,999,816 $ 7,466,670 $ 5,946,843 Reinsurance premiums ceded (1,197,304) (803,012) (2,955,840) (2,079,132) -------------- ------------- ------------ ------------- Net premiums written 1,305,067 1,196,804 4,510,830 3,867,711 Change in unearned premiums 94,362 (22,022) (357,098) (420,287) -------------- ------------- ------------ ------------- Net premiums earned 1,399,429 1,174,782 4,153,732 3,447,424 Net investment income 192,909 197,584 593,606 561,548 Net realized gains (losses) on investments (58,843) (12,797) (62,654) 13,899 -------------- ------------- ------------ ------------- Total revenues 1,533,495 1,359,569 4,684,684 4,022,871 -------------- ------------- ------------ ------------- Expenses Losses and loss expenses 1,571,333 772,887 3,506,272 2,256,481 Policy acquisition costs 204,666 168,258 558,996 482,628 Administrative expenses 207,389 177,912 607,788 554,784 Amortization of goodwill 19,912 19,919 59,664 58,889 Interest expense 49,130 55,408 153,094 166,544 -------------- ------------- ------------ ------------- Total expenses 2,052,430 1,194,384 4,885,814 3,519,326 -------------- ------------- ------------ ------------- Income (loss) before income tax and cumulative effect of adopting a new accounting standard (518,935) 165,185 (201,130) 503,545 Income tax expense (benefit) (76,345) 24,432 (31,121) 74,351 -------------- ------------- ------------ ------------- Income (loss) before cumulative effect of adopting new accounting standard (442,590) 140,753 (170,009) 429,194 Cumulative effect of adopting a new accounting standard (net of income tax) - - (22,670) - -------------- ------------- ------------ ------------- Net income (loss) $ (442,590) $ 140,753 $ (192,679) $ 429,194 ============== ============= ============ ============= Basic earnings (loss) per share before cumulative effect of adopting a new accounting standard $ (1.95) $ 0.60 $ (0.82) $ 1.92 ============== ============= ============ ============= Basic earnings (loss) per share $ (1.95) $ 0.60 $ (0.92) $ 1.92 ============== ============= ============ ============= Diluted earnings (loss) per share before cumulative effect of adopting a new accounting standard $ (1.95) $ 0.58 $ (0.82) $ 1.88 ============== ============= ============ ============= Diluted earnings (loss) per share $ (1.95) $ 0.58 $ (0.92) $ 1.88 ============== ============= ============ ============= See accompanying notes to interim consolidated financial statements 4
<CAPTION> ACE AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY For the Nine Months ended September 30, 2001 and 2000 (Unaudited) Nine Months Ended September 30 2001 2000 ---- ---- (in thousands of U.S. dollars) <S> <C> <C> Ordinary Shares Balance - beginning of period $ 9,681 $ 9,061 Shares issued 8 584 Exercise of stock options 41 41 Issued under Employee Stock Purchase Plan (ESPP) 9 2 Cancellation of Shares (24) (28) Repurchase of Shares (282) - -------------- ------------- Balance - end of period 9,433 9,660 -------------- ------------- Additional paid-in capital Balance - beginning of period 2,637,085 2,214,989 Ordinary Shares issued 3,206 434,178 Exercise of stock options 19,729 14,863 Issued under ESPP 7,054 1,232 Repurchase of Ordinary Shares (76,849) - Cancellation of Ordinary Shares (15,145) (19,074) Equity offering expenses - (7,196) FELINE PRIDES issuance costs - (9,884) -------------- ------------- Balance - end of period 2,575,080 2,629,108 -------------- ------------- Unearned stock grant compensation Balance - beginning of period (29,642) (28,908) Stock grants awarded (18,503) (9,845) Stock grants forfeited 813 - Amortization 7,203 7,041 -------------- ------------- Balance - end of period (40,129) (31,712) -------------- ------------- Retained earnings Balance - beginning of period 2,733,633 2,321,570 Net income (loss) (192,679) 429,194 Dividends declared on Ordinary Shares (98,756) (82,294) Dividends declared on FELINE PRIDES (19,179) (11,862) Repurchase of Ordinary Shares (102,315) - -------------- ------------- Balance - end of period 2,320,704 2,656,608 -------------- ------------- Accumulated other comprehensive income (loss) Net unrealized appreciation (depreciation) on investments Balance - beginning of period 102,335 (83,327) Change in period, net of income tax 84,629 70,907 -------------- ------------- Balance - end of period 186,964 (12,420) -------------- ------------- Cumulative translation adjustments Balance - beginning of period (32,881) 17,175 Net adjustment for period, net of income tax (1,391) (27,914) -------------- ------------- Balance - end of period (34,272) (10,739) ------------- ------------- Accumulated other comprehensive income (loss) 152,692 (23,159) -------------- ------------- Total shareholders' equity $ 5,017,780 $ 5,240,505 ============== ============= See accompanying notes to interim consolidated financial statements 5
<CAPTION> ACE LIMITED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME For the Nine Months ended September 30, 2001 and 2000 (Unaudited) Nine Months Ended September 30 2001 2000 ---- ---- (in thousands of U.S. dollars) <S> <C> <C> Net income (loss) $ (192,679) $ 429,194 Other comprehensive income (loss) Net unrealized appreciation on investments Unrealized appreciation on investments 137,718 115,880 Less: reclassification adjustment for net realized gains included in net income (15,334) (37,463) ------------- -------------- 122,384 78,417 Cumulative translation adjustments (6,297) (34,825) -------------- ------------- Other comprehensive income before income tax 116,087 43,592 Income tax expense related to other comprehensive income items (32,849) (599) -------------- ------------- Other comprehensive income 83,238 42,993 -------------- ------------- Comprehensive income (loss) $ (109,441) $ 472,187 ============== ============= See accompanying notes to interim consolidated financial statements 6
<CAPTION> ACE LIMITED AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Nine Months ended September 30, 2001 and 2000 (Unaudited) Nine Months Ended September 30 2001 2000 ---- ---- (in thousands of U.S. dollars) <S> <C> <C> Cash flows from operating activities Net income (loss) $ (192,679) $ 429,194 Adjustments to reconcile net income to net cash provided by operating activities: Unearned premiums 753,329 673,258 Unpaid losses and loss expenses, net of reinsurance recoverable 807,342 (45,631) Prepaid reinsurance premiums (376,271) (289,812) Deferred income taxes (69,604) 23,062 Net realized (gains) losses on investments 62,654 (13,899) Amortization of premium/discounts on fixed maturities (5,166) (5,384) Amortization of goodwill 59,664 58,889 Deferred policy acquisition costs (115,426) (43,838) Insurance and reinsurance balances receivable (375,967) (233,286) Premiums received in advance (5,143) (3,892) Insurance and reinsurance balances payable 244,558 (582,177) Accounts payable, accrued expenses and other liabilities 92,028 (332,680) Net change in contract holder deposit funds (28,763) (49,932) Cumulative effect of adopting a new accounting standard 22,670 - Other 88,096 41,610 --------------- ---------------- Net cash flows from (used for) operating activities $ 961,322 $ (374,518) --------------- ---------------- Cash flows from investing activities Purchases of fixed maturities (10,914,332) (8,231,880) Purchases of equity securities (158,103) (321,340) Sales of fixed maturities 10,371,634 8,151,291 Sales of equity securities 153,871 689,415 Maturities of fixed maturities 39,190 48,890 Net realized gains (losses) on financial future contracts (44,060) (8,751) Other investments (83,821) (170,985) --------------- ---------------- Net cash from (used for) investing activities $ (635,621) $ 156,640 --------------- ---------------- Cash flows from financing activities Dividends paid on Ordinary Shares $ (94,279) $ (76,075) Dividends paid on FELINE PRIDES (19,251) (8,839) Net proceeds from (repayment of) short-term debt 86,961 (697,119) Proceeds from exercise of options for Ordinary Shares 19,770 14,904 Proceeds from shares issued under ESPP 7,063 1,234 Repurchase of Ordinary Shares (179,446) - Proceeds from issuance of trust preferred securities - 300,000 Proceeds from issuance of FELINE PRIDES - 311,050 Issuance costs of FELINE PRIDES - (9,884) Net proceeds from issuance of Ordinary Shares - 400,346 --------------- ---------------- Net cash from (used for) financing activities $ (179,182) $ 235,617 --------------- ---------------- Net increase in cash 146,519 17,739 Cash - beginning of period 608,069 599,232 --------------- ---------------- Cash - end of period $ 754,588 $ 616,971 =============== ================ See accompanying notes to interim consolidated financial statements </TABLE> 7
ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd) (Unaudited) 1. General The interim unaudited consolidated financial statements, which include the accounts of the Company and its subsidiaries, have been prepared on the basis of accounting principles generally accepted in the United States of America and, in the opinion of management, reflect all adjustments (consisting of normally recurring accruals) necessary for a fair presentation of results for such periods. The results of operations and cash flows for any interim period are not necessarily indicative of 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, 2000. ACE Limited ("ACE" or "the Company") is a holding company incorporated with limited liability under the Cayman Islands Companies Law and maintains its business office in Bermuda. The Company, through its various subsidiaries, provides insurance and reinsurance for a diverse group of customers worldwide. ACE operates through six business segments: ACE Bermuda, ACE Global Markets, ACE Global Reinsurance, ACE USA, ACE International and ACE Financial Services. The analysis of gross premiums written by geographic regions is as follows: Nine Months Ended September 30 2001 2000 ---- ---- North America 61% 61% Europe 22 19 Australia and New Zealand 2 6 South America 5 3 Asia Pacific 9 5 Other (1) 1 6 ---------- -------- 100% 100% ========== ======== (1) includes world wide coverages 2. Significant Accounting Policies New accounting pronouncements In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("FAS 142"). FAS 142 primarily addresses the accounting for goodwill and intangible assets subsequent to their acquisition. As required, the Company will adopt FAS 142 on January 1, 2002 and will cease amortizing goodwill at that time. All goodwill recognized in the Company's consolidated balance sheet at January 1, 2002 will be assigned to one or more reporting units. Goodwill in each reporting unit should be tested for impairment by June 30, 2002. An impairment loss recognized as a result of a transitional impairment test of goodwill should be reported as the cumulative effect of a change in accounting principle. The Company does not expect any impairment in goodwill to arise from testing during initial adoption. In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"). FAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the consolidated balance sheet and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as a fair value, cash flow or foreign currency hedge. The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation. Upon initial application of FAS 133, hedging relationships must be designated anew and documented pursuant to the provisions of this statement. The Company adopted FAS 133, as amended, as of January 1, 2001. 8
ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd) (Unaudited) The Company maintains investments in derivative instruments such as futures, option contracts and foreign currency forward contracts for which the primary purposes are to manage duration and foreign currency exposure, yield enhancement or to obtain an exposure to a particular financial market. The Company has historically recorded the changes in market value of these instruments as realized gains or losses in the consolidated statements of operations and, accordingly, has estimated that FAS 133, as amended, is not expected to have a significant impact on the results of operations, financial condition or liquidity in future periods as it relates to these instruments. Certain products (principally credit protection oriented) issued by the Company have been determined to meet the definition of a derivative under FAS 133. These products consist primarily of credit default swaps, index-based instruments and certain financial guarantee coverages. Effective January 1, 2001, the Company records these products at their fair value. To reflect the adoption of FAS 133 on January 1, 2001, the Company recorded an expense related to the cumulative effect of adopting this standard of $23 million, net of income tax of $12 million. The Company has recorded in net realized gains (losses) on investments, a pretax loss of $14 million to reflect the change in the fair value of derivatives for the nine months ended September 30, 2001. The level of gains and losses resulting from changes in the fair value of derivatives on a prospective basis is dependent upon a number of factors including changes in interest rates, credit spreads and other market factors. The Company's involvement with derivative instruments and transactions is primarily to offer protection to others or to mitigate its own risk and is not considered speculative in nature. 3. Commitments and Contingencies The Company has considered asbestos and environmental claims and claims expenses in establishing the liability for unpaid losses and loss expenses. The Company has developed reserving methods, which incorporate new sources of data with historical experience to estimate the ultimate losses arising from asbestos and environmental exposures. The reserves for asbestos and environmental claims and claims expenses represent management's best estimate of future loss and loss expense payments and recoveries which are expected to develop over the next several decades. The Company continuously monitors evolving case law and its effect on environmental damage and latent injury claims. While reserving for these claims is inherently uncertain, the Company believes that the reserves carried for these claims are adequate based on known facts and current law. 4. Restricted Stock Awards Under the Company's long-term incentive plans, 569,102 restricted Ordinary Shares were awarded during the nine months ended September 30, 2001, to officers of the Company and its subsidiaries. These shares vest at various dates through September 2005. In addition, during the period, 12,896 restricted Ordinary Shares were awarded to outside directors under the terms of the 1995 Outside Directors Plan. These shares vest in May 2002. At the time of grant the market value of the shares awarded under these grants is recorded as unearned stock grant compensation and is presented as a separate component of shareholders' equity. The unearned compensation is charged to income over the vesting period. 5. Shareholders' Equity On October 25, 2001, the Company completed a public offering of 32,890,000 Ordinary Shares (which included the over-allotment option of 4,290,000 shares) in which it raised aggregate net proceeds of approximately $1.1 billion. The Company expects to use the net proceeds of the Ordinary Share offering to expand its net underwriting capacity, either through internal growth and/or through acquisitions of lines of business or companies and for general corporate purposes. 9
ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd) (Unaudited) 6. September 11, 2001 Tragedy The terrorist attacks on September 11, 2001 ("the September 11th tragedy") resulted in the largest insured loss in history and had a substantial impact on the results of the Company. Detailed below is an analysis, by operating segment, of the impact of the September 11th tragedy on the Company's statement of operations for the three months and nine months ended September 30, 2001. The analysis of the impact of the September 11th tragedy includes the effects of intercompany reinsurance transactions. The Company's net income was reduced by $559 million on an after tax basis. The losses and loss expenses estimate of $650 million, net of reinsurance recoveries, is management's best estimate and is based on the most recent information and could change as more information becomes available. While reserving for claims is inherently uncertain, the Company believes that the reserves carried for these claims are adequate based on known facts. <TABLE> <CAPTION> Impact of September 11, 2001 Tragedy Three months and nine months ended September 30, 2001 (in thousands of U.S. dollars) ACE ACE ACE ACE Global Global ACE Inter- ACE Bermuda Markets Reinsurance USA national Consolidated ------- ------- ----------- --- -------- ------------ <S> <C> <C> <C> <C> <C> <C> Operations Data: Gross premiums written $ 142,426 $ (20,691) $ - $ - $ - $ 121,735 Net premiums written 138,676 (66,292) 1,768 (18,124) (4,500) 51,528 Net premiums earned 100,092 (66,292) 2,892 (18,124) (4,500) 14,068 Losses and loss expenses 341,785 140,212 122,017 28,178 18,300 650,492 Policy acquisition costs - - 502 - - 502 ------------- -------------- ------------ ------------ ------------- ---------------- Underwriting income (241,693) (206,504) (119,627) (46,302) (22,800) (636,926) Income tax benefit - (61,951) - (16,206) - (78,157) ------------- -------------- ------------ ------------ ------------- ---------------- Net loss $ (241,693) $ (144,553) $(119,627) $ (30,096) $ (22,800) $ (558,769) ============= ============== ============ ============ ============= ================ </TABLE> In estimating the impact of the tragedy on the Company, premium payments required to reinstate reinsurance policies have been accrued. Premiums from insureds required to reinstate their insurance or reinsurance coverage with the Company have not been accrued in the estimate. The premiums accrued in ACE Bermuda represent additional premiums due under the terms of certain financial solutions reinsurance programs directly impacted by the tragedy. The Company's exposure to the tragedy is derived from losses incurred by insured and reinsured clients of ACE. Gross insured claims incurred by ACE with respect to the tragedy are covered by significant amounts of reinsurance from high quality reinsurers. In order to identify policies which may have been affected by the September 11th tragedy, the Company conducted a review of its insurance and reinsurance portfolios on a policy by policy basis, which included first party, third party, reinsurance, retrocessional, financial guaranty and life reinsurance exposures. Net losses and loss expenses of $650 million result from estimated gross losses and loss expenses of approximately $1.9 billion, net of estimated reinsurance recoveries of approximately $1.3 billion. Approximately 98 percent of all reinsurance purchased by ACE is with reinsurers rated A- or better, including 38 percent with reinsurers rated AAA- and 33 percent with reinsurers rated AA-, as rated by Standard & Poor's. 10
ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd) (Unaudited) 7. Discontinued Operations As part of the ACE INA Acquisition in July 1999, the Company planned to dispose of the operations of Commercial Insurance Services ("CIS"), a division of ACE INA. Following the acquisition, the Company sold the renewal rights for all of its CIS business and planned to sell the assets and liabilities pertaining to the in-force book of business which it still owned. Therefore, in accordance with Emerging Issues Task Force ("EITF") 87-11, "Allocation of Purchase Price to Assets to Be Sold," and EITF 90-6, "Accounting for Certain Events Not Addressed in Issue No. 87-11 Relating to an Acquired Operating Unit to Be Sold," the Company presented CIS as a discontinued operation, with effect from July 2, 1999. On July 2, 1999, the Company reduced the consolidated balance sheet for all items that pertained specifically to CIS, together with the estimated proceeds on sale and estimated operating results over the twelve months from July 2, 1999, through July 1, 2000, into a net liability of approximately $170 million, which was recorded in accounts payable, accrued expenses and other liabilities. As the CIS business was not sold within the allotted time period, the Company was required, as of July 2, 2000, to record the CIS balance sheet into its constituent parts in the balance sheet and to record any resulting income or loss from CIS in its statement of operations prospectively from July 2, 2000. The results of the CIS operations from July 2, 2000 are reflected in the ACE USA segment. 11
ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd) (Unaudited) 8. Earnings Per Share The following table sets forth the computation of basic and diluted earnings per share: <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30 September 30 2001 2000 2001 2000 ---- ---- ---- ---- (In thousands of U.S. dollars, except share and per share data) <S> <C> <C> <C> <C> Numerator Net income before cumulative effect of adopting a new accounting standard $ (442,590) $ 140,753 $ (170,009) $ 429,194 Dividends on FELINE PRIDES (6,416) (6,537) (19,179) (11,862) --------------- ---------------- ---------------- -------------- Net income available to the holders of Ordinary Shares before cumulative effect (449,006) 134,216 (189,188) 417,332 Cumulative effect of adopting a new accounting standard - - (22,670) - --------------- ---------------- ---------------- -------------- Net income available to the holders of Ordinary $ (449,006) $ 134,216 $ (211,858) $ 417,332 Shares =============== ================ ================ ============== Denominator Denominator for basic earnings per share: Weighted average shares outstanding 230,610,425 222,042,432 231,390,682 217,615,849 Dilutive effect of FELINE PRIDES - 2,663,691 - - Effect of other dilutive securities - 6,679,576 - 4,431,705 --------------- ---------------- ---------------- -------------- Denominator for diluted earnings per share: Adjusted weighted average shares outstanding and assumed conversions 230,610,425 231,385,699 231,390,682 222,047,554 =============== ================ ================ ============== Basic earnings per share: Earnings (loss) per share before cumulative effect of adopting a new accounting standard $ (1.95) $ 0.60 $ (0.82) $ 1.92 =============== ================ ================ ============== Earnings (loss) per share $ (1.95) $ 0.60 $ (0.92) $ 1.92 =============== ================ ================ ============== Diluted earnings per share: Earnings (loss) per share before cumulative effect of adopting a new accounting standard $ (1.95) $ 0.58 $ (0.82) $ 1.88 =============== ================ ================ ============== Earnings (loss) per share $ (1.95) $ 0.58 $ (0.92) $ 1.88 =============== ================ ================ ============== </TABLE> The denominator for diluted loss per share for the three months and nine months ended September 30, 2001 does not include the dilutive effect of FELINE PRIDES and other dilutive securities. The incremental shares from assumed conversions are not included in computing diluted loss per share amounts as these shares are considered anti-dilutive. The dilutive effect of FELINES PRIDES for the three months and nine months ended September 30, 2001 is 2,462,861 shares and 3,067,185 shares, respectively. Other dilutive securities totaled 5,907,562 shares and 6,440,916 shares for the three months and nine months ended September 30, 2001. 12
ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd) (Unaudited) 9. Credit Facilities In August 2001, the Company, along with ACE Bermuda and ACE Tempest Re as Account Parties and Guarantors, entered into a syndicated, one year Letter of Credit ("LOC") facility in the amount of $450 million for general business purposes, including the issuance of insurance and reinsurance letters of credit. This facility replaced an LOC facility originally arranged in September 1999 and renewed in September 2000. This facility requires that the Company and/or certain of its subsidiaries maintain specific covenants, including a consolidated tangible net worth covenant and a maximum leverage covenant. Usage under this facility was $239 million as of September 30, 2001. 10. Debt The following table sets forth the Company's consolidated debt position at September 30, 2001 and December 31, 2000. <TABLE> <CAPTION> September 30 December 31 2001 2000 ---- ---- (in millions of U.S. dollars) <S> <C> <C> Short-term debt ACE INA commercial paper $ 268 $ 340 ACE Financial Services Note 25 25 ACE INA bank borrowings 158 - ------------- -------------- $ 451 $ 365 ============= ============== Long-term debt ACE Financial Services Debentures due 2002 $ 75 $ 75 ACE INA Notes due 2004 400 400 ACE INA Notes due 2006 299 299 ACE US Holdings Senior Notes due 2008 250 250 ACE INA Subordinated Notes due 2009 300 300 ACE INA Debentures due 2029 100 100 ------------- -------------- $ 1,424 $ 1,424 ============= ============== Trust Preferred Securities ACE INA RHINO Preferred Securities due 2002 $ 400 $ 400 Capital Re LLC Monthly Income Preferred Securities due 2044 75 75 ACE INA Trust Preferred Securities due 2029 100 100 ACE INA Capital Securities due 2030 300 300 ------------- -------------- $ 875 $ 875 ============= ============== </TABLE> Commercial paper and money market facilities In June 1999, the Company arranged certain commercial paper programs. The programs use revolving credit facilities as back-up facilities and provide for up to $2.8 billion in commercial paper issuance (subject to the availability of back-up facilities, which currently total $1.05 billion) for ACE and for ACE INA. Commercial paper rates averaged 4 percent during the three months ended September 30, 2001 and 6.1 percent during the nine months ended September 30, 2001. In September 2001 ACE INA borrowed $158 million under revolving credit facilities. The average rate on this borrowing was 3.8 percent. 13
ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd) (Unaudited) 11. Reinsurance The Company purchases reinsurance to manage various exposures including catastrophe risks. Although reinsurance agreements contractually obligate the Company's reinsurers to reimburse it for the agreed upon portion of its gross paid losses, they do not discharge the primary liability of the Company. The amounts for net premiums written and net premiums earned in the statements of operations are net of reinsurance. Direct, assumed and ceded amounts for these items for the three and nine months ended September 30, 2001 and 2000 are as follows: <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30 September 30 2001 2000 2001 2000 ---- ---- ---- ---- (in thousands of U.S. dollars) <S> <C> <C> <C> <C> Premiums Premiums written Direct $ 1,923,847 $ 1,739,116 $ 5,698,290 $ 4,788,872 Assumed 578,524 260,700 1,768,380 1,157,971 Ceded (1,197,304) (803,012) (2,955,840) (2,079,132) ---------------- --------------- --------------- --------------- Net premiums written $ 1,305,067 $ 1,196,804 $ 4,510,830 $ 3,867,711 ================ =============== =============== =============== Premiums earned Direct $ 1,776,333 $ 1,645,052 $ 5,155,324 $ 4,279,020 Assumed 694,181 234,095 1,609,875 982,914 Ceded (1,071,085) (704,365) (2,611,467) (1,814,510) ---------------- --------------- --------------- --------------- Net premiums earned $ 1,399,429 $ 1,174,782 $ 4,153,732 $ 3,447,424 ================ =============== =============== =============== The Company's provision for reinsurance recoverable at September 30, 2001 and December 31, 2000, is as follows: <CAPTION> September 30 December 31 2001 2000 ---- ---- (in thousands of U.S. dollars) <S> <C> <C> Reinsurance recoverable on paid losses and loss expenses $ 1,036,602 $ 937,496 Reinsurance recoverable on unpaid losses and loss expenses 10,401,072 8,767,111 Provision for uncollectible balances on reinsurance recoverable (735,941) (709,667) ------------- -------------- Reinsurance recoverable $ 10,701,733 $ 8,994,940 ============= ============== </TABLE> 12. Taxation Under current Cayman Islands law, the Company is not required to pay any taxes in the Cayman Islands on its income or capital gains. The Company has received an undertaking that, in the event of any taxes being imposed, the Company will be exempted from taxation in the Cayman Islands until the year 2013. Under current Bermuda law, the Company and its Bermuda subsidiaries are not required to pay any taxes in Bermuda on its income or capital gains. The Company has received an undertaking from the Minister of Finance in Bermuda that, in the event of any taxes being imposed, the Company will be exempt from taxation in Bermuda until March 2016. Income from the Company's operations at Lloyd's are subject to United Kingdom corporation taxes. Lloyd's is required to pay U.S. income tax on U.S. connected income ("U.S. income") written by Lloyd's syndicates. Lloyd's has a closing agreement with the IRS whereby the amount of tax due on this business is calculated by Lloyd's and remitted directly to the IRS. These amounts are then charged to the personal accounts of the 14
ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd) (Unaudited) Names/Corporate Members in proportion to their participation in the relevant syndicates. The Company's Corporate Members are subject to this arrangement but, as UK domiciled companies, will receive UK corporation tax credits for any U.S. income tax incurred up to the value of the equivalent UK corporation income tax charge on the U.S. income. ACE INA, ACE US Holdings and ACE Financial Services are subject to income taxes imposed by U.S. authorities and file U.S. tax returns. Certain international operations of the Company are also subject to income taxes imposed by the jurisdictions in which they operate. There can be no assurance that applicable laws, regulations or treaties will remain the same. If they were to change the Company might have to change the way it operates or become subject to taxation. The income tax expense for the three and nine months ended September 30, 2001 and 2000 is as follows: <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30 September 30 2001 2000 2001 2000 ---- ---- ---- ---- (in thousands of U.S. dollars) <S> <C> <C> <C> <C> Current tax expense $ 9,366 $ 29,254 $ 38,483 $ 51,289 Deferred tax expense (benefit) (85,711) (4,822) (69,604) 23,062 ------------ ------------ ------------- ------------ Total income tax expense (benefit) $ (76,345) $ 24,432 $ (31,121) $ 74,351 ============ ============ ============= ============ The components of the net deferred tax asset as of September 30, 2001 and December 31, 2000 are as follows: <CAPTION> September 30 December 31 2001 2000 ---- ---- (in thousands of U.S. dollars) <S> <C> <C> Deferred tax assets Loss reserve discount $ 496,045 $ 536,005 Foreign tax credits 158,278 137,765 Uncollectible reinsurance 28,297 28,297 Net operating loss carry forward 518,605 500,916 Other 254,991 199,689 --------------- ------------- Total deferred tax assets 1,456,216 1,402,672 --------------- ------------- Deferred tax liabilities Deferred policy acquisition costs 59,470 62,080 Unrealized appreciation on investments 48,881 25,861 Other 32,972 32,064 --------------- ------------- Total deferred tax liabilities 141,323 120,005 --------------- ------------- Valuation allowance 136,475 138,406 --------------- ------------- Net deferred tax asset $ 1,178,418 $ 1,144,261 =============== ============= </TABLE> 15
ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd) (Unaudited) 13. Subsidiary Issuer Information The following tables present the condensed consolidating financial information for ACE Limited (the "Parent Guarantor"), ACE INA Holdings, Inc. and ACE Financial Services, Inc. (formerly Capital Re Corporation), (the "Subsidiary Issuers") as of September 30, 2001 and December 31, 2000 and for the three and nine months ended September 30, 2001 and 2000. The Subsidiary Issuers are direct or indirect wholly-owned subsidiaries of the Parent Guarantor. Investments in subsidiaries are accounted for by the Parent Guarantor and the Subsidiary Issuers 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 Issuers (see Note 10). <TABLE> <CAPTION> - ----------------------------------------------------------------------------------------------------------------------------------- Condensed Consolidating Balance Sheet as at September 30, 2001 (in thousands of U.S. dollars) Other ACE ACE INA ACE Financial Limited ACE Limited Holdings, Inc. Services, Inc. Subsidiaries (Parent Co. (Subsidiary (Subsidiary and Consolidating ACE Limited Guarantor) Issuer) Issuer) Eliminations (1) Adjustments (2) Consolidated ---------- ------- ------- ------------ -------------- ------------ <S> <C> <C> <C> <C> <C> <C> Assets Total investments and cash $ 454,963 $ 6,491,154 $ 1,096,505 $ 6,549,766 $ - $ 14,592,388 Insurance and reinsurance balances receivable - 1,705,217 10,209 741,354 - 2,456,780 Reinsurance recoverable - 8,664,937 71,248 1,965,548 - 10,701,733 Goodwill - 2,200,419 97,775 492,792 - 2,790,986 Investments in subsidiaries 4,619,760 - 152,000 (152,000) (4,619,760) - Due from subsidiaries and affiliates, net 294,312 (105,019) 2,257 102,762 (294,312) - Other assets 27,311 3,177,120 184,658 978,299 - 4,367,388 ------------------------------------------------------------------------------------------------- Total assets $ 5,396,346 $ 22,133,828 $ 1,614,652 $ 10,678,521 $ (4,914,072) $ 34,909,275 ================================================================================================= Liabilities Unpaid losses and loss expenses $ - $ 13,707,042 $ 241,059 $ 5,935,656 $ - $ 19,883,757 Unearned premiums - 2,041,495 299,956 1,436,464 - 3,777,915 Short-term debt - 426,470 25,000 - - 451,470 Long-term debt - 1,099,459 74,970 250,000 - 1,424,429 Trust preferred securities - 800,000 75,000 - - 875,000 Other liabilities 67,516 2,497,180 260,669 342,509 - 3,167,874 ------------------------------------------------------------------------------------------------- Total liabilities 67,516 20,571,646 976,654 7,964,629 - 29,580,445 ------------------------------------------------------------------------------------------------- Mezzanine equity 311,050 - - - - 311,050 ------------------------------------------------------------------------------------------------- Total shareholders' equity 5,017,780 1,562,182 637,998 2,713,892 (4,914,072) 5,017,780 ------------------------------------------------------------------------------------------------- Total liabilities, mezzanine equity and shareholders' equity $ 5,396,346 $ 22,133,828 $ 1,614,652 $ 10,678,521 $ (4,914,072) $ 34,909,275 ================================================================================================= - ----------------------------------------------------------------------------------------------------------------------------------- (1) Includes all other subsidiaries of ACE Limited and intercompany eliminations. (2) Includes ACE Limited parent company eliminations. </TABLE> 16
ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd.) (Unaudited) 13. Subsidiary Issuer Information (cont'd.) <TABLE> <CAPTION> - ----------------------------------------------------------------------------------------------------------------------------------- Condensed Consolidating Balance Sheet as at December 31, 2000 (in thousands of U.S. dollars) Other ACE ACE INA ACE Financial Limited ACE Limited Holdings, Inc. Services, Inc. Subsidiaries (Parent Co. (Subsidiary (Subsidiary and Consolidating ACE Limited Guarantor) Issuer) Issuer) Eliminations (1) Adjustments (2) Consolidated ---------- ------- ------- ------------ -------------- ------------ <S> <C> <C> <C> <C> <C> <C> Assets Total investments and cash $ 479,969 $ 6,655,182 $ 919,181 $ 5,707,992 $ - $ 13,762,324 Insurance and reinsurance balances receivable - 1,616,027 9,832 469,714 - 2,095,573 Reinsurance recoverable - 7,603,352 76,087 1,315,501 - 8,994,940 Goodwill - 2,240,505 100,928 505,276 - 2,846,709 Investments in subsidiaries 4,975,663 - 152,000 (152,000) (4,975,663) - Due from subsidiaries and affiliates, net 318,806 (111,131) 1,596 109,535 (318,806) - Other assets 27,404 3,069,648 154,687 738,241 - 3,989,980 ----------------------------------------------------------------------------------------------- Total assets $ 5,801,842 $21,073,583 $ 1,414,311 $ 8,694,259 $ (5,294,469) $ 31,689,526 =============================================================================================== Liabilities Unpaid losses and loss expenses $ - $13,126,965 $ 246,174 $ 4,015,255 $ - $ 17,388,394 Unearned premiums - 1,680,166 293,618 1,061,504 - 3,035,288 Short-term debt - 339,509 25,000 - - 364,509 Long-term debt - 1,099,417 74,942 249,869 - 1,424,228 Trust preferred securities - 800,000 75,000 - - 875,000 Other liabilities 70,581 2,497,734 78,874 223,657 - 2,870,846 ----------------------------------------------------------------------------------------------- Total liabilities 70,581 19,543,791 793,608 5,550,285 - 25,958,265 ----------------------------------------------------------------------------------------------- Mezzanine equity 311,050 - - - - 311,050 ----------------------------------------------------------------------------------------------- Total shareholders' equity 5,420,211 1,529,792 620,703 3,143,974 (5,294,469) 5,420,211 ----------------------------------------------------------------------------------------------- Total liabilities, mezzanine equity and shareholders' equity $ 5,801,842 $21,073,583 $ 1,414,311 $ 8,694,259 $ (5,294,469) $ 31,689,526 =============================================================================================== - ----------------------------------------------------------------------------------------------------------------------------------- (1) Includes all other subsidiaries of ACE Limited and intercompany eliminations. (2) Includes ACE Limited parent company eliminations. 17
ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd.) (Unaudited) 13. Subsidiary Issuer Information (cont'd.) <CAPTION> - ----------------------------------------------------------------------------------------------------------------------------------- Condensed Consolidating Statement of Operations For the three months ended September 30, 2001 (in thousands of U.S. dollars) Other ACE ACE INA ACE Financial Limited ACE Limited Holdings, Inc. Services, Inc. Subsidiaries (Parent Co. (Subsidiary (Subsidiary and Consolidating ACE Limited Guarantor) Issuer) Issuer) Eliminations (1) Adjustments (2) Consolidated ---------- ------- ------- ------------ -------------- ------------ <S> <C> <C> <C> <C> <C> <C> Net premiums written $ - $ 662,841 $ (1,229) $ 643,455 $ - $ 1,305,067 Net premiums earned - 639,010 17,688 742,731 - 1,399,429 Net investment income 14,605 88,546 11,542 86,161 (7,945) 192,909 Equity in earnings of subsidiaries (417,958) - - - 417,958 - Net realized gains (losses) on investments (25,065) (9,709) (8,879) (15,190) - (58,843) Losses and loss expenses - 461,693 16,038 1,093,602 - 1,571,333 Policy acquisition costs and administrative expenses 15,080 199,828 8,161 189,184 (198) 412,055 Amortization of goodwill - 14,490 1,051 4,371 - 19,912 Interest expense (3,034) 43,808 3,840 5,564 (1,048) 49,130 Income tax expense (benefit) 2,126 3,295 (12,100) (69,666) - (76,345) ------------------------------------------------------------------------------------------------- Net income (loss) $ (442,590) $ (5,267) $ 3,361 $ (409,353) $ 411,259 $ (442,590) ================================================================================================= - ----------------------------------------------------------------------------------------------------------------------------------- <CAPTION> - ----------------------------------------------------------------------------------------------------------------------------------- Condensed Consolidating Statement of Operations For the three months ended September 30, 2000 (in thousands of U.S. dollars) Other ACE ACE INA ACE Financial Limited ACE Limited Holdings, Inc. Services, Inc. Subsidiaries (Parent Co. (Subsidiary (Subsidiary and Consolidating ACE Limited Guarantor) Issuer) Issuer) Eliminations (1) Adjustments (2) Consolidated ---------- ------- ------- ------------ -------------- ------------ <S> <C> <C> <C> <C> <C> <C> Net premiums written $ - $ 560,417 $ 24,578 $ 611,809 $ - $1,196,804 Net premiums earned - 560,547 17,148 597,087 - 1,174,782 Net investment income 8,665 100,310 12,053 83,031 (6,475) 197,584 Equity in earnings of subsidiaries 146,292 - - - (146,292) - Net realized gains (losses) on investments 210 (9,526) 2,456 (5,937) - (12,797) Losses and loss expenses - 408,350 1,251 363,286 - 772,887 Policy acquisition costs and administrative expenses 14,805 156,868 9,260 165,435 (198) 346,170 Amortization of goodwill - 14,490 1,051 4,378 - 19,919 Interest expense (2,329) 48,987 3,378 6,366 (994) 55,408 Income tax expense 1,938 10,801 4,537 7,156 - 24,432 ------------------------------------------------------------------------------------------------ Net income $ 140,753 $ 11,835 $ 12,180 $ 127,560 $(151,575) $ 140,753 ================================================================================================ - ----------------------------------------------------------------------------------------------------------------------------------- (1) Includes all other subsidiaries of ACE Limited and intercompany eliminations. (2) Includes ACE Limited parent company eliminations. 18
ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd.) (Unaudited) 13. Subsidiary Issuer Information (cont'd.) <CAPTION> - ----------------------------------------------------------------------------------------------------------------------------------- Condensed Consolidating Statement of Operations For the nine months ended September 30, 2001 (in thousands of U.S. dollars) Other ACE ACE INA ACE Financial Limited ACE Limited Holdings, Inc. Services, Inc. Subsidiaries (Parent Co. (Subsidiary (Subsidiary and Consolidating ACE Limited Guarantor) Issuer) Issuer) Eliminations (1) Adjustments (2) Consolidated ---------- ------- ------- ------------ -------------- ------------ <S> <C> <C> <C> <C> <C> <C> Net premiums written $ - $ 1,872,616 $ 42,209 $ 2,596,005 $ - $ 4,510,830 Net premiums earned - 1,763,422 56,049 2,334,261 - 4,153,732 Net investment income 42,015 275,700 35,205 262,144 (21,458) 593,606 Equity in earnings of subsidiaries (166,398) - - - 166,398 - Net realized gains (losses) on investments (25,065) (39,662) 14,779 (12,706) - (62,654) Losses and loss expenses - 1,252,928 21,814 2,231,530 - 3,506,272 Policy acquisition costs and administrative expenses 45,342 550,395 27,437 544,205 (595) 1,166,784 Amortization of goodwill - 43,470 3,153 13,041 - 59,664 Interest expense (8,282) 137,240 10,486 16,769 (3,119) 153,094 Income tax expense (benefit) 6,171 17,620 2,652 (57,564) - (31,121) ------------------------------------------------------------------------------------------------- Income before cumulative effect of adopting a new accounting standard (192,679) (2,193) 40,491 (164,282) 148,654 (170,009) Cumulative effect of adopting a new accounting standard (net of income tax) - (50) (22,800) 180 - (22,670) ------------------------------------------------------------------------------------------------- Net income (loss) $(192,679) $ (2,243) $ 17,691 $ (164,102) $ 148,654 $ (192,679) ================================================================================================= - ----------------------------------------------------------------------------------------------------------------------------------- <CAPTION> - ----------------------------------------------------------------------------------------------------------------------------------- Condensed Consolidating Statement of Operations For the nine months ended September 30, 2000 (in thousands of U.S. dollars) Other ACE ACE INA ACE Financial Limited ACE Limited Holdings, Inc. Services, Inc. Subsidiaries (Parent Co. (Subsidiary (Subsidiary and Consolidating ACE Limited Guarantor) Issuer) Issuer) Eliminations (1) Adjustments (2) Consolidated ---------- ------- ------- ------------ -------------- ------------ <S> <C> <C> <C> <C> <C> <C> Net premiums written $ - $ 1,830,277 $ 63,109 $ 1,974,325 $ - $ 3,867,711 Net premiums earned - 1,815,350 52,835 1,579,239 - 3,447,424 Net investment income 29,354 285,232 35,537 233,354 (21,929) 561,548 Equity in earnings of subsidiaries 417,117 - - - (417,117) - Net realized gains (losses) on investments 43,589 5,680 (41,038) 5,668 - 13,899 Losses and loss expenses - 1,299,260 4,439 952,782 - 2,256,481 Policy acquisition costs and administrative expenses 45,283 526,447 28,867 437,410 (595) 1,037,412 Amortization of goodwill - 42,490 3,154 13,245 - 58,889 Interest expense 9,281 138,411 10,016 17,208 (8,372) 166,544 Income tax expense 6,302 41,127 12,166 14,756 - 74,351 ------------------------------------------------------------------------------------------------- Net income (loss) $ 429,194 $ 58,527 $ (11,308) $ 382,860 $ (430,079) $ 429,194 ================================================================================================= - ----------------------------------------------------------------------------------------------------------------------------------- (1) Includes all other subsidiaries of ACE Limited and intercompany eliminations. (2) Includes ACE Limited parent company eliminations. 19
ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd.) (Unaudited) 13. Subsidiary Issuer Information (cont'd.) <CAPTION> - ----------------------------------------------------------------------------------------------------------------------------------- Condensed Consolidating Statement of Cash Flows For the nine months ended September 30, 2001 (in thousands of U.S. dollars) Other ACE ACE INA ACE Financial Limited ACE Limited Holdings, Inc. Services, Inc. Subsidiaries (Parent Co. (Subsidiary (Subsidiary and Consolidating ACE Limited Guarantor) Issuer) Issuer) Eliminations (1) Adjustments (2) Consolidated ---------- ------- ------- ------------ -------------- ------------ <S> <C> <C> <C> <C> <C> <C> Net cash flows from (used for) operating activities $ (8,893) $ (270,099) $ 51,909 $ 1,188,405 $ - $ 961,322 Cash flow from investing activities Purchases of fixed maturities (119,715) (1,245,557) (819,018) (8,730,042) - (10,914,332) Purchases of equity securities - (94,569) - (63,534) - (158,103) Sales of fixed maturities 96,274 1,598,007 664,717 8,012,636 - 10,371,634 Sales of equity securities - 101,501 - 52,370 - 153,871 Maturities of fixed maturities - - 6,500 32,690 - 39,190 Net realized gains (losses) on financial future contracts - - - (44,060) - (44,060) Other investments - (3,876) 68,178 (148,123) - (83,821) ----------------------------------------------------------------------------------------------- Net cash from (used for) investing activities $ (23,441) $ 355,506 $ (79,623) $ (888,063) $ - $ (635,621) ----------------------------------------------------------------------------------------------- Cash flow from financing activities Dividends paid on Ordinary Shares (94,279) - - - - (94,279) Dividends paid on FELINE PRIDES (19,251) - - - - (19,251) Repayment of bank, net - 86,961 - - - 86,961 Advances to affiliates 8,697 (41,861) 41,346 (8,182) - - Proceeds from exercise of options for Ordinary Shares 19,770 - - - - 19,770 Proceeds from shares issued under ESPP 7,063 - - - - 7,063 Repurchase of Ordinary Shares (179,446) - - - - (179,446) Dividends received from 258,691 - - (258,691) - - subsidiaries ----------------------------------------------------------------------------------------------- Net cash from (used for) financing activities $ 1,245 $ 45,100 $ 41,346 $ (266,873) $ - $ (179,182) ----------------------------------------------------------------------------------------------- Net increase (decrease) in cash (31,089) 130,507 13,632 33,469 - 146,519 Cash - beginning of period 46,516 253,447 26,576 281,530 - 608,069 ----------------------------------------------------------------------------------------------- Cash - end of period $ 15,427 $ 383,954 $ 40,208 $ 314,999 $ - $ 754,588 =============================================================================================== - ----------------------------------------------------------------------------------------------------------------------------------- (1) Includes all other subsidiaries of ACE Limited and intercompany eliminations. (2) Includes ACE Limited parent company eliminations. 20
ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd.) (Unaudited) 13. Subsidiary Issuer Information (cont'd.) <CAPTION> - ----------------------------------------------------------------------------------------------------------------------------------- Condensed Consolidating Statement of Cash Flows For the nine months ended September 30, 2000 (in thousands of U.S. dollars) Other ACE ACE INA ACE Financial Limited ACE Limited Holdings, Inc. Services, Inc. Subsidiaries (Parent Co. (Subsidiary (Subsidiary and Consolidating ACE Limited Guarantor) Issuer) Issuer) Eliminations (1) Adjustments (2) Consolidated ---------- ------- ------- ------------ -------------- ------------ <S> <C> <C> <C> <C> <C> <C> Net cash flows from (used for) operating activities $ (24,702) $(1,190,125) $ 53,761 $ 786,548 $ - $ (374,518) ------------------------------------------------------------------------------------------------ Cash flow from investing activities Purchases of fixed maturities (540,524) (1,989,046) (508,808) (5,193,502) - (8,231,880) Purchases of equity securities - (183,369) - (137,971) - (321,340) Sales of fixed maturities 375,910 2,902,872 468,011 4,404,498 - 8,151,291 Sales of equity securities - 408,729 - 280,686 - 689,415 Maturities of fixed maturities - - 2,000 46,890 - 48,890 Net realized gains (losses) on financial futures contracts - - - (8,751) - (8,751) Sale (acquisition) of subsidiaries 82,244 - 10,200 (10,200) (82,244) - Other investments (6,953) 17,322 (2,920) (178,434) - (170,985) ------------------------------------------------------------------------------------------------ Net cash from (used for) investing activities $ (89,323) $ 1,156,508 $ (31,517) $ (796,784) $ (82,244) $ 156,640 ------------------------------------------------------------------------------------------------ Cash flow from financing activities Dividends paid on Ordinary Shares (76,075) - - - - (76,075) Dividends paid on FELINE PRIDES (8,839) - - - - (8,839) Repayment of bank debt, net (424,886) (267,995) - (4,238) - (697,119) Proceeds from issuance of trust preferred securities - 300,000 - - - 300,000 Proceeds from issuance of FELINE PRIDES 311,050 - - - - 311,050 Issuance costs of FELINE PRIDES (9,884) - - - - (9,884) Advances to affiliate (167,320) - - 167,320 - - Proceeds from exercise of options for Ordinary Shares 14,904 - - - - 14,904 Proceeds from shares issued under ESPP 1,234 - - - - 1,234 Capitalization of subsidiary (5,000) - 5,000 - - - Net proceeds from issuance of Ordinary Shares 400,346 - - - - 400,346 Dividends received from subsidiaries 81,147 - - (81,147) - - ------------------------------------------------------------------------------------------------ Net cash from (used for) financing activities $ 116,677 $ 32,005 $ 5,000 $ 81,935 $ - $ 235,617 ------------------------------------------------------------------------------------------------ Net increase (decrease) in cash 2,652 (1,612) 27,244 71,699 (82,244) 17,739 Cash - beginning of period 15,942 282,426 231 300,633 - 599,232 ------------------------------------------------------------------------------------------------ Cash - end of period $ 18,594 $ 280,814 $ 27,475 $ 372,332 $ (82,244) $ 616,971 ================================================================================================ - ----------------------------------------------------------------------------------------------------------------------------------- (1) Includes all other subsidiaries of ACE Limited and intercompany eliminations. (2) Includes ACE Limited parent company eliminations. </TABLE> 21
ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd.) (Unaudited) 14. Segment Information The following tables summarize the operations by segment for the three and nine months ended September 30, 2001 and 2000. For segment reporting purposes, certain items have been presented in a different manner than in the consolidated financial statements. For segment reporting purposes, items considered non-recurring in nature have been aggregated and shown separately net of related taxes, and net realized gains (losses) have been presented net of related taxes. <TABLE> <CAPTION> - ----------------------------------------------------------------------------------------------------------------------------------- Three months ended September 30, 2001 ACE ACE ACE ACE Global Global ACE ACE Financial ACE Bermuda Markets Reinsurance USA International Services Other (1) Consolidated ------- ------- ----------- --- ------------- -------- ----- ------------ (in thousands of U.S. dollars) <S> <C> <C> <C> <C> <C> <C> <C> <C> Operations Data Gross premiums written $ 321,162 $ 219,474 $ 102,361 $ 1,308,049 $ 514,071 $ 37,254 $ - $ 2,502,371 Net premiums written 180,289 86,098 75,821 585,967 341,953 34,939 - 1,305,067 Net premiums earned 281,334 112,412 102,469 515,233 344,091 43,890 - 1,399,429 Losses and loss expenses 478,996 256,787 160,318 426,518 230,926 17,788 - 1,571,333 Policy acquisition costs 5,026 55,470 13,354 55,146 66,296 9,374 - 204,666 Administrative expenses 11,798 18,158 11,917 66,625 68,445 8,265 22,181 207,389 -------------------------------------------------------------------------------------------------------- Underwriting income (loss) (214,486) (218,003) (83,120) (33,056) (21,576) 8,463 (22,181) (583,959) Net investment income 35,882 8,288 15,847 84,541 20,545 25,845 1,961 192,909 Amortization of goodwill (225) 958 3,503 135 - 1,051 14,490 19,912 Interest expense 859 653 - 8,508 - 3,840 35,270 49,130 Income tax expense (benefit) 697 (74,819) - 14,523 3,102 5,516 (18,997) (69,978) -------------------------------------------------------------------------------------------------------- Income (loss) excluding net realized gains (losses) (179,935) (136,507) (70,776) 28,319 (4,133) 23,901 (50,983) (390,114) Net realized gains (losses) (net of income tax) (2,602) 2,808 (5,003) (3,944) 2,214 (20,884) (25,065) (52,476) ------------------------------------------------------------------------------------------------------ Net income (loss) $ (182,537) $ (133,699) $ (75,779) $ 24,375 $ (1,919) $ 3,017 $ (76,048) $ (442,590) ======================================================================================================== Total Assets $ 3,593,375 $2,588,941 $ 1,574,361 $18,017,153 $3,978,797 $2,484,086 $ 2,672,562 $34,909,275 ======================================================================================================== - ----------------------------------------------------------------------------------------------------------------------------------- (1) Includes ACE Limited, ACE INA Holdings and intercompany eliminations. 22
ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd.) (Unaudited) 14. Segment Information (cont'd.) <CAPTION> - ----------------------------------------------------------------------------------------------------------------------------------- Three months ended September 30, 2000 ACE ACE ACE ACE Global Global ACE ACE Financial ACE Bermuda Markets Reinsurance USA International Services Other (1) Consolidated ------- ------- ----------- --- ------------- -------- ----- ------------ (in thousands of U.S. dollars) <S> <C> <C> <C> <C> <C> <C> <C> <C> Operations Data Gross premiums written $ 199,741 $ 239,484 $ 30,750 $ 974,862 $ 496,953 $ 58,026 $ - $ 1,999,816 Net premiums written 181,573 176,672 12,811 450,518 324,779 50,451 - 1,196,804 Net premiums earned 170,292 174,266 37,707 410,472 339,101 42,944 - 1,174,782 Losses and loss expenses 132,701 102,503 5,813 307,692 205,976 18,202 - 772,887 Policy acquisition costs 7,565 44,844 6,180 40,430 59,339 9,900 - 168,258 Administrative expenses 7,494 18,499 2,957 58,631 68,552 7,665 14,114 177,912 -------------------------------------------------------------------------------------------------------- Underwriting income (loss) 22,532 8,420 22,757 3,719 5,234 7,177 (14,114) 55,725 Net investment income 38,906 7,932 15,056 89,599 24,612 24,168 (2,689) 197,584 Amortization of goodwill (225) 965 3,503 135 - 1,051 14,490 19,919 Interest expense 908 1,897 - 11,404 - 3,378 37,821 55,408 Income tax expense (benefit) 655 5,623 - 26,238 4,400 6,403 (15,890) 27,429 -------------------------------------------------------------------------------------------------------- Income (loss) excluding net realized gains (losses) 60,100 7,867 34,310 55,541 25,446 20,513 (53,224) 150,553 Net realized gains (losses) (net of income tax) 7,135 (1,245) (12,433) (5,989) 492 2,030 210 (9,800) -------------------------------------------------------------------------------------------------------- Net income (loss) $ 67,235 $ 6,622 $ 21,877 $ 49,552 $ 25,938 $ 22,543 $ (53,014) $ 140,753 ======================================================================================================== Total Assets $ 3,044,189 $ 1,842,913 $ 1,360,806 $16,454,908 $ 3,804,099 $ 2,289,005 $ 2,736,180 $31,532,100 ======================================================================================================== - ----------------------------------------------------------------------------------------------------------------------------------- (1) Includes ACE Limited, ACE INA Holdings and intercompany eliminations 23
ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd.) (Unaudited) 14. Segment Information (cont'd.) <CAPTION> - ----------------------------------------------------------------------------------------------------------------------------------- Nine months ended September 30, 2001 ACE ACE ACE ACE Global Global ACE ACE Financial ACE Bermuda Markets Reinsurance USA International Services Other(1) Consolidated ------- ------- ----------- --- ------------- -------- ------- ------------ (in thousands of U.S. dollars) <S> <C> <C> <C> <C> <C> <C> <C> <C> Operations Data Gross premiums written $ 894,631 $ 870,847 $ 367,350 $3,293,341 $1,725,948 $ 314,553 $ - $ 7,466,670 Net premiums written 720,109 516,781 327,496 1,505,970 1,133,864 306,610 - 4,510,830 Net premiums earned 782,206 458,615 248,049 1,334,846 1,063,467 266,549 - 4,153,732 Losses and loss expenses 933,967 455,113 245,395 1,011,216 674,048 186,533 - 3,506,272 Policy acquisition costs 14,872 158,157 34,556 134,464 186,455 30,492 - 558,996 Administrative expenses 28,568 52,716 21,542 209,702 197,126 27,079 64,682 601,415 ----------------------------------------------------------------------------------------------------- Underwriting income (loss) (195,201) (207,371) (53,444) (20,536) 5,838 22,445 (64,682) (512,951) Net investment income 113,728 28,575 47,932 256,265 64,291 75,657 7,158 593,606 Amortization of goodwill (675) 2,803 10,508 405 - 3,153 43,470 59,664 Interest expense 888 2,078 - 25,856 - 10,486 113,786 153,094 Income tax expense (benefit) 2,046 (65,384) - 66,856 15,733 15,199 (55,704) (21,254) ----------------------------------------------------------------------------------------------------- Income (loss) excluding net realized gains (losses), non-recurring expenses and cumulative effect (83,732) (118,293) (16,020) 142,612 54,396 69,264 (159,076) (110,849) Non-recurring expenses (net of income tax) - (4,461) - - - - - (4,461) ----------------------------------------------------------------------------------------------------- Income (loss) excluding net realized gains (losses) and cumulative effect (83,732) (122,754) (16,020) 142,612 54,396 69,264 (159,076) (115,310) Net realized gains (losses) (net of income tax) 10,773 5,838 (23,572) (21,422) 977 (2,228) (25,065) (54,699) ----------------------------------------------------------------------------------------------------- Income (loss) excluding cumulative effect of adopting a new accounting standard (72,959) (116,916) (39,592) 121,190 55,373 67,036 (184,141) (170,009) Cumulative effect of adopting a new accounting standard (net of income tax) - 510 470 (50) - (23,600) - (22,670) ----------------------------------------------------------------------------------------------------- Net income (loss) $ (72,959) $ (116,406) $ (39,122) $ 121,140 $ 55,373 $ 43,436 $ (184,141) $ (192,679) ----------------------------------------------------------------------------------------------------- Total Assets $3,593,375 $2,588,941 $1,574,361 $18,017,153 $3,978,797 $2,484,086 $2,672,562 $34,909,275 ===================================================================================================== - ----------------------------------------------------------------------------------------------------------------------------------- (1) Includes ACE Limited, ACE INA Holdings and intercompany eliminations 24
ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd.) (Unaudited) 14. Segment Information (cont'd.) <CAPTION> - ----------------------------------------------------------------------------------------------------------------------------------- Nine months ended September 30, 2000 ACE ACE ACE ACE Global Global ACE ACE Financial ACE Bermuda Markets Reinsurance USA International Services Other(1) Consolidated ------- ------- ----------- --- ------------- -------- ------- ------------ (in thousands of U.S. dollars) <S> <C> <C> <C> <C> <C> <C> <C> <C> Operations Data Gross premiums written $510,788 $752,791 $178,223 $2,662,542 $1,553,853 $288,646 $ - $5,946,843 Net premiums written 446,297 551,140 146,265 1,369,785 1,080,317 273,907 - 3,867,711 Net premiums earned 356,164 454,599 96,061 1,256,043 1,037,411 247,146 - 3,447,424 Losses and loss expenses 265,001 258,271 17,476 938,782 613,942 163,009 - 2,256,481 Policy acquisition costs 14,648 119,577 17,877 118,498 173,462 38,566 - 482,628 Administrative expenses 22,278 54,069 7,806 188,552 211,589 23,705 46,785 554,784 ------------------------------------------------------------------------------------------------------- Underwriting income (loss) 54,237 22,682 52,905 10,211 38,418 21,866 (46,785) 153,531 Net investment income 111,240 23,420 44,839 251,542 69,498 71,002 (9,993) 561,548 Amortization of goodwill (658) 2,990 10,508 405 - 3,154 42,490 58,889 Interest expense 1,598 4,080 - 28,009 - 10,016 122,841 166,544 Income tax expense (benefit) 1,920 11,068 (173) 72,992 19,235 15,664 (48,725) 71,981 ------------------------------------------------------------------------------------------------------- Income (loss) excluding net realized gains (losses) 162,617 27,964 87,409 160,347 88,681 64,034 (173,384) 417,665 Net realized gains (losses) (net of income tax) 31,432 (2,194) (20,378) (16,834) 19,779 1,565 (1,841) 11,529 ------------------------------------------------------------------------------------------------------- Net income (loss) $194,049 $25,770 $67,031 $143,513 $108,460 $65,599 $(175,225) $429,194 ------------------------------------------------------------------------------------------------------- Total Assets $3,044,189 $1,842,913 $1,360,806 $16,454,908 $3,804,099 $2,289,005 $2,736,180 $31,532,100 ======================================================================================================= - ----------------------------------------------------------------------------------------------------------------------------------- (1) Includes ACE Limited, ACE INA Holdings and intercompany eliminations 25
<CAPTION> ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd.) (Unaudited) 14. Segment Information (cont'd.) The following tables summarize the revenues of each segment by product offering for the three and nine months ended September 30, 2001 and 2000. - ------------------------------------------------------------------------------------------------------------------ Net premiums earned by type of premium Three months ended September 30, 2001 - ------------------------------------- Property & Life & Financial ACE Casualty Health Products Consolidated -------- ------ -------- ------------ (in thousands of U.S. dollars) <S> <C> <C> <C> <C> ACE Bermuda $ 39,742 $ - $ 241,592 $ 281,334 ACE Global Markets 107,854 4,558 - 112,412 ACE Global Reinsurance 70,293 32,176 - 102,469 ACE USA 371,920 - 143,313 515,233 ACE International 220,991 121,211 1,889 344,091 ACE Financial Services - - 43,890 43,890 ------------- ------------- ------------ ------------- Net premiums earned $ 810,800 $ 157,945 $ 430,684 $ 1,399,429 ============= ============= ============ ============= Three months ended September 30, 2000 - ------------------------------------- Property & Life & Financial ACE Casualty Health Products Consolidated -------- ------ -------- ------------ (in thousands of U.S. dollars) ACE Bermuda $ 114,685 $ - $ 55,607 $ 170,292 ACE Global Markets 168,231 6,035 - 174,266 ACE Global Reinsurance 37,707 - - 37,707 ACE USA 395,798 - 14,674 410,472 ACE International 239,846 99,255 - 339,101 ACE Financial Services - - 42,944 42,944 ------------- ------------- ------------ ------------- Net premiums earned $ 956,267 $ 105,290 $ 113,225 $ 1,174,782 ============= ============= ============ ============= - ------------------------------------------------------------------------------------------------------------------ 26
<CAPTION> ACE LIMITED AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (cont'd.) (Unaudited) 14. Segment Information (cont'd.) - ------------------------------------------------------------------------------------------------------------------ Net premiums earned by type of premium Nine months ended September 30, 2001 - ------------------------------------ Property & Life & Financial ACE Casualty Health Products Consolidated -------- ------ -------- ------------ (in thousands of U.S. dollars) <S> <C> <C> <C> <C> ACE Bermuda $ 132,919 $ - $ 649,287 $ 782,206 ACE Global Markets 445,702 12,913 - 458,615 ACE Global Reinsurance 184,894 63,155 - 248,049 ACE USA 1,128,887 - 205,959 1,334,846 ACE International 696,537 359,331 7,599 1,063,467 ACE Financial Services - - 266,549 266,549 ------------ ------------- ------------- ------------- Net premiums earned $ 2,588,939 $ 435,399 $ 1,129,394 $ 4,153,732 ============ ============= ============= ============= Nine months ended September 30, 2000 - ------------------------------------ Property & Life & Financial ACE Casualty Health Products Consolidated -------- ------ -------- ------------ (in thousands of U.S. dollars) ACE Bermuda $ 225,019 $ - $ 131,145 $ 356,164 ACE Global Markets 412,380 42,219 - 454,599 ACE Global Reinsurance 96,062 - - 96,062 ACE USA 1,054,464 - 201,578 1,256,042 ACE International 695,503 341,908 - 1,037,411 ACE Financial Services - - 247,146 247,146 ------------- ------------- ------------ -------------- Net premiums earned $ 2,483,428 $ 384,127 $ 579,869 $ 3,447,424 ============= ============= ============ ============== - ------------------------------------------------------------------------------------------------------------------ </TABLE> 27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following is a discussion of the Company's results of operations, financial condition, liquidity and capital resources as of and for the three and nine months ended September 30, 2001. The results of operations and cash flows for any interim period are not necessarily indicative of results for the full year. This discussion should be read in conjunction with the consolidated financial statements, related notes thereto and the Management's Discussion and Analysis of Results of Operations and Financial Condition included in the Company's Annual Report on Form 10-K for the year ended December 31, 2000. Safe Harbor Disclosure The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Any written or oral statements made by or on behalf of the Company may include forward-looking statements which reflect the Company's current views with respect to future events and financial performance. These forward-looking statements are subject to certain uncertainties and other factors that could cause actual results to differ materially from such statements. These uncertainties and other factors (which are described in more detail elsewhere herein and in other documents filed by the Company with the Securities and Exchange Commission) include, but are not limited to: (i) the impact of the September 11th tragedy and its aftermath on ACE's insureds and reinsureds, on the insurance and reinsurance industry and on the economy in general and uncertainties relating to governmental responses to the tragedy, (ii) the ability to collect reinsurance recoverables and any delays with respect thereto, (iii) the occurrence of catastrophic events or other insured or reinsured events with a frequency or severity exceeding the Company's estimates, (iv) the uncertainties of the loss reserving process, including the difficulties associated with assessing environmental damage and latent injuries, (v) uncertainties relating to government and regulatory policies such as subjecting the Company to insurance regulation or taxation in additional jurisdictions or amending, revoking or enacting any laws, regulations or treaties affecting the Company's current operations and other legal, regulatory and legislative developments, (vi) the actual amount of new and renewal business and market acceptance of the Company's products, (vii) risks associated with the introduction of new products and services, (viii) the competitive environment in which the Company operates, related trends and associated pricing pressures, market perception, and developments, (ix) the impact of mergers and acquisitions, competing demands for ACE's capital and the risk of undisclosed liabilities, (x) developments in global financial markets, which could affect the Company's investment portfolio and financing plans, (xi) changing rates of inflation and other economic conditions, (xii) losses due to foreign currency exchange rate fluctuations, (xiii) loss of the services of any of the Company's executive officers, (xiv) the ability of technology to perform as anticipated, (xv) the amount of dividends received from subsidiaries, and, (xvi) management's response to these factors. The words "believe", "anticipate", "estimate", "project", "plan", "expect", "intend", "hope", "will likely result" or "will continue" and variations thereof and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. The Company undertakes no obligation to publicly update or review any forward-looking statements, whether as a result of new information, future events or otherwise. 28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) General The Company, through its various subsidiaries, provides a broad range of insurance and reinsurance for a diverse group of customers worldwide. ACE operates through six business segments: ACE Bermuda, ACE Global Markets, ACE Global Reinsurance, ACE USA, ACE International and ACE Financial Services. On July 2, 1999, the Company, through a U.S. holding company, ACE INA Holdings, Inc. ("ACE INA"), acquired CIGNA Corporation's domestic property and casualty insurance operations including its run-off business and also its international property and casualty insurance companies and branches, including most of the accident and health business written through those companies for $3.45 billion in cash (the "ACE INA Acquisition"). On December 30, 1999, the Company acquired Capital Re Corporation, which is engaged in the financial guaranty reinsurance business. Following the acquisition, Capital Re Corporation was renamed ACE Financial Services, Inc. Under the terms of the acquisition agreement, the Company paid aggregate consideration of $110.3 million in cash and issued approximately 20.8 million ACE Ordinary Shares. The Company expects to continue evaluating potential new product lines and other opportunities in the insurance and reinsurance markets. In addition, the Company evaluates potential acquisitions of other companies and businesses and holds discussions with potential acquisition candidates. As a general rule, the Company publicly announces such acquisitions only after a definitive agreement has been reached. September 11th, 2001 Tragedy The terrorist attacks on September 11, 2001 ("the September 11th tragedy") resulted in the largest insured loss in history and had a substantial impact on the results of the Company. Detailed below is an analysis, by operating segment, of the impact of the September 11th tragedy on the Company's statement of operations for the three months and nine months ended September 30, 2001. The analysis of the impact of the September 11th tragedy includes the effects of intercompany reinsurance transactions. As noted, the Company's net income was reduced by $559 million on an after tax basis. In estimating the impact of the tragedy on the Company, premium payments required to reinstate reinsurance policies have been accrued. Premiums from insureds required to reinstate their insurance or reinsurance coverage with the Company have not been accrued in the estimate. The premiums accrued in ACE Bermuda represent additional premiums due under the terms of certain financial solutions reinsurance programs directly impacted by the tragedy. <TABLE> <CAPTION> Impact of September 11, 2001 Tragedy Three months and nine months ended September 30, 2001 (in millions of U.S. dollars) ACE ACE ACE ACE Global Global ACE Inter- ACE Bermuda Markets Reinsurance USA national Consolidated ------- ------- ----------- --- -------- ------------ <S> <C> <C> <C> <C> <C> <C> Operations Data: Gross premiums written $ 142 $ (20) $ - $ - $ - $ 122 Net premiums written 139 (66) 2 (18) (5) 52 Net premiums earned 100 (66) 3 (18) (5) 14 Losses and loss expenses 342 140 122 28 18 650 Policy acquisition costs - - 1 - - 1 ------------- ------------ ------------ ------------ ------------- ------------ Underwriting income (242) (206) (120) (46) (23) (637) Income tax benefit - (62) - (16) - (78) ------------- ------------ ------------ ------------ ------------- ------------ Net loss $ (242) $ (144) $ (120) $ (30) $ (23) $ (559) ============= ============ ============ ============ ============= ============ </TABLE> 29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) Prior to the September 11th tragedy, the Company was operating in an environment where insurance and reinsurance rates were increasing. For the nine months ended September 30, 2001, gross and net premiums written have increased by 26 percent and 17 percent, respectively. As a result of the tragedy, the changes in the insurance and reinsurance industry have accelerated. Prices are increasing, available capacity has reduced, and coverage along with policy terms and conditions are changing. Changes in industry conditions will be discussed where relevant in the segment discussions. In line with the industry, ACE is benefiting from price increases in most lines of business. In certain areas, at times, the Company is reducing the gross capacity it offers to insureds as reinsurance prices increase and available capacity reduces. The Company is also assessing the amount of gross and net capacity offered in lines of business where price increases have not been commensurate with its assessment of risk. However, the Company expects it will increase its net retention in other areas. In addition, the Company is assessing its exposure to terrorism related risks and, where considered necessary, has and will continue to take steps to reduce or eliminate these risks from its insurance portfolios. <TABLE> <CAPTION> Results of Operations - Three Months Ended September 30, 2001 and 2000 Net income (loss) Three Months Ended September 30 2001 2000 ---- ---- (in millions of U.S. dollars) <S> <C> <C> Income (loss) excluding net realized losses on investments $ (390) $ 151 Net realized losses on investments (net of income tax) (52) (10) --------- --------- Net income (loss) $ (442) $ 141 ========= ========= </TABLE> The Company incurred a loss excluding net realized losses on investments of $390 million for the quarter ended September 30, 2001 compared with income of $151 million for the quarter ended September 30, 2000. This decrease is primarily due to losses incurred as a result of the September 11th tragedy, which adversely impacted the Company's earnings and reduced net income by $559 million after tax. Excluding the impact of the September 11th tragedy, income excluding net realized losses on investments, would have been $169 million for the current quarter, an increase of 12 percent compared with the same quarter last year. Net realized losses on investments (net of income tax) were $52 million for the quarter ended September 30, 2001, compared with net realized losses of $10 million for the quarter ended September 30, 2000. The net realized losses were primarily the result of losses on financial futures and option contracts, certain "other" investments as well as FAS 133 fair value adjustments on derivatives. As discussed later in this report, the Company implemented FAS 133 on January 1, 2001, which requires that all derivatives be recognized as either assets or liabilities in the consolidated balance sheet and measured at fair value. The change in fair value for the quarter ended September 30, 2001, as a result of FAS 133, was a pre-tax loss of $29 million and is reflected in net realized gains (losses) on investments. 30
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) Premiums Three Months Ended Percentage September 30 Change From 2001 2000 Prior Year ---- ---- ---------- (in millions of U.S. dollars) Gross premiums written: ACE Bermuda $ 321 $ 200 61% ACE Global Markets 220 239 (8) ACE Global Reinsurance 102 31 233 ACE USA 1,308 975 34 ACE International 514 497 3 ACE Financial Services 37 58 (36) ---------- ---------- -------- Consolidated $ 2,502 $ 2,000 25% ========== ========== ======== Net premiums written: ACE Bermuda $ 180 $ 182 (1)% ACE Global Markets 86 177 (51) ACE Global Reinsurance 76 13 492 ACE USA 586 450 30 ACE International 342 325 5 ACE Financial Services 35 50 (31) ---------- ---------- -------- Consolidated $ 1,305 $ 1,197 9% ========== ========== ======== Net premiums earned: ACE Bermuda $ 281 $ 170 65% ACE Global Markets 112 174 (35) ACE Global Reinsurance 103 38 172 ACE USA 515 411 26 ACE International 344 339 1 ACE Financial Services 44 43 2 ---------- ---------- -------- Consolidated $ 1,399 $ 1,175 19% ========== ========== ======== For the quarter ended September 30, 2001, gross premiums written increased by $502 million to $2.5 billion compared with $2 billion for the quarter ended September 30, 2000. Included in the increase are $122 million of gross premiums written in connection with the September 11th tragedy. ACE Bermuda recorded $142 million of gross premiums written on certain of its financial solutions reinsurance contracts related to the September 11th tragedy which was offset by return premiums of $20 million recorded by ACE Global Markets. Excluding the impact of the September 11th tragedy, gross premiums written increased by $381 million or 19 percent compared with the same quarter last year. New business opportunities in ACE Global Reinsurance, ACE International and ACE Financial Services, continued market improvements in the U.S. and the continued global recovery of insurance pricing resulted in the growth in gross premiums written again this quarter. Net premiums written as well as net premiums earned benefited from the same factors that led to the increase in gross premiums written. Net premiums written increased by $108 million and net premiums earned increased by $224 million compared with the same quarter last year. Excluding the impact of the September 11th tragedy, net premiums written would have increased by $56 million or 5 percent and net premiums earned would have increased by $210 million or 18 percent, compared with the quarter ended September 30, 2000. 31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) ACE Bermuda: Gross premiums written for the quarter ended September 30, 2001, increased by $121 million to $321 million compared with the same quarter last year. This increase is primarily due to the September 11th tragedy, which resulted in additional premiums of $142 million as previously explained. Excluding this event, the gross premiums written decreased by $21 million to $179 million compared to the quarter ended September 30, 2000. The financial solutions division, political risk and excess liability showed growth during the quarter which was offset by declines in business written by the aviation and satellite business. As disclosed in prior filings, the ACE Bermuda aviation business was moved to ACE Global Markets and a large part of the satellite business written by ACE Bermuda was moved to ACE USA. Excess liability and excess property had solid premium growth rates, even before the September 11th tragedy. Since that time the increase in rates has accelerated with increases in the region of 20 to 50 percent. Net premiums written for the quarter ended September 30, 2001 decreased compared with the same quarter last year. Excluding the September 11th tragedy, net premiums written would have decreased by $141 million or 77 percent, due to reinsurance ceded on the financial solutions program, the decline in aviation and satellite business and to a one-time professional lines contract written in 2000. The increase in net premiums earned of $111 million is primarily attributable to the immediate earning of the additional premiums written with respect to the September 11th tragedy. ACE Global Markets: Gross premiums written for the quarter ended September 30, 2001 decreased by $19 million to $220 million compared with the same quarter last year. Excluding the September 11th tragedy, gross premiums written would have been $240 million for the current quarter compared with $239 million for the same quarter last year. ACE Global Markets accelerated its reporting to a current basis from a quarter in arrears in the March 2000 quarter. On a comparable basis, excluding the impact of the September 11th tragedy, gross premiums written increased by 10 percent. The underlying increase is primarily the result of a continued hardening in the London market and to a lesser extent an increase in the Company's participation in the Lloyd's syndicate it manages. As a result of the September 11th losses, the focus at ACE Global Markets will be on aviation, marine, property, energy and financial institutions business. The Company believes that adequate reinsurance protection has been secured by ACE going forward to complement this strategy. An immediate impact of the terrorist attacks was an increase in reinsurance costs for ACE Global Markets due to the resulting reinstatement premiums, which has reduced net premiums written and earned. Net premiums written and earned for the quarter decreased by $91 million and $62 million, respectively, compared with the same quarter last year, with $66 million being attributable to the reinstatement premiums. The remainder of the decrease in net premiums written is the result of a combination of relatively static premium levels combined with a trend of increased reinsurance costs. ACE Global Reinsurance: Gross premiums written for the quarter ended September 30, 2001, increased by $71 million to $102 million compared with the same quarter last year. As with the previous quarter, this significant increase is a reflection of the improved pricing in the international property catastrophe reinsurance marketplace, together with the continuing development of the life and U.S. property and casualty reinsurance businesses. The new life reinsurance business contributed $32 million and the new U.S. property and casualty reinsurance business contributed $17 million to gross premiums written this quarter. The improved property catastrophe reinsurance market conditions resulted in an increase of $22 million compared to the third quarter of 2000. The U.S. property and casualty reinsurance unit has seen price increases of 25 to 50 percent following the September 11th tragedy. Net premiums written for the quarter ended September 30, 2001, increased by $63 million to $76 million compared with the same quarter last year. This increase is primarily due to the new life reinsurance business and the higher property and casualty production levels experienced. Net premiums earned for the quarter ended September 30, 2001, increased by $65 million to $103 million compared with the same quarter last year. This increase is primarily due to higher production resulting from improved property and casualty market conditions experienced since the latter half of fiscal 2000 and growth in the new lines of business. 32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) ACE USA: Gross premiums written for the quarter ended September 30, 2001, increased by $333 million to $1.3 billion compared with the same quarter last year. Most of the operating divisions achieved premium growth in the quarter, with the majority of the increase due to special risk facilities ("SRF"), Westchester Specialty, financial solutions and the property division. Market conditions continue to be very favorable in the U.S. and growth and price increases were especially strong in Westchester Specialty's property segment and in U.S. International business. Financial solutions generated a $124 million increase in gross premiums written during the quarter. ACE USA's current expansion in professional risk is continuing to show growth primarily in the directors and officers liability and errors and omissions segments. Net premiums written for the quarter ended September 30, 2001, increased by $136 million to $586 million in comparison to the same quarter last year. This increase, with the exception of SRF, mainly follows the increases in gross premiums written. Much of SRF's current quarter growth was in its more heavily ceded business segments resulting in somewhat flat net premiums written over the prior year quarter. Financial solutions accounted for $113 million of the increase from the prior year. Excluding financial solutions, ACE USA's net premiums written increased by 5 percent over the same period last year and including financial solutions, net premiums written increased by 30 percent. Net premiums written and earned during the current quarter were reduced by $18 million due to reinstatement premiums associated with the September 11th tragedy. Net premiums earned for the quarter ended September 30, 2001, increased by $104 million to $515 million compared with the same quarter last year. Financial solutions accounted for much of the increase. Westchester Specialty, with new business and substantial price increases added $23 million in earned premium over the prior year. These increases helped offset the impact from declines in the premium from several lines of business that are in run-off and had contributed to earned premiums in the prior year quarter. The run-off lines of business include forced placement mortgage and other unprofitable lines of business discontinued subsequent to the acquisition. ACE International: Gross premiums written for the quarter ended September 30, 2001, increased by $17 million to $514 million compared with the same quarter last year. This increase is primarily due to an increase in the accident and health business, new business opportunities and price increases in Europe. The accident and health business contributed 25 percent of gross premiums written by ACE International during the current quarter. The continuing devaluation of the major currencies partially offset the increase described above. Net premiums written for the quarter ended September 30, 2001, increased by $17 million to $342 million compared with the same quarter last year. The accident and health business contributed $7 million of this increase. Net premiums earned for the quarter ended September 30, 2001, increased by $5 million to $344 million compared with the same quarter last year. The increases are due to the same influences described above for gross premiums written. ACE Financial Services: Gross premiums written for the quarter ending September 30, 2001, decreased by $21 million to $37 million, compared with the same quarter last year. The decrease is attributable to a multi-year reinsurance program put in place during the quarter at ACE Guaranty Re. This decrease was partially offset by growth from new business in the life, accident and health line of business, which completed two transactions in the third quarter, as well as an increase in swap and structured finance business. Net premiums written for the quarter ending September 30, 2001, decreased by $15 million to $35 million, compared with the same quarter last year. The decrease is attributable to a multi-year reinsurance program put in place during the quarter at ACE Guaranty Re. Net premiums earned for the quarter ending September 30, 2001, increased by $1 million to $44 million, compared with the same quarter last year. The growth is primarily due to an increase in premiums earned in the structured finance, non-municipal, credit and swap lines of business, which was offset by an increase in ceded earned premium from the ACE Bermuda retrocession. 33
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) Underwriting Results The underwriting results of a property and casualty insurer are discussed frequently by reference to its combined ratio, loss and loss expense ratio and underwriting and administrative expense ratio. Each ratio is derived by dividing the relevant expense amounts by net premiums earned. The combined ratio is the sum of the loss and loss expense ratio and the underwriting and administrative expense ratio. A combined ratio under 100 percent indicates underwriting income and a combined ratio exceeding 100 percent indicates underwriting losses. Three Months Ended September 30 2001 2000 ---- ---- Loss and loss expense ratio ACE Bermuda 170.2% 77.9% ACE Global Markets 228.4 58.8 ACE Global Reinsurance 185.8 15.4 ACE USA 82.8 75.0 ACE International 67.1 60.7 ACE Financial Services 40.5 42.4 Consolidated 112.7% 65.8% Underwriting and administrative expense ratio ACE Bermuda 6.0% 8.9% ACE Global Markets 65.5 36.3 ACE Global Reinsurance 33.1 24.3 ACE USA 23.6 24.1 ACE International 39.2 37.8 ACE Financial Services 40.2 40.9 Consolidated 30.0% 29.4% Combined Ratio ACE Bermuda 176.2% 86.8% ACE Global Markets 293.9 95.1 ACE Global Reinsurance 218.9 39.7 ACE USA 106.4 99.1 ACE International 106.3 98.5 ACE Financial Services 80.7 83.3 Consolidated 142.7% 95.2% The Company establishes reserves for unpaid losses and loss expenses, which are estimates of future payments of reported and unreported claims for losses and related expenses, with respect to insured events that have occurred. The process of establishing reserves for property and casualty claims continues to be a complex and imprecise process, requiring the use of informed estimates and judgments. The Company's estimates and judgments may be revised as additional experience and other data becomes available and are reviewed, as new or improved methodologies are developed or as current laws or regulations change. Any such revisions could result in future changes in estimates of losses or reinsurance recoverable, and would be reflected in the Company's results of operations in the period in which the estimates are changed. In addition, catastrophe losses may have a significant effect on the insurance and reinsurance industry. ACE Global Reinsurance and other segments of the group have exposure to windstorm, hail, earthquake and other catastrophic events, all of which are managed using measures including underwriting controls, occurrence caps as well as modeling, monitoring and managing its accumulations of potential losses across the group. The Company uses its retrocessional programs to limit its net losses from catastrophes. However, property catastrophe loss experience is generally characterized as low frequency but high severity short-tail claims, which may result in volatility in financial results. The ratios presented above exclude the life reinsurance contracts written by the ACE Global Reinsurance segment as combined ratios are not an appropriate measure of life reinsurance business. 34
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) As previously discussed, the September 11th tragedy had a substantial impact on the Company's results and increased losses and loss expenses by $650 million. As a result, the loss and loss expense ratio increased to 112.7 percent from 65.8 percent for the same quarter last year. Excluding the September 11th tragedy the loss and loss expense ratio would have been 65.9 percent. ACE Bermuda: The loss and loss expense ratio increased to 170.2 percent for the quarter ended September 30, 2001, from 77.9 percent for the same quarter last year. The increase is the result of the September 11th tragedy. Excluding the tragedy, the ratio would have been 75.7 percent. The small decline from the prior year is due to the change in business mix. ACE Global Markets: The loss and loss expense ratio increased to 228.4 percent for the quarter ended September 30, 2001, compared with 58.8 percent for the same quarter last year. Again, the increase is the result of the September 11th tragedy as well as additional losses incurred in the RGB syndicate that is in run-off. Excluding the September 11th tragedy and the RGB losses, the loss and loss expense ratio would have been 65.2 percent for the quarter ended September 30, 2001. ACE Global Reinsurance: The loss and loss expense ratio, which excludes life reinsurance contracts, was 185.8 percent for the quarter ended September 30, 2001, compared with 15.4 percent for the same quarter last year. Excluding the September 11th tragedy, the loss and loss expense ratio would have been 12.8 percent for the current quarter, reflecting very little loss activity. There was no significant loss activity in the same quarter last year. ACE USA: The loss and loss expense ratio increased to 82.8 percent for the quarter ended September 30, 2001, from 75 percent for the quarter ended September 30, 2000. This increase is related to the September 11th tragedy. Excluding this event, the loss and loss expense ratio would have been 74.7 percent for the current quarter. ACE International: The loss and loss expense ratio for the quarter ended September 30, 2001, increased to 67.1 percent from 60.7 percent for the same quarter last year. Excluding the September 11th tragedy, the loss and loss expense ratio would have been 61 percent for the current quarter. ACE Financial Services: The loss and loss expense ratio decreased to 40.5 percent for the quarter ended September 30, 2001, from 42.4 percent for the quarter ended September 30, 2000. The decrease is primarily due to lower incurred losses in the life, accident and health, trade credit and title lines. Underwriting and Administrative Expense Underwriting and administrative expenses are comprised of the amortization of deferred policy acquisition costs, which include commissions, premium taxes, underwriting and other costs that vary with and are primarily related to the production of premium, and administrative expenses which include all other operating costs. The underwriting and administrative expense ratio increased slightly to 30 percent for the quarter ended September 30, 2001, from 29.4 percent for the quarter ended September 30, 2000. The ratio excludes life reinsurance contracts written by the ACE Global Reinsurance segment as combined ratios are not an appropriate measure of life reinsurance business. ACE Bermuda: The underwriting and administrative expense ratio decreased to 6 percent for the quarter ended September 30, 2001, from 8.9 percent for the quarter ended September 30, 2000. This decrease is primarily the result of an increase in premiums earned on certain financial solutions reinsurance programs, primarily resulting from the September 11th tragedy. ACE Global Markets: The underwriting and administrative expense ratio increased to 65.5 percent for the quarter ended September 30, 2001, from 36.3 percent for the quarter ended September 30, 2000. Excluding the September 11th tragedy the ratio would have been 41.2 percent. The increase is due to higher policy acquisition costs on business assumed. 35
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) ACE Global Reinsurance: The underwriting and administrative expense ratio increased to 33.1 percent for the quarter ended September 30, 2001, from 24.3 percent for the quarter ended September 30, 2000. This increase is primarily the result of increased administrative costs incurred in the current quarter partially offset by a higher earned premium base. ACE USA: The underwriting and administrative expense ratio decreased slightly to 23.6 percent for the current quarter, from 24.1 percent for the same quarter last year. The decline is primarily the result of consistent acquisition and general and administrative expense increases in relation to the increase in earned premiums. This decrease was offset by a reduction of the earned premium base due to the September 11th tragedy. Excluding the September 11th tragedy, the underwriting and administrative expense ratio for the current quarter would have been 22.8 percent. ACE International: The underwriting and administrative expense ratio increased to 39.2 percent for the current quarter compared with 37.8 percent for the same quarter last year. This change is primarily the result of an increase in solicitation-related expenses on the accident and health business. ACE Financial Services: The underwriting and administrative expense ratio decreased to 40.2 percent for the quarter ended September 30, 2001, from 40.9 percent for the quarter ended September 30, 2000. The decrease is due primarily to a greater portion of the business being from the structured finance, life, accident and health and swap lines, which typically have lower ceding commissions than the other lines of business. Net Investment Income Three Months Ended Percentage September 30 Change from 2001 2000 Prior Year ---- ---- ----------- (in millions of U.S. dollars) ACE Bermuda $ 36 $ 39 (8)% ACE Global Markets 8 8 - ACE Global Reinsurance 16 15 4 ACE USA 84 90 (6) ACE International 21 25 (17) ACE Financial Services 26 24 7 Other (1) 2 (3) N.M. ---------- ---------- --------- Total net investment income $ 193 $ 198 (2)% ========== ========== ========= (1) Includes ACE Limited, ACE INA Holdings and intercompany eliminations. N.M. not meaningful Net investment income decreased by $5 million to $193 million for the quarter ended September 30, 2001, from $198 million for the quarter ended September 30, 2000. The primary reason for this change was a declining interest rate environment and a higher cash position, held for liquidity purposes, which generated a lower yield than the invested assets. ACE Bermuda: Net investment income decreased by $3 million to $36 million for the quarter ended September 30, 2001, compared with the quarter ended September 30, 2000. Although the asset base has increased compared with last year, investment income has decreased primarily due to declining interest rates. ACE Global Markets: Net investment income was unchanged for the quarter ended September 30, 2001, compared with the quarter ended September 30, 2000. Additional income generated from increased syndicate participation was offset by declining interest rates. ACE Global Reinsurance: Net investment income for the quarter ended September 30, 2001, increased slightly to $16 million. This is primarily the result of increases in investable assets arising from positive operating cash flows. ACE USA: Net investment income decreased by $6 million to $84 million for the quarter ended September 30, 2001, compared with the quarter ended September 30, 2000. This decline is primarily the result of a lower invested asset base in the current year due to the run-off of its discontinued operations. 36
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) ACE International: Net investment income decreased by $4 million to $21 million for the quarter ended September 30, 2001, compared with the quarter ended September 30, 2000. This decrease is primarily the result of foreign currency devaluations and lower investable assets. ACE Financial Services: Net investment income increased by $2 million to $26 million for the quarter ended September 30, 2001, compared with the quarter ended September 30, 2000. The invested portfolio increased due to positive cash flows, but this was offset partially by declining interest rates during 2001. Net Realized Gains (Losses) on Investments Three Months Ended September 30 2001 2000 ---- ---- (in millions of U.S. dollars) Fixed maturities and short-term investments $ 12 $(16) Equity securities 9 7 Financial futures and option contracts (26) (2) Other investments (23) (3) FAS 133 (29) - Currency (2) 1 ----------- -------- Total net realized losses on investments $ (59) $(13) =========== ======== The Company's investment strategy takes a long-term view and the portfolio is actively managed to maximize total return within certain specific guidelines, which minimize risk. The portfolio is reported at fair value. The effect of market movements on the investment portfolio will directly impact net realized gains (losses) on investments when securities are sold. Changes in unrealized gains and losses, which result from the revaluation of securities held, are reported as a separate component of accumulated other comprehensive income. The Company uses foreign currency forward and option contracts to minimize the effect of fluctuating foreign currencies on the value of non-U.S. dollar holdings currently held in the portfolio not specifically targeted to match the currency of liabilities. The contracts used are not designated as specific hedges and therefore, realized and unrealized gains and losses recognized on these contracts are recorded as a component of net realized gains (losses) in the period in which the fluctuations occur, together with net foreign currency gains (losses) recognized when non-U.S. dollar securities are sold. Sales proceeds for fixed maturity securities were generally higher than their amortized cost during the quarter. This resulted in net realized gains of $12 million being recognized on fixed maturities and short-term investments for the quarter ended September 30, 2001. Sales proceeds for equity securities were generally higher than their cost during the quarter. This resulted in net realized gains of $9 million being recognized on equity investments for the quarter ended September 30, 2001, compared with net realized gains of $7 million for the quarter ended September 30, 2000. Certain of the Company's external managers of fixed income securities use fixed income futures contracts to manage duration exposure; losses of $1 million were recognized on these for the quarter ended September 30, 2001. Net realized losses generated by the Company's equity index futures contracts amounted to $25 million for the quarter ended September 30, 2001 and are a result of the decline in equity markets during the period. Total net realized losses attributable to the financial futures and option contracts for the quarter ended September 30, 2001, amounted to $26 million, compared with net realized losses of $2 million for the quarter ended September 30, 2000. Other investments had a loss of $23 million primarily because the Company wrote down the value of an investment by $28 million during the current quarter. 37
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) The Company implemented FAS 133 on January 1, 2001, which requires that all derivatives be recognized as either assets or liabilities in the consolidated balance sheet and measured at fair value. The change in fair value for the quarter ended September 30, 2001, as a result of FAS 133, was a loss of $29 million. The level of such gains and losses is dependent upon a number of factors including changes in interest rates, credit spreads and other market factors. The September 11th tragedy increased credit spreads resulting in losses for the quarter. Other Expenses Three Months Ended Percentage September 30 Change 2001 2000 From Prior Year ---- ---- --------------- (in millions of U.S. dollars) Amortization of Goodwill $ 20 $ 20 - ======= ======= ======= Interest expense $ 49 $ 55 (11%) ======= ======= ======= Income tax expense (benefit) $ (76) $ 24 N.M. ======= ======= ======= N.M.- Not Meaningful Interest expense decreased by $6 million to $49 million for the quarter ended September 30, 2001, from $55 million for the quarter ended September 30, 2000. The decrease results from lower interest rates on both the short-term instruments and on the ACE INA RHINO preferred securities. The Company recorded an income tax benefit of $76 million for the quarter ended September 30, 2001 compared with an expense of $24 million for the quarter ended September 30, 2000. This decrease was due primarily to the tax benefit of $78 million generated as a result of the net loss incurred for the quarter. <TABLE> <CAPTION> Results of Operations - Nine Months Ended September 30, 2001 and 2000 Net income (loss) Nine Months Ended September 30 2001 2000 ---- ---- (in millions of U.S. dollars) <S> <C> <C> Income (loss) excluding net realized gains (losses) on investments, non-recurring expenses and cumulative effect $ (111) $ 418 Non-recurring expenses (net of income tax) (4) - Net realized gains (losses) on investments (net of income tax) (55) 11 Cumulative effect of adopting a new accounting standard (net of income tax) (23) - ---------- -------- Net income (loss) $ (193) $ 429 ========== ======== </TABLE> The Company incurred a loss excluding net realized gains (losses) on investments, non-recurring expenses and the cumulative effect of adopting a new accounting standard of $111 million for the nine months ended September 30, 2001, compared with income of $418 million for the nine months ended September 30, 2000. This decrease is primarily due to the September 11th tragedy, which adversely impacted the Company's earnings and reduced net income by $559 million after tax. Excluding the impact of the September 11th tragedy, income for the current nine month period excluding net realized gains (losses) on investments, non-recurring expenses and the cumulative effect of adopting a new accounting standard would have been $448 million, an increase of 7 percent compared with the same period last year. The Company incurred non-recurring expenses of $4 million (net of income tax) during the period relating to a contractual obligation due to a departing employee. 38
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) Net realized losses on investments (net of income tax) were $55 million for the nine months ended September 30, 2001, compared with net realized gains of $11 million for the nine months ended September 30, 2000. The net realized losses were primarily the result of losses on the financial futures and option contracts, certain "other" investments and FAS 133 fair value adjustments on derivatives. As discussed later in this report, the Company implemented FAS 133 on January 1, 2001, which requires that all derivatives be recognized as either assets or liabilities in the consolidated balance sheet and measured at fair value. The change in fair value for the nine months ended September 30, 2001, as a result of FAS 133, was a pre-tax loss of $14 million and is reflected in net realized gains (losses) on investments. Premiums Nine Months Ended Percentage September 30 Change From 2001 2000 Prior Year ---- ---- ---------- (in millions of U.S. dollars) Gross premiums written: ACE Bermuda $ 895 $ 511 75% ACE Global Markets 871 753 16 ACE Global Reinsurance 367 178 106 ACE USA 3,293 2,662 24 ACE International 1,726 1,554 11 ACE Financial Services 315 289 9 ---------- ---------- ------- $ 7,467 $ 5,947 26% ========== ========== ======= Net premiums written: ACE Bermuda $ 720 $ 446 61% ACE Global Markets 517 551 (6) ACE Global Reinsurance 327 146 124 ACE USA 1,506 1,370 10 ACE International 1,134 1,080 5 ACE Financial Services 307 274 12 ---------- ---------- ------- $ 4,511 $ 3,867 17% ========== ========== ======= Net premiums earned: ACE Bermuda $ 782 $ 356 120% ACE Global Markets 459 455 1 ACE Global Reinsurance 248 96 158 ACE USA 1,335 1,256 6 ACE International 1,063 1,037 3 ACE Financial Services 267 247 8 ---------- --------- ------- $ 4,154 $ 3,447 20% ========== ========= ======= Gross premiums written for the nine months ended September 30, 2001, increased by $1.6 billion to $7.5 billion compared with the nine months ended September 30, 2000. All of the operating segments experienced premium growth during the current period. The most significant areas of growth were in ACE Global Reinsurance, the financial solutions division at ACE Bermuda, and the specialty business units at ACE USA. Net premiums written increased by $644 million to $4.5 billion and net premiums earned increased by $707 million to $4.2 billion. As with gross premiums written, these increases were primarily due to new business opportunities, several financial solutions contracts written and fully earned in the period, and the price increases being experienced by most of the segments. ACE Bermuda: Gross premiums written for the nine months ended September 30, 2001, increased by $384 million to $895 million compared with the nine months ended September 30, 2000. This increase is primarily due to growth in the financial solutions division of $489 million, which includes three significant loss portfolio transfer ("LPT") contracts in the period totaling $322 million. The increase was offset by the discontinuation of aviation and reduction in satellite business, which resulted in a reduction of gross premiums written of $74 million. 39
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) Net premiums written for the nine months ended September 30, 2001, increased by $274 million to $720 million and net premiums earned for the nine months ended September 30, 2001, increased by $426 million to $782 million compared with the nine months ended September 30, 2000. These increases are primarily due to the items noted above. Financial solutions increased by $371 million or 170 percent, of which $322 million are LPT contracts, which are fully earned when written. ACE Global Markets: Gross premiums written for the nine months ended September 30, 2001, increased by $118 million to $871 million, compared with the nine months ended September 30, 2000. This increase is primarily due to an increase in ACE's participation in Lloyd's syndicate 2488, as previously discussed, and higher premium levels for the 2001 year of account primarily due to price increases. In addition, in the March 2000 quarter, ACE Global Markets accelerated its reporting to a current basis from a quarter in arrears. On a comparable basis, gross and net premiums written increased by 35 percent and 17 percent, respectively. Net premiums written for the nine months ended September 30, 2001, decreased by $34 million to $517 million compared with the nine months ended September 30, 2000. This decrease is primarily due to higher reinsurance costs incepting at the start of the year. Net premiums earned for the nine months ended September 30, 2001, increased by $4 million to $459 million compared with the nine months ended September 30, 2000. This increase is again primarily due to an increase in ACE's participation in the Lloyd's syndicate under management. ACE Global Reinsurance: Gross premiums written for the nine months ended September 30, 2001, increased by $189 million to $367 million compared with the nine months ended September 30, 2000. This increase is primarily due to new business from the life reinsurance division and higher property and casualty production arising from improved reinsurance market conditions. Net premiums written for the nine months ended September 30, 2001, increased by $181 million to $327 million compared with the nine months ended September 30, 2000. As with gross premiums written, this increase is primarily due to the new life reinsurance business and higher property and casualty production levels experienced during 2001. Net premiums earned for the nine months ended September 30, 2001, increased by $152 million to $248 million compared with the nine months ended September 30, 2000. This increase is primarily due to the improved property and casualty reinsurance market conditions experienced since the third quarter of fiscal 2000 and growth in the new lines of business. ACE USA: Gross premiums written for the nine months ended September 30, 2001, increased by $631 million to $3.3 billion compared with the nine months ended September 30, 2000. Most of the active divisions achieved year-over-year premium growth with SRF, Westchester Specialty, property, professional risk and USI casualty generating much of the USA growth. Net premiums written for the nine months ended September 30, 2001, increased by $136 million to $1.5 billion compared with the nine months ended September 30, 2000. With the exception of SRF the increases are consistent with the increases in gross premiums. SRF's net premiums written was slightly lower than the prior year reflecting a current year shift of business mix into lower retention accounts. Net premiums earned for the nine months ended September 30, 2001, increased by $79 million to $1.3 billion compared with the nine months ended September 30, 2000. The growth was attributable to Westchester Specialty with $64 million of the $79 million growth in the year-over-year period. Reinsurance reinstatement premium expense related to the September 11th tragedy reduced ACE USA net premiums written and earned by $18 million. ACE International: Gross premiums written for the nine months ended September 30, 2001, increased by $172 million to $1.7 billion compared with the nine months ended September 30, 2000. This increase is primarily due to new inward programs in Europe and Latin America, rate increases in Asia Pacific and Europe and new business opportunities in Europe and Canada. 40
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) Net premiums written for the nine months ended September 30, 2001, increased by $54 million to $1.1 billion compared with the nine months ended September 30, 2000. Net premiums earned for the nine months ended September 30, 2001, increased by $26 million to $1 billion compared with the nine months ended September 30, 2000. These increases are primarily due to rate increases in Asia Pacific and Europe and new business opportunities in Europe and Canada. ACE Financial Services: Gross premiums written for the nine months ended September 30, 2001, increased by $26 million to $315 million compared with the nine months ended September 30, 2000. This increase can be attributed to a large auto residual value reinsurance contract written in 2001 as well as growth in the swap and structured finance lines of business, offset by a decrease in life, accident and health line of business. Net premiums written for the nine months ended September 30, 2001, increased by $33 million to $307 million compared with the nine months ended September 30, 2000. The increase is due to the growth in the lines of business discussed above. Net premiums earned for the nine months ended September 30, 2001, increased by $20 million to $267 million compared with the nine months ended September 30, 2000. This increase is primarily due to the auto residual value reinsurance contract, offset by a decrease in the life, accident and health line of business. Underwriting Results Nine Months Ended September 30 2001 2000 ---- ---- Loss and loss expense ratio ACE Bermuda 119.4% 74.4% ACE Global Markets 99.2 56.8 ACE Global Reinsurance 101.1 18.2 ACE USA 75.7 74.8 ACE International 63.4 59.2 ACE Financial Services 70.0 66.0 Consolidated 84.3% 65.5% Underwriting and administrative expense ratio ACE Bermuda 5.6% 10.4% ACE Global Markets 46.0 38.2 ACE Global Reinsurance 28.0 26.8 ACE USA 25.8 24.4 ACE International 36.0 37.1 ACE Financial Services 21.6 25.2 Consolidated 28.2% 30.1% Combined Ratio ACE Bermuda 125.0% 84.8% ACE Global Markets 145.2 95.0 ACE Global Reinsurance 129.1 45.0 ACE USA 101.5 99.2 ACE International 99.4 96.3 ACE Financial Services 91.6 91.2 Consolidated 112.5% 95.6% The Company's loss and loss expense ratio increased to 84.3 percent for the nine months ended September 30, 2001, from 65.5 percent for the same period last year. The September 11th tragedy increased net loss and loss expenses by $650 million. Excluding the September 11th tragedy, the Company's loss and loss expense ratio would have been 69 percent. The financial solutions contracts written and earned in the quarter also influenced the loss and loss expense ratio, as these contracts are generally recorded at loss ratios close to 100 percent. ACE Bermuda: The loss and loss expense ratio increased to 119.4 percent for the nine months ended September 30, 2001, from 74.4 percent for the nine months ended September 30, 2000. This increase is primarily the result of the September 11th tragedy and several financial solutions policies with loss ratios close to 100 percent. 41
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) ACE Global Markets: The loss and loss expense ratio increased to 99.2 percent for the nine months ended September 30, 2001, from 56.8 percent for the nine months ended September 30, 2000. Excluding the September 11th tragedy the ratio would have been 60 percent. The remaining increase is primarily the result of the additional losses incurred in the RGB syndicate which is in run-off and a change in the mix of business across the years of account. ACE Global Reinsurance: The loss and loss expense ratio increased to 101.1 percent for the nine months ended September 30, 2001, from 18.2 percent for the nine months ended September 30, 2000. The 2001 loss ratio excludes the life policyholder benefits of $58.5 million, as combined ratios are not an appropriate measure of life reinsurance business. The increase is primarily the result of the September 11th tragedy and catastrophe losses in the second quarter. Excluding the impact of the tragedy and life reinsurance contracts, the loss and loss expense ratio would have been 35.6 percent. ACE USA: The loss and loss expense ratio increased to 75.7 percent for the nine months ended September 30, 2001, from 74.8 percent for the nine months ended September 30, 2000. This increase is primarily related to the September 11th tragedy. Excluding the tragedy, the loss and loss expense ratio would have been 72.7 percent. This decrease is primarily due to the lower proportion of financial solutions business written in the current period compared with the prior year. Excluding financial solutions in both the current period and the same period last year, the loss and loss expense ratio would have been 70.9 percent and 69.9 percent, respectively. ACE International: The loss and loss expense ratio increased to 63.4 percent for the nine months ended September 30, 2001, from 59.2 percent for the nine months ended September 30, 2000. This increase is primarily the result of the September 11th tragedy and additional losses incurred in the UK property and casualty book as noted last quarter. ACE Financial Services: The loss and loss expense ratio increased to 70 percent for the nine months ended September 30, 2001 from 66 percent for the nine months ended September 30, 2000. The increase in the loss and loss expense ratio can be attributed to a change in the mix of business earned in 2001 compared with 2000. Underwriting and Administrative Expenses Total underwriting and administrative expenses increased from $1 billion for the nine months ended September 2000 to $1.2 billion for the nine months ended September 2001 primarily due to higher acquisition costs and increased operating expenses. Despite the increase in acquisition costs and higher administrative expenses, the underwriting and administrative expense ratio decreased from 30.1 percent to 28.2 percent primarily due to higher earned premiums in all segments. ACE Bermuda: The underwriting and administrative expense ratio decreased to 5.6 percent for the nine months ended September 30, 2001, from 10.4 percent for the nine months ended September 30, 2000. This decrease is primarily the result of increased net premiums earned on certain financial solutions reinsurance contracts including those resulting from the September 11th tragedy. Since most financial solutions contracts do not incur acquisition costs, the acquisition cost ratio will fluctuate depending on the level of financial solutions business earned in the quarter. In addition, as the administrative cost base is generally fixed, the administrative expense ratio will decline as net premiums earned increase. ACE Global Markets: The underwriting and administrative expense ratio increased to 46 percent for the nine months ended September 30, 2001, from 38.2 percent for the nine months ended September 30, 2000. This increase is primarily due to a higher acquisition cost ratio, as a result of the increased earned reinsurance costs from reinstatement premiums from the September 11th tragedy lowering net premiums earned. In addition, the administrative expense base increased for the current year due to a non-recurring contractual obligation to a departing employee. 42
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) ACE Global Reinsurance: The underwriting and administrative expense ratio increased to 28 percent for the nine months ended September 30, 2001, from 26.8 percent for the nine months ended September 30, 2000. This increase is primarily the result of increased administrative expense during the quarter ended September 30, 2001 offset by higher earned premiums. ACE USA: The underwriting and administrative expense ratio increased to 25.8 percent for the nine months ended September 30, 2001, from 24.4 percent for the nine months ended September 30, 2000. This increase is primarily the result of higher administrative expenses and acquisition costs in 2001. ACE International: The underwriting and administrative expense ratio decreased from 37.1 percent to 36 percent for the nine months ended September 30, 2001. This decrease is primarily the result of higher net premiums earned in 2001 primarily due to the creation of its consumer solutions division. ACE Financial Services: The underwriting and administrative expense ratio decreased to 21.6 percent for the nine months ended September 30, 2001, from 25.2 percent for the nine months ended September 30, 2000. The decrease is due primarily to a greater portion of business being from the structured finance, life, accident and health and swap lines, which typically have a much lower or no associated acquisition costs. Net Investment Income Percentage Nine Months Ended Change September 30 From Prior 2001 2000 Year ---- ---- ---------- (in millions of U.S. dollars) ACE Bermuda $ 114 $ 111 2% ACE Global Markets 29 23 22 ACE Global Reinsurance 48 45 6 ACE USA 256 252 2 ACE International 64 69 (7) ACE Financial Services 76 71 7 Other (1) 7 (9) N.M. --------- ---------- --------- Total investment income $ 594 $ 562 6% ========= ========== ========= (1) Includes ACE Limited, ACE INA Holdings and intercompany eliminations N.M.- Not Meaningful Net investment income increased by $32 million for the nine months ended September 30, 2001, compared with the nine months ended September 30, 2000. The reasons for the increase were an increase in the asset base resulting from the proceeds from a public share offering in September 2000, positive operating cash flows and the reclassification of CIS. The increase in invested assets was offset by declining interest rates during 2001. ACE Bermuda: Net investment income increased by $3 million to $114 million for the nine months ended September 30, 2001, compared with the nine months ended September 30, 2000. This is primarily the result of a larger asset base in the current year compared to the prior year, offset by a decline in investment yields. ACE Global Markets: Net investment income increased by $6 million to $29 million for the nine months ended September 30, 2001, compared with the nine months ended September 30, 2000. This is primarily the result of ACE's increased participation in the syndicate managed by ACE Global Markets and to a lesser extent modest increases in the level of investable assets. ACE Global Reinsurance: Net investment income increased by $3 million to $48 million for the nine months ended September 30, 2001, compared with the nine months ended September 30, 2000. The additional assets arising from positive cash flows was offset by dividends paid to ACE Limited. 43
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) ACE USA: Net investment income increased by $4 million to $256 million for the nine months ended September 30, 2001, compared with the nine months ended September 30, 2000. This increase is primarily due to the presentation of the CIS activity in investment income in 2001. Prior to July 2, 2000, CIS was presented as a discontinued operation. As of July 2, 2000, the CIS operations had not been sold and its activity was reconsolidated into the Company's operations. ACE International: Net investment income decreased by $5 million to $64 million for the nine months ended September 30, 2001, compared with the nine months ended September 30, 2000. This decrease is primarily the result of foreign currency devaluation and lower yields. ACE Financial Services: Net investment income increased by $5 million to $76 million for the nine months ended September 30, 2001, compared with the nine months ended September 30, 2000. An increase in invested assets was offset by declining interest rates during 2001. Net Realized Gains (Losses) on Investments Nine Months Ended September 30 2001 2000 ---- ---- (in millions of U.S. dollars) Fixed maturities and short-term investments $ 1 $ (74) Equity securities 33 100 Financial futures and option contracts (44) (10) Other investments (33) 4 FAS 133 (14) - Currency (6) (6) --------- ---------- Net realized gains (losses) on investments $ (63) $ 14 ========= ========== Sales proceeds for fixed maturity securities were generally higher than their amortized cost during the nine months ended September 30, 2001. This resulted in net realized gains of $1 million being recognized on fixed maturities and short-term investments compared with net realized losses of $74 million for the nine months ended September 30, 2000. Sales proceeds for equity securities were generally higher than their cost during the nine months ended September 30, 2001, resulting in net realized gains of $33 million being recognized for the period, compared with $100 million for the nine months ended September 30, 2000. Certain of the Company's external managers of fixed income securities use fixed income futures contracts to manage duration exposure, and losses of $4 million were recognized on these for the nine months ended September 30, 2001. Net realized losses generated by the Company's equity index futures contracts amounted to $40 million for the nine months ended September 30, 2001 and are a result of the decline in equity markets during the quarter ended September 30, 2001. Total net realized losses attributable to the financial futures and option contracts amounted to $44 million for the nine months ended September 30, 2001, compared with net realized losses of $10 million for the nine months ended September 30, 2000. Other investments had a loss of $33 million primarily because the Company wrote down the value of an investment by $28 million during the current quarter. 44
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) The Company implemented FAS 133 on January 1, 2001, which requires that all derivatives be recognized as either assets or liabilities in the consolidated balance sheet and measured at fair value. The change in fair value for the nine months ended September 30, 2001, as a result of FAS 133, was a loss of $14 million. The level of such gains and losses is dependent upon a number of factors including changes in interest rates, credit spreads and other market factors. The September 11th tragedy increased credit spreads resulting in losses for the nine months ended September 30, 2001. Other Expenses Nine Months Ended Percentage September 30 Change 2001 2000 From Prior Year ---- ---- --------------- (in millions of U.S. dollars) Amortization of Goodwill $ 60 $ 59 1% ======= ======= ======= Interest expense $ 153 $ 167 (8%) ======= ======= ======= Income tax expense (benefit) $ (31) $ 74 N.M. ======= ======= ======= N.M.- not meaningful Interest expense for the nine months ended September 30, 2001 decreased by $14 million compared with the same period last year. The decrease results from lower interest rates on both the short-term debt instruments and the ACE INA RHINO preferred securities. The Company recorded an income tax benefit of $31 million for the nine months ended September 30, 2001, compared with an expense of $74 million for the same period last year. This decrease was due primarily to the tax benefit of $78 million realized during the current quarter on the net loss incurred from the September 11th tragedy and the tax benefit realized on the incurred losses in the RGB syndicate that is in run-off. 45
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) CONSOLIDATED FINANCIAL POSITION At September 30, 2001, total assets were $34.9 billion compared with $31.7 billion at December 31, 2000, an increase of $3.2 billion. This increase is primarily due to an increase of $830 million on investments and cash and an increase of $1.7 billion on reinsurance recoverables. In addition, insurance and reinsurance balances receivable and prepaid reinsurance premiums increased by $361 million and $376 million, respectively, as a result of insurance business transacted. At September 30, 2001, total investments and cash amounted to $14.6 billion compared with $13.8 billion at December 31, 2000. The increase of $830 million is primarily due to positive cash flows from operations resulting from strong premium volume and positive market movements. These items were partially offset by dividend payments of $114 million and share repurchases of $179 million. The Company maintains reserves for the estimated unpaid ultimate liability for losses and loss expenses under the terms of its policies and agreements. The reserve for unpaid losses and loss expenses was $19.9 billion at September 30, 2001, compared with $17.4 billion at December 31, 2000, and includes $11.7 billion of case and loss expense reserves. Gross loss reserves increased by $2.5 billion during the period, primarily due to the $1.9 billion of gross losses incurred during the September 2001 quarter with respect to the September 11th tragedy. While the Company believes that its reserve for unpaid losses and loss expenses at September 30, 2001, is adequate, future developments may result in ultimate losses and loss expenses significantly greater or less than the reserve provided. One of the ways the Company manages its loss exposure is through the use of reinsurance. While reinsurance arrangements are designed to limit losses from large exposures and to permit recovery of a portion of direct losses, reinsurance does not relieve the Company of its liability to its insureds. Accordingly, the Company's loss reserves represent total gross losses, and reinsurance recoverable represents anticipated recoveries of a portion of those losses as well as amounts recoverable from reinsurers with respect to claims which have already been paid by the Company. Due to the magnitude of the losses and the related recoveries arising from the September 11th tragedy, the Company conducted a review of its insurance and reinsurance portfolios on a policy by policy basis. Gross insured claims incurred by ACE with respect to the September 11th tragedy are covered by significant amounts of reinsurance from high quality reinsurers. Reinsurance recoverables increased by $1.7 billion during the period, primarily due to the $1.3 billion of reinsurance recoverables accrued during the quarter ended September 30, 2001 with respect to the September 11th tragedy. Approximately 98 percent of all reinsurance purchased by ACE is with reinsurers rated A- or better, including 38 percent with reinsurers rated AAA- and 33 percent with reinsurers rated AA-, as rated by Standard & Poor's. The allowance for unrecoverable reinsurance is required principally due to the failure of reinsurers to indemnify the Company, primarily because of disputes under reinsurance contracts and insolvencies. Reinsurance disputes continue to be significant, particularly on larger and more complex claims, such as those related to asbestos and environmental pollution (discussed in more detail below) and London reinsurance market exposures. Allowances have been established for amounts estimated to be uncollectible. The Company's reinsurance recoverable was approximately $10.7 billion at September 30, 2001, and $9.0 billion at December 31, 2000, net of allowances for unrecoverable reinsurance of $736 million and $710 million, respectively. 46
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) Included in the Company's liabilities for losses and loss expenses are liabilities for asbestos, environmental damage and latent injury claims and expenses. These claims are principally related to claims arising from remediation costs associated with hazardous waste sites and bodily injury claims related to asbestos products and environmental hazards. The Company has considered asbestos and environmental claims and claims expenses in establishing the liability for unpaid losses and loss expenses. The Company has developed reserving methods, which incorporate new sources of data with historical experience to estimate the ultimate losses arising from asbestos and environmental exposures. The reserves for asbestos and environmental claims and claims expenses represent management's best estimate of future loss and loss expense payments and recoveries which are expected to develop over the next several decades. The Company continuously monitors evolving case law and its effect on environmental damage and latent injury claims. While reserving for these claims is inherently uncertain, the Company believes that the reserves carried for these claims are adequate based on known facts and current law. The Company's short-term debt at September 30, 2001 was $451 million, an increase of $87 million from the balance at December 31, 2000. The Company has taken advantage of relatively low interest rates to use short-term debt instruments to settle certain claims and other liabilities rather than liquidating investments. The Company's long-term debt, including trust preferred securities remained unchanged from December 31, 2000. Fully diluted book value per share was $22.10 at September 30, 2001, compared with $23.25 at December 31, 2000, reflecting a decrease in shareholders' equity during the period. LIQUIDITY AND CAPITAL RESOURCES As a holding company, ACE's assets consist primarily of the stock of its subsidiaries as well as other investments. In addition to investment income, its cash flows currently depend primarily on dividends or other statutorily permissible payments from its Bermuda-based operating subsidiaries (the "Bermuda subsidiaries"). There are currently no legal restrictions on the payment of dividends from retained earnings by the Bermuda subsidiaries, as the minimum statutory capital and surplus requirements are satisfied by the share capital and additional paid-in capital of each of the Bermuda subsidiaries. However, the payment of dividends or other statutorily permissible distributions by the Bermuda subsidiaries is subject to the need to maintain shareholders' equity at a level adequate to support the level of insurance and reinsurance operations. During the nine months ended September 30, 2001, dividends of $105 million and $154 million were declared by ACE Tempest Life Re and ACE Bermuda, respectively. The payment of any dividends from ACE Global Markets or its subsidiaries would be subject to applicable United Kingdom insurance law including those promulgated by the Society of Lloyd's. No dividends were received from ACE Global Markets during the nine months ended September 30, 2001, and the Company does not anticipate receiving dividends from ACE Global Markets during the remainder of 2001. ACE INA has issued debt to provide partial financing for the ACE INA Acquisition and for other operating needs. Cash flow requirements to service this debt are expected to be met primarily by upstreaming dividend payments from ACE INA's insurance subsidiaries. ACE INA Holdings received dividends of $16 million from its subsidiaries during the nine months ended September 30, 2001. Under various U.S. insurance laws to which ACE INA's U.S. insurance subsidiaries are subject, ACE INA's U.S. insurance subsidiaries may pay a dividend only from earned surplus subject to the maintenance of a minimum capital requirement, without prior regulatory approval. ACE INA's international subsidiaries are also subject to various insurance laws and regulations in the countries in which they operate. These regulations include restrictions that limit the amount of dividends that can be paid without prior approval of the insurance regulatory authorities. No dividends have been received by ACE Limited from ACE INA during the nine months ended September 30, 2001, and the Company does not anticipate receiving dividends from ACE INA during the remainder of 2001. 47
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) ACE Financial Services' U.S. insurance subsidiaries are also subject to various U.S. insurance laws under which subsidiaries may pay a dividend only from earned surplus subject to the maintenance of a minimum capital requirement, without prior regulatory approval. No dividends have been received from ACE Financial Services during the nine months ended September 30, 2001, and the Company does not anticipate receiving dividends from ACE Financial Services during the remainder of 2001. The Company's consolidated sources of funds consist primarily of net premiums written, investment income, and proceeds from sales and maturities of investments. Funds are used primarily to pay claims, operating expenses and dividends and for the purchase of investments. The Company's insurance and reinsurance operations provide liquidity in that premiums are normally received substantially in advance of the time claims are paid. The Company's consolidated net cash flow from operating activities was $961 million for the nine months ended September 30, 2001, compared with $(375) million for the nine months ended September 30, 2000. The positive operating cash flows were generated from strong premium volume during the current year. Generally cash flows are affected by claim payments which, due to the nature of the Company's operations, may comprise large loss payments on a limited number of claims and therefore can fluctuate significantly from year to year. The irregular timing of these loss payments, for which the source of cash can be from operations, available net credit facilities or routine sales of investments, can create significant variations in cash flows from operations between periods. The Company believes that it has sufficient liquidity to meet its anticipated cash flow obligations from the September 11th tragedy. Although the Company's ongoing operations continue to generate positive cash flows from operations, the Company's cash flows are currently impacted by a large book of loss reserves from businesses in run-off. The run-off operations generated negative cash flows of $516 million and $599 million for the nine months ended September 30, 2001 and 2000, respectively, primarily due to claim payments. The run-off book of business continues to require cash to meet its liabilities and cash flows are very dependent on the timing of claim settlements. Net loss and loss expense payments amounted to $2.8 billion for both the nine months ended September 30, 2001, and the nine months ended September 30, 2000. On October 25, 2001, the Company completed a public offering of 32,890,000 Ordinary Shares (which included the over-allotment option of 4,290,000 shares) in which it raised aggregate net proceeds of approximately $1.1 billion. The Company expects to use the net proceeds of the Ordinary Share offering to expand its net underwriting capacity, either through internal growth and/or through acquisitions of lines of business or companies and for general corporate purposes. The Board of Directors, on November 17, 2000, authorized the repurchase of any ACE issued debt or capital securities including ACE's Ordinary Shares, up to an aggregate total of $250 million. During the nine months ended September 30, 2001, the Company repurchased and cancelled 6,760,900 Ordinary Shares under the program for an aggregate cost of $179.4 million. Approximately $71 million of the Board authorization has not been utilized. On January 12, 2001, and April 13, 2001, the Company paid dividends of 13 cents per share to shareholders of record on December 29, 2000, and March 30, 2001, respectively. On July 13, 2001 and October 12, 2001, the Company paid dividends of 15 cents per share to shareholders of record on July 29, 2001 and September 28, 2001 respectively. The declaration and payment of future dividends is at the discretion of the Board of Directors and will be dependent upon the profits and financial requirements of the Company and other factors, including legal restrictions on the payment of dividends and such other factors as the Board of Directors deems relevant. In April 2001, the Company renewed its $800 million, 364-day revolving credit facility. This facility, together with the Company's $250 million, five-year revolving credit facility, which was last renewed in May 2000, is available for general corporate purposes and each of the facilities may also be used as commercial paper back-up facilities. The five-year facility also permits the issuance of letters of credit. Under these facilities the Company and various subsidiaries are named borrowers and guarantors. Each facility requires that the Company and/or certain of its subsidiaries maintain specific covenants, including a consolidated tangible net worth covenant and a maximum leverage covenant. 48
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) In June 1999, the Company arranged certain commercial paper programs. The programs use revolving credit facilities as back-up facilities and provide for up to $2.8 billion in commercial paper issuance (subject to the availability of back-up facilities, which currently total $1.05 billion) for ACE and for ACE INA. At September 30, 2001, short-term debt consisted of $268 million of commercial paper issued by ACE INA, $25 million in bank borrowings by ACE Financial Services and $158 million in bank borrowings by ACE INA. Following the September 11th tragedy, ACE INA's ability to access the commercial paper markets was disrupted, partly because certain of the Company's debt ratings were placed on "negative watch". As a result, ACE INA replaced commercial paper that matured between September 11, 2001 and September 30, 2001, with borrowings of $158 million under the $800 million 364-day revolving credit facility at a rate of 3.8 percent. Commercial paper rates during the quarter ended September 30, 2001, averaged 4.0 percent and 6.1 percent during the nine months ended September 30, 2001. With the exception of the Standard and Poors rating, the "negative watch" on the Company's debt ratings have now been lifted. The Company continues to have access to substantial liquidity resources. In addition to its cash and investment portfolios of $14.6 billion, the Company has approximately $650 million available under its existing credit facilities. In addition, subsequent to September 30, 2001, the Company has entered into repurchase agreements to replace the $182 million of commercial paper that has matured since September 30, 2001. Under these repurchase agreements, the Company agrees to sell securities and repurchase them at a date in the future for a predetermined price, thereby creating liquidity for the Company. To date, the agreements entered into have ranged from overnight to 30 days, at rates that approximate the Federal Funds rate at the time of the transaction. Both internal and external forces influence the Company's financial condition, results of operations and cash flows. Claim settlements, premium levels and investment returns may be impacted by changing rates of inflation and other economic conditions. In many cases, significant periods of time, ranging up to several years or more, may lapse between the occurrence of an insured loss, the reporting of the loss to the Company and the settlement of the Company's liability for that loss. The Company believes that its cash balances, cash flow from operations, routine sales of investments and the liquidity provided by its credit facilities are adequate to meet the Company's expected cash requirements. NEW ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("FAS 142"). FAS 142 primarily addresses the accounting for goodwill and intangible assets subsequent to their acquisition. As required, the Company will adopt FAS 142 on January 1, 2002 and will cease amortizing goodwill at that time. All goodwill recognized in the Company's consolidated balance sheet at January 1, 2002 will be assigned to one or more reporting units. Goodwill in each reporting unit should be tested for impairment by June 30, 2002. An impairment loss recognized as a result of a transitional impairment test of goodwill should be reported as the cumulative effect of a change in accounting principle. The Company does not expect any impairment in goodwill to arise from testing during initial adoption. 49
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (cont'd.) CUMULATIVE EFFECT OF ADOPTING A NEW ACCOUNTING STANDARD In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"). FAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the consolidated balance sheet and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as a fair value, cash flow or foreign currency hedge. The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation. Upon initial application of FAS 133, hedging relationships must be designated anew and documented pursuant to the provisions of this statement. The Company adopted FAS 133, as amended, as of January 1, 2001. The Company maintains investments in derivative instruments such as futures, option contracts and foreign currency forward contracts of which the primary purposes are to manage duration and foreign currency exposure, yield enhancement or to obtain an exposure to a particular financial market. The Company has historically recorded the changes in market value of these instruments as realized gains (losses) in the consolidated statement of operations and, accordingly, has estimated that FAS 133, as amended, is not expected to have a significant impact on the results of operations, financial condition or liquidity in future periods as it relates to these instruments. Certain products (principally credit protection oriented) issued by the Company have been determined to meet the definition of a derivative under FAS 133. These products consist primarily of credit default swaps, index-based instruments and certain financial guarantee coverages. Effective January 1, 2001, the Company records these products at their fair value. To reflect the adoption of FAS 133 on January 1, 2001, the Company recorded an expense related to the cumulative effect of adopting a new accounting standard of $23 million, net of income tax of $12 million. The Company has recorded in net realized gains (losses) on investments, a pretax loss of $14 million to reflect the change in the fair value of derivatives for the nine months ended September 30, 2001. The level of such gains and losses is dependent upon a number of factors including changes in interest rates, credit spreads and other market factors. The Company's involvement with derivative instruments and transactions is primarily to offer protection to others or to mitigate its own risk and is not considered speculative in nature. 50
PART II - OTHER INFORMATION --------------------------- ITEM 5. OTHER INFORMATION - -------------------------- 1. On November 5, 2001, the company announced the appointment of Evan Greenberg, as Vice Chairman of ACE Limited and President and CEO of ACE Tempest Life Re. Evan Greenberg was most recently president and chief operating officer of AIG, a position he held from 1997 until 2000. Mr. Greenberg replaces John Engestrom, who will be retiring, as President and CEO of ACE Tempest Life Re. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K - ----------------------------------------- 1. Exhibits 10.1 The ACE Limited Supplemental Retirement Plan 10.2 Reimbursement Agreement dated August 24, 2001 among ACE Limited, certain subsidiaries, various lenders and First Union National Bank. 10.3 Second Amendment dated as of October 23, 2001, amending the Amended and Restated 364-day Credit Agreement dated as of May 8, 2000, as amended as of October 23, 2000 and amended and restated as of April 6, 2001 among ACE Limited, certain subsidiaries, various lenders and Morgan Guaranty Trust Company of New York. 10.4 Second Amendment dated as of October 23, 2001, amending the Amended and Restated Five Year Credit Agreement dated as of May 8, 2000, and as amended as of October 23, 2000 among ACE Limited, certain subsidiaries, various lenders and Morgan Guaranty Trust Company of New York. 10.5 Amendment dated as of October 23, 2001, relating to a letter of credit facility agreement dated as of November 19, 1999 and amended November 17, 2000 among ACE Limited, ACE Bermuda Insurance Ltd., Citibank, N.A. as arranger, Barclays Bank plc and ING Barings, as co-security arrangers and Citibank International plc, as agent and trustee and certain financial institutions. 10.6 First Amendment dated as of October 23, 2001 amending the Reimbursement Agreement dated as of August 24, 2001 among ACE Limited, certain subsidiaries, various lenders and First Union National Bank. 2. Reports on Form 8-K The Company filed a Form 8-K current report (date of earliest event reported: September 12, 2001) pertaining to the estimated impact of the September 11, 2001 tragedy on its September 30, 2001, net operating income. The Company filed a Form 8-K current report (date of earliest event reported: September 24, 2001) pertaining to the updating of the estimated impact of the September 11, 2001 tragedy on its September 30, 2001, net operating income. The Company filed a Form 8-K current report (date of earliest event reported: October 25, 2001) pertaining to the announcing of its September 30, 2001, earnings highlights. The Company filed a Form 8-K current report (date of earliest event reported: October 24, 2001) pertaining to ACE Limited's commencement of a public offering of its Ordinary Shares. The Company filed a Form 8-K current report (date of earliest event reported: October 30, 2001) pertaining to the announcing of its September 30, 2001, earnings. 51
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ACE LIMITED -------------------------------------------- November 14, 2001 /s/ Brian Duperreault -------------------------------------------- Brian Duperreault Chairman and Chief Executive Officer November 14, 2001 /s/ Robert A. Blee -------------------------------------------- Robert A. Blee Chief Accounting Officer 52
EXHIBIT INDEX Exhibit Numbered Number Description Page - ------ ----------- -------- 1. Exhibits 10.1 The ACE Limited Supplemental Retirement Plan 10.2 Reimbursement Agreement dated August 24, 2001 among ACE Limited, certain subsidiaries, various lenders and First Union National Bank. 10.3 Second Amendment dated as of October 23, 2001, amending the Amended and Restated 364-day Credit Agreement dated as of May 8, 2000, as amended as of October 23, 2000 and amended and restated as of April 6, 2001 among ACE Limited, certain subsidiaries, various lenders and Morgan Guaranty Trust Company of New York. 10.4 Second Amendment dated as of October 23, 2001, amending the Amended and Restated Five Year Credit Agreement dated as of May 8, 2000, and as amended as of October 23, 2000 among ACE Limited, certain subsidiaries, various lenders and Morgan Guaranty Trust Company of New York. 10.5 Amendment dated as of October 23, 2001, relating to a letter of credit facility agreement dated as of November 19, 1999 and amended November 17, 2000 among ACE Limited, ACE Bermuda Insurance Ltd., Citibank, N.A. as arranger, Barclays Bank plc and ING Barings, as co-security arrangers and Citibank International plc, as agent and trustee and certain financial institutions. 10.6 First Amendment dated as of October 23, 2001 amending the Reimbursement Agreement dated as of August 24, 2001 among ACE Limited, certain subsidiaries, various lenders and First Union National Bank. 53