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 March 31, 1998
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. N/A
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 May 11, 1998 was 179,171,309.
<PAGE>
ACE LIMITED
INDEX TO FORM 10-Q
Part I. FINANCIAL INFORMATION
Page No.
Item 1. Financial Statements:
Consolidated Balance Sheets
March 31, 1998 (Unaudited) and September 30, 1997 1
Consolidated Statements of Operations (Unaudited)
Three Months Ended March 31, 1998 and March 31, 1997
Six Months Ended March 31, 1998 and March 31, 1997 2
Consolidated Statements of Shareholders' Equity (Unaudited)
Six Months Ended March 31, 1998 and March 31, 1997 3
Consolidated Statements of Cash Flows (Unaudited)
Six Months Ended March 31, 1998 and March 31, 1997 4
Notes to Interim Consolidated Financial Statements (Unaudited) 5
Item 2. Management's Discussion and Analysis of Results of Operations
and Financial Condition 11
Part II. OTHER INFORMATION
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 25
<PAGE>
<TABLE>
<CAPTION>
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31 September 30
1998 1997
-------- ------
(unaudited)
(in thousands of U.S. dollars
except share and per share data)
<S> <C> <C>
Assets
Investments and cash
Fixed maturities available for sale,
at fair value (amortized
cost - $3,718,918 and $3,226,511) $ 3,783,428 $ 3,290,336
Equity securities, at fair value
(cost - $328,706 and $502,481) 410,337 634,970
Short-term investments, at fair value
(amortized cost - $968,670 and $ 364,552) 968,692 364,432
Other investments, at cost 84,995 78,691
Cash 194,182 106,336
---------- ----------
Total investments and cash 5,441,634 4,474,765
Goodwill on Tempest acquisition 194,128 196,667
Premiums and insurance balances receivable 188,996 135,815
Accrued investment income 45,003 40,581
Deferred acquisition costs 32,410 27,018
Reinsurance recoverables 771,223 -
Prepaid reinsurance premiums 69,013 22,196
Deferred income taxes 74,540 -
Other assets 176,457 104,504
------- ----------
Total assets $ 6,993,404 $ 5,001,546
========= =========
Liabilities
Unpaid losses and loss expenses $ 3,324,869 $ 1,869,995
Unearned premiums 461,469 400,689
Premiums received in advance 41,585 24,973
Reinsurance balances payable 19,982 11,245
Accounts payable and accrued liabilities 101,301 63,014
Dividend payable 13,282 12,436
Bank debt 250,000 -
--------- --------
Total liabilities 4,212,488 2,382,352
--------- ---------
Commitments and Contingencies
Shareholders' equity
Ordinary Shares ($0.041666667 par value,
300,000,000 shares authorized;
162,655,201 and 165,879,654 shares
issued and outstanding) 6,776 6,911
Additional paid-in capital 1,082,390 1,102,824
Unearned stock grant compensation (8,062) (1,993)
Net unrealized appreciation on investments 146,080 196,194
Cumulative translation adjustments 817 855
Retained earnings 1,552,915 1,314,403
--------- ---------
Total shareholders' equity 2,780,916 2,619,194
--------- ---------
Total liabilities and shareholders' equity $ 6,993,404 $ 5,001,546
========= =========
See accompanying notes to interim consolidated financial statements
1
<PAGE>
<CAPTION>
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months and Six Months
Ended March 31, 1998 and 1997
(Unaudited)
Three Months Ended Six Months Ended
March 31 March 31
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues
Gross premiums written $ 242,857 $ 203,333 $ 413,102 $ 335,845
Reinsurance premiums ceded (46,208) (14,745) (89,476) (36,643)
-------- --------- -------- ---------
Net premiums written 196,649 188,588 323,626 299,202
Change in unearned premiums (11,903) (29,947) 28,941 23,839
-------- -------- --------- ---------
Net premiums earned 184,746 158,641 352,567 323,041
Net investment income 73,129 58,094 131,542 117,832
Net realized gains (losses)
on investments 145,616 (2,339) 173,108 39,384
------- ---------- ------- --------
Total Revenues 403,491 214,396 657,217 480,257
------- -------- ------- --------
Expenses
Losses and loss expenses 116,265 105,290 225,426 215,440
Acquisition costs 16,811 11,887 31,012 26,016
Administrative expenses 26,585 19,270 44,953 35,111
Loan interest expense 3,858 - 3,858 -
--------- ------------ --------- -------
Total expenses 163,519 136,447 305,249 276,567
------- -------- ------- --------
Income before income taxes 239,972 77,949 351,968 203,690
Income taxes 3,767 - 2,947 -
--------- ------------ --------- -------
Net income $ 236,205 $ 77,949 $ 349,021 $ 203,690
======= ======== ======= =======
Basic earnings per share $ 1.45 $ 0.45 $ 2.13 $ 1.17
==== ==== ==== ====
Diluted earnings per share $ 1.41 $ 0.45 $ 2.08 $ 1.16
==== ==== ==== ====
See accompanying notes to interim consolidated financial statements
2
<PAGE>
<CAPTION>
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
SHAREHOLDERS' EQUITY
For the Six Months Ended March 31, 1998 and 1997
(Unaudited)
March 31 March 31
1998 1997
------- ------
(in thousands of U.S. dollars)
<S> <C> <C>
Ordinary Shares
Balance - beginning of period $ 6,911 $ 7,271
Exercise of stock options 12 8
Issued under Employee Stock Purchase - 1
Plan
Issued under Stock Appreciation Right
Replacement Plan - 8
Repurchase of shares (147) (188)
------------- -------------
Balance - end of period 6,776 7,100
------------ ------------
Additional paid-in capital
Balance - beginning of period 1,102,824 1,156,194
Exercise of options for Ordinary Shares 2,649 1,641
Issued under Employee Stock Purchase Plan - 228
Issued under Stock Appreciation Right
Replacement Plan - 3,919
Cancellation of awards - (87)
Repurchase of Ordinary Shares (23,083) (29,580)
----------- -----------
Balance - end of period 1,082,390 1,132,315
--------- ---------
Unearned stock grant compensation
Balance - beginning of period (1,993) (1,299)
Stock grants awarded (8,113) (3,225)
Stock grants forfeited - 79
Amortization 2,044 1,090
------------ ------------
Balance - end of period (8,062) (3,355)
------------ ------------
Net unrealized appreciation on investments
Balance - beginning of period 196,194 61,281
Net depreciation during period (50,031) (70,569)
Change in deferred income taxes (83) -
---------- -------
Balance - end of period 146,080 (9,288)
---------- ------------
Cumulative translation adjustments
Balance - beginning of period 855 131
Net adjustment for period (38) 1,079
------------- ------------
Balance - end of period 817 1,210
------------- ------------
Retained earnings
Balance - beginning of period 1,314,403 1,020,700
Net income 349,021 203,690
Dividends declared (26,095) (20,665)
Repurchase of Ordinary Shares (84,414) (59,659)
----------- -----------
Balance - end of period 1,552,915 1,144,066
--------- ---------
Total shareholders' equity $ 2,780,916 $ 2,272,048
========= =========
See accompanying notes to interim consolidated financial statements
3
<PAGE>
<CAPTION>
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended March 31, 1998 and 1997
(Unaudited)
March 31 March 31
1998 1997
------ ------
(in thousands of U.S. dollars)
<S> <C> <C>
Cash flows from operating activities
Net income $ 349,021 $ 203,690
Adjustments to reconcile net income to
net cash provided by
Operating activities
Unearned premiums (27,220) (15,758)
Unpaid losses and loss expenses, net
of reinsurance recoverables 13,651 88,898
Prepaid reinsurance premiums (6,817) (7,371)
Net realized gains on investments (173,108) (39,384)
Amortization of premium/discounts (5,333) (2,511)
Deferred acquisition costs 3,608 3,319
Insurance balances receivable (37,181) (12,949)
Premiums received in advance 16,612 8,639
Reinsurance balances payable 8,737 (2,299)
Accounts payable and accrued liabilities (15,783) (8,531)
Other (11,413) 1,005
--------------- ---------------
Net cash flows from operating activities 114,774 216,748
------------- ------------
Cash flows from investing activities
Purchases of fixed maturities (3,181,805) (3,255,722)
Purchases of equity securities (168,308) (402,393)
Sales of fixed maturities 3,048,158 3,371,215
Sales of equity securities 427,338 224,781
Maturities of fixed maturities 13,000 5,000
Net realized gains on financial futures
contracts 59,225 9,246
Other investments (6,304) -
Acquisition of subsidiaries, net of cash
acquired (338,000) (30,416)
----------- ------------
Net cash used in investing activities (146,696) (78,289)
----------- ------------
Cash flows from financing activities
Repurchase of Ordinary Shares (107,644) (89,427)
Dividends paid (25,249) (20,630)
Proceeds from exercise of options for
Ordinary Shares 2,661 1,649
Proceeds from shares issued under
Stock Appreciation Right Replacement Plan - 4,156
Proceeds from bank debt 250,000 -
---------- ---------------
Net cash from (used for) financing activities 119,768 (104,252)
---------- -----------
Net increase in cash 87,846 34,207
Cash - beginning of period 106,336 53,374
----------- ------------
Cash - end of period $ 194,182 $ 87,581
========= ===========
</TABLE>
See accompanying notes to interim consolidated financial statements
4
<PAGE>
ACE LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. General
The interim 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
normal 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
1997 Annual Report on Form 10-K.
On January 2, 1998, the Company completed the acquisition of ACE USA, Inc.
(formerly Westchester Specialty Group, Inc.) ("ACE USA"), through its
newly-created U.S. holding company, ACE US Holdings, Inc ("ACE US"). ACE
USA, through its insurance subsidiaries, provides specialty commercial
property and umbrella liability coverages in the U.S. Under the terms of
the agreement, the Company purchased all of the outstanding capital stock
of ACE USA for aggregate cash consideration of $338 million. In connection
with the acquisition, National Indemnity, a subsidiary of Berkshire
Hathaway, has provided $750 million (75 percent quota share of $1 billion)
of reinsurance protection to ACE USA with respect to its loss reserves for
the 1996 and prior accident years. The Company financed the transaction
with $250 million of bank debt (see note 7 - Credit Facilities) and the
remainder with available cash. The total purchase price is allocated to the
acquired assets and liabilities based on their fair values and accordingly,
the consolidated financial statements of the company include the results of
ACE US and its subsidiaries from January 2, 1998, the date of acquisition.
On March 26, 1998 the Company announced that it had entered into an
agreement with CAT Limited to acquire all of the outstanding capital stock
of CAT Limited, a privately held, Bermuda-based property catastrophe
reinsurer. The Company completed the transaction on April 1, 1998 for an
aggregate cash consideration of approximately $711 million. The acquisition
was financed with $385 million of short-term bank debt (see note 7 - Credit
Facilities) and from available cash. The acquisition will be recorded using
the purchase method of accounting and accordingly, the consolidated
financial statements of the company will include the results of CAT Limited
from April 1, 1998, the date of acquisition. It is estimated that
approximately $200 million of goodwill will arise as a result of the
acquisition.
At March 31, 1998 approximately 69 percent of the Company's written
premiums came from North America with approximately 13 percent coming
from the United Kingdom and continental Europe and approximately 18
percent from other countries.
2. Significant Accounting Policies
a) Earnings per share
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings per Share". Statement 128
replaced the previously reported primary and fully diluted earnings per
share with basic and diluted earnings per share. Basic earnings per share
is calculated utilising weighted average shares outstanding and exclude any
dilutive effects of options, warrants and convertible securities. Diluted
earnings per share include the effect of dilutive securities outstanding .
All earnings per share amounts for all periods presented, where necessary,
have been restated to conform to the Statement 128 requirements.
b) Reinsurance
Reinsurance recoverables include the balances due from reinsurance
companies for paid and unpaid losses and loss expenses that will be
recovered from reinsurers, based on reinsurance policies in force. A
reserve for uncollectible reinsurance is determined based upon a review of
the financial condition of the insurers and reinsurers and an assessment of
other available information.
5
<PAGE>
ACE LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
2. Significant Accounting Policies (cont'd)
c) Income Taxes
Income taxes have been provided in accordance with the provisions of FAS No.
109, "Accounting for Income Taxes" on those operations which are subject to
income taxes (see - Note 9). Deferred tax assets and liabilities result from
temporary differences between the amounts recorded in the consolidated
financial statements and the tax bases of the Company's assets and
liabilities. Such temporary differences are primarily due to the tax basis
discount on unpaid losses, adjustment for unearned premiums, uncollectible
reinsurance, and tax benefits of net operating loss carryforwards.
Additionally, the effect on deferred tax assets and liabilities of a change in
tax rates is recognized in the income in the period that includes the
enactment date. A valuation allowance against deferred tax assets is recorded
if it is more likely than not, all or some portion of the benefits related to
deferred tax assets will not be realized.
3. Commitments and Contingencies
A number of the Company's insureds have given notice of claims relating to
breast implants or components or raw material thereof that had been produced
and/or sold by such insureds. Lawsuits including class actions, involving
thousands of implant recipients have been filed in both state and federal
courts throughout the United States. Most of the federal cases have been
consolidated pursuant to the rules for Multidistrict Litigation to a Federal
District Court in Alabama, although cases are in the process of being
transferred back to federal courts or remanded in state courts.
On May 15, 1995, the Dow Corning Corporation, a significant defendant,
filed for protection under Chapter 11 of the U.S. Bankruptcy Code and
claims against Dow Corning remain stayed subject to the Bankruptcy Code.
On October 1, 1995, negotiators for three of the major defendants agreed on
the essential elements of a revised individual settlement plan for U.S.
claimants with at least one implant from any of those manufacturers ("the
Settlement"). In general, under the Settlement, the amounts payable to
individual participants, and the manufacturers' obligations to make those
payments, would not be affected by the number of claimants electing to opt out
from the new plan. Also, in general, the compensation would be fixed and not
affected by the number of participants, and the manufacturers would not have a
right to walk away because of the amount of claims payable. Finally, each
settling defendant agreed to be responsible only for cases in which its
implant was identified, and not for a percentage of all claims.
By November 13, 1995, the Settlement was approved by the three major
defendants. In addition, two other defendants became part of the Settlement,
although certain of their settlement terms are different and more restricted
than the plan offered by the original three defendants.
On December 22, 1995, the multidistrict litigation judge approved the
Settlement and the materials for giving notice to claimants. Beginning in
mid-January, 1996, the three major defendants have each made payments to a
court-established fund for use in making payments under the Settlement. The
Settlement Claims Office had reported that as of October 31, 1997, it has sent
out Notification of Status Letters to more than 360,000 non-opt-out domestic
implant recipients who had registered with the Settlement Claims Office. As of
October 31, 1997, approximately $565 million had been distributed under the
Settlement to implant recipients of the three major defendants; in addition,
in January 1998 the Settlement Claims Office made a payment of approximately
$110 million as a second annual installment of approved benefits under the
Settlement. The multidistrict litigation judge has also directed that
distribution begin on certain additional payments to claimants relating to
other implants since all appeals on the Settlement have now been dismissed.
The Settlement Claims Office has also reported that approximately 32,500
domestic registrants exercised opt-out rights after receiving their status
letters. Previously, approximately 19,000 other domestic implant recipients
had exercised opt-out rights in 1994 and/or before receiving status letters.
At June 30, 1994, the Company increased its then existing reserves relating to
breast implant claims. Although the reserve increase was partially satisfied
by an allocation from existing IBNR, it also required an increase in the
Company's total reserve for unpaid losses and loss expenses at June 30, 1994
of $200 million. The increase in reserves was based on information made
available in conjunction with the lawsuits and information made available from
the Company's insureds and was predicated upon an allocation between coverage
provided before and after the end of 1985 (when the Company commenced
underwriting operations). No additional reserves relating to breast implant
claims have been added since June 30, 1994.
6
<PAGE>
ACE LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
3. Commitments and Contingencies (cont'd.)
The Company continually evaluates its reserves in light of developing
information and in light of discussions and negotiations with its insureds.
During fiscal 1997 and the first six months of fiscal 1998, the Company made
payments of approximately $260 million with respect to breast implant claims.
These payments were included in previous reserves and are consistent with the
Company's belief that its reserves are adequate. Significant uncertainties
continue to exist with regard to the ultimate outcome and cost of the
Settlement and value of the opt-out claims. While the Company is unable at
this time to determine whether additional reserves, which could have a
material adverse effect upon the financial condition, results of operations
and cash flows of the Company, may be necessary in the future, the Company
believes that its reserves for unpaid losses and loss expenses including those
arising from breast implant claims are adequate as at March 31, 1998.
4. Shares Issued and Outstanding
The Board of Directors has authorized the repurchase from time to time of the
Company's Ordinary Shares in open market and private purchase transactions. On
May 9, 1997 the Board of Directors terminated the then existing share
repurchase program and authorized a new share program for up to $300 million
of the Company's Ordinary Shares. During the six month period ended March 31,
1998, the Company repurchased 3,521,100 Ordinary Shares under the share
repurchase program for an aggregate cost of $107.6 million. As at March 31,
1998, approximately $160.1 million of the Board authorization had not been
utilized.
On March 2, 1998 the Company effected a three for one split of the
Company's Ordinary Shares.
5. Restricted Stock Awards
Under the terms of the 1995 Long-Term Incentive Plan 264,000 restricted
Ordinary Shares were awarded during the six months ended March 31, 1998, to
officers of the Company and its subsidiaries. These shares vest at various
dates through November 2002. In addition during the period, 14,952 restricted
Ordinary Shares were awarded to outside directors under the terms of the 1995
Outside Directors Plan. These shares vest in February 1999.
6. Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share.
All share and per share amounts have been restated to reflect the three for
one split of the Company's Ordinary Shares effected on March 2, 1998.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
March 31 March 31
1998 1997 1998 1997
---- ---- ---- ----
(In thousands of U.S. dollars except share
and per share data)
<S> <C> <C> <C> <C>
Numerator:
Net Income $ 236,205 $ 77,949 $ 349,021 $ 203,690
=========== ========= ========== =========
Denominator:
Denominator for basic
earning per share -
Weighted average shares
outstanding 162,860,328 171,996,927 163,765,734 173,655,336
Effect of dilutive
securities 4,124,388 2,340,390 4,012,446 2,147,358
----------- ----------- ----------- -----------
Denominator for diluted
earnings per share -
Adjusted weighted average
shares outstanding and
assumed conversions 166,984,716 174,337,317 167,778,180 175,802,694
=========== =========== =========== ===========
Basic earnings per share $ 1.45 $ 0.45 $ 2.13 $ 1.17
==== ==== ==== ====
Diluted earnings per share $ 1.41 $ 0.45 $ 2.08 $ 1.16
==== ==== ==== ====
</TABLE>
7
<PAGE>
ACE LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
7. Credit Facilities
In December 1997 the Company put in place syndicated credit facilities which
replaced the existing facilities. J.P. Morgan Securities, Inc. and Mellon
Bank N.A. acted as co-arrangers of these credit facilities. The new facilities
provide:
* A $200 million 364 day revolving credit facility and a $200 million five
year revolving credit facility which together make up a combined $400
million committed, unsecured revolving credit facility. This new five
year revolving credit facility has a $50 million LOC sublimit. As
discussed in note 1, the Company drew down on this facility to finance
the acquisition of CAT Limited on April 1, 1998. The debt was
subsequently repaid from a portion of the proceeds from the sale of
16.5 million new Ordinary Shares of the Company. See note 10 -
Subsequent Event.
* A five year LOC of approximately (pound)154 million ($260 million) which
is being used to fulfill the requirements of Lloyd's to provide funds
to support underwriting capacity on Lloyd's syndicates in which the
Company participates. The minimum consolidated tangible net worth
required for A.C.E. Insurance Company, Ltd. under this LOC is $1.0
billion.
* A $250 million seven year Amortizing Term Loan Facility which was used
on January 2, 1998 to partially finance the acquisition of ACE USA.
The interest rate on the term loan is LIBOR plus an applicable spread.
As of March 31, 1998, $250 million was outstanding under this
facility. The interest rate for the period January 2, 1998 through
April 2, 1998 was 6.3125%.
The revolving credit and term loan facilities require that the Company
maintain a minimum consolidated tangible net worth of $1.4 billion.
8. Reinsurance
The Company purchases reinsurance to manage various exposures including
catastrophic risks. The Company significantly increased its use of
reinsurance during the six months ended March 31, 1998. 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. Net premiums written
and net premiums earned, reported in the statements of operations, are net
of reinsurance. Direct, assumed and ceded amounts for these items for the
six months ended March 31, 1998 and 1997 are as follows:
1998 1997
---- ----
(In thousands of U.S. dollars)
Premiums written
Direct $ 278,739 $ 257,395
Assumed 134,363 78,450
Ceded (89,476) (36,643)
-------- --------
Net premiums written $ 323.626 $ 299,202
======= =======
Premiums earned
Direct $ 289,701 $ 279,240
Assumed 151,085 74,109
Ceded (88,219) (30,308)
------- -------
Net premiums earned $ 352,567 $ 323,041
======= =======
8
<PAGE>
ACE LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
8. Reinsurance (cont'd.)
The Company's provision for reinsurance recoverables, in respect of the ACE
USA book of business, at March 31, 1998 and at September 30, 1997 are as
follows:
1998 1997
---- ----
(in thousands of U.S. dollars)
Reinsurance recoverables on paid
losses and loss expenses: $ 19,696 $ -
Reinsurance recoverables on unpaid
losses and loss expenses: 751,527 -
------- ------
Total Reinsurance recoverables: $ 771,223 $ -
========== =======
9. Taxation
Under current Cayman Islands law, the Company is not required to pay any
taxes 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 on its income or capital gains. 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. ACE USA is subject to income taxes imposed by
U.S. authorities.
The provision for income taxes of $2.9 million represents the Company's
estimate of tax liability in respect of the Company's operations at Lloyd's
and at ACE USA and is calculated at a rate equal to the statutory income
tax rate.
The income tax provision for the six months ended March 31, 1998 and 1997 is
as follows:
1998 1997
(in thousands of U.S. dollars)
Current tax expense $ 865 $ -
Deferred tax expense 2,082 -
----- -------
Provision for income taxes $2,947 $ -
===== =====
9
<PAGE>
ACE LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
9. Taxable (cont'd.)
The components of the net deferred tax asset as of March 31, 1998 and
September 30, 1997 is as follows:
1998 1997
(in thousands of U.S. dollars)
Deferred tax assets
Loss reserve discount $ 59,116 $ -
Unearned premium adjustment 3,046 -
Uncollectable reinsurance 2,786 -
Other 19,055 -
----- ------
Total deferred tax assets $ 84,003 -
------ -------
Deferred tax liabilities
Deferred policy acquisition costs $ 3,084 -
Other 6,379 -
----- -------
Total deferred tax liabilities $ 9,463 -
----- -------
Net deferred tax asset $ 74,540 $ -
====== =======
10. Subsequent Event
On April 17, 1998, the Company sold 16.5 million new Ordinary Shares for
total net proceeds of approximately $605.8 million after deducting expenses
related to the offering. A portion of the proceeds was used to repay $385
million of indebtedness incurred by the Company in connection with the
acquisition of CAT Limited and the remaining proceeds will be used for
general corporate purposes. (For further discussions, see "Management's
Discussion and Analysis - Liquidity and Capital Resources".)
11. Reclassification
Certain items in the prior period financial statements have been
reclassified to conform with the current period presentation.
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
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 six months ended March 31, 1998. 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 1997 Annual Report on Form 10-K.
ACE Limited ("ACE") is a holding company which, through its Bermuda-based
operating subsidiaries, A.C.E. Insurance Company, Ltd. ("ACE Insurance"),
Corporate Officers & Directors Assurance Ltd. ("CODA") and Tempest
Reinsurance Company Limited ("Tempest"), provides insurance and reinsurance
for a diverse group of international clients. Through its U.S. based
subsidiary, ACE USA, Inc. (formerly Westchester Speciality Group, Inc.)
("ACE USA"), the Company provides commercial and umbrella coverages to a
broad range of clients in the United States. In addition, the Company
provides funds at Lloyd's to support underwriting by Lloyd's syndicates
managed by Methuen Underwriting Limited, ("MUL") ACE London Aviation
Limited ("ALA") and ACE London Underwriting Limited ("ALU"), each indirect
wholly owned subsidiaries of ACE. The term "the Company" refers to ACE and
its subsidiaries, excluding MUL, ALA and ALU.
The Lloyd's syndicates managed by these agencies in which the Company
participates underwrite aviation, marine and non-marine risks. For the
1996, 1997 and 1998 years of account, the Company, through corporate
subsidiaries, has or will participate in the underwriting of these
syndicates by providing funds at Lloyd's, primarily in the form of a letter
of credit, supporting approximately $37 million, $229 million and $485
million, respectively, of underwriting capacity. Underwriting capacity is
the amount of gross premiums that a syndicate at Lloyd's can underwrite in
a given year of account. However, a syndicate is not required to fully
utilize all of the capacity and it is not unusual for capacity utilization
to be significantly lower than 100 percent.
On January 2, 1998, the Company completed the acquisition of ACE USA,
through its newly-created U.S. holding company, ACE US Holdings, Inc. ("ACE
US"). ACE USA, through its insurance subsidiaries, provides specialty
commercial property and umbrella liability coverages in the U.S. Under the
terms of the acquisition agreement, the Company purchased all of the
outstanding capital stock of ACE USA for aggregate cash consideration of
$338 million. In connection with the acquisition, National Indemnity, a
subsidiary of Berkshire Hathaway, has provided $750 million (75 percent
quota share of $1 billion) of reinsurance protection to ACE USA with
respect to their loss reserves for the 1996 and prior accident years (see
"Liquidity and Capital Resources").
On March 11, 1998, the Company announced the formation of a joint venture,
ACE Capital Re Limited, with Capital Re Corporation ("Capital Re"). ACE
Capital Re Limited, a Bermuda-domiciled professional insurance company,
will write both traditional and custom-designed programs covering financial
guaranty, mortgage guaranty and a broad range of financial risks.
Operations will be underwritten and managed in Bermuda by a joint venture
managing agency, ACE Capital Re Managers Ltd. The Company and Capital Re
each have a 50 percent economic interest in ACE Capital Re Limited and ACE
Capital Re Managers Ltd.
On March 26, 1998 the Company announced that it had entered into an
agreement with CAT Limited to acquire all of the outstanding capital stock
of CAT Limited, a privately held, Bermuda-based property reinsurer. The
Company completed the transaction on April 1, 1998 for an aggregate cash
consideration of approximately $711 million. The acquisition was financed
with $385 million of short-term bank debt and available cash. CAT Limited
will be integrated with ACE's existing property catastrophe subsidiary,
Tempest and the combined property catastrophe reinsurance operations
will operate under the Tempest name.
The Company will continue to evaluate potential new product lines and other
opportunities in the insurance and reinsurance markets.
11
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Safe Harbor Disclosure
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements. This Form 10-Q or any other 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 in documents filed by the Company with the Securities and
Exchange Commission) include, but are not limited to, (i) uncertainties
relating to government and regulatory policies (such as subjecting the Company
to insurance regulation or taxation in additional jurisdictions), (ii) the
occurrence of catastrophic events with a frequency or severity exceeding the
Company's estimates, (iii) the legal environment, (iv) the uncertainties of the
reserving process, (v) loss of the services of any of the Company's executive
officers, (vi) changing rates of inflation and other economic conditions, (vii)
losses due to foreign currency exchange rate fluctuations, (viii) ability to
collect reinsurance receivables and (ix) the competitive environment
in which the Company operates. The words "believe", "anticipate",
"project", "plan", "expect", "intend", "will likely result" or "will continue"
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 revise any forward-looking statements, whether as a result
of new information, future events or otherwise.
<TABLE>
<CAPTION>
Results of Operations - Three Months ended March 31, 1998
Net Income
Three Months ended % Change
March 31 from
1998 1997 Prior year
------ ------ ----------
(in millions)
<S> <C> <C> <C>
Income excluding net realized gains
(losses) on investments $ 90.6 $ 80.3 12.8%
Net realized gains (losses) on investment 145.6 (2.3) N.M.
----- ------- -------
Net income $ 236.2 $ 78.0 N.M.
===== ==== =======
(N.M. - Not meaningful)
</TABLE>
Income excluding net realized gains (losses) on investments for the second
quarter of fiscal 1998 increased by 12.8 percent, compared with the
corresponding fiscal 1997 quarter. This increase is predominantly the
result of the inclusion of the results of ACE USA following its acquisition
on January 2, 1998, as well as increases in net investment income and
income from insurance operations from the other operating companies in the
ACE group.
12
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Results of Operations - Three Months ended March 31, 1998 (continued)
Net income for the current quarter benefited from positive movements in the
investment markets which produced net realized gains on investments of
$145.6 million in the quarter.
<TABLE>
<CAPTION>
Premiums
Three Months ended % Change
March 31 from
1998 1997 Prior year
------ ------ ----------
(in millions)
<S> <C> <C> <C>
Gross premiums written:
ACE Insurance (including CODA) $ 123.4 $ 126.5 (2.5)%
Lloyd's syndicates 29.0 4.3 N.M.
Property catastrophe (Tempest) 51.8 72.5 (28.5)%
ACE USA 38.7 - N.M.
------ ------- -------
$ 242.9 $ 203.3 19.4%
===== ===== =======
Net premiums written:
ACE Insurance (including CODA) $ 108.8 $ 113.4 (4.0)%
Lloyd's syndicates 19.6 2.7 N.M.
Property catastrophe (Tempest) 47.6 72.5 (34.5)%
ACE USA 20.6 - N.M.
------ ------- ------
$ 196.6 $ 188.6 4.2%
===== ===== =====
Net premiums earned:
ACE Insurance (including CODA) $ 112.1 $ 123.0 (8.9)%
Lloyd's syndicates 26.8 4.6 N.M.
Property catastrophe (Tempest) 21.1 31.0 (31.9)
ACE USA 24.8 - N.M.
------ ------- -------
$ 184.8 $ 158.6 16.5%
===== ===== =======
(N.M. - Not meaningful)
</TABLE>
Gross premiums written increased by 19.4 percent to $242.9 million in the
quarter ended March 31, 1998 compared with $203.3 million in the quarter
ended March 31, 1997. This increase is a result of contributions from ACE
USA which was acquired by the Company on January 2, 1998 and contributed
$38.7 million of gross written premiums in the quarter and an increase of
$24.7 million in gross premiums written with respect to the Company's
participation in the Lloyd's syndicates managed by ACE London at Lloyd's.
This growth in ACE London premiums, which was achieved despite continuing
price competition in the Lloyd's market, is a result of the Company's
increased participation in the syndicates under management. Gross premiums
written in ACE Insurance remained relatively flat in the quarter compared
with the comparable quarter last year as most lines of business continued
to experience competitive pressures. Gross premiums written in the
financial lines division increased during the quarter compared to 1997.
This increase was offset by a continuing decline in the excess liability
line of business and a decrease in the satellite premiums written. The
decline in excess liability is the result of non-renewed accounts, premium
adjustments and pricing changes resulting primarily from increases in
attachment points and decreases in limits provided. While this has resulted
in decreasing premiums, it continues to reduce the Company's exposure and
improve its risk profile. The majority of the decline in satellite premiums
written was due to lower launch exposures. Tempest experienced continuing
price pressures on its January 1998 renewals and due to inadequate pricing
Tempest did not renew several of its accounts. This price pressure resulted
in a decline in gross written premiums in the quarter of $20.7 million or
28.5 percent compared to the comparable quarter last year.
13
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
Results of Operations - Three Months ended March 31, 1998 (continued)
Net premiums written increased by $8.0 million to $196.6 million this
quarter from $188.6 million in the quarter ended March 31, 1997, an
increase of 4.2 percent. This increase was the result of increases in the
Company's participation in the Lloyd's syndicates managed by ACE London at
Lloyd's and the contribution of ACE USA in the quarter offset by a decline
in net premiums written in A.C.E. Insurance of 4.0 percent in the quarter
compared to the second quarter of fiscal 1997. The decline at A.C.E.
Insurance is primarily the result of the continuing decline in excess
liability premiums and a drop in satellite premiums in the quarter, offset
somewhat by growth in premiums from the financial lines division. The Company
increased its purchase of reinsurance to protect the Company's individual
business segments. Net premiums written in several divisions in ACE Insurance
were affected by the purchase of reinsurance. In particular, during the quarter,
the excess liability division purchased a 25 percent quota share reinsurance
treaty and also put in place an excess of loss treaty that limits the
retained risks on a single occurrence to $100 million. In addition, the
satellite division purchased additional reinsurance this quarter to cover
catastrophic events. ACE USA also increased its use of reinsurance during the
quarter. Net premiums written in Tempest also declined due primarily to
continuing price pressures.
Net premiums earned increased to $184.8 million compared with $158.6
million last year, an increase of 16.5 percent. This increase was a result
of the contribution of ACE USA in the quarter as well as a $22.2 million
increase in net premiums earned from our Lloyd's syndicate participation.
This increase was offset somewhat by declines in earned premiums in ACE
Insurance and in the property catastrophe business in Tempest.
Net Investment Income
Three Months ended % Change
March 31 from
1998 1997 Prior year
---- ---- ----------
(in millions)
Net investment income $ 73.1 $ 58.1 25.9%
==== ==== =====
Net investment income increased to $73.1 million in the quarter compared to
$58.1 million in the quarter ended March 31, 1997. This increase is mainly
due to the inclusion of investment income from ACE USA, for the first time
this quarter, which totalled $13.7 million. Excluding the effect of ACE
USA, net investment income increased by 2.2 percent.
Net Realized Gains (Losses) on Investment
Three Months ended
March 31
1998 1997
---- ----
(in millions)
Fixed maturities and short-term investments $ 12.1 $ 10.8
Equity securities 87.5 5.3
Financial futures and option contracts 50.5 (8.4)
Currency (4.5) (10.0)
------- -------
$ 145.6 $ (2.3)
====== =======
14
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
Results of Operations - Three Months ended March 31, 1998 (continued)
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 shareholders'
equity.
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. 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) on
investments in the period in which the fluctuations occur, together with
net foreign currency gains and losses recognized when non-U.S. dollar
securities are sold.
The sales proceeds for fixed maturity securities were generally higher than
their amortized cost during most of the quarter which resulted in net
realized gains of $12.1 million being recognized on fixed maturities and
short-term investments.
Strong U.S. equity markets, and the liquidation of two domestic stock
portfolios during the quarter, contributed significantly to net realized
gains on sales of equity securities of $87.5 million in the second quarter
of fiscal 1998, compared with gains of $5.3 million in the second quarter
of fiscal 1997.
Proceeds from the liquidated stock portfolios were placed in synthetic
equity funds, increasing the Company's use of equity index futures
contracts during the quarter. In the second quarter of fiscal 1998, the
equity stock indices rose approximately 13 percent and net realized gains
on equity index futures contracts of $48.9 million were generated. The
remainder of the net realized gains on financial futures and option
contracts in the second quarter of fiscal 1998 arose from gains recognized
on futures contracts used by certain of the Company's external managers of
fixed income securities. Net realized losses on financial futures contracts
of $8.4 million recorded in the second quarter of fiscal 1997 were
primarily generated by the futures contracts used by the Company's external
managers of fixed income securities to manage duration and yield curve
exposures.
Combined Ratio
Three Months ended
March 31
1998 1997
---- ----
(in millions)
Loss and loss expense ratio 62.9% 66.4%
Underwriting and administrative expense ratio 23.5 19.6
----- -----
Combined ratio 86.4% 86.0%
==== ====
15
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
Results of Operations - Three Months ended March 31, 1998 (continued)
The underwriting results of a property and casualty insurer are discussed
frequently by reference to its loss and loss expense ratio, underwriting
and administrative expense ratio and combined 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 the administrative expense ratio. A combined ratio under
100 percent indicates underwriting profits and a combined ratio exceeding
100 percent indicates underwriting losses. Property catastrophe reinsurance
companies generally expect to have overall lower combined ratios as
compared with other reinsurance companies with long-tail exposures.
However, property catastrophe loss experience is generally characterized by
low frequency but high severity short-tail claims which may result in
significant volatility in results.
Several aspects of the Company's operations, including the low frequency
and high severity of losses in the high excess layers in certain lines of
business in which the Company provides insurance and reinsurance,
complicate the actuarial reserving techniques utilized by the Company.
Management believes, however, that the Company's reserves for unpaid losses
and loss expenses, including those arising from breast implant litigation,
are adequate to cover the ultimate cost of losses and loss expenses
incurred through March 31, 1998. Since such provisions are necessarily
based on estimates, future developments may result in ultimate losses and
loss expenses significantly greater or less than such amounts (see "Breast
Implant Litigation").
For the quarter ended March 31, 1998, the loss and loss expense ratio
decreased to 62.9 percent from 66.4 percent for the second quarter of
fiscal 1997. This decline is partly due to the fact that Tempest had very
little loss activity in the quarter, the inclusion of ACE USA whose
business is predominantly property and the continuing change in the mix of
insurance business in ACE Insurance.
Acquisition costs increased by $4.9 million mainly due to the inclusion of
$2.4 million of acquisition costs from ACE USA as well as the increase in
earned premiums and acquisition costs from the Lloyd's participation in the
quarter. Administrative expenses increased by $7.3 million in the current
quarter compared to the second quarter of fiscal 1997. This was due primarily
to the costs associated with our increased participation in the Lloyd's market
and the inclusion of administrative cost from ACE USA for the first time this
quarter of $6.5 million. The underwriting and administrative expense ratio
increased compared to the previous year primarily because the underwriting and
administrative expense ratios generated by ACE USA and ACE UK are generally
higher then the traditional book of business.
16
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
Results of operations - Six Months ended March 31, 1998
Net Income
Six Months ended % Change
March 31 from
1998 1997 Prior year
---- ---- ----------
(in millions)
Income excluding net realized gains
(losses) in investments $ 175.9 $ 164.3 7.1%
Net realized gains (losses) on investments 173.1 39.4 N.M.
----- ----- -----
Net income $ 349.0 $ 203.7 N.M.
===== ===== =====
(N.M. - not meaningful)
Income excluding net realized gains (losses) on investments for the six
months ended March 31, 1998 increased by 7.1 percent compared with the
corresponding period of fiscal 1997. The increase in investment income and
income from insurance operations were primarily attributable to the
inclusion of the results of ACE USA in the current period as well as
increases in net investment income and income from insurance operations
from the other operating companies in the ACE Group.
Premiums
Six Months ended % Change
March 31 from
1998 1997 Prior year
---- ---- ----------
(in millions)
Gross premiums written:
ACE Insurance (including CODA) $ 250.9 $ 251.1 (0.10)%
Lloyd's syndicates 71.6 10.5 N.M.
Property catastrophe (Tempest) 51.9 74.2 (30.0)
ACE USA 38.7 - N.M.
----- ----- -----
$ 413.1 $ 335.8 23.0%
===== ===== ======
Net premiums written:
ACE Insurance (including CODA) $ 203.6 $ 218.5 (6.8)%
Lloyd's syndicates 51.8 6.5 N.M.
Property catastrophe (Tempest) 47.6 74.2 (35.9)%
ACE USA 20.6 - N.M.
---- ----- -----
$ 323.6 $ 299.2 8.1%
===== ===== =====
Net premiums earned:
ACE Insurance (including CODA) $ 231.7 $ 249.0 (6.9)%
Lloyd's syndicates 46.6 6.9 N.M.
Property catastrophe (Tempest) 49.5 67.1 (26.2)
ACE USA 24.8 - N.M.
----- ------- -------
$ 352.6 $ 323.0 9.1%
======= ========== =======
(N.M. - Not meaningful)
17
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
Results of operations - Six Months ended March 31, 1998
Gross premiums written increased by 23.0 percent to $413.1 million in the
six months ended March 31, 1998 compared with $335.8 million in the six
month period ended March 31, 1997. This increase is mainly a result of the
contribution from ACE USA of $38.7 million in the period and an increase of
$61.1 million in gross premiums written with respect to the Company's
participation in the Lloyd's syndicates managed by ACE London at Lloyd's.
This growth, which was achieved despite continuing price competition in the
Lloyd's market, is a result of the Company's increased participation in the
syndicates under management. Gross premiums written in ACE Insurance were
flat compared with the similar period last year as most lines of business
continued to experience competitive pressures. However, the mix of premiums
written in ACE Insurance continues to change. Gross premiums written from
the financial lines division increased during the six month period.
Premiums from the satellite division increased as launch activity was
strong in the period. These increases were offset by continuing declines in
the directors and officers liability and excess liability lines of
business. The decline in excess liability is mainly the result of
non-renewed accounts, premium adjustments and pricing changes resulting
primarily from increases in attachment points and decreases in limits
provided. While this has resulted in decreasing premiums, it has also led
to a reduction in the Company's exposure and an improved risk profile. As
Tempest renewals primarily occur in January and July of each year premium
transactions were minimal during the first fiscal quarter. Tempest
experienced continuing price pressures on its January 1998 renewals, their
largest renewal period and due to inadequate pricing Tempest did not renew
several of its accounts. This price pressure resulted in a decline in gross
written premiums in the period of $22.3 million or 30.0 percent compared to
the comparable period last year.
Net premiums written increased by $24.4 million, or 8.1 percent, to $323.6
million from $299.2 million in the six month period ended March 31, 1998
compared to the first six months of fiscal 1997. This increase was the
result of increases in the Company's participation in the Lloyd's
syndicates managed by ACE London at Lloyd's and the contribution of ACE USA
in the period. Net premiums written in ACE Insurance declined by $14.9
million or 6.8 percent in the period compared to the same period last year.
This decline is primarily the result of continuing declines in directors
and officers liability and excess liability premiums, as described above in
the discussion of gross written premiums, offset somewhat by growth in net
premiums written from the satellite and financial lines divisions. Net premiums
written were affected by a significant increase in the use of reinsurance
during the period. The increased use of reinsurance was seen at ACE USA and in
several divisions of ACE Insurance. In particular, the excess liability
division of ACE Insurance has purchased a 25 percent quota share reinsurance
treaty and also put in place an excess of loss treaty that limits the retained
risks on a single occurrence to $100 million. In addition, the satellite
division of ACE Insurance purchased additional reinsurance in the second
quarter to cover catastrophic events.
Net premiums earned increased to $352.6 million compared to $323.0 million
last year, an increase of 9.1 percent. This increase was a result of the
contribution of ACE USA in the second quarter as well as a $39.7 million
increase in net premiums earned from our Lloyd's syndicate participation.
This increase was partially offset by declines in earned premiums in ACE
Insurance and in the property catastrophe business in Tempest.
Net Investment Income
Six Months ended % Change
March 31 from
1998 1997 Prior year
---- ---- ----------
(in millions)
Net investment income $ 131.5 $ 117.8 11.6%
===== ===== =====
18
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
Results of operations - Six Months ended March 31, 1998
Net investment income increased by $13.7 million or 11.6 percent in the
current period, as compared with the similar period of fiscal 1997, as a
result of a larger investable asset base due to the inclusion of the ACE
USA portfolio in the current period as well as positive cash flows from
operations.
Net Realized Gains(Losses) on Investment
Six Months ended
March 31
1998 1997
---- ----
(in millions)
Fixed maturities and short-term investments $ 33.5 $ 32.3
Equity securities 94.8 9.5
Financial futures and option contracts 59.2 9.2
Currency (14.4) (11.6)
------ ------
$ 173.1 $ 39.4
===== ======
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 shareholders'
equity.
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. 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 most of the period which resulted in net
realized gains of $33.5 million being recognized on fixed maturities and
short-term investments compared to net realized gains of $32.3 million for
the same period last year.
Strong U.S. equity markets, and the liquidation of two domestic stock
portfolios during the period, contributed significantly to net realized
gains on sales of equity securities of $94.8 million in the first six
months of fiscal 1998, compared with gains of $9.5 million in the first six
months of 1997.
Proceeds from the liquidated stock portfolios were placed in synthetic
equity funds, increasing the Company's use of equity index futures
contracts during the period. Increases in the equity stock indices and the
use of equity index futures contracts during the period, generated net
realized gains of $52.9 million. The remainder of the net realized gains on
financial futures and option contracts during the period, arose from gains
recognized on futures contracts used by certain of the Company's external
managers of fixed income securities.
19
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
Results of operations - Six Months ended March 31, 1998
Combined Ratio
Six Months ended
March 31
1998 1997
---- ----
(in millions)
Loss and loss expense ratio 63.9% 66.7%
Underwriting and administrative expense ratio 21.6 18.9
----- -----
Combined Ratio 85.5% 85.6%
===== =====
For the six months ended March 31, 1998, the loss and loss expense ratio
was 63.9 percent compared to 66.7 percent for the six months ended March
31, 1997. The ratio for the current period is impacted by the inclusion of
the results of ACE USA, whose business is predominantly property, and by
the results of Tempest which saw little loss activity. Property catastrophe
loss experience is generally characterized by low frequency but high
severity short-tail claims which may result in significant volatility in
results. Several aspects of the Company's operations, including the low
frequency and high severity of losses in the high excess layers in certain
lines of business in which the Company provides insurance and reinsurance,
complicate the actuarial reserving techniques utilized by the Company.
Management believes, however, that the Company's reserves for unpaid losses
and loss expenses, including those arising from breast implant litigation,
are adequate to cover the ultimate cost of losses and loss expenses
incurred through March 31, 1998. Since such provisions are necessarily
based on estimates, future developments may result in ultimate losses and
loss expenses significantly greater or less than such amounts (see "Breast
Implant Litigation").
Acquisition costs increased by $5.0 million during the period, due
primarily to the continuing change in the mix of business written by the
Company and the inclusion of $2.5 million in acquisition costs from ACE
USA. Administrative expenses increased by $9.8 million in the current
period, compared to the six month period ended March 31, 1997. These
additional expenses are primarily due to the increased cost base resulting
from the strategic diversification by the Company over the past two years,
including the recent acquisition of ACE USA, which accounted for $6.5
million of the increase. The underwriting and administrative expense in ACE
USA and ACE UK is generally higher then the Company's traditional book of
business and thus contributed to the increase in the underwriting and
administrative expense ratio.
20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
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 shareholder's equity at a
level adequate to support the level of insurance and reinsurance
operations. During December 1997 ACE received a dividend of $115 million
from Tempest.
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 and for share
repurchases.
For the six months ended March 31, 1998, the Company's consolidated net
cash flow from operating activities was $114.8 million, compared with
$216.7 million for the six months ended March 31, 1997. Cash flows are
affected by claims payments, which due to the nature of the insurance and
reinsurance coverage provided by the Company, may comprise large loss
payments on a limited number of claims and can therefore fluctuate
significantly. The irregular timing of these large loss payments, for which
the source of cash can be from operations, available credit facilities or
routine sales of investments, can create significant variations in cash
flow from operations between periods. For the six month periods ended March
31, 1998 and 1997, loss and loss expense payments amounted to $213.2
million and $125.6 million respectively. Total loss and loss expense
payments amounted to $402.1 million, $101.4 million and $73.1 million in
fiscal years 1997, 1996 and 1995, respectively.
At March 31, 1998, total investments and cash amounted to approximately
$5.4 billion, compared to $4.5 billion at September 30, 1997.
The Company's investment portfolio is structured to provide a high level of
liquidity to meet insurance related or other obligations. The consolidated
investment portfolio is externally managed by independent professional
investment managers and is invested in high quality investment grade
marketable fixed income and equity securities, the majority of which trade
in active, liquid markets. The Company believes that its cash balances,
cash flow from operations, routine sales of investments and the liquidity
provided by its credit facilities (discussed below) are adequate to allow
the Company to pay claims within the time periods required under its
policies.
During December 1997, the Company put in place syndicated credit facilities
which replaced the existing facilities. J.P. Morgan Securities, Inc. and
Mellon Bank N.A. acted as co-arrangers of these credit facilities. The new
facilities provide:
* $200 million 364 day revolving credit facility and a $200 million five
year revolving credit facility which together make up a combined $400
million committed, unsecured revolving credit facility. This new five
year revolving credit facility has a $50 million LOC sublimit. As
discussed in note 1 to the Interim Consolidated Financial Statements,
the Company drew down on this facility to finance the acquisition of
CAT Limited on April 1, 1998. The debt was subsequently repaid from a
portion of the proceeds from the sale of 16.5 million new Ordinary
Shares of the Company. (See Note 10 to the Interim Consolidated
Financial Statements - Subsequent Events.)
21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
LIQUIDITY AND CAPITAL RESOURCES (continued)
* A five year LOC of approximately (pound)154 million ($260 million) which
is being used to fulfill the requirements of Lloyd's to provide funds
to support underwriting capacity on Lloyd's syndicates in which the
Company participates. The minimum consolidated tangible net worth
covenant for ACE Insurance under this LOC is $1.0 billion.
* $250 million seven year Amortizing Term Loan Facility which was used
on January 2, 1998 to partially finance the acquisition of ACE USA.
The interest rate on the term loan is LIBOR plus an applicable spread.
At March 31, 1998, $250 million remains outstanding under this
facility. The interest rate for the period January 2, 1998 through
April 2, 1998 was 6.3125%.
The revolving credit and term loan facilities require that the Company
maintain a minimum consolidated tangible net worth of $1.4 billion.
On November 13, 1997, the Board of Directors approved a special resolution
to split each outstanding Ordinary Share of the Company into three Ordinary
Shares. The stock split was voted on and approved by the shareholders of
the Company on February 6, 1998. The record date for determining those
shareholders entitled to receive certificates representing additional
shares pursuant to the Stock Split was as of close of business on February
17, 1998. Certificates representing the additional shares of stock were
mailed on March 2, 1998.
The Board of Directors has authorized the repurchase from time to time of
the Company's Ordinary Shares in open market and private purchase
transactions. On May 9, 1997, the Board of Directors terminated the then
existing share repurchase program and authorized a new program for up to
$300.0 million of the Company's Ordinary Shares. During the six months
ended March 31, 1998, the Company repurchased 3,521,100 Ordinary Shares
under the share repurchase program for an aggregate cost of $107.6 million,
leaving approximately $160.1 million of the Board authorization not
utilized.
On October 18, 1997 and January 16, 1998, the Company paid quarterly
dividends of 22 cents and 24 cents per share, respectively to shareholders
of record on September 30, 1997 and December 13, 1997. On February 6, 1998,
following approval by the shareholders of the three-for-one stock split,
the Board of Directors declared a quarterly dividend of 8 cents per share
payable on April 18, 1998 to shareholders of record on March 31, 1998. On
May 8, 1998 the Board of Directors declared a quarterly dividend of 9 cents
per share payable on July 17, 1998 to shareholders of record on June 30,
1998. 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.
As previously discussed, on January 2, 1998, the Company completed the
acquisition of ACE USA, through its newly-created U.S. holding company, ACE
US, for an aggregate cash consideration of $338 million. ACE US was
capitalized by ACE Limited with $75 million and received $35 million from
an inter-company loan. ACE US financed the acquisition of ACE USA with $250
million of bank debt (see discussion of syndicated credit facilities above)
and the remaining $88 million came from available funds.
Fully diluted net asset value per share was $17.15 at March 31, 1998,
compared with $15.71 at September 30, 1997.
The Company maintains loss reserves for the estimated unpaid ultimate
liability for losses and loss expenses under the terms of its policies and
agreements. With the inclusions of the reserve for unpaid losses and loss
expense of $1.4 million from ACE USA, the reserve for unpaid losses and loss
expenses is $3.3 billion at March 31, 1998. Included in the reserve for unpaid
losses and loss expenses is $1.4 billion of case and loss expense reserves.
While the Company believes that its reserve for unpaid losses and loss
expenses at March 31, 1998 is adequate, future developments may result in
ultimate losses and loss expenses significantly greater or less than the
reserve provided. A number of the Company's insureds have given notice of
claims relating to breast implants or components or raw material thereof
that had been produced and/or sold by such insureds.
22
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
LIQUIDITY AND CAPITAL RESOURCES (continued)
During fiscal 1997 and 1998, the Company has made certain payments to
policyholders with respect to these claims. However, the Company does not
have adequate data upon which to anticipate the timing of future payments
relating to these liabilities, and it expects that the amount of time
required to determine the ultimate financial impact of the options selected
by claimants may extend well into 1998 and beyond (see "Breast Implant
Litigation").
The Company's financial condition, results of operations and cash flow are
influenced by both internal and external forces. Claims 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 elapse 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 liquidity of
its investment portfolio, cash flows and the credit facilities are, in
management's opinion, adequate to meet the Company's expected cash
requirements.
Breast Implant Litigation
A number of the Company's insureds have given notice of claims relating to
breast implants or components or raw material thereof that had been
produced and/or sold by such insureds. Lawsuits, including class actions,
involving thousands of implant recipients have been filed in both state and
federal courts throughout the United States. Most of the federal cases have
been consolidated pursuant to the rules for Multidistrict Litigation to a
Federal District Court in Alabama, although cases are in the process of
being transferred back to federal courts or remanded to state courts.
On May 15, 1995, the Dow Corning Corporation, one of the major defendants,
filed for protection under Chapter 11 of the U.S. Bankruptcy Code and
claims against Dow Corning remain stayed subject to the Bankruptcy Code.
On October 1, 1995, negotiators for three of the major defendants agreed on
the essential elements of an individual settlement plan for U.S. claimants
with at least one implant from any of those manufacturers (" the
Settlement"). In general, under the Settlement, the amounts payable to
individual participants, and the manufacturers' obligations to make those
payments, would not be affected by the number of participants electing to
opt out from the new plan. Also, in general, the compensation would be
fixed and not affected by the number of participants, and the manufacturers
would not have a right to walk away because of the amount of claims
payable. Finally, each settling defendant agreed to be responsible only for
cases in which its implant was identified, and not for a percentage of all
cases. By November 13, 1995, the Settlement was approved by the three major
defendants. In addition, two other defendants became part of the
Settlement, although certain of their settlement terms are different and
more restricted than the plan offered by the original three defendants. On
December 22, 1995, the multidistrict litigation judge approved the
Settlement and the materials for giving notice to claimants.
Beginning in mid-January, 1996, the three major defendants have each made
payments to a court-established fund for use in making payments under the
Settlement. The Settlement Claims Office had reported that as of October
31, 1997, it has sent out Notification of Status Letters to more than
360,000 non-opt-out domestic implant recipients who had registered with the
Settlement Claims Office. As of October 31, 1997, approximately $565
million had been distributed under the Settlement to implant recipients of
the three major defendants; in addition, in January 1998 the Settlement
Claims Office made a payment of approximately $110 million as a second
annual installment of approved benefits under the Settlement. The
multidistrict litigation judge has also directed that distribution begin on
certain additional payments to claimants relating to other implants since
all appeals on the Settlement have now been dismissed. The Settlement
Claims Office has also reported that approximately 32,500 domestic
registrants exercised opt-out rights after receiving their status letters.
Previously, approximately 19,000 other domestic implant recipients had
exercised opt-out rights in 1994 and/or before receiving status letters.
23
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION (continued)
Breast Implant Litigation (continued)
Although the Company has underwritten the coverage for a number of the
defendant companies including four of the companies involved in the
Settlement, the Company anticipates that insurance coverage issued prior to
the time the Company issued policies will be available for a portion of the
defendants' liability. In addition, the Company's policies only apply when
the underlying liability insurance policies or per occurrence retentions
are exhausted.
Declaratory judgment lawsuits, involving four of the Company's insureds,
have been filed seeking guidance on the appropriate trigger for their
insurance coverage. None of the insureds have named the Company in such
lawsuits, although other insurers and third parties have sought to involve
the Company in those lawsuits. To date, one court has stayed a lawsuit
against the Company by other insurers; two courts have dismissed actions by
other insurers against the Company. Another court in Texas has ruled
against the Company's arguments that the court should dismiss the claims by
other insurers and certain doctors attempting to bring the Company into
coverage litigation there. On appeal in the Texas lawsuit, the appellate
court affirmed the lower court's order refusing to dismiss the claims
against the Company; further appellate review in the Texas Supreme Court is
pending. In addition, further efforts are contemplated to stay or dismiss
the doctor's claims against the Company in the Texas lawsuit.
At June 30, 1994, the Company increased its then existing reserves relating
to breast implant claims. Although the reserve increase was partially
satisfied by an allocation from existing IBNR, it also required an increase
in the Company's total reserve for unpaid losses and loss expenses at June
30, 1994 of $200 million. The increase in reserves was based on information
made available in the pending lawsuits and information from the Company's
insureds and was predicated upon an allocation between coverage provided
before and after the end of 1985 (when the Company commenced underwriting
operations). No additional reserves relating to breast implant claims have
been added since June 30, 1994.
The Company continually evaluates its reserves in light of developing
information and in light of discussions and negotiations with its insureds.
During fiscal 1997 and the first six months of fiscal 1998, the Company made
payments of approximately $260 million with respect to breast implant
claims. These payments were included in previous reserves and are
consistent with the Company's belief that its reserves are adequate.
Significant uncertainties continue to exist with regard to the ultimate
outcome and cost of the Settlement and value of the opt-out claims. While
the Company is unable, at this time, to determine whether additional
reserves, which could have a material adverse effect upon the financial
condition, results of operations and cash flows of the Company, may be
necessary in the future, the Company believes that its reserves for unpaid
losses and loss expenses, including those arising from breast implant
claims, are adequate as at March 31, 1998.
IMPACT OF THE YEAR 2000 ISSUE
Management has initiated a Company wide program to prepare the Company's
various computer systems and selected applications for the Year 2000. The
Company has established an oversight committee that meets regularly to
review progress towards Year 2000 compliance. The Company has appointed
individuals in each business segment to review all systems to assess their
ability to process transactions in the Year 2000. Based on these
assessments, the Company has determined that certain business segments,
particularly ACE USA and ACE London, need to modify or replace significant
portions of their computer systems so these systems will properly utilize
dates beyond December 31, 1999. The Company presently believes that with
these modifications and replacements the Year 2000 Issue can be adequately
addressed. The Company will utilize both internal and external resources to
reprogram or replace, and test these systems for Year 2000 modifications.
The Company has initiated communications with its significant business
partners to determine the extent to which the Company is vulnerable to
those third parties' failure to remediate their own Year 2000 Issue. The
Company may also have exposure to claims that may be asserted in the future
under certain insurance policies for damages caused by the failure of
insured companies to effectively address their Year 2000 computer problem.
The total cost of this effort is still being evaluated and the Company has
not yet determined if the total cost will be material.
24
<PAGE>
ACE LIMITED
PART II - OTHER INFORMATION
---------------------------
ITEM 5. OTHER INFORMATION
- --------------------------
1) On May 8, 1998, the Company declared a dividend of $0.09 per Ordinary
Share payable on July 17, 1998 to shareholders of record on June 30,
1998.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ------------------------------------------
1) Exhibits
2.1 Stock Purchase Agreement, dated as of March 25, 1998,
by and among ACE Limited, CAT Limited and the Selling
stockholders named therein (Incorporated by reference
to Exhibit 2.1 to ACE Limited's Registration
Statement on Form S-3 (No. 333-49257)).
27.1 Financial Data Schedule
2) Reports on Form 8-K
The Company filed a Form 8-K-A current report (date of earliest event
reported: January 2, 1998) pertaining to the completion of the
acquisition of Westchester Specialty Group, Inc.
The Company filed a Form 8-K current report (date of earliest event
reported: March 25, 1998) pertaining to its agreement to acquire CAT
Limited.
The Company filed a Form 8-K current report (date of earliest event
reported: April 1, 1998) pertaining to the completion of the
acquisition of CAT Limited.
25
<PAGE>
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
______________________________________
/s/ Brian Duperreault
May 13, 1998 _____________________________________
Brian Duperreault
Chairman, President and Chief
Executive Officer
/s/ Christopher Z. Marshall
May 13, 1998 _____________________________________
Christopher Z. Marshall
Chief Financial Officer
26
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description Numbered Page
- ------- ----------- -------------
27 Financial Data Schedule
27
<TABLE> <S> <C>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-END> MAR-31-1998
<DEBT-HELD-FOR-SALE> 3,783,428
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 410,337
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 5,247,452
<CASH> 194,182
<RECOVER-REINSURE> 19,696
<DEFERRED-ACQUISITION> 32,410
<TOTAL-ASSETS> 6,993,404
<POLICY-LOSSES> 3,324,869
<UNEARNED-PREMIUMS> 461,469
<POLICY-OTHER> 61,567
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 6,776
<OTHER-SE> 2,774,140
<TOTAL-LIABILITY-AND-EQUITY> 6,993,404
352,567
<INVESTMENT-INCOME> 131,542
<INVESTMENT-GAINS> 173,108
<OTHER-INCOME> 0
<BENEFITS> 225,426
<UNDERWRITING-AMORTIZATION> 31,012
<UNDERWRITING-OTHER> 0
<INCOME-PRETAX> 351,968
<INCOME-TAX> 2,947
<INCOME-CONTINUING> 349,021
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 349,021
<EPS-PRIMARY> 2.13
<EPS-DILUTED> 2.08
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
