01—Abstract
Summary
Summary of the 10-K filed March 16, 2005. Cited figures are marked; the original filing is the authoritative source.
ACE Limited (NYSE: ACE), the Bermuda-based (Cayman-incorporated) holding company, reported 2004 net income of $1.14 billiona, down 20% from $1.42 billion in 2003, and diluted EPS of $3.83 versus $5.01.
The decline was driven primarily by a $465 millionb pre-tax increase in asbestos, environmental (A&E) and other run-off reserves recorded in the fourth quarter, and record 2004 catastrophe losses of $499 million net (mainly Caribbean and U.S. hurricanes and Asian typhoons). Net premiums written grew 13% to $11.5 billion, with P&C net premiums written up 22%, though the rate of growth slowed as pricing softened, and the combined ratio deteriorated to 96.6% from 91.5%. Diluted book value per share rose to $32.48 from $29.46.
The balance sheet strengthened: shareholders' equity reached $9.8 billion and invested assets grew to $28.5 billionc, supported by roughly $5 billion of operating cash flow. The 2004 sale of 65.3% of the financial and mortgage guaranty businesses through the Assured Guaranty IPO raised about $835 million plus a $200 million capital return, and ACE retains a 34.7% equity stake accounted for under the equity method. Investors should weigh the significant legacy reserve exposure: net unpaid losses were $17.2 billion, cumulative deficiencies on pre-1999 accident years are large (about $5.9 billion gross on 1999 and prior, largely U.S. liabilities including A&E), and the company faces numerous insurance-industry investigations by state attorneys general and the SEC, plus multiple putative class actions tied to broker compensation practices.
Looking forward, management expects positive operating cash flow to cover claims through 2005, flagged the possible expiration of TRIA at year-end 2005, and noted pending sales of certain Brandywine run-off units. Management also cautioned that FAS 123R will materially reduce reported earnings beginning July 1, 2005, since stock options will need to be expensed.
02—Key points
Key Highlights
- Net income fell 20% to $1.14 billion (diluted EPS $3.83 vs. $5.01), driven by A&E reserve strengthening of $459 million pre-tax and $499 million of net catastrophe losses.
- Net premiums written rose 13% to $11.5 billion, with P&C NPW up 22%, though growth decelerated as market rates softened in 2004.
- Combined ratio deteriorated to 96.6% from 91.5%, with the loss and loss expense ratio rising to 70.7% from 65.0%.
- Diluted book value per share increased to $32.48 from $29.46; shareholders' equity reached $9.8 billion.
- Net unpaid losses and loss expenses totaled $17.2 billion, and management reported a cumulative gross deficiency of $5.9 billion on 1999 and prior accident years, mostly U.S. liabilities.
- The April 2004 IPO of Assured Guaranty generated about $835 million in net proceeds plus a $200 million capital return; ACE retains a 34.7% stake.
- Ongoing regulatory and litigation exposure includes 43 subpoenas from state attorneys general and regulators, SEC and NYAG inquiries, and multiple class actions tied to broker compensation practices.
03—Questions
Frequently Asked Questions
Why did ACE's 2004 earnings decline compared with 2003?
Net income fell to $1.14 billion from $1.42 billion. The main drivers were a $465 million fourth-quarter increase in asbestos, environmental and other run-off reserves (about $302 million after tax) and $499 million of net catastrophe losses from hurricanes and typhoons. Lower realized gains and higher administrative costs also contributed, partly offset by investment income growth.
Is ACE's premium growth sustainable given softening market conditions?
Premium growth remained strong in 2004, but management acknowledged that the rate of growth slowed as rate reductions appeared across several classes of business, and that downward rate pressure continued into early 2005. Casualty growth in North America was already slowing because of increased competition. Future growth will depend on maintaining underwriting discipline in a softer market.
How significant is ACE's asbestos and environmental (A&E) exposure?
The exposure is material. Gross A&E reserves were about $4.95 billion at year-end 2004, with the largest exposure from the CIGNA P&C acquisition and the Brandywine run-off operations. Reserves are not discounted and make no allowance for possible future asbestos legislation. Management noted a federal asbestos trust proposal in which ACE would participate, but could not predict whether it would be adopted.
What regulatory and legal risks do investors face?
ACE has received 43 subpoenas and inquiries from state attorneys general, regulators and the SEC concerning industry practices such as contingent commissions and loss-mitigation products. An underwriter formerly with an ACE subsidiary pleaded guilty to a misdemeanor, and ACE is conducting an internal investigation. Multiple federal and state class actions and securities suits are pending, with unspecified damages. Management said it has not established a liability for compensatory damages but recorded $11.5 million of legal fees, and believes the ultimate liability is unlikely to be materially adverse to consolidated financial condition.
04—Continue