01—Abstract
Summary
Summary of the 10-K filed February 27, 2015. Cited figures are marked; the original filing is the authoritative source.
ACE Limited (NYSE: ACE), a Swiss-incorporated global insurer and reinsurer, reported solid operating results for 2014 but a sharp decline in GAAP net income.
Net income fell 24.1% to $2.85 billiona (diluted EPS $8.42) from $3.76 billion, driven mainly by $507 million of net realized losses, largely from mark-to-market accounting on its legacy variable annuity guaranteed living benefit (GLB) reinsurance book, where lower interest rates increased liabilities. Underwriting remained strong: the GAAP combined ratio was 88.1% (P&C combined ratio 87.7%), net premiums earned rose 4.9% to $17.4 billion, and favorable prior period reserve development of $527 million contributed about 3.4 points to the combined ratio. Net investment income rose 5.1% to $2.25 billion.
Growth was supported by acquisitions, including the large corporate account P&C business of Itaú Seguros in Brazil, Samaggi in Thailand, and an agreement signed in December 2014 to buy Fireman's Fund's high net worth personal lines business for about $365 millionb. Total net premiums written grew 4.6% (5.7% on a constant-dollar basis). Capital return remained significant: ACE repurchased $1.45 billion of shares in 2014, paid $862 million in common dividends, and authorized a new $1.5 billion buyback for 2015, with $1.3 billion remaining at February 26, 2015.
Shareholders' equity reached $29.6 billionc (book value per share $90.02), and total assets were $98.2 billion. Key risks investors should monitor include reserve adequacy (net unpaid losses of $27.0 billion, with A&E exposure through the run-off Brandywine operations and Century Indemnity), catastrophe exposure (a 1-in-100 year U.S. hurricane net PML of $1.76 billion), reinsurance counterparty credit risk ($12.0 billion of recoverables net of allowances), and the earnings volatility of the variable annuity book. ACE also faces structural considerations from being a Swiss company, including Swiss withholding tax on dividends and limits on flexibility for capital management, and it expects Solvency II to take effect January 1, 2016, without a material impact in management's view.
02—Key points
Key Highlights
- Net income declined 24.1% to $2.85 billion (diluted EPS $8.42), versus $3.76 billion (EPS $10.92) in 2013, largely due to $507 million of net realized losses tied to the variable annuity GLB reinsurance book and interest rate movements.
- GAAP combined ratio of 88.1% (vs. 88.0% in 2013) and P&C combined ratio of 87.7%, reflecting disciplined underwriting; favorable prior period development of $527 million contributed 3.4 points.
- Net premiums earned grew 4.9% to $17.4 billion and net premiums written grew 4.6% to $17.8 billion (5.7% in constant dollars), led by Insurance – Overseas General (+7.5% NPE) and Insurance – North American P&C (+6.8% NPE).
- Net investment income increased 5.1% to $2.25 billion, supported by a larger invested asset base; the portfolio is 96% investment grade with an average duration of 4.0 years and a 100 bp rate rise would reduce fixed income value by about $2.4 billion.
- Strong capital return: $1.45 billion in share repurchases and $862 million in dividends paid in 2014, plus a new $1.5 billion repurchase authorization for 2015 ($1.3 billion remaining at February 26, 2015).
- Acquisitions in 2014 included Itaú Seguros' large corporate P&C business in Brazil (~$610 million) and Samaggi in Thailand (~$176 million), with a $365 million agreement to acquire Fireman's Fund's high net worth personal lines business expected to close in Q2 2015.
- Balance sheet remains strong, with total assets of $98.2 billion, shareholders' equity of $29.6 billion, and a debt-to-total-capitalization ratio of 16.5%; reserves are described as adequate, with a 5% change in net loss reserves equal to about $1.4 billion.
03—One dollar
04—Financials
Financial Highlights
Figures from 10-KFY2014filed February 27, 2015Financial Statements
FY2014 against FY2013
| Line item | FY2014FY2013 | Change |
|---|---|---|
| Revenue | $19.17B$19.26B | −0.5% |
| Interest Expense | $280.00M$275.00M | +1.8% |
| Net Income | $2.85B$3.76B | −24.1% |
| EPS (Basic) | $8.50$11.02 | −22.9% |
| EPS (Diluted) | $8.42$10.92 | −22.9% |
| Shares Outstanding (Basic) | 335.61M340.91M | −1.6% |
| Shares Outstanding (Diluted) | 338.99M344.15M | −1.5% |
05—Questions
Frequently Asked Questions
Why did ACE's net income fall in 2014 even though underwriting results were stable?
The decline was driven mainly by non-operating items rather than core underwriting. ACE recorded $507 million of total net realized losses in 2014, compared with $504 million of gains in 2013. The main driver was the mark-to-market accounting for its legacy variable annuity guaranteed living benefit (GLB) reinsurance, where falling interest rates increased the liability and caused $213 million of realized losses. Derivative hedges and other items also contributed. Underwriting income in the segments rose, and the GAAP combined ratio was broadly flat at 88.1%.
How much reserve risk does ACE carry, and has it been reliable?
At year-end 2014, net unpaid losses and loss expenses were $27.0 billion, and gross reserves were $38.3 billion. ACE reports favorable prior period development in each of the last several years: $527 million in 2014, $530 million in 2013, and $479 million in 2012. The exposure to asbestos and environmental (A&E) claims is relevant, with gross A&E liabilities representing about 4.4% of loss reserves, and adverse development has occurred within the run-off Westchester and Brandywine operations, which took $247 million of adverse development in 2014. Management believes reserves are adequate, but a 5% change in net loss reserves equals about $1.4 billion, which is about 5% of shareholders' equity.
What is ACE's exposure to catastrophes and reinsurance counterparties?
ACE's modeled 1-in-100 year annual aggregate net pre-tax probable maximum loss from U.S. hurricanes is $1.76 billion, or about 5.9% of shareholders' equity, and about $2.2 billion for California earthquake. Total pre-tax catastrophe losses were $288 million in 2014, or 1.8 points of the combined ratio, which is relatively light compared with 2012 (Superstorm Sandy). ACE had $12.0 billion of reinsurance recoverables net of a $357 million provision for uncollectible reinsurance. A one-notch downgrade across rated reinsurers would increase that provision by about $73 million.
Are there tax or structural risks for U.S. shareholders?
Yes. ACE is a Swiss holding company, so dividends are generally subject to a 35% Swiss withholding tax unless paid as a par value reduction or from capital contribution reserves, which ACE has done in recent years. Shareholders' voting rights are capped at 10% of votes for any holder of 10% or more, and Swiss law limits capital management flexibility because share issuance below par requires shareholder approval. The filing also describes possible U.S. tax issues for 10% U.S. shareholders under the CFC and PFIC rules, and notes that Bermuda's tax undertaking runs until March 31, 2035. Management states that Solvency II, expected effective January 1, 2016, is not expected to have a material effect.
What does the 2015 outlook look like based on the filing?
The filing does not provide formal earnings guidance. Management says it is off to a good start in 2015 and remains confident in its strategy. It has signed to acquire the Fireman's Fund high net worth personal lines business for about $365 million, expected to close in Q2 2015, and has launched retail distribution for U.S. middle-market specialty and excess and surplus lines business and a micro business division. Continued share repurchases are supported by the $1.3 billion authorization remaining through December 31, 2015. Investors should note that the GLB book will continue to produce earnings volatility, as the filing states that realized losses are expected in the first quarter of 2015 from timing effects, which are partly offset by underwriting income from that portfolio.
06—Continue