CB 10-Q Quarterly Report Sept. 30, 2012 | Alphaminr
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CB 10-Q Quarter ended Sept. 30, 2012

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10-Q 1 ace-9302012x10q.htm 10-Q ACE-9.30.2012-10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2012
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
ACE LIMITED
(Exact name of registrant as specified in its charter)
Switzerland
98-0091805
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
Baerengasse 32
Zurich, Switzerland CH-8001
(Address of principal executive offices) (Zip Code)
+41 (0)43 456 76 00
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES x NO ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YES x NO ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer ¨
Non-accelerated filer ¨
Smaller reporting company ¨
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES ¨ NO x
The number of registrant’s Common Shares (CHF 29.34 par value) outstanding as of October 17, 2012 was 339,808,296 .


ACE LIMITED
INDEX TO FORM 10-Q
Page No.
Part I.
FINANCIAL INFORMATION
Item 1.
Note 1.
Note 2.
Note 3.
Note 4.
Note 5.
Note 6.
Note 7.
Note 8.
Note 9.
Note 10.
Note 11.
Item 2.
Item 3.
Item 4.
Part II.
OTHER INFORMATION
Item 1.
Item 1A.
Item 2.
Item 6.


2

PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30
December 31
2012
2011
(in millions of U.S. dollars, except share and per share data)
Assets
Investments
Fixed maturities available for sale, at fair value (amortized cost – $43,758 and $40,450)
$
46,504

$
41,967

(includes hybrid financial instruments of $410 and $357)
Fixed maturities held to maturity, at amortized cost (fair value – $7,879 and $8,605)
7,493

8,447

Equity securities, at fair value (cost – $741 and $671)
770

647

Short-term investments, at fair value and amortized cost
2,429

2,301

Other investments (cost – $2,385 and $2,112)
2,621

2,314

Total investments
59,817

55,676

Cash
690

614

Securities lending collateral
2,039

1,375

Accrued investment income
564

547

Insurance and reinsurance balances receivable
5,288

4,387

Reinsurance recoverable on losses and loss expenses
11,857

12,389

Reinsurance recoverable on policy benefits
246

249

Deferred policy acquisition costs
1,793

1,548

Value of business acquired
632

676

Goodwill and other intangible assets
4,990

4,799

Prepaid reinsurance premiums
1,613

1,541

Deferred tax assets
344

673

Investments in partially-owned insurance companies (cost – $352 and $345)
354

352

Other assets
3,281

2,495

Total assets
$
93,508

$
87,321

Liabilities
Unpaid losses and loss expenses
$
38,200

$
37,477

Unearned premiums
7,068

6,334

Future policy benefits
4,414

4,274

Insurance and reinsurance balances payable
3,448

3,542

Deposit liabilities
804

663

Securities lending payable
2,044

1,385

Payable for securities purchased
733

287

Accounts payable, accrued expenses, and other liabilities
4,542

3,948

Income taxes payable
221

159

Short-term debt
1,402

1,251

Long-term debt
3,360

3,360

Trust preferred securities
309

309

Total liabilities
66,545

62,989

Commitments and contingencies


Shareholders’ equity
Common Shares (CHF 29.34 and CHF 30.27 par value; 342,832,412 shares issued; 339,735,109 and 336,927,276 shares outstanding)
9,759

10,095

Common Shares in treasury (3,097,303 and 5,905,136 shares)
(187
)
(327
)
Additional paid-in capital
5,109

5,326

Retained earnings
9,268

7,327

Accumulated other comprehensive income (AOCI)
3,014

1,911

Total shareholders’ equity
26,963

24,332

Total liabilities and shareholders’ equity
$
93,508

$
87,321



See accompanying notes to consolidated financial statements

3

ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended
Nine Months Ended
September 30
September 30
2012
2011
2012
2011
(in millions of U.S. dollars,
except per share data)
Revenues
Net premiums written
$
4,716

$
4,343

$
12,418

$
11,742

Change in unearned premiums
(51
)
147

(589
)
(186
)
Net premiums earned
4,665

4,490

11,829

11,556

Net investment income
533

564

1,614

1,677

Net realized gains (losses):

Other-than-temporary impairment (OTTI) losses gross
(10
)
(31
)
(30
)
(45
)
Portion of OTTI losses recognized in other comprehensive income (OCI)
—

11

—

13

Net OTTI losses recognized in income
(10
)
(20
)
(30
)
(32
)
Net realized gains (losses) excluding OTTI losses
(50
)
(740
)
(164
)
(846
)
Total net realized gains (losses)
(60
)
(760
)
(194
)
(878
)
Total revenues
5,138

4,294

13,249

12,355

Expenses
Losses and loss expenses
3,047

2,745

6,970

7,234

Policy benefits
130

83

379

282

Policy acquisition costs
609

669

1,810

1,840

Administrative expenses
519

520

1,543

1,537

Interest expense
63

62

187

187

Other (income) expense
(17
)
89

14

88

Total expenses
4,351

4,168

10,903

11,168

Income before income tax
787

126

2,346

1,187

Income tax expense
147

165

405

382

Net income (loss)
$
640

$
(39
)
$
1,941

$
805

Other comprehensive income (loss)
Unrealized appreciation
$
731

$
22

$
1,369

$
391

Reclassification adjustment for net realized gains included in net income
(56
)
(18
)
(147
)
(152
)
675

4

1,222

239

Change in:
Cumulative translation adjustment
190

(152
)
162

149

Pension liability
(4
)
3

(5
)
(2
)
Other comprehensive income (loss), before income tax
861

(145
)
1,379

386

Income tax expense related to OCI items
(185
)
(5
)
(276
)
(141
)
Other comprehensive income (loss)
676

(150
)
1,103

245

Comprehensive income (loss)
$
1,316

$
(189
)
$
3,044

$
1,050

Earnings per share
Basic earnings per share
$
1.88

$
(0.11
)
$
5.71

$
2.38

Diluted earnings per share
$
1.86

$
(0.11
)
$
5.67

$
2.36


See accompanying notes to consolidated financial statements

4

ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Unaudited)
Nine Months Ended
September 30
2012
2011
(in millions of U.S.
dollars)
Common Shares
Balance – beginning of period
$
10,095

$
10,161

Exercise of stock options
—

47

Dividends declared on Common Shares-par value reduction
(336
)
(113
)
Balance – end of period
9,759

10,095

Common Shares in treasury
Balance – beginning of period
(327
)
(330
)
Common Shares repurchased
(7
)
(100
)
Common Shares issued in treasury, net of net shares redeemed under employee share-based compensation plans
147

80

Balance – end of period
(187
)
(350
)
Additional paid-in capital
Balance – beginning of period
5,326

5,623

Net shares redeemed under employee share-based compensation plans
(102
)
(111
)
Exercise of stock options
(8
)
26

Share-based compensation expense and other
93

103

Funding of dividends declared to Retained earnings
(200
)
(236
)
Balance – end of period
5,109

5,405

Retained earnings
Balance – beginning of period, as reported
7,327

5,926

Cumulative effect of adjustment resulting from adoption of new accounting guidance
—

(139
)
Balance – beginning of period, as adjusted
7,327

5,787

Net income
1,941

805

Funding of dividends declared from Additional paid-in capital
200

236

Dividends declared on Common Shares
(200
)
(236
)
Balance – end of period
9,268

6,592

Deferred compensation obligation
Balance – beginning and end of period
$
—

$
2










See accompanying notes to consolidated financial statements

5

ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (continued)
(Unaudited)
Nine Months Ended
September 30
2012
2011
(in millions of U.S.
dollars)
Accumulated other comprehensive income
Net unrealized appreciation on investments
Balance – beginning of period
$
1,715

$
1,399

Change in period, net of income tax expense of $(234) and $(112)
988

127

Balance – end of period
2,703

1,526

Cumulative translation adjustment
Balance – beginning of period
258

262

Change in period, net of income tax expense of $(44) and $(30)
118

119

Balance – end of period
376

381

Pension liability adjustment
Balance – beginning of period
(62
)
(67
)
Change in period, net of income tax benefit of $2 and $1
(3
)
(1
)
Balance – end of period
(65
)
(68
)
Accumulated other comprehensive income
3,014

1,839

Common Shares issued to employee trust
Balance – beginning and end of period
—

(2
)
Total shareholders’ equity
$
26,963

$
23,581




See accompanying notes to consolidated financial statements

6

ACE LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30
2012
2011
(in millions of U.S.
dollars)
Cash flows from operating activities
Net income
$
1,941

$
805

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


Net realized (gains) losses
194

878

Amortization of premiums/discounts on fixed maturities
161

105

Deferred income taxes
46

3

Unpaid losses and loss expenses
430

826

Unearned premiums
708

232

Future policy benefits
109

51

Insurance and reinsurance balances payable
(174
)
158

Accounts payable, accrued expenses, and other liabilities
252

508

Income taxes payable
44

74

Insurance and reinsurance balances receivable
(828
)
(1,103
)
Reinsurance recoverable on losses and loss expenses
606

133

Reinsurance recoverable on policy benefits
47

26

Deferred policy acquisition costs
(260
)
(139
)
Prepaid reinsurance premiums
(115
)
(52
)
Other
(136
)
493

Net cash flows from operating activities
3,025

2,998

Cash flows from investing activities
Purchases of fixed maturities available for sale
(17,348
)
(18,783
)
Purchases of to be announced mortgage-backed securities
(308
)
(785
)
Purchases of fixed maturities held to maturity
(217
)
(285
)
Purchases of equity securities
(114
)
(289
)
Sales of fixed maturities available for sale
11,058

13,567

Sales of to be announced mortgage-backed securities
297

756

Sales of equity securities
57

364

Maturities and redemptions of fixed maturities available for sale
3,596

2,603

Maturities and redemptions of fixed maturities held to maturity
1,092

966

Net derivative instruments settlements
(358
)
67

Acquisition of subsidiaries (net of cash acquired of $8 and $81)
(98
)
(394
)
Other
(339
)
(317
)
Net cash flows used for investing activities
(2,682
)
(2,530
)
Cash flows from financing activities
Dividends paid on Common Shares
(484
)
(342
)
Common Shares repurchased
(11
)
(168
)
Proceeds from issuance of short-term debt
2,083

3,985

Repayment of short-term debt
(1,932
)
(4,035
)
Proceeds from share-based compensation plans
73

82

Net cash flows used for financing activities
(271
)
(478
)
Effect of foreign currency rate changes on cash and cash equivalents
4

4

Net increase (decrease) in cash
76

(6
)
Cash – beginning of period
614

772

Cash – end of period
$
690

$
766

Supplemental cash flow information
Taxes paid
$
323

$
306

Interest paid
$
156

$
151


See accompanying notes to consolidated financial statements

7

ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1 . General
a) Basis of presentation
ACE Limited is a holding company incorporated in Zurich, Switzerland. ACE Limited, through its various subsidiaries, provides a broad range of insurance and reinsurance products to insureds worldwide. ACE operates through the following business segments: Insurance – North American, Insurance – Overseas General, Global Reinsurance, and Life. Refer to Note 9 for additional information.
The interim unaudited consolidated financial statements, which include the accounts of ACE and its subsidiaries (collectively, ACE, we, us, or our), have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and, in the opinion of management, reflect all adjustments (consisting of normally recurring accruals) necessary for a fair statement of the results and financial position for such periods. All significant intercompany accounts and transactions have been eliminated.
The results of operations and cash flows for any interim period are not necessarily indicative of the results for the full year. These consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our 2011 Form 10-K.
Effective January 1, 2012, we retrospectively adopted new accounting guidance for costs associated with acquiring or renewing insurance contracts. Under the new guidance, the definition of acquisition costs was modified to specify that a cost must be directly related to the successful acquisition of a new or renewal insurance contract in order to be deferred. Prior year amounts contained in these consolidated financial statements have been adjusted to reflect the impact of retrospective adjustments as a result of applying this new accounting guidance.
b) Deferred policy acquisition costs and value of business acquired (VOBA)
Policy acquisition costs consist of commissions, premium taxes, and certain underwriting costs related directly to the successful acquisition of a new or renewal insurance contract. A VOBA intangible asset is established upon the acquisition of blocks of long duration contracts and represents the present value of estimated net cash flows for the contracts in force at the time of the acquisition. Acquisition costs and VOBA, collectively policy acquisition costs, are deferred and amortized. Policy acquisition costs on property and casualty (P&C) contracts are generally amortized ratably over the period in which premiums are earned. Policy acquisition costs on long duration contracts are amortized over the estimated life of the contracts, generally in proportion to premium revenue recognized. Policy acquisition costs are reviewed to determine if they are recoverable from future income, including investment income. Unrecoverable costs are expensed in the period identified.
Advertising costs are expensed as incurred except for direct-response campaigns that meet the criteria of the new guidance, principally related to accident and health (A&H) business produced by the Insurance – Overseas General segment, which are deferred and recognized as a component of policy acquisition costs. For individual direct-response marketing campaigns that we can demonstrate have specifically resulted in incremental sales to customers and such sales have probable future economic benefits, incremental costs directly related to the marketing campaigns are capitalized. Deferred marketing costs are reviewed regularly for recoverability from future income, including investment income, and amortized in proportion to premium revenue recognized, primarily over a ten year period.
c) Accounting guidance adopted
Accounting for costs associated with acquiring or renewing insurance contracts
In October 2010, the Financial Accounting Standards Board (FASB) issued new guidance related to the accounting for costs associated with acquiring or renewing insurance contracts. Under the new guidance, the definition of acquisition costs was modified to specify that a cost must be directly related to the successful

8
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


acquisition of a new or renewal insurance contract in order to be deferred. We adopted this guidance retrospectively effective January 1, 2012 and reduced Retained earnings as of January 1, 2011 by $ 139 million which represents the cumulative effect of adjustment resulting from adoption of new accounting guidance. We adjusted prior year amounts contained in these consolidated financial statements to reflect the effect of adjustment from adoption of new accounting guidance including reducing Deferred policy acquisition costs and Retained earnings by $ 213 million and $ 181 million, respectively, as of December 31, 2011. The reduction to Deferred policy acquisition costs is primarily due to lower deferrals associated with unsuccessful efforts. We also reduced Net income by $ 8 million, or $ 0.02 per share, and $ 30 million, or $ 0.09 per share, for the three and nine months ended September 30, 2011 , respectively.
Fair value measurements
In May 2011, the FASB issued new guidance on fair value measurements to revise the wording used to describe the requirements for measuring fair value and for disclosing information about fair value measurements. The guidance is not necessarily intended to result in a significant change in the application of the current requirements. Instead, it is intended to clarify the intended application of existing fair value measurement requirements. It also changes certain principles or requirements for measuring fair value and disclosing information about fair value measurements. We adopted this guidance prospectively effective January 1, 2012. The application of this guidance resulted in additional fair value measurements disclosures only and did not impact our financial condition or results of operations.

d) Subsequent event

In late October 2012, superstorm Sandy made landfall in the United States.  Given its recent occurrence and the limited information available, we cannot estimate at this time the amount of any possible losses from this event. The impact of this event will be reflected in our fourth quarter 2012 results.

2 . Acquisitions

On June 13, 2012, we announced that we and our local partner had signed a definitive agreement to acquire PT Asuransi Jaya Proteksi (JaPro), one of Indonesia's leading general insurers. On September 18, 2012, we acquired 80 percent of JaPro and our local partner expects to complete the purchase of the remaining 20 percent , subject to regulatory approvals and other closing conditions, by the end of 2012. The total purchase price is expected to be approximately $ 95 million in cash. The information needed to complete the purchase price allocation is preliminary and will be adjusted as further information becomes available during the measurement period. JaPro operates under our Insurance – Overseas General segment.

On September 12, 2012, we announced that we reached a definitive agreement to acquire Fianzas Monterrey, a leading surety lines company in Mexico offering administrative performance bonds primarily to clients in the construction and industrial sectors, for approximately $ 285 million in cash. This transaction, which is subject to regulatory approvals and other customary closing conditions, is expected to be completed during the first quarter of 2013.

On October 18, 2012, we announced that we reached a definitive agreement to acquire ABA Seguros, a property and casualty insurer in Mexico that provides automobile, homeowners, and small business coverages. We expect to pay approximately $ 865 million in cash for this transa ction, subject to adjustment for dividends paid between signing and closing. This transaction, which is subj ect to regulatory approvals and other customary closing conditions, is expected to be completed in the first half of 2013.
Prior year acquisitions

9
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


We acquired New York Life’s Korea operations on February 1, 2011 and New York Life’s Hong Kong operations on April 1, 2011 for approximately $ 450 million in cash. These acquired businesses operate under our Life segment, expand our presence in the North Asia market and complement our life insurance business established in that region. In 2012, we finalized purchase price allocations resulting in $ 91 million of goodwill, none of which is expected to be deductible for income tax purposes, and $ 163 million of intangible assets. The most significant intangible asset is VOBA.
We acquired Penn Millers Holding Corporation (PMHC) on November 30, 2011 for approximately $ 107 million in cash. PMHC’s primary insurance subsidiary, Penn Millers Insurance Company, is a well-established underwriter in the agribusiness market since 1887. PMHC operates under our Insurance – North American segment.
We acquired Rio Guayas Compania de Seguros y Reaseguros (Rio Guayas), a general insurance company in Ecuador on December 28, 2011. Rio Guayas sells a range of insurance products, including auto, life, property, and A&H. The acquisition of Rio Guayas expands our capabilities in terms of geography, products, and distribution. Rio Guayas operates under our Insurance – Overseas General segment.


10
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)



3 . Investments
a) Fixed maturities
The following tables present the amortized cost and fair value of fixed maturities and related OTTI recognized in AOCI:
September 30, 2012
Amortized
Cost
Gross
Unrealized
Appreciation
Gross
Unrealized
Depreciation
Fair
Value
OTTI Recognized
in AOCI
(in millions of U.S. dollars)
Available for sale
U.S. Treasury and agency
$
3,357

$
197

$
—

$
3,554

$
—

Foreign
13,241

750

(24
)
13,967

(1
)
Corporate securities
14,677

1,192

(36
)
15,833

(12
)
Mortgage-backed securities
10,227

545

(36
)
10,736

(88
)
States, municipalities, and political subdivisions
2,256

159

(1
)
2,414

—

$
43,758

$
2,843

$
(97
)
$
46,504

$
(101
)
Held to maturity
U.S. Treasury and agency
$
1,084

$
45

$
—

$
1,129

$
—

Foreign
919

52

(1
)
970

—

Corporate securities
2,182

140

—

2,322

—

Mortgage-backed securities
2,222

108

—

2,330

—

States, municipalities, and political subdivisions
1,086

46

(4
)
1,128

—

$
7,493

$
391

$
(5
)
$
7,879

$
—

December 31, 2011
Amortized
Cost
Gross
Unrealized
Appreciation
Gross
Unrealized
Depreciation
Fair
Value
OTTI Recognized
in AOCI
(in millions of U.S. dollars)
Available for sale
U.S. Treasury and agency
$
2,774

$
186

$
—

$
2,960

$
—

Foreign
12,025

475

(99
)
12,401

(2
)
Corporate securities
14,055

773

(135
)
14,693

(22
)
Mortgage-backed securities
9,979

397

(175
)
10,201

(151
)
States, municipalities, and political subdivisions
1,617

96

(1
)
1,712

—

$
40,450

$
1,927

$
(410
)
$
41,967

$
(175
)
Held to maturity
U.S. Treasury and agency
$
1,078

$
48

$
—

$
1,126

$
—

Foreign
935

18

(23
)
930

—

Corporate securities
2,338

44

(45
)
2,337

—

Mortgage-backed securities
2,949

90

(3
)
3,036

—

States, municipalities, and political subdivisions
1,147

32

(3
)
1,176

—

$
8,447

$
232

$
(74
)
$
8,605

$
—


11
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


As discussed in Note 3 c), if a credit loss is indicated on an impaired fixed maturity, an OTTI is considered to have occurred and the portion of the impairment not related to credit losses (non-credit OTTI) is recognized in OCI. Included in the “OTTI Recognized in AOCI” columns above are the cumulative amounts of non-credit OTTI recognized in OCI adjusted for subsequent sales, maturities, and redemptions. OTTI recognized in AOCI does not include the impact of subsequent changes in fair value of the related securities. In periods subsequent to a recognition of OTTI in OCI, changes in the fair value of the related fixed maturities are reflected in Unrealized appreciation (depreciation) in the consolidated statement of shareholders’ equity. For the three and nine months ended September 30, 2012 , $46 million and $130 million, respectively, of net unrealized appreciation related to such securities is included in OCI. For the three and nine months ended September 30, 2011 , $30 million and $38 million, respectively, of net unrealized depreciation related to such securities is included in OCI. At September 30, 2012 and December 31, 2011 , AOCI includes net unrealized depreciation of $28 million and $155 million, respectively, related to securities remaining in the investment portfolio at those dates for which ACE has recognized a non-credit OTTI.
Mortgage-backed securities (MBS) issued by U.S. government agencies are combined with all other to be announced mortgage derivatives held (refer to Note 6 a) (iv)) and are included in the category, “Mortgage-backed securities”. Approximately 86 percent and 84 percent of the total mortgage-backed securities at September 30, 2012 and December 31, 2011 , respectively, are represented by investments in U.S. government agency bonds. The remainder of the mortgage exposure consists of collateralized mortgage obligations and non-government mortgage-backed securities, the majority of which provide a planned structure for principal and interest payments and carry a rating of AAA by the major credit rating agencies.
The following table presents fixed maturities by contractual maturity:
September 30, 2012
December 31, 2011
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
(in millions of U.S. dollars)
Available for sale
Due in 1 year or less
$
2,210

$
2,231

$
2,321

$
2,349

Due after 1 year through 5 years
12,591

13,174

12,325

12,722

Due after 5 years through 10 years
14,699

15,852

12,379

12,995

Due after 10 years
4,031

4,511

3,446

3,700

33,531

35,768

30,471

31,766

Mortgage-backed securities
10,227

10,736

9,979

10,201

$
43,758

$
46,504

$
40,450

$
41,967

Held to maturity
Due in 1 year or less
$
676

$
681

$
393

$
396

Due after 1 year through 5 years
1,839

1,914

2,062

2,090

Due after 5 years through 10 years
2,118

2,272

2,376

2,399

Due after 10 years
638

682

667

684

5,271

5,549

5,498

5,569

Mortgage-backed securities
2,222

2,330

2,949

3,036

$
7,493

$
7,879

$
8,447

$
8,605

Expected maturities could differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties.

12
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


b) Equity securities
The following table presents the cost and fair value of equity securities:
September 30

December 31
2012

2011
(in millions of U.S. dollars)
Cost
$
741

$
671

Gross unrealized appreciation
34

18

Gross unrealized depreciation
(5
)
(42
)
Fair value
$
770

$
647

c) Net realized gains (losses)
In accordance with guidance related to the recognition and presentation of OTTI, when an impairment related to a fixed maturity has occurred, OTTI is required to be recorded in net income if management has the intent to sell the security or it is more likely than not that we will be required to sell the security before the recovery of its amortized cost. Further, in cases where we do not intend to sell the security and it is more likely than not that we will not be required to sell the security, ACE must evaluate the security to determine the portion of the impairment, if any, related to credit losses. If a credit loss is indicated, an OTTI is considered to have occurred and any portion of the OTTI related to credit losses must be reflected in net income while the portion of OTTI related to all other factors is recognized in OCI. For fixed maturities held to maturity, OTTI recognized in OCI is accreted from AOCI to the amortized cost of the fixed maturity prospectively over the remaining term of the securities.
Each quarter, securities in an unrealized loss position (impaired securities), including fixed maturities, securities lending collateral, equity securities, and other investments, are reviewed to identify impaired securities to be specifically evaluated for a potential OTTI.
For all non-fixed maturities, OTTI is evaluated based on the following:
•
the amount of time a security has been in a loss position and the magnitude of the loss position;
•
the period in which cost is expected to be recovered, if at all, based on various criteria including economic conditions and other issuer-specific developments; and
•
ACE’s ability and intent to hold the security to the expected recovery period.
As a general rule, we also consider that equity securities in an unrealized loss position for twelve consecutive months are impaired.
We review each fixed maturity in an unrealized loss position to assess whether the security is a candidate for credit loss. Specifically, we consider credit rating, market price, and issuer-specific financial information, among other factors, to assess the likelihood of collection of all principal and interest as contractually due. Securities for which we determine that credit loss is likely are subjected to further analysis to estimate the credit loss recognized in net income, if any. In general, credit loss recognized in net income equals the difference between the security’s amortized cost and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security. All significant assumptions used in determining credit losses are subject to change as market conditions evolve.
Projected cash flows for corporate securities (principally senior unsecured bonds) are driven primarily by assumptions regarding probability of default and also the timing and amount of recoveries associated with defaults. We develop these estimates using information based on market observable data, issuer-specific information, and credit ratings. ACE developed its default assumption by using historical default data by Moody’s Investors Service (Moody’s) rating category to calculate a 1-in-100 year probability of default, which results in a

13
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


default assumption in excess of the historical mean default rate. We believe that use of a default assumption in excess of the historical mean is reasonable in light of current market conditions.
For the three and nine months ended September 30, 2012 , credit losses recognized in net income for corporate securities were $5 million and $9 million, respectively. For the three and nine months ended September 30, 2011 , credit losses recognized in net income for corporate securities were $ 4 million.
For mortgage-backed securities, credit impairment is assessed using a cash flow model that estimates the cash flows on the underlying mortgages, using the security-specific collateral and transaction structure. The model estimates cash flows from the underlying mortgage loans and distributes those cash flows to various tranches of securities, considering the transaction structure and any subordination and credit enhancements that exist in that structure. The cash flow model incorporates actual cash flows on the mortgage-backed securities through the current period and then projects the remaining cash flows using a number of assumptions, including default rates, prepayment rates, and loss severity rates (the par value of a defaulted security that will not be recovered) on foreclosed properties.
For the three and nine months ended September 30, 2012 , credit losses recognized in net income for mortgage-backed securities were $2 million and $5 million, respectively. For the three and nine months ended September 30, 2011 , credit losses recognized in net income for mortgage-backed securities were $5 million and $8 million, respectively.

14
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


The following table presents the Net realized gains (losses) and the losses included in Net realized gains (losses) and OCI as a result of conditions which caused us to conclude the decline in fair value of certain investments was “other-than-temporary”:
Three Months Ended

Nine Months Ended
September 30

September 30
2012
2011
2012
2011
(in millions of U.S. dollars)
Fixed maturities:
OTTI on fixed maturities, gross
$
(10
)
$
(30
)
$
(18
)
$
(41
)
OTTI on fixed maturities recognized in OCI (pre-tax)
—

11

—

13

OTTI on fixed maturities, net
(10
)
(19
)
(18
)
(28
)
Gross realized gains excluding OTTI
71

92

287

309

Gross realized losses excluding OTTI
(14
)
(53
)
(120
)
(138
)
Total fixed maturities
47

20

149

143

Equity securities:
OTTI on equity securities
—

(1
)
(5
)
(1
)
Gross realized gains excluding OTTI
3

—

5

12

Gross realized losses excluding OTTI
(1
)
(1
)
(2
)
(2
)
Total equity securities
2

(2
)
(2
)
9

OTTI on other investments
—

—

(7
)
(3
)
Foreign exchange gains (losses)
(50
)
20

(64
)
(89
)
Investment and embedded derivative instruments
4

(89
)
(3
)
(157
)
Fair value adjustments on insurance derivative
83

(926
)
44

(925
)
S&P put options and futures
(147
)
220

(308
)
152

Other derivative instruments
—

2

(4
)
(1
)
Other
1

(5
)
1

(7
)
Net realized gains (losses)
$
(60
)
$
(760
)
$
(194
)
$
(878
)
The following table presents a roll-forward of pre-tax credit losses related to fixed maturities for which a portion of OTTI was recognized in OCI:
Three Months Ended
Nine Months Ended
September 30
September 30
2012
2011
2012
2011
(in millions of U.S. dollars)
Balance of credit losses related to securities still held – beginning of period
$
47

$
94

$
74

$
137

Additions where no OTTI was previously recorded
1

6

3

8

Additions where an OTTI was previously recorded
6

3

11

4

Reductions for securities sold during the period
(4
)
(24
)
(38
)
(70
)
Balance of credit losses related to securities still held – end of period
$
50

$
79

$
50

$
79


15
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


d) Gross unrealized loss
At September 30, 2012 , there were 1,473 fixed maturities out of a total of 23,322 fixed maturities in an unrealized loss position. The largest single unrealized loss in the fixed maturities was $4 million. There were approximately 68 equity securities out of a total of 197 equity securities in an unrealized loss position. The largest single unrealized loss in the equity securities was $1 million. Fixed maturities in an unrealized loss position at September 30, 2012 comprised both investment grade and below investment grade securities for which fair value declined primarily due to widening credit spreads since the date of purchase. Equity securities in an unrealized loss position include foreign fixed income securities held in a commingled fund structure for which fair value declined primarily due to widening credit spreads since the date of purchase.
The following tables present, for all securities in an unrealized loss position (including securities on loan), the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position:
0 – 12 Months
Over 12 Months
Total
Fair Value
Gross
Unrealized
Loss
Fair Value
Gross
Unrealized
Loss
Fair Value
Gross
Unrealized
Loss
(in millions of U.S. dollars)
September 30, 2012
Foreign
$
839

$
(14.8
)
$
186

$
(9.7
)
$
1,025

$
(24.5
)
Corporate securities
663

(20.1
)
195

(15.5
)
858

(35.6
)
Mortgage-backed securities
225

(1.3
)
412

(35.0
)
637

(36.3
)
States, municipalities, and political subdivisions
29

(1.3
)
59

(4.0
)
88

(5.3
)
Total fixed maturities
1,756

(37.5
)
852

(64.2
)
2,608

(101.7
)
Equity securities
543

(5.4
)
—

—

543

(5.4
)
Other investments
113

(6.3
)
—

—

113

(6.3
)
Total
$
2,412

$
(49.2
)
$
852

$
(64.2
)
$
3,264

$
(113.4
)
0 – 12 Months
Over 12 Months
Total
Fair Value
Gross
Unrealized
Loss
Fair Value
Gross
Unrealized
Loss
Fair Value
Gross
Unrealized
Loss
(in millions of U.S. dollars)
December 31, 2011
Foreign
$
1,801

$
(82.2
)
$
529

$
(40.0
)
$
2,330

$
(122.2
)
Corporate securities
3,084

(148.2
)
268

(32.2
)
3,352

(180.4
)
Mortgage-backed securities
440

(7.5
)
586

(170.2
)
1,026

(177.7
)
States, municipalities, and political subdivisions
30

(0.4
)
98

(3.5
)
128

(3.9
)
Total fixed maturities
5,355

(238.3
)
1,481

(245.9
)
6,836

(484.2
)
Equity securities
484

(42.3
)
—

—

484

(42.3
)
Other investments
88

(8.3
)
—

—

88

(8.3
)
Total
$
5,927

$
(288.9
)
$
1,481

$
(245.9
)
$
7,408

$
(534.8
)

16
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


e) Restricted assets
ACE is required to maintain assets on deposit with various regulatory authorities to support its insurance and reinsurance operations. These requirements are generally promulgated in the statutory regulations of the individual jurisdictions. The assets on deposit are available to settle insurance and reinsurance liabilities. ACE is also required to restrict assets pledged under reverse repurchase agreements. We also use trust funds in certain large reinsurance transactions where the trust funds are set up for the benefit of the ceding companies and generally take the place of letter of credit (LOC) requirements. We also have investments in segregated portfolios primarily to provide collateral or guarantees for LOCs and derivative transactions. Included in restricted assets at September 30, 2012 and December 31, 2011 , are fixed maturities and short-term investments totaling $16.3 billion and $14.9 billion, respectively, and cash of $116 million and $179 million, respectively.
The following table presents the components of restricted assets:
September 30
December 31
2012
2011
(in millions of U.S. dollars)
Trust funds
$
11,149

$
9,940

Deposits with non-U.S. regulatory authorities
2,120

2,240

Assets pledged under reverse repurchase agreements
1,402

1,251

Deposits with U.S. regulatory authorities
1,325

1,307

Other pledged assets
390

364

$
16,386

$
15,102


4 . Fair value measurements
a ) Fair value hierarchy
Fair value of financial assets and financial liabilities is estimated based on the framework established in the fair value accounting guidance. The guidance defines fair value as the price to sell an asset or transfer a liability in an orderly transaction between market participants and establishes a three-level valuation hierarchy in which inputs into valuation techniques used to measure fair value are classified. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data.
The three levels of the hierarchy are as follows:
•
Level 1 – Unadjusted quoted prices for identical assets or liabilities in active markets;
•
Level 2 – Includes, among other items, inputs other than quoted prices that are observable for the asset or liability such as interest rates and yield curves, quoted prices for similar assets and liabilities in active markets, and quoted prices for identical or similar assets and liabilities in markets that are not active; and
•
Level 3 – Inputs that are unobservable and reflect management’s judgments about assumptions that market participants would use in pricing an asset or liability.
We categorize financial instruments within the valuation hierarchy at the balance sheet date based upon the lowest level of inputs that are significant to the fair value measurement. Accordingly, transfers between levels within the valuation hierarchy occur when there are significant changes to the inputs, such as increases or decreases in market activity, changes to the availability of current prices, changes to the transparency to underlying inputs, and whether there are significant variances in quoted prices. Transfers in and/or out of any level are assumed to occur at the end of the period.

17
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


We use one or more pricing services to obtain fair value measurements for the majority of the investment securities we hold. Based on management’s understanding of the methodologies used, these pricing services only produce an estimate of fair value if there is observable market information that would allow them to make a fair value estimate. Based on our understanding of the market inputs used by the pricing services, all applicable investments have been valued in accordance with GAAP. We do not typically adjust prices obtained from pricing services. The following is a description of the valuation techniques and inputs used to determine fair values for financial instruments carried at fair value, as well as the general classification of such financial instruments pursuant to the valuation hierarchy.
Fixed maturities
We use pricing services to estimate fair value measurements for the majority of our fixed maturities. The pricing services use market quotations for fixed maturities that have quoted prices in active markets; such securities are classified within Level 1. For fixed maturities other than U.S. Treasury securities that generally do not trade on a daily basis, the pricing services prepare estimates of fair value measurements using their pricing applications, which include available relevant market information, benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing. Additional valuation factors that can be taken into account are nominal spreads, dollar basis, and liquidity adjustments. The pricing services evaluate each asset class based on relevant market and credit information, perceived market movements, and sector news. The market inputs used in the pricing evaluation, listed in the approximate order of priority include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. The extent of the use of each input is dependent on the asset class and the market conditions. Given the asset class, the priority of the use of inputs may change or some market inputs may not be relevant. Additionally, the valuation of fixed maturity investments is more subjective when markets are less liquid due to the lack of market based inputs (i.e., stale pricing), which may increase the potential that the estimated fair value of an investment is not reflective of the price at which an actual transaction would occur. The overwhelming majority of fixed maturities are classified within Level 2 because the most significant inputs used in the pricing techniques are observable. For a small number of fixed maturities, we obtain a quote from a broker (typically a market maker). Due to the disclaimers on the quotes that indicate that the price is indicative only, we include these fair value estimates in Level 3.
Equity securities
Equity securities with active markets are classified within Level 1 as fair values are based on quoted market prices. For non-public equity securities, fair values are based on market valuations and are classified within Level 2. Equity securities for which pricing is unobservable are classified within Level 3.
Short-term investments
Short-term investments, which comprise securities due to mature within one year of the date of purchase that are traded in active markets, are classified within Level 1 as fair values are based on quoted market prices. Securities such as commercial paper and discount notes are classified within Level 2 because these securities are typically not actively traded due to their approaching maturity and, as such, their cost approximates fair value.
Other investments
Fair values for the majority of Other investments including investments in partially-owned investment companies, investment funds, and limited partnerships are based on their respective net asset values or equivalent (NAV). The majority of these investments, for which NAV was used as a practical expedient to measure fair value, are classified within Level 3 because either ACE will never have the contractual option to redeem the investments or will not have the contractual option to redeem the investments in the near term. The remainder of such investments is classified within Level 2. Certain of our long duration contracts have assets that do not qualify for separate account reporting under GAAP. These assets comprise mutual funds classified within Level 1 in the valuation hierarchy on the same basis as other equity securities traded in active markets. Other investments also includes equity securities and fixed maturities held in rabbi trusts maintained by ACE for deferred compensation

18
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


plans, which are classified within the valuation hierarchy on the same basis as other equity securities and fixed maturities.
Securities lending collateral
The underlying assets included in Securities lending collateral in the consolidated balance sheets are fixed maturities which are classified in the valuation hierarchy on the same basis as other fixed maturities. Excluded from the valuation hierarchy is the corresponding liability related to ACE’s obligation to return the collateral plus interest as it is reported at contract value and not fair value on the consolidated balance sheets.
Investment derivative instruments
Actively traded investment derivative instruments, including futures, options, and exchange-traded forward contracts are classified within Level 1 as fair values are based on quoted market prices. The fair value of cross-currency swaps are based on market valuations and are classified within Level 2. Investment derivative instruments are recorded in Accounts payable, accrued expenses, and other liabilities in the consolidated balance sheets.
Other derivative instruments
We maintain positions in other derivative instruments including exchange-traded equity futures contracts and option contracts designed to limit exposure to a severe equity market decline, which would cause an increase in expected claims and, therefore, reserves for our guaranteed minimum death benefits (GMDB) and guaranteed living benefits (GLB) reinsurance business. Our position in exchange-traded equity futures contracts is classified within Level 1. The fair value of the majority of the remaining positions in other derivative instruments is based on significant observable inputs including equity security and interest rate indices. Accordingly, these are classified within Level 2. Our position in credit default swaps is typically included within Level 3. Other derivative instruments are recorded in Accounts payable, accrued expenses, and other liabilities in the consolidated balance sheets.
Separate account assets
Separate account assets represent segregated funds where investment risks are borne by the customers, except to the extent of certain guarantees made by ACE. Separate account assets comprise mutual funds classified in the valuation hierarchy on the same basis as other equity securities traded in active markets and are classified within Level 1. Separate account assets also include fixed maturities classified within Level 2 because the most significant inputs used in the pricing techniques are observable. Excluded from the valuation hierarchy are the corresponding liabilities as they are reported at contract value and not fair value in the consolidated balance sheets. Separate account assets are recorded in Other assets in the consolidated balance sheets.
Guaranteed living benefits
The GLB arises from life reinsurance programs covering living benefit guarantees whereby we assume the risk of guaranteed minimum income benefits (GMIB) and guaranteed minimum accumulation benefits (GMAB) associated with variable annuity contracts. GLB’s are recorded in Accounts payable, accrued expenses, and other liabilities and Future policy benefits in the consolidated balance sheets. For GLB reinsurance, ACE estimates fair value using an internal valuation model which includes current market information and estimates of policyholder behavior. All of the treaties contain claim limits, which are factored into the valuation model. The fair value depends on a number of inputs, including changes in interest rates, changes in equity markets, credit risk, current account value, changes in market volatility, expected annuitization rates, changes in policyholder behavior, and changes in policyholder mortality.
The most significant policyholder behavior assumptions include lapse rates and the GMIB annuitization rates. Assumptions regarding lapse rates and GMIB annuitization rates differ by treaty but the underlying methodologies to determine rates applied to each treaty are comparable. The assumptions regarding lapse and GMIB

19
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


annuitization rates determined for each treaty are based on a dynamic calculation that uses several underlying factors.
A lapse rate is the percentage of in-force policies surrendered in a given calendar year. All else equal, as lapse rates increase, ultimate claim payments will decrease. In general, the base lapse function assumes low lapse rates (ranging from about 1 percent to 6 percent per annum) during the surrender charge period of the GMIB contract, followed by a “spike” lapse rate (ranging from about 10 percent to 30 percent per annum) in the year immediately following the surrender charge period, and then reverting to an ultimate lapse rate (generally around 10 percent per annum), typically over a 2 -year period. This base rate is adjusted downward for policies with more valuable guarantees (policies with guaranteed values far in excess of their account values) by multiplying the base lapse rate by a factor ranging from 15 percent to 75 percent . Additional lapses due to partial withdrawals and older policyholders with tax-qualified contracts (due to required minimum distributions) are also included.
The GMIB annuitization rate is the percentage of policies for which the policyholder will elect to annuitize using the guaranteed benefit provided under the GMIB. All else equal, as GMIB annuitization rates increase, ultimate claim payments will increase, subject to treaty claim limits. In general ACE assumes that GMIB annuitization rates will be higher for policies with more valuable guarantees (policies with guaranteed values far in excess of their account values). In addition, we also assume that GMIB annuitization rates are higher in the first year immediately following the waiting period (the first year the policies are eligible to annuitize using the GMIB) in comparison to all subsequent years. We do not yet have a robust set of annuitization experience because most of our clients’ policyholders are not yet eligible to annuitize using the GMIB. However, for certain clients representing approximately 36 percent of the total GMIB guaranteed value there are several years of annuitization experience. For these clients the annuitization function reflects the actual experience and has a maximum annuitization rate per annum of 8 percent (a higher maximum applies in the first year a policy is eligible to annuitize using the GMIB—it is over 13 percent ). For most clients, there is not a credible amount of observable relevant behavior data and so we use a weighted-average (with a heavier weighting on the observed experience noted previously) of three different annuitization functions with maximum annuitization rates per annum of 8 percent , 12 percent , and 30 percent , respectively (with significantly higher rates in the first year a policy is eligible to annuitize using the GMIB). The GMIB reinsurance treaties include claim limits to protect ACE in the event that actual annuitization behavior is significantly higher than expected.
The effect of changes in key market factors on assumed lapse and annuitization rates reflect emerging trends using data available from cedants. For treaties with limited experience, rates are established in line with data received from other ceding companies adjusted, as appropriate, with industry estimates. The model and related assumptions are continuously re-evaluated by management and enhanced, as appropriate, based upon additional experience obtained related to policyholder behavior and availability of more information, such as market conditions, market participant assumptions, and demographics of in-force annuities. During the three and nine months ended September 30, 2012 , no material changes were made to actuarial or behavioral assumptions. We made minor technical refinements to the model with a favorable net income impact of approximately $21 million for the three and nine months ended September 30, 2012.
We view the variable annuity reinsurance business as having a similar risk profile to that of catastrophe reinsurance, with the probability of a cumulative long-term economic net loss relatively small at the time of pricing. However, adverse changes in market factors and policyholder behavior will have an adverse impact on net income, which may be material. Because of the significant use of unobservable inputs including policyholder behavior, GLB reinsurance is classified within Level 3.

20
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


The following tables present, by valuation hierarchy, the financial instruments measured at fair value on a recurring basis:
Level 1
Level 2
Level 3
Total
(in millions of U.S. dollars)
September 30, 2012
Assets:
Fixed maturities available for sale
U.S. Treasury and agency
$
1,991

$
1,563

$
—

$
3,554

Foreign
204

13,738

25

13,967

Corporate securities
19

15,684

130

15,833

Mortgage-backed securities
—

10,707

29

10,736

States, municipalities, and political subdivisions
—

2,413

1

2,414

2,214

44,105

185

46,504

Equity securities
761

5

4

770

Short-term investments
1,561

868

—

2,429

Other investments
248

195

2,178

2,621

Securities lending collateral
—

2,039

—

2,039

Investment derivative instruments
(3
)
—

—

(3
)
Other derivative instruments
6

32

—

38

Separate account assets
1,024

61

—

1,085

Total assets measured at fair value
$
5,811

$
47,305

$
2,367

$
55,483

Liabilities:
GLB (1)
$
—

$
—

$
1,279

$
1,279

____________________
(1)
Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as Future policy benefits in the consolidated balance sheets. Refer to Note 5 for additional information.


21
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


Level 1
Level 2
Level 3
Total
(in millions of U.S. dollars)
December 31, 2011
Assets:
Fixed maturities available for sale
U.S. Treasury and agency
$
1,691

$
1,264

$
5

$
2,960

Foreign
212

12,156

33

12,401

Corporate securities
20

14,539

134

14,693

Mortgage-backed securities
—

10,173

28

10,201

States, municipalities, and political subdivisions
—

1,711

1

1,712

1,923

39,843

201

41,967

Equity securities
632

2

13

647

Short-term investments
1,246

1,055

—

2,301

Other investments
208

229

1,877

2,314

Securities lending collateral
—

1,375

—

1,375

Investment derivative instruments
10

—

—

10

Other derivative instruments
(16
)
54

3

41

Separate account assets
607

53

—

660

Total assets measured at fair value
$
4,610

$
42,611

$
2,094

$
49,315

Liabilities:
GLB (1)
$
—

$
—

$
1,319

$
1,319

____________________
(1)
Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as Future policy benefits in the consolidated balance sheets. Refer to Note 5 for additional information.
The transfers between Level 1 and Level 2 during the three and nine months ended September 30, 2012 and 2011 were not material.
Fair value of alternative investments
Included in Other investments in the fair value hierarchy at September 30, 2012 and December 31, 2011 are investment funds, limited partnerships, and partially-owned investment companies measured at fair value using NAV as a practical expedient. At September 30, 2012 and December 31, 2011 , there were no probable or pending sales related to any of the investments measured at fair value using NAV.

22
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


The following table presents, by investment category, the expected liquidation period, fair value, and maximum future funding commitments of alternative investments:
Expected
Liquidation
Period
September 30, 2012
December 31, 2011
Fair
Value
Maximum
Future
Funding
Commitments
Fair
Value
Maximum
Future
Funding
Commitments
(in millions of U.S. dollars)
Financial
5 to 9 Years
$
210

$
124

$
205

$
141

Real estate
3 to 9 Years
323

66

270

96

Distressed
6 to 9 Years
189

142

182

57

Mezzanine
6 to 9 Years
269

294

195

282

Traditional
3 to 8 Years
647

541

565

200

Vintage
1 to 3 Years
16

1

18

1

Investment funds
Not Applicable
389

—

378

—

$
2,043

$
1,168

$
1,813

$
777

Included in all categories in the above table except for Investment funds are investments for which ACE will never have the contractual option to redeem but receives distributions based on the liquidation of the underlying assets. Included in the “Expected Liquidation Period” column above is the range in years over which ACE expects the majority of underlying assets in the respective categories to be liquidated. Further, for all categories except for Investment funds, ACE does not have the ability to sell or transfer the investments without the consent from the general partner of individual funds.
Financial
Financial consists of investments in private equity funds targeting financial services companies such as financial institutions and insurance services around the world.
Real estate
Real estate consists of investments in private equity funds targeting global distress opportunities, value added U.S. properties, and global mezzanine debt securities in the commercial real estate market.
Distressed
Distressed consists of investments in private equity funds targeting distressed debt/credit and equity opportunities in the U.S.
Mezzanine
Mezzanine consists of investments in private equity funds targeting private mezzanine debt of large-cap and mid-cap companies in the U.S. and worldwide.
Traditional
Traditional consists of investments in private equity funds employing traditional private equity investment strategies such as buyout and venture with different geographical focuses including Brazil, Asia, Europe, and the U.S.

23
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


Vintage
Vintage consists of investments in private equity funds made before 2002 and where the funds’ commitment periods had already expired.
Investment funds
ACE’s investment funds employ various investment strategies such as long/short equity and arbitrage/distressed. Included in this category are investments for which ACE has the option to redeem at agreed upon value as described in each investment fund’s subscription agreement. Depending on the terms of the various subscription agreements, investment fund investments may be redeemed monthly, quarterly, semi-annually, or annually. If ACE wishes to redeem an investment fund investment, it must first determine if the investment fund is still in a lock-up period (a time when ACE cannot redeem its investment so that the investment fund manager has time to build the portfolio). If the investment fund is no longer in its lock-up period, ACE must then notify the investment fund manager of its intention to redeem by the notification date prescribed by the subscription agreement. Subsequent to notification, the investment fund can redeem ACE’s investment within several months of the notification. Notice periods for redemption of the investment funds range between 5 and 120 days. ACE can redeem its investment funds without consent from the investment fund managers.
Level 3 financial instruments
The fair value of assets and liabilities measured at fair value using significant unobservable inputs (Level 3) consist of various inputs and assumptions that management makes when determining the fair value. Management analyzes changes in fair value measurements classified within Level 3 by comparing pricing and returns of our investments to benchmarks, including month-over-month movements, investment credit spreads, interest rate movements, and credit quality of securities.
The following table presents the significant unobservable inputs used in the Level 3 liability valuations. Excluded from the table below are inputs used to fair value Level 3 assets which are based on single broker quotes or net asset value and contain no quantitative unobservable inputs developed by management.
(in millions of U.S. dollars)
Fair Value at
September 30,
2012
Valuation
Technique
Significant
Unobservable Inputs
Ranges
GLB (1)
$
1,279

Actuarial model
Lapse rate
1% - 30%
Annuitization rate
0% - 50%
____________________
(1)
Discussion of the most significant inputs used in the fair value measurement of GLB and the sensitivity of those assumptions is included within Note 4 a) Guaranteed living benefits.

24
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


The following tables present a reconciliation of the beginning and ending balances of financial instruments measured at fair value using significant unobservable inputs (Level 3):
Three Months Ended September 30, 2012
Assets
Liabilities
Available-for-Sale Debt Securities
Equity
securities
Other
investments
Other
derivative
instruments
GLB (1)
U.S.
Treasury
and
Agency
Foreign
Corporate
securities
MBS
States,
municipalities,
and political
subdivisions
(in millions of U.S. dollars)
Balance-Beginning of Period
$
4

$
20

$
137

$
27

$
1

$
12

$
2,047

$
1

$
1,354

Transfers into Level 3
—

5

5

10

—

2

53

—

—

Transfers out of Level 3
(4
)
(6
)
(26
)
—

—

(10
)
—

—

—

Change in Net Unrealized Gains (Losses) included in OCI
—

—

3

—

—

(1
)
13

—

—

Net Realized Gains/Losses
—

—

—

—

—

—

—

—

(75
)
Purchases
—

6

11

—

—

1

121

—

—

Sales
—

—

—

(7
)
—

—

(5
)
—

—

Settlements
—

—

—

(1
)
—

—

(51
)
(1
)
—

Balance-End of Period
$
—

$
25

$
130

$
29

$
1

$
4

$
2,178

$
—

$
1,279

Net Realized Gains/Losses Attributable to Changes in Fair Value at the Balance Sheet Date
$
—

$
—

$
—

$
—

$
—

$
—

$
—

$
—

$
(75
)
____________________
(1)
Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as Future policy benefits in the consolidated balance sheets. Refer to Note 5 for additional information.

25
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


Three Months Ended September 30, 2011
Assets
Liabilities
Available-for-Sale Debt Securities
Equity
securities
Other
investments
Other
derivative
instruments
GLB (1)
Foreign
Corporate
securities
MBS
States,
municipalities,
and political
subdivisions
(in millions of U.S. dollars)
Balance-Beginning of Period
$
27

$
142

$
34

$
1

$
10

$
1,680

$
4

$
524

Transfers into Level 3
—

—

—

—

—

—

—

—

Transfers out of Level 3
(11
)
—

(13
)
—

—

—

—

—

Change in Net Unrealized Gains (Losses) included in OCI
—

(6
)
—

—

—

59

—

—

Net Realized Gains/Losses
(1
)
—

—

—

—

(1
)
5

952

Purchases
1

1

—

—

—

85

—

—

Sales
—

(3
)
(2
)
—

—

—

—

—

Settlements
—

(9
)
(1
)
—

—

(58
)
(1
)
—

Balance-End of Period
$
16

$
125

$
18

$
1

$
10

$
1,765

$
8

$
1,476

Net Realized Gains/Losses Attributable to Changes in Fair Value at the Balance Sheet Date
$
—

$
—

$
—

$
—

$
—

$
(1
)
$
4

$
952

____________________
(1)
Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as Future policy benefits in the consolidated balance sheets. The liability for GLB reinsurance was $1,635 million at September 30, 2011 , and $ 676 million at June 30, 2011 , which includes a fair value derivative adjustment of $1,476 million and $524 million, respectively.
Nine Months Ended September 30, 2012
Assets
Liabilities
Available-for-Sale Debt Securities
Equity
securities
Other
investments
Other
derivative
instruments
GLB (1)
U.S.
Treasury
and
Agency
Foreign
Corporate
securities
MBS
States,
municipalities,
and political
subdivisions
(in millions of U.S. dollars)
Balance-Beginning of Period
$
5

$
33

$
134

$
28

$
1

$
13

$
1,877

$
3

$
1,319

Transfers into Level 3
—

6

33

22

1

2

53

—

—

Transfers out of Level 3
(4
)
(7
)
(35
)
(15
)
—

(10
)
—

—

—

Change in Net Unrealized Gains (Losses) included in OCI
—

—

6

—

—

—

37

—

—

Net Realized Gains/Losses
—

—

(1
)
—

—

—

(7
)
(4
)
(40
)
Purchases
—

46

19

4

—

4

366

3

—

Sales
—

(52
)
(15
)
(7
)
—

(5
)
(6
)
—

—

Settlements
(1
)
(1
)
(11
)
(3
)
(1
)
—

(142
)
(2
)
—

Balance-End of Period
$
—

$
25

$
130

$
29

$
1

$
4

$
2,178

$
—

$
1,279

Net Realized Gains/Losses Attributable to Changes in Fair Value at the Balance Sheet Date
$
—

$
—

$
—

$
—

$
—

$
—

$
(7
)
$
—

$
(40
)
____________________
(1)
Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as Future policy benefits in the consolidated balance sheets. Refer to Note 5 for additional information.

26
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


Nine Months Ended September 30, 2011
Assets
Liabilities
Available-for-Sale Debt Securities
Equity
securities
Other
investments
Other
derivative
instruments
GLB (1)
Foreign
Corporate
securities
MBS
States,
municipalities,
and political
subdivisions
(in millions of U.S. dollars)
Balance-Beginning of Period
$
26

$
115

$
39

$
2

$
13

$
1,432

$
4

$
507

Transfers into Level 3
9

34

4

—

—

—

—

—

Transfers out of Level 3
(18
)
(4
)
(48
)
—

—

—

—

—

Change in Net Unrealized Gains (Losses) included in OCI
(1
)
(5
)
—

—

(1
)
110

—

—

Net Realized Gains/Losses
—

(2
)
—

—

4

(4
)
6

969

Purchases
6

23

46

—

2

418

—

—

Sales
(3
)
(23
)
(17
)
—

(8
)
(55
)
—

—

Settlements
(3
)
(13
)
(6
)
(1
)
—

(136
)
(2
)
—

Balance-End of Period
$
16

$
125

$
18

$
1

$
10

$
1,765

$
8

$
1,476

Net Realized Gains/Losses Attributable to Changes in Fair Value at the Balance Sheet Date
$
—

$
—

$
—

$
—

$
—

$
(4
)
$
4

$
969

____________________
(1)
Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as Future policy benefits in the consolidated balance sheets. The liability for GLB reinsurance was $1,635 million at September 30, 2011 , and $ 648 million at December 31, 2010 , which includes a fair value derivative adjustment of $1,476 million and $507 million, respectively.
b) Financial instruments disclosed, but not measured, at fair value
ACE uses various financial instruments in the normal course of its business. Our insurance contracts are excluded from fair value of financial instruments accounting guidance, and therefore, are not included in the amounts discussed below.
The carrying values of cash, other assets, other liabilities, and other financial instruments not included below approximated their fair values.
Investments in partially-owned insurance companies
Fair values for investments in partially-owned insurance companies are based on ACE’s share of the net assets based on the financial statements provided by those companies.
Short- and long-term debt and trust preferred securities
Where practical, fair values for short-term debt, long-term debt, and trust preferred securities are estimated using discounted cash flow calculations based principally on observable inputs including incremental borrowing rates, which reflect ACE’s credit rating, for similar types of borrowings with maturities consistent with those remaining for the debt being valued.

27
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


The following table presents carrying values and fair values of financial instruments not measured at fair value:
September 30, 2012
December 31, 2011
Carrying
Value
Fair
Value
Carrying
Value
Fair
Value
Assets:
(in millions of U.S. dollars)
Fixed maturities held to maturity
U.S. Treasury and agency
$
1,084

$
1,129

$
1,078

$
1,126

Foreign
919

970

935

930

Corporate securities
2,182

2,322

2,338

2,337

Mortgage-backed securities
2,222

2,330

2,949

3,036

States, municipalities, and political subdivisions
1,086

1,128

1,147

1,176

7,493

7,879

8,447

8,605

Partially-owned insurance companies
354

354

352

352

Total assets
$
7,847

$
8,233

$
8,799

$
8,957

Liabilities:
Short-term debt
$
1,402

$
1,402

$
1,251

$
1,251

Long-term debt
3,360

3,964

3,360

3,823

Trust preferred securities
309

459

309

404

Total liabilities
$
5,071

$
5,825

$
4,920

$
5,478


28
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


The following table presents, by valuation hierarchy, the financial instruments not measured at fair value:
Level 1
Level 2
Level 3
Total
September 30, 2012
(in millions of U.S. dollars)
Assets:
Fixed maturities held to maturity
U.S. Treasury and agency
$
615

$
514

$
—

$
1,129

Foreign
—

970

—

970

Corporate securities
—

2,306

16

2,322

Mortgage-backed securities
—

2,330

—

2,330

States, municipalities, and political subdivisions
—

1,128

—

1,128

615

7,248

16

7,879

Partially-owned insurance companies
—

—

354

354

Total assets
$
615

$
7,248

$
370

$
8,233

Liabilities:
Short-term debt
$
—

$
1,402

$
—

$
1,402

Long-term debt
—

3,964

—

3,964

Trust preferred securities
—

459

—

459

Total liabilities
$
—

$
5,825

$
—

$
5,825

5 . Assumed life reinsurance programs involving minimum benefit guarantees under annuity contracts
The following table presents income and expenses relating to GMDB and GLB reinsurance. GLBs include GMIBs as well as some GMABs originating in Japan.
Three Months Ended
Nine Months Ended
September 30
September 30
2012
2011
2012
2011
(in millions of U.S. dollars)
GMDB
Net premiums earned
$
20

$
24

$
64

$
75

Policy benefits and other reserve adjustments
$
22

$
20

$
61

$
63

GLB
Net premiums earned
$
40

$
40

$
121

$
122

Policy benefits and other reserve adjustments
7

7

30

19

Net realized gains (losses)
75

(952
)
41

(969
)
Gain (loss) recognized in income
$
108

$
(919
)
$
132

$
(866
)
Net cash received
$
35

$
40

$
114

$
121

Net (increase) decrease in liability
$
73

$
(959
)
$
18

$
(987
)
At September 30, 2012 , reported liabilities for GMDB and GLB reinsurance were $114 million and $1.5 billion, respectively, compared with $138 million and $1.5 billion, respectively, at December 31, 2011 . The reported liability for GLB reinsurance at September 30, 2012 and December 31, 2011 of $1.5 billion includes a fair value derivative adjustment of $1.3 billion. Included in Net realized gains (losses) in the table above are gains (losses) related to foreign exchange and other fair value derivative adjustments. Reported liabilities for both GMDB and GLB reinsurance are determined using internal valuation models. Such valuations require considerable judgment

29
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


and are subject to significant uncertainty. The valuation of these products is subject to fluctuations arising from, among other factors, changes in interest rates, changes in equity markets, changes in credit markets, changes in the allocation of the investments underlying annuitants’ account values, and assumptions regarding future policyholder behavior. These models and the related assumptions are continually reviewed by management and enhanced, as appropriate, based upon improvements in modeling assumptions and availability of more information, such as market conditions and demographics of in-force annuities.
Variable Annuity Net Amount at Risk
(i) Reinsurance covering the GMDB risk only
At September 30, 2012 and December 31, 2011 , the net amount at risk from reinsurance programs covering the GMDB risk only was $1.4 billion and $1.8 billion, respectively.
For reinsurance programs covering the GMDB risk only, the net amount at risk is defined as the present value of future claim payments under the following assumptions:
•
policy account values and guaranteed values are fixed at the valuation date ( September 30, 2012 and December 31, 2011 , respectively);
•
there are no lapses or withdrawals;
•
mortality according to 100 percent of the Annuity 2000 mortality table;
•
future claims are discounted in line with the discounting assumption used in the calculation of the benefit reserve averaging between 1.0 percent and 2.0 percent; and
•
reinsurance coverage ends at the earlier of the maturity of the underlying variable annuity policy or the reinsurance treaty.
The total claim amount payable on reinsurance programs covering the GMDB risk only, if all the cedants’ policyholders were to die immediately at September 30, 2012 was approximately $486 million. This takes into account all applicable reinsurance treaty claim limits.
(ii) Reinsurance covering the GLB risk only
At September 30, 2012 and December 31, 2011 , the net amount at risk from reinsurance programs covering the GLB risk only was $382 million and $380 million, respectively.
For reinsurance programs covering the GLB risk only, the net amount at risk is defined as the present value of future claim payments under the following assumptions:
•
policy account values and guaranteed values are fixed at the valuation date ( September 30, 2012 and December 31, 2011 , respectively);
•
there are no deaths, lapses, or withdrawals;
•
policyholders annuitize at a frequency most disadvantageous to ACE (in other words, annuitization at a level that maximizes claims taking into account the treaty limits) under the terms of the reinsurance contracts;
•
for annuitizing policyholders, the GMIB claim is calculated using interest rates in line with those used in calculating the reserve;
•
future claims are discounted in line with the discounting assumption used in the calculation of the benefit reserve averaging between 3.5 percent and 4.5 percent; and
•
reinsurance coverage ends at the earlier of the maturity of the underlying variable annuity policy or the reinsurance treaty.

30
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


(iii) Reinsurance covering both the GMDB and GLB risks on the same underlying policyholders
At September 30, 2012 and December 31, 2011 , the GMDB net amount at risk from reinsurance programs covering both the GMDB and GLB risks on the same underlying policyholders was $137 million and $182 million, respectively.
At September 30, 2012 and December 31, 2011 , the GLB net amount at risk from reinsurance programs covering both the GMDB and GLB risks on the same underlying policyholders was $825 million and $998 million, respectively.
These net amounts at risk reflect the interaction between the two types of benefits on any single policyholder (eliminating double-counting), and therefore the net amounts at risk should be considered additive.
For reinsurance programs covering both the GMDB and GLB risks on the same underlying policyholders, the net amount at risk is defined as the present value of future claim payments under the following assumptions:
•
policy account values and guaranteed values are fixed at the valuation date ( September 30, 2012 and December 31, 2011 , respectively);
•
there are no lapses, or withdrawals;
•
mortality according to 100 percent of the Annuity 2000 mortality table;
•
policyholders annuitize at a frequency most disadvantageous to ACE (in other words, annuitization at a level that maximizes claims taking into account the treaty limits) under the terms of the reinsurance contracts;
•
for annuitizing policyholders, the GMIB claim is calculated using interest rates in line with those used in calculating the reserve;
•
future claims are discounted in line with the discounting assumption used in the calculation of the benefit reserve averaging between 1.0 percent and 2.0 percent; and
•
reinsurance coverage ends at the earlier of the maturity of the underlying variable annuity policy or the reinsurance treaty.
The total claim amount payable on reinsurance programs covering both the GMDB and GLB risks on the same underlying policyholders, if all of the cedants’ policyholders were to die immediately at September 30, 2012 was approximately $885 million. This takes into account all applicable reinsurance treaty claim limits. Although there would be an increase in death claims resulting from 100 percent immediate mortality of all policyholders, the GLB claims would be zero.
The average attained age of all policyholders under sections i), ii), and iii) above, weighted by the guaranteed value of each reinsured policy, is approximately 68 years.
6 . Commitments, contingencies, and guarantees
a) Derivative instruments
Derivative instruments employed
ACE maintains positions in derivative instruments such as futures, options, swaps, and foreign currency forward contracts for which the primary purposes are to manage duration and foreign currency exposure, yield enhancement, or to obtain an exposure to a particular financial market. Along with convertible bonds and to be announced mortgage-backed securities (TBA), discussed below, these are the most numerous and frequent derivative transactions.
ACE maintains positions in convertible bond investments that contain embedded derivatives. In addition, we purchase TBAs as part of our investing activities. These securities are included within the fixed maturities available for sale (FM AFS) portfolio.

31
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


Under reinsurance programs covering GLBs, ACE assumes the risk of GLBs, including GMIB and GMAB, associated with variable annuity contracts. The GMIB risk is triggered if, at the time the contract holder elects to convert the accumulated account value to a periodic payment stream (annuitize), the accumulated account value is not sufficient to provide a guaranteed minimum level of monthly income. The GMAB risk is triggered if, at contract maturity, the contract holder’s account value is less than a guaranteed minimum value. The GLB reinsurance product meets the definition of a derivative instrument. Benefit reserves in respect of GLBs are classified as Future policy benefits (FPB) while the fair value derivative adjustment is classified within Accounts payable, accrued expenses, and other liabilities (AP). ACE also maintains positions in exchange-traded equity futures contracts and options on equity market indices to limit equity exposure in the GMDB and GLB blocks of business.
In relation to certain debt issuances, ACE, from time to time, enters into interest rate swap transactions for the purpose of either fixing or reducing borrowing costs. Although the use of these interest rate swaps has the economic effect of fixing or reducing borrowing costs on a net basis, gross interest expense on the related debt issuances is included in Interest expense while the settlements related to the interest rate swaps are reflected in Net realized gains (losses) in the consolidated statements of operations. At September 30, 2012 , ACE had no in-force interest rate swaps.
ACE, from time to time, buys credit default swaps to mitigate global credit risk exposure, primarily related to reinsurance recoverables. At September 30, 2012 , ACE had no in-force credit default swaps.
All derivative instruments are carried at fair value with changes in fair value recorded in Net realized gains (losses) in the consolidated statements of operations. None of the derivative instruments are designated as hedges for accounting purposes.

32
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)



The following table presents the balance sheet locations, fair values in an asset or (liability) position, and notional values/payment provisions of our derivative instruments:
September 30, 2012
December 31, 2011
Consolidated
Balance
Sheet
Location
Fair
Value
Notional
Value/
Payment
Provision
Fair
Value
Notional
Value/
Payment
Provision
(in millions of U.S. dollars)
Investment and embedded derivative instruments
Foreign currency forward contracts
AP
$
(6
)
$
841

$
7

$
674

Cross-currency swaps
AP
—

50

—

—

Futures contracts on money market instruments
AP
3

2,200

7

10,476

Futures contracts on notes and bonds
AP
—

931

(4
)
1,055

Options on money market instruments
AP
—

3,030

—

292

Options on notes and bonds futures
AP
—

56

—

—

Convertible bonds
FM AFS
410

378

357

353

TBAs
FM AFS
75

71

60

56

$
482

$
7,557

$
427

$
12,906

Other derivative instruments
Futures contracts on equities (1)
AP
$
6

$
2,342

$
(16
)
$
1,367

Options on equity market indices (1)
AP
32

250

54

250

Credit default swaps
AP
—

—

3

350

Other
AP
—

6

—

6

$
38

$
2,598

$
41

$
1,973

GLB (2)
AP/FPB
$
(1,487
)
$
1,207

$
(1,505
)
$
1,378

____________________
(1)
Related to GMDB and GLB blocks of business.
(2)
Includes both future policy benefits reserves and fair value derivative adjustment. Refer to Note 5 for additional information. Note that the payment provision related to GLB is the net amount at risk. The concept of a notional value does not apply to the GLB reinsurance contracts.

33
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


The following table presents net realized gains (losses) related to derivative instrument activity in the consolidated statements of operations:
Three Months Ended
Nine Months Ended
September 30
September 30
2012
2011
2012
2011
(in millions of U.S. dollars)
Investment and embedded derivative instruments
Foreign currency forward contracts
$
(9
)
$
15

$
(8
)
$
(3
)
All other futures contracts and options
—

(64
)
(20
)
(91
)
Convertible bonds
12

(41
)
24

(63
)
TBAs
1

1

1

—

Total investment and embedded derivative instruments
$
4

$
(89
)
$
(3
)
$
(157
)
GLB and other derivative instruments
GLB (1)
$
83

$
(926
)
$
44

$
(925
)
Futures contracts on equities (2)
(138
)
197

(286
)
134

Options on equity market indices (2)
(9
)
23

(22
)
18

Credit default swaps
—

2

(4
)
(1
)
Total GLB and other derivative instruments
$
(64
)
$
(704
)
$
(268
)
$
(774
)
$
(60
)
$
(793
)
$
(271
)
$
(931
)
____________________
(1)
Excludes foreign exchange gains (losses) related to GLB.
(2)
Related to GMDB and GLB blocks of business.
Derivative instrument objectives
(i) Foreign currency exposure management
A foreign currency forward contract (forward) is an agreement between participants to exchange specific foreign currencies at a future date. ACE uses forwards to minimize the effect of fluctuating foreign currencies.
(ii) Duration management and market exposure
Futures
Futures contracts give the holder the right and obligation to participate in market movements, determined by the index or underlying security on which the futures contract is based. Settlement is made daily in cash by an amount equal to the change in value of the futures contract times a multiplier that scales the size of the contract. Exchange-traded futures contracts on money market instruments, notes and bonds are used in fixed maturity portfolios to more efficiently manage duration, as substitutes for ownership of the money market instruments, bonds and notes without significantly increasing the risk in the portfolio. Investments in futures contracts may be made only to the extent that there are assets under management not otherwise committed.
Exchange-traded equity futures contracts are used to limit exposure to a severe equity market decline, which would cause an increase in expected claims and therefore, reserves for GMDB and GLB reinsurance business.
Options
An option contract conveys to the holder the right, but not the obligation, to purchase or sell a specified amount or value of an underlying security at a fixed price. Option contracts are used in the investment portfolio as protection against unexpected shifts in interest rates, which would affect the duration of the fixed maturity portfolio. By using options in the portfolio, the overall interest rate sensitivity of the portfolio can be reduced. Option contracts may also be used as an alternative to futures contracts in the synthetic strategy as described above.

34
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


Another use for option contracts is to limit exposure to a severe equity market decline, which would cause an increase in expected claims and therefore, reserves for GMDB and GLB reinsurance business.
The price of an option is influenced by the underlying security, expected volatility, time to expiration, and supply and demand.
The credit risk associated with the above derivative financial instruments relates to the potential for non-performance by counterparties. Although non-performance is not anticipated, in order to minimize the risk of loss, management monitors the creditworthiness of its counterparties and obtains collateral. The performance of exchange-traded instruments is guaranteed by the exchange on which they trade. For non-exchange-traded instruments, the counterparties are principally banks which must meet certain criteria according to our investment guidelines.
Cross-currency swaps
We use cross-currency swaps to manage specific foreign currency denominated investments. These swaps enable us to reduce the duration gap between assets and liabilities by more closely matching the liabilities with the maturities of the underlying bonds.
Interest rate swaps
We use interest rate swaps related to certain debt issuances for the purpose of either fixing and/or reducing borrowing costs.
Credit default swaps
A credit default swap is a bilateral contract under which two counterparties agree to isolate and separately trade the credit risk of at least one third-party reference entity. Under a credit default swap agreement, a protection buyer pays a periodic fee to a protection seller in exchange for a contingent payment by the seller upon a credit event (such as a default or failure to pay) related to the reference entity. When a credit event is triggered, the protection seller pays the protection buyer the difference between the fair value of assets and the principal amount.
(iii) Convertible security investments
A convertible bond is a debt instrument that can be converted into a predetermined amount of the issuer’s equity at certain times prior to the bond’s maturity. The convertible option is an embedded derivative within the fixed maturity host instruments which are classified in the investment portfolio as available for sale. ACE purchases convertible bonds for their total return and not specifically for the conversion feature.
(iv) TBA
By acquiring a TBA, we make a commitment to purchase a future issuance of mortgage-backed securities. For the period between purchase of the TBA and issuance of the underlying security, we account for our position as a derivative in the consolidated financial statements. ACE purchases TBAs both for their total return and for the flexibility they provide related to our mortgage-backed security strategy.
(v) GLB
Under the GLB program, as the assuming entity, ACE is obligated to provide coverage until the expiration or maturity of the underlying annuities. Premiums received under the reinsurance treaties are classified as premium. Expected losses allocated to premiums received are classified as Future policy benefits and valued similar to GMDB reinsurance. Other changes in fair value, principally arising from changes in expected losses allocated to expected future premiums, are classified as Net realized gains (losses). Fair value represents management’s estimate of exit price and thus, includes a risk margin. We may recognize a realized loss for other changes in fair value due to adverse changes in the capital markets (e.g., declining interest rates and/or declining equity markets) and changes in actual or estimated future policyholder behavior (e.g., increased annuitization or decreased lapse

35
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


rates) although we expect the business to be profitable. We believe this presentation provides the most meaningful disclosure of changes in the underlying risk within the GLB reinsurance programs for a given reporting period.
b) Other investments
At September 30, 2012 , included in Other investments in the consolidated balance sheet are investments in limited partnerships and partially-owned investment companies with a carrying value of $1,654 million. In connection with these investments, we have commitments that may require funding of up to $1,168 million over the next several years.
c) Taxation
In April 2012, ACE reached final settlement with the Internal Revenue Service (IRS) Appeals Division regarding several issues raised by the IRS Examination Division in its federal tax returns for 2005, 2006 and 2007. The settlement of these issues had no net impact on our results of operations. In addition, the IRS completed its field examination of ACE’s federal tax returns for 2008 and 2009 during June 2012. No material adjustments resulted from this examination. It is reasonably possible that over the next twelve months, the amount of unrecognized tax benefits may change resulting from the re-evaluation of unrecognized tax benefits arising from examinations of taxing authorities and the closing of tax statutes of limitations. With few exceptions, ACE is no longer subject to state and local or non-U.S. income tax examinations for years before 2005.
d) Legal proceedings
(i) Claims and other litigation
Our insurance subsidiaries are subject to claims litigation involving disputed interpretations of policy coverages and, in some jurisdictions, direct actions by allegedly-injured persons seeking damages from policyholders. These lawsuits, involving claims on policies issued by our subsidiaries which are typical to the insurance industry in general and in the normal course of business, are considered in our loss and loss expense reserves. In addition to claims litigation, we are subject to lawsuits and regulatory actions in the normal course of business that do not arise from or directly relate to claims on insurance policies. This category of business litigation typically involves, among other things, allegations of underwriting errors or misconduct, employment claims, regulatory activity, or disputes arising from our business ventures. In the opinion of management, our ultimate liability for these matters is not likely to have a material adverse effect on our consolidated financial condition, although it is possible that the effect could be material to our consolidated results of operations for an individual reporting period.
(ii) Business practices litigation
ACE Limited, ACE INA Holdings Inc., and ACE USA, Inc., along with a number of other insurers and brokers, were named in a series of federal putative nationwide class actions brought by insurance policyholders. The Judicial Panel on Multidistrict Litigation (JPML) consolidated these cases in the District of New Jersey. On August 1, 2005, plaintiffs in the New Jersey consolidated proceedings filed two consolidated amended complaints – one concerning commercial insurance and the other concerning employee benefit plans. The employee benefit plans litigation against ACE Limited has been dismissed.
In the commercial insurance complaint, the plaintiffs named ACE Limited, ACE INA Holdings Inc., ACE USA, Inc., ACE American Insurance Co., Illinois Union Insurance Co., and Indemnity Insurance Co. of North America. They allege that certain brokers and insurers, including certain ACE entities, conspired to increase premiums and allocate customers through the use of “B” quotes and contingent commissions. In addition, they allege that the broker defendants received additional income by improperly placing their clients’ business with insurers through related wholesale entities that acted as intermediaries between brokers and insurers. Plaintiffs also allege that broker defendants tied the purchase of primary insurance to the placement of such coverage with reinsurance carriers through the broker defendants’ reinsurance broker subsidiaries. The complaint asserts the following causes of action against the ACE defendants: Federal Racketeer Influenced and Corrupt Organizations Act (RICO), federal antitrust law, state antitrust law, aiding and abetting breach of fiduciary duty, and unjust enrichment.

36
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


In 2006 and 2007, the Court dismissed plaintiffs’ first two attempts to properly plead a case without prejudice and permitted plaintiffs one final opportunity to re-plead. The amended complaint, filed on May 22, 2007, purported to add several new ACE defendants: ACE Group Holdings, Inc., ACE US Holdings, Inc., Westchester Fire Insurance Company, INA Corporation, INA Financial Corporation, INA Holdings Corporation, ACE Property and Casualty Insurance Company, and Pacific Employers Insurance Company. Plaintiffs also added a new antitrust claim against Marsh, the ACE defendants, and other insurers based on the same allegations as the other claims but limited to excess casualty insurance. In 2007, the Court granted defendants’ motions to dismiss plaintiffs’ antitrust and RICO claims with prejudice. The Court also declined to exercise supplemental jurisdiction over plaintiffs’ state law claims and dismissed those claims without prejudice. Plaintiffs appealed to the United States Court of Appeals for the Third Circuit. On August 16, 2010, the Third Circuit affirmed, in part, and vacated, in part, the District Court’s previous dismissals with instructions for further briefing at the District Court on remand. Defendants renewed their motions consistent with the Third Circuit’s instructions. On June 28, 2011 the District Court administratively terminated defendants’ motions without prejudice to re-file after adjudication of issues related to a proposed class settlement involving a number of other parties and stayed the case. On October 17, 2011, the Court lifted the stay and, shortly thereafter, entered an order permitting defendants to re-file their motions to dismiss.  Defendants did so on October 21, 2011.  On April 30, 2012 the Court entered a discovery scheduling order.  On May 31, 2012, the Court once again administratively terminated defendants' motions to dismiss.  On September 25, 2012, at defendants' urging, the Court ordered that the defendants' motions to dismiss would be reinstated.
As of October 30, 2012, plaintiffs have not specified an amount of alleged damages and the Court has not decided defendants’ renewed motions to dismiss. The Court has also not determined if this case may proceed as a class action and has, therefore, not determined the size or scope of any class. As a result, ACE is unable to reasonably estimate the potential loss or range of losses, if any, arising from this litigation.
There are a number of federal actions brought by policyholders based on allegations similar to the allegations in the consolidated federal actions that were filed in, or transferred to, the United States District Court for the District of New Jersey for coordination (“tag-along cases”). On October 17, 2011 the Court lifted the stay and on April 30, 2012 the Court entered a discovery scheduling order.  On September 25, 2012, at defendants' urging, the Court ordered the tag-along plaintiffs to file their final complaints.  The tag-along defendants will now be permitted to file threshold motions against those complaints in November 2012.  Discovery is ongoing.
•
New Cingular Wireless Headquarters LLC et al. v. Marsh & McLennan Companies, Inc. et al. (Case No. 06-5120; D.N.J.), was originally filed in the Northern District of Georgia on April 4, 2006. ACE Limited, ACE American Ins. Co., ACE USA, Inc., ACE Bermuda Insurance Ltd., Illinois Union Ins. Co., Pacific Employers Ins. Co., and Lloyd’s of London Syndicate 2488 AGM, along with a number of other insurers and brokers, are named.
•
Avery Dennison Corp. v. Marsh & McLennan Companies, Inc. et al. (Case No. 07-00757; D.N.J.) was filed on February 13, 2007. ACE Limited, ACE INA Holdings Inc., ACE USA, Inc., and ACE American Insurance Co., along with a number of other insurers and brokers, are named.
•
Henley Management Co., Inc. et al. v. Marsh, Inc. et al. (Case No. 07-2389; D.N.J.) was filed on May 27, 2007. ACE USA, Inc., along with a number of other insurers and Marsh, Inc., are named.
•
Sears, Roebuck & Co. et al. v. Marsh & McLennan Companies, Inc. et al. (Case No. 07-2535; D.N.J.) was originally filed in the Northern District of Georgia on October 12, 2007. ACE American Insurance Co., ACE Bermuda Insurance Ltd., and Westchester Surplus Lines Insurance Co., along with a number of other insurers and brokers, are named.
•
Lincoln Adventures LLC et al. v. Those Certain Underwriters at Lloyd’s, London Members of Syndicates 0033 et al. (Case No. 07-60991; D.N.J.) was originally filed in the Southern District of Florida on July 13, 2007. Supreme Auto Transport LLC et al. v. Certain Underwriters of Lloyd’s of London, et al. (Case No. 07-6703; D.N.J.) (Supreme Auto) was originally filed in the Southern District of New York on July 25, 2007. Lloyd’s of London Syndicate 2488 AGM, along with a number of other Lloyd’s of London Syndicates and various brokers, are named in both actions. The

37
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


allegations in these putative class-action lawsuits are similar to the allegations in the consolidated federal actions identified above, although these lawsuits focus on alleged conduct within the London insurance market. On May 29, 2012 the Supreme Auto case was voluntarily dismissed without prejudice by the plaintiffs.
As of October 30, 2012, plaintiffs have not specified an amount of alleged damages in any of the remaining tag-along cases. The proceedings in the tag-along cases were stayed at a very early stage, before the ACE defendants could challenge the sufficiency of the claims with, for example, motions to dismiss. Also, the scope of the tag-along cases, in large part, will be affected by the outcome of the Multidistrict Litigation Court’s decision on defendants’ renewed motions to dismiss. As a result, ACE is unable to reasonably estimate the potential loss or range of losses, if any, arising from these litigations.
In addition to the related federal cases, there are two state cases with allegations similar to those in the consolidated federal actions described above:
•
Van Emden Management Corporation v. Marsh & McLennan Companies, Inc., et al. (Case No. 05-0066A; Superior Court of Massachusetts), a class action in Massachusetts, was filed on January 13, 2005. Illinois Union Insurance Company is named. The Van Emden case has been stayed pending resolution of the consolidated proceedings in the District of New Jersey or until further order of the Court.
As of October 30, 2012, plaintiffs have not specified an amount of alleged damages in this case. The proceedings were stayed at a very early stage, before Illinois Union could challenge the sufficiency of the claims with, for example, a motion to dismiss. As a result, ACE is unable to reasonably estimate the potential loss or range of losses, if any, arising from this litigation.
•
State of Ohio, ex. rel. Marc E. Dann, Attorney General v. American Int’l Group, Inc. et al. (Case No. 07-633857; Court of Common Pleas in Cuyahoga County, Ohio) is an Ohio state action filed by the Ohio Attorney General on August 24, 2007. ACE INA Holdings Inc., ACE American Insurance Co., ACE Property & Casualty Insurance Co., Insurance Company of North America, and Westchester Fire Insurance Co., along with a number of other insurance companies and Marsh, are named. In December 2011 the ACE parties agreed to settle the case for $1.97 million. On December 27, 2011 the case was voluntarily dismissed with prejudice.
In all of the lawsuits described above, except where specifically noted, plaintiffs seek compensatory and in some cases special damages without specifying an amount. As a result, ACE cannot at this time estimate its potential costs related to these legal matters and, accordingly, no liability for compensatory damages has been established in the consolidated financial statements.
ACE’s ultimate liability for these matters is not likely to have a material adverse effect on ACE’s consolidated financial condition, although it is possible that the effect could be material to ACE’s consolidated results of operations for an individual reporting period.
7 . Shareholders’ equity
All of ACE’s Common Shares are authorized under Swiss corporate law. Though the par value of Common Shares is stated in Swiss francs, ACE continues to use U.S. dollars as its reporting currency for preparing the consolidated financial statements. Under Swiss corporate law, dividends, including distributions through a reduction in par value (par value distributions) or from legal reserves, must be declared by ACE in Swiss francs though dividend payments are made by ACE in U.S. dollars. At our May 2011 annual general meeting, our shareholders approved a dividend for the following year, payable in four quarterly installments after the May 2011 annual general meeting from our capital contribution reserves (Additional paid-in capital), a subaccount of legal reserves. At our May 2012 annual general meeting, our shareholders approved a dividend for the following year, payable in four quarterly installments after the May 2012 annual general meeting in the form of a distribution by way of a par value reduction. We have determined this procedure is more appropriate for us at this time due to current Swiss law. For the three and nine months ended September 30, 2012 , dividends per Common Share

38
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


amounted to CHF 0.45 ($ 0.49 ) and CHF 1.46 ($ 1.57 ), including a par value reduction of CHF 0.93 per Common Share that had the effect of reducing par value per Common Share to CHF 29.34 at September 30, 2012. Dividends for the nine months ended September 30, 2012 included a $0.12 per Common Share increase (approved by our shareholders at the January 9, 2012 extraordinary general meeting) to the third and fourth installments of the dividend approved at the May 2011 annual general meeting.
For the three and nine months ended September 30, 2011 , dividends per Common Share amounted to CHF 0.31 ($ 0.35 ) and CHF 0.90 ($ 1.03 ), including a par value reduction of CHF 0.30 per Common Share.
Common Shares in treasury are used principally for issuance upon the exercise of employee stock options, grants of restricted stock, and purchases under the Employee Stock Purchase Plan (ESPP). At September 30, 2012 , 3,097,303 Common Shares remain in treasury after net shares redeemed under employee share-based compensation plans.
ACE Limited securities repurchase authorization
In August 2011, the Board of Directors authorized the repurchase of up to $ 303 million of ACE’s Common Shares through December 31, 2012. The amount authorized in August 2011 was in addition to the $ 197 million balance remaining under a $ 600 million share repurchase program approved in November 2010. These authorizations were granted to allow ACE to repurchase Common Shares to partially offset potential dilution from the exercise of stock options and the granting of restricted stock under share-based compensation plans. Such repurchases may be made in the open market, in privately negotiated transactions, block trades, accelerated repurchases and/or through option or other forward transactions. In January 2012, ACE repurchased an additional 100,000 Common Shares for a cost of $ 7 million. At September 30, 2012 , $461 million in share repurchase authorization remained through December 31, 2012 pursuant to the November 2010 and August 2011 Board authorizations.
8 . Share-based compensation
The ACE Limited 2004 Long-Term Incentive Plan (the 2004 LTIP) provides for grants of both incentive and non-qualified stock options principally at an option price per share equal to the fair value of ACE’s Common Shares on the date of grant. Stock options are generally granted with a 3-year vesting period and a 10-year term. The stock options vest in equal annual installments over the respective vesting period, which is also the requisite service period. On February 23, 2012 , ACE granted 1,452,605 stock options with a weighted-average grant date fair value of $15.58 each. The fair value of the options issued is estimated on the date of grant using the Black-Scholes option pricing model.
The 2004 LTIP also provides for grants of restricted stock and restricted stock units. ACE generally grants restricted stock and restricted stock units with a 4-year vesting period, based on a graded vesting schedule. The restricted stock is granted at market close price on the day of grant. On February 23, 2012 , ACE granted 1,462,230 restricted stock awards and 255,850 restricted stock units to employees and officers of ACE and its subsidiaries with a grant date fair value of $73.35 each. Each restricted stock unit represents our obligation to deliver to the holder one Common Share upon vesting.
9 . Segment information
ACE operates through the following business segments: Insurance – North American, Insurance – Overseas General, Global Reinsurance, and Life. These segments distribute their products through various forms of brokers, agencies, and direct marketing programs. All business segments have established relationships with reinsurance intermediaries.
For segment reporting purposes, certain items have been presented in a different manner than in the consolidated financial statements. Management uses underwriting income as the main measure of segment performance. ACE calculates underwriting income by subtracting Losses and loss expenses, Policy benefits, Policy acquisition costs, and Administrative expenses from Net premiums earned. For the Life business, management also includes Net investment income and (Gains) losses from fair value changes in separate account assets that do not qualify for

39
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


separate account reporting as components of underwriting income. For example, for the three months ended September 30, 2012 , Life underwriting income of $ 102 million includes Net investment income of $ 63 million and (Gains) losses from fair value changes in separate account assets of $ (14) million.
Effective January 1, 2012, we reclassified prior year segment operating results in order to conform to certain organizational realignments. These realignments resulted in a transfer of operating revenue and underwriting results of our international direct-marketed and credit life businesses from the Insurance – Overseas General segment to the Life segment. These realignments have no impact on consolidated operating results; however, prior year amounts contained in these consolidated financial statements have been adjusted to conform to the current year presentation.
The following tables present the operations by segment:
Statement of Operations by Segment
For the Three Months Ended September 30, 2012
(in millions of U.S. dollars)
Insurance –
North
American
Insurance –
Overseas
General
Global
Reinsurance
Life
Corporate
and Other
ACE
Consolidated
Net premiums written
$
2,537

$
1,384

$
307

$
488

$
—

$
4,716

Net premiums earned
2,472

1,432

281

480

—

4,665

Losses and loss expenses
2,110

622

151

164

—

3,047

Policy benefits
—

—

—

130

—

130

Policy acquisition costs
160

329

40

80

—

609

Administrative expenses
148

234

13

81

43

519

Underwriting income (loss)
54

247

77

25

(43
)
360

Net investment income
263

127

72

63

8

533

Net realized gains (losses) including OTTI
(1
)
13

(2
)
(71
)
1

(60
)
Interest expense
3

2

1

3

54

63

Other (income) expense:
(Gains) losses from fair value changes in separate account assets
—

—

—

(14
)
—

(14
)
Other
(5
)
(3
)
(5
)
—

10

(3
)
Income tax expense (benefit)
81

77

11

14

(36
)
147

Net income (loss)
$
237

$
311

$
140

$
14

$
(62
)
$
640




40
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


Statement of Operations by Segment
For the Three Months Ended September 30, 2011
(in millions of U.S. dollars)
Insurance –
North
American
Insurance –
Overseas
General
Global
Reinsurance
Life
Corporate
and Other
ACE
Consolidated
Net premiums written
$
2,207

$
1,398

$
250

$
488

$
—

$
4,343

Net premiums earned
2,299

1,471

240

480

—

4,490

Losses and loss expenses
1,838

671

94

142

—

2,745

Policy benefits
—

—

—

83

—

83

Policy acquisition costs
174

353

50

92

—

669

Administrative expenses
153

236

12

81

38

520

Underwriting income (loss)
134

211

84

82

(38
)
473

Net investment income
291

138

70

60

5

564

Net realized gains (losses) including OTTI
(2
)
1

(29
)
(732
)
2

(760
)
Interest expense
4

2

—

3

53

62

Other (income) expense
(Gains) losses from fair value changes in separate account assets
—

—

—

39

—

39

Other
21

10

7

10

2

50

Income tax expense (benefit)
120

56

7

13

(31
)
165

Net income (loss)
$
278

$
282

$
111

$
(655
)
$
(55
)
$
(39
)
Statement of Operations by Segment
For the Nine Months Ended September 30, 2012
(in millions of U.S. dollars)
Insurance –
North
American
Insurance –
Overseas
General
Global
Reinsurance
Life
Corporate
and Other
ACE
Consolidated
Net premiums written
$
5,690

$
4,387

$
879

$
1,462

$
—

$
12,418

Net premiums earned
5,411

4,243

748

1,427

—

11,829

Losses and loss expenses
4,122

2,030

355

463

—

6,970

Policy benefits
—

—

—

379

—

379

Policy acquisition costs
444

996

125

244

1

1,810

Administrative expenses
448

696

38

237

124

1,543

Underwriting income (loss)
397

521

230

104

(125
)
1,127

Net investment income
808

386

213

186

21

1,614

Net realized gains (losses) including OTTI
16

59

(6
)
(261
)
(2
)
(194
)
Interest expense
9

4

3

9

162

187

Other (income) expense:
(Gains) losses from fair value changes in separate account assets
—

—

—

(18
)
—

(18
)
Other
4

3

(7
)
14

18

32

Income tax expense (benefit)
279

166

17

44

(101
)
405

Net income (loss)
$
929

$
793

$
424

$
(20
)
$
(185
)
$
1,941




41
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


Statement of Operations by Segment
For the Nine Months Ended September 30, 2011
(in millions of U.S. dollars)
Insurance –
North
American
Insurance –
Overseas
General
Global
Reinsurance
Life
Corporate
and Other
ACE
Consolidated
Net premiums written
$
5,227

$
4,251

$
847

$
1,417

$
—

$
11,742

Net premiums earned
5,249

4,164

754

1,389

—

11,556

Losses and loss expenses
4,065

2,244

485

439

1

7,234

Policy benefits
—

—

—

282

—

282

Policy acquisition costs
455

989

143

253

—

1,840

Administrative expenses
448

698

38

233

120

1,537

Underwriting income (loss)
281

233

88

182

(121
)
663

Net investment income
886

406

213

166

6

1,677

Net realized gains (losses) including OTTI
8

(18
)
(56
)
(813
)
1

(878
)
Interest expense
11

4

1

9

162

187

Other (income) expense
(Gains) losses from fair value changes in separate account assets
—

—

—

39

—

39

Other
8

3

2

27

9

49

Income tax expense (benefit)
304

112

25

41

(100
)
382

Net income (loss)
$
852

$
502

$
217

$
(581
)
$
(185
)
$
805

Underwriting assets are reviewed in total by management for purposes of decision-making. Other than goodwill, ACE does not allocate assets to its segments.
The following table presents the net premiums earned for each segment by product:
Property &
All Other
Casualty
Life,
Accident &
Health
ACE
Consolidated
(in millions of U.S. dollars)
For the Three Months Ended September 30, 2012
Insurance – North American
$
1,519

$
860

$
93

$
2,472

Insurance – Overseas General
547

356

529

1,432

Global Reinsurance
131

150

—

281

Life
—

—

480

480

$
2,197

$
1,366

$
1,102

$
4,665

For the Three Months Ended September 30, 2011
Insurance – North American
$
1,395

$
815

$
89

$
2,299

Insurance – Overseas General
553

366

552

1,471

Global Reinsurance
118

122

—

240

Life
—

—

480

480

$
2,066

$
1,303

$
1,121

$
4,490



42
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


Property &
All Other
Casualty
Life,
Accident &
Health
ACE
Consolidated
(in millions of U.S. dollars)
For the Nine Months Ended September 30, 2012
Insurance – North American
$
2,631

$
2,505

$
275

$
5,411

Insurance – Overseas General
1,637

1,027

1,579

4,243

Global Reinsurance
355

393

—

748

Life
—

—

1,427

1,427

$
4,623

$
3,925

$
3,281

$
11,829

For the Nine Months Ended September 30, 2011
Insurance – North American
$
2,413

$
2,570

$
266

$
5,249

Insurance – Overseas General
1,517

1,056

1,591

4,164

Global Reinsurance
345

409

—

754

Life
—

—

1,389

1,389

$
4,275

$
4,035

$
3,246

$
11,556

10 . Earnings per share
The following table presents the computation of basic and diluted earnings per share:
Three Months Ended
Nine Months Ended
September 30
September 30
2012
2011
2012
2011
(in millions of U.S. dollars, except share and per share data)
Numerator:
Net income (loss)
$
640

$
(39
)
$
1,941

$
805

Denominator:
Denominator for basic earnings per share:
Weighted-average shares outstanding
340,207,037

338,385,734

339,523,388

338,139,477

Denominator for diluted earnings per share:


Share-based compensation plans
2,665,676

—

2,831,798

2,733,434

Adjusted weighted-average shares outstanding and assumed conversions
342,872,713

338,385,734

342,355,186

340,872,911

Basic earnings per share
$
1.88

$
(0.11
)
$
5.71

$
2.38

Diluted earnings per share
$
1.86

$
(0.11
)
$
5.67

$
2.36

Excluded from adjusted weighted-average shares outstanding and assumed conversions is the impact of securities that would have been anti-dilutive during the respective periods. For the three months ended September 30, 2012 and 2011 , the potential anti-dilutive share conversions were 1,449,610 shares and 2,295,260 shares, respectively. The potential anti-dilutive share conversions for the nine months ended September 30, 2012 and 2011 were 1,193,839 shares and 223,987 shares, respectively.
11 . Information provided in connection with outstanding debt of subsidiaries
The following tables present condensed consolidating financial information at September 30, 2012 and December 31, 2011 , and for the three and nine months ended September 30, 2012 and 2011 , for ACE Limited (the Parent Guarantor) and ACE INA Holdings Inc. (the Subsidiary Issuer). The Subsidiary Issuer is an indirect 100 percent-owned subsidiary of the Parent Guarantor. Investments in subsidiaries are accounted for by the Parent

43
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


Guarantor under the equity method for purposes of the supplemental consolidating presentation. Earnings of subsidiaries are reflected in the Parent Guarantor’s investment accounts and earnings. The Parent Guarantor fully and unconditionally guarantees certain of the debt of the Subsidiary Issuer. Condensed consolidating financial information of the Subsidiary Issuer is presented on a consolidated basis and consists principally of the net assets, results of operations, and cash flows of operating insurance company subsidiaries.

Condensed Consolidating Balance Sheet at September 30, 2012
(in millions of U.S. dollars)

ACE
Limited
(Parent
Guarantor)
ACE INA
Holdings Inc.
(Subsidiary
Issuer)
Other ACE
Limited
Subsidiaries
and
Eliminations (1)
Consolidating
Adjustments (2)
ACE Limited
Consolidated
Assets
Investments
$
31

$
31,249

$
28,537

$
—

$
59,817

Cash (3)
(116
)
550

256

—

690

Insurance and reinsurance balances receivable
—

4,767

521

—

5,288

Reinsurance recoverable on losses and loss expenses
—

16,943

(5,086
)
—

11,857

Reinsurance recoverable on policy benefits
—

1,196

(950
)
—

246

Value of business acquired
—

628

4

—

632

Goodwill and other intangible assets
—

4,415

575

—

4,990

Investments in subsidiaries
26,998

—

—

(26,998
)
—

Due from subsidiaries and affiliates, net
270

—

—

(270
)
—

Other assets
16

7,711

2,261

—

9,988

Total assets
$
27,199

$
67,459

$
26,118

$
(27,268
)
$
93,508

Liabilities
Unpaid losses and loss expenses
$
—

$
31,640

$
6,560

$
—

$
38,200

Unearned premiums
—

5,973

1,095

—

7,068

Future policy benefits
—

3,819

595

—

4,414

Due to subsidiaries and affiliates, net
—

584

(314
)
(270
)
—

Short-term debt
—

851

551

—

1,402

Long-term debt
—

3,360

—

—

3,360

Trust preferred securities
—

309

—

—

309

Other liabilities
236

8,992

2,564

—

11,792

Total liabilities
236

55,528

11,051

(270
)
66,545

Total shareholders’ equity
26,963

11,931

15,067

(26,998
)
26,963

Total liabilities and shareholders’ equity
$
27,199

$
67,459

$
26,118

$
(27,268
)
$
93,508

____________________
(1)
Includes all other subsidiaries of ACE Limited and intercompany eliminations.
(2)
Includes ACE Limited parent company eliminations.
(3)
ACE maintains two notional multicurrency cash pools (Pools) with a third-party bank. Various ACE entities participate in one or the other of the Pools, pursuant to which credit and debit balances in individual ACE accounts are translated daily into a single currency and pooled on a notional basis. Individual ACE entities are permitted to overdraw on their individual accounts provided the overall Pool balances do not fall below zero. At September 30, 2012 , the cash balance of one or more entities was negative; however, the overall Pool balances were positive.






44
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


Condensed Consolidating Balance Sheet at December 31, 2011
(in millions of U.S. dollars)

ACE
Limited
(Parent
Guarantor)
ACE INA
Holdings Inc.
(Subsidiary
Issuer)
Other ACE
Limited
Subsidiaries
and
Eliminations (1)
Consolidating
Adjustments (2)
ACE Limited
Consolidated
Assets
Investments
$
33

$
28,848

$
26,795

$
—

$
55,676

Cash
106

382

126

—

614

Insurance and reinsurance balances receivable
—

3,944

443

—

4,387

Reinsurance recoverable on losses and loss expenses
—

17,146

(4,757
)
—

12,389

Reinsurance recoverable on policy benefits
—

941

(692
)
—

249

Value of business acquired
—

676

—

—

676

Goodwill and other intangible assets
—

4,248

551

—

4,799

Investments in subsidiaries
23,871

—

—

(23,871
)
—

Due from subsidiaries and affiliates, net
498

—

—

(498
)
—

Other assets
8

7,018

1,505

—

8,531

Total assets
$
24,516

$
63,203

$
23,971

$
(24,369
)
$
87,321

Liabilities
Unpaid losses and loss expenses
$
—

$
30,837

$
6,640

$
—

$
37,477

Unearned premiums
—

5,416

918

—

6,334

Future policy benefits
—

3,673

601

—

4,274

Due to subsidiaries and affiliates, net
—

316

182

(498
)
—

Short-term debt
—

850

401

—

1,251

Long-term debt
—

3,360

—

—

3,360

Trust preferred securities
—

309

—

—

309

Other liabilities
184

7,769

2,031

—

9,984

Total liabilities
184

52,530

10,773

(498
)
62,989

Total shareholders’ equity
24,332

10,673

13,198

(23,871
)
24,332

Total liabilities and shareholders’ equity
$
24,516

$
63,203

$
23,971

$
(24,369
)
$
87,321

____________________
(1)
Includes all other subsidiaries of ACE Limited and intercompany eliminations.
(2)
Includes ACE Limited parent company eliminations.


45
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


Condensed Consolidating Statements of Operations and Comprehensive Income
For the Three Months Ended September 30, 2012
(in millions of U.S. dollars)

ACE
Limited
(Parent
Guarantor)
ACE INA
Holdings Inc.
(Subsidiary
Issuer)
Other ACE
Limited
Subsidiaries
and
Eliminations (1)
Consolidating
Adjustments (2)
ACE
Limited
Consolidated
Net premiums written
$
—

$
2,868

$
1,848

$
—

$
4,716

Net premiums earned
—

2,819

1,846

—

4,665

Net investment income
—

255

278

—

533

Equity in earnings of subsidiaries
616

—

—

(616
)
—

Net realized gains (losses) including OTTI
(4
)
11

(67
)
—

(60
)
Losses and loss expenses
—

1,977

1,070

—

3,047

Policy benefits
—

77

53

—

130

Policy acquisition costs and administrative expenses
16

587

525

—

1,128

Interest (income) expense
(8
)
67

4

—

63

Other (income) expense
(39
)
17

5

—

(17
)
Income tax expense
3

123

21

—

147

Net income
$
640

$
237

$
379

$
(616
)
$
640

Comprehensive income
$
1,316

$
593

$
23

$
(616
)
$
1,316


Condensed Consolidating Statements of Operations and Comprehensive Income
For the Three Months Ended September 30, 2011
(in millions of U.S. dollars)

ACE
Limited
(Parent
Guarantor)
ACE INA
Holdings Inc.
(Subsidiary
Issuer)
Other ACE
Limited
Subsidiaries
and
Eliminations (1)
Consolidating
Adjustments (2)
ACE
Limited
Consolidated
Net premiums written
$
—

$
2,581

$
1,762

$
—

$
4,343

Net premiums earned
—

2,700

1,790

—

4,490

Net investment income
—

281

283

—

564

Equity in earnings of subsidiaries
(63
)
—

—

63

—

Net realized gains (losses) including OTTI
2

28

(790
)
—

(760
)
Losses and loss expenses
—

1,782

963

—

2,745

Policy benefits
—

22

61

—

83

Policy acquisition costs and administrative expenses
14

631

544

—

1,189

Interest (income) expense
(9
)
66

5

—

62

Other (income) expense
(30
)
85

34

—

89

Income tax expense
3

146

16

—

165

Net income (loss)
$
(39
)
$
277

$
(340
)
$
63

$
(39
)
Comprehensive income (loss)
$
(189
)
$
355

$
(418
)
$
63

$
(189
)
____________________
(1)
Includes all other subsidiaries of ACE Limited and intercompany eliminations.
(2)
Includes ACE Limited parent company eliminations.


46
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


Condensed Consolidating Statements of Operations and Comprehensive Income
For the Nine Months Ended September 30, 2012
(in millions of U.S. dollars)

ACE
Limited
(Parent
Guarantor)
ACE INA
Holdings Inc.
(Subsidiary
Issuer)
Other ACE
Limited
Subsidiaries
and
Eliminations (1)
Consolidating
Adjustments (2)
ACE
Limited
Consolidated
Net premiums written
$
—

$
7,293

$
5,125

$
—

$
12,418

Net premiums earned
—

6,967

4,862

—

11,829

Net investment income
1

777

836

—

1,614

Equity in earnings of subsidiaries
1,845

—

—

(1,845
)
—

Net realized gains (losses) including OTTI
18

71

(283
)
—

(194
)
Losses and loss expenses
—

4,484

2,486

—

6,970

Policy benefits
—

217

162

—

379

Policy acquisition costs and administrative expenses
42

1,883

1,428

—

3,353

Interest (income) expense
(25
)
191

21

—

187

Other (income) expense
(102
)
51

65

—

14

Income tax expense
8

327

70

—

405

Net income
$
1,941

$
662

$
1,183

$
(1,845
)
$
1,941

Comprehensive income
$
3,044

$
1,203

$
642

$
(1,845
)
$
3,044


Condensed Consolidating Statements of Operations and Comprehensive Income
For the Nine Months Ended September 30, 2011
(in millions of U.S. dollars)

ACE
Limited
(Parent
Guarantor)
ACE INA
Holdings Inc.
(Subsidiary
Issuer)
Other ACE
Limited
Subsidiaries
and
Eliminations (1)
Consolidating
Adjustments (2)
ACE
Limited
Consolidated
Net premiums written
$
—

$
6,910

$
4,832

$
—

$
11,742

Net premiums earned
—

6,863

4,693

—

11,556

Net investment income
1

825

851

—

1,677

Equity in earnings of subsidiaries
742

—

—

(742
)
—

Net realized gains (losses) including OTTI
—

32

(910
)
—

(878
)
Losses and loss expenses
—

4,521

2,713

—

7,234

Policy benefits
—

121

161

—

282

Policy acquisition costs and administrative expenses
50

1,839

1,488

—

3,377

Interest (income) expense
(27
)
199

15

—

187

Other (income) expense
(92
)
121

59

—

88

Income tax expense
7

323

52

—

382

Net income
$
805

$
596

$
146

$
(742
)
$
805

Comprehensive income (loss)
$
1,050

$
947

$
(205
)
$
(742
)
$
1,050

____________________
(1)
Includes all other subsidiaries of ACE Limited and intercompany eliminations.
(2)
Includes ACE Limited parent company eliminations.

47
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


Condensed Consolidating Statement of Cash Flows
For the Nine Months Ended September 30, 2012
(in millions of U.S. dollars)

ACE
Limited
(Parent
Guarantor)
ACE INA
Holdings Inc.
(Subsidiary
Issuer)
Other ACE
Limited
Subsidiaries
and
Eliminations (1)
Consolidating
Adjustments (2)
ACE
Limited
Consolidated
Net cash flows from operating activities
$
210

$
1,553

$
1,262

$
—

$
3,025

Cash flows from investing activities
Purchases of fixed maturities available for sale
—

(8,553
)
(9,103
)
—

(17,656
)
Purchases of fixed maturities held to maturity
—

(215
)
(2
)
—

(217
)
Purchases of equity securities
—

(65
)
(49
)
—

(114
)
Sales of fixed maturities available for
sale
—

5,154

6,201

—

11,355

Sales of equity securities
—

48

9

—

57

Maturities and redemptions of fixed maturities available for sale
—

1,757

1,839

—

3,596

Maturities and redemptions of fixed maturities held to maturity
—

798

294

—

1,092

Net derivative instruments settlements
(1
)
(10
)
(347
)
—

(358
)
Advances from (to) affiliates
36

—

—

(36
)
—

Acquisition of subsidiaries (net of cash acquired of $8)
—

(98
)
—

—

(98
)
Capital contribution to subsidiary
—

—

(90
)
90

—

Other
—

(279
)
(60
)
—

(339
)
Net cash flows from (used for) investing activities
35

(1,463
)
(1,308
)
54

(2,682
)
Cash flows from financing activities
Dividends paid on Common Shares
(484
)
—

—

—

(484
)
Common Shares repurchased
—

—

(11
)
—

(11
)
Net proceeds from issuance of short-term debt
—

1

150

—

151

Proceeds from share-based compensation plans
17

—

56

—

73

Advances (to) from affiliates
—

(10
)
(26
)
36

—

Capital contribution from subsidiary
—

90

—

(90
)
—

Net cash flows from (used for) financing activities
(467
)
81

169

(54
)
(271
)
Effect of foreign currency rate changes on cash and cash equivalents
—

(3
)
7

—

4

Net increase (decrease) in cash
(222
)
168

130

—

76

Cash – beginning of period
106

382

126

—

614

Cash – end of period (3)
$
(116
)
$
550

$
256

$
—

$
690

____________________
(1)
Includes all other subsidiaries of ACE Limited and intercompany eliminations.
(2)
Includes ACE Limited parent company eliminations.
(3)
ACE maintains two notional multi-currency cash pools (Pools) with a third-party bank. Various ACE entities participate in one or the other of the Pools, pursuant to which credit and debit balances in individual ACE accounts are translated daily into a single currency and pooled on a notional basis. Individual ACE entities are permitted to overdraw on their individual accounts provided the overall Pool balances do not fall below zero. At September 30, 2012 , the cash balance of one or more entities was negative; however, the overall Pool balances were positive.

48
ACE LIMITED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(Unaudited)


Condensed Consolidating Statement of Cash Flows
For the Nine Months Ended September 30, 2011
(in millions of U.S. dollars)

ACE
Limited
(Parent
Guarantor)
ACE INA
Holdings Inc.
(Subsidiary
Issuer)
Other ACE
Limited
Subsidiaries
and
Eliminations (1)
Consolidating
Adjustments (2)
ACE
Limited
Consolidated
Net cash flows from operating activities
$
652

$
1,219

$
1,807

$
(680
)
$
2,998

Cash flows from investing activities
Purchases of fixed maturities available for sale
—

(9,434
)
(10,134
)
—

(19,568
)
Purchases of fixed maturities held to maturity
—

(282
)
(3
)
—

(285
)
Purchases of equity securities
—

(149
)
(140
)
—

(289
)
Sales of fixed maturities available for sale
7

7,366

6,950

—

14,323

Sales of equity securities
—

347

17

—

364

Maturities and redemptions of fixed maturities available for sale
—

1,234

1,369

—

2,603

Maturities and redemptions of fixed maturities held to maturity
—

724

242

—

966

Net derivative instruments settlements
(2
)
(19
)
88

—

67

Capital contribution to subsidiary
(385
)
—

—

385

—

Advances from (to) affiliates
(90
)
—

—

90

—

Acquisition of subsidiaries (net of cash acquired of $81)
—

(357
)
(37
)
—

(394
)
Other
—

(469
)
152

—

(317
)
Net cash flows used for investing activities
(470
)
(1,039
)
(1,496
)
475

(2,530
)
Cash flows from financing activities
Dividends paid on Common Shares
(342
)
—

—

—

(342
)
Common Shares repurchased
—

—

(168
)
—

(168
)
Net proceeds from (repayments) issuance of short-term debt
(300
)
(150
)
400

—

(50
)
Proceeds from share-based compensation plans
82

—

—

—

82

Advances from (to) affiliates
—

35

55

(90
)
—

Dividends to parent company
—

—

(680
)
680

—

Capital contribution from parent
—

—

385

(385
)
—

Net cash flows from (used for) financing activities
(560
)
(115
)
(8
)
205

(478
)
Effect of foreign currency rate changes on cash and cash equivalents
—

2

2

—

4

Net (decrease) increase in cash
(378
)
67

305

—

(6
)
Cash – beginning of period (3)
308

573

(109
)
—

772

Cash – end of period (3)
$
(70
)
$
640

$
196

$
—

$
766

____________________
(1)
Includes all other subsidiaries of ACE Limited and intercompany eliminations.
(2)
Includes ACE Limited parent company eliminations.
(3)
ACE maintains two notional multi-currency cash pools (Pools) with a third-party bank. Various ACE entities participate in one or the other of the Pools, pursuant to which credit and debit balances in individual ACE accounts are translated daily into a single currency and pooled on a notional basis. Individual ACE entities are permitted to overdraw on their individual accounts provided the overall Pool balances do not fall below zero. At September 30, 2011 and December 31, 2010 , the cash balance of one or more entities was negative; however, the overall Pool balances were positive.

49

Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following is a discussion of our results of operations, financial condition, and liquidity and capital resources as of and for the three and nine months ended September 30, 2012 .
All comparisons in this discussion are to the corresponding prior year periods unless otherwise indicated.
Our results of operations and cash flows for any interim period are not necessarily indicative of our results for the full year. This discussion should be read in conjunction with our consolidated financial statements and related notes and our Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2011 ( 2011 Form 10-K).
Effective January 1, 2012, we retrospectively adopted new accounting guidance for costs associated with acquiring or renewing insurance contracts. Under the new guidance, the definition of acquisition costs was modified to specify that a cost must be directly related to the successful acquisition of a new or renewal insurance contract in order to be deferred. Prior year amounts and ratios contained in these consolidated financial statements have been adjusted to reflect the impact of retrospective adjustments as a result of applying this new accounting guidance.
In addition, effective January 1, 2012, we reclassified prior year segment operating results in order to conform to certain organizational realignments. These realignments resulted in a transfer of operating revenue and underwriting results of our international direct-marketed and credit life businesses from the Insurance – Overseas General segment to the Life segment. These realignments have no impact on consolidated operating results; however, prior year amounts and underwriting ratios contained in these consolidated financial statements have been adjusted to conform to the current year presentation.


50

Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. Any written or oral statements made by us or on our behalf may include forward-looking statements that reflect our current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks, uncertainties, and other factors that could, should potential events occur, cause actual results to differ materially from such statements. These risks, uncertainties, and other factors (which are described in more detail elsewhere herein and in other documents we file with the U.S. Securities and Exchange Commission (SEC)) include but are not limited to:
•
developments in global financial markets, including changes in interest rates, stock markets, and other financial markets, increased government involvement or intervention in the financial services industry, the cost and availability of financing, and foreign currency exchange rate fluctuations (which we refer to in this report as foreign exchange and foreign currency exchange), which could affect our statement of operations, investment portfolio, financial position, and financing plans;
•
general economic and business conditions resulting from volatility in the stock and credit markets and the depth and duration of recession;
•
losses arising out of natural or man-made catastrophes such as hurricanes, typhoons, earthquakes, floods, climate change (including effects on weather patterns, greenhouse gases, sea, land and air temperatures, sea levels, rain and snow), nuclear accidents or terrorism which could be affected by:
•
the number of insureds and ceding companies affected;
•
the amount and timing of losses actually incurred and reported by insureds;
•
the impact of these losses on our reinsurers and the amount and timing of reinsurance recoverable actually received;
•
the cost of building materials and labor to reconstruct properties or to perform environmental remediation following a catastrophic event; and
•
complex coverage and regulatory issues such as whether losses occurred from storm surge or flooding and related lawsuits;
•
actions that rating agencies may take from time to time, such as financial strength or credit ratings downgrades or placing these ratings on credit watch negative or the equivalent;
•
global political conditions, the occurrence of any terrorist attacks, including any nuclear, radiological, biological, or chemical events, or the outbreak and effects of war, and possible business disruption or economic contraction that may result from such events;
•
the ability to collect reinsurance recoverable, credit developments of reinsurers, and any delays with respect thereto and changes in the cost, quality, or availability of reinsurance;
•
actual loss experience from insured or reinsured events and the timing of claim payments;
•
the uncertainties of the loss-reserving and claims-settlement processes, including the difficulties associated with assessing environmental damage and asbestos-related latent injuries, the impact of aggregate-policy-coverage limits, and the impact of bankruptcy protection sought by various asbestos producers and other related businesses and the timing of loss payments;
•
changes to our assessment as to whether it is more likely than not that we will be required to sell, or have the intent to sell, available for sale fixed maturities before their anticipated recovery;
•
infection rates and severity of pandemics and their effects on our business operations and claims activity;
•
judicial decisions and rulings, new theories of liability, legal tactics, and settlement terms;

51

•
the effects of public company bankruptcies and/or accounting restatements, as well as disclosures by and investigations of public companies relating to possible accounting irregularities, and other corporate governance issues, including the effects of such events on:
•
the capital markets;
•
the markets for directors and officers (D&O) and errors and omissions (E&O) insurance; and
•
claims and litigation arising out of such disclosures or practices by other companies;
•
uncertainties relating to governmental, legislative and regulatory policies, developments, actions, investigations and treaties, which, among other things, could subject us to insurance regulation or taxation in additional jurisdictions or affect our current operations;
•
the actual amount of new and renewal business, market acceptance of our products, and risks associated with the introduction of new products and services and entering new markets, including regulatory constraints on exit strategies;
•
the competitive environment in which we operate, including trends in pricing or in policy terms and conditions, which may differ from our projections and changes in market conditions that could render our business strategies ineffective or obsolete;
•
acquisitions made by us performing differently than expected, our failure to realize anticipated expense-related efficiencies or growth from acquisitions, the impact of acquisitions on our pre-existing organization or announced acquisitions not closing;
•
risks associated with being a Swiss corporation, including reduced flexibility with respect to certain aspects of capital management and the potential for additional regulatory burdens;
•
the potential impact from government-mandated insurance coverage for acts of terrorism;
•
the availability of borrowings and letters of credit under our credit facilities;
•
the adequacy of collateral supporting funded high deductible programs;
•
changes in the distribution or placement of risks due to increased consolidation of insurance and reinsurance brokers;
•
material differences between actual and expected assessments for guaranty funds and mandatory pooling arrangements;
•
the effects of investigations into market practices in the property and casualty (P&C) industry;
•
changing rates of inflation and other economic conditions, for example, recession;
•
the amount of dividends received from subsidiaries;
•
loss of the services of any of our executive officers without suitable replacements being recruited in a reasonable time frame;
•
the ability of our technology resources to perform as anticipated; and
•
management’s response to these factors and actual events (including, but not limited to, those described above).
The words “believe,” “anticipate,” “estimate,” “project,” “should,” “plan,” “expect,” “intend,” “hope,” “feel,” “foresee,” “will likely result,” or “will continue,” and variations thereof and similar expressions, identify forward-looking statements. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. We undertake no obligation to publicly update or review any forward-looking statements, whether as a result of new information, future events or otherwise.

52

Overview
ACE Limited is the Swiss-incorporated holding company of the ACE Group of Companies. ACE opened its business office in Bermuda in 1985 and continues to maintain operations in Bermuda. ACE, which is headquartered in Zurich, Switzerland, and its direct and indirect subsidiaries, is a global insurance and reinsurance organization, serving the needs of a diverse group of clients around the world. We are predominantly a global property and casualty insurance company with both a commercial and specialty product orientation. We offer commercial insurance, specialty products and accident and health (A&H) solutions and are expanding our personal lines and international life insurance businesses. As we have grown, we have developed products and diversified our offerings to meet the needs of our customers. At September 30, 2012 , ACE had total assets of $94 billion and shareholders’ equity of $27 billion.
We operate through the following business segments: Insurance – North American, Insurance – Overseas General, Global Reinsurance, and Life.
The Insurance – North American segment includes retail divisions ACE USA (including ACE Canada), ACE Commercial Risk Services and ACE Private Risk Services; our wholesale and specialty divisions ACE Westchester, ACE Agriculture and ACE Bermuda; and various run-off operations, including Brandywine Holdings Corporation (Brandywine). Our retail products range from commercial lines with service offerings such as risk management, loss control and engineering programs, and specialty commercial P&C and A&H to personal lines homeowners, automobiles, liability, valuable articles and marine coverages. Our wholesale and specialty products include excess and surplus property, professional liability, inland marine, specialty property, specialty casualty, political risk, and comprehensive multiple-peril crop and hail insurance products.
The Insurance – Overseas General segment comprises ACE International, our retail business serving territories outside the U.S., Bermuda, and Canada; the international A&H and life business of Combined Insurance (Combined); and the wholesale insurance business of ACE Global Markets. ACE International has a presence in major developed markets and growing economies serving multinational clients and local customers. A significant amount of our global business is with local companies, offering traditional and specialty P&C products including D&O and professional liability, specialty personal lines, and energy products. Our international A&H business primarily focuses on personal accident and supplemental medical. ACE Global Markets offers specialty products including aviation, marine, financial lines, energy, and political risk.
The Global Reinsurance segment represents our reinsurance operations, comprising ACE Tempest Re Bermuda, ACE Tempest Re USA, ACE Tempest Re International, ACE Tempest Re Canada, and the reinsurance operation of ACE Global Markets. Global Reinsurance provides solutions for customers ranging from small commercial insureds to multinational ceding companies. Global Reinsurance offers products such as property and workers’ compensation catastrophe, D&O, professional liability, specialty casualty and specialty property.
The Life segment includes our international life operations (ACE Life), ACE Tempest Life Re (ACE Life Re), and the North American supplemental A&H and life business of Combined Insurance. For more information on each of our segments refer to “Segment Information” in our 2011 Form 10-K.

On June 13, 2012, we announced that we and our local partner had signed a definitive agreement to acquire PT Asuransi Jaya Proteksi (JaPro), one of Indonesia's leading general insurers. On September 18, 2012, we acquired 80 percent of JaPro and our local partner expects to complete the purchase of the remaining 20 percent, subject to regulatory approvals and other closing conditions, by the end of 2012. The total purchase price for 100 percent of JaPro is expected to be approximately $95 million in cash. The information needed to complete the purchase price allocation is preliminary and will be adjusted as further information becomes available during the measurement period. JaPro operates under our Insurance – Overseas General segment.

On September 12, 2012, we announced that we reached a definitive agreement to acquire Fianzas Monterrey, a leading surety lines company in Mexico offering administrative performance bonds primarily to clients in the construction and industrial sectors, for approximately $285 million in cash. This transaction, which is subject to

53

regulatory approvals and other customary closing conditions, is expected to be completed during the first quarter of 2013.

On October 18, 2012, we announced that we reached a definitive agreement to acquire ABA Seguros, a property and casualty insurer in Mexico that provides automobile, homeowners, and small business coverages. We expect to pay approximately $865 million in cash for this transaction, subject to adjustment for dividends paid between signing and closing. This transaction, which is subject to regulatory approvals and other customary closing conditions, is expected to be completed in the first half of 2013.

In late October 2012, superstorm Sandy made landfall in the United States.  Given its recent occurrence and the limited information available, we cannot estimate at this time the amount of any possible losses from this event. The impact of this event will be reflected in our fourth quarter 2012 results.

Financial Highlights for the Three Months Ended September 30, 2012
•
Total company net premiums written increased 8.6 percent and 11.1 percent on a constant-dollar basis.
•
The P&C combined ratio was 92.0 percent compared with 90.2 percent in the prior year period.
•
Favorable prior period development pre-tax was $236 million, representing 5.7 percentage points of the combined ratio, compared with $194 million in the prior year period.
•
Total pre-tax and after-tax catastrophe losses including reinstatement premiums were $53 million and $41 million, respectively, compared with $121 million and $86 million, respectively, in the prior year period.
•
The current accident year P&C combined ratio was 97.7 percent compared with 95.1 percent in the prior year period. Adjusting for catastrophe losses, the current accident year P&C combined ratio was 96.4 percent compared with 92.0 percent in the prior year period.
•
The P&C expense ratio for the quarter was 23.1 percent compared with 25.3 percent in the prior year period.
•
Operating cash flow was $1.6 billion for the quarter.
•
Net investment income for the quarter decreased six percent to $533 million due to lower reinvestment rates and the negative impact of foreign exchange, partially offset by higher distributions from private equity funds.
•
Net realized losses from derivative accounting related to variable annuity reinsurance were $64 million.

54


Consolidated Operating Results – Three and Nine Months Ended September 30, 2012 and 2011
Three Months Ended
Nine Months Ended
September 30
% Change
September 30
% Change
2012
2011
Q-12 vs.
Q-11
2012
2011
YTD-12 vs.
YTD-11
(in millions of U.S. dollars, except for percentages)
Net premiums written
$
4,716

$
4,343

8.6
%
$
12,418

$
11,742

5.8
%
Net premiums earned
4,665

4,490

3.9
%
11,829

11,556

2.4
%
Net investment income
533

564

(5.6
)%
1,614

1,677

(3.8
)%
Net realized gains (losses)
(60
)
(760
)
(92.1
)%
(194
)
(878
)
(77.9
)%
Total revenues
5,138

4,294

19.7
%
13,249

12,355

7.2
%
Losses and loss expenses
3,047

2,745

11.0
%
6,970

7,234

(3.6
)%
Policy benefits
130

83

56.6
%
379

282

34.4
%
Policy acquisition costs
609

669

(9.0
)%
1,810

1,840

(1.6
)%
Administrative expenses
519

520

(0.2
)%
1,543

1,537

0.4
%
Interest expense
63

62

1.6
%
187

187

—
%
Other (income) expense
(17
)
89

NM

14

88

(84.1
)%
Total expenses
4,351

4,168

4.4
%
10,903

11,168

(2.4
)%
Income before income tax
787

126

NM

2,346

1,187

97.6
%
Income tax expense
147

165

(10.9
)%
405

382

6.0
%
Net income (loss)
$
640

$
(39
)
NM

$
1,941

$
805

141.1
%
NM – not meaningful
The following table summarizes, by major product line, the approximate effect of changes in foreign currency exchange rates on the growth of net premiums written and earned for the periods indicated:
Three Months Ended
Nine Months Ended
September 30, 2012
September 30, 2012
P&C
Life
A&H
Total
P&C
Life
A&H
Total
Net premiums written:
Growth in original currency
13.7
%
(0.4
)%
4.4
%
11.1
%
8.7
%
9.6
%
3.3
%
7.6
%
Foreign exchange effect
(1.8
)%
(3.3
)%
(4.8
)%
(2.5
)%
(1.3
)%
(2.8
)%
(3.0
)%
(1.8
)%
Growth as reported in U.S. dollars
11.9
%
(3.7
)%
(0.4
)%
8.6
%
7.4
%
6.8
%
0.3
%
5.8
%
Net premiums earned:
Growth in original currency
7.7
%
(0.9
)%
3.8
%
6.6
%
4.4
%
8.3
%
3.1
%
4.3
%
Foreign exchange effect
(1.9
)%
(3.4
)%
(4.8
)%
(2.7
)%
(1.5
)%
(2.7
)%
(3.1
)%
(1.9
)%
Growth as reported in U.S. dollars
5.8
%
(4.3
)%
(1.0
)%
3.9
%
2.9
%
5.6
%
—
%
2.4
%

Net premiums written reflect the premiums we retain after purchasing reinsurance protection. For the three months ended September 30, 2012 , retail premiums grew in our Insurance – North American segment primarily related to good growth in our risk management, commercial P&C, both retail and wholesale, and ACE Private Risk Services businesses. For the three and nine months ended September 30, 2012 , retail premiums grew due to

55

rate increases in most lines, strong renewal retention, and new business opportunities, partially offset by our continued planned reductions in our U.S. general market risk transfer workers’ compensation business. For the three and nine months ended September 30, 2012 , the North American wholesale and specialty division grew primarily from agriculture business due to crop hail production and the increased premiums from the November 2011 acquisition of Penn Millers Insurance Company (Penn Millers). Our Global Reinsurance segment reported an increase in net premiums written for the three months ended September 30, 2012 primarily due to a new medical malpractice loss portfolio transfer (LPT) treaty and new U.S. property treaties written in the quarter. For the nine months ended September 30, 2012 , net premiums written also benefited from improving pricing conditions in our U.S. property catastrophe business, partially offset by lower production from competitive market conditions experienced in the first quarter and a non-recurring LPT treaty written in the prior year. Our Life segment net premiums written were flat for the three months and increased for the nine months ended September 30, 2012 , primarily in Life insurance due to growth in our Asian markets from prior year acquisitions, partially offset by the run-off of our Life reinsurance variable annuity business and the impact of foreign exchange. Our Insurance – Overseas General segment reported a decrease in net premiums written for the three months ended September 30, 2012 due to a weakening of major currencies relative to the U.S. dollar. On a constant-dollar basis, net premiums written increased for the three and nine months ended September 30, 2012 from continued growth in our Latin America and Asian markets. For the nine months ended September 30, 2012 , our Insurance – Overseas General segment also benefited from the favorable impact of reinstatement premiums expensed in the prior year related to first quarter 2011 catastrophe activity. This growth was partially offset by decreases in certain retail A&H production in Combined’s United Kingdom (U.K.) and Ireland regions. Combined Insurance premiums continue to be hampered by the economic recession in its target markets.
Net premiums earned reflect the portion of net premiums written that were recorded as revenues for the period as the exposure periods expire. Our Insurance – North American segment reported an increase in net premiums earned for the three months ended September 30, 2012 in the retail division from our risk management business, and from growth in commercial and personal lines. This growth was partially offset by our continued planned reduction of our U.S. general market risk transfer workers’ compensation business. Retail results for the nine months ended September 30, 2012 were also partially offset by lower premiums associated with a couple of large structured prospective risk management programs. For the three and nine months ended September 30, 2012 , our wholesale and specialty division reported growth in net premiums earned primarily in our agriculture business from our crop hail business and the acquisition of Penn Millers in November 2011. For the three months ended September 30, 2012 , our Global Reinsurance segment reported an increase in net premiums earned primarily due to the new reinsurance treaties noted above. This growth was more than offset in our nine month results due to consecutive annual net decreases in production in prior quarters and to the effect of a non-recurring loss portfolio transfer treaty written in the prior year. In our Life segment, net premiums earned were flat for the three months ended September 30, 2012 , and increased for the nine months ended September 30, 2012 , primarily from business generated from prior year acquisitions in Life insurance, partially offset by the run off of our Life reinsurance variable annuity business. In our Insurance – Overseas General segment, results for the three months ended September 30, 2012 grew on a constant-dollar basis driven by continued strong written premium production in Latin America and Asia, though results reported in U.S. dollars decreased. Results for the nine months ended September 30, 2012 increased on both a constant-dollar and reported U.S. dollar basis from growth noted in Latin America and Asia as well as from the favorable impact of reinstatement premiums expensed in the prior year.

56

The following table provides a consolidated breakdown of net premiums earned by line of business for the periods indicated:
Three Months Ended

Nine Months Ended

September 30
% Change
September 30
% Change
2012
2011
Q-12 vs.
Q-11
2012
2011
YTD-12 vs.
YTD-11
(in millions of U.S. dollars, except for percentages)
Property and all other
$
1,031

$
986

5
%
$
3,014

$
2,761

9
%
Agriculture
1,166

1,080

8
%
1,609

1,514

6
%
Casualty
1,366

1,303

5
%
3,925

4,035

(3
)%
Subtotal
3,563

3,369

6
%
8,548

8,310

3
%
Personal accident (A&H)
882

891

(1
)%
2,605

2,606

—
%
Life
220

230

(4
)%
676

640

6
%
Net premiums earned
$
4,665

$
4,490

4
%
$
11,829

$
11,556

2
%
2012
% of  total
2011
% of  total
2012
% of  total
2011
% of  total
Property and all other
22
%
22
%
25
%
24
%
Agriculture
25
%
24
%
14
%
13
%
Casualty
29
%
29
%
33
%
35
%
Subtotal
76
%
75
%
72
%
72
%
Personal accident (A&H)
19
%
20
%
22
%
22
%
Life
5
%
5
%
6
%
6
%
Net premiums earned
100
%
100
%
100
%
100
%
In evaluating our segments excluding Life, we use the combined ratio, the loss and loss expense ratio, the policy acquisition cost ratio, and the administrative expense ratio. We calculate these ratios by dividing the respective expense amounts by net premiums earned. We do not calculate these ratios for the Life segment as we do not use these measures to monitor or manage that segment. The combined ratio is determined by adding the loss and loss expense ratio, the policy acquisition cost ratio, and the administrative expense ratio. A combined ratio under 100 percent indicates underwriting income and a combined ratio exceeding 100 percent indicates underwriting loss.
The following table shows our consolidated loss and loss expense ratio, policy acquisition cost ratio, administrative expense ratio, and combined ratio for the periods indicated:
Three Months Ended
Nine Months Ended
September 30
September 30
2012
2011
2012
2011
Loss and loss expense ratio
68.9
%
64.9
%
62.6
%
66.8
%
Policy acquisition cost ratio
12.7
%
14.4
%
15.0
%
15.6
%
Administrative expense ratio
10.4
%
10.9
%
12.6
%
12.9
%
Combined ratio
92.0
%
90.2
%
90.2
%
95.3
%


57

The following table shows the impact of catastrophe losses and related reinstatement premiums and the impact of prior period development on our consolidated loss and loss expense ratio for the periods indicated:
Three Months Ended
Nine Months Ended
September 30
September 30
2012
2011
2012
2011
Loss and loss expense ratio, as reported
68.9
%
64.9
%
62.6
%
66.8
%
Catastrophe losses and related reinstatement premiums
(1.3
)%
(3.3
)%
(1.2
)%
(7.2
)%
Prior period development
5.8
%
5.1
%
4.3
%
4.4
%
Loss and loss expense ratio, adjusted
73.4
%
66.7
%
65.7
%
64.0
%
Total net pre-tax catastrophe losses, excluding related reinstatement premiums, were $55 million and $129 million for the three and nine months ended September 30, 2012 , compared with $147 million and $704 million for the prior year periods, respectively. Catastrophe losses through September 30, 2012 were primarily related to Hurricane Isaac, flooding in the U.K. and other severe weather-related events in North America. Catastrophe losses through September 30, 2011 were primarily related to earthquakes in Japan and New Zealand, storms in Australia, and severe weather-related events in the U.S. including Hurricane Irene.
Prior period development arises from changes to loss estimates recognized in the current year that relate to loss reserves first reported in previous calendar years and excludes the effect of losses from the development of earned premium from previous accident years. We experienced net favorable prior period development of $236 million and $442 million for the three and nine months ended September 30, 2012 , respectively. This compares with net favorable prior period development of $194 million and $433 million for the prior year periods, respectively. Refer to “Prior Period Development” for additional information.
Net investment income for the three and nine months ended September 30, 2012 was $533 million and $1.6 billion, compared with $564 million and $1.7 billion for the prior year periods, respectively. Refer to “Net Investment Income” and “Investments” for additional information.
Policy acquisition costs consist of commissions, premium taxes, and certain underwriting costs related directly to the successful acquisition of a new or renewal insurance contract. Administrative expenses include all other operating costs. Our policy acquisition cost ratio decreased for the three and nine months ended September 30, 2012 due to premium growth in our Insurance – North American segment in lower acquisition cost agriculture business as well as from the impact of the medical malpractice LPT in our Global Reinsurance segment. Our administrative expense ratio decreased for the three and nine months ended September 30, 2012 primarily due to an increase in net premiums earned in agriculture business and the new medical malpractice LPT, both of which have relatively low expense ratios, and lower regulatory costs in our Insurance – Overseas General segment.
Our effective income tax rate, which we calculate as income tax expense divided by income before income tax, is dependent upon the mix of earnings from different jurisdictions with various tax rates. A change in the geographic mix of earnings would change the effective income tax rate. Our effective income tax rate was 19 percent and 17 percent for the three and nine months ended September 30, 2012 , respectively, compared with 132 percent and 32 percent for the prior year periods, respectively. The decrease in our effective income tax rate for the three and nine months ended September 30, 2012 was primarily due to a decrease in the amount of net realized losses on derivatives generated in lower tax-paying jurisdictions.

Prior Period Development
The favorable prior period development of $236 million and $442 million during the three and nine months ended September 30, 2012 , respectively, was the net result of several underlying favorable and adverse movements. In the sections following the tables below, significant prior period movements within each reporting segment are discussed in more detail. Long-tail lines include lines such as workers’ compensation, general liability, and professional liability; while short-tail lines include lines such as most property lines, energy, personal accident, aviation, and marine (including associated liability-related exposures).

58

The following table summarizes (favorable) and adverse prior period development by segment:
Three Months Ended September 30
Long-tail
Short-tail
Total
% of net
unpaid
reserves*
(in millions of U.S. dollars, except for percentages)
2012
Insurance – North American
$
(76
)
$
(4
)
$
(80
)
0.5
%
Insurance – Overseas General
(110
)
(25
)
(135
)
1.8
%
Global Reinsurance
(17
)
(4
)
(21
)
1.0
%
Total
$
(203
)
$
(33
)
$
(236
)
0.9
%
2011
Insurance – North American
$
(51
)
$
(7
)
$
(58
)
0.4
%
Insurance – Overseas General
(125
)
(1
)
(126
)
1.7
%
Global Reinsurance
(15
)
5

(10
)
0.4
%
Total
$
(191
)
$
(3
)
$
(194
)
0.7
%
*
Calculated based on the segment/total beginning of period net unpaid loss and loss expenses reserves.
Nine Months Ended September 30
Long-tail
Short-tail
Total
% of net
unpaid
reserves*
(in millions of U.S. dollars, except for percentages)
2012
Insurance – North American
$
(150
)
$
(49
)
$
(199
)
1.2
%
Insurance – Overseas General
(110
)
(86
)
(196
)
2.7
%
Global Reinsurance
(33
)
(14
)
(47
)
2.1
%
Total
$
(293
)
$
(149
)
$
(442
)
1.7
%
2011
Insurance – North American
$
(89
)
$
(75
)
$
(164
)
1.1
%
Insurance – Overseas General
(125
)
(85
)
(210
)
3.1
%
Global Reinsurance
(59
)
—

(59
)
2.6
%
Total
$
(273
)
$
(160
)
$
(433
)
1.7
%
*
Calculated based on the segment/total beginning of period net unpaid loss and loss expenses reserves.

59

Insurance – North American
Insurance – North American experienced net favorable prior period development of $80 million in the three months ended September 30, 2012 , which was the net result of several underlying favorable and adverse movements, driven by the following principal changes:

•
Net favorable development of $76 million on long-tail business, including:

•
Favorable development of $56 million in our medical risk operations, primarily in the 2007 and prior accident years. Reported and paid loss activity for these accident years continues to be lower than expected based on our prior review and our original pricing assumptions.

•
Net favorable development of $17 million on a collection of casualty programs, primarily in the 2008 and prior accident years. The programs represent general casualty risks (primary and excess) and professional lines exposure. We experienced lower levels of reported and paid loss activity than expected based on our prior review. This favorable development was partially offset by modest adverse development on the professional programs in the 2009 to 2011 accident years where reported loss activity exceeded our expectations.

•
Favorable development of $11 million in our financial solutions business, primarily in the 2008 and prior accident years. This business is a collection of loss portfolio transfers as well as prospective insurance contracts, some of which have adjustable premium features based on loss activity. Net favorable development resulted from lower than expected loss activity which was partially offset by a reduction in accrued adjustable premiums.

•
Net adverse development of $8 million across a number of lines and accident years, none of which was significant individually or in the aggregate.

•
Net favorable development of $4 million on short-tail business across a number of lines and accident years, none of which was significant individually or in the aggregate.

Insurance – North American experienced net favorable prior period development of $58 million in the three months ended September 30, 2011 , which was the net result of several underlying favorable and adverse movements, driven by the following principal changes:

•
Net favorable development of $51 million on long-tail business, including:

•
Favorable development of $43 million in our medical risk operations, primarily in the 2006 and prior accident years. This portfolio, composed largely of excess hospital professional liability insurance, experienced continued low levels of reported and paid loss activity leading to reduced estimates of ultimate loss versus our prior review.

•
Favorable development of $26 million in our foreign casualty Controlled Master Program product in the 2007 and prior accident years. The reported and paid loss activity on the general liability and employers liability lines for this product were lower than expected based on our prior review, resulting in reductions in ultimate losses for these coverage lines.

•
Adverse development of $14 million in our environmental liability business unit in the 2005 accident year. The adverse activity was associated with a single remediation cost cap policy where we increased our estimate of ultimate losses based on remediation cost information provided by the insured in the three months ended September 30, 2011.

•
Adverse development of $4 million on long-tail business across a number of lines and accident years, none of which was significant individually or in the aggregate.

60


•
Net favorable development of $7 million on short-tail businesses across a number of lines and accident years, none of which was significant individually or in the aggregate.

Insurance – Overseas General

Insurance – Overseas General experienced net favorable prior period development of $135 million in the three months ended September 30, 2012 , which was the net result of several underlying favorable and adverse movements, driven by the following principal changes:

•
Net favorable development of $110 million in long-tail business, including:

•
Favorable development of $146 million in casualty (primary and excess) and financial lines in the 2008 and prior accident years. Actuarial reviews completed in the three months ended September 30, 2012 indicated favorable claim activity and placed greater reliance on experienced-based methods as these accident years continued to mature.

•
Adverse development of $36 million in casualty (mainly primary) and financial lines in the 2009 to 2011 accident years. The actuarial review completed in the three months ended September 30, 2012 indicated increased frequency trends in accident year 2011 primary casualty as well as individual large losses in excess of expectations.

•
Net favorable development of $25 million on short-tail business, including:

•
Net favorable development of $13 million in aviation, which is the net result of a $21 million reduction in the 2005 to 2010 accident years, partially offset by increases of $8 million in the 2004 and prior accident years. A claims review conducted in the three months ended September 30, 2012 provided information on a number of significant claims, which was the predominant source of the changes across all the years.

•
Favorable development of $13 million in Political Risk business, mainly in the 2008 to 2010 accident years. The review conducted in the three months ended September 30, 2012 indicated favorable loss activity on smaller claims as well as a reduction in the estimate of a large claim.

•
Adverse development of $1 million in other short-tail business across a number of lines and accident years, none of which was significant individually or in the aggregate.

Insurance – Overseas General experienced net favorable prior period development of $126 million in the three months ended September 30, 2011 , which was the net result of several underlying favorable and adverse movements, driven by the following principal changes:

•
Net favorable development of $125 million on long-tail business, including:

•
Favorable development of $245 million in casualty (primary and excess) and financial lines in the 2007 and prior accident years. The findings of the detailed actuarial reviews completed in the three months ended September 30, 2011 recognized the impact of favorable loss emergence and the increased weight given to experience-based methods on maturing accident years.

•
Adverse development of $62 million in financial lines in the 2008 to 2010 accident years. A claims review completed in the three months ended September 30, 2011 of the exposure to financial fraud and subprime claims led to an increase of $20 million. The remaining development was a result of higher than expected large claim activity in the 2008 and 2010 accident years.

61


•
Adverse development of $58 million in casualty lines in the 2008 to 2010 accident years. Previously observed increasing frequency and severity trends in 2008 and 2009 within certain European countries continued into accident year 2010 and have led to $17 million of strengthening of reserves for that year. The rest of the development was primarily from large loss development across the primary and excess book.

•
Net favorable development of $1 million on short-tail business across a number of lines and accident years, none of which was significant individually or in the aggregate.
Global Reinsurance

Global Reinsurance experienced net favorable prior period development of $21 million in the three months ended September 30, 2012 , which was the net result of several underlying favorable and adverse movements, driven by the following principal changes:

•
Net favorable development of $17 million on long-tail business, including:

•
Favorable development of $18 million on medical malpractice business principally in treaty years 2005 to 2009. Following the reserve studies completed in the three months ended September 30, 2012, we reflected a greater weighting towards experience-based methods. Since experience has tended to be generally favorable, compared with assumptions, the changes resulted in favorable development.

•
Adverse development of $1 million in other long-tail business across a number of lines and accident years, none of which was significant individually or in the aggregate.

•
Favorable development of $4 million on short-tail business across a number of lines and accident years, none of which was significant individually or in the aggregate.

Global Reinsurance experienced net favorable prior period development of $10 million in the three months ended September 30, 2011 , which was the net result of several underlying favorable and adverse movements, driven by the following principal changes:

•
Favorable development of $15 million on long-tail business, including:

•
Favorable development of $14 million on medical malpractice business principally in treaty years 2004 to 2007. Following the reserve studies completed in the three months ended September 30, 2011, we reflected a greater weighting towards experience-based methods. Since experience has tended to be generally favorable, compared with assumptions, the changes resulted in favorable development.

•
Favorable development of $1 million on long-tail business across a number of lines and accident years, none of which was significant individually or in the aggregate.

•
Net adverse development of $5 million on short-tail business across a number of lines and accident years, none of which was significant individually or in the aggregate.

62


Segment Operating Results – Three and Nine Months Ended September 30, 2012 and 2011
The discussions that follow include tables that show our segment operating results for the three and nine months ended September 30, 2012 and 2011 .
We operate through the following business segments: Insurance – North American, Insurance – Overseas General, Global Reinsurance, and Life. For additional information on each of our segments refer to “Segment Information” in our 2011 Form 10-K.
Insurance – North American
The Insurance – North American segment comprises our operations in the U.S., Canada, and Bermuda. This segment includes our retail divisions ACE USA (including ACE Canada), ACE Commercial Risk Services, and ACE Private Risk Services; our wholesale and specialty divisions ACE Westchester, ACE Agriculture, and ACE Bermuda; and various run-off operations, including Brandywine Holdings Corporation (Brandywine).
Three Months Ended

Nine Months Ended

September 30
% Change
September 30
% Change
2012
2011
Q-12 vs.
Q-11
2012
2011
YTD-12 vs.
YTD-11
(in millions of U.S. dollars, except for percentages)
Net premiums written
$
2,537

$
2,207

14.9
%
$
5,690

$
5,227

8.9
%
Net premiums earned
2,472

2,299

7.5
%
5,411

5,249

3.1
%
Losses and loss expenses
2,110

1,838

14.8
%
4,122

4,065

1.4
%
Policy acquisition costs
160

174

(8.0
)%
444

455

(2.4
)%
Administrative expenses
148

153

(3.3
)%
448

448

—
%
Underwriting income
54

134

(59.7
)%
397

281

41.3
%
Net investment income
263

291

(9.6
)%
808

886

(8.8
)%
Net realized gains (losses)
(1
)
(2
)
(50.0
)%
16

8

100.0
%
Interest expense
3

4

(25.0
)%
9

11

(18.2
)%
Other (income) expense
(5
)
21

NM

4

8

(50.0
)%
Income tax expense
81

120

(32.5
)%
279

304

(8.2
)%
Net income
$
237

$
278

(14.7
)%
$
929

$
852

9.0
%
Loss and loss expense ratio
85.3
%
80.0
%
76.2
%
77.4
%
Policy acquisition cost ratio
6.5
%
7.6
%
8.2
%
8.7
%
Administrative expense ratio
6.0
%
6.6
%
8.3
%
8.6
%
Combined ratio
97.8
%
94.2
%
92.7
%
94.7
%

Net premiums written increased for the three months ended September 30, 2012 in our retail and wholesale and specialty divisions reflecting rate increases in most lines, strong renewal retention, and new business. In our retail division, premium growth was primarily due to growth in our risk management business and growth in specialty casualty and professional risk lines of business. In addition, we continued to generate higher personal lines production including higher premiums in the homeowner and automobile business offered through ACE Private Risk Services. Growth in our retail division was partially offset by lower premiums in certain casualty and program business from adherence to our underwriting standards; in particular, we continued our planned reduction in our U.S. general market workers' compensation business. Our wholesale and specialty division contributed to the increase in net premiums written primarily from agriculture business due to crop hail production and the increased premiums from the November 2011 acquisition of Penn Millers, as well as from higher production in

63

our wholesale casualty line of business. In addition to the factors noted above, net premiums written for the nine months ended September 30, 2012 increased in our retail division due to higher production from national account risk management business, as well as from our property and accident and health lines of business. The wholesale and specialty division also experienced growth in the property line of business.

Net premiums earned increased for the three and nine months ended September 30, 2012 due to growth in our retail division from higher premiums earned in our property, national account risk management, specialty casualty, professional, and A&H lines of business along with growth in our personal lines business from continued expansion of the ACE Private Risk Services product offerings. Growth in net premiums earned for our retail division was partially offset by lower premiums in certain casualty and program business; in particular, we continued our planned reduction in our U.S. general market workers' compensation business. For the nine months ended September 30, 2012 , these increases were partially offset by lower premiums associated with a couple of large structured prospective risk management programs that did not renew. For the three and nine months ended September 30, 2012 , our wholesale and specialty division also generated higher net premiums earned primarily in our agriculture business from our crop hail business and the acquisition of Penn Millers in November 2011, as well as from higher premiums in wholesale property and inland marine lines of business.
The following two tables provide a line of business breakdown of Insurance – North American’s net premiums earned for the periods indicated:
Three Months Ended

Nine Months Ended

September 30
% Change
September 30
% Change
2012
2011
Q-12 vs.
Q-11
2012
2011
YTD-12 vs.
YTD-11
(in millions of U.S. dollars, except for percentages)
Property and all other
$
353

$
315

12
%
$
1,022

$
899

14
%
Agriculture
1,166

1,080

8
%
1,609

1,514

6
%
Casualty
860

815

6
%
2,505

2,570

(3
)%
Personal accident (A&H)
93

89

4
%
275

266

3
%
Net premiums earned
$
2,472

$
2,299

8
%
$
5,411

$
5,249

3
%
2012
% of Total
2011
% of Total
2012
% of Total
2011
% of Total
Property and all other
14
%
14
%
19
%
17
%
Agriculture
47
%
47
%
30
%
29
%
Casualty
35
%
35
%
46
%
49
%
Personal accident (A&H)
4
%
4
%
5
%
5
%
Net premiums earned
100
%
100
%
100
%
100
%
The following table shows the impact of catastrophe losses and related reinstatement premiums, and prior period development on our loss and loss expense ratio for the periods indicated:
Three Months Ended
Nine Months Ended
September 30
September 30
2012
2011
2012
2011
Loss and loss expense ratio, as reported
85.3
%
80.0
%
76.2
%
77.4
%
Catastrophe losses and related reinstatement premiums
(1.5
)%
(5.0
)%
(1.9
)%
(5.9
)%
Prior period development
3.4
%
2.6
%
3.8
%
3.2
%
Loss and loss expense ratio, adjusted
87.2
%
77.6
%
78.1
%
74.7
%

64

Net pre-tax catastrophe losses, excluding reinstatement premiums, were $38 million and $103 million for the three and nine months ended September 30, 2012 , compared with $119 million and $305 million for the prior year periods, respectively. Catastrophe losses through September 30, 2012 were primarily from Hurricane Isaac and other severe weather-related events in the U.S. and Canada. Catastrophe losses through September 30, 2011 were from severe weather-related events in the U.S., including Hurricane Irene, flooding in the Midwest, and the earthquake in Japan. Net favorable prior period development was $80 million and $199 million for the three and nine months ended September 30, 2012 , compared with $58 million and $164 million in the prior year periods, respectively. Refer to the “Prior Period Development” section for additional information. The adjusted loss and loss expense ratio increased for the three and nine months ended September 30, 2012 primarily due to an increase in the current accident year loss ratio from the impact of the U.S. drought on our agriculture business, partially offset by a reduction in the current accident year loss ratio for several of our property, casualty and professional lines where execution of detailed portfolio management plans has resulted in improved loss ratio performance.

The policy acquisition cost ratio decreased for the three and nine months ended September 30, 2012 due to premium growth in our agriculture business which carries a lower acquisition rate than our other businesses. This decrease was partially offset by growth in certain businesses, including personal lines and A&H that carry a higher acquisition rate than our other businesses, and increased spending for strategic initiatives to support future growth opportunities.

The administrative expense ratio decreased for the three and nine months ended September 30, 2012 primarily from an increase in premiums earned in our agriculture business which generates lower expenses than our other lines of business, partially offset by growth in spending due to the Penn Millers acquisition, and, for the nine months, increased spending required to support business growth primarily in our retail businesses, including ACE Private Risk Services.


65

Insurance – Overseas General
The Insurance – Overseas General segment comprises ACE International, our retail business serving territories outside the U.S., Bermuda, and Canada; the international A&H and life business of Combined Insurance; and the wholesale insurance business of ACE Global Markets, our London-based excess and surplus lines business that includes Lloyd’s Syndicate 2488. The reinsurance operation of ACE Global Markets is included in the Global Reinsurance segment.
Three Months Ended

Nine Months Ended

September 30
% Change
September 30
% Change
2012
2011
Q-12 vs.
Q-11
2012
2011
YTD-12 vs.
YTD-11
(in millions of U.S. dollars, except for percentages)
Net premiums written
$
1,384

$
1,398

(1.0
)%
$
4,387

$
4,251

3.2
%
Net premiums earned
1,432

1,471

(2.6
)%
4,243

4,164

1.9
%
Losses and loss expenses
622

671

(7.3
)%
2,030

2,244

(9.5
)%
Policy acquisition costs
329

353

(6.8
)%
996

989

0.7
%
Administrative expenses
234

236

(0.8
)%
696

698

(0.3
)%
Underwriting income
247

211

17.1
%
521

233

123.6
%
Net investment income
127

138

(8.0
)%
386

406

(4.9
)%
Net realized gains (losses)
13

1

NM

59

(18
)
NM

Interest expense
2

2

—
%
4

4

—
%
Other (income) expense
(3
)
10

NM

3

3

—
%
Income tax expense
77

56

37.5
%
166

112

48.2
%
Net income
$
311

$
282

10.3
%
$
793

$
502

58.0
%
Loss and loss expense ratio
43.4
%
45.6
%
47.8
%
53.9
%
Policy acquisition cost ratio
23.1
%
24.1
%
23.5
%
23.7
%
Administrative expense ratio
16.2
%
15.9
%
16.4
%
16.8
%
Combined ratio
82.7
%
85.6
%
87.7
%
94.4
%
Insurance – Overseas General conducts business internationally and in most major foreign currencies.
The following table summarizes by major product line the approximate effect of changes in foreign currency exchange rates on the growth of net premiums written and earned for the periods indicated:
Three Months Ended
Nine Months Ended
September 30, 2012
September 30, 2012
P&C
A&H
Total
P&C
A&H
Total
Net premiums written:
Growth in original currency
6.8
%
3.4
%
5.5
%
9.3
%
4.2
%
7.4
%
Foreign exchange effect
(6.1
)%
(7.1
)%
(6.5
)%
(4.0
)%
(4.5
)%
(4.2
)%
Growth as reported in U.S. dollars
0.7
%
(3.7
)%
(1.0
)%
5.3
%
(0.3
)%
3.2
%
Net premiums earned:
Growth in original currency
5.2
%
2.9
%
4.4
%
8.4
%
3.8
%
6.7
%
Foreign exchange effect
(6.7
)%
(7.2
)%
(7.0
)%
(4.8
)%
(4.7
)%
(4.8
)%
Growth as reported in U.S. dollars
(1.5
)%
(4.3
)%
(2.6
)%
3.6
%
(0.9
)%
1.9
%


66

For the three months ended September 30, 2012 , net premiums written decreased due to a weakening of major currencies relative to the U.S. dollar. On a constant-dollar basis, net premiums written increased for the three and nine months ended September 30, 2012 from growth in all of our major product lines - P&C, A&H and personal lines business. Growth in our P&C lines reflects new business opportunities in Latin America as well as new business and rate increases in Asia. Our A&H growth is driven by strong results in both Latin America and Asia. New business opportunities in Latin America, Asia and Europe drive the growth in personal lines. In addition, the increase for the nine months ended September 30, 2012 reflects the favorable impact of reinstatement premiums expensed in the prior year, partially offset by continued decreases in certain retail A&H business due to suspension of Combined sales in the U.K. and Ireland.
Net premiums earned decreased in reported U.S. dollars for the three months ended September 30, 2012 , though growth in original currencies increased. The constant-dollar growth was driven by continued strong written premium performance in Latin America and Asia. Net premiums earned grew in original currencies and in reported U.S. dollars for the nine months ended September 30, 2012 , driven by growth noted in Latin America and Asia as well as reinstatement premiums expensed in the prior year period.
The following tables provide a line of business breakdown of Insurance – Overseas General’s net premiums earned for the periods indicated:
Three Months Ended

Nine Months Ended

September 30
% Change
September 30
% Change
2012
2011
Q-12 vs.
Q-11
2012
2011
YTD-12 vs.
YTD-11
(in millions of U.S. dollars, except for percentages)
Property and all other
$
547

$
553

(1
)%
$
1,637

$
1,517

8
%
Casualty
356

366

(3
)%
1,027

1,056

(3
)%
Personal accident (A&H)
529

552

(4
)%
1,579

1,591

(1
)%
Net premiums earned
$
1,432

$
1,471

(3
)%
$
4,243

$
4,164

2
%
Three Months Ended
Nine Months Ended
September 30, 2012
September 30, 2012
2012
% of Total
2011
% of Total
2012
% of Total
2011
% of Total
Property and all other
38
%
38
%
39
%
37
%
Casualty
25
%
25
%
24
%
25
%
Personal accident (A&H)
37
%
37
%
37
%
38
%
Net premiums earned
100
%
100
%
100
%
100
%
The following table shows the impact of catastrophe losses and related reinstatement premiums, and prior period development on our loss and loss expense ratio for the periods indicated:
Three Months Ended
Nine Months Ended
September 30
September 30
2012
2011
2012
2011
Loss and loss expense ratio, as reported
43.4
%
45.6
%
47.8
%
53.9
%
Catastrophe losses and related reinstatement premiums
(0.3
)%
(1.8
)%
(0.3
)%
(6.0
)%
Prior period development
9.5
%
8.7
%
4.7
%
5.0
%
Loss and loss expense ratio, adjusted
52.6
%
52.5
%
52.2
%
52.9
%


67

Net pre-tax catastrophe losses, excluding reinstatement premiums, were $4 million and $11 million for the three and nine months ended September 30, 2012 , compared with $34 million and $231 million in the prior year periods, respectively. Catastrophe losses through September 30, 2012 were primarily related to Hurricane Isaac and flooding in the U.K. Catastrophe losses through September 30 , 2011 included earthquakes in New Zealand and Japan and storms in the U.S. and Australia. Net favorable prior period development was $135 million and $196 million for the three and nine months ended September 30, 2012 compared with $126 million and $210 million in the prior year periods, respectively. Refer to the “Prior Period Development” section for additional information. The adjusted loss and loss expense ratio was relatively flat for the three months ended September 30, 2012 and decreased for the nine months ended September 30, 2012 due to the reduction in the current accident year loss ratio across several lines of business in several regions.
The policy acquisition cost ratio decreased for the three months ended September 30, 2012 due to lower A&H costs and a favorable change in the mix of business. The policy acquisition cost ratio decreased slightly for the nine months ended September 30, 2012 .
The administrative expense ratio increased for the three months ended September 30, 2012 primarily due to the favorable impact of reinstatement premiums collected in the prior year. The administrative expense ratio decreased for the nine months ended September 30, 2012 due to lower regulatory costs for Combined in the U.K. and Ireland.
Global Reinsurance
The Global Reinsurance segment represents our reinsurance operations comprising ACE Tempest Re Bermuda, ACE Tempest Re USA, ACE Tempest Re International, and ACE Tempest Re Canada. Global Reinsurance markets its reinsurance products worldwide under the ACE Tempest Re brand name and provides a broad range of coverage to a diverse array of primary P&C companies.
Three Months Ended

Nine Months Ended

September 30
% Change
September 30
% Change
2012
2011
Q-12 vs.
Q-11
2012
2011
YTD -12 vs.
YTD -11
(in millions of U.S. dollars, except for percentages)
Net premiums written
$
307

$
250

22.2
%
$
879

$
847

3.6
%
Net premiums earned
281

240

16.8
%
748

754

(0.8
)%
Losses and loss expenses
151

94

60.6
%
355

485

(26.8
)%
Policy acquisition costs
40

50

(20.0
)%
125

143

(12.6
)%
Administrative expenses
13

12

8.3
%
38

38

—
%
Underwriting income
77

84

(8.3
)%
230

88

161.4
%
Net investment income
72

70

2.9
%
213

213

—
%
Net realized gains (losses)
(2
)
(29
)
(93.1
)%
(6
)
(56
)
(89.3
)%
Interest expense
1

—

NM

3

1

200.0
%
Other (income) expense
(5
)
7

NM

(7
)
2

NM

Income tax expense
11

7

57.1
%
17

25

(32.0
)%
Net income
$
140

$
111

26.1
%
$
424

$
217

95.4
%
Loss and loss expense ratio
53.9
%
39.2
%
47.4
%
64.3
%
Policy acquisition cost ratio
14.1
%
20.6
%
16.7
%
18.9
%
Administrative expense ratio
4.7
%
5.6
%
5.1
%
5.2
%
Combined ratio
72.7
%
65.4
%
69.2
%
88.4
%


68

Net premiums written increased for the three months ended September 30, 2012 primarily due to a new medical malpractice LPT treaty and new U.S. property treaties written in the quarter. For the nine months ended September 30, 2012 , net premiums written also benefited from improving pricing conditions in our property catastrophe business, partially offset by lower production in the first quarter 2012 from competitive market conditions, adherence to underwriting standards, and a non-recurring LPT treaty written in the prior year.

Net premiums earned increased for the three months ended September 30, 2012 primarily due to the new medical malpractice LPT treaty, which is fully earned when written, as well as from the new U.S. property treaties noted above. This increase in net premiums earned in the quarter is more than offset in our nine months ended September 30, 2012 results due to consecutive annual net decreases in production resulting from competitive market conditions, particularly in casualty and other long-tail lines.
The following tables provide a line of business breakdown of Global Reinsurance’s net premiums earned for the periods indicated:
Three Months Ended

Nine Months Ended

September 30
% Change
September 30
% Change
2012
2011
Q-12 vs.
Q-11
2012
2011
YTD -12 vs.
YTD -11
(in millions of U.S. dollars, except for percentages)
Property and all other
$
54

$
47

15
%
$
138

$
132

5
%
Casualty
150

122

23
%
393

409

(4
)%
Property catastrophe
77

71

8
%
217

213

2
%
Net premiums earned
$
281

$
240

17
%
$
748

$
754

(1
)%
2012
% of Total
2011
% of Total
2012
% of Total
2011
% of Total
Property and all other
19
%
20
%
18
%
18
%
Casualty
53
%
50
%
53
%
54
%
Property catastrophe
28
%
30
%
29
%
28
%
Net premiums earned
100
%
100
%
100
%
100
%
The following table shows the impact of catastrophe losses and related reinstatement premiums, and prior period development on our loss and loss expense ratio for the periods indicated:
Three Months Ended
Nine Months Ended
September 30
September 30
2012
2011
2012
2011
Loss and loss expense ratio, as reported
53.9
%
39.2
%
47.4
%
64.3
%
Catastrophe losses and related reinstatement premiums
(4.3
)%
2.7
%
(1.9
)%
(21.9
)%
Prior period development
8.1
%
7.2
%
6.5
%
8.8
%
Loss and loss expense ratio, adjusted
57.7
%
49.1
%
52.0
%
51.2
%
Net pre-tax catastrophe (gains) losses, excluding reinstatement premiums were $13 million and $15 million for the three and nine months ended September 30, 2012 , compared with $(6) million and $168 million in the prior year periods, respectively. Catastrophe losses through September 30, 2012 were primarily from Hurricane Isaac, and other North American weather-related events. The catastrophe gains in the three months ended September 30, 2011 were related to an industry loss warranty recovery payment received, partially offset by losses related to Hurricane Irene and the storms in Australia and the Netherlands. The catastrophe losses through the nine months ended September 30, 2011 were primarily related to earthquakes in Japan and New Zealand, natural catastrophes

69

in Australia and other severe weather-related events in the U.S. Net favorable prior period development was $21 million and $47 million for the three and nine months ended September 30, 2012 , respectively (both of which are net of $4 million of unfavorable premium adjustments to loss sensitive treaties). This compares with net favorable prior period development of $10 million and $59 million in the prior year periods, respectively (both of which are net of $13 million of unfavorable premium adjustments to loss sensitive treaties). Refer to the “Prior Period Development” section for additional information. The adjusted loss and loss expense ratio increased for the three and nine months ended September 30, 2012 primarily due to the new medical malpractice LPT written in the third quarter and unfavorable current accident year loss development, partially offset by an increase in lower loss ratio property catastrophe business. In addition, the nine months ended September 30, 2012 adjusted loss and loss expense ratio benefited from the impact of an LPT treaty written in the prior year.

The policy acquisition cost ratio decreased for the three and nine months ended September 30, 2012 from the impact of the new medical malpractice LPT treaty which did not generate acquisition costs, overall lower commission costs on other business, and net favorable adjustments on loss sensitive contract provisions.

The administrative expense ratio decreased for the three months ended September 30, 2012 as a result of an increase in net premiums earned and decreased slightly for the nine months ended September 30, 2012.
Life
The Life segment includes our international life operations (ACE Life), ACE Tempest Life Re (ACE Life Re) and the North American supplemental A&H and life business of Combined Insurance. We assess the performance of our life business based on life underwriting income, which includes net investment income and (gains) losses from fair value changes in separate account assets that do not qualify for separate account reporting under GAAP.
Three Months Ended

Nine Months Ended

September 30
% Change
September 30
% Change
2012
2011
Q-12 vs.
Q-11
2012
2011
YTD-12 vs.
YTD-11
(in millions of U.S. dollars, except for percentages)
Net premiums written
$
488

$
488

—
%
$
1,462

$
1,417

3.2
%
Net premiums earned
480

480

—
%
1,427

1,389

2.8
%
Losses and loss expenses
164

142

15.5
%
463

439

5.5
%
Policy benefits
130

83

56.6
%
379

282

34.4
%
(Gains) losses from fair value changes in separate account assets (1)
(14
)
39

NM

(18
)
39

NM

Policy acquisition costs
80

92

(13.0
)%
244

253

(3.6
)%
Administrative expenses
81

81

—
%
237

233

1.7
%
Net investment income
63

60

5.0
%
186

166

12.0
%
Life underwriting income
102

103

(1.0
)%
308

309

(0.3
)%
Net realized gains (losses)
(71
)
(732
)
(90.3
)%
(261
)
(813
)
(67.9
)%
Interest expense
3

3

—
%
9

9

—
%
Other (income) expense (1)
—

10

NM

14

27

(48.1
)%
Income tax expense
14

13

7.7
%
44

41

7.3
%
Net income (loss)
$
14

$
(655
)
NM

$
(20
)
$
(581
)
(96.6
)%
____________________
(1)
(Gains) losses from fair value changes in separate account assets that do not qualify for separate account reporting under GAAP are reclassified from Other (income) expense for purposes of presenting Life underwriting income.

70

The following table provides a line of business breakdown of Life's net premiums written for the periods indicated:
Three Months Ended

Nine Months Ended

September 30
% Change
September 30
% Change
2012
2011
Q-12 vs.
Q-11
2012
2011
YTD-12 vs.
YTD-11
(in millions of U.S. dollars, except for percentages)
A&H
$
255

$
246

4
%
$
742

$
743

—
%
Life insurance
156

157

(1
)%
482

415

16
%
Life reinsurance
77

85

(9
)%
238

259

(8
)%
Net premiums written
$
488

$
488

—
%
$
1,462

$
1,417

3
%

A&H net premiums written increased for the three months ended September 30, 2012 due to a catch-up in premium registrations during the quarter, partially offset by decreases in net premiums written due to the continuing effects on the economy resulting in lower new business and renewals. A&H net premiums written for the nine months ended September 30, 2012 were relatively flat. Life insurance net premiums written decreased slightly for the three months ended September 30, 2012 as growth in Asia was more than offset by the impact of foreign exchange. For the nine months ended September 30, 2012 , Life insurance net premiums written increased primarily due to prior year acquisitions. Life reinsurance net premiums written decreased for the three and nine months ended September 30, 2012 because no new life reinsurance business is currently being written.

Net realized gains (losses), which are excluded from life underwriting income, relate primarily to the change in the net fair value of reported GLB reinsurance liabilities and changes in the fair value of derivatives used to partially offset the risk in the variable annuity guarantee portfolio. During the three and nine months ended September 30, 2012 , realized losses were associated with an increased value of GLB liabilities primarily due to falling interest rates and the unfavorable impact of discounting future claims for one and three fewer quarters, respectively, partially offset by a decreased value of GLB liabilities due to rising equity levels. In addition, for the three and nine months ended September 30, 2012 , we experienced a decrease in the value of the derivative instruments, which decrease in value when the S&P 500 index increases.
Other Income and Expense Items
Three Months Ended
Nine Months Ended
September 30
September 30
2012
2011
2012
2011
(in millions of U.S. dollars)
Equity in net (income) loss of partially-owned entities
$
(33
)
$
25

$
(47
)
$
(11
)
(Gains) losses from fair value changes in separate account assets
(14
)
39

(18
)
39

Amortization of intangible assets
12

7

36

21

Acquisition-related costs
8

1

11

4

Federal excise and capital taxes
7

6

16

15

Other
3

11

16

20

Other (income) expense
$
(17
)
$
89

$
14

$
88

Other (income) expense includes (gains) losses from fair value changes in separate account assets that do not qualify for separate account reporting under GAAP. The offsetting movement in the separate account liabilities is included in Policy benefits in the consolidated statements of operations. Equity in net (income) loss of partially-owned entities includes our share of net (income) loss related to investment funds, limited partnerships, partially-owned investment companies, and partially-owned insurance companies. Certain federal excise and capital taxes

71

incurred as a result of capital management initiatives are included in Other (income) expense in the consolidated statements of operations. As these are considered capital transactions, they are excluded from underwriting results.
Net Investment Income
Three Months Ended
Nine Months Ended
September 30
September 30
2012
2011
2012
2011
(in millions of U.S. dollars)
Fixed maturities
$
534

$
555

$
1,605

$
1,646

Short-term investments
2

10

20

36

Equity securities
8

10

25

28

Other
19

10

47

39

Gross investment income
563

585

1,697

1,749

Investment expenses
(30
)
(21
)
(83
)
(72
)
Net investment income
$
533

$
564

$
1,614

$
1,677

Net investment income is influenced by a number of factors including the amounts and timing of inward and outward cash flows, the level of interest rates, and changes in overall asset allocation. Net investment income decreased six percent and four percent for the three and nine months ended September 30, 2012 , respectively. The decline in net investment income was primarily due to lower reinvestment rates and the negative impact of foreign exchange, partially offset by higher distributions from private equity funds.
The investment portfolio’s average market yield on fixed maturities was 2.2 percent and 3.2 percent at September 30, 2012 and 2011 , respectively. Average market yield on fixed maturities represents the weighted average yield to maturity of our fixed income portfolio based on the market prices of the holdings at that date.
The yield on short-term investments reflects the global nature of our insurance operations ( 0.5 percent — 1.2 percent yield). For example, yields on short-term investments in Malaysia, Korea, and Ecuador range from 3.0 percent — 4.4 percent .
The yield on our equity securities portfolio is high relative to the yield on the S&P 500 Index because we classify our strategic emerging debt portfolio, which is a mutual fund, as equity ( 3.7 percent — 4.1 percent yield). The strategic emerging debt portfolio represents approximately 60 percent of our equity securities portfolio.
Net Realized and Unrealized Gains (Losses)
We take a long-term view with our investment strategy, and our investment managers manage our investment portfolio to maximize total return within certain specific guidelines designed to minimize risk. The majority of our investment portfolio is available for sale and reported at fair value. Our held to maturity investment portfolio is reported at amortized cost.
The effect of market movements on our available for sale investment portfolio impacts net income (through net realized gains (losses)) when securities are sold or when we record an Other-than-temporary impairment (OTTI) charge in net income. For a discussion related to how we assess OTTI for all of our investments, including credit-related OTTI, and the related impact on net income, refer to Note 3 c) to the consolidated financial statements. Additionally, net income is impacted through the reporting of changes in the fair value of derivatives, including financial futures, options, swaps, and GLB reinsurance. Changes in unrealized appreciation and depreciation on available for sale securities, which result from the revaluation of securities held, are reported as a separate component of Accumulated other comprehensive income in shareholders’ equity in the consolidated balance sheets.

72

The following tables present our pre-tax net realized and unrealized gains (losses) as well as a breakdown of our OTTI and other net realized gains (losses) on investments for the periods indicated:
Three Months Ended
Three Months Ended
September 30, 2012
September 30, 2011
Net
Realized
Gains
(Losses)
Net
Unrealized
Gains
(Losses)
Net
Impact
Net
Realized
Gains
(Losses)
Net
Unrealized
Gains
(Losses)
Net
Impact
(in millions of U.S. dollars)
Fixed maturities
$
47

$
642

$
689

$
20

$
81

$
101

Fixed income derivatives
4

—

4

(89
)
—

(89
)
Total fixed maturities
51

642

693

(69
)
81

12

Public equity
2

23

25

(2
)
(59
)
(61
)
Other
1

4

5

(5
)
(4
)
(9
)
Subtotal
54

669

723

(76
)
18

(58
)
Derivatives
Fair value adjustment on insurance derivatives
83

—

83

(926
)
—

(926
)
S&P put option and futures
(147
)
—

(147
)
220

—

220

Fair value adjustment on other derivatives
—

—

—

2

—

2

Subtotal derivatives
(64
)
—

(64
)
(704
)
—

(704
)
Foreign exchange gains (losses)
(50
)
—

(50
)
20

—

20

Total gains (losses)
$
(60
)
$
669

$
609

$
(760
)
$
18

$
(742
)
Nine Months Ended

Nine Months Ended
September 30, 2012

September 30, 2011
Net
Realized
Gains
(Losses)
Net
Unrealized
Gains
(Losses)
Net
Impact
Net
Realized
Gains
(Losses)
Net
Unrealized
Gains
(Losses)
Net
Impact
(in millions of U.S. dollars)
Fixed maturities
$
149

$
1,136

$
1,285

$
143

$
244

$
387

Fixed income derivatives
(3
)
—

(3
)
(157
)
—

(157
)
Total fixed maturities
146

1,136

1,282

(14
)
244

230

Public equity
(2
)
52

50

9

(51
)
(42
)
Other
(6
)
5

(1
)
(10
)
2

(8
)
Subtotal
138

1,193

1,331

(15
)
195

180

Derivatives
Fair value adjustment on insurance derivatives
44

—

44

(925
)
—

(925
)
S&P put option and futures
(308
)
—

(308
)
152

—

152

Fair value adjustment on other derivatives
(4
)
—

(4
)
(1
)
—

(1
)
Subtotal derivatives
(268
)
—

(268
)
(774
)
—

(774
)
Foreign exchange losses
(64
)
—

(64
)
(89
)
—

(89
)
Total gains (losses)
$
(194
)
$
1,193

$
999

$
(878
)
$
195

$
(683
)

73


Three Months Ended
Three Months Ended
September 30, 2012
September 30, 2011
OTTI
Other
Net
Realized
Gains
(Losses)
Net
Realized
Gains
(Losses)
OTTI
Other
Net
Realized
Gains
(Losses)
Net
Realized
Gains
(Losses)
(in millions of U.S. dollars)
Fixed maturities
$
(10
)
$
57

$
47

$
(19
)
$
39

$
20

Public equity
—

2

2

(1
)
(1
)
(2
)
Other
—

1

1

—

(5
)
(5
)
Total
$
(10
)
$
60

$
50

$
(20
)
$
33

$
13

Nine Months Ended
Nine Months Ended
September 30, 2012
September 30, 2011
OTTI
Other
Net
Realized
Gains
(Losses)
Net
Realized
Gains
(Losses)
OTTI
Other
Net
Realized
Gains
(Losses)
Net
Realized
Gains
(Losses)
(in millions of U.S. dollars)
Fixed maturities
$
(18
)
$
167

$
149

$
(28
)
$
171

$
143

Public equity
(5
)
3

(2
)
(1
)
10

9

Other
(7
)
1

(6
)
(3
)
(8
)
(11
)
Total
$
(30
)
$
171

$
141

$
(32
)
$
173

$
141

Our net realized gains (losses) for the three and nine months ended September 30, 2012 , included write-downs of $10 million and $30 million, respectively, as a result of an other-than-temporary decline in fair value of certain securities. This compares with write-downs of $20 million and $32 million for the three and nine months ended September 30, 2011 , respectively.
At September 30, 2012 , our investment portfolios held by U.S. legal entities included approximately $31 million of gross unrealized losses on fixed income investments. Our tax planning strategy related to these losses is based on our view that we will hold these fixed income investments until they recover their cost. As such, we have recognized a deferred tax asset of approximately $11 million related to these fixed income investments. This strategy allows us to recognize the associated deferred tax asset related to these fixed income investments as we do not believe these losses will ever be realized.
We engage in a securities lending program which involves lending investments to other institutions for short periods of time. ACE invests the collateral received in securities of high credit quality and liquidity, with the objective of maintaining a stable principal balance. Certain investments purchased with the securities lending collateral declined in value resulting in an unrealized loss of $5 million at September 30, 2012 . The unrealized loss is attributable to fluctuations in market values of the underlying performing debt instruments held by the respective mutual funds, rather than default of a debt issuer. It is our view that the decline in value is temporary.
Investments
Our investment portfolio is invested primarily in publicly traded, investment grade fixed income securities with an average credit quality of A/Aa as rated by the independent investment rating services Standard and Poor’s (S&P)/ Moody’s Investors Service (Moody’s). The portfolio is externally managed by independent, professional investment managers and is broadly diversified across geographies, sectors, and issuers. Other investments principally comprise direct investments, investment funds, and limited partnerships. We hold no collateralized debt obligations or collateralized loan obligations in our investment portfolio and we provide no credit default

74

protection. We have long-standing global credit limits for our entire portfolio across the organization. Exposures are aggregated, monitored, and actively managed by our Global Credit Committee, comprising senior executives, including our Chief Financial Officer, our Chief Risk Officer, our Chief Investment Officer, and our Treasurer. We also have well-established, strict contractual investment rules requiring managers to maintain highly diversified exposures to individual issuers and closely monitor investment manager compliance with portfolio guidelines.
The average duration of our fixed income securities, including the effect of options and swaps, was 3.7 years at both September 30, 2012 and December 31, 2011 . We estimate that a 100 basis point (bps) increase in interest rates would reduce our fixed income portfolio by approximately $2.1 billion at September 30, 2012 .
The following table shows the fair value and cost/amortized cost of our invested assets:
September 30, 2012
December 31, 2011
Fair
Value
Cost/
Amortized
Cost
Fair
Value
Cost/
Amortized
Cost
(in millions of U.S. dollars)
Fixed maturities available for sale
$
46,504

$
43,758

$
41,967

$
40,450

Fixed maturities held to maturity
7,879

7,493

8,605

8,447

Short-term investments
2,429

2,429

2,301

2,301

56,812

53,680

52,873

51,198

Equity securities
770

741

647

671

Other investments
2,621

2,385

2,314

2,112

Total investments
$
60,203

$
56,806

$
55,834

$
53,981

The fair value of our total investments increased $4.4 billion during the nine months ended September 30, 2012 , primarily due to the investing of operating cash flows and unrealized appreciation.

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The following tables show the market value of our fixed maturities and short-term investments at September 30, 2012 and December 31, 2011 . The first table lists investments according to type and the second according to S&P credit rating:
September 30, 2012
December 31, 2011
Market
Value
Percentage
of Total
Market
Value
Percentage
of Total
(in millions of U.S. dollars, except for percentages)
Treasury
$
2,731

5
%
$
2,361

5
%
Agency
1,952

3
%
1,725

3
%
Corporate and asset-backed securities
18,155

32
%
17,030

32
%
Mortgage-backed securities
13,066

23
%
13,237

25
%
Municipal
3,542

7
%
2,888

6
%
Non-U.S.
14,937

26
%
13,331

25
%
Short-term investments
2,429

4
%
2,301

4
%
Total
$
56,812

100
%
$
52,873

100
%
AAA
$
9,270

17
%
$
9,284

18
%
AA
22,423

39
%
20,562

39
%
A
10,391

18
%
10,106

19
%
BBB
6,424

11
%
6,152

12
%
BB
4,264

8
%
3,755

7
%
B
3,506

6
%
2,428

4
%
Other
534

1
%
586

1
%
Total
$
56,812

100
%
$
52,873

100
%

As part of our overall investment strategy, we may invest in states, municipalities, and other political subdivisions fixed maturity securities (Municipal). We apply the same investment selection process described previously to our Municipal investments. The portfolio is highly diversified primarily in state general obligation bonds and essential service revenue bonds including education and utilities (water, power, and sewers). As of September 30, 2012 , one state, including political subdivisions and other municipal issuers within the state, represented approximately 17 percent of our Municipal investments. A majority of the single state exposure represents special revenue bonds. Over 69 percent of our Municipal investments carry an S&P rating of AA- or better and none carry fair values that reflect a significantly different risk compared to those ratings. These Municipal investments are split 43 percent and 57 percent between general obligation and special revenue bonds, respectively.
Our exposure to the Euro results primarily from ACE European Group which is headquartered in London and offers a broad range of coverages throughout the European Union, Central, and Eastern Europe. ACE primarily invests in Euro denominated investments to support its local currency insurance obligations and required capital levels. ACE’s local currency investment portfolios have strict contractual investment guidelines requiring managers to maintain a high quality and diversified portfolio to both sector and individual issuers. Investment portfolios are monitored daily to ensure investment manager compliance with portfolio guidelines.
Our non-U.S. investment grade fixed income portfolios are currency-matched with the insurance liabilities of our non-U.S. operations. We have 78 percent of our non-U.S. fixed income portfolio denominated in G7 currencies. The average credit quality of our non-U.S. fixed income securities is A and 54 percent of our holdings are rated AAA or guaranteed by governments or quasi-government agencies. Within the context of these investment portfolios, our government and corporate bond holdings are highly diversified across industries and geographies. Issuer limits are based on credit rating (AA— two percent, A— one percent, BBB— 0.5 percent of the total portfolio) and are monitored daily via an internal compliance system. Because of this investment approach we do

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not have a direct exposure to troubled sovereign borrowers in Europe. We manage our indirect exposure using the same credit rating based investment approach. Accordingly, we do not believe our indirect exposure is material.
The table below summarizes the market value and amortized cost of our non-U.S. fixed income portfolio by country/sovereign for non-U.S. government securities at September 30, 2012 :
Market Value
Amortized Cost
(in millions of U.S. dollars)
United Kingdom
$
1,254

$
1,213

Canada
979

943

Republic of Korea
537

475

Japan
397

396

Germany
387

378

Province of Ontario
253

241

Federative Republic of Brazil
217

213

France
211

203

Kingdom of Thailand
204

200

Province of Quebec
169

157

Commonwealth of Australia
148

131

State of Queensland
142

130

Federation of Malaysia
124

123

Swiss Confederation
122

116

People's Republic of China
119

115

United Mexican States
110

101

State of New South Wales
85

79

Taiwan
81

78

State of Victoria
63

58

Socialist Republic of Vietnam
62

58

Republic of Indonesia
52

49

Russian Federation
47

46

Republic of Colombia
42

40

Province of British Columbia
42

40

Republic of Austria
40

39

Other Non-U.S. Government (1)
753

717

Non-U.S. Government Securities
6,640

6,339

Eurozone Non-U.S. Corporate (excluding United Kingdom) (2)
2,460

2,336

Other Non-U.S. Corporate
5,837

5,487

Total
$
14,937

$
14,162

____________________
(1)
There are no investments in Portugal, Ireland, Italy, Greece or Spain. Our gross and net Eurozone Non-U.S. Government Securities exposure is the same.
(2)
Refer to the following table for further detail on Eurozone Non-U.S. Corporate Securities. Our gross and net Eurozone Non-U.S. Corporate Securities exposure is the same.

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The table below summarizes the market value and amortized cost of our Eurozone fixed income portfolio (excluding United Kingdom) by industry at September 30, 2012 :
Market Value by Industry
Amortized Cost
Bank
Financial
Industrial
Utility
Total
(in millions of U.S. dollars)
Netherlands
$
215

$
154

$
338

$
150

$
857

$
804

France
103

41

140

161

445

426

Germany
277

2

87

8

374

360

Luxembourg
10

2

233

99

344

329

Euro Supranational
206

—

—

—

206

195

Ireland
12

2

96

15

125

116

Finland
26

—

14

3

43

41

Belgium
—

—

30

1

31

30

Austria
20

—

7

1

28

28

Spain
6

—

—

—

6

6

Portugal
—

—

1

—

1

1

Eurozone Non-U.S. Corporate Securities
$
875

$
201

$
946

$
438

$
2,460

$
2,336

The table below summarizes the market value and amortized cost of the top 10 Eurozone bank exposures within our Eurozone fixed income portfolio (excluding United Kingdom) at September 30, 2012 :
Market Value
Amortized Cost
(in millions of U.S. dollars)
European Investment Bank
$
174

$
166

KFW
148

142

Rabobank Nederland NV
116

108

Deutsche Bank AG
47

45

ABN AMRO Group NV
31

29

Bank Nederlandse Gemeenten
31

29

BNP Paribas SA
29

27

Credit Agricole Groupe
28

27

Erste Abwicklungsanstalt
24

23

Nordea Bank AB
23

22


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The table below summarizes the market value and amortized cost of the top 10 Eurozone corporate exposures within our Eurozone fixed income portfolio (excluding United Kingdom) at September 30, 2012 :
Market Value
Amortized Cost
(in millions of U.S. dollars)
ING Groep NV
$
97

$
93

Electricite de France SA
92

88

Intelsat SA
79

75

Royal Dutch Shell PLC
76

71

Deutsche Telekom AG
72

64

LyondellBasell Industries NV
55

49

France Telecom SA
43

40

Gazprom OAO
41

37

General Electric Co
40

37

Liberty Global Inc
38

34



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The table below summarizes our largest exposures to corporate bonds by market value at September 30, 2012 :
Market Value
(in millions of U.S. dollars)
General Electric Co
$
443

JP Morgan Chase & Co
431

Citigroup Inc
352

The Goldman Sachs Group Inc
333

Bank of America Corp
313

Morgan Stanley
286

Verizon Communications Inc
284

HSBC Holdings Plc
211

Wells Fargo & Co
210

AT&T INC
207

Kraft Foods Inc
170

Comcast Corp
167

Anheuser-Busch InBev NV
145

Duke Energy Corp
139

Royal Bank of Scotland Group Plc
134

Time Warner Cable Inc
130

Barclays Plc
129

BP Plc
127

ConocoPhillips
127

UBS AG
126

American Express Co
124

Pfizer Inc
123

Rabobank Nederland NV
116

Credit Suisse Group
114

Lloyds Banking Group Plc
108


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Mortgage-backed securities
Additional details on the mortgage-backed component of our investment portfolio at September 30, 2012 , are provided below:
Mortgage-backed securities
Market Value
(in millions of U.S. dollars)
S&P Credit Rating
AAA
AA
A
BBB
BB
and
below
Total
Mortgage-backed securities
Agency residential mortgage-backed (RMBS)
$
—

$
11,237

$
—

$
—

$
—

$
11,237

Non-agency RMBS
155

6

24

10

414

609

Commercial mortgage-backed
1,184

18

11

7

—

1,220

Total mortgage-backed securities
$
1,339

$
11,261

$
35

$
17

$
414

$
13,066


Mortgage-backed securities
Amortized Cost
(in millions of U.S. dollars)
S&P Credit Rating
AAA
AA
A
BBB
BB
and
below
Total
Mortgage-backed securities
Agency RMBS
$
—

$
10,685

$
—

$
—

$
—

$
10,685

Non-agency RMBS
152

6

24

10

446

638

Commercial mortgage-backed
1,096

15

9

6

—

1,126

Total mortgage-backed securities
$
1,248

$
10,706

$
33

$
16

$
446

$
12,449

Our mortgage-backed securities are rated predominantly AA and comprise approximately 23 percent of our fixed income portfolio. This compares with a 32 percent mortgage-backed weighting in representative indices of the U.S. fixed income market at September 30, 2012 . The minimum rating for our initial purchases of mortgage-backed securities is AA for agency mortgages and AAA for non-agency mortgages.
Agency RMBS represent securities which have been issued by Federal agencies (Government National Mortgage Association, Federal National Mortgage Association, and Federal Home Loan Mortgage Corporation) with implied or explicit government guarantees. These represent 95 percent of our total RMBS portfolio. Our non-agency RMBS are backed primarily by prime collateral and are broadly diversified in over 45,000 loans. This portfolio’s original loan-to-value ratio is approximately 67 percent with an average Fair Isaac Corporation (FICO) score of 732 . With this conservative loan-to-value ratio and subordinated collateral of six percent , the cumulative 5-year foreclosure rate would have to rise to 18 percent from current levels before principal is significantly impaired. The foreclosure rate of our non-agency RMBS portfolio at September 30, 2012 was seven percent .
Our commercial mortgage-backed securities (CMBS) are rated predominantly AAA, broadly diversified with over 13,000 loans with 40 percent of the portfolio issued before 2006 and 42 percent issued after 2009. The average loan-to-value ratio is approximately 65 percent with a debt service coverage ratio in excess of 1.9 and weighted-

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average subordinated collateral of 29 percent . The cumulative foreclosure rate would have to rise to 42 percent before principal is impaired. The foreclosure rate for our CMBS portfolio at September 30, 2012 was 2.1 percent .
Below-investment grade corporate fixed income portfolio
Below-investment grade securities have different characteristics than investment grade corporate debt securities. Risk of loss from default by the borrower is greater with below-investment grade securities. Below-investment grade securities are generally unsecured and are often subordinated to other creditors of the issuer. Also, issuers of below-investment grade securities usually have higher levels of debt and are more sensitive to adverse economic conditions, such as recession or increasing interest rates, than are investment grade issuers. At September 30, 2012 , our corporate fixed income investment portfolio included below-investment grade and non-rated securities which, in total, comprised approximately 13 percent of our fixed income portfolio. Our below-investment grade and non-rated portfolio includes over 1,000 issuers, with the greatest single exposure being $99 million.
We manage high-yield bonds as a distinct and separate asset class from investment grade bonds. The allocation to high yield bonds is explicitly set by internal management and is targeted to securities in the upper tier of credit quality (BB/B). Our minimum rating for initial purchase is BB/B. Six external investment managers are responsible for high yield security selection and portfolio construction. Our high yield managers have a conservative approach to credit selection and very low historical default experience. Holdings are highly diversified across industries and subject to a 1.5 percent issuer limit as a percentage of high yield allocation. We monitor position limits daily through an internal compliance system. Derivative and structured securities (e.g., credit default swaps and collateralized loan obligations) are not permitted in the high-yield portfolio.
Critical Accounting Estimates
As of September 30, 2012 , with the exception noted below, there were no material changes to our critical accounting estimates. Refer to Note 1 to the consolidated financial statements for additional information. For full discussion of our critical accounting estimates, refer to Item 7 in our 2011 Form 10-K.
Effective January 1, 2012, we retrospectively adopted new accounting guidance for costs associated with acquiring or renewing insurance contracts. Under the new guidance, the definition of acquisition costs was modified to specify that a cost must be directly related to the successful acquisition of a new or renewal insurance contract in order to be deferred. Prior year amounts and ratios have been adjusted to reflect the impact of retrospective adjustments as a result of applying this new accounting guidance.
Reinsurance recoverable on ceded reinsurance
The following table shows a composition of our reinsurance recoverable for the periods indicated:
September 30
December 31
2012
2011
(in millions of U.S. dollars)
Reinsurance recoverable on unpaid losses and loss expenses (1)
$
11,162

$
11,602

Reinsurance recoverable on paid losses and loss expenses (1)
695

787

Net reinsurance recoverable on losses and loss expenses
$
11,857

$
12,389

Reinsurance recoverable on policy benefits
$
246

$
249

____________________
(1)
Net of provision for uncollectible reinsurance
We evaluate the financial condition of our reinsurers and potential reinsurers on a regular basis and also monitor concentrations of credit risk with reinsurers.  The provision for uncollectible reinsurance is required principally due to the potential failure of reinsurers to indemnify us, primarily because of disputes under reinsurance contracts

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and insolvencies. The provision for uncollectible reinsurance is based on a default analysis applied to gross reinsurance recoverables, net of approximately $ 2.5 billion and $2.8 billion of collateral at September 30, 2012 and December 31, 2011 , respectively. The decrease in net reinsurance recoverable on losses and loss expenses was primarily due to collections relating to prior period catastrophe events and run-off operations and favorable prior period development, partially offset by crop activity and the impact of foreign exchange.
Unpaid losses and loss expenses
As an insurance and reinsurance company, we are required by applicable laws and regulations and GAAP to establish loss and loss expense reserves for the estimated unpaid portion of the ultimate liability for losses and loss expenses under the terms of our policies and agreements with our insured and reinsured customers. The estimate of the liabilities includes provisions for claims that have been reported but are unpaid at the balance sheet date (case reserves) and for obligations on claims that have been incurred but not reported (IBNR) at the balance sheet date. IBNR may also include provisions to account for the possibility that reported claims may settle for amounts that differ from the established reserves. Loss reserves also include an estimate of expenses associated with processing and settling unpaid claims (loss expenses). At September 30, 2012 , our gross unpaid loss and loss expense reserves were $38.2 billion and our net unpaid loss and loss expense reserves were $27.0 billion. With the exception of certain structured settlements, for which the timing and amount of future claim payments are reliably determinable, and certain reserves for unsettled claims that are discounted in statutory filings, our loss reserves are not discounted for the time value of money.
The table below presents a roll-forward of our unpaid losses and loss expenses:
Gross
Losses
Reinsurance
Recoverable (1)
Net
Losses
(in millions of U.S. dollars)
Balance at December 31, 2011
$
37,477

$
11,602

$
25,875

Losses and loss expenses incurred
9,285

2,315

6,970

Losses and loss expenses paid
(8,870
)
(2,837
)
(6,033
)
Other (including foreign exchange translation)
308

82

226

Balance at September 30, 2012
$
38,200

$
11,162

$
27,038

____________________
(1)
Net of provision for uncollectible reinsurance
The process of establishing loss reserves for property and casualty claims can be complex and is subject to considerable uncertainty as it requires the use of informed estimates and judgments based on circumstances known at the date of accrual.
The following table shows our total reserves (including loss expense reserves) segregated between case reserves and IBNR reserves:
September 30, 2012
December 31, 2011
Gross
Ceded
Net
Gross
Ceded
Net
(in millions of U.S. dollars)
Case reserves
$
18,008

$
5,670

$
12,338

$
17,143

$
5,681

$
11,462

IBNR reserves
20,192

5,492

14,700

20,334

5,921

14,413

Total
$
38,200

$
11,162

$
27,038

$
37,477

$
11,602

$
25,875


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Asbestos and Environmental (A&E) and Other Run-off Liabilities
There was no unexpected A&E reserve activity during the nine months ended September 30, 2012 . Refer to our 2011 Form 10-K for additional information.
Fair value measurements
The accounting guidance on fair value measurements defines fair value as the price to sell an asset or transfer a liability in an orderly transaction between market participants and establishes a three-level valuation hierarchy in which inputs into valuation techniques used to measure fair value are classified.
The fair value hierarchy gives the highest priority to quoted prices in active markets (Level 1 inputs) and the lowest priority to unobservable data (Level 3 inputs). Inputs in Level 1 are unadjusted quoted prices for identical assets or liabilities in active markets. Level 2 includes inputs other than quoted prices included within Level 1 that are observable for assets or liabilities either directly or indirectly. Level 2 inputs include, among other items, quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and inputs other than quoted prices that are observable for the asset or liability such as interest rates and yield curves. Level 3 inputs are unobservable and reflect our judgments about assumptions that market participants would use in pricing an asset or liability.
We categorize financial instruments within the valuation hierarchy at the balance sheet date based upon the lowest level of inputs that are significant to the fair value measurement. Accordingly, transfers between levels within the valuation hierarchy occur when there are significant changes to the inputs, such as increases or decreases in market activity, changes to the availability of current prices, changes to the transparency to underlying inputs, and whether there are significant variances in quoted prices. Transfers in and/or out of any level are assumed to occur at the end of the period.
While we obtain values for the majority of the investment securities we hold from one or more pricing services, it is ultimately management’s responsibility to determine whether the values obtained and recorded in the financial statements are representative of fair value. We periodically update our understanding of the methodologies used by our pricing services in order to validate that the prices obtained from those services are consistent with the GAAP definition of fair value as an exit price. Based on our understanding of the methodologies, our pricing services only produce an estimate of fair value if there is observable market information that would allow them to make a fair value estimate. Based on our understanding of the market inputs used by our pricing services, all applicable investments have been valued in accordance with GAAP valuation principles. We have controls to review significant price changes and stale pricing, and to ensure that prices received from pricing services have been accurately reflected in the consolidated financial statements. We do not typically adjust prices obtained from pricing services.
Additionally, the valuation of fixed maturity investments is more subjective when markets are less liquid due to the lack of market based inputs (i.e., stale pricing), which may increase the potential that the estimated fair value of an investment is not reflective of the price at which an actual transaction would occur. For a small number of fixed maturities, we obtain a quote from a broker (typically a market maker). Due to the disclaimers on the quotes that indicate that the price is indicative only, we include these fair value estimates in Level 3.
At September 30, 2012 , Level 3 assets represented four percent of assets that are measured at fair value and three percent of total assets. Level 3 liabilities represented 100 percent of liabilities that are measured at fair value and two percent of our total liabilities. During the three and nine months ended September 30, 2012 , we transferred assets of $ 75 million and $ 117 million, respectively, into our Level 3 assets from other levels of the valuation hierarchy. During the three and nine months ended September 30, 2012 , we transferred assets of $ 46 million and $ 71 million, respectively, out of our Level 3 assets to other levels of the valuation hierarchy. Refer to Note 4 to the consolidated financial statements for a description of the valuation techniques and inputs used to determine fair values for our financial instruments measured or disclosed at fair value by valuation hierarchy (Levels 1, 2, and 3)

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as well as a roll-forward of Level 3 financial instruments measured at fair value for the three and nine months ended September 30, 2012 and 2011 .
Guaranteed living benefits (GLB) derivatives
Under life reinsurance programs covering living benefit guarantees, we assumed the risk of GLBs associated with variable annuity (VA) contracts. We ceased writing this business in 2007. Our GLB reinsurance product meets the definition of a derivative for accounting purposes and is therefore carried at fair value. We believe that the most meaningful presentation of these derivatives is to reflect cash inflows or revenue as net premiums earned, and to record estimates of the average modeled value of future cash outflows as incurred losses. Accordingly, we recognize benefit reserves consistent with the accounting guidance related to accounting and reporting by insurance enterprises for certain non-traditional long-duration contracts and for separate accounts. Changes in the benefit reserves are reflected as Policy benefits expense, which is included in life underwriting income. The incremental difference between fair value and benefit reserves is reflected in Accounts payable, accrued expenses, and other liabilities in the consolidated balance sheet and related changes in fair value are reflected in Net realized gains (losses) in the consolidated statement of operations. We intend to hold these derivative contracts to maturity (i.e., the expiration of the underlying liabilities through lapse, annuitization, death, or expiration of the reinsurance contract). At maturity, the cumulative gains and losses will net to zero (excluding cumulative hedge gains or losses) because, over time, the insurance liability will be increased or decreased to equal our obligation. For a sensitivity discussion of the effect of changes in interest rates, equity indices, and other assumptions on the fair value of GLBs, and the resulting impact on our net income, refer to Item 3.
The fair value of GLB reinsurance is estimated using an internal valuation model, which includes current market information and estimates of policyholder behavior from the perspective of a theoretical market participant that would assume these liabilities. All of our treaties contain claim limits, which are factored into the valuation model. The fair value depends on a number of factors, including interest rates, current account value, market volatility, expected annuitization rates and other policyholder behavior, and changes in policyholder mortality. The model and related assumptions are continuously re-evaluated by management and enhanced, as appropriate, based upon additional experience obtained related to policyholder behavior and availability of more timely market information, such as market conditions and demographics of in-force annuities. Due to the inherent uncertainties of the assumptions used in the valuation models to determine the fair value of these derivative products, actual experience may differ from the estimates reflected in our Consolidated Financial Statements, and the differences may be material.
The most significant policyholder behavior assumptions include lapse rates and the guaranteed minimum income benefit (GMIB) annuitization rates. Assumptions regarding lapse rates and GMIB annuitization rates differ by treaty but the underlying methodologies to determine rates applied to each treaty are comparable. The assumptions regarding lapse and GMIB annuitization rates determined for each treaty are based on a dynamic calculation that uses several underlying factors.
A lapse rate is the percentage of in-force policies surrendered in a given calendar year. All else equal, as lapse rates increase, ultimate claim payments will decrease. Key factors affecting the lapse rate assumption include investment performance and policy duration. In general, the base lapse function assumes low lapse rates (ranging from about 1 percent to 6 percent per annum) during the surrender charge period of the variable annuity contract, followed by a “spike” lapse rate (ranging from about 10 percent to 30 percent per annum) in the year immediately following the surrender charge period, and then reverting to an ultimate lapse rate (generally around 10 percent per annum), typically over a 2 -year period. This base rate is adjusted downward for policies with more valuable (more “in the money”) guarantees by multiplying the base lapse rate by a factor ranging from 15 percent to 75 percent. Additional lapses due to partial withdrawals and older policyholders with tax-qualified contracts (due to required minimum distributions) are also included.
The GMIB annuitization rate is the percentage of policies for which the policyholder will elect to annuitize using the guaranteed benefit provided under the GMIB. All else equal, as GMIB annuitization rates increase, ultimate claim payments will increase, subject to treaty claim limits. Key factors affecting the GMIB annuitization rate include investment performance and the level of interest rates after the GMIB waiting period, since these factors

85

determine the value of the guarantee to the policyholder. In general, we assume that GMIB annuitization rates will be higher for policies with more valuable (more “in the money”) guarantees. In addition, we also assume that GMIB annuitization rates are higher in the first year immediately following the waiting period (the first year the policies are eligible to annuitize utilizing the GMIB) in comparison to all subsequent years. We do not yet have a robust set of annuitization experience because most of our clients’ policyholders are not yet eligible to annuitize utilizing the GMIB. However, for certain clients representing approximately 36 percent of the total GMIB guaranteed value there are several years of annuitization experience – for those clients the annuitization function reflects the actual experience and has a maximum annuitization rate per annum of 8 percent (a higher maximum applies in the first year a policy is eligible to annuitize utilizing the GMIB – it is over 13 percent). For most clients there is not a credible amount of observable relevant behavior data and so we use a weighted average (with a heavier weighting on the observed experience noted previously) of three different annuitization functions with maximum annuitization rates per annum of 8 percent, 12 percent, and 30 percent, respectively (with significantly higher rates in the first year a policy is eligible to annuitize utilizing the GMIB). As noted elsewhere, our GMIB reinsurance treaties include claim limits to protect us in the event that actual annuitization behavior is significantly higher than expected.
During the three and nine months ended September 30, 2012 , no material changes were made to actuarial or behavioral assumptions. We made minor technical refinements to the model with a favorable net income impact of approximately $21 million for the three and nine months ended September 30, 2012.
During the three and nine months ended September 30, 2012 , realized gains of $75 million and $ 41 million, respectively, were associated with a decreased value of GLB liabilities primarily due to rising equity levels partially offset by the unfavorable impact of interest rate movements and the impact of discounting future claims for one and three fewer quarters, respectively. This excludes realized losses of $ 147 million and $ 308 million during the three and nine months ended September 30, 2012 , respectively, on derivative hedge instruments held to partially offset the risk in the VA guarantee reinsurance portfolio. These derivatives do not receive hedge accounting treatment. Refer to the “Net Realized and Unrealized Gains (Losses)” section for a breakdown of the realized gains (losses) on GLB reinsurance and derivatives for the three and nine months ended September 30, 2012 and 2011 .
ACE Tempest Life Re employs a strategy to manage the financial market and policyholder behavior risks embedded in the reinsurance of VA guarantees. Risk management begins with underwriting a prospective client and guarantee design, with particular focus on protecting our position from policyholder options that, because of anti-selective behavior, could adversely impact our obligation.
A second layer of risk management is the structure of the reinsurance contracts. All VA guarantee reinsurance contracts include some form of annual or aggregate claim limit(s). The different categories of claim limits are described below:
•
Reinsurance programs covering guaranteed minimum death benefits (GMDB) with an annual claim limit of two percent of account value. This category accounts for approximately 65 percent of the total reinsured GMDB guaranteed value. Approximately one percent of the guaranteed value in this category has additional reinsurance coverage for GLB.
•
Reinsurance programs covering GMDB with claim limit(s) that are a function of the underlying guaranteed value. This category accounts for approximately 20 percent of the total reinsured GMDB guaranteed value. The annual claim limit expressed as a percentage of guaranteed value ranges from 0.4 percent to 2 percent. Approximately 70 percent of guaranteed value in this category is also subject to annual claim deductibles that range from 0.1 percent to 0.2 percent of guaranteed value (i.e., our reinsurance coverage would only pay total annual claims in excess of 0.1 percent to 0.2 percent of the total guaranteed value). Approximately 50 percent of guaranteed value in this category is also subject to an aggregate claim limit which was approximately $ 380 million as of September 30, 2012 . Approximately 75 percent of guaranteed value in this category has additional reinsurance coverage for GLB.

86

•
Reinsurance programs covering GMDB and guaranteed minimum accumulation benefits (GMAB). This category accounts for approximately 20 percent of the total reinsured GLB guaranteed value and 15 percent of the total reinsured GMDB guaranteed value. These reinsurance programs are quota-share agreements with the quota-share decreasing as the ratio of account value to guaranteed value decreases. The quota-share is 100 percent for ratios between 100 percent and 75 percent, 60 percent for additional losses on ratios between 75 percent and 45 percent, and 30 percent for further losses on ratios below 45 percent. Approximately 35 percent of guaranteed value in this category is also subject to a claim deductible of 8.8 percent of guaranteed value (i.e., our reinsurance coverage would only pay when the ratio of account value to guaranteed value is below 91.2 percent).
•
Reinsurance programs covering GMIB with an annual claim limit. This category accounts for approximately 50 percent of the total reinsured GLB guaranteed value. The annual claim limit is 10 percent of guaranteed value on over 95 percent of the guaranteed value in this category. Additionally, reinsurance programs in this category have an annual annuitization limit that ranges between 17.5 percent and 30 percent with approximately 40 percent of guaranteed value subject to an annuitization limit of 20 percent or under, and the remaining 60 percent subject to an annuitization limit of 30 percent. Approximately 40 percent of guaranteed value in this category is also subject to minimum annuity conversion factors that limit the exposure to low interest rates. Approximately 40 percent of guaranteed value in this category has additional reinsurance coverage for GMDB.
•
Reinsurance programs covering GMIB with aggregate claim limit. This category accounts for approximately 30 percent of the total reinsured GLB guaranteed value. The aggregate claim limit for reinsurance programs in this category is approximately $ 1.9 billion. Additionally, reinsurance programs in this category have an annual annuitization limit of 20 percent and approximately 55 percent of guaranteed value in this category is also subject to minimum annuity conversion factors that limit the exposure to low interest rates. Approximately 45 percent of guaranteed value in this category has additional reinsurance coverage for GMDB.
A third layer of risk management is the hedging strategy which is focused on mitigating long-term economic losses at a portfolio level. ACE Tempest Life Re owned financial market instruments as part of the hedging strategy with a fair value of $38 million at September 30, 2012 and December 31, 2011 . The instruments are substantially collateralized by our counterparties, on a daily basis.
We also limit the aggregate amount of variable annuity reinsurance guarantee risk we are willing to assume. The last substantive U.S. transaction was quoted in mid-2007 and the last transaction in Japan was quoted in late 2007. The aggregate number of policyholders is currently decreasing through policyholder withdrawals, annuitizations, and deaths at a rate of 5 percent - 10 percent annually.
Note that GLB claims cannot occur for any reinsured policy until it has reached the end of its “waiting period”. The vast majority of policies we reinsure reach the end of their “waiting periods” in 2013 or later, as shown in the table below.

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Year of first payment eligibility
Percent of living benefit
account values
September 30, 2012 and prior
4%
Remainder of 2012
4%
2013
23%
2014
18%
2015
5%
2016
5%
2017
19%
2018
16%
2019 and after
6%
Total
100%
The following table provides the historical cash flows under these policies for the periods indicated. The amounts represent accrued past premium received and claims paid, split by benefit type.
Three Months Ended
Nine Months Ended
September 30
September 30
2012
2011
2012
2011
(in millions of U.S. dollars)
Death Benefits (GMDB)
Premium
$
20

$
24

$
63

$
75

Less paid claims
26

31

78

80

Net
$
(6
)
$
(7
)
$
(15
)
$
(5
)
Living Benefits (Includes GMIB and GMAB)
Premium
$
40

$
41

$
120

$
123

Less paid claims
4

1

6

3

Net
$
36

$
40

$
114

$
120

Total VA Guaranteed Benefits
Premium
$
60

$
65

$
183

$
198

Less paid claims
30

32

84

83

Net
$
30

$
33

$
99

$
115

Death Benefits (GMDB)
For premiums and claims from VA contracts reinsuring GMDBs, at current market levels, we expect approximately $ 114 million of claims and $ 76 million of premium on death benefits over the next 12 months.
GLB (includes GMIB and GMAB)
Our GLBs predominantly include premiums and claims from VA contracts reinsuring GMIB and GMAB. Substantially all of our living benefit reinsurance clients’ policyholders are currently ineligible to trigger a claim payment. The vast majority of these policyholders become eligible in years 2013 and beyond. At current market levels, we expect approximately $22 million of claims and $153 million of premium on living benefits over the next 12 months.
Collateral

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In order for its U.S.-domiciled clients to obtain statutory reserve credit, ACE Tempest Life Re holds collateral on behalf of its clients in the form of qualified assets in trust or letters of credit, in an amount sufficient for them to obtain statutory reserve credit. The timing of the calculation and amount of the collateral varies by client according to the particulars of the reinsurance treaty and the statutory reserve guidelines of the client’s state of domicile.
Catastrophe management
We actively monitor our catastrophe risk accumulation around the world. The following modeled loss information reflects our in-force portfolio and reinsurance program at July 1, 2012.
The table below shows our modeled annual aggregate pre-tax probable maximum loss (PML), net of reinsurance, for 100-year and 250-year return periods for U.S. hurricanes and California earthquakes at September 30, 2012 and 2011 . The table also shows ACE’s corresponding share of pre-tax industry losses for each of the return periods for U.S. hurricanes and California earthquakes at September 30, 2012 . For example, according to the model, for the 1-in-100 return period scenario, there is a one percent chance that our losses incurred in any year from U.S. hurricanes could be in excess of $1.7 billion (or six percent of our total shareholders’ equity at September 30, 2012 ). We estimate that at such hypothetical loss levels, ACE’s share of aggregate industry losses would be approximately one percent.
U.S. Hurricanes
California Earthquakes
September 30
September 30
September 30
September 30
2012
2011
2012
2011
Modeled Annual Aggregate Net PML
ACE
% of Total
Shareholders’
Equity
% of
Industry
ACE
ACE
% of Total
Shareholders’
Equity
% of
Industry
ACE
(in millions of U.S. dollars, except for percentages)
1-in-100
$1,743
6%
1.0%
$1,295
$820
3%
2.1%
$804
1-in-250
$2,325
9%
1.0%
$1,739
$1,094
4%
1.8%
$954
The modeling estimates of both ACE and industry loss levels are inherently uncertain owing to key assumptions. First, while the use of third-party catastrophe modeling packages to simulate potential hurricane and earthquake losses is prevalent within the insurance industry, the models are reliant upon significant meteorology, seismology, and engineering assumptions to estimate hurricane and earthquake losses. In particular, modeled hurricane and earthquake events are not always a representation of actual events and ensuing additional loss potential. Second, there is no universal standard in the preparation of insured data for use in the models and the running of the modeling software. Third, we are reliant upon third-party estimates of industry insured exposures and there is significant variation possible around the relationship between our loss and that of the industry following an event. Fourth, we assume that our reinsurance recoveries following an event are fully collectible. These loss estimates do not represent our potential maximum exposures and it is highly likely that our actual incurred losses would vary materially from the modeled estimates.
The above hurricane PMLs at September 30, 2012 reflect the findings from an in-depth review of hurricane risk during 2011 , including assessment of the latest third-party hurricane models, implementation of the revised models through a multi-model framework for risk assessment, and custom model output adjustments to better reflect ACE’s underlying exposure profile. The September 2011 hurricane PMLs were based on the previous view of modeled risk.
Natural catastrophe property reinsurance program
ACE’s core property catastrophe reinsurance program provides protection against natural catastrophes impacting its primary property operations (i.e., excluding our Global Reinsurance and Life segments) and consists of two separate towers.

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We regularly review our reinsurance protection and corresponding property catastrophe exposures. This may or may not lead to the purchase of additional reinsurance prior to a program’s renewal date. In addition, prior to each renewal date, we consider how much, if any, coverage we intend to buy and we may make material changes to the current structure in light of various factors, including modeled PML assessment at various return periods, reinsurance pricing, our risk tolerance and exposures, and various other structuring considerations.
There were no significant changes to ACE’s coverage under its North American Core Program during the third quarter. The North American Calabash program expired June 15, 2012 without renewal. With respect to our International Property Catastrophe Program, we renewed the layers of reinsurance protection in excess of $150 million on our Core Program for the period from July 1, 2012 through June 30, 2013 with no significant change in coverage from the expiring program. Refer to our 2011 Form 10-K for additional information.

Crop insurance
ACE is one of the leading writers of crop insurance in the U.S. Our crop insurance business primarily comprises two components – Multiple Peril Crop Insurance (MPCI) and hail insurance. The MPCI program is offered in conjunction with the U.S. Department of Agriculture (USDA), which sets the terms and conditions of the program under the annual Standard Reinsurance Agreement (SRA). Given the crops covered in the program, we typically see a substantial written and earned premium impact in the second and third quarters.
MPCI represents about 85 percent of our Agriculture net premiums written; however, this percentage may change as a result of, among other things, growth in our other non-MPCI agriculture lines and changes in commodity prices.
We purchase third party stop-loss reinsurance for our MPCI business to reduce our exposure. The attachment point for this stop-loss reinsurance is based upon the ACE underwriting loss after the impact of the SRA risk sharing between ACE and the Federal Crop Insurance Corporation.
For the three months ended September 30, 2012, the net adverse impact included in the MPCI business underwriting results due to the drought in the U.S. was $147 million pre-tax and $97 million after-tax. No net profit or loss is expected on this business in the fourth quarter related to the 2012 crop year. The combined ratio for the MPCI business was 114 percent for the quarter and is expected to be approximately 104 percent for the full year.
In June 2012, the USDA’s Risk Management Agency (RMA) released the 2013 SRA for the 2013 reinsurance year (i.e., July 1, 2012 through June 30, 2013) that replaced the 2012 SRA. There were no significant changes in the terms and conditions. Refer to our 2011 Form 10-K for additional information.
Liquidity
We anticipate that positive cash flows from operations (underwriting activities and investment income) should be sufficient to cover cash outflows under most loss scenarios through the next 12 months. In addition to cash from operations, we have agreements with a third party bank provider which implemented two international multi-currency notional cash pooling programs to enhance cash management efficiency during periods of short-term timing mismatches between expected inflows and outflows of cash by currency. The programs allow us to optimize investment income by avoiding portfolio disruption. Should the need arise, we generally have access to capital markets and available credit facilities. At September 30, 2012 , our available credit lines totaled $2.4 billion and usage to support issued letters of credit was $1.6 billion. Our access to funds under existing credit facilities is dependent on the ability of the banks that are parties to the facilities to meet their funding commitments. Our existing credit facilities have remaining terms expiring between 2012 and 2015 and require that we maintain certain financial covenants, all of which we met at September 30, 2012 . Should any of our existing credit providers experience financial difficulty, we may be required to replace credit sources, possibly in a difficult market. There has also been recent consolidation in the banking industry which could lead to increased reliance on and exposure to particular institutions. If we cannot obtain adequate capital or sources of credit on favorable

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terms, on a timely basis or at all, our business, operating results, and financial condition could be adversely affected. To date, we have not experienced difficulty accessing any of our credit facilities . Refer to “Credit Facilities” in our 2011 Form 10-K.
The payments of dividends or other statutorily permissible distributions from our operating companies are subject to the laws and regulations applicable to each jurisdiction, as well as the need to maintain capital levels adequate to support the insurance and reinsurance operations, including financial strength ratings issued by independent rating agencies. During the nine months ended September 30, 2012 , we were able to meet all of our obligations, including the payments of dividends on our Common Shares, with our net cash flows.
We assess which subsidiaries to draw dividends from based on a number of factors. Considerations such as regulatory and legal restrictions as well as the subsidiary’s financial condition are paramount to the dividend decision. The legal restrictions on the payment of dividends from retained earnings by our Bermuda subsidiaries are currently satisfied by the share capital and additional paid-in capital of each of the Bermuda subsidiaries. ACE Limited received no dividends from its Bermuda subsidiaries during the nine months ended September 30, 2012 . ACE Limited received dividends of $500 million from its Bermuda subsidiaries during the nine months ended September 30, 2011 .
The payment of any dividends from ACE Global Markets or its subsidiaries is subject to applicable U.K. insurance laws and regulations. In addition, the release of funds by Syndicate 2488 to subsidiaries of ACE Global Markets is subject to regulations promulgated by the Society of Lloyd’s. The U.S. insurance subsidiaries of ACE INA may pay dividends, without prior regulatory approval, subject to restrictions set out in state law of the subsidiary’s domicile (or, if applicable, commercial domicile). ACE INA’s international subsidiaries are also subject to insurance laws and regulations particular to the countries in which the subsidiaries operate. These laws and regulations sometimes include restrictions that limit the amount of dividends payable without prior approval of regulatory insurance authorities. ACE Limited received no dividends from ACE Global Markets during the nine months ended September 30, 2012 and received dividends of $180 million during the nine months ended September 30, 2011 . ACE Limited received no dividends from ACE INA during both the nine months ended September 30, 2012 and 2011 . Debt issued by ACE INA is serviced by statutorily permissible distributions by ACE INA’s insurance subsidiaries to ACE INA as well as other group resources.
Cash Flows
Sources of liquidity include cash from operations, routine sales of investments, and financing arrangements. The following is a discussion of our cash flows for the nine months ended September 30, 2012 and 2011 .
Our consolidated net cash flows from operating activities were $3.0 billion in both the nine months ended September 30, 2012 and 2011 . Net loss and loss expenses paid were $6.0 billion in the nine months ended September 30, 2012 , compared with $6.2 billion.
Our consolidated net cash flows used for investing activities were $2.7 billion in the nine months ended September 30, 2012 , compared with $2.5 billion. Net investing activities for the indicated periods were related primarily to net purchases of fixed maturities.
Our consolidated net cash flows used for financing activities were $271 million in the nine months ended September 30, 2012 , compared with $478 million. Financing cash flows included $151 million of proceeds from issuance of short-term debt, net of repayments, compared with a net repayment of $50 million. Dividends paid on Common Shares were $484 million in the nine months ended September 30, 2012 , compared with $342 million.
Both internal and external forces influence our financial condition, results of operations, and cash flows. Claim settlements, premium levels, and investment returns may be impacted by changing rates of inflation and other economic conditions. In many cases, significant periods of time, ranging up to several years or more, may lapse between the occurrence of an insured loss, the reporting of the loss to us, and the settlement of the liability for that loss.

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In the current low interest rate environment, we utilize reverse repurchase agreements as a low-cost alternative for short-term funding needs and to address short-term cash timing differences without disrupting our investment portfolio holdings. We subsequently settle these transactions with future operating cash flows. At September 30, 2012 , there were $1.4 billion in reverse repurchase agreements outstanding.
Capital Resources
Capital resources consist of funds deployed or available to be deployed to support our business operations. The following table summarizes the components of our capital resources:
September 30
December 31
2012
2011
(in millions of U.S. dollars,
except for percentages)
Short-term debt
$
1,402

$
1,251

Long-term debt
3,360

3,360

Total debt
4,762

4,611

Trust preferred securities
309

309

Total shareholders’ equity
26,963

24,332

Total capitalization
$
32,034

$
29,252

Ratio of debt to total capitalization
14.9
%
15.8
%
Ratio of debt plus trust preferred securities to total capitalization
15.8
%
16.8
%
The following table reports the significant movements in our shareholders’ equity:
September 30, 2012
(in millions of
U.S. dollars)
Balance at December 31, 2011
$
24,332

Net income
1,941

Change in net unrealized appreciation on investments, net of tax
988

Dividends on Common Shares
(536
)
Change in net cumulative translation, net of tax
118

Share-based compensation expense
91

Exercise of stock options
77

Repurchase of shares
(7
)
Other movements, net of tax
(41
)
Balance at September 30, 2012
$
26,963


During January 2012, we repurchased $7 million of Common Shares in a series of open market transactions under the August 2011 and November 2010 Board of Directors authorizations. At September 30, 2012 , $461 million in share repurchase authorizations remained through December 31, 2012. At September 30, 2012 there were 3,097,303 Common Shares in treasury with a weighted average cost of $60.23 per share.
We generally maintain the ability to issue certain classes of debt and equity securities via an unlimited Securities and Exchange Commission (SEC) shelf registration which is renewed every three years. This allows us capital market access for refinancing as well as for unforeseen or opportunistic capital needs. Our current shelf registration on file with the SEC expires in December 2014.

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Dividends
We have paid dividends each quarter since we became a public company in 1993. Under Swiss law, dividends must be stated in Swiss francs though dividend payments are made by ACE in U.S. dollars. Following ACE’s redomestication to Switzerland in July 2008 through March 2011, dividends were distributed by way of a par value reduction. At the May 2011 annual general meeting, our shareholders approved dividend distributions from capital contribution reserves (Additional paid-in capital) through the transfer of dividends from Additional paid-in capital to Retained earnings. At the May 2012 annual general meeting, our shareholders approved an annual dividend distribution for the following year by way of a par value reduction equal to $1.96 per share, or CHF 1.80 per share, calculated using the USD/CHF exchange rate as published in the Wall Street Journal on May 10, 2012.
The annual dividend is payable in four quarterly installments, with each installment equaling $0.49 per share, provided that the Swiss franc equivalent of that amount per share (based on the then-current USD/CHF exchange rate), taken together with the Swiss franc equivalents of all other installments of this annual dividend, will not exceed 150 percent of CHF 1.80 (the aggregate distribution cap). If the Swiss franc equivalent of an upcoming dividend installment would cause the aggregate distribution cap to be exceeded, then that dividend installment will be reduced to equal the Swiss franc amount remaining available under the aggregate distribution cap, and the U.S. dollar amount distributed for that installment will be the then-applicable U.S. dollar equivalent of the remaining Swiss franc amount.
The following table represents dividends paid per Common Share to shareholders of record on each of the following dates:
Shareholders of record as of:
Dividends paid as of:
January 10, 2012
January 31, 2012
$0.47 (CHF 0.44)
March 30, 2012
April 20, 2012
$0.47 (CHF 0.42)
July 31, 2012
August 21, 2012
$0.49 (CHF 0.48)
September 28, 2012
October 19, 2012
$0.49 (CHF 0.45)
Recent accounting pronouncements
Refer to Note 1 to the consolidated financial statements for a discussion of new accounting pronouncements.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Refer to Item 7A included in our 2011 Form 10-K.
Reinsurance of GMDB and GLB guarantees
Our net income is directly impacted by changes in the benefit reserves calculated in connection with the reinsurance of variable annuity guarantees, primarily GMDB and GLB. The benefit reserves are calculated in accordance with the guidance related to accounting and reporting by insurance enterprises for certain non-traditional long-duration contracts and for separate accounts. Changes in the benefit reserves are reflected as policy benefits expense, which is included in life underwriting income. In addition, our net income is directly impacted by the change in the fair value of the GLB liability (FVL), which is classified as a derivative for accounting purposes. The FVL established for a GLB reinsurance contract represents the difference between the fair value of the contract and the benefit reserves. Changes in the FVL, net of associated changes in the calculated benefit reserves, are reflected as realized gains or losses.
ACE views its variable annuity reinsurance business as having a similar risk profile to that of catastrophe reinsurance with the probability of long-term economic loss relatively small, at the time of pricing. Adverse changes in market factors and policyholder behavior will have an impact on both life underwriting income and net income. When evaluating these risks, we expect to be compensated for taking both the risk of a cumulative long-

93

term economic net loss, as well as the short-term accounting variations caused by these market movements. Therefore, we evaluate this business in terms of its long-term economic risk and reward.
At September 30, 2012 , management established benefit reserves based on the benefit ratio calculated using assumptions reflecting management’s best estimate of the future performance of the variable annuity line of business. Management exercises judgment in determining the extent to which short-term market movements impact the benefit reserves. The benefit reserves are based on the calculation of a long-term benefit ratio (or loss ratio) for the variable annuity guarantee reinsurance. Despite the long-term nature of the risk, the benefit ratio calculation is impacted by short-term market movements that may be judged by management to be temporary or transient. Management’s best estimate reflected a judgment that the equity markets will exhibit above average growth over the next several years. Management regularly examines both quantitative and qualitative analysis and for the quarter ended September 30, 2012 , determined that no change to the benefit ratio was warranted. The benefit ratio used to establish the benefit reserves at September 30, 2012 , has averaged less than 1/4 standard deviation from the calculated benefit ratios, averaging the periodic results from a 2 -year rolling period ending September 30, 2012 .
The guidance requires us to “regularly evaluate estimates used and adjust the liability balance... if actual experience or other evidence suggests that earlier assumptions should be revised.” ACE evaluates its estimates regularly and management uses judgment to determine the extent to which the assumptions underlying the benefit ratio calculation used to establish benefit reserves should be adjusted. The benefit ratio will be calculated based on management’s expectation for the short-term and long-term performance of the variable annuity guarantee liability. Management’s quantitative analysis includes a review of the differential between the benefit ratio used at the most recent valuation date and the benefit ratio calculated on subsequent dates. The differential is measured in terms of the standard deviation of the distribution of benefit ratios (reflecting 1,000 stochastic scenarios) calculated on subsequent dates.
The benefit reserves and FVL calculations are directly affected by market factors, including equity levels, interest rate levels, credit risk, and implied volatilities, as well as policyholder behaviors, such as annuitization and lapse rates. The tables below assume no changes to the benefit ratio used to establish the benefit reserves at September 30, 2012 and show the sensitivity, at September 30, 2012 , of the FVL associated with the variable annuity guarantee reinsurance portfolio. In addition, the tables below show the sensitivity of the fair value of specific derivative instruments held (hedge value) to partially offset the risk in the variable annuity guarantee reinsurance portfolio. The tables below are estimates of the sensitivities to instantaneous changes in economic inputs or actuarial assumptions.
The tables below do not reflect the expected quarterly run rate of net income generated by the variable annuity guarantee reinsurance portfolio if markets remain unchanged during the period. All else equal, if markets remain unchanged during the period, the Gross FVL will increase, resulting in a realized loss. The realized loss occurs primarily because, during the period, we will collect premium while paying little or no claims on our GLB reinsurance (since most policies are not eligible to annuitize until 2013 or later). This increases the Gross FVL because future premiums are lower by the amount collected in the quarter, and also because future claims are discounted for a shorter period. We refer to this increase in Gross FVL as “timing effect”. The unfavorable impact of timing effect on our Gross FVL in a quarter is not reflected in the sensitivity tables below. For this reason, when using the tables below to estimate the sensitivity of Gross FVL in the fourth quarter to various changes, it is necessary to assume an additional $30 million to $60 million increase in Gross FVL and realized losses. However, the majority of this realized loss is offset by the positive quarterly run rate of life underwriting income generated by the variable annuity guarantee reinsurance portfolio if markets remain unchanged during the period, with little or no impact to Net income. Note that both the timing effect and the quarterly run rate of life underwriting income change over time as the book ages.


94

Worldwide Equity Shock
Interest Rate Shock
+10%
Flat
-10%
-20%
-30%
-40%
(in millions of U.S. dollars)
+100 bps
(Increase)/decrease in Gross FVL
$
610

$
351

$
28

$
(356
)
$
(795
)
$
(1,288
)
Increase/(decrease) in hedge value
(244
)
(4
)
240

486

734

987

Increase/(decrease) in net income
$
366

$
347

$
268

$
130

$
(61
)
$
(301
)
Flat
(Increase)/decrease in Gross FVL
$
326

$
—

$
(390
)
$
(836
)
$
(1,332
)
$
(1,868
)
Increase/(decrease) in hedge value
(242
)
—

244

490

740

993

Increase/(decrease) in net income
$
84

$
—

$
(146
)
$
(346
)
$
(592
)
$
(875
)
-100 bps
(Increase)/decrease in Gross FVL
$
(128
)
$
(523
)
$
(975
)
$
(1,480
)
$
(2,019
)
$
(2,580
)
Increase/(decrease) in hedge value
(238
)
4

248

496

746

1,000

Increase/(decrease) in net income
$
(366
)
$
(519
)
$
(727
)
$
(984
)
$
(1,273
)
$
(1,580
)
AA-rated
Interest Rate
Equity
Sensitivities to Other Economic Variables
Credit Spreads
Volatility
Volatility
+100
-100
+2%
-2%
+2%
-2%
(in millions of U.S. dollars)
(Increase)/decrease in Gross FVL
$
155

$
(157
)
$
(4
)
$
—

$
(22
)
$
20

Increase/(decrease) in hedge value
—

—

—

—

3

(3
)
Increase/(decrease) in net income
$
155

$
(157
)
$
(4
)
$
—

$
(19
)
$
17

Sensitivities to Actuarial Assumptions
Mortality
+20%
+10%
-10%
-20%
(in millions of U.S. dollars)
(Increase)/decrease in Gross FVL
$
37

$
19

$
(19
)
$
(38
)
Increase/(decrease) in hedge value
—

—

—

—

Increase/(decrease) in net income
$
37

$
19

$
(19
)
$
(38
)
Lapses
+50%
+25%
-25%
-50%
(in millions of U.S. dollars)
(Increase)/decrease in Gross FVL
$
399

$
217

$
(259
)
$
(571
)
Increase/(decrease) in hedge value
—

—

—

—

Increase/(decrease) in net income
$
399

$
217

$
(259
)
$
(571
)
Annuitization
+50%
+25%
-25%
-50%
(in millions of U.S. dollars)
(Increase)/decrease in Gross FVL
$
(345
)
$
(198
)
$
248

$
549

Increase/(decrease) in hedge value
—

—

—

—

Increase/(decrease) in net income
$
(345
)
$
(198
)
$
248

$
549

The above tables assume equity shocks impact all global equity markets equally and that the interest rate shock is a parallel shift in the U.S. yield curve. Our liabilities are sensitive to global equity markets in the following proportions: 70 percent— 80 percent U.S. equity, 10 percent— 20 percent international equity ex-Japan, 5 percent

95

— 15 percent Japan equity. Our current hedge portfolio is sensitive to global equity markets in the following proportions: 100 percent U.S. equity. We would suggest using the S&P 500 index as a proxy for U.S. equity, the MSCI EAFE index as a proxy for international equity, and the TOPIX as a proxy for Japan equity.
Our liabilities are also sensitive to global interest rates at various points on the yield curve, mainly the U.S. Treasury curve in the following proportions: 5 percent— 15 percent short-term rates (maturing in less than 5 years), 20 percent— 30 percent medium-term rates (maturing between 5 years and 10 years, inclusive), and 60 percent— 70 percent long-term rates (maturing beyond 10 years). A change in AA-rated credit spreads (AA-rated credit spreads are a proxy for both our own credit spreads and the credit spreads of the ceding insurers) impacts the rate used to discount cash flows in the fair value model. The hedge sensitivity is from September 30, 2012 market levels.
The above sensitivities are not directly additive because changes in one factor will affect the sensitivity to changes in other factors. Also, the sensitivities do not scale linearly and may be proportionally greater for larger movements in the market factors. Sensitivities may also vary due to foreign exchange rate fluctuations. The calculation of the FVL is based on internal models that include assumptions regarding future policyholder behavior, including lapse, annuitization, and asset allocation. These assumptions impact both the absolute level of the FVL as well as the sensitivities to changes in market factors shown above. Additionally, actual sensitivity of our net income may differ from those disclosed in the tables above due to differences between short-term market movements and management judgment regarding the long-term assumptions implicit in our benefit ratios. Furthermore, the sensitivities above could vary by multiples of the sensitivities in the tables above.
Variable Annuity Net Amount at Risk
a) Reinsurance covering the GMDB risk only
The table below shows the net amount at risk at September 30, 2012 following an immediate change in equity market levels, assuming all global equity markets are impacted equally.
Equity Shock
+20%
Flat
-20%
-40%
-60%
-80%
(in million of U.S. dollars, except percentages)
GMDB net amount at risk
$
1,259

$
1,363

$
1,945

$
2,293

$
2,216

$
1,888

Claims at 100% immediate mortality
717

486

325

307

284

255

At September 30, 2012 and December 31, 2011 the net amount at risk from reinsurance programs covering the GMDB risk only was $1.4 billion and $1.8 billion, respectively.
For reinsurance programs covering the GMDB risk only, the net amount at risk is defined as the present value of future claim payments under the following assumptions:
•
policy account values and guaranteed values are fixed at the valuation date ( September 30, 2012 and December 31, 2011 , respectively);
•
there are no lapses or withdrawals;
•
mortality according to 100 percent of the Annuity 2000 mortality table;
•
future claims are discounted in line with the discounting assumption used in the calculation of the benefit reserve averaging between 1.0 percent and 2.0 percent; and
•
reinsurance coverage ends at the earlier of the maturity of the underlying variable annuity policy or the reinsurance treaty.
The total claim amount payable on reinsurance programs covering the GMDB risk only, if all the cedants’ policyholders were to die immediately at September 30, 2012 was approximately $486 million. This takes into account all applicable reinsurance treaty claim limits.

96

In addition, the table shows the total claim amount payable on reinsurance programs covering the GMDB risk only, if all of the cedants’ policyholders were to die immediately at September 30, 2012 . This takes into account all applicable reinsurance treaty claim limits.
The treaty claim limits function as a ceiling on the net amount at risk as equity markets fall. In addition, the claims payable if all of the policyholders were to die immediately declines as equity markets fall due to the specific nature of these claim limits, many of which are annual claim limits calculated as a percentage of the reinsured account value. There is also some impact due to a small portion of the GMDB reinsurance under which claims are positively correlated to equity markets (claims decrease as equity markets fall).
b) Reinsurance covering the GLB risk only
The table below shows the net amount at risk at September 30, 2012 following an immediate change in equity market levels, assuming all global equity markets are impacted equally.
Equity Shock
+20%
Flat
-20%
-40%
-60%
-80%
(in million of U.S. dollars, except percentages)
GLB net amount at risk
$
129

$
382

$
1,013

$
1,836

$
2,461

$
2,615

At September 30, 2012 and December 31, 2011 , the net amount at risk from reinsurance programs covering the GLB risk only was $382 million and $380 million, respectively.
For reinsurance programs covering the GLB risk only, the net amount at risk is defined as the present value of future claim payments under the following assumptions:
•
policy account values and guaranteed values are fixed at the valuation date ( September 30, 2012 and December 31, 2011 , respectively);
•
there are no deaths, lapses, or withdrawals;
•
policyholders annuitize at a frequency most disadvantageous to ACE (in other words, annuitization at a level that maximizes claims taking into account the treaty limits) under the terms of the reinsurance contracts;
•
for annuitizing policyholders, the GMIB claim is calculated using interest rates in line with those used in calculating the reserve;
•
future claims are discounted in line with the discounting assumption used in the calculation of the benefit reserve averaging between 3.5 percent and 4.5 percent; and
•
reinsurance coverage ends at the earlier of the maturity of the underlying variable annuity policy or the reinsurance treaty.
The treaty claim limits cause the net amount at risk to increase at a declining rate as equity markets fall.
c) Reinsurance covering both the GMDB and GLB risks on the same underlying policyholders
The table below shows the net amount at risk at September 30, 2012 following an immediate change in equity market levels, assuming all global equity markets are impacted equally.

97

Equity Shock
+20%
Flat
-20%
-40%
-60%
-80%
(in million of U.S. dollars, except percentages)
GMDB net amount at risk
$
89

$
137

$
187

$
234

$
280

$
329

GLB net amount at risk
419

825

1,393

2,022

2,537

2,840

Claims at 100% immediate mortality
502

885

1,136

1,343

1,534

1,730

At September 30, 2012 and December 31, 2011 , the GMDB net amount at risk from reinsurance programs covering both the GMDB and GLB risks on the same underlying policyholders was $137 million and $182 million, respectively.
At September 30, 2012 and December 31, 2011 , the GLB net amount at risk from reinsurance programs covering both the GMDB and GLB risks on the same underlying policyholders was $825 million and $998 million, respectively.
These net amounts at risk reflect the interaction between the two types of benefits on any single policyholder (eliminating double-counting), and therefore the net amounts at risk should be considered additive.
In addition, the table shows the total claim amount payable on reinsurance programs covering both the GMDB and GLB risks on the same underlying policyholders, if all of the cedants’ policyholders were to die immediately at September 30, 2012 . This takes into account all applicable reinsurance treaty claim limits. Although this calculation shows an increase in death claims resulting from 100 percent immediate mortality of all policyholders, the GLB claims would be zero in this scenario.
For reinsurance programs covering both the GMDB and GLB risks on the same underlying policyholders, the net amount at risk is defined as the present value of future claim payments under the following assumptions:
•
policy account values and guaranteed values are fixed at the valuation date ( September 30, 2012 and December 31, 2011 , respectively);
•
there are no lapses, or withdrawals;
•
mortality according to 100 percent of the Annuity 2000 mortality table;
•
policyholders annuitize at a frequency most disadvantageous to ACE (in other words, annuitization at a level that maximizes claims taking into account the treaty limits) under the terms of the reinsurance contracts;
•
for annuitizing policyholders, the GMIB claim is calculated using interest rates in line with those used in calculating the reserve;
•
future claims are discounted in line with the discounting assumption used in the calculation of the benefit reserve averaging between 1.0 percent and 2.0 percent; and
•
reinsurance coverage ends at the earlier of the maturity of the underlying variable annuity policy or the reinsurance treaty.
The treaty limits control the increase in the GMDB net amount at risk as equity markets fall. The GMDB net amount at risk continues to grow as equity markets fall because most of these reinsurance treaties do not have annual claim limits calculated as a percentage of the underlying account value.
The treaty limits cause the GLB net amount at risk to increase at a declining rate as equity markets fall.
Item 4. Controls and Procedures
ACE’s management, with the participation of ACE’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of ACE’s disclosure controls and procedures as defined in Rule 13a-15(e) and Rule

98

15d-15(e) under the Securities Exchange Act of 1934 as of September 30, 2012 . Based upon that evaluation, ACE’s Chief Executive Officer and Chief Financial Officer concluded that ACE’s disclosure controls and procedures are effective in allowing information required to be disclosed in reports filed under the Securities and Exchange Act of 1934 to be recorded, processed, summarized, and reported within time periods specified in the rules and forms of the SEC, and that such information is accumulated and communicated to ACE’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
There has been no change in ACE’s internal controls over financial reporting during the three months ended September 30, 2012 that has materially affected, or is reasonably likely to materially affect, ACE’s internal controls over financial reporting.


99

ACE LIMITED
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
The information required with respect to this item is included in Note 6 d) to the consolidated financial statements which is hereby incorporated herein by reference.
Item 1A. Risk Factors
Refer to “Risk Factors” under Item 1A of Part I of our 2011 Form 10-K. There have been no material changes to the risk factors disclosed in Part I, Item 1A of our 2011 Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds and Issuer Repurchases of Equity Securities
The following table provides information with respect to purchases by ACE of its Common Shares during the three months ended September 30, 2012 :
Issuer’s Repurchases of Equity Securities
Period
Total
Number of
Shares
Purchased (1)
Average Price Paid per Share
Approximate Dollar
Value of Shares that
May Yet be
Purchased Under the
Board Repurchase
Authorization (2)
July 1 through July 31
2,268


$73.50

$461 million
August 1 through August 31
3,484


$73.13

$461 million
September 1 through September 30
6,696


$73.87

$461 million
Total
12,448

____________________
(1)
This column includes activity related to the surrender to ACE of Common Shares to satisfy tax withholding obligations in connection with the vesting of restricted stock issued to employees and the exercising of options by employees.
(2)
Refer to Note 7 to the Consolidated Financial Statements for more information on the ACE Limited securities repurchase authorization. The $ 461 million of remaining authorizations expire December  31, 2012.
Item 6. Exhibits
Refer to the Exhibit Index.

100

ACE LIMITED
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
(Registrant)
October 31, 2012
/s/ Evan G. Greenberg
Evan G. Greenberg
Chairman, President and Chief
Executive Officer
October 31, 2012
/s/ Philip V. Bancroft
Philip V. Bancroft
Chief Financial Officer


101

Incorporated by Reference
Exhibit
Number
Exhibit Description
Form
Original
Number
Date Filed
Filed
Herewith
3.1
Organizational Regulations of the Company, as amended and restated
8-K
3

August 15, 2012
3.2
Articles of Association of the Company, as amended and restated
8-K
3

September 28, 2012
4.1
Organizational Regulations of the Company, as amended and restated
8-K
4

August 15, 2012
4.2
Articles of Association of the Company, as amended and restated
8-K
4

September 28, 2012
31.1
Certification Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002
X
31.2
Certification Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002
X
32.1
Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002
X
32.2
Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002
X
101.1
The following financial information from ACE Limited’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012 formatted in XBRL: (i) Consolidated Balance Sheets at September 30, 2012, and December 31, 2011; (ii) Consolidated Statements of Operations and Comprehensive Income for the three months and nine months ended September 30, 2012 and 2011; (iii) Consolidated Statements of Shareholders’ Equity for the nine months ended September 30, 2012 and 2011; (iv) Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and 2011; and (v) Notes to Consolidated Financial Statements
X




















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TABLE OF CONTENTS