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, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
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Commission file number 1-8661
THE CHUBB CORPORATION
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(Exact name of registrant as specified in its charter)
NEW JERSEY 13-2595722
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(State or other jurisdiction of (I. R. S. Employer
incorporation or organization) Identification No.)
15 MOUNTAIN VIEW ROAD, WARREN, NEW JERSEY 07061-1615
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (908) 903-2000
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 is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
YES [X] NO [ ]
The number of shares of common stock outstanding as of October 31, 2003
was 187,778,139.
THE CHUBB CORPORATION
INDEX
Page Number
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Part I. Financial Information:
Item 1 - Financial Statements:
Consolidated Statements of Income for the
Three Months and Nine Months Ended
September 30, 2003 and 2002.................................. 1
Consolidated Balance Sheets as of
September 30, 2003 and December 31, 2002..................... 2
Consolidated Statements of Comprehensive Income
for the Three Months and Nine Months Ended
September 30, 2003 and 2002.................................. 3
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2003 and 2002................ 4
Notes to Consolidated Financial Statements.................... 5
Item 2 - Management's Discussion and Analysis
of Financial Condition and Results of Operations.............. 11
Item 4 - Controls and Procedures................................ 34
Part II. Other Information:
Item 1 - Legal Proceedings...................................... 35
Item 6 - Exhibits and Reports on Form 8-K....................... 36
Signatures........................................................ 36
Page 1
Part I. Financial Information
Item 1 - Financial Statements
THE CHUBB CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
PERIODS ENDED SEPTEMBER 30
Third Quarter Nine Months
--------------- --------------
2003 2002 2003 2002
---- ---- ---- ----
(in millions)
Revenues
Premiums Earned ......... $ 2,608.2 $ 2,085.5 $ 7,466.6 $ 5,868.8
Investment Income ....... 287.9 252.9 816.6 745.2
Real Estate and
Other Revenues ........ (9.4) (17.9) 32.7 3.6
Realized Investment Gains 60.5 43.9 85.7 75.5
---------- ---------- ---------- ----------
Total Revenues ... 2,947.2 2,364.4 8,401.6 6,693.1
---------- ---------- ---------- ----------
Claims and Expenses
Insurance Claims and
Claim Expenses ........ 1,711.3 2,052.0 4,850.0 4,513.0
Amortization of
Deferred Policy
Acquisition Costs ..... 653.3 524.8 1,863.7 1,502.6
Other Insurance Operating
Costs and Expenses ..... 173.9 158.4 533.5 434.8
Real Estate and
Other Expenses ......... 30.4 25.9 67.3 65.7
Investment Expenses ...... 5.0 8.4 21.4 19.3
Corporate Expenses ....... 35.6 27.5 116.9 83.8
---------- ---------- ---------- ----------
Total Claims and
Expenses ........ 2,609.5 2,797.0 7,452.8 6,619.2
---------- ---------- ---------- ----------
Income (Loss) Before Federal
and Foreign Income Tax ... 337.7 (432.6) 948.8 73.9
Federal and Foreign
Income Tax (Credit)....... 77.9 (190.5) 212.3 (92.4)
---------- ---------- ---------- ----------
Net Income (Loss) .......... $ 259.8 $ (242.1) $ 736.5 $ 166.3
========== ========== ========== ==========
Net Income (Loss) Per Share
Basic ..................... $ 1.39 $ (1.42) $ 4.17 $ .97
Diluted ................... 1.37 (1.42) 4.13 .96
Dividends Declared Per Share .36 .35 1.08 1.05
See Notes to Consolidated Financial Statements.
Page 2
THE CHUBB CORPORATION
CONSOLIDATED BALANCE SHEETS
Sept. 30, Dec. 31,
2003 2002
--------- ---------
(in millions)
Assets
Invested Assets
Short Term Investments ................................. $ 2,689.4 $ 1,756.7
Fixed Maturities
Held-to-Maturity - Tax Exempt (market $570.0
and $850.7) ......................................... 529.3 794.9
Available-for-Sale
Tax Exempt (cost $9,977.8 and $8,449.2) ............. 10,611.4 9,082.9
Taxable (cost $10,062.0 and $8,112.5) ............... 10,393.3 8,385.7
Equity Securities (cost $1,407.6 and $998.3) ........... 1,482.7 992.2
--------- ---------
TOTAL INVESTED ASSETS ........................... 25,706.1 21,012.4
Cash ..................................................... 45.1 41.9
Securities Lending Collateral ............................ 1,314.1 1,354.8
Accrued Investment Income ................................ 280.3 246.9
Premiums Receivable ...................................... 2,097.0 2,040.6
Reinsurance Recoverable on Unpaid Claims
and Claim Expenses ...................................... 3,443.6 4,071.5
Prepaid Reinsurance Premiums ............................. 461.8 479.3
Deferred Policy Acquisition Costs ........................ 1,299.3 1,150.0
Real Estate Assets ....................................... 586.0 602.9
Investment in Partially Owned Company .................... 298.9 266.7
Deferred Income Tax ...................................... 476.1 612.5
Goodwill ................................................. 467.4 467.4
Other Assets ............................................. 1,615.2 1,767.5
--------- ---------
TOTAL ASSETS .................................... $38,090.9 $34,114.4
========= =========
Liabilities
Unpaid Claims and Claim Expenses ......................... $17,226.3 $16,713.1
Unearned Premiums ........................................ 5,760.7 5,049.9
Securities Lending Payable ............................... 1,314.1 1,354.8
Long Term Debt ........................................... 2,814.1 1,959.1
Dividend Payable to Shareholders ......................... 67.5 59.9
Accrued Expenses and Other Liabilities ................... 2,430.6 2,118.4
--------- ---------
TOTAL LIABILITIES ............................... 29,613.3 27,255.2
--------- ---------
Shareholders' Equity
Common Stock - $1 Par Value; 196,076,468 and
180,296,834 Shares ...................................... 196.1 180.3
Paid-In Surplus .......................................... 1,321.4 445.4
Retained Earnings ........................................ 6,897.8 6,352.5
Accumulated Other Comprehensive Income
Unrealized Appreciation of Investments, Net of Tax ...... 676.0 585.5
Foreign Currency Translation Losses, Net of Tax ......... (18.9) (56.5)
Receivable from Employee Stock Ownership Plan ............ (26.2) (34.1)
Treasury Stock, at Cost - 8,423,744 and
9,095,162 Shares ........................................ (568.6) (613.9)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY ...................... 8,477.6 6,859.2
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ...... $38,090.9 $34,114.4
========= =========
See Notes to Consolidated Financial Statements.
Page 3
THE CHUBB CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
PERIODS ENDED SEPTEMBER 30
Third Quarter Nine Months
-------------- -------------
2003 2002 2003 2002
---- ---- ---- ----
(in millions)
Net Income (Loss) .................. $ 259.8 $ (242.1) $ 736.5 $ 166.3
---------- ---------- ---------- ----------
Other Comprehensive Income (Loss)
Change in Unrealized Appreciation
of Investments, Net of Tax ...... (150.4) 212.6 90.5 332.3
Foreign Currency Translation Gains
(Losses), Net of Tax ............ (8.8) 3.8 37.6 5.1
---------- ---------- ---------- ----------
(159.2) 216.4 128.1 337.4
---------- ---------- ---------- ----------
Comprehensive Income (Loss) ........ $ 100.6 $ (25.7) $ 864.6 $ 503.7
========== ========== ========== ==========
See Notes to Consolidated Financial Statements.
Page 4
THE CHUBB CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30
2003 2002
---- ----
(in millions)
Cash Flows from Operating Activities
Net Income ............................................... $ 736.5 $ 166.3
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities
Increase in Unpaid Claims and Claim Expenses, Net ...... 1,141.1 1,234.1
Increase in Unearned Premiums, Net ..................... 670.9 751.4
Increase in Premiums Receivable ........................ (56.4) (275.4)
Increase in Deferred Policy Acquisition Costs .......... (133.7) (181.3)
Change in Deferred Income Tax .......................... 69.9 (107.0)
Depreciation ........................................... 77.8 76.7
Realized Investment Gains .............................. (85.7) (75.5)
Other, Net ............................................. 68.9 (2.4)
--------- ---------
Net Cash Provided by Operating Activities ................ 2,489.3 1,586.9
--------- ---------
Cash Flows from Investing Activities
Proceeds from Sales of Fixed Maturities .................. 4,415.4 3,585.8
Proceeds from Maturities of Fixed Maturities ............. 1,730.5 1,390.4
Proceeds from Sales of Equity Securities ................. 367.6 321.8
Purchases of Fixed Maturities ............................ (9,196.1) (5,970.2)
Purchases of Equity Securities ........................... (732.2) (302.9)
Increase in Short Term Investments, Net .................. (932.7) (500.5)
Increase in Net Payable from Security
Transactions Not Settled ................................ 81.6 252.5
Purchases of Property and Equipment, Net ................. (55.7) (98.0)
Other, Net ............................................... .6 (2.8)
--------- ---------
Net Cash Used in Investing Activities .................... (4,321.0) (1,323.9)
--------- ---------
Cash Flows from Financing Activities
Decrease in Short Term Debt, Net ......................... - (199.0)
Proceeds from Issuance of Long Term Debt ................. 960.0 -
Repayment of Long Term Debt .............................. (100.3) (7.8)
Increase in Funds Held Under Deposit Contracts ........... 261.7 118.2
Proceeds from Common Stock Offering ...................... 886.8 -
Proceeds from Issuance of Common Stock Under
Incentive and Purchase Plans ............................ 25.2 102.3
Repurchase of Shares ..................................... - (99.4)
Dividends Paid to Shareholders ........................... (183.6) (177.8)
Other, Net ............................................... (14.9) 7.2
--------- ---------
Net Cash Provided by (Used in) Financing Activities ...... 1,834.9 (256.3)
--------- ---------
Net Increase in Cash ....................................... 3.2 6.7
Cash at Beginning of Year .................................. 41.9 25.8
--------- ---------
Cash at End of Period .................................... $ 45.1 $ 32.5
========= =========
See Notes to Consolidated Financial Statements.
Page 5
THE CHUBB CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1) General
The amounts included in this report are unaudited but include
those adjustments, consisting of normal recurring items, which
management considers necessary for a fair presentation. These
consolidated financial statements should be read in conjunction with
the consolidated financial statements and related notes in the Notes to
Consolidated Financial Statements included in the Corporation's 2002
Annual Report on Form 10-K.
2) Adoption of New Accounting Pronouncement
Effective January 1, 2003, the Corporation adopted the fair
value method of accounting for stock-based employee compensation plans,
which is the method of accounting defined in Statement of Financial
Accounting Standards (SFAS) No. 123, Accounting for Stock-Based
Compensation. Under the fair value method of accounting, compensation
cost is measured based on the fair value of the award at the grant date
and recognized over the service period. The Corporation has elected to
use the modified prospective method of transition, as permitted by SFAS
No. 148, Accounting for Stock-Based Compensation - Transition and
Disclosure. Under this method, stock-based employee compensation cost
is recognized from the beginning of 2003 as if the fair value method of
accounting had been used to account for all employee awards granted,
modified, or settled in years beginning after December 15, 1994. Prior
period financial statements were not restated. The adoption of the fair
value method of accounting for stock-based employee compensation plans
increased compensation cost by $51.1 million for the nine months ended
September 30, 2003, which resulted in a reduction in net income of
$35.7 million or $0.20 per basic and diluted share.
The following information illustrates the effect on net income
and earnings per share as if the Corporation had accounted for
stock-based employee compensation using the fair value method.
Periods Ended September 30
-----------------------------------
Third Quarter Nine Months
-------------- ---------------
2003 2002 2003 2002
---- ---- ---- ----
(in millions,
except per share amounts)
Net income (loss), as reported ......... $ 259.8 $(242.1) $ 736.5 $ 166.3
Add: stock-based employee
compensation expense included in
reported net income, net of tax ....... 15.1 3.0 45.7 11.9
Deduct: stock-based employee
compensation expense determined
using the fair value method,
net of tax ............................ (15.1) (17.4) (45.7) (51.9)
------- ------- ------- -------
Pro forma net income (loss) ............ $ 259.8 $(256.5) $ 736.5 $ 126.3
======= ======= ======= =======
Earnings per share
Basic, as reported ................... $ 1.39 $ (1.42) $ 4.17 $ .97
Basic, pro forma ..................... 1.39 (1.50) 4.17 .74
Diluted, as reported ................. 1.37 (1.42) 4.13 .96
Diluted, pro forma ................... 1.37 (1.50) 4.13 .73
Page 6
3) Adoption of New Accounting Pronouncement
In January 2003, the Financial Accounting Standards Board
(FASB) issued FASB Interpretation No. 46 (FIN 46), Consolidation of
Variable Interest Entities, an interpretation of Accounting Research
Bulletin No. 51, which requires an enterprise to assess its interests
in a variable interest entity to determine whether to consolidate that
entity. A variable interest entity is an entity in which the equity
investment at risk is not sufficient to permit the entity to finance
its activities without additional subordinated financial support from
other parties or the equity investors do not have the characteristics
of a controlling financial interest. FIN 46 requires that a variable
interest entity be consolidated by its primary beneficiary, which is
the party that will absorb a majority of the entity's expected losses
if they occur, receive a majority of the entity's expected residual
returns if they occur, or both.
The provisions of FIN 46 were effective immediately for
variable interest entities created after January 31, 2003 and for
variable interest entities in which the Corporation obtains an interest
after that date. The Corporation has not acquired an interest in any
variable interest entities subsequent to January 31, 2003.
For any variable interest entities in which the Corporation
holds a variable interest that it acquired prior to February 1, 2003,
the provisions of FIN 46, as amended by FASB Staff Position No. FIN
46-6, are effective for the quarter ending December 31, 2003. For any
such variable interest entity for which the Corporation determines that
it is the primary beneficiary, the Corporation should initially measure
the assets, liabilities and noncontrolling interests of the entity at
their carrying amounts. Any difference between the net amount added to
the Corporation's balance sheet and the amount of any previously
recognized interest in the newly consolidated entity should be
recognized as the cumulative effect of an accounting change.
The Corporation's real estate subsidiary has a collateralized
mortgage note receivable from a real estate partnership in which it
does not have an equity interest. The carrying value of the receivable
was $74.6 million at September 30, 2003. The partnership is a variable
interest entity. The Corporation's real estate subsidiary has certain
lease obligations related to the property held by the partnership. As a
result of its variable interests, the Corporation's real estate
subsidiary is the primary beneficiary of the partnership. Accordingly,
consolidation of the real estate partnership will be required under FIN
46.
No other interests in variable interest entities have been
identified that would require consolidation or disclosure.
The adoption of FIN 46 is not expected to have a significant
effect on the Corporation's financial position or results of
operations.
Page 7
4) Investments
Short term investments, which have an original maturity of one
year or less, are carried at amortized cost which approximates market
value. Fixed maturities classified as held-to-maturity are carried at
amortized cost. Fixed maturities classified as available-for-sale and
equity securities are carried at market value as of the balance sheet
date.
The net change in unrealized appreciation or depreciation of
investments carried at market value was as follows:
Periods Ended September 30
-----------------------------------------
Third Quarter Nine Months
-------------- -------------
2003 2002 2003 2002
---- ---- ---- ----
(in millions)
Change in unrealized appreciation or
depreciation of equity securities ..... $ 8.1 $ (15.2) $ 81.2 $ 11.1
Change in unrealized appreciation of
fixed maturities ...................... (239.5) 342.3 58.0 500.1
--------- --------- --------- ---------
(231.4) 327.1 139.2 511.2
Deferred income tax (credit) ........... (81.0) 114.5 48.7 178.9
--------- --------- --------- ---------
Change in unrealized appreciation
of investments, net ................... $ (150.4) $ 212.6 $ 90.5 $ 332.3
========= ========= ========= =========
5) Debt
In March 2003, the Corporation issued $225 million of
unsecured 3.95% notes due April 1, 2008 and $275 million of unsecured
5.2% notes due April 1, 2013, the aggregate net proceeds from which
were $495 million.
In June 2003, the Corporation issued $460 million of unsecured
2 1/4% senior notes due August 16, 2008 and 18.4 million purchase
contracts to purchase the Corporation's common stock. The notes and
purchase contracts were issued together in the form of 7% equity units.
The net proceeds from the issuance of the equity units were $446
million.
Each equity unit initially represents one purchase contract
and $25 principal amount of senior notes. The notes are pledged by the
holders to secure their obligations under the purchase contracts. The
Corporation will make quarterly interest payments to the holders of the
notes initially at a rate of 2 1/4% per year. In May 2006, the notes
will be remarketed. At that time, the remarketing agent will have the
ability to reset the interest rate on the notes in order to generate
sufficient remarketing proceeds to satisfy the holder's obligation
under the purchase contract. If the senior notes are not successfully
remarketed, the Corporation will exercise its rights as a secured party
to obtain and extinguish the notes and deliver its common stock to the
holders pursuant to the purchase contracts. The purchase contracts are
further described in Note (8).
Page 8
6) Earnings Per Share
The following table sets forth the computation of basic and
diluted earnings per share:
Periods Ended September 30
-----------------------------------
Third Quarter Nine Months
--------------- ---------------
2003 2002 2003 2002
---- ---- ---- ----
(in millions,
except per share amounts)
Basic earnings per share:
Net income (loss) ................... $ 259.8 $(242.1) $ 736.5 $ 166.3
======= ======= ======= =======
Weighted average number of common
shares outstanding .................. 186.6 170.6 176.5 170.5
======= ======= ======= =======
Basic earnings (loss) per share ........ $ 1.39 $ (1.42) $ 4.17 $ .97
======= ======= ======= =======
Diluted earnings per share:
Net income (loss) ................... $ 259.8 $(242.1) $ 736.5 $ 166.3
======= ======= ======= =======
Weighted average number of common
shares outstanding .................. 186.6 170.6 176.5 170.5
Additional shares from assumed
exercise of stock-based
compensation awards ................. 2.8 - 1.9 2.8
------- ------- ------- -------
Weighted average number of common
shares and potential common shares
assumed outstanding for computing
diluted earnings per share .......... 189.4 170.6 178.4 173.3
======= ======= ======= =======
Diluted earnings (loss) per share ...... $ 1.37 $ (1.42) $ 4.13 $ .96
======= ======= ======= =======
7) Segments Information
The property and casualty operations include three reportable
underwriting segments and the investment function. The underwriting
segments are personal insurance, commercial insurance and specialty
insurance. The personal segment targets the personal insurance market.
The personal classes include automobile, homeowners and other personal
coverages. The commercial segment includes those classes of business
that are generally available in broad markets and are of a more
commodity nature. Commercial classes include multiple peril, casualty,
workers' compensation and property and marine. The specialty segment
includes those classes of business that are available in more limited
markets since they require specialized underwriting and claim
settlement. Specialty classes include executive protection, financial
institutions and other specialty coverages. Performance of the
underwriting segments is based on underwriting results before deferred
policy acquisition costs and certain charges. Investment income
performance is based on investment income net of investment expenses,
excluding realized investment gains.
Chubb Financial Solutions' (CFS) non-insurance business was
primarily structured credit derivatives, principally as a counterparty
in portfolio credit default swap contracts. In the second quarter of
2003, the Corporation implemented a plan to exit the credit derivatives
business and is running off the financial products portfolio of CFS.
Corporate and other includes investment income earned on
corporate invested assets, corporate expenses and the Corporation's
real estate and other non-insurance subsidiaries.
Page 9
Revenues and income before income tax of the operating
segments were as follows:
Periods Ended September 30
-------------------------------------
Third Quarter Nine Months
------------------ ------------------
2003 2002 2003 2002
-------- -------- -------- --------
(in millions)
Revenues
Property and casualty insurance
Premiums earned
Personal insurance............... $ 620.1 $ 546.1 $1,804.0 $1,566.9
Commercial insurance............. 985.4 776.3 2,786.2 2,116.6
Specialty insurance.............. 1,002.7 763.1 2,876.4 2,185.3
-------- -------- -------- --------
2,608.2 2,085.5 7,466.6 5,868.8
Investment income.................. 274.1 241.3 794.2 709.1
-------- -------- -------- --------
Total property and casualty
insurance....................... 2,882.3 2,326.8 8,260.8 6,577.9
Chubb Financial Solutions
non-insurance business.............. (35.2) (34.5) (17.3) (41.3)
Corporate and other.................. 39.6 28.2 72.4 81.0
Realized investment gains............ 60.5 43.9 85.7 75.5
-------- -------- -------- --------
Total revenues................... $2,947.2 $2,364.4 $8,401.6 $6,693.1
======== ======== ======== ========
Income (loss) before income tax
Property and casualty insurance
Underwriting
Personal insurance............... $ (21.2) $ (19.6) $ (28.6) $ (25.6)
Commercial insurance............. 81.6 (610.7) 201.5 (652.3)
Specialty insurance.............. (46.2) (64.8) (64.6) (68.2)
-------- -------- -------- --------
14.2 (695.1) 108.3 (746.1)
Increase in deferred policy
acquisition costs............... 56.4 48.9 133.7 181.3
-------- -------- -------- --------
Underwriting income (loss)....... 70.6 (646.2) 242.0 (564.8)
Investment income.................. 269.6 233.3 776.7 691.3
Other charges...................... (.9) (3.5) (22.6) (16.8)
-------- -------- -------- --------
Total property and casualty
insurance....................... 339.3 (416.4) 996.1 109.7
Chubb Financial Solutions
non-insurance business.............. (38.8) (40.4) (30.6) (55.9)
Corporate and other.................. (23.3) (19.7) (102.4) (55.4)
Realized investment gains............ 60.5 43.9 85.7 75.5
-------- -------- -------- --------
Total income (loss) before
income tax...................... $ 337.7 $ (432.6) $ 948.8 $ 73.9
======== ======== ======== ========
Property and casualty commercial insurance underwriting
results in the third quarter of 2002 included net losses of $625.0
million related to asbestos and toxic waste claims.
Page 10
8) Shareholders' Equity
In June 2003, the Corporation sold 15,525,000 shares of common
stock. Net proceeds from the sale were $887 million.
In June 2003, the Corporation issued 18.4 million purchase
contracts to purchase the Corporation's common stock and $460 million
of 2 1/4% senior notes. The purchase contracts and notes were issued
together in the form of 7% equity units. For further discussion of the
notes and purchase contracts, see Note (5).
Each purchase contract obligates the holder to purchase, and
obligates the Corporation to sell, on or before August 16, 2006, for a
settlement price of $25, a variable number of newly issued shares of
the Corporation's common stock. The number of shares of the
Corporation's common stock to be purchased will be determined based on
a formula that considers the market price of the Corporation's common
stock immediately prior to the time of settlement in relation to the
$59.50 per share sale price of the common stock at the time the equity
units were offered. Upon settlement of the purchase contracts, the
Corporation will receive proceeds of approximately $460 million and
will issue between approximately 6.5 million and 7.7 million shares of
common stock.
The Corporation will make quarterly contract adjustment
payments to the equity unit holders at a rate of 4 3/4% per year on the
stated amount of $25 per purchase contract until the purchase contract
is settled. The $66.2 million present value of the contract adjustment
payments was accrued as a liability at the date of issuance of the
equity units with an offsetting charge to paid-in surplus. The
liability is included in other liabilities. Subsequent contract
adjustment payments will be allocated between this liability account
and interest expense based on a constant rate calculation over the term
of the purchase contracts. Paid-in surplus also reflected a charge of
$11.9 million, representing the portion of the equity unit issuance
costs that was allocated to the purchase contracts.
Page 11
Item 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations for the Nine Months Ended September 30, 2003 and
2002 and for the Quarters Ended September 30, 2003 and 2002
Certain statements in this document are "forward-looking statements" as
that term is defined in the Private Securities Litigation Reform Act of 1995
(PSLRA). These forward-looking statements are made pursuant to the safe harbor
provisions of the PSLRA and include estimates and assumptions related to
economic, competitive, regulatory, judicial, legislative and other developments.
These include statements relating to trends in, or representing management's
beliefs about, our future strategies, operations and financial results, as well
as other statements that include words such as "anticipate," "believe,"
"estimate," "expect," "intend," "may," "plan," "should," "will," or other
similar expressions. Forward-looking statements are made based upon management's
current expectations and beliefs concerning trends and future developments and
their potential effects on us. These statements are not guarantees of future
performance. Actual results may differ materially from those suggested by
forward-looking statements as a result of risks and uncertainties, which
include, among others, those discussed or identified from time to time in our
public filings with the Securities and Exchange Commission and those associated
with:
- the availability of primary and reinsurance coverage, including the
implications relating to terrorism legislation and regulation;
- global political conditions and the occurrence of terrorist attacks,
including any nuclear, biological or chemical events;
- the effects of the outbreak or escalation of war or hostilities;
- premium price increases and profitability or growth estimates overall
or by lines of business or geographic area, and related expectations
with respect to the timing and terms of any required regulatory
approvals;
- adverse changes in loss cost trends;
- our ability to retain existing business;
- material differences between actual and expected assessments for
guaranty funds and mandatory pooling arrangements;
- our expectations with respect to cash flow projections and investment
income and with respect to other income;
- the adequacy of loss reserves, including:
- our expectations relating to reinsurance recoverables;
- the effects of proposed asbestos liability legislation,
including the impact of claims patterns arising from the
possibility of legislation and those that may arise if
legislation is not passed;
- our estimates relating to ultimate asbestos liabilities and
related reinsurance recoverables;
- the impact from the bankruptcy protection sought by various
asbestos producers and other related businesses;
- the willingness of parties, including us, to settle disputes;
- developments in judicial decisions or regulatory or
legislative actions relating to coverage and liability for
asbestos, toxic waste and mold claims;
Page 12
- the impact of the current economic climate on companies on whose behalf
we have issued surety bonds, and in particular, on those companies that
have filed for bankruptcy or otherwise experienced deterioration in
creditworthiness;
- the effects of disclosures by, and investigations of, public companies
relating to possible accounting irregularities, practices in the energy
and securities industries and other corporate governance issues,
including:
- the effects on the energy markets and the companies that
participate in them, and in particular as they may relate to
concentrations of risk in our surety business;
- the effects on the capital markets and the markets for
directors and officers and errors and omissions insurance;
- claims and litigation arising out of actual or alleged
accounting or other corporate malfeasance by other companies;
- claims and litigation arising out of investment banking
practices;
- legislative or regulatory proposals or changes, including the
changes in law and regulation implemented under the
Sarbanes-Oxley Act of 2002;
- the occurrence of significant weather-related or other natural or
human-made disasters;
- any downgrade in our claims-paying, financial strength or other credit
ratings;
- the ability of our subsidiaries to pay us dividends;
- general economic conditions including:
- changes in interest rates, market credit spreads and the
performance of the financial markets, generally and as they
relate to credit risks assumed by our Chubb Financial
Solutions unit in particular;
- the effects of inflation;
- changes in domestic and foreign laws, regulations and taxes;
- changes in competition and pricing environments;
- regional or general changes in asset valuations;
- the inability to reinsure certain risks economically;
- changes in the litigation environment;
- general market conditions; and
- our ability to implement management's strategic plans and initiatives.
Our forward-looking statements speak only as of the date made, and we undertake
no obligation to update these forward-looking statements.
Page 13
CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS
The consolidated financial statements include amounts based on informed
estimates and judgments of management for those transactions that are not yet
complete or for which the ultimate effects are uncertain. Such estimates and
judgments affect the reported amounts in the financial statements. Those
estimates and judgments that were most critical to the preparation of the
financial statements involved the adequacy of loss reserves and the
recoverability of related reinsurance recoverables, the fair value of credit
derivative obligations, the recoverability of the carrying value of real estate
properties and the realization of deferred income tax benefits. These estimates
and judgments are discussed within the following analysis of our results of
operations. If different estimates and judgments had been applied, materially
different amounts might have been reported in the financial statements.
SUMMARY OF FINANCIAL RESULTS
Net income was $736.5 million in the first nine months of 2003 and
$259.8 million in the third quarter compared with net income of $166.3 million
in the first nine months of 2002 and a net loss of $242.1 million in the third
quarter of 2002.
Results in the first nine months of 2003 included realized investment
gains of $85.7 million, or $55.7 million after tax, compared with realized
investment gains of $75.5 million, or $49.1 million after tax, in the first nine
months of 2002. Results in the third quarter of 2003 included realized
investment gains of $60.5 million, or $39.3 million after tax, compared with
realized investment gains of $43.9 million, or $28.6 million after tax, in the
third quarter of 2002. Decisions to sell securities are governed principally by
considerations of investment opportunities and tax consequences. As a result,
realized gains and losses on the sale of investments may vary significantly from
period to period.
Results in 2002 were adversely affected by the recognition of net
losses of $625 million, or $406 million after tax, in the third quarter related
to asbestos and toxic waste claims.
Effective January 1, 2003, the Corporation adopted the fair value
method of accounting for stock-based employee compensation plans, which is the
method of accounting defined in Statement of Financial Accounting Standards No.
123, Accounting for Stock-Based Compensation. Prior period financial statements
were not restated. Under the fair value method of accounting, compensation cost
is measured based on the fair value of an award at the grant date and recognized
over the service period. The adoption of the fair value method of accounting for
stock-based employee compensation plans increased compensation cost by $51.1
million in the first nine months of 2003 and $15.4 million in the third quarter,
which resulted in a reduction in net income of $35.7 million and $10.4 million,
respectively. The adoption of the fair value method of accounting for
stock-based employee compensation plans is discussed further in Note (2) of the
Notes to Consolidated Financial Statements.
Page 14
The following is a summary of the Corporation's results for the third
quarter and nine months ended September 30, 2003 and 2002:
Periods Ended September 30
---------------------------------------------
Third Quarter Nine Months
--------------------- ---------------------
2003 2002 2003 2002
--------- --------- --------- ---------
(in millions)
PROPERTY AND CASUALTY INSURANCE
Underwriting
Net Premiums Written ............... $ 2,845.5 $ 2,315.2 $ 8,137.5 $ 6,620.2
Increase in Unearned Premiums ...... (237.3) (229.7) (670.9) (751.4)
--------- --------- --------- ---------
Premiums Earned ................. 2,608.2 2,085.5 7,466.6 5,868.8
--------- --------- --------- ---------
Claims and Claim Expenses .......... 1,711.3 2,052.0 4,850.0 4,513.0
Operating Costs and Expenses ....... 876.7 719.6 2,490.3 2,075.3
Increase in Deferred Policy
Acquisition Costs ................. (56.4) (48.9) (133.7) (181.3)
Dividends to Policyholders ......... 6.0 9.0 18.0 26.6
--------- --------- --------- ---------
Underwriting Income (Loss) ......... 70.6 (646.2) 242.0 (564.8)
--------- --------- --------- ---------
Investments
Investment Income Before
Expenses .......................... 274.1 241.3 794.2 709.1
Investment Expenses ................ 4.5 8.0 17.5 17.8
--------- --------- --------- ---------
Investment Income .................. 269.6 233.3 776.7 691.3
--------- --------- --------- ---------
Other Charges ....................... (.9) (3.5) (22.6) (16.8)
--------- --------- --------- ---------
Property and Casualty
Income (Loss) ...................... 339.3 (416.4) 996.1 109.7
CHUBB FINANCIAL SOLUTIONS
NON-INSURANCE BUSINESS .............. (38.8) (40.4) (30.6) (55.9)
CORPORATE AND OTHER .................. (23.3) (19.7) (102.4) (55.4)
REALIZED INVESTMENT GAINS ............ 60.5 43.9 85.7 75.5
--------- --------- --------- ---------
CONSOLIDATED INCOME (LOSS)
BEFORE INCOME TAX ................... 337.7 (432.6) 948.8 73.9
Federal and Foreign Income
Tax (Credit) ........................ 77.9 (190.5) 212.3 (92.4)
--------- --------- --------- ---------
CONSOLIDATED NET INCOME (LOSS) ....... $ 259.8 $ (242.1) $ 736.5 $ 166.3
========= ========= ========= =========
PROPERTY AND CASUALTY INVESTMENT
INCOME AFTER INCOME TAX ............. $ 213.9 $ 190.1 $ 619.1 $ 566.5
========= ========= ========= =========
Page 15
PROPERTY AND CASUALTY INSURANCE
Our property and casualty business produced income before taxes of
$996.1 million in the first nine months of 2003 and $339.3 million in the third
quarter compared with income of $109.7 million in the first nine months of 2002
and a loss of $416.4 million in the third quarter of 2002. Results in both
periods of 2002 were adversely affected by the recognition of net losses of $625
million in the third quarter related to asbestos and toxic waste claims (the
$625 million asbestos charge). Our asbestos and toxic waste related exposures
are further discussed under "Loss Reserves." Excluding the $625 million asbestos
charge, property and casualty income before taxes amounted to $734.7 million in
the first nine months of 2002 and $208.6 million in the third quarter. Earnings
were significantly higher in the first nine months and third quarter of 2003
compared with the same periods of 2002, as adjusted to exclude the $625 million
asbestos charge. Underwriting income was significantly higher in 2003 due
primarily to the exceptionally strong results in our commercial classes, which
include multiple peril, casualty, workers' compensation and property and marine.
Investment income also increased in 2003 compared with 2002.
Net premiums written were $8.1 billion in the first nine months of 2003
and $2.8 billion in the third quarter, representing increases of 23% over the
comparable periods of 2002. Premium growth from Chubb Re, our reinsurance
business that began operations in 1999, was particularly strong. Excluding
premiums produced by Chubb Re, premium growth was 18% in the first nine months
of 2003 and 15% in the third quarter.
U.S. premiums grew 22% in the first nine months of 2003 and 23% in the
third quarter. Substantial premium growth was also achieved outside the United
States in 2003. On a reported basis, non-U.S. premiums grew 26% in the first
nine months of 2003 and 22% in the third quarter. In local currencies, non-U.S.
premium growth was 17% in the first nine months and 15% in the third quarter.
Premium growth in the first nine months of 2003 was strong in all
segments of our business due in large part to higher rates. We continue to write
new business and we are retaining more of our accounts upon renewal. We continue
to get rate increases on much of the business we write, with favorable policy
terms and conditions. We expect that rate increases will continue throughout
2003 and into 2004, although the size of rate increases will decelerate.
As a result of the substantial losses incurred by reinsurers in recent
years, the cost of reinsurance in the marketplace has increased significantly
and reinsurance capacity for certain coverages, such as terrorism, is limited
and expensive.
Our reinsurance program in 2003 is similar to that in 2002. We have
discontinued some lower limit treaties that we believed were no longer
economical and have increased our participation in certain layers of the
treaties that we renewed. In addition, for our property catastrophe treaty for
events in the United States, we have increased our coverage at the top due to
our increased exposure in certain catastrophe prone areas. Our reinsurance costs
have increased in 2003 in line with the higher premiums on the policies
reinsured.
We are making a concerted effort to reduce terrorism risk aggregations.
However, our future operating results could be more volatile due to the limited
terrorism coverage in our reinsurance program.
Page 16
The Terrorism Risk Insurance Act of 2002 (the Terrorism Act)
established a program under which the federal government will share the risk of
loss from certain acts of international terrorism with the insurance industry.
The program terminates on December 31, 2005. The Terrorism Act is applicable to
almost all commercial lines of insurance. Insurance companies with direct
commercial insurance exposure in the United States are required to participate
in the program. Each insurer has a separate deductible in the event of an act of
terrorism before federal assistance becomes available. The deductible is based
on a percentage of direct commercial earned premiums from the previous calendar
year. For 2003, that deductible is 7% of direct commercial premiums earned in
2002. For losses above the deductible, the federal government will pay for 90%
of insured losses, while the insurer contributes 10%. For certain classes of
business, such as workers' compensation, terrorism coverage is mandatory. For
those classes of business where it is not mandatory, insureds may choose not to
accept the terrorism coverage, which would reduce our exposure. As expected, in
2003, most of our middle market commercial insureds have opted for terrorism
coverage. While the provisions of the Terrorism Act will serve to mitigate our
exposure in the event of a large-scale terrorist attack, our deductible is
substantial, approximately $350 million in 2003. Therefore, we continue to
monitor concentrations of risk.
The combined loss and expense ratio, expressed as a percentage, is the
key measure of underwriting profitability traditionally used in the property and
casualty business. We evaluate the performance of our insurance businesses using
the combined loss and expense ratio calculated in accordance with statutory
accounting principles applicable to property and casualty insurance companies.
It is the sum of the ratio of losses to premiums earned (loss ratio) plus the
ratio of statutory underwriting expenses to premiums written (expense ratio)
after reducing both premium amounts by dividends to policyholders. When the
combined ratio is under 100%, underwriting results are generally considered
profitable; when the combined ratio is over 100%, underwriting results are
generally considered unprofitable.
Statutory accounting principles differ in certain respects from
generally accepted accounting principles (GAAP). Under statutory accounting
principles, policy acquisition and other underwriting expenses are recognized
immediately, not at the time premiums are earned. To convert underwriting
expenses to a GAAP basis, policy acquisition expenses are deferred and
recognized over the period in which the related premiums are earned.
Underwriting results were profitable in the first nine months and third
quarter of 2003. Underwriting results were highly unprofitable in the first nine
months and third quarter of 2002 due to the $625 million asbestos charge.
Excluding the effect of this charge, underwriting results were profitable in the
first nine months of 2002 and near breakeven in the third quarter. Our combined
loss and expense ratio was 95.8% in the first nine months of 2003 and 96.6% in
the third quarter compared with 108.7% and 130.0%, respectively, in 2002.
Excluding the effect of the $625 million asbestos charge, our combined loss and
expense ratio was 98.0% in the first nine months of 2002 and 99.9% in the third
quarter.
Page 17
The loss ratio was 65.1% for the first nine months of 2003 and 65.7%
for the third quarter compared with 77.2% and 98.8%, respectively, in the prior
year. Adjusted to exclude the $625 million asbestos charge, the loss ratio was
66.5% and 68.7% in the first nine months and third quarter of 2002,
respectively. The loss ratio was lower in the 2003 periods than in the
comparable 2002 periods, as adjusted, despite higher catastrophe losses.
Catastrophe losses during the first nine months of 2003 amounted to $261.5
million which represented 3.5 percentage points of the loss ratio compared with
$75.2 million or 1.3 percentage points in 2002. Catastrophe losses for the third
quarter of 2003 amounted to $96.0 million or 3.7 percentage points of the loss
ratio compared with $51.6 million or 2.5 percentage points in 2002. The
catastrophe losses in 2003 resulted primarily from storms in the United States.
The 2002 catastrophe losses resulted primarily from tornadoes in the midwest
United States and floods in eastern Europe in the third quarter.
Our expense ratio was 30.7% for the first nine months of 2003 and 30.9%
for the third quarter compared with 31.5% and 31.2%, respectively, in 2002. The
decrease in the expense ratio was due primarily to premiums written growing at a
substantially higher rate than overhead expenses, and was achieved despite an
approximate 0.5 of a percentage point adverse impact of expensing stock options
in the 2003 periods.
Page 18
Underwriting results during 2003 and 2002 by class of business were as
follows:
Net Premiums Combined Loss and
Written Expense Ratios
---------------- ------------------
2003 2002 2003 2002
---- ---- ---- ----
(in millions)
Nine Months Ended September 30
PERSONAL INSURANCE
Automobile ...................... $ 443.6 $ 402.1 98.9% 98.5%
Homeowners ...................... 1,114.2 971.1 106.6 105.7
Other ........................... 391.4 364.1 77.8 77.5
--------- --------- ------- -------
Total Personal 1,949.2 1,737.3 98.9 98.0
--------- --------- ------- -------
COMMERCIAL INSURANCE
Multiple Peril .................. 809.4 687.5 90.3 101.5
Casualty ........................ 1,010.0 834.7 88.7 185.8 *
Workers' Compensation ........... 475.9 350.3 92.2 92.6
Property and Marine ............. 766.1 652.7 89.3 86.2
--------- --------- ------- -------
Total Commercial 3,061.4 2,525.2 89.6 124.7 *
--------- --------- ------- -------
SPECIALTY INSURANCE
Executive Protection ............ 1,526.0 1,214.3 104.0 105.8
Financial Institutions .......... 603.4 508.3 111.5 103.3
Other ........................... 997.5 635.1 84.4 88.2
--------- --------- ------- -------
Total Specialty 3,126.9 2,357.7 99.8 100.9
--------- --------- ------- -------
TOTAL $ 8,137.5 $ 6,620.2 95.8% 108.7%*
========= ========= ======= =======
Quarter Ended September 30
PERSONAL INSURANCE
Automobile ...................... $ 154.3 $ 144.0 96.4% 94.5%
Homeowners ...................... 402.9 353.4 108.7 108.8
Other ........................... 132.1 123.3 78.7 78.3
--------- --------- ------- -------
Total Personal 689.3 620.7 99.9 99.0
--------- --------- ------- -------
COMMERCIAL INSURANCE
Multiple Peril .................. 276.6 235.1 92.7 103.0
Casualty ........................ 331.4 275.9 90.8 333.1 *
Workers' Compensation ........... 158.4 116.4 94.1 91.8
Property and Marine ............. 253.6 238.4 86.4 93.6
--------- --------- ------- -------
Total Commercial 1,020.0 865.8 90.6 175.6 *
--------- --------- ------- -------
SPECIALTY INSURANCE
Executive Protection ............ 525.0 442.8 104.2 112.3
Financial Institutions .......... 182.8 168.2 111.4 115.7
Other ........................... 428.4 217.7 87.8 84.2
--------- --------- ------- -------
Total Specialty 1,136.2 828.7 100.6 106.1
--------- --------- ------- -------
TOTAL $ 2,845.5 $ 2,315.2 96.6% 130.0%*
========= ========= ======= =======
* The combined loss and expense ratios for 2002 include the effect of
losses of $625.0 million related to asbestos and toxic waste claims
recognized in the third quarter. For the nine months ended September
30, 2002, excluding the effect of such losses, the combined loss and
expense ratio was 96.5% for Casualty, 94.9% for Total Commercial and
98.0% in total. For the third quarter of 2002, excluding the effect of
such losses, the combined loss and expense ratio was 88.5% for
Casualty, 94.4% for Total Commercial and 99.9% in total.
Page 19
PERSONAL INSURANCE
Premiums from personal insurance coverages, which represent 24% of
total premiums written in the first nine months of 2003, increased by 12% in the
first nine months of 2003 and 11% in the third quarter compared with the
comparable periods in 2002. Premium growth occurred in all classes. The
significant premium growth in our homeowners business was due to higher rates
and increased insurance-to-value; the in-force policy count for this class has
remained flat.
Our personal insurance business produced modestly profitable
underwriting results in the first nine months of 2003 and 2002. Third quarter
results were near breakeven in 2003 compared with modestly profitable results in
2002. Results in the first nine months and third quarter of 2003 were adversely
affected by higher catastrophe losses. The combined loss and expense ratio was
98.9% in the first nine months of 2003 and 99.9% in the third quarter compared
with 98.0% and 99.0%, respectively, in 2002. Excluding catastrophe losses, the
combined ratio was 89.6% in the first nine months of 2003 and 89.2% in the third
quarter compared with 96.0% and 96.8%, respectively, in 2002.
Homeowners results were unprofitable in 2003 and 2002. Higher
catastrophe losses in 2003 were substantially offset by a decrease in
non-catastrophe losses and the impact of improved pricing. Results in 2003
benefited from a decline in fire and water damage losses. Catastrophe losses
represented 16.1 percentage points of the loss ratio for this class in the first
nine months of 2003 and 18.6 percentage points in the third quarter compared
with 3.9 and 4.1 percentage points, respectively, in 2002. Homeowners results
outside the United States were profitable in 2003, particularly in the third
quarter, compared with unprofitable results in 2002. We are in the process of
exiting our personal lines business in Continental Europe, with the exception of
the ultra high net worth market segment.
Our remediation plan relating to our homeowners business in the United
States, which began in the latter part of 2001, is on track. We have made
substantial progress in implementing rate increases in states where rates have
been deficient. While the impact of losses related to water damage, including
mold, has decreased in the first nine months of 2003 compared with the first
nine months of 2002, we remain concerned about the potential for such claims. We
have made regulatory filings in most states to introduce contract changes that
would enable us to treat mold as a separate peril available at an appropriate
price. These changes have been implemented in 36 states, including Texas,
California and Florida, and approved in four other states.
Our automobile business produced similarly profitable results in 2003
and 2002. Other personal coverages, which include insurance for valuable
articles and excess liability, produced highly profitable results in 2003 and
2002 due to continued favorable loss experience.
Page 20
COMMERCIAL INSURANCE
Premiums from commercial insurance, which represent 38% of our total
writings, increased by 21% in the first nine months of 2003 and 18% in the third
quarter compared with the similar periods in 2002. The substantial premium
growth in this business was due to continued price increases and an increase in
our in-force policy count. Growth occurred in all segments of this business but
was particularly strong in the workers' compensation class. We are seeing more
competition in the U.S. marketplace across most lines of business. Despite this,
retention levels in the first nine months of 2003 were slightly higher than
those in the same period of 2002. On the business that was renewed, rate
increases were substantial although the level of rate increases has continued to
decline from 2002 levels. During the first nine months of 2003, we wrote 1.8
dollars of new business for every dollar of business we lost. The substantial
growth in new business was produced with the same tightened underwriting
discipline that has existed over the past several years. We expect that rates
will continue to rise but that the level of rate increases will continue to
decline.
Our commercial insurance business produced highly profitable
underwriting results in the first nine months and third quarter of 2003 compared
with highly unprofitable results in the similar periods of 2002. The 2002
results were adversely affected by the $625 million asbestos charge. Excluding
the effect of this charge, our commercial insurance business produced profitable
results in 2002. The combined loss and expense ratio was 89.6% for the first
nine months of 2003 and 90.6% for the third quarter compared with 124.7% and
175.6%, respectively, in 2002. Adjusted to exclude the effect of the $625
million asbestos charge, the combined loss and expense ratio for the first nine
months and third quarter of 2002 was 94.9% and 94.4%, respectively. Our
commercial insurance results in 2003 were more profitable than the as-adjusted
results in 2002. The improvement in 2003 was due in large part to the cumulative
effect of price increases, better terms and conditions and more stringent risk
selection in recent years. The improvement was most substantial in our
commercial multiple peril and casualty classes of business.
Multiple peril produced highly profitable results in 2003 compared with
modestly unprofitable results in 2002. The improvement was most significant in
the property component of this business as improved non-catastrophe loss
experience more than offset an increase in catastrophe losses. In the liability
component, we experienced significantly fewer large losses compared with 2002.
Catastrophe losses represented 4.7 percentage points of the loss ratio for this
class in the first nine months of 2003 and 5.2 points for the third quarter
compared with 1.2 and 4.7 percentage points, respectively, in 2002.
Our casualty business produced highly profitable results in 2003.
Results in 2002 were highly unprofitable due to the $625 million asbestos
charge. Excluding the effect of this charge, our casualty business produced
profitable results in 2002. The automobile, primary liability and excess
liability components each produced profitable results in 2003 and 2002. Casualty
results in 2003 benefited from an absence of incurred losses related to asbestos
and toxic waste claims. In addition to the $625 million asbestos charge in the
third quarter of 2002 noted above, asbestos and toxic waste losses of $41
million were recognized in the first half of 2002.
Workers' compensation results were highly profitable in the first nine
months of 2003 and 2002 due in large part to our disciplined risk selection
during the past several years.
Page 21
Property and marine results were highly profitable in both 2003 and
2002. Both years benefited from a low number of severe losses. Results in 2003
were adversely affected by one $25 million loss in the second quarter that
resulted from an adverse arbitration decision rendered against an insurance pool
in which we were formerly a 5.5% participant. The decision related to a fire
that occurred in 1995. Results in the third quarter of 2002 were adversely
affected by significantly higher catastrophe losses. Catastrophe losses
represented 6.9 percentage points of the loss ratio for this class in the first
nine months of 2003 and 5.9 percentage points in the third quarter compared with
6.6 percentage points and 14.8 percentage points, respectively, in 2002.
SPECIALTY INSURANCE
Premiums from specialty insurance, which represent 38% of our total
writings, increased by 33% in the first nine months of 2003 and 37% in the third
quarter compared with the similar periods a year ago. The growth in executive
protection and the professional liability component of our financial
institutions business was primarily attributable to higher rates. In response to
claim severity trends, we initiated a program in the latter half of 2001 to
increase pricing and improve policy terms and to not renew business that no
longer met our underwriting criteria. We have implemented tighter terms and
conditions, including lower policy limits and higher deductibles. We continue to
reprofile our book of business, generating most of our new business from small
and middle market customers. In the fidelity and standard commercial components
of our financial institutions business, rates continued to increase as well. In
our executive protection and financial institutions business, rate increases
have begun to level off as we are seeing more competition in the marketplace.
Growth in our other specialty business was primarily from Chubb Re.
Premiums produced by Chubb Re grew 124% in the first nine months of 2003 and
190% in the third quarter to $668 million and $318 million, respectively.
Our specialty business produced near breakeven underwriting results in
the first nine months of 2003 and 2002. Results were near breakeven in the third
quarter of 2003 compared with unprofitable results in the similar period in
2002. The combined loss and expense ratio was 99.8% for the first nine months of
2003 and 100.6% for the third quarter compared with 100.9% and 106.1%,
respectively, in 2002.
Our executive protection business produced similarly unprofitable
results in the first nine months of 2003 and 2002. Results in both years were
adversely affected by directors and officers liability and errors and omissions
liability claim experience, particularly from claims that have arisen due to the
corporate abuses and accounting irregularities in recent years. Results were
unprofitable in the third quarter of both years, but more so in 2002 due to
adverse trends in loss severity in Europe caused by an increase in litigation,
often involving European companies being sued in U.S. courts for securities
fraud.
Page 22
Financial institutions results were unprofitable in the first nine
months of 2003 and 2002, but more so in 2003. Results for the professional
liability component of this business were highly unprofitable in both years due
to continued adverse directors and officers liability and errors and omissions
liability claim experience. Financial institutions continue to be the focus of
scrutiny by regulators and the plaintiffs' bar. The fidelity component was
highly profitable in both years due to favorable loss experience. The standard
commercial business written on financial institutions also produced profitable
results in the first nine months of both years due in large part to the rate
increases and more stringent risk selection in recent years. Results in the
third quarter of 2003, however, were unprofitable.
Our other specialty results were highly profitable in 2003 and 2002.
Our reinsurance assumed business generated by Chubb Re produced profitable
results in both years, but more so in 2003. Our surety business produced highly
profitable results in both years, but more so in 2003 due primarily to a $17
million recovery in the second quarter from the sale of a bankruptcy claim
against various Enron entities.
As a result of disarray in the surety reinsurance market caused by
several years of declining prices and high losses, the availability of surety
reinsurance in the near term has been significantly reduced. As a result, our
future surety results could be volatile.
The surety business tends to be characterized by infrequent but
potentially high severity losses. Since the end of 2001, we have been reducing
our exposure on an absolute basis and by specific bond type. The majority of our
obligations are intended to be performance-based guarantees. When losses occur,
they are mitigated by the customer's balance sheet, contract proceeds and
bankruptcy recovery.
Notwithstanding our efforts to manage and reduce our surety exposure,
we continue to have substantial commercial surety exposure for outstanding
bonds. In that regard, we have exposures related to commercial surety bonds
issued on behalf of companies that have experienced deterioration in
creditworthiness, including several gas forward purchase surety bonds. Given the
current economic climate and its impact on these and other companies, there is
an increased likelihood that we may experience an increase in filed claims and
may incur high severity losses. Such losses would be recorded if and when claims
are filed and determined to be valid, and could have a material adverse effect
on the Corporation's results of operations and liquidity.
In particular, we have in force $525 million of gas forward purchase
surety bonds with one principal, Aquila, Inc. Our exposure under these bonds
will decline over the terms of the bonds, which extend until 2012. These surety
bonds, which are uncollateralized, secure Aquila's obligation to supply gas
under long-term forward purchase agreements. Under the terms of these bonds, our
entire obligation to pay could be triggered if Aquila failed to provide gas
under its forward purchase contracts or was the subject of a bankruptcy filing.
There is currently no reinsurance in place covering our exposure under any of
these bonds. Aquila continues to perform its obligations under the related gas
forward purchase agreements.
Page 23
SEPTEMBER 11 ATTACK
In the third quarter of 2001, we incurred net costs of $645 million
related to the September 11 attack. We estimate that our gross claims and claim
expenses from the September 11 attack were about $3.2 billion. Most of the
claims were from property exposure and business interruption losses. We also had
significant workers' compensation losses. Our property exposures were protected
by facultative reinsurance, property per risk treaties that limited our net loss
per risk, and our property catastrophe treaties. Our workers' compensation
losses were protected by a casualty catastrophe treaty and a casualty clash
treaty.
Business interruption claims from the September 11 attack will take
some time to resolve, while potential liability claims could take years to
resolve. Therefore, it is possible that our estimate of ultimate gross losses
related to the September 11 attack may change in the future, and that the change
in estimate could have a material effect on the Corporation's results of
operations. However, we do not expect that any such change would have a material
effect on the Corporation's financial condition or liquidity.
LOSS RESERVES
Loss reserves at September 30, 2003 and December 31, 2002 included
significant amounts related to the September 11 attack and to asbestos and toxic
waste claims. Loss reserves at December 31, 2002 also included a significant
amount related to our surety exposure arising from the bankruptcy of Enron
Corp., which was substantially paid in the first quarter of 2003. The components
of loss reserves were as follows:
September 30, December 31,
2003 2002
--------------- --------------
(in millions)
Gross loss reserves
Total, per balance sheet $ 17,226 $ 16,713
Less:
Related to September 11 attack 1,155 2,063
Related to asbestos and toxic
waste claims 1,079 1,136
Related to Enron surety exposure 14 113
--------------- ---------------
Total, as adjusted $ 14,978 $ 13,401
=============== ===============
Reinsurance recoverable
Total, per balance sheet $ 3,443 $ 4,071
Less:
Related to September 11 attack 835 1,558
Related to asbestos and toxic
waste claims 47 53
Related to Enron surety exposure - 7
--------------- ---------------
Total, as adjusted $ 2,561 $ 2,453
=============== ===============
Net loss reserves
Total $ 13,783 $ 12,642
Total, as adjusted 12,417 10,948
Page 24
The loss reserves related to the September 11 attack, asbestos and
toxic waste claims and our Enron surety exposure are significant components of
our total loss reserves, but they distort the growth trend in our loss reserves.
Adjusted to exclude such loss reserves, our loss reserves, net of reinsurance
recoverable, increased by $1,469 million during the first nine months of 2003,
of which approximately $125 million was due to the weakness of the U.S. dollar.
Net loss reserves, as adjusted, by segment were as follows:
September 30, December 31,
2003 2002
------------- -------------
(in millions)
Personal insurance $ 1,197 $ 1,064
Commercial insurance 5,069 4,714
Specialty insurance 6,151 5,170
------------- -------------
Net loss reserves, as adjusted $ 12,417 $ 10,948
============= =============
Loss reserves for each segment of our business increased in the first
nine months of 2003, but most significantly for specialty insurance. The
increase in loss reserves for specialty insurance was due in large part to
directors and officers and errors and omissions claim activity combined with
relatively low paid losses for these coverages during the period. Unpaid claims
related to catastrophes contributed approximately $57 million to the increase in
personal insurance loss reserves.
Reserves for asbestos and toxic waste claims cannot be estimated with
traditional actuarial techniques that rely on historical accident year loss
development factors. We establish case reserves and expense reserves for costs
of related litigation where sufficient information has been developed to
indicate the involvement of a specific insurance policy. In addition, IBNR
reserves are established to cover additional exposures on both known and
unasserted claims.
In establishing our asbestos reserves, we evaluate the exposure
presented by each insured. As part of this evaluation, we consider the available
insurance coverage; limits and deductibles; the potential role of other
insurance, particularly underlying coverage below our excess liability policies;
and applicable coverage defenses, including asbestos exclusions.
In the third quarter of 2002, our actuaries and outside actuarial
consultants commenced their periodic ground-up exposure based analysis of our
asbestos related liabilities. As part of this analysis, they considered the
following recent adverse trends:
- Estimates of the ultimate liabilities for traditional asbestos
defendants have increased as the number of plaintiff claims
has surged over the past few years. The notable increase in
claimants as well as potential future claimants has resulted
in large settlements of asbestos related litigation. As a
result, it now appears more likely that many of these
traditional defendants will access higher excess layers of
insurance coverage as well as more years of coverage than
previously anticipated.
Page 25
- Claims have been more aggressively pursued against peripheral
asbestos defendants in recent years, partly in response to the
bankruptcy or exhaustion of insurance coverage for many of the
major traditional defendants.
- The number of claims filed under the non-aggregate premises or
operations section of general liability policies has
increased, creating potentially greater exposure.
- The litigation environment has become increasingly adverse.
More than half of the lawsuits filed in recent years have been
filed in five plaintiff oriented states, where significant
verdicts historically have been rendered against commercial
defendants.
- The number of asbestos defendants in bankruptcy has increased,
resulting in an increase in the number and cost of declaratory
judgment lawsuits to resolve coverage disputes and to effect
settlement in the bankruptcy courts.
Upon completion of the analysis and assessment of the results, we
increased our net asbestos loss reserves by $545 million in the third quarter of
2002. Following a thorough review in the fourth quarter of 2002 by our internal
actuarial, claims and reinsurance personnel, we reduced our previous estimate of
reinsurance recoverable on potential asbestos claims. As a result, our net
asbestos loss reserves increased by an additional $75 million.
Significant uncertainty remains as to our ultimate liability relating
to asbestos related claims due to such factors as the long latency period
between asbestos exposure and disease manifestation and the resulting potential
for involvement of multiple policy periods for individual claims as well as the
increase in the volume of claims by plaintiffs who claim exposure but who have
no symptoms of asbestos-related disease and an increase in claims filed under
the non-aggregate premises or operations section of general liability policies.
There is also the possibility of federal legislation that would address
the asbestos problem. In this regard, a recent Senate proposal for the creation
of an asbestos trust fund received conditional support from the property and
casualty insurance industry. We believe it is unlikely that a bill can be passed
this year. Our asbestos reserve assumptions have not anticipated any legislative
relief so the demise of the bill would have no impact on our estimates. However,
we have noticed that the number of claims reported by policyholders has
increased this year. On the other hand, bankruptcy filings have been fewer than
we expected and fewer than last year. These factors may have been influenced by
the possibility the bill might pass. We will review our asbestos reserves in the
course of our year end review of overall loss reserves.
Hazardous waste sites are another potential exposure. There is
significant uncertainty involved in estimating our liabilities related to these
claims. These uncertainties are not likely to be resolved definitively in the
near future.
Toxic waste losses appear to be developing as expected due to
relatively stable claim trends. In many cases, claims are being settled for less
than initially anticipated due to various factors, including more efficient site
remediation efforts and increasing success with policy buy backs.
Page 26
Despite the stable claim trends, we increased our toxic waste loss
reserves by $80 million in the third quarter of 2002 based on the most recent
estimate of our actuaries and actuarial consultants as to our ultimate exposure.
We continually review and update our loss reserves. Based on all
information currently available, we believe that the aggregate loss reserves of
the property and casualty subsidiaries at September 30, 2003 were adequate to
cover claims for losses that had occurred, including both those known to us and
those yet to be reported. In establishing such reserves, we consider facts
currently known and the present state of the law and coverage litigation.
However, given the judicial decisions and legislative actions that have
broadened the scope of coverage and expanded theories of liability in the past
and the possibilities of similar interpretations in the future, particularly as
they relate to asbestos claims and, to a lesser extent, toxic waste claims,
additional increases in loss reserves may emerge in future periods. Such
increases could have a material adverse effect on the Corporation's future
operating results. However, management does not expect that any such increases
would have a material effect on the Corporation's consolidated financial
condition or liquidity.
INVESTMENT INCOME
Property and casualty investment income before taxes increased by 12.4%
in the first nine months of 2003 and 15.6% in the third quarter compared with
the same periods in 2002. The growth in investment income was due to an increase
in invested assets since the third quarter of 2002 resulting from substantial
cash flow from operations over the period as well as capital contributions of $1
billion and $800 million to the property and casualty subsidiaries by the
Corporation in the fourth quarter of 2002 and the second quarter of 2003,
respectively. However, lower available reinvestment rates on fixed maturities
that matured over the past year dampened the growth in investment income.
The effective tax rate on investment income increased to 20.3% in the
first nine months of 2003 from 18.1% in the comparable period in 2002 due to our
holding a smaller proportion of our investment portfolio in tax-exempt
securities.
On an after-tax basis, property and casualty investment income
increased by 9.3% in the first nine months of 2003 and 12.5% in the third
quarter. Management uses property and casualty investment income after-tax, a
non-GAAP financial measure, to evaluate its investment performance because it
reflects the impact of any change in the proportion of the investment portfolio
invested in tax-exempt securities and is therefore more meaningful for analysis
purposes than investment income before taxes.
OTHER CHARGES
Other charges include miscellaneous income and expenses of the property
and casualty subsidiaries. Other charges in the first nine months of 2003
included expenses of $15 million, mostly in the second quarter, related to the
restructuring of our operations in Continental Europe. The restructuring costs
consist primarily of severance costs. We have received the necessary regulatory
and works council approvals and are moving ahead with our planned branch
closings and work force reductions, which should be completed by the end of
2003.
Page 27
CHUBB FINANCIAL SOLUTIONS
Chubb Financial Solutions (CFS) was organized by the Corporation in
2000 to develop and provide customized products to address specific financial
needs of corporate clients. CFS operated through both the capital and insurance
markets. CFS's non-insurance business was primarily structured credit
derivatives, principally as a counterparty in portfolio credit default swap
contracts. The Corporation guaranteed all of these obligations.
In April 2003, the Corporation announced its intention to run-off the
financial products portfolio of CFS. We have implemented the plan to exit the
credit derivatives business and we are running off our portfolio. The
Corporation does not intend to write any new credit derivative transactions but
might enter into transactions for hedging and other risk management reasons in
the future.
In a typical portfolio credit default swap, CFS participated in the
senior layer of a structure designed to replicate the performance of a portfolio
of corporate securities, a portfolio of asset-backed securities or a specified
pool of loans. The structure of these portfolio credit default swaps generally
requires CFS to make payment to counterparties to the extent cumulative losses,
related to numerous credit events, exceed a specified threshold. The risk below
that threshold, referred to as subordination, is assumed by other parties with
the primary risk layer sometimes retained by the buyer. The amount of
subordination for each contract varies based on the credit quality of the
underlying portfolio and the term to maturity of the contract. Credit events
generally arise when one of the referenced entities within a portfolio becomes
bankrupt, undergoes a debt restructuring or fails to make timely interest or
principal payments.
Portfolio credit default swaps are derivatives and are carried in the
financial statements at estimated fair value, which represents management's best
estimate of the cost to exit the positions. Most of these credit default swaps
tend to be unique transactions and there is no traded market for such exposures.
To estimate the fair value of the obligation in each credit default swap, we use
internal valuation models that are similar to external valuation models. Such
valuations require considerable judgment and are subject to significant
uncertainty.
The fair value of credit default swaps is subject to fluctuations
arising from, among other factors, changes in credit spreads, the financial
ratings of referenced asset-backed securities, actual credit events reducing
subordination, credit correlation within a portfolio, anticipated recovery rates
related to potential defaults and changes in interest rates. Changes in fair
value are included in income in the period of the change. Thus, CFS's results
are subject to volatility, which could have a significant effect on the
Corporation's results of operations from period to period.
Revenues from the non-insurance business of CFS, principally consisting
of the change in fair value of derivative contracts, were negative $18.1 million
in the first nine months of 2003 compared with negative $42.7 million in the
same period in 2002. Revenues were negative due to the adverse impact of changes
in fair value during each of the periods.
Page 28
The non-insurance business of CFS produced a loss before taxes of $30.6
million in the first nine months of 2003 compared with a loss of $55.9 million
in the first nine months of 2002. The losses were due to adverse movements in
the mark-to-market adjustment. In 2003, the primary factor contributing to the
increase in the fair value of our obligations related to credit default swaps
was deterioration in the credit quality of certain referenced securities
underlying two of our asset-backed portfolio credit default swaps. The primary
factor contributing to the increase in the fair value of our obligations in 2002
was a substantial widening of market credit spreads, particularly in the third
quarter.
At September 30, 2003, CFS's aggregate exposure, or retained risk,
referred to as notional amounts, from its in-force portfolio credit default
swaps was approximately $39.2 billion, of which $3.9 billion related to the two
asset-backed portfolio credit default swaps that have experienced deterioration
in credit quality. Notional amounts are used to express the extent of
involvement in swap transactions. These amounts are used to calculate the
exchange of contractual cash flows and are not necessarily representative of the
potential for gain or loss. The notional amounts are not recorded on the balance
sheet.
The realistic loss exposure of CFS is a small portion of the $39.2
billion notional amount due to several factors. The position of CFS is senior to
subordinated interests of $6.6 billion in the aggregate. Of the $6.6 billion of
subordination, there were only $99 million of defaults through September 30,
2003, none of which has pierced the subordination limits of any of the
contracts. In addition, using our internal ratings model, we estimate that the
credit ratings of CFS's exposures, other than those that relate to the portfolio
credit default swaps that have experienced deterioration in credit quality, are
either AAA or AA.
The two asset-backed portfolio credit default swaps that have
experienced deterioration in the credit quality of the underlying referenced
securities have $80 million of subordination. Using our internal ratings model,
we estimate that the average credit ratings of these exposures is BB+.
In connection with our plan to exit the credit derivatives business, we
are accelerating the reduction of our notional exposure. During the third
quarter of 2003, CFS terminated its obligations under certain portfolio credit
default swaps, which reduced its notional exposure by $3.8 billion. An
additional $6.6 billion of notional exposure has been eliminated since the end
of the third quarter. These transactions did not have a significant impact on
CFS's results of operations. If we were to enter into transactions to reduce or
eliminate our exposure relating to the two portfolio credit default swaps that
have experienced deterioration in credit quality, it is possible that losses may
be recognized that would have a material adverse effect on the Corporation's
results of operations.
In addition to portfolio credit default swaps, CFS entered into a
derivative contract linked to an equity market index and a few other
insignificant non-insurance transactions.
Page 29
The notional amount and fair value of our future obligations by type of
risk were as follows:
Notional Amount Fair Value
----------------------------- -----------------------------
September 30, December 31, September 30, December 31,
2003 2002 2003 2002
------------- ------------- ------------- -------------
(in billions) (in millions)
Credit default swaps
Corporate
securities $ 21.3 $ 21.2 $ 44 $ 88
Asset-backed
securities 15.2 15.5 171 103
Loan portfolios 2.7 2.0 2 4
------------- ------------- ------------- -------------
39.2 38.7 217 195
Other .4 .4 9 9
------------- ------------- ------------- -------------
$ 39.6 $ 39.1 $ 226 $ 204
============= ============= ============= =============
CORPORATE AND OTHER
Corporate and other includes investment income earned on corporate
invested assets, interest expense and other expenses not allocated to the
operating subsidiaries, and the results of our real estate and other
non-insurance subsidiaries. Corporate and other produced a loss before taxes of
$102.4 million in the first nine months of 2003 compared with a loss of $55.4
million in the first nine months of 2002. The substantially higher loss in 2003
was due primarily to higher interest expense and lower investment income.
Interest expense was higher in 2003 due to the issuance of $600 million of debt
in the fourth quarter of 2002, $500 million of debt in the first quarter of 2003
and $460 million of debt in the second quarter of 2003. Investment income was
lower in 2003 due to lower average corporate invested assets resulting from the
capital contributions to the property and casualty subsidiaries. Results in 2003
include income from our investment in Allied World Assurance Company, Ltd.,
which was partially offset by a loss at Chubb Institute, Inc., our computer
training subsidiary.
REAL ESTATE
Real estate operations resulted in a loss before taxes of $3.2 million
in the first nine months of 2003 compared with a loss of $4.8 million in the
same period in 2002, which amounts are included in the corporate and other
results.
We own approximately $290 million of land that we expect will be
developed in the future. In addition, we own approximately $175 million of
commercial properties and land parcels under lease. We are continuing to explore
the sale of certain of our remaining properties.
Loans receivable, which amounted to $94 million at September 30, 2003,
are primarily purchase money mortgages. Such loans, which were issued in
connection with our joint venture activities and other property sales, are
generally collateralized by buildings and, in some cases, land. We continually
evaluate the ultimate collectibility of such loans and establish appropriate
reserves.
Page 30
The recoverability of the carrying value of our real estate assets is
assessed based on our ability to fully recover costs through a future revenue
stream. The assumptions used reflect future improvement in demand for office
space, an increase in rental rates and the ability and intent to obtain
financing in order to hold and develop such remaining properties and protect our
interests over the long term. We believe that we have made adequate provisions
for impairment of real estate assets. However, if the assets are not sold or
developed or if leased properties do not perform as presently contemplated, it
is possible that additional impairment losses may be recognized that would have
a material adverse effect on the Corporation's results of operations.
INVESTMENT GAINS AND LOSSES
Net realized investment gains before taxes were $85.7 million in the
first nine months of 2003 compared with net gains of $75.5 million for the same
period in 2002.
We regularly review the value of our invested assets for other than
temporary impairment. In evaluating whether a decline in value is other than
temporary, we consider various factors including the length of time and the
extent to which the fair value has been less than the cost, the financial
condition and near term prospects of the issuer, whether the debtor is current
on contractually obligated interest and principal payments, and our intent and
ability to hold the investment for a period of time sufficient to allow us to
recover our cost. If a decline in the fair value of an individual security is
deemed to be other than temporary, the difference between cost and estimated
fair value is charged to income as a realized investment loss. In the first nine
months of 2003 and 2002, net realized investment gains reflected writedowns of
$48.1 million and $43.3 million, respectively, due to the recognition of other
than temporary impairment on certain securities.
INCOME TAXES
We establish deferred income taxes on the undistributed earnings of
foreign subsidiaries. Similarly, we establish deferred tax assets related to the
expected future U.S. tax benefit of losses and foreign taxes incurred by our
foreign subsidiaries.
At December 31, 2002, the deferred income tax asset related to the
expected future U.S. tax benefit of the losses and foreign taxes incurred by
Chubb Insurance Company of Europe (Chubb Europe) was $140 million. Results in
Chubb Europe were profitable in the first nine months of 2003. As a result, this
deferred tax asset was approximately $110 million at September 30, 2003.
To evaluate the realization of this deferred tax asset, management must
consider whether it is more likely than not that Chubb Europe will generate
sufficient taxable income to realize the future tax benefit of the deferred tax
asset. Management's judgment is based on its assessment of business plans and
related projections of future taxable income that reflect assumptions about
increased premium volume, higher rates and improved policy terms as well as
available tax planning strategies. While the tax loss carryforwards and foreign
tax credits have no expiration and we expect to generate sufficient taxable
income to realize these benefits in the future, we are required under generally
accepted accounting principles to consider a relatively near term horizon when
we evaluate the likelihood of realizing future tax benefits.
Page 31
During the fourth quarter of 2002, we established a valuation allowance
of $40 million for the portion of the deferred tax asset that we cannot realize
for accounting purposes. We did not adjust the valuation allowance in the first
nine months of 2003. If our estimates of future taxable income in Chubb Europe
were revised, we would need to adjust the valuation allowance accordingly.
Depending on the amount of any such adjustment, the effect on the Corporation's
results of operations could be significant.
INVESTED ASSETS
Our investment portfolio is primarily comprised of high quality bonds,
principally tax-exempt, U.S. Treasury and government agency, mortgage-backed
securities and corporate issues as well as foreign bonds that support our
international operations. In addition, the portfolio includes equity securities
held primarily with the objective of capital appreciation.
In the first nine months of 2003, we invested new cash in tax-exempt
bonds and taxable bonds and, to a lesser extent, equity securities. The taxable
bonds were primarily mortgage-backed securities and foreign government bonds.
Our objective is to try to achieve the appropriate mix of taxable and tax-exempt
securities in our portfolio to balance both investment and tax strategies.
The unrealized appreciation before tax of investments carried at market
value, which includes fixed maturities classified as available-for-sale and
equity securities, was $1,040 million and $901 million at September 30, 2003 and
December 31, 2002, respectively. Such unrealized appreciation is reflected in a
separate component of other comprehensive income, net of applicable deferred
income tax.
The unrealized market appreciation before tax of those fixed maturities
carried at amortized cost was $41 million at September 30, 2003 and $56 million
at December 31, 2002. Such unrealized appreciation was not reflected in the
consolidated financial statements.
Changes in unrealized market appreciation or depreciation of fixed
maturities were due primarily to fluctuations in interest rates.
CAPITAL RESOURCES AND LIQUIDITY
Capital resources and liquidity represent the overall financial
strength of the Corporation and its ability to generate cash flow from its
operating subsidiaries, to borrow funds at competitive rates and to raise new
capital to meet operating and growth needs.
CAPITAL RESOURCES
In February 2003, $100 million of 6 7/8% notes were paid when due.
In March 2003, the Corporation issued $225 million of unsecured 3.95%
notes due in 2008 and $275 million of unsecured 5.2% notes due in 2013. Net
proceeds from the issuance of the notes were $495 million.
Page 32
In June 2003, the shelf registration statement that the Corporation
filed in March 2003 was declared effective by the Securities and Exchange
Commission. Under the registration statement, up to $2.5 billion of various
types of securities may be issued. In June 2003, the Corporation completed the
following offerings of securities under the shelf registration statement. At
September 30, 2003, the Corporation had approximately $650 million remaining
under the shelf.
The Corporation sold 15,525,000 shares of common stock. Net proceeds
from the sale of the shares were $887 million. Concurrently, the Corporation
issued $460 million of unsecured 2.25% senior notes due in 2008 and 18.4 million
purchase contracts. The senior notes and purchase contracts were issued together
in the form of 7% equity units, each of which initially represents $25 principal
amount of senior notes and one purchase contract. The net proceeds from this
offering were $446 million. Each purchase contract obligates the investor to
purchase for $25 a variable number of shares of the Corporation's common stock
on August 16, 2006. The number of shares to be purchased will be determined
based on a formula that considers the market price of our common stock
immediately prior to the time of settlement in relation to the $59.50 per share
sale price of our common stock at the time the equity units were offered. Upon
settlement of the purchase contracts, the Corporation will receive proceeds of
approximately $460 million and will issue between approximately 6,500,000 and
7,700,000 shares of common stock.
The aggregate net proceeds from the issuance of the notes, the common
stock and the equity units are being used for general corporate purposes,
including capital contributions to our property and casualty subsidiaries to
support growth.
Management continuously monitors the amount of capital resources that
the Corporation maintains both for itself and its operating subsidiaries. In
connection with our long-term capital strategy, the Corporation from time to
time contributes capital to its property and casualty subsidiaries. In addition,
in order to satisfy its capital needs as a result of any rating agency capital
adequacy or other future rating issues, or in the event the Corporation were to
need additional capital to make strategic investments in light of market
opportunities, the Corporation may take a variety of actions, which could
include the issuance of additional debt and/or equity securities.
In July 1998, the Board of Directors authorized the repurchase of up to
12,500,000 shares of the Corporation's common stock. In June 2001, the Board of
Directors authorized the repurchase of up to an additional 16,000,000 shares.
The 1998 authorization has no expiration; the 2001 authorization expired on June
30, 2003. The Corporation made no share repurchases during the first nine months
of 2003. As of September 30, 2003, 3,287,100 shares remained under the 1998
share repurchase authorization. We do not anticipate that we will repurchase any
shares of our common stock in 2003.
RATINGS
The Corporation and its insurance subsidiaries are rated by major
rating agencies. These ratings reflect the rating agency's opinion of our
financial strength, operating performance, capital resources, strategic position
and ability to meet our obligations to policyholders.
Page 33
Ratings are an important factor in establishing our competitive
position in our operating businesses. There can be no assurance that our ratings
will continue for any given period of time or that they will not be changed.
Reductions in our ratings could adversely affect the competitive position of our
operating businesses.
LIQUIDITY
Liquidity is a measure of our ability to generate sufficient cash flows
to meet the short and long term cash requirements of our business operations.
In our property and casualty subsidiaries, premiums are generally
received months or even years before losses are paid under the policies
purchased by such premiums. These funds are used first to make current claim and
expense payments. The balance is invested to augment the investment income
generated by the existing portfolio. Historically, cash receipts from
operations, consisting of insurance premiums and investment income, have
provided more than sufficient funds to pay losses, operating expenses and
dividends to the Corporation.
New cash from operations available for investment by the property and
casualty subsidiaries was approximately $2,200 million in the first nine months
of 2003 compared with $1,275 million in the same period in 2002. The increase in
new cash in 2003 was due to the significant growth in premium receipts without a
commensurate increase in paid losses or operating expenses.
In addition to the cash from operations, the property and casualty
subsidiaries received a capital contribution from the Corporation of $800
million in June 2003.
Our property and casualty subsidiaries maintain investments in highly
liquid, short-term and other marketable securities to provide for immediate cash
needs.
The Corporation's liquidity requirements are met by dividends from its
property and casualty subsidiaries and the issuance of commercial paper and debt
and equity securities.
The Corporation has lines of credit with a group of banks pursuant to
two agreements that provide for unsecured borrowings of up to $500 million in
the aggregate. The $250 million short term revolving credit facility, which was
to have terminated on June 27, 2003, was extended to June 24, 2004. The $250
million medium term revolving credit facility terminates on June 28, 2007. There
have been no borrowings under these agreements.
ACCOUNTING PRONOUNCEMENT NOT YET ADOPTED
In January 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an
interpretation of Accounting Research Bulletin No. 51 (FIN 46), which requires
an enterprise to assess its interests in a variable interest entity to determine
whether to consolidate that entity. The provisions of FIN 46 are generally
effective for the Corporation beginning in the quarter ending December 31, 2003.
The adoption of FIN 46 is not expected to have a significant effect on the
Corporation's financial position or results of operations. FIN 46 is discussed
further in Note (3) of the Notes to Consolidated Financial Statements.
Page 34
Item 4 - Controls and Procedures
As of September 30, 2003, an evaluation of the effectiveness of the
design and operation of the Corporation's disclosure controls and procedures was
performed under the supervision and with the participation of the Corporation's
management, including the chief executive officer and chief financial officer.
Based on that evaluation, the chief executive officer and chief financial
officer concluded that the Corporation's disclosure controls and procedures were
effective as of the evaluation date.
During the three month period ended September 30, 2003, there were no
changes in internal control over financial reporting that have materially
affected, or are reasonably likely to affect, the Corporation's internal control
over financial reporting.
Page 35
PART II. OTHER INFORMATION
Item 1 - Legal Proceedings
As previously disclosed, a purported class action complaint was filed
in the United States District Court for the District of New Jersey on August 31,
2000 by the California Public Employees' Retirement System. The complaint
alleges that the Corporation and one current officer, Henry B. Schram, and two
former officers, Dean R. O'Hare and David B. Kelso, and Executive Risk Inc. and
three of its former officers, Stephen J. Sills, Robert H. Kullas and Robert V.
Deutsch, are liable for certain misrepresentations and omissions regarding,
among other matters, disclosures made between April 27, 1999 and October 15,
1999 relating to the improved pricing in the Corporation's standard commercial
insurance business and relating to the offer of the Corporation's securities to,
and solicitation of votes from, the former shareholders of Executive Risk Inc.
in connection with the Corporation's acquisition of Executive Risk Inc. On
August 11, 2003, the trial court dismissed the entire action with prejudice. On
September 10, 2003, the plaintiffs filed a Notice of Appeal to the United States
Court of Appeals for The Third Circuit. The Corporation is defending the action
vigorously.
Also, the Corporation and its Directors, as previously reported, were
named as defendants in a purported shareholder derivative action, which was
filed on October 18, 2001 in the United States District Court for the District
of New Jersey. The derivative action alleged that the Directors breached their
fiduciary duties, engaged in gross mismanagement, and failed properly to
exercise control over the dissemination of information regarding the
Corporation's operations and performance, which allegations are based on
substantially the same allegations made in the complaint by the California
Public Employees' Retirement System, described above. The complaint sought
unspecified damages on behalf of the Corporation. On September 11, 2003, the
plaintiffs voluntarily dismissed the entire action with prejudice by Stipulation
and Order.
As previously disclosed, beginning in December 2002, Chubb Indemnity
Insurance Company was served with a number of complaints related to a series of
actions commenced by various plaintiffs against Chubb Indemnity and other
non-affiliated insurers in the District Courts of Nueces and Bexar Counties in
Texas. To date, Chubb Indemnity has been served with a total of thirty-nine
complaints in Texas. Since July 2003, the trial court has ordered dismissal of
seven of the Nueces County cases and three Nueces County cases have been
voluntarily dismissed by plaintiffs. Also, beginning in June 2003, Chubb
Indemnity was served with similar cases in Cuyahoga County, Ohio. To date, Chubb
Indemnity has been served in eight cases in Ohio. The allegations and the
damages sought in the Ohio actions are substantially similar to those in the
Texas actions. Chubb Indemnity is vigorously defending all of these actions.
Page 36
Item 6 - Exhibits and Reports on Form 8-K
A. Exhibits
Exhibit (31) Rule 13a-14(a)/15d-14(a) Certifications
(1) Certification by John D. Finnegan
(2) Certification by Michael O'Reilly
Exhibit (32) Section 1350 Certifications
(1) Certification by John D. Finnegan
(2) Certification by Michael O'Reilly
B. Reports on Form 8-K
The Registrant filed a current report on Form 8-K on July 30, 2003
furnishing under Item 12 information with respect to the issuance of a
press release announcing its results for the quarter ended June 30,
2003.
The Registrant filed a current report on Form 8-K on October 27, 2003
furnishing under Item 12 information with respect to the issuance of a
press release announcing its results for the quarter ended September
30, 2003.
The Registrant filed a current report on Form 8-K on October 30, 2003
furnishing under Item 12 information with respect to the issuance of
its Supplementary Investor Information Report for the quarter ended
September 30, 2003.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
The Chubb Corporation has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
THE CHUBB CORPORATION
(Registrant)
By: /s/ Henry B. Schram
--------------------------
Henry B. Schram
Senior Vice-President and
Chief Accounting Officer
Date: November 14, 2003