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 June 30, 2004
OR
____ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to _____________
Commission file number 1-8661
THE CHUBB CORPORATION
------------------------------------------------------
(Exact name of registrant as specified in its charter)
NEW JERSEY 13-2595722
------------------------------- --------------------
(State or other jurisdiction of (I. R. S. Employer
incorporation or organization) Identification No.)
15 MOUNTAIN VIEW ROAD, WARREN, NEW JERSEY 07061-1615
----------------------------------------- ----------
(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 June 30, 2004 was
190,999,729.
THE CHUBB CORPORATION
INDEX
Page Number
-----------
Part I. Financial Information:
Item 1 - Financial Statements:
Consolidated Statements of Income for the
Three Months and Six Months Ended
June 30, 2004 and 2003....................................... 1
Consolidated Balance Sheets as of
June 30, 2004 and December 31, 2003.......................... 2
Consolidated Statements of Comprehensive Income
for the Three Months and Six Months Ended
June 30, 2004 and 2003....................................... 3
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2004 and 2003...................... 4
Notes to Consolidated Financial Statements.................... 5
Item 2 - Management's Discussion and Analysis
of Financial Condition and Results of Operations.............. 8
Item 4 - Controls and Procedures................................ 29
Part II. Other Information:
Item 6 - Exhibits and Reports on Form 8-K....................... 30
Signatures........................................................ 31
Page 1
Part I. Financial Information
Item 1 - Financial Statements
THE CHUBB CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
PERIODS ENDED JUNE 30
Second Quarter Six Months
------------------ ------------------
2004 2003 2004 2003
-------- -------- -------- --------
(in millions)
Revenues
Premiums Earned....................... $2,861.6 $2,533.2 $5,655.6 $4,858.4
Investment Income..................... 308.6 271.7 604.5 528.7
Other Revenues........................ 19.0 12.9 26.5 42.1
Realized Investment Gains............. 16.7 20.7 97.6 25.2
-------- -------- -------- --------
Total Revenues................. 3,205.9 2,838.5 6,384.2 5,454.4
-------- -------- -------- --------
Losses and Expenses
Insurance Losses and Loss Expenses.... 1,805.9 1,633.2 3,546.5 3,138.7
Amortization of Deferred Policy
Acquisition Costs.................... 703.0 630.3 1,390.2 1,210.4
Other Insurance Operating Costs
and Expenses......................... 159.2 182.6 348.0 359.6
Investment Expenses................... 6.1 6.2 13.4 16.4
Other Expenses........................ 25.8 19.9 53.0 36.9
Corporate Expenses.................... 39.6 37.4 77.8 81.3
-------- -------- -------- --------
Total Losses and Expenses...... 2,739.6 2,509.6 5,428.9 4,843.3
-------- -------- -------- --------
Income Before Federal and Foreign
Income Tax............................. 466.3 328.9 955.3 611.1
Federal and Foreign Income Tax.......... 110.2 76.8 238.5 134.4
-------- -------- -------- --------
Net Income.............................. $ 356.1 $ 252.1 $ 716.8 $ 476.7
======== ======== ======== ========
Net Income Per Share
Basic.................................. $ 1.88 $ 1.46 $ 3.80 $ 2.78
Diluted................................ 1.85 1.45 3.73 2.76
Dividends Declared Per Share............ .39 .36 .78 .72
See Notes to Consolidated Financial Statements.
Page 2
THE CHUBB CORPORATION
CONSOLIDATED BALANCE SHEETS
June 30, Dec. 31,
2004 2003
--------- ---------
(in millions)
Assets
Invested Assets
Short Term Investments............................... $ 1,627.1 $ 2,695.9
Fixed Maturities
Held-to-Maturity - Tax Exempt (market $424.5
and $502.2)....................................... 400.2 467.0
Available-for-Sale
Tax Exempt (cost $12,004.4 and $10,509.7)......... 12,269.6 11,154.0
Taxable (cost $12,016.3 and $10,531.8)............ 12,057.1 10,790.7
Equity Securities (cost $1,538.1 and $1,381.4)....... 1,665.9 1,514.4
--------- ---------
TOTAL INVESTED ASSETS......................... 28,019.9 26,622.0
Cash................................................... 48.1 52.2
Securities Lending Collateral.......................... 1,980.6 704.8
Accrued Investment Income.............................. 319.2 286.8
Premiums Receivable.................................... 2,392.3 2,188.0
Reinsurance Recoverable on Unpaid Losses
and Loss Expenses..................................... 3,593.5 3,426.6
Prepaid Reinsurance Premiums........................... 370.4 391.0
Deferred Policy Acquisition Costs...................... 1,394.5 1,343.4
Real Estate Assets..................................... 500.8 518.8
Investment in Partially Owned Company.................. 345.3 312.3
Deferred Income Tax.................................... 789.1 641.4
Goodwill............................................... 467.4 467.4
Other Assets........................................... 1,456.9 1,405.9
--------- ---------
TOTAL ASSETS.................................. $41,678.0 $38,360.6
========= =========
Liabilities
Unpaid Losses and Loss Expenses........................ $19,053.3 $17,947.8
Unearned Premiums...................................... 6,218.5 5,939.4
Securities Lending Payable............................. 1,980.6 704.8
Long Term Debt......................................... 2,811.6 2,813.9
Dividend Payable to Shareholders....................... 74.5 67.7
Accrued Expenses and Other Liabilities................. 2,636.6 2,365.0
--------- ---------
TOTAL LIABILITIES............................. 32,775.1 29,838.6
--------- ---------
Shareholders' Equity
Common Stock - $1 Par Value; 195,803,824 and
195,803,824 Shares.................................... 195.8 195.8
Paid-In Surplus........................................ 1,302.6 1,318.8
Retained Earnings...................................... 7,437.2 6,868.9
Accumulated Other Comprehensive Income
Unrealized Appreciation of Investments, Net of Tax.... 282.0 673.6
Foreign Currency Translation Gains, Net of Tax........ 18.9 12.0
Receivable from Employee Stock Ownership Plan.......... (9.3) (17.9)
Treasury Stock, at Cost - 4,804,095 and
7,840,448 Shares...................................... (324.3) (529.2)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY.................... 8,902.9 8,522.0
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.... $41,678.0 $38,360.6
========= =========
See Notes to Consolidated Financial Statements.
Page 3
THE CHUBB CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
PERIODS ENDED JUNE 30
Second Quarter Six Months
----------------- ----------------
2004 2003 2004 2003
------- ------ ------- ------
(in millions)
Net Income................................ $ 356.1 $252.1 $ 716.8 $476.7
------- ------ ------- ------
Other Comprehensive Income
Change in Unrealized Appreciation
of Investments, Net of Tax............. (516.1) 198.6 (391.6) 240.9
Foreign Currency Translation Gains
(Losses), Net of Tax................... (2.7) 36.9 6.9 46.4
------- ------ ------- ------
(518.8) 235.5 (384.7) 287.3
------- ------ ------- ------
Comprehensive Income (Loss)............... $(162.7) $487.6 $ 332.1 $764.0
======= ====== ======= ======
See Notes to Consolidated Financial Statements.
Page 4
THE CHUBB CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30
2004 2003
--------- ---------
(in millions)
Cash Flows from Operating Activities
Net Income............................................ $ 716.8 $ 476.7
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities
Increase in Unpaid Losses and Loss Expenses, Net.... 938.6 767.2
Increase in Unearned Premiums, Net.................. 291.4 433.6
Increase in Premiums Receivable..................... (204.3) (102.1)
Increase in Deferred Policy Acquisition Costs....... (49.4) (77.3)
Change in Deferred Income Tax....................... 54.1 18.9
Depreciation........................................ 54.1 55.8
Realized Investment Gains........................... (97.6) (25.2)
Other, Net.......................................... 89.7 (275.9)
--------- ---------
Net Cash Provided by Operating Activities............. 1,793.4 1,271.7
--------- ---------
Cash Flows from Investing Activities
Proceeds from Sales of Fixed Maturities............... 1,800.2 2,971.5
Proceeds from Maturities of Fixed Maturities.......... 1,126.3 1,063.5
Proceeds from Sales of Equity Securities.............. 465.1 197.3
Purchases of Fixed Maturities......................... (5,848.4) (5,593.1)
Purchases of Equity Securities........................ (491.9) (421.1)
Decrease (Increase) in Short Term Investments, Net.... 1,068.8 (1,832.3)
Increase in Net Payable from Security
Transactions Not Settled............................. 62.4 654.5
Purchases of Property and Equipment, Net.............. (32.2) (40.8)
Other, Net............................................ (1.1) -
--------- ---------
Net Cash Used in Investing Activities................. (1,850.8) (3,000.5)
--------- ---------
Cash Flows from Financing Activities
Proceeds from Issuance of Long Term Debt.............. - 960.0
Repayment of Long Term Debt........................... (.2) (100.2)
Increase in Funds Held Under Deposit Contracts........ 22.6 92.4
Proceeds from Common Stock Offering................... - 886.8
Proceeds from Issuance of Common Stock Under
Incentive and Purchase Plans......................... 164.0 14.4
Dividends Paid to Shareholders........................ (141.7) (121.7)
Other, Net............................................ 8.6 (13.6)
--------- ---------
Net Cash Provided by Financing Activities............. 53.3 1,718.1
--------- ---------
Net Decrease in Cash.................................... (4.1) (10.7)
Cash at Beginning of Year............................... 52.2 41.9
--------- ---------
Cash at End of Period................................. $ 48.1 $ 31.2
========= =========
See Notes to Consolidated Financial Statements.
Page 5
THE CHUBB CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1) General
The accompanying consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in
the United States and include the accounts of The Chubb Corporation and
its subsidiaries (collectively, the Corporation). Significant intercompany
transactions have been eliminated in consolidation.
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 2003 Annual Report on Form 10-K.
2) 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 June 30
------------------------------------
Second Quarter Six Months
---------------- ----------------
2004 2003 2004 2003
------- ------ ------- ------
(in millions)
Change in unrealized appreciation or
depreciation of equity securities... $ (39.0) $ 78.3 $ (5.2) $ 73.1
Change in unrealized appreciation of
fixed maturities.................... (755.1) 227.2 (597.2) 297.5
------- ------ ------- ------
(794.1) 305.5 (602.4) 370.6
Deferred income tax (credit)......... (278.0) 106.9 (210.8) 129.7
------- ------ ------- ------
Change in unrealized appreciation
of investments, net................. $(516.1) $198.6 $(391.6) $240.9
======= ====== ======= ======
Page 6
3) Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share:
Periods Ended June 30
-----------------------------------
Second Quarter Six Months
--------------- ---------------
2004 2003 2004 2003
------ ------ ------ ------
(in millions,
except per share amounts)
Basic earnings per share:
Net income......................... $356.1 $252.1 $716.8 $476.7
====== ====== ====== ======
Weighted average number of common
shares outstanding................... 189.5 172.5 188.7 171.5
====== ====== ====== ======
Basic earnings per share.............. $ 1.88 $ 1.46 $ 3.80 $ 2.78
====== ====== ====== ======
Diluted earnings per share:
Net income........................... $356.1 $252.1 $716.8 $476.7
====== ====== ====== ======
Weighted average number of common
shares outstanding................... 189.5 172.5 188.7 171.5
Additional shares from assumed
exercise of stock-based
compensation awards.................. 3.0 1.8 3.4 1.4
------ ------ ------ ------
Weighted average number of common
shares and potential common shares
assumed outstanding for computing
diluted earnings per share........... 192.5 174.3 192.1 172.9
====== ====== ====== ======
Diluted earnings per share............ $ 1.85 $ 1.45 $ 3.73 $ 2.76
====== ====== ====== ======
4) Segments Information
The principal business of the Corporation is property and casualty
insurance. The profitability of the property and casualty insurance
business depends on the results of both underwriting operations and
investments, which are viewed as two distinctive operations. The
under-writing operations are managed separately from the investment
function.
The property and casualty underwriting operations consist of three
separate business units: 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.
Chubb Financial Solutions' non-insurance business was primarily
structured credit derivatives, principally as a counterparty in portfolio
credit default swap contracts. The Corporation has implemented a plan to
exit the credit derivatives business.
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 7
Revenues and income before income tax of the operating segments were
as follows:
Periods Ended June 30
---------------------------------------
Second Quarter Six Months
------------------ ------------------
2004 2003 2004 2003
-------- -------- -------- --------
(in millions)
Revenues
Property and casualty insurance
Premiums earned
Personal insurance............... $ 668.2 $ 604.1 $1,328.0 $1,183.9
Commercial insurance............. 1,084.4 922.1 2,138.9 1,800.8
Specialty insurance.............. 1,109.0 1,007.0 2,188.7 1,873.7
-------- -------- -------- --------
2,861.6 2,533.2 5,655.6 4,858.4
Investment income.................. 296.8 266.5 580.8 520.1
-------- -------- -------- --------
Total property and casualty
insurance....................... 3,158.4 2,799.7 6,236.4 5,378.5
Chubb Financial Solutions
non-insurance business.............. 1.8 .5 (3.2) 17.9
Corporate and other.................. 29.0 17.6 53.4 32.8
Realized investment gains............ 16.7 20.7 97.6 25.2
-------- -------- -------- --------
Total revenues................... $3,205.9 $2,838.5 $6,384.2 $5,454.4
======== ======== ======== ========
Income (loss) before income tax
Property and casualty insurance
Underwriting
Personal insurance............... $ 38.6 $ 8.2 $ 53.8 $ (7.4)
Commercial insurance............. 223.2 65.7 351.2 119.9
Specialty insurance.............. (76.6) 18.0 (81.0) (18.4)
-------- -------- -------- --------
185.2 91.9 324.0 94.1
Increase in deferred policy
acquisition costs............... 9.8 9.4 49.4 77.3
-------- -------- -------- --------
Underwriting income.............. 195.0 101.3 373.4 171.4
Investment income.................. 291.0 260.8 568.7 507.1
Other charges...................... (1.5) (14.2) (2.5) (21.7)
-------- -------- -------- --------
Total property and casualty
insurance....................... 484.5 347.9 939.6 656.8
Chubb Financial Solutions
non-insurance business.............. (2.9) (5.8) (17.2) 8.2
Corporate and other loss............. (32.0) (33.9) (64.7) (79.1)
Realized investment gains............ 16.7 20.7 97.6 25.2
-------- -------- -------- --------
Total income before income tax... $ 466.3 $ 328.9 $ 955.3 $ 611.1
======== ======== ======== ========
Page 8
Item 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations for the Six Months Ended June 30, 2004 and 2003
and for the Quarters Ended June 30, 2004 and 2003
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 any terrorist attacks,
including any nuclear, biological, chemical or radiological events;
- the effects of 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;
- development of new theories of liability;
Page 9
- the impact of economic factors 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, particularly in locations where we have
concentrations of risk;
- 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
- the ability to implement management's strategic plans and initiatives.
The Corporation assumes no obligation to update any forward-looking
information set forth in this document, which speak as of the date hereof.
Page 10
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. 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 future obligations under financial products contracts and the
recoverability of the carrying value of real estate properties. These estimates
and judgments, which are discussed within the following analysis of our results
of operations, require the use of assumptions about matters that are highly
uncertain and therefore are subject to change as facts and circumstances
develop. If different estimates and judgments had been applied, materially
different amounts might have been reported in the financial statements.
EXECUTIVE SUMMARY
The following highlights do not address all of the matters covered in the
other sections of Management's Discussion and Analysis of Financial Condition
and Results of Operations or contain all of the information that may be
important to the Corporation's shareholders or the investing public. This
summary should be read in conjunction with the other sections of Management's
Discussion and Analysis of Financial Condition and Results of Operations.
- Net income was $716.8 million in the first six months of 2004 and $356.1
million in the second quarter compared with $476.7 million and $252.1
million, respectively, in the comparable periods of 2003.
- The fundamentals of our property and casualty insurance business remain
strong. Premium growth was 12% in both the first six months and second
quarter of 2004.
- Our combined loss and expense ratio was 92.7% in the first six months of
2004 and 92.8% in the second quarter compared with 95.3% in both
corresponding periods of 2003.
- Our underwriting results in the second quarter of 2004 were adversely
affected by an increase in net loss reserves of about $160 million for
errors and omissions losses related to investment banks. Conversely, these
results benefited from an $80 million reduction in net loss reserves
related to the September 11, 2001 attack.
- We reached an agreement in July 2004 that resulted in Aquila providing us
with collateral sufficient to cover our entire $500 million exposure under
surety bonds issued for Aquila.
- Property and casualty investment income after taxes increased by 12% in
both the first six months and second quarter of 2004.
Page 11
A summary of the Corporation's results for the second quarter and six
months ended June 30, 2004 and 2003 is as follows:
Periods Ended June 30
-------------------------------------------
Second Quarter Six Months
-------------------- --------------------
2004 2003 2004 2003
-------- -------- -------- --------
(in millions)
PROPERTY AND CASUALTY INSURANCE
Underwriting
Net Premiums Written........... $2,929.6 $2,617.3 $5,947.0 $5,292.0
Increase in Unearned Premiums.. (68.0) (84.1) (291.4) (433.6)
-------- -------- -------- --------
Premiums Earned............. 2,861.6 2,533.2 5,655.6 4,858.4
-------- -------- -------- --------
Losses and Loss Expenses....... 1,805.9 1,633.2 3,546.5 3,138.7
Operating Costs and Expenses... 863.3 802.1 1,770.6 1,613.6
Increase in Deferred Policy
Acquisition Costs............. (9.8) (9.4) (49.4) (77.3)
Dividends to Policyholders..... 7.2 6.0 14.5 12.0
-------- -------- -------- --------
Underwriting Income............ 195.0 101.3 373.4 171.4
-------- -------- -------- --------
Investments
Investment Income Before
Expenses...................... 296.8 266.5 580.8 520.1
Investment Expenses............ 5.8 5.7 12.1 13.0
-------- -------- -------- --------
Investment Income.............. 291.0 260.8 568.7 507.1
-------- -------- -------- --------
Other Charges................... (1.5) (14.2) (2.5) (21.7)
-------- -------- -------- --------
Property and Casualty Income.... 484.5 347.9 939.6 656.8
CHUBB FINANCIAL SOLUTIONS
NON-INSURANCE BUSINESS.......... (2.9) (5.8) (17.2) 8.2
CORPORATE AND OTHER.............. (32.0) (33.9) (64.7) (79.1)
REALIZED INVESTMENT GAINS........ 16.7 20.7 97.6 25.2
-------- -------- -------- --------
CONSOLIDATED INCOME BEFORE
INCOME TAX...................... 466.3 328.9 955.3 611.1
Federal and Foreign Income Tax... 110.2 76.8 238.5 134.4
-------- -------- -------- --------
CONSOLIDATED NET INCOME.......... $ 356.1 $ 252.1 $ 716.8 $ 476.7
======== ======== ======== ========
PROPERTY AND CASUALTY INVESTMENT
INCOME AFTER INCOME TAX......... $ 232.4 $ 207.2 $ 454.2 $ 405.2
======== ======== ======== ========
Net income included realized investment gains after taxes of $67.7 million
in the first six months of 2004 and $15.1 million in the second quarter compared
with realized investment gains after taxes of $16.4 million and $13.5 million in
the comparable periods of 2003. 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.
Page 12
PROPERTY AND CASUALTY INSURANCE RESULTS
Earnings from our property and casualty business were significantly higher
in the first six months and second quarter of 2004 compared with the same
periods of 2003. Underwriting income was substantially higher in 2004 due to the
exceptionally strong results in our commercial business and, to a lesser extent,
improvement in our personal business. Investment income also increased
significantly in 2004 compared with 2003. Property and casualty income before
taxes amounted to $939.6 million in the first six months of 2004 and $484.5
million in the second quarter compared with $656.8 million and $347.9 million,
respectively, in 2003.
The profitability of the property and casualty insurance business depends
on the results of both underwriting operations and investments, which we view as
two distinctive operations. The underwriting functions are managed separately
from the investment function. Accordingly, in assessing our performance, we
evaluate underwriting results separately from investment results.
UNDERWRITING RESULTS
We evaluate the underwriting results of our property and casualty
insurance business in the aggregate and also for each of our three separate
business units: personal insurance, commercial insurance and specialty
insurance.
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 underwriting operations
and of each of our business units using the combined loss and expense ratio
calculated in accordance with statutory accounting principles. It is the sum of
the ratio of losses to premiums earned (loss ratio) plus the ratio of
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
applicable to property and casualty insurance companies, policy acquisition and
other underwriting expenses are recognized immediately, not at the time premiums
are earned. We use underwriting results determined in accordance with GAAP,
among other measures, to assess the overall performance of the underwriting
operations. To convert statutory underwriting results to a GAAP basis, policy
acquisition expenses are deferred and amortized over the period in which the
related premiums are earned. Underwriting income determined in accordance with
GAAP is defined as premiums earned less losses incurred and GAAP underwriting
expenses incurred.
Net Premiums Written
Net premiums written were $5.9 billion in the first six months of 2004 and
$2.9 billion in the second quarter, representing increases of 12% compared with
the same periods in 2003. Premium growth was particularly strong in our
reinsurance assumed business generated by Chubb Re.
Page 13
About 80% of our net premiums written are in the United States. U.S.
premiums grew 12% in both the first six months and second quarter of 2004.
Premiums produced by Chubb Re accounted for 4 percentage points of the U.S.
growth in the first six months of 2004 and 2 percentage points of such growth in
the second quarter. On a reported basis, non U.S. premiums grew 15% in the first
six months of 2004 and 12% in the second quarter. In local currencies, such
growth was 4% and 5%, respectively.
We experienced premium growth in the first six months of 2004 in all
segments of our business. The growth was the result of our retaining a high
percentage of our existing customers, attracting new customers and securing
modest rate increases.
As was true for most of 2003, the size of rate increases has decelerated
as the marketplace has become more competitive. We expect that this trend will
continue throughout 2004.
Reinsurance
Our premiums written are net of amounts ceded to reinsurers who assume a
portion of the risk under the insurance policies that are subject to the
reinsurance. 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 costs are expected to increase modestly in 2004. We
discontinued a casualty per risk treaty that responded primarily to excess
liability exposures over $25 million, as underwriting actions we have taken in
recent years have resulted in a reduction in the number of such exposures, which
we believe made this treaty no longer economical. Our executive protection per
risk treaty was renewed with coverage similar to the prior year. On our casualty
clash treaty, which operates like a catastrophe treaty, our retention remained
at $50 million.
Our property reinsurance program was renewed in April 2004. On the
property per risk treaty, our retention remained at $15 million. Our property
catastrophe treaty for events in the United States was modified to increase our
initial retention from $150 million to $250 million and to increase the
reinsurance coverage at the top. The program now provides coverage of
approximately 88% of losses between $250 million and $1.25 billion, with
additional coverage of 95% of losses between $1.25 billion and $1.5 billion in
the northeastern part of the country.
We are making a concerted effort to monitor and control terrorism risk
aggregations. However, given the uncertainty of any potential terrorist attack
and the limited terrorism coverage in our reinsurance program, our future
operating results could be more volatile.
Profitability
Underwriting results were more profitable in the first six months and
second quarter of 2004 than in the comparable periods in 2003. Our combined loss
and expense ratio was 92.7% in the first six months of 2004 and 92.8% in the
second quarter compared with 95.3% in both periods of 2003.
Page 14
Underwriting results in the second quarter of 2004 were adversely affected
by an increase in net loss reserves of about $160 million for errors and
omissions losses related to investment banks. Such results benefited from an $80
million reduction in net loss reserves related to the September 11, 2001 attack.
These reserve adjustments are further discussed under "Loss Reserves."
The loss ratio was 62.9% for the first six months of 2004 and 63.3% for
the second quarter compared with 64.8% and 64.6%, respectively, in the prior
year. Catastrophe losses during the first six months of 2004 amounted to $142.4
million, which represented 2.5 percentage points of the loss ratio compared with
$165.5 million or 3.4 percentage points in 2003. Catastrophe losses for the
second quarter of 2004 amounted to $45.7 million or 1.6 percentage points of the
loss ratio compared with $70.6 million or 2.8 percentage points in 2003. The
above 2004 catastrophe loss amounts exclude the $80 million reduction in loss
reserves related to the September 11, 2001 attack, which reduced the loss ratio
by 1.4 and 2.8 percentage points in the first six months and second quarter,
respectively.
Our expense ratio was 29.8% for the first six months of 2004 and 29.5% for
the second quarter compared with 30.5% and 30.7%, respectively, in 2003. The
decrease in the expense ratio was due primarily to premiums written growing at a
higher rate than overhead expenses.
Page 15
REVIEW OF UNDERWRITING RESULTS BY BUSINESS UNIT
Underwriting results during 2004 and 2003 by business unit were as
follows:
Net Premiums Combined Loss and
Written Expense Ratios
------------------- -----------------
2004 2003 2004 2003
-------- -------- ----- -----
(in millions)
Six Months Ended June 30
PERSONAL INSURANCE
Automobile........................ $ 310.4 $ 289.3 95.0% 100.2%
Homeowners........................ 774.4 711.3 100.6 105.5
Other............................. 278.4 259.3 79.4 77.3
-------- -------- ----- -----
Total Personal................ 1,363.2 1,259.9 95.1 98.5
-------- -------- ----- -----
COMMERCIAL INSURANCE
Multiple Peril.................... 591.6 532.8 76.6 89.0
Casualty.......................... 783.4 678.6 86.1 87.5
Workers' Compensation............. 388.9 317.5 92.7 91.0
Property and Marine............... 558.3 512.5 72.0 90.8
-------- -------- ----- -----
Total Commercial.............. 2,322.2 2,041.4 80.9 89.1
-------- -------- ----- -----
SPECIALTY INSURANCE
Executive Protection.............. 1,051.7 1,001.0 101.6 103.8
Financial Institutions............ 458.1 420.6 135.2 111.7
Other............................. 751.8 569.1 85.5 82.2
-------- -------- ----- -----
Total Specialty............... 2,261.6 1,990.7 102.8 99.3
-------- -------- ----- -----
TOTAL......................... $5,947.0 $5,292.0 92.7% 95.3%
======== ======== ===== =====
Quarter Ended June 30
PERSONAL INSURANCE
Automobile........................ $ 165.8 $ 156.4 94.1% 99.0%
Homeowners........................ 432.7 398.8 92.3 97.8
Other............................. 148.9 139.7 81.9 76.9
-------- -------- ----- -----
Total Personal................ 747.4 694.9 90.7 93.8
-------- -------- ----- -----
COMMERCIAL INSURANCE
Multiple Peril.................... 288.8 256.3 68.7 90.0
Casualty.......................... 371.2 334.5 84.8 89.7
Workers' Compensation............. 167.4 129.1 95.5 95.5
Property and Marine............... 267.7 239.2 72.2 93.9
-------- -------- ----- -----
Total Commercial.............. 1,095.1 959.1 79.0 91.6
-------- -------- ----- -----
SPECIALTY INSURANCE
Executive Protection.............. 497.1 479.4 101.8 104.1
Financial Institutions............ 223.9 196.8 159.8 112.3
Other............................. 366.1 287.1 86.7 85.3
-------- -------- ----- -----
Total Specialty............... 1,087.1 963.3 107.5 99.5
-------- -------- ----- -----
Total......................... $2,929.6 $2,617.3 92.8% 95.3%
======== ======== ===== =====
Page 16
Personal Insurance
Premiums from personal insurance coverages, which represent 23% of net
premiums written, increased by 8% in both the first six months and second
quarter of 2004 compared with the comparable periods in 2003. Premium growth
occurred in all classes; however, growth has slowed somewhat from prior periods
due to increased competition in the marketplace. The premium growth in our
homeowners business was due to increased insurance-to-value and modestly higher
rates; the in force policy count for this class was flat.
Our personal insurance business produced profitable underwriting results
in 2004 and 2003, but more so in 2004. The combined loss and expense ratio was
95.1% in the first six months of 2004 and 90.7% for the second quarter compared
with 98.5% and 93.8%, respectively, in 2003. Results in both years were
adversely affected by significant catastrophe losses. Excluding catastrophe
losses, the combined ratio was 86.7% in the first six months of 2004 and 85.3%
in the second quarter compared with 90.0% and 87.6%, respectively, in 2003.
Our homeowners business produced near breakeven underwriting results in
the first six months of 2004 compared with unprofitable results in 2003. Results
in the second quarter of both years were profitable, but more so in 2004. The
improvement in 2004 was largely the result of better pricing and contract
wording changes. Results in both 2004 and 2003 were adversely affected by
significant catastrophe losses, particularly in the first quarter due to severe
winter weather in the northeastern part of the United States where we have a
significant market presence. Catastrophe losses represented 14.4 percentage
points of the loss ratio for this class in the first six months of 2004 and 8.9
percentage points in the second quarter compared with 14.7 and 10.1 percentage
points, respectively, in 2003.
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 implemented
rate increases in many states. In addition, 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, which have
been implemented in 43 states, are beginning to reduce the frequency and
severity of our water damage losses, particularly in Texas, the state in which
such losses have been most significant.
Our automobile business produced profitable results in 2004 compared with
near breakeven results in 2003. The improvement was due to stable claim
frequency and severity. Other personal coverages, which include insurance for
valuable articles and excess liability, produced highly profitable results in
2004 and 2003 due to continued favorable loss experience.
Commercial Insurance
Premiums from commercial insurance, which represent 39% of our net
writings, increased by 14% in both the first six months and second quarter of
2004 compared with the same periods a year ago. Growth occurred in all segments
of this business but was particularly strong in the workers' compensation class.
Rates continued to increase in 2004 although, as expected, the level of rate
increases declined from 2003 levels as we experienced more competition in the
marketplace. Despite this, retention levels in the first six months of 2004 were
somewhat higher than those in the comparable period of 2003. New business
remained strong but was down from 2003 levels due to a decrease in submission
activity. We continue to get favorable terms and conditions on business written.
Page 17
Our commercial insurance business produced highly profitable underwriting
results in 2004 and 2003. The 2004 results were exceptionally profitable due to
unusually low property losses. The combined loss and expense ratio for
commercial business was 80.9% for the first six months of 2004 and 79.0% for the
second quarter compared with 89.1% and 91.6%, respectively, in 2003. These
profitable results reflect the cumulative effect of price increases, better
terms and conditions and more stringent risk selection in recent years.
Multiple peril produced highly profitable results in 2004 and 2003, but
more so in 2004. Results in the property component of this business were
exceptionally profitable in the second quarter of 2004 due to unusually low
losses. Catastrophe losses represented 2.2 percentage points of the loss ratio
for this class in the first six months of 2004 and 0.4 of a percentage point for
the second quarter compared with 4.4 percentage points and 2.0 percentage
points, respectively, in 2003.
Our casualty business produced highly profitable results in 2004 and 2003.
Such results were due to the price increases over the last several years and
favorable loss experience. The automobile component of this business was highly
profitable in both years. The excess liability component was profitable in both
years, but more so in 2004 due to a $30 million reduction in net loss reserves
in the second quarter related to the September 11, 2001 attack. The primary
liability component was highly profitable in 2003 but was somewhat less
profitable in 2004.
Workers' compensation results were profitable in 2004 and 2003 due in
large part to our disciplined risk selection during the past several years.
Property and marine results were highly profitable in both years,
particularly in 2004, due to few severe losses. Results in the second quarter of
2003 included one $25 million loss that resulted from an adverse arbitration
decision rendered against an insurance pool in which we were formerly a
participant. Catastrophe losses represented 3.1 percentage points of the loss
ratio for this class in the first six months of 2004 and 2.8 percentage points
in the second quarter compared with 7.5 percentage points and 9.2 percentage
points, respectively, in 2003.
Specialty Insurance
Premiums from specialty insurance, which represent 38% of our net
writings, increased by 14% in the first six months of 2004 and 13% in the second
quarter compared with the similar periods in 2003. Premium growth in our
specialty business was enhanced by the growth in premiums generated by Chubb Re.
Premiums produced by Chubb Re grew 53% in the first six months of 2004 and 35%
in the second quarter. We expect that Chubb Re's premium growth in the second
half of the year will be minimal compared with the second half of 2003.
The aggregate growth in our executive protection and financial
institutions businesses was 6% in the first six months of 2004 and 7% in the
second quarter. The pace of rate increases has dropped off significantly as a
result of increased competition in the marketplace. New business in the first
six months of 2004 was down slightly from 2003 levels. Retention levels,
however, were significantly higher than in 2003 and we continued to get
favorable terms and conditions on both renewals and new business.
Page 18
Our specialty insurance business produced unprofitable underwriting
results in the first six months and second quarter of 2004 compared with near
breakeven results in the similar periods of 2003. The combined loss and expense
ratio was 102.8% for the first six months of 2004 and 107.5% for the second
quarter compared with 99.3% and 99.5%, respectively, in 2003. The deterioration
in 2004 was in our financial institutions business.
Executive protection results were unprofitable in 2004 and 2003, but
showed improvement in 2004 due to the impact of higher premiums. Results in both
years were adversely affected by unfavorable development on loss reserves
related to accident years 2002 and prior.
Financial institutions results were highly unprofitable in 2004 and 2003,
but far more so in 2004. The deterioration in 2004 was due to an increase in net
loss reserves of about $160 million in the second quarter for errors and
omissions losses related to investment banks, offset in part by a $50 million
reduction in net loss reserves related to the September 11, 2001 attack. Results
for the professional liability component of this business were highly
unprofitable in both years due to substantial unfavorable prior year development
in the directors and officers liability and errors and omissions liability
classes. Such results were particularly unprofitable in 2004 due to the reserve
increase in the second quarter related to investment banks. Fidelity results
were highly profitable in both years due to favorable loss experience. The
standard commercial business written on financial institutions produced highly
profitable results in both years, reflecting the rate increases and more
stringent risk selection in recent years. Such results were particularly
profitable in 2004 due to the $50 million reduction in loss reserves in the
second quarter related to the September 11, 2001 attack.
Our other specialty results were highly profitable in 2004 and 2003. Our
surety business produced highly profitable results in both years, but more so in
2003 due to a $17 million recovery from the sale of a bankruptcy claim against
various Enron entities. Our accident business was more profitable in 2004 than
in 2003. Our reinsurance assumed business generated by Chubb Re was similarly
profitable in 2004 and 2003.
Our 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. We
therefore 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.
Page 19
We have in force $500 million of gas forward purchase surety bonds with
one principal, Aquila. Our exposure under these bonds will decline over the
terms of the bonds, which extend until 2012. These surety bonds 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. Neither of these events has occurred. In July 2004, a
settlement was reached and approved by the court that resulted in Aquila
providing us with collateral sufficient to cover our entire exposure under the
surety bonds. The cost of this agreement to us will be no more than $15 million.
LOSS RESERVES
Loss reserves at June 30, 2004 and December 31, 2003 included significant
amounts related to asbestos and toxic waste claims and the September 11, 2001
attack. The components of loss reserves were as follows:
June 30, December 31,
2004 2003
-------- ------------
(in millions)
Gross loss reserves
Total, per balance sheet $ 19,053 $ 17,948
Less:
Related to asbestos and toxic
waste claims 1,129 1,295
Related to September 11 attack 790 999
-------- ------------
Total, as adjusted $ 17,134 $ 15,654
======== ============
Reinsurance recoverable
Total, per balance sheet $ 3,593 $ 3,427
Less:
Related to asbestos and toxic
waste claims 55 57
Related to September 11 attack 649 748
-------- ------------
Total, as adjusted $ 2,889 $ 2,622
======== ============
Net loss reserves
Total $ 15,460 $ 14,521
Total, as adjusted 14,245 13,032
The loss reserves related to asbestos and toxic waste claims and the
September 11 attack 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
$1,213 million during the first six months of 2004.
Page 20
Net loss reserves, as adjusted, by segment were as follows:
June 30, December 31,
2004 2003
-------- ------------
(in millions)
Personal insurance $ 1,341 $ 1,219
Commercial insurance 5,518 5,248
Specialty insurance 7,386 6,565
-------- ------------
Net loss reserves, as adjusted $ 14,245 $ 13,032
======== ============
Loss reserves for each of our business segments increased significantly in
the first six months of 2004. The increase was most significant in specialty
insurance, due in large part to directors and officers liability and errors and
omissions liability claim activity, including the errors and omissions reserve
increase related to investment banks discussed below, as well as the strong
growth in our reinsurance assumed business.
In the second quarter, we updated our analysis of our exposure to
investment banking errors and omissions claims related to report years 2002 and
prior. These claims pertain principally to allegations against investment banks
of laddering or of aiding and abetting in certain of the high-profile corporate
abuse cases. During the quarter, the last of the significant regulatory
settlements was announced, clearing the way for intensified and accelerated
attention to the class action litigation that drives our exposure. In addition,
recent developments in litigation relating to various corporate abuse scandals
have led a number of investment banks to focus on, and in some cases pursue
vigorously, settlement strategies. These developments and other information
about potential settlement ranges and allocations of responsibility among
investment banks for which we were one of the insurers were considered as part
of the analysis of our exposure that led to our decision to increase net loss
reserves by about $160 million.
Separately, we reduced our net loss reserves related to the September 11,
2001 attack by $80 million in the second quarter as a result of several recent
events. In March, the deadline for filing a liability claim with respect to the
September 11 attack expired. That enabled us to define more precisely the number
of claimants under liability policies. Then, in June, the final award
determinations for claimants of the World Trade Center Victims Compensation Fund
were made. As for our property exposure, in April, the jury in the Silverstein
case found that we had bound coverage under a policy form that defined the
September 11 attack as one occurrence. The effect of that verdict was to
eliminate the need for us to make any additional payment. While we expect an
appeal by the August 15 filing deadline, we believe any appeal would have no
merit.
Page 21
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 June 30, 2004 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 liabilities may
emerge in future periods for amounts in excess of carried reserves. Such
increases in estimates 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 RESULTS
Property and casualty investment income before taxes increased by 12% in
both the first six months and second quarter of 2004 compared with the same
periods in 2003. The growth in investment income was due to an increase in
invested assets since the second quarter of 2003. The increase in invested
assets was due to substantial cash flow from operations over the period as well
as a capital contribution of $800 million to the property and casualty
subsidiaries by the Corporation toward the end of the second quarter of 2003.
Growth in investment income in 2004 was dampened, however, by lower available
reinvestment rates on fixed maturities that matured over the past year.
The effective tax rate on investment income was 20.1% in both the first
six months of 2004 and 2003. The effective tax rate on investment income is
lower than the statutory tax rate due to our holding a portion of our investment
portfolio in tax-exempt securities. On an after-tax basis, property and casualty
investment income increased by 12% both in the first six months and second
quarter of 2004. 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 income tax.
OTHER CHARGES
Other charges include miscellaneous income and expenses of the property
and casualty subsidiaries. Other charges in the first six months of 2003
included expenses of $15 million related to the restructuring of our operations
in Continental Europe, of which $11 million was expensed in the second quarter.
The restructuring costs consisted primarily of severance costs.
CHUBB FINANCIAL SOLUTIONS
Chubb Financial Solutions (CFS) was organized 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.
In April 2003, the Corporation announced its intention to exit CFS's
non-insurance business and to run-off the existing financial products portfolio.
Page 22
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.
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 the credit default swaps
tend to be unique transactions and there is no market for trading 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.
The fair value of our 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 has had a significant effect on the
Corporation's results of operations from period to period.
The non-insurance business of CFS produced a loss before taxes of $17.2
million in the first six months of 2004 compared with income of $8.2 million in
the first six months of 2003. The loss in the first six months of 2004 was
primarily related to the termination during the period of CFS's obligations
under certain credit default swaps. Results for the first six months of 2003
benefited from an improvement in corporate credit spreads, partially offset by
deterioration in the credit quality of the asset-backed portfolio and severance
costs.
Revenues from the non-insurance business of CFS, primarily consisting of
the change in fair value of derivative contracts, were negative $3.2 million in
the first six months of 2004 and positive $17.9 million in the same period of
2003. Revenues were negative in 2004 due to the termination of several portfolio
credit default swaps during the period.
CFS's aggregate exposure, or retained risk, from each of its in-force
portfolio credit default swaps is referred to as notional amount. 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 notional amount of CFS's credit default swaps was reduced to $11.4
billion at June 30, 2004 from $24.7 billion at December 31, 2003 and $43.0
billion at June 30, 2003. This reduction in notional amount of credit default
swaps has been accomplished either by terminating the swap with the original
counterparty at a negotiated settlement amount or by entering into a credit
default swap with a third party that effectively offsets the existing credit
default swap. As of June 30, 2004, approximately $1.5 billion of the reduction
in notional amount of credit default swaps had been accomplished by entering
into offsetting credit default swaps.
Page 23
Our realistic loss exposure is a very small portion of the $11.4 billion
notional amount due to several factors. Our position is senior to subordinated
interests of $5.4 billion in the aggregate. Of the $5.4 billion of
subordination, only $37 million has eroded due to defaults through June 30,
2004, none of which has pierced the subordination limits of any of our
contracts. In addition, using internal rating models, CFS estimates that the
credit ratings of the individual portfolio credit default swaps at June 30,
2004 were either AAA or AA.
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.
The notional amount and fair value of our future obligations under
derivative contracts by type of risk were as follows:
Notional Amount Fair Value
----------------------- -----------------------
June 30, December 31, June 30, December 31,
2004 2003 2004 2003
-------- ------------ -------- ------------
(in billions) (in millions)
Credit default swaps
Corporate securities $ 1.3 $ 11.2 $ 6 $ 21
Asset-backed securities 7.4 10.5 9 23
Loan portfolios 2.7 3.0 1 2
-------- ------------ -------- ------------
11.4 24.7 16 46
Other .3 .4 8 9
-------- ------------ -------- ------------
$ 11.7 $ 25.1 $ 24 $ 55
======== ============ ======== ============
In the fourth quarter of 2003, CFS terminated two asset-backed portfolio
credit default swaps that had experienced deterioration in credit quality and
simultaneously entered into a new contract that guarantees principal and
interest obligations. The Corporation guaranteed CFS's obligations under the
contract. CFS's potential payment obligation extends to the date when the last
of the underlying obligations expires. At June 30, 2004, the notional amount of
referenced securities was $2.1 billion. Under the agreement, CFS's maximum
potential payment obligation is limited to $500 million regardless of the amount
of losses that might be incurred on the $2.1 billion of referenced securities.
Moreover, if losses are incurred, CFS's payment obligations are limited to an
extended payment schedule under which no payment would be due until 2010 at the
earliest.
CFS established a liability of $186 million related to the principal and
interest contract, which represented the estimated fair value of the guarantee
at its inception. The principal and interest guarantee is not a derivative
contract. Therefore, the liability related to this contract is not
marked-to-market each period. Due to the nature of the guarantee, we will reduce
this liability only upon either the expiration or settlement of the guarantee.
If actual losses are incurred, a liability for the losses will be established,
and a portion of the guarantee liability will be released. The amount released
will depend on our evaluation of expected ultimate loss experience.
Page 24
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. Corporate and other produced a loss before taxes of
$64.7 million in the first six months of 2004 compared with a loss of $79.1
million in the first six months of 2003. The lower loss in 2004 was due
primarily to higher investment income and higher income from our investment in
Allied World Assurance Company, Ltd. offset in part by higher interest expense.
Investment income was higher in 2004 due to an increase in corporate invested
assets resulting from the issuance of debt and equity securities during 2003.
Interest expense was higher in 2004 due primarily to the issuance of $500
million of debt in the first quarter of 2003 and $460 million of debt in the
second quarter of 2003.
In both 2004 and 2003, corporate results included a loss at The Chubb
Institute, Inc., our post secondary educational subsidiary. As part of our focus
on our core insurance business, in May 2004, we entered into an agreement to
sell Chubb Institute. The sale transaction is further discussed under "Realized
Investment Gains and Losses."
REAL ESTATE
Real estate operations resulted in a loss before taxes of $8.5 million in
the first six months of 2004 compared with a loss of $2.5 million in the same
period in 2003, which amounts are included in the corporate and other results.
We own approximately $275 million of land that we expect will be developed
in the future. In addition, our real estate assets include approximately $175
million of commercial properties and land parcels under lease, of which $23
million relates to a variable interest entity in which we are the primary
beneficiary. We are continuing to explore the sale of certain of our remaining
properties.
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.
Page 25
REALIZED INVESTMENT GAINS AND LOSSES
Net investment gains realized were as follows:
Periods Ended June 30
---------------------------------------
Second Quarter Six Months
----------------- -----------------
2004 2003 2004 2003
------ ----- ------ -----
(in millions)
Net realized gains (losses)
Equity securities $ 73.8 $ 3.5 $129.9 $19.4
Fixed maturities (30.1) 40.1 (5.3) 52.7
Chubb Institute (27.0) - (27.0) -
------ ----- ------ -----
16.7 43.6 97.6 72.1
------ ----- ------ -----
Other than temporary impairment
Equity securities - 5.2 - 13.3
Fixed maturities - 17.7 - 33.6
------ ----- ------ -----
- 22.9 - 46.9
------ ----- ------ -----
Realized investment gains
before tax $ 16.7 $20.7 $ 97.6 $25.2
====== ===== ====== =====
Realized investment gains
after tax $ 15.1 $13.5 $ 67.7 $16.4
====== ===== ====== =====
A substantial portion of the realized gains in 2004 from equity securities
related to our share of gains recognized by investment partnerships in which we
have an interest.
In May 2004, we entered into an agreement to sell Chubb Institute. Based
on the terms of the agreement, we recognized a loss of $27 million in the second
quarter. The sale is expected to close in the third quarter.
We regularly review our invested assets with a fair value below cost to
determine if an other than temporary decline in value has occurred. In
evaluating whether a decline in value of any investment is other than temporary,
we consider various quantitative and qualitative 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. The
fair value of the investment becomes its new cost basis.
CAPITAL RESOURCES AND LIQUIDITY
Capital resources and liquidity represent the overall financial strength
of the Corporation and its ability to generate cash flows from its operating
subsidiaries, borrow funds at competitive rates and raise new capital to meet
operating and growth needs.
Page 26
CAPITAL RESOURCES
Capital resources provide protection for policyholders, furnish the
financial strength to support the business of underwriting insurance risks and
facilitate continued business growth. At June 30, 2004, the Corporation had
shareholders' equity of $8.9 billion and total debt of $2.8 billion.
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 June 2003,
a 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. At June 30, 2004, the Corporation had approximately $650 million
remaining under the shelf registration statement.
In July 1998, the Board of Directors authorized the repurchase of up to
12,500,000 shares of the Corporation's common stock. The authorization has no
expiration. The Corporation made no share repurchases during the first six
months of 2004. As of June 30, 2004, 3,287,100 shares remained under the share
repurchase authorization. We do not anticipate that we will repurchase any
shares of our common stock in 2004.
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, strategic position and ability to meet our
obligations to policyholders.
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.
It is possible that positive or negative ratings actions may occur in the
future. If our ratings were downgraded, the Corporation may incur higher
borrowing costs and may have more limited means to access capital.
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.
Page 27
Our property and casualty operations provide liquidity in that premiums
are generally received months or even years before losses are paid under the
policies purchased by such premiums. 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. After satisfying our cash requirements, excess
cash flows are used to build the investment portfolio and thereby increase
future investment income.
New cash from operations available for investment by the property and
casualty subsidiaries was approximately $1.7 billion in the first six months
of 2004 compared with $1.1 billion in the same period in 2003. The increase in
new cash in 2004 was due to premium receipts increasing at a greater rate than
paid losses and operating expenses.
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 in the past have been met by
dividends from its property and casualty subsidiaries and the issuance of
commercial paper and debt and equity securities. Subject to our operating
results, financial condition, capital structure and any regulatory constraints,
it is expected that our liquidity requirements in the future will be met by
these sources of funds or, if necessary, borrowings from our credit facilities.
The Corporation has two credit agreements with a group of banks 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 24, 2004, was extended to June 22, 2005. The $250 million medium term
revolving credit facility terminates on June 28, 2007. There have been no
borrowings under these agreements.
INVESTED ASSETS
The main objectives in managing our investment portfolios are to maximize
after-tax investment income and total investment returns while minimizing credit
risks in order to provide maximum support to the insurance underwriting
operations. Investment strategies are developed based on many factors including
underwriting results and our resulting tax position, regulatory requirements,
fluctuations in interest rates and consideration of other market risks.
Investment decisions are centrally managed by investment professionals based on
guidelines established by management and approved by the boards of directors.
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 six months of 2004, we invested new cash in tax-exempt bonds
and taxable bonds. The taxable bonds were primarily mortgage-backed securities
and U.S. Treasury securities. Our objective is to achieve the appropriate mix of
taxable and tax-exempt securities in our portfolio to balance both investment
and tax strategies.
Page 28
The unrealized appreciation before tax of investments carried at market
value, which includes fixed maturities classified as available-for-sale and
equity securities, was $434 million and $1,036 million at June 30, 2004 and
December 31, 2003, respectively. Such unrealized appreciation is reflected in a
separate component of other comprehensive income, net of applicable deferred
income tax. The decrease in unrealized appreciation in the first six months of
2004 was due primarily to the impact of an increase in interest rates on the
market value of our fixed maturities.
The unrealized market appreciation before tax of those fixed maturities
carried at amortized cost was $24 million at June 30, 2004 and $35 million at
December 31, 2003. Such unrealized appreciation was not reflected in the
consolidated financial statements.
Page 29
Item 4 - Controls and Procedures
As of June 30, 2004, 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 June 30, 2004, there were no changes
in internal control over financial reporting that have materially affected, or
are reasonably likely to materially affect, the Corporation's internal control
over financial reporting.
Page 30
PART II. OTHER INFORMATION
Item 6 - Exhibits and Reports on Form 8-K
A. Exhibits
Exhibit (10) Material contracts
(1) Medium-Term Credit Agreement, dated as of June 28, 2002, among
The Chubb Corporation, the Banks listed on the signature pages
thereof, Deutsche Bank Securities Inc. and Salomon Smith
Barney Inc., as Arrangers, Deutsche Bank AG New York Branch,
as Administrative Agent, and Citibank, N.A., as Syndication
Agent.
(2) Amended and Restated Short-Term Credit Agreement and
Amendment to Medium-Term Credit Agreement, dated as of June
26, 2003, among The Chubb Corporation, the Banks listed on
the signature pages thereof, Deutsche Bank Securities Inc.
and Salomon Smith Barney Inc., as Arrangers, Deutsche Bank AG
New York Branch and Citibank, N.A. as Swingline Lenders,
Deutsche Bank AG New York Branch, as Administrative Agent,
and Citibank, N.A., as Syndication Agent.
(3) Amended and Restated Short-Term Credit Agreement, dated as of
June 23, 2004, among The Chubb Corporation, the Banks listed
on the signature pages thereof, Deutsche Bank Securities Inc.
and Citigroup Global Markets Inc., as Arrangers, Deutsche Bank
AG New York Branch and Citicorp USA, Inc. as Swingline
Lenders, Deutsche Bank AG New York Branch, as Administrative
Agent, and Citicorp USA, Inc., as Syndication Agent.
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 April 14, 2004
furnishing under Item 9 information with respect to the sale by the
Registrant of its investment in Hiscox plc.
The Registrant filed a current report on Form 8-K on April 26, 2004
furnishing under Item 12 information with respect to the issuance of a
press release announcing its results for the quarter ended March 31,
2004 and the availability of its Supplementary Investor Information
Report for the quarter ended March 31, 2004.
The Registrant filed a current report on Form 8-K on May 4, 2004 under
Item 5 regarding matters submitted to a vote of the Corporation's
security holders at the Corporation's annual meeting conducted on April
27, 2004, including the voting results relating thereto.
The Registrant filed a current report on Form 8-K on May 21, 2004 under
Item 9 regarding the execution by one of its subsidiaries of an
agreement to sell The Chubb Institute and regarding the Registrant's
receipt of a subpoena from the Attorney General of the State of New
York seeking information regarding broker compensation.
Page 31
The Registrant filed a current report on Form 8-K on July 20, 2004
furnishing under Item 9 information with respect to a settlement
agreement between two subsidiaries of the Registrant and Aquila, Inc.
The Registrant filed a current report on Form 8-K on July 22, 2004
furnishing under Item 9 information with respect to court approval of
the settlement agreement between two subsidiaries of the Registrant
and Aquila, Inc.
The Registrant filed a current report on Form 8-K on July 27, 2004
furnishing under Item 12 information with respect to the issuance of a
press release announcing its results for the quarter ended June 30,
2004 and the availability of its Supplementary Investor Information
Report for the quarter ended June 30, 2004.
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: August 6, 2004