Chubbs Corporation (FSA)

Kanan Shah, PGP35214

Chubb Corporation is a P&C insurance holding company whose insurance operations are divided into three
business units:
1. Chubb commercial insurance: Offers full range of retail customer insurance products.
2. Chubb Specialty Insurance: Offers specialized commercial products as well as reinsurance through Chubb
Re. This included specialty surety and business continuity lines.
3. Chubb Personal Insurance: Offers products for individuals who require greater coverage choices and higher
limits than standard insurance policies.

How do insurers make money?

Insurance companies primarily make money in two ways:
Underwriting operational income: This is the excess of earned premiums over claims and other expenses
pertaining to claims handling and business acquisition.
Investment Income: Insurers reserve a portion of the premiums received to meet the claims and other
expenses. The rest is invested to generate shareholder returns. Hence this income is operational too. This
investment income may or may not be realized, since the insurers typically invest part of their premiums in
assets which may be held till maturity.

Reformulated balance sheet:

(US$mn, Dec YE) 2007 2006

Operating assets
Cash 49 38
Premiums receivable 2,227 2,314
Reinsurance recoverable on unpaid claims 2,307 2,594
Prepaid reinsurance premiums 392 354
Deferred policy acquisition costs 1,556 1,480
Deferred income tax 442 591
Goodwill 467 467
Other assets 1,366 1,715
Total operating assets (A) 8,806 9,553

Operating liabilities
Unpaid claims and loss expenses 22,623 22,293
Unearned premiums 6,599 6,546
Accrued expenses and other liabilities 2,090 2,385
Total operating liabilities (B) 31,312 31,224

Net operating assets- Underwriting (C=A-B) (22,506) (21,671)

Short-term investments 1,839 2,254

Held-to-maturity-tax exempt(market $142 in 2006) 135
Available-for sale
Tax exempt (cost $18,208 and $17,314) 18,559 17,613
Taxable (cost $15,266 and $14,310) 15,312 14,218
Equity securities (cost $1,907 and $1,561) 2,320 1,957
Other invested assets 2,051 1,516
Securities lending collateral 1,247 2,620
 Accrued investment income 440 411
Total Investment Operating Assets (D) 41,768 40,724

Financial Liabilities
Securities lending payable 1,247 2,620
Long-term debt 3,460 2,466
Total Financial Operating Liabilities (E) 4,707 5,086

Net Financial Operating assets (F=D-E) 37,061 35,638

Common shareholders' equity (C+F) 14,555 13,967

Reported common shareholders' equity 14,445 13,863

Dividends payable 110 104
14,555 13,967
Note that Cash is treated as operating asset here as Insurers have greater Working capital requirement as cash to ensure claims fulfilment

Reformulated comprehensive income statement:

(US$mn, Dec YE) 2007 2006 2005

Underwriting operations
Premiums earned 11,946 11,958 12,176
Claims and expenses:
Losses and loss expenses (6,299) (6,574) (7,813)
Amortization of deferred policy acquisition costs (3,092) (2,919) (2,931)
Other insurance operating costs and expenses (444) (550) (512)
Other expenses (48) (207) (161)
Corporate expenses (252) (194) (190)
Operating income before tax, underwriting and other 1,811 1,514 569

Income tax reported (1,130) (997) (621)

Tax on investment income (663) (704) (657)
Core operating income after tax - underwriting (467) (293) 36
Foreign currency translation gains (losses), net of tax 125 34 (22)
Change in post-retirement benefit costs, net of tax (17)
Operating income after tax, underwriting and other 1,452 1,255 583

Investment operations:
Before-tax revenues:
Taxable Investment income 1,506 1,580 1,408
Other revenues 49 220 115
Realized investment gains 374 245 384
Investment expenses (35) (34) (29)
Investment Income before tax 1,894 2,011 1,878
Tax (35%) (663) (704) (657)
Investment Income after tax 1,231 1,307 1,221
Tax-exempted investment income 232
Change in unrealized appreciation of investments, net of tax 134 81 (313)
 Net investment income after tax 1,597 1,388 908

Total comprehensive income 3,049 2,643 1,491

A: Insurance companies have Fixed income portfolios- a part of which they hold till maturity. Hence these
investments are recorded at book value. Any investments that are not to be held till maturity would be marked to
market. These unrealised gains/losses would be a part of investment income in the reformulated income statement.

B: Insurance companies may have negative NOA from their underwriting operations. This is because the premiums
they receive are more or less fixed cash inflows and the cash outflow from claims is spread over a longer time
period. This this mismatch can be exploited by investing the premium amount( which would reduce cash) and
generating returns from it. However, the recorded liabilities arising from the business would be larger hence NOA
would be negative.

C: Investment gains/losses tend to be notional. Also, many insurers have negative earnings from their underwriting
operations which are offset by unrealised investment gains. Therefore, keeping these income streams separate for
the purpose of analysis in important

D: It is desirable to have income from an insurer to be reported on a comprehensive basis as insurers may overstate
their income by booking profits which they haven’t realised yet on their profitable investments to inflate their
investment incomes and hence the overall profit

E: Value of investments= 41,768 – 1,247 = 40,521, as most investments are marked to market
F: Some key ratios for Chubb Corporation:
(US$mn, Dec YE) 2007
Underwriting margin (pre tax) 15.2%
Investment income margin (pre tax) 15.9%
Comprehensive RoAE (%) 21.4%
Claims ratio (%) 52.7%
Expense ratio (%) 32.1%
Combined ratio (%) 84.8%
OLLEV 162.6%

Chubb Corporation is profitable at the underwriting level which showing strong fundamentals and lesser risk of
change in investment income due to market movements. It has a combined ratio below 100%. Comprehensive RoAE
of 21.4% is also pretty solid for an insurance firm.
The OLLEV of 162.6% may look like a cause for concern but it may stem from the negative NOA and the typical cash
cycle for insurer. Hence it must be examined with respect to the OLLEV for a typical P&C insurer in USA like Allstate.