ace tempest reinsurance ltd. and its subsidiaries

ACE Tempest Reinsurance Ltd. and itssubsidiaries(Incorporated in Bermuda)

Consolidated Financial StatementsDecember 31, 2012 and 2011(in thousands of dollars)

PricewaterhouseCoopers, Chartered Accountants, P.O. Box HM 1171, Hamilton HM EX, BermudaT: +1 (441) 295 2000, F: +1 (441) 295 1242, www.pwc.com/bermuda

Independent Auditor's Report

To the Board of Directors and Shareholder ofACE Tempest Reinsurance Ltd. and its subsidiaries

We have audited the accompanying consolidated financial statements of ACE Tempest ReinsuranceLtd. and its subsidiaries, which comprise the consolidated balance sheets as of December 31, 2012and 2011, and the related consolidated statements of operations and comprehensive income, ofshareholder’s equity and of cash flows for the years then ended.

Management's Responsibility for the Consolidated Financial StatementsManagement is responsible for the preparation and fair presentation of the consolidated financialstatements in accordance with accounting principles generally accepted in the United States ofAmerica; this includes the design, implementation, and maintenance of internal control relevant tothe preparation and fair presentation of consolidated financial statements that are free frommaterial misstatement, whether due to fraud or error.

Auditor's ResponsibilityOur responsibility is to express an opinion on the consolidated financial statements based on ouraudits. We conducted our audits in accordance with auditing standards generally accepted in theUnited States of America. Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the consolidated financial statements are free from materialmisstatement.

An audit involves performing procedures to obtain audit evidence about the amounts anddisclosures in the consolidated financial statements. The procedures selected depend on ourjudgment, including the assessment of the risks of material misstatement of the consolidatedfinancial statements, whether due to fraud or error. In making those risk assessments, we considerinternal control relevant to the Company's preparation and fair presentation of the consolidatedfinancial statements in order to design audit procedures that are appropriate in the circumstances,but not for the purpose of expressing an opinion on the effectiveness of the Company's internalcontrol. Accordingly, we express no such opinion. An audit also includes evaluating theappropriateness of accounting policies used and the reasonableness of significant accountingestimates made by management, as well as evaluating the overall presentation of the consolidatedfinancial statements. We believe that the audit evidence we have obtained is sufficient andappropriate to provide a basis for our audit opinion.

Reference: Independent Auditor’s Report on the consolidated financial statements of ACE TempestReinsurance Ltd. and its subsidiaries for the years ended December 31, 2012 and 2011.

Page: 2 of 2

OpinionIn our opinion, the consolidated financial statements referred to above present fairly, in all materialrespects, the financial position of ACE Tempest Reinsurance Ltd. and its subsidiaries atDecember 31, 2012 and 2011, and the results of their operations and their cash flows for the yearsthen ended in accordance with accounting principles generally accepted in the United States ofAmerica.

Chartered AccountantsBermudaApril 26, 2013

ACE Tempest Reinsurance Ltd. and its subsidiariesConsolidated Balance SheetsAs at December 31, 2012 and 2011

(in thousands of U.S. dollars, except par value)

The accompanying notes are an integral part of these consolidated financial statements.

2012$

2011$

AssetsFixed maturities available for sale, at fair value

(amortized cost $13,865,520 and $12,584,216) 14,781,847 13,067,204Fixed maturities held to maturity, at amortized cost

(fair value $149,730 and $222,641) 144,357 214,645Equity securities, at fair value (cost $491,790 and $465,313) 499,860 432,127Short-term investments, at cost and fair value 475,065 402,655Other investments (cost $1,628,295 and $1,416,480) 1,777,566 1,534,575Cash 77,951 91,861Total investments and cash 17,756,646 15,743,067

Securities lending collateral 632,358 454,176Accrued investment income 141,201 146,884Reinsurance balances receivable 623,273 708,153Prepaid reinsurance premiums 189,259 181,074Reinsurance recoverable 1,157,735 1,227,924Value of reinsurance business assumed 249,151 259,449Deferred policy acquisition costs 132,118 125,180Goodwill 364,959 364,959Amounts due from affiliates 532,332 104,467Funds withheld 286,415 103,468Other assets 82,162 34,617Total assets 22,147,609 19,453,418

LiabilitiesUnpaid losses and loss expenses 7,207,735 7,326,121Future policy benefits 1,044,258 757,504Unearned premiums 1,184,380 1,140,945Reinsurance balances payable 545,373 520,612Securities lending payable 633,414 457,474Payable for securities purchased 259,314 72,172Accounts payable, accrued expenses and other liabilities 281,763 234,316Short-term debt 550,470 400,210Amounts due to affiliates 13,360 38,928Funds withheld 12,561 -Total liabilities 11,732,628 10,948,282

Shareholder’s equityACE Tempest Reinsurance Ltd. shareholder’s equityCommon shares ($10 par value, 10,000,000 authorized

280,000 issued and outstanding) 2,800 2,800Additional paid-in capital 2,472,332 2,472,332Retained earnings 6,412,891 5,030,231Accumulated other comprehensive income 1,057,288 575,651Total ACE Tempest Reinsurance Ltd. shareholder’s equity 9,945,311 8,081,014Non-controlling interest 469,670 424,122Total shareholder’s equity 10,414,981 8,505,136Total liabilities and shareholder’s equity 22,147,609 19,453,418

ACE Tempest Reinsurance Ltd. and its subsidiariesConsolidated Statements of Operations and Comprehensive IncomeFor the years ended December 31, 2012 and 2011

(in thousands of dollars)


2012$

2011$

RevenuesGross premiums written

Property and casualty premiums 4,244,099 4,072,869Life and annuity premiums 617,712 568,705

4,861,811 4,641,574Reinsurance premiums ceded (180,088) (646,069)

Net premiums written 4,681,723 3,995,505Change in unearned premiums (64,938) (5,294)

Net premiums earned 4,616,785 3,990,211Net investment income 657,134 654,353Net realized gains (losses):Other-than-temporary impairment (OTTI) losses gross (16,379) (29,516)Portion of OTTI losses recognized in other comprehensive income 463 4,599

Net OTTI losses recognized in income (15,916) (24,917)Net realized gains (losses) excluding OTTI losses (154,696) 8,923

Total net realized losses (170,612) (15,994)

Total revenues 5,103,307 4,628,570

ExpensesLosses and loss expenses 2,129,164 2,327,365Future policy benefits 102,313 19,067Policy acquisition costs 1,285,237 1,295,195Administrative expenses 18,490 19,449Interest expense 3,299 1,485Other expenses, net 28,116 34,596

Total expenses 3,566,619 3,697,157

Net Income 1,536,688 931,413Less: Net income attributable to the non-controlling interest 29,028 13,638

Net Income attributable to ACE Tempest Reinsurance Ltd. 1,507,660 917,775

Other comprehensive incomeUnrealized appreciation on investments 552,596 112,685Reclassification adjustments for net realized gainsincluded in net income (66,972) (62,809)

485,624 49,876Change in:Cumulative Translation Adjustments (3,987) 1,442

Other comprehensive income 481,637 51,318

Comprehensive income 2,018,325 982,731Less: Comprehensive income attributable to the non-controlling interest 45,548 20,962

Comprehensive income attributable to ACE Tempest Reinsurance Ltd. 1,972,777 961,769

ACE Tempest Reinsurance Ltd. and its subsidiariesConsolidated Statements of Shareholder’s EquityFor the years ended December 31, 2012 and 2011



2012$

2011$

Common sharesBalance – beginning and end of year 2,800 2,800

Additional paid-in capitalBalance – beginning of year 2,472,332 2,472,332Change in year - -

Balance – end of year 2,472,332 2,472,332

Retained earningsBalance, beginning of year, as reported 4,926,860Cumulative effect of adjustment resulting from adoption of newaccounting guidance (4,404)Balance – beginning of year, as adjusted 5,030,231 4,922,456Net income 1,507,660 917,775Dividends declared (125,000) (810,000)

Balance - end of year 6,412,891 5,030,231

Accumulated other comprehensive incomeNet unrealized appreciation on investments

Balance – beginning of year 585,020 535,144Change in year 485,624 49,876

Balance - end of year 1,070,644 585,020

Cumulative Translation AdjustmentsBalance – beginning of year (9,369) (10,811)Change in year (3,987) 1,442

Balance - end of year (13,356) (9,369)

Accumulated other comprehensive income 1,057,288 575,651

Total ACE Tempest Reinsurance Ltd. shareholder’s equity 9,945,311 8,081,014

Non-controlling interestBalance - beginning of year 424,122 413,321Distributions to holder of non-controlling interest - (10,161)Net income 29,028 13,638Change in year - unrealized appreciation 16,520 7,324

Total non-controlling interest 469,670 424,122

ACE Tempest Reinsurance Ltd. and its subsidiariesConsolidated Statements of Cash FlowsFor the years ended December 31, 2012 and 2011



2012$

2011$

Cash flows from (used in) operating activitiesNet income 1,536,688 931,413Adjustments to reconcile net income to net cash flows from

operating activities:Net realized losses 170,612 15,994Amortization of premiums/discounts on fixed maturities 35,006 23,774Unpaid losses and loss expenses, net of reinsurance recoverable (168,481) 21,097Future policy benefits, net of reinsurance recoverable 327,325 14,875Unearned premiums 36,402 3,953Reinsurance balances payable 23,676 218,317Amounts due from affiliates (428,920) 29,678Accounts payable, accrued expenses, other liabilities and funds withheld (132,743) 130,242Reinsurance balances receivable 78,582 261,420Prepaid reinsurance premiums (2,981) 1,818Accrued investment income 6,651 (6,383)Deferred policy acquisition costs (5,972) (512)Value of reinsurance business assumed 10,298 23,312Amounts due to affiliates (25,568) (19,342)Other (256,090) (16,123)

Net cash flows from operating activities 1,204,485 1,633,533

Cash flows from (used in) investing activitiesPurchases of fixed maturities (available for sale and held to maturity) (7,254,509) (6,700,241)Purchases of equity securities (35,286) (135,679)Sales of fixed maturities available for sale 4,498,129 4,442,727Sales of equity securities 8,995 17,092Maturities and redemptions of fixed maturities available for sale 1,639,750 966,529Maturities and redemptions of fixed maturities held to maturity 68,809 86,315Net derivative instruments settlements (13,308) (43,142)Purchases of other investments, net (165,030) (126,610)Other 2,574 -Net cash flows used in investing activities (1,249,876) (1,493,009)

Cash flows from (used in) financing activitiesDistributions to non-controlling interest - (10,161)Repayment of short-term debt (950,000) -Proceeds from issuance of short-term debt 1,100,260 400,210Dividends paid (125,000) (810,000)Proceeds from repayment of loan to affiliate - 133,204Net cash flows from (used in) financing activities 25,260 (286,747)

Effect of foreign currency rate change on cash and cash equivalents 6,221 45

Net decrease in cash (13,910) (146,178)Cash - beginning of year 91,861 238,039Cash - end of year 77,951 91,861

Supplemental cash flow informationInterest paid 3,015 1,275

ACE Tempest Reinsurance Ltd. and its subsidiariesNotes to Consolidated Financial StatementsDecember 31, 2012 and 2011

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1. General

ACE Tempest Reinsurance Ltd. (“the Company” or “ATR”) was incorporated under the laws of Bermuda on February 22,1996 and is a wholly-owned subsidiary of ACE Tempest Life Reinsurance Ltd. (“ATLR”). The Company’s ultimateparent company is ACE Limited (“ACE”).

2. Principal Business

The Company provides property catastrophe, property, casualty and accident and health reinsurance for a diverse group ofcustomers worldwide. For these classes of business during the year ended December 31, 2012, approximately 51 percent(2011 - 46 percent) of the Company’s net premiums earned came from North America, 21 percent (2011 - 25 percent)from Europe, 19 percent (2011 – 19 percent) from Asia and 9 percent (2011 - 10 percent) from Latin America.

3. Significant accounting policies

(a) Basis of presentationThe accompanying consolidated financial statements, which include the accounts of the Company and itssubsidiaries, have been prepared in accordance with accounting principles generally accepted in the United States ofAmerica (GAAP) and, in the opinion of management, reflect all adjustments (consisting of normally recurringaccruals) necessary for a fair statement of the results and financial position for such periods. All significantintercompany accounts and transactions have been eliminated. Certain items in the prior year financial statementshave been reclassified to conform to the current year presentation.

The preparation of financial statements in conformity with GAAP requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities atthe date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.Amounts included in the consolidated financial statements reflect the Company’s best estimates and assumptions;actual amounts could differ materially from these estimates. The Company’s principal estimates include:

unpaid loss and loss expense reserves and future policy benefits reserves; value of reinsurance business assumed; reinsurance recoverable, including a provision for uncollectible reinsurance; the assessment of risk transfer for certain reinsurance contracts; the valuation of the investment portfolio and assessment of OTTI; the valuation of certain derivatives; and the valuation of goodwill.

(b) PremiumsPremiums are generally recognized as written upon inception of the policy. For multi-year policies for whichpremiums written are payable in annual installments, only the current annual premium is included as written at policyinception due to the ability of the insured/reinsured to commute or cancel coverage within the term of the policy.The remaining annual premiums are included as written at each successive anniversary date within the multi-yearterm.

For property and casualty (P&C) reinsurance products, premiums written are primarily earned on a pro-rata basisover the terms of the policies to which they relate. Unearned premiums represent the portion of premiums writtenapplicable to the unexpired portion of the policies in force.

Mandatory reinstatement premiums assessed on reinsurance policies are earned in the period of the loss event thatgave rise to the reinstatement premiums. All remaining unearned premiums are recognized over the remainingcoverage period.


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Premiums from long duration contracts such as certain long duration personal accident and health (A&H) policies aregenerally recognized as revenue when due from policyholders. Benefits and expenses are matched with such incometo result in the recognition of profit over the life of the contracts.

Retroactive loss portfolio transfer (LPT) contracts in which the insured loss events occurred prior to the inception ofthe contract are evaluated to determine whether they meet the established criteria for reinsurance accounting. Ifreinsurance accounting is appropriate, written premiums are fully earned and corresponding losses and loss expensesrecognized at the inception of the contract. The contracts can cause significant variances in gross premiums written,net premiums written, net premiums earned, and net incurred losses in the years in which they are written.

(c) Deferred policy acquisition costsPolicy acquisition costs consist of commissions, premium taxes, and underwriting costs related directly to thesuccessful acquisition of new or renewal insurance contracts. Policy acquisition costs are deferred and amortized.Policy acquisition costs on P&C contracts are generally amortized ratably over the period in which premiums areearned. Policy acquisition costs are reviewed to determine if they are recoverable from future income, includinginvestment income. Unrecoverable costs are expensed in the period identified.

(d) ReinsuranceThe Company assumes and cedes reinsurance with other insurance companies to provide greater diversification ofbusiness and minimize the net loss potential arising from large risks. Ceded reinsurance contracts do not relieve theCompany of its primary obligation to its policyholders.

For both ceded and assumed reinsurance, risk transfer requirements must be met in order to obtain reinsurance statusfor accounting purposes, principally resulting in the recognition of cash flows under the contract as premiums andlosses. To meet risk transfer requirements, a reinsurance contract must include insurance risk, consisting of bothunderwriting and timing risk, and a reasonable possibility of a significant loss for the assuming entity. To assess risktransfer for certain contracts, the Company generally develops expected discounted cash flow analyses at contractinception.

Reinsurance recoverable includes the balances due from reinsurance companies for paid and unpaid losses and lossexpenses and policy benefits that will be recovered from reinsurers, based on contracts in force. The method fordetermining the reinsurance recoverable on unpaid losses and loss expenses incurred but not reported (IBNR)involves actuarial estimates consistent with those used to establish the associated liability for unpaid losses and lossexpenses as well as a determination of the Company’s ability to cede unpaid losses and loss expenses.

Reinsurance recoverable is presented net of a provision for uncollectible reinsurance determined based upon a reviewof the financial condition of the reinsurers and other factors. The provision for uncollectible reinsurance is based onan estimate of the amount of the reinsurance recoverable balance that the Company will ultimately be unable torecover due to reinsurer insolvency, a contractual dispute, or any other reason. The valuation of this provisionincludes several judgments including certain aspects of the allocation of reinsurance recoverable on IBNR claims byreinsurer and a default analysis to estimate uncollectible reinsurance. The primary components of the default analysisare reinsurance recoverable balances by reinsurer, net of collateral, and default factors used to determine the portionof a reinsurer’s balance deemed uncollectible. The definition of collateral for this purpose requires some judgmentand is generally limited to assets held in trust, letters of credit, and liabilities held by the Company with the samelegal entity for which it believes there is a contractual right of offset. The determination of the default factor isprincipally based on the financial strength rating of the reinsurer. Default factors require considerable judgment andare determined using the current financial strength rating, or rating equivalent, of each reinsurer as well as other keyconsiderations and assumptions. The more significant considerations include, but are not necessarily limited to, thefollowing:

• For reinsurers that maintain a financial strength rating from a major rating agency, and for which recoverablebalances are considered representative of the larger population (i.e., default probabilities are consistent withsimilarly rated reinsurers and payment durations conform to averages), the financial rating is based on apublished source and the default factor is based on published default statistics of a major rating agency


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applicable to the reinsurer’s particular rating class. When a recoverable is expected to be paid in a brief periodof time by a highly rated reinsurer, such as certain property catastrophe claims, a default factor may not beapplied;

• For balances recoverable from reinsurers that are both unrated by a major rating agency and for whichmanagement is unable to determine a credible rating equivalent based on a parent, affiliate, or peer company, theCompany determines a rating equivalent based on an analysis of the reinsurer that considers an assessment ofthe creditworthiness of the particular entity, industry benchmarks, or other factors as considered appropriate.The Company then applies the applicable default factor for that rating class. For balances recoverable fromunrated reinsurers for which the ceded reserve is below a certain threshold, the Company generally applies adefault factor of 34 percent, consistent with published statistics of a major rating agency;

• For balances recoverable from reinsurers that are either insolvent or under regulatory supervision, the Companyestablishes a default factor and resulting provision for uncollectible reinsurance based on reinsurer-specific factsand circumstances. Upon initial notification of an insolvency, the Company generally recognizes expense for asubstantial portion of all balances outstanding, net of collateral, through a combination of write-offs ofrecoverable balances and increases to the provision for uncollectible reinsurance. When regulatory action istaken on a reinsurer, the Company generally recognizes a default factor by estimating an expected recovery onall balances outstanding, net of collateral. When sufficient credible information becomes available, theCompany adjusts the provision for uncollectible reinsurance by establishing a default factor pursuant toinformation received; and

• For other recoverables, management determines the provision for uncollectible reinsurance based on the specificfacts and circumstances of that dispute.

The methods used to determine the reinsurance recoverable balance and related provision for uncollectiblereinsurance are regularly reviewed and updated and any resulting adjustments are reflected in earnings in the periodidentified.

Prepaid reinsurance premiums represent the portion of premiums ceded to reinsurers applicable to the unexpiredcoverage terms of the reinsurance contracts in force.

The value of reinsurance business assumed represents the excess of estimated ultimate value of the liabilitiesassumed under retroactive reinsurance contracts over consideration received. The value of reinsurance businessassumed is amortized and recorded to losses and loss expenses based on the payment pattern of the losses assumed,expected to be up to 40 years. The unamortized value is reviewed regularly to determine if it is recoverable basedupon the terms of the contract, estimated losses and loss expenses, and anticipated investment income.Unrecoverable amounts are expensed in the period identified.

(e) InvestmentsFixed maturity investments are classified as either available for sale or held to maturity. The available for saleportfolio is reported at fair value. The held to maturity portfolio includes securities for which the Company has theability and intent to hold to maturity or redemption and is reported at amortized cost. Equity securities are classifiedas available for sale and are recorded at fair value. Short-term investments comprise securities due to mature withinone year of the date of purchase and are recorded at fair value which typically approximates cost. Short-terminvestments include certain cash and cash equivalents, which are part of investment portfolios under the managementof external investment managers.

Included in other investments are investments in hedge funds and private equity investments, made through theinvestment vehicles Oasis Investments Limited and Oasis Investments 2 Ltd (collectively “Oasis Investments”). TheCompany is the majority shareholder in Oasis Investments and has the ability to exercise control, and as such, theresults of operations and related assets and liabilities of Oasis Investments are consolidated. The non-majorityownership in Oasis Investments is reported as non-controlling interest in the Consolidated Balance Sheets and


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Statements of Operations and Comprehensive Income. Other investments also include a direct investment in apartially-owned insurance company over which the Company has significant influence and, as such, meet therequirements for equity accounting. The Company reports its share of the net income or loss of the partially-ownedinsurance company in Other income (expense). Other investments for which the Company cannot exercise significantinfluence, are carried at fair value.

Realized gains or losses on sales of investments are determined on a first-in, first-out basis. Unrealized appreciation(depreciation) on investments is included as a separate component of Accumulated other comprehensive income inshareholders’ equity. The Company regularly reviews its investments for OTTI. Refer to Note 4.

With respect to securities where the decline in value is determined to be temporary and the security’s value is notwritten down, a subsequent decision may be made to sell that security and realize a loss. Subsequent decisions onsecurity sales are the result of changing or unforeseen facts and circumstances (e.g., arising from a large insured losssuch as a catastrophe), deterioration of the creditworthiness of the issuer or its industry, or changes in regulatoryrequirements. The Company believes that subsequent decisions to sell such securities are consistent with theclassification of the majority of the portfolio as available for sale.

The Company uses derivative instruments including futures, options, swaps, and foreign currency forward contractsfor the purpose of managing certain investment portfolio risks and exposures. Refer to Note 8. Derivatives arereported at fair value and recorded in the accompanying consolidated balance sheets in Accounts payable, accruedexpenses, and other liabilities with changes in fair value included in Net realized gains (losses) excluding OTTIlosses in the consolidated statements of operations. Collateral held by brokers equal to a percentage of the total valueof open futures contracts is included in the investment portfolio.

Net investment income includes interest and dividend income together with amortization of fixed maturity marketpremiums and discounts and is net of investment management and custody fees. For mortgage-backed securities, andany other holdings for which there is a prepayment risk, prepayment assumptions are evaluated and revised asnecessary. Any adjustments required due to the resultant change in effective yields and maturities are recognizedprospectively. Prepayment fees or call premiums that are only payable when a security is called prior to its maturityare earned when received and reflected in Net investment income.

The Company participates in a securities lending program operated by a third party banking institution wherebycertain assets are loaned to qualified borrowers and from which the Company earns an incremental return. Borrowersprovide collateral, in the form of either cash or approved securities, of 102 percent of the fair value of the loanedsecurities. Each security loan is deemed to be an overnight transaction. Cash collateral is invested in a collateralpool which is managed by the banking institution. The collateral pool is subject to written investment guidelineswith key objectives which include the safeguard of principal and adequate liquidity to meet anticipated redemptions.The fair value of the loaned securities is monitored on a daily basis, with additional collateral obtained or refunded asthe fair value of the loaned securities changes.

The collateral is held by the third party banking institution, and the collateral can only be accessed in the event thatthe institution borrowing the securities is in default under the lending agreement. As a result of these restrictions, theCompany considers its securities lending activities to be non-cash investing and financing activities. Anindemnification agreement with the lending agent protects the Company in the event a borrower becomes insolventor fails to return any of the securities on loan. The fair value of the securities on loan is included in fixed maturitiesand equity securities. The securities lending collateral is reported as a separate line in total assets with a relatedliability reflecting the Company’s obligation to return the collateral plus interest.

Similar to securities lending arrangements, securities sold under reverse repurchase agreements, whereby theCompany sells securities and repurchases them at a future date for a predetermined price, are accounted for ascollateralized investments and borrowings and are recorded at the contractual repurchase amounts plus accruedinterest. Assets to be repurchased are the same, or substantially the same, as the assets transferred and the transferor,through right of substitution, maintains the right and ability to redeem the collateral on short notice. The fair value ofthe underlying securities is included in fixed maturities. In contrast to securities lending programs, the use of cash


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received is not restricted. The Company reports the obligation to return the cash as Short-term debt in theconsolidated balance sheets.

Refer to Note 11 for a discussion on the determination of fair value for the Company’s various investment securities.

(f) CashCash includes cash on hand and deposits with an original maturity of three months or less at time of purchase. Cashheld by external money managers is included in Short-term investments.

ACE Limited has agreements with a third party bank provider which implemented two international multi-currencynotional cash pooling programs. In each program, participating ACE entities establish deposit accounts in differentcurrencies with the bank provider and each day the credit or debit balances in every account are notionally translatedinto a single currency (U.S. dollars) and then notionally pooled. The bank extends overdraft credit to anyparticipating ACE entity as needed, provided that the overall notionally-pooled balance of all accounts in each pool atthe end of each day is at least zero. Actual cash balances are not physically converted and are not commingledbetween legal entities. Any overdraft balances incurred under this program by an ACE entity would be guaranteed byACE Limited (up to $300 million in the aggregate). The revolving credit facility allows for same day drawings tofund a net pool overdraft should participating ACE entities withdraw contributed funds from the pool. The Companyis a participating ACE entity.

(g) GoodwillGoodwill represents the excess of the cost of acquisitions over the fair value of net assets acquired and is notamortized. Goodwill is assigned at acquisition to the applicable reporting unit of the acquired entities giving rise tothe goodwill. Goodwill impairment tests are performed annually, or more frequently if circumstances indicate apossible impairment. For goodwill impairment testing, the Company uses a qualitative assessment to determinewhether it is more likely than not (i.e., more than a 50 percent probability) that the fair value of a reporting unit isgreater than its carrying amount. If assessment indicates less than a 50 percent probability that fair value exceedscarrying value, the Company quantitatively estimates a reporting unit’s fair value using a consistently appliedcombination of the following models: an earnings multiple, a book value multiple, a discounted cash flow, or anallocated market capitalization model. The earnings and book value models apply multiples of comparable publiclytraded companies to forecasted earnings or book value of each reporting unit and consider current markettransactions. The discounted cash flow model applies a discount to estimated cash flows including a terminal valuecalculation. The market capitalization model allocates market capitalization to each reporting unit. Whereappropriate, the Company considers the impact of a control premium. No goodwill impairment occurred in 2012 or2011.

(h) Unpaid losses and loss expensesA liability is established for the estimated unpaid losses and loss expenses under the terms of, and with respect to, theCompany’s policies and agreements. These amounts include provision for both reported claims (case reserves) andincurred but not reported (IBNR) claims. The methods of determining such estimates and establishing the resultingliability are reviewed regularly and any adjustments are reflected in operations in the period in which they becomeknown. Future developments may result in losses and loss expenses materially greater or less than the recordedamounts. The Company does not discount its property and casualty loss reserves.

Prior period development arises from changes to loss estimates recognized in the current year that relate to lossreserves first reported in previous calendar years and excludes the effect of losses from the development of earnedpremiums from previous accident years. For purposes of analysis and disclosure, management views prior perioddevelopment to be changes in the nominal value of loss estimates from period to period and excludes changes in lossestimates that do not arise from the emergence of claims, such as those related to uncollectible reinsurance, interest,unallocated loss adjustment expenses, or foreign currency. Accordingly, specific items excluded from prior perioddevelopment include the following: gains/losses related to foreign currency remeasurement; losses recognized fromthe early termination or commutation of reinsurance agreements that principally relate to the time value of money;changes in the value of reinsurance business assumed reflected in losses incurred but principally related to the time


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value of money; and losses that arise from changes in estimates of earned premiums from prior accident years.Except for foreign currency revaluation, which is disclosed separately, these items are included in current year losses.

(i) Future policy benefitsThe valuation of long duration contract reserves requires management to make estimates and assumptions regardingexpenses, mortality, persistency, and investment yields. Such estimates are primarily based on historical experienceand information provided by ceding companies and include a margin for adverse deviation. Interest rates used incalculating reserves range from less than 1 percent to 4 percent and from less than 1 percent to 6 percent at December31, 2012 and 2011, respectively. Actual results could differ materially from these estimates. Management monitorsactual experience, and where circumstances warrant, will revise its assumptions and the related reserve estimates.Revisions are recorded in the period they are determined.

(j) Assumed reinsurance programs involving minimum benefit guarantees under annuity contractsThe Company reinsures various living benefit guarantees (GLB) associated with variable annuities issued in theUnited States. Through December 31, 2011, the Company retroceded 100 percent of its GLB business to ATLR.Effective January 1, 2012, the Company and ATLR entered into a termination addendum pursuant to which ATLRreturned to the Company premiums paid under the retrocession agreement. Each reinsurance treaty covers variableannuities written during a limited period. The Company receives a monthly premium during the accumulation phaseof the covered annuities (in-force) based on a percentage of the underlying accumulated guaranteed values.Depending on an annuitant's age, the accumulation phase can last many years. To limit exposure under theseprograms, all reinsurance treaties include aggregate claim limits.

Under reinsurance programs covering GLBs, the Company assumes the risk of guaranteed minimum income benefits(GMIB) and guaranteed minimum accumulation benefits (GMAB) associated with variable annuity contracts. TheGMIB risk is triggered if, at the time the contract holder elects to convert the accumulated account value to a periodicpayment stream (annuitize), the accumulated account value is not sufficient to provide a guaranteed minimum levelof monthly income. The GMAB risk is triggered if, at contract maturity, the contract holder's account value is lessthan a guaranteed minimum value. The GLB reinsurance product meets the definition of a derivative for accountingpurposes and is carried at fair value with changes in fair value recognized in income and classified as describedbelow. As the assuming entity, the Company is obligated to provide coverage until the earlier of the expiration of theunderlying guaranteed benefit or the treaty expiration date. Premiums received under the reinsurance treaties areclassified as premium. Expected losses allocated to premiums received are classified as policy benefits. Otherchanges in fair value, principally arising from changes in expected losses allocated to expected future premiums, areclassified as Net realized gains (losses). Fair value represents management's estimate of exit price and thus includesa risk margin. The Company may recognize a realized loss for other changes in fair value due to adverse changes inthe capital markets (i.e., declining interest rates and/or declining equity markets) and changes in policyholderbehavior (i.e., increased annuitization or decreased lapse rates) although the business is expected to be profitable.Management believes this presentation provides the most meaningful disclosure of changes in the underlying riskwithin the GLB reinsurance programs for a given reporting period.

(k) Foreign currency remeasurement and translationThe functional currency for each of our foreign operations is generally the currency of the local operatingenvironment. Transactions in currencies other than the operation’s functional currency are remeasured into thefunctional currency and the resulting foreign exchange gains and losses are reflected in Net realized gains (losses) inthe consolidated statements of operations. Functional currency assets and liabilities are translated into the reportingcurrency, U.S. dollars, using period end rates of exchange and the related translation adjustments are recorded as aseparate component of Accumulated Other Comprehensive Income “AOCI”. Functional statement of operationsamounts expressed in functional currencies are translated using average exchange rates. Gains and losses resultingfrom foreign currency transactions are recorded in Net realized gains (losses).

(l) Administrative expensesAdministrative expenses generally include all operating costs other than policy acquisition costs.


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(m) Cash flow informationPremiums received and losses paid associated with the GLB reinsurance products, which as discussed previouslymeet the definition of a derivative instrument for accounting purposes, are included within cash flows from operatingactivities in the consolidated statement of cash flows. Cash flows, such as settlements and collateral requirements,associated with all other derivative instruments are included on a net basis within cash flows from investing activitiesin the consolidated statement of cash flows. Purchases, sales, and maturities of short-term investments are recordednet for purposes of the consolidated statements of cash flows and are classified with cash flows related to fixedmaturities.

(n) DerivativesThe Company recognizes all derivatives at fair value in the consolidated balance sheets. The Company participates inderivative instruments to mitigate our own financial risks, principally arising from our investment holdings, productssold, or assets and liabilities held in foreign currencies. For these instruments, changes in assets or liabilitiesmeasured at fair value are recorded as realized gains or losses in the consolidated statement of operations.

During 2012 and 2011, the Company did not designate any derivatives as hedges.

(o) Share-based compensationThe Company receives an allocation of share based compensation costs from its ultimate parent, ACE Limited. ACELimited measures and records compensation cost for all share-based payment awards at grant-date fair value.Compensation costs are recognized for share-based payment awards with only service conditions that have gradedvesting schedules on a straight-line basis over the requisite service period for each separately vesting portion of theaward as if the award was, in substance, multiple awards.

(p) New accounting pronouncements

Adopted in 2012

Accounting for costs associated with acquiring or renewing insurance contractsIn October 2010, the Financial Accounting Standards Board (FASB) issued new guidance related to the accountingfor costs associated with acquiring or renewing insurance contracts. Under the new guidance, the definition ofacquisition costs was modified to specify that a cost must be directly related to the successful acquisition of a new orrenewal insurance contract in order to be deferred. The Company adopted this guidance retrospectively effectiveJanuary 1, 2012 and reduced Retained earnings as of January 1, 2011 by $4.4 million which represents thecumulative effect of adjustment resulting from adoption of new accounting guidance. The Company adjusted prioryear amounts contained in this report to reflect the effect of adjustment from adoption of new accounting guidanceincluding reducing Other Investments and Retained earnings by $6.0 million, as of December 31, 2011. Thereduction to Other Investments is primarily due to lower deferrals associated with unsuccessful efforts. TheCompany also reduced Net income by $1.6 million for the year ended December 31, 2011.

Fair value measurementsIn May 2011, the FASB issued new guidance on fair value measurements to revise the wording used to describe therequirements for measuring fair value and for disclosing information about fair value measurements. The guidance isnot necessarily intended to result in a significant change in the application of the current requirements. Instead it isintended to clarify the application of existing fair value measurement requirements. It also changes certain principlesor requirements for measuring fair value and disclosing information about fair value measurements. The Companyadopted this guidance prospectively effective January 1, 2012. The application of this guidance resulted in additionalfair value measurements disclosures only and did not impact our financial condition or results of operations.Adopted in 2011

Testing goodwill for impairmentIn September 2011, the FASB issued new accounting guidance which eliminates the requirement to calculate the fairvalue of reporting units at least annually and replaces it with an optional qualitative assessment. This guidance iseffective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15,


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2011, with early adoption permitted. The Company adopted this guidance on October 1, 2011. The application of thenew guidance resulted in a change in the procedures for assessing goodwill impairment, and did not impact ourfinancial condition or results of operations.

4. Investments

(a) Fixed maturitiesThe following tables present the amortized cost and fair value of fixed maturities and related OTTI recognized inAOCI at December 31, 2012 and 2011.

2012

AmortizedCost

GrossUnrealized

Appreciation

GrossUnrealized

Depreciation Fair Value

OTTI Recognizedin Accumulated

OtherComprehensive

Income(in thousands of U.S. dollars)

Available for sale

U.S. Treasury andagency $ 1,305,917 54,543 (851) 1,359,609 -

Foreign 3,215,250 221,148 (2,737) 3,433,661 (253)

Corporate securities 6,051,806 496,484 (16,222) 6,532,068 (797)

Mortgage-backedsecurities 3,097,379 154,697 (6,945) 3,245,131 (15,445)States, municipalities,and politicalsubdivisions 195,168 16,407 (197) 211,378 -

$ 13,865,520 943,279 (26,952) 14,781,847 (16,495)

Held to maturityU.S. Treasury andagency 19,170 130 - 19,300 -

Foreign 1,177 34 - 1,211 -

Corporate securities 40,158 2,182 - 42,340 -

Mortgage-backedsecurities 81,752 3,010 (14) 84,748 -States, municipalities,and politicalsubdivisions 2,100 31 - 2,131 -

$ 144,357 5,387 (14) 149,730 -


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2011

AmortizedCost

GrossUnrealized

Appreciation

GrossUnrealized

Depreciation Fair Value

OTTI Recognizedin Accumulated

OtherComprehensive

Income(in thousands of U.S. dollars)

Available for sale

U.S. Treasury andagency $ 840,840 47,054 (72) 887,822 -

Foreign 3,117,465 130,092 (48,085) 3,199,472 (1,009)

Corporate securities 5,319,364 314,580 (58,589) 5,575,355 (3,630)

Mortgage-backedsecurities 3,113,417 131,778 (47,040) 3,198,155 (36,109)States, municipalities,and politicalsubdivisions 193,130 13,347 (77) 206,400 -

$ 12,584,216 636,851 (153,863) 13,067,204 (40,748)

Held to maturityU.S. Treasury andagency 20,617 1,068 - 21,685 -

Foreign 2,767 88 - 2,855 -

Corporate securities 55,441 2,126 (89) 57,478 -

Mortgage-backedsecurities 133,458 4,956 (265) 138,149 -States, municipalities,and politicalsubdivisions 2,362 112 - 2,474 -

$ 214,645 8,350 (354) 222,641 -

As discussed in Note 4 (d), if a credit loss is indicated on an impaired fixed maturity investment, an OTTI isconsidered to have occurred and the portion of the impairment not related to credit losses (non-credit OTTI) isrecognized in Other comprehensive income (OCI). Included in “OTTI Recognized in Accumulated OtherComprehensive Income (AOCI)” is the cumulative amount of non-credit OTTI recognized in OCI adjusted forsubsequent sales, maturities, and redemptions. “OTTI Recognized in Accumulated Other Comprehensive Income”does not include the impact of subsequent changes in fair value of the related securities. In periods subsequent to arecognition of OTTI in OCI, changes in the fair value of the related fixed maturity investments are reflected in Netunrealized appreciation (depreciation) on investments in the consolidated statement of shareholder’s equity. For theyears ended December 31, 2012 and 2011, $33 million of net unrealized appreciation and $11 million of netunrealized depreciation, respectively, related to such securities is included in OCI. At December 31, 2012 and 2011,AOCI includes net unrealized depreciation of $3 million and $33 million, respectively, related to securities remainingin the investment portfolio at those dates for which the Company has recognized a non-credit OTTI.

Mortgage-backed securities issued by U.S. government agencies are combined with all other “to be announced”mortgage derivatives held (refer to Note 8 a) (iv)) and are included in the category, “Mortgage-backed securities”.Approximately 85 percent of the total mortgage-backed securities at December 31, 2012 and 2011, are represented byinvestments in U.S. government agency bonds. The remainder of the mortgage exposure consists of collateralizedmortgage obligations and non-government mortgage-backed securities, the majority of which provide a plannedstructure for principal and interest payments and carry a rating of AAA by the major credit rating agencies.


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The following table presents fixed maturities by contractual maturity at December 31, 2012 and 2011.

2012 2011

Fair ValueAmortized

Cost Fair ValueAmortized

Cost

(in thousands of U.S. dollars)

Available for sale; maturity periodDue in 1 year or less $ 466,427 462,506 $ 572,571 565,200Due after 1 year through 5 years 4,435,834 4,200,472 3,569,771 3,459,816Due after 5 years through 10 years 5,976,758 5,523,554 5,043,710 4,801,458Due after 10 years 657,697 581,609 682,997 644,325

11,536,716 10,768,141 9,869,049 9,470,799Mortgage-backed securities 3,245,131 3,097,379 3,198,155 3,113,417

$ 14,781,847 13,865,520 $ 13,067,204 12,584,216

Held to maturity; maturity periodDue in 1 year or less $ 35,388 35,038 $ 16,069 15,934Due after 1 year through 5 years 25,925 24,264 64,708 61,695Due after 5 years through 10 years 1,955 1,679 1,910 1,705Due after 10 years 1,712 1,624 1,805 1,853

64,980 62,605 84,492 81,187Mortgage-backed securities 84,750 81,752 138,149 133,458

$ 149,730 144,357 $ 222,641 214,645

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

(b) Equity securitiesThe following table presents the fair value and cost of and gross unrealized appreciation (depreciation) related toequity securities at December 31, 2012 and 2011.

(in thousands of U.S. dollars) 2012 2011

Equity securities - cost 491,790 465,313Gross unrealized appreciation 8,971 543Gross unrealized depreciation (901) (33,729)

Equity securities – fair value 499,860 432,127

(c) Other investmentsThe following table presents other investments at December 31, 2012 and 2011.

2012 2011


FairValue/Carrying

Value Cost

FairValue/Carrying

Value Cost

Hedge funds and private equityinvestments 1,608,886 1,461,161 1,423,869 1,309,182Huatai Insurance Company (9.6%) 168,680 167,134 110,706 107,298

1,777,566 1,628,295 1,534,575 1,416,480


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The hedge funds and private equity investments are made through the investment vehicles Oasis Investments Limitedand Oasis Investments 2 Ltd. Oasis Investments Limited and Oasis Investments 2 Ltd are consolidated in thesefinancial statements as the Company owns 66.6%. There has been no change in the ownership percentages heldduring 2012.

(d) Net realized gains (losses)In accordance with guidance related to the recognition and presentation of OTTI, when an impairment related to afixed maturity has occurred, OTTI is required to be recorded in net income if management has the intent to sell thesecurity or it is more likely than not that the Company will be required to sell the security before the recovery of itsamortized cost. Further, in cases where the Company does not intend to sell the security and it is more likely than notthat the Company will not be required to sell the security, the Company must evaluate the security to determine theportion of the impairment, if any, related to credit losses. If a credit loss is indicated, an OTTI is considered to haveoccurred and any portion of the OTTI related to credit losses must be reflected in net income while the portion ofOTTI related to all other factors is recognized in OCI. For fixed maturities held to maturity, OTTI recognized in OCIis accreted from AOCI to the amortized cost of the fixed maturity prospectively over the remaining term of thesecurities.

Each quarter, securities in an unrealized loss position (impaired securities), including fixed maturities, securitieslending collateral, equity securities, and other investments, are reviewed to identify impaired securities to bespecifically evaluated for a potential OTTI.

For all non-fixed maturities, OTTI is evaluated based on the following:

• the amount of time a security has been in a loss position and the magnitude of the loss position;• the period in which cost is expected to be recovered, if at all, based on various criteria including economic

conditions and other issuer-specific developments; and• the Company’s ability and intent to hold the security to the expected recovery period.

As a general rule, the Company also considers that equity securities in an unrealized loss position for twelveconsecutive months are impaired.

Evaluation of potential credit losses related to fixed maturities

The Company reviews each fixed maturity security in an unrealized loss position to assess whether the security is acandidate for credit loss. Specifically, the Company considers credit rating, market price, and issuer-specificfinancial information, among other factors, to assess the likelihood of collection of all principal and interest ascontractually due. Securities for which the Company determines that credit loss is likely are subjected to furtheranalysis to estimate the credit loss recognized in net income, if any. In general, credit loss recognized in net incomeequals the difference between the security’s amortized cost and the net present value of its projected future cashflows discounted at the effective interest rate implicit in the debt security. All significant assumptions used indetermining credit losses are subject to change as market conditions evolve.

U.S. Treasury and agency obligations (including agency mortgage-backed securities), foreign governmentobligations, and states, municipalities, and political subdivisions obligations

U.S. Treasury and agency obligations (including agency mortgage-backed securities), foreign governmentobligations, and states, municipalities, and political subdivisions obligations represent approximately $2.3 millionand $1.4 million of gross unrealized loss at December 31, 2012 and 2011, respectively. These securities wereevaluated for credit loss primarily using qualitative assessments of the likelihood of credit loss considering creditrating of the issuers and level of credit enhancement, if any. The Company concluded that the high level of creditworthiness of the issuers coupled with credit enhancement, where applicable, supports recognizing no credit loss innet income.


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Corporate securities

Projected cash flows for corporate securities (principally senior unsecured bonds) are driven primarily byassumptions regarding probability of default and also the timing and amount of recoveries associated with defaults.The Company develops these estimates using information based on market observable data, issuer-specificinformation, and credit ratings. The Company developed its default assumption by using historical default data byMoody’s Investors Service (Moody’s) rating category to calculate a 1-in-100 year probability of default, whichresults in a default assumption in excess of the historical mean default rate. The Company believes that use of adefault assumption in excess of the historical mean is reasonable in light of recent market conditions.

The following table presents default assumptions by Moody’s rating category (historical mean default rate providedfor comparison).

1-in-100 Year Historical MeanMoody's Rating

Category Default Rate Default Rate

Investment Grade:

Aaa-Baa 0.0-1.4% 0.0-0.3%

Below Investment Grade:

Ba 4.9% 1.1%

B 12.8% 3.4%

Caa-C 53.4% 13.8%

Consistent with management’s approach to developing default rate assumptions considering recent marketconditions, the Company assumed a 32 percent recovery rate (the par value of a defaulted security that will berecovered) across all rating categories rather than using Moody’s historical mean recovery rate of 42 percent. TheCompany believes that use of a recovery rate assumption lower than the historical mean is reasonable in light ofrecent market conditions.

Application of the methodology and assumptions described above resulted in credit losses recognized in net incomefor corporate securities for the years ended December 31, 2012 and 2011 of $5.2 million and $3.0 million,respectively.

Mortgage-backed securities

For mortgage-backed securities, credit impairment is assessed using a cash flow model that estimates the cash flowson the underlying mortgages, using the security-specific collateral and transaction structure. The model estimatescash flows from the underlying mortgage loans and distributes those cash flows to various tranches of securities,considering the transaction structure and any subordination and credit enhancements that exist in that structure. Thecash flow model incorporates actual cash flows on the mortgage-backed securities through the current period andthen projects the remaining cash flows using a number of assumptions, including default rates, prepayment rates, andloss severity rates (the par value of a defaulted security that will not be recovered) on foreclosed properties.

The Company develops specific assumptions using market data, where available, and includes internal estimates aswell as estimates published by rating agencies and other third-party sources. The Company projects default rates bymortgage sector considering current underlying mortgage loan performance, generally assuming lower loss severityfor Prime sector bonds versus ALT-A and Sub-prime bonds.

These estimates are extrapolated along a default timing curve to estimate the total lifetime pool default rate. Otherassumptions used contemplate the actual collateral attributes, including geographic concentrations, rating agency lossprojections, rating actions, and current market prices. If cash flow projections indicate that losses will exceed thecredit enhancement for a given tranche, then the Company does not expect to recover its amortized cost basis andrecognizes an estimated credit loss in net income.


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Application of the methodology and assumptions described above resulted in credit losses recognized in net incomefor mortgage-backed securities for the years ended December 31, 2012 and 2011, of $1.8 million and $2.4 million,respectively.

The following table presents, for the years ended December 31, 2012 and 2011 the net realized gains (losses)included in Net realized gains (losses) and OCI as a result of conditions which caused the Company to conclude thedecline in fair value of certain investments was “other-than-temporary” and the change in net unrealized appreciation(depreciation) on investments.

2012 2011Fixed maturities:OTTI on fixed maturities, gross $ (9,525) $ (25,971)OTTI on fixed maturities recognized in other comprehensiveincome (pre-tax) 463 4,599

OTTI on fixed maturities, net (9,062) (21,372)Gross realized gains excluding OTTI 133,556 145,679Gross realized losses excluding OTTI (50,358) (60,050)

Total fixed maturities 74,136 64,257

Equity securities:OTTI on equity securities (32) (18)Gross realized gains excluding OTTI 799 4,375Gross realized losses excluding OTTI (579) (1,503)

Total equity securities 188 2,854

OTTI on other investments (6,822) (3,527)Foreign exchange gains (losses) (22,954) 1,843Derivative instruments (214,630) (80,646)Other (530) (775)

Net realized gains (losses) (170,612) (15,994)

Change in net unrealized appreciation (depreciation) on investments:Fixed maturities available for sale 413,113 69,753Fixed maturities held to maturity (1,206) (1,500)Equity securities 39,724 (38,175)Other 33,993 19,798

Change in net unrealized appreciation (depreciation) on investments 485,624 49,876Total net realized gains (losses) and change in net unrealizedappreciation (depreciation) on investments $ 315,012 $ 33,882


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The following table presents, for the years ended December 31, 2012 and December 31, 2011, a roll-forward of pre-tax credit losses related to fixed maturities for which a portion of OTTI was recognized in OCI.

2012 2011

(in thousands of U.S. dollars)Balance of credit losses related to securities still held-beginning of period $ 24,915 $ 56,669

Additions where no OTTI was previously recorded 3,469 3,939

Additions where an OTTI was previously recorded 3,550 1,429Reductions reflecting amounts previously recorded in OCI butsubsequently reflected in net income - -

Reductions for securities sold during the period (18,262) (37,122)Balance of credit losses related to securities still held-end ofperiod $ 13,672 $ 24,915

(e) Gross unrealized lossAt December 31, 2012, there were 451 fixed maturities out of a total of 5,278 fixed maturities in an unrealized lossposition. The largest single unrealized loss in the fixed maturities was $1.8 million. There were 9 equity securities outof a total of 27 equity securities in an unrealized loss position. The largest single unrealized loss in the equitysecurities was $.4 million. Fixed maturities in an unrealized loss position at December 31, 2012 comprised bothinvestment grade and below investment grade securities for which fair value declined primarily due to wideningcredit spreads since the date of purchase.

The following tables present, for all securities in an unrealized loss position at December 31, 2012, and December 31,2011 (including securities on loan), the aggregate fair value and gross unrealized loss by length of time the securityhas continuously been in an unrealized loss position.

As at December 31, 2012 0 - 12 Months Over 12 Months Total

FairValue

GrossUnrealized

LossFair

Value

GrossUnrealized

LossFair

Value

GrossUnrealized

Loss(in thousands of U.S. dollars)

U.S. Treasury and agency $ 135,503 (851) - - 135,503 (851)Foreign bonds 161,029 (834) 14,168 (1,903) 175,197 (2,737)Corporate securities 429,711 (11,565) 40,971 (4,657) 470,682 (16,222)Mortgage-backedsecurities 297,670 (1,105) 55,844 (5,854) 353,514 (6,959)States, municipalities,and politicalsubdivisions 20,917 (104) 2,808 (93) 23,725 (197)Total fixed maturities 1,044,830 (14,459) 113,791 (12,507) 1,158,621 (26,966)Equity securities 9,807 (901) - - 9,807 (901)Total $ 1,054,637 (15,360) 113,791 (12,507) 1,168,428 (27,867)


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As at December 31, 2011 0 - 12 Months Over 12 Months Total

FairValue

GrossUnrealized

LossFair

Value

GrossUnrealized

LossFair

Value

GrossUnrealized

Loss(in thousands of U.S. dollars)

U.S. Treasury and agency $ 27,895 (34) 525 (38) 28,420 (72)Foreign bonds 642,548 (42,579) 40,366 (5,504) 682,914 (48,083)Corporate securities 1,215,966 (54,815) 21,639 (3,864) 1,237,605 (58,679)Mortgage-backedsecurities 89,239 (1,880) 127,792 (45,426) 217,031 (47,306)States, municipalities,and politicalsubdivisions 6,841 (77) - - 6,841 (77)Total fixed maturities 1,982,489 (99,385) 190,322 (54,832) 2,172,811 (154,217)Equity securities 424,338 (33,729) - - 424,338 (33,729)Total $ 2,406,827 (133,114) 190,322 (54,832) 2,597,149 (187,946)

(f) Net investment incomeThe following table presents the source of net investment income for the years ended December 31, 2012 and 2011.


Fixed maturities 622,080 616,420Short-term investments 1,159 (86)Equity securities 22,802 20,888Other investments 56,385 41,577Investment (expense) income from affiliates (1,285) 4,408

Gross investment income 701,141 683,207

Investment expenses (44,007) (28,854)

Net investment income 657,134 654,353

(g) Restricted AssetsThe Company is required to maintain assets on deposit with various regulatory authorities to support its reinsuranceoperations. These requirements are generally promulgated in the statutory regulations of the individual jurisdictions.The assets on deposit are available to settle reinsurance liabilities. The Company is required to restrict assets pledgedunder reverse repurchase agreements. The Company also utilizes trust funds in certain transactions where the trustfunds are set up for the benefit of the ceding companies and generally take the place of Letter of Credit (“LOC”)requirements. The Company also has investments in segregated portfolios primarily to provide collateral orguarantees for LOCs and derivative transactions. Included in restricted assets at December 31, 2012, are fixedmaturities totaling $6,902.7 million and cash of $5.6 million. The following table presents the components of therestricted assets at December 31, 2012 and 2011.


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Deposits with non-U.S. regulatory authorities 6,060 1,003Trust funds 6,351,779 5,617,392Other pledged assets (1) 550,470 400,000

6,908,309 6,018,395

(1) Includes restricted assets of $550 million and $400 million at December 31, 2012 and 2011, respectively, pledged underreverse repurchase agreements.

In addition, the Company also utilizes a floating charge over certain assets for the benefit of a ceding company.Under the agreement, the Company would be required to secure assets in a trust for the benefit of the cedingcompany upon certain triggering events, including a rating downgrade below “A” by Standard and Poor’s. Themaximum amount of the floating charge through December 31, 2012 is $500 million.

5. Unpaid losses and loss expenses

The Company establishes reserves for the estimated unpaid ultimate liability for losses and loss expenses under the termsof its policies and agreements. These reserves include estimates for both claims that have been reported and for IBNR, andinclude estimates of expenses associated with processing and settling these claims. The process of establishing reserves forP&C claims can be complex and is subject to considerable variability as it requires the use of informed estimates andjudgments. The Company’s estimates and judgments may be revised as additional experience and other data becomeavailable and are reviewed, as new or improved methodologies are developed, or as current laws change. The Companycontinually evaluates its estimates of reserves in light of developing information and in light of discussions andnegotiations with its insureds. While the Company believes that its reserves for unpaid losses and loss expenses atDecember 31, 2012, are adequate, new information or trends may lead to future developments in ultimate losses and lossexpenses significantly greater or less than the reserves provided. Any such revisions could result in future changes inestimates of losses or reinsurance recoverable, and would be reflected in the Company’s results of operations in the periodin which the estimates are changed.


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The following table presents a reconciliation of unpaid losses and loss expenses for the years ended December 31, 2012and 2011.


Gross unpaid losses and loss expenses at beginning of year $7,326,121 $7,152,724

Reinsurance recoverable (1,102,804) (1,004,012)

Net unpaid losses and loss expenses at beginning of year 6,223,317 6,148,712

Net losses and loss expenses incurred in respect of losses occurring in:

Current year 2,371,231 2,549,789

Prior years (242,067) (222,424)

Total 2,129,164 2,327,365

Net losses and loss expenses paid in respect of losses occurring in:

Current year (911,876) 943,558

Prior years (1,379,509) 1,293,978

Total (2,291,385) 2,237,536

Foreign currency revaluation 62,125 (16,642)Other movements on losses and loss expenses 6,604 1,418

68,729 (15,224)

Net unpaid losses and loss expenses at end of year 6,129,825 6,223,317

Reinsurance recoverable 1,077,910 1,102,804

Gross unpaid losses and loss expenses at end of year 7,207,735 7,326,121

Net losses and loss expenses incurred includes $242 million and $222 million of net favorable prior period development inthe years ended December 31, 2012 and 2011, respectively. These developments followed a detailed review by theactuaries and reflected lower reported claim development than previously anticipated.

Much of the business written or assumed by the Company is long-tailed in nature (e.g., Workers' Compensation andProfessional Lines) and can exhibit a high degree of variability. Furthermore, many of the lines of business written by theCompany have grown significantly over the past several years as compared to the volume of business written in the early-to mid-2000's. The nature of the business written coupled with the relative immaturity of the business can expose thereserves to a higher-than-normal degree of uncertainty and the ultimate losses may be materially different.

In 2012, $208 million of net favorable prior period development was attributable to long-tailed business across a numberof lines and accident years due to better than expected claims emergence and favorable claim settlements. In addition,there was favorable development of $34 million in short-tailed lines primarily related to accident years 2010 and 2011,due to lack of emergence of newly reported claims and favorable development on known claims.

In 2011, $178 million of net favorable prior period development was attributable to long-tailed business across a numberof lines and accident years due to better than expected claims emergence and favorable claim settlements. In addition,there was favorable development of $44 million in short-tailed lines primarily related to accident years 2009 and 2010,due to lack of emergence of newly reported claims and favorable development on known claims.


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6. Reinsurance

The Company purchases reinsurance to manage various exposures including catastrophic risks. Although reinsuranceagreements contractually obligate the Company’s reinsurers to reimburse it for the agreed upon portion of its gross paidlosses, they do not discharge the primary liability of the Company. The amounts for net premiums written and netpremiums earned in the consolidated statements of operations are net of reinsurance. The following table presents direct,assumed, and ceded premiums for the years ended December 31, 2012 and 2011.

(in thousands of U.S. dollars) 2012 2011Premiums writtenAssumed 4,861,811 4,641,574Ceded (180,088) (646,069)Net $4,681,723 $3,995,505

Premiums earnedAssumed $4,789,060 $4,638,929Ceded (172,275) (648,718)Net 4,616,785 $3,990,211

The following table presents the composition of the Company’s reinsurance recoverable on losses and loss expenses atDecember 31, 2012 and 2011.


Reinsurance recoverable on paid losses and loss expenses, net of aprovision for uncollectible reinsurance $79,825 $70,715Reinsurance recoverable on unpaid losses and loss expenses, net of aprovision for uncollectible reinsurance 1,077,910 1,102,804Reinsurance recoverable on future policy benefits - 54,405Net reinsurance recoverable $1,157,735 $1,227,924

The Company evaluates the financial condition of its reinsurers and potential reinsurers on a regular basis and alsomonitors concentrations of credit risk with reinsurers. The provision for uncollectible reinsurance is required principallydue to the potential failure of reinsurers to indemnify the Company, primarily because of disputes under reinsurancecontracts and insolvencies. Provisions have been established for amounts estimated to be uncollectible. At December 31,2012 and 2011, the Company recorded a provision for uncollectible reinsurance of $15.7 million and $17.7 million,respectively.

The following tables present a listing, at December 31, 2012 and 2011, of the categories of the Company’s reinsurers. Thefirst category, largest reinsurers, represents all reinsurers where the gross recoverable exceeds one percent of theCompany’s total shareholders’ equity. The provision for uncollectible reinsurance for the largest reinsurers, otherreinsurers rated A- or better, and other reinsurers with ratings lower than A- is principally based on an analysis of thecredit quality of the reinsurer and collateral balances. The Company establishes its provision for uncollectible reinsurancein this category based on a case by case analysis of individual situations including the merits of the underlying matter,credit and collateral analysis, and consideration of the Company’s collection experience in similar situations.


Largest reinsurers $358,553 $423,099Other reinsurers balances rated A- or better 786,503 788,909Other reinsurers with ratings lower than A- 12,679 15,916Total 1,157,735 $1,227,924


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Largest Reinsurers

Munich Re Group

Transatlantic Holdings

Hannover Rueckversicherungs AG

7. Related party business

The Company reinsures a number of affiliates for property, casualty, marine, accident and health risks. Also, the companycedes or has ceded certain business to affiliates, including ATLR. The business has been ceded on an excess of loss and aquota share basis. The related statement of operations and balance sheet account balances for the years ended December31, 2012 and 2011 have been affected by these intercompany reinsurance agreements as follows:

There are amounts due from related parties of $532.3 million and $104.5 million and due to related parties of $13.4 millionand $38.9 million as at December 31, 2012 and 2011, respectively. The noncontrolling interest in Oasis Investments isheld by a related party. Further, the Company has entered into an interest rate swap and a foreign currency forwardcontract with a related party. Refer to Note 8. The affiliated termination addendum discussed in Note 3(j) resulted in areduction in ceded premiums of $357.8 million and a net gain of $106.8 million in 2012.

8. Commitments, contingencies and guarantees

(a) Derivative InstrumentsThe Company maintains positions in derivative instruments such as futures, options, swaps, and foreign currencyforward contracts for which the primary purposes are to manage duration and foreign currency exposure, yieldenhancement, or to obtain an exposure to a particular financial market. Along with convertible bonds and to beannounced mortgage-backed securities (TBA), discussed below, these are the most numerous and frequent derivativetransactions.

The Company maintains positions in convertible bond investments that contain embedded derivatives. In addition,the Company purchases TBAs as part of its investing activities. These securities are included within the Company’sfixed maturities available for sale (FM AFS) portfolio.


Gross premiums written $4,470,512 $4,295,143Reinsurance premiums ceded (354,239) 43,351Net premiums earned 4,280,747 3,674,796Net realized losses on investments 213,982 -Losses and loss expenses 2,055,974 2,165,932Future policy benefits 22,227 (9,599)Policy acquisition costs 1,237,178 1,265,734

Reinsurance balances receivable 526,629 629,584Prepaid reinsurance premiums 755 -Reinsurance recoverable 27 135Reinsurance recoverable on future policy benefits - 54,405Deferred policy acquisition costs 119,936 114,156Value of reinsurance business assumed 249,151 259,449Unpaid losses and loss expenses 7,022,751 7,126,969Future policy benefits 965,171 703,099Unearned premiums 1,096,679 1,063,819Reinsurance balances payable 487,392 375,715


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The Company carries all derivative instruments at fair value with changes in fair value recorded in Net realized gains(losses) in the consolidated statements of operations. None of the derivative instruments are designated as hedges foraccounting purposes.

The following table presents the balance sheet locations, fair values in an asset or (liability) position, and notionalvalues/payment provisions of the Company’s derivative instruments at December 31, 2012 and 2011.

2012 2011

ConsolidatedBalance Sheet

Location

FairValue

NotionalValue

FairValue

NotionalValue

(in thousands of U.S. dollars)Other derivative instrument AP $ - - $ 56 5,600

Future contracts on money marketinstruments

AP 361 420,538 2,803 5,020,000

Future contracts on notes and bonds AP 6,226 418,705 (2,352) 406,700

Options on money marketinstruments

AP - - (123) 292,000

Foreign exchange forward contracts AP (1,554) 295,245 8,354 424,278

Convertible Bonds FM AFS 250,660 219,462 302,605 293,190

TBAs FM AFS - - 5,988 5,700

Total $ 255,693 1,353,950 $ 317,331 6,447,468

GLB(1) AP FPB 293,070 230,522 - -

(1) Note that the payment provision related to GLB is the net amount at risk. The concept of a notional value does not apply to the GLBreinsurance contracts.

Derivatives on money market instruments have durations of approximately 3 months regardless of the maturity dateof the derivative.

Derivative instrument objectives

(i) Foreign currency exposure managementA foreign currency forward contract (forward) is an agreement between participants to exchange specificforeign currencies at a future date. The Company uses forwards to minimize the effect of fluctuating foreigncurrencies.

(ii) Duration management and market exposure

FuturesFutures contracts give the holder the right and obligation to participate in market movements, determined by theindex or underlying security on which the futures contract is based. Settlement is made daily in cash by anamount equal to the change in value of the futures contract times a multiplier that scales the size of the contract.Exchange-traded bond and note futures contracts are used in fixed maturity portfolios to more efficientlymanage duration, as substitutes for ownership of the money market instruments, bonds and notes withoutsignificantly increasing the risk in the portfolio. Investments in futures contracts may be made only to the extentthat there are assets under management not otherwise committed.

OptionsAn option contract conveys to the holder the right, but not the obligation, to purchase or sell a specified amountor value of an underlying security at a fixed price. Option contracts are used in the investment portfolio asprotection against unexpected shifts in interest rates, which would affect the duration of the fixed maturityportfolio. By using options in the portfolio, the overall interest rate sensitivity of the portfolio can be reduced.Option contracts may also be used as an alternative to futures contracts in the Company’s synthetic strategy as


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described above. The price of an option is influenced by the underlying security, expected volatility, time toexpiration, and supply and demand.

The credit risk associated with the above derivative financial instruments relates to the potential for non-performance by counterparties. Although non-performance is not anticipated, in order to minimize the risk ofloss, management monitors the creditworthiness of its counterparties and obtains collateral. The performance ofexchange-traded instruments is guaranteed by the exchange on which they trade. For non-exchange-tradedinstruments, the counterparties are principally banks which must meet certain criteria according to theCompany's investment guidelines.

(iii) Convertible security investmentsA convertible bond is a debt instrument that can be converted into a predetermined amount of the issuer’s equityat certain times prior to the bond's maturity. The convertible option is an embedded derivative within the fixedmaturity host instruments which are classified in the investment portfolio as available for sale. The Companypurchases convertible bonds for their total return and not specifically for the conversion feature.

(iv) To be announced mortgage-backed securities (TBA)By acquiring a TBA, the Company makes a commitment to purchase a future issuance of mortgage-backedsecurities. For the period between purchase of the TBA and issuance of the underlying security, the Company’sposition is accounted for as a derivative in the consolidated financial statements. The Company purchases TBAsboth for their total return and for the flexibility they provide related to the Company’s mortgage-backed securitystrategy.

(v) GLBUnder the GLB program, as the assuming entity, the Company is obligated to provide coverage until theexpiration or maturity of the underlying deferred annuity contracts or the expiry of the reinsurance treaty.Premiums received under the reinsurance treaties are classified as premium. Expected losses allocated topremiums received are classified as Future policy benefits. Other changes in fair value, principally arising fromchanges in expected losses allocated to expected future premiums, are classified as Net realized gains (losses).Fair value represents management’s estimate of exit price and thus, includes a risk margin. The Company mayrecognize a realized loss for other changes in fair value due to adverse changes in the capital markets (e.g.,declining interest rates and/or declining equity markets) and changes in actual or estimated future policyholderbehavior (e.g., increased annuitization or decreased lapse rates). The Company believes this presentationprovides the most meaningful disclosure of changes in the underlying risk within the GLB reinsurance programsfor a given reporting period.

(b) Concentrations of credit riskThe Company’s investment portfolio is managed following prudent standards of diversification. Specific provisionslimit the allowable holdings of a single issue and issuer. The Company believes that there are no significantconcentrations of credit risk associated with the investment portfolio. Our three largest exposures by issuer atDecember 31, 2012, were General Electric Company, JP Morgan Chase & Co., and Bank of America Corp. Ourlargest exposure by industry at December 31, 2012 was financial services.

(c) Credit facilities and letters of creditACE and its participating subsidiaries (including the Company) have a $1.0 billion unsecured operational creditfacility (adjustable to $1.5 billion upon consent of the issuers) expiring in November 2017. Under the new facility,the Company is no longer jointly liable for drawings made by ACE or other participating subsidiaries. We areallowed to utilize up to $300 million of this facility as an unsecured revolving credit facility. This facility replacesthe $1.0 billion syndicated letter of credit (LOC) facility and $500 million unsecured revolving credit facility thatexpired in November 2012. At December 31, 2012, the Company’s outstanding LOCs issued under this facility were$64.2 million.

This facility requires that ACE Limited and/ or certain of its subsidiaries continue to maintain certain covenants.


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(d) GuaranteeDuring October 2007, the Company placed $200 million in a trust account for the benefit of an affiliated company,ACE Property and Casualty Insurance Company, to secure the affiliate’s reinsurance amounts due from otherreinsurance companies.

(e) Claims and Other LitigationThe Company may be subject to arbitration proceedings involving disputed interpretations of treaty coverage. Thesearbitration proceedings, involving disputed interpretations of treaty coverage and/or claims on policies issued byceding companies, are typical to the reinsurance industry in general and in the normal course of business and areconsidered in the Company’s loss and loss expense reserves. In addition to arbitration proceedings, the Companymay be subject to lawsuits and regulatory actions in the normal course of business that do not arise from or directlyrelate to claims on assumed reinsurance treaties. This category of business litigation could involve, amongst otherthings, allegations of underwriting errors or misconduct, employment claims, regulatory activity or disputes arisingfrom business ventures. In the opinion of the Company’s management, the ultimate liability for these matters is notlikely to have a material adverse effect on the Company’s consolidated financial condition, although it is possible thatthe effect could be material to the Company’s consolidated results of operations for an individual reporting period.

9. Short-term debt

The Company has executed reverse repurchase agreements with certain counterparties under which the Company agreed tosell securities and repurchase them at a future date for a predetermined price. At December 31, 2012 and 2011, there were$550.5 million and $ 400.2 million of reverse repurchase agreements outstanding with a weighted average interest rate of0.4 percent and 0.35 percent, respectively.

10. Shareholder’s equity

The Company's authorized share capital is $100,000,000 consisting of 10,000,000 Common Shares of $10 par value. TheCompany’s issued share capital is $2,800,000 consisting of 280,000 Common Shares of $10 par value.

During the years ended December 31, 2012 and 2011 dividends amounting to $125 million and $810 million respectively,were declared and paid.

11. Fair value measurements

Fair value hierarchyFair value of financial assets and financial liabilities is estimated based on the framework established in the fair valueaccounting guidance. The guidance defines fair value as the price to sell an asset or transfer a liability in an orderlytransaction between market participants and establishes a three-level valuation hierarchy in which inputs into valuationtechniques used to measure fair value are classified. The fair value hierarchy gives the highest priority to quoted prices inactive markets and the lowest priority to unobservable data.

The three levels of the hierarchy are as follows:

• Level 1 – Unadjusted quoted prices for identical assets or liabilities in active markets;• Level 2 – Includes, among other items, inputs other than quoted prices that are observable for the asset or liability

such as interest rates and yield curves, quoted prices for similar assets and liabilities in active markets, and quoted

prices for identical or similar assets and liabilities in markets that are not active; and

• Level 3 – Inputs that are unobservable and reflect management’s judgments about assumptions that marketparticipants would use in pricing an asset or liability.

The Company categorizes financial instruments within the valuation hierarchy at the balance sheet date based upon thelowest level of inputs that are significant to the fair value measurement. Accordingly, transfers between levels within thevaluation hierarchy occur when there are significant changes to the inputs, such as increases or decreases in market


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activity, changes to the availability of current prices, changes to the transparency of underlying inputs, and whether thereare significant variances in quoted prices. Transfers in and/or out of any level are assumed to occur at the end of theperiod.

The Company uses one or more pricing services to obtain fair value measurements for the majority of the investmentsecurities the company holds. Based on management’s understanding of the methodologies used, these pricing servicesonly produce an estimate of fair value if there is observable market information that would allow them to make a fair valueestimate. Based on the Company’s understanding of the market inputs used by the pricing services, all applicableinvestments have been valued in accordance with GAAP. The Company does not typically adjust prices obtained frompricing services. The following is a description of the valuation techniques and inputs used to determine fair values forfinancial instruments carried at fair value, as well as the general classification of such financial instruments pursuant to thevaluation hierarchy.

Fixed maturitiesThe Company utilizes pricing services to estimate fair value measurements for the majority of its fixed maturities. Thepricing services utilize market quotations for fixed maturities that have quoted prices in active markets; such securities areclassified within Level 1. For fixed maturities other than U.S. Treasury securities that generally do not trade on a dailybasis, the pricing services prepare estimates of fair value measurements using their pricing applications, which includeavailable relevant market information, benchmark curves, benchmarking of like securities, sector groupings, and matrixpricing. Additional valuation factors that can be taken into account are nominal spreads, dollar basis, and liquidityadjustments. The pricing services evaluate each asset class based on relevant market and credit information, perceivedmarket movements, and sector news. The market inputs utilized in the pricing evaluation, listed in the approximate orderof priority include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmarksecurities, bids, offers, reference data, and industry and economic events. The extent of the use of each input is dependanton the asset class and the market conditions. Given the asset class, the priority of the use of inputs may change or somemarket inputs may not be relevant. Additionally, the valuation of fixed maturity investments is more subjective whenmarkets are less liquid due to the lack of market based inputs (i.e., stale pricing), which may increase the potential that theestimated fair value of an investment is not reflective of the price at which an actual transaction would occur. Theoverwhelming majority of fixed maturities are classified within Level 2 because the most significant inputs used in thepricing techniques are observable. For a small number of fixed maturities, the Company obtains a quote from a broker(typically a market maker). Due to the disclaimers on the quotes that indicate that the price is indicative only, the Companyincludes these fair value estimates in Level 3.

Equity securitiesEquity securities with active markets are classified within Level 1 as fair values are based on quoted market prices. Fornon-public equity securities, fair values are based on market valuations and are classified within Level 2. Equity securitiesfor which pricing is unobservable are classified within Level 3.

Short-term investmentsShort-term investments, which comprise securities due to mature within one year of the date of purchase, that are traded inactive markets are classified within Level 1 as fair values are based on quoted market prices. Securities such ascommercial paper and discount notes are classified within Level 2 because these securities are typically not actively tradeddue to their approaching maturity and, as such, their cost approximates fair value.

Other investmentsFair values for the majority of Other investments including investments in partially-owned investment companies,investment funds, and limited partnerships are based on their respective net asset values or equivalent (NAV). Themajority of these investments, for which the Company has used NAV as a practical expedient to measure fair value, areclassified within Level 3 because either the Company will never have the contractual option to redeem the investment orwill not have the contractual option to redeem the investments in the near term. The remainder of such investments areclassified within Level 2.


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Securities lending collateralThe underlying assets included in Securities lending collateral are fixed maturities which are classified in the valuationhierarchy on the same basis as other fixed maturities. Excluded from the valuation hierarchy is the corresponding liabilityrelated to the Company’s obligation to return the collateral plus interest as it is reported at contract value and not fair valueon the consolidated balance sheets.

Investment derivative instrumentsActively traded investment derivative instruments, including futures, options, and exchange-traded forward contracts, areclassified within Level 1 as fair values are based on quoted market prices. Investment derivative instruments are recordedin Accounts payable, accrued expenses, and other liabilities in the consolidated balance sheets.

Other derivative instrumentThe Company maintains positions in other derivative instruments including exchange-traded equity futures contracts andoption contracts designed to limit exposure to a severe equity market decline. The Company’s position in exchange-tradedequity futures contracts is classified within Level 1. The fair value of options on equity market indices is based onsignificant observable inputs and are accordingly classified within Level 2. Further, the Company’s positions in theinterest rate swap and foreign currency forward contract are valued based on significant observable inputs and aretherefore classified within Level 2. Other derivative instruments are recorded in Accounts payable, accrued expenses, andother liabilities in the consolidated balance sheets.

Guaranteed living benefitsThe GLB arises from life reinsurance programs covering living benefit guarantees whereby the Company assumes the riskof guaranteed minimum income benefits (GMIB) and guaranteed minimum accumulation benefits (GMAB) associatedwith variable annuity contracts. GLB’s are recorded in Accounts payable, accrued expenses, and other liabilities andFuture policy benefits in the consolidated balance sheets. For GLB reinsurance, the Company estimates fair value using aninternal valuation model which includes current market information and estimates of policyholder behavior. All of thetreaties contain claim limits, which are factored into the valuation model. The fair value depends on a number of inputs,including changes in interest rates, changes in equity markets, credit risk, current account value, changes in marketvolatility, expected annuitization rates, changes in policyholder behavior, and changes in policyholder mortality.

The most significant policyholder behavior assumptions include lapse rates and the GMIB annuitization rates.Assumptions regarding lapse rates and GMIB annuitization rates differ by treaty but the underlying methodologies todetermine rates applied to each treaty are comparable. The assumptions regarding lapse and GMIB annuitization ratesdetermined for each treaty are based on a dynamic calculation that uses several underlying factors. A lapse rate is thepercentage of in-force policies surrendered in a given calendar year. All else equal, as lapse rates increase, ultimate claimpayments will decrease. The GMIB annuitization rate is the percentage of policies for which the policyholder will elect toannuitize using the guaranteed benefit provided under the GMIB. All else equal, as GMIB annuitization rates increase,ultimate claim payments will increase, subject to treaty claim limits. In general, the Company assumes that GMIBannuitization rates will be higher for policies with more valuable guarantees (policies with guaranteed values far in excessof their account values). In addition, the Company also assumes that GMIB annuitization rates are higher in the first yearimmediately following the waiting period (the first year the policies are eligible to annuitize using the GMIB) incomparison to all subsequent years. The GMIB reinsurance treaties include claim limits to protect the Company in theevent that actual annuitization behavior is significantly higher than expected.

The model and related assumptions are continuously re-evaluated by management and enhanced, as appropriate, basedupon additional experience obtained related to policyholder behavior and availability of more information, such as marketconditions, market participant assumptions, and demographics of in-force annuities. During 2012, no material changeswere made to actuarial or behavioral assumptions.

The Company views the variable annuity reinsurance business as having a similar risk profile to that of catastrophereinsurance, with the probability of a cumulative long-term economic net loss relatively small at the time of pricing.However, adverse changes in market factors and policyholder behavior will have an adverse impact on net income, whichmay be material. Because of the significant use of unobservable inputs including policyholder behavior, GLB reinsuranceis classified within Level 3.


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The following tables present, by valuation hierarchy, the financial instruments carried or disclosed at fair value, andmeasured on a recurring basis, at December 31, 2012, and December 31, 2011.

December 31, 2012

Quoted Prices inActive Markets forIdentical Assets orLiabilities Level 1

Significant OtherObservable Inputs

Level 2

SignificantUnobservableInputs Level 3 Total


Assets:

Fixed maturities available for sale

U.S. Treasury and agency $ 770,175 589,434 - 1,359,609

Foreign - 3,431,247 2,414 3,433,661

Corporate securities 1,409 6,470,858 59,801 6,532,068

Mortgage-backed securities - 3,243,587 1,544 3,245,131

States, municipalities, and politicalsubdivisions - 211,378 - 211,378

771,584 13,946,504 63,759 14,781,847

Equity securities 13,471 486,387 2 499,860

Short-term investments 332,860 142,205 - 475,065

Other investments - 40,373 1,568,513 1,608,886

Securities lending collateral - 632,358 - 632,358

Investment derivative instruments 5,033 - - 5,033

Total assets at fair value $ 351,364 1,301,323 1,568,515 3,221,202

1,122,948 15,247,827 1,632,274 18,003,049

Liabilities:

GLB(1)$ - $ - $ 213,982 $ 213,982

(1)The GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value.

Excluded from the table above is the portion of the GLB derivative liability classified as Future policy benefits in the consolidated balance sheets.

There were no significant gross transfers between Level 1 and Level 2 during the year ended December 31, 2012.

December 31, 2011

Quoted Prices inActive Markets forIdentical Assets orLiabilities Level 1

Significant OtherObservable Inputs

Level 2

SignificantUnobservableInputs Level 3 Total


Assets:

Fixed maturities available for sale

U.S. Treasury and agency $ 444,298 $ 438,867 $ 4,657 $ 887,822

Foreign - 3,198,672 800 3,199,472

Corporate securities 1,920 5,495,544 77,891 5,575,355

Mortgage-backed securities - 3,184,837 13,318 3,198,155

States, municipalities, and politicalsubdivisions - 206,400 - 206,400

446,218 12,524,320 96,666 13,067,204

Equity securities 14,629 417,496 2 432,127

Short-term investments 199,951 202,704 - 402,655

Other investments - 40,546 1,383,323 1,423,869

Securities lending collateral - 454,176 - 454,176

Investment derivative instruments 8,681 - - 8,681

Other derivative instrument - - 56 56

Total assets at fair value $ 669,479 13,639,242 1,480,047 15,788,768(1)

The GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value.Excluded from the table above is the portion of the GLB derivative liability classified as Future policy benefits in the consolidated balance sheets.


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There were no significant gross transfers between Level 1 and Level 2 during the year ended December 31, 2011.

Fair value of alternative investmentsIncluded in Other investments in the fair value hierarchy at December 31, 2012 and 2011, are investment funds, limitedpartnerships, and partially-owned investment companies measured at fair value using NAV as a practical expedient. AtDecember 31, 2012, there were no probable or pending sales related to any of the investments measured at fair value usingNAV.

The following table presents, by investment category, the fair values of and maximum future funding commitments relatedto these investments at December 31, 2012 and December 31, 2011. The table also shows the expected liquidation periodfrom December 31, 2012.

Included in all categories in the above table except for Investment funds are investments for which the Company willnever have the contractual option to redeem but receives distributions based on the liquidation of the underlying assets.Included in the “Expected Liquidation Period” column above is the range in years over which the Company expects themajority of underlying assets in the respective categories to be liquidated. Further, for all categories except for Investmentfunds, the Company does not have the ability to sell or transfer the investments without the consent from the generalpartner of individual funds.

FinancialFinancial primarily consists of investments in private equity funds targeting financial services companies such as financialinstitutions and insurance services around the world.

DistressedDistressed consists of investments in private equity funds targeting distressed debt/credit and equity opportunities in theU.S.

MezzanineMezzanine consists of investments in private equity funds targeting private mezzanine debt of large-cap and mid-capcompanies in the U.S. and worldwide.

TraditionalTraditional consists of investments in private equity funds employing traditional private equity investment strategies suchas buyout and venture with different geographical focuses including Brazil, Asia, Europe, and the U.S.

December 31, 2012 December 31, 2011

ExpectedLiquidation

Period Fair Value

MaximumFuture

FundingCommitments Fair Value

MaximumFuture FundingCommitments


Financial 5 to 9 Years $ 223,200 102,764 $ 201,900 141,623

Distressed 6 to 9 Years 122,600 97,500 144,600 10,000

Mezzanine 6 to 9 Years 206,300 259,722 159,100 219,261

Traditional 3 to 8 Years 653,400 390,806 527,400 112,947

Vintage 1 to 3 Years 8,200 - 12,806 939

Investment funds Not Applicable 395,186 - 378,063 -

$ 1,608,886 850,792 $ 1,423,869 484,770


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VintageVintage consists of investments in private equity funds made before 2002 and where the funds’ commitment periods hadalready expired.

Investment fundsThe Company’s investment funds employ various investment strategies such as long/short equity and arbitrage/distressed.Included in this category are investments for which the Company has the option to redeem at agreed upon value asdescribed in each investment fund’s subscription agreement. Depending on the terms of the various subscriptionagreements, the Company may redeem investment fund investments monthly, quarterly, semi-annually, or annually. If theCompany wishes to redeem an investment fund investment, it must first determine if the investment fund is still in a lock-up period (a time when the Company cannot redeem its investment so that the investment fund manager has time to buildthe portfolio). If the investment fund is no longer in its lock-up period, the Company must then notify the investment fundmanager of its intention to redeem by the notification date prescribed by the subscription agreement. Subsequent tonotification, the investment fund can redeem the Company’s investment within several months of the notification. Noticeperiods for redemption of the Company’s investment funds range between 5 and 120 days. The Company can redeem itsinvestment funds without consent from the investment fund managers.

Level 3 financial instrumentsThe fair value of assets and liabilities measured at fair value using significant unobservable inputs (Level 3) consist ofvarious inputs and assumptions that management makes when determining fair value. Management analyzes changes infair value measurements classified within Level 3 by comparing pricing and returns of investments to benchmarks,including month-over-month movements, investment credit spreads, interest rate movements, and credit quality ofsecurities.

The following table presents the significant unobservable inputs used in the Level 3 liability valuations. Excluded from thetable below are inputs used to fair value Level 3 assets which are based on single broker quotes or net asset value andcontain no quantitative unobservable inputs developed by management.

(in thousands of U.S. dollars)Fair Value at

December 31, 2012Valuation

TechniqueSignificant

Unobservable Inputs Ranges

GLB(1)$ 213,982 Actuarial model Lapse rate 1% - 30%

Annuitization rate 0% - 13.33%

(1) Discussion of the most significant inputs used in the fair value measurement of GLB and the sensitivity of those assumptions is discussed previously in this footnote.


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The following tables present a reconciliation of the beginning and ending balances of financial instruments measured atfair value using significant unobservable inputs (Level 3):

Year Ended December 31, 2012 (in thousands of U.S. dollars)

Assets Liabilities

Available-for-Sale Debt Securities

U.S.Treasury

and agency ForeignCorporatesecurities MBS

Equitysecurities

Otherinvestments

Otherderivative

instruments GLB(1)

(in millions of U.S. dollars)

Balance-Beginning ofyear $ 4,657 $ 800 $ 77,891 $ 13,318 $ 2 $ 1,383,323 $ 56 $ 0Transfers into Level 3 1,651 15,459 8,217Transfers out of Level 3 (4,657) (2,315) (14,602) (13,633) (1,200) - -Change in Net UnrealizedGains (Losses) includedin OCI - 237 3,674 94 - 49,731 - 213,982Net RealizedGains/Losses - (328) (226) 31 - (6,822) (56)Purchases - 4,940 5,400 3 1,200 293,536 -Sales - (2,626) (4,988) (4,713) - - -Issuances - 55 - - - - -Settlements - - (22,807) (1,773) - (151,255) -Balance-End of year $ - $ 2,414 $ 59,801 $ 1,544 $ 2 $ 1,568,513 $ - $ 213,982

Net RealizedGains/Losses Attributableto Changes in Fair Valueat the Balance Sheet Date $ - $ - $ $ - $ $ - $ (6,822) $ - $ 213,982

(1) Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is

the portion of the GLB derivative liability classified as Future policy benefits in the consolidated balance sheets.

Year Ended December 31, 2011 (in thousands of U.S. dollars)

Available-for-Sale Debt Securities

U.S. Treasuryand agency Foreign

Corporatesecurities

Mortgage-backed

securitiesEquity

securitiesOther

investments

Otherderivative

instruments

Balance-Beginning of year $ - $ 1,406 $ 57,520 $ 21,784 $ 2,585 $ 1,213,347 $ (192)Transfers into Level 3 - 3,992 31,211 2,203 - - -

Transfers out of Level 3 - (5,865) (120) (31,111) - - -

Change in Net Unrealized Gains(Losses) included in OCI (10) (159) (2,534) 114 (1,482) 16,033 -

Net Realized Gains/Losses - (13) (362) 38 2,338 (3,527) 248Purchases 4,667 2,670 15,731 37,817 361,716 -

Sales - (1,228) (13,129) (12,810) (3,440) (54,482) -Settlements - (3) (10,426) (4,717) - (149,764) -

Balance-End of year $ 4,657 $ 800 $ 77,891 $ 13,318 $ 2 $ 1,383,323 $ 56

Net Realized Gains/LossesAttributable to Changes in Fair Valueat the Balance Sheet Date $ - $ (57) $ (301) $ - $ 1 $ (3,527) $ -


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Financial instruments disclosed, but not carried, at fair valueThe Company uses various financial instruments in the normal course of its business. The Company’s reinsurancecontracts are excluded from fair value of financial instruments accounting guidance and, therefore, are not included in theamounts discussed below.

The carrying values of cash, other assets, other liabilities, and other financial instruments not included below approximatedtheir fair values.

Investment in partially-owned insurance companyThe fair value of the Company’s investment in a partially-owned insurance company is based on the share of the net assetsbased on its financial statements.

Short-term debtWhere practical, fair values for short-term debt is estimated using discounted cash flow calculations based principally onobservable inputs including incremental borrowing rates, which reflect the Company’s credit rating, for similar types ofborrowings with maturities consistent with those remaining for the debt being valued.

The following table presents carrying values and fair values of financial instruments not measured at fair value:

December 31, 2012 December 31, 2011Carrying

ValueFair

ValueCarrying

ValueFair

Value(in thousands of U.S. dollars)

Assets:Fixed maturities held to maturityU.S. Treasury and agency $ 19,170 $ 19,300 $ 20,617 $ 21,685Foreign 1,177 1,211 2,767 2,855Corporate securities 40,158 42,340 55,441 57,478Mortgage-backed securities 81,752 84,748 133,458 138,149States, municipalities, and politicalsubdivisions 2,100 2,131 2,362 2,474

Total fixed maturities held tomaturity 144,357 149,730 214,645 222,641

Liabilities:Short-term debt 550,470 550,000 400,210 400,000

12. Taxation

Under current Bermuda law, the Company and its Bermuda subsidiaries are not required to pay any taxes on income orcapital gains. If a Bermuda law were enacted that would impose taxes on income or capital gains, ACE Limited and theBermuda subsidiaries have received an undertaking from the Minister of Finance in Bermuda that would exempt suchcompanies from Bermudian taxation until March 2035.

The Company does not consider itself to be engaged in trade or business in the United States and, accordingly, does notexpect to be subject to United States taxation.

13. Statutory financial information

The Company is registered under The Insurance Act 1978 (Bermuda), amendments thereto and related regulations (the“Act”) as a Class 4 insurer. The Act requires the Company to meet a minimum solvency margin and a minimum liquidityratio. The Company has satisfied these requirements for 2012 and 2011. The Bermuda Statutory Capital Requirement(“BSCR”) is a risk-based capital model to measure risk and to determine an enhanced capital requirement and targetcapital level (defined as 120% of the enhanced capital requirement (“ECR”)) for Class 4 insurers. For the year ended


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December 31, 2012 the Company had statutory capital and surplus of $8,994 million (2011 - $7,129 million) whichexceeded the ECR of $2,793 million (2011 – $2,687 million).

A Class 4 insurer is prohibited from declaring or paying a dividend if in breach of its ECR, solvency margin or minimumliquidity ratio or if the declaration or payment of such dividend would cause such a breach. Where an insurer fails to meetits solvency margin or minimum liquidity ratio on the last day of any financial year, it is prohibited from declaring orpaying any dividends during the next financial year without the approval of the Bermuda Monetary Authority. Further, aClass 4 insurer is prohibited from declaring or paying in any financial year dividends of more than 25% of its totalstatutory capital and surplus (as shown on its previous financial year’s statutory balance sheet) unless it files (at least sevendays before payment of such dividends) with the Authority an affidavit signed by at least two directors and the insurer’sprincipal representative stating that the declaration of such dividends has not caused the insurer to fail to meet its solvencymargin or minimum liquidity ratio. Class 4 insurers must obtain the Authority’s prior approval for a reduction by 15% ormore of the total statutory capital as set forth in its previous year’s statutory financial statements.

14. Subsequent events

The Company has performed an evaluation of subsequent events through April 26, 2013, which is the date that thefinancial statements were issued. No significant subsequent events were identified.

ace tempest reinsurance ltd. and its subsidiaries

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