Commitments, contingencies, and guarantees

a) Derivative instruments

Foreign currency management

As a global company, ACE entities transact business in multiple currencies. Our policy is to generally match assets, liabilities and required capital for each individual jurisdiction in local currency, which would include the use of derivatives discussed below. We do not hedge our net asset non-USD capital positions, however we do consider hedging for planned cross border transactions.

Derivative instruments employed

ACE maintains positions in derivative instruments such as futures, options, swaps, and foreign currency forward contracts for which the primary purposes are to manage duration and foreign currency exposure, yield enhancement, or to obtain an exposure to a particular financial market. ACE also maintains positions in convertible securities that contain embedded derivatives. Investment derivative instruments are recorded in either Other assets (OA) or Accounts payable, accrued expenses, and other liabilities (AP), convertible bonds are recorded in Fixed maturities available for sale (FM AFS) and convertible equity securities are recorded in Equity securities (ES) in the consolidated balance sheets. These are the most numerous and frequent derivative transactions.

In addition, ACE from time to time purchases to be announced mortgage-backed securities (TBAs) as part of its investing activities.

Under reinsurance programs covering GLBs, ACE assumes the risk of GLBs, including GMIB and GMAB, associated with variable annuity contracts. The GMIB risk is triggered if, at the time the contract holder elects to convert the accumulated account value to a periodic payment stream (annuitize), the accumulated account value is not sufficient to provide a guaranteed minimum level of monthly income. The GMAB risk is triggered if, at contract maturity, the contract holder’s account value is less than a guaranteed minimum value. The GLB reinsurance product meets the definition of a derivative instrument. Benefit reserves in respect of GLBs are classified as Future policy benefits (FPB) while the fair value derivative adjustment is classified within AP. ACE also maintains positions in exchange-traded equity futures contracts and options on equity market indices to limit equity exposure in the GMDB and GLB blocks of business.

All derivative instruments are carried at fair value with changes in fair value recorded in Net realized gains (losses) in the consolidated statements of operations. None of the derivative instruments are designated as hedges for accounting purposes.

The following table presents the balance sheet locations, fair values of derivative instruments in an asset or (liability) position, and notional values/payment provisions of our derivative instruments:



				June 30, 2015							December 31, 2014
	Consolidated Balance Sheet Location	Fair Value					Notional Value/ Payment Provision		Fair Value					Notional Value/ Payment Provision
(in millions of U.S. dollars)	Consolidated Balance Sheet Location	Derivative Asset		Derivative (Liability)			Notional Value/ Payment Provision		Derivative Asset		Derivative (Liability)			Notional Value/ Payment Provision
Investment and embedded derivative instruments
Foreign currency forward contracts	OA / (AP)	$	6	$	(13	)	$	1,309	$	12	$	(7	)	$	1,329
Cross-currency swaps	OA / (AP)	—		—			95		—		—			95
Futures contracts on money market instruments	OA / (AP)	1		(1		)	4,355		—		—			2,467
Options/Futures contracts on notes and bonds	OA / (AP)	9		(1		)	920		6		(29		)	1,636
Convertible securities⁽¹⁾	FM AFS / ES	292		—			277		291		—			267
		$	308	$	(15	)	$	6,956	$	309	$	(36	)	$	5,794
Other derivative instruments
Futures contracts on equities⁽²⁾	OA / (AP)	$	16	$	—		$	1,286	$	—	$	(21	)	$	1,384
Options on equity market indices⁽²⁾	OA / (AP)	—		—			250		2		—			250
Other	OA / (AP)	7		(3		)	401		—		(4		)	10
		$	23	$	(3	)	$	1,937	$	2	$	(25	)	$	1,644
GLB⁽³⁾	(AP) / (FPB)	$	—	$	(615	)	$	786	$	—	$	(663	)	$	675


⁽¹⁾	Includes fair value of embedded derivatives.


⁽²⁾	Related to GMDB and GLB blocks of business.


⁽³⁾	Includes both future policy benefits reserves and fair value derivative adjustment. Refer to Note 5 for additional information. Note that the payment provision related to GLB is the net amount at risk. The concept of a notional value does not apply to the GLB reinsurance contracts.

At June 30, 2015 and December 31, 2014, derivative liabilities of $19 million and $34 million, respectively, included in the table above were subject to a master netting agreement. The remaining derivatives included in the table above were not subject to a master netting agreement.

b) Secured borrowings

ACE participates in a securities lending program operated by a third-party banking institution whereby certain assets are loaned to qualified borrowers and from which we earn an incremental return. At June 30, 2015 and December 31, 2014, our securities lending collateral was $1,080 million and $1,330 million, respectively, and our securities lending payable, reflecting our obligation to return the collateral plus interest, was $1,081 million and $1,331 million, respectively. At June 30, 2015 the securities lending collateral held by ACE on overnight and continuous securities lending contracts comprised $526 million of Cash, $477 million of Foreign securities, $74 million of U.S. Treasury and agency securities and $3 million of Corporate securities. The carrying value of the securities lending collateral held is $1 million lower than the securities lending payable due to accrued interest recorded in the securities lending payable. The securities lending collateral can only be drawn down by ACE in the event that the institution borrowing the securities is in default under the lending agreement. An indemnification agreement with the lending agent protects us in the event a borrower becomes insolvent or fails to return any of the securities on loan. The collateral is recorded in Securities lending collateral and the liability is recorded in Securities lending payable in the consolidated balance sheets.

At both June 30, 2015 and December 31, 2014, our repurchase agreement obligations of $1,402 million were fully collateralized. In contrast to securities lending programs, the use of cash received is not restricted for the repurchase obligations. The fair value of the underlying securities sold remains in Fixed maturities available for sale and Equity securities and the repurchase agreement obligation is recorded in Short-term debt in the consolidated balance sheets.

The following table presents the carrying value of collateral pledged under repurchase agreements by investment category and maturity date of the underlying agreements:



	Remaining contractual maturity
June 30, 2015	30 - 90 Days		Greater than 90 Days		Total
(in millions of U.S. dollars)	30 - 90 Days		Greater than 90 Days		Total
Collateral pledged under repurchase agreements:
Cash	$	—	$	5	$	5
U.S. Treasury and agency	62		176		238
Mortgage-backed securities	86		1,129		1,215
	$	148	$	1,310	$	1,458
Gross amount of recognized liabilities for repurchase agreements					$	1,402
Difference⁽¹⁾					$	56


⁽¹⁾	Per the repurchase agreements, the amount of collateral posted is required to exceed the amount of gross liability.

Potential risks exist in our secured borrowing transactions due to market conditions and counterparty exposure. With collateral that we pledge, there is a risk that the collateral may not be returned at the expiration of the agreement. If the counterparty fails to return the collateral, ACE will have free use of the borrowed funds until our collateral is returned. In addition, we may encounter the risk that ACE may not be able to renew outstanding borrowings with a new term or with an existing counterparty due to market conditions including a decrease in demand as well as more restrictive terms from banks due to increased regulatory and capital constraints. Should this condition occur, ACE may seek alternative borrowing sources or reduce borrowings. Additionally, increased margins and collateral requirements due to market conditions would increase our restricted assets as we are required to provide additional collateral to support the transaction.

The following table presents net realized gains (losses) related to derivative instrument activity in the consolidated statements of operations:



	Three Months Ended						Six Months Ended
	June 30						June 30
(in millions of U.S. dollars)	2015			2014			2015			2014
Investment and embedded derivative instruments
Foreign currency forward contracts	$	(10	)	$	(1	)	$	15		$	(4	)
All other futures contracts and options	42			(18		)	13			(40		)
Convertible securities⁽¹⁾	(5		)	4			—			4
Total investment and embedded derivative instruments	$	27		$	(15	)	$	28		$	(40	)
GLB and other derivative instruments
GLB⁽²⁾	$	104		$	2		$	59		$	(46	)
Futures contracts on equities⁽³⁾	(2		)	(71		)	(13		)	(88		)
Options on equity market indices⁽³⁾	—			(1		)	(1		)	(3		)
Other	(1		)	9			(1		)	7
Total GLB and other derivative instruments	$	101		$	(61	)	$	44		$	(130	)
	$	128		$	(76	)	$	72		$	(170	)


⁽¹⁾	Includes embedded derivatives.


⁽²⁾	Excludes foreign exchange gains (losses) related to GLB.


⁽³⁾	Related to GMDB and GLB blocks of business.

c) Derivative instrument objectives

(i) Foreign currency exposure management

A foreign currency forward contract (forward) is an agreement between participants to exchange specific foreign currencies at a future date. ACE uses forwards to minimize the effect of fluctuating foreign currencies as discussed above.

(ii) Duration management and market exposure

Futures

Futures contracts give the holder the right and obligation to participate in market movements, determined by the index or underlying security on which the futures contract is based. Settlement is made daily in cash by an amount equal to the change in value of the futures contract times a multiplier that scales the size of the contract. Exchange-traded futures contracts on money market instruments, notes and bonds are used in fixed maturity portfolios to more efficiently manage duration, as substitutes for ownership of the money market instruments, bonds and notes without significantly increasing the risk in the portfolio. Investments in futures contracts may be made only to the extent that there are assets under management not otherwise committed.

Exchange-traded equity futures contracts are used to limit exposure to a severe equity market decline, which would cause an increase in expected claims and therefore, an increase in reserves for GMDB and GLB reinsurance business.

Options

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

Another use for option contracts is to limit exposure to a severe equity market decline, which would cause an increase in expected claims and therefore, an increase in reserves for GMDB and GLB reinsurance business.

The price of an option is influenced by the underlying security, expected volatility, time to expiration, and supply and demand.

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

Cross-currency swaps

Cross-currency swaps are agreements under which two counterparties exchange interest payments and principal denominated in different currencies at a future date. We use cross-currency swaps to reduce the foreign currency and interest rate risk by converting cash flows back into local currency. We invest in foreign currency denominated investments to improve credit diversification and also to obtain better duration matching to our liabilities that is limited in the local currency market.

Other

Included within Other are derivatives intended to reduce potential losses which may arise from certain exposures in our insurance business. The economic benefit provided by these derivatives is similar to purchased reinsurance. For example, ACE may enter into crop derivative contracts to protect underwriting results in the event of a significant decline in commodity prices. Also included within Other are certain life insurance products that meet the definition of a derivative instrument for accounting purposes.

(iii) Convertible security investments

A convertible security is a debt instrument or preferred stock that can be converted into a predetermined amount of the issuer’s equity. The convertible option is an embedded derivative within the host instruments which are classified in the investment portfolio as either available for sale or as an equity security. ACE purchases convertible securities for their total return and not specifically for the conversion feature.

(iv) TBA

By acquiring TBAs, we make a commitment to purchase a future issuance of mortgage-backed securities. For the period between purchase of the TBAs and issuance of the underlying security, we account for our position as a derivative in the consolidated financial statements. ACE purchases TBAs both for their total return and for the flexibility they provide related to our mortgage-backed security strategy.

(v) GLB

Under the GLB program, as the assuming entity, ACE is obligated to provide coverage until the expiration or maturity of the underlying deferred annuity contracts or the expiry of the reinsurance treaty. Premiums received under the reinsurance treaties are classified as premium. Expected losses allocated to premiums received are classified as Future policy benefits and valued similar to GMDB reinsurance. Other changes in fair value, principally arising from changes in expected losses allocated to expected future premiums, are classified as Net realized gains (losses). Fair value represents management’s estimate of an exit price and thus, includes a risk margin. We may recognize a realized loss for other changes in fair value due to adverse changes in the capital markets (e.g., declining interest rates and/or declining equity markets) and changes in actual or estimated future policyholder behavior (e.g., increased annuitization or decreased lapse rates) although we expect the business to be profitable. We believe this presentation provides the most meaningful disclosure of changes in the underlying risk within the GLB reinsurance programs for a given reporting period.

d) Other investments

At June 30, 2015, included in Other investments in the consolidated balance sheet are investments in limited partnerships and partially-owned investment companies with a carrying value of $2.2 billion. In connection with these investments, we have commitments that may require funding of up to $1.0 billion over the next several years.

e) Taxation

At June 30, 2015, $23 million of unrecognized tax benefits remains outstanding. It is reasonably possible that over the next twelve months, the amount of unrecognized tax benefits may change resulting from the re-evaluation of unrecognized tax benefits arising from examinations of taxing authorities. With few exceptions, ACE is no longer subject to state and local or non-U.S. income tax examinations for years before 2005.

f) Legal proceedings

Our insurance subsidiaries are subject to claims litigation involving disputed interpretations of policy coverages and, in some jurisdictions, direct actions by allegedly-injured persons seeking damages from policyholders. These lawsuits, involving claims on policies issued by our subsidiaries which are typical to the insurance industry in general and in the normal course of business, are considered in our loss and loss expense reserves. In addition to claims litigation, we are subject to lawsuits and regulatory actions in the normal course of business that do not arise from or directly relate to claims on insurance policies. This category of business litigation typically involves, among other things, allegations of underwriting errors or misconduct, employment claims, regulatory activity, or disputes arising from our business ventures. In the opinion of management, our ultimate liability for these matters could be, but we believe is not likely to be, material to our consolidated financial condition and results of operations.