Item 1.     Business

Safe Harbor Disclosure

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. Any written or oral statements made by or on our behalf may include forward-looking statements which reflect our current views with respect to future events and financial performance. These forward-looking statements are subject to certain uncertainties and other factors that could cause actual results to differ materially from such statements. These uncertainties and other factors (which are described in more detail elsewhere herein and in other documents we file with the Securities and Exchange Commission (“SEC”)) include, but are not limited to:

1

Table of Contents

The words “believe”, “anticipate”, “estimate”, “project”, “should”, “plan”, “expect”, “intend”, “hope”, “will likely result” or “will continue”, and variations thereof and similar expressions, identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. We undertake no obligation to publicly update or review any forward-looking statements, whether as a result of new information, future events or otherwise.

General Development of Business

ACE Limited (“ACE”) is a holding company incorporated with limited liability under the Cayman Islands Companies Law. We created our business office in Bermuda in 1985 when we initially incorporated the Company and we continue to maintain our business office in Bermuda. Through our various operating subsidiaries, we provide a broad range of insurance and reinsurance products to insureds worldwide through operations in the U. S. and almost 50 other countries. At December 31, 2002, we had total assets of $43.4 billion and shareholders’ equity of $6.4 billion. We derive our revenue principally from premiums, fees and investment income.

Our long-term business strategy focuses on achieving underwriting profits and providing value to our clients and shareholders through the utilization of our substantial capital base in the insurance and reinsurance markets. As part of this strategy, we have made a number of acquisitions and have entered into strategic alliances that diversify our operations, both geographically and by product type. Each completed transaction filled a particular niche and added additional expertise and market access to the group. In addition, we continue to review, and adjust where appropriate, our portfolio of products. As a result, we have evolved from a highly specialized corporate insurer focusing on excess liability and directors and officers liability (“D&O”) to a widely diversified global insurance and reinsurance operation servicing clients in every major insurance market in the world.

We entered the property catastrophe reinsurance market in 1996 with the acquisition of Tempest Reinsurance Company Ltd. (“ACE Tempest Re”) and added to our existing market position when we acquired CAT Limited in 1998. The combination of these two participants gave us a property catastrophe reinsurance company with a capital base in excess of $1.2 billion. We also entered the Lloyd’s market in 1996 which broadened our international exposure through Lloyd’s worldwide insurance licenses. In 1998, we added to our position in the Lloyd’s market through the acquisition of the Charman syndicates. Combined with our original acquisitions in 1996, we became, and remain, one of the largest capital providers in the Lloyd’s market. We entered the U.S. market in early 1998 with the acquisition of the Westchester group (“ACE Westchester Specialty”). This acquisition gave us insurance licenses in the U.S. for the first time. In 1999, we acquired the international and domestic property and casualty (“P&C”) businesses of CIGNA Corporation (“ACE INA”) which made us one of the few P&C insurers to operate on a truly global scale. In 1999, we also acquired Capital Re Corporation which added depth, expertise and new products to our financial reinsurance capabilities.

2

Table of Contents

Employees

At December 31, 2002, we employed a total of 7,907 employees. Approximately 1,100 of our employees are represented by various collective bargaining agreements, all of which are outside the U.S., U.K. and Bermuda. We believe that employee relations are satisfactory.

Customers

For most of the commercial lines of business that we offer, insureds typically use the services of an insurance broker. An insurance broker acts as an agent for the insureds, offering advice on the types and amount of insurance to purchase and also assisting in the negotiation of price and terms and conditions. We obtain business from all of the major international insurance brokers and typically pay a commission to brokers for any business accepted and bound. In our opinion, no material part of our business is dependent upon a single customer or group of customers. We do not believe that the loss of any one customer would have a materially adverse effect on us and no one customer or group of affiliated customers accounts for as much as ten percent of our consolidated revenues.

Competition

With over 3,000 insurance and reinsurance companies operating throughout the world, competition in the international insurance and reinsurance marketplace is substantial. Competition varies by type of business and geographic area. We compete for business not only on the basis of price, but also on the basis of availability of coverage desired by customers and quality of service. Our ability to compete is dependent on a number of factors, particularly our ability to maintain the appropriate financial strength ratings as assigned by independent rating agencies. Our strong capital position and global platform affords us opportunities for growth not available to smaller insurance companies. While most of the sectors in which we operate have experienced significant improvement in both price and coverage terms in the past 12 months, competition continues to be considerable, partly because new capital has been invested in the industry to meet capacity shortages in certain lines of business. Competitive information by segment is included in each of the segment discussions.

Trademarks and Trade Names

We use various trademarks and trade names in our business. These trademarks and trade names protect names of certain of the products and services we offer and are important to the extent they provide goodwill and name recognition in the insurance industry. We use commercially reasonable efforts to protect these proprietary rights, including trade secret and trademark laws. One or more of the trademarks and trade names could be material to our ability to sell our products and services. We have taken appropriate steps to protect our ownership of key names and we believe it is unlikely that anyone would be able to prevent us from using names in places or circumstances material to our operations.

Web Site Information

We make available free of charge through our internet site (www.acelimited.com) our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act (15 U.S.C. 78m(a) or 78o(d)) as soon as reasonably practicable after we file such material with, or furnish it to, the SEC.

Segment Information

In 2002, following changes in executive management, we reassessed and changed our reporting segments from individual operating units to lines of business. We now operate through four business segments: Insurance—North American, Insurance—Overseas General, Global Reinsurance and Financial Services. These business segments were determined under the Statement of Financial Accounting Standard (“FAS”) No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“FAS 131”).

3

Table of Contents

The following table sets forth an analysis of gross premiums written by segment for the years ended December 31, 2002, 2001 and 2000. Additional financial information about our segments, including revenues by geographic area, is included in Note 17 of the Consolidated Financial Statements incorporated by reference to our 2002 Annual Report to Shareholders.

Insurance—North American

Background

Our Insurance—North American segment includes the operations of ACE USA, ACE Canada and ACE Bermuda, excluding the financial solutions business in both the U.S. and Bermuda, which are included in the Financial Services segment.

ACE USA comprises the U.S. and Canadian operations of ACE INA, which were acquired in 1999, and the operations of ACE US Holdings, which were acquired in 1998. At ACE USA, we operate through several insurance companies using a network of offices throughout the U.S. and one office in Canada. These operations provide a broad range of P&C insurance and reinsurance products to a diverse group of commercial and non-commercial enterprises and consumers. These products include excess liability, excess property, professional lines, aerospace, accident and health (“A&H”) coverages and claim and risk management products and services. The operations of ACE USA also include run-off operations, which are discussed below.

Following our acquisition of ACE USA, we made substantial structural and operational changes to enhance profitability and operating controls. These changes included restructuring the operating divisions of ACE USA from three large groups to the niche product business groups discussed below. We made these restructuring changes to enhance ACE USA’s ability to focus on profitable underwriting and to better cross-market products between our U.S. operating groups and our other segments. ACE USA also consolidated locations and closed offices throughout the U.S., outsourced the information technology function, and reduced staff by approximately 2,000 people. These cost reduction efforts have had a positive impact on both the underwriting and administrative expense ratio and the loss and loss expense ratio.

As part of the restructuring of our U.S. operating divisions, we evaluated our lines of business and adjusted our portfolio of products where appropriate. As a result, we diversified into several new areas, or increased our emphasis in areas, and exited contracts and lines of business that did not have a long-term strategic fit. For example, in 1999, we sold the renewal rights to our Commercial Insurance Services (“CIS”) business and placed this line of business into run-off. Also during 2000, we culled certain unprofitable and non-strategic businesses, which resulted in a reduction of gross premiums written of approximately $160 million. This effort continued in 2001 with the sale of our Financial Institution Specialists Division. Our focus on profitable business, together with a commitment to continually promote cost reduction efforts, enabled ACE USA to operate for the years ended December 31, 2001 and 2000, at a combined ratio under 100 percent. The cost-savings initiatives, combined with our focus on higher profit potential business, have left ACE USA well-positioned to grow in the current, improved insurance market.

4

Table of Contents

Our run-off operations include Brandywine Holdings, Inc. (“Brandywine”), CIS, residual market workers’ compensation business, pools and syndicates not attributable to a single business group, the run-off of open market facilities and the run-off results of various other smaller exited lines of business. Run-off operations do not actively sell insurance products, but are responsible for the management of existing policies and related claims.

The Brandywine run-off operation was created in 1995 (prior to our acquisition of ACE INA) by the restructuring of ACE INA’s U.S. operations into two separate operations, ongoing and run-off. Although there are some asbestos claims in ACE Westchester Specialty, Brandywine contains substantially all of ACE INA’s asbestos and environmental (“A&E”) pollution exposures, as well as various run-off insurance and reinsurance businesses.

ACE Bermuda, the original operating company in the group, provides commercial insurance products to a global client base, covering risks that are generally low in frequency and high in severity. Generally, this operation retains significant insurance risk on the contracts that it writes (up to $90 million per risk after reinsurance). In addition to the commercial insurance products offered, ACE Bermuda provides a rent-a-captive service through its wholly-owned subsidiary, Paget Re.

Products and Distribution

At ACE USA, we primarily distribute our insurance products through a limited group of retail and wholesale brokers with whom we have forged long-term relationships. In addition to using brokers, certain of our products are also distributed through channels such as general agents, independent agents, managing general agents, managing general underwriters and direct marketing operations. We have also established Internet distribution channels for some of our products, primarily in the Consumer Solutions Group.

Our ongoing insurance operations at ACE USA are organized into distinct business groups, each offering specialized products and services targeted at specific niche markets.

5

Table of Contents

Headquartered in Toronto, Ontario, ACE Canada also maintains a local presence in Montreal and Vancouver. ACE Canada specializes in providing innovative and customized P&C and A&H products to businesses and individuals nationally and internationally.

The principal lines of business for ACE Bermuda are excess liability, professional lines, excess property and political risk—the latter being written on a subscription basis by Sovereign Risk, a managing agent in which ACE Bermuda has a 50 percent interest. All policy applications (both for renewals and new policies) to ACE Bermuda are subject to underwriting and acceptance by underwriters in our Bermuda office. A substantial number of policyholders meet with us outside of the U.S. each year to discuss their insurance coverage. ACE Bermuda accesses its clients primarily through the Bermuda offices of major, internationally recognized insurance brokers located outside of the U.S. and believes that conducting its operations through its offices in Bermuda has not materially or adversely affected its underwriting and marketing activities to date.

Underwriting

Operating in a market in which capacity and price adequacy for products can change dramatically, ACE USA’s underwriting strategy is to employ consistent, disciplined pricing and risk selection in order to maintain a profitable book of business. Our priority is to ensure that criteria for risk selection are closely adhered to by our underwriting professionals by maintaining high levels of experience and expertise in our underwriting staff. In addition, ACE USA has established a business review structure that ensures control of risk quality and conservative use of policy limits, terms and conditions. ACE USA also employs sophisticated catastrophe loss

6

Table of Contents

and risk modeling techniques to ensure that risks are well distributed and that loss potentials are well within our financial capacity. In this regard, we also purchase reinsurance, which provides the means for greater diversification of risk and serves to further limit the net loss potential of catastrophes and large or unusually hazardous risks.

Reinsurers utilized by ACE USA must meet certain financial and experience requirements and are put through a stringent financial review process in order to be pre-approved by our Reinsurance Security Committee, comprised of senior management. As a result of these controls, reinsurance is placed with a select group of only the most financially secure and experienced companies in the reinsurance industry. ACE USA has the ability to write business on an admitted basis using forms and rates as filed with state insurance regulators and on a non-admitted, or surplus lines basis, using flexible forms and rates not filed with state insurance regulators. Having access to non-admitted carriers provides the pricing flexibility needed to write non-standard coverage.

An integral part of the ACE USA operating strategy is to maximize the efficiency and effectiveness of our operations while reducing operating costs. As part of this strategy, we are in the process of investing in technology which will replace numerous existing policy issuance and claims systems with an integrated product currently being utilized by other ACE segments. This action is expected to further facilitate the streamlining of our underwriting and claims-processing operations.

ACE Bermuda emphasizes quality of underwriting rather than volume of business to obtain a suitable spread of risk. This enables us to operate with a relatively small number of employees and, together with the reduced costs of operating in favorable regulatory and tax environments, results in a favorable administrative expense ratio relative to other companies in our industry.

Competitive Environment

ACE USA operates in what has historically been a highly competitive industry and has faced competition from both domestic and foreign insurers. For the year ended December 31, 2002, we have seen a noticeable reduction in competition in the niche markets in which ACE USA participates. The September 11 tragedy and the concentration of associated losses in the reinsurance industry have significantly reduced capacity in the markets where customer demand is now the strongest. These include excess and specialty property and excess liability, including workers’ compensation markets. High-profile corporate failures as well as allegations of public company management impropriety have greatly increased demand for management and professional risk coverage, including errors and ommissions (“E&O”), D&O, and surety coverage. All of these factors have led to increases in premium levels, some substantially, in most of our lines of business. While there is no sign of the current hard market ending in the near term, we expect that at some point in the future the current level of pricing and use of restrictive policy conditions will not be sustainable.

Traditionally, the markets in which ACE USA competes are subject to significant cycles of fluctuating capacity and wide disparities in price adequacy. Although we currently enjoy exceptionally strong demand for our products, we continue to strive to offer superior service, which we believe has always differentiated ACE USA from our competitors. The ACE USA operations pursue a specialist strategy and focus on market opportunities where we can compete effectively based on service levels and product design, while still achieving an adequate level of profitability. ACE USA offers experienced claims-handling, loss control and risk management staff with proven expertise in specialty fields, including large-risk P&C, recreational and ocean marine, aviation, professional risk and workers’ compensation. A competitive advantage is also achieved through ACE USA’s innovative product offerings, such as ARM bundled business, which combines tailored coverage solutions for large insureds with expert claim management and loss reduction functions provided by ESIS, a nationally-recognized leader in the third party claims management field. An additional competitive strength of all the domestic commercial units is the ability to deliver global products and coverages to customers in concert with our other segments. A significant source of ACE USA’s growth has resulted from the leveraging of cross-marketing opportunities with our other operations to take advantage of our organization’s global presence.

7

Table of Contents

ACE Bermuda maintains its competitive edge through the continued development of its policy forms and the levels of risk retained, which requires less reliance on reinsurance markets. Its competitors tend to be large international and national multi-line insurance companies, which vary by line of business.

Insurance—Overseas General

Background

The Insurance—Overseas General segment consists of ACE International, which comprises our network of indigenous insurance operations, and the insurance operations of ACE Global Markets, our Lloyd’s operation. This segment has four regions of operations: ACE Asia Pacific, ACE Far East, ACE Latin America and the ACE European Group (which comprises ACE Europe, ACE INA UK Limited and the insurance operations of ACE Global Markets). Companies within this segment write a variety of insurance products including property, primary and excess casualty, energy, professional risk (D&O and E&O), marine, political risk, trade credit, A&H, aviation and consumer-oriented products.

ACE International’s global franchise was created in 1984 through the merger of the Insurance Company of North America, which started its international operations over 100 years ago, and the American Foreign Insurance Association. ACE International provides insurance coverage on a worldwide basis.

ACE Global Markets comprises our insurance operations at Lloyd’s and provides funds at Lloyd’s to support underwriting by Syndicate 2488. Syndicate 2488 is managed by ACE Underwriting Agencies Limited and was the largest syndicate trading at Lloyd’s for the 2002-year, with an underwriting capacity of £900 million (approximately $1.5 billion). In 2002, we acquired all of the remaining Syndicate 2488 capacity not already owned by us for the 2003-year, moving our ownership level from 99.6 percent in 2002 to 100 percent in 2003. The run-off of Syndicate 1171, a life syndicate acquired as part of the Capital Re acquisition, is managed by Ridge Underwriting Agencies Limited. Syndicate 1171 ceased underwriting as of December 31, 2000.

On December 20, 2002, we received approval from the Financial Services Authority (“FSA-U.K.”), the U.K. insurance regulator, to use ACE INA UK, as our London-based, FSA-U.K. regulated company to underwrite U.K. and Continental Europe insurance and reinsurance business.

Products and Distribution

ACE International maintains a sales or operational presence in every major insurance market in the world. Its P&C business is generally written, on both a direct and assumed basis, through major international, regional and local brokers. A&H and other consumer lines products are distributed through brokers, agents, direct marketing programs and sponsor relationships.

ACE International’s P&C operations are organized geographically along products that provide dedicated underwriting focus to customers. Our international organization offers capacity and technical expertise in underwriting and servicing clients from large, and complex risks to general market customer segments as well as individual coverages in selected markets. Property insurance products include traditional commercial fire coverage as well as energy industry-related and other technical coverages. Principal casualty products are commercial general liability and liability coverage for multinational organizations. Marine cargo and hull coverages are written in the London market as well as in marine markets throughout the world. The A&H insurance operations provide products that are designed to meet the insurance needs of individuals and groups outside of U.S. insurance markets. These products include accidental death, medical, and hospital indemnity and income protection coverages. Our consumer products division provides specialty products and services designed to meet the needs of specific target markets and include warranty, auto, homeowners, personal liability and recreational marine.

8

Table of Contents

ACE International’s business strategy is carried out through four regional teams: ACE European Group, ACE Asia Pacific, ACE Far East and ACE Latin America.

ACE Global Markets primarily underwrites P&C insurance through Lloyd’s Syndicate 2488 and ACE INA UK. All business underwritten by ACE Global Markets is accessed through Lloyd’s registered brokers. The main lines of business include aviation, property, energy, professional lines, marine, political risk and A&H. A number of smaller niche business lines, such as bloodstock, were discontinued in 2002. During 2002, the reinsurance business written through Syndicate 2488 was branded as ACE Tempest Re Europe and is discussed within the Global Reinsurance segment. With effect from January 1, 2002, all business written via our service company, ACE Underwriting Services Limited, was transferred to ACE Europe. In addition, a number of accounts previously written within Syndicate 2488’s political risk and A&H portfolios, but better suited to distribution by a company underwriting platform, were migrated to ACE Europe. Syndicate 2488 is an established lead underwriter on a significant portion of the risks underwritten, particularly within the aviation and marine lines of business, and hence is able to set the policy terms and conditions of many of the policies written.

Syndicate 2488 transacts business throughout the year; however, a significant proportion of the portfolio incepts at January 1. Some lines of business have distinct renewal periods, for example the airline book, which tends to renew during the fourth quarter of each year, and aviation products and airports accounts, which tend to renew April 1. Syndicate 2488 also writes a number of delegated binding authorities, largely within the property book and, to a lesser extent, in the professional lines arena.

Underwriting

Insurance—Overseas General’s operations are diversified by line of business and the geographic spread of risk. A global approach to risk management allows each local operation to underwrite and accept large insurance accounts. A global approach such as this requires substantial control over each process to ensure best practice and standards are maintained around the world. To do this, Insurance—Overseas General manages the regions as one integrated team.

Clearly defined underwriting authorities, standards, and guidelines are in place in each of the local operations. Global profit centers and product boards ensure consistency of approach and the establishment of best practices throughout the world. A formal underwriting review process is in place to periodically test compliance

9

Table of Contents

against standards and guidelines. Experienced underwriting teams maintain underwriting discipline through the use of pricing models, sophisticated catastrophe and risk management methodologies and strict risk selection criteria. We have qualified actuaries in each region that work closely with the underwriting teams to provide additional expertise in the underwriting process. Centrally coordinated reinsurance management facilitates appropriate risk transfer and efficient cost-effective use of external reinsurance markets. Reinsurers utilized by Insurance—Overseas General must meet certain financial criteria and experience requirements and are subject to approval by an internal Security Committee consisting of senior executive officers of ACE. The Security Committee maintains a list of approved reinsurers – those not on the list are considered on a case by case basis. Our global claims management team ensures there is a consistent approach to reserving practices and the settlement of claims. The oversight process includes regular operational claims reviews throughout the world to ensure adherence to established guidelines.

In addition to these internal controls and peer reviews, all of our operating units and functional areas are subject to review by the corporate audit team that regularly carries out operational audits.

Competitive Environment

ACE International’s primary competitors include U.S.-based companies with global operations, as well as other, non-U.S. global carriers and indigenous companies in regional and local markets. For the A&H lines of business, locally-based competitors include financial institutions and bank-owned insurance subsidiaries.

Our international operations have a distinct advantage being one of a few international insurance groups with a global network of licensed companies able to write policies on locally admitted paper. The principal competitive factors that affect the international operations are underwriting expertise and pricing, relative operating efficiency, product differentiation, producer relations and the quality of policyholder services. A competitive strength of our international operations is our global network and breadth of insurance programs, which assist individuals and business organizations to meet their risk management objectives. Insurance operations in nearly 50 countries also represent a competitive advantage in terms of depth of local technical expertise, accomplishing a spread of risk and offering a global network to service multinational accounts.

ACE Global Markets holds a position of significant influence in the London market. Not withstanding the significant improvement in market conditions during the latter part of 2001 and throughout 2002, all lines of business written by Syndicate 2488 face competition, depending on the business class, from Lloyd’s syndicates, the Institute of London Underwriters companies and other major international insurers and reinsurers. Competition for international risks is also seen from domestic insurers in the country of origin of the insured.

Global Reinsurance—Property and Casualty

Background

The Global Reinsurance P&C segment comprises ACE Tempest Re Bermuda, ACE Tempest Re USA, and ACE Tempest Re Europe, ACE Tempest Life Re (“ACE Life Re”), our Bermuda-based life reinsurance operation is discussed separately. Today, the Global Reinsurance segment markets its reinsurance products worldwide under the “ACE Tempest Re” brand name and provides a broad range of coverages to a diverse range of primary P&C companies. For the year ended December 31, 2002, approximately 50 percent of written premiums came from the property catastrophe business and the remainder from non-property catastrophe lines.

ACE Tempest Re Bermuda is a leading Bermuda-based property catastrophe reinsurer created in October 1993 in response to the dislocation of the catastrophe reinsurance market following Hurricane Andrew. We acquired ACE Tempest Re Bermuda in 1996, followed by the acquisition in 1998 of CAT Limited, another leading Bermuda-based property catastrophe reinsurer. CAT Limited was combined with ACE Tempest Re Bermuda.

10

Table of Contents

ACE Tempest Re Bermuda principally provides property catastrophe reinsurance globally to insurers of commercial and personal property. Property catastrophe reinsurance on an occurrence basis protects a ceding company against an accumulation of losses covered by its issued-insurance policies, arising from a common event or “occurrence.” ACE Tempest Re Bermuda underwrites reinsurance principally on an excess of loss basis, meaning that its exposure only arises after the ceding company’s accumulated losses have exceeded the attachment point of the reinsurance policy. ACE Tempest Re Bermuda also writes other types of property reinsurance on a limited basis for selected clients. Examples include proportional property (reinsurer shares a proportional part of the premiums and losses of the ceding company) and per risk excess of loss treaty reinsurance (coverage applies on a per risk basis rather than per event or aggregate basis), together with specialty lines (catastrophe workers compensation and terrorism).

In 2000, ACE Tempest Re initiated plans aimed to build a leading global multi-line reinsurance business within ACE. This expansion has reduced volatility by diversifying ACE Tempest Re’s business to offer a comprehensive-range of products to satisfy client demand. We consider an expanded product offering vital to competing effectively in the reinsurance market, but not at the expense of profitability. ACE Tempest Re USA, located in Stamford, Connecticut, was established in 2000 as a wholly-owned subsidiary of ACE INA and acts as an underwriting agency on behalf of two of our U.S. companies. The focus of ACE Tempest Re USA has been on writing property per risk and casualty reinsurance, including marine and surety, principally on a treaty basis, with a weighting toward casualty.

After the successful launch of ACE Tempest Re USA, ACE Tempest Re Europe was established in 2002, with locations in London and Dublin. The new operation writes all lines of traditional and non-traditional property, casualty, marine, aviation, and medical malpractice but is oriented to specialty and short-tail products. ACE Tempest Re Europe offers clients coverage through our Lloyd’s Syndicate 2488 and ACE INA UK in London, as well as coverage through ACE European Markets Reinsurance Limited in Dublin.

Products and Distribution

The Global Reinsurance segment services clients globally through its three major units: ACE Tempest Re Bermuda, ACE Tempest Re USA and ACE Tempest Re Europe. Through these three operations, we are able to provide a complete portfolio of products on a global basis to clients using the access point of their choice. Major international brokers submit business to one or more of these units’ underwriting teams who have built strong relationships with both key brokers and clients by explaining their approach and demonstrating consistently open, responsive and dependable service.

ACE Tempest Re Bermuda offers catastrophe reinsurance products on a global basis through reinsurance intermediaries. ACE Tempest Re USA writes all lines of traditional and non-traditional P&C business for the North American market. This unit underwrites a diversified treaty reinsurance portfolio produced through reinsurance intermediaries.

Through ACE Tempest Re Europe, the Global Reinsurance segment provides treaty reinsurance of P&C business of insurance companies worldwide, with emphasis on non-U.S. and London market risks. The London based division of ACE Tempest Re Europe focuses on the development of business sourced through London market brokers and consequently writes a diverse book of international business. The Dublin based division, established late in 2002, focuses on providing reinsurance to continental European insurers via continental European brokers. We expect this division to grow in 2003 and to write reinsurance across all lines of traditional P&C treaty business worldwide, much of it being business not previously accessed elsewhere in ACE. ACE Tempest Re Europe’s underwriting capabilities include property treaty, casualty treaty, and specialty.

11

Table of Contents

Underwriting

Global Reinsurance underwrites through its offices in Bermuda, the U.S. (Stamford) and Europe (London and Dublin). We believe by operating through a small number of offices, underwriting expertise is centralized in a few locations which allows us to provide consistent service while providing additional control over the underwriting process. Global Reinsurance considers itself to be a disciplined underwriter and has built an underwriting environment, involving both underwriters and actuaries, to provide the necessary controls over the underwriting process. In addition to substantial management oversight, these controls include regular underwriting audits (by peer groups), actuarial pricing and reserve support, catastrophe exposure management (using sophisticated modeling software) and regular reviews by our corporate internal audit department.

Rates, policy limits, retentions, and other reinsurance terms and conditions are generally established in a worldwide competitive market that evaluates exposure and balances demand for property catastrophe coverage against the available supply. ACE Tempest Re believes it is perceived by the market as being a “lead” reinsurer and is typically involved in the negotiation and quotation of the terms and conditions of the majority of the contracts in which it participates. Deals are structured and priced by teams of underwriters and actuaries using a comprehensive suite of experience and exposure based actuarial models. This process is designed to ensure that full consideration is given to a complete understanding of the underlying risk profile of the product and that the terms and conditions are appropriate. Each deal is peer-reviewed and approved by other underwriters and actuaries.

Because ACE Tempest Re Bermuda underwrites property catastrophe reinsurance and has large aggregate exposures to natural and man-made disasters, its claims experience generally will involve infrequent events of considerable severity. ACE Tempest Re Bermuda seeks to diversify its property catastrophe reinsurance portfolio to moderate the impact of this severity. The principal means of diversification are by geographic coverage and by varying attachment points and imposing coverage limits per program. ACE Tempest Re Bermuda also establishes zonal and peril accumulation limits to avoid concentrations of risk from either natural or man-made perils.

Furthermore, ACE Tempest Re Bermuda applies an underwriting process for property catastrophe risks based on models that use exposure data submitted by prospective reinsureds in accordance with requirements set by our underwriters. We then analyze this data using a suite of catastrophe analysis tools, including externally developed event based models licensed from credible vendors as well as proprietary models developed in-house. The output from these catastrophe analysis tools is fed into ACE Tempest Re’s proprietary risk management platform (“Heuron”), enabling it to extensively simulate possible combinations of events affecting the portfolio and price coverages accordingly. Heuron measures the accumulation of exposures and assigns risk-based capital to each new risk that is being underwritten. The amount of risk-based capital required to support the new risk will vary according to the contribution that the new risk makes to existing portfolio accumulations. This unique analytical approach requires exposure data from each cedant within the portfolio. Heuron also provides decision support analysis for capital management, including the purchase of retrocessional coverages.

Competitive Environment

The Global Reinsurance segment competes worldwide with major U.S. and non-U.S. reinsurers as well as reinsurance departments of numerous multi-line insurance organizations. Competitors include Munich Re, Swiss Re, PartnerRe, Converium, RenaissanceRe, XL Re and certain Lloyd’s syndicates. Global Reinsurance competes effectively in P&C markets worldwide because of our strong capital position, the quality of service provided to customers, the leading role we play in setting the terms, pricing and conditions in negotiating contracts, and our customized approach to risk selection. While consolidation and closures have reduced our number of competitors, there is still meaningful competition in the marketplace.

12

Table of Contents

Global Reinsurance—Life Reinsurance

Background

ACE Life Re was formed in 2001 as a niche player in the life reinsurance market. Our strategic focus at ACE Life Re is to differentiate ourselves in our targeted business which is principally to provide reinsurance coverage to other life insurance companies focusing on guarantees included in certain annuity products (fixed and variable). We do not compete on a “traditional” basis for pure mortality business. The reinsurance transactions we enter into typically help clients (ceding companies) to manage mortality, morbidity, and/or lapse risks embedded in their book of business.

Products and Distribution

ACE Life Re markets its products directly to clients as well as through reinsurance intermediaries. The marketing plan seeks to capitalize on the relationships developed by our executive officers and underwriters with members of the actuarial profession and executives at client companies. ACE Life Re targets potential ceding insurers that it believes would benefit from its reinsurance products based on analysis of publicly available information and other industry data. In addition, reinsurance transactions are often placed by reinsurance intermediaries and consultants. ACE Life Re works with such third party marketers in an effort to maintain a high degree of visibility in the reinsurance marketplace.

ACE Life Re’s strategy and business does not depend on a single client or a few clients. To date, we have entered into reinsurance agreements with over 20 clients. However, like most start-up operations, a single large transaction can account for a significant percentage of total revenue. We anticipate that as business continues to grow, ACE Life Re will have a reasonably diversified source of revenue by number of clients and by lines of business.

Underwriting

ACE Life Re underwrites transactions on a qualitative and quantitative basis. The underwriters in this unit are individuals with specialized experience and expertise in the specific products we write. Underwriting guidelines have been developed with the objective of controlling the risks of the reinsurance policies written as well as to determine appropriate pricing levels. The guidelines are amended from time to time in response to changing industry conditions, market developments, changes in technology and other factors.

In implementing the underwriting guidelines, an experienced underwriting team is utilized to select opportunities with acceptable risk/return profiles. Reinsurance business is assumed only after considering many factors, including the type of risks to be covered, actuarial evaluations, historical performance data for the client and the industry as a whole, the client’s retention, the product to be reinsured, pricing assumptions, underwriting standards, reputation and financial strength of the client, the likelihood of establishing a long term relationship with the client, and the market share of the client. Pricing of reinsurance products is based on ACE Life Re’s sophisticated actuarial and investment models which incorporate a number of factors, including assumptions for mortality, morbidity, expenses, demographics, persistency and investment returns, as well as certain macroeconomic factors such as inflation, taxation and certain regulatory factors such as surplus requirements.

Competitive Environment

The reinsurance industry is highly competitive. Most of the reinsurance companies are well established, have significant operating histories, strong claims paying ability ratings, and long-standing client relationships through existing treaties with ceding companies. ACE Life Re’s primary competitors include major life reinsurers such as Swiss Re and Hannover Re and smaller specialty companies such as Annuity and Life Re, Scottish Annuity & Life, and Max Re. ACE Life Re competes effectively by leveraging the strength of our client relationships, underwriting expertise and capacity, and our brand name and capital position.

13

Table of Contents

Financial Services

Background

Our Financial Services segment includes the financial guaranty business of ACE Guaranty Corp. and ACE Capital Re International and the financial solutions business in the U.S. and Bermuda.

On December 30, 1999, we diversified our product offering by acquiring Capital Re Corporation. This transaction added significant depth and expertise to our financial reinsurance capabilities and represented a strategic complement to our diversified portfolio by fully establishing us as a key financial guaranty reinsurer.

Our guaranty business is written through the following companies: ACE Guaranty Corp. (“AGC”) (formerly ACE Guaranty Re Inc.), ACE Capital Re International Ltd. (“ACRI”), ACE Capital Mortgage Reinsurance Company (“ACMR”), ACE Capital Re Overseas Ltd. (“ACRO”), and ACE Capital Title Reinsurance Company (“ACTR”).

The financial guaranty business is primarily conducted through AGC. AGC serves the U.S. domestic and international financial guaranty insurance and reinsurance markets. Its principal business is the insurance and reinsurance of investment grade public finance and asset-backed debt issues (insured and ceded by the primary bond insurance companies), and the insurance and reinsurance of credit default swaps. In addition to financial guaranty business, AGC provides trade credit reinsurance. ACRI and ACRO are primarily focused on providing highly-structured solutions to problems of financial and risk management through reinsurance and other forms of credit enhancement products, while ACMR and ACTR are New York regulated monoline reinsurance companies providing mortgage guaranty reinsurance and title reinsurance respectively.

The financial solutions business is the other broad category of the Financial Services segment. This business is primarily conducted through ACE Financial Solutions (“AFS”) and ACE Financial Solutions International (“AFSI”). AFS was established in April 2000 as an operating division of ACE USA, with employees based in Philadelphia, PA, and New York, NY. AFS consists of three lines of business: securitization and risk trading (“SRT”), finite and structured risk products (“FSRP”), and retroactive contracts in the form of loss portfolio transfers (“LPTs”). The structured life and A&H line of business was discontinued in December 2002. AFSI started in 1995 as a line of business within ACE Bermuda. It originally had a broad business plan, considering all alternative risk transfer submissions, but later narrowed its focus to writing only finite risk programs. Based in Bermuda, AFSI offers FSRPs, LPTs and enterprise risk management.

Products and Distribution

The companies writing guaranty business offer value-added insurance, reinsurance and financial derivative products that provide protection from credit or financial risks to the insurance and capital markets. The financial guaranty operation’s product line consists of municipal and non-municipal financial guaranty reinsurance, single-name and portfolio credit default swaps, mortgage guaranty reinsurance, trade credit reinsurance, title reinsurance and residual value reinsurance. According to Moody’s Investors Service (“Moody’s”), until 1998 AGC and a competitor accounted for approximately 70 percent of the entire market for financial guaranty reinsurance. Since then, primary insurance companies have been diversifying among reinsurers, the result of which has been a dramatic spreading of market share across financial guaranty reinsurers. Moody’s estimates that at the end of 2001, AGC’s share of this market had dropped to 22.6 percent from 37.5 percent in 1997. AGC has reacted to this shift by adopting a hybrid strategy of fostering its reinsurance relationships with primary financial guarantors while developing alternative credit-enhancement platforms as a primary company. This strategy, which diversified AGC’s product offering, has resulted in a significant increase in other business written including credit default swaps and trade credit enhancement. AGC expects that by 2004 over 50 percent of net premiums earned will be from sources other than the financial guaranty business.

14

Table of Contents

Our financial guaranty companies maintain relationships with major U.S. primary financial guaranty insurers, mortgage guaranty insurers in the U.S., U.K. and Australia, title insurers and major European trade credit insurers. Major U.S. and European investment banks act as counterparties (market makers) on credit default swaps. Additionally, a portion of this operation’s reinsurance business is developed through relationships with brokers and reinsurance intermediaries. The title reinsurance business has developed substantially all of its business opportunities through direct contacts with primary title insurers, while the financial guaranty business has been developed through direct contacts with U.S. primary companies and major investment banks in the U.S. and Europe.

As stated above, the financial solutions operation of this segment provides the SRT, FSRP, LPT, and enterprise risk management lines of business.

Due to the nature of the financial solutions business, premium volume can vary significantly from period to period and therefore premiums written in any one period are not indicative of premiums to be written in future periods.

15

Table of Contents

Underwriting

For the majority of the guaranty business the underwriting process is premised on reinsuring investment grade credit risks and risk-remote or finite financial risks. The underwriting process is based on multiple levels of credit review, actuarial analysis, stress-based modeling and legal review. Underwriters minimize correlation and aggregation through diversification of exposures by geography, tenor, industry sector, credit enhancement/attachment point and rating category of underlying credits.

Each financial solutions contract is unique and specifically tailored for an individual client, but generally they are multi-year and contain some form of client participation. Both the financial guaranty and the financial solutions units write structured finance transactions which are recorded at higher loss and loss expense ratios than other business. These transactions are typically longer-term contracts where profit emerges over the term of the contract and relies on investment income as a component of profitability. At the time these contracts are written, management make certain assumptions with respect to the ultimate amount and timing of payments in order to establish loss and loss expense reserves. As with most loss reserves, the actual amount and timing of payments may result in loss and loss expenses which are significantly greater or less than the reserves initially provided.

It is generally expected that losses ultimately paid under retroactive contracts will exceed the premiums received, in some cases by large margins. Premiums are based in part on time-value-of-money concepts because loss payments may occur over lengthy time periods. However, retroactive contracts do not have a significant impact on reported earnings in the period of inception. When writing a retrospective contract, the excess of the estimated ultimate losses over the premiums received is established as a deferred charge and amortized against income over the estimated future claim settlement period. Management expects that these contracts will produce significant underwriting losses over time, but also that this business will be profitable due to expected investment earnings on the premiums received.

Competitive Environment

The Financial Services segment faces direct and indirect competition from equally-rated financial institutions on all lines of business. The differentiating factors include pricing, customer service, market perception and historical performance.

There are approximately six major players in the financial guaranty market. The financial guaranty business faces competition indirectly from other highly rated financial institutions that provide capital substitutes to the primary financial guaranty insurers. Competition is also a function of the ease with which primary insurers can raise capital in the private or public equity markets. Increased primary capital increases the ability of insurers to retain risk and the need for reinsurance in general is diminished. In the mortgage reinsurance market, competition comes from some non-U.S. mortgage reinsurers and, in a minor way, from U.S. multi-line insurers. In the title business, the large title insurers have traditionally provided reinsurance capacity. The trade credit business faces a high degree of competition from traditional participants in these markets, including large multi-line insurers and reinsurers.

For financial solutions, the SRT line competes with insurance companies and other financial institutions that assume and trade credit risk. This operation focuses on investment-grade portfolio credit exposures and competes in this market sector on terms of price, capacity and terms. The FSRP and retroactive contracts operations compete with several other P&C insurance companies, which have groups offering LPTs, traditional and non-traditional buy-outs and finite insurance and reinsurance. Competition is generally based on contract price, capacity and terms.

16

Table of Contents

Unpaid Losses and Loss Expenses

We establish reserves for unpaid losses and loss expenses, which are estimates of future payments of reported and unreported claims for losses and related expenses, with respect to insured events that have occurred. The process of establishing reserves for P&C claims can be complex and imprecise as it requires the use of informed estimates and judgments. These estimates and judgments are based on numerous factors, and may be revised as additional experience and other data become available and are reviewed, as new or improved methodologies are developed or as current laws change. We have actuarial staff in each of our operating segments who track insurance reserves and regularly evaluate the levels of loss reserves, taking into consideration factors that may impact the ultimate loss reserves. Any such revisions could result in future changes in estimates of losses or reinsurance recoverable and would be reflected in our results of operations in the period in which the estimates are changed. As part of our evaluation process, we also engage independent actuarial firms on an annual basis to review the methods and assumptions we use in estimating unpaid losses and loss expenses.

Losses and loss expenses are charged to income as incurred. The reserve for unpaid losses and loss expenses represents the estimated ultimate losses and loss expenses less paid losses and loss expenses, and comprises case reserves, loss expense reserves and incurred but not reported loss reserves (“IBNR”). During the loss settlement period, which can be many years in duration, additional facts regarding individual claims and trends often will become known. As these become apparent, case reserves may be adjusted by allocation from IBNR without any change in the overall reserve. In addition, application of statistical and actuarial methods may require the adjustment of the overall reserves upward or downward from time to time. The final liability, nonetheless, may be significantly greater than or less than the prior estimates.

We continually evaluate our estimates of reserves in light of developing information and in light of discussions and negotiations with our insureds. While we are unable at this time to determine whether additional reserves, which could have a material adverse effect upon our financial condition, results of operations and cash flows, may be necessary in the future, we believe that our reserves for unpaid losses and loss expenses are adequate as of December 31, 2002.

We have considered A&E claims and claims expenses in establishing the liability for unpaid losses and loss expenses and have developed reserving methods, which incorporate new sources of data with historical experience to estimate the ultimate losses arising from A&E exposures. The reserves for A&E claims and claims expenses represent management’s best estimate of future loss and loss expense payments and recoveries which are expected to develop over the next several decades. We continuously monitor evolving case law and its effect on environmental and latent injury claims.

In January 2003, we completed an internal review of our A&E reserves. As a result of this review, we increased our gross A&E reserve for the year ended December 31, 2002, by $2.2 billion, offset by $1.9 billion of reinsurance recoverable, including $533 million of reinsurance purchased from the National Indemnity Company (“NICO”) as part of the acquisition of CIGNA’s P&C business. We also increased our bad debt provision for reinsurance recoverable by $145 million. As a result of these two items, together with ACE Bermuda’s ten percent participation in the NICO cover, the net increase in exposure was determined to be $516 million ($354 million after income tax) and was recorded in the fourth quarter of 2002.

Our exposure to asbestos principally arises out of liabilities acquired when we purchased the P&C business of CIGNA in 1999 and Westchester Specialty from Talegen in 1998. While we certainly have other insurance operations, exposure to asbestos liabilities is concentrated in these two areas of our business. Of these two areas, the larger and potentially more volatile exposure is contained within the liabilities acquired in the CIGNA transaction. These liabilities reside in the various subsidiaries of Brandywine, which was created in 1995 by the restructuring of CIGNA’s domestic operations into separate ongoing and run-off operations.

As part of the acquisition of the CIGNA P&C business, NICO provided reinsurance protection against adverse development for the aggregate liabilities of Brandywine, including environmental and asbestos liabilities. In the fourth quarter of 2002, we increased our A&E reserves, exhausting the NICO reinsurance cover protecting Brandywine.

17

Table of Contents

As part of the acquisition of the Westchester business, NICO provided reinsurance protection for adverse development for all losses occurring prior to 1997. At December 31, 2002, the remaining limit in the NICO reinsurance cover protecting ACE Westchester Specialty was approximately $600 million. None of the recent increase to reserves is attributable to Westchester’s asbestos liabilities.

We conduct a reserve review of our asbestos reserves on a quarterly basis. This reserve review includes a detailed individual claim review and analysis of the policies at issue, legal precedents, and our asbestos settlement history, as well as factual and investigative developments. Our latest review, by an internal task force, included a comprehensive re-evaluation of claims as of September 2002. This included a review of:

This evaluation process included a detailed review of assumptions relating to projections of future new defendants, and non-product exposures were identified and reserved as part of the task force process.

In addition to our internal review of asbestos reserves, the normal, biennial, reserve review by an internationally-known actuarial consulting firm, required by the Pennsylvania Insurance Department when Brandywine was established, was recently completed. Our asbestos reserves, taking into account the additions for the quarter ended December 31, 2002, represent the high end of our internal task force’s indication of range of liability and is consistent with the best estimate of the external actuary retained by the Pennsylvania Insurance Department.

In the context of our asbestos reviews, many risk factors are considered. In establishing our asbestos reserves, we believe the most significant variables include assumptions with respect to payments to unimpaired claimants and the liability of peripheral defendants. In establishing reserves for periods prior to the fourth quarter of 2002, we assumed that significant additional state judicial or legislative reform would substantially eliminate payments to future claimants who are not physically impaired. The fourth quarter reserve additions were based on the more conservative assumption that there will be no future state or federal asbestos reform. Therefore, the booked asbestos reserves do not reflect any anticipated changes in the legal, social or economic environment, or any benefit from future legislative reforms.

The vast majority of the reserve increase in the fourth quarter of 2002 is due to the strengthening of the IBNR provision for peripheral defendants and future increases in severity.

We also consider multiple recoveries by claimants against various defendants; the ability of a claimant to bring a claim in a state in which they have no residency or exposure; the ability of a policyholder to claim the right to non-products coverage; and whether high-level excess policies have the potential to be accessed given the policyholder’s claim trends and liability situation. The results in other asbestos cases announced by other carriers may have little or no relevance to us because other coverage exposures are highly dependent upon the specific facts of individual coverage and resolution status of disputes among carrier, policyholder and claimants.

Based on the policies, the facts, the law and a careful analysis of the impact that these risk factors will likely have on any given account, management estimates the potential liability for indemnity, policyholder defense costs and coverage litigation expense. There are many complex variables that are considered when estimating the reserves for its inventory of asbestos accounts. The variables involved may directly impact the predicted outcome. Sometimes, the outcomes change significantly based on a small change in one risk factor related to just one account.

18

Table of Contents

Our current asbestos reserves are based upon an assessment of our policies, legal precedents and investigative facts, and how the various risk factors are likely to be played out as those issues are litigated. While reserving for these claims is inherently uncertain, we believe that the reserves carried for these claims are adequate based on known facts and current law. Our reserve review process involves a continual evaluation of cases taking into account all currently known information as well as reasonable assumptions related to unknown information. When facts and circumstance change, including the impact of the risk factors, changes are made to reflect overall reserve adequacy. It is possible that adverse developments could cause us to re-evaluate our assumptions. This could lead us to further increase our asbestos related reserves, which could have a material adverse effect on future operating results.

In 2001, we incurred losses of $650 million relating to the terrorist attack on September 11, 2001. We continue to evaluate our total potential liability based upon individual insurance and reinsurance policy language, legal and factual developments in underlying matters involving our insureds as well as legislative developments in the U.S. involving the terrorist attack. If our current assessments of future developments are proved wrong, the financial impact of any of them, singularly or in the aggregate, could be material. For example, business interruption insurance claims could materialize in the future with greater frequency than we anticipated or provided for in our estimates, or, insureds that we expect will not be held responsible for injuries resulting from the attack, are ultimately found to be responsible at a financial level that impacts our insurance or reinsurance policies. We believe that our current estimate for the September 11 tragedy is reasonable and accurate based on information currently available.

The “Analysis of Losses and Loss Expenses Development” shown below presents the subsequent development of the estimated year-end liability for net unpaid losses and loss expenses for the last eleven years. On July 2, 1999, we changed our fiscal year-end from September 30 to December 31. As a result, the information provided for the 1999 year is actually for the 15-month period from October 1, 1998, through December 31, 1999. Prior to December 31, 1999, the net unpaid losses and loss expenses are in respect of annual periods ending on September 30 of each year. The table also presents as at December 31, 2002, the cumulative development of the estimated year-end liability for gross unpaid losses and loss expenses for the years 1994 through 2001. The top lines of the table shows the estimated liability for gross and net unpaid losses and loss expenses recorded at the balance sheet date for each of the indicated periods. This liability represents the estimated amount of losses and loss expenses for claims arising from all prior years’ policies and agreements that were unpaid at the balance sheet date, including IBNR loss reserves. The upper (paid) portion of the table presents the net amounts paid as of subsequent periods on those claims for which reserves were carried as of each balance sheet date. The lower portion of the table shows the re-estimated amount of the previously recorded net liability as of the end of each succeeding period. The bottom lines of the table show the re-estimated amount of previously recorded gross liability at December 31, 2002, together with the change in reinsurance recoverable. We do not consider it appropriate to extrapolate future deficiencies or redundancies based upon the table below, as conditions and trends that have affected development of the liability in the past may not necessarily occur in the future. Several aspects of our operations, including the low frequency and high severity of losses in the high excess layers in which we provide insurance, complicate the actuarial reserving techniques we utilize. Accordingly, we expect that ultimate losses and loss expenses attributable to any single underwriting year will be either more or less than the incremental changes in the lower portion of the table. The “cumulative redundancy/deficiency” shown in the table below represents the aggregate change in the reserve estimates over all subsequent years. The amounts noted are cumulative in nature; that is, an increase in loss estimate for prior year losses generates a deficiency in each intermediate year. On November 1, 1993, we acquired CODA, on July 1, 1996, we acquired ACE Tempest Re, and on July 9, 1998, we acquired Tarquin. The table has been restated to include CODA, ACE Tempest Re and Tarquin’s loss experience as if each of these companies had been our wholly-owned subsidiaries from their inception. On January 2, 1998, we acquired ACE US Holdings, on April 1, 1998, we acquired CAT Limited; and on July 2, 1999, we acquired ACE INA. The unpaid loss information for ACE US Holdings, CAT Limited and ACE INA has been included in the table commencing in the year of acquisition. As a result, 1999 includes net reserves of $6.8 billion related to ACE INA at the date of acquisition and subsequent development thereon.

19

Table of Contents

The cumulative gross redundancy/deficiency is the difference between the gross loss reserves originally recorded and the re-estimated liability at December 31, 2002. We utilized little or no reinsurance for 1997 and prior years. In 1999, ACE INA acquired the CIGNA P&C insurance operations and the acquired loss reserves for 1999 and prior years are included in the table commencing in 1999. As of December 31, 2002, the cumulative deficiency for 1999 is $3.9 billion. This relates primarily to U.S. liabilities, including A&E liabilities for 1995 and prior. Reinsurance coverages have the effect of substantially reducing the net loss as follows: Of the total $3.9 billion of cumulative deficiency for the 1999 and prior years, approximately $2.2 billion was covered by reinsurance placed when the risks were originally written, and $1.25 billion of the remaining liability has been ceded to NICO. Of the cumulative deficiency of $3.9 billion noted for 1999, approximately $500 million was identified and recorded in fiscal 2000, $630 million was identified and recorded in fiscal 2001, and $2.8 billion was identified and recorded in 2002.

20

Table of Contents

Our net incurred losses in 2002 were $4.9 billion. Net losses and loss expenses incurred for the year ended December 31, 2002, include $709 million of prior year development. Of this amount, $516 million relates to a charge taken in the fourth quarter of 2002 to strengthen our A&E reserves and is analysed in more detail below. All of the A&E development was incurred in the Insurance—North American segment. An analysis of the remaining $193 million of prior period development follows:

Incurred losses of $2.2 billion for Insurance—North American include $79 million of prior period development, $59 million from ACE USA and $20 million from ACE Bermuda. In ACE USA, prior period development arose from several lines of business including $13 million from our ACE Risk Management business, $11 million from consumer solutions business and $35 million from two lines of business now in run-off. ACE Risk Management, ACE USA’s largest business line with over $1.3 billion of net loss reserves, is the large commercial package business that includes workers compensation and commercial automobile covers. During 2002, we incurred $13 million to increase the workers’ compensation, commercial automobile and the health care asset management run-off books, principally for the 2000 accident year, as a result of regular actuarial reviews of these lines of business. The Consumer Solutions group incurred $11 million related to the 2001 accident year, principally from its warranty line as a result of an actuarial study completed in late 2002. Of the $35 million from run-off business, $18 million arose from CIS, which comprises middle market casualty exposures. In 1999, we sold the renewal rights to this business and are running off the existing reserves. $12 million relates to one adverse court decision in the Financial Institutions business on a 2001 accident year claim and the remaining $5 million relates to general reserve increases resulting from actuarial reviews.

21

Table of Contents

In ACE Bermuda, we incurred $45 million of prior year losses related to aerospace losses, $31 million related to satellite losses and $14 million of aviation losses. The satellite losses principally relate to three losses from satellites launched between 1999 and 2001 that have subsequently experienced problems. The aviation losses relate to increases in claims reserves on almost 300 claims in the 1997 through 2001 accident years. The remaining reserves on this line principally relate to long-tail product liability policies. ACE Bermuda discontinued the satellite business in 2002 and the aviation business in 2000. These increases were partially offset as excess liability reserves improved by $28 million. We were successful in recovering subrogation on a loss from the 1988 accident year and had positive development on a claim for the 1989 accident year. These two items accounted for an improvement of $45 million. This was partially offset by claims development in 1995 and 1996. The remaining $3 million relates to general reserve increases resulting from actuarial reviews.

Incurred losses of $1.4 billion for Insurance – Overseas General include $104 million of prior year losses, of which $36 million came from ACE Global Markets and $68 million came from ACE International. In ACE Global Markets, $26 million of prior period development arose from aerospace losses in the 2000 and 2001 accident years, principally from the same satellite losses that impacted ACE Bermuda. The remaining $10 million relates to a number of small losses across several business lines. In ACE International, $44 million of prior period development arose from developing casualty losses in Australia, Norway, Italy and the Netherlands. The increases related to development on several large claims caused by new information that changed the total value of these claims from last year. In addition, ACE Europe incurred $14 million of D&O losses, partly in response to specific large losses and partly due to a change in assumptions as experience has changed from last year. The remaining $10 million relates to small losses across several lines.

Total incurred losses of $304 million for Global Reinsurance include positive development in prior period reserves of $20 million. Most of Global Reinsurance’s reserves at December 31, 2002, relate to short-tail, catastrophe oriented lines where unpaid claims are set using a blend of market share analysis on industry loss reports and reported claims from customers. Initial loss reserve estimates are then revised as necessary, to reflect the actual loss experience of the customer. During 2002, Global Reinsurance determined that the loss reserves carried on certain of its contracts related to the 1998 through 2001 accident years were in excess of the reserves required based on the latest assessment. This resulted in favorable prior year loss development. There were no changes in assumptions used in the reserving process in 2002.

Total incurred losses of $947 million for Financial Services include $30 million of prior period development principally from the ACE Financial Solutions International book, which comprises large, unique transactions, including LPTs. $12 million relates to the amortization of the deferred assets on the LPTs. The remaining amount principally relates to three accounts where recent information resulted in an increase in the total reserve positions for these accounts primarily for the 1998 through 2001 accident years

As discussed above, net loss and loss expenses for the year ended December 31, 2001 were impacted by $94 million of prior year development principally in the Insurance—Overseas General segment. This development was recorded during the fourth quarter of 2001, when we recorded additional reserves to strengthen our casualty loss reserves.

Net loss and loss expenses for the year ended December 31, 2000, were impacted by favorable development of reserves from prior periods primarily from the Global Reinsurance and Insurance—North American segments, partially offset by unfavorable development in the Financial Services segment.

Investments

Our principal investment objective is to ensure that funds will be available to meet our primary insurance and reinsurance obligations. Within this broad liquidity constraint, the investment portfolio’s structure seeks to maximize return subject to specifically-approved guidelines of overall asset classes, credit quality, liquidity, and volatility of expected returns. As such, our investment portfolio is invested primarily in investment-grade fixed income securities as measured by the major rating agencies.

22

Table of Contents

The management of our investment portfolio is the responsibility of ACE Asset Management. ACE Asset Management operates principally to guide and direct our investment process. In this regard, ACE Asset Management:

For the portfolio, we determine allowable, targeted asset allocation and ranges for each of the operating segments. These asset allocation targets are derived from sophisticated asset and liability modeling that measures correlated histories of returns and volatilities of returns. Allowable investment classes are further refined through analysis of our operating environment, including expected volatility of cash flows, overall capital position, regulatory and rating agency considerations.

The Finance Committee of the Board of Directors approves asset allocation targets and reviews our investment policy to ensure that it is consistent with our overall goals, strategies and objectives. Overall investment guidelines are approved by the Finance Committee to ensure appropriate levels of portfolio liquidity, credit quality, diversification, and volatility are maintained. In addition, the Finance Committee systematically reviews the portfolio’s exposures to capture any potential violations of investment guidelines.

Within the guidelines and asset allocation parameters established by the Finance Committee, individual investment committees of the operating segments determine tactical asset allocation. Additionally, these committees review all investment-related activity that affects their operating company, including the selection of outside investment advisors, proposed asset allocations changes, and the systematic review of investment guidelines.

For additional information regarding the investment portfolio, including breakdowns of the sector and maturity distributions, see Note 3 of the Consolidated Financial Statements included in the 2002 Annual Report to Shareholders.

Regulation

Our insurance and reinsurance subsidiaries are subject to regulation and supervision by the local authority in the countries or states in which they do business. The extent of such regulation most commonly has its source in statutes, which delegate regulatory, supervisory and administrative power to a department of insurance.

Bermuda Operations

In Bermuda, our insurance subsidiaries are regulated by the Insurance Act (as amended) and related regulations (the “Act”). The Act imposes on Bermuda insurance companies, solvency and liquidity standards, and auditing and reporting requirements, and grants the Bermuda Monetary Authority powers to supervise, investigate and intervene in the affairs of insurance companies. Significant requirements include the appointment of an independent auditor, the appointment of a loss reserve specialist and the filing of the Annual Statutory

23

Table of Contents

Financial Return with the Supervisor of Insurance (“the Supervisor”). The Supervisor is the chief administrative officer under the Act.

We must comply with the provisions of the Act regulating the payment of dividends and distributions from contributed surplus. A Bermuda company may not declare or pay a dividend or make a distribution out of contributed surplus if there are reasonable grounds for believing that: (a) the company is, or would after the payment be, unable to pay its liabilities as they become due; or (b) the realizable value of the company’s assets would thereby be less than the aggregate of its liabilities and its issued share capital and share premium accounts.

The Supervisor may appoint an inspector with extensive powers to investigate the affairs of an insurer if he believes that an investigation is required in the interest of the insurer’s policyholders or persons who may become policyholders. In order to verify or supplement information otherwise provided to him, the Supervisor may direct an insurer to produce documents or information relating to matters connected with the insurer’s business. If it appears to the Supervisor that there is a risk of the insurer becoming insolvent, or that the insurer is in breach of the Act or any conditions or its registration under the Act, the Supervisor may direct the insurer not to take on any new insurance business, not to vary any insurance contract if the effect would be to increase the insurer’s liabilities, not to make certain investments, to realize certain investments, to maintain in or transfer to the custody of a specified bank certain assets, not to declare or pay any dividends or other distributions, or to restrict the making of such payments and/or to limit its premium income.

United Kingdom Regulation of Lloyd’s

ACE, certain of our U.K. subsidiaries and staff employed within the Lloyd’s operations, are subject to regulation by the Council of Lloyd’s (the “Council”) and the FSA-U.K. The Council and FSA-U.K. regulate us and our subsidiaries in the ownership chain of our Lloyd’s managing agencies and the Corporate Capital Vehicles (“CCVs”) pursuant to their authority with respect to a “controller”. Certain U.K.-based directors and employees are subject to regulation by the Council as “individually registered persons” and by the FSA-U.K. as “approved persons”. The managing agencies and the CCVs are also subject to Lloyd’s regulation.

The FSA-U.K. is the single U.K. statutory regulator for the supervision of securities, banking and insurance business, although Lloyd’s has retained certain self-regulatory responsibilities. The FSA-U.K. imposes capital adequacy, auditing, financial reporting and other requirements upon the Lloyd’s market.

In 2002, the Council approved a number of proposals for Lloyd’s reform based on the recommendations of the Chairman’s Strategy Group which include (1) the implementation of a Lloyd’s franchise concept to managing agencies, (2) the formation of a Franchise board, reporting to the Council, to direct the market’s commercial regulatory governance, and (3) prohibition of new unlimited liability members, beginning in 2003. It is envisaged that the FSA-U.K. will increase its direct regulation of Lloyd’s managing agencies.

United States Regulation of Lloyd’s

Regulation of alien insurers varies on a state by state basis, however, generally, insurance is written pursuant to a license (admitted insurer), excess and surplus lines eligibility (eligible insurer) or exemptions (non-admitted insurer or non-admitted basis). Reinsurance is written by an alien company as an admitted or non- admitted company or on an admitted or non-admitted basis. Admitted alien insurers are subject to regulation of solvency, premium rates and policy forms similar to regulation of domestic insurers. Eligible and non-admitted alien insurers are subject to minimum solvency and security requirements, in addition to certain state specific criteria.

Lloyd’s is licensed for direct insurance in Illinois, Kentucky and the U.S. Virgin Islands and it is an eligible excess and surplus lines insurer in all states and territories except Kentucky and the U. S. Virgin Islands. Lloyd’s is also an accredited reinsurer in all states and territories. In certain states, various categories of direct insurance

24

Table of Contents

are exempt under state laws. Lloyd’s maintains various trust funds in the state of New York in support of past, current and future underwriting of U.S. business, subject to regulation by the New York Insurance Department, which acts as the domiciliary commissioner for Lloyd’s U.S. trust funds. There are also deposit trust funds in other states to support both reinsurance and excess and surplus lines insurance business.

ACE International

The extent of insurance regulation varies significantly among the countries in which the non-U.S. ACE operations conduct business. While each country imposes licensing, solvency, auditing and financial reporting requirements, the type and extent of the requirements differ substantially. For example:

Significant variations can also be found in the size, structure and resources of the local regulatory departments that oversee insurance activities. Certain regulators prefer close relationships with all subject insurers and others operate a risk-based approach.

ACE International operates in some countries through subsidiaries of ACE and in some countries through branches of those subsidiaries. Local capital requirements applicable to a subsidiary generally include its branches. Certain ACE companies are jointly owned with local companies to comply with legal requirements for local ownership. Other legal requirements include discretionary licensing procedures, compulsory cessions of reinsurance, local retention of funds and records, and foreign exchange controls. ACE’s international companies are also subject to multinational application of certain U.S. laws. The complex regulatory environments in which ACE International operates are subject to change and are regularly monitored.

The largest insurance companies within ACE International are ACE Insurance S.A.—N.V. (“ACE Europe”) and ACE Insurance in Japan (“ACE Japan”).

25

Table of Contents

Operations in the United States of America

Although at the present time there is limited federal regulation of the insurance business in the U.S., the U.S. insurance subsidiaries are subject to extensive regulation in the states in which they do business. The laws of the various states establish supervisory agencies with broad authority to regulate, among other things: licenses to transact business, soliciting business, advertising, rates for certain business, policy language, underwriting and claims practices, transactions with affiliates, reserve adequacy, dividends, investments and insurer solvency. In addition, the U.S. insurance subsidiaries are subject to judicial decisions that define the risks and benefits for which insurance is sought and provided. These include judicial interpretations of the nature of the insured risk in such areas as product liability and environmental coverages.

Regulations generally require insurance and reinsurance companies to furnish information concerning activities which may materially affect the operations, management or financial condition and solvency of the company. Regulations vary from state to state but generally require that each primary insurance company obtain a license from the department of insurance of a state to conduct business in that state. A reinsurance company does not generally require an insurance license to reinsure a U.S. ceding company. For a U.S. ceding company to obtain financial statement credit for reinsurance ceded, the reinsurer must obtain an insurance license or accredited status from the cedent’s state of domicile or must post collateral to support the liabilities ceded. In addition, regulations for reinsurers vary somewhat from primary insurers in that reinsurers are typically not subject to regulator approval of insurance policy forms or the rates agreed to between ceding insurers and their reinsurers.

The U.S. insurance subsidiaries are required to file detailed annual and quarterly reports with state insurance regulators in each of the states in which they do business. Such annual and quarterly reports are required to be prepared on a calendar year basis. In addition, the U.S. insurance subsidiaries’ operations and accounts are subject to examination at regular intervals by state regulators. The respective reports filed in accordance with applicable insurance regulations with respect to the most recent periodic examinations of the U.S. insurance subsidiaries contained no material adverse findings.

Statutory surplus is an important measure utilized by the regulators and rating agencies to assess our U.S. insurance subsidiaries’ ability to support business operations and provide dividend capacity. Our U.S. insurance subsidiaries are subject to various state statutory and regulatory restrictions that limit the amount of dividends that may be paid without prior approval from regulatory authorities. These restrictions differ by state, but are generally based on calculations incorporating statutory surplus, statutory net income, and/or investment income.

State insurance regulators have also adopted Risk Based Capital (“RBC”) requirements that are applicable to some of the U.S. insurance subsidiaries. These RBC requirements are designed to monitor capital adequacy and to raise the level of protection that statutory surplus provides for policyholders. The RBC formula provides a mechanism for the calculation of an insurance company’s Authorized Control Level (“ACL”) RBC amount. The initial RBC level which triggers regulatory action is known as the Company Action Level. Failure to achieve this level of RBC, which occurs if policyholders’ surplus falls below 200 percent of the ACL, requires the insurance company to submit a plan of corrective action to the relevant insurance commissioner. Based on the RBC formula, at December 31, 2002, the policyholders’ surplus of each of the ongoing U.S. insurance subsidiaries was higher than the Company Action Level.

There are additional progressive RBC failure levels, which trigger more stringent regulatory action. An insurance commissioner may allow a P&C company at or below the mandatory control level that is writing no

26

Table of Contents

business and is running off its existing business to continue its run-off. Brandywine is running-off its liabilities consistent with the terms of an Order by the Commissioner of Pennsylvania. This includes periodic reporting obligations to the Pennsylvania Insurance Department. The Commissioner has determined that Brandywine has sufficient assets to meet its obligations.

In November 2002, the U.S. Congress passed the Terrorism Risk Insurance Act (“TRIA”), which requires commercial P&C insurers to offer coverage for losses due to certified acts of terrorism that does not differ materially from the terms, amounts and other coverage limitations offered by the insurer for other types of risks. Insured losses which are compensable under TRIA are those losses caused by an act certified by the Secretary of the Treasury, in concurrence with the Secretary of State and the Attorney General, to be an act of terrorism. The Secretary may only certify an act as terrorism if it involves a foreign person or group and has resulted in damage within the United States or to an air carrier or U.S. flag vessel. To be certified, the act must have caused aggregate damages exceeding $5 million. TRIA nullifies all terrorism exclusions in existing commercial P&C policies, but such exclusions may be reinstated if the insured either gives written authorization for such reinstatement or fails to pay any increased premium for the terrorism coverage after 30 days’ notice.

TRIA also provides for the federal government to reimburse insurers for 90 percent of their terrorism-related losses, subject to a premium-based deductible. The deductible for 2003 is seven percent of direct earned premiums for the year. For 2004, the deductible will be ten percent of direct earned premium and for 2005 it will be 15 percent of direct earned premium.

In the event of a loss similar to the losses sustained in connection with the September 11 tragedy, our deductible and ten percent share of losses would have a material adverse effect on our results of operations in the period in which the loss is incurred and on our financial condition.

United States Regulations and Tax of Non-U.S. Operations

Each state in the U.S. licenses insurers and prohibits, with some exceptions, the sale of insurance by non-admitted, non-U.S. insurers within its jurisdictions. ACE and its non-U.S. insurance subsidiaries, excluding its Lloyd’s operations, are not licensed to do business as admitted insurers in any jurisdiction in the U.S.

Many states impose a premium tax (typically two percent to four percent of gross premiums written) on insureds who obtain insurance from non-admitted foreign insurers, such as ACE Bermuda. The premiums charged by the non-U.S. insurer do not include any U.S. state premium tax. Each insured is responsible for determining whether it is subject to any such tax and for paying such tax as may be due.

The U.S. Internal Revenue Code also imposes on policyholders an excise tax on insurance and reinsurance premiums paid to foreign insurers or reinsurers with respect to risks located in the U.S. The rates of tax applicable to premiums paid to non-US domiciled companies are four percent for insurance premiums and one percent for reinsurance premiums, unless a tax treaty is applicable.

There can be no assurance that new or additional legislation in the U.S. will not be proposed and enacted that has the effect of subjecting our non-U.S. insurance subsidiaries, including our Lloyd’s operations, to regulation in the U.S.

Tax Matters

Corporate Income Tax

ACE Limited is a Cayman Islands corporation that operates as a holding company with offices only in Bermuda and does not pay U.S. corporate income taxes (except certain withholding taxes) on the basis that it is not engaged in a trade or business in the U.S. However, there can be no assurance that the Internal Revenue

27

Table of Contents

Service (“IRS”) will not contend to the contrary. If ACE Limited were subject to U.S. income tax, there could be a material adverse effect on our shareholders’ equity and earnings. ACE Limited and its Bermuda-based insurance and reinsurance subsidiaries do not file U.S. income tax returns reporting income subject to U.S. income tax since they do not conduct business within the U.S. However, ACE Limited and its Bermuda-based insurance and reinsurance subsidiaries have filed protective tax returns reporting no U.S. income to preserve their ability to deduct their ordinary and necessary business expenses should the IRS successfully challenge their contention that none of their income is subject to a net income tax in the U.S.

Under current Cayman Islands law, ACE Limited is not required to pay any taxes on its income or capital gains. ACE Limited has received an undertaking that, in the event of any taxes being imposed, ACE Limited will be exempted from taxation in the Cayman Islands until the year 2013.

Under current Bermuda law, ACE Limited and its Bermuda subsidiaries are not required to pay any taxes on its income or capital gains. ACE Limited and the Bermuda subsidiaries have received an undertaking from the Minister of Finance in Bermuda that, in the event of any taxes being imposed, we will be exempt from taxation in Bermuda until March 2016.

Income from the operations at Lloyd’s is subject to U.K. corporation taxes. Lloyd’s is required to pay U.S. income tax on U.S. connected income (“U.S. income”) written by Lloyd’s syndicates. Lloyd’s has a closing agreement with the IRS whereby the amount of tax due on this business is calculated by Lloyd’s and remitted directly to the IRS. These amounts are then charged to the personal accounts of the Names/Corporate Members in proportion to their participation in the relevant syndicates. Our Corporate Members are subject to this arrangement but, as U.K. domiciled companies, will receive U.K. corporation tax credits for any U.S. income tax incurred up to the value of the equivalent U.K. corporation income tax charge on the U.S. income.

ACE Prime Holdings, ACE US Holdings, ACE Capital Re USA Holdings and their respective subsidiaries are subject to income taxes imposed by U.S. authorities and file U.S. tax returns. Certain of our international operations are also subject to income taxes imposed by the jurisdictions in which they operate.

Related Person Insurance Income

Each U.S. person, who beneficially owns our Ordinary Shares (directly or through foreign entities) on the last day of a non-U.S. insurance company subsidiary’s fiscal year, will have to include in such person’s gross income for U.S. tax purposes a proportionate share (determined as described herein) of the related person insurance income (“RPII”) of such insurance company subsidiary if the RPII of such insurance company subsidiary, determined on a gross basis, is 20 percent or more of that insurance company subsidiary’s gross insurance income in such fiscal year. RPII is income attributable to insurance policies where the direct or indirect insureds are U.S. shareholders or are related to U.S. shareholders of ACE. RPII may be includible in a U.S. shareholder’s gross income for U.S. tax purposes regardless of whether or not such shareholder is an insured.

For the calendar year ended December 31, 2002, we believe that gross RPII of each of our insurance company subsidiaries was below 20 percent for the year. Although no assurances can be given, we anticipate that gross RPII of each of our non-U.S. insurance company subsidiaries will be less than 20 percent of each such subsidiary’s gross insurance income for subsequent years and we will endeavor to take such steps as we determine to be reasonable to cause its gross RPII to remain below such level.