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NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS

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1. General

ACE Limited (ACE or the Company) is a holding company incorporated with limited liability under the Cayman Islands Companies Law and maintains its corporate business office in Bermuda. The Company, through its various subsidiaries, provides a broad range of insurance and reinsurance products to insureds worldwide. ACE operates through the following business segments: Insurance – North American, Insurance – Overseas General, Global Reinsurance, Financial Services and Life Insurance and Reinsurance. These segments are described in Note 10.

The interim unaudited consolidated financial statements, which include the accounts of the Company and its subsidiaries, have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and, in the opinion of management, reflect all adjustments (consisting of normally recurring accruals) necessary for a fair presentation of the results for such periods. All significant intercompany accounts and transactions have been eliminated. Certain items in the prior year/period financial statements have been reclassified to conform to the current period presentation. The results of operations and cash flows for any interim period are not necessarily indicative of the results for the full year. These financial statements should be read in conjunction with the consolidated financial statements, and related notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

2. Significant accounting policies

a) Direct-response marketing costs

Advertising costs are expensed as incurred except for direct-response campaigns, principally related to personal accident business produced by the Insurance – Overseas General segment, which are deferred and recognized over the expected future benefit period in accordance with Statement of Position 93-7, Reporting on Advertising Costs. For individual direct-response marketing campaigns that the Company can demonstrate have specifically resulted in incremental sales to customers and such sales have probable future economic benefits, incremental costs directly related to the marketing campaigns are capitalized. Deferred marketing costs are reviewed regularly for recoverability and amortized over the expected economic future benefit period. The expected future benefit period is evaluated periodically based on historical results and adjusted prospectively. The amount of deferred marketing costs reported in deferred policy acquisition costs was $188 million and $126 million at September 30, 2006 and December 31, 2005, respectively. The amount of expense amortized into earnings was $32 million and $45 million for the nine months ended September 30, 2006 and 2005, respectively. In the first quarter of 2006, the Company completed a study of revenues derived from historical direct-response marketing campaigns. Beginning January 1, 2006, the Company revised the amortization for deferred costs arising from direct-response marketing campaigns to be consistent with the findings of the study. As a result of this change in estimate, the average amortization period has been lengthened from 3 to 5 years. With respect to direct-response marketing campaigns completed prior to January 1, 2006, the lengthening of the average amortization period, relative to previous amortization schedules, did not have a significant impact on amortization expense for the three and nine month periods ended September 30, 2006.

b) Call options in debt instruments

In 2005, the Financial Accounting Standards Board (FASB) issued Statement 133 Implementation Issue No. B38, Embedded Derivatives: Evaluation of Net Settlement with Respect to the Settlement of a Debt Instrument through Exercise of an Embedded Put Option or Call Option (Issue B38), which clarifies that the potential settlement of a debtor’s obligation to the creditor that would occur upon exercise of the put option or call option meets the net settlement criterion in paragraph (9a) of Financial Accounting Standard (FAS) No. 133, Accounting for Derivatives Instruments and Hedging Activities (FAS 133). Issue B38 became effective in the first quarter of 2006. In adopting Issue B38, the Company determined that call options within three debt instruments were embedded derivatives and must be reported at fair value. At September 30, 2006, the Company recognized a net liability of $4 million with a corresponding loss in net realized gains (losses) for the nine months ended September 30, 2006.

c) New accounting pronouncements

Pensions

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R)

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(FAS 158). FAS 158 requires an employer to recognize the over-funded or under-funded status of a defined benefit postretirement plan as an asset or liability in its balance sheet and to recognize changes in funded status in the year in which the changes occur through comprehensive income. Additionally, FAS 158 requires an employer to measure the funded status of a plan as of the date of its year-end balance sheet, with limited exceptions. The Company will be required to adopt the recognition and disclosure provisions of FAS 158 as of December 31, 2006.

As of December 31, 2005, the Company’s defined benefit pension plans had an under-funded status of $128 million. With respect to this amount, the Company recognized $116 million of pre-tax liabilities as of December 31, 2005, comprised of: i) a net liability of $25 million that was reflected in income thereby reducing shareholders’ equity. The $25 million net liability consisted of a prepaid asset of $33 million, accrued liability of $59 million, and an intangible asset of $1 million; and ii) an additional minimum liability of $91 million that reduced shareholders’ equity through accumulated other comprehensive income. Accordingly, if applied to the Company’s financial statements as of December 31, 2005, FAS 158 would have reduced shareholders’ equity by $8 million. The Company is currently evaluating the impact of adopting FAS 158 as of December 31, 2006.

Fair Value Measurements

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (FAS 157). FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. FAS 157 focuses on how to measure fair value and establishes a 3-level hierarchy for both measurement and disclosure purposes. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. Under FAS 157, fair value measurements would be separately disclosed by level within the fair value hierarchy. FAS 157 does not expand the use of fair value to any new circumstances. The Company is currently evaluating the impact of adopting FAS 157.

Considering the Effect of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements

In September 2006, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108). SAB 108 provides guidance as to how errors should be evaluated to assess materially from a quantitative perspective. SAB 108 permits companies to initially apply its provisions by either restating prior financial statements or recording the cumulative effect of initially applying the approach as adjustments to the carrying values of assets and liabilities as of January 1, 2006 with an offsetting adjustment to retained earnings. SAB 108 is required to be adopted by December 31, 2006 and the Company is currently evaluating the potential impact on the financial statements of adopting SAB 108.

Accounting for Uncertainty in Income Taxes

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for uncertainty in tax positions by prescribing a financial statement recognition threshold and measurement attribute for tax positions taken or expected to be taken in a tax return. Further, FIN 48 expands the required disclosures associated with such uncertain tax positions. The provisions of FIN 48 are effective January 1, 2007 and the cumulative effect of adoption, if any, will result in an adjustment to opening retained earnings. The Company is currently evaluating the potential impact on the financial statements of adopting FIN 48.

Accounting for Certain Hybrid Financial Instruments

In February 2006, the FASB issued FAS 155, Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140 (FASB 155). FAS 155 permits fair value re-measurement of an entire hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; narrows the scope exemption applicable to interest-only strips and principal-only strips from FAS 133 (the FASB has recently proposed to expand this exception by issuing a FAS 133 Implementation Issue which will, if approved, also create a scope exception for certain securitized interests that contain prepayment risk from underlying financial assets); establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain embedded derivatives requiring bifurcation; and clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives. FAS 155 is effective for all financial instruments acquired or issued after January 1, 2007 and is not expected to have a material impact on the Company’s financial condition or results of operations.

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3. Sale of Certain Run-Off Reinsurance Subsidiaries

On July 3, 2006, the Company completed the sale of ACE American Reinsurance Company (AARe), Brandywine Reinsurance Company (UK) Ltd (BRUK), and Brandywine Reinsurance Company SANV (collectively, “the three companies”) to Randall & Quilter Investment Holdings Limited (R&Q). At June 30, 2006, the three companies had total losses and loss expenses reserves of approximately $808 million, reinsurance recoverables, net of provision for uncollectible reinsurance, of approximately $320 million, cash of approximately $372 million, investments of approximately $127 million and other liabilities, net of other assets, of approximately $29 million. In connection with the sale, the Company received a $5 million interest bearing note from R&Q plus contingent consideration in the form of preference shares issued by R&Q with a total potential benefit of $15 million, depending upon the performance of BRUK and AARe. The Company will not recognize the contingent consideration until its receipt is assured.

The transaction resulted in a pre-tax realized gain of approximately $9 million which is included in realized gains (losses) in the accompanying statement of operations and an after-tax gain of approximately $23 million. The income tax benefit of approximately $14 million principally relates to the effect of the sale on U.S. federal income taxes reflecting differences in the bases of the assets of the three companies for financial reporting purposes compared to the corresponding tax bases.

The Company eliminated a deferred tax asset valuation allowance of $48.3 million that had been established in connection with the purchase of the three companies in 1999 as part of the acquisition of CIGNA’s property/casualty business. Pursuant to Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes , the Company has reduced goodwill by $48.3 million to reflect the elimination of this valuation allowance.

The ultimate accounting gain is subject to adjustment due to final settlement with R&Q regarding the closing balance sheets of each of the three companies sold and the contingent consideration referred to above. Financial results related to the sold business are included in the Insurance - North American segment.

Subsequent to the sale, the Company maintains two obligations related to the three companies as follows:

Additionally, prior to the sale, an ACE affiliate ceded 100 percent of the risks associated with certain insurance policies to BRUK. Subsequent to the sale, this cession remains in force. At June 30, 2006, the reinsurance recoverable by the ACE affiliate from BRUK under this agreement was approximately $69 million.

4. Share-Based Compensation

The Company has share-based compensation plans which currently provide for awards of stock options, restricted stock, and restricted stock units to its employees and members of the Board of Directors. In December 2004, the FASB issued FAS 123 (Revised) “Share-Based Payment” (FAS 123R) which is a revision of FAS 123 that supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). This statement requires all companies to measure and record compensation cost for all share-based payment awards (including employee stock options) at grant-date fair value. The Company adopted FAS 123R effective January 1, 2006. Prior to the adoption of FAS 123R, the Company accounted for its share-based compensation plans in accordance with APB 25. In accordance with APB 25, the Company did not recognize compensation expense for employee stock options in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying Ordinary Shares on the date of the grant. In addition, the Company did not recognize expenses related to its employee stock purchase plan (ESPP). Upon adopting FAS 123R on January 1, 2006, the Company was required to expense employee stock options and expenses related to its ESPP. FAS 123R also requires that the excess tax benefits of deductions resulting from the exercise of stock options be classified as cash flows from financing activities. Prior to the adoption of FAS 123R, the Company presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows.

In adopting FAS 123R, the Company applied the modified prospective method and accordingly, prior period amounts have not been restated. Under this method, the Company recognizes compensation expense for all share-based payments granted, modified, or settled after January 1, 2006, as well as for any awards that were granted prior to January 1, 2006 for which the requisite service had not been provided as of January 1, 2006 (i.e., unvested awards). Unvested awards are to be expensed consistent with the valuation used in previous disclosures of the pro forma effect of FAS 123. The Company used the Black-Scholes option-pricing model to disclose the pro forma effect of FAS 123 and to determine the fair value of share compensation under FAS 123R.

The Company principally issues restricted stock grants and stock options on a graded vesting schedule. Prior to the adoption of FAS 123R, the Company recognized compensation cost for restricted stock grants with only service conditions that have a graded vesting schedule on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in-substance, multiple awards. Upon adopting FAS 123R, the Company recognizes compensation costs for both restricted stock grants and stock options on this basis. Further, prior to the adoption of FAS 123R, forfeitures were recognized as they occurred. Upon adopting FAS 123R, an estimate of future forfeitures is incorporated into the determination of compensation cost for both restricted stock grants and stock options. At January 1, 2006, the cumulative effect of this change in accounting principle was $4 million, net of income tax. This effect related to the recognition of expected forfeitures on restricted stock grants that had not vested as of January 1, 2006.

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The following table outlines the Company’s net income (loss) available to holders of Ordinary Shares and basic and diluted earnings (loss) per share for the three and nine months ended September 30, 2005 had the compensation cost been determined in accordance with the fair value method recommended in FAS 123. The reported and pro forma net income and basic and diluted earnings per share for the three and nine months ended September 30, 2006 are the same since share-based compensation expense is calculated under the provisions of FAS 123R. The amounts for the three and nine months ended September 30, 2006 are included in the table below only to provide the detail for a comparative presentation to the three and nine months ended September 30, 2005.

The adoption of FAS 123R resulted in incremental share-based compensation expense for the cost of stock options and shares issued under the ESPP of $5 million before and after tax and $14 million ($13 million after tax), respectively, for the three and nine months ended September 30, 2006, ($0.01 and $0.04, respectively, per basic and diluted share) that would not have otherwise been recognized. For the three and nine months ended September 30, 2006, the expense for the restricted stock was $15 million and $46 million, respectively ($12 million and $35 million, respectively, after tax).

Under the ACE Limited 2004 Long-Term Incentive Plan (the 2004 LTIP) a total of 15,000,000 Ordinary Shares of the Company are authorized to be issued pursuant to awards made as stock options, stock appreciation rights, performance shares, performance units, restricted stock and restricted stock units. The maximum number of shares that may be delivered to participants and their beneficiaries under the 2004 LTIP shall be equal to the sum of: (i) 15,000,000 shares; and (ii) any shares that are represented by awards granted under the ACE Limited 1995 Long-Term Incentive Plan, the ACE Limited 1995 Outside Directors Plan, the ACE Limited 1998 Long-Term Incentive Plan, and the ACE Limited 1999 Replacement Long-Term Incentive Plan (the Prior Plans) that are forfeited, expired or are canceled after the effective date of the 2004 LTIP of February 25th, 2004, without delivery of shares or which result in the forfeiture of the shares back to the Company to the extent that such shares would have been added back to the reserve under the terms of the applicable Prior Plan. As of September 30, 2006, a total of 11,454,562 shares remain available for future issuance under this plan.

At the Annual General Meeting, held on May 18, 2006, the Second Amendment to the ACE Limited ESPP was approved by shareholders. The Second Amendment of the ESPP increased the number of Ordinary Shares available for issuance under the ESPP by 1,500,000 shares (Additional Shares), which shares are in addition to the 1,500,000 Ordinary Shares previously reserved under the ESPP. As of September 30, 2006, a total of 1,398,641 Ordinary Shares remain available for issuance under the ESPP.

Stock Options

The Company’s 2004 LTIP provides for grants of both incentive and non-qualified stock options principally at an option price per share of 100 percent of the fair market value of the Company’s Ordinary Shares on the date of grant. Stock options are generally granted with a 3-year vesting period and a 10-year term. The stock options vest in equal annual installments over

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the respective vesting period, which is also the requisite service period. Included in the beginning of period balance are 5-year cliff vest options of 100,000, 150,000 and 25,000 issued respectively in 2002, 2003 and 2004. There were 150,000 5-year cliff vest options granted in February 2006.

Included in the Company’s share-based compensation expense in the nine months ended September 30, 2006 is the cost related to the unvested portion of the 2005, 2004 and 2003 stock option grants. The fair value of the stock options was estimated on the date of grant using a Black-Scholes option valuation model that uses the assumptions noted in the following table. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected life (estimated period of time from grant to exercise date) was estimated using the historical exercise behavior of employees. For 2005 and prior options, expected volatility was based on historical volatility for a period equal to the stock option’s expected life, ending on the date of grant, and calculated on a monthly basis. For 2006 options, expected volatility was calculated as a blend of (a) historical volatility based on daily closing prices over a period equal to the expected life assumption, (b) long-term historical volatility based on daily closing prices over the period from ACE’s initial public trading date through the most recent quarter; and (c) implied volatility derived from ACE’s publicly traded options.

The fair value of the options issued is estimated on the date of grant using the Black-Scholes option-pricing model, with the following weighted-average assumptions used for grants for the periods indicated:

The following table shows, for the periods indicated, changes in the Company’s stock options:

The weighted-average remaining contractual term was 6.12 years for the stock options outstanding and 5.24 years for the stock options exercisable at September 30, 2006. The total intrinsic value was approximately $195 million for stock options outstanding and $172 million for stock options exercisable at September 30, 2006. The total intrinsic value for stock options exercised during the three and nine months ended September 30, 2006 was approximately $10 million and $28 million, respectively. The weighted-average fair values for the stock options granted for the three and nine months ended September 30, 2006 was $14.89 and $18.32, respectively.

The amount of cash received during the three and nine months ended September 30, 2006 from the exercise of stock options was $17 million and $50 million, respectively.

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Restricted Stock

The Company’s 2004 LTIP also provides for grants of restricted stock. The Company generally grants restricted stock with a 4-year vesting period, based on a graded vesting schedule. The restricted stock is granted at market close price on the date of grant. Included in the Company’s share-based compensation expense in the nine months ended September 30, 2006 is a portion of the cost related to the unvested restricted stock granted in the years 2002 to 2006.

The following table shows, for the periods indicated, changes in the Company’s restricted stock:

Included in the above table are 96,200 performance-based restricted shares issued to executive officers, consisting of 50,200 target awards issued in 2006 and 46,000 target awards issued prior to 2006. With respect to the 2006 target awards, the performance goal is based on the achievement by ACE Limited of growth in GAAP book value exceeding the median growth of a specified peer group, according to a designated financial measure listed in the ACE Limited 2004 Long-Term Incentive Plan. The target awards are based on a graded vesting schedule over a 4-year period. If an installment does not vest because the initial one-year performance goal is missed, a re-measurement feature provides additional vesting opportunities based on cumulative performance over a series of extended measurement periods within the 4-year performance period. If performance measures are not achieved by the end of the 4-year performance period, related shares are forfeited. Excluded from the above table are premium awards granted in 2006 that provide the same executive officers an opportunity to earn up to an additional 50,200 shares based on the Company’s performance. The premium awards vest at the end of four years and, similar to target awards, performance is measured based on the Company’s growth in GAAP book value relative to its peers. With respect to the 2006 premium awards, if cumulative performance is less than the peer group’s 65 ^th percentile, no premium award will be earned. For performance between the 65 ^th and 75 ^th percentile, the premium will be interpolated between 50 percent and 100 percent of the number of actual shares earned from the target award. With respect to target awards granted prior to 2006, the performance measurement and vesting period is comparable to the 2006 target awards. The Company recognizes expense related to performance-based restricted shares based on an estimate of the restricted shares that will ultimately be earned. For the nine months ended September 30, 2006, compensation expense was recognized for the 96,200 target awards but not the premium awards.

Under the provisions of FAS 123R, the recognition of deferred compensation, a contra-equity account representing the amount of unrecognized restricted stock expense that is reduced as expense is recognized, at the date restricted stock is granted is no longer permitted. Therefore, the amount of deferred compensation that had been reflected in “Unearned stock grant compensation” was reclassified to “Additional paid-in capital” in the Company’s Consolidated Balance Sheet.

Restricted Stock Units

The Company’s 2004 LTIP also provides for grants of other awards, including restricted stock units. In 2006, the Company granted restricted stock units with a 4-year vesting period, based on a graded vested schedule. Each restricted stock unit represents the Company’s obligation to deliver to the holder one share of Ordinary Shares upon vesting. On February 22, 2006, the Company granted 80,120 restricted stock units with a weighted-average grant date fair value of $56.40.

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The Company also grants restricted stock units with a 1-year vesting period to non-management directors. Delivery of Ordinary Shares on account of these restricted stock units to non-management directors is deferred until six months after the date of the non-management directors’ termination from the Board. During the nine months ended September 30, 2006, 23,092 stock units were awarded to non-management directors. These units will vest in May 2007. During the nine months ended September 30, 2005, 24,856 stock units were awarded to non-management directors. These units vested in May 2006.

ESPP

The ESPP gives participating employees the right to purchase Ordinary Shares through payroll deductions during consecutive “Subscription Periods.” Annual purchases by participants are limited to the number of whole shares that can be purchased by an amount equal to ten percent of the participant’s compensation or $25,000, whichever is less. The ESPP has two six-month Subscription Periods, the first of which runs between January 1 and June 30 and the second of which runs between July 1 and December 31 of each year. The amounts that have been collected from participants during a Subscription Period are used on the “Exercise Date” to purchase full shares of Ordinary Shares. An Exercise Date is generally the last trading day of a Subscription Period. The number of shares purchased is equal to the total amount, as of the Exercise Date, that has been collected from the participants through payroll deductions for that Subscription Period, divided by the Purchase Price, rounded down to the next full share. The “Purchase Price” is 85 percent of the lower of (1) the fair market value of an Ordinary Share on the first day of the Subscription Period, or (2) the fair market value of an Ordinary Share on the Exercise Date. Participants may withdraw from an offering before the exercise date and obtain a refund of the amounts withheld through payroll deductions. Included in the Company’s share-based compensation expense in the nine months ended September 30, 2006 is a portion of the cost related to the estimated December 31, 2006 ESPP offering.

The fair values of the offerings of the Subscription Periods ended December 31, 2006 and June 30, 2006 were calculated using a Black-Scholes option valuation model that used the assumptions noted in the following table. The risk-free interest rate is based on the U.S. Treasury yield curve. Expected volatility was based on an average of historical and implied volatility.

The weighted-average fair value for the Company’s ESPP rights was $11.22 and $12.21, respectively, for the December 31, 2006 and June 30, 2006 ESPP offerings.

As of September 30, 2006, unrecognized compensation expense related to the unvested portion of the Company’s Employee Share-Based Awards was approximately $125 million and is expected to be recognized over a weighted-average period of approximately 2.14 years.

The Company generally issues shares for the exercise of stock options, for restricted stock and shares under the ESPP from un-issued reserved shares.

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5. Investments

a) Gross unrealized loss

As of September 30, 2006, there were 6,391 fixed maturities in an unrealized loss position out of a total of 13,666 fixed maturities in the investment portfolio. The largest single unrealized loss for a fixed maturity security was $1.7 million. There were 369 equity securities in an unrealized loss position out of a total of 1,093 equity securities in the investment portfolio. The largest single unrealized loss for an equity security was $2.8 million. There were no securities that had been in a loss position for the previous nine consecutive months with a market value of less than 80 percent of amortized cost, or cost for equity securities. Most of the fixed maturities in an unrealized loss position were investment grade securities for which fair value declined due to increases in market interest rates from the date of purchase.

The following tables summarize, for all securities in an unrealized loss position at September 30, 2006 and December 31, 2005 (including securities on loan), the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position.

September 30, 2006

Included in the “0 – 12 Months” and “Over 12 Months” aging categories at September 30, 2006, are fixed maturities held to maturity with combined fair values of $1.1 billion and $1.6 billion, respectively. The associated gross unrealized losses related to these fixed maturities are $10.2 million and $22.9 million, respectively.

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