Annual Report 2005 - Chubb Group of Insurance Companies

On an after-tax basis, property and casualty investment income increased by 11% in 2005 and 13%
in 2004. Management uses property and casualty investment income after-tax, a non-GAAP Ñnancial
measure, to evaluate its investment performance because it reÖects the impact of any change in the
proportion of the investment portfolio invested in tax-exempt securities and is therefore more
meaningful for analysis purposes than investment income before income tax.
Other Charges
Other charges include miscellaneous income and expenses of the property and casualty
subsidiaries.
Other charges in 2003 included expenses of $18 million related to the restructuring of our
operations in Continental Europe. The restructuring costs consisted primarily of severance costs
related to branch closings and work force reductions.
CHUBB FINANCIAL SOLUTIONS
Chubb Financial Solutions (CFS) was organized in 2000 to develop and provide customized
products to address speciÑc Ñnancial needs of corporate clients. CFS operated through both the capital
and insurance markets. The insurance and reinsurance solutions were written by our property and
casualty subsidiaries, and the results of such business are included within our underwriting results.
In April 2003, the Corporation announced its intention to exit CFS's non-insurance business and to
run-oÅ the existing Ñnancial products portfolio. Since that date, our objective has been to exit this
business as quickly as possible while minimizing the potential of a large payment due to an unexpected
credit event.
CFS's non-insurance business was primarily structured credit derivatives, principally as a
counterparty in portfolio credit default swap contracts. The Corporation guaranteed all of these
obligations.
In a typical portfolio credit default swap, CFS participated in the senior layer of a structure
designed to replicate the performance of a portfolio of corporate or asset-backed securities. The
structure of these portfolio credit default swaps generally requires CFS to make payment to
counterparties to the extent cumulative losses, related to numerous credit events, exceed a speciÑed
threshold. The risk below that threshold, referred to as subordination, is assumed by other parties with
the primary risk layer sometimes retained by the buyer. Credit events generally arise when one of the
referenced entities within a portfolio becomes bankrupt, undergoes a debt restructuring or fails to
make timely interest or principal payments.
Portfolio credit default swaps are derivatives and are carried in the Ñnancial statements at
estimated fair value, which represents management's best estimate of the cost to exit our positions.
Credit default swaps tend to be unique transactions and there is no market for trading such exposures.
To estimate the fair value of the obligation in each credit default swap, we use internal valuation
models that are similar to external valuation models.
The fair value of our credit default swaps is subject to Öuctuations arising from, among other
factors, changes in credit spreads, the Ñnancial ratings of referenced asset-backed securities, actual
credit events reducing subordination, credit correlation within a portfolio, anticipated recovery rates
related to potential defaults and changes in interest rates. Changes in fair value are included in income
in the period of the change. Thus, CFS's results have been subject to volatility.
The non-insurance business of CFS produced a loss before taxes of $6 million in 2005 compared
with losses of $17 million in 2004 and $127 million in 2003.
The substantial loss in 2003 was due to downgrades in the Ñnancial ratings of certain referenced
securities underlying two of our asset-backed portfolio credit default swaps. In the Ñrst nine months of
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