Chubb Corporation is a property and casualty insurance holding company providing insurance through its subsidiaries in the United States, Canada, Europe, and parts of Latin America and Asia. Its subsidiaries include Federal, Vigilant, Pacific Indemnity, Great Northern, Chubb National, Chubb Indemnity, and Texas Pacific Indemnity insurance companies.

The insurance operations are divided into three business units. Chubb Commercial Insurance offers a full range of commercial customer insurance products, including coverage for multiple peril, casualty, workers compensation, and property and marine. Chubb Commercial Insurance writes policies for niche business through agents and brokers. Chubb Specialty Insurance offers a wide variety of specialized executive protection and professional liability products for privately and publicly owned companies, financial institutions, professional firms, and health care organizations. Chubb Specialty Insurance also includes surety and accident businesses, as well as reinsurance through Chubb Re. Chubb Personal Insurance offers products for individuals with fine homes and possessions who require more coverage choices and higher limits than standard insurance policies.

Before proceeding with this case, you should understand how insurers "make money." Insurance companies run underwriting operations where they write insurance policies and processes and pay claims on those policies. The delay between receipt of premiums and payment of claims produces a "float," so they are also involved in investment operations where they manage investments in which the float is invested. Accordingly, you see both investment assets and liabilities on the balance sheet as well as assets and liabilities associated with insurance. You also see revenues and expenses associated with both activities in the income statement.

A frequently used measure of property and casualty insurance underwriting results is the combined loss and expense ratio. This ratio is the sum of the ratio of incurred losses and related loss adjustment expenses to premiums earned (the loss ratio) and the ratio of underwriting expenses to premiums written (the expense ratio), after reducing both premium amounts by dividends to policy holders. When the combined ratio is under 100 percent, underwriting results are generally considered profitable; when the combined ratio is over 100 percent, underwriting results are generally considered unprofitable.

Chubb's ratios for years 2001-2007 are below. In their discussion of results for 2007, management noted that underwriting results were significantly more profitable in 2007 and 2006 compared with 2005. The loss ratio for 2005 was attributed to catastrophic losses primarily from Hurricane Katrina. The lower results in 2003 were due to large asbestos and toxic waste claims, but even excluding these, the combined loss and expense ratio would have been 97.5 percent. The 2001 ratio was affected by claims arising from the September 11 attack in New York and surety bond losses relating to the Enron bankruptcy. Without these claims, the combined ratio would have been 100.5 percent.

These ratios give a good indication of the profitability of the insurance operations, but we need dollar numbers to get to the valuation implications. Further, they do not consider the performance of the investment operations. Chubb's balance sheets for 2007 and 2006 are in Exhibit 9.16 in Chapter 9 as part of the Chubb case M 9.2 there. Its 2007 income statement is also given, along with a statement of comprehensive income that Chubb reports outside both the equity statement and the income statement. If you worked case M 9.2, you will have reformulated these statements. If not, do so now before you proceed. The reformulation should capture the way that Chubb carries out its business operations, with the analysis of the profitability of the business in mind. In particular, make sure you distinguish the underwriting operations from the investment operations. Chubb has some relatively small real estate operations. Group these with the underwriting operations. The firm's statutory tax rate is 35 percent, but note that tax-exempt securities account for $232 million of investment income.
Chubb's loss and expense ratios indicate that 2007 was a very good year. The stock price, under the ticker CB, rose from $50 to $54 on these results. You are required to carry out an analysis that challenges this stock price. You do not have the complete information that you would like for forecasting, but you will be surprised how far you get simply on the basis of the financial statement information before you.
As you proceed, also deal with the following:
A. Calculate the residual income from underwriting operations and from the investment operations and decide how you will use these numbers for your valuation. Use a required return of 9 percent for the underwriting operations and 6 percent for investment operations. Why would the two operations have different required returns?
B. Explain how you dealt with the following features in your valuation:
1. Investment income
2. Realized investment gains
3. Unrealized appreciation of investments
4. Book value of investments
5. Equity investments
6. Net operating assets
7. Tax allocation
C. Insurance companies are suspected of cherry-picking investments. How did you deal with this?
D. What features of Chubb's accounting-and insurers in general-might give you pause in basing your valuation on the financialstatements?

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2006 2007 Operating income Net operating assets 2008 214. 10 1,390.42 2009 229.08 1,487.75 187.00 1,214.45 200.09 1,299.46