ACE InitiatingCoverage

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INITIATING COVERAGE REPORT William C. Dunkelberg Owl FundSeptember 19, 2014

Brandon C. George: Lead A

[email protected] Mathew: Associate A

[email protected] Ford: Associate Ana

[email protected]

Sector Outperform

Recommendation: BUYKey StatisticsPrice $107.00 52 Wk. Low $89.3

Projected Return 13.49% 52 Wk. High $108.6

Shares O/S (M) 335.70 Yield 2.43%

Market Cap $35.92 Enterprise Value $41.0Earnings HistoryEarnings Date EPS RevenueYoY Price

3Q13 $2.49 1% -1.54%

4Q13 $2.39 8% -0.57%

1Q14 $2.27 3% -0.26%

2Q14 $2.42 3% 1.09%

Earnings ProjectionsYear Q1 Q2 Q3 Q4 Total

2011 $0.79 $2.01 $2.22 $1.94 $6.97

2012 $2.05 $2.17 $2.01 $1.43 $7.65

2013 $2.17 $2.29 $2.49 $2.39 $9.35

2014 $2.27 $2.42 $2.24 $2.22 $9.13

2015E $2.27 $2.38 $2.31 $2.35 $9.26

All prices current at end of previous trading

sessions from date of report. Data is sourced from

local exchanges via CapIQ, Bloomberg and other

vendors. The William C. Dunkelberg Owl fund does

and seeks to do business with companies covered

in its research reports.

COMPANY OVERVIEWACE Limi ted, the parent company of ACE Group, is one of the world s largest

global Property and Casualty (P&C) insurers and reinsurers operating across 53

countries. The companys primary operations can be broken dow n into three

segments: Overseas General Insurance (36%), North America P&C (44%), and

Global Reinsurance and Life Insurance (20%). Under the Overseas General

Insurance umbre lla, the firm offers various lines of personal, commercial P&C

and P&C re insurance in addition to accident and supplemental health (A&H)

insurance across Europe, Latin America and the Asia Pacifi c. Through its

North American segment, the companys clients range from high net worth

individuals to large mul tinationals, offering a wide range of P&C, A&H and riskmanagement products. Moreover, the North American Agricultu re segment

offers multi-peril c rop and crop-hail insurance in addition to specialty P&C

products for companies that manufacture, process and distribu te agricu ltural

goods. Lastly, ACE Life offers traditional life i nsurance and life rei nsurance

across North America, Asia, Latin America and the Middle East. The

companysdistribution network reaches cli ents through brokerage, agencies,

bancassurance and direct marketing.

Investment ThesisInitiating coverage on ACE Limi ted (ACE), we not only find the Property and

Casualty Index to be und ervalued to the broader Financial sector but we also

find ACE to be undervalued relative to its peers on a P/B basis. Compared to

comps, ACE trades at ~1.19x book value per share versus the peer group

average at 1.25x. Moreover, we find the discount that the street has placed onthe P&C sector, cu rrently standing at ~1.26x versus the Financial sector at

~1.36x, to be rather draconian. While the P&C insurance market tends to enter

cycles of competitive and noncompetitive pricing, historically low interest rates

have extended the soft market cycle , further suppressing not only premi um

revenue but investment income as wel l. Despite ACEs posi tioning as a global

leader in specialty insurance lines, investors have underestimated the quality and

ability of ACE to continuously underwrite at profi table levels with a diverse risk

appetite. Historically the company has traded at a discount to its peers,

justifiably so, as it did not have the global reach and growth possibi lities that it

does now. Over the near term, significantly higher insurance cl aims as a result

of a lengthier winter season have suppressed the P&C index as a whole, further

causing a drag on ACEs earnings. With respect to competitors, ACE has

unique ly positioned itself wi th a 50/50 split in its U.S. and overseas operationsand over the last decade, ACE has extended its reach into foreign markets

through a bolt-on acquisition strategy, tapping into the growth potential of

developing markets in Latin America, the Asia Pacific, and the Midd le East.

Through its unmatched ri sk profil e created by its acquisitive nature and

bellwether management, ACE wil l continue to drive premium growth while

maintaining superb underw riting quality and profitability, without having to

substantially leverage up. Going forward, we bel ieve the former wi ll drive ACE

to proper valuation of 1.22x projected BVPS of $97.16 to our target price of

$118.76.FinancialSectorProperty

andC

asualty

Insur

ance

ACE LimitedExchange: NYSETicker: ACETarget Price: $118.76


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T h e W i l l i a m C . D u n k e l b e r g O w l F u n d Pag

Positives

Surplus and Capital levels allows not only for continued bolt-onacquisition strategy but for signifi cant returns to shareholde rs

through bu ybacks and increased dividends. In Q4 2013, ACEannounced a record share buyback of $1.5 bi llion in common stockthat it is cu rrently being executed in FY 2014.

Bolt-on Acquisition strategy allows ACE to better pricepremiu ms in fore ign markets through greater transparencies in r iskprofi les, derived from pu rchasing smaller insurance companies withintargets domiciled operations. Through this strategy, ACE has seenrevenue for its Overseas General Insurance segment grow by roughl y47% between FY06 and FY13. Between 2009 and 2012, netpremiu ms earned for the Latin America and Asia Pacifi c segmentsgrew by roughly 66% and 58% respec tively.

Historically low underwriting capacity, measured as net premiumswri tten to surplus, means that ACE i s highly underleveraged (i.e.taking on less risk with regards to wr iting premiums relative to howmuch is kept in surplus). Being under -levered at 0.88 net premiums tosurplus means that ACE has capacity to wri te 14% more premiumsand still be evenly levered.

Underwriting quality is Superb due in part to ACEs global strategythrough diversification and effective risk management. This isexplained by ACEs 87.70 combined ratio, a measure of underwr itingprofi tabili ty (or unprofi tability when >100), which is well be low theindustry average of about 100. Within the last decade alone,underwriting for the P&C sector has only been profitable four years, atestament toACEs und erwriting as the fi rm hasnt seen underwritingloss since FY02 w ith a combined ratio of only 101.70.

Historically strong management sees its roots extending from theglobal P&C insuring powerhouse that AIG once was. CEO EvanGreenberg, son of former AIG Chairman and CEO MauriceGreenberg, left AIGs Far East divi sion and position as COO in 2001

to take on the rol e as vice chairman of ACE. He w ould l ater go on toassume the role of CEO in 2004 and re fused bailout assistance dur ingthe 2008 financial crisis. The Greenberg family has a strong history in

insurance as Evans brother, Jeffre y, is former CEO of Marsh andMcLennan Companies, the insurance brokerage firm .

Catalysts

Pricing Cycle and Global Macroeconomic environment stand tofurther d rive premium growth within overseas segments as globaldemand for P&C insurance ri ses with increases in GDP andeconomic stability. Shift toward competitive pricing cycle should drivepremiu m revenue as insurers begin to raise rates.

Acquisition of Itau Seguros , a P&C insurer based out of Brazil thathas seen premium growth of roughly 22% over three years in aninsurance market that has grown by 10%, and i s expected to continuegrowing,wi ll extend ACEs Latin American reach. As it stands, Itau

Seguros stands to add 18% of Brazils P&C i nsurance market to ACEGlobal Markets.

Improving Interest Rate Environment stands to drive netinvestment income as most of ACEs portfoli o allocation is towardsfixed income secu rities. The historically low interest rate environmenthas kept investment income relatively flat across all insurers (incl udingACE) as a whole . As rates begin to rise begin to rise , P&C insurersshould see greater return on their fixed income portfolios.

Risks

Macroeconomic decline: Multiplemacroeconomic factors have the potential toimpact ACEs valuationin scales ranging fromminimal to dramatic. Impacts for ACE wouldbe felt within investment income and premium

demand. Potentially Unique Risk Exposures: Within

ACEs specialty property lines, uniqueexposures include developing technologiessuch as medical nanotechnologies, newindustries such unmanned drone aviation andspace travel, and exotic liabilities such ascounterparty, talent, and trademarkprotections. However, these risks arestrategically distributed between multiplesyndicates with the Lloyd's of Londonstructure keeping claims stable movingforward.

Exposures to Weather related losses:American agribusiness protections accountsfor 12.5% of global premiums written,however catastrophic losses have the potentialto occur in this segment with adverse weather.Meteorologist consensus anticipates a lossheavy winter this year with hurricane seasonstarting at the beginning of the month, thoughconsensus for hurricanes is much lower.However, this risk is industry wide and is veryhard to predict.

Potentially increasing governmentregulation: Expiration of the Terrorism Riskand Insurance Protection (TRIP) act,regulatory standards proposed by the FederalInsurance Office (FIO), and G-SIFIdesignations stand to materially hinder theP&C industry as a whole through acombination of potentially tighter regulationand loss of government backing.

Economic Moats

Scale/ScopeThrough their bolt-onacquisition strategy, ACE can accurately andcompetitively out price competitors in foreignmarkets through their acquisitions. With apowerful centralized data analytics network,

ACE is able to improve insight within riskprofiles through historical information givingthem competitive advantage over new entrantsand smaller competitors in developingmarkets.

Switching Costscreated by cross sellingstrategies makes it hard for insured to switchto competitors as insurance products tend tobe sticky and switching tends to be costly.


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Financial AnalysisRevenue Breakdown by Segments

While insurers can traditionally break their revenue up in a multitude of various segments, we felt the easiest way to

introduce ACE was through their three primary segments as they are explained in their annual report. Overseas General

Insurance (36%), North America P&C (44%), and Global Reinsurance and Life Insurance (20%) make up ACEs

infrastructure, as CEO Evan Greenbergs motto for their model being when one side of the world is down , another is

up. ACE has capitalize5d on developing market insurance demand, avoiding much of the losses and premium

slowdown experienced by U.S. insurers. Moreover ACE keeps a very well diversified regional investment portfolio,utilized to generate investment income for claims payouts. Making up 11% of total revenue, total investment income has

lagged across the entire industry, where typically m aking up 15-25% of revenues, historically low rates have suppressedreturns.

PEER GROUP IDENTIFICATION

Alls tate Corporation (ALL)

o Provides personal property, casualty, and life insuranc

as well as retirement services and investment product The Travelers Companies (TRV)

o Provides commercial, personal property and casualty

insurance products and services to businesses,

government units, associations and individuals in the

U.S. Operates in three segments: business, insurance,

and financial services.

Chubb Corporation (CB)

o Offers property and casualty insurance to businesses

and individuals. Specialty insurance products include

directors and officers liability, errors and omissions

liability and fiduciary liability.

Cincinnati Financial Corporation (CINF)

o

Provides commercial and personal P&C, as well as

excess and s urplus P&C and clients across the U.S.

TARGET PRICE

PEER GROUP IMPLIED P/B: Using a 10 year mean

spread ratio we found that the average P/B multiple of

ACEs comp group is 1.22x, discounting ACE by a mere3% at 1.19x. Using this average, we multiplied it by the

forecas ted NTM BV of 97.16 to come up with a target

price of 118.76 netting us a 10.99% return including a

dividend yield of 2.5%, totaling our return on investment

of 13.49%.

Peer Anal ysis Target Pri ce= $118.76

Relative Target Multiple =1.22xNTM Forecasted BVPS= $97.16


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Segmented Financial Analysis

InsuranceNorth American P&C

For FY13, North American P&C and Agricultural P&C comprised roughly

44% of net premiums written. The insured in this segment range from

multinational firms to mid and small businesses, as well as high net worthindividuals. Products for multinationals down to small businesses include

accident and health insurance products in addition to risk management

services. High net worth individuals and families have access to homeowners,

auto, goods and recreational m arine insurance through ACE Private Risk

Services. Coverage offered through the North American Agricultural division

includes comprehensive multiple peril crop and crop-hail insurance offered

through Rain and Hail, acquired in 2010 as a part of ACEs bolt on

acquisition-diversification strategy. Despite downward net premium trends

of about 14% for ACE Agricultural in 2Q 14, the firm has seen these losses

offset by higher performing segments not only in their commercial risk

services, premiums up 15%, but through their overseas segments. North

Americas P&C insurance market tends to be highly competit ive, and yet,coupled with slower economic growth of the United States, ACE has seenpremium growth in its North American segment at a 5-year CAGR of 5.42%.

InsuranceOverseas General

Servicing clients in over 50 countries across the globe, ACEs Overseas

General Insurance practice consists of ACE International, their retail

broker distributor and ACE Global Markets. ACE Global Markets is

comprised of their Lloyd's syndicate trading desk which is d iscussed

under Life Insurance and Reinsurance. ACEs Overseas General segment

underwrites a broad array of commercial and personal insurance products

for multinationals down to the everyday citizens. Coverage lines includeand are not lim ited to, traditional P&C, professional, marine, energy,

aviation, political risk and construction. The Overseas General Insurance

segment, making up ~40% of premiums earned, has seen growth at a 5-

year CAGR of 5.27% for net premiums written, largely attributed to

greater demand within developing markets. Going forward, we should

expect to continue seeing premium growth in the Overseas General

segment in the mid-to-high single digit range as demand in developingmarkets continues, capitalized on by ACEs bolt on acquisition strategy.

Life Insurance and Reinsurance

Ace underwrites $1.7 Billion (7% of ACEs global premiums written) ofLife insurance premiums as of Q2 2014. This is a relatively small segment

and consists of ACE life, an individual health line provider in secondary

markets, and ACE Combined Insurance, a captive provider in North

America. Both sub-segments are quoted mainly as a secondary product

for product bundles and compliance purposes with possible future

legislation (FIO guidelines would mandate that all home insurers would

also have to carry injury lines). The life insurance segment has seen

modest growth YOY despite the Combined Insurance subsidiary

Premium Breakdown FY13:

Clients and Industries


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Bolt-on acquisition strategy

As a global insurer, ACE has managed to diversify its product offering through a highly acquisitive strategy,

approximately named Bolt-on acquisition strategy. ACE uses the term bolt-on because average acquisition size is

never more than $1 billion, as out of the 25+ acquisitions (only 20 disclosed deal values) made in the last 2 decades, only

three of which were valued over the $1 billion mark. Because these acquisitions are so small in nature, they are a

supplement to organic growth, showing immediate accretion to earnings. ACE has effectively made these acquisitions inspecialty insurance segments such as their agricultural segment, in addition to acquisitions made in regions of developing

markets where demand for insurance rises with GDP. Moreover, these acquisitions not only further diversify away the

overall risks ofACEs risk profile, but they allow ACE to underwrite better than competitors within these regions. By

acquiring small specialty insurers, ACE has a beat on new entrants into these markets and due to its s ize can out price

and absorbs losses more effectively than competitors already in the market. Their most recent acquisition of Itau

Seguros generated $950 million in gross premiums, specifically in the property and marine lines. Going forward we

expect to see ACE benefit from its acquisitive nature, experiencing premium growth, continuation of qualityunderwriting through greater levels of information and greater risk transparency.

Acquisition History

Returns to shareholders

Escaping the global economic crisis relatively unscathed relative to the rest of financials, ACE not only maintained their

quarterly dividend but ratcheted it up a little over 50% since the pits of the recession slowed their returns to

shareholders. In addition to their dividends, on 11 November 2013, the company announced a $1.5 billion share

buyback set to be completed 31 December 2014. So far, in the first two quarters of 2014, the company has purchased

$700 million worth of the $1.5 billion dollar plan. Going forward, we believe ACE has the adequate capital levels to not

only be as acquisitive as it has in the past, but to continue to return to shareholders through dividends and sharerepurchases.


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Margins and Ratios

Operating Margin

At 20.33% versus the peer group average of 15.14% is a testament to ACEs effective pricing strategy within the U.S.

and across the globe. Operative Margins have seen a 3-year CAGR of almost 19%. Going forward, we expect to see the

operating margin driven higher through continued acquisitions, strengthening pricing and operating efficiencies.

Profit Margin

Despite historically low interest levels driving down yields on fixed income assets, suppressant to net investment income,

ACE boasts a profit margin of 16.10%, well above the peer group average of 10.90%. ACEs profit margins have grownby 76% since the worst of the low interest rate environment suppressed the margin to 9.15%.

ROE and ROA

Return on assets is a measurement of how effectively management is using their assets to generate earnings. ACE proves

once again that their top tier management is effectively using their assets to generate a steady income stream. ROA sits at

3.59%, significantly higher than the 2.99% average of the comp group. Return on equity measures not only theprofitability of a company but how effectively a company is investing their shareholders capital to generate income.

ACE currently has a ROE of 11.90% which is slightly higher than the comps average 11.39%. ACEs ROE and ROAhave shown significant improvements since the recession, growing at a 3-year CAGR of 27.02% and 30.71% respectively.

Expense Ratio

The expense ratio is a measurement of how much the company is spending for expenses such as overhead, marketing,

and commissions to brokers and employees. This function of the combination ratio represents the aforementioned

underwriting expenses to earned premiums. Through effective expense management generated by scale, ACEscombined ratio sits slightly below the comp group average of 29.70% at 29.3%.

Loss Ratio

The loss ratio is the percent of

premiums that is used to pay claims.

Representing the other portion of

ACEs combined ratio at58.4%, the

loss ratio has improved significantly

since the pre-recession era, showing

ACEs greaterunderstanding risk

management. ACEs acquisitions in

foreign markets have given them

insight on how to minimize risk and

increase profitability in areas where

competitors dont have equal access to

data to support potential customers orexpansion.

50

55

60

65

70

75

80

2013 2012 2011 2010 2009 2008 2007 2006 2005 2004

Loss Ratio

All US Equity TRV US Equity CB US Equity

CINF US Equi ty A CE US E quity


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TICKER P/BV 10 YEAR WEIGHTED TARGET BOOK VALUE RETURN

MEAN P/BV P/BV NTM 10.99%

CB 1.32x 0.85 1.12x 1.22x 97.16$ PLUS DIVIDEND

TRV 1.26x 1.00 1.26x 2.50%

CINF 1.25x 1.02 1.28x TARGET PRICE CURRENT PRICE TOTAL RETURN

ALL 1.28x 0.96 1.22x 118.76$ 107.00$ 13.49%

Combined Ratio

The combined ratio, designated as

one of the most important measures

indicating an insurance companies

underwriting profitability, is made up

of the loss ratio and the expense ratio.The ratio states incurred losses and

underwriting expenses as a

percentage of premium revenue

earned. The breakeven point is 100,

with anything above 100 a loss and

anything below a profit. ACEs

combined ratio for 2Q14 was 88

versus the comp group average is a

90.4. The loss ratio has finally

returned to its historical average, pre-

recession levels, demonstrating the

companys underwriting is at its mostprofitable once again.

Valuation

ACE is currently undervalued compared to its comp group that consists of the companies that operate in similar

segments as ACE, within the Property and Casualties Industry. Due to its scale and size, no competitor can truly mim ic

ACEs model on a global scalemaking its risk profile unlike any other P&C insurer within the industry. It is because of

this intricate and seemingly ambiguous risk profile that ACE derives its poorly and ill-informed historical valuation. Our

team found ACE to be undervalued on relative peer group P/B basis, a 10 year historical P/B spread ratio, in addition

to the whole P&C sector trading at a discount (typically a 5% premium) to the financial sector on a 5-year basis (See

Appendix). We decided to value ACE on the 10 year P/B spread ratio to even out historical and economic indifferences

between ACE and the comp group. Moreover, going with the spread ratio gives us a more conservative return on

investment. Looking forward, our team anticipates that improving pricing cycles within P&C, coupled with ACEs

industry leading underwriting quality, acquisitive nature and expanding global footprint will drive ACE to its fair valueand beyond.

80

85

90

95

100

105

110

2013 2012 2011 2010 2009 2008 2007 2006 2005 2004

Combined Ratio

All US Equity TRV US Equity CB US Equity

CINF US Equi ty A CE US E quity

Capitalizatio Leverage

Market P/E Profit Operating Return on Return on Return on Effective Debt/ Net Investment Net Premiums Combined Loss

ker Company Value LTM NTM LTM LTM LTM Equity Assets Capital Tax Rate Equity Yield Written /Surplus Ratio Ratio

Chubb Corp. 21.83$ 12.57x 1.25x 1.32x 14.12% 19.19% 12.85% 4.01% - 27.56% 20.00% 3.46% 0.67 90.00% 58.70%

NF Cincinnati Fin. 7.92$ 20.62x 1.18x 1.25x 6.92% 9.88% 7.11% 2.42% 6.76% 27.59% 13.87% 4.04% 0.83 100.90% 70.20%

V Travelers Corp 31.33$ 9.55x 1.16x 1.26x 10.07% 14.64% 14.16% 3.47% 12.31% 25.72% 24.86% 4.11% 1.14 95.10% 63.60%

L Allstate Corp. 26.44$ 11.23x 1.17x 1.28x 7.28% 11.68% 11.42% 2.06% 9.57% 32.86% 25.56% 3.09% 1.63 97.40% 71.40%

21.88$ 13.49$ 1.19$ 1.28$ 9.60% 13.85% 11.39% 2.99% 9.55% 28.43% 21.07% 3.68% 1.07 96% 66%

24.14$ 11.90$ 1.18$ 1.27$ 8.68% 13.16% 12.14% 2.95% 9.57% 27.58% 22.43% 3.75% 0.99 96% 67%

E Ace Limited 35.21$ 11.23x 1.10x 1.19x 16.10% 20.33% 11.90% 3.59% 10.53% 11.33% 20.50% 3.26% 0.88 87.70% 58.40%

Industry SpecificValuation Multiples Profitability

erage

edian

Margin Analysis

Price/Book


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AppendixACE Initiating Coverage Report

ACE vs. Comp Index (CB, ALL, TRV, CINF)10 yr. Historical Average

ACE vs. Comps (CB, ALL, TRV, CINF)10 yr. Historical Average

S&P P&C vs S&P Financials5 yr. Historical Average


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T h e W i l l i a m C . D u n k e l b e r g O w l F u n d Page

Spread Ratio


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DISCLAIMER

This report is prepared strictly for educational purposes and should not be used as an actual investment guide.

The forward looking statements contained within are simply the authors opinions. The writer does not own any

ACE Limited stock.

TUIA STATEMENT

Established in honor of Professor William C. Dunkelberg, former Dean of the Fox School of Business, for his

tireless dedication to educating students in real-world principles of economics and business, the William C.

Dunkelberg (WCD) Owl Fund will ensure that future generations of students have exposure to a challenging,

practical learning experience. Managed by Fox School of Business graduate and undergraduate students withoversight from its Board of Directors, the WCD Owl Funds goals are threefold:

Provide students with hands-on investment management experience

Enable students to work in a team-based setting in consultation with investment professionals.

Connect student participants with nationally recognized money managers and financial institutions

Earnings from the fund will be reinvested net of fund expenses, which are primarily trading and auditing costsand partial scholarships for student participants.

Documents

ACE InitiatingCoverage