Fair value of financial assets and financial liabilities is estimated based on the framework established in the fair value accounting guidance. The guidance defines fair value as the price to sell an asset or transfer a liability in an orderly transaction between market participants and establishes a three-level valuation hierarchy in which inputs into valuation techniques used to measure fair value are classified. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. The three levels of the hierarchy are as follows:

We categorize financial instruments within the valuation hierarchy at the balance sheet date based upon the lowest level of inputs that are significant to the fair value measurement. Accordingly, transfers between levels within the valuation hierarchy occur when there are significant changes to the inputs, such as increases or decreases in market activity, changes to the availability of current prices, changes to the transparency to underlying inputs, and whether there are significant variances in quoted prices. Transfers in and/or out of any level are assumed to occur at the end of the period.

We use one or more pricing services to obtain fair value measurements for the majority of the investment securities we hold. Based on management's understanding of the methodologies used by these pricing services, all applicable investments have been valued in accordance with GAAP. The following is a description of the valuation techniques and inputs used to determine fair value for financial instruments carried at fair value, as well as the general classification of such financial instruments pursuant to the valuation hierarchy.

We use pricing services to estimate fair value measurements for the majority of our fixed maturities. The pricing services use market quotations for fixed maturities that have quoted prices in active markets; such securities are classified within Level 1. For fixed maturities other than U.S. Treasury securities that generally do not trade on a daily basis, the pricing services prepare estimates of fair value measurements using their pricing applications, which include available relevant market information, benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing. Additional valuation factors that may be taken into account are nominal spreads, dollar basis, and liquidity adjustments. The pricing services evaluate each asset class based on relevant market and credit information, perceived market movements, and sector news. The market inputs used in the pricing evaluation, listed in the approximate order of priority include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. The extent of the use of each input is dependent on the asset class and the market conditions. Additionally, given the asset class, the priority of the use of inputs may change or some market inputs may not be relevant. The overwhelming majority of fixed maturities are classified within Level 2 because the most significant inputs used in the pricing techniques are observable. Fixed maturities for which pricing is unobservable are classified within Level 3.

Equity securities with active markets are classified within Level 1 as fair values are based on quoted market prices. For non-public equity securities, fair values are based on market valuations and are classified within Level 2. Equity securities for which pricing is unobservable are classified within Level 3.

Short-term investments, which comprise securities due to mature within one year of the date of purchase that are traded in active markets, are classified within Level 1 as fair values are based on quoted market prices. Securities such as commercial paper and discount notes are classified within Level 2 because these securities are typically not actively traded due to their approaching maturity and, as such, their cost approximates par value.

Fair values for the majority of Other investments including investments in partially-owned investment companies, investment funds, and limited partnerships are based on their respective net asset values or equivalent (NAV). The majority of these investments, for which NAV was used as a practical expedient to measure fair value, are classified within Level 3 because either ACE will never have the contractual option to redeem the investment or will not have the contractual option to redeem the investments in the near term. The remainder of such investments are classified within Level 2. Equity securities and fixed maturities held in rabbi trusts maintained by ACE for deferred compensation plans as well as other portfolios, and included in Other investments, are classified within the valuation hierarchy on the same basis as other equity securities and fixed maturities.

The underlying assets included in Securities lending collateral are fixed maturities which are classified in the valuation hierarchy on the same basis as other fixed maturities. Excluded from the valuation hierarchy is the corresponding liability related to ACE's obligation to return the collateral plus interest.

Actively traded investment derivative instruments, including futures, options, and exchange-traded forward contracts are classified within Level 1 as fair values are based on quoted market prices.

The liability for Guaranteed Living Benefits (GLB) arises from life reinsurance programs covering living benefit guarantees whereby we assume the risk of Guaranteed Minimum Income Benefits (GMIB) and Guaranteed Minimum Accumulation Benefits (GMAB) associated with variable annuity contracts. For GLB reinsurance, ACE estimates fair value using an internal valuation model which includes current market information and estimates of policyholder behavior. All of the treaties contain claim limits, which are factored into the valuation model. The fair value depends on a number of inputs, including changes in interest rates, changes in equity markets, credit risk, current account value, changes in market volatility, expected annuitization rates, changes in policyholder behavior, and changes in policyholder mortality.

The most significant policyholder behavior assumptions include lapse rates and the GMIB annuitization rates. Assumptions regarding lapse rates and GMIB annuitization rates differ by treaty but the underlying methodologies to determine rates applied to each treaty are comparable. The assumptions regarding lapse and GMIB annuitization rates determined for each treaty are based on a dynamic calculation that uses several underlying factors.

A lapse rate is the percentage of in-force policies surrendered in a given calendar year. All else equal, as lapse rates increase, ultimate claim payments will decrease. In general, the base lapse function assumes low lapse rates (ranging from about 1 percent to 6 percent per annum) during the surrender charge period of the GMIB contract, followed by a “spike” lapse rate (ranging from about 10 percent to 30 percent per annum) in the year immediately following the surrender charge period, and then reverting to an ultimate lapse rate (generally around 10 percent per annum), typically over a 2-year period. This base rate is adjusted downward for policies with more valuable guarantees (policies with guaranteed values far in excess of their account values) by multiplying the base lapse rate by a factor ranging from 15 percent to 75 percent. Additional lapses due to partial withdrawals and older policyholders with tax-qualified contracts (due to required minimum distributions) are also included.

The GMIB annuitization rate is the percentage of policies for which the policyholder will elect to annuitize using the guaranteed benefit provided under the GMIB. All else equal, as GMIB annuitization rates increase, ultimate claim payments will increase, subject to treaty claim limits. In general ACE assumes that GMIB annuitization rates will be higher for policies with more valuable guarantees (policies with guaranteed values far in excess of their account values). In addition, we also assume that GMIB annuitization rates are higher in the first year immediately following the waiting period (the first year the policies are eligible to annuitize using the GMIB) in comparison to all subsequent years. We do not yet have a robust set of annuitization experience because most of our clients' policyholders are not yet eligible to annuitize using the GMIB. However, for certain clients there are several years of annuitization experience. For these clients the annuitization function reflects the actual experience and has a maximum annuitization rate per annum of 8 percent (a higher maximum applies in the first year a policy is eligible to annuitize using the GMIB - it is over 13 percent). For most clients, there is no currently observable relevant annuitization behavior data and so we use a weighted-average (with a heavier weighting on the observed experience noted previously) of three different annuitization functions with maximum annuitization rates per annum of 8 percent, 12 percent, and 30 percent, respectively (with significantly higher rates in the first year a policy is eligible to annuitize using the GMIB). The GMIB reinsurance treaties include claim limits to protect ACE in the event that actual annuitization behavior is significantly higher than expected.

The effect of changes in key market factors on assumed lapse and annuitization rates reflect emerging trends using data available from cedants. For treaties with limited experience, rates are established in line with data received from other ceding companies adjusted as appropriate with industry estimates. The model and related assumptions are continuously re-evaluated by management and enhanced, as appropriate, based upon additional experience obtained related to policyholder behavior and availability of more information, such as market conditions, market participant assumptions, and demographics of in-force annuities. Based on our first and second quarter 2011 review, no changes were made to actuarial or behavior assumptions. We made minor technical refinements to the model with a favorable net income impact of approximately $0.3 million and $6.3 million for the three and six months ended June 30, 2011, respectively.

We view the variable annuity reinsurance business as having a similar risk profile to that of catastrophe reinsurance, with the probability of a cumulative long-term economic net loss relatively small at the time of pricing. However, adverse changes in market factors and policyholder behavior will have an adverse impact on net income, which may be material. Because of the significant use of unobservable inputs including policyholder behavior, GLB reinsurance is classified within Level 3.

We maintain positions in other derivative instruments including exchange-traded equity futures contracts and option contracts designed to limit exposure to a severe equity market decline, which would cause an increase in expected claims and, therefore, reserves for Guaranteed Minimum Death Benefits (GMDB) and GLB reinsurance business. Our position in exchange-traded equity futures contracts is classified within Level 1. The fair value of the majority of the remaining positions in other derivative instruments is based on significant observable inputs including equity security and interest rate indices. Accordingly, these are classified within Level 2. Our position in credit default swaps is typically included within Level 3.

The following tables present, by valuation hierarchy, the financial instruments measured at fair value on a recurring basis:

	Level 1		Level 2		Level 3		Total

	(in millions of U.S. dollars)
June 30, 2011
Assets:
Fixed maturities available for sale
U.S. Treasury and agency	$	1,245	$	1,250	$	-	$	2,495
Foreign		207		12,445		27		12,679
Corporate securities		43		14,328		142		14,513
Mortgage-backed securities		-		9,977		34		10,011
States, municipalities, and political subdivisions		-		1,339		1		1,340
		1,495		39,339		204		41,038

Equity securities		567		5		10		582
Short-term investments		1,266		1,114		-		2,380
Other investments		239		237		1,680		2,156
Securities lending collateral		-		1,593		-		1,593
Investment derivative instruments		3		-		-		3
Other derivative instruments		(37)		41		4		8
Total assets measured at fair value	$	3,533	$	42,329	$	1,898	$	47,760

Liabilities:
GLB⁽¹⁾	$	-	$	-	$	524	$	524

⁽¹⁾Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as future policy benefits in the consolidated balance sheets. Refer to Note 6 for additional information.

	Level 1		Level 2		Level 3		Total

	(in millions of U.S. dollars)
December 31, 2010
Assets:
Fixed maturities available for sale
U.S. Treasury and agency	$	1,564	$	1,399	$	-	$	2,963
Foreign		187		10,973		26		11,186
Corporate securities		31		13,441		115		13,587
Mortgage-backed securities		-		8,477		39		8,516
States, municipalities, and political subdivisions		-		1,285		2		1,287
		1,782		35,575		182		37,539

Equity securities		676		3		13		692
Short-term investments		903		1,080		-		1,983
Other investments		39		221		1,432		1,692
Securities lending collateral		-		1,495		-		1,495
Investment derivative instruments		11		-		-		11
Other derivative instruments		(25)		46		4		25
Total assets measured at fair value	$	3,386	$	38,420	$	1,631	$	43,437

Liabilities:
GLB⁽¹⁾	$	-	$	-	$	507	$	507

⁽¹⁾Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as future policy benefits in the consolidated balance sheets. Refer to Note 6 for additional information.

There were no significant gross transfers between Level 1 and Level 2 during the three and six months ended June 30, 2011 and 2010.

Included in Other investments in the fair value hierarchy at June 30, 2011 and December 31, 2010 are investment funds, limited partnerships, and partially-owned investment companies measured at fair value using NAV as a practical expedient. At June 30, 2011 and December 31, 2010, there were no probable or pending sales related to any of the investments measured at fair value using NAV.

The following table presents, by investment category, the fair value and maximum future funding commitments related to these investments. The table also shows the expected liquidation period from June 30, 2011.

Included in all categories in the above table except for Investment funds are investments for which ACE will never have the contractual option to redeem but receives distributions based on the liquidation of the underlying assets. Included in the “Expected Liquidation Period” column above is the range in years over which ACE expects the majority of underlying assets in the respective categories to be liquidated. Further, for all categories except for Investment funds, ACE does not have the ability to sell or transfer the investments without the consent from the general partner of individual funds.

Financial consists of investments in private equity funds targeting financial services companies such as financial institutions and insurance services around the world.

Real estate consists of investments in private equity funds targeting global distress opportunities, value added U.S. properties, and global mezzanine debt securities in the commercial real estate market.

Distressed consists of investments in private equity funds targeting distressed debt/credit and equity opportunities in the U.S.

Mezzanine consists of investments in private equity funds targeting private mezzanine debt of large-cap and mid-cap companies in the U.S. and worldwide.

Traditional consists of investments in private equity funds employing traditional private equity investment strategies such as buyout and venture with different geographical focuses including Brazil, Asia, Europe, and the U.S.

Vintage consists of investments in private equity funds made before 2002 and where the funds' commitment periods had already expired.

ACE's investment funds employ various investment strategies such as long/short equity and arbitrage/distressed. Included in this category are investments for which ACE has the option to redeem at agreed upon value as described in each investment fund's subscription agreement. Depending on the terms of the various subscription agreements, investment fund investments may be redeemed monthly, quarterly, semi-annually, or annually. If ACE wishes to redeem an investment fund investment, it must first determine if the investment fund is still in a lock-up period (a time when ACE cannot redeem its investment so that the investment fund manager has time to build the portfolio). If the investment fund is no longer in its lock-up period, ACE must then notify the investment fund manager of its intention to redeem by the notification date prescribed by the subscription agreement. Subsequent to notification, the investment fund can redeem ACE's investment within several months of the notification. Notice periods for redemption of the investment funds range between 5 and 120 days. ACE can redeem its investment funds without consent from the investment fund managers.

The following tables present a reconciliation of the beginning and ending balances of financial instruments measured at fair value using significant unobservable inputs (Level 3):

		Three Months Ended June 30, 2011
	Assets														Liabilities
		Available-for-Sale Debt Securities
	Foreign		Corporate securities		Mortgage-backed securities		States, municipalities, and political subdivisions		Equity securities		Other investments		Other derivative instruments		GLB⁽¹⁾
		(in millions of U.S. dollars)
Balance- Beginning of Period	$	26	$	113	$	81	$	1	$	10	$	1,564	$	4	$	449
Transfers into Level 3		5		29		3		-		-		-		-		-
Transfers out of Level 3		(6)		-		(35)		-		-		-		-		-
Change in Net Unrealized Gains (Losses) included in OCI		-		-		-		-		-		9		-		-
Net Realized Gains/Losses		1		(1)		-		-		2		(3)		-		75
Purchases		5		3		-		-		2		243		-		-
Issuances		-		-		-		-		-		-		-		-
Sales		(2)		(1)		(12)		-		(4)		(55)		-		-
Settlements		(2)		(1)		(3)		-		-		(78)		-		-
Balance-End of Period	$	27	$	142	$	34	$	1	$	10	$	1,680	$	4	$	524

Net Realized Gains/Losses Attributable to Changes in Fair Value at the Balance Sheet Date	$	-	$	-	$	-	$	-	$	-	$	(3)	$	-	$	75
⁽¹⁾Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as future policy benefits in the consolidated balance sheets. Refer to Note 6 for additional information.

		Three Months Ended June 30, 2010
	Assets														Liabilities
		Available-for-Sale Debt Securities
	Foreign		Corporate securities		Mortgage-backed securities		States, municipalities, and political subdivisions		Equity securities		Other investments		Other derivative instruments		GLB⁽¹⁾
		(in millions of U.S. dollars)
Balance-Beginning of Period	$	21	$	133	$	12	$	2	$	13	$	1,236	$	14	$	347
Transfers into (Out of) Level 3		6		-		-		-		-		-		-		-
Change in Net Unrealized Gains (Losses) included in OCI		1		3		-		-		(1)		14		-		-
Net Realized Gains/Losses		-		(1)		-		-		1		(14)		12		301
Purchases, Sales, Issuances, and Settlements, Net		-		(14)		-		1		3		(9)		(12)
Balance- End of Period	$	28	$	121	$	12	$	3	$	16	$	1,227	$	14	$	648

Net Realized Gains/Losses Attributable to Changes in Fair Value at the Balance Sheet Date	$	-	$	-	$	-	$	-	$	-	$	(14)	$	12	$	301
⁽¹⁾Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as future policy benefits in the consolidated balance sheets. The liability for GLB reinsurance was $776 million at June 30, 2010, and $469 million at March 31, 2010, which includes a fair value derivative adjustment of $648 million and $347 million, respectively.

		Six Months Ended June 30, 2011
	Assets														Liabilities
		Available-for-Sale Debt Securities
	Foreign		Corporate securities		Mortgage-backed securities		States, municipalities, and political subdivisions		Equity securities		Other investments		Other derivative instruments		GLB⁽¹⁾
		(in millions of U.S. dollars)
Balance-Beginning of Period	$	26	$	115	$	39	$	2	$	13	$	1,432	$	4		507
Transfers into Level 3		9		34		4		-		-		-		-		-
Transfers out of Level 3		(7)		(4)		(35)		-		-		-		-		-
Change in Net Unrealized Gains (Losses) included in OCI		(1)		1		-		-		(1)		51		-		-
Net Realized Gains/Losses		1		(2)		-		-		4		(3)		1		17
Purchases		5		22		46		-		2		333		-		-
Sales		(3)		(20)		(15)		-		(8)		(55)		-		-
Settlements		(3)		(4)		(5)		(1)		-		(78)		(1)		-
Balance-End of Period	$	27	$	142	$	34	$	1	$	10	$	1,680	$	4	$	524

Net Realized Gains/Losses Attributable to Changes in Fair Value at the Balance Sheet Date	$	-	$	-	$	-	$	-	$	-	$	(3)	$	1	$	17
⁽¹⁾Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as future policy benefits in the consolidated balance sheets. Refer to Note 6 for additional information.

		Six Months Ended June 30, 2010
	Assets														Liabilities
		Available-for-Sale Debt Securities
	Foreign		Corporate securities		Mortgage-backed securities		States, municipalities, and political subdivisions		Equity securities		Other investments		Other derivative instruments		GLB⁽¹⁾
		(in millions of U.S. dollars)
Balance- Beginning of Period	$	59	$	168	$	21	$	3	$	12	$	1,149	$	14	$	443
Transfers into (Out of) Level 3		(31)		(35)		-		-		-		-		-		-
Change in Net Unrealized Gains (Losses) included in OCI		1		6		-		-		-		33		-		-
Net Realized Gains/Losses		(1)		(1)		-		-		1		(13)		12		205
Purchases, Sales, Issuances, and Settlements, Net		-		(17)		(9)		-		3		58		(12)
Balance- End of Period	$	28	$	121	$	12	$	3	$	16	$	1,227	$	14	$	648

Net Realized Gains/Losses Attributable to Changes in Fair Value at the Balance Sheet Date	$	-	$	-	$	-	$	-	$	-	$	(13)	$	12	$	205
⁽¹⁾Our GLB reinsurance product meets the definition of a derivative instrument for accounting purposes and is accordingly carried at fair value. Excluded from the table above is the portion of the GLB derivative liability classified as future policy benefits. The liability for GLB reinsurance was $776 million at June 30, 2010, and $559 million at December 31, 2009, which includes a fair value derivative adjustment of $648 million and $443 million, respectively.

ACE uses various financial instruments in the normal course of its business. Our insurance contracts are excluded from fair value of financial instruments accounting guidance, and therefore excluded from the discussion below.

The carrying values of cash, other assets, other liabilities, and other financial instruments not included below approximated their fair values.

Fair values for investments in partially-owned insurance companies are based on ACE's share of the net assets based on the financial statements provided by those companies.

Where practical, fair values for short-term debt, long-term debt, and trust preferred securities are estimated using discounted cash flow calculations based principally on observable inputs including incremental borrowing rates, which reflect ACE's credit rating, for similar types of borrowings with maturities consistent with those remaining for the debt being valued.

The following table presents carrying values and fair values of financial instruments not measured at fair value:

			June 30, 2011				December 31, 2010
			Carrying Value		Fair Value		Carrying Value		Fair Value
			(in millions of U.S. dollars)
Assets:
Fixed maturities held to maturity
U.S. Treasury and agency		$	1,067	$	1,092	$	1,105	$	1,127
Foreign			1,051		1,028		1,049		1,013
Corporate securities			2,311		2,292		2,361		2,313
Mortgage-backed securities			3,414		3,472		3,811		3,846
States, municipalities, and political subdivisions			1,190		1,194		1,175		1,162
	Total assets		9,033		9,078		9,501		9,461
Liabilities:
Short-term debt			1,400		1,400		1,300		1,300
Long-term debt			3,360		3,719		3,358		3,846
Trust preferred securities			309		385		309		376
	Total liabilities	$	5,069	$	5,504	$	4,967	$	5,522