ACGL Arch Capital Group Ltd

Arch Capital Group Ltd. (NASDAQ: ACGL) reports that net income available to common shareholders for the 2007 second quarter was $199.4 million, or $2.65 per share, compared to $137.8 million, or $1.81 per share, for the 2006 second quarter, and $397.9 million, or $5.24 per share, for the six months ended June 30, 2007, compared to $267.5 million, or $3.52 per share, for the 2006 period. The Company also reported after-tax operating income available to common shareholders of $209.0 million, or $2.78 per share, for the 2007 second quarter, compared to $171.0 million, or $2.24 per share, for the 2006 second quarter, and $416.4 million, or $5.48 per share, for the six months ended June 30, 2007, compared to $314.1 million, or $4.13 per share, for the 2006 period. The Company�s after-tax operating income available to common shareholders represented a 24.5% annualized return on average common equity for the 2007 second quarter, compared to 26.1% for the 2006 second quarter, and 25.1% for the six months ended June 30, 2007, compared to 24.3% for the 2006 period. After-tax operating income available to common shareholders, a non-GAAP measure, is defined as net income available to common shareholders, excluding net realized gains or losses and net foreign exchange gains or losses, net of income taxes. See page 6 for a further discussion of after-tax operating income available to common shareholders and Regulation G. The Company�s book value per common share, including the effects of share repurchases, increased to $47.41 at June 30, 2007 from $43.97 per share at December 31, 2006. Gross and net premiums written for the 2007 second quarter were $1.10 billion and $757.9 million, respectively, compared to $1.14 billion and $794.6 million, respectively, for the 2006 second quarter, and $2.31 billion and $1.63 billion, respectively, for the six months ended June 30, 2007, compared to $2.30 billion and $1.67 billion, respectively, for the 2006 period. The Company�s combined ratio was 84.1% for the 2007 second quarter, compared to 86.3% for the 2006 second quarter, and 83.9% for the six months ended June 30, 2007, compared to 87.2% for the 2006 period. All per share amounts discussed in this release are on a diluted basis. The following table summarizes the Company�s underwriting results: (Unaudited) (Unaudited) Three Months Ended Six Months Ended June 30, June 30, (U.S. dollars in thousands) 2007 2006 2007 2006 � Gross premiums written $1,102,210 $1,136,274 $2,312,824 $2,304,088 Net premiums written 757,895 794,558 1,629,640 1,668,277 Net premiums earned 751,412 797,450 1,496,905 1,559,051 Underwriting income 120,295 112,214 244,893 202,442 � Combined ratio 84.1% 86.3% 83.9% 87.2% The following table summarizes, on an after-tax basis, the Company�s consolidated financial data, including a reconciliation of after-tax operating income available to common shareholders to net income available to common shareholders and related diluted per share results: (Unaudited) (Unaudited) Three Months Ended Six Months Ended June 30, June 30, (U.S. dollars in thousands, except per share data) 2007 2006 2007 2006 After-tax operating income available to common shareholders $209,002 $171,036 $416,374 $314,117 Net realized losses, net of tax (2,791 ) (31,458 ) (2,005 ) (34,370 ) Net foreign exchange losses, net of tax (6,817 ) (1,730 ) (16,424 ) (12,276 ) Net income available to common shareholders $199,394 � $137,848 � $397,945 � $267,471 � � Diluted per common share results: After-tax operating income available to common shareholders $2.78 $2.24 $5.48 $4.13 Net realized losses, net of tax (0.04 ) (0.41 ) (0.03 ) (0.45 ) Net foreign exchange losses, net of tax (0.09 ) (0.02 ) (0.21 ) (0.16 ) Net income available to common shareholders $2.65 � $1.81 � $5.24 � $3.52 � � Weighted average common shares and common share equivalents outstanding � diluted 75,254,846 76,155,438 75,947,858 76,014,819 The combined ratio represents a measure of underwriting profitability, excluding investment income, and is the sum of the loss ratio and expense ratio. A combined ratio under 100% represents an underwriting profit and a combined ratio over 100% represents an underwriting loss. The combined ratio of the Company�s insurance and reinsurance subsidiaries consisted of a loss ratio of 56.6% and an underwriting expense ratio of 27.5% for the 2007 second quarter, compared to a loss ratio of 58.0% and an underwriting expense ratio of 28.3% for the 2006 second quarter. The combined ratio of the Company�s insurance and reinsurance subsidiaries consisted of a loss ratio of 56.5% and an underwriting expense ratio of 27.4% for the six months ended June 30, 2007, compared to a loss ratio of 59.7% and an underwriting expense ratio of 27.5% for the 2006 period. The loss ratio of 56.6% for the 2007 second quarter was comprised of 34.4 points of paid losses, 7.6 points related to reserves for reported losses and 14.6 points related to incurred but not reported reserves. In establishing the reserves for losses and loss adjustment expenses, the Company has made various assumptions relating to the pricing of its reinsurance contracts and insurance policies and also has considered available historical industry experience and current industry conditions. The Company�s reserving method to date has been, to a large extent, the expected loss method, which is commonly applied when limited loss experience exists. Any estimates and assumptions made as part of the reserving process could prove to be inaccurate due to several factors, including the fact that limited historical information has been reported to the Company through June 30, 2007. For a discussion of underwriting activities and a review of the Company�s results by operating segment, see �Segment Information� in the Supplemental Financial Information section of this release. Consolidated cash flow provided by operating activities for the 2007 second quarter was $273.9 million, compared to $400.0 million for the 2006 second quarter, and $677.0 million for the six months ended June 30, 2007, compared to $823.2 million for the 2006 period. The lower level of operating cash flows in the 2007 periods primarily resulted from a higher level of payments by the Company�s reinsurance operations to Flatiron Re Ltd. and an increase in paid losses as the Company�s insurance and reinsurance loss reserves have continued to mature. Net investment income was $117.3 million for the 2007 second quarter, compared to $90.5 million for the 2006 second quarter, and $230.0 million for the six months ended June 30, 2007, compared to $170.8 million for the 2006 period. The increase in net investment income in the 2007 periods primarily resulted from a higher level of average invested assets and an increase in the pre-tax investment income yield to 4.99% for the 2007 second quarter, compared to 4.53% for the 2006 second quarter, and 4.97% for the six months ended June 30, 2007, compared to 4.44% for the 2006 period. The Company�s investment portfolio, which mainly consists of high quality fixed income securities, had an average Standard & Poor�s quality rating of �AA+� at June 30, 2007, compared to �AAA� at December 31, 2006. The average effective duration of the Company�s investment portfolio was 3.3 years at June 30, 2007, compared to 3.2 years at December 31, 2006. For the 2007 second quarter, the effective tax rates on income before income taxes and pre-tax operating income were 2.8% and 3.0%, respectively, compared to 9.1% and 7.6%, respectively, for the 2006 second quarter. For the six months ended June 30, 2007, the effective tax rates on income before income taxes and pre-tax operating income were 3.4% and 3.8%, respectively, compared to 8.6% and 7.5%, respectively, for the 2006 period. The reduction in the effective tax rate on pre-tax operating income available to common shareholders in the 2007 periods, compared to the 2006 periods, primarily resulted from a change in the relative mix of income reported by jurisdiction. The Company�s effective tax rates may fluctuate from period to period based on the relative mix of income reported by jurisdiction primarily due to the varying tax rates in each jurisdiction. The Company�s quarterly tax provision is adjusted to reflect changes in its expected annual effective tax rates, if any. As noted above, during the 2007 second quarter, the Company reduced its estimated annual effective tax rate on pre-tax operating income. The impact of applying the lower effective tax rate on pre-tax operating income for the 2007 first quarter increased the Company�s after-tax results for the 2007 second quarter by $2.2 million, or $0.03 per share. The Company currently expects that its annual effective tax rate on pre-tax operating income available to common shareholders for 2007 will be in the range of 3.0% to 5.0%. Net foreign exchange losses for the 2007 second quarter of $6.5 million consisted of net unrealized losses of $5.9 million and net realized losses of $0.6 million, compared to net foreign exchange losses for the 2006 second quarter of $1.1 million, which consisted of net unrealized losses of $0.1 million and net realized losses of $1.0 million. Net foreign exchange losses for the six months ended June 30, 2007 of $16.2 million consisted of net unrealized losses of $23.1 million and net realized gains of $6.9 million, compared to net foreign exchange losses for the 2006 period of $11.4 million, which consisted of net unrealized losses of $8.0 million and net realized losses of $3.4 million. Net unrealized foreign exchange gains or losses result from the effects of revaluing the Company�s net insurance liabilities required to be settled in foreign currencies at each balance sheet date. The Company holds investments in foreign currencies which are intended to mitigate its exposure to foreign currency fluctuations in its net insurance liabilities. However, changes in the value of such investments due to foreign currency rate movements are reflected as a direct increase or decrease to shareholders� equity and are not included in the statement of income. Diluted weighted average common shares and common share equivalents outstanding, used in the calculation of after-tax operating income and net income per common share, were 75.3 million in the 2007 second quarter, compared to 76.2 million in the 2006 second quarter, and 75.9 million for the six months ended June 30, 2007, compared to 76.0 million in the 2006 period. The lower level of weighted average shares outstanding in the 2007 periods was primarily due to the weighted average impact of share repurchases as discussed below, partially offset by increases in the dilutive effects of stock options and nonvested restricted stock calculated using the treasury stock method and the exercise of stock options. Under the treasury stock method, the dilutive impact of options and nonvested stock on diluted weighted average shares outstanding increases as the market price of the Company�s common shares increases. On February 28, 2007, ACGL�s Board of Directors authorized the investment of up to $1 billion in ACGL�s common shares through a share repurchase program. Repurchases under the program may be effected from time to time in open market or privately negotiated transactions through February 2009. Through June 30, 2007, ACGL repurchased 3.6 million common shares under the share repurchase program for an aggregate purchase price of $255.0 million. As a result of share repurchase transactions, book value per common share was reduced by $1.10 per share at June 30, 2007 and weighted average shares outstanding for the 2007 second quarter and six months ended June 30, 2007 were reduced by 1.8 million and 1.0 million shares, respectively. The timing and amount of the repurchase transactions under this program will depend on a variety of factors, including market conditions and corporate and regulatory considerations. At June 30, 2007, the Company�s capital of $4.0 billion consisted of $300.0 million of senior notes, representing 7.5% of the total, $325.0 million of preferred shares, representing 8.1% of the total, and common shareholders� equity of $3.38 billion, representing the balance. The increase in the Company�s capital during 2007 of $113.4 million was primarily attributable to operating income for 2007, partially offset by $255.0 million of share repurchases during the period and an after-tax decrease in the fair value of the Company�s investment portfolio. The decrease in the fair value of the investment portfolio was primarily due to an increase in the level of interest rates in the 2007 second quarter. The Company will hold a conference call for investors and analysts at 11:00 a.m. Eastern Time on Thursday, July 26, 2007. A live webcast of this call will be available via the Media-Earnings Webcasts section of the Company's website at http://www.archcapgroup.bm and will be archived on the website from 1:00 p.m. Eastern Time on July 26 through midnight Eastern Time on August 26, 2007. A telephone replay of the conference call also will be available beginning on July 26 at 1:00 p.m. Eastern Time until August 2 at midnight Eastern Time. To access the replay, domestic callers should dial 888-286-8010 (passcode 34806733), and international callers should dial 617-801-6888 (passcode 34806733). Arch Capital Group Ltd., a Bermuda-based company with over $4.0 billion in capital at June 30, 2007, provides insurance and reinsurance on a worldwide basis through its wholly owned subsidiaries. Cautionary Note Regarding Forward-Looking Statements The Private Securities Litigation Reform Act of 1995 provides a �safe harbor� for forward-looking statements. This release or any other written or oral statements made by or on behalf of the Company may include forward-looking statements, which reflect the Company�s current views with respect to future events and financial performance. All statements other than statements of historical fact included in this release are forward-looking statements. Forward-looking statements can generally be identified by the use of forward-looking terminology such as �may,� �will,� �expect,� �intend,� �estimate,� �anticipate,� �believe� or �continue� or their negative or variations or similar terminology. Forward-looking statements involve the Company�s current assessment of risks and uncertainties. Actual events and results may differ materially from those expressed or implied in these statements. Important factors that could cause actual events or results to differ materially from those indicated in such statements are discussed below and elsewhere in this release and in the Company�s periodic reports filed with the Securities and Exchange Commission (the �SEC�), and include: the Company�s ability to successfully implement its business strategy during �soft� as well as �hard� markets; acceptance of the Company�s business strategy, security and financial condition by rating agencies and regulators, as well as by brokers and its insureds and reinsureds; the Company�s ability to maintain or improve its ratings, which may be affected by its ability to raise additional equity or debt financings, by ratings agencies� existing or new policies and practices, as well as other factors described herein; general economic and market conditions (including inflation, interest rates and foreign currency exchange rates) and conditions specific to the reinsurance and insurance markets in which the Company operates; competition, including increased competition, on the basis of pricing, capacity, coverage terms or other factors; the Company�s ability to successfully integrate, establish and maintain operating procedures (including the implementation of improved computerized systems and programs to replace and support manual systems) to effectively support its underwriting initiatives and to develop accurate actuarial data, especially in light of the rapid growth of its business; the loss of key personnel; the integration of businesses the Company has acquired or may acquire into its existing operations; accuracy of those estimates and judgments utilized in the preparation of the Company�s financial statements, including those related to revenue recognition, insurance and other reserves, reinsurance recoverables, investment valuations, intangible assets, bad debts, income taxes, contingencies and litigation, and any determination to use the deposit method of accounting, which for a relatively new insurance and reinsurance company, like the Company, are even more difficult to make than those made in a mature company since limited historical information has been reported to the Company through June 30, 2007; greater than expected loss ratios on business written by the Company and adverse development on claim and/or claim expense liabilities related to business written by its insurance and reinsurance subsidiaries; severity and/or frequency of losses; claims for natural or man-made catastrophic events in the Company�s insurance or reinsurance business could cause large losses and substantial volatility in its results of operations; acts of terrorism, political unrest and other hostilities or other unforecasted and unpredictable events; losses relating to aviation business and business produced by a certain managing underwriting agency for which the Company may be liable to the purchaser of its prior reinsurance business or to others in connection with the May�5, 2000 asset sale described in the Company�s periodic reports filed with the SEC; availability to the Company of reinsurance to manage its gross and net exposures and the cost of such reinsurance; the failure of reinsurers, managing general agents, third party administrators or others to meet their obligations to the Company; the timing of loss payments being faster or the receipt of reinsurance recoverables being slower than anticipated by the Company; material differences between actual and expected assessments for guaranty funds and mandatory pooling arrangements; changes in accounting principles or policies or in the Company�s application of such accounting principles or policies; and statutory or regulatory developments, including as to tax policy and matters and insurance and other regulatory matters such as the adoption of proposed legislation that would affect Bermuda-headquartered companies and/or Bermuda-based insurers or reinsurers and/or changes in regulations or tax laws applicable to the Company, its subsidiaries, brokers or customers. In addition, other general factors could affect the Company�s results, including�developments in the world�s financial and capital markets and its access to such markets. All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by these cautionary statements. The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with other cautionary statements that are included herein or elsewhere. The Company undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. Comment on Regulation G Throughout this release, the Company presents its operations in the way it believes will be the most meaningful and useful to investors, analysts, rating agencies and others who use the Company�s financial information in evaluating the performance of the Company. This presentation includes the use of after-tax operating income available to common shareholders, which is defined as net income available to common shareholders, excluding net realized gains or losses and net foreign exchange gains or losses, net of income taxes. The presentation of after-tax operating income available to common shareholders is a �non-GAAP financial measure� as defined in Regulation G. The reconciliation of such measure to net income available to common shareholders (the most directly comparable GAAP financial measure) in accordance with Regulation G is included on page 2 of this release. The Company believes that net realized gains or losses and net foreign exchange gains or losses in any particular period are not indicative of the performance of, or trends in, the Company�s business performance. Although net realized gains or losses and net foreign exchange gains or losses are an integral part of the Company�s operations, the decision to realize investment gains or losses and the recognition of foreign exchange gains or losses are independent of the insurance underwriting process and result, in large part, from general economic and financial market conditions. Furthermore, certain users of the Company�s financial information believe that, for many companies, the timing of the realization of investment gains or losses is largely opportunistic, and, under applicable GAAP accounting, losses on the Company�s investments can be realized as the result of other-than-temporary declines in value without actual realization. Due to these reasons, the Company excludes net realized gains or losses and net foreign exchange gains or losses from the calculation of after-tax operating income available to common shareholders. The Company believes that showing net income available to common shareholders exclusive of the items referred to above reflects the underlying fundamentals of the Company�s business since the Company evaluates the performance of and manages its business to produce an underwriting profit. In addition to presenting net income available to common shareholders, the Company believes that this presentation enables investors and other users of the Company�s financial information to analyze the Company�s performance in a manner similar to how the Company�s management analyzes performance. The Company also believes that this measure follows industry practice and, therefore, allows the users of the Company�s financial information to compare the Company�s performance with its industry peer group. The Company believes that the equity analysts and certain rating agencies which follow the Company and the insurance industry as a whole generally exclude these items from their analyses for the same reasons. ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES SUPPLEMENTAL FINANCIAL INFORMATION � Selected Information on Losses and Loss Adjustment Expenses � (Unaudited) (Unaudited) Three Months Ended Six Months Ended June 30, June 30, (U.S. dollars in thousands) 2007 2006 2007 2006 � Components of losses and loss adjustment expenses Paid losses and loss adjustment expenses $258,505 $260,175 $532,873 $481,229 Increase in unpaid losses and loss adjustment expenses 167,158 � 202,080 � 312,851 � 449,204 � Total losses and loss adjustment expenses $425,663 � $462,255 � $845,724 � $930,433 � � Estimated net (favorable) adverse development in prior year loss reserves, net of related adjustments Insurance $3,922 ($14,805 ) $6,848 ($6,883 ) Reinsurance (36,076 ) (3,317 ) (82,303 ) (4,827 ) Total ($32,154 ) ($18,122 ) ($75,455 ) ($11,710 ) � Impact on combined ratio: Insurance 0.9 % (3.8 %) 0.8 % (0.9 %) Reinsurance (11.3 %) (0.8 %) (12.7 %) (0.6 %) Total (4.3 %) (2.3 %) (5.0 %) (0.8 %) � Estimated net losses incurred from current period catastrophic events (1) Insurance � � � � Reinsurance $12,100 � $11,352 � $27,858 � $27,628 � Total $12,100 � $11,352 � $27,858 � $27,628 � � Impact on loss ratio: Insurance � � � � Reinsurance 3.8 % 2.8 % 4.3 % 3.5 % Total 1.6 % 1.4 % 1.9 % 1.8 % (1) Equals estimated losses from catastrophic events occurring in the current accident year, net of reinsurance and reinstatement premiums. Amounts shown for the insurance segment are for named catastrophic events only. Amounts shown for the reinsurance segment include (i) named events with over $5 million of losses incurred by its Bermuda operations and (ii) all catastrophe losses incurred by its U.S. operations. Annualized Operating Return on Average Common Equity � (Unaudited) (Unaudited) Three Months Ended Six Months Ended June 30, June 30, (U.S. dollars in thousands) 2007 2006 2007 2006 � After-tax operating income available to common shareholders $209,002 $171,036 $416,374 $314,117 Annualized operating income available to common shareholders 836,008 684,144 832,748 628,234 � Beginning common shareholders� equity 3,458,348 2,549,554 3,265,619 2,480,527 Ending common shareholders� equity 3,379,067 2,690,780 3,379,067 2,690,780 Average common shareholders� equity 3,418,708 2,620,167 3,322,343 2,585,654 � Annualized operating return on average common equity 24.5% 26.1% 25.1% 24.3% ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES SUPPLEMENTAL FINANCIAL INFORMATION � Investment Information � (Unaudited) (Unaudited) Three Months Ended Six Months Ended June 30, June 30, (U.S. dollars in thousands) 2007 2006 2007 2006 � Net investment income $117,299 $90,503 $229,988 $170,829 � Pre-tax investment income yield (at amortized cost) 4.99 % 4.53 % 4.97 % 4.44 % After-tax investment income yield (at amortized cost) 4.84 % 4.36 % 4.81 % 4.27 % � Cash flow from operations $273,872 $399,976 $677,003 $823,154 � (Unaudited) June 30, December 31, 2007 2006 � Investable assets: Total cash and investments (1) $9,830,698 $9,319,148 Securities transactions entered into but not settled at the balance sheet date (379,670 ) (227,941 ) Investable assets $9,451,028 � $9,091,207 � � Fixed income portfolio (1): Average effective duration (in years) 3.3 3.2 Average credit quality (Standard & Poors) AA+ AAA Imbedded book yield (2) 5.03 % 4.97 % (1) Includes fixed maturities pledged under securities lending agreements and excludes short-term investment of funds received under securities lending agreements. (2) Before investment expenses. Book Value Per Common Share and Share Repurchases � (Unaudited) June 30, December 31, (U.S. dollars in thousands, except share data) 2007 2006 � Calculation of book value per common share: � Total shareholders� equity $3,704,067 $3,590,619 Less preferred shareholders� equity (325,000 ) � (325,000 ) Common shareholders� equity 3,379,067 3,265,619 Common shares outstanding (1) 71,273,285 � 74,270,466 � Book value per common share $47.41 � $43.97 � � Effect of share repurchases during year-to-date period: Aggregate market price of shares repurchased $254,973 Shares repurchased 3,638,642 � Average market price per share repurchased $70.07 � Estimated dilutive impact on ending book value per common share (2) ($1.10 ) (1) Excludes the effects of 5,641,834 and 5,669,994 stock options and 118,537 and 91,514 restricted stock units outstanding at June 30, 2007 and December 31, 2006, respectively. (2) As the average price per share repurchased during the period exceeded the book value per common share at June 30, 2007, the repurchase of shares during the period reduced book value per common share. ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (U.S. dollars in thousands, except share data) � (Unaudited) (Unaudited) Three Months Ended Six Months Ended June 30, June 30, 2007 2006 2007 2006 Revenues Net premiums written $757,895 $794,558 $1,629,640 $1,668,277 (Increase) decrease in unearned premiums (6,483 ) 2,892 � (132,735 ) (109,226 ) Net premiums earned 751,412 797,450 1,496,905 1,559,051 Net investment income 117,299 90,503 229,988 170,829 Net realized losses (3,757 ) (32,202 ) (4,738 ) (35,585 ) Fee income 2,091 3,468 4,060 5,273 Other income 265 � � � 869 � � � Total revenues 867,310 � 859,219 � 1,727,084 � 1,699,568 � � Expenses Losses and loss adjustment expenses 425,663 462,255 845,724 930,433 Acquisition expenses 117,277 148,581 237,405 278,253 Other operating expenses 100,505 84,367 191,318 167,344 Interest expense 5,523 5,651 11,046 11,206 Net foreign exchange losses 6,450 � 1,146 � 16,192 � 11,399 � Total expenses 655,418 � 702,000 � 1,301,685 � 1,398,635 � � Income before income taxes 211,892 157,219 425,399 300,933 � Income tax expense 6,037 � 14,332 � 14,532 � 25,756 � � Net income 205,855 142,887 410,867 275,177 � Preferred dividends 6,461 � 5,039 � 12,922 � 7,706 � � Net income available to common shareholders $199,394 � $137,848 � $397,945 � $267,471 � � Net income per common share Basic $2.75 $1.88 $5.44 $3.66 Diluted $2.65 $1.81 $5.24 $3.52 � Weighted average common shares and common share equivalents outstanding Basic 72,494,823 73,188,101 73,209,439 73,044,473 Diluted 75,254,846 76,155,438 75,947,858 76,014,819 ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (U.S. dollars in thousands, except share data) � (Unaudited) June 30, December�31, 2007 2006 Assets Investments and cash: Fixed maturities available for sale, at fair value (amortized cost: 2007, $6,972,705; 2006, $6,858,970) $6,923,478 $6,876,548 Short-term investments available for sale, at fair value (amortized cost: 2007, $1,110,053; 2006, $956,926) 1,114,485 957,698 Short-term investment of funds received under securities lending agreements, at fair value 1,114,959 891,376 Other investments (cost: 2007, $429,486; 2006, $282,923) 461,835 307,082 Cash 245,143 � 317,017 Total investments and cash 9,859,900 9,349,721 � Accrued investment income 71,064 68,440 Fixed maturities and short-term investments pledged under securities lending agreements, at fair value 1,085,757 860,803 Premiums receivable 1,041,921 749,961 Funds held by reinsureds 79,335 82,385 Unpaid losses and loss adjustment expenses recoverable 1,545,820 1,552,157 Paid losses and loss adjustment expenses recoverable 131,441 122,149 Prepaid reinsurance premiums 544,137 470,138 Deferred income tax assets, net 70,688 63,606 Deferred acquisition costs, net 309,651 290,999 Receivable for securities sold 54,954 190,168 Other assets 499,100 � 511,940 Total Assets $15,293,768 � $14,312,467 � Liabilities Reserve for losses and loss adjustment expenses $6,782,433 $6,463,041 Unearned premiums 2,001,736 1,791,922 Reinsurance balances payable 382,488 301,679 Senior notes 300,000 300,000 Deposit accounting liabilities 43,559 45,107 Securities lending collateral 1,114,959 891,376 Payable for securities purchased 434,624 418,109 Other liabilities 529,902 � 510,614 Total Liabilities 11,589,701 � 10,721,848 � Commitments and Contingencies � Shareholders� Equity Non-cumulative preferred shares ($0.01 par value, 50,000,000 shares authorized) - Series A (issued: 2007 and 2006, 8,000,000) 80 80 - Series B (issued: 2007 and 2006, 5,000,000) 50 50 Common shares ($0.01 par value, 200,000,000 shares authorized, issued: 2007, 71,273,285; 2006, 74,270,466) 713 743 Additional paid-in capital 1,716,295 1,944,304 Retained earnings 1,993,963 1,596,018 Accumulated other comprehensive income (loss), net of deferred income tax (7,034 ) 49,424 Total Shareholders� Equity 3,704,067 � 3,590,619 Total Liabilities and Shareholders� Equity $15,293,768 � $14,312,467 ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS� EQUITY (U.S. dollars in thousands) � (Unaudited) Six Months Ended June 30, 2007 2006 Non-Cumulative Preferred Shares Balance at beginning of period $130 $� Preferred shares issued � � 130 � Balance at end of period 130 � 130 � � Common Shares Balance at beginning of year 743 733 Common shares issued, net 6 6 Purchases of common shares under share repurchase program (36 ) � � Balance at end of period 713 � 739 � � Additional Paid-in Capital Balance at beginning of year 1,944,304 1,595,440 Cumulative effect of change in accounting for unearned stock grant compensation � (9,646 ) Series A non-cumulative preferred shares issued � 193,388 Series B non-cumulative preferred shares issued � 120,866 Common shares issued 405 410 Exercise of stock options 13,373 15,572 Common shares retired (257,162 ) (658 ) Amortization of share-based compensation 14,457 7,510 Other 918 � 274 � Balance at end of period 1,716,295 � 1,923,156 � � Deferred Compensation Under Share Award Plan Balance at beginning of year � (9,646 ) Cumulative effect of change in accounting for unearned stock grant compensation � � 9,646 � Balance at end of period � � � � � Retained Earnings Balance at beginning of year 1,593,907 901,348 Adjustment to adopt SFAS No. 155, �Accounting for Certain Hybrid Financial Instruments�an amendment of FASB Statements No. 133 and 140� 2,111 � � � Balance at beginning of year, as adjusted 1,596,018 901,348 Dividends declared on preferred shares (12,922 ) (7,706 ) Net income 410,867 � 275,177 � Balance at end of period 1,993,963 � 1,168,819 � � Accumulated Other Comprehensive Income (Loss) Balance at beginning of year 51,535 (7,348 ) Adjustment to adopt SFAS No. 155, �Accounting for Certain Hybrid Financial Instruments�an amendment of FASB Statements No. 133 and 140� (2,111 ) � � Balance at beginning of year, as adjusted 49,424 (7,348 ) Change in unrealized appreciation (decline) in value of investments, net of deferred income tax (67,513 ) (64,272 ) Foreign currency translation adjustments, net of deferred income tax 11,055 � (5,444 ) Balance at end of period (7,034 ) (77,064 ) � Total Shareholders� Equity $3,704,067 � $3,015,780 � ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (U.S. dollars in thousands) � (Unaudited) Six Months Ended June 30, 2007 2006 Comprehensive Income Net income $410,867 $275,177 Other comprehensive loss, net of deferred income tax Unrealized decline in value of investments: Unrealized holding losses arising during period (72,486 ) (97,560 ) Reclassification of net realized losses, net of income taxes, included in net income 4,973 33,288 Foreign currency translation adjustments 11,055 � (5,444 ) Other comprehensive loss (56,458 ) (69,716 ) Comprehensive Income $354,409 � $205,461 � ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (U.S. dollars in thousands) � (Unaudited) Six Months Ended June 30, 2007 � 2006 � Operating Activities Net income $410,867 $275,177 Adjustments to reconcile net income to net cash provided by operating activities: Net realized losses 4,854 35,673 Other income (869 ) � Share-based compensation 14,457 7,510 Changes in: Reserve for losses and loss adjustment expenses, net of unpaid losses and loss adjustment expenses recoverable 324,793 473,996 Unearned premiums, net of prepaid reinsurance premiums 135,525 117,298 Premiums receivable (290,437 ) (224,498 ) Deferred acquisition costs, net (18,702 ) (5,971 ) Funds held by reinsureds 3,050 82,879 Reinsurance balances payable 79,254 105,193 Deferred income tax assets, net (3,757 ) (5,555 ) Other liabilities 1,737 18,331 Other items, net 16,231 � (56,879 ) Net Cash Provided By Operating Activities 677,003 � 823,154 � � Investing Activities Purchases of fixed maturity investments (8,933,304 ) (8,196,081 ) Proceeds from sales of fixed maturity investments 8,407,340 7,440,922 Proceeds from redemptions and maturities of fixed maturity investments 305,847 96,360 Purchases of other investments (185,357 ) (63,813 ) Proceeds from sales of other investments 62,309 6,062 Net purchases of short-term investments (141,217 ) (279,297 ) Change in securities lending collateral (223,583 ) 131,153 Purchases of furniture, equipment and other (8,998 ) (8,679 ) Net Cash Used For Investing Activities (716,963 ) (873,373 ) � Financing Activities Purchases of common shares under share repurchase program (254,973 ) � Proceeds from common shares issued, net 7,427 11,212 Proceeds from preferred shares issued, net of issuance costs � 314,538 Change in securities lending collateral 223,583 (131,153 ) Excess tax benefits from share-based compensation 3,965 3,143 Preferred dividends paid (12,922 ) (4,622 ) Net Cash Provided By Financing Activities (32,920 ) 193,118 � � Effects of exchange rate changes on foreign currency cash 1,006 � 997 � � (Decrease) increase in cash (71,874 ) 143,896 Cash beginning of year 317,017 � 222,477 � Cash end of period $245,143 � $366,373 � � Income taxes paid, net $1,881 � $32,407 � Interest paid $11,025 � $11,067 � ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES SEGMENT INFORMATION The Company classifies its businesses into two underwriting segments � insurance and reinsurance � and a corporate and other segment (non-underwriting). The Company�s insurance and reinsurance operating segments each have segment managers who are responsible for the overall profitability of their respective segments and who are directly accountable to the Company�s chief operating decision makers, the President and Chief Executive Officer of ACGL and the Chief Financial Officer of ACGL. The chief operating decision makers do not assess performance, measure return on equity or make resource allocation decisions on a line of business basis. The Company determined its reportable operating segments using the management approach described in SFAS No. 131, �Disclosures About Segments of an Enterprise and Related Information.� Management measures segment performance based on underwriting income or loss. The Company does not manage its assets by segment and, accordingly, investment income is not allocated to each underwriting segment. In addition, other revenue and expense items are not evaluated by segment. The accounting policies of the segments are the same as those used for the preparation of the Company�s consolidated financial statements. Inter-segment insurance business is allocated to the segment accountable for the underwriting results. The insurance segment consists of the Company�s insurance underwriting subsidiaries which primarily write on both an admitted and non-admitted basis. The insurance segment consists of eight specialty product lines, including: casualty; construction, surety and national accounts; executive assurance; healthcare; professional liability; programs; property, marine and aviation; and other (consisting of collateral protection business and excess workers� compensation and employers� liability business produced by Wexford). The reinsurance segment consists of the Company�s reinsurance underwriting subsidiaries. The reinsurance segment generally seeks to write significant lines on specialty property and casualty reinsurance treaties. Classes of business include: casualty; marine and aviation; other specialty; property catastrophe; property excluding property catastrophe (losses on a single risk, both excess of loss and pro rata); and other (consisting of non-traditional and casualty clash business). The corporate and other segment (non-underwriting) includes net investment income, other fee income, net of related expenses, other income (loss), other expenses incurred by the Company, interest expense, net realized gains or losses, net foreign exchange gains or losses and income taxes. In addition, results for the corporate and other segment included dividends on the Company�s non-cumulative preferred shares. The following tables set forth underwriting income or loss by segment, together with a reconciliation of underwriting income to net income available to common shareholders: (Unaudited) Three Months Ended June 30, 2007 (U.S. dollars in thousands) Insurance Reinsurance Total � Gross premiums written (1) $684,725 $427,348 $1,102,210 Net premiums written 451,828 306,067 757,895 � Net premiums earned $432,560 $318,852 $751,412 Fee income 1,276 815 2,091 Losses and loss adjustment expenses (272,658 ) (153,005 ) (425,663 ) Acquisition expenses, net (47,532 ) (69,745 ) (117,277 ) Other operating expenses (70,269 ) (19,999 ) (90,268 ) Underwriting income $43,377 � $76,918 � 120,295 � Net investment income 117,299 Net realized losses (3,757 ) Other income 265 Other expenses (10,237 ) Interest expense (5,523 ) Net foreign exchange losses (6,450 ) Income before income taxes 211,892 Income tax expense (6,037 ) � Net income 205,855 Preferred dividends (6,461 ) Net income available to common shareholders $199,394 � � Underwriting Ratios Loss ratio 63.0 % 48.0 % 56.6 % Acquisition expense ratio (2) 10.8 % 21.9 % 15.5 % Other operating expense ratio 16.2 % 6.3 % 12.0 % Combined ratio 90.0 % 76.2 % 84.1 % (1) Certain amounts included in the gross premiums written of each segment are related to intersegment transactions and are included in the gross premiums written of each segment. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total. (2) The acquisition expense ratio is adjusted to include certain fee income. (Unaudited) Three Months Ended June 30, 2006 (U.S. dollars in thousands) Insurance Reinsurance Total � Gross premiums written (1) $647,817 $499,241 $1,136,274 Net premiums written 409,302 385,256 794,558 � Net premiums earned $385,877 $411,573 $797,450 Fee income 1,253 2,215 3,468 Losses and loss adjustment expenses (251,172 ) (211,083 ) (462,255 ) Acquisition expenses, net (41,275 ) (107,306 ) (148,581 ) Other operating expenses (63,689 ) (14,179 ) (77,868 ) Underwriting income $30,994 � $81,220 � 112,214 � Net investment income 90,503 Net realized losses (32,202 ) Other income � Other expenses (6,499 ) Interest expense (5,651 ) Net foreign exchange losses (1,146 ) Income before income taxes 157,219 Income tax expense (14,332 ) � Net income 142,887 Preferred dividends (5,039 ) Net income available to common shareholders $137,848 � � Underwriting Ratios Loss ratio 65.1 % 51.3 % 58.0 % Acquisition expense ratio (2) 10.5 % 26.1 % 18.5 % Other operating expense ratio 16.5 % 3.4 % 9.8 % Combined ratio 92.1 % 80.8 % 86.3 % (1) Certain amounts included in the gross premiums written of each segment are related to intersegment transactions and are included in the gross premiums written of each segment. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total. (2) The acquisition expense ratio is adjusted to include certain fee income. (Unaudited) Six Months Ended June 30, 2007 (U.S. dollars in thousands) Insurance Reinsurance Total � Gross premiums written (1) $1,345,935 $986,002 $2,312,824 Net premiums written 880,172 749,468 1,629,640 � Net premiums earned $846,407 $650,498 $1,496,905 Fee income 2,701 1,359 4,060 Losses and loss adjustment expenses (531,980 ) (313,744 ) (845,724 ) Acquisition expenses, net (94,227 ) (143,178 ) (237,405 ) Other operating expenses (139,163 ) (33,780 ) (172,943 ) Underwriting income $83,738 � $161,155 � 244,893 � Net investment income 229,988 Net realized losses (4,738 ) Other income 869 Other expenses (18,375 ) Interest expense (11,046 ) Net foreign exchange losses (16,192 ) Income before income taxes 425,399 Income tax expense (14,532 ) � Net income 410,867 Preferred dividends (12,922 ) Net income available to common shareholders $397,945 � � Underwriting Ratios Loss ratio 62.9 % 48.2 % 56.5 % Acquisition expense ratio (2) 10.9 % 22.0 % 15.8 % Other operating expense ratio 16.4 % 5.2 % 11.6 % Combined ratio 90.2 % 75.4 % 83.9 % (1) Certain amounts included in the gross premiums written of each segment are related to intersegment transactions and are included in the gross premiums written of each segment. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total. (2) The acquisition expense ratio is adjusted to include certain fee income. (Unaudited) Six Months Ended June 30, 2006 (U.S. dollars in thousands) Insurance Reinsurance Total � Gross premiums written (1) $1,263,301 $1,063,909 $2,304,088 Net premiums written 806,556 861,721 1,668,277 � Net premiums earned $766,131 $792,920 $1,559,051 Fee income 2,657 2,616 5,273 Losses and loss adjustment expenses (499,174 ) (431,259 ) (930,433 ) Acquisition expenses, net (79,160 ) (199,093 ) (278,253 ) Other operating expenses (125,765 ) (27,431 ) (153,196 ) Underwriting income $64,689 � $137,753 � 202,442 � Net investment income 170,829 Net realized losses (35,585 ) Other income � Other expenses (14,148 ) Interest expense (11,206 ) Net foreign exchange losses (11,399 ) Income before income taxes 300,933 Income tax expense (25,756 ) � Net income 275,177 Preferred dividends (7,706 ) Net income available to common shareholders $267,471 � � Underwriting Ratios Loss ratio 65.2 % 54.4 % 59.7 % Acquisition expense ratio (2) 10.1 % 25.1 % 17.7 % Other operating expense ratio 16.4 % 3.5 % 9.8 % Combined ratio 91.7 % 83.0 % 87.2 % (1) Certain amounts included in the gross premiums written of each segment are related to intersegment transactions and are included in the gross premiums written of each segment. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total. (2) The acquisition expense ratio is adjusted to include certain fee income. The following table sets forth the insurance segment�s net premiums written and earned by major line of business, together with net premiums written by client location: (Unaudited) Three Months Ended June 30, 2007 2006 INSURANCE SEGMENT(U.S. dollars in thousands) Amount % of Total Amount % of Total � Net premiums written Property, marine and aviation $104,705 23.2 $74,712 18.2 Professional liability 81,603 18.1 63,555 15.5 Construction, surety and national accounts 68,482 15.1 66,717 16.3 Programs 59,154 13.1 56,512 13.8 Casualty 57,240 12.7 66,643 16.3 Executive assurance 47,904 10.6 53,841 13.2 Healthcare 12,383 2.7 14,199 3.5 Other 20,357 (1) 4.5 13,123 3.2 Total $451,828 100.0 $409,302 100.0 � Net premiums earned Property, marine and aviation $92,387 21.4 $54,783 14.2 Professional liability 82,142 19.0 65,639 17.0 Construction, surety and national accounts 67,562 15.6 67,967 17.6 Programs 57,036 13.2 57,478 14.9 Casualty 52,570 12.1 61,121 15.9 Executive assurance 47,408 11.0 49,707 12.9 Healthcare 17,107 3.9 17,869 4.6 Other 16,348 (1) 3.8 11,313 2.9 Total $432,560 100.0 $385,877 100.0 � Net premiums written by client location United States $361,733 80.1 $343,923 84.0 Europe 60,968 13.5 39,886 9.8 Other 29,127 6.4 25,493 6.2 Total $451,828 100.0 $409,302 100.0 (1) Includes excess workers� compensation and employers� liability business. (Unaudited) Six Months Ended June 30, 2007 2006 INSURANCE SEGMENT(U.S. dollars in thousands) Amount % of Total Amount % of Total � Net premiums written Property, marine and aviation $189,568 21.5 $143,358 17.8 Professional liability 152,006 17.3 126,009 15.6 Construction, surety and national accounts 147,711 16.8 147,346 18.3 Programs 117,478 13.3 117,046 14.5 Casualty 100,330 11.4 117,393 14.6 Executive assurance 91,995 10.4 99,432 12.3 Healthcare 33,914 3.9 32,314 4.0 Other 47,170 (1) 5.4 23,658 2.9 Total $880,172 100.0 $806,556 100.0 � Net premiums earned Property, marine and aviation $174,191 20.6 $117,751 15.4 Professional liability 159,272 18.8 119,684 15.6 Construction, surety and national accounts 134,666 15.9 134,670 17.6 Programs 113,245 13.4 114,867 15.0 Casualty 104,112 12.3 123,929 16.2 Executive assurance 92,786 10.9 99,783 13.0 Healthcare 36,951 4.4 34,546 4.5 Other 31,184 (1) 3.7 20,901 2.7 Total $846,407 100.0 $766,131 100.0 � Net premiums written by client location United States $681,738 77.5 $668,388 82.9 Europe 135,903 15.4 87,466 10.8 Other 62,531 7.1 50,702 6.3 Total $880,172 100.0 $806,556 100.0 (1) Includes excess workers� compensation and employers� liability business. The following table sets forth the reinsurance segment�s net premiums written and earned by major line of business and type of business, together with net premiums written by client location: (Unaudited) Three Months Ended June 30, 2007 2006 REINSURANCE SEGMENT (U.S. dollars in thousands) Amount % of Total Amount % of Total � Net premiums written Casualty (1) $110,106 36.0 $176,116 45.7 Property catastrophe 77,514 25.3 33,786 8.8 Property excluding property catastrophe 69,353 22.7 88,785 23.0 Other specialty 27,971 9.1 64,493 16.7 Marine and aviation 19,812 6.5 20,626 5.4 Other 1,311 0.4 1,450 0.4 Total $306,067 100.0 $385,256 100.0 � Net premiums earned Casualty (1) $131,112 41.1 $183,474 44.6 Property catastrophe 38,151 12.0 49,481 12.0 Property excluding property catastrophe 64,737 20.3 81,668 19.8 Other specialty 52,582 16.5 70,970 17.2 Marine and aviation 30,021 9.4 23,701 5.8 Other 2,249 0.7 2,279 0.6 Total $318,852 100.0 $411,573 100.0 � Net premiums written Pro rata $184,972 60.4 $288,439 74.9 Excess of loss 121,095 39.6 96,817 25.1 Total $306,067 100.0 $385,256 100.0 � Net premiums earned Pro rata $228,815 71.8 $321,438 78.1 Excess of loss 90,037 28.2 90,135 21.9 Total $318,852 100.0 $411,573 100.0 � Net premiums written by client location United States $206,456 67.5 $228,677 59.4 Europe 37,710 12.3 111,663 29.0 Bermuda 47,851 15.6 23,843 6.2 Other 14,050 4.6 21,073 5.4 Total $306,067 100.0 $385,256 100.0 (1) Includes professional liability and executive assurance business. (Unaudited) Six Months Ended June 30, 2007 2006 REINSURANCE SEGMENT (U.S. dollars in thousands) Amount % of Total Amount % of Total � Net premiums written Casualty (1) $254,582 34.0 $339,104 39.3 Property excluding property catastrophe 164,297 21.9 195,567 22.7 Property catastrophe 158,173 21.1 104,122 12.1 Other specialty 101,967 13.6 157,757 18.3 Marine and aviation 63,527 8.5 61,978 7.2 Other 6,922 0.9 3,193 0.4 Total $749,468 100.0 $861,721 100.0 � Net premiums earned Casualty (1) $271,556 41.7 $354,671 44.7 Property excluding property catastrophe 137,776 21.2 161,288 20.3 Property catastrophe 72,842 11.2 98,587 12.4 Other specialty 104,624 16.1 128,889 16.3 Marine and aviation 56,643 8.7 47,351 6.0 Other 7,057 1.1 2,134 0.3 Total $650,498 100.0 $792,920 100.0 � Net premiums written Pro rata $448,787 59.9 $560,973 65.1 Excess of loss 300,681 40.1 300,748 34.9 Total $749,468 100.0 $861,721 100.0 � Net premiums earned Pro rata $471,254 72.4 $616,726 77.8 Excess of loss 179,244 27.6 176,194 22.2 Total $650,498 100.0 $792,920 100.0 � Net premiums written by client location United States $460,447 61.4 $505,992 58.7 Europe 162,048 21.6 238,926 27.7 Bermuda 98,692 13.2 67,682 7.9 Other 28,281 3.8 49,121 5.7 Total $749,468 100.0 $861,721 100.0 (1) Includes professional liability and executive assurance business. Discussion of 2007 Second Quarter Performance � Insurance Segment � (Unaudited) Three Months Ended June 30, (U.S. dollars in thousands) 2007 2006 � Gross premiums written $684,725 $647,817 Net premiums written 451,828 409,302 Net premiums earned 432,560 385,877 Underwriting income 43,377 30,994 � Loss ratio 63.0% 65.1% Acquisition expense ratio 10.8% 10.5% Other operating expense ratio 16.2% 16.5% Combined ratio 90.0% 92.1% Gross premiums written by the insurance segment in the 2007 second quarter were 5.7% higher than in the 2006 second quarter, while net premiums written increased 10.4%. The larger growth rate in net premiums written primarily resulted from an increase in the percentage retained on certain short-tail business in 2007 along with changes in the insurance segment�s mix of business. A significant portion of the growth in net premiums written was generated by the insurance segment�s European operations primarily as a result of increases in property and professional liability lines. The balance of the growth was generated by the insurance segment�s U.S. operations primarily through increases in property lines, partially offset by reductions in casualty business. Net premiums earned by the insurance segment in the 2007 second quarter were 12.1% higher than in the 2006 second quarter, and reflect changes in net premiums written over the previous five quarters, including the mix and type of business written. The insurance segment�s loss ratio was 63.0% in the 2007 second quarter, compared to 65.1% for the 2006 second quarter. The 2007 second quarter loss ratio included 0.8 points related to estimated net adverse development in prior year loss reserves, compared to a 3.8 point reduction in the loss ratio related to estimated net favorable development in the 2006 second quarter. The insurance segment�s results for the 2007 second quarter also reflect better experience on property business than in the 2006 second quarter. The insurance segment�s underwriting expense ratio was 27.0% in both the 2007 and 2006 second quarters. The acquisition expense ratio was 10.8% for the 2007 second quarter, compared to 10.5% for the 2006 second quarter. The acquisition expense ratio is influenced by, among other things, (1) the amount of ceding commissions received from unaffiliated reinsurers and (2) the amount of business written on a surplus lines (non-admitted) basis. The insurance segment�s other operating expense ratio was 16.2% for the 2007 second quarter, compared to 16.5% for the 2006 second quarter. Reinsurance Segment � (Unaudited) Three Months Ended June 30, (U.S. dollars in thousands) 2007 2006 � Gross premiums written $427,348 $499,241 Net premiums written 306,067 385,256 Net premiums earned 318,852 411,573 Underwriting income 76,918 81,220 � Loss ratio 48.0% 51.3% Acquisition expense ratio 21.9% 26.1% Other operating expense ratio 6.3% 3.4% Combined ratio 76.2% 80.8% Gross premiums written by the reinsurance segment in the 2007 second quarter were 14.4% lower than in the 2006 second quarter. Growth in property and marine lines was offset by a reduction in casualty and other specialty business. The growth in property and marine lines was in response to current market opportunities as the pricing environment for catastrophe-exposed property and marine lines remained attractive. The decrease in casualty business was in response to increasing competition. Ceded premiums written by the reinsurance segment were 28.4% of gross premiums written for the 2007 second quarter, compared to 22.8% for the 2006 second quarter. Arch Re Bermuda ceded $115.9 million, or 27.1% of gross premiums written, of certain lines of property and marine premiums written to Flatiron Re Ltd. in the 2007 second quarter, compared to $77.7 million, or 15.6%, in the 2006 second quarter. On an earned basis, Arch Re Bermuda ceded $72.5 million to Flatiron Re Ltd. in the 2007 second quarter, compared to $25.3 million in the 2006 second quarter. Primarily as a result of the additional business ceded to Flatiron Re Ltd. discussed above, the decrease in net premiums written of 20.6% from the 2006 second quarter to the 2007 second quarter was greater than the 14.4% decrease in gross premiums written. In addition, net premiums earned by the reinsurance segment in the 2007 second quarter were 22.5% lower than in the 2006 second quarter. The decrease in net premiums earned in the 2007 second quarter primarily resulted from changes in net premiums written over the previous five quarters, including the mix and type of business written. The reinsurance segment�s loss ratio was 48.0% in the 2007 second quarter, compared to 51.3% for the 2006 second quarter. The loss ratio for the 2007 second quarter reflected a 12.1 point reduction related to estimated net favorable development in prior year loss reserves, compared to a 0.6 point reduction in the 2006 second quarter. In addition, a substantial portion of the change in the 2007 second quarter loss ratio was due to changes in the reinsurance segment�s mix and type of business. The 2007 second quarter loss ratio also reflected approximately 3.8 points of catastrophic activity, consisting of $7.5 million of losses incurred related to the June flooding in Australia and $4.6 million related to U.S. storm and other activity, while the 2006 second quarter loss ratio reflected approximately 2.8 points of catastrophic activity. The underwriting expense ratio for the reinsurance segment was 28.2% in the 2007 second quarter, compared to 29.5% in the 2006 second quarter. The acquisition expense ratio for the 2007 second quarter was 21.9%, compared to 26.1% for the 2006 second quarter. The acquisition expense ratio included commission income (in excess of the reimbursement of direct acquisition expenses) on the quota-share reinsurance treaty with Flatiron Re Ltd. which reduced the 2007 second quarter acquisition expense ratio by 3.1 points, compared to 0.9 points in the 2006 second quarter. In addition, the acquisition expense ratio for the 2007 second quarter included 0.8 points related to prior year loss development, compared to a decrease of 0.2 points in the 2006 second quarter. The reinsurance segment�s other operating expense ratio was 6.3% for the 2007 second quarter, compared to 3.4% for the 2006 second quarter. The higher ratio primarily resulted from expenses related to the reinsurance segment�s new property facultative reinsurance operation, which commenced operations during the 2007 second quarter and produced a negligible amount of premiums written.