Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark
One)
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
|
|
EXCHANGE
ACT OF 1934
|
|
|
|
For the
quarterly period ended June 30, 2008
|
|
|
|
Or
|
|
|
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
|
|
EXCHANGE
ACT OF 1934
|
|
|
|
For the
transition period to
|
Commission file number:
0-26456
ARCH CAPITAL GROUP LTD
.
(Exact name of registrant as specified in its
charter)
Bermuda
|
Not Applicable
|
(State or other jurisdiction of incorporation or
|
(I.R.S. Employer Identification No.)
|
organization)
|
|
|
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Wessex House, 45 Reid Street
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|
Hamilton HM 12, Bermuda
|
|
(Address of principal executive offices)
|
(Zip Code)
|
Registrants telephone number, including area
code:
(441)
278-9250
(Former name, former address and former
fiscal year, if changed since last report)
Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes
x
No
o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of large accelerated filer, accelerated filer and smaller
reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
|
Accelerated filer
o
|
|
|
Non-accelerated filer
o
|
Smaller reporting company
o
|
(Do not check if a smaller reporting coming)
|
|
Indicate
by check mark whether the Registrant is a shell company (as defined in Rule 12b-2
of the Exchange Act). Yes
o
No
x
Indicate
the number of shares outstanding of each of the issuers classes of common
shares as of the latest practicable date.
Class
|
Outstanding at
August 1, 2008
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Common Shares, $0.01 par value
|
60,111,444
|
Table of Contents
ARCH CAPITAL GROUP LTD.
INDEX
|
Page No.
|
PART I.
Financial Information
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|
|
|
Item 1 Consolidated Financial
Statements
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|
|
|
Report of Independent
Registered Public Accounting Firm
|
2
|
|
|
Consolidated Balance
Sheets
|
3
|
June 30, 2008 (unaudited) and
December 31, 2007
|
|
|
|
Consolidated Statements
of Income
|
4
|
For the three and six month periods ended
June 30, 2008 and 2007 (unaudited)
|
|
|
|
Consolidated Statements
of Changes in Shareholders Equity
|
5
|
For the six month periods ended
June 30, 2008 and 2007 (unaudited)
|
|
|
|
Consolidated Statements
of Comprehensive Income
|
6
|
For the six month periods ended
June 30, 2008 and 2007 (unaudited)
|
|
|
|
Consolidated Statements
of Cash Flows
|
7
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For the six month periods ended
June 30, 2008 and 2007 (unaudited)
|
|
|
|
Notes to Consolidated
Financial Statements (unaudited)
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8
|
|
|
Item 2 Managements
Discussion and Analysis of Financial Condition
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|
and Results of Operations
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33
|
|
|
Item 3 Quantitative and
Qualitative Disclosures About Market Risk
|
57
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|
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Item
4 Controls and Procedures
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57
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|
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PART II.
Other Information
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|
|
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Item 1 Legal Proceedings
|
58
|
|
|
Item 2 Unregistered Sales of
Equity Securities and Use of Proceeds
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58
|
|
|
Item 4 Submission of Matters
to a Vote of Security Holders
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59
|
|
|
Item 5 Other Information
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60
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|
|
Item 6 Exhibits
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60
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1
Table
of Contents
Report of Independent Registered Public Accounting
Firm
To
the
Board of Directors and Shareholders of
Arch Capital Group Ltd.:
We
have reviewed the accompanying consolidated balance sheets of Arch Capital
Group Ltd. and its subsidiaries
(the Company)
as of June 30, 2008, and the related consolidated
statements of income for each of the three-month and six-month periods ended June 30,
2008 and June 30, 2007, and the consolidated statements of changes in
shareholders equity, comprehensive income and cash flows for the six-month
periods ended June 30, 2008 and June 30, 2007. These interim
financial statements are the responsibility of the Companys management.
We
conducted our review in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board (United States), the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based
on our review, we are not aware of any material modifications that should be
made to the accompanying consolidated interim financial statements for them to
be in conformity with accounting principles generally accepted in the United
States of America.
We previously audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated
balance sheet as of December 31, 2007, and the related
consolidated statements of income, changes in shareholders equity,
comprehensive income, and of cash flows for the year then ended
(not presented herein), and in our report dated February 28,
2008, we expressed an unqualified opinion on those consolidated financial
statements. In our opinion, the information set forth in the accompanying
consolidated balance sheet information as of December 31, 2007, is fairly
stated in all material respects in relation to the consolidated balance sheet
from which it has been derived.
/s/
PricewaterhouseCoopers LLP
New York, New York
August 8, 2008
2
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(U.S. dollars in thousands, except share data)
|
|
(Unaudited)
|
|
|
|
|
|
June 30,
|
|
December 31,
|
|
|
|
2008
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|
2007
|
|
Assets
|
|
|
|
|
|
Investments:
|
|
|
|
|
|
Fixed maturities
available for sale, at fair value (amortized cost: 2008, $7,787,994; 2007,
$7,037,272)
|
|
$
|
7,746,296
|
|
$
|
7,137,998
|
|
Short-term
investments available for sale, at fair value (amortized cost: 2008,
$644,156; 2007, $700,262)
|
|
645,587
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|
699,036
|
|
Short-term
investment of funds received under securities lending agreements, at fair
value
|
|
918,207
|
|
1,503,723
|
|
Other
investments (cost: 2008, $281,243; 2007, $323,950)
|
|
295,638
|
|
353,694
|
|
Investment funds
accounted for using the equity method
|
|
351,879
|
|
235,975
|
|
Investment in joint venture
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|
100,000
|
|
|
|
Total investments
|
|
10,057,607
|
|
9,930,426
|
|
|
|
|
|
|
|
Cash
|
|
246,544
|
|
239,915
|
|
Accrued investment income
|
|
76,313
|
|
73,862
|
|
Fixed maturities and short-term investments pledged
under securities lending agreements, at fair value
|
|
890,822
|
|
1,463,045
|
|
Premiums receivable
|
|
859,261
|
|
729,628
|
|
Unpaid losses and loss adjustment expenses
recoverable
|
|
1,586,201
|
|
1,609,619
|
|
Paid losses and loss adjustment expenses recoverable
|
|
113,439
|
|
132,289
|
|
Prepaid reinsurance premiums
|
|
364,226
|
|
480,462
|
|
Deferred income tax assets, net
|
|
66,944
|
|
57,051
|
|
Deferred acquisition costs, net
|
|
319,732
|
|
290,059
|
|
Receivable for securities sold
|
|
1,053,379
|
|
17,359
|
|
Other assets
|
|
647,034
|
|
600,552
|
|
Total Assets
|
|
$
|
16,281,502
|
|
$
|
15,624,267
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
Reserve for losses and loss adjustment expenses
|
|
$
|
7,349,083
|
|
$
|
7,092,452
|
|
Unearned premiums
|
|
1,735,371
|
|
1,765,881
|
|
Reinsurance balances payable
|
|
254,830
|
|
301,309
|
|
Senior notes
|
|
300,000
|
|
300,000
|
|
Revolving credit agreement borrowings
|
|
100,000
|
|
|
|
Securities lending payable
|
|
918,207
|
|
1,503,723
|
|
Payable for securities purchased
|
|
1,064,224
|
|
23,155
|
|
Other liabilities
|
|
673,554
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|
601,936
|
|
Total Liabilities
|
|
12,395,269
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|
11,588,456
|
|
|
|
|
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|
Commitments and Contingencies
|
|
|
|
|
|
|
|
|
|
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|
Shareholders Equity
|
|
|
|
|
|
Non-cumulative preferred shares ($0.01 par value,
50,000,000 shares authorized)
|
|
|
|
|
|
-Series A
(issued: 2008 and 2007, 8,000,000)
|
|
80
|
|
80
|
|
-Series B
(issued: 2008 and 2007, 5,000,000)
|
|
50
|
|
50
|
|
Common shares
($0.01 par value, 200,000,000 shares authorized, issued: 2008, 61,943,100;
2007, 67,318,466)
|
|
619
|
|
673
|
|
Additional paid-in capital
|
|
1,089,636
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|
1,451,667
|
|
Retained earnings
|
|
2,809,821
|
|
2,428,117
|
|
Accumulated other comprehensive (loss) income, net
of deferred income tax
|
|
(13,973
|
)
|
155,224
|
|
Total Shareholders Equity
|
|
3,886,233
|
|
4,035,811
|
|
Total Liabilities and Shareholders Equity
|
|
$
|
16,281,502
|
|
$
|
15,624,267
|
|
See Notes to Consolidated Financial
Statements
3
Table of Contents
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,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
Net premiums
written
|
|
$
|
686,118
|
|
$
|
757,895
|
|
$
|
1,497,460
|
|
$
|
1,629,640
|
|
Decrease
(increase) in unearned premiums
|
|
19,557
|
|
(6,483
|
)
|
(83,551
|
)
|
(132,735
|
)
|
Net premiums
earned
|
|
705,675
|
|
751,412
|
|
1,413,909
|
|
1,496,905
|
|
Net investment
income
|
|
117,120
|
|
113,923
|
|
239,313
|
|
223,970
|
|
Net realized
(losses) gains
|
|
(12,669
|
)
|
(3,757
|
)
|
23,306
|
|
(4,738
|
)
|
Fee income
|
|
1,238
|
|
2,091
|
|
2,306
|
|
4,060
|
|
Equity in net
income (loss) of investment funds accounted for using the equity method
|
|
19,583
|
|
3,376
|
|
(2,730
|
)
|
6,018
|
|
Other income
|
|
4,968
|
|
265
|
|
9,004
|
|
869
|
|
Total
revenues
|
|
835,915
|
|
867,310
|
|
1,685,108
|
|
1,727,084
|
|
|
|
|
|
|
|
|
|
|
|
Expenses
|
|
|
|
|
|
|
|
|
|
Losses and loss
adjustment expenses
|
|
404,625
|
|
425,663
|
|
809,042
|
|
845,724
|
|
Acquisition
expenses
|
|
119,226
|
|
117,277
|
|
233,865
|
|
237,405
|
|
Other operating
expenses
|
|
102,578
|
|
100,505
|
|
199,765
|
|
191,318
|
|
Interest expense
|
|
5,788
|
|
5,523
|
|
11,312
|
|
11,046
|
|
Net foreign
exchange (gains) losses
|
|
(298
|
)
|
6,450
|
|
23,289
|
|
16,192
|
|
Total
expenses
|
|
631,919
|
|
655,418
|
|
1,277,273
|
|
1,301,685
|
|
|
|
|
|
|
|
|
|
|
|
Income
before income taxes
|
|
203,996
|
|
211,892
|
|
407,835
|
|
425,399
|
|
|
|
|
|
|
|
|
|
|
|
Income tax
expense
|
|
5,253
|
|
6,037
|
|
13,209
|
|
14,532
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
198,743
|
|
205,855
|
|
394,626
|
|
410,867
|
|
|
|
|
|
|
|
|
|
|
|
Preferred
dividends
|
|
6,461
|
|
6,461
|
|
12,922
|
|
12,922
|
|
|
|
|
|
|
|
|
|
|
|
Net
income available to common shareholders
|
|
$
|
192,282
|
|
$
|
199,394
|
|
$
|
381,704
|
|
$
|
397,945
|
|
|
|
|
|
|
|
|
|
|
|
Net
income per common share
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
3.05
|
|
$
|
2.75
|
|
$
|
5.95
|
|
$
|
5.44
|
|
Diluted
|
|
$
|
2.92
|
|
$
|
2.65
|
|
$
|
5.71
|
|
$
|
5.24
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average common shares and common share equivalents outstanding
|
|
|
|
|
|
|
|
|
|
Basic
|
|
62,995,550
|
|
72,494,823
|
|
64,145,533
|
|
73,209,439
|
|
Diluted
|
|
65,748,119
|
|
75,254,846
|
|
66,886,972
|
|
75,947,858
|
|
See Notes to Consolidated Financial
Statements
4
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
(U.S. dollars in thousands)
|
|
(Unaudited)
|
|
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
|
2008
|
|
2007
|
|
Non-Cumulative
Preferred Shares
|
|
|
|
|
|
Balance at
beginning and end of period
|
|
$
|
130
|
|
$
|
130
|
|
|
|
|
|
|
|
Common
Shares
|
|
|
|
|
|
Balance at
beginning of year
|
|
673
|
|
743
|
|
Common shares
issued, net
|
|
2
|
|
6
|
|
Purchases of
common shares under share repurchase program
|
|
(56
|
)
|
(36
|
)
|
Balance at end
of period
|
|
619
|
|
713
|
|
|
|
|
|
|
|
Additional
Paid-in Capital
|
|
|
|
|
|
Balance at
beginning of year
|
|
1,451,667
|
|
1,944,304
|
|
Common shares
issued
|
|
3,511
|
|
405
|
|
Exercise of
stock options
|
|
9,073
|
|
13,373
|
|
Common shares
retired
|
|
(391,776
|
)
|
(257,162
|
)
|
Amortization of
share-based compensation
|
|
17,511
|
|
14,457
|
|
Other
|
|
(350
|
)
|
918
|
|
Balance at end
of period
|
|
1,089,636
|
|
1,716,295
|
|
|
|
|
|
|
|
Retained
Earnings
|
|
|
|
|
|
Balance at
beginning of year
|
|
2,428,117
|
|
1,593,907
|
|
Adjustment to
adopt SFAS No. 155,
Accounting for Certain Hybrid Financial
Instrumentsan amendment of FASB Statements No. 133 and 140
|
|
|
|
2,111
|
|
Balance at
beginning of year, as adjusted
|
|
2,428,117
|
|
1,596,018
|
|
Dividends
declared on preferred shares
|
|
(12,922
|
)
|
(12,922
|
)
|
Net income
|
|
394,626
|
|
410,867
|
|
Balance at end
of period
|
|
2,809,821
|
|
1,993,963
|
|
|
|
|
|
|
|
Accumulated
Other Comprehensive Income (Loss)
|
|
|
|
|
|
Balance at
beginning of year
|
|
155,224
|
|
51,535
|
|
Adjustment to
adopt SFAS No. 155,
Accounting for Certain Hybrid Financial
Instrumentsan amendment of FASB Statements No. 133 and 140
|
|
|
|
(2,111
|
)
|
Balance at
beginning of year, as adjusted
|
|
155,224
|
|
49,424
|
|
Change in
unrealized appreciation (decline) in value of investments, net of deferred
income tax
|
|
(169,023
|
)
|
(67,513
|
)
|
Foreign currency
translation adjustments, net of deferred income tax
|
|
(174
|
)
|
11,055
|
|
Balance at end
of period
|
|
(13,973
|
)
|
(7,034
|
)
|
|
|
|
|
|
|
Total
Shareholders Equity
|
|
$
|
3,886,233
|
|
$
|
3,704,067
|
|
See Notes to Consolidated Financial
Statements
5
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(U.S. dollars in thousands)
|
|
(Unaudited)
|
|
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
|
2008
|
|
2007
|
|
Comprehensive
Income
|
|
|
|
|
|
Net income
|
|
$
|
394,626
|
|
$
|
410,867
|
|
Other
comprehensive income (loss), net of deferred income tax
|
|
|
|
|
|
Unrealized
decline in value of investments:
|
|
|
|
|
|
Unrealized
holding losses arising during period
|
|
(127,124
|
)
|
(72,486
|
)
|
Reclassification
of net realized (gains) losses, net of income taxes, included in net income
|
|
(41,899
|
)
|
4,973
|
|
Foreign currency
translation adjustments
|
|
(174
|
)
|
11,055
|
|
Other
comprehensive loss
|
|
(169,197
|
)
|
(56,458
|
)
|
Comprehensive
Income
|
|
$
|
225,429
|
|
$
|
354,409
|
|
See Notes to Consolidated Financial
Statements
6
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(U.S. dollars in thousands)
|
|
(Unaudited)
|
|
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
|
2008
|
|
2007
|
|
Operating
Activities
|
|
|
|
|
|
Net income
|
|
$
|
394,626
|
|
$
|
410,867
|
|
Adjustments to
reconcile net income to net cash provided by operating activities:
|
|
|
|
|
|
Net realized
(gains) losses
|
|
(20,087
|
)
|
4,854
|
|
Equity in net
(income) loss of investment funds accounted for using the equity method and
other income
|
|
(6,009
|
)
|
(6,887
|
)
|
Share-based
compensation
|
|
17,511
|
|
14,457
|
|
Changes in:
|
|
|
|
|
|
Reserve for
losses and loss adjustment expenses, net of unpaid losses and loss adjustment
expenses recoverable
|
|
278,357
|
|
324,793
|
|
Unearned
premiums, net of prepaid reinsurance premiums
|
|
85,364
|
|
135,525
|
|
Premiums
receivable
|
|
(126,518
|
)
|
(290,437
|
)
|
Deferred
acquisition costs, net
|
|
(29,810
|
)
|
(18,702
|
)
|
Reinsurance
balances payable
|
|
(47,774
|
)
|
79,254
|
|
Other
liabilities
|
|
48,281
|
|
1,737
|
|
Other items, net
|
|
(3,133
|
)
|
21,542
|
|
Net
Cash Provided By Operating Activities
|
|
590,808
|
|
677,003
|
|
|
|
|
|
|
|
Investing
Activities
|
|
|
|
|
|
Purchases of
fixed maturity investments
|
|
(7,510,262
|
)
|
(8,933,304
|
)
|
Proceeds from
sales of fixed maturity investments
|
|
7,044,479
|
|
8,407,340
|
|
Proceeds from
redemptions and maturities of fixed maturity investments
|
|
317,369
|
|
305,847
|
|
Purchases of
other investments
|
|
(187,652
|
)
|
(185,357
|
)
|
Proceeds from
sales of other investments
|
|
89,324
|
|
62,309
|
|
Investment in
joint venture
|
|
(100,000
|
)
|
|
|
Net sales
(purchases) of short-term investments
|
|
60,739
|
|
(141,217
|
)
|
Change in
investment of securities lending collateral
|
|
585,516
|
|
(223,583
|
)
|
Purchases of
furniture, equipment and other
|
|
(4,984
|
)
|
(8,998
|
)
|
Net
Cash Provided By (Used For) Investing Activities
|
|
294,529
|
|
(716,963
|
)
|
|
|
|
|
|
|
Financing
Activities
|
|
|
|
|
|
Purchases of
common shares under share repurchase program
|
|
(389,753
|
)
|
(254,973
|
)
|
Proceeds from
common shares issued, net
|
|
8,050
|
|
7,427
|
|
Revolving credit
agreement borrowings
|
|
100,000
|
|
|
|
Change in
securities lending collateral
|
|
(585,516
|
)
|
223,583
|
|
Excess tax
benefits from share-based compensation
|
|
1,276
|
|
3,965
|
|
Preferred
dividends paid
|
|
(12,922
|
)
|
(12,922
|
)
|
Net
Cash Used For Financing Activities
|
|
(878,865
|
)
|
(32,920
|
)
|
|
|
|
|
|
|
Effects of
exchange rate changes on foreign currency cash
|
|
157
|
|
1,006
|
|
|
|
|
|
|
|
Increase
(decrease) in cash
|
|
6,629
|
|
(71,874
|
)
|
Cash beginning
of year
|
|
239,915
|
|
317,017
|
|
Cash
end of period
|
|
$
|
246,544
|
|
$
|
245,143
|
|
|
|
|
|
|
|
Income taxes
paid, net
|
|
$
|
5,233
|
|
$
|
1,881
|
|
Interest paid
|
|
$
|
11,259
|
|
$
|
11,025
|
|
See Notes to Consolidated Financial
Statements
7
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. General
Arch Capital Group Ltd. (ACGL)
is a Bermuda public limited liability company which provides insurance and
reinsurance on a worldwide basis through its wholly owned subsidiaries.
The interim consolidated
financial statements have been prepared in conformity with accounting
principles generally accepted in the United States of America (GAAP) and
include the accounts of ACGL and its wholly owned subsidiaries (together with
ACGL, the Company). All significant intercompany transactions and balances
have been eliminated in consolidation. The preparation of financial statements
in conformity with GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates and assumptions. In the opinion of
management, the accompanying unaudited interim consolidated financial
statements reflect all adjustments (consisting of normal recurring accruals)
necessary for a fair statement of results on an interim basis. The results of
any interim period are not necessarily indicative of the results for a full
year or any future periods.
Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with GAAP have been condensed or omitted; however, management
believes that the disclosures are adequate to make the information presented
not misleading. This report should be read in conjunction with the Companys
Annual Report on Form 10-K for the year ended December 31, 2007,
including the Companys audited consolidated financial statements and related
notes and the section entitled Risk Factors.
To facilitate period-to-period
comparisons, certain amounts in the 2007 consolidated financial statements have
been reclassified to conform to the 2008 presentation. Such reclassifications
had no effect on the Companys consolidated net income. Tabular dollars and
share amounts are in thousands, except per share amounts.
2. Share Transactions
Share Repurchase Program
The board of directors of
ACGL has authorized the investment of up to $1.5 billion in ACGLs common
shares through a share repurchase program. Such amount consisted of a $1.0
billion authorization in February 2007 and a $500 million authorization in
May 2008. Repurchases under the program may be effected from time to time
in open market or privately negotiated transactions through February 2010.
Since the inception of the share repurchase program, ACGL has repurchased
approximately 13.4 million common shares for an aggregate purchase price of
$926.8 million. During the 2008 second quarter and six months ended June 30,
2008, ACGL repurchased approximately 2.9 million and 5.6 million common shares,
respectively, for an aggregate purchase price of $199.9 million and $389.8
million, respectively. As a result of share repurchase transactions, book value
per common share was reduced by $2.09 per share at June 30, 2008. Weighted
average shares outstanding for the 2008 second quarter and six months ended June 30,
2008 were reduced by 11.9 million and 10.6 million shares, respectively.
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. In connection with the repurchase program, the Warburg Pincus
funds waived their rights relating to share repurchases under its shareholders
agreement with ACGL for all repurchases of common shares by ACGL under the
repurchase program in open market transactions and certain privately negotiated
transactions.
8
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Non-Cumulative Preferred Shares
During 2006, ACGL
completed two public offerings of non-cumulative preferred shares (Preferred
Shares). On February 1, 2006, $200.0 million principal amount of 8.0%
series A non-cumulative preferred shares (Series A Preferred Shares)
were issued with net proceeds of $193.5 million and, on May 24, 2006,
$125.0 million principal amount of 7.875% series B non-cumulative preferred
shares (Series B Preferred Shares) were issued with net proceeds of
$120.9 million. The net proceeds of the offerings were used to support the
underwriting activities of ACGLs insurance and reinsurance subsidiaries. ACGL
has the right to redeem all or a portion of each series of Preferred Shares at
a redemption price of $25.00 per share on or after (1) February 1,
2011 for the Series A Preferred Shares and (2) May 15, 2011 for
the Series B Preferred Shares. Dividends on the Preferred Shares are
non-cumulative. Consequently, in the event dividends are not declared on the
Preferred Shares for any dividend period, holders of Preferred Shares will not
be entitled to receive a dividend for such period, and such undeclared dividend
will not accrue and will not be payable. Holders of Preferred Shares will be entitled
to receive dividend payments only when, as and if declared by ACGLs board of
directors or a duly authorized committee of the board of directors. Any such
dividends will be payable from the date of original issue on a non-cumulative
basis, quarterly in arrears. To the extent declared, these dividends will
accumulate, with respect to each dividend period, in an amount per share equal
to 8.0% of the $25.00 liquidation preference per annum for the Series A
Preferred Shares and 7.875% of the $25.00 liquidation preference per annum for
the Series B Preferred Shares. At June 30, 2008, the Company had
declared an aggregate of $3.3 million of dividends to be paid to holders of the
Preferred Shares.
Share-Based Compensation
As
required by the provisions of
Financial Accounting Standards Board (FASB)
Statement No. 123 (revised 2004), Share-Based Payment (SFAS No. 123(R))
, the Company
recorded after-tax share-based compensation expense related to stock options in
the 2008 second quarter of $2.8 million, or $0.04 per diluted share, compared
to $2.8 million, or $0.04 per diluted share, in the 2007 second quarter, and
$3.9 million, or $0.06 per diluted share, for the six months ended June 30,
2008, compared to $4.4 million, or $0.06 per diluted share, for the six months
ended June 30, 2007.
During
the 2008 second quarter, the Company made a stock grant of 333,175 stock
appreciation rights and stock options and 328,575 restricted shares and units
to certain employees. The stock appreciation rights and stock options were
valued at the grant date using the Black-Scholes option pricing model. The
weighted average grant-date fair value of the stock appreciation rights and
options and restricted shares and units granted were approximately $19.07 and
$69.30 per share, respectively. Such value will be amortized over the
respective substantive vesting period.
9
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
3. Debt and Financing Arrangements
Senior
Notes
On May 4, 2004, ACGL
completed a public offering of $300 million principal amount of 7.35% senior
notes (Senior Notes) due May 1, 2034 and received net proceeds of $296.4
million. ACGL used $200 million of the net proceeds to repay all amounts
outstanding under a revolving credit agreement. The Senior Notes are ACGLs
senior unsecured obligations and rank equally with all of its existing and future
senior unsecured indebtedness. Interest payments on the Senior Notes are due on
May 1st and November 1st of each year. ACGL may redeem the Senior
Notes at any time and from time to time, in whole or in part, at a make-whole
redemption price. For the six months ended June 30, 2008 and 2007, i
nterest expense
on the Senior Notes was approximately $11.0 million. The fair value of the
Senior Notes at June 30, 2008 and December 31, 2007 was $304.1
million and $325.4 million, respectively.
Letter
of Credit and Revolving Credit Facilities
As of June 30, 2008,
the Company had a $300 million unsecured revolving loan and letter of credit
facility and a $1.0 billion secured letter of credit facility (the Credit
Agreement). The $300 million unsecured revolving loan is also available for
the issuance of unsecured letters of credit up to $100 million for Arch
Reinsurance Company (Arch Re U.S.). Borrowings of revolving loans may be made
by ACGL and Arch Re U.S. at a variable rate based on LIBOR or an alternative
base rate at the option of the Company. Secured letters of credit are available
for issuance on behalf of the Companys insurance and reinsurance subsidiaries.
Issuance of letters of credit and borrowings under the Credit Agreement are subject
to the Companys compliance with certain covenants and conditions, including
absence of a material adverse change. These covenants require, among other
things, that the Company maintain a debt to shareholders equity ratio of not
greater than 0.35 to 1 and shareholders equity in excess of $1.95 billion plus
25% of future aggregate net income for each quarterly period (not including any
future net losses) beginning after June 30, 2006 and 25% of future
aggregate proceeds from the issuance of common or preferred equity and that the
Companys principal insurance and reinsurance subsidiaries maintain at least a B++
rating from A.M. Best. In addition, certain of the Companys subsidiaries
which are party to the Credit Agreement are required to maintain minimum
shareholders equity levels. The Company was in compliance with all covenants
contained in the Credit Agreement at June 30, 2008. The Credit Agreement
expires on August 30, 2011.
In May 2008, the
Company borrowed $100.0 million under the Credit Agreement at a variable
interest rate based on 1 month, 3 month or 6 month LIBOR rates plus 27.5 basis
points. The proceeds from such borrowings, which are repayable on August 30,
2011, were contributed to Arch Reinsurance Ltd. (Arch Re Bermuda) and used to
fund an investment in a joint venture.
See Note 6, Investment
InformationInvestment in Joint Venture.
The Company incurred interest expense in connection
with the borrowing of $0.3 million during the 2008 second quarter.
Including the secured
letter of credit portion of the Credit Agreement and another letter of credit
facility (together, the LOC Facilities), the Company has access to letter of
credit facilities for up to a total of $1.45 billion. The principal purpose of
the LOC Facilities is to issue, as required, evergreen standby letters of
credit in favor of primary insurance or reinsurance counterparties with which
the Company has entered into reinsurance arrangements to ensure that such
counterparties are permitted to take credit for reinsurance obtained from the
Companys reinsurance subsidiaries in United States jurisdictions where such
subsidiaries are not licensed or otherwise admitted as an insurer, as required
under insurance regulations in the United States, and to comply with
requirements of Lloyds of London in connection with qualifying quota share and
other arrangements. The amount of letters of credit issued is driven by, among
other things, the timing and payment of catastrophe losses, loss development of
existing reserves, the payment pattern of such reserves, the further expansion
of the Companys business and the loss experience of such business. When
issued, certain letters of credit are secured by a portion of the Companys
investment portfolio. In addition, the LOC Facilities also require the
maintenance
10
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
of certain
covenants, which the Company was in compliance with at June 30, 2008. At
such date, the Company had approximately $565.0 million in outstanding letters
of credit under the LOC Facilities, which were secured by investments totaling $582.2
million at fair value. It is anticipated that the LOC Facilities will be
renewed (or replaced) on expiry, but such renewal (or replacement) will be
subject to the availability of credit from banks which the Company utilizes. In
addition to letters of credit, the Company has and may establish insurance
trust accounts in the U.S. and Canada to secure its reinsurance amounts payable
as required.
4. Segment Information
The Company classifies
its businesses into two underwriting segments insurance and reinsurance and
corporate and other (non-underwriting). The Companys 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 Companys 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 Companys consolidated
financial statements. Intersegment business is allocated to the segment
accountable for the underwriting results.
The insurance segment consists
of the Companys insurance underwriting subsidiaries which primarily write on
both an admitted and non-admitted basis. The insurance segment consists of nine
product lines: casualty; construction and national accounts; executive
assurance; healthcare; professional liability; programs; property, marine and
aviation; surety; and other (consisting of collateral protection, excess
workers compensation and employers liability business and travel and accident
business).
The reinsurance segment
consists of the Companys 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).
Corporate
and other (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, equity in net income
(loss) of investment funds accounted for using the equity method, net foreign
exchange gains or losses and income taxes. In addition, corporate and other
results include dividends on the Companys non-cumulative preferred shares
.
11
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following tables set
forth an analysis of the Companys underwriting income by segment, together
with a reconciliation of underwriting income to net income available to common
shareholders:
|
|
Three Months Ended
|
|
|
|
June 30, 2008
|
|
|
|
Insurance
|
|
Reinsurance
|
|
Total
|
|
|
|
|
|
|
|
|
|
Gross premiums
written
(1)
|
|
$
|
621,663
|
|
$
|
273,318
|
|
$
|
886,926
|
|
Net premiums
written
(1)
|
|
421,501
|
|
264,617
|
|
686,118
|
|
|
|
|
|
|
|
|
|
Net premiums
earned
(1)
|
|
$
|
416,585
|
|
$
|
289,090
|
|
$
|
705,675
|
|
Fee income
|
|
880
|
|
358
|
|
1,238
|
|
Losses and loss
adjustment expenses
|
|
(262,633
|
)
|
(141,992
|
)
|
(404,625
|
)
|
Acquisition
expenses
|
|
(55,400
|
)
|
(63,826
|
)
|
(119,226
|
)
|
Other operating
expenses
|
|
(71,566
|
)
|
(20,091
|
)
|
(91,657
|
)
|
Underwriting
income
|
|
$
|
27,866
|
|
$
|
63,539
|
|
91,405
|
|
Net investment
income
|
|
|
|
|
|
117,120
|
|
Net realized
losses
|
|
|
|
|
|
(12,669
|
)
|
Equity in net
income (loss) of investment funds accounted for using the equity method
|
|
|
|
|
|
19,583
|
|
Other income
|
|
|
|
|
|
4,968
|
|
Other expenses
|
|
|
|
|
|
(10,921
|
)
|
Interest expense
|
|
|
|
|
|
(5,788
|
)
|
Net foreign
exchange gains
|
|
|
|
|
|
298
|
|
Income before
income taxes
|
|
|
|
|
|
203,996
|
|
Income tax
expense
|
|
|
|
|
|
(5,253
|
)
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
|
|
|
198,743
|
|
Preferred
dividends
|
|
|
|
|
|
(6,461
|
)
|
Net
income available to common shareholders
|
|
|
|
|
|
$
|
192,282
|
|
|
|
|
|
|
|
|
|
Underwriting
Ratios
|
|
|
|
|
|
|
|
Loss ratio
|
|
63.0
|
%
|
49.1
|
%
|
57.3
|
%
|
Acquisition
expense ratio
(2)
|
|
13.1
|
%
|
22.1
|
%
|
16.8
|
%
|
Other operating
expense ratio
|
|
17.2
|
%
|
6.9
|
%
|
13.0
|
%
|
Combined ratio
|
|
93.3
|
%
|
78.1
|
%
|
87.1
|
%
|
(1)
Certain amounts included in the gross
premiums written of each segment are related to intersegment transactions.
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. The insurance segment
and reinsurance segment results include $0.1 million and $8.0 million,
respectively, of gross and net premiums written and $0.1 million and $8.5
million, respectively, of net premiums earned assumed through intersegment
transactions.
(2)
The acquisition expense ratio is adjusted
to include policy-related fee income.
12
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
Three Months Ended
|
|
|
|
June 30, 2007
|
|
|
|
Insurance
|
|
Reinsurance
|
|
Total
|
|
|
|
|
|
|
|
|
|
Gross premiums
written
(1)
|
|
$
|
684,725
|
|
$
|
427,348
|
|
$
|
1,102,210
|
|
Net premiums
written
(1)
|
|
451,828
|
|
306,067
|
|
757,895
|
|
|
|
|
|
|
|
|
|
Net premiums
earned
(1)
|
|
$
|
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
|
|
(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
|
|
|
|
|
|
113,923
|
|
Net realized
losses
|
|
|
|
|
|
(3,757
|
)
|
Equity in net
income (loss) of investment funds accounted for using the equity method
|
|
|
|
|
|
3,376
|
|
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.
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. The insurance segment
and reinsurance segment results include $0.3 million and $9.6 million,
respectively, of gross and net premiums written and $0.3 million and $10.8
million, respectively, of net premiums earned assumed through intersegment
transactions.
(2)
The acquisition expense ratio is adjusted
to include policy-related fee income.
13
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
Six Months Ended
June 30, 2008
|
|
|
|
Insurance
|
|
Reinsurance
|
|
Total
|
|
|
|
|
|
|
|
|
|
Gross premiums
written
(1)
|
|
$
|
1,248,011
|
|
$
|
707,145
|
|
$
|
1,940,078
|
|
Net premiums
written
(1)
|
|
824,265
|
|
673,195
|
|
1,497,460
|
|
|
|
|
|
|
|
|
|
Net premiums
earned
(1)
|
|
$
|
835,685
|
|
$
|
578,224
|
|
$
|
1,413,909
|
|
Fee income
|
|
1,762
|
|
544
|
|
2,306
|
|
Losses and loss
adjustment expenses
|
|
(549,936
|
)
|
(259,106
|
)
|
(809,042
|
)
|
Acquisition
expenses
|
|
(107,289
|
)
|
(126,576
|
)
|
(233,865
|
)
|
Other operating
expenses
|
|
(145,203
|
)
|
(38,329
|
)
|
(183,532
|
)
|
Underwriting
income
|
|
$
|
35,019
|
|
$
|
154,757
|
|
189,776
|
|
|
|
|
|
|
|
|
|
Net investment
income
|
|
|
|
|
|
239,313
|
|
Net realized
gains
|
|
|
|
|
|
23,306
|
|
Equity in net
income (loss) of investment funds accounted for using the equity method
|
|
|
|
|
|
(2,730
|
)
|
Other income
|
|
|
|
|
|
9,004
|
|
Other expenses
|
|
|
|
|
|
(16,233
|
)
|
Interest expense
|
|
|
|
|
|
(11,312
|
)
|
Net foreign
exchange losses
|
|
|
|
|
|
(23,289
|
)
|
Income before
income taxes
|
|
|
|
|
|
407,835
|
|
Income tax
expense
|
|
|
|
|
|
(13,209
|
)
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
|
|
|
394,626
|
|
Preferred
dividends
|
|
|
|
|
|
(12,922
|
)
|
Net
income available to common shareholders
|
|
|
|
|
|
$
|
381,704
|
|
|
|
|
|
|
|
|
|
Underwriting
Ratios
|
|
|
|
|
|
|
|
Loss ratio
|
|
65.8
|
%
|
44.8
|
%
|
57.2
|
%
|
Acquisition
expense ratio
(2)
|
|
12.6
|
%
|
21.9
|
%
|
16.4
|
%
|
Other operating
expense ratio
|
|
17.4
|
%
|
6.6
|
%
|
13.0
|
%
|
Combined ratio
|
|
95.8
|
%
|
73.3
|
%
|
86.6
|
%
|
(1)
|
|
Certain amounts
included in the gross premiums written of each segment are related to
intersegment transactions. 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. The insurance segment and reinsurance segment results include $0.1
million and $15.0 million, respectively, of gross and net premiums written
and $0.2 million and $17.2 million, respectively, of net premiums earned
assumed through intersegment transactions.
|
|
|
|
(2)
|
|
The acquisition expense
ratio is adjusted to include policy-related fee income.
|
14
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
Six Months Ended
June 30, 2007
|
|
|
|
Insurance
|
|
Reinsurance
|
|
Total
|
|
|
|
|
|
|
|
|
|
Gross premiums
written
(1)
|
|
$
|
1,345,935
|
|
$
|
986,002
|
|
2,312,824
|
|
Net premiums written
(1)
|
|
880,172
|
|
749,468
|
|
1,629,640
|
|
|
|
|
|
|
|
|
|
Net premiums
earned
(1)
|
|
$
|
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
|
|
(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
|
|
|
|
|
|
223,970
|
|
Net realized
losses
|
|
|
|
|
|
(4,738
|
)
|
Equity in net
income (loss) of investment funds accounted for using the equity method
|
|
|
|
|
|
6,018
|
|
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. 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. The insurance segment and reinsurance segment results include $0.8
million and $18.3 million, respectively, of gross and net premiums written
and $0.8 million and $21.4 million, respectively, of net premiums earned
assumed through intersegment transactions.
|
|
|
|
(2)
|
|
The acquisition expense
ratio is adjusted to include policy-related fee income.
|
15
Table of
Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The following table sets
forth the insurance segments net premiums written and earned by major line of
business and type of business, together with net premiums written by client
location and underwriting location:
|
|
Three Months Ended
June 30,
|
|
|
|
2008
|
|
2007
|
|
|
|
Amount
|
|
% of
Total
|
|
Amount
|
|
% of
Total
|
|
INSURANCE
SEGMENT
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written (1)
|
|
|
|
|
|
|
|
|
|
Property, marine
and aviation
|
|
$
|
90,569
|
|
21.5
|
|
$
|
104,705
|
|
23.2
|
|
Programs
|
|
73,202
|
|
17.3
|
|
59,154
|
|
13.1
|
|
Construction and
national accounts
|
|
65,752
|
|
15.6
|
|
55,514
|
|
12.3
|
|
Professional
liability
|
|
63,583
|
|
15.1
|
|
64,584
|
|
14.3
|
|
Executive
assurance
|
|
43,740
|
|
10.4
|
|
47,904
|
|
10.6
|
|
Casualty
|
|
30,266
|
|
7.2
|
|
57,240
|
|
12.6
|
|
Healthcare
|
|
11,027
|
|
2.6
|
|
12,383
|
|
2.7
|
|
Surety
|
|
10,206
|
|
2.4
|
|
12,968
|
|
2.9
|
|
Other
(2)
|
|
33,156
|
|
7.9
|
|
37,376
|
|
8.3
|
|
Total
|
|
$
|
421,501
|
|
100.0
|
|
$
|
451,828
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned (1)
|
|
|
|
|
|
|
|
|
|
Property, marine
and aviation
|
|
$
|
84,472
|
|
20.3
|
|
$
|
92,387
|
|
21.4
|
|
Programs
|
|
62,085
|
|
14.9
|
|
57,036
|
|
13.2
|
|
Construction and
national accounts
|
|
58,166
|
|
14.0
|
|
50,965
|
|
11.8
|
|
Professional
liability
|
|
66,200
|
|
15.9
|
|
65,804
|
|
15.2
|
|
Executive
assurance
|
|
44,496
|
|
10.7
|
|
47,408
|
|
11.0
|
|
Casualty
|
|
37,650
|
|
9.0
|
|
52,570
|
|
12.1
|
|
Healthcare
|
|
13,137
|
|
3.1
|
|
17,107
|
|
3.9
|
|
Surety
|
|
12,057
|
|
2.9
|
|
16,597
|
|
3.8
|
|
Other
(2)
|
|
38,322
|
|
9.2
|
|
32,686
|
|
7.6
|
|
Total
|
|
$
|
416,585
|
|
100.0
|
|
$
|
432,560
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written by client location (1)
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
330,154
|
|
78.3
|
|
$
|
361,733
|
|
80.1
|
|
Europe
|
|
56,657
|
|
13.5
|
|
60,968
|
|
13.5
|
|
Other
|
|
34,690
|
|
8.2
|
|
29,127
|
|
6.4
|
|
Total
|
|
$
|
421,501
|
|
100.0
|
|
$
|
451,828
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written by underwriting location (1)
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
318,227
|
|
75.5
|
|
$
|
341,456
|
|
75.6
|
|
Europe
|
|
79,854
|
|
18.9
|
|
83,730
|
|
18.5
|
|
Other
|
|
23,420
|
|
5.6
|
|
26,642
|
|
5.9
|
|
Total
|
|
$
|
421,501
|
|
100.0
|
|
$
|
451,828
|
|
100.0
|
|
(1)
|
|
Insurance segment
results include premiums written and earned assumed through intersegment
transactions of $0.1 million for the 2008 second quarter and $0.3 million for
the 2007 second quarter. Insurance segment results exclude premiums written
and earned ceded through intersegment transactions of $8.0 million and $8.5
million, respectively, for the 2008 second quarter and $9.6 million and $10.8
million, respectively, for the 2007 second quarter.
|
|
|
|
(2)
|
|
Includes excess
workers compensation and employers liability business and travel and
accident business.
|
16
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
Six Months Ended
June 30,
|
|
|
|
2008
|
|
2007
|
|
|
|
Amount
|
|
% of
Total
|
|
Amount
|
|
% of
Total
|
|
INSURANCE
SEGMENT
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written (1)
|
|
|
|
|
|
|
|
|
|
Property, marine
and aviation
|
|
$
|
188,731
|
|
22.9
|
|
$
|
189,568
|
|
21.5
|
|
Programs
|
|
127,785
|
|
15.5
|
|
117,477
|
|
13.3
|
|
Construction and
national accounts
|
|
126,963
|
|
15.4
|
|
115,997
|
|
13.2
|
|
Professional
liability
|
|
117,664
|
|
14.3
|
|
122,939
|
|
14.0
|
|
Executive
assurance
|
|
85,909
|
|
10.4
|
|
91,995
|
|
10.4
|
|
Casualty
|
|
57,884
|
|
7.0
|
|
100,331
|
|
11.4
|
|
Healthcare
|
|
22,024
|
|
2.7
|
|
33,913
|
|
3.9
|
|
Surety
|
|
21,073
|
|
2.6
|
|
31,715
|
|
3.6
|
|
Other
(2)
|
|
76,232
|
|
9.2
|
|
76,237
|
|
8.7
|
|
Total
|
|
$
|
824,265
|
|
100.0
|
|
$
|
880,172
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned (1)
|
|
|
|
|
|
|
|
|
|
Property, marine
and aviation
|
|
$
|
169,464
|
|
20.3
|
|
$
|
174,191
|
|
20.6
|
|
Programs
|
|
119,072
|
|
14.2
|
|
113,245
|
|
13.4
|
|
Construction and
national accounts
|
|
115,281
|
|
13.8
|
|
98,940
|
|
11.7
|
|
Professional
liability
|
|
135,010
|
|
16.2
|
|
133,688
|
|
15.8
|
|
Executive
assurance
|
|
88,904
|
|
10.6
|
|
92,786
|
|
10.9
|
|
Casualty
|
|
79,422
|
|
9.5
|
|
104,112
|
|
12.3
|
|
Healthcare
|
|
26,582
|
|
3.2
|
|
36,951
|
|
4.4
|
|
Surety
|
|
25,556
|
|
3.1
|
|
35,726
|
|
4.2
|
|
Other
(2)
|
|
76,394
|
|
9.1
|
|
56,768
|
|
6.7
|
|
Total
|
|
$
|
835,685
|
|
100.0
|
|
$
|
846,407
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written by client location (1)
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
609,409
|
|
73.9
|
|
$
|
681,738
|
|
77.5
|
|
Europe
|
|
142,957
|
|
17.4
|
|
135,903
|
|
15.4
|
|
Other
|
|
71,899
|
|
8.7
|
|
62,531
|
|
7.1
|
|
Total
|
|
$
|
824,265
|
|
100.0
|
|
$
|
880,172
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written by underwriting location (1)
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
605,436
|
|
73.4
|
|
$
|
673,014
|
|
76.5
|
|
Europe
|
|
181,865
|
|
22.1
|
|
165,746
|
|
18.8
|
|
Other
|
|
36,964
|
|
4.5
|
|
41,412
|
|
4.7
|
|
Total
|
|
$
|
824,265
|
|
100.0
|
|
$
|
880,172
|
|
100.0
|
|
(1)
|
|
Insurance segment
results include premiums written and earned assumed through intersegment
transactions of $0.1 million and $0.2 million, respectively, for the 2008
period and $0.8 million for the 2007 period. Insurance segment results
exclude premiums written and earned ceded through intersegment transactions
of $15.0 million and $17.2 million, respectively, for the 2008 period and
$18.3 million and $21.4 million, respectively, for the 2007 period.
|
|
|
|
(2)
|
|
Includes excess
workers compensation and employers liability business and travel and
accident business.
|
17
Table of
Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The following table sets
forth the reinsurance segments net premiums written and earned by major line
of business and type of business, together with net premiums written by client
location and underwriting location:
|
|
Three Months Ended
June 30,
|
|
|
|
2008
|
|
2007
|
|
|
|
Amount
|
|
% of Total
|
|
Amount
|
|
% of Total
|
|
REINSURANCE
SEGMENT
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written (1)
|
|
|
|
|
|
|
|
|
|
Casualty
(2)
|
|
$
|
86,974
|
|
32.9
|
|
$
|
110,108
|
|
36.0
|
|
Property
excluding property catastrophe
(3)
|
|
85,748
|
|
32.4
|
|
69,351
|
|
22.7
|
|
Property
catastrophe
|
|
52,797
|
|
19.9
|
|
77,514
|
|
25.3
|
|
Other specialty
|
|
20,693
|
|
7.8
|
|
27,971
|
|
9.1
|
|
Marine and
aviation
|
|
17,975
|
|
6.8
|
|
19,812
|
|
6.5
|
|
Other
|
|
430
|
|
0.2
|
|
1,311
|
|
0.4
|
|
Total
|
|
$
|
264,617
|
|
100.0
|
|
$
|
306,067
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned (1)
|
|
|
|
|
|
|
|
|
|
Casualty
(2)
|
|
$
|
106,199
|
|
36.8
|
|
$
|
131,114
|
|
41.1
|
|
Property
excluding property catastrophe
(3)
|
|
67,445
|
|
23.3
|
|
64,734
|
|
20.3
|
|
Property
catastrophe
|
|
51,496
|
|
17.8
|
|
38,152
|
|
12.0
|
|
Other specialty
|
|
36,058
|
|
12.5
|
|
52,582
|
|
16.5
|
|
Marine and
aviation
|
|
26,946
|
|
9.3
|
|
30,021
|
|
9.4
|
|
Other
|
|
946
|
|
0.3
|
|
2,249
|
|
0.7
|
|
Total
|
|
$
|
289,090
|
|
100.0
|
|
$
|
318,852
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written (1)
|
|
|
|
|
|
|
|
|
|
Pro rata
|
|
$
|
168,025
|
|
63.5
|
|
$
|
184,972
|
|
60.4
|
|
Excess of loss
|
|
96,592
|
|
36.5
|
|
121,095
|
|
39.6
|
|
Total
|
|
$
|
264,617
|
|
100.0
|
|
$
|
306,067
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned (1)
|
|
|
|
|
|
|
|
|
|
Pro rata
|
|
$
|
195,070
|
|
67.5
|
|
$
|
228,815
|
|
71.8
|
|
Excess of loss
|
|
94,020
|
|
32.5
|
|
90,037
|
|
28.2
|
|
Total
|
|
$
|
289,090
|
|
100.0
|
|
$
|
318,852
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written by client location (1)
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
153,106
|
|
57.9
|
|
$
|
206,456
|
|
67.5
|
|
Europe
|
|
58,372
|
|
22.1
|
|
37,710
|
|
12.3
|
|
Bermuda
|
|
40,784
|
|
15.4
|
|
47,851
|
|
15.6
|
|
Other
|
|
12,355
|
|
4.6
|
|
14,050
|
|
4.6
|
|
Total
|
|
$
|
264,617
|
|
100.0
|
|
$
|
306,067
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written by underwriting location (1)
|
|
|
|
|
|
|
|
|
|
Bermuda
|
|
$
|
160,228
|
|
60.6
|
|
$
|
205,138
|
|
67.0
|
|
United States
|
|
92,629
|
|
35.0
|
|
99,515
|
|
32.5
|
|
Other
|
|
11,760
|
|
4.4
|
|
1,414
|
|
0.5
|
|
Total
|
|
$
|
264,617
|
|
100.0
|
|
$
|
306,067
|
|
100.0
|
|
(1)
|
|
Reinsurance segment
results include premiums written and earned assumed through intersegment
transactions of $8.0 million and $8.5 million, respectively, for the 2008
second quarter and $9.6 million and $10.8 million, respectively, for the 2007
second quarter. Reinsurance segment results exclude premiums written and
earned ceded through intersegment transactions of $0.1 million for the 2008
second quarter and $0.3 million for the 2007 second quarter.
|
|
|
|
(2)
|
|
Includes professional
liability, executive assurance and healthcare business.
|
|
|
|
(3)
|
|
Includes facultative
business.
|
18
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
Six Months Ended
June 30,
|
|
|
|
2008
|
|
2007
|
|
|
|
Amount
|
|
% of Total
|
|
Amount
|
|
% of Total
|
|
REINSURANCE
SEGMENT
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written (1)
|
|
|
|
|
|
|
|
|
|
Casualty
(2)
|
|
$
|
192,961
|
|
28.7
|
|
$
|
254,582
|
|
34.0
|
|
Property
excluding property catastrophe
(3)
|
|
181,670
|
|
27.0
|
|
164,297
|
|
21.9
|
|
Property
catastrophe
|
|
159,021
|
|
23.6
|
|
158,173
|
|
21.1
|
|
Other specialty
|
|
96,373
|
|
14.3
|
|
101,967
|
|
13.6
|
|
Marine and
aviation
|
|
40,139
|
|
6.0
|
|
63,527
|
|
8.5
|
|
Other
|
|
3,031
|
|
0.4
|
|
6,922
|
|
0.9
|
|
Total
|
|
$
|
673,195
|
|
100.0
|
|
$
|
749,468
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned (1)
|
|
|
|
|
|
|
|
|
|
Casualty
(2)
|
|
$
|
213,847
|
|
37.0
|
|
$
|
271,556
|
|
41.7
|
|
Property
excluding property catastrophe
(3)
|
|
130,786
|
|
22.6
|
|
137,776
|
|
21.2
|
|
Property
catastrophe
|
|
101,777
|
|
17.6
|
|
72,842
|
|
11.2
|
|
Other specialty
|
|
74,542
|
|
12.9
|
|
104,624
|
|
16.1
|
|
Marine and
aviation
|
|
54,377
|
|
9.4
|
|
56,643
|
|
8.7
|
|
Other
|
|
2,895
|
|
0.5
|
|
7,057
|
|
1.1
|
|
Total
|
|
$
|
578,224
|
|
100.0
|
|
$
|
650,498
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written (1)
|
|
|
|
|
|
|
|
|
|
Pro rata
|
|
$
|
383,444
|
|
57.0
|
|
$
|
448,787
|
|
59.9
|
|
Excess of loss
|
|
289,751
|
|
43.0
|
|
300,681
|
|
40.1
|
|
Total
|
|
$
|
673,195
|
|
100.0
|
|
$
|
749,468
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned (1)
|
|
|
|
|
|
|
|
|
|
Pro rata
|
|
$
|
387,146
|
|
67.0
|
|
$
|
471,254
|
|
72.4
|
|
Excess of loss
|
|
191,078
|
|
33.0
|
|
179,244
|
|
27.6
|
|
Total
|
|
$
|
578,224
|
|
100.0
|
|
$
|
650,498
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written by client location (1)
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
370,285
|
|
55.0
|
|
$
|
460,447
|
|
61.4
|
|
Europe
|
|
202,292
|
|
30.1
|
|
162,048
|
|
21.6
|
|
Bermuda
|
|
74,844
|
|
11.1
|
|
98,692
|
|
13.2
|
|
Other
|
|
25,774
|
|
3.8
|
|
28,281
|
|
3.8
|
|
Total
|
|
$
|
673,195
|
|
100.0
|
|
$
|
749,468
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written by underwriting location (1)
|
|
|
|
|
|
|
|
|
|
Bermuda
|
|
$
|
380,897
|
|
56.6
|
|
$
|
457,166
|
|
61.0
|
|
United States
|
|
247,109
|
|
36.7
|
|
279,877
|
|
37.3
|
|
Other
|
|
45,189
|
|
6.7
|
|
12,425
|
|
1.7
|
|
Total
|
|
$
|
673,195
|
|
100.0
|
|
$
|
749,468
|
|
100.0
|
|
(1)
|
|
Reinsurance segment
results include premiums written and earned assumed through intersegment
transactions of $15.0 million and $17.2 million, respectively, for the 2008
period and $18.3 million and $21.4 million, respectively, for the 2007
period. Reinsurance segment results exclude premiums written and earned ceded
through intersegment transactions of $0.1 million and $0.2 million,
respectively, for the 2008 period and $0.8 million for the 2007 period.
|
|
|
|
(2)
|
|
Includes professional
liability, executive assurance and healthcare business.
|
|
|
|
(3)
|
|
Includes facultative
business.
|
19
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
5. Reinsurance
In the normal course of business, the Companys insurance
subsidiaries cede a substantial portion of their premium through pro rata,
excess of loss and facultative reinsurance agreements. The Companys
reinsurance subsidiaries participate in common account retrocessional
arrangements for certain pro rata treaties. Such arrangements reduce the effect
of individual or aggregate losses to all companies participating on such
treaties, including the reinsurers, such as the Companys reinsurance
subsidiaries, and the ceding company. In addition, the Companys reinsurance
subsidiaries may purchase retrocessional coverage as part of their risk
management program. Reinsurance recoverables are recorded as assets, predicated
on the reinsurers ability to meet their obligations under the reinsurance
agreements. If the reinsurers are unable to satisfy their obligations under the
agreements, the Companys insurance or reinsurance subsidiaries would be liable
for such defaulted amounts. The effects of reinsurance on the Companys written
and earned premiums and losses and loss adjustment expenses with unaffiliated
reinsurers were as follows:
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
Premiums
Written
|
|
|
|
|
|
|
|
|
|
Direct
|
|
$
|
579,006
|
|
$
|
673,960
|
|
$
|
1,198,492
|
|
$
|
1,323,840
|
|
Assumed
|
|
307,920
|
|
428,250
|
|
741,586
|
|
988,984
|
|
Ceded
|
|
(200,808
|
)
|
(344,315
|
)
|
(442,618
|
)
|
(683,184
|
)
|
Net
|
|
$
|
686,118
|
|
$
|
757,895
|
|
$
|
1,497,460
|
|
$
|
1,629,640
|
|
|
|
|
|
|
|
|
|
|
|
Premiums
Earned
|
|
|
|
|
|
|
|
|
|
Direct
|
|
$
|
615,216
|
|
$
|
655,173
|
|
$
|
1,246,030
|
|
$
|
1,292,181
|
|
Assumed
|
|
354,712
|
|
407,543
|
|
720,076
|
|
823,675
|
|
Ceded
|
|
(264,253
|
)
|
(311,304
|
)
|
(552,197
|
)
|
(618,951
|
)
|
Net
|
|
$
|
705,675
|
|
$
|
751,412
|
|
$
|
1,413,909
|
|
$
|
1,496,905
|
|
|
|
|
|
|
|
|
|
|
|
Losses
and Loss Adjustment Expenses
|
|
|
|
|
|
|
|
|
|
Direct
|
|
$
|
355,680
|
|
$
|
378,249
|
|
$
|
776,651
|
|
$
|
737,725
|
|
Assumed
|
|
186,099
|
|
183,150
|
|
327,348
|
|
378,421
|
|
Ceded
|
|
(137,154
|
)
|
(135,736
|
)
|
(294,957
|
)
|
(270,422
|
)
|
Net
|
|
$
|
404,625
|
|
$
|
425,663
|
|
$
|
809,042
|
|
$
|
845,724
|
|
The Company monitors the financial condition of its
reinsurers and attempts to place coverages only with substantial, financially
sound carriers. At June 30, 2008 and December 31, 2007, approximately
86.2% and 88.5%, respectively, of the Companys reinsurance recoverables on
paid and unpaid losses (not including prepaid reinsurance premiums) of $1.70
billion and $1.74 billion, respectively, were due from carriers which had an A.M.
Best rating of A- or better. At June 30, 2008 and December 31,
2007, the largest reinsurance recoverables from any one carrier were less than
5.8% and 5.2%, respectively, of the Companys total shareholders equity.
On December 29, 2005, Arch Re Bermuda entered
into a quota share reinsurance treaty with Flatiron Re Ltd., a Bermuda
reinsurance company, pursuant to which Flatiron Re Ltd. assumed a 45% quota
share (the Treaty) of certain lines of property and marine business
underwritten by Arch Re Bermuda for unaffiliated third parties for the 2006 and
2007 underwriting years (January 1, 2006 to December 31, 2007).
Effective June 28, 2006, the parties amended the Treaty to increase the
percentage ceded to Flatiron Re Ltd. from 45% to 70% of all covered business
bound by Arch Re Bermuda from (and including) June 28, 2006 until (and
including) August 15, 2006 provided such business did not incept beyond September 30,
2006. The ceding percentage for all business bound outside of this period
continued to be 45%. On December 31, 2007, the Treaty expired by its
terms.
20
Table of
Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Flatiron Re Ltd. is required to contribute funds into
a trust for the benefit of Arch Re Bermuda (the Trust). Effective June 28,
2006, the parties amended the Treaty to provide that, through the earning of
all written premium, the amount required to be on deposit in the Trust,
together with certain other amounts, will be an amount equal to a calculated
amount estimated to cover ceded losses arising from in excess of two 1-in-250
year events for the applicable forward twelve-month period (the Requisite
Funded Amount). If the actual amounts on deposit in the Trust, together with
certain other amounts (the Funded Amount), do not at least equal the
Requisite Funded Amount, Arch Re Bermuda will, among other things, recapture
unearned premium reserves and reassume losses that would have been ceded in
respect of such unearned premiums. No assurances can be given that actual
losses will not exceed the Requisite Funded Amount or that Flatiron Re Ltd.
will make, or will have the ability to make, the required contributions into
the Trust.
Arch Re Bermuda pays to Flatiron Re Ltd. a reinsurance
premium in the amount of the ceded percentage of the original gross written
premium on the business reinsured less a ceding commission, which includes a
reimbursement of direct acquisition expenses as well as a commission to Arch Re
Bermuda for generating the business. The Treaty also provides for a profit
commission to Arch Re Bermuda based on the underwriting results for the 2006
and 2007 underwriting years on a cumulative basis. For the 2008 second quarter,
$7.0 million of premiums written, $45.9 million of premiums earned and $15.7
million of losses and loss adjustment expenses were ceded to Flatiron Re Ltd.
by Arch Re Bermuda, compared to $115.9 million of premiums written, $72.5
million of premiums earned and $28.0 million of losses and loss adjustment
expenses for the 2007 second quarter. For the six months ended June 30,
2008, $25.4 million of premiums written, $104.7 million of premiums earned and
$27.5 million of losses and loss adjustment expenses were ceded to Flatiron Re
Ltd. by Arch Re Bermuda, compared to $224.8 million of premiums written, $138.5
million of premiums earned and $53.4 million of losses and loss adjustment
expenses for 2007 period. At June 30, 2008, $65.6 million of premiums
ceded to Flatiron Re Ltd. were unearned. Reinsurance recoverables from Flatiron
Re Ltd., which is not rated by A.M. Best, were $180.1 million at June 30,
2008, compared to $152.6 million at December 31, 2007. As noted above,
Flatiron Re Ltd. is required to contribute funds into a trust for the benefit
of Arch Re Bermuda. The recoverable from Flatiron Re Ltd. was fully
collateralized through such trust at June 30, 2008 and December 31,
2007.
6.
Investment Information
The following
table summarizes the Companys invested assets:
|
|
June 30,
2008
|
|
December 31,
2007
|
|
|
|
|
|
|
|
Fixed maturities
available for sale, at fair value
|
|
$
|
7,746,296
|
|
$
|
7,137,998
|
|
Fixed maturities
pledged under securities lending agreements, at fair value
(1)
|
|
890,822
|
|
1,462,826
|
|
Total fixed
maturities
|
|
8,637,118
|
|
8,600,824
|
|
Short-term
investments available for sale, at fair value
|
|
645,587
|
|
699,036
|
|
Short-term
investments pledged under securities lending agreements, at fair value
(1)
|
|
|
|
219
|
|
Other
investments
|
|
295,638
|
|
353,694
|
|
Investment funds
accounted for using the equity method
|
|
351,879
|
|
235,975
|
|
Investment in
joint venture
|
|
100,000
|
|
|
|
Total
investments
(1)
|
|
10,030,222
|
|
9,889,748
|
|
Securities
transactions entered into but not settled at the balance sheet date
|
|
(10,845
|
)
|
(5,796
|
)
|
Total
investments, net of securities transactions
|
|
$
|
10,019,377
|
|
$
|
9,883,952
|
|
(1)
|
|
In securities lending
transactions, the Company receives collateral in excess of the fair value of
the fixed maturities and short-term investments pledged under securities
lending agreements. For purposes of this table, the Company has excluded the
collateral received at June 30, 2008 and December 31, 2007 of
$918.2 million and $1.5 billion, respectively, which is reflected as
short-term investment of funds received under securities lending agreements,
at fair value and included the $890.8 million and $1.46 billion, respectively,
of fixed maturities and short-term investments pledged under securities
lending agreements, at fair value.
|
21
Table of
Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Fixed Maturities and
Fixed Maturities Pledged Under Securities Lending Agreements
The following table details the Companys fixed
maturities and fixed maturities pledged under securities lending agreements:
|
|
Estimated
Fair Value
|
|
Gross
Unrealized
Gains
|
|
Gross
Unrealized
Losses
|
|
Amortized
Cost
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
2008:
|
|
|
|
|
|
|
|
|
|
Corporate bonds
|
|
$
|
2,318,198
|
|
$
|
42,801
|
|
$
|
(70,098
|
)
|
$
|
2,345,495
|
|
Mortgage backed
securities
|
|
1,532,524
|
|
13,235
|
|
(48,999
|
)
|
1,568,288
|
|
Commercial
mortgage backed securities
|
|
1,277,512
|
|
9,761
|
|
(5,481
|
)
|
1,273,232
|
|
Asset backed
securities
|
|
1,100,914
|
|
8,190
|
|
(7,505
|
)
|
1,100,229
|
|
Municipal bonds
|
|
1,066,325
|
|
5,905
|
|
(7,825
|
)
|
1,068,245
|
|
U.S. government
and government agencies
|
|
937,496
|
|
10,839
|
|
(7,055
|
)
|
933,712
|
|
Non-U.S.
government securities
|
|
404,149
|
|
23,205
|
|
(10,097
|
)
|
391,041
|
|
Total
|
|
$
|
8,637,118
|
|
$
|
113,936
|
|
$
|
(157,060
|
)
|
$
|
8,680,242
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
2007:
|
|
|
|
|
|
|
|
|
|
Corporate bonds
|
|
$
|
2,452,527
|
|
$
|
40,296
|
|
$
|
(10,994
|
)
|
$
|
2,423,225
|
|
Mortgage backed
securities
|
|
1,234,596
|
|
14,211
|
|
(4,087
|
)
|
1,224,472
|
|
Commercial
mortgage backed securities
|
|
1,315,680
|
|
17,339
|
|
(558
|
)
|
1,298,899
|
|
Asset backed
securities
|
|
1,008,030
|
|
9,508
|
|
(4,030
|
)
|
1,002,552
|
|
Municipal bonds
|
|
990,325
|
|
13,213
|
|
(195
|
)
|
977,307
|
|
U.S. government
and government agencies
|
|
1,165,423
|
|
21,598
|
|
(447
|
)
|
1,144,272
|
|
Non-U.S.
government securities
|
|
434,243
|
|
28,032
|
|
(3,056
|
)
|
409,267
|
|
Total
|
|
$
|
8,600,824
|
|
$
|
144,197
|
|
$
|
(23,367
|
)
|
$
|
8,479,994
|
|
In February 2006,
the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial
Instruments an amendment of FASB Statements No. 133 and 140 (SFAS No. 155).
Upon adopting SFAS No. 155 on January 1, 2007, the Company applied
the fair value option to certain hybrid securities which are included in the
Companys fixed maturities and records changes in market value of such
securities as realized gains or losses. The fair market values of such
securities at June 30, 2008 were approximately $61.9 million and the
Company recorded a realized gain of $0.1 million on such securities for the six
months ended June 30, 2008.
As of June 30, 2008,
the Company held insurance enhanced municipal bonds, net of prerefunded bonds
that are escrowed in U.S. government obligations, in the amount of
approximately $387.5 million, which represented approximately 3.9% of the
Companys total invested assets. These securities had an average rating of Aa2
by Moodys and AA+ by Standard & Poors. Giving no effect to the
insurance enhancement, the overall credit quality of the Companys insured
municipal bond portfolio was an average underlying rating of Aa3 by Moodys
and AA- by Standard & Poors. Guarantors of the Companys $387.5
million of insurance enhanced municipal bonds, net of prerefunded bonds that
are escrowed in U.S. government obligations, include MBIA Insurance Corporation
($148.0 million), Financial Security Assurance Inc. ($86.4 million), Ambac
Financial Group, Inc. ($76.7 million), Financial Guaranty Insurance
Company ($53.3 million) and the Texas Permanent School Fund ($23.1 million).
The Company does not have a significant exposure to insurance enhanced
asset-backed or mortgage-backed securities. The Company does not have any significant
investments in companies which guarantee securities at June 30, 2008.
22
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The Companys investment
portfolio, which includes fixed maturity securities, short-term investments and
other investments, had a AA+ average credit quality rating at June 30,
2008 and December 31, 2007. The credit quality distribution of the Companys
fixed maturities and fixed maturities pledged under securities lending
agreements are shown below:
|
|
June 30, 2008
|
|
December 31, 2007
|
|
Rating (1)
|
|
Estimated
Fair Value
|
|
% of Total
|
|
Estimated
Fair Value
|
|
% of Total
|
|
|
|
|
|
|
|
|
|
|
|
AAA
|
|
$
|
6,110,053
|
|
70.7
|
|
$
|
6,600,258
|
|
76.7
|
|
AA
|
|
1,287,086
|
|
14.9
|
|
882,262
|
|
10.3
|
|
A
|
|
772,697
|
|
9.0
|
|
677,047
|
|
7.9
|
|
BBB
|
|
227,699
|
|
2.6
|
|
243,610
|
|
2.8
|
|
BB
|
|
48,083
|
|
0.6
|
|
25,390
|
|
0.3
|
|
B
|
|
123,650
|
|
1.4
|
|
128,459
|
|
1.5
|
|
Lower than B
|
|
9,738
|
|
0.1
|
|
11,321
|
|
0.1
|
|
Not rated
|
|
58,112
|
|
0.7
|
|
32,477
|
|
0.4
|
|
Total
|
|
$
|
8,637,118
|
|
100.0
|
|
$
|
8,600,824
|
|
100.0
|
|
(1) Ratings as
assigned by the major rating agencies.
Securities Lending
Agreements
The Company participates
in a securities lending program under which certain of its fixed income
portfolio securities are loaned to third parties, primarily major brokerage
firms, for short periods of time through a lending agent. Such securities have
been reclassified as Fixed maturities and short-term investments pledged under
securities lending agreements, at fair value. The Company maintains control
over the securities it lends, retains the earnings and cash flows associated
with the loaned securities and receives a fee from the borrower for the
temporary use of the securities. Collateral received, which to date has only
been cash, is required at a rate of 102% of the market value of the loaned
securities (or 105% of the market value of the loaned securities when the
collateral and loaned securities are denominated in non-U.S. currencies)
including accrued investment income and is monitored and maintained by the
lending agent. Such collateral is reinvested and is reflected as Short-term
investment of funds received under securities lending agreements, at fair
value. At June 30, 2008, the fair value and amortized cost of fixed
maturities and short-term investments pledged under securities lending
agreements were $890.8 million and $892.2 million, respectively, while
collateral received totaled $918.2 million at fair value and amortized cost.
At December 31,
2007, the fair value and amortized cost of
fixed maturities and short-term investments pledged
under securities lending agreements were $1.46 billion and $1.44 billion,
respectively, while collateral received totaled $1.5 billion at fair value and
amortized cost.
Investment-Related
Derivatives
The Companys investment
strategy allows for the use of derivative securities. Derivative instruments
may be used to enhance investment performance, replicate investment positions
or manage market exposures and duration risk that would be allowed under the
Companys investment guidelines if implemented in other ways. The fair values
of those derivatives are based on quoted market prices. At June 30, 2008,
the notional value of the net short position for equity futures was nil,
compared to a net long position for equity futures of $91.2 million at December 31,
2007. At June 30, 2008 and December 31, 2007, the notional value of
the net long position for Treasury note futures was nil and $61.7 million,
respectively. For the 2008 second
quarter and six months ended June 30, 2008, the Company recorded net
realized losses of $11.0 million and $16.8 million, respectively, related to
changes in the fair value of all futures contracts, compared to net realized
gains of $4.8 million and $3.9 million, respectively, for the 2007 second
quarter and six months ended June 30, 2007.
23
Table of
Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Other Investments
The following table details the Companys other
investments:
|
|
June 30, 2008
|
|
December 31, 2007
|
|
|
|
Estimated
Fair Value
|
|
Cost
|
|
Estimated
Fair Value
|
|
Cost
|
|
|
|
|
|
|
|
|
|
|
|
Mutual funds
|
|
$
|
228,466
|
|
$
|
222,393
|
|
$
|
286,147
|
|
$
|
266,515
|
|
Privately held
securities and other
|
|
67,172
|
|
58,850
|
|
67,547
|
|
57,435
|
|
Total
|
|
$
|
295,638
|
|
$
|
281,243
|
|
$
|
353,694
|
|
$
|
323,950
|
|
Other investments include: (i) mutual funds which
invest in fixed maturity securities and international equity index funds; and (ii) privately
held securities and other which include the Companys investment in Aeolus LP
(see Note 9). The Companys investment commitments relating to its other
investments and investment funds accounted for using the equity method totaled
approximately $53.3 million at June 30, 2008.
Investment Funds
Accounted for Using the Equity Method
The Companys investment portfolio includes certain
funds that invest in fixed maturity securities which, due to their ownership
structure, are accounted for by the Company using the equity method. In
applying the equity method, these investments are initially recorded at cost
and are subsequently adjusted based on the Companys proportionate share of the
net income or loss of the funds (which include changes in the market value of
the underlying securities in the funds). Changes in the carrying value of such
investments are recorded in net income as Equity in net income (loss) of
investment funds accounted for using the equity method. Changes in the
carrying value of the Companys other fixed income investments are recorded as
an unrealized gain or loss component of accumulated other comprehensive income
in shareholders equity.
Investment funds accounted for using the
equity method totaled $351.9 million at June 30, 2008, compared to $294.4
million at March 31, 2008 and $236.0 million at December 31, 2007.
For the 2008 second quarter, the Company recorded $19.6 million of equity in
net income of investment funds accounted for using the equity method, compared
to $3.4 million of equity in net income for the 2007 second quarter. For the
six months ended June 30, 2008, the Company recorded $2.7 million of
equity in net loss of investment funds accounted for using the equity method,
compared to $6.0 million of equity in net income for the 2007 period.
Investment in Joint
Venture
In May 2008, the Company provided $100.0 million of
funding to Gulf Reinsurance Limited (Gulf Re), a newly formed reinsurer based
in the Dubai International Financial Centre, pursuant to the joint venture
agreement with Gulf Investment Corporation GSC (GIC). Under the agreement,
each of Arch Re Bermuda and GIC owns 50% of Gulf Re, which has commenced
underwriting activities. Gulf Re will initially target the six member states of
the Gulf Cooperation Council, which include Bahrain, Kuwait, Oman, Qatar, Saudi
Arabia and the United Arab Emirates. The joint venture will write a broad range
of property and casualty reinsurance, including aviation, energy, commercial
transportation, marine, engineered risks and property, on both a treaty and
facultative basis. The initial total capital of the joint venture consists of
$200.0 million, plus an additional $200.0 million to be funded equally by the
Company and GIC depending on the joint ventures business needs. The Company
accounts for its investment in Gulf Re using the equity method and records its
equity in the operating results of Gulf Re on a quarter lag basis.
24
Table of
Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Restricted Assets
The Company is required
to maintain assets on deposit, which primarily consist of fixed maturities,
with various regulatory authorities to support its insurance and reinsurance
operations. The assets on deposit are available to settle insurance and
reinsurance liabilities to third parties. The Company also has investments in
segregated portfolios primarily to provide collateral or guarantees for letters
of credit to third parties. The following table details the value of restricted
assets:
|
|
June 30,
2008
|
|
December 31,
2007
|
|
|
|
|
|
|
|
Assets used for
collateral or guarantees
|
|
$
|
665,656
|
|
$
|
736,938
|
|
Deposits with
U.S. regulatory authorities
|
|
245,088
|
|
251,586
|
|
Trust funds
|
|
136,901
|
|
133,238
|
|
Deposits with
non-U.S. regulatory authorities
|
|
51,799
|
|
46,789
|
|
Total restricted
assets
|
|
$
|
1,099,444
|
|
$
|
1,168,551
|
|
In addition, certain of
the Companys operating subsidiaries maintain assets in trust accounts as
collateral for insurance and reinsurance transactions with affiliated
companies. At June 30, 2008 and December 31, 2007, such amounts
approximated $3.85 billion and $3.8 billion, respectively.
Net
Investment Income
The components of net
investment income were as follows:
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities
|
|
$
|
110,883
|
|
$
|
102,472
|
|
$
|
218,133
|
|
$
|
200,571
|
|
Short-term
investments
|
|
5,486
|
|
8,829
|
|
12,601
|
|
18,563
|
|
Other
(1)
|
|
4,393
|
|
6,103
|
|
15,214
|
|
12,122
|
|
Gross investment
income
|
|
120,762
|
|
117,404
|
|
245,948
|
|
231,256
|
|
Investment
expenses
|
|
(3,642
|
)
|
(3,481
|
)
|
(6,635
|
)
|
(7,286
|
)
|
Net investment
income
|
|
$
|
117,120
|
|
$
|
113,923
|
|
$
|
239,313
|
|
$
|
223,970
|
|
(1) Primarily
consists of interest income on operating cash accounts, other investments and
securities lending transactions.
Net
Realized Gains (Losses)
The components of net
realized gains (losses) were as follows:
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities
|
|
$
|
(4,143
|
)
|
$
|
(8,983
|
)
|
$
|
48,678
|
|
$
|
(10,127
|
)
|
Other
investments
|
|
(2,103
|
)
|
1,000
|
|
(5,281
|
)
|
2,139
|
|
Other
|
|
(6,423
|
)
|
4,226
|
|
(20,091
|
)
|
3,250
|
|
Net realized
(losses) gains
|
|
$
|
(12,669
|
)
|
$
|
(3,757
|
)
|
$
|
23,306
|
|
$
|
(4,738
|
)
|
Currently, the Companys
portfolio is actively managed on a total return basis within certain
guidelines. The effect of financial market movements will influence the
recognition of net realized gains and losses as the portfolio is adjusted and
rebalanced.
25
Table of
Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
For the 2008 second
quarter and six months ended June 30, 2008, net realized gains or losses
on the Companys fixed maturities included provisions for declines in the
market value of investments held in the Companys available for sale portfolio
which were considered to be other-than-temporary of $10.7 million and $23.4
million, respectively, based on reviews performed in each period. For the
2007 second quarter and six months ended June 30, 2007, net realized
losses on the Companys fixed maturities included provisions for declines in
the market value of investments held in the Companys available for sale
portfolio which were considered to be other-than-temporary of $0.5 million and
$7.7 million, respectively, based on reviews performed in each period. For the
2008 and 2007 periods, the balance of net realized gains or losses on the
Companys fixed maturities resulted from the sale of securities following the
Companys decisions to reduce credit exposure, changes in duration targets and
sales related to rebalancing the portfolio.
Certain of the Companys investments, primarily those
included in other investments and investment funds accounted for using the
equity method on the Companys balance sheet, may use leverage to achieve a
higher rate of return. While leverage presents opportunities for increasing the
total return of such investments, it may increase losses as well. Accordingly,
any event that adversely affects the value of the underlying securities held by
such investments would be magnified to the extent leverage is used and the
Companys potential losses from such investments would be magnified.
Fair
Value
Effective January 1,
2008, the Company adopted and implemented SFAS No. 159, The Fair Value
Option for Financial Assets and Financial Liabilities Including an Amendment
of FASB Statement No. 115 (SFAS No. 159), which provides a fair
value option to measure many financial instruments and certain other assets and
liabilities at fair value on an instrument-by-instrument basis. The Company did
not apply the fair value option on any financial assets or financial
liabilities during 2008.
In addition, effective January 1,
2008, the Company adopted and implemented SFAS No. 157, Fair Value
Measurements (SFAS No. 157), which addresses how companies should
measure fair value when they are required to use a fair value measure for
recognition or disclosure purposes under GAAP and provides a common definition
of fair value to be used throughout GAAP. SFAS No. 157 defines fair value
as the price that would be received to sell an asset or paid to transfer a liability
in an orderly fashion between market participants at the measurement date.
SFAS No. 157
establishes a three-level valuation hierarchy for the disclosure of fair value
measurements. The valuation hierarchy is based upon the transparency of inputs
to the valuation of an asset or liability as of the measurement date. The level
in the hierarchy within which a given fair value measurement falls is
determined based on
the lowest level input that is significant to the
measurement (Level 1 being the highest priority and Level 3 being the lowest
priority). The three levels are defined as follows:
Level
1:
|
Inputs
to the valuation methodology are observable inputs that reflect quoted prices
(unadjusted) for
identical
assets or liabilities in
active markets
|
|
|
Level
2:
|
Inputs
to the valuation methodology include quoted prices for similar assets and
liabilities in active markets, and inputs that are observable for the asset
or liability, either directly or indirectly, for substantially the full term
of the financial instrument
|
|
|
Level
3:
|
Inputs
to the valuation methodology are unobservable and significant to the fair
value measurement
|
26
Table of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Following
is a description of the valuation methodologies
used for securities measured at fair value, as well
as the general classification of such securities pursuant to the valuation
hierarchy.
The Company uses quoted
values and other data provided by nationally recognized independent pricing
sources as inputs into its process for determining fair values of its fixed
maturity investments. To validate the techniques or models used by pricing
sources, the Companys review process includes, but is not limited to: (i) quantitative
analysis (e.g., comparing the quarterly return for each managed portfolio to
its target benchmark, with significant differences identified and
investigated); (ii) initial and ongoing evaluation of methodologies used
by outside parties to calculate fair value; (iii) comparing the fair value
estimates to its knowledge of the current market; and (iv) back-testing,
which includes randomly selecting purchased or sold securities and comparing
the executed prices to the fair value estimates from the pricing service. Based
on the above review, the Company will challenge any prices for a security or
portfolio which are considered not to be representative of fair value.
The independent pricing
sources obtain market quotations and actual transaction prices for securities
that have quoted prices in active markets. Each source has its own proprietary
method for determining the fair value of securities that are not actively
traded. In general, these methods involve the use of matrix pricing in which
the independent pricing source uses observable market inputs including, but not
limited to, investment yields, credit risks and spreads, benchmarking of like
securities, broker-dealer quotes, reported trades and sector groupings to
determine a reasonable fair market value. In addition, pricing vendors use
model processes, such as an Option Adjusted Spread model, to develop prepayment
and interest rate scenarios. The Option Adjusted Spread model is commonly used
to estimate fair value for securities such as mortgage backed and asset backed
securities. In certain circumstances, when fair market values are unavailable
from these independent pricing sources, quotes are obtained directly from
broker-dealers who are active in the corresponding markets. Such quotes are
subject to the validation procedures noted above.
The Company reviews its
securities measured at fair value and discusses the proper classification of
such investments with investment advisors and others. Upon adoption of SFAS No. 157
and at June 30, 2008, the Company determined that Level 1 securities would
include highly liquid, recent issue U.S. Treasuries and certain of its short-term
investments held in highly liquid money market-type funds where it believes
that quoted prices are available in an active market.
Where the Company
believes that quoted market prices are not available or that the market is not
active, fair values are estimated by using quoted prices of securities with
similar characteristics, pricing models or matrix pricing and are generally
classified as Level 2 securities. The Company determined that Level 2
securities would include corporate bonds, mortgage backed securities, municipal
bonds, asset backed securities, certain U.S. government and government
agencies, non-U.S. government securities, certain short-term securities and
investments in mutual funds.
In certain cases where
there is limited activity or less transparency around inputs to the valuation,
securities are classified within Level 3 of the valuation hierarchy. Securities
classified within Level 3 include certain private equity investments and a
small number of corporate premium-tax bonds held at amortized cost by the
Companys U.S. insurance operations. Private equity investments are valued
initially based upon transaction price and then adjusted upwards or downwards
from the transaction price to reflect expected exit values.
Further, on a quarterly
basis, the Company evaluates whether the fair value of any of its investments
are other-than-temporarily impaired. The Companys process for identifying
declines in the fair value of investments that are other-than-temporary
involves consideration of several factors. These factors include (i) the
time period in which there has been a significant decline in value, (ii) an
analysis of the liquidity, business prospects and overall financial condition
of the issuer, (iii) the significance of the decline and (iv) the
Companys intent and ability to hold the investment for a sufficient period of
time for the value to recover. Where the Companys analysis of the above
factors results in the conclusion that declines in fair values are
27
Table
of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
other-than-temporary,
the cost basis of the securities is written down to fair value and the
write-down is reflected as a realized loss.
The following table
presents the Companys invested assets, categorized by the level within the
SFAS No. 157 hierarchy in which the fair value measurements fall, at June 30,
2008:
|
|
|
|
Fair Value Measurement Using:
|
|
|
|
June 30,
|
|
Quoted Prices
in Active
Markets for
Identical
Assets
|
|
Significant
Other
Observable
Inputs
|
|
Significant
Unobservable
Inputs
|
|
|
|
2008
|
|
(Level 1)
|
|
(Level 2)
|
|
(Level 3)
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities
(1)
|
|
$
|
8,637,118
|
|
$
|
95,021
|
|
$
|
8,535,618
|
|
$
|
6,479
|
|
Short-term
investments
(1)
|
|
645,587
|
|
598,452
|
|
47,135
|
|
|
|
Other
investments
(2)
|
|
227,196
|
|
|
|
217,554
|
|
9,642
|
|
Total
|
|
$
|
9,509,901
|
|
$
|
693,473
|
|
$
|
8,800,307
|
|
$
|
16,121
|
|
(1)
In securities lending transactions, the
Company receives collateral in excess of the fair value of the fixed maturities
and short-term investments pledged under securities lending agreements. For
purposes of this table, the Company has excluded the collateral received of
$918.2 million which is reflected as short-term investment of funds received
under securities lending agreements, at fair value and included the $890.8
million of fixed maturities and short-term investments pledged under
securities lending agreements, at fair value.
(2)
Excludes the Companys investment in
Aeolus LP, which is accounted for using the equity method.
The following table
presents a reconciliation of the beginning and ending balances for all
investments measured at fair value on a recurring basis using Level 3 inputs
for the 2008 second quarter and six months ended June 30, 2008:
|
|
Fair Value Measurements Using:
|
|
|
|
Significant Unobservable Inputs (Level 3)
|
|
|
|
Fixed
Maturities
|
|
Other
Investments
|
|
Total
|
|
|
|
|
|
|
|
|
|
Three
Months Ended June 30, 2008:
|
|
|
|
|
|
|
|
Beginning
balance at April 1, 2008
|
|
$
|
5,136
|
|
$
|
11,145
|
|
$
|
16,281
|
|
Total gains or
(losses) (realized/unrealized)
|
|
|
|
|
|
|
|
Included in
earnings
(1)
|
|
(38
|
)
|
222
|
|
184
|
|
Included in
other comprehensive income
|
|
|
|
(1,486
|
)
|
(1,486
|
)
|
Purchases,
issuances and settlements
|
|
1,381
|
|
(239
|
)
|
1,142
|
|
Transfers in
and/or out of Level 3
|
|
|
|
|
|
|
|
Ending balance
at June 30, 2008
|
|
$
|
6,479
|
|
$
|
9,642
|
|
$
|
16,121
|
|
|
|
|
|
|
|
|
|
Six
Months Ended June 30, 2008:
|
|
|
|
|
|
|
|
Beginning
balance at January 1, 2008
|
|
$
|
3,752
|
|
$
|
11,504
|
|
$
|
15,256
|
|
Total gains or
(losses) (realized/unrealized)
|
|
|
|
|
|
|
|
Included in
earnings
(1)
|
|
(76
|
)
|
459
|
|
383
|
|
Included in
other comprehensive income
|
|
|
|
(1,789
|
)
|
(1,789
|
)
|
Purchases,
issuances and settlements
|
|
2,803
|
|
(532
|
)
|
2,271
|
|
Transfers in
and/or out of Level 3
|
|
|
|
|
|
|
|
Ending balance
at June 30, 2008
|
|
$
|
6,479
|
|
$
|
9,642
|
|
$
|
16,121
|
|
(1)
Losses on fixed maturities were recorded
as a component of net investment income while gains on other investments were
recorded in net realized gains.
28
Table of
Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The amount of total gains
for the 2008 second quarter and six months ended June 30, 2008 included in
earnings attributable to the change in unrealized gains or losses relating to
assets still held at June 30, 2008 was $0.2 million and $0.4 million,
respectively.
7. Earnings Per Common Share
The following table sets
forth the computation of basic and diluted earnings per common share:
|
|
Three Months Ended
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
June 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
Basic
earnings per common share:
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
198,743
|
|
$
|
205,855
|
|
$
|
394,626
|
|
$
|
410,867
|
|
Preferred
dividends
|
|
(6,461
|
)
|
(6,461
|
)
|
(12,922
|
)
|
(12,922
|
)
|
Net income
available to common shareholders
|
|
192,282
|
|
199,394
|
|
381,704
|
|
397,945
|
|
Divided by:
|
|
|
|
|
|
|
|
|
|
Weighted average
common shares outstanding
|
|
62,996
|
|
72,495
|
|
64,146
|
|
73,209
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings
per common share
|
|
$
|
3.05
|
|
$
|
2.75
|
|
$
|
5.95
|
|
$
|
5.44
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
earnings per common share:
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
198,743
|
|
$
|
205,855
|
|
$
|
394,626
|
|
$
|
410,867
|
|
Preferred
dividends
|
|
(6,461
|
)
|
(6,461
|
)
|
(12,922
|
)
|
(12,922
|
)
|
Net income
available to common shareholders
|
|
192,282
|
|
199,394
|
|
381,704
|
|
397,945
|
|
Divided by:
|
|
|
|
|
|
|
|
|
|
Weighted average
common shares outstanding
|
|
62,996
|
|
72,495
|
|
64,146
|
|
73,209
|
|
Effect of
dilutive securities:
|
|
|
|
|
|
|
|
|
|
Nonvested
restricted shares
|
|
248
|
|
143
|
|
239
|
|
158
|
|
Stock options
(1)
|
|
2,504
|
|
2,617
|
|
2,502
|
|
2,581
|
|
Weighted average
common shares and common share equivalents outstanding diluted
|
|
65,748
|
|
75,255
|
|
66,887
|
|
75,948
|
|
Diluted earnings
per common share
|
|
$
|
2.92
|
|
$
|
2.65
|
|
$
|
5.71
|
|
$
|
5.24
|
|
(1)
Certain stock options were not included
in the computation of diluted earnings per share where the exercise price of
the stock options exceeded the average market price and would have been
anti-dilutive or where, when applying the treasury stock method to in-the-money
options, the sum of the proceeds, including unrecognized compensation, exceeded
the average market price and would have been anti-dilutive. For the 2008 second
quarter and six months ended June 30, 2008, the number of stock options
excluded were 0.5 million and 0.4 million, respectively. For the 2007 second
quarter and six months ended June 30, 2007, the number of stock options
excluded were 0.2 million and 0.1 million, respectively.
8. Income Taxes
ACGL is incorporated
under the laws of Bermuda and, under current Bermuda law, is not obligated to
pay any taxes in Bermuda based upon income or capital gains. The Company has
received a written undertaking from the Minister of Finance in Bermuda under
the Exempted Undertakings Tax Protection Act 1966 that, in the event that any
legislation is enacted in Bermuda imposing any tax computed on profits, income,
gain or appreciation on any capital asset, or any tax in the nature of estate
duty or inheritance tax, such tax will not be applicable to ACGL or any of its
operations until March 28, 2016. This undertaking does not, however,
prevent the imposition of taxes on any person ordinarily resident in Bermuda or
any company in respect of its ownership of real property or leasehold interests
in Bermuda.
29
Table
of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
ACGL and its non-U.S.
subsidiaries will be subject to U.S. federal income tax only to the extent that
they derive U.S. source income that is subject to U.S. withholding tax or
income that is effectively connected with the conduct of a trade or business
within the U.S. and is not exempt from U.S. tax under an applicable income tax
treaty with the U.S. ACGL and its non-U.S. subsidiaries will be subject to a
withholding tax on dividends from U.S. investments and interest from certain
U.S. payors (subject to reduction by any applicable income tax treaty). ACGL
and its non-U.S. subsidiaries intend to conduct their operations in a manner
that will not cause them to be treated as engaged in a trade or business in the
United States and, therefore, will not be required to pay U.S. federal income
taxes (other than U.S. excise taxes on insurance and reinsurance premium and
withholding taxes on dividends and certain other U.S. source investment
income). However, because there is uncertainty as to the activities which
constitute being engaged in a trade or business within the United States, there
can be no assurances that the U.S. Internal Revenue Service will not contend
successfully that ACGL or its non-U.S. subsidiaries are engaged in a trade or
business in the United States. If ACGL or any of its non-U.S. subsidiaries were
subject to U.S. income tax, ACGLs shareholders equity and earnings could be
materially adversely affected. ACGL has subsidiaries and branches that operate
in various jurisdictions around the world that are subject to tax in the
jurisdictions in which they operate. The significant jurisdictions in which
ACGLs subsidiaries and branches are subject to tax are the United States,
United Kingdom, Canada, Switzerland, Germany and Denmark.
The Companys income tax
provision resulted in an effective tax rate on income before income taxes of
2.6% and 3.2%, respectively, for the 2008 second quarter and six months ended June 30,
2008, compared to 2.8% and 3.4%, respectively, for the 2007 second quarter and
six months ended June 30, 2007. The Companys effective tax rate, which is
based upon the expected annual effective tax rate, may fluctuate from period to
period based on the relative mix of income reported by jurisdiction due
primarily to the varying tax rates in each jurisdiction.
The United States also imposes an excise tax on insurance and
reinsurance premiums paid to non-U.S. insurers or reinsurers with respect to
risks located in the United States. The rates of tax, unless reduced by an
applicable U.S. tax treaty, are four percent for non-life insurance premiums
and one percent for life insurance and all reinsurance premiums. The Company
incurs federal excise taxes on certain of its reinsurance transactions,
including amounts ceded through intercompany transactions. For the 2008 second
quarter and six months ended June 30, 2008, the Company withheld and paid
approximately $4.3 million and $7.2 million, respectively, of federal excise
taxes, compared to $2.7 million and $6.6 million, respectively, for the 2007
second quarter and six months ended June 30, 2007.
9. Transactions with Related Parties
The Company made an
investment of $50.0 million in Aeolus LP (Aeolus) in 2006. Aeolus operates as
an unrated reinsurance platform that provides property catastrophe protection
to insurers and reinsurers on both an ultimate net loss and industry loss
warranty basis. In return for its investment, included in Other investments
on the Companys balance sheet, the Company received an approximately 4.9% preferred
interest in Aeolus and a pro rata share of certain founders interests. The
Company made its investment in Aeolus on the same economic terms as a fund
affiliated with Warburg Pincus, which has invested $350 million in Aeolus.
Funds affiliated with Warburg Pincus owned 12.1% of the Companys outstanding
voting shares as of June 30, 2008. In addition, one of the founders of
Aeolus is Peter Appel, former President and CEO and a former director of the
Company.
10. Contingencies Relating to the Sale of Prior
Reinsurance Operations
On May 5, 2000, the
Company sold the prior reinsurance operations of Arch Re U.S. pursuant to an
agreement entered into as of January 10, 2000 with Folksamerica
Reinsurance Company and Folksamerica Holding Company (collectively, Folksamerica).
Folksamerica Reinsurance Company assumed Arch Re U.S.s
30
Table
of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
liabilities under
the reinsurance agreements transferred in the asset sale and Arch Re U.S.
transferred to Folksamerica Reinsurance Company assets estimated in an
aggregate amount equal in book value to the book value of the liabilities
assumed. The Folksamerica transaction was structured as a transfer and
assumption agreement (and not reinsurance) and, accordingly, the loss reserves
(and any related reinsurance recoverables) relating to the transferred business
are not included as assets or liabilities on the Companys balance sheet.
Folksamerica assumed Arch Re U.S.s rights and obligations under the
reinsurance agreements transferred in the asset sale. The reinsureds under such
agreements were notified that Folksamerica had assumed Arch Re U.S.s
obligations and that, unless the reinsureds object to the assumption, Arch Re
U.S. will be released from its obligations to those reinsured. None of such
reinsureds objected to the assumption. However, Arch Re U.S. will continue to
be liable under those reinsurance agreements if the notice is found not to be
an effective release by the reinsureds. Folksamerica has agreed to indemnify
the Company for any losses arising out of the reinsurance agreements transferred
to Folksamerica Reinsurance Company in the asset sale. However, in the event
that Folksamerica refuses or is unable to perform its obligations to the
Company, Arch Re U.S. may incur losses relating to the reinsurance agreements
transferred in the asset sale. Folksamericas A.M. Best rating was A-
(Excellent) at June 30, 2008.
Under the terms of the
agreement, in 2000, the Company had also purchased reinsurance protection
covering the Companys transferred aviation business to reduce the net financial
loss to Folksamerica on any large commercial airline catastrophe to
$5.4 million, net of reinstatement premiums. Although the Company believes
that any such net financial loss will not exceed $5.4 million, the Company
has agreed to reimburse Folksamerica if a loss is incurred that exceeds
$5.4 million for aviation losses under certain circumstances prior to May 5,
2003. The Company also made representations and warranties to Folksamerica
about the Company and the business transferred to Folksamerica for which the
Company retains exposure for certain periods, and made certain other
agreements. In addition, the Company retained its tax and employee benefit
liabilities and other liabilities not assumed by Folksamerica, including all
liabilities not arising under reinsurance agreements transferred to
Folksamerica in the asset sale and all liabilities (other than liabilities
arising under reinsurance agreements) arising out of or relating to a certain
managing underwriting agency. Although Folksamerica has not asserted that any
amount is currently due under any of the indemnities provided by the Company
under the asset purchase agreement, Folksamerica has previously indicated a
potential indemnity claim under the agreement in the event of the occurrence of
certain future events. Based on all available information, the Company has
denied the validity of any such potential claim.
11. Commitments and Contingencies
Variable Interest Entities
On
December 29, 2005, Arch Re Bermuda entered into a quota share reinsurance
treaty with Flatiron Re Ltd., a newly-formed Bermuda reinsurance company,
pursuant to which Flatiron Re Ltd. assumed a 45% quota share (the Treaty) of
certain lines of property and marine business underwritten by Arch Re Bermuda
for unaffiliated third parties for the 2006 and 2007 underwriting years (January 1,
2006 to December 31, 2007). As a result of the terms of the Treaty, the
Company determined that Flatiron Re Ltd. is a variable interest entity.
However, Arch Re Bermuda is not the primary beneficiary of Flatiron Re Ltd.
and, as such, the Company is not required to consolidate the assets,
liabilities and results of operations of Flatiron Re Ltd. per FIN 46R. On December 31,
2007, the Treaty expired by its terms. See Note 5, Reinsurance for
information on the Treaty with Flatiron Re Ltd.
12. Legal Proceedings
The Company, in common with the insurance industry in
general, is subject to litigation and arbitration in the normal course of its
business. As of June 30, 2008, the Company was not a party to any material
litigation or arbitration other than as a part of the ordinary course of
business in relation to claims and reinsurance
31
Table of
Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
recoverable
matters, none of which is expected by management to have a significant adverse
effect on the Companys results of operations and financial condition and
liquidity.
13. Recent Accounting Pronouncements
In December 2007, the FASB issued Statement No. 141(R),
Business Combinations (SFAS No. 141R). SFAS No. 141R replaces
SFAS No. 141 and provides greater consistency in the accounting and
financial reporting of business combinations. SFAS No. 141R requires the
acquiring entity in a business combination to recognize all assets acquired and
liabilities assumed in the transaction, establishes the acquisition date fair value
as the measurement objective for all assets acquired and liabilities assumed,
establishes principles and requirements for how an acquirer recognizes and
measures any non-controlling interest in the acquiree and the goodwill
acquired, and requires the acquirer to disclose the nature and financial effect
of the business combination. Among other changes, SFAS No. 141R also
requires that negative goodwill be recognized in earnings as a gain
attributable to the acquisition, that acquisition-related costs are to be
recognized separately from the acquisition and expensed as incurred and that
any deferred tax benefits resulted in a business combination are recognized in
income from continuing operations in the period of the combination. SFAS No. 141R
is effective for business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after December 15,
2008. The Company will assess the impact that SFAS No. 141R may have on
its financial position and results of operations.
In December 2007, the FASB issued Statement No. 160,
Noncontrolling Interests in
Consolidated Financial Statements An amendment of ARB No. 51 (SFAS
No. 160). SFAS No. 160 amends ARB No. 51 to establish
accounting and reporting standards for the noncontrolling interest in a
subsidiary and for the deconsolidation of a subsidiary. It clarifies that a
noncontrolling interest in a subsidiary, which is sometimes referred to as
minority interest, is an ownership interest in the consolidated entity that
should be reported as equity in the consolidated financial statements. Among
other requirements, this statement requires consolidated net income to be
reported at amounts that include the amounts attributable to both the parent and
the noncontrolling interest. It also requires disclosure, on the face of the
consolidated income statement, of the amounts of consolidated net income
attributable to the parent and to the noncontrolling interest. This Statement
is effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008. Earlier adoption is prohibited.
The Company is currently assessing the effect SFAS No. 160 may have on its
consolidated results of operations and financial position.
In March 2008, the FASB issued SFAS No. 161,
Disclosures about Derivative Instruments and Hedging Activities (SFAS No. 161).
SFAS No. 161 is intended to improve financial reporting about derivative
instruments and hedging activities by requiring enhanced disclosures to enable
investors to better understand their effects on an entitys financial position,
financial performance, and cash flows. The new standard also improves
transparency about the location and amounts of derivative instruments in an entitys
financial statements; how derivative instruments and related hedged items are
accounted for under Statement 133; and how derivative instruments and related
hedged items affect its financial position, financial performance, and cash
flows. SFAS No. 161 is effective for financial statements issued for
fiscal years and interim periods beginning after November 15, 2008, with
early application encouraged. The Company is reviewing the impact that adopting
SFAS No. 161 will have on its financial statements.
32
Table of
Contents
ITEM 2.
MANAGEMENTS DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion
and analysis contains forward-looking statements which involve inherent risks
and uncertainties. All statements other than statements of historical fact are
forward-looking statements. These statements are based on our current
assessment of risks and uncertainties. Actual 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 in this report, including the section entitled
Cautionary Note Regarding Forward Looking Statements, and in our periodic
reports filed with the Securities and Exchange Commission (SEC).
For additional
information regarding our business and operations, please also refer to our
Annual Report on Form 10-K for the year ended December 31, 2007,
including our audited consolidated financial statements and related notes and
the sections entitled Risk Factors and Managements Discussion and Analysis
of Financial Condition and Results of Operations.
GENERAL
Overview
Arch Capital Group Ltd. (ACGL
and, together with its subsidiaries, we or us) is a Bermuda public limited
liability company with approximately $4.3 billion in capital at June 30,
2008 and, through operations in Bermuda, the United States, Europe and Canada,
writes insurance and reinsurance on a worldwide basis. While we are positioned
to provide a full range of property and casualty insurance and reinsurance
lines, we focus on writing specialty lines of insurance and reinsurance. It is
our belief that our underwriting platform, our experienced management team and
our strong capital base that is unencumbered by significant pre-2002 risks have
enabled us to establish a strong presence in the insurance and reinsurance
markets.
The worldwide insurance
and reinsurance industry is highly competitive and has traditionally been
subject to an underwriting cycle in which a hard market (high premium rates,
restrictive underwriting standards, as well as terms and conditions, and
underwriting gains) is eventually followed by a soft market (low premium rates,
relaxed underwriting standards, as well as broader terms and conditions, and
underwriting losses). Insurance market conditions may affect, among other
things, the demand for our products, our ability to increase premium rates, the
terms and conditions of the insurance policies we write, changes in the
products offered by us or changes in our business strategy.
The financial results of
the insurance and reinsurance industry are influenced by factors such as the
frequency and/or severity of claims and losses, including natural disasters or
other catastrophic events, variations in interest rates and financial markets,
changes in the legal, regulatory and judicial environments, inflationary
pressures and general economic conditions. These factors influence, among other
things, the demand for insurance or reinsurance, the supply of which is
generally related to the total capital of competitors in the market.
In general, market
conditions improved during 2002 and 2003 in the insurance and reinsurance
marketplace. This reflected improvement in pricing, terms and conditions
following significant industry losses arising from the events of September 11,
2001, as well as the recognition that intense competition in the late 1990s led
to inadequate pricing and overly broad terms, conditions and coverages. Such
industry developments resulted in poor financial results and erosion of the
industrys capital base. Consequently, many established insurers and reinsurers
reduced their participation in, or exited from, certain markets and, as a
result, premium rates escalated in many lines of business. These developments
provided relatively new insurers and reinsurers, like us, with an opportunity
to provide needed underwriting capacity. Beginning in late 2003 and continuing
through 2005, additional capacity emerged in many classes of business and,
consequently, premium rate increases decelerated significantly and, in many
classes of business, premium rates decreased. The weather-related catastrophic
events that occurred in the second half of 2005 caused significant industry
losses and led to
33
Table
of Contents
a strengthening of
rating agency capital requirements for catastrophe-exposed business. The 2005
events also resulted in substantial improvements in market conditions in
property and certain marine lines of business and slowed declines in premium
rates in other lines. During 2006 and 2007, excellent industry results led to a
significant increase in capacity and, accordingly, competition intensified in
2007 and prices, in general, declined in all lines of business, including
property. This trend has continued in 2008.
Current
Outlook
We increased our writings
in property and certain marine lines of business in 2006 and 2007 in order to
take advantage of improved market conditions and these lines represented a
larger proportion of our overall book of business in 2006 and 2007 than in
prior periods. We expect that our writings in these lines of business will
continue to represent a significant proportion of our overall book of business
in future periods and may represent a larger proportion of our overall book of
business in future periods, which could increase the volatility in our results
of operations. Although we saw price erosion in many of our lines in 2006 and
2007, current pricing remains at acceptable levels in many areas. We believe
that we are still able to write insurance and reinsurance business at what we
believe to be acceptable rates. We have maintained underwriting discipline
during 2008 and, as a result, premiums written by our insurance and reinsurance
operations were lower than in 2007. Such trend may continue as market
conditions remain challenging.
In December 2005, we
entered into a quota-share reinsurance treaty with Flatiron Re Ltd., a
dedicated reinsurance vehicle, which allowed us to increase our participation
in property and marine lines without significantly increasing our probable
maximum loss. On December 31, 2007, the treaty expired by its terms. For
its January 1, 2008 renewals, our Bermuda-based reinsurer adjusted its
book of business in light of the expiration of the treaty with Flatiron Re Ltd.
The
treaty
with Flatiron
Re Ltd. provides for commission income (in excess
of the reimbursement of direct acquisition expenses) which includes a profit
commission based on the reported underwriting results on a cumulative basis. We
record the profit commission portion of income from Flatiron Re Ltd. based on
underwriting experience recorded each quarter. The profit commission
arrangement with Flatiron Re Ltd. may increase the volatility of our reported
results of operations on both a quarterly and annual basis.
At June 30, 2008, $65.6 million of
premiums ceded to Flatiron Re Ltd. were unearned. The attendant premiums
earned, losses incurred and acquisition expenses will primarily be reflected in
our results during the balance of 2008.
We
believe that the most attractive area from a pricing point of view remains
catastrophe-related property business. We seek to limit the probable maximum
pre-tax loss to a specific level for severe catastrophic events. Currently, we
generally seek to limit the probable maximum pre-tax loss to approximately 25%
of total shareholders equity for a severe catastrophic event in any geographic
zone that could be expected to occur once in every 250 years, although we
reserve the right to change this threshold at any time. In July 2008, the
probable maximum pre-tax loss for a catastrophic event in any geographic zone
arising from a 1-in-250 year event was approximately $815 million, compared to
$765 million in February 2008. There can be no assurances that we will not
suffer pre-tax losses greater than 25% of our total shareholders equity from
one or more catastrophic events due to several factors, including the inherent
uncertainties in estimating the frequency and severity of such events and the
margin of error in making such determinations resulting from potential
inaccuracies and inadequacies in the data provided by clients and brokers, the
modeling techniques and the application of such techniques or as a result of a
decision to change the percentage of shareholders equity exposed to a single
catastrophic event. See Risk FactorsRisk Relating to Our Industry and Managements
Discussion and Analysis of Financial Condition and Results of
OperationsNatural and Man-Made Catastrophic Events contained in our Annual
Report on Form 10-K for the year ended December 31, 2007
.
34
Table
of Contents
CRITICAL ACCOUNTING POLICIES,
ESTIMATES AND RECENT ACCOUNTING PRONOUNCEMENTS
Critical accounting
policies, estimates and recent accounting pronouncements are discussed in
Managements Discussion and Analysis of Financial Condition and Results of
Operations contained in our Annual Report on Form 10-K for the year ended December 31,
2007, updated where applicable in the
notes accompanying our
consolidated financial statements
.
RESULTS OF OPERATIONS
Three
Months Ended June 30, 2008 and 2007
The following table sets
forth net income available to common shareholders and earnings per common share
data:
|
|
Three Months Ended
|
|
|
|
June 30,
|
|
|
|
2008
|
|
2007
|
|
Net income
available to common shareholders
|
|
$
|
192,282
|
|
$
|
199,394
|
|
Diluted net
income per common share
|
|
$
|
2.92
|
|
$
|
2.65
|
|
Diluted weighted
average common shares and common share equivalents outstanding
|
|
65,748
|
|
75,255
|
|
Net income available to
common shareholders was $192.3 million for the 2008 second quarter, compared to
$199.4 million for the 2007 second quarter. The decrease in net income was
primarily due to a decrease in underwriting income from our insurance and
reinsurance operations, as discussed in Segment Information below. Our net
income available to common shareholders for the 2008 second quarter represented
a 21.2% annualized return on average common equity, compared to 23.3% for the
2007 second quarter. For purposes of computing return on average common equity,
average common equity has been calculated as the average of common shareholders
equity outstanding at the beginning and ending of each period.
Diluted weighted average
common shares and common share equivalents outstanding, used in the calculation
of net income per common share, were 65.7 million in the 2008 second quarter,
compared to 75.3 million in the 2007 second quarter. The lower level of
weighted average shares outstanding in the 2008 second quarter was primarily
due to the impact of share repurchases. As a result of the share repurchase
transactions to date, weighted average shares outstanding for the 2008 second
quarter were reduced by 11.9 million shares, compared to 1.8 million shares for
the 2007 second quarter.
Segment
Information
We classify our
businesses into two underwriting segments insurance and reinsurance and
corporate and other (non-underwriting). SFAS No. 131, Disclosures About
Segments of an Enterprise and Related Information, requires certain
disclosures about operating segments in a manner that is consistent with how
management evaluates the performance of the segment. For a description of our
underwriting segments, refer to note 4, Segment Information, of the notes
accompanying our consolidated financial statements. Management measures segment
performance based on underwriting income or loss.
35
Table of
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Insurance Segment
The following table sets
forth our insurance segments underwriting results:
|
|
Three Months Ended
|
|
|
|
June 30,
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
Gross premiums
written
|
|
$
|
621,663
|
|
$
|
684,725
|
|
Net premiums
written
|
|
421,501
|
|
451,828
|
|
|
|
|
|
|
|
Net premiums
earned
|
|
$
|
416,585
|
|
$
|
432,560
|
|
Fee income
|
|
880
|
|
1,276
|
|
Losses and loss
adjustment expenses
|
|
(262,633
|
)
|
(272,658
|
)
|
Acquisition
expenses
|
|
(55,400
|
)
|
(47,532
|
)
|
Other operating
expenses
|
|
(71,566
|
)
|
(70,269
|
)
|
Underwriting
income
|
|
$
|
27,866
|
|
$
|
43,377
|
|
|
|
|
|
|
|
Underwriting
Ratios
|
|
|
|
|
|
Loss ratio
|
|
63.0
|
%
|
63.0
|
%
|
Acquisition
expense ratio
(1)
|
|
13.1
|
%
|
10.8
|
%
|
Other operating
expense ratio
|
|
17.2
|
%
|
16.2
|
%
|
Combined ratio
|
|
93.3
|
%
|
90.0
|
%
|
(1)
The acquisition expense ratio is adjusted
to include certain fee income.
The insurance segments
underwriting income was $27.9 million for the 2008 second quarter, compared to
$43.4 million for the 2007 second quarter. The combined ratio for the insurance
segment was 93.3% for the 2008 second quarter, compared to 90.0% for the 2007
second quarter. The components of the insurance segments underwriting income
are discussed below.
Premiums Written
.
Gross premiums written by the insurance segment in the 2008 second
quarter were 9.2% lower than in the 2007 second quarter, while net premiums
written were 6.7% lower as the insurance segment maintained underwriting
discipline in response to the current rate environment. The decrease in net
premiums written in the 2008 second quarter was partially driven by a lower
level of U.S. specialty casualty business, primarily due to the decline in U.S.
residential construction project activity. For information regarding net
premiums written produced by major line of business and geographic location,
refer to note 4, Segment Information, of the notes accompanying our
consolidated financial statements.
Net Premiums Earned
.
Net premiums earned by the insurance segment in the 2008 second quarter
were 3.7% lower than in the 2007 second quarter, and reflect changes in net
premiums written over the previous five quarters, including the mix and type of
business written.
Losses and Loss Adjustment
Expenses
. The insurance segments loss ratio was 63.0% in
the 2008 and 2007 second quarters. The 2008 second quarter loss ratio reflected
a 5.6 point reduction related to estimated net favorable development in prior
year loss reserves, compared to 0.8 points of estimated net adverse development
in prior year loss reserves in the 2007 second quarter. The estimated net
favorable development in the 2008 second quarter was primarily in medium-tail
and longer-tail lines and resulted from better than expected claims emergence.
The insurance segments loss ratio in the 2008 second quarter also reflected an
increase in expected loss ratios across a number of lines of business primarily
due to rate changes and changes in the mix of business. In addition, the 2008
second quarter included a higher level of large, specific risk loss activity
than the 2007 second quarter.
In
the 2008 first quarter, the insurance segment renewed its reinsurance program
which provides coverage for certain property-catastrophe related losses
occurring during 2008 equal to a maximum of 70% of the first
36
Table of
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$275 million in excess of a $75 million retention per occurrence. The
insurance segment had in effect during 2007 a reinsurance program which
provided coverage equal to a maximum of 88% of the first $325 million in excess
of a $75 million retention per occurrence for certain property
catastrophe-related losses occurring during 2007.
Underwriting Expenses
.
The insurance segments underwriting expense ratio was 30.3% in the 2008
second quarter, compared to 27.0% in the 2007 second quarter. The acquisition
expense ratio was 13.1% for the 2008 second quarter, compared to 10.8% for the
2007 second quarter. The acquisition expense ratio is influenced by, among
other things, (1) the amount of ceding commissions received from
unaffiliated reinsurers, (2) the amount of business written on a surplus
lines (non-admitted) basis and (3) mix of business. The higher acquisition
expense ratio in the 2008 second quarter primarily resulted from changes in the
form of reinsurance ceded and the mix of business. In addition, the acquisition
expense ratio for the 2008 second quarter included 0.9 points related to
favorable prior year loss development, compared to 0.1 points in the 2007
second quarter. The insurance segments other operating expense ratio was 17.2%
for the 2008 second quarter, compared to 16.2% in the 2007 second quarter.
Operating expenses in the 2008 second quarter included $1.6 million of costs
related to the relocation of certain of the insurance segments U.S.
operations. Such actions were undertaken as part of an expense management plan,
which includes office relocation, personnel and other expense saving
initiatives, the implementation of which began in response to market
conditions.
Reinsurance Segment
The following table sets
forth our reinsurance segments underwriting results:
|
|
Three Months Ended
|
|
|
|
June 30,
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
Gross premiums
written
|
|
$
|
273,318
|
|
$
|
427,348
|
|
Net premiums
written
|
|
264,617
|
|
306,067
|
|
|
|
|
|
|
|
Net premiums
earned
|
|
$
|
289,090
|
|
$
|
318,852
|
|
Fee income
|
|
358
|
|
815
|
|
Losses and loss
adjustment expenses
|
|
(141,992
|
)
|
(153,005
|
)
|
Acquisition
expenses
|
|
(63,826
|
)
|
(69,745
|
)
|
Other operating
expenses
|
|
(20,091
|
)
|
(19,999
|
)
|
Underwriting
income
|
|
$
|
63,539
|
|
$
|
76,918
|
|
|
|
|
|
|
|
Underwriting
Ratios
|
|
|
|
|
|
Loss ratio
|
|
49.1
|
%
|
48.0
|
%
|
Acquisition
expense ratio
|
|
22.1
|
%
|
21.9
|
%
|
Other operating
expense ratio
|
|
6.9
|
%
|
6.3
|
%
|
Combined ratio
|
|
78.1
|
%
|
76.2
|
%
|
The reinsurance segments
underwriting income was $63.5 million for the 2008 second quarter, compared to
$76.9 million for the 2007 second quarter. The combined ratio for the
reinsurance segment was 78.1% for the 2008 second quarter, compared to 76.2%
for the 2007 second quarter. The components of the reinsurance segments
underwriting income are discussed below.
Premiums Written
.
Gross premiums written by the reinsurance segment in the 2008 second
quarter were 36.0% lower than in the 2007 second quarter, with reductions in
all treaty lines of business. Commencing in 2006, the reinsurance segments
Bermuda-based reinsurer, Arch Reinsurance Ltd. (Arch Re Bermuda), ceded
certain lines of property and marine premiums written under a quota share reinsurance
treaty (the Treaty) to Flatiron Re Ltd. Under the Treaty, Flatiron Re Ltd.
assumed a 45% quota share of certain lines of property and marine business
underwritten by Arch Re Bermuda for the 2006 and 2007 underwriting years (the
percentage
37
Table of
Contents
ceded was
increased from 45% to 70% of covered business bound from June 28, 2006
until August 15, 2006 provided such business did not incept beyond September 30,
2006). On December 31, 2007, the Treaty expired by its terms. For its
January 1, 2008 renewals, Arch Re Bermuda adjusted its book of business in
light of the expiration of the Treaty. In addition, gross and net premiums
written for the 2007 second quarter included $64.0 million and $35.2 million,
respectively, of property catastrophe business on a contract written with a
two-year term while the 2008 second quarter did not include any comparable
contracts. Other reductions in the reinsurance segments book of business
resulted from continued competition which led to non-renewals or lower shares
written.
Ceded premiums written by
the reinsurance segment were 3.2% of gross premiums written for the 2008 second
quarter, compared to 28.4% for the 2007 second quarter. In the 2008 second
quarter, Arch Re Bermuda ceded $7.0 million, or 2.6% of gross premiums written,
of certain lines of property and marine premiums written under the Treaty to
Flatiron Re Ltd., compared to $115.9 million, or 27.1%, in the 2007 second
quarter, with the lower level due to the expiration of the Treaty. On an earned
basis, Arch Re Bermuda ceded $45.9 million to Flatiron Re Ltd. in the 2008
second quarter, compared to $72.5 million in the 2007 second quarter.
Commission income from the Treaty (in excess of the reimbursement of direct
acquisition expenses) reduced the reinsurance segments acquisition expense
ratio by 2.3 points in the 2008 second quarter, compared to 3.1 points in the
2007 second quarter. At June 30, 2008, $65.6 million of premiums ceded to
Flatiron Re Ltd. were unearned. The attendant premiums earned, losses incurred
and acquisition expenses will primarily be reflected in the reinsurance segments
results during the balance of 2008.
Net premiums written by
the reinsurance segment in the 2008 second quarter were 13.5% lower than in the
2007 second quarter. For information regarding net premiums written produced by
major line of business and geographic location, refer to note 4, Segment
Information, of the notes accompanying our consolidated financial statements.
Net Premiums Earned
.
Net premiums earned by the reinsurance segment in the 2008 second
quarter were 9.3% lower than in the 2007 second quarter. The decrease in net
premiums earned in the 2008 second quarter primarily resulted from changes in
net premiums written over the previous five quarters, including the mix and
type of business written.
Losses and Loss Adjustment
Expenses
. The reinsurance segments loss ratio was 49.1%
in the 2008 second quarter, compared to 48.0% for the 2007 second quarter. The 2008 second quarter loss ratio reflected
approximately 5.8 points of catastrophic activity, while the 2007 second
quarter loss ratio reflected approximately 3.8 points of catastrophic activity.
The loss ratio for the 2008 second quarter also reflected a 13.5 point
reduction related to estimated net favorable development in prior year loss
reserves, compared to a 12.1 point reduction in the 2007 second quarter. The
estimated net favorable development in the 2008 second quarter was primarily in
short-tail lines and resulted from better than anticipated claims emergence.
The reinsurance segments loss ratio in the 2008 second quarter also reflected
an increase in expected loss ratios across a number of lines of business
primarily due to rate changes and changes in the mix of business.
For its January 1
renewals, Arch Re Bermuda adjusted its book of business in light of the
expiration of the Treaty with Flatiron Re Ltd. While our reinsurance operations
may purchase
industry loss warranty contracts
and other reinsurance which is intended
to limit their exposure, the expiration of the Treaty increases the level of
risk retained by our reinsurance operations and, a
s a result, may increase the
volatility in our results of operations in future periods.
Underwriting Expenses
.
The underwriting expense ratio for the reinsurance segment was 29.0% in
the 2008 second quarter, compared to 28.2% in the 2007 second quarter. The
acquisition expense ratio for the 2008 second quarter was 22.1%, compared to
21.9% for the 2007 second quarter. The acquisition expense ratio for the 2008
second quarter included 1.2 points related to favorable prior year loss
development, compared to 0.8 points in the 2007 second quarter. In addition,
the acquisition expense ratio is influenced by, among other
38
Table of
Contents
things, the mix
and type of business written and earned and the level of ceding commission
income. The reinsurance segments other operating expense ratio was 6.9% for
the 2008 second quarter, compared to 6.3% for the 2007 second quarter. The
higher ratio in the 2008 second quarter primarily resulted from a lower level
of net premiums earned.
Net
Investment Income
Net
investment income for the 2008 second quarter was $117.1 million, compared to
$113.9 million for the 2007 second quarter. The increase in net investment income
in the 2008 second quarter primarily resulted from a higher level of average
invested assets
. The
pre-tax
investment income yield was 4.80% for
the 2008 second quarter, compared to 4.94% for the 2007 second quarter. The
pre-tax investment income yields were calculated based on amortized cost.
Yields on future investment income may vary based on financial market
conditions, investment allocation decisions and other factors.
Net
Realized Gains or Losses
Following is a summary of
net realized gains (losses):
|
|
Three Months Ended
|
|
|
|
June 30,
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
Fixed maturities
|
|
$
|
(4,143
|
)
|
$
|
(8,983
|
)
|
Other
investments
|
|
(2,103
|
)
|
1,000
|
|
Other
|
|
(6,423
|
)
|
4,226
|
|
Total
|
|
$
|
(12,669
|
)
|
$
|
(3,757
|
)
|
Currently, our portfolio
is actively managed to maximize total return within certain guidelines. In
assessing returns under this approach, we include net investment income, net
realized gains and losses and the change in unrealized gains and losses
generated by our investment portfolio. The effect of financial market movements
on the investment portfolio will directly impact net realized gains and losses
as the portfolio is adjusted and rebalanced. Total return on our portfolio
under management, as reported to us by our investment advisors, for the 2008
second quarter was (0.09%), compared to 0.27% for the 2007 second quarter.
For the 2008 second quarter, net realized losses on
our fixed maturities of $4.1 million included a provision for declines in the
market value of investments held in our available for sale portfolio which were
considered to be other-than-temporary of $10.7 million based on a review
performed. For the 2007 second quarter, net realized losses on our fixed
maturities of $9.0 million included a provision for declines in the market
value of investments held in our available for sale portfolio which were
considered to be other-than-temporary of $0.5 million based on a review
performed. For the 2008 and 2007 second quarters, the balance of net realized
gains or losses on our fixed maturities resulted from the sale of securities
following our decisions to reduce credit exposure, changes in duration targets
and sales related to rebalancing the portfolio.
Equity
in Net Income (Loss) of Investment Funds Accounted for Using the Equity Method
Our investment portfolio
includes certain funds that invest in fixed maturity securities which, due to
the ownership structure of the funds, are accounted for by us using the equity
method. In applying the equity method, these investments are initially recorded
at cost and are subsequently adjusted based on our proportionate share of the
net income or loss of the funds (which include changes in the market value of
the underlying securities in the funds).
We recorded $19.6 million of
equity in net income of investment funds accounted for using the equity method
in the 2008 second quarter, compared to $3.4 million of equity in net income
for the 2007 second quarter.
Investment funds accounted for using the equity method totaled $351.9
39
Table of
Contents
million at June 30,
2008, compared to $294.4 million at March 31, 2008 and $236.0 million at December 31,
2007.
Other
Expenses
Other
expenses, which are included in our other operating expenses and part of
corporate and other (non-underwriting), were $10.9 million for the 2008 second
quarter, compared to $10.2 million for the 2007 second quarter.
Such amounts primarily represent certain
holding company costs necessary to support our worldwide insurance and
reinsurance operations, share based compensation expense and costs associated
with operating as a publicly traded company.
Net
Foreign Exchange Gains or Losses
Net foreign exchange
gains for the 2008 second quarter of $0.3 million consisted of net unrealized
gains of $1.1 million and net realized losses of $0.8 million, compared to net
foreign exchange losses for the 2007 second quarter of $6.5 million, which
consisted of net unrealized losses of $5.9 million and net realized losses of
$0.6 million. Net unrealized foreign exchange gains or losses result from the
effects of revaluing our net insurance liabilities required to be settled in
foreign currencies at each balance sheet date. We hold investments in foreign
currencies which are intended to mitigate our exposure to foreign currency
fluctuations in our 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, as part of the
Change in
unrealized appreciation (decline) in value of investments, net of deferred
income tax in accumulated other comprehensive income,
and not in the statement of income.
Income
Taxes
The effective tax rate on
income before income taxes was 2.6% for the 2008 second quarter, compared to
2.8% for the 2007 second quarter. Our 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. Our quarterly tax provision
is adjusted to reflect changes in our expected annual effective tax rates, if
any.
A significant portion of
our catastrophe-exposed property business is written by a Bermuda-based
subsidiary. As a result, generally, our effective tax rate is likely to be
favorably affected in periods that have a low level of catastrophic losses
incurred and adversely impacted in periods with significant catastrophic claims
activity. In addition, our Bermuda-based reinsurer incurs federal excise taxes
for premiums assumed on U.S. risks. Such expenses are included in our
acquisition expenses.
Six
Months Ended June 30, 2008 and 2007
The following table sets
forth net income available to common shareholders and earnings per common share
data:
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
Net income
available to common shareholders
|
|
$
|
381,704
|
|
$
|
397,945
|
|
Diluted net
income per common share
|
|
$
|
5.71
|
|
$
|
5.24
|
|
Diluted weighted
average common shares and common share equivalents outstanding
|
|
66,887
|
|
75,948
|
|
Net income available to
common shareholders was $381.7 million for the 2008 period, compared to $397.9
million for the 2007 period. The decrease in net income was primarily due to a
decrease in underwriting income
40
Table of
Contents
from our insurance
and reinsurance operations, as discussed in Segment Information below. Our
net income available to common shareholders for the 2008 period represented a
21.0% annualized return on average common equity, compared to 24.0% for the
2007 period. For purposes of computing return on average common equity, average
common equity has been calculated as the average of common shareholders equity
outstanding at the beginning and ending of each period.
Diluted weighted average
common shares and common share equivalents outstanding, used in the calculation
of net income per common share, were 66.9 million in the 2008 period, compared
to 75.9 million in the 2007 period. The lower level of weighted average shares
outstanding in the 2008 period was primarily due to the impact of share
repurchases. As a result of the share repurchase transactions to date, weighted
average shares outstanding for the 2008 period were reduced by 10.6 million
shares, compared to 1.0 million shares for the 2007 period.
Segment
Information
Insurance Segment
The following table sets
forth our insurance segments underwriting results:
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
Gross premiums
written
|
|
$
|
1,248,011
|
|
$
|
1,345,935
|
|
Net premiums
written
|
|
824,265
|
|
880,172
|
|
|
|
|
|
|
|
Net premiums
earned
|
|
$
|
835,685
|
|
$
|
846,407
|
|
Fee income
|
|
1,762
|
|
2,701
|
|
Losses and loss
adjustment expenses
|
|
(549,936
|
)
|
(531,980
|
)
|
Acquisition
expenses
|
|
(107,289
|
)
|
(94,227
|
)
|
Other operating
expenses
|
|
(145,203
|
)
|
(139,163
|
)
|
Underwriting
income
|
|
$
|
35,019
|
|
$
|
83,738
|
|
|
|
|
|
|
|
Underwriting
Ratios
|
|
|
|
|
|
Loss ratio
|
|
65.8
|
%
|
62.9
|
%
|
Acquisition
expense ratio
(1)
|
|
12.6
|
%
|
10.9
|
%
|
Other operating
expense ratio
|
|
17.4
|
%
|
16.4
|
%
|
Combined ratio
|
|
95.8
|
%
|
90.2
|
%
|
(2)
The acquisition expense ratio is adjusted
to include certain fee income.
The insurance segments
underwriting income was $35.0 million for the 2008 period, compared to $83.7
million for the 2007 period. The combined ratio for the insurance segment was
95.8% for the 2008 period, compared to 90.2% for the 2007 period. The
components of the insurance segments underwriting income are discussed below.
Premiums Written
.
Gross premiums written by the insurance segment in the 2008 period were
7.3% lower than in the 2007 period, while net premiums written were 6.4% lower
as the insurance segment maintained underwriting discipline in response to the
current rate environment. The decrease in net premiums written in the 2008
period was partially driven by a lower level of U.S. specialty casualty
business, primarily due to the decline in U.S. residential construction project
activity. Other contributors to the decrease in the 2008 period were a
reduction in healthcare business in response to competition and the current
rate environment and an increase in the use of reinsurance on surety business.
For information regarding net premiums written produced by major line of
business and geographic location, refer to note 4, Segment Information, of
the notes accompanying our consolidated financial statements.
41
Table of
Contents
Net Premiums Earned
.
Net premiums earned by the insurance segment in the 2008 period were
1.3% lower than in the 2007 period, and reflect changes in net premiums written
over the previous five quarters, including the mix and type of business
written.
Losses and Loss Adjustment
Expenses
. The insurance segments loss ratio was 65.8%
for the 2008 period, compared to 62.9% for the 2007 period. The 2008 period
loss ratio reflected approximately 3.3 points of catastrophic activity, while
the 2007 period did not include significant catastrophic activity. The 2008
period loss ratio also reflected a 3.5 point reduction related to estimated net
favorable development in prior year loss reserves, compared to 0.3 points of
estimated net adverse development in prior year loss reserves in the 2007
period. The estimated net favorable development in the 2008 period was
primarily in medium-tail and longer-tail lines and resulted from better than
expected claims emergence. The insurance segments loss ratio in the 2008
period also reflected an increase in expected loss ratios across a number of
lines of business primarily due to rate changes and changes in the mix of
business.
Underwriting Expenses
.
The underwriting expense ratio for the insurance segment was 30.0% in
the 2008 period, compared to 27.3% in the 2007 period. The acquisition expense
ratio was 12.6% for the 2008 period, compared to 10.9% for the 2007 period. 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
acquisition expense ratio in the 2008 period reflects changes in the form of
reinsurance ceded and the mix of business. In addition, the acquisition expense
ratio for the 2008 period included 0.5 points related to favorable prior year
loss development, compared to 0.5 points in the 2007 period. The insurance
segments other operating expense ratio was 17.4% for the 2008 period, compared
to 16.4% for the 2007 period. Operating expenses in the 2008 period included
$1.6 million of costs related to the relocation of certain of the insurance
segments U.S. operations. Such actions were undertaken as part of an expense
management plan, which includes office relocation, personnel and other expense
saving initiatives, the implementation of which began in response to market
conditions.
Reinsurance Segment
The following table sets
forth our reinsurance segments underwriting results:
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
Gross premiums
written
|
|
$
|
707,145
|
|
$
|
986,002
|
|
Net premiums
written
|
|
673,195
|
|
749,468
|
|
|
|
|
|
|
|
Net premiums
earned
|
|
$
|
578,224
|
|
$
|
650,498
|
|
Fee income
|
|
544
|
|
1,359
|
|
Losses and loss
adjustment expenses
|
|
(259,106
|
)
|
(313,744
|
)
|
Acquisition
expenses
|
|
(126,576
|
)
|
(143,178
|
)
|
Other operating
expenses
|
|
(38,329
|
)
|
(33,780
|
)
|
Underwriting
income
|
|
$
|
154,757
|
|
$
|
161,155
|
|
|
|
|
|
|
|
Underwriting
Ratios
|
|
|
|
|
|
Loss ratio
|
|
44.8
|
%
|
48.2
|
%
|
Acquisition
expense ratio
|
|
21.9
|
%
|
22.0
|
%
|
Other operating
expense ratio
|
|
6.6
|
%
|
5.2
|
%
|
Combined ratio
|
|
73.3
|
%
|
75.4
|
%
|
The reinsurance segments
underwriting income was $154.8 million for the 2008 period, compared to $161.2
million for the 2007 period. The combined ratio for the reinsurance segment was
73.3% for the 2008
42
Table of
Contents
period, compared
to 75.4% for the 2007 period. The components of the reinsurance segments
underwriting income are discussed below.
Premiums Written
.
Gross premiums written by the reinsurance segment in the 2008 period
were 28.3% lower than in the 2007 period, with reductions in all treaty lines
of business. For its January 1, 2008 renewals, Arch Re Bermuda adjusted
its book of business in light of the expiration of the Treaty with Flatiron Re
Ltd. In addition, gross and net premiums written for the 2007 period included
$64.0 million and $35.2 million, respectively, of property catastrophe business
on a contract written with a two-year term while the 2008 period did not
include any comparable contracts. Other reductions in the reinsurance segments
book of business resulted from continued competition which led to non-renewals
or lower shares written.
Ceded premiums written by
the reinsurance segment were 4.8% of gross premiums written for the 2008
period, compared to 24.0% for the 2007 period. In the 2008 period, Arch Re
Bermuda ceded $25.4 million, or 3.6% of gross premiums written, of certain
lines of property and marine premiums written under the Treaty to Flatiron Re
Ltd., compared to $224.8 million, or 22.8%, in the 2007 period, with the lower
level due to the expiration of the Treaty. On an earned basis, Arch Re Bermuda
ceded $104.7 million to Flatiron Re Ltd. in the 2008 period, compared to $138.5
million in the 2007 period. Commission income from the Treaty (in excess of the
reimbursement of direct acquisition expenses) reduced the reinsurance segments
acquisition expense ratio by 2.8 points in the 2008 period, compared to 2.9
points in the 2007 period.
Net premiums written by
the reinsurance segment in the 2008 period were 10.2% lower than in the 2007
period. For information regarding net premiums written produced by major line
of business and geographic location, refer to note 4, Segment Information, of
the notes accompanying our consolidated financial statements.
Net Premiums Earned
.
Net premiums earned by the reinsurance segment in the 2008 period were
11.1% lower than in the 2007 period. The decrease in net premiums earned in the
2008 period primarily resulted from changes in net premiums written over the
previous five quarters, including the mix and type of business written.
Losses and Loss Adjustment
Expenses
. The reinsurance segments loss ratio was
44.8% in the 2008 period, compared to 48.2% for the 2007 period. The loss ratio for the 2008 period reflected
a 15.6 point reduction related to estimated net favorable development in prior
year loss reserves, compared to a 13.1 point reduction in the 2007 period. The
estimated net favorable development in the 2008 period was primarily in
short-tail lines and resulted from better than anticipated loss emergence. The 2008
period loss ratio also reflected approximately 3.9 points of catastrophic
activity, while the 2007 period loss ratio reflected approximately 4.3 points
of catastrophic activity. The reinsurance segments loss ratio in the 2008
period also reflected an increase in expected loss ratios across a number of
lines of business and changes in the mix of business.
Underwriting Expenses
.
The underwriting expense ratio for the reinsurance segment was 28.5% in
the 2008 period, compared to 27.2% in the 2007 period. The acquisition expense
ratio for the 2008 period was 21.9%, compared to 22.0% for the 2007 period. The
acquisition expense ratio is influenced by, among other things, the mix and
type of business written and earned and the level of ceding commission income.
The reinsurance segments other operating expense ratio was 6.6% for the 2008
period, compared to 5.2% for the 2007 period. The higher ratio in the 2008
period resulted from expenses related to the reinsurance segments property
facultative reinsurance operation, which commenced operations during the 2007
second quarter, and a lower level of net premiums earned.
Net
Investment Income
Net
investment income for the 2008 period was $239.3 million, compared to $224.0
million for the 2007 period. The increase in net investment income in the 2008
period primarily resulted from a higher level of
43
Table of
Contents
average invested assets
. The
pre-tax
investment income yield was 4.84% for
the 2008 period, compared to 4.90% for the 2007 period. The pre-tax investment
income yields were calculated based on amortized cost.
Net
Realized Gains or Losses
Following is a summary of
net realized gains (losses):
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
Fixed maturities
|
|
$
|
48,678
|
|
$
|
(10,127
|
)
|
Other
investments
|
|
(5,281
|
)
|
2,139
|
|
Other
|
|
(20,091
|
)
|
3,250
|
|
Total
|
|
$
|
23,306
|
|
$
|
(4,738
|
)
|
Total return on our
portfolio under management, as reported to us by our investment advisors, for
the 2008 period was 0.86%, compared to 1.74% for the 2007 period. For the 2008
period, net realized gains on our fixed maturities of $48.7 million included a
provision for declines in the market value of investments held in our available
for sale portfolio which were considered to be other-than-temporary of $23.4
million based on reviews performed during the period. For the 2007 period,
net realized losses on our fixed maturities of $10.1 million included a
provision for declines in the market value of investments held in our available
for sale portfolio which were considered to be other-than-temporary of $7.7
million based on reviews performed during the period. For the 2008 and 2007
periods, the balance of net realized gains or losses on our fixed maturities
resulted from the sale of securities following our decisions to reduce credit
exposure, changes in duration targets and sales related to rebalancing the
portfolio.
Equity
in Net Income (Loss) of Investment Funds Accounted for Using the Equity Method
Our investment portfolio
includes certain funds that invest in fixed maturity securities which, due to
the ownership structure of the funds, are accounted for by us using the equity
method. In applying the equity method, these investments are initially recorded
at cost and are subsequently adjusted based on our proportionate share of the
net income or loss of the funds (which include changes in the market value of
the underlying securities in the funds).
We recorded $2.7 million of
equity in net loss of investment funds accounted for using the equity method in
the 2008 period, compared to equity in net income of $6.0 million in the 2007
period.
Other
Expenses
Other
expenses, which are included in our other operating expenses and part of
corporate and other (non-underwriting), were $16.2 million for the 2008 period,
compared to $18.4 million for the 2007 period.
Such amounts primarily represent certain holding
company costs necessary to support our worldwide insurance and reinsurance
operations, share based compensation expense and costs associated with
operating as a publicly traded company.
Net
Foreign Exchange Gains or Losses
Net foreign exchange
losses for the 2008 period of $23.3 million consisted of net unrealized losses
of $21.2 million and net realized losses of $2.1 million, compared to net
foreign exchange losses for the 2007 period of $16.2 million, which consisted
of net unrealized losses of $23.1 million and net realized gains of $6.9
million.
44
Table of
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Income
Taxes
The effective tax rate on
income before income taxes was 3.2% for the 2008 period, compared to 3.4% for
the 2007 period. Our 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. Our quarterly tax provision is
adjusted to reflect changes in our expected annual effective tax rates, if any.
A significant portion of
our catastrophe-exposed property business is written by a Bermuda-based
subsidiary. As a result, on a relative basis, our effective tax rate is likely
to be favorably affected in periods that have a low level of catastrophic
losses incurred and adversely impacted in periods with significant catastrophic
claims activity. In addition, our Bermuda-based reinsurer incurs federal excise
taxes for premiums assumed on U.S. risks. Such expenses are included in our
acquisition expenses.
FINANCIAL CONDITION, LIQUIDITY
AND CAPITAL RESOURCES
Financial Condition
Investable
Assets
The finance and investment committee of our board of
directors establishes our investment policies and creates guidelines for our
investment managers. The finance and investment committee reviews the
implementation of the investment strategy on a regular basis. Our current
approach stresses preservation of capital, market liquidity and diversification
of risk.
On a consolidated basis,
our aggregate investable assets totaled $10.27 billion at June 30, 2008,
compared to $10.12 billion at December 31, 2007, as detailed in the
table below. The increase in investable assets in the 2008 period resulted
primarily from cash flows from operations during the period, partially offset
by share repurchase activity.
|
|
June 30,
|
|
December 31,
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
Fixed maturities
available for sale, at fair value
|
|
$
|
7,746,296
|
|
$
|
7,137,998
|
|
Fixed maturities
pledged under securities lending agreements, at fair value
(1)
|
|
890,822
|
|
1,462,826
|
|
Total fixed
maturities
|
|
8,637,118
|
|
8,600,824
|
|
Short-term
investments available for sale, at fair value
|
|
645,587
|
|
699,036
|
|
Short-term
investments pledged under securities lending agreements, at fair value
(1)
|
|
|
|
219
|
|
Cash
|
|
246,544
|
|
239,915
|
|
Other
investments
|
|
295,638
|
|
353,694
|
|
Investment funds
accounted for using the equity method
|
|
351,879
|
|
235,975
|
|
Investment in
joint venture
|
|
100,000
|
|
|
|
Total cash and
investments
(1)
|
|
10,276,766
|
|
10,129,663
|
|
Securities
transactions entered into but not settled at the balance sheet date
|
|
(10,845
|
)
|
(5,796
|
)
|
Total investable
assets
|
|
$
|
10,265,921
|
|
$
|
10,123,867
|
|
(1) In our
securities lending transactions, we receive collateral in excess of the fair
value of the fixed maturities and short-term investments pledged under
securities lending agreements. For purposes of this table, we have excluded the
collateral received at June 30, 2008 and December 31, 2007 of $918.2
million and $1.5 billion, respectively, which is reflected as short-term
investment of funds received under securities lending agreements, at fair value
and included the $890.8 million and $1.46 billion, respectively, of fixed
maturities and short-term investments pledged under securities lending
agreements, at fair value.
At June 30, 2008,
our fixed income portfolio, which includes fixed maturity securities and
short-term investments, had a AA+ average Standard & Poors quality
rating, an average effective duration of 3.36 years,
45
Table of
Contents
and an average
yield to maturity (imbedded book yield), before investment expenses, of 4.96%.
At December 31, 2007, our fixed income portfolio had a AA+ average
Standard & Poors quality rating, an average effective duration of
3.29 years, and an average yield to maturity (imbedded book yield), before
investment expenses, of 5.03%.
In recent months, delinquencies and losses with
respect to residential mortgage loans generally have increased and may continue
to increase, particularly in the subprime sector. In addition, in recent months
residential property values in many states have declined or remained stable,
after extended periods during which those values appreciated. A continued
decline or an extended flattening in those values may result in additional
increases in delinquencies and losses on residential mortgage loans generally,
especially with respect to second homes and investment properties, and with
respect to any residential mortgage loans where the aggregate loan amounts (including
any subordinate loans) are close to or
greater than the related
property values. These developments may have a significant adverse effect on
the prices of loans and securities, including those in our investment
portfolio. The situation continues to have wide ranging consequences, including
downward pressure on economic growth and the potential for increased insurance
and reinsurance exposures, which could have an adverse impact on our results of
operations, financial condition, business and operations.
Certain of our investments, primarily those included
in other investments and investment funds accounted for using the equity
method on our balance sheet, may use leverage to achieve a higher rate of
return. While leverage presents opportunities for increasing the total return
of such investments, it may increase losses as well. Accordingly, any event
that adversely affects the value of the underlying securities held by such investments
would be magnified to the extent leverage is used and our potential losses from
such investments would be magnified.
Our Chief Investment Officer administers the
investment portfolio, oversees our investment managers, formulates investment
strategy in conjunction with our finance and investment committee and directly
manages certain portions of our fixed income portfolio. At June 30, 2008,
approximately $4.75 billion, or 46.3%, of our total investments and cash was
internally managed, compared to $4.61 billion, or 45.5%, at December 31,
2007. While maintaining our emphasis on preservation of capital and liquidity,
we expect our portfolio to become more diversified and, as a result, we may
expand into areas which are not currently part of our investment strategy.
Our investment strategy
allows for the use of derivative instruments. We utilize various derivative
instruments such as futures contracts as part of the management of our stock
index fund investments and to replicate equity investment positions. Derivative
instruments may be used to enhance investment performance, to replicate
investment positions or to manage market exposures and duration risk that would
be allowed under our investment guidelines if implemented in other ways.
See Note 6, Investment
InformationInvestment-Related Derivatives, of the notes accompanying our
consolidated financial Statements for
additional disclosures concerning derivatives.
Other investments totaled $295.6 million at June 30,
2008, compared to $353.7 million at December 31, 2007.
Investment
funds accounted for using the equity method totaled $351.9 million at June 30,
2008, compared to $236.0 million at December 31, 2007.
Our investment commitments related to
other investments and investment funds accounted for using the equity method
totaled approximately $53.3 million at June 30, 2008. See Note 6
, Investment
InformationOther Investments and Investment InformationInvestment Funds
Accounted for Using the Equity Method of the notes accompanying our consolidated
financial statements for further details.
In May 2008, Arch Re
Bermuda provided $100.0 million of funding to Gulf Reinsurance Limited (Gulf
Re), a newly formed reinsurer based in the Dubai International Financial
Centre, pursuant to the joint venture agreement with Gulf Investment
Corporation GSC (GIC). Under the agreement, each of Arch Re Bermuda
46
Table
of Contents
and GIC owns 50%
of Gulf Re. The initial total capital of the joint venture consists of $200.0
million, plus an additional $200.0 million to be funded equally by us and GIC
depending on the joint ventures business needs.
Effective January 1, 2008, we adopted and
implemented SFAS No. 157, Fair Value Measurements (SFAS No. 157),
which addresses how companies should measure fair value when they are required
to use a fair value measure for recognition or disclosure purposes under GAAP
and provides a common definition of fair value to be used throughout GAAP. See
Note 6, Investment InformationFair Value
of the notes accompanying
our consolidated financial statements for further details.
Reinsurance Recoverables
We monitor the financial
condition of our reinsurers and attempt to place coverages only with
substantial, financially sound carriers. At June 30, 2008, approximately
86.2% of reinsurance recoverables on paid and unpaid losses (not including
prepaid reinsurance premiums) of $1.7 billion were due from carriers which had
an A.M. Best rating of A- or better and the largest reinsurance
recoverable from any one carrier was less than 5.8% of our total shareholders
equity. At December 31, 2007, approximately 88.5% of our reinsurance
recoverables on paid and unpaid losses (not including prepaid reinsurance
premiums) of $1.74 billion were due from carriers which had an A.M. Best
rating of A- or better, and the largest reinsurance recoverable from any one
carrier was less than 5.2%, respectively, of our total shareholders equity.
Reinsurance recoverables
from Flatiron Re Ltd., which is not rated by A.M. Best, were $180.1
million at June 30, 2008, compared to $152.6 million at December 31,
2007. Flatiron Re Ltd. is required to contribute funds into a trust for the
benefit of Arch Re Bermuda. The recoverable from Flatiron Re Ltd. was fully
collateralized through such trust at June 30, 2008 and December 31,
2007.
See Note 5, Reinsurance,
of the notes accompanying our consolidated financial Statements for
further details on the quota share
reinsurance treaty with Flatiron Re Ltd.
Reserves for Losses and
Loss Adjustment Expenses
We establish reserves for
losses and loss adjustment expenses (Loss Reserves) which represent estimates
involving actuarial and statistical projections, at a given point in time, of
our expectations of the ultimate settlement and administration costs of losses
incurred. Estimating Loss Reserves is inherently difficult, which is
exacerbated by the fact that we are a relatively new company with relatively
limited historical experience upon which to base such estimates. We utilize
actuarial models as well as available historical insurance industry loss ratio
experience and loss development patterns to assist in the establishment of Loss
Reserves. Actual losses and loss adjustment expenses paid will deviate, perhaps
substantially, from the reserve estimates reflected in our financial
statements.
47
Table
of Contents
At June 30, 2008 and
December 31, 2007, our Loss Reserves, net of unpaid losses and loss
adjustment expenses recoverable, by type and by operating segment were as
follows:
|
|
June 30,
|
|
December 31,
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
Insurance:
|
|
|
|
|
|
Case reserves.
|
|
$
|
941,056
|
|
$
|
811,054
|
|
IBNR reserves
|
|
2,176,842
|
|
2,100,696
|
|
Total net
reserves
|
|
$
|
3,117,898
|
|
$
|
2,911,750
|
|
|
|
|
|
|
|
Reinsurance:
|
|
|
|
|
|
Case reserves.
|
|
$
|
632,345
|
|
$
|
623,419
|
|
Additional case
reserves
|
|
91,541
|
|
80,438
|
|
IBNR reserves
|
|
1,921,098
|
|
1,867,226
|
|
Total net
reserves
|
|
$
|
2,644,984
|
|
$
|
2,571,083
|
|
|
|
|
|
|
|
Total:
|
|
|
|
|
|
Case reserves.
|
|
$
|
1,573,401
|
|
$
|
1,434,473
|
|
Additional case
reserves
|
|
91,541
|
|
80,438
|
|
IBNR reserves
|
|
4,097,940
|
|
3,967,922
|
|
Total net
reserves
|
|
$
|
5,762,882
|
|
$
|
5,482,833
|
|
At June 30, 2008 and
December 31, 2007, the insurance segments Loss Reserves by major line of
business, net of unpaid losses and loss adjustment expenses recoverable, were
as follows:
|
|
June 30,
|
|
December 31,
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
Casualty
|
|
$
|
660,250
|
|
$
|
647,842
|
|
Construction and
national accounts
|
|
478,713
|
|
431,309
|
|
Professional
liability
|
|
459,980
|
|
412,527
|
|
Executive
assurance
|
|
455,901
|
|
431,068
|
|
Property, marine
and aviation.
|
|
402,720
|
|
345,177
|
|
Programs
|
|
379,932
|
|
370,852
|
|
Healthcare
|
|
152,226
|
|
153,018
|
|
Surety
|
|
83,873
|
|
87,232
|
|
Other
|
|
44,303
|
|
32,725
|
|
Total net
reserves
|
|
$
|
3,117,898
|
|
$
|
2,911,750
|
|
At June 30, 2008 and
December 31, 2007, the reinsurance segments Loss Reserves by major line
of business, net of unpaid losses and loss adjustment expenses recoverable,
were as follows:
|
|
June 30,
|
|
December 31,
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
Casualty
|
|
$
|
1,764,469
|
|
$
|
1,715,712
|
|
Property
excluding property catastrophe
|
|
300,885
|
|
295,728
|
|
Other specialty.
|
|
240,421
|
|
212,088
|
|
Marine and
aviation
|
|
164,195
|
|
167,290
|
|
Property
catastrophe
|
|
111,856
|
|
111,084
|
|
Other
|
|
63,158
|
|
69,181
|
|
Total net
reserves
|
|
$
|
2,644,984
|
|
$
|
2,571,083
|
|
48
Table
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Shareholders Equity
Our shareholders equity
was $3.89 billion at June 30, 2008, compared to $4.04 billion at December 31,
2007. The decrease in the 2008 period of $149.6 million was primarily
attributable to share repurchase activity and an after-tax decrease in the fair
value of our investment portfolio, partially offset by net income in the
period.
Liquidity
and Capital Resources
ACGL is a holding company
whose assets primarily consist of the shares in its subsidiaries. Generally,
ACGL depends on its available cash resources, liquid investments and dividends
or other distributions from its subsidiaries to make payments, including the
payment of debt service obligations and operating expenses it may incur and any
dividends or liquidation amounts with respect to the series A non-cumulative
and series B non-cumulative preferred shares and common shares.
On a consolidated basis,
our aggregate cash and invested assets totaled $10.27 billion at June 30,
2008, compared to $10.12 billion at December 31, 2007. ACGLs readily
available cash, short-term investments and marketable securities, excluding
amounts held by our regulated insurance and reinsurance subsidiaries, totaled
$5.1 million at June 30, 2008, compared to $36.3 million at December 31,
2007. For the six months ended June 30, 2008, ACGL received dividends of
$381.0 million from Arch Re Bermuda which were used to fund the share
repurchase program described below along with the payment of preferred
dividends, interest expense and other corporate expenses.
The ability of our
regulated insurance and reinsurance subsidiaries to pay dividends or make
distributions or other payments to us is dependent on their ability to meet
applicable regulatory standards. Under Bermuda law, Arch Re Bermuda is required
to maintain a minimum solvency margin (
i.e.
, the
amount by which the value of its general business assets must exceed its
general business liabilities) equal to the greatest of (1) $100 million, (2) 50%
of net premiums written (being gross premiums written by us less any premiums
ceded by us, but we may not deduct more than 25% of gross premiums when
computing net premiums written) and (3) 15% of loss and other insurance
reserves. Arch Re Bermuda is prohibited from declaring or paying any dividends
during any financial year if it is not in compliance with its minimum solvency
margin or minimum liquidity ratio. In addition, Arch Re Bermuda is prohibited
from declaring or paying in any financial year dividends of more than 25% of
its total statutory capital and surplus (as shown on its previous financial
years statutory balance sheet) unless it files, at least seven days before
payment of such dividends, with the Bermuda Monetary Authority an affidavit
stating that it will continue to meet the required margins. In addition, Arch
Re Bermuda is prohibited, without prior approval of the Bermuda Monetary
Authority, from reducing by 15% or more its total statutory capital, as set out
in its previous years statutory financial statements. At December 31,
2007, as determined under Bermuda law, Arch Re Bermuda had statutory capital of
$2.0 billion and statutory capital and surplus of $3.73 billion. Such amounts
include ownership interests in U.S. insurance and reinsurance subsidiaries.
Accordingly, Arch Re Bermuda can pay approximately $933 million to ACGL during
2008 without providing an affidavit to the Bermuda Monetary Authority, as
discussed above. Our U.S. insurance and reinsurance subsidiaries can pay
approximately $113.9 million in dividends or distributions to Arch-U.S., our
U.S. holding company, which is owned by Arch Re Bermuda, during 2008 without
prior regulatory approval. Such dividends or distributions may be subject to
applicable withholding or other taxes. Arch-Europe can pay approximately £8.4
million, or $16.7 million, in dividends to ACGL during 2008 without prior
notice to and approval by the Financial Services Authority. In addition, the
ability of our insurance and reinsurance subsidiaries to pay dividends is also
constrained by our dependence on the financial strength ratings of our
insurance and reinsurance subsidiaries from independent rating agencies. The
ratings from these agencies depend to a large extent on the capitalization
levels of our insurance and reinsurance subsidiaries. We believe that ACGL has
sufficient cash resources and available dividend capacity to service its
indebtedness and other current outstanding obligations.
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Table
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Our insurance and
reinsurance subsidiaries are required to maintain assets on deposit, which
primarily consist of fixed maturities, with various regulatory authorities to
support their operations. The assets on deposit are available to settle
insurance and reinsurance liabilities to third parties. Our insurance and
reinsurance subsidiaries also have investments in segregated portfolios
primarily to provide collateral or guarantees for letters of credit to third
parties. At June 30, 2008 and December 31, 2007, such amounts
approximated $1.1 billion and $1.17 billion, respectively. In addition, certain
of our operating subsidiaries maintain assets in trust accounts as collateral
for insurance and reinsurance transactions with affiliated companies. At June 30,
2008 and December 31, 2007, such amounts approximated $3.85 billion and
$3.8 billion, respectively.
ACGL, through its
subsidiaries, provides financial support to certain of its insurance
subsidiaries and affiliates, through certain reinsurance arrangements essential
to the ratings of such subsidiaries. Except as described in the preceding
sentence, or where express reinsurance, guarantee or other financial support
contractual arrangements are in place, each of ACGLs subsidiaries or
affiliates is solely responsible for its own liabilities and commitments (and
no other ACGL subsidiary or affiliate is so responsible). Any reinsurance
arrangements, guarantees or other financial support contractual arrangements
that are in place are solely for the benefit of the ACGL subsidiary or
affiliate involved and third parties (creditors or insureds of such entity) are
not express beneficiaries of such arrangements.
Our insurance and
reinsurance operations provide liquidity in that premiums are received in
advance, sometimes substantially in advance, of the time losses are paid. The
period of time from the occurrence of a claim through the settlement of the
liability may extend many years into the future. Sources of liquidity include
cash flows from operations, financing arrangements or routine sales of
investments.
As part of our investment
strategy, we seek to establish a level of cash and highly liquid short-term and
intermediate-term securities which, combined with expected cash flow, is
believed by us to be adequate to meet our foreseeable payment obligations.
However, due to the nature of our operations, cash flows are affected by claim
payments that may comprise large payments on a limited number of claims and
which can fluctuate from year to year. We believe that our liquid investments
and cash flow will provide us with sufficient liquidity in order to meet our
claim payment obligations. However, the timing and amounts of actual claim
payments related to recorded Loss Reserves vary based on many factors,
including large individual losses, changes in the legal environment, as well as
general market conditions. The ultimate amount of the claim payments could
differ materially from our estimated amounts. Certain lines of business written
by us, such as excess casualty, have loss experience characterized as low
frequency and high severity. The foregoing may result in significant
variability in loss payment patterns. The impact of this variability can be
exacerbated by the fact that the timing of the receipt of reinsurance
recoverables owed to us may be slower than anticipated by us. Therefore, the
irregular timing of claim payments can create significant variations in cash
flows from operations between periods and may require us to utilize other
sources of liquidity to make these payments, which may include the sale of
investments or utilization of existing or new credit facilities or capital
market transactions. If the source of liquidity is the sale of investments, we
may be forced to sell such investments at a loss, which may be material.
Consolidated cash
provided by operating activities was $590.8 million for the six months ended June 30,
2008, compared to $677.0 million for the 2007 period.
The lower level
of operating cash flows in the 2008 period primarily resulted from an increase
in paid losses, as our insurance and reinsurance loss reserves have continued
to mature, along with a lower level of premiums written and collected.
Cash flow from operating activities are
provided by premiums collected, fee income, investment income and collected
reinsurance recoverables, offset by losses and loss adjustment expense
payments, reinsurance premiums paid, operating costs and current taxes paid.
We expect that our
operational needs, including our anticipated insurance obligations and
operating and capital expenditure needs, for the next twelve months, at a
minimum, will be met by our balance of cash, short-
50
Table
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term investments
and our credit facilities, as well as by funds generated from underwriting
activities and investment income and proceeds on the sale or maturity of our
investments.
We monitor our capital
adequacy on a regular basis and will seek to adjust our capital base (up or
down) according to the needs of our business. The future capital requirements
of our business will depend on many factors, including our ability to write new
business successfully and to establish premium rates and reserves at levels
sufficient to cover losses. Our ability to underwrite is largely dependent upon
the quality of our claims paying and financial strength ratings as evaluated by
independent rating agencies. In particular, we require (1) sufficient
capital to maintain our financial strength ratings, as issued by several
ratings agencies, at a level considered necessary by management to enable our
key operating subsidiaries to compete; (2) sufficient capital to enable
our underwriting subsidiaries to meet the capital adequacy tests performed by
statutory agencies in the U.S. and other key markets; and (3) letters of
credit and other forms of collateral that are necessary for our non-U.S.
operating companies because they are non-admitted under U.S. state insurance
regulations.
As part of our capital
management program, we may seek to raise additional capital or may seek to
return capital to our shareholders through share repurchases, cash dividends or
other methods (or a combination of such methods). Any such determination will
be at the discretion of our board of directors and will be dependent upon our
profits, financial requirements and other factors, including legal restrictions,
rating agency requirements and such other factors as our board of directors
deems relevant.
The board of directors of
ACGL has authorized the investment of up to $1.5 billion in ACGLs common
shares through a share repurchase program. Such amount consisted of a $1.0
billion authorization in February 2007 and a $500 million authorization in
May 2008. Repurchases under the program may be effected from time to time
in open market or privately negotiated transactions through February 2010.
Since the inception of the share repurchase program through June 30, 2008,
ACGL has repurchased approximately 13.4 million common shares for an aggregate
purchase price of $926.8 million. During the six months ended June 30,
2008, ACGL repurchased approximately 5.6 million common shares under the share
repurchase program for an aggregate purchase price of $389.8 million. As a
result of the share repurchase transactions to date, book value per common
share was reduced by $2.09 per share at June 30, 2008, compared to $1.45 at
December 31, 2007.
In July 2008, we
purchased approximately 1.8 million common shares for an aggregate purchase
price of $122.2 million. 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. In connection with the
repurchase program, the Warburg Pincus funds waived their rights relating to
share repurchases under the shareholders agreement for all repurchases of
common shares by ACGL under the repurchase program in open market transactions
and certain privately negotiated transactions.
To the extent that our
existing capital is insufficient to fund our future operating requirements or
maintain such ratings, we may need to raise additional funds through financings
or limit our growth. If we are not able to obtain adequate capital, our
business, results of operations and financial condition could be adversely
affected, which could include, among other things, the following possible
outcomes: (1) potential downgrades in the financial strength ratings
assigned by ratings agencies to our operating subsidiaries, which could place
those operating subsidiaries at a competitive disadvantage compared to
higher-rated competitors; (2) reductions in the amount of business that
our operating subsidiaries are able to write in order to meet capital
adequacy-based tests enforced by statutory agencies; and (3) any resultant
ratings downgrades could, among other things, affect our ability to write business
and increase the cost of bank credit and letters of credit.
In addition to common
share capital, we depend on external sources of finance to support our
underwriting activities, which can be in the form (or any combination) of debt
securities, preference shares, common equity and bank credit facilities
providing loans and/or letters of credit. Any equity or debt financing, if
available at all, may be on terms that are unfavorable to us. In the case of
equity financings, dilution to our shareholders could
51
Table
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result, and, in
any case, such securities may have rights, preferences and privileges that are
senior to those of our outstanding securities.
In June 2006, ACGL
and Arch-U.S. filed a universal shelf registration statement with the SEC. This
registration statement allows for the possible future offer and sale by us of
various types of securities, including unsecured debt securities, preference
shares, common shares, warrants, share purchase contracts and units and
depositary shares. The shelf registration statement enables us to efficiently
access the public debt and/or equity capital markets in order to meet our
future capital needs. The shelf registration statement also allows selling
shareholders to resell common shares that they own in one or more offerings
from time to time. We will not receive any proceeds from any shares offered by
the selling shareholders. This report is not an offer to sell or the
solicitation of an offer to buy nor shall there be any sale of these securities
in any state in which such offer, solicitation or sale would be unlawful prior
to registration or qualification under the securities laws of any such state.
In August 2006, we
entered into a five-year agreement for a $300 million unsecured revolving loan
and letter of credit facility and a $1.0 billion secured letter of credit
facility. The $300 million unsecured loan and letter of credit facility is also
available for the issuance of unsecured letters of credit up to $100 million
for our U.S.-based reinsurance operation.
Including the secured letter
of credit portion of the Credit Agreement and another letter of credit facility
(together, the LOC Facilities), we have access to letter of credit facilities
for up to a total of $1.45 billion. At June 30, 2008 and December 31,
2007, we had approximately $565.0 million and $612.4 million, respectively, in
outstanding letters of credit under the LOC Facilities, which were secured by
investments at fair value totaling $582.2 million and $652.8 million,
respectively.
In May 2008,
we borrowed $100.0 million under the Credit Agreement at a variable interest
rate based on 1 month, 3 month or 6 month LIBOR rates plus 27.5 basis points.
The proceeds from such borrowings, which are repayable in August 2011,
were contributed to Arch Re Bermuda and used to fund the investment in Gulf Re
noted above.
During 2006, ACGL
completed two public offerings of non-cumulative preferred shares. On February 1,
2006, $200.0 million principal amount of 8.0% series A non-cumulative preferred
shares (series A preferred shares) were issued with net proceeds of $193.5
million and, on May 24, 2006, $125.0 million principal amount of 7.875%
series B non-cumulative preferred shares (series B preferred shares and
together with the series A preferred shares, the preferred shares) were
issued with net proceeds of $120.9 million. The net proceeds of the offerings
were used to support the underwriting activities of ACGLs insurance and
reinsurance subsidiaries. ACGL has the right to redeem all or a portion of each
series of preferred shares at a redemption price of $25.00 per share on or
after (1) February 1, 2011 for the series A preferred shares and (2) May 15,
2011 for the series B preferred shares. Dividends on the preferred shares are
non-cumulative. Consequently, in the event dividends are not declared on the
preferred shares for any dividend period, holders of preferred shares will not
be entitled to receive a dividend for such period, and such undeclared dividend
will not accrue and will not be payable. Holders of preferred shares will be
entitled to receive dividend payments only when, as and if declared by ACGLs
board of directors or a duly authorized committee of ACGLs board of directors.
Any such dividends will be payable from the date of original issue on a
non-cumulative basis, quarterly in arrears. To the extent declared, these
dividends will accumulate, with respect to each dividend period, in an amount
per share equal to 8.0% of the $25.00 liquidation preference per annum for the
series A preferred shares and 7.875% of the $25.00 liquidation preference per
annum for the series B preferred shares. During the six months ended June 30,
2008 and 2007, we paid $12.9 million to holders of the preferred shares and, at
June 30, 2008, had declared an aggregate of $3.3 million of dividends to
be paid to holders of the preferred shares.
At June 30, 2008,
ACGLs capital of $4.29 billion consisted of $300.0 million of senior notes,
representing 7.0% of the total, $100.0 million of revolving credit agreement
borrowings, representing 2.3% of the total, $325.0 million of preferred shares,
representing 7.6% of the total, and common shareholders equity of $3.56
billion, representing the balance. At December 31, 2007, ACGLs capital of
$4.34 billion consisted of $300.0 million of senior notes, representing 6.9% of
the total, $325.0 million of preferred shares, representing 7.5% of the total,
and common shareholders equity of $3.71 billion, representing the balance. The
decrease in capital
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Table
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during 2008 was
primarily attributable to share repurchase activity and an after-tax decrease
in the fair value of our investment portfolio, partially offset by net income
and borrowings during the period.
Off-Balance Sheet Arrangements
Off-balance sheet
arrangements are discussed in Managements Discussion and Analysis of Financial
Condition and Results of Operations contained in our Annual Report on Form 10-K
for the year ended December 31, 2007.
Book Value Per Common Share and Share Repurchases
The following table
presents the calculation of book value per common share and the impact of
transactions under the share repurchase program on book value per common share:
|
|
June 30,
|
|
December 31,
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
Calculation of
book value per common share:
|
|
|
|
|
|
Total
shareholders equity
|
|
$
|
3,886,233
|
|
$
|
4,035,811
|
|
Less preferred
shareholders equity
|
|
(325,000
|
)
|
(325,000
|
)
|
Common
shareholders equity
|
|
$
|
3,561,233
|
|
$
|
3,710,811
|
|
Common shares
outstanding
(1)
|
|
61,943
|
|
67,318
|
|
Book value per
common share
|
|
$
|
57.49
|
|
$
|
55.12
|
|
|
|
|
|
|
|
Effect of share
repurchases to date:
|
|
|
|
|
|
Aggregate
purchase price of shares repurchased
|
|
$
|
926,819
|
|
$
|
537,066
|
|
Shares
repurchased
|
|
13,391
|
|
7,769
|
|
Average price
per share repurchased
|
|
$
|
69.21
|
|
$
|
69.13
|
|
|
|
|
|
|
|
Estimated
dilutive impact on ending book value per common share
(2)
|
|
$
|
(2.09
|
)
|
$
|
(1.45
|
)
|
|
|
|
|
|
|
|
|
|
|
(1)
Excludes the effects of 5.6 million and
5.5 million stock options and 0.4 million and 0.1 million restricted stock
units outstanding at June 30, 2008 and December 31, 2007,
respectively.
(2)
As the average price per share
repurchased during the periods exceeded the book value per common share at June 30,
2008 and December 31, 2007, the repurchase of shares during the periods
reduced book value per common share at both dates.
Market Sensitive Instruments and
Risk Management
In accordance with the
SECs Financial Reporting Release No. 48, we performed a sensitivity
analysis to determine the effects that market risk exposures could have on the
future earnings, fair values or cash flows of our financial instruments as of June 30,
2008. (See section captioned Managements Discussion and Analysis of Financial
Condition and Results of OperationsMarket Sensitive Instruments and Risk
Management included in our 2007 Annual Report on Form 10-K.) Market risk
represents the risk of changes in the fair value of a financial instrument and
is comprised of several components, including liquidity, basis and price risks.
At June 30, 2008, material changes in market risk exposures that affect
the quantitative and qualitative disclosures presented as of December 31,
2007 were as follows:
Investment
Market Risk
Fixed Income Securities
. We invest in interest rate sensitive
securities, primarily debt securities. We consider the effect of interest rate
movements on the market value of our fixed maturities, fixed maturities pledged
under securities lending agreements, short-term investments and certain of our
other investments and
53
Table
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investment funds
accounted for using the equity method which invest in fixed income securities
and the corresponding change in unrealized appreciation. As interest rates
rise, the market value of our interest rate sensitive securities falls, and the
converse is also true. The following table summarizes the effect
that an
immediate, parallel shift in the interest rate yield curve would have had on
the portfolio at June 30, 2008 and December 31, 2007. Based on
historical observations, there is a low probability that all interest rate
yield curves would shift in the same direction at the same time
and, accordingly, the actual effect of
interest rate movements may differ materially from the amounts set forth below.
For further discussion on investment activity, please refer to Investments.
|
|
Interest Rate Shift in Basis Points
|
|
(U.S. dollars in millions)
|
|
-100
|
|
-50
|
|
0
|
|
50
|
|
100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
2008:
|
|
|
|
|
|
|
|
|
|
|
|
Total market
value
|
|
$
|
10,080.6
|
|
$
|
9,911.9
|
|
$
|
9,745.4
|
|
$
|
9,584.3
|
|
$
|
9,425.7
|
|
Market value
change from base
|
|
3.44
|
%
|
1.71
|
%
|
|
|
(1.65
|
%)
|
(3.28
|
%)
|
Change in
unrealized value
|
|
$
|
335.2
|
|
$
|
166.5
|
|
|
|
$
|
(161.1
|
)
|
$
|
(319.7
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
2007:
|
|
|
|
|
|
|
|
|
|
|
|
Total market
value
|
|
$
|
10,048.9
|
|
$
|
9,885.3
|
|
$
|
9,725.0
|
|
$
|
9,565.4
|
|
$
|
9,409.6
|
|
Market value
change from base
|
|
3.33
|
%
|
1.65
|
%
|
|
|
(1.64
|
%)
|
(3.24
|
%)
|
Change in
unrealized value
|
|
$
|
323.9
|
|
$
|
160.3
|
|
|
|
$
|
(159.6
|
)
|
$
|
(315.4
|
)
|
Another method that
attempts to measure portfolio risk is Value-at-Risk (VaR). VaR attempts to
take into account a broad cross-section of risks facing a portfolio by
utilizing relevant securities volatility data skewed towards the most recent
months and quarters. VaR measures the amount of a portfolio at risk for
outcomes 1.65 standard deviations from the mean based on normal market
conditions over a one year time horizon and is expressed as a percentage of the
portfolios initial value. In other words, 95% of the time, should the risks
taken into account in the VaR model perform per their historical tendencies,
the portfolios loss in any one year period is expected to be less than or
equal to the calculated VaR, stated as a percentage of the measured portfolios
initial value. As of June 30, 2008, our portfolios VaR was estimated to
be 5.28%, compared to an estimated 3.73% at December 31, 2007.
Equities and Privately Held
Securities.
Our
investment portfolio includes an allocation to other investments which include
investments in certain stock index funds, other preferred stocks and privately
held securities.
See Note 6, Investment InformationOther
Investments, of the notes accompanying our consolidated financial Statements
for
additional
disclosures concerning our other investments. At June 30, 2008 and December 31,
2007, the fair value of our investments in equities and privately held
securities totaled $184.8 million and $164.8 million, respectively. These
securities are exposed to price risk, which is the potential loss arising from
decreases in the market value of equities. An immediate hypothetical 10%
depreciation in the value of each equity position would reduce the fair value
of such investments by approximately $18.5 million and $16.5 million at June 30,
2008 and December 31, 2007, respectively, and would have decreased book
value per common share by approximately $0.30 and $0.24, respectively.
Investment-Related
Derivatives.
We invest in certain
derivative instruments to replicate investment positions and to manage market
exposures and duration risk. At June 30, 2008, the notional value of the
net short position for equity futures was nil, compared to a net long position
for equity futures of $91.2 million at December 31, 2007. At June 30,
2008 and December 31, 2007, the notional value of the net long position
for Treasury note futures was nil and $61.7 million, respectively. A 10%
depreciation of the underlying exposure to these derivative instruments at June 30,
2008 and December 31, 2007 would have resulted in a reduction in net
income of nil and $15.3 million, respectively, and would have decreased book
value per common share by nil and $0.23, respectively.
54
Table
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Foreign
Currency Exchange Risk
Foreign currency rate
risk is the potential change in value, income and cash flow arising from
adverse changes in foreign currency exchange rates. A 10% depreciation of the
U.S. Dollar against other currencies under our outstanding contracts at June 30,
2008 and December 31, 2007, net of unrealized appreciation on our
securities denominated in currencies other than the U.S. Dollar, would have
resulted in unrealized gains of approximately $10.9 million and $12.9 million,
respectively, and would have increased book value per common share by
approximately $0.18 and $0.19, respectively. A 10% appreciation of the U.S.
Dollar against other currencies under our outstanding contracts at June 30,
2008 and December 31, 2007, net of unrealized depreciation on our
securities denominated in currencies other than the U.S. Dollar, would have
resulted in unrealized losses of approximately $10.9 million and $12.9 million,
respectively, and would have decreased book value per common share by
approximately $0.18 and $0.19, respectively. Historical observations indicate a
low probability that all foreign currency exchange rates would shift against
the U.S. Dollar in the same direction and at the same time and, accordingly, the
actual effect of foreign currency rate movements may differ materially from the
amounts set forth above. For further discussion on foreign exchange activity,
please refer to Results of Operations.
Cautionary Note Regarding
Forward-Looking Statements
The Private Securities
Litigation Reform Act of 1995 (PLSRA) provides a safe harbor for
forward-looking statements. This report or any other written or oral statements
made by or on behalf of us may include forward-looking statements, which
reflect our current views with respect to future events and financial
performance. All statements other than statements of historical fact included
in or incorporated by reference in this report are forward-looking statements.
Forward-looking statements, for purposes of the PLSRA or otherwise, can
generally be identified by the use of forward-looking terminology such as may,
will, expect, intend, estimate, anticipate, believe or continue
and similar statements of a future or forward-looking nature or their negative
or variations or similar terminology.
Forward-looking
statements involve our 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, elsewhere in this report and in our periodic reports filed with the SEC,
and include:
·
our ability to successfully implement our business
strategy during soft as well as hard markets;
·
acceptance of our business strategy, security and
financial condition by rating agencies and regulators, as well as by brokers
and our insureds and reinsureds;
·
our ability to maintain or improve our ratings,
which may be affected by our 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, foreign currency exchange rates and prevailing
credit terms) and conditions specific to the reinsurance and insurance markets
in which we operate;
·
competition, including increased competition, on the
basis of pricing, capacity, coverage terms or other factors;
·
our 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 our underwriting initiatives and to develop accurate
actuarial data;
55
Table of Contents
·
the loss of key personnel;
·
the integration of
businesses we have acquired or may acquire into our existing operations;
·
accuracy of those estimates
and judgments utilized in the preparation of our 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 our company, are even more difficult to make than
those made in a mature company since relatively limited historical information
has been reported to us through June 30, 2008;
·
greater than expected loss
ratios on business written by us and adverse development on claim and/or claim
expense liabilities related to business written by our insurance and
reinsurance subsidiaries;
·
severity and/or frequency of
losses;
·
claims for natural or
man-made catastrophic events in our insurance or reinsurance business could
cause large losses and substantial volatility in our 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 we may be liable to the purchaser of our prior reinsurance business or to
others in connection with the May 5, 2000 asset sale described in our
periodic reports filed with the SEC;
·
availability to us of
reinsurance to manage our 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 us;
·
the timing of loss payments
being faster or the receipt of reinsurance recoverables being slower than
anticipated by us;
·
our investment performance;
·
material differences between
actual and expected assessments for guaranty funds and mandatory pooling
arrangements;
·
changes in accounting
principles or policies or in our application of such accounting principles or
policies;
·
changes in the political environment
of certain countries in which we operate or underwrite business;
·
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 us, our subsidiaries,
brokers or customers; and
·
the other matters set forth
in this Quarterly Report on Form 10-Q, as well as the risk and other
factors set forth in ACGLs Annual Report on Form 10-K and other documents
on file with the SEC.
In
addition, other general factors could affect our results,
including developments in the worlds financial and capital markets and
our access to such markets.
56
Table of
Contents
All
subsequent written and oral forward-looking statements attributable to us or
persons acting on our 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. We undertake no obligation to
publicly update or revise any forward-looking statement, whether as a result of
new information, future events or otherwise.
Other Financial Information
The interim financial
information included in this Quarterly Report on Form 10-Q as of and for
the three and six months ended June 30, 2008 has not been audited by
PricewaterhouseCoopers LLP. In reviewing such information,
PricewaterhouseCoopers LLP has applied limited procedures in accordance with
professional standards for reviews of interim financial information. However,
their separate report included in this Quarterly Report on Form 10-Q for
the 2008 second quarter states that they did not audit and they do not express
an opinion on that interim financial information. Accordingly, you should
restrict your reliance on their reports on such information.
PricewaterhouseCoopers LLP is not subject to the liability provisions of Section 11
of the Securities Act of 1933 for their reports on the interim financial
information because such reports do not constitute reports or parts of the
registration statements prepared or certified by PricewaterhouseCoopers LLP
within the meaning of Sections 7 and 11 of the Securities Act of 1933.
ITEM 3. QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Reference is made to the
information appearing above under the subheading Market Sensitive Instruments
and Risk Management under the caption Managements Discussion and Analysis of
Financial Condition and Results of Operations, which information is hereby
incorporated by reference.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
In connection with the
filing of this Form 10-Q, our management, including the Chief Executive
Officer and Chief Financial Officer, conducted an evaluation of the
effectiveness of disclosure controls and procedures pursuant to applicable
Exchange Act Rules as of the end of the period covered by this report.
Based on that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that the disclosure controls and procedures were effective as
of the end of and during the period covered by this report with respect to
information being recorded, processed, summarized and reported within time
periods specified in the SECs rules and forms and with respect to timely
communication to them and other members of management responsible for preparing
periodic reports of all material information required to be disclosed in this report
as it relates to ACGL and its consolidated subsidiaries.
We
continue to enhance our operating procedures and internal controls to
effectively support our business and our regulatory and reporting requirements.
Our management does not expect that our disclosure controls or our internal
controls will prevent all errors and all fraud. A control system, no matter how
well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met. Further, the
design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. As a result of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within the company have been detected. These
inherent limitations include the realities that judgments in decision-making
can be faulty, and that breakdowns can occur because of simple error or
mistake. Additionally, controls can be circumvented by the individual acts of
some persons or by collusion of two or more people. The design of any system of
controls also is based in part upon certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions;
57
Table of
Contents
over time, controls may become inadequate because of changes in
conditions, or the degree of compliance with the policies or procedures may
deteriorate. As a result of the inherent limitations in a cost-effective control
system, misstatement due to error or fraud may occur and not be detected.
Accordingly, our disclosure controls and procedures are designed to provide
reasonable, not absolute, assurance that the disclosure controls and procedures
are met.
Changes
in Internal Controls Over Financial Reporting
There have been no
changes in internal control over financial reporting that occurred during the
fiscal quarter ended June 30, 2008 that have materially affected, or are
reasonably likely to materially affect, internal control over financial
reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We, in common with the
insurance industry in general, are subject to litigation and arbitration in the
normal course of our business. As of June 30, 2008, we were not a party to
any material litigation or arbitration other than as a part of the ordinary
course of business in relation to claims and reinsurance recoverable matters,
none of which is expected by management to have a significant adverse effect on
our results of operations and financial condition and liquidity.
Item 2. Unregistered Sales of Equity Securities and
Use of Proceeds
The following table
summarizes ACGLs purchases of its common shares for the 2008 second quarter:
(U.S.
dollars in thousands, except share data)
|
|
Issuer Purchases of Equity Securities
|
|
|
|
Period
|
|
Total Number
of Shares
Purchased (1)
|
|
Average
Price Paid
per Share
|
|
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs (2)
|
|
Approximate
Dollar Value of
Shares that May
Yet be Purchased
Under the Plan or
Programs (2)
|
|
4/1/2008-4/30/2008
|
|
601,986
|
|
$
|
70.51
|
|
599,674
|
|
$
|
731,046
|
|
5/1/2008-5/31/2008
|
|
1,367,007
|
|
$
|
70.64
|
|
1,347,100
|
|
$
|
637,337
|
|
6/1/2008-6/30/2008
|
|
925,761
|
|
$
|
70.63
|
|
925,085
|
|
$
|
573,181
|
|
Total
|
|
2,894,754
|
|
$
|
70.63
|
|
2,871,859
|
|
$
|
573,181
|
|
(1)
Includes 22,895 shares repurchased from
employees in order to facilitate the payment of withholding taxes on restricted
shares granted. We purchased these shares at their fair market value, as
determined by reference to the closing price of our common shares on the day
the restricted shares vested.
(2)
ACGLs Board of Directors have authorized
ACGL to invest up to $1.5 billion in ACGLs 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 2010.
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. In connection with the repurchase program, the
Warburg Pincus funds waived their rights relating to share repurchases under
the shareholders agreement for all repurchases of common shares by ACGL under
the repurchase program in open market transactions and certain privately
negotiated transactions.
58
Item 4. Submission of Matters to a Vote of Security
Holders
(a)
The annual meeting of shareholders (the Annual
Meeting) of ACGL was held on May 9, 2008.
(b)
Proxies for the Annual Meeting were
solicited pursuant to Regulation 14 under the Securities Exchange Act of 1934.
There was no solicitation in opposition to managements nominees as listed in
ACGLs proxy statement, dated April 1, 2008 (the Proxy Statement).
(c)
The shareholders of ACGL (1) elected
Class I Directors to hold office until the 2011 annual meeting of shareholders
or until their successors are elected or qualified, (2) elected certain
individuals as Designated Company Directors of certain of ACGLs non-U.S.
subsidiaries and (3) appointed PricewaterhouseCoopers LLP as independent
registered public accounting firm for the fiscal year ending December 31,
2008. Set forth below are the voting results for these proposals:
Election
of Class I Directors of ACGL
|
|
FOR
|
|
WITHHOLD
|
|
|
|
|
|
|
|
Paul B. Ingrey
|
|
|
|
|
|
Total:
|
|
56,131,779
|
|
296,793
|
|
|
|
|
|
|
|
Kewsong Lee
|
|
|
|
|
|
Total:
|
|
55,904,391
|
|
524,181
|
|
|
|
|
|
|
|
Robert F. Works
|
|
|
|
|
|
Total:
|
|
56,134,387
|
|
294,185
|
|
Election
of Designated Directors of Non-U.S. Subsidiaries
|
|
FOR
|
|
WITHHOLD
|
|
|
|
|
|
|
|
Graham B. Collis
|
|
|
|
|
|
Total:
|
|
54,627,275
|
|
1,801,297
|
|
|
|
|
|
|
|
Marc Grandisson
|
|
|
|
|
|
Total:
|
|
56,371,916
|
|
56,656
|
|
|
|
|
|
|
|
W. Preston
Hutchings
|
|
|
|
|
|
Total:
|
|
56,376,581
|
|
51,991
|
|
|
|
|
|
|
|
Constantine
Iordanou
|
|
|
|
|
|
Total:
|
|
56,376,430
|
|
52,142
|
|
|
|
|
|
|
|
Ralph E. Jones
III
|
|
|
|
|
|
Total:
|
|
56,374,439
|
|
54,133
|
|
|
|
|
|
|
|
Thomas G. Kaiser
|
|
|
|
|
|
Total:
|
|
56,375,466
|
|
53,106
|
|
|
|
|
|
|
|
Mark D. Lyons
|
|
|
|
|
|
Total:
|
|
56,375,751
|
|
52,821
|
|
|
|
|
|
|
|
Martin J. Nilsen
|
|
|
|
|
|
Total:
|
|
56,376,276
|
|
52,296
|
|
|
|
|
|
|
|
Nicolas
Papadopoulo
|
|
|
|
|
|
Total:
|
|
56,376,536
|
|
52,036
|
|
|
|
|
|
|
|
Michael Quinn
|
|
|
|
|
|
Total:
|
|
56,374,855
|
|
53,717
|
|
59
Table
of Contents
Maamoun Rajeh
|
|
|
|
|
|
Total:
|
|
56,376,585
|
|
51,987
|
|
|
|
|
|
|
|
Paul S. Robotham
|
|
|
|
|
|
Total:
|
|
54,797,751
|
|
1,630,821
|
|
|
|
|
|
|
|
Robert T. Van
Gieson
|
|
|
|
|
|
Total:
|
|
56,375,301
|
|
53,271
|
|
|
|
|
|
|
|
John D. Vollaro
|
|
|
|
|
|
Total:
|
|
54,796,491
|
|
1,632,081
|
|
|
|
|
|
|
|
James
Weatherstone
|
|
|
|
|
|
Total:
|
|
56,377,676
|
|
50,896
|
|
Ratification
of Selection of PricewaterhouseCoopers LLP as Independent Registered Public
Accounting Firm
|
|
FOR
|
|
AGAINST
|
|
ABSTAIN
|
|
|
|
|
|
|
|
|
|
Total:
|
|
56,367,458
|
|
48,401
|
|
12,713
|
|
Item 5. Other Information
In accordance with Section 10a(i)(2) of
the Securities Exchange Act of 1934, as amended, we are responsible for
disclosing non-audit services to be provided by our independent auditor,
PricewaterhouseCoopers LLP, which are approved by the Audit Committee of our
board of directors. During the 2008 second quarter, the Audit Committee
approved engagements of PricewaterhouseCoopers LLP for the following permitted
non-audit services: tax services, tax consulting and tax compliance.
Item 6. Exhibits
Exhibit No.
|
|
Description
|
|
|
|
10.1
|
|
Agreement,
dated May 14, 2008, among Arch Capital Group Ltd., Arch Insurance Group
Inc. and Ralph E. Jones III
|
|
|
|
10.2
|
|
Amendment
to Employment Agreement, dated May 21, 2008, between Arch Capital Group
Ltd. and W. Preston Hutchings
|
|
|
|
15
|
|
Accountants
Awareness Letter (regarding unaudited interim financial information)
|
|
|
|
31.1
|
|
Certification
of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
|
|
|
|
31.2
|
|
Certification
of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
|
|
|
|
32.1
|
|
Certification
of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
|
|
|
|
32.2
|
|
Certification
of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
|
60
Table of Contents
SIGNATURES
Pursuant to the
requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.
|
|
ARCH CAPITAL GROUP LTD.
|
|
|
(REGISTRANT)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
/s/ Constantine
Iordanou
|
Date: August 8,
2008
|
|
Constantine Iordanou
|
|
|
President and Chief
Executive Officer
|
|
|
(Principal Executive
Officer) and Director
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
/s/ John D. Vollaro
|
Date: August 8,
2008
|
|
John D. Vollaro
|
|
|
Executive Vice
President, Chief Financial
|
|
|
Officer and Treasurer
(Principal Financial and
|
|
|
Accounting Officer)
|
61
Table of
Contents
EXHIBIT
INDEX
Exhibit No.
|
|
Description
|
|
|
|
10.1
|
|
Agreement,
dated May 14, 2008, among Arch Capital Group Ltd., Arch Insurance Group
Inc. and Ralph E. Jones III
|
|
|
|
10.2
|
|
Amendment
to Employment Agreement, dated May 21, 2008, between Arch Capital Group
Ltd. and W. Preston Hutchings
|
|
|
|
15
|
|
Accountants
Awareness Letter (regarding unaudited interim financial information)
|
|
|
|
31.1
|
|
Certification
of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
|
|
|
|
31.2
|
|
Certification
of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002
|
|
|
|
32.1
|
|
Certification
of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
|
|
|
|
32.2
|
|
Certification
of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
|
62
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