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
March 31, 2009
Or
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
|
Commission file number: 001-26456
ARCH CAPITAL GROUP LTD.
(Exact name of registrant as specified in its charter)
Bermuda
(State or other jurisdiction of incorporation or organization)
Not Applicable
(I.R.S. Employer Identification No.)
Wessex House, 45 Reid Street
Hamilton HM 12, Bermuda
(Address of principal executive offices)
(441) 278-9250
(Registrants telephone number, including area code)
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 has submitted electronically and posted on its corporate
Web site, if any, every Interactive Data File required to be submitted and
posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)
during the preceding 12 months (or for such shorter period that the registrant
was required to submit and post such files). Yes
o
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
|
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 April 30, 2009
|
Common Shares,
$0.01 par value
|
|
60,555,269
|
Table of Contents
ARCH CAPITAL GROUP LTD.
INDEX
See Notes to Consolidated Financial
Statements
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 March 31, 2009, and the
related consolidated statements of income, changes in shareholders equity,
comprehensive income and cash flows for each of the three-month periods ended March 31,
2009 and March 31, 2008. 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.
As
discussed in Note 7 to the consolidated financial statements, the Company
changed the manner in which it accounts for other-than-temporary impairment
losses in 2009.
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, 2008, 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 March 2,
2009, 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, 2008, 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
May 11, 2009
2
Table
of Contents
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(U.S. dollars in thousands, except share data)
|
|
(Unaudited)
|
|
|
|
|
|
March 31,
|
|
December 31,
|
|
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
Investments:
|
|
|
|
|
|
Fixed maturities
available for sale, at market value (amortized cost: 2009, $8,735,769; 2008,
$8,314,615)
|
|
$
|
8,540,653
|
|
$
|
8,122,221
|
|
Short-term
investments available for sale, at market value (amortized cost: 2009,
$749,178; 2008, $478,088)
|
|
749,708
|
|
479,586
|
|
Investment of
funds received under securities lending agreements, at market value
(amortized cost: 2009, $571,102; 2008, $750,330)
|
|
550,821
|
|
730,194
|
|
Other
investments (cost: 2009, $114,779; 2008, $125,858)
|
|
104,988
|
|
109,601
|
|
Investment funds
accounted for using the equity method
|
|
293,452
|
|
301,027
|
|
Total
investments
|
|
10,239,622
|
|
9,742,629
|
|
|
|
|
|
|
|
Cash
|
|
244,037
|
|
251,739
|
|
Accrued
investment income
|
|
65,365
|
|
78,052
|
|
Investment in
joint venture (cost: $100,000)
|
|
101,143
|
|
98,341
|
|
Fixed maturities
and short-term investments pledged under securities lending agreements, at
market value
|
|
559,691
|
|
728,065
|
|
Premiums
receivable
|
|
720,724
|
|
628,951
|
|
Unpaid losses
and loss adjustment expenses recoverable
|
|
1,710,781
|
|
1,729,135
|
|
Paid losses and
loss adjustment expenses recoverable
|
|
76,312
|
|
63,294
|
|
Prepaid
reinsurance premiums
|
|
274,578
|
|
303,707
|
|
Deferred income
tax assets, net
|
|
62,210
|
|
60,192
|
|
Deferred
acquisition costs, net
|
|
313,973
|
|
295,192
|
|
Receivable for
securities sold
|
|
1,191,896
|
|
105,073
|
|
Other assets
|
|
531,955
|
|
532,175
|
|
Total
Assets
|
|
$
|
16,092,287
|
|
$
|
14,616,545
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
Reserve for
losses and loss adjustment expenses
|
|
$
|
7,709,317
|
|
$
|
7,666,957
|
|
Unearned
premiums
|
|
1,617,431
|
|
1,526,682
|
|
Reinsurance
balances payable
|
|
146,981
|
|
138,509
|
|
Senior notes
|
|
300,000
|
|
300,000
|
|
Revolving credit
agreement borrowings
|
|
100,000
|
|
100,000
|
|
Securities
lending payable
|
|
574,337
|
|
753,528
|
|
Payable for
securities purchased
|
|
1,433,732
|
|
123,309
|
|
Other
liabilities
|
|
580,093
|
|
574,595
|
|
Total
Liabilities
|
|
12,461,891
|
|
11,183,580
|
|
|
|
|
|
|
|
Commitments and Contingencies
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders
Equity
|
|
|
|
|
|
Non-cumulative
preferred shares ($0.01 par value, 50,000,000 shares authorized, issued: 13,000,000)
|
|
130
|
|
130
|
|
Common shares
($0.01 par value, 200,000,000 shares authorized, issued: 2009, 60,532,222;
2008, 60,511,974)
|
|
605
|
|
605
|
|
Additional
paid-in capital
|
|
996,417
|
|
994,585
|
|
Retained
earnings
|
|
2,894,577
|
|
2,693,239
|
|
Accumulated
other comprehensive income (loss), net of deferred income tax
|
|
(261,333
|
)
|
(255,594
|
)
|
Total
Shareholders Equity
|
|
3,630,396
|
|
3,432,965
|
|
Total
Liabilities and Shareholders Equity
|
|
$
|
16,092,287
|
|
$
|
14,616,545
|
|
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)
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
Revenues
|
|
|
|
|
|
Net premiums
written
|
|
$
|
822,863
|
|
$
|
811,342
|
|
Increase in
unearned premiums
|
|
(122,299
|
)
|
(103,108
|
)
|
Net premiums
earned
|
|
700,564
|
|
708,234
|
|
Net investment
income
|
|
95,882
|
|
122,193
|
|
Net realized
gains (losses)
|
|
(5,164
|
)
|
48,686
|
|
|
|
|
|
|
|
Total
other-than-temporary impairment losses
|
|
(92,989
|
)
|
(12,711
|
)
|
Portion of loss
recognized in other comprehensive income (loss), before taxes
|
|
56,855
|
|
|
|
Net impairment
losses recognized in earnings
|
|
(36,134
|
)
|
(12,711
|
)
|
|
|
|
|
|
|
Fee income
|
|
925
|
|
1,068
|
|
Equity in net
income (loss) of investment funds accounted for using the equity method
|
|
(9,581
|
)
|
(22,313
|
)
|
Other income
|
|
3,951
|
|
4,036
|
|
Total
revenues
|
|
750,443
|
|
849,193
|
|
|
|
|
|
|
|
Expenses
|
|
|
|
|
|
Losses and loss
adjustment expenses
|
|
400,542
|
|
404,417
|
|
Acquisition
expenses
|
|
126,458
|
|
114,639
|
|
Other operating
expenses
|
|
87,116
|
|
97,187
|
|
Interest expense
|
|
5,712
|
|
5,524
|
|
Net foreign
exchange (gains) losses
|
|
(25,205
|
)
|
23,587
|
|
Total
expenses
|
|
594,623
|
|
645,354
|
|
|
|
|
|
|
|
Income
before income taxes
|
|
155,820
|
|
203,839
|
|
|
|
|
|
|
|
Income tax
expense
|
|
9,490
|
|
7,956
|
|
|
|
|
|
|
|
Net
income
|
|
146,330
|
|
195,883
|
|
|
|
|
|
|
|
Preferred
dividends
|
|
6,461
|
|
6,461
|
|
|
|
|
|
|
|
Net
income available to common shareholders
|
|
$
|
139,869
|
|
$
|
189,422
|
|
|
|
|
|
|
|
Net
income per common share
|
|
|
|
|
|
Basic
|
|
$
|
2.32
|
|
$
|
2.90
|
|
Diluted
|
|
$
|
2.24
|
|
$
|
2.78
|
|
|
|
|
|
|
|
Weighted
average common shares and common share equivalents outstanding
|
|
|
|
|
|
Basic
|
|
60,313,550
|
|
65,295,516
|
|
Diluted
|
|
62,559,969
|
|
68,019,413
|
|
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)
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
Non-Cumulative
Preferred Shares
|
|
|
|
|
|
Balance at
beginning and end of period
|
|
$
|
130
|
|
$
|
130
|
|
|
|
|
|
|
|
Common
Shares
|
|
|
|
|
|
Balance at
beginning of year
|
|
605
|
|
673
|
|
Common shares
issued, net
|
|
0
|
|
0
|
|
Purchases of
common shares under share repurchase program
|
|
(0
|
)
|
(27
|
)
|
Balance at end
of period
|
|
605
|
|
646
|
|
|
|
|
|
|
|
Additional
Paid-in Capital
|
|
|
|
|
|
Balance at
beginning of year
|
|
994,585
|
|
1,451,667
|
|
Common shares issued
|
|
0
|
|
0
|
|
Exercise of
stock options
|
|
528
|
|
3,749
|
|
Common shares
retired
|
|
(3,760
|
)
|
(190,278
|
)
|
Amortization of
share-based compensation
|
|
4,318
|
|
4,600
|
|
Other
|
|
746
|
|
83
|
|
Balance at end
of period
|
|
996,417
|
|
1,269,821
|
|
|
|
|
|
|
|
Retained
Earnings
|
|
|
|
|
|
Balance at
beginning of year
|
|
2,693,239
|
|
2,428,117
|
|
Cumulative
effect of change in accounting principle, adoption of FSP FAS 115-2/124-2 (1)
|
|
61,469
|
|
|
|
Balance at
beginning of year, as adjusted
|
|
2,754,708
|
|
2,428,117
|
|
Dividends
declared on preferred shares
|
|
(6,461
|
)
|
(6,461
|
)
|
Net income
|
|
146,330
|
|
195,883
|
|
Balance at end
of period
|
|
2,894,577
|
|
2,617,539
|
|
|
|
|
|
|
|
Accumulated
Other Comprehensive Income (Loss)
|
|
|
|
|
|
Balance at
beginning of year
|
|
(255,594
|
)
|
155,224
|
|
Cumulative
effect of change in accounting principle, adoption of FSP FAS 115-2/124-2 (1)
|
|
(61,469
|
)
|
|
|
Balance at
beginning of year, as adjusted
|
|
(317,063
|
)
|
155,224
|
|
Change in
unrealized appreciation (decline) in value of investments, net of deferred
income tax
|
|
114,844
|
|
(37,577
|
)
|
Portion of
other-than-temporary impairment losses recognized in other comprehensive
income, net of deferred income tax
|
|
(56,855
|
)
|
|
|
Foreign currency
translation adjustments, net of deferred income tax
|
|
(2,259
|
)
|
(1,239
|
)
|
Balance at end
of period
|
|
(261,333
|
)
|
116,408
|
|
|
|
|
|
|
|
Total
Shareholders Equity
|
|
$
|
3,630,396
|
|
$
|
4,004,544
|
|
(1)
FASB Staff Position No. FAS
115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary
Impairments (FSP FAS 115-2/124-2)
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)
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2009
|
|
2008
|
|
Comprehensive
Income
|
|
|
|
|
|
Net income
|
|
$
|
146,330
|
|
$
|
195,883
|
|
Other
comprehensive income (loss), net of deferred income tax
|
|
|
|
|
|
Unrealized
appreciation (decline) in value of investments:
|
|
|
|
|
|
Unrealized
holding gains (losses) arising during period
|
|
58,324
|
|
12,707
|
|
Portion of
other-than-temporary impairment losses recognized in other comprehensive
income, net of deferred income tax
|
|
(56,855
|
)
|
|
|
Reclassification
of net realized (gains) losses, net of income taxes, included in net income
|
|
56,520
|
|
(50,284
|
)
|
Foreign currency
translation adjustments
|
|
(2,259
|
)
|
(1,239
|
)
|
Other
comprehensive income (loss)
|
|
55,730
|
|
(38,816
|
)
|
Comprehensive
Income
|
|
$
|
202,060
|
|
$
|
157,067
|
|
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)
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2009
|
|
2008
|
|
Operating
Activities
|
|
|
|
|
|
Net income
|
|
$
|
146,330
|
|
$
|
195,883
|
|
Adjustments to
reconcile net income to net cash provided by operating activities:
|
|
|
|
|
|
Net realized (gains)
losses
|
|
5,620
|
|
(46,502
|
)
|
Net impairment
losses recognized in earnings
|
|
36,134
|
|
12,711
|
|
Equity in net
(income) loss of investment funds accounted for using the equity method and
other income
|
|
10,428
|
|
18,277
|
|
Share-based
compensation
|
|
4,318
|
|
4,600
|
|
Changes in:
|
|
|
|
|
|
Reserve for
losses and loss adjustment expenses, net of unpaid losses and loss adjustment
expenses recoverable
|
|
83,763
|
|
182,498
|
|
Unearned
premiums, net of prepaid reinsurance premiums
|
|
120,867
|
|
105,497
|
|
Premiums
receivable
|
|
(94,777
|
)
|
(148,197
|
)
|
Deferred
acquisition costs, net
|
|
(18,933
|
)
|
(21,319
|
)
|
Reinsurance
balances payable
|
|
11,278
|
|
19,677
|
|
Other
liabilities
|
|
2,802
|
|
40,490
|
|
Other items, net
|
|
(13,027
|
)
|
(29,070
|
)
|
Net
Cash Provided By Operating Activities
|
|
294,803
|
|
334,545
|
|
|
|
|
|
|
|
Investing
Activities
|
|
|
|
|
|
Purchases of
fixed maturity investments
|
|
(3,632,350
|
)
|
(3,772,652
|
)
|
Proceeds from
sales of fixed maturity investments
|
|
3,377,680
|
|
3,523,338
|
|
Proceeds from
redemptions and maturities of fixed maturity investments
|
|
168,758
|
|
136,932
|
|
Purchases of
other investments
|
|
(22,670
|
)
|
(146,815
|
)
|
Proceeds from
sales of other investments
|
|
24,027
|
|
65,226
|
|
Net (purchases)
sales of short-term investments
|
|
(204,924
|
)
|
74,201
|
|
Change in
investment of securities lending collateral
|
|
179,191
|
|
274,855
|
|
Purchases of
furniture, equipment and other assets
|
|
(7,647
|
)
|
(3,045
|
)
|
Net
Cash Provided By (Used For) Investing Activities
|
|
(117,935
|
)
|
152,040
|
|
|
|
|
|
|
|
Financing
Activities
|
|
|
|
|
|
Purchases of
common shares under share repurchase program
|
|
(1,552
|
)
|
(189,843
|
)
|
Proceeds from
common shares issued, net
|
|
(1,688
|
)
|
2,540
|
|
Change in
securities lending collateral
|
|
(179,191
|
)
|
(274,855
|
)
|
Excess tax
benefits from share-based compensation
|
|
742
|
|
660
|
|
Preferred
dividends paid
|
|
(6,461
|
)
|
(6,461
|
)
|
Net
Cash Used For Financing Activities
|
|
(188,150
|
)
|
(467,959
|
)
|
|
|
|
|
|
|
Effects of
exchange rate changes on foreign currency cash
|
|
3,580
|
|
139
|
|
Increase
(decrease) in cash
|
|
(7,702
|
)
|
18,765
|
|
Cash beginning
of year
|
|
251,739
|
|
239,915
|
|
Cash
end of period
|
|
$
|
244,037
|
|
$
|
258,680
|
|
|
|
|
|
|
|
Income taxes
paid, net
|
|
$
|
2,231
|
|
$
|
2,510
|
|
Interest paid
|
|
$
|
184
|
|
|
|
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 normally 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, 2008,
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 2008 consolidated
financial statements have been reclassified to conform to the 2009
presentation. Such reclassifications had no effect on the Companys
consolidated net income. Additionally, the Company adopted FSP No. FAS
115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary
Impairments, effective for its interim period ending March 31, 2009. See
note 7, Investment InformationOther-Than-Temporary Impairments for further
details.
2. Share Transactions
Share Repurchases
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. Repurchases under the program may be
effected from time to time in open market or privately negotiated transactions
through February 2010. In March 2009, ACGL repurchased $1.6 million
of common shares through the share repurchase program. Since the inception of
the share repurchase program through March 31, 2009, ACGL has repurchased
15.3 million common shares for an aggregate purchase price of $1.05 billion. As
a result of the share repurchase transactions to date, weighted average shares
outstanding were reduced by 15.3 million for the 2009 first quarter, compared
to 9.4 million shares for the 2008 first quarter.
At March 31, 2009,
$448.3 million of repurchases were available under the share repurchase
program. 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 share
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 share 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 March 31, 2009, the Company had
declared an aggregate of $3.3 million of dividends to be paid to holders of the
Preferred Shares.
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 2009 and 2008 first quarters, i
nterest expense
on the Senior Notes was $5.5 million. The market value of the Senior Notes at March 31,
2009 and December 31, 2008 was $193.4 million and $246.1 million,
respectively.
Letter
of Credit and Revolving Credit Facilities
As of March 31,
2009, 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). Under the terms of the agreement, Arch Reinsurance Company (Arch
Re U.S.) is limited to issuing $100 million of unsecured letters of credit as
part of the $300 million unsecured revolving loan. 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
total capital 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
9
Table of
Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
shareholders
equity levels. The Company was in compliance with all covenants contained in
the Credit Agreement at March 31, 2009. The Credit Agreement expires on August 30,
2011.
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 of certain covenants, which the Company was in compliance with at March 31,
2009. At such date, the Company had $585.7 million in outstanding letters of
credit under the LOC Facilities, which were secured by investments totaling
$700.0 million. In May 2008, the Company borrowed $100.0 million under the
Credit Agreement at a Company-selected variable interest rate that is based on
1 month, 3 month or 6 month reset option terms and their corresponding term
LIBOR rates plus 27.5 basis points. The proceeds from such borrowings, which
are repayable in August 2011, were contributed to Arch Reinsurance Ltd. (Arch
Re Bermuda) and used to fund the investment in Gulf Re (see Note 6).
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 eleven product lines: casualty; construction; executive assurance;
healthcare; national accounts casualty; professional liability; programs;
property, energy marine and aviation; surety; travel and accident; and other
(consisting of excess workers compensation and employers liability business
and lender products).
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).
10
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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, net impairment losses
recognized in earnings, 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.
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
|
|
|
|
March 31, 2009
|
|
(U.S. dollars in thousands)
|
|
Insurance
|
|
Reinsurance
|
|
Total
|
|
|
|
|
|
|
|
|
|
Gross premiums
written
(1)
|
|
$
|
638,409
|
|
$
|
390,129
|
|
$
|
1,024,971
|
|
Net premiums
written
(1)
|
|
441,586
|
|
381,277
|
|
822,863
|
|
|
|
|
|
|
|
|
|
Net premiums
earned
(1)
|
|
$
|
401,097
|
|
$
|
299,467
|
|
$
|
700,564
|
|
Fee income
|
|
870
|
|
55
|
|
925
|
|
Losses and loss
adjustment expenses
|
|
(270,015
|
)
|
(130,527
|
)
|
(400,542
|
)
|
Acquisition
expenses, net
|
|
(57,623
|
)
|
(68,835
|
)
|
(126,458
|
)
|
Other operating
expenses
|
|
(62,908
|
)
|
(18,192
|
)
|
(81,100
|
)
|
Underwriting
income
|
|
$
|
11,421
|
|
$
|
81,968
|
|
93,389
|
|
|
|
|
|
|
|
|
|
Net investment
income
|
|
|
|
|
|
95,882
|
|
Net realized
losses
|
|
|
|
|
|
(5,164
|
)
|
Net impairment
losses recognized in earnings
|
|
|
|
|
|
(36,134
|
)
|
Equity in net
income (loss) of investment funds accounted for using the equity method
|
|
|
|
|
|
(9,581
|
)
|
Other income
|
|
|
|
|
|
3,951
|
|
Other expenses
|
|
|
|
|
|
(6,016
|
)
|
Interest expense
|
|
|
|
|
|
(5,712
|
)
|
Net foreign
exchange gains
|
|
|
|
|
|
25,205
|
|
Income before
income taxes
|
|
|
|
|
|
155,820
|
|
Income tax
expense
|
|
|
|
|
|
(9,490
|
)
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
|
|
|
146,330
|
|
Preferred
dividends
|
|
|
|
|
|
(6,461
|
)
|
Net
income available to common shareholders
|
|
|
|
|
|
$
|
139,869
|
|
|
|
|
|
|
|
|
|
Underwriting
Ratios
|
|
|
|
|
|
|
|
Loss ratio
|
|
67.3
|
%
|
43.6
|
%
|
57.2
|
%
|
Acquisition
expense ratio
(2)
|
|
14.1
|
%
|
23.0
|
%
|
17.9
|
%
|
Other operating
expense ratio
|
|
15.7
|
%
|
6.1
|
%
|
11.6
|
%
|
Combined ratio
|
|
97.1
|
%
|
72.7
|
%
|
86.7
|
%
|
(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 $3.5 million, respectively, of gross and net premiums written and
$0.5 million and $4.7 million, respectively, of net premiums earned assumed
through intersegment transactions.
|
(2)
|
|
The acquisition expense
ratio is adjusted to include policy-related fee income.
|
11
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
|
|
Three Months Ended
|
|
|
|
March 31, 2008
|
|
(U.S. dollars in thousands)
|
|
Insurance
|
|
Reinsurance
|
|
Total
|
|
|
|
|
|
|
|
|
|
Gross premiums
written
(1)
|
|
$
|
626,348
|
|
$
|
433,827
|
|
$
|
1,053,152
|
|
Net premiums
written
(1)
|
|
402,764
|
|
408,578
|
|
811,342
|
|
|
|
|
|
|
|
|
|
Net premiums
earned
(1)
|
|
$
|
419,100
|
|
$
|
289,134
|
|
$
|
708,234
|
|
Fee income
|
|
882
|
|
186
|
|
1,068
|
|
Losses and loss
adjustment expenses
|
|
(287,303
|
)
|
(117,114
|
)
|
(404,417
|
)
|
Acquisition
expenses, net
|
|
(51,889
|
)
|
(62,750
|
)
|
(114,639
|
)
|
Other operating
expenses
|
|
(73,637
|
)
|
(18,238
|
)
|
(91,875
|
)
|
Underwriting
income
|
|
$
|
7,153
|
|
$
|
91,218
|
|
98,371
|
|
|
|
|
|
|
|
|
|
Net investment
income
|
|
|
|
|
|
122,193
|
|
Net realized
gains
|
|
|
|
|
|
48,686
|
|
Net impairment losses
recognized in earnings
|
|
|
|
|
|
(12,711
|
)
|
Equity in net
income (loss) of investment funds accounted for using the equity method
|
|
|
|
|
|
(22,313
|
)
|
Other income
|
|
|
|
|
|
4,036
|
|
Other expenses
|
|
|
|
|
|
(5,312
|
)
|
Interest expense
|
|
|
|
|
|
(5,524
|
)
|
Net foreign
exchange losses
|
|
|
|
|
|
(23,587
|
)
|
Income before
income taxes
|
|
|
|
|
|
203,839
|
|
Income tax
expense
|
|
|
|
|
|
(7,956
|
)
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
|
|
|
195,883
|
|
Preferred
dividends
|
|
|
|
|
|
(6,461
|
)
|
Net
income available to common shareholders
|
|
|
|
|
|
$
|
189,422
|
|
|
|
|
|
|
|
|
|
Underwriting
Ratios
|
|
|
|
|
|
|
|
Loss ratio
|
|
68.6
|
%
|
40.5
|
%
|
57.1
|
%
|
Acquisition
expense ratio
(2)
|
|
12.2
|
%
|
21.7
|
%
|
16.1
|
%
|
Other operating
expense ratio
|
|
17.6
|
%
|
6.3
|
%
|
13.0
|
%
|
Combined ratio
|
|
98.4
|
%
|
68.5
|
%
|
86.2
|
%
|
(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 nil and $7.0
million, respectively, of gross and net premiums written and $0.1 million and
$8.7 million, respectively, of net premiums earned assumed through
intersegment transactions.
|
(2)
|
|
The acquisition expense
ratio is adjusted to include certain fee income.
|
12
Table of
Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Set forth below is
summary information regarding net premiums written and earned by major line of
business and net premiums written by client location for the insurance segment:
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2009
|
|
2008
|
|
INSURANCE SEGMENT
(U.S. dollars in thousands)
|
|
Amount
|
|
% of
Total
|
|
Amount
|
|
% of
Total
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written (1)
|
|
|
|
|
|
|
|
|
|
Property,
energy, marine and aviation
|
|
$
|
106,029
|
|
24.0
|
|
$
|
97,237
|
|
24.1
|
|
Programs
|
|
74,807
|
|
16.9
|
|
54,583
|
|
13.6
|
|
Professional
liability
|
|
52,008
|
|
11.8
|
|
54,081
|
|
13.4
|
|
Executive
assurance
|
|
50,079
|
|
11.3
|
|
42,169
|
|
10.5
|
|
Construction
|
|
36,571
|
|
8.3
|
|
39,480
|
|
9.8
|
|
Casualty
|
|
26,539
|
|
6.0
|
|
28,543
|
|
7.1
|
|
National
accounts casualty
|
|
24,227
|
|
5.5
|
|
13,055
|
|
3.2
|
|
Travel and
accident
|
|
17,534
|
|
4.0
|
|
16,653
|
|
4.1
|
|
Surety
|
|
11,358
|
|
2.6
|
|
10,867
|
|
2.7
|
|
Healthcare
|
|
11,219
|
|
2.5
|
|
10,997
|
|
2.7
|
|
Other (2)
|
|
31,215
|
|
7.1
|
|
35,099
|
|
8.8
|
|
Total
|
|
$
|
441,586
|
|
100.0
|
|
$
|
402,764
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned (1)
|
|
|
|
|
|
|
|
|
|
Property,
energy, marine and aviation
|
|
$
|
73,840
|
|
18.4
|
|
$
|
84,458
|
|
20.2
|
|
Programs
|
|
66,669
|
|
16.6
|
|
56,987
|
|
13.6
|
|
Professional
liability
|
|
58,234
|
|
14.5
|
|
68,810
|
|
16.4
|
|
Executive
assurance
|
|
47,816
|
|
11.9
|
|
44,408
|
|
10.6
|
|
Construction
|
|
40,420
|
|
10.1
|
|
42,717
|
|
10.2
|
|
Casualty
|
|
32,698
|
|
8.2
|
|
42,306
|
|
10.1
|
|
National
accounts casualty
|
|
14,439
|
|
3.6
|
|
7,923
|
|
1.9
|
|
Travel and
accident
|
|
13,156
|
|
3.3
|
|
15,485
|
|
3.7
|
|
Surety
|
|
13,391
|
|
3.3
|
|
13,499
|
|
3.2
|
|
Healthcare
|
|
10,928
|
|
2.7
|
|
13,445
|
|
3.2
|
|
Other
(2)
|
|
29,506
|
|
7.4
|
|
29,062
|
|
6.9
|
|
Total
|
|
$
|
401,097
|
|
100.0
|
|
$
|
419,100
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written by client location (1)
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
317,044
|
|
71.8
|
|
$
|
279,255
|
|
69.3
|
|
Europe
|
|
92,396
|
|
20.9
|
|
86,300
|
|
21.4
|
|
Other
|
|
32,146
|
|
7.3
|
|
37,209
|
|
9.3
|
|
Total
|
|
$
|
441,586
|
|
100.0
|
|
$
|
402,764
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written by underwriting location (1)
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
320,829
|
|
72.7
|
|
$
|
287,208
|
|
71.3
|
|
Europe
|
|
105,313
|
|
23.8
|
|
102,012
|
|
25.3
|
|
Other
|
|
15,444
|
|
3.5
|
|
13,544
|
|
3.4
|
|
Total
|
|
$
|
441,586
|
|
100.0
|
|
$
|
402,764
|
|
100.0
|
|
(1)
|
|
Insurance segment
results include premiums written and earned assumed through intersegment
transactions of $0.1 million and $0.5 million, respectively, for the 2009
first quarter and premiums written and earned assumed of nil and $0.1
million, respectively, for the 2008 first quarter. Insurance segment results
exclude premiums written and earned ceded through intersegment transactions
of $3.5 million and $4.7 million, respectively, for the 2009 first quarter
and $7.0 million and $8.7 million, respectively, for the 2008 first quarter.
|
(2)
|
|
Includes excess
workers compensation and employers liability business and lender products.
|
13
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:
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
REINSURANCE SEGMENT
|
|
2009
|
|
2008
|
|
(U.S. dollars in thousands)
|
|
Amount
|
|
% of Total
|
|
Amount
|
|
% of Total
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written (1)
|
|
|
|
|
|
|
|
|
|
Property excluding
property catastrophe
(2)
|
|
$
|
119,088
|
|
31.2
|
|
$
|
95,922
|
|
23.5
|
|
Casualty
(3)
|
|
99,432
|
|
26.1
|
|
105,987
|
|
25.9
|
|
Property
catastrophe
|
|
91,903
|
|
24.1
|
|
106,224
|
|
26.0
|
|
Other specialty
|
|
40,712
|
|
10.7
|
|
75,680
|
|
18.5
|
|
Marine and
aviation
|
|
28,523
|
|
7.5
|
|
22,164
|
|
5.4
|
|
Other
|
|
1,619
|
|
0.4
|
|
2,601
|
|
0.7
|
|
Total
|
|
$
|
381,277
|
|
100.0
|
|
$
|
408,578
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned (1)
|
|
|
|
|
|
|
|
|
|
Property
excluding property catastrophe
(2)
|
|
$
|
96,231
|
|
32.1
|
|
$
|
63,341
|
|
21.9
|
|
Casualty
(3)
|
|
85,946
|
|
28.7
|
|
107,648
|
|
37.2
|
|
Property catastrophe
|
|
58,601
|
|
19.6
|
|
50,281
|
|
17.4
|
|
Other specialty
|
|
33,450
|
|
11.2
|
|
38,484
|
|
13.3
|
|
Marine and
aviation
|
|
24,830
|
|
8.3
|
|
27,431
|
|
9.5
|
|
Other
|
|
409
|
|
0.1
|
|
1,949
|
|
0.7
|
|
Total
|
|
$
|
299,467
|
|
100.0
|
|
$
|
289,134
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written (1)
|
|
|
|
|
|
|
|
|
|
Pro rata
|
|
$
|
181,222
|
|
47.5
|
|
$
|
215,419
|
|
52.7
|
|
Excess of loss
|
|
200,055
|
|
52.5
|
|
193,159
|
|
47.3
|
|
Total
|
|
$
|
381,277
|
|
100.0
|
|
$
|
408,578
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums earned (1)
|
|
|
|
|
|
|
|
|
|
Pro rata
|
|
$
|
194,518
|
|
65.0
|
|
$
|
192,076
|
|
66.4
|
|
Excess of loss
|
|
104,949
|
|
35.0
|
|
97,058
|
|
33.6
|
|
Total
|
|
$
|
299,467
|
|
100.0
|
|
$
|
289,134
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written by client location (1)
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
229,968
|
|
60.3
|
|
$
|
217,179
|
|
53.2
|
|
Europe
|
|
101,501
|
|
26.6
|
|
143,920
|
|
35.2
|
|
Bermuda
|
|
37,567
|
|
9.9
|
|
34,060
|
|
8.3
|
|
Other
|
|
12,241
|
|
3.2
|
|
13,419
|
|
3.3
|
|
Total
|
|
$
|
381,277
|
|
100.0
|
|
$
|
408,578
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net
premiums written by underwriting location (1)
|
|
|
|
|
|
|
|
|
|
Bermuda
|
|
$
|
195,600
|
|
51.3
|
|
$
|
220,669
|
|
54.0
|
|
United States
|
|
146,193
|
|
38.3
|
|
154,480
|
|
37.8
|
|
Other
|
|
39,484
|
|
10.4
|
|
33,429
|
|
8.2
|
|
Total
|
|
$
|
381,277
|
|
100.0
|
|
$
|
408,578
|
|
100.0
|
|
(1)
|
|
Reinsurance segment
results include premiums written and earned assumed through intersegment
transactions of $3.5 million and $4.7 million, respectively, for the 2009
first quarter and $7.0 million and $8.7 million, respectively, for the 2008
first quarter. Reinsurance segment results exclude premiums written and
earned ceded through intersegment transactions of $0.1 million and $0.5
million, respectively, for the 2009 first quarter and premiums written and
earned ceded of nil and $0.1 million, respectively, for the 2008 first
quarter.
|
(2)
|
|
Includes facultative
business.
|
(3)
|
|
Includes professional
liability, executive assurance and healthcare business.
|
14
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 and excess of loss reinsurance agreements on a
treaty or facultative basis. 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
|
|
|
|
March 31,
|
|
(U.S. dollars in thousands)
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
Premiums
Written
|
|
|
|
|
|
Direct
|
|
$
|
620,446
|
|
$
|
619,486
|
|
Assumed
|
|
404,525
|
|
433,666
|
|
Ceded
|
|
(202,108
|
)
|
(241,810
|
)
|
Net
|
|
$
|
822,863
|
|
$
|
811,342
|
|
|
|
|
|
|
|
Premiums
Earned
|
|
|
|
|
|
Direct
|
|
$
|
587,760
|
|
$
|
630,814
|
|
Assumed
|
|
332,567
|
|
365,364
|
|
Ceded
|
|
(219,763
|
)
|
(287,944
|
)
|
Net
|
|
$
|
700,564
|
|
$
|
708,234
|
|
|
|
|
|
|
|
Losses
and Loss Adjustment Expenses
|
|
|
|
|
|
Direct
|
|
$
|
351,493
|
|
$
|
420,971
|
|
Assumed
|
|
147,145
|
|
141,249
|
|
Ceded
|
|
(98,096
|
)
|
(157,803
|
)
|
Net
|
|
$
|
400,542
|
|
$
|
404,417
|
|
The Company monitors the
financial condition of its reinsurers and attempts to place coverages only with
substantial, financially sound carriers. At March 31, 2009, approximately
88.9% of the Companys reinsurance recoverables on paid and unpaid losses (not
including prepaid reinsurance premiums) of $1.79 billion were due from carriers
which had an A.M. Best rating of A- or better and the largest
reinsurance recoverables from any one carrier was less than 6.9% of the Companys
total shareholders equity. At December 31, 2008, approximately 88.5% of
the Companys reinsurance recoverables on paid and unpaid losses (not including
prepaid reinsurance premiums) of $1.79 billion were due from carriers which had
an A.M. Best rating of A- or better and the largest reinsurance
recoverables from any one carrier was less than 7.3% of the Companys total
shareholders equity.
On December 29,
2005, Arch Re Bermuda entered into a quota share reinsurance treaty with
Flatiron Re Ltd. (Flatiron), a Bermuda reinsurance company, pursuant to which
Flatiron 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 from 45% to 70% of all covered business bound
by Arch Re Bermuda from (and including) June 28, 2006 until (and
including) August
15
Table of
Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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. At March 31,
2009, $7.3 million of premiums ceded to Flatiron were unearned.
Flatiron 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
will make, or will have the ability to make, the required contributions into
the Trust.
Arch Re Bermuda pays to
Flatiron 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
2009 first quarter, $3.5 million of premiums written, $14.5 million of premiums
earned and $3.7 million of losses and loss adjustment expenses were ceded to
Flatiron by Arch Re Bermuda, compared to $18.4 million of premiums written,
$58.9 million of premiums earned and $11.8 million of losses and loss
adjustment expenses for the 2008 first quarter. Reinsurance recoverables from
Flatiron, which is not rated by A.M. Best, were $153.5 million at March 31,
2009, compared to $148.7 million at December 31, 2008. As noted above,
Flatiron is required to contribute funds into a trust for the benefit of Arch
Re Bermuda. The recoverable from Flatiron was fully collateralized through such
trust at March 31, 2009 and December 31, 2008.
6. 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, Arch Re Bermuda and GIC each own
50% of Gulf Re, which commenced underwriting activities in June 2008. 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 capital of the joint venture consisted of $200.0 million with an
additional $200.0 million commitment 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, shown as Investment in joint venture, using the
equity method and records its equity in the operating results of Gulf Re in Other
income on a quarter lag basis.
16
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
7. Investment
Information
The following table
summarizes the Companys invested assets:
|
|
March 31,
|
|
December 31,
|
|
(U.S. dollars in thousands)
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
Fixed maturities
available for sale, at market value
|
|
$
|
8,540,653
|
|
$
|
8,122,221
|
|
Fixed maturities
pledged under securities lending agreements, at market value
(1)
|
|
503,449
|
|
626,501
|
|
Total fixed
maturities
|
|
9,044,102
|
|
8,748,722
|
|
Short-term
investments available for sale, at market value
|
|
749,708
|
|
479,586
|
|
Short-term
investments pledged under securities lending agreements, at market value
(1)
|
|
56,242
|
|
101,564
|
|
Other
investments
|
|
104,988
|
|
109,601
|
|
Investment funds
accounted for using the equity method
|
|
293,452
|
|
301,027
|
|
Total
investments
(1)
|
|
10,248,492
|
|
9,740,500
|
|
Securities
transactions entered into but not settled at the balance sheet date
|
|
(241,836
|
)
|
(18,236
|
)
|
Total
investments, net of securities transactions
|
|
$
|
10,006,656
|
|
$
|
9,722,264
|
|
(1)
|
|
In securities lending
transactions, the Company receives collateral in excess of the market 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 March 31, 2009 and December 31, 2008 of
$550.8 million and $730.2 million, respectively, which is reflected as
investment of funds received under securities lending agreements, at market
value and included the $559.7 million and $728.1 million, respectively, of
fixed maturities and short-term investments pledged under securities lending
agreements, at market value.
|
17
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
summarizes the Companys fixed maturities and fixed maturities pledged under
securities lending agreements:
|
|
|
|
Included in Accumulated Other
Comprehensive Income (AOCI)
|
|
|
|
|
|
|
|
|
|
Gross Unrealized Losses
|
|
|
|
(U.S. dollars in thousands)
|
|
Estimated
Market
Value
|
|
Gross
Unrealized
Gains
|
|
Non-OTTI
Unrealized
Losses
|
|
OTTI
Unrealized
Losses (1)
|
|
Amortized
Cost
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
2009:
|
|
|
|
|
|
|
|
|
|
|
|
Corporate bonds
|
|
$
|
2,181,763
|
|
$
|
32,016
|
|
$
|
(99,877
|
)
|
$
|
(23,672
|
)
|
$
|
2,273,296
|
|
Mortgage backed
securities
|
|
1,692,863
|
|
31,111
|
|
(70,249
|
)
|
(67,981
|
)
|
1,799,982
|
|
U.S. government
and government agencies
|
|
1,547,416
|
|
51,239
|
|
(6,940
|
)
|
(614
|
)
|
1,503,731
|
|
Commercial
mortgage backed securities
|
|
1,209,605
|
|
20,153
|
|
(42,587
|
)
|
(5,689
|
)
|
1,237,728
|
|
Asset backed
securities
|
|
922,560
|
|
8,388
|
|
(29,955
|
)
|
(15,833
|
)
|
959,960
|
|
Municipal bonds
|
|
861,954
|
|
32,621
|
|
(1,959
|
)
|
(198
|
)
|
831,490
|
|
Non-U.S.
government securities
|
|
627,941
|
|
22,550
|
|
(23,477
|
)
|
(647
|
)
|
629,515
|
|
Total
|
|
$
|
9,044,102
|
|
$
|
198,078
|
|
$
|
(275,044
|
)
|
$
|
(114,634
|
)
|
$
|
9,235,702
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
2008:
|
|
|
|
|
|
|
|
|
|
|
|
Corporate bonds
|
|
$
|
2,019,373
|
|
$
|
51,131
|
|
$
|
(98,979
|
)
|
|
|
$
|
2,067,221
|
|
Mortgage backed
securities
|
|
1,581,736
|
|
23,306
|
|
(125,759
|
)
|
|
|
1,684,189
|
|
U.S. government
and government agencies
|
|
1,463,897
|
|
77,762
|
|
(14,159
|
)
|
|
|
1,400,294
|
|
Commercial
mortgage backed securities
|
|
1,219,737
|
|
16,128
|
|
(68,212
|
)
|
|
|
1,271,821
|
|
Asset backed
securities
|
|
970,041
|
|
1,121
|
|
(70,762
|
)
|
|
|
1,039,682
|
|
Municipal bonds
|
|
965,966
|
|
26,815
|
|
(1,730
|
)
|
|
|
940,881
|
|
Non-U.S.
government securities
|
|
527,972
|
|
33,690
|
|
(31,884
|
)
|
|
|
526,166
|
|
Total
|
|
$
|
8,748,722
|
|
$
|
229,953
|
|
$
|
(411,485
|
)
|
|
|
$
|
8,930,254
|
|
(1) Represents
the total other-than-temporary impairments (OTTI) recognized in accumulated
other comprehensive income (AOCI) at March 31, 2009.
The contractual maturities of the Companys fixed
maturities and fixed maturities pledged under securities lending agreements are
shown below. Expected maturities, which are managements best estimates, will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
|
|
March 31, 2009
|
|
December 31, 2008
|
|
(U.S. dollars in thousands)
Maturity
|
|
Estimated
Market Value
|
|
Amortized
Cost
|
|
Estimated
Market Value
|
|
Amortized
Cost
|
|
|
|
|
|
|
|
|
|
|
|
Due in one year
or less
|
|
$
|
177,866
|
|
$
|
180,842
|
|
$
|
173,168
|
|
$
|
169,187
|
|
Due after one
year through five years
|
|
2,835,183
|
|
2,857,223
|
|
2,451,062
|
|
2,452,344
|
|
Due after five
years through 10 years
|
|
1,784,817
|
|
1,756,034
|
|
1,726,742
|
|
1,686,575
|
|
Due after 10
years
|
|
421,208
|
|
443,933
|
|
626,236
|
|
626,456
|
|
|
|
5,219,074
|
|
5,238,032
|
|
4,977,208
|
|
4,934,562
|
|
Mortgage backed
securities
|
|
1,692,863
|
|
1,799,982
|
|
1,581,736
|
|
1,684,189
|
|
Commercial
mortgage backed securities
|
|
1,209,605
|
|
1,237,728
|
|
1,219,737
|
|
1,271,821
|
|
Asset backed
securities
|
|
922,560
|
|
959,960
|
|
970,041
|
|
1,039,682
|
|
Total
|
|
$
|
9,044,102
|
|
$
|
9,235,702
|
|
$
|
8,748,722
|
|
$
|
8,930,254
|
|
18
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)
The following table
provides an analysis of the length of time each of those fixed maturities,
fixed maturities pledged under securities lending agreements, equity securities
and short-term investments with an unrealized loss has been in a continual
unrealized loss position:
|
|
Less than 12 Months
|
|
12 Months or More
|
|
Total
|
|
(U.S. dollars in thousands)
|
|
Estimated
Market
Value
|
|
Gross
Unrealized
Losses (1)
|
|
Estimated
Market
Value
|
|
Gross
Unrealized
Losses (1)
|
|
Estimated
Market
Value
|
|
Gross
Unrealized
Losses (1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate bonds
|
|
$
|
874,438
|
|
$
|
(97,914
|
)
|
$
|
92,736
|
|
$
|
(25,635
|
)
|
$
|
967,174
|
|
$
|
(123,549
|
)
|
Mortgage backed
securities
|
|
459,638
|
|
(51,091
|
)
|
127,043
|
|
(87,139
|
)
|
586,681
|
|
(138,230
|
)
|
U.S. government
and government agencies
|
|
187,544
|
|
(7,554
|
)
|
|
|
|
|
187,544
|
|
(7,554
|
)
|
Commercial
mortgage backed securities
|
|
499,768
|
|
(31,161
|
)
|
80,292
|
|
(17,115
|
)
|
580,060
|
|
(48,276
|
)
|
Asset backed
securities
|
|
385,775
|
|
(35,666
|
)
|
48,813
|
|
(10,122
|
)
|
434,588
|
|
(45,788
|
)
|
Municipal bonds
|
|
67,822
|
|
(1,818
|
)
|
7,562
|
|
(339
|
)
|
75,384
|
|
(2,157
|
)
|
Non-U.S.
government securities
|
|
43,630
|
|
(23,908
|
)
|
5,741
|
|
(216
|
)
|
49,371
|
|
(24,124
|
)
|
Total
|
|
2,518,615
|
|
(249,112
|
)
|
362,187
|
|
(140,566
|
)
|
2,880,802
|
|
(389,678
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
investments
|
|
28,715
|
|
(17,687
|
)
|
|
|
|
|
28,715
|
|
(17,687
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term
investments
|
|
88,597
|
|
(1,124
|
)
|
|
|
|
|
88,597
|
|
(1,124
|
)
|
Total
|
|
$
|
2,635,927
|
|
$
|
(267,923
|
)
|
$
|
362,187
|
|
$
|
(140,566
|
)
|
$
|
2,998,114
|
|
$
|
(408,489
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate bonds
|
|
$
|
870,093
|
|
$
|
(89,446
|
)
|
$
|
30,608
|
|
$
|
(9,533
|
)
|
$
|
900,701
|
|
$
|
(98,979
|
)
|
Mortgage backed
securities
|
|
417,373
|
|
(105,154
|
)
|
23,295
|
|
(20,605
|
)
|
440,668
|
|
(125,759
|
)
|
U.S. government
and government agencies
|
|
356,719
|
|
(14,159
|
)
|
|
|
|
|
356,719
|
|
(14,159
|
)
|
Commercial
mortgage backed securities
|
|
714,497
|
|
(68,210
|
)
|
52
|
|
(2
|
)
|
714,549
|
|
(68,212
|
)
|
Asset backed
securities
|
|
888,908
|
|
(63,845
|
)
|
26,185
|
|
(6,917
|
)
|
915,093
|
|
(70,762
|
)
|
Municipal bonds
|
|
93,072
|
|
(1,730
|
)
|
|
|
|
|
93,072
|
|
(1,730
|
)
|
Non-U.S.
government securities
|
|
223,314
|
|
(31,882
|
)
|
142
|
|
(2
|
)
|
223,456
|
|
(31,884
|
)
|
Total
|
|
3,563,976
|
|
(374,426
|
)
|
80,282
|
|
(37,059
|
)
|
3,644,258
|
|
(411,485
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
investments
|
|
20,510
|
|
(3,649
|
)
|
13,715
|
|
(20,919
|
)
|
34,225
|
|
(24,568
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term
investments
|
|
33,080
|
|
(2,535
|
)
|
|
|
|
|
33,080
|
|
(2,535
|
)
|
Total
|
|
$
|
3,617,566
|
|
$
|
(380,610
|
)
|
$
|
93,997
|
|
$
|
(57,978
|
)
|
$
|
3,711,563
|
|
$
|
(438,588
|
)
|
(1) Gross
unrealized losses include non-OTTI unrealized losses and OTTI losses recognized
in accumulated other comprehensive income at March 31, 2009.
Other-Than-Temporary
Impairments
Adoption of FSP FAS 115-2/124-2
In April 2009, the
FASB issued FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation
of Other-Than-Temporary Impairments (FSP FAS 115-2/124-2). FSP FAS
115-2/124-2 requires entities to separate an other-than-temporary impairment (OTTI)
of a debt security into two components when there are credit related losses
associated with the impaired debt security for which the Company asserts that
it does not have the intent to sell the security, and it is more likely than
not that it will not be required to sell the security before recovery of its
cost basis.
Prior to January 1, 2009, the Company had to
determine whether it had the intent and ability to hold the investment for a
sufficient period of time for the value to recover. When the
19
Table of
Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)
analysis of the above factors resulted in the Companys conclusion that
declines in market values were other-than-temporary, the cost of the securities
was written down to market value and the reduction in value was reflected as a
realized loss. Effective under FSP FAS 115-2/124-2,
the amount of the OTTI related to a credit loss is
recognized in earnings, and the amount of the OTTI related to other factors (
e.g.
, interest rates, market conditions, etc.) is recorded
as a component of other comprehensive income (loss).
In instances
where no credit loss exists but it is more likely than not that the Company
will have to sell the debt security prior to the anticipated recovery, the
decline in market value below amortized cost is recognized as an OTTI in
earnings. In periods after the recognition of an OTTI on debt securities, the
Company accounts for such securities as if they had been purchased on the
measurement date of the OTTI at an amortized cost basis equal to the previous
amortized cost basis less the OTTI recognized in earnings. For debt securities
for which OTTI were recognized in earnings, the difference between the new
amortized cost basis and the cash flows expected to be collected will be
accreted or amortized into net investment income.
FSP FAS 115-2/124-2 is effective for periods ending
after June 15, 2009, with early adoption permitted for periods ending
after March 15, 2009. The Company elected to adopt FSP FAS 115-2/124-2
effective for its interim period ending March 31, 2009.
FSP FAS 115-2/124-2
requires that the Company record, as of the beginning of the interim period of
adoption, a cumulative effect adjustment to reclassify the noncredit component
of a previously recognized OTTI from retained earnings to other comprehensive
income (loss). For purposes of calculating the cumulative effect adjustment, the
Company reviewed OTTI it had recorded through realized losses on securities
held at December 31, 2008, which were $171.1 million, and estimated the
portion related to credit losses (
i.e.
, where the
present value of cash flows expected to be collected are lower than the
amortized cost basis of the security) and the portion related to all other
factors. The Company determined that $109.1 million of the OTTI previously
recorded related to specific credit losses and $62.0 million related to all
other factors. Under FSP FAS 115-2/124-2, the Company increased the amortized
cost basis of these debt securities by $62.0 million and recorded a cumulative
effect adjustment, net of tax, in its shareholders equity section. The
cumulative effect adjustment had no effect on total shareholders equity as it
increased retained earnings and reduced accumulated other comprehensive income.
2009 and 2008 First Quarters
The
Company performed reviews of its investments in the 2009 and 2008 first
quarters in order to determine whether declines in market value below the
amortized cost basis were considered other-than-temporary in accordance with
applicable guidance. The Companys process for identifying declines in the
market value of investments that were considered other-than-temporary involved
consideration of several factors. These factors included (i) an analysis
of the liquidity, business prospects and overall financial condition of the
issuer, (ii) the time period in which there was a significant decline in
value, and (iii) the significance of the decline.
For the 2009 first
quarter, the Company recorded $93.0 million of OTTI of which $36.1 million was
related to credit losses and recognized as net impairment losses recognized in
earnings, with the remaining $56.9 million related to all other factors and
recorded as an unrealized loss component of accumulated other comprehensive
income. Of the $36.1 million related to credit losses, $21.8 million related to
credit losses for which a portion of the OTTI was recognized in accumulated
other comprehensive income while $14.3 million related to an investment for
which the total OTTI was recognized in earnings (see description below).
20
Table of
Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)
The following table
provides a rollforward of the amount related to credit losses recognized in
earnings for which a portion of an OTTI was recognized in accumulated other
comprehensive income for the 2009 first quarter:
(U.S. dollars in thousands)
|
|
|
|
|
|
|
|
Beginning
balance at January 1, 2009
|
|
$
|
35,474
|
|
Addition for the
amount related to the credit loss for which an OTTI was not previously
recognized
|
|
12,647
|
|
Additional
increases to the amount related to the credit loss for which an OTTI was
previously recognized
|
|
9,135
|
|
Reductions for
securities sold during the period (realized)
|
|
|
|
Ending balance
at March 31, 2009
|
|
$
|
57,256
|
|
At March 31, 2009,
the Company did not have the intent to sell such securities, and determined
that it is more likely than not that it will not be required to sell the
securities before recovery of their cost basis. A description of the methodology
and significant inputs used to measure the amount of the $36.1 million of
credit losses (shown in parentheses) in the 2009 first quarter is as follows:
·
Corporate bonds ($3.0 million) the
Company reviewed the business prospects, credit ratings, estimated loss given
default factors and incorporated available information received from asset
managers and rating agencies for each security. The amortized cost basis of the
corporate bonds were adjusted down, if required, to the expected recovery value
calculated in the OTTI review process;
·
Mortgage backed securities ($11.1
million) the Company utilized underlying data, where available, for each
security provided by asset managers and additional information from credit
agencies in order to determine an expected recovery value for each security.
The analysis provided by the asset managers includes expected cash flow
projections under base case and stress case scenarios which modify expected
default expectations and loss severities and slow down prepayment assumptions.
The significant inputs in the models include the expected default rates,
delinquency rates, foreclosure costs, etc. On an ongoing basis, the Company
reviews the process used by each asset manager in developing their analysis
and, following such reviews, the Company determines what the expected recovery
values are for each security, which incorporates both base case and stress case
scenarios. The amortized cost basis of the mortgage backed securities were
adjusted down, if required, to the expected recovery value calculated in the
OTTI review process;
·
Asset backed securities ($5.6 million)
the Company utilized underlying data, where available, for each security
provided by asset managers and additional information from credit agencies in
order to determine an expected recovery value for each security. The analysis
provided by the asset managers on home equity asset backed securities includes
expected cash flow projections under base case and stress case scenarios which
modify expected default expectations and loss severities and slow down
prepayment assumptions. The significant inputs in the models include the
expected default rates, delinquency rates, foreclosure costs, etc. On an
ongoing basis, the Company reviews the process used by each asset manager in
developing their analysis and, following such reviews, the Company determines
what the expected recovery values are for each security, which incorporates
both base case and stress case scenarios. For non-home equity asset backed
securities, the Company relied on reports and analysis from asset managers and
rating agencies to determine an expected recovery value for such securities.
The amortized cost basis of the asset backed securities were adjusted down, if
required, to the expected recovery value calculated in the OTTI review process;
·
Investment of funds received under
securities lending agreements ($2.1 million) at March 31, 2009, the
reinvested collateral included sub-prime securities with a market value of
$33.8 million and an average
21
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)
credit quality of AAA
from Standard & Poors and Ba2 from Moodys. The Company utilized
analysis from its securities lending program manager in order to determine an
expected recovery value for certain securities which are on a watch-list. The
analysis provided expected cash flow projections for the securities using
similar criteria as described in the mortgage backed securities section above.
The amortized cost basis of the investment of funds received under securities
lending agreements was adjusted down, if required, to the expected recovery
value calculated in the OTTI review process;
·
Other investments ($14.3 million)
during the 2009 first quarter, the Companys investment in a Euro-denominated
bank loan fund was written down to zero as the fund was required to wind down
and begin the liquidation process during the period. The fund operated with
leverage and was unable to successfully deleverage its balance sheet and
restructure.
The Company believes that
the $56.9 million of OTTI included in accumulated other comprehensive income in
the 2009 first quarter on the securities which were considered by the Company
to be impaired was due to market and sector-related factors, including limited
liquidity and wide credit spreads. The Company believes that these factors
resulted in the market value for such securities, in general, to be lower than
their estimated recovery values. The Company recorded $12.7 million of OTTI as
a charge against earnings in the 2008 first quarter
. Such amount was recorded
prior to the adoption of FSP FAS 115-2/124-2 and included a portion related to
credit losses and a portion related to all other factors.
Securities Lending
Agreements
The Company operates 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. The Company maintains legal 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, primarily in the form of 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 Investment of funds received under securities lending
agreements, at market value. At March 31, 2009, the market value and
amortized cost of fixed maturities
and short-term investments pledged under securities
lending agreements were $559.7 million and $556.2 million, respectively. At December 31,
2008, the market value and amortized cost of fixed maturities and short-term
investments pledged under securities lending agreements were $728.1 million and
$717.2 million, respectively.
At March 31, 2009,
the market value and amortized cost of the reinvested collateral, shown as Investment
of funds received under securities lending agreements, totaled $550.8 million
and $571.1 million, respectively, compared to $730.2 million and $750.3
million, respectively, at December 31, 2008. At March 31, 2009, the
reinvested collateral included sub-prime securities with a market value of
$33.8 million and an average credit quality of AAA from Standard &
Poors and Ba2 from Moodys, compared to $45.7 million at December 31,
2008 with an average credit quality of AAA from Standard & Poors
and AA+ from Moodys.
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 market values of those derivatives are based on quoted market prices. At March 31,
2009 and December 31, 2008, the notional value of the net long position
for Treasury note futures was $438.0 million and $556.3 million, respectively.
At March 31, 2009 and December 31, 2008, the notional value of the
net long position for
22
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)
U.K. and German government futures was nil and $363.3 million (at December 31,
2008 foreign currency rates), respectively. At March 31, 2009, the
notional value of the net long position of gold futures was $18.5 million,
compared to nil at December 31, 2008. For the 2009 first quarter, the
Company recorded $0.5 million of net realized gains related to changes in the
market value of all futures contracts, compared to $5.8 million of net realized
losses for the 2008 first quarter
. The derivative open margin position at each balance
sheet date is included in other investments.
The open margin position at March 31, 2009 was $1.1 million,
compared to a negative $0.9 million at December 31, 2008.
In addition, certain of
the Companys corporate bonds are managed in a global bond portfolio which,
under their guidelines, incorporates the use of foreign currency forward
contracts which are intended to hedge against foreign currency movements on the
portfolios non-U.S. Dollar denominated holdings. At March 31, 2009, the
market value of the foreign currency forward contracts, which are included in
other investments, was $0.7 million, compared to a negative $10.8 million at December 31,
2008.
Other Investments
The following table details the Companys other
investments:
|
|
March 31, 2009
|
|
December 31, 2008
|
|
(U.S. dollars in thousands)
|
|
Estimated
Market Value
|
|
Cost
|
|
Estimated
Market Value
|
|
Cost
|
|
|
|
|
|
|
|
|
|
|
|
Fixed income
mutual funds
|
|
$
|
32,912
|
|
$
|
49,271
|
|
$
|
39,858
|
|
$
|
63,618
|
|
Privately held
securities and other
|
|
72,076
|
|
65,508
|
|
69,743
|
|
62,240
|
|
Total
|
|
$
|
104,988
|
|
$
|
114,779
|
|
$
|
109,601
|
|
$
|
125,858
|
|
Other
investments include: (i) mutual funds which invest in fixed maturity
securities and (ii) privately held securities and other which include the
Companys investment in Aeolus LP (see Note 10).
During the 2009 first quarter, the Company recorded a
$14.3 million OTTI provision in earnings on a Euro-denominated bank loan fund
which was written down to zero as the fund was forced to wind down and enter
liquidation during the period.
Investment Funds
Accounted for Using the Equity Method
The
Company recorded $9.6 million of net losses related to investment funds
accounted for using the equity method for the 2009 first quarter, compared to
$22.3 million of net losses for the 2008 first quarter. Due to the ownership
structure of these investment funds, which invest in fixed maturity securities,
the Company uses 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). Such investments are generally recorded on a one month lag with some
investments reported for on a three month lag based on the availability of
reports from the investment 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 while 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. As such, fluctuations in the carrying value of the
investment funds accounted for using the equity method may increase the
volatility of the Companys reported results of operations. Investment funds
accounted for using the equity method totaled $293.5 million at March 31,
2009, compared to $301.0 million at December 31, 2008. The Companys
investment commitments relating to investment funds accounted for using the
equity method totaled approximately $7.9 million at March 31, 2009.
23
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 Company has investments in segregated portfolios which are
primarily used to provide collateral or guarantees for letters of credit to
third parties (see Note 3). In addition, the Company maintains assets on
deposit which are available to settle insurance and reinsurance liabilities to
third parties. The following table details the value of restricted assets:
(U.S. dollars in thousands)
|
|
March 31,
2009
|
|
December 31,
2008
|
|
|
|
|
|
|
|
Assets used for
collateral or guarantees
|
|
$
|
842,238
|
|
$
|
804,934
|
|
Deposits with
U.S. regulatory authorities
|
|
273,800
|
|
264,988
|
|
Trust funds
|
|
151,757
|
|
153,182
|
|
Deposits with
non-U.S. regulatory authorities
|
|
56,839
|
|
57,336
|
|
Total restricted
assets
|
|
$
|
1,324,634
|
|
$
|
1,280,440
|
|
In addition, certain of
the Companys operating subsidiaries maintain assets in trust accounts as
collateral for insurance and reinsurance transactions with affiliated
companies. At March 31, 2009 and December 31, 2008, such amounts
approximated $4.18 billion and $4.03 billion, respectively.
Net
Investment Income
The components of net
investment income were derived from the following sources:
|
|
Three Months Ended
March 31,
|
|
(U.S. dollars in thousands)
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
Fixed maturities
|
|
$
|
96,958
|
|
$
|
107,233
|
|
Short-term
investments
|
|
1,240
|
|
7,167
|
|
Other
(1)
|
|
1,565
|
|
10,782
|
|
Gross investment
income
|
|
99,763
|
|
125,182
|
|
Investment
expenses
|
|
(3,881
|
)
|
(2,989
|
)
|
Net investment
income
|
|
$
|
95,882
|
|
$
|
122,193
|
|
(1) Primarily
consists of interest income on operating cash accounts, other investments and
securities lending transactions.
Net
Realized Gains (Losses)
Net realized gains
(losses) were as follows, excluding the other-than-temporary impairment
provisions discussed above:
|
|
Three Months Ended
March 31,
|
|
(U.S. dollars in thousands)
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
Fixed maturities
|
|
$
|
6,170
|
|
$
|
65,467
|
|
Other
investments
|
|
(18,586
|
)
|
(3,113
|
)
|
Other
(1)
|
|
7,252
|
|
(13,668
|
)
|
Net realized
gains (losses)
|
|
$
|
(5,164
|
)
|
$
|
48,686
|
|
|
|
|
|
|
|
|
|
|
(1) Primarily
consists of net realized gains or losses related to investment-related
derivatives and foreign currency forward contracts.
24
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Proceeds from the sales
of fixed maturities during the 2009 first quarter were $3.38 billion, compared
to $3.52 billion for the 2008 first quarter. Gross gains of $71.6 million and
$85.9 million were realized on those transactions during the 2009 and 2008
first quarters, respectively, while gross losses were $65.4 million and $20.4 million,
respectively. Realized gains or losses on fixed maturities include changes in
the market value of certain hybrid securities pursuant to SFAS No. 155, Accounting
for Certain Hybrid Financial Instruments an amendment of FASB Statements No. 133
and 140). The fair market values of such securities at March 31, 2009
were approximately $52.1 million, compared to $43.7 million at December 31,
2008. The Company recorded realized gains of $4.0 million on such securities
for the 2009 first quarter, compared to realized losses of $2.4 million for the
2008 first quarter.
Fair
Value
SFAS No. 157, Fair
Value Measurements (SFAS No. 157) 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
|
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) a review of the average number of
prices obtained in the pricing process and the range of resulting market
values; (iii) initial and ongoing evaluation of methodologies used by
outside parties to calculate fair value including a review of deep dive reports
on selected securities which indicated the use of observable inputs in the
pricing process; (iv) comparing the fair value estimates to its knowledge
of the current market; and (v) 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.
25
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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. Of the $9.9 billion of
financial assets and liabilities measured at fair value, approximately $524
million, or 5.3%, were priced using non-binding broker-dealer quotes.
In April 2009, the FASB issued FSP No. FAS
157-4, Determining Fair Value When Volume and Level of Activity for the Asset
or Liability Have Significantly Decreased and Identifying Transactions that are
Not Orderly (FSP FAS 157-4). FSP FAS 157-4 affirms that the objective of
fair value when the market for an asset is not active is the price that would
be received to sell the asset in an orderly transaction, and clarifies and
includes additional factors for determining whether there has been a
significant decrease in market activity for an asset when the market for that
asset is not active. Under FSP FAS 157-4, if an entity determines that there
has been a significant decrease in the volume and level of activity for the
asset or the liability in relation to the normal market activity for the asset
or liability (or similar assets or liabilities), then transactions or quoted
prices may not accurately reflect fair value. In addition, if there is evidence
that the transaction for the asset or liability is not orderly, the entity
shall place little, if any weight on that transaction price as an indicator of
fair value. FSP FAS 157-4 also amended SFAS No. 157 to expand certain
disclosure requirements. FSP FAS 157-4 is effective for periods ending after June 15,
2009, with early adoption permitted for periods ending after March 15,
2009. The Company elected to adopt FSP FAS 157-4 effective for its interim
period ending March 31, 2009, and its adoption did not have a material
impact on the Companys consolidated financial condition or results of
operations.
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 March 31, 2009, the Company determined that Level 1 securities
included 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 included 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
certain other investments.
The Company determined
that three Euro-denominated corporate bonds which invest in underlying
portfolios of fixed income securities for which there is a low level of
transparency around inputs to the valuation process should be classified within
Level 3 of the valuation hierarchy. In addition, the Company determined that
two mutual funds, included in other investments, which invest in underlying
portfolios of fixed income securities for which there is a low level of
transparency around inputs to the valuation process should be classified within
Level 3 of the valuation hierarchy. In addition, Level 3 securities include a
small number of premium-tax bonds.
26
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)
The following table
presents the Companys financial assets and liabilities measured at fair value
by SFAS No. 157 hierarchy:
|
|
|
|
Fair Value Measurement Using:
|
|
(U.S. dollars in thousands)
|
|
Estimated
Market
Value
|
|
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
2009:
|
|
|
|
|
|
|
|
|
|
Fixed
maturities:
(1)
|
|
|
|
|
|
|
|
|
|
Corporate bonds
(2)
|
|
$
|
2,181,763
|
|
$
|
|
|
$
|
2,051,202
|
|
$
|
130,561
|
|
Mortgage backed
securities
|
|
1,692,863
|
|
|
|
1,692,863
|
|
|
|
U.S. government
and government agencies
|
|
1,547,416
|
|
465,533
|
|
1,081,883
|
|
|
|
Commercial
mortgage backed securities
|
|
1,209,605
|
|
|
|
1,209,605
|
|
|
|
Asset backed
securities
|
|
922,560
|
|
|
|
922,560
|
|
|
|
Municipal bonds
|
|
861,954
|
|
|
|
861,954
|
|
|
|
Non-U.S.
government securities
|
|
627,941
|
|
|
|
627,941
|
|
|
|
Total
|
|
9,044,102
|
|
465,533
|
|
8,448,008
|
|
130,561
|
|
|
|
|
|
|
|
|
|
|
|
Short-term
investments
(1)
|
|
805,950
|
|
724,412
|
|
81,538
|
|
|
|
Other
investments
(3)
|
|
42,452
|
|
|
|
9,693
|
|
32,759
|
|
Total
|
|
$
|
9,892,504
|
|
$
|
1,189,945
|
|
$
|
8,539,239
|
|
$
|
163,320
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
2008:
|
|
|
|
|
|
|
|
|
|
Fixed
maturities:
(1)
|
|
|
|
|
|
|
|
|
|
Corporate bonds
(2)
|
|
$
|
2,019,373
|
|
$
|
|
|
$
|
1,876,802
|
|
$
|
142,571
|
|
Mortgage backed
securities
|
|
1,581,736
|
|
|
|
1,581,736
|
|
|
|
U.S. government
and government agencies
|
|
1,463,897
|
|
241,851
|
|
1,222,046
|
|
|
|
Commercial
mortgage backed securities
|
|
1,219,737
|
|
|
|
1,219,737
|
|
|
|
Asset backed
securities
|
|
970,041
|
|
|
|
970,041
|
|
|
|
Municipal bonds
|
|
965,966
|
|
|
|
965,966
|
|
|
|
Non-U.S.
government securities
|
|
527,972
|
|
|
|
527,972
|
|
|
|
Total
|
|
8,748,722
|
|
241,851
|
|
8,364,300
|
|
142,571
|
|
|
|
|
|
|
|
|
|
|
|
Short-term
investments
(1)
|
|
581,150
|
|
474,504
|
|
106,646
|
|
|
|
Other
investments
(3)
|
|
36,913
|
|
|
|
(3,426
|
)
|
40,339
|
|
Total
|
|
$
|
9,366,785
|
|
$
|
716,355
|
|
$
|
8,467,520
|
|
$
|
182,910
|
|
(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 March 31,
2009 and December 31, 2008 of $550.8 million and $730.2 million,
respectively, which is reflected as investment of funds received under
securities lending agreements, at market value and included the $559.7 million
and $728.1 million, respectively, of fixed maturities and short-term
investments pledged under securities lending agreements, at market value.
(2)
Consists of (i) three corporate
bonds which invest in underlying portfolios of fixed income securities for
which there is a low level of transparency around inputs and (ii) a small
number of premium-tax bonds.
(3)
Excludes the Companys investment in
Aeolus LP, which is accounted for using the equity method.
27
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)
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:
|
|
Fair Value Measurements Using:
Significant Unobservable Inputs (Level 3)
|
|
(U.S. dollars in thousands)
|
|
Corporate
Bonds
|
|
Other
Investments
|
|
Total
|
|
|
|
|
|
|
|
|
|
2009
First Quarter:
|
|
|
|
|
|
|
|
Beginning
balance at January 1, 2009
|
|
$
|
142,571
|
|
$
|
40,339
|
|
$
|
182,910
|
|
Total gains or
(losses) (realized/unrealized)
|
|
|
|
|
|
|
|
Included in
earnings
(1)
|
|
(519
|
)
|
(14,307
|
)
|
(14,826
|
)
|
Included in
other comprehensive income
|
|
(11,491
|
)
|
6,722
|
|
(4,769
|
)
|
Purchases,
issuances and settlements
|
|
|
|
5
|
|
5
|
|
Transfers in
and/or out of Level 3
|
|
|
|
|
|
|
|
Ending balance
at March 31, 2009
|
|
$
|
130,561
|
|
$
|
32,759
|
|
$
|
163,320
|
|
|
|
|
|
|
|
|
|
2008
First Quarter:
|
|
|
|
|
|
|
|
Beginning
balance at January 1, 2008
|
|
$
|
3,752
|
|
$
|
11,504
|
|
$
|
15,256
|
|
Total gains or
(losses) (realized/unrealized)
|
|
|
|
|
|
|
|
Included in
earnings
(1)
|
|
(38
|
)
|
237
|
|
199
|
|
Included in
other comprehensive income
|
|
|
|
(303
|
)
|
(303
|
)
|
Purchases,
issuances and settlements
|
|
1,422
|
|
(293
|
)
|
1,129
|
|
Transfers in
and/or out of Level 3
|
|
|
|
|
|
|
|
Ending balance
at March 31, 2008
|
|
$
|
5,136
|
|
$
|
11,145
|
|
$
|
16,281
|
|
(1)
Losses
on fixed maturities were recorded as a component of net investment income while
losses on other investments were recorded in net realized losses.
The amount of total
losses for the 2009 first quarter included in earnings attributable to the
change in unrealized gains or losses relating to assets still held at March 31,
2009 was $0.5 million. The amount of total losses for the 2008 first quarter
included in earnings attributable to the change in unrealized gains or losses
relating to assets still held at March 31, 2008 was $0.2 million.
28
Table of
Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)
8. Earnings
Per Common Share
The following table sets
forth the computation of basic and diluted earnings per common share:
|
|
Three Months Ended
March 31,
|
|
(U.S. dollars in thousands, except share data)
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
Net income
|
|
$
|
146,330
|
|
$
|
195,883
|
|
Preferred
dividends
|
|
(6,461
|
)
|
(6,461
|
)
|
Net income
available to common shareholders (numerator)
|
|
$
|
139,869
|
|
$
|
189,422
|
|
|
|
|
|
|
|
Weighted average
common shares and effect of dilutive common share equivalents used in the
computation of earnings per common share:
|
|
|
|
|
|
Weighted average
common shares outstanding basic (denominator)
|
|
60,313,550
|
|
65,295,516
|
|
Effect of
dilutive common share equivalents:
|
|
|
|
|
|
Nonvested
restricted shares
|
|
274,167
|
|
223,787
|
|
Stock options
(1)
|
|
1,972,252
|
|
2,500,110
|
|
Weighted average
common shares and common share equivalents outstanding diluted
(denominator)
|
|
62,559,969
|
|
68,019,413
|
|
|
|
|
|
|
|
Earnings per
common share:
|
|
|
|
|
|
Basic
|
|
$
|
2.32
|
|
$
|
2.90
|
|
Diluted
|
|
$
|
2.24
|
|
$
|
2.78
|
|
(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 2009 and 2008 first quarters, the number of stock
options excluded were 697,273 and 347,298, respectively.
9. 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.
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
29
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)
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, Ireland, Canada, Switzerland, Germany and Denmark.
The Companys income tax
provision resulted in an effective tax rate on income before income taxes of
6.1% for the 2009 first quarter, compared to 3.9% for the 2008 first quarter.
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 2009 and 2008 first quarters, the
Company incurred $3.3 million of federal excise taxes.
Such amounts are reflected as acquisition
expenses in the Companys consolidated statements of income.
10. 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 6.6% of the Companys outstanding
voting shares as of March 31, 2009. In addition, one of the founders of
Aeolus is Peter Appel, former President and CEO and a former director of the
Company. During the 2009 first quarter, the Company received a distribution of
$14.0 million from Aeolus as part of a repurchase agreement. Following such
receipt, the Companys preferred interest percentage decreased to approximately
4.4%.
11. 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 White Mountains
Reinsurance Company of America, formerly known as Folksamerica Reinsurance
Company, and a related holding company (collectively, WTM Re). WTM Re assumed
Arch Re U.S.s liabilities under the reinsurance agreements transferred in the
asset sale and Arch Re U.S. transferred to WTM Re assets estimated in an
aggregate amount equal in book value to the book value of the liabilities
assumed. The WTM Re 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. WTM Re
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 WTM Re 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. WTM Re has agreed to indemnify the Company for any losses
arising out of the reinsurance agreements transferred to WTM Re in the asset
sale. However, in the event that WTM Re 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. WTM Res A.M. Best
rating was A- (Excellent) at March 31, 2009. WTM Re reported
policyholders surplus of $708.8 million at December 31, 2008.
30
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)
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 WTM Re 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 WTM Re 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 WTM Re about the
Company and the business transferred to WTM Re 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 WTM Re, including all liabilities not arising under
reinsurance agreements transferred to WTM Re 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
WTM Re has not asserted that any amount is currently due under any of the
indemnities provided by the Company under the asset purchase agreement, WTM Re
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.
12. Commitments and Contingencies
Variable Interest Entities
On December 29,
2005, Arch Re Bermuda entered into a quota share reinsurance treaty with
Flatiron, a Bermuda reinsurance company, pursuant to which Flatiron is assuming
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). On December 31, 2007, the Treaty expired by its terms. As a result
of the terms of the Treaty, the Company has determined that Flatiron is a
variable interest entity. However, Arch Re Bermuda is not the primary
beneficiary of Flatiron and, as such, the Company is not required to
consolidate the assets, liabilities and results of operations of Flatiron per
FIN 46R
. See Note 5, Reinsurance for information on the Treaty with
Flatiron.
13. 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 March 31, 2009, 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 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.
31
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)
14. Recent Accounting Pronouncements
In April 2009, the FASB issued FSP No. FAS
115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary
Impairments (FSP FAS 115-2/124-2). FSP FAS 115-2/124-2 requires entities to
separate an other-than-temporary impairment of a debt security into two
components when there are credit related losses associated with the impaired
debt security for which the Company asserts that it does not have the intent to
sell the security, and it is more likely than not that it will not be required
to sell the security before recovery of its cost basis. The amount of the
other-than-temporary impairment related to a credit loss is recognized in
earnings, and the amount of the other-than-temporary impairment related to
other factors (e.g., interest rates, market conditions, etc.) is recorded as a
component of other comprehensive income (loss). FSP FAS 115-2/124-2 is
effective for periods ending after June 15, 2009, with early adoption
permitted for periods ending after March 15, 2009. The Company elected to
adopt FSP FAS 115-2/124-2 effective for its interim period ending March 31,
2009. See Note 7, Investment InformationOther Than Temporary Impairments.
In April 2009, the FASB issued FSP No. FAS
157-4, Determining Fair Value When Volume and Level of Activity for the Asset
or Liability Have Significantly Decreased and Identifying Transactions that are
Not Orderly (FSP FAS 157-4). FSP FAS 157-4 also amended SFAS No. 157, Fair
Value Measurements, to expand certain disclosure requirements. FSP FAS 157-4
is effective for periods ending after June 15, 2009, with early adoption
permitted for periods ending after March 15, 2009. The Company elected to
adopt FSP FAS 157-4 effective for its interim period ending March 31,
2009, and its adoption did not have a material impact on the Companys
consolidated financial condition or results of operations. See Note 7, Investment
InformationFair Value.
In April 2009, the FASB issued FSP No. FAS
107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial
Instruments (FSP FAS 107-1/APB 28-1). FSP FAS 107-1/APB 28-1 requires
disclosures about fair value of financial instruments in interim and annual
financial statements. FSP FAS 107-1/APB 28-1 is effective for periods ending
after June 15, 2009, with early adoption permitted for periods ending
after March 15, 2009. The Company elected to adopt FSP FAS 107-1/APB 28-1
effective for its interim period ending March 31, 2009, and has included
the required disclosures in its notes to consolidated financial statements
where applicable.
In addition, the Company adopted the following
accounting standards in the 2009 first quarter, none of which had a material
effect on its consolidated financial condition or results of operations:
·
SFAS No. 141(R), Business
Combinations;
·
SFAS No. 160, Noncontrolling
Interests in Consolidated Financial Statements an amendment of Accounting
Research Bulletin No. 51;
·
SFAS No. 161, Disclosures about
Derivative Instruments and Hedging Activities; and
·
FSP No. EITF 03-6-1, Determining
Whether Instruments Granted in Share-Based Payment Transactions Are
Participating Securities.
32
Table of Contents
ITEM 2.
|
|
MANAGEMENTS DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|
.
Arch Capital Group Ltd. (ACGL
and, together with its subsidiaries, we or us) is a Bermuda public limited
liability company with over $4.0 billion in capital at March 31, 2009 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 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. More recently, we increased our
writings in property and certain marine lines of business in order to take
advantage of improved market conditions and these lines represented a larger
proportion of our overall book of business in 2008 and 2009 than in prior
periods.
Current Outlook
During the second half of
2008, the financial markets experienced significant adverse credit events and a
loss of liquidity, which have reduced the amount and availability of capital in
the insurance industry. In addition, certain of our competitors have
experienced significant financial difficulties. We believe that the impacts of
such events, along with the recent catastrophic activity, have begun to affect
market conditions positively and may lead to rate strengthening in a number of
specialty lines. However, the current economic conditions also could
33
Table
of Contents
have a material
impact on the frequency and severity of claims and therefore could negatively
impact our underwriting returns. In addition, volatility in the financial
markets could continue to significantly affect our investment returns, reported
results and shareholders equity. We consider the potential impact of economic
trends in the estimation process for establishing unpaid losses and loss
adjustment expenses (LAE) and in determining our investment strategies.
We
continue to believe that the most attractive area from a pricing point of view
remains U.S. catastrophe-related property business.
We expect that our writings in property and marine
lines of business will continue to represent a significant proportion of our
overall book of business in future periods, which could increase the volatility
of our results of operations.
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. As of April 1,
2009, the probable maximum pre-tax loss for a catastrophic event in any
geographic zone arising from a 1-in-250 year event was approximately $767
million, compared to $763 million as of January 1, 2009. 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.
In addition, in the 2009
first quarter, we established a managing agent and syndicate at Lloyds. The
newly formed Syndicate 2012 commenced underwriting activities in April 2009.
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,
2008, updated where applicable in the
notes accompanying our
consolidated financial statements
.
34
Table of
Contents
RESULTS OF OPERATIONS
Three
Months Ended March 31, 2009 and 2008
The following table sets
forth net income available to common shareholders and earnings per common share
data:
|
|
Three Months Ended
March 31,
|
|
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
Net income
available to common shareholders
|
|
$
|
139,869
|
|
$
|
189,422
|
|
Diluted net
income per common share
|
|
$
|
2.24
|
|
$
|
2.78
|
|
Diluted weighted
average common shares and common share equivalents outstanding
|
|
62,559,969
|
|
68,019,413
|
|
Net income available to
common shareholders was $139.9 million for the 2009 first quarter, compared to
$189.4 million for the 2008 first quarter. The decrease in net income was primarily
due to a lower level of investment returns consisting of net investment income
and net realized gains or losses. Our net income available to common
shareholders for the 2009 first quarter represented a 17.4% annualized return
on average common equity, compared to 20.5% for the 2008 first 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 62.6 million in the 2009 first quarter,
compared to 68.0 million in the 2008 first quarter. The lower level of weighted
average shares outstanding in the 2009 first 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 2009 first quarter were
reduced by 15.3 million shares, compared to 9.4 million shares for the 2008
first 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 Contents
Insurance Segment
The following table sets
forth our insurance segments underwriting results:
|
|
Three Months Ended
March 31,
|
|
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
Gross premiums
written
|
|
$
|
638,409
|
|
$
|
626,348
|
|
Net premiums
written
|
|
441,586
|
|
402,764
|
|
|
|
|
|
|
|
Net premiums
earned
|
|
$
|
401,097
|
|
$
|
419,100
|
|
Fee income
|
|
870
|
|
882
|
|
Losses and loss
adjustment expenses
|
|
(270,015
|
)
|
(287,303
|
)
|
Acquisition
expenses, net
|
|
(57,623
|
)
|
(51,889
|
)
|
Other operating
expenses
|
|
(62,908
|
)
|
(73,637
|
)
|
Underwriting
income
|
|
$
|
11,421
|
|
$
|
7,153
|
|
|
|
|
|
|
|
Underwriting
Ratios
|
|
|
|
|
|
Loss ratio
|
|
67.3
|
%
|
68.6
|
%
|
Acquisition
expense ratio
(1)
|
|
14.1
|
%
|
12.2
|
%
|
Other operating
expense ratio
|
|
15.7
|
%
|
17.6
|
%
|
Combined ratio
|
|
97.1
|
%
|
98.4
|
%
|
(1)
The acquisition expense ratio is adjusted
to include certain fee income.
The insurance segments
underwriting income was $11.4 million for the 2009 first quarter, compared to
$7.2 million for the 2008 first quarter. The combined ratio for the insurance
segment was 97.1% for the 2009 first quarter, compared to 98.4% for the 2008
first quarter. The components of the insurance segments underwriting income
are discussed below.
Premiums Written
.
Gross premiums written by the insurance segment in the 2009 first
quarter were 1.9% higher than in the 2008 first quarter, with growth in
programs, national accounts casualty and executive assurance business. The
increase in programs and national accounts casualty business primarily resulted
from new business while the increase in executive assurance business primarily
resulted from renewal rate increases. Such amounts were partially offset by
reductions in casualty, construction and professional liability business as the
insurance segment continued to maintain underwriting discipline in response to
the current market environment. The higher net premiums written growth rate of
9.6% primarily resulted from changes in reinsurance usage and the impact of
changes in the mix of 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.
Net Premiums Earned
.
Net premiums earned by the insurance segment in the 2009 first quarter
were 4.3% lower than in the 2008 first 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 loss ratio for the insurance segment was
67.3% in the 2009 first quarter, compared to 68.6% in the 2008 first quarter.
The 2009 first quarter loss ratio reflected a 2.3 point reduction related to
estimated net favorable development in prior year loss reserves, compared to
1.4 points in the 2008 first quarter. The estimated net favorable development
in the 2009 first quarter was primarily in medium-tail lines and mainly
resulted from better than expected claims emergence. The 2009 first quarter
loss ratio did not include any significant catastrophic activity while the 2008
first quarter loss ratio included 4.8 points related to the Australian floods.
The insurance segments loss ratio in the 2009 first quarter reflected an
increase in expected loss ratios across a number of lines of business primarily
due to the anticipated impact of rate changes and changes in the mix of
business.
36
Table
of Contents
The
insurance segment has in effect a reinsurance program which provides coverage
for certain property-catastrophe related losses occurring during 2009 equal to
a maximum of 80% of the first $275 million in excess of a $75 million retention
per occurrence. The insurance segment has in effect a reinsurance program which
provides coverage for certain property-catastrophe related losses occurring
during 2008 equal to a maximum of 70% of the first $275 million in excess of a
$75 million retention per occurrence.
Underwriting Expenses
.
The insurance segments underwriting expense ratio was 29.8% in the 2009
and 2008 first quarters. The acquisition expense ratio was 14.1% for the 2009
first quarter, compared to 12.2% for the 2008 first 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. In addition, the 2009 first quarter loss ratio reflected 0.3 points
related to estimated net favorable development in prior year loss reserves,
compared to 0.1 points in the 2008 first quarter. The comparison of the 2009
first quarter and 2008 first quarter acquisition expense ratios reflects changes
in the form of reinsurance ceded and the mix of business. The insurance segments
other operating expense ratio was 15.7% for the 2009 first quarter, compared to
17.6% in the 2008 first quarter, with the decrease due, in part, to
non-recurring adjustments in compensation costs in the 2009 first quarter. In
addition, the 2009 first quarter operating expense ratio reflects the benefits
of the insurance segments expense management plan implemented in 2008, which
included office relocation and personnel and other expense saving initiatives.
Reinsurance Segment
The following table sets
forth our reinsurance segments underwriting results:
|
|
Three Months Ended
March 31,
|
|
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
Gross premiums
written
|
|
$
|
390,129
|
|
$
|
433,827
|
|
Net premiums written
|
|
381,277
|
|
408,578
|
|
|
|
|
|
|
|
Net premiums
earned
|
|
$
|
299,467
|
|
$
|
289,134
|
|
Fee income
|
|
55
|
|
186
|
|
Losses and loss
adjustment expenses
|
|
(130,527
|
)
|
(117,114
|
)
|
Acquisition
expenses, net
|
|
(68,835
|
)
|
(62,750
|
)
|
Other operating
expenses
|
|
(18,192
|
)
|
(18,238
|
)
|
Underwriting
income
|
|
$
|
81,968
|
|
$
|
91,218
|
|
|
|
|
|
|
|
Underwriting
Ratios
|
|
|
|
|
|
Loss ratio
|
|
43.6
|
%
|
40.5
|
%
|
Acquisition
expense ratio
|
|
23.0
|
%
|
21.7
|
%
|
Other operating
expense ratio
|
|
6.1
|
%
|
6.3
|
%
|
Combined ratio
|
|
72.7
|
%
|
68.5
|
%
|
The reinsurance segments
underwriting income was $82.0 million for the 2009 first quarter, compared to
$91.2 million for the 2008 first quarter. The combined ratio for the
reinsurance segment was 72.7% for the 2009 first quarter, compared to 68.5% for
the 2008 first quarter. The components of the reinsurance segments
underwriting income are discussed below.
Premiums Written
.
Gross premiums written by the reinsurance segment in the 2009 first
quarter were 10.1% lower than in the 2009 first quarter, primarily due to
reductions in other specialty and property catastrophe business written in the
2009 first quarter. The decrease in other specialty was primarily due to the
non-renewal of a non-standard auto treaty, while the lower level of property
catastrophe business resulted from
37
Table
of Contents
the impact of
non-renewals of a small number of contracts. The decreases were partially
offset by an increase in writings by the reinsurance segments property
facultative operation, which contributed $12.4 million of additional gross
premiums written in the 2009 first quarter compared to the 2008 first quarter.
Ceded premiums written by
the reinsurance segment were 2.3% of gross premiums written for the 2009 first
quarter, compared to 5.8% for the 2008 first quarter. In the 2009 first
quarter, Arch Reinsurance Ltd. (Arch Re Bermuda) ceded $3.5 million of
premiums written, or 0.9%, under a quota share reinsurance treaty to Flatiron
Re Ltd. (Flatiron), compared to $18.4 million, or 4.2%, in the 2008 first
quarter. Commission income from the treaty (in excess of the reimbursement of
direct acquisition expenses) reduced the reinsurance segments acquisition
expense ratio by 0.8 points in the 2009 first quarter, compared to 3.3 points
in the 2008 first quarter. On December 31, 2007, the quota share
reinsurance treaty with Flatiron expired by its terms.
Net premiums written by
the reinsurance segment in the 2009 first quarter were 6.7% lower than in the
2008 first quarter, primarily due to the items noted above. 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 in the 2009 first quarter were 3.6% higher than in
the 2008 first 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 reinsurance segments loss ratio was
43.6% in the 2009 first quarter, compared to 40.5% for the 2008 first quarter.
The loss ratio for the 2009 first quarter reflected a 14.0 point reduction
related to estimated net favorable development in prior year loss reserves,
compared to a 17.7 point reduction in the 2008 first quarter. The estimated net
favorable development in the 2009 first quarter primarily resulted from better
than anticipated claims emergence in older underwriting years. The 2009 first
quarter loss ratio also reflected approximately 2.7 points of catastrophic
activity, while the 2008 first quarter loss ratio reflected approximately 2.0
points of catastrophic activity. The reinsurance segments 2009 first quarter
loss ratio also reflected an increase in expected loss ratios in a number of
lines of business primarily due to the anticipated impact of rate changes as
well as changes in the mix of business.
Prior to April 2006,
the reinsurance segment had in effect a catastrophe reinsurance program which
provided coverage for certain catastrophe-related losses worldwide. The
coverage was not renewed upon expiration. While our reinsurance operations may
purchase
industry loss warranty contracts
and other reinsurance which is intended to limit
their exposure, the non-renewal of the catastrophe reinsurance program and the
quota share reinsurance treaty with Flatiron increases the risk retention of
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 29.1% in
the 2009 first quarter, compared to 28.0% in the 2008 first quarter. The acquisition
expense ratio for the 2009 first quarter was 23.0%, compared to 21.7% for the
2008 first quarter, with the increase primarily due to a lower level of
commission income from the Treaty with Flatiron noted above. In addition, the
2009 first quarter loss ratio reflected 0.7 points related to estimated net
favorable development in prior year loss reserves. The comparison of the 2009
first quarter and 2008 first quarter acquisition expense ratios 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 6.1% for the 2009 first quarter, compared to 6.3% for the
2008 first quarter. The decrease in the operating expense ratio primarily
related to a higher level of net premiums earned in the 2009 first quarter.
38
Table
of Contents
Net
Investment Income
Net
investment income for the 2009 first quarter was $
95.9
million, compared to $
122.2
million in the 2008 first
quarter. The lower level of net investment income in the 2009 first quarter,
compared to the 2008 first quarter, was primarily driven by a decline in yields
on our invested assets and also reflected (i) a reduction in the portfolios
effective duration, (ii) a decrease in income from our securities lending
program; and (iii) reductions to the cost basis of treasury inflation
protected securities (TIPS) in the 2009 first quarter which resulted from a
decline in the consumer price index (CPI). In addition, the 2008 first quarter
included
$3.4 million
of interest income
related to a favorable arbitration decision.
The
pre-tax
investment income yield was 3.82% for
the 2009 first quarter, compared to 4.88% (excluding the arbitration interest)
for the 2008 first 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
Net realized gains
(losses) were as follows, excluding other-than-temporary impairment provisions:
|
|
Three Months Ended
March 31,
|
|
(U.S. dollars in thousands)
|
|
2009
|
|
2008
|
|
|
|
|
|
|
|
Fixed maturities
|
|
$
|
6,170
|
|
$
|
65,467
|
|
Other
investments
|
|
(18,586
|
)
|
(3,113
|
)
|
Other
(1)
|
|
7,252
|
|
(13,668
|
)
|
Net realized
gains (losses)
|
|
$
|
(5,164
|
)
|
$
|
48,686
|
|
|
|
|
|
|
|
|
|
|
(1) Primarily
consists of net realized gains or losses related to investment-related
derivatives and foreign currency forward contracts.
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 2009
first quarter was 1.09%, compared to 0.95% for the 2008 first quarter.
Excluding foreign exchange, total return was 1.23% for the 2009 first quarter,
compared to 0.71% for the 2008 first quarter.
Net
Impairment Losses Recognized in Earnings
We review our investment
portfolio each quarter to determine if declines in value are
other-than-temporary. The process for identifying declines in the market 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) the liquidity, business prospects and
overall financial condition of the issuer, and (iii) the significance of
the decline. For the 2009 first quarter, we recorded $93.0 million of
other-than-temporary impairments (OTTI) of which $36.1 million was recognized
as credit related impairments in earnings, with the remaining $56.9 million
related to other factors and recorded as an unrealized loss in accumulated
other comprehensive income (loss). The OTTI recorded in the 2009 first quarter
primarily resulted from reductions in estimated recovery values on certain
mortgage-backed and asset-backed securities following the review of such
securities. We recorded $12.7 million of OTTI as a charge against earnings in the
2008 first quarter
. Such amount was recorded prior to the adoption of
FSP No. FAS 115-2 and FAS 124-2, Recognition
and Presentation of Other-Than-Temporary Impairments,
and included a
portion related to credit losses and a portion related to all other factors.
39
Table of Contents
Equity
in Net Income (Loss) of Investment Funds Accounted for Using the Equity Method
We
recorded $
9.6
million of net
losses related to investment funds accounted for using the equity method in the
2009 first quarter, compared to net losses of $
22.3
million for the 2008 first quarter. Due to
the ownership
structure
of these funds, which invest in fixed maturity securities, we use 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). Fluctuations in the carrying value of
the
investment funds accounted for using the equity method may increase the
volatility of our reported results of operations.
Investment funds accounted for using the equity method
totaled $293.5 million at March 31, 2009, compared to $301.0 million at December 31,
2008.
Other
Expenses
Other
expenses, which are included in our other operating expenses and part of
corporate and other (non-underwriting), were $6.0 million for the 2009 first
quarter, compared to $5.3 million for the 2008 first 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 2009 first quarter of $25.2 million consisted of net unrealized
gains of $25.9 million and net realized losses of $
0.7
million, compared to net foreign
exchange losses for the 2008 first quarter of $23.6 million which consisted of
net unrealized losses of $
22.3
million and net realized losses of $
1.3
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
its exposure to foreign currency fluctuations in its net insurance liabilities.
However, changes in the value of such investments due to foreign currency rate
movements are reflected as a direct increase or decrease to shareholders
equity and are not included in the statements of income.
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 sets the parameters for creating 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. 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 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.
40
Table of
Contents
On a consolidated basis,
our aggregate investable assets totaled $10.25 billion at March 31, 2009,
compared to $9.97 billion at December 31, 2008, as detailed in the
table below:
|
|
March 31,
2009
|
|
December 31,
2008
|
|
|
|
|
|
|
|
Fixed maturities
available for sale, at market value
|
|
$
|
8,540,653
|
|
$
|
8,122,221
|
|
Fixed maturities
pledged under securities lending agreements, at market value
(1)
|
|
503,449
|
|
626,501
|
|
Total fixed
maturities
|
|
9,044,102
|
|
8,748,722
|
|
Short-term
investments available for sale, at market value
|
|
749,708
|
|
479,586
|
|
Short-term
investments pledged under securities lending agreements, at market value
(1)
|
|
56,242
|
|
101,564
|
|
Cash
|
|
244,037
|
|
251,739
|
|
Other
investments
|
|
|
|
|
|
Fixed income
mutual funds
|
|
32,912
|
|
39,858
|
|
Privately held
securities and other
|
|
72,076
|
|
69,743
|
|
Investment funds
accounted for using the equity method
|
|
293,452
|
|
301,027
|
|
Total cash and
investments
(1)
|
|
10,492,529
|
|
9,992,239
|
|
Securities
transactions entered into but not settled at the balance sheet date
|
|
(241,836
|
)
|
(18,236
|
)
|
Total investable
assets
|
|
$
|
10,250,693
|
|
$
|
9,974,003
|
|
(1) In our
securities lending transactions, we receive collateral in excess of the market
value of the fixed maturities and short-term investments pledged under
securities lending agreements. For purposes of this table, we have excluded the
investment of collateral received at March 31, 2009 and December 31,
2008 of $550.8 million and $730.2 million, respectively, which is reflected as investment
of funds received under securities lending agreements, at market value and
included the $559.7 million and $728.1 million, respectively, of fixed
maturities and short-term investments pledged under securities lending
agreements, at market value.
At March 31, 2009,
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 3.02 years, and an average yield to
maturity (imbedded book yield), before investment expenses, of 4.17%. At December 31,
2008, our fixed income portfolio had a AA+ average Standard & Poors
quality rating, an average effective duration of 3.62 years, and an average
yield to maturity (imbedded book yield), before investment expenses, of 4.55%.
At March 31, 2009, approximately $5.84 billion, or 57.0%, of our total
investments and cash was internally managed, compared to $5.3 billion, or
52.2%, at December 31, 2008.
The distribution of our fixed maturities and fixed
maturities pledged under securities lending agreements by type is shown below:
|
|
March 31, 2009
|
|
December 31, 2008
|
|
|
|
Estimated
Market Value
|
|
Net
Unrealized
Gains (Losses)
|
|
Estimated
Market Value
|
|
Net
Unrealized
Gains (Losses)
|
|
|
|
|
|
|
|
|
|
|
|
Corporate bonds
|
|
$
|
2,181,763
|
|
$
|
(91,533
|
)
|
$
|
2,019,373
|
|
$
|
(47,848
|
)
|
Mortgage backed
securities
|
|
1,692,863
|
|
(107,119
|
)
|
1,581,736
|
|
(102,453
|
)
|
U.S. government
and government agencies
|
|
1,547,416
|
|
43,685
|
|
1,463,897
|
|
63,603
|
|
Commercial
mortgage backed securities
|
|
1,209,605
|
|
(28,123
|
)
|
1,219,737
|
|
(52,084
|
)
|
Asset backed
securities
|
|
922,560
|
|
(37,400
|
)
|
970,041
|
|
(69,641
|
)
|
Municipal bonds
|
|
861,954
|
|
30,464
|
|
965,966
|
|
25,085
|
|
Non-U.S.
government securities
|
|
627,941
|
|
(1,574
|
)
|
527,972
|
|
1,806
|
|
Total
|
|
$
|
9,044,102
|
|
$
|
(191,600
|
)
|
$
|
8,748,722
|
|
$
|
(181,532
|
)
|
41
Table of
Contents
The credit quality
distribution of our fixed maturities and fixed maturities pledged under
securities lending agreements is shown below:
|
|
March 31, 2009
|
|
December 31, 2008
|
|
Rating (1)
|
|
Estimated
Market Value
|
|
% of
Total
|
|
Estimated
Market Value
|
|
% of
Total
|
|
|
|
|
|
|
|
|
|
|
|
AAA
|
|
$
|
7,146,184
|
|
79.0
|
|
$
|
6,756,503
|
|
77.2
|
|
AA
|
|
833,192
|
|
9.2
|
|
815,512
|
|
9.3
|
|
A
|
|
645,995
|
|
7.2
|
|
750,947
|
|
8.6
|
|
BBB
|
|
178,854
|
|
2.0
|
|
195,319
|
|
2.2
|
|
BB
|
|
54,094
|
|
0.6
|
|
52,349
|
|
0.6
|
|
B
|
|
126,670
|
|
1.4
|
|
126,688
|
|
1.5
|
|
Lower than B
|
|
11,825
|
|
0.1
|
|
9,549
|
|
0.1
|
|
Not rated
|
|
47,288
|
|
0.5
|
|
41,855
|
|
0.5
|
|
Total
|
|
$
|
9,044,102
|
|
100.0
|
|
$
|
8,748,722
|
|
100.0
|
|
(1) Ratings as
assigned by the major rating agencies.
The
following table summarizes our top ten exposures to fixed income corporate
issuers at March 31, 2009:
|
|
Estimated Market Value
|
|
(U.S. dollars in thousands)
|
|
Government Guaranteed (1)
|
|
Not
Guaranteed
|
|
Total
|
|
|
|
|
|
|
|
|
|
JPMorgan
Chase & Co.
|
|
$
|
75,837
|
|
$
|
37,671
|
|
$
|
113,508
|
|
Bank of America
Corp.
|
|
65,924
|
|
44,059
|
|
109,983
|
|
General Electric
Capital Corp.
|
|
20,022
|
|
61,791
|
|
81,813
|
|
Citigroup Inc.
|
|
10,367
|
|
43,830
|
|
54,197
|
|
Wells
Fargo & Company
|
|
|
|
52,213
|
|
52,213
|
|
Goldman Sachs
Group Inc.
|
|
37,720
|
|
10,667
|
|
48,387
|
|
Verizon
Communications Inc.
|
|
|
|
47,632
|
|
47,632
|
|
Japan Finance
Corp.
|
|
46,787
|
|
|
|
46,787
|
|
Macquarie Group
Ltd.
|
|
43,540
|
|
|
|
43,540
|
|
HSBC Holdings
PLC
|
|
26,107
|
|
13,986
|
|
40,093
|
|
Total
|
|
$
|
326,304
|
|
$
|
311,849
|
|
$
|
638,153
|
|
(1) Securities
of U.S.-domiciled issuers are guaranteed by the Federal Deposit Insurance
Corporation (FDIC), a U.S. government agency, under the Temporary Liquidity
Guarantee Program. Japan Finance Corp., Macquarie Group Ltd. and HSBC Holdings
PLC securities are guaranteed by the governments of Japan, Australia and the
United Kingdom, respectively.
As of March 31,
2009, we held insurance enhanced municipal bonds, net of prerefunded bonds that
are escrowed in U.S. government obligations, in the amount of $324.9 million,
which represented 3.2% of our total invested assets. These securities had an
average rating of Aa3 by Moodys and AA by Standard & Poors.
Giving no effect to the insurance enhancement, the overall credit quality of
our insured municipal bond portfolio was an average underlying rating of Aa3
by Moodys and AA by Standard & Poors. Guarantors of our insurance
enhanced municipal bonds, net of prerefunded bonds that are escrowed in U.S.
government obligations, included MBIA Insurance Corporation ($142.9 million),
Financial Security Assurance Inc. ($87.4 million), Ambac Financial Group, Inc.
($47.9 million), Financial Guaranty Insurance Company ($24.4 million) and the
Texas Permanent School Fund ($22.3 million). We do not have a significant
exposure to insurance enhanced asset-backed or mortgage-backed securities. We
do not have any significant investments in companies which guarantee securities
at March 31, 2009.
42
Table
of Contents
The following
table provides information on our mortgage backed securities (MBS) and
commercial mortgage backed securities (CMBS) at March 31, 2009,
excluding amounts guaranteed by the U.S. government:
|
|
|
|
|
|
|
|
Estimated Market Value
|
|
(U.S. dollars in thousands)
|
|
Issuance
Year
|
|
Par Value
|
|
Average
Credit
Quality
|
|
Total
|
|
% of Asset
Class
|
|
% of
Investable
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
MBS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-agency MBS
|
|
2002
|
|
$
|
5,363
|
|
AAA
|
|
$
|
4,880
|
|
0.3
|
%
|
0.0
|
%
|
|
|
2003
|
|
4,367
|
|
AAA
|
|
3,777
|
|
0.2
|
%
|
0.0
|
%
|
|
|
2004
|
|
42,508
|
|
AAA
|
|
31,190
|
|
1.8
|
%
|
0.3
|
%
|
|
|
2005
|
|
111,702
|
|
AA+
|
|
60,574
|
|
3.6
|
%
|
0.6
|
%
|
|
|
2006
|
|
86,381
|
|
AA+
|
|
46,989
|
|
2.8
|
%
|
0.5
|
%
|
|
|
2007
|
|
124,097
|
|
A
|
|
73,793
|
|
4.4
|
%
|
0.7
|
%
|
|
|
2008
|
|
30,211
|
|
AAA
|
|
23,751
|
|
1.4
|
%
|
0.2
|
%
|
Total non-agency
MBS
|
|
|
|
$
|
404,629
|
|
AA
|
|
$
|
244,954
|
|
14.5
|
%
|
2.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CMBS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-agency CMBS
|
|
1998
|
|
$
|
3,400
|
|
AAA
|
|
$
|
3,289
|
|
0.3
|
%
|
0.0
|
%
|
|
|
1999
|
|
86,929
|
|
AAA
|
|
88,419
|
|
7.3
|
%
|
0.9
|
%
|
|
|
2000
|
|
129,351
|
|
AAA
|
|
131,302
|
|
10.9
|
%
|
1.3
|
%
|
|
|
2001
|
|
131,981
|
|
AAA
|
|
128,942
|
|
10.7
|
%
|
1.3
|
%
|
|
|
2002
|
|
70,822
|
|
AAA
|
|
67,959
|
|
5.6
|
%
|
0.7
|
%
|
|
|
2003
|
|
97,332
|
|
AAA
|
|
91,854
|
|
7.6
|
%
|
0.9
|
%
|
|
|
2004
|
|
77,045
|
|
AAA
|
|
69,348
|
|
5.7
|
%
|
0.7
|
%
|
|
|
2005
|
|
77,943
|
|
AAA
|
|
64,212
|
|
5.3
|
%
|
0.6
|
%
|
|
|
2006
|
|
36,807
|
|
AAA
|
|
28,027
|
|
2.3
|
%
|
0.3
|
%
|
|
|
2007
|
|
37,900
|
|
AAA
|
|
31,750
|
|
2.6
|
%
|
0.3
|
%
|
Total non-agency
CMBS
|
|
|
|
$
|
749,510
|
|
AAA
|
|
$
|
705,102
|
|
58.3
|
%
|
7.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional Statistics:
|
|
Non-Agency MBS
|
|
Non-Agency
CMBS (1)
|
|
Weighted average
loan age (months)
|
|
39
|
|
81
|
|
Weighted average
life (months)
(2)
|
|
47
|
|
34
|
|
Effective
duration
|
|
0.15
|
|
1.76
|
|
Weighted average
loan-to-value %
(3)
|
|
69.4
|
%
|
57.0
|
%
|
Total
delinquencies
(4)
|
|
9.9
|
%
|
1.3
|
%
|
Current credit
support %
(5)
|
|
15.5
|
%
|
30.0
|
%
|
(1) Loans defeased with
government/agency obligations represented approximately 22% of the collateral
underlying our CMBS holdings.
(2) The weighted average life
for MBS is based on the interest rates in effect at March 31, 2009. The
weighted average life for CMBS reflects the average life of the collateral
underlying our CMBS holdings.
(3) The range of loan-to-values
on MBS is 37% to 91% while the range of loan-to-values on CMBS is 43% to 76%.
(4) Total delinquencies includes
60 days and over.
(5) Current credit support %
represents the percentage for a collateralized mortgage obligation (CMO) or
CMBS class/tranche from other subordinate classes in the same CMO or CMBS deal.
43
Table
of Contents
The following
table provides information on our asset backed securities (ABS) at March 31,
2009:
|
|
|
|
|
|
|
|
Estimated Market Value
|
|
(U.S. dollars in thousands)
|
|
Par Value
|
|
Average
Credit
Quality
|
|
Effective
Duration
|
|
Total
|
|
% of Asset
Class
|
|
% of
Investable
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sector:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Autos
(1)
|
|
$
|
259,576
|
|
AAA
|
|
1.32
|
|
$
|
253,993
|
|
27.5
|
%
|
2.5
|
%
|
Credit cards
(2)
|
|
441,359
|
|
AAA
|
|
1.26
|
|
421,599
|
|
45.7
|
%
|
4.1
|
%
|
Rate reduction
bonds
(3)
|
|
140,997
|
|
AAA
|
|
1.84
|
|
146,393
|
|
15.9
|
%
|
1.4
|
%
|
Student loans
(4)
|
|
40,625
|
|
AAA
|
|
(0.02
|
)
|
39,020
|
|
4.2
|
%
|
0.4
|
%
|
Equipment
(5)
|
|
32,899
|
|
AAA
|
|
1.53
|
|
32,863
|
|
3.6
|
%
|
0.3
|
%
|
Other
|
|
9,346
|
|
AAA
|
|
0.20
|
|
8,086
|
|
0.9
|
%
|
0.1
|
%
|
|
|
924,802
|
|
AAA
|
|
1.31
|
|
901,954
|
|
97.8
|
%
|
8.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Home equity
(6)
|
|
$
|
33,019
|
|
AAA
|
|
0.01
|
|
$
|
17,866
|
|
1.9
|
%
|
0.2
|
%
|
|
|
17,705
|
|
AA
|
|
0.01
|
|
2,447
|
|
0.3
|
%
|
0.0
|
%
|
|
|
760
|
|
A
|
|
0.01
|
|
158
|
|
0.0
|
%
|
0.0
|
%
|
|
|
13
|
|
B
|
|
0.01
|
|
0
|
|
0.0
|
%
|
0.0
|
%
|
|
|
5,400
|
|
CCC
|
|
0.01
|
|
76
|
|
0.0
|
%
|
0.0
|
%
|
|
|
697
|
|
D
|
|
0.07
|
|
59
|
|
0.0
|
%
|
0.0
|
%
|
|
|
57,594
|
|
AA
|
|
0.01
|
|
20,606
|
|
2.2
|
%
|
0.2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total ABS
|
|
$
|
982,396
|
|
AAA
|
|
1.23
|
|
$
|
922,560
|
|
100.0
|
%
|
9.0
|
%
|
(1) The weighted average credit
support % on autos is 18.2%.
(2) The average excess spread %
on credit cards is 6.9%.
(3) The weighted average credit
support % on rate reduction bonds is 1.5%.
(4) The weighted average credit
support % on student loans is 4.5%.
(5) The weighted average credit
support % on equipment is 5.5%.
(6) The weighted average credit
support % on home equity is 33.7%.
At March 31, 2009, our fixed income portfolio
included $62.7 million par value in sub-prime securities with an estimated
market value of $24.1 million and an average credit quality of AA. Such
amounts were primarily in the home equity sector of our asset backed securities
with the balance in other ABS, MBS and CMBS sectors. We define sub-prime
mortgage-backed securities as investments in which the underlying loans
primarily exhibit one or more of the following characteristics: low FICO
scores, above-prime interest rates, high loan-to-value ratios or high
debt-to-income ratios. In addition, the portfolio of collateral backing
our securities lending program contains $33.8 million estimated market value of
sub-prime securities with an average credit quality of Ba2 from Moodys and AAA
from Standard & Poors.
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. In
addition, the structures used to generate leverage may lead to such investment
funds being required to meet covenants based on market valuations and asset
coverage. Market valuation declines in the funds could force the sale of
investments into a depressed market, which may result in significant additional
losses. Alternatively, the funds may attempt to deleverage by raising
additional equity or potentially changing the terms of the established
financing arrangements. We may choose to participate in the additional funding
of such investments.
Our
investment commitments related to investment funds accounted for using the
equity method, totaled approximately $7.9 million.
44
Table of
Contents
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 7, Investment
InformationInvestment-Related Derivatives, of the notes accompanying our
consolidated financial Statements for
additional disclosures concerning derivatives.
Other investments totaled $105.0 million at March 31,
2009, compared to $109.6 million at December 31, 2008.
Investment
funds accounted for using the equity method totaled $
293.5
million at March 31,
2009, compared to $301.0 million at December 31, 2008.
See Note 7
, Investment InformationOther
Investments and Investment InformationInvestment Funds Accounted for Using
the Equity Method of the notes accompanying our consolidated financial
statements for further details.
SFAS No. 157, Fair
Value Measurements (SFAS No. 157) 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.
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
|
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.
We use 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, our
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) a review of the average number of
prices obtained in the pricing process and the range of resulting market values;
(iii) initial and ongoing evaluation of methodologies used by outside
parties to calculate fair value including a review of deep dive reports on
selected securities which indicated the use of observable inputs in the pricing
process; (iv) comparing the fair value estimates to its knowledge of the
current market; and (v) 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, we 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
45
Table of
Contents
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. Of the $9.9 billion of
financial assets and liabilities measured at fair value, approximately $524
million, or 5.3%, were priced using non-binding broker-dealer quotes.
We review our 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 March 31, 2009, we determined that Level 1 securities included
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 we believe 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. We determined that Level 2 securities included 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 certain other investments.
We determined that three
Euro-denominated corporate bonds which invest in underlying portfolios of fixed
income securities for which there is a low level of transparency around inputs
to the valuation process should be classified within Level 3 of the valuation
hierarchy. In addition, we determined that two mutual funds, included in other
investments, which invest in underlying portfolios of fixed income securities
for which there is a low level of transparency around inputs to the valuation
process should be classified within Level 3 of the valuation hierarchy. In
addition, Level 3 securities include a small number of premium-tax bonds.
See Note 7, Investment
InformationFair Value of the notes accompanying our consolidated financial
statements for a summary of our financial assets and liabilities measured at
fair value at March 31, 2009 by SFAS No. 157 hierarchy
.
Reinsurance
Recoverables
We monitor the financial
condition of our reinsurers and attempt to place coverages only with
substantial, financially sound carriers. At March 31, 2009, approximately
88.9% of reinsurance recoverables on paid and unpaid losses (not including
prepaid reinsurance premiums) of $1.79 billion were due from carriers which had
an A.M. Best rating of A- or better and the largest reinsurance
recoverables from any one carrier was less than 6.9% of our total shareholders
equity. At December 31, 2008, approximately 88.5% of reinsurance
recoverables on paid and unpaid losses (not including prepaid reinsurance
premiums) of $1.79 billion were due from carriers which had an A.M. Best
rating of A- or better and the largest reinsurance recoverables from any one
carrier was less than 7.3% of our total shareholders equity.
Reinsurance recoverables
from Flatiron, which is not rated by A.M. Best, were $153.5 million at March 31,
2009, compared to $148.7 million at December 31, 2008. As noted above,
Flatiron is required to contribute funds into a trust for the benefit of Arch
Re Bermuda. The recoverable from Flatiron was fully collateralized through such
trust at March 31, 2009 and December 31, 2008.
See Note 5, Reinsurance,
of the notes accompanying our consolidated financial Statements for
further details on the quota share
reinsurance treaty with Flatiron.
46
Table of
Contents
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.
At March 31, 2009
and December 31, 2008, our Loss Reserves, net of unpaid losses and loss
adjustment expenses recoverable, by type and by operating segment were as
follows:
|
|
March 31,
2009
|
|
December 31,
2008
|
|
|
|
|
|
|
|
Insurance:
|
|
|
|
|
|
Case reserves
|
|
$
|
1,047,926
|
|
$
|
1,043,168
|
|
IBNR reserves
|
|
2,322,929
|
|
2,257,735
|
|
Total net
reserves
|
|
$
|
3,370,855
|
|
$
|
3,300,903
|
|
|
|
|
|
|
|
Reinsurance:
|
|
|
|
|
|
Case reserves
|
|
$
|
679,172
|
|
$
|
661,621
|
|
Additional case
reserves
|
|
88,283
|
|
87,820
|
|
IBNR reserves
|
|
1,860,226
|
|
1,887,478
|
|
Total net reserves
|
|
$
|
2,627,681
|
|
$
|
2,636,919
|
|
|
|
|
|
|
|
Total:
|
|
|
|
|
|
Case reserves
|
|
$
|
1,727,098
|
|
$
|
1,704,789
|
|
Additional case
reserves
|
|
88,283
|
|
87,820
|
|
IBNR reserves
|
|
4,183,155
|
|
4,145,213
|
|
Total net
reserves
|
|
$
|
5,998,536
|
|
$
|
5,937,822
|
|
At March 31, 2009
and December 31, 2008, the insurance segments Loss Reserves by major line
of business, net of unpaid losses and loss adjustment expenses recoverable,
were as follows:
|
|
March 31,
2009
|
|
December 31,
2008
|
|
|
|
|
|
|
|
Casualty
|
|
$
|
663,786
|
|
$
|
673,511
|
|
Property,
energy, marine and aviation.
|
|
525,450
|
|
518,475
|
|
Executive
assurance
|
|
473,834
|
|
445,922
|
|
Professional
liability
|
|
452,617
|
|
448,769
|
|
Programs
|
|
412,228
|
|
400,245
|
|
Construction
|
|
405,473
|
|
389,931
|
|
Healthcare
|
|
148,369
|
|
148,915
|
|
Surety
|
|
77,825
|
|
79,705
|
|
National
accounts casualty
|
|
63,619
|
|
54,974
|
|
Travel and
accident
|
|
19,949
|
|
20,638
|
|
Other
|
|
127,705
|
|
119,818
|
|
Total net
reserves
|
|
$
|
3,370,855
|
|
$
|
3,300,903
|
|
47
Table of Contents
At March 31, 2009
and December 31, 2008, the reinsurance segments Loss Reserves by major
line of business, net of unpaid losses and loss adjustment expenses recoverable,
were as follows:
|
|
March 31,
2009
|
|
December 31,
2008
|
|
|
|
|
|
|
|
Casualty
|
|
$
|
1,739,612
|
|
$
|
1,739,394
|
|
Property
excluding property catastrophe
|
|
298,591
|
|
299,811
|
|
Marine and
aviation
|
|
239,634
|
|
238,959
|
|
Other specialty
|
|
157,820
|
|
163,099
|
|
Property catastrophe
|
|
143,755
|
|
145,211
|
|
Other
|
|
48,269
|
|
50,445
|
|
Total net
reserves
|
|
$
|
2,627,681
|
|
$
|
2,636,919
|
|
Shareholders Equity
Our shareholders equity
was $3.63 billion at March 31, 2009, compared to $3.43 billion at December 31,
2008. The increase in the 2009 period of $197.4 million was attributable to net
income for the period and an after-tax increase in the fair value of our
investment portfolio.
Book Value per Common Share
The following table
presents the calculation of book value per common share at March 31, 2009
and December 31, 2008:
(U.S. dollars in thousands, except share data)
|
|
March 31,
2009
|
|
December 31,
2008
|
|
|
|
|
|
|
|
Calculation of
book value per common share:
|
|
|
|
|
|
Total
shareholders equity
|
|
$
|
3,630,396
|
|
$
|
3,432,965
|
|
Less preferred
shareholders equity
|
|
(325,000
|
)
|
(325,000
|
)
|
Common
shareholders equity
|
|
$
|
3,305,396
|
|
$
|
3,107,965
|
|
Common shares
outstanding
(1)
|
|
60,532,222
|
|
60,511,974
|
|
Book value per
common share
|
|
$
|
54.61
|
|
$
|
51.36
|
|
(1)
|
Excludes the effects of
5,111,344 and 5,131,135 stock options and 347,019 and 412,622 restricted
stock units outstanding at March 31, 2009 and December 31, 2008,
respectively.
|
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. ACGLs readily
available cash, short-term investments and marketable securities, excluding
amounts held by our regulated insurance and reinsurance subsidiaries, totaled
$12.5 million at March 31, 2009, compared to $16.8 million at December 31,
2008. During the 2009 first quarter, ACGL received dividends of $6.5 million
from Arch Re Bermuda which were used to fund the payment of preferred
dividends.
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 an enhanced capital requirement which must equal or exceed its
48
Table of
Contents
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) $100.0
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 enhanced capital requirement, 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, 2008, as determined under Bermuda law, Arch Re
Bermuda had statutory capital of $2.21 billion and statutory capital and
surplus of $3.36 billion. Such amounts include ownership interests in U.S.
insurance and reinsurance subsidiaries. Accordingly, Arch Re Bermuda can pay
approximately $834 million to ACGL during 2009 without providing an affidavit
to the Bermuda Monetary Authority, as discussed above. In addition to meeting
applicable regulatory standards, the ability of our insurance and reinsurance
subsidiaries to pay dividends to intermediate parent companies owned by Arch Re
Bermuda 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.
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 March 31, 2009 and December 31, 2008, such amounts
approximated $1.32 billion and $1.28 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 March 31, 2009 and December 31, 2008, such amounts
approximated $4.18 billion and $4.03 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
49
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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 net cash
provided by operating activities was $294.8 million for the 2009 first quarter,
compared to $334.5 million for the 2008 first quarter. The lower level of
operating cash flows in the 2009 first quarter primarily resulted from an
increase in paid losses, as our insurance and reinsurance loss reserves have
continued to mature. 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.
On a consolidated basis,
our aggregate cash and invested assets totaled $10.25 billion at March 31,
2009, compared to $9.97 billion at December 31, 2008. The primary goals of
our asset liability management process are to satisfy the insurance
liabilities, manage the interest rate risk embedded in those insurance
liabilities and maintain sufficient liquidity to cover fluctuations in
projected liability cash flows. Generally, the expected principal and
interest payments produced by our fixed income portfolio adequately fund the
estimated runoff of our insurance reserves. Although this is not an exact
cash flow match in each period, the substantial degree by which the market
value of the fixed income portfolio exceeds the expected present value of the
net insurance liabilities, as well as the positive cash flow from newly sold
policies and the large amount of high quality liquid bonds, provide assurance
of our ability to fund the payment of claims without having to sell securities
at distressed prices in an illiquid market or access credit facilities.
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-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.
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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 $500.0 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.
In March 2009, ACGL repurchased $1.6 million of common shares through the
share repurchase program. Since the inception of the share repurchase program
through March 31, 2009, ACGL has repurchased approximately 15.3 million
common shares for an aggregate purchase price of $1.05 billion.
At March 31, 2009,
approximately $448.3 million of share repurchases were available under the
program. 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 light of current financial and insurance
market conditions, we will likely not repurchase significant amounts of shares
in 2009, although our plans may change depending on market conditions, our
share price performance or other factors. In connection with the share
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 share 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. Given the recent severe disruptions in the public debt and equity
markets, including among other things, widening of credit spreads, lack of
liquidity and bankruptcies, we can provide no assurance that, if needed, we
would be able to obtain additional funds through financing on satisfactory
terms or at all. Continued adverse developments in the financial markets, such
as disruptions, uncertainty or volatility in the capital and credit markets,
may result in realized and unrealized capital losses that could have a material
adverse effect on our results of operations, financial position and our
businesses, and may also limit our access to capital required to operate our
business.
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, under certain of the reinsurance agreements assumed by our
reinsurance operations, upon the occurrence of a ratings downgrade or other
specified triggering event with respect to our reinsurance operations, such as
a reduction in surplus by specified amounts during specified periods, our
ceding company clients may be provided with certain rights, including, among
other things, the right to terminate the subject reinsurance agreement and/or
to require that our reinsurance operations post additional collateral.
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. As noted above, 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 result, and,
in any case, such securities may have rights, preferences and privileges that
are senior to those of our outstanding securities.
In August 2006, we
entered into a five-year agreement for a $300.0 million unsecured revolving
loan and letter of credit facility and a $1.0 billion secured letter of credit
facility. Under the terms of the agreement, Arch Reinsurance Company (Arch Re
U.S.) is limited to issuing $100 million of unsecured letters of credit as
part of the $300 million unsecured revolving loan. See Contractual
Obligations and Commercial CommitmentsLetters of Credit and Revolving Credit
Facilities for a discussion of our available facilities, applicable covenants
on such facilities and available capacity. It is anticipated that the available
facilities will be renewed
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(or replaced) on
expiry, but such renewal (or replacement) will be subject to the availability
of credit from banks which we utilize. Given the recent disruptions in the
capital markets, we can provide no assurance that we will be able to renew the
facilities in August 2011 on satisfactory terms and, if renewed, the costs
of the facilities may be significantly higher than the costs of our existing
facilities.
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 2009 and 2008 first
quarters, we paid $6.5 million to holders of the preferred shares and, at March 31,
2009, had declared an aggregate of $3.3 million of dividends to be paid to
holders of the preferred shares.
In March 2009, ACGL
and Arch Capital Group (U.S.) Inc. 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.
At March 31, 2009,
our capital of $
4.03
billion consisted of $300.0 million of senior notes,
representing
7.4
% of the total, $100.0 million of revolving credit
agreement borrowings due in August 2011, representing
2.5
% of the total, $325.0 million of
preferred shares, representing
8.1
% of the total, and common shareholders
equity of $
3.31
billion,
representing the balance. At December 31, 2008, ACGLs capital of $3.83
billion consisted of $300.0 million of senior notes, representing 7.8% of the
total, $100.0 million of revolving credit agreement borrowings due in August 2011,
representing 2.6% of the total, $325.0 million of preferred shares,
representing 8.5% of the total, and common shareholders equity of $3.11
billion, representing the balance. The increase in capital during the 2009
first quarter was primarily attributable to net income and an after-tax
increase in the market value of our investment portfolio.
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Table of Contents
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, 2008.
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 March 31,
2009. (See section captioned Managements Discussion and Analysis of Financial
Condition and Results of OperationsMarket Sensitive Instruments and Risk
Management included in our 2008 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 March 31, 2009, material changes in market risk exposures that affect
the quantitative and qualitative disclosures presented as of December 31,
2008 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 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 March 31,
2009 and December 31, 2008. 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.
Furthermore, in recent months interest rate movements in many credit
sectors have exhibited a much lower correlation to changes in U.S. Treasury
yields. 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 Financial Condition, Liquidity and
Capital ResourcesFinancial ConditionInvestable Assets
|
|
Interest Rate Shift in Basis Points
|
|
(U.S. dollars in millions)
|
|
-100
|
|
-50
|
|
0
|
|
50
|
|
100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
2009:
|
|
|
|
|
|
|
|
|
|
|
|
Total market
value
|
|
$
|
10,229.6
|
|
$
|
10,084.8
|
|
$
|
9,935.2
|
|
$
|
9,784.5
|
|
$
|
9,633.6
|
|
Market value
change from base
|
|
2.96
|
%
|
1.51
|
%
|
|
|
(1.52
|
)%
|
(3.04
|
)%
|
Change in
unrealized value
|
|
$
|
294.4
|
|
$
|
149.6
|
|
|
|
$
|
(150.7
|
)
|
$
|
(301.6
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
2008:
|
|
|
|
|
|
|
|
|
|
|
|
Total market
value
|
|
$
|
9,999.5
|
|
$
|
9,832.3
|
|
$
|
9,641.7
|
|
$
|
9,481.8
|
|
$
|
9,312.7
|
|
Market value change
from base
|
|
3.71
|
%
|
1.98
|
%
|
|
|
(1.66
|
)%
|
(3.41
|
)%
|
Change in
unrealized value
|
|
$
|
357.8
|
|
$
|
190.6
|
|
|
|
$
|
(159.9
|
)
|
$
|
(329.0
|
)
|
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Table of Contents
In addition, we consider
the effect of credit spread 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 investment
funds accounted for using the equity method which invest in fixed income
securities and the corresponding change in unrealized appreciation. As credit
spreads widen, the market value of our fixed income securities falls, and the
converse is also true.
The following table
summarizes the effect that an immediate, parallel shift in credit spreads in a
static interest rate environment would have had on the portfolio at March 31,
2009 and December 31, 2008:
|
|
Credit Spread Shift in Basis Points
|
|
(U.S. dollars in millions)
|
|
-100
|
|
-50
|
|
0
|
|
50
|
|
100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
2009:
|
|
|
|
|
|
|
|
|
|
|
|
Total market
value
|
|
$
|
10,138.9
|
|
$
|
10,084.8
|
|
$
|
9,935.2
|
|
$
|
9,832.9
|
|
$
|
9,731.5
|
|
Market value change
from base
|
|
2.05
|
%
|
1.03
|
%
|
|
|
(1.03
|
)%
|
(2.05
|
)%
|
Change in
unrealized value
|
|
$
|
203.7
|
|
$
|
102.3
|
|
|
|
$
|
(102.3
|
)
|
$
|
(203.7
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
2008:
|
|
|
|
|
|
|
|
|
|
|
|
Total market
value
|
|
$
|
9,850.0
|
|
$
|
9,745.8
|
|
$
|
9,641.7
|
|
$
|
9,537.6
|
|
$
|
9,433.4
|
|
Market value
change from base
|
|
2.16
|
%
|
1.08
|
%
|
|
|
(1.08
|
)%
|
(2.16
|
)%
|
Change in
unrealized value
|
|
$
|
208.3
|
|
$
|
104.1
|
|
|
|
$
|
(104.1
|
)
|
$
|
(208.3
|
)
|
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 March 31, 2009, our portfolios VaR was estimated to
be 7.24%, compared to an estimated 8.49% at December 31, 2008.
Investment-Related
Derivatives.
We invest in certain
derivative instruments to replicate investment positions and to manage market
exposures and duration risk. At March 31, 2009, the notional value of the
net long position for Treasury note futures was $438.0 million, compared to
$556.3 million at December 31, 2008. At March 31, 2009, the notional
value of the net long position for U.K. and German government futures was nil,
compared to $363.3 million at December 31, 2008 (at December 31, 2008
foreign currency rates). At March 31, 2009, the notional value of the net
long position of gold futures was $18.5 million, compared to nil at December 31,
2008. A 10% depreciation of the underlying exposure to these derivative
instruments at March 31, 2009 and December 31, 2008 would have
resulted in a reduction in net income of approximately $45.7 million and $92.0
million, respectively, and would have decreased book value per common share by
$0.75 and $1.52, respectively.
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 March 31,
2009 and December 31, 2008, net of unrealized appreciation on our
securities denominated in currencies other than the U.S. Dollar, would have
resulted in unrealized gains of approximately $5.4 million and $4.9 million,
respectively, and would have increased book value per common share by
approximately $0.09 and $0.08, respectively. A 10% appreciation of the U.S.
Dollar against other currencies under our outstanding contracts at March 31,
2009 and December 31, 2008, net of unrealized depreciation on our
securities denominated in currencies other than the U.S. Dollar, would have
resulted in unrealized losses of approximately $5.4 million and $4.9 million,
respectively, and would have decreased book
54
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value per common
share by approximately $0.09 and $0.08, 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;
·
developments in the worlds financial and
capital markets and our access to such markets;
·
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;
·
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
55
Table of Contents
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 March 31, 2009;
·
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, including
legislative or regulatory developments that may adversely affect the market
value of our investments;
·
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.
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.
56
Table of Contents
Other Financial Information
The consolidated
financial statements as of March 31, 2009 and for the three-month periods
ended March 31, 2009 and 2008 have been reviewed by PricewaterhouseCoopers
LLP, an independent registered public accounting firm. Their report (dated May 11,
2009) is included on page 2. The report of PricewaterhouseCoopers LLP
states that they did not audit and they do not express an opinion on that
unaudited financial information. Accordingly, the degree of reliance on their
report on such information should be restricted in light of the limited nature
of the review procedures applied. PricewaterhouseCoopers LLP is not subject to
the liability provisions of Section 11 of the Securities Act of 1933 for
their report on the unaudited financial information because that report is not
a report or a part of the registration statement 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; 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.
57
Table of
Contents
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 March 31, 2009 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 March 31, 2009, 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 2009 first quarter:
|
|
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)
|
|
1/1/2009-1/31/2009
|
|
26,820
|
|
$
|
70.10
|
|
|
|
$
|
449,804
|
|
2/1/2009-2/28/2009
|
|
6,301
|
|
$
|
52.10
|
|
|
|
$
|
449,804
|
|
3/1/2009-3/31/2009
|
|
33,305
|
|
$
|
46.62
|
|
33,305
|
|
$
|
448,252
|
|
Total
|
|
66,426
|
|
$
|
56.62
|
|
33,305
|
|
$
|
448,252
|
|
(1)
ACGL repurchases shares, from time to
time, from employees in order to facilitate the payment of withholding taxes on
restricted shares granted and the exercise of stock appreciation rights. 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 or the stock appreciation rights were exercised.
(2)
ACGLs board of directors authorized ACGL
to invest 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 $500.0 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 15.3 million
common shares for an aggregate purchase price of $1.05 billion. 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.
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 2009 first quarter, the Audit Committee approved
engagements of PricewaterhouseCoopers LLP for permitted non-audit services,
substantially all of which consisted of tax services, tax consulting and tax
compliance.
58
Item 6. Exhibits
Exhibit No.
|
|
Description
|
|
|
|
10.1
|
|
Restricted
Share Agreement, dated as of April 1, 2009, between Arch Capital Group
Ltd. and John C.R. Hele
|
|
|
|
10.2
|
|
Non-Qualified
Stock Option Agreement, dated as of April 1, 2009, between Arch Capital
Group Ltd. and John C.R. Hele
|
|
|
|
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
|
59
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: May 11, 2009
|
|
Constantine Iordanou
|
|
|
President and Chief
Executive Officer
(Principal Executive Officer) and Director
|
|
|
|
|
|
|
|
|
/s/ John C.R. Hele
|
Date: May 11, 2009
|
|
John C.R. Hele
|
|
|
Executive Vice
President, Chief Financial
Officer and Treasurer (Principal Financial and
Accounting Officer)
|
60
Table of
Contents
EXHIBIT
INDEX
Exhibit No.
|
|
Description
|
|
|
|
10.1
|
|
Restricted
Share Agreement, dated as of April 1, 2009, between Arch Capital Group
Ltd. and John C.R. Hele
|
|
|
|
10.2
|
|
Non-Qualified
Stock Option Agreement, dated as of April 1, 2009, between Arch Capital
Group Ltd. and John C.R. Hele
|
|
|
|
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
|
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