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,
2010
|
|
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
The number of the
registrants common shares (par value, $0.01 per share) outstanding as of May 4,
2010 was 52,307,829.
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 sheet of Arch Capital Group Ltd. and its
subsidiaries (the Company) as of March 31, 2010, and the related
consolidated statements of income, changes in shareholders equity and
comprehensive income for each of the three-month periods ended March 31,
2010 and March 31, 2009 and the consolidated statements of cash flows for
the three month periods ended March 31, 2010 and March 31, 2009. These interim financial statements are the
responsibility of the Companys management.
We conducted our review
in accordance with the standards of the Public Company Accounting Oversight
Board (United States). A review of
interim financial information consists principally of applying analytical
procedures and making inquiries of persons responsible for financial and
accounting matters. It is substantially
less in scope than an audit conducted in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the objective of
which is the expression of an opinion regarding the financial statements taken
as a whole. Accordingly, we do not
express such an opinion.
Based on our review, we
are not aware of any material modifications that should be made to the
accompanying consolidated interim financial statements for them to be in conformity
with accounting principles generally accepted in the United States of America.
We previously audited, in
accordance with the standards of the Public Company Accounting Oversight Board
(United States), the consolidated balance sheet as of December 31, 2009,
and the related consolidated statements of income, changes in shareholders
equity, comprehensive income, and of cash flows for the year then ended (not
presented herein), and in our report dated February 26, 2010, 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 March 31,
2010, 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, NY
|
|
May 7, 2010
|
|
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,
|
|
|
|
2010
|
|
2009
|
|
Assets
|
|
|
|
|
|
Investments:
|
|
|
|
|
|
Fixed
maturities available for sale, at market value (amortized cost: 2010,
$9,129,065; 2009, $9,227,432)
|
|
$
|
9,295,680
|
|
$
|
9,391,926
|
|
Short-term
investments available for sale, at market value (amortized cost: 2010,
$671,902; 2009, $570,469)
|
|
669,798
|
|
571,489
|
|
Investment
of funds received under securities lending agreements, at market value (amortized
cost: 2010, $182,338; 2009, $96,590)
|
|
177,954
|
|
91,160
|
|
TALF
investments, at market value (amortized cost: 2010, $400,347; 2009, $247,192)
|
|
406,997
|
|
250,265
|
|
Other
investments (cost: 2010, $251,917; 2009, $162,505)
|
|
263,608
|
|
172,172
|
|
Investment
funds accounted for using the equity method
|
|
405,584
|
|
391,869
|
|
Total
investments
|
|
11,219,621
|
|
10,868,881
|
|
|
|
|
|
|
|
Cash
|
|
338,708
|
|
334,571
|
|
Accrued
investment income
|
|
74,214
|
|
70,673
|
|
Investment
in joint venture (cost: $100,000)
|
|
102,946
|
|
102,855
|
|
Fixed
maturities and short-term investments pledged under securities lending
agreements, at market value
|
|
184,221
|
|
212,820
|
|
Securities
purchased under agreements to resell using funds received under securities
lending agreements
|
|
|
|
115,839
|
|
Premiums
receivable
|
|
699,385
|
|
595,030
|
|
Unpaid
losses and loss adjustment expenses recoverable
|
|
1,643,573
|
|
1,659,500
|
|
Paid
losses and loss adjustment expenses recoverable
|
|
67,734
|
|
60,770
|
|
Prepaid
reinsurance premiums
|
|
250,841
|
|
277,985
|
|
Deferred
acquisition costs, net
|
|
298,371
|
|
280,372
|
|
Receivable
for securities sold
|
|
1,427,085
|
|
187,171
|
|
Other
assets
|
|
628,407
|
|
609,323
|
|
Total
Assets
|
|
$
|
16,935,106
|
|
$
|
15,375,790
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
Reserve
for losses and loss adjustment expenses
|
|
$
|
7,898,162
|
|
$
|
7,873,412
|
|
Unearned
premiums
|
|
1,495,265
|
|
1,433,331
|
|
Reinsurance
balances payable
|
|
114,254
|
|
156,500
|
|
Senior
notes
|
|
300,000
|
|
300,000
|
|
Revolving
credit agreement borrowings
|
|
100,000
|
|
100,000
|
|
TALF
borrowings, at market value (par: 2010, $346,950; 2009, $218,740)
|
|
346,746
|
|
217,565
|
|
Securities
lending payable
|
|
189,024
|
|
219,116
|
|
Payable
for securities purchased
|
|
1,429,529
|
|
136,381
|
|
Other
liabilities
|
|
683,369
|
|
616,136
|
|
Total
Liabilities
|
|
12,556,349
|
|
11,052,441
|
|
|
|
|
|
|
|
Commitments and Contingencies
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders Equity
|
|
|
|
|
|
Non-cumulative
preferred shares ($0.01 par, issued and outstanding: 13,000,000)
|
|
130
|
|
130
|
|
Common
shares ($0.01 par, issued and outstanding: 2010, 52,709,934; 2009,
54,761,678)
|
|
527
|
|
548
|
|
Additional
paid-in capital
|
|
420,796
|
|
578,336
|
|
Retained
earnings
|
|
3,816,342
|
|
3,605,809
|
|
Accumulated
other comprehensive income, net of deferred income tax
|
|
140,962
|
|
138,526
|
|
Total
Shareholders Equity
|
|
4,378,757
|
|
4,323,349
|
|
Total
Liabilities and Shareholders Equity
|
|
$
|
16,935,106
|
|
$
|
15,375,790
|
|
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,
|
|
|
|
2010
|
|
2009
|
|
Revenues
|
|
|
|
|
|
Net
premiums written
|
|
$
|
767,754
|
|
$
|
822,863
|
|
Increase
in unearned premiums
|
|
(97,837
|
)
|
(122,299
|
)
|
Net
premiums earned
|
|
669,917
|
|
700,564
|
|
Net
investment income
|
|
92,972
|
|
95,882
|
|
Net
realized gains (losses)
|
|
47,782
|
|
(5,164
|
)
|
|
|
|
|
|
|
Other-than-temporary
impairment losses
|
|
(2,336
|
)
|
(97,422
|
)
|
Less
investment impairments recognized in other comprehensive income, before taxes
|
|
730
|
|
61,288
|
|
Net
impairment losses recognized in earnings
|
|
(1,606
|
)
|
(36,134
|
)
|
|
|
|
|
|
|
Fee
income
|
|
794
|
|
925
|
|
Equity
in net income (loss) of investment funds accounted for using the equity
method
|
|
29,050
|
|
(9,581
|
)
|
Other
income
|
|
5,978
|
|
3,951
|
|
Total
revenues
|
|
844,887
|
|
750,443
|
|
|
|
|
|
|
|
Expenses
|
|
|
|
|
|
Losses
and loss adjustment expenses
|
|
428,051
|
|
400,542
|
|
Acquisition
expenses
|
|
117,624
|
|
126,458
|
|
Other
operating expenses
|
|
106,806
|
|
87,116
|
|
Interest
expense
|
|
7,260
|
|
5,712
|
|
Net
foreign exchange gains
|
|
(38,601
|
)
|
(25,205
|
)
|
Total
expenses
|
|
621,140
|
|
594,623
|
|
|
|
|
|
|
|
Income
before income taxes
|
|
223,747
|
|
155,820
|
|
|
|
|
|
|
|
Income
tax expense
|
|
6,753
|
|
9,490
|
|
|
|
|
|
|
|
Net
Income
|
|
216,994
|
|
146,330
|
|
|
|
|
|
|
|
Preferred
dividends
|
|
6,461
|
|
6,461
|
|
|
|
|
|
|
|
Net
income available to common shareholders
|
|
$
|
210,533
|
|
$
|
139,869
|
|
|
|
|
|
|
|
Net income per common share
|
|
|
|
|
|
Basic
|
|
$
|
3.97
|
|
$
|
2.32
|
|
Diluted
|
|
$
|
3.79
|
|
$
|
2.24
|
|
|
|
|
|
|
|
Weighted average common shares and common share
equivalents outstanding
|
|
|
|
|
|
Basic
|
|
53,039,026
|
|
60,313,550
|
|
Diluted
|
|
55,513,827
|
|
62,559,969
|
|
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,
|
|
|
|
2010
|
|
2009
|
|
Non-Cumulative Preferred Shares
|
|
|
|
|
|
Balance
at beginning and end of period
|
|
$
|
130
|
|
$
|
130
|
|
|
|
|
|
|
|
Common Shares
|
|
|
|
|
|
Balance
at beginning of year
|
|
548
|
|
605
|
|
Common
shares issued, net
|
|
4
|
|
|
|
Purchases
of common shares under share repurchase program
|
|
(25
|
)
|
(0
|
)
|
Balance
at end of period
|
|
527
|
|
605
|
|
|
|
|
|
|
|
Additional Paid-in Capital
|
|
|
|
|
|
Balance
at beginning of year
|
|
578,336
|
|
994,585
|
|
Common
shares issued
|
|
14
|
|
|
|
Exercise
of stock options
|
|
16,700
|
|
528
|
|
Common
shares retired
|
|
(181,350
|
)
|
(3,760
|
)
|
Amortization
of share-based compensation
|
|
7,096
|
|
4,318
|
|
Other
|
|
|
|
746
|
|
Balance
at end of period
|
|
420,796
|
|
996,417
|
|
|
|
|
|
|
|
Retained Earnings
|
|
|
|
|
|
Balance
at beginning of year
|
|
3,605,809
|
|
2,693,239
|
|
Cumulative
effect of change in accounting principle (1)
|
|
|
|
61,469
|
|
Balance
at beginning of year, as adjusted
|
|
3,605,809
|
|
2,754,708
|
|
Dividends
declared on preferred shares
|
|
(6,461
|
)
|
(6,461
|
)
|
Net
income
|
|
216,994
|
|
146,330
|
|
Balance
at end of period
|
|
3,816,342
|
|
2,894,577
|
|
|
|
|
|
|
|
Accumulated Other Comprehensive Income (Loss)
|
|
|
|
|
|
Balance
at beginning of year
|
|
138,526
|
|
(255,594
|
)
|
Cumulative
effect of change in accounting principle (1)
|
|
|
|
(61,469
|
)
|
Balance
at beginning of year, as adjusted
|
|
138,526
|
|
(317,063
|
)
|
Change
in unrealized appreciation in value of investments, net of deferred income
tax
|
|
5,240
|
|
119,277
|
|
Portion
of other-than-temporary impairment losses recognized in other comprehensive
income, net of deferred income tax
|
|
(730
|
)
|
(61,288
|
)
|
Foreign
currency translation adjustments, net of deferred income tax
|
|
(2,074
|
)
|
(2,259
|
)
|
Balance
at end of period
|
|
140,962
|
|
(261,333
|
)
|
|
|
|
|
|
|
Total
Shareholders Equity
|
|
$
|
4,378,757
|
|
$
|
3,630,396
|
|
(1) Adoption of accounting guidance regarding the recognition and
presentation of other-than-temporary impairments.
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,
|
|
|
|
2010
|
|
2009
|
|
Comprehensive Income
|
|
|
|
|
|
Net
income
|
|
$
|
216,994
|
|
$
|
146,330
|
|
Other
comprehensive income, net of deferred income tax
|
|
|
|
|
|
Unrealized
appreciation in value of investments:
|
|
|
|
|
|
Unrealized
holding gains arising during period
|
|
42,847
|
|
62,757
|
|
Portion
of other-than-temporary impairment losses recognized in other comprehensive
income, net of deferred income tax
|
|
(730
|
)
|
(61,288
|
)
|
Reclassification
of net realized (gains) losses, net of income taxes, included in net income
|
|
(37,607
|
)
|
56,520
|
|
Foreign
currency translation adjustments
|
|
(2,074
|
)
|
(2,259
|
)
|
Other
comprehensive income
|
|
2,436
|
|
55,730
|
|
Comprehensive
Income
|
|
$
|
219,430
|
|
$
|
202,060
|
|
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,
|
|
|
|
2010
|
|
2009
|
|
Operating Activities
|
|
|
|
|
|
Net
income
|
|
$
|
216,994
|
|
$
|
146,330
|
|
Adjustments
to reconcile net income to net cash provided by operating activities:
|
|
|
|
|
|
Net
realized (gains) losses
|
|
(49,483
|
)
|
5,620
|
|
Net
impairment losses recognized in earnings
|
|
1,606
|
|
36,134
|
|
Equity
in net (income) loss of investment funds accounted for using the equity
method and other income
|
|
(15,012
|
)
|
10,428
|
|
Share-based
compensation
|
|
7,096
|
|
4,318
|
|
Changes
in:
|
|
|
|
|
|
Reserve
for losses and loss adjustment expenses, net of unpaid losses and loss
adjustment expenses recoverable
|
|
91,247
|
|
83,763
|
|
Unearned
premiums, net of prepaid reinsurance premiums
|
|
96,645
|
|
120,867
|
|
Premiums
receivable
|
|
(116,571
|
)
|
(94,777
|
)
|
Deferred
acquisition costs, net
|
|
(19,655
|
)
|
(18,933
|
)
|
Reinsurance
balances payable
|
|
(36,669
|
)
|
11,278
|
|
Other
liabilities
|
|
41,448
|
|
2,802
|
|
Other
items, net
|
|
(33,023
|
)
|
(13,027
|
)
|
Net
Cash Provided By Operating Activities
|
|
184,623
|
|
294,803
|
|
|
|
|
|
|
|
Investing Activities
|
|
|
|
|
|
Purchases
of:
|
|
|
|
|
|
Fixed
maturity investments
|
|
(4,597,713
|
)
|
(3,037,132
|
)
|
Other
investments
|
|
(185,102
|
)
|
(22,670
|
)
|
Proceeds
from the sales of:
|
|
|
|
|
|
Fixed
maturity investments
|
|
4,443,108
|
|
2,782,462
|
|
Other
investments
|
|
101,235
|
|
24,027
|
|
Proceeds
from redemptions and maturities of fixed maturity investments
|
|
212,625
|
|
168,758
|
|
Net
purchases of short-term investments
|
|
(102,921
|
)
|
(204,924
|
)
|
Change
in investment of securities lending collateral
|
|
30,092
|
|
179,191
|
|
Purchases
of furniture, equipment and other assets
|
|
(1,803
|
)
|
(7,647
|
)
|
Net
Cash Used By Investing Activities
|
|
(100,479
|
)
|
(117,935
|
)
|
|
|
|
|
|
|
Financing Activities
|
|
|
|
|
|
Purchases
of common shares under share repurchase program
|
|
(181,272
|
)
|
(1,552
|
)
|
Proceeds
from common shares issued, net
|
|
10,591
|
|
(1,688
|
)
|
Proceeds
from borrowings
|
|
214,526
|
|
|
|
Repayments
of borrowings
|
|
(86,317
|
)
|
|
|
Change
in securities lending collateral
|
|
(30,092
|
)
|
(179,191
|
)
|
Other
|
|
5,061
|
|
742
|
|
Preferred
dividends paid
|
|
(6,461
|
)
|
(6,461
|
)
|
Net
Cash Used For Financing Activities
|
|
(73,964
|
)
|
(188,150
|
)
|
|
|
|
|
|
|
Effects
of exchange rate changes on foreign currency cash
|
|
(6,043
|
)
|
3,580
|
|
|
|
|
|
|
|
Increase
(decrease) in cash
|
|
4,137
|
|
(7,702
|
)
|
Cash
beginning of year
|
|
334,571
|
|
251,739
|
|
Cash
end of period
|
|
$
|
338,708
|
|
$
|
244,037
|
|
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,
2009, including the Companys audited consolidated financial statements and
related notes and the section entitled Risk Factors.
The Company has reclassified
the presentation of certain prior year information to conform to the current
presentation. Such reclassifications had no effect on the Companys net income,
shareholders equity or cash flows. Tabular amounts are in U.S. Dollars in
thousands, except share amounts, unless otherwise noted.
2. Recent Accounting Pronouncements
In March 2010,
the Financial Accounting Standards Board (FASB) issued an Accounting
Standards Update (ASU) that
clarifies the type of embedded credit derivative that is exempt from embedded
derivative bifurcation requirements. Only one form of embedded credit
derivative qualifies for the exemptionone that is related only to the
subordination of one financial instrument to another. As a result, entities
that have contracts containing an embedded credit derivative feature in a form
other than such subordination may need to separately account for the embedded
credit derivative feature. This ASU is effective at the beginning of the first
fiscal quarter beginning after June 15, 2010. The Company does not expect
the adoption of this ASU to have a material effect on the Companys
consolidated financial position or results of operations.
In February 2010, the FASB issued an ASU, which defers the
effective date of certain amendments to recent consolidation requirements
concerning variable interest entities (VIEs) relating to a reporting entitys
interest in certain types of entities (primarily investment funds) and
clarifies other aspects of the amendments. As a result of the deferral, a
reporting entity will not be required to apply the consolidation requirements
to its interest in an entity that meets the criteria to qualify for the
deferral. This ASU also clarifies how a related partys interests in an entity
should be considered when evaluating the criteria for determining whether a
decision maker or service provider fee represents a variable interest. In
addition, the ASU also clarifies that a quantitative calculation should not be
the sole basis for evaluating whether a decision makers or service providers
fee is a variable interest. The Company adopted the amended guidance on January 1,
2010, and its adoption did not have a material impact on the Companys
consolidated financial position or results of operations.
8
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
In January 2010,
the FASB issued an ASU to improve disclosure requirements related to fair value
measurements. The ASU requires more robust disclosures about (i) different
classes of assets and liabilities measured at fair value, (ii) the
valuation techniques and inputs to fair value measurements for both Levels 2
and 3, (iii) the activity within Level 3 fair value measurements (
i.e
., in the reconciliation for fair value measurements
using significant unobservable inputs activity should be presented on a gross
basis), and (iv) the transfers between Levels 1, 2 and 3, (
i.e
., include the reasons for significant transfers in and
out of Levels 1 and 2 ).The ASU is effective for interim and annual reporting
periods beginning after December 15, 2009, except for the disclosures
about purchases, sales, issuances, and settlements in the roll forward activity
in Level 3 fair value measurements, which will become effective for fiscal
years beginning after December 15, 2010. Accordingly, the Company adopted
the appropriate disclosure provisions of the ASU on January 1, 2010.
In June 2009, the
FASB issued amendments to the guidance regarding the consolidation of VIEs,
which affect all entities currently within the scope of the December 2003
revised version of the guidance, as well as qualifying special-purpose entities
that are currently excluded from the scope of the guidance. The amendments
require an analysis to determine whether a variable interest gives a company a
controlling financial interest in a VIE. In addition, they require an ongoing
reassessment of all VIEs and eliminate the quantitative approach previously
required for determining whether a company is the primary beneficiary. The
Company adopted the amended guidance on January 1, 2010, and its adoption
did not have a material impact on the Companys consolidated financial position
or results of operations.
In June 2009, the
FASB issued an amendment to the guidance regarding accounting for transfers of
financial assets. This amendment removes the concept of a qualifying
special-purpose entity from the guidance regarding the accounting for transfers
and servicing of financial assets and extinguishment of liabilities, and
removes the exception from applying to the consolidation of VIEs. This
amendment also clarifies the requirements for isolation and limitations on
portions of financial assets that are eligible for sale accounting and enhances
disclosures about transfers of financial assets and a transferors continuing
involvement with transferred financial assets. This amendment is effective
prospectively to transfers of financial assets occurring in fiscal years
beginning after November 15, 2009. The Company adopted this amendment on January 1,
2010 and its adoption did not have a material impact on the Companys
consolidated financial position or results of operations.
9
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
3. Share Transactions
Share
Repurchases
The board of
directors of ACGL has authorized the investment of up to $2.5 billion in ACGLs
common shares through a share repurchase program, consisting of a $1.0 billion
authorization in February 2007, a $500 million authorization in May 2008,
and a $1.0 billion authorization in November 2009. Repurchases under the
program may be effected from time to time in open market or privately
negotiated transactions through December 2011. Since the inception of the
share repurchase program, ACGL has repurchased approximately 24.5 million
common shares for an aggregate purchase price of $1.69 billion. During the 2010
first quarter, ACGL repurchased 2.5 million common shares for an aggregate
purchase price of $181.3 million, compared to a de minimis number of shares and
aggregate purchase price of $1.6 million during the 2009 period.
At March 31,
2010, approximately $810.1 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 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.
Non-Cumulative
Preferred Shares
ACGLs outstanding
non-cumulative preferred shares consist of $200.0 million principal amount of
8.0% series A non-cumulative preferred shares (Series A Preferred Shares)
and $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). 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. During the 2010 and 2009 first quarters, the Company paid
$6.5 million to holders of the Preferred Shares. At March 31, 2010, the
Company had declared an aggregate of $3.3 million of dividends to be paid to
holders of the Preferred Shares.
10
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
4. 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 2010 and 2009 first quarters,
interest expense on the Senior Notes was $5.5 million. The market value of the
Senior Notes at March 31, 2010 and December 31, 2009 was $300.8
million and $298.6 million, respectively.
Letter
of Credit and Revolving Credit Facilities
As of March 31,
2010, 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. The Credit Agreement and related documents are
structured such that each party that requests a letter of credit or borrowing
does so only for itself and for only its own obligations. 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
shareholders equity levels. The Company was in compliance with all covenants
contained in the Credit Agreement at March 31, 2010. The Credit Agreement
expires on August 30, 2011.
Including the
secured letter of credit portion of the Credit Agreement, the Company has
access to letter of credit facilities for up to a total of $1.45 billion. Arch
Reinsurance Ltd. (Arch Re Bermuda) also has access to other letter of credit
facilities, some of which are available on a limited basis and for limited
purposes (together with the secured portion of the Credit Agreement and these
letter of credit facilities, the LOC Facilities). 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,
2010. At such date, the
11
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Company had $777.8
million in outstanding letters of credit under the LOC Facilities, which were
secured by investments with a market value of $909.8 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.
TALF
Program
The Company
participates in the Federal Reserve Bank of New Yorks (FRBNY) Term
Asset-Backed Securities Loan Facility (TALF). TALF provides secured financing
for asset-backed securities backed by certain types of consumer and small
business loans and for legacy commercial mortgage-backed securities. TALF
financing is non-recourse to the Company, except in certain limited instances,
and is collateralized by the purchased securities and provides financing for
the purchase price of the securities, less a haircut that varies based on the
type of collateral. The Company can deliver the collateralized securities to a
special purpose vehicle created by the FRBNY in full defeasance of the
borrowings.
The Company
elected to carry the securities and related borrowings at fair value under the
fair value option afforded by accounting guidance regarding the fair value
option for financial assets and financial liabilities. As of March 31,
2010, the Company had $407.0 million of securities under TALF which are
reflected as TALF investments, at market value and $346.7 million of secured
financing from the FRBNY which is reflected as TALF borrowings, at market
value. As of December 31, 2009, the Company had $250.3 million of
securities under TALF which are reflected as TALF investments, at market value
and $217.6 million of secured financing from the FRBNY which is reflected as TALF
borrowings, at market value. The original maturity dates for the TALF
borrowings vary between 2 to 5 years with floating or fixed coupons depending
on the related TALF investments.
Interest
Paid
During the 2010
first quarter, the Company made interest payments of $1.8 million related to
its debt and financing arrangements, compared to $0.2 million for the 2009
first quarter.
12
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
5.
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
Chairman, 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 accounting guidance regarding 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. Specialty product
lines include: 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, employers liability and collateral protection
business).
The reinsurance
segment consists of the Companys reinsurance underwriting subsidiaries. The
reinsurance segment generally seeks to write significant lines on specialty
property and casualty reinsurance contracts. Classes of business include:
casualty; marine and aviation; other specialty; property catastrophe; property
excluding property catastrophe (losses on a single risk, both excess of loss
and pro rata); and other (consisting of non-traditional and casualty clash
business).
Corporate and
other (non-underwriting) includes net investment income, other 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, income taxes and dividends on the Companys
non-cumulative preferred shares.
13
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The following
tables set forth an analysis of the Companys underwriting income by segment,
together with a reconciliation of underwriting income to net income available
to common shareholders, summary information regarding net premiums written and
earned by major line of business and net premiums written by location:
|
|
Three Months Ended
|
|
|
|
March 31, 2010
|
|
|
|
Insurance
|
|
Reinsurance
|
|
Total
|
|
|
|
|
|
|
|
|
|
Gross
premiums written (1)
|
|
$
|
633,576
|
|
$
|
323,477
|
|
$
|
953,687
|
|
Net
premiums written (1)
|
|
452,924
|
|
314,830
|
|
767,754
|
|
|
|
|
|
|
|
|
|
Net
premiums earned (1)
|
|
429,477
|
|
240,440
|
|
669,917
|
|
Fee
income
|
|
753
|
|
41
|
|
794
|
|
Losses
and loss adjustment expenses
|
|
(312,011
|
)
|
(116,040
|
)
|
(428,051
|
)
|
Acquisition
expenses, net
|
|
(67,431
|
)
|
(50,193
|
)
|
(117,624
|
)
|
Other
operating expenses
|
|
(80,720
|
)
|
(20,398
|
)
|
(101,118
|
)
|
Underwriting
income (loss)
|
|
$
|
(29,932
|
)
|
$
|
53,850
|
|
23,918
|
|
|
|
|
|
|
|
|
|
Net investment
income
|
|
|
|
|
|
92,972
|
|
Net
realized gains
|
|
|
|
|
|
47,782
|
|
Net
impairment losses recognized in earnings
|
|
|
|
|
|
(1,606
|
)
|
Equity
in net income of investment funds accounted for using the equity method
|
|
|
|
|
|
29,050
|
|
Other
income
|
|
|
|
|
|
5,978
|
|
Other
expenses
|
|
|
|
|
|
(5,688
|
)
|
Interest
expense
|
|
|
|
|
|
(7,260
|
)
|
Net
foreign exchange gains
|
|
|
|
|
|
38,601
|
|
Income
before income taxes
|
|
|
|
|
|
223,747
|
|
Income
tax expense
|
|
|
|
|
|
(6,753
|
)
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
|
|
|
216,994
|
|
Preferred
dividends
|
|
|
|
|
|
(6,461
|
)
|
Net
income available to common shareholders
|
|
|
|
|
|
$
|
210,533
|
|
|
|
|
|
|
|
|
|
Underwriting Ratios
|
|
|
|
|
|
|
|
Loss
ratio
|
|
72.6
|
%
|
48.3
|
%
|
63.9
|
%
|
Acquisition
expense ratio (2)
|
|
15.5
|
%
|
20.9
|
%
|
17.4
|
%
|
Other
operating expense ratio
|
|
18.8
|
%
|
8.5
|
%
|
15.1
|
%
|
Combined
ratio
|
|
106.9
|
%
|
77.7
|
%
|
96.4
|
%
|
(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 $3.4 million, respectively, of gross and net
premiums written and $0.3 million and $3.5 million, respectively, of net
premiums earned assumed through intersegment transactions.
(2)
The acquisition expense ratio is adjusted to include
policy-related fee income.
14
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
Three Months Ended
|
|
|
|
March 31, 2009
|
|
|
|
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 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.
15
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2010
|
|
2009
|
|
INSURANCE
SEGMENT
|
|
Amount
|
|
% of Total
|
|
Amount
|
|
% of Total
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums written (1)
|
|
|
|
|
|
|
|
|
|
Property,
energy, marine and aviation
|
|
$
|
100,665
|
|
22.2
|
|
$
|
106,029
|
|
24.0
|
|
Programs
|
|
70,498
|
|
15.6
|
|
74,807
|
|
16.9
|
|
Executive
assurance
|
|
61,355
|
|
13.5
|
|
50,079
|
|
11.3
|
|
Professional
liability
|
|
58,726
|
|
13.0
|
|
52,008
|
|
11.8
|
|
Construction
|
|
36,322
|
|
8.0
|
|
36,571
|
|
8.3
|
|
National
accounts casualty
|
|
30,809
|
|
6.8
|
|
24,227
|
|
5.5
|
|
Casualty
|
|
25,463
|
|
5.6
|
|
26,539
|
|
6.0
|
|
Travel
and accident
|
|
21,806
|
|
4.8
|
|
17,534
|
|
4.0
|
|
Surety
|
|
8,091
|
|
1.8
|
|
11,358
|
|
2.6
|
|
Healthcare
|
|
8,524
|
|
1.9
|
|
11,219
|
|
2.5
|
|
Other
(2)
|
|
30,665
|
|
6.8
|
|
31,215
|
|
7.1
|
|
Total
|
|
$
|
452,924
|
|
100.0
|
|
$
|
441,586
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums earned (1)
|
|
|
|
|
|
|
|
|
|
Property,
energy, marine and aviation
|
|
$
|
95,037
|
|
22.1
|
|
$
|
73,840
|
|
18.4
|
|
Programs
|
|
66,159
|
|
15.4
|
|
66,669
|
|
16.6
|
|
Executive
assurance
|
|
56,322
|
|
13.1
|
|
47,816
|
|
11.9
|
|
Professional
liability
|
|
62,245
|
|
14.5
|
|
58,234
|
|
14.5
|
|
Construction
|
|
34,485
|
|
8.0
|
|
40,420
|
|
10.1
|
|
National
accounts casualty
|
|
21,773
|
|
5.1
|
|
14,439
|
|
3.6
|
|
Casualty
|
|
28,069
|
|
6.5
|
|
32,698
|
|
8.2
|
|
Travel
and accident
|
|
16,078
|
|
3.7
|
|
13,156
|
|
3.3
|
|
Surety
|
|
10,258
|
|
2.4
|
|
13,391
|
|
3.3
|
|
Healthcare
|
|
9,943
|
|
2.3
|
|
10,928
|
|
2.7
|
|
Other
(2)
|
|
29,108
|
|
6.9
|
|
29,506
|
|
7.4
|
|
Total
|
|
$
|
429,477
|
|
100.0
|
|
$
|
401,097
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums written by client location (1)
|
|
|
|
|
|
|
|
|
|
United
States
|
|
$
|
303,168
|
|
66.9
|
|
$
|
317,044
|
|
71.8
|
|
Europe
|
|
102,489
|
|
22.6
|
|
92,396
|
|
20.9
|
|
Other
|
|
47,267
|
|
10.5
|
|
32,146
|
|
7.3
|
|
Total
|
|
$
|
452,924
|
|
100.0
|
|
$
|
441,586
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums written by underwriting location
(1)
|
|
|
|
|
|
|
|
|
|
United
States
|
|
$
|
302,437
|
|
66.8
|
|
$
|
320,829
|
|
72.7
|
|
Europe
|
|
133,739
|
|
29.5
|
|
105,313
|
|
23.8
|
|
Other
|
|
16,748
|
|
3.7
|
|
15,444
|
|
3.5
|
|
Total
|
|
$
|
452,924
|
|
100.0
|
|
$
|
441,586
|
|
100.0
|
|
(1)
Insurance segment results include premiums written and
earned assumed through intersegment transactions of nil and $0.3 million,
respectively, for the 2010 first quarter and premiums written and earned of $0.1
million and $0.5 million, respectively, for the 2009 first quarter. Insurance
segment results exclude premiums written and earned ceded through intersegment
transactions of $3.4 million and $3.5 million, respectively, for the 2010 first
quarter and premiums written and earned of $3.5 million and $4.7 million,
respectively, for the 2009 first quarter.
(2)
Includes excess workers compensation, employers
liability, and collateral protection business.
16
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2010
|
|
2009
|
|
REINSURANCE
SEGMENT
|
|
Amount
|
|
% of Total
|
|
Amount
|
|
% of Total
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums written (1)
|
|
|
|
|
|
|
|
|
|
Property
catastrophe
|
|
$
|
88,802
|
|
28.2
|
|
$
|
91,903
|
|
24.1
|
|
Property
excluding property catastrophe (2)
|
|
74,927
|
|
23.8
|
|
119,088
|
|
31.2
|
|
Casualty
(3)
|
|
72,582
|
|
23.1
|
|
99,432
|
|
26.1
|
|
Other
specialty
|
|
54,762
|
|
17.4
|
|
40,712
|
|
10.7
|
|
Marine
and aviation
|
|
21,238
|
|
6.7
|
|
28,523
|
|
7.5
|
|
Other
|
|
2,519
|
|
0.8
|
|
1,619
|
|
0.4
|
|
Total
|
|
$
|
314,830
|
|
100.0
|
|
$
|
381,277
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums earned (1)
|
|
|
|
|
|
|
|
|
|
Property
catastrophe
|
|
$
|
53,873
|
|
22.4
|
|
$
|
58,601
|
|
19.6
|
|
Property
excluding property catastrophe (2)
|
|
79,239
|
|
33.0
|
|
96,231
|
|
32.1
|
|
Casualty
(3)
|
|
70,436
|
|
29.3
|
|
85,946
|
|
28.7
|
|
Other
specialty
|
|
17,769
|
|
7.4
|
|
33,450
|
|
11.2
|
|
Marine
and aviation
|
|
18,072
|
|
7.5
|
|
24,830
|
|
8.3
|
|
Other
|
|
1,051
|
|
0.4
|
|
409
|
|
0.1
|
|
Total
|
|
$
|
240,440
|
|
100.0
|
|
$
|
299,467
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums written (1)
|
|
|
|
|
|
|
|
|
|
Pro
rata
|
|
$
|
118,037
|
|
37.5
|
|
$
|
181,222
|
|
47.5
|
|
Excess
of loss
|
|
196,793
|
|
62.5
|
|
200,055
|
|
52.5
|
|
Total
|
|
$
|
314,830
|
|
100.0
|
|
$
|
381,277
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums earned (1)
|
|
|
|
|
|
|
|
|
|
Pro
rata
|
|
$
|
130,871
|
|
54.4
|
|
$
|
194,518
|
|
65.0
|
|
Excess
of loss
|
|
109,569
|
|
45.6
|
|
104,949
|
|
35.0
|
|
Total
|
|
$
|
240,440
|
|
100.0
|
|
$
|
299,467
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums written by client location (1)
|
|
|
|
|
|
|
|
|
|
United
States
|
|
$
|
171,001
|
|
54.3
|
|
$
|
229,968
|
|
60.3
|
|
Europe
|
|
107,142
|
|
34.0
|
|
101,501
|
|
26.6
|
|
Bermuda
|
|
22,675
|
|
7.2
|
|
37,567
|
|
9.9
|
|
Other
|
|
14,012
|
|
4.5
|
|
12,241
|
|
3.2
|
|
Total
|
|
$
|
314,830
|
|
100.0
|
|
$
|
381,277
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums written by underwriting location
(1)
|
|
|
|
|
|
|
|
|
|
Bermuda
|
|
$
|
164,934
|
|
52.4
|
|
$
|
195,600
|
|
51.3
|
|
United
States
|
|
103,726
|
|
32.9
|
|
146,193
|
|
38.3
|
|
Other
|
|
46,170
|
|
14.7
|
|
39,484
|
|
10.4
|
|
Total
|
|
$
|
314,830
|
|
100.0
|
|
$
|
381,277
|
|
100.0
|
|
(1)
Reinsurance segment results include premiums written
and earned assumed through intersegment transactions of $3.4 million and $3.5
million, respectively, for the 2010 first quarter and premiums written and
earned of $3.5 million and $4.7 million, respectively, for the 2009 first
quarter. Reinsurance segment results exclude premiums written and earned ceded
through intersegment transactions of nil and $0.3 million, respectively, for
the 2010 first quarter and premiums written and earned of $0.1 million and $0.5
million, respectively, for the 2009 first quarter.
(2)
Includes facultative business.
(3)
Includes professional liability, executive assurance
and healthcare business.
17
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
6. Reinsurance
In the normal
course of business, the Companys insurance subsidiaries cede a 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,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Premiums Written
|
|
|
|
|
|
Direct
|
|
$
|
617,935
|
|
$
|
620,446
|
|
Assumed
|
|
335,752
|
|
404,525
|
|
Ceded
|
|
(185,933
|
)
|
(202,108
|
)
|
Net
|
|
$
|
767,754
|
|
$
|
822,863
|
|
|
|
|
|
|
|
Premiums Earned
|
|
|
|
|
|
Direct
|
|
$
|
600,645
|
|
$
|
587,760
|
|
Assumed
|
|
262,535
|
|
332,567
|
|
Ceded
|
|
(193,263
|
)
|
(219,763
|
)
|
Net
|
|
$
|
669,917
|
|
$
|
700,564
|
|
|
|
|
|
|
|
Losses and Loss Adjustment Expenses
|
|
|
|
|
|
Direct
|
|
$
|
398,951
|
|
$
|
351,493
|
|
Assumed
|
|
107,167
|
|
147,145
|
|
Ceded
|
|
(78,067
|
)
|
(98,096
|
)
|
Net
|
|
$
|
428,051
|
|
$
|
400,542
|
|
The Company
monitors the financial condition of its reinsurers and attempts to place
coverages only with substantial, financially sound carriers. At March 31,
2010, approximately 90.2% of the Companys reinsurance recoverables on paid and
unpaid losses (not including prepaid reinsurance premiums) of $1.71 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 5.5% of
the Companys total shareholders equity. At December 31, 2009,
approximately 90.0% of the Companys reinsurance recoverables on paid and
unpaid losses (not including prepaid reinsurance premiums) of $1.72 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 5.8% of
the Companys total shareholders equity.
18
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,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Fixed
maturities available for sale, at market value
|
|
$
|
9,295,680
|
|
$
|
9,391,926
|
|
Fixed
maturities pledged under securities lending agreements, at market value (1)
|
|
181,871
|
|
208,826
|
|
Total
fixed maturities
|
|
9,477,551
|
|
9,600,752
|
|
Short-term
investments available for sale, at market value
|
|
669,798
|
|
571,489
|
|
Short-term
investments pledged under securities lending agreements, at market value (1)
|
|
2,350
|
|
3,994
|
|
TALF
investments, at market value
|
|
406,997
|
|
250,265
|
|
Other
investments
|
|
263,608
|
|
172,172
|
|
Investment
funds accounted for using the equity method
|
|
405,584
|
|
391,869
|
|
Total
investments (1)
|
|
11,225,888
|
|
10,990,541
|
|
Securities
transactions entered into but not settled at the balance sheet date
|
|
(2,444
|
)
|
50,790
|
|
Total
investments, net of securities transactions
|
|
$
|
11,223,444
|
|
$
|
11,041,331
|
|
(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 and reinvested of $178.0 million and $207.0 million at March 31,
2010 and December 31, 2009, respectively, and included the $184.2 million
and $212.8 million, respectively, of fixed maturities and short-term
investments pledged under securities lending agreements, at market value.
19
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, excluding TALF investments:
|
|
Estimated
|
|
Gross
|
|
Gross
|
|
|
|
OTTI
|
|
|
|
Market
|
|
Unrealized
|
|
Unrealized
|
|
Amortized
|
|
Unrealized
|
|
|
|
Value
|
|
Gains
|
|
Losses
|
|
Cost
|
|
Losses (1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2010:
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
$
|
2,929,992
|
|
$
|
94,809
|
|
$
|
(14,477
|
)
|
$
|
2,849,660
|
|
$
|
(19,073
|
)
|
Mortgage
backed securities
|
|
1,850,700
|
|
20,840
|
|
(36,172
|
)
|
1,866,032
|
|
(44,164
|
)
|
U.S.
government and government agencies
|
|
1,435,477
|
|
10,288
|
|
(5,828
|
)
|
1,431,017
|
|
(492
|
)
|
Commercial
mortgage backed securities
|
|
1,073,487
|
|
37,040
|
|
(8,890
|
)
|
1,045,337
|
|
(3,750
|
)
|
Municipal
bonds
|
|
873,272
|
|
37,032
|
|
(2,168
|
)
|
838,408
|
|
(130
|
)
|
Non-U.S.
government securities
|
|
719,697
|
|
29,759
|
|
(11,664
|
)
|
701,602
|
|
(351
|
)
|
Asset
backed securities
|
|
594,926
|
|
21,809
|
|
(5,519
|
)
|
578,636
|
|
(4,662
|
)
|
Total
|
|
$
|
9,477,551
|
|
$
|
251,577
|
|
$
|
(84,718
|
)
|
$
|
9,310,692
|
|
$
|
(72,622
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
$
|
3,134,088
|
|
$
|
99,446
|
|
$
|
(12,983
|
)
|
$
|
3,047,625
|
|
$
|
(19,667
|
)
|
Mortgage
backed securities
|
|
1,449,382
|
|
13,158
|
|
(45,536
|
)
|
1,481,760
|
|
(43,930
|
)
|
U.S.
government and government agencies
|
|
1,553,672
|
|
8,716
|
|
(12,999
|
)
|
1,557,955
|
|
(499
|
)
|
Commercial
mortgage backed securities
|
|
1,185,799
|
|
35,161
|
|
(11,724
|
)
|
1,162,362
|
|
(3,750
|
)
|
Municipal
bonds
|
|
957,752
|
|
44,043
|
|
(2,284
|
)
|
915,993
|
|
(145
|
)
|
Non-U.S.
government securities
|
|
752,215
|
|
41,858
|
|
(7,712
|
)
|
718,069
|
|
(351
|
)
|
Asset
backed securities
|
|
567,844
|
|
21,713
|
|
(8,220
|
)
|
554,351
|
|
(6,111
|
)
|
Total
|
|
$
|
9,600,752
|
|
$
|
264,095
|
|
$
|
(101,458
|
)
|
$
|
9,438,115
|
|
$
|
(74,453
|
)
|
(1)
Represents the total other-than-temporary
impairments (OTTI) recognized in accumulated other comprehensive income (AOCI).
It does not include the change in market value subsequent to the impairment
measurement date. At March 31, 2010, the net unrealized loss related to
securities for which a non-credit OTTI was recognized in AOCI was $24.8
million, compared to $37.9 million at December 31, 2009.
20
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
|
|
|
|
Estimated
|
|
Gross
|
|
Estimated
|
|
Gross
|
|
Estimated
|
|
Gross
|
|
|
|
Market
|
|
Unrealized
|
|
Market
|
|
Unrealized
|
|
Market
|
|
Unrealized
|
|
|
|
Value
|
|
Losses
|
|
Value
|
|
Losses
|
|
Value
|
|
Losses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2010:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
$
|
609,246
|
|
$
|
(12,137
|
)
|
$
|
38,333
|
|
$
|
(2,340
|
)
|
$
|
647,579
|
|
$
|
(14,477
|
)
|
Mortgage
backed securities
|
|
587,249
|
|
(26,187
|
)
|
64,912
|
|
(9,985
|
)
|
652,161
|
|
(36,172
|
)
|
U.S.
government and government agencies
|
|
786,526
|
|
(5,815
|
)
|
141
|
|
(13
|
)
|
786,667
|
|
(5,828
|
)
|
Commercial
mortgage backed securities
|
|
60,979
|
|
(490
|
)
|
72,292
|
|
(8,400
|
)
|
133,271
|
|
(8,890
|
)
|
Municipal
bonds
|
|
186,073
|
|
(2,168
|
)
|
|
|
|
|
186,073
|
|
(2,168
|
)
|
Non-U.S.
government securities
|
|
264,398
|
|
(11,664
|
)
|
|
|
|
|
264,398
|
|
(11,664
|
)
|
Asset
backed securities
|
|
50,580
|
|
(2,020
|
)
|
23,010
|
|
(3,499
|
)
|
73,590
|
|
(5,519
|
)
|
|
|
2,545,051
|
|
(60,481
|
)
|
198,688
|
|
(24,237
|
)
|
2,743,739
|
|
(84,718
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
investments
|
|
3,086
|
|
(402
|
)
|
31,310
|
|
(3,325
|
)
|
34,396
|
|
(3,727
|
)
|
Short-term
investments
|
|
54,202
|
|
(3,227
|
)
|
|
|
|
|
54,202
|
|
(3,227
|
)
|
Total
|
|
$
|
2,602,339
|
|
$
|
(64,110
|
)
|
$
|
229,998
|
|
$
|
(27,562
|
)
|
$
|
2,832,337
|
|
$
|
(91,672
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
$
|
547,376
|
|
$
|
(7,742
|
)
|
$
|
45,399
|
|
$
|
(5,241
|
)
|
$
|
592,775
|
|
$
|
(12,983
|
)
|
Mortgage
backed securities
|
|
636,817
|
|
(33,388
|
)
|
62,382
|
|
(12,148
|
)
|
699,199
|
|
(45,536
|
)
|
U.S.
government and government agencies
|
|
1,112,534
|
|
(12,510
|
)
|
5,309
|
|
(489
|
)
|
1,117,843
|
|
(12,999
|
)
|
Commercial
mortgage backed securities
|
|
154,087
|
|
(4,808
|
)
|
67,744
|
|
(6,916
|
)
|
221,831
|
|
(11,724
|
)
|
Municipal
bonds
|
|
151,412
|
|
(2,284
|
)
|
|
|
|
|
151,412
|
|
(2,284
|
)
|
Non-U.S.
government securities
|
|
218,394
|
|
(7,712
|
)
|
|
|
|
|
218,394
|
|
(7,712
|
)
|
Asset
backed securities
|
|
101,679
|
|
(5,838
|
)
|
22,915
|
|
(2,382
|
)
|
124,594
|
|
(8,220
|
)
|
|
|
2,922,299
|
|
(74,282
|
)
|
203,749
|
|
(27,176
|
)
|
3,126,048
|
|
(101,458
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
investments
|
|
9,071
|
|
(304
|
)
|
29,439
|
|
(5,195
|
)
|
38,510
|
|
(5,499
|
)
|
Short-term
investments
|
|
64,616
|
|
(1,858
|
)
|
|
|
|
|
64,616
|
|
(1,858
|
)
|
Total
|
|
$
|
2,995,986
|
|
$
|
(76,444
|
)
|
$
|
233,188
|
|
$
|
(32,371
|
)
|
$
|
3,229,174
|
|
$
|
(108,815
|
)
|
21
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The contractual
maturities of the Companys fixed maturities and fixed maturities pledged under
securities lending agreements are shown in the following table. 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, 2010
|
|
December 31, 2009
|
|
|
|
Estimated
|
|
Amortized
|
|
Estimated
|
|
Amortized
|
|
Maturity
|
|
Market Value
|
|
Cost
|
|
Market Value
|
|
Cost
|
|
|
|
|
|
|
|
|
|
|
|
Due
in one year or less
|
|
$
|
226,299
|
|
$
|
229,882
|
|
$
|
227,668
|
|
$
|
220,095
|
|
Due
after one year through five years
|
|
3,603,876
|
|
3,505,794
|
|
3,988,306
|
|
3,885,111
|
|
Due
after five years through 10 years
|
|
1,873,249
|
|
1,835,942
|
|
1,844,377
|
|
1,800,371
|
|
Due
after 10 years
|
|
255,014
|
|
249,069
|
|
337,376
|
|
334,065
|
|
|
|
5,958,438
|
|
5,820,687
|
|
6,397,727
|
|
6,239,642
|
|
Mortgage
backed securities
|
|
1,850,700
|
|
1,866,032
|
|
1,449,382
|
|
1,481,760
|
|
Commercial
mortgage backed securities
|
|
1,073,487
|
|
1,045,337
|
|
1,185,799
|
|
1,162,362
|
|
Asset
backed securities
|
|
594,926
|
|
578,636
|
|
567,844
|
|
554,351
|
|
Total
|
|
$
|
9,477,551
|
|
$
|
9,310,692
|
|
$
|
9,600,752
|
|
$
|
9,438,115
|
|
At March 31, 2010,
on a lot level basis, approximately 1,120 security lots out of a total of
approximately 4,810 security lots were in an unrealized loss position and the
largest single unrealized loss from a single lot in the Companys fixed
maturity portfolio was $2.1 million. At December 31, 2009, on a lot level
basis, approximately 1,430 security lots out of a total of approximately 4,520
security lots were in an unrealized loss position and the largest single
unrealized loss from a single lot in the Companys fixed maturity portfolio was
$2.2 million.
Other-Than-Temporary Impairments
The Company
performs quarterly reviews of its investments in order to determine whether
declines in market value below the amortized cost basis were considered
other-than-temporary in accordance with applicable guidance. For the 2010 first
quarter and 2009 first quarter, the Company recorded $1.6 million and $36.1
million of net impairment losses recognized in earnings, respectively. A
description of the methodology and significant inputs used to measure the
amount of OTTI related to credit losses of $1.6 million in the 2010 first
quarter is as follows:
·
Asset
backed securities the Company recorded $1.2 million of OTTI related to credit
losses in the 2010 first quarter. The Company utilized underlying data, where
available, for each security provided by asset managers, cash flow projections
and additional information from credit agencies in order to determine an
expected recovery value for each security. The analysis 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 and foreclosure
costs. In the 2010 first quarter, the expected recovery values were reduced on
a number of asset backed securities backed by sub-prime or Alt-A collateral due
to reductions in the expected recovery values on such securities. These
reductions followed the quarterly review of information received which
indicated increases in expected default rates, foreclosure costs and other
factors. 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 used reports and analysis from
asset managers and rating agencies in order to determine an
22
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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;
·
Mortgage
backed securities the Company recorded $0.4 million of OTTI related to credit
losses in the 2010 first quarter. The Company utilized underlying data, where
available, for each security provided by asset managers, cash flow projections
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 and foreclosure costs. In
the 2010 first quarter, the expected recovery values were reduced on a number
of mortgage backed securities due to reductions in the expected recovery values
on such securities in each period. These reductions followed the quarterly
review of information received which indicated increases in expected default
expectations and foreclosure costs. 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;
The Company
believes that the $0.7 million of OTTI included in accumulated other
comprehensive income at March 31, 2010 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 (
i.e.
, not credit losses). At March 31, 2010, the
Company did not have the intent to sell such securities, and determined that it
is more likely than not that the Company will not be required to sell the
securities before recovery of their cost basis.
The following
table provides a roll forward of the amount related to credit losses recognized
in earnings for which a portion of an OTTI was recognized in accumulated other
comprehensive income:
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Balance
at start of year
|
|
$
|
84,147
|
|
$
|
35,474
|
|
Credit
loss impairments recognized on securities not previously impaired
|
|
204
|
|
12,647
|
|
Credit
loss impairments recognized on securities previously impaired
|
|
1,402
|
|
9,135
|
|
Reductions
for increases in cash flows expected to be collected that are recognized over
the remaining life of the security
|
|
|
|
|
|
Reductions
for securities sold during the period
|
|
(265
|
)
|
|
|
Balance
at end of period
|
|
$
|
85,488
|
|
$
|
57,256
|
|
23
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Securities Lending Agreements
At March 31,
2010, the market value and amortized cost of fixed maturities and short-term
investments pledged under securities lending agreements were $184.2 million and
$184.0 million, respectively. At December 31, 2009, the market value and
amortized cost of fixed maturities and short-term investments pledged under
securities lending agreements were $212.8 million and $214.7 million,
respectively.
At March 31,
2010, the market value and amortized cost of the reinvested collateral, shown
as Investment of funds received under securities lending agreements, totaled
$178.0 million and $182.3 million, respectively. At December 31, 2009, the
market value and amortized cost of the reinvested collateral shown as Investment
of funds received under securities lending agreements totaled $91.2 million
and $96.6 million, respectively, while Securities purchased under agreements
to resell using funds received under securities lending agreements totaled
$115.8 million.
TALF Program
As of March 31,
2010, the Company had $407.0 million of securities under TALF which are
reflected as TALF investments, at market value and $346.7 million of secured
financing from the FRBNY which is reflected as TALF borrowings, at market
value. As of December 31, 2009, the Company had $250.3 million of TALF
investments, at market value, and $217.6 million of TALF borrowings, at market
value. Changes in market value for both the securities and borrowings are
included in Net realized gains (losses) while interest income on the TALF
investments is reflected in net investment income and interest expense on the
TALF borrowings is reflected in interest expense. The Company recorded net
realized gains for the 2010 first quarter of $2.6 million on the TALF program,
consisting of realized gains of $3.6 million and realized losses of $1.0 of
million on the TALF investments and TALF borrowings, respectively. See Note 4, Debt
and Financing ArrangementsTALF Program, for further details.
Other
Investments
Other investments
include: (i) mutual funds which invest in fixed maturity securities and (ii) privately
held securities, equities and other which include the Companys investment in
Aeolus LP (see Note 12), an equity portfolio which includes allocations to
global natural resource markets and a mutual fund which invests in equities,
fixed income, commodities and property as part of a total return objective. The
Company elected to carry the equity portfolio at fair value under the fair
value option afforded by accounting guidance regarding the fair value option
for financial assets and financial liabilities.
The following table
details the Companys other investments:
|
|
March 31, 2010
|
|
December 31, 2009
|
|
|
|
Estimated
|
|
|
|
Estimated
|
|
|
|
|
|
Market Value
|
|
Cost
|
|
Market Value
|
|
Cost
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
income mutual funds
|
|
$
|
70,204
|
|
$
|
65,264
|
|
$
|
63,146
|
|
$
|
60,571
|
|
Privately
held securities, equities and other
|
|
193,404
|
|
186,653
|
|
109,026
|
|
101,934
|
|
Total
|
|
$
|
263,608
|
|
$
|
251,917
|
|
$
|
172,172
|
|
$
|
162,505
|
|
24
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Investment Funds Accounted for Using the Equity Method
The Company
recorded $29.1 million of equity in net income related to investment funds
accounted for using the equity method for the 2010 first quarter, compared to
$9.6 million of equity in net losses for the 2009 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 $405.6 million at March 31, 2010, compared
to $391.9 million at December 31, 2009. The Companys investment
commitments relating to investment funds accounted for using the equity method
totaled approximately $95.0 million at March 31, 2010.
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 4, Debt and Financing ArrangementsLetter of
Credit and Revolving Credit Facilities, for further details. In addition, the
Company maintains assets on deposit which are available to settle insurance and
reinsurance liabilities to third parties. 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,
2010 and December 31, 2009, such amounts approximated $4.30 billion and
$4.28 billion, respectively. The following table details the value of
restricted assets:
|
|
March 31,
|
|
December 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Assets
used for collateral or guarantees
|
|
$
|
1,021,470
|
|
$
|
1,017,482
|
|
Deposits
with U.S. regulatory authorities
|
|
285,883
|
|
279,136
|
|
Trust
funds
|
|
113,961
|
|
115,585
|
|
Deposits
with non-U.S. regulatory authorities
|
|
87,205
|
|
76,094
|
|
Total
restricted assets
|
|
$
|
1,508,519
|
|
$
|
1,488,297
|
|
25
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Net Investment Income
The components of
net investment income were derived from the following sources:
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Fixed
maturities
|
|
$
|
97,661
|
|
$
|
96,958
|
|
Short-term
investments
|
|
230
|
|
1,240
|
|
Other
(1)
|
|
485
|
|
1,565
|
|
Gross
investment income
|
|
98,376
|
|
99,763
|
|
Investment
expenses
|
|
(5,404
|
)
|
(3,881
|
)
|
Net
investment income
|
|
$
|
92,972
|
|
$
|
95,882
|
|
(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,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Fixed
maturities
|
|
$
|
40,215
|
|
$
|
6,170
|
|
Other
investments
|
|
(700
|
)
|
(18,586
|
)
|
Other
(1)
|
|
8,267
|
|
7,252
|
|
Net
realized gains (losses)
|
|
$
|
47,782
|
|
$
|
(5,164
|
)
|
(1) Primarily
consists of net realized gains or losses related to investment-related
derivatives, foreign currency forward contracts and changes in the market value
of TALF investments and TALF borrowings.
Proceeds from the
sales of fixed maturities during the 2010 first quarter were $4.44 billion,
compared to $2.78 billion for the 2009 first quarter. Gross gains of $60.8
million and $71.6 million were realized on those transactions during the 2010
first quarter and 2009 first quarter, respectively, while gross losses were
$20.6 million and $65.4 million, respectively. Realized gains or losses on
fixed maturities include changes in the market value of certain hybrid
securities pursuant to applicable guidance. The fair market values of such
securities at March 31, 2010 were approximately $93.3 million, compared to
$84.8 million at December 31, 2009. The Company recorded realized losses
of $1.3 million on such securities for the 2010 first quarter, compared to
realized gains of $4.0 million for the 2009 first quarter.
26
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
8. Fair Value
Accounting guidance
regarding fair value measurements 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. It 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. In addition, it
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
determines the existence of an active market based on its judgment as to
whether transactions for the financial instrument occur in such market with
sufficient frequency and volume to provide reliable pricing information. The
independent pricing sources obtain market quotations and actual transaction
prices for securities that have quoted prices in active markets. 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; (v) a comparison of the pricing services fair
values to other pricing services fair values for the same investments; and (vi) back-testing,
which includes randomly selecting purchased or sold securities and comparing
the executed prices to the fair value estimates from the pricing service. At March 31,
2010, the Company obtained an average of 3.0 quotes per investment, compared to
2.6 quotes at December 31, 2009. Where multiple quotes or prices were
obtained, a price source hierarchy was maintained in order to determine which
price source provided the fair value (i.e., a price obtained from a pricing
service with more seniority in the hierarchy will be used from a less senior
one in all cases). The hierarchy prioritizes pricing services based on
availability and reliability and assigns the highest priority to index
providers. Based on the above review, the Company will challenge any prices for
a security or portfolio which are considered not to be representative of fair
value. The Company did not adjust the prices or quotes provided by the pricing
services at March 31, 2010 or December 31, 2009.
27
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 $11.1 billion of
financial assets and liabilities measured at fair value at March 31, 2010,
approximately $1.62 billion, or 14.6%, were priced using non-binding
broker-dealer quotes. Of the $10.74 billion of financial assets and liabilities
measured at fair value at December 31, 2009, approximately $1.17 billion,
or 10.8%, were priced using non-binding broker-dealer quotes.
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 the accounting guidance regarding fair value measurement, 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. On January 1, 2010, the Company determined that all U.S.
Treasuries would be classified as Level 1 securities due to observed levels of
trading activity, the high number of strongly correlated pricing quotes
received on U.S. Treasuries and other factors.
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, non-U.S. government securities, TALF
investments and TALF borrowings, 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. The Company reviews the classification
of its investments each quarter.
28
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 level:
|
|
|
|
Fair Value Measurement Using:
|
|
|
|
Estimated
Market
|
|
Quoted Prices
in Active
Markets for
Identical Assets
|
|
Significant
Other
Observable
Inputs
|
|
Significant
Unobservable
Inputs
|
|
|
|
Value
|
|
(Level 1)
|
|
(Level 2)
|
|
(Level 3)
|
|
March 31, 2010:
|
|
|
|
|
|
|
|
|
|
Assets
measured at fair value:
|
|
|
|
|
|
|
|
|
|
Fixed
maturities: (1)
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
$
|
2,929,992
|
|
$
|
|
|
$
|
2,752,318
|
|
$
|
177,674
|
|
Mortgage
backed securities
|
|
1,850,700
|
|
|
|
1,850,700
|
|
|
|
U.S.
government and government agencies
|
|
1,435,477
|
|
1,435,477
|
|
|
|
|
|
Commercial
mortgage backed securities
|
|
1,073,487
|
|
|
|
1,073,487
|
|
|
|
Municipal
bonds
|
|
873,272
|
|
|
|
873,272
|
|
|
|
Non-U.S.
government securities
|
|
719,697
|
|
|
|
719,697
|
|
|
|
Asset
backed securities
|
|
594,926
|
|
|
|
594,926
|
|
|
|
Total
|
|
9,477,551
|
|
1,435,477
|
|
7,864,400
|
|
177,674
|
|
|
|
|
|
|
|
|
|
|
|
Short-term
investments (1)
|
|
672,148
|
|
607,617
|
|
64,531
|
|
|
|
TALF
investments, at market value
|
|
406,997
|
|
|
|
406,997
|
|
|
|
Other
investments
|
|
201,595
|
|
76,334
|
|
73,774
|
|
51,487
|
|
Total
assets measured at fair value
|
|
$
|
10,758,291
|
|
$
|
2,119,428
|
|
$
|
8,409,702
|
|
$
|
229,161
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
measured at fair value:
|
|
|
|
|
|
|
|
|
|
TALF
borrowings, at market value
|
|
$
|
346,746
|
|
$
|
|
|
$
|
346,746
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2009:
|
|
|
|
|
|
|
|
|
|
Assets
measured at fair value:
|
|
|
|
|
|
|
|
|
|
Fixed
maturities: (1)
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
$
|
3,134,088
|
|
$
|
|
|
$
|
2,955,703
|
|
$
|
178,385
|
|
Mortgage
backed securities
|
|
1,449,382
|
|
|
|
1,449,382
|
|
|
|
U.S.
government and government agencies
|
|
1,553,672
|
|
466,779
|
|
1,086,893
|
|
|
|
Commercial
mortgage backed securities
|
|
1,185,799
|
|
|
|
1,185,799
|
|
|
|
Municipal
bonds
|
|
957,752
|
|
|
|
957,752
|
|
|
|
Non-U.S.
government securities
|
|
752,215
|
|
|
|
752,215
|
|
|
|
Asset
backed securities
|
|
567,844
|
|
|
|
567,844
|
|
|
|
Total
|
|
9,600,752
|
|
466,779
|
|
8,955,588
|
|
178,385
|
|
|
|
|
|
|
|
|
|
|
|
Short-term
investments (1)
|
|
575,483
|
|
564,281
|
|
11,202
|
|
|
|
TALF
investments, at market value
|
|
250,265
|
|
|
|
250,265
|
|
|
|
Other
investments
|
|
95,374
|
|
36,374
|
|
9,332
|
|
49,668
|
|
Total
assets measured at fair value
|
|
$
|
10,521,874
|
|
$
|
1,067,434
|
|
$
|
9,226,387
|
|
$
|
228,053
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
measured at fair value:
|
|
|
|
|
|
|
|
|
|
TALF
borrowings, at market value
|
|
$
|
217,565
|
|
$
|
|
|
$
|
217,565
|
|
$
|
|
|
(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 and
reinvested of $178.0 million and $207.0 million at March 31, 2010 and December 31,
2009, respectively, and included the $184.2 million and $212.8 million,
respectively, of fixed maturities and short-term investments pledged under
securities lending agreements, at market value.
29
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
As discussed
earlier, the Company determined that all U.S. Treasuries would be classified as
Level 1 securities on January 1, 2010 due to observed levels of trading
activity, the high number of strongly correlated pricing quotes received on
U.S. Treasuries and other factors. Such determination resulted in $1.09 billion
of U.S. Treasuries which were previously classified as Level 2 being moved into
Level 1. No securities were reclassified between Level 2 and Level 3 during the
2010 first quarter.
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)
|
|
|
|
Corporate
Bonds
|
|
Other
Investments
|
|
Total
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, 2010:
|
|
|
|
|
|
|
|
Balance
at beginning of period
|
|
$
|
178,385
|
|
$
|
49,668
|
|
$
|
228,053
|
|
Total
gains or (losses) (realized/unrealized)
|
|
|
|
|
|
|
|
Included
in earnings (1)
|
|
5,797
|
|
18
|
|
5,815
|
|
Included
in other comprehensive income
|
|
(6,508
|
)
|
1,819
|
|
(4,689
|
)
|
Purchases,
issuances and settlements
|
|
|
|
(18
|
)
|
(18
|
)
|
Transfers
in and/or out of Level 3
|
|
|
|
|
|
|
|
Balance
at end of period
|
|
$
|
177,674
|
|
$
|
51,487
|
|
$
|
229,161
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, 2009:
|
|
|
|
|
|
|
|
Balance
at beginning of period
|
|
$
|
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
|
|
|
|
|
|
|
|
Balance
at end of period
|
|
$
|
130,561
|
|
$
|
32,759
|
|
$
|
163,320
|
|
(1)
Gains or losses on fixed maturities were recorded as a
component of net investment income while gains or losses on other investments
were recorded in net realized gains (losses).
The amount of
total gains for the 2010 first quarter included in earnings attributable to the
change in unrealized gains or losses relating to assets still held at March 31,
2010 was $5.8 million. 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.
30
Table
of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
9.
Derivative Instruments
The Companys
investment strategy allows for the use of derivative securities. The Companys
derivative instruments are recorded on its consolidated balance sheets at
market value. The market values of those derivatives are based on quoted market
prices. All realized and unrealized contract gains and losses are reflected in
the Companys results of operations. The Company utilizes exchange traded U.S.
Treasury note, Eurodollar and other futures contracts and commodity futures to
manage portfolio duration or replicate investment positions in its portfolios.
In addition, certain of the Companys corporate bonds are managed in a global
bond portfolio which incorporates the use of foreign currency forward contracts
which are intended to provide an economic hedge against foreign currency
movements on the portfolios non-U.S. Dollar denominated holdings.
In addition, the
Company purchases to-be-announced mortgage backed securities (TBAs) as part
of its investment strategy. TBAs represent commitments to purchase a future
issuance of agency mortgage backed securities. For the period between purchase
of a TBA and issuance of the underlying security, the Companys position is
accounted for as a derivative. The Company purchases TBAs in both long and
short positions to enhance investment performance and as part of its overall
investment strategy. The Company did not hold any derivatives which were
designated as hedging instruments at March 31, 2010 or December 31,
2009. The following table summarizes information on the balance sheet
locations, market values and notional values of the Companys derivative
instruments:
|
|
|
|
Asset Derivatives
|
|
Liability Derivatives
|
|
|
|
Balance Sheet
Location
|
|
Estimated
Market
Value
|
|
Notional
Value
|
|
Estimated
Market
Value
|
|
Notional
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2010:
|
|
|
|
|
|
|
|
|
|
|
|
Futures
contracts
|
|
Other investments
|
|
$
|
1,087
|
|
$
|
1,496,332
|
|
$
|
(560
|
)
|
$
|
306,534
|
|
Foreign
currency forward contracts
|
|
Other investments
|
|
901
|
|
72,189
|
|
(5,071
|
)
|
324,211
|
|
TBAs
|
|
Fixed maturities
|
|
955,049
|
|
913,305
|
|
(918,890
|
)
|
880,700
|
|
Other
|
|
Other investments
|
|
2,295
|
|
42,595
|
|
(1,445
|
)
|
771,637
|
|
Total
|
|
|
|
$
|
959,332
|
|
|
|
$
|
(925,966
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
Futures
contracts
|
|
Other investments
|
|
$
|
577
|
|
$
|
472,904
|
|
$
|
(208
|
)
|
$
|
513,034
|
|
Foreign
currency forward contracts
|
|
Other investments
|
|
757
|
|
73,340
|
|
(12,408
|
)
|
310,030
|
|
TBAs
|
|
Fixed maturities
|
|
11,070
|
|
11,000
|
|
(616
|
)
|
600
|
|
Other
|
|
Other investments
|
|
26
|
|
1,975
|
|
(1,010
|
)
|
143,870
|
|
Total
|
|
|
|
$
|
12,430
|
|
|
|
$
|
(14,242
|
)
|
|
|
The following
table summarizes derivative instrument activity in the consolidated statements
of operations:
|
|
Location of Gain or (Loss)
|
|
Three Months Ended
|
|
|
|
Recognized in Income on
|
|
March 31,
|
|
Derivatives
not designated as hedging instruments
|
|
Derivative
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
Futures
contracts
|
|
Net realized gains
(losses)
|
|
$
|
161
|
|
$
|
(427
|
)
|
Foreign
currency forward contracts
|
|
Net realized gains
(losses)
|
|
5,108
|
|
7,225
|
|
TBAs
|
|
Net realized gains
(losses)
|
|
1,321
|
|
|
|
Other
|
|
Net realized gains
(losses)
|
|
827
|
|
454
|
|
Total
|
|
|
|
$
|
7,417
|
|
$
|
7,252
|
|
31
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
10.
Earnings Per Common Share
The following
table sets forth the computation of basic and diluted earnings per common
share:
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
216,994
|
|
$
|
146,330
|
|
Preferred
dividends
|
|
(6,461
|
)
|
(6,461
|
)
|
Net
income available to common shareholders (numerator)
|
|
$
|
210,533
|
|
$
|
139,869
|
|
|
|
|
|
|
|
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)
|
|
53,039,026
|
|
60,313,550
|
|
Effect
of dilutive common share equivalents:
|
|
|
|
|
|
Nonvested
restricted shares
|
|
390,909
|
|
274,167
|
|
Stock
options (1)
|
|
2,083,892
|
|
1,972,252
|
|
Weighted
average common shares and common share equivalents outstanding diluted
(denominator)
|
|
55,513,827
|
|
62,559,969
|
|
|
|
|
|
|
|
Earnings
per common share:
|
|
|
|
|
|
Basic
|
|
$
|
3.97
|
|
$
|
2.32
|
|
Diluted
|
|
$
|
3.79
|
|
$
|
2.24
|
|
(1)
Certain stock options were not included in the
computation of diluted earnings per share where the exercise price of the stock
options exceeded the average market price and would have been anti-dilutive or
where, when applying the treasury stock method to in-the-money options, the sum
of the proceeds, including unrecognized compensation, exceeded the average
market price and would have been anti-dilutive. For the 2010 first quarter and
2009 first quarter, the number of stock options excluded were 108,184 and
697,273, respectively.
11.
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, 2010,
the Company was not a party to any litigation or arbitration which is expected
by management to have a material adverse effect on the Companys results of
operations and financial condition and liquidity.
32
Table of Contents
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
12.
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
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 and Denmark.
The Companys
income tax provision resulted in an effective tax rate on income before income
taxes of 3.0% for the 2010 first quarter, compared to 6.1% for the 2009 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 Company had a net deferred tax asset of
$53.0 million at March 31, 2010, compared to $56.3 million at December 31,
2009. In addition, the Company paid $0.7 million for income taxes, net of
recoveries, during the 2010 first quarter, compared to $2.2 million for the
2009 first quarter.
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. The Company incurred $3.0 million of federal excise
taxes in the 2010 first quarter, compared to $3.3 million in the 2009 first
quarter. Such amounts are reflected as acquisition expenses in the Companys
consolidated statements of income.
33
Table of Contents
ITEM 2. MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a
discussion and analysis of our financial condition and results of operations.
This should be read in conjunction with our consolidated financial statements
included in Item 1 of this report and also our 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, 2009 (2009
Form 10-K). In addition, readers should review Risk Factors set forth
in Item 1A of Part I of our 2009 Form 10-K. Tabular amounts are in
U.S. Dollars in thousands, except share amounts, unless otherwise noted.
Arch Capital Group
Ltd. (ACGL and, together with its subsidiaries, we or us) is a Bermuda
public limited liability company with approximately $4.78 billion in capital at
March 31, 2010 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.
Current
Outlook
During the second
half of 2008, the financial markets experienced significant adverse credit
events and a loss of liquidity, which reduced the amount and availability of
capital in the insurance industry. In addition, certain of our competitors
experienced significant financial difficulties. During the first six months of
2009, we experienced rate stabilization and some improvements in rates.
However, with no significant catastrophic activity in the 2009 third quarter
and substantial improvements in market values across most investment sectors,
the degree of rate improvement we saw in the first six months of 2009 was
moderated and the pricing environment was basically unchanged at the end of
2009.
During the 2010
first quarter, in general, rates for all lines of business were slightly down
from previous periods, with increased competition experienced in executive
assurance and certain property lines of business. In the 2010 first quarter,
catastrophe losses were above long term averages in parts of the world, such as
the recent Chilean earthquake. While these events affected the 2010 first
quarter industry underwriting results, it is not anticipated at this time that
these events will cause significant increases in global property rates.
The current
economic conditions could continue to 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 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-exposed
business. We expect that our writings in this business will continue to
represent a significant proportion of our overall book, which could increase
the volatility of our operating results.
34
Table of Contents
Natural
Catastrophe Risk
We monitor our
natural catastrophe risk globally for all perils and regions, in each case,
where we believe there is significant exposure. Our models employ both
proprietary and vendor-based systems and include cross-line correlations for
property, marine, offshore energy, aviation, workers compensation and personal
accident. Currently, we seek to limit our 1-in-250 year return period net
probable maximum pre-tax loss from a severe catastrophic event in any
geographic zone to approximately 25% of total shareholders equity. We reserve
the right to change this threshold at any time. Based on in-force exposure
estimated as of April 1, 2010, our modeled peak zone catastrophe exposure
is a Northeast windstorm, with a net probable maximum pre-tax loss of $719
million. Based on in-force exposure estimated as of January 1, 2010, our
modeled peak zone exposure was a hurricane affecting the Florida Tri-County
area, with a net probable maximum pre-tax loss of $750 million. Our exposures
to other perils, such as U.S. earthquake and international events, are less
than the exposures arising from U.S. windstorms and hurricanes. As of April 1,
2010, our modeled peak zone earthquake exposure (Los Angeles area earthquake)
represented less than 75% of our peak zone catastrophe exposure, and our modeled
peak zone international exposure (United Kingdom windstorm) is substantially
less than both our peak zone windstorm and earthquake exposures. Net probable
maximum pre-tax loss estimates are net of expected reinsurance recoveries,
before income tax and before excess reinsurance reinstatement premiums. Loss
estimates are reflective of the zone indicated and not the entire portfolio.
Since hurricanes and windstorms can affect more than one zone and make multiple
landfalls, our loss estimates include clash estimates from other zones.
The loss estimates
shown above do not represent our maximum exposures and it is highly likely that
our actual incurred losses would vary materially from the modeled estimates.
There can be no assurances that we will not suffer a net loss 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. In addition,
actual losses may increase if our reinsurers fail to meet their obligations to
us or the reinsurance protections purchased by us are exhausted or are
otherwise unavailable. 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 our 2009 Form 10-K.
Financial
Measures
Management uses
the following three key financial indicators in evaluating our performance and
measuring the overall growth in value generated for ACGLs common shareholders:
Book
Value per Common Share
Book value per
common share represents total common shareholders equity divided by the number
of common shares outstanding. Management uses growth in book value per common
share as a key measure of the value generated for our common shareholders each
period and believes that book value per common share is the key driver of ACGLs
share price over time. Book value per common share is impacted by, among other
factors, our underwriting results, investment returns and share repurchase
activity, which has an accretive or dilutive impact on book value per common
share depending on the purchase price.
35
Table of Contents
Book value per
common share was $76.91 at March 31, 2010, compared to $73.01 at December 31,
2009. The 5.3% growth in the 2010 first quarter was generated through
underwriting results and investment returns and also reflects the accretive
impact of share repurchases made during the period.
Operating
Return on Average Common Equity
Operating return
on average common equity (Operating ROAE) represents after-tax operating
income available to common shareholders divided by the average of beginning and
ending common shareholders equity during the period. After-tax operating
income available to common shareholders, a non-GAAP measure as defined in the
SEC rules, represents net income available to common shareholders, excluding
net realized gains or losses, net impairment losses recognized in earnings,
equity in net income or loss of investment funds accounted for using the equity
method and net foreign exchange gains or losses, net of income taxes.
Management uses Operating ROAE as a key measure of the return generated to
common shareholders and has set an objective to achieve an average Operating
ROAE of 15% or greater over the insurance cycle, which it believes to be an
attractive return to common shareholders given the risks we assume. See Comment
on Non-GAAP Financial Measures.
Our Operating ROAE
was 9.8% for the 2010 first quarter, compared to 21.1% for the 2009 first
quarter. The lower Operating ROAE for the 2010 first quarter resulted from a
higher level of catastrophic events than in the 2009 first quarter along with
the impacts of current insurance and reinsurance market conditions and lower
interest yields.
Total
Return on Investments
Total return on
investments includes net investment income, equity in net income or loss of
investment funds accounted for using the equity method, net realized gains and
losses and the change in unrealized gains and losses generated by our investment
portfolio. Total return is calculated on a pre-tax basis and before investment
expenses and includes the effect of financial market conditions along with
foreign currency fluctuations. Management uses total return on investments as a
key measure of the return generated to common shareholders on the capital held
in the business, and compares the return generated by our investment portfolio
against benchmark returns which we measured our portfolio against during the
periods. The benchmark return is a weighted average of the benchmarks assigned
to each of our investment managers and vary based on the nature of the
portfolios under management.
The following
table summarizes the pre-tax total return (before investment expenses) of our
investment portfolio compared to the benchmark return against which we measured
our portfolio during the periods:
|
|
Arch
|
|
Benchmark
|
|
|
|
Portfolio (1)
|
|
Return
|
|
|
|
|
|
|
|
Pre-tax
total return (before investment expenses):
|
|
|
|
|
|
2010
first quarter
|
|
1.58
|
%
|
1.95
|
%
|
2009
first quarter
|
|
1.09
|
%
|
(0.45
|
)%
|
(1)
Our investment expenses were approximately 0.20% of
average invested assets in the 2010 first quarter, compared to 0.15% in the
2009 first quarter.
36
Table of Contents
Comment
on Non-GAAP Financial Measures
Throughout this
filing, we present our operations in the way we believe will be the most
meaningful and useful to investors, analysts, rating agencies and others who
use our financial information in evaluating the performance of our company.
This presentation includes the use of after-tax operating income available to
common shareholders, which is defined as net income available to common
shareholders, excluding net realized gains or losses, net impairment losses
recognized in earnings, equity in net income or loss of investment funds
accounted for using the equity method and net foreign exchange gains or losses,
net of income taxes. The presentation of after-tax operating income available
to common shareholders is a non-GAAP financial measure as defined in
Regulation G. The reconciliation of such measure to net income available to
common shareholders (the most directly comparable GAAP financial measure) in
accordance with Regulation G is included under Results of Operations below.
We believe that
net realized gains or losses, net impairment losses recognized in earnings,
equity in net income or loss of investment funds accounted for using the equity
method and net foreign exchange gains or losses in any particular period are
not indicative of the performance of, or trends in, our business. Although net
realized gains or losses, net impairment losses recognized in earnings, equity
in net income or loss of investment funds accounted for using the equity method
and net foreign exchange gains or losses are an integral part of our
operations, the decision to realize investment gains or losses, the recognition
of net impairment losses, the recognition of equity in net income or loss of
investment funds accounted for using the equity method and the recognition of
foreign exchange gains or losses are independent of the insurance underwriting
process and result, in large part, from general economic and financial market
conditions. Furthermore, certain users of our financial information believe
that, for many companies, the timing of the realization of investment gains or
losses is largely opportunistic. In addition, net impairment losses recognized
in earnings on our investments represent other-than-temporary declines in
expected recovery values on securities without actual realization. The use of
the equity method on certain of our investments in certain funds that invest in
fixed maturity securities is driven by the ownership structure of such funds
(either limited partnerships or limited liability companies). 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). This method of accounting is different from the way
we account for our other fixed maturity securities and the timing of the
recognition of equity in net income or loss of investment funds accounted for
using the equity method may differ from gains or losses in the future upon sale
or maturity of such investments. Due to these reasons, we exclude net realized
gains or losses, net impairment losses recognized in earnings, equity in net
income or loss of investment funds accounted for using the equity method and
net foreign exchange gains or losses from the calculation of after-tax
operating income available to common shareholders.
We believe that
showing net income available to common shareholders exclusive of the items
referred to above reflects the underlying fundamentals of our business since we
evaluate the performance of and manage our business to produce an underwriting
profit. In addition to presenting net income available to common shareholders,
we believe that this presentation enables investors and other users of our
financial information to analyze our performance in a manner similar to how
management analyzes performance. We also believe that this measure follows
industry practice and, therefore, allows the users of financial information to
compare our performance with our industry peer group. We believe that the
equity analysts and certain rating agencies which follow us and the insurance
industry as a whole generally exclude these items from their analyses for the
same reasons.
37
Table of Contents
RESULTS
OF OPERATIONS
The following
table summarizes, on an after-tax basis, our consolidated financial data,
including a reconciliation of after-tax operating income available to common
shareholders to net income available to common shareholders:
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
After-tax
operating income available to common shareholders
|
|
$
|
98,731
|
|
$
|
169,001
|
|
Net
realized gains (losses), net of tax
|
|
45,503
|
|
(9,111
|
)
|
Net
impairment losses recognized in earnings, net of tax
|
|
(1,606
|
)
|
(36,134
|
)
|
Equity
in net income (loss) of investment funds accounted for using the equity
method, net of tax
|
|
29,050
|
|
(9,581
|
)
|
Net
foreign exchange gains, net of tax
|
|
38,855
|
|
25,694
|
|
Net
income available to common shareholders
|
|
$
|
210,533
|
|
$
|
139,869
|
|
The lower level of
after-tax operating income in the 2010 first quarter compared to the 2009 first
quarter resulted from a higher level of catastrophic events than in the 2009
first quarter along with the impacts of current insurance and reinsurance
market conditions and lower interest yields.
Segment
Information
We classify our
businesses into two underwriting segments insurance and reinsurance and
corporate and other (non-underwriting). Accounting guidance regarding
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 5, Segment Information, of the
notes accompanying our consolidated financial statements. Management measures
segment performance based on underwriting income or loss.
38
Table of Contents
Insurance
Segment
The following
table sets forth our insurance segments underwriting results:
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Gross
premiums written
|
|
$
|
633,576
|
|
$
|
638,409
|
|
Net
premiums written
|
|
452,924
|
|
441,586
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
429,477
|
|
$
|
401,097
|
|
Fee
income
|
|
753
|
|
870
|
|
Losses
and loss adjustment expenses
|
|
(312,011
|
)
|
(270,015
|
)
|
Acquisition
expenses, net
|
|
(67,431
|
)
|
(57,623
|
)
|
Other
operating expenses
|
|
(80,720
|
)
|
(62,908
|
)
|
Underwriting
income (loss)
|
|
$
|
(29,932
|
)
|
$
|
11,421
|
|
|
|
|
|
|
|
Underwriting Ratios
|
|
|
|
|
|
Loss
ratio
|
|
72.6
|
%
|
67.3
|
%
|
Acquisition
expense ratio (1)
|
|
15.5
|
%
|
14.1
|
%
|
Other
operating expense ratio
|
|
18.8
|
%
|
15.7
|
%
|
Combined
ratio
|
|
106.9
|
%
|
97.1
|
%
|
(1)
The acquisition expense ratio is adjusted
to include certain fee income.
The components of
the insurance segments underwriting results for the 2010 first quarter and
2009 first quarter are discussed below.
Premiums
Written
. Gross premiums written by the insurance
segment in the 2010 first quarter were 0.8% lower than in the 2009 first
quarter as reductions in commercial aviation and casualty lines of business
were partially offset by increases in executive assurance and professional
liability business. The reduction in commercial aviation business primarily
resulted from a strategic decision to reduce exposure while the lower level of
casualty business was due to underwriting actions relating to the current
market environment. Growth in executive assurance and professional liability
business primarily resulted from contributions from business written by the
insurance segments European operations. Net premiums written increased by 2.6%,
reflecting changes in the mix of business, reinstatement premiums and the
impact of changes in reinsurance structure. For information regarding net
premiums written produced by major line of business and geographic location,
refer to note 5, Segment Information, of the notes accompanying our
consolidated financial statements.
Net
Premiums Earned
. Net premiums earned by the insurance segment
in the 2010 first quarter were 7.1% higher than in the 2009 first quarter, and
reflect changes in net premiums written over the previous five quarters.
39
Table
of Contents
Losses
and Loss Adjustment Expenses
. The table below shows the components of the
insurance segments loss ratio:
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Current
year
|
|
71.7
|
%
|
69.6
|
%
|
Prior
period reserve development
|
|
0.9
|
%
|
(2.3
|
)%
|
Loss
ratio
|
|
72.6
|
%
|
67.3
|
%
|
Current
Year Loss Ratio
.
The insurance segments
current year loss ratio was 2.1 points higher in the 2010 first quarter
compared to the 2009 period, primarily due to the lack of any significant
catastrophic event activity in 2009, while the 2010 current year loss ratio
included 5.6 points of catastrophic activity, primarily from the Chilean
earthquake in February 2010. In addition, the 2010 current year loss ratio
benefited from a higher contribution of property net premiums earned in the mix
of business than in the 2009 first quarter.
Prior Period
Reserve Development
.
2010
first quarter
:
The insurance segments net adverse development of $3.8 million, or 0.9 points,
reflected adverse development in a small number of high severity casualty
claims from the 2003 and 2004 accident years (
i.e.
,
the year in which a loss occurred) of $10.0 million and $6.0 million,
respectively, which was partially offset by favorable development in
short-tailed lines primarily consisting of reductions in property (including
special risk other than marine) reserves from the 2006 to 2008 accident years
of $1.6 million, $3.0 million and $7.5 million, respectively. This favorable
development was due to better-than-expected non-catastrophe claims activity.
2009
first quarter
:
The insurance segments net favorable development of $9.1 million, or 2.3
points, reflected reductions in reserves for professional liability of $13.0
million driven by accident years 2005 to 2007 and healthcare of $5.0 million
driven by favorable development across all prior accident years. These were
partially offset by adverse development on executive assurance reserves of $6.1
million, driven by unfavorable development from the 2006 to 2008 accident years
combined with favorable development from the 2005 and prior accident years, and
property (including special risk) losses of $4.6 million, driven by aviation
losses from the 2005 to 2007 accident years.
Underwriting
Expenses
. The insurance segments underwriting expense
ratio was 34.3% in the 2010 first quarter, compared to 29.8% in the 2009 first
quarter. The acquisition expense ratio was 15.5% for the 2010 first quarter,
compared to 14.1% for the 2009 first quarter. The acquisition expense ratio
reflects changes in the form of reinsurance ceded and mix of business compared
to the 2009 first quarter. The other operating expense ratio for the 2010 first
quarter included 1.4 points of costs incurred which are not currently expected
to impact the insurance segments operating expense ratio for the balance of
2010 while the 2009 first quarter ratio benefitted from 1.6 points of
reductions in compensation costs which are non-recurring.
40
Table
of Contents
Reinsurance
Segment
The following
table sets forth our reinsurance segments underwriting results:
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Gross
premiums written
|
|
$
|
323,477
|
|
$
|
390,129
|
|
Net
premiums written
|
|
314,830
|
|
381,277
|
|
|
|
|
|
|
|
Net
premiums earned
|
|
$
|
240,440
|
|
$
|
299,467
|
|
Fee
income
|
|
41
|
|
55
|
|
Losses
and loss adjustment expenses
|
|
(116,040
|
)
|
(130,527
|
)
|
Acquisition
expenses, net
|
|
(50,193
|
)
|
(68,835
|
)
|
Other
operating expenses
|
|
(20,398
|
)
|
(18,192
|
)
|
Underwriting
income
|
|
$
|
53,850
|
|
$
|
81,968
|
|
|
|
|
|
|
|
Underwriting Ratios
|
|
|
|
|
|
Loss
ratio
|
|
48.3
|
%
|
43.6
|
%
|
Acquisition
expense ratio
|
|
20.9
|
%
|
23.0
|
%
|
Other
operating expense ratio
|
|
8.5
|
%
|
6.1
|
%
|
Combined
ratio
|
|
77.7
|
%
|
72.7
|
%
|
The components of
the reinsurance segments underwriting results for the 2010 first quarter and
2009 first quarter are discussed below.
Premiums
Written
. Gross premiums written by the reinsurance
segment in the 2010 first quarter were 17.1% lower than in the 2009 first
quarter, primarily due to share decreases and non-renewals in property other
than property catastrophe business and casualty business, partially offset by
growth in the reinsurance segments other specialty lines. Net premiums written
by the reinsurance segment in the 2010 first quarter were 17.4% lower than in
the 2009 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 5, Segment Information, of the notes
accompanying our consolidated financial statements.
Net
Premiums Earned
. Net premiums earned in the 2010 first quarter
were 19.7% lower than in the 2009 first quarter, and reflect changes in net
premiums written over the previous five quarters, including the mix and type of
business written.
41
Table of Contents
Losses
and Loss Adjustment Expenses
. The table below shows the components of the
reinsurance segments loss ratio:
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Current
year
|
|
63.5
|
%
|
57.6
|
%
|
Prior
period reserve development
|
|
(15.2
|
)%
|
(14.0
|
)%
|
Loss
ratio
|
|
48.3
|
%
|
43.6
|
%
|
Current
Year Loss Ratio
.
The reinsurance
segments current year loss ratio was 5.9 points higher in the 2010 first
quarter compared to the 2009 period, primarily due to the higher level of
current year catastrophic event activity in the 2010 first quarter. The 2010
first quarter current year loss ratio included 14.2 points related to current
year catastrophic activity, compared to 2.7 points in the 2009 first quarter.
Specific 2010 first quarter catastrophic events included the Chilean
earthquake, European Windstorm Xynthia and the Australian hailstorms and
floods. The reinsurance segments 2010 first quarter loss ratio also reflected
an increase in the underwriting profit in its property facultative operations,
while the 2009 first quarter loss ratio included 1.2 points of losses related to
trade credit business.
Prior
Period Reserve Development
.
2010
first quarter
:
The reinsurance segments net favorable development of $36.5 million, or 15.2
points, was primarily due to reductions in reserves in short-tailed lines of
business. Such amount included favorable development in property catastrophe
and property other than property catastrophe reserves of $19.8 million,
including $5.3 million and $8.9 million from the 2008 and 2009 underwriting
years, respectively, and $5.6 million from prior underwriting years. In
addition, $12.4 million of favorable development developed on other specialty
reserves, including $3.4 million, $1.9 million and $4.6 million from the 2004,
2008 and 2009 underwriting years, respectively. The 2010 first quarter loss ratio
also benefitted from $6.8 million of favorable development on marine and
aviation business, primarily from the 2007 underwriting year. Such amounts were
partially offset by adverse development in casualty business of $3.2 million,
including adverse development from the 2008 underwriting year of $9.5 million
and favorable development in other underwriting years.
2009
first quarter
:
The reinsurance segments net favorable development of $42.0 million, or 14.0
points, reflected reductions in short-tailed and long-tailed lines of business.
Reductions in short-tailed lines included $11.0 million of favorable
development in other specialty reserves, including $6.0 million from the 2004
underwriting year and $3.8 million from the 2008 underwriting year, and $11.0
million from property catastrophe and property other than property catastrophe
reserves, including $3.9 million, $2.6 million and $4.1 million from the 2005,
2007 and 2008 underwriting years, respectively. Favorable development included
$19.1 million from casualty business, including $3.3 million, $7.3 million and
$6.7 million from the 2002, 2003 and 2004 underwriting years.
Underwriting
Expenses
. The underwriting expense ratio for the
reinsurance segment was 29.4% in the 2010 first quarter, compared to 29.1% in
the 2009 first quarter. The acquisition expense ratio for the 2010 first
quarter was 20.9%, compared to 23.0% for the 2009 first quarter. The comparison
of the 2010 first quarter and 2009 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 increase in the other
operating expense ratio primarily resulted from the lower level of net premiums
earned in the 2010 first quarter.
42
Table of Contents
Net
Investment Income
The components of
net investment income were derived from the following sources:
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Fixed
maturities
|
|
$
|
97,661
|
|
$
|
96,958
|
|
Short-term
investments
|
|
230
|
|
1,240
|
|
Other
(1)
|
|
485
|
|
1,565
|
|
Gross
investment income
|
|
98,376
|
|
99,763
|
|
Investment
expenses
|
|
(5,404
|
)
|
(3,881
|
)
|
Net
investment income
|
|
$
|
92,972
|
|
$
|
95,882
|
|
(1) Primarily
consists of interest income on operating cash accounts, other investments and
securities lending transactions.
The pre-tax
investment income yield was 3.41% for the 2010 first quarter, compared to 3.45%
for the 2009 fourth quarter and 3.82% for the 2009 first quarter, reflecting
the lower prevailing interest rates available in the market. 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.
Equity
in Net Income (Loss) of Investment Funds Accounted for Using the Equity Method
We recorded $29.1
million of equity in net income related to investment funds accounted for using
the equity method in the 2010 first quarter, compared to $9.6 million of equity
in net losses for the 2009 first quarter. Due to the ownership structure of
these investment 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. The equity in
net income recorded in the 2010 first quarter primarily resulted from
recoveries in market values in U.S. and Euro-denominated bank loan funds which
were significantly impacted by the extreme volatility in the capital and credit
markets during the latter portion of 2008 and early 2009. Investment funds
accounted for using the equity method totaled $405.6 million at March 31,
2010, compared to $391.9 million at December 31, 2009. At March 31,
2010, our portfolio included $439.6 million of investments in bank loan funds,
of which $272.3 million are reflected in the investment funds accounted for
using the equity method.
43
Table of Contents
Net
Realized Gains or Losses
Net realized gains
(losses) were as follows, excluding net impairment losses recognized in
earnings:
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Fixed
maturities
|
|
$
|
40,215
|
|
$
|
6,170
|
|
Other
investments
|
|
(700
|
)
|
(18,586
|
)
|
Other
(1)
|
|
8,267
|
|
7,252
|
|
Net
realized gains (losses)
|
|
$
|
47,782
|
|
$
|
(5,164
|
)
|
(1) Primarily
consists of realized gains or losses related to investment-related derivatives
and foreign currency forward contracts.
Net realized gains
or losses from the sale of fixed maturities primarily resulted from our
decisions to reduce credit exposure, changes in duration targets, relative
value determinations and sales related to rebalancing investment portfolios. In
addition, net realized gains or losses include changes in the market value of
certain hybrid securities pursuant to applicable guidance. The fair market
values of such securities at March 31, 2010 were approximately $93.3
million, compared to $84.8 million at December 31, 2009. We recorded
realized losses of $1.3 million for the 2010 first quarter, compared to
realized gains of $4.0 million for the 2009 first quarter.
Net
Impairment Losses Recognized in Earnings
We review our
investment portfolio each quarter to determine if declines in market 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) 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 2010 first quarter, we recorded $1.6
million of credit related impairments in earnings, compared to $36.1 million
for the 2009 first quarter. The OTTI recorded in the 2010 first quarter
primarily resulted from reductions in estimated recovery values on certain
mortgage-backed and asset-backed securities following the review of such
securities. See note 7, Investment InformationOther-Than-Temporary
Impairments, of the notes accompanying our consolidated financial statements
for additional information.
Other
Expenses
Other expenses,
which are included in our other operating expenses and part of corporate and
other (non-underwriting), were $5.7 million for the 2010 first quarter,
compared to $6.0 million for the 2009 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 2010 first quarter of $38.6 million consisted of net
unrealized gains of $37.9 million and net realized gains of $0.7 million,
compared to 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. The 2010 first quarter net foreign exchange gains
primarily resulted from the strengthening of the U.S. Dollar against the Euro
and British Pound during the period. 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
44
Table of Contents
each balance sheet date.
Historically, we have held investments in foreign currencies which are intended
to mitigate our exposure to foreign currency fluctuations in our net insurance
liabilities. However, changes in the value of such investments due to foreign
currency rate movements are reflected as a direct increase or decrease to
shareholders equity and are not included in the consolidated statements of
income. As a result of the current financial and economic environment as well
as the potential for additional investment returns, we may not match a portion
of our projected liabilities in foreign currencies with investments in the same
currencies, which could increase our exposure to foreign currency fluctuations
and increase the volatility in our shareholders equity.
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 2009 Form 10-K, updated where
applicable in the notes accompanying our consolidated financial statements.
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.
45
Table
of Contents
The following
table summarizes our invested assets:
|
|
March 31,
|
|
December 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Fixed
maturities available for sale, at market value
|
|
$
|
9,295,680
|
|
$
|
9,391,926
|
|
Fixed
maturities pledged under securities lending agreements, at market value (1)
|
|
181,871
|
|
208,826
|
|
Total
fixed maturities
|
|
9,477,551
|
|
9,600,752
|
|
Short-term
investments available for sale, at market value
|
|
669,798
|
|
571,489
|
|
Short-term
investments pledged under securities lending agreements, at market value (1)
|
|
2,350
|
|
3,994
|
|
Cash
|
|
338,708
|
|
334,571
|
|
TALF
investments, at market value
|
|
406,997
|
|
250,265
|
|
Other
investments
|
|
|
|
|
|
Fixed
income mutual funds
|
|
70,204
|
|
63,146
|
|
Privately
held securities and other
|
|
193,404
|
|
109,026
|
|
Investment
funds accounted for using the equity method
|
|
405,584
|
|
391,869
|
|
Total
cash and investments (1)
|
|
11,564,596
|
|
11,325,112
|
|
Securities
transactions entered into but not settled at the balance sheet date
|
|
(2,444
|
)
|
50,790
|
|
Total
investable assets
|
|
$
|
11,562,152
|
|
$
|
11,375,902
|
|
(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
and reinvested at March 31, 2010 and December 31, 2009 of $178.0
million and $207.0 million, respectively, and included the $184.2 million and
$212.8 million, respectively, of fixed maturities and short-term investments
pledged under securities lending agreements, at market value.
At March 31,
2010, 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 2.77 years, and an average yield to
maturity (imbedded book yield), before investment expenses, of 3.57%. At December 31,
2009, our fixed income portfolio had a AA+ average Standard & Poors
quality rating, an average effective duration of 2.87 years, and an average
yield to maturity (imbedded book yield), before investment expenses, of 3.64%.
At March 31, 2010, approximately $6.55 billion, or 58%, of our total
investments and cash was internally managed, compared to $6.6 billion, or 58%,
at December 31, 2009.
46
Table of Contents
The following
table summarizes our fixed maturities and fixed maturities pledged under
securities lending agreements, excluding TALF investments:
|
|
Estimated
|
|
Gross
|
|
Gross
|
|
|
|
OTTI
|
|
|
|
Market
|
|
Unrealized
|
|
Unrealized
|
|
Amortized
|
|
Unrealized
|
|
|
|
Value
|
|
Gains
|
|
Losses
|
|
Cost
|
|
Losses (1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2010:
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
$
|
2,929,992
|
|
$
|
94,809
|
|
$
|
(14,477
|
)
|
$
|
2,849,660
|
|
$
|
(19,073
|
)
|
Mortgage
backed securities
|
|
1,850,700
|
|
20,840
|
|
(36,172
|
)
|
1,866,032
|
|
(44,164
|
)
|
U.S.
government and government agencies
|
|
1,435,477
|
|
10,288
|
|
(5,828
|
)
|
1,431,017
|
|
(492
|
)
|
Commercial
mortgage backed securities
|
|
1,073,487
|
|
37,040
|
|
(8,890
|
)
|
1,045,337
|
|
(3,750
|
)
|
Municipal
bonds
|
|
873,272
|
|
37,032
|
|
(2,168
|
)
|
838,408
|
|
(130
|
)
|
Non-U.S.
government securities
|
|
719,697
|
|
29,759
|
|
(11,664
|
)
|
701,602
|
|
(351
|
)
|
Asset
backed securities
|
|
594,926
|
|
21,809
|
|
(5,519
|
)
|
578,636
|
|
(4,662
|
)
|
Total
|
|
$
|
9,477,551
|
|
$
|
251,577
|
|
$
|
(84,718
|
)
|
$
|
9,310,692
|
|
$
|
(72,622
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
$
|
3,134,088
|
|
$
|
99,446
|
|
$
|
(12,983
|
)
|
$
|
3,047,625
|
|
$
|
(19,667
|
)
|
Mortgage
backed securities
|
|
1,449,382
|
|
13,158
|
|
(45,536
|
)
|
1,481,760
|
|
(43,930
|
)
|
U.S.
government and government agencies
|
|
1,553,672
|
|
8,716
|
|
(12,999
|
)
|
1,557,955
|
|
(499
|
)
|
Commercial
mortgage backed securities
|
|
1,185,799
|
|
35,161
|
|
(11,724
|
)
|
1,162,362
|
|
(3,750
|
)
|
Municipal
bonds
|
|
957,752
|
|
44,043
|
|
(2,284
|
)
|
915,993
|
|
(145
|
)
|
Non-U.S.
government securities
|
|
752,215
|
|
41,858
|
|
(7,712
|
)
|
718,069
|
|
(351
|
)
|
Asset
backed securities
|
|
567,844
|
|
21,713
|
|
(8,220
|
)
|
554,351
|
|
(6,111
|
)
|
Total
|
|
$
|
9,600,752
|
|
$
|
264,095
|
|
$
|
(101,458
|
)
|
$
|
9,438,115
|
|
$
|
(74,453
|
)
|
(1)
Represents the total other-than-temporary
impairments (OTTI) recognized in accumulated other comprehensive income (AOCI).
It does not include the change in market value subsequent to the impairment
measurement date. At March 31, 2010, the net unrealized loss related to
securities for which a non-credit OTTI was recognized in AOCI was $24.8
million, compared to $37.9 million at December 31, 2009.
The following
table provides the credit quality distribution of our fixed maturities and
fixed maturities pledged under securities lending agreements, excluding TALF
investments:
|
|
March 31, 2010
|
|
December 31, 2009
|
|
|
|
Estimated
|
|
% of
|
|
Estimated
|
|
% of
|
|
Rating
(1)
|
|
Market Value
|
|
Total
|
|
Market Value
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
AAA
|
|
$
|
7,010,314
|
|
74.0
|
|
$
|
7,072,381
|
|
73.7
|
|
AA
|
|
1,117,951
|
|
11.8
|
|
1,281,377
|
|
13.3
|
|
A
|
|
580,769
|
|
6.1
|
|
547,104
|
|
5.7
|
|
BBB
|
|
263,195
|
|
2.8
|
|
231,988
|
|
2.4
|
|
BB
|
|
97,634
|
|
1.0
|
|
85,952
|
|
0.9
|
|
B
|
|
204,743
|
|
2.2
|
|
209,417
|
|
2.2
|
|
Lower
than B
|
|
118,362
|
|
1.2
|
|
80,871
|
|
0.8
|
|
Not
rated
|
|
84,583
|
|
0.9
|
|
91,662
|
|
1.0
|
|
Total
|
|
$
|
9,477,551
|
|
100.0
|
|
$
|
9,600,752
|
|
100.0
|
|
(1) Ratings as
assigned by the major rating agencies.
47
Table of Contents
The following
table provides information on the severity of the unrealized loss position as a
percentage of amortized cost for all fixed maturities and fixed maturities
pledged under securities lending agreements which were in an unrealized loss
position:
|
|
March 31, 2010
|
|
December 31, 2009
|
|
Severity
of
Unrealized Loss
|
|
Estimated
Market Value
|
|
Gross
Unrealized
Losses
|
|
% of
Total Gross
Unrealized
Losses
|
|
Estimated
Market Value
|
|
Gross
Unrealized
Losses
|
|
% of
Total Gross
Unrealized
Losses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0-10%
|
|
$
|
2,545,252
|
|
$
|
(34,908
|
)
|
41.2
|
|
$
|
2,892,977
|
|
$
|
(39,362
|
)
|
38.8
|
|
10-20%
|
|
139,657
|
|
(23,450
|
)
|
27.7
|
|
162,875
|
|
(28,542
|
)
|
28.1
|
|
20-30%
|
|
38,856
|
|
(13,072
|
)
|
15.4
|
|
36,872
|
|
(10,957
|
)
|
10.8
|
|
30-40%
|
|
16,426
|
|
(8,951
|
)
|
10.6
|
|
24,214
|
|
(12,204
|
)
|
12.0
|
|
40-50%
|
|
2,684
|
|
(1,947
|
)
|
2.3
|
|
8,031
|
|
(6,316
|
)
|
6.2
|
|
50-60%
|
|
85
|
|
(112
|
)
|
0.1
|
|
158
|
|
(171
|
)
|
0.2
|
|
60-70%
|
|
151
|
|
(242
|
)
|
0.3
|
|
69
|
|
(136
|
)
|
0.1
|
|
70-100%
|
|
628
|
|
(2,036
|
)
|
2.4
|
|
852
|
|
(3,770
|
)
|
3.8
|
|
Total
|
|
$
|
2,743,739
|
|
$
|
(84,718
|
)
|
100.0
|
|
$
|
3,126,048
|
|
$
|
(101,458
|
)
|
100.0
|
|
Approximately 95%
of the fixed maturities and fixed maturities pledged under securities lending
agreements held by us were rated investment grade by the major rating agencies
at March 31, 2010, compared to 95% at December 31, 2009.
The following
table provides information on the severity of the unrealized loss position as a
percentage of amortized cost for non-investment grade fixed maturities and
fixed maturities pledged under securities lending agreements which were in an
unrealized loss position:
|
|
March 31, 2010
|
|
December 31, 2009
|
|
Severity
of
Unrealized Loss
|
|
Estimated
Market Value
|
|
Gross
Unrealized
Losses
|
|
% of
Total Gross
Unrealized
Losses
|
|
Estimated
Market Value
|
|
Gross Unrealized
Losses
|
|
% of
Total Gross
Unrealized
Losses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0-10%
|
|
$
|
82,478
|
|
$
|
(3,936
|
)
|
4.6
|
|
$
|
64,198
|
|
$
|
(2,384
|
)
|
2.3
|
|
10-20%
|
|
76,216
|
|
(12,504
|
)
|
14.8
|
|
75,235
|
|
(13,139
|
)
|
12.9
|
|
20-30%
|
|
15,091
|
|
(5,973
|
)
|
7.1
|
|
8,550
|
|
(2,309
|
)
|
2.3
|
|
30-40%
|
|
11,170
|
|
(6,037
|
)
|
7.1
|
|
19,673
|
|
(9,704
|
)
|
9.6
|
|
40-50%
|
|
1,762
|
|
(1,281
|
)
|
1.5
|
|
3,303
|
|
(2,603
|
)
|
2.6
|
|
50-60%
|
|
85
|
|
(112
|
)
|
0.1
|
|
158
|
|
(171
|
)
|
0.2
|
|
60-70%
|
|
151
|
|
(242
|
)
|
0.3
|
|
69
|
|
(136
|
)
|
0.1
|
|
70-100%
|
|
627
|
|
(2,036
|
)
|
2.4
|
|
851
|
|
(3,028
|
)
|
3.0
|
|
Total
|
|
$
|
187,580
|
|
$
|
(32,121
|
)
|
37.9
|
|
$
|
172,037
|
|
$
|
(33,474
|
)
|
33.0
|
|
At March 31,
2010 and December 31, 2009, below-investment grade securities comprised
approximately 5% of our fixed maturities and fixed maturities pledged under
securities lending agreements. In accordance with our investment strategy, we
invest in high yield fixed income securities which are included in Corporate
bonds. Upon issuance, these securities are typically rated below investment
grade (i.e., rating assigned by the major rating agencies of BB or less). At March 31,
2010, corporate bonds represented 27% of the total below investment grade
securities at market value, mortgage backed securities represented 70% of the
total and 3% were in other classes. At December 31, 2009, corporate bonds
represented 27% of the total below investment
48
Table of Contents
grade securities at
market value, mortgage backed securities represented 69% of the total and 4%
were in other classes.
We determine
estimated recovery values for our fixed maturities and fixed maturities pledged
under securities lending agreements following a review of the business
prospects, credit ratings, estimated loss given default factors and information
received from asset managers and rating agencies for each security. For
structured securities, we utilize 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.
In the tables above, securities at March 31, 2010 which were in an
unrealized loss position of greater than 40% of amortized cost were primarily
in asset backed and mortgage backed securities where the estimated market value
for the securities was lower than our expected recovery value.
The following table
summarizes our top ten exposures to fixed income corporate issuers by market
value at March 31, 2010, excluding guaranteed amounts:
|
|
Estimated
Market Value
|
|
|
|
|
|
Banco
Santander SA
|
|
$
|
90,032
|
|
JPMorgan
Chase & Co.
|
|
76,935
|
|
General
Electric Co.
|
|
59,284
|
|
Sovrisc
BV
|
|
47,395
|
|
Total
SA
|
|
45,236
|
|
Bank
of America Corp.
|
|
44,799
|
|
Citigroup
Inc.
|
|
44,793
|
|
The
Goldman Sachs Group Inc.
|
|
41,547
|
|
Barclays
PLC
|
|
39,856
|
|
Wells
Fargo & Company
|
|
38,918
|
|
Total
|
|
$
|
528,795
|
|
At March 31,
2010, we held insurance enhanced municipal bonds, net of prerefunded bonds that
are escrowed in U.S. government obligations, the estimated market value of
which was approximately $274.9 million, or approximately 2.5% of our total
investable 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
had an average underlying rating of Aa3 by Moodys and AA by Standard &
Poors. The ratings were obtained from the individual rating agencies and were
assigned a numerical amount with 1 being the highest rating. The average
ratings were calculated using the weighted average market values of the
individual bonds. The average ratings with and without the insurance
enhancement are substantially the same at March 31, 2010. This is due to
the fact that, in cases where the claims paying ratings of the guarantors are
below investment grade, those ratings have been withdrawn from the bonds by the
relevant rating agencies, and the insured ratings have been equated to the
underlying ratings. Guarantors of our insurance enhanced municipal bonds, net
of prerefunded bonds that are escrowed in U.S. government obligations, included
National Public Finance Guarantee (f.k.a. MBIA Insurance Corporation) ($116.1
million), Assured Guaranty Ltd. ($78.8 million), Ambac Financial Group, Inc.
($45.8 million), Financial Guaranty Insurance Company ($21.5 million) and the
Texas Permanent School Fund ($12.7 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, 2010.
Our portfolio
includes investments, such as mortgage-backed securities, which are subject to
prepayment risk. At March 31, 2010, our investments in mortgage-backed
securities (MBS), excluding commercial
49
Table of Contents
mortgage-backed
securities, amounted to approximately $1.85 billion, or 16.0% of total
investable assets, compared to $1.45 billion, or 12.7%, at December 31,
2009. As with other fixed income investments, the market value of these
securities fluctuates depending on market and other general economic conditions
and the interest rate environment. Changes in interest rates can expose us to
changes in the prepayment rate on these investments. In periods of declining
interest rates, mortgage prepayments generally increase and MBS are prepaid
more quickly, requiring us to reinvest the proceeds at the then current market
rates. Conversely, in periods of rising rates, mortgage prepayments generally
fall, preventing us from taking full advantage of the higher level of rates.
However, current economic conditions may curtail prepayment activity as
refinancing becomes more difficult, thus limiting prepayments on MBS.
Since 2007, the
residential mortgage market in the U.S. has experienced a variety of
difficulties. During this time, delinquencies and losses with respect to
residential mortgage loans generally have increased and may continue to
increase, particularly in the subprime sector. In addition, during this period,
residential property values in many states have declined or remained stable, after
extended periods during which those values appreciated. A continued decline or
an extended flattening in those values may result in additional increases in
delinquencies and losses on residential mortgage loans generally, especially
with respect to second homes and investment properties, and with respect to any
residential mortgage loans where the aggregate loan amounts (including any
subordinate loans) are close to or greater than the related property values.
These developments may have a significant adverse effect on the prices of loans
and securities, including those in our investment portfolio. The situation
continues to have wide ranging consequences, including downward pressure on
economic growth and the potential for increased insurance and reinsurance
exposures, which could have an adverse impact on our results of operations,
financial condition, business and operations. Our portfolio includes commercial
mortgage backed securities (CMBS). At March 31, 2010, CMBS constituted
approximately $1.07 billion, or 9.3% of total investable assets, compared to
$1.19 billion, or 10.4%, at December 31, 2009. The commercial real estate
market has experienced price deterioration, which could lead to increased
delinquencies and defaults on commercial real estate mortgages.
50
Table of Contents
The following
table provides information on our mortgage backed securities (MBS) and CMBS
at March 31, 2010, excluding amounts guaranteed by the U.S. government and
TALF investments:
|
|
|
|
|
|
|
|
Estimated Market Value
|
|
|
|
Issuance
Year
|
|
Amortized
Cost
|
|
Average
Credit
Quality
|
|
Total
|
|
% of
Amortized
Cost
|
|
% of
Investable
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-agency MBS:
|
|
2003
|
|
$
|
3,212
|
|
AAA
|
|
$
|
3,100
|
|
96.5
|
%
|
0.0
|
%
|
|
|
2004
|
|
21,869
|
|
A-
|
|
19,483
|
|
89.1
|
%
|
0.2
|
%
|
|
|
2005
|
|
71,272
|
|
BBB-
|
|
59,706
|
|
83.8
|
%
|
0.5
|
%
|
|
|
2006
|
|
54,118
|
|
B-
|
|
46,806
|
|
86.5
|
%
|
0.4
|
%
|
|
|
2007
|
|
68,120
|
|
CCC+
|
|
58,596
|
|
86.0
|
%
|
0.5
|
%
|
|
|
2008
|
|
11,797
|
|
CCC
|
|
9,663
|
|
81.9
|
%
|
0.1
|
%
|
|
|
2009
|
(6)
|
166,478
|
|
AAA
|
|
173,752
|
|
104.4
|
%
|
1.5
|
%
|
|
|
2010
|
(6)
|
1,934
|
|
AAA
|
|
1,982
|
|
102.5
|
%
|
0.0
|
%
|
Total
non-agency MBS
|
|
|
|
$
|
398,800
|
|
A-
|
|
$
|
373,088
|
|
93.6
|
%
|
3.2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-agency CMBS:
|
|
1998
|
|
3,688
|
|
AAA
|
|
3,844
|
|
104.2
|
%
|
0.0
|
%
|
|
|
1999
|
|
163
|
|
AAA
|
|
163
|
|
100.0
|
%
|
0.0
|
%
|
|
|
2000
|
|
4,151
|
|
AAA
|
|
4,159
|
|
100.2
|
%
|
0.0
|
%
|
|
|
2001
|
|
239,312
|
|
AAA
|
|
243,407
|
|
101.7
|
%
|
2.1
|
%
|
|
|
2002
|
|
66,587
|
|
AAA
|
|
68,137
|
|
102.3
|
%
|
0.6
|
%
|
|
|
2003
|
|
71,551
|
|
AAA
|
|
75,271
|
|
105.2
|
%
|
0.7
|
%
|
|
|
2004
|
|
99,487
|
|
AAA
|
|
99,861
|
|
100.4
|
%
|
0.9
|
%
|
|
|
2005
|
|
51,154
|
|
AAA
|
|
50,782
|
|
99.3
|
%
|
0.4
|
%
|
|
|
2006
|
|
64,665
|
|
AAA
|
|
67,614
|
|
104.6
|
%
|
0.6
|
%
|
|
|
2007
|
|
50,128
|
|
AAA
|
|
54,654
|
|
109.0
|
%
|
0.5
|
%
|
Total
non-agency CMBS
|
|
|
|
$
|
650,886
|
|
AAA
|
|
$
|
667,892
|
|
102.6
|
%
|
5.8
|
%
|
Additional Statistics:
|
|
Non-Agency MBS
|
|
Non-Agency
|
|
|
|
Re-REMICs
|
|
All Other
|
|
CMBS (1)
|
|
Weighted
average loan age (months)
|
|
39
|
|
50
|
|
92
|
|
Weighted
average life (months) (2)
|
|
30
|
|
60
|
|
29
|
|
Weighted
average loan-to-value % (3)
|
|
72.7
|
%
|
69.9
|
%
|
71.4
|
%
|
Total
delinquencies (4)
|
|
22.5
|
%
|
20.2
|
%
|
5.1
|
%
|
Current
credit support % (5)
|
|
40.7
|
%
|
13.4
|
%
|
25.1
|
%
|
(1)
|
Loans defeased with
government/agency obligations represented approximately 27% of the collateral
underlying our CMBS holdings. Non-agency CMBS statistics exclude securities
backed by cell tower assets for which current data was not available (par
value of $106 million, amortized cost of $103 million and an estimated market
value of $110 million).
|
(2)
|
The weighted average
life for MBS is based on the interest rates in effect at March 31, 2010.
The weighted average life for CMBS reflects the average life of the
collateral underlying our CMBS holdings.
|
(3)
|
The range of
loan-to-values is 37.9% to 85.6% on MBS and 56.5% to 113.7% on CMBS.
|
(4)
|
Total delinquencies
includes 60 days and over.
|
(5)
|
Current credit support
% represents the % for a collateralized mortgage obligation (CMO) or CMBS
class/tranche from other subordinate classes in the same CMO or CMBS deal.
|
(6)
|
Primarily represents
Re-REMICs issued in 2009 and 2010 with an average credit quality of AAA
from Fitch Ratings.
|
51
Table
of Contents
The following table
provides information on our asset backed securities (ABS), excluding TALF
investments, at March 31, 2010:
|
|
|
|
|
|
Estimated Market Value
|
|
|
|
Amortized
Cost
|
|
Average
Credit
Quality
|
|
Total
|
|
% of
Amortized
Cost
|
|
% of
Investable
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sector:
|
|
|
|
|
|
|
|
|
|
|
|
Autos
(1)
|
|
$
|
228,717
|
|
AAA
|
|
$
|
235,400
|
|
102.9
|
%
|
2.0
|
%
|
Credit
cards (2)
|
|
240,212
|
|
AAA
|
|
250,983
|
|
104.5
|
%
|
2.2
|
%
|
Rate
reduction bonds (3)
|
|
34,451
|
|
AAA
|
|
35,411
|
|
102.8
|
%
|
0.3
|
%
|
Equipment
(4)
|
|
25,923
|
|
AAA
|
|
26,944
|
|
103.9
|
%
|
0.2
|
%
|
Student
loans (5)
|
|
20,500
|
|
AAA
|
|
21,674
|
|
105.7
|
%
|
0.2
|
%
|
Other
|
|
9,399
|
|
AA+
|
|
8,806
|
|
93.7
|
%
|
0.1
|
%
|
|
|
559,202
|
|
AAA
|
|
579,218
|
|
103.6
|
%
|
5.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
Home
equity (6)
|
|
$
|
6,579
|
|
AAA
|
|
$
|
5,788
|
|
88.0
|
%
|
0.1
|
%
|
|
|
293
|
|
A
|
|
294
|
|
100.3
|
%
|
0.0
|
%
|
|
|
646
|
|
BBB
|
|
632
|
|
97.8
|
%
|
0.0
|
%
|
|
|
9,651
|
|
BB to B
|
|
6,931
|
|
71.8
|
%
|
0.1
|
%
|
|
|
2,019
|
|
CCC to C
|
|
1,991
|
|
98.6
|
%
|
0.0
|
%
|
|
|
246
|
|
D
|
|
72
|
|
29.3
|
%
|
0.0
|
%
|
|
|
19,434
|
|
BBB
|
|
15,708
|
|
80.8
|
%
|
0.1
|
%
|
Total
ABS
|
|
$
|
578,636
|
|
AAA
|
|
$
|
594,926
|
|
102.8
|
%
|
5.1
|
%
|
The effective duration of
the total ABS was 1.2 years at March 31, 2010.
(1) The weighted
average credit support % on autos is 32.5%.
(2) The weighted
average credit support % on credit cards is 22.8%.
(3) The weighted
average credit support % on rate reduction bonds is 20.1%.
(4) The weighted
average credit support % on equipment is 12.6%.
(5) The weighted
average credit support % on student loans is 6.8%.
(6) The weighted
average credit support % on home equity is 23.7%.
At March 31,
2010, our fixed income portfolio included $50.3 million par value in sub-prime
securities with an estimated market value of $19.2 million and an average
credit quality of BBB from Standard & Poors and Baa3 from Moodys.
At December 31, 2009, our fixed income portfolio included $52.1 million
par value in sub-prime securities with an estimated market value of $18.5
million and an average credit quality of BBB+ from Standard & Poors
and Baa3 from Moodys. 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 approximately $16.6 million estimated
market value of sub-prime securities with an average credit quality of B from
Standard & Poors and B2 from Moodys at March 31, 2010,
compared to approximately $18.9 million estimated market value with an average
credit quality of BB from Standard & Poors and B2 from Moodys at
December 31, 2009.
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
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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 and other investments
totaled approximately $95.0 million at March 31, 2010.
Our investment
strategy allows for the use of derivative instruments. We utilize various
derivative instruments such as futures contracts to enhance investment
performance, replicate investment positions or manage market exposures and
duration risk that would be allowed under our investment guidelines if
implemented in other ways. See note 9, Derivative Instruments, of the notes
accompanying our consolidated financial statements for additional disclosures
concerning derivatives.
Other investments
totaled $263.6 million at March 31, 2010, compared to $172.2 million at December 31,
2009. Investment funds accounted for using the equity method totaled $405.6
million at March 31, 2010, compared to $391.9 million at December 31,
2009. 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.
Accounting
guidance regarding fair value measurements addresses how companies should
measure fair value when they are required to use a fair value measure for
recognition or disclosure purposes under GAAP and provides a common definition
of fair value to be used throughout GAAP. See note 8, Fair 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, 2010
and December 31, 2009 by level.
Reinsurance
Recoverables
We monitor the
financial condition of our reinsurers and attempt to place coverages only with
substantial, financially sound carriers. At March 31, 2010, approximately
90.2% of reinsurance recoverables on paid and unpaid losses (not including
prepaid reinsurance premiums) of $1.71 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 5.5% of our total shareholders
equity. At December 31, 2009, approximately 90.0% of reinsurance
recoverables on paid and unpaid losses (not including prepaid reinsurance
premiums) of $1.72 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 5.8% of our total shareholders equity.
Reinsurance
recoverables from Flatiron Re Ltd. (Flatiron), which is not rated by A.M.
Best, were $92.3 million at March 31, 2010, compared to $97.6 million at December 31,
2009. 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, 2010 and December 31, 2009.
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
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loss adjustment expenses
paid will deviate, perhaps substantially, from the reserve estimates reflected
in our financial statements.
At March 31,
2010 and December 31, 2009, our Loss Reserves, net of unpaid losses and
loss adjustment expenses recoverable, by type and by operating segment were as
follows:
|
|
March 31,
|
|
December 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Insurance:
|
|
|
|
|
|
Case
reserves
|
|
$
|
1,158,171
|
|
$
|
1,166,441
|
|
IBNR
reserves
|
|
2,504,361
|
|
2,431,193
|
|
Total
net reserves
|
|
$
|
3,662,532
|
|
$
|
3,597,634
|
|
|
|
|
|
|
|
Reinsurance:
|
|
|
|
|
|
Case
reserves
|
|
$
|
783,439
|
|
$
|
812,455
|
|
Additional
case reserves
|
|
80,146
|
|
61,226
|
|
IBNR
reserves
|
|
1,728,472
|
|
1,742,597
|
|
Total
net reserves
|
|
$
|
2,592,057
|
|
$
|
2,616,278
|
|
|
|
|
|
|
|
Total:
|
|
|
|
|
|
Case
reserves
|
|
$
|
1,941,610
|
|
$
|
1,978,896
|
|
Additional
case reserves
|
|
80,146
|
|
61,226
|
|
IBNR
reserves
|
|
4,232,833
|
|
4,173,790
|
|
Total
net reserves
|
|
$
|
6,254,589
|
|
$
|
6,213,912
|
|
At March 31,
2010 and December 31, 2009, the insurance segments Loss Reserves by major
line of business, net of unpaid losses and loss adjustment expenses
recoverable, were as follows:
|
|
March 31,
|
|
December 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Casualty
|
|
$
|
660,579
|
|
$
|
641,793
|
|
Executive
assurance
|
|
550,739
|
|
536,151
|
|
Property,
energy, marine and aviation
|
|
528,237
|
|
533,859
|
|
Professional
liability
|
|
508,084
|
|
504,454
|
|
Programs
|
|
459,099
|
|
452,143
|
|
Construction
|
|
431,124
|
|
421,729
|
|
Healthcare
|
|
142,770
|
|
139,414
|
|
National
accounts casualty
|
|
106,519
|
|
96,251
|
|
Surety
|
|
86,371
|
|
89,501
|
|
Travel
and accident
|
|
28,673
|
|
29,033
|
|
Other
|
|
160,337
|
|
153,306
|
|
Total
net reserves
|
|
$
|
3,662,532
|
|
$
|
3,597,634
|
|
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At March 31, 2010
and December 31, 2009, the reinsurance segments Loss Reserves by major
line of business, net of unpaid losses and loss adjustment expenses
recoverable, were as follows:
|
|
March 31,
|
|
December 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Casualty
|
|
$
|
1,788,426
|
|
$
|
1,792,750
|
|
Property
excluding property catastrophe
|
|
311,757
|
|
322,476
|
|
Marine
and aviation
|
|
212,707
|
|
228,708
|
|
Property
catastrophe
|
|
128,852
|
|
111,784
|
|
Other
specialty
|
|
106,558
|
|
116,799
|
|
Other
|
|
43,757
|
|
43,761
|
|
Total
net reserves
|
|
$
|
2,592,057
|
|
$
|
2,616,278
|
|
Shareholders
Equity
Our shareholders
equity was $4.38 billion at March 31, 2010, compared to $4.32 billion at December 31,
2009. The increase in the three months ended March 31, 2010 of $55.4
million was attributable to net income, partially offset by share repurchase
activity.
Book
Value per Common Share
The following
table presents the calculation of book value per common share at March 31,
2010 and December 31, 2009:
|
|
March 31,
|
|
December 31,
|
|
(U.S.
dollars in thousands, except share data)
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Calculation
of book value per common share:
|
|
|
|
|
|
Total
shareholders equity
|
|
$
|
4,378,757
|
|
$
|
4,323,349
|
|
Less
preferred shareholders equity
|
|
(325,000
|
)
|
(325,000
|
)
|
Common
shareholders equity
|
|
$
|
4,053,757
|
|
$
|
3,998,349
|
|
Common
shares outstanding (1)
|
|
52,709,934
|
|
54,761,678
|
|
Book
value per common share
|
|
$
|
76.91
|
|
$
|
73.01
|
|
(1)
Excludes the effects of 4,595,975 and
5,016,104 stock options and 258,213 and 261,012 restricted stock units
outstanding at March 31, 2010 and December 31, 2009, 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
$22.4 million at March 31, 2010, compared to $25.7 million at December 31,
2009. During the 2010 first quarter, ACGL received dividends of $180.0 million
from Arch Re Bermuda which were primarily used to fund the share repurchase
program described below.
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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
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 less any
premiums ceded by Arch Re Bermuda, but Arch Re Bermuda may not deduct more than
25% of gross premiums when computing net premiums written) and (3) 15% of
net discounted aggregated losses and loss expense provisions 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 (BMA) an affidavit stating that it will continue
to meet the required margins. In addition, Arch Re Bermuda is prohibited,
without prior approval of the BMA, from reducing by 15% or more its total
statutory capital, as set out in its previous years statutory financial
statements. Arch Re Bermuda is required to meet enhanced capital requirements
and a target capital level (defined as 120% of the enhanced capital
requirements) as calculated using a new risk based capital model called the
Bermuda Solvency Capital Requirement (BSCR) model. At December 31, 2009,
as determined under Bermuda law, Arch Re Bermuda had statutory capital of $2.23
billion and statutory capital and surplus of $4.26 billion, which amounts were
in compliance with Arch Re Bermudas enhanced capital requirement at such date.
Such amounts include ownership interests in U.S. insurance and reinsurance
subsidiaries. Accordingly, Arch Re Bermuda can pay approximately $1.07 billion
to ACGL during 2010 without providing an affidavit to the BMA, 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, 2010 and December 31, 2009, such amounts
approximated $1.51 billion and $1.49 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, 2010 and December 31, 2009, such amounts
approximated $4.30 billion and $4.28 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.
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As part of our
investment strategy, we seek to establish a level of cash and highly liquid
short-term and intermediate-term securities which, combined with expected cash
flow, is believed by us to be adequate to meet our foreseeable payment obligations.
However, due to the nature of our operations, cash flows are affected by claim
payments that may comprise large payments on a limited number of claims and
which can fluctuate from year to year. We believe that our liquid investments
and cash flow will provide us with sufficient liquidity in order to meet our
claim payment obligations. However, the timing and amounts of actual claim
payments related to recorded Loss Reserves vary based on many factors,
including large individual losses, changes in the legal environment, as well as
general market conditions. The ultimate amount of the claim payments could
differ materially from our estimated amounts. Certain lines of business written
by us, such as excess casualty, have loss experience characterized as low
frequency and high severity. The foregoing may result in significant
variability in loss payment patterns. The impact of this variability can be
exacerbated by the fact that the timing of the receipt of reinsurance
recoverables owed to us may be slower than anticipated by us. Therefore, the
irregular timing of claim payments can create significant variations in cash
flows from operations between periods and may require us to utilize other
sources of liquidity to make these payments, which may include the sale of
investments or utilization of existing or new credit facilities or capital
market transactions. If the source of liquidity is the sale of investments, we
may be forced to sell such investments at a loss, which may be material.
Our investments in
certain securities, including certain fixed income and structured securities,
investments in funds accounted for using the equity method, other investments
and our investment in Gulf Re (joint venture) may be illiquid due to
contractual provisions or investment market conditions. If we require
significant amounts of cash on short notice in excess of anticipated cash
requirements, then we may have difficulty selling these investments in a timely
manner or may be forced to sell or terminate them at unfavorable values.
Consolidated net
cash provided by operating activities was $184.6 million for the 2010 first
quarter, compared to $294.8 million for the 2009 first quarter. Comparability
between the two periods was affected by an unearned premium portfolio transfer
which lowered the 2010 first quarter cash flow by $15.0 million, but increased
the 2009 first quarter cash flow by $25.0 million. The remaining decline in
cash flow from operations reflected a lower level of premium collections and an
increase in paid losses as the Companys insurance and reinsurance loss
reserves continue 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 investments totaled $11.6 billion at March 31,
2010, compared to $11.3 billion at December 31, 2009. 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, including debt service
obligations. 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 and to service our outstanding debt 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.
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We monitor our
capital adequacy on a regular basis and will seek to adjust our capital base
(up or down) according to the needs of our business. The future capital
requirements of our business will depend on many factors, including our ability
to write new business successfully and to establish premium rates and reserves
at levels sufficient to cover losses. Our ability to underwrite is largely
dependent upon the quality of our claims paying and financial strength ratings
as evaluated by independent rating agencies. In particular, we require (1) sufficient
capital to maintain our financial strength ratings, as issued by several
ratings agencies, at a level considered necessary by management to enable our
key operating subsidiaries to compete; (2) sufficient capital to enable our
underwriting subsidiaries to meet the capital adequacy tests performed by
statutory agencies in the U.S. and other key markets; and (3) letters of
credit and other forms of collateral that are necessary for our non-U.S.
operating companies because they are non-admitted under U.S. state insurance
regulations.
As part of our
capital management program, we may seek to raise additional capital or may seek
to return capital to our shareholders through share repurchases, cash dividends
or other methods (or a combination of such methods). Any such determination
will be at the discretion of our board of directors and will be dependent upon
our profits, financial requirements and other factors, including legal
restrictions, rating agency requirements and such other factors as our board of
directors deems relevant.
The board of
directors of ACGL has authorized the investment of up to $2.5 billion in ACGLs
common shares through a share repurchase program. Such amount consisted of a
$1.0 billion authorization in February 2007, a $500 million authorization
in May 2008, and a $1.0 billion authorization in November 2009.
Repurchases under the program may be effected from time to time in open market
or privately negotiated transactions through December 2011. Since the
inception of the share repurchase program, ACGL has repurchased approximately
24.5 million common shares for an aggregate purchase price of $1.69 billion.
During the 2010 first quarter, ACGL repurchased 2.5 million common shares for
an aggregate purchase price of $181.3 million, compared to a de minimis number
of shares and aggregate purchase price of $1.6 million during the 2009 period.
Weighted average shares outstanding for the 2010 first quarter were reduced by
23.5 million shares, compared to 15.3 million shares for the 2009 period. At March 31,
2010, approximately $810.1 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. We will continue to monitor our share price and, depending upon
results of operations, market conditions and the development of the economy, as
well as other factors, we will consider share repurchases on an opportunistic
basis.
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,
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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 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 $100.0 million of unsecured letters of credit as
part of the $300.0 million unsecured revolving loan. Arch Re Bermuda also has
access to other letter of credit facilities, some of which are available on a
limited basis for limited purposes. Refer to note 4, Debt and Financing
ArrangementsLetter of Credit and Revolving Credit Facilities, of the notes
accompanying our consolidated financial statements 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 (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 three month periods ended March 31,
2010 and 2009, we paid $6.5 million to holders of the preferred shares and, at March 31,
2010, 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
59
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state in which such
offer, solicitation or sale would be unlawful prior to registration or
qualification under the securities laws of any such state.
We purchase
asset-backed and commercial mortgage-backed securities under the FRBNYs TALF
program. As of March 31, 2010, we had $407.0 of securities under TALF
which are reflected as TALF investments, at market value and $346.7 million
of secured financing from the FRBNY which is reflected as TALF borrowings, at
market value. As of December 31, 2009, we had $250.3 million TALF
investments, at market value and $217.6 million of TALF borrowings, at market
value. Refer to note 4, Debt and Financing ArrangementsTALF Program, of the
notes accompanying our consolidated financial statements for further details on
the TALF Program.
At March 31,
2010, ACGLs capital of $4.78 billion consisted of $300.0 million of senior
notes, representing 6.3% of the total, $100.0 million of revolving credit
agreement borrowings due in August 2011, representing 2.1% of the total,
$325.0 million of preferred shares, representing 6.8% of the total, and common
shareholders equity of $4.05 billion, representing the balance. At December 31,
2009, ACGLs capital of $4.72 billion consisted of $300.0 million of senior
notes, representing 6.4% of the total, $100.0 million of revolving credit agreement
borrowings due in August 2011, representing 2.1% of the total, $325.0
million of preferred shares, representing 6.9% of the total, and common
shareholders equity of $4.0 billion, representing the balance. TALF borrowings
are not included in the calculation of total capital. The increase in capital
during the three month period ending March 31, 2010 was primarily
attributable to net income, partially offset by share repurchase activity.
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, 2009.
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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,
2010. (See section captioned Managements Discussion and Analysis of Financial
Condition and Results of OperationsMarket Sensitive Instruments and Risk
Management included in our 2009 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.
An analysis of material changes in market risk exposures at March 31, 2010
that affect the quantitative and qualitative disclosures presented as of December 31,
2009 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. 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.
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, 2010 and December 31,
2009:
|
|
Interest Rate Shift in Basis Points
|
|
(U.S. dollars in millions)
|
|
-100
|
|
-50
|
|
-
|
|
50
|
|
100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2010:
|
|
|
|
|
|
|
|
|
|
|
|
Total
market value
|
|
$
|
10,901.6
|
|
$
|
10,769.2
|
|
$
|
10,618.9
|
|
$
|
10,471.8
|
|
$
|
10,318.8
|
|
Market
value change from base
|
|
2.66
|
%
|
1.42
|
%
|
|
|
(1.39
|
)%
|
(2.83
|
)%
|
Change
in unrealized value
|
|
$
|
282.7
|
|
$
|
150.3
|
|
$
|
|
|
$
|
(147.1
|
)
|
$
|
(300.1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
Total
market value
|
|
$
|
11,227.5
|
|
$
|
11,078.3
|
|
$
|
10,920.7
|
|
$
|
10,757.7
|
|
$
|
10,593.9
|
|
Market
value change from base
|
|
2.81
|
%
|
1.44
|
%
|
|
|
(1.49
|
)%
|
(2.99
|
)%
|
Change
in unrealized value
|
|
$
|
306.8
|
|
$
|
157.6
|
|
$
|
|
|
$
|
(163.0
|
)
|
$
|
(326.8
|
)
|
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.
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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,
2010 and December 31, 2009:
|
|
Credit Spread Shift in Basis Points
|
|
(U.S.
dollars in millions)
|
|
-100
|
|
-50
|
|
-
|
|
50
|
|
100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2010:
|
|
|
|
|
|
|
|
|
|
|
|
Total
market value
|
|
$
|
10,869.6
|
|
$
|
10,746.2
|
|
$
|
10,618.9
|
|
$
|
10,485.7
|
|
$
|
10,348.6
|
|
Market
value change from base
|
|
2.36
|
%
|
1.20
|
%
|
|
|
(1.25
|
)%
|
(2.55
|
)%
|
Change
in unrealized value
|
|
$
|
250.7
|
|
$
|
127.3
|
|
$
|
|
|
$
|
(133.2
|
)
|
$
|
(270.3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
Total
market value
|
|
$
|
11,198.4
|
|
$
|
11,061.6
|
|
$
|
10,920.7
|
|
$
|
10,775.8
|
|
$
|
10,627.8
|
|
Market
value change from base
|
|
2.54
|
%
|
1.29
|
%
|
|
|
(1.33
|
)%
|
(2.68
|
)%
|
Change
in unrealized value
|
|
$
|
277.7
|
|
$
|
140.9
|
|
$
|
|
|
$
|
(144.9
|
)
|
$
|
(292.9
|
)
|
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, 2010, our portfolios VaR was estimated to
be 4.01%, compared to an estimated 4.79% at December 31, 2009.
Privately
Held Securities and Equity Securities.
Our investment portfolio includes an allocation to
privately held securities and equity securities. At March 31, 2010 and December 31,
2009, the market value of our investments in privately held securities and
equity securities (excluding our investment in Aeolus LP which is accounted for
using the equity method) totaled $134.0 million and $44.5 million,
respectively. These securities are exposed to price risk, which is the
potential loss arising from decreases in market value. An immediate
hypothetical 10% depreciation in the value of each position would reduce the
market value of such investments by approximately $13.4 million and $4.5
million at March 31, 2010 and December 31 2009, respectively, and
would have decreased book value per common share by approximately $0.25 and
$0.08, respectively.
Investment-Related
Derivatives.
Derivative
instruments may be used to enhance investment performance, replicate investment
positions or manage market exposures and duration risk that would be allowed
under our investment guidelines if implemented in other ways. The market values
of those derivatives are based on quoted market prices. See note 9, Derivative
Instruments, of the notes accompanying our consolidated financial Statements
for additional disclosures concerning derivatives. At March 31, 2010, the
notional value of the net long position of derivative instruments (excluding
to-be-announced mortgage backed securities which are included in the fixed
income securities analysis above and foreign currency forward contracts which
are included in the foreign currency exchange risk analysis below) was $2.62
billion, compared to $1.13 billion at December 31, 2009. A 100 basis point
depreciation of the underlying exposure to these derivative instruments at March 31,
2010 and December 31, 2009 would have resulted in a reduction in net
income of approximately $26.2 million and $11.3 million, respectively, and
would have decreased book value per common share by $0.50 and $0.21,
respectively.
For further discussion on
investment activity, please refer to Financial Condition, Liquidity and
Capital ResourcesFinancial ConditionInvestable Assets.
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Foreign
Currency Exchange Risk
Foreign currency
rate risk is the potential change in value, income and cash flow arising from
adverse changes in foreign currency exchange rates. Through our subsidiaries
and branches located in various foreign countries, we conduct our insurance and
reinsurance operations in a variety of local currencies other than the U.S.
Dollar. We generally hold investments in foreign currencies which are intended
to mitigate our exposure to foreign currency fluctuations in our net insurance
liabilities. We may also utilize foreign currency forward contracts and
currency options as part of our investment strategy. In addition, as a result
of the current financial and economic environment as well as the potential for
additional investment returns, we may not match a portion of our projected
liabilities in foreign currencies with investments in the same currencies,
which would increase our exposure to foreign currency fluctuations and increase
the volatility in our results of operations. A 10% appreciation of the U.S.
Dollar against the major foreign currencies for our outstanding contracts at March 31,
2010 and December 31, 2009, net of unrealized depreciation on our
securities denominated in currencies other than the U.S. Dollar, would have
resulted in unrealized losses of approximately $38.6 million and $40.1 million,
respectively, and would have decreased book value per common share by approximately
$0.73 and $0.73, 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 release 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 release 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 and elsewhere in this release and in our periodic reports filed with the
Securities and Exchange Commission (the SEC), and include:
·
our ability to successfully implement its 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;
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·
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 its 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 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,
2010;
·
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 its 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 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 under Item 1A Risk
Factors, Item 7 Managements Discussion and Analysis of Financial Condition
and Results of Operations and other sections of our Annual Report on Form 10-K,
as well as the other factors set forth in our other documents on file with the
SEC, and managements response to any of the aforementioned factors.
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
64
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that are included herein
or elsewhere. We undertake no obligation to publicly update or revise any
forward-looking statement, whether as a result of new information, future
events or otherwise.
Other
Financial Information
The consolidated
financial statements as of March 31, 2010 and for the three month periods
ended March 31, 2010 and 2009 have been reviewed by PricewaterhouseCoopers
LLP, an independent registered public accounting firm. Their report (dated May 7,
2010) 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.
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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, 2010 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, 2010, we were not a
party to any litigation or arbitration which is expected by management to have
a material 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 our purchases of our common shares for the 2010 first quarter:
(U.S. dollars in thousands, except share data)
|
|
Issuer Purchases of Equity Securities
|
|
Approximate
|
|
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)
|
|
Dollar Value of
Shares that May
Yet be Purchased
Under the Plan or
Programs (2)
|
|
1/1/2010-1/31/2010
|
|
861,921
|
|
$
|
71.49
|
|
861,894
|
|
$
|
929,785
|
|
2/1/2010-2/28/2010
|
|
1,397,094
|
|
71.13
|
|
1,395,957
|
|
$
|
830,496
|
|
3/1/2010-3/31/2010
|
|
272,335
|
|
74.86
|
|
272,062
|
|
$
|
810,131
|
|
Total
|
|
2,531,350
|
|
$
|
71.65
|
|
2,529,913
|
|
$
|
810,131
|
|
(1)
Includes repurchases by ACGL of 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)
The Board of Directors of ACGL has authorized the
investment of up to $2.5 billion in ACGLs common shares through a share
repurchase program. Such amount consisted of a $1.0 billion authorization in February 2007,
a $500 million authorization in May 2008, and a $1.0 billion authorization
in November 2009. Repurchases under this authorization may be effected
from time to time in open market or privately negotiated transactions through December 31,
2011. Since the inception of the share repurchase program, ACGL has repurchased
approximately 24.5 million common shares for an aggregate purchase price of
$1.69 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.
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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 2010 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.
Item 6. Exhibits
Exhibit No.
|
|
Description
|
|
|
|
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
|
67
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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 7, 2010
|
|
Constantine Iordanou
|
|
|
President and Chief
Executive Officer (Principal Executive Officer) and Chairman of the Board of
Directors
|
|
|
|
|
|
|
|
|
/s/ John C.R. Hele
|
Date: May 7, 2010
|
|
John C.R. Hele
|
|
|
Executive Vice
President, Chief Financial Officer and Treasurer (Principal Financial and
Accounting Officer)
|
68
Table
of Contents
EXHIBIT INDEX
Exhibit No.
|
|
Description
|
|
|
|
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
|
69
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