ACGL Arch Capital Group Ltd

Arch Capital Group Ltd. (NASDAQ: ACGL) reports that net income available to common shareholders for the 2011 fourth quarter was $136.8 million, or $1.00 per share, compared to $227.7 million, or $1.51 per share, for the 2010 fourth quarter, and $410.5 million, or $2.97 per share for 2011, compared to $816.7 million, or $5.18 per share, for 2010. The Company also reported after-tax operating income available to common shareholders of $126.8 million, or $0.92 per share, for the 2011 fourth quarter, compared to $129.5 million, or $0.86 per share, for the 2010 fourth quarter, and $303.6 million, or $2.20 per share, for 2011, compared to $491.1 million, or $3.12 per share, for 2010. All earnings per share amounts discussed in this release are on a diluted basis. All information in this release has been adjusted to reflect the three-for-one share split effected in May 2011.

The Company’s book value per common share was $32.03 at December 31, 2011, a 2.7% increase from $31.20 per share at September 30, 2011 and a 6.8% increase from $29.99 per share at December 31, 2010. The Company’s after-tax operating income available to common shareholders represented a 12.0% annualized return on average common equity for the 2011 fourth quarter, compared to 12.1% for the 2010 fourth quarter, and 7.2% for 2011, compared to 12.0% for 2010. After-tax operating income available to common shareholders, a non-GAAP measure, is defined as net income available to common shareholders, excluding net realized gains or losses, 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. See page 7 for a further discussion of after-tax operating income available to common shareholders and Regulation G.

The Company’s 2011 fourth quarter results included losses for current year catastrophic events of $70.8 million, net of reinsurance and reinstatement premiums. Such amount included $60.6 million from the severe flooding in Thailand and $5.4 million from an Australian hailstorm in the 2011 fourth quarter, with the remainder due to net increases in loss estimates from other catastrophic events. The Company’s estimates for these events are based on currently available information derived from modeling techniques, industry assessments of exposure, preliminary claims information obtained from the Company’s clients and brokers to date and a review of in-force contracts. The severe flooding in Thailand spanned several months between July and December 2011 and has had a significant impact on the Thai economy. Due to the size, duration and complexity of the event, substantial uncertainty remains regarding total covered losses for the insurance industry and the assumptions underlying the Company’s estimates. Actual losses will depend to a great extent on claims from contingent business interruption coverage. The Company’s actual losses from catastrophic events may vary materially from the estimates due to the inherent uncertainties in making such determinations resulting from several factors, including the preliminary nature of available information, the potential inaccuracies and inadequacies in the data provided by clients and brokers, the modeling techniques and the application of such techniques, the contingent nature of business interruption exposures, the effects of any resultant demand surge on claims activity and attendant coverage issues. In addition, actual losses may increase if the Company’s reinsurers fail to meet their obligations to the Company or the reinsurance protections purchased by the Company are exhausted or are otherwise unavailable.

The following table summarizes the Company’s underwriting results:

  Three Months Ended   Year Ended December 31, December 31, (U.S. dollars in thousands) 2011   2010 2011   2010   Gross premiums written $ 699,662 $ 664,212 $ 3,436,456 $ 3,266,787 Net premiums written 511,124 482,911 2,673,326 2,511,040 Net premiums earned 673,192 632,146 2,631,815 2,552,483 Underwriting income 67,046 48,356 44,654 195,004   Combined ratio (1) 90.1% 92.7% 98.3% 92.5% (1)   The combined ratio represents a measure of underwriting profitability, excluding investment income, and is the sum of the loss ratio and expense ratio. A combined ratio under 100% represents an underwriting profit and a combined ratio over 100% represents an underwriting loss.

The following table summarizes, on an after-tax basis, the Company’s consolidated financial data, including a reconciliation of after-tax operating income available to common shareholders to net income available to common shareholders and related diluted per share results:

  Three Months Ended   Year Ended December 31, December 31, (U.S. dollars in thousands, except share data) 2011   2010 2011   2010   After-tax operating income available to common shareholders $ 126,831 $ 129,489 $ 303,577 $ 491,074 Net realized gains, net of tax 13,464 71,821 108,306 247,054 Net impairment losses recognized in earnings, net of tax (1,959) (3,230) (9,062) (11,321) Equity in net income (loss) of investment funds accounted for using the equity method, net of tax (14,702) 22,990 (9,605) 61,400 Net foreign exchange gains, net of tax   13,177   6,581   17,298   28,537 Net income available to common shareholders $ 136,811 $ 227,651 $ 410,514 $ 816,744   Diluted per common share results: After-tax operating income available to common shareholders $ 0.92 $ 0.86 $ 2.20 $ 3.12 Net realized gains, net of tax 0.10 0.48 0.78 1.56 Net impairment losses recognized in earnings, net of tax (0.01) (0.02) (0.07) (0.07) Equity in net income (loss) of investment funds accounted for using the equity method, net of tax (0.11) 0.15 (0.07) 0.39 Net foreign exchange gains, net of tax   0.10   0.04   0.13   0.18 Net income available to common shareholders $ 1.00 $ 1.51 $ 2.97 $ 5.18   Weighted average common shares and common share equivalents outstanding – diluted 137,473,670 150,306,429 138,289,702 157,565,157

In establishing the reserves for losses and loss adjustment expenses, the Company has made various assumptions relating to the pricing of its reinsurance contracts and insurance policies and also has considered available historical industry experience and current industry conditions. Any estimates and assumptions made as part of the reserving process could prove to be inaccurate due to several factors, including the fact that relatively limited historical information has been reported to the Company through December 31, 2011. As actual loss information is reported to the Company and it develops its own loss experience, the Company will give more emphasis to other actuarial techniques. For a discussion of underwriting activities and a review of the Company’s results by operating segment, see “Segment Information” in the Supplemental Financial Information section of this release.

The Company’s investment portfolio continues to be comprised primarily of high quality fixed income securities with an average credit quality of “AA/Aa1.” The average effective duration of the investment portfolio was 2.99 years at December 31, 2011, compared to 3.17 years at September 30, 2011 and 2.83 years at December 31, 2010. Including the effects of foreign exchange, total return on the Company’s investment portfolio was approximately 0.82% for the 2011 fourth quarter, compared to (0.07)% for the 2010 fourth quarter. Excluding the effects of foreign exchange, total return was 0.95% for the 2011 fourth quarter, compared to (0.04)% for the 2010 fourth quarter. Total return in the 2011 fourth quarter reflected a recovery in U.S. equity markets and relatively stable U.S. Treasury yields, partially offset by negative returns on certain investments funds discussed below.

Net investment income for the 2011 fourth quarter was $80.5 million, or $0.59 per share, compared to $90.6 million, or $0.60 per share, for the 2010 fourth quarter. The comparability of net investment income between the periods was influenced by the Company’s share repurchase program. The pre-tax investment income yield was 2.72% for the 2011 fourth quarter, compared to 3.24% for the 2010 fourth quarter, reflecting the effects of lower prevailing interest rates available in the market.

The Company recorded $14.7 million of equity in net losses related to investment funds accounted for using the equity method in the 2011 fourth quarter, compared to $23.0 million of equity in net income for the 2010 fourth quarter. The Company’s losses on its investment funds accounted for using the equity method in the 2011 fourth quarter resulted, in part, from the effect of weakness in global economic conditions (both in the U.S. and Europe) and general risk aversion in certain asset types. The Company uses the equity method on certain investments due to the ownership structure of these investment funds (e.g., limited partnership), where it does not have a controlling interest and is not the primary beneficiary. In applying the equity method, these investments are initially recorded at cost and are subsequently adjusted based on the Company’s 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 recorded on a three month lag based on the availability of reports from the investment funds.

Consolidated cash flow provided by operating activities for the 2011 fourth quarter was $109.6 million, compared to $144.5 million for the 2010 fourth quarter. The decline in operating cash flows in the 2011 fourth quarter primarily resulted from the collection of profit commissions in the 2010 fourth quarter from Flatiron Re Ltd., a Bermuda reinsurance company that assumed certain lines of property and marine business underwritten by the Company in the 2006 and 2007 underwriting years.

During 2006, the Company invested $50 million in Aeolus LP, which operates as an unrated reinsurance platform that provides collateralized property catastrophe protection to insurers and reinsurers on both an ultimate net loss and industry loss warranty basis. This investment is accounted for using the equity method on a three month lag (based on the availability of their financial statements) with changes in the carrying value recorded in “other income (loss).” As of December 31, 2011, the carrying value of this investment, after taking into account the $67 million in cash distributions received through December 31, 2011, was approximately $35 million, with no unfunded capital commitments. The Company recorded a loss of $5.7 million on its investment in Aeolus LP in the 2011 fourth quarter. Based upon information currently available to the Company as to the 2011 fourth quarter results of Aeolus LP, the Company estimates that it will record in its 2012 first quarter results a loss in the range of $8 million to $10 million with respect to this investment. However, actual losses may vary materially from the estimates due to the inherent uncertainties in making estimates for catastrophic events, as discussed earlier.

In addition, the Company’s 2012 first quarter results will be impacted by the January 2012 Costa Concordia marine event. Although it is early in the estimation process, the Company’s preliminary estimate of losses for the event is in the range of $18 million to $35 million, net of reinsurance and reinstatement premiums. The Company’s estimates for the Costa Concordia event is based, in part, on preliminary estimates of industry insured losses ranging from $850 million to $2.0 billion. The Company’s actual losses from this event may vary materially from the estimates due to the inherent uncertainties in making such determinations.

For 2011, the Company’s effective tax rates on income before income taxes and pre-tax operating income were a benefit of 2.2% and 3.7%, respectively, compared to an expense of 0.9% and 0.5%, respectively, for 2010. The Company’s effective tax rates may fluctuate from period to period based on the relative mix of income or loss reported by jurisdiction and the varying tax rates in each jurisdiction. The Company’s quarterly tax provision is adjusted to reflect changes in its expected annual effective tax rate, if any. In addition, the Company’s Bermuda-based reinsurer incurs federal excise taxes for premiums assumed on U.S. risks. The Company incurred $9.3 million of federal excise taxes for 2011, compared to $11.5 million for 2010. Such amounts are reflected as acquisition expenses in the Company’s consolidated statements of income.

Net unrealized foreign exchange gains or losses result from the effects of revaluing the Company’s net insurance liabilities required to be settled in foreign currencies at each balance sheet date. Historically, the Company has held investments in foreign currencies which are intended to mitigate its exposure to foreign currency fluctuations in its net insurance liabilities. However, changes in the value of such investments due to foreign currency rate movements are reflected as a direct increase or decrease to shareholders’ equity and are not included in the consolidated statements of income. As a result of the current financial and economic environment as well as the potential for additional investment returns, the Company may not match a portion of its projected liabilities in foreign currencies with investments in the same currencies, which could increase the Company’s exposure to foreign currency fluctuations and increase the volatility of the Company’s shareholders’ equity.

Net foreign exchange gains for the 2011 fourth quarter were $12.6 million (net unrealized gains of $16.4 million and net realized losses of $3.8 million), compared to net foreign exchange gains for the 2010 fourth quarter of $6.0 million (net unrealized gains of $8.5 million and net realized losses of $2.5 million). Net foreign exchange gains for 2011 were $17.4 million (net unrealized gains of $23.5 million and net realized losses of $6.1 million), compared to net foreign exchange gains for 2010 of $28.1 million (net unrealized gains of $29.5 million and net realized losses of $1.4 million). The 2011 fourth quarter net foreign exchange gains primarily resulted from the strengthening of the U.S. Dollar against the Euro during the period.

At December 31, 2011, the Company’s capital of $5.03 billion consisted of $300.0 million of senior notes, representing 6.0% of the total, $100.0 million of revolving credit agreement borrowings due in August 2014, representing 2.0% of the total, $325.0 million of preferred shares, representing 6.5% of the total, and common shareholders’ equity of $4.30 billion, representing the balance. At December 31, 2010, the Company’s capital of $4.91 billion consisted of $300.0 million of senior notes, representing 6.1% of the total, $100.0 million of revolving credit agreement borrowings, representing 2.0% of the total, $325.0 million of preferred shares, representing 6.6% of the total, and common shareholders’ equity of $4.19 billion, representing the balance.

The Company will hold a conference call for investors and analysts at 11:00 a.m. Eastern Time on Wednesday, February 15, 2012. A live webcast of this call will be available via the Investor Relations – Events & Presentations section of the Company's website at http://www.archcapgroup.bm. A telephone replay of the conference call also will be available beginning on February 15 at 1:00 p.m. Eastern Time until February 22, 2012 at midnight Eastern Time. To access the replay, domestic callers should dial 888-286-8010 (passcode 31165287), and international callers should dial 617-801-6888 (passcode 31165287).

Please refer to the Company’s Financial Supplement dated December 31, 2011, which is posted on the Company’s website at http://www.archcapgroup.bm/EarningsReleases.aspx. The Financial Supplement provides additional detail regarding the financial performance of the Company. From time to time, the Company posts additional financial information and presentations to its website, including information with respect to its subsidiaries. Investors and other recipients of this information are encouraged to check the Company’s website regularly, including the Investor Relations — Events & Presentations section of the Company’s website at http://www.archcapgroup.bm/presentations.aspx for additional information regarding the Company.

Arch Capital Group Ltd., a Bermuda-based company with approximately $5.03 billion in capital at December 31, 2011, provides insurance and reinsurance on a worldwide basis through its wholly owned subsidiaries.

Cautionary Note Regarding Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995 (“PSLRA”) provides a “safe harbor” for forward-looking statements. This release or any other written or oral statements made by or on behalf of the Company may include forward-looking statements, which reflect the Company’s current views with respect to future events and financial performance. All statements other than statements of historical fact included in or incorporated by reference in this release are forward-looking statements. Forward-looking statements, for purposes of the PSLRA 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 the Company’s current assessment of risks and uncertainties. Actual events and results may differ materially from those expressed or implied in these statements. Important factors that could cause actual events or results to differ materially from those indicated in such statements are discussed below and elsewhere in this release and in the Company’s periodic reports filed with the Securities and Exchange Commission (the “SEC”), and include:

• the Company’s ability to successfully implement its business strategy during “soft” as well as “hard” markets;
• acceptance of the Company’s business strategy, security and financial condition by rating agencies and regulators, as well as by brokers and its insureds and reinsureds;
• the Company’s ability to maintain or improve its ratings, which may be affected by its ability to raise additional equity or debt financings, by ratings agencies’ existing or new policies and practices, as well as other factors described herein;
• general economic and market conditions (including inflation, interest rates, foreign currency exchange rates, prevailing credit terms and the depth and duration of a recession) and conditions specific to the reinsurance and insurance markets (including the length and magnitude of the current “soft” market) in which the Company operates;
• competition, including increased competition, on the basis of pricing, capacity, coverage terms or other factors;
• developments in the world’s financial and capital markets and the Company’s access to such markets;
• the Company’s ability to successfully enhance, integrate and maintain operating procedures (including information technology) to effectively support its current and new business;
• the loss of key personnel;
• the integration of businesses the Company has acquired or may acquire into its existing operations;
• accuracy of those estimates and judgments utilized in the preparation of the Company’s financial statements, including those related to revenue recognition, insurance and other reserves, reinsurance recoverables, investment valuations, intangible assets, bad debts, income taxes, contingencies and litigation, and any determination to use the deposit method of accounting, which for a relatively new insurance and reinsurance company, like the Company, are even more difficult to make than those made in a mature company since relatively limited historical information has been reported to the Company through December 31, 2011;
• greater than expected loss ratios on business written by the Company and adverse development on claim and/or claim expense liabilities related to business written by its insurance and reinsurance subsidiaries;
• severity and/or frequency of losses;
• claims for natural or man-made catastrophic events in the Company’s insurance or reinsurance business could cause large losses and substantial volatility in its results of operations;
• acts of terrorism, political unrest and other hostilities or other unforecasted and unpredictable events;
• availability to the Company of reinsurance to manage its gross and net exposures and the cost of such reinsurance;
• the failure of reinsurers, managing general agents, third party administrators or others to meet their obligations to the Company;
• the timing of loss payments being faster or the receipt of reinsurance recoverables being slower than anticipated by the Company;
• the Company’s investment performance, including legislative or regulatory developments that may adversely affect the fair value of the Company’s investments;
• the impact of the continued weakness of the U.S., European countries and other key economies, projected budget deficits for the U.S., European countries and other governments and the consequences associated with possible additional downgrades of securities of the U.S., European countries and other governments by credit rating agencies, and the resulting effect on the value of securities in the Company’s investment portfolio as well as the uncertainty in the market generally;
• losses relating to aviation business and business produced by a certain managing underwriting agency for which the Company may be liable to the purchaser of its prior reinsurance business or to others in connection with the May 5, 2000 asset sale described in the Company’s periodic reports filed with the SEC;
• changes in accounting principles or policies or in the Company’s application of such accounting principles or policies;
• changes in the political environment of certain countries in which the Company operates, underwrites business or invests;
• 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 the Company, its subsidiaries, brokers or customers; and
• the other matters set forth under Item 1A “Risk Factors”, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other sections of the Company’s Annual Report on Form 10-K, as well as the other factors set forth in the Company’s other documents on file with the SEC, and management’s response to any of the aforementioned factors.

All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by these cautionary statements. The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with other cautionary statements that are included herein or elsewhere. The Company undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

Comment on Regulation G

Throughout this release, the Company presents its operations in the way it believes will be the most meaningful and useful to investors, analysts, rating agencies and others who use the Company’s financial information in evaluating the performance of the Company. This presentation includes the use of after-tax operating income available to common shareholders, which is defined as net income available to common shareholders, excluding net realized gains or losses, 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 on page 2 of this release.

The Company believes 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, the Company’s business performance. 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 the Company’s 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 the Company’s 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 the Company’s investments represent other-than-temporary declines in expected recovery values on securities without actual realization. The use of the equity method on certain of the Company’s 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 the Company’s proportionate share of the net income or loss of the funds (which include changes in the fair value of the underlying securities in the funds). This method of accounting is different from the way the Company accounts for its 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, the Company excludes 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.

The Company believes that showing net income available to common shareholders exclusive of the items referred to above reflects the underlying fundamentals of the Company’s business since the Company evaluates the performance of and manages its business to produce an underwriting profit. In addition to presenting net income available to common shareholders, the Company believes that this presentation enables investors and other users of the Company’s financial information to analyze the Company’s performance in a manner similar to how the Company’s management analyzes performance. The Company also believes that this measure follows industry practice and, therefore, allows the users of the Company’s financial information to compare the Company’s performance with its industry peer group. The Company believes that the equity analysts and certain rating agencies which follow the Company and the insurance industry as a whole generally exclude these items from their analyses for the same reasons.

  ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES SUPPLEMENTAL FINANCIAL INFORMATION     Book Value Per Common Share   December 31, December 31, (U.S. dollars in thousands, except share data) 2011 2010   Calculation of book value per common share: Total shareholders’ equity $ 4,628,486 $ 4,513,003 Less preferred shareholders’ equity   (325,000)   (325,000) Common shareholders’ equity $ 4,303,486 $ 4,188,003 Common shares outstanding, net of treasury shares (1)   134,358,345   139,632,225 Book value per common share $ 32.03 $ 29.99 (1)   Excludes the effects of 8,706,441 and 12,251,568 stock options and 298,425 and 519,534 restricted stock units outstanding at December 31, 2011 and December 31, 2010, respectively. Share Repurchase Activity             Three Months Ended Year Ended Cumulative (U.S. dollars in thousands, December 31, December 31, December 31, except share data) 2011 2010 2011 2010 2011   Effect of share repurchases: Aggregate cost of shares repurchased $ 3 $ 258,151 $ 287,561 $ 761,874 $ 2,558,033 Shares repurchased   100   8,679,051   9,600,216   29,244,666   104,758,218 Average price per share repurchased $ 31.51 $ 29.74 $ 29.95 $ 26.05 $ 24.42 Estimated net accretive impact on diluted earnings per share (1) $ 0.32 $ 0.25 $ 0.63 $ 0.80 Estimated net accretive impact on ending book value per common share (2) $ 3.33   Remaining share repurchase authorization $ 941,967 (1)   The estimated impact on diluted earnings per share was calculated comparing reported results versus (i) after-tax operating income per share plus an estimate of lost net investment income on the cumulative share repurchases divided by (ii) weighted average diluted shares outstanding excluding the weighted average impact of cumulative share repurchases. The impact of cumulative share repurchases was accretive to diluted earnings per share in the periods presented. (2) As the cumulative average price per share of shares repurchased through December 31, 2011 was lower than the ending book value per common share, the repurchase of shares increased ending book value per common share. Investment Information           Three Months Ended Year Ended December 31, December 31, (U.S. dollars in thousands, except share data) 2011 2010 2011 2010   Components of net investment income: Fixed maturities $ 79,219 $ 92,631 $ 331,469 $ 378,682 Equity securities 2,145 953 7,332 1,363 Short-term investments 561 379 2,174 1,337 Other (1) 4,381 1,586 22,006 3,882 Gross investment income 86,306 95,549 362,981 385,264 Investment expense   (5,839)   (4,948)   (24,783)   (20,386) Net investment income $ 80,467 $ 90,601 $ 338,198 $ 364,878   Per share $ 0.59 $ 0.60 $ 2.45 $ 2.32   Investment income yield, at amortized cost (2): Pre-tax 2.72% 3.24% 2.89% 3.34% After-tax 2.61% 3.13% 2.77% 3.23%   Total return (3): Including effects of foreign exchange 0.82% (0.07%) 3.81% 7.00% Excluding effects of foreign exchange 0.95% (0.04%) 4.10% 7.26%   Cash flow from operations $ 109,641 $ 144,513 $ 866,112 $ 802,074 (1)   Includes interest on term loan investments (included in “investments accounted for using the fair value option”), dividends on investment funds and other items. (2) Investment income yield calculations exclude the impact of investments for which returns are not included within investment income, such as investments accounted for using the equity method and certain equities. (3) 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 or losses generated by the Company’s investment portfolio. Total return is calculated on a pre-tax basis and before investment expenses. Investment Information (continued)       December 31, December 31, (U.S. dollars in thousands) 2011 2010   Investable assets: Fixed maturities available for sale, at fair value $ 9,375,604 $ 8,957,859 Fixed maturities, at fair value (1) 147,779 124,969 Fixed maturities pledged under securities lending agreements, at fair value (2)   56,393   75,575 Total fixed maturities 9,579,776 9,158,403 Short-term investments available for sale, at fair value 904,219 915,841 Cash 351,699 362,740 Equity securities available for sale, at fair value 299,584 310,194 Equity securities, at fair value (1) 87,403 94,204 Other investments available for sale, at fair value 238,111 275,538 Other investments, at fair value (1) 131,721 - TALF investments, at fair value (3) 387,702 402,449 Investments accounted for using the equity method (4) 380,507 508,334 Securities sold but not yet purchased (5) (27,178) (41,143) Securities transactions entered into but not settled at the balance sheet date   (17,339)   (144,047) Total investable assets $ 12,316,205 $ 11,842,513   Investment portfolio statistics (2): Average effective duration (in years) 2.99 2.83 Average credit quality (Standard and Poors/Moody's Investors Service) AA/Aa1 AA+/Aa1 Imbedded book yield (before investment expenses) 2.98% 3.52% (1)   Represents securities which are carried at fair value under the fair value option and reflected as “investments accounted for using the fair value option” on the Company’s balance sheet. Changes in the carrying value of such securities are recorded in net realized gains or losses. (2) This table excludes the collateral received and reinvested and includes the fixed maturities and short-term investments pledged under securities lending agreements, at fair value. (3) The Federal Reserve's Term Asset-Backed Securities Loan Facility ("TALF") provides secured financing for certain asset-backed securities and legacy commercial mortgage-backed securities. TALF financing is non-recourse to the Company, 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 the Federal Reserve in full defeasance of the loan. (4) Changes in the carrying value of investment funds accounted for using the equity method are recorded as “equity in net income (loss) of investments funds accounted for using the equity method” rather than as an unrealized gain or loss component of accumulated other comprehensive income. (5) Represents the Company’s obligation to deliver securities that it did not own at the time of sale. Such amounts are included in “other liabilities” on the Company’s balance sheet. Selected Information on Losses and Loss Adjustment Expenses         Three Months Ended Year Ended December 31, December 31, (U.S. dollars in thousands) 2011 2010 2011 2010   Components of losses and loss adjustment expenses incurred Paid losses and loss adjustment expenses $ 438,871 $ 369,054 $ 1,452,623 $ 1,307,285 Change in unpaid losses and loss adjustment expenses   (60,804)   (1,728)   274,930   210,430 Total losses and loss adjustment expenses $ 378,067 $ 367,326 $ 1,727,553 $ 1,517,715   Estimated net (favorable) adverse development in prior year loss reserves, net of related adjustments Net impact on underwriting results: Insurance $ (21,199) $ (7,081) $ (44,255) $ (12,456) Reinsurance   (80,068)   (31,396)   (231,205)   (125,638) Total $ (101,267) $ (38,477) $ (275,460) $ (138,094)   Impact on losses and loss adjustment expenses: Insurance $ (24,017) $ (5,794) $ (52,119) $ (19,101) Reinsurance   (80,381)   (32,711)   (232,896)   (127,595) Total $ (104,398) $ (38,505) $ (285,015) $ (146,696)   Impact on acquisition expenses: Insurance $ 2,818 $ (1,287) $ 7,864 $ 6,645 Reinsurance   313   1,315   1,691   1,957 Total $ 3,131 $ 28 $ 9,555 $ 8,602   Impact on combined ratio: Insurance (5.0%) (1.8%) (2.6%) (0.8%) Reinsurance (32.0%) (13.8%) (24.3%) (13.9%) Total (15.0%) (6.1%) (10.5%) (5.4%)   Impact on loss ratio: Insurance (5.7%) (1.4%) (3.1%) (1.2%) Reinsurance (32.1%) (14.4%) (24.4%) (14.2%) Total (15.5%) (6.1%) (10.8%) (5.7%)   Impact on acquisition expense ratio: Insurance 0.7% (0.4%) 0.5% 0.4% Reinsurance 0.1% 0.6% 0.1% 0.3% Total 0.5% 0.0% 0.3% 0.3%   Estimated net losses incurred from current accident year catastrophic events (1) Insurance $ 28,216 $ 1,147 $ 109,126 $ 30,958 Reinsurance   42,571   29,830   294,977   89,271 Total $ 70,787 $ 30,977 $ 404,103 $ 120,229   Impact on loss ratio: Insurance 6.7% 0.3% 6.5% 1.9% Reinsurance 17.0% 13.1% 31.0% 9.9% Total 10.5% 4.9% 15.4% 4.7% (1)   Equals estimated losses from catastrophic events occurring in the current accident year, net of reinsurance and reinstatement premiums. Amounts shown for the insurance segment are for named catastrophic events only. Amounts shown for the reinsurance segment include (i) named events with over $5 million of losses incurred by its Bermuda and Europe operations and (ii) all catastrophe losses incurred by its U.S. operations.

Segment Information

The following section provides analysis on the Company’s 2011 fourth quarter performance by operating segment. For additional details regarding the Company’s operating segments, please refer to the Company’s Financial Supplement dated December 31, 2011 on the Company’s website at http://www.archcapgroup.bm/EarningsReleases.aspx.

Insurance Segment

  Three Months Ended December 31, (U.S. dollars in thousands) 2011   2010   % Change   Gross premiums written $ 540,617 $ 527,783 2.4 Net premiums written 360,739 351,841 2.5 Net premiums earned 422,667 404,275 4.5 Underwriting loss (11,569) (5,793) n/m   % Point Underwriting Ratios Change Loss ratio 66.9% 65.5% 1.4 Acquisition expense ratio 17.3% 15.4% 1.9 Other operating expense ratio   18.5%   20.5% (2.0) Combined ratio   102.7%   101.4% 1.3   Catastrophic activity and prior year development: Current accident year catastrophic events 6.7% 0.3% 6.4 Net (favorable) adverse development in prior year loss reserves, net of related adjustments   (5.0%)   (1.8%) (3.2) Combined ratio excluding such items   101.0%   102.9% (1.9)

Gross premiums written by the insurance segment in the 2011 fourth quarter were 2.4% higher than in the 2010 fourth quarter, while net premiums written were 2.5% higher than in the 2010 fourth quarter. The growth in net premiums written reflected increases in national accounts, surety, executive assurance and construction lines, partially offset by a lower level of lenders products business. The higher level of national accounts and construction business primarily resulted from new business written while the increase in surety business was due, in part, from a reduction in amounts ceded to reinsurers in 2011. Growth in executive assurance primarily resulted from a continued focus on middle market business and a shift towards private company business which is subject to a lower level of ceded reinsurance. The decrease in lenders products business written in the 2010 fourth quarter reflected certain premium items which did not recur in 2011. Net premiums earned by the insurance segment in the 2011 fourth quarter were 4.5% higher than in the 2010 fourth quarter, and reflect changes in net premiums written over the previous five quarters.

The 2011 fourth quarter combined ratio reflected 6.7 points of current year catastrophic event activity, with 7.7 points related to the severe flooding in Thailand partially offset by a net reduction in losses related to catastrophic events from the first nine months of 2011. Estimated net favorable development in prior year loss reserves, before related adjustments, reduced the loss ratio by 5.7 points in the 2011 fourth quarter, compared to 1.4 points in the 2010 fourth quarter. The estimated net favorable development in the 2011 fourth quarter primarily resulted from better than expected claims emergence in property and other short-tail and medium-tail lines.

The underwriting expense ratio was 35.8% in the 2011 fourth quarter, compared to 35.9% in the 2010 fourth quarter. The acquisition expense ratio was 17.3% in the 2011 fourth quarter, compared to 15.4% in the 2010 fourth quarter. The 2011 fourth quarter acquisition expense ratio included an increase of 0.7 points of commission expense related to the estimated net favorable development in prior year loss reserves, compared to a 0.4 point reduction in the 2010 fourth quarter. The operating expense ratio was 18.5% in the 2011 fourth quarter, compared to 20.5% in the 2010 fourth quarter, primarily due to employee benefit costs recorded in the 2010 fourth quarter which did not recur in 2011.

Reinsurance Segment           Three Months Ended December 31, (U.S. dollars in thousands) 2011 2010 % Change   Gross premiums written $ 161,904 $ 139,015 16.5 Net premiums written 150,385 131,070 14.7 Net premiums earned 250,525 227,871 9.9 Underwriting income 78,615 54,149 45.2   % Point Underwriting Ratios Change Loss ratio 38.0% 45.0% (7.0) Acquisition expense ratio 19.7% 18.3% 1.4 Other operating expense ratio   11.0%   13.9% (2.9) Combined ratio   68.7%   77.2% (8.5)   Catastrophic activity and prior year development: Current accident year catastrophic events 17.0% 13.1% 3.9 Net (favorable) adverse development in prior year loss reserves, net of related adjustments   (32.0%)   (13.8%) (18.2) Combined ratio excluding such items   83.7%   77.9% 5.8

Gross premiums written by the reinsurance segment in the 2011 fourth quarter were 16.5% higher than in the 2010 fourth quarter, while net premiums written were 14.7% higher than in the 2010 fourth quarter, reflecting increases in other specialty and property catastrophe lines. The growth in other specialty lines primarily resulted from a new opportunity in U.K. motor and an increase recorded in accident and health business. The higher level of property catastrophe business primarily resulted from new business written following the 2011 fourth quarter catastrophic events. Premiums written in property other than property catastrophe, excluding facultative reinsurance, and marine and aviation business were lower than in the 2010 fourth quarter, reflecting non-renewals and share reductions based on market conditions. Net premiums earned in the 2011 fourth quarter were 9.9% higher than in the 2010 fourth quarter, and reflect changes in net premiums written over the previous five quarters, including the mix and type of business written.

The 2011 fourth quarter combined ratio reflected 17.0 points of current year catastrophic activity, with 11.1 points related to the severe flooding in Thailand, 2.8 points from the Australian hailstorm and other attritional events in the 2011 fourth quarter, and the remainder related to catastrophic events from the first nine months of 2011. The 2010 fourth quarter ratio included 13.1 points of catastrophic activity. In addition, the 2010 fourth quarter loss ratio reflected a lower than expected level of attritional losses which benefited the period. Estimated net favorable development in prior year loss reserves, before related adjustments, reduced the loss ratio by 32.1 points in the 2011 fourth quarter, compared to 14.4 points in the 2010 fourth quarter. The estimated net favorable development in the 2011 fourth quarter primarily resulted from better than expected claims emergence in property and other short-tail reserves and in casualty reserves from the 2004 to 2007 underwriting years.

The underwriting expense ratio was 30.7% in the 2011 fourth quarter, compared to 32.2% in the 2010 fourth quarter. The acquisition expense ratio for the 2011 fourth quarter was 19.7%, compared to 18.3% for the 2010 fourth quarter. The comparison of the 2011 fourth quarter and 2010 fourth 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 operating expense ratio was 11.0% in the 2011 fourth quarter, compared to 13.9% in the 2010 fourth quarter. The 2010 fourth quarter operating expense ratio reflected an increase in the accrual for incentive compensation costs which added approximately 2.8 points to the ratio.

  ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (U.S. dollars in thousands, except share data)     Three Months Ended Year Ended December 31, December 31, 2011   2010 2011   2010 Revenues Net premiums written $ 511,124 $ 482,911 $ 2,673,326 $ 2,511,040 Change in unearned premiums   162,068   149,235   (41,511)   41,443 Net premiums earned 673,192 632,146 2,631,815 2,552,483 Net investment income 80,467 90,601 338,198 364,878 Net realized gains 14,542 74,027 110,646 252,751   Other-than-temporary impairment losses (3,443) (3,341) (13,850) (13,073) Less investment impairments recognized in other comprehensive income, before taxes   1,484   111   4,788   1,752 Net impairment losses recognized in earnings (1,959) (3,230) (9,062) (11,321)   Fee income 982 2,814 3,429 5,365 Equity in net income (loss) of investment funds accounted for using the equity method (14,702) 22,990 (9,605) 61,400 Other income (loss)   (4,848)   6,165   (2,114)   18,511 Total revenues   747,674   825,513   3,063,307   3,244,067   Expenses Losses and loss adjustment expenses 378,067 367,326 1,727,553 1,517,715 Acquisition expenses 123,339 104,824 462,937 441,202 Other operating expenses 112,499 121,335 431,480 432,795 Interest expense 8,087 7,460 31,691 30,007 Net foreign exchange gains   (12,613)   (6,039)   (17,366)   (28,108) Total expenses   609,379   594,906   2,636,295   2,393,611   Income before income taxes 138,295 230,607 427,012 850,456   Income tax (benefit) expense   (4,977)   (3,505)   (9,346)   7,868   Net income 143,272 234,112 436,358 842,588   Preferred dividends   6,461   6,461   25,844   25,844   Net income available to common shareholders $ 136,811 $ 227,651 $ 410,514 $ 816,744   Net income per common share Basic $ 1.03 $ 1.59 $ 3.10 $ 5.43 Diluted $ 1.00 $ 1.51 $ 2.97 $ 5.18   Weighted average common shares and common share equivalents outstanding Basic 132,612,528 143,320,146 132,221,970 150,545,148 Diluted 137,473,670 150,306,429 138,289,702 157,565,157   ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (U.S. dollars in thousands, except share data)     December 31,   December 31, 2011 2010 Assets Investments: Fixed maturities available for sale, at fair value (amortized cost: $9,165,438 and $8,771,988) $ 9,375,604 $ 8,957,859 Short-term investments available for sale, at fair value (amortized cost: $909,121 and $913,488) 904,219 915,841 Investment of funds received under securities lending, at fair value (amortized cost: $48,577 and $69,682) 48,419 69,660 Equity securities available for sale, at fair value (cost: $299,058 and $292,958) 299,584 310,194 Other investments available for sale, at fair value (cost: $235,381 and $252,590) 238,111 275,538 Investments accounted for using the fair value option 366,903 219,173 TALF investments, at fair value (amortized cost: $373,040 and $389,200) 387,702 402,449 Investments accounted for using the equity method 380,507 508,334 Total investments 12,001,049 11,659,048   Cash 351,699 362,740 Accrued investment income 70,739 74,837 Investment in joint venture (cost: $100,000) 107,576 105,698 Fixed maturities and short-term investments pledged under securities lending, at fair value 56,393 75,575 Premiums receivable 501,563 503,434 Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses 1,851,584 1,763,985 Contractholder receivables 748,231 660,546 Prepaid reinsurance premiums 265,696 263,448 Deferred acquisition costs, net 279,109 277,861 Receivable for securities sold 462,891 56,145 Other assets   445,239   475,911 Total Assets $ 17,141,769 $ 16,279,228   Liabilities Reserve for losses and loss adjustment expenses $ 8,456,210 $ 8,098,454 Unearned premiums 1,411,872 1,370,075 Reinsurance balances payable 133,866 132,452 Contractholder payables 748,231 660,546 Senior notes 300,000 300,000 Revolving credit agreement borrowings 100,000 100,000 TALF borrowings, at fair value (par: $310,868 and $326,219) 310,486 325,770 Securities lending payable 58,546 78,021 Payable for securities purchased 480,230 200,192 Other liabilities   513,842   500,715 Total Liabilities $ 12,513,283 $ 11,766,225   Commitments and Contingencies   Shareholders’ Equity Non-cumulative preferred shares - Series A and B 325,000 325,000 Common shares ($0.0033 par, shares issued: 164,636,338 and 160,073,616) 549 534 Additional paid-in capital 161,419 110,325 Retained earnings 4,833,067 4,422,553 Accumulated other comprehensive income, net of deferred income tax 153,923 204,503 Common shares held in treasury, at cost (shares: 30,277,993 and 20,441,391)   (845,472)   (549,912) Total Shareholders’ Equity   4,628,486   4,513,003 Total Liabilities and Shareholders’ Equity $ 17,141,769 $ 16,279,228