Arch Capital Group Ltd. (NASDAQ:ACGL) reports that net income
available to Arch common shareholders for the 2014 second quarter
was $202.5 million, or $1.48 per share, compared to $171.5 million,
or $1.26 per share, for the 2013 second quarter. The Company also
reported after-tax operating income available to Arch common
shareholders of $160.7 million, or $1.17 per share, for the 2014
second quarter, compared to after-tax operating income available to
Arch common shareholders of $135.0 million, or $0.99 per share, for
the 2013 second quarter. The Company’s after-tax operating income
available to Arch common shareholders represented an annualized
return on average common equity of 11.2% for the 2014 second
quarter, compared to 10.9% for the 2013 second quarter. The
Company’s net income available to Arch common shareholders
represented an annualized return on average common equity of 14.1%
for the 2014 second quarter, compared to 13.8% for the 2013 second
quarter. The Company’s book value per common share was $43.73 at
June 30, 2014, a 5.3% increase from $41.52 per share at March 31,
2014 and an 18.8% increase from $36.80 per share at June 30,
2013.
After-tax operating income or loss available to Arch common
shareholders, a non-GAAP measure, is defined as net income
available to Arch 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 ‘Comments on Regulation G’ for a further
discussion of after-tax operating income or loss available to Arch
common shareholders. All earnings per share amounts discussed in
this release are on a diluted basis.
In March 2014, the Company invested $100.0 million to acquire
approximately 11% of Watford Holdings Ltd.’s common equity and a
warrant to purchase additional common equity. Watford Holdings Ltd.
is the parent of Watford Re Ltd., a multi-line Bermuda reinsurance
company (together with Watford Holdings Ltd., “Watford”). Watford
is considered a variable interest entity and the Company concluded
that it is the primary beneficiary of Watford in accordance with
GAAP. As such, 100% of the results of Watford are included in the
Company’s consolidated financial statements. Watford, which is
included in the ‘other’ segment, reported $51.8 million of net
premiums written and a net loss attributable to common shareholders
of $1.4 million (net income less dividends attributable to
redeemable noncontrolling interests) for the 2014 second quarter.
For additional details regarding Watford, please refer to the
Company’s Financial Supplement dated June 30, 2014. All discussions
of line items in this release exclude the ‘other’ segment
amounts.
The following table summarizes the Company’s underwriting
results (excluding the ‘other’ segment). For a discussion of
underwriting activities and a review of the Company’s results by
operating segment, see the “Segment Information” section of this
release.
Three Months Ended June 30, Six
Months Ended June 30, (U.S. dollars in thousands)
2014 2013
% Change 2014
2013 %
Change Gross premiums written $ 1,256,934
$ 1,040,738 20.8 $ 2,552,070 $ 2,204,437 15.8 Net
premiums written 920,126 810,535 13.5 1,952,922 1,763,311 10.8 Net
premiums earned 894,172 758,816 17.8 1,751,786 1,511,586 15.9
Underwriting income 125,133 96,029 30.3 258,711 212,427 21.8
Underwriting Ratios
% PointChange
% PointChange
Loss ratio 53.4 % 55.2 % (1.8 ) 52.1 % 54.1 % (2.0 )
Acquisition expense ratio 17.2 % 17.3 % (0.1 ) 17.8 % 17.1 % 0.7
Other operating expense ratio 15.6 % 14.9 % 0.7 15.5 % 14.8
% 0.7 Combined ratio 86.2 % 87.4 % (1.2 ) 85.4 % 86.0 % (0.6
)
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 Arch common shareholders
to net income available to Arch common shareholders and related
diluted per share results:
Three Months Ended Six Months Ended June
30, June 30, (U.S. dollars in thousands, except share
data)
2014 2013
2014 2013
After-tax operating income available to Arch common shareholders $
160,669 $ 135,021 $ 325,073 $ 293,769
Net realized gains, net of tax 50,267 13,779 68,540 68,702 Net
impairment losses recognized in earnings, net of tax (14,749 ) (724
) (17,720 ) (2,970 )
Equity in net income of investment funds
accounted for using the equitymethod, net of tax
9,054 10,941 12,218 24,764 Net foreign exchange gains (losses), net
of tax (2,710 ) 12,438 (8,564 ) 38,182 Net income
available to Arch common shareholders $ 202,531 $
171,455 $ 379,547 $ 422,447
Diluted per common
share results:
After-tax operating income available to Arch common shareholders $
1.17 $ 0.99 $ 2.38 $ 2.17 Net realized gains, net of tax 0.37 0.10
0.50 0.50 Net impairment losses recognized in earnings, net of tax
(0.11 ) — (0.13 ) (0.02 )
Equity in net income of investment funds
accounted for using the equitymethod, net of tax
0.07 0.08 0.09 0.18 Net foreign exchange gains (losses), net of tax
(0.02 ) 0.09 (0.06 ) 0.28 Net income available to
Arch common shareholders $ 1.48 $ 1.26
$ 2.78 $ 3.11
Weighted average common shares and common
share equivalentsoutstanding - diluted
136,889,944 135,849,050 136,716,889 135,624,226
The Company’s investment portfolio continues to be comprised
primarily of high quality fixed income securities with an average
credit quality of “AA/Aa2.” The average effective duration of the
Company’s investment portfolio was 3.14 years at June 30, 2014,
compared to 2.62 years at December 31, 2013. Including the effects
of foreign exchange, total return on the Company’s investment
portfolio was 1.80% for the 2014 second quarter, compared to
(1.59)% for the 2013 second quarter. Excluding the effects of
foreign exchange, total return was 1.63% for the 2014 second
quarter, compared to (1.56)% for the 2013 second quarter.
Net investment income for the 2014 second quarter was $72.5
million, or 0.53 per share, compared to $67.0 million, or 0.49 per
share, for the 2014 first quarter, and $68.4 million, or 0.50 per
share, for the 2013 second quarter. Investment income for the 2014
second quarter included a $4.1 million interest income distribution
received on a fund investment. The annualized pre-tax investment
income yield was 2.05% for the 2014 second quarter, excluding the
interest income distribution noted above, compared to 2.08% for the
2014 first quarter and 2.20% for the 2013 second quarter. Such
yields reflect the effects of low prevailing interest rates
available in the market and the Company’s investment strategy,
which puts an emphasis on total return. Consolidated cash flow
provided by operating activities was $254.2 million for the 2014
second quarter, compared to $182.7 million for the 2013 second
quarter, primarily reflecting an increase in premiums
collected.
The Company recorded after-tax net impairment losses on
investments of $14.7 million in the 2014 second quarter. Such
amount was primarily related to two fund investments and followed a
review of various factors in accordance with GAAP, including the
time period in which there was a significant decline in value. The
Company also recorded $4.9 million of other income in the 2014
second quarter. Such amount was primarily due to a non-recurring
income item.
On a pre-tax basis, net foreign exchange losses for the 2014
second quarter were $2.8 million (net unrealized losses of $2.1
million and net realized losses of $0.7 million), compared to net
foreign exchange gains for the 2013 second quarter of $13.8 million
(net unrealized gains of $21.6 million and net realized losses of
$7.8 million). Net unrealized foreign exchange gains or losses
result from the effects of revaluing the Company’s net insurance
liabilities required to be settled in foreign currencies at each
balance sheet date. Changes in the value of available-for-sale
investments held in foreign currencies 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. The Company has not matched a portion of its
projected liabilities in foreign currencies with investments in the
same currencies and may not match such amounts in future periods,
which could increase the Company’s exposure to foreign currency
fluctuations and increase the volatility of the Company’s
shareholders’ equity.
The Company’s effective tax rate on income before income taxes
was 3.3% for the 2014 second quarter and 2.7% for the six months
ended June 30, 2014, compared to 2.8% for the 2013 second quarter
and 2.2% for the six months ended June 30, 2013. The Company’s
effective tax rate on pre-tax operating income available to Arch
shareholders was 3.6% for the 2014 second quarter and 2.6% for the
six months ended June 30, 2014, compared to 3.3% for the 2013
second quarter and 2.5% for the six months ended June 30, 2013. The
Company’s quarterly tax provision is adjusted to reflect changes in
its estimated annual effective tax rate, if any. The adjustment to
the estimated annual effective tax rate in the 2014 second quarter
reduced the Company’s after-tax results by $1.4 million, or
$0.01 per share.
At June 30, 2014, total capital available to Arch of $7.13
billion consisted of $800.0 million of senior notes, representing
11.2% of the total, $100.0 million of revolving credit agreement
borrowings due in June 2019, representing 1.4% of the total, $325.0
million of preferred shares, representing 4.6% of the total, and
common shareholders’ equity of $5.90 billion, representing 82.8% of
the total. At December 31, 2013, total capital available to Arch of
$6.55 billion consisted of $800.0 million of senior notes,
representing 12.2% of the total, $100.0 million of revolving credit
agreement borrowings, representing 1.5% of the total, $325.0
million of preferred shares, representing 5.0% of the total, and
common shareholders’ equity of $5.32 billion, representing 81.3% of
the total.
The Company will hold a conference call for investors and
analysts at 11:00 a.m. Eastern Time on August 1, 2014. A live
webcast of this call will be available via the Investors section of
the Company’s website at http://www.archcapgroup.com. A telephone replay of
the conference call also will be available beginning on August 1,
2014 at 3:00 p.m. Eastern Time until August 8, 2014 at midnight
Eastern Time. To access the replay, domestic callers should dial
888-286-8010 (passcode 91603488), and international callers should
dial 617-801-6888 (passcode 91603488).
Please refer to the Company’s Financial Supplement dated June
30, 2014, which is available via the Investors section of the
Company’s website at http://www.archcapgroup.com. 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 for additional information
regarding the Company.
Arch Capital Group Ltd., a Bermuda-based company with
approximately $7.13 billion in capital at June 30, 2014, provides
insurance and reinsurance on a worldwide basis through its wholly
owned subsidiaries.
Supplemental Information
Book Value Per
Common Share
(U.S. dollars in thousands, except share data)
June 30, 2014
December 31, 2013
Calculation of book value per common share: Total
shareholders’ equity available to Arch $ 6,229,399 $
5,647,496 Less preferred shareholders’ equity 325,000
325,000 Common shareholders’ equity available to Arch 5,904,399
5,322,496 Common shares outstanding, net of treasury shares (1)
135,030,886 133,674,884 Book value per common share $
43.73 $ 39.82 (1) Excludes the effects
of 8,282,092 and 8,338,480 stock options and 460,217 and 443,710
restricted stock units outstanding at June 30, 2014 and December
31, 2013, respectively.
Investment
Information
Three Months Ended Six Months Ended June
30, June 30, (U.S. dollars in thousands, except share
data)
2014 2013 2014
2013 Components of net
investment income (1): Fixed maturities $ 64,499 $
62,004 $ 126,948 $ 124,010 Term loan
investments (2) 5,233 6,026 10,902 10,243 Equity securities
(dividends) 3,271 3,164 6,192 4,587 Short-term investments 103 364
508 756 Other 9,067 4,734 13,785 11,033
Gross investment income 82,173 76,292 158,335 150,629 Investment
expenses (9,715 ) (7,923 ) (18,884 ) (16,588 ) Net investment
income $ 72,458 $ 68,369 $
139,451 $ 134,041 Per share $ 0.53 $ 0.50 $
1.02 $ 0.99
Investment income yield, at amortized cost
(1) (3): Pre-tax 2.05 % 2.20 % 2.07 % 2.20 % After-tax 1.91 %
2.07 % 1.93 % 2.07 %
Total return (1) (4): Including effects
of foreign exchange 1.80 % (1.59 )% 2.84 % (1.11 )% Excluding
effects of foreign exchange 1.63 % (1.56 )% 2.67 % (0.57 )%
Cash flow from operations (1) $ 254,168 $ 182,695 $ 451,563 $
388,354 (1) Excludes amounts related to the ‘other’
segment. (2) Included in “investments accounted for using the fair
value option” on the Company’s balance sheet. (3) Investment income
yield is presented on an annualized basis and excludes 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. (4) 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)
(U.S. dollars in thousands)
June 30, 2014
December 31, 2013 Amount % of
Total Amount % of
Total Investable assets (1) (2): Fixed maturities
available for sale, at fair value $ 10,714,532 72.9 $
9,571,776 68.1 Fixed maturities, at fair value (3) 372,746 2.5
448,254 3.2 Fixed maturities pledged under securities lending
agreements, at fair value 82,730 0.6 105,081
0.8 Total fixed maturities 11,170,008 76.0 10,125,111 72.1
Short-term investments available for sale, at fair value 977,058
6.7 1,478,367 10.5 Short-term investments pledged under securities
lending agreements, at fair value 4,301 — — — Cash 471,721 3.2
434,057 3.1 Equity securities available for sale, at fair value
608,820 4.2 496,824 3.5 Other investments available for sale, at
fair value 457,567 3.1 498,310 3.6 Other investments, at fair value
(3) 848,864 5.8 773,280 5.5 Investments accounted for using the
equity method (4) 281,464 1.9 244,339 1.7 Securities transactions
entered into but not settled at the balance sheet date (130,922 )
(0.9 ) (763 ) — Total investable assets managed by the Company $
14,688,881 100.0 $ 14,049,525
100.0
Investment portfolio statistics (1): Average
effective duration (in years) 3.14 2.62 Average credit quality
(Standard & Poor’s/Moody’s Investors Service) AA/Aa2 AA-/Aa2
Embedded book yield (before investment expenses) 2.17 % 2.38 %
(1) The table above excludes investable assets
attributable to the ‘other’ segment. Such amounts are summarized as
follows:
(U.S. dollars in thousands)
June 30,2014
Investable assets in ‘other’ segment: Cash $
454,722 Investments accounted for using the fair value
option (3) 819,481 Securities transactions entered into but not
settled at the balance sheet date (159,484 ) Total investable
assets included in ‘other’ segment $ 1,114,719
(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) Represents investments 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 investments are recorded in
net realized gains or losses. (4) Changes in the carrying value of
investment funds accounted for using the equity method are recorded
as “equity in net income (loss) of investment funds accounted for
using the equity method” rather than as an unrealized gain or loss
component of accumulated other comprehensive income.
Selected
Information on Losses and Loss Adjustment Expenses
(1)
Three Months Ended Six Months Ended June
30, June 30, (U.S. dollars in thousands)
2014
2013 2014
2013 Components of losses and loss adjustment
expenses incurred Paid losses and loss adjustment expenses $
435,370 $ 429,634 $ 861,284 $ 851,219
Change in unpaid losses and loss adjustment expenses 41,954
(10,981 ) 50,924 (33,163 ) Total losses and loss adjustment
expenses $ 477,324 $ 418,653 $
912,208 $ 818,056
Estimated net (favorable) adverse
development in prior yearloss reserves, net of related
adjustments
Net impact on underwriting results: Insurance $ (16,137 ) $ (13,965
) $ (26,554 ) $ (19,303 ) Reinsurance (67,700 ) (55,173 ) (137,802
) (103,441 ) Mortgage 58 — (1,112 ) — Total $
(83,779 ) $ (69,138 ) $ (165,468 ) $
(122,744 ) Impact on losses and loss adjustment expenses: Insurance
$ (19,388 ) $ (15,990 ) $ (34,960 ) $ (20,991 ) Reinsurance (69,115
) (53,507 ) (139,514 ) (102,910 ) Mortgage 88 —
(1,046 ) — Total $ (88,415 ) $ (69,497 ) $
(175,520 ) (123,901 ) Impact on acquisition expenses:
Insurance $ 3,251 $ 2,025 $ 8,406 $ 1,688 Reinsurance 1,415 (1,666
) 1,712 (531 ) Mortgage (30 ) — (66 ) — Total $
4,636 $ 359 $ 10,052 $
1,157 Impact on combined ratio: Insurance (3.2 )%
(3.0 )% (2.7 )% (2.1 )% Reinsurance (20.2 )% (19.2 )% (20.4 )%
(17.7 )% Mortgage 0.1 % — % (1.2 )% — % Total (9.4 )% (9.1 )% (9.4
)% (8.1 )% Impact on loss ratio: Insurance (3.8 )% (3.5 )% (3.5 )%
(2.3 )% Reinsurance (20.6 )% (18.6 )% (20.6 )% (17.6 )% Mortgage
0.2 % — % (1.2 )% — % Total (9.9 )% (9.2 )% (10.0 )% (8.2 )% Impact
on acquisition expense ratio: Insurance 0.6 % 0.5 % 0.8 % 0.2 %
Reinsurance 0.4 % (0.6 )% 0.2 % (0.1 )% Mortgage (0.1 )% — % — % —
% Total 0.5 % 0.1 % 0.6 % 0.1 %
Estimated net losses incurred from
current accident yearcatastrophic events (2)
Insurance $ 3,739 $ 6,681 $ 6,353 $ 6,681 Reinsurance 12,748
29,583 15,682 40,789 Total $ 16,487
$ 36,264 $ 22,035 $
47,470 Impact on combined ratio: Insurance 0.7 % 1.5 % 0.6 %
0.7 % Reinsurance 3.8 % 10.3 % 2.3 % 7.0 % Total 1.8 % 4.8 % 1.3 %
3.1 % (1) Excludes amounts related to the ‘other’
segment. (2) 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. Amounts not
applicable for the mortgage segment.
Segment Information
The following section provides analysis on the Company’s 2014
second quarter performance by operating segment. For additional
details regarding the Company’s operating segments, please refer to
the Company’s Financial Supplement dated June 30, 2014, which is
available via the Investors section of the Company’s website at
http://www.archcapgroup.com.
Insurance
Segment
Three Months Ended June 30, (U.S. dollars in
thousands)
2014 2013
% Change Gross premiums written
$ 852,231 $ 703,904 21.1 Net premiums written 578,882
501,568 15.4 Net premiums earned 507,712 458,656 10.7 Underwriting
income 34,422 13,577 153.5
Underwriting Ratios %
Point Change Loss ratio 61.4 % 63.5 % (2.1 ) Acquisition
expense ratio 15.0 % 16.1 % (1.1 ) Other operating expense ratio
16.9 % 17.5 % (0.6 ) Combined ratio 93.3 % 97.1 % (3.8 )
Catastrophic activity and prior year development: Current accident
year catastrophic events, net of reinsurance and reinstatement
premiums 0.7 % 1.5 % (0.8 ) Net (favorable) adverse development in
prior year loss reserves, net of related adjustments (3.2 )% (3.0
)% (0.2 ) Combined ratio excluding such items 95.8 % 98.6 % (2.8 )
Gross premiums written by the insurance segment in the 2014
second quarter were 21.1% higher than in the 2013 second quarter,
while net premiums written were 15.4% higher than in the 2013
second quarter. The differential in gross versus net premiums
written primarily resulted from growth in alternative markets
business which is subject to a high level of cessions, primarily to
captives. The growth in net premiums written primarily resulted
from increases in: alternative markets; excess and surplus
casualty; travel, accident and health; and construction and
national accounts. Such amounts were partially offset by a
reduction in professional lines. The increase in alternative
markets reflected new accounts written in the quarter resulting
from a renewal rights agreement, while the growth in excess and
surplus casualty primarily resulted from contract binding business
along with rate increases. Growth in travel, accident and health
primarily resulted from expansion in existing and new distribution
channels while the increase in construction and national accounts
primarily resulted from growth in existing accounts and rate
increases. The decrease in professional lines was primarily due to
a continued strategic reduction in exposure to international
business. Net premiums earned by the insurance segment in the 2014
second quarter were 10.7% higher than in the 2013 second quarter,
and reflect changes in net premiums written over the previous five
quarters.
The 2014 second quarter loss ratio reflected 0.7 points of
current year catastrophic activity, compared to 1.5 points in the
2013 second quarter. Estimated net favorable development in prior
year loss reserves, before related adjustments, reduced the loss
ratio by 3.8 points in the 2014 second quarter, compared to 3.5
points in the 2013 second quarter. The estimated net favorable
development in the 2014 second quarter primarily resulted from
better than expected claims emergence in short-tail business from
more recent accident years. The 2014 second quarter loss ratio also
reflected the impact of rate improvement on net premiums earned
over the previous five quarters and changes in the mix of
business.
The underwriting expense ratio was 31.9% in the 2014 second
quarter, compared to 33.6% in the 2013 second quarter. The
acquisition expense ratio was 15.0% in the 2014 second quarter,
compared to 16.1% in the 2013 second quarter. The comparison of the
2014 second quarter and 2013 second quarter acquisition expense
ratios is influenced by, among other things, the mix and type of
business written and earned and the level of ceding commissions.
The 2014 second quarter ratio was disproportionately impacted by
ceding commissions on the alternative markets business noted above.
In addition, the acquisition expense ratio was impacted by changes
in development of prior year loss reserves which increased the 2014
second quarter commission expense ratio by 0.6 points, compared to
a 0.5 point increase in the 2013 second quarter. The operating
expense ratio was 16.9% in the 2014 second quarter, compared to
17.5% in the 2013 second quarter, primarily due to the higher level
of net premiums earned.
Reinsurance
Segment
Three Months Ended June 30, (U.S. dollars in
thousands)
2014 2013
% Change Gross premiums written
$ 349,841 $ 318,898 9.7 Net premiums written 290,847
290,223 0.2 Net premiums earned 335,627 287,492 16.7 Underwriting
income 81,904 77,389 5.8
Underwriting Ratios %
Point Change Loss ratio 44.8 % 43.6 % 1.2 Acquisition
expense ratio 19.7 % 18.5 % 1.2 Other operating expense ratio 11.2
% 11.1 % 0.1 Combined ratio 75.7 % 73.2 % 2.5
Catastrophic activity and prior year development: Current accident
year catastrophic events, net of reinsurance and reinstatement
premiums 3.8 % 10.3 % (6.5 ) Net (favorable) adverse development in
prior year loss reserves, net of related adjustments (20.2 )% (19.2
)% (1.0 ) Combined ratio excluding such items 92.1 % 82.1 % 10.0
Gross premiums written by the reinsurance segment in the 2014
second quarter were 9.7% higher than in the 2013 second quarter,
while net premiums written were 0.2% higher than in the 2013 second
quarter. The differential in gross versus net premiums written
reflects the cession of premiums to the ‘other’ segment (Watford)
in the 2014 second quarter and a higher level of other
retrocessions than in the 2013 second quarter. The growth in net
premiums written reflected increases in other specialty and
casualty lines, partially offset by reductions in property
catastrophe, property excluding property catastrophe and marine
lines. Growth in other specialty premiums primarily reflected a
higher level of accident and health business while the increase in
casualty premiums reflected new international excess motor business
as well as quota shares of U.S. professional liability business
which were written after June 30, 2013. The reduction in property
lines reflected market conditions, selected non-renewals and a
higher usage of retrocessional coverage. Net premiums earned in the
2014 second quarter were 16.7% higher than in the 2013 second
quarter, and primarily reflect changes in net premiums written over
the previous five quarters, including the mix and type of business
written.
The 2014 second quarter loss ratio reflected 4.1 points of
current year catastrophic activity, compared to 11.6 points of
catastrophic activity in the 2013 second quarter. Estimated net
favorable development in prior year loss reserves, before related
adjustments, reduced the loss ratio by 20.6 points in the 2014
second quarter, compared to 18.6 points in the 2013 second quarter.
The estimated net favorable development in the 2014 second quarter
primarily resulted from better than expected claims emergence in
short-tail business from more recent underwriting years and in
longer-tail business, primarily from older underwriting years. The
balance of the increase in the 2014 second quarter loss ratio
primarily resulted from changes in the mix of net premiums earned,
including a lower contribution from property catastrophe business
than in the 2013 second quarter, and also resulted from a higher
level of non-catastrophic large loss activity.
The underwriting expense ratio was 30.9% in the 2014 second
quarter, compared to 29.6% in the 2013 second quarter. The
acquisition expense ratio for the 2014 second quarter was 19.7%,
compared to 18.5% for the 2013 second quarter. The acquisition
expense ratio was impacted by changes in development of prior year
loss reserves which increased the 2014 second quarter commission
expense ratio by 0.4 points, compared to a 0.6 point reduction in
the 2013 second quarter. In addition, the comparison of the
acquisition expense ratios is influenced by, among other things,
the mix and type of business written and earned and the level of
ceding commissions. The operating expense ratio for the 2014 second
quarter was 11.2%, compared to 11.1% in the 2013 second
quarter.
Mortgage
Segment
Three Months Ended June 30, (U.S. dollars in
thousands)
2014 2013
% Change Gross premiums written
$ 55,476 $ 18,744 196.0 Net premiums
written 50,397 18,744 168.9 Net premiums earned 50,833 12,668 301.3
Underwriting income 8,807 5,063 73.9
Underwriting
Ratios % Point Change Loss ratio 30.4 % 17.2 %
13.2 Acquisition expense ratio 22.6 % 32.7 % (10.1 ) Other
operating expense ratio 32.0 % 10.2 % 21.8 Combined ratio
85.0 % 60.1 % 24.9 Net (favorable) adverse
development in prior year loss reserves, net of related adjustments
0.1 % — % 0.1 Combined ratio excluding prior year
development 84.9 % 60.1 % 24.8
The mortgage segment includes the results of Arch MI U.S., a
leading provider of mortgage insurance products and services to the
U.S. marketplace, which was acquired in January 2014, along with
the Company’s other global mortgage insurance, reinsurance and
risk-sharing products.
Net premiums written in the 2014 second quarter included $24.6
million of business underwritten by Arch MI U.S., substantially all
of which was for credit union clients. In addition, net premiums
written included $9.3 million from a 100% quota share indemnity
reinsurance agreement with PMI for all certificates of insurance
that were issued by PMI between and including January 1, 2009 and
December 31, 2011 that were not in default as of an agreed upon
effective date. The mortgage segment’s net premiums written also
included other reinsurance treaties covering U.S. and international
mortgages. The change on such business was minimal. Net premiums
earned for the 2014 second quarter were substantially higher than
in the 2013 second quarter, primarily due to the acquisition of
Arch MI U.S. along with a higher earned contribution from the
mortgage segment’s quota share reinsurance business. As the
mortgage segment’s mix is expected to shift more towards U.S.
mortgage insurance business, the underwriting expense ratio is
expected to stay at an elevated rate until Arch MI U.S. reaches
scale.
At June 30, 2014, the mortgage segment’s risk-in-force consisted
of $5.3 billion from Arch MI U.S. (substantially all of which
relates to credit union customers) and an additional $4.7 billion
through the mortgage segment’s reinsurance and risk-sharing
operations. Arch MI U.S. generated $941 million of new insurance
written (“NIW”) during the 2014 second quarter, substantially all
of which was to credit union clients. For additional information on
the mortgage segment, please refer to the Company’s Financial
Supplement.
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (U.S. dollars in
thousands, except share data)
(Unaudited) (Unaudited)
Three Months Ended Six Months Ended June 30,
June 30, 2014 2013
2014 2013 Revenues Net
premiums written $ 971,928 $ 810,535 $
2,036,918 $ 1,763,311 Change in unearned premiums (64,776 )
(51,719 ) (269,986 ) (251,725 ) Net premiums earned 907,152 758,816
1,766,932 1,511,586 Net investment income 72,990 68,369 139,984
134,041 Net realized gains 54,144 12,652 73,841 70,992
Other-than-temporary impairment losses (14,749 ) (724 ) (17,720 )
(2,972 )
Less investment impairments recognized in
other comprehensiveincome, before taxes
— — — 2 Net impairment losses
recognized in earnings (14,749 ) (724 ) (17,720 ) (2,970 )
Other underwriting income 2,033 902 3,615 1,440
Equity in net income of investment funds
accounted for using theequity method
9,240 10,941 12,493 24,764 Other income (loss) 4,850 834
2,746 2,078
Total revenues 1,035,660
851,790 1,981,891 1,741,931
Expenses Losses and loss adjustment expenses 485,518 418,653
921,758 818,056 Acquisition expenses 158,158 131,677 318,500
259,269 Other operating expenses 156,350 127,408 302,149 247,591
Interest expense 14,334 5,852 28,738 11,750 Net foreign exchange
losses (gains) 2,294 (13,811 ) 8,857 (38,075 )
Total expenses 816,654 669,779 1,580,002
1,298,591
Income before income taxes
219,006 182,011 401,889 443,340 Income tax expense 7,289
5,071 11,027 9,924
Net income $ 211,717
$ 176,940 $ 390,862 $ 433,416 Amounts attributable to
noncontrolling interests (3,701 ) — (346 ) —
Net
income available to Arch 208,016 176,940 390,516 433,416
Preferred dividends 5,485 5,485 10,969 10,969
Net income available to Arch common shareholders $
202,531 $ 171,455 $ 379,547
$ 422,447
Net income per common
share Basic $ 1.53 $ 1.31 $ 2.87 $ 3.22 Diluted $ 1.48 $ 1.26 $
2.78 $ 3.11
Weighted average common shares and
common shareequivalents outstanding
Basic 132,650,634 131,377,274 132,256,462 131,143,885 Diluted
136,889,944 135,849,050 136,716,889 135,624,226
ARCH
CAPITAL GROUP LTD. AND SUBSIDIARIES CONSOLIDATED BALANCE
SHEETS (U.S. dollars in thousands, except share data)
(Unaudited) June 30, 2014 December
31, 2013 Assets Investments: Fixed maturities
available for sale, at fair value (amortized cost: $10,599,911 and
$9,564,634) $ 10,714,532 $ 9,571,776
Short-term investments available for sale, at fair value (amortized
cost: $977,347 and $1,477,584) 977,058 1,478,367 Investment of
funds received under securities lending, at fair value (amortized
cost: $79,242 and $97,943) 82,603 100,584 Equity securities
available for sale, at fair value (cost: $513,094 and $433,275)
608,820 496,824 Other investments available for sale, at fair value
(cost: $428,958 and $488,687) 457,567 498,310 Investments accounted
for using the fair value option 2,041,091 1,221,534 Investments
accounted for using the equity method 281,464 244,339
Total investments 15,163,135 13,611,734 Cash 926,443 434,057
Accrued investment income 64,869 66,848 Investment in joint venture
(cost: $100,000) 103,934 104,856 Fixed maturities and short-term
investments pledged under securities lending, at fair value 87,031
105,081 Premiums receivable 1,098,692 753,924 Reinsurance
recoverable on unpaid and paid losses and loss adjustment expenses
1,796,403 1,804,330 Contractholder receivables 1,234,392 1,064,246
Prepaid reinsurance premiums 430,214 328,343 Deferred acquisition
costs, net 399,385 342,314 Receivable for securities sold 261,669
50,555 Goodwill and intangible assets 118,721 27,319 Other assets
888,627 872,487
Total assets $
22,573,515 $ 19,566,094
Liabilities Reserve for losses and loss adjustment expenses
$ 9,018,989 $ 8,824,696 Unearned premiums 2,299,692 1,896,365
Reinsurance balances payable 263,347 196,167 Contractholder
payables 1,234,392 1,064,246 Deposit accounting liabilities 397,337
421,297 Senior notes 800,000 800,000 Revolving credit agreement
borrowings 100,000 100,000 Securities lending payable 89,298
107,999 Payable for securities purchased 552,075 51,318 Other
liabilities 577,320 456,510
Total liabilities
15,332,450 13,918,598
Commitments and
Contingencies Redeemable noncontrolling interests
219,326 —
Shareholders' Equity Non-cumulative
preferred shares 325,000 325,000 Common shares ($0.0033 par, shares
issued: 171,096,771 and 169,560,591) 570 565 Additional paid-in
capital 353,208 299,517 Retained earnings 6,421,701 6,042,154
Accumulated other comprehensive income, net of deferred income tax
233,883 74,964 Common shares held in treasury, at cost (shares:
36,065,885 and 35,885,707) (1,104,963 ) (1,094,704 ) Total
shareholders' equity available to Arch 6,229,399 5,647,496
Noncontrolling interests 792,340 —
Total
shareholders' equity 7,021,739 5,647,496
Total
liabilities, noncontrolling interests and shareholders' equity
$ 22,573,515 $ 19,566,094
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 June 30, 2014;
- 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 or loss available to Arch common shareholders,
which is defined as net income available to Arch 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 or loss available to
Arch common shareholders is a “non-GAAP financial measure” as
defined in Regulation G. The reconciliation of such measure to net
income available to Arch 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 the change in the carrying value of
investments accounted for using the fair value option in net
realized 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 or loss available to Arch common
shareholders.
The Company believes that showing net income available to Arch
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 Arch 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.Mark D. Lyons, 441-278-9250Executive Vice
President and Chief Financial Officer
Arch Capital (NASDAQ:ACGL)
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