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Arch Capital Group Ltd. Reports 2012 Third Quarter Results

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
 
September 30, December 31,
(U.S. dollars in thousands, except share data) 2012   2011  
 
Calculation of book value per common share:
Total shareholders’ equity $ 5,348,794 $ 4,592,074
Less preferred shareholders’ equity   (325,000 )   (325,000 )
Common shareholders’ equity $ 5,023,794 $ 4,267,074
Common shares outstanding, net of treasury shares (1)   136,540,178     134,358,345  
Book value per common share $ 36.79   $ 31.76  
 
(1)   Excludes the effects of 7,835,519 and 8,706,441 stock options and 365,224 and 298,425 restricted stock units outstanding at September 30, 2012 and December 31, 2011, respectively.
           
Investment Information
 
Three Months Ended Nine Months Ended
September 30, September 30,
(U.S. dollars in thousands, except share data) 2012   2011   2012   2011  
 
Components of net investment income:
Fixed maturities $ 68,195 $ 82,686 $ 211,934 $ 252,250
Term loan investments (1) 4,877 881 10,733 1,565
Equity securities 2,009 1,796 6,098 5,187
Short-term investments 487 430 1,619 1,613
Other 3,799   3,383   9,973   16,060  
Gross investment income 79,367 89,176 240,357 276,675
Investment expenses   (6,146 )   (6,423 )   (19,231 )   (18,944 )
Net investment income $ 73,221   $ 82,753   $ 221,126   $ 257,731  
 
Per share $ 0.53 $ 0.60 $ 1.60 $ 1.86
 
Investment income yield, at amortized cost (2):
Pre-tax 2.45 % 2.83 % 2.51 % 2.98 %
After-tax 2.33 % 2.73 % 2.38 % 2.85 %
 
Total return (3):
Including effects of foreign exchange 2.45 % (0.23 %) 5.04 % 2.97 %
Excluding effects of foreign exchange 2.17 % 0.38 % 4.89 % 3.11 %
 
Cash flow from operations $ 334,683 $ 309,924 $ 731,951 $ 756,471
 
(1)   Included in “investments accounted for using the fair value option” on the Company’s balance sheet.
(2) 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.
(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)
 
September 30, December 31,
(U.S. dollars in thousands) 2012   2011  
 
Investable assets:
Fixed maturities available for sale, at fair value $ 9,944,186 $ 9,375,604
Fixed maturities, at fair value (1) 306,424 147,779
Fixed maturities pledged under securities lending agreements, at fair value (2)   34,769     56,393  
Total fixed maturities 10,285,379 9,579,776
Short-term investments available for sale, at fair value 845,158 904,219
Cash 422,440 351,699
Equity securities available for sale, at fair value 312,371 299,584
Equity securities, at fair value (1) 28,405 87,403
Other investments available for sale, at fair value 477,857 238,111
Other investments, at fair value (1) 363,239 131,721
TALF investments, at fair value (3) 270,206 387,702
Investments accounted for using the equity method (4) 339,587 380,507
Securities sold but not yet purchased (5) (8,017 ) (27,178 )
Securities transactions entered into but not settled at the balance sheet date   (117,742 )   (17,339 )
Total investable assets $ 13,218,883   $ 12,316,205  
 
Investment portfolio statistics (2):
Average effective duration (in years) 2.90 2.99
Average credit quality (Standard & Poor's/Moody's Investors Service) AA/Aa2 AA/Aa1
Imbedded book yield (before investment expenses) 2.80 % 2.98 %
 
(1)   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.
(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 Nine Months Ended
September 30, September 30,
(U.S. dollars in thousands) 2012   2011   2012   2011  
 
Components of losses and loss adjustment expenses
incurred
Paid losses and loss adjustment expenses $ 371,529 $ 373,682 $ 1,058,758 $ 1,013,752
Increase in unpaid losses and loss adjustment expenses   72,342     50,302     180,013     335,734  
Total losses and loss adjustment expenses $ 443,871   $ 423,984   $ 1,238,771   $ 1,349,486  
 
Estimated net (favorable) adverse development in prior
year loss reserves, net of related adjustments
Net impact on underwriting results:
Insurance $ (13,441 ) $ (490 ) $ (26,424 ) $ (23,056 )
Reinsurance   (39,712 )   (57,739 )   (137,340 )   (151,137 )
Total $ (53,153 ) $ (58,229 ) $ (163,764 ) $ (174,193 )
 
Impact on losses and loss adjustment expenses:
Insurance $ (10,283 ) $ (5,265 ) $ (27,959 ) $ (28,102 )
Reinsurance   (40,224 )   (58,317 )   (139,643 )   (152,515 )
Total $ (50,507 ) $ (63,582 ) $ (167,602 ) $ (180,617 )
 
Impact on acquisition expenses:
Insurance $ (3,158 ) $ 4,775 $ 1,535 $ 5,046
Reinsurance   512     578     2,303     1,378  
Total $ (2,646 ) $ 5,353   $ 3,838   $ 6,424  
 
Impact on combined ratio:
Insurance (2.9 %) (0.1 %) (2.0 %) (1.8 %)
Reinsurance (13.6 %) (23.7 %) (16.9 %) (21.5 %)
Total (7.1 %) (8.5 %) (7.6 %) (8.9 %)
 
Impact on loss ratio:
Insurance (2.3 %) (1.2 %) (2.1 %) (2.2 %)
Reinsurance (13.8 %) (23.9 %) (17.2 %) (21.7 %)
Total (6.7 %) (9.3 %) (7.8 %) (9.2 %)
 
Impact on acquisition expense ratio:
Insurance (0.6 %) 1.1 % 0.1 % 0.4 %
Reinsurance 0.2 % 0.2 % 0.3 % 0.2 %
Total (0.4 %) 0.8 % 0.2 % 0.3 %
 
Estimated net losses incurred from current accident
year catastrophic events (1)
Insurance $ 14,338 $ 6,997 $ 19,122 $ 80,910
Reinsurance   13,361     52,609     38,782     252,406  
Total $ 27,699   $ 59,606   $ 57,904   $ 333,316  
 
Impact on combined ratio:
Insurance 3.1 % 1.6 % 1.4 % 6.4 %
Reinsurance 4.6 % 21.6 % 4.8 % 35.9 %
Total 3.7 % 8.7 % 2.7 % 17.0 %
 
(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 2012 third quarter performance by operating segment. For additional details regarding the Company’s operating segments, please refer to the Company’s Financial Supplement dated September 30, 2012 on the Company’s website at http://www.archcapgroup.bm/EarningsReleases.aspx.
     

Insurance Segment
 
Three Months Ended September 30,
(U.S. dollars in thousands) 2012     2011     % Change  
 
Gross premiums written $ 658,599 $ 634,280 3.8
Net premiums written 483,356 472,986 2.2
Net premiums earned 456,341 437,970 4.2
Underwriting income (loss) 789 (6,541 ) n/m
 
% Point
Underwriting Ratios Change
Loss ratio 67.3 % 66.4 % 0.9
Acquisition expense ratio 16.0 % 17.4 % (1.4 )
Other operating expense ratio   16.5 %   17.8 % (1.3 )
Combined ratio   99.8 %   101.6 % (1.8 )
 
Catastrophic activity and prior year development:
Current accident year catastrophic events 3.1 % 1.6 % 1.5
Net (favorable) adverse development in prior year loss
reserves, net of related adjustments   (2.9 %)   (0.1 %) (2.8 )
Combined ratio excluding such items   99.6 %   100.1 % (0.5 )
 

Gross premiums written by the insurance segment in the 2012 third quarter were 3.8% higher than in the 2011 third quarter, while net premiums written were 2.2% higher than in the 2011 third quarter. The growth in net premiums written reflected increases in programs, national accounts and surety business, partially offset by a lower level of onshore energy (included in the ‘property, energy, marine and aviation’ line) and casualty business. The higher level of program business was primarily due to an earlier 2012 bound program that has gained traction, rate increase impacts and increased customer penetration within existing programs. Growth in national accounts primarily resulted from new business, a large account advancing their renewal date, rate increases and audit premiums whereas the increase in surety primarily resulted from expansion into the commercial surety area. The reduction in onshore energy premiums reflected a strategic shift towards writing more on an excess basis and utilizing smaller capacity per account while the decline in casualty business, while achieving rate increases, reflected moving up higher on excess programs and binding smaller accounts. Net premiums earned by the insurance segment in the 2012 third quarter were 4.2% higher than in the 2011 third quarter, and reflect changes in net premiums written over the previous five quarters.

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