Arch Capital Group Ltd. (NASDAQ:ACGL) reports that net income
available to Arch common shareholders for the 2016 fourth quarter
was $62.4 million, or $0.50 per share, compared to $53.1 million,
or $0.42 per share, for the 2015 fourth quarter. The Company’s net
income available to Arch common shareholders represented an
annualized return on average common equity of 3.9% for the 2016
fourth quarter, due primarily to net realized losses and
non-recurring transaction costs related to the Company’s
acquisition of United Guaranty Corporation (“UGC”) which closed on
December 31, 2016. For the year ended December 31, 2016, net income
available to Arch common shareholders produced a 10.9% return on
average common equity. The Company’s book value per common share
was $55.19 at December 31, 2016, a 3.5% increase from $53.30 per
share at September 30, 2016 and a 15.8% increase from $47.64 per
share at December 31, 2015. All earnings per share amounts
discussed in this release are on a diluted basis.
The Company also reported after-tax operating income available
to Arch common shareholders of $141.5 million, or $1.13 per share,
for the 2016 fourth quarter, compared to $143.6 million, or $1.15
per share, for the 2015 fourth quarter. The Company’s after-tax
operating income available to Arch common shareholders represented
an annualized return on average common equity of 8.7% for the 2016
fourth quarter, compared to 9.9% for the 2015 fourth quarter. For
the year ended December 31, 2016, after-tax operating income
available to Arch common shareholders produced a 9.4% return on
average common equity. After-tax operating income or loss available
to Arch common shareholders and the related return on average
common equity are non-GAAP measures. See ‘Comments on Regulation G’
for further details.
The following table summarizes the Company’s consolidated
underwriting results:
(U.S. dollars in thousands)
Three
Months Ended December 31, Year Ended December 31,
2016 2015 % Change 2016
2015 % Change Gross premiums written $
1,155,467 $ 1,066,740 8.3 $ 5,202,134 $ 4,797,163 8.4 Net premiums
written 872,315 834,984 4.5 4,031,391 3,817,531 5.6 Net premiums
earned 968,855 943,520 2.7 3,884,822 3,733,905 4.0 Underwriting
income 109,246 113,143 (3.4 ) 454,717 429,507 5.9
Underwriting
Ratios
% Point Change
% Point Change
Loss ratio 57.2 % 53.6 % 3.6 56.3 % 54.9 % 1.4 Underwriting expense
ratio 33.5 % 35.3 % (1.8 ) 33.6 % 34.6 % (1.0 ) Combined ratio 90.7
% 88.9 % 1.8 89.9 % 89.5 % 0.4
Please note that these amounts include the impact of the ‘other’
segment (i.e., results of Watford Re). Pursuant to generally
accepted accounting principles, Watford Re is considered a variable
interest entity and the Company concluded that it is the primary
beneficiary of Watford Re. As such, the Company consolidates the
results of Watford Re in its consolidated financial statements,
although it only owns approximately 11% of Watford Re’s common
equity. See ‘Comments on Regulation G’ for a reconciliation of
underwriting income or loss to income before income taxes and net
income available to Arch common shareholders.
The following table summarizes the Company’s consolidated
financial data, including a reconciliation of net income available
to Arch common shareholders to after-tax operating income available
to Arch common shareholders and related diluted per share
results:
(U.S. dollars in thousands, except
share data)
Three Months Ended Year Ended December
31, December 31, 2016 2015
2016 2015 Net income available to Arch common
shareholders $ 62,396 $ 53,094 $ 664,668 $ 515,800 Net realized
(gains) losses 98,477 90,856 (77,081 ) 108,690 Net impairment
losses recognized in earnings 13,593 7,336 30,442 20,116 Equity in
net (income) loss of investment funds accounted for using the
equity method (16,421 ) (5,517 ) (48,475 ) (25,456 ) Net foreign
exchange (gains) losses (35,547 ) (2,533 ) (31,987 ) (63,011 ) UGC
transaction costs and other 34,587 — 41,729 — Income tax expense
(1) (15,557 ) 363 (1,852 ) 9,060 After-tax operating
income available to Arch common shareholders $ 141,528 $
143,599 $ 577,444 $ 565,199
Diluted per common
share results:
Net income available to Arch common shareholders $ 0.50 $ 0.42 $
5.33 $ 4.09 Net realized (gains) losses 0.78 0.73 (0.62 ) 0.86 Net
impairment losses recognized in earnings 0.11 0.06 0.24 0.16 Equity
in net (income) loss of investment funds accounted for using the
equity method (0.13 ) (0.04 ) (0.38 ) (0.20 ) Net foreign exchange
(gains) losses (0.28 ) (0.02 ) (0.26 ) (0.50 ) UGC transaction
costs and other 0.27 — 0.33 — Income tax expense (1) (0.12 ) —
(0.01 ) 0.07 After-tax operating income available to
Arch common shareholders $ 1.13 $ 1.15 $ 4.63
$ 4.48 Weighted average common shares and common
share equivalents outstanding — diluted 125,427,259 125,311,942
124,717,493 126,038,743 Beginning common shareholders’
equity $ 6,538,983 $ 5,799,476 $ 5,841,542 $ 5,766,714 Ending
common shareholders’ equity 7,481,163 5,841,542
7,481,163 5,841,542 Average common shareholders’
equity (2) $ 6,471,392 $ 5,820,509 $ 6,113,718
$ 5,804,128 Annualized return on average common
equity (2) 3.9 % 3.6 % 10.9 % 8.9 % Annualized operating return on
average common equity (2) 8.7 % 9.9 % 9.4 % 9.7 % (1)
Income tax expense on net realized gains or losses, net impairment
losses recognized in earnings, equity in net income (loss) of
investment funds accounted for using the equity method, net foreign
exchange gains or losses and UGC transaction costs and other
reflects the relative mix reported by jurisdiction and the varying
tax rates in each jurisdiction. (2) Average common shareholders’
equity and the related returns on average common equity reflect the
weighted impact of the $1.10 billion of convertible non-voting
common equivalent preferred shares, which were issued on December
31, 2016 as part of the UGC acquisition.
Each line item in the table above reflects the impact of the
Company’s approximate 11% ownership of Watford Re’s common equity.
See ‘Comments on Regulation G’ for a discussion of non-GAAP
financial measures.
Segment Information
The following section provides analysis on the Company’s 2016
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, 2016. The
Company’s segment information includes the use of underwriting
income and a combined ratio excluding catastrophic activity and
prior year development for the insurance segment and reinsurance
segment and a combined ratio excluding prior year development for
the mortgage segment. Such items are non-GAAP financial measures
(see ‘Comments on Regulation G’ for further details).
Insurance Segment
Three Months Ended December 31, (U.S.
dollars in thousands)
2016 2015 %
Change Gross premiums written $ 707,519 $ 680,617 4.0
Net premiums written 465,861 451,606 3.2 Net premiums earned
514,087 504,525 1.9 Underwriting income 2,581 28,022 (90.8 )
Underwriting Ratios
% Point Change
Loss ratio 67.7 % 62.2 % 5.5 Underwriting expense ratio 31.7 % 32.4
% (0.7 ) Combined ratio 99.4 % 94.6 % 4.8
Catastrophic activity and prior year development: Current accident
year catastrophic events, net of reinsurance and reinstatement
premiums 4.6 % 0.4 % 4.2 Net (favorable) adverse development in
prior year loss reserves, net of related adjustments (1.5 )% (2.1
)% 0.6 Combined ratio excluding catastrophic activity and
prior year development (1) 96.3 % 96.3 % — (1)
See ‘Comments on Regulation G’ for further discussion.
Gross premiums written by the insurance segment in the 2016
fourth quarter were 4.0% higher than in the 2015 fourth quarter
while net premiums written were 3.2% higher than in the 2015 fourth
quarter. The increase in net premiums written reflected growth in
the travel line from a mix of new business and continued expansion
in existing accounts. In addition, net premiums written reflected
growth in construction and national accounts primarily resulting
from new project premiums in existing construction accounts along
with new national accounts business and in alternative markets
business from a combination of new and existing relationships. Net
premiums earned by the insurance segment in the 2016 fourth quarter
were 1.9% higher than in the 2015 fourth quarter, and reflect
changes in net premiums written over the previous five
quarters.
The 2016 fourth quarter loss ratio reflected 4.6 points of
current year catastrophic activity, primarily related to Hurricane
Matthew, compared to 0.4 points in the 2015 fourth quarter.
Estimated net favorable development in prior year loss reserves,
before related adjustments, reduced the loss ratio by 1.6 points in
the 2016 fourth quarter, compared to 2.0 points in the 2015 fourth
quarter. The estimated net favorable development in the 2016 fourth
quarter primarily resulted from better than expected claims
emergence in medium-tail lines across most accident years. The
balance of the change in the 2016 fourth quarter loss ratio
resulted, in part, from changes in the mix of business.
The underwriting expense ratio was 31.7% in the 2016 fourth
quarter, compared to 32.4% in the 2015 fourth quarter. The
comparison of the underwriting expense ratios reflected changes in
the mix of business and the level of reinsurance ceded on a quota
share basis.
Reinsurance Segment
Three Months Ended December 31, (U.S.
dollars in thousands)
2016 2015 %
Change Gross premiums written $ 276,593 $ 262,482 5.4
Net premiums written 206,120 200,065 3.0 Net premiums earned
251,841 263,022 (4.3 ) Other underwriting income 13,744 3,736 267.9
Underwriting income 67,612 71,022 (4.8 )
Underwriting Ratios
% Point Change
Loss ratio 44.5 % 38.3 % 6.2 Underwriting expense ratio 34.1 % 36.0
% (1.9 ) Combined ratio 78.6 % 74.3 % 4.3
Catastrophic activity and prior year development: Current accident
year catastrophic events, net of reinsurance and reinstatement
premiums 4.1 % 5.3 % (1.2 ) Net (favorable) adverse development in
prior year loss reserves, net of related adjustments (16.7 )% (21.1
)% 4.4 Combined ratio excluding catastrophic activity and
prior year development (1) 91.2 % 90.1 % 1.1 (1)
See ‘Comments on Regulation G’ for further discussion.
Gross premiums written by the reinsurance segment in the 2016
fourth quarter were 5.4% higher than in the 2015 fourth quarter,
while net premiums written were 3.0% higher than in the 2015 fourth
quarter. Although property catastrophe gross premiums written were
down 5.4% relative to the 2015 fourth quarter, net premiums written
increased primarily due to year-end net retrocessional portfolio
transactions. This growth was partially offset by a reduction in
property excluding property catastrophe business, reflecting
current market conditions.
The 2016 fourth quarter loss ratio included 4.5 points of
current year catastrophic activity (before the impact of
reinstatement premiums), primarily related to Hurricane Matthew,
compared to 5.8 points of catastrophic activity in the 2015 fourth
quarter. Estimated net favorable development in prior year loss
reserves, before related adjustments, reduced the loss ratio by
16.7 points in the 2016 fourth quarter, compared to 22.5 points in
the 2015 fourth quarter. The estimated net favorable development in
the 2016 fourth quarter primarily resulted from better than
expected claims emergence in short-tail business from most
underwriting years and in longer-tail business from 2013 and prior
underwriting years.
The underwriting expense ratio was 34.1% in the 2016 fourth
quarter, compared to 36.0% in the 2015 fourth quarter. The
comparison of the underwriting expense ratios reflected changes in
the mix and type of business.
Mortgage Segment
Three Months Ended December 31, (U.S.
dollars in thousands)
2016 2015 %
Change Gross premiums written $ 138,285 $ 91,787 50.7
Net premiums written 92,944 87,127 6.7 Net premiums earned 81,477
56,736 43.6 Other underwriting income 4,354 3,461 25.8
Underwriting income 42,319 17,656 139.7
Underwriting
Ratios % Point Change Loss ratio 10.9 % 12.8 % (1.9 )
Underwriting expense ratio 42.6 % 62.2 % (19.6 ) Combined ratio
53.5 % 75.0 % (21.5 ) Net (favorable) adverse development in
prior year loss reserves, net of related adjustments (6.0 )% (8.1
)% 2.1 Combined ratio excluding prior year development (1)
59.5 % 83.1 % (23.6 ) (1) See ‘Comments on Regulation
G’ for further discussion.
The mortgage segment includes the Company’s U.S. and
international mortgage insurance and reinsurance operations as well
as government sponsored enterprise (“GSE”) credit-risk sharing
transactions. Arch Mortgage Insurance Company (“Arch MI U.S.”) is
approved as an eligible mortgage insurer by Fannie Mae and Freddie
Mac. On December 31, 2016, the Company completed the acquisition of
UGC. As such, the results in the table above do not reflect UGC
business. The acquisition of UGC expands the scale of Arch’s
existing mortgage insurance businesses by combining UGC’s position
as the market leader in the U.S. private mortgage insurance
industry with Arch’s financial strength and history of innovation,
further diversifying the Company’s business profile and customer
base.
Gross premiums written by the mortgage segment in the 2016
fourth quarter were 50.7% higher than in the 2015 fourth quarter,
reflecting growth in U.S. primary business, Australian mortgage
reinsurance and GSE credit risk-sharing transactions receiving
insurance accounting treatment. The lower increase in net premiums
written of 6.7% reflected a $40.1 million retrocession on
Australian mortgage reinsurance business covering exposures written
since May 2015, with 57% of this amount being retroactive in
nature. Net premiums earned for the 2016 fourth quarter were 43.6%
higher than in the 2015 fourth quarter, reflecting the growth in
insurance in force.
Other underwriting income, which is primarily related to GSE
risk-sharing transactions receiving derivative accounting
treatment, was $4.4 million for the 2016 fourth quarter, compared
to $3.5 million for the 2015 fourth quarter.
The loss ratio for the 2016 fourth quarter reflected estimated
net favorable development in prior year loss reserves, before
related adjustments, of 6.0 points, compared to 8.1 points in the
2015 fourth quarter, driven primarily by continued lower than
expected losses. At December 31, 2016, the mortgage segment’s
risk-in-force, net of reinsurance, consisted of $42.2 billion from
the combined Arch MI U.S. and UGC and $4.7 billion from the
mortgage segment’s reinsurance and risk-sharing operations. Arch MI
U.S. generated $8.8 billion of new insurance written (“NIW”) during
the 2016 fourth quarter, of which 82% was from banks and other
non-credit union mortgage originators. For additional information
on the mortgage segment, please refer to the Company’s Financial
Supplement.
Corporate and Non-Underwriting
Corporate and non-underwriting results include net investment
income, other income (loss), corporate expenses, UGC transaction
costs and other, interest expense, net realized gains or losses,
net impairment losses included in earnings, equity in net income or
loss of investment funds accounted for using the equity method, net
foreign exchange gains or losses, income taxes and dividends
related to the Company’s non-cumulative preferred shares. Such
amounts exclude the results of the ‘other’ segment.
Net investment income for the 2016 fourth quarter was $0.56 per
share, or $70.0 million, compared to $0.53 per share, or $67.0
million, for the 2015 fourth quarter, and $0.53 per share, or $66.3
million, for the 2016 third quarter. The 2016 fourth quarter net
investment income growth primarily reflected higher income
distributions on term loan investments. The annualized pre-tax
investment income yield was 1.92% for the 2016 fourth quarter,
compared to 2.02% for the 2015 fourth quarter and 1.81% for the
2016 third quarter.
Corporate expenses were $11.5 million for the 2016 fourth
quarter, compared to $12.2 million for the 2015 fourth quarter.
Such amounts primarily represent certain holding company costs
necessary to support our worldwide insurance and reinsurance
operations and costs associated with operating as a publicly traded
company.
UGC transaction costs and other were $34.6 million for the 2016
fourth quarter, compared to $7.1 million in the 2016 third quarter
(previously reflected in corporate expenses). UGC transaction
costs, which relate to non-recurring costs such as advisory,
financing, legal, etc. related to the UGC acquisition discussed
below, were $25.2 million in the 2016 fourth quarter, compared to
$7.1 million in the 2016 third quarter. In addition, the Company
recorded an expense of $9.4 million in the 2016 fourth quarter
related to a change in its accounting policy with respect to
deferred acquisition costs. This change in accounting policy, which
was reflected retroactively in the financial statements, also
resulted in adjustments to the deferred acquisition costs, other
assets, and retained earnings accounts on the balance sheet. The
impact on the Company’s book value as of December 31, 2016 of this
change, including the income statement charge noted above and net
of tax, was a reduction of $41.9 million, or $0.31 per share.
Interest expense for the 2016 fourth quarter was $15.5 million,
compared to $12.8 million for the 2015 fourth quarter, with the
increase resulting from the Company’s capital raising activity
described below.
On a pre-tax basis, net foreign exchange gains for the 2016
fourth quarter were $35.2 million, compared to net foreign exchange
gains for the 2015 fourth quarter of $2.3 million. For both
periods, such amounts were primarily unrealized and resulted 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.
Although the Company generally attempts to match the currency of
its projected liabilities with investments in the same currencies,
from time to time the Company may elect to over or underweight one
or more currencies, which could increase the Company’s exposure to
foreign currency fluctuations and increase the volatility of the
Company’s shareholders’ equity.
Preferred dividends for the 2016 fourth quarter were $11.6
million, compared to $5.5 million for the 2015 fourth quarter, with
the increase reflecting the impact of the issuance of the Company’s
series E preferred shares in late September 2016. The Company used
the net proceeds from the series E offering to fund a portion of
the cash consideration required in the UGC acquisition.
The Company’s effective tax rate on income before income taxes
(based on the Company’s annual effective tax rate) was a benefit of
19.9% for the 2016 fourth quarter and an expense of 4.3% for the
year ended December 31, 2016, compared to an expense of 16.4% for
the 2015 fourth quarter and an expense of 7.0% for the year ended
December 31, 2015. The Company’s effective tax rate on pre-tax
operating income available to Arch shareholders was 2.1% for the
2016 fourth quarter and 5.2% for the year ended December 31, 2016,
compared to 6.9% for the 2015 fourth quarter and 5.1% for the year
ended December 31, 2015. The Company’s effective tax rate
fluctuates from year to year based upon the relative mix of income
or loss reported by jurisdiction and the varying tax rates in each
jurisdiction.
UGC Acquisition
On December 31, 2016, the Company completed the acquisition of
UGC pursuant to the Stock Purchase Agreement with American
International Group, Inc. (“AIG”) entered into on
August 15, 2016. As such, the Company’s balance sheet reflects
the acquisition of UGC while the income statement for 2016 does not
include UGC activity other than the impact of capital raising
activity and UGC transaction costs noted above. For a complete
description of the UGC acquisition, please refer to the Company’s
Form 8-K filed on August 15, 2016 and other documents on file with
the SEC.
The following table summarizes the purchase consideration and
condensed net assets acquired and liabilities assumed in the UGC
acquisition:
(U.S. dollars in thousands)
Purchase price Cash consideration $ 2,159,524 Funded
through: Net proceeds from senior notes $ 940,741 Net proceeds from
preferred shares 434,899 Drawdown of revolving credit agreement
400,000 Cash and investments 383,884 Convertible non-voting common
equivalent preferred shares (1) 1,101,304
Total purchase
price $ 3,260,828 Net assets
acquired and liabilities assumed Cash and investments 3,591,982
Reserves for losses and loss adjustment expenses, net (551,096 )
Unearned premiums, net (535,085 ) Intangible asset -- acquired
insurance contracts 350,000 Intangible asset -- distribution
relationships 115,000 Intangible asset -- operating platform 15,000
Intangible asset -- insurance licenses 27,000 Other assets acquired
and liabilities assumed, net 59,269
Net assets
acquired $ 3,072,070 Goodwill
$ 188,758
(1) Based upon a formula set forth in the
Stock Purchase Agreement, AIG received 1,276,820 of ACGL’s
convertible non-voting common equivalent preferred shares, each of
which is convertible into 10 shares of ACGL fully paid
non-assessable common stock. The Company has determined that, based
on a review of the terms, features and rights of the Company’s
non-voting common equivalent preferred shares compared to the
rights of the Company’s common shareholders, the underlying
12,762,820 common shares that the convertible securities convert to
were common share equivalents at the time of their issuance.
The expected useful life is between 5 to 8 years for the
acquired insurance contracts, 18 to 20 years for the distribution
relationships, and 9 to 11 years for the operating platform. For
information on the combined risk metrics of the Company’s U.S.
mortgage insurance operations (combined Arch MI U.S. and UGC),
please refer to the Company’s Financial Supplement.
Capitalization and Shareholders’ Equity
On December 8, 2016, Arch Capital Finance LLC, a wholly-owned
subsidiary of the Company, completed the public offering of $500
million aggregate principal amount of its 4.011% senior notes due
2026 and $450 million aggregate principal amount of 5.031% senior
notes due 2046. Such notes are fully and unconditionally guaranteed
by ACGL. The Company used the net proceeds from the offering of
$940.7 million to fund a portion of the cash consideration required
in the UGC acquisition. In addition, the Company borrowed $400.0
million under its revolving credit agreement in late December 2016
to fund a portion of the UGC acquisition.
At December 31, 2016, total capital available to Arch of $10.49
billion consisted of $1.73 billion of senior notes, representing
16.5% of the total, $500.0 million of revolving credit agreement
borrowings, representing 4.8% of the total, $772.6 million of
preferred shares, representing 7.4% of the total, and common
shareholders’ equity of $7.48 billion, representing 71.3% of the
total. At December 31, 2015, total capital available to Arch of
$7.06 billion consisted of $791.3 million of senior notes,
representing 11.2% of the total, $100.0 million of revolving credit
agreement borrowings, representing 1.4% of the total, $325.0
million of preferred shares, representing 4.6% of the total, and
common shareholders’ equity of $5.84 billion, representing 82.8% of
the total. Incorporating the impact of the issuance of 12.8 million
common share equivalents issued in the UGC acquisition described
above, total common shares and common share equivalents
outstanding, net of treasury shares, increased to 135.6 million at
December 31, 2016, from 122.7 million at September 30, 2016.
Conference Call
The Company will hold a conference call for investors and
analysts at 11:00 a.m. Eastern Time on February 14, 2017. 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 February
14, 2017 at 2:00 p.m. Eastern Time until February 21, 2017 at
midnight Eastern Time. To access the replay, domestic callers
should dial 855-859-2056, and international callers should dial
404-537-3406 (passcode 49728094 for all callers).
Please refer to the Company’s Financial Supplement dated
December 31, 2016, 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 $10.49 billion in capital at December 31, 2016,
provides insurance, reinsurance and mortgage insurance on a
worldwide basis through its wholly owned subsidiaries.
Comments 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 and that investors and such other persons benefit from
having a consistent basis for comparison between quarters and for
comparison with other companies within the industry. These measures
may not, however, be comparable to similarly titled measures used
by companies outside of the insurance industry. Investors are
cautioned not to place undue reliance on these non-GAAP financial
measures in assessing the Company’s overall financial
performance.
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, net foreign exchange
gains or losses, UGC transaction costs and other and income taxes,
and the use of annualized operating return on average common
equity. The presentation of after-tax operating income available to
Arch common shareholders and annualized operating return on average
common equity are non-GAAP financial measures as defined in
Regulation G. The reconciliation of such measures to net income
available to Arch common shareholders and annualized return on
average common equity (the most directly comparable GAAP financial
measures) 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, net
foreign exchange gains or losses and UGC transaction costs and
other 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. UGC transaction
costs and other include non-recurring advisory, financing, legal
and other transaction costs related to the UGC acquisition and
non-recurring expenses related to a change in the Company’s
approach on the deferral of certain internal underwriting costs
which are no longer being deferred. The Company believes that UGC
transaction costs and other, due to their non-recurring nature, are
not indicative of the performance of, or trends in, the Company’s
business performance. 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, net foreign exchange gains
or losses and UGC transaction costs and other 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.
The Company’s segment information includes the presentation of
consolidated underwriting income or loss and a subtotal of
underwriting income or loss before the contribution from the
‘other’ segment. Such measures represent the pre-tax profitability
of its underwriting operations and include net premiums earned plus
other underwriting income, less losses and loss adjustment
expenses, acquisition expenses and other operating expenses. Other
operating expenses include those operating expenses that are
incremental and/or directly attributable to the Company’s
individual underwriting operations. Underwriting income or loss
does not incorporate items included in the Company’s corporate
(non-underwriting) segment. While these measures are presented in
the Segment Information footnote to the Company’s Consolidated
Financial Statements, they are considered non-GAAP financial
measures when presented elsewhere on a consolidated basis. The
reconciliations of underwriting income or loss to income before
income taxes (the most directly comparable GAAP financial measure)
on a consolidated basis and a subtotal before the contribution from
the ‘other’ segment, in accordance with Regulation G, is shown on
pages 10 and 11.
Management measures segment performance for its three
underwriting segments based on underwriting income or loss. The
Company does not manage its assets by underwriting segment and,
accordingly, investment income and other non-underwriting related
items are not allocated to each underwriting segment. As noted
earlier, the ‘other’ segment includes the results of Watford Re.
Watford Re has its own management and board of directors that is
responsible for the overall profitability of the ‘other’ segment.
For the ‘other’ segment, performance is measured based on net
income or loss. The Company does not guarantee or provide credit
support for Watford Re, and the Company’s financial exposure to
Watford Re is limited to its investment in Watford Re’s common and
preferred shares and counterparty credit risk (mitigated by
collateral) arising from reinsurance transactions. Along with
consolidated underwriting income, the Company provides a subtotal
of underwriting income or loss before the contribution from the
‘other’ segment and believes that this presentation enables
investors and other users of the Company’s financial information to
analyze the Company’s underwriting performance in a manner similar
to how the Company’s management analyzes performance.
In addition, the Company’s segment information includes the use
of a combined ratio excluding catastrophic activity and prior year
development for the insurance segment and reinsurance segment and a
combined ratio excluding prior year development for the mortgage
segment. These ratios are non-GAAP financial measures as defined in
Regulation G. The reconciliation of such measures to the combined
ratio (the most directly comparable GAAP financial measure) in
accordance with Regulation G are shown on the individual segment
pages. The Company’s management utilizes the adjusted combined
ratio excluding current accident year catastrophic events and
favorable or adverse development in prior year loss reserves in its
analysis of the underwriting performance of each of its
underwriting segments.
The following tables summarize the Company’s results by segment
for the 2016 fourth quarter and 2015 fourth quarter and a
reconciliation of underwriting income or loss to income before
income taxes and net income available to Arch common
shareholders:
(U.S. Dollars in thousands)
Three Months
Ended December 31, 2016 Insurance
Reinsurance Mortgage Sub-total
Other Total Gross premiums written (1)
$ 707,519 $ 276,593 $ 138,285 $ 1,121,338 $ 113,467 $ 1,155,467
Premiums ceded (241,658 ) (70,473 ) (45,341 ) (356,413 ) (6,077 )
(283,152 ) Net premiums written 465,861 206,120 92,944 764,925
107,390 872,315 Change in unearned premiums 48,226 45,721
(11,467 ) 82,480 14,060 96,540 Net
premiums earned 514,087 251,841 81,477 847,405 121,450 968,855
Other underwriting income — 13,744 4,354 18,098 824 18,922 Losses
and loss adjustment expenses (348,226 ) (112,149 ) (8,841 )
(469,216 ) (84,659 ) (553,875 ) Underwriting expenses (2) (163,280
) (85,824 ) (34,671 ) (283,775 ) (40,881 ) (324,656 ) Underwriting
income (loss) $ 2,581 $ 67,612 $ 42,319
112,512 (3,266 ) 109,246 Net investment income 70,105 20,946
91,051 Net realized gains (losses) (99,149 ) 6,088 (93,061 ) Net
impairment losses recognized in earnings (13,593 ) — (13,593 )
Equity in net income (loss) of investment funds accounted for using
the equity method 16,421 — 16,421 Other income (loss) (368 ) — (368
) Corporate expenses (2) (11,470 ) — (11,470 ) UGC transaction
costs and other (2) (34,587 ) — (34,587 ) Interest expense (15,481
) (3,058 ) (18,539 ) Net foreign exchange gains (losses) 35,221
2,955 38,176
Income before income taxes
59,611 23,665 83,276 Income tax expense 12,298 —
12,298
Net income 71,909 23,665 95,574 Dividends
attributable to redeemable noncontrolling interests — (4,588 )
(4,588 ) Amounts attributable to nonredeemable noncontrolling
interests — (16,973 ) (16,973 )
Net income available to
Arch 71,909 2,104 74,013 Preferred dividends (11,617 ) —
(11,617 )
Net income available to Arch common shareholders $
60,292 $ 2,104 $ 62,396
Underwriting
Ratios Loss ratio 67.7 % 44.5 % 10.9 % 55.4 % 69.7 % 57.2 %
Underwriting expense ratio 31.7 % 34.1 % 42.6 % 33.4 % 33.7 % 33.5
% Combined ratio 99.4 % 78.6 % 53.5 % 88.8 % 103.4 % 90.7 %
Net premiums written to gross premiums written 65.8 % 74.5 % 67.2 %
68.2 % 94.6 % 75.5 % (1) Certain amounts included in
the gross premiums written of each segment are related to
intersegment transactions and are included in the gross premiums
written of each segment. Accordingly, the sum of gross premiums
written for each segment does not agree to the total gross premiums
written as shown in the table above due to the elimination of
intersegment transactions in the total. (2) Certain expenses have
been excluded from ‘corporate expenses’ and ‘underwriting expenses’
totaling $25.2 million and $9.4 million, respectively, and
reflected in ‘UGC transaction costs and other.’ (U.S.
Dollars in thousands)
Three Months
Ended December 31, 2015 Insurance
Reinsurance Mortgage Sub-total
Other Total Gross premiums written (1)
$ 680,617 $ 262,482 $ 91,787 $ 1,031,341 $ 101,147 $ 1,066,740
Premiums ceded (229,011 ) (62,417 ) (4,660 ) (292,543 ) (4,961 )
(231,756 ) Net premiums written 451,606 200,065 87,127 738,798
96,186 834,984 Change in unearned premiums 52,919 62,957
(30,391 ) 85,485 23,051 108,536 Net
premiums earned 504,525 263,022 56,736 824,283 119,237 943,520
Other underwriting income 526 3,736 3,461 7,723 898 8,621 Losses
and loss adjustment expenses (313,966 ) (100,855 ) (7,237 )
(422,058 ) (83,962 ) (506,020 ) Underwriting expenses (163,063 )
(94,881 ) (35,304 ) (293,248 ) (39,730 ) (332,978 ) Underwriting
income (loss) $ 28,022 $ 71,022 $ 17,656
116,700 (3,557 ) 113,143 Net investment income 66,970 28,930
95,900 Net realized gains (losses) (84,302 ) (59,465 ) (143,767 )
Net impairment losses recognized in earnings (7,336 ) — (7,336 )
Equity in net income (loss) of investment funds accounted for using
the equity method 5,517 — 5,517 Other income (loss) (451 ) — (451 )
Corporate expenses (12,243 ) — (12,243 ) Interest expense (12,757 )
(3,070 ) (15,827 ) Net foreign exchange gains (losses) 2,286
2,234 4,520
Income before income taxes 74,384
(34,928 ) 39,456 Income tax expense (11,450 ) — (11,450 )
Net income 62,934 (34,928 ) 28,006 Dividends attributable to
redeemable noncontrolling interests — (4,589 ) (4,589 ) Amounts
attributable to nonredeemable noncontrolling interests —
35,162 35,162
Net income available to Arch
62,934 (4,355 ) 58,579 Preferred dividends (5,485 ) — (5,485
)
Net income available to Arch common shareholders $ 57,449
$ (4,355 ) $ 53,094
Underwriting Ratios
Loss ratio 62.2 % 38.3 % 12.8 % 51.2 % 70.4 % 53.6 % Underwriting
expense ratio 32.4 % 36.0 % 62.2 % 35.6 % 33.4 % 35.3 % Combined
ratio 94.6 % 74.3 % 75.0 % 86.8 % 103.8 % 88.9 % Net
premiums written to gross premiums written 66.4 % 76.2 % 94.9 %
71.6 % 95.1 % 78.3 % (1) Certain amounts included in
the gross premiums written of each segment are related to
intersegment transactions and are included in the gross premiums
written of each segment. Accordingly, the sum of gross premiums
written for each segment does not agree to the total gross premiums
written as shown in the table above due to the elimination of
intersegment transactions in the total.
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 (including
alternative sources of capital), 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 UGC and any other
businesses we have acquired or may acquire into our 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, 2016;
- 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;
- changes in general economic conditions,
including new or continued sovereign debt concerns in Eurozone
countries or downgrades of U.S. securities by credit rating
agencies, which could affect the Company’s business, financial
condition and results of operations;
- the volatility of the Company’s
shareholders’ equity from foreign currency fluctuations, which
could increase due to us not matching portions of the Company’s
projected liabilities in foreign currencies with investments in the
same currencies;
- 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.
View source
version on businesswire.com: http://www.businesswire.com/news/home/20170213006144/en/
Arch Capital Group Ltd.Mark D. Lyons, 441-278-9250Executive Vice
President andChief Financial Officer
Arch Capital (NASDAQ:ACGL)
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