Arch Capital Group Ltd. (NASDAQ:ACGL) reports that, as a result
of the significant level of catastrophic event activity in the 2017
third quarter, the Company incurred a net loss to Arch common
shareholders of $52.8 million, or $0.39 per share, compared to net
income available to Arch common shareholders of $247.4 million, or
$1.98 per share, for the 2016 third quarter. For the nine months
ended September 30, 2017, the Company reported net income available
to Arch common shareholders of $363.0 million, or $2.61 per share,
compared to $602.3 million, or $4.84 per share, for the 2016
period. The Company’s book value per common share was $59.61 at
September 30, 2017, consistent with the $59.60 per share reported
at June 30, 2017 and an 11.8% increase from $53.30 per share at
September 30, 2016. All earnings per share amounts discussed in
this release are on a diluted basis. However, due to the net loss
recorded in the 2017 third quarter, reported weighted average
common shares and common share equivalents outstanding for the 2017
third quarter do not include the effect of dilutive securities
since the inclusion of such securities is anti-dilutive to per
share results.
The Company also reported an after-tax operating loss to Arch
common shareholders, a non-GAAP measure, of $107.1 million, or
$0.79 per share, for the 2017 third quarter, compared to after-tax
operating income to Arch common shareholders of $149.6 million, or
$1.20 per share, for the 2016 third quarter. For the nine months
ended September 30, 2017, the Company reported after-tax operating
income available to Arch common shareholders of $259.8 million, or
$1.87 per share, compared to $435.9 million, or $3.50 per share,
for the 2016 period. See ‘Comments on Regulation G’ for further
details.
The following table summarizes the Company’s underwriting
results, both on a consolidated basis and a consolidated basis
excluding the ‘other’ segment (i.e., results of Watford Re). See
‘Comments on Regulation G’ for a reconciliation of underwriting
income (loss) to income (loss) before income taxes and net income
(loss) available to Arch common shareholders.
(U.S. dollars in thousands)
Consolidated
Consolidated Excluding ‘Other’ Segment (1) Three Months
Ended September 30, Three Months Ended September 30,
2017 2016 % Change 2017
2016 % Change Gross premiums
written $ 1,648,246 $ 1,278,765 28.9 $ 1,557,179 $ 1,214,765 28.2
Net premiums written 1,325,403 1,014,278 30.7 1,171,676 856,842
36.7 Net premiums earned 1,261,886 958,403 31.7 1,133,256 847,967
33.6 Underwriting income (loss) (142,172 ) 127,647 (211.4 )
(107,617 ) 126,268 (185.2 )
Underwriting Ratios
% PointChange
% PointChange
Loss ratio 82.9 % 54.7 % 28.2 81.4 % 53.1 % 28.3 Acquisition
expense ratio 15.4 % 16.8 % (1.4 ) 14.3 % 15.6 % (1.3 ) Other
operating expense ratio 13.5 % 16.0 % (2.5 ) 14.3 % 17.2 % (2.9 )
Combined ratio 111.8 % 87.5 % 24.3 110.0 % 85.9 % 24.1
(1) Pursuant to generally accepted accounting
principles, the Company concluded that Watford Re is considered a
variable interest entity and that the Company is the primary
beneficiary of Watford Re. As such, the Company consolidates the
results of Watford Re (i.e., the ‘other’ segment) in its
consolidated financial statements, although it only owns
approximately 11% of Watford Re’s common equity.
The Company’s 2017 third quarter results reflect estimated
after-tax net losses from current accident year catastrophic events
of $319.8 million (pre-tax net losses of $347.8 million), net of
reinsurance and reinstatement premiums and excluding the ‘other’
segment. Such amounts were primarily related to Hurricanes Harvey,
Irma and Maria, along with the Mexican earthquakes and other more
minor global events. The Company’s estimates for these events are
based on currently available information derived from modeling
techniques, industry assessments of exposure, preliminary claims
information obtained from the Company’s clients and brokers to date
and a review of in-force contracts. The Company’s actual losses
from these events may vary materially from the estimates due to the
inherent uncertainties in making such determinations resulting from
several factors, including the preliminary nature of available
information, the potential inaccuracies and inadequacies in the
data provided by clients and brokers, the modeling techniques and
the application of such techniques, the contingent nature of
business interruption exposures, the effects of any resultant
demand surge on claims activity and attendant coverage issues. In
addition, actual losses may increase if the Company’s reinsurers
fail to meet their obligations to the Company or the reinsurance
protections purchased by the Company are exhausted or are otherwise
unavailable.
The following table summarizes the Company’s consolidated
financial data, including a reconciliation of net income or loss
available to Arch common shareholders to after-tax operating income
or loss available to Arch common shareholders and related diluted
per share results:
(U.S. dollars in thousands, except share data)
Three Months Ended Nine Months Ended September
30, September 30, 2017 2016
2017 2016 Net income (loss) available to Arch
common shareholders $ (52,760 ) $ 247,388 $ 362,967 $ 602,272 Net
realized (gains) losses (64,344 ) (99,159 ) (111,930 ) (175,558 )
Net impairment losses recognized in earnings 1,878 3,867 5,415
16,849 Equity in net (income) loss of investment funds accounted
for using the equity method (31,090 ) (16,662 ) (111,884 ) (32,054
) Net foreign exchange (gains) losses 27,811 4,054 85,619 3,560 UGC
transaction costs and other 2,990 7,142 21,249 7,142 Loss on
redemption of preferred shares 6,735 — 6,735 — Income tax expense
(1) 1,647 2,970 1,580 13,705 After-tax
operating income (loss) available to Arch common shareholders $
(107,133 ) $ 149,600 $ 259,751 $ 435,916
Diluted per common
share results:
Net income (loss) available to Arch common shareholders $ (0.39 ) $
1.98 $ 2.61 $ 4.84 Net realized (gains) losses (0.48 ) (0.79 )
(0.80 ) (1.41 ) Net impairment losses recognized in earnings 0.02
0.03 0.04 0.14 Equity in net (income) loss of investment funds
accounted for using the equity method (0.23 ) (0.13 ) (0.80 ) (0.27
) Net foreign exchange (gains) losses 0.21 0.03 0.61 0.03 UGC
transaction costs and other 0.02 0.06 0.15 0.06 Loss on redemption
of preferred shares 0.05 — 0.05 — Income tax expense (1) 0.01
0.02 0.01 0.11 After-tax operating
income (loss) available to Arch common shareholders $ (0.79 ) $
1.20 $ 1.87 $ 3.50 Weighted average
common shares and common share equivalents outstanding-diluted (2)
134,885,451 124,931,653 139,222,324 124,528,174 Beginning
common shareholders’ equity $ 8,126,332 $ 6,340,583 $ 7,481,163 $
5,841,542 Ending common shareholders’ equity 8,138,589
6,538,983 8,138,589 6,538,983 Average common
shareholders’ equity $ 8,132,461 $ 6,439,783 $
7,809,876 $ 6,190,263 Annualized return on
average common equity (2.6 )% 15.4 % 6.2 % 13.0 % Annualized
operating return on average common equity (5.3 )% 9.3 % 4.4 % 9.4 %
(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, UGC transaction costs
and other and loss on redemption of preferred shares reflects the
relative mix reported by jurisdiction and the varying tax rates in
each jurisdiction. (2) Due to the net loss recorded in the 2017
third quarter, diluted weighted average common shares and common
share equivalents outstanding for such period do not include the
effect of dilutive securities since the inclusion of such
securities is anti-dilutive to per share results. Due to the net
gain reported for all other periods presented, weighted average
common shares and common share equivalents outstanding for such
periods reflect the effect of dilutive securities.
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 2017
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, 2017. The
Company’s segment information includes the use of underwriting
income (loss) 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 September 30, (U.S. dollars
in thousands)
2017 2016 % Change
Gross premiums written $ 787,447 $ 758,934 3.8 Net premiums
written 564,931 541,488 4.3 Net premiums earned 535,165 519,078 3.1
Underwriting income (loss) $ (207,143 ) $ 22,474 (1,021.7 )
Underwriting Ratios
% PointChange
Loss ratio 106.3 % 64.1 % 42.2 Underwriting expense ratio 32.4 %
31.6 % 0.8 Combined ratio 138.7 % 95.7 % 43.0
Catastrophic activity and prior year development: Current accident
year catastrophic events, net of reinsurance and reinstatement
premiums 40.1 % 0.3 % 39.8 Net (favorable) adverse development in
prior year loss reserves, net of related adjustments (0.3 )% (2.3
)% 2.0 Combined ratio excluding catastrophic activity and
prior year development (1) 98.9 % 97.7 % 1.2 (1)
See ‘Comments on Regulation G’ for further discussion.
Gross premiums written by the insurance segment in the 2017
third quarter were 3.8% higher than in the 2016 third quarter while
net premiums written were 4.3% higher than in the 2016 third
quarter. The increase in net premiums written reflected growth in
program business, due to the continued effects of two newer
programs, and in travel business. Such amounts were partially
offset by a decrease in excess and surplus casualty business which
reflected a lower level of project-related premiums, primarily due
to the fact that the 2016 period included a significant amount of
premium from one large construction project, along with a targeted
reduction in certain exposures. Net premiums earned by the
insurance segment in the 2017 third quarter were 3.1% higher than
in the 2016 third quarter, and reflect changes in net premiums
written over the previous five quarters.
The 2017 third quarter loss ratio reflected 40.1 points of
current year catastrophic activity, primarily related to Hurricanes
Harvey, Irma and Maria, compared to 0.3 points in the 2016 third
quarter. Estimated net favorable development in prior year loss
reserves, before related adjustments, reduced the loss ratio by 0.6
points in the 2017 third quarter, compared to 2.6 points in the
2016 third quarter. The balance of the change in the 2017 third
quarter loss ratio resulted, in part, from the effects of market
conditions and changes in the mix of business.
The underwriting expense ratio was 32.4% in the 2017 third
quarter, compared to 31.6% in the 2016 third quarter. The
comparison of the underwriting expense ratios reflected changes in
the mix of business.
Reinsurance Segment
Three Months Ended September 30, (U.S. dollars
in thousands)
2017 2016 % Change
Gross premiums written $ 422,083 $ 324,361 30.1 Net premiums
written 316,694 234,810 34.9 Net premiums earned 323,573 251,927
28.4 Other underwriting income 1,728 2,216 (22.0 )
Underwriting income (loss) $ (86,862 ) $ 62,638 (238.7 )
Underwriting Ratios
% PointChange
Loss ratio 98.5 % 42.0 % 56.5 Underwriting expense ratio 28.9 %
33.9 % (5.0 ) Combined ratio 127.4 % 75.9 % 51.5
Catastrophic activity and prior year development: Current accident
year catastrophic events, net of reinsurance and reinstatement
premiums 41.2 % 3.5 % 37.7 Net (favorable) adverse development in
prior year loss reserves, net of related adjustments (10.7 )% (24.0
)% 13.3 Combined ratio excluding catastrophic activity and
prior year development (1) 96.9 % 96.4 % 0.5 (1)
See ‘Comments on Regulation G’ for further discussion.
Gross premiums written by the reinsurance segment in the 2017
third quarter were 30.1% higher than in the 2016 third quarter,
while net premiums written were 34.9% higher than in the 2016 third
quarter. Gross and net premiums written for the 2017 third quarter
reflected an increase of $45.4 million in casualty business related
to a retroactive reinsurance contract which was substantially
earned in the period and resulted in a corresponding increase to
losses and loss adjustment expenses. In addition, reinstatement
premiums related to Hurricanes Harvey, Irma and Maria contributed
$25.0 million to gross premiums written and $15.8 million to net
premiums written in the 2017 third quarter. The increase in net
premiums written in the 2017 third quarter also reflected growth in
other specialty business, primarily in international motor quota
share contracts. Net premiums earned by the reinsurance segment in
the 2017 third quarter were 28.4% higher than in the 2016 third
quarter, and reflect the retroactive reinsurance contract and
reinstatement premium impacts discussed above as well as changes in
net premiums written over the previous five quarters.
The 2017 third quarter loss ratio included 46.3 points of
current year catastrophic activity, primarily related to Hurricanes
Harvey, Irma and Maria, compared to 4.1 points of catastrophic
activity in the 2016 third quarter. Estimated net favorable
development in prior year loss reserves, before related
adjustments, reduced the loss ratio by 11.3 points in the 2017
third quarter, compared to 23.6 points in the 2016 third quarter.
The estimated net favorable development in the 2017 third quarter
primarily resulted from better than expected claims emergence in
short-tail business from more recent underwriting years and in
longer-tail business across earlier underwriting years. The balance
of the change in the 2017 third quarter loss ratio resulted, in
part, from the effects of market conditions and changes in the mix
of business.
The underwriting expense ratio was 28.9% in the 2017 third
quarter, compared to 33.9% in the 2016 third quarter. The
retroactive reinsurance contract noted above improved the reported
2017 third quarter underwriting expense ratio by 4.1 points and the
comparison of the underwriting expense ratios also reflected
changes in the mix and type of business.
Mortgage Segment
Three Months Ended September 30, (U.S. dollars
in thousands)
2017 2016 % Change
Gross premiums written $ 347,951 $ 131,726 164.1 Net
premiums written 290,051 80,544 260.1 Net premiums earned 274,518
76,962 256.7 Other underwriting income 3,599 4,740 (24.1 )
Underwriting income $ 186,388 $ 41,156 352.9
Underwriting
Ratios
% PointChange
Loss ratio 12.8 % 14.4 % (1.6 ) Underwriting expense ratio 20.6 %
38.2 % (17.6 ) Combined ratio 33.4 % 52.6 % (19.2 ) Prior
year development:
Net (favorable) adverse development in
prior year loss reserves, net of related adjustments
(7.8 )% (3.2 )% (4.6 ) Combined ratio excluding prior year
development (1) 41.2 % 55.8 % (14.6 ) (1) See
‘Comments on Regulation G’ for further discussion.
The mortgage segment includes the Company’s U.S. mortgage
insurance operations (“Arch MI U.S.”), international mortgage
insurance and reinsurance operations as well as government
sponsored enterprise (“GSE”) credit-risk sharing transactions. On
December 31, 2016, the Company completed the acquisition of United
Guaranty Corporation (“UGC”). As such, the 2017 third quarter
results reflect the combination of Arch and UGC while the 2016
third quarter does not reflect UGC activity.
Gross premiums written by the mortgage segment in the 2017 third
quarter were significantly higher than in the 2016 third quarter,
primarily reflecting the growth in insurance in force due to the
acquisition of UGC. Premiums ceded for the 2017 third quarter were
primarily related to the 50% quota share reinsurance agreement to
AIG, covering 2014 to 2016 policy years of UGC business on a
run-off basis, while the 2016 third quarter reflected the
retrocession of $45.4 million of Australian mortgage reinsurance
business. The increase in net premiums earned for the 2017 third
quarter reflected growth in insurance in force over the last twelve
months.
Arch MI U.S. generated $17.7 billion of new insurance written
(“NIW”) during the 2017 third quarter, compared to $17.3 billion
during the 2017 second quarter. The sequential growth in NIW
reflected seasonality and an increase in purchase market activity.
Monthly premium policies contributed 87.0% of 2017 third quarter
NIW, compared to 85.7% in the 2017 second quarter.
The loss ratio for the 2017 third quarter reflected estimated
net favorable development in prior year loss reserves, before
related adjustments, of 7.8 points, compared to 11.5 points in the
2017 second quarter. The estimated net favorable development in the
2017 periods was primarily driven by continued lower than expected
claim rates and subrogation activity. The ending percentage of
loans in default on first lien business declined to 1.98% at
September 30, 2017, from 2.02% at June 30, 2017.
The mortgage segment’s underwriting expense ratio was 20.6% in
the 2017 third quarter, compared to 22.5% in the 2017 second
quarter. The lower underwriting expense ratio in the 2017 third
quarter reflected the continued benefits of integration activities
which reduced aggregate expenses for the period, along with the
impact of growth in net premiums earned.
At September 30, 2017, the mortgage segment’s risk-in-force
(before reinsurance) of $69.2 billion consisted of $64.0 billion
from Arch MI U.S. with the remainder from reinsurance and
risk-sharing operations. For additional information on the mortgage
segment, please refer to the Company’s Financial Supplement dated
September 30, 2017.
Corporate and Non-Underwriting
Corporate and non-underwriting results include net investment
income, other income (loss), corporate expenses, UGC transaction
costs and other, amortization of intangible assets, interest
expense, items related to the Company’s non-cumulative preferred
shares, 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 and income taxes. Such amounts exclude the results
of the ‘other’ segment.
Net investment income for the 2017 third quarter was $0.70 per
share, or $94.1 million, compared to $0.53 per share, or $66.3
million, for the 2016 third quarter. The 2017 third quarter net
investment income reflected income on the acquired UGC portfolio,
partially offset by higher investment expenses. The annualized
pre-tax investment income yield was 2.00% for the 2017 third
quarter, compared to 1.81% for the 2016 third quarter.
Corporate expenses were $14.1 million for the 2017 third
quarter, compared to $11.3 million for the 2016 third quarter, with
the increase primarily due to equity incentive grants related to
recent management changes. UGC transaction costs and other were
$3.0 million for the 2017 third quarter, compared to $2.7 million
in the 2017 second quarter. UGC transaction costs and other include
advisory, financing, legal, severance, incentive compensation and
other transaction costs related to the UGC acquisition. Amounts for
both periods primarily reflected severance and severance related
costs.
Amortization of intangible assets for the 2017 third quarter was
$31.8 million, compared to $4.9 million for the 2016 third quarter.
The higher level of expense for the 2017 third quarter reflects the
amortization of intangible assets related to the UGC acquisition,
including intangible assets for acquired insurance contracts and
distribution relationships.
Interest expense for the 2017 third quarter was $26.3 million,
compared to $12.9 million for the 2016 third quarter, with the
increase primarily reflecting the impact of the issuance of the
Company’s 2026 and 2046 senior notes in December 2016 and the
higher level of borrowings under the Company’s revolving credit
agreement. During the 2017 third quarter, the Company repaid $100.0
million of revolving borrowings.
Preferred dividends for the 2017 third quarter were $12.4
million, compared to $5.5 million for the 2016 third quarter, with
the increase primarily reflecting the impact of the issuance of
series E preferred shares in September 2016. The proceeds from the
debt and preferred offerings were used to close the UGC acquisition
on December 31, 2016. In addition, the Company issued $230 million
of 5.45% Series F preferred shares in August 2017 and received net
proceeds of $222.1 million. In September 2017, the Company redeemed
$230 million of 6.75% Series C preferred shares and, in accordance
with GAAP, recorded a loss of $6.7 million to remove original
issuance costs related to the redeemed shares from additional
paid-in capital. Such adjustment had no impact on total
shareholders’ equity or cash flows.
For additional information on the Company’s capital structure,
please refer to the Financial Supplement dated September 30,
2017.
On a pre-tax basis, net foreign exchange losses for the 2017
third quarter were $27.8 million, compared to net foreign exchange
losses for the 2016 third quarter of $4.2 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,
the Company may elect to over or underweight one or more currencies
from time to time, 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
(based on the Company’s estimated annual effective tax rate) was
14.9% for the nine months ended September 30, 2017, compared to
6.6% for the 2016 period. The Company’s effective tax rate on
pre-tax operating income available to Arch shareholders was 19.0%
for the nine months ended September 30, 2017, compared to 13.9% for
the six months ended June 30, 2017 and 6.2% for the 2016 period.
The Company’s effective tax rate fluctuates from year to year based
upon the relative mix of income or loss reported by jurisdiction,
the level of catastrophic loss activity incurred, and the varying
tax rates in each jurisdiction. 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 2017 third quarter reduced the Company’s
after-tax results by $26.5 million, or $0.20 per share.
Conference Call
The Company will hold a conference call for investors and
analysts at 11:00 a.m. Eastern Time on October 26, 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 October 26,
2017 at 2:00 p.m. Eastern Time until November 2, 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 93724925 for all callers).
Please refer to the Company’s Financial Supplement dated
September 30, 2017, 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 $11.04 billion in capital at September 30, 2017,
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 loss on
redemption of preferred shares, net of 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 the following page 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, UGC transaction costs and other
and loss on redemption of preferred shares 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 advisory, financing, legal,
severance, incentive compensation and other transaction costs
related to the UGC acquisition. During the 2016 fourth quarter, UGC
transaction costs and other included 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. The loss on
redemption of preferred shares related to the redemption of the
Company's Series C preferred shares in September 2017 and had no
impact on shareholders' equity or cash flows. 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, UGC transaction costs and other and loss
on redemption of preferred shares 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
the following pages.
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 2017 third quarter and 2016 third quarter and a
reconciliation of underwriting income or loss to income or loss
before income taxes and net income or loss available to Arch common
shareholders:
(U.S. Dollars in thousands)
Three Months Ended
September 30, 2017 Insurance
Reinsurance Mortgage Sub-total
Other Total Gross premiums written (1)
$ 787,447 $ 422,083 $ 347,951 $ 1,557,179 $ 166,198 $ 1,648,246
Premiums ceded (222,516 ) (105,389 ) (57,900 ) (385,503 ) (12,471 )
(322,843 ) Net premiums written 564,931 316,694 290,051 1,171,676
153,727 1,325,403 Change in unearned premiums (29,766 ) 6,879
(15,533 ) (38,420 ) (25,097 ) (63,517 ) Net premiums earned
535,165 323,573 274,518 1,133,256 128,630 1,261,886 Other
underwriting income — 1,728 3,599 5,327 737 6,064 Losses and loss
adjustment expenses (568,795 ) (318,609 ) (35,156 ) (922,560 )
(123,581 ) (1,046,141 ) Acquisition expenses (82,638 ) (57,340 )
(21,803 ) (161,781 ) (32,073 ) (193,854 ) Other operating expenses
(90,875 ) (36,214 ) (34,770 ) (161,859 ) (8,268 ) (170,127 )
Underwriting income (loss) $ (207,143 ) $ (86,862 ) $ 186,388
(107,617 ) (34,555 ) (142,172 ) Net investment income
94,127 22,332 116,459 Net realized gains (losses) 64,104 2,171
66,275 Net impairment losses recognized in earnings (1,878 ) —
(1,878 ) Equity in net income (loss) of investment funds accounted
for using the equity method 31,090 — 31,090 Other income (loss)
(342 ) — (342 ) Corporate expenses (14,108 ) — (14,108 ) UGC
transaction costs and other (2,990 ) — (2,990 ) Amortization of
intangible assets (31,824 ) — (31,824 ) Interest expense (26,264 )
(3,246 ) (29,510 ) Net foreign exchange gains (losses) (27,785 )
(243 ) (28,028 )
Income (loss) before income taxes (23,487 )
(13,541 ) (37,028 ) Income tax expense (8,168 ) (21 ) (8,189 )
Net income (loss) (31,655 ) (13,562 ) (45,217 ) Dividends
attributable to redeemable noncontrolling interests — (4,586 )
(4,586 ) Amounts attributable to nonredeemable noncontrolling
interests — 16,147 16,147
Net income (loss)
available to Arch (31,655 ) (2,001 ) (33,656 ) Preferred
dividends (12,369 ) — (12,369 ) Loss on redemption of preferred
shares (6,735 ) — (6,735 )
Net income (loss) available to
Arch common shareholders $ (50,759 ) $ (2,001 ) $ (52,760 )
Underwriting Ratios Loss ratio 106.3 % 98.5 % 12.8 %
81.4 % 96.1 % 82.9 % Acquisition expense ratio 15.4 % 17.7 % 7.9 %
14.3 % 24.9 % 15.4 % Other operating expense ratio 17.0 % 11.2 %
12.7 % 14.3 % 6.4 % 13.5 % Combined ratio 138.7 % 127.4 % 33.4 %
110.0 % 127.4 % 111.8 % Net premiums written to gross
premiums written 71.7 % 75.0 % 83.4 % 75.2 % 92.5 % 80.4 %
(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. (U.S. Dollars in thousands)
Three
Months Ended September 30, 2016 Insurance
Reinsurance Mortgage Sub-total
Other Total Gross premiums written (1)
$ 758,934 $ 324,361 $ 131,726 $ 1,214,765 $ 163,736 $ 1,278,765
Premiums ceded (217,446 ) (89,551 ) (51,182 ) (357,923 ) (6,300 )
(264,487 ) Net premiums written 541,488 234,810 80,544 856,842
157,436 1,014,278 Change in unearned premiums (22,410 ) 17,117
(3,582 ) (8,875 ) (47,000 ) (55,875 ) Net premiums earned
519,078 251,927 76,962 847,967 110,436 958,403 Other underwriting
income — 2,216 4,740 6,956 1,024 7,980 Losses and loss adjustment
expenses (332,845 ) (105,924 ) (11,107 ) (449,876 ) (74,307 )
(524,183 ) Acquisition expenses (77,146 ) (50,192 ) (5,190 )
(132,528 ) (28,739 ) (161,267 ) Other operating expenses (86,613 )
(35,389 ) (24,249 ) (146,251 ) (7,035 ) (153,286 ) Underwriting
income $ 22,474 $ 62,638 $ 41,156 126,268
1,379 127,647 Net investment income 66,282 27,336 93,618 Net
realized gains (losses) 95,946 29,159 125,105 Net impairment losses
recognized in earnings (3,867 ) — (3,867 ) Equity in net income
(loss) of investment funds accounted for using the equity method
16,662 — 16,662 Other income (loss) (400 ) — (400 ) Corporate
expenses (11,343 ) — (11,343 ) UGC transaction costs and other
(7,142 ) — (7,142 ) Amortization of intangible assets (4,865 ) —
(4,865 ) Interest expense (12,924 ) (3,019 ) (15,943 ) Net foreign
exchange gains (losses) (4,232 ) 1,611 (2,621 )
Income
before income taxes 260,385 56,466 316,851 Income tax (expense)
benefit (13,232 ) 1 (13,231 )
Net income 247,153
56,467 303,620 Dividends attributable to redeemable noncontrolling
interests — (4,588 ) (4,588 ) Amounts attributable to nonredeemable
noncontrolling interests — (46,160 ) (46,160 )
Net income
available to Arch 247,153 5,719 252,872 Preferred dividends
(5,484 ) — (5,484 )
Net income available to Arch common
shareholders $ 241,669 $ 5,719 $ 247,388
Underwriting Ratios Loss ratio 64.1 % 42.0 % 14.4 %
53.1 % 67.3 % 54.7 % Acquisition expense ratio 14.9 % 19.9 % 6.7 %
15.6 % 26.0 % 16.8 % Other operating expense ratio 16.7 % 14.0 %
31.5 % 17.2 % 6.4 % 16.0 % Combined ratio 95.7 % 75.9 % 52.6 % 85.9
% 99.7 % 87.5 % Net premiums written to gross premiums
written 71.3 % 72.4 % 61.1 % 70.5 % 96.2 % 79.3 % (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 integration of United Guaranty
Corporation and any other businesses the Company has acquired or
may acquire into its existing operations;
- 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;
- 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 September 30, 2017;
- 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/20171025006294/en/
Arch Capital Group Ltd.Mark D. Lyons, 441-278-9250Fax:
441-278-9255Executive Vice President andChief Financial Officer
Arch Capital (NASDAQ:ACGL)
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