ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
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September 30, 2022 and December 31, 2021 (unaudited) | | |
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For the three and nine month periods ended September 30, 2022 and 2021 (unaudited) | | |
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For the three and nine month periods ended September 30, 2022 and 2021 (unaudited) | | |
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For the three and nine month periods ended September 30, 2022 and 2021 (unaudited) | | |
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For the nine month periods ended September 30, 2022 and 2021 (unaudited) | | |
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Notes to Consolidated Financial Statements (unaudited) | | |
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ARCH CAPITAL | 4 | 2022 THIRD QUARTER FORM 10-Q |
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Arch Capital Group Ltd.
Results of Review of Interim Financial Statements
We have reviewed the accompanying consolidated balance sheet of Arch Capital Group Ltd. and its subsidiaries (the “Company”) as of September 30, 2022, and the related consolidated statements of income, comprehensive income, and changes in shareholders’ equity for the three-month and nine-month periods ended September 30, 2022 and 2021, and the consolidated statements of cash flows for the nine-month periods ended September 30, 2022 and 2021, including the related notes (collectively referred to as the “interim financial statements”). Based on our reviews, we are not aware of any material modifications that should be made to the accompanying interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheet of the Company as of December 31, 2021, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for the year then ended (not presented herein), and in our report dated February 25, 2022, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2021, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
Basis for Review Results
These interim financial statements are the responsibility of the Company’s management. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our review in accordance with the standards of the PCAOB. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the PCAOB, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
/s/ PricewaterhouseCoopers LLP
New York, New York
November 3, 2022
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ARCH CAPITAL | 5 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(U.S. dollars in thousands, except share data)
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| (Unaudited) |
| September 30, 2022 | | December 31, 2021 |
Assets | | | |
Investments: | | | |
Fixed maturities available for sale, at fair value (amortized cost: $19,913,055 and $17,973,823; net of allowance for credit losses: $45,993 and $2,883) | $ | 18,120,727 | | | $ | 17,998,109 | |
Short-term investments available for sale, at fair value (amortized cost: $1,941,071 and $1,734,738; net of allowance for credit losses: $0 and $0) | 1,940,857 | | | 1,734,716 | |
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Equity securities, at fair value | 809,869 | | | 1,804,170 | |
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Other investments, at fair value | 1,578,751 | | | 1,973,550 | |
Investments accounted for using the equity method | 3,565,946 | | | 3,077,611 | |
Total investments | 26,016,150 | | | 26,588,156 | |
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Cash | 813,583 | | | 858,668 | |
Accrued investment income | 116,263 | | | 85,453 | |
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Investment in operating affiliates | 891,212 | | | 1,135,655 | |
Premiums receivable (net of allowance for credit losses: $38,229 and $39,958) | 3,579,380 | | | 2,633,280 | |
Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses (net of allowance for credit losses: $17,366 and $13,230) | 6,356,456 | | | 5,880,735 | |
Contractholder receivables (net of allowance for credit losses: $2,360 and $3,437) | 1,735,730 | | | 1,828,691 | |
Ceded unearned premiums | 2,115,539 | | | 1,729,455 | |
Deferred acquisition costs | 1,122,711 | | | 901,841 | |
Receivable for securities sold | 27,042 | | | 60,179 | |
Goodwill and intangible assets | 806,655 | | | 944,983 | |
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Other assets | 2,756,383 | | | 2,453,849 | |
Total assets | $ | 46,337,104 | | | $ | 45,100,945 | |
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Liabilities | | | |
Reserve for losses and loss adjustment expenses | $ | 19,288,291 | | | $ | 17,757,156 | |
Unearned premiums | 7,271,279 | | | 6,011,942 | |
Reinsurance balances payable | 1,669,592 | | | 1,583,253 | |
Contractholder payables | 1,738,089 | | | 1,832,127 | |
Collateral held for insured obligations | 254,720 | | | 242,352 | |
Senior notes | 2,725,153 | | | 2,724,394 | |
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Payable for securities purchased | 174,769 | | | 64,850 | |
Other liabilities | 1,411,193 | | | 1,329,742 | |
Total liabilities | 34,533,086 | | | 31,545,816 | |
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Commitments and Contingencies | | | |
Redeemable noncontrolling interests | 8,908 | | | 9,233 | |
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Shareholders' Equity | | | |
Non-cumulative preferred shares | 830,000 | | | 830,000 | |
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Common shares ($0.0011 par, shares issued: 587,134,047 and 583,289,850) | 652 | | | 648 | |
Additional paid-in capital | 2,186,599 | | | 2,085,075 | |
Retained earnings | 15,042,561 | | | 14,455,868 | |
Accumulated other comprehensive income (loss), net of deferred income tax | (1,891,827) | | | (64,600) | |
Common shares held in treasury, at cost (shares: 217,812,057 and 204,365,956) | (4,372,875) | | | (3,761,095) | |
Total shareholders' equity available to Arch | 11,795,110 | | | 13,545,896 | |
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Total liabilities, noncontrolling interests and shareholders' equity | $ | 46,337,104 | | | $ | 45,100,945 | |
See Notes to Consolidated Financial Statements
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ARCH CAPITAL | 6 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(U.S. dollars in thousands, except share data)
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| (Unaudited) | | (Unaudited) |
| Three Months Ended | | Nine Months Ended |
| September 30, | | September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
Revenues | | | | | | | |
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Net premiums earned | $ | 2,470,750 | | | $ | 1,929,337 | | | 6,917,158 | | | 5,998,668 | |
Net investment income | 128,640 | | | 88,195 | | | 315,468 | | | 298,664 | |
Net realized gains (losses) | (183,673) | | | (25,040) | | | (742,666) | | | 320,328 | |
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Other underwriting income | 3,077 | | | 7,274 | | | 11,944 | | | 18,913 | |
Equity in net income (loss) of investment funds accounted for using the equity method | (18,861) | | | 105,398 | | | 75,505 | | | 299,270 | |
Other income (loss) | (13,684) | | | (3,960) | | | (34,486) | | | 1,151 | |
Total revenues | 2,386,249 | | | 2,101,204 | | | 6,542,923 | | | 6,936,994 | |
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Expenses | | | | | | | |
Losses and loss adjustment expenses | 1,682,696 | | | 1,226,019 | | | 3,786,187 | | | 3,588,950 | |
Acquisition expenses | 447,587 | | | 306,015 | | | 1,239,065 | | | 945,639 | |
Other operating expenses | 274,747 | | | 230,832 | | | 842,082 | | | 736,808 | |
Corporate expenses | 17,710 | | | 19,672 | | | 77,662 | | | 61,007 | |
Amortization of intangible assets | 26,104 | | | 20,135 | | | 80,478 | | | 49,823 | |
Interest expense | 33,063 | | | 33,176 | | | 98,566 | | | 107,222 | |
Net foreign exchange (gains) losses | (90,509) | | | (36,078) | | | (182,129) | | | (38,366) | |
Total expenses | 2,391,398 | | | 1,799,771 | | | 5,941,911 | | | 5,451,083 | |
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Income (loss) before income taxes and income (loss) from operating affiliates | (5,149) | | | 301,433 | | | 601,012 | | | 1,485,911 | |
Income tax (expense) benefit | 14,900 | | | (4,137) | | | (19,042) | | | (94,176) | |
Income (loss) from operating affiliates | 8,507 | | | 124,119 | | | 37,665 | | | 224,052 | |
Net income (loss) | $ | 18,258 | | | $ | 421,415 | | | $ | 619,635 | | | $ | 1,615,787 | |
Net (income) loss attributable to noncontrolling interests | (1,157) | | | (1,473) | | | (2,390) | | | (82,203) | |
Net income (loss) available to Arch | 17,101 | | | 419,942 | | | 617,245 | | | 1,533,584 | |
Preferred dividends | (10,184) | | | (16,090) | | | (30,552) | | | (38,159) | |
Loss on redemption of preferred shares | — | | | (15,101) | | | — | | | (15,101) | |
Net income (loss) available to Arch common shareholders | $ | 6,917 | | | $ | 388,751 | | | $ | 586,693 | | | $ | 1,480,324 | |
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Net income per common share and common share equivalent | | | | | | | |
Basic | $ | 0.02 | | | $ | 1.00 | | | $ | 1.59 | | | $ | 3.74 | |
Diluted | $ | 0.02 | | | $ | 0.98 | | | $ | 1.55 | | | $ | 3.66 | |
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Weighted average common shares and common share equivalents outstanding | | | | | | | |
Basic | 365,190,527 | | | 389,274,220 | | | 369,525,348 | | | 395,899,591 | |
Diluted | 373,727,277 | | | 397,903,347 | | | 378,373,180 | | | 404,260,485 | |
See Notes to Consolidated Financial Statements
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ARCH CAPITAL | 7 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(U.S. dollars in thousands)
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| (Unaudited) | | (Unaudited) |
| Three Months Ended | | Nine Months Ended |
| September 30, | | September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
Comprehensive Income | | | | | | | |
Net income (loss) | $ | 18,258 | | | $ | 421,415 | | | $ | 619,635 | | | $ | 1,615,787 | |
Other comprehensive income (loss), net of deferred income tax | | | | | | | |
Unrealized appreciation (decline) in value of available-for-sale investments: | | | | | | | |
Unrealized holding gains (losses) arising during period | (609,759) | | | (95,923) | | | (1,892,119) | | | (279,102) | |
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Reclassification of net realized (gains) losses, included in net income (loss) | 46,585 | | | (62,654) | | | 206,573 | | | (120,504) | |
Foreign currency translation adjustments | (70,388) | | | (31,710) | | | (141,681) | | | (54,089) | |
Comprehensive income (loss) | (615,304) | | | 231,128 | | | (1,207,592) | | | 1,162,092 | |
Net (income) loss attributable to noncontrolling interests | (1,157) | | | (1,473) | | | (2,390) | | | (82,203) | |
Other comprehensive (income) loss attributable to noncontrolling interests | — | | | 9,423 | | | — | | | 13,983 | |
Comprehensive income (loss) available to Arch | $ | (616,461) | | | $ | 239,078 | | | $ | (1,209,982) | | | $ | 1,093,872 | |
See Notes to Consolidated Financial Statements
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ARCH CAPITAL | 8 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(U.S. dollars in thousands)
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| (Unaudited) | | (Unaudited) |
| Three Months Ended | | Nine Months Ended |
| September 30, | | September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
Non-cumulative preferred shares | | | | | | | |
Balance at beginning of period | $ | 830,000 | | | $ | 1,280,000 | | | $ | 830,000 | | | $ | 780,000 | |
Preferred shares issued | — | | | — | | | — | | | 500,000 | |
Preferred shares redeemed | — | | | (450,000) | | | — | | | (450,000) | |
Balance at beginning and end of period | $ | 830,000 | | | $ | 830,000 | | | $ | 830,000 | | | $ | 830,000 | |
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Common shares | | | | | | | |
Balance at beginning of period | 652 | | | 647 | | | 648 | | | 643 | |
Common shares issued, net | — | | | 1 | | | 4 | | | 5 | |
Balance at end of period | 652 | | | 648 | | | 652 | | | 648 | |
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Additional paid-in capital | | | | | | | |
Balance at beginning of period | 2,170,661 | | | 2,028,919 | | | 2,085,075 | | | 1,977,794 | |
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Amortization of share-based compensation | 13,518 | | | 14,216 | | | 80,023 | | | 71,279 | |
Issue costs on preferred shares | — | | | — | | | — | | | (14,179) | |
Reversal of issue costs on preferred shares redeemed | — | | | 15,101 | | | — | | | 15,101 | |
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Other changes | 2,420 | | | 3,670 | | | 21,501 | | | 11,911 | |
Balance at end of period | 2,186,599 | | | 2,061,906 | | | 2,186,599 | | | 2,061,906 | |
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Retained earnings | | | | | | | |
Balance at beginning of period | 15,035,644 | | | 13,454,036 | | | 14,455,868 | | | 12,362,463 | |
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Net income (loss) | 18,258 | | | 421,415 | | | 619,635 | | | 1,615,787 | |
Net (income) loss attributable to noncontrolling interests | (1,157) | | | (1,473) | | | (2,390) | | | (82,203) | |
Preferred share dividends | (10,184) | | | (16,090) | | | (30,552) | | | (38,159) | |
Loss on redemption of preferred shares | — | | | (15,101) | | | — | | | (15,101) | |
Balance at end of period | 15,042,561 | | | 13,842,787 | | | 15,042,561 | | | 13,842,787 | |
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Accumulated other comprehensive income (loss), net of deferred income tax | | | | | | | |
Balance at beginning of period | (1,258,265) | | | 230,048 | | | (64,600) | | | 488,895 | |
Unrealized appreciation (decline) in value of available-for-sale investments, net of deferred income tax: | | | | | | | |
Balance at beginning of period | (1,108,886) | | | 264,702 | | | 13,486 | | | 501,295 | |
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Unrealized holding gains (losses) during period, net of reclassification adjustment | (563,174) | | | (158,577) | | | (1,685,546) | | | (399,606) | |
Unrealized holding gains (losses) during period attributable to noncontrolling interests | — | | | 10,752 | | | — | | | 15,188 | |
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Balance at end of period | (1,672,060) | | | 116,877 | | | (1,672,060) | | | 116,877 | |
Foreign currency translation adjustments, net of deferred income tax: | | | | | | | |
Balance at beginning of period | (149,379) | | | (34,654) | | | (78,086) | | | (12,400) | |
Foreign currency translation adjustments | (70,388) | | | (31,710) | | | (141,681) | | | (54,089) | |
Foreign currency translation adjustments attributable to noncontrolling interests | — | | | (1,329) | | | — | | | (1,204) | |
Balance at end of period | (219,767) | | | (67,693) | | | (219,767) | | | (67,693) | |
Balance at end of period | (1,891,827) | | | 49,184 | | | (1,891,827) | | | 49,184 | |
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Common shares held in treasury, at cost | | | | | | | |
Balance at beginning of period | (4,361,126) | | | (3,007,578) | | | (3,761,095) | | | (2,503,909) | |
Shares repurchased for treasury | (11,749) | | | (389,421) | | | (611,780) | | | (893,090) | |
Balance at end of period | (4,372,875) | | | (3,396,999) | | | (4,372,875) | | | (3,396,999) | |
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Total shareholders’ equity | $ | 11,795,110 | | | $ | 13,387,526 | | | $ | 11,795,110 | | | $ | 13,387,526 | |
See Notes to Consolidated Financial Statements
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ARCH CAPITAL | 9 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(U.S. dollars in thousands)
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| (Unaudited) |
| Nine Months Ended |
| September 30, |
| 2022 | | 2021 |
Operating Activities | | | |
Net income (loss) | $ | 619,635 | | | $ | 1,615,787 | |
Adjustments to reconcile net income (loss) to net cash provided by operating activities: | | | |
Net realized (gains) losses | 742,680 | | | (367,313) | |
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Equity in net (income) or loss of investment funds accounted for using the equity method and other income or loss | 106,405 | | | (372,650) | |
Amortization of intangible assets | 80,478 | | | 49,823 | |
Share-based compensation | 80,029 | | | 72,303 | |
Changes in: | | | |
Reserve for losses and loss adjustment expenses, net of unpaid losses and loss adjustment expenses recoverable | 1,553,084 | | | 1,548,211 | |
Unearned premiums, net of ceded unearned premiums | 1,125,395 | | | 985,242 | |
Premiums receivable | (1,095,741) | | | (847,098) | |
Deferred acquisition costs | (242,377) | | | (247,966) | |
Reinsurance balances payable | 128,418 | | | 618,571 | |
Other items, net | (264,289) | | | (427,359) | |
Net cash provided by operating activities | 2,833,717 | | | 2,627,551 | |
Investing Activities | | | |
Purchases of fixed maturity investments | (13,065,302) | | | (29,870,023) | |
Purchases of equity securities | (786,733) | | | (978,951) | |
Purchases of other investments | (1,270,099) | | | (1,350,056) | |
Proceeds from sales of fixed maturity investments | 9,990,418 | | | 30,067,792 | |
Proceeds from sales of equity securities | 1,539,808 | | | 695,633 | |
Proceeds from sales, redemptions and maturities of other investments | 1,075,679 | | | 1,487,919 | |
Proceeds from redemptions and maturities of fixed maturity investments | 577,864 | | | 1,234,412 | |
Net settlements of derivative instruments | (106,347) | | | (67,830) | |
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Net (purchases) sales of short-term investments | (151,980) | | | (1,172,798) | |
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Purchase of operating affiliate | — | | | (753,916) | |
Impact of the deconsolidation of the variable interest entity | — | | | (349,202) | |
Purchases of fixed assets | (38,383) | | | (34,407) | |
Other | 128,354 | | | (361,857) | |
Net cash used for investing activities | (2,106,721) | | | (1,453,284) | |
Financing Activities | | | |
Proceeds from issuance of preferred shares, net | — | | | 485,821 | |
Redemption of preferred shares | — | | | (450,000) | |
Purchases of common shares under share repurchase program | (585,823) | | | (872,197) | |
Proceeds from common shares issued, net | (2,863) | | | 281 | |
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Third party investment in non-redeemable noncontrolling interests | — | | | 15,971 | |
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Dividends paid to redeemable noncontrolling interests | — | | | (1,907) | |
Other | (84,639) | | | (21,752) | |
Preferred dividends paid | (30,552) | | | (38,096) | |
Net cash used for financing activities | (703,877) | | | (881,879) | |
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Effects of exchange rate changes on foreign currency cash and restricted cash | (79,566) | | | (34,023) | |
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Increase (decrease) in cash and restricted cash | (56,447) | | | 258,365 | |
Cash and restricted cash, beginning of year | 1,314,771 | | | 1,290,544 | |
Cash and restricted cash, end of period | $ | 1,258,324 | | | $ | 1,548,909 | |
See Notes to Consolidated Financial Statements
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ARCH CAPITAL | 10 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Basis of Presentation and Recent Accounting Pronouncements
General
Arch Capital Group Ltd. (“Arch Capital”) is a public listed Bermuda exempted company which provides insurance, reinsurance and mortgage insurance on a worldwide basis through its wholly-owned subsidiaries. As used herein, the “Company” means Arch Capital and its subsidiaries. The Company’s consolidated financial statements through June 30, 2021 included the results of Somers Group Holdings Ltd. (formerly Watford Holdings Ltd.) and its wholly owned subsidiaries (“Somers”). Effective July 1, 2021, Somers is wholly owned by Greysbridge Holdings Ltd., (“Greysbridge”) and Greysbridge is owned 40% by the Company, 30% by certain investment funds managed by Kelso & Company (“Kelso”) and 30% by certain investment funds managed by Warburg Pincus LLC (“Warburg”). Based on the governing documents of Greysbridge, the Company concluded that, while it retains significant influence over Somers, Somers no longer constitutes a variable interest entity. Accordingly, effective July 1, 2021, Arch no longer consolidates the results of Somers in its consolidated financial statements and footnotes. See note 11. Basis of Presentation
The interim consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). All significant intercompany transactions and balances have been eliminated in consolidation. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates and assumptions. In the opinion of management, the accompanying unaudited interim consolidated financial statements reflect all adjustments (consisting of normally recurring accruals) necessary for a fair statement of results on an interim basis. The results of any interim period are not necessarily indicative of the results for a full year or any future periods.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted; however, management believes that the disclosures are adequate to make the information presented not misleading. This report should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2021
(“2021 Form 10-K”), including the Company’s audited consolidated financial statements and related notes.
The Company has reclassified the presentation of certain prior year information to conform to the current presentation. Such reclassifications had no effect on the Company’s net income, comprehensive income, shareholders’ equity or cash flows. Tabular amounts are in U.S. Dollars in thousands, except share amounts, unless otherwise noted.
Recent Accounting Pronouncements
Inflation Reduction Act of 2022
On August 16, 2022, the U.S. government enacted the Inflation Reduction Act of 2022, which among other things implements a 15% minimum tax on book income of certain large corporations, a 1% excise tax on net stock repurchases and several tax incentives to promote clean energy. The effective date of these provisions is January 1, 2023. Based on its current analysis of the provisions, the Company does not expect that this legislation will have a material effect on the Company’s consolidated financial statements.
Recently Issued Accounting Standards Adopted
For information regarding additional accounting standards that the Company has not yet adopted, see note 3(s), “Significant Accounting Policies—Recent Accounting Pronouncements,” of the notes to consolidated financial statements in the Company’s 2021 Form 10-K.
2. Share Transactions
Share Repurchases
The board of directors of Arch Capital has authorized the investment in Arch Capital’s common shares through a share repurchase program. Since the inception of the share repurchase program, Arch Capital has repurchased 433.6 million common shares for an aggregate purchase price of $5.87 billion. For the nine months ended September 30, 2022, Arch Capital repurchased 12.9 million shares under the share repurchase program with an aggregate purchase price of $585.8 million. At September 30, 2022, $596.4 million of share repurchases were available under the program, which may be effected from time to time in open market or privately negotiated transactions. The timing and amount of the repurchase transactions under this program will depend on a variety of factors, including market conditions and corporate and regulatory considerations.
| | | | | | | | |
ARCH CAPITAL | 11 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The 2022 Long-Term Incentive and Share Award Plan (the“2022 Plan”)
The 2022 Plan became effective as of May 4, 2022 following approval by shareholders of the Company. The 2022 Plan provides for the issuance of stock options, stock appreciation rights, restricted shares, restricted share units payable in common shares or cash, dividend equivalents, performance shares and performance units and other share-based awards to Arch Capital’s eligible employees and directors. The number of common shares reserved for grants under the 2022 Plan, subject to anti-dilution adjustments in the event of certain changes in Arch Capital’s capital structure, is 9,000,000; provided, that no more than 6,000,000 common shares may be issued as incentive stock options under Section 422 of the Code. The 2022 Plan will terminate as to future awards on February 25, 2032. At September 30, 2022, 9,000,000 shares are available for future issuance.
Series G Preferred Shares
In June 2021, Arch Capital completed a $500 million underwritten public offering of 20.0 million depositary shares (the “Depositary Shares”), each of which represents a 1/1,000th interest in a share of its 4.55% Non-Cumulative Preferred Shares, Series G $0.01 par value and $25,000 liquidation preference per share (equivalent to $25 liquidation preference per Depositary Share) (the “Series G Preferred Shares”). Each Depositary Share, evidenced by a depositary receipt, entitles the holder, through the depositary, to a proportional fractional interest in all rights and preferences of the Series G Preferred Shares represented thereby (including any dividend, liquidation, redemption and voting rights).
Holders of Series G Preferred Shares will be entitled to receive dividend payments only when, as and if declared by the Company’s board of directors or a duly authorized committee of the board. Any such dividends will be payable from, and including, the date of original issue on a noncumulative basis, quarterly in arrears on the last day of March, June, September and December of each year, at an annual rate of 4.55%. Dividends on the Series G Preferred Shares are not cumulative. The Company will be restricted from paying dividends on or repurchasing its common shares unless certain dividend payments are made on the Series G
Preferred Shares. The Company may not declare or pay a dividend on the Series G Preferred Shares under certain circumstances, including if the Company is or, after giving effect to such payment, would be in breach of applicable individual or group solvency and liquidity requirements or applicable individual or group enhanced capital requirements (“ECR”). The Series G Preferred Shares may not be redeemed at any time if the ECR would be breached immediately before or after giving effect to such redemption, unless the Company replaces the capital represented by preference shares to be redeemed with capital having equal or better capital treatment.
Except in specified circumstances relating to certain tax or corporate events, the Series G Preferred Shares are not redeemable prior to June 11, 2026. On and after that date, the Series G Preferred Shares will be redeemable at the Company’s option, in whole or in part, at a redemption price of $25,000 per share of the Series G Preferred Shares (equivalent to $25 per depositary share), plus any declared and unpaid dividends, without accumulation of any undeclared dividends to, but excluding, the redemption date.
The Depositary Shares will be redeemed if and to the extent the related Series G Preferred Shares are redeemed by the Company. Neither the Depositary Shares nor the Series G Preferred Shares have a stated maturity, nor will they be subject to any sinking fund or mandatory redemption. The Series G Preferred Shares are not convertible into any other securities. The Series G Preferred Shares do not have voting rights, except under limited circumstances.
The net proceeds from the Series G Preferred Shares offering of approximately $485.8 million were used to redeem the Company’s issued and outstanding 5.25% Series E Non-Cumulative Preferred Shares in September 2021. The preferred shares were redeemed at a redemption price equal to $25 per depositary share, plus all declared and unpaid dividends to (but excluding) the redemption date. In accordance with GAAP, following the redemption, original issuance costs related to such shares have been removed from additional paid-in capital and recorded as a “loss on redemption of preferred shares.” Such adjustment had no impact on total shareholders’ equity or cash flows.
| | | | | | | | |
ARCH CAPITAL | 12 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
3. Earnings Per Common Share
The following table sets forth the computation of basic and diluted earnings per common share:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
| September 30, | | September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
Numerator: | | | | | | | |
Net income (loss) | $ | 18,258 | | | $ | 421,415 | | | $ | 619,635 | | | $ | 1,615,787 | |
Amounts attributable to noncontrolling interests | (1,157) | | | (1,473) | | | (2,390) | | | (82,203) | |
Net income (loss) available to Arch | 17,101 | | | 419,942 | | | 617,245 | | | 1,533,584 | |
Preferred dividends | (10,184) | | | (16,090) | | | (30,552) | | | (38,159) | |
Loss on redemption of preferred shares | — | | | (15,101) | | | — | | | (15,101) | |
Net income (loss) available to Arch common shareholders | $ | 6,917 | | | $ | 388,751 | | | $ | 586,693 | | | $ | 1,480,324 | |
| | | | | | | |
Denominator: | | | | | | | |
| | | | | | | |
| | | | | | | |
Weighted average common shares and common share equivalents outstanding — basic | 365,190,527 | | | 389,274,220 | | | 369,525,348 | | | 395,899,591 | |
Effect of dilutive common share equivalents: | | | | | | | |
Nonvested restricted shares | 2,351,039 | | | 2,131,915 | | | 2,171,158 | | | 1,877,930 | |
Stock options (1) | 6,185,711 | | | 6,497,212 | | | 6,676,674 | | | 6,482,964 | |
Weighted average common shares and common share equivalents outstanding — diluted | 373,727,277 | | | 397,903,347 | | | 378,373,180 | | | 404,260,485 | |
| | | | | | | |
Earnings per common share: | | | | | | | |
Basic | $ | 0.02 | | | $ | 1.00 | | | $ | 1.59 | | | $ | 3.74 | |
Diluted | $ | 0.02 | | | $ | 0.98 | | | $ | 1.55 | | | $ | 3.66 | |
(1) Certain stock options were not included in the computation of diluted earnings per share where the exercise price of the stock options exceeded the average market price and would have been anti-dilutive or where, when applying the treasury stock method to in-the-money options, the sum of the proceeds, including unrecognized compensation, exceeded the average market price and would have been anti-dilutive. For the 2022 third quarter and 2021 third quarter, the number of stock options excluded were 774,481 and 1,948,006, respectively. For the nine months ended September 30, 2022 and 2021, the number of stock options excluded were 785,682 and 2,397,507, respectively.
| | | | | | | | |
ARCH CAPITAL | 13 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
4. Segment Information
The Company classifies its businesses into three underwriting segments — insurance, reinsurance and mortgage — and two other operating segments — corporate and ‘other.’ The Company determined its reportable segments using the management approach described in accounting guidance regarding disclosures about segments of an enterprise and related information. The accounting policies of the segments are the same as those used for the preparation of the Company’s consolidated financial statements. Intersegment business is allocated to the segment accountable for the underwriting results.
The Company’s insurance, reinsurance and mortgage segments each have managers who are responsible for the overall profitability of their respective segments and who are directly accountable to the Company’s chief operating decision makers, the Chief Executive Officer of Arch Capital, the Chief Financial Officer and Treasurer of Arch Capital and the President and Chief Underwriting Officer of Arch Capital. The chief operating decision makers do not assess performance, measure return on equity or make resource allocation decisions on a line of business basis. 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, with the exception of goodwill and intangible assets, and accordingly, investment income is not allocated to each underwriting segment.
The insurance segment consists of the Company’s insurance underwriting units which offer specialty product lines on a worldwide basis. Product lines include: construction and national accounts; excess and surplus casualty; lenders products; professional lines; programs; property, energy, marine and aviation; travel, accident and health; and other (consisting of alternative markets, excess workers' compensation and surety business).
The reinsurance segment consists of the Company’s reinsurance underwriting units which offer specialty product lines on a worldwide basis. Product lines include: casualty; marine and aviation; other specialty; property catastrophe; property excluding property catastrophe (losses on a single risk, both excess of loss and pro rata); and other (consisting of life reinsurance, casualty clash and other).
The mortgage segment includes the Company’s U.S. primary mortgage insurance business, investment and services related to U.S. credit-risk transfer (“CRT”) which are predominately with government sponsored enterprises (“GSE’s”) and international mortgage insurance and reinsurance operations. Arch Mortgage Insurance Company and United Guaranty Residential Insurance Company (combined “Arch MI U.S.”) are approved as eligible mortgage insurers by Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”), each a GSE. Arch MI U.S. also includes Arch Mortgage Guaranty Company, which is not a GSE-approved entity.
The corporate segment results include net investment income, net realized gains or losses (which includes changes in the allowance for credit losses on financial assets and net impairment losses recognized in earnings), equity in net income or loss of investments accounted for using the equity method, other income (loss), corporate expenses, transaction costs and other, amortization of intangible assets, interest expense, net foreign exchange gains or losses, income taxes, income or loss from operating affiliates and items related to the Company’s non-cumulative preferred shares. Such amounts exclude the results of the ‘other’ segment.
Through June 30, 2021, the ‘other’ segment included the results of Somers. In July 2021, the Company announced the completion of the previously disclosed acquisition of Somers by Greysbridge. Based on the governing documents of Greysbridge, the Company has concluded that, while it retains significant influence over Somers, Somers no longer constitutes a variable interest entity. Accordingly, effective July 1, 2021, Arch no longer consolidates the results of Somers in its consolidated financial statements. See note 11.
| | | | | | | | |
ARCH CAPITAL | 14 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The following tables summarize the Company’s underwriting income or loss by segment, together with a reconciliation of underwriting income or loss to net income available to Arch common shareholders:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended |
| September 30, 2022 |
| Insurance | | Reinsurance | | Mortgage | | Sub-Total | | Other | | Total |
| | | | | | | | | | | |
Gross premiums written (1) | $ | 1,862,026 | | | $ | 1,639,061 | | | $ | 362,409 | | | $ | 3,860,683 | | | $ | — | | | $ | 3,860,683 | |
Premiums ceded | (493,267) | | | (560,225) | | | (86,230) | | | (1,136,909) | | | — | | | (1,136,909) | |
Net premiums written | 1,368,759 | | | 1,078,836 | | | 276,179 | | | 2,723,774 | | | — | | | 2,723,774 | |
Change in unearned premiums | (181,851) | | | (77,062) | | | 5,889 | | | (253,024) | | | — | | | (253,024) | |
Net premiums earned | 1,186,908 | | | 1,001,774 | | | 282,068 | | | 2,470,750 | | | — | | | 2,470,750 | |
Other underwriting income (loss) | — | | | 452 | | | 2,625 | | | 3,077 | | | — | | | 3,077 | |
Losses and loss adjustment expenses | (822,663) | | | (927,911) | | | 67,878 | | | (1,682,696) | | | — | | | (1,682,696) | |
Acquisition expenses | (232,469) | | | (208,425) | | | (6,693) | | | (447,587) | | | — | | | (447,587) | |
Other operating expenses | (165,499) | | | (62,777) | | | (46,471) | | | (274,747) | | | — | | | (274,747) | |
Underwriting income (loss) | $ | (33,723) | | | $ | (196,887) | | | $ | 299,407 | | | 68,797 | | | — | | | 68,797 | |
| | | | | | | | | | | |
Net investment income | | | | | | | 128,640 | | | — | | | 128,640 | |
Net realized gains (losses) | | | | | | | (183,673) | | | — | | | (183,673) | |
| | | | | | | | | | | |
Equity in net income (loss) of investment funds accounted for using the equity method | | | | | | | (18,861) | | | — | | | (18,861) | |
Other income (loss) | | | | | | | (13,684) | | | — | | | (13,684) | |
Corporate expenses (2) | | | | | | | (17,634) | | | — | | | (17,634) | |
Transaction costs and other (2) | | | | | | | (76) | | | — | | | (76) | |
Amortization of intangible assets | | | | | | | (26,104) | | | — | | | (26,104) | |
Interest expense | | | | | | | (33,063) | | | — | | | (33,063) | |
Net foreign exchange gains (losses) | | | | | | | 90,509 | | | — | | | 90,509 | |
Income (loss) before income taxes and income (loss) from operating affiliates | | | | | | | (5,149) | | | — | | | (5,149) | |
Income tax (expense) benefit | | | | | | | 14,900 | | | — | | | 14,900 | |
Income (loss) from operating affiliates | | | | | | | 8,507 | | | — | | | 8,507 | |
Net income (loss) | | | | | | | 18,258 | | | — | | | 18,258 | |
Amounts attributable to redeemable noncontrolling interests | | | | | | | (1,157) | | | — | | | (1,157) | |
| | | | | | | | | | | |
Net income (loss) available to Arch | | | | | | | 17,101 | | | — | | | 17,101 | |
Preferred dividends | | | | | | | (10,184) | | | — | | | (10,184) | |
| | | | | | | | | | | |
Net income (loss) available to Arch common shareholders | | | | | | | $ | 6,917 | | | $ | — | | | $ | 6,917 | |
| | | | | | | | | | | |
Underwriting Ratios | | | | | | | | | | | |
Loss ratio | 69.3 | % | | 92.6 | % | | (24.1) | % | | 68.1 | % | | — | % | | 68.1 | % |
Acquisition expense ratio | 19.6 | % | | 20.8 | % | | 2.4 | % | | 18.1 | % | | — | % | | 18.1 | % |
Other operating expense ratio | 13.9 | % | | 6.3 | % | | 16.5 | % | | 11.1 | % | | — | % | | 11.1 | % |
Combined ratio | 102.8 | % | | 119.7 | % | | (5.2) | % | | 97.3 | % | | — | % | | 97.3 | % |
| | | | | | | | | | | |
Goodwill and intangible assets | $ | 224,525 | | | $ | 140,800 | | | $ | 441,330 | | | $ | 806,655 | | | $ | — | | | $ | 806,655 | |
(1) Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. 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 reflected in ‘transaction costs and other.’
| | | | | | | | |
ARCH CAPITAL | 15 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended |
| September 30, 2021 |
| Insurance | | Reinsurance | | Mortgage | | Sub-Total | | Other | | Total |
| | | | | | | | | | | |
Gross premiums written (1) | $ | 1,596,619 | | | $ | 1,251,760 | | | $ | 360,934 | | | $ | 3,207,415 | | | $ | — | | | $ | 3,207,415 | |
Premiums ceded | (442,806) | | | (630,371) | | | (60,207) | | | (1,131,486) | | | — | | | (1,131,486) | |
Net premiums written | 1,153,813 | | | 621,389 | | | 300,727 | | | 2,075,929 | | | — | | | 2,075,929 | |
Change in unearned premiums | (215,143) | | | 57,313 | | | 11,238 | | | (146,592) | | | — | | | (146,592) | |
Net premiums earned | 938,670 | | | 678,702 | | | 311,965 | | | 1,929,337 | | | — | | | 1,929,337 | |
Other underwriting income (loss) | — | | | 3,293 | | | 3,981 | | | 7,274 | | | — | | | 7,274 | |
Losses and loss adjustment expenses | (668,630) | | | (545,846) | | | (11,543) | | | (1,226,019) | | | — | | | (1,226,019) | |
Acquisition expenses | (152,467) | | | (129,450) | | | (24,098) | | | (306,015) | | | — | | | (306,015) | |
Other operating expenses | (138,931) | | | (45,647) | | | (46,254) | | | (230,832) | | | — | | | (230,832) | |
Underwriting income (loss) | $ | (21,358) | | | $ | (38,948) | | | $ | 234,051 | | | 173,745 | | | — | | | 173,745 | |
| | | | | | | | | | | |
Net investment income | | | | | | | 88,195 | | | — | | | 88,195 | |
Net realized gains (losses) | | | | | | | (25,040) | | | — | | | (25,040) | |
| | | | | | | | | | | |
Equity in net income (loss) of investment funds accounted for using the equity method | | | | | | | 105,398 | | | — | | | 105,398 | |
Other income (loss) | | | | | | | (3,960) | | | — | | | (3,960) | |
Corporate expenses (2) | | | | | | | (18,636) | | | — | | | (18,636) | |
Transaction costs and other (2) | | | | | | | (1,036) | | | — | | | (1,036) | |
Amortization of intangible assets | | | | | | | (20,135) | | | — | | | (20,135) | |
Interest expense | | | | | | | (33,176) | | | — | | | (33,176) | |
Net foreign exchange gains (losses) | | | | | | | 36,078 | | | — | | | 36,078 | |
Income (loss) before income taxes and income (loss) from operating affiliates | | | | | | | 301,433 | | | — | | | 301,433 | |
Income tax (expense) benefit | | | | | | | (4,137) | | | — | | | (4,137) | |
Income (loss) from operating affiliates | | | | | | | 124,119 | | | — | | | 124,119 | |
Net income (loss) | | | | | | | 421,415 | | | — | | | 421,415 | |
Amounts attributable to redeemable noncontrolling interests | | | | | | | (1,473) | | | — | | | (1,473) | |
| | | | | | | | | | | |
Net income (loss) available to Arch | | | | | | | 419,942 | | | — | | | 419,942 | |
Preferred dividends | | | | | | | (16,090) | | | — | | | (16,090) | |
Loss on redemption of preferred shares | | | | | | | (15,101) | | | — | | | (15,101) | |
Net income (loss) available to Arch common shareholders | | | | | | | $ | 388,751 | | | $ | — | | | $ | 388,751 | |
| | | | | | | | | | | |
Underwriting Ratios | | | | | | | | | | | |
Loss ratio | 71.2 | % | | 80.4 | % | | 3.7 | % | | 63.5 | % | | — | % | | 63.5 | % |
Acquisition expense ratio | 16.2 | % | | 19.1 | % | | 7.7 | % | | 15.9 | % | | — | % | | 15.9 | % |
Other operating expense ratio | 14.8 | % | | 6.7 | % | | 14.8 | % | | 12.0 | % | | — | % | | 12.0 | % |
Combined ratio | 102.2 | % | | 106.2 | % | | 26.2 | % | | 91.4 | % | | — | % | | 91.4 | % |
| | | | | | | | | | | |
Goodwill and intangible assets | $ | 261,103 | | | $ | 176,128 | | | $ | 526,091 | | | $ | 963,322 | | | $ | — | | | $ | 963,322 | |
(1) Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. 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 reflected in ‘transaction costs and other.’
| | | | | | | | |
ARCH CAPITAL | 16 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended |
| September 30, 2022 |
| Insurance | | Reinsurance | | Mortgage | | Sub-Total | | Other | | Total |
| | | | | | | | | | | |
Gross premiums written (1) | $ | 5,286,798 | | | $ | 5,151,401 | | | $ | 1,099,144 | | | $ | 11,531,185 | | | $ | — | | | $ | 11,531,185 | |
Premiums ceded | (1,482,886) | | | (1,770,807) | | | (241,097) | | | (3,488,632) | | | — | | | (3,488,632) | |
Net premiums written | 3,803,912 | | | 3,380,594 | | | 858,047 | | | 8,042,553 | | | — | | | 8,042,553 | |
Change in unearned premiums | (488,164) | | | (646,421) | | | 9,190 | | | (1,125,395) | | | — | | | (1,125,395) | |
Net premiums earned | 3,315,748 | | | 2,734,173 | | | 867,237 | | | 6,917,158 | | | — | | | 6,917,158 | |
Other underwriting income (loss) | — | | | 5,814 | | | 6,130 | | | 11,944 | | | — | | | 11,944 | |
Losses and loss adjustment expenses | (2,053,161) | | | (1,920,189) | | | 187,163 | | | (3,786,187) | | | — | | | (3,786,187) | |
Acquisition expenses | (641,807) | | | (569,915) | | | (27,343) | | | (1,239,065) | | | — | | | (1,239,065) | |
Other operating expenses | (493,412) | | | (198,606) | | | (150,064) | | | (842,082) | | | — | | | (842,082) | |
Underwriting income (loss) | $ | 127,368 | | | $ | 51,277 | | | $ | 883,123 | | | $ | 1,061,768 | | | $ | — | | | $ | 1,061,768 | |
| | | | | | | | | | | |
Net investment income | | | | | | | 315,468 | | | — | | | 315,468 | |
Net realized gains (losses) | | | | | | | (742,666) | | | — | | | (742,666) | |
| | | | | | | | | | | |
Equity in net income (loss) of investment funds accounted for using the equity method | | | | | | | 75,505 | | | — | | | 75,505 | |
Other income (loss) | | | | | | | (34,486) | | | — | | | (34,486) | |
Corporate expenses (2) | | | | | | | (76,928) | | | — | | | (76,928) | |
Transaction costs and other (2) | | | | | | | (734) | | | — | | | (734) | |
Amortization of intangible assets | | | | | | | (80,478) | | | — | | | (80,478) | |
Interest expense | | | | | | | (98,566) | | | — | | | (98,566) | |
Net foreign exchange gains (losses) | | | | | | | 182,129 | | | — | | | 182,129 | |
Income (loss) before income taxes and income (loss) from operating affiliates | | | | | | | 601,012 | | | — | | | 601,012 | |
Income tax (expense) benefit | | | | | | | (19,042) | | | — | | | (19,042) | |
Income (loss) from operating affiliates | | | | | | | 37,665 | | | — | | | 37,665 | |
Net income (loss) | | | | | | | 619,635 | | | — | | | 619,635 | |
Amounts attributable to redeemable noncontrolling interests | | | | | | | (2,390) | | | — | | | (2,390) | |
| | | | | | | | | | | |
Net income (loss) available to Arch | | | | | | | 617,245 | | | — | | | 617,245 | |
Preferred dividends | | | | | | | (30,552) | | | — | | | (30,552) | |
| | | | | | | | | | | |
Net income (loss) available to Arch common shareholders | | | | | | | $ | 586,693 | | | $ | — | | | $ | 586,693 | |
| | | | | | | | | | | |
Underwriting Ratios | | | | | | | | | | | |
Loss ratio | 61.9 | % | | 70.2 | % | | (21.6) | % | | 54.7 | % | | — | % | | 54.7 | % |
Acquisition expense ratio | 19.4 | % | | 20.8 | % | | 3.2 | % | | 17.9 | % | | — | % | | 17.9 | % |
Other operating expense ratio | 14.9 | % | | 7.3 | % | | 17.3 | % | | 12.2 | % | | — | % | | 12.2 | % |
Combined ratio | 96.2 | % | | 98.3 | % | | (1.1) | % | | 84.8 | % | | — | % | | 84.8 | % |
| | | | | | | | | | | |
(1) Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. 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 reflected in ‘transaction costs and other.’
| | | | | | | | |
ARCH CAPITAL | 17 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended |
| September 30, 2021 |
| Insurance | | Reinsurance | | Mortgage | | Sub-Total | | Other | | Total |
| | | | | | | | | | | |
Gross premiums written (1) | $ | 4,381,372 | | | $ | 4,080,840 | | | $ | 1,143,691 | | | $ | 9,602,213 | | | $ | 457,465 | | | $ | 9,890,912 | |
Premiums ceded | (1,269,165) | | | (1,535,607) | | | (171,923) | | | (2,973,005) | | | (102,763) | | | (2,907,002) | |
Net premiums written | 3,112,207 | | | 2,545,233 | | | 971,768 | | | 6,629,208 | | | 354,702 | | | 6,983,910 | |
Change in unearned premiums | (488,636) | | | (484,607) | | | 10,735 | | | (962,508) | | | (22,734) | | | (985,242) | |
Net premiums earned | 2,623,571 | | | 2,060,626 | | | 982,503 | | | 5,666,700 | | | 331,968 | | | 5,998,668 | |
Other underwriting income (loss) | — | | | 3,148 | | | 15,026 | | | 18,174 | | | 739 | | | 18,913 | |
Losses and loss adjustment expenses | (1,750,257) | | | (1,494,539) | | | (85,112) | | | (3,329,908) | | | (259,042) | | | (3,588,950) | |
Acquisition expenses | (417,541) | | | (381,060) | | | (84,297) | | | (882,898) | | | (62,741) | | | (945,639) | |
Other operating expenses | (409,386) | | | (150,856) | | | (143,697) | | | (703,939) | | | (32,869) | | | (736,808) | |
Underwriting income (loss) | $ | 46,387 | | | $ | 37,319 | | | $ | 684,423 | | | $ | 768,129 | | | $ | (21,945) | | | $ | 746,184 | |
| | | | | | | | | | | |
Net investment income | | | | | | | 256,354 | | | 42,310 | | | 298,664 | |
Net realized gains (losses) | | | | | | | 239,690 | | | 80,638 | | | 320,328 | |
| | | | | | | | | | | |
Equity in net income (loss) of investment funds accounted for using the equity method | | | | | | | 299,270 | | | — | | | 299,270 | |
Other income (loss) | | | | | | | 1,151 | | | — | | | 1,151 | |
Corporate expenses (2) | | | | | | | (59,279) | | | — | | | (59,279) | |
Transaction costs and other (2) | | | | | | | (793) | | | (935) | | | (1,728) | |
Amortization of intangible assets | | | | | | | (48,925) | | | (898) | | | (49,823) | |
Interest expense | | | | | | | (98,812) | | | (8,410) | | | (107,222) | |
Net foreign exchange gains (losses) | | | | | | | 39,691 | | | (1,325) | | | 38,366 | |
Income (loss) before income taxes and income (loss) from operating affiliates | | | | | | | 1,396,476 | | | 89,435 | | | 1,485,911 | |
Income tax (expense) benefit | | | | | | | (93,942) | | | (234) | | | (94,176) | |
Income (loss) from operating affiliates | | | | | | | 224,052 | | | — | | | 224,052 | |
Net income (loss) | | | | | | | 1,526,586 | | | 89,201 | | | 1,615,787 | |
Amounts attributable to redeemable noncontrolling interests | | | | | | | (1,936) | | | (1,953) | | | (3,889) | |
Amounts attributable to nonredeemable noncontrolling interests | | | | | | | — | | | (78,314) | | | (78,314) | |
Net income (loss) available to Arch | | | | | | | 1,524,650 | | | 8,934 | | | 1,533,584 | |
Preferred dividends | | | | | | | (38,159) | | | — | | | (38,159) | |
Loss on redemption of preferred shares | | | | | | | (15,101) | | | — | | | (15,101) | |
Net income (loss) available to Arch common shareholders | | | | | | | $ | 1,471,390 | | | $ | 8,934 | | | $ | 1,480,324 | |
| | | | | | | | | | | |
Underwriting Ratios | | | | | | | | | | | |
Loss ratio | 66.7 | % | | 72.5 | % | | 8.7 | % | | 58.8 | % | | 78.0 | % | | 59.8 | % |
Acquisition expense ratio | 15.9 | % | | 18.5 | % | | 8.6 | % | | 15.6 | % | | 18.9 | % | | 15.8 | % |
Other operating expense ratio | 15.6 | % | | 7.3 | % | | 14.6 | % | | 12.4 | % | | 9.9 | % | | 12.3 | % |
Combined ratio | 98.2 | % | | 98.3 | % | | 31.9 | % | | 86.8 | % | | 106.8 | % | | 87.9 | % |
| | | | | | | | | | | |
(1) Certain amounts included in the gross premiums written of each segment are related to intersegment transactions. 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 reflected in ‘transaction costs and other.’
| | | | | | | | |
ARCH CAPITAL | 18 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
5. Reserve for Losses and Loss Adjustment Expenses
The following table represents an analysis of losses and loss adjustment expenses and a reconciliation of the beginning and ending reserve for losses and loss adjustment expenses:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
| September 30, | | September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
Reserve for losses and loss adjustment expenses at beginning of period | $ | 18,194,324 | | | $ | 17,196,648 | | | $ | 17,757,156 | | | $ | 16,513,929 | |
Unpaid losses and loss adjustment expenses recoverable | 5,686,348 | | | 4,146,020 | | | 5,599,231 | | | 4,314,855 | |
Net reserve for losses and loss adjustment expenses at beginning of period | 12,507,976 | | | 13,050,628 | | | 12,157,925 | | | 12,199,074 | |
| | | | | | | |
Net incurred losses and loss adjustment expenses relating to losses occurring in: | | | | | | | |
Current year | 1,863,519 | | | 1,348,528 | | | 4,280,048 | | | 3,812,381 | |
Prior years | (180,823) | | | (122,509) | | | (493,861) | | | (223,431) | |
Total net incurred losses and loss adjustment expenses | 1,682,696 | | | 1,226,019 | | | 3,786,187 | | | 3,588,950 | |
| | | | | | | |
Net losses and loss adjustment expense reserves of acquired business (1) | — | | | 104,307 | | | — | | | 104,307 | |
| | | | | | | |
Retroactive reinsurance transactions (2) | — | | | — | | | — | | | (183,893) | |
| | | | | | | |
Impact of deconsolidation of Somers (3) | — | | | (1,460,611) | | | — | | | (1,460,611) | |
| | | | | | | |
Net foreign exchange (gains) losses and other | (243,387) | | | (78,152) | | | (524,682) | | | 10,818 | |
| | | | | | | |
Net paid losses and loss adjustment expenses relating to losses occurring in: | | | | | | | |
Current year | (226,575) | | | (208,923) | | | (463,847) | | | (432,348) | |
Prior years | (538,967) | | | (417,368) | | | (1,773,840) | | | (1,610,397) | |
Total net paid losses and loss adjustment expenses | (765,542) | | | (626,291) | | | (2,237,687) | | | (2,042,745) | |
| | | | | | | |
Net reserve for losses and loss adjustment expenses at end of period | 13,181,743 | | | 12,215,900 | | | 13,181,743 | | | 12,215,900 | |
Unpaid losses and loss adjustment expenses recoverable | 6,106,548 | | | 5,115,147 | | | 6,106,548 | | | 5,115,147 | |
Reserve for losses and loss adjustment expenses at end of period | $ | 19,288,291 | | | $ | 17,331,047 | | | $ | 19,288,291 | | | $ | 17,331,047 | |
(1) Represents activity related to the Company’s acquisitions in the 2021 period of the Westpac Lenders Mortgage Insurance Limited and Somerset Bridge Group Limited, Southern Rock Holdings Limited and affiliates.
(2) During the 2021 first quarter, the Company entered into a reinsurance to close and other related agreements with Premia Managing Agency Limited (“Premia”), in connection with the 2018 and prior years of account related to the acquisition of Barbican Group Holdings Limited (“Barbican”).
Development on Prior Year Loss Reserves
2022 Third Quarter
During the 2022 third quarter, the Company recorded net favorable development on prior year loss reserves of $180.8 million, which consisted of $5.4 million from the insurance segment, $49.2 million from the reinsurance segment and $126.2 million from the mortgage segment.
The insurance segment’s net favorable development of $5.4 million, or 0.5 loss ratio points, for the 2022 third quarter consisted of $15.9 million of net favorable development in short-tailed lines and $10.5 million of net adverse development in medium-tailed and long-tailed lines. Net favorable development in short-tailed lines reflected $8.9 million of favorable development in property (excluding marine), primarily from 2020 and 2021 accident years (i.e.,
the year in which a loss occurred) and $5.7 million of favorable development in lenders products, primarily from the 2021 accident year. Net adverse development in medium-tailed lines included $11.3 million of adverse development in professional liability business, primarily from the 2013 to 2016 and 2020 accident years, partially offset by favorable development in marine business of $5.9 million, across most accident years. Net adverse development in long-tailed lines reflected $12.3 million related to casualty business, primarily from the 2014 and 2020 accident years, partially offset by favorable development in construction, executive assurance and other lines of business.
The reinsurance segment’s net favorable development of $49.2 million, or 4.9 loss ratio points, for the 2022 third quarter consisted of $58.1 million of net favorable development in short-tailed and medium-tailed lines and
| | | | | | | | |
ARCH CAPITAL | 19 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
$8.9 million of net adverse development in long-tailed lines. Net favorable development in short-tailed lines reflected $35.8 million of favorable development related to property other than property catastrophe business, primarily from 2015 to 2021 underwriting years (i.e., all premiums and losses attributable to contracts having an inception or renewal date within the given twelve-month period) and $12.7 million of favorable development related to property catastrophe business, primarily from the 2014 to 2017 underwriting years. Net favorable development in medium-tailed lines included $7.9 million in marine and aviation lines, across most underwriting years. Net adverse development in long-tailed lines reflected $9.5 million related to casualty business, primarily from the 2014 to 2017 underwriting years.
The mortgage segment’s net favorable development was $126.2 million, or 44.7 loss ratio points, for the 2022 third quarter, with the largest contributor being reserve releases associated with the U.S. first lien portfolio from the 2020 and 2021 accident years. The Company’s credit risk transfer, international, second lien and student loan businesses also contributed to the favorable development.
2021 Third Quarter
During the 2021 third quarter, the Company recorded net favorable development on prior year loss reserves of $122.5 million, which consisted of $5.1 million from the insurance segment, $72.3 million from the reinsurance segment and $45.1 million from the mortgage segment.
The insurance segment’s net favorable development of $5.1 million, or 0.5 loss ratio points, for the 2021 third quarter consisted of $49.0 million of net favorable development in short-tailed and long-tailed lines and $43.9 million of net adverse development in medium-tailed lines. Net favorable development in short-tailed lines reflected $5.4 million of favorable development in lenders products, primarily from the 2020 accident year, $5.4 million of favorable development from property (excluding marine), primarily from the 2020 accident year, and $5.1 million of favorable development in travel and accident, across most accident years. Net favorable development in long-tailed lines reflected $26.3 million of favorable development related to construction and national accounts, across most accident years, and $6.7 million of favorable development related to other business, including alternative markets, primarily from the 2015 to 2018 accident years. Net adverse development in medium-tailed lines included $37.0 million of adverse development in contract binding business, across most accident years, partially offset by favorable development in marine and programs, primarily from more recent accident years.
The reinsurance segment’s net favorable development of $72.3 million, or 10.7 loss ratio points, for the 2021 third quarter consisted of $65.4 million of net favorable
development in short-tailed lines and $6.9 million in medium-tailed and long-tailed lines. Net favorable development in short-tailed lines reflected $46.1 million of favorable development related to property catastrophe and property other than property catastrophe business, primarily from the 2017 to 2020 underwriting years and $18.9 million of favorable development related to other specialty, primarily from the 2012 to 2017 underwriting years. Net favorable development in medium-tailed and long-tailed lines included $4.7 million of favorable development in casualty, primarily from the 2013 and 2014 underwriting years.
The mortgage segment’s net favorable development was $45.1 million, or 14.5 loss ratio points, for the 2021 third quarter, about half of which came from U.S. primary mortgage insurance, from better than expected cure activity in pre-pandemic delinquencies and recoveries on second lien and student loans, and the other half from our CRT portfolio and international mortgage insurance.
Nine Months Ended September 30, 2022
During the nine months ended September 30, 2022, the Company recorded net favorable development on prior year loss reserves of $493.9 million, which consisted of $19.4 million from the insurance segment, $128.1 million from the reinsurance segment and $346.4 million from the mortgage segment.
The insurance segment’s net favorable development of $19.4 million, or 0.6 loss ratio points, for the 2022 period consisted of $49.1 million of net favorable development in short-tailed and $29.7 million of net adverse development in medium and long-tailed lines. Net favorable development in short-tailed lines reflected $36.5 million of favorable development in lenders products, primarily from the 2021 accident year, and $14.3 million of favorable development related to travel and accident business, primarily from the 2019 to 2021 accident years. Net adverse development in medium-tailed lines included $24.9 million of adverse development in professional liability business, primarily from the 2013 to 2015 and 2018 to 2020 accident years, and $5.5 million of adverse development in contract binding business, across most accident years, partially offset by $11.4 million of favorable development in marine business, across most accident years. Net adverse development in long-tailed lines reflected $18.0 million of adverse development related to casualty business, primarily from the 2020 and 2021 accident years, partially offset by $17.4 million of favorable development in other business, including alternative markets and excess workers’ compensation, primarily from the 2019 and prior accident years.
The reinsurance segment’s net favorable development of $128.1 million, or 4.7 loss ratio points, for the 2022 period consisted of $147.8 million of net favorable development from short and medium-tailed lines, partially offset by
| | | | | | | | |
ARCH CAPITAL | 20 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
$19.7 million of net adverse development from long-tailed lines. Net favorable development in short-tailed lines reflected $83.2 million of favorable development from property other than property catastrophe business, primarily from the 2015 to 2021 underwriting years, $22.4 million of favorable development from property catastrophe, primarily from the 2018 to 2020 underwriting years, and $19.8 million from other specialty business, primarily from the 2021 underwriting year. Net favorable development in medium-tailed lines included $22.7 million in marine and aviation lines, across most underwriting years. Net adverse development in long-tailed lines primarily reflected $19.3 million in casualty reserves, primarily from the 2021 underwriting year.
The mortgage segment’s net favorable development was $346.4 million, or 39.9 loss ratio points, for the 2022 period, with the largest contributor being reserve releases associated with the U.S. first lien portfolio from the 2020 and 2021 accident years. The Company’s credit risk transfer, international, second lien and student loan businesses also contributed to the favorable development.
Nine Months Ended September 30, 2021
During the nine months ended September 30, 2021, the Company recorded net favorable development on prior year loss reserves of $223.4 million, which consisted of $13.1 million from the insurance segment, $119.6 million from the reinsurance segment, $99.1 million from the mortgage segment, partially offset by $8.4 million of adverse development from the ‘other’ segment (activity for the six months ended June 30, 2021 prior to deconsolidation of Somers).
The insurance segment’s net favorable development of $13.1 million, or 0.5 loss ratio points, for the 2021 period consisted of $102.5 million of net favorable development in short-tailed and long-tailed lines, partially offset by $89.4 million of net adverse development in medium-tailed lines. Net favorable development of $65.3 million in short-tailed lines reflected $27.0 million of favorable development from property (excluding marine), primarily from the 2019 and 2020 accident years, $24.0 million of favorable development in lenders products, primarily from the 2020 accident year, and $14.4 million of favorable development in travel and accident, primarily from the 2017 to 2020 accident years. Net favorable development of $37.1 million in long-tailed lines included favorable development primarily related to construction, national accounts and alternative markets, primarily from the 2016 to 2019 accident years. Net adverse development in medium-tailed lines reflected $57.1 million of adverse development in contract binding business, primarily from the 2014 to 2019 accident years, $26.2 million of adverse development in professional liability business, primarily from the 2019 and 2020 accident years, and
$6.9 million of adverse development in programs business, primarily from the 2019 accident year.
The reinsurance segment’s net favorable development of $119.6 million, or 5.8 loss ratio points, for the 2021 period consisted of $139.7 million of net favorable development from short-tailed and medium-tailed lines, partially offset by $20.1 million of net adverse development from long-tailed lines. Net favorable development of $132.6 million in short-tailed lines reflected $97.1 million of favorable development from other specialty lines, primarily from the 2016 to 2019 underwriting years, and $71.7 million of favorable development from property other than property catastrophe business, primarily from the 2017 to 2020 underwriting years. Such amounts were partially offset by adverse development of $36.3 million from property catastrophe, primarily from the 2020 underwriting year. Adverse development in long-tailed lines reflected an increase in reserves from casualty, primarily from the 2018 underwriting year.
The mortgage segment’s net favorable development was $99.1 million, or 10.1 loss ratio points, for the 2021 period, which included reserve releases associated with various vintage credit risk transfer contracts that were called by the GSEs, favorable development on U.S. and international business and subrogation recoveries on second lien and student loan business.
| | | | | | | | |
ARCH CAPITAL | 21 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
6. Allowance for Expected Credit Losses
Premiums Receivable
The following table provides a roll forward of the allowance for expected credit losses of the Company’s premium receivables:
| | | | | | | | | |
| Premium Receivables, Net of Allowance | Allowance for Expected Credit Losses | |
Three Months Ended September 30, 2022 | | |
Balance at beginning of period | $ | 3,634,182 | | $ | 38,170 | | |
Change for provision of expected credit losses (1) | 59 | | |
Balance at end of period | $ | 3,579,380 | | $ | 38,229 | | |
| | | |
Three Months Ended September 30, 2021 | | |
Balance at beginning of period | $ | 2,866,578 | | $ | 35,979 | | |
Change for provision of expected credit losses (1) | 2,736 | | |
Balance at end of period | $ | 2,807,720 | | $ | 38,715 | | |
| | | |
Nine Months Ended September 30, 2022 | | | |
Balance at beginning of period | $ | 2,633,280 | | $ | 39,958 | | |
Change for provision of expected credit losses (1) | (1,729) | | |
Balance at end of period | $ | 3,579,380 | | $ | 38,229 | | |
| | | |
Nine Months Ended September 30, 2021 | | | |
Balance at beginning of period | $ | 2,064,586 | | $ | 37,781 | | |
Change for provision of expected credit losses (1) | 934 | | |
Balance at end of period | $ | 2,807,720 | | $ | 38,715 | | |
(1)Amounts deemed uncollectible are written-off in operating expenses. For the 2022 third quarter and 2021 third quarter, amounts written off were $1.9 million and $1.2 million, respectively. For the nine months ended September 30, 2022 and 2021 period, amounts written off were $6.6 million and $2.4 million, respectively.
Reinsurance Recoverables
The following table provides a roll forward of the allowance for expected credit losses of the Company’s reinsurance recoverables:
| | | | | | | | | | | | |
| Reinsurance Recoverables, Net of Allowance | | Allowance for Expected Credit Losses | |
Three Months Ended September 30, 2022 | | |
Balance at beginning of period | $ | 5,938,511 | | | $ | 14,740 | | |
Change for provision of expected credit losses | | 2,626 | | |
Balance at end of period | $ | 6,356,456 | | | $ | 17,366 | | |
| | | | |
Three Months Ended September 30, 2021 | | |
Balance at beginning of period | $ | 4,314,515 | | | $ | 11,029 | | |
Change for provision of expected credit losses | | 1,802 | | |
Balance at end of period | $ | 5,358,852 | | | $ | 12,831 | | |
| | | | |
Nine Months Ended September 30, 2022 | | | | |
Balance at beginning of period | $ | 5,880,735 | | | $ | 13,230 | | |
Change for provision of expected credit losses | | 4,136 | | |
Balance at end of period | $ | 6,356,456 | | | $ | 17,366 | | |
| | | | |
Nine Months Ended September 30, 2021 | | | | |
Balance at beginning of period | $ | 4,500,802 | | | $ | 11,636 | | |
Change for provision of expected credit losses | | 1,195 | | |
Balance at end of period | $ | 5,358,852 | | | $ | 12,831 | | |
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ARCH CAPITAL | 22 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The following table summarizes the Company’s reinsurance recoverables on paid and unpaid losses (not including ceded unearned premiums):
| | | | | | | | | | | |
| September 30, | | December 31 |
| 2022 | | 2021 |
Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses | $ | 6,356,456 | | $ | 5,880,735 |
% due from carriers with A.M. Best rating of “A-” or better | 69.5 | % | | 69.7 | % |
% due from all other rated carriers | 0.1 | % | | 0.1 | % |
% due from all other carriers with no A.M. Best rating (1) | 30.4 | % | | 30.2 | % |
Largest balance due from any one carrier as % of total shareholders’ equity | 9.1 | % | | 6.7 | % |
(1) At September 30, 2022 and December 31, 2021 over 95% and 91% of such amount were collateralized through reinsurance trusts, funds withheld arrangements, letters of credit or other, respectively.
Contractholder Receivables
The following table provides a roll forward of the allowance for expected credit losses of the Company’s contractholder receivables:
| | | | | | | | | | | | |
| Contract-holder Receivables, Net of Allowance | | Allowance for Expected Credit Losses | |
Three Months Ended September 30, 2022 | | |
Balance at beginning of period | $ | 1,758,018 | | | $ | 3,005 | | |
Change for provision of expected credit losses | | (645) | | |
Balance at end of period | $ | 1,735,730 | | | $ | 2,360 | | |
| | | | |
Three Months Ended September 30, 2021 | | |
Balance at beginning of period | $ | 1,882,948 | | | $ | 4,471 | | |
Change for provision of expected credit losses | | (987) | | |
Balance at end of period | 1,824,990 | | | $ | 3,484 | | |
| | | | |
Nine Months Ended September 30, 2022 | | | | |
Balance at beginning of period | $ | 1,828,691 | | | $ | 3,437 | | |
Change for provision of expected credit losses | | (1,077) | | |
Balance at end of period | $ | 1,735,730 | | | $ | 2,360 | | |
| | | | |
Nine Months Ended September 30, 2021 | | | | |
Balance at beginning of period | $ | 1,986,924 | | | $ | 8,638 | | |
Change for provision of expected credit losses | | (5,154) | | |
Balance at end of period | 1,824,990 | | | $ | 3,484 | | |
| | | | | | | | |
ARCH CAPITAL | 23 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
7. Investment Information
Available For Sale Investments
The following table summarizes the fair value and cost or amortized cost of the Company’s securities classified as available for sale:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Estimated Fair Value | | Gross Unrealized Gains | | Gross Unrealized Losses | | Allowance for Expected Credit Losses | | Cost or Amortized Cost | | |
September 30, 2022 | | | | | | | | | | | |
Fixed maturities: | | | | | | | | | | | |
Corporate bonds | $ | 7,096,269 | | | $ | 51,777 | | | $ | (895,365) | | | $ | (35,657) | | | $ | 7,975,514 | | | |
Residential mortgage backed securities | 763,371 | | | 7,561 | | | (84,183) | | | 2 | | | 839,991 | | | |
Municipal bonds | 407,724 | | | 5,437 | | | (37,692) | | | (99) | | | 440,078 | | | |
Commercial mortgage backed securities | 1,064,238 | | | 3,079 | | | (50,010) | | | (1,583) | | | 1,112,752 | | | |
U.S. government and government agencies | 5,126,407 | | | 36,074 | | | (400,784) | | | — | | | 5,491,117 | | | |
Non-U.S. government securities | 2,073,170 | | | 9,315 | | | (287,583) | | | (1,720) | | | 2,353,158 | | | |
Asset backed securities | 1,589,548 | | | 1,076 | | | (105,037) | | | (6,936) | | | 1,700,445 | | | |
Total | 18,120,727 | | | 114,319 | | | (1,860,654) | | | (45,993) | | | 19,913,055 | | | |
| | | | | | | | | | | |
Short-term investments | 1,940,857 | | | 1,419 | | | (1,633) | | | — | | | 1,941,071 | | | |
Total | $ | 20,061,584 | | | $ | 115,738 | | | $ | (1,862,287) | | | $ | (45,993) | | | $ | 21,854,126 | | | |
| | | | | | | | | | | |
December 31, 2021 | | | | | | | | | | | |
Fixed maturities: | | | | | | | | | | | |
Corporate bonds | $ | 6,553,333 | | | $ | 104,170 | | | $ | (69,194) | | | $ | (2,037) | | | $ | 6,520,394 | | | |
Residential mortgage backed securities | 408,477 | | | 2,825 | | | (5,410) | | | (48) | | | 411,110 | | | |
Municipal bonds | 404,666 | | | 18,724 | | | (1,409) | | | (2) | | | 387,353 | | | |
Commercial mortgage backed securities | 1,046,484 | | | 1,740 | | | (3,117) | | | (6) | | | 1,047,867 | | | |
U.S. government and government agencies | 4,772,764 | | | 10,076 | | | (45,967) | | | — | | | 4,808,655 | | | |
Non-U.S. government securities | 2,120,294 | | | 54,048 | | | (34,749) | | | (82) | | | 2,101,077 | | | |
Asset backed securities | 2,692,091 | | | 6,540 | | | (11,108) | | | (708) | | | 2,697,367 | | | |
Total | 17,998,109 | | | 198,123 | | | (170,954) | | | (2,883) | | | 17,973,823 | | | |
| | | | | | | | | | | |
Short-term investments | 1,734,716 | | | 568 | | | (590) | | | — | | | 1,734,738 | | | |
Total | $ | 19,732,825 | | | $ | 198,691 | | | $ | (171,544) | | | $ | (2,883) | | | $ | 19,708,561 | | | |
| | | | | | | | |
ARCH CAPITAL | 24 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The following table summarizes, for all available for sale securities in an unrealized loss position, the fair value and gross unrealized loss by length of time the security has been in a continual unrealized loss position:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Less than 12 Months | | 12 Months or More | | Total |
| Estimated Fair Value | | Gross Unrealized Losses | | Estimated Fair Value | | Gross Unrealized Losses | | Estimated Fair Value | | Gross Unrealized Losses |
September 30, 2022 | | | | | | | | | | | |
Fixed maturities: | | | | | | | | | | | |
Corporate bonds | $ | 5,596,229 | | | $ | (625,774) | | | $ | 1,470,800 | | | $ | (269,591) | | | $ | 7,067,029 | | | $ | (895,365) | |
Residential mortgage backed securities | 620,572 | | | (63,732) | | | 93,902 | | | (20,451) | | | 714,474 | | | (84,183) | |
Municipal bonds | 373,219 | | | (36,039) | | | 9,399 | | | (1,653) | | | 382,618 | | | (37,692) | |
Commercial mortgage backed securities | 995,680 | | | (49,215) | | | 34,445 | | | (795) | | | 1,030,125 | | | (50,010) | |
U.S. government and government agencies | 4,205,475 | | | (303,805) | | | 715,347 | | | (96,979) | | | 4,920,822 | | | (400,784) | |
Non-U.S. government securities | 1,728,965 | | | (221,540) | | | 301,298 | | | (66,043) | | | 2,030,263 | | | (287,583) | |
Asset backed securities | 1,193,405 | | | (74,885) | | | 310,838 | | | (30,152) | | | 1,504,243 | | | (105,037) | |
Total | 14,713,545 | | | (1,374,990) | | | 2,936,029 | | | (485,664) | | | 17,649,574 | | | (1,860,654) | |
| | | | | | | | | | | |
Short-term investments | 227,201 | | | (1,633) | | | — | | | — | | | 227,201 | | | (1,633) | |
Total | $ | 14,940,746 | | | $ | (1,376,623) | | | $ | 2,936,029 | | | $ | (485,664) | | | $ | 17,876,775 | | | $ | (1,862,287) | |
| | | | | | | | | | | |
December 31, 2021 | | | | | | | | | | | |
Fixed maturities: | | | | | | | | | | | |
Corporate bonds | $ | 3,639,582 | | | $ | (63,938) | | | $ | 98,867 | | | $ | (5,256) | | | $ | 3,738,449 | | | $ | (69,194) | |
Residential mortgage backed securities | 222,176 | | | (3,545) | | | 46,809 | | | (1,865) | | | 268,985 | | | (5,410) | |
Municipal bonds | 26,665 | | | (385) | | | 16,361 | | | (1,024) | | | 43,026 | | | (1,409) | |
Commercial mortgage backed securities | 675,603 | | | (2,805) | | | 5,908 | | | (312) | | | 681,511 | | | (3,117) | |
U.S. government and government agencies | 4,211,621 | | | (44,180) | | | 33,373 | | | (1,787) | | | 4,244,994 | | | (45,967) | |
Non-U.S. government securities | 1,511,301 | | | (31,983) | | | 62,957 | | | (2,766) | | | 1,574,258 | | | (34,749) | |
Asset backed securities | 1,667,002 | | | (9,853) | | | 33,082 | | | (1,255) | | | 1,700,084 | | | (11,108) | |
Total | 11,953,950 | | | (156,689) | | | 297,357 | | | (14,265) | | | 12,251,307 | | | (170,954) | |
| | | | | | | | | | | |
Short-term investments | 284,733 | | | (590) | | | — | | | — | | | 284,733 | | | (590) | |
Total | $ | 12,238,683 | | | $ | (157,279) | | | $ | 297,357 | | | $ | (14,265) | | | $ | 12,536,040 | | | $ | (171,544) | |
At September 30, 2022, on a lot level basis, approximately 9,590 security lots out of a total of approximately 11,500 security lots were in an unrealized loss position and the largest single unrealized loss from a single lot in the Company’s fixed maturity portfolio was $7.2 million. At December 31, 2021, on a lot level basis, approximately 4,700 security lots out of a total of approximately 10,240 security lots were in an unrealized loss position and the largest single unrealized loss from a single lot in the Company’s fixed maturity portfolio was $1.1 million.
| | | | | | | | |
ARCH CAPITAL | 25 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The contractual maturities of the Company’s fixed maturities are shown in the following table. Expected maturities, which are management’s best estimates, will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | September 30, 2022 | | December 31, 2021 |
Maturity | | Estimated Fair Value | | Amortized Cost | | Estimated Fair Value | | Amortized Cost |
Due in one year or less | | $ | 579,231 | | | $ | 599,970 | | | $ | 300,889 | | | $ | 299,772 | |
Due after one year through five years | | 10,029,151 | | | 10,808,495 | | | 8,355,255 | | | 8,339,387 | |
Due after five years through 10 years | | 3,856,180 | | | 4,495,113 | | | 4,689,155 | | | 4,684,393 | |
Due after 10 years | | 239,008 | | | 356,289 | | | 505,758 | | | 493,927 | |
| | 14,703,570 | | | 16,259,867 | | | 13,851,057 | | | 13,817,479 | |
Residential mortgage backed securities | | 763,371 | | | 839,991 | | | 408,477 | | | 411,110 | |
Commercial mortgage backed securities | | 1,064,238 | | | 1,112,752 | | | 1,046,484 | | | 1,047,867 | |
Asset backed securities | | 1,589,548 | | | 1,700,445 | | | 2,692,091 | | | 2,697,367 | |
Total | | $ | 18,120,727 | | | $ | 19,913,055 | | | $ | 17,998,109 | | | $ | 17,973,823 | |
Equity Securities, at Fair Value
At September 30, 2022, the Company held $0.8 billion of equity securities, at fair value, compared to $1.8 billion at December 31, 2021. Such holdings include publicly traded common stocks primarily in the consumer cyclical and non-cyclical, technology, communication and financial sectors and exchange-traded funds in fixed income, equity and other sectors.
Other Investments, at Fair Value
The following table summarizes the Company’s other investments and other investable assets:
| | | | | | | | | | | |
| September 30, 2022 | | December 31, 2021 |
Fixed maturities | $ | 530,303 | | | $ | 416,698 | |
Other investments | 1,005,929 | | | 1,432,553 | |
Short-term investments | 28,614 | | | 97,806 | |
Equity securities | 13,905 | | | 26,493 | |
| | | |
| | | |
| | | |
Total | $ | 1,578,751 | | | $ | 1,973,550 | |
The following table summarizes the Company’s other investments, as detailed in the previous table, by strategy:
| | | | | | | | | | | |
| September 30, 2022 | | December 31, 2021 |
Lending | $ | 398,789 | | | $ | 536,345 | |
Investment grade fixed income | 229,262 | | | 147,810 | |
Term loan investments | 151,649 | | | 484,950 | |
Private equity | 117,856 | | | 91,126 | |
Energy | 55,250 | | | 81,692 | |
Credit related funds | 53,123 | | | 70,278 | |
Infrastructure | — | | | 20,352 | |
| | | |
Total | $ | 1,005,929 | | | $ | 1,432,553 | |
Investments Accounted For Using the Equity Method
The following table summarizes the Company’s investments accounted for using the equity method, by strategy:
| | | | | | | | | | | |
| September 30, 2022 | | December 31, 2021 |
Credit related funds | $ | 1,135,623 | | | $ | 1,022,334 | |
Private equity | 761,997 | | | 436,042 | |
Real estate | 474,666 | | | 396,395 | |
Lending | 454,196 | | | 376,649 | |
Equities | 261,650 | | | 395,090 | |
Infrastructure | 236,920 | | | 230,070 | |
Energy | 113,778 | | | 119,141 | |
Fixed income | 127,116 | | | 101,890 | |
Total | $ | 3,565,946 | | | $ | 3,077,611 | |
Certain of the Company’s other investments are in investment funds for which the Company has the option to redeem at agreed upon values as described in each investment fund’s subscription agreement. Depending on the terms of the various subscription agreements, investments in investment funds may be redeemed daily, monthly, quarterly or on other terms. Two common redemption restrictions which may impact the Company’s ability to redeem these investment funds are gates and lockups. A gate is a suspension of redemptions which may be implemented by the general partner or investment manager of the fund in order to defer, in whole or in part, the redemption request in the event the aggregate amount of redemption requests exceeds a predetermined percentage of the investment fund’s net assets which may otherwise hinder the general partner or investment manager’s ability to liquidate holdings in an orderly fashion in order to generate the cash necessary to fund extraordinarily large redemption payouts. A lockup period is the initial amount of time an investor is contractually required to hold the security before having the ability to redeem. If the investment funds are eligible to be
| | | | | | | | |
ARCH CAPITAL | 26 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
redeemed, the time to redeem such fund can take weeks or months following the notification.
Limited Partnership Interests
In the normal course of its activities, the Company invests in limited partnerships as part of its overall investment strategy. Such amounts are included in ‘investments accounted for using the equity method’ and ‘investments accounted for using the fair value option.’ The Company has determined that it is not required to consolidate these investments because it is not the primary beneficiary of the funds. The Company’s maximum exposure to loss with respect to these investments is limited to the investment carrying amounts reported in the Company’s consolidated balance sheet and any unfunded commitment.
The following table summarizes investments in limited partnership interests where the Company has a variable interest by balance sheet line item:
| | | | | | | | | | | |
| September 30, 2022 | | December 31, 2021 |
Investments accounted for using the equity method (1) | $ | 3,565,946 | | | $ | 3,077,611 | |
Investments accounted for using the fair value option (2) | 120,498 | | | 170,595 | |
Total | $ | 3,686,444 | | | $ | 3,248,206 | |
(1) Aggregate unfunded commitments were $2.8 billion at September 30, 2022, compared to $2.6 billion at December 31, 2021.
(2) Aggregate unfunded commitments were $21.5 million at September 30, 2022, compared to $18.8 million at December 31, 2021.
Net Investment Income
The components of net investment income were derived from the following sources:
| | | | | | | | | | | |
| September 30, |
| 2022 | | 2021 |
Three Months Ended | | | |
Fixed maturities | $ | 123,568 | | | $ | 75,964 | |
Term loans | 88 | | | 1,736 | |
Equity securities | 4,261 | | | 9,867 | |
Short-term investments | 9,304 | | | 1,858 | |
Other (1) | 8,556 | | | 17,378 | |
Gross investment income | 145,777 | | | 106,803 | |
Investment expenses | (17,137) | | | (18,608) | |
Net investment income | $ | 128,640 | | | $ | 88,195 | |
| | | |
Nine Months Ended | | | |
Fixed maturities | $ | 310,963 | | | $ | 255,215 | |
Term loans | 2,106 | | | 33,343 | |
Equity securities | 16,620 | | | 24,101 | |
Short-term investments | 15,999 | | | 3,603 | |
Other (1) | 26,598 | | | 51,683 | |
Gross investment income | 372,286 | | | 367,945 | |
Investment expenses | (56,818) | | | (69,281) | |
Net investment income | $ | 315,468 | | | $ | 298,664 | |
(1) Includes income distributions from investment funds and other items.
Net Realized Gains (Losses)
Net realized gains (losses), which include changes in the allowance for credit losses on financial assets and net impairment losses recognized in earnings were as follows:
| | | | | | | | | | | |
| September 30, |
| 2022 | | 2021 |
Three Months Ended | | | |
Available for sale securities: | | | |
Gross gains on investment sales | $ | 18,030 | | | $ | 86,819 | |
Gross losses on investment sales | (73,970) | | | (18,446) | |
Change in fair value of assets and liabilities accounted for using the fair value option: | | | |
Fixed maturities | (19,304) | | | (7,492) | |
Other investments | (17,882) | | | 3,811 | |
Equity securities | (584) | | | 3,042 | |
Short-term investments | (975) | | | 16 | |
Equity securities, at fair value: | | | |
Net realized gains (losses) on sales during the period | (6,401) | | | 14,736 | |
Net unrealized gains (losses) on equity securities still held at reporting date | (36,162) | | | (40,155) | |
Allowance for credit losses: | | | |
Investments related | 8,652 | | | (456) | |
Underwriting related | (4,232) | | | (3,985) | |
| | | |
Derivative instruments (1) | (48,196) | | | (21,435) | |
Other | (2,649) | | | (41,495) | |
Net realized gains (losses) | $ | (183,673) | | | $ | (25,040) | |
| | | |
Nine Months Ended | | | |
Available for sale securities: | | | |
Gross gains on investment sales | $ | 52,923 | | | $ | 267,362 | |
Gross losses on investment sales | (239,493) | | | (132,071) | |
Change in fair value of assets and liabilities accounted for using the fair value option: | | | |
Fixed maturities | (89,148) | | | 19,973 | |
Other investments | (35,203) | | | 111,550 | |
Equity securities | (6,021) | | | 10,599 | |
Short-term investments | (3,132) | | | 648 | |
Equity securities, at fair value: | | | |
Net realized gains (losses) on sales during the period | 75,689 | | | 86,155 | |
Net unrealized gains (losses) on equity securities still held at reporting date | (318,732) | | | 45,400 | |
Allowance for credit losses: | | | |
Investments related | (48,096) | | | (1,208) | |
Underwriting related | (7,676) | | | 2,664 | |
| | | |
Derivative instruments (1) | (117,591) | | | (36,428) | |
Other | (6,186) | | | (54,316) | |
Net realized gains (losses) | $ | (742,666) | | | $ | 320,328 | |
(1) See note 9 for information on the Company’s derivative instruments.
| | | | | | | | |
ARCH CAPITAL | 27 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Equity in Net Income (Loss) of Investment Funds Accounted for Using the Equity Method
The Company recorded a loss of $18.9 million related to investment funds accounted for using the equity method in the 2022 third quarter, compared to income of $105.4 million for the 2021 third quarter and an income of $75.5 million for the nine months ended September 30, 2022, compared to income of $299.3 million for nine months ended September 30, 2021. In applying the equity method, investments are initially recorded at cost and are subsequently adjusted based on the Company’s proportionate share of the net income or loss of the funds (which include changes in the market value of the underlying securities in the funds). Such investments are generally recorded on a one to three month lag based on the availability of reports from the investment funds.
Investments in Operating Affiliates
Investments in which the Company has significant influence over the operating and financial policies are classified as ‘investments in operating affiliates’ on the Company’s balance sheets and are accounted for under the equity method. Such investments primarily include the Company’s investment in Coface SA (“Coface”), Greysbridge and Premia. Investments in Coface and Premia are generally recorded on a three month lag, while the Company’s investment in Greysbridge is not recorded on a lag.
In 2021, the Company completed the share purchase agreement with Natixis to purchase 29.5% of the common equity of Coface, a France-based leader in the global trade credit insurance market. The consideration paid was €9.95 per share, or an aggregate €453 million (approximately
$546 million) including related fees. Income (loss) from operating affiliates reflected a one-time gain of $74.5 million realized from the acquisition. As of September 30, 2022, the Company owned approximately 29.86% of the issued shares of Coface, or 30.05% excluding treasury shares, with a carrying value of $506.7 million, compared to $630.5 million at December 31, 2021.
In July 2021, the Company announced the completion of the previously disclosed acquisition of Somers by Greysbridge for a cash purchase price of $35.00 per common share.
Effective July 1, 2021, Somers is wholly owned by Greysbridge, and Greysbridge is owned 40% by the Company, 30% by certain investment funds managed by Kelso and 30% by certain investment funds managed by Warburg. At September 30, 2022 the Company’s carrying value in Greysbridge was $277.6 million, compared to $375.7 million at December 31, 2021, which reflected the Company’s aggregate purchase price of $278.9 million along with income (loss) from operating affiliates, which included a one-time gain of $95.7 million recognized from the acquisition.
Income from operating affiliates for the 2022 third quarter was income of $8.5 million, compared to an income of $124.1 million, for the 2021 third quarter and income of $37.7 million for the nine months ended September 30, 2022, compared to income of $224.1 million for nine months ended September 30, 2021.
| | | | | | | | |
ARCH CAPITAL | 28 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Allowance for Expected Credit Losses
The following table provides a roll forward of the allowance for expected credit losses of the Company’s securities classified as available for sale:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Structured Securities (1) | | Municipal Bonds | | Corporate Bonds | | | | Total |
Three Months Ended September 30, 2022 | | | | | | | | |
Balance at beginning of period | | $ | 18,283 | | | $ | 298 | | | $ | 39,829 | | | | | $ | 58,410 | |
| | | | | | | | | | |
Additions for current-period provision for expected credit losses | | 1,782 | | | 12 | | | 1,986 | | | | | 3,780 | |
Additions (reductions) for previously recognized expected credit losses | | (9,767) | | | (211) | | | (2,552) | | | | | (12,530) | |
Reductions due to disposals | | (1,780) | | | — | | | (1,887) | | | | | (3,667) | |
| | | | | | | | | | |
Balance at end of period | | $ | 8,518 | | | $ | 99 | | | $ | 37,376 | | | | | $ | 45,993 | |
| | | | | | | | | | |
Three Months Ended September 30, 2021 | | | | | | | | |
Balance at beginning of period | | $ | 759 | | | $ | 6 | | | $ | 1,359 | | | | | $ | 2,124 | |
| | | | | | | | | | |
Additions for current-period provision for expected credit losses | | 48 | | | — | | | — | | | | | 48 | |
Additions (reductions) for previously recognized expected credit losses | | 14 | | | (4) | | | 395 | | | | | 405 | |
Reductions due to disposals | | (234) | | | — | | | (232) | | | | | (466) | |
| | | | | | | | | | |
Balance at end of period | | $ | 587 | | | $ | 2 | | | $ | 1,522 | | | | | $ | 2,111 | |
| | | | | | | | | | |
Nine Months Ended September 30, 2022 | | | | | | | | | | |
Balance at beginning of period | | $ | 802 | | | $ | 2 | | | $ | 2,079 | | | | | $ | 2,883 | |
| | | | | | | | | | |
Additions for current-period provision for expected credit losses | | 12,560 | | | 359 | | | 40,602 | | | | | 53,521 | |
Additions (reductions) for previously recognized expected credit losses | | (2,575) | | | (262) | | | (2,772) | | | | | (5,609) | |
Reductions due to disposals | | (2,269) | | | — | | | (2,533) | | | | | (4,802) | |
| | | | | | | | | | |
Balance at end of period | | $ | 8,518 | | | $ | 99 | | | $ | 37,376 | | | | | $ | 45,993 | |
| | | | | | | | | | |
Nine Months Ended September 30, 2021 | | | | | | | | | | |
Balance at beginning of period | | $ | 1,490 | | | $ | 11 | | | $ | 896 | | | | | $ | 2,397 | |
| | | | | | | | | | |
Additions for current-period provision for expected credit losses | | 282 | | | — | | | 2,428 | | | | | 2,710 | |
Additions (reductions) for previously recognized expected credit losses | | (751) | | | (9) | | | (557) | | | | | (1,317) | |
Reductions due to disposals | | (434) | | | — | | | (1,245) | | | | | (1,679) | |
| | | | | | | | | | |
Balance at end of period | | $ | 587 | | | $ | 2 | | | $ | 1,522 | | | | | $ | 2,111 | |
(1) Includes asset backed securities, residential mortgage backed securities and commercial mortgage backed securities.
| | | | | | | | |
ARCH CAPITAL | 29 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Restricted Assets
The Company is required to maintain assets on deposit, which primarily consist of fixed maturities, with various regulatory authorities to support its underwriting operations. The Company’s subsidiaries maintain assets in trust accounts as collateral for transactions with affiliated companies and also have investments in segregated portfolios primarily to provide collateral or guarantees for letters of credit to third parties. See note 18, “Commitments and Contingencies,” of the notes to consolidated financial statements in the Company’s 2021 Form 10-K.
The following table details the value of the Company’s restricted assets:
| | | | | | | | | | | |
| September 30, 2022 | | December 31, 2021 |
Assets used for collateral or guarantees: | | | |
Affiliated transactions | $ | 4,212,521 | | | $ | 4,223,955 | |
Third party agreements | 2,847,814 | | | 2,721,160 | |
Deposits with U.S. regulatory authorities | 756,368 | | | 798,100 | |
Deposits with non-U.S. regulatory authorities | 519,254 | | | 506,517 | |
| | | |
Total restricted assets | $ | 8,335,957 | | | $ | 8,249,732 | |
Reconciliation of Cash and Restricted Cash
The following table details reconciliation of cash and restricted cash within the Consolidated Balance Sheets:
| | | | | | | | | | | |
| September 30, 2022 | | December 31, 2021 |
Cash | $ | 813,583 | | | $ | 858,668 | |
Restricted cash (included in ‘other assets’) | 444,741 | | | 456,103 | |
Cash and restricted cash | $ | 1,258,324 | | | $ | 1,314,771 | |
8. Fair Value
Accounting guidance regarding fair value measurements addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under GAAP and provides a common definition of fair value to be used throughout GAAP. It defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly fashion between market participants at the measurement date. In addition, it establishes a three-level valuation hierarchy for the disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The level in the hierarchy within which a given fair value measurement falls is determined based on the lowest level input that is significant to the measurement (Level 1 being the highest priority and Level 3 being the lowest priority).
The levels in the hierarchy are defined as follows:
| | | | | | | | |
Level 1: | | Inputs to the valuation methodology are observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets |
| | |
Level 2: | | Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument |
| | |
Level 3: | | Inputs to the valuation methodology are unobservable and significant to the fair value measurement |
Following is a description of the valuation methodologies used for securities measured at fair value, as well as the general classification of such securities pursuant to the valuation hierarchy. The Company reviews its securities measured at fair value and discusses the proper classification of such investments with investment advisers and others.
The Company determines the existence of an active market based on its judgment as to whether transactions for the financial instrument occur in such market with sufficient frequency and volume to provide reliable pricing information. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. The Company uses quoted values and other data provided by nationally recognized independent pricing sources as inputs into its process for determining fair values of its fixed maturity investments. To validate the techniques or models used by pricing sources, the Company's review process includes, but is not limited to: (i) quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to its target benchmark, with significant differences identified and investigated); (ii) a review of the average number of prices obtained in the pricing process and the range of resulting fair values; (iii) initial and ongoing evaluation of methodologies used by outside parties to calculate fair value; (iv) a comparison of the fair value estimates to the Company’s knowledge of the current market; (v) a comparison of the pricing services' fair values to other pricing services' fair values for the same investments; and (vi) periodic back-testing, which includes randomly selecting purchased or sold securities and comparing the executed prices to the fair value estimates from the pricing service. A price source hierarchy was maintained in order to determine which price source would be used (i.e., a price obtained from a pricing service with more seniority in the hierarchy will be used over a less senior one in all cases). The hierarchy prioritizes pricing services based on availability and reliability and assigns the highest priority to index providers. Based on the above
| | | | | | | | |
ARCH CAPITAL | 30 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
review, the Company will challenge any prices for a security or portfolio which are considered not to be representative of fair value. The Company did not adjust any of the prices obtained from the independent pricing sources at September 30, 2022.
In certain circumstances, when fair values are unavailable from these independent pricing sources, quotes are obtained directly from broker-dealers who are active in the corresponding markets. Such quotes are subject to the validation procedures noted above. Where quotes are unavailable, fair value is determined by the Investment Manager using quantitative and qualitative assessments such as internally modeled values. Of the $22.8 billion of financial assets and liabilities measured at fair value at September 30, 2022, approximately $12.6 million, or 0.1%, were priced using non-binding broker-dealer quotes or modeled valuations. Of the $23.8 billion of financial assets and liabilities measured at fair value at December 31, 2021, approximately $7.7 million, or 0.0%, were priced using non-binding broker-dealer quotes or modeled valuations.
Fixed maturities
The Company uses the market approach valuation technique to estimate the fair value of its fixed maturity securities, when possible. The market approach includes obtaining prices from independent pricing services, such as index providers and pricing vendors, as well as to a lesser extent quotes from broker-dealers. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. Each source has its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of “matrix pricing” in which the independent pricing source uses observable market inputs including, but not limited to, investment yields, credit risks and spreads, benchmarking of like securities, broker-dealer quotes, reported trades and sector groupings to determine a reasonable fair value.
The following describes the significant inputs generally used to determine the fair value of the Company’s fixed maturity securities by asset class:
U.S. government and government agencies – valuations provided by independent pricing services, with all prices provided through index providers and pricing vendors. The Company determined that all U.S. Treasuries would be classified as Level 1 securities due to observed levels of trading activity, the high number of strongly correlated pricing quotes received on U.S. Treasuries and other factors. The fair values of U.S. government agency securities are generally determined using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the
fair values of U.S. government agency securities are classified within Level 2.
Corporate bonds – valuations provided by independent pricing services, substantially all through index providers and pricing vendors with a small amount through broker-dealers. The fair values of these securities are generally determined using the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and from broker-dealers who trade in the relevant security market. As the significant inputs used in the pricing process for corporate bonds are observable market inputs, the fair value of these securities are classified within Level 2. A small number of securities are included in Level 3 due to a low level of transparency on the inputs used in the pricing process.
Municipal bonds – valuations provided by independent pricing services, with all prices provided through index providers and pricing vendors. The fair values of these securities are generally determined using spreads obtained from broker-dealers who trade in the relevant security market, trade prices and the new issue market. As the significant inputs used in the pricing process for municipal bonds are observable market inputs, the fair value of these securities are classified within Level 2.
Residential mortgage-backed securities – valuations provided by independent pricing services, substantially all through pricing vendors and index providers with a small amount through broker-dealers. The fair values of these securities are generally determined through the use of pricing models (including Option Adjusted Spread) which use spreads to determine the expected average life of the securities. These spreads are generally obtained from the new issue market, secondary trading and from broker-dealers who trade in the relevant security market. The pricing services also review prepayment speeds and other indicators, when applicable. As the significant inputs used in the pricing process for mortgage-backed securities are observable market inputs, the fair value of these securities are classified within Level 2. A small number of securities are included in Level 3 due to a low level of transparency on the inputs used in the pricing process.
Commercial mortgage-backed securities – valuations provided by independent pricing services, substantially all through index providers and pricing vendors with a small amount through broker-dealers. The fair values of these securities are generally determined through the use of pricing models which use spreads to determine the appropriate average life of the securities. These spreads are generally obtained from the new issue market, secondary trading and from broker-dealers who trade in the relevant security market. The pricing services also review prepayment speeds and other indicators, when applicable. As the significant inputs used in the pricing process for commercial mortgage-
| | | | | | | | |
ARCH CAPITAL | 31 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
backed securities are observable market inputs, the fair value of these securities are classified within Level 2.
Non-U.S. government securities – valuations provided by independent pricing services, with all prices provided through index providers and pricing vendors. The fair values of these securities are generally based on international indices or valuation models which include daily observed yield curves, cross-currency basis index spreads and country credit spreads. As the significant inputs used in the pricing process for non-U.S. government securities are observable market inputs, the fair value of these securities are classified within Level 2.
Asset-backed securities – valuations provided by independent pricing services, substantially all through index providers and pricing vendors with a small amount through broker-dealers. The fair values of these securities are generally determined through the use of pricing models (including Option Adjusted Spread) which use spreads to determine the appropriate average life of the securities. These spreads are generally obtained from the new issue market, secondary trading and from broker-dealers who trade in the relevant security market. The pricing services also review prepayment speeds and other indicators, when applicable. As the significant inputs used in the pricing process for asset-backed securities are observable market inputs, the fair value of these securities are classified within Level 2. A small number of securities are included in Level 3 due to a low level of transparency on the inputs used in the pricing process.
Equity securities
The Company determined that exchange-traded equity securities would be included in Level 1 as their fair values are based on quoted market prices in active markets. Certain equity securities are included in Level 2 of the valuation hierarchy as the significant inputs used in the pricing process for such securities are observable market inputs. Other equity securities are included in Level 3 due to the lack of an available independent price source for such securities. As the significant inputs used to price these securities are unobservable, the fair value of such securities are classified as Level 3.
Other investments
The Company’s other investments include term loan investments for which fair values are estimated by using quoted prices of term loan investments with similar characteristics, pricing models or matrix pricing. Such investments are generally classified within Level 2. The fair values for certain of the Company’s other investments are determined using net asset values as advised by external fund managers. The net asset value is based on the fund manager’s valuation of the underlying holdings in accordance with the fund’s governing documents. In accordance with applicable accounting guidance, certain investments that are measured at
fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. A small number of securities are included in Level 3 due to the lack of an available independent price source for such securities.
Derivative instruments
The Company’s futures contracts, foreign currency forward contracts, interest rate swaps and other derivatives trade in the over-the-counter derivative market. The Company uses the market approach valuation technique to estimate the fair value for these derivatives based on significant observable market inputs from third party pricing vendors, non-binding broker-dealer quotes and/or recent trading activity. As the significant inputs used in the pricing process for these derivative instruments are observable market inputs, the fair value of these securities are classified within Level 2.
Short-term investments
The Company determined that certain of its short-term investments held in highly liquid money market-type funds, Treasury bills and commercial paper would be included in Level 1 as their fair values are based on quoted market prices in active markets. The fair values of other short-term investments are generally determined using the spread above the risk-free yield curve and are classified within Level 2.
Residential mortgage loans
The Company’s residential mortgage loans (included in ‘other assets’ in the consolidated balance sheets) include amounts related to the Company’s whole mortgage loan purchase and sell program. Fair values of residential mortgage loans are generally determined based on market prices. As significant inputs used in pricing process for these residential mortgage loans are observable market inputs, the fair value of these securities are classified within Level 2.
Other liabilities
The Company’s other liabilities include contingent and deferred consideration liabilities related to the Company’s acquisitions. Contingent consideration liabilities are remeasured at fair value at each balance sheet date with changes in fair value recognized in ‘net realized gains (losses).’ To determine the fair value of contingent consideration liabilities, the Company estimates the future payments using an income approach based on modeled inputs which include a weighted average cost of capital. Deferred consideration liabilities are measured at fair value on the transaction date. The Company determined that contingent and deferred consideration liabilities would be included within Level 3.
| | | | | | | | |
ARCH CAPITAL | 32 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The following table presents the Company’s financial assets and liabilities measured at fair value by level at September 30, 2022:
| | | | | | | | | | | | | | | | | | | | | | | |
| | | Estimated Fair Value Measurements Using: |
| Estimated Fair Value | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) |
Assets measured at fair value: | | | | | | | |
Available for sale securities: | | | | | | | |
Fixed maturities: | | | | | | | |
Corporate bonds | $ | 7,096,269 | | | $ | — | | | $ | 7,096,256 | | | $ | 13 | |
Residential mortgage backed securities | 763,371 | | | — | | | 763,371 | | | — | |
Municipal bonds | 407,724 | | | — | | | 407,724 | | | — | |
Commercial mortgage backed securities | 1,064,238 | | | — | | | 1,064,238 | | | — | |
U.S. government and government agencies | 5,126,407 | | | 5,100,908 | | | 25,499 | | | — | |
Non-U.S. government securities | 2,073,170 | | | — | | | 2,073,170 | | | — | |
Asset backed securities | 1,589,548 | | | — | | | 1,589,548 | | | — | |
Total | 18,120,727 | | | 5,100,908 | | | 13,019,806 | | | 13 | |
| | | | | | | |
Short-term investments | 1,940,857 | | | 1,873,480 | | | 67,377 | | | — | |
| | | | | | | |
Equity securities, at fair value | 809,869 | | | 775,264 | | | 31,566 | | | 3,039 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Derivative instruments (2) | 176,160 | | | — | | | 176,160 | | | — | |
| | | | | | | |
Residential mortgage loans | 2,255 | | | — | | | 2,255 | | | — | |
| | | | | | | |
Fair value option: | | | | | | | |
Corporate bonds | 524,177 | | | — | | | 524,177 | | | — | |
Non-U.S. government bonds | 4,032 | | | — | | | 4,032 | | | — | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Asset backed securities | 2,094 | | | — | | | 2,094 | | | — | |
| | | | | | | |
Short-term investments | 28,614 | | | 405 | | | 28,209 | | | — | |
Equity securities | 13,905 | | | 9,312 | | | 1 | | | 4,592 | |
Other investments | 175,259 | | | — | | | 141,021 | | | 34,238 | |
Other investments measured at net asset value (1) | 830,670 | | | | | | | |
Total | 1,578,751 | | | 9,717 | | | 699,534 | | | 38,830 | |
| | | | | | | |
Total assets measured at fair value | $ | 22,628,619 | | | $ | 7,759,369 | | | $ | 13,996,698 | | | $ | 41,882 | |
| | | | | | | |
Liabilities measured at fair value: | | | | | | | |
Other liabilities | $ | (13,421) | | | $ | — | | | $ | — | | | $ | (13,421) | |
| | | | | | | |
Derivative instruments (2) | (112,577) | | | — | | | (112,577) | | | — | |
Total liabilities measured at fair value | $ | (125,998) | | | $ | — | | | $ | (112,577) | | | $ | (13,421) | |
(1) In accordance with applicable accounting guidance, certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets.
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ARCH CAPITAL | 33 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The following table presents the Company’s financial assets and liabilities measured at fair value by level at December 31, 2021:
| | | | | | | | | | | | | | | | | | | | | | | |
| | | Estimated Fair Value Measurements Using: |
| Estimated Fair Value | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) |
Assets measured at fair value: | | | | | | | |
Available for sale securities: | | | | | | | |
Fixed maturities: | | | | | | | |
Corporate bonds | $ | 6,553,333 | | | $ | — | | | $ | 6,553,320 | | | $ | 13 | |
Residential mortgage backed securities | 408,477 | | | — | | | 408,477 | | | — | |
Municipal bonds | 404,666 | | | — | | | 404,666 | | | — | |
Commercial mortgage backed securities | 1,046,484 | | | — | | | 1,046,484 | | | — | |
U.S. government and government agencies | 4,772,764 | | | 4,744,517 | | | 28,247 | | | — | |
Non-U.S. government securities | 2,120,294 | | | — | | | 2,120,294 | | | — | |
Asset backed securities | 2,692,091 | | | — | | | 2,688,744 | | | 3,347 | |
Total | 17,998,109 | | | 4,744,517 | | | 13,250,232 | | | 3,360 | |
| | | | | | | |
Short-term investments | 1,734,716 | | | 1,052,822 | | | 681,894 | | | — | |
| | | | | | | |
Equity securities, at fair value | 1,804,170 | | | 1,762,864 | | | 38,388 | | | 2,918 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Derivative instruments (2) | 127,121 | | | — | | | 127,121 | | | — | |
| | | | | | | |
Residential mortgage loans | 49,847 | | | — | | | 49,847 | | | — | |
| | | | | | | |
| | | | | | | |
Fair value option: | | | | | | | |
Corporate bonds | 388,546 | | | — | | | 388,546 | | | — | |
Non-U.S. government bonds | 23,785 | | | — | | | 23,785 | | | — | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Asset backed securities | 4,367 | | | — | | | 4,367 | | | — | |
| | | | | | | |
Short-term investments | 97,806 | | | 528 | | | 97,278 | | | — | |
Equity securities | 26,493 | | | 21,745 | | | — | | | 4,748 | |
Other investments | 310,798 | | | 20,352 | | | 262,465 | | | 27,981 | |
Other investments measured at net asset value (1) | 1,121,755 | | | | | | | |
Total | 1,973,550 | | | 42,625 | | | 776,441 | | | 32,729 | |
| | | | | | | |
Total assets measured at fair value | $ | 23,687,513 | | | $ | 7,602,828 | | | $ | 14,923,923 | | | $ | 39,007 | |
| | | | | | | |
Liabilities measured at fair value: | | | | | | | |
Other liabilities | $ | (16,960) | | | $ | — | | | $ | — | | | $ | (16,960) | |
| | | | | | | |
Derivative instruments (2) | (54,224) | | | — | | | (54,224) | | | — | |
Total liabilities measured at fair value | $ | (71,184) | | | $ | — | | | $ | (54,224) | | | $ | (16,960) | |
(1) In accordance with applicable accounting guidance, certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets.
| | | | | | | | |
ARCH CAPITAL | 34 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The following table presents a reconciliation of the beginning and ending balances for all financial assets and liabilities measured at fair value on a recurring basis using Level 3 inputs:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Assets | Liabilities |
s | Available For Sale | | Fair Value Option | | Fair Value | | |
| Structured Securities (1) | | Corporate Bonds | | Corporate Bonds | | Other Investments | | Equity Securities | | Equity Securities | | Other Liabilities |
Three Months Ended September 30, 2022 | | | | | | | | | | | | | |
Balance at beginning of period | $ | 2,867 | | | $ | 3,570 | | | $ | — | | | $ | 33,331 | | | $ | 4,392 | | | $ | 2,906 | | | $ | (16,205) | |
Total gains or (losses) (realized/unrealized) | | | | | | | | | | | | | |
Included in earnings (2) | (601) | | | 52 | | | — | | | 116 | | | 200 | | | 133 | | | (89) | |
Included in other comprehensive income | 144 | | | (59) | | | — | | | — | | | — | | | — | | | 965 | |
Purchases, issuances, sales and settlements | | | | | | | | | | | | | |
Purchases | — | | | — | | | — | | | 1,458 | | | — | | | — | | | — | |
Issuances | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Sales | (2,051) | | | (3,550) | | | — | | | (667) | | | — | | | — | | | — | |
Settlements | (359) | | | — | | | — | | | — | | | — | | | — | | | 1,908 | |
Transfers in and/or out of Level 3 | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Balance at end of period | $ | — | | | $ | 13 | | | $ | — | | | $ | 34,238 | | | $ | 4,592 | | | $ | 3,039 | | | $ | (13,421) | |
| | | | | | | | | | | | | |
Three Months Ended September 30, 2021 | | | | | | | | | | | | | |
Balance at beginning of period | $ | 3,424 | | | $ | 13 | | | $ | 998 | | | $ | 73,900 | | | $ | 73,678 | | | $ | 49,136 | | | $ | (466) | |
Total gains or (losses) (realized/unrealized) | | | | | | | | | | | | | |
Included in earnings (2) | 10 | | | — | | | — | | | — | | | 38 | | | 11 | | | — | |
Included in other comprehensive income | 10 | | | — | | | — | | | — | | | — | | | — | | | — | |
Purchases, issuances, sales and settlements | | | | | | | | | | | | | |
Purchases | — | | | — | | | — | | | — | | | — | | | 208 | | | (17,345) | |
Issuances | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Sales (3) | — | | | — | | | (998) | | | (44,143) | | | (69,181) | | | (46,773) | | | — | |
Settlements | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Transfers in and/or out of Level 3 | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Balance at end of period | $ | 3,444 | | | $ | 13 | | | $ | — | | | $ | 29,757 | | | $ | 4,535 | | | $ | 2,582 | | | $ | (17,811) | |
| | | | | | | | | | | | | |
Nine Months Ended September 30, 2022 | | | | | | | | | | | | | |
Balance at beginning of year | $ | 3,347 | | | $ | 13 | | | $ | — | | | $ | 27,981 | | | $ | 4,748 | | | $ | 2,918 | | | $ | (16,960) | |
Total gains or (losses) (realized/unrealized) | | | | | | | | | | | | | |
Included in earnings (2) | (592) | | | 52 | | | — | | | 150 | | | (156) | | | (103) | | | (284) | |
Included in other comprehensive income | (1) | | | (59) | | | — | | | — | | | — | | | — | | | 1,915 | |
Purchases, issuances, sales and settlements | | | | | | | | | | | | | |
Purchases | — | | | — | | | — | | | 12,228 | | | — | | | 227 | | | — | |
Issuances | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Sales | (2,051) | | | (3,550) | | | — | | | (3,138) | | | — | | | (3) | | | — | |
Settlements | (703) | | | — | | | — | | | (2,983) | | | — | | | — | | | 1,908 | |
Transfers in and/or out of Level 3 | — | | | 3,557 | | | — | | | — | | | — | | | — | | | — | |
Balance at end of period | $ | — | | | $ | 13 | | | $ | — | | | $ | 34,238 | | | $ | 4,592 | | | $ | 3,039 | | | $ | (13,421) | |
| | | | | | | | | | | | | |
Nine Months Ended September 30, 2021 | | | | | | | | | | | | | |
Balance at beginning of year | $ | 3,426 | | | $ | 13 | | | $ | 985 | | | $ | 67,103 | | | $ | 68,988 | | | $ | 42,015 | | | $ | (461) | |
Total gains or (losses) (realized/unrealized) | | | | | | | | | | | | | |
Included in earnings (2) | (46) | | | — | | | 13 | | | 881 | | | 4,728 | | | 1,837 | | | — | |
Included in other comprehensive income | 67 | | | — | | | — | | | — | | | — | | | — | | | — | |
Purchases, issuances, sales and settlements | | | | | | | | | | | | | |
Purchases | — | | | — | | | — | | | 13,003 | | | — | | | 5,503 | | | (17,345) | |
Issuances | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Sales (3) | — | | | — | | | (998) | | | (51,230) | | | (69,181) | | | (46,773) | | | — | |
Settlements | (3) | | | — | | | — | | | — | | | — | | | — | | | (5) | |
Transfers in and/or out of Level 3 | — | | | — | | | — | | | — | | | — | | | — | | | — | |
Balance at end of period | $ | 3,444 | | | $ | 13 | | | $ | — | | | $ | 29,757 | | | $ | 4,535 | | | $ | 2,582 | | | $ | (17,811) | |
(1) Includes asset backed securities, residential mortgage backed securities and commercial mortgage backed securities.
(2) Gains or losses were included in net realized gains (losses).
(3) Sales for the 2021 periods primarily related to the Company’s deconsolidation of Somers..
| | | | | | | | |
ARCH CAPITAL | 35 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Financial Instruments Disclosed, But Not Carried, At Fair Value
The Company uses various financial instruments in the normal course of its business. The carrying values of cash, accrued investment income, receivable for securities sold, certain other assets, payable for securities purchased and certain other liabilities approximated their fair values at September 30, 2022, due to their respective short maturities. As these financial instruments are not actively traded, their respective fair values are classified within Level 2.
At September 30, 2022, the Company’s senior notes were carried at their cost, net of debt issuance costs, of $2.7 billion and had a fair value of $2.3 billion. At December 31, 2021, the Company’s senior notes were carried at their cost, net of debt issuance costs, of $2.7 billion and had a fair value of $3.3 billion. The fair values of the senior notes were obtained from a third party pricing service and are based on observable market inputs. As such, the fair values of the senior notes are classified within Level 2.
9. Derivative Instruments
The Company’s investment strategy allows for the use of derivative instruments. The Company’s derivative instruments are recorded on its consolidated balance sheets at fair value. The Company utilizes exchange traded U.S. Treasury note, Eurodollar and other futures contracts and commodity futures to manage portfolio duration or replicate investment positions in its portfolios and the Company routinely utilizes foreign currency forward contracts, currency options, index futures contracts and other derivatives as part of its total return objective. In addition, certain of the Company’s investments are managed in portfolios which incorporate the use of foreign currency forward contracts which are intended to provide an economic hedge against foreign currency movements.
In addition, the Company purchases to-be-announced mortgage backed securities (“TBAs”) as part of its investment strategy. TBAs represent commitments to purchase a future issuance of agency mortgage backed securities. For the period between purchase of a TBA and issuance of the underlying security, the Company’s position is accounted for as a derivative. The Company purchases TBAs in both long and short positions to enhance investment performance and as part of its overall investment strategy.
The following table summarizes information on the fair values and notional values of the Company’s derivative instruments:
| | | | | | | | | | | | | | | | | |
| Estimated Fair Value | | |
| Asset Derivatives (1) | | Liability Derivatives (1) | | Notional Value (2) |
September 30, 2022 | | | | | |
Futures contracts | $ | 72,730 | | | $ | (60,684) | | | $ | 2,189,945 | |
Foreign currency forward contracts | 25,281 | | | (26,995) | | | 835,941 | |
TBAs | — | | | — | | | — | |
Other | 78,149 | | | (24,898) | | | 3,766,549 | |
Total | $ | 176,160 | | | $ | (112,577) | | | |
| | | | | |
December 31, 2021 | | | | | |
Futures contracts | $ | 34,999 | | | $ | (9,808) | | | $ | 2,826,564 | |
Foreign currency forward contracts | 7,734 | | | (11,390) | | | 915,962 | |
TBAs | 11,227 | | | — | | | 11,227 | |
Other | 73,161 | | | (33,026) | | | 3,736,773 | |
Total | $ | 127,121 | | | $ | (54,224) | | | |
(1) The fair value of asset derivatives are included in ‘other assets’ and the fair value of liability derivatives are included in ‘other liabilities.’
(2) Represents the absolute notional value of all outstanding contracts, consisting of long and short positions.
The Company did not hold any derivatives which were designated as hedging instruments at September 30, 2022 or December 31, 2021.
The Company’s derivative instruments can be traded under master netting agreements, which establish terms that apply to all derivative transactions with a counterparty. In the event of a bankruptcy or other stipulated event of default, such agreements provide that the non-defaulting party may elect to terminate all outstanding derivative transactions, in which case all individual derivative positions (loss or gain) with a counterparty are closed out and netted and replaced with a single amount, usually referred to as the termination amount, which is expressed in a single currency. The resulting single net amount, where positive, is payable to the party “in-the-money” regardless of whether or not it is the defaulting party, unless the parties have agreed that only the non-defaulting party is entitled to receive a termination payment where the net amount is positive and is in its favor. Contractual close-out netting reduces derivatives credit exposure from gross to net exposure.
At September 30, 2022, asset derivatives and liability derivatives of $164.9 million and $112.6 million, respectively, were subject to a master netting agreement, compared to $122.3 million and $53.9 million, respectively, at December 31, 2021. The remaining derivatives included in the preceding table were not subject to a master netting agreement.
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ARCH CAPITAL | 36 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Realized and unrealized contract gains and losses on the Company’s derivative instruments are reflected in ‘net realized gains (losses)’ in the consolidated statements of income, as summarized in the following table:
| | | | | | | | | | | | | | |
Derivatives not designated as | | September 30, |
hedging instruments: | | 2022 | | 2021 |
| | | | |
Three Months Ended | | | | |
Net realized gains (losses): | | | | |
Futures contracts | | $ | (26,347) | | | $ | (10,073) | |
Foreign currency forward contracts | | (18,340) | | | (16,146) | |
TBAs | | — | | | (46) | |
Other (1) | | (3,509) | | | 4,830 | |
Total | | $ | (48,196) | | | $ | (21,435) | |
| | | | |
Nine Months Ended | | | | |
Net realized gains (losses): | | | | |
Futures contracts | | $ | (112,326) | | | $ | (17,394) | |
Foreign currency forward contracts | | (46,016) | | | (36,922) | |
TBAs | | (51) | | | (46) | |
Other (1) | | 40,802 | | | 17,934 | |
Total | | $ | (117,591) | | | $ | (36,428) | |
(1) Includes realized gains and losses on swaps, options and other derivatives contracts.
10. Commitments and Contingencies
Letter of Credit and Revolving Credit Facilities
In the normal course of its operations, the Company enters into agreements with financial institutions to obtain secured and unsecured credit facilities. On April 7, 2022, Arch Capital and certain of its subsidiaries amended the existing five-year credit agreement into a $925.0 million facility (the “Credit Facility”) with a syndication of lenders. The Credit Facility, as amended, consists of a $425.0 million secured facility for letters of credit (the “Secured Facility”) and a $500.0 million unsecured facility for revolving loans and letters of credit (the “Unsecured Facility”). Obligations of each borrower under the Secured Facility for letters of credit are secured by cash and eligible securities of such borrower held in collateral accounts. Commitments under the Credit Facility may be increased up to, but not exceeding, an aggregate of $1.3 billion. Arch Capital has a one-time option to convert any or all outstanding revolving loans of Arch Capital and/or Arch-U.S. to term loans with the same terms as the revolving loans except that any prepayments may not be re-borrowed. Arch-U.S. guarantees the obligations of Arch Capital, and Arch Capital guarantees the obligations of Arch-U.S. Borrowings of revolving loans may be made at a variable rate based on SOFR. Secured letters of credit are available for issuance on behalf of certain Arch Capital subsidiaries. At September 30, 2022, the $425.0 million secured letter of credit facility, had $311.8 million of letters of credit outstanding and remaining capacity of
$113.2 million. In addition, certain of Arch Capital’s subsidiaries had outstanding secured and unsecured letters of credit through other facilities of $22.7 million and $290.0 million respectively, which were issued in the normal course of business.
Investment Commitments
The Company’s investment commitments, which are primarily related to agreements entered into by the Company to invest in funds and separately managed accounts when called upon, were approximately $3.1 billion at September 30, 2022, compared to $3.0 billion at December 31, 2021.
Interest Paid
Interest paid on the Company’s senior notes and other borrowings were $65.0 million for the nine months ended September 30, 2022, compared to $75.8 million for the 2021 period.
11. Variable Interest Entities and Noncontrolling Interests
Somers
In March 2014, the Company invested $100.0 million and acquired approximately 11% of Somers’ outstanding common equity. Somers was considered a VIE and the Company concluded that it was the primary beneficiary of Somers, through June 30, 2021. As such, the results of Somers were included in the Company’s consolidated financial statements as of and for the periods ended June 30, 2021.
In the 2020 fourth quarter, Arch Capital, Somers and Greysbridge, a wholly-owned subsidiary of Arch Capital, entered into an Agreement and Plan of Merger (as amended, the “Merger Agreement”). The merger contemplated by the Merger Agreement and the related Greysbridge equity financing closed on July 1, 2021. In connection therewith and effective July 1, 2021, Somers became wholly owned by Greysbridge, and Greysbridge is now owned 40% by the Company, 30% by certain investment funds managed by Kelso and 30% by certain investment funds managed by Warburg. Based on the governing documents of Greysbridge, the Company concluded that, while it retains significant influence over Somers, Somers no longer constitutes a variable interest entity. Accordingly, effective July 1, 2021, the Company no longer consolidates the results of Somers in its consolidated financial statements and footnotes. Beginning in the 2021 third quarter, the Company classifies its investment as ‘investments in operating affiliates’ on the Company’s balance sheets and is accounted for under the equity method.
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ARCH CAPITAL | 37 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Through June 30, 2021, Somers generated $47.0 million of cash provided by operating activities, $96.3 million of cash provided by investing activities and $2.0 million of cash used for financing activities.
Redeemable noncontrolling interests
The following table sets forth activity in the redeemable non-controlling interests:
| | | | | | | | | | | |
| September 30, |
| 2022 | | 2021 |
Three Months Ended | | | |
Balance, beginning of period | $ | 8,459 | | | $ | 57,533 | |
| | | |
Impact of deconsolidation of Somers | — | | | (48,919) | |
| | | |
Other | 449 | | | 1,623 | |
Balance, end of period | $ | 8,908 | | | $ | 10,237 | |
| | | |
Nine Months Ended | | | |
Balance, beginning of year | $ | 9,233 | | | $ | 58,548 | |
| | | |
Impact of deconsolidation of Somers | — | | | (48,919) | |
| | | |
Other | (325) | | | 608 | |
Balance, end of period | $ | 8,908 | | | $ | 10,237 | |
The portion of income or loss attributable to third party investors, recorded in the Company’s consolidated statements of income in ‘net (income) loss attributable to noncontrolling interests,’ are summarized in the table below:
| | | | | | | | | | | |
| September 30, |
| 2022 | | 2021 |
Three Months Ended | | | |
Amounts attributable to non-redeemable noncontrolling interests | $ | — | | | $ | — | |
Amounts attributable to redeemable noncontrolling interests | (1,157) | | | (1,473) | |
Net (income) loss attributable to noncontrolling interests | $ | (1,157) | | | $ | (1,473) | |
| | | |
Nine Months Ended | | | |
Amounts attributable to non-redeemable noncontrolling interests | $ | — | | | $ | (78,314) | |
Amounts attributable to redeemable noncontrolling interests | (2,390) | | | (3,889) | |
Net (income) loss attributable to noncontrolling interests | $ | (2,390) | | | $ | (82,203) | |
Bellemeade Re
The Company has entered into aggregate excess of loss mortgage reinsurance agreements with various special purpose reinsurance companies domiciled in Bermuda (the “Bellemeade Agreements”). At the time the Bellemeade Agreements were entered into, the applicability of the accounting guidance that addresses VIEs was evaluated. As a result of the evaluation of the Bellemeade Agreements, the Company concluded that these entities are VIEs. However, given that the ceding insurers do not have the unilateral power to direct those activities that are significant to their economic performance, the Company does not consolidate such entities in its consolidated financial statements. The following table presents the total assets of the Bellemeade entities, as well as the Company’s maximum exposure to loss associated with these VIEs, calculated as the maximum historical observable spread between the benchmark index for each respective transaction and short term invested trust asset yields. The benchmark index for agreements effective prior to 2021 is based on one-month LIBOR, while the 2021 and later agreements benchmark index is based on the Secured Overnight Financing Rate (“SOFR”). SOFR is a measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities, and is based on directly observable U.S. Treasury-backed repurchase transactions.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | September 30, 2022 | | | | | | December 31, 2021 |
| | | | Maximum Exposure to Loss | | | | | | Maximum Exposure to Loss |
Bellemeade Entities (Issue Date) | | Total VIE Assets | | On-Balance Sheet (Asset) Liability | | Off-Balance Sheet | | Total | | Coverage Remaining from Reinsurers (1) | | Total VIE Assets | | On-Balance Sheet (Asset) Liability | | Off-Balance Sheet | | Total |
| | | | | | | | | | | | | | | | | | |
2017-1 Ltd. (Oct-17) | | $ | 46,772 | | | $ | (23) | | | $ | 88 | | | $ | 65 | | | $ | — | | | $ | 108,368 | | | $ | (159) | | | $ | 424 | | | $ | 265 | |
2018-1 Ltd. (Apr-18) | | 103,131 | | | (220) | | | 644 | | | 424 | | | — | | | 181,136 | | | (528) | | | 1,268 | | | 740 | |
2018-3 Ltd. (Oct-18) | | 217,701 | | | (862) | | | 2,107 | | | 1,245 | | | — | | | 302,563 | | | (1,018) | | | 2,496 | | | 1,478 | |
2019-1 Ltd. (Mar-19) | | 119,193 | | | (496) | | | 2,704 | | | 2,208 | | | — | | | 181,324 | | | (380) | | | 5,807 | | | 5,427 | |
2019-2 Ltd. (Apr-19) | | 347,050 | | | (656) | | | 4,308 | | | 3,652 | | | — | | | 398,316 | | | (515) | | | 3,998 | | | 3,483 | |
2019-3 Ltd. (Jul-19) | | 257,663 | | | (192) | | | 1,492 | | | 1,300 | | | — | | | 409,859 | | | (584) | | | 3,190 | | | 2,606 | |
2019-4 Ltd. (Oct-19) | | 283,684 | | | (532) | | | 3,663 | | | 3,131 | | | — | | | 411,954 | | | (462) | | | 4,759 | | | 4,297 | |
2020-2 Ltd. (Sep-20) | | 122,897 | | | (20) | | | 595 | | | 575 | | | 153 | | | 217,766 | | | (177) | | | 1,984 | | | 1,807 | |
2020-3 Ltd. (Nov-20) | | 268,385 | | | (204) | | | 2,845 | | | 2,641 | | | 8,569 | | | 348,818 | | | (128) | | | 5,793 | | | 5,665 | |
2020-4 Ltd. (Dec-20) | | 107,396 | | | 10 | | | 707 | | | 717 | | | 4,795 | | | 176,826 | | | (50) | | | 1,630 | | | 1,580 | |
2021-1 Ltd. (Mar-21) | | 497,069 | | | (2,234) | | | 936 | | | (1,298) | | | 43,198 | | | 568,986 | | | (303) | | | 3,283 | | | 2,980 | |
2021-2 Ltd. (Jun-21) | | 471,039 | | | (2,047) | | | 984 | | | (1,063) | | | 80,268 | | | 522,807 | | | 281 | | | 4,124 | | | 4,405 | |
2021-3 Ltd. (Sep-21) | | 498,309 | | | (2,414) | | | 991 | | | (1,423) | | | 129,127 | | | 507,873 | | | (411) | | | 3,446 | | | 3,035 | |
2022-1 Ltd. (Jan-22) | | 283,500 | | | (1,326) | | | 627 | | | (699) | | | 33,260 | | | | | | | | | |
2022-2 Ltd. (Sep-22) | | 201,005 | | | — | | | 744 | | | 744 | | | 126,160 | | | | | | | | | |
Total | | $ | 3,824,794 | | | $ | (11,216) | | | $ | 23,435 | | | $ | 12,219 | | | $ | 425,530 | | | $ | 4,336,596 | | | $ | (4,434) | | | $ | 42,202 | | | $ | 37,768 | |
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(1) Coverage from a separate panel of reinsurers remaining at September 30, 2022. | | | | | | | | |
ARCH CAPITAL | 38 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
12. Other Comprehensive Income (Loss)
The following tables present details about amounts reclassified from accumulated other comprehensive income and the tax effects allocated to each component of other comprehensive income (loss):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Amounts Reclassified from AOCI |
| | Consolidated Statement of Income | | Three Months Ended | | Nine Months Ended |
Details About | | Line Item That Includes | | September 30, | | September 30, |
AOCI Components | | Reclassification | | 2022 | | 2021 | | 2022 | | 2021 |
| | | | | | | | | | |
Unrealized appreciation (decline) on available-for-sale investments | | | | | | | | |
| | Net realized gains (losses) | | $ | (55,940) | | | $ | 68,373 | | | $ | (186,570) | | | $ | 135,291 | |
| | Provision for credit losses | | 8,652 | | | (457) | | | (48,096) | | | (1,208) | |
| | | | | | | | | | |
| | Total before tax | | (47,288) | | | 67,916 | | | (234,666) | | | 134,083 | |
| | Income tax (expense) benefit | | 703 | | | (5,262) | | | 28,093 | | | (13,579) | |
| | Net of tax | | $ | (46,585) | | | $ | 62,654 | | | $ | (206,573) | | | $ | 120,504 | |
| | | | | | | | | | | | | | | | | |
| Before Tax Amount | | Tax Expense (Benefit) | | Net of Tax Amount |
Three Months Ended September 30, 2022 | | | | | |
Unrealized appreciation (decline) in value of investments: | | | | | |
Unrealized holding gains (losses) arising during period | $ | (671,907) | | | $ | (62,148) | | | $ | (609,759) | |
| | | | | |
Less reclassification of net realized gains (losses) included in net income | (47,288) | | | (703) | | | (46,585) | |
Foreign currency translation adjustments | (70,388) | | | — | | | (70,388) | |
Other comprehensive income (loss) | $ | (695,007) | | | $ | (61,445) | | | $ | (633,562) | |
| | | | | |
Three Months Ended September 30, 2021 | | | | | |
Unrealized appreciation (decline) in value of investments: | | | | | |
Unrealized holding gains (losses) arising during period | $ | (104,607) | | | $ | (8,684) | | | $ | (95,923) | |
| | | | | |
Less reclassification of net realized gains (losses) included in net income | 67,916 | | | 5,262 | | | 62,654 | |
Foreign currency translation adjustments | (32,060) | | | (350) | | | (31,710) | |
Other comprehensive income (loss) | $ | (204,583) | | | $ | (14,296) | | | $ | (190,287) | |
| | | | | |
Nine Months Ended September 30, 2022 | | | | | |
Unrealized appreciation (decline) in value of investments: | | | | | |
Unrealized holding gains (losses) arising during period | $ | (2,132,845) | | | $ | (240,726) | | | $ | (1,892,119) | |
| | | | | |
Less reclassification of net realized gains (losses) included in net income | (234,666) | | | (28,093) | | | (206,573) | |
Foreign currency translation adjustments | (141,515) | | | 166 | | | (141,681) | |
Other comprehensive income (loss) | $ | (2,039,694) | | | $ | (212,467) | | | $ | (1,827,227) | |
| | | | | |
Nine Months Ended September 30, 2021 | | | | | |
Unrealized appreciation (decline) in value of investments: | | | | | |
Unrealized holding gains (losses) arising during period | $ | (307,910) | | | $ | (28,808) | | | $ | (279,102) | |
| | | | | |
Less reclassification of net realized gains (losses) included in net income | 134,083 | | | 13,579 | | | 120,504 | |
Foreign currency translation adjustments | (54,083) | | | 6 | | | (54,089) | |
Other comprehensive income (loss) | $ | (496,076) | | | $ | (42,381) | | | $ | (453,695) | |
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ARCH CAPITAL | 39 | 2022 THIRD QUARTER FORM 10-Q |
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
13. Income Taxes
The Company’s income tax provision on income before income taxes, including income (loss) from operating affiliates, resulted in an effective tax rate of 3.0% for the nine months ended September 30, 2022, compared to 5.5% for the nine months ended September 30, 2021. The effective tax rate for the nine months ended September 30, 2022 and 2021 periods included discrete income tax benefits of $36.5 million and $28.7 million, respectively. The discrete income tax benefits had the effect of decreasing the effective tax rate on net income available to Arch common shareholders by 5.7% and 1.7%, respectively. The discrete tax items in both periods were primarily related to the release of a valuation allowance on certain U.K. deferred tax assets.
The Company’s effective tax rate, which is based upon the expected annual effective tax rate, may fluctuate from period to period based on the relative mix of income or loss reported by jurisdiction and the varying tax rates in each jurisdiction.
The Company had a net deferred tax asset of $572.1 million at September 30, 2022, compared to a net deferred tax asset of $194.0 million at December 31, 2021. The change is primarily a result of market value fluctuations in the investment portfolio. In addition, the Company paid $201.6 million and $202.4 million of income taxes for the nine months ended September 30, 2022 and 2021, respectively.
14. Legal Proceedings
The Company, in common with the insurance industry in general, is subject to litigation and arbitration in the normal course of its business. As of September 30, 2022, the Company was not a party to any litigation or arbitration which is expected by management to have a material adverse effect on the Company’s results of operations and financial condition and liquidity.
15. Transactions with Related Parties
In the 2021 first quarter, as part of the Company’s acquisition of Barbican, the Company entered into an agreement with Premia Managing Agency Limited for the reinsurance to close of Syndicate 1955’s 2018 underwriting year of account into Premia Syndicate 1884’s 2021 underwriting year of account. The reinsurance to close covers legacy business underwritten by Syndicate 1955 on the underwriting 2018 and prior years of account and under the agreement, approximately $380 million of net liabilities was transferred to Syndicate 1884, with an effective date of January 1, 2021. The Company had no reinsurance recoverable on unpaid and paid losses or funds held liability at September 30, 2022 and December 31, 2021.
In July 2021, following consummation of the Merger Agreement and the related Greysbridge equity financing, pursuant to which Somers became wholly owned by Greysbridge, and Greysbridge became owned 40% by the Company, 30% by certain funds managed by Kelso and 30% by certain funds managed by Warburg, the Company entered into certain reinsurance transactions with Somers. For the three and nine months ended September 30, 2022, the Company ceded premiums written related to such transactions of $236.5 million and $661.1 million, respectively (which includes reinsurance transactions in force as well as those entered into in conjunction with the Merger Agreement). For the three and nine months ended September 30, 2021, the Company ceded premiums written related to such transactions of $316.2 million. In addition, Somers paid certain acquisition costs and administrative fees to the Company. At September 30, 2022, reinsurance recoverable on unpaid and paid losses from Somers was $1.1 billion, with a reinsurance balance payable to Somers of $408.0 million. At December 31, 2021, reinsurance recoverable on unpaid and paid losses from Somers was $902.8 million, with a reinsurance balance payable to Somers of $258.4 million. See note 11 for information about Somers. The Company has a put/call option that was entered into in connection with the Greysbridge equity financing, whereby beginning January 1, 2024 the Company will have a call right (but not the obligation) and Warburg and Kelso will each have a put right (but not the obligation) to buy/sell one third of their initial shares annually at the tangible book value per share of Greysbridge for the most recently ended fiscal quarter.
As of September 30, 2022, the Company owns $35.0 million in aggregate principal amount of Somers Group Holdings Ltd’s 6.5% senior notes, due July 2, 2029.
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ARCH CAPITAL | 40 | 2022 THIRD QUARTER FORM 10-Q |