UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 

FORM 10-Q

 

(Mark One)

ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

 

 

 

For the quarterly period ended September 30, 2004

 

 

Or

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

 

 

 

For the transition period                                                 to                                                          

 

 

 

Commission file number: 0-26456

 

ARCH CAPITAL GROUP LTD.

(Exact name of registrant as specified in its charter)

 

Bermuda

Not Applicable

(State or other jurisdiction of incorporation or
organization)

(I.R.S. Employer Identification No.)

 

 

Wessex House, 45 Reid Street

 

Hamilton HM 12, Bermuda

 

(Address of principal executive offices)

(Zip Code)

 

 

Registrant’s telephone number, including area code: (441) 278-9250

 

 

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes   ý   No   o

 

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes   ý   No   o

 

Indicate the number of shares outstanding of each of the issuer’s classes of common shares as of the latest practicable date.

 

Class

 

Outstanding at November 5, 2004

 

Common Shares, $0.01 par value

 

34,774,241

 

 

 



 

ARCH CAPITAL GROUP LTD.

 

INDEX

 

PART I. Financial Information

 

 

 

Item 1 — Consolidated Financial Statements

 

 

 

Report of Independent Registered Public Accounting Firm

2

 

 

Consolidated Balance Sheets
September 30, 2004 and December 31, 2003

3

 

 

Consolidated Statements of Income
For the three and nine month periods ended September 30, 2004 and 2003

4

 

 

Consolidated Statements of Changes in Shareholders’ Equity
For the nine month periods ended September 30, 2004 and 2003

5

 

 

Consolidated Statements of Comprehensive Income
For the nine month periods ended September 30, 2004 and 2003

6

 

 

Consolidated Statements of Cash Flows
For the nine month periods ended September 30, 2004 and 2003

7

 

 

Notes to Consolidated Financial Statements

8

 

 

Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations

26

 

 

Item 3 — Quantitative and Qualitative Disclosures About Market Risk

64

 

 

Item 4 — Controls and Procedures

64

 

 

PART II. Other Information

65

 

 

Item 1 — Legal Proceedings

65

 

 

Item 2 — Changes in Securities, Use of Proceeds and Issuer Purchase of Equity Securities

65

 

 

Item 5 — Other Information

66

 

 

Item 6 — Exhibits and Reports on Form 8-K

66

 

1



 

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Shareholders of

Arch Capital Group Ltd.:

 

We have reviewed the accompanying consolidated balance sheet of Arch Capital Group Ltd. and its subsidiaries as of September 30, 2004, and the related consolidated statements of income for each of the three and nine month periods ended September 30, 2004 and 2003, and the consolidated statements of comprehensive income, changes in shareholders’ equity and cash flows for each of the nine month periods ended September 30, 2004 and 2003. These interim consolidated financial statements are the responsibility of the Company’s management.

 

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States).  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 standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the consolidated financial statements taken as a whole.  Accordingly, we do not express such an opinion.

 

Based on our review, we are not aware of any material modifications that should be made to the accompanying consolidated interim financial information for it to be in conformity with accounting principles generally accepted in the United States of America.

 

We previously audited in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2003, 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 13, 2004, we expressed an unqualified opinion on those consolidated financial statements.  In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2003, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.

 

 

/s/ PricewaterhouseCoopers LLP

 

New York, New York

November 3, 2004

 

2



 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(U.S. dollars in thousands, except share data)

 

 

 

(Unaudited)

 

 

 

 

 

September 30,
2004

 

December 31,
2003

 

Assets

 

 

 

 

 

Investments:

 

 

 

 

 

Fixed maturities available for sale, at fair value (amortized cost: 2004, $5,049,129; 2003, $3,363,193)

 

$

5,095,952

 

$

3,398,424

 

Short-term investments available for sale, at fair value (amortized cost: 2004, $138,263; 2003, $228,816)

 

138,260

 

229,348

 

Privately held securities (cost: 2004, $17,937; 2003, $27,632)

 

23,292

 

32,476

 

Total investments

 

5,257,504

 

3,660,248

 

 

 

 

 

 

 

Cash

 

92,763

 

56,899

 

Accrued investment income

 

49,706

 

30,316

 

Premiums receivable

 

601,220

 

477,032

 

Funds held by reinsureds

 

203,818

 

211,944

 

Unpaid losses and loss adjustment expenses recoverable

 

623,317

 

409,451

 

Paid losses and loss adjustment expenses recoverable

 

20,231

 

18,549

 

Prepaid reinsurance premiums

 

260,332

 

236,061

 

Goodwill and intangible assets

 

31,423

 

35,882

 

Deferred income tax assets, net

 

43,443

 

33,979

 

Deferred acquisition costs, net

 

304,454

 

275,696

 

Other assets

 

170,317

 

139,264

 

Total Assets

 

$

7,658,528

 

$

5,585,321

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Reserve for losses and loss adjustment expenses

 

$

3,229,783

 

$

1,951,967

 

Unearned premiums

 

1,565,097

 

1,402,998

 

Reinsurance balances payable

 

126,387

 

117,916

 

Senior notes

 

300,000

 

 

Revolving credit agreement borrowings

 

 

200,000

 

Deposit accounting liabilities

 

55,277

 

25,762

 

Other liabilities

 

253,530

 

175,949

 

Total Liabilities

 

5,530,074

 

3,874,592

 

 

 

 

 

 

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ Equity

 

 

 

 

 

Preference shares ($0.01 par value, 50,000,000 shares authorized, issued: 2004, 37,348,150; 2003, 38,844,665)

 

373

 

388

 

Common shares ($0.01 par value, 200,000,000 shares authorized, issued: 2004, 34,737,693; 2003, 28,200,372)

 

347

 

282

 

Additional paid-in capital

 

1,555,284

 

1,361,267

 

Deferred compensation under share award plan

 

(12,262

)

(15,004

)

Retained earnings

 

537,729

 

327,963

 

Accumulated other comprehensive income, net of deferred income tax

 

46,983

 

35,833

 

Total Shareholders’ Equity

 

2,128,454

 

1,710,729

 

Total Liabilities and Shareholders’ Equity

 

$

7,658,528

 

$

5,585,321

 

 

See Notes to Consolidated Financial Statements

 

3



 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(U.S. dollars in thousands, except share data)

 

 

 

(Unaudited)

 

(Unaudited)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Revenues

 

 

 

 

 

 

 

 

 

Net premiums written

 

$

743,229

 

$

774,167

 

$

2,304,463

 

$

2,111,032

 

Increase in unearned premiums

 

(7,821

)

(165,211

)

(137,830

)

(588,769

)

Net premiums earned

 

735,408

 

608,956

 

2,166,633

 

1,522,263

 

Net investment income

 

40,752

 

20,542

 

98,136

 

58,752

 

Net realized gains

 

13,503

 

11,366

 

20,083

 

21,454

 

Fee income

 

5,853

 

5,489

 

14,151

 

16,099

 

Other income (loss)

 

95

 

546

 

(3,248

)

2,271

 

Total revenues

 

795,611

 

646,899

 

2,295,755

 

1,620,839

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

Losses and loss adjustment expenses

 

561,602

 

391,974

 

1,428,111

 

986,435

 

Acquisition expenses

 

137,480

 

115,851

 

427,225

 

289,623

 

Other operating expenses

 

70,331

 

47,202

 

195,579

 

119,276

 

Interest expense

 

6,334

 

 

12,350

 

 

Net foreign exchange losses (gains)

 

1,787

 

(3,708

)

1,603

 

(6,519

)

Non-cash compensation

 

2,330

 

3,899

 

7,724

 

11,661

 

Total expenses

 

779,864

 

555,218

 

2,072,592

 

1,400,476

 

 

 

 

 

 

 

 

 

 

 

Income Before Income Taxes and Extraordinary Item

 

15,747

 

91,681

 

223,163

 

220,363

 

 

 

 

 

 

 

 

 

 

 

Income tax (benefit) expense

 

(2,282

)

9,910

 

13,397

 

24,322

 

 

 

 

 

 

 

 

 

 

 

Income Before Extraordinary Item

 

18,029

 

81,771

 

209,766

 

196,041

 

 

 

 

 

 

 

 

 

 

 

Extraordinary gain – excess of fair value of net assets acquired over cost (net of $0 income tax)

 

 

816

 

 

816

 

 

 

 

 

 

 

 

 

 

 

Net Income

 

$

18,029

 

$

82,587

 

$

209,766

 

$

196,857

 

 

 

 

 

 

 

 

 

 

 

Net Income Per Share Data

 

 

 

 

 

 

 

 

 

Basic:

 

 

 

 

 

 

 

 

 

Income before extraordinary item

 

$

0.55

 

$

3.12

 

$

6.82

 

$

7.50

 

Extraordinary gain

 

 

$

0.03

 

 

$

0.03

 

Net income

 

$

0.55

 

$

3.15

 

$

6.82

 

$

7.53

 

 

 

 

 

 

 

 

 

 

 

Diluted:

 

 

 

 

 

 

 

 

 

Income before extraordinary item

 

$

0.25

 

$

1.21

 

$

2.91

 

$

2.90

 

Extraordinary gain

 

 

$

0.01

 

 

$

0.01

 

Net income

 

$

0.25

 

$

1.22

 

$

2.91

 

$

2.91

 

 

 

 

 

 

 

 

 

 

 

Weighted Average Shares Outstanding

 

 

 

 

 

 

 

 

 

Basic

 

32,985,085

 

26,255,775

 

30,770,428

 

26,153,718

 

Diluted

 

73,547,450

 

67,774,722

 

72,090,798

 

67,539,330

 

 

See Notes to Consolidated Financial Statements

 

4



 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(U.S. dollars in thousands)

 

 

 

(Unaudited)

 

 

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

Preference Shares

 

 

 

 

 

Balance at beginning of year

 

$

388

 

$

388

 

Converted to common shares

 

(15

)

 

Balance at end of period

 

373

 

388

 

 

 

 

 

 

 

Common Shares

 

 

 

 

 

Balance at beginning of year

 

282

 

277

 

Common shares issued

 

50

 

4

 

Converted from preference shares

 

15

 

 

Balance at end of period

 

347

 

281

 

 

 

 

 

 

 

Additional Paid-in Capital

 

 

 

 

 

Balance at beginning of year

 

1,361,267

 

1,347,165

 

Common shares issued

 

189,542

 

5,666

 

Exercise of stock options

 

5,430

 

6,068

 

Common shares retired

 

(3,019

)

(794

)

Other

 

2,064

 

1,227

 

Balance at end of period

 

1,555,284

 

1,359,332

 

 

 

 

 

 

 

Deferred Compensation Under Share Award Plan

 

 

 

 

 

Balance at beginning of year

 

(15,004

)

(25,290

)

Restricted common shares issued

 

(7,395

)

(4,762

)

Deferred compensation expense recognized

 

10,137

 

11,973

 

Balance at end of period

 

(12,262

)

(18,079

)

 

 

 

 

 

 

Retained Earnings

 

 

 

 

 

Balance at beginning of year

 

327,963

 

47,372

 

Net income

 

209,766

 

196,857

 

Balance at end of period

 

537,729

 

244,229

 

 

 

 

 

 

 

Accumulated Other Comprehensive Income

 

 

 

 

 

Balance at beginning of year

 

35,833

 

41,332

 

Change in unrealized appreciation in value of investments, net of deferred income tax

 

12,735

 

8,756

 

Foreign currency translation adjustments

 

(1,585

)

 

Balance at end of period

 

46,983

 

50,088

 

 

 

 

 

 

 

Total Shareholders’ Equity

 

$

2,128,454

 

$

1,636,239

 

 

See Notes to Consolidated Financial Statements

 

5



 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(U.S. dollars in thousands)

 

 

 

(Unaudited)

 

 

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

Comprehensive Income

 

 

 

 

 

Net income

 

$

209,766

 

$

196,857

 

Other comprehensive income, net of deferred income tax

 

 

 

 

 

Unrealized appreciation in value of investments:

 

 

 

 

 

Unrealized holding gains arising during period

 

28,948

 

28,071

 

Reclassification of net realized investment gains, net of income taxes, included in net income

 

(16,213

)

(19,315

)

Foreign currency translation adjustments

 

(1,585

)

 

Other comprehensive income

 

11,150

 

8,756

 

Comprehensive Income

 

$

220,916

 

$

205,613

 

 

See Notes to Consolidated Financial Statements

 

6



 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(U.S. dollars in thousands)

 

 

 

(Unaudited)

 

 

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

Operating Activities

 

 

 

 

 

Net income

 

$

209,766

 

$

196,857

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Net realized gains

 

(19,570

)

(21,454

)

Other loss (income)

 

3,248

 

(2,271

)

Non-cash compensation

 

11,719

 

12,873

 

Excess of fair value of net assets acquired over cost

 

 

(816

)

Changes in:

 

 

 

 

 

Reserve for losses and loss adjustment expenses, net of unpaid losses and loss adjustment expenses recoverable

 

1,063,950

 

820,862

 

Unearned premiums, net of prepaid reinsurance premiums

 

137,828

 

588,769

 

Premiums receivable

 

(124,188

)

(252,421

)

Deferred acquisition costs, net

 

(28,758

)

(132,810

)

Funds held by reinsureds

 

8,126

 

(126,551

)

Reinsurance balances payable

 

8,471

 

21,740

 

Accrued investment income

 

(19,390

)

(5,986

)

Paid losses and loss adjustment expenses recoverable

 

(1,682

)

(8,441

)

Deferred income tax asset

 

(8,285

)

(1,934

)

Deposit accounting liabilities

 

29,515

 

17,903

 

Other liabilities

 

68,202

 

47,129

 

Other items, net

 

13,537

 

(7,360

)

Net Cash Provided By Operating Activities

 

1,352,489

 

1,146,089

 

 

 

 

 

 

 

Investing Activities

 

 

 

 

 

Purchases of fixed maturity investments

 

(5,260,351

)

(3,595,697

)

Sales of fixed maturity investments

 

3,566,717

 

2,099,515

 

Sales of equity securities

 

13,332

 

7,801

 

Net sales of short-term investments

 

99,062

 

134,119

 

Acquisitions, net of cash

 

 

(11,774

)

Purchases of furniture, equipment and other

 

(13,809

)

(19,930

)

Net Cash Used For Investing Activities

 

(1,595,049

)

(1,385,966

)

 

 

 

 

 

 

Financing Activities

 

 

 

 

 

Proceeds from common shares issued

 

183,775

 

4,843

 

Proceeds from issuance of senior notes

 

296,442

 

 

(Repayment of) proceeds from revolving credit agreement borrowings

 

(200,000

)

200,000

 

Repurchase of common shares

 

(1,525

)

(795

)

Net Cash Provided By Financing Activities

 

278,692

 

204,048

 

 

 

 

 

 

 

Effects of exchange rate changes on foreign currency cash

 

(268

)

 

Increase (decrease) in cash

 

35,864

 

(35,829

)

Cash beginning of year

 

56,899

 

91,717

 

Cash end of period

 

$

92,763

 

$

55,888

 

 

 

 

 

 

 

Income taxes paid, net

 

$

25,304

 

$

28,399

 

Interest paid

 

$

1,967

 

 

 

See Notes to Consolidated Financial Statements

 

7



 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1.                   General

 

Arch Capital Group Ltd. (“ACGL”) is a Bermuda public limited liability company which provides insurance and reinsurance on a worldwide basis through its wholly owned subsidiaries.

 

The interim consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and include the accounts of ACGL and its subsidiaries (together with ACGL, the “Company”). 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 from those estimates and assumptions. In the opinion of management, the accompanying unaudited interim consolidated financial statements reflect all adjustments 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 pursuant to such rules and regulations; 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, 2003, including the Company’s audited consolidated financial statements and related notes and the section entitled “Business—Risk Factors.”

 

To facilitate period-to-period comparisons, certain amounts in the 2003 consolidated financial statements have been reclassified to conform to the 2004 presentation. Such reclassifications had no effect on the Company’s consolidated net income, shareholders’ equity or cash flows.

 

2.                   Stock Options

 

The Company has adopted the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), and related interpretations in accounting for its employee stock options. Accordingly, under APB No. 25, compensation expense for stock option grants is recognized by the Company to the extent that the fair value of the underlying stock exceeds the exercise price of the option at the measurement date. As provided under Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” the Company has elected to continue to account for stock-based compensation in accordance with APB No. 25 and has provided the required additional pro forma disclosures.

 

8



 

If compensation expense for stock-based employee compensation plans had been determined using the fair value recognition provisions of SFAS No. 123, the Company’s net income and earnings per share would have instead been reported as the pro forma amounts indicated below:

 

 

 

(Unaudited)

 

(Unaudited)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

(U.S. dollars in thousands, except share data)

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Net income, as reported

 

$

18,029

 

$

82,587

 

$

209,766

 

$

196,857

 

Total stock-based employee compensation expense under fair value method, net of income taxes

 

(2,349

)

(1,896

)

(3,286

)

(5,188

)

Pro forma net income

 

$

15,680

 

$

80,691

 

$

206,480

 

$

191,669

 

 

 

 

 

 

 

 

 

 

 

Earnings per share – basic:

 

 

 

 

 

 

 

 

 

As reported

 

$

0.55

 

$

3.15

 

$

6.82

 

$

7.53

 

Pro forma

 

$

0.48

 

$

3.07

 

$

6.71

 

$

7.33

 

Earnings per share – diluted:

 

 

 

 

 

 

 

 

 

As reported

 

$

0.25

 

$

1.22

 

$

2.91

 

$

2.91

 

Pro forma

 

$

0.21

 

$

1.19

 

$

2.86

 

$

2.84

 

 

3.                   Accounting Pronouncements

 

In December 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46R (“FIN 46R”), “Consolidation of Variable Interest Entities.” This interpretation of Accounting Research Bulletin No. 51 (“ARB 51”), “Consolidated Financial Statements”, which replaces FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities”, addresses consolidation by business enterprises of variable interest entities (“VIEs”). FIN 46R clarifies the application of ARB 51 to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. In addition, FIN 46R modified FIN 46 to address certain technical corrections and implementation issues relating to FIN 46. Pursuant to FIN 46, if an enterprise has a controlling financial interest in a VIE, the assets, liabilities and results of operations of the variable interest entity must be included in the consolidated financial statements with those of the business enterprise. An enterprise with an interest in an entity to which the provisions of FIN 46 had not been applied as of December 24, 2003, applied the provisions of FIN 46R no later than the end of the first reporting period ending after March 15, 2004. The provisions of FIN 46 applied immediately to VIEs created after January 31, 2003; however, for VIEs created prior to January 31, 2003 the provisions of FIN 46R were effective for the first year or interim period beginning after March 15, 2004. The provisions of FIN 46R are required to be applied to financial statements of public entities that have interests in VIEs, commonly referred to as special-purpose entities, for periods ending after December 15, 2003.

 

The Company concluded that, under FIN 46R, it is required to consolidate the assets, liabilities and results of operations (if any) of a certain managing general agency in which one of the Company’s subsidiaries has an investment. Such agency ceased producing business in 1999 and is currently running-off its operations. Based on current information, there are no assets or liabilities of such agency required to be reflected on the face of the Company’s consolidated financial statements that are not, or have not been previously, otherwise reflected therein. Therefore, the adoption of FIN 46R did not have a material impact on the Company’s consolidated financial statements as of or for the nine months ended September 30, 2004.

 

9



 

In March 2004, the FASB released an exposure draft, “Share-Based Payment-an Amendment of Statements No. 123 and 95” (the “Proposed Statement”), that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The Proposed Statement would eliminate the ability to account for share-based compensation transactions using the intrinsic method under APB No. 25 and, generally, would require instead that such transactions be accounted for using a fair-value-based method. The proposed effective date is for interim and annual periods beginning after June 15, 2005. The Company will evaluate the impact of the Proposed Statement upon issuance by the FASB.

 

In March 2004, the FASB’s Emerging Issues Task Force (“EITF”) reached a consensus regarding EITF 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The consensus provides guidance for evaluating whether an investment is other-than-temporarily impaired and was effective beginning with the 2004 third quarter. In October 2004, the FASB issued a final FASB Staff Position that delayed the effective date of the application guidance on impairment of securities that is included in paragraphs 10 through 20 of EITF 03-1. The annual disclosure requirements under paragraphs 20 through 21 of EITF 03-1 have not been deferred. The Company is currently evaluating the impact that EITF 03-1 may have on its consolidated financial statements. The delay in the effective date for the application guidance is not a suspension of currently existing accounting requirements for assessing other-than-temporary impairments for securities under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” or other current accounting standards, including current guidance for cost-method and equity-method investments.

 

4.                   Segment Information

 

The Company classifies its businesses into two underwriting segments — reinsurance and insurance — and a corporate and other segment (non-underwriting). The Company’s reinsurance and insurance operating segments each have segment 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 President and Chief Executive Officer of ACGL and the Chief Financial Officer of ACGL. The chief operating decision makers do not assess performance, measure return on equity or make resource allocation decisions on a line of business basis. The Company determined its reportable operating segments using the management approach described in SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information.”

 

Management measures segment performance based on underwriting income or loss. The Company does not manage its assets by segment and, accordingly, investment income is not allocated to each underwriting segment. In addition, other revenue and expense items are not evaluated by segment. The accounting policies of the segments are the same as those used for the preparation of the Company’s consolidated financial statements. Inter-segment insurance business is allocated to the segment accountable for the underwriting results.

 

The reinsurance segment, or division, consists of the Company’s reinsurance underwriting subsidiaries. The reinsurance segment generally seeks to write significant lines on specialty property and casualty reinsurance treaties. Classes of business include: casualty; casualty clash; marine and aviation; non-traditional; other specialty; property catastrophe; and property excluding property catastrophe (losses on a single risk, both excess of loss and pro rata).

 

The insurance segment, or division, consists of the Company’s insurance underwriting subsidiaries which primarily write on a direct basis. The insurance segment consists of eight product lines, including: casualty; construction and surety; executive assurance; healthcare; professional liability; programs; property, marine and aviation; and other (primarily non-standard auto, collateralized protection business and certain programs).

 

The corporate and other segment (non-underwriting) includes net investment income, other fee income, net of related expenses, other income, other expenses incurred by the Company, net realized gains or losses, net

 

10



 

foreign exchange gains or losses and non-cash compensation. The corporate and other segment also includes the results of Hales & Company Inc. (“Hales”), the Company’s merchant banking operations. Included in other income (loss) for the nine months ended September 30, 2004 is a charge of $4.5 million resulting from a write-down of the carrying value of Hales (see Note 14, “Goodwill and Intangible Assets”). During the 2004 second quarter, the Company entered into negotiations to sell Hales. In October 2004, the sale of Hales was completed.

 

The following table sets forth an analysis of the Company’s underwriting income by segment, together with a reconciliation of underwriting income to net income:

 

 

 

(Unaudited)

 

 

 

Three Months Ended
September 30, 2004

 

(U.S. dollars in thousands)

 

Reinsurance

 

Insurance

 

Total

 

 

 

 

 

 

 

 

 

Gross premiums written (1)

 

$

412,355

 

$

552,608

 

$

927,658

 

Net premiums written (1)

 

394,495

 

348,734

 

743,229

 

 

 

 

 

 

 

 

 

Net premiums earned (1)

 

$

403,113

 

$

332,295

 

$

735,408

 

Policy-related fee income

 

 

4,915

 

4,915

 

Other underwriting-related fee income

 

184

 

635

 

819

 

Losses and loss adjustment expenses

 

(329,451

)

(232,151

)

(561,602

)

Acquisition expenses, net

 

(101,622

)

(35,858

)

(137,480

)

Other operating expenses

 

(11,562

)

(54,264

)

(65,826

)

Underwriting (loss) income

 

$

(39,338

)

$

15,572

 

(23,766

)

 

 

 

 

 

 

 

 

Net investment income

 

 

 

 

 

40,752

 

Net realized gains

 

 

 

 

 

13,503

 

Other fee income, net of related expenses

 

 

 

 

 

119

 

Other income

 

 

 

 

 

95

 

Other expenses

 

 

 

 

 

(4,505

)

Interest expense

 

 

 

 

 

(6,334

)

Net foreign exchange losses

 

 

 

 

 

(1,787

)

Non-cash compensation

 

 

 

 

 

(2,330

)

Income before income taxes

 

 

 

 

 

15,747

 

Income tax benefit

 

 

 

 

 

2,282

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

$

18,029

 

 

 

 

 

 

 

 

 

Underwriting Ratios

 

 

 

 

 

 

 

Loss ratio

 

81.7

%

69.9

%

76.4

%

Acquisition expense ratio (2)

 

25.2

%

9.3

%

18.0

%

Other operating expense ratio

 

2.9

%

16.3

%

9.0

%

Combined ratio

 

109.8

%

95.5

%

103.4

%

 


(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. The reinsurance segment and insurance segment results include $36.3 million and $1.0 million, respectively, of gross and net premiums written and $37.5 million and $1.9 million, respectively, of net premiums earned assumed through intersegment transactions.

(2)          The acquisition expense ratio is adjusted to include policy-related fee income.

 

11



 

The following table sets forth an analysis of the Company’s underwriting income by segment, together with a reconciliation of underwriting income to net income:

 

 

 

(Unaudited)

 

 

 

Three Months Ended
September 30, 2003

 

(U.S. dollars in thousands)

 

Reinsurance

 

Insurance

 

Total

 

 

 

 

 

 

 

 

 

Gross premiums written (1)

 

$

411,443

 

$

558,863

 

$

928,243

 

Net premiums written (1)

 

397,418

 

376,749

 

774,167

 

 

 

 

 

 

 

 

 

Net premiums earned (1)

 

$

348,883

 

$

260,073

 

$

608,956

 

Policy-related fee income

 

 

3,583

 

3,583

 

Other underwriting-related fee income

 

1,369

 

 

1,369

 

Losses and loss adjustment expenses

 

(223,419

)

(168,555

)

(391,974

)

Acquisition expenses, net

 

(79,011

)

(36,840

)

(115,851

)

Other operating expenses

 

(8,862

)

(33,654

)

(42,516

)

Underwriting income

 

$

38,960

 

$

24,607

 

63,567

 

 

 

 

 

 

 

 

 

Net investment income

 

 

 

 

 

20,542

 

Net realized gains

 

 

 

 

 

11,366

 

Other fee income, net of related expenses

 

 

 

 

 

537

 

Other income

 

 

 

 

 

546

 

Other expenses

 

 

 

 

 

(4,686

)

Net foreign exchange gains

 

 

 

 

 

3,708

 

Non-cash compensation

 

 

 

 

 

(3,899

)

Income before income taxes and extraordinary item

 

 

 

 

 

91,681

 

Income tax expense

 

 

 

 

 

(9,910

)

Income before extraordinary item

 

 

 

 

 

81,771

 

Extraordinary gain, net of $0 income tax

 

 

 

 

 

816

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

$

82,587

 

 

 

 

 

 

 

 

 

Underwriting Ratios

 

 

 

 

 

 

 

Loss ratio

 

64.0

%

64.8

%

64.4

%

Acquisition expense ratio (2)

 

22.6

%

12.8

%

18.4

%

Other operating expense ratio

 

2.5

%

12.9

%

7.0

%

Combined ratio

 

89.1

%

90.5

%

89.8

%

 


(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. The reinsurance segment results include $42.1 million of gross and net premiums written and $36.2 million of net premiums earned assumed through intersegment transactions.

(2)          The acquisition expense ratio is adjusted to include policy-related fee income.

 

12



 

The following table sets forth an analysis of the Company’s underwriting income by segment, together with a reconciliation of underwriting income to net income:

 

 

 

(Unaudited)

 

 

 

Nine Months Ended
September 30, 2004

 

(U.S. dollars in thousands)

 

Reinsurance

 

Insurance

 

Total

 

 

 

 

 

 

 

 

 

Gross premiums written (1)

 

$

1,361,081

 

$

1,499,693

 

$

2,753,769

 

Net premiums written (1)

 

1,309,654

 

994,809

 

2,304,463

 

 

 

 

 

 

 

 

 

Net premiums earned (1)

 

$

1,165,037

 

$

1,001,596

 

$

2,166,633

 

Policy-related fee income

 

 

12,308

 

12,308

 

Other underwriting-related fee income

 

560

 

1,059

 

1,619

 

Losses and loss adjustment expenses

 

(767,747

)

(660,364

)

(1,428,111

)

Acquisition expenses, net

 

(307,015

)

(120,210

)

(427,225

)

Other operating expenses

 

(31,213

)

(152,047

)

(183,260

)

Underwriting income

 

$

59,622

 

$

82,342

 

141,964

 

 

 

 

 

 

 

 

 

Net investment income

 

 

 

 

 

98,136

 

Net realized gains

 

 

 

 

 

20,083

 

Other fee income, net of related expenses

 

 

 

 

 

224

 

Other income (loss)

 

 

 

 

 

(3,248

)

Other expenses

 

 

 

 

 

(12,319

)

Interest expense

 

 

 

 

 

(12,350

)

Net foreign exchange losses

 

 

 

 

 

(1,603

)

Non-cash compensation

 

 

 

 

 

(7,724

)

Income before income taxes

 

 

 

 

 

223,163

 

Income tax expense

 

 

 

 

 

(13,397

)

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

$

209,766

 

 

 

 

 

 

 

 

 

Underwriting Ratios

 

 

 

 

 

 

 

Loss ratio

 

65.9

%

65.9

%

65.9

%

Acquisition expense ratio (2)

 

26.4

%

10.8

%

19.2

%

Other operating expense ratio

 

2.7

%

15.2

%

8.5

%

Combined ratio

 

95.0

%

91.9

%

93.6

%

 


(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. The reinsurance segment and insurance segment results include $100.8 million and $6.2 million, respectively, of gross and net premiums written and $106.2 million and $5.4 million, respectively, of net premiums earned assumed through intersegment transactions.

(2)          The acquisition expense ratio is adjusted to include policy-related fee income.

 

13



 

The following table sets forth an analysis of the Company’s underwriting income by segment, together with a reconciliation of underwriting income to net income:

 

 

 

(Unaudited)

 

 

 

Nine Months Ended
September 30, 2003

 

(U.S. dollars in thousands)

 

Reinsurance

 

Insurance

 

Total

 

 

 

 

 

 

 

 

 

Gross premiums written (1)

 

$

1,311,142

 

$

1,283,776

 

$

2,464,348

 

Net premiums written (1)

 

1,268,374

 

842,658

 

2,111,032

 

 

 

 

 

 

 

 

 

Net premiums earned (1)

 

$

932,334

 

$

589,929

 

$

1,522,263

 

Policy-related fee income

 

 

10,358

 

10,358

 

Other underwriting-related fee income

 

5,097

 

 

5,097

 

Losses and loss adjustment expenses

 

(591,131

)

(395,304

)

(986,435

)

Acquisition expenses, net

 

(217,379

)

(72,244

)

(289,623

)

Other operating expenses

 

(22,644

)

(86,145

)

(108,789

)

Underwriting income

 

$

106,277

 

$

46,594

 

152,871

 

Net investment income

 

 

 

 

 

58,752

 

Net realized gains

 

 

 

 

 

21,454

 

Other fee income, net of related expenses

 

 

 

 

 

644

 

Other income

 

 

 

 

 

2,271

 

Other expenses

 

 

 

 

 

(10,487

)

Net foreign exchange gains

 

 

 

 

 

6,519

 

Non-cash compensation

 

 

 

 

 

(11,661

)

Income before income taxes and extraordinary item

 

 

 

 

 

220,363

 

Income tax expense

 

 

 

 

 

(24,322

)

Income before extraordinary item

 

 

 

 

 

196,041

 

Extraordinary gain, net of $0 income tax

 

 

 

 

 

816

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

$

196,857

 

 

 

 

 

 

 

 

 

Underwriting Ratios

 

 

 

 

 

 

 

Loss ratio

 

63.4

%

67.0

%

64.8

%

Acquisition expense ratio (2)

 

23.3

%

10.5

%

18.3

%

Other operating expense ratio

 

2.4

%

14.6

%

7.1

%

Combined ratio

 

89.1

%

92.1

%

90.2

%

 


(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. The reinsurance segment results include $130.6 million of gross and net premiums written and $97.7 million of net premiums earned assumed through intersegment transactions.

(2)          The acquisition expense ratio is adjusted to include policy-related fee income.

 

14



 

Set forth below is summary information regarding net premiums written and earned by major line of business and by client location for the reinsurance segment:

 

 

 

(Unaudited)

 

 

 

Three Months Ended
September 30,

 

 

 

2004

 

2003

 

REINSURANCE SEGMENT
(U.S. dollars in thousands)

 

Amount

 

% of
Total

 

Amount

 

% of
Total

 

 

 

 

 

 

 

 

 

 

 

Net premiums written (1)

 

 

 

 

 

 

 

 

 

Casualty

 

$

222,448

 

56.4

%

$

174,945

 

44.0

%

Property excluding property catastrophe

 

57,943

 

14.7

%

76,996

 

19.4

%

Other specialty

 

51,792

 

13.1

%

107,638

 

27.1

%

Marine and aviation

 

23,263

 

5.9

%

14,548

 

3.7

%

Property catastrophe

 

23,052

 

5.8

%

21,872

 

5.5

%

Non-traditional

 

13,692

 

3.5

%

(231

)

(0.1

)%

Casualty clash

 

2,305

 

0.6

%

1,650

 

0.4

%

Total

 

$

394,495

 

100.0

%

$

397,418

 

100.0

%

 

 

 

 

 

 

 

 

 

 

Net premiums earned (1)

 

 

 

 

 

 

 

 

 

Casualty

 

$

212,371

 

52.7

%

$

123,840

 

35.5

%

Property excluding property catastrophe

 

68,654

 

17.0

%

81,645

 

23.4

%

Other specialty

 

64,047

 

15.9

%

83,984

 

24.1

%

Marine and aviation

 

26,195

 

6.5

%

18,333

 

5.2

%

Property catastrophe

 

23,357

 

5.8

%

24,408

 

7.0

%

Non-traditional

 

5,320

 

1.3

%

14,010

 

4.0

%

Casualty clash

 

3,169

 

0.8

%

2,663

 

0.8

%

Total

 

$

403,113

 

100.0

%

$

348,883

 

100.0

%

 

 

 

 

 

 

 

 

 

 

Net premiums written by client location (1)

 

 

 

 

 

 

 

 

 

North America

 

$

219,842

 

55.7

%

$

233,577

 

58.8

%

Europe

 

86,769

 

22.0

%

124,435

 

31.3

%

Bermuda

 

66,515

 

16.9

%

26,711

 

6.7

%

Asia and Pacific

 

5,099

 

1.3

%

1,273

 

0.3

%

Other

 

16,270

 

4.1

%

11,422

 

2.9

%

Total

 

$

394,495

 

100.0

%

$

397,418

 

100.0

%

 


(1)          Reinsurance segment results include premiums written and earned assumed through intersegment transactions of $36.3 million and $37.5 million, respectively, for the 2004 third quarter and $42.1 million and $36.2 million, respectively, for the 2003 third quarter. Reinsurance segment results exclude premiums written and earned ceded through intersegment transactions of $1.0 million and $1.9 million, respectively, for the 2004 third quarter.

 

15



 

Set forth below is summary information regarding net premiums written and earned by major line of business and by client location for the reinsurance segment:

 

 

 

(Unaudited)

 

 

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

REINSURANCE SEGMENT
(U.S. dollars in thousands)

 

Amount

 

% of
Total

 

Amount

 

% of

Total

 

 

 

 

 

 

 

 

 

 

 

Net premiums written (1)

 

 

 

 

 

 

 

 

 

Casualty

 

$

674,624

 

51.5

%

$

480,769

 

37.9

%

Property excluding property catastrophe

 

232,519

 

17.8

%

258,844

 

20.4

%

Other specialty

 

200,323

 

15.3

%

311,579

 

24.6

%

Property catastrophe

 

94,276

 

7.2

%

93,982

 

7.4

%

Marine and aviation

 

65,973

 

5.0

%

60,318

 

4.8

%

Non-traditional

 

31,171

 

2.4

%

51,352

 

4.0

%

Casualty clash

 

10,768

 

0.8

%

11,530

 

0.9

%

Total

 

$

1,309,654

 

100.0

%

$

1,268,374

 

100.0

%

 

 

 

 

 

 

 

 

 

 

Net premiums earned (1)

 

 

 

 

 

 

 

 

 

Casualty

 

$

554,724

 

47.6

%

$

314,448

 

33.7

%

Other specialty

 

223,962

 

19.2

%

204,572

 

21.9

%

Property excluding property catastrophe

 

210,329

 

18.1

%

213,396

 

22.9

%

Property catastrophe

 

73,968

 

6.4

%

81,653

 

8.8

%

Marine and aviation

 

68,658

 

5.9

%

55,604

 

6.0

%

Non-traditional

 

24,842

 

2.1

%

52,461

 

5.6

%

Casualty clash

 

8,554

 

0.7

%

10,200

 

1.1

%

Total

 

$

1,165,037

 

100.0

%

$

932,334

 

100.0

%

 

 

 

 

 

 

 

 

 

 

Net premiums written by client location (1)

 

 

 

 

 

 

 

 

 

North America

 

$

800,581

 

61.1

%

$

785,006

 

61.9

%

Europe

 

323,450

 

24.7

%

355,099

 

28.0

%

Bermuda

 

129,922

 

9.9

%

75,008

 

5.9

%

Asia and Pacific

 

22,970

 

1.8

%

23,796

 

1.9

%

Other

 

32,731

 

2.5

%

29,465

 

2.3

%

Total

 

$

1,309,654

 

100.0

%

$

1,268,374

 

100.0

%

 


(1)          Reinsurance segment results include premiums written and earned assumed through intersegment transactions of $100.8 million and $106.2 million, respectively, for the nine months ended September 30, 2004 and $130.6 million and $97.7 million, respectively, for the nine months ended September 30, 2003. Reinsurance segment results exclude premiums written and earned ceded through intersegment transactions of $6.2 million and $5.4 million, respectively, for the nine months ended September 30, 2004.

 

16



 

Set forth below is summary information regarding net premiums written and earned by major line of business and by client location for the insurance segment:

 

 

 

(Unaudited)

 

 

 

Three Months Ended
September 30,

 

 

 

2004

 

2003

 

INSURANCE SEGMENT
(U.S. dollars in thousands)

 

Amount

 

% of
Total

 

Amount

 

% of

Total

 

 

 

 

 

 

 

 

 

 

 

Net premiums written (1)

 

 

 

 

 

 

 

 

 

Casualty

 

$

67,250

 

19.3

%

$

68,788

 

18.3

%

Programs

 

62,327

 

17.9

%

116,172

 

30.8

%

Property, marine and aviation

 

48,886

 

14.0

%

42,770

 

11.3

%

Construction and surety

 

45,799

 

13.1

%

53,374

 

14.2

%

Professional liability

 

45,763

 

13.1

%

28,850

 

7.7

%

Executive assurance

 

31,342

 

9.0

%

34,817

 

9.2

%

Healthcare

 

18,036

 

5.2

%

9,855

 

2.6

%

Other

 

29,331

 

8.4

%

22,123

 

5.9

%

Total

 

$

348,734

 

100.0

%

$

376,749

 

100.0

%

 

 

 

 

 

 

 

 

 

 

Net premiums earned (1)

 

 

 

 

 

 

 

 

 

Programs

 

$

72,239

 

21.7

%

$

81,712

 

31.4

%

Casualty

 

57,687

 

17.4

%

46,660

 

17.9

%

Professional liability

 

45,406

 

13.7

%

21,428

 

8.2

%

Construction and surety

 

45,264

 

13.6

%

25,672

 

9.9

%

Property, marine and aviation

 

39,446

 

11.9

%

27,730

 

10.7

%

Executive assurance

 

29,873

 

9.0

%

24,380

 

9.4

%

Healthcare

 

14,676

 

4.4

%

10,900

 

4.2

%

Other

 

27,704

 

8.3

%

21,591

 

8.3

%

Total

 

$

332,295

 

100.0

%

$

260,073

 

100.0

%

 

 

 

 

 

 

 

 

 

 

Net premiums written by client location (1)

 

 

 

 

 

 

 

 

 

North America

 

$

338,029

 

96.9

%

$

368,308

 

97.8

%

Other

 

10,705

 

3.1

%

8,441

 

2.2

%

Total

 

$

348,734

 

100.0

%

$

376,749

 

100.0

%

 


(1)          Insurance segment results include premiums written and earned assumed through intersegment transactions of $1.0 million and $1.9 million, respectively, for the 2004 third quarter. Insurance segment results exclude premiums written and earned ceded through intersegment transactions of $36.3 million and $37.5 million, respectively, for the 2004 third quarter and $42.1 million and $36.2 million, respectively, for the 2003 third quarter.

 

17



 

Set forth below is summary information regarding net premiums written and earned by major line of business and by client location for the insurance segment:

 

 

 

(Unaudited)

 

 

 

Nine Months Ended
September 30,

 

 

 

2004

 

2003

 

INSURANCE SEGMENT
(U.S. dollars in thousands)

 

Amount

 

% of
Total

 

Amount

 

% of

Total

 

 

 

 

 

 

 

 

 

 

 

Net premiums written (1)

 

 

 

 

 

 

 

 

 

Programs

 

$

244,304

 

24.6

%

$

263,748

 

31.3

%

Casualty

 

183,509

 

18.5

%

169,115

 

20.1

%

Professional liability

 

125,814

 

12.6

%

77,538

 

9.2

%

Property, marine and aviation

 

114,409

 

11.5

%

77,511

 

9.2

%

Construction and surety

 

111,787

 

11.2

%

95,588

 

11.3

%

Executive assurance

 

89,357

 

9.0

%

80,583

 

9.6

%

Healthcare

 

41,830

 

4.2

%

24,656

 

2.9

%

Other

 

83,799

 

8.4

%

53,919

 

6.4

%

Total

 

$

994,809

 

100.0

%

$

842,658

 

100.0

%

 

 

 

 

 

 

 

 

 

 

Net premiums earned (1)

 

 

 

 

 

 

 

 

 

Programs

 

$

262,806

 

26.2

%

$

182,872

 

31.0

%

Casualty

 

170,028

 

17.0

%

108,671

 

18.4

%

Construction and surety

 

136,436

 

13.6