Edgar Filing: ARCH CAPITAL GROUP LTD.

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

[X]		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended June 30, 2005
Or
[ ]		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 X No ______

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

Yes X No ______

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 July 28, 2005
Common Shares, $0.01 par value		35,274,505

ARCH CAPITAL GROUP LTD.

INDEX

	*Page No.*
*PART I. Financial Information*

Item 1 — Consolidated Financial Statements

Report of Independent Registered Public Accounting Firm	2

Consolidated Balance Sheets June 30, 2005 and December 31, 2004	3

Consolidated Statements of Income For the three and six month periods ended June 30, 2005 and 2004	4

Consolidated Statements of Changes in Shareholders’ Equity For the six month periods ended June 30, 2005 and 2004	5

Consolidated Statements of Comprehensive Income For the six month periods ended June 30, 2005 and 2004	6

Consolidated Statements of Cash Flows For the six month periods ended June 30, 2005 and 2004	7

Notes to Consolidated Financial Statements	8

Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations	27

Item 3 — Quantitative and Qualitative Disclosures About Market Risk	67

Item 4 — Controls and Procedures	67

*PART II. Other Information*

Item 1 — Legal Proceedings	68

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds	68

Item 4 – Submission of Matters to a Vote of Security Holders	69

Item 5 — Other Information	71

Item 6 — Exhibits	71

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 June 30, 2005, and the related consolidated statements of income for each of the three-month and six-month periods ended June 30, 2005 and 2004, and the consolidated statements of comprehensive income, changes in shareholders’ equity and cash flows for the six-month periods ended June 30, 2005 and 2004. These interim 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 the standards of the Public Company Accounting Oversight Board, 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.

Based on our review, we are not aware of any material modifications that should be made to the accompanying consolidated 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), the consolidated balance sheet as of December 31, 2004, and the related consolidated statements of income, comprehensive income, and changes in shareholders’ equity and of cash flows for the year then ended, management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004 and the effectiveness of the Company’s internal control over financial reporting as of December 31,2004; and in our report dated March 14, 2005, we expressed unqualified opinions thereon. The consolidated financial statements and management’s assessment of the effectiveness of internal control over financial reporting referred to above are not presented herein. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2004, 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
August 2, 2005

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

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

	(Unaudited)
	June 30,	December 31,
	2005	2004
Assets
Investments:
Fixed maturities available for sale, at fair value (amortized cost: 2005, $6,079,549; 2004, $5,506,193)	$6,124,248	$5,545,121
Short-term investments available for sale, at fair value (amortized cost: 2005, $177,156; 2004, $155,498)	176,268	155,771
Privately held securities, at fair value (cost: 2005, $13,619; 2004, $17,022)	22,251	21,571
Total investments	6,322,767	5,722,463

Cash	162,017	113,052
Accrued investment income	63,210	57,163
Premiums receivable	622,664	520,781
Funds held by reinsureds	199,283	209,946
Unpaid losses and loss adjustment expenses recoverable	798,752	695,582
Paid losses and loss adjustment expenses recoverable	31,611	26,874
Prepaid reinsurance premiums	336,721	321,422
Goodwill and intangible assets	16,666	16,666
Deferred income tax assets, net	54,101	58,745
Deferred acquisition costs, net	303,969	278,184
Other assets	216,883	197,876
Total Assets	$9,128,644	$8,218,754

Liabilities
Reserve for losses and loss adjustment expenses	$4,175,403	$3,570,734
Unearned premiums	1,641,659	1,541,217
Reinsurance balances payable	143,838	169,502
Senior notes	300,000	300,000
Deposit accounting liabilities	50,337	44,023
Payable for securities purchased	20,152	53,642
Other liabilities	293,863	297,730
Total Liabilities	6,625,252	5,976,848

Commitments and Contingencies

Shareholders’ Equity
Preference shares ($0.01 par value, 50,000,000 shares authorized, issued: 2005, 37,327,502; 2004, 37,348,150)	373	373
Common shares ($0.01 par value, 200,000,000 shares authorized, issued: 2005, 35,262,005; 2004, 34,902,923)	353	349
Additional paid-in capital	1,568,955	1,560,291
Deferred compensation under share award plan	(6,389)	(9,879)
Retained earnings	886,746	644,862
Accumulated other comprehensive income, net of deferred income tax	53,354	45,910
Total Shareholders’ Equity	2,503,392	2,241,906
Total Liabilities and Shareholders’ Equity	$9,128,644	$8,218,754

See Notes to Consolidated Financial Statements

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

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

	(Unaudited)		(Unaudited)
	Three Months Ended		Six Months Ended
	June 30,		June 30,
	2005	2004	2005	2004
Revenues
Net premiums written	$723,728	$677,646	$1,523,529	$1,561,234
(Increase) decrease in unearned premiums	16,164	45,753	(86,569)	(130,009)
Net premiums earned	739,892	723,399	1,436,960	1,431,225
Net investment income	53,660	32,811	103,576	57,384
Net realized gains (losses)	2,105	(2,321)	2,566	6,580
Fee income	1,025	4,304	7,137	8,298
Other income (loss)	—	(4,385)	—	(3,343)
Total revenues	796,682	753,808	1,550,239	1,500,144

Expenses
Losses and loss adjustment expenses	443,918	436,895	869,454	866,509
Acquisition expenses	148,538	136,889	274,671	289,745
Other operating expenses	74,232	69,155	147,633	125,248
Interest expense	5,629	4,642	11,265	6,016
Net foreign exchange gains	(10,198)	(5,503)	(13,435)	(184)
Non-cash compensation	753	2,756	1,527	5,394
Total expenses	662,872	644,834	1,291,115	1,292,728

Income Before Income Taxes	133,810	108,974	259,124	207,416

Income tax expense	7,818	4,692	17,240	15,679

Net Income	$125,992	$104,282	$241,884	$191,737

Net Income Per Share Data
Basic	$3.65	$3.26	$7.02	$6.47
Diluted	$1.69	$1.42	$3.26	$2.69

Weighted Average Shares Outstanding
Basic	34,563,565	32,023,865	34,464,740	29,650,932
Diluted	74,412,553	73,500,041	74,249,728	71,336,798

See Notes to Consolidated Financial Statements

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(U.S. dollars in thousands)

	(Unaudited)
	Six Months Ended June 30,
	2005	2004
Preference Shares
Balance at beginning of year	$373	$388
Converted to common shares	(0)	(4)
Balance at end of period	373	384

Common Shares
Balance at beginning of year	349	282
Common shares issued	4	49
Converted from preference shares	0	4
Balance at end of period	353	335

Additional Paid-in Capital
Balance at beginning of year	1,560,291	1,361,267
Common shares issued	1,698	184,437
Exercise of stock options	7,430	3,592
Common shares retired	(846)	(2,708)
Other	382	1,854
Balance at end of period	1,568,955	1,548,442

Deferred Compensation Under Share Award Plan
Balance at beginning of year	(9,879)	(15,004)
Restricted common shares issued	(291)	(2,142)
Deferred compensation expense recognized	3,781	5,354
Balance at end of period	(6,389)	(11,792)

Retained Earnings
Balance at beginning of year	644,862	327,963
Net income	241,884	191,737
Balance at end of period	886,746	519,700

Accumulated Other Comprehensive Income
Balance at beginning of year	45,910	35,833
Change in unrealized appreciation (decline) in value of investments, net of deferred income tax	8,514	(53,958)
Foreign currency translation adjustments, net of deferred income tax	(1,070)	(1,440)
Balance at end of period	53,354	(19,565)

Total Shareholders’ Equity	$2,503,392	$2,037,504

See Notes to Consolidated Financial Statements

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(U.S. dollars in thousands)

	(Unaudited)
	Six Months Ended June 30,
	2005	2004
Comprehensive Income
Net income	$241,884	$191,737
Other comprehensive income (loss), net of deferred income tax
Unrealized appreciation (decline) in value of investments:
Unrealized holding gains (losses) arising during period	9,239	(50,987)
Reclassification of net realized gains, net of income taxes, included in net income	(725)	(2,971)
Foreign currency translation adjustments	(1,070)	(1,440)
Other comprehensive income (loss)	7,444	(55,398)
Comprehensive Income	$249,328	$136,339

See Notes to Consolidated Financial Statements

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(U.S. dollars in thousands)

	(Unaudited)
	Six Months Ended
	June 30,
	2005	2004
Operating Activities
Net income	$241,884	$191,737
Adjustments to reconcile net income to net cash provided by operating activities:
Net realized gains	(1,022)	(5,630)
Other (income) loss	—	3,343
Non-cash compensation	4,073	5,394
Changes in:
Reserve for losses and loss adjustment expenses, net of unpaid losses and loss adjustment expenses recoverable	501,499	653,127
Unearned premiums, net of prepaid reinsurance premiums	85,143	130,009
Premiums receivable	(101,883)	(125,830)
Deferred acquisition costs, net	(25,785)	(26,373)
Funds held by reinsureds	10,663	5,148
Reinsurance balances payable	(25,664)	(13,534)
Accrued investment income	(6,047)	(11,903)
Paid losses and loss adjustment expenses recoverable	(4,737)	(4,634)
Deferred income tax assets, net	5,142	(13,213)
Deposit accounting liabilities	6,314	15,733
Other liabilities	(1,395)	24,360
Other items, net	(2,592)	15,671
Net Cash Provided By Operating Activities	685,593	843,405

Investing Activities
Purchases of fixed maturity investments	(1,985,427)	(3,413,832)
Proceeds from sales of fixed maturity investments	1,194,890	2,152,504
Proceeds from redemptions and maturities of fixed maturity investments	163,973	124,585
Sales of equity securities	1,986	11,043
Net (purchases) sales of short-term investments	(9,528)	148,182
Purchases of furniture, equipment and other	(7,588)	(10,878)
Net Cash Used For Investing Activities	(641,694)	(988,396)

Financing Activities
Proceeds from common shares issued	6,348	182,090
Proceeds from issuance of senior notes	—	296,442
Repayment of revolving credit agreement borrowings	—	(200,000)
Repurchase of common shares	(780)	(879)
Net Cash Provided By Financing Activities	5,568	277,653
Effects of exchange rate changes on foreign currency cash	(502)	(1,440)
Increase in cash	48,965	131,222
Cash beginning of year	113,052	56,899
Cash end of period	$162,017	$188,121
Income taxes paid, net	$34,958	$22,663
Interest paid	$11,141	$1,861

See Notes to Consolidated Financial Statements

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 unaudited 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 wholly owned 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 consolidated 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 (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, 2004, 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 2004 consolidated financial statements have been reclassified to conform to the 2005 presentation. Such reclassifications had no effect on the Company’s consolidated net income.

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.

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 June 30,		Six Months Ended June 30,
(U.S. dollars in thousands, except share data)	2005	2004	2005	2004

Net income, as reported	$125,992	$104,282	$241,884	$191,737
Total stock-based employee compensation expense under fair value method, net of income taxes	(1,119)	(427)	(2,196)	(937)
Pro forma net income	$124,873	$103,855	$239,688	$190,800

Earnings per share – basic:
As reported	$3.65	$3.26	$7.02	$6.47
Pro forma	$3.61	$3.24	$6.95	$6.43
Earnings per share – diluted:
As reported	$1.69	$1.42	$3.26	$2.69
Pro forma	$1.68	$1.41	$3.22	$2.67

3. Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.123 (revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”). SFAS No. 123(R) replaces SFAS No. 123 and supersedes APB No. 25 and requires that the estimated expense resulting from all share-based payment transactions be recognized in the financial statements. SFAS No. 123(R) eliminates the alternative to disclose, on a pro forma basis, the effects of the fair value based method. Pursuant to a Securities and Exchange Commission ruling released on April 14, 2005, which deferred the effective date of SFAS No. 123(R) for calendar year companies from July 1, 2005 to January 1, 2006, the Company will adopt the fair value recognition provisions of accounting for employee stock option awards as defined in SFAS No. 123(R) on January 1, 2006 under the modified prospective application. Under the fair value method of accounting, compensation expense is estimated based on the fair value of the award at the grant date and recognized over the requisite service period. Under the modified prospective application, the fair value based method described in SFAS No. 123(R) is applied to new awards granted after January 1, 2006. Additionally, the unrecognized expense related to the unvested portions of option awards that were outstanding as of the effective date will be recognized as compensation expense as the requisite service is rendered. The Company is currently evaluating the impact of adopting SFAS No. 123(R) on the results of its operations. However, the impact of adopting SFAS No. 123(R) will have no effect on the Company’s cash flows or shareholders’ equity.

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 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; 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 non-traditional and casualty clash business).

The insurance segment consists of the Company’s insurance underwriting subsidiaries which primarily write on both an admitted and non-admitted basis. The insurance segment consists of eight product lines: casualty; construction and surety; executive assurance; healthcare; professional liability; programs; property, marine and aviation; and other (primarily non-standard auto prior to the sale of such operations in December 2004, 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, interest expense, net realized gains or losses, net foreign exchange gains or losses and non-cash compensation. The corporate and other segment also includes the results of the Company’s merchant banking operations prior to the sale of such operations in October 2004.

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following tables set 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 June 30, 2005
(U.S. dollars in thousands)	Reinsurance	Insurance	Total

Gross premiums written (1)	$376,803	$577,420	$940,753
Net premiums written (1)	350,056	373,672	723,728

Net premiums earned (1)	$385,806	$354,086	$739,892
Policy-related fee income	—	732	732
Other underwriting-related fee income	22	271	293
Losses and loss adjustment expenses	(213,947)	(229,971)	(443,918)
Acquisition expenses, net	(113,443)	(35,095)	(148,538)
Other operating expenses	(11,882)	(57,232)	(69,114)
Underwriting income	$46,556	$32,791	79,347

Net investment income			53,660
Net realized gains			2,105
Other expenses			(5,118)
Interest expense			(5,629)
Net foreign exchange gains			10,198
Non-cash compensation			(753)
Income before income taxes			133,810
Income tax expense			(7,818)

Net income			$125,992

Underwriting Ratios
Loss ratio	55.5%	64.9%	60.0%
Acquisition expense ratio (2)	29.4%	9.7%	20.0%
Other operating expense ratio	3.1%	16.2%	9.3%
Combined ratio	88.0%	90.8%	89.3%

(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 $12.8 million and $0.7 million, respectively, of gross and net premiums written and $14.7 million and $1.2 million, respectively, of net premiums earned assumed through intersegment transactions.

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

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

	(Unaudited)
	Three Months Ended June 30, 2004
(U.S. dollars in thousands)	Reinsurance	Insurance	Total

Gross premiums written (1)	$382,987	$465,516	$816,323
Net premiums written (1)	364,271	313,375	677,646

Net premiums earned (1)	$378,874	$344,525	$723,399
Policy-related fee income	—	3,608	3,608
Other underwriting-related fee income	56	296	352
Losses and loss adjustment expenses	(218,479)	(218,416)	(436,895)
Acquisition expenses, net	(98,265)	(38,624)	(136,889)
Other operating expenses	(10,380)	(54,524)	(64,904)
Underwriting income	$51,806	$36,865	88,671

Net investment income			32,811
Net realized losses			(2,321)
Other fee income, net of related expenses			344
Other income (loss)			(4,385)
Other expenses			(4,251)
Interest expense			(4,642)
Net foreign exchange gains			5,503
Non-cash compensation			(2,756)
Income before income taxes			108,974
Income tax expense			(4,692)

Net income			$104,282

Underwriting Ratios
Loss ratio	57.7%	63.4%	60.4%
Acquisition expense ratio (2)	25.9%	10.2%	18.4%
Other operating expense ratio	2.7%	15.8%	9.0%
Combined ratio	86.3%	89.4%	87.8%

(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 and insurance segment results include $29.8 million and $2.4 million, respectively, of gross and net premiums written and $34.7 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.

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

	(Unaudited)
	Six Months Ended June 30, 2005
(U.S. dollars in thousands)	Reinsurance	Insurance	Total

Gross premiums written (1)	$865,598	$1,084,164	$1,921,445
Net premiums written (1)	827,749	695,780	1,523,529

Net premiums earned (1)	$761,838	$675,122	$1,436,960
Policy-related fee income	—	1,649	1,649
Other underwriting-related fee income	4,645	843	5,488
Losses and loss adjustment expenses	(432,621)	(436,833)	(869,454)
Acquisition expenses, net	(212,895)	(61,776)	(274,671)
Other operating expenses	(22,775)	(114,187)	(136,962)
Underwriting income	$98,192	$64,818	163,010

Net investment income			103,576
Net realized gains			2,566
Other expenses			(10,671)
Interest expense			(11,265)
Net foreign exchange gains			13,435
Non-cash compensation			(1,527)
Income before income taxes			259,124
Income tax expense			(17,240)

Net income			$241,884

Underwriting Ratios
Loss ratio	56.8%	64.7%	60.5%
Acquisition expense ratio (2)	27.9%	8.9%	19.0%
Other operating expense ratio	3.0%	16.9%	9.5%
Combined ratio	87.7%	90.5%	89.0%

(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 $26.8 million and $1.5 million, respectively, of gross and net premiums written and $31.1 million and $2.4 million, respectively, of net premiums earned assumed through intersegment transactions.

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

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

	(Unaudited)
	Six Months Ended June 30, 2004
(U.S. dollars in thousands)	Reinsurance	Insurance	Total

Gross premiums written (1)	$948,726	$947,085	$1,826,111
Net premiums written (1)	915,159	646,075	1,561,234

Net premiums earned (1)	$761,924	$669,301	$1,431,225
Policy-related fee income	—	7,393	7,393
Other underwriting-related fee income	376	424	800
Losses and loss adjustment expenses	(438,296)	(428,213)	(866,509)
Acquisition expenses, net	(205,393)	(84,352)	(289,745)
Other operating expenses	(19,651)	(97,783)	(117,434)
Underwriting income	$98,960	$66,770	165,730

Net investment income			57,384
Net realized gains			6,580
Other fee income, net of related expenses			105
Other income (loss)			(3,343)
Other expenses			(7,814)
Interest expense			(6,016)
Net foreign exchange gains			184
Non-cash compensation			(5,394)
Income before income taxes			207,416
Income tax expense			(15,679)

Net income			$191,737

Underwriting Ratios
Loss ratio	57.5%	64.0%	60.5%
Acquisition expense ratio (2)	27.0%	11.5%	19.7%
Other operating expense ratio	2.6%	14.6%	8.2%
Combined ratio	87.1%	90.1%	88.4%

(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 $64.5 million and $5.2 million, respectively, of gross and net premiums written and $68.7 million and $3.5 million, respectively, of net premiums earned assumed through intersegment transactions.

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

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following tables provide summary information regarding net premiums written and earned by major line of business and type of business, together with net premiums written by client location for the reinsurance segment:

	(Unaudited)
	Three Months Ended June 30,
	2005		2004
REINSURANCE SEGMENT (U.S. dollars in thousands)	Amount	% of Total	Amount	% of Total

Net premiums written (1)
Casualty	$160,646	45.9%	$223,626	61.4%
Property excluding property catastrophe	81,341	23.2%	65,987	18.1%
Other specialty	74,988	21.4%	42,234	11.6%
Marine and aviation	18,089	5.2%	12,067	3.3%
Property catastrophe	9,362	2.7%	13,019	3.6%
Other	5,630	1.6%	7,338	2.0%
Total	$350,056	100.0%	$364,271	100.0%

Net premiums earned (1)
Casualty	$176,399	45.7%	$189,777	50.1%
Property excluding property catastrophe	87,488	22.7%	56,878	15.0%
Other specialty	68,545	17.8%	73,800	19.5%
Marine and aviation	20,619	5.3%	21,682	5.7%
Property catastrophe	21,768	5.6%	23,397	6.2%
Other	10,987	2.9%	13,340	3.5%
Total	$385,806	100.0%	$378,874	100.0%

Net premiums written (1)
Pro rata	$305,842	87.4%	$287,312	78.9%
Excess of loss	44,214	12.6%	76,959	21.1%
Total	$350,056	100.0%	$364,271	100.0%

Net premiums earned (1)
Pro rata	$294,526	76.3%	$279,940	73.9%
Excess of loss	91,280	23.7%	98,934	26.1%
Total	$385,806	100.0%	$378,874	100.0%

Net premiums written by client location (1)
United States and Canada	$205,837	58.8%	$239,841	65.9%
Europe	109,970	31.4%	78,079	21.4%
Bermuda	17,314	5.0%	26,282	7.2%
Asia and Pacific	9,829	2.8%	12,419	3.4%
Other	7,106	2.0%	7,650	2.1%
Total	$350,056	100.0%	$364,271	100.0%

(1) Reinsurance segment results include premiums written and earned assumed through intersegment transactions of $12.8 million and $14.7 million, respectively, for the 2005 second quarter and $29.8 million and $34.7 million, respectively, for the 2004 second quarter. Reinsurance segment results exclude premiums written and earned ceded through intersegment transactions of $0.7 million and $1.2 million, respectively, for the 2005 second quarter and $2.4 million and $1.9 million, respectively, for the 2004 second quarter.

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

	(Unaudited)
	Six Months Ended June 30,
	2005		2004
REINSURANCE SEGMENT (U.S. dollars in thousands)	Amount	% of Total	Amount	% of Total

Net premiums written (1)
Casualty	$371,515	44.9%	$452,177	49.4%
Property excluding property catastrophe	169,536	20.5%	174,576	19.1%
Other specialty	166,017	20.1%	148,531	16.2%
Property catastrophe	53,924	6.5%	71,223	7.8%
Marine and aviation	48,118	5.8%	42,710	4.7%
Other	18,639	2.2%	25,942	2.8%
Total	$827,749	100.0%	$915,159	100.0%

Net premiums earned (1)
Casualty	$389,660	51.1%	$342,353	44.9%
Property excluding property catastrophe	144,983	19.0%	141,675	18.6%
Other specialty	119,299	15.7%	159,915	21.0%
Property catastrophe	46,529	6.1%	50,610	6.6%
Marine and aviation	42,610	5.6%	42,464	5.6%
Other	18,757	2.5%	24,907	3.3%
Total	$761,838	100.0%	$761,924	100.0%

Net premiums written (1)
Pro rata	$625,489	75.6%	$611,418	66.8%
Excess of loss	202,260	24.4%	303,741	33.2%
Total	$827,749	100.0%	$915,159	100.0%

Net premiums earned (1)
Pro rata	$572,138	75.1%	$564,222	74.1%
Excess of loss	189,700	24.9%	197,702	25.9%
Total	$761,838	100.0%	$761,924	100.0%

Net premiums written by client location (1)
United States and Canada	$486,587	58.8%	$580,739	63.5%
Europe	265,465	32.1%	236,681	25.9%
Bermuda	44,378	5.4%	63,407	6.9%
Asia and Pacific	15,399	1.8%	17,871	1.9%
Other	15,920	1.9%	16,461	1.8%
Total	$827,749	100.0%	$915,159	100.0%

(1) Reinsurance segment results include premiums written and earned assumed through intersegment transactions of $26.8 million and $31.1 million, respectively, for the six months ended June 30, 2005 and $64.5 million and $68.7 million, respectively, for the six months ended June 30, 2004. Reinsurance segment results exclude premiums written and earned ceded through intersegment transactions of $1.5 million and $2.4 million, respectively, for the 2005 second quarter and $5.2 million and $3.5 million, respectively, for the 2004 second quarter.

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

	(Unaudited)
	Three Months Ended June 30,
	2005		2004
INSURANCE SEGMENT (U.S. dollars in thousands)	Amount	% of Total	Amount	% of Total

Net premiums written (1)
Casualty	$72,503	19.4%	$52,712	16.8%
Property, marine and aviation	68,090	18.2%	35,792	11.4%
Programs	58,524	15.7%	92,197	29.4%
Professional liability	57,795	15.5%	41,318	13.2%
Executive assurance	48,131	12.9%	30,533	9.7%
Construction and surety	40,552	10.8%	27,745	8.9%
Healthcare	12,626	3.4%	10,367	3.3%
Other	15,451	4.1%	22,711	7.3%
Total	$373,672	100.0%	$313,375	100.0%

Net premiums earned (1)
Casualty	$73,686	20.8%	$57,560	16.7%
Property, marine and aviation	55,534	15.7%	33,643	9.8%
Programs	53,154	15.0%	102,496	29.7%
Professional liability	52,922	15.0%	44,619	13.0%
Executive assurance	37,149	10.5%	31,373	9.1%
Construction and surety	46,910	13.2%	41,260	12.0%
Healthcare	16,339	4.6%	12,149	3.5%
Other	18,392	5.2%	21,425	6.2%
Total	$354,086	100.0%	$344,525	100.0%

Net premiums written by client location (1)
United States and Canada	$327,754	87.7%	$303,075	96.7%
Europe	29,195	7.8%	5,890	1.9%
Other	16,723	4.5%	4,410	1.4%
Total	$373,672	100.0%	$313,375	100.0%

(1) Insurance segment results include premiums written and earned assumed through intersegment transactions of $0.7 million and $1.2 million, respectively, for the 2005 second quarter and $2.4 million and $1.9 million, respectively, for the 2004 second quarter. Insurance segment results exclude premiums written and earned ceded through intersegment transactions of $12.8 million and $14.7 million, respectively, for the 2005 second quarter and $29.8 million and $34.7 million, respectively, for the 2004 second quarter.

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

	(Unaudited)
	Six Months Ended June 30,
	2005		2004
INSURANCE SEGMENT (U.S. dollars in thousands)	Amount	% of Total	Amount	% of Total

Net premiums written (1)
Casualty	$136,301	19.6%	$116,259	18.0%
Programs	111,791	16.1%	181,977	28.2%
Property, marine and aviation	110,182	15.8%	65,523	10.1%
Professional liability	108,235	15.6%	92,882	14.4%
Construction and surety	92,594	13.2%	65,988	10.2%
Executive assurance	74,161	10.7%	58,016	9.0%
Healthcare	29,062	4.2%	23,793	3.7%
Other	33,454	4.8%	41,637	6.4%
Total	$695,780	100.0%	$646,075	100.0%

Net premiums earned (1)
Casualty	$142,953	21.2%	$112,340	16.8%
Programs	108,465	16.1%	190,567	28.5%
Property, marine and aviation	99,083	14.7%	68,355	10.2%
Professional liability	101,672	15.0%	85,246	12.8%
Construction and surety	89,689	13.3%	91,172	13.6%
Executive assurance	64,371	9.5%	62,411	9.3%
Healthcare	33,339	4.9%	23,666	3.5%
Other	35,550	5.3%	35,544	5.3%
Total	$675,122	100.0%	$669,301	100.0%

Net premiums written by client location (1)
United States and Canada	$614,296	88.3%	$627,910	97.2%
Europe	56,301	8.1%	6,885	1.1%
Other	25,183	3.6%	11,280	1.7%
Total	$695,780	100.0%	$646,075	100.0%

(1) Insurance segment results include premiums written and earned assumed through intersegment transactions of $1.5 million and $2.4 million, respectively, for the six months ended June 30, 2005 and $5.2 million and $3.5 million, respectively, for the six months ended June 30, 2004. Insurance segment results exclude premiums written and earned ceded through intersegment transactions of $26.8 million and $31.1 million, respectively, for the six months ended June 30, 2005 and $64.5 million and $68.7 million, respectively, for the six months ended June 30, 2004.

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

5. Reinsurance

In the normal course of business, the Company’s insurance subsidiaries cede a substantial portion of their premium through pro rata, excess of loss and facultative reinsurance agreements. The Company’s reinsurance subsidiaries purchase a limited amount of retrocessional coverage as part of their aggregate risk management program. In addition, the Company’s reinsurance subsidiaries participate in “common account” retrocessional arrangements for certain pro rata treaties. Such arrangements reduce the effect of individual or aggregate losses to all companies participating on such treaties, including the reinsurers, such as the Company’s reinsurance subsidiaries, and the ceding company. Reinsurance recoverables are recorded as assets, predicated on the reinsurers’ ability to meet their obligations under the reinsurance agreements. If the reinsurers are unable to satisfy their obligations under the agreements, the Company’s insurance subsidiaries would be liable for such defaulted amounts.

The following table sets forth the effects of reinsurance with unaffiliated reinsurers on the Company’s reinsurance and insurance subsidiaries:

	(Unaudited)		(Unaudited)
	Three Months Ended		Six Months Ended
	June 30,		June 30,
(U.S. dollars in thousands)	2005	2004	2005	2004

Premiums Written:
Direct	$559,357	$446,137	$1,057,682	$907,168
Assumed	381,396	370,186	863,763	918,943
Ceded	(217,025)	(138,677)	(397,916)	(264,877)
Net	$723,728	$677,646	$1,523,529	$1,561,234

Premiums Earned:
Direct	$535,780	$474,416	$1,025,591	$906,244
Assumed	401,109	388,256	792,500	793,593
Ceded	(196,997)	(139,273)	(381,131)	(268,612)
Net	$739,892	$723,399	$1,436,960	$1,431,225

Losses and Loss Adjustment Expenses Incurred:
Direct	$326,084	$304,902	$626,798	$583,700
Assumed