Table of Contents

 

 

 

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 September 30, 2012

 

Or

 

 

o

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

 

Commission file number:  001-26456

 

ARCH CAPITAL GROUP LTD.

(Exact name of registrant as specified in its charter)

 

Bermuda

(State or other jurisdiction of incorporation or organization)

 

Not Applicable

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

 

Wessex House, 5th Floor, 45 Reid Street

Hamilton HM 12, Bermuda

(Address of principal executive offices)

 

(441) 278-9250

(Registrant’s telephone number, including area code)

 

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 o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o   No x

 

The number of the registrant’s common shares (par value, $0.0033 per share) outstanding as of November 1, 2012 was 136,550,744.

 

 

 



Table of Contents

 

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

 

 

September 30, 2012 (unaudited) and December 31, 2011

 

3

 

 

 

Consolidated Statements of Income

 

 

For the three and nine month periods ended September 30, 2012 and 2011 (unaudited)

 

4

 

 

 

Consolidated Statements of Comprehensive Income

 

 

For the nine months ended ended September 30, 2012 and 2011 (unaudited)

 

5

 

 

 

Consolidated Statements of Changes in Shareholders’ Equity

 

 

For the nine months ended ended September 30, 2012 and 2011 (unaudited)

 

6

 

 

 

Consolidated Statements of Cash Flows

 

 

For the nine months ended ended September 30, 2012 and 2011 (unaudited)

 

7

 

 

 

Notes to Consolidated Financial Statements (unaudited)

 

8

 

 

 

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

 

31

 

 

 

Item 3 — Quantitative and Qualitative Disclosures About Market Risk

 

70

 

 

 

Item 4 — Controls and Procedures

 

70

 

 

 

PART II. Other Information

 

 

 

 

 

Item 1 — Legal Proceedings

 

71

 

 

 

Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds

 

71

 

 

 

Item 5 — Other Information

 

71

 

 

 

Item 6 — Exhibits

 

72

 

1



Table of Contents

 

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 (the “Company”) as of September 30, 2012, and the related consolidated statements of income for the three-month and nine-month periods ended September 30, 2012 and September 30, 2011, and the consolidated statements of comprehensive income, changes in shareholders’ equity and cash flows for the nine-month periods ended September 30, 2012 and September 30, 2011. 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 (United States), 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 previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2011, 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 29, 2012, we expressed an unqualified opinion on those consolidated financial statements.  As discussed in Note 3 to the accompanying consolidated financial statements, the Company changed its method of accounting for costs associated with acquiring or renewing insurance contracts. The accompanying December 31, 2011 consolidated balance sheet reflects this change.

 

/s/ PricewaterhouseCoopers LLP

 

New York, NY

November 9, 2012

 

2



Table of Contents

 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

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

 

 

 

(Unaudited)

 

 

 

 

 

September 30,

 

December 31,

 

 

 

2012

 

2011

 

Assets

 

 

 

 

 

Investments:

 

 

 

 

 

Fixed maturities available for sale, at fair value (amortized cost: $9,616,883 and $9,165,438)

 

$

9,944,186

 

$

9,375,604

 

Short-term investments available for sale, at fair value (amortized cost: $840,457 and $909,121)

 

845,158

 

904,219

 

Investment of funds received under securities lending, at fair value (amortized cost: $25,651 and $48,577)

 

26,279

 

48,419

 

Equity securities available for sale, at fair value (cost: $297,506 and $299,058)

 

312,371

 

299,584

 

Other investments available for sale, at fair value (cost: $455,149 and $235,381)

 

477,857

 

238,111

 

Investments accounted for using the fair value option

 

698,068

 

366,903

 

TALF investments, at fair value (amortized cost: $255,615 and $373,040)

 

270,206

 

387,702

 

Investments accounted for using the equity method

 

339,587

 

380,507

 

Total investments

 

12,913,712

 

12,001,049

 

 

 

 

 

 

 

Cash

 

422,440

 

351,699

 

Accrued investment income

 

68,069

 

70,739

 

Investment in joint venture (cost: $100,000)

 

109,363

 

107,576

 

Fixed maturities and short-term investments pledged under securities lending, at fair value

 

34,769

 

56,393

 

Premiums receivable

 

773,172

 

501,563

 

Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses

 

1,733,830

 

1,851,584

 

Contractholder receivables

 

849,352

 

748,231

 

Prepaid reinsurance premiums

 

302,513

 

265,696

 

Deferred acquisition costs, net

 

279,171

 

227,884

 

Receivable for securities sold

 

894,318

 

462,891

 

Other assets

 

509,048

 

460,052

 

Total Assets

 

$

18,889,757

 

$

17,105,357

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Reserve for losses and loss adjustment expenses

 

$

8,562,328

 

$

8,456,210

 

Unearned premiums

 

1,815,524

 

1,411,872

 

Reinsurance balances payable

 

172,016

 

133,866

 

Contractholder payables

 

849,352

 

748,231

 

Senior notes

 

300,000

 

300,000

 

Revolving credit agreement borrowings

 

100,000

 

100,000

 

TALF borrowings, at fair value (par: $186,291 and $310,868)

 

185,223

 

310,486

 

Securities lending payable

 

35,707

 

58,546

 

Payable for securities purchased

 

1,012,060

 

480,230

 

Other liabilities

 

508,753

 

513,842

 

Total Liabilities

 

13,540,963

 

12,513,283

 

 

 

 

 

 

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ Equity

 

 

 

 

 

Non-cumulative preferred shares

 

325,000

 

325,000

 

Common shares ($0.0033 par, shares issued: 167,004,690 and 164,636,338)

 

556

 

549

 

Additional paid-in capital

 

200,607

 

161,419

 

Retained earnings

 

5,351,241

 

4,796,655

 

Accumulated other comprehensive income, net of deferred income tax

 

324,132

 

153,923

 

Common shares held in treasury, at cost (shares: 30,464,512 and 30,277,993)

 

(852,742

)

(845,472

)

Total Shareholders’ Equity

 

5,348,794

 

4,592,074

 

Total Liabilities and Shareholders’ Equity

 

$

18,889,757

 

$

17,105,357

 

 

See Notes to Consolidated Financial Statements

 

3



Table of Contents

 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

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

 

 

 

(Unaudited)

 

(Unaudited)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Revenues

 

 

 

 

 

 

 

 

 

Net premiums written

 

$

 

755,249

 

$

691,381

 

$

2,439,093

 

$

2,162,202

 

Change in unearned premiums

 

(6,558

)

(9,332

)

(283,434

)

(203,579

)

Net premiums earned

 

748,691

 

682,049

 

2,155,659

 

1,958,623

 

Net investment income

 

73,221

 

82,753

 

221,126

 

257,731

 

Net realized gains

 

60,391

 

30,199

 

139,379

 

96,104

 

 

 

 

 

 

 

 

 

 

 

Other-than-temporary impairment losses

 

(2,644

)

(5,180

)

(6,129

)

(10,407

)

Less investment impairments recognized in other comprehensive income, before taxes

 

265

 

2,441

 

776

 

3,304

 

Net impairment losses recognized in earnings

 

(2,379

)

(2,739

)

(5,353

)

(7,103

)

 

 

 

 

 

 

 

 

 

 

Fee income

 

1,077

 

848

 

2,426

 

2,447

 

Equity in net income (loss) of investment funds accounted for using the equity method

 

24,330

 

(30,549

)

56,943

 

5,097

 

Other income (loss)

 

(532

)

2,432

 

(7,905

)

2,734

 

Total revenues

 

904,799

 

764,993

 

2,562,275

 

2,315,633

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

Losses and loss adjustment expenses

 

443,871

 

423,984

 

1,238,771

 

1,349,486

 

Acquisition expenses

 

128,065

 

120,205

 

375,316

 

339,598

 

Other operating expenses

 

113,429

 

106,321

 

337,602

 

322,045

 

Interest expense

 

7,378

 

8,125

 

22,338

 

23,604

 

Net foreign exchange losses (gains)

 

16,959

 

(60,040

)

5,958

 

(4,753

)

Total expenses

 

709,702

 

598,595

 

1,979,985

 

2,029,980

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

195,097

 

166,398

 

582,290

 

285,653

 

 

 

 

 

 

 

 

 

 

 

Income tax expense (benefit)

 

5,441

 

(2,357

)

8,110

 

(5,178

)

 

 

 

 

 

 

 

 

 

 

Net income

 

189,656

 

168,755

 

574,180

 

290,831

 

 

 

 

 

 

 

 

 

 

 

Preferred dividends

 

5,484

 

6,461

 

19,594

 

19,383

 

 

 

 

 

 

 

 

 

 

 

Net income available to common shareholders

 

$

 

184,172

 

$

162,294

 

$

554,586

 

$

271,448

 

 

 

 

 

 

 

 

 

 

 

Net income per common share

 

 

 

 

 

 

 

 

 

Basic

 

$

 

1.36

 

$

1.23

 

$

4.12

 

$

2.06

 

Diluted

 

$

 

1.33

 

$

1.18

 

$

4.01

 

$

1.96

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares and common share equivalents outstanding

 

 

 

 

 

 

 

 

 

Basic

 

135,067,360

 

131,560,851

 

134,519,046

 

132,090,354

 

Diluted

 

138,696,934

 

137,140,929

 

138,235,995

 

138,542,558

 

 

See Notes to Consolidated Financial Statements

 

4



Table of Contents

 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 (U.S. dollars in thousands)

 

 

 

(Unaudited)

 

 

 

Nine Months Ended

 

 

 

September 30,

 

 

 

2012

 

2011

 

Comprehensive Income

 

 

 

 

 

Net income

 

$

574,180

 

$

290,831

 

Other comprehensive income, net of deferred income tax

 

 

 

 

 

Unrealized appreciation in value of investments:

 

 

 

 

 

Unrealized holding gains arising during period

 

277,656

 

53,371

 

Portion of other-than-temporary impairment losses recognized in other comprehensive income, net of deferred income tax

 

(776

)

(3,303

)

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

 

(118,714

)

(98,565

)

Foreign currency translation adjustments, net of deferred income tax

 

12,043

 

(9,430

)

Other comprehensive income

 

170,209

 

(57,927

)

Comprehensive Income

 

$

744,389

 

$

232,904

 

 

See Notes to Consolidated Financial Statements

 

5



Table of Contents

 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

 (U.S. dollars in thousands)

 

 

 

(Unaudited)

 

 

 

Nine Months Ended

 

 

 

September 30,

 

 

 

2012

 

2011

 

Non-Cumulative Preferred Shares

 

 

 

 

 

Balance at beginning of year

 

$

325,000

 

$

325,000

 

Shares issued - Series C

 

325,000

 

 

Shares repurchased - Series A and B

 

(325,000

)

 

Balance at end of period

 

325,000

 

325,000

 

 

 

 

 

 

 

Common Shares

 

 

 

 

 

Balance at beginning of year

 

549

 

534

 

Common shares issued, net

 

7

 

10

 

Balance at end of period

 

556

 

544

 

 

 

 

 

 

 

Additional Paid-in Capital

 

 

 

 

 

Balance at beginning of year

 

161,419

 

110,325

 

Common shares issued, net

 

4,561

 

3,910

 

Issue costs on Series C preferred shares

 

(9,398

)

 

Exercise of stock options

 

7,619

 

9,379

 

Amortization of share-based compensation

 

34,659

 

25,286

 

Other

 

1,747

 

1,982

 

Balance at end of period

 

200,607

 

150,882

 

 

 

 

 

 

 

Retained Earnings

 

 

 

 

 

Balance at beginning of year

 

4,796,655

 

4,422,553

 

Cumulative effect of adjustment resulting from adoption of new accounting guidance (1)

 

 

(36,217

)

Balance at beginning of year, as adjusted

 

4,796,655

 

4,386,336

 

Dividends declared on preferred shares

 

(19,594

)

(19,383

)

Net income

 

574,180

 

290,831

 

Balance at end of period

 

5,351,241

 

4,657,784

 

 

 

 

 

 

 

Accumulated Other Comprehensive Income

 

 

 

 

 

Balance at beginning of year

 

153,923

 

204,503

 

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

 

158,942

 

(45,194

)

Portion of other-than-temporary impairment losses recognized in other comprehensive income, net of deferred income tax

 

(776

)

(3,303

)

Foreign currency translation adjustments, net of deferred income tax

 

12,043

 

(9,430

)

Balance at end of period

 

324,132

 

146,576

 

 

 

 

 

 

 

Common Shares Held in Treasury, at Cost

 

 

 

 

 

Balance at beginning of year

 

(845,472

)

(549,912

)

Shares repurchased for treasury

 

(7,270

)

(294,975

)

Balance at end of period

 

(852,742

)

(844,887

)

 

 

 

 

 

 

Total Shareholders’ Equity

 

$

5,348,794

 

$

4,435,899

 

 


(1) Adoption of accounting guidance regarding costs incurred that can be capitalized by insurance entities.

 

See Notes to Consolidated Financial Statements

 

6



Table of Contents

 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(U.S. dollars in thousands)

 

 

 

(Unaudited)

 

 

 

Nine Months Ended

 

 

 

September 30,

 

 

 

2012

 

2011

 

Operating Activities

 

 

 

 

 

Net income

 

$

574,180

 

$

290,831

 

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

 

 

 

 

 

Net realized gains

 

(142,703

)

(100,982

)

Net impairment losses recognized in earnings

 

5,353

 

7,103

 

Equity in net income or loss of investment funds accounted for using the equity method and other income or loss

 

(37,318

)

50,324

 

Share-based compensation

 

34,659

 

25,286

 

Changes in:

 

 

 

 

 

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

 

180,016

 

334,620

 

Unearned premiums, net of prepaid reinsurance premiums

 

283,433

 

204,042

 

Premiums receivable

 

(204,854

)

(114,044

)

Deferred acquisition costs, net

 

(51,222

)

(26,082

)

Reinsurance balances payable

 

19,171

 

(3,381

)

Other liabilities

 

21,664

 

12,678

 

Other items, net

 

49,572

 

76,076

 

Net Cash Provided By Operating Activities

 

731,951

 

756,471

 

 

 

 

 

 

 

Investing Activities

 

 

 

 

 

Purchases of:

 

 

 

 

 

Fixed maturity investments

 

(12,670,073

)

(10,116,781

)

Equity securities

 

(215,921

)

(343,062

)

Other investments

 

(700,308

)

(373,814

)

Proceeds from the sales of:

 

 

 

 

 

Fixed maturity investments

 

11,522,538

 

8,855,624

 

Equity securities

 

264,417

 

311,117

 

Other investments

 

329,093

 

396,514

 

Proceeds from redemptions and maturities of fixed maturity investments

 

867,080

 

738,081

 

Net sales of short-term investments

 

72,139

 

112,465

 

Change in investment of securities lending collateral

 

22,840

 

3,325

 

Purchase of business, net of cash acquired

 

28,948

 

 

Purchases of furniture, equipment and other assets

 

(13,894

)

(15,526

)

Net Cash Used For Investing Activities

 

(493,141

)

(432,057

)

 

 

 

 

 

 

Financing Activities

 

 

 

 

 

Proceeds from issuance of Series C preferred shares, net

 

315,763

 

 

Repurchase of Series A and B preferred shares

 

(325,000

)

 

Purchases of common shares under share repurchase program

 

 

(287,558

)

Proceeds from common shares issued, net

 

1,604

 

3,087

 

Repayments of borrowings

 

(124,577

)

(11,839

)

Change in securities lending collateral

 

(22,840

)

(3,325

)

Other

 

4,479

 

3,999

 

Preferred dividends paid

 

(22,897

)

(19,383

)

Net Cash Used For Financing Activities

 

(173,468

)

(315,019

)

 

 

 

 

 

 

Effects of exchange rate changes on foreign currency cash

 

5,399

 

(2,240

)

 

 

 

 

 

 

Increase in cash

 

70,741

 

7,155

 

Cash beginning of year

 

351,699

 

362,740

 

Cash end of period

 

$

422,440

 

$

369,895

 

 

See Notes to Consolidated Financial Statements

 

7



Table of Contents

 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

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 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 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, 2011, 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, shareholders’ equity or cash flows. Tabular amounts are in U.S. Dollars in thousands, except share amounts, unless otherwise noted.

 

2.                    Share Transactions

 

Share Repurchases

 

The board of directors of ACGL has authorized the investment in ACGL’s common shares through a share repurchase program. Repurchases under the program may be effected from time to time in open market or privately negotiated transactions through December 2012. Since the inception of the share repurchase program, ACGL has repurchased approximately 104.8 million common shares for an aggregate purchase price of $2.56 billion. During the 2012 periods, ACGL did not repurchase any common shares, compared to 0.7 million common shares for an aggregate purchase price of $20.8 million during the 2011 third quarter and 9.6 million common shares for an aggregate purchase price of $287.6 during the nine months ended September 30, 2011. At September 30, 2012, $942.0 million of share repurchases were available under the program. 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.

 

Preferred Share Offering

 

On April 2, 2012, the Company completed the underwritten public offering of $325 million of its 6.75% Series C non-cumulative preferred shares. Except in specified circumstances relating to certain tax or corporate events, the Series C non-cumulative preferred shares are not redeemable prior to April 2, 2017. The net proceeds from the offering of approximately $316 million and other available funds were used to redeem all of the Company’s $200 million of 8.0% Series A preferred shares and $125 million of 7.875% Series B preferred shares on May 2, 2012. The preferred shares were redeemed at a redemption price equal to $25.00 per share, plus all declared and unpaid dividends to (but excluding) the redemption date.

 

8



Table of Contents

 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

3.                   Recent Accounting Pronouncements

 

Effective January 1, 2012, the Company adopted an Accounting Standards Update (“ASU”) issued by the Financial Accounting Standards Board (“FASB”) concerning the accounting for costs associated with acquiring or renewing insurance contracts. This guidance was adopted retrospectively and has been applied to all prior period financial information contained in these consolidated financial statements. The impact of the adoption of the new guidance on the consolidated financial statements was as follows:

 

 

 

As Previously

 

Effect of

 

As Currently

 

 

 

Reported

 

Change

 

Reported

 

 

 

 

 

 

 

 

 

December 31, 2010

 

 

 

 

 

 

 

Deferred acquisition costs, net

 

$

277,861

 

$

(50,583

)

$

227,278

 

Other assets (1)

 

475,911

 

14,366

 

490,277

 

Retained earnings

 

4,422,553

 

(36,217

)

4,386,336

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 2011

 

 

 

 

 

 

 

Other operating expenses

 

$

105,998

 

$

323

 

$

106,321

 

Income tax benefit

 

(2,267

)

(90

)

(2,357

)

Net income

 

168,988

 

(233

)

168,755

 

 

 

 

 

 

 

 

 

Net income per common share - basic

 

$

1.24

 

$

(0.01

)

$

1.23

 

Net income per common share - diluted

 

$

1.19

 

$

(0.01

)

$

1.18

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2011

 

 

 

 

 

 

 

Other operating expenses

 

$

318,981

 

$

3,064

 

$

322,045

 

Income tax benefit

 

(4,369

)

(809

)

(5,178

)

Net income

 

293,086

 

(2,255

)

290,831

 

 

 

 

 

 

 

 

 

Net income per common share - basic

 

$

2.07

 

$

(0.01

)

$

2.06

 

Net income per common share - diluted

 

$

1.98

 

$

(0.02

)

$

1.96

 

 


(1) Effect of change equals tax benefit included in “other assets” on the Company’s balance sheet.

 

9



Table of Contents

 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Effective January 1, 2012, the Company prospectively adopted an ASU that provides clarification or changes to existing fair value measurement and disclosure requirements, including, for example, additional disclosure for fair value measurements categorized within Level 3 of the fair value hierarchy. See Note 8, “Fair Value,” for the Company’s disclosures on fair value.

 

Effective January 1, 2012, the Company adopted an ASU that is intended to increase the prominence of other comprehensive income in the financial statements by allowing only two options for reporting comprehensive income: (1) A single statement that presents the components of net income and total net income, the components of other comprehensive income and total other comprehensive income, and a total for comprehensive income or (2) in a two-statement approach that presents the components of net income and total net income in the first statement. That statement must be immediately followed by a financial statement that presents the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. The adoption of this ASU did not impact the presentation of the Company’s consolidated financial statements.

 

In December 2011, the FASB issued an ASU that expands the required disclosures about financial instruments and derivative instruments that are either offset for balance sheet presentation purposes or subject to an enforceable master netting arrangement or similar arrangement, regardless of whether they are offset for balance sheet presentation purposes. This ASU is effective for periods beginning on or after January 1, 2013. This new guidance is disclosure-related only and does not amend existing guidance on offsetting on the balance sheet. As such, the Company does not believe that the adoption of this ASU will impact the presentation of its consolidated financial statements.

 

4.                   Commitments and Contingencies

 

Letter of Credit and Revolving Credit Facilities

 

As of September 30, 2012, the Company had a $300 million unsecured revolving loan and letter of credit facility and a $500 million secured letter of credit facility (the “Credit Agreement”). The Credit Agreement expires on August 18, 2014. In addition, the Company had access to secured letter of credit facilities of approximately $81 million as of September 30, 2012, which are available on a limited basis and for limited purposes (together with the secured portion of the Credit Agreement and these letter of credit facilities, the “LOC Facilities”). At September 30, 2012, the Company had $444.8 million in outstanding letters of credit under the LOC Facilities, which were secured by investments with a fair value of $518.7 million, and had $100.0 million of borrowings outstanding under the Credit Agreement. The Company was in compliance with all covenants contained in the LOC Facilities at September 30, 2012.

 

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 $528.0 million at September 30, 2012.

 

10



Table of Contents

 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

5.                   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,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income

 

$

189,656

 

$

168,755

 

$

574,180

 

$

290,831

 

Preferred dividends

 

(5,484

)

(6,461

)

(19,594

)

(19,383

)

Net income available to common shareholders

 

$

184,172

 

$

162,294

 

$

554,586

 

$

271,448

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding — basic

 

135,067,360

 

131,560,851

 

134,519,046

 

132,090,354

 

Effect of dilutive common share equivalents:

 

 

 

 

 

 

 

 

 

Nonvested restricted shares

 

723,538

 

750,289

 

847,959

 

952,898

 

Stock options (1)

 

2,906,036

 

4,829,789

 

2,868,990

 

5,499,306

 

Weighted average common shares and common share equivalents outstanding — diluted

 

138,696,934

 

137,140,929

 

138,235,995

 

138,542,558

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

1.36

 

$

1.23

 

$

4.12

 

$

2.06

 

Diluted

 

$

1.33

 

$

1.18

 

$

4.01

 

$

1.96

 

 


(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 2012 third quarter and 2011 third quarter, the number of stock options excluded were 621,556 and 698,912, respectively. For the nine months ended September 30, 2012 and 2011, the number of stock options excluded were 860,088 and 385,444, respectively.

 

11



Table of Contents

 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

6.                   Segment Information

 

The following table summarizes the Company’s underwriting income or loss by segment, together with a reconciliation of underwriting income or loss to net income available to common shareholders:

 

 

 

Three Months Ended

 

Three Months Ended

 

 

 

September 30, 2012

 

September 30, 2011

 

 

 

Insurance

 

Reinsurance

 

Total

 

Insurance

 

Reinsurance

 

Total

 

Gross premiums written (1)

 

$

658,599

 

$

279,751

 

$

936,764

 

$

634,280

 

$

227,837

 

$

860,289

 

Net premiums written

 

483,356

 

271,893

 

755,249

 

472,986

 

218,395

 

691,381

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net premiums earned

 

$

456,341

 

$

292,350

 

$

748,691

 

$

437,970

 

$

244,079

 

$

682,049

 

Fee income

 

645

 

432

 

1,077

 

661

 

187

 

848

 

Losses and loss adjustment expenses

 

(307,155

)

(136,716

)

(443,871

)

(290,608

)

(133,376

)

(423,984

)

Acquisition expenses, net

 

(73,663

)

(54,402

)

(128,065

)

(76,763

)

(43,442

)

(120,205

)

Other operating expenses

 

(75,379

)

(29,001

)

(104,380

)

(77,801

)

(22,340

)

(100,141

)

Underwriting income (loss)

 

$

789

 

$

72,663

 

73,452

 

$

(6,541

)

$

45,108

 

38,567

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net investment income

 

 

 

 

 

73,221

 

 

 

 

 

82,753

 

Net realized gains

 

 

 

 

 

60,391

 

 

 

 

 

30,199

 

Net impairment losses recognized in earnings

 

 

 

 

 

(2,379

)

 

 

 

 

(2,739

)

Equity in net income (loss) of investment funds accounted for using the equity method

 

 

 

 

 

24,330

 

 

 

 

 

(30,549

)

Other income (loss)

 

 

 

 

 

(532

)

 

 

 

 

2,432

 

Other expenses

 

 

 

 

 

(9,049

)

 

 

 

 

(6,180

)

Interest expense

 

 

 

 

 

(7,378

)

 

 

 

 

(8,125

)

Net foreign exchange gains (losses)

 

 

 

 

 

(16,959

)

 

 

 

 

60,040

 

Income before income taxes

 

 

 

 

 

195,097

 

 

 

 

 

166,398

 

Income tax (expense) benefit

 

 

 

 

 

(5,441

)

 

 

 

 

2,357

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

189,656

 

 

 

 

 

168,755

 

Preferred dividends

 

 

 

 

 

(5,484

)

 

 

 

 

(6,461

)

Net income available to common shareholders

 

 

 

 

 

$

184,172

 

 

 

 

 

$

162,294

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Underwriting Ratios

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss ratio

 

67.3

%

46.8

%

59.3

%

66.4

%

54.6

%

62.2

%

Acquisition expense ratio (2)

 

16.0

%

18.6

%

17.0

%

17.4

%

17.8

%

17.5

%

Other operating expense ratio

 

16.5

%

9.9

%

13.9

%

17.8

%

9.2

%

14.7

%

Combined ratio

 

99.8

%

75.3

%

90.2

%

101.6

%

81.6

%

94.4

%

 


(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.

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

 

12



Table of Contents

 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

The following table summarizes the Company’s underwriting income or loss by segment, together with a reconciliation of underwriting income or loss to net income available to common shareholders, for the nine months ended September 30, 2012 and 2011:

 

 

 

Nine Months Ended

 

Nine Months Ended

 

 

 

September 30, 2012

 

September 30, 2011

 

 

 

Insurance

 

Reinsurance

 

Total

 

Insurance

 

Reinsurance

 

Total

 

Gross premiums written (1)

 

$

2,022,802

 

$

1,036,708

 

$

3,055,233

 

$

1,903,868

 

$

836,616

 

$

2,736,794

 

Net premiums written

 

1,438,620

 

1,000,473

 

2,439,093

 

1,360,540

 

801,662

 

2,162,202

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net premiums earned

 

$

1,344,675

 

$

810,984

 

$

2,155,659

 

$

1,256,380

 

$

702,243

 

$

1,958,623

 

Fee income

 

1,803

 

623

 

2,426

 

2,141

 

306

 

2,447

 

Losses and loss adjustment expenses

 

(900,735

)

(338,036

)

(1,238,771

)

(889,973

)

(459,513

)

(1,349,486

)

Acquisition expenses, net

 

(223,591

)

(151,725

)

(375,316

)

(204,721

)

(134,877

)

(339,598

)

Other operating expenses

 

(225,366

)

(84,264

)

(309,630

)

(230,204

)

(67,238

)

(297,442

)

Underwriting income (loss)

 

$

(3,214

)

$

237,582

 

234,368

 

$

(66,377

)

$

40,921

 

(25,456

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net investment income

 

 

 

 

 

221,126

 

 

 

 

 

257,731

 

Net realized gains

 

 

 

 

 

139,379

 

 

 

 

 

96,104

 

Net impairment losses recognized in earnings

 

 

 

 

 

(5,353

)

 

 

 

 

(7,103

)

Equity in net income of investment funds accounted for using the equity method

 

 

 

 

 

56,943

 

 

 

 

 

5,097

 

Other income (loss)

 

 

 

 

 

(7,905

)

 

 

 

 

2,734

 

Other expenses

 

 

 

 

 

(27,972

)

 

 

 

 

(24,603

)

Interest expense

 

 

 

 

 

(22,338

)

 

 

 

 

(23,604

)

Net foreign exchange gains (losses)

 

 

 

 

 

(5,958

)

 

 

 

 

4,753

 

Income before income taxes

 

 

 

 

 

582,290

 

 

 

 

 

285,653

 

Income tax (expense) benefit

 

 

 

 

 

(8,110

)

 

 

 

 

5,178

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

574,180

 

 

 

 

 

290,831

 

Preferred dividends

 

 

 

 

 

(19,594

)

 

 

 

 

(19,383

)

Net income available to common shareholders

 

 

 

 

 

$

554,586

 

 

 

 

 

$

271,448

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Underwriting Ratios

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss ratio

 

67.0

%

41.7

%

57.5

%

70.8

%

65.4

%

68.9

%

Acquisition expense ratio (2)

 

16.5

%

18.7

%

17.3

%

16.1

%

19.2

%

17.2

%

Other operating expense ratio

 

16.8

%

10.4

%

14.4

%

18.3

%

9.6

%

15.2

%

Combined ratio

 

100.3

%

70.8

%

89.2

%

105.2

%

94.2

%

101.3

%

 


(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.

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

 

13



Table of Contents

 

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 investments classified as available for sale:

 

 

 

Estimated

 

Gross

 

Gross

 

Cost or

 

OTTI

 

 

 

Fair

 

Unrealized

 

Unrealized

 

Amortized

 

Unrealized

 

 

 

Value

 

Gains

 

Losses

 

Cost

 

Losses (2)

 

At September 30, 2012

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities and fixed maturities pledged under securities lending agreements (1):

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

$

2,707,999

 

$

113,295

 

$

(7,039

)

$

2,601,743

 

$

(113

)

Mortgage backed securities

 

1,873,874

 

42,374

 

(7,439

)

1,838,939

 

(9,342

)

Municipal bonds

 

1,579,872

 

74,558

 

(730

)

1,506,044

 

(17

)

Commercial mortgage backed securities

 

824,162

 

42,745

 

(1,838

)

783,255

 

(3,498

)

U.S. government and government agencies

 

1,131,358

 

28,015

 

(1,520

)

1,104,863

 

(19

)

Non-U.S. government securities

 

1,026,432

 

37,927

 

(11,193

)

999,698

 

 

Asset backed securities

 

835,258

 

25,400

 

(6,093

)

815,951

 

(3,459

)

Total

 

9,978,955

 

364,314

 

(35,852

)

9,650,493

 

(16,448

)

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

312,371

 

29,744

 

(14,879

)

297,506

 

 

Other investments

 

477,857

 

24,737

 

(2,029

)

455,149

 

 

Short-term investments

 

845,158

 

5,439

 

(738

)

840,457

 

 

Total

 

$

11,614,341

 

$

424,234

 

$

(53,498

)

$

11,243,605

 

$

(16,448

)

 

 

 

 

 

 

 

 

 

 

 

 

At December 31, 2011

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities and fixed maturities pledged under securities lending agreements (1):

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

$

2,596,118

 

$

79,407

 

$

(29,922

)

$

2,546,633

 

$

(1,138

)

Mortgage backed securities

 

1,592,762

 

27,633

 

(23,226

)

1,588,355

 

(20,466

)

Municipal bonds

 

1,430,565

 

77,977

 

(886

)

1,353,474

 

(105

)

Commercial mortgage backed securities

 

1,046,326

 

28,780

 

(2,904

)

1,020,450

 

(3,259

)

U.S. government and government agencies

 

1,451,993

 

34,811

 

(3

)

1,417,185

 

(207

)

Non-U.S. government securities

 

737,477

 

33,486

 

(17,684

)

721,675

 

 

Asset backed securities

 

576,757

 

14,649

 

(10,078

)

572,186

 

(3,876

)

Total

 

9,431,998

 

296,743

 

(84,703

)

9,219,958

 

(29,051

)

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

299,584

 

22,870

 

(22,344

)

299,058

 

 

Other investments

 

238,111

 

8,340

 

(5,610

)

235,381

 

 

Short-term investments

 

904,219

 

390

 

(5,292

)

909,121

 

 

Total

 

$

10,873,912

 

$

328,343

 

$

(117,949

)

$

10,663,518

 

$

(29,051

)

 


(1)         In securities lending transactions, the Company receives collateral in excess of the fair value of the fixed maturities and short-term investments pledged. For purposes of this table, the Company has excluded the collateral received and reinvested and included the fixed maturities and short-term investments pledged. See “—Securities Lending Agreements.”

(2)         Represents the total other-than-temporary impairments (“OTTI”) recognized in accumulated other comprehensive income (“AOCI”). It does not include the change in fair value subsequent to the impairment measurement date. At September 30, 2012, the net unrealized gain related to securities for which a non-credit OTTI was recognized in AOCI was $1.1 million, compared to a net unrealized loss of $18.0 million at December 31, 2011.

 

14



Table of Contents

 

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

 

Gross

 

Estimated

 

Gross

 

Estimated

 

Gross

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

 

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

 

At September 30, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities and fixed maturities pledged under securities lending agreements (1):

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

$

199,075

 

$

(2,673

)

$

67,200

 

$

(4,366

)

$

266,275

 

$

(7,039

)

Mortgage backed securities

 

280,362

 

(5,268

)

42,033

 

(2,171

)

322,395

 

(7,439

)

Municipal bonds

 

46,307

 

(248

)

9,802

 

(482

)

56,109

 

(730

)

Commercial mortgage backed securities

 

9,901

 

(451

)

14,632

 

(1,387

)

24,533

 

(1,838

)

U.S. government and government agencies

 

123,700

 

(1,520

)

 

 

123,700

 

(1,520

)

Non-U.S. government securities

 

153,052

 

(1,103

)

126,123

 

(10,090

)

279,175

 

(11,193

)

Asset backed securities

 

27,932

 

(71

)

90,149

 

(6,022

)

118,081

 

(6,093

)

Total

 

840,329

 

(11,334

)

349,939

 

(24,518

)

1,190,268

 

(35,852

)

Equity securities

 

60,326

 

(5,985

)

43,562

 

(8,894

)

103,888

 

(14,879

)

Other investments

 

56,778

 

(1,027

)

27,539

 

(1,002

)

84,317

 

(2,029

)

Short-term investments

 

80,420

 

(738

)

 

 

80,420

 

(738

)

Total

 

$

1,037,853

 

$

(19,084

)

$

421,040

 

$

(34,414

)

$

1,458,893

 

$

(53,498

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At December 31, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

Fixed maturities and fixed maturities pledged under securities lending agreements (1):

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

$

781,635

 

$

(24,977

)

$

47,687

 

$

(4,945

)

$

829,322

 

$

(29,922

)

Mortgage backed securities

 

255,101

 

(11,988

)

44,606

 

(11,238

)

299,707

 

(23,226

)

Municipal bonds

 

39,156

 

(537

)

14,988

 

(349

)

54,144

 

(886

)

Commercial mortgage backed securities

 

87,796

 

(1,676

)

14,582

 

(1,228

)

102,378

 

(2,904

)

U.S. government and government agencies

 

7,059

 

(3

)

 

 

7,059

 

(3

)

Non-U.S. government securities

 

310,182

 

(16,139

)

20,482

 

(1,545

)

330,664

 

(17,684

)

Asset backed securities

 

260,647

 

(8,197

)

7,317

 

(1,881

)

267,964

 

(10,078

)

Total

 

1,741,576

 

(63,517

)

149,662

 

(21,186

)

1,891,238

 

(84,703

)

Equity securities

 

130,045

 

(22,039

)

1,923

 

(305

)

131,968

 

(22,344

)

Other investments

 

98,605

 

(3,053

)

22,443

 

(2,557

)

121,048

 

(5,610

)

Short-term investments

 

189,100

 

(5,292

)

 

 

189,100

 

(5,292

)

Total

 

$

2,159,326

 

$

(93,901

)

$

174,028

 

$

(24,048

)

$

2,333,354

 

$

(117,949

)

 


(1)         In securities lending transactions, the Company receives collateral in excess of the fair value of the fixed maturities and short-term investments pledged. For purposes of this table, the Company has excluded the collateral received and reinvested and included the fixed maturities and short-term investments pledged. See “—Securities Lending Agreements.”

 

15



Table of Contents

 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

At September 30, 2012, on a lot level basis, approximately 590 security lots out of a total of approximately 4,440 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 $3.1 million. At December 31, 2011, on a lot level basis, approximately 1,150 security lots out of a total of approximately 4,520 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 $3.0 million.

 

The contractual maturities of the Company’s fixed maturities and fixed maturities pledged under securities lending agreements 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, 2012

 

December 31, 2011

 

 

 

Estimated

 

Amortized

 

Estimated

 

Amortized

 

Maturity

 

Fair Value

 

Cost

 

Fair Value

 

Cost

 

Due in one year or less

 

$

471,678

 

$

462,425

 

$

486,986

 

$

476,734

 

Due after one year through five years

 

3,664,256

 

3,556,156

 

2,850,578

 

2,793,982

 

Due after five years through 10 years

 

2,083,013

 

1,978,601

 

2,532,834